Power & Market

In An Inquiry Into the Nature and Causes of the Wealth of Nations, Adam Smith described what he called the Invisible Hand - a metaphor to describe the mechanism of the market and the social benefit that individuals who participate in the market in self-interested ways intentionally and unintentionally serve others. The invisible hand guides individuals entrepreneurially to improve their own circumstances, and they unintentionally or unconsciously create social benefits for everyone by serving the ultimate purpose of creating markets, economic growth, trade and prosperity. The invisible hand guides individuals’ purposes to the most needed ends – the benefit that customers value most highly - and they express these purposes by using their skills and resources in market pursuits that benefit the larger society, intended or otherwise.

Alfred Chandler, on the contrary, took the opposite approach and described the visible hand, which he said was a managerial revolution. The visible hand guided the managerial class of large enterprises and replaced the spontaneous order of the invisible Hand with the visible hand of experts managing production, focusing on mass manufacturing and distribution. Alfred Chandler said, "Such internalization permitted the Visible Hand of administrative coordination to make more intensive use of resources invested in these processes of production and distribution than could the Invisible Hand of market coordination." Chandler sought to replace the implicit guidance of the invisible hand with the explicit control of an elite management class and the tools of organizational structure, command-and-control methods and tightly constructed processes.

We are seeing the results of the visible hand today, in the rigid structures of established businesses that struggle to respond to fast-paced change and rapid innovation, and also in the rejection of business by younger generations who see it as elitist and exploitative.

Happily, the visible hand is losing its grip. Today, what I see emerging is the Digital Hand.

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As Table 1indicates, the digital hand is the enablement of a broad and deep population of new entrepreneurs who have easy access to infrastructure and resources available via the internet and who can connect to every available source of knowledge, expertise and support. The digital hand opens economic opportunities for everyday people who can participate as entrepreneurs in today's economic marketspaces. Ecommerce and digital marketspaces are giving rise to digitalpreneurs, both nationally and globally. Chandler's visible hand has made significant improvements in the production of economic goods and mass service offerings, no doubt. However, never in human history has there been a digital hand guiding individuals who offer services, products, and entertainment, with the power of prosperity except in this current time of mass accessibility of eCommerce platforms.

Recent data suggests that social e-platforms, digital stores, and online marketspaces are a $200 billion industry. The cause of this boon is the result of human action and not of human design; the effect is the opportunity for regular people – not Chandler’s elite - to be guided to economic success by the digital hand. Now brick-and-mortar business models can be offered through a digital marketspace or a hybrid of both click-and-mortar. One person startups or small teams or small and medium sized businesses can harness the virtually unlimited resources of the digitally interconnected global economy and serve its digitally interconnected markets.

Is the entrepreneurial participation of everyday people using digital platforms via the digital hand the final, irreversible shift to free and unhampered markets? Is the level of ease for the average person to be involved in the market process the great breakthrough for individual economic freedom, even though their investment in entrepreneurial endeavors is not as consequential as an investment of a high-profile millionaire or billionaire? In the short run, we see more real people – you, your neighbor, and your friend – profitably exercising their talents, serving consumers, using the digital hand. In the long run, an entire emergent class of individuals can realize their positive impact on society using the digital hand.

With a tremendous uptick in digital businesses opportunities within the past decade, there is anticipation that more digitalpreneurs will arise in the future, thereby expanding this class of entrepreneurs. Facebook's Marketplace has grown to millions of sellers across many countries, providing real people with enormous entrepreneurial and innovative opportunities within just a few years of its formation in the digital space. No matter the division of labor one represents in the eCommerce sphere, there are sufficient and inexpensive marketspaces to enable the expression of entrepreneurship. Poshmark, eBay, Etsy, Shopify, Volusion, and other eCommerce marketspaces have built-in buyer networks serving millions of people. These e-platforms remove arbitrary barriers to the advancement of everyday people who wish to participate in the marketspace. Digitalpreneurs, newcomers, or entrepreneurs transitioning to digital platforms develop entrepreneurial skills and can profit from them.

Eighty years ago, the American economist Paul Samuelson published his acclaimed doctoral dissertation "The Observation Significance of Economic Theory," which would later form the basis of his book Foundations of Economic Analysis. These works were instrumental in convincing the majority of economists that the use of mathematical and statistical methods are the indispensable means of investigating economic phenomena. Any economist who objects to the “Samuelsonian consensus” is derisively referred to as a literary economist. The literary economist is not really an economist at all because he refuses to use the superior methods delineated by Samuelson and other mathematical economists. To the mathematical economists, the Austrians are the vanguard of literary economics and thus not authentic economists; they are aberrant logicians who obstinately cling to anachronistic methods, which have been rendered defunct by the advent of quantitative economic methods. 

