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Notes – “Economics: The User’s Guide” Part 2

Economics: The User’s Guide

by Ha-Joon Chang, published 2014

A contrarian’s view of the history of capitalism?

In the second chapter, HJC attempts to demonstrate how capitalism has changed from the time of Adam Smith and his “The Wealth of Nations”, to the present global economy, with the implication being that our understanding of economics should change along with the tide of history. HJC claims that both “economic actors” (those who engage in economic activities) and “economic institutions” (the rules regarding how production and other economic activities are organized) have changed. Further, HJC defines “capitalism” as,

an economy in which production is organized in pursuit of profit, rather than for own consumption (as in subsistence farming, where you grow your own food) or for political obligations (as in feudal societies or socialist economics, where political authorities, respectively aristocrats and the central planning authority, tell you what to produce)

Already, an Austrian economist would pick several points of contention. The first is the idea that “economic actors” could be anyone other than individuals. HJC is going to argue that various collective organizations and identities such as labor unions, corporations and governments are “economic actors” but the Austrian economist, laboring under methodological individualism, would be quick to point out that while individuals composing these groups may identify with and be psychologically motivated by their affiliation with such a group, it is ultimately the individuals themselves who act (both in choosing such an identity, and in making decisions under such an identity or as a representative of such an identity) which is an important epistemological distinction for clarifying the meaning of economic observations.

The second point would be to clarify the definition of capitalism itself. While HJC simplifies capitalism as an economy in search of profit, there is much more to the definition and the way capitalism differs from alternatives (such as feudal economies and socialism) that it is worth exploring the nuances in depth.

Capitalism is distinguished most of all by the fact that the means of production are privately owned. This means a person gets to be a capitalist one of two ways– by saving part of one’s income and thereby creating additional capital with which to invest, or by being loaned or otherwise granted capital by people willing to bet on the entrepreneurial talents of such a person at which point they can prove or disprove their ability. In capitalism, capital is “mobile”– it moves from person to person over time, always accumulating in the hands of those who are most capable with it, that is, in the hands of those who are most talented at realizing profit by efficiently serving consumer demands. It tends to leave the possession of those who waste it or fail to steward it well, and enter the hands of those who not only prize it but can do something valuable with it.

The theoretical alternative to capitalism is socialism, or public ownership of the means of production. Leaving aside the questionable nature of the concept of “public ownership”, socialism relies on some kind of political decision-making apparatus to not only determine who should be the public mandatories in charge of directing the means of production, but also to intuit the “public good” insofar as it is a goal that can be aimed at with the central production plan. In socialism, one can not become a director of the economy without being selected for such a role by the political authority. And it is inconceivable that one could “accumulate capital” by saving because the political authority would control consumption patterns and determine how much of the productive output each individual receives, maintaining control of any excess (savings) to deploy as it sees fit.

Under capitalism, the very fact that all the means of production are privately owned implies 1.) that the current amount of capital is always “optimum” for present purposes because every individual can freely decide if he’d prefer to save more or save less and 2.) that every exchange increases the total wealth of society because it is voluntarily entered into. This simply isn’t so under socialism. In fact, the Austrians believe it is impossible to succeed in either endeavor because the absence of money prices means that socialist economies suffer calculational chaos when it comes to judging the value of various arrangements and exchange patterns amongst alternatives. That’s a larger topic for a later post, though. For now, it is sufficient to point out the major (but not necessarily all-encompassing) nuances of capitalism not given any heed by HJC’s definition.

The errors of definition and reasoning exhibited by HJC in discussing a wide range of historical changes which have occurred in market economies since Adam Smith’s time provide too many objections to raise in one post. Instead, it is enough to leap to his conclusion and comment further, when he says:

competition among profit-seeking firms may still be the key driving force of capitalism, as in Smith’s scheme. But it is not between small, anonymous firms which, accepting consumer tastes, fight it out by increasing the efficiency in the use of given technology. Today, competition is among huge multinational companies, with the ability not only to influence prices but to redefine technologies in a short span of time (think about the battle between Apple and Samsung) and to manipulate consumer tastes through brand-image building and advertising

Let’s tease this apart.

First, price always has two components– supply, and demand. The number of firms producing a particular good or service, and the ways in which they produce this good or service, influence price on the supply side. The number of consumers eager to purchase the good or service, and their eagerness to purchase this good or service at the expense of other goods and services they could obtain with the same quantity of money, influence the price on the demand side.

The idea that both consumer tastes and technological means of production were “given” at some point in time are to completely misconstrue not only the facts of economic history, but also their significance. All firms, whether in Adam Smith’s era, modern times or somewhere in between make choices not only concerning which markets to compete in but also about which vendors to utilize, what technological recipes to use in production, what quality and quantity to produce of a given good or service and how to market these goods and services to the buying public. It may appear relatively primitive or limited in looking back from today’s economic circumstances to the past, but that doesn’t change the nature of production, competition and consumption itself. None of this was given or fixed. Any firm which might decide to enter or exit a market could influence the price by its increasing or decreasing the overall supply. HJC’s claim is akin to suggesting that prices were either arbitrary, or that markets failed to clear and there was a continual shortage or excess of certain goods and services. It suggests that prices never even changed, after all, how could they if all firms were small and alike and none had any influence? It couldn’t be the consumers changing demands, their tastes were “given” (by whom? for what purpose?). This is a revisionist history without accuracy or merit.

The labeling of branding and advertising as a “manipulation” of consumer tastes is also a cause for concern in clearly understanding the issues. Manipulation has a pejorative sense, that it is somehow illegitimate or involves exploitation or deceit. Branding and advertising both serve useful economic purposes. A brand helps to designate to a customer what kind of quality to expect from a given product or service under that brand (for example, Porsche is reputed as a high-quality brand, whereas Chevy is reputed as a low-quality brand– the fact that different brands exist help car buyers quickly choose between vehicle quality). It might also connote certain features or other characteristics common to a brand identity (using Porsche and Chevy again, Porsche is known as luxurious and performance-inspired, while Chevy is known as “all-American” and economical). In other words, a brand contains information which consumers consider valuable to know about products and services they intend to purchase.

Advertising provides similar informational value. Individuals have certain needs but do not know, omnisciently, what products and services are available to meet their needs. Advertising seeks to communicate to individuals which of their needs can be met by a given product or service. It might also communicate information about how the product or service compares to competing offers. Additionally, advertising might communicate solutions to problems individuals might not even realize they have until they see the advertisement!

This last bit is probably what HJC is aiming at with his description of changes in the economic history of capitalism. But this claim, too, is invalid. There is nothing inherently suspect or illegitimate about a business creating awareness of new needs and new ways of acting that can fulfill those needs as compared to any other influential source (friends, family, introspection, etc.) And businesses can not force individuals to adopt these desires and needs as their own and as valid– that’s something the individual must decide for himself.

The aim of this characterization is to suggest that while competition exists on its face, it isn’t “real” or “legitimate” competition– that individuals are actually faced with a strongly restricted frame of reference about what they want and how they can get it as well as what they must pay to acquire it that is actually constructed by a small group of very large firms. This is a veiled accusation of monopoly and a backdoor argument for government intervention in market places to reassert “consumer sovereignty.”

It is from this erroneous foundation that HJC proceeds to re-tell the “true history of capitalism”, the one he claims most economists don’t want you to know about.

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