Economic Theory and Social Change : Problems and Revisions [1 ed.] 9780203848500, 9780415564236

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Economic Theory and Social Change

This book is a discourse on modelling Man in a social context. Its focus is on economic mainstream theory in its capacity to handle basic problems such as uncertainty, social dynamics and ethics. The point of departure is a systematic critique of the specific methodology of economics and its axiomatic structure. The ultimate aim is to develop an economic theory for a socially sustainable society. Economic Theory and Social Change analyses the foundation of economic market theory in relation to its social implications. On rejecting the axiomatic structure of the market theory, Hasse Ekstedt and Angelo Fusari analyse the concept of growth and uncertainty with respect to a more realistic modelling of Man. The book also addresses central political problems and their potential solutions, including permanent unemployment, distribution of income, the interaction of real and financial growth, money and the credit system. In seeking objective values to help to obtain a socially sustainable society, the book traces a tentative revision of economic and social thought based on a deepening of some crucial features of modern economies and societies. These features include innovation, the connected flows of uncertainty, entrepreneurship, and their role in fuelling and characterizing economic growth and development. This book will be of interest to postgraduate students and researchers of economics, particularly to those focusing on economic theory and political economy. Hasse Ekstedt is Lecturer at the University of Gothenburg, Sweden. Angelo Fusari, newly retired, has been Chief of Research at the Institute of Economic Programming (ISPE) and Director of Research at the Institute of Studies and Economic Ana­lyses, ISAE, Italy.

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  90 Race and Economic Opportunity in the Twenty-­First Century Edited by Marlene Kim

  93 Imagining Economics Otherwise Encounters with identity/ difference Nitasha Kaul   94 Reigniting the Labour Movement Restoring means to ends in a democratic labour movement Gerald Friedman   95 The Spatial Model of Politics Norman Schofield   96 The Economics of American Judaism Carmel Ullman Chiswick   97 Critical Political Economy Christian Arnsperger   98 Culture and Economic Explanation Economics in the US and Japan Donald W. Katzner

  99 Feminism, Economics and Utopia Time travelling through paradigms Karin Schönpflug 100 Risk in International Finance Vikash Yadav

107 Fiscal Decentralization and Local Public Finance in Japan Nobuki Mochida 108 The ‘Uncertain’ Foundations of Post-­Keynesian Economics Essays in exploration Stephen P. Dunn

101 Economic Policy and Performance in Industrial Democracies Party governments, central banks and the fiscal–monetary policy mix Takayuki Sakamoto

109 Karl Marx’s Grundrisse Foundations of the critique of political economy 150 years later Edited by Marcello Musto

102 Advances on Income Inequality and Concentration Measures Edited by Gianni Betti and Achille Lemmi

111 Sublime Economy On the intersection of art and economics Edited by Jack Amariglio, Joseph W. Childers and Stephen E. Cullenberg

103 Economic Representations Academic and everyday Edited by David F. Ruccio 104 Mathematical Economics and the Dynamics of Capitalism Goodwin’s legacy continued Edited by Peter Flaschel and Michael Landesmann 105 The Keynesian Multiplier Edited by Claude Gnos and Louis-­Philippe Rochon 106 Money, Enterprise and Income Distribution Towards a macroeconomic theory of capitalism John Smithin

110 Economics and the Price Index S.N. Afriat and Carlo Milana

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117 Economics Versus Human Rights Manuel Couret Branco 118 Hayek Versus Marx and Today’s Challenges Eric Aarons 119 Work Time Regulation as Sustainable Full Employment Policy Robert LaJeunesse 120 Equilibrium, Welfare and Uncertainty Mukul Majumdar 121 Capitalism, Institutions and Economic Development Michael Heller 122 Economic Pluralism Robert Garnett, Erik Olsen and Martha Starr 123 Dialectics of Class Struggle in the Global Economy Clark Everling 124 Political Economy and Globalization Richard Westra 125 Full-­Spectrum Economics Toward an inclusive and emancipatory social science Christian Arnsperger

126 Computable, Constructive and Behavioural Economic Dynamics Essays in honour of Kumaraswamy (Vela) Velupillai Stefano Zambelli 127 Monetary Macrodynamics Toichiro Asada, Carl Chiarella, Peter Flaschel and Reiner Franke 128 Rationality and Explanation in Economics Maurice Lagueux 129 The Market, Happiness, and Solidarity A Christian perspective Johan J. Graafland 130 Economic Complexity and Equilibrium Illusion Essays on market instability and macro vitality Ping Chen 131 Economic Theory and Social Change Problems and revisions Hasse Ekstedt and Angelo Fusari

Economic Theory and Social Change Problems and revisions

Hasse Ekstedt and Angelo Fusari

First published 2010 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Avenue, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business This edition published in the Taylor & Francis e-Library, 2010. To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk. © 2010 Hasse Ekstedt and Angelo Fusari All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Ekstedt, Hasse. Economic theory and social change: problems and revisions/by Hasse Ekstedt and Angelo Fusari. p. cm. Includes bibliographical references and index. 1. Economics. 2. Social change. I. Fusari, Angelo. II. Title. HB71.E37 2010 330–dc22 ISBN 0-203-84850-0 Master e-book ISBN

ISBN13: 978-0-415-56423-6 (hbk) ISBN13: 978-0-203-84850-0 (ebk)

2009053337

Contents



List of illustrations Preface

xvii xix

hasse ekstedt and angelo fusari



Acknowledgements

xxi

hasse ekstedt and angelo fusari



Introduction

1

hasse ekstedt and angelo fusari

The structure of the book  6 1

The method of social theory: suggestions for a shared basic view

9

angelo fusari

Introduction  9 1.1  The untenable positivist legacy  9 1.2  The anti-­positivist reaction  18 1.3  Some more recent developments  23 1.4  On the methodological procedure and rules of social science  29 1.5  Necessity, choice, functional and ontological imperatives in the constitution and organization of social systems  32 1.6  Evolution and institutions. The interpretation of social processes  36 1.7  Conclusion  38 2

Homo Œconomicus versus Homo Politicus hasse ekstedt

Introduction  40 2.1  The neoclassical general equilibrium theory  45

40

xiv   Contents 2.2  The complications of Arrow’s paradox and the Marxist interpretation  59 2.3  Towards a Homo Rationalis  67 2.4  Summing up  74 3

The axiological–normative question in economics and social sciences: objective and subjective values

76

angelo fusari

Introduction  76 3.1  A quick review of the treatment of values in the modern world, before the twentieth century. Vico’s premonitory contribution  77 3.2  A turning point: Weber’s irrational rationality  80 3.3  Ambiguities and circumlocutions on the ‘reasonableness’ of values: the Rawlsian neo-­contractualism  82 3.4  Boudon’s contribution to an objectivist theory of values  84 3.5  Objective and relative values. An ignored and contrasted law of moral progress  86 3.6  The World Values Surveys and Inglehart’s analysis  89 3.7  Religions and ethics  91 3.8  Economic values and ethics  92 3.9  Conclusions  98 4

On time and ethics

100

hasse ekstedt

Introduction  100 4.1  Physical and social space–time  104 4.2  The conception of time and space and ethics  108 4.3  The direction of time  115 4.4  Social space-­time topology  123 4.5  The role of institutions  127 4.6  An outline of ethical principles based on the assumptions that humans are subjects  130 4.7  The problematic but intriguing conclusion  133 5

Innovation, uncertainty, entrepreneurship: modelling the dynamic process of the economy – discussion and formalization angelo fusari

Introduction  135

135

Contents   xv 5.1  The theoretical foundations of our economic analysis  136 5.2  A critical review  146 5.3  Formalization of our model of dynamic competition  160 5.4  Conclusion  178 6

From invisible hand to perpetuum mobile: the problem of economic growth

180

hasse ekstedt

Introduction  180 6.1  What is economic growth?  180 6.2  Solow’s model of exogenous growth  186 6.3  Endogenous growth  190 6.4  The Product Cycle  192 6.5  Growth, equilibrium and the equimarginal principle  195 6.6  The demand side  200 6.7  Market structure and uncertainty  205 6.8  Tentative conclusions  211 7

Uncertainty, money and labour demand

213

hasse ekstedt

Introduction  213 7.1  Unemployment and factors creating uncertainty  215 7.2  Money  229 7.3  Money and the monetary economy  236 7.4  Policy  241 8

Towards a non-­capitalist market system: spontaneous order and organization angelo fusari

Introduction  248 8.1  A historical sketch of the market  249 8.2  The capitalist market  252 8.3  Entrepreneurial role and profit rate. The public and private spheres within the working of the market  255 8.4  The cycle of production and distribution within the market operating as a pure mechanism of imputation of costs and efficiency  257 8.5  Interest rate, production financing and effective demand  262

248

xvi   Contents 8.6  On the international economic order  266 8.7  Conclusion  267

Appendix Notes Bibliography Subject index Name index

269 275 284 295 299

Illustrations

Figures 2.1 Suggested interpretation of proposition 6.211 2.2 Equivalence relation created by the axioms 2.3 Additive aggregation in general equilibrium, a three commodity space 2.4 The structure of the proof of general equilibrium 2.5 Epistemic cycle 4.1 Transformation of spaces at different speeds 4.2 Standard decision tree 4.3 A space–time illustration 4.4a Bus stops in three dimensions to be projected onto a two-­dimensional surface 4.4b A functional ‘projection’ of the bus stops 6.1 Salter growth engine 6.2 Swedish GDP 1950–2008 6.3 Variations in profit rate 6.4 Convergence of excess demand 6.5 The Product Cycle 6.6 Three characteristics, four commodities 7.1 Growth of world trade and world GDP 7.2a Changing epistemic structures (1965) 7.2b Changing epistemic structures (1987) 7.3 Marginal costs for new labour 7.4 Productivity variations with respect to complementarities 7.5 Variations in productivity and profit share in Swedish Industry 7.6 Productivity increase and increased volatility in the liquidity position 7.7 Portfolio risk 7.8 The cyclical structure of the welfare system

48 51 56 57 70 105 121 122 126 126 181 184 189 191 193 204 218 219 219 223 224 227 228 230 245

xviii   Illustrations

Tables 1.1 2.1 5.1 5.2 5.3 6.1 6.2 6.3 6.4 7.1 7.2

Boudon’s clarification Arrow’s voting paradox Values of parameters Initial values of the endogenous variables and of the exogenous Ls0 and ir Values of parameters and constants varying with simulations Estimates of macro-­production functions Estimates of macro-­production functions based on moving eight-­year periods Estimation of the differentiated production functions Mean value of actual return in relation to calculated return in the investment plan Development of a market structure Capital intensity and productivity

26 60 174 175 176 188 188 188 194 218 228

Preface

The two authors of this book were, until three years ago, unknown to each other. We worked on different sides of Europe and with respect to different intellectual traditions. When we met we realized that we had arrived at a common view of the shortcomings of economic theory. Since both of us have been politically active we were deeply unsatisfied at both the ignorance and the arrogance of mainstream theory as well as of some representatives of the alternative economic science. Although many economists do serious and respectable work, mainstream economic theory contains an almost complete disregard for the importance of social, cultural and political structures which are the very foundation of the society. Worse than that, such disregard is developed into arrogance when representatives and textbooks maintain the illusions of economic mainstream science as value-­free. Sometimes it is even asserted that only if the economic system could be free from disturbing interferences from collective bodies it would function even without any ethical principles. Such testimonies of ignorance of historical and philosophical knowledge and lack of understanding of social structures are not maintained by serious researchers of economic science but are more to be seen as ideological statements. However these testimonies are unfortunately based on a very specific apprehension of both the society and the space and time from the eighteenth century when the scientific discoveries and theories of Galileo and Newton were turned into a mechanistic and idealistic philosophy. It is true that Adam Smith did not fully accept such a view but, alongside the philosophical approaches of Kant and Hegel, the economic theory in the later writings of Marx and the neoclassical theorists made economic science into a machinery which culminated with Walras, Pareto and Pigou although it was mathematically refined in the so-­called Arrow and Debreu model. A main cause of the limitations of economics is its closure and excessive specialization in the context of sometimes very sophisticated modelling, formally rigorous but elusive of crucial aspects of reality, the causes of which remain therefore outside the adopted explanatory framework, as exogenous factors. It seems to us that a treatment of economics seen as a part of social thought is essential to an adequate deepening of social change and hence of economic

xx   Preface dynamics. This general view will oblige us to dedicate an accurate analysis to the method of investigation and interpretation of social reality, and will imply a detailed critical review not only of mainstream economics but also of the alternative proposals of a growing number of schools of thought. We shall see that our more comprehensive vision than the habitual ones is, however, not hostile to a rigorous formalization of the economic process able to give due importance to crucial features of modern dynamic economies. It is difficult to tell anything about the educational prerequisites in order to grasp the content of this book. We are well aware that much of the content is fairly abstract, so acquaintance with abstract reasoning is valuable. The book is not necessarily limited to an economists’ audience but we think and hope that also social and political scientists will enjoy it, since we try to bring back economic science as a subset of sociological and political sciences, where it belongs. If students of philosophy should find something of interest in this book, we would be pleased.

Acknowledgements

Angelo Fusari

[email protected] Dr Gianfranco G. Berardi, a colleague of mine, with whom I had prolonged discussions on some main ideas developed in the book. Dr Murray Pellissier, Bureau for Economic Research (BER), University of Stellenbosch, South Africa, provided a valuable collaboration in the development of my idea to measure radical uncertainty using the results of the inquiries on business conditions; he also provided some application using the data for South Africa. Dr Angelo Reati, former official of the European Commission, for the intensive discussions on the endogenization of technical change and hence innovation, uncertainty and entrepreneurship, and the implications of these aspects for the analysis of long waves. Special thanks go to Dr Clifford R. Wymer, the author of the sophisticated software used for the computation of the formal model. He also gave precious advice on the specification of some explanatory equations.

Hasse Ekstedt

[email protected] My deepest gratitude and respect goes to the late Professor Lars Westberg, my teacher, colleague and co-­writer in several studies. His philosophical wisdom and knowledge in economics has been of fundamental importance for me. His death when 87 years young was too early with respect to his intellectual brightness and depth. My friend and colleague Professor Torbjörn Larsson, Pol. Sc., at the University of Stockholm has read my various chapters and frankly told me both about virtues and shortcomings. His support as a friend in taking me out for discussions in conjunction with good wines and food has been a necessary prerequisite for the research process. My friend Chris Sanders and his wife Elisabeth Savage at Sanders Research Associates Ltd have given me their support for a long time partly through publishing texts but most of all through discussing both theoretical and empirical problems.

xxii   Acknowledgements I have had many constructive discussions with Professor Michel Dombrecht, University of Ghent, earlier at Belgium National Bank and ECB. I have learnt much from his deep knowledge of economic and financial policy. I have also benefited from discussions with and support from Professor Herbert Gleiser, University of Namur and Free University in Brussels and from Dr Homa Motamen-­Scobie, European Economic and Financial Centre in London. I also want to mention my son Fredrik Ekstedt, M.Sc. Math. who has been instrumental to my writings in his ability to help me to understand the deeper interpretations of mathematical theorems. We both want to give our devotion and love to our families, who have been the fundament of our writing and a prerequisite for our research.

Introduction Hasse Ekstedt and Angelo Fusari

Human activity directed to knowledge, like Man’s day-­to-day action in general, is obliged to proceed by trial and error and to develop by the free interplay and confrontation of ideas, for the simple reason that human cognitive capacities are limited. The point is to prevent this trial and error method from proceeding blindly. This requires methodological rules that permit judging the explanatory power of ideas and theoretical proposals, which means recognizing clearly enough the contribution of models and theories to the advancement of earlier knowledge and hence to the intelligence of decision making, by comparison with earlier theories. This methodological procedural support is indispensable to the advance of knowledge, i.e. to the accumulation and growth of knowledge based on knowledge. Creativeness, by definition, is not the product of method. But method is indispensable for selecting the contributions of creative processes to knowledge. In a world where all modes of thought and judgement are accorded equal dignity, as advocated by methodological anarchy (improperly called ‘pluralism’), knowledge will grow haltingly and advance in a most confused fashion. A number of scholars, most notably Feyerabend, have disputed the comparability of theories with sophisticated, even stimulating arguments. Their critical contribution deserves appreciation, but their negation of method denies science and is accordingly unacceptable. The title of this book, Economic Theory and Social Change, contains an implicit question: is there an economic structure separate from social structures and their evolution? The principle question is whether economics is actually analysing a substructure of the surrounding social structure. If so there are few possibilities for isolating a logical system of the economic structure within the realm of the social structure when we live in a dynamic society. Our scope with this book which appears in the second part of the title, Problems and Revisions, implies that we want to discuss the logical problems of such an isolation, and we will also suggest some revisions of the theory in order to bring in other questions and other analytical approaches. Not seldom, it is said that the market is always right. For those not understanding the language of economics the relevant question is, of course, ‘Who is the market?’ but for economists this proposition is also a bit tricky, after the financial debacle of autumn 2008. We may ask the leading persons of the

2   H. Ekstedt and A. Fusari financial industry why they did not listen to the advice of the market. Did some agents wish to have a breakdown and some not or is the market result something else than the sum of good wishes and optimal individual behaviour? If either of these explanations are true we are at difference with the traditional neoclassical market theory. Furthermore it is sometimes claimed that the market should govern itself and further that the market, although void of any ethics, leads towards results which are ethically acceptable in the society. A prominent banker in Sweden claimed in an editorial debate article in one of the biggest Swedish newspapers, in spring 2008, that moral questions were to be held outside the realm of the markets and that markets will correct themselves with respect to moral failures. That is a very convenient approach – the individual agent has no responsibility for the aggregate result but that is fixed by someone beside or above the human agents, maybe we can call this agent the invisible hand. These lines of argument are probably due to Adam Smith’s famous invisible hand. Scientists within economics seldom discuss this invisible hand seriously except for historical reasons, and reject it in its naïve form, however many mainstream economists struggle implicitly with the question of aggregating microeconomic analysis into normative discussions of economic policy. Keynes frankly dismissed any such possibility by rejecting Say’s law, but in the modern variants of neoclassical theory Say’s law lingers in the shadows under the name of Axiom of Local Non-­Satiation and thus there is still a strong temptation to use the neoclassical theory for normative analysis of the society in the form of welfare theory. After the financial debacle at the end of 2008 the general sentiment has also been changed towards political actions to support different groups of market agents and the whole banking sector has been begging, save for a few financial organizations, for guaranties and help with capital support from the taxpayers. Another interesting effect of the financial debacle is the remorse it seems to have created among economists. The Nobel Laureate Paul Krugman wrote in the New York Times on 2 September 2009: Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy . . . the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-­looking mathematics, for truth . . . economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations . . . Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets – especially financial markets – that can cause the economy’s operating system to undergo sudden, unpredictable crashes;

Introduction   3 and to the dangers created when regulators don’t believe in regulation. . . . When it comes to the all-­too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. (Krugman 2009: 36) First of all, quite a few economists saw the crises coming since the so-­called NINJA – No Income, No Job or Assets – was discussed several years before the crises and a rather general judgement was that the banks and policy makers were out of their minds in allowing these kinds of ‘financial inventions’. That people do not listen to what afterwards were regarded as warnings is not a sign of lacking rationality but of different agendas, therefore our question above – did perhaps some agents look at a crash as something quite beneficial to them, or was it simply a game of ‘chicken’? Second, the above quotation put all the responsibility on the poor humans who are now declared to be totally irrational. It is a huge fall from being perfectly rational to being totally irrational. If we think of an economic theory of totally irrational agents we indeed need a chaos theory. Third, if some agents are more rational and more informed and more economically powerful than others and use this to their benefit, we run towards a fundamental moral and political analysis and then we have to admit that economic structures are part of surrounding social and political structures and then the economic theory must realize this fact and include such variables and parameters. Yes – the market is always right, in a very precise meaning. If you want to sell something to other people to a certain price and you accept the principle of individual freedom to sell and buy then you cannot in an intellectually consistent way claim that other people are wrong when they do not want to buy the thing at your offered price. You cannot claim that they are irrational. In this precise way the market is always right. Whether this can be evolved into an ethical principle other than that force shall not be used in market relations, or not, we will not discuss in depth, but we certainly discuss the need of ethics. It seems that economics has developed into a substructure within the social structure with its own standards of logics, measurements and agents. Social students of other subjects accuse economics of being both ‘asocial’ and even ‘antisocial’, but because of the character of economic theory with seemingly precise concepts, a seemingly logically consistent market theory, the neoclassical theory, and a highly technical methodology, students from other social disciplines have difficulties in finding the right angle of criticism; it is said that ‘the proof of the pudding is in the eating’ and they say it tastes rotten. Often their criticism is aimed at the use of mathematics and critics within the economic discipline often agree with this line of criticism. We find much of this criticism relevant since we reject the notion that the economic structure is the core of the social structure, we lean more towards the attitude that the working of the economic system is a consequence of, and also reflects, the surrounding social and ethical structures.

4   H. Ekstedt and A. Fusari With respect to the question of mathematics we partly agree that trotting around with poorly understood mathematical models often contradictory to the proposed underlying axiomatic structure is not particularly impressive and we partly agree with Krugman. On the other hand, logical analysis is indispensable in scientific work and all scientific work must take seriously the question of measurement; mathematics in one or another form is often an excellent tool. But on yet another other hand, as Russell and Whitehead showed in Principia Mathematica, mathematics is one of several logical languages. Mathematics is an extremely valuable logical tool since it is precise but that requires good understanding of the limits of the mathematical analysis. It is often claimed that economics, particularly the neoclassical theory, advances Newtonian physics into economics and through that also into the social sciences in general. That has fostered counter-­reactions built on the opinion that we cannot use physical models for describing the actions of humans. In conjunction with the above-­mentioned criticism of mathematics there have even occurred opinions in favour of anti-­rational and anti-­logical scientific research. We agree that particularly the neoclassical economic theory is a variant of a Newtonian equilibrium system. But our approach is that this has nothing to do with the use of logics or mathematics but with the axiomatic specification of the problem. It is a matter of astonishment that long after physics has rejected the idea of an everlasting general equilibrium, economics, a basically social science, devotes analytical skill on methods based on an a priori axiomatic structure long ago rejected by natural sciences. Whether this is due to inappropriate traditionalism or to ideological ties it is hard to say. However we will show that such axiomatic structures transform human beings into n-­dimensional rigid bodies. Our attitude has nothing principally to do with the use of logical and/or mathematical models per se but deals with the axiomatic structure where we show that the basic axiomatic structure of the neoclassical theory deprives humans of being subjects and as subjects they are, in a local and temporal setting, final causes. The acknowledgement of Man as a subject will have vital consequences for both economic theory and methodology. The neoclassical theory has provided us with an efficient measure of commodities, and development. By rejecting the neoclassical theory we, so to say, throw economic theory into a theoretical chaos. But more than that: by using two of the majestic paradoxes in mathematical logics, developed during the twentieth century, Russell’s paradox, and by then implicitly also Gödel’s paradox, we show that there does not exist a global rationality. In fact the idea of a global rationality has to be replaced by a more humble but also more intriguing proposition. Another fundamental concept upon which we lean hard is the concept of innovation, as developed from a Shumpeterian approach. Our rejection of the neoclassical theory, in fact, opens up a more systematic analysis of the growth process, but as we also show appropriate measures must be developed. Neoclassical mainstream economics has been the object of a quantity of criticisms even if largely different in content than those in the present book. A

Introduction   5 number of schools of thought has proliferated, aimed at remedying the main ‘irrealisms’ and shortcomings of mainstream economics. The most relevant alternative approaches are represented by Schumpeterian and neo-­Austrian teaching. Evolutionary and institutional economics, and a nebula of theoretical developments denominated heterodox economics, have provided a fragmented alternative thought, each component of which, while emphasizing some relevant aspect of the economic reality, forgets some other, no less relevant, aspects. The main cause of the resulting confusion is methodological poverty and equivocation. A method founded on the most relevant contents and behaviours of the economy, able to unify and fertilize the plurality of contributions, is absent; this grants, even today, some attraction to neoclassical economics as provided by a more stringent methodological architecture. This situation suggests an accurate deepening of the main alternative and heterodox tools, with the aim of delineating a more rigorous and comprehensive theory mainly with the support of a methodological approach able to capture the main features of the modern dynamic economy. A fundamental effect of the rejection of the neoclassical theory is, however, the necessity of introducing the question of ethics. We show that the stability of the social system in general and of the economic system in particular requires a generally accepted ethics. Our discussions of ethics have nothing to do with metaphysical spheres, but are a requirement for the stability of society. We show a method to derive objective values, in addition to subjective-­relative values that contemporary social thought emphasizes, and show the crucial importance of an objective ethics, which is strongly opposed by relativism. The neoclassical model of thinking has sometimes produced the idea that the economic system controls and remedies moral deficiencies among the agents via the price system. This attitude is consistent with the axiomatic structure, which transforms the agent into an automaton. We emphasize the innovatory process which will have a definitive effect on our discussions of ethics. In general ethical discussions focus on preserving the conditions of existence for the individual, an ethics for being; however when we introduce innovation as a fundamental concept, the ethical discussions must also allow for an ethics granting the innovatory ability of the individual, an ethics of doing. What has happened during recent years in the world economy culminating in the breakdown of the credit system has shown the inability of the market economy is inherent in its structure. From a scientific point of view it is a mystery how economic science, after the violent twentieth century, still can advocate that the pure market economy is stable and that public policies are generally destabilizing. It is clear from the neoclassical theory that such conclusions are viable to draw but to us it seems equally as valid as the Marxist claim of the benefits of the communist economy. Some economists even say that the breakdown of the Soviet Union is a proof that the Marxist claim is invalid. How shall we then comprehend the unwillingness to understand the instability of the market economy? We may answer that we have not seen the pure market economy, but then we can equally well answer that we have not seen the pure communist economy.

6   H. Ekstedt and A. Fusari The fundamental purpose of this book is to show that the market economy is a part of a social and cultural structure and thus shares all the strengths and weaknesses of such a structure. In economics this is actually the basic measure of John Maynard Keynes; there are also many others but Keynes may be regarded as the intellectual antipode to the neoclassical theory. Attempts have been made to unify the two theoretical approaches but that only shows ignorance of the basic lessons in Keynes’ work, not only General Theory but Treatise on Probability and particularly The Economic Consequences of the Peace and also other works. Someone has said once that in order to be a good economist you should at least know three good stories about Keynes, so here is one. It is said that during the 1930s the Treasury was to decide whether or not to support a certain currency. Almost all members of the board were in favour of not supporting it. But at the decisive meeting Keynes participated and he needed 15 minutes to persuade the rest of the participants to vote for support. When all were prepared to make the formal decision, Keynes raised his hand and said, ‘On the other hand I could be wrong.’ What did he mean by saying that? If you advocate an opinion you should really know if you are right or wrong. How much better is it to have – or not have – a well-­established model of let us say 75,000 equations covering all the most important causal relations? Well, this is actually the very gist of our analysis and the reason why we rather carefully link our discussion to basic philosophy and the philosophy of science.

The structure of the book We can see the book as four parts with two chapters in each part, of which one chapter analyses the general problem and suggests ways out of it and the second chapter deals, on the one hand, with the logical problems with respect to the current mainstream methodologies and, on the other, the logical difficulties with proposed revisions. Thus the first part (Chapters 1 and 2) deals with methodological questions: Chapter 1 contains, at first, a critical review of a number of important and meaningful schools of thought, starting from positivism and hence insisting on the fragmented galaxy that, from the beginning of last century, has tried to remedy the shortcomings of positivist and mainstream economics. Then the chapter deals with general problems of methodology in social sciences and the problem of modelling Man in a social context. There is a growing difficulty of managing the problems in the societies of our time, mainly due to the growing intensity of technical progress. This necessitates a fairly general analysis, the development of social theorizing into the current state of art. The fact that social thought concerns both what is and what should be implies that organizational rationality requires what must be termed a constructivist standard of rationality, i.e. one that includes the interpretative and normative aspects. Important is also the character of its initial hypotheses. They must not consist in nominalist postulates, as logical-­formal method does, but

Introduction   7 must consist in realistic premises. A main aspect of the proposed method is the distinction between necessity and choice possibility in the organization of human society. The second chapter deals with the problem of a priori modelling in general and the neoclassical theory in particular, which is the core of economic theory in the sense that it is seen as the theory for the free market economy. Furthermore it is often claimed that the political side of the society, although perhaps necessary, nevertheless creates inefficiencies in the working of the economy. Theoretically this is expressed in the very wording of first best and second best in relation to social optimization. Thus we have to scrutinize the axiomatic structure of the neoclassical theory with reference to its precise content of restrictions with respect to the everyday perceived reality of human beings. Thus we will also focus on Arrow’s paradox which results in the claim that this is not a logical paradox since it concerns two different definitions of the economic agent. To set for a different kind of theorizing the economic reality we suggest a different definition of rationality consisting partly of the traditional neoclassical rationality but only in a specific epistemic cycle. The latter concept is taken from the physicist and mathematician Thomas Brody. With the help of this concept we show that there cannot exist a global rational model, thus there does not exist a global optimum for any aggregate economy implying that each agent in it will reach also an individual optimum. The fundamental reason for this is that we must treat the individual agent as a subject. The second part (Chapters 3 and 4) consists of an analysis of ethical standards for the market economy. In Chapter 3 we analyse the problem of social dynamics with respect to the necessity of an ethics of being, that is the necessity of protecting the individual agent, and an ethics of doing, which is the necessity to grant the creativity, inventiveness and lust for entrepreneurship of the agents. Thus we have to distinguish between necessity and choice/possibility in social organizations. This also means that uncertainty must be seen from the aspect of protection but also from the aspect of possibilities. The fourth chapter is a logical discussion of the connection between ethics and the social space-­time since we must have both an ethics for being and an ethics for doing and this is a consequence of treating economic agents as subjects. We start with an analysis of the ethical consequences of a Newtonian time concept and also of a time concept à la Einstein/Minkowski. This leads us to a definition of a social space-­time concept which underpins a general formulation of an ethics for the democratic society. Applying our reasoning from Chapter 2, we however show that there cannot exist a general aggregate optimum at the same time as all agents reach an individual optimum. The third part is a discussion of economic growth and development. Differently from the two previous parts, the analysis here concerns purely economic analysis, and sees the previous parts as a method of social thought. Chapter 5 is devoted to the analysis of the structural, institutional and, more generally, organizational necessities of modern dynamic economies, i.e. the main organizational

8   H. Ekstedt and A. Fusari features strictly required by the functioning and the same existence of a modern economy. The attention is centred on the role of innovation, radical uncertainty attached both to innovation and to other factors exogenous to the economic process; entrepreneurship is analysed which is, at the same time, the main actor of innovative processes and the bearer of the uncertainty attached to them or due to other causes. We shall see that a crucial engine of the whole dynamic motion of the economy is the search for profit through innovation, the diffusion of this and the adaptive action promoted by disequilibria or, more precisely, the connected opportunities in a world deeply permeated by uncertainty. We do not consider here income distribution and hence the appropriation of profits. A significant representation of economic dynamics is provided through the notion of dynamic competition that expresses the interaction of innovation, uncertainty and entrepreneurship. In a critical review we point out the shortcomings of the different schools of economic thought in representing the above interaction between innovation, uncertainty and entrepreneurship and hence the dynamic process of the economy. A formalized general model referable to dynamic economies is then set out and used for simulations. Chapter 6 deals with growth and what happens when we abandon the neoclassical growth models, based on Maurice Allais’ equimarginal principle we bring in the demand side and its structure as a key aspect of economic growth. In the first chapter of the last part, Chapter 7, we discuss some fundamental economic problems, such as permanent unemployment and the distribution of income and wealth, which we also link to the working of the financial side of the economy. The last chapter deals with a tentative suggestion of a non-­capitalistic market economy. Here the choice-­possibility aspect is at centre stage, an aspect expressed by civilization and other less important choices consistent with a dynamic economy. Some considerations are devoted both to the spontaneous and voluntaristic forces that have favoured the birth of capitalism; this is considered a peculiar historic feature of the modern dynamic economy and society. Then we investigate the possibility of alternative kinds of income distribution and, more generally, of non-­capitalistic forms consistent with a dynamic economy, that is, consistent with the structural and organizational necessities considered in the previous part. A saying displayed in St. Mary Redcliffe church of Bristol and entitled ‘Sheep, ships and slavery’, which were the main sources of the town’s wealth, warns: ‘Church communities, like all human institutions can be imperfect. It is well for each age to examine its activities and values.’ This book is aimed at improving the possibility of founding such examination on a scientific basis.

1 The method of social theory Suggestions for a shared basic view Angelo Fusari

Introduction The growing difficulty of understanding and managing the problems of society, in our age in which a permanent revolution ceaselessly shakes and overturns established institutions and perceptions, brings out a sort of impotence of social thought just when the suffering bound up with adaptation to change would appear to exalt that discipline’s function and importance. To break this impasse, a number of clarifications concerning the procedures of inquiry from which social thought springs are essential. A capital misunderstanding on the character of social reality undermines social thought and will lead to the proposal of a method addressed to remedy that misunderstanding and make the confrontation among social students easier, hence to increase the fecundity of pluralism and the comparability of social theories, which is essential to the profitableness of research and the cumulative principle of knowledge. Using the proposed approach on method, the way to find general principles – in the presence of rapid social change – and achieve some other specific knowledge will be explored. In particular, the first three sections dwell on the inappropriateness to social reality of the principal methods in use and point out the growing methodological confusion that afflicts social thought in the present age. The fourth and the fifth sections expound a methodological proposal calibrated on the main characteristics of social reality and give some examples of the way the proposal operates. Finally the sixth section exposes some major implications of the proposal for the analysis of ethic-­ideological values, civilizations, and the interpretation of social­historical processes.

1.1  The untenable positivist legacy Misunderstandings that have brought social inquiry to a dead end The method of inquiry into social reality has been powerfully influenced, in the past three centuries, by the methodological developments in the natural sciences. It may thus be illuminating to examine those developments. Until the sixteenth

10   A. Fusari century the study of the natural world stagnated and was much more backward than the inquiries of social thinkers. The most insightful investigators of natural phenomena were alchemists and sorcerers, who at least regularly performed experiments, conceived though they were for impossible objectives like the discovery of the philosopher’s stone. The great thinkers, for their part, stubbornly dwelt on senseless questions that held out absolutely no possibility of an answer. That is, they were convinced that to understand the natural world one had to penetrate its ‘essence’, its intimate nature and ultimate explanation. They speculated on the reasons why the natural world is what it is. In the late Middle Ages, this field saw the rise of the famous contention between nominalists and realists. Finally, the great methodologists of the seventeenth century clearly and distinctly established that it is a waste of time to inquire into the essential properties of nature or ask why nature is the way it is. As Man is not the creator of the world, he can never know why the world was made the way we perceive it. In exchange, there arose a much more fruitful, rational procedure of inquiry, one that the nominalists had already foreshadowed: carefully observe the phenomena that occur in nature and, from this observation, seek to derive their laws of motion, if possible expressed in mathematical form, the knowledge of which facilitated Man’s interaction with the natural world.1 Thus was born the method that we may term ‘observationist’ in that it sought to understand phenomena and to acquire the ability to predict them on the basis of prolonged observation of their manifestation in nature or their experimental reproduction. This radical change in point of view got science out of the blind alley in which it had been trapped by the essentialist-­realist method. The road was open for an exponential growth of knowledge that in our own era appears nothing less than explosive. The enormous success of the observationist method in studying natural phenomena enabled it to overflow into the field of social inquiry. This method’s high water mark came with nineteenth-­century positivism, but it remains solidly entrenched even today, especially among economists. And as we shall soon see, observationism in social theory has been resurrected in not properly positivist forms and surfaces here and there, while the anti-­positivist reaction has produced a confused, shifting terrain. The observationist method rests on the idea of the ‘spontaneous phenomenon and spontaneous order’ and that reality operates rationally and with regularity. That is, one observes what occurs spontaneously (or, what amounts to the same thing, what occurs by experimental reproduction) and tries to understand it. Hence the application of this method to social inquiry implies the idea of a social spontaneous order and the acceptance of existing reality, although scholars are for the most part unaware of this implication. The positivist version of observationism also needs the repetitiveness and regularity of the observed phenomena, that imply the stationary motion and hence vegetativity of social order. But the non-­positivist observationism (social evolutionism, Weber’s method, neo-­ Austrian thought) disregards the hypothesis of repetition of phenomena. These topics require some further deepening.

The method of social theory   11 The observationist method entails a radical misrepresentation of the nature of social reality, which in its constituent forms is the contrary of the natural world. However, the distinction between nature and society is methodologically important for reasons quite different from those adduced, in various modulations, by Dilthey and hermeneutics, Rickert and Weber (that emphasize respectively, erlebnis and the role of intuition, value relation and orientation towards individual phenomena). Nature is not the work of Man. Instead, society is; in a way, therefore, social thinking must adopt the standpoint that until the sixteenth century imprisoned natural science in a dead end: why is the world what it is? In fact this question and the inquiry on values and ends, which are senseless with reference to the natural world, are appropriate to the social world, this being a product of human activity. An example may help to clarify this important point. Predation is largely diffused among animal species. Lotka-­Volterra’s predator–prey system gives a mathematical representation of the phenomenon and the natural scientist can feel gratified by that representation. But let us suppose the existence of a human society based on predation, i.e. operating according to Lotka-­Volterra’s model. In this case, the social scientist cannot feel gratified just by that model. He must ask himself if it is possible to organize society in a way less cruel and more open to creativity and development, for instance, one based on cooperation or solidarity. But the transition from predation to cooperation implies the entry of a new and completely different universe, with new values and institutions, and this violates the hypothesis of repetitiveness. In sum, even if we are analysing a repetitive society, for example of closed quasi-­stationary society, as soon as we refuse to accept the given reality and its values and suppose the transition to an open dynamic society, we implicitly reject the hypothesis of repetitiveness. Therefore, such a hypothesis is not only inappropriate to a modern dynamic society; more generally, it is inappropriate at full length to the study of society, being senseless in social analysis to limit oneself to accept the factual situation and to disregard values and ends. Social reality is much more highly subject than nature to non-­repetitive change as a consequence of the steadily increasing constructive, creative, innovative action of human beings. This makes the observationist standpoint, insofar as it requires a stable frame of reference, deceptive in the extreme, ever more incapable of truly explaining human society.2 Social reality, being a human product, allows a deeper penetration by human intelligence than the natural world if, mistrusting mere observation, we allow ourselves to be guided by methods appropriate to social inquiry. We shall see that some contemporary schools of thought underline the need of a social ontology, consisting ‘in a theoretical description of the nature and constitution of social reality’ (Ardebili 2003: 11). But, as far as we know, nobody has provided so far a satisfactory and appropriate methodological development of this important statement. Three centuries ago Giambattista Vico had polemicized with the method that was then coming to the fore. He said: One marvels at the fact that all the philosophers have insistently sought the knowledge of this natural world, of which, God having created it, He only

12   A. Fusari has knowledge. And they neglected to meditate upon this world of nations, or world of civil society, of which, because men made it, men could obtain true knowledge. (Vico 1987: 107–8) We must therefore inquire why Man has made social systems the way they are, why they are plagued by inefficiencies or replete with virtues, how to intervene to reconstruct or modify them so that they respond more satisfactorily to human intentions. Besides, the method of social sciences must include creative phenomena, not to explain them, this being impossible by definition, but simply to take them into account. This is, for instance, the viewpoint of social economics, which bears on how social reality is constructed at the hands of Man and on the way to intervene and orient it in the fashion that one deems or that proves to be most fruitful. Economic and social sciences must take great care to distinguish the aspect of ‘choice–possibility–creativity’ from that of ‘necessity’ i.e. imposed in the given situation by impelling reasons of efficiency and rational organization. Inquiry into human society must concern, at once, the interpretative and the normative aspect, being and doing, and integrate both aspects in a unitarian methodology, and must lead to the edification of a ‘science of the constitution, organization and change of social systems’ whose dictates can and should guide social thought and action, for instance the analyses and proposals of social economics, and give this discipline the instruments for controlling them. In short, while it is senseless with respect to the natural (given) world, investigation based on alternative hypotheses is completely justified when the object is society and may also help the understanding of historical processes. But let us proceed step by step. An instructive borderline position of positivism: Popper’s method One might object to the foregoing argument that the observationist viewpoint implies human intervention in nature based on the knowledge acquired and directed to influencing it, so that some kind of interventionism is also compatible with the application of this method to social reality as well. Yet this point does not eliminate but rather highlights the great difference between the two realms of knowledge. That is, intervention in the natural world is interactive, in that the laws of nature remain external to Man, who interacts with them; while intervention in social reality is constituent, in that social systems are constructed by Man, even though in doing so Man must obviously take a number of conditioning factors into account, including natural reality. Reference to the work of Karl Popper will help us clear up these questions. Popper’s methodological propositions, in fact, mark a sort of borderline position of empiricism that helps us to discern the methodological turnaround that is needed in social thought. It also provides a good example of the way in which the observationist stance can be brought forth again in forms that are positivist not in an inductive sense but that are nonetheless highly misleading for the study

The method of social theory   13 of social reality. Popper is known as a deductivist. He holds that theories are nothing but conjectures, guesses and, as such, not verifiable. But he adds that they can be subjected to severe critical checks, attempts to falsify them relying on events and experiments. This conjecturalist approach helped sow the seeds of incommensurabilism in the epistemological discussion conducted by the works of Hanson, Kuhn and Michael Polanyi. Indeed, it helped drive Popper’s student Feyerabend to methodological anarchism. But Popper himself, fine rationalist that he was, did not accept any such conclusion. He escaped by combining a deductive method based on hypotheses relying on the creativeness and intuition of the scholar with checks of theory via falsification, a particularly exigent form of observationism.3 The two-­fold methodological approach suggested by Popper, of conjecturalism combined with the principle of falsification, can be deemed appropriate or at least useful to inquiries into the natural world. For as that world is not the work of Man, it is sensible and perhaps even essential to investigate it by beginning with guesswork. Society, however, is the work of Man. This fact places the social scientist on a terrain which, as noted, is well suited to penetration by the human mind; it is the creation of the mind itself, so the scholar can thus do better than mere guesswork, all the more so in that, as we shall see, the initial hypotheses in social science are generally founded on rather definite knowledge. However, this advantage is offset by a series of difficulties, consisting in the fact that social science must come to grips with the enormous and increasing changeableness of human society owing to the constructive, inventive activity of men and women, resulting in accelerating social change. The point is that the pace of social change makes the principle of falsification utterly unreliable, practically meaningless, in social inquiry. For in this case the falsifying phenomena are very frequent; the speed of change vaporizes the methodological usefulness of the principle of falsification, like all sorts of observationism. In any case, one must recognize the great shrewdness of Popper’s references to social theory. As far as I know Popper has been the most able in his efforts to adapt the positivist method, in its guise of the principle of falsification, to the analysis of social reality in order to extract what little that approach has to teach us in this field. Significantly, however, his teaching (Popper’s ‘piecemeal technique’) does not go beyond limited capability for intervention, closely resembling Man’s interactive intervention in the natural world. Truth to tell, Popper is careful to point out that the operational capability of his piecemeal mechanics is not limited in principle and can range from no intervention at all to very far-­reaching action. But the fact remains that inherently the observationist approach does not allow far-­reaching intervention but only modest interactive adjustments, while as we shall see the point as far as human societies are concerned is to identify the pillars upon which they must be erected and determine how they must be rebuilt or adapted when this is required by the sedimentation of significant innovation implying a substantial transformation of the general conditions of development. In The Poverty of Historicism Popper writes that ‘in general the social sciences should not be looking for a Newton or a Darwin but for a Galileo or a

14   A. Fusari Pasteur’, but in a footnote he recognizes that mathematical economics shows that at least one of the social sciences has already had its Newtonian revolution. The allusion is to general economic equilibrium theory. If Popper had been more familiar with social theory and social reality, he would have realized that that revolution was one of the most unrealistic and useless ever spawned by social thought. But this has only marginal importance in our present framework. The point is not to substitute Galileo or Pasteur for Newton and Darwin; the problem is to remove social inquiry from the observationist approach of all those great natural scientists in order for social thought to be able to develop and advance. For the observationist method is unsuited to social reality, which throws its ana­ lyses off target or, at the very most, and with all the many stratagems noted by Popper, allows quite modest gains in knowledge despite great investigative effort. Some significant steps in the transition from positivism to methodological pluralism. The contributions of the Polanyi brothers The Polanyi brothers’ investigation embraces very distant topics that, directly or indirectly, gave rise to some different but crucial methodological questions. Their results and proposals mark in two different ways the beginning of the current crisis of social thought: the first through a misleading mixture of the organizational and observational perspective; the second through a deep, original and more direct analysis of method that contributed to opening the door to the so-­called epistemological revolution of the second half of the last century and hence to the rise of the present inconclusive and improper pluralism in social thought as stimulated by the absence, in this field, of a general and shared methodological foundation. A basic contradiction undermines the wide research of Karl Polanyi. On the one hand, this is marked by the attention to the organization of social systems; on the other, it is inspired by a strictly observational empiricism that, as we know, is inappropriate to an organizational view. The author observes the great variety of social systems appeared in the course of history and manages to capture some generalizations useful to understand that variety, mainly taking profit of analogy and comparative analysis. The three well-­known categories and integrative principles that Polanyi denominated ‘reciprocity’, ‘redistribution’ and ‘market’, characterizing with variable intensity social orders, are the main tools of the anthropological analysis and comparative history of this author. He writes, significantly: ‘In any case, the integrative forms (that is, the above principles) do not represent “stages” of development. They do not imply any temporal sequence . . . The Soviet Union represents an extreme example.’4 Polanyi never considers the organizational implications of the general conditions of development in the various historical ages. He thinks that it is possible to freely choose the above principles in the organization of human society. But an analytical approach disregarding the changes in the general conditions of development is condemned, at the best, to a very weak interpretative capacity and can cause serious equivoca-

The method of social theory   15 tions, while analogy and comparative analyses do not seem able to open a promising methodological door. One main misunderstanding of Polanyi’s analyses of societies and their historical behaviour is represented by the ignorance of a basic distinction on which our development on method will strongly insist: the distinction between ‘necessity’ and ‘choice–possibility’ in the organization and management of social systems. It is surprising that Polanyi, notwithstanding that his view is dominated by the organization of social systems, has not realized both the importance of distinguishing the aspect of his integrative principles that express ‘necessity’ from those expressing ‘choice–possibility–creativeness’ and the suffocating effect on evolutionary motion and development of the predominance of some important integrative forms that he underlines. An unconstrained domination of the principles of ‘reciprocity’ and ‘redistribution’ characterizes the quasi-­stationary societies of the ancient world, while market institutions prevail in modern societies. Karl Polanyi does not meditate on the cause of this regularity operating at universal scale. Such meditation would probably have enlightened him on the analytical importance of the distinction between ‘necessity’ and ‘choice–possibility–creativity’. Polanyi’s considerations on the role of the market well clarify the substance of this omission. He prefers general planning since this would have the capacity to improve integration and the states of equilibrium among the various components of the social system, and writes: ‘Socialism essentially expresses the tendency of each industrial civilisation to surpass self regulating market by submitting it to a democratic society’ (1974: 294). This statement forgets that modern societies, pushed by persistent endogenous creative changes and hence by a high flow of innovation and uncertainty, need decentralization and therefore a self-­regulating market, mainly due to the limits of knowledge (that his brother Michael Polanyi emphasizes, as we shall see). In the absence of the market institutions, social systems would be forced to regress towards a stationary state. Karl Polanyi is disgusted by the iniquities of the observed market relations. The pendulum, in the life of capitalism, of market and non-­market institutions, fuelled by market failures, suggests to the author the so-­called theory of ‘double motion’ that today some institutional analyses start to propose once more. But the mere observational view and the correlated absence of the distinction between ‘necessity’ and ‘choice-­possibility’ makes the above theory a vehicle of erroneous interpretations. Karl Polanyi’s analysis only contemplates choice-­ possibility. The market simply is the observed one and represents one among the various organizational possibilities of the economy, at the service of one particular civilization. The author does not see that, notwithstanding the ‘double motion’ between market and non-­market institutions, the market represents, in the modern dynamic economies, a necessity, even if surrounded by many other institutions. He does not realize that the market can be amended by its capitalistic features and coupled with various civilizations, using it as a mere mechanism for costs imputation and efficiency, and hence consistent with incisive redistributive forms and financial systems completely different from the usual ones. The

16   A. Fusari disregard, by his theory of the ‘two-­fold motion’, of this possibility, is an effect of his mere observational attitude and makes evident the contradiction implied by the combination of the organizational view with the mere observational method. Capitalism made possible the advent of the modern dynamic society, helped by the action of national states against feudal and guilds’ privileges; but different dynamic societies and civilizations could have been organized in principle, consistently with market institutions. Michael Polanyi’s work directly defies the question of method, starting from an important, absolutely general and realistic premise: the limitations and imperfections of human knowledge that are forced to advance by trial and error. Such a premise leads him to discover the decisive role of ‘tacit knowledge’, concerning ‘an important area where explicit thought is ineffective’ (M. Polanyi 1988), i.e. things that are known but that people are unable to say, skills used in a conscious or unconscious way during existence, such as the skills to drive a bicycle, to swim, play tennis and even walk. But Polanyi goes beyond personal knowledge; he also investigates the formation of scientific knowledge and writes: No rule can give account of the way a good idea (for research) is set up; there are not precise rules to verify or confute the proposed solution of a problem . . . Scientific discovery cannot be achieved through explicit inference and its proclaimed truth cannot be explicitly assessed. (op. cit. p. 174) A large part of the above statements are right, but a further deepening of this author’s thinking gives rise to substantial disagreements. It is undeniable that a similar thing can appear completely different if considered from a different point of view. It also is undeniable that intuition plays a central role in research and creativity. We agree that discoveries largely follow the road of Polanyian tacit knowledge. But this does not deny the central fact that the fecundity of research can be largely improved by rules helping to select relevant problems, to avoid dead ends and to profitably observe the considered phenomena without being deviated by a free and misleading use of points of view. Moreover, assessing the degree of usefulness of the research results requires a marked overdependence on rules. Of course, discoveries cannot be automatically generated by appropriate rules, expressed in the statement that: ‘every attempt to get a complete control of thought through explicit rules is self contradictory, systematically misleading and culturally disruptive’ (op. cit. p. 194). Discoveries are a product of student’s genius, and creative genius is for most a casual gift of nature’s lottery. But it is of crucial importance to help the human mind to see and select true problems and to supply the skill for evaluating the achieved results, so that to avoid the waste of a precious resource such as natural ability. Michael Polanyi appears, indeed, to be conscious of all that when he writes: ‘No research can be successful if it does not start from a true, or at least partially true, knowledge of nature’ (ibid.). This statement gives rise to the problem of

The method of social theory   17 how to verify the degree of veracity of a particular piece of knowledge. Nevertheless, he attributes a marginal and supplementary importance to rules helping to do that and to the way of making knowledge explicit. Indeed, Polanyi seems to contradict his statement on the supplementary role of rules when he considers the question of the growth of science and the ways of organizing students’ communities. In this regard, he makes, for exemplification, the hypothesis that the components of an enormous puzzle are allotted to a team charged with the solution at the maximum speed, and shows that the best way of doing that is to give to each member of the team the ability to annotate the pieces arranged in the course of the work, so as to deduce the subsequent decisions. This implies that the success achieved in the previous movements must be clearly visible. Polanyi intends to show, through that example, that the best organization of scientific effort is represented by independent and self-­coordinated initiatives. To better clarify the question, the author refers to the work of the self-­regulated market, where the price mechanism pushes the single operators’ independent decisions toward the right direction in the utilization of scarce resources. As is well known, at the basis of this result there is the existence, beside the price mechanism, of precise and well-­determined criteria of firms’ action and consumers’ decisions. Similarly, research in order to operate successfully and extract the best results from the available skills, necessitates the availability of some guiding rule helping the students’ effort of research and allowing the evaluation of results. Michael Polanyi presumes that this exists, just as it happens in natural sciences that benefit from a well-­tested methodological common denominator. But the main drama of the so-­called social sciences is the absence of a methodological common denominator, i.e. a shared methodology, extracted from the character of the considered reality. The need of such denominator contradicts the subsidiary role of rules he emphasizes. Due to these equivocations on rules, Michael Polanyi’s development on personal knowledge has offered a main contribution to the so-­called ‘New philosophy of sciences’. Kuhn, in Chapter 5 of his Structure of Scientific Revolutions, quoted the ‘brilliant’ Polanyi’s reasoning on the mechanisms of knowledge, to maintain that the notion of ‘paradigm’ does not necessarily need the formulation of rules. But, as a matter of fact, Kuhn’s theory of scientific process exposes some completely different ideas on the topic that, due to their success and influence, deserve attention and some confrontation to Polanyi’s thinking, useful to give a synthetic picture of new philosophers of science’s attitude and their misunderstandings. Kuhn maintains that scientific progress takes place through revolutionary jumps going from a paradigm to a superior one, under the stimulus of the progressive exhaustion of the work of the ‘normal science’ in developing the potentialities of the current paradigm (Kuhn 1970). On the contrary, some other authors, for instance Popper and Lakatos, expressed a notion of steadier scientific progress, considered as a quasi-­permanent revolution. We find scarcely convincing the idea that innovative dash and the revolution generating a new paradigm is surely primed by the exhaustion of the role of ‘normal science’.

18   A. Fusari More precisely, it seems to us that such push plays a secondary role. Many paradigms of primitive societies (taboo, sorcery) have survived till now. It is the propensity to innovate that consumes paradigms and generates new ones; the appearance of such propensity does not need that normal science has exhausted its work. In fact, normal science tends, by itself, to become immortal, just as the paradigms of stationary societies. Kuhn indicated Michael Polanyi’s teaching as expressing a static notion of paradigm, i.e. excluding revolutionary leaps. But, in effect, the notion of paradigm is a stranger to Polanyi’s theory of the advancement of knowledge. While Kuhn postulates a solid, even if transitory, common base for scientists’ work, represented by the paradigms and their rules, Polanyi inclines, as we said, to undervalue the role of rules by stressing their subsidiary character, to the advantage of the personal decision, intuition and creative aspect. This Polanyi’s emphasis on tacit knowledge has given an important contribution to the incommensurabilism of the ‘New philosophy of science’, a contribution, however, that greatly differs from the Kuhnian one which is distinguished by the gestaltic character of paradigms. Social thought has been afflicted by a sequence of exaggerations and misunderstandings, for instance, the positivist ones, followed by the opposite teaching of the ‘new philosophers of science’. It is indeed urgent to redress this situation. For a better clarification of the growing methodological confusion that paralyses social theory, a rapid exposition of some other more significant investigative approaches is indispensable.

1.2  The anti-­positivist reaction The growing fragmentation, incommunicability and incomparability of social inquiries The observational method has assumed, in social thought, two standards that can be denominated strong observationism (or social positivism), that we have considered above, and weak observationism that does not share the hypothesis of repetition (recurrence) of social phenomena this being clearly contradicted by growing social change, but retains the hypothesis of acceptance of de facto reality that implies an anchorage merely observational to phenomena. It retains, therefore, the idea of spontaneous behaviours, but in the context of some non-­ positivist methodologies. Also this weak observationism, however, erases doing and the distinction between freedom and constriction, or ‘necessity’ and ‘choice– possibility–creativity’. Well, the anti-­positivist reaction that started at the end of nineteenth century took the form of weak observationism, that is, rejecting the hypothesis of repetition of phenomena but preserving that of spontaneous behaviour. This weak observationism is shared by very distant schools of thought: liberalism, social naturalism, Marxism when this appeals to the fantasy of history, Hegelian identification of reality and reason, evolutionary and historicist thinking. So that, the spontaneous view has strongly oriented, implicitly or explicitly, modern social thought that, in the twentieth century, developed

The method of social theory   19 aggressive anti-­positivist formulations. But, instead of getting social theory out of the observationist dead end, however, this threw it out of the frying pan and into the fire. Since observationism was replaced by methodological anarchy, the view developed that all the various modes of thought and the various theoretical approaches are of equal worth and intellectual dignity. However that may be, and even ignoring such extreme claims, one must acknowledge that a swarm of methodological approaches has arisen,5 giving rise to a proliferation of fields of non-­communicating inquiry, mutually impenetrable and not comparable, and so unable to interact, to forge syntheses. This incapacity for interaction and communication impedes the process of inquiry, which as we have seen needs selection in order to grow and develop. Many years ago, Durkheim pointed out that the prestige of both magic and modern scientific thought is founded on pure beliefs; he also added that both these kinds of knowledge incline to explain their failures through ad hoc hypotheses (Durkheim 1979). These statements, which show a strong resemblance to Feyerabend’s argument, forget that the main achievement of modern scientific thought, unlike primitive and magical thought, is accumulation, that is the exponential growth of knowledge. However, Durkheim is not completely wrong; in fact, even today a close resemblance joins social thought to the magical and primitive: the absence, in both cases, of accumulation, i.e. the marked incommensurability of theories. But just this is the real plague of social thought, that this essay is aimed at contributing to eliminate. More recently, the situation is much worsened. It must be recognized that the Kuhnian notion of paradigm shed some light upon the determinants of the cognitive process in the natural sciences, but in the field of social thought, with its profound ambiguities and methodological differences, the notion threatens to legitimize and intensify the unhappy state of fragmentation, incommunicability and incommensurability. Some recent deepening by Dow on the role of schools of thought recalls the substance of Kuhn’s notion of paradigm but referred to social theory, mainly economics. She writes: Schools of thought may thus be considered as evidence of division of labour in economic thought . . . But these segmentations are partial, provisional and with the boundaries not precisely defined . . . The partial, provisional and vague nature of these categorisations creates an openness to cross fertilisation across schools of thought, and an evolution of the schools of thought themselves. (Dow 2003: 8–9) These statements may be shared with reference to natural sciences. On the contrary, in social theory, which is afflicted by radical dissent and a growing methodological confusion, schools of thought are becoming some more and more separated analytical areas, often irreducibly opposed to each other, that express a sort of degenerate and unfruitful pluralism. On the strength of growing

20   A. Fusari d­ ivergences and the consolidation of a multiplicity of schools of thought, a kind of tacit agreement is spreading: each student cultivates his own cabbage-­patch without interfering in that of others.6 In this regard, Ardebili writes: ‘Such (post-­ positivist) philosophy, as discussed below, would fragment the entire contingent of heterodox economists into separate groups where each group would pursue its own perspective and practice its own methodology’ (Ardebili 2003: 2). This is the point. In order for schools of thought to express a sound pluralism and the openness to cross-­fertilization that Dow emphasizes, a preliminary problem must be solved: the definition of some basic methodological procedure and rules that fit social reality and serve as a common denominator that makes interaction possible. Of course, method cannot (and must not) be a strictly determined tool, i.e. precisely defined in each particular, without becoming a prison obstructing creativity. The epistemological debate on the method of natural sciences has clearly shown the lacks in that method. Nevertheless, a great achievement was the definition of some basic rules and very general principles well suited to the character of natural reality and allowing commensurability, hence accumulation of knowledge. Constructivism, abstract rationality and evolutionary social thought The constructivist and evolutionary views on social process deserve some attention as they express well two main and opposite errors of social thought and represent, in some sense, the two extremes of the anti-­positivist nebula. A brief reference will be dedicated to the abstract rationality approach that emphasizes the main error of constructivism: the elusive attitude towards crucial aspects of reality. First the constructivist view, which focuses explicitly on the organization of social systems, represents a main methodological alternative to observationism. It deserves attention both for its special consideration of the organizational aspect and the surprising carelessness with which it has wasted that important peculiarity, doing substantial damage to the standing of social science and economics. Constructivism does not pay due attention to reality. It proposes an arbitrary social engineering that has suggested senseless interventions and produced untenable results. Its propensity for projects of rebuilding society lacking real foundations, which have been sharply criticized by Hayek and some other supporters of spontaneous order, points to the perils to which abandonment of the observationist viewpoint exposes the scholar. An impressive example of the mistakes that may cause constructivism is offered by the experience of the so-­called ‘real socialism’. Its centralized bureaucratic organization was condemned to inefficiency and stagnancy. In fact, that organization inclines to suppress innovation and is unable to meet variety and change. Therefore, it was appropriate to the ancient quasi-­stationary societies but not to the modern dynamic world. There is a way of radically ignoring reality, which is much more frequent in theory than in practice: the method of abstract rationality typical of logical-­

The method of social theory   21 formal sciences that starts from nominalist unrealistic postulates. An example of its application is the neo-­classical general equilibrium theory, as well as von Neumann’s equilibrium model (1952). The point is that if we reject the observationist approach, we must concentrate on finding an ‘alternative and more efficient way of taking account of reality’ in the running of human societies and building theory. The constructivist view cannot avoid deepening the problem of rationality in social reality and, even more, what may be the object of agency and what resists human action and influences it. But these problems need to be considered in a much more involving way than constrained optimization and the so-­called programmatic approach do (that has been largely used in economics where it was initially developed by Frisch and Tinbergen); in fact, the efficiency, viability and survival of real socialism were not warranted by the large use of mathematical programming. Precisely, the organization and constitution of social systems needs a preliminary and accurate clarification of the value-­ideological aspect, the distinction of necessity from choice-­possibility and between necessity and duration, choice-­possibility and temporariness. Evolutionary thought, on the other hand, which represents one of the most lively and ambitious branches of the modern social theory, falls into an opposite error with respect to constructivism, deriving from an exaggeration of the limitations in human cognitive skills. We have seen that those limitations oblige knowledge to advance through a plurality of proposals and that this requires method, to make possible the interaction among different contributions as well as their selection. We have also pointed out that human society is a product of Man, and hence that the method of social sciences must be directed to help social construction. One main error of evolutionary social thought is its inclination toward a supine acceptance of spontaneous behaviour resulting from intentional and unintentional events, in the presumption that Man is unable to cautiously influence the state of affairs. This implies an observationist-­naturalistic view, notwithstanding this is only appropriate to natural sciences, as we know. Truth to tell, evolutionary observationism refuses the hypothesis that reality means necessity, due to the high importance it attributes to creative events; but it shares, implicitly or explicitly, the naturalistic hypothesis that reality implies rationality as a result of selection. Following biology, it shares the observationist method. But biological evolution is extremely slow thus making such a method acceptable, while social evolution is not. The spontaneous convergence of reality towards rationality requires very long periods of time and, in the social field, some trial and error processes, the dimension and painfulness of which grow with the acceleration of social change. Variety generation and environmental selection, whichever are the supposed relations between these two poles of the evolutionary process (independence, backward or forward dependence), do not provide a useful scientific tool if change is fast. It may be greatly deceitful for social research to be inspired by biology. In particular, Darwinism did a bad turn to social thought from its

22   A. Fusari e­ xtensive application to social reality by Herbert Spencer, social evolution being the product of human genius and uneasiness and not of slow selective processes of accidental mutations. The naturalistic and observationist base of social evolutionary teaching, while giving great importance to creativity, does not give proper consideration, however, either to the factors that determine the intensity of creativity notwithstanding this varies so much in different social contexts and in the course of history, or to the possibility of alternative choices. For their part, unintentional events and the unintentional birth of institutions, such as money in Menger’s analysis (1951 [1892]), have exaggeratedly inspired evolutionary thought. Of course, interventionism may be detrimental and spontaneous behaviour should be preferred if social thought is equivocal and unreliable. But the point is to improve theoretical knowledge and hence the ability to manage the social system. Moreover, an interior ambivalence afflicts evolutionary social thought. One branch of this strongly underlines spontaneous behaviour and unintentional events while strongly oppose organization. Hayek is the most known exponent of this position, with his anti-­constructivist opposition of spontaneous order to organization: as a consequence, he dislikes the firm. The other branch, North and Williamson, emphasizes organization and institutional analysis. In the last decades, a good deal of work in the light of the evolutionary view has been carried out by economics and institutional analysis. The so-­called ‘evolutionary and institutional economics’, widely represented in the European Association for Evolutionary Political Economy (EAEPE), dedicates a great deal of attention to the subject (Dosi, Hodgson, Witt and many others). Its research programme is attractive; unfortunately, it is weak from a methodological point of view and its criticism is not addressed to observationist and abstract rationality methods but, more specifically, only to Newtonian mechanistic metaphor and equilibrium theory. Evolutionary realism is inspired by a strong observationist standard. It tries to explain what happened without asking what could have happened rationally speaking but simply accepting it. In other words, evolutionary social thought is centred on being, while neglects doing. But it must be recognized that the inclination of the evolutionary analysis of institutions is to escape this ‘acceptance’ standard, in accordance with the constructivist nature of institutions. Unfortunately, this inclination is strongly repressed by the observationist view, which prevents a proper institutional analysis.7 Excepting the disputable use of biological metaphor, on the whole, evolutionary social thought is not driven by a well-­ defined and appropriate method, i.e. distinguished by a definite procedure and the associated rules. In point of fact, it practises and recommends methodological pluralism, mainly in the form of creative metaphors, but with the exclusion of ‘the precept of “anything goes” ’ (Hodgson 1999: 82). As we know, the absence of a reliable methodological common denominator obstructs cross-­ fertilization and makes dispersive inquiries. Here we have an important example of the multiplicity of ways observationist equivocation may affect social thought.8 In the final section of this chapter, we shall see that our method seems

The method of social theory   23 to provide a simple and almost natural link between institutional and evolutionary analysis and some clear and fecund development on this subject. In conclusion, evolutionary thought disregards the possibility of a science of the organization of social systems, with some spurious exception expressed by its mixing with institutional analysis, while constructivism strongly and ingenuously exaggerates that possibility. The second ignores crucial aspects of reality and hence gives free rein to social planning, while the first inclines to consider social reality as a spontaneous order. Therefore, both positions do not provide social sciences with a suitable method.

1.3  Some more recent developments Critical realism and the constitution of society One promising school of social thought is the so called ‘critical realism’ that recommends deducing the methodological construction from the characters of social reality. It expresses the strongest answer to the method of abstract rationality and many other misrepresentations of reality in social thought. Some reference to two leading critical realist authors may be sufficient to delineate the main contents and limitations of this school of thought. A book by Margaret S. Archer, The Morphogenesis of Society, starts by saying: ‘Social reality differs from every other, due to its human constitution’ (1997: 11). She emphasizes the links between social ontology and social methodology, i.e. the dependency on the nature of the object of study. Archer maintains: ‘Ontology without methodology is deaf mute; methodology without ontology is blind’ (op. cit. p. 40). The term morphogenesis underlines that society has not a predetermined conformation or an optimal state but is created by intentional and unintentional actions of social agents. Archer also insists on the idea that human beings are, at the same time, free and prisoners and that a measure of the appropriateness of social theory is its ability to represent human freedom and constriction. She dislikes both collectivism and individualism, which is the conflation of subjectivism with objectivism or vice versa. A similar position is expressed by a non-­critical realist author, Giddens who in a book entitled The Constitution of Society (1984) condemns both the ‘imperialism of subject and of object’, underlines that structure is both a mean and a product of human action and focuses the interaction between structure and agency. Lawson is even more drastic on the relation between reality and method. He writes: ‘My alternative strategy, as I say, has been to investigate in a sustained and explicit way the nature of social reality, and to tailor methods of social investigation accordingly’ (2003: 68). He resolutely drives away critical realism from the method of natural science. He insists on the concept that ‘social structure, unlike natural structure, depends for its existence on human intentional agency’ and adds: ‘Rather, process denotes here the genesis, reproduction and decline of some structure mechanism or thing’ (op. cit. p. 149).

24   A. Fusari We plainly agree with these concepts; but it seems to us that some crucial omission afflicts the developments drawn by the premises referred above. Precisely, the critical realist’s attention to the ontology of social reality does not achieve the results that one should expect in terms of methodological procedures and rules. The more explicit proposal on method that we find in Lawson’s extensive development sounds as follows: the essential mode of inference drawn upon in science is neither induction nor deduction. Rather it is one that can be styled retroduction or abduction or ‘as if ’ reasoning. This consists in the movement, on the basis of analogy and metaphor amongst other things, from a conception of some phenomenon of interest to a conception of some totally different type of thing, mechanism, structure or condition that are responsible for the given phenomenon. (op. cit. p. 145) The concept of abduction mainly refers to the creative formulation of theoretical hypotheses; it pertains, therefore, to the most obscure part of method. But, apart from this, analogy is largely insufficient from a methodological point of view, notwithstanding the great utility of comparative analysis both in social and historical inquiries. In particular, it does not provide per se some scientific standard of judgement on the degree of importance (superiority, inferiority) at least of the main aspects of the compared societies. So the risk of misunderstanding is high. For its part, metaphor contradicts, in some way, the emphasis of critical realism on the methodological importance of the ontology of the considered reality, which should suggest a distrust of the theoretical concepts elabourated by other sciences. Our author says: ‘the questions of ontology have been largely neglected in discussions of borrowing from others; and here my purpose is to help rectify this situation’ (op. cit. p. 111). But the best way to do that seems the search for a general method well suited to social reality. This is much more important and resolute than trying to improve caution in the use of metaphor (for instance, in the use of the evolutionary approach). Lawson writes that theorization ‘is a movement, paradigmatically, from a surface phenomenon to some “deeper” causal thing’ and adds that ‘the possibility of social sciences depends on there being social structures to uncover, i.e. structures whose existence depends upon human actions as well as the states of affairs’ (op. cit. p. 147). But we do not see, in the development of this school of thought, a precise methodological tool able to achieve some relevant deepening in the matter. It seems evident that a main limitation of critical realism is to disregard the important methodological problem of the way to combine being and doing, in particular, the absence of a methodological criterion, in the study of social systems, to differentiate between necessity and choice-­possibility and to clarify the diversity of this distinction from the binomial duration-­temporariness. Some major misunderstandings in social thought are due to the dominating confusion between these terms. We shall see later the great importance of these

The method of social theory   25 notions and differentiations for understanding structures, rules, institutions and social relations, their meaning and variation over time, their birth and decadence, the relation between freedom and constriction that critical realism emphasizes, as well as to understand the degree of importance of the existing structural aspects. Individuals’ behaviour, human actions, institutions, structures, etc. are completely different, for instance, in a capitalistic or theocratic society. We shall also see that of paramount importance is the scientific ability to understand the degree of accordance of these societies with the existing general conditions of development and identify their aspects that are a matter of choice. Another objection that may be addressed to critical realism seems to concern its carelessness in discussing rationality and developing rational standards useful to hinder the disruptive effects of the irrational feelings of human beings. The above methodological incompleteness causes an evident openness of this school of thought to pluralism. This is not a shortcoming, per se, but may engender confusion if a well-­defined methodological common denominator does not exist. At this point, we hope that the ground has been prepared to move on from critical analysis to proposition. But after having considered some intriguing aspects of Boudon’s recent teaching. Boudon’s ‘ordinary rationality’ and his criticism of the rational choice theory A stimulating contribution on rationality has been recently developed by Boudon and concerns the core of the methodological problem of social sciences. His insistence on the objectivity of values is well known. Recently, he has generalized his view on method through a theory of cognitive rationality aimed at contrasting and possibly replacing, in social theory, the current monopoly of instrumental rationality. The author mainly directs his criticism against the most refined version of instrumentalism expressed by the rational choice theory and its more open formulation consisting in the theory of ‘bounded rationality’. As is well known, instrumental rationality asserts that people can choose rationally the means to achieve a goal but the foundation of this or, more in general, of the ends and values, is always subtracted to scientific explanation. Boudon sharply objects to instrumentalism: ‘Why could not on the other hand the ends endorsed by a subject be expressed by the fact that they are inspired by beliefs grounded on theories grounded themselves on assumptions?’ (Boudon 2008: 2–3). He underlines the cognitive limitation of the idea to apply reason to questions concerning the means while denying the possibility of rationally inquiring on the goals. Coherently with this position, the author attempts to delineate a theory of ‘ordinary rationality’ including the explanation of values and ends. His starting point sounds as follows: Let us assume X represents some objective, some opinion or some normative or positive belief. The Theory of Ordinary Rationality (TOR) assumes that a subject will likely endorse X if he has more or less consciously the

26   A. Fusari impression: 1) that X is grounded on a system of reasons (S) including the statements s1, s2 . . . sn which appear to him as being individually acceptable and mutually compatible and, 2) if he has additionally the impression that no alternative system of reasons (S) is available which would be preferable to (S) and which would lead to an alternative objective, opinion or normative or positive belief . . . In a word, what I call the Theory of Ordinary Cognitive Rationality or more briefly Theory of Ordinary Rationality postulates that this basic process is more or less at work whatever the nature of X: whether X is some opinion, normative or representational belief or objective. (op. cit. p. 6) Boudon warns that some deviations from the ideal-­typical case are possible and frequent, mainly due to lack of information, cognitive incompetence or the interference of conflicting goals and passions and that, after all, the same happens with instrumental rationality. Then the author considers the different nature of statements: factual statements or principles and beliefs (context-­free and context-­ dependent beliefs). In this very inclusive notion of ‘ordinary rationality’, rational explanation has not the unique feature that Hollis pointed out by saying that rational action is ‘its own explanation’, that is a self-­sufficient explanation, a scientific one. Boudon clarifies this point well by forwarding Table 1.1 with four ideal cases derived from the combination of context-­free, context-­dependent beliefs and their weak or strong character: And he confirms: My main thesis is again that ordinary rationality in the sense I have just defined can be applied whether X is an objective, a normative or positive belief, a value or a means. By contrast, the conventional theory of rationality even in the broader definition proposed by H. Simon, is limited to explaining the choice of means. (ibid.) Then the author provides some applications of his theory, directed to support its explanatory potential; he takes care in pointing out that ‘ordinary rationality’ must be referred to individual social behaviour, not to individual human behaviour which often is irrational. Table 1.1  Boudon’s clarification System of reasons

Strong

Context-free

Scientific beliefs (Torricelli) Private property is natural (Pareto) Rain dances, miracles Beliefs of civil servants (Durkheim) (Tocqueville)

Context-dependent

Weak

The method of social theory   27 Boudon’s theory can be considered a useful generalization on rationality. But it should not be missed that the real problem is to extend as much as possible the object of the first cell of the table, i.e. scientific rationality. In other words, the problem is the decontextualization of beliefs, to make the theory a clear and stringent guide for human and social action. Otherwise, the suggestions of the theory are questionable; but what is controversial and a matter of opinion, weakens action and may cause insolvable conflicts. As a matter of fact, the indeterminateness due to the extremely reduced role of the first cell in the above table is the main lack afflicting social thought: it has no scientific standard, since it is not provided with some general methodological foundations, basic rules and procedure of research and discovery shared by the scientific community, that make possible the confrontation (and cooperation) among students, the assessment of the real contribution to the advancement of knowledge and hence its cumulative growth. Boudon’s reference to the more open form of choice theory as expressed by the notion of bounded rationality is appreciable. In effect, rationality is always bounded due to the limits of human cognitive skills. But it may be useful to underline that an important question, additional to the one-­sidedness of instrumentalism, concerns the accurate consideration of the character of bounds, which the followers of Simonian rationality have largely misunderstood. An example in this regard is offered by the growing consideration, mainly in economics, of radical uncertainty (that is, uncertainty that cannot be expressed by well-­defined distribution of probability) just as a sort of fog and a vague atmosphere afflicting rational choice.9 The deepening of bounds is particularly important in the context of an extended notion of rationality like the one proposed by Boudon. Unfortunately, his development of rationality completely eludes the scientific aspect, i.e. cell one. In fact, all his examples are context-­dependent. He quotes Einstein’s statement that there is a deep continuity between science and common sense; in some respects this is true, but it is undeniable that there is a qualitative jump between science and common sense, due to the methodological foundations of the first. Magical thought is a completely different thing from scientific thought: the second has the important property of providing cumulative knowledge. It can be said, therefore, that ordinary rationality corresponds to social thought while scientific rationality corresponds to social science. In sum, the real problem is to build social science and this requires a method appropriate to social reality. In other words, the problem is to marry, to instrumental rationality of the logic-­formal and natural sciences, a social science able to develop teleological and instrumental rationality. The progress of knowledge is largely due to the incorporation in scientific rationality of a growing number of phenomena previously treated according to the remaining three components of ordinary rationality. Unfortunately, while some other branches of research have achieved a substantial success in the extension of scientific rationality, this stagnates in social thought. It seems to us that the main (and obliged) way to remedy the stagnation of scientific rationality in social thought is the investigation on the statements included in the System of Reasons, S.

