Monday, 13 July 2015

THE SPHERE OF EXCHANGE AND THE LAW OF VALUE – Smith, Hayek and Mises




Wealth and Political Economy

Smith’s “nature and causes” refers precisely to this “diachronic” dimension analysis or theory dealing with “the origins” of the present reality – not just in an “evenementiel” sequence (a list of events or facts), but in “practical” terms that “explain” this present reality in a way that makes us conscious agents of its present transformation and creation or “making” (cf. Thompson’s “The Making of the English Working Class”, in this double meaning of conscious politico-institutional ‘erecting’ in the face of antagonistic social relations). This aspect we will examine in connection with Hegel and Marx. To ask about “the nature of wealth” invites us to question its “meaning”, to find out “of what” it consists, what is its “substance”. And to ask about “the causes” of wealth invites us to enquire about its “origins”, about its “source”, about its “efficient cause”.

Already, by asking these related questions, Smith is intimating that “wealth” is not a “fixed amount”; that it is not a fixed quantity already in existence and immutable so that all that can take place between its “owners” is a simple “exchange”. Nor is Smith confining his enquiry to the mere “horizontal” growth of “wealth” through the simple expansion of the national population or the annexation of foreign territories and their wealth.

Smith is enquiring therefore about “the creation” or “pro-duction” (leading forth, creation, making) of wealth. And his answer to these questions is of two contrasting orders: on one hand, he suggests that “wealth” is created through the amount of “labour” that goes in the pro-duction of goods and services; on the other hand, he suggests that this wealth is created instead through the “exchange” of goods and services between self-interested individuals who can then “specialize” in their employment and therefore be more “pro-ductive” so that “wealth” expands.

But in both cases, Smith never abandons the belief that the “exchange” between individuals is an “equal exchange” because the competitive (leveling) forces of the free market mechanism will ensure that any “inequality” of exchange will be “leveled out” through the price mechanism. So not only does the market price mechanism ensure “equal exchange”, but also it leads to the expansion of wealth through the efficient allocation of individual resources for production.


Market And Social Osmosis

Two doubts arise at this stage: First, what exactly do we mean by “in-dividual”? Here the whole “empiricist” conception of reality (social and metaphysical) from Hobbes to Schopenhauer comes to the fore and is brought into question. Note that the “individual as a “physical unit of political decision-making” may have some relevance/force, but not as an economic unit where it seems entirely arbitrary.

Second, if individuals are truly “self-interested”, how can they “exchange” anything? How are their activities, their individual labours “co-ordinated”? Let us assume that these individuals are seeking to maximize their “utility” through exchange. Obviously, they will seek to derive from the “exchange” as much personal utility as they can by minimizing the amount of “endowments/utility” that they exchange with other self-interested individuals. But given that each good and service that these individuals exchange with one another contains “at equilibrium” a given “level” of “utility” (not “quantity” because utilities are incommensurable except in terms of objectified relative prices), it can then be argued that the individuals are not necessarily seeking to maximize “utility” but rather any number of “quantities” (including those in inverse proportion, as with “labour”, which has a “disutility”). Thus, we can see that “utility” is a purely “metaphysical” entity or substance that simply does not explain why “exchange” takes place: we may as well replace it with “labour” or any other “good or service”.

So now we can see that if we assume that the market economy involves “equal or equivalent exchange”, then everything within it is “equivalent” and the selection of a particular “substance” that lies “behind” the exchange, from “utility” to “labour”, is just a “metaphysical” entity that tells us absolutely nothing about the market economy and does not “explain” in causal terms the “nature” of “wealth” or indeed its “causes”. (Myrdal, below, seems to make the same point about the “tautology of circular definitions”. But he is wrong in branding this circularity “meaningless”, as we will show with Wittgenstein.)

Furthermore, here we are assuming that all these “exchanges” are happening “simultaneously” or “synchronically” and that all individuals know fully the “utilities/endowments” of everyone else. Even the Walrasian process of “tatonnement” (“groping”), or auctioneering, assumes that exchange ratios are fixed “simultaneously”, because there is simply no way of moving from one “intertemporal” fixing of prices to the next without having before us all the information needed to attain equilibrium! In other words, though utility maximization may be proposed as the “purpose” behind the process of market activity, it is not a purpose that can effectively serve as a price-discovery entity driving the process of exchange toward equilibrium – because market exchange is “blind” outside of equilibrium and, as established above, “empty” (“purposeless” or a “non-action state” as Mises dubbed it) once we assume that we have attained it. (Hayek makes similar points about the “timelessness” of equilibrium and its “omniscience” [“happening in a single mind”].)

