Earnings of labour, continued

Book 6, Chapter 5

§1. Workers need training and education whose value often outlasts capital equipment. Investing in such education requires a long time horizon. Parents might be better equipped to evaluate such an investment than their children or employers.

§2. Parents often choose potential trades (and training) for their children based on current trends, conditions and wages. Such a view  implies that future supply will be (mis)calibrated to past demand.

§3. That said, labor can and will switch between trades in direct proportion to workers’ ability to adapt skills to other work.

§4. Since labor skills are slow to change, it is not sure that they will be efficiently awarded for productivity or matched to demand at all times.

§5. The slow pace of change in labor supply means that workers will make excess profits when demand in their industry rises quickly but also face excess losses when demand flees.

§6. Ignoring wages, physical and mental stress will rise (fall) as demand for labor rises (falls).

§7. Although it may be tempting to describe the extra wages (or reduction in  effort) to good workers as “rents” (see 6.1), Marshall describes them as “lucky” — in explicit contrast to the losses and extra work that “unlucky” workers face from be mismatched into a job or trade that they might have a hard time leaving for another.


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Read: It’s 2021! Time to tidy your digital life and start some good micro-habits. (I usually delete articles like these, but there’s some good info here.)
  2. Read: Big data may not be very good for medical patients
  3. Read: Much as I suspected, COVID has changed dating… for the better.
  4. Read: As discussed in Jive Talking #88, the savings boom in the US (fed by the CARES act and reductions in spending) has played a big role in boosting asset prices: “This combination of soaring personal income and falling spending pushed Americans’ savings rate through the roof. From March through November, personal savings was $1.56 trillion higher than in 2019, a rise of 173 percent. Normally the savings rate bounces around in a narrow range, around 7 percent just before the pandemic. It spiked to 33.7 percent in April, its highest level on record dating to 1959.” Additional thoughts: Share prices are ALSO rising because monetary inflation (JPow’s money printer goes “brrrr”) is channeling into assets that have returns only slightly higher than 0% (or negative) returns on bonds. So the P/E ratios can climb way higher. What will cause a crash? Government budget surpluses or a cut in money supply, both of which are politically unpopular.
  5. Read: Global food prices are up 18%, to 6-year highs due to climate and politics. Next up food riots?
  6. Read: Applied game theory: Coordination
  7. Read: Humans created “social reality” to augment physical reality
  8. Listen: Why generalists (and “late starters”) are more successful than specialists
  9. Listen: A really interesting discussion of how economists over-emphasise “homo economicus” selfishness over our more generous natures.
  10. Watch (a few times): “A white guy drops a wicked freestyle rap

Earnings of labour, continued

Book 6, Chapter 4

§1. Wages might reflect custom more than current values. In cases where the interaction of supply and demand pushes down wages, workers’ difficult conditions are made worse.

§2. A businessman investing in machines (or slaves) will do so with the intention of future returns. Improvements to workers stays with those workers, which can lead to underinvestment by outsiders but efficient investment if the worker makes those decisions. (Marshall quotes Smith’s point that a slave-owner will not invest as wisely as the slave would themself.) While parents are eager to invest in their children (converting financial into human capital), it is easier for middle-class parents than working-class parents, which can trap generations in poverty.

§3. Within families, the father can earn wages to help the family and introduce his sons into trade, while the mother raises and improves children as they grow. Among the poor, fathers are often tired and mothers forced to work, leaving their children worse off in the present and future.

In a footnote on page 469, Marshall discusses the “net contribution” of migrant workers and warns against overvaluing men and undervaluing women due to the their joint-importance in raising children (the next generation of workers). This topic (migration, national accounts, and brain-drain) is still hotly debated.

§4. An employer’s investment in workers will only be partially repaid in higher output and profits, but a minority of employers invest as part of their overall quest for performance. Their workers will benefit immediately, as will their families. A majority of employers will not invest more than they immediately get back — weakening future returns to themselves, their workers and society.

§5. The location and quality of the workplace matters. Workers will demand higher wages in dirty or dangerous workplaces. A big distance between home and workplace limits the supply of labor unless wages rise. Immobile workers have fewer options and lower wages. Related:  US-labor mobility is at an all-time low:

§6. Workers who lose their jobs lose wages. If they do not have reserve savings, they suffer from a lack of necessities as well as a decline in their labor value based on greater hunger and poverty. (The homeless are challenged by a lack of an address for employers, bad sleeping conditions, needing to buy food “by the plate” and other burdens.) Workers with special skills and/or union membership will have greater job security and earn a larger share of their “value added.”


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Listen: Ezra looks back on 5 years of his podcast. Lesson #1: Do the reading
  2. Watch: A coup in the US? It’s unlikely but less unlikely with Trump’s rhetoric
  3. Read: What we know about COVID after one year
  4. Read: Nature is not healing. We need to dial back way more if we want that.
  5. Read: Rich countries (US, UK) are facilitating corruption in poor countries
  6. Read: The “Russia hack” is way way bigger than anyone thought
  7. Listen: A CEO makes the case for bitcoin as an inflation hedge
  8. Listen: The art of rest
  9. Listen: A health economist of the (response to the) pandemic (hint: it’s a collective action problem)
  10. Read: The unexpected beginnings of ARM computing
  11. Read: A surprising and (not) shocking of fast decisions leading to poor results: Thousands of ships are now burning toxic dangerous “green” oil
  12. Read: You think Facebook is bad? Data privacy in India is a disaster.
  13. Watch: President Obama, elder statesman, has good opinions
  14. Read: Is purity or compromise better?