28   A. Fusari Unfortunately, various reasons derived both from logic-­formal and natural sciences have obstructed the deepening of this topic. An important reason is well expressed by Popper’s deductivism when he underlines the strict conjectural character of the initial assumptions that could be even chosen at random since the validity of the deduced theory can be tested through falsification, a particularly exigent kind of observation-­experimentation. Moreover, natural reality does not imply the normative aspect and this further reduces the problem of principles (in fact, in natural sciences, the introduction of values, as essentialists do, is senseless). The disregard of the investigation of initial hypotheses has been reinforced by the role of creativity in research and discovery. The consequence has been a wide diffusion of the idea of the non-­demonstrability of principles (extensively intended as statements) and a diffuse abuse, mainly in social thought, of Gödel’s teaching. But the removal (or a strong limitation) of the problem of statements is not possible in the social sciences: neither in the sense of logical-­ formal sciences since social science has strictly to do with reality, nor in the sense of natural sciences, since social reality cannot be intended as an (almost) repetitive process, that as such can be understood and verified through mere observation.10 Unfortunately, the insistence by Popper and the so called ‘new philosophy of science’ on the non-­demonstrability of initial hypotheses has benefited from a great sensitivity and acceptance by social students. This attitude has, explicitly or implicitly, determined a substantial aversion of social thought toward scientific developments and a paralysing proliferation of schools of thought unable to communicate; in sum, has propitiated a real scientific disaster in social studies. In this respect, Boudon’s assertion that principles by definition cannot be proved is misleading. It is important, at this point, for a better understanding of Boudon’s investigation of method, to briefly consider the way he treats the problem of the objectivity of values. He bases the demonstration of that objectivity on observation; but this subtends a contradiction since the simple observation and hence acceptance of reality excludes the normative aspect, the ethical dimension. Boudon tries to escape from this contradiction by asking help to the Weberian notion of ‘diffuse rationality’, according to which in the long run a spontaneous convergence toward crucial values should take place through a Darwinian selective process. But the idea of diffuse rationality simply says that what happens must happen that erases doing to the benefit of being. In other words, Boudon’s reference to diffuse rationality aspires to explain values through the convergence of spontaneous processes toward them. But the spontaneous behaviour is exactly the opposite of doing, i.e. of normative instance, and is only consistent with an evolutionary view of social process that ignores the problem of organization of social systems, distinguishing social reality from natural reality. In our opinion, the true problem in the social sciences (and a main challenge for social scientists) is to choose realistic, well-­founded and fecund premises inside S, to base on them the theoretical constructions. How to do that? This is a main object of the proposal on method that will be shown in the next two sections.

The method of social theory   29

1.4  On the methodological procedure and rules of social science The fundamental distinctive trait of science compared with other forms of thought is that its constructs rest on a stringent standard of rationality. For the reasons set forth in section 1.1, however, the social scientist must not let himself be bewitched by the observationist, inductivist definition of rationality, founded upon the postulate that what is real is rational. He must ground his inquiries in deductive procedures. Unhappily this assertion, widely endorsed by scholars, teaches us little, given the great variety of deductive procedures in use. We have seen that the Popperian hypothetical deductivism is inappropriate to social reality. Even more inappropriate is the abstract deductivism of logical-­formal science, which ignores reality. Another inappropriate procedure is what may be termed observationist deductivism that is based on some generic and bungler consideration of reality, e.g. the derivation of general principles from specific hypotheses. We need a more stringent, more highly circumstantiated outline of the characteristics of reality that the procedure must take on in social thought, starting with the nature of the standard of rationality and then defining some appropriate criteria of selection and distinction of initial hypotheses from which deductions will be derived. Let us see in more detail the basic character of our proposal on method that can be denominated social and cultural objectivism. The task of social science is to develop and foster rationality in the organization, constitution, explanation and administration of social systems, as a deterrent against the irrationality of many individual and collective modes of behaviour;11 but not in the sense of social engineering. Organizational rationality is only intended here as essential to reduce the errors, difficulties and sometimes monstrousnesses that accompany the spontaneous gravitation of social systems towards order and efficiency lauded by Mandeville and by the apologists of spontaneous order and the invisible hand. All the more so in that this gravitation is hindered by many well-­known impediments (chaotic movement, entrapment in particular paths, those human instincts averse to rational action that Pareto set at the centre of his sociological construct) and is made all the more tortuous by the accelerating pace of social transformation. In short, those processes of gravitation have inflicted enormous suffering on mankind, humiliating intelligence and genius and mortifying the spirit. It follows that in social theory the standard of scientific deduction must be targeted on the organizational rationality of social systems. Moreover, the fact that social thought concerns both what is and what should be, being and doing, implies that organizational rationality requires what must be termed a constructivist standard of rationality, i.e. one that includes the interpretative and normative aspects. The other important trait of procedure is the character of its initial hypotheses. For the reasons previously discussed, they must not consist in nominalist postulates, as logical-­formal method does, but must consist in realistic premises. The appropriate choice and classification of these premises in the whole of statements on which (as Boudon says) opinions, objective, beliefs and

30   A. Fusari theories are grounded, is a crucial step for the success of the devised procedure, as we shall soon see. In this respect, the choice of initial hypotheses has, in social science, the importance of postulates in logical-­formal sciences, but with the difference that they must strongly relate to reality. So, the methodological procedure we propose may be sketched as follows: theorization must start from the selection of ‘realistic’, fecund and involving hypotheses and deduce from them all consequences according to the postulate of ‘organizational rationality’. Therefore, in the suggested procedure, positive (realistic hypotheses) and normative aspects (organizational rationality) and ethical premises are strictly intertwined, showing that the so-­called Hume’s theorem does not deny the possibility of combining being and doing. The investigation of statements has largely engaged logical-­formal sciences in the long-­lasting controversy on axioms, postulates, etc. But these sciences are entitled and obliged, by their own character, to strongly limit the whole of statements or premises; in fact, a wide departure from reality is required by the task of these sciences to provide some very general languages and tools for analyses and reasoning. On the other side, the birth of the observation-­experimentation method granted to natural sciences a great capacity and inclination to remove the investigation of statements, since such a method implies that the validity of a theory can be verified through its systematic confrontation to reality: a possibility that weakens the importance of investigating the premises in which a theory is rooted. On the contrary, the inquiry into premises represents, as just seen, the core of a methodological procedure appropriate to social science that, as previously noted, has strictly to do with reality but cannot verify the validity of the theories through the method of natural sciences. It follows that an important (and the next) step is to outline some rules for the classification and selection of fecund and involving initial realistic hypotheses in a whole of statements. This represents the most delicate aspect of a suitable method for deducing general principles and some other knowledge about social theory. The list below is open and hence may be improved. It classifies initial hypotheses as follows: a

b

c

Those extracted from very general aspects of the social reality in question, mainly the general conditions of development that express Man’s evolutionary way, or some other general aspects. The considered aspects must exclude ideological and technological choices, expressing particular options, even if these are extremely long-­lasting. Those representing creative events and ethic-­ideological choices, led by the ‘grand options’ that characterize civilization, i.e. the long-­lasting ethic-­ ideological choices and views on which the entire society is structured and integrated and that greatly influence the advent of new values and preferences caused by economic and social change. Those concerning the conditions of nature and basic technological conditions the absence of which makes the existing level of development impossible. Natural conditions highly influenced traditional societies, for

The method of social theory   31

d

instance nomadism. In modern societies, technological progress strongly reduces their impact. Those focusing on the evolutionary and creative potential of human beings.

To each component of this list will correspond different initial hypotheses and deductions. Of course, it is necessary to investigate carefully on the importance and plausibility of the selected hypotheses. Since the hypotheses sub (a) do not include specific ideological and technological conditions and choices, or specific aspect of nature, they allow the derivation of general principles, basic organizational forms, rules and structures. Those principles and organizational forms, which are not affected by definition by specific ideological and technological choices and hence their revision (or, in a word, innovation), have considerable persistence over time and vary with the general conditions of development. In other words, they are pushed to emerge, in the course of history, as the product of the sedimentation of successive innovations and moral or ideological value judgements, and technological choices. They give, therefore, an important expression of the dynamics of society and the way how one can identify to what stage of development a particular society is, as we shall see better at the end of this essay. The selection of hypothesis sub (a) is rather problematic; it involves the student’s creativity and requires a profound sense of reality and of history. Precisely, its appropriateness and efficiency for theorization depend on the student’s ability and talent in perceiving essential aspects and synthesizing. This selection represents the most difficult and important part of theoretical effort and needs to be attentively controlled through deep analyses. But, after all, it is not extremely difficult. For instance, one of the most significant aspects of the general conditions of development in the present age is quite clear and is represented by high uncertainty that (as we shall see) has suggested some main insights in economics and requires appropriate social institutions. However, the basic aspects and contents of social reality are easier to interpret than natural reality. In fact, the general conditions of development represent a sound and reliable ground for selecting some cogent initial hypotheses from which to deduct fundamental organizational rules, structures, institutions and general principles able to enlighten the road. For their part, the particulars of social systems are still clearer. In fact, choices are precisely what they are presupposed to be, as well as the creative events being those certified. With reference to the hypotheses sub (b) and (c) there is no need of the Popperian guesswork. But choices sub (b) are, as such, questionable. Starting from well-­defined value-­ideological aspects and choices and creative phenomena, their effects on the social system may be deduced according to the criterion of organizational rationality, and compared with the consequences of other choices. The same may be done with reference to technological choices and the particular conditions of nature. It will be opportune to classify ideological and technological options according to their presumable duration. The grand options, characterizing civilizations, are at the summit of such a hierarchy; as a matter of fact, they embody very important and involving ideological premises defining the basic physiognomy of the social system that, as such, tend

32   A. Fusari to persist for very long periods of time. In this regard, it is important to investigate the way the existing grand options and other traditional values stimulate or obstruct value-­ideological choices and the apparition of new values in the course of social process, and the effects on social variety of their combination. Finally, the hypotheses sub (d), decisive for deriving the conditions for social growth and development, may be distinctly defined (as we shall see in the next section) on the basis of some simple and clear a priori considerations. An important remark is that choices must not contradict each other, as well as the implications of the general conditions of development and the human creative and evolutionary potential sub (d). We shall see soon the enormous inconveniences that those contradictions caused in the course of history. Moreover, it may be useful to remark that, while the derivation of general principles and the necessities implied by natural conditions are univocal, their fulfilment may be performed by various organizational forms. On the general plane, the methodology set out here forms part of the so-­called analytical method,12 i.e. open to the constant search for and verification of new hypotheses, first of all those stemming from new general conditions of development. This incessant definition and revision of initial hypotheses provides a plain openness to a stimulating and cross-­fertilizing pluralism in social theory. To sum up, the deductive method applied to human society has a number of necessary features: 1 2

3

It should be based on the standard of organizational rationality of social systems. It should concentrate on the procedures for defining and corroborating the initial hypotheses, making sure that they are erected not upon nominalist postulates but upon solid, realistic foundations and or programmatic realistic objectives and verifying their plausibility in advance rather than putting them forth as mere conjectures. In this way the reality check is moved up from the final stage in the deductive process (as in the doctrine of falsification) to the initial stage. It should appropriately classify initial hypotheses: for instance, according to whether they are designed to produce general principles, consider crucial aspects of human nature or analyse particular aspects; or whether they focus on short-­term or long-­term phenomena.

1.5  Necessity, choice, functional and ontological imperatives in the constitution and organization of social systems This and the next sections provide some main applications of the proposed method. It is important to underline, first of all, that it allows us to distinguish rigorously, in the organization of social systems, between the aspects of necessity and those of choice-­possibility13 as well as to distinguish necessity from duration. We shall give shortly some examples on the abstract developments that will follow.

The method of social theory   33 Initial hypotheses sub (a) and (c) allow the derivation of necessity, on the basis of the standard of rational organization. So, the realm of necessity is represented by general principles, organizational forms, institutions and rules imposed (and pushed to emerge), for simple reasons of rationality, i.e. coherence and efficiency, by the characteristics of the general conditions of development in being the synthesis of the way of Man over time, and by specific natural and basic technological conditions (with their implications). They may be denominated ‘functional imperatives’, but paying attention not to confuse this expression with the notion of functional imperative that Parsons made famous. In fact, the Parsonsian notion of imperative mixes necessity, choice-­possibility and duration. This mixture is very frequent in social thought and is a decisive cause of confusion and misunderstandings.14 Various organizational forms may be suitable to meet the necessities above. Thus the necessity to bind the exertion of authority, for instance entrepreneurial function, to well-­defined responsibilities may be fulfilled through different kinds of firm’s organization. Necessity does not means determinism. In point of fact, necessity may be (and usually is) largely violated by spontaneous phenomena; an important task of government is to remedy that violation.15 The realm of choice or possibility is expressed in choices of values (initial hypotheses sub (b)), headed by the overriding options that distinguish the forms of civilization, and by technological choices with all that they imply. Choices may be characterized by duration and temporariness. In fact the concept of duration does not coincide with that of necessity: the grand options and forms of civilization tend to be extremely durable over time, notwithstanding they are optional in nature and accordingly not organizational necessities, and some organizational forms that violated functional imperatives had long duration. Necessity and choice-­possibility-creativity express respectively constriction and freedom in the life of social systems. The evocation of creativity may cause some misunderstanding; there is an almost general conviction that it lies outside science. In this regard, it should be clear that the advancement of science needs both creativity and the work of reason. The two are strictly intertwined, with reason displaying a sort of control on the whole scientific process. This consideration may moderate the controversy between creationists and naturalists: the first should not dislike or ignore the role of reason and the second the role of creativity. Another important analytical aspect is the notion of ‘ontological imperatives’. They may be derived by initial hypotheses concerning the evolutionary and creative potential of Man, causing the evolution of the general conditions of development and the advent of new functional imperatives. For this potential to be operative, thus fuelling the evolution of society, some appropriate social institutions, rules and civilizations are needed. In brief, it is immediately evident that individual action and freedom are the main sources of creativity, while tolerance and pluralism are indispensable to the expression of creativity, to the utilization of highly diversified skills, to the growth of human skills and knowledge since the limitations in human cognitive skills imply that people must necessarily

34   A. Fusari proceed by trial and error. Also personal responsibility is indispensable to the expression of human potential. Therefore, those principles undeniably represent some ‘ontological imperatives’. The presence or absence of these imperatives profoundly characterize civilizations and mark the distinction between open society and closed society. The evolutionary and creative potential of human beings is also influenced by distributive justice (conjugated to the principle of merit) and institutions allowing the transition of power as service, from power as domination, so as to avoid the stifling of people’s potential by some elite of despotic rulers, and by injustice and starvation for large masses.16 In some sense, ‘ontological imperatives’ are halfway through necessity and choice-­possibility. Unlike the organizational necessities or ‘functional imperatives’ considered so far, the ‘ontological imperatives’ are universal, but their advent is not pushed by reasons of organizational coherence. Precisely, they do not vary with the general conditions of development and are not imposed, in the course of history, by their indispensability to efficient social organization. Rather, they may be repressed even for unlimited periods of time without apparent contradictions if the social order hinges upon a civilization adverse to them. In fact, the repetitive motion of closed societies, that the denial of ‘ontological imperatives’ implies, usually shows an almost perfect coherence: various great Eastern authoritarian civilizations strongly repressed the role of individual, creativity and pluralism in the context of obedient civilizations; this inculcated stationary motion in their social systems across centuries and even millennia. An important staging post of social evolution is represented by the modern open dynamic society, one important characteristic of which is the transformation of ontological imperatives into functional imperatives. Precisely, in this stage of development, ontological imperatives also become functional imperatives since they are indispensable to the preservation of the modern dynamism, i.e. are requested by the existing general conditions of development, which give rise to a strong push toward them. The considered distinctions, in particular that between necessity and choice-­ possibility, may greatly help the theoretical effort in various branches of social thought, for instance: economics and the rise of economic institutions; politics and reformist action; the foundations of laws; sociological and historical investigation.17 Let us now look at these methodological points, using examples that will also permit further analytical advances. In surveying the history of human society, the scholar observes a curious spectacle. Many societies have trampled on ‘ontological imperatives’ for very long periods of time, thus remaining in a quasi-­ stationary condition and sometimes locked up in brilliant civilizations; while the civilizations incorporating in some measure ontological imperatives experienced a higher openness to evolution. Another impressive spectacle is represented by the behaviour, in the course of history, of the great organizational, institutional and ideological normative and structural forms and rules. They advance laboriously as time goes on, through almost blind processes of trial and error, hence very slow and tortuous, accom-

The method of social theory   35 panied by suffering and bitter conflict. Then, once established, the roles are inverted and they tend to dominate the scene much longer than they should, imprinting the societies in which they are established and influencing more or less contiguous ones.18 We can see the dominating structural role of the extended family in tribal societies that was followed, in parallel lines with the evolution of the general conditions of development, by more and more elaborated organizational forms as, for instance, in the realm of command power: arm companions; state power; great centralized empires. At the beginning of the second millennium, the medieval cities fought bitter battles lasting centuries before they could free themselves from a feudal order that was incompatible with the growth of trade and introduce institutions, legal orders and forms of liberty that were absolutely essential to the new, more advanced stage of development that was emerging. No few merchants ended their days in repentance because their business dealings, necessary for the world to go ahead, were considered wicked and were held up to public execration. In some parts of the world the battle for these elementary values and institutions continued to our own times. During the Renaissance, hard-­fought battles accompanied the advent of Modern Man. The full affirmation of individual role and responsibility, essential to development, required the schism of the Protestant Reformation and a series of bloody wars of religion. Violent struggles accompanied the rise of national states and their notion of sovereignty, which were necessary to social and political advance after the failure of medieval universalism. No less violent was the dismantling of the guilds and other institutions no longer compatible with the development of manufacturing and the surge in trade, after those institutions themselves had overcome immense difficulties in the way of their establishment. The advent of industrial society clashed with entrenched hostility to machinery. Its rise through practically blind processes of trial and error imposed immense suffering, well-­described in Karl Polanyi’s Great Transformation (1944). The stages of laissez-­faire, monopoly and consumer capitalism experienced no less severe travail, owing to a radical misunderstanding of emerging needs. Just think of the laborious acceptance, by economic policy, of the ‘principle of effective demand’, which is simply an organizational necessity for governing dynamic economies characterized by high uncertainty. In fact, uncertainty implies that effective demand may result in both deficient and excessive demand and this makes its management (through taxation, budget and monetary policies) an organizational necessity. The establishment of this principle paved the way to extraordinary transformations in social life. But before it could be grasped, there had to be a devastating worldwide depression. And even afterwards, imperfect comprehension of the principle produced grave distortions and blunders for which we are still paying the price. All these overriding organizational necessities, together with other organizational matters implicit in them simply for reasons of consistency, were nothing but the consequence of the general conditions of development typifying the successive historical eras, and they could

36   A. Fusari accordingly have been understood and deduced through careful examination of those conditions. This scientific understanding would have avoided the human suffering that accompanied the gradual emergence of the above necessities and imperatives through blind, spontaneous trial and error. Alongside the laborious gravitation of human societies towards the organizational forms required by changing general conditions of development, historical processes provide us with examples of conflicting forms of varying degrees of severity, imposed by the optional nature of many aspects of social systems. Special importance attaches to choices of civilization, the great ideological and normative options associated with given world views, and their inclusion or exclusion of ontological imperatives. It is worthwhile noting, in this regard, that ontological imperatives should have been (and may be) stated as such on the basis of a priori considerations. Focusing on value and ideological questions and technological elements highlights the decisive role of human creativity in the evolution of societies. Equally stimulating inquiries could be conducted of the more or less pervasive propensities of the great options and the terrible conflicts and misunderstandings they have triggered between the peoples of the world, as well as of the role of those options in repressing or stimulating the emergence of ontological imperatives. Here, it will suffice to note the crucial importance, in the organization and management of social systems, of the scientific distinction between necessity and choice-­possibility-creativity and their relation with ontological imperatives. The confusion in this area is discussed in next section.

1.6  Evolution and institutions. The interpretation of social processes A main aspect of our proposal on method is its fitness to investigate the establishment and development of institutions. The analytical derivation of functional imperatives that may vary with the general conditions of development, allows the understanding of some important institutional aspects and their evolution in a more appropriate way than biological metaphor. Many other institutions may be derived from grand value options and less important ethical ideological choices. Some telegraphic examples will help the clarification of this point. The examples can be usefully extracted, among other things, from institutional and evolutionary economics, so as to clarify the profitability of our method in that field. Some aspects of the general conditions of development in the present age, relevant for economics, are the high pace of innovation, stimulated by competition based on innovation that causes high radical (i.e. not probabilistic) uncertainty. Starting from these relevant basic aspects of modern economies, it is straightforward to derive the necessity of entrepreneurship and entrepreneurial firm, the market and some main characters of these institutions. A centralized economy is unable to meet uncertainty and dislikes innovation. High uncertainty makes also relevant the principle of effective demand that allows the derivation of some other institutions connected to the welfare state. Moreover, our method

The method of social theory   37 permits one to derive other institutions concerning the realm of choice-­possibility and consequent to particular ideological choices; this propitiates a good deal of work on the organization of financial markets, income distribution and the possible institutional differentiation from capitalism in these fields admitting choice (Fusari 2005a). This should also be clear: the importance of the notions of ontological and functional imperatives and of great ideological value options or choices of civilization (and their relations) for the representation of social-­historical processes. The modernization process is one of the most fascinating aspects of social reality and deserves great attention in our time as characterized by growing social change. Some authors, mainly Marx, attribute a substantial linear tendency to social process, across a well-­defined evolution of institutions and civilizations, a kind of necessary path of development. Some other authors have expressed an opposite view and emphasized the autonomous role of civilizations and the tendency of values to persist over time. Weber is the main exponent of this line. Recently, the two interpretations have been re-­proposed and, in a sense, accentuated by the well-­known theories of Fukuyama (1992) and Huntington (1996) on the meaning and implications of globalization. The first predicted the convergence of values as a result of modernization, and precisely the diffusion of liberal democracy across the world, while the second emphasized the differences among civilizations, their autonomous influence on society, their tendency to persist and hence to clash, and shaped eight major cultural zones mainly characterized by religious beliefs. We can see, in the light of our method, that Fukuyama exaggerates the role of functional imperatives and the tendency of the implied values to converge, at the expense of the role of civilizations. On the contrary, Huntington exaggerates the role of civilizations and disregards that of functional and ontological imperatives. Inglehart seems to be more accurate when he expresses an intermediate position: the tendency of values to change with development, accompanied by a collateral tendency of traditional values to persist (Inglehart 2000; Inglehart and Norris 2003). He, therefore, maintains that social development is the result of a combination among traditional and modern values that gives rise to several not deterministic paths, differentiated by cultural zones, mainly by inherited religious beliefs. This is suggested by the observational evidence. But the suggestion is unable to solve an important problem: the way to facilitate and give steadiness to such a difficult process, which requires a major articulation of the theoretical frame. Let see if some clarification on the matter can be achieved through our methodological proposal and analytical categories. We have seen in the preceding section that evolutionary motion requires (and is mainly pushed by) the existence of forms of civilization that include ontological imperatives. Social change implies the variation of the general conditions of development and hence the apparition of new functional imperatives that may be taken as indicators for a rigorous distinction of the historical process in stages or phases of development.19 Since value choices, mainly grand options (distinguishing civilizations), must not contradict functional imperatives, the variations of

38   A. Fusari these will push civilizations to vary toward some new grand options consistent with the values implied by the new functional imperatives. At the same time, the tendency of traditional values to survive will imply the persistence of those of them that do not contrast with functional imperatives, thus causing a mixture of new and old values. So, the following interpretative chain of social-­historic processes can be drawn: the way civilizations reflect ontological imperatives determines the degree of evolution of the general conditions of development; this engenders new functional imperatives that stimulate the variation of civilization toward new more appropriate grand options. In the meantime, the reciprocal influence between traditional values and the new values and preferences that do not represent functional imperatives, promoted by the development process will cause a differentiation of development paths by cultural zones. So that, social process would be characterized by, in sum, some growing and differentiated cyclical motions based on an alternation of creativity and structural organization of society on novelties. This profoundly differs from quasi-­stationary societies of ancient times that the absence of novelties pushed toward a parabolic behaviour: the decay of the social system and its civilization. The knowledge of the analytical categories set forth by our analysis, mainly the distinction between necessity and choice-­possibility, may greatly facilitate and accelerate the process. Finally, it is important to remember that, in the stage of the modern dynamic society, ontological imperatives acquire the much more imperious status of functional imperatives and this implies a strong acceleration of modernization.

1.7  Conclusion This chapter has examined the method of economic and social theory in the light of the fundamental difference between natural phenomena and those deriving from the creative, constructive and relational action of men and women. This analytical perspective shows the great importance, for understanding human societies and their government, of the distinction between necessity and choice-­ possibility-creativeness and of the notions of functional imperatives, ontological imperatives and civilizations, and their interactions. We have seen that the method of social theory cannot be inductive. Neither, however, can it be content with the forms of deductivism now current. First of all, social science must shun the abstract deductivism of logical-­formal science, which derives theoretical formulas from purely nominalist postulates, as is typical for instance of pure Paretian economics. Second, it cannot be content with ‘observationistic’ deductionism, which claims to deduce general principles from hypotheses about particular aspects of the reality studied and which ­indistinctly combines elements of necessity with those of choice-­possibility. Third, social theory cannot settle for Popper’s conjecturalist-­falsificationist deductivism. The soundest terrain available to economic and social thought for deriving useful, well-­grounded generalizations and explanations is the analysis of facts

The method of social theory   39 and events from the point of view of the constitution and organization of social systems, with a view to the general conditions of development of the historical era considered, the features indispensable to the expression of human potential, and to the particular ideological and normative options, especially the forms of civilization. This perspective implies the recognition that the organization of human society is not the work just of individuals (thus rejecting methodological individualism) but also of masses, churches, political parties, armed groups and so on. Above all, it highlights the scientific importance of identifying rational and efficient organizational criteria which, once established, cannot be ignored by single social actors. Clearly the analysis of these matters requires that the intelligence of social scholars concentrates principally on the systematic, case-­ by-case distinction between necessity and choice, duration and temporariness, in the organization, management and evolution of human societies.

2 Homo Œconomicus versus Homo Politicus1 Hasse Ekstedt

Introduction Now and then it is claimed that, to achieve rational government, politics should be under the control of economists. The logic is something like: people are rational when they act according to their own scarce resources. The implication of this is that markets, where individuals only express their individual desires, are in principle rational. As we well know, it is claimed, politicians often act according to their individual desires leading society into a state of inefficiency and even irrationality. Theoretically this has been expressed in the theory of rational choice, which is a part of both economic and political science. The thought is that public policy and social actions are built on self-­interest. Thus, a government built on rational market-­like decisions could impose some sort of balance with respect to market failures and distribution of welfare. This is by no means new but traces some of its roots back to Hobbes and Machiavelli. Economic theory provides us with an approach to rationality which forms a rational market structure also on the aggregate level and thus it has become a powerful challenge to traditional political analysis. The formal structure of modern rational choice theory is built on the axioms of the general equilibrium theory in economics which provides a clear-­cut logical understanding of the aggregate economy, forming an excellent base for normative welfare analysis. Anthony Downs was early in using the economic rationality concepts and advocates a programme to integrate government with private-­decision makers in the general equilibrium theory. The intention of governance should be to create a market-­like situation so government could be successfully integrated with private decision makers in a general equilibrium (Downs 1957: 3). Modern scientists are less devoted to full integration of government and economic theory although they basically use the same setting as Downs. Thus Michael Laver claims that ‘The essential purpose of the rational choice approach is thus to construct a logically coherent potential explanation of the phenomenon under investigation’ (1997: 4). Doron and Sened claim the purpose of their book is ‘To explain how strategic choices made by the individual actors yield, through complex bargaining

Homo Œconomicus versus Homo Politicus   41 p­ rocesses, the political outcomes that define the social orders in which we live’ (2001: 19). To achieve this, they postulate methodological individualism and purposeful action. The two postulates are thought to be at least implicitly expressed by the axioms of economic general equilibrium theory but as we will see they can be interpreted in other ways. Rational choice theory got a considerable boost through Arrow’s impossibility theorem which highlighted the potential conflict between Homo Œconomicus and Homo Politicus (Arrow 1950). The conflict created by this theorem revived the debate since it appeared as if Rational Man was unable to handle aggregate matters in a society. Research by particularly McKelvey and Schofield (1986) worsened the case by showing that with respect to the Nash equilibrium in a multidimensional political space, stable majority cores almost never existed, which was formulated into a sort of chaos theorem. Thus, seemingly, we have on one hand a potential conflict between democracy and efficiency and, on the other, between policy and the rational market action, heightened by Arrow’s impossibility theorem. This tells us that majority voting will not lead to a unique equilibrium implying the so-­called Pareto optimum. Often its interpretation is that the only way to restore the state of general equilibrium according to market theory is to impose dictatorship. This indeed leads us to a rather confusing point in the discussion. The Nobel laureate Milton Friedman (2002) claimed that the free market economy was a necessary prerequisite for political freedom, but at the same time we have a famous logical result from the analysis of the market economy by the Nobel laureate Kenneth Arrow where it is said that if we are going to achieve the same level of rationality of the collective choice as we have for the individual action on the market, we must install dictatorship. This is the basic rationale for those who advocate that politicians should be set under the command of economists, although the logic seems to be a bit confusing. Do we have an insoluble conflict between Homo Œconomicus and Homo Politicus? Based on these negative results the research has roughly followed two lines: game theoretical considerations and institutional theory. The core of the game theoretic approach is the prisoner’s dilemma, which certainly is a powerful challenge, and potentially it ends in the Nash equilibrium (1950). The Nash equilibrium is, however, built on the same logical pillars as general equilibrium theory and shares its strength and weaknesses (Debreu 1982). The interesting thing about the Nash equilibrium, as we will discuss in Chapter 4, is that it implicitly presupposes a Kantian ethics. The institutional research has concentrated around the need to limit the dimensionality of the decision space of the agents. The problem of these two lines of analysing the democratic society is that they always end up with what may be called an insufficient cause.2 Thus with respect to the prisoner’s dilemma one may ask, ‘Who is the judge?’ Similarly, with respect to the institutional analysis, ‘Who imposes the proper institutions?’ However, underlying these

42   H. Ekstedt a­ nalytical ventures the question gnaws: whether Homo Rationalis is an intelligent creature or a rational fool. The concept of rationality has become a doubtful concept. One might perhaps think of some ethical rules governing the rational actions but this is traditionally not a part of the market theory, which is alleged to be value-­free. In Public Sector Economics by Richard Tresch (2008: 77) we read about distributive justice: Chapter 4 has told us a fairly depressing tale about the quest for distributive justice in democratic, humanistic societies. Its main message is that all societies must solve the distribution question of end–results equity or distributive justice, but they can do so only if the citizens can agree upon a set of ethical rankings of individuals that can be analytically represented by the Bergson-­Samuelson individualistic social welfare function. Unfortunately, a majority rule, democratic voting process is unlikely to select a particular social welfare function. In fact we are also driven into a situation where both the market theory and the democracy are doubtful. Are there any alternatives but dictatorship? But to this add another question: what are we trying to achieve by aggregate structures? Underlying philosophical reflections Roughly speaking there are two types of attitudes towards rationality: the rationalistic and the empiricist attitude. To start with the latter we may see David Hume as an early proponent for the modern empiricism. To him the rational reasoning is merely a tool for the will and the will in its turn is linked to passion: Nothing is more usual in philosophy, and even in common life, than to talk of the combat of passion and reason, to give the preference to reason, and assert that men are only so far virtuous as they conform themselves to its dictates. . . . I shall endeavour to prove first that reason alone can never be a motive to any action of the will; and secondly that it can never oppose passion in the direction of the will. (Hume 2002 [1740]: 265) Proponents of deductive rationalism endeavour to link the action of Man to the mind as a logical relation, thus the concept of rationality is an a priori concept. A central achievement of this a priori analysis is that the theorem of revealed preference is singled out as a vital empirical tool. This theorem implies a reversible relation from the decision/action space back to the preference space. Thus we have created a clear and unique causal structure, in an Aristotelian sense.3 A result of this reversibility is that social science is reduced to the same characteristics as a natural science. The empiricist may accept this hypothesis as an

Homo Œconomicus versus Homo Politicus   43 approximation in relation to experienced inertia of the agents but this is an empirical matter based on observations of inert social, cultural and ethical structures. Deductive rationalism starts from a set of postulates from which proper theorems are derived. The strength of this attitude is a high precision in the prescribed behaviour and as such it creates an excellent structure for empirical analysis. The problem begins, however, when the postulates are supposed to be a priori right. The empiricists may also sooner or later arrive at some postulates as a base for logical analysis but these are posterior and provisional with respect to empirically perceived generic patterns. A.R.M. Murray (1955: 23) concludes: It will be argued that the broad division in Philosophy is between Rationalist and Empiricist Theories, and that this division respects, and depends upon, the division between rationalist and empiricists’ theory of logic and knowledge. If this is so, no final answer can be given to the questions of political philosophy without the decision in these broader issues, but a necessary and important task will be accomplished if the problems of political philosophy are reduced to their ultimate and logical form. We suggest that we follow Murray’s recommendation and look more carefully at the concept of rationality used in the theory of the market economy since it has been brought to the political arena through the Rational Choice hypothesis and related models and thus not only concerns individual behaviour but also aggregate decisions. Only a partial structure of an answer is discussed in this chapter, but after Chapters 3 and 4 we will see a structure of the answer to Murray’s demand. Structure of the chapter This chapter is to be seen as a systematic empiricist critique of the neoclassical rationality concept as a global concept affecting the analysis of social and political behaviour. The earlier quotations from Hume and Murray will serve as a starting point for the discussion. We will reconsider the basic model of rational choice with respect to the interpretation of its axiomatic structure and on the basis of this, interpret Arrow’s paradox. The basic attitude of the chapter is that the rationality of human beings is far more complex than the particular rationality used in the rational choice theory and that the simple rationality concept used in general equilibrium theory is a misconception when applied outside the very axiomatic structure of the general equilibrium theory and applied to general political behaviour. We claim that the logic of rational choice theory, when it is based on the neoclassical axioms, is not particularly logical, if by logic we mean a strict treatment of an axiomatic structure. The fundamental point of the chapter is that the axioms of the rational choice theory may work under certain conditions in

44   H. Ekstedt e­ conomics, provided an empirical assumption that the behaviour of the agents is inert, and then the axiomatic structure, locally and temporally, may work as an approximation and as such be of some interest with respect to the quality of deriving precise empirically useful theorems. However, transforming the theory to cover the political and social field will add some logical peculiarities with respect to the desires which span the utility space, and these logical peculiarities are strange to a political and social analysis. In fact this is a part of more general critics, that in order to analyse the reality we have to pass over to a logical (mathematical) language to achieve possible deductions. The problem with this is not really the logic in itself but the translation process from the ordinary language to logical postulates and back from theorems to ordinary language. This problem is discussed by Wittgenstein (1974 [1921]) and we will use his proposition 6.211 in Tractatus as a basis for our discussion. This chapter can be seen in three parts. The first part deals with the question of whether the axiomatic structure of the neoclassical theory can be seen as a proper rationality concept for general human behaviour and as such be used to analyse aggregate political behaviour. It is claimed that the axioms which are seen as the definition of rationality is directly taken from algebra and has specific consequences, not always realized. Furthermore the axiomatic structure of the neoclassical theory will not discriminate between a centrally planned economy of the Soviet type and a market economy. Thus the political question is outside the realm of the axiomatic structure. The second part will be devoted to discussing the implications of Arrow’s paradox which consists of two different types of agents which we denominate Homo Politicus and Homo Œconomicus. Their respective ways of behaviour do not coincide and that is why the paradox occurs. The central point underlying Arrow’s paradox and the conflict between Homo Œconomicus and Homo Politicus is that in general equilibrium, the individual’s maximal utility in the exchange process coincides with the maximal utility of the society. In a society where we have majority decisions this is not true. Thus there is some kind of problem when we aggregate the behaviour of the agents. These problems will induce other severe problems in applying neoclassical theory outside local and temporal states where we can assume a certain degree of inertia. In this part we also discuss different types of criticism and alternatives to Homo Œconomicus, particularly the Bounded Rationality Approach. A conclusion of such an analysis could be that the Marxist model, because of its fundamental similarity to the neoclassical model, could be an answer to an approach like bounded rationality. It may also be an answer to simple interpretations of Arrow’s paradox. The third part is a suggestion of a two-­dimensional rationality concept built on a conceptualization by the physicist and mathematician, Thomas Brody (1994). Employing his concept, epistemological (epistemic) cycles, we will save the neoclassical rationality concept as one dimension of rationality, which is seen as a simple animal rationality but in order to explain a paradox like Arrow’s and the alleged conflict between democracy and efficiency we need to conceptu-

Homo Œconomicus versus Homo Politicus   45 alize another dimension of rationality which has to do with the human analysis of aims in relation to environment and also provides the possibility of handling such concepts as creativity and innovations. Brody’s conceptualization will also be used to discuss the question of whether it exists a globally rational model, which is the implicit assumption of a rationalistic approach. As a simple clarification of the requirements for the existence of a global rational model we use Russell’s paradox. This will imply a methodological point of view, which have a considerable importance for social analysis and in Chapter 4, on time and ethics, we will proceed in this analysis with respect to the question of whether there is a space-­ time topology for social sciences in general and economics in particular. It is important to note that we, in this chapter, do not discuss the use of the theory in microeconomic studies. Given a certain amount of inertia it is relevant to use the demand and supply theories as local and temporal approximations. Here we deal only with the conclusions for the aggregate level of the society.

2.1  The neoclassical general equilibrium theory The essence of the theory The neoclassical theory is often regarded as the theory par preference of the market economy. It is supposed to carry the heritage of Adam Smith into a modern mathematical setting with the proof of the existence of general equilibrium as the jewel in the crown. This implies, and is also proven formally, that there exists a result of the exchange process summed up in the following three points: • • •

Pareto Optimality: no agent can engage in further exchange without somebody else losing utility value, which means that each individual has reached a utility maximum, given the distribution of initial resources. Social Welfare Maximum: the total utility value, as the sum of all individuals’ utility value, reaches its maximum at the same point as each one of the individual agents reaches her/his individual optimum. Unique Price Vector: fixed precise relative valuation of all goods at the market, thus there exists a unique set of prices for the different commodities.

When all these three conditions are reached we have attained general equilibrium. The model may be enlarged to contain the production economy as well and in such a case we shall see the individual agent as bearer of a productive ability (physical and/or mental) which is sold and valued according to the relative prices of the final production. The market for production capital works in a similar way. There are three points of fundamental interest of the general equilibrium concept:

46   H. Ekstedt •

•

•

In general equilibrium all the individuals attain the highest possible utility, given the individual preferences and the original wealth and income distribution, as well as the total economy, which attains its maximal value at the same point as each and every individual reaches their maximal utility value. In general equilibrium none of the individual agents needs to take care of anything other than her/his own interests. The market forces equilibrate the individual actions to reach the maximal public welfare. This is what Adam Smith called the invisible hand. Thus we do not need to bother about ethics and similar questions in the market’s very actions but leave it to the market. The agents act solely according to their own interests. The market process is neutral with respect to the distribution of wealth and incomes.

As we can see, the three points indeed invite us to use the theory for an aggregate social and political analysis and we also understand that the theory may have great consequences for ethical analysis of the market economy. We may illustrate the idea of the general equilibrium, as it appears in the mathematical analysis, by the example of a local flea market: Imagine a flea market in a park where people have brought things they do not want anymore. All those who have brought something exchange these things for something else. Thus the maximal value we can get for our things will be used for buying something else at the market. The effect will be that we have a piece of junk which has no utility value for us but it possesses a utility value for somebody else, while we might find something which has a utility value for us but is just a piece of scrap for the original owner. Then it is possible to imagine a situation where all the stuff is exchanged for something else. The result is that the total utility value of the total sum of commodities has increased compared to the situation when these different things were lying idle in the cupboards of the former owners. We may use some kind of money in this process for counting purposes: why not a poker marker? The maximum utility applies to the individual agents as well as to the collective as a whole, since the collective utility is just a simple addition of the individual utilities. When we discuss the real world, the theoretical model serves as a norm in the sense that the neoclassical model postulates perfect competition in order to achieve the desirable result, which is in fact the rationale for the antitrust legislation. Given this, the market will attain the highest form of distributive efficiency. Therefore the market solution in theoretical literature on public welfare is called the first best solution – the norm. A solution implying political measures of any kind is subsequently called the second best solution. The original idea of second best is a purely mathematical idea (Lipsey and Lancaster 1956). It tells us that if we have an optimization problem with certain goal-­functions and a set of restrictions, and impose a set of new restrictions, then the original optimal solution will

Homo Œconomicus versus Homo Politicus   47 change in such a way, given that the new restrictions are effective, that the new optimum solution will attain a lower level than the original. When, however, we use this in economic discussions we seem to implicitly assume that the new set of restrictions imposed by, for example the state, has less legitimacy than the original set of restrictions and most of all assume them to be independent of eventually generic individual behaviour. Furthermore it implies that restrictions in the use of a good in certain contexts must not influence the market action. A plausible theoretical reason for this is the presumption of methodological individualism and perhaps also the alleged ethical neutrality of the market theory. However from a strict methodological point of view the normative character of the market theory stems from the specific axiomatic structure, which implies a one-­to-one correspondence between the interior mind of the agent and the exterior commodity space and thus, as we shall see, corresponds closely to the Kantian ethical imperative. In the introduction we claimed that the individual acting on the market is rational, but at the same time we know that one of the severe criticisms of public politics from public choice theoreticians is that politicians act according to their own self-­interest, which prevents collective rationality. Thus the concept of individual rationality obviously does not work at the collective level. This is the rationale for claiming that since individuals as agents on the market are rational the collective level should be suppressed and replaced by the markets to the largest possible degree. Let us then look at the precise concept of rationality in economic theory, more specifically within the realm of the theory of general equilibrium. It is important to understand that this theory is not built on a massive bulk of empirical studies but is a rationalistic theory built on a priori axioms, said to catch the essential features of Adam Smith’s market concept. The theory is based on six axioms, which form a particular kind of universe suitable for mathematical analysis. The axioms can be grouped into two sets of three. The first set contains the axioms which basically define the particular form of rationality used in the further analysis. The second group contains the axioms necessary to create a utility function of such a character that it will mirror an exact, uniquely ordered picture of the commodities traded at the market. All the six axioms are linked to basic mathematical principles necessary to build a fixed space. Thus if we only assumed three dimensions it would be equivalent to a rigid body.4 As said, the first three axioms serve to define the rationality concept but they also basically define the space of analysis. The other three concern the construction of the utility function and spell out the exact mathematical conditions in order to achieve general equilibrium. The axioms concerning rationality When we lecture on the neoclassical axioms we often try to find real world examples to convince the students of the relevance of each of the axioms. From

48   H. Ekstedt a scientific point of view this is a very suspect method. To grasp the meaning of Adam Smith’s discussion of market economy, it is probably better to tell the story above about the flea market. The axioms necessary to achieve general equilibrium are basically pure mathematical axioms. Rationality implies that we are able to order the world and act consistently on that ordering. This seems simple but by expressing it with the help of axioms we also bring other features which may create some logical peculiarities. It is necessary to emphasize the difference between the propositions, like: people involve in the exchange of goods and services which is good since people best know what they want, and an axiomatic structure which is a prerequisite to achieve a precise logical proposition of general equilibrium with the precise features we listed above. These two levels of analysis are often mixed, which confuses the logic of the analysis. Wittgenstein spells out this problem in Tractatus, where in proposition 6.211 he writes: Indeed in real life a mathematical proposition is never what we want. Rather, we make use of mathematical propositions only in inferences from propositions that do not belong to mathematics to others that likewise do not belong to mathematics. (In philosophy the question, ‘What do we actually use this word or this proposition for?’ repeatedly leads to valuable insights.) Thus, when we pass over to a strict mathematical analysis we have an interpretation problem, and likewise when we pass over from a mathematical analysis to ordinary language. What is the precise relation between these two kinds of analysis? Before starting the analysis of the axiomatic structure of the neoclassical theory we will therefore spell out the precise mathematical environment of the concept of rationality. In Figure 2.1 we illustrate the proposition by Wittgenstein. As we can see, the logical analysis is reversible but not the causal one. Hume’s causality concept, which we apply to our analysis, implies that the cause is always prior to the effect in time. Causal structure Pictures of reality

Translation

Logical propositions

Conclusions about reality

Causality in Hume’s sense

Logical analysis

Translation

Logical conclusions

Note the reversibility of logical analysis

Figure 2.1  Suggested interpretation of proposition 6.211.

Homo Œconomicus versus Homo Politicus   49 Practically that implies, and we will later on analyse this more in depth, that if we drop something heavy on our toe we can expect that it will hurt, but if the toe hurts we cannot deduce that we have dropped something on it. The first three axioms concerning rationality, i.e. the axioms about completeness, reflexivity and transitivity respectively, are basically built on a famous principle from algebra which is called a partial order. Furthermore this leads to an even more basic principle, namely that of an equivalence relation. These two principles are basic to any analysis concerning measuring. We want particularly to emphasize the concept of equivalence. If we deal with two spaces and we can show point-­wise equivalence between these two spaces, we can find parallel functional forms on both spaces. In economics we think of a preference space, so to speak, inside the heads of the agents, and a choice space concerning the relevant commodities outside the agents. If we can presuppose equivalence between these two spaces then a preferred alternative, given certain restrictions, will also be chosen. This implies that the mathematical analysis is reduced to concerning only one space. But the problem is that equivalence is a very strong concept and our understanding is that this creates severe difficulties in transforming our logical analysis to everyday language and much of the difficulties in applying the neoclassical analysis stems from this condition of equivalence. Thus if we construct a set of axioms all the assumptions must in some respect have a discriminatory quality. The present axioms are brought from algebra, but in natural sciences, for example, there exist fields where these axioms are not true. In chemistry, there is a sharp line between a mixture of two substances and a compound: the axioms may hold for both cases separately but not in joint analysis. Thus, although evidently concerning numbers, the axioms are powerful in natural sciences. It seems plausible, therefore, that these axioms may not always be true when they are used to describe human behaviour. The aim of the axioms is to define what is called a partial order relation in algebra. The basic rationale is that the agents are able to order the items contained in the choice space and act with respect to this ordering. Definition 1: Let X be a non-­empty set (choice set). A partial order relation in X, denoted , have the following properties: 1 2 3

x  x; ∀ x  X x  y;  y  x;  x ~ y; ∀ x  y  X x  y  y  z;  x  z; ∀ x  y  z  X

This definition cannot exist without the more basic concept of equivalence. Thus we define the concept of equivalence relation. Definition 2: Let X be a set. An equivalence relation on X is any relation   R2 (X × X) such that for all x, y, z in X we have: 1 2 3

x ~ x; (reflexive) x ~ y;  y ~ x;  x = y; (symmetric) x ~ y;  y ~ z;  x ~ z; (transitive)

50   H. Ekstedt The axioms of the general equilibrium theory concerning rationality are a direct replica of the above two definitions. However the concept of symmetry, as in the second item of definitions 1 and 2, must be defined outside the axioms. Definition 3 (symmetry): Any two commodities, x and y, can be ordered by individuals in such a way that they regard x as at least as good as y. This means that we have a symmetry such that; if x is regarded as at least as good as y and y at least as good as x; the consumer is indifferent between x and y. We are now ready to list the three axioms of the general equilibrium theory which are said to be the definition, par preference, of rationality. Axiom 1 (completeness): We postulate that all items in the set that we want to order can be ordered. Thus for the market economy it means that any commodity which can be sold on the market belongs to the set which can be ordered. (For all x and y in X (choice space) either x  y or y  x) Axiom 2 (reflexivity): We postulate that any commodity is weakly preferred to itself. Applying the symmetry which we mentioned above, this implies that for any commodity x, the consumer is indifferent to the same commodity, x ~ x. Axiom 3 (transitivity): Assume three commodities x, y and z, then the ­following statements always hold: (i) If the consumer prefers x to y and y to z then the consumer must prefer x to z. (ii) If the consumer is indifferent between x and y and between y and z then the consumer must be indifferent between x and z. As we see, the three axioms together with the definition of symmetry cover the mathematical meaning of partial order and equivalence relation. The three axioms imply an important corollary: Corollary 1: Assume any basket of commodities, then the binary ranking of any two commodities in that basket is independent of the rest of the content of that basket. This corollary used to be called ‘the independence of irrelevant alternatives’. The meaning is that the preference relation between any two commodities is independent of the context in which the binary comparison is made. The structure of the axioms, above, is the fundamental issue really, not so much the individual axioms. Thus, we may regard a single axiom as reasonable and explain it in relation to the real world, but this is not relevant. The full flavour of the single axioms can only be understood when we regard the total structure. The axiomatic structure regarding basic rationality (axioms 1, 2, 3) could be interpreted like this: Assume two sets, W, the choice set and R, the preference set, which is partially ordered. The set W is outside the agent while the preference set, R, by necessity must be interior to the mind of the agent. Then there exists a one-­toone projection, Q, such that to each xi in W there exists a point yi in R (the projection Q is reversible so to each yi there exists one and only one xi). By the axioms we thus define an equivalence relation between W and R implying that W and R are numerically equivalent.

Homo Œconomicus versus Homo Politicus   51 It is important to understand that W and R cannot be the same set since the preference set must be wholly inside the agent, while the choice set is wholly outside. This is an excellent example of the problem Wittgenstein discusses and which we illustrated in Figure 2.1. Mathematically we create a fixed relation between the choice set outside the agents and the preference set interior to the agents. Since we have created the equivalence relation thus making the two sets numerically equivalent to each other the choice W will be partially ordered since that is the case of the preference set, R. However this technique will raise some peculiar results when we try to use the theory in a dynamic setting and/or in aggregate analysis. Our interpretation is illustrated in Figure 2.2. We may say that that the three axioms create some kind of pre-­ordering machine inside the heads of the agents. In textbooks and in teaching we often try to rationalize the single axioms with respect to consumer behaviour. The three axioms A1–A3 are often regarded as the definition of rational behaviour. All the three axioms seem to be pretty evident, the most complex one seems to be A3 concerning transitivity. Axiom A2 is often regarded as the most trivial one; an agent is indifferent to a commodity and the very same commodity or a basket of commodities and the same basket, x ~ x. The axiom seems to be trivial and many theorists disregard it as evident. Doron and Sened (2001: 22) tell us that: ‘Reflexivity requires that any outcome in the set of feasible outcomes be weakly preferred to itself. This requirement is self-­evident and we rarely refer to it.’ Varian (2006: 35) tells us about the two first axioms: ‘The second axiom, reflexivity, is trivial. Any bundle is certainly at least as good as an identical bundle. Perhaps of small children we may occasionally observe behaviour that The three axioms of choice create an Equivalence relation which means that the two spaces are numerically equivalent The utility space The choice space commodities

N-dimensional rigid body

Figure 2.2  Equivalence relation created by the axioms.

52   H. Ekstedt violates this assumption, but it seems plausible for more adult behaviour.’ What we have done in our exercise is create an exact equivalence between the preference set which must be supposed to be inside the heads of the agents and the choice set. In doing that, the axioms used cannot really be trivial since the acquired result is indeed not trivial. The first axiom is defining the choice set. Every commodity in the choice set must be subject to partial ordering. The third axiom is equally clear in the sense that it tells us that the partial ordering of the choice set is consistent. Well, that leaves us with the ‘self-­evident’ and ‘trivial’ axiom A2. With respect to this axiom our quotation from Wittgenstein is relevant. First of all Doron and Sened have a correct interpretation in ‘preferred to itself ’. Varian uses the words ‘as good as an identical’, which is actually wrong. We are dealing not with an identical bundle but the bundle itself. Axiom A2 tells us that commodity xi is indeed commodity xi and that it keeps its place in the partial ordering. This axiom is in fact the fundamental axiom for the corollary of independence of irrelevant alternatives above. Thus contrary to Doron and Sened, and Varian, we regard this axiom, together with the above definition of symmetry, to be an extremely restrictive requirement to the analysis. Why is that so? Think of the card game blackjack. The ace can take on two values 1 and 11. Which one is chosen is decided by the other cards. During a single game the preferred value may switch from 11 to 1 and in rare cases back again. Thus in blackjack, axiom A2 does not hold. The effect the axioms have for choice theory is that the choice only concerns the exact physical characteristics of the commodity. There is no separation between the physical characteristics and their use. You buy a commodity just for buying it and you prefer the particular commodity to others. As teenagers the author and his friends were considerable consumers of sugar. The reason for that was not that they wanted to contribute to the household expenses or were craving extra sweets, but that they discovered that the herbicide Clorex mixed with sugar in certain proportions was an excellent base for pyrotechnical activities. Thus, sugar appeared to behave differently and very excitingly when it was mixed with Clorex, compared to the mixture with porridge and milk in the mornings. We have many such examples in chemistry. Clorex is now forbidden but the substance appears as an ingredient in other products.5 The reason for this axiomatic construction is of course that in conjunction with symmetry the axiom guarantees in the exchange model that an item, good or service, may be linked to one and only one price, in any possible bundle of goods, which is fundamental for additive aggregation and furthermore the production system only produces the physical characteristics of a commodity and not its functions in the households. Obviously the axiom is very intricate when we engage in an intertemporal analysis. But it is also crucial when we put a commodity in different baskets as we showed in the blackjack example. If we do not postulate the reflexivity

Homo Œconomicus versus Homo Politicus   53 condition we may end up in several possible prices for the same good depending on the actual basket. In such a case a general equilibrium would not be unique. Thus reflexivity postulates equivalence between the commodity, as a physical thing or act, with the function of the commodity in question, which might vary according to the environment, which we develop later. Suffice to say here that the axiom of reflexivity has the effect that each piece of a commodity is an indivisible atom as a part of a particular dimension, like a tick on a measuring rod of real numbers. The dimensionality of the bought commodity is however more problematic, since the real line is a Cantor Set, thus the mass of the ‘tick’, its Lesbesgue measure, is zero (Weisstein 2000). An important point, particularly in relation to Figure 2.1, is that defining human rationality according to the axioms above, where we create equivalence between the choice space and the preference space, also implies logical reversibility, as we pointed out as a feature of the logical analysis but non-­existing in causal analysis à la David Hume.6 In economic theory this feature is called the revealed preference hypothesis, which is not a hypothesis but a logical necessity in the realm of the axiomatic structure. Paul Samuelson (1950: 370) discussed the concept of revealed preference with respect to the time dimension and ended up with the following: If at the price and income of a situation A you could have bought the goods actually bought at a different point B and if you actually chose not to, then A is defined to be ‘revealed to be better than’ B. The basic postulate is that B never reveals itself to be also ‘better than’ A. Samuelson tries to find a definition suitable to empirical research but then he also reveals the difficulty of finding an empirical parallel to the precise mathematical principle of the equivalence relation. We can see that it is necessary for him to involve the time dimension, and that makes his definition questionable, not as a basis for an empirical inquiry, but as a postulate for a deductive mathematical analysis. The mathematical axioms do not involve time, since they postulate a numerical equivalence between two sets. However Samuelson’s definition is empirical since measuring the postulate is only possible in the time dimension. The principle of revealed preferences illustrates the reversible relation in Figure 2.1 with respect to logics and it is a consequence of the created equivalence relation by the first three axioms. There is a famous discussion of the logical content of the revealed preference principle at the Mad Tea-­Party in Alice in Wonderland: ‘Then you should say what you mean,’ the March Hare went on. ‘I do,’ Alice hastily replied; ‘at least – at least I mean what I say – that’s the same thing you know.’

54   H. Ekstedt    ‘Not the same thing a bit!’ said the Hatter. ‘Why, you might as well say that “I see what I eat” is the same thing as “I eat what I see”!’    ‘You might just as well say,’ added the March Hare, ‘that “I like what I get” is the same thing as “I get what I like”!’ (Carroll 1914: 100) The last argument by the March Hare illustrates exactly the revealed preference principle and to contradict the Hatter and the March Hare and support Alice we must create the equivalence relation as illustrated in Figure 2.2. This is why the reflexivity axiom and subsequently the corollary of independence of irrelevant alternatives become crucial. If these two postulates are not taken the equivalence relation does not hold, and furthermore we lose the possibility of additive aggregation. A preference for a commodity or a commodity basket must be independent of its environment, according to the axioms. It is easy to understand such an assumption if we assume that all contextual considerations are done and the only thing left for the consumer to do is to get an overview of the market and decide on the optimal basket. But if so we lose any reliability of the theory in a temporal sense. We then assume that there exists a kind of superstructure in the mind of the agent which considers the contextual considerations and then we are lost from the point of view of the axiomatic structure. The three axioms and the corollary are, however, still richer. The implicit effect, which is desirable from a mathematical point of view and which will be used in the next three axioms to complete the utility function, is that each commodity is an independent dimension. This excludes so called menu-­dependence (Sen 1994). It also excludes much of the modern consumer theory, the characteristics approach and the whole theory of household production by Gary Becker and others (Becker 1976). One can ask why it is necessary to exclude such interesting research approaches concerning human consumer behaviour. The reason is of course that the equivalent relation in Figure 2.2 then is irrelevant, that something is going on in the heads of the agents which is not reflected in the choice space and that destroys the equivalence relation and, as we shall see, the whole idea of a general equilibrium. The household production approach and also the menu dependency approach imply that commodities are multidimensional. Thus we have non-­equivalence between the physical appearance of a commodity and its functions and the production system does not produce the potential functions of a commodity. This will have a crucial effect on the measurement problem of the economy on the aggregate level; it will also be central to our discussions of Arrow’s paradox. The completion of the utility function We have, through the three first axioms, created a possibility of having consistent choices with respect to preferences. What we now need is to construct the

Homo Œconomicus versus Homo Politicus   55 characteristics of the actual choice function, the utility function. To produce the necessary conditions for the utility function we need three more axioms. It is possible to interpret them in behavioural terms although their purpose, from a mathematical point of view, is to define a measurable choice space. We need a measure in order to choose, and the measure used in economic theory is called prices. The first three axioms defined the interior preference space of the agent as numerically equivalent to the commodity space. The remaining axioms provide us with a measurable utility space. Observe that the utility space, by the three first axioms, is spanned by the independent dimensions created by the different commodities. Thus the utility space is a Cartesian (Euclidian) space spanned by the commodities and a commodity basket is subsequently a vector in this space. This provides us with exciting aggregation possibilities but let us go through the rest of the axioms to complete this. One often hears criticism of the general equilibrium theory because it is supposed to crave global non-­satiation i.e. the agents display non-­satiation for every commodity. This criticism is wrong. We need, however, an axiom of local non-­ satiation. Axiom 4 (local non-­satiation): A preference relation  on a goods space W is locally non-­satiated if for all x  W and e < 0 there is a y  C such that y < x and  y – x  < e. It means that given any combination of goods in a consumer basket there exists at least one good such that an increase of that good leads to an increase in the utility of the agent. Technically the axiom creates a monotonous function. Although not totally unrealistic, given a constant dimensionality of the commodity space, it is in fact a variant of Say’s law. Axiom 5 (continuity): For each e > 0 there exists a d > 0 such that given the points x and x1 both belonging to a measurable set C with a defined function U onto itself which is continuous such that, given the distance functions d1 and d2, d1[x; x1] < d implies that d2[U[x];U[x1]] < e. As readily seen axiom A5 depends indeed on the concept of an equivalence relation. Roughly it means that the utility changes with infinitesimally small increases in a commodity. The axiom is ruling out indivisibilities and strengthens that commodities are seen as independent dimensions. Axiom 6 (convexity): If C is convex then a preference relation  on C is such that x  y  x ≠ y imply ax + (1 – a)y  y for any 1  a > 0. Strict convexity means that if x  y  x ≠ y imply ax + (1 – a)y  y for any 1  a > 0. The last axiom, the one of convexity, is a rich axiom. It has substantial consequences when it is projected on reality. Roughly it means that, given the budget of an agent, which is totally spent on either basket A or basket B, where basket A only contains good x and B contains a combination of goods x and y, then basket B is as good as or better than basket A. Thus we may say the agent prefers a balanced commodity basket to an un­balanced one.

56   H. Ekstedt The axiom rules out any kind of addicted behaviour, and also in a more technical sense it rules out that the agents retract a commodity completely from their commodity basket. The latter condition is in fact necessary since we then, if this is possible, could end up in comparing commodity spaces of different dimensionality and for this eventuality there exists no measure. We will lean hard on this problem when we discuss the concept of growth later on in the book. Finally axiom A6 implies that any local maxima (or minima) must be global, and also unique if we have strict convexity. This condition provides us with the ability to aggregate. Assume two commodity baskets A and B chosen by two consumers such that the agents respectively have reached a maximum utility then the aggregated basket A+B represents the global maximum utility of the two consumers in question. Thus we have opened up the possibility of additive aggregation, which is an extremely useful condition for mathematical analysis but an equally problematic condition in the real world. Since the different commodities are to be seen as dimensions spanning the choice space, C, we can illustrate the additive aggregation as a simple vector aggregation as in Figure 2.3. In Figure 2.3 the two boxes (A1;B1;C1) and (A2;B2;C2) display the utility content of the commodity baskets for Consumers 1 and 2 respectively. We can see that Debreu’s definition of the consumer (i, ei) is transformed to an optimizing commodity basket where the consumers are now defined as commodity vectors. Thus the utility space is spanned by the three commodities and this is in fact exactly with what the equivalence relation, illustrated in Figure 2.2 provides us.­ The utility content of the aggregate commodity basket is the resulting commodity vector (A*;B*;C*) which is the summation vector and we receive

C

(A*;B*;C*)

B

B*

C*

(A2;B2;C2) C*

C2

(A1;B1;C1)

C1 B1

B2

A2

A1

A*

A

Figure 2.3  Additive aggregation in general equilibrium, a three commodity space.

Homo Œconomicus versus Homo Politicus   57 the utility content of the aggregate basket in the figure as the summation of the ‘volume’ of two individual utility ‘boxes’ for Consumers 1 and 2 respectively. We have now presented all the axioms necessary to prove the existence of general equilibrium. Our comments on the axiom serve to show in relation to our quotation from Wittgenstein, illustrated in Figure 2.1, that there is an axiomatic structure which is consistent, but together with the mathematical precision we also have to accept restrictions which are perhaps far more restrictive than we wish. The jewel in the crown: the existence of general equilibrium We will not prove formally the existence of general equilibrium but only sketch the general idea. It is instructive to see the essential steps in the proof since it reveals information about the axiomatic structure. When we think of the choice problem we imagine two spaces: one concerning the inner world of the agent regarding preferences and one outer world concerning the act of choice. The three axioms concerning rationality tell us that these two spaces are numerically equivalent. Thus we may attach an index to each of the spaces and these indexes are equivalent, thus they may be replaced by only one index. Since Axioms 1, 2 and 3 provide us with a numerical equivalence between the two spaces we are allowed to work in the choice space in proving the general equilibrium and subsequently we may use the powerful fix point theorem, which presupposes that we have a mapping from a space onto itself. Schematically we can see the proof as follows:

Axiomatic structure The utility function: monotony, convexity and continuity

Rationality: Ordering of the choice set Completely ordered choice set Axiom of choice and Zorn’s lemma Existence of a greatest value

Existence of a measure Existence of homomorphism

Fix-point theorem Existence of general equilibrium

Figure 2.4  The structure of the proof of general equilibrium.

58   H. Ekstedt 1 2

3 4

5

The three axioms of rationality, 1–3, provide us with an ordering of the choice space. Given this, the axiom of choice and/or Zorn’s lemma grant the existence of a greatest value.7 The three axioms of monotony (non-­satiation), continuity and convexity grant that any space fulfilling these conditions can be completely ordered, and furthermore it is measurable. The measure is formally an index which we call the price vector. The three axioms of rationality define a partial order but if this is applied on a space defined by Axioms A4–A6 we know that this space will be completely ordered and measurable. We may now look at the utility function as a function of the created utility space onto itself. To see the implication of such a function let us go back to our flea market example. The agent is defined technically as a preference relation and a set of endowments, that is the junk brought to the flea market, [i; ei], thus the agent applies the choice function and the imposed price vector to the commodities he has brought to acquire what others have brought. Thus the endowments of the agents are changed into a utility which is achieved by the exchange into new commodities. Since we have postulated numerical equivalence between the commodity space and the utility space we perform the operation in the same space. Thus when all agents have made their exchanges and are satisfied we are left with the same total basket of commodities but its utility value has increased. This is roughly the meaning of a function from a space onto itself and it is reasonably well covered by our example of the flea market. The axiom of convexity grants that any maximum is global and the axiom of local non-­satiation grants that the function is strictly increasing. The fix point theorem implies that there exists a commodity basket which is equal in value to the initial endowments, given the equilibrium price vector, the measure, such that it provides the agent with a maximum of utility. The steps 1–4 above work for each agent and then we can display the jewel in the crown. Since the basket attaining the maximal utility of each agent is in value equal to its initial endowments we conclude that the total value of endowments, given the equilibrium price vector, is, in equilibrium, the value of the social maximum, given the total initial endowments.

The general equilibrium possesses the Pareto property and furthermore there exists a price vector common to all agents such that we have a unique measure of the utility. In fact the income of the individual is the measure of utility in such a way that if the income increases, given the price vector, the utility increases. But this also accounts for the total collective of the agents. In general equilibrium we are able to sum the individual optima to a global optimum for the society. The collective welfare is a simple addition of the welfare of the individuals, as we have illustrated in Figure 2.3. The principle is simple since each agent’s commodity basket can be seen as a vector which can be measured by the index we call prices. We only have to add the vectors.

Homo Œconomicus versus Homo Politicus   59 In equilibrium the hypothesis of revealed preferences which Samuelson discussed is not a hypothesis but a corollary: given the distribution of endowments and the price vector a chosen commodity basket exactly mirrors the individual preference structure. There are however some problems with this jewel. Let us go back to our example from the flea market. The axioms reaso­n­ ably well carry the suggested picture into a mathematical setting but who sets the prices? This question is the foundation for the famous invisible hand. It is easy to understand that people in negotiations arrive at some sort of agreement, but are the different negotiations consistent in relative prices all over the marketplace? The question, although often quickly passed over, is significant since the whole question of aggregation depends on the answer. The reason for this is the time problem. It is possible to interpret the six axioms in such a way that given all pre-­choice considerations of the agents we will in each moment have a state of equilibrium. The problem with this interpretation is that it leaves the question of the link between different states of equilibrium unanswered, thus the theory, at least with respect to aggregation, is a bit meaningless. The six axioms, particularly the first three concerning rationality, connect the mind of the agent to one and only one specific set of preference relations. Even more, each basket of commodities is a vector of the commodity space. Given this, the choice of a basket is directly linked to the price vector. Thus the price vector of the mathematical analysis is not created by the agents but is set by the invisible hand. Furthermore in the mathematical setting of the problem the principle of additive aggregation is only possible given one and only one price vector. So who controls this price vector?

2.2  The complications of Arrow’s paradox and the Marxist interpretation Arrow’s complication We have already mentioned the problem of Arrow’s paradox and its ugly statement that the market solution in terms of the above-­presented general equilibrium only can be achieved by imposing dictatorship (Arrow 1950). The paradox is of central theoretical interest since it restricts the use of general equilibrium theory to aggregate questions, at least in a democracy. It shows the impossibility of creating a social welfare function out of the axiomatic structure of the neoclassical theory in accordance with a voting procedure. In economic theory we call the result a paradox, but since we are later on going to discuss some logical paradoxes, most of all Russell’s paradox, we must emphasize that Arrow’s paradox is logical only in relation to a specific interpretation of an axiomatic structure. In fact it contains an implicit assumption which defines an agent, which we may call Homo Politicus to be separated from the one defined by the above axioms, Homo Œconomicus.

60   H. Ekstedt The central point in Arrow’s paradox is that he allows the agents to vote. However, he defines the agents with the earlier discussed rationality axioms. He then imposes the following restrictions on the social welfare function: • • • •

Universality: meaning that the social welfare function should be based on every agent’s individual preference order. Citizen sovereignty: this means that any individual agent could maintain the social welfare function as their own preference function. Non-­dictatorship: implying that the social welfare function should not satisfy an individual or a group of individuals irrespective of other agents’ preference functions. Correspondence between social and individual values: this means that if an individual preference is changed in a particular dimension the social welfare function must be changed in the same direction independently of other dimensions.

Based upon these characteristics it is shown that there exists no voting process which by necessity leads to the same solution as the market solution as defined in the general equilibrium theory. We may illustrate the voting example much used in tentative descriptions of the proof: A, B and C individual agents and x, y and z alternatives, the numbers represents the rankings. As we can see, we have three possible coalitions breaking the non-­dictatorship postulate. The most interesting thing about the proof is that the voting procedure also breaks the non-­dictatorship postulate so we are indeed in trouble; if we allow for voting about alternatives we plunge into dictatorship, but if we impose a pure market system this can be done only by dictatorial means. We may indeed ask: What is democracy and is the concept at all relevant? The restrictions underlying the social welfare function are interesting in relation to the axioms concerning the individual agent. Universality, in order to be meaningful, implies that no preferences between agents are contradictory. We will discuss this later when we outline another approach to rationality. Citizen sovereignty is very interesting in relation to public goods. It presupposes that the agents’ preferences are non-­negative with respect to any public good. Thus we are in a position to aggregate the demand according to willingness to pay, which is consistent with the corollary of revealed preferences. Table 2.1  Arrow’s voting paradox

x y z

A

B

C

1 2 3

2 3 1

3 1 2

Homo Œconomicus versus Homo Politicus   61 Non-­dictatorship is rich; the social welfare function suggested by Arrow is an attempt to create some form of ethical structure for a society. Axiom 3 is the cornerstone in this attempt and it bears a strong resemblance to the Kantian imperative that you should always act in such a way that your actions could be seen as a common law. We will come back to this in Chapter 4. Correspondence between social and individual values underlines the fact that the commodities are seen as independent dimensions also on the societal level. This is of course of great importance and follows the lines discussed in relation to the characteristics of the equivalent relation. The proved result that there is no voting procedure leading to the same result as the market equilibrium solution is certainly interesting since the axioms of the social welfare function seems to convey the axioms concerning the individual rather well onto the aggregate level. The explanation of the paradox is, however, rather simple, but enlightens the character of the neoclassical axioms. Homo Œconomicus in Figure 2.2 cannot vote if the axioms hold. So the paradox which appears is due to the fact that the imposition of a voting procedure creates a new agent, which we may call Homo Politicus, and this agent has other abilities than Homo Œconomicus. Thus in relation to Arrow’s paradox we use in fact two definitions of the individual agent. The neoclassical agent appearing in general equilibrium theory and defined by Gerard Debreu in 1959’s Theory of Value can be written as (i; ei), which means that the i:th agent is defined by a preference set and an endowment vector.8 The interior mind of this agent is, as we showed above, in a fixed relation, an equivalent relation, to the commodity space. If we loosen up this condition we lose any possibility to create a measure. In fact if we consider only three commodities as in Figure 2.3 and apply the reasoning of Tarski, in his ‘Foundations of the Geometry of Solids’ we end up with the not-­so-flattering conclusion that the mind of Homo Œconomicus, in Figure 2.2, is equivalent to a rigid body (Tarski 1983). This is once more an example of Wittgenstein’s point, illustrated in Figure 2.1. When we define something mathematically we cannot alter this definition without jeopardizing the entire logical structure. The same with discussing singular axioms: we may discuss possible associations to the reality of each of the axioms but the axioms must be interpreted in relation to the entire axiomatic structure. Homo Œconomicus cannot vote by definition, since the mind, the preference structure, of this agent is defined as numerically equivalent to the commodity space. The result of the voting process is already in the axiomatic structure. Let us now look at Homo Politicus. We can interpret this agent in two ways. In Table 2.1 we see that there are several possibilities for coalitions between two of the agents leaving the third out. Such behaviour is strictly forbidden in the non-­dictatorship postulate. In this case we are left with chaos. But not only that, we have also implicitly, when accepting this chaos, left out the possibility of additive aggregation. In such a case the whole exercise is a bit overambitious. In

62   H. Ekstedt Arrow’s paradox we prove that the axiomatic structure does not hold for other aggregation schemes than the additive scheme with respect to the equilibrium price vector. On the other hand, however, we can use the exercise to show that, in fact, we have the possibility of coalitions. But if so we must change the definition of the agents. If we should define the agent according to Debreu’s definition which we used above it could be something like: [i (1, – -, i–1, i+1, – - -, n); ei] Thus the agent takes into account the preferences of other agents in order to create a social welfare function and this fact breaks the reflexivity axiom. The voting procedure is not an additive process in the same sense as in the general equilibrium theory. One could say that we have two measuring principles. So – we are stuck with a paradox; that if the agents behave according to the behavioural axioms of the neoclassical theory the only way they can achieve the Pareto efficiency of the general equilibrium theory is through the market result. Any kind of voting procedure leads to chaos, given the axiomatic structure defining the agents. On the other hand if we let the agents vote and form coalitions, in accordance with the voting procedure induced in the proof of the paradox, we end up contradicting the non-­dictatorship axiom underlying the social welfare function. When applied to the collective decision on public goods in relation to external effects we also implicitly break the axiom of reflexivity and thus give rise to Homo Politicus. The axioms of rational choice imply that the individuals decide independently of each other; but if we are content with just modelling the individual agent, the axioms tell us nothing about whether or not the agents affect each other in forming their preferences. However if we want the possibility of additive aggregation we must keep the independence of irrelevant alternatives. When the agents engage in so-­called public goods we already, in discussing the free rider problem, accept the agents’ interference with each other and strictly speaking we leave the universe of the six axioms. Thus in general equilibrium theory the independence of irrelevant alternatives is indispensable since this implies that we may use an additive aggregation. Thus Arrow’s paradox is not telling us anything about whether Homo Politicus is irrational and Homo Œconomicus is rational or vice versa. It tells us at best that Homo Sapiens may exercise seemingly different rationality under different kinds of circumstances and that the definition of the rational agent is not properly met by the axiomatic structure of the general equilibrium theory in economics, if we want the agent also to be a part of the political society.