But if instead we see these “exchanges” taking place over time, there can be no guarantee that the exchanges would lead the market price mechanism “to converge” toward “equilibrium”. For it is just as likely, if not indeed more likely, that the “self-interested” behaviour of individuals would lead the mechanism “to diverge” from equilibrium over time. Imagine, for instance, the existence of “opportunistic” behaviour whereby some individuals concealed the extent of their “endowments” so as to be able to exchange the lesser amount for a greater quantum of “utility” from other individuals, and so forth. Eventually, “competition” among self-interested individuals would not lead to “convergent price discovery” and therefore to “equilibrium” but rather to the opposite of “competition”, that is, to “monopoly”.

So therefore this “exchange” theory of the market economy does not even tell us how “competition” in its “pure” form at “equilibrium” can ever lead to “equilibrium” and “co-ordination” at all, rather than its opposite, either monopoly or indeed “chaos”. This is why, once Adam Smith took the “equilibrium” approach to the market economy not as one where “wealth” is pro-duced but where it is merely “exchanged” he had to assume or posit the existence of “com-petition” as a convergent force, and therefore had to invoke a “deus ex machina”, an “invisible hand” or a “deus absconditus”, a “hidden god” or “hidden rationality” (ratio abscondita) that “guided” the market economy to “self-regulation” and “co-ordination” – an unconscious, involuntary, “spontaneous” Plan that turned the “self-interest” of “individuals” into “enlightened self-interest”.

Crises, cycles, Planlosigkeit and “the Law of Value”.

We have seen that if we assume that the market economy involves the exchange of given “quantities”, whether they be a quantum of “ subjective utility” or a given amount of “labour” measured in “socially necessary labour time” – the latter being the “socialist” position whereby “wealth” is pro-duced by the amount of labour-time socially necessary to produce a good or service – then the problem for a just market economy is to ensure a just “distribution” of the “wealth” either through market exchange via competition or by more direct political means. Socialists were quick to observe that the distribution of the “value” or wealth produced by workers with their labour was clearly not equal to their contribution to the creation of the wealth and that this was distorted by the “ownership” of the means of production by capitalists which led to the unjust or unfair “expropriation” of workers of the product of their labour. Indeed, the obvious fluctuations in business, investment and employment conditions in the market economy were attributed by socialists to the very “Planlosigkeit” (unplanned and chaotic nature) of market capitalist production due to the private ownership of the means of production. They proposed therefore a “Plan” to ensure the equitable distribution of social wealth and the full employment of social resources.

For their part, proponents of the market economy saw these fluctuations in part as necessary yet temporary disequilibria due to the efficiency and productivity gains of competitive activities among entrepreneurs that would ultimately benefit consumers, or else as distortions arising from “exogenous factors” not controllable through the market pricing mechanism, or else at worst as occasioned by “political interference” with the free operation of the market, especially on the part of governments.

In both cases, we can see that, whether we see the sphere of exchange as one of “equivalent exchange” tending toward equilibrium or as one of “unequal exchange”, the question is whether or not “the market pricing mechanism” can work efficiently without political planning (as in the case of “utility”) or whether it needs to be guided and reformed politically to ensure the equitable redistribution of “value” based on “socially necessary labour time”. But, once again, in both cases the “quantity” of value produced by or ‘endowed’ to participants in the economy is taken as “given” and “quantifiable” so that the pivotal economic problem is that of “distribution” of wealth or the “co-ordinated exchange” of wealth and not that of how wealth is produced!

In the market capitalist and the socialist view, the Law of Value says that the amount of “wealth” (labour value or utility) is fixed and quantifiable either absolutely (in terms of labour time) for the socialists or relatively (in terms of utilities as displayed by supply and demand of goods) for the market capitalists. In both cases it is possible to have an “equivalent exchange” either through political distribution of value in a centrally planned economy (socialism) or else through the “unplanned” competitive market mechanism where the relative prices of goods and services are set by supply and demand which in turn “co-ordinate” economic activity without the need for a “planning authority”.

The Law of Value and the Sphere of Equivalent Exchange – Equilibrium and Circular Flow. – Plan turns society into a factory – Market allows “Choice” or “Spontaneity” – Indeterminacy of “labour time” and of “equilibrium”: a posteriori definition arbitrary and tautologous because “labour time” and “utility” are “metaphysical” notions. Again, sphere of production hidden from analysis.

From our exposition, it is easy to see why the socialist labour theory of value would call for the “planned” redistribution of social wealth and why its market opponents would object that such “political” interference with the market pricing mechanism would remove the “free choice” of individuals based on their self-interest and would also be tantamount to “transforming society into a factory” because the only “value” allowed by socialist theories is that coming out of workers. For the “socialists” instead the “freedom” claimed by the market proponents is really the freedom of the owners of the means of production “to steal labour time” from workers and their “choice” of investments only leads to harmful fluctuations in the level of economic activity.

Surplus Value (theft of labour time) or Efficient Allocation of Resources (exchange and division of labour). Economics as “Science of Value” (labour time “hidden behind” market prices [metaphysics]) or as ‘Pure Logic or Science of Choice’ (means-ends co-ordination through competition; market-price empiricism “hiding” utility).