Review: The Fatal Conceit

Friedrich Hayek (1899-1992) published this book in 1988 as his last word in opposition to socialism. I read it to “update” myself on his thinking since The Road to Serfdom (1944) and “The use of knowledge in society” (1945) — an article I regularly recommend to students.

This book is full of insights on how individuals with distributed knowledge coordinate their actions (so this “review” will be long with his words), but Hayek also throws out the baby (the importance of social management of collective goods) with the bathwater (the dangers of centralized, “rational” social control). Given my interest and the global importance of the commons and environment (both social, or non-excludable goods), I think that Hayek — like Milton Friedman — could have delivered a sharper message. But most of this review focuses on what Hayek gets right.

Chapter 1: Between instinct and reason

This book argues that our civilisation depends, not only for its origin but also for its preservation, on what can be precisely described only as the extended order of human cooperation, an order more commonly, if somewhat misleadingly, known as capitalism. To understand our civilisation, one must appreciate that the extended order resulted not from human design or intention but spontaneously: it arose from unintentionally conforming to certain traditional and largely moral practices, many of which men tend to dislike, whose significance they usually fail to understand, whose validity they cannot prove, and which have nonetheless fairly rapidly spread by means of an evolutionary selection – the comparative increase of population and wealth – of those groups that happened to follow them. The unwitting, reluctant, even painful adoption of these practices kept these groups together, increased their access to valuable information of all sorts, and enabled them to be ‘fruitful, and multiply, and replenish the earth, and subdue it’ (Genesis 1:28). This process is perhaps the least appreciated facet of human evolution.

Socialists take a different view of these matters. They not only differ in their conclusions, they see the facts differently. That socialists are wrong about the facts is crucial to my argument, as it will unfold in the pages that follow… If it were for instance true that central direction of the means of production could effect a collective product of at least the same magnitude as that which we now produce, it would indeed prove a grave moral problem how this could be done justly. This, however, is not the position in which we find ourselves.

[snip]

The main point of my argument is, then, that the conflict between, on one hand, advocates of the spontaneous extended human order created by a competitive market, and on the other hand those who demand a deliberate arrangement of human interaction by central authority based on collective command over available resources is due to a factual error by the latter about how knowledge of these resources is and can be generated and utilised (pp 6-8).

These opening paragraphs focus on the main issue, which is not morality but prosperity. Socialists who fail to understand this difference often suggest that equal access to the means of production will lead to equal outcomes from the fruits of production (“From each according to his ability, to each according to his needs“) when (a) that doesn’t happen and (b) capitalism’s job is to create wealth while the state’s job is to redistribute it (so-called “mixed economies”).

Why are (would-be) socialists or those sympathetic to socialism so often mislead? Hayek points the finger at our limited capacity to comprehend our complex social systems:

They [human instincts] were adapted to life in the small roving bands or troops in which the human race and its immediate ancestors evolved during the few million years while the biological constitution of homo sapiens was being formed. These genetically inherited instincts served to steer the cooperation of the members of the troop, a cooperation that was, necessarily, a narrowly circumscribed interaction of fellows known to and trusted by one another… The primitive individualism described by Thomas Hobbes is hence a myth. The savage is not solitary, and his instinct is collectivist. There was never a ‘war of all against all’. (pp 11-12)

Hayek calls our collective and innate instincts natural morality, defining “morality” as “those non-instinctive rules that enabled mankind to expand into an extended order” (p. 12). Hayek places morality between natural morality (a non-scaleable concern for one’s tribe) and rationality (a non-scaleable assumption that one can design the mechanism for converting resources into desired outcomes). Hayek’s morality allows us to compete with strangers (as we would not with “family”) in ways that convert our greed into gains (“as if guided by an invisible hand”) that we would never (in a tribe) knowingly share with other strangers:

In our economic activities we do not know the needs which we satisfy nor the sources of the things which we get. Almost all of us serve people whom we do not know, and even of whose existence we are ignorant; and we in turn constantly live on the services of other people of whom we know nothing. All this is possible because we stand in a great framework of institutions and traditions – economic, legal, and moral – into which we fit ourselves by obeying certain rules of conduct that we never made, and which we have never understood (p. 14).

How did these morals develop? As Joseph Heinrich explained in The Secret of Our Success (2015), they emerged as cultural evolution favored tribes willing to exchange with non-blood relatives over tribes held back by kin loyalty (Hayek cites much older sources). As a result, we created context-dependent loyalties:

If we were to apply the unmodified, uncurbed, rules of the micro-cosmos (i.e., of the small band or troop, or of, say, our families) to the macro-cosmos (our wider civilisation), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were always to apply the rules of the extended order to our more intimate groupings, we would crush them. So we must learn to live in two sorts of world at once. To apply the name ‘society’ to both, or even to either, is hardly of any use, and can be most misleading (p. 18, emphasis in original).

In those two worlds, it is necessary to Think Fast and Slow (2011) in discriminating between instincts (Type 1 thinking) and learnt rules (Type 2 thinking), and competition drove this process: “Competition is a procedure of discovery, a procedure involved in all evolution, that led man unwittingly to respond to novel situations; and through further competition, not through agreement, we gradually increase our efficiency” (p. 19). To Hayek, the most important word in that description is “unwittingly,” which refers both to the unintentional way that humans have improved their condition and the difficulty of wittingly designing improvements (the “fatal conceit”) — a concern at the center of Scott’s brilliant Seeing Like a State (and more recent Two Cheers for Anarchism).