Homo Œconomicus versus Homo Politicus   63 The Marxist complication In Arrow’s discussion and subsequent discussions, based on his paradox, of the aggregation problem, we seldom find anything about who is controlling the price vector if we do not count the invisible hand, the economists answer to deus ex machina of the classical theatre. Remembering the introductory discussion about the arguments about markets as a prerequisite for democracy and at the same time needing a dictator to impose the market rationality, we now can imagine the root of this discussion. The neoclassical economy lacks a ruler and if humans have a collective memory of something it is that of their rulers in history. In 1977 two Russian economists/mathematicians, Makarov and Rubinov (1977), wrote a book on Economic Dynamics and Equilibria. They observed this problem and they coped with it. Their book is, although highly technical, of utmost interest. They start from a Neuman–Gale production model and show the necessary conditions for a generalized technological model to converge asymptotically to an optimal trajectory.9 The inputs of the production process include labour, capital, natural resources, services etc. The subsequent analysis concerns the distribution of the equilibrium output. To prove the existence of equilibrium they use a game-­theoretic approach, which is linked to the standard Arrow–Debreu model (op. cit. p. 204).10 Through this procedure they link the production process to the exchange process. However the whole analysis depends on the existence of a price vector for the output. Furthermore the distribution of the profit of the production sector must also be decided. We quote directly from page 202: Finally, the last or (m + n + 1)st part is called the central agency. This organ chooses the prices of all products, i.e. it selects the vector p ∈[Rs+]*. The financial relationship between consumers and producers is defined in terms of the matrix Q = ||Qij||, where Qij  0 and ∑j Qij = 1. The element Qij represents the share of the profits of producer i that goes to consumer j. There are several ways of determining the shares matrix. For example, the shares may result from coalitions between producers and consumers. Then, naturally, a consumer gets a share of the profits that are realized by the coalitions, in which he is a member. The sizes of shares are determined by different mechanisms, say under socialism and capitalism [our emphasis]. In summary, the Arrow–Debreu model is determined by the sets X1; ---; Xm, the functions u1; ---; us and the matrix Q. In addition, we now describe the objectives of each part of the model. The producers strive to maximize their profit, the consumers maximize their utility functions, and the centre, like the producers, maximize the profits from its activities. These activities of the centre are indeed fundamental to the system from a dynamic point of view. We read on page 203:

64   H. Ekstedt A state may be associated with a point of time if the model is considered in a fixed period of time. However, if we are considering an economy over several periods, then ‘products’ should be taken to be ingredients, as defined in Section 2.1. In other words, ‘products’ which are associated with a single time are ‘products’ but if they are considered over several periods of time, then they are ingredients. In that case, the sets Xi and the functions ui are not associated with a single time point but with several. Similarly, a state of the model characterizes a sequence of time points rather than one. Indeed we are approaching the heart of the matter. We will dwell on this more extensively later in this chapter but the fact is that in general equilibrium theory we have no solution to the problem of the market process. There are no dynamics, which leaves the question of whether or not the market converges to equilibrium outside the axiomatic structure unanswered. This is as we know much discussed in macroeconomic theory. The concepts of ex ante and ex post are illustrations of this problem. It is solved by Makarov/Rubinov, who give the central agency the responsibility of manipulating the price vector and they do this with respect to intertemporal issues. Thus we do not need to cope with the problems of out-­of-equilibrium trade. It is also interesting to read Keynes in the end of Chapter 12 in General Theory, where he expects the state to take more responsibility to organize investments based on social grounds. We furthermore read in Blanchard and Fischer (1989: 21) who make a similar observation and conclude: We start the chapter by studying the optimal allocation of resources, the optimal consumption and investment decisions that would be chosen by a central planner maximizing the utility of the representative individual in the model (a problem first analysed by Ramsey 1928). We then show the equivalence of this central planning allocation to that implied by a competitive economy in which individuals make optimal consumption and investment decisions based on the sequences of current and anticipated market-­clearing wage and interest rates. This equivalence is hardly surprising, given our assumptions, but it turns out nevertheless to be very useful: it is often much simpler to solve the central planning problem directly rather than to solve for the equilibrium of the decentralised economy. As we pointed out, the central agency has resigned in the neoclassical theory, if we do not regard the invisible hand as empirically justified. Let us consider our flea market again. We leave the people to themselves in searching for the equilibrating price vector. However we may then suspect that some of the visitors to the market are satisfied pretty soon with what they have achieved and leave. The consequence of this is that we obtain trading at non-­equilibrium prices, false

Homo Œconomicus versus Homo Politicus   65 trading which implies that the distribution of endowments will change and thus some agents will become relatively worse off. Would it not be better from a social point of view to have a central agency which imputes a price vector to which everybody has to adapt? The Bounded Rationality approach launched by Simon, is indeed close to our example above when you leave the flea market at a point when you feel fairly satisfied and lunch is waiting. Hodgson describes the rational for the bounded rationality approach: Simon’s argument, of course, is that a complete or global rational calculation is ruled out, and thus rationality is ‘bounded’; agents do not maximize but attempt to attain acceptable minima instead. But it is important to note that this ‘satisficing’ behaviour does not arise simply because of inadequate information, but also because it would be too difficult to perform the calculations even if the relevant information was available. (Hodgson 1999: 207) Oliver Williamson (1981a) describes bounded rationality in a similar way and sees a provisional remedy to increase friction and develop contractual relations among agents which, however, imply high transaction costs: Bounded rationality needs to be distinguished from both hyperrationality and irrationality (Simon 1978). Unlike ‘economic man’, to whom hyper-­ rationality is often attributed, ‘organization man’ is endowed with less powerful analytical and data-­processing apparatus. Such limited competence does not, however, imply irrationality. Instead, although boundedly rational agents experience limits in solving complex problems and in processing (receiving, storing, retrieving, transmitting) information (Simon 1957), they otherwise remain ‘intendedly rational’. But for bounded rationality, all economic exchange could be efficiently organized by contract. Given bounded rationality, however, it is impossible to deal with complexity in all contractually relevant respects. As a consequence, incomplete contracting is the best that can be achieved. (Williamson 1981a: 450) According to our analysis of the general equilibrium theory the important effect of bounded rationality behaviour is that we will have false trading with respect to the initial stock of endowments, which will change the relative distribution of economic resources, if the deficiencies of calculation competence and information is unevenly distributed among the agents. We will have an out of equilibrium price vector.11 This will in the next time period change the potential general equilibrium relative to that of the first period, and the consumers will face a new price structure of their endowments.12 We will thus have some sort of random walk by the collective of agents in a vain search for a prevalent

66   H. Ekstedt e­ quilibrium. The economy will set on an unstable path and will not attain a viable equilibrium.13 Should we not rather have a centrally set price vector, based on social considerations, so the negative effects of false trading will be limited to a couple of time periods, but will not affect the valuation of the endowments of the agents? The effect will be that the economy, in the end, will converge to a social acceptable equilibrium. Thus the Makarov and Rubinov approach is certainly a powerful argument for a centrally governed state, when we claim bounded rationality. Thus if we try to claim some weakness of the competence in calculating power and information processing by the, otherwise ‘intendedly’ rational, agents the easiest conceivable remedy will be to set up a central planning bureau and set the price vector politically and thus impose the necessary inertia to the system. Observe that this is well in the realm of the axiomatic structure of the neoclassical model. In the axiomatic structure of the neoclassical theory, the commodity space is linked in a one-­to-one relation to a utility space. The bounded rationality approach tells us that this one-­to-one relation is a bit fussy. Then we have two alternatives. We can see the fussiness as systematic and if so we must change the representation of the agent, according to Roy Radner (1982: 940), to something like [i, ei, ci] where ei is the ‘physical’ endowments and ci represents information processing capabilities, which we perhaps can remedy with a ‘Central Institute for Consumers’.14 The second alternative is that the fussiness is randomly distributed among the agents, and this is the case where a centrally set price vector does the job in making the markets converge to long run equilibrium. We may thus look at the bounded rationality approach from two perspectives: the individual and the aggregate. From the individual perspective it is somewhat difficult to claim that the individual agent is bounded rational without setting an explicit norm. The introduction of transaction costs does not really change the reasoning since those costs also must be rationally analysed and indeed they must not be measured differently. We thus enter a totally new path, namely context dependence, which we will analyse later but that is, however, a vastly different problem than bounded rationality. From an aggregate perspective the bounded rationality hypothesis develops the neoclassical model but eventual remedies do not cope with the central political problem – who decides the price vector. Still the agents are seen as a kind of non-­perfect Homo Œconomicus that can be helped at least temporally by a central agency but the question is who will help them – the central agency? The question is highly relevant since those who occupy the chairs of the central agency must be the same kind of deficient Homo Œconomicus.

Homo Œconomicus versus Homo Politicus   67

2.3  Towards a Homo Rationalis We have already discussed that the axioms do not distinguish between the commodity and its functions. By the function of a commodity, we mean that the utility value of the arbitrary commodity depends on the commodity structure of the particular basket, the social/cultural environment and most of all of the local and temporary purposes of the consumer. In the neoclassical theory all commodities are demanded as such, and not in relation to a particular context. Economists like Gary Becker (1976), Kelvin Lancaster (1966) and William Gorman (1980 [1956]) have noticed this weakness in their works on consumer theory but the full flavour of its implications has not had any effect on the general equilibrium theory. The fundamental aim of the general equilibrium theory is to link consumer choice to the production structure and its demand for productive factors, and to prove that there is a situation where all production factors can be employed and efficiently used in a way such that we have a Pareto optimum for the entire market economy; but if so the consumers must demand what the production sector produces and it produces commodities and not the functions of the commodities. So the reflexivity axiom is the basic key to the corollary that any binary comparison between two arbitrary commodities is independent of the context. This is obviously not true in the real world. Even if you normally prefer red wines to white you would not choose a red Saint Emilion instead of a Sancerre to accompany a sole meuniere. Thus the function of a commodity in a context is the real reason why we buy it. When you choose between two kinds of meat, your preference structure depends for example on if you are going to use just for a single course or if you will use it as a part of a menu. This shows also the difficulty to apply the above definition of Samuelson of revealed preferences, because he is working with the time dimension. Obviously there are examples where Samuelson’s definition of revealed preferences are true but there are probably as many examples where it is not true, and remember that if the axiomatic structure shall be meaningful it has always to be true. Debreu’s and Allais’ concepts of a commodity Gerard Debreu, who created the modern mathematical structure for the neoclassical theory, was obviously fully aware of the problem which the reflexivity axiom creates (Theory of Value 1959). He claimed that a commodity at a specific time in a specific place was a different commodity from the same physical item at another time and place (Part 2.2 ‘Dates and Locations’ and Part 2.3 ‘Goods’). Thus he claimed that all commodities should be dated and spatially specified in the General Equilibrium Analysis. Thus a good A should be indexed temporally and spatially Atl and we then must conclude that At1l1 ≠ At2l2 although we conceive the same good.≠ Maurice Allais, also discussed this problem in relation to the Neuman– Morgenstern expected utility function where he arrived at the so-­called Allais’

68   H. Ekstedt lottery paradox (Allais 1953). His point is that the ranking alternatives which the agent must value are, on the one hand, the utility and on the other hand, the degree of uncertainty. In this situation the corollary of independence of irrelevant alternatives does not hold. The very point of Allais’ paradox is that the alternatives which the agent has to rank are not one-­dimensional (the utility of the good and the uncertainty), and the multidimensionality of commodities are in fact the basic implication of Debreu’s specification with respect to space-­time environment. In fact we may press the case a bit further. When we look at a commodity, physical good or service, the very function of this commodity varies depending on the context, and the consumer chooses the commodity with respect to the function in the particular context. Thus applying the specification by Debreu and to a certain extent also the specification by Allais we may interpret a commodity, a good or a service, as a multidimensional complex, which is projected into different contexts. But such an interpretation will have remarkable methodological consequences. The principle thought underlying the neoclassical theory is that the micro entities form by addition the macro levels. In general equilibrium theory, given a price vector, we may sum according to the value of commodities or through the individual endowments. We may say that the macro level is defined by the micro level. However, when we apply the thought of a multidimensional commodity, the utility of which depends on contextual considerations, we must realize that there is an interdependence between aggregate levels and underlying disaggregated levels. In itself this could lead to the conclusion that economic analysis of microand macro-­levels are different but the mutual interdependency must be accounted for. An elementary conclusion is also that the choice between holistic and atomistic methodologies ends with the insights that both are necessary and complements to each other. But we definitely leave the world of simple atomism à la ancient Greece and move into another complex world. The specific axioms of the neoclassical theory work at a specific time at a specific place, which is the same as saying that the consumer is normally rational but the outcome of the rationality depends on the specific environment. Thus the consumer may be perfectly rational at two moments of time although the behaviour at the two moments is contradictory. This has a tremendous effect on the logical conclusions. Accepting that consumers act with respect to the functions of the commodities and not the commodities as such, implies that we separate the consumer demand from the production economy and this is the very root of the genuine uncertainty of production when this is dependent on inert production capital. From this follows the problem of the uncertainty of investment in fixed capital. We may also allude to Keynes’s critique of the so-­called Say’s law, which implies that supply creates its own demand. Say’s law is automatically correct when the six axioms are true, particularly the axiom of local non-­satiation, but then only when the consumer consumes the

Homo Œconomicus versus Homo Politicus   69 very commodity and not the function of the commodity. Thus the Keynesian critics of the neoclassical theory can be defended by analysis of the precise meaning of the axiomatic structure. When we make the agents’ preferences dependent on context there is no way to save the axiomatic structure of the general equilibrium theory in an intertemporal sense. At best, on the aggregate level, there will be a more or less random walk between different temporary states of equilibrium lacking logical relations between each other. Even that seems to be a vain hope since all trading is what we call false trading, which means trading out of equilibrium. We will later on discuss Maurice Allais’ The Equimarginal Principle. With respect to rationality the introduction of context dependent preferences reduces rationality, in the sense of the axioms of general equilibrium theory, to an empty concept and any claim of some global rationality seems farfetched. So – let us attack these problems by introducing Homo Rationalis. Homo Rationalis From our earlier discussions we have a kind of two dimensional rationality; on one hand the agent must evaluate her/his purposes relative to a context and on the other hand choose among relevant alternatives. The rationality concept used in the neoclassical theory deals with the latter aspect. That means that its rationality concept is relevant when all contextual considerations are done. This is in fact a form of animal rationality. When we just have simple survival and reproduction needs/purposes which are not intellectual but instincts, the only context we need is now. However when we claim that Homo Sapiens has an intellect which makes it possible to vary the time horizon and to have multidimensional purposes different from basic instincts, we end up in a pretty complex contextual analysis and then we must equip Homo Rationalis with at least a two-­dimensional rationality concept. Such a change in the attitude towards rationality will obviously have enormous analytical consequences. It will certainly affect the discussions relative to the concepts of risk and uncertainty. If we just need to consider the animal rationality of the neoclassical theory the uncertainty may in principle be reduced to probabilities of the states of the world, which are independent of the market actions of the individual. However when we introduce the two-­dimensional rationality concept and subsequently the interdependence between macro and micro states we introduce a formidable source of uncertainty, namely the Homo Rationalis itself. The very root of this uncertainty is the human ability to adapt to the environment and reformulate both purposes and time horizon. A new environment would imply new possibilities. This is in fact similar to redefining a set of axioms and gives rise to a completely new analysis.15 Introducing contextual considerations obviously breaks the logical link between the human mind and the commodity space, thus neither the independence of irrelevant alternatives nor the revealed preference hypothesis are viable

70   H. Ekstedt as conclusions/propositions. In fact we introduce chaos and we lose our ability to speak in systematic terms since we break the assumed link between the agents. The neoclassical theory creates a link between the agents but this link is not a directly between the agents but goes through the so-­called invisible hand. So if we want to proceed we must introduce a new concept which covers, at least partly, our two-­dimensional rationality. We will not go into the psychology of Man but introduce a simple concept which to a certain degree covers the contextual considerations. This concept, epistemological (epistemic) cycles (in the following we use the term epistemic cycles) is, to our knowledge, introduced as a scientific concept by the mathematician and philosopher Thomas Brody (1994). We define it as a consistent set of concepts and axioms concerning a precise context, which governs the agent’s actions. It is perhaps easiest to think of a scientific theory in natural sciences where the experimental environment is controlled. In this case the scientists are bound to expect certain effects to appear as a consequence of certain actions. If expectations are fulfilled the hypothesis is reinforced. If not, the scientists have to go back and either check the theory and/or the created environment. Thus this concept is directed towards actions and their effects which impose a learning process. When an epistemic cycle is closed the agent is reinforced in the belief of the hypothesis and thus uncertainty is lowered. On the other hand when the cycle is broken uncertainty is not decreased and may even be increased. When it comes to social behaviour, of which economic behaviour is a part, the environment is not controlled by the agent and this implies that the agents are dependent on other agents’ reactions to their actions. Thus when the epistemic cycle is closed the agents are reinforced in the conviction that their environmental comprehension is correct. If the cycle is broken more has to be learnt about the context which may also lead to reconsiderations of purposes and perceived restrictions. In Figure 2.5 we give a simple illustration of an epistemic cycle in a social context. Purposes Fulfilment of purposes

Contextual comprehension

Reaction/effect Perceived means and restrictions ACTION

Figure 2.5  Epistemic cycle.

Failure

Homo Œconomicus versus Homo Politicus   71 Introducing the epistemic cycle concept as we have defined it does not help us to get away from our created chaos but at least we see that the better the agents can perceive the context the less their uncertainty will be and this will give us an opening to introduce ethics as a central concept in economic analysis. We will come back to this in Chapters 3 and 4. Is there a global rationality? By introducing the concept of epistemic cycles we are now in a position to discuss the question of the existence of globally rational models. This question is not possible within the neoclassical rationality axioms since they form an equivalence relation such that if the axioms are fulfilled we are ‘inside’ a globally rational universe; otherwise we are irrational, a state that does not exist in that particular universe. Through the introduction of epistemic cycles we have a meta-­axiomatic conceptualization such that we postulate that within an epistemic cycle we can use the neoclassical definition of rationality but the union of any two cycles may contain a disjoint space, of a larger or smaller degree, where the axiom systems and/or the concepts are inconsistent with each other. Thus when we move from one epistemic cycle to another we move from one set of axioms/presumptions to another and these two are disjoint, at least partially. Let us postulate that the agent is rational in the sense of the six axioms of the general equilibrium theory, with respect to a given epistemic cycle. That means that if all agents agree to the same set of restrictions as well as to the set of purposes and the state of the world we will have an outcome which may be described as a Nash-­equilibrium (Nash 1950). We may now ask under what precise conditions there exists a global rational model. If two different sets of agents act according to different epistemic cycles, can we then still have Nash equilibrium? A global rational model must then contain all possible epistemic cycles and rationality, in the sense of the six axioms, and can be exercised on this universal set of epistemic cycles. The precise meaning of this is that the universal set of rational models belongs to itself. Thus the global set of agents must be rational as must all individuals individually be. This leads us to the classical Russell’s paradox, which in a non-­technical form may be expressed in the following way:16 Russell’s paradox, version 1: P1. Define a proper class, as a class of subsets where the universal class is not a subset of itself. P2. Define furthermore a non-­proper class, as a class of subsets where the universal class is a subset of itself.

72   H. Ekstedt C. Then the class of all proper classes can not belong to itself. Thus the universal class of proper classes does not belong to the set of proper classes. Example of a proper class: Let us as an example of a proper class take a particular breed of dogs, like cocker spaniels. We may then ask whether the universal class of classes of dogs is a particular breed of dogs. The answer is of course no. Example of a non-­proper class: In this example we use Cantor’s unaccountability theorem which is said to have given Russell the idea of his paradox. Assume a set of natural numbers, (1; 2; 3). According to Cantor we will end up in infinitely many subsets. (The numbered parenthesis, with subscripts, indicates subsets on respective levels.) Level 1: 1[1; (1; 2); 2; (2;3); 3; (1;3)]1 Level 2: 2[1; (1; 2); 1[1; (1; 2); 2; (2;3); 3; (1;3)]1]2 Level 3: 3[1; 2; (2; 3); 1[1; (1; 2); 2; (2;3); 3; (1;3)]1; 2[1; (1; 2); 1[1; (1; 2); 2; (2;3); 3; (1;3)]1]2]3 And so on, each level of subsets may be a subset on a higher level which implies that there will be infinitely many subsets. But the universal class of all subsets will certainly belong to itself. Technically we express Russell’s paradox as follows: Russell’s paradox, version 2 (Weisstein 2000): Let S be the set of all sets which are not members of themselves. Then S is neither a member of itself nor not a member of itself. Symbolically we will have: Let S = {x | x  x} then S  S if and only if S  S. Observe the close links to the axiom of reflexivity in general equilibrium theory. In fact we now have isolated the exact point where the Wittgenstein problem of interpreting a mathematical image of reality into actual reality occurs. When we translate commodities into real numbers in the n-­dimensional real space Rn+ and furthermore declare that there is an equivalence relation between the interior of an agent, the utility space, and the exterior world, the commodity space, we obviously transform the whole problem to a problem of real numbers and we end up in Cantor’s unaccountability theorem. This means that a subset of any level, as exemplified above, will not have any other characteristics than a singular number or any kind of other subsets of numbers. Thus the mathematical analysis of neoclassical economic theory will deal with what we, in relation to Russell’s paradox, call non-­proper classes. In this analysis there exists a global rational model provided rationality is defined as an equivalence relation.

Homo Œconomicus versus Homo Politicus   73 However if we reject the axiom of reflexivity we will end up in proper classes and then any universal class of rational models will not belong to itself. But what does that really mean? We mentioned earlier that we should look at commodities as different dimensions; thus the commodity space is to be seen as a vector space. Furthermore a piece of a commodity is to be seen as a ‘tick’ on a measuring rod. That is exactly what it is about. The commodity space is an empty space where the commodities just span the different dimensions. A consumer is to be seen as a point in that space, a vector, given the price vector. Thus we can say that the consumers fill up the commodity space, not the opposite. This means that a piece of a commodity does not contain any other characteristics besides being a ‘tick’ on a measuring rod (which might be used in any of the dimensions), which Lebesque measure is zero. That is also the reason why the consumers are nothing more that vectors and lack any other characteristics. In Arrow’s paradox the agents suddenly are supposed to be able to rank alternatives. How does it come about that a vector can vote? This is exactly why we get the problem in Arrow’s paradox; the voting agents are not vectors but separated by different ranking schemes and then they are apart from each other and cannot be aggregated. To be blunt we can say that neither neoclassical theory nor Arrow’s paradox add something to the social and political analysis. Arrow’s paradox is useful since it tells us that something is wrong but besides that we cannot use it as an analytical tool. Thus when we analyse real people they consist of a set of characteristics which separates them from each other and these sets of characteristics are disjointed. This ends up in the conclusion that the only way we can speak about an aggregate society is to aggregate the individual agents but that means that we build in contradictions in the aggregate, ending up in proper classes where the aggregate is not to be seen as a part of itself. That is the proper start of an economic analysis of a society and that is the proper start of a social and political analysis. The concept of epistemic cycles will enter the analysis here. As we have defined it, it is an extremely abstract concept telling virtually nothing more than might be found contexts where purposes, actions and restrictions can be rational in the meaning of the six axioms of the neoclassical analysis. However since we now have no a priori possibility of additive aggregation we impute the possibility of epistemic cycles on aggregate levels although there are contradictive cycles on disaggregated levels. This leads to a much more complicated situation than is described in Arrow’s paradox. People may accept alternatives contradictory to their private preferences in order to have a stable social situation. Thus they may have a ranking of purposes with their action depending on the aggregate level. On the other hand however, agents who regularly fail to adapt to a social context, where they actually live, will seldom be reinforced by successive actions and their uncertainty of their perceptions will undergo constant changes. The effect of this may be fatal for social stability if this is the situation for a large part of the community.

74   H. Ekstedt In analysing Arrow’s paradox we saw that the agents have the ability to apprehend the aggregate level but they were in fact not social creatures but individual voting automata. This brings us right back to the quote from David Hume. Humans are not solely governed by reason but most of all by passion in a broad sense and thus rationality as a concept must consist of the kind of rationality defined by the six axioms, particularly the first three, but there must also exist a rationality in analysing contexts with respect to fundamental purposes, which includes the possibility of rankings of purposes. This in fact opens up the possibility of individuals having seemingly contradictory purposes on different aggregate levels. The neoclassical kind of rationality is of course fundamental to have any kind of purposeful action but it is a mean with respect to the higher form of rationality which concerns contextual questions and passion. This is also where ethics enters as a key concept in social analysis. In the quote from Richard Tresch on page 42 we see that he expresses that it is a complication to the economic analysis as the ethics must be agreed upon. Our answer is that it is only a complication to the mathematical analysis and that such an agreement is a necessity for an economic structure.

2.4  Summing up The neoclassical general equilibrium theory is seen as a powerful analytical tool for analysing economic exchange. However its axiomatic structure is demanding in the way that conclusions with respect to an aggregate level become somewhat peculiar from a strictly logical point of view when applied to social and political behaviour. The very root of these peculiarities lies in the very definition of rationality. Given considerable inertia of a market structure the theory may, at best, be used temporally and locally on the microeconomic level and for microeconomic policy. When the model is brought to discussing the aggregate economy and even the political field in the form of rational choice or formulating a social welfare function where the ‘commodities’ are generalized to cover choices of a complex and often aggregate character, the precise axiomatic structure of the concept of rationality creates even greater peculiarities which have sometimes lead to conclusions that rationality on aggregate levels should be executed by economists or some kind of dictators. We have shown that such ideas stem from a poor understanding of the precise logic of the axioms underlying the neoclassical rationality concept. However this rationality concept can be saved as a means in a higher form of rationality concerning rankings of purposes, contextual analysis and creating epistemic cycles. This is actually the only interpretation in which Debreu’s space-­time indexation is adequate. That implies that although the agents may execute rationality according to the axioms there might be a contradiction depending on the differences between epistemic cycles. On the other hand, such contradictions may disappear in aggregate decisions due to some form of acceptance of social rules.

Homo Œconomicus versus Homo Politicus   75 The discussion of first best and second best which we touched on in the introduction to this chapter will subsequently be meaningless since the aggregate level is not a simple additive function of the individual outcomes. The alleged normative character of the market theory is entirely depending on the claims of a global rationality concept, which we reject. Rational choice theory may have been useful to apply to political analysis in the way that several interesting game theory cases have been pursued. However its logical underpinnings are basically not analysed enough in order to make it an interesting scientific tool if we take an empiricist point of view. The axiomatic structure implies nothing relative to the inertia of the preference structure. The simplest interpretation of the axioms is that we postulate that the agents are rational when choosing, but whether this rationality refers to inert norms or to dissipative environmental necessities we cannot say. Thus the question of whether democracy is efficient or not is not even a question; the problems of democracy lie in the spread of epistemic cycles but this is something which cannot be discussed within the realm of neoclassical rationality. Using the neoclassical general equilibrium theory to explain the real world gives some significance to Bertrand Russell’s words: .

This illustrates an important truth, namely, that the worse the logic the more interesting the consequences to which it gives rise. (Russell 1996 [1946]: 715)

3 The axiological–normative question in economics and social sciences Objective and subjective values Angelo Fusari Introduction The ethical-­normative problem is central to the study of social reality. In economics, it assumes a particularly explicit form and clearly shows the underlying methodological confusion. In particular, the distinction between economics and political economy expresses and, so to speak, formalizes a dissociation between positive and normative aspect, being and doing, that causes serious errors and confusion both in the theory and practice. In fact, the pretension to use the teachings of positive economics at the service of normative economy is contradictory since the positivist method excludes, as we know, the normative aspect. The situation is worsened by the dominating influence of the rational choice theory with its instrumental character, that is, the idea that reason cannot indicate where to go but only the way to get efficiently to the established goals. More precisely, according to rational choice theory, beliefs and values come from outside and the task of reason is to choose the more suitable means to achieve the proposed goals. This instrumentalist view has gained a more realistic content in the context of the ‘theory of bounded rationality’, emphasizing the limits of reason. But this benefit in terms of realism has been shortened by various exaggerations and misunderstandings on the characters of bounds, as exemplified, for instance, by the current and mistaken insistence on the unmeasurability of radical uncertainty that strongly reduces the explanatory potentialities of theoretical effort. The formal rigour of the rational choice theory has promoted a deep penetration of its teaching across the scientific community. It is not exaggerated to say that it is at the heart of the difficulties, limitations and contradictions of social thought. In particular, the success of such a theory has much reinforced the postulate of the non-­scientific content of values and hence has given a decisive contribution to legitimize the distinction between economics and political economy. All that has suggested to dedicate, in this book, an apposite part to values and rationality. After all, a main characteristic of social reality is the presence of doing alongside being. Such reality cannot escape from moral tension and ignore values; at the same time, it cannot ignore being. As we know, the main and most peculiar methodological problem of social thought concerns the way to combine

The axiological–normative question   77 those two aspects of human societies, being and doing, instead of sermonizing their inevitable separation. This chapter contains some ideas expressed in Fusari (2009).

3.1  A quick review of the treatment of values in the modern world, before the twentieth century. Vico’s premonitory contribution This analysis of ethics may usefully start by recalling the thinking that prevailed in the field some centuries ago. At the beginning of modern age, the Roman Catholic Church abandoned medieval rationalism, mainly as an effect of her harsh opposition to the methodological developments and achievements of natural sciences. This hostility to scientific thought was congenial to the idea that values are faith precepts. For their part, lay students derived, from the inconsistency of some religious dogma with modern dynamic society, the conviction that the expulsion of ethics from social thought was a methodological and practical necessity. Machiavelli illustrated with many examples that ethics has nothing to do with politics; Adam Smith extended such teaching to economics. Mandeville went beyond. He was impressed, much earlier than Adam Smith, by the capability of the market to warrant the coherence, on the whole, of a lot of different and not reiterated decisions, independent of each other and sometimes in harsh conflict.1 He underlined the ‘vileness of the ingredients that represent on the whole the healthy mixture of a well ordered society’ (Mandeville 2000:  3) and stated the transformation of ‘private vices into public virtues’. Mandeville does not show a deep sense of history when he says that this heterogenesis of ends is inevitable in large communities, while the little ones could be organized and directed on the base of doing and moral sentiments. In fact, this statement can be objected to, that the mercantile societies expressed by medieval communes totally adhered to the logic of his Fable of the Bees, while the opposite happened in ancient bureaucratic and autocratic empires. But the final verse of his poetry on the dissatisfied beehive, saying ‘He who wants go back to the golden age, must be ready for acorns,’ shows a good perception of the main question: the government of a society based on well-­established ethical ends needs their closing and stagnation. At any rate, Mandeville’s idea of the usefulness, in complex and dynamic societies, of the vileness of human behaviour, even if it may seem true from an observational point of view is not from an organizational perspective. We shall see that such vileness can be separated from some organizational necessities to which it is associated by the current view and that it makes sense to manage for suppressing it. The referred teachings imply the exclusion of ethics from the whole of social thought, in accordance with the method of inquiry of natural sciences as based on the strict observation of reality and characterized by the absence of a prescriptive aspect. But such a method is, as we know, not appropriate to social phenomena, even if the expulsion of ethics from social theory was useful to dupe

78   A. Fusari the obstacle to modernity represented by what the secularization movement indicated as clerical obscurantism. But the separation of ethics from the various branches of social thought is senseless; in fact, ethics represents an important (probably the most important) aspect of social reality and it is inseparable from political, economical and all the remaining aspects of social life since all the various social subsystems always operate conjointly. This groundless separation has perhaps given the main push to the diffusion of the idea that values cannot be scientifically explained, and hence to modern relativism. At this point we must refer to a premonitory contribution on method that unfortunately has been largely disregarded. Two important and opposite stars in the field of method marked the advent of the modern age: Galileo and Vico. The teaching of the first, concerning natural sciences, enjoyed full success, while that of the second was almost ignored and often misunderstood, probably also due to the fact that it offered a method much less clear and poorly defined than the methodologists of the seventeenth century. Nevertheless, it is greatly to Vico’s merit that he advised in a timely manner against the rapid diffusion of Cartesian teaching and the method of natural sciences in historical-­social thought. He sharply pointed out the great difference between the two branches of knowledge through the admonition that historical facts are a product of man, from which he deducted the ‘convertibility of the true into the fact’. Vico underlined the ability of social order to be preserved ‘without any human expedient or device and often against the purposes of men’. He attributed such wonders to Providence; but he claimed to deepen if ‘notwithstanding the diffused misery afflicting men, it was possible to better manage and preserve human society’ (Vico 1987:  113–14). As just seen, his contemporary, Mande­ ville, deduced from the behaviour of the society of his time the tendency of social systems to preserve, and to act differently from human purposes and even to flourish through vice. So Providence became the invisible hand that later Hegel denominated ‘astuteness of history’. Unfortunately these authors had not the Vico’s distinguishing acute sense of history; this probably was the main cause of the disregard for the deepening he proposed. Clearly, the ability of social systems to survive in an evident state of diffuse confusion is due to their tendency to gravitate, through trial and error, toward coherence; in fact, the persistence of unconstrained inconsistencies would imply their extinction. So, if civilization forms are based on vice, sorcery, militarism, etc. their coherence will be established upon those values, that therefore will seem a cause of public benefit. Here, the importance of Vico’s concern about the way of ‘better managing and preserving human society’ becomes evident, a possibility which is eluded in principle by the standard-­bearers of spontaneous motion. Such skill mainly lies in the distinction of ‘social necessity’ (that is, the organizational forms required by the existent general conditions of development and the state of nature), from ‘choice-­possibility’. This distinction allows the pursuit in respect of organizational necessities and combines with them the forms of civilization able to promote the development of human skills and know-

The axiological–normative question   79 ledge. The point is that the edified civilizations are not obliged to be based on vice. The above distinction between ‘necessity’ and ‘choice-­possibility’ allows the explanation of the development and fall of social systems in the course of history, their stagnation and the transformation of parabolic motion to a spiral of increasingly outward motion, of the kind of Vico’s courses and returns, that is, the advent of the historical-­social cycle along an increasing trend. The secular stagnation that characterized the later Roman Empire and many other ancient societies (Byzantine, Chinese, Ottoman etc.) was due to the establishment of ‘obedience societies’ that suffocated individual initiative and creativeness. While the development of medieval Italy was propitiated by the opposite situation, the subsequent stagnation and decadence was mainly due to the inability to meet some institutional necessities generated by the evolution of the general conditions of development: for instance, a renewed political organization and some wider state dimensions. The tolerant Holland benefited from rapid development; England took advantage of the constitutional revolution, the USA has derived great benefit from the institutional foresight of its founding fathers. It is evident that the systematic hegemony, from the ancient ages until today, of the societies has better fulfilled the organizational necessities imposed in the course of time by the state of the general conditions of development. In the end, the advent of cumulative endogenous growth and development has defeated the condemnation of human societies to the repeated falling back to the proximity of starting point or to stagnation, as is typical of ‘obedience societies’. In underlining the role of Vichian Providence in human vicissitude, one is obliged to refer to the gift of reason, i.e. Vico’s reference to the ability ‘to better manage and preserve human societies’. Only an intensive use of reason can avoid serious errors, deceit, abuse and failures, and strengthen human successes. Unfortunately the overflow, in social thought, of the method of natural sciences, notwithstanding Vico’s premonitory advice, condemned his intuitions to oblivion. The application to social reality of the observational method, as based on the acceptance of existence, implies the expulsion of guiding aspects, that is doing, from scientific analysis. Sometimes this exclusion is justified on the basis of a supposed Hume’s law according to which it is mistaken to come from being to doing and hence to combine both. But it seems that such a law has rather represented an excuse. In fact, Hume simply stated that it is not possible to derive a prescriptive conclusion from assertive statements; this does not deny the possibility of combining being and doing, as we saw in Chapter 1. In effect, Hume dedicated a good deal of study to ethics and his statement that moral laws derive from the needs of society, which probably represents the most important contribution of empiricism to ethics, implies a combination of being and doing. But Hume’s omission of methodological developments on the way the combination can be carried out gives to his development on ethics the resemblance of an ad hoc formulation. The work of the sharpest social students, until the beginning of the last century, mainly faced the methodological difficulties on values through ad hoc

80   A. Fusari hypotheses that were less rigorous but, in compensation, less misleading than the reduction of social thought to being. A main example is Adam Smith’s Theory of Moral Sentiments that conjugates social utility, subjective values and natural laws with a brilliant practical sense but disregarding methodological severity. The other main theoretical constructions on ethics are not up to the occasion. All of them elude or treat in an unacceptable way the crucial problem of the combination of being and doing. For instance: Kantian formalism ignores being; for their part, utilitarianism misunderstood the problem by making the hypothesis of a stabbing search of happiness by Man (clearly contradicted by reality) that pretended to specify through the idea of maximization of the sum of individual values, a sum that indeed is made impossible by the non-­comparability of personal values. Hegel eluded the combination of being and doing through the identification of ethics with reality, an identification that absolves and justifies everything. For its part, contractualism, mainly jusnaturalism, equivocally combines being and doing; this combination is also ignored or misunderstood by neo-­Kantian philosophy, neo-­contractualism and neo-­utilitarianism. The equivocations and ambiguities did not diminish in the course of time. On the contrary, some others were added that became interwoven with the transition from the nineteenth to the twentieth century. Social positivists and empiricists tried to have it both ways, that is, in some cases they theorized on values notwithstanding that this contradicts the observationist method, while in other cases set aside values.

3.2  A turning point: Weber’s irrational rationality At the beginning of the twentieth century, the exclusion of values from scientific analysis that positivism implies but often avoided to profess, was, on the contrary, clearly postulated by some famous observationists hostile to positivism. Pareto, Weber, and Spengler, just to name the most important, dedicated deep analyses and many historical references to prove that values cannot have a scientific explanation. This proposition greatly stimulated the irrationalism that afflicted human societies in the first half of the twentieth century. Weber was the main thinker responsible for this landfall. He asserted the absolute subjectivity and ‘polytheism’ of values considered as visions, just as points of view. But he did not set aside values; on the contrary, he underlined their great importance in the analysis of human societies. As a matter of fact, the inquiry on values and religions is a main characteristic and the most fascinating aspect of Weberian work. The underlining of the importance of values, combined with the drastic denial of their scientific nature, i.e. the idea of values’ subjectivity, gave impulse to ‘cultural and cognitive relativism’ that legitimates each value and each explanatory model. A methodological galaxy, afflicted by growing equivocations and misunderstandings, started. A century and half of social studies had caused, in the end, a substantial withdrawal with respect to Hume’s inquiry on ethics, showing that scientific research does not advance in the absence of a solid methodological basis.

The axiological–normative question   81 It must be stressed that the plurality of ethics that Weber underlines (‘for erotic or business relations, domestic or work relations, . . . the friend or the enemy’) (Weber 1997: 99), professional or class ethics, etc. does not justify the idea of subjectivity of values. On the contrary, that plurality has objective roots, nourished by reality. It is implied by the combination of being and doing on which we insist; different conditions imply different values. But Weber insists in denying any relation between science and doing. He wrote: ‘An empirical science cannot teach to anybody what he must, but only what he can and sometimes what he wants’ (op cit. p. 61). The expulsion of values from scientific inquiry is coherent with observationism since this limits itself to being. But the result is that Weberian explanations are conditioned by the chosen point of view and therefore are conditional, as a consequence of values subjectivity. This makes Weberian insistence on rationality limited and open to possible irrational outlets. The indefensibility of the Weberian denial of values’ objectivity clearly emerged in his analysis of politics and forced the author to resort to the expedient of the double moral, the well known distinction between ‘ethics of responsibility’ and ‘ethics of conviction’. But the first notion of ethics has some clear objective content: responsibility is always related to something: a notion of responsibility deprived of objective foundation is senseless. It is surprising that the objective implications of the notion of ethics of responsibility did not induce Weber to any reconsideration of the idea of the subjectivity of values. Coherently with the adhesion to observationism, he accurately masked those objective implications by identifying responsibility with the permissive Machiavelli’s virtue. In sum, Weber substantially misses the crucial question of the object and content of responsibility: does this refer to self interest, the desire for glory, faith precepts, some generic notion of the common good, or something other? He does not care to clarify these crucial questions. The consequent great indeterminateness of the notion of responsibility is much more devastating than the Weberian ethical dualism; it implies a multiplicity of ethics that, with the help of the double moral, allow a diffuse manipulating power on values. Weber emphasizes the individual character of social events; therefore, he is not interested in the positivist assumption of the repetitiveness of reality. However, similarly to positivists, he bases his analyses on the strict observation of reality. So he observes, in the course of history, a succession of crimes by important or less important rulers and, as an observationist, he accepts all that. Consequently, he thinks that the splitting of ethics and politics that Machiavelli underlined is inevitable and craftily defines it ‘ethics of responsibility’, with responsibility simply referred to politicians’ purposes. This dualistic landfall on morals is inevitable if, on the basis of historical observation, one assumes that power must necessarily take the form of domination and hence is exerted through abuse. But the persistence of domination power across centuries does not imply that domination power is inevitable. Society is a product of Man; the transition from domination-­power to service-­power, i.e. based on well-­defined responsibilities is possible in principle; a transition that would imply a substantial ethical progress.

82   A. Fusari The diffuse denial of the objectivity of values takes, in the present time, two opposite forms, both having a relativist substance since they intend values as ‘relative’ to the considered civilization or to the precepts of faith proclaiming them: cultural relativism and absolutist relativism. The first attributes an equal dignity in principle to all values and civilizations. On the contrary, the second is exclusivist; it implies, therefore, an uncompromising opposition among the various precepts of faith. Cultural relativism is flexible in nature and hence open to the variable exigencies of the changing world; but it is unable and reluctant to give indications of what to do. It intends this openness as synonymous with tolerance; but its denial of objective values does not allow us to prove the objectivity of the value of tolerance that therefore remains an ethical precept among many others. On the contrary, absolutist relativism imperatively indicates, through the precepts of faith, what to believe and to do; this may give it some attraction in the presence of difficult and confused situations, mainly if afflicted by a profound crisis of values. But its stiffness may forcefully obstruct the development process through dogmatic prescriptions. Moreover, the contrasts among different precepts of faith strongly entangle, in the global world, the human relations and the capacity to collaborate with other people. Briefly, absolutist relativism inclines toward civilization conflicts and to suffocate the fecundating seeds provided by the variety of civilizations. Both the relativisms oppose the birth of a global ethics that the present world greatly needs.2 They symmetrically and clearly express the limits and implications of the postulate that values cannot have a scientific explanation, are fierce protagonists of an irremediable theoretical conflict and get reciprocal support from their respective lacks.

3.3  Ambiguities and circumlocutions on the ‘reasonableness’ of values: the Rawlsian neo-­contractualism Rawls’ neo-­contractualist development, aimed at remedying the crisis of jusnaturalist contractualism caused by its extensive notion of natural rights, constitutes the main and more elaborated theory that manages to combine a feeble objectivity of values to the postulate denying teleological rationality, i.e. concerning values and ends. But such an attempt is afflicted by an inherent ambiguity. Rawls points out that justice is the first virtue of social systems, just as truth is the main virtue of systems of thought. The statement clearly shows the absence of scientific pretension in the theory that, in fact, is not directed to discover scientific truth but only to provide reasonable bases for the life of human societies. This neo-­contractualism is hinged upon the definition of two principles of justice that sound as follows: First principle: Every society is entitled to a system of fundamental freedom as large as possible consistent with an analogous system of freedom for all. Second principle: Social and economic inequalities must be: a) for the major benefit of the less advantaged, consistently with the principle of fair saving, and b) connected to offices and positions accessible to all people in conditions of equality of opportunity.

The axiological–normative question   83 Rawls clarifies that the first principle, i.e. the system of fundamental freedom, cannot in any way be postponed to social justice. To provide a contractual justification of both principles or, in other words, to explain the convergence of ‘reasonable people’ toward them, Rawls is obliged to make a number of fictitious assumptions and exaggerations: the representative individual; the veil of ignorance that, as a matter of fact, is much more than a veil; the supposition of an ethereal initial position where no one knows his social position, his social status and class, the distribution of natural skills, his notion of good, his life rational plans, his psychological tendencies such as the propensity to risk, optimism and pessimism, the offspring to which he is parent, the level of civilization of the concerned society, or the political and economic situation. In sum, each contracting part simply should feel to be ‘one among many’. It is evident that notwithstanding their extreme unrealism, these assumptions are nevertheless indispensable to Rawls’ approach since their absence would make it impossible to reach a contractual agreement and formulate a theory of justice. The author writes that the principles of justice also are categorical imperatives in Kant’s sense. But this reference appears to be improper. Rawls’ development of ethics intends to be more effective, less sublime and abstract than Kantian ethics. His two principles of justice are far from the evanescence of categorical imperatives. Kantian ethics refers to the individual, is personal; it is not concerned with the analysis and organization of social systems. On the contrary, Rawls’ research is directed to provide basic principles to that organization; but, in this regard, his notion of the initial position expresses a sequence of unacceptable limitations. Boudon is right in considering Rawlsian development as not pertaining to scientific rationality. We propose a simpler and more effective way to show the contractual convergence: the notion of functional imperative, from which no reasonable person should dissent since it expresses an objective necessity. It can be easily shown, through some integration, that Rawls’ two principles embody functional imperatives. The first principle of justice clearly represents a main functional imperative of modern dynamic societies since these strictly need individual initiative, freedom, and dissent. In fact, the individual is a main source of creativity and the suffocation of his initiative and motivation would push toward stagnation. For its part, the equality of freedom for all is essential to take advantage of the available skills. Also the condition sub b of the second principle of justice, that extends the freedom envisaged by the first principle to all professions, expresses, for the reasons considered above, a functional imperative. A major attention deserves condition sub a, that Rawls denominates ‘difference principle’. This combines two aspects usually considered incompatible with each other: productive efficiency and distributive justice. Rawls’ analysis on the matter is important but not coherent. Two questions arise if we want to consider the difference principle a functional imperative: is the minimization of inequalities consistent with productive efficiency indispensable to the dynamics of human societies? And what prevents that large inequalities stimulate social dynamism even more? The answer is immediate: natural skills, mainly creativeness, are

84   A. Fusari r­ andomly distributed among human beings, i.e. according to what Rawls denominates a ‘natural lottery’. So to turn them to account, it is necessary that society does not tolerate extensive exclusions caused by the poverty of large masses. Moreover, the fruits of those skills must be to the advantage of all human beings not just for ethical reasons, as Rawls maintains, but mainly because this is required to make development effective, that is, because this is a functional imperative of a dynamic society. More precisely, the operation of Rawls’ principle of difference is necessary for the promotion of the participation of large masses and hence to make effective the natural lottery of skills, i.e. to avoid massive exclusions provoked by the enriching and privileges consequent to exceptional skills and also to avoid the corruption of their owners due to luxury. In effect, the difference principle is indispensable to make effective the first principle and the condition sub b of the second. So, the two Rawlsian principles of justice express a compact whole of functional imperatives. As such, they possess an unquestionable and scientific justification. We can see, therefore, that the analysis of values and ends can, and in effect must, achieve an higher and more explicit degree of objectivity and scientific rationality than in Rawls’ development and leads to a more stringent theory of justice and social systems. In order to better clarify this topic, let come to a more explicit attempt to formulate an objective theory of values, performed by Raymond Boudon.

3.4  Boudon’s contribution to an objectivist theory of values As far as we know, only one student professes a clear and harsh opposition to cultural relativisms and is strongly engaged in the elaboration of an objective theory of values: Raymond Boudon. Therefore, the analysis of his contribution is important and obliges us to pay particular attention to the question of rationality and, more in general, to some methodological impasses afflicting social thought. Boudon has tried to show the objectivity of values starting from some aspects of Weber, Durkheim and de Tocqueville’s teachings. He pursues the demonstration on the basis of observation; but this aim subtends a contradiction since the simple observation and hence acceptance of reality excludes the normative aspect, even if social reality is largely permeated by the ethical dimension. As previously seen, Weber’s ethical subjectivism is coherent with the idea that the explanation of reality must limit itself to consider this as given and hence the object of strict observation. In fact, this positivist notion of science excludes the normative (i.e. ethical) aspect, just as he does. All the same, Boudon tries to keep his objectivism and anti-­relativism in the Weberian track. In doing that, he stresses the question of rationality. The reference to rationality is very important not only as a reaction to the diffuse irrationalism of social thinking but also because it makes evident some great methodological weaknesses of social theory. Boudon does not undergo Weber’s contradiction of rationality consisting in the exclusion of values from scientific thought, his

The axiological–normative question   85 objectivist effort being directed to overcome it. But the ambiguous Weberian legacy on rationality displays its influence in some other way, mainly through two key notions at the heart of Boudon’s theoretical development: the Weberian notion of ‘behavioural cognitivism’ and that of ‘diffuse rationality’. The cognitive statement that there are always some reasons at the basis of human action is certainly true. Unfortunately, this evidence teaches us very little about the rationality of individual behaviour. The reasons for human actions and decisions may include even foolishness. It seems to us that human action, being largely influenced by instincts and sometimes by morally questionable feelings, is a weak and deceitful expression of rational behaviour. Rationality must be referred to science; as such, it is tightly linked to the question of method, which is indispensable for putting the problem in scientific terms.3 Boudon objects to the criticism that rationality must be referred to individual social behaviour, i.e. aimed at being approved by the other, not to individual human behaviour. Moreover, it must be added that his notion of ‘ordinary rationality’ is a very general one, also including scientific rationality. But the point is that a main and urgent need of social thought is to extend as much as possible the role of scientific rationality at the expense of the other components of ordinary rationality. In fact, those components may be highly misleading while the extension of the role of scientific rationality is strongly opposed, in social thought, by deep methodological equivocations. It is, therefore, absolutely indispensable to remove those equivocations. Some considerations on the other notion that our author derives from Weber’s teaching, i.e. the principle of ‘diffuse rationality’ clearly shows the heavy equivocations that may be associated to the non-­scientific components of his ‘ordinary rationality’ and some other methodological weakness. The notion of diffuse rationality expresses the idea that in the very long run things adjust by themselves, through a spontaneous trial and error process. In this way, values would converge towards the ‘right ones’ and this would warrant them a scientific objectivity. Boudon’s statement that ‘contingency has caused values genesis and diffuse rationalization their selection’, that gives an efficacious synthesis of his theory, is Darwinian. This landfall is not convincing and does not help daily life through science. It is undeniable that, notwithstanding disasters and catastrophes, the world is obliged to adjust in such a way to allow the human species to survive till extinction, as experienced by other species that lived a much longer time than Homo sapiens’ 30,000 years. But Man is the author of growing social change, without comparison to the rare accidental mutations and slow selective processes characterizing the natural world. For understanding Man’s work of transformation, it is not enough (and may cause growing equivocations with the acceleration of social evolution) some ex post judgement, as implied by the assumption of spontaneity of changes. In sum, with reference to the analysis of man’s construction, it is not sufficient to observe what happened; the research must also concern the way to build social reality and set out a science helping with this task. Weber is strongly aware of the non-­ repetitive character of social phenomena. But he does not consider that this non-­ repetition, which implies a great difference between social and natural reality,

86   A. Fusari makes the positivist method inappropriate to the first. The principle of ‘diffuse rationality’ is the tool he uses to prove that the observed behaviours are rational. To sum up, even if the principle of ‘diffuse rationality’ reconciles reality and rationality, just as Boudon is aimed at doing, it derives this reconciliation from Darwinian selection. But it seems to us that this rationality based on spontaneous facts, their observation, and the acceptance of what happened, cannot give a science of social relations, these being determined by human voluntarist action. Thus Boudon’s thesis threatens to reinforce a wide and powerful coalition that includes Weberian diffuse rationality and idealism, both based on the idea that real means rational, and agrees with the positivist assumption of the spontaneity of processes.4 The coalition has been strengthened by the confluence of the Roman Catholic Church and other religions that point out the reasonableness, wisdom, and good sense warranted to religious doctrines by long-­lasting elaborations across centuries, just as the principle of diffuse rationality maintains. This is, in effect, the basic weakness of the idea of world ethics expressed by the Chicago Declaration. In effect, the science of nature largely bypassed the principle of diffuse rationality at the beginning of modern age, when some clear methodological procedure and rules were set out. Before Francis Bacon and Galileo’s revolution, technological and natural knowledge grew according to the above principle: a slow selection of fecund intuitions that often stagnated for a long time in a sort of incubation or got lost and were accidentally rediscovered.5 In the absence of a scientific procedure of research and discovery, knowledge advanced slowly and with difficulty across millennia. The discovery, in the sixteenth and seventeenth centuries, of a method appropriate to natural reality made the growth of knowledge in the field exponential.

3.5  Objective and relative values. An ignored and contrasted law of moral progress Objectivity is hinged on scientificity and hence on method. Therefore, it is strongly related to our development in Chapter 1, sections 1.4 and 1.5, mainly to the notions of functional and ontological imperatives and to the distinction between ‘necessity’ and ‘choice-­possibility-creativity’. At this point we must remark on a methodological point that does not appear to have been properly perceived by studies in the method of social theory notwithstanding it is especially well suited to shedding light on several of the most inextricable misunderstandings that have plagued social thought and relations between different peoples. One is struck by the presence, among the organizational necessities and imperatives set forth in Chapter 1, section 1.4 and of a number of fundamental ethical or value requisites: freedom of movement, freedom of association, free trade; overcoming other doctrines and feudal constraints; the concept of individual responsibility and the principle of effective demand that fostered the advent of the welfare state and the redistribution of income and wealth. These

The axiological–normative question   87 elementary organizational necessities demonstrate that some fundamental values are objective. And they thus demonstrate the erroneousness, in fundamental respects, of the doctrine of cultural relativism that dominates today. It is mistaken, and a source of grave misunderstanding, to maintain that the various forms of value and civilization present or past are all of equal dignity and cannot be compared with one another. This is true only of the ethical-­normative aspects relating to the field of choice/possibility, not to those of necessity in the successive stages of development, which as we have observed are imposed by rationality and organizational consistency under the existing general conditions of development. Forms of civilization must be suited to those conditions. One cannot expect to move to higher levels of development while retaining values that, to one degree or another, clash with them. A simple example of the distinction between the objective and subjective aspects of values can be formulated as follows. Take a central aspect of civilizations, the idea of beauty or, more generally, their aesthetic view, and suppose that a civilization intends womanly beauty as proportional to corporal weight, or the smallness of feet like ancient China. These ideas will cause the tendency of women to fatten as much as possible or toward a substantial inability to walk, that will suffocate or obstruct the expression of their natural potentialities. The contrary happens if the aesthetical view of a civilization attributes a great importance to mental openness and intellectual skills. A civilization that, as on Dobu, is based on sorcery does not stimulate the evolutionary potential of man. The values that stimulate or suffocate this potential exhibit clear elements of objectivity suggesting to favour or reject them. On the contrary, the values not affected by those implications belong to the field of choice-­possibility, that is, they have a subjective and relative nature.6 These objective normative-­ideological elements also have useful lessons to offer for the study of Utopias, for utopian forms that clash with those objective values representing functional imperatives or ontological imperatives are inevitably degenerate phenomena, bound for failure. By contrast, those Utopias that state ontological imperatives or prophetically foretell objective values that will ripen in subsequent stages of development and stimulate their maturation are particularly fecund. An important law of social and moral development can be expressed as follows: as soon as society overcomes the condition of secular stagnation, the evolution of the general conditions of development starts to transform some ontological imperatives repressed across centuries into functional imperatives and hence pushed to be fulfilled by stringent problems of efficiency. The importance of scientific developments on values is evident for the narrowing of the area of choice (hence of conflict) on crucial, often burning ideological questions. The notions of ‘functional imperative’ and ‘ontological imperative’ allow the dialogue among civilizations to hinge on solid scientific bases, greatly facilitating the dialogue. Cultural relativism can be only referred to the realm of choice-­possibility; the associated cultural diversification is a precious source of variety and creativity that makes vivacious life without seriously

88   A. Fusari obstructing relations among peoples. Rather it stimulates reciprocal interest if clarity has been achieved on ontological and functional imperatives. A prime cause of conflict and misunderstanding in today’s world, which is global yet simultaneously rich in cultural forms, innovation and creativity, consists in the widespread failure to recognize this elementary evidence on the part of so many apostles of ethics and learned advocates of a notion of openness and tolerance incapable of telling necessity apart from choice in the organization of social systems, hence of perceiving how the two are related. The absolutist relativism, proclaiming values as faith precepts, denies in principle the objectivity of values. The doctrine of the absolute subjectiveness of ethics and values typical of ‘cultural relativism’, which pretends to belong to scientific thought, is among the most distressing of mankind’s intellectual products. As we saw, this doctrine drew strength from Weber’s inquiry into method (which postulates the parity, in principle, of the points of view from which scientific exploration begins) and from the anthropologists’ care to point out the enormous variety of forms of civilization that have existed in the world while neglecting to highlight or adequately investigate the most important facet of this question, namely what relation obtains between those forms of civilization and the relevant general conditions of development. Truth to tell, Aleksander Gerschenkron’s (1962) theory of the prerequisites for development, and their surrogates, posed this crucial theme properly. But the broad confusion between necessity and choice has weakened his teaching and prevented a rigorous definition of the notion of stage of development. Some leading social theories prefer the aspect of necessity and sometimes consider the whole reality in terms of ‘necessity’. Marxism and social Darwinism belong to this view. Some other theories show an opposite behaviour and insist on the subjectivity of phenomena and the aspect of ‘choice-­possibility’. These two opposite and unilateral attitudes are firmly rooted in social thought and characterize some recent theories that have intended to deepen the general content of the globalization process and social change. For instance, some years ago, Fukuyama pretended to foresee the convergence of the world toward liberal institutions, forgetting the clamorous failure of the Marxian analogous statement on the inevitable convergence towards communism. On the other hand, Huntington has centred his analysis of the global world on the idea of a clash of civilizations and cultural areas that resumes the Weberian view on the incompatibility of civilizations and the subjectivity of values. A more equilibrated and realistic position has been expressed by Inglehart, who sees in the data supplied by the World Values Surveys the combination of tradition and social change and the advent of new values as a result of the development process; at the same time, he underlines the survival of some old values notwithstanding the radical changes of social environment. These insights will be more extensively considered in the next section. The work of the leading social scientists is shot through with this confusion. There is the persistent, indeed worsening, inability to clearly discern the great pillars, which vary with the general conditions of development, on which social

The axiological–normative question   89 systems must rest (as well as to see ontological imperatives), and hence to see distinctly the area of choice/possibility, relating to the ‘aesthetics’, so to speak, of the social edifice. In this state of affairs, the vested interests in any given society, especially those that control intellectual output and the means of propaganda, can easily present as organizational necessities arrangements that are particularly dear to them but that are actually in the realm of choice or possibility. As far as we know, only natural law doctrine postulates the combination between being and doing since natural laws are intended as a lighthouse of doing. Unfortunately, this doctrine, on the one hand extends too much the notion of natural law thus becoming an easy object of cultural relativists and anthropologists’ criticism, while on the other it disregards history and hence a main part of social reality constructed by Man that causes the changes of general conditions of development implying the advent of some important values.

3.6  The World Values Surveys and Inglehart’s analysis Some fecund analysis on values may be based on the World Values Surveys (WVS) that have suggested to Inglehart useful considerations on development and social change. The World Values Surveys cover 75 per cent of the world’s population and 65 per cent of societies. They consider some most meaningful values: those expressing the people’s attitude toward modernization, religion freedom, tradition, participation, etc. Inglehart defines some broad categories of the WVS values distinguishing, in particular: a) self-­expression values (individual autonomy, tolerance, trust, participation) and their opposite, i.e. survival values; and b) traditional values and their opposite, i.e. secular-­rational values. Inglehart investigates the behaviour of these values across nations, cultural zones and in the course of the modernization process; the polarization of traditional values toward secular-­rational values; and survival values toward self-­expression values. But he does not consider the question of objectivity or subjectivity of values, even if the data he uses have some clear implications on the matter: the categories of materialist and postmaterialist, modern and postmodern values show that values vary strongly with development and hence have objective roots. It seems that a more penetrating use of the Surveys’ data needs an explicit consideration of the organizational view and of the question of objective or subjective character of values. In this regard, the following distinction should improve the severity of analyses and the data utilization and interpretation: a b c d

Values essential to make development possible. Values consistent with the existing general conditions of development and hence indispensable to avoid going back with respect to them. Values stimulated by the impact of development on people’s preferences. Traditional values, mainly religious beliefs and choices of civilization.

90   A. Fusari The accurate combination between modernization and tradition, the coherence among values, the stimulation of social change, seems to require the above value distinction and an organizational view in social thought. A plain justification of this distinction can be found in Chapter 1, sections 1.4 and 1.5, that present our methodological proposals. A main implication of the distinction is the shift of the analysis of values from the observationist to the organizational view. In fact, the importance of warranting the presence of values sub a and b and testing their possible combinations with values sub c and d, after removal of those that contrast the objective values expressed by the first two classes, appears evident. This represents an obliged road for achieving the best development path in terms of steadiness and consistency with inherited traditions and civilizations, and attenuating the trauma caused by social change. Inglehart’s analysis and the associated WVS data are not far from the above distinction and problems, for instance, where the author writes: ‘economic development is linked with systematic changes in basic values’ (Inglehart and Baker 2000: 19). ‘The value systems of rich countries differ systematically from those of poor countries’ (op cit. p. 29, our emphasis). ‘Prolonged periods of prosperity tend to encourage the spread of post-­materialist values (giving higher priority to quality of life than to economic growth), economic decline tends to have the opposite effect’ (Inglehart 2000), i.e. tends to favour survival values. These statements clearly imply the distinction between sub a and b. The implication is even more evident where Inglehart writes: ‘the rise of post-­industrial society leads to a growing emphasis on self-­expression’ and ‘In preindustrial societies the family is crucial to survival . . . They emphasize social conformity rather than individualistic striving’ (Inglehart and Baker 2000:  22, 25) and ‘interpersonal trust is essential for building the social structures on which democracy depends and for creating the complex social organizations on which large scale economic enterprises are based’ (op. cit. p. 34). Inglehart’s confrontation of the Western and Muslim world provides an excellent example of the importance of our distinction. He underlines that the major difference between the two civilizations concerns the sexual habits and role of women, not the political aspect. In fact, the WVS data show that the appreciation of democracy is high almost everywhere in the world, including Muslim countries. The point is that democracy is inconsistent with some main characteristics of the Islamic world: the theocratic inclination, gender inequalities and the lack of some other self-­expression values (social tolerance, freedom of speech). Nobody would deny the essential role of personal responsibility for modernization and development and that the failure of communist rule was mainly a consequence of the refusal of some essential values and institutions. It is, therefore, evident that not all values sub c and d should be accepted; their appropriate and efficient combination with the values indispensable to development should be accurately pursued, and attention should be paid to avoid traditional values obstructing development. It is impressive to see that the major clash of civilization of the present time, that opposes the Western to the Muslim world, is nourished by the Islamic

The axiological–normative question   91 contradictory pretension to pursue development while retaining some untenable gender inequalities, institutions and habits that, in the end, prevent development and that modernization tends to erase. Japan and, more recently, some other countries of East Asia that have practised a successful combination of traditional and modern values, have been able to achieve a high rate of social change and development. But unfortunately, these represent rather isolated events.

3.7  Religions and ethics The discussion on ethics cannot ignore religions as strongly concerned in values being the ethical amelioration of Man at the heart of their action. A common trait of monotheist religions is the statement that Man has been entitled by God to dominate the natural world and hence all the other species; the Franciscan teaching on the fraternity among species represents an exception. Clearly, that statement is a faith precept, deprived of any scientific base. Rather, scientific development tends to promote the fraternity among species by improving the availability of goods and probably providing in the coming years with artificial meat, thus removing the habit of killing animals. Religions insist on the absolute character of values, a notion that completely differs from that of objectivity of values. Indeed, the teaching and attitude of religions to ethics show frequent contradictions. They have often opposed reason and today the aversion continues, sometimes in an implicit form, sometimes giving rise to an arrogant and explicit fundamentalism. Truth to tell, Western Christian religions have, for the most part, well understood the importance of conjugating faith and reason to be able to cohabit with the modern world. Unfortunately, such an attitude is afflicted by frequent contradictions. Clearly, the dialogue and conciliation between faith and reason needs a scientific treatment of values. But religions incline to intend values in the absolutist sense of faith precepts, which ignore reason. To well understand the relation between faith and reason, it is important to remember that research, discovery, and the increase in scientific knowledge need creativity beside reason, and creativity may have to do with faith. Science is rooted in the development, according to reason, of creative and fecund intuitions. Therefore, the growth of scientific knowledge is not an exclusive matter of reason. In fact, a main foundation of modern rationality, the notion of linear time, comes from Biblical teaching. Unfortunately, there exists a frequent tendency of monotheist religions to contradict the notion of linear time. Linear time, referred to social systems, is something completely different from the notion of linear time (the arrow of time) implied by thermodynamics and/or Darwinian evolutionary teaching. The evolution of social systems, being fed by human work and intelligence, is much more rapid and involving than natural evolution. It moves through historical eras distinguished by different general conditions of development. As we know, the change in those general conditions cause the ‘necessity’ of appropriate new values that can contradict old faith precepts. But religions dislike this displacement of faith precepts and

92   A. Fusari consequently the idea of objective values. In this regard, it is particularly evident the contradictory behaviour of Christianity, as it operates in the rapidly changing and strongly rationalist Western world. A scientific and objective treatment of values requires the acceptance of the variation of objective values across historical ages. The refusal of this kind of scientific objectivity, to flow back in an absolutist notion of values and ethical precepts, contradicts Biblical teaching on linear time. Sometimes theological teaching tries to syntonize itself with social thought by calling for help with the theory of diffuse rationality that allows the emphasis of the foundation of important religious values on a long-­lasting development and selection across centuries. But, as we know, the principle of diffuse rationality is not a scientific one. In the thirteenth century, the Italian monk Gioacchino da Fiore deducted from the Bible the notion of historical ages. He spoke of three ages parallel to the Father, the Son and the Holy Spirit and characterized by very different ethical feelings. This represented the first theory of historical ages and has been largely replicated by subsequent students. Such Biblical development implies the variation over time of objective values. But religions tend to prefer an absolute notion of time underlining that time is of God, not of Man. Well, God is the Lord of time; but time has to do with Man and it is the use of Man’s intelligence that creates substantial novelties. Believers cannot deny that human reason is the work of God and that its unfolding reflects divine will. It seems, therefore, unacceptable and a mystification to pretend that dogma repugnant to reason are in accordance with (or dictated by) God’s will. To eliminate such an ambiguity and reconcile faith with reason, the scientific analysis of values is indispensible.

3.8  Economic values and ethics It is a common error in economics to confuse exchange value with ethical values. This confusion dates back to the medieval canonists. It was reproposed with some ambiguity by classical economists, was fully developed by Marxian thought, and has also affected mainstream economics in a different way. This obliges us to dedicate some further examination, in this chapter, to exchange value considered in the light of ethics. The question of exchange value We owe the first systematic treatment of the value of goods to the eighteenth-­ century thinker Ferdinando Galiani, who tied value to the utility and the scarcity of the good. But in proceeding further with his analysis he changed approach and identified value with the ‘effort’ that goods cost. ‘Effort’ was then explicitly defined as the quantity and quality of the labour contained in any given good. Adam Smith’s approach to value is more eclectic than Galiani’s but no less rigorous. Smith uses the entire range of interpretations, bringing together all the elements that would illuminate the subsequent debate. First of all, he insists on

The axiological–normative question   93 the concept that value is equal to labour. Distinguishing labour contained from labour ordered, amidst countless contradictions he explains exchange value with the concept of ‘natural price’. He associates the notion of natural price both with ‘net product’ and with the opposite notion of ‘value as the sum of the productive contribution of the single factors’. Finally, he also takes some steps in the direction of utilitarian value theory: that is, he asserts that value corresponds to the ‘disutility’ of the effort needed to procure useful things and offers a careful ana­ lysis of the concept of ‘use value’. The classical, Marxian analysis of labour is much less dispersive than Smith’s account, but it also lacks an unequivocal position. Indeed, it sets out two distinct theories: a) the classical, ideological labour theory of value; and b) the theory of natural prices (or, in Marxian terminology, production prices), a more empirical and scientific theory. This theoretical dualism emerges clearly in David Ricardo, especially in his efforts to find an invariable measure of value. To be sure, Marx believed (though we cannot say how firmly) that he had overcome dualism. Specifically, he believed he had demonstrated, with the method of the transformation of value into price, that production prices are nothing but a ‘different’ form of labour-­ value. This theme has been the occasion for one of the most captious and pseudoscientific debates in the history of economic thought. The other great branch of economic theory, i.e. the neoclassical, marginalist school, resumed and systematically developed Galiani’s original insight that value was an expression of a good’s utility and scarcity. The utilitarian approach was basically completed with the ‘theory of imputation’ developed by Friedrich von Wieser, which explains the price of capital goods as a reflection of the price of consumer goods. Based on this intuition it can be argued that it is consumers’ choices (or in other words their utility functions, combined with the disposable income constraint) that determine consumer prices and, as a consequence, the price of the capital goods needed to activate production (whose final purpose, in this view, is to satisfy consumer necessities expressed as above). Subsequent work along these lines, which was directed mainly to eliminate the psychological degeneration of marginalist theory, was important but only secondary. What was fundamental (and qualitatively new) was the contribution of Léon Walras, who while remaining within the marginalist theoretical apparatus had the great merit of placing it within a general interdependence framework. In this way Walras explained a fact of the greatest importance, namely that prices and volumes are inextricably bound together. To see this contribution in the proper light, we must recall that one of the greatest shortcomings of the classical approach was precisely the assumption that quantity does not determine natural prices but only fluctuations around them (market prices). Both these theoretical schools made invaluable contributions to the analysis of value: classical Marxian through the elaboration of the concept of natural (or production) price; neoclassical marginalism through the stress on the link between value and quantity. Subsequent analysis tended to neglect these important premises in favour of the ideological components of the two rival theories –

94   A. Fusari the irreconcilable postulates that value was equal to labour (for the former) or to the productive contribution of the single factors (for the latter). In this way, an act of faith came to prevail over scientific criteria. The gap between the two schools became unbridgeable, and the work of even eminent economists was divided by an absolute incommunicability. In the early twentieth century, with the pioneering work of Dmitrieff and Bortkiewicz, there began a rich, innovative critical revision of the theory of value.7 This process hinged on multisector models of reproduction, and its main result was the revaluation of the classical concept of production price (or natural price). This turning-­point in the value debate came long after the work of Dmitrieff and Bortkiewicz, however. It did not really come until the 1950s, when Francis Seton’s seminal essay (1957) examined the problem of transformation along the lines traced out by Bortkiewicz and clarified its content in practically definitive fashion. With the publication in 1960 of Piero Sraffa’s Production of Commodities by Means of Commodities and thanks to the analyses of the Sraffian school, the value debate had attained a new, higher level. It was demonstrated that the classical labour theory of value met with insuperable contradictions in the heterogeneousness of labour itself and in joint production, not to mention the impossibility of solving the problem of transformation. I believe that another fundamental contradiction in the labour theory of value emerges from an analysis of the Marxian notion of the value of labour-­power. And as this point has not yet been adequately developed on the theoretical plane, it is worth at least a brief treatment here. It suffices to note that the neoclassical approach, as expressed in the general equilibrium theory of Walras and Arrow-­ Debreu, is based on decidedly abstract hypotheses, such as perfect competition and perfect knowledge of the future, the absence of returns to scale, the maximizing behaviour of entrepreneurs and consumers, the impersonality of market relations, and more. At the same time, the explanatory power of neoclassical aggregate production functions is undermined by the existence of circular relations between the value of capital and the rate of profit (reswitch of techniques). As for the neo-­Ricardian framework, its worst weakness is the strict distinction of prices (and income distribution) from quantities. In Chapter 5 there is a more thorough-­going critique of the neo-­Ricardian and neoclassical analyses, with some references to the approaches of optimization and the duality between value and level of production. Exchange value and value judgements. The problem of exploitation The logical tool that enabled Marx to consider the problem of profit in the framework of the labour theory of value is the notion of the value of labour-­power. Specifically, this notion enabled Marx to argue that the origin, or the existence, of profit not only was not in contradiction with the labour theory of value but was actually the product of the consistent working of its laws and could not be

The axiological–normative question   95 adequately explained save by its rigorous formulation. In short, in permitted him to define profit as (transformed) ‘surplus value’. To verify the plausibility of this approach, we must ask whether it is possible to define the notion of the value of labour-­power non-­ambiguously. Obviously, there are two possible definitions: 1

2

The value of labour-­power is given by the value of the means of subsistence (biological) necessary to the worker.8 So understood, the concept appears to be defined clearly and precisely enough, i.e. unequivocally. Unfortunately, though, this definition of labour-­power clashes with reality. For it has to be acknowledged that the compensation of labour, historically, is more than the subsistence minimum so defined. Hence, if we accept that definition, we are forced to conclude that wages as historically given are not determined by the value of labour-­power: that is, that labour-­power itself is not subject to the labour theory of value, which is therefore incapable of explaining profit – the key category for the capitalist mode of production. The value of labour-­power is the value of the subsistence of workers, but this time as historically determined (as Marx takes it). In this case the notion is susceptible of two alternative specifications: a the value of labour-­power (so defined) is taken as variable (historically) but according to definite, predetermined parameters; b the value of labour-­power is taken, more realistically, as a historical variable independent of any preset determination.

The first notion of the value of labour-­power (a) has the advantage of appearing as unequivocally determined. But unfortunately it is subject to the same objection as under point (1): these parameters cannot be arbitrary, and there is no assurance that their value will determine the actual trend of wages. The second specification (b) avoids this difficulty, but only on condition of making the value of labour-­power identical with everything that the worker actually receives in compensation for his labour. Such a notion of the value of labour-­ power, however, is indeterminate. Only an inquiry into and a specification of the causes for workers getting that amount can enable us to escape from indeterminacy. In short, it is clear that the claim to explain the origin of profit by reference to the value of labour-­power so defined is pure nominalism. More specifically, in the case of specification (b) the distribution of income is indeed apparently explained by (or, more accurately, is framed within) the labour theory of value – not however, by virtue of any objective quality of the theory that makes this happy coincidence possible, but only by virtue of a definition of labour-­power that in order to be specified itself requires a specific, presupposed theory of distribution. Actually, if the notion of the value of labour-­power can be salvaged (at least formally), it is essential that the two principles underlying the Marxian theory of income distribution be valid and strongly operational. These are the principle that the ratio of capital to output is rising over time (at sufficiently high rates)

96   A. Fusari and the principle of the reserve army of the unemployed. For in this case, real wages will be relatively invariable; they will be held permanently very low, quite near the cost of reproduction of labour-­power.9 It follows that Marx’s rebuttal of Samuel Bailey’s objection to Ricardo that it was impossible to define the concept of the value of labour consistent with the labour theory of value is actually only a pseudo response. It maintains a certain consistency on the formal plane only in the case in which wages stagnate at the level of biological subsistence or, to be more flexible, only if they vary extremely slowly over time – in such a way, that is, that the concept of subsistence itself is meaningful as the expression of the habitual standard of living of the working class of a given era. When, however, it happens that entrepreneurs (or some of them) promote increases in workers’ income (whatever the manipulations in the attendant demand for consumer goods), as happens in the affluent economy; and when, moreover, collective bargaining succeeds in winning steady increases in real wages attendant to the rapid increase in productivity typical of the industrial economies, then it is clear that the definition of wages as the value of labour-­ power becomes untenable. So we can conclude that in the framework of Marxian thought the labour theory of value and the related notion of the value of labour-­power have a certain formal consistency only thanks to Marx’s peculiar theory of income distribution, and in particular to the unrealistic principle that the capital/output ratio not only rises over time but also (though Marx did not say so expressly) rises sufficiently rapidly. The least we can say, therefore, is that the Marxian theories of value and of income distribution are two separate things, and that the former can be salvaged only if the latter is accepted inflexibly and indeed in reinforced form (specifying that the rate of increase in the capital/output ratio must be sufficiently rapid). Thus the theory of distribution becomes the true premise to Marx’s analysis of profit. The identification of exchange value with price might seem to express a predilection to identify being with doing – that is, an acceptance or endorsement of reality as it is and a conscious rejection of any and all norms for judging it. But this impression is totally unfounded. We are convinced that doing should constitute the predominant motivation of the social researcher, but one must be careful not to identify this, hastily, with some norm that implies an a priori concept of exchange value. Its roots must be sought elsewhere. Unfortunately, there has always been a powerful tendency to ascribe to the notion of exchange value a kind of absolute, quasi-­theological content. The concept has accordingly been confused with the problem of value judgements. As regards the capitalist economies, the economic notion of value has to be clearly distinguished from so-­called ‘value premises’. Above all, this notion cannot ignore the fact that exchange value is a ‘result’ that derives from a complex of ‘circumstances’: technology, levels of output, composition of demand, forms of market, conditions of distribution, institutional arrangements, and so forth. Now, value premises can refer to these circumstances (especially the last four, which count so heavily in social terms). On the basis of these

The axiological–normative question   97 premises one can make judgements on the presence or absence of injustice or exploitation, the efficiency of the institutional system for the promotion of growth and welfare, etc. Ipso facto this implies a collateral judgement on exchange values as an expression of the particular configuration of these circumstances. But it would be a mistake to presume that we can define, once and for all, a sort of optimal, desirable configuration of the circumstances and thence derive the system of exchange values. For the best state of these circumstances varies with the conditions of development, civilization, and so on. More generally, it is ‘relative’ to the historical era and cannot even be ‘thought’ except in reference to that era. It is worth recalling that the economic values typical of a centralized system derive also, in part, from a previous formulation of value judgements, expressed via an objective function. But we must not forget that the objective function, in addition to having only a partial effect on the configuration of accounting prices, also varies with time and situation. The notion of exchange value per se does not permit the definition of exploitation, much less the measurement of its intensity. This may cause dissatisfaction, but this is unmotivated. We can speak of exploitation only if there is a relationship of ‘domination’ (of the exploiters over the exploited). If social relations are not characterized by domination, there may still be forms of injustice, but we cannot speak of exploitation except in the weakest form. The concept of exploitation is fundamentally qualitative. However, I do not mean to assert, by this, that it has no economic content. On the contrary, it is undeniable that exploitation occurs in large part precisely in the sphere of economic relations. I only want to say that the concept escapes precise criteria of quantification: not only because of its extra-­economic content but also because even the economic part of exploitation cannot be precisely measured. Only if the mass of those subject to domination earned merely strict subsistence wages would it be possible to define the measure of overall economic exploitation.10 This measure would be quite nearly given by the difference between total output and that part of it that is given to the mass of the exploited. Yet it would still not be possible to define the level of (economic) exploitation of individuals, which would require knowledge of a norm for assigning the surplus-­ value to the individual members of society corresponding to a situation in which there is no exploitation. But such a rule cannot exist as an objective, absolute fact. For example, within a participatory society in which the notion of exploitation would be impossible to grasp, the assignment of the surplus to individual citizens would vary with the associative structures agreed on in any given period. If the mass of the subject population receives more than the subsistence minimum, however, then it is not possible even to calculate the overall amount of economic exploitation. On this hypothesis, in fact, the level of consumption and the habitual living standards of the subject population are not an objective datum but are affected by the decisions of the dominant group (which may largely determine, for instance, the characteristics of the consumer goods produced). Thus this level of consumption already comprises forms of exploitation,

98   A. Fusari which is impossible to isolate and quantify precisely. In these conditions (which constitute the normal case) the qualitative nature of the concept of exploitation emerges in all its clarity. Nevertheless, something more than would appear to follow from the foregoing can be said on the theme of the overall – aggregate – amount or measure of economic exploitation. For it can be argued that this type of exploitation comprises all the distributive components that do not derive from a specific contribution to production on the part of the class that enjoys those components: interest, rents, the proceeds of non-­Schumpeterian monopoly. The fact is that the notion of exploitation will not tolerate facile, schematic exposition. But within our definition, the concept proves to be less intractable than it might seem at first glance. For if one asks (quite an embarrassing question, in fact) whether exploitation is implicit in certain sectoral, social, and geographical wage differences not reducible to productive contributions, we can answer as follows. These inequalities may exist because they are useful and necessary to the exercise of capitalist hegemony (or any other type of dominion), in which case while they cannot be termed exploitation as such (since their direct beneficiaries, let us say the privileged workers, are often not part of the dominant group), they are nevertheless an integral part of the logic of exploitation linked to the system of domination. Alternatively, the society is not organized on the principle of exploitation but of participation (which we shall not define here11). In this case by definition there can exist no exploitation but only forms of social injustice. Naturally, a society may also include transitional structures towards an indefinite future system. That is, it may be in a state of flux that is hard to judge. To avoid misunderstanding, let us note that in our present framework the explanatory power of the Marxian distinction between value and form of value is fundamentally preserved, but without falling into the ambiguity of the labour theory of value. It is expressed in our distinction between value judgements and exchange value. Both Marx and the neoclassical economists pronounce an a priori judgement on capitalism – one of condemnation without hope of appeal (once it is posited that value = labour content), given that the worker can never earn his entire product; the other an apologetic, through the definition of value as the expression of the productive contribution of the single factors. It can never be stressed too heavily that value judgements cannot be made on the basis of some absolute canon and identified with a particular concept of economic value; and in any case (for our purposes) they can only be deduced from the analysis of the modalities governing the formation of ‘exchange value’, of the relations of production underlying those modalities, of their implications for the society as a whole and for the various classes, the obstacles to the full development of productive forces, and so on.

