Thursday, April 21, 2011

Humpty Dumpty analysis

In Alice’s Adventures in Wonderland, Humpty Dumpty famously holds that a word means what he wants it to mean:
"When I use a word," Humpty Dumpty said in rather a scornful tone, "it means just what I choose it to mean — neither more nor less."

"The question is," said Alice, "whether you can make words mean so many different things."

"The question is," said Humpty Dumpty, "which is to be master— that's all."
Since 'Lewis Carroll' was the nom de plume of Charles Dodgson, a serious mathematician, we can be confident that the every bit of satirical irony that can be reasonably ascribed to the joke was intended.

The great virtue of Humpty Dumpty’s approach is that one cannot be wrong: one just adjusts the meaning of the terms involved so that no criticism “takes”. It is also an utterly pointless exercise in analytical terms, as one is not holding any specific position; for one is merely using words as placeholders, filling them with whatever content allows one to “win” the argument.

When I learnt that Terry Eagleton had published a book with the title Marx was Right, it seemed – this side of the tyrannical and murderous failures of Leninism and its derivatives – at best a profoundly quixotic exercise. Having now read his recent essay summarising his arguments, it turns out to be a much less interesting exercise than that.

The first principle he wishes to establish is that none of the experience of actually trying to introduce Marxism counts:
Marx was no more responsible for the monstrous oppression of the communist world than Jesus was responsible for the Inquisition. For one thing, Marx would have scorned the idea that socialism could take root in desperately impoverished, chronically backward societies like Russia and China. If it did, then the result would simply be what he called "generalized scarcity," by which he means that everyone would now be deprived, not just the poor. It would mean a recycling of "the old filthy business"—or, in less tasteful translation, "the same old crap." Marxism is a theory of how well-heeled capitalist nations might use their immense resources to achieve justice and prosperity for their people. It is not a program by which nations bereft of material resources, a flourishing civic culture, a democratic heritage, a well-evolved technology, enlightened liberal traditions, and a skilled, educated work force might catapult themselves into the modern age.
One might think that this is glibly dismissive of immense human suffering. One would be right.

But let us turn this around: what about Marxism in the Western world? Have Marxists in the West typically displayed respect and admiration for the:
flourishing civic culture, a democratic heritage, a well-evolved technology, enlightened liberal traditions
of Western societies? Or have they typically, sneered and denigrated such things? Typically, that is precisely what they have done. (Consider any Western Communist Party of your choice, for example.)

So, by ‘Marxism’, Eagleton neither means Marxism as practised outside the West, nor Marxism as typically practised inside the West. ‘Marxism’ apparently means ‘the thought of Marx, but not where it motivates bad things’. We are truly in the realm of Humpty Dumpty analysis. One is reminded of G. K. Chesterton’s comment on Christianity:
The Christian ideal has not been tried and found wanting. It has been found difficult; and left untried.
So, defending Marxism becomes “easy”, because no facts about the history of actual Marxism count – not if they are bad facts. Good facts get to count, however. Eagleton reminds of, to Marx’s credit:
the political movement which his work set in motion has done more to help small nations throw off their imperialist masters than any other political current. …
In the 1920s and 30s, practically the only men and women to be found preaching racial equality were communists. Most anticolonial movements were inspired by Marxism.
Capitalism does not, however, get the same treatment. On the contrary, everything that might be adduced against capitalism counts – even if it is something as ubiquitous in human history as imperialism. So, you are allowed to exclude any inconvenient fact about the history of Marxism, but no inconvenient fact about, or even vaguely tied to, the history of capitalism.

Terry Eagleton is the Humpty Dumpty of historical analysis – the facts only count when he says they do.

Eagleton’s point about the Gospels not being a natural support for the Inquisition is also rather less telling than he seems to think. For the Inquisition may have little to do with the preaching of the Gospels, but it has a much closer connection to the logic of monotheism: to the notion of a single, absolutely trumping authority which is a source of definitive understanding of the truth.