Yet, this was not always the case. Before empiricism-positivism swept through the economics discipline, virtually all economists conceived of economic theory as a purely deductive framework. Indeed, Lionel Robbins' book The Nature and Significance of Economic Science, which was first published in 1932, is essentially praxeology in all but name, and it was heralded as the gold standard of economic methodology for almost twenty years. In his preface, Robbins expresses his intellectual indebtedness to Ludwig von Mises, whom he identifies as the foremost influence on his own methodological position. 

Moreover, while mathematical economics can be traced back to the marginal revolution of the 1870s, it was not, as aforementioned, until Paul Samuelson’s treatise appeared in 1947 that the quantitative approach usurped the traditional qualitative approach – the approach to economics propounded so eloquently by Carl Menger in his 1871 Principles of Economics. Clearly, then, the qualitative economics practiced by the Austrians is not a mere idiosyncrasy peculiar to the Austrian school; it was once the dominant methodology.

The fundamental defect of quantitative, mathematical economics is manifest. Quantitative analysis implies the possibility of measurement, but measurement implies relating something to a standard. Without a standard, there is no measurement. In the realm of economic phenomena, there are no standards and, therefore, there can be no measurement. Mises has poignantly articulated this point, "There are, in the field of economics, no constant relations, and consequently no measurement is possible." 

Menger postulated that all economic phenomena are ultimately caused by the purposive actions of individuals. But there is no objective, fixed standard for measuring the minds and values of men; they are not perfectly predictable inanimate objects, but conscious actors with minds of their own. In short, there is no constancy in the province of human behavior. Accordingly, mathematical economics is nothing but an epistemologically sterile exercise in symbolism. It cannot yield explanations of economic phenomena and has contributed nothing but confusion and intellectual incoherence to the science of economics. 

In sum, the absence of empirical constants precludes the fruitful use of mathematics in economic theorizing. Contrary to the prevailing doctrine, economics is not an empirical, a posteriori science—it is a deductive, a priori science. The whole corpus of economic theory can be deduced from the axiom of purposeful human behavior. And since it is strictly impossible to derive true economic propositions from the use of mathematics, the attempt to do so can produce nothing but empirically redundant formalisms. The adoption of mathematical economics by the great body of economists represents a profound regression in our economic understanding, and it is the noble endeavor of the Austrians to oppose this inherently unscientific and perverse doctrine. 

This Wednesday concludes September’s Federal Open Market Committee (FOMC) meeting. It couldn’t come at a more tremulous time for Chair Powell and the Board of Governors. As of Monday, the Dow saw massive sell off, news headlines over China’s Evergrande facing bankruptcy continued, DC is facing another debt ceiling debate and COVID continues to dominate. As for the Fed, they too have been coming under scrutiny. A CNBC headline reads:

After years of being ‘squeaky clean,’ the Federal Reserve is surrounded by controversy.

And another titled:

Fed Chief Powell, other officials owned securities central bank bought during Covid pandemic.

Those were last week's headlines as the story only recently broke. To their credit, CNBC is asking novel questions like:

Should the Fed have banned officials from holding, buying and selling the same assets the Fed itself was buying last year when it dramatically widened the types of assets it would purchase in response to the pandemic?

The security trading involved key members, such as Powell, who held municipal bonds from around $1.25 to $2.5 million. Other Fed Presidents were also named in the press. Perhaps top ranking decision members at the Fed should not be able to own the same securities they were buying through America’s central bank? It would at least remove the optics of having a conflict of interest or acting in a way that is against the public's interest.

To be clear, as far as the public is aware, no member of the Fed violated any laws. But one should always remember there is a difference between law and ethics.

Adding to Chair Powell’s agenda is what appears to be a growing divide amongst the Board of Governors over the timing of the Fed’s tapering strategy. Per CNBC:

By Goldman Sachs’ count, six officials who have spoken publicly on the issue of tapering asset purchases are for it and six are against.

Having a split board on something as large as asset purchases doesn’t make his job any easier. The voting results and minutes will reveal if they managed to work out their differences during their closed door meetings this week. And what of inflation? Do they still believe we’re living in a transitory period?

With uncertainty over Powell’s term as chair, which expires in a few months, the last quarter of 2021 promises to make for interesting news stories. As to what Biden might do, a former chief economist of the National Economic Council provided a solution:

The administration is understandably going to wait and see how the Fed handles the taper and what the markets do. That could be the determining factor in whether he’s reappointed.