3.9  Conclusions This chapter has intended to show the crucial importance of the axiological problem in social thought, that goes well behind the usual treatment of values,

The axiological–normative question   99 mainly in economics. This importance of the topic is both due to the fundamental impact of value-­ethical principles and choices on social reality and the existence of some misleading, and even paralysing, theoretical confusion on values. Our analysis has pointed out, in particular, the mistakes of the dominating opposition of theorists to a rational-­scientific approach on ethics that reduces the controversy on values to relativist and absolutist positions, respectively considering the question as a matter of free choice or a problem of faith. We do not deny the role of choice and faith in the field of ethics. But we underline that the most important and pervasive ethical principles can (and hence must) be scientifically explained and, in this way, objectively justified. Apparently irremediable controversies that strongly trouble the relations both among individuals and scientists as well as among peoples, would vanish if this scientific clarification takes root; as a consequence, the collaboration among different civilizations will be substantially improved, without affecting the creative role of new ethical proposals and choice. Unfortunately, some powerful interests take advantage of the dominating confusion on ethics and this helps preserve scientific chaos in the matter. The controversy on economic values has strongly contributed to make this situation more and more complicated, in particular with reference to the notion of exploitation. If we consider economics not per se but in the more general context of social thought, it appears evident that some crucial ethical values are much more than exogenous entities, as the notion of objective function states. Such a statement misses a crucial aspect of social process, since the presumption of the exogenity of objective function allows the economic process to be based on any assumption on values (cultural relativism) or on indisputable and irreconcilable faith assumptions. One aspect of this analysis consists in the linkage between the concept of the value of economic goods and the institutional features of the society; that is, this analysis absolutely rejects the possibility of universal application of the concept, holding that there is no possible meeting-­ground between the values typical of a totally centralized system (calculated with optimizing models) and those typical of a decentralized system: they are two completely different species. It seems to us that economic values can be conveniently reduced to the question of prices. In Chapters 5 and 6 we shall try to delineate a more general view on ethics, indispensable to the treatment of the organization of economic systems.

4 On time and ethics Hasse Ekstedt

Introduction At the beginning of Chapter 2 we quoted Murray on the differences between rationalistic and empiricist ways to analyse the reality with respect to their theories of logic and knowledge. On that basis we analysed the axiomatic structure of the neoclassical theory. In this chapter we will further analyse the apprehension of space and time of empiricists and rationalists. This analysis will be necessary in order to understand the respective approaches to questions regarding ethics. When rejecting the axiom of reflexivity of the neoclassical theory and introducing some sort of multidimensional rationality with the concept of epistemic cycles as a key concept, we also throw the economic analysis into a state of chaos. The remedy for such a chaos is not inventing some logical theory but a matter of the study of the generic behaviour of the individuals living in a society. History shows unfortunately that chaos modelling is not a sort of deviant thinking with respect to neither social nor economic reality. When we introduce the concept of epistemic cycles, we also theoretically introduce a formidable source of uncertainty. This uncertainty is intertemporal and, as we shall see, is in fact the basic reason for bringing in ethical considerations into the economic analysis. The fundamental reason for this uncertainty is that epistemic cycles exist on both different aggregate levels and on the same aggregate level but are partly contradictory on the same level as between levels of aggregation. However the comprehension of both time and space varies between sciences, philosophical approaches as well as between individuals, so we will devote a considerable part of this chapter to analysing some philosophical attitudes of time and space in order to achieve a viable concept of time for social sciences, a social space-­time. In the preceding chapter we discussed ethics and objective values from a social point of view. In this chapter we will analyse it with respect to their logical connotations to the concepts of time and space. Social actions are executed by subjects in time and space and that requires a precise analysis of a social time concept separate from physical time. Our considerations in the pre-

On time and ethics   101 ceding chapter also imply that an objective ethics for being and doing, thus an ethics for the social dynamics, is required. There is however also another aspect which is implicit in the rejection of the axiom of reflexivity. We claimed that this axiom was the key to the corollary of independence of irrelevant alternatives implying that commodities are independent of the context. This corollary is in fact also a central key to the existence of a measure. In the neoclassical theory the universal measure is prices and exists only in general equilibrium. The price vector is out of the control of the agents and we showed that either a central agency or the so-­called invisible hand controls it. This is also the reason why ethical questions are seemingly superfluous in the neoclassical theory; the agents passively adapt to a price vector since they, according to Debreu, are defined as n-­dimensional rigid bodies by a vector of initial endowments and a preference order. Thus the agents are represented by vectors in the commodity space. There is no connection between the agents except the passive acceptance of the price vector. When we reject the axiom of reflexivity and furthermore introduce the concept of epistemic cycles we do not only destroy the measure but, as we will show in this chapter, we also even question the existence of a space-­time topology, and since any kind of measure requires a topology of the relevant space, this is indeed devastating. Thus if we reject the axiom of reflexivity we lose the possibility of using prices both regarding intertemporal measurements and aggregate welfare measures, which is fatal for example in measuring economic growth. Finally the effect of rejecting the axiom of reflexivity and the introduction of epistemic cycles is necessary if we introduce Homo Rationalis as a subject. If we look back at Figure 2.5 in Chapter 2 we realize that any two individuals will be different with respect to epistemic cycles. This implies that we logically must regard a subject as a final cause, which implies that any deterministic analysis of the subject is impossible. The actions of the subjects may be inert with respect to an inert environment but a change of one agent’s purposes or perception of the environment destroys the whole analysis. As we claimed in Chapter 2; the true form of uncertainty is the agents themselves. Thus rejecting the axiomatic structure of the neoclassical theory destroys the reversibility of the theory and thus the logical necessity of the revealed preference hypothesis. These three aspects are the very basis for introducing ethics as a scientific concept in economic theory. Ethics is by many people – and scientists – regarded as something of a lesser scientific matter or even of a metaphysical character. We quoted, at the beginning of Chapter 2, Richard Tresch and his discussion of ethical rankings agreed among the citizens that neither the market process nor the majority voting rules can do without these rankings, which violates the individual’s independence. If you think about the striving in economics for individualism it is a bit curious as the assumptions of the neoclassical theory do not create an individualistic person, but a non-­individualistic automaton. Individualism does not exclude social adaptation. But if individuals are going to adapt to a community some

102   H. Ekstedt kind of ethics is vital. Thus ethics is indeed a scientific concept which must be analysed logically. Of course we can derive an ethics out of metaphysic beliefs but essentially ethics is to be seen as a more or less formalized institution. Ethical principles give rise to dynamic patterns and are indeed as open to logical analysis as any other set of abstract rules or axiomatic structure. Dismissal of ethical analysis in social analysis is in itself a metaphysical consideration. Our analysis in Chapter 2 also implies that we must accept the individual as a kind of ultimate source of action. Thus accepting the existence of contradicting epistemic cycles among individuals in a society induces us to realize that the aggregate action is only possible if individuals deliberately concede to, or are forced to, accept solutions at variance with their own goals and even at variance with their own understanding of the society. This is the very basis for Arrow’s paradox and why the ugly analysis pops up in the lovely neoclassical world based on mutual understanding and exchange and where the individuals never have to confront their epistemic cycles and goals since there is just one big happy epistemic cycle. So in Chapter 2 we, by rejecting the axiomatic structure of the neoclassical theory, threw it into chaos in an analytical sense, chaos with respect to the rejected axiomatic structure, but it does not imply anything particular with respect to the social reality. In fact the neoclassical structure reduces humans to automata, to separate atoms, or Islands, as John Donne expresses it in his famous poem. The neoclassical analysis aggregated into an analysis of the society is an ‘a-­social’ theory not to say ‘anti-­social’. Luigi Amoroso (1938: 5–6, 6–7) in his famous overview of the work of Vilfredo Pareto calls attention to the asocial features of the Paretian theory. In general the meaning of obstacles is that economic goods are limited; until violence and fraud, theft and donation are excluded, a thing cannot be had except by giving in exchange for it one of equal value pro tempore; that every product is the result of a certain combination of the factors of production in harmony with the laws of techniques, as they are known pro tempore; that legal order and the economic organization fetter individual actions; and so on. . . . It is at this point that the crux of Pareto’s system becomes apparent. The internal forces of the economic system are not susceptible of a theoretical representation as simple, elegant, and universal as is the case for the applied forces. They are not only, as for the material macrocosmic systems, forces of conservation, by which – to express it elegantly – the dead city dominates through inertia the living city; they are also directed forces or forces of impulsion, through which the living city forms or attempts to form the city of the future. The internal forces, therefore, are History, they are even Ethics and Politics, something powerful, but vague and indistinct, which is not susceptible of mathematical representation; an expression of the freedom of the will, which does not allow itself to be enclosed in the meshes of a mechanical representation, and, because it is mechanical, determinist.

On time and ethics   103 As we mentioned in Chapter 2 we can see a behaviour similar to the axiomatic structure of the neoclassical theory as a sort of animal behaviour after contextual judgements are done. Thus in an inert society the neoclassical axioms applied on microeconomic behaviour may well be a reasonable approximation and there is seemingly no call for an explicit ethics. However in a changing society some kind of ethics is indispensable for not throwing the society into chaos. Thus ethics is basically an intertemporal concept giving some kind of stability to a dynamic process and also forming basis for norms for intertemporal measurements. If so – we have a basis for some kind of topology and thus there might be some kind of intertemporal measure. Such measures must then have their roots somehow in the explicit ethics. We must create an abstract social space with a topology, and the time concept we need to consider is first of all with respect to the physical space and second with respect to human subjects. We will discuss the specific features of the social space-­time. However, having said this we must realize that, as the axiomatic structure of the neoclassical theory fails both in intertemporal and aggregate settings, an objective ethics for a free society is equally problematic with respect to these aspects. Thus we must relate the ethics both to the individual as well as the aggregate levels and furthermore it must hold intertemporally. Since we also have introduced the possibility of contradictive epistemic cycles the objective ethics must include this possibility. Thus we have to look at norms also from a measurement point of view but that requires some sort of stability of the relevant space-­time, which is the basis also of ethical systems in general. Rationalism, according to the quote from Murray, is linked to idealism and claims the uniqueness of ethical rules, but also empiricists may express a need for objective values. What is then the difference? As we will see in this chapter it is the basic apprehension of the world, particularly with respect to space and time. The approaches to these questions are in fact the basic difference between the rationalists and the empiricists. The classical proponent for the rationalist and idealist thinking is of course Plato, but today his late-­eighteenth century descendent Immanuel Kant who to a great extent was affected by the Newtonian system, is probably the most influential representative of the rationalist thinking. The opposite view must then be built on the idea that humans are subjects and thus the ultimate cause for their interference with both each other and nature. This analysis requires quite different analytical questions and presents a formidable difficulty in finding appropriate measures to use for social ana­ lysis. However at the same time we must never forget that social theories must sooner or later come to the analysis of actions not of ideals. The concept of epistemic cycles introduced earlier is of utmost value to this discussion and helps us to understand both the social space-­time and the difficulties of aggregation.

104   H. Ekstedt

4.1  Physical and social space-­time In economics Paul Samuelson was early to discuss different time concepts in his Foundations of Economic Analysis (1947) but these were more attached to modelling reality than to the reality itself, although the different concepts at least implicitly relate to different time apprehensions of the reality. Samuelson introduces two types of time concepts regarding modelling Logical Time and Historical Time. Logical time implies that the physical space can be seen as a set of ordinary differential equations which start from given initial conditions and develop according to the conditions specified at the start of the trajectory. In economics a Solowian growth function, with a simple assumption of exogenous technological growth, looks however like a logical time model. Historical time implies that the development over time is dependent on the initial conditions but also dependent on the respective conditions in each period through which the trajectory passes. We will come back to the growth problems in Chapters 5 and 6, suffice to say here that the Samuelson’s distinction of different time concepts is more attached to modelling reality than to the apprehension of reality, if we allude to the discussion of Wittgenstein illustrated in Chapter 2 at Figure 2.1. However, as we understand, Samuelson is open-­minded with respect to modelling and the historical time models give certainly the possibility of an ad hoc modelling which may contain any kind of comprehension of space-­time. Mathematical models do not need to be attached to Newtonian time but may be completed with other types of assumptions contradicting the Newtonian time concept. Thus mathematically it is, in principle, possible to handle any type of apprehension of time and space by introducing new axiomatic structures. When we speak about space and time in the physical world we usually think of a Newtonian time concept where time is an independent dimension, separated from space. Such a time concept has certain consequences for the analysis of space and the perhaps most systematic philosophy analysing space and time according to Newtonian time is the one by Immanuel Kant (1933). His inquiries in Kritik der Reinen Vernunft (Critique of Pure Reason) in which he also derives his famous ethical imperative have had a vast importance, boosted by philosophers like Heidegger and Derrida for European and American thinking. Kant’s philosophy in general and the space-­time apprehension in particular gives form to an absolute ethics. Almost contrary to the Newtonian time concept is the Einstein/Minkowski approach, although it can be questioned if this approach really gives rise to a proper time concept. Time is here just a consequence of the relative speed of movements in the space, thus time is completely dependent on the relative movements of different spaces. Explicitly there has not been developed an ethics based on this space-­time concept although one may suspect that many value-­ relativistic proposals are at least implicitly supported by referring to such an approach.

On time and ethics   105 Indeed the Einstein/Minkowski’s space-­time approach has given rise to a quite different type of mathematics, tensor-­space. This type of analysis deals with transformation of spaces of the same dimensionality. In this approach the relative speed becomes fundamental. We could illustrate two states as in Figure 4.1. An interesting thing about this approach is that it bears some resemblance to Debreu’s commodity specification with respect to different epistemic cycles. Let the two spaces A and B in Figure 4.2 represent two context spaces and thus the commodity will be transformed in its characteristics with respect to the context. We will not press this resemblance too hard but in principle we may think of a given commodity space as moulded in different contexts or epistemic cycles. Subjects Introducing a subject into the physical space requires some considerations with respect to a social space-­time concept. Being subjects implies that humans are to be regarded as locally and temporally fundamental causes. Humans have the ability to start causal chains by their actions, which may have both expected and unexpected effects on the physical environment as well as on other individuals or collectives of individuals. Such actions are based on individually or collectively perceived epistemological cycles. The introduction of the concept of epistemic cycles causes severe analytical problems in social analysis and requires a link between the subjects of another kind than through an anonymous invisible hand. To be meaningful the neoclassical theory requires, as we have seen in Chapter 2, that no epistemic cycles are in contradiction with other epistemic cycles. Thus, if this assumption is regarded as empirically false, then according to Russell’s paradox the universal class of rational models will not be a rational model and from this follows that any aggregate of epistemic cycles will contain contradictory epistemic cycles. Whether or not this will make aggregate decisions impossible is dependent on other kinds of individual actions than those available for Homo Œconomicus.

Space A

Space B

Figure 4.1  Transformation of spaces at different speeds.

106   H. Ekstedt Thus, from a mathematical/logical point of view, we will have a problem even to apply a topology to the social space-­time, which means, to construct a space where we can apply consistent measures. The rejection of the reflexivity axiom and the introduction of epistemic cycles causes that the commodity space will not be a measurable space in the neoclassical meaning. As shown in Chapter 2, the reversibility of general equilibrium implies that we may aggregate the economy either with regard to individual commodities and their respective prices or by aggregating the optimal commodity baskets of each agent. This is possible since the agents are represented just by a preference order and an endowment vector. Thus we must find other ways to aggregate an economy and find other measures, which must however be solely depending on the acting subjects. Reason/logics/rationality as the sole and global determinant of individual action is destroyed. We quoted David Hume in Chapter 2 on reason and passion and his claim that passion is the principal determinant and reason is the mean. Passion must then be interpreted as defining and ranking purposes as well as revising them according to a specific context. Passion, in Hume’s meaning, is always outside the epistemic cycle in question, which is one of the fundamental reasons why epistemic cycles belong to proper classes with respect to Russell’s paradox. A failure to close the cycle, often caused by reactions by other subjects leads to revisions of both ends and means and also sometimes of the apprehensions of the context, which is the basis for a learning process. The study of subjects with which social sciences are dealing implies that focus is set on the investigations of generic structures in individual behaviour as well as in the social dynamics of human societies. In this respect social sciences do not differ from natural sciences. However a fundamental difference between social sciences and natural sciences is that in natural sciences the researcher is not a part of the research field which is the case in social sciences. Technically this means that social sciences are running into the formidable logical problem, expressed by Gödel’s paradox, which implies that it is impossible from within an axiomatic system to tell anything about the consistency of the system itself.1 Thus the fate of humans is to judge themselves. Since humans define their different societies and their functioning, differences in scientific norms cannot be settled through empirical observations in a logically acceptable way. In natural sciences the ability to describe a causal structure normally implies a good forecasting ability at least with respect to experimental activities. This is not the case in social affairs. Alluding to Norbert Wiener we may say that the natural scientist is up against an honourable antagonist while this is not the case for the social scientist. In natural sciences the basic procedure is to observe and then to use induction to set up a theory which, in most cases, can be experimentally tested. The social scientist may do the same but is then stuck in social, cultural and ethical filters together with the eminent ability (conscious or non-­conscious) of humans to adapt to the contextual structure, which jumbles the whole effort. Economics, although technically advanced, is the victim of the same difficulties as other

On time and ethics   107 social sciences. Physics is a science where the researcher studies objects under the presumption that the objects do not change their appearance in a conscious way. Thus we may induce changes, shocks, to the physical environment but we can in principle foresee the consequences, save for intricate complexities exhausting computational skills. In social sciences, however, it is not only a fact that the research subject(s) may adapt to the research process and react to new knowledge but also that the attitude of the researcher, as a subject, causes scientific uncertainty caused by ideological, psychological and social idiosyncrasies. Forecasting individual behaviour is limited to quite a small range of well-­ specified situations and even then, there might be poor results. The same is applicable to aggregates of individuals, and to some extent aggregates are more inert than individuals due to social norms and habits, even if distributions of opinions are somewhat unstable at least during certain periods.2 One of the fundamental problems comparing physics and social sciences is that in physics we may use standard clocks and more than that, through the propositions by Einstein/Minkowski, we have methods of transforming spatial appearance according to different speeds of spatial objects. The physical objects can be related to the clocks by means outside the objects. In social science we may use the same kind of clocks used in physics but the relations and the dynamics of the subjects are to a large extent due to the internal agendas of the subjects. William Unruh (1995: 24) expresses this excellently: It is precisely this conflict between a mutable notion of time and the absolute and unitary notion of time inherited from Newton that has caused consternation and confusion. This confusion came about not because of any innate violation of the sense of time that we are born with. Time for children is flexible and changeable, and certainly need not to be the same here as it is there. Throughout our early years we were taught the lessons of Newton. Time was something out there, something that our watches measured, and something that really was the same everywhere. We learnt while very young that our excuse to the teacher that our time was different from the teacher’s time was not acceptable. Moreover when research includes subjects, the causality structure is to a large extent hidden and possibly also unstable. This is not only the case when we study individuals but also when we study society. In a society there are formal and informal institutional relations but there are also subgroups more or less consciously distorting the causality of institutional relations on a more aggregate level which in its turn may cause increasing uncertainty among the individuals of the society thus causing increased instability. Thus in social sciences causal pro­ cesses are created by nature, formal institutions, informal institutions and cultural imperatives, individual goals and desires, individual idiosyncrasies and so on. Thus the neoclassical theory is an example of a social theory seemingly built on the same pillars as natural sciences but from an empirical point of view it reduces to a mathematical/logical discourse. Based on observed behaviour of

108   H. Ekstedt basic economic exchange an axiomatic structure has been developed such that it is possible to derive propositions possible to transform into empirically testable hypotheses of individual behaviour. But this testing always take place from a specific scientific epistemic cycle, similar to a Newtonian equilibrium system. The axiomatic structure allows us, given a prevailing equilibrium, a simple additive aggregation of individual economic behaviour into aggregate behaviour of the society which makes it possible to form simple normative rules for the aggregate economy. However, while the empirical evidence on a microeconomic level seems to, at least partially, support the theory, the empirical results on the macroeconomic level are poor. Our earlier analysis of Arrow’s paradox showed that these problems of founding macroeconomic reasoning on microeconomic evidence is in fact a sign of the inconsistency of the definition of the agents in the paradox. The two types of agent, Homo Œconomicus and Homo Politicus, representing two kinds of epistemic cycles and partly contradicting each other, are nevertheless still accepted by many economists when using the theory for normative analysis in welfare economics and also for rather general questions concerning the realm of politics.

4.2  The conception of time and space and ethics We claimed in Chapter 2 that the neoclassical theory lacked any form of time concept and also that the only form of space concept is the commodity space. The introduction of epistemic cycles therefore requires a precise conception of time and space which ideally may allow the use of some kind of measure of variables regarded as central to the development of the society. We have mentioned the two extremes of space-­time approaches, Kant/ Newton/Laplace on one side and Einstein/Minkowski on the other. It is instructive to analyse these two extremes to see their precise effects on social analysis in general and ethics in particular. Equilibrium and ethics Although the Kantian approach is based both on Newton and Laplace, Kant developed a powerful philosophy based on the time concept underlying Newton and the determinism advocated by Laplace, but Kant developed a philosophy for the conduct of the individual as well as for the society based on this very precise apprehension of space and time. Much of this philosophy is still viable so therefore we choose Kant as our representative of a space-­time conception of a deterministic Platonic character. There are strong links between neoclassical thinking and Kantian philosophy, which are mostly implicit, but actually become almost explicit in the neoclassical theory with respect to its ethical consequences. This might seem a bit curious since it is often claimed that market theory lacks any form of ethics. So when we deal with dynamic development it is rather easy to understand the need of ethics

On time and ethics   109 and social rules for the purpose of preservation of stability and also for a security reason. But the definition by Debreu (1982) of an agent,(i; ei), a preference relation and a vector of endowment of the ith agent, is seemingly difficult to interpret in ethical terms. However if look at the quotation from Amoroso in the introduction to this chapter we may ask how people keep to themselves during the exchange process and there are no signs of cheating or even persuasive tendencies: the agents seems to be atoms totally independent and even unaware of each other. We may then ask if there is such an ethics with which the agents would comply and which is in compliance with general equilibrium, which is equivalent to a Nash-­equilibrium. In fact there is: a Nash-­equilibrium can be reformulated as such; the economy will be in a state of general equilibrium when all agents maximize their welfare function given their respective budgets and the welfare functions of all other agents. Thus there must not be any contradictions between the different welfare functions and if there are any restrictions on the commodity space or with respect to state variables all agents must stick to these restrictions. Such a formulation seems in fact to be very close to the Kantian imperative: always act in such a way that your actions can be a common law. In fact the introduction of such an ethical rule, more or less, is a prerequisite for the invisible hand to work by excluding unpleasant ways of persuading fellow market agents. In Chapter 2 when we discussed Arrow’s paradox we also noted that the axiom of Citizen Sovereignty can be interpreted as the Kantian imperative. From such a point of view the neoclassical theory is extremely idealistic and as we saw in Chapter 2 it also fits well into a Marxian setting, save for the invisible hand which has to be replaced by a more resolute central authority. But it is also another issue which is causing formidable trouble in economic theory and that is the total lack of dynamic processes. It is important to realize that if we introduce another time concept this will by necessity affect the implicit ethics. Kant on time and ethics To Kant, time is a dimension independent from space, a concept a priori and a single independent dimension on which subjectively apparent, to our senses, changes in space are attached and ordered. We do not experience time as such but through the order of succession and simultaneity of sensations. Thus the flow of time is not a part of the actions but only a sort of measure for ordering physical sensations in the perceived space. Time is for example not related to a causality concept à la Hume which is asymmetric with respect to time and there is furthermore no clear link between sensations of events and the actual events which have a spatial representation. Thus time is just attached to the sensually apparent world. Time is not an empirical concept that has been derived from any experience. For neither coexistence nor succession would ever come within our perception, if the representation of time were not presupposed as underlying them

110   H. Ekstedt à priori. Only under the presupposition of time can we represent to ourselves a number of things as existing at one and the same time (simultaneously) or in different times (successively). (Kant 1933: 74) Kant separates the perception of the spatial events from any bearing of temporal information, which is in line with his attitude towards space. Time is nothing but the form of inner sense, that is, of the intuition of ourselves and of our inner state. It cannot be a determination of outer appearances; it has to do neither with shape or position, but with the relation of representations in our inner state. (op. cit. p. 77) Thus the time dimension is intrinsic to Man and has nothing to do with the objective spatial world. Appearances to our senses of spatial phenomena are ordered through the time ‘filter’. What we are maintaining is, therefore, the empirical reality of time, that is, its objective validity in respect to all objects which allow of ever being given to our senses. And since our intuition is always  sensible, no object can ever be given to us in experience which does not conform to the condition of time. On the other hand, we deny to time all claim to absolute reality; that is to say, we deny that it belongs to things absolutely, as their condition or property, independent of any reference to the form of our sen­ sible intuition; properties that belong to things in themselves can never be given to us through the senses. (op. cit. p. 78) As the quotation shows there is an absolute independence between space and time and objects represented in space in their a priori meaning has no temporal representation and the temporal dimension concerns only our perceptions of the physical (objective) world. This is interesting since it opens up for the axiom of reflexivity and the subsequent corollary of independence of irrelevant alternatives. A consequence of his distinction between a priori knowledge and sensations, Kant simply dismisses the space we experience by our senses as just a representation of our sensibility. . . . a rose, is being treated by the empirical understanding as a thing in itself, which, nevertheless, in respect of its colour, can appear differently to every observer. The transcendental concept of appearances in space, on the other hand, is a critical reminder that nothing intuited in space is a thing, in itself, that space is not a form inhering in things in themselves as their intrinsic property, that objects in themselves are quite unknown to us, and that what

On time and ethics   111 we call outer objects are nothing but mere representations of our sensibility, the form of which is space. (op. cit. pp. 73–4) Kant separates the thing from its appearances to the observer, he is not interested in distinguishing between the multidimensional rose as such and its projection to the human mind which might be affected by factors such as distance, weather conditions, physical and psychological dispositions such as having caught a cold or being concentrated on different matters, but claims that there is an intrinsic property to the rose which is independent of our perceptions. Those readers interested in roses know well that a rose in rain is a different entity from a rose in sunshine, with respect to colour and olfactory characteristics these may also change during the day depending on the light. A consequence of this Kantian distinction between a thing a priori and its appearance is a separation of the individual actions based on appearances and based on an analysis of the a priori world. How do we get in touch with the world which is a priori? Kant envisages pure intuition as the only way. This is however not what we call intuition in everyday language but a logically/mathematically trained sensibility. This pure form of sensibility may also in itself be called pure intuition. Thus if I take away from the representation of a body that which the understanding thinks in regard to its substance, force, divisibility, etc. and likewise what belongs to sensation, impenetrability, hardness, colour, etc., something still remains over from this empirical intuition, namely, extension and figure. These belong to pure intuition, which, even without any object of the senses or of a sensation, exists in the mind à priori as a mere form of sensibility. (op. cit. p. 66) It seems that Kant conceives that things/entities are projected on the abstract n-­dimensional Euclidian space as true representations. Observe that he discusses the space and does not introduce time. Thus the a priori world seems to be a Platonic state of art where true forms equip the space according to true relations. When we contemplate the neoclassical axiomatic structure it bears close resemblance to the Kantian a priori space. The commodity space is a Euclidian space where the choice of the agent can be represented by a vector and this vector is independent of the actual context. The particular approach to space and time by Kant implies very precise ethical considerations. In fact Kant derives an objective ethics relative to his apprehension of space and time. Pure ethics is a matter of pure logical analysis of a priori concepts. It is evident that his ethics is objective and universal since the a priori world is so and furthermore it is independent of the local (and temporal) individual sensual sensations and emotions. The ethics is thus contextually independent. ‘In the

112   H. Ekstedt universal principles of morals nothing can be uncertain, because the principles are either altogether void and meaningless, or must be derived from the concepts of our reason’ (op. cit. p. 433). This implies two things concerning ethics, (i) ethics is absolute since it is linked to the a priori world; (ii) since the action of Man is linked to projections of the a priori world distorted by our senses and passions there must be an ethics/morality, controlling this aspect of human existence and it must basically concern the depression of sensations and passions in order to converge to the a priori ethics. Thus given our interpretation of Kant illustrated in the quotations above, pure ethics is one and it is eternal; thus we have a norm both with respect to analysing the relations of the world and with respect to the ethical laws. The only way to get in touch with it is through contemplation of the things as they are a priori, which is seemingly equal to their mathematical/geometric forms. We can see the clear resemblance to the axiomatic structure of the general equilibrium theory. The Kantian ethical values are absolute both with respect to space and time and they concern the ideal organization of the physical and social dimensions of the society. But moreover the Kant implicitly presupposes that Man can achieve knowledge of the pure ethics/social values through individual contemplation of the a priori world. Thus Man is not necessarily regarded as a social being in the analysis of Kant, and furthermore the ethics, as well as the logical analysis of the physical and social reality, is independent of local and temporal environments. By defining time as an independent dimension Kant also dismisses time as only important for our sensations but not for the a priori world. It is interesting to see that from his analysis follows that he believes that human emotions, sensual apprehensions and passions are only temporally ordered but since they do not affect the a priori space they cannot be ordered logically. This is indeed contrary to the earlier but partly contemporary philosopher, David Hume, who claimed the opposite view which we quoted in Chapter 2. Time and the sensually apparent space never meet since the apparent space is just a subjective sensation and time is intrinsic to Man as an ordering measure. The individual may remember and also lay out plans in time. These plans are viable however only when related to a priori matters but may still be jumbled by sensual erroneousness and emotional mish-­mash. If time and a priori space do not meet since a priori space is timeless and time is an independent dimension only concerning the ordering of sensual apprehensions, we obviously run into a circular time concept. We have the natural clocks, the sun, the moon, the seasons, but apart from that nothing. The appearances to our senses change but these appearances are not connected to the true reality and thus lack logical meaning. In Chapter 2 we claimed that the neoclassical theory is built on the same logical pillars as the Marxist materialism, turned into an idealistic dream, and we can see that the latter is quite a natural hypothesis with respect to the Kantian view. Time ends when we reach the paradise of the communist state, the synthesis, which obviously has to be the a priori world. So is also the neoclassical economy. Let the economy be free from any interventions, save for some lump sum corrections to the distribution of initial endowments,

On time and ethics   113 and the invisible hand will lead us to paradise which in this case is general equilibrium. Kant creates an a priori world which is infinite. We are all (hopefully) on our way towards that world and during the journey we experience time as an intrinsic dimension but when we have reached the a priori world we have been transformed into our true nature which is timeless. Consequently Kant claims that we have a norm, the world a priori, and this norm is timeless and concerns the whole space of the world. The fundamental ethical responsibility of the human beings, according to Kant, is to inform themselves of the a priori world, through logical/mathematical intuition, which does not need social interaction, and to oppress the sensual/emotional impulses in order to converge on a correct apprehension of the a priori world. The Kantian ethics summed up in its moral imperative implies that any individual independently of others can act as the action can be formed into a common law. The Man is responsible for reading the a priori commandments independently of the social and physical environment. The opposite view of Einstein/Minkowski  3 The Einstein/Minkowski view of the universe contradicts that of Kant’s, with respect to both time and space. Basically they accept the world as it can be measured by our senses, with the help of instruments for measurement purposes, They use a norm, the speed of light, which conceptually can be replaced by the principle of the fastest signal, which is more convenient for social theory.4 They implicitly define the world as it appears locally, and say that the only way to experience the world is through its appearances and since we have a universal norm namely the speed of light or a fastest signal, we may transform the space from one appearance to another. Thus the central thing in this theory is the concept of simultaneity, which indeed is difficult, and leads, with respect to Einstein’s general theory of relativity, to bold fantasies of time travelling, which we touch on later on. Two events are simultaneous only when their relative speed is taken into consideration by a so-­called Lorenz transformation, but even then the signal carrying the message of one event to the other has to travel at the speed of light. That implies that the form of the perceived event/object will be distorted relative to the original event/object in relation to the relative speeds of the observer and the observed as in Figure 4.1. In principle the Einstein/Minkovsky theory bases its substance on exactly the same geometrical world, which Kant considers as the world a priori. But, as we saw, Kant deprived physical objects of their sensual characteristics and was left with the geometrical image which he sees as the a priori object, the sensual appearances are not real in Kant’s opinion. That opinion is indeed contradicted both by Einstein/Minkowski’s time discussions and most of all in the general relativity theory. Einstein states the ultimate conversion of spatial bodies is into energy. That implies that there is an ultimate link between the sensations of the observer and the inner form of mass, using the language of Kant, namely, the

114   H. Ekstedt energy. That in turn implies i) that mass has a true spatial representation; ii) the image of two spatial objects at different speeds can be transformed into a different space by taking the relative speeds into consideration; and iii) a spatial object, which possesses an inert mass can theoretically be transformed into spaceless energy according to the general relativity theory. Consequently the Einstein/Minkowski calculations with respect to the relation of space and time when we compare it to the Kantian attitude restore the observed reality. The space becomes the true reality while time is reduced to the relative changes of space, i.e. the sensation of time is basically the same as the sensation of the changing space, since the concept of simultaneous events is dependent on the relative speed in relation to the fastest signal, light, but having said that, true succession in spatial events is possible to state through mathematical calculations, thus accepting spatial events as real. Furthermore at a low speed, compared to light, the relative movements seem to be in space altogether, while at high speed differences we have a transformation of spatial masses for the imagined observer, which ultimately converge into energy forms. Thus time is a concept depending on relative inertia, which implies that the relative changes create the sensation of time. We may say that time is just a sensation produced by asymmetric spatial changes. The Einstein/Minkowski presupposes an observer, who can measure the asymmetric changes and this presupposes that the appearances of the observer is the ultimate basis for measurement and calculation. The approach is valuable in two aspects: first it links time to space and second it introduces the concept of relative inertia. However the approach is insufficient since it is in fact nothing but an accounting scheme for the spatial entities. Since we just care about relative speeds we can transform the coordinates of one system into coordinates of another at a different speed. Thus it reduces in fact the whole time problem to a spatial problem, which leads to a seemingly paradoxical result of the so-­called Grandfather’s Paradox; you can travel back in time and shoot your grandfather. This paradox concerns the very construction of the Einstein/Minkowski time concept, and tells us that their time concept is insufficient, since the physical world, and its conditions for human life, is omitted in the analysis. We know rather well what would be the probable result if we accelerated ourselves to the speed of light in accordance with the general relativity theory, namely an enormous explosion which perhaps makes us kill people but not necessarily our grandfathers. However in relation to Kant they restore trust in the reality we perceive and also the conviction that this reality is subject to the changing perspectives of different observers depending on asymmetric speeds. This is indeed an achievement both with respect to Kant and to Newton. The quotation from William Unruh in section 4.1, above, reveals the essential message: we live in a real physical world and our perceptions of that world are true but in a broad sense dependent on different perspectives. Basically that leads us to a couple of strong conclusions with respect to human apprehensions of the surrounding world.

On time and ethics   115 Most of all any appearance of the physical world can be measured in some way or the other and objects can be defined in a more or less precise way. We can see that Kant struggles with the problem of definitions. There is a mighty ghost with respect to definitions and that is the reminiscences from Plato and Aristotle, substance. The definitions of cats, in general, were based on their ‘cattishness’, tables on their ‘tableness’. Substance was thought to separate families of concepts from each other and this substance was inherent to the items. This was the link between the concepts and the outer world.5 A cat, a dog or a table are certainly difficult to define sometimes but those difficulties do not affect the physical thing and its functions but may complicate communication between people, and that is indeed important, but a different complex of analysis. When it concerns the space-­time relations we have a precise norm and that is the speed of light, which is the fastest signal, but when we communicate with others it is sometimes difficult to find such a norm, since we need to communicate more complex characteristics about an item than just the geometrical and physical characteristics. But, and this is important, any interference with the real world produces measurable effects which may correct the ex ante ideas with respect to definitions and functions of physical items. But as long as we keep our ideas in our mind without confronting them with the real world in real actions we can believe that the moon is made out of cheese. This conclusion is extremely important with respect to social sciences. We must never forget that we constantly interfere with the real world and that sometimes cultural differences in opinions are understandable with respect to differences in norms created by differences in the physical reality. For social research, however, the Einstein/ Minkowski approach is not sufficient, as we mentioned above, since we have the more complicated problem of acting and reacting subjects.

4.3  The direction of time6 The views of Kant and of Einstein/Minkowski on time are both insufficient in one aspect with respect to social analysis, namely the lack of direction. The Kantian view disregards time as just an accounting scheme for ephemeral sensations and emotions not affecting the real world; since the true world is given a priori, our senses and emotions when not disciplined by mathematical intuition can only delay the converging to true knowledge. Since his ethics is by definition given a priori, ethical behaviour is equivalent to rational behaviour. This view is probably a good metaphysical rationale for the invisible hand in neoclassical theory. The Einstein/Minkowski view is also a bit problematic. As it stands it is also just an accounting scheme and lacks any direction since it just concerns the relative movement of spatial objects. However this approach concerns the physical space and thus it needs to be completed to be valid for the social space. With respect to social sciences, however, it is incomplete and this incompleteness may  open up a Kantian view since the humans, occupying the physical space

116   H. Ekstedt sometimes build their actions on expectations, dreams or the like, which indeed is difficult to take into consideration. Thus, in order to have a precise time concept in the line of the quotation from Unruh in section 4.1 above, which ultimately may allow for some kind of topology necessary for measurement, we need to develop Einstein/Minkowski a bit. A first approach to the directed time is to rule out reversibility as a universal principle. There is a radical difference between causality in the real world and logical analysis. From axioms we can deduce propositions but we can equally well deduce the axioms from the propositions. Thus when we use logical analysis in empirical research we must always bear in mind that the logic we use is picturing causal propositions, thus we have to decide the direction of causality ‘outside’ the logical analysis. Causality of the Kantian world is by necessity reversible since the world with its true relations is given a priori. It is however interesting that Kant introduces time as an independent dimension, not with respect to the a priori world but at least with respect to sensual apprehensions. Thus if we accept that our senses somehow are attached to the reality, we must accept David Hume’s concept of causality and that implies that it is irreversible since the effects never can produce a cause, thus implying a locally directed time concept. If we set fire to a paper with the sunlight and a magnifying glass we cannot deduce from the burning paper how it was set on fire, other than the immediate cause was that the temperature when paper burst into flame must have been equal to or above approximately 300oC. To find what caused this temperature we need further empirical information. With respect to Figure 2.1 on Wittgenstein’s proposition 2.211, we realize that the reversed arrow with respect to the logical analysis must include a set of restrictions not relevant with respect to the other direction. Hans Reichenbach notes this in his distinction between context of discovery and context of justification (1938: 382). This example in its simplicity shows the danger of logical models, particularly a priori models. It also reveals the peculiarity of the ‘revealed preference theorem’ in the neoclassical theory. This is also the fundamental base for Hume’s doubts about empirical work and we must admit that he had some grounds for it. If actions cause effects and these are to some extent irreversible, induction as an empirical tool is indeed a difficult and complex tool. Bertrand Russell, however, replied in a brilliant manner, that in the end research is a social process and this is basic for all research. The scepticism of Hume is entirely founded on his rejection of the principle of induction, . . . if this principal will be valid there has to be a sufficient number of cases, making the probability to approach certainty. If this principle, or someone else out of which it could be derived, is true, the deductions of cause-­effect relations, which Hume rejects, are correct, not that they will imply full certainty, but a probability sufficient for all practical purposes [our emphasis]. If the principle of induction is untrue, every attempt by science to achieve general laws from single events is bound to fail, and

On time and ethics   117 the empiricism cannot escape the criticisms of Hume. The principle in itself can obviously not be proved, except through circular reasoning, be derived from detected regularities, since it is required to legitimate such a proof. It has therefore to be, or to be derived from, an independent principle not founded in the experience. So far Hume has proved that the pure empiricism is not a sufficient foundation of science. . . . What it shows and I do not think any refutation is possible – is that induction is an independent logical principle, which not can be derived either from experience or from other logical principles, and that any science is meaningless without this principle. (1948: 344) Thus according to Russell all empirical research is a social process and as such dependent on a value judgement in order to achieve a probability sufficient for all practical purposes. The other aspect ruling out reversibility is of course the entropy process which is said to be universal to nature. Entropy increases monotonously in the universe which may be seen as the ultimate birth and death process. Having said this however, human industriousness lowers the entropy at least locally and temporally. The fly in the ointment is however that given two systems A and B where B is a subsystem to A, then the lowering of the entropy in B implies that we increase the entropy in the complement to B more than proportional to the decrease in B. However to discuss space-­time in social sciences we need more than the causality of the physical sciences. Henri Bergson (1912) has explicitly developed a theory where he confronts the observing subject with the flow of time. His construction of the concept Flux of Now is based on three principles: 1

Interaction of physical processes creates continuity. If time should be identified as an ordinary clock, where events progress through state changes we should easily end up in the Zenonian problem of cinematographic time. That is – what happens between the impressions? The density of space and its multitude of seemingly discontinuous events create in fact continuity. I write this part between 12.20 and 12.30 when I will go to lunch but in the meantime the physical space is filled with the laughter of the librarians, my hunger feelings, my writing, the movements of the clouds which I can see through the window, the actions of different kind of my fellow students in the library and so on. These events are added to the inertia of the physical room and form the continuity of space-­time, but that specific continuity is only apparent to me. When I rise to go to the café in the square outside it is a discontinuous movement to my fellow students. It is very important to realize what the mathematical concept of continuity means in the real world and particularly in space-­time. Continuity is one of the fundamental concepts in mathematics but it is indeed tricky to understand in relation to the perceived reality. In his discussion on space-­time topology Roy Douglas (1995) concluded that from a point of view where we disregard the

118   H. Ekstedt p­ rocesses of the conscious human mind it is hard to see that the Universe displays any global continuity: The (global) Hausdorff property certainly simplifies the mathematics of our models; unfortunately, it is also an entirely inappropriate restriction for models of spacetime, precisely because (as we have seen) it is a strictly global constraint, in spite of any naive intuition to the contrary. (op. cit. p. 180)

2

3

Douglas discusses from a universal physical perspective but we add the conscious human mind with memory and expectations and that will imply that an individual may perceive a continuous space-­time with respect to an epistemic level. Later we will introduce a sort of continuity but that is related to Hume’s causality and Man as the fundamental cause, and that is also from a general perspective the most fundamental source of discontinuity from a global point of view and also the true source of uncertainty. Objects, and processes in physical space not only possess the dimensions of spatial extension but also qualities which the observer’s senses are able to detect. This is a major deviation from Kant, who dismissed these qualities as being subjective and not attached to the true item but an appearance subjective to the observer. He only regarded Euclidian space as a true space where physical items are represented as their abstract forms. But such qualities are to a great extent scientifically observable and measurable, such as colours, density, smells, tonality and tastes, depending on its specific contextual projection, which means that the physical space apparent to our minds is of different dimensions than the n-­dimensional Euclidian space we perceive with our eyes and most probably the dimensionality differs between different individuals. Differentiated subjective intensities of the impressions of the events in the physical space create in principle subjective clocks. Bergson mentions the difference of tickling the palm of your hand with a needle compared to when you press it into your flesh with increasing strength. This is a major point since it links the physical space to the subjective states of mind and may cause physical actions. We can also see the parallel to the quotation from William Unruh in section 4.1.

Through these three points, together with memory, it is possible to create a link between future expectations based on the present situation and history. But here the third point of Bergson comes in and makes these expectations purely subjective depending on the history and the current epistemic cycle. However, this subjectivity is possible to discuss in an objective way since it is based on the real physical space and particularly when the subjective perceptions and the perceived epistemic cycle are the basis for actions causing changes of the physical space. We have chosen to start the discussion of the directed time with Bergson although his approach is not entirely convincing in respect of an overall directed

On time and ethics   119 time, only directed temporally and locally if we interpret the text carefully. On the other hand Bergson presents a link between the outer and the inner space such that we can discuss subjectivity interlinked to physical events. From the above considerations we find that there is indeed a close interaction between space and time when we are discussing the direction of time. Time seems also to be closely related to human perception, which is also perceived by Kant although he dismisses it as something ephemeral. This means that we must consider birth and death processes in both the ordinary sense and also in the sense of variations in degree of inertia. But these processes may be completely random from a general perspective. Thus let as assume a completely random world with birth and death processes. These processes give rise to a locally directed time since there exists a before, a between and an after but besides that, perfectly random. In such a world we would have no clocks whatsoever though birth and death indeed give a before and after but both are random. In this world there would be no time concept to even consider. Let us now add the rising and setting of the sun and the four seasons, and then there would be a radical break in the randomness, we would have a certain causality, a circular one, but still a causality in a passive sense which means that something is before and something is after and thus something must be in between. Thus we have a couple of clocks but apart from the circular time introduced by the clocks nothing is changed. The lack of conscious mind makes the clocks totally superfluous and adds nothing to the concept of time. Thus in total randomness there are no clocks and furthermore the mere introduction of regularity in nature produces some kind of clock but with respect to causality nothing more than circular time with no meaning. Thus the time concept in the sense that clocks, apart from the very existence of circular regularities, needs a purpose outside the regularities themselves. The clock is a measuring rod of a phenomena but it is not the phenomena itself. This is the very basis for the view expressed by the quotation from William Unruh in section 4.1 and is a striking comparison to the absolute character of Newton’s physical time and social time and it also tells us that social time must be a prior concept to that of the physical structures producing the very clocks. The consequence is that the time concept expresses not only a measurement of something but the apprehension of the organization of the physical and social space and the questions of cause and effect. This is the basic rationale for the otherwise esoteric problem of time and space. This is also why ethical questions must be basically discussed with respect to time since they deal with the problems of conservation and change apart from a random process. Thus – in the physical world, we must start with Hume´s causality concept, which not only presents an asymmetry with respect to time as measured by clocks, but also an asymmetry with respect to space. A cause must precede its effect.7 The second aspect is that we regard the human being as a subject, a fundamental cause and this presents a significant feature to the space-­time concept of

120   H. Ekstedt social sciences. But not only that, the quotation from Bertrand Russell earlier in this section concerning Hume’s scepticism of empirical investigations links all sciences, whether natural, medical, or social to the social context. That means that the Einstein/Minkowski space-­time which from a precise point of view makes time just a matter of relative speed is the correct one if we extract the human mind. The entropy concept provides us with a directed time but that is indeed difficult since in many cases it evolves through discontinuous processes like natural disasters, which may be caused by more or less continuous tear – and – wear, for example erosion, but are manifested in a discontinuous manner. If we look at animals, some probably have a rudimentary time concept in the sense that they have a memory which might lead to some form of expectations. Humans however have the ability to build up pretty complex pictures of the future with different implicit time perspectives. That leads us to a strange conclusion. We have earlier claimed that humans perceive the environment from a particular perspective and also build up epistemic cycles which are a kind of filter with respect to further perceptions of the reality. These epistemic cycles make it possible to experience a sort of continuity. But on the other hand unexpected events may cause revisions of these epistemic cycles such that the entire behaviour is changed. This imply that a set of events which might be expected on a defined aggregate level may be unexpected on the individual level and thus cause revisions of individual behaviour not possible to forecast with respect to earlier behaviour. Furthermore as we said about the decision to end the morning session and go to the café and have lunch, this is filling up the space-­time of my fellow students and creates a sort of general continuity of time but as an individual act it is completely discontinuous. Thus we arrive at an attitude which we discussed with respect to Russell’s paradox in Chapter 2. An epistemic cycle on an aggregate level consisting of different individual classes of epistemic cycles may contain contradictory epistemic cycles but still be regarded as consistent but that is at the pleasure of the individuals contained in the aggregate. An interesting example of the complex character of causality in human systems is to be found in a crime novel, The Bride of Newgate, by John Dickson Carr (1950). The story, which takes place around the time of the battle of Waterloo, starts with a scene from Newgate prison where the execution of a man, Dick Darwent, who was said to had killed another man in a duel, was prevented a couple of hours before the execution by the fact that the message reached London that his two cousins had been killed in the battle of Waterloo before the duel. This meant that he had been a nobleman, a marquis, when the duel took place. Thus the trial had been carried out under false premises, since the nobility had the right to challenge to a duel. This example shows the complexity of simultaneity and time order, which in physics is the key concept in understanding the theory of relativity, but which reaches its full flavour in social organizations. In the example from J.D. Carr, the simultaneity and the time order was only important with respect to the law of succession, not inherent in the physical event as

On time and ethics   121 such. During the night before the execution Dick Darwent was more or less forced to marry a noblewoman, Lady Caroline, who wished to marry a man sentenced to death in order to get her inheritance, since her father’s will stated that she must marry before she could have the inheritance; but then she also subsequently lost the control of it. The marriage took place in the gaol under the assumption that the verdict of the prisoner was bona fide. This story is an excellent example of irreversibility, causality and the discontinuous space-­time when we are discussing subjects who are to be seen as final causes. The concept of epistemic cycles is obvious here. The marriage took place under seemingly correct premises given the current state of the world but the arrival of news from the battle of Waterloo changed the whole epistemic cycle for both of the involved parties. When we illustrate decision trees they often have the shape given in Figure 4.2. However such a decision tree is always given a set of epistemic cycles. In the story from J.D. Carr the new information implied that history had to be rewritten which gave rise to completely new epistemic cycles for the two involved parties. The new epistemic cycle made the earlier expected ex ante probabilities meaningless. This is actually close to Keynes in his Treatise of Probability, but we will discuss this more in Chapter 7. As we see here, up to the arrival of the courier there were two more or less continuous processes, one caused by the death of Dick Darwent’s two cousins which implied the transportation of a message and another one caused by the juncture of Lady Caroline’s plans and the verdict on Dick Darwent. These two processes met and because of the institutional structure the latter process was discontinuously broken. If we illustrate the time problems of Dick Darwent and Lady Caroline it could have the form shown in Figure 4.3 (a simplification of the figure in Reichenbach (1991 [1956]: 41)). C (0.7) A (0.6) D (0.3) E (0.5) (Now)

B (0.4) F (0.5) Timescale

The letters indicate different possible states of world and the figures the ex ante probability of that state given the preceding states. Thus the ex ante probability of state F is 0.2.

Figure 4.2  Standard decision tree.

122   H. Ekstedt

Probable states according to inert structures

Unknown and unordered states with respect to time

*A

Unknown and unordered states with respect to time Now

Timescale

*B Known history

Figure 4.3  A space–time illustration.

When time goes by, NOW is revised with respect to known history which sometimes confirms the believed states of the world and sometimes not. Thus when NOW evolves in time we learn about states of the world which have earlier been hidden. In the case of Dick Darwent and Lady Caroline point A indicates the battle of Waterloo while B indicates when the duel took place. In NOW the quadrants containing unordered and unknown states of the world in some sense is simultaneous to our NOW; our knowledge of the general state of the world is at its minimum at NOW. Furthermore – and this is important – for those who have experienced that their believed epistemic cycle has not been closed (in the sense of Figure 2.5, Chapter 2) we must expect a changed pattern of action/reaction in the future which is an important explanation for social irreversibility. With respect to our question of the direction of time, given the existence of subjects we can expect that time is at least piecewise directed since the subjects based their actions on known history and an assumed state of the world. Thus, in the Einstein/Minkowski world, time is created by the relative movements between spaces but has no direction. In the social space-­time we must however add a direction which is then created by a perceived or expected causality. The basic reason for this lies in the fact that we regard humans as subjects and thus any action must build on some kind of apprehension of both continuity of the

On time and ethics   123 space-­time and causality. As we see from the example from J.D. Carr the causality was not inherent in the physical processes but required an institutional structure.

4.4  Social space–time topology Our rejection of the neoclassical theory and introduction of epistemic cycles throw us in to complete chaos with respect to measuring the economic reality from a scientific point of view. The neoclassical theory provides us with a measuring rod but that exists only in general equilibrium and rejecting the axiom of reflexivity rules out the existence of a global equilibrium. However we have also hinted that ethical rules could be a way of finding a solution to the problem of measurement. It seems natural that the basic conditions of a measure of economic activities must be that it is consistent in time and space and is accepted by all agents. The latter conditions do not rule out breaks of ethical principles but such acts must be regarded as socially non-­acceptable. With respect to these conditions it is interesting to see how we use the price-­ measures in economic statistics. Although we seldom can say if we are in a state of general equilibrium and worse, there is not even the slightest possibility of an intertemporal general equilibrium we still use prices as the sole measure in economic modelling and, worse, for normative analysis of the aggregate society. To construct any measure we need a topology. The most general topology on a space, for example a collection of things, or numbers, requires the following conditions: Definition 1: A General Topology Let X be a set with a collection of subsets T, we then define a topology if the subsets in T obeys the following properties: 1 2 3

The universal set X and the empty set  are subsets of X. Whenever sets A and B are in T so are A\B. Whenever two or more sets are in T so are their union.

The first condition seems to be trivial. But as we earlier claimed no axiom is trivial but has to be regarded with respect to the complete axiomatic structure. If X was not a part of the topology we could not express that if X consisted of two subsets A and B, the union of A and B was equal to X. In the same manner we may say that if the empty set was not part of the topology we could not express that the complement to the union of A and B in X was the empty set. Thus the first property is a fundament for the other two. But now a serious problem appears. Remember the technical definition of Russell’s paradox: Let S be the set of all sets which are not member of themselves. Then S is neither a member of itself nor not a member of itself. Symbolically we will have: Let S = {x | x  x} then S  S if and only if S  S.

124   H. Ekstedt According to our discussions of this in Chapter 2 we arrived at the conclusion that if the neoclassical theory is a relevant description of reality and there exists a global rationality then all epistemic cycles must be regarded as non-­proper classes. If so there also exists a topology, and this exists only in a state of general equilibrium. However, if the concept of epistemic cycles are to be regarded as belonging to proper classes then the universal class is not a member of itself. Thus there exists no topology and subsequently no unique measure if we try to express the economic reality using the concept of epistemic cycles. It already fails the most general conditions of a topology. Obviously the concept of epistemic cycles is a devastating concept, so let us ask why. The basic reason is that we have defined individuals as subjects. That implies that we have given them an ability to value all aggregate complexes of which they are a part. The very definition of epistemic cycles implies that each subject measures the environment with respect to the individual purposes and the perceived context, but we reject any aggregate complex this ability. Thus any aggregate complex sets its goals, and perceives its environment through an individual or a set of individuals, maybe a local power structure. That means that the behaviour of the aggregate complex is not possible to derive through the behaviour of the contained individuals as individuals. Here we are at a philosophical crossroads; for Kant and even more Hegel, reason was not an individual’s characteristic but a feature of the total reality, independent of individuals. That idea was a necessary ingredient in the philosophy of bureaucracy initiated by Hegel and brought to its extremes by Treitschke and other Prussian bureaucratic philosophers claiming that the state, and subsequently its bureaucracy, was the bearer of this global reason. The aggregate thus became a subject. This is an interesting development and also basic to the Marxian analysis. It is also important to realize that it goes along very well with neoclassical thinking. Through its axiomatic structure the individual is deprived of any kind of individualism and the whole system is governed through an aggregate principle apart from the individuals, sometimes called the invisible hand. So when we take our stance in Hume’s approach that passion sets the goals, the purposes, and reason is the mean, the obedient servant of passion, we end up in a completely different analysis. To choose between these approaches, which Murray (see beginning of Chapter 2) called the rationalist and the empiricist view is basically a metaphysical question. Anyway we have now achieved the full conclusions of what Murray demanded, namely we have brought the different views of rationalism and empiricism to their ultimate logical forms. Our introduction of Thomas Brody’s concept of epistemic cycles in conjunction with the definition of individuals as subjects, thus final causes, implies that, (i) there is no global rationalism; (ii) there is no global measure in social science, dealing with subjects; (iii) on each aggregate level there might exist a measure, but this is at the pleasure of the individuals contained in the very aggregate; and

On time and ethics   125 (iv) an imposed measure by any aggregate complex can obviously be imposed by using force: in a democracy the individuals voluntarily submit to this, but it implies an objective ethics which must be internalized since the aggregate measure must to some extent be at variance with the individual epistemic cycles. Point iv is of an extreme importance. A growing social unease implies that the subordination of the individuals is questioned and for the aggregate to function as before the internal ethics of the individuals has to be replaced with an external system of rules which implies control systems and systems of sanctions which raise the costs of the aggregate level, which as long as the ‘global reason’ does not provide any real and financial resources, to an increasingly higher degree, they have to be raised from those who are dissatisfied with the aggregate complex, thus probably causing even higher costs of controlling money raising. Thus it might be wise to exercise power in a democracy as if we are empiricists just for financial reasons. The problem of dimensionality We now understand that any aggregate level may exercise measurements specific to the aggregate complex in question, but this presupposes individual subordination and thus an internalized ethics. An example of very rudimentary topology (the example is taken from Brody), is a bus map of a city consisting of different lines with different colours marking the different bus lines and the bus stops marked and named in the order of appearance from one terminus to the other. To use it as a car map or a map for pedestrians is useless but for its particular purpose it is useful. Thus to aggregate purposes we have a set of rules, measures, but these only function with respect to the very purpose. Thus for complexes on different aggregate levels these measures do not necessarily work. We may use this example to illustrate the lack of topology and that is exactly when the dimensionality of spaces varies; if you think of a three-­dimensional map you may very well have three points on a line in one dimension which implies that they appear as a point at the surface created by the other dimensions. This is in fact the basic rational for the Dimension Invariance Theorem: Rn is Homeomorphic to Rm if and only if n = m The word homeomorphic means that we may create a relation which is continuous and invertible. If we take our bus map, which is of dimension one, it is continuous in the sense that the bus does not stop at one place and then suddenly go back or take a different route onward. Furthermore it is invertible in the sense that the order of the bus stops is reversed from the other direction. If we draw a map of the bus stops based on the perspective of the eye we may miss stop number two, so the projection must only exhibit the order of the bus stops and thus invalidate the projection as a map for other purposes.

126   H. Ekstedt

2

3 1

The eye

Figure 4.4a Bus stops in three dimensions to be projected onto a two-dimensional surface. 1

2

3

Figure 4.4b  A functional ‘projection’ of the bus stops.

In relation to Russell’s paradox we realize that the universal class of bus stops belongs to itself. The example of the bus map illustrates the simplest kind of topology, ordering in one dimension; if we look at the neoclassical economics the whole axiomatic apparatus serves one purpose, namely to convert a multidimensional commodity space to a one-­dimensional measure, which we call prices. Thus given a particular general equilibrium there is one and only one order of microeconomic states as well as macroeconomic states. What this means is that any projection of an n-­dimensional space onto an (n-­1)-dimensional surface implies that some points will not be pictured in the projection. So when we say that we can see a commodity as a multidimensional complex which is projected onto a specific epistemic cycle we also presuppose

On time and ethics   127 that this projection implies that the desired functions of the commodity in question are less than those available to the commodity. When we apply this discussion to the problem of aggregation in relation to Russell’s paradox one explanation of why we get Russell’s paradox for so-­called proper classes is that the universal class contain more dimensions than any of the subclasses. Thus in our discussion the aggregate complex is spanned by more dimensions than the sub-­complexes, which, as a consequence of the above Dimension Invariance Theorem, actually explains why we cannot can have consistent measures between different aggregate levels. Thus we have a difference between individual and aggregate levels and that might have inspired philosophers like Kant and Hegel to overemphasize the aggregate level, since it has the most dimensions compared to contained individual epistemic cycles. What they possibly forgot was that the individual projection of the aggregate level is also subject to the same problem, namely that the projection has fewer dimensions than the space it projects. Thus giving preference to the aggregate level, other than in the form of a democracy, is probably worse than chaos, and we think history rather supports us in this opinion.

4.5  The role of institutions For social space-­time, the physical space-­time considerations are not enough to create a topology underlying anything but strictly temporal and local measurability due to inert behaviour. It is also important to realize the ability of humans to analyse aggregate structures from their own set of epistemic cycles and to limit the action space through creating aggregate institutions. Those institutions are indeed not neutral with respect to the market process but may set a particular form of causality and logic with respect to human actions, and thus they create a kind of measurement, a rudimentary form of topology. With respect to Figures 4.4a and 4.4b we may now give another example, partly from the ‘opposite side’ relative to the example from J.D. Carr’s novel, of an aggregate process changing the causality of individual actions and creating another form of individual rationality with respect to aggregate structures, which also change the development of the society. It is often said that the modern neoclassical theory is a picture of the market analysis of Adam Smith (1952 [1776]). There is however an interesting difference between general equilibrium theory and the writings of Adam Smith. General equilibrium theory, interpreted intertemporally, implies a market process, which does not affect the relative initial distribution of wealth and power among the individuals, given the rules. Adam Smith’s theory does not imply this. The market process is part of an accumulation process implying distribution to be changed according to certain factors which ‘naturally introduces subordination’: i.e. superiority of personal qualifications, superiority of age, superiority of fortune and superiority of birth (op. cit. pp. 309–10). Further he claims that civil government presupposes certain subordination, but since necessity of civil government gradually grows up with the acquisition

128   H. Ekstedt of valuable property, the principal causes which naturally introduce subordination gradually grow with the growth of that valuable property. The rules of the sovereign should protect the acquired property and the execution of personal superiority. Thus a dynamic growth process is introduced through the system of rules. It is hard to see that the law system organized according to Adam Smith conserves an initial distribution of endowments through the market process but it sooner conserves the accumulation process. The set of endowments is hardly static in its character. Therefore to make the market process a distribution preserving process, as in the neoclassical theory, we have to consider the specific form of ethics in the sense of behavioural rules with respect to economic behaviour. In Figures 4.4a and 4.4b it is also indicated that the future is also partly possible to forecast as well as the part of history is known. This is partly due to the inertia of the physical space but when the analysis concerns the social space-­ time institutions creates inertia of the individual behaviour, we know when we will start working, we know about holidays, tax payments and so on. But we have also institutional rules as in the case of Dick Darwent, which we obey although they may completely alter the individual plans, as was the case for Lady Caroline. According to the reasoning with respect to Russell’s paradox this is only due to the individuals’ acceptance of the aggregate logic of the imposed institutional system. We may well think of a growing number of individuals breaking the imposed rules and the institutional system breaking down. An external control system would sooner or later break down because of the almost infinitely increasing costs. This is a strong argument for an ethics which is accepted by the individuals, who let the ethical rules be internally accepted. To use Adam Smith’s wording, the individual subordination must increase with the increase of social and economic integration. We have a rather dramatic period in the Norwegian history by Snorre Sturlasson showing the content of Adam Smith’s approach to accumulation and endowments, when Norway, at least the part under the control of Eirik Jarl, made a single switch from a non-­accumulative distribution system to a system similar to that described by Adam Smith. We read about it in the Icelandic Sagas, more precisely The Saga of Egil Skallagrimsson and The Saga of Grette ‘The Strong’ Asmundsen.8 The first one relates events around 980–985 ad, while the second event took place around 40–50 years later. During the times of Egil Skallagrimsson there was a law for duels in Norway (Holmgångslag). If a man challenged another man in a duel about goods, land or anything else and won, he should gain the property the duel had concerned. If the challenger lost the duel he had to pay a value comparable to what he had demanded. It is obvious that such a law will have negative consequences for the economic growth in an agrarian society. A mighty fighter, not particularly skilled as a farmer, could escape demanding cultivation of new land, which also happened.

On time and ethics   129 A Swede, Ljot, challenged a friend of Egil’s, about his farm and all the servants. Ljot was a rich man, but his wealth was entirely collected through challenges and he had killed many skilful farmers in duels. Since Egil’s friend was away, serving the King, the oldest son was left to defend the property. His mother Gyda persuaded Egil to fight instead of her son, with the evident result that Ljot was killed. An economic interpretation of the dynamic aggregate result of this law would be that good farmers should be careful in their cultivation efforts not to attract professional fighters. This would decrease macroeconomic growth. On the other hand we could also see the law as an elementary distribution policy. The acquisition of frugal land was more or less a random process so if one person was prevented by unforeseen factors or unclear inheritance, he should have the right to settle the final ownership through fights. In Grette Asmundsens Saga we can read how, around 50 years later, Eirik Jarl in a conference with the most prominent farmers in Norway decided to cancel the duel law and forbid duels.9 Many good farmers had been deprived of their wealth or had been killed. The new law would obviously be very positive for the farming industry and increased growth since the uncertainty diminished. On the other hand the new law also changed the institutions in favour of concentration of wealth since the new norm was strength in wealth possessions, not in superior fighting abilities. The valuation of endowments was redefined which caused changed dynamic properties for the economy. The change of law was in favour of accumulation, but did not affect the market process other than that it set the framework. An ethics, generally accepted, thus grants certain reversibility, development of patterns, reducing uncertainty, etc. on the micro-­level. Since all human actions in strict social and physical senses are irreversible with respect to the macro-­ states, an ethics create a certain inertia which grants a set of values to be more or less constant. Thus we may in this way create a standard, able to be a condition for comparisons within this set of values, which may be seen as a rudimentary topology. Before we go into developing a possible objective ethics based on our earlier considerations, let us remind ourselves of the Pareto concept as an efficiency criterion. In general equilibrium we know that we also have Pareto optimality, thus nobody can achieve a better situation without worsening it for somebody else. Based on this condition we also have a principle rule by which to judge economic changes. What we have done when we have destroyed the measuring rod of the neoclassical economy, the price vector, is that we have also destroyed prices as temporal measuring rods, at least in the longer run and also with respect to interpersonal comparisons. In the short run we may use them if we regard the inertia as enough, but this must be an empirical statement, not an a priori statement. However, this does not affect Pareto principle as such since that is not solely an economic, but a sociological principle. The problem is that we lack a rule, a measuring rod, to use in accordance with the Pareto principle. This is actually our basic rationale for an objective ethics.

130   H. Ekstedt

4.6  An outline of ethical principles based on the assumption that humans are subjects So far in our discussion we have emphasized the human being as a subject and thus a final cause. The basic characteristic of a subject is that the rationality is only relevant according to a precise epistemic cycle. Furthermore, and as a consequence of this, the subject has the ability to redefine the axiomatic structure. We will, in Chapters 5 and 6 discuss economic and social growth and other developments, partly as a consequence of innovations and inventions and this is precisely changed in some axiomatic structures; we may call it human creativity.10 Human creativity may imply both positive and negative social developments for different agents so we need an ethics both granting the existence of the humans and the possibility for action, an ethics both for being and doing, thus granting an ethics concerning actions, the drive for change, the creative forces, but there must also be a counterbalancing conservation ethics directed towards the very existence of the individual and the security of the individual as a social being. These two forces are indeed of equal importance in creating the dynamics of the society. An analysis of this kind implies two methodological perspectives of economic analysis of equal importance, the social/cultural aspect and the logical/technical one. The two perspectives must interact since the former provides the basis of understanding and the latter forms ultimately the basis for measurement, but the social cultural understanding is the more fundamental perspective. The time perspective is necessary in a development of an objective ethics and we have shown that neither the Newtonian nor the Einstein/Minkowski time concepts are enough to catch the social space-­time. Human interaction with the physical space-­time can be summed up in the following features: • • • •

Hume’s causality principle applied to the physical space implies that time is at least locally directed. Humans interacting with the physical space both as individuals and through institutional arrangements may create causal multidimensional effects. Given globally directed physical time, the effects are irreversible. Humans can cause effects which can both increase and decrease the entropy locally and temporally. Both causes and effects are stochastically dependent on the precise environment.

Given this we may sum up the basic conditions for a social time concept ­separate from the Newtonian time concept but also separate from that implicit in ­Einstein/ Minkowski. •

Humans analyse the causality structure of the external world, by which we mean natural processes, and decide locally and temporally which causality

On time and ethics   131

• • • •

structures should be regarded as most important for survival. Furthermore humans can build techniques/institutions which are used to foresee and alter physical causal structures. Humans are able to create causality structures which link a historical state to a future state with a substantial probability, i.e. technological and institutional structures. Humans act according to intrinsic aims, which include crude survival as well as qualitative aspects of life. These actions as well as aims may be purely individualistic or socially based. Humans have the ability to locally and temporally change the entropy process in both directions by conscious actions. Humans can act with respect to a temporal/local environment, change the axiomatic structure and/or adapt to a new environment.

From this we understand that the social time perspectives are set by specific epistemic cycles. These cycles may exist on different aggregate levels and may also well be at variance with each other and thus timescales with respect to certain actions may vary over time. What is possible at one time is not possible at another time. The idea of aggregate decisions through referendums for all of the future is thus entirely absurd. But this also casts some shadow on the consistency of aggregate decisions in a temporal meaning. So this must be a start of the objective ethics. The role of the ethics is thus to grant the individual rights and possibilities as independent of any set of epistemic cycles as possible. The temporal consistency is thus not with respect to the decisions per se but with respect to the ethical content and its consequences for the individuals. When we look at these features we easily understand the need for an ethics for being and doing. Let us suggest a very aggregate and abstract general principle as a start for such an ethics on the basis of our discussion: The human being is a subject and this accounts for all human beings in any local and temporal environment. Any subject has the right to survive on such a level that he/she can exercise his/her creative capability.    Thus no subject or groups of subjects may deny other subjects these rights on a priori grounds. To be viable this ethics must be valid both for individuals and for aggregate structures. If we compare this rule with the Kantian imperative we first of all note that there is no a priori explicit or implicit rule of a context. The ethical rule is only attached to human existence and there is a link between the individuals through the effect of the actions of the individuals, thus this implies the social structures. Furthermore the very existence of the individuals must be granted in relation to the right to act according to individual creativity, which implicitly may be developed into some rules for social freedom and also a certain standard of

132   H. Ekstedt living. The individual must be granted an existence of a certain quality. The last sentence allows for limitations of the creativity necessarily based on social acceptance and rejects the principle of George Orwell’s Animal Farm that ‘all animals are equal but some animals are more equal than others’. On the other hand we can see that the rules seem to be purely individualistic and negative in the sense that they are formed as a set of restrictions with respect to the effects on the individuals. In that aspect it has some resemblance to the Pareto principle, but to our view a separate ethics for aggregate structures is an anomaly since these are basically made up by subjects. Should we accept an ethics, like the proposed one, we neither accept additive aggregation within the ethical field nor leave it open for ‘king by the providence of God’, or the Machiavellian Prince. We may also ask if it is possible to form an ethical rule containing that humans are social creatures and discuss the direction of both collective and individual action in a more positive manner. This problem is indeed difficult since humans are subjects and thus define the character of the social interaction. Already the rule as it stands is implicitly an act of social interaction since it defines a principle of equality. The actual character of social action must then be defined by the context and subject to individual judgement about such a necessity. There have been efforts to define such an ethics explicitly recognizing humans as social creatures, most notably the so-­called Golden Rule in Matthew 7:12 in the Bible: ‘Therefore whatever you desire for men to do to you, you should also do to them.’ The very content of this rule is however present in many cultures. The rule as we see is perfectly flexible with respect to physical, social and economic structures. There is no a priori rule except the necessity of social sensitivity to a certain degree and it presupposes social interaction. We however must strictly sort out the negative variants based on the principle: ‘Do not to others what you do not want others to do to you’. This is obviously something else and refers more to the ethics of being since it is a restriction on action which might be equal to inaction. The Golden Rule is similar to Epicurus’ doctrine where he says that you cannot live pleasurably without living honourably (DeWitt 1954: 33). Our formulation can and must be completed with the Golden Rule, or similar formulations in order to have a direction of social action, since it states explicitly the necessity of the two aspects of being and doing. However although we have brought in the Bible, we must be aware that neither our basic principle nor the Golden Rule in itself contain any metaphysical connotations; they are basically examples of an extended rational egoism recognizing the fact that humans are social creatures depending on each other for both good and bad and they have a formidable ability, namely the ability to consider abstract aggregate structures. It is important to realize that an ethical rule of the above type will probably not lead to a global optimum. We accept the concept of epistemic cycles which

On time and ethics   133 implies that we probably have contradictions between them both with respect to different environments and purposes and with respect to aggregate levels, so the basic level of analysis not taking Man as a social being into consideration is chaos. This is extremely important to realize. Since we have rejected the a priori reasoning of the neoclassical theory with its invisible hand as well as the Kantian mathematical intuition of the a priori world we are not left with anything but the ability of social organization within human beings. We have historical evidence that the human ability to create chaos is undisputable; our hope must be set to our own ability of organization.11 It is not our task to launch any far-­fetched theory of how this is possible but obviously some concordance between passion and reason has to be maintained, where reason must be used to understand the social risks and possibilities of our actions, both on the individual and societal level.

