Tuesday, July 24, 2012

The Three Hands of Development
Five Centuries of Thinking About
Natural Order and Change in the Economy

      With the other masquerades
      That time resumes,
      One thinks of all the hands
      That are raising dingy shades
      In a thousand furnished rooms.
            Preludes, T.S. Eliot

While discussing the virtues of the market system in his 1972 Nobel Memorial Lecture, Kenneth Arrow, one of the world’s most influential economists, reflected that a ‘recurrent theme of economic analysis has been the remarkable degree of coherence’ in the economy, amongst ‘the vast numbers of individual and seemingly separate decisions about the buying and selling of commodities.’ Noting that in our ‘everyday, normal experience, there is something of a balance between the amounts of goods and services that some individuals want to supply and the amounts that other, different individuals want to sell,’ he suggested that such is the strength of this innate equilibrating force, ‘would-be buyers ordinarily count correctly on being able to carry out their intentions, and would-be sellers do not ordinarily find themselves producing great amounts of goods that they cannot sell.’ Markets have flaws, acknowledged Arrow, but one of their greatest virtues is their unrivalled capacity for coherence; their natural order.
Indeed, since Adam Smith’s now providential musing that economic activity may in fact be coordinated by an invisible hand, whereby the self regarding individual ‘without intending it, without knowing it, advance[s] the interest of the society,’ many of the twentieth century’s most important economists have gone to great lengths to formalize Smith’s relatively off hand suggestion as a foundational axiom of the discipline. Markets are Pareto efficient, according to this view. They are optimal.
And with such claims, supported by seemingly irrefutable, and often incomprehensible formal proofs, the discipline of economics proceeded to trample its way through the twentieth century, throwing about its normative weight under a mathematical cloak of objectivity.
Since I have begun to sit in the meetings of the Gross National Happiness Commission however, and consider the careful discussion of policies aimed at nurturing the growth of the country’s key industries, I have become only more steadfast in my conviction that economic development cannot rely upon the invisible hand alone. A healthy economy needs not only to be embedded in an accommodating society (an important aspect ignored by such formal models, though admittedly, not by Smith), it also requires Entrepreneurs to innovate and drive commercial activity and quite often an Active State to intervene and foster commercial development when civil society lacks the capacity to do so independently.

The Alchemic Hand of the Entrepreneur
Joseph Schumpeter is perhaps the most influential economist to have highlighted the importance of the role played by the entrepreneur in the economy. In one of his many influential works, The Theory of Economic Growth, he speaks of the entrepreneur’s ‘will to conquer: the impulse to fight, to prove oneself superior to others, to succeed for the sake, not of the fruits of success, but of success itself,’ as being an essential driver of innovation. Indeed, while Smith believed the economic growth he was observing at the beginning of the Industrial Revolution to be the product of gains made from trade and the division of labour, contemporary analysis now places technological progress at the heart of this economic development. And as the economic historian Robert Allen has noted, it was the ‘projector’ entrepreneurs that Smith was so skeptical of, that were in fact driving this process.
But the origin of the idea of the ‘entrepreneur’ has its roots in much earlier work than that of Schumpeter and even Smith. Writing almost half a century prior to the publication of The Wealth of Nations, a relatively unknown Irishman named Richard Cantillon provided the first known account of the entrepreneur, or undertaker as he called it. In what is perhaps the first treatise of modern economics, Essai sur la Nature du Commerce en Général, Cantillon puts forward an account of the undertaker, somebody who buys at a known price to sell at one that is unknown. A specialist in assuming risk, this figure plays a vital role in the economy by solving for the information deficit faced by ordinary economic agents. As Robert Casson of Reading University puts it, the entrepreneur ‘‘insures’ workers by buying their products (or their labor services) for resale before consumers have indicated how much they are willing to pay for them. The workers receives an assured income (in the short run, at least), while the entrepreneur bears the risk caused by price fluctuations in consumer markets.’
As a Summer Fellow with the Women and Public Policy Program, I have been reflecting upon how these thoughts relate to fairness and gender. It would be understandable to dismiss these reflections upon a discipline that is oppressively male in composition as irrelevant or even hostile to women empowerment. But while the discipline of economics is quite clearly in need of substantial reform with regards to the gender balance in its ranks, a reorientation of its intellectual programme for development, placing greater weight on the importance of the entrepreneur as an essential driver of economic growth, has quite some significance for women in developing countries.
As has been frequently noted in the literature on microfinance, the main source of commercial finance for poor people seeking to establish enterprises; women, quite simply, are better, more reliable, entrepreneurs. When it comes to deciding upon potential clients, micro-finance institutions consistently find women, who are more likely to honour their debts, to be more suitable candidates. A development agenda that places the entrepreneur at the heart of its focus therefore, will focus on empowering women not only because of its intrinsic value, but also because of the instrumental role it plays in achieving other desirable ends (e.g. economic development). At a time when women in developing countries face persistent glass ceilings (and often barriers that are much more substantial) as they seek to gain senior positions in established, male dominated, institutions, the return on investing in the next generation of leaders and in gender balanced firms seems especially promising.

