Living Economics: Yesterday, Today, and Tomorrow - by Peter J. Boettke

The core idea in the "mainline" approach to economics is that there are two fundamental observations of commercial society: (1) individual pursuit of their self-interest, and (2) complex social order that aligns individual interests with the general interest. In the mainline of economics, the "invisible hand postulate" reconciles self-interest with the general interest not by collapsing one to the other or by assuming super-human cognitive capabilities among the actors, but through the reconciliation process of exchange within specific institutional environments. It is the "higgling and bargaining" within the market economy, as Adam Smith argues, that produces social order. The "invisible hand" solution does not emerge because the mainline economist postulates a perfectly rational individual interacting with other perfectly rational individuals within a perfectly structured market, as many critics suppose. Such idealizations would be as alien to Adam Smith as they would be to F.A. Hayek. Instead, for those who "sit in the seat of Adam Smith" man is a very imperfect being operating within a very imperfect world. Sound economic reasoning, by focusing on exchange, and the institutions within which exchange takes place, explains how complex social order emerges through the aid of prices and the entrepreneurial market process.

The mainline of economics, in my narrative, is to be contrasted with the "mainstream" of economic thought. Mainline is defined by a set of positive propositions about social order that were held in common from Adam Smith onward, but mainstream economics is a sociological concept related to what is currently fashionable among the scientific elite of the profession. Often the mainline and the mainstream dovetail, but at other times they deviate from one another. It is at these moments of deviation that acts of intellectual entrepreneurship are acutely needed by those working within the mainline of economics to recapture the imagination of mainstream economies, getting the discipline back on track.

What Adam Smith Did Not Say, and What He Did Say

A new generation of scholars such as Emma Rothchild and Sam Fleischacker are battling to save Smith's legacy from the Adam Smith tie-wearing conservative policy community. Stressing the human and egalitarian sides of Smith's theory, they seek to counter the reading of Smith that focuses exclusively on self-interest and market efficiency. This caricature of Smith, as this egalitarian and progressive reading of Smith points out, is false. Smith never said "Greed works" and that is that. His argument is much different. But the Smith of Rothchild and Fleischacker is also a confused caricature. Smith was not an egalitarian social democrat. He was an analytical egalitarian, but he was also a classical liberal political economist. In Smith's The Wealth of Nations, the scale and scope of government is limited. While not nonexistent, it is limited to basically the "night watchman" state of classical liberal political philosophy: protections from foreign aggressors, protection of person and property and the administration of justice domestically, and the provision of essential public works. Only a distorted reading of Smith could produce either the institutionally antiseptic "self interest"-only interpretation, or the Smith as precursor of the modern social democratic welfare state. The more modern social democratic reading of Smith is a consequence of the caricature prevalent in our culture of the "self-interest" reading as that of the laissez-faire economists in general. To distance Smith from the "economists," they offer an interpretation that is more compassionate to the poor and the dispossessed.

The Wealth of Nations is about social order among strangers--a social order in which our span of moral sympathy moves far beyond the realm of the familiar. "In civilized society," Smith argued, man "stands at all times in need of the co-operation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons." The source of the wealth of nations arises from social cooperation under the division of labor, and to realize this social cooperation certain fundamental institutions in society must be in place--the delineation and enforcement of private property, the keeping of promises through contract, and the acceptance of the legitimacy of the transfer of property by consent. Benevolence would not be able to achieve this social cooperation under the division of labor. The relationships exist at the outer bounds of our span of moral sympathy. But when the institutions of property, contract, and consent are in place, then the self-interest of individuals can be marshaled to realize the mutual gains from trade and the benefits of every refined division of labor in society.

Smith certainly did not teach that individuals should pursue their self-interest at all costs. But he also didn't even teach the more subtle presentation that the pursuit of self-interest will automatically translate into public benefits. Smith's analysis does not turn on the behavioral postulate of self-interest but instead on the institutional specifications that are in operation. The institutional specification of a private property market economy guided by price signals and disciplined by profit and loss accounting will steer self-interested behavior in the direction of social cooperation. This is just another way to state Smith's "invisible hand" proposition. Individuals pursuing their own self-interest within an institutional setting of property, contract, and consent will produce an overall order that, although not of their intention, enhances the public good. Absent that institutional setting, self-interest may very well not produce publicly desirable outcomes and, in fact, may produce the opposite.