4.7  The problematic but intriguing conclusion However, the general ethical rule we have formulated, although global, does not imply any unique global optimum even if, according to Zorn’s lemma, there exists a greatest value for any epistemic cycle separately. As we have discussed earlier our concept of epistemic cycles does not mean that an aggregate level of underlying subsystems is consistent with the subsystems. This is the very consequence of defining the subsystems and their aggregates as proper classes, in the sense of Russell’s paradox. The aggregate level of a set of subsystems is in fact separate from any kind of additive function of the subsystems. The reason for this is that we cannot grant that subsystems are of equal dimensionality. This leads to a sad but intriguing correlate to our application of Russell’s paradox, which may be called the Mereological Rule of Thumb:12 Assume a system A consisting of a finite number of subsystems, which are to be regarded as proper classes, s1 --- sn. If we then have a measure allowing us to define an optimizing rule both on A as well as s1 --- sn; optimization of the global system A must imply that at least one of the subsystems si must sub-­optimize.    If on the other hand all the subsystems, s1 --- sn are optimised according to the same optimizing process the global system A must sub-­optimize. The proof of this proposition is a simple application of Russell’s paradox. If any of the parts of the proposition fails the condition of the subsystems as proper classes must be wrong. The practical consequence of the proposition is that the individual must individually agree to subordinate to the rules or actions decided on an aggregate level. Thus this is the basic argument for the necessity of bringing in an objective ethics into the scientific analysis of economic matters. We saw earlier that the neoclassical theory, although alleged value-­free, implicitly presuppose an ethics similar to the Kantian, and that together with the

134   H. Ekstedt invisible hand, this is the only way to get the conclusions of general equilibrium, but that also implies a completely static society. Bringing in a dynamic social change affecting the dimensionality of the decision space of the individuals necessitates an explicit ethics as a consequence of the above Mereological Rule of Thumb otherwise no aggregate decision making is possible in a democracy. Thus an action by an aggregate institution, group or class of subjects can lead to an optimal state relative to the purposes of the aggregate institution or whatever it is. But this optimal state only concerns the agreed aggregate level. It does not imply that the subjects contained in the aggregate optimize their respective goal-­functions relative to their individual restrictions. Furthermore optimizing one particular level of aggregation does not imply anything decidedly good or bad for higher aggregate levels. As easily can be understood, this opens up for a political multilevel society, where the subsidiary principle is a meaningful condition. But on the other hand it might lead to oppression of subgroups in the society and then the general acceptance of the ethical principle is at stake. However since our suggested ethical rule implies social interaction as well as consideration of the social structure, rational behaviour on the individual level may be non-­rational on a more aggregate social level; this is probably an essential feature of what we call civilization.

5 Innovation, uncertainty, entrepreneurship Modelling the dynamic process of the economy – discussion and formalization Angelo Fusari

Introduction This chapter discusses some misunderstandings that afflict economic thought, in an attempt to contribute to their clarification. They concern three important aspects of the economy tightly linked with each other: innovation, uncertainty and entrepreneurship. Their interaction will be represented here through the notion of dynamic competition. This feature of the economy is inconsistent with the analytical apparatus of mainstream economics that, as a consequence, has yielded completely delusive results despite the use of sophisticated techniques and procedures. The situation is made worse by the fact that the various branches of heterodox economics, even if animated by an acute and growing dissatisfaction toward mainstream economics, have not offered a satisfactory treatment of the three aspects. A study of the matter must meet a complex and encroaching intellectual apparatus that has been built over time on methodological bases that, although fashionable, are substantially misleading. This will oblige us to start from some treatment on method additional to that in Chapter 1 and limited to what is absolutely indispensable. The chapter is articulated as follows. Section 5.1 starts with some considerations on method, mainly addressed to economics. Then it presents a simple and concise representation of the productive process based on the notion of dynamic competition as expressing the interaction between uncertainty, entrepreneurship and innovation. It follows an analysis of uncertainty, innovation and a description of the dynamic and cyclical motion of the economy; these developments also allow the explanation of entrepreneurship, this being inconceivable in the absence of uncertainty. The section ends up with a treatment of fixed capital, which is a protagonist of dynamic motion and is deeply concerned with innovation and uncertainty. These analyses will provide the foundations of the subsequent development. Section 5.2 expounds a critical review, starting with some main omissions and equivocations of general economics. Afterwards, we discuss two enlighten-

136   A. Fusari ing approaches that provide the premises for a satisfactory treatment of dynamic competition; this allows showing a missing ring, represented by the postulate of non-­measurability of radical uncertainty and the impossibility of its explanation, a postulate that strongly opposes the necessary clarification on the matter. We then suggest that the current insistence on bounded rationality, polemically with the neoclassical theory of perfect knowledge, has accentuated the difficulty of formalizing dynamic competition and caused various equivocations on decision making. Some consideration on institutions, with reference to the theory of the firm, will follow. Finally, Section 5.3, after having indicated various ways of measuring radical (i.e. non-­probabilistic) uncertainty, presents a formal model of the dynamic process of the economy, and carries out some simulations with the specified model. The hope of these analyses is to stimulate some implementation of economic research along lines that have been insufficiently deepened until now.

5.1  The theoretical foundations of our economic analysis Some consideration on method: a clarifying example The reader of this chapter may ask the reason why, if our focalization on the importance of dynamic competition and specifically a measure and explanation of radical (endogenous) uncertainty is right, economists have dedicated so little attention to the matter. To answer this, a brief treatment on method, specifically referring to economics, is required. Economic theory makes great use of both the method of logical-­formal sciences and natural sciences; the first is based on the criterion of ‘abstract rationality’ that ignores crucial aspects of reality; while the second bases the control of theories on the accurate observation of the considered phenomena. We saw in Chapter 1 that both methods are far from satisfying the needs of social thought: the first one because the study of social phenomena must base itself on an accurate analysis of the considered reality; the second, because it cannot be referred to social reality, being the ‘observation principle’ that such method follows simply based on the acceptance of the existing situation and the postulate of repetition of observed phenomena. The persistent acceleration of social change has determined a growing consciousness of economists and other social students of both the erroneousness of the above postulate of repetition (and mere acceptance of the given situation) and the importance to consider more appropriately the investigated reality. Unfortunately, this realization has led to an excess of analytical fragmentation and hence a lack of comparability among theories; a main cause of that is the frequent denial of the feasibility of shared methodological rules that make possible the confrontation among students and the control of theoretical hypotheses. As a consequence, many economists proceed freely; so an inconclusive and sterile pluralism is born, consisting in a variety of incompatible positions unable to interact.

Innovation, uncertainty, entrepreneurship   137 An important aspect of the situation is economists’ disregard for the explanation and measurability of uncertainty. Proper (or radical) uncertainty contradicts the postulate of the repetition of phenomena, implied by observationist method, thus making itself unacceptable to the followers of that method. A frequent and easy way to set aside radical uncertainty consists in the use of the ‘abstract rationality’ criterion, and/or in referring uncertainty to known subjective or objective distributions of probability, as is typical of the economics of perfect knowledge. Unfortunately, heterodox economics (and its criticism of mainstream economics), which strongly insists on radical uncertainty, the implied limits of knowledge and the connected notion of bounded rationality, has been conquered by the idea of the non-­measurability and the non-­explanation of uncertainty. To complete this analysis, it is necessary to remember the main methodological considerations that induce us to insist on some current misunderstandings on uncertainty, innovation and entrepreneurship. Unlike the natural sciences, social sciences concern a reality that is generated by Man. This is obvious. What is not so obvious is the implication that social sciences, in order to properly investigate this reality, must focus on the better ways to organize social relations, that is the institutional pillars of these, and coherently combining being and doing. In Chapter 1 we saw that the investigation of the organizational form of society may usefully start from some basic aspects of the considered reality (the character of the existing general conditions of development), and deduce their implications. In fact, those basic aspects require some organizational forms of the economic system coherent with them and the absence of which would weakness the competitiveness and sustainability of economic order. Uncertainty and the connected phenomena of innovation and entrepreneurship represent some of those organizational premises and features; precisely they pertain to what we called systems necessity. Keynesian economics clarifies the question well, but such clarification has not been pointed out by the numerous debates on Keynesian teaching. The core of such teaching can be outlined thus: • • • •

A main aspect of the general conditions of development of modern age is endogenous radical uncertainty caused by dynamic competition, increasingly based on innovation. Uncertainty and the state of expectations imply, mainly through their influence on investment, that effective demand be either insufficient or in excess relative to production and hence reduce output or stimulate inflation. It follows that the control of effective demand is a main ‘organizational requirement’ or necessity of modern economies. This implies some important programmatic, normative and institutional prescriptions, such as redistributive policies, welfare state, fiscal and monetary policies and deficit spending.

As we can see, Keynesian theory starts from an important feature of the modern general conditions of development that is radical uncertainty, and

138   A. Fusari deduces some crucial implications or organizational necessities. Unfortunately, Keynesian teaching limits itself to such an aspect and makes other questionable hypotheses. Moreover, it concerns macroeconomics, thus omitting the microeconomic aspects of modern economies linked to uncertainty, mainly entrepreneurship and innovation. Let us assert that the analysis that will follow emphasizes the relationship (and their implications) among those variables (i.e. entrepreneurship, innovation and uncertainty). The functional and organizational requirements implied by these phenomena are not deterministic entities, automatically engendered by the economic process; they may be absent or badly reflected within the social system. Specific attention may be needed to remedy this deficiency and to make evident the connected organizational necessities. Dynamic competition and economic development In a market economy, production is a way to get profit in the context of dynamic competition. This statement is not only referable to private but also public entrepreneurship since profit rate matters for accountability purposes, i.e. to measure an entrepreneur’s degree of success, as we shall see in the final chapter of this book. Economic phenomena, as resulting from some actions and decisions taken independently by a plurality of agents, assume in general different and even opposite contents from expected results. It is mistaken to think this fracture (between actions and results) may be remedied through a centralized system of decision-­making. Centralization makes sense only in a stationary society; it cannot face creative and innovative events, as these imply a qualitative leap with respect to the previous situation. In fact, the centralization of decision making is inconsistent with a world of beings endowed with limited capabilities but able to evolve. It tends to suppress novelties as it is almost impotent towards them and hence suffocates innovation and creativity, pushing economic systems toward a stationary state. Advancement in knowledge as well as in material and spiritual conditions proceeds by trial and error, through a plurality of intuitions, decisions and initiatives in competition each others. This requires the building of institutions able to stimulate personal qualities, especially creativity, to evaluate the achieved results, to facilitate the coordination among the plurality of decisions. At the basis of these organizational requirements there is the limitation of knowledge, that is, uncertainty. A qualitative and decisive leap in human history took place when the economy began to display an extraordinary ability to stimulate and govern innovation and took central stage in the social system. The modern age started at that point. All seems to indicate that the economic system will preserve this strategic position, even if flanked in the future by some other social subsystems in this special role. In fact, the economy is well equipped to operate in the presence of uncertainty and stimulate exploration; in other words, it is well equipped to govern and feed the dynamism of social process. In particular, the economy has

Innovation, uncertainty, entrepreneurship   139 developed an efficient mechanism of the coordination of individual initiatives that, in addition, strongly stimulates innovation, gets information on tendencies at work and is clever in evaluating the degree of appropriateness of decision making and to adjust this as needed. Such a mechanism of production is represented by the competition in the market and the search for profit: a mechanism nourished by trial and error and that warrants the adjustment to unpredictable events and attributes with inflexibility the merit and responsibility for success and failure. The economy has also developed the key agent of such a mechanism, the entrepreneur, which meets and, through innovation, stimulates uncertainty with the purpose of making a profit. It is our hope that the brief description has shown some key elements for the representation of the dynamic competition process. Entrepreneurial arbitrage, aimed at getting profit from market disequilibria, acts as the invisible hand that warrants the coordination over time and space of individual initiatives, in particular demand and supply. Such an adjustment process tends to erase profit opportunities deriving from errors’ and market disequilibria. Therefore, if entrepreneurs limited themselves to arbitrage, very low profit would result. But the entrepreneur can recreate disequilibria, uncertainty and the connected profit opportunities through innovation; thus even scarcely creative entrepreneurs can get profit both through imitation of innovations and because these recreate spaces for arbitrage. The described innovation-­adaptation mechanism is not limited to the economy but constitutes a basic expression of social-­historical processes and hence is an important analytical tool for the interpretation of those processes.1 But it is the economy that exhibits the best and more efficient innovation-­adaptation mechanism that, in addition, can be formalized and investigated in quantitative terms. The mechanism can be synthesized as follows: the starting point of the dynamic process is innovation that tends to intensify as a consequence of entrepreneurial arbitrage and imitation of innovations, and the related reduction in uncertainty; approaching toward a stationary state reduces the opportunities of arbitrage and imitation of innovations, thus stimulating the introduction of novelties. In turn, innovation causes the rise of disequilibria and radical uncertainty that discourage further innovation, both directly and due to the advent of new profit opportunities through arbitrage. And so on, with an incessant disequilibrating-­ equilibrating economic process pushed by the adaptive and innovative search, discovery and creation of profit opportunities. This main form of competition characterizing modern economic action and production we indicate with the notion of dynamic competition; it is hinged on entrepreneurial adaptive and innovative action directed to take advantage from existing opportunities and to create new ones, and results from the interaction between entrepreneurship, innovation and uncertainty. One main task of economics should be the combination of those components in a unitary process of dynamic competition2 able to explain innovation, uncertainty and entrepreneurship, as our treatment attempts to do. This competition is the basic mechanism of

140   A. Fusari economic development and would be impossible in the absence both of uncertainty and the connected limitation of knowledge. Moreover, we shall see later that uncertainty is the crucial variable explaining both the demand and supply of entrepreneurship, and in fact this is inseparable from the phenomenon of radical uncertainty. Therefore, an accurate treatment of uncertainty is of central importance and we shall see that some misunderstandings in this regard are a main impediment to an acceptable specification of the notion of dynamic competition. The current omission or fragmentation of the analysis of dynamic competition is a main lack of economics. This competition completely differs from that usually represented through the inclination of supply and demand curves: in fact, it causes day by day changes in those curves, creates new ones, influences costs, quality of products, etc. The usual theoretical treatment of production based on the notion of production function well expresses the dimensions and the seriousness of the analytical lacks on dynamic competition. The production function approach is apparently in accordance with evidence; but that accordance is warranted only in a stationary economy. In incorporating a production function in dynamic analysis, various and sophisticated modifications of that function have been developed, mainly the inclusion of human capital and exogenous or endogenous technical progress. But no satisfactory results have been achieved along this line. A production function is useful if it is limited to costs specification. But other elements, in addition to costs, influence production. These can be taken into account only through the help of the notion of dynamic competition. Radical uncertainty: the mistaken postulate of the impossibility of its explanation and measurability. Uncertainty and expectations This paragraph will specifically consider the question of uncertainty. The probability that, in the throwing of a well balanced die, a determined face appears is undoubtedly one in six and expresses probabilistic certainty. This objective probability does not involve capabilities and does not express uncertainty; it is the same for everybody. On the contrary, uncertainty involves capabilities; some people have better knowledge than others; somebody is clever to scent the wind and to adapt himself to new events, while some others are not. It may be objected that subjective distributions of probability are not identical for everybody and involve capability. But the subjective probabilistic approach presumes that the decision maker knows the probabilities of the considered events; instead, true uncertainty is an expression of the degree of ignorance. Speaking of expectations, we shall see better that subjective probability has nothing to do with true (or radical) uncertainty, even if an eventual measure of this uncertainty should help to define subjective probability or expectations. Radical (or true) uncertainty simply expresses the lack of knowledge. A growing number of students define uncertainty as each aleatory phenomenon that cannot be included in the notion of probability. They also maintain that uncertainty is impossible to measure and hence to be insured. This notion of

Innovation, uncertainty, entrepreneurship   141 uncertainty, apparently simple and clear, implies serious errors and confusions on measurability and insurability. Some clarifications are, therefore, indispensable. In deciding on future events, an entrepreneur must formulate expectations. Some of the corresponding probability distribution will be well defined and the properties of the distribution either known or able to be specified to sufficiently good accuracy; others will not and will be more or even highly subjective. It is very important to measure the degree of reliability of the expectations which does not correspond to a well defined probability distribution and hence probabilistic certainty. The degree of variability, or the dispersion, of expectations expresses radical uncertainty. It is senseless to deny the possibility of measuring and explaining such uncertainty; as a matter of fact, entrepreneurs must pay great attention to get that measure. Expectations lacking in a measure of their reliability may prove very deceitful. It is important to underline that the question of insurability has no relevance in discussing uncertainty. Probably all possible events are insurable at a price; whether or not insurance is used depends on the cost and the assessment of the effect of having or not having it. Insurance companies may dislike treating very high degrees of uncertainty; but this has nothing to do with the impossibility of measuring uncertainty that, in fact, is supposed to be very high. It is well known that various hazardous events are insured notwithstanding they cannot be expressed through probability distributions allowing a precise measure of the risk corresponding to them. Insurance does not strictly need probability calculus and in fact it was practised much before such calculus was invented. Fire risks or theft and shipwreck risks are roughly classified to make possible their consolidation. Their insurance is not based on some accurate probability calculation; nevertheless, it is made convenient by its low cost relative to the damages that the occurrence of those events would cause. On the contrary, it does not make sense to insure the casual events concerning dynamic competition among firms, notwithstanding the entrepreneur takes great care to measure the variability of expectations (or uncertainty), as just seen. The imposition by law of insurance for the benefit of creditors of bankrupt firms may be imagined, but not insurance aimed at avoiding bankruptcy: that will contradict dynamic competition, as we shall see soon. The insurance of firms’ losses is made senseless not by the impossibility of measuring business uncertainty but the peculiar content of the dynamic competition process. As we know, this process is made active by the search for profit opportunities, i.e. the tendency to use entrepreneurial skills to get profits. But insurance against firms’ losses tends to erase profit and implies the renunciation of the entrepreneurial role, making the entrepreneur similar to a foolhardy gambler: to cover insurance costs, he would look for ill-­considered opportunities of profit and this would cause the rise of insurance costs, distort entrepreneurial function and hence push such a gambler out of the market. In conclusion, the non-­insurability of firms’ results is not a consequence of the impossibility of measuring uncertainty, but of the fact that business need the competence, i.e. the judgement, intuition and responsibility of decision maker in

142   A. Fusari facing uncertainty. The insurance of firms’ losses would distort the role and use of those indispensable skills; so that these false entrepreneurs would be defeated by the competition of more genuine entrepreneurship. Radical uncertainty is a result of innovation in the context of the dynamic competition processs.3 This is the key of its explanation that, in turn, allows the explanation of entrepreneurship, its role, use and formation. More precisely, uncertainty is explained by radical process innovations and their diffusion, radical product innovations and incremental innovations. Economics and empirical research attempt to remedy the supposed non-­ measurability of uncertainty through the estimation of expectations. But, even if uncertainty implies expectations, their estimation is a completely different matter from the measure of the degree of uncertainty. Expectation, and the notion of subjective probability (i.e. the degree of confidence that an agent attributes to the fact that some event may happen) expresses hope, more or less well founded, while uncertainty simply indicates a limitation of knowledge, so that its measure simply gives the degree of ignorance. Expectation is, in a certain sense, a pretension of knowledge, while uncertainty is an expression of cognitive impotence. In sum, uncertainty expresses an affliction caused by the limitation of knowledge while, on the contrary, expectation is an attempt to penetrate the fog of cognitive vagueness, a way to react to uncertainty. Due to these differences, the effects of uncertainty on economic variables are different from those of expectations; the two take different roles in the economic process. We shall see that a way of measuring uncertainty is offered by the changes of opinions of firms. This volatility of expectations is just the opposite of expectations since expresses their violation. Economics has proposed some analytical expressions to estimate expectations: static expectations, adaptive expectations, and rational expectations. These expressions give some arbitrary and oversimplified formalization. The study of their accuracy, for instance a sensitivity analysis of the effect of changes or errors in the parameters of those expressions, is referable to uncertainty. Expectations probably represent the most important aspect of entrepreneurship; their content results in entrepreneurial coupe d’oeil, intuition, talent and experience, so that each entrepreneur has his proper expectations. Uncertainty is another thing; it has to do with the variability of results and it can (and must) be explained and measured. We shall see that the postulate of the non-­measurability and non-­explicability of uncertainty causes great equivocations and deprives economists of an indispensable variable to represent the economic process with realism. Innovation, endogenous time and the dynamic motion of the economy. The cycles of process and product Economic dynamics is primed by innovation, that is, the introduction into practice of inventions that can be the result of discoveries sometimes made many decades before. But in the present time invention and innovation are, for the

Innovation, uncertainty, entrepreneurship   143 most, tightly linked each others in the context of the research and development practised by modern firms. Of course, many kinds of innovation may come to light. Here we limit ourselves to a main distinction which is of a great analytical importance: radical innovation that, from time to time, gives rise to completely new products as well as radically new organizational or technical processes and hence to an economic and behavioural revolution; incremental innovations, improving existing products and processes, that accompany the diffusion of the main innovations.5 It may be useful to underline that here the new processes are intended both with reference to technical and organizational aspects (that Schumpeter considered separately); for its part, the concept of new product can be extended to include the Schumpeterian discovery of new markets. The explanation of innovation must focus on entrepreneurship and uncertainty, as previously shown in the treatment of dynamic competition process. Innovation implies a notion of endogenous time. This differs both from time intended as an absolute exogenous variable, in the Kantian sense, and a relative variable in the sense of Einstein/Minkowski or thermodynamics (Prigogine, Georgescu-­Roegen). Our endogenous time also differs from the Darwinian evolutionary perspective, this being an extremely slow natural mutation-­selection process and hence it does not shows true leaps. The endogeneity of time in this analysis may be interpreted as stating that a new time starts when radical innovation appears. In the formalized and simulated model that will follow, endogenous time will appear in the diffusion, through a logistic (or a Gompertz function), of radical product innovation, while in the diffusion of radical process innovation, endogenous time is implicit in the ‘memory’ of a Gamma distribution. The leaps caused by the apparition of innovations are formalized through switch functions. As we noted in the paragraphs on dynamic competition and uncertainty, the entrepreneurs’ search for profit is at the heart of the innovative process. In particular, the push to innovate depends on the persistence of negative profit rates (innovate or perish), a low degree of radical uncertainty, the excess of entrepreneurship and the improvements stimulated by radical innovations; while product innovations are also stimulated by the difficulty of selling the existing products and the inequalities in income distribution. An important consequence of innovation, i.e. breaking the existing equilibrium, is a push to radical uncertainty (to be distinguished by probabilistic certainty) that reinforces the entrepreneur’s role. The development process is obliged to be an entrepreneurial one, both because it cannot do without innovation, its prime mover, and being obscured by the clouds of radical uncertainty. The interaction between innovation, uncertainty and entrepreneurship, in the context of the dynamic competition process previously discussed, generates a cyclical behaviour promoted by the advent of new processes and new products. The cycle can be described as follows. Let us start from a cyclical phase characterized by the stagnation of production, low innovation and low uncertainty (since there is no variability of expectations and opinions, they are diffusely and firmly negative), and hence a high excess of entrepreneurship (depression). This situation and the associated decline

144   A. Fusari in profit rates will favour the rise of radical innovations (innovate or perish)4 and hence the beginning of a recovery of production and profit rates. During the depression, innovation operates both in the field of process and product; it privileges existing industries which can benefit from a more immediate push. But recovery sees a fall in the main process innovations in existing industries, while the advent of product innovation persists. The diffusion of radical innovation and the advent of incremental innovations following the radical ones will favour expansion, thus opening the door to a phase of prosperity. The associated economic expansion markedly reduces the excess of entrepreneurship and innovation, leading toward a break point: recession. The consequent decrease in profit rates opens the door to a new phase of depression with an excess of entrepreneurship. Such a mechanism is at the heart of the so-­called long waves.6 This cyclical motion is twofold, as distinguished by the adoption of new productive forms and techniques, with the associated increases in productivity; and the advent of new products, mainly new consumer goods. In parallel, the advent of new capital goods will strengthen the achievement of productivity increases. There exists an important nexus between both kinds of innovations: precisely, the advent of new products is pushed and made necessary by the increase in productivity due to process innovation; in fact, sooner or later, the demand for the existing goods will become insufficient to absorb the productivity increase. Pyka and Saviotti (2004) have pointed out this aspect. But their modelling is partial since it does not contemplate process innovation, notwithstanding these are indispensable to cause, through the productivity rise, the deficiency in the demand for existing goods that pushes product innovation. The advent of a new product and its diffusion according to a sigmoid function (the logistic or Gompertz curve) explains the product cycle that goes through the following phases: introduction of the new product in the market – acceleration of its demand – maturity, when demand stops to grow – decline, when consumers’ preference for the product starts to decrease. New products cause the increase of uncertainty in the existing sectors of consumer and capital goods. This interferes with the process innovations that precede, in some sense, the cycle of consumer products and, as previously seen, are promoted by the search for productivity increases. The formal model that will follow is aimed at providing a more stringent description than the previous one of the whole development process in the modern dynamic economies; the purpose is to give some substantial push to the research in this field afflicted by too much misunderstandings. The problem of fixed capital The stock of fixed capital is heavily influenced by innovation and by radical uncertainty, and accordingly deserves special treatment in a study focused specifically on these two phenomena; all the more so as present-­day analyses of fixed capital mostly ignore them. In particular, the disregard of both those crucial aspects is complete in the formalized general models of the economy hinged

Innovation, uncertainty, entrepreneurship   145 upon the accumulation process, such as the Walrasian model with capital accumulation and Leontief ’s input-­output dynamic model. To make evident the above limitation (and disregard), it may be useful to dedicate some detail to one of the most sophisticated analyses of the subject. Piero Sraffa and John von Neumann have inculcated the conviction that the problem of fixed capital can be adequately treated by recourse to joint production models. But it seems to me that despite their formal, mathematical elegance and complications, these models offer no advantage in the treatment of fixed capital. The claim that joint production models (i.e. the expedient of including capital goods inherited from the past among the products of the current year) permit the exact solution of the problem of depreciation is unfounded. It would be so only if the technique were immutable. But this is not so. The desperate battle of the neo-­Ricardian economists with their command of linear algebra against the difficulties of joint production in the name of the theory of capital resembles an attempt, with daring architectonical solutions, to construct an elegant building on foundations laid on clay. The clay that destabilizes the foundations of the neo-­ Ricardian analysis is the fact of technical progress, because when there is technical progress the rate of obsolescence has a decisive impact on the depreciation table.7 In this case the neo-­Ricardian method of calculating depreciation and the economic life of machinery by taking the technical coefficients, the physical life of machines and distribution quotas of income as given is incapable of yielding correct and reliable results. Treating fixed capital through the joint production model is in principle in no way superior to the Leontief method of defining a matrix each year of the amounts to depreciate alongside those of fixed and circulating capital. Indeed, this second method is formally simpler and corresponds better to real world practice. On the connected theme of the choice of technique the neo-­Ricardian school again seems to err on the side of excessive virtuosity. That is, the criteria of technological choice that it develops are solidly grounded only insofar as they deal with the problem of ‘truncation’, i.e. determining the economic life of machinery (but here too they fall into the difficulties set out above). The neo-­ Ricardian school posits that the technology considered has already been introduced (and the only question is to determine how to depreciate it) and that it is perfectly known. But when the question is whether or not to adopt a new technology, a number of complications arise that severely diminish the significance of the criteria for choice that the neo-­Ricardians set out. Precisely: once a technology has been introduced there is no turning back, even if the circumstances that induced the choice cease, wholly or in part, to obtain. The technology to be introduced is almost never perfectly known, given that the proportions between its input ratios generally develop and evolve in the course of its creation and depend on a large number of circumstances that are variable from case to case, and with which the businessman must grapple. The foregoing means that technological choices cannot be made on the basis of the analysis of the ‘factor price frontier’, since that frontier is unknown. This

146   A. Fusari implies that it is unadvisable to base decisions on small variations in profitability. The decision to introduce a new technology will be taken only if the prospective benefits are sufficiently great. In particular, these decisions will be taken according to much more empirical criteria of valuation than the neo-­Ricardians would maintain.8 In the presence of radical uncertainty (in this case, due to technical progress), the prices that are set necessarily rest on fragile bases, given the hypothetical nature of the charging of costs for amortization. In these conditions, one way of dealing with uncertainty (if the entrepreneur is endowed with a good nose for business and common sense) is to set a period for recovering the capital invested and to distribute over that period the depreciation/amortization quotas, either rigidly or flexibly depending on the circumstances, policies adopted, etc. Competition will ensure that this calculation by businessmen will approximate reality fairly closely over the entire period considered – when, naturally, the extra-­ profits from innovation (i.e. from successfully dealing with the sort of uncertainty posited by Knight or Schumpeter) are considered as a component of price.9 Our formulation of a model of dynamic competition that is mainly based on the interaction of innovation, uncertainty and entrepreneurship presents a simple specification in considering the impact of innovation and uncertainty on the stock of fixed capital. We express this through an adjustment equation to production, corrected with a term representing the negative impact of radical uncertainty on that adjustment. If we substitute for the term production in this equation its explanatory variables, we can see the crucial effects that play on the variation of the capital stock, entrepreneurship, profit rate, hence innovation, and again radical uncertainty. Thus we obtain a notion of fixed capital plainly linked to the critical phenomena that influence it in a dynamic economy that is powerfully affected by innovation and uncertainty. For its part, gross investment, considered as a component of demand, is explained in the model by the variation of net capital stock, plus the replacement of the worn capital, plus obsolescence (of existing equipment) due to the diffusion of radical innovations concerning capital goods.

5.2  A critical review Some equivocations and omissions of general economics 1   Economics has usually disregarded uncertainty. In particular, mainstream economics has grown as a theory of perfect knowledge. Coherently with this assumption, it has taken care to include only casual events expressing probabilistic certainty, i.e. well specified probability distributions, while it does not consider uncertainty, entrepreneurship, innovation or, in other words, dynamic competition. F.H. Knight was the first economist that insisted on the notion of uncertainty; he intended to designate by this term chance not implying some known probabil-

Innovation, uncertainty, entrepreneurship   147 ity distribution and hence non-­insurable and non-­transformable into costs. This author insistently underlines that both profit and entrepreneurial function are the result of non-­measurable uncertainty. That non-­measurability is the leitmotif of his main work. He writes: We restrict the use of the term ‘uncertainty’ to non-­quantitative cases. It is this ‘effective’ uncertainty, not risk, as we said, that constitutes the base for a correct theory of profit and gives account of the divergences between effective and theoretical competition. . . The essential principle of perfect competition that warrants, in principle, the results toward which effective competition ‘tends’, is the absence of uncertainty (in the true sense of non-­ measurable uncertainty). (Knight 1960: 18, 19) And so on. We have seen that one main task of economics and businessmen is to get a measure (and explanation) of the degree of uncertainty of expectations. Moreover, we shall see that it is in general quite easy to measure uncertainty by industry and size of firms.10 Knight insists on the uniqueness of the events representing uncertainty. As we said, a lot of events normally insured are unique. A theft and a fire are unique events; their grouping by homogeneous classes is always rather forced. A road accident is unique as connected to the ability of the driver. Notwithstanding, those events are, as a rule, insured. Knight writes in a note: ‘If in a particular case uncertainty is measurable, it can be substantially eliminated by grouping and consolidating a number of cases large enough to warrant certainty with respect to all the group’ (1960: 165). But we have previously seen that firms’ results are not insured because the entrepreneur must be charged with the final responsibility of decision making to be induced to decide accurately. It seems to us very important to insist on the falsity of Knight’s postulate of non-­measurability of uncertainty since it has caused great equivocations in economic thought, mainly a diffused hostility to (and a denial of ) the possibility of explaining radical uncertainty, as we shall see later more in detail. For this point may be clarified: it must be connected to the notion of dynamic competition that, as we know, has uncertainty at centre stage. More precisely, it is necessary to assert that it is not the non-­measurability of uncertainty that causes dynamic competition and prevents insurance; the opposite is true: dynamic competition is the central feature of the economic process and the engine of economic growth and development, which stimulates uncertainty and makes senseless the insurance of firms’ results. Knight does not treat the phenomenon of dynamic competition. At the basis of this omission there is a methodological misunderstanding, which is surprising in an author who dedicated great attention to method. Precisely, he confuses abstraction, necessary to any theoretical development, with the method of abstract rationality typical of logical-­formal sciences that uses postulates abstracting from reality; as such, they may upset the content of reality and lead to absurd

148   A. Fusari formulations. Knight treats the theory of perfect knowledge (pure economics) without seeing that the idea of perfect knowledge implies a total distortion of reality. He introduces the notion of uncertainty only to mitigate the hypothesis of omniscience, while accurately ignoring the crucial phenomenon of dynamic competition as this is inconsistent with the neoclassical approach. He states that the removal of the hypothesis of perfect knowledge implies only some non-­ substantial difference with respect to the neoclassical model of omniscience, and that such difference is expressed by the appearance of profit and losses. In sum, he limits himself to operating in a neoclassical context. His insistence on uncertainty represents an analytical advancement; but he refuses to see the irremediable fracture that uncertainty introduces with respect to neoclassical theory, mainly through the correlated phenomenon of dynamic competition. In effect, Knight’s contribution is aimed at conferring a realistic look to neoclassical economics; in this way, he gets honours and avoids being considered a heretic. In effect, the ability to confer to their strongly unrealistic approach a realistic look through some superficial manipulations is frequent among neoclassical students. 2   But reality cannot be suppressed. In fact, the phenomenon of uncertainty soon regained a first order position in economics with Keynes’ macroeconomic analysis. Keynes concentrated on the links among uncertainty, money, long-­term expectations and the connected volatility of investment and proved, on this basis, the phenomenon of the deficiency or excess of effective demand. This led him to show the importance of managing demand in facing the ghost of uncertainty. The Second World War, which caused an enormous expansion of public expenditure, offered a precious opportunity to prove the usefulness of that theory and the associated economic policies. Neoclassical students quickly integrated Keynes’ teaching into their theories, in particular through the Hicksian IS-­LM approach that accepts the idea of the non-­neutrality of money. But at the micro-­level persisted the hegemony of the Walrasian theory of general equilibrium, with its pretension to represent the whole economic system rigorously and in all details. That persistence was strongly supported by Knight’s teaching on uncertainty. Precisely, the exclusion from microeconomics of all the crucial features of modern economies represented by uncertainty, entrepreneurship and innovation, was considered, on the basis of Knight’s teaching, as an admissible simplification instead of an unacceptable distortion of reality. The confusion afflicting the method of social thought preserved by substantial criticism the majestic futility of Walrasian theoretical approach. As far as we know, nobody has insisted with the due energy (as Hasse Ekstedt does in this book) on the basic mistake of general equilibrium models, that is, their inspiration to the method of abstract rationality, typical of logical-­formal sciences: a method that leads to deduce, from purely nominalist postulates, some precise but useless and totally misleading consequences. Neo-­Ricardian criticism has limited itself to showing the inconsistency of the neoclassical aggregate function of production, but has not affected the substance of Walrasian microeconomics. Indeed, neo-­Ricardian animosity against neoclassical economics could not do more since it shared the basic neoclassical method-

Innovation, uncertainty, entrepreneurship   149 ology, that is, the method of abstract rationality, thus purging theory from uncertainty, entrepreneurship, innovation and hence dynamic competition, exactly like mainstream economics does. In effect, neo-­Ricardian students have formalized nothing more than a simple linear system of prices by industry. This, together with its dual counterpart represented by output equations, gives a general equilibrium model specified at the industry level and hence much more limited than neoclassical one. Its usefulness only concerns the statistical field. The above reference to general equilibrium models cannot omit a consideration on von Neumann’s system, representing another largely appreciated application of the abstract rationality method. Von Neumann substitutes, to neoclassical unreal hypotheses, some others no less unreal (the absence of scarce resources, strictly subsistence wages, equal rates of growth by industry); on this basis and using the duality relation between output and prices, he calculates a vector of prices that, being associated to the highest possible rate of growth, are considered some best efficiency parameters. All these general models of the economy share a basic lack: the absence of dynamic competition and the corresponding triad, that is, uncertainty, innovation and entrepreneurship. Their attraction only depends on being some brilliant mathematical toys. The fact that the models of perfect knowledge and stationary motion are coherent both with the prevailing method based on observation (and the connected hypothesis of repetition of events) and the method of abstract rationality has helped their acceptance. But both methods are non-­appropriate to social reality. The acceptance, by the main economic schools, of the above senseless methodologies has impeded a fruitful debate and the necessary revision. As is well known, the controversies between classical and neoclassical schools of thought were mainly centred on the problem of economic value and exploitation, and precisely the relations between prices and income distribution. But they did not achieve some important advancement in knowledge. What is worse, in such a field dominated by resentments and class conflicts, theoretical equivocations have caused dramatic consequences in practice. In particular, Marxism has associated with the fight against exploitation an extreme struggle against the entrepreneur and a market made plausible by the diffuse misconception of the phenomenon of uncertainty. Let us insist on this vicissitude constituting an important example of the absurdities that may be generated by human minds, even the sharpest ones, if deviated by methodological misunderstandings. 3    The Marxian interpretation of social and historical process offers, notwithstanding some serious errors,11 a superb theoretic monument if confronted by the analytical poverty of the models sketched above. Marx draws an analysis of capitalism magnifying the role of the market and bourgeoisie for the building of modern world. Such an interpretation could have favoured the development of a realistic and fecund economic theory; but, on the contrary, it has propitiated a real theoretical and operational disaster. What are the reasons for that? Marx, as an economist, was strongly influenced by classical thought; but much more by Ricardian than Smithian thought. In particular, Marx insisted on

150   A. Fusari the value-­labour theory and hence indicated the market and entrepreneur as major causes of the troubles of society. He concluded, therefore, that it is necessary to erase those institutions, as a condition of erasing exploitation.12 Marx’s Das Kapital shows some of the deepening characterizing the superb Marxian interpretation of history, more frequently in the second and third book of that work, where the sterility of Ricardian influence becomes evident. He ignores the problem of the concrete organization of socialist systems that commits to the ‘imagination of history’, coherently with his method swinging between naturalism and Hegel’s teaching. But a social order deprived by the entrepreneur and the market is obliged to be a centralized social system, like ‘real socialism’, and hence only suitable to a stationary society, that is antecedent to the stage of a modern dynamic society. If Marx’s economics had been more influenced by his historical analysis of capitalism than by the investigation of classical economists, probably he would have perceived the necessity, in modern dynamic societies, of the market and the entrepreneurial role (even if not necessarily in the form of the capitalist entrepreneur). All that should have appeared obvious to a student of historical process of Marx’s stature. What is the reason for his misunderstandings on the matter? Certainly the arid Ricardo’s teaching was not enough to confuse Marx. The roots of his mistakes are in his method that blends Darwin and Hegel’s teaching, a mixture which is disastrous for the analysis of social reality mainly because both these authors identify, for different reasons, real with rational despite the importance of reducing, in social reality, the distance between real and rational. Marx considered society in Darwinian terms, that is, as resulting from spontaneous evolution; at the same time, he considered, like Hegel, evolution as able to proceed with rationality and evolve toward paradise on earth. This position forbade Marx to think in terms of the organization of social systems, i.e. to investigate the institutional pillars requested by the general conditions of development typical of each historical age. In particular, this prevented him from understanding the importance of the entrepreneur and the institutional implications of uncertainty. Mainstream economics, which has not been invested by the Marxian-­ Darwinian–Hegelian methodological wave, has largely used, as previously seen, the method of abstract rationality. Sometimes those methodologies operate simultaneously, as it is witnessed by the neo-­Ricardian mixtures between Marxism and abstract rationalism, as well as by the mixture between naturalism and abstract rationality frequent in neoclassical thought. In this theoretical landscape, the hypothesis of perfect knowledge and neoclassical economics could consolidate their hegemony without difficulty. As a consequence, even the controversy on market socialism that occurred between the two world wars found almost natural to base itself on that theoretical paradigm. But the versatility of neoclassical theoretical approach to incorporate both centralization, as in Barone’s essay on ‘The Ministry of Production in Collectivist State’ (1971), and decentralization, as in Lange–Lerner–Taylor’s decentralized socialism where a simple rule for decision making substitutes for the

Innovation, uncertainty, entrepreneurship   151 entrepreneurial role, reveals the total unrealism of the approach. In fact, such a surprising possibility of generalization of the model derives from the fact that it ignores the crucial phenomena of entrepreneurship, uncertainty and innovation that is the dynamic competition process; so that it has nothing to do with reality. It is, therefore, not surprising that the debate on market socialism gave up in favour of the more realistic and useful Keynesian policies that made possible ‘social democratic compromise’. But some posthumous resurrection of Barone’s teaching took place in the 1960s and fed the Soviet Union’s illusion to warrant the efficiency of its centralized economy simply using optimization models. Finally, the total failure of real socialism made clear that its main vice consisted in the denial of some crucial necessities of modern dynamic economies, mainly the entrepreneur and market; it became clear that it was improper and foolish to oppose the two in the name of social justice, and that such opposition had given rise to a system of domination worse than the capitalist one. Unfortunately, the roots of wrong institutions cannot be rapidly extirpated; dominating interests always act as fierce defenders of them. 4    The analyses on market forms, mainly perfect and monopolistic competition and monopoly, added no clarification to the omissions and misunderstandings discussed above, in particular on the triad of uncertainty, entrepreneurship and innovation, and the notion of dynamic competition. Those static analyses were based on the shape of supply–demand curves, even if with some exception in the studies of oligopoly. But it is easy to see that the earthquake caused by dynamic competition destroys the graphical bases of those theories on market forms. Dynamic competition implies, among other things, different prices for identical goods or, more precisely, that one source of profit is the skill to get advantageous prices. Besides, dynamic competition implies monopoly prices on new goods, for the duration of the degree of the monopoly deriving from novelties. Of course, price variations in a competitive market are caused by the disequilibria between supply and demand that drive to the coordination of both. But what factors causes the variation of the supply and demand curves? This is the true problem, impossible to solve if the notion of dynamic competition and its components represented by uncertainty, entrepreneurship and innovation are ignored.13 Post-­Keynesian economics has extended Keynesian macroeconomics to the industry level, thus driving economic theory to a higher degree of realism. But it does not consider microeconomic level and dynamic competition. The post-­ Keynesian attempts to combine Keynes, Marx and Ricardo’s teaching have caused some strong equivocations as a result of the omission of that crucial problem. The vivacious criticism addressed to the Walrasian notion of equilibrium14 has not offered some formulation able to remedy the lacks of mainstream economics. Today the fragmentation of economics in a variety of schools of thought unable to interact dominates the scene. Such a fragmented and confused theoretical context has prevented some important intuitions (that we shall consider in

152   A. Fusari next paragraphs) to express useful synergies. In this theoretical landscape, neoclassical economics has been able to preserve the fascination deriving from its pretension to give a detailed and coherent representation of economic system. Various students of this school of thought have been clever to mask its unrealism, both at the macro level, for instance through the models of endogenous growth and the IS-­LM approach; and at the micro level, for instance, Clower’s removal of the Walrasian hypothesis that transactions take place at equilibrium prices, which has stimulated a proliferation of studies on the so called ‘non-­ Walrasian equilibrium’. A development even more elegant and innocuous was provided by Patinkin by introducing money in the Walrasian model of general equilibrium, so that eliminating (but only apparently) the breakage between the monetary and real aspects without violating the idea of the neutrality of money. For their part, Wald, von Neumann and Zeuthen’s contributions warranted the existence of economically meaningful solutions (non negative output and prices) of equilibrium models. Finally, the theorists of rational expectations have managed to specify a surreptitious form of perfect knowledge in spite of radical uncertainty. So, the neoclassical theory of omniscience, even if based on some absurd postulates and method, has succeeded in reinforcing its hegemony through astute patchworks and with the help of the errors of opponents. It must be recognized, however, that among all schools of economic thought, the neoclassical is distinguished by an admirable coherence. It has been a gymnasium of theoretical skills that may offer some important contribution as soon as a methodology more appropriate to economic reality has been defined. Now consider some formulations that may offer useful elements to build an economic theory able to bring on the scene the great absent: dynamic competition, to be placed at the centre stage of economics. Some important advancements: the missing link between the two faces of dynamic competition As previously seen, Keynes provided, at the macro-­level, a precious deepening on the question of uncertainty. But, in other aspects, this phenomenon has been misunderstood or neglected, mainly due to the influence of Knight’s analysis that held the consideration of uncertainty just as a refinement of the economics of perfect knowledge. Nevertheless, the problem of uncertainty was not long in returning to the fore and was subject to considerable deepening by Shackle and Davidson. They insisted on: crucial decisions and experiments; the world of order and inspiration; essential novelties and creative events; ergodicity and non­ergodicity of processes; and subjective and objective uncertainty. But the attribution of decisive importance to the limits of knowledge and to trial and error processes is to the merit of neo-­Austrian economics. The students of this school of thought have insistently underlined the links between entrepreneurship and uncertainty and the role of the market as a mechanism of information and discovery. In particular, they have insisted on representing economic competition

Innovation, uncertainty, entrepreneurship   153 as a result of entrepreneurial activity directed to benefit from the profit opportunities engendered by disequilibria, errors in decision making and the accidents which make economic life uneven. But neo-­Austrians are responsible for some unilateral exaggerations, in particular Hayek, who based an apologia of spontaneous order on the limits of knowledge. He forgets that the condemnation of Man to advance just by trial and error implies that it is important to find ways of reducing as much as possible the number of errors, mainly through interventionism and the building of some organizational forms suitable to dynamic reality. Probably the most enlightening teachings on uncertainty in neo-­Austrian economics are due to Kirzner’s work, mainly his development of ‘market process’. He delineates a realistic and effective, even if incomplete, representation of the process of economic production and competition based on entrepreneurial alertness in taking profit from the opportunities offered by economic reality and the inevitable failures of forecasting. Unfortunately, Kirzner’s analysis explains only one half of the process of dynamic competition, the one concerning adaptive entrepreneurial action directed to take advantage of the existing profit opportunities that, as we saw, tend to erase profit. Kirzner neglects entrepreneurship directed at creating new profit opportunities through innovation. Indeed, he makes some attempts to remedy this lack by dividing entrepreneurial process by two components: entrepreneurial short-­run competition and entrepreneurial discovery concerning the long run. But Kirzner limits himself to emphasizing the discovery of the existing opportunities, not the creation of new opportunities.15 He substantially ignores entrepreneurial action that engenders uncertainty and disequilibria thus giving rise to arbitrage and market process. In sum, Kirzner disregards specifying radical innovation or, more generally, the dynamic aspect of competition process, and hence ‘endogenous’ uncertainty. A promising way to remedy this shortcoming and try to complete the representation of the dynamic competition process may consist in marrying Kirzner’s market process to the Schumpeterian ‘creative destruction’. Unfortunately, neo-­ Austrian and Schumpeterian teachings remain two separated branches of investigation, notwithstanding they are strongly complementary. They make two opposite errors: the substantial absence of consideration of innovation, which is typical of neo-­Austrians, and the substantial Schumpeterian absence of consideration of uncertainty.16 In particular, Schumpeter does not attribute any importance to endogenous uncertainty that is produced by the economic system, notwithstanding such endogeneity clearly springs off his notion of ‘creative destruction’. This omission has determined the most surprising Schumpeterian error: the forecasting of the exhaustion of entrepreneurial function17 and the advent of socialism through big business. The error was repeated by J. K. Galbraith in The New Industrial State that diagnosed the convergence between capitalism and socialism through the managerial firm.18 A superficial consideration of uncertainty would have been sufficient to show the authors the great obstacle that such a phenomenon opposes the centralization of decision making. It is surprising that the above two approaches have not been unified so as to supply a proper theoretical analysis of the great absent: dynamic competition.

154   A. Fusari The missing link that has prevented an effective and persuasive representation of dynamic competition process, starting from the above neo-­Austrian and Schumpeterian contributions, is represented by the exclusion from economics of a variable expressing the dimension of true or radical uncertainty and the explanation of this. In fact, the representation of the interaction between innovation and adaptation requires the expression of the endogenous variations of the level of uncertainty. Those variations cause: a) the rise of entrepreneurial adaptive action when uncertainty (and disequilibria) grow together with the connected profit opportunities; b) the rise of innovation when uncertainty (and disequilibria) decrease due to adaptation process, since this decrease will make easier to innovate and will oblige to create profit opportunities through innovation. So that, the explanation of the level of uncertainty is necessary and it may allow to unify neo-­Austrian and Schumpeterian competition and, in this way, give a more complete and coherent formulation of the dynamic competition process and of the explanation of entrepreneurship. The mistaken Knight’s postulate of the non-­measurability of uncertainty, retained by economists with a surprising superficiality, and the connected diffusion of the idea that radical uncertainty cannot (and must not) be explained, have obstructed such a development. For better evidence of the persistent separation in economics of the two branches of dynamic competition, innovation and adaptation, it may be useful to quote the opinion that Kirzner has recently expressed to me on the matter in private correspondence dated 7 December, 2006. He said: I realize, of course (and this was one of the purposes of my ‘Creativity and/ or alertness’ paper), that there are differences between the kinds of innovation Schumpeter had in mind, and the entrepreneurial ‘discoveries’ which I had insisted were the steps in the process by which Schumpeter’s ‘imitators’ tend to bring about equilibrium. . . I am reminded of Samuelson’s imagery of the Schumpeterian process as similar to a violin string that has been plucked into vibration (by innovation), subsequently returning to its quiescent state (through the imitators) – except that you postulate that the very quiescence of this state stimulates further innovation, etc. etc. . . You imply that a reduction of uncertainty stimulates the rate of Schumpeterian innovation. I have not yet seen any reasoning firmly leading to this conclusion. You seem to take it as obvious. Yes, it simply is an expression of the search for profit and is crucial for the specification of dynamic competition as given by the interaction of innovation and adaptation: when uncertainty and the adaptive opportunities of profit are low, there will be a stimulus to create opportunities of profit through innovation, easier to introduce in the presence of low uncertainty. The persistent lack of consideration of dynamic competition is surprising. This seems to be a result of the absence of a method of social theory appropriate to the basic character of social reality. Such a lack condemns economics to offer confusing teachings. These darken even the most obvious and elementary prob-

Innovation, uncertainty, entrepreneurship   155 lems through complicated and misleading formulations, with everybody claiming to be right in his own way. Now we come to consider some equivocations that affect the strong opposition of heterodox economics to the economics of perfect knowledge. The exaggerated success of the notion of bounded rationality and the associated attack to optimization The aversion to the economics of perfect knowledge has grown with the acceleration of economic dynamics and hence the rise of uncertainty. In such an intellectual climate, the notion of ‘bounded rationality’ has come to light and has enjoyed rapid success due to its usefulness in opposing neoclassical perfect rationality. Unfortunately, that notion is undermined by numerous equivocations that need to be clarified. In every field of life, Man is forced to go ahead by trial and error. In the study of nature, human bounded rationality is particularly evident being that reality not the work of Man and hence difficult to understand. The difficulty of understanding social reality is different, this being darkened by the fact that it is a result of the interaction of a lot of human actions and creative events. But this difficulty is better expressed by the term uncertainty or limited knowledge than by the expression ‘bounded rationality’. In effect, human skills and rationality are always bounded by definition, i.e. due to the limits of human knowledge. An interesting definition may consist in the notion of ‘cognitive rationality’ that underlines the learning process connected to the use of human rationality (see Morroni 2006). This process requires a measure of the degree of uncertainty to express the formation and use of entrepreneurial skills, and to define the constraints of the cognitive process, as we shall soon see. It must be recognized that the notion of bounded rationality has promoted some useful deepening on cognitive processes, in conjunction with Michael Polanyi’s research on ‘tacit knowledge’. Unfortunately, that notion almost neglects the dynamic competition process, notwithstanding this represents the backbone of the economic process in the presence of limited knowledge. Therefore, the notion of bounded rationality fails to explore the soil feeding the roots of the limits of knowledge. What is more surprising in the economics of bounded rationality is that it does not seem to understand the crucial importance of considering the level (and hence a measure) of the factor on which the limits of rationality depend, that is, the degree of radical uncertainty. This omission has implied the denial or the darkening of the possibility to explain uncertainty, suffocates the potentiality of this branch of heterodox economics and prevents, as just seen with reference to neo-­Austrian and Schumpeterian teachings, the formalization of the phenomenon of dynamic competition. It seems, therefore, sensible to ask to the growing number of students insisting on the notion of bounded rationality: what prevents you from seeing the importance of a measure and explanation of the factor expressing the limitation of rationality that is the level of radical uncertainty? The economists who insist on

156   A. Fusari bounded rationality disregard the question of the accuracy of expectations. But their negligence in producing a measure and explanation of the volatility or variability of expectations is a surprising omission. This volatility is, at the same time, perfectly coherent with the notion of bounded rationality and gives a possible measure of the degree of radical uncertainty. The galaxy of theories constituting the so-­called ‘heterodox economics’ testifies to an enormous analytical fragmentation that prevents the unification of efforts and results. One of the few aspects shared by heterodox students is the disputation with mainstream economics. But this convergence is afflicted by exaggerations and equivocations. In particular, the disputation has obscured, mainly through some abuse of the expression of ‘bounded rationality’, the important fact that Man is obliged, by his interests and competition, to use to the best his rational skills, just like the optimization procedure maintains. It has been erroneously assumed that optimization presumes omniscience, an assumption that indeed would imply that Pontryagin’s and Kantorovich’s work is pointless. Kirzner has written: Where the circumstances of decision are believed to be certainly known to the decision-­maker, we can ‘predict’ what form that decision will take merely by identifying the optimum course of action relevant to the known circumstances. Now this ‘mechanical’ interpretation of decision-­making would be entirely acceptable for a world of perfect knowledge and prediction. (Kirzner 1973: 33, 37) This assimilation of optimization to neoclassical economics is mistaken. Optimization does not require perfect knowledge; it is only a tool for decision making that often is more rational than others. Perhaps it would be much more enlightening to hinge the polemics against neoclassical thought on the notion of uncertainty than on that of bounded rationality. The father of bounded rationality, Herbert Simon, opposed the principle of ‘satisfying behaviour’ against optimization. But this principle is vague and can be variously interpreted, mainly with reference to the levels of aspiration and satisfaction. For their part, Nelson and Winter write: Orthodoxy treats the skilful behaviour of the businessman as maximizing choice and ‘choice’ carries connotations of ‘deliberation’. We, on the other hand, emphasize the automaticity of skilful behaviour and the suppression of choice that this involves. Formal orthodox theory, on the other hand, does not rate solutions as maximizing because they are better than some other observed solutions, but because they are the best feasible solutions. (Nelson and Winter 1982: 94) All seem s to show that the hostility against optimization is mainly due to two prejudices. First, the habit of connecting the optimization principle to the

Innovation, uncertainty, entrepreneurship   157 hypothesis of omniscience, that is, perfect knowledge, thus forgetting that such a principle is simply a mathematical tool that does not need that hypothesis. Second, the postulate of non-­measurability and non-­explanation of uncertainty, that is the denial of the possibility of defining an endogenous variable expressing the degree of limitation of knowledge; this denial prevents the possibility of formalizing an optimization model including both uncertainty and the availability of entrepreneurial skills and hence the tension in the use of these. In fact, to define the above availability and tension, a measure and explanation of the degree of uncertainty is needed. Firms are forced by competition, more than other subjects, to act rationally as much as possible. This implies that firms’ competition drives to optimization; but this only means that optimization gives better solutions than other procedures. In sum, an aprioristic refusal of optimization is not wise, this being able to supply a better rationality criteria than other decision-­making tools. All that is quite simple and evident. The main reason obscuring this banal evidence is (let us repeat) the conviction that uncertainty is something impalpable and, as such, inconsistent with optimization: a conviction that inclines them to consider the decision-­making technique represented by optimization as only referable to the absurd hypothesis of perfect information. The result is that, while neoclassical economists tend to strongly exaggerate human knowledge on the basis of the hypothesis of perfect knowledge, their opponents make an opposite exaggeration: the postulate of non-­measurability and non-­explicability of uncertainty that prevents obtaining important knowledge and urgent analytical development. An ambivalence of economic and institutional evolutionary thought: entrepreneurial skills and decisional routines The notion of evolution strongly influences modern economic thought and the analysis of institutions, in connection with the insistence on the limits of knowledge or radical uncertainty. Unfortunately, the use by economics of the evolutionary metaphor of biology is afflicted by ambivalence. From the one side, Hayek and neo-­Austrians underline the limitation of knowledge as a support to the idea that economic process and the evolution of institutions are the result of spontaneous behaviour; as a consequence, they strongly dislike ‘organization’, to which they oppose ‘spontaneous order’, and hence are inclined to neglect the problem of the firm. On the contrary, institutional students emphasize organization and utilize the notion of uncertainty to explain institutions and hence the firm. For the understanding of these aspects, some consideration on Nelson and Winter’s contribution may be useful.19 The development of these authors is mainly based on Schumpeterian work; this has prevented, for the reasons indicated in the previous paragraph, the adequate representation of the dynamic competition process, which should be at centre stage of heterodox economics. Nelson and Winter’s analysis shows, however, some differences with respect to Schumpeter that are opportune to underline.

158   A. Fusari Evolutionary economics does not neglect uncertainty; but it incorporates it in the notion of bounded rationality and considers unquestionable the postulate of non-­measurability of (and the impossibility to explain) uncertainty. Unfortunately, this postulate and the consequent setting aside of the optimization principle engender a vague theoretic atmosphere. A main remedy of evolutionary economics to that vagueness is the notion of ‘decisional routines’, intended to provide a solid conceptual basis to decision making: some evolutionary economists have assimilated decisional routines to biological genes. Here it appears again the methodological inappropriateness of the postulate of the non­ measurability of uncertainty. In fact, it is mainly due to that postulate that this branch of economics separates entrepreneurial function from uncertainty in the context of the notion of routine. But the various developments on routines do not provide stringent empirical and conceptual formulations;20 they presume some very simple decisional rules emphasizing the automaticity of decision making; but this is inconsistent with the entrepreneurial role and hence does not allow the explanation of entrepreneurship. Nelson and Winter intend routines as organizational memory, as a form of tacit knowledge in Michael Polanyi’s sense. They consider routines as the most important storage of organizational knowledge. The firm’s behaviour should be explained through the routines used and approximately it should be expected that in the future the firm will behave similarly to the past, the change in routines being obstructed by the consequent fracture of equilibrium and organizational compromises. But entrepreneurship is inconceivable and inexplicable if separated by radical uncertainty However, innovation in the rules of decision making is considered possible and important. It must be stressed that the notion of routine has nothing to do with entrepreneurship. This is mainly a skill to meet uncertainty, while routine means repetition and hence implies bureaucratic skills. Heterodox analyses have dedicated a good deal of work to organizational skills, but they say very little on entrepreneurship. Entrepreneurial decisions, mainly the most important of them, do not follow any precise rule. The various branches of heterodox economics, in trying to reduce, through the notion of routine, the indeterminacy deriving from the notion of bounded rationality and from the postulate of the non-­measurability of uncertainty, forget the flexibility and versatility of entrepreneurship. Egidi and Narduzzo have empirically shown that the use of routines that were effective in the past may cause systematic decisional errors. It is our opinion that the analytical indeterminacy of entrepreneurial decisions cannot be faced through the reference to some precise decisional rules; it requires venturing upon uncertainty, this representing the sea where entrepreneurship acts. More precisely, it is important to define some criteria allowing us to measure and explain the level of radical uncertainty and its variations, so as to provide both a more solid basis for decision making and some analytical developments on the formation and the use of entrepreneurial skills, on innovation, disequilibria, adaptation, in brief, on the dynamic competition process. It must be noted, however, that the growing attention dedicated to uncertainty and to the limits of knowledge has stimulated, among evolutionary students and

Innovation, uncertainty, entrepreneurship   159 in opposition to spontaneous evolutionism, some interesting developments on organization, mainly in the field of the firm. We saw that uncertainty requires some peculiar institutional forms. In this light, it is relevant that the firm has been indicated, by the economists of ‘transaction costs’, as an organizational necessity since it reduces uncertainty due to those costs by introducing hierarchical command mechanisms to the market. This theory is important; but it explains less than supposed, mainly on the firm dimension. In fact, the increase in firms’ size, while on the one hand reducing the proportion of market transactions, and hence the uncertainty caused by the incompleteness of contracts, on the other, the connected bureaucratization of decision-­making reduces the capabilities to face the unknown. Of course, it is possible to remedy that inconvenience through decentralized organizational forms. But this possibility is opposed by the inevitable centralization of last instance responsibility. Besides, the strategies devoted to reducing uncertainty are weakened and opposed by the fact that entrepreneurial innovation engenders uncertainty. The dimensions of the firm seem mainly influenced by the quality and quantity of available entrepreneurial skills and uncertainty, which determine respectively the potentialities of those skills and their demand. In conclusion, the best way to treat radical or true uncertainty seems to introduce explicitly it into the models for decision making so as to estimate its impact on strategic choices and some other important variables, instead of setting uncertainty aside on the basis of the hypothesis that it cannot be measured and explained. Neoclassical students, clever to scent the wind and with the purpose of improving the realism of their theories, have suggested introducing into optimization models the preservation of the skill to face uncertainty. But this idea and the others concerning uncertainty need a variable expressing its level, a possibility denied by the postulate of non-­measurability (and non-­explanation) of radical uncertainty. Such a postulate seems to represent a principal obstacle to the building of an economic theory able to conjugate uncertainty, entrepreneurship and innovation and to define the way uncertainty influences (and is influenced by) entrepreneurship and innovation. The representation of the dynamic competition process and economic development requires the abolition of that postulate. There exists a tight link between entrepreneurial skill and uncertainty; in fact, in the absence of radical uncertainty, there would be no need for (and no formation of ) entrepreneurship. As the notion of dynamic competition shows, the entrepreneur meets uncertainty, but also generates uncertainty through innovation. Entrepreneurial capabilities are mainly a result of ‘tacit knowledge’ (learning by doing, by watching and by using) and of innate skills. These capabilities vary, therefore, with experience. It follows that, even if one main characteristic of them is versatility, the operational experience confers to skills some degree of specialization that restricts their field of competence.

160   A. Fusari

5.3  Formalization of our model of dynamic competition Some limitations of econometrics and the definition of a measure of uncertainty In the last 50 years, sophisticated econometric methods have been developed, sometimes using some impressive mathematical techniques. A dominating conviction is that those methodologies are founded on assumptions and procedures able to achieve universally valid results. But the opposite is true. In general, econometric estimations may be referred only to the past or, more precisely, to the considered observation period, not to the future. Some limited and cautious application to the future may be justified if there exist reasons to think that the considered phenomena are long lasting. But how to prove this property of phenomena? An important way to do that may consist in determining if they result from the existing general conditions of development. In this case, the high durability characterizing those conditions should warrant a parallel durability of the corresponding phenomena, these being an expression of those conditions of development that impose corresponding organizational structures for reasons of coherence and efficiency. Well, dynamic competition and its constituent triad, that is, uncertainty, entrepreneurship and innovation, are basic durable aspects of modern dynamic economies. Even if the parameters resulting from the connected estimation may vary over time, those variations do not destroy the explanatory power of the estimated relations. To get hold the ghost of uncertainty, more than one quantitative indicator of this variable must be defined. We have specified and experimented three criteria of measure. One has been derived from the EU-­ISAE surveys on business tendency and consists in the measure of the variability over time of the answers, i.e. the volatility of the opinions (concerning the expectations on delivery orders, production, prices, and cost of financing and liquidity assets) of each firm of the utilized sample. Another indicator has been provided through the inclusion of an apposite question on uncertainty in an ISAE survey for some recent quarterly returns starting from April 2004. Another measure of uncertainty could be derived from the deviations between expectations and results in the EU-­ISAE surveys. A peculiar indicator of uncertainty may be given by the standard deviation of profit rates across firms; in fact, in the absence of uncertainty and of institutional monopolies, profit (and hence its standard deviation across firms) would be zero: differentials in capabilities and the associated profits are conceivable only in the presence of limits to knowledge (true uncertainty); for this reason, the variance of profit rates across firms may be intended as an expression of the limits of knowledge and hence of uncertainty. This indicator is particularly suitable to the representation of dynamic competition process and business cycle.21 Some other indicators of uncertainty may consist in the specification, by surveys, of a minimum-­maximum range of expectations, with the distance between the minimum and maximum expectation that may be considered as an

Innovation, uncertainty, entrepreneurship   161 expression of the degree of uncertainty. Also the standard deviation of foresights may be interpreted as a measure of uncertainty. As is well known, uncertainty displays some very important effects on irrevocable choices and hence on investment. In order to improve the explanation of investment, some studies22 have proposed to specify the laws (or costs) of learning in getting information if decisions are postponed, so that one may estimate the convenience of postponing the decisions to invest. But the hypotheses concerning those laws and costs are, in general, scarcely realistic. Uncertainty discourages investment in a different and more direct way. Precisely, high uncertainty suggests the postponement of investment for at least two reasons: the waiting for a more serene atmosphere and the increase in the use of entrepreneurial skills in ordinary activities, requested by the increase in turbulence. This makes the degree of uncertainty an important explanatory variable of investment. Unfortunately, econometric estimations using some proper indicators of the degree of uncertainty are rare. In the model that will follow, radical uncertainty influences, directly and indirectly, the variation of capital stock and hence gross investment. Mathematical specification of the model The formal model hypothesizes the maximum level of sectoral disaggregation (one sector for each good); but the exposition is accompanied by the reference to a much simpler model (used by the quantitative analysis) that allows the eliminate of the complication due to the presence of some matrices. The use of logarithms and of some adjustment equations should not give rise to real difficulties to the reader. In the model representation that will follow, the variables are preceded in general by ln (the notation for a natural logarithm) as this makes the model presentation more understandable to non-­specialists.23 At the heart of the model there are innovation, uncertainty and entrepreneurship, the relations among which express, as we know, the phenomenon of dynamic competition, so that a main content of the formalization below is the endogenization of those three variables It may be useful to remember, for a proper understanding of the model that will follow, that one main feature of our analysis is a treatment of innovation outside the notion of production function since this strongly constrains and substantially obstructs the study of innovation by economics. As a matter of fact, production function is appropriate to consider the productive contribution of labour and capital in a stationary economy, but not to analyse innovation that represents a qualitative jump of the system. Therefore, in this model production equations differ from the usual ones derived by a production function. A main complication is imposed by a proper specification of innovations: the use of a Dirac function δ and its reciprocal 1-δ, such that δ = 1 if its argument is ≥ 0 otherwise is δ = 0 (therefore 1-δ = 1 if its argument is < 0). This allows one to specify the qualitative jump (and discontinuity) expressed by the advent of radical innovation. More precisely, it is intended that a radical process innovation will

162   A. Fusari happen if the argument of δ (i.e. the function for the increase in productivity due to radical innovation, minus a trigger value kPrR) is ≥ 0; or, in other words, if the specified explanatory function is not lower than the specified trigger kPrR, while a radical product innovation happens if M (a value given by the difference between the equation explaining the advent of a new product and a trigger or threshold value km) is positive. Therefore, the advent of a new product is specified by multiplying the relative variable by (1-δ)(-M) which (according to the definition of δ) is equal to 1 if M is positive, otherwise = 0 this implying the absence of the variable (i.e. of the product innovation). The model can be referred to n sectors producing consumer goods, m sectors producing capital goods, g new consumer goods and h new capital goods; therefore, the model formalizes, for each endogenous variable, four groups of n, m, g and h equations, with n, m, g and h that may be intended as expressing a complete disaggregation of the economy: one sector for each specific merchandise. But the model that we use for simulation is formed by 5 sectors: one for consumer goods, one for capital goods and three new sectors expressing product innovation, one for new consumer goods and two for new capital goods. The micro-­level is not considered here. A previous model published on the Journal of Evolutionary Economics (Fusari 2005b) was extended to the firms’ level; but it considered only process innovation, not product innovation. Its combination with the sectoral model that will follow may give an idea of the extension to the micro level.24 The distinction between consumer goods and capital goods has been suggested by the different way innovation operates in both sectors, mainly by the fact that capital product innovations stimulate process innovations in the sectors utilizing the new capital goods and also stimulate investment i.e. accumulation process.25 The derivative of the logistic is used to represent the diffusion of product innovation across sectors, while a gamma distribution is used to represent the diffusion across sectors of radical process innovations. The initial time when the logistic starts to operate is endogenously given by the advent of radical innovations (endogenous time). The initial values of productivity of radical process innovation and incremental innovation is set = 0, so that the level (accumulation of the variations) of those variables gives the increases in productivity generated by both kinds of innovations. Some scaling parameters (λ) have been included in the adjustment equations. All variables, except Г, γ, M, u, r, R are expressed in natural logarithms so that their derivatives indicate variation rates. For the sake of simplicity, we usually attach, in each group of equations, the same parameters to each explanatory variable; but, in principle, the parameters could (probably should) be different. The interdependent equations system formalized below includes only three exogenous variables, interest rate, labour supply and ordinary time. Twenty-­five groups of equations have been specified, one for each endogenous variable. Simulations with five sectors are carried out.

Innovation, uncertainty, entrepreneurship   163 The first group of equations, concerning production, gives the formalization of all equations, i.e. concerning n+m+g+h goods, while the subsequent groups are limited, for brevity, to the first n goods, if the other equations are similar. List of variables Endogenous

X K PrR(f )

Production (at constant prices) Stock of fixed capital (at constant prices) Productivity of radical process innovation (f means firm, i.e. individual innovator) SW Variable that singles out the advent of a radical process innovation K Stock of fixed capital (at constant prices) PrI Productivity of incremental innovations G Gamma distribution for the diffusion of PrR γ Variable to reduce the second order derivative concerning G to a first order one M Variable that singles out the advent of a new sector (a new good) Pr Productivity of labour (VA/L) w Nominal wage rate PRE Prices u Radical uncertainty CON Consumption (at constant prices) I Gross investment (at constant prices) KD Demand of each pre-­existing capital good ND Demand of new goods ti and tj Endogenous time due to the advent of innovation (for instance, used for the diffusion of innovations through a logistic) CT Average consumption level in a specified number of recent years XT As above, for production of pre-­existing consumer and capital goods KDT As above, for the demand of pre-­existing capital goods R As above, for profit rates Es Supply of entrepreneurship Ed Demand of entrepreneurship MKP Flexible markup (precisely 1 + markup margin) L Employment VA Value added (at constant prices) r Profit rate (exceeding the interest rate on invested capital) Exogenous

ir Interest rate Ls Labour supply, varying according to a time trend t Ordinary time

164   A. Fusari Other symbols TI Transition matrix of investment from sectors of utilization to sectors of origin TK Transition matrix of capital from sectors of utilization to sectors of origin Kd Diagonal matrix of net fixed capital (at constant prices) ln Natural logarithm D Derivative with respect to time (the derivative of the natural logarithm of a variable gives the variation rate of that variable, e.g. DlnX = DX/X) EXP Exponential k(Prr) Threshold value for the advent of a radical process innovation k(M) Threshold value for the advent of a new product Q Total productivity increase due to radical process innovation (it might be explained by the R&D expenditure) e Unit column vector μ1 Depreciation rate of capital (worn out capacity) η Degree of obsolescence as a percentage of new capital goods v Technical coefficient (linking VA to X) a Adjustment parameter b Other parameters δ Switch function (Dirac variable) λ Scaling parameter a Constant term Indexes and subscripts ‘ i j (n)i (n)j

Symbol indicating partial equilibrium variables in adjustment equations Suffix indicating consumption goods Suffix indicating capital goods Suffix indicating new consumption goods Suffix indicating new capital goods

When the equations for sectors i, j, (n)i and (n)j are similar, they will be specified only for sectors i. In the simulated model, i=1, j=1, n(i)=1, (n)j=1; 2; that is only one consumer goods sector, one capital goods sector, one new consumer good and two new capital goods are considered. For product innovations, we do not use the distinction between radical and incremental ones. Their degree of importance can be determined in note 5. Model equations 1   P roduction

DlnXi = b1ri + b2 (lnEsi- lnEdi) + b3lnCONi

i = 1,…n

DlnXj = b1rj + b2 (lnEsj-­lnEdj) + b4lnKDj

j = 1,…m

Innovation, uncertainty, entrepreneurship   165 DlnX(n)i = (1-d)(-M(n)i)b45DND(n)i

(n)i = 1,…g

DlnX(n)j = (1-d)(-M(n)j)b46DND(n)j

(n)j =1,…h

The variation rate of production is expressed as a positive function of the current profit rate and the excess of entrepreneurship; demand is an explanatory variable. As previously seen, production is a consequence of dynamic competition devoted to the search for profit, so that it is essentially pushed by profit rate. Precisely, in competitive activities, the variation rate of production can be expressed as DlnX = α(r – r*), where r* is a desired or partial equilibrium profit rate required to produce X units of output for given values of the excess of entrepreneurship (Es – Ed), with this variable that negatively influences the requested r*. α indicates the entrepreneurial alertness in taking advantage of the market opportunities. If actual profit rate exceeds the profit rate requested to produce the current level of output (r > r*) output grows, and vice versa if r 0, since an innovation reducing (or leaving unchanged) productivity is a nonsense and a mistake. Incremental innovation refer to those improving already existing processes. The first and second explanatory terms of the equation (uncertainty and the excess of entrepreneurship) respectively opposes and stimulates incremental innovations, The third explanatory term refers to the incremental productivity promoted by the diffusion of radical process innovation and is weighted by the excess of entrepreneurship that stimulates the introduction of incremental innovations made possible by the radical ones. 5   G amma distribution for the diffusion of the effects over time of radical process innovation

D2Gi = b15 b16(DlnPrRi – Gi) – (b15 + b16)DGi

Innovation, uncertainty, entrepreneurship   167 This equation can be reduced to a first order derivative (and hence the model to a first order one) by adding a first order identity DGi = γi with: Dγi = f(x) Where f(x) is the right hand side of expression 5. By substituting DGi in γi, we come back to the second order derivative in expression 5. The endogenous time is not explicitly present here; it is embodied in the ‘memory’ of the Gamma distribution. 6   T rigger functions expressing the advent of new products

DM(n)i = d[-b7ui+b8(lnEsi - lnEdi) - b9Ri - b17(lnCTi - lnXTi) +b18lnEsi - k(M)ii] DM(n)j = d[-b7uj + b8 (lnEsj - lnEdj) - b9Rj -b19(lnKDTj - lnXTj) + b20lnEsj – k(M) j] k(M) is a trigger value. These equations give the advent of new products, if the term in the square brackets is higher than or equal to zero. Such an advent is (negatively or positively) influenced by factors concerning the supply side (uncertainty, availability of entrepreneurship and its excess, profitableness) and by some pushes coming from the demand side; precisely, it is stimulated by the industry deficiency of demand in the average of recent years (saturation effect); for consumer goods, also an index of the inequality in income distribution (e.g. a Gini index, that cannot be specified here) could be considered in stimulating the advent of new products. We make the hypothesis that new consumer goods can only be originated by each one of the pre-­existing consumer goods sectors and new capital goods by each one of the pre-­existing capital goods sectors. But the above restrictive hypothesis would be eliminated if the distinction between consumer and capital goods is erased. In the simulated model, the decision to limit the specification to three new goods (two new capital goods) has required, in the third equation (for the second new capital goods) the summation of the trigger expressions of the two other capital goods sectors (one for the pre-­existing capital goods and one other for the new capital good previously appeared). 7   L abour productivity in each industry

DlnPri = Gi + DlnPrIi The sum of the diffusion of radical process innovations and of incremental innovations. A productivity increase not due to innovation may be added.

168   A. Fusari 8   N ominal wage rate

Dlnw = a1 ln(w’/ w) with lnw’ = β21 [ln∑VAi+j - lnSLi+j] + β22indexPREi + β23 ln SLi+j - β23(lnLs0 + β24* t) + λ1 This equation expresses the adjustment process of wage rate to the productivity of the economy, the inflation rate and the ratio between demand and supply of labour (this supply is supposed to grow exponentially over time, where the initial supply of labour is Ls0). α expresses, here and elsewhere, the delay implied by the adjustment process (a kind of time lag in continuous time). A better specification should add the wage equations of the new sectors, with an increased weight (on wages determination) of the demand and supply of labour in those sectors. In the equation, a main part of wages appears to have a distributive meaning (the distribution of average productivity) while the remaining part is due to labour demand and supply. 9   P rices

Remember that MKP = 1 + markup margin. DlnPREi = a2ln(PRE’i /PREi)

9.1

with lnPREi ‘ = β25(lnw +lnMKPi - lnPri ) + β26(lnCONi - lnXi ) DlnPREj = a2ln(PRE’j /PREj)

9.2

with lnPREj‘ = β25(lnw + lnMKPj - lnPrj ) + β27(lnKDj - lnXj ) Dln.PRE(n) i= (1-d)(-M(n)i)[a2ln(PRE’(n)i/PRE(n)i)]

9.3

with lnPRE’ (n)i = β28(ln w + lnMKP(n)i - ln Pr(n)i) DlnPRE(n)j = (1-d)(-M(n)j)[a2ln(PRE’(n)j /PRE(n)j)]

9.4

with lnPRE’ (n)j = β28(ln w + lnMKP(n)j - lnPr(n)j) The prices are intended to adjust to unit costs and/or to the excess of demand Since the consumer and capital goods prices equations may concern aggregate sectors, the expressions 9.1 and 9.2 includes one term for markup and one for demand, with β28 that is influenced by the weight of administered prices, while β26 and β27 are influenced by the weights of the competitive prices. b28 >b25 since the degree of monopoly and hence the markup is higher on new goods than the existing ones.