Similarly, the notion that one can have such a correct understanding of social dynamics that one knows where history is “properly” heading, an understanding which profoundly de-legitimises the very basis of current social arrangements, has a natural affinity with totalitarianism. It is much easier to go from Marx’s writings to the totalitarian impulse than from the Gospels to the Inquisition. And both historical journeys occurred: repeatedly. There is something to be explained here, and “they got it wrong” is not enough. Powerful patterns need explanation, not dismissive exculpation. Lezsek Kolakowski is, in every sense, much more serious on these points than Eagleton.

For how much of what Eagleton invokes, the:
flourishing civic culture, a democratic heritage, a well-evolved technology, enlightened liberal traditions
of Western societies rests on strong and vigorous private property rights? All of it, surely. Yet that is precisely what Marx profoundly and absolutely rejects and delegitimizes. The difficulty is not in arguing that undermining these things is a bad thing: the difficulty is in arguing that Marxism is compatible with any of it.

Though this is not a problem if one can engage in Humpty Dumpty analysis and say words mean – and the facts they refer to count – when convenient and not if inconvenient. Except, of course, that just takes the point out of the exercise. If Marxism means whatever it has to mean, or at least has whatever implications are required, in order to be benignly correct, then it does not mean anything in particular. It becomes a series of analytical placeholders, to be filled as convenient.

There is a way of preserving specific content but insulating doctrine from inconvenient facts. That is to declare such inconvenient facts as manifestations of perversion, of instances of corruption or deviance; not proper manifestations of the underlying doctrine or principle at all.

This is a favourite tactic of natural law theory, operating all the way back to Aristotle. Aristotle, for example, excludes random events from his causal analysis. So, his causal analysis works for all events, except random ones. What is any event it does not work for? A random event, clearly. Can you see the little problem?

This, the-conclusion-gets-to-exclude-inconvenient-instances principle, is classically applied by natural law theorists to sexual activity. So the purpose of sex is reproduction and any sexual act that is not reproductive in purposes is a perversion of sex. What if sex has many other functions in nature? None of them count, they are just perversions. The conclusion – the sole legitimate purpose of sex is reproduction – cannot be wrong, since any contradicting usage is a perversion and does not count.

The same with Terry Eagleton’s history: any use of Marxism that has bad consequences is a perversion and does not count. Only good uses of Marxism count.

But that an entire philosophical tradition is based on a technique does not make any more analytically or intellectual worthy. And it is still, at bottom, Humpty Dumpty analysis – except the word that gets to mean whatever the Humpty Dumpty theorist wants it to mean is ‘perversion’ or whatever is the equivalent excluder-from-counting.

Humpty Dumpty analysis does make for splendid polemics – as a polemical exercise, Eagleton’s piece is full of righteous energy. It just does not make for anything resembling serious analysis.

The problem remains that Marx was wrong: his theory of value is false, his theory of exploitation incoherent. He may indeed, as Eagleton notes, been tremendously impressed by the creative power of capitalism: but he did not actually understand it. Marx was wrong on things that matter to an analytically disabling extent, and no amount of Humpty Dumpty analysis changes that.

Tuesday, April 19, 2011

If we shout loudly enough, will you hear us?

Anti (Muslim) immigrant sentiment is proving increasingly an electoral winner in Europe. Adding anti-bailout sentiment seems to increase the appeal, as the True Finns have just discovered.

The “European project” has two levels to it. One is the European common market: creating a huge common commerce area. The aim was, by entangling European peoples so deeply with each other that another Great European War became outside the realm of emotional, and above all political, likelihood.

The other manifestation of the “European project” is to create a European superstate. To create a political identity and superstructure that sits above, and ultimately subsumes, the various European ethnic identities and associated states.

The first is a liberal project (in the classical liberal sense, not in the modern we-know-better conspicuous-virtue progressivist sense). It widens the range of interactions that people can choose to engage in. The second project is a deeply illiberal one.

Confederal democracy need not be an illiberal project, but the European superstate is not a confederal democracy. It is bureaucratic internationalism with an elected figleaf, given the European Parliament is little more than a talkshop.

