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The Limits of Economics

Between Capitalism and Socialism: Essays in Political Economics

by Robert L. Heilbroner
Random House, 294 pp., $1.95 (paper)

Philosophy asks the important questions, but as soon as an answer is in sight a new discipline splits away and sets out on its own pursuit. This possibly explains why now—as two thousand years ago—philosophers are still preoccupied with unsolvable problems: those that can be solved are always snatched out of their hands.

Locke, Hume, Adam Smith, and even Karl Marx and John Stuart Mill were still philosophers interested in economic problems among other things. By the turn of the century economics established itself as a separate academic discipline. With the adoption of the mathematical approach it became as little understandable to the layman as chemistry or physics and thus began to be considered the most advanced of the social sciences.

More recently, however, this position of pre-eminence has been undermined by creeping doubts. When translated from mathematical language into English, the answers given by modern economics seem to miss or to beg the questions that were originally raised, and economists find themselves again in the company of philosophers with more important problems on their hands than they know how to solve.

Not that the profession is tormented by internal strife. A reader of leading economic journals would hardly notice that something is amiss. “Monetarists” contend with the “neo-Keynesian fiscalists” in the same tone that bimetalists used a hundred years ago in their controversies with the partisans of an unadulterated gold standard. So far as the great majority of professional economists is concerned, their discipline is now in as satisfactory a shape as it ever was.

Most of the fundamental questioning comes from outside the profession and is echoed by a few inside. Today, as in the past, more often than not, a critic of the prevailing style of economic thought is also a critic of the dominant social and political institutions. This turns the ensuing debate into something more (or less, depending on where one stands) than a purely academic controversy. If not kept carefully apart, value judgments become confused with factual assertions and both are all too often drowned out by arguments originating in and addressed to political emotions.

Robert Heilbroner’s writing is singularly free of such confusion. His skeptical appraisal of contemporary academic economics derives from a discriminating understanding of the capabilities and limitations of modern economic theory. His criticism of capitalist and socialist systems as they exist now in both hemispheres is developed within a broad historical perspective free from the myopic distortion so characteristic of much of the new radical thinking.

Whether he calls for new “political economics” or examines the transition “from capitalism to socialism” or explores “alternatives for the future,” Heilbroner’s argument carries us toward the fundamental dilemma of wishing versus understanding, acting versus explaining, of practical pursuit of human values as against theoretical analysis of unbreakable and endless chains of causes and effects. Any social scientist endeavoring to clarify for himself the significance of his own intellectual position is bound to face these questions. A political activist cannot avoid confronting them when he challenges the social scientist to provide useful knowledge.

The potential conflict between analytical explanation derived from factual knowledge on the one hand and purposeful social action based on deliberate conscious choice on the other is well exemplified by the peculiar role played in modern economics by the so-called “maximum principle.” The pursuit of maximum profits by the capitalist, highest possible wages by laborers, and largest possible rents by the landowners was recognized by the great classical economists, and Karl Marx must certainly be counted among them, as the dominant driving force of the industrial system that grew before their eyes. Together with the Malthusian theory of population and the Darwinian theory of natural selection—all of which shared the principle of the survival of the fittest—classical economics marked the successful extension of a deterministic, as contrasted to a pragmatic teleological, explanation not only of biological but of social phenomena as well.

According to classical economics and the neoclassical version of it that prevails today, the functioning of the economic system as a whole is explained by analyzing a blind mechanical interaction of households, businesses, trade unions, governmental organization, and so on. But the behavior of each one of these units of decision is interpreted as representing a predictable result of purposeful rational choice. Here is where the “maximum principle” (or the minimum principle, as the case may be) comes in.

If there are several different methods of generating electric power, which of them should actually be used if one’s aim is to minimize the cost per kilowatt? If one assumes that there is an ideal ordering of human needs, how should government expenditures be apportioned among different agencies in view of competing claims of public health, education, housing, and, say, national defense so as to provide the maximum satisfaction of public needs according to these ideals?

The formal setting of the problem and its solution are in each case essentially the same. They always involve the relationship between means and ends. The decision maker can influence the magnitude of the variable that he would like to “maximize” or “minimize” only indirectly by manipulating other “variables” upon which that magnitude in its turn depends. The Edison Electric Company can affect the cost of power by building atomic instead of conventional thermal plants or by shifting from coal to oil or to natural gas. The government can affect the satisfaction of competing public needs by financing more hospitals and fewer schools or more of both at the expense of military outlays.