And out of this concern, Hayek harkens to an old-fashioned (think Burke vs Paine) version of conservatism:*

Learning how to behave is more the source than the result of insight, reason, and understanding. Man is not born wise, rational and good, but has to be taught to become so. It is not our intellect that created our morals; rather, human interactions governed by our morals make possible the growth of reason and those capabilities associated with it. Man became intelligent because there was tradition – that which lies between instinct and reason – for him to learn. This tradition, in turn, originated not from a capacity rationally to interpret observed facts but from habits of responding. It told man primarily what he ought or ought not to do under certain conditions rather than what he must expect to happen.

[snip]

It is less accurate to suppose that thinking man creates and controls his cultural evolution than it is to say that culture, and evolution, created his reason. In any case, the idea that at some point conscious design stepped in and displaced evolution substitutes a virtually supernatural postulate for scientific explanation. So far as scientific explanation is concerned, it was not what we know as mind that developed civilisation, let alone directed its evolution, but rather mind and civilisation which developed or evolved concurrently.

[Thus…]

Just as instinct is older than custom and tradition, so then are the latter older than reason: custom and tradition stand between instinct and reason – logically, psychologically, temporally (pp. 21-23).

Hayek then repeats the oft-forgotten fact that Darwin read Smith’s Wealth of Nations before he came up with a theory of evolution. Darwin borrowed from Smith’s ideas of undirected, beneficial social evolution (“as if guided…”) when looking at the much-longer process of natural selection. Sociologists, likewise, claim “group selection” explains why some cultures succeed over others, without guidance, in continuously changing circumstances, i.e., “biological and cultural evolution… rely on the same principle of selection: survival or reproductive advantage… Not only does all evolution rest on competition; continuing competition is necessary even to preserve existing achievements,” regardless of what we consider fair or rational: “I do not claim that the results of group selection of traditions are necessarily ‘good’ – any more than I claim that other things that have long survived in the course of evolution, such as cockroaches, have moral value” (pp. 26-27).

…and that’s the first chapter. If you’ve made it this far, I suggest taking a short break to think over these ideas, since they underpin the rest of the book.

2: The origins of liberty

Liberty was not given as much as taken by the Mediterranean merchants who would leave oppressive for welcoming ports, taking their custom with them. In this early (pre-Roman) period, private property was synonymous with individual freedom. Slaves lived the difference. Traders knew the difference. Tribes did not know the difference, so their members were caught in a collective, protective — and stifling — safety net. Some Greek philosophers (Aristotle, Plato) disliked private property, and their influence might explain how the Greeks lost out to pro-property, pro-market Rome.

There is a tension between ruler’s desire to tax and control and their subjects’ desire to protect their money and autonomy. Individual and state prosperity suffered when the state was too strong. Paradoxically, strength came from weakness:

The revival of European civilisation during the later Middle Ages… owes its origins and raison d’être to political anarchy. It was not under the more powerful governments, but in the towns of the Italian Renaissance, of South Germany and of the Low Countries, and finally in lightly-governed England, i.e., under the rule of the bourgeoisie rather than of warriors, that modern industrialism grew. Protection of several property, not the direction of its use by government, laid the foundations for the growth of the dense network of exchange of services that shaped the extended order (p 33).

From these experiences, philosophers such as Locke argued that private property, justice and freedom went hand-in-hand, since the right to property could be interpreted to include oneself as well as one’s land, possessions and ideas (The Declaration of Independence very nearly said “life, liberty and property”). More recent examinations of “property rights” have veered into novel but important areas, e.g., Coase’s “Nature of the Firm” (where does control start and stop) and “Problem of Social Costs” (the right to pollute — or not be polluted).

Hayek thinks the application of property rights to ideas, patents, and copyright slows their exchange and thus learning and innovation.

3. The evolution of the market

“Modern archaeology confirms confirms that trade is older than agriculture or any other sort of regular production” (p39) — read my review of Jacobs (1969) for more support of Hayek’s rejection of the conventional wisdom of agriculture preceding trade or towns. From trade came norms of hospitality (and protection) for strangers, an appreciation of different ideas, and specializations in sourcing raw materials and crafted goods. Crossroads grew into towns and towns into cities. Cooperation was expected. Surpluses allowed more people to live better lives.

Rebels added bridging social capital to the bonding social capital of their home communities:

In any case, some individuals did tear away, or were released, from the hold and obligations of the small community, and began not only to settle other communities, but also to lay the foundations for a network of connections with members of still other communities – a network that ultimately, in countless relays and ramifications, has covered the whole earth (p. 42).

Historians and archaeologists can be biased by evidence, crediting rulers and bureaucrats (who left behind buildings, laws and records) instead of individuals for successes. Their informal, bottom up actions left few traces but delivered more prosperity. Rulers, sadly, preferred their control over people’s prosperity:

What led the greatly advanced civilisation of China to fall behind Europe was its governments’ clamping down so tightly as to leave no room for new developments, while… Europe probably owes its extraordinary expansion in the Middle Ages to its political anarchy (p. 45). 

…and China has not changed: President Xi’s need for control is more important than freedom (and prosperity) in Hong Kong — something I worried about on my first (and last) visit to HK in 2018.

Aristotle admired oiknomia (home economics) but not markets. He preferred autarky (self-sufficiency), so he was not an economist. His (surviving) writings omit discussion or understanding of evolution or self-organizing phenomena. His insistence that nature and human activities must be organized (via taxonomy) before they could be accepted or understood left him and his followers blind to most evolutionary successes.