The root of the problem is the underlying analysis, which holds that the great problem of European history is nationalism. This is nonsense. Europeans have found many reasons to slaughter each other over the centuries, even in the last century, nationalism is only one.

The power problem
The great problem of European history is unaccountable power. Nationalism was simply a sentiment that unaccountable power mobilised for its own purposes.
The First World War occurred because dynastic authoritarians wished to stave off political changes that would undermine their power. Invoking their roles as war leaders was a way of attempting to bind their subjects to them against threatening notions of democracy and ethnic equality, a role their alliances were based on and which a series of events either trapped them into or motivated them to take “all the way”. The representative democracies of Serbia, France and the United Kingdom got drawn into the war, but it was Dynastic empires of Habsburg Austria-Hungary, Hohenzollern Germany and Romanov Russia that created the War between them. It was, at its heart, the Dynasts’ War.

The Second World War occurred because Hitler had created a system where he was accountable to nothing but his own Will, and his Will was to create the Empire of Lebensraum. Stalin, equally unaccountable, saw a way of expanding his own Empire and entangling the “Imperialist” Powers against each other and so they divided Eastern Europe between them. It was, at its heart, the Dictators’ War.

But if one diagnoses the problem of European history as unaccountable power, then that implies the answer is democracy, is giving power to the vulgar masses, and limited power, a system of strong checks and balances. If one diagnoses the problem of European history as nationalism, that is a popular sentiment, and then the answer is for a “wise and virtuous elite” to curtail the “dangers” of popular sentiment. In other words, create yet another manifestation of unaccountable power.

It also means that the people only “get it right” when they agree with said virtuous elite.

This is, of course, an exercise in hubris. And, in the words of Proverbs 16:18
Pride goes before destruction,
a haughty spirit before a fall.
Failed integration
What we are currently seeing is the intersection between two failures of the European elites. The first failure is managing successful integration of large migrant (specifically Muslim) populations. Not only are second generation male Muslims “de-assimilating”, but much of the European political left is using migrants as a new basis for support, to the extent of apparently deliberately manipulating migration policy to that effect.

Note, this is an active policy of preferring newcomers to the original residents. It fits in with the “anti-custodian” attitude of the Progressivist Ascendancy where critiquing what exists, what has been handed down from the past, in the name of a legitimating vision of virtue is an essential element in progressivist sense of status and identity. So, making any complaint about problems with newcomers because automatically “racism” and beyond the pale. But there are issues of integration and friction, and if they cannot be articulated within mainstream politics, then they will be taken up by whichever political entrepreneurs move into the available political territory first. (The point is not to claim that all complaints are legitimate: merely that issues that cannot be meaningfully discussed cannot be dealt with, so continue to fester.)

There are two problem with progressivists managing integration into the wider society. First, the point is not to have the newcomers behave (and so vote) like the existing residents. Differentiation is basic to the underlying political purpose.

Secondly, successful integration acts to legitimate the existing culture, society, institutions. If one’s status and sense of virtue is based on critiquing all that, then clearly having such “expand” their operation, to display their worth and effectiveness, gets in the way. The point is to use migrant difficulties as a critique of the existing culture, society and institutions, not as a means for such to display their power and worth.

To put it another way, given Western civilisation is, in so many ways, such a successful one, if one defines virtue against success, then one is going to produce a lot of failure. Particularly if failure is actually functional – that is, vindicates one’s sense of virtue and status and keeps the differentiated groups as moral and political mascots.

After all, if, for example, African-Americans became socially successful, they might start voting Republican, rather than being captive political dependents of the Democratic Party. (Having the Democratic Party as their monopoly political provider – how is that working for most African-Americans, exactly?) But if you want to see these processes operating in all its horrid logic, I direct your attention to the failure of indigenous policy in Australia, which displays these patterns in all their pathological glory.