The Nursing Hand of the State
The idea that the entrepreneur plays a vital role in the economy meets with little resistance, even if it is often sadly ignored in contemporary economic analysis. The third hand of economic development I wish to discuss; that of the active state, does not enjoy such ambivalence. The notion that the state can play an important and active role in facilitating economic progress has been widely unpopular for decades now. Indeed, from direct participation in the economy, to indirect stimulation of aggregate demand, to mere regulation even, the government has seen the legitimacy of its competencies slowly stripped away.
David Moss, an economic historian at Harvard Business School, has framed this phenomenon as a ‘reversal in the null.’ According Moss, social scientists shifted their focus of inquiry from scrutinizing the effectiveness of markets to challenging the usefulness of government intervention. The methodological implications of this evolution, he argues, had a serious impact on policy: ‘As scholars of political economy quietly shifted their focus from market failure to government failure over the second half of the twentieth century,’ this dramatic reversal ‘set the stage for a revolution in both government and markets, the full ramifications of which are still only beginning to be understood’.
There was a time, however, back when the world’s great economic powerhouses, the United State and the United Kingdom, were still in their nascency, that the state was recognized for the active role it played in fostering industrial developed. From the 16th century to the late 18th century, for example, Great Britain was guided by a Mercantilist doctrine that embraced the importance of the state. It is noteworthy that it was during this period that many of the pre-requisites associated with the modern economy and growth of the industrial revolution were instituted; a modern unified state with the capacity to enforce the rule of law, a proto-modern financial system with the beginnings of a central bank, elaborate international trade links with periphery economies, intellectual societies that drove innovative ideas. Many of these conditions were put in place with strong support of the state, indeed they may not have been possible without it.
As the early 20th century economic historian Eli Heckscher discusses in the fifth section of his classic consideration of mercantilism, while the thinkers of the day believed in social causation, they also believed that the policy maker had the capacity to influence this, indeed ought to, so that the society’s true purpose could be realized. Indeed, in societies that lack universal and sound education systems, where only the tiny few are empowered with the capabilities and resources to engage in ambitious commercial endeavors, it is not unreasonable that the state temporarily lend a nursing hand in support of infant industries.
Interestingly, 19th century United States, whose ideological environment, as Tocqueville famously observed, had a distinctly particularistic civic republican character (similar to the political tradition of 17th century Britain), is also likely to have benefited from state policies that would be frowned upon by economists today. Joshua Rosenbloom of Kansas University, for example, makes the intriguing case that ‘the protection provided by the Embargo Act of 1807 and the War of 1812 led to the initial expansion of textile manufacturing in the United States,’ a development that was ‘an important component of the broader process of American industrialization.’ Indeed, looking at today’s rising power, even the most casual spectator at China will notice the important role that the state has played in driving its economic growth.
It thus seems to me that there is somewhat of a contradiction between the way we make sense of economic development conceptually and how it actually plays out historically in the real world; that perhaps we need to reconsider how we think about how we think about these processes.

Towards a new framework for conceptualizing development
‘The notion of spontaneous social order, an order in human affairs operating without the intervention of any directly ordering mind’, writes the Princeton philosopher Phillip Pettit, ‘has a natural fascination for social and political theorists.’ Development, however, cannot afford to indulge in such fancies. The stakes are too high. Its challenges are too great. It is time to reassess this narrow epistemology that pervades our approach to its analysis and limits our ability to consider important ideas or ways of thinking that do not lend themselves easily to mathematical modeling.
This view is slowly beginning to gain traction. The idea, for example, that history matters for development is beginning to be taken seriously in the policy arena, as is evidenced by an illuminating paper by experts at the World Bank and the University of Cambridge. One of the most interesting conclusions from this is the potential utility of viewing history as a foreign country, a perspective echoed in this piece. But if history matters for development, surely then, so too does the history of ideas. Yet despite the wealth of insights that history’s great economic thinkers, themselves immersed in the sensibilities of development, have provided, its study continues to operate only at the outermost periphery. Apart from lazy references to Adam Smith like the one at the beginning of this essay, contemporary economists have virtually no interest in the great intuitive debates that raged from the 16th through to the 19th century. The history of economic thought, rather, has become the 20th century’s “emeritus” profession, a pursuit enjoyed by retired economic professors who have left their serious work behind them to indulge in more leisurely activities. This needs to change.
If we are to re-establish political economy as a discipline that is methodologically equipped to engage in the intellectual curiosity that is necessary to reveal not just the three hands that drive development discussed here, but the many others that may not yet be revealed, then we must begin to develop a more dialectic and critically mannered approach. This alternative method, moreover, has thrived in the study of past ideas; critiquing them, embracing them, adapting them in order to better understand the contemporary world. Just as the early modern intellectual tradition in Britain looked back to the Roman republic, indeed just as Smith looked back to the ancients and Schumpeter looked back to the physiocrats, today’s intellectuals ought put the great history of ideas back in its rightful place.

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