Innovation, uncertainty, entrepreneurship   169 1 0   R adical uncertainty

Dui = b29Гi+ b30 DlnPrIi + b31DlnPrR(f )i +β32∑DNDi - a2 Radical uncertainty is supposed to depend on both the increase in productivity due to the diffusion of radical process innovation and to incremental innovations; it also depends on a separate term for the apparition of radical process innovation, as well as on the variation of the demand for new goods (product innovation). The constant term means that, in the absence of innovation, uncertainty tends to decrease toward that due to exogenous factors. This would be better expressed by an adjustment equation. In the quantified model, the equations for endogenous uncertainty in the two sectors of new capital goods does not include the first and third term in the right hand side, since we suppose the absence of radical process innovation in those sectors, while the summation of DND is (of course) substituted by only one term DND in each equation and none DND in the equation for new consumer goods. 1 1   C onsumption

DlnCONi = a3 ln( CON’i / CONi) with lnCON’i = b33(lnw + ln∑Li+j+(n)i+(n)j) - b34lnPREi + λi Consumption is indicated to adjust to both total wage income and consumer prices.



1 2   G ross investment

Ii = DlnKiKi + μ1Ki + ηi∑X(n)j Gross investment is expressed as the sum of the increase in productive capacity, the depreciation rate of capital and the obsolescence indicated as a percentage η of the new capital goods. Of course, the same applies for the sectors j of capital goods, as well as new consumer goods and new capital goods. 1 3   D emand of pre- ­existing capital goods

KDj = TI*Ii+j+(n)i+(n)j The transition matrix TI from sectors of utilization to sectors of origin, relatively to pre-­existing capital goods, has i+j+(n)i+(n)j columns (i.e. the total number of sectors is n+m+g+h) and j (1...m) rows relative to the pre-­existing capital goods. I is a column vector of investment in each sector. The elements of

170   A. Fusari the transition matrix in the columns (n)i and (n)j cause great difficulties in the definition of the matrix: this should be redefined each year due to the advent of new capital goods. Also the explanation of the sectoral degrees of obsolescence (ηi) is not easy; of course, η are very low for the sectors of new goods. The difficulties above may be overcome if we put j = 1 (only one sector for pre-­existing capital goods (as in the simulations that will follows). In this case, the demand for capital goods is expressed by: 12’) I = ∑DlnKiKi + μ1∑Ki +η∑X(n)j Obsolescence can be easily expressed by a per cent η of the amount of demanded new capital goods (∑X(n)j). And the demand of pre-­existing capital goods can be expressed as: 13’) KD = I - ∑NDj that is, the difference between gross investment and the sum of new capital goods. 1 4   D emand of new goods

DND( n )i = (1 − δ)(− M )( n )i

Ciβ35β36 EXP[−β36 (ti − t °)] {1 + β35 EXP[−β36 (ti − t °)]}2

The right hand side of this expression is the derivative of the logistic. C is a final value of the variable and t° is one half of the duration of the cycle of product; in the simulated model, t° = 14. (1-d) (-M(n)i) marks, as is usual, the advent of the new goods if M is positive thus making this switch equal to 1; otherwise the whole expression 14 is zero (no demand for non-­existing goods). Of course, the logistic starts when the innovation appears, i.e. at time ti or tj (endogenous time) as equations 15 below state. An identical expression holds for (n)j. 1 5   E ndogenous time

Dti = (1-d) (-M(n)i)

(n)i = 1, 2...g

Dti = (1-d) (-M(n)j)

(n)j = 1, 2, ...h

That is, the endogenous time starts when M is positive (the advent of a new product, while for process innovations the endogenous time is implicit in the memory of Gamma distribution). Let us remember that in the quantified model (n)i = 1 and (n)j = 1, 2.

Innovation, uncertainty, entrepreneurship   171 1 6   C onsumption in recent years

DlnCTi = a4 (lnCONi - lnCTi) This equation (and the three that follow) come from the expression for ­distributed lags attributing a weight of 0.63 to CON (consumption) of the last !/ α4 years. It gives an average value of the considered variable in the last !/α4 years. 1 7   P roduction in recent years

DlnXTi = α4(lnXTi - lnXi) The same holds for j. 1 8   D emand of pre- ­existing capital goods in recent years

DlnKDTj = a4(lnKDj - lnKDTj) 1 9   P rofit rates in recent years

DRi = a5 (ri – Ri) 2 0   A vailability of entrepreneurship

DlnEsi = α6ln(Esi’/Esi) with lnEsi’= β37(lnui+ lnXi) + β38lnPri - λi We suppose here that the supply of entrepreneurship grows with production (learning by doing) weighted by the degree of uncertainty, since in the absence of uncertainty there would be no formation of entrepreneurship. Learning by doing is also influenced by innovation as expressed by the tendency of productivity. The entrepreneurship in the new sectors grows according to the variation of the demand of the produced goods, i.e.: DlnEs(n)i = β39DNDn)i The same holds for DlnE(n)j but with β different from β39 The right hand side term is the variation of the logistic. The logistic begins at the time the innovation (the new product) appears.

172   A. Fusari 2 1   D emand of entrepreneurship

DlnEdi = α7ln(Edi’/Edi) with lnEdi’ = β40(lnui+ lnXi) + β41lnPri - λi This demand is supposed to adjust to production weighted by the degree of uncertainty (since in the absence of uncertainty no entrepreneurship would be requested) and to productivity, intended as expressive of innovation. The scaling parameter λ differs in each equation i, j (n)i and (n)j. 2 2   F lexible markup

DlnMKPi =α8ln(MKPi’/MKP)

22.1

with lnMKP’ì = b42DCTi +λi DlnMKPj =α8ln(MKPj’/MKPj)

22.2

with lnMKP’j = b42DKDTi +λj DlnMKP(n)i=(1-d)(-M(n)i)[α8ln(MKP’(n)in)/MKP(n)i]

22.3

with lnMKP’(n)i = b43DlnND(n)I +λ(n)i DlnMKP(n)j = (1-d)(-M(n)j)[α8ln(MKP(n)inj’/MKP)(n)j]

22.4

with lnMKP’(n)i = b44DlnND(n)j + λ(n)j The markup is expressed as a function of the average changes in demand, in a specified number of recent years and, for new products, as a function of the variation rate of their demand. To specify the variation of the markup by steps, a mixed model of difference and differential equations would be required.

Innovation, uncertainty, entrepreneurship   173 2 3   P rofit rate

ri =

VAi PREi − Li w PRE TK K (d ) ei

− ir

As we know, in the simulated model the matrix TK has been eliminated and substituted by K since the pre-­existing capital goods are absolutely dominating.We can see that profit rate is intended as excluding ir, the interest rate on invested capital. Note that the equation above is in effect a quasi identity in the hypothesis that the dynamics of PRE is almost identical to that of the value added deflator. An identity should be written using, in the place of VA, production (X) multiplied by its price (PRE) and subtracting intermediate consumption in nominal terms. 2 4   E mployment

Li = VAi /Pri 2 5   V alue added

VAi = nXi Quantitative solution and simulations The model has been simulated using the WYSEA package (Clifford R. Wymer System for Estimation and Simulation Analysis). The econometric estimation could utilize Wymer’s program Escona built for the estimation of non-­linear models. But this is made impossible by the lack of data series. With a model of around 100 equations (as the one considered by our quantification) and various non-­linearities (first of all those due to the switch functions indispensable to formalize innovations), at least 200 terms of time series would be required that, if available quarterly, would take 50 years, or 200 years in case of yearly data series: much too long a period to refer the estimation to the near future and even to the present. A partial remedy could be the use of cross sections data. But these are available only for some variables. In addition, the very little number of radical innovations within the sample makes the available information insufficient to allow estimations in the matter: therefore, this aspect of the model would be under identified. An alternative should be to estimate the model without considering innovations explicitly but including them implicitly only for simulation purposes. But this would erase from estimation a crucial aspect of the model. The shortcomings above have obliged us to limit to some simulations, using Wymer’s program Apredic. For consumer goods innovation, the substitution and complementary effects on the existing consumer products are supposed to compensate each other; so that the degree of importance of this innovation depends on the superior asymptote of the diffusion function. For new capital goods, their degree of importance also depends on their effects in stimulating process innovation, i.e. the parameter β10 in equation 3 of process innovation. Three solutions,

β18 = 0.025 β26 = 0.31

β34 = 0.5

β42 = 0.8 λ2 = 2.24 μ1 = 0.08

β17 = 0.1 β25 = 0.77

β33 = 0.95

β41 = 0.7 λ1 = 0.091 λ9 = 0.279

β43 = 0.26 λ3 = 1.56 η = 0.3

β35 = 1.0

β19 = 0.18 β27 = 0.97

α3 = 0.65 β3 = 0.0012 β11 = 4.0

β44 = 0.28 λ4 = 0.145 ν = –1.298

β36 = 0.2

α4 = 0.166 β4 = 0.0016 β12 = 0.013 (but for new capital goods, β12 = 0.069) β20 = 0.03 β28 = 0.79

β45 = 0.00878 λ5 = 0.767

β37=0.57

β21 = 0.996 β29 = 0.28

α5 = 0.25 β5 = 0.032 β13 = 0.055

β46 = 0.082 λ6 = 1.454

β22 = 0.75 β30 = 0.11 (for new capital goods = 0.71) β38= 0.22

α6 = 0.55 β6 = 0.01 β14 = 0.98

β39=0.0033 (for new capital goods = 0.035) a1 = 0.025 λ7 = 6.732

β23 = 0.25 β31 = 0.065

α7 = 1.1 β7 = 0.07 β15 = 0.14

a2= 0.0091 λ8 = 7.343

β24 = 0.001 β32 = 0.00038 (for new capital goods = 0.0025) β40 = 0.33

α8 = 0.43 β8 = 0.51 β16 = 0.27

Note 1 λ3 and λ4 are scaling parameters concerning the first two equations of Es; λ5 λ6 λ7 and λ8 concern the equations for the demand of entrepreneurship, while λ9 refers to mark up equations.

α2 = 0.45 β2 = 0.02 β10 = 0.3

α1 = 0.57 β1 = 1.2 β9 = 2.3

Table 5.1  Values of parameters

4.367 0.05

8.9628 8.7008 0.0 0.0 0.0 0.0 0.0 – – 3.38 3.435 0.095 0.8 8.9748 – 8.94 8.95 – – −0.03 5.858 5.452 0.095

6.47383 6.5028 0.0 0.0 0.0 0.0 0.0 – – 3.38 – 0.04 0.8 – – – – 6.36 6.35 −0.018 3.367 2.9634 0.095

j

Note All expressed in natural logarithms, except SW, Г, γ, M, ND, u, R, r and ir.

Exogenous Ls ir

Endogenous X K PrR SW PrI γ Г M ND Pr W (whole economy) PRE u CON t CT XT XT2 KDT R Es Ed MKP

i

Sectors to which each variable refers

Table 5.2  Initial values of the endogenous variables and of the exogenous Ls0 and ir

0.0 1.43 0.0 0.0 0. 0 0.0 0.0 0.0 1.0 3.38 – 0.31 1.0 – 0.0 – – – – 0.09 −3.124 −3.529 0.295

(n)i 0.0 1.72 – – 0.0 – – 0.0 1.0 3.5 – 0.33 1.0 – 0.0 – – – – 0.028 −3.73 −4.135 0.295

(n)j1

0.0 1.72 – – 0.0 – – 0.0 1.0 3.58 – 0.33 1.0 – 0.0 – – – – 0.028 −3.73 −4.135 0.295

(n)j2

176   A. Fusari Table 5.3  Values of parameters and constants varying with simulations

β12 β13 β14 β15 β16 Q1 Q2 k(PrR)1 k(PrR)2 k(PrR)3 k(M)1 k(M)2 k(M)3

Intermediate case

High dynamic competition

Low dynamic competition

0.013 0.055 0.98 0.14 0.27 0.45 0.55 1.15 0.58 1.00 0.20 0.20 0.18

0.0065 0.0825 1.47 0.21 0.405 0.585 0.715 0.97 0.348 0.60 0.12 0.12 0.102

0.0182 0.033 0.588 0.084 0.162 0.2475 0.3025 1.61 0.812 1.40 0.28 0.28 0.252

based on the initial values of endogenous variables and the parameters and trigger values shown in Tables 5.1, 5.2 and 5.3, have been carried out. The simulations make different hypotheses on the strength of the dynamic competition process: see the values indicated in Table 5.3 for the parameters of the equations concerning radical innovations and their diffusion, incremental innovations, threshold values for the triggers. The hypothetical changes in the parameters affecting product and process innovations considerably influence the other variables, mainly entrepreneurship and uncertainty but also productivity and production, investment, employment, profit rates, etc. No radical process innovation is supposed to happen in the sector of new capital goods; the hypothesis is that the advent of these goods stimulates radical process innovations in the other sectors. A version of the model postulating no innovation is not provided; it should be qualitatively different and much simpler than the specified model. The aggregation mainly affects the equations for production, prices, gross investment and profit rate, as clarified in the formulation of those equations. The quantitative experiments refer to 16 years starting from the depression and continuing in the recovery phase; this allows a fair representation of the dynamic competition process. The values in the three tables allow the reproduction, with the formalized model, of the quantitative results presented in the figures in the Appendix. The simulation expresses the following variables in natural logarithms: X, PrR, K PrI, ND, Pr, w, PRE, CON, CT, KDT, Es, Ed, I, VA, L. The graphs shown in the Appendix do not include: a

the variables concerning the production of new goods, as simply following the specified logistic and sometimes overlapping in the three simulations;

Innovation, uncertainty, entrepreneurship   177 b c d e f

the stock of fixed capital since the behaviour of this is almost similar to that of production, except for the impact due to uncertainty; value added, employment and the averages of consumption, production, demand of capital goods and profit rate, since the behaviour of these variables can be deduced from the variables on which they depend; entrepreneurship in the new sectors, this being scarcely relevant; the demand of new goods, since this simply follows a logistic; and flexible markup: in the first two sectors, this varies between 0.095 and 0.28 in natural logarithms, that is 1.10 and 1.32 (i.e. 10 and 32 per cent of markup margin), while in the new sectors starts from 0.295 and declines toward 0.23, i.e. from 34% to 26% of mark up margin.

A brief comment The figures in the Appendix clearly show the incisive role of dynamic competition on the behaviour of variables, as well as its different tendencies in the depression phase and later, in the course of the recovery. The lines concerning Solution A are always in an intermediate position between those corresponding to Simulation C (that presumes a low dynamic competition, i.e. innovation and the connected variables) and those of Simulation B postulating high dynamic competition. The results of Simulation B are almost always much higher than the other two simulations; but in the case of prices the contrary happens, i.e. prices expressed by the Simulation C (low competition and low innovation and hence low productivity) are higher than those of the two other simulations. Simulation B shows the lowest and rapidly decreasing prices, due to the high productivity increase. But in the sectors of new capital goods prices grow due to their high degree of monopoly and higher unit labour cost. Simulation C, with very low innovation, shows, on the whole, almost stationary behaviour. Productivity yielded by incremental innovations, i.e. due to the improvement of existing process, grows substantially, but in the two first sectors much less than that caused by the diffusion of radical process innovations. This diffusion is quick in Simulation B (high dynamic competition), thus implying a shortening of the cycle; the contrary happens in Simulation C (the almost stationary case). The figures of the diffusion process relative to Sector 1 and 3 are almost similar, due to the fact that the increase in productivity yielded by radical process innovation is supposed identical in the two sectors and those radical innovations appear almost simultaneously. However, the diffusion process is far from being complete in the considered number of years. Incremental innovations in Sector 5 start after 16 periods, so that the relative figure is not represented here. Various variables concerning Sector 5 and even Sector 4 appear on the scene at the half, or (in Simulation C) near the end, of the considered period. In the new capital goods sectors, even if deprived by radical process innovation (these sectors are supposed only to be stimulating radical innovations elsewhere), incremental innovations are higher than in the other sectors as a

178   A. Fusari consequence of the novelty of production. The highest increases in labour productivity are shown by the new consumer goods sector as experiencing both radical process and product innovations. Radical uncertainty is strongly stimulated by the advent of radical process and  product innovations so that it rapidly increases in Simulation B, but remains  almost stationary in Simulation C. New capital goods are (of course) supposed to start from a higher level of uncertainty; in the new capital goods (i.e. experiencing only incremental innovation) uncertainty decreases at first and then starts to increase. Both the supply and demand of entrepreneurship grow with production, uncertainty and innovation (learning by doing); of course, the demand grows more than supply during the recovery. Finally, profit rates grow substantially during the recovery, mainly in Simulation B as this postulates a strong acceleration of dynamic competition and hence innovation and productivity, while in Simulation C (low dynamic competition and low innovation) profit rates remain always negative notwithstanding their increase. Of course, new consumer goods, as experiencing radical process and product innovation, benefit from the highest profit rates, while new capital goods show decreasing profit rates at the beginning but soon those rates start to grow quickly. In conclusion, the importance of the dynamic competition process in determining the behaviour of each variable appears to be crucial.

5.4  Conclusion This chapter points out that one main deficiency of economic thought is the lack of consideration of dynamic competition processes, i.e. hinged upon entrepreneurship, innovation and uncertainty. This aspect is completely neglected by mainstream economics. Only three schools of thought have dedicated some useful consideration to the phenomenon. Two of them, neo-­Austrian and Schumpeterian, are strongly complementary: the first emphasizes uncertainty and entrepreneurship, but almost ignores innovation, while the second emphasizes the entrepreneurial role and innovation but neglects uncertainty. These omissions prevent the two schools of thought adequately developing the notion of dynamic competition. We have seen that the assumption of non-­measurability of uncertainty and the associated denial of its explanation, which are explicit in neo-­Austrians (Kirzner’s ‘fog of uncertainty’) and implicit in Schumpeter, prevents an adequate treatment of the formation and use of entrepreneurship and the innovation-­adaptation process, hence economic development. Moreover, the assumption of non-­measurability of uncertainty and the emphasis on the limits of knowledge have diffused the mistaken conviction that the maximization principle is only applicable in the neoclassical economics of perfect knowledge. The equivocations we are stressing are shared by heterodox economics which insists on the notion of ‘bounded rationality’. Indeed, this notion has amplified

Innovation, uncertainty, entrepreneurship   179 the misunderstandings provoked by the assumption of non-­measurability and non-­explanation of uncertainty. This is clearly evident in evolutionary economics, the third school of thought that embody some aspects of dynamic competition. Such a school (following Schumpeterian thought) has at its heart innovation and emphasizes the limits of knowledge just as expressed by the notion of ‘bounded rationality’. Unfortunately, that notion is rather ambiguous: human rationality is always bounded, but this does not deny that decision making must make an effort to use reason at its best, as the optimization approach attempts to do. Nevertheless, heterodox economics rejects optimization. Evolutionary economics tries to remedy some theoretical vacuity arising from the limitations above through the notion of ‘decisional routines’. But this notion is far from clear. In particular, it refers to a kind of skill that has nothing to do with entrepreneurship since it postulates repetitive, bureaucratic decision making, while a main characteristic of entrepreneurial skills is versatility and flexibility. So that, also, evolutionary economics is afflicted by various misunderstandings on dynamic competition, even if for theoretical reasons partly different from neo-­Austrian and Schumpeterian thought. In sum, the crucial phenomenon represented by dynamic competition, when it is not disregarded altogether, is treated in a partial and misleading way without properly considering entrepreneurship, uncertainty and innovation. This chapter has tried to remedy these drawbacks; moreover, it proposes measures (and an explanation) of the degree of true uncertainty and an interpretation of the dynamic and cyclical motion of the economy. To make stringent the developed analysis, the formalization of a model with dynamic competition has been set out; it includes as crucial endogenous variables innovation, uncertainty and entrepreneurship, indeed much too neglected and misunderstood by general economics notwithstanding, let us insist, their central importance for a realistic representation and interpretation of the reality. Finally, some simulation experiments with the specified model have been carried out.

6 From invisible hand to perpetuum mobile The problem of economic growth Hasse Ekstedt

Introduction At the end of the 1860s a British engineer patented an automatic machine for watering cows. The machine became a market success and probably increased the labour productivity of the cattle breeding business. A couple of years later a student of philosophy discovered that the drawings of such a machine were to be found in Hero of Alexandria’s collected works which had been translated into English in the middle of the 1860s. In fact a closer investigation revealed that the drawings sent by the engineer to the patent authorities were replicas of Hero’s drawings. (Koestler 1970). The Swedish engineer Gustav de Laval depended also on Hero in his development of the steam-­turbine, patented in 1883. We may indeed ask ourselves why it took around 1,800 years until Hero’s inventions became economically useful. Knowing that Hero was leaning heavily on old Greek, Babylonian and Arabic mathematics, geometry and mechanics, it is not strange to think that some of his inventions benefited from already well-­known principles. More recently Paul S. Segerstrom observed that in comparing six countries there was no clear-­cut relation between patent grants to residents in the respective countries and the growth ratios of the countries (Segerstrom 1998). Of course his observations concerned a substantially shorter time span, 30 years, than the Hero example. The examples cause questions: do knowledge and inventions really drive economic growth or is economic growth a necessary condition for the ability to utilize knowledge? If the latter, we may ask:

6.1  What is economic growth? The problem of growth is generally not a problem in itself. A society with increasing social and economic integration will almost certainly have an increasing turnover of goods and services both with respect to volume and speed. Furthermore, growth of knowledge in general increases the prospect of life and makes people more flexible in their choices. We understand the very essence of the term economic growth in its everyday meaning without much ado. The problems occur when we try to find some

From invisible hand to perpetuum mobile   181 overall measures which cover an aggregate understanding and may be used in economic policy for the society as a whole. Furthermore the problem worsens considerably when we link economic growth to the distribution of the production results. A traditional view in economics is to look at growth as a causal effect of investments in physical capital and R&D, but given that uncertainty is intrinsic to all kind of investments we may look upon the problem so that in order to have risky investments we need investors ready to take the risks and that necessarily implies an uneven distribution of wealth and income. On the other hand in order to minimize the failure rate of investments it is of the essence to have a high rate of marginal propensity to consume, and then we need an even distribution of wealth and income. Thus we end up in an implicit conflict which may be solved as an aggregate optimization problem for the total society. But if so the problem of measurement becomes vital. Textbooks normally define growth from a production perspective; growth is linked to productivity and technological change, thus there is a natural link between technological change, knowledge and education. On one hand changes in technology are linked to R&D and on the other hand productivity may be linked to trained labour, some kind of on the job training. Therefore we may try to set up a causal model such that growth is a functional relation of investments in R&D, education, and on the job training. Given a constant failure rate of investments we thus obtain an endogenous model of production and growth, which in principle has no upper limit. The so-­ called Salter Growth Engine is a good example of such a model (Warr and Ayres 2006). A machine like this concerns only the production side and, consequently, from a macroeconomic perspective, the working of such a machine, to be

Product improvement Increased revenues and increased demand for final goods and services

Process improvement

Economies of scale

Lower limits to costs of production

Lower prices of materials and energy

Figure 6.1  Salter Growth Engine.

R&D substitution of knowledge for labour and capital

Substitution of energy for labour and capital

182   H. Ekstedt r­ elevant in social analysis, presupposes Say’s law. As soon as we place any restrictions of any kind of social character, such as employment on a socially desirable level, Say’s law is a necessity, but with that follows the entire logical machinery which is not always pleasant with respect to the reality, as we discussed in Chapter 2. Economists are a bit embarrassed by this fact and in modern neoclassical theory, it is expressed as the axiom of reflexivity in conjunction with the axiom of local non-­satiation. Economic mainstream theory, as it appears in textbooks, has still not congested the Keynesian critics, particularly not when it comes to growth theories more or less emanating from a neoclassical approach. In his preface to the French edition to General Theory, Keynes writes: I believe that economics everywhere up to recent times has been dominated, much more than has been understood, by the doctrines associated with the name of J-­B Say. It is true that his ‘law of markets’ has been long abandoned by most economists; but they have not extricated themselves from his basic assumptions and particularly from his fallacy that demand is created by supply. Say was implicitly assuming that the economic system was always operating up to its full capacity, so that a new activity was always in substitution for, and never in addition to, some other activity. [Our emphasis.] Nearly all subsequent economic theory has depended on, in the sense that it has required, this same assumption. Yet a theory so based is clearly incompetent to tackle the problems of unemployment and of the trade cycle. Perhaps I can best express to French readers what I claim for this book by saying that in theory of production it is a final break-­away from the doctrines of J-­B Say and that in the theory of interest it is a return to the doctrines of Montesquieu. (1973 [1936]: xxxv) The essence of Keynes’ critics with respect to Salter’s Growth Engine is that neoclassical growth works when existing production technique is improved and prices are lowered, thus increasing the volume of production. When new areas of consumption activities are invented we end up with a problem where the number of dimensions of the demand space is increased and this leaves us, at least with respect to the neoclassical theory, with the problem of how prices are formed. Earlier in this book, particularly in Chapters 2 and 4, we have emphasized the importance of invariant dimensionality of the commodity space in order to construct some kind of consistent measure, and this is in fact the abstract essence of the above quotation from Keynes. As we have said, earlier explanations of economic growth are often generally linked to innovations of new production technologies. In basic economics we often use the standard production possibility frontier in a two-­dimensional commodity diagram to illustrate growth and discuss symmetric and asymmetric movements of the frontier, often accompanied with historic examples from ‘Spinning Jenny’ or the automatic loom in production of fabric, in relation to food production. Unfortunately this links the growth aspects to engineering

From invisible hand to perpetuum mobile   183 aspects in a naïve way, while the subsequent organization and control of the society are equally important technological features. Increased interaction between agents requires investments in both physical and social organization, which increase the dimensionality of the commodity space. Following our discussions in the preceding chapters the measurement of economic activity is a problem and measuring economic growth highlights the problem both with respect to the theoretical abstract measures but also with respect to the general goals of the individual and the society. What are we trying to explain in our growth models? Do we ask for the basic resource conditions and sector composition of the economy and its sustainability and welfare effects; are we looking at the effects of growth on central policy variables such as inflation and unemployment; or are we trying to explain the basic causal structure underlying innovations and the development of new technologies? The examples from Hero and Segerstrom give a hint of the difficulty of the latter. GDP-­ measures imply simplicity of analysis where seemingly the same growth measure can be used for all purposes of analysis. However rejecting the prevailing equilibrium throws us into the shadows because growth must now be defined according to social, political and cultural dimensions. There are objections from economic analysts and also from politicians to the use of crude GDP – measures and analysis are often completed, particularly when it comes to international comparisons of welfare, with central dimensions such as health variables, child mortality, civil rights, education and similar variables. The United Nations has developed measures for these aspects and there is considerable work continuously going on in developing indices of welfare and environmental aspects. Professor Hans Rosling, International Medicine, at the Karolinska Institute in Stockholm, has set up a group which constantly follows the development of the different growth dimensions defined by the UN. The presented material at www.gapminder.org is indeed impressive and thought-­ provoking. However such variables seldom enter the theoretical models of growth in economic theory; they are particularly rare in textbooks, both on the basic and the advanced levels. Mostly these models are devoted to money measured variables such as GDP and the discussed causal structure mainly concerns the microeconomic production structure. From the short-­run perspective this may be defended in the sense that basic variables for stabilization policy are more linked to the crude turnover of money in an economy due to inertia in sector composition and technology, but when such models form the basis of the long perspective there is room for doubt. Without a firm link to individual utilities and aggregate goals of the society the GDP concept measures nothing but the turnover of money in a society, which certainly is interesting with respect to political variables as unemployment and inflation in the short-­run perspective, but linked to growth it becomes more obscure. A quick glance at published growth figures reveals the problem of GDP-­ figures.

184   H. Ekstedt Speaking about 2 per cent or 3 per cent annual growth of an economy implies that we may use an ordinary exponential function like Y = Yo  eλt

E 6.1

as a proxy. An example of this is the average growth of the Swedish GDP during the period 1950 to 2008 according to Swedish Central Bureau of Statistics: The average growth function calculated on the end values is: Q = 25 ⋅ e0,027045⋅t

E 6.2

What does it tell us? Applying the reasoning of Salter’s Growth Engine and a constant commodity space, implying that new commodities are always substitutes for old ones it is hard to imagine the social, political and demographic changes which have taken place. We also know that needs not even known in the 1950s are now at the top of the political and social agenda. Furthermore if we use the above function, E 6.2, to project the GDP in year 2035, index in fixed prices would be around 248. What does that mean in reality? Can we maintain the assumption of constant commodity space?

125

100

75

50

25 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2008

Figure 6.2 Swedish GDP 1950–2008 (source: Swedish Central Bureau of Statistics). Note 2000 = 100.

From invisible hand to perpetuum mobile   185 If the commodities are linked to exhaustible resources, the dynamics of these resources will in principle follow the development described by Gaussian distribution, until exhaustion. In principle the Salter Growth Engine could work in such a case. New knowledge, new techniques and switching to other resources may solve the problem but that also implies that such a process should not have any other effects on society than just the replacement of old commodities with new ones. But the organization of infrastructure, production structure, organizational and legal structure of the society and so on, must then not be affected. Moreover the substitution process implied by the Salter Growth Machine theoretically rules out the invention of new commodity dimensions. This is contrary to common experiences when, for instance, we look at the so called IT revolution. It has to some extent replaced earlier existing goods and services but it has indeed given rise to entirely new commodity dimensions. Thus if a resource is diminishing it is natural to think of some kind of saving/ substitution process; but if so will that be neutral to the agents in the economy and will it leave the dimensionality of the commodity space and the distribution unchanged? If this is not the case our monetary measure will be impossible to interpret in an intertemporal perspective. An example of this is the current discussions of the limits of oil supply. The American oil geologist, the late Dr M. King Hubbert (1956), developed the so called Hubbert Curve during the 1940s and 1950s concerning the availability of oil. Duncan and Youngquist (1998) estimated a Hubbert Curve 2000, on the basis of known reserves and expected discoveries. According to their estimations the oil would peak around 2007/2008 and there seems to be a rather general view that it actually did. Their calculations imply that we will have a maximum possible oil consumption in 2030 around the same level as the late 1960s. This problem seems to be disastrous but we may apply the reasoning like the Salter Growth Machine and find that there is still hope. There is no doubt that there already exist technologies increasing the efficiency of using, not only of oil energy, but also of other energy sources. We will see that oil will be substituted by other energy sources as well as new technologies for saving energy being developed. This process will indeed look very similar to the Salter Growth Machine. But as almost always there is a caterpillar in the salad, which links the reasoning back to the quotation from Keynes. When we change the composition of energy use we have also to consider a considerable reorganization of the energy infrastructure with respect to production, distribution and control. This will imply, most probably, that the commodity basket for the end user not only will be changed in its composition but also in its dimensionality with respect to new commodities. It will certainly effect both welfare and its distribution but how is more difficult to say. However with respect to the turnover of money it is very hard to say how this process turns out. Thus in a scenario like the Gaussian distribution it is natural to expect a rather substantial reorganization of the society. Not that such an reorganization would

186   H. Ekstedt by necessity imply less welfare experienced by people in the long run but it is obvious that a crude monetary measure like GDP will not catch the illustrated problem at all, and worse, according to the above arguments it will give a distorted and most probably an over-­optimistic view of the real growth possibilities for the society as a whole, at least with respect to the current material standard. In the long run, however, the human ability to adapt to new environments may be the most important factor for the growth of welfare. Our discussion so far seems to indicate that analysis of growth is sensitive to the choice of the commodity basket both with respect to physical conditions and monetary measures. Growth implies reorganization processes and adaptation processes for both the individual and the whole society when we introduce new dimensions of commodities/needs and new technologies, making measures of growth linked to a particular commodity basket spurious. It is true that the neoclassical theory provides us with a utility index which, if it is based on the general equilibrium axioms, implies sufficient flexibility. As long as a particular commodity provides utility to the agents it is irrelevant how it is produced, switching from oil energy to electric energy or from nuclear power to wind power does not affect the end user of a particular commodity. But that only holds when the output of energy does not affect the organization of the rest of the society and it only concerns the production of energy in a narrow sense. If we take the neoclassical attitude seriously and accept the money measures for long-­run studies of growth, we cannot see any logical restrictions why we should not be able to create a perpetuum mobile with eternal growth. If the axioms of general equilibrium theory are not acceptable as a realistic description of the economy we are stuck with respect to the measurement of growth. The GDP measure will in fact not measure anything but the turnover of money in an economy, which by all means is an interesting measure in the short and the medium run because of the inertia of the economy, with respect to technology and capital stock. However from a theoretical perspective we are left with an ad hoc measure.

6.2  Solow’s model of exogenous growth The growth model taught in basic courses in economics is basically Solow’s model. The basic reasoning is an extension of the neoclassical, built on additive individual production processes, assuming perfect substitution both with respect to demand and production, to create one aggregate production process. To this aggregate production process the usual production optimizing conditions are applied. Given saving and investment behaviour as well as depreciation rates of capital we will achieve a maximum consumption. This technique may be applied to any aggregate production function, fulfilling normal neoclassical conditions, and if we then assume a growth rate we will have a revision upwards of this maximum, subject to eventual changes of saving and depreciation rates. We thus end up with the Golden Rule, which in fact is an

From invisible hand to perpetuum mobile   187 interesting result even if we question the realism of the model. We can also link the endogenous growth to this model by assuming labour in efficiency terms, that is we add an efficiency growth to the working hours, in principle: L* = L0·er·t. The Solowian model, although excellent from a pedagogical point of view in discussing the expansion of markets, does not really discuss the reasons for technological growth but keeps it entirely outside the analysis. Furthermore the approach leans heavily on the existence in every moment of a prevailing general equilibrium, and thus a constant dimensionality. Since the model is an aggregate model the equilibrating assumption is Say’s law, we thus need additional assumptions to fit the model into a discussion of ex ante dynamic processes in reality. An example of this is a growth model that was presented at the Conference on Growth in the Euro Area in May 2000, discussing fiscal policy. It is assumed that the economy is on a macroeconomic general equilibrium trajectory. The government supply of infrastructure is assumed to be evenly distributed over the economy as a free good and furthermore: ‘The model concerns an economy where all N individuals are identical and each of them has infinite planning horizon and perfect foresight, furthermore the population remains fixed over time’ (Turnovsky 2000). Solow’s model lacks realism but as said before it gives an excellent pedagogical basis for discussions of the limitations within constant technology both with respect to labour and capital expansion in limiting the efficiency of investment as well as the precise conditions for long-­run economic growth. Furthermore through its simple form it may be used for ex post studies of growth. Another way of using the Solowian exogenous growth technique is in Ekstedt and Westberg (1991), who investigated the Swedish production sector with respect to growth and factor income distribution. They estimated production functions based on quarterly data. Their results were disappointing from the perspective of the required conditions. Without going deeper into their methods, involving a measure of capacity utilization of the capital stock based on energy consumption, heating excluded, we sum up their results in a couple of tables. They estimated an ordinary Hicksian growth function of the following type: Qt = eλt K ta Lbt



E 6.3

They did not use any restriction of constant returns to scale i.e. a + b = 1. The production function was tested in its logarithmic form. Here we omit the statistical measures except R2 since we use their results for illustration purposes. The next experiment was to split the total period into moving eight-­year periods. As we can see from Table 6.2 the parameters do not sum up to 1 as they do in Table 6.1. The results of Table 6.2 rather show a process of structural

188   H. Ekstedt Table 6.1  Estimates of macro-production functions Period

α

β

λ

Intercept

R2

1961–86 1970–86

0.508 0.34

0.492 0.66

0.012 –0.003

–0.68 0.08

0.96 0.94

Table 6.2  Estimates of macro-production functions based on moving eight-year periods Period

α

β

λ

Intercept

R2

1963–70 1965–72 1967–74 1969–76 1971–78 1973–80 1975–82 1977–84 1979–86

0.006 0.050 0.100 0.330 0.509 1.119 1.378 0.600 0.160

0.602 0.468 0.397 0.215 0.689 0.680 0.232 –0.096 0.605

0.057 0.051 0.045 0.031 0.022 0.024 0.008 0.008 0.014

1.46 2.01 2.22 2.14 –0.75 –3.47 –2.57 2.47 1.34

0.99 0.99 0.99 0.97 0.93 0.87 0.87 0.77 0.99

Table 6.3  Estimation of the differentiated production functions Period

b1

b2

b3

b0

R2

1963–70 1965–72 1967–74 1969–76 1971–78 1973–80 1975–82 1977–84 1979–86

0.439 0.357 0.402 0.539 0.366 0.537 0.168 0.524 0.426

–0.076 –0.111 –0.048 0.160 0.488 0.877 1.187 0.758 0.490

–0.003 –0.001 –0.003 –0.006 –0.001 –0.0004 0.003 –0.010 0.0001

0.069 –0.050 0.063 0.067 0.023 0.023 –0.012 0.075 0.018

0.04 0.04 0.78 0.78 0.29 0.56 0.66 0.66 0.76

change. This interpretation was supported by other inquiries about the development of the Swedish economy during the considered period. Table 6.2 exhibits the usual problems of naïve temporal statistical studies but is still interesting with respect to the violent volatility of the parameters and even the size of R2 varies in an un-­usual way. The differentiated production function was also tested: DQ = b0 + b1DL + b2DK + b3Dt

E 6.4

They used standard OLS for the statistical testing, which is an averaging method and the parameters of Tables 6.2 and 6.3 show a kind of chaotic behaviour. In this case they used the production function ex post with no claims of

From invisible hand to perpetuum mobile   189 equilibrium. How can we explain the negative parameters within traditional economic theory? It is not our aim to discuss Swedish development, suffice to say that the two first periods where dominated by a heavy reallocation of the labour force through a conscious policy followed by huge centralized state investments in housing. During the end of the 1970s Sweden, as did many other countries, experienced a heavy industrial restructuring, partly due to changed demand and increased competition for the structural steel industry, producing steel of a low degree of refinement, and the decreased demand for ships, particularly tankers, but also due to the general effects of increased oil prices. Thus using a specific mathematical technique does not imply that we adapt to a certain theory but only use it for ex post investigations. Another problem with the Solowian model, used as a theoretical framework, is that it basically assumes constant distribution between labour and capital and if the technology changes the factor intensifies into higher capital intensity for example the increased investments offset the decreased relative use of labour which together with the increased labour productivity keep the factor income distribution constant. The variations in the factor income distribution of Sweden during the period 1980–2005 are considerable. What happens in periods of structural change is that some capital becomes obsolete and the replacing capital takes a considerable time to adapt to the 20 10 0 �10 �20 �30 �40

�60

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

�50

Percentage change

Figure 6.3 Variations in profit rate- percentage change (sources: Swedish Central Bureau of Statistics and own calculations).

190   H. Ekstedt market so the process is time-­consuming. Thus we might discuss different periods where the economy seems to have settled on a relatively stable trajectory which might seem like a Solowian trajectory towards the Golden Rule or a process indicated by the Salter Growth Machine. The Second World War’s effect on demand implied consumption needs as well as new capacity and together with the increased international trade it created a sort of greenhouse effect on growth in many countries (Eichengreen 1995). After that followed a period of structural changes causing severe stabilization problems; this period with rapid changes seems like a prolonged state out of equilibrium implying false trading. During such a period a methodology based on inside equilibrium trading does not grasp the essential features of the reality.

6.3  Endogenous growth The theory of endogenous growth is an effort to include knowledge and innovation into the growth process. In principle we add a new sector which may be called R&D. This sector produces an intermediary good used in traditional production, which changes the labour productivity (Romer 1994). The Salter Growth Engine in Figure 6.1 gives a good illustration of the principle working in the theory. To have a complete endogenous model there is however a need for an assumption that says that competition forces the agents to R&D production. The problems are of basically two kinds, which are connected. The first problem is that new technology changes productivity and profits in a way that contradicts the perfect competition model (Pack 1994). Thus, if a firm has an invention and earns a better profit we will have a singular break in the perfect competition which changes the distribution of wages and profits. From a general equilibrium point of view we then have a new potential general equilibrium; Tables 6.2 and 6.3 indicate such an interpretation. If so we are in principle lost from the point of view of general equilibrium theory. In order to remedy this we may assume an imitation/diffusion process of knowledge quick enough to make us regard the innovation as a kind of chock which momentarily changes the price vector; competition will however drive it back to the old equilibrium price vector. Arrow and Hahn (1971) give an example of such a process, which covers similar examples in textbooks, as a standard technique to handle chocks and show how these, driven by market forces, converge to the old equilibrium. Arrow and Hahn use in their example the concept of excess demand, positive or negative. The time dimension is implicit in a process, which converges to a state where the earlier existing excess demand will vanish. The two functions z1(p) and z2(p) represent two excess demand functions. Relative to these functions the following rules of behaviour are introduced: 1 2 3

Raise the price of the good in positive excess demand. Lower or at least do not raise the price of the good in excess supply, but never lower the price below zero. Do not change the price of a good in zero excess demand.

From invisible hand to perpetuum mobile   191 4

Multiply the resulting price vector by a scalar, leaving relative prices unchanged, so that the new price vector obtained is in Sn.

Following these rules we obtain the following differential system: dz1 = f ( p ) dz2 = g ( p ) dp = h( z1 − z2 )

E 6.5

Assuming a sufficiently small area around equilibrium, which allows us to approximate the functions f, g and h to linear expressions dz1 = a + a ⋅ p dz2 = b + b ⋅ p dp = g(dz1 − dz2 )

E 6.6

The equilibrium price will be p∗ = g (

�

( a + b) (a + b)



E 6.7

z1(p)

z2(p) Price

�

Figure 6.4  Convergence of excess demand.

192   H. Ekstedt Since g is just a scalar we may set to 1 and that gives us the dynamic solution: p = ( a + b )e ( a +b ) t

E 6.8

The condition for convergence is a + b  0. This condition is not one implied by the axioms, but a standard technique for simple differential equations, as is also the case for the four rules above. Far more serious however, is that such a process breaks the fundamental principles for the axiomatic structure if we allow trade during the converging process. We then formally allow for so-­called false trading and that changes the distribution. For the reasoning to hold logically we must not allow for any trade during the convergence process, it must be an auctioneer solution or some kind of negotiation without actual trading. Furthermore it does not cover any change in the dimensionality of the commodity space. Thus if we try to save the endogenous growth model as an improvement of the neoclassical growth model we end up in a marsh of additional assumptions which counteract the eventual realism of the explanation of the origins of growth and furthermore we still do not answer Keynes’ critique. Save for the last point there is a way of saving the endogenous growth theory as a closed model and that is to regard innovations and new knowledge as a public good which is spread out over the economy as a free utility. The problems with this rescue plan are evident.

6.4  The Product Cycle A standard reasoning which has some realism, if not pressed too hard, is the so-­ called Product Cycle Model. It is well known, with about 47.5 million hits at Google, and its design and interpretations are almost approaching infinity. In its modern version it originates from Vernon’s article ‘International Investments and International Trade in the Product Cycle’ in the 1960s (Vernon 1966), although the concept is said to have been invented by E. Hoover in the 1930s. It is, however, interesting to use and to adapt it for our discussion in the preceding and current chapter on entrepreneurship. In Figure 6.5 A and W represent the birth and death of a product concept. The birth is not the invention as in Hero of Alexandria’s case but what we call an innovation, which in the Hero example is what the British engineer accomplished. The invention does not need to be connected to market needs whatsoever, but is in principle to be seen as development of general knowledge. There are almost infinite examples of this. For example in the end of the nineteenth century the Russian mathematician Lobachevski developed the first systematic non-­Euclidian geometry which, when developed by Riemann, ended up in the modern space geometry necessary for space adventures. Nearly all fundamental scientific principles are pretty old but were not ‘marketable’ at the time of invention.

From invisible hand to perpetuum mobile   193

Phase 2: Market introduction

Phase 3: Market growth

Phase 1: Innovation A

Phase 4: Market maturation and decline �

Figure 6.5  The Product Cycle.

The death of a product cycle is when the whole concept is obsolete. However it is worth remembering that obsolescence is like being out of fashion, the concept may, slightly changed, pop up in the future. Phase 1 in the Product Cycle Model is what we define as innovation. That implies that someone, an individual or a firm, realizes a need for a new concept relative to the market. As in the example from Hero’s watering machine the invention could sometimes be used as it is, but normally, as in the example of Hero’s eolipil, which was his name for the machine, it needs refinement and a new design, as Gustav de Laval provided to get the first steam turbine. The latter process can be very difficult and time-­consuming. Thus the step from invention to innovation requires the realization of a specific market need which could be covered by a particular knowledge or concept. This phase is indeed risky and costly. Phase 2, the introduction of the new concept at the market is not much better from the aspect of risk and costs. This introduction requires quite a considerable pile of money. The new product has to be defined by the market with respect to its functions in different contexts and its potential for further use. This is illustrating in our reasoning in Chapter 2 when we rejected the axiom of reflexivity. The learning process may take a considerable time and that is indeed costly. These two first phases are to be seen as a kind of purgatory in reaching phase 3 which from the entrepreneur’s point of view is paradise, the commodity, concept or process is accepted by the market, which means that you are paid for your efforts and hopefully make one or two euros or dollars extra. But, as we are discussing the real world and not metaphysics, your commodity, process or concept reaches phase 4, matures and declines depending on

194   H. Ekstedt e­ fficient substitutes, structural changes of consumption demand or society’s organization. When we reach the end of phase 4, it becomes obsolete. When you reach the point W your financial survival depends on how you replace, adapt or refine your concept. In some sectors it is a relatively smooth process but in some it is violent and risky. The market needs are probably there and relatively continuous but the context is constantly changing, but how is up to you to imagine. For society as a whole it is important to realize the total cycle. To have reasonable long-­run stability for employment and incomes in a region or even country, we must realize that we need entrepreneurs and production organizations in all the four phases of the Product Cycle. Even phase 4 is necessary since the sector has reached is maximal size so it is vital for employment. Then, however, restructuring and mergers start which probably implies structural unemployment. Thus we must care for organizations in all the phases. The tricky thing is to make the jump from W to A. Investments in new concepts are always risky, but even more risky is to stick to the past. During the 1960s there was a gigantic company in Sweden making mechanical calculators, Facit. It was the third biggest employer in Sweden. The machines could do addition, subtraction and multiplication while emitting a loud noise. We have been told that during a board meeting in the mid-­1960s they discussed a small electronic toy from Japan which could be used in the same way. The board decided however to make investments in current production technology but set up a group to follow the development of the Japanese toys. Facit survived two years and its bankruptcy was at that time the biggest in Sweden after the Second World War. The riskiness in investing in new concepts – new markets are illustrated by Joseph Bower’s study in the 1960s on managing resource allocation and investments in private companies, where he categorized three different types of investments: cost reducing investments; capacity increasing; and investments in new product (Bower 1970: 3). He followed 50 different investment projects in a big American company for ten years and calculated the ratio of actual return to expected return and the calculations ended up in the following table: The figures are really deterrent to an enthusiastic entrepreneur. Thus trying to close the gap between W and A, Figure 6.5 is in fact representative of the prime problem when leaving neoclassical thinking and entering into the world of Table 6.4 Mean value of actual return in relation to calculated return in the investment plan Type of investment

Ratio of actual return to calculated

Cost reducing Capacity increasing New product

1.1 0.6 0.1

From invisible hand to perpetuum mobile   195 uncertainty, created by changing dimensionality of both the spaces of needs and spaces of commodities. Let us now look again at the endogenous growth model. It is obvious that it partly captures the important aspect of production improvements. Going back to the catastrophic ending of Facit, the producer of mechanical calculators, the electronic toys in some sense could be seen as a production improvement. However from the investors’ point of view this is hardly enough. Investing in a brand new technology for the same market as the market for mechanical calculators seems doubtful with respect to reasonable return. The investors probably also understood that the size of the calculator was an important feature and important for market size. That means that the smallness of electronic calculators filled a need from other market segments, like private persons, whose needs of calculating power were not enough to buy and store a mechanical monster of 5–6 kg (11–13 lbs). The first electronic calculators also added the very practical ability of division. The introduction of electronic calculators not only improved the commodity as such but could also be sold to a quite different market segment. Thus the dimensionality of the commodity space was changed for a different set of consumers. This example may seem a bit futile but this was the first introduction to the general public of the digital technique and this technique indeed changed the global market making some commodities obsolete and added new dimensions, which created another world of information, as well as a general increase in labour productivity. The net effect of such radical changes will not be captured by an endogenous model of growth. The example also highlights the importance of the demand side and the nature of the concept of risk.

6.5  Growth, equilibrium and the equimarginal principle The exogenous and endogenous growth models concern the production side and keep the relative prices and the commodity space intact. It is easy to understand because the general equilibrium theory is basically a theory of exchange and improving the production side is therefore allowed only after very strict assumptions (Ekstedt 2006). The Keynesian critique is therefore a blow, which upsets the whole pattern of analysis. Thus there is a strong case for abandoning the whole general equilibrium thinking with respect to growth analysis, except for discussions on the optimal employment level relative to capital stock given technology and commodity space, which creates, at least theoretically, a sort of optimal capacity utilization and thus the employment level at any moment. It is a bit curious that economists analysing dynamic social behaviour continue to utilize the basic ideas of the world created by the classical physics, although in a modern mathematical form, while modern physical science has abandoned the concept of general equilibrium. It is particularly curious since economics analyses human behaviour with its variability, difference in cultural forms and strive for novelty. Georgescu-­ Roegen (1971: 13) writes:

196   H. Ekstedt And if we look beyond thermodynamics we see, first that Classical mechanics leaves nothing indeterminate, and second, that the freedom allowed by quantum mechanics is limited only to random, not to permanent, variations. It would seem, therefore, that the variability of living creatures is still a puzzle. Yet the puzzle has a solution, which is provided by a fundamental, albeit unremarked, principle: the emergence of novelty by combination (original emphasis). A natural reaction to both exogenous and endogenous growth models is that there are a lot of learning and inventions in the production side but what happens to the demand side? If we introduce changes in the dimensionality of the commodity space as an important aspect of the growth process any allusion to Say’s law is impossible, and thus the demand side must be developed in order to discuss the question of economic growth properly. The quotation from Georgescu–Roegen is interesting but the combinatory principle is perhaps a bit mechanic and also too general. Can we treat household demand as a combinatorial game? It is bit hard to swallow. If we look at the commodity space as such why should the households suddenly start demanding a brand new commodity? In that case we end up with very curious explanations why it took 1,800 years before Hero of Alexandria’s invention was introduced to the market. A passive combinatory principle degrades humans a bit when analysing their relevant needs. We agree with Georgescu-­Roegen that inventions may well follow a combinatory principle. Hero’s inventions might be explained by observation, combination and deduction, but the British engineer who realized the market’s need for the invention was certainly not following a passive combinatory rule but linked the invention to an experienced need. That is, we emphasize, the distinction between invention and innovation. Looking at the changes of the commodity space it is clear that it must be linked to both an economic and social process and thus the introduction of demand as a vital factor for growth will necessitate a social analysis, and furthermore such an inclusion of the demand side will cast further doubts over the concept of general equilibrium and equilibrium growth. As we have claimed earlier any commodity needs a social context and also a social epistemology. In mobilizing the demand side there is a risk that we end up with completely endogenous models, since we then model both the supply and demand, which may look like another sort of general equilibrium approach, but it is only temporally inert patterns which may be easy to interpret as deterministic. However such social processes as habit formation, learning processes and imitations are fruitful ways of introducing both inertia and change. But it requires awareness of what we cannot model. The first aspect which we cannot model the inventive process itself. When Hero invented the cow watering machine it can be seen as a unique combinatory effort, but when Hero’s machine came into general economic use and became a marketable commodity the situation was quite different from the invention. The

From invisible hand to perpetuum mobile   197 development of a marketable commodity is about the structural composition of the economy in respect to changes in demand structure, where educational, social and demographical factors play important roles.1 The second aspect is what we have already mentioned and that occurs when we try to squeeze processes of increasing dimensionality into some sort of general equilibrium modelling, requiring unchanged distribution of endowments. Such processes will change the factor income distribution as well as the distribution of incomes in general, as a consequence of the changed commodity space. Maurice Allais (1987) describes such processes as the equimarginal principle. The equimarginal principle deals with processes in an economy approaching some states of equilibrium and to obtain maximal efficiency by the detection and utilization of distributable surpluses: we could describe it as ongoing arbitrage created by the social changes. In a proper market process where both supply and demand are subject to development there will always appear possibilities of improvements and new products, similar to our reasoning about the Product Cycle. With respect to the Hero example, the engineer who realized that the watering machine was a marketable invention deserves respect (although he could have mentioned Hero in a footnote). We are quite sure that there are loads of patents today waiting to become marketable during the next hundred years. Allais describes the problem [It was thus shown] that when in a situation of maximum efficiency consumption or production units consume (or produce) the same goods, one unit at most is in a situation of local concavity, i.e. in a situation of marginal increasing returns. Consequently, when maximum efficiency obtains, most operators are in a situation of local convexity and marginal decreasing returns. However, this condition cannot be interpreted as meaning that all fields of choice and production are convex everywhere, this hypothesis being totally contradicted by observed data. (op. cit. p. 707, original emphasis) That means that inventions and learning processes temporally create increasing returns to scale situations. But if we accept this kind of reasoning we cannot think of a sustainable equilibrium. Either we have to allow for out of equilibrium trading, so-­called false trading, or we must assume some kind of successive local states of equilibrium with no causal connection, but if the latter, all these states are local so there might exist many price vectors. With these considerations in mind we may open up the growth process for a more structural attitude. Maurice Allais observes: ‘There is a very strong interdependence between the point of view of efficiency corresponding to the discovery and realization of surpluses and an ethical point of view corresponding to their sharing’ (op. cit. p. 700, original emphasis). Thus the future distribution of the distributable surpluses will be different from the current one. Since only what is produced can be shared the point of maximizing efficiency corresponding to the

198   H. Ekstedt realization of surpluses, i.e. the closing of local concavities should be beneficial to those agents who detected and brought the inventions to the market and this is at variance with any kind of approach that new knowledge and innovations are to be seen as free utilities as may be suggested in order to save the endogenous growth model.2 Allais’ discussion of the equimarginal principle and the theoretical acceptance for the investors/producers search for distributable surpluses imply that we must allow for non-­uniqueness of prices and for out-­of-equilibrium pricing. Thus there is no such converging process as we described in Figure 6.5. However there might be a longer-­run converging process similar to that described by the Product Cycle hypothesis. Thus the learning or imitation or whatever we call it together with a saturation will cause the initially concavities, increasing returns, to turn into convexities, decreasing returns. The innovation, by which we mean an introduction of a new commodity to the market, is an event exogenous to the market, while the process after the commodity is introduced and accepted by the market may well be described by a market analysis in line with endogenous growth theory, implying imitation, development of substitutes and so on. We may also apply Solow’s model, in a broad sense, according to which there will be investments in the new product until the market is saturated and the return diminishes until the so-­called Golden Rule is reached then there will come a rough time of mergers and bankruptcies where the firms, through concentrations of production, try to create monopoly surpluses. In Figure 6.6 where we illustrated the Product Cycle we left a gap between A and W. The closure of this gap is entirely outside the market process. The market can, so to say, handle distributable surpluses but cannot create them. So – the entrepreneurs who bring the innovations to the market work, so to say, in two directions in fitting in existing inventions to aroused market needs, but the entrepreneur does not create the market needs. Thus the dynamics of the market are also to a great extent exogenous to entrepreneurs and innovations and that is where social change comes into the picture, and social change creates new epistemic cycles and institutional structures. Social interaction creates on one hand informal structures of behaviour in a broad respect and on the other formalized structures/institutions. The latter are relevant both within the private as well as public sphere, often in conjunction. The system and the working of infrastructure in an economy is a good example. From the demand side social interaction and change creates structures where there are often strong complementarities between, not only the commodities of different character, but of the needs. The neoclassical market approach tempts us to look at the commodity space as consisting of independent dimensions, but in Chapter 2 we claimed that commodities were not demanded as such but because of their functions, thus we must look at commodities as multidimensional complexes, evidently to different degrees, but still not an independent a priori dimension. Since people demand a commodity for its function/services with respect to particular epistemic cycles

From invisible hand to perpetuum mobile   199 an increasing social mobility and interaction in itself creates a more complex world of epistemic cycles. Many individuals today above a certain economic level deal individually with several epistemic cycles which are partly contradictory and require rather complex consumption including several varieties with respect to qualities and form of seemingly the same basic commodities. These points are well covered in consumption studies: Gary Becker and Robert Pollak are prominent figures in this research. We will later comment more on some of these studies. Furthermore, leaving the abstract Euclidian commodity space all commodities need, to a higher or lower degree, institutional systems of distribution and control. Thus an increasing dimensionality of the commodity space or, more correctly, of needs requires a more complex institutional system since the different commodities themselves, at least some of them, require a unique treatment. Baking baguettes for the needs of a small village in France requires a very limited, if any, institutional structure beside the internalized ethics. However baking baguettes from pieces of dough transported in 45-foot containers, each week, from Lyon to Stockholm requires a rather complex system of transport and control, both from the market actors as well as from the public authorities.3 The necessity of ethics In introducing social change and social interaction as a key to market development we also understand the necessity of both legal structures as well as ethical principles. The claim, sometimes heard, that the market process is free from ethical commandments but will correct the behaviour of the market agents in conjunction with ethical norms outside the realm of the market economy is, as we showed in Chapter 4, not even valid for the neoclassical theory, although it does not appear in the axiomatic structure. In a setting like the one we pursue, ethics is a fundamental aspect of the society in general and market economy in particular. In our earlier chapter on ethics we claimed that some set of ethical rules are necessary for a society to work. If these ethical rules are internalized in the individuals there is no particular need for a complex exogenous law system with its subsequent system of control and sanctions. In the medieval village the exchange of commodities took place under strict social control in the absence of anonymity and variations in epistemic cycles were limited within the range of social classes. The modern market system however has been abstracted from this kind of social control into an anonymous organism. In such a system there is a constant clash of epistemic cycles and an endless creation of more or less aggregated subsystems through social interaction. This may be the most important basic cause for a changing commodity structure – changing needs and changing dimensionality. But this is a process under a high degree of anonymity and requires that the earlier internal ethical systems within different social classes are replaced by exogenous systems of distribution, control and sanctions. Although we might

200   H. Ekstedt agree to an objective global ethics on the aggregate level, the variability in epistemic cycles caused by increased social interaction requires different disaggregated norms; and even contradictions of norms in different epistemic cycles might be acceptable from an abstract ethical point of view. The social interaction and clashes of epistemic cycles, through the commodities as multidimensional complexes, increases the turnover of activities in society. Increasing dimensionality of needs, organization and control is therefore a forceful engine for equimarginal processes. Thus, alluding to Salter’s Growth Engine, there is also another ‘growth engine’ in social change. But since we regard human beings as subjects this social process can hardly be modelled in a simple mathematical way and there is a need for students of sociology, social psychology and policy to complete economic information with respect to the innovative processes. But given these processes we may analyse the learning and imitation processes as well as the capital accumulation process with existing economic techniques of macroeconomics and welfare economics, save for the equilibrium concept. It is hard to see how we can avoid the effect of the social changes on the demand side in the invention/learning process. The Hero example and also Segerstrom’s investigations to some degree show that an invention or acquired knowledge does not automatically provide profitable market possibilities. There must be some kind of relevant environment for an innovation to come into market use.

6.6  The demand side In economic theory we have many intriguing approaches to the development of demand with great potential although they violate the axiomatic structure of general equilibrium theory. Two which are partly overlapping are the so-­called characteristics approach invented by Gorman (1980, 1956) and developed by Lancaster (1966), and the famous Household Production Approach by Gary Becker (1976). Becker’s approach has been much used for empirical research, a Google check gives 2.5 million hits, but it has also been much criticized for its implicit behaviourism. His approach, however, is not bound to determinism. Consumer behaviour can to a large extent be analysed as if we were behaviourists depending on its inertia. Robert Pollak’s studies on habit formation are an important step to develop the demand side and his paper in 1970 is an early important contribution. We reject a priori modelling but as we claimed in the introduction to Chapter 2, empirical studies, discovering inert structures, may obviously lay a grounding for limited deductive modelling, although we then must reject the general equilibrium concept in toto. Of the two approaches Becker’s is the more interesting from a sociological perspective while the Gorman/Lancaster approach is easier to use when discussing economic growth from a standard economic approach since its mathematical form is simple and limited. It is also possible to link them to the growth discussion in general and Allais’ equimarginal principle in particular. Let us however start with Becker’s approach. The commodities bought at the market are to be seen as inputs in the household production of utilities. Thus

From invisible hand to perpetuum mobile   201 from a mathematical point of view we drop the equivalence relation between the internal mind of the consumer and the external choice space as we illustrated in Figure 2.2 in Chapter 2. But since we have introduced a production sector in the minds of the consumers this sector can also be subject to changes in technology. These changes are affected by social interaction, education, physical conditions, health and organization of the surrounding society and similar factors. Since these factors normally create inert structures they also induce habit formation as in Pollak (1978) and Lluch (1974). The National Consumer Centre in Finland published a report on Household Production in 2005 and it was stated that: Apart from their importance as consumers, household members also have a prominent role as producers of goods and services. These goods and services have a direct effect on people’s well-­being, although the absence of systematic knowledge in this area has kept the topic outside official economic parlance. (Varjonen and Ahlquist 2005) Research in this field has been directed to several areas. Becker, Pollack and Lluch mentioned above, studied the composition of the consumer basket with respect to social variables, education and habit formation. An interesting study by Andersson (1975) emphasized the educational effects on the demand structure. Becker (1981) was also among those who opened up more detailed study of the family as a production unit in a more substantial way when taking into account home work as partly substitution to certain consumption commodities and also a drift towards more or less investing in the family production. Later on, during the 2000s, the participation of the households in non-­profit organizations has received attention. This is, in Europe and the USA, a substantial addition to welfare in many aspects but also through their effects on public opinion there are effects on the structure of the aggregate demand. The forming of consumption habits is not a passive process in society, but it is an important political factor and the effects on future growth are indeed important. Reasoning along Maslov’s hierarchy of needs when analysing the consumption from a growth perspective is not very far-­fetched and is a, so to say, bio-­ social dynamics which could well be a basis for linking the production side to the demand side. Pasinetti (1983) discusses the dynamics of structural changes in the economy based on the exploration of new needs at the same time as more basic needs are satisfied. Marc Lavoie (1994, 2004) develops this approach which is fruitful and could be well discussed both within the household production approach as well as within the characteristics approach. Trigg (2004) however makes an important point when he claims that although the psychological aspects of individual learning and general development are important with respect to needs and purposes, these are also affected by the socialization process.

202   H. Ekstedt The household production approach has wide use in the interface between economics and sociology and implies a complete departure from the neoclassical axiomatic structure and gives full credit to consumer choice in a true meaning. The Gorman/Lancaster so-­called characteristics approach is also of great interest in discussing growth since it enters a mechanism which separates the consumers’ utility from their commodity demand. In the characteristics approach consumers maximize their utility functions with respect to a set of characteristics to fulfil specific purposes, not directly with respect to the commodities themselves. These characteristics are functions of the market commodities. This gives the following utility maximizing behaviour: s.t. Utility functions

V1 = ϕ1 ( x1 , − − −, xn )

Characteristic functions

Vm = ϕm ( x1 , − − −, xn )

MaxU = U ( z1 , − − −, zm )

Vm = ϕm ( x1 , − − −, xn ) and

∑ p ⋅ x = B i

1

Budget restriction

E.9

i

The V-­matrix forms a sort of consumption technology where the consumer links the service of a good to different so-­called characteristics, in a simple case of a quadratic matrix changes in relative prices, while not causing any changes in the utility function, cause changes in the commodity space. Thus in a dynamic analysis we end up in price combinations which imply that the demand functions for some of the commodities are not defined: we call them critical points. In fact there exist an infinite number of such points and they are nowhere dense. This leaves us with an unstable commodity space although the characteristics space may be stable, and this may also imply discontinuities in the price behaviour. To make this approach compatible with neoclassical theory we must assume that one specific commodity is attached to one and only one characteristic. If the commodities, as we claimed in Chapter 2, are multidimensional complexes a commodity may, so to say, carry several characteristics. Gorman/Lancaster saw the characteristics as linked to the commodities in more or less fixed relations. Cars for example have characteristics such as comfort, speed, acceleration, safety, luxury image, environmental effects etc. These characteristics are more or less fixed. This means that a diamond necklace and a Ferrari could be substitutes in the luxury dimension so we could buy the diamond necklace for luxury and a small battery-­driven car to announce our environmental concern.

From invisible hand to perpetuum mobile   203 However when we use the characteristics approach in a Household Production setting the technology of the households partly decides the V-­matrix above. In this case we shift the focus of the characteristics to express the needs and purposes of the households. Given the physical environment, and social class distribution, we might assume temporary and local inertia of the V-­matrix. Thus the characteristics are not fixed with respect to the commodities but the commodities are seen as inputs in a vector of a service desired by the household, and thus the matrix will be affected by the relevant set of epistemic cycles. The economic effect of introducing the V-­matrix is that changes in the relative prices of the commodities do not necessarily change the relative valuations of characteristics but imply discontinuous changes in the commodity demand. In relation to Figure 2.2 in Chapter 2 which implied that the agent was reduced to a n-­dimensional rigid body we are now discussing a characteristics space which is linked to the utility of the consumer and a commodity space in which the consumer acts at the market. This link however is not an equivalence relation so there is no unique solution of the consumers’ utility maximizing efforts. When the number of dimensions in the characteristics space and the commodity space are different then the situation is considerably worse than when the matrix is quadratic, as V1 = a1X + b1Y + 1Z + 1W V2 = a2X + b2Y + 2Z + 2W V3 = a3X + b3Y + 3Z + 3W

E 6.104

First of all we can see that if the number of characteristics is separate from the number of commodities there are no unique solutions. In Figure 6.6 we illustrate four different solutions which we may assume are indifferent to the consumer but at a given price vector only one is optimal to the consumer. There are four different boxes in the figure spanned by the four vectors (X1; Y1; Z1), (X2; Y2; W2), (Y3; Z3; W3) and (X4; Z4; W4). Observe that the scale does not need to be the same on the four axes. We recall the fact that we are not able to draw a unifying indifference curve in the commodity space but in the characteristics space this is possible. Thus the four vectors depict four solutions on the same indifference curve in the characteristics space. However when the relative prices change we will at certain price ratios have discontinuous jumps between the four commodity bundles although the movement along the indifference curve in the characteristics space may be smooth. We may however produce even nastier examples, when there are more dimensions in the characteristics space than in the commodity space, that is the case when changes in proportions of a couple of commodities changes qualities and thus the characteristic content. Steel is a good example of this with respect to different qualities for different uses.

204   H. Ekstedt Z

Y

(X1; Y1; Z1)

(X4; Z4; W4) (Y3; Z3; W3)

X

(X2; Y2; W2)

W

Figure 6.6  Three characteristics, four commodities.

If this situation appears we may expect rather violent price behaviour. Lavoie and Liu (2007), although not discussing the methodology of the characteristics model, rejected the use of unit values in aggregating differentiated products. They found that positive pricing-­to-market results in the literature could be a sign of the product heterogeneity embodied in unit values rather than evidence of imperfect competition. A commodity name for seemingly homogenous products covers often a rich variety of qualities or we might call it characteristics, diesel oil, wheat flour not to mention such commodities as chairs, cars etc. This fact implies that the purchase of one product implicitly may ‘decide’ a particular other product, thus we may have complicated patterns of complementarities which lead to sometimes chaotic price behaviour or at least to discontinuous price behaviour. The Gorman/Lancaster approach is an excellent example of a model structure where we have basically rational behaviour of the individual not with respect to commodities but with respect to needs/characteristics. It also implies that we regard commodities as being multidimensional complexes.

From invisible hand to perpetuum mobile   205

6.7  Market structure and uncertainty We have dwelt with the household production and characteristics approaches at some length because they display our discussion, initiated in Chapter 2, on the role of prices, rejecting the principle of an equivalence relation between the utility space interior to the agent and the exterior choice space, implying that we cannot use prices in the neoclassical meaning as a measure. Thus money measures may well be used but they have no global consistency but are formed according to a multitude of markets depending of the multitude of epistemic cycles. Earlier in this chapter we claimed that rejecting Say’s law in all forms implies that money measures, such as GDP, do not mirror anything but the turnover of money in an economy. Such a measure is of great value in the short run when we can assume a high degree of inertia of the structural composition of the economy. In longer run, which we hopefully will experience, such a measure is doubtful. Furthermore from the production point of view we have now introduced a formidable source of uncertainty, which also implies a dynamic element where the demand is explained outside the production sphere and is affected by social, demographical and other types of structural changes and the explanation of changes in the dimensionality of the characteristic space as well as the commodity space are exogenous to the market. In the 1970s Ralph Nader was pretty much alone in the debate advocating environmental concern; nowadays these aspects are important in driving the market structure. It is not the market that drives changes in the characteristics/commodity spaces but social changes, in a broad meaning. Our discussion, based on research approaches from consumption theory, shows that there is an intricate interdependence between the two sides of supply and demand. The demand side develops through social changes as well as institutional changes in the economy. The supply side develops through birth and death processes described by the Product Cycle hypothesis, fuelled by innovations bringing inventions to the market adapting to changed desires and thus increasing the dimensionality of the product space. The critique by Keynes, which we quoted earlier in this chapter, is essential for economic theory to grasp. In Chapter 4 we claimed that Man, through being a subject and thus a final cause, is the major creator of uncertainty in the economy, this is in fact the basic root of Keynes’ discussion about genuine uncertainty. The dynamic process of the demand side is in the longer run affected by social, demographic and institutional development changes creating new epistemic cycles of virtually all aggregate levels and affecting desires and purposes of both individuals as well as institutions. Also changes in the production structure will itself call for changes in institutions and social structure. From a theoretical point of view however this means that new light is cast on Arrow’s paradox. When discussing that in Chapter 2 we claimed that it was not

206   H. Ekstedt a paradox in a logical meaning but brought in a new agent different from Homo Œconomicus, which we called Homo Politicus. If our discussion of the demand side is to be regarded as relevant, the concept of rationality must be seen as far more complex than in mainstream economic analysis. The rationality of Homo Œconomicus is covering only a rather tiny bit of the problem. The neoclassical definition of rationality is interesting in the sense of stressing logical consistency but that does not save us from logical traps like the one in Alice’s Adventures in Wonderland quoted in Chapter 2. Genuine uncertainty When we discuss economic growth the concept of uncertainty is of central importance since growth is connected to investments in capital and production organizations. In Chapter 7 we will discuss the concept of permanent unemployment as partly depending on decreasing capital growth due to growth in the physical productivity in relation to an insufficient growth of demand, which is in line with Keynes and Lord Beveridge’s discussions during the 1930s and 1940s where they claimed that the market economy was too unstable to create an environment promoting sufficient investments to maintain a socially desirable volume of employment. The neoclassical theory has difficulties with these attitudes by Keynes and Beveridge, mostly due to the claim that neoclassical market theory is a global model and thus its axiomatic structure either is a true representation of the reality or should be so, i.e. the theory become a universal norm. This implies, as we have discussed earlier, that the neoclassical theory is unable to contain the concept of genuine uncertainty. This concept is either consciously replaced by the concept of risk or the two concepts are simply mixed up. In neoclassical theory nothing but risk is discussed in relation to future markets. Arrow and Hahn (1971: 122) and Radner (1982), describe the approach as future market consumption decisions being dependent on the future environment where they are taken. It is then presumed that the future environment can be ordered with respect to possible states of relevance for the respective commodities. Thus a set of possible future consumption decisions is attached to different states of the environment. This means that since the agent is rational and the preferences given, the future market price will be given in relation to the probabilities of the different states of the environment. The problem then is with respect to the forming of the subjective probability distribution over the possible states of the environment. This is depending on the information structure; if it is evenly spread among the agents we will have perfect future markets but if we have asymmetric information we have to add a vector of information to the vector of endowments, as we discussed in Chapter 2. This also leads to another interesting conclusion as Roy Radner (op. cit. p. 941) expresses it: ‘More generally, an economic agent who has a good understanding of the market is in a position to use market prices to make inferences about the (non-­price) information received by other agents.’ This implies that

From invisible hand to perpetuum mobile   207 although there are different opinions of subjective probabilities we will have some convergence process à la Figure 6.5, with respect to subjective probability distribution. However such results are heavily dependent on the assumption of constant dimensionality of the commodity space and that the information space converges to a stable apprehension of the state variables. It is instructive to look at this result in relation to Bower’s investigation (1970) concerning the different kind of investments related in Table 6.4. Obviously the kind of investments which are called cost reducing investments fits into such a risk analysis. The market is there unaffected by the investment decision which only concern the internal efficiency of production. This is well described in Salter’s Growth Engine. We may also partly count the kind of investments in Bower’s investigation called capacity increasing investments. These may be appropriate in a neoclassical setting when the economy adapts to the new technology and we are approaching the Solowian Golden Rule. If so, the lower ratio of actual result to calculated in Table 6.4 is explained by innovations of new technologies before the economy has reached the point of the Golden Rule with the old technology. We must, however, add assumptions of constant aggregate preference distribution and constant income distribution during the convergence process together with the basic assumption of constant commodity space in order to keep an intertemporal equilibrium, and when discussing the case of a new technology we need to add an assumption that education and innovation are free utilities. So we have a lot of trouble already with capacity increasing investments not altering the markets. The third type of investments, new product, in Bower’s investigation does not fit in whatsoever in the neoclassical approach and neither so the Product Cycle hypothesis when it is linked to innovations changing the dimensionality of the commodity space. Our introduction of the concept of epistemic cycles worsens this situation since we then separate the commodity demand from the preference orderings of the agents. We then also get the problem illustrated in Chapter 4 by the adventures of Dick Darwent and Lady Caroline. The occurrence of new information not only implied new decisions, but a completely new epistemic cycle which changed their foundations for rational behaviour. This change in the epistemic cycle was caused by a new piece of information and caused the two parties to change their approach to an existing decision space since the new piece of information changed the space of ‘characteristics’, alluding to the Gorman/Lancaster approach. This is actually also the fundamental meaning of changing dimensionality of the commodity space or, in a broader sense, the decision space. As we claimed in Chapter 4, the traditional decision tree, illustrated in Figure 4.2, fails to capture this aspect in any way since it presumes a given epistemic cycle and is basically picturing state probabilities which we discussed above. Since we regard commodities as multidimensional complexes a new commodity thus adds possibilities for interpreting existing commodities in a new light and thus may

208   H. Ekstedt create new needs, characteristics or whatever we will call it and this is the foundation of genuine uncertainty, which by all mean does not need to be entirely negative but also opens up new possibilities. But what is uncertainty and what is genuine uncertainty with respect to Keynes’ own analysis? Keynes has a small passage in Chapter 12 of General Theory (1973 [1936]: 148) which is of utmost interest and extremely intriguing: It would be foolish, in forming our expectations, to attach a great weight to matters which are very uncertain. To this passage he attached a small footnote: ‘By “very uncertain” I do not mean the same thing as “very improbable”. Cf. my Treatise on Probability, chap. 6 on “The Weight of Arguments”.’ So what does he say in Chapter 6 in Treatise on Probability? The question to be raised in this chapter is somewhat novel; after much consideration I remain uncertain as to how much importance to attach to it. The magnitude of the probability of an argument, in the sense discussed in Chapter III, depends upon the balance between what may be termed the favourable and the unfavourable evidence; a new piece of evidence which leaves this balance unchanged, also leaves the probability of the argument unchanged. But it seems that there may be another respect in which some kind of quantitative comparison between arguments is possible. This comparison turns upon the balance not between the favourable and the unfavourable evidence, but between the absolute amounts of relevant knowledge and of relevant ignorance respectively. I express this by saying that an accession of new evidence increases the weight of an argument. New evidence will sometimes decrease the probability of an argument, but it will always increase its ‘weight’. (1962 [1921]: 71) This quotation is indeed intriguing from many aspects and introduces an approach which has been criticized by mathematicians but still contains a valuable point for economists working with Homo Rationalis, who is a subject. Formally Keynes’ approach to probability has been much discussed and also criticized, basically because he mixes the propositions with the propositional function (Russell 1948: 390ff. and Brody 1994: 124). Brody takes an example of tossing coins. If all the coins are correct you get one probability distribution but if the coins are bent in a certain way you obviously get another probability distribution. Thus you have to specify the physical context correctly. The two distributions are, however, independent of each other. Thus if you mix the coins you will get a totally different distribution but still if the coins are separated you will go back to the original ones. Brody separates correlation and non-­commutativity, that is, the ensemble dis-

From invisible hand to perpetuum mobile   209 tribution is not affected by possible separations in subgroups and the conditions for these groups. Thus the ‘macro’ distribution is unaffected by physical specifications at disaggregated levels. However the quotation from Treatise on Probability has more to do with information/learning and the inductive analysis. To have a correct probability of the coins you need to know that there exist bent coins. Keynes later discusses swans. If you only have observed white swans you may be tempted to assume a proposition that all swans are white. If you then see a black swan, this observation, although from a strict probability point of view is rather tiny, will change your whole attitude to the analysis. You will probably have to restructure your research programs.5 We discussed earlier the Swedish company Facit during the 1960s. They were pretty safe in their position at the market for mechanical calculators. When thus the first electronic item came into their hands, it changed indeed the whole universe of possibilities although there still did not even exist a market for electronic calculators. Could they declare their total production organization as obsolete or should they try to get as much profit from the old production assets as possible and at what speed should they build out the new organization? I think that we should be pretty satisfied at not being CEO of Facit at that time. The quotation from Keynes’ Treatise on Probability tells us that uncertainty does not rise from the tails in a given distribution but from the structural changes of the problem when we have some new pieces of information changing the dimensionality of the decision space and as we see this also is interlinked with new possibilities. We agree with the formal aspects of Brody’s and Russell’s critique but we maintain that from economic point of view Keynes’ discussion is of utmost value. Thus with respect to these aspects there is no simple relation between state probabilities and commodities but that is related to the social development and the spread and character of epistemic cycles. Thus in order to create future markets, à la Arrow and Hahn (1971: 53ff.), a sort of insurance system, we need stable probabilities between different states. But the concept of epistemic cycles makes this impossible. Their discussion on the problems of bankruptcy and a probable general insurance system is still interesting although very difficult to discuss within the frames of the neoclassical economic theory, and Arrow and Hahn conclude at page 354: Clearly, the actual bankruptcy is a matter of law, but it seems plain that history of the economy may make it impossible to guarantee the continuity properties of the various functions and correspondences and this is bad for existence proofs. Our analysis of Figure 4.3 in Chapter 4, and Keynes’ discussion partly quoted above, deals with the distinction between probabilities of a state and the relevance of the state for a decision/choice.