Euro mess
The other great hubristic failure of the European elite is, of course, the euro itself, which has operated to make the looming demographic-fiscal crunch of European welfare states much worse. Economist Tyler Cowen has a particularly grim analysis of the current problems of the euro.

Paul Krugman summarises the underlying problem aptly:
But the architects of the euro, caught up in their project’s sweep and romance, chose to ignore the mundane difficulties a shared currency would predictably encounter — to ignore warnings, which were issued right from the beginning, that Europe lacked the institutions needed to make a common currency workable. Instead, they engaged in magical thinking, acting as if the nobility of their mission transcended such concerns.
Alas, the “magical thinking” Krugman points to is not some euro-specific malady, it pervades progressivist outlooks and particularly those of the European elites. Their sense of status and virtue comes fundamentally from the nobility of their intentions, of their moral vision. Yet a sense of virtue not ameliorated with a strong sense of responsibility grounded in social reality is a dangerous, hubristic indulgence. Without truth, there can be no morality for there is nothing which resists mere convenience. (This, by the way, is why serious narcissists are not seriously bound by moral considerations: since their convenience is their reality principle, they just reconstrue matters to evade any inconvenient moral constraints or obligations.)

Hence good intentions being what the road to Hell is proverbially paved with. While such “magical thinking” is generally a matter of various levels of public policy failure, these can have vile consequences for the sufficiently vulnerable – many indigenous communities in outback Australia include women and children living in hellish conditions. The recent Mullighan report (pdf) gives a sense of the horror.

So, if you are a European voter, confronting a EU system that gives you no direct levers of power beyond national politics and yet the EU structures are used increasingly to override national (and thus democratically accountable) decisions, what do you do? You see if people will hear you if you shout loud enough.

And voting for “right wing populism” is certainly a way to shout loudly.

Elite hubris
The problem is that this is as likely just to confirm the Euro-elite in its own hubristic belief that its virtue is “needed” to block “clearly pernicious” popular sentiments. If agreeing with the elite leads to being taken for granted and disagreeing with the elite leads to being contemptuously ignored, then a very nasty spiral can be set in train where increasingly intense mechanisms of complaint are resorted to in a vicious interaction between popular frustration and hubristic self-satisfaction.

The question becomes, a what point do people shout loudly enough that they will be heard? What is more important to the European elite, its sense of virtue and status or some dim sense of that the current political framings are not invulnerable? This is an open question: plenty of elites in history have ridden their sense of virtue and superiority to crashing collapse.

The fundamental problem of European history remains what it has always been: unaccountable power. The EU is not the solution, it is the latest manifestation of the problem. Unless it changes to become far more accountable, the pattern of spiraling disaster is only going to get worse.

ADDENDA I have amended this post to include the actual verse from Proverbs, rather than the common misquote.

Sunday, April 17, 2011

Signaling support

This is based on a comment I made here.

Xavier Marquez has a great post on the role of cult of personalities in signaling support for a dictator. The basic idea is that adhering to the cult of personality is a way to signal support by engaging in costly activity (public endorsement and engagement of overblown praise).

This is a very plausible, indeed powerful, analysis. There may also be a further element, one general to propaganda in totalitarian societies in particular: crowding out. Part of the purpose is to literally leave no public space for critical views. So, not only are you signaling support by the rituals of the cult of personality, it excludes alternatives.

In the original post, commenter AC offered the following:
Thought experiment: suppose that instead of a single dictator, there is an elite class, which has general control over most cultural organs and elite institutions but whose political ascendancy is somewhat tenuous. Like the dictator, it will want signals of loyalty (both for determining loyalties and because of general ingroup/outgroup dynamics.) But because it’s not a single dictator, the signal can’t just be “the Generalissimo is awesome.” Instead, the shibboleth would be particular statements, or articles of faith, that are known to be supported by the ruling class.

Of course, making the shibboleth a mathematical axiom would be pointless; if nothing else, non-loyal mathematicians would be misperceived as loyal elites. The signal must be costly. So the articles of faith must be faintly ridiculous; easily challengeable on the facts, so that only people really devoted would at first make those claims. (Of course they can’t be obviously false either, else the integrity of the ruling class would also be called into question.)