Hayek has argued that Smith designed his political economy to be robust against both the stupidity and arrogance of actors within the system. Smith and his contemporaries (e.g., Hume) sought to discover a system of governance in which bad men can do the least harm and which did not require for its operation that only the best and the brightest be in charge. They sought, in other words, a system of social governance that treated men as they are--sometimes good, sometimes bad; sometimes intelligent, sometimes not so bright--and that would use their human variety to produce peace and prosperity.

What Should Economists Do?

The economist looking out into the world of a commercial society is immediately struck with two primordial facts: individuals pursure their self-interest, and modern commercial society with its vast division of labor is orderly. It is not from the benevolence of the butcher, the baker, and the brewer that we get our dinner; despite the disparate purposes being pursued by economic actors in the market, "Paris gets fed." In short, the first task of the economist is to explain how these two facts of commercial life--self-interest, and social order--are consistent with one another. If one cannot explain the consistency, then one has failed in the first task of being an economist.

Not only must the invisible hand or "spontaneous order" proposition be understood, but it has to be understood in a dynamic, rather than static, sense if it is going to be helpful. We must not understand the overall order in the economy as if a benevolent social planner is choosing the optimal allocation of resourcces for society. Instead, the order we are trying to understand is the composite outcome of a multitude of individuals each striving to realize their plans, often in conflict with one another, and reconciled through the exchange process.

The central message of Buchanan's classic paper "What Should Economists Do?" is that theory of exchange and not the theory of resource allocation should take center stage in economics. The dominant allocation problem approach misleads economists into viewing the economic problem in society as one of applied mathematics that can be addressed by social engineers entrusted with the policy levers of control. But the economic problem of society is decidedly not one of allocating scarce means to obtain a defined end. When elementary economics is taught in this optimal allocation manner, the message is easily communicated to students that someone or some group must be in charge at the levers of social control and manage the economic system.

"Efficiency" is not the goal or purpose of the market. The market economy itself does not possess a teleology, though the individuals participating in the market have their own purposes and plans they are striving to achieve. As Buchanan stresses: "The 'market' or market organization is not a means toward the accomplishment of anything. It is, instead, the institutional embodiment of the voluntary exchange processes that are entered into by individuals in their several capacities.

Buchanan puts great emphasis on the economist's role as student of society and teacher of basic principles of economics. The task of the economist and political economist is never conceived as that of the social engineer in command of the levers of social control in the polity and over the economy. As economists we teach students (broadly defined) the basic principles of our scientific discipline so that they may in fact become informed participants within the democratic process.

Theoretical Contributions on the Problems with Socialism

Ludwig von Mises demonstrated that economic calculation within a socialist commonwealth was, strictly speaking, impossible. Absent rational economic calculation, economic production would be reduced to merely stabs in the dark. In choosing between production project A or production project B, economic planners would be left without any economic criterion in making their decision. To put this in more practical terms, imagine a socialist planner confronted with the task of deciding whether railroad track should be made of platinum or steel. Platinum is the technologically superior metal for the task of ensuring long-lasting and smooth train rides. In a capitalist economy, the market for capital goods would reflect the alternative uses of platinum and thus give the investor some guidepost by which to make the decision in terms of cost effectiveness. But under the assumptions of socialism, the market for the means of production would be abolished. Under full socialism all reference to world markets and memory of previous market allocations would be abolished. Planners would be confronted with a situation where the price system, being abolished, could no longer serve as a relative scarcity indicator that provides the necessary knowledge input into the calculation of decision makers. In short, economic criterion would be out. The inability to engage in rational economic calculation means that socialist economy is impossible.

Rothbard's discussion of why the Soviet system is not really a centrally planned one is worth quoting at length:

Moreover, it should be noted that a centrally "planned" economy is a centrally prohibited economy. The concept of "social engineering" is a deceptive metaphor, since in the social realm, it is largely people who are being planned, rather than the inanimate machinery of engineering blueprints. And since every individual is by nature, if not always by law, a self-owner and self-starter--i.e., self-energizer, this means that central orders, backed up, as they must be under socialism, by force and violence, effectively prohibit all the individuals doing what they want most or what they believe themselves to be best fitted to do.

The Soviet system was in essence a prohibition economy writ large. People within this prohibition environment still pursue their plans, but they are forced to do so in a manner that is different from what would take place in an unhampered market environment. Prohibition in the 1920s did not curtail alcohol consumption, but it did create an environment that gave rise to bathtub gin and Al Capone. Similarly, the prohibition of the market throughout Soviet Russia did not curtail market exchange--it just forced it underground.

