The end of economics

197 Pages·1996·2.147 MB·English

by  Perelman, Michael

THE END OF ECONOMICS
Most economic theory assumes a pure capitalism of perfect competition. Even when
perfect competition does not exist, many politicians and captains of industry pay a great
deal of lip service to the idea of the market, while doing all they can to protect business
from market forces. This book goes beyond this rhetoric to explore how, even in the
United States—the most capitalist of all countries—the market has always been subjected
to numerous constraints. Further, in the opinion of many figures from the right, these
ameliorating factors have been a very good thing. As well as discussing the opinions of
economists, the book looks at the opinions and practices of such figures as Henry Ford,
J.P.Morgan, and Herbert Hoover.
Michael Perelman is Professor of Economics at California State University, Chico.
His previous books include: The Pathology of the U.S. Economy; Information, Social
Relations and the Economics of High Technology; Keynes, Investment Theory and the
Economic Slowdown and Karl Marx’s Crisis Theory.
ROUTLEDGE FRONTIERS OF POLITICAL
ECONOMY
1 EQUILIBRIUM VERSUS UNDERSTANDING
Towards the rehumanization of economics within social theory
Mark Addleson
2 EVOLUTION, ORDER AND COMPLEXITY
Edited by Elias L.Khalil and Kenneth E.Boulding
3 NEW DIRECTIONS IN POST-KEYNESIAN ECONOMICS
Malvern after ten years
Edited by Steven Pressman
4 THE END OF ECONOMICS
Michael Perelman
5 PROBABILITY IN ECONOMICS
Omar F.Hamouda and Robin Rowley
THE END OF
ECONOMICS
Michael Perelman

London and New York
First published 1996
by Routledge
11 New Fetter Lane, London EC4P 4EE
Simultaneously published in the USA and Canada
by Routledge
29 West 35th Street, New York, NY 10001
Routledge is an imprint of the Taylor & Francis Group
This edition published in the Taylor & Francis e-Library, 2005.
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© 1996 Michael Perelman
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 Cataloguing in Publication Data
Perelman, Michael.
The end of economics/Michael Perelman.
(Routledge frontiers of political economy; 4)
Includes bibliographical references and index.
1. Economics—History—20th century. 2. Economics—History
3. Economic history. 4. Economics. I. Title. II. Series.
HB87.P347 1996
330–dc20 95–46225 CIP
ISBN 0-203-43718-7 Master e-book ISBN
ISBN 0-203-74542-6 (Adobe e-reader Format)
ISBN 0-415-13737-3 (Print Edition)
CONTENTS
Introduction 1
1 THE END OF ECONOMICS 11
2 ECONOMIC THEORY AND THE HISTORICAL INCREASE OF

FIXED CAPITAL 36
3 RAILROADS AND THE INCREASE IN FIXED CAPITAL 48
4 THE ROLE OF FINANCE 83
5 INDUSTRY TAKES COMMAND: THE RISE OF WELFARE