Aristotle (and many religions) opposed interest, free prices, and profits. Rulers who embraced the insights of Hume and Smith (“one can serve another without kind intentions”) gave space for undirected but mutually beneficial trade. The move from feudalism and tribalism towards bourgeois dignity and a “propensity to truck barter and exchange” created wealth that was distributed through a self-organized system that no individual could understand, explain or control.

4. The revolt of instinct and reason

Enlightenment thinkers such as Decartes raised the profile of reason at the expense of tradition, sometimes pursuing “scientism” to the point of discarding “irrational” but functional institutions in favour of rational but dysfunctional replacements. Rousseau opposed rationalism with admiration for the “noble savage” but his admiration of “animal instinct” and “the will of the people” discarded thousands of years of tradition that had delivered — without design — the civilisation that supported Rousseau and others.

It’s hard to be an individualistic noble savage if you don’t have freedom for yourself or your property, but that “bug” was a “feature” to those — like Rousseau — who favoured collectivism over property. Academics and intellectuals (e.g., Marx) mythologize the past as they espoused flawed ideologies on putting humanity on the socially engineered path to a workers paradise.

One’s initial surprise at finding that intelligent people tend to be socialists diminishes when one realises that, of course, intelligent people will tend to overvalue intelligence, and to suppose that we must owe all the advantages and opportunities that our civilisation offers to deliberate design rather than to following traditional rules, and likewise to suppose that we can, by exercising our reason, eliminate any remaining undesired features by still more intelligent reflection, and still more appropriate design and ‘rational coordination’ of our undertakings. This leads one to be favourably disposed to the central economic planning and control that lie at the heart of socialism. Of course intellectuals will demand explanations for everything they are expected to do, and will be reluctant to accept practices just because they happen to govern the communities into which they happen to have been born (pp. 53-54).

Hayek’s complaint here echoes that of Vincent and Elinor Ostrom, both of whom spent their careers understanding and explaining how informal institutions emerged, evolved and prevented “common pool situations” from turning into “common pool dilemmas” (or tragedies).

Hayek lists four ideas (rationalism, empiricism, positivism and utilitarianism) that “scientific” people implicitly accept before delving into the presuppositions that support those ideas, i.e.,

  1. The idea that it is unreasonable to follow what one cannot justify scientifically or prove observationally (Monod, Born).
  2. The idea that it is unreasonable to follow what one does not understand (Popper).
  3. The related idea that it is unreasonable to follow a particular course unless its purpose is fully specified in advance (Einstein, Russell, Keynes).
  4. The idea, also closely related, that it is unreasonable to do anything unless its effects are not only fully known in advance but also fully observable and seen to be beneficial (the utilitarians).

“To what purpose tradition, suffering or obedience?” Hayek answers:

…intellectuals from Rousseau to such recent figures in French and German thought as Foucault and Habermas regard alienation as rampant in any system in which an order is ‘imposed’ on individuals without their conscious consent…

On a less sophisticated level than the argument against ‘alienation’ are the demands for ‘liberation’ from the burdens of civilisation – including the burdens of disciplined work, responsibility, risk-taking, saving, honesty, the honouring of promises, as well as the difficulties of curbing by general rules one’s natural reactions of hostility to strangers and solidarity with those who are like oneself – an ever more severe threat to political liberty.

Everywhere, in the name of liberation, people disavow practices that enabled mankind to reach its present size and degree of cooperation because they do not rationally see, according to their lights, how certain limitations on individual freedom through legal and moral rules make possible a greater – and freer! – order than can be attained through centralised control (pp. 64-65).

5. The fatal conceit

Traditions, institutions and beliefs…  may be seen, as is especially fashionable today, as sources of alienation and oppression, and of ‘social injustice’. After such objections, the conclusion is reached that there is an urgent need to construct a new, rationally revised and justified morality which does meet these requirements (p. 67). 

What’s the danger of pursuing rationality?

If we stopped doing everything for which we do not know the reason, or for which we cannot provide a justification in the sense demanded, we would probably very soon be dead  (p. 68). 

Economists’ models of “rational” behaviour, expectations and so on, contribute to problems because they are used to argue for bad policies, such as those that contributed to the 2007+ financial crisis (read more and more).

Hayek explains how the “extended order” in which we live and which contributes so much to our prosperity is “transcendent”, i.e., beyond our understanding and thus immune to rationalist design and control. Those who ignore such orders are counterproductive (“decimal time” in revolutionary France) or dangerous (the Khmer Rouge killed ~2 million citizens in their quest to reset society to Year 0).

Turning to the opposite side of “it must fit in my brain box”, Hayek warns against an obsession with “moral” rules. Many people do good things for reasons outsiders cannot understand: “As if guided by an invisible hand” applies in markets as well as social situations. A requirement to “justify your actions” is not just a waste of time but a version of petty fascism. Who cares why consenting adults — whether they know each other or not — do what they do. (I give “reddit gold” anonymously to strangers whose ideas and words I like; they don’t need to know why.)

Civilisation is not only a product of evolution – it is a process; by establishing a framework of general rules and individual freedom it allows itself to continue to evolve. This evolution cannot be guided by and often will not produce what men demand. Men may find some previously unfulfilled wishes satisfied, but only at the price of disappointing many others. Though by moral conduct an individual may increase his opportunities, the resulting evolution will not gratify all his moral desires. Evolution cannot be just (p. 74). 