What is important for us to notice, however, is that neither the socialist nor the market theory of the economy can determine satisfactorily its basis. First of all, it is simply impossible to define a “socially necessary labour time” for a society to reproduce overall or indeed for each sector of the economy, let alone for each individual good or service. Besides, this theory simply cannot account for capitalist profits and accumulation or “surplus value” because, if labour time” is already “socially necessary” to produce existing goods and services, then where does the “surplus value” that enables the “theft of labour time” by capitalists come from? (Schump in ‘CS&D’ makes this point.) And if we allow that “necessary labour time” contains a “surplus” component, then how “socially necessary” is this labour time? The objection that “necessary labour time” is not a quantity as such but must take into account “social standards” as well simply relegates the analytical problem from that of “labour time” to that of “political and social relations”. So it is to these that we will turn at a later stage to complete our analysis.

For the market proponents, however, the suggestion that “utility” lies at the heart of exchange can be refuted quite simply with the objection that “utility” is a very “metaphysical” notion indeed. And if it is impossible to define “labour time” then it is even harder to define the “marginal utility” that determines market prices because, in order to do so, we must first identify an “equilibrium” so that all marginal utilities can be given a “price” denominated in terms of a “numeraire”, that is, in terms of any of the goods or services traded in the market. In that sense, we could have relative market prices denominated in oranges or apples or cars and trucks – and where does that leave “utility”?

We can conclude on the metaphysical character of both approaches to economic activity by saying that whereas the Law of (Labour) Value indicates “labour time” as the metaphysical entity “hidden behind” market prices – something that needs to be “uncovered” by “transforming” prices into values; the market theory instead can far more easily indicate market prices as the actual exchange ratio at the margin of the “utilities” of the goods and services exchanged to their market sellers and buyers so that “utility” can be conveniently “hidden” behind actual market prices (at equilibrium) far more easily than “labour time values” because the latter, unlike the former, do not need to be “transformed” into market prices.

Wealth as ‘Growth potential’ or ‘tumescence/ex-crescence’ through efficient exchange and specialisation (immanence) or as ‘Trans-crescence/Krisis’ (transcendence).Entwicklung.

The notion of “equilibrium” is entirely concerned with and wholly originates from “equal exchange”. Equally, both the Law of Value and Marginal Utility allow the theoretical possibility of “equal exchange” in a market capitalist economy by positing a “Value” (labour time or utility) that can be maximized by the economy through its “regulation” either by the market mechanism (unplanned) or by political intervention (planned). Therefore both theories presume the existence of “individual labours” (Trennung) and of “private property”.

But by concentrating respectively on the “distribution” of wealth (socialism) and on the “exchange” of goods and services (market economists) it is clear that both the Law of Value and Marginal Utility Theory have the powerful effect of concentrating our attention exclusively on the Sphere of Exchange and hiding from our view and analysis the Sphere of Production. Now, in the Sphere of Exchange every category is “equi-valent” so that every category is linked to every other and can “sprout” or “swell” from it homogeneously like an “ex-crescence”. This is why for Hayek and now for the GE theoreticians (Hahn) “co-ordination” becomes the central problem of economics and “the division of labour”, now that it has become a mere “sign” in the uni-versal equi-valence of equilibrium analysis, is inter-changeable with “information/knowledge” even when the system has no “intellectual exchange or activity” whatsoever” (Debreu). - Because equilibrium has no “action”, no “purpose” as pure “crystallized immanence” where the sheer “id-entity” of its categories nullifies any “telos” or “conatus” or “aim” or “goal”, where “choice” becomes meaningless because there is no further “choice” to be taken, where all “values” are “semaphored”. In this empyrean frozen for eternity, in this paralysis, everything is “fungible” and therefore becomes pure “form” without content – sheer apory.

In other words, what is left out is the notion of “wealth” itself, its “development”, its tumescence or else trans-crescence – the quidditas of the system, its human “purpose” in terms of “nature and causes”, in terms of “origin”, of “whys and wherefores” – the quaestio occulta, the causa finalis, the “reason for it”. “Tumescence”is immanent/endogenous and “trans-crescence” is transcendent/exogenous. But the latter refers to “wealth” as an amorphous protean category that undergoes a metamorphosis and that cannot be “quantified” by a homogeneous “substance” that “lies behind and is transformed” into market prices or is “hidden/represented” by them.

Let us assume that we finally reach equilibrium either by planned or unplanned means. We still have not accounted for “growth” or the “expansion of wealth”. Indeed, because we cannot be sure about what exactly “wealth” consists of in this market mechanism (we have seen that it could be any number of “substances” or “entities” or “ectoplasms”), we cannot really talk of “growth” or “expansion” of “wealth” – so we need to talk rather of “development” or “trans-crescence”, that is, the movement of the market economy from “equilibrium” to “something else” whose nature and causes we do not know yet.