CAPITALISM 101
6 MODERN FINANCE CAPITAL 118
7 THE DEPRESSION 124
8 THE GOLDEN AGE 139
9 CONCLUSION 158
BIBLIOGRAPHY 162
Index 185
INTRODUCTION
CONFESSIONS OF A LAPSED ECONOMIST
Let me begin with a frank confession. I am an economist. At least, a major institution has
conferred a degree on me that certifies me as an economist.
Despite my credentials, I am a lapsed economist. Yes, I still teach in an economics
department, but I can no longer accept the validity of prevailing economic orthodoxy.
I do not claim to be unique in my fall from grace. A small minority of economists
always does depart from the orthodox doctrine. A select few of these, as we shall see,
sometimes even win the accolades of the economics profession.
Some of those who stray from the path of economic orthodoxy do so for ethical or
aesthetic reasons. Others reject key articles of faith because they find technical defects in
analytical machinery of conventional economics. I count myself among this group.
I am by no means the first economist to a discover a defect in orthodox economic
theory. In the late nineteenth century, economists who were then considered among the
premier practitioners of the discipline in their respective nations, developed a penetrating
critique of economic theory. They realized that a modern economy that followed the
recommendations of conventional economic theory would court disaster.
These economists did not come by their discovery while hermetically sealed in ivory
towers. Instead, they were the sort of economists who worked closely with government
and business leaders. Although they were very conservative, they saw market forces
tearing industry apart. In order to prevent the economy from disintegrating, they
recommended that the great industries of the day be permitted to form trusts, cartels and
monopolies.
Although the vast majority of contemporary economists are unaware of the work of
these economists, their ideas still have significant relevance. My intention is to draw
attention to and to rehabilitate this largely forgotten economic tradition, in part to call
attention to a major defect in conventional economic theory.
THE CONSERVATIVE REJECTION OF MARKET ECONOMICS
During the late nineteenth and early twentieth centuries, the leading economists in the
United States closely followed the railroad industry. Although conventional economic
theory would lead one to expect competition to make railroads healthy, these economists
realized that competition was wreaking havoc in the railroad industry. By 1893, one third
of the railroads had already fallen into receivership.
Given the experience of the railroads, these economists came to fear the disruptive
results of market forces. They became contemptuous of the simplistic economic theories
that claimed to justify market forces. In the process, these conservative railroad
The end of economics 2
economists railed against pure market forces with rhetorical flourishes worthy of the
Marxian left.
While these economists agreed with the Marxists about the deficiencies both of the
market and the conventional economic theories of the market, these economists were
generally not leftists at all. They reached their conclusions by looking at the market from
the perspective of business rather than labor.
Rather than calling for a socialist revolution, these economists recommended that
large corporations be allowed to protect themselves against excessive competition by
forming trusts, cartels, or monopolies. They envisioned something more or less similar to
the modern Japanese organization of industry.
The legacy of the railroad economists is mixed. The economics profession continued
to follow one tradition of the railroad economists, teaching its students that markets were
the most efficient method of organizing a society. At the same time, later economists
quickly forgot the valuable insights of the railroad economists concerning the reasons to
be leery of markets.
THE FORGOTTEN TRADITION OF RAILROAD ECONOMICS
The time has come now to turn the pages of history back to these conservative thinkers of
a century ago to rediscover the critical element of their theory, which has since fallen into
oblivion.
These early railroad economists centered their critique of economic theory on one
particular assumption that was absolutely unwarranted for the railroad industry.
Conventional economic theory assumes that investors can easily undo mistaken
investments.
Unlike the assumed world of conventional economic theory, the railroads required
significant sunk costs. Laying railroad track is an enormous investment. If that
investment is misplaced, the railroad cannot costlessly convert the track into computers
or trendy boutiques. That investment is irrevocably lost, except for what the railroad can
earn from salvaging it. Salvage values are generally trivial compared to the initial cost of
the investment.
As we shall see in Chapter 1, conventional economics teaches that when competition
is strong enough, business must set prices equal to the cost of producing one more unit of
output. When prices are set in this fashion, the economy supposedly produces an optimal
outcome. Unfortunately, this theory works only when investments can move costlessly in
and out of industries; that is, when industry has few sunk costs.
Of course, this conventional economic theory made no sense for the railroads, which
had enormous investments in fixed capital. The railroad economists realized that the
failure to address the complications that sunk costs pose for economic theory made
conventional economics absolutely unrealistic for other industries as well as for railroads.
For this reason, they rejected the central idea of conventional economics, which holds
that strong competition results in ideal outcomes.
We need not blindly follow these economists. In fact, they were not even consistent in
following themselves. Despite their strong reservations about the efficiency of market
forces and the contempt for simplistic economic theory as a guide to practical economic
Introduction 3
questions, these same economists wrote economic textbooks extolling the virtues of