210   H. Ekstedt The quotations from Keynes underscore that information is only relevant given a specific epistemic cycle. The relevance of the quote from Radner is dependent on this fact. Thus when we discuss subjective probabilities or degrees of rational belief the word subjective is a bit misplaced. When we discussed the concept of rationality we claimed that the neoclassical concept of rationality is only one part of the human rationality. The other part is the ability to catch the relevant environment. We introduced the concept of epistemic cycles to express this form of rationality, and this concept makes learning a productive economic activity since information without the ability to judge the relevance of the information is rather useless. Interpreting the quotation from Keynes in this direction gives rise to Allais’ equimarginal principle, information is judged according to different epistemic cycles and that induces us to believe that this is the same when judging the usefulness/relevance of inventions. Thus a piece of information may be of little interest vis-­à-vis one set of epistemic cycles but of the utmost interest to another set. In the real market when the dimensionality of either commodity space or characteristics space or both are changing we will have rather complicated pro­ cesses of price formations since we run into a whole complex of new complementarities and substitutability among commodities. In this context we may remind of the hypothesis of rational expectations, which is basically an interesting hypothesis with respect to our discussions. The general outfit of the society is that it is rather inert and thus the introduction of new commodities will in general be adapted by the economic environment. Thus we may work under a hypothesis that people want to live a good life and try to adapt changes in a beneficial way for them. We may also make the assumption, which we also have done earlier that people are basically rational, given their relevant sets of epistemic cycles. The latter condition is crucial because it gives rise to unpredictable reactions which may change the conditions of the macro-­ states. An interesting event was the so-­called Black Monday 1987. The markets fell due to fundamental news which triggered hedge programmes to realize holdings and the new portfolios had to be risk-­covered against further decline. But when the press reported about the general character and the size of the hedge programmes the individual actors were surprised and the prior expectations had to be adjusted which lead a further decline of the market and the crash was a fact (Arnér and Ekstedt 2008). This example shows the devastating effect of an assumed additive aggregation. Thus we may relatively safely assume that all agents are rational with respect to their perceived sets of epistemic cycles but since the aggregate effect is based on an aggregate rationality or, we may rather say, that the aggregate causal structures are created out of the individual behaviour in sets of epistemic cycles, partly at variance with each other, and that creates an aggregate causality separate from at least the expectations of one agent which then must revise the expectations that cause further changes in the aggregate structure. This is also in accordance with the proposed Mereological Rule of Thumb at the end of Chapter 4. Thus there is not anything basically

From invisible hand to perpetuum mobile   211 wrong about the rational expectation hypothesis when predicting behaviour of fellow agents if we do not truncate the problem to an average behaviour with additive aggregation. The hypothesis used in general equilibrium models where the agents more or less expect the model result, given some time for the converging process, is almost nonsensical. A suitable view of the risk concept is that it deals with an inert environment where there might exist different states, subject to judgement on the probability distribution. In such a case the market price formation in real markets will give a hint of the average probability judgement, provided that cheating is not taken into consideration. Uncertainty, however, is a very different state where commodity/characteristics space is changing, creating new sets of epistemic cycles.6 Since we think that humans are able to analyse epistemic cycles on different aggregate levels we open up to structural catastrophes, that is, a combination of changing environment and changed behaviour by the agents, like our discussion concerning Figure 4.3 in Chapter 4, and that is basically a state of genuine uncertainty. This state is however by no means necessary to be a state of general despair. Every cloud has a silver lining. This state is also the state where we might find considerable chances for distributable surpluses in Allais’ sense. Thus such uncertainty is not entirely negative in the way we usually think of increased volatility. It also makes room for new distributable surpluses which start new developments and possibilities of growth. Although we must realize that this is a fundamental problem with respect to the aggregate working of the economy to which we will come back to in the next chapter. Uncertainty is thus an interesting and very complex concept in economics and trying to catch it in an one-­dimensional measure like volatility is only possible in dealing with financial instruments, but that is also a topic in the next chapter.

6.8  Tentative conclusions One conclusion is that the dynamics of economic growth are exogenous to the current production structure. Normative conclusions from a closed economic models as the neoclassical one and endogenous growth models are of limited value. The major cause for this is that growth analysis built on money measures virtually tells us nothing of the development of central economic policy variables other than in the short run perspective where sufficient structural inertia may be assumed. The concepts of risk and uncertainty become much more crucial when we regard the changes in the structural composition of the real market. We have discussed the matters both from the demand side, the household production and the characteristics approach and from the production side with the help of the Product Cycle model. A changing commodity/characteristics space allows for new combinations of commodities and commercializing non-­utilized or new

212   H. Ekstedt inventions which are basic conditions for the existence of new distributable surpluses. Thus increasing market uncertainty is not necessarily something bad for society as a whole but we will most probably have redistributions effects as well as reallocations effects in the society. All kind of growth modelling based on general equilibrium must by necessity keep the dimensionality of the commodity space. The relative prices are kept constant and a simple Laspeyre index will do the trick in order to get fixed prices. Why bother with anything else? The Paasche principle, and any other principle separate from Laspeyre’s is an anomaly with respect to the equilibrium modelling. The Paasche principle is an implicit acknowledgement of the fact that we may have changes in the aggregate commodity basket. We can understand that in the short run a Laspeyre index may work excellently as there is inertia in the economy. Changing structures will then appear according to the Laspeyre principle when the structure is changing, and the old price structure is vanishing and a new one will come. When the new price structure (and production and consumption technologies) have been established we must redefine the commodity basket and then by definition we will have growth according to the new basis for the index. Unfortunately this index is telling us nothing about the sustainability of the growth or the welfare effects since such questions only can be given a unique answer within the realm of a prevailing general equilibrium, thus in reality it will be a matter of politics to answer this. In principle we are in fact already exercising this kind of procedure via the Paasche index, but the problem seems to be that general equilibrium theorists of growth do not realize the trick. We have in fact created a possibility of eternal growth, a perpetuum mobile, but we have to abandon the invisible hand and thus we may conclude with Candide that we live in the best of all possible worlds.

7 Uncertainty, money and labour demand Hasse Ekstedt

Introduction We have earlier claimed that, on the microscopic level, the neoclassical theory may be a reasonable approximation to the behaviour of the agents. Given a set of epistemic cycles, we have said, there is no reason, but in abnormal cases, to expect the agent to be irrational in the sense of the three axioms defining rationality in the neoclassical theory. We may look at the rationality concept of the neoclassical theory as a very basic form of animal rationality which is executed when all the environmental, social and temporal considerations are done. Animals which in general are seen as honourable have this kind of rationality; they react upon the precise current needs, which make them both ‘efficient’ and ‘naïve’. Thus we still regard the assumption of individual optimization behaviour as a valid tool for microeconomic analysis. To assume agents consciously sacrificing achievable welfare improvements is indeed a remarkable assumption of deeper philosophical significance than assuming temporal and local rationality. We suspect that an assumption of non-­rationality is due to implicit norms by the analysts. Optimization is, however, a sort of temporal and local equilibrium, but since we reject the additive aggregation there exists a multitude of partial and temporal states of equilibrium where the aggregate situation is more or less stable. These states are attached to specific sets of epistemic cycles and may be contradictory or even contrary to other epistemic cycles, and may also internally contain actual or potential contradictions although they appear stable, since normally any epistemic cycle underlying a complex decision is to be seen as an aggregate of epistemic cycles. Thus, eventual local and temporal states of equilibrium in a mathematical sense may very well exist but are normally dissipative states of more or less inertia. We have in the preceding chapters rejected two central results deducted from the axiomatic structure of the neoclassical theory: Say’s law in all its forms and additive aggregation, both closely linked to the reflexivity axiom. Furthermore we have discussed genuine uncertainty in earlier chapters and come to the conclusion that it is difficult and even not possible to attach a probability distribution to future sets of epistemic cycles. From a company’s point of view this implies that investments in inert capital and organizations are risky and must be protected with appropriate measures.

214   H. Ekstedt This also means that we doubt the stability of the market economy in creating a production structure at an employment level which is desirable from a social point of view, promoting social stability. As we discussed in relation to the Mereological Rule of Thumb at the end of Chapter 4 it is impossible for an economy to satisfy both aggregate and all different individual goals and purposes simultaneously, thus there will always exist a residual, a set of epistemic cycles which fails to be closed (see Figure 2.5 in Chapter 2). This is both the reason for the necessity of a general ethics but also a source for social unease and even instability, since those agents who are not satisfied will alter their behaviour and thus create a new set of responses to seemingly rational behaviour by those who experienced a fulfilment of their purposes in an earlier stage. Thus the individual rationality may have both good and bad effects on an aggregate level which also have reversal effects of some kind on the individual level. We rejected the neoclassical reversibility in Chapters 2 and 4 but we stated that the aggregated and individual levels are interdependent: but it is a dynamic interdependence. Remember that we have showed that given aggregate organizations there exists a rational behaviour of these irrespective of contradictions of underlying aggregate levels or individuals as long as the latter accept to submit to the aggregate level. That means that changed behaviour of individuals or subsets of the aggregate level in question provoke changes in the aggregate rational behaviour. From the point of view of the individual or the group of individuals, changed behaviour at the aggregate level implies changes in the perceived epistemic cycles. Thus it is a fundamental mistake in much of economic thinking that individuals in general define their environment only with respect to other individuals and their behaviour. The general conditions of different aggregate levels are equally or, in some cases, more important. The theoretical significance of this is obvious when additive aggregation is not possible. With respect to the meaning of economic growth this leaves us in difficulties, as discussed in Chapter 6, and when discussing questions of unemployment, distribution and money these rejections will mean that we have to change our questions with respect to such problems. Furthermore we must realize according to our discussion in Chapter 4 that the human subject itself is the fundamental source of genuine uncertainty. The surrounding physical conditions are possible to handle with risk models if we have enough knowledge or with different types of chaos modelling. Remember our discussion of nature as an honourable opponent. We will in this chapter discuss the questions of unemployment, distribution of wealth, and money. It may seem strange to link unemployment and money. We all know that unemployment belongs to the department of labour economics and money to the department of general economics sub monetary theory. But since we have rejected the neoclassical theory and additive aggregation we have ended up in a situation where money has lost its role as an index of prices and as we saw in our discussions with respect to economic growth in Chapter 6, money is pretty meaningless as a measure and thus it must have another role since it is

Uncertainty, money and labour demand   215 the fundamental item in a monetary economy. We must then ask what is its role? Our answer is in conjunction with the traditional Keynesian view in linking money to liquidity and thus an insurance of uncertainty. It requires that we realize the fundamental theoretical difference between money and commodities, both with respect to its social role and its mathematical characteristics. The latter is gravely confused in the neoclassical theory and modelling. We have linked economic growth, or let us more correctly say economic change, to Allais’ equimarginal principle, Becker’s household production approach and the characteristics approach by Gorman/Lancaster. By linking these approaches to the Product Cycle hypothesis we indicate a dynamics such that the commodity space undergoes constant changes with respect to dimensionality which also implies a multitude of price vectors as well as temporal and local states of equilibrium. Thus at best we have stable phases in a general state of non-­equilibrium. The stability is not created by the markets but by the social, political and cultural structures; this can be institutions, traditions or ethical norms. But we also must realize that the economic change is driven by social, political and cultural forces, even ethical forces are seemingly of more importance than ever. All this creates a fundamental uncertainty with respect to investments in inert capital and organizations, and this is the prime source for keeping liquidity. But who grants money if there is a multitude of price vectors and the general economic situation can be described as best as a stable disequilibrium? It is in fact the strength of a social convention in a society. So the link between unemployment, distribution of welfare and money will go through the concept of Social Stability. Lord Beveridge states the very problem in his postscript (1945: 274): This is the root of the matter. The Government in the White Paper are fighting unemployment. They ought to be planning for productive employment. But one cannot do that unless there is something that one desires passionately to see accomplished. Employment is wanted not for its own sake but as a means to an objective. Experience in peace has shown that the desires of men who are already above want to increase their profits by investment is not a strong enough motive or sufficiently persistent in its action to produce a demand for labour which is strong enough and steady enough. Experience of war has shown that it is possible to have a human society in which every man has value and the opportunity for service, when the motive power and direction of economic activity are given not by private interest but by collective determined pursuit of a common good.

7.1  Unemployment and factors creating uncertainty The two central questions for stability in a democratic society are on the one hand people’s ability to live on the fruits of their own work and on the other the  distribution of wealth and income. These two questions are fundamentally

216   H. Ekstedt interlocked since the degree of unemployment, not in a neoclassical sense, but in the sense that there are people who want to work but cannot get a decent job and the relation between profit and wages are the basic determinants for both growth of consumption and the level of investments. This includes also the complex of the welfare state since this could be seen both as a sophisticated distribution of wealth through investments in human capital and a complex insurance system covering also aggregate aspects not taken into account in privately financed systems.1 The size and content of the welfare state is not an economic question in a basic sense but a social, cultural and political complex. Nevertheless the welfare state cannot escape the realm of the dismal science. Scarce resources are to be used and the question of distribution requires something to distribute. We will later look at the dynamics, and see how structural changes, increased competition etc. radically changes the conditions for the welfare policy. Thus the structure of production, its competitive conditions, uncertainty and innovations are basic questions for welfare and its distribution in a society. Therefore it is appropriate to look at some of the problems of unemployment and also relate this to profits and profit share of the producing firms. In mainstream economics the naming of unemployment is apparent. We have words like Keynesian unemployment, classical unemployment, structural unemployment, frictional unemployment, natural unemployment, permanent unemployment, and the unemployment implicit in the so-­called NAIRU,2 which by all means can be covered by the other concepts of unemployment. In lecturing this is of course a constant source of confusion and in politics it is often the cause of rather meaningless debates on the wording of a rather fuzzy concept. The different names indicate different characteristics of a cause for the discussed employment. At the same time it seems that NAIRU, natural unemployment and frictional unemployment are of similar kind, on the other hand frictional and structural unemployment seems to be much of the same character but if there is a difference, frictional unemployment is more temporal while structural unemployment tends to turn into permanent unemployment. Permanent unemployment does not necessarily mean that individuals are permanently unemployed although that may also be the case, but that the volumes of the stock of unemployed do not vary with trade cycle increases. Some economists might say that the search time for a job increases. The word ‘permanent’ however reflects an increasing burden on the welfare systems and might also increase social unease. There is a particular kind of unemployment which leads us into some theoretical reflections, namely classical unemployment. Classical unemployment may be defined as in DeLong and Olney (2006: 486): ‘When unemployment arises not because aggregate demand is too low, but because government regulations or market power keep labour market from clearing and keep labour demand by firms below labour supply.’ Classical unemployment refers to the kind of unemployment which may exist in the neoclassical theory, namely when workers demand wages above the ruling market wage. Thus the maximal employment occurs at the market clearing wage rate. DeLong and Olney’s definition could

Uncertainty, money and labour demand   217 also apply to non-­competitive markets but the general discussion often centres around government regulations and union power to increase wages above the market rate. The discussions of classical unemployment are also sometimes attached to rigidities caused by policy regulations. We will not dispute that this is a possible explanation for some fraction of the total unemployment but rigidities are indeed also rising from other sources and furthermore the name of classical unemployment alludes to the neoclassical theory which makes the whole discussion conspicuous, not per se as the mentioned identified cause, but the whole discourse in itself builds on quasi-­ theoretical arguments lacking logical substance. If there are other forms of unemployment there must by necessity be an out of equilibrium situation and neoclassical analysis does not present an analysis of that case. There are however other approaches. Blanchard and Fischer (1989: 349) link natural unemployment to the heterogeneity of the labour force and search costs for the companies, which is an interesting approach but they treat the problem without any causal analysis and in a static way. The problem as we already have discussed is that if we regard government regulations as the only exogenous restriction attached to the market optimization this reasoning would be sensible but as we have showed earlier the very use of the neoclassical market theory as a norm is susceptible, which means that using it as a norm requires the introduction of several other restrictions, not to mention the dimensionality problem, and simultaneous analysis of them. Thus there is no doubt that government regulations may have a substantial effect on the rigidities of the labour market but the question is if these regulations really are the cause or are they consequences; the opinions seem to be more due to ideological idiosyncrasies then to actual empirical analysis. In the Keynesian tradition, the market economy is unable to create a labour demand that is appropriate from a social point of view; unemployment is not a separate problem but integrated in the economic structure. Thus the working of the economy is fundamental to social development and structure but the reverse dependence is also true. In discussing unemployment one fundamental question is why the growth of capital stock is insufficient. This refers to the socially desirable employment level. Another question is why there exists unemployment and shortage of labour at the same time, thus the development of heterogeneities has to be discussed. The competitive forces and globalization We mentioned in Chapter 6 the development after the Second World War as some kind of greenhouse effect both on production and international trade. The explosive growth ceased, however, at the beginning of 1970s and was replaced by a deceleration (Boltho 1982). The reasons for this were many: the end of the war effect on capacity needs and demand; creating a different environment of competition; the end of the Bretton Woods system; rising prices of raw materials, particularly oil; and inflationary pressure partly through the Vietnam War

218   H. Ekstedt 160 140 120 100 80 60 40

2003

2002

2001

2000

1997

1993

1990

1988

1985

1983

1980

1976

1975

1973

1970

1965

1960

1955

1950

0

1995

World GDP World goods trade

20

Figure 7.1  Growth of world trade and world GDP (sources: IMF and own calculations). Note 1995 = 100.

Table 7.1  Development of a market structure Sweden

Market share (%) Share of production (%)

USA

1965

1987

1965

1987

35 85

25 17

≈0 bihi. Thus the bigger Ki the smaller bi·hi have to be. In our discussion of the conditions for the financial markets we concluded that the parameter K as well as both b and h are pretty big as we can hardly expect financial markets to be stable. The article by Enthoven and Arrow was intended to discuss expectations in the real market and was soon elaborated to cover other forms of expectations formation, adaptive expectations; nowadays some economists seem to look at the contribution by Enthoven and Arrow as a first analysis of rational expectations. The interesting thing, however, is to look at the discussions of expectations from the point of view of our discussions of Wittgenstein and Russell’s paradox in Chapter 2. Transforming the humans into Homo Œconomicus and commodities into independent dimensions with no other difference than that of different numbers in an index, implies that we drain the real commodities of their inertia which is linked to social and cultural structures. We thus transform both individual human subjects and real commodities into non-­proper classes in the meaning of Russell’s paradox. But when we accept the difference between commodities and money and use the Enthoven and Arrow theorem on financial assets, that is future money, we smell the aroma of a serious theory of money.

Uncertainty, money and labour demand   237

7.3  Money and the monetary economy Most economists agree when it is said that the pure neoclassical theory or a Walrasian model does not concern a monetary economy but an exchange economy. The reason why Arrow and Hahn (1971) call for a serious theory of money is that they analyse the exact structure of an exchange economy and clearly see the inability to analyse certain questions in a proper way. We have discussed two processes which affect the production companies behaviour as we illustrated in Figure 7.6, namely increasing their proportion of financial capital in relation to real capital and thus decreasing the growth of the capital stock. One process is global competition, not in the sense of Salter’s Growth Machine but in the sense of changes in the commodity space as well as in consumer needs, creating radical uncertainty of the future. The other is the technical process of decreasing substitutability of capital and labour creating higher variability of the liquidity position of the companies. The increased holdings of liquid resources in relation to total capital implies, in conjunction with technological advances, that a gap is created between the level of socially desirable employment and the employment at full capacity utilization of the economically adequate capital stock. This also implies that we will have a considerable amount of liquid resources in the economies which are not supposed to be chained to inert productive assets. In fact we get a situation almost like money hoarding. Thus we may say that the earlier discussed permanent unemployment has a correspondence to this ‘money hoarding’. We discussed earlier the effects of an increasing labour hoarding and saw that it could increase the risk for production organizations so let us now discuss if there are any corresponding effects of money hoarding. With respect to the financial markets we have a quite tricky aspect of how the financial system will earn money. We have an increasing stock of liquid resources and a diminishing labour force. The productive companies keep a higher part of their total capital in financial capital thus they in fact become competitors to the banks. The banks will have a shrinking public to which to provide liquid money since the part of the public which is inside the productive system has no incentives to change behaviour with respect to an alleged macroeconomic development. So how are banks earning money? The collapse of the credit system in 2008 was to a large extent due to refined ways of hiding risks of lending to people with small or no credit worthiness, the so-­called NINJA (No Income, No Job or Assets). This scandal is an excellent illustration of the relation between unsystematic risk and systematic risk in Figure 7.7 and the reason was of course that the money-­earning scope overturned the security precautions. The problem of such financial adventures is that they serve to undermine the trust of the credit system as a whole and thus increase the perceived systemic risk which accentuates the liquidity motive and furthermore we then also undermine the trust in assets which are used by production organizations to insure against uncertainty immanent in the inert production capital. Thus the failure of

238   H. Ekstedt the financial market actors and the supervising authorities is a splendid example of increasing the social uncertainty of a sector which is totally depending on social acceptance. In this respect it is obvious that the neoclassical theory is gravely misleading since it cannot handle the fundamental role of money. Currencies So far we have avoided discussing the problem of currencies and we have kept the discussion strictly to theoretical money as in a world with just one currency. The role of different currencies in a world with practically free financial flows does not change the fundamental discussion of money as the most liquid asset but it blurs the question of what is to be regarded as money and it also blurs the question of which social acceptance is relevant. Currencies are interesting phenomena, since they display both the character of money and real assets. Separately they belong to money but in the international context there are some other aspects. First we have the aspect of convertibility. In an integrated financial system we expect good convertibility between currencies but then there must be some standard conventions of bank behaviour; we have the agreement of Basel II. However in the 2008 crash we could see the reluctance of banks to trade with each other since they were uncertain about liquidity positions of their partners. Thus for the efficiency of convertibility among currencies we need common norms of behaviour among agents on the financial markets. The second aspect is however the relative valuation. A currency of a country contains all aspects affecting social, economic and political stability of the country in question but furthermore it also represents a possible consumer market and thus also investment possibilities. Thus the different currencies have characteristics which disqualify them in an international context to belong to non-­proper classes. At the currency markets the anomalies of currencies with clearly different characteristics make them belong to proper classes and in the same way they are to a certain degree to be seen as money belonging to non-­proper classes. A system like Bretton Woods thus transforms the contained currencies to equivalents of money since perfect convertibility is granted. The same is the case when much of Europe converged into a single currency which represented a gigantic market. These aspects are important for evaluating the effects of inflation on the stability of the different currencies. A big stable currency that represents a real market where we have investment possibilities will be less sensible to inflation than an equally stable but small currency. That also means that in times of general uncertainty there will be a flight to big currencies almost irrespective of reasonable levels of inflation. For small open economies it means that in order to have a reasonable currency stability anti-­inflationary policy must be at the top of the agenda while in bigger economies a more relaxed attitude may be taken. It also means that the tolerance of state budget deficits are less important in big currency areas compared to small currency areas, provided of course that they stay within reasonable frames.

Uncertainty, money and labour demand   239 We have mentioned gold and that might be a good store of value if there is a social acceptance; as a currency standard it has, however, the earlier discussed weaknesses. Fundamentally the existence of different currencies compromises the concept of liquidity which means that to have liquidity today both with respect to current liquidity as well as future money we must create portfolios which protect the liquidity of the liquid resources. The effect of this is that we add a further motive of money hoarding thus diminishing the part of the total capital going to productive investments. Thus labour hoarding and money hoarding actually work in the same direction with respect to increasing the permanent unemployment. Inflation Our discussions of the character of money imply that we must look at money both from the perspective of the real economy and the perspective of future money. Money as the highest form of liquidity is deprived of any characteristics besides being the highest form of liquidity. As we have said money fulfils the reflexivity axiom, when it comes to current money. With respect to future money however, other forms of financial assets will introduce a risk in our liquid holdings, which may vary between a three-­month treasury bill to a so-­called NINJA, so keeping pure money for the future is the most risk-­free link in transferring current wealth into future wealth. However this ability of money is compromised by inflation. From an abstract point of view we may say that expected inflation adds a further characteristic to the concept of money which lowers its liquidity. Furthermore if we refer to our discussion of currencies this aggravates the risks in the relative valuation of different currencies and may necessitate further insurances in liquid portfolios. Thus we will have an increased demand for securities which also drives down the interest rate. But what will be the effects of these reductions in interest?7 The conditions for investments in productive investments are not changed but the volume of liquid capital and also the existence of inflation implies that demand for securities and such assets as different kinds of property, stock shares, land and houses, art and jewellery, will increase and we will have inflation in these things. The immanent risk increase is obvious, in a changing demand and particularly in prospect of severe market changes in the world such that the future effects of asset inflation will be impossible to forecast. Our question of how banks are going to earn money can now be raised to covering whole societies. With respect to the direct real effects there are some other points to be made. From a traditional point of view at the aggregate level we can see the two regimes which we may call the Keynesian regime and the inflation regime. To this we add the variations of the gross profit share. The point is that the liquidity position of the firms reaches its maximum at the optimal capacity utilization but in case of production above optimal capacity utilization there may be some ease in some upward price pressure. Production under optimal capacity utilization implies an upward unit cost pressure but no ease from rising prices. Thus, given

240   H. Ekstedt that the industry, particularly the internationally competing industry, displays the problems of Figures 7.4 and 7.6, the long-­run risk for the societies is on the Keynesian side of the problem, so to say. The fundamental point is that the liquidity position of firms may be negatively affected irrespective of if the deviation of production is upwards or downwards, but if it is upwards it may be compensated by inflationary pressure. The downward variations may be eased by wage decreases but taking the reasons for labour hoarding into consideration we then lower the wage for people who are the most attractive to the companies, besides of course the problems of the deflationary pressure. With fully flexible labour we have only problems of this kind in production over the optimal production level but when the production decreases to below the optimal level the liquidity position is improved. Thus in economic models we will have the result that over-­reactive anti-­inflationary policy is not that risky under the assumption that labour is a fully flexible production factor since the firms’ risk-­position is not affected negatively. But this is not the case when we have the problem of complementarities in production between labour and capital. Under such a regime, over-­reactive anti-­inflationary policy will increase the risk of the production sector and threaten long-­run growth of the capital stock, thus increasing permanent unemployment. High inflation may damage long-­run growth, it is said, and to this we agree to a certain extent but an over-­sensitive anti-­inflationary policy killing investments is perhaps the bigger problem today threatening the stability of the society. The quintessence of this is that the liquidity risk of the firm increases and when the problem is generic for the economy it will give the result that a higher rate of total capital will be held in financial capital. We might therefore say, drastically expressed, that when labour hoarding is a generic phenomenon in an economy this will boost money hoarding. In a precise sense it is not money hoarding but investment in financial assets and from a production point of view it has the same effects. But idle liquidity triggers financial innovations which may increase the systemic risk since we may ask where are the groups ready to sign a financial contract. What about inflation as a problem in the sketched regime of Figures 7.5 and 7.7? What we have said so far may give the impression that we recommend a downgrading of the inflation problem and an upgrading of the unemployment problem. Unfortunately it is not as simple as that. In modern textbooks the costs of inflation are usually seen as tax distortions, arbitrary redistributions between debtors and creditors through real interest rate variations, and redistributions between people living on wage-­incomes and those living off other sources. Some textbooks even rank relative price-­changes to the costs of inflation, which is a bit hard to understand. We agree with these aspects but there is something much more serious in the real world and that is the fact that contracts are made in money terms. That happens when we have an internationally integrated financial system and firms use money, near money assets and currencies as an insurance system, and asym-

Uncertainty, money and labour demand   241 metric inflation between different currency areas may cause substantial uncertainty and thereby volatility in the ‘insurance system’. Thus the states do not fight inflation any more, but expected inflation, which is an entirely different thing. To assure the financial market that we will not have inflation requires an attitude totally different from fighting existing inflation on commodities. Thus if we do not fight inflation we might end up in higher volatility of financial assets and thereby cause firms to experience even higher uncertainty since the financial security to cover increasing risks in the inert production capital will be more volatile, thus increasing the total uncertainty. Going back to the romantic picture in Figure 7.7 we now realize that the two kinds of risks are not and cannot be independent and now we also see the full relevance of the Enthoven and Arrow theorem, earlier discussed. Finally there is one aspect on inflation policy to be made on inflation norms. We are a bit uncertain of whether it is of empirical relevance or not but it falls out theoretically with respect to our discussion of changes in the commodity spaces. When we measure inflation we, for the short run, use Laspeyre index which is linked to the long-­run Paasche index by certain methods. Theoretically we know that a Laspeyre index will have the same characteristics as a gold standard, thus adding a commodity dimension in some commodity group requires a total revision of relative prices. If not, it will show up as inflation. Thus using Laspeyre indexing in an upturn of a trade cycle can be problematic. We know by experience that the best time for introducing new commodities is in the upturn of the trade cycle but this may imply that inflationary signs will be due to these technical factors rather than inflation in the strict sense. Thus a strict enforcement of inflationary rules might be counterproductive. But as said this is a matter of empirical investigations. However together with earlier considerations it might be a further argument for cautiousness with respect to insensitive anti-­inflationary policy.

7.4  Policy In elementary discussions of the circular flow in a theoretical economy we point out the dangers of labour hoarding. From this point of view the neoclassical standpoint that money is a medium of exchange and an accounting tool is desirable. In the circular flow of the economy money should have no intrinsic value and then all money-­flows will have a real purpose. The value of money as liquid assets is created by uncertainty as we discussed above. Thus when we have a development where on one hand the pressure of the international markets on the single state is to a great extent coming from increased liquidity in the system, and the basic roots of this to a large extent can be found in the fact that the production organizations, particularly in the industrialized countries must have a larger portion of the total capital as financial capital and liquidity. On the other hand, we have a situation where the financial operations to a greater extent are loosened from the real economy. In such a case we, so to say, aggravate the problem expressed in the Enthoven and Arrow theorem.

242   H. Ekstedt If the financial markets are not firmly based on the real economy we lose stability. In neoclassical economics money is, so to say, a residual with no real importance; money is just a measurement of relative prices, which are set in the general equilibrium of the exchange economy. The inclusion of liquidity as an independent value in money separates it from the neoclassical discussion of prices and then it will be entirely based on the strength of social, political and economic stability and basically the strength of the social convention. The euro is an excellent recent example of this process. This raises an important question: what is money on the international market? The Enthoven and Arrow theorem deals particularly with an asset which has no value except the price the agents are willing to attach to it and then expectations on the price are the only matter which counts. This is important to realize. Other consumption and investments commodities are linked to the social and technological structure but that is not the case with the value of money. Financial assets bound to a particular country are in fact bound to the entire dimensionality which is relevant for the social, political and economic stability of that country. That means that expectations can be formed on any subset of dimensions, whether they are realistic or not is impossible to say, but they affect the market price. This knowledge and understanding must be basic to any kind of ‘serious monetary theory’ alluding to Arrow and Hahn. Money contracts are thus based on the social and political stability first and then to a certain extent to economic stability. Thus if we pursue an economic policy aggravating social and political unease which might turn into instability it is a direct attack on the foundations of the free society and the free market economy. That is exactly why increasing permanent unemployment is a basic threat to the stability of society. Because, if we shall fight environmental problems, energy problems, poverty problems, the problem of an ageing population and so on, we need social and political stability; this is not a sufficient condition but a necessary condition for the democratic society. Thus we have obviously two main policy tracks which partly must be carried out simultaneously: stabilizing the financial markets and diversifying the economic structure. The latter problem is probably more urgent in Europe than in the USA. In basic economic teaching we usually say that only investments in real production capital are the true source of real growth, beneficial for the whole society. Fiscal policy in underbalancing the budget has the only aim of keeping up demand as a temporary measure to stabilize the development. But as we saw in the above analysis the space for traditional so-­called Keynesian politics is rather limited. Public consumption/production must be financed by taxes or fees. This is traditional wisdom, still valid, but the basic epistemic cycles are changed because of changed investment behaviour. In a closed economy the possibilities for individual agents to gain on transactions of liquid assets are soon

Uncertainty, money and labour demand   243 exhausted. Since the world is also closed but on a bigger scale we may expect earnings on liquid assets to evaporate but that is a much longer process and most of all the different kind of borders, national, cultural and religious that exist together with sets of rules, sometimes relevant, sometimes working as aggressive economic warfare but also to some extent obsolete, creating thresholds which prevent a beneficial trading of liquidities. Internationally the question of liquidity is a difficult question. The US dollar and gold, traditionally during the Bretton Woods era, were first officially and later more or less informally acknowledged as the most liquid assets since the Second World War, but as the competitive position of the US changed, as her foreign policy became more and more nested in world affairs, the liquid value of US dollars has been uncertain. We are perhaps now evolving into an era of a bipolar system of euros and US dollars since these two are still the largest economic areas. For how long is difficult to say: the rapid development of China, India and the rest of Asia is certainly intriguing with respect to these aspects. Anyway, so far the US and the euro area are the two biggest economies with respect to both production and demand. Production is faltering to some extent but the international importance of the demand in these areas is still undisputed but for the USA the imbalances in trade, particularly with China, may alter the situation quickly and if so, what are the socially stabilizing forces? What happens now in the US and Europe is that larger amounts of liquid assets are held to a large extent, due to the industrial development illustrated in Figures 7.4 and 7.6. At the same time this development tends to create permanent unemployment and furthermore the whole show is set up by the increasing risk of production capital; thus with an increased international competition there is little room for wage increases other than the necessary in order to save important staff. The bank crises of 2008 were to a large extent underpinned by loans based on the possibility of issuing so-­called NINJA (No Income No Job Assets), which were a brilliant example of interdependence between unsystematic and systematic risk, that is, all of it melted down to genuine uncertainty. The outcome was quite clear but the question was who shall carry the burden of the crash. From a traditional and economically sound perspective the banks and authorities supervising the banking sector had behaved in a totally irresponsible way. But how can banks make money in the present international economic environment? Investments in production are dominated by the big conglomerates, either directly or indirectly. These investments are, however, to a great extent internally financed. When these organizations handle their liquidities in financial investments, they use the very same market spheres as the banks. To earn money the banks are forced to riskier parts of the market and try to catch newly evolving sectors and areas, normally attached with both higher risk and considerable uncertainty. As we saw from the analysis of Chapters 5 and 6, increased uncertainty within the real economy is not entirely negative but contains a rich field of possibilities for the future. The arrival of the imagined future is however certainly uncertain.

244   H. Ekstedt A particular political feature both in the USA and partly also in Europe has been the temptation to use the credit sector for redistribution purposes, as the finance of states both with respect to tax income and to public borrowing has reached a ceiling and the need for economic transfers have disfavoured investments in human capital and infrastructure. There is a temptation to use the credit sector which has also, more or less consciously, functioned as a means for redistribution policy by lifting the restrictions on banks. Entering such a policy is suicidal, not even in the particularly long run since it is a threat to the liquidity of the whole system. Public authorities are now, in the aftermath of the banking crises of 2008, with great determination bringing the banking system back to order. But which order – the order of the 1960s, the 1970s, the 1980s or the 1990s? Unfortunately these times are past and the environment of the banks is completely different, not so much with respect to internationalization as such but with respect to the conditions of the real economy, particularly in Europe and the USA. The solution to this dilemma is maybe that the banking sector has to come back to a relatively regulated reality, where fancy moneymaking innovations are to be restricted. This road under the present development of industries in Western countries is rather gloomy since the relevant space for banking activities is diminishing. However in the view of a changed industrial development of diversification both regionally and with respect to new production sectors it might still be profitable for society as a whole. Furthermore Europe and the USA are in a situation where permanent unemployment increases while the economies are more liquid than ever. In the US the total deficits have reached unprecedented levels, so the money sector seems to be a potential threat to Western societies. Distribution of wealth, income and work In Europe we have substantial collective welfare systems. To discuss if these systems are compatible with the market economy or if they are signs of socialism is, with respect to our analysis, irrelevant since those discussions use the neoclassical setting as a theoretical basis and end up in first and second best analysis. Such an analysis is, as we have shown, entirely inadequate in a discussion of a real economy. As ideological statements they are of course relevant, but that is outside our scope. However these welfare systems are currently under heavy pressure from on one the hand an ageing population and on the other hand a diversity of cost increasing processes in conjunction with a rather high general tax pressure which tend to restrict growth of private demand. Let us first repeat our discussion in Chapter 6 on economic growth when we said that we can expect an increasing role for the public authorities when social integration increases as well as every new commodity dimension also adding an increase of public control and administration. An instructive example is the discussions of legal protection and control of intellectual property rights vis-­à-vis

Uncertainty, money and labour demand   245 Permanent part Cyclically independent

Variable part Anti-cyclical

• Education and youth policy • Health and medical care • Parental support • Pensions and geriatric care • Regional support

• Unemployment insurance • Labour-market policy • Supplementary benefits

Figure 7.8  The cyclical structure of the welfare system.

the Internet. Thus the legal control and supervision increases also with the complexity of the commodity space. We have already mentioned Adam Smith’s discussions of increasing subordination when the amount of valuable property increases (Smith 1952 [1776]). The welfare systems are generally directed towards three areas: investments and maintenance of human capital; general insurance systems; and social stability. These aspects are of course nested in practice. However processes like the ageing population, together with the effects of advancements in medical treatments which give rise to the so-­called ‘Baumol’s disease’ increase costs in the health and medical care sector, the complexity of the society and the production system require higher investment in education and the increase in permanent unemployment comes on top of this. Figure 7.8 illustrates the problem. What happens is that the right hand part, of anti-­cyclical measures, now tends to grow and crowd out the left, permanent, part, when permanent unemployment increases. This is more pronounced in small open economies like Sweden which suffers with this problem together with decreasing terms of trade, even if we can see this problem in most European countries. A larger share of the public budget is devoted to short-­term measures and also to supervision and control, and that affects particularly investments in human capital, bringing in the necessity of social stability in order to cope with these problems and makes current and future policy really challenging. To solve these problems together with environmental and energy problems by setting hope against the market forces, backed up by a neoclassical analysis, seems to be a rather ugly prospect. Permanent unemployment is rising and fundamental long-­run investments in human capital have to be squeezed. An increasing stock of unemployed is frightening. The words of the title page of Lord Beveridge’s Report (1945) from the middle of the 1940s come to our minds: ‘Misery generates hate’. These words are vital to remember for all economists. Society is a social organism and the democratic society is essentially founded on social stability, but this stability is not a matter of distribution policy. Income distributions are to be seen as insurances intertemporally, and in case of unemployment only of short-­run duration or in cases of individual disability. The fundamental principle is that humans

246   H. Ekstedt have to feed themselves and their offspring by their own work. Furthermore the pure market economy will not lead to its assumed general equilibrium, not because of public interference but since it does not exist a pure market economy of the neoclassical description. We quoted earlier Lord Beveridge when he expressed his pessimism about the ability of the market economy to create full employment. His words are strong but are they necessarily gloomy? We started this book by rejecting the neoclassical theory and pointed out the necessity of an ethics. Contrary to the Kantian ethics which implicitly must underpin the neoclassical theory an ethics meaningful for democratic society must explicitly concern the creativity of Man. But as we have said an ethics is not the root of actions but it expresses a right and a responsibility. The human creativity is part of what David Hume calls ‘passion of the will’ and we also allude to Keynes’ ‘animal spirit’. In Chapters 5 and 6 we maintained that human creativity both creates uncertainty and is triggered by uncertainty. We also claimed that the rejection of the neoclassical theory deprives us of a general topology for measurement in economics. Such a topology could partly be created by the introduction of an ethics, but only partly and in a conservative meaning. We are not prepared to risk social position or wealth for the benefit of the society other than if the society is at a considerable risk, in parallel to the earlier quote from Beveridge. Amartya Sen (2002: 76) discusses along the same lines: When distributional issues dominate and when people seek to maximize their own ‘shares’ without concern for others (as for example in a ‘cake division’ problem, with each preferring any division that increases her own share, no matter what happens to the others), then majority rule will tend to be thoroughly inconsistent. But when there is a matter of national outrage (for example, in response to the inability of a democratic government to prevent famine), the electorate may be reasonably univocal and thoroughly consistent. We have claimed that any aggregate epistemic cycle normally consists of contradictions. It is probable that the individual epistemic cycles reaches its maximal diversity and perhaps also a considerable reluctance to creative uncertainty in a peaceful, prosperous and stable society, as we indicated in Chapter 5. When stability and prosperity are threatened there tends to be a wider acceptance of aggregating measures restoring stability but at the same time, when Sen alludes to the cake sharing problem he touches the sensitive question of competition of ideologies and the potential ideological instability of voters. So far Beveridge’s words are gloomy. How do we reach the necessary social focus on destabilizing forces when the individuals are fighting to preserve their relative prosperity in a society with increasing permanent unemployment, rioting young unemployed people who have been defined as not fitting into the appropriate working force, reports on long-­term decreasing oil supply, the climate ‘bomb’ and so on? How do we think people shall vote for ‘investments’ in others.

Uncertainty, money and labour demand   247 Beveridge continues in his postscript (1945: 274): But, as experience has shown, it is possible to make such declarations without being prepared for war and for all the changes of economic and social habits that are necessary for success in war. The time calls for total war against unemployment and other social evils, not for a war with inhibitions. Otto von Bismarck famously said, ‘Politics is the art of the possible’. We may interpret this in two ways, adapt to what is possible in the current opinions of the electorate or make the electorate prepared for a change. We claimed in Chapter 2 that democracy has nothing to do with economic efficiency; thus the different kind of voting models of Rational Choice are pretty meaningless. Democracy is about submitting to a set of aggregate epistemic cycles in spite of contradictions on lower aggregate levels and individual levels. We sometimes dream of ‘economic machines’ solving distributional questions without affecting our prosperity. There are no such machines irrespective of which ideology these ‘machines’ are based upon. Thus we can never solve these problems for an infinite length of time, only temporarily, and the solution must be based on social acceptance in a democratic society. But there is also a nice interpretation of Beveridge’s words. Western civilization is under threat, to a great extent due to its own lack of understanding and responsibility for the future. We need however readdress our energy consumption and the effects on environment of economic activities, and to this we might add social stability both on the international and the national level. This cannot be done except by major changes in the structure of society and also changes in the individual way of living. These matters call for a mobilization of all resources and for maximal creativity in both an engineering sense and an organizational sense. So we have a war to fight and that is obvious to many people, and young people seem to accept this to a greater extent than older generations. This is indeed a good start for making a necessary political consensus. Whether our political leaders will succeed or not is beyond our ability to judge. Historically we are well aware of the consequences of political failure and the consequences seem to be in proportion of the human technical skill. Distribution of income and wealth is not basically a matter of fancying a redistribution system but of the people’s right and ability to work. This also requires that the wealth of the society and the individuals is invested in production capital requiring the socially desirable working force. For those who are not in the socially defined labour force there should be an appropriate welfare policy as well as a policy of investment in human capital. However these are matters which cannot be solved by the market but require proper political actions. Whether such proper political actions in reality exist or not are a matter of contradictions between individuals and classes of individuals and that is a question beyond our scope.

8 Towards a non-­capitalist market system Spontaneous order and organization Angelo Fusari

Introduction This chapter analyses a central question of modern society: how does one best use ‘the instrument of the market’ – this being a basic mechanism of organizational efficiency in dynamic economies characterized by a high degree of uncertainty – in such a way as to prevent the market itself from turning everyone and everything into expendable tools, with consequences that are ever more disastrous for equity and for human dignity? The purpose here is to envisage the possibility and, more importantly, the necessity of economic forms adapted to human society that are different from those that have emerged from the spontaneous transformation of the Western world. Persisting in the denial and ignorance that such a possibility of change is indeed possible will inevitably lead to the (often fanatical) conviction that the capitalistic market, with all its degenerations and inefficiencies, is the unavoidable, even if bitter, outcome of institutional evolution—a necessary, teleological fruit of human exertion: ‘the end of history’. Students’ and practical people’s attitude towards social phenomena oscillates between two opposite positions: the idea that those phenomena must be considered and accepted as spontaneous events; the pretension to govern them. This chapter points out the intermingling of the two aspects in the life of each social system. As a matter of fact, the history of human societies and logical sense confirm that spontaneous forces and their governance always operate together, even if the one or the other can be largely prevalent in various cases. The suffocation of spontaneous forces obstructs creativity thus causing stagnation. But, on the other hand, the ability to govern society is more and more required by the steady acceleration, via creativity, of social change. Here we shall insist on the possibility, which after all is a necessity in the modern world, to drive market economies outside a capitalistic context, and the way to do that. Therefore, the aspect of choice-­possibility will be emphasized, after having insisted, in Chapter 5, on the aspect of necessity. To analyse this topic with the depth and the breadth it deserves, we will first sketch a brief account of those institutions and forms of civilization that in the course of history have promoted the rise and spread of the market, eventually

Towards a non-capitalist market   249 making it into an organizational necessity of modern economies. This account will be concluded by a summary of the pros and cons of the capitalistic market. The subsequent step concentrates on the notion of competition, and in particular on the role of the entrepreneur and the significance of the rate of profit as a gauge of accountability. This is essential in order to highlight the powers of resilience of the market, and to show its flexibility as an organizational tool with regard to various kinds of ideological options: for instance we will contemplate how it may be extended to either private or public systems of ownership. In section 8.4 we discuss how the market may be turned into a mere mechanism for the imputation of costs and efficiency, and this discussion is at the heart of the following proposal for a non-­capitalistic market and the merits of its social openness. This argument will then lead directly to the treatment of a defining, and fundamental component of the system, upon which all reformist propositions impinge by necessity: the nature and management of the interest rate and the attending financial system. These are two dominating and interconnected aspects of traditional economic systems that increasingly thwart entrepreneurship and stifle production since they are predicated on a high concentration of economic power in the hands of a social class de facto devoted to speculation rather than production. We offer a solution to this problem, and conclude the essay with a few considerations on the international order. The goal here is to devise a coherent reformist agenda articulated in several key points pertaining to the vital nodes of the economic system.1 This is just a beginning, a first attempt: naturally, given the complexities of the issue, the remedies recommended are by no means exhaustive, but merely indicative of the broad path all humanist forces should undertake together in days to come.

8.1  A historical sketch of the market In this section, which is devoted to ages in which the market was hardly the protagonist, we will identify the structural obstacles that impeded the development of market relations and the contingencies that eventually allowed those relations, in some instances, to rise gradually and spread all around. We then consider the strong interaction between the growing influence of the market and the rapid pace of social transformation, which has brought the market to become the essential mechanism for efficiency, growth and development. In ancient times markets were absent or marginal because they were not necessary to the organizational efficiency of social systems; rather, as we shall see, the market obstructed efficiency. The major role played in some ancient societies by individual initiative, critical spirit and the propensity to adventure was much more a stimulus to creativity, scientific research and geographic discovery than it was to the market economy. The economy did not hold a central position2 and did not attract the interest of students and practical people. Of course, the great empires of the ancient world devoted considerable resources to hydraulic, monumental and military works. However, these were centrally administered, authoritarian societies that suffocated individual initiative, and in

250   A Fusari particular mercantile activities. Which does not mean that they could not achieve wealth, power and social sophistication: in fact, a stationary-­repetitive economy may be efficiently managed by centralized processes and bureaucracy. Indeed, the most advanced societies of the ancient quasi-­stationary world were bureaucratic, autocratic and centralized empires, whose neatly ramified branches often afforded complete and efficient control over extensive regions, thereby avoiding dissolution and fragmentation. The crises of the two main commercial empires of the ancient world, Carthage and Athens, are good instances. Those empires were defeated by less rich but more highly structured rival powers. The organizational inconsistencies of the two empires, the avariciousness of their ruling classes, and the resentment of their confederates and subjects, all represented heavy functional handicaps in the static outlook of both systems. But the best illustration of the market’s unsuitability to quasi-­stationary societies is provided by the experience of the Roman Empire from Augustus to the Antonines. That empire was governed by highly advanced institutions, suitable to the modern world and unique in ancient times. An active and efficient body of public servants authoritatively administered justice, public order and taxation; the remaining public functions were assigned to the municipal self-­government of the decurions;3 individual initiative was well represented and taxation low. But the major pride of the empire, the great Greco-­Roman civilization with its central idea of circular time, and the marginal role of the economy, the running of which depended on the polarization of aristocracy/slavery, hindered cumulative development and the role of the market.4 The persistence in remaining stationary, leading to stagnation, transformed the promising decentralized public administration of the empire into a factor of dissolution. So the great crisis of the third century AD and an extremely painful process of trial and error drove the Roman Empire toward the bureaucratically centralized, hierarchical society of Diocletian and Constantine the Great. In that society, as in the other great empires, the market was clearly marginalized. The collapse of the Western Empire – which, unlike the Eastern provinces, was socially and economically dominated by large estate slavery tenancy and a large state-­subsidized urban populace – resulted in a severe retrogression in the general conditions of development. In this new stage of arrested growth, the body social reverted to a primitive structure governed by familial links: the quasi-­familial relations of loyalty on the part of the populace to the descendants of the great senatorial landowning class, or to Germanic military chiefs, assumed a basic role. No proper state power came into being. The sovereigns of the barbaric states were for the most do-­ nothing kings, controlled by a military aristocracy. Nor was there any centralized or autocratic empire in fragmented post-­imperial Europe. Charlemagne’s empire was a kind of ‘shooting star’. After his death, social organization took to the feudal model: a world governed by strong and arrogant individuals, plunderers more than administrators; as Anna Comnena noticed during the transit through the Byzantine Empire of crusaders’ expeditions: these

Towards a non-capitalist market   251 were fighters for the faith, but also for spoils and fortune, ‘extremely greedy for any kind of gain’.5 In such turmoil, what became of the market? The Western European world dominated by avidity and the spirit of independence, and well disposed to adventure, favoured a luxuriant efflorescence of mercantile activities. The maritime towns were clever at making huge profits from the Near-­Eastern conquests and the growing hunger for exotic goods. The medieval communes that followed, carefully created laws and institutions suited to trade, and were resolved to defend and extend their independence by fraud, talent and the sword. The economy began to take on a central role; it now wielded progressively political power and came to finance troops and mastermind conquests. Innovations became more frequent, and while they might have appeared at first to be of little importance, they contributed greatly to productive efficiency. Ancient Chinese inventions were adopted; others were rediscovered in the Arab world, which had been driven into decline by Islamic theocracy, despotism and the vice and decadence, as deplored by Ibn Khaldun.6 The figure of the so-­called merchant adventurer arose and the drive for discoveries and profit opportunities intensified. This triumph of individualism and activism contaminated the intellectual milieu of Europe. Philosophy and scientific investigation flourished. The religious world, cultivated in the monasteries, which held a monopoly of knowledge, now began to court heterodoxy. The spread of heretical groups and then the explosion of the Protestant Reformation made theocracy impossible. The idea of linear time, which infused the perception of ‘becoming’ and the sense of expectation, once it became wedded to a pluralistic, decentralized social structure permeated by the individual search for material wealth, ended up fertilizing the soil of commercial spirit and economic activity. A world open to creativity and change wedges its way into history. Nevertheless, until the sixteenth century, there was no such thing as the self-­ sustained growth of the economy. Despite the progressive build-­up of this pre-­ modern ‘dress rehearsal’ for capitalism, Western Europe was still less developed than China, though it had a key advantage: entrepreneurship. In fact, the great geographical discoveries of Ming admiral Zheng-­Ha in the early fifteenth century had no effect on the centralized Celestial Empire, hostile as it was to businessmen and inclined to isolate itself from the outside world. By contrast, the European Age of Discovery was an epochal turning point, driven mainly by the impetus of merchants and adventurers. The growing dimension of the market began strongly to stimulate labour division and hence labour productivity. Still, the immense flows of resources that accompanied those events and the appearance of manufactures could not by themselves have averted European society’s relapse into quasi-­stationary motion (even if at a higher level of development), or even disintegration and the extinction of creativity, as in ancient Greece. This danger was averted thanks to the immense contribution of science. Henceforth, economic competition would be based even more strongly on

252   A Fusari innovation – Schumpeter’s ‘creative destruction.’ The era of industrial society began and capitalism was fully established, at last. The rise of a dynamic social system made the market a crucial organizational necessity. In fact, it is impossible for bureaucracy to govern a dynamic economy, which by definition is characterized by great uncertainty, and which needs a steady supply of creativity and innovation. Bureaucratic organization inevitably leads to the stationary state. Entrepreneurship, creativity and innovation need the market, which is the sole mechanism that can coordinate a large quantity of disconnected initiatives and conflicting decisions in a radical state of uncertainty, and eventually assure their overall consistency while providing adequate incentives for all activities. The central role of the economy and the need for the market – both of which imply the ontological imperatives of individual action, creativity and inquiry – allowed the progressive destruction of the centralized, authoritarian societies that had submerged the world until modern times. The extremely peculiar causes of this turning point are well exemplified by the case of Japan: a society that, despite many affinities with European feudalism and decentralization, was unable to free itself from stationary motion but relapsed into a centralized Shogun feudalism that lasted until the Meiji revolution of the nineteenth century. This result, starkly different from that of Western Europe, can only be attributed, primarily, to the lack of the capitalistic market.

8.2  The capitalist market This section focuses on the capitalistic nature of the evolutionary process previously discussed. In particular, it underlines the initial propulsive strength of the capitalistic market and proceeds to single out its growing limitations, which appear to form an explosive blend of contradiction, discontent and inefficiency in the present age. In the eighteenth century, Mandeville emphasized the role of selfishness and corruption in driving society to prosperity and dynamism.7 Soon after, Adam Smith’s economics celebrated the invisible hand, a metaphor for the combination of the market with individual interest. Both were right as commentators of their own era. In fact, the robberies and lack of all ethical constraint on the part of merchants and entrepreneurs were crucial to primitive accumulation; they were the prerequisite for the advent of industrial society. Well-­governed social orders, like the great empires or Tokugawa centralized feudalism, were unable to promote endogenous growth, which was stimulated above all by the lubricating role of the market and self-­interest. However, Mandeville and Smith went too far in asserting that these phenomena represented natural laws. Secularization proceeded, promoting the theory of separation of economics and politics from ethics, and thus silenced the grumbling of the moralists. Such separation represented an evident scientific error. As a matter of fact, social subsystems, as we have shown earlier in this book, always interact: they cannot be

Towards a non-capitalist market   253 separated. But the scientific mistake operated very well in practice: it eliminated the submission to some ethical rules that contradicted various organizational and functional necessities of the new, modern world. Besides, it stimulated the alluring powers of material incentives and the role of the market. This drift accelerated the completion of the great march towards the open society, which gradually smashed the closed and authoritarian civilizations that were still left standing. The accumulation of financial capital represents a central aspect of dynamic economies: an acute hunger for capital has accompanied the evolution of capitalism from its first steps. In medieval times, international traders from Italy invented a peculiar institution called collegantia to collect the commercial capital they required. Loans at interest and discounting (of commercial bills) were diffused in medieval fairs. The banking system came to know a rapid diffusion. Amsterdam, and later London, became the heart of a powerful world capital market. The domination of finance capital had just started. The management of interest rates became the crucial mechanism of the monetary system, and speculative activities gradually ousted production from centre stage. The moral impudence of market relations and standard financial manoeuvres soon began to engender disgust and moral disapproval, which were strengthened by intensifying exploitation. This development gave birth, in the realm of social thought, to a great error, well expressed by Karl Polanyi: namely the idea that the market is just one of various organizational possibilities and that it can therefore be discarded in favour of a different one, say, a ‘redistributive’ (socialist) system. Such a conception found expression in a variety of utopian designs, which were for the most part fuelled by indignation over the infamies of the market and its agents, and which all called for the abolition of the latter. The aims of an anti-­market Utopia, however, never seemed to go beyond the notion of the stationary state and the closed society, which ultimately signify regression to retarded stages of development. This was shown clearly by the most distressing of such Utopias, communism, which aimed to eliminate the market but never escaped its influence, from the early period of the NEP under Lenin’s tyranny up to the recent collapse of all the socialist systems. The methodological equivocations afflicting social theory obscured the fact that the market, entrepreneurship and individual initiative are simply organizational necessities in modern dynamic economies and the open society. The only critique of the market based on scientific foundations appears to be the analysis of ‘market failure,’ according to which, the market is in some instances found incapable of acting efficiently, in particular with reference to public goods, and when market demand for goods is insufficient to absorb production. As a routine, governments – colluding with business – have encouraged a large expansion of public expenditure to remedy the deficiency of demand, and therefore allow the market to ‘digest’ less troublesomely. Yet this routine was gravely flawed from the outset: it disregarded the efficiency of the public sector and of the public administration. This oversight stimulated the birth of an alternative approach that emphasized government failure, which, coupled with the fall of ‘real Socialism’ in the East, greatly strengthened the market fundamentalists,

254   A Fusari and thus boosted the advent of the so called new economics: a gospel preaching absolute free trade and a blind faith in the free market. Meanwhile, the rapid development of communications has allowed market relations to envelop the entire planet with thousands of tentacles, transforming the open society into a global society. Thus the free market has become the owner of the world, with the devastating presence of the four modern Horsemen of the Apocalypse: distributive iniquity, growing international disequilibria, social disintegration, and mass unemployment. These phenomena are most acute in the underdeveloped countries, but they do not spare even the heartland of the free market. In the United States, following the trend in the concentration of wealth, the difference between the highest and lowest personal income groups has almost trebled in the last forty years. The earnings of a CEO are almost 1,000 times those of a simple workman, while public opinion is increasingly concerned over the unspeakable abuses of corporate power. The transition in the former socialist countries has almost always taken the worst of the market economy: privatization has usually produced massive frauds and corruption. Everywhere around the world one may see the astounding facility with which the free market makes instruments of everyone and everything. The necessity of the market favours the diffusion of so-­called capitalistic ‘ethics’ and ‘civilization’, even if they are not strictly necessary to market institutions. So, an insidious kind of colonization is at work, which people accustomed to different cultural values have come to hate with a passion. As mentioned before, not even the Western world can blindly trust the sorceries of the free market. A highly dynamic society is obliged to cultivate a diffuse solidarity and a deep sense of cooperation to defend individuals from uncertainty, precariousness, loneliness and frustrations, which rapid social change is wont to inflict on Man. Here, contrary to appearance, we have a basic inconsistency of the present historical era with the idea of a spontaneous social order. Today, moreover, the virtues of public expenditure in recreating the structural consistency between production and socialization have disappeared, having the public deficit become a constraint instead of a stimulus to production. As we shall see later, such consistency now requires the market to be a mere mechanism of imputation of costs and efficiency. This is an important new organizational necessity of modern social systems. The race for earnings may itself foster the worst misdeeds and has, from a moral standpoint, incredibly destructive power. We have seen that the ability on the part of market relations to furnish incentives, during the march towards the open, global society, was intensified when it came to be combined with non-­ethical behaviour. Today it is ever-­more indispensable to link market relations to higher level of ethics. The global dynamic impulse of the separation of ethics from politics and economics in social thought and action is beginning to turn into an obstacle to the growth and development of human societies. The high level now attained by the general conditions of development and the growing social maturity of the masses make the persistent phenomenon of

Towards a non-capitalist market   255 ‘power as domination’ ever more indigestible, a factor of growing contradiction. The transition to ‘power as responsibility’ is urgent in both politics and economics. One of the great merits of the market is its capacity for automatic, objective and inflexible attribution of accountability for the results of daily economic activity and decisions. But it is necessary to flank this responsibility with an equally objective and inescapable responsibility to the laws governing market relations, so as to avoid, for instance, bribery and corruption, which also undercut economic efficiency. The crucial imperative today is, again, to disengage the market from its inclination and ability to turn all of us and the world at large into its tools. Let us provide a set of solutions to this problem.

8.3  Entrepreneurial role and profit rate. The public and private spheres within the working of the market In this section we will identify some precise organizational requisites for the establishment of a wholesome entrepreneurial economy. Such a careful definition will enable us to combine our revisited model with diverse ideological options. We have just seen that modern economies cannot do without entrepreneurship and market relations; and that the market’s automatic, objective attribution of the entrepreneurial responsibility for action and decision is a precious device. Both in private and public companies (operating for the market), the only reliable indicator of success and hence of responsibility is the profit rate.8 All other significant indices refer only to particular aspects of entrepreneurial action; they are partial and may accordingly become misleading. Various economic theories maintain that the entrepreneur is interested in total profit, not in the profit rate. But total profit is not a ratio of return; therefore, it does not represent an indicator of entrepreneurial success. The search for total profit demands that investments be ranked on the basis of their earnings rate, if the global activity of the firm is constrained (as it always is) by the availability of some factor of production.9 But the profit rate is a good indicator of success only if it is obtained in a competitive market, not through monopoly, for competitive markets force the entrepreneur to engage in a ceaseless struggle for profit, and thus bind him to his function and his responsibilities. To avoid misunderstandings on this crucial matter, an important specification on the notion of competition is required. The competition based on the entrepreneur’s search for profit is the one considered here. It may also be intended as a combination of Kirzner’s ‘market process’ and Schumpeter’s ‘creative destruction’.10 This notion of competition seems to be the only appropriate one in a discursive analysis of modern dynamic economies characterized by innovation and uncertainty. But a complication arises: successful innovation causes temporary monopoly. The complication is only apparent, however: in fact, an innovator’s monopoly does not cause restrictions to competition rather it is the engine of dynamic competition. Therefore, anti-­monopolistic vigilance must not target this

256   A Fusari kind of monopoly, which will vanish as soon as the incumbent innovation is undermined by a superior one – and that is, as soon as the benefits for the community deriving from the original innovation cease. In short, an innovator’s profits express the success achieved in the performance of entrepreneurial function, not a privilege.11 Under this set-­up it will be important to prevent entrepreneurs falsifying the accounts with a view to showing larger than actual profits, and so deceive bankers and other financiers. In public firms, such falsifications may also be triggered by the aim of avoiding blame. The greatest watchfulness is therefore required.12 Procedures have been devised at the EU level to facilitate monitoring and gauging corporate profitability. Other controls on corporate results are used for tax purposes. It is important to perfect them. We shall see that the main difficulties in auditing business accounts are due to the confusion and complications of international relations. The situation is aggravated by widespread bad faith. In effect, the alarming frauds reported in the press are possible only because of the ‘kindness’ of the authorities, which turn a blind eye; such complicity must be harshly repressed. The basic characteristics of the market as set forth here do not, at first glance, imply any theoretical innovation. However, their strict essentiality has substantial analytical value. Our model implies the unrestricted possibility of combining the market mechanism with a large number of different institutional, ideological and relational forms. In particular, our concise analytical foundations allow us to deal with the problem of property free from prejudice, inhibition and mystification, making evident that private ownership may be severely limited by public firms operating in the market without damage to efficiency and with some important advantages for social justice and the control of the overall rate of accumulation, and thus of aggregate demand. For in this kind of firm, profit serves only as the indicator of entrepreneurial success, which should determine whether the managers are kept on or discharged, and not as the vehicle for personal enrichment or unconstrained speculation. As is well known, private property is one of the institutions that have vaunted, in the course of recent centuries, the greatest merits and demerits. It has been at one and the same time a great source of freedom and oppression. It has been the main barrier against the stifling domination of public institutions, it has stimulated pluralism, it has been an important source of individual incentive, and it has constituted an important defensive shield of personal independence. At the same time, it has greatly stimulated and inculcated greed and it has been a formidable means for the exploitation of human by human, and for countless other abominations. Moreover, it has fostered an enormous concentration of power. How are we to separate virtues from drawbacks, to preserve the former and eliminate the latter? This problem largely coincides with the question of delimiting the appropriate sphere for private property, while guaranteeing freedom and justice for all citizens.

Towards a non-capitalist market   257 We can set out a general principle: private property should be preserved insofar as it promotes productive efficiency, the satisfaction of citizens and the full appreciation of their qualities and aspirations, without implying the creation of dominant positions. Both durable and non-­durable consumption should be included in the sphere of private property, in particular homes, gardens and intensively cultivated plots of land. Moreover, small farms, craft and commercial enterprises, whose success is difficult to monitor and hence to control, should be privately run. For efficient performance, these firms need the dedication that comes from private ownership and private appropriation of profits. And as these firms are small, they do not imply dominant positions. In this economic system, everyone can consume what he wishes, as the search for profit will push firms, driven by prices, to satisfy consumers’ preferences. Here the question of new goods and the manipulation of demand through advertisement arises. The introduction of new goods and services is of critical importance for consumers since it broadens their range of choice. Furthermore, in the absence of new products, consumption would be saturated and the economy would stagnate. The entrepreneur produces new goods if he thinks they will be bought. But new goods require advertisement to inform people of their existence. What must be condemned is false, misleading advertisement, not informative publicity. It is undeniable that the purpose of publicity is always to influence consumers. But the purpose of any message whatever is always to influence the listener. The only guarantee against the risk that such influence may create a dominant position, which jeopardizes freedom, is pluralism.

8.4  The cycle of production and distribution within the market operating as a pure mechanism of imputation of costs and efficiency We are about the broach the core of our reformist proposal. Its goal is to delineate the widest possible bounds of social equality, in ways that are consistent with freedom, efficiency and development: in other words, we are seeking to find the preconditions guaranteeing the highest degree of social equality that modern society may achieve.13 The pursuit of these aims requires the transformation of the market into a pure mechanism of imputation of costs and efficiency. Such a transformation needs the establishment of a special fund; therefore some preliminary considerations are necessary to clarify the nature of this fund. The rapport of economics and social science vis-­à-vis the market is twofold: on the one hand, the market has been considered as a potent vector of immorality, instability and social precariousness, and because of this, many have called for its wholesale abolition; on the other, the market has been understood as an institution indispensable to the efficiency of production, which, at most, is allegedly thought of requiring but the complement of social welfare to run perfectly. We saw that the first course of action is completely senseless in modern dynamic societies, while the second perspective appears nowadays utterly

258   A Fusari insufficient.14 We wish to offer a different model, which operates a profound transformation of the market mechanism, and which is predicated, among other things, on the creation of a special fund. This fund of community wealth should enable the system to conjugate the achievement of the highest possible productive efficiency with freedom in the distribution of income. More precisely, it will be proved that this fund is crucial to the pursuit of four main aims: business efficiency, distributive justice, full employment, and individual autonomy. As far as we can tell, there is no example of such a fund in the present and past ages. Let see how our suggested model functions by starting with production. In this model, the firm buys the goods, factors of production and services required by its productive decisions on the market, at market price, just as it does today. But it does not pay wages; instead it pays the price of labour as computed by work offices on the basis of the supply and demand of the various types of labour.15 However, the firm may pay incentives to its workers and also overtime, if it deems it advantageous. Moreover, companies will pay into the fund a penalty for any damages to the environment; conversely, they should receive contributions for any social benefits deriving from their action. Firms are also taxed. Finally, they may have to pay into the fund a surplus over regular labour costs to assist with the transfer of workers from the district of origin. The purpose of this is to stimulate capital to flow toward labour, so as to minimize the effects of uprooting, congestion and urbanization generated by migration. At the end of the production phase, the firm will sell output at market prices. With the proceeds, it will cover constant and variables costs, including capital depreciation and costs on borrowing, as well as taxation. The difference between revenue and costs, divided by capital employed, yields the profit rate. In addition to incentives and overtime paid directly by the firm, workers are entitled to a portion of the fund of community wealth. The determination of this portion and its distribution among social groups will follow criteria defined outside the firms, in the political sphere and through negotiations among social groups and their representatives. The share of each occupational group in income distribution may also depend, in part, on supply and demand for each kind of labour specialization; that is, each group’s share may be augmented or decreased, depending on whether demand for that type of labour is greater or less than supply. In this way, the balance between labour supply and demand will be fostered by variations of supply, not only by the reaction of demand to changes in the price of labour. Each worker will be entitled to receive, from the fund of community wealth, compensation proportional to his working time (but not overtime work, which as noted is paid by the firm) multiplied by the hourly compensation for his skill. To reduce transactions, firms themselves may pay this compensation, deducting it from their payments to the fund of community wealth. At the end of each year, along with the share of output to distribute to labour in the next year, the average gain in labour productivity will be calculated and

Towards a non-capitalist market   259 the share of that increase to be allocated to labour income and the share allocated to a reduction in working time, will be set. This allocation converts technological progress into higher labour income and free time, not unemployment. People look for jobs by direct contact with firms and following the suggestions of labour exchanges, which have knowledge of the supply and demand conditions for various skills (because they monitor supply and demand in order to set the price of each skill that firms have to pay into the fund of community wealth). Everyone chooses the job he or she finds most gratifying (by the type of activity, responsibility, distance from home etc.) and, if satisfied, will keep the job; otherwise he or she will continue to search for more satisfactory employment. In the case of collective dismissals, due for instance to a firm’s closing or downsizing, the dismissed workers will receive benefits for the time needed to find another job. We can see that this model does not consider labour as a commodity that wage earners sell to the firm but as a service to the productive system that entitles the worker to share in the income generated. To prevent people from choosing not to work, in fact, the principle must be that except for those unable to work, the condition for a person to share in the community’s income is that he or she be employed. In this organization of production, large-­scale long-­term unemployment is prevented by the perfect flexibility of the price of labour with respect to demand and supply for various skills. As the price paid by firms for the use of labour skills is determined by the labour exchange on the basis of supply and demand, a labour glut would drive down its price and cost, and thus stimulate firms (in the search for profit) to employ more labour and adopt capital-­saving technology. The opposite happens if labour is scarce. This should push labour demand and supply toward equilibrium.16 The tendency is strengthened if the education system produces versatile workers, enabling people to find various kinds of gratifying jobs. But to move the economy toward full employment it is also necessary to pay attention (to this we will return in the next section) to guaranteeing the equilibrium between aggregate supply and demand. This need is particularly strong in modern dynamic societies, with their continuous local and global changes and adjustments. Even more, one must consider that knowledge and its evolution come largely from experience;17 so that people excluded from the productive process are also excluded from important channels of knowledge and will be increasingly unable to avoid marginalization and alienation. It may be useful, at this point, for a better comprehension of the proposed revision of market dynamics, to work out a more extensive critique of some important aspects of the existing economic systems and ideologies, in the light of this very model. If, as in the capitalist order, the distribution of income between labour and capital is the result of the clash between wage earners and firms, unemployment cannot be eradicated. For employers, to counter unions and working people’s demands, do, in fact, use the infallible weapon of unemployment. If profits are low or firms incur losses, dismissals rise to crush labour’s pretensions, and in

260   A Fusari dynamic economies, firms may also try, with the help of technical progress, to save on labour where it causes rigidities. It is senseless to found protection of labour on laws, norms and rules that oppose the mobility of labour: indeed, such legislation is one of the key impediments to the increase in employment. It seems clear that the establishment of a fully flexible labour market, which is indispensable in modern dynamic economy, requires the abolition of wages set at the company and collective bargaining level. This is all the more urgent in that ordinary collective bargaining does cause inefficiencies in the use of labour and makes unemployment endemic. Uniformity of national wage agreements and some other rigidities swell the underground economy in the areas where labour productivity is too low for the national wage rate. These illegal activities allow a fierce exploitation of workers, who have no protection whatever. And the worst of it is that this underground economy is often the only alternative to unemployment. Trade unions must seriously consider the severe restraints on their bargaining power. They may win as long as the claims of labour lubricate the entrepreneurial system; as wages, increasing in step with productivity gains, stimulate consumption, hence sales, and eventually lead to an improvement in the condition of the workers in the name of social peace and efficiency. But as soon as profits fall, unions find it impossible to force employers to pay higher wages. In substance, the game of wage bargaining is always dominated by the employers, who are most often propelled by competition, avidity and unscrupulous behaviour. It is surprising that trade unions, whose function is to defend labour, have not understood that the root of exploitation is the institution of wage labour itself. It is a misfortune that the distribution of income is so largely determined by wage earnings. Conflict between labour and capital over wage rates is the worst possible method of income distribution and works as a powerful obstacle to production. The task of firms is to produce material wealth and create jobs. They should be able to do so without being plagued by the perennial conflict with labour, which may be seen as an inappropriate social conflict since it takes place in the wrong place. Income policies to remedy the conflict demonstrate the failure of the company wage approach. They are a rather tortuous way of establishing some kind of income distribution more rational than that implied by the ‘labour market’. It is crucial to bring income distribution outside the firm, as far as this is possible. This is indispens­ able to full employment and company efficiency consistent with social justice and individual autonomy. Trade unions should oversee health and safety at the work place. They should fight for the distribution of the fund of common wealth, but not for the company wage. Let me also point out that the idea of the workers’ self-­management18 of the firm is mistaken. And workers’ remuneration based on firms’ results is a vehicle of inequalities and managerial degeneracy. Firms must be managed by entrepreneurs, and must not be involved in the struggle over income distribution. Entrepreneurs’ ability in decision making and innovating must not be con-

Towards a non-capitalist market   261 strained by the decision-­power of incompetent persons. The entrepreneur must be responsible in terms of results, i.e. profit rate, not subjected to the command of a non-­entrepreneurial body. Besides, the rational organization of the economy requires that firms pay for the resources they utilize, including labour, at prices determined by supply and demand. This is a fundamental rule of efficiency, indispensable both to rational use of the resources available and to defeating unemployment. Income distribution is a totally different matter, one that concerns society as a whole. The usual forms of wage bargaining obstruct efficient utilization of resources and prevent farseeing policies of distribution of wealth. Such bargaining is the product of spontaneous evolution, a sort of ‘primitive’ organizational form of society. An advanced society should be able to supplant those institutions with better thought-­out organizational forms. Moreover, the strict link between the production and distribution of income – or, more precisely, the fact that the distributive conflict affects business accounts, seriously undermines the firms’ investment, as well as economic growth and employment. Aggregate investment must be determined by the community and as part of the process of income distribution. This aspect will be clarified by discussing how firms should be financed. In conclusion, it should be clear that income distribution concerns the entire society and that even production is a social entity since it depends on productive forces engendered by society, such as techniques and knowledge. Some ingenuous theories of exchange value have long maintained that there is an unbreakable connection between income production and distribution. But no such connection exists, except the part due to incentives and the fact that income distribution influences production through the propensity to consume. In particular, it is senseless to attribute to exchange value an ethic-­ideological content as, for instance, the labour-­value theory does. The statement value = labour makes some sense only in a stationary economy. In an economy based on innovation, wealth is, for the large part, a result of creativity, genius, and of the entrepreneurial search and intuition. Price is, therefore, a completely different thing from labour-­value, and there is no bridge between the two. Really, exchange value displays only the mere functional price role. Precisely, it acts as an indicator of productive opportunities and relative abundance, and as a means to make homogeneous a multiplicity of commodities physically different from each other; its role is thus to facilitate comparison and exchange among these goods. So the ethic and ideological flavour of the labour-­value hypothesis, with its implications on income distribution, expresses not only a limiting but also a senseless formulation of the much wider ethical and ideological problem. The organization of production, distribution and exchange as discussed here attributes a social content both to income production and to distribution. Moralists and social reformers have always considered the market a gymnasium for corruption and aggressiveness, a place of violent contrasts among men, an open space for selfishness and fraud; in brief, it has been depicted as one of the worst instruments of domination, oppression and exploitation of human by human. But we have seen that the market can be shorn of these unpleasant attributes and

262   A Fusari transformed into a mere mechanism for the imputation of costs and the stimulus to efficiency through prices, which serve to signal the availability of each commodity. We have also seen that the market mechanism, aided by competition, and combined with a profit rate as an indicator of success (which, as such, allows accountability) can be a highly effective mechanism for stimulating efficient decision making and management in the absence of monopolistic privileges and under the clear and inescapable rule of law (designed to prevent bribes and other abuses). The disconnection of the market mechanism from the struggle for income distribution makes for efficiency, individual initiative and social justice, and may thus be relied upon to turn selfishness into healthy rivalry.

