The Book of Vices
Mises Review 2, No. 4 (Winter 1996)
HIDDEN ORDER: THE ECONOMICS OF EVERYDAY LIFE
David Friedman
Harper Business, 1996, xi + 340 pgs.
This book starts to derail around Chapter 15. Before then, the work provides a largely sound elementary account of economic principles. Our author writes from a neoclassical, rather than an Austrian perspective; and Austrian readers will find it revealing to compare Friedman’s approach with their own. But of this more later.
In the fateful chapter, Friedman confronts a key issue. Economics is a descriptive science; but popular interest in economic issues centers on matters of practice. Are minimum wages good or bad? What should the government do in a depression? Should we redistribute income to the poor? However much the economist might wish to devote himself to Edgeworth boxes or the reswitching controversy, policy questions require his attention.
But precisely here a problem arises. On questions of value, the economist, as such, has nothing to say. He can tell you how to achieve various economic goals, or whether your policy will have the results you anticipate; but he cannot settle questions of what ought, or ought not, to be the case. Not, I hasten to add, because questions of value have no correct answers. That view is a philosophical doctrine (in my opinion a wrong one) that cannot be assumed as given. Rather, questions of value belong to philosophy and stand outside the economist’s expertise.
At one place, Friedman appears to grasp this basic point. After discussing (with considerable subtlety) the argument that the market distributes income fairly, he comments: “Fortunately, determining what is just is one of the problems that is not part of economics. Yet.” (p. 199).
But our self-described economic imperialist cannot leave it at that. He thinks that economics can define a concept, efficiency, “that is an important part of what I suspect most of you mean by ‘good’” (p. 217). As soon becomes apparent, he uses his notion of efficiency to preempt much of the job of ordinary morality.
He does not profess ethical subjectivism; if I am not mistaken, he has elsewhere rejected it. But he thinks that moral arguments, if not firmly wedded to efficiency, quickly dissolve into conflicts that cannot be resolved. Efficiency, at any rate, is a crucial component of a rational approach to ethics.
What then is efficiency, as Friedman conceives it? To understand it, we had best take a page from Austrian economics and adopt a “round-about method of production.” Friedman’s account of efficiency, as he notes, differs from the way most neoclassical economists explain the concept; and an account of the more conventional view will enable us to grasp Friedman’s departure more readily.
Conventional economists hope to avoid the need for controversial ethical judgments in this way: Suppose some change makes at least one person better off, and no one worse off. Then, salvation is at hand: while making no interpersonal comparisons of utility we can nevertheless say an improvement has taken place. But improvements of this kind, called Pareto superior moves, are few and far between. Usually every change will make someone worse off; and, if so, the Pareto criterion cannot be used.
Why not, then, weaken the rule? Suppose a change would make some better off and others worse off; but the winners could compensate the losers. Is not this change without doubt good? Not at all. As Friedman notes: “What is wrong with the potential- Pareto approach [the view just described] is that it is used to argue for changes that are not going to be combined with side payments . . . and are thus not going to be actual Pareto improvements. It thus presents the pretense of avoiding interpersonal comparisons while actually recommending policies that make some people better off and others worse off” (p. 222).
Our author has thus set himself a difficult task. He recognizes the limitations, if not outright failure, of the conventional Pareto approach. Nevertheless, he proposes not to give up: he does not wish to abandon questions of good and bad to the philosophers. What, then, is his solution?
His answer has at least the virtue of simplicity. We count up the dollar gains and losses of a proposal, and adopt it if a net gain will ensue. More specifically, Friedman’s plan makes use of the concepts of consumer’s and producer’s surplus, which he has been at pains earlier in the book to explain.
Suppose Mr. Friedman sells a copy of his book for $25.00; but, so anxious is he to spread his version of secular salvation that he would have paid the reader $5.00 to take a copy. Then, his producer’s surplus is $30.00. If the reader turns out to be an ardent Friedmanite who would have paid $500.00 for the book, then his consumer surplus is $475.00. Given the concept of surplus, we can state the policymaker’s task simply: maximize total surplus. Or, as Marx phrased it: “Accumulate, accumulate! that is Moses and the Prophets!”
Oddly enough, this proposal falls victim to exactly the same difficulty that besets the potential-Pareto rule. The gains and losses go to different people: how, then, can an economist judge whether “society” is better off? Further, estimates in dollars of gains and losses cannot be taken as measures of utility, since the utility of money may differ from person to person.
Friedman recognizes these problems with his standard. Another, which he does not state in this context, is this: what group is it whose surplus is to be taken into account? A nation? The world? As our author elsewhere notes, a policy can sometimes benefit one country without producing any gain for the world’s economy. In a discussion of tariffs, he sums up: “So if the United States is a price searcher in international markets, the outcome without tariffs is efficient if all interests are considered but inefficient if only American interests are” (p. 287).
And if our goal is to maximize total surplus, should we not encourage a large population increase? The more people, the more potential gains in surplus. (Of course, externalities also have to be taken into account.) Or are we supposed to be maximizing surplus over a constant population? Friedman does not tell us. (Problems of this kind for utilitarianism have been studied by Derek Parfit, in his Reasons and Persons.)