Like cults of personality, there is a ratchet effect. As the elite becomes more entrenched, the shibboleths, while never changing in form (too costly to coordinate), will ever increase in intensity and audaciousness. And the enforcement of the party line will be strongest in educational institutions where the future members of the elite class are trained. It would be considered a matter of proper education – like the finishing schools of old – when “politically incorrect” thoughts in these institutions are mercilessly squelched.
Continuing AC's analysis of political correctness, one notes the rhetorical viciousness with which people who are critical of said markers of virtue are often treated. The point being to preserve said markers as signs of virtue (which clearly they are not if merely contestable opinion: so having "wrong" opinions clearly has to be a character defect) as well as punishing, and seek to crowd out, dissent.

Continuing the extension of Xavier Marquez's original analysis, political correctness often involves overblown, or even contradictory, positions. (e.g. being in favour of high migration while being against new dams, power stations or releasing land for housing). Such signaling virtue by adherence to one-sided, overblown or even contradictory positions works in a similar way to the way cults of personalities work in Xavier Marquez’s analysis: by taking on the implicit cost one signals one’s membership of “Club Virtue”. Taking on AC’s point, it is also why one gets particularly intense forms of political correctness in certain milieus (e.g. academic departments). Not only is more effort, more cost, have to be taken on to differentiate and so to signal one’s virtue, the lack of internal challenge allows various considerations to be ignored: hence the intensifying effect.

So, instead of status through conspicuous consumption, you get status through conspicuous compassion or other forms of conspicuous virtue. It is not what one spends in money which counts, but what one accepts and undertakes in cognitive intensity: including willingness to discount contrary evidence and disparage those who offer it or otherwise have contrary perspectives.

(Partly related, Arnold Kling offers a comparison of two status systems -- it is obvious which one would be more prone to the above pattern.)

Tuesday, April 12, 2011

Money inertia

This was originally provoked by a question and answer here.

The problem with the real price of money is that it is not real.

There is a view within economics – which was at one stage canonical – that money is an epiphenomenon; what matters is the “real price”, the price in terms of actual goods and services, and the “real economy”, the production, distribution, exchange and consumption of goods and services. (And assets, but we leave that aside.) To think that money mattered in its own right was to believe in the money illusion. As James Tobin wrote in 1972 (as quoted here [pdf]):
“An economic theorist can, of course, commit no greater crime than to assume money illusion”
Now it is obviously true that goods and services are what ultimately matters – we value money because we can buy goods and services with it and pay off obligations (to people who can then buy goods and services with it, and pay off obligations to people who can …: note that such obligations are typically implicit or explicit contracts – i.e. transactions operating across time). But if what matters is the “real price”, so that money is an epiphenomenon, the question then arises, why have money in the first place? What role is it playing?

To which the answer is: providing a huge reduction in transaction costs. What money provides is a universal transaction item. The more it does so, the more it is prized. It becomes the means by which transaction offers are made and accepted. It frames transaction offers and acceptances. It also frames obligations to pay. That is to say, its crucial value is being the medium of account (i.e., in Scott Sumner’s words, “the object that embodies the unit of account”).

For the alternative is barter, which is a much clumsier alternative: so much clumsier that even times of ludicrous hyperinflation, people still use money. What economists call ‘the real price’ is the barter price – the price in terms of goods and services. (Expressing this as ‘relative prices’ is another way of making this point, but one that continues to assume the use of money.) What economists call the ‘real price of money’ is its average barter price across all goods and services.

So, when I refer to ‘barter price’ I mean what economists call ‘real price’ as a barter price is a price in terms of goods and services and the real price is barter price expressed in a unit of account (typically money for a particular year) – a usage which in itself expresses the utility of money.