If “wealth” remains homogeneous, then we can see how Smith could mistakenly derive it from “exchange” and then pass seamlessly to “specialization” and “efficiency” as “generating” greater wealth (tumescence) from endogenous (immanent) factors (exchange of existing values or utilities). But this is antinomical because “efficiency” means “better use of” some pre-existing “quantity” that cannot “generate” greater wealth except as “potential”. But potential production (like energy) must be contained already in the existing division of labour or information. The system cannot outgrow its “potential”. But there is something very wrong with a theory that starts with a notion of “equilibrium” that maximizes utility and then pretends that “exchange” can lead indefinitely to growth through constant “co-ordination” and “specialization”! It is obvious that an economy where exchange can induce growth through efficient allocation of resources is one in disequilibrium, and one that will stagnate once it reaches equilibrium. Therefore, “exchange” cannot generate growth unless we do away with the notion of equilibrium.

But then, if we do, we have to introduce some notion of “unequal exchange”, because “equivalent exchange” by definition will be neutral and cannot induce growth outside of the “potential” that can be realized from some initial position through greater allocative efficiency with existing techniques and inputs or “resources”, until we reach equilibrium. For the economy to grow or trans-cresce beyond equilibrium, we must introduce some “exogenous” factor such as “competition” or “innovation” that can stir the system away from stagnant equilibrium. The next question is: how can these “exogenous factors” be explained in terms of “how” they upset equilibrium and of “why” actors are motivated to engage in “growth activities”. In other words, what is it about “growth” that induces economic agents to act? What is the “aim” (substantive and strategic) of competition? If it is “wealth”, what does “wealth” mean? And how is such motivation consistent with the “equivalent exchange” of the market pricing mechanism?

Evidently, our conclusion is that “utility maximization” from “self-interested individuals” cannot be indicated as a “motivation” for economic activity outside of the state of equilibrium because it is incompatible with “convergence” to equilibrium and indeed it cannot be defined at all because its “definition” presupposes the attainment of equilibrium so “relative prices” can be calculated to define the “maximization of utility”. But once we do reach equilibrium, then utility can no longer “act” as a motivation to drive the system out of equilibrium and into growth – because no further “action” or “motivation” is possible. And this is why “utility” cannot be indicated as a “purpose” or “goal” of economic activity. Because “utility” is an utterly “subjective” notion, its “reality” is totally inscrutable in social terms by definition. That is the meaning of Hayek’s “subjectivism”.

This also means that the Hayek-Robbins “science of logic” as a technique of  “means-ends” rationality must be discarded – because the “ends” become redundant at equilibrium, and so does the further use of any means. The logical flaw with Robbins’s formulation is that it fails to define both “resources” and “efficiency” independently of the relative prices attained at equilibrium, which is needed ex ante to assess the appropriateness of the means, the “choice” of the “science of choice”, to achieve the proposed ends/goals! (Hayek made the same point contra the market socialists in the “Socialist Calculation” debate. We will see with our discussion of Demsetz-Alchian that “resources” cannot be defined independently of “property rights”, which destroys the “scientific neutrality” of economics because its aim at all times was to define “resources” and “efficiency” neutrally/scientifically in terms of means-ends.) Robbins was obviously thinking in terms of “output growth” – but this begs the question of how “output” is to be measured! It is a petitio principii.

Thus, ex ante, the market mechanism is “unfounded” as a means for achieving equilibrium and requires the postulation of an “invisible hand” or of a “spontaneous order” (a ratio abscondita) which transforms the exercise into a petitio principii. If however we wish to define equilibrium ex post, then we have a tautology - this is equilibrium because this is equilibrium – given that “utility” or “utilities” are inscrutable notions that are “hidden” by relative prices determined by market forces (supply and demand).
 

A.   Exchange and Equivalence

THE MOST IMPORTANT PROBLEM with Hayek’s theoretical revision of economic theory is therefore that, fixed as it is within the uni-verse of “exchange” of neoclassical theory, the “prices” of his “intertemporal equilibrium”, just like those of general equilibrium, become mere “signals” or ciphers to enable the equilibrium co-ordination of economic activities in the market economy. This is what enables Hayek to suggest the replacement of “the division of labour” (which points clearly towards the uni-verse of “production”) with “the division of information” which, as symbolic exchange, is clearly anchored to “the uni-verse of exchange”.

Indeed, Hahn and Loasby have suggested that “prices and quantities” in equilibrium analysis ought to be abandoned in favour of “information and action” (see Loasby, ‘Eq&Evol’).