…and that means that the impacts of actions and choices, structures and relations should not — and cannot — be judged ex-ante or even ex-post, as impacts are partially felt and unevenly distributed days, years and centuries later. Hayek’s statement of this perspective is famous for those of us who play the Econtalk drinking game:

If we had deliberately built, or were consciously shaping, the structure of human action, we would merely have to ask individuals why they had interacted with any particular structure. Whereas, in fact, specialised students, even after generations of effort, find it exceedingly difficult to explain such matters, and cannot agree on what are the causes or what will be the effects of particular events. The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design (p. 76). 

I often think of this curious task when teaching, as one of my main jobs is convincing students that “it’s not as easy as you think.” That said, way back in 1995, I remember sitting in Sienna as a 25-year old with ambitious plans for government reform. (My plans, sadly, are lost. Government will have to struggle without me.)

Hayek then explains how decentralised information recommends decentralised  decisions in markets and politics (what the Ostrom’s called “polycentricity” [pdf]). Hayek reinforces these points by citing long human childhoods (necessary for understanding social norms), different sets of moral rules (allowing experimentation and adaptation), and diversification (individuals coming together to exchange based on their several talents, ideas and assets).

In calling for such humility, Hayek attracts opposition, i.e., “the individual can no longer know whose needs his efforts do or ought to serve… Directing his productive efforts altruistically thus becomes literally impossible for him… for intellectuals generally, the feeling of being mere tools of concealed, even if impersonal, market forces appears almost as a personal humiliation” (pp. 81-82). These words remind me of Peter Singer’s (utilitarian) quest to shame people for prioritising care for neighbours over the distant, anonymous poor. I think Singer is misguided. Hayek would probably call him dangerous.

Turning against Hayek, I think he misses an important role for the bureaucrats he despises: “Attempts to intervene in spontaneous order rarely result in anything closely corresponding to men’s wishes, since these orders are determined by more particular facts than any such intervening agency can know” (p. 84). I am not sure where he would stand on correcting market failures (such as pollution) via regulations and/or taxes, but I think those interventions are necessary and useful.

Hayek ends with an appeal to respect institutions that distribute power to those possessing the local and tacit knowledge needed to make good decisions.

6. The mysterious world of trade and money

A “primitive minds” distrusts a win-win transaction (e.g., I sell you a hamburger) because it is accustomed to simple win-lose interactions among peers (more meat for you means less meat for others) rather than mutually beneficial, impersonal exchanges based on comparative advantage. When I teach economics, I must always explain the differences among cost, price and value — concepts that many assume are interchangeable.

Trade – regarded as real work or not – brought not only individual but also collective wealth through effort of brain rather than of muscles. That a mere change of hands should lead to a gain in value to all participants, that it need not mean gain to one at the expense of the others (or what has come to be called exploitation), was and is nonetheless intuitively difficult to grasp (p. 93). 

Many people still prefer “honest” physical labor over the “alchemy” of ideas, innovations and value gradients. Marx’s obsession with the labor theory of value blinded him to the means in which capital multiplied the value of labor as well as the gains from trade arising from differences in talent, resources and taste. These fears only multiply when the marketplace under consideration expands beyond a few vendors or small-scale manufacturers to larger markets and longer supply chains that no individual (due to the knowledge problem) can ever hope to understand. For some people, it is fine to believe in an almighty, all-seeing god (who plays no role in our daily lives) but totally wrong to believe in the “magic of markets” delivering goods made by some strangers for the benefit of other strangers. Markets are autonomous, complex and robust — like ecosystems. People accustomed to simplifying ecosystems into gardens and food courts will also try to simplify markets into good, bad, ethical, and so on. Anyone who has studied (or operated) supply chains will know that such descriptors (let alone KPIs) are nearly impossible to measure or apply to supply chains.

That said, Hayek claims (correctly) that prices help us navigate this complexity as buyers of goods or sellers of inputs. Prices can be wrong if they ignore the costs of  “negative externalities” (such as pollution) or reflect a monopolist’s market power, but even flawed prices are better than no prices. We have not found any mechanism better suited to coordinating self-interested strangers than the invisible hand.

Money, interest, borrowing and lending are feared for their complexity (see, e.g., debates over fractional vs full-reserve banking), which leads to bad policies, resource waste, and greater income inequality (those who “get it” grow wealthier). Politicians, of course, have sometimes neglected citizens. Inflationary spending harms savers and the poor while saving debtors from accountability and the rich from taxes. In 2020, short term (MZM) money supply jumped by 25% in the US — a rate far greater than historic norms.

7. Our poisoned language

Understanding and cooperation require a common language. In some cases, language for new ideas needs to be invented (e.g., “telephone” to “mobile phone” to “zoom”). In other cases, language based on “erroneous theory” sows confusion and division. I see this problem with “post-modern” thinking faffing, but Hayek worries (justly) about socialists who attribute order to design when “observed order” actually results from an evolutionary process. Likewise, discarding the “state” for “society” is dangerous because it trades accountable known people for an unaccountable nebulous “movement.”

Building on this statement, Hayek then looks into the (mis)use of “liberal,” “capitalism” and “socialism” — terms with a variety of (sometimes) contradictory meanings. “Capitalists” and the “proletariat,” for example, are portrayed as opponents when they actually benefit each other.

One of the oldest terms… societas, from socius [Latin], the personally known fellow or companion… has been used to describe both an actually existing state of affairs and a relation between individuals… To call by the same name such completely different formations as the companionship of individuals in constant personal contact and the structure formed by millions who are connected only by signals resulting from long and infinitely ramified chains of trade is not only factually misleading but also almost always contains a concealed desire to model this extended order on the intimate fellowship for which our emotions long (p. 112-3)

Thus, we are confused when people use “social” to refer to small groups joined by personal relations as well as larger groups joined by impersonal norms.