The real price of money is unknowable at the time of any given transaction. It can be (retrospectively) estimated, but that is all. If all prices were static for a known time period, so that the barter price for all goods and services relative to each other was known at the time of any given transaction, then any transferrable good or promise of service would do as payment, since its exchange value would be determinant for all parties. But money would still be used because it so reduces transaction costs (such as ease of movement and storage, allowing immediate transfer, economising on information and calculation, etc).
Barter thus makes sense only when money is not available, or there is some strong penalty involved in using money sufficient to outweigh search and other costs involved in some specific barter or barters.

But all prices are not static for known time periods, so the real price of money is not knowable at the time of any given transaction. This means that prices and contracts will be in nominal values, because nominal values are specific, numeric (so can be added, subtracted, divided, multiplied, etc), applicable across goods and services and knowable. In that sense, nominal prices are real (in the sense of being knowable), and the “real” price (in terms of aggregation across all goods and services, or even just across one’s own budget set) is not. (The real price is not even numeric in quite the same sense, since it can easily involve odd fractions.)

Which means money can have real effects, because of the information lag between shifts in (nominal) supply and demand for money and overall price effects (i.e. shifts in the overall barter price of money). People will act according to nominal shifts because that is what they have immediate information on and it is what their prices, wages, contracts and obligations are specified in (money being the medium of account.) As the universal transaction item with a clear nominal value but a not-immediately-knowable overall barter price, money is not an epiphenomenon.

Moreover, as people tend to be loss averse (since people build up expectations and obligations based on existing income and wealth), and part of what is unknowable is how quickly other people’s prices will adjust to shifts in the real price, deflationary shocks (falling nominal prices, so rising barter prices for money) will tend to have more nominal stickiness than inflationary ones (rising nominal prices, so falling barter prices for money). This asymmetry in responsiveness (noted in a series of experiment here) is because raising one’s nominal price(s) is clearly compatible with being able to cover existing nominal prices, contracts and obligations. Lowering one’s nominal price is rather less so. Indeed, if it is known that certain prices, contracts and obligations will be slow to adjust or have already been set in nominal terms (such as, for example, tax obligations), then that effect is reinforced.

Remembering that, with regard to money, we are also dealing with powerful cognitive habits: which themselves are rational responses to the time and effort engaged in cognition and gathering information. Moreover, revealed rationality (rationality in behaviour) can easily vary from expressed justification. You do things because they work: one will not necessarily recall later all the considerations which led you to undertake an action, develop a habit, etc.

In particular, the slower one’s general cognitive responses and the more limited the relevant information available, the more dependant on cognitive habits and routines one will be. What people call ‘stupidity’ is often simple tardiness in responding to changed circumstances combined with some pertinent level of ignorance: hence the expression “x is slow on the uptake” and the importance of training to speed up responses (i.e. increasing the range and immediate availability of cognitive resources) to particular circumstances. So the higher the premium on cognitive economy (either in calculation or information), the greater will be the tendency to rely on nominal values.

Thus the term ‘money illusion’ is an illusion, because much of what is going on is not mere illusion, but (broadly) rational responses to information and other cognitive limitations as well as accrued obligations. It would be better to call it money inertia: the information lag to shifts in the overall barter price of money plus resistance to receiving less of the medium of account. Even when it is "pure" illusion, it is still a form of money inertia -- continuing to calculate in monetary terms rather than attempting to shift to (more complex) barter prices.

Sunday, April 10, 2011

Why have contracts?

This was originally provoked by a question and answer here.

One of the most productive questions ever asked in economics is: “why do firms exist?” Why are not all economic agents sole traders? Alternatively, why is there not one big firm? Why, indeed, do firm structures vary so noticeably across industries?

The question was famously posed by Ronald Coase and he answered it with what became known as transaction costs. (A useful summary and appreciation of his work is here [pdf].) In effect, firms existed to minimise transaction costs: if it is cheaper to do a transaction in-house, then it is. If it is cheaper to do purchase a good or service externally, then it is. Firms are alternatives to coordination by the price mechanism. In a sense, they are areas of the suppression of the price mechanism. (Original article is here [pdf].) This was very productive question because it transformed organisational and institutional analysis -- many subsequent Nobel prices in economics were awarded for work based on use of transaction costs.