The difficulty here is that once we define an empirically determinable “catallaxy” that determines prices ex ante, which gives the market economy a “tendency to equilibrium”, then the “economic” problem becomes a strictly “technical” one from which all “competitive choice” or “self-interest” is removed: – in short, economics becomes a branch of engineering (see our discussion of “the Pure Logic of Choice”) or an ex post facto “rationalization” of a “mechanical evolutionary process” independent of human will (Hayek’s “spontaneous order”, see our discussion in ‘Hayek’s Scientism’). Hayek does not state clearly whether it is “the price mechanism” that ensures economic ‘co-ordination’, or whether it is the “spontaneous order” and the “institutions” that compose it that determine the price mechanism. The ambiguity is illustrated by Hayek himself: -

The economic problem of society is not merely a problem of how to allocate ‘given’ resources… It is rather a problem of how to secure the best use of resources known to any members of society, for ends whose relative importance only the individuals know… it is a problem of the utilization of knowledge not given to anyone in its totality,”

Hayek is clearly hypothesizing that the co-ordination problem is one of explaining not the optimal ‘potential’ allocation of resources, but rather the best available allocation from the perspective of freely-competing ‘individuals’ – which is what transforms ‘co-ordination’ from a ‘technical (engineering) allocation’ problem to a “spontaneous/institutional or political” one.

[Incompatibility of “co-ordination” and “competition” is the greatest problem. Hayek speaks of “different plans” or “(individual) ends of relative importance” and of “utilization of knowledge”. But he presumes all along that these “plans”, “ends” and “knowledge” all have a common goal or convergent aim, which is not at all what “competition by self-interested individuals” actually means! The outcome is that no “co-ordination” is possible without the further specification of a “convergence mechanism”. This takes us back to the ‘metaphysical’ notion of ‘utility’/endowments, that of “scarcity” and “resources”, and above all brings into question that of “self-interested individual”! Hence, the need for Hayek to embark on the whole “evolutionary” enterprise of discovering a “spontaneous order” accompanied by the “institutional” regulation of competition”.]

The problem with this approach is that we can never know, even a posteriori – except tautologically – whether the market pricing mechanism truly ensures this “best use” of resources in the sense of “best utilization of knowledge”.

So, either we prescribe a “spontaneous order” that ensures “co-ordination” as an outcome; or we postulate (a posteriori) that the existing system is the “best use” in any case. Obviously, because Hayek sees ‘co-ordination’ as a problem, his approach must favour the former pathway.

But another even greater difficulty emerges right away. If indeed the entire purpose of “the division of knowledge/information” is solely to ensure the “efficient co-ordination” of different individual plans, even assuming that these “plans by self-interested individuals” can be “convergent” and therefore are capable of “co-ordination”, it is no longer possible to divine what is the basis of the “market competition” that determines the “economic” character of the whole “market exchange mechanism based on the price system”. Again it seems evident that unless individuals can “profit” from this process, the logic of “equivalent exchange” will result in equilibrium and stagnation. Alternatively, if individuals do profit from the exchange, then the logic of “competition” will end up in “monopoly”, with devastating consequences for Hayek’s entire analysis of “best use of resources known”, and tendentially “monopoly” will result once again in “stagnation” and “non-action”.

Economic theory involves the interaction between prices and quantities for exchange. Ultimately, the purpose of “market exchange” is not “information” or “knowledge” – but something far more controversial such as profits!  It will never be clear whether it is “prices” that determine “the utilization of knowledge” (the ‘institutions’ of NIE) or “utilization of knowledge based on quantities” that determines “prices” to ensure the “co-ordination” of economic decisions in the sphere of exchange. The question remains: do prices determine “the utilization of knowledge” (the shape of ‘institutions’) so that some individuals may ‘profit’ or is it the other way around so that the end-result will be a stagnant equilibrium with no profits and no price changes? It is no answer to break up the economic decision-making process into ex ante plans and ex post “verification” (as do Boettke et al. in ‘Context’) because no amount of slicing up of individual exchange decisions (or learning process or Walrasian ‘tatonnement’) will ever give us the answer to the fundamental arrow of causality:

Boettke et alii:

Economic coordination requires the dovetailing of the diverse plans of individuals dispersed throughout the economic system.  The production plans of some, must mesh with consumption demands of others, and do so in a manner that tends to exploit the gains from trade, and realize technological efficiency. Minds must meet and this is accomplished through the market process of relative price adjustments and profit and loss accounting.  Ex ante expectations guide the decisions of individuals and are informed by the existing array of prices that decision-makers confront.  Ex post improvements of plans are communicated via profit and loss, and serve to indicate the appropriateness of those plans in terms of the competing demands for the resources and the concurrent plans of everyone else in the economy,” (‘Context’). 

Walrasian ‘tatonnement’ was meant precisely, like Boettke’s ex ante/ex post analysis, to remedy the aporetic ‘timelessness’ of the equilibrium simultaneous equations (see Hayek quote above). But neither stratagem can remove the insuperable difficulty that the ‘theoretic’ framework is an ‘identity’ and therefore lacks ‘causality’ and ‘time’ (is ‘synchronic’ and not ‘diachronic’, and therefore is ‘aporetic’).