One of the most damaging consequences of this prohibition environment for the long-term performance of the Soviet economy, Rothbard pointed out, was the detrimental impact on invention and innovation that the attempt at central planning produced. "Inventions, innovations, technological developments, by their very nature, by definition, cannot ve predicted in advance and therefore cannot be centrally and bureaucratically planned." Leaving room for the unforeseen possibilities is not in the nature of planning exercises. In a free market society, what will be invented, when it will be invented, and who will do the inventing remains hidden from us until after the fact. The central planning task, if it is to be coherent, would require knowing in advance and planning for technological innovation. Planned innovation, however, is a classic oxymoron. And once we recognize that central planning cannot plan technological innovations, the claims to economic rationalization must be abandoned completely.

Reconciling Spontaneous Order and Public Choice

A core presumption of public choice economics is that we can infer intentions from outcomes. Some critics of spontaneous order theorizing mischaracterize the position arguing that intentionality is absent from the analysis. Hayek's phraseology, some need to be reminded, was of human action though not of human design. Adam Smith, it is important to stress, did not presume that acting self-interestedly was enough to ensure a benevolent social order. On the contrary, it is self-interest that guides the statesmen to overburden himself; it is also what leads Oxford dons into not satisfying the educational demands of their students, and teachers of religious doctrine into being less zealous and hard-working in the state-supported religious sects as compared to those sects that rely solely on voluntary contributions. Self-interest also leads the businessman to conspire with his competitors to set price, and to seek out protection from foreign competitors. It is self-interest that is behind the sophistry of the merchants and the manufacturers in the quest for monopolistic status, just as it is self-interest among professors and preachers when they seek secure incomes and protection from competitors in the instruction of philosophy and religious doctrine.

Self-interest is also what drives the refinements in the division of labor, the coordinate activities of an economy guided by relative price movements, and the innovations of the entrepreneur. Self-interest is not unique to laissez-faire, but a regime of laissez-faire (within the specified institutions of natural libert or what Hume called the system of "property, contract and consent") will channel self-interest in a direction that will maximize the likelihood of a social order of peace and prosperity. When the institutions of natural liberty are absent, or government attempts to thwart their development, Smith's claim was that tyranny and poverty would result.

Tullock is not really a pessimist nor an optimist; he is instead a realist. People are what they are; politics is what it is. Markets work because they take people as they are and utilize their base motivations to illicit cooperative behavior from them. Politics, despite the rhetoric of improving mankind and ennobling him through public service, operates on the basis of self-interest no less than markets. But the institutional environment within which political choices are made is radically different from the context of private property, freedom of contract, and profit-and-loss accounting. Due to the altered structure of rewards and penalties, self-interest manifests itself differently than it does in the market economy. But it is self-interest nevertheless that drives human action, and because of that we can as political economists reasonably identify how changing the institutional structure will steer behavior in this or that direction.

Is the Only Form of "Reasonable Regulation" Self-Regulation?

Much of the history of public choice has been defined by the economic examination of politics and formal government. The work of Lin Ostrom certainly isn't blind to formal government. But the work also asks us to think more broadly about governance--the formal and informal rules of the social game that tame, harness, and check our passions, and the mechanisms of enforcement that ensure effective governance even in the most unexpected environments. How good governance actually works in situations when it shouldn't and how individuals in these societies develop the capacities necessary to be self-governing citizens are the questions this work forces us to consider.

I would argue that the first enduring lesson from Lin Ostrom's work is that individuals in their local situation are more effective at knowing the right rules and actions to avoid conflict and promote cooperation than are government officials removed from the daily life of the community. Trust in the people to craft the right rules rather than experts from afar who promise rational solution to social ills. This conclusion can be interpreted either as a caution to would-be reformers to respect local traditions and customs prior to efforts at imposing change in government structures (let's call this caution optimism), or as a sanction against all such efforts at reform from afar and an embracing of the conclusion that the only path to reform is an indigenous one (let's call this pessimistic). Ostrom would not deny the possibilities of improvements in governance coming from foreign experts, but she does stress that these reform efforts must respect the incentives that recipients of the assistance face and the nested games that are being played throughout the policy process.