To make a purposeful, rational choice the decision maker must first of all have a well-defined aim, he must know what it is that he wants to maximize or minimize; he must have what economists call an “objective function.” Second, he has to know the “limiting condition”: the causal, structural relationship between the ultimate objective and the factors that he can in fact control. The power company must have detailed knowledge of the technical characteristics of various types of plants among which it has to choose as well as the costs of different fuels. The government must be able to assess the efficiency of various schools and hospitals that it may want to finance.

In cases where the “objective function” is intricate and the structural relations describing the “limiting conditions” numerous and complex, not only the solution but even the formulation of a maximum problem requires much logical and mathematical finesse. Consider, for example, a political program that calls for “maximum national income” with “minimum inequality” in its distribution, or the theoretical proposition that corporations seek maximum profits with minimum risk. On close examination, these two statements turn out to make no real sense. In both instances, after a certain level of attainment, the strains of pushing against various structural limitations will be felt and the two different objectives will be found competing with each other: greater equality in the distribution of national income will be attainable only at the cost of some reduction in its total level; the reduction in the riskiness of a business venture will require some sacrifice in the expected level of profits.

Rational choice presupposes the existence of a well-defined single goal. In the first example the level of income and some measure of the equality (or inequality) of its distribution would have to be viewed not as two separate objectives of economic policies, but rather as two different factors contributing each in its own well-specified way to the attainment of the unique goal of maximizing something that, for lack of a better word, might be called public welfare. Only after we visualize a single “objective function” describing the policy maker’s assessment of the specific dependence of public welfare on these two and perhaps also many other factors, can his actions be legitimately interpreted as rational maximizing choices.

For a similar reason the profit motive can be used to explain entrepreneurial decisions only if the quantity to be maximized is specified as depending not only on the expected profits but also on some index of the incurred risk. The objective function turns out again to be not something that one can observe directly but rather an abstract entity whose existence can be ascertained only through introspection or indirect inference.

However complicated the formal solution of the related mathematical problems may be, experience has shown that the difficulty of using the maximum principle to explain the behavior of actual decision makers in the real world is incomparably greater. And this does not refer to the mechanics of large-scale data handling that have been fully mastered by modern computers, but rather to the difficulties of knowing, for example, what exactly a typical American corporation tries to maximize: What are the specific limiting conditions that its management takes into account in deciding on a particular course of action? Does it seek a certain rate of profit, for example, or a certain rate of growth, and what risks will it accept to gain either or both?

In reviewing the answers of Adolf Berle and John Kenneth Galbraith to these questions, Heilbroner finds the first to be “soft, uncritical and complaisant,” the second “essentially ambiguous.” Berle, after having first exposed and explained the immense power wielded by the few men controlling our largest corporations, indeed ended up (as quoted by Heilbroner) by calling them the “conscience earners of twentieth-century America.” Could he have prophetically been referring to Mr. Geneen of ITT? As for Galbraith, let us hope that his position will be made clearer in his future writings.

The specific data that should be fitted into the elaborate theoretical framework prepared to receive them are missing. Heilbroner opens his critical attack on contemporary neoclassical economics with the observation that formal solutions of more and more intricate “maximum” problems have contributed very little to a concrete factual explanation of the operation and development of our own or of any other economic system.

Maximizing…constitutes the bedrock on which conventional economic theory rests [p. 169)… [but] once we enter the world of oligopoly [a few large sellers], maximization of returns becomes an aim that can be translated into practice through the most contradictory activities—a fact that again makes the word “maximizing” disconcertingly empty of precise meaning. [P. 170]

As Paul Samuelson explained in his brilliant Nobel Prize address in 1971, not only the actions of consumers and producers but even the behavior of Newton’s falling apple can be interpreted as if they were solutions of appropriately formulated maximizing or minimizing problems. This clearly demonstrates, of course, that the maximum principle is in its formal generality as devoid of any empirical content as, say, the principle of multiplication or division. Its power as a tool of factual analysis depends entirely on an accurate specification of the function that is maximized (or minimized) in a particular operational context and on the full knowledge of the existing “limiting conditions.” The maximizing principle cannot serve as a substitute for factual knowledge.

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