Above all, this framework always needs to introduce surreptitiously the whole rationale of the “exchange” – profit and loss – which is what makes it “competitive” and destroys all the sanctimonious elaborations on “co-ordination” and “spontaneous order”. As long as economic analysis remain ‘imprisoned’ in the sphere of exchange, these ‘apories’ will be irresoluble and the “theory” will remain “flat” in the sense that it will lack “the arrow of causality” or “the purpose” between production and prices for exchange. Let us examine these separately.

EXCHANGE

The profound incomprehension of the fundamental problem of economic theory and the well-nigh total confusion and misconception of the fact that it cannot be “reduced/traduced” to a simple problem of “exchange” is again made evident by Boettke et alii:

“Hayek’s focus on the epistemic properties of the market process led him to recognize the role of the division of knowledge in promoting social order just as Smith (1776) emphasized the division of labor to promote economic prosperity. Adam Smith taught us that the great increase in the productive capacity of a people resulted from expansions in the division of labor.  Hayek, similarly, taught us that a division of labor also entailed a division of knowledge in society.  Both emphasized the complexity that the division of labor and division of knowledge implied and the enormity of the coordinative task that must be accomplished by the market system to realize the great benefits of specialization and trade,” (‘Context’, p3, my emphasis).

The problems are compounded by the fact that, as Boettke et alii confirm above, both Smith and Hayek sought to theorise the role of competitive market ‘co-ordination’ (“the market system”) “to realize the great benefits of specialization and trade”. In other words, they are aware of the fact that “best use of resources” is not just an “epistemic” problem, but also one of “specialization and trade” – or rather… one of productivity and growth!

The “allocation of resources” can get us to “distribution” and then to “productive distribution using existing technological and human resources” – which returns us to the “technical (engineering)” definition of ‘co-ordination’. But it will not take us to “innovation”, because otherwise market co-ordination would have to encompass not just existing technologies but also other “combinations” of technologies and innovation (Schumpeter). [Metcalfe (‘Evol.Econs.&Cr.Destr.’) agrees with the futility of pursuing this line of enquiry.]

But then we need also a theory of how market system ‘co-ordination’ not only ‘allocates’ resources but also causes these resources to grow. And yet, the mechanism that causes resources “to grow” (the economy “to develop”) must be conceptually and institutionally distinct and separate from the market process of ‘co-ordination’ through exchange of resources!

In other words, it is not possible to incorporate the notion of “development and growth” in the concept of ‘co-ordination’ because the former involves more than sheer ‘co-ordination’, whether of ‘given resources’ or of ‘knowledge about use of existing resources’. It involves the expansion of resources however defined.

So, what can Boettke et alii mean by “the enormity of the coordinative task that must be accomplished by the market system to realize the great benefits of specialization and trade”? Because no “enormity of the coordinative task” will ever be enormous enough to cause “the market system to realize the great benefits of specialization and trade”, once we concede (as we must) that “the great benefits of specialization and trade” are necessarily distinct and separate in theory and in practice from “the co-ordinative task of the market system”!

The economic concept of “productivity and growth”, or “development” involve social mechanisms or interactions that are quite different from the concepts of ‘co-ordination’ and ‘exchange’ and ‘allocation’. For growth and development to occur, we need to specify a “motor or engine of growth or development”.

Recall that it was Adam Smith’s original confusion of exchange as the cause of specialization (rather than the other way around) that led him astray from his quest “to enquire into the nature and causes of wealth” (that is, ‘growth’) and that condemned him ultimately to seek ‘value’ in the sphere of exchange and to turn therefore into “the father of general equilibrium” (Arrow and Hahn) and to invoke “the invisible hand” (timeless equilibrium determined by simultaneous equations).

Even if we follow the orthodox interpretation of Schumpeter’s ‘theory’and locate ‘innovation’ endogenously with Rosenberg within ‘corporations/firms’, there is still absolutely no conceptual link between “the market” as a “co-ordinating” mechanism of “knowledge/information utilization” (Hayek) and the actual process of “innovation”.

And even superficially, quite apart from the ‘conceptual’ difficulties of Boettke’s hypothesis, there is ample evidence to show that, purely at a ‘geographical/logistical’ level, “innovation” very often takes place in a ‘non-market’, non-competitive setting – “the fourth quadrant”, as Steven Johnson has called it.

Metcalfe (‘Evol.Econs.&Cr.Destr.’) accepts the difficulties but clings to the role of “market competition” in innovation. His theses are so bizarre as to defy belief! – Worthy of quotation to show how “scarce resources” are not applicable to “evolutionary and institutional economics”!