Lin often pointed to Hamilton's quote from The Federalist Papers for inspiration: "whether societies of men are really capable or not of establishing good government from reflection and choice, or whether they are forever destines to depend for their political constitutions on accident and force." She is cautiously optimistic that man can establish good government through reflection and choice, and not forever be knocked about by the rough seas of history. However, it is important to stress where Ostrom found her reasons for optimism. Hope, in her writings, is not to be found in rationalistic reforms of government planners informed by the modern science of public administration, but in the "science and art of association" as practiced by a self-governing citizenry. It is people and their capacity to embrace (rather than shirk from) the troubles of thinking and the cares of living, not the machinations of politics, that give rise to hope that constitutional craftsmanship will produce a social order of peace and prosperity.

The second major lesson from Ostrom's work: In examining systems of governance, it is the "rules in use" (the lived practice of everyday life) that matter for social cooperation, not so much the "rules in form" (on the books). Ostrom's detailed studies of the management of common-pool resoures should make us think twice about the well-worn classifications of ownership rights. What she has demonstrated is not only that the "rules in use" determine practice, but that the same function of rules can be served by a diversity of forms of rules. In short, the function that private property rights has served in terms of providing incentives for accountability and responsibility in resource use has been served by a variety of community-based rule systems. These rules in use employ various methods to limit access to the resource, assign accountability to those who use it or are entrusted with its care, and establish methods of punishment for those who violate the community rules (ranging from monetary fines to social sanctions such as shaming and shunning). The work demonstrates that people are capable of devising systems of self-regulation in a variety of circumstances. We see in the varied experience of common-pool resources in Western societies as well as non-Western societies, and across historical epochs and stages of development, self-regulation systems work to discipline the passions of man and turn situations of potential conflict into a reality of social cooperation. And, since the self-regulation systems in these varied environments and across time are operating outside of the formal realm of politics, they do not face the problem of protecting against unwanted influence of politically empowered special interest groups. Governance without government can, and does, happen in the lived world in which we study as political economists, even in the least favorable of circumstances.

Economic Mindset

You can be your own teacher of economics by never taking statements as given but always scrutinizing them by asking, "Is this so?" and "Under what conditions?"--never forgetting to ask not only what the immediate effects of a policy will be, but also demanding that the long-run and indirect effects be explicitly considered. You can train your economic intuition by constantly seeking to explain the reason why the ordinary behavior you see occuring everyday. In short, to be seduced by economics proper (i.e., not scientism or a toolkit for social engineering) is to enable oneself to be amazed at the miracle of the mundane.

Entrepreneurs and the Market Process

Entrepreneurs rely on price signals to guide them in their production projects so that they are allocating scarce capital resources in the most valuable direction and employing the least costly technologies. The capital structure does not automatically replenish itself but instead requires the careful calculations of economic actors to determine which production plans are the most profitable ones to pursue. If price signals are confusing, then decisions concerning the maintenance and allocation of capital will be mistaken from the point of view of economic value maximization.

James M. Buchanan and the Rebirth of Political Economy

The basic propositions which guide Buchanan's work can be summarized neatly:

  • Economics is a "science," but it is a "philosophical" science, and the strictures against scientism offered by Knight and Friedrich Hayek should be heeded.

  • Economics is about choice and processes of adjustment, not states of rest. Equilibrium models are only useful when we recognize their limits.

  • Economics is about exchange, not about maximizing. Exchange and arbitrage should be the central focus of economic analysis.

  • Economics is about individual actors, not collective entities. Only individuals choose.

  • Economics is about a game played within rules.

  • Economics cannot be studied properly outside of politics. The choices among different rules of the game cannot be ignored.

  • The most important function of economics as a discipline is its didactic role in explaining the principle of spontaneous order.

  • Economics is elementary.

Finally, it is important to recognize the methodological schema that Buchanan employs to address questions in political economy and how this scheme allows him to weave these eight propositions into a coherent framework for social theory. Buchanan emphasizes that we must distinguish between pre- and postconstitutional levels of analysis. Preconstitutional analysis concerns the rules of the game, while postconstitutional analysis examines the strategies players adopt within a set of defined rules. Political economy, properly understood, involves moving back and forth between these two levels. Successful application of modern political economy to the world of public policy demands a constitutional perspective. In this regard, Buchanan introduces the vital distincition between "policy within politics" and systematic changes in the rules of the game. Lasting reform results not from policy changes within the existing rules but rather from changing the rules of governance. Thus, far from being a conservative intellectual, Buchanan is an intellectual radical seeking to get at the root cause of social and political ills.