But is a firm defined by a transaction costs boundary? Or is it, as Yoram Barzel has argued, defined by the range of the guarantee of the equity capital? By the range across which expenditure to match obligations is guaranteed (and, if the guarantee fails, bankruptcy occurs). Firms then become mechanisms to deal with both risks and transaction costs. It is the intersection of comparative transactions costs and risk coverage that sets the boundary of the firm. Noting that it is existence of a realm where it is beneficial to replace the price mechanism (Coase’s point) that creates the range of expenditures needing the equity guarantee (as identified by Barzel) in the first place.

Coase’s analysis in itself does not explain why firm ownership is purchased and why the owner is the recipient of the residuum (the net income of the firm, whether positive or negative after all expenditures are paid for): adding Barzel’s analysis does. While Barzel's analysis does not identify why there is a range of transactions needing the equity guarantee in the first place (as Coase's analysis does.)

So, why do contracts exist? Why are not all transactions just on-the-spot swaps?

Lots of transactions are, after all. Not only are there spot markets, but retail markets are dominated by such on-the-spot swaps, where prices are free to move between transactions.
Contracts exist for the same reasons firms exist, to lower transaction costs and manage risks. Contracts structure, and thereby permit, economic interactions that extend beyond a caveat emptor swap on the spot. A contract is any agreed transaction or series of transactions across time. So, any purchase which is not on a caveat emptor basis has some contractual element, as there is an obligation across time. (So even spot markets can have contractual elements.)

This is easiest to see with regard to labour markets. While spot markets for labour have existed, they tend to be relatively rare. Generally, people providing goods and services they do not make or provide themselves need to use labour with some regularity, and labour with specific skill sets and characteristics (such as reliability). A contract offers income to the provider of the labour on the basis of providing particular skill sets and personal characteristics. The promise of future income (to the labour provider) and future use (to the hirer of the labour) gives the hirer of the labour reason to engage in necessary training (even if only in the procedures of the firm) and a reasonable expectation of the labour being available. The hirer can then have a reasonable expectation of providing the goods or services he can then offer to customers.

The point can be extended to any good or service that is a regular part of the production process.

So, contracts exist to manage interactions across time. They are more than simply repeated games (such as one has with a regular customer/purveyor: though these can involve built-up expectations which can become implicit contracts). Contracts structure any interactions where there is a delay between provision and payment. So, ordering a meal in a restaurant is a contract, since you are promising to pay at the end of the meal. Even if payment for an on-the-spot swap is immediate, if a transaction is not caveat emptor there will be some continuing obligations about quality which make the transaction a contract.

In common law, a contract is a matter of offer and acceptance (i.e. mutual assent) and consideration. That is, a contract involves mutual agreement for some benefit (typically, an exchange of benefits). The mere matter of assent and benefit simply makes it a transaction: it is having explicit or implicit operation over time that makes it a contract.

Contracts reduce transaction costs – in particular, you do not have to keep searching for providers, negotiation costs are reduced (particularly if standard contracts, whether customary or statutory, are used) – and they reduce risks: you can act on the basis of reasonable expectations, with means of redress if there is a failure to provide as promised, making planning ahead easier. Since time-range transactions are so common, contracts are ubiquitous in human economies. So much so, that customary contracts evolve to an extent that people are not even conscious of being engaged in an (implicit) contract, as in purchasing a restaurant meal. By creating a structure one that allows transactions that operate across time (that is, loosen the time constraint) a contract also allows much more complex interactions than would otherwise be practical.

Having high levels of social trust and effective contract law enforcement greatly increases the range of transactions that it is reasonable to engage in. The biggest single economic advantage to high levels of social trust may well be the expanded ability to engage in contractual (i.e. time-range) transactions.

While there is some minimal trust element in on-the-spot swaps, there is so little that even black markets can engage in them easily. To engage in time-delay transactions generally requires an enforcement/recourse mechanism. This accounts for much of the overt menace in black markets, since such enforcement have to provided by the purveyor themself. (The rest of the menace and violence comes from the need to privately enforce property rights, making them much more “up for grabs”, and to deter assisting the state to enforce its ban of those transactions.)