Hayek lists over 160 nouns that are qualified by “social” (e.g., “social animal” or “social justice”), to show how those claiming (social) legitimacy try to avoid accurate terms that deliver less authority: “The traditional term for what is now called the ‘social state’ was ‘benevolent despotism’, and the very real problem of achieving such despotism democratically, i.e., while preserving individual freedom, is simply wished away by the concoction ‘social democracy’” (p. 117).

Hayek warns that social justice warriors’ support for redistributive interventions undermines the market forces that bring wealth and “society.” Although I agree with his point, note that some “social” measures (regulating bad behaviour, taxing wealth, subsidizing public goods, and reducing inequality) can be designed and implemented in ways that allow for individual decisions, market-efficiency and overall prosperity.

8. The extended order and population growth

It is, then, not simply more men, but more different men, which brings an increase in productivity. Men have become powerful because they have become so different: new possibilities of specialisation – depending not so much on any increase in individual intelligence but on growing differentiation of individuals – provide the basis for a more successful use of the earth’s resources This in turn requires an extension of the network of indirect reciprocal services which the signalling mechanism of the market secures. As the market reveals ever new opportunities of specialisation, the two-factor model, with its Malthusian conclusions, becomes increasingly inapplicable. (pp. 122-123). 

Although Hayek is right about the development and deepening of markets, he overlooks population- and growth-related issues as they affect the commons, which (by definition, due to missing property rights) are not amenable to market incentives or solutions. Hayek indirectly invokes such a caveat:

As long as an increase in population has been made possible by the growing productivity of the populations in the regions concerned, or by more effective utilisation of their resources, and not by deliberate artificial support of this growth from outside [=negative externalities], there is little cause for concern (p 124).

…but then fails to admit its relevance:

There is no danger whatever that, in any foreseeable future with which we can be concerned, the population of the world as a whole will outgrow its raw material resources, and every reason to assume that inherent forces will stop such a process long before that could happen (p. 125).

This bold statement is just wrong, and the fact that Hayek cites Julian Simon (see this post and this review) confirms his myopia with respect to non-excludable goods.

Hayek argues that population growth should be allowed to run its course and that humans will “find a way” to live sustainably, innovate solutions and thrive. Such hopes are misplaced as long as politicians and communities fail to manage their collective goods and markets continue to “grow artificially” using outside (non-priced) resources, as we can see with climate chaos, crashing biodiversity and increasing water scarcity.

9. Religion and the guardians of tradition

Hayek and I agree that “If God did not exist then it would be necessary to invent Him.” But the existence of so many religions — in contradiction to Voltaire’s gist — provides evidence of their social value. How do religions help? They use stories, beliefs and superstition to direct individuals towards choices that benefit the group.

In any case, the religious view that morals were determined by processes incomprehensible to us may at any rate be truer (even if not exactly in the way intended) than the rationalist delusion that man, by exercising his intelligence, invented morals that gave him the power to achieve more than he could ever foresee. If we bear these things in mind, we can better understand and appreciate those clerics who are said to have become somewhat sceptical of the validity of some of their teachings and who yet continued to teach them because they feared that a loss of faith would lead to a decline of morals. No doubt they were right; and even an agnostic ought to concede that we owe our morals, and the tradition that has provided not only our civilisation but our very lives, to the acceptance of such scientifically unacceptable factual claims. (p. 137). 

Collective well-being also helps religions survive. Judaism may have strange rules (no cheeseburgers, closed for Shabbat, etc.), but you can’t deny its long-running (3,500+ years) benefits to the Jewish community. Other religions (e.g., Communism) are doomed (recall this book is from 1988) because they denounce property and family, thereby undermining their current effectiveness and future prospects.

Hayek reminds readers that we have come this far without knowing why we believe, act or hesitate in certain situations. Taking success as the ultimate measure, he recommends we put our faith into the evolved institutions that have brought collective prosperity rather than the “rational” schemes offered by scientists, visionaries and quacks.

This “review” is now over 5,300 words, so congratulations for reading so far! I hope this review helps you understand (or decide to read) this excellent book. I think Hayek is 90 percent right and 10 percent wrong (mostly regarding collective goods) in his argument and analysis of how private decisions can combine to create positive collective outcomes. I give this book FIVE STARS.


* I definitely recommend you read “Why I am not a conservative,” an excerpt from Hayek’s 1960 Constitution of Liberty. In that short accessible essay, you will see how Hayek worried about radicals from the Right as much as the Left.


Here are all my reviews.

Earnings of labour

Book 6, Chapter 3

§1. This chapter looks more deeply into the factors (e.g., natural skills or experience) affecting wages, as later chapters will examine business profits and land rents.

§2. The prices of commodities vary with their quality or the terms of sale, so wages for (more irregular) labor will very more. Assuming a competitive labor market and similar capital inputs, then we will see a greater difference in wages between workers with different skills (i.e., efficiency). Put differently, wages will be equal for workers of different skill if laws prohibit wage discrimination or if there is little competition. More interesting (or counterintuitive), it makes sense to pay more to higher skilled workers because they can operate expensive machinery more efficiently and produce  more output per hour per machine than the less skilled.

§3. Real wages, unlike nominal wages (cash payments), depend on the cost of living and the mix of goods workers consume. (They usually care more for the price of bread than the price of opera tickets.)