On the Practice of Economics

The Formalist Revolution

In 1947, the gap between the Austrians and the mainstream of neoclassical economics was widened by the publication of Paul Samuelson's Foundations of Economic Analysis. Samuelson pioneered a synthesis of neoclassical and Keynesian economics, as well as endorsing the Lange-Lerner argument for market socialism. Samuelson's hold over economists can be explained on two levels. First, economists suffer from physics envy; Samuelson's mathematization of economics promised to complete the transformation of economics into social physics that was started by Leon Walras. Second, Samuelson was not only smart, but strategic. Shortly after his Foundations became the major textbook in graduate education, Samuelson's Economics became the leading undergraduate text. Samuelson influenced students on their way in and on their way out. Within a decade, Samuelson became synonymous with economics, and his hold over the style--if no longer the substance--of economic reasoning has not waned since.

The first casualty of the formalist revolution was the historically and institutionally rich tradition of economics still evident in the 1930s. Case studies of particular industries, for example, had been common. After the development of econometrics, however, the case study approach was discarded in favor of large-sample data analysis. The second casualty of the formalist revolution was what might be called "the economist's way of thinking," the defining characteristic of the discipline in both its classical and early neoclassical renditions. The best of the earlier economics combined an appreciation for the particularities of institutional context with theory grounded in the generalities of choice under conditions of scarcity. Individuals always face trade-offs, in this view, but the manner in which they weight their choices is contingent upon the particual context of choice.

Samuelson drained economic theory of institutional context, and the econometric approach to empirical economics eliminated historical detail. Parsimony won out over thoroughness. Economics moved at this time from one side of the cultural divide (the liberal arts) to the other side (the sciences)--or at least that was the self-image of economists, who equated science more with precision than accuracy. The physicist does not allow the impossibility of making accurate predictions in many real-world contexts (such as meteorology) interfere with the pursuit of precise formal laws that govern them. By myopically pursuing only the formal aspects of the discipline, economics was reduced to its present state, in which we continually know more and more about less and less.

On Equilibrium Theory

The Austrian critique of the standard model is that it has no place for the multifaceted role that disequilibrium prices serve within the market process. The very idea of an economic theory of the market process stands in contrast to the static nature of equilibrium analysis. Since only and array of disequilibrium prices sets in motion the competitive process characterizing real-world markets, the formalist orthodoxy, by its very nature, must ignore this process. As Mises wrote:

The activities of the entrepreneur or of any other actor on the economic scene are not guided by considerations of any such thing as equilibrium prices and the evenly rotating economy. The entrepreneurs take into account anticipated future prices, not final prices or equilibrium prices. They discover discrepancies between the heigh of the prices of the complementary factors of production and the anticipated future prices of the products, and they are intent upon taking advantage of such discrepancies.

Prices serve as the basis of economic calculation only in the context of a process of competition brought into being by what formalism assumes away: disequilibrium. Real-world market prices do not perfectly contain all of the relevant information required for competitive equilibrium; if such information were known already, there would be no need for economic activity in the first place. Under disequilibrium conditions, however, the active bidding up of prices when demand exceeds supply, and their bidding down when supply exceeds demand, generates the incentives and information necessary to coordinate economic decisions. The discrepancy between the current array of prices and the anticipated future array of prices provides the incentive for entrepreneurs to discover hitherto unknown opportunities for economic profit. Of course, in this process of perceiving the future, entrepreneurs may (and do) make errors, but these errors can, by creating further discovery opportunities, generate further activity aimed at allocating or reallocating resources in a more effective manner to obtain the ends sought after. "The market process," Israel Kirzner writes, "emerges as the necessary implication of the circumstances that people act, and that in their actions they err, discover their errors, and tend to revise their actions in a direction likely to be less erroneous than before." While the assumption of perfect knowledge was essential for modeling the state of competitive equilibrium, it precluded an examination of the path by which adjustment toward equilibrium could be achieved. If the system were not already in equilibrium, one could not explain how it would get there. Omniscience logically results in nonaction. A profit opportunity that is known to all can be realized by none. Thus, if it is to be realistic, the model's assumptions have to be relaxed, but then it becomes overly complex and loses its formal elegance.