unfettered markets for reasons that we will discuss later.
The importance of the railroad economists rests on their development of solid
theoretical grounds for rejecting conventional theory. They understood that conventional
economic theory bases itself on a set of very specific assumptions. The realism of a
theory depends on how closely these assumptions conform to reality.
THE END OF LAISSEZ FAIRE
In 1926, John Maynard Keynes, perhaps the most influential economist of the twentieth
century, wrote an essay entitled, “The End of Laissez Faire” (Keynes 1926). About the
same time, Keynes, working within the British textile industry, had come to conclusions
strikingly similar to the railroad economists in the United States (Perelman 1989, Chapter
1).
Although Keynes rebelled against the conventions of economic thought, he always
remained fiercely loyal to the culture of his elite strata of British society. In this article as
well, Keynes exuded his upbringing, expressing a snobbish contempt for both the
deficiencies of a market economy as well as the Bolshevik model that was evolving in the
Soviet Union.
Keynes proposed that the values of the well-bred elite would eventually conquer the
corporate boardrooms. As a result, the single-minded lust for profits common to the
rough-and-tumble world of business was destined to give way to a more public spirited
perspective—at least within the large corporations. Over time, Keynes maintained, the
behavior of the large corporations would become indistinguishable from those of
universities or other public institutions. In this way, Keynes believed that capitalism
could transcend the shortcomings of the market while avoiding the turmoil of a
revolution.
Far-fetched as Keynes’s s vision might sound today, he did not create this theory out
of whole cloth. Later, we shall see that many prominent corporate leaders at the time,
recognizing the same defects of the market that occupied the railroad economists,
proclaimed their allegiance to what eventually became known as welfare capitalism—a
self-imposed code of public spirited corporate behavior that flourished in the 1920s, at
least, until the Great Depression forced them to abandon any pretence to higher motives.
EMOTIONAL INVESTMENT IN THE IMAGINARY WORLD OF
PERFECT COMPETITION
The railroad economists believed that conventional economics was a restrictive theory,
relevant for a special kind of capitalism—the capitalism of perfect competition. We may
justly compare this ideal vision of a perfectly competitive capitalism to a unicorn. We all
know what it is supposed to look like, although none of us have ever seen it.
Many people express an irrational attachment to this imaginary world of perfect
competition. Political and business leaders commonly extol the virtues of this ideal of
capitalism with great eloquence, often equating it with morality. Among the general
The end of economics 4
public, many people would willingly go to war—or at least send our young people to
war—to protect the sanctity of the capitalist way of life.
Yes, our current economy does bear some passing resemblance to pure capitalism, in
the sense that we presently give owners of business a great deal of discretion.
Nonetheless, we put substantial limits on the degree to which we leave business to its
own devices.
Indeed, much of the dissatisfaction with our present-day economy concerns our
numerous departures from the market-based rules. People from all parts of the political
spectrum have taken issue with substantial violations of market rules, implicitly assuming
that the market, left to itself, would produce a result that would be both fairer and more
efficient.
When we look more closely at the rhetoric of these defenders of a pure market society,
we find that they do not want a pure market society at all. Instead, we discover a
remarkable degree of selectivity in their calls for reform.
On the right, innumerable commentators vehemently oppose what they consider to be
unwarranted government intrusion. They contend that such actions are motivated either
by the misguided ideals of the regulators or by the unwarranted influence of special
interests. Often they portray the government as socialistic, especially when it comes to
the aid of the less fortunate members of society.
Many, but certainly not all people on the left have made a similar case, although they
differ from their more conservative brethren by identifying big business interests, rather
than the poor or government bureaucrats, as the major recipients of government largesse.
Like the conservatives, they often refer to our present system as socialism, but with an
ironic turn of the phrase: they proclaim our existing brand of socialism as socialism for
the rich.
Both critiques of government programs, from the left and the right, single out specific
programs as unfair or unjustified. Neither acknowledges that the capitalist system
necessarily requires a considerable amount of control.
BUSINESS AND LAISSEZ FAIRE
Among those who have their hands on the levers of power, only a distinct minority
sincerely believes in the glib slogans of freewheeling capitalism. Indeed, rant and rail as
they might about the abuses of government, more knowledgeable political and business
leaders rarely believe their own rhetoric. Their obligatory lip service to the magic of the
marketplace is nothing more than a hypocritical attempt to further their own interests.
Certainly, business should have a deep appreciation for the wide range of services that
the government performs for them. Not only does the government provide a substantial
market for the goods that private business sells, the government also goes to great lengths
in an effort to create a “healthy business climate.”
The government organizes and regulates financial conditions through central banks, as
well as through protective legislation. It creates a legal structure that gives business the
upper hand relative to labor. When the economy falters, it increases demand, often by
discovering imaginary threats that require more military spending.