But the problems Friedman recognizes himself are quite enough. He has not offered the slightest reason to think that efficiency, in his sense, is a good at all, let alone an important part of what we mean by good. Why should anyone be concerned with maximizing dollar surplus for some arbitrarily selected group? Sometimes ethics requires sacrifices of self-interest; but why should anyone faced with a loss care morally at all about surplus of the Friedmanite kind?
Friedman’s efforts to cope with the difficulties strike me as grossly inadequate. He knows full well “the obvious argument against treating people as if they all had the same utility from a dollar. They don’t” (p. 219). But, like Alfred Marshall, the English economist who devised the definition of improvements he favors, he hopes the differences in utility will, given a large enough group of people, somehow “cancel out.” In similar fashion, though some people may lose from each Marshall “improvement,” we shall probably benefit everyone given enough such changes.
Besides, Friedman asks, what better criterion is there? The alternative to his jerry-built structure “seems to be intuition: One thinks about a change and decides whether it is, on the whole, good, or bad” (p. 225). And surely here lies ruin. No one can calculate the consequences of a measure for the thousands who may be affected. However theoretically impure the Marshall improvement notion, it is the best we have.
Friedman’s cavalier reference to moral intuition manifests his apparently complete lack of acquaintance with moral philosophy other than the economistic sort he peddles. Has it ever occurred to our author that some moral theories do not depend on guesses as to the consequences of a measure for people’s happiness? Whatever happened to non-utilitarian rights?
Friedman would be entitled to dismiss competing theories of the good as relying on arbitrary intuition or as vague, only after a thorough study of these accounts. Absent this, he is a layman writing of areas beyond his ken. He bemoans the fact that non-experts, such as his father-in-law, presume to differ with him about economics; but he has no hesitation in passing judgment on “most of what we mean” by the good.
The author’s blinkered treatment of morality manifests a wider failing, present throughout the book. In a way that Austrians will approve, Friedman characterizes the theme of economics as “the implications, especially the non-obvious implications, of the fact that humans act rationally” (p. 3). But in order to “get anywhere,” Friedman thinks, we must assume that people have simple motives.
“Simple,” apparently, means “readily graspable by Mr. Friedman”; and to our author, nearly all rational behavior reduces to the pursuit of cash. He himself notes that “[m]oney is no more the only thing with value than yardsticks are the only thing with length” (p. 219), but it soon transpires that the warning is pro forma. Indeed, the very sentence following the warning is: “Life, health, wisdom, all have value provided someone is willing to give up money to get them.” How reassuring!
The extent of Friedman’s reductionism at times is staggering. Thus he can, with apparent seriousness, inquire why theft ought to be prevented. “From the standpoint of economic efficiency, it is not immediately obvious why. Theft appears to be merely a transfer; I lose $100 and the thief gains $100” (p. 306). Our author’s explanation of theft’s inefficiency will no doubt delight Judge Richard Posner; but the notion of the wrongness of the approach becomes even more apparent in Chapter 21, “The Economics of Love and Marriage”; but, to prevent accusations of caricature, I shall pass it by in silence.
When the author manages to stick to economics he is generally much better. Austrian readers will balk at some details: he allows negative time preference, uses indifference curves, and considers Smith, Ricardo, and Marshall the founders of modern economics. But he often explains matters with clarity, insight, and wit: his account of why owners of movie theaters charge high prices for popcorn is ingenious.
Yet even within his own specialty, not all is well. Friedman makes great play over the fact that economic analysis may have surprising implications. And one of his surprises is this: “You have just bought a house. A month later, the price of houses goes down. Are you worse off (your house is worth less) or better off (prices are lower)? Most people reply that you are worse off . . . It seems obvious that if a rise in the price of housing makes you better off, then a fall must make you worse off” (p. 34).
Mr. Friedman has a surprise. You are better off, even if the price of housing goes down, since you may now sell your house and buy a larger one. His diagram proves it: the price change enables you to land on a higher indifference curve (p. 35)! Unfortunately, our author has taken housing purely as a consumption good. For many people, a house is an important asset; and if its value falls, one has in a perfectly ordinary sense of the word in fact been made worse off.
No doubt Friedman is right that, given the change, his diagram shows how you may improve your position from what it would otherwise have been. But it does not follow from this that you are on the whole better off. Our author elsewhere warns against a fallacy of “naive price theory,” in which one wrongly assumes that whatever in a problem has not been specified to change remains the same (p. 21). It appears that Friedman, in assuming away the change in net worth caused by the price drop, falls victim to the fallacy himself.
And this is not the only questionable point. Does the fact that muggers prey on old ladies rather than football players suffice to show that they are nothing but “rational businessmen” (p. 299)? What if they enjoy terrorizing people weaker than themselves?
Friedman offers (p. 286) a “verbal proof” that under specified conditions, “American tariffs on net injure Americans” (p. 286). But his verbal proof fails to show this (though his mathematical proof does). He here shows only that a tariff cannot improve an efficient outcome. But he has not shown that only one outcome is efficient; absent a showing of uniqueness, he has not proved that a tariff must worsen things.
Whatever its failings, the book nevertheless is useful for showing the mind of a Chicago School epigone. Let us leave him as he contemplates “the hostility to money, especially in personal interactions, which seems typical of our society. Consider, for example, the number of men who would think it entirely proper to take a woman to an expensive restaurant in the hope of return benefits later in the evening, but would never dream of offering her money for the same objective” (p. 331). I know, I know: I said I wouldn’t quote from Chapter 21. But this was too much to resist.