The precision of equilibrium modeling is gained at the expense of correspondence with the imprecise world the model was once supposed to help us understand. Paradoxically, the careful expression of imprecise concepts and processes in natural language supplies us with a more accurate picture of the economic world than the most rigorous mathematical modeling. Careful thought requires coherence; relevant thought requires correspondence to reality. Good economics requires both coherence and correspondence. The often-stated argument that mathematical modeling eliminates ambiguity in thought by forcing theorists to state assumptions explicitly is based on a conflation of the concepts of syntactic and semantic clarity. Mathematical reasoning ensures that modeling is disciplined by syntactic clarity, but semantic ambiguity is the result. The abandonment of mathematical reasoning using equilibrium models would herald a return to semantically rigorous standards of argument about the economic world "out there."

Man as Machine

A key element of the neoclassical research effort described previously is the examination of comparative statics as a means to understanding the welfare and efficiency properties of economic outcomes under varying conditions. This endeavor, however, largely ignored the role of the human actor in economic analysis. The Samuelson-Bergon social welfare function, which was to represent the aggregate preferences of all members of society, dealt with individuals in such an abstract way as to virtually purge them completely from the analysis. Rather than understanding human preferences as the constantly changing, immeasurable, and creative products of choice and decision making, neoclassical welfare economics treated them as the homogenous, static outcomes of deterministic assumptions. In a sense, the neoclassical notion of welfare economics divorced economics from man. In the end, while neoclassical economics succeeded in making economics look like physics, it is questionable to what extent it developed our understanding of market processes and fallible human behavior that characterize the real world. Without a doubt, formalism added technical sophistication to the field, but these advances did not come without a cost in terms of the human element's centrality to economic study.

The intellectual landscape of modern political economy has shifted considerably since the beginning of the twentieth century. We have argued that the discipline began the century in a position where economists thought they had discovered universal laws which they could express in the prose of natural language. Their opponents denied this, but they did so by arguing that economic theory was not universal. By midcentury, the discipline moved to a position where economists thought they had refined the universal principles by expressing them in the nonambiguous language of mathematics. However, to convey economic propositions in such terms, restrictive assumptions had to be employed to assure mathematical tractability. The entrepreneurial element of human action was a casualty of the mathematical revolution in economics because it defies tractability. Unfortunately for economic science, we cannot explain the operation of the market and the adjustments of the price system without recourse to the entrepreneur. Instead of recognizing this, economic discourse embarked on a detour which resulted in a form of formalistic historicism dominating economics by the last decade of the twentieth century. We enter the new century with hope that the universal logic of economic science and their contingencies of human volition and historical conditions can coexist under the intellectual umbrella of the sciences of human actors. This is the inspiring vision that Ludwig von Mises provided in 1949. More than fifty years later, Mises's pioneering work provided the foundation for a science of economics that is at once humanistic in its methods and humanitarian in its concerns.

The Limits of Economic Expertise

There is an interesting relationship between the epistemic outlook of economics and the disposition of the economist that plays itself out in the history of development economics. To simplify two continuums down to their poles, we can see the discipline of economics as moving between "epistemic modesty" and "epistemic hubris" in the way it understands its own claims to scientific knowledge (particularly in the sense of prediction and control), and we can envision economists as approaching their work as either "students of society" or "saviors of society." The interaction between the dominant culture of the discipline and the disposition of the economist is portrayed in the following table.

Economist as StudentEconomist as Savior
Economics has epistemic modesty.Happy cautionary prophetFrustrated engineer
Economics has epistemic hubris.Frustrated cautionary prophetPracticing engineer

We broadly categorize the results in terms of "cautionary prophets" or "engineers." We use "prophet" in the sense of a person who offers predictive warnings ("if you do x, y will happen") rather than someone who is divinely inspired or the like. By using the adjective "cautionary," we are suggesting that the economist as prophet is largely in the business of cautioning us about the limits of what we can and cannot do. The economist as prophet is more likely to utter "Thou Cannot" than "Thou Shalt Not." This sort of economist has a default, though not inviolable, respect for the workings and value of institutions that have survived the process of social evolution. This puts him or her in the position of cautioning those who would remake or ignore the lasting results of those historical processes.

Over the last 150 years, the economist as engineer, by contrast, has moved through two distinct, though related, worldviews with respect to historically emergent institutions. During the late nineteenth century, a period characterized by "frustration," the engineering-oriented economist was interested in the role of institutions but concerned with designing new social institutions to replace those seen as responsible for the problems of the day. The spirit of science and engineering, which had been apparently so successful in taming nature, would be used to rein in the forcces of the social world so that they would serve the cause of human betterment by being the results of human reason rather than blind evolution. By the middle of the twentieth century, with the failures of wholesale institutional redesign more obvious, the economist as engineer was more likely to ignore historically emergent institutions, focusing instead on the problems of optimal resource and income allocation as explored in what amounted to an institutional vacuum. What unites the engineers of the two centuries, and makes grouping them together intellectually coherent, is their rejection of the cautionary prophet's default respect for historically successful social institutions. The older ones rejected it because they thought they could do better; the more recent ones simply ignore the issue.

