It is an unquestionable article of faith among economists that capital flows downstream; which is to say that investors, who are ever seeking to economize, will automatically plow their investments into enterprises whose factors give them the highest return on their investment. If Mumbai offers me the lowest factors of production (land, labor, rent), then I will move my operations to Mumbai, caeteris paribus.
And since it is so unquestionable an article of faith, one might anticipate that so faithful a defender of these articles as the University of Chicago’s Robert Lucas would be among this article’s most unyielding defenders. He is not. And in a moment I will tell you why. But before I do I want to fill you in on a little history of economic thought, which is what I teach these days at the University of California, Berkeley.
Neoclassical economics, the brand of economics that is taught nearly everywhere nowadays (Harvard, Berkeley, MIT, Chicago), distinguished itself from the German Historical School way back in the middle of the nineteenth century, by showing that no matter what it was the Gustav von Schmoller and his crowd were doing, it was not scientific economics. It was not scientific economics because it gave factors like social forces and political movements and regulatory environments an equal hearing alongside supply and demand and price, etc. The contest between the German Historical School and the Austrian Marginal Utility School broke out into a full-fledged Methodenstreit in the 1870s. But that was the end of the German Historical School.
Students in my ECON 105 History of Economic Thought class who have read both GFW Hegel’s Civil Society and Gustav von Schmoller’s Class Conflict will no doubt appreciate how and why Thorstein Veblen excoriated Schmoller as a “Hegelian,” i.e., an economist who explores the ways that social, cultural, and political forces shape economic forms. Veblen’s criticism stuck. For indeed it was accurate. After all, there can be little question but that von Schmoller, in the section on Class Conflict from his multi-volume Principles of National Economy, did how as the working classes and their Social Democratic political arm became more tightly integrated into Bismark’s and Wilhelmine state, they invariably abandoned their particular interests, exchanging them for the interests of all of society as a whole. Such integration, thought von Schmoller, was a necessary, but inevitable, prerequisite not only to political tranquility, but also economic growth. That is to say, von Schmoller, following Hegel, agreed that the more tightly integrated all elements of society grow, the better equipped they are to serve the interests of the whole, among which interests are included economic growth.
Back to Mr. Lucas. As my students will be aware, Robert Lucas offered an argument nearly identical to von Schmoller’s in his 2002 Lectures on Economic Development, there showing how it was the historical, political, social, institutional, and cultural idiosyncrasies of developing nations that prevented them from attracting capital and therefore prevented capital from flowing downhill.
Four observations. First, this argument is not new, not even among neoclassical economists, who have always argued that it is only through the rule of law and rational, predictable, and therefore stable political institutions that free economic markets can thrive. Second, when neoclassical economists (i.e., all economists) argue that public intervention into markets generates distortions and inefficiencies, they are, in effect, arguing that public interventions are instances when historical, political, social, institutional, or cultural idiosyncrasies are permitted to shape our relationships with one another in contrast to purely market forces. However, third, when pure market forces have the unintended consequence of enhancing and strengthening purely local customs and practices – for example, were these unbound market forces to so drive down wages, educational levels and the standard of living overall as to bring social actors to embrace and enforce traditional religious values, say, in blue laws or laws opposed to free medical choices for women –then neoclassical economic policy is found to generate economic and cultural formations that, rather than driving out market distortions, instead serve to enhance these distortions. And, fourth, when neo-Keynesians argue in favor of policies that increase the standard of living and educational levels of economic actors, their policy recommendations may end up removing or mitigating the effects of historical, political, social, institutional, and cultural idiosyncrasies whose persistence distorts market operations.
If I am not mistaken, Gustav von Schmoller, against whom Carl Menger leveled his most severe charges during the Methodenstreit, would in this case be found to agree with Mr. Lucas insofar as both believed that the elimination of historical particularity was critical to economic growth and development. And, in point of fact, the two do agree on this if on no other point.
Yet, insofar as neoliberal economic policies have promoted the proliferation of class differences and the expansion of particularity, they have actually promoted a cultural and institutional landscape that does not lend itself to economic growth and development. This, in turn, would suggest that in order to achieve the end towards which Lucas seeks to move – and which he believes he charts in chapters 3 and 4 of his book – we would have to adopt and advance the social welfare policies adopted by states during this period, policies that led to the outcomes that he finds most productive for economic growth and expansion.
This said, it might also be said that in pursuing this end – i.e., the wholesale elimination of effective historical and social particularity – Lucas is pursuing an end which is most illiberal, totalizing, and indeed totalitarian in form. But that is another matter.