So, a contract is a way of reducing transaction costs and managing risks thereby permitting transactions that have some element across time. Which leads rather naturally into the notion of a firm as a nexus of contracts.

Unlike firms, contracts are not generally suppressions of the price mechanism: typically, they are ways of extending its operation – that is, they bring a wider range of possible transactions into the market. What is distinctive about the contracts of a firm is that they provide the basis for alternatives to the price mechanism in coordination and their operation is within the guarantee of the equity capital. Noting that firms are a nexus of contracts does not, of itself, appear to add anything to the combined Coase-Barzel analysis of firms outlined above.

It is more that firms are a particular nexus of contracts. That is, firms and contracts are both ways of reducing transaction costs and managing risks: it is just that a firm uses contracts to create a specific realm of coordination and equity guarantee. Contracts are the mechanism, the firm is a particular conjunction of the use of contracts.

Saturday, April 9, 2011

Natural money bunkum

I kept trying to read this natural money site but it is so ignorant of economic history it makes my head hurt. Interest on loans is (mostly) the level of risk that has to be covered for credit to be offered. One cannot abolish risk, one can merely degrade the ability to price it and so deal with it more effectively.

If I was to nominate a single reason why the Western economic take-off occurred, I would nominate capital markets. Capital markets meant ideas could be operationalised. To take one example that made so much of a difference (we live in the Renaissance that never ended because of it), the printing press operated very differently in Europe than it did in China because of capital markets.

To be sure, those capital markets were embedded in property rights and competitive jurisdictions that allowed them to operate, but their operation then had effects back on the operation of property rights and competitive jurisdictions. And yes, debt was misused. Sovereign monarchs could be even worse than the duly elected representatives of sovereign peoples at mishandling the taxpayer-guarantee – Philip II of Spain was paying amazingly high interest rates at one stage due to previous Habsburg bankruptcies. But, even given all that, the operation of capital markets was an incredible advantage to Europe and its offshoots. Some financial instability has been a small price to pay, just as the business cycle pales compared to the long run trend of higher incomes and higher life expectancies.

The Aristotelian argument, in all its offshoots, against interest rates is natural law bunkum. Risk is a real factor in economic affairs: a central factor, as assessment of risk is so central to economic actions in so many ways. Being able to price it properly, and in diverse ways, is an enormous advantage. The problem in recent times is not interest rates, it is action which badly distorts risk assessments and incentives. The economy will not work better if one closes down such a basic information channel: that is massively magnifying the problem, not creating any sort of solution.

Friday, April 8, 2011

Great art as transcending constraint

A friend has been painted for the Archibald Prize. The artist knows how modern critics want her to paint, but it is not how she likes to paint. As the portrait's subject’s partner said to me recently, art evaded the constraints of the Church and then produced what of value exactly? (Somewhat harsh, but one takes his point.) It is not the abolition of constraint, but its transcendence, that produces great art. If there are no constraints, there is nothing to transcend.

In Christopher Beckwith’s Empires of the Silk Road he mounts a heartfelt critique of modernism and post-modernism. He observes:
But before the twentieth century, although the greatest artists nearly all achieved their success by striving against tradition and sometimes breaking the rules, there was a balance between the two forces: the goal of the upward-aiming aristocratic system was to achieve success by creating artworks that were as near to perfection as possible within the traditional rules based on the natural order. The goal of the downward-aiming modern tendency was to achieve success by creating art works that effectively changed the traditional or previously followed rules. Because the two forces were in balance, the great artists of the past did not destroy existing rules, they stretched or otherwise modified them (p.292).
Part of that natural order being the continuity of human nature:
The consistency of human behaviour over such great expanses of space and time can clearly be due only to our common genetic heritage (p.xi).
Constraints gave art something to both strive against and be judged by. Without constraints, what is the point?