Rothbard tackles the problem more helpfully. He invokes Mises to say that it is “mutual benefit” derived from “the diversity and inequality of talents and interest among men” that causes “exchange” and “the division of labor”, rather than the other way around, as the “anti-rationalist” Adam Smith would have it. Taken to an extreme, Mises would then have to argue that butchers and carpenters have innate talents that lead them to specialize in those trades! No further comment is required on the foolishness of this notion. But Rothbard asks a valid question: “If for Smith, the diversity and inequality of talent is not the root cause of the division of labor but the effect, what in the world is the root cause?” Smith ought to answer that it is the obvious productivity advantages of “specialization”. – Which is acceptable and preferable to what Mises and Rothbard propose for an explanation. Instead, he opts for “the natural tendency to barter, truck and exchange one thing for another” (quoted below). But none of this deals with “the nature and causes” of exchange value!

“It should be noted that Smith was antirationalist
as well, if for rather different reasons. Smith was concerned to purge economic theory of all
subjective utility considerations, so he had to discard mutual benefit as the reason for exchange. Indeed, in
contrast to Mises’s insight that the division of labor (the base of exchange) stems from the diversity and
inequality of talents and interests among men, Smith maintained that all people and children are originally
almost totally the same, and that the existing division of labor and of occupation willy-nilly pushes them
into specialization and differences of interest. As Smith puts it: “the very different genius which appears to
distinguish men of different professions . . . is not. . . so much the cause, as the effect of the division of
labor.”
If for Smith, the diversity and inequality of talent is not the root cause of the division of labor but the effect,
what in the world is the root cause?....[Smith] falls back on some sort of built-in “instinct”: or, as he put it. “a certain propensity in human nature” which has no regard for utility, but is instead, “a propensity to truck, barter, and exchange one thing for another,” Ibid., pp. 25, 28. Or, as Smith rather absurdly put it: “without disposition to truck, barter, and exchange, every man must have procured to himself every necessary and convenience of life which he wanted,” ibid., p. 29.” (Rothbard, ‘PresentStateofAE’, p26 fn46)

Rothbard then continues to discover the motivation behind the exchange, which changes the entire “nature” of the “exchange”, which neither Smith nor Mises nor anyone else seems to be able to comprehend, still less to admit!

‘Perhaps the best case for stress on unintended consequences comes from analyzing the
motive of exchange on the free market and was best expressed in the famous quote from
The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the
baker, that we expect our dinner, but from their regard to their own interest. We address
ourselves, not to their humanity but to their self-love, and never talk to them of our own
necessities but of their advantages.(26)
To translate this passage into our current concerns: the butcher and the baker’s actions
result in the intended consequences of yielding them a profit, but, more importantly for
society, they result in the unintended consequences of benefiting consumers, indeed
society as a whole, in the most efficient possible manner.
This is surely an important and valid point, so far as it goes. But, we might wonder: why
the rush to celebrate unintended consequences? Wouldn’t it have been better if these proconsumer
or pro-general standard of living consequences had been understood and
intended by the actors as well? To put it another way: the butcher, baker, and so on desire
and intend the consequences of their production yielding them a satisfying profit. But
suppose that they are informed, by economists and others, that their actions also have the
effect of helping the rest of society and the general standard of living? Wouldn’t they
then come to intend this general welfare as well, even conceding that their own selfinterest
would still be their primary goal? Wouldn’t they be likely, at the very least, to
feel better and happier about their own activities, knowing now that they benefit the body
of consumers as well as themselves? How could such knowledge hurt?’ (p27).

As is evident, Rothbard is totally blind and deaf to the fact that if we allow “altruistic” motives to enter the field of economic theory, the entire basis of “individual decision-making or choice” falls apart together with “the market mechanism” because now the individual will weigh up private and public gains. So, market agents’ “purposive rationality” implied by “praxeology” dissipates into an infinity of conflicting selfish and altruistic considerations! But the whole point to “the Pure Logic of Choice” is that “individual plans” are invariably the best – no, the “only” rational choices possible! Because Rothbard-Pangloss believes that individual preferences always lead to the greater good, then there is no ‘difference’ or, to put it with Hayek, no adverse “unintended consequences” following from pursuing the former.

This exquisite brand of stupidity was obviously too much for Hayek, and he wisely eschewed it:

‘Thus, Mises’s view of why men participate in the basic form of market interaction exchange, which also implies participating in the social division of labor. Harking back to the insight of the Scholastics, beginning at least with the great fourteenth-century French philosopher and scientist John Buridan, Mises saw that a man participates in an exchange because he sees that he will benefit more from the good or service received, than the good or service he has to give up. Here is the root of the basic subjective-utility, or Austrian, insight: men engage in exchange because and only because they subjectively prefer what they will receive in exchange to what they give up. Hence, also, Mises’s conclusion on how to preserve and maintain the great oecumene, the mighty network, or system, of voluntary, mutually beneficial exchanges that constitute the free-market economy: The mass of the public must learn, must be educated to understand, the vast importance of maintaining and preserving that free market from aggression and coercive interference.