8.5  Interest rate, production financing and effective demand A reformist agenda aimed at the overhaul (if not the transformation) of the capitalist economy would clearly be incomplete without a critique of the most capitalist trait of all: the rate of interest and the rhythm of financial capital. By clarifying the nature of these instruments’ role, we will open to the door to a reform of the process of capital accumulation and of the system of corporate finance. The rate of interest has been considered, in the course of history, as an unjust appropriation of revenue by capital owners. The dispute on its permissibility reached a paroxysm in the medieval age – in times marked by the florescence of mercantile activity – and was mainly driven by the conflict that arose between Christian ethics and the business drift. The phenomenon of interest continued to loom largely throughout the turbulent transition that led to the advent of the modern world: and the tragic irony is that this turbulent episode, from an organizational point of view, turned out to be a gigantic, sad waste of life and time, as shall be seen hereafter. The suspicion of there being foul play and manipulation behind the eternal vicissitudes of monetary dynamics seems corroborated by the spasmodic variability of the rate of interest in the course of history; rates always appear painfully high within societies chronically afflicted by misery and stagnant production. Homer (1996) has dedicated a ponderous study to the history of interest rates. The first development of banking, in medieval Italy, acted like a brake on the surge of interest rates, which indeed fell in this country to levels between 10 and 20 per cent, while in the British Isles and Germany they shot to levels as high as 100 per cent. In the late fourteenth century, Italian interest rates on commercial loans hovered around 8 per cent, with a minimum of 5 per cent, and in the fifteenth century an average of 5 per cent prevailed in Germany. A century later, interest rates between 4 and 12 per cent were frequent in Italy, Antwerp and Lyons. The historian Cipolla (1980) has documented that the Genoa’s financial powerhouse, the Banco di San Giorgio, charged interest and discount rates of 5 per cent in the fifteenth century and little above 1 per cent a century later. The wars of the sixteenth and seventeenth centuries caused a rise of the rates, but the seventeenth witnessed a new fall: in the Netherlands interest reached 4 per cent and, by the end of the century, 3 per cent. The incessant development of the

Towards a non-capitalist market   263 banking system was the main cause of these decreases. With the advent of the financial leadership of England, in the eighteenth century, long-­term government bond yields declined in that country towards 3 per cent and the usury laws reduced the maximum rate of interest to 5 per cent. In the nineteenth century, Britain’s long-­term interest rates stabilized at around 3 per cent, while government bond yields reached 2 per cent by the end of the century. The wars that followed caused the rates to rise again. This course of business shows an inverse correlation between prosperity and interest rates; contrary to Homer’s opinion, it does not give the causal direction of the two phenomena; but the association of these is meaningful. True, low levels of interest stimulate growth, and they often stand thereby as an expression of prosperity. What is more important, however, is that since interest rates decrease with the development of banking, their level and their very existence come indeed to depend on the characteristics of the credit system itself. It is worthwhile to emphasize that interest basically represents a deduction from profit; and it may partially be discharged at the expense of wages, which is a sure way of exacerbating social conflict. In any case, interest stifles entrepreneurial initiative. Can such an impediment to entrepreneurship be eliminated? Can the ensuing deduction from labour-­income be eliminated? A complex issue – marred by a host of misconceptions. The first problem is the moralists’ and the political economists’ insistence (from Aquinas to Marx) on denying interest on the basis of the labour theory of value19 – a theory whose ultimate purpose seemed in fact that of shielding the exaction of interest. As set out earlier, such a theory is senseless. Therefore, the alternative justification for the rate of interest as the just fruit (reward) of capital productivity – indispensable to the equilibrium between the supply and demand of capital – could easily gain ground (as in neoclassical and Austrian theories). But that justification is contradicted by a simple remark: capital productivity needs technical progress,20 which, for its part, has almost nothing to do with financial capital. Afterwards, the Sraffian discovery of the phenomenon of the ‘re-­switch of techniques’ (that is the possibility that a rise in the rate of interest may imply an increase in the intensity of capital, instead of a decrease), undermined the thesis of Böhm-Bawerk’s average period of production, finishing off once and for all the fashionable models of capital productivity built upon Robinson Crusoe’s Utopia. There exists a reasoning capable of solving the debate on interest and usury at once. We ask: is interest strictly necessary for productive and organizational efficiency? If it is not, the existence (and exaction) of interest is unnecessary, and we may thus safely conclude that interest represents an arbitrary and artificial form of income pocketed by the financial cartel. Is this the case? Tily has written: If there is no necessary limit to the volume of credit/debt that can be created then it is essentially a free good. A rate of interest is a price, and prices are

264   A Fusari paid for scarce resources. . . . Interest becomes a social construct, to be manipulated according to the mandate, principles or interests of a country’s authorities. (2004: 8, 13) I would claim that we need an argument somewhat more stringent in this regard. Interest has not much to do with the equilibrium between supply and demand of capital. As a matter of fact, far more than on interest, saving depends on the amount of income gained and therefore on the level of production and, on the other hand, the entrepreneurs’ demand for capital depends on entrepreneurship and the state of business, which is mainly expressed by profit expectations. The argument that the rate of interest is necessary in order to prevent ‘over-­ investment’ and the concomitant waste of capital is belied by the fact that such a role is as a rule fulfilled not by the interest rate but by profit rate, that is by (1) the entrepreneurial search for profit, i.e. the tendency to extract the highest rate of profit from investment, and (2) by the gauge of the accountability role of the profit rate (as discussed in section 8.3). All of the foregoing implies that the role of interest is simply to throttle entrepreneurship and to subtract income from distribution. It is, therefore, evident that, in principle, the share of income to be invested may be determined by the community abstracting from interest, and that, being the profit rate sufficient to impose a judicious use of capital, it is perfectly possible and efficient to share financing among the entrepreneurs at zero interest. In sum, there are no technical impediments to the abolition of the interest rate through legal prohibition, i.e. by defining as usurious a positive real interest rate. Of course, within of a free international financial market, there would need to be a concerted agreement to abolish interest everywhere across the world. However, 0 per cent might encourage the tendency to hoard money; but this could be opposed through a low rate of inflation or some sort of Gesellian demurrage scheme on cash money. At any rate, nowadays the tendency to hoard seems to be almost irrelevant, since the variety of modern banking services manages to keep private consumption flowing in a perennial and tumultuous flow. It is indeed remarkable that on the shoulders of a variable, as unnecessary, if not wholly pernicious, as the interest rate, has grown an enormous, complicated and rather obscure economic body mainly devoted to speculation and entirely responsible for all the serious shocks and malfunctions of the global network. There remains, at this point, to try to delineate a blueprint for a financing system of production shorn of the negative and pervasive presence of interest – a blueprint capable, among other things, of clipping the wings of financial capital, stimulating entrepreneurship and contrasting the deficiency of global demand. A discussion on the procedures to modify the banking system in accordance to what will follow is not relevant in this context, and a detailed analysis of the tricks and abuses of that system may form the theme of another paper. The important point is, at this juncture, to stress that the central function of the

Towards a non-capitalist market   265 banking system, when it comes to fund production, needs to be radically modified. Financial capital was born not to serve production but to enslave it, and exploit the toiling community into the bargain. This distortion needs to be redressed at once. Our proposal, born as a reaction against the undue appropriation of wealth perpetrated by the financial oligarchy, is presented here in a fashion as simple and transparent as possible. Every year the community should define the share of value added to assign to consumption and investment, and to investment in selected strategic sectors. After that, care must be taken to ensure, through stimulus and instructions to the banking system, that these prescriptions are executed, as each investment is at the discretion of the businesses. The capital required by the firms will come, in the first place, from profits. The uninvested portion of a firm’s profits may be set aside for future investment. But the financing of capital must generally exceed the reinvested profits, so as to allow the formation of new firms and the financing of the firms’ investment plans in excess of gross profit. Such extra accumulation may be covered in part by private saving, which should yield a real interest rate of zero per cent.21 However savers should not be allowed to buy shares directly, since the stock exchange is much worse than a gambling house, as we shall show in the next section. The rest of the funds required to achieve the planned rate of accumulation will be provided by the fund of common wealth, which should channel the residual quota to the banking system, to be distributed among firms. Each bank’s application to the fund for resources should be judged on the basis of the profit rate. In fact, bankers must be obliged to operate as entrepreneurs, and their commercial tenure must depend on business results. The more successful they are, as expressed by the profit rate, the more capital will be granted by the fund of common wealth via their commercial bank. Banks’ profits should derive from the prices of the services that they offer to their customers; competition should keep these prices low. A substantial feature of such a reform would be the creation of a mechanism directed to the achievement, through the firms’ investment, of the yearly rate of accumulation projected by the community, thus avoiding or reducing substantially the possibility of a deficiency of global demand. It would also act as a stimulus to entrepreneurship. A major condition for the effectiveness of the mechanism is that bankers provide sufficient credit to firms to achieve the community’s projected accumulation rate. Therefore, if the banks’ requests for capital do not exhaust the fund set aside for accumulation, the difference should be assigned compulsorily to banks (say, in proportion to the amount each has requested), for distribution among investing firms. This implies that, if the propensity to invest is low, banks will be forced to lower the prices for their ser­ vices so that all the funds allotted to them for investment may be placed with the applicant firms. Vice versa, if the amount of capital provided by the fund of common wealth is lower than the total applications of banks based on the firms’ borrowing, the negative difference will be deducted from those requests, in inverse proportion to their profit rates. This guideline of equality between the

266   A Fusari allocations for saving and investment is of crucial importance for the control of aggregate demand; in particular, it moderates the cyclical effects of entrepreneurial euphoria or pessimism. Moreover, it stimulates entrepreneurship since, when demand for credit is slack, firms may obtain inexpensive loans, as banks are required to lend funds up to the accumulation target. So banks are induced to make golden bridges to entrepreneurship, as it were. If the propensity to invest is low, the duty to attain the established aggregate rate of accumulation may cause heavy losses to the banking system. But this does not represent a problem for public firms, for which the profit rate is only an indicator of success; in fact, the relative degree of success may also be expressed by the inverse of the rate of loss.

8.6  On the international economic order On the international plane, the absurdities of capitalism – and the urgency of a remedy – therefore appear even more starkly than do as when contemplated from the national angle. In fact, the growing integration of world markets, which has given rise to the global society, multiplies the distortions, opacity and larceny so characteristic of the ‘free market’. Speculation shifts enormous masses of capital instantaneously around the world. There is no supranational authority deputed to discipline these activities or prevent the crises provoked by such massive transfers of ‘hot money’. Some codes of conduct have been devised as remedies, but unfortunately speculators are clever in crafting tricks to elude them. Moreover, the evolution of financial instruments and markets systematically makes these guidelines obsolete. In effect, it is most difficult to obtain reliable information and craft control instruments in a sphere dominated by uncertainty and rapid change to an extraordinary degree. As a consequence, the concentration of enormous wealth in private hands enables the holders to carry out gigantic frauds, e.g. the sale or dismemberment of healthy concerns at very low prices through manufactured crises. Public ownership of large companies and the model of accumulation set out above would greatly facilitate the exertion of controls and impede speculation. It is most desirable to deter or prevent savers from engaging themselves in speculation in a landscape full of snares like the international capital markets. Firms should also be discouraged from dabbling in speculation, which distorts and denatures the imperatives of production and the accountability role of the profit rate. The vices of the international market are aggravated by the selfish myopia of international economic institutions – those institutionally appointed to aiding countries in economic difficulty, usually the less developed economies. The so-­ called Washington Consensus hinges on three recommendations: privatization, austerity and openness to the international market. But it is short-­sighted as well as cynical to require that, to get aid, the less developed countries must enact policies to balance the budget, put their international accounts back in order, open up the international goods and capital market, and proceed to privatize all that is public. Macroeconomic stabilization centring on monetary and fiscal restrictions,

Towards a non-capitalist market   267 which free trade and the free capital market make particularly harsh, yields high interest rates and the contraction of demand, both of which throttle entrepreneurship and force large-­scale bankruptcy. All this reduces output and employment, and increases the share of the population, dependent on welfare. The disaster is completed by usurious interest rates on short-­term loans, which must be complemented by reserve funds yielding much lower interest rates. During the 1997 crisis in East Asia, the IMF ratcheted up its rate by 25 points: a real disaster for production. Again, it is disheartening to see how interest, a variable that is technically useless, comes to play such an important and destructive role. Significantly, an economist well versed in the operation of international economic institutions like Stiglitz (2002), has harshly criticized those policies. These avoid the true problem, i.e. rebuilding the economy by stimulating efficiency and a sense of duty predicated on a system of clear responsibilities. The promotion of entrepreneurship, and public entrepreneurship in particular, is ignored, while privatizations are often nothing but the theft of public capital. In the recent past, various underdeveloped countries have tried to stimulate economic growth by promoting state industries through central planning. The failure of those efforts opened the door to privatization. Many state industries in Russia ended up in private hands almost for nothing, even when they could have operated efficiently as public firms, had they been subjected to the accountability of the profit rate and the associated restructuring process. The policies enforced by the international institutions have had disastrous effects in the underdeveloped countries, where an entrepreneurial spirit is generally lacking and the ruling class is much more prone to dissipation, robbery and oppression than to production and innovation. With their systems of patronage and clientele they have perpetuated a corrupt power structure and condemned their masses to hunger. Production should not be stifled by the class conflict over distribution. It should not be disturbed by the bitterness, the agitation and the despair of underdeveloped countries, or be troubled by unrestrained speculation, mainly to the detriment of working people. International institutions should not offer aid to keep big speculators from going bankrupt. Instead, they should ask, as a condition for aid: systems of accountability based on well-­defined criteria of success and, in synthesis, the creation of an efficient, transparent system of economic power capable of production and administration, in lieu of governments dominated by adventurers, arrogant dictatorships or confusing systems of law that only encourage abuse.

8.7  Conclusion This book has shown that the growing varieties of theories and visions characterizing economic thought is mainly due to some basic misunderstandings on the changeable economic and social reality, instead of being the expression of a sound and fecund pluralism. The misunderstandings darken, among other things, the meaning and the propulsive role of ideologies. In the absence of science,

268   A Fusari Man has recourse to intuition and common sense. But this is not enough to face the growing change caused by the rapid development of knowledge of natural phenomena and technology. This cognitive penury has heavy consequences on a world scale, the reduction of which needs a penetrating criticism of the economic system that dominates the international landscape today. One of the chief economic problems of the West has been its increasing reliance on a strange sense of sublimated superiority, which it has erroneously imputed to the most proximate origin of its wealth: the capitalist market. The inference is mistaken in that the source of this wealth, whatever the merits and demerits of its nature and uses, lies in human ingenuity rather than in the capitalist machine, whose essentially constrictive and feudal countenance has come, fraudulently, to represent Western economy as a whole. But capitalism is not Western inventiveness as a whole; it is but a proprietary scheme that has usurped all the fruits of Western creation. And this tragic quid pro quo, has led the West to clash violently with the rest of the world. In truth, the capitalist system is the source of so many disadvantages to the westerners themselves: namely, social injustice poisoned labour relations and the threat to human dignity, social and geographical disequilibria, the wideness of fluctuations, the sorceries and distortions promoted by the hegemony of finance capital, and finally the smothering of entrepreneurship, freedom and growth. The present essay has attempted to show a possible way to remedy these ills, in particular the pervasive and distorting influence of the current market and financial systems. Our aim was to devise a model that couples efficiency with social justice, structural consistency with innovation; a system able to eliminate speculation and unnecessary (if not senseless) strife, while preserving the conflicts implicit in the very functioning of a dynamic society, such as the battle between innovators and conservatives. And we have shown that a proper functioning of the market is not inconsistent with Man’s noble propensities, and that it may very well reduce fraud and greed. The necessary set of conditions to achieve this goal consists of: (1) the reduction of the market to a mere mechanism for imputation of costs and of efficiency, (2) an expansion of the sphere in which public firms are allowed to operate within the market, and (3) a drastic reform of the banking system. More particularly, we have dwelled on: the essential role of the profit rate as an instrument of accountability for all concerns (public and private); the means of rebuilding a non-­capitalistic economic body with a free market; and a model of capital accumulation able to stimulate entrepreneurship, and to achieve the aggregate accumulation rate – a rate to be set by the community, with a view to eliminating the timorous growth of overhead and interest charges and the volatile disasters of finance capital. The final section on the international market and disequilibria, wrought by the devilries of international finance, is but a beckoning call to drift toward a different conception of market economics, and a simpler and more transparent financial system than the dominant one, which is largely ridden by speculation, the concentration of power and the exploitation of the weak.

Appendix

These are the results of the simulations discussed in Chapter 5. 9.4

Production of consumer goods at constant prices (X1) 6.8 6.7 6.6 6.5 6.4 6.3 6.2 6.1

9.2 9 8.8 8.6

1

3

5

7

9

Simulation A Simulation C

11 13 15

0.28 0.18 0.08 �0.02

1

3

5

7

9

Simulation A Simulation C

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

0.6 0.5 0.4 0.3 0.2 0.1 0

11 13 15

3

5

7

9

11 13 15 Simulation B

Productivity of incremental innovations in the sector of capital goods (Prl2)

1

3

5

7

9

Simulation A Simulation C

Simulation B

Productivity of the incremental innovations in the sector of new consumer goods (Prl3)

1

Simulation A Simulation C

Simulation B

Productivity of incremental innovations in the sector of consumer goods (Prl1) 0.38

Production of capital goods at constant prices (X2)

11 13 15 Simulation B

Productivity of the incremental innovations in a sector of new capital goods (Prl4) 0.2 0.15 0.1 0.05 0

1 3 5 7 Simulation A Simulation C

9

11 13 15 Simulation B

1

3

5

Simulation A

7

9

11 13 15

Simulation B

270   Appendix Diffusion of radical process innovation in the sector of consumer goods 0.071 0.061 0.051 0.041 0.031 0.021 0.011 0.001 1 3 5 7 9 11 13 15 Simulation A Simulation C

Simulation B

Diffusion of radical process innovation in the new sector of consumer goods 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0 1 3 5 7 9 11 13 15 Simulation A Simulation C

Simulation A Simulation C

Simulation B

Simulation B

Labour productivity in the sector of consumer goods (Pr1) 4.5 4.3 4.1 3.9 3.7 3.5 3.3 1 3 5 7 9 11 13 15 Simulation A Simulation C

Simulation B

Labour productivity in the sector of capital goods (Pr2) 4.7 4.5 4.3 4.1 3.9 3.7 3.5 3.3 1 3 5 7 9 11 13 15 Simulation A Simulation C

Diffusion of radical process innovation in the sector of capital goods 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0 1 3 5 7 9 11 13 15

4.7 4.5 4.3 4.1 3.9 3.7 3.5 3.3

Simulation B

Labour productivity in the sector of new consumer goods (Pr3)

1

3

5

Simulation A Simulation C

7

9

11 13 15 Simulation B

Appendix   271 Labour productivity in a sector of new capital goods (Pr4) 3.7

Labour productivity in a sector of new capital goods (Pr5)

3.65

3.73

3.6

3.68

3.55

3.63

3.5

1

3

5

7

9

Simulation A Simulation C

11 13 15 Simulation B

Nominal wage rate in the whole economy (w) 4.4

1

3

5

7

Simulation A Simulation C

9

11 13 15 Simulation B

Price in the sector of consumer goods (PRE1) 0.5 0.4

4.2

0.3

4.0

0.2

3.8

0.1

3.6 3.4

3.58

0 1

3

5

Simulation A Simulation C

7

9

11 13 15

Simulation B

Price in the sector of capital goods (PRE2) 0.38 0.28 0.18 0.08 �0.02 �0.12 1 3 5 7 9 11 13 15

Simulation A Simulation C

Simulation B

1

3

5

Simulation A Simulation C

7

9 11 13 15

Simulation B

Price in the sector of new consumer goods (PRE3) 0.4 0.3 0.2 0.1 0 �0.1 1 3 5 7 9 11 13 15

Simulation A Simulation C

Simulation B

272   Appendix

0.8

Price in a sector of new capital goods (PRE5) 0.67

0.6

0.57

0.4

0.47

0.2

0.37

Price in a sector of new capital goods (PRE4)

0

1

3

5

7

9 11 13 15

Simulation A Simulation C

3

5

7

9

1.07

11 13 15 Simulation B

Radical uncertainty in the capital goods sector (u2)

0.97 0.87 0.77 0.67 1

3

5

7

9 11 13 15

Simulation A Simulation C

1.7 1.5 1.3 1.1 0.9 1

3

5

Simulation A Simulation C

7

9

11 13 15 Simulation B

1

3

5

7

9 11 13 15

Simulation A Simulation C

Simulation B

Radical uncertainty in the new consumer goods sector (u3)

0.7

1

Simulation A Simulation C

Simulation B

Radical uncertainty in the consumer goods sector (u1) 1.05 1.0 0.95 0.9 0.85 0.8 0.75 0.7

0.27

Simulation B

Radical uncertainty in a new sector of capital goods (u4) 1.1 1.05 1.0 0.95 0.9 0.85 0.8

1

3

5

Simulation A Simulation C

7

9

11 13 15 Simulation B

Appendix   273 Radical uncertainty in a sector of new capital goods (u5) 0.994 0.984 0.974 0.964 0.954 0.944

9.1

Consumption at constant prices (CON)

9.0 8.9 8.8 8.7 1

3

5

7

9

Simulation A Simulation C

11 13 15

1

Simulation B

Simulation A Simulation C

3

5

7

9

11 13 15 Simulation B

6.7

Supply of entrepreneurship in the consumer goods sector (Es1) 6.2

6.6

6.0

6.5

5.8

6.4

5.6

Total gross investment (I)

5.4

6.3 6.2

5.2 1 3 5 7 Simulation A Simulation C

9

11 13 15 Simulation B

Supply of entrepreneurship in the sector of capital goods (Es2) 4.2 4.0 3.8 3.6 3.4 3.2 3.0 1 3 5 7 9 11 13 15 Simulation A Simulation C

Simulation B

1

3

5

7

Simulation A Simulation C

9

11 13 15 Simulation B

Demand of entrepreneurship in the sector of consumer goods (Ed1) 6.2 6.0 5.8 5.6 5.4 5.2 5.0 4.8 4.6 1 3 5 7 9 11 13 15 Simulation A Simulation C

Simulation B

274   Appendix Demand of entrepreneurship in the sector of capital goods (Ed2) 4.1 3.9 3.7 3.5 3.3 3.1 2.9 1 3 5 7 9 11 13 15 Simulation A Simulation C

0.036 0.016 �0.004 �0.024 �0.044

1

3

0.03 0.02 0.01 0 �0.01 �0.02 �0.03 �0.04

1

5

7

9 11 13 15

Simulation A Simulation C

0.19 0.14

5

7

9

0.35 0.3 0.25 0.2 0.15 0.1 0.05 0

11 13 15 Simulation B

Profit rate in the sector of new consumer goods (r3)

1

3

5

7

Simulation A Simulation C

Simulation B

Profit rate in the sector of a new capital goods (r4)

3

Simulation A Simulation C

Simulation B

Profit rate in the sector of capital goods (r2)

�0.064

Profit rate in the sector of consumer goods (r1)

9

11 13 15 Simulation B

Profit rate in the sector of a new capital goods (r5) 0.11 0.06

0.09 0.04

0.01

�0.01 �0.06

1

3

5

Simulation A Simulation C

7

9

11 13 15 Simulation B

�0.04

1

3

5

7

Simulation A Simulation C

9 11 13 15 Simulation B

Notes

1  The method of social theory: suggestions for a shared basic view   1 The question of theories’ ‘instrumental’ nature, as against Galileo’s affirmation of their capacity to describe the real world, is irrelevant here.   2 Even today the contradictions of naturalistic observationism are the source of intense epistemological debate, kicked off by the skepticism of Hume, the empiricist, on the explanatory role of experience. He wrote: ‘It is impossible, therefore, that any arguments from experience can prove this resemblance of the past to the future; since all these arguments are founded on the supposition of that resemblance’. See Hume (1996: 56). But these contradictions have not affected the successes of observationism in the natural sciences in the least, due to the high degree of repetitiveness of natural reality.   3 Popper wrote ‘I am both an empiricist and a rationalist, in some sense of these terms; but I believe that while observation and reason have an important function, their functions hardly resemble those that their classical advocates attribute to them’, meaning by this that they cannot reveal ultimate, definitive truths. See Popper (1969: 73).   4 See K. Polanyi (1978), ‘The economy as institutional process’. p. 313.   5 A critical review of some most important schools of social thought and their methodological views is in Fusari (2004).   6 Neo-­Austrian and Schumpeterian schools give an important example of the unwillingness of schools of social thought, even if tightly contiguous, to communication and cross-­fertilization. As we shall see in Chapter 5, the strong complementarity of the above two schools is evident with reference to the central notion of dynamic competition as expressed by the entrepreneurial activity of innovation (the Schumpeterian creative destruction) and arbitrage-­adaptation (the neo-­Austrian market process), and hence the great usefulness of a fusion of their contributions to the representation of entrepreneurship and the treatment of innovation and uncertainty. Nevertheless the economists of the two schools continue to operate separately, so that those complementarities remain unutilized and unexplored.   7 Coase, North and Williamson’s studies make clear some institutional necessity, through the interpretative succession: uncertainty-­transaction costs-­nature of the firm. This succession shows some resemblance to the methodological tool that we shall set forth later. But the observationist standard mixes optional aspects to necessity, thus causing great confusion.   8 Some criticism on the use of evolutionary view in sociology is in Fusari (2007).   9 I have dedicated a great deal of study to thin out that fog by showing the measurability of radical uncertainty through various proxies that allow inclusion in models of decision making. Ultimately, some studies of mine on the lack of European harmonized surveys have insisted in indicating the volatility of respondents’ answers in periodical surveys as a possible measure of radical uncertainty. See Fusari (2006).

276    Notes 10 With reference to social reality, it is senseless to assume that what happened will again happen. The impossibility of such an assumption is due to reasons much stronger than Hume’s assertion of the general non-­demonstrability of the idea of repetitiveness. 11 In this perspective, the Paretian sociology of non-­logical actions seems to settle down outside science. 12 For an excellent illustration of that method, see Cellucci (2000). 13 At first glance, constrained optimization seems to express a clear distinction between choice, as represented by objective function, and necessity, reflected by constraints. But optimization presupposes a preliminary capacity to distinguish what concerns objectives and constraints, i.e. necessity and choice-­possibility; moreover, it does not consider the main aspects of necessity, as imposed by the general conditions of development (institutions, etc.) and substantially privileges a particular aspect of the method of social science, the programmatic one. More generally, the constrained optimization technique expresses an instrumental theory of rationality, that takes as given objectives, values, etc. in sum some crucial aspects of the social process that need to be explained. It is not the case that it has given rise in economics to one of the most unrealistic and useless theories: the neoclassical general equilibrium theory. Optimization simply is a decision-­making technique and, as such, is unable to investigate structures, rules, institutions and social process. It may be considered, at most, as a particular aspect of our proposal on method. 14 The Marxian concepts of structure and superstructure is a main example of that confusion. 15 Real socialism has represented an outstanding violation of some important functional imperatives of modern dynamic societies. 16 Clearly, our imperatives have nothing to do with Kantian imperatives. For instance, the Kantian moral imperative excludes any reference to reality. 17 Some extensive developments on these matters are in Fusari (1996a, 2000, 2005a, 2005b, 2007). 18 For a detailed treatment of these historical processes, see Fusari (2000). 19 These subjects are extensively developed in Fusari (1996a). 2  Homo Œconomicus versus Homo Politicus   1 The author is grateful for important suggestions and constructive criticism from Mr Fredrik Ekstedt, M.Sc. Mathematics, and Professor Torbjörn Larsson, Dept. of Political Science, University of Stockholm. Most of the technical formulas in this chapter are checked with, and partly taken from Weisstein (2000), but also from Hewitt and Stromberg (1984), which is used frequently.   2 By an insufficient cause we mean a cause outside the axiomatic structure on which the analysis is founded. This is not particularly remarkable and is a consequence of Russell’s and Gödel’s paradoxes. In fact all scientific analysis must force its analysis to this border in order to raise proper questions for developing the science.   3 Aristotle discusses a causality concept when humans are involved in Aristotle (1966: 39). ‘Furthermore we have a fourth way in which the word (causality) is used for the end. This is what something is for, as health for example, may be what walking is for. If asked, “Why is he walking?” we reply, “To get healthy”, and in saying this we mean to explain the cause of his walking.’ Thus applying the revealed preference hypothesis we know that a person walking does so to become healthy.   4 See for example Chapter 2, Foundations of the geometry of solids, in Tarski (1983).   5 If the reader want to test, we strongly recommend a ‘controlled experiment’ both from jurisdictional aspects and from the aspect of physical fitness.   6 Basic to Hume’s analysis of causality is that the effect is posterior to the cause thus creating a temporal asymmetry. In Chapter 4 we will dwell more extensively on this problem.

Notes    277   7 If S is any non-­empty Partially Ordered Set in which every Chain has an upper bound, then S has a maximal element. This statement is equivalent to the Axiom of Choice (Weisstein 2000).   8 If we add Debreu’s strict definition of goods and services, but assume that the total set of goods and services is given, we must add time and spatial coordinates to the definition.   9 The final theorem appears as Theorem 4.4.4 in Makarov and Rubinov (1977: 198). The Neuman-­Gale model could be seen as a generalized Input-­Output model. 10 The fundamental theorems are Theorem 5.1.1 and Theorem 5.2.1, op. cit. pp. 200 and 204 respectively. 11 Such an out-­of-equilibrium analysis can not exist, strictly speaking, within the general equilibrium theory. Either the axioms hold or not, since we have now dynamics. That is why Makarov and Rubinov provides such an ingenious solution. 12 Within the Makarov and Rubinow analysis we interpret the initial endowments of each period as working capability and capital ownership. 13 In fact they do not even search for it, since the equilibrating forces are outside the minds of the agents, who just trade according to some rules. 14 Radner also alludes to Bounded Rationality in the sense that he sees the rational expectations approach as some sort of remedy to deficient momentary information. However he turns down the intertemporal working of the rational expectations hypothesis on similar arguments which we have used above. 15 Shackle separates, in his book on Decision, Order and Time, uncertainty as a probability and uncertainty as a possibility (Shackle 1970). Furthermore Keynes in his Treatise on Probability distinguishes between uncertainty in terms of frequencies and uncertainty with respect to the choice of model of analysis (Keynes 1962 (1921)). 16 For a more comprehensive reading on Russell’s paradox and Cantor’s Unaccountability Theorem see Weisstein (2002) 3  The axiological–normative question in economics and social sciences: objective and subjective values   1 It may be useful to underline that the notion of the invisible hand was not an invention of Adam Smith. He does not mention it in his Theory of Moral Sentiments but only in the study on The Wealth of Nations and precisely in the well-­known paragraph on brewer, butcher and baker, i.e. with reference to the role of the market. At most may be attributed to Smith the separation of ethics from the economy that, in conjunction with the separation by Machiavelli of ethics from politics, liberated the development of Western societies from the impediment due to some ethical principles inconsistent with the modern general conditions of development. Mandeville went much beyond and was much more coherent than the two; in fact, he denied the ethical problem in principle. Therefore, his analysis of the invisible hand refers to all social fields instead of limiting itself to the separation of ethics from particular social subsystems.   2 It must be recognized, however, that the Chicago Declaration of 1993 by some religions and religious movements has represented the only endeavour to set up a global ethics. Unfortunately, this attempt intends to build a world ethics on some moral precepts present in various religions, irrespective of the assessment of their scientific foundation, i.e. the appropriateness to the basic character of reality. The same limiting idea is at the basis of the research on values promoted by the United Nations, the results of which were published on a document entitled Crossing the divide; dialogue among civilizations (2001).   3 Le Roy Ladurie (1966) explained the Languedoc look-­out for witches in the sixteenth century through false beliefs and mass raving. Skinner replied that it is possible to adopt a false belief in a rational way. This dispute can be solved only by referring rationality to science.

278    Notes   4 Liberal doctrine is consistent with this attitude that distrusts voluntarism. But the idealist identification of reality with reason has deprived the variegated group of the heirs of idealism of the skill to manage social reality, condemning them to clamorous failures in the cases where they have conquered political power and attempted to carry out revolutionary experiments.   5 A history of pre-­modern science based on such view would be interesting.   6 Sometimes the extreme defenders of cultural relativism maintain that also the principle of rationality is just a choice, and hence a relative one. But science needs the rationality principle. Man can choose to kill himself, but such irrationality is pathology and lies outside science.   7 Dmitrieff (1968): Théorie de la valeur de D. Ricardo [1904]; von Bortkiewicz (1973).   8 The level of subsistence itself can be understood in flexible fashion, i.e. as an amount that can vary between a lower bound of goods required for physical survival and an upper bound corresponding to the full satisfaction of all the physiological requirements short of voluptuary consumption – i.e. such as to permit satisfactory physical development.   9 In Marx, as we know, these two principles are strictly connected. That is, the operation of the first increases relative overpopulation (and the need for a higher rate of surplus-­value to combat the falling rate of profit). This considerably reinforces the tendency to keep wages to subsistence level. Some authors (e.g. Steindl 1952) argue that the Marxian theory of distribution sees the fundamental determinant as the rate of accumulation (which in the long run, in Marxian thought, is an exogenous variable). Actually, however, this position corresponds to the post-­Keynesian (not Marxian) theory of income distribution. However, incorporating it does not jeopardize our argument here, because it does not prevent us from taking the actual values of distribution as a premise to the notion of the value of labour-­power, although now they are regulated by the dynamics of accumulation of capital and not by the two principles just cited. In any event, for precision it is worth repeating that in Marx it is the operation of these two principles that decides income shares, and not the pace of accumulation of capital per se. It is the increasing organic composition of capital which, by driving the profit rate down, forces capitalists to extract ever-­greater quantities of surplus-­value (which is possible thanks to the reserve army of the unemployed) and thus requires constantly rising levels of accumulation in order to counteract the falling rate of profit; and this forces wages down to subsistence levels. The frenzy of accumulation, by reason of competition, could not operate unimpeded and expropriate ever-­increasing amounts of surplus value if this were to translate (in the absence of the tendential rise in the capital/output ratio) into rising rates of profit. And this also for reasons of competition. 10 By subsistence wage we mean an amount that can vary between a lower bound of goods required for physical survival and an upper bound corresponding to the full satisfaction of all the physiological requirements short of voluptuary consumption. 11 See Fusari (2008). 4  On time and ethics   1 Since the sentences A and Not A, where A is the sentence the axioms are not consistent, are possible to express given any axiomatic system, both the sentences are consistent with respect to the axioms. Since both the sentences are expressible within the same axiomatic structure, it is impossible to discriminate between them with respect to truth. This is, by the way, also the basic structure of Russell’s paradox. The difference between the two paradoxes is that Russell discusses paradoxes in the language while Gödel discusses the axiomatic structure in itself.   2 The American presidential election, 2008, is an excellent example if we shall believe the polls. Until the financial crash McCain was well up to Obama, in fact he was in a

Notes    279 slight lead. After the crash however the focus of the voters changed, which favoured Obama.   3 This part is particularly based on Aleksandrov (1999). The writings of Hans Riechenbact have also been of great value in particular The Direction of Time (1991 [1956]) and The Philosophy of Space and Time (1958).   4 Hans Reichenbach (1958) has a comprehensive discussion of the concept of the fastest signal.   5 There is an interesting example of this in the Aeneid. For example the concept ‘a table’ was connected to the outside world through its ‘tableness’. This excludes redefinitions as is found in the Aeneid and the prophecy of the foundation of Rome. The prophecy tells Aeneas that he has come to the place when he eats his table. The solution to this problem was when Aeneas and his men sat down on the ground to eat and some of the men found ears of wheat and started to eat; and then Aeneas was reminded of the prophecy. The ground existed for sure and it was used as a table but in normal use of the language the table is regarded as something else (but then we usually have no prophecies to bother about).   6 This topic has received a lot of attention both in natural sciences and philosophy. In our discussion here we particularly deal with Henri Bergson Time and the Free Will (Swedish translation from 1912) since he discusses time in a social context. In advanced theology there are also good discussions of similar perspectives for example Peacocke (2000). But the main scientific analysis has been produced within natural sciences, with philosophy more directed to direction of time in a physical perspective. First of all we will mention Reichenbach’s works, and we strongly recommend him to those who are interested in the problem of time. We have also used a more recent but also more technical collection of essays edited by Steven Savitt – Time’s Arrow Today (1995). The different essays deals with the basic physical and mathematical analysis of the problem of direction of time. Ilya Prigogine, in End of Certainty (1997) has an interesting discussion on irreversibility and the direction of time.   7 Hume (2002 [1740]): 116–17.   8 Sometime this is questioned in economics, maybe not in scientific analysis but at least in teaching, and we are sometimes taught that the existence of expectations violate this rule. If so this is entirely wrong. An expectation is built on a particular epistemic cycle and thus an expectation may imply a certain action but not the reaction. Thus if the reaction follows the expectations it closes the epistemic cycle but to make a general statement we must grant that the relevant epistemic cycle is prevailing over an indefinite future.   9 Isländska Sagor (1986), pp. 179, 126. 10 A Jarl was a man who represented the King and was in possession of the rights to create laws. The Jarls were as a matter of fact very independent from the King. 11 The concept of creativity is dangerously close to metaphysics which we do not want to involve, so we mean creativity in its everyday common use: we do not want to define it in a narrow sense. 12 A fascinating discussion of this can be read in Herman Raushning’s The Nihilist Revolution (1939). Raushning was a Gauleiter in Danzig and close to Hitler. At the end of 1930s he realized the goals and the consequences of the Nazi regime, which made him escape to USA where he wrote this book. 13 Mereology is the study of the relations between the whole and its parts. 5  Innovation, uncertainty, entrepreneurship: modelling the dynamic process of the economy – discussion and formalization   1 See Fusari (1996a).   2 A specification of a model of dynamic competition is in Fusari (2005b), that also provides some simulations.

280    Notes   3 With the exception of its exogenous part depending, for instance, on natural events.   4 Mensch (1979).   5 The distinction between radical and incremental innovations, frequent in economics, is for the most part not rigorous. It needs a precise expression of the degree of importance of innovations. The degree of importance of a new consumer product can be represented by the quantity of its production (the conquered market as expressed by the superior asymptote of the Logistic) at the end of the diffusion period and by the substitution and complementary effects of the new product on the existing consumer goods. The degree of importance of a capital product innovation may be expressed by the superior asymptote of Logistic and the parameters indicating the stimulating effects of the new capital products on process innovation. Finally, the degree of importance of process innovations is represented by the leap in productivity that they cause.   6 See Fusari and Reati (2010).   7 When a better technology is invented, the old production processes must adapt to the prices imposed by the new one. At this point, if those prices no longer enable old producers to amortize the cost of their plant and the latter cannot be fully depreciated, the businesses with obsolete technology will make a loss. There will also be losses if the new prices are such as only to permit, for the remaining physical life of the equipment, amortization rates lower than would be necessary to fully recoup the investment.   8 Thus their analysis is not particularly suitable for explaining the efficiency of choices made in different social and institutional contexts.   9 For if depreciation were systematically overestimated (and thus overcharged), this would introduce an arbitrary element of extra profit. If, on the other hand, depreciation were systematically underestimated, it would introduce a systematic factor of loss. But this cannot happen, for the same reasons given previously. 10 See Fusari (2006). 11 See Fusari (1996a). 12 The generic attribution of production to labour is pointless since production largely results from human creativity. The other thing is the statement that the fruits of the natural lottery of talents must be for the benefit of the whole of society, but paying attention not to obstruct creativeness. 13 For more details, see Fusari (2005b). 14 Kaldor wrote: ‘In effect, the theory of (general) equilibrium has reached a stage of development characterized by the fact that pure theorists have succeeded (even if unconsciously) to prove the impossibility that the implications of that theory are empirically true’. See Kaldor, ‘The irrelevance of the theory of economic equilibrium’, in D’Antonio (1975: 77). 15 Kirzner writes: ‘To understand development it is necessary to understand the entrepreneurial process whereby opportunities that where hitherto existent but unseen become opportunities seen and exploited’. See Kirzner (1985: 74). 16 Schumpeter very much admired the Walrasian model of general equilibrium: ‘Magna Charta of economics. . .enormous research program. . . the base of the best work of our time’. See Schumpeter (1972: 482, 556). 17 Schumpeter writes: ‘The giant industrial unit, perfectly bureaucratised. . . supplants the entrepreneur’. See Schumpeter (1977: 130). 18 Galbraith says: ‘Nothing is today more interesting than to see that the entity previously known as a capitalist firm and that previously known as a socialist firm begin to resemble each other under the oligarchic direction of technostructure’. See Galbraith (1968: 343). 19 See Nelson and Winter (1982). 20 See Becker (2001). 21 See Fusari (2005b).

Notes    281 22 See Pindyck (1991), and Ulph and Ulph (1994). 23 A specification and more accurate simulation of the model extended to the long run (long waves) is in Fusari and Reati (2010). 24 In Fusari (2005b), the distinction between basic and applied innovations stays for the distinction between radical and incremental innovations in this model. In principle, the extension of the present model to the micro-­level is not difficult. In particular, it should be specified: a) the impact of radical innovation on the firm’s incremental innovations, in terms of technological perfectioning and stimuli to innovate; b) the adaptive increase in productivity, i.e. due to the imitation of innovations and, more generally, the search and discovery of pre-­existing more productive possibilities. 25 The distinction may allow, among other things, some clarification on the long-­lasting controversy on capitalism raised by the Marxian distinction of the economy in two sections, one concerning consumer goods and the other capital goods. 26 See Fusari (1996b). 6  From invisible hand to perpetuum mobile: the problem of economic growth 1 Robert Pollak (1978) discusses these matters in an interesting way. 2 It is difficult not to link the efforts to save the endogenous growth model to what we discussed in Chapter 2 with respect to the logical similarity between the neoclassical model and a centralized socialist economy. The remuneration of successful entrepreneurs bringing innovations to the market is generally seen as a quite natural ingredient of the market economy but in saving the endogenous growth model such features are not welcome. 3 At the time when the author was CEO for a RO-­RO shipping company, we transported two such containers every week. 4 For the simplicity we assume linear relationships, furthermore characteristics and commodities are supposed to attain values 0. Particularly the latter assumption is by no means evident with respect to characteristics. 5 Umberto Eco (2000) has a very amusing discussion of this problem in Kant and the Platypus. 6 Observe that we have since Chapter 2 dropped the assumption of gross substitutability. 7  Uncertainty, money and labour demand 1 Kenneth Arrow’s paper on ‘Uncertainty and Medical Care’ is an elegant discussion of both these aspects, although primarily about medical care, and covers the more fundamental questions of the welfare state (Arrow 1963). 2 Non-­Accelerating Inflation Rate Unemployment. 3 Table 7.1 comes from a seminal work 1989 concerning the actual company, however we prefer to suppress the name of the company. Since the development is generic to many export companies in small open economies the table can be looked upon as a general description of a problem. 4 The following analysis as well as the principles of the figures used is based on Ekstedt and Westberg (1991: Chapter 2). 5 A rather extreme example of such a short-­run production function is that of a RO-­RO shipping firm. The author has some experience of such businesses as a CEO for a RO-­RO shipping firm during the 1990s. For such a shipping firm around 88–90 per cent of the costs are fixed in the short run. The size of the crews are dependent on the ships and the ruling law with respect to security, the land based employees are the technical staff, sales office and administrative office. The land based staff is basically fixed with respect to the average capacity utilization of the ships. The capital costs are of course fixed except for some small variations in oil consumption depending on the

282    Notes draught. The most substantial variable costs with respect to the average level of capacity utilization are the costs for the stevedores including their capital costs, which is less than 8 per cent of the total costs at average capacity utilization and with respect to labour costs the stevedores are less that 20 per cent of the total labour costs. As we can understand the capacity utilization is the key variable to profit. Reducing costs adds little if not counter-­productive. 6 Gold may be attached to a value but that is of the same kind as diamonds, art and such things. Of course we also have to take into account mythical traditions from the past. Thus gold may have a cultural status as a composite of its chemical characteristics, store of value and as jewellery. 7 In our discussion here we will be rather close to Keynes’ discussion in Book IV: ‘The Dynamics of the Price Level’, in Treatise on Money Vol I (Keynes 1930). 8  Towards a non-­c apitalist market system: spontaneous order and organization   1 The development on the method of social science given in Fusari (2004) may allow a better understanding of this essay.   2 In the few ancient societies based on the activities of traders, like the Phoenicians and a few other poleis situated on caravan routes or along the shore, trading did not engender a cumulative development. Such a failure condemned them to extinction or subordination.   3 These were the members of the councils of the urban communities, who were vested with deliberative power and competence on local finance, building, public works and public utilities.   4 The enormous economic power of the Roman aristocracy grew over time as a partial compensation for the political influence removed to the senatorial class by the emperors and their civil servants. But aristocratic culture disregarded economic productivity and influenced the culture of the merchant class, and slavery made possible the sustainability of such a culture. On the other hand, the Christian-­Judaic notion of linear time was obscured by the dominating civilization.   5 See Comnena (1849: 189). Cupidity was very widespread, even among true believers. The crusaders of Peter the Hermit devastated the Balkans to a surprising degree, pillaging and slaughtering. They greedily ventured into Anatolia, too impatient to wait for support, and were promptly exterminated.   6 See Ibn Khaldun (1958). He was a great Arab historian and traveller across dar al Islam who lived in the fourteenth century. He wrote an important and voluminous history of Arabs, Persians and Berbers, in which he fashioned a peculiar theory of historical processes. Through his creative analysis he identified the cause of the decadence of Arab world in the excesses of absolute power, injustice, unproductive expenditure, nepotism and corruption.   7 He was persuaded that ‘personal vices may be made useful, by a clever government, to the worldly happiness and the greatness of the whole’. See Mandeville (2000: 5)   8 The well-­known Lange and Lerner’s rules, that should drive the entrepreneurial behaviour in market socialism, make sense only in a static economy, that is excluding innovation and uncertainty. Therefore, they cannot be referred to reality.   9 This clearly appears from the formulation of a problem of optimization under the constraint of the available entrepreneurial skills (or some other scarce factor). 10 See Kirzner (1973) and Schumpeter (1954). 11 In neoclassical economics, price competition results in allocative efficiency. However, this is a result of comparative statics as opposed to a dynamic process. This is like taking a series of pictures – the economy that results is stationary: it does not move – the process by which we go from one point to another is an illusion, just as a motion picture provides the illusion of movement. However, since the movement from one

Notes    283 point to another is not considered, the efficiency that results is one that is based only in the moment and is, thus, a stationary efficiency. The notion of competition relevant in this context does not imply such stationary efficiency. Indeed, neoclassical competition is almost senseless; a stationary economy does not need the market. 12 In workers’ self-­managed firms the falsifications are stimulated by the interest of workers to increase their earnings. A way of exaggerating profits may consist in the underestimation of capital depreciation and, on the part of banks, in the concealment of the losses due to the insolvency of the financed concerns. But these manipulations (directed to hide losses) will depress profit rates in successive years, since they will cause a fictitious growth of capital, and will thus force the firms performing those tricks to feed a growing fraud over time, which would become increasingly more difficult to conceal. 13 The treatment of this topic bears some resemblance to Rawls’ investigation (see Rawls 1971); but our analysis is more specific and operative than his, it being specifically concentrated on the concrete management of market relationships. 14 The debate on market socialism in the years between the two wars was hinged on the hypothesis of a stationary economy, which does not need entrepreneurship, and thus made room to the formulation both of a centralized model of the economy, as elaborated by Barone in the essay on ‘The Minister of Production in the Collectivist State’ (1971), as well as of that of a decentralized model of market socialism, with the managers’ decision-­making simply dictated by Lange, Lerner and Taylor’s rule (see Lerner 1938; Lange and Taylor 1938). 15 As is well known, supply and demand give, by themselves, relative prices. So, to obtain the prices of nominal labour it is necessary to refer to some labour price expressed in money units or, taking variations, refer to initial prices expressed in money units. 16 Sraffa’s demonstration of the re-­switch of techniques is not relevant in this context, it only shows the erroneousness of the notion of an average period of production and of the explanation of the interest rate on the basis of capital productivity; moreover, it makes the hypothesis that wage rate is exogenous, disregarding the relation between wage rate and the supply and demand of labour. 17 Michael Polanyi’s pioneering insistence on tacit knowledge has provided a deep and extensive illustration of this aspect. 18 Where ‘workers have control over the production process in the enterprise in which they work, since they have ultimate authority, one-­person, one-­vote, on the enterprise itself ’. See David Schweickart in Ollman (1998: 127). 19 In the Tabula Exemplorum, a manuscript of the thirteenth century, it is written: ‘All men abstain from working on Sunday, but usurers work incessantly’. See Le Goff (1987: 24). 20 In the absence of technical progress, the accumulation process would push capital productivity toward zero. 23 See Tily (2004: 8, 13). 24 A real interest rate of 0 per cent on saving would actually be a bargain for savers. These in the course of time have generally suffered a continuous devaluation of their savings owing to inflation, fraud and robbery, which in turn are mainly caused by speculation on financial markets. 25 See Stiglitz (2002).

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Subject index

aggregation 55, 59, 62–3, 103, 127, 176; additive 52, 54–6, 59, 61–2, 73, 108, 132, 210–11, 213–4; dis- 161–2; levels of 100, 104 axiom 50, 57, 71, 123; completeness 50, 52; reflexivity 50–4, 62, 67, 72–3, 100–1, 106, 110, 123, 182, 193, 213, 233, 239; transitivity 50–2; local nonsatiation 2, 55, 58, 68, 182; continuity 55; convexity 55–6, 58; of choice 57, 58, 277; non-dictatorship 60–2; universality 60; citizen sovereignty 60, 109; correspondence between social and individual values 60, 61 axiomatic structures 4, 104, 130 being and doing 5, 7, 11–12, 22, 24, 28–30, 76–7, 79–81, 85, 89, 96, 101, 130–2, 137 Black Monday 210 Bretton Woods 217, 219, 238, 243 capacity utilization 187; optimal 195, 226–7, 236, 239; average 281n5 capital intensity 189, 221, 227, 228 capitalism 8, 15–16, 35, 37, 63, 98, 149–50, 153, 251–2, 266, 268, 280n23, 287, 292 cause: final 4, 101, 103, 105, 118, 121, 124, 130, 205; insufficient 41, 276n2 central agency 63–6, 101 chaos 3–4, 41, 61–2, 70–1, 99–100, 102–3, 123, 127, 133, 214, 291 characteristics approach 200–3, 205, 211, 215 Chicago Declaration of 1993 86, 277n2 choice: collective/public 41, 47; consumer 67, 202, 290; possibility 7–8, 12, 15, 18, 21, 24, 32–4, 37–8, 78–9,

86–9, 276n13; rational 25, 27, 40–1, 62, 74–6, 247, 289, 292; set/space 49–58, 201, 205 Cobb–Douglas production function 223, 225–6 commodity space xvii, 47, 55–6, 58–9, 61, 66, 69, 72–3, 101, 105–6, 108–9, 111, 126, 182–5, 192, 195–9, 202–3, 205, 207, 210–12, 215, 229, 231, 237, 241, 245 communism 88, 253; communist economy 5, 90 complementarities: in consumption 198, 204; in production 221, 223–6, 240 constructivism 20–3 convergence 21, 28, 83, 88, 153, 156, 191–2, 207, 235 decision space 41–2, 209 decisional routines 157–9 dues ex machina 63 disequilibrium(a) 8, 139, 153–4, 158, 215, 254, 268, 291 Dirac switch function 143, 161, 164 distributable surplus 197–8, 211, 231 distribution of: factor income 187, 189, 197, 211, 219; income 8, 37, 86, 94–6, 143, 149, 167, 207, 245, 258–62, 278n9; wealth 8, 46, 86, 127, 181, 214–16, 239, 244, 247, 254, 261, 266 doing see being and doing dynamic competition 138–40, 142, 146–8, 159–60 Einstein/Minkovsky time 7, 104–8, 113–16, 120, 122, 130, 143, 234 empiricism(ts) 12, 14, 42–3, 75, 79–80, 100, 103, 124, 275n2, 275n3 Endogenous time 142, 163, 170

296   Subject index entrepreneur(s), entrepreneurship, entrepreneurial 7–8, 33, 36, 94, 96, 135–79, 192–4, 198, 231–2, 249, 251–3, 267–8, 272–3, 275n6, 280n16, 282n8, 282n9, 282n16, 283n14, 287–9; entrepreneurship and profit rate 255–66 equimarginal principle 8, 69, 195, 197–8, 200, 210, 215, 231, 284 ethics 2–3, 5, 7. 45–6, 71, 74, 77–83, 199, 214, 246, 252, 254, 262, 277n1, 277n2, 284, 287, 288; being and doing 7, 76–7, 79, 101, 130–2; cultural relativism 82, 87, 99; economic values and 92–9; equilibrium and 108–9; Kantian 41, 83, 109–13, 115, 246; objective 103, 111, 125, 129–31, 133; necessity of 199–200, 246; religion and 91–2; time and 100–34 Europe 201, 218, 222, 238, 242–5, 250–2, 286–7; Western 251 European 104, 222, 251–2, 275; commission 222; countries 222; economy 222, 285; Union 287 evolution 1, 19, 21–4, 30, 33–9, 79, 85, 87, 91, 150, 157, 248, 253, 259, 261; Darwinian evolution 21, 85, 91, 143; Evolutionary (economics) 5, 22–3, 157–9, 162, 178, 287, 288, 290–2, 294 ex ante 64, 115, 121, 187, 224; ex post 64, 85, 187–9, 224 expectations 70, 116, 118, 137, 140–2, 147–8, 156, 160, 208, 210, 232, 235–6, 242, 264, 279n8, 287, 293; adaptive 142, 235–6; extrapolative 235; measures 140–2, 156, 160; rational 142, 152, 210, 277n14; static 142, 235–6 false trading 65–6, 69, 190, 192, 197 fiat money 232–3 flea market 46, 48, 58–9, 64–5 future money 233–6, 239 Gamma distribution 143, 166 General Equilibrium 4, 14, 21, 40–1, 50, 53–62, 64–5, 71–2, 74–5, 94, 101, 106, 109, 112, 123–4, 126–7, 129, 134, 148–9, 152, 186–7, 190, 195–7, 200, 211–12, 231–2, 234, 242, 246, 276n13, 277n11, 280n13, 280n15, 285–6, 289–91; trading out of 65, 69, 190, 197, 217 Golden Rule: in Ethics 132; Solowian growth 186, 190, 201 Gold standard 231–2, 239, 241, 243, 281n6 Gresham’s law 233

Growth: endogenous 79, 187, 190–2, 195–6, 198, 211, 252, 281n2, 291–2; equilibrium 196; Hicksian 187; Solowian 186–90 habit formation 196, 200–1, 290–1 heterodox (economics) 5, 20, 135, 137, 155–8, 178, 284, 286 hoarding: labour 221–9, 237, 239–41, 287; money 237, 239–40 household production theory 54, 200–2, 205, 211, 215, 293 idealism 86, 103, 278; idealist (s) 103; idealistic xix, 109 independence of irrelevant alternatives 50, 52, 62, 101, 110 inert, inertia 43–5, 66, 68, 74–5, 101–3, 114, 117, 122, 127–9, 183, 186, 196, 200–1, 203–5, 210–15, 229, 232, 234–7, 241 innovation 4–5, 8, 13, 31, 36, 45, 88, 130, 135–79, 182–3, 190, 192–3, 261, 267–8, 270–1, 275n6, 280n22, 281n2, 282n8, 285, 287, 290, 294 inflation 137, 168, 183, 217–20, 233, 238–41, 264, 281n2, 283n24; index of 212, 241; norm 241; policy 238, 240–1 invention 3, 130, 142, 180, 185, 190, 192–3, 196–8, 200, 205, 210, 212, 251, 277n1 invisible hand 2, 29, 46, 59, 63–4, 70, 101, 105, 109, 113, 115, 133–4, 139, 180, 191, 212, 252, 277 labour productivity 165–7, 189–90, 195, 221–3, 227, 251, 258, 260, 271 liquidity 160, 215, 230–4, 237, 239–44; position of the firm 221, 224, 227–30, 234, 237–8, 240 logistic (and Gompertz) curve 143, 162, 170 Lotka-Volterra predator–prey system 11 Marxism 18, 88, 93, 96, 149–50–1; Marxist(s) xiv, 5, 44, 59, 63, 112 Maslov’s hierarchy of needs 201, 220, 293 measure (ments) 3–4, 6, 23, 34, 46, 53, 55–8, 61, 66, 93, 97–8, 101, 103, 106–9, 112–16, 119, 123–7, 130, 133, 138, 181–3, 185–7, 205, 211, 213–14, 231–4, 241–2, 245–6; money 183, 186, 205, 211, 232; of uncertainty 136, 140–2, 147, 155–61, 179, 275n9

Subject index   297 mereology 279n13 methodological anarchy 1, 19 multidimensionality 69, 100, 111, 130; commodity space 68, 126, 198, 200, 202, 204, 207, 232; political space 41 neo-Austrian approach 5, 10, 152–5, 157, 178, 275n6 neo-Ricardian school 145, 148, 150 Neuman–Gale model 63, 277 Neuman–Morgenstern utility function 67 No Job No Income Asset (NINJA), 3, 237, 239, 243 nominalism 95; postulates of 6, 21, 32, 38, 148 norm(s) 46, 66, 96–7, 103, 106–7, 112–13, 115, 129, 199, 200, 213, 215, 238, 241, 260; normative 2, 6, 10, 12, 25–6, 28–30, 34, 36, 39–40, 75, 76–99, 108, 123, 137, 211, 231, 289 objective function 99, 276n13 optimum 47, 156; aggregate 7; global 7, 58, 132–3; individual 7; Pareto 41, 45, 67; optimization 21, 155–7, 276n2 optimal 2, 23, 46, 64, 97, 203; capacity utilization 195, 221, 223, 225–7, 229, 239–40; commodity basket 54, 106; decisions 64 paradox 7, 206; Allais’ 68; Arrow’s 7, 43–4, 54, 59–63, 68, 73–4, 102, 108–9, 205; Grandfather’s 114; Gödel’s 4, 106, 276n2, 278n1; Russell’s 4, 45, 71–4, 105–6, 120, 123, 126–8, 133, 232, 236, 277n16, 278n1 Pareto efficiency 62; optimality 45, 129; optimum 41, 67 partial order(ing) 49, 50, 52, 58 physics, physical science 4, 107, 120, 195, 234, 284, 285 pluralism 9, 14, 19, 20, 22, 25, 32–4, 136, 256–7, 267, 284, 292 Pontyagin’s maximum principle 156 preference(s) 54, 60, 144, 207; order 60, 101, 106, 207; relation 50, 55, 58–9, 109; revealed 53–4, 69, 101, 116, 276n3; set 50–1, 61; space 42, 49, 53, 55; structure 59, 61 profit rate 138, 143–4, 146, 160, 163, 171, 173, 176–8, 189, 221–9, 255–8, 261–2, 264–8, 273–4 profit share 216, 221–9, 239, 290 public goods 60, 62, 253

rationalism (ts) 13, 42–3, 45, 47, 77, 80, 84–5, 92, 100, 103, 106, 124, 150, 275n3 rationality 3, 6, 7, 21, 25–9, 33, 40, 42, 47, 62, 68, 84–5, 127, 130, 150, 206, 213–14, 217, 292; abstract 20, 22, 137, 147–50; aggregate 47, 74, 210; animal 44, 69, 213; bounded 25, 27, 44, 65–6, 76, 136, 155–8, 178, 277n3, 277n14, 278n6; cognitive 26, 155; diffuse (irrational) 28, 80–1, 85–6, 92; global 4, 69, 71–2, 75, 124; human 2, 43, 155, 210; instrumental 25–7, 276n13; multi-dimensional 44–5, 69–70, 74, 100, 210; neoclassical 40–4, 47–53, 57–60, 63, 69, 71, 74–5, 206, 210, 213; organizational 6, 29–32; ordinary 25–7, 85, 285; scientific 27, 83–5; rational choice 76; teleological 82 revealed preference hypothesis 53–4, 59–60, 67, 69, 101, 116, 276n3 reversibility (ir-) 42, 48, 101, 106, 116–17, 121–2, 279n6, 291, 293 rigid body 4, 47, 51, 61, 101, 203 Russell’s paradox 4, 45, 59, 71–2, 105–6, 127–8, 133, 232, 236, 277n16, 278n1 Salter Growth Engine 181, 185, 190 Say’s law 2, 55, 68, 187, 196, 205, 213, 220, 224 second best 7, 46, 75, 244, 290 Soviet Union 5, 14, 151 space-time 103–4, 108, 115, 117–21, 123, 233; Debreu’s 74; Einstein/Minkowski 104–5, 120, 234; physical 127, 130; social 7, 100, 104–6, 122–3, 127–8, 130, 231, 233 subject (s) Humans as 4, 7, 25, 97, 101, 105, 107, 117, 119, 124, 130–1, 145, 205, 208, 214; aggregates as 124 technical (technological) change 181, 221, 229, 288, 292 theorems: Arrow’s impossibility 141; see also Arrow’s paradox; Cantor’s unaccountability 72, 233, 277n16; chaos 41; Dimension Invariance 125, 127; Enthoven–Arrow 236, 241–2, 287; fix point 57–8; Hume 30; Mereological Rule of Thumb 133–4, 214; Metzler 235–6, 290 time: Einstin/Minkowski concept 7, 104–8, 113–16, 120, 122, 130, 143, 434, 234; Newtonian 107–8; physical 100, 107, 119, 130; social 100, 119, 130

298   Subject index uncertainty: genuine 68, 205–8, 211, 213–14, 230, 243; radical 8, 136–43, 146–7, 154–9, 163, 169, 177, 237, 271n9, 287 unemployment: and profit share variations 221–9; and uncertainty 215–29; classical 216–7; endemic 260; frictional 216; Keynesian 216; mass- 254, 259; NAIRU 216, 281n2; natural 216–7; structural 194, 216

United States (USA) 79, 201, 218, 222, 242–4, 254, 279 welfare 97, 183, 185–6, 201, 212–13, 257, 267; analysis 40, 108; collective, public 46, 58; distribution of 40, 215–6; function 42, 59–62, 74, 109; individual 58; measures 101, 183; policy 216, 247; state 36, 86, 137, 216, 281n1; system 216, 244–5; theory 2, 200

Name index

Ahlquist, K. 201, 293 Alchian, A.A. 284 Aleksandrov, A. 279n3, 284 Allais, M. 8, 67–9, 197–8, 200, 202, 210–11, 215, 284 Amoroso, L. , 102, 109, 284 Anderson, E. 284 Andersson, Å.E. 201, 284 Andrews, V.L. 287 Aquinas T. 263 Archer, M.S. 23, 284 Ardebili, M.H. 11, 20, 284 Arnér, M. 210, 284 Arpaia, A. 222, 284 Arrow, K.J. 41, 44, 59–63, 190, 206, 209, 230, 232, 234–7, 241–2, 281, 284 Ayres, R. 181, 294 Bacon, F. 86 Bailey, S. 96 Baker, W.E. 90, 289 Barone, E. 150–1, 283n14, 285 Becker, G.S. 54, 67, 199–201, 285 Becker, M.C. 280n19, 285 Berardi, G.G. 285 Bergson, H. 117–19, 233, 279n6, 285 Bernabè, F. 218, 285 Beveridge, W.H. 206, 215, 246–7, 285 Bhaskar, R. , 284, 285 Blanchard, O.J. 64, 217, 285 Bock, R.D. 222, 285 Boltho, A. 217, 285 Bortkiewicz, L. von 94, 278n7 Boudon, R. 25–8, 84–6, 278n7, 285 Bower, J.L. 194, 207, 227, 285 Brody, T. 29, 44–5, 70, 124–5, 208–9, 285 Burda, M. 222, 285 Calcagnini, G. 285

Cantner, U. 285 Carr, J.D. 120–3, 127, 285 Carroll, L. 54, 285 Cellucci, C. 276, 285 Choi, S.C. 286 Cipolla, C.M. 262, 286 Clower, R.W. 152 Coase, R.H. 275, 286 Collier, A. 284 Comnena, A. 250, 282, 286 D’Antonio, M. 280, 286 Davidson, P. 152, 286 Debreu, G. 41, 56, 61–2, 67–8, 74, 101, 105, 109, 277n8, 284, 286 DeLong, J.B. 216, 286 Demsetz, H. 284 DeWitt, N. 132, 286 Dimitrieff, V.K. 94, 278n7, 286 Dobb, M.H. 286 Doron, G. 40, 51–2, 286 Dosi, G. 22, 286 Douglas, R. 117, 286 Dow, S. 19–20, 286 Downs, A. 40, 286 Duncan, R.C. 185, 286 Durkheim, E. 19, 26, 84, 286 Eco, U. 281n5, 286 Egidi, M. 158, 286 Egil Skallagrimson 128–9, 289 Eichengreen, B.E. 190, 286 Einstein A. 27, 113; see also Einstein/ Minkowski space-time Eirik Jarl 128–9 Ekstedt, F. 210, 276n1, 284 Ekstedt, H. 148, 187, 195, 221, 287 Embree, L. 288 Enthoven, A.C. 234–6, 241–2, 287

300   Name index Epstein, J.B. 221, 291 Felices, G. 222, 287 Fischer, S. 64, 217, 285 Foss, N,J 289 Friedman, M. 41, 287 Friend, I. 221, 287 Frisch, R. 21, 287 Fukuyama F. 37, 88, 287 Fusari, A. 162, 275n5, 275n8, 275n10, 276n17, 276n18, 276n19, 278n11, 279n1, 279n2, 280n5, 280n9, 280n10, 280n12, 280n20, 280n22, 280n24, 282n1, 287, 288 Galbraith, J.K. 280n17, 288 Galiani, F. 92–3 Galilei, G. 13, 86, 275n1 Garegnani, P. 288 Georgescu-Roegen, N. 143, 195–6, 288 Gerschenkron, A. 88, 288 Gertler, P. 288 Giddens, A. 23, 288 Gioacchino da Fiore 92 Godel, K. 28 Gorman, W.M. 67, 200–4, 207, 215, 288 Grebel, T. 288 Hahn, F.H. 190, 206, 209, 230, 232, 234, 237, 242, 285 Hanson, N.R. 13, 288 Hanusch, H. 285, 288, 293 Hart, J. 288 Hayek, F.A. 20, 22, 153, 157, 288, 290 Hegel, G.W.F. 80, 150 Hero of Alexandria 180, 183, 192–3, 196–7 Hewitt, E. 276n1, 288 Hobbes, T. 40 Hodgson, G.M. 22, 65, 288 Hollis, M. 26, 288 Homer, S. 262–3, 288 Hubbert, M.K. 185, 288 Hume, D. 30, 42–3, 48, 53, 74, 79–80, 106, 109, 112, 116–20, 124, 130, 246, 275n2, 276n6, 276n10, 288, 292 Huntington, S.P. 37, 88, 288 Ibn Khaldun 251, 282n6, 288 Inglehart, R. 37, 88–90, 289 Isham, J. 289 Kaldor, N. 280n13, 289

Kant, I. xix, 83, 103–4, 108–16, 118–19, 124, 127, 276n16, 281n5, 286, 289 Kantorovich, L.V. 156 Keynes, J.M. 2, 6, 64, 68, 121, 148, 151–2, 182, 185, 192, 205–6, 208–10, 229–30, 236, 246, 277n15, 281n7, 289 Kimberly, G. 289 Kirzner, I.M. 153–4, 156, 178, 255, 280n14, 282n10, 289 Knight, F.H. 146–8, 152, 154, 289 Knight, M.D. 294 Koestler, A. 180, 289 Kolodinsky, J. 289 Korscaard, C. 289 Krugman, P. 2–4, 289 Kuhn, T.S. 13, 17–19, 289 Lakatos, I. 17, 289 Lancaster, K. 46, 67, 200–4, 215, 289 Lange, O. 150, 282n8, 283n14, 289 Langlois, R.N. 289 Larsson, T. 276n1, 287 Laver, M. 40, 289 Lavoie, M. 201, 290 Lavoie, N. 204, 290 Lawson, T. 23–4, 284, 290 Le Goff, J. 283n19, 290 Le Roy Ladurie, E. 277n3, 290 Lerner, A.P. 150, 282n8, 283n14, 290 Levine, D. 288 Lipsey, R.G. 46, 290 Liu, Q. 204, 290 Lluch, C. 201, 290 Machiavelli, N. 40, 77, 81, 277n1 Makarov, V.L. 63–4, 66, 277n9, 277n11, 277n12, 290 Mandeville, B. 29, 77, 252, 277n1, 282n7, 290 Marx, K. 37, 93, 94–6, 98, 149–51, 263, 278n9, 285, 290 McDowell, J. 290 McKelvey, R.D. 41, 290 Mende, W. 291 Menger, C. 22, 290 Mensch, G. 280n4, 290 Metcalfe, J.S. 292 Metzler, L. 235–6, 290 Minsky, H.P. 221, 287 Mises, L. von 290 Moretti, E. 288 Morishima, M. 290 Morris, C. 290 Morroni, M. 155, 290

Name index   301 Munley, F. 221, 290 Murray, A.R.M. 43, 100, 103, 124, 290 Myrdal, G. 290

Russell, B. 4, 72, 75, 116–17, 120, 123, 126, 208, 209, 278n1, 291; see also Russell’s paradox

Nagel, E. 290 Napoleoni, C. 290 Narduzzo, A. 158, 286 Nash, J.F. see Nash equilibrium Nelson, R.R. 156–8, 280n18, 286, 290 Neumann, J. von 149, 152; see Neuman–Gale and Neuman–Morgenstern Newton, I. 13 North, D.C. 22, 275n7, 291

Salanti, A. 292 Samuelson, P.A. 42, 53, 59, 67, 104, 154, 292 Sanders, C. 292 Saviotti, P.P. 144, 292 Savitt, S.F. 279n6, 292 Schumpeter, J.A. 5, 98, 143, 146, 153–5, 157, 178, 252, 255, 275n6, 280n15, 280n16, 282n10, 285, 288, 292 Screpanti, E. 292 Segerstrom, P.S. 180, 183, 200, 292 Sen, A. 54, 246, 292 Seton, F. 94, 293 Shackle, G.L.S. 152, 277n15, 293 Simon, H. 26, 65, 156, 293 Singer, P. 293 Smith, A. 2, 45–8, 77, 80, 92–3, 127–8, 245, 252, 277n1, 293 Sraffa, P. 94, 145, 283n16, 293 Steindl, J. 278n9, 293 Stiglitz, J.E. 267, 283n25, 293 Stoneman, P. 293 Stromberg, K. 276n1, 288

Odagiri, H. 291 Ollman, B. 293n18, 291 Olney, M.L. 216, 286 Orwell, G. 132 Osborne, H.D. 221, 291 Pack, H. 190, 291 Pagano, U. 291 Pareto, V. 26, 29, 80, 102, 284, 285, 291 Parsons, T. 33, 291 Pasinetti, L.L. 201, 291, 292 Patinkin, D. 152 Peacocke, A. 279n6, 291 Pera, M. 291 Peschel, M. 291 Pichelmann, K. 222, 284 Pindyck, R.S. 280n21, 291 Plato 103, 115 Polanyi, K. 13–15, 35, 253, 275n4, 291 Polanyi, M. 13–18, 155, 158, 283n17, 291 Pollak, R. 199–201, 281n1, 291 Pontryagin, L. 156 Popper, K.R. 12–14, 17, 28, 38, 275n3, 291 Prigogine, I. 143, 279n6, 291 Pyka, A. 144, 285, 288, 291, 293 Rachels, J. 291 Radner, R. 66, 206, 210, 236, 277n14, 291 Rauschning, H. 291 Rawls, J. 82–4, 282n13, 292 Reati, A. 280n5, 288, 292 Reichenbach, H. 116, 121, 233, 279n4, 279n6, 292 Ricardo, D. 96, 150–1 Richardson, G.B. 292 Romer, P. 190, 292 Rostow, W.W. 292

Tarski, A. 61, 276n4, 293 Taylor, F.M. 150, 289 Teece, D.J. 286 Tily, G. 263, 283n23, 293 Tinbergen, J. 21, 293 Tocqueville, A. de 26, 84, 293 Tresch, R.W. 42, 74, 101, 293 Trigg, A. 201, 293 Turnovsky, S. 187, 293 Uemura, H. 221, 293 Ulph, A. 280n21, 293 Ulph, D. 280n21, 293 Unruh, W. 107, 114, 116, 118–19, 293 Varian, H. 51–2, 293 Varjonen, J. 201, 293 Vernon, R. 192, 293 Volterra, V., 11 Vico, G.B. 11–12, 77–9, 294 Wald, A. 152, 294 Walras, L. 93–4, 285, 294 Warr, B. 181, 294 Weber, M. 10–11, 37, 80–5, 88, 287, 294 Weisskopf, T.E. 221, 294

302   Subject index Weisstein, E.W. 53, 72, 276n1, 277n7, 277n16, 294 Welfens, P.J. 294 Westberg, L. 187, 221, 281n4, 287 Wette, R. 286 Wieser, F. von 93 Williamson, O.E. 22, 65, 275n7, 294 Winter, S.G. 156–8, 280n18, 286, 290 Witt, U. 22, 294

Wittgenstein, L. 44, 48, 51–2, 57, 61, 72, 104, 116, 224, 236, 294 Wymer, C.R. 173, 294 Wyplosz, C. 222, 285 Youngquist, W. 185, 286 Zeuthen, F. 152, 294