High Priests and Lowly Philosophers

The economic way of thinking is a powerful tool for organizing and interpreting events and may well be value-neutral; but economists as advisors are definitely not value-neutral. This conclusion led Robert Nelson to ponder why is is then that economists are given a privileged position in the policy arena. Why are other disciplines that also provide a useful framework for thinking about important problems not afforded the same public hearing on issues of public policy? Nelson reasoned that since the economic way of thinking provides a way for us to understand and legitimate our modern world, perhaps economics has become the modern theology that has replaced traditional theology as the set of doctrines that give meaning to our social reality and hope to our endeavors for improving our lives. At least that is what Nelson sought to explore in Reaching for Heaven on Earth, and to amazing effect. Since economic progress was seen as the solution to social ills, the discipline of economics is awarded a special status as the harbinger of progress and its practitioners are transformed from lowly philosophers, who only study the world, to high priests of social control, who are responsible for ushering in an age of unlimited progress and prosperity. Nelson's work should not be read as an indictment of economics in the least. All that he is attempting to show is that economists do not practice a form of value-free analysis, and, in fact, cannot practice value-freedom when they offer policy guidance.


The economic way of thinking is not just one window on the world; it is the only window that deals with man as a human actor. This may sound arrogant to the casual reader, but economics also teaches humility. As F.A. Hayek put it, "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." The mainline of economic teaching from Adam Smith to F.A. Hayek taught not only what economics can tell us but more importantly what it cannot tell us. There are real limits to economic analysis, and efforts at economic control. The main reasons economics got off track in the twentieth century are because of a failure to recognize those limits and a confusing of the policy sciences with the engineering sciences. Commercial life did not emerge through design, but instead out of the human proclivity to truck, barter, and exchange with one another. Specialization in production and exchange existed well before economists came up with those terms to help explain that behavior. Economists, in other words, did not invent the economy but rather came to their study with the economy already operating and were tasked with the role of providing philosophic understanding of already existing practice. This is radically different than the civil engineer who designs the bridge to ease travel between Manhattan and Brooklyn. The demand by politicians and the public that economics be more like engineering is perhaps the greatest corrupting force on the science.

But if we accept the judgment that economics cannot play the role of social engineering, we need not be content with economics being purely philosophical. Economics and political economy are capable of generating significant empirical information. The discipline can inform us about how alternative institutional frameworks will impact our ability to realize the gains from trade and innovation. If the institutional framework impedes trade and innovation, then those gains will go unrealized; if the institutional framework encourages those aspects of an economy, then those gains will be realized. I often tell students that humankind has demonstrated two natural propensities--to truck, barter, and exchange (as Adam Smith taught); and to rape, pillage, and plunder (as Thomas Hobbes taught us)--and which propensity is pursued is a function of the institutional framework within which individuals find themselves living and interacting. The life experience can be a virtuous cycle of wealth creation and healthier and wealthier lives, or it can be a nasty and brutish hell on earth. So while economics cannot give us exact point predictions, it can, as a science, inform us of tendencies and directions of change as well as the wealth-creating or wealth-destroying capacity of the political economic system.

The mainline of economics explained the operation of the economy not by making heroic assumptions about the cognitive capability of individuals, nor did it describe politics by reference to benevolent despots. Instead, the political economy of Adam Smith to F.A. Hayek takes humans as they are and seeks to find the institutional framework that both constrains bad people so they do least harm when in positions of power and uses the ordinary motivations of humans and their limited cognitive capabilities to realize social cooperation under the division of labor. The mainline economists found that in the private property market economy and a constitutionally limited government, such constraining individuals' aggressive ambitions on the use of power and individuals' unique knowledge of time and place could be marshaled to realize a peaceful and prosperous social order. What economics and political economy had to guard against was human hubris. Hubris can come in two forms: a hubris that one is of a higher moral character, and a hubris that one is of a higher intellectual caliber than one's fellow citizens. It is this hubris that Hayek called The Fatal Conceit.