§4. Gross wages do not translate into real wages as it is necessary to deduct the cost of education, special tools, and other expenses needed to do one’s job. In some cases, those expenses may include membership to a club, fancy clothes, etc. (My dad was a real estate agent in Southern California, where a fancy car is de rigeur.)

§5. The employee’s value of non-cash “wages” often differs from their cost to the employer, so it’s a mistake to assert their value based on cost, price or some other number. In some cases, the value is less than the cost; in others the opposite (read Marshall’s footnote on scams). It’s no problem that these matters affect employer-employee dynamics. It’s a problem when outsiders misunderstand how values, prices and costs affect decisions.

§6.  A 50% chance of earning either x or 3x is less valuable than 100% chance at 2x (cf. Book 3, Chapter 6). Entry-level workers will accept below-market wages if they can potentially be promoted to above-market-wage positions (young men often take these odds). To compensate for the “anxiety and worry of waiting,” irregular employment requires higher wages than steady employment.

§7. Besides the worker’s wages, it’s important to consider the situation (e.g., potential jobs and wages) affecting the worker’s family.

§8. The attraction of a trade — and thus its wage level — depends on the tastes, skills, background, social position of potential workers. Some are willing to accept jobs others won’t. After lamenting that “the progress of science has kept alive many  people who are unfit for any but the lowest grade of work” (p 464), Marshall explains that some jobs are kept dirty (not made attractive to skilled workers) employers know they can save money by hiring the lowest classes to do them. “There is no more urgent social need than that labour of this kind should be made scarce and therefore dear” (p 464).


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Preliminary survey of distribution, continued

Book 6, Chapter 2

§1. Labor earnings are not — as some assert — only a function of the “value” of production. They depend on the supply of labor relative to demand for labor.

§2. Workers, like machines, need time to recover from work. The first hours of work are easier than the last hours but wages are paid at the margin (i.e., to motivate those last hours of work), which implies that workers gain much more surplus from their earlier hours of work. That said, some workers (“from Southern climes”) may see higher wages as an incentive to stop working earlier, since they more quickly hit their “earnings target.”

§3. The supply of labor should increase with wages, assuming higher wages increase productivity-enhancing (e.g., good food or entertainment) rather than productivity-weakening (e.g., alcohol and gambling) consumption.

[D]emand and supply exert coordinate influences on wages; neither has a claim to predominance; any more than has either blade of a pair of scissors, or either pier of an arch. Wages tend to equal the net product of labour; its marginal productivity rules the demand-price for it; and, on the other side, wages tend to retain a close though indirect and intricate relation with the cost of rearing, training and sustaining the energy of efficient labour. The various elements of the problem mutually determine (in the sense of governing) one another; and incidentally this secures that supply-price and demand-price tend to equality: wages are not governed by demand-price nor by supply-price, but by the whole set of causes which govern demand and supply (p 442).

§4.

We have seen that the accumulation of wealth is governed by a great variety of causes: by custom, by habits of self-control and of realizing the future, and above all by the power of family affection: security is a necessary condition for it, and the progress of knowledge and intelligence furthers it in many ways. But though saving in general is affected by many causes other than the rate of interest: and though the saving of many people is but little affected by the rate of interest; while a few, who have determined to secure an income of a certain fixed amount for themselves or their family, will save less with a high rate than with a low rate of interest: yet a strong balance of evidence seems to rest with the opinion that a rise in the rate of interest, or demand-price for saving, tends to increase the volume of saving.

…that said, higher interest only gradually attracts more capital since it takes time to reallocate capital from existing investments.

§5. Increases in the supply and productivity of labor and capital (and thus returns to either) lead to increases in national income, for the benefit of all. Land is different because it is fixed in quantity, which means that increased land use by one user leaves less land for others.

§6. Increases in national income benefits factors in proportion to demand for each of those factors. Higher returns to a factor dampen demand for it as cheaper alternatives are investigated, with a long-run result of factor prices tracking their “real” contribution to productivity.

§7. An increase in the supply of a factor will lower returns to that factor and benefit other factors that that combine with that input without lowering their returns. In general, factors will be able to buy as much as their productivity (=wages) implies, with more productive or scarce factors having more “buying power” than less productive or abundant factors.

§8. Do not assume “perfect information” of any factors but labor and capital are always looking for opportunities.

§9. Since capital can also be understood as the embodiment of past labor, it is better to see capital-labor competition as past vs present labor. Greater savings (or patience) will increase the stock of capital, which can increase labor productivity but also displace demand for labor!

§10. Although labor contributes to finishing products on behalf of capital, most wages to labor are advanced by capitalists planning to repay those advances by selling consumption goods and using (new) capital goods.

Capital in general and labour in general co-operate in the production of the national dividend, and draw from it their earnings in the measure of their respective (marginal) efficiencies. Their mutual dependence is of the closest; capital without labour is dead; the labourer without the aid of his own or someone else’s capital would not long be alive. Where labour is energetic, capital reaps a high reward and grows apace; and, thanks to capital and knowledge, the ordinary labourer in the western world is in many respects better fed, clothed and even housed than were princes in earlier times (p 452).