‘But now, in his Foreword [to Socialism] written after Mises’s death, Hayek writes:
“I had always felt a little uneasy about that statement of basic philosophy, but only now can I articulate why I was uncomfortable with it.” Hayek then adds patronizingly: “The extreme rationalism of this passage, which as a child of his time he could not escape from, and which he perhaps never fully abandoned, now seems to me factually mistaken.
It certainly was not rational insight into its general benefits that led to the spreading of the market economy.”42 (Rothbard, pp23-4).

Yet even for Hayek this still leaves open the whole problem of how individual needs or wants or preferences or choices, especially if axiomatically “self-interested”,  can lead to economic let alone social “co-ordination” (remember “externalities” and “income distribution” [Napoleoni on Robbins]).



This is not just a matter of “natura non facit saltum”. It is not just a matter of the conceptual impossibility of deriving “innovation” from “combination” (see Loasby re Schumpeter in ‘Eq&Evltn’). It is rather that no amount of ‘co-ordination’ can give us ‘development’. If indeed ‘development’ is a product of ‘innovation’, then the ‘mechanism’ of innovation is different from that of ‘co-ordination’:- the “institutions” are different, or heterogeneous. But it is essential to remember that this is not a problem of ‘institutions’! It is a problem that requires us to move from the ‘sphere of exchange’ to the ‘sphere of production’!

In this context, Robbins (quoted by Coase) was intuitively quite right to insist that “institutions” such as the firm were not within the scope of economics – something Coase himself seems to accept. (See our discussion below, ‘The NIE’, where we insist on the ‘theoretical dependence’ of the NIE on the neoclassical paradigm.) As Klein reminds us (‘The NIE’, par.9):
Speaking of Lionel Robbins’s influential Nature and Significance of Economic Science (1932), Coase (1992, p. 714) remarked that ‘in Robbins’s view, an economist does not interest himself in the internal arrangements within organizations but only in what happens on the market’. Even Coase himself believed, as late as 1988, that ‘[w]hy firms exist, what determines the number of firms, what determines what firms do ... are not questions of interest to most economists’ (Coase, 1988, p. 5).


Exchange does not lead to the division of (social) labour (it’s the other way around!) and the division of (social) labour or of knowledge does not lead to “innovation” or “development/growth”. We must explore the nexus between these last two:- but remember, “innovation” is about novelties that lead to greater market share. But market share is a share of ‘consumption’! What we need is “greater production”, not in “physical” terms but in terms of “share of purchasing power” (the real meaning of “market share”). “Purchasing power” means, in terms of revenue and profits, “the power to purchase” more existing goods for sale on the market. So we see that “greater production” must involve a “growing exchange” in terms of “greater purchasing power”. This means “greater command over existing resources”, which entails “greater resources” and “greater command”!

Hence, “growth” means “growth of purchasing power” – but this has nothing to do with “innovation” or “productivity” which are concepts relating to “novelty” and “rate of output”. Only the “command” side remains to be explained. What can “purchasing power” or “greater command over resources” mean?

Let us state this as emphatically as we can: no amount of “exchange” or “co-ordination” will ever cause “specialization” and no amount of “specialization” will ever tell us what determines “prices” – the total amount of “value” – in an economy! What the “price mechanism” can do is ‘optimise’ or ‘maximise’ the pro-duction of existing resources through their efficient allocation or co-ordination: but no amount of ‘allocation’ or ‘co-ordination’ will be able to expand the productive potential of a ‘given’ economy. Indeed, because we can only speak of “given resources” (Hayek above) we will never know what the “efficient allocation of existing resources” or “price co-ordination” or “the problem of utilization of knowledge” really means! – Except a posteriori, after the event (!). But in that case our conclusions will be empty “rationalizations” of the status quo: we will assume what we are seeking to prove!

In reality, it is the division of social labour that permits ‘exchange’, so that when ‘social labour’ is separated into ‘in-dividual labours’ through ‘private property’ over the means of production, then the ‘exchange’ must become one of ‘equivalents’ (exchange values) that need to be measured. And the ‘measure’ can only be ‘value’, not a ‘numeraire’ or a relative price, because the ‘exchange’ is not one of ‘use values’ (utility) but one of ‘potential pro-duction’ where the use values for exchange are not ‘given’ as “endowments” at the outset but must be pro-duced in terms of the amount of ‘exchange value’ they can command potentially.

To command more ‘value’, the exchangers need to control the quantities (potential pro-duction) of use values that are pro-duced for exchange (potential exchange). This can be achieved by “owning the factors of pro-duction”, that is the means of production and the now “individual labours” of workers who do not “possess” independent means of production.

The ‘exchange’ now is not one of “use values” but one of “exchange values” and is aimed at commanding more exchange values, which means “owning” more means of production and “individual labours”, or the “labour-power” of “commanded living labours”. It is this last “exchange” that is the vital one!

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