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Read: Mafiosi protected those making “The Godfather” (a film about them)
  2. Read: “No Frenchman worthy of the name has ever apologized for anything, and I’m certainly not going to start. Obviously the English word “snob” is an inaccurate description, since a snob is someone who thinks he’s superior, which is different from a Frenchman, who knows he’s superior.” Funny but also insightful.
  3. Listen: An interesting podcast on financing development in Africa
  4. Read: “Ravens parallel great apes in physical and social cognitive skills” but we knew this, didn’t we, from The Hobbit (1937).
  5. Read: Is it easier to become a billionaire if you’re an asshole? No.
  6. Listen: Biden’s top economist is into sustainability
  7. Read: “History suggests it might be better to regard pandemics less as crises than as occasions for political ‘reckoning’ that may – or may not – see the resolution of long-standing social and economic grievances.”
  8. Listen: “Stakeholders gone wrong” consultations over neighborhood land use
  9. Interesting data:

…and that’s all the “interesting stuff” I have for you in 2020.

See you in 2021!

The distribution of the national income

Book 6, Chapter 1

§1. Marshall’s thoughts on national income are too good to summarise (p 418):

The keynote of this Book is in the fact that free human beings are not brought up to their work on the same principles as a machine, a horse, or a slave. If they were, there would be very little difference between the distribution and the exchange side of value; for every agent of production would reap a return adequate to cover its own expenses of production with wear-and-tear, etc… But as it is, our growing power over nature makes her yield an ever larger surplus above necessaries; and this is not absorbed by an unlimited increase of the population. There remain therefore the questions: What are the general causes which govern the distribution of this surplus among the people? What part is played by conventional necessaries, i.e. the Standard of Comfort? What by the influence which methods of consumption and of living generally exert on efficiency; by wants and activities, i.e. by the Standard of Life? What by the many-sided action of the principle of substitution, and by the struggle for survival between hand-workers and brain-workers of different classes and grades? What by the power which the use of capital gives to those in whose hands it is? What share of the general flow is turned to remunerate those who work (including here the undertaking of ventures) and “wait,” as contrasted with those who work and consume at once the fruits of their endeavours?

Recall that Marshall is writing in 1920, whereas GDP was “invented” in 1934. His points above were (and are) often forgotten by people focussing on the size, rather than the distribution, of GDP.

§2. Marshall delves into historic thinking about labor and capital. He summarises the views of France’s 17th century physiocrats and Malthus as variations on “iron laws” in which capital comes and goes as taxes fall and rise, and labor supply rises and falls as food is plentiful or scarce, respectively. From these views came the idea of “laisser faire, laisser passer“, which advises the King to raise revenues by taxing landowners’ surplus rents (capital and labor having no surplus in equilibrium) while leaving everyone else to do what they like (laissez faire is the expression we’re more familiar with). Adam Smith, David Ricardo, et al. did not agree with these “laws;” instead, they focussed on incentives, e.g., higher wages lead to greater effort, not more children. These thoughts had evolved by Marshall’s time into an empirical investigation of how higher productivity could cause (permanently) higher wages, thereby introducing questions of distribution among “rich” and “poor” labor.

§3. To explain distribution, Marshall begins with an imaginary world in which capital and resources are “free,” and everyone can do any job. In this world, wages and prices are directly proportional to effort (labor theory of value), and increases in labor productivity make everyone better off, i.e., consuming more goods for the same labor input.

§4. Specialisation does not change these relations, since anyone can change trades (with some time), but it does increase the diversity of goods/services on offer.

§5. Population growth brings an increase in demand and diminishing returns on land-based food production. With higher prices for food, land “rents” will grow faster than returns to labor or capital.

§6. By adding back obvious factors affecting labor (mobility, tradition, law and morality), Marshall approaches realism, and unequal returns to labor emerge.

§7. Marshall adds realistic assumptions on capital, i.e., that capital is limited and “lumpy” (not matching each unit of labor). Now managers must match labor and capital “on the margin,” in two ways. First, each labourer’s additional production must exceed their wages. Second, management should decide based on marginal rather than average values. Although economists had been advocating “marginal thinking” for several decades before Marshall’s Principles, he still played an important role in explaining how such thinking was useful for making business decisions.

§8. Interest rates push capital from wasteful to useful investments, since (in)efficient investments (lose) make money.

§9. In sum, “every agent of production, land, machinery, skilled labour, unskilled labour, etc., tends to be applied in production as far as it profitably can be. If employers, and other business men, think that they can get a better result by using a little more of any one agent they will do so” p 432.

§10. The “net” in national income reflects replacement of worn machines plus a fraction of the enduring contribution of new machines, but excludes “income’ (benefits) derived from common practices of individuals, i.e.,

Thus, unless anything is said to the contrary, the services which a person renders to himself, and those which he renders gratuitously to members of his family or friends; the benefits which he derives from using his own personal goods, or public property such as toll-free bridges, are not reckoned as parts of the national dividend, but are left to be accounted for separately (p 434).

This last statement will be familiar to anyone critical of the exclusion of “self-production” or “a mother’s work” from GDP statistics. It’s also unusual (relative to GDP discussions) in calling for those factors to be accounted for separately.


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

Interesting stuff

  1. Watch: The ongoing failure to protect the quality of Americans’ drinking water
  2. Listen: Good Econtalk on covid in schools and maturing as a parent
  3. Read: A (fascinating) history of autopsies
  4. Read: A Norwegian tracks the trackers on his phone.. back to US intelligence
  5. Read: Using clams as “dirty water” detectors in Poland (shitty website — sorry!)
  6. Listen: Debate on Should the West get tough with China? 
  7. Read: Teamwork delivers more than the sum of player talents
  8. Read: The drawbacks of video “teaching” can be overcome (hint: smaller groups)
  9. Listen: Why don’t economists study the Big Questions?
  10. Read: How the ballpoint pen changed handwriting