An interesting feature of the Fed becomes captured: For the entity entrusted to manage the nation’s unemployment and rate of inflation, it seems we’re always concerned as to how the market, namely stock, bond and real-estate reacts to every move the Fed makes. While not in their job description, the Fed has, for a very long time, been the de facto market savior.

Should Biden, or his advisors, use market performance to judge the merits of Powell’s tenure, as the article suggests, then Powell would be confronted with another moral dilemma. Trading securities as Fed chair has already pushed ethical boundaries. But having one’s job security tied to stock market performance, when you have legal authority to increase the money supply at will, creates another set of challenges. One can only hope those in charge use more than the market’s response as a barometer of Powell’s achievement... but it must be reiterated: one can only hope.

“Government is that great fiction, through which everybody seeks to live at the expense of everyone else.”

~ Frederic Bastiat

If everyone was irrational all of the time we would be in big trouble. You’d never know when someone was suddenly going to swerve off the road for no apparent reason and drive into a building, or start babbling to you in tongues over the phone when all you wanted to do was order a pizza.

(I will define, for our purposes, rational as: having and acting upon beliefs that are in accordance with reality.)1

That being said – people are irrational enough of the time, that behavioral economists are never done telling us that they are not suitable for a market economy and need regulations to “nudge” them in the right direction. They illustrate the point with examples such as the fact that if you want to motivate someone to run you are better off giving them $105 dollars a week and fining them $15 a day every day they don’t run, than rewarding them with $15 a day every day they do run — even though these things essentially amount to the same thing. So, naturally, we need policymakers to save us from ourselves and make us do the right thing. The irony of this position is that it presupposes that people are rational enough to respond to the incentives the behavioral economists want to mete out to them. Meanwhile, entrepreneurs have been going more to devise apps that interphase with human psychology and help them adopt better habits than governments ever have! After all, it was the market that gave us Fitbit, mindfulness apps, nicotine gum, calendar apps with built-in alarms to make sure we don’t forget appointments; the list goes on and is ever increasing.

The Market Rewards Rationality

Meanwhile, for the main part, the market defends us against the consequences of the irrationality of others.  If someone was irrational at all times in all respects, they could not meet the demands of life or sustain themselves, therefore they would either be dead, under the care of others, in a mental institution, or in prison. So, while no one is rational all the time, most people are apparently at least rational enough of the time to exist within a society.

The great thing about the market is, as far as we are concerned, others only need to be rational upon the basis we deal with them. My mechanic might be a raving lunatic who drives his wife up the wall (no pun intended) with his crazy theories about the flat earth and interdimensional big foot people when he is at home, but so long as he is rational when it comes to the operations of fixing my car, it need not be any concern of mine. The pizza delivery guy could have views on race that most people find abhorrent, and I would never even know so long as he delivered it on time! The architect hired to design a bridge for a new highway might be a fanatical communist who thinks all property should be publicly owned, but as long as he is rational enough to follow the laws of physics when it comes to the blueprints, the bridge won’t be built upside down and will not collapse under the weight of the vehicles crossing over it. No one is remunerated on the market for doing irrational things, for example, bringing Squid Waffles to market. No one is interested in buying or eating Squid Waffles. Therefore, they don’t exist.

Political Institutions, Unlike Markets, Reward Irrationality

Now, need I point out, that none of this is the case when it comes to the alternative to the market, which is the political process. All of a sudden everyone’s crazy, irrational views that were none of my business become very real problems to me, because they are going to entre the voting booth and try and model a society that is fashioned based upon them. Someone might even lobby for a government subsidy to open up the first ever Squid Waffles diner! Sound crazy? Well how come the government both subsidizes and taxes tobacco at the same time? This is seemingly “irrational” but it makes sense when you understand that one lobbying block wants tobacco farmers to remain in business, and another wants people to smoke less.

While people’s performance on the market is tied to their rationality, ie., the fact that their views conform to reality and therefore they can deliver the desired results, there is no such failsafe at the ballot box. In fact, as the public choice theorists have been pointing out to us, it’s rational for voters to be ignorant about abstract topics like economics, political science, sociology, statecraft and basically anything necessary to cast a good vote, because learning the facts is time consuming and costly with very few payoffs.2

Typically, when you go into the world with irrational views that affect your day-to-day life you will be met with negative consequences. If you have irrational views about eating, you will get sick; if you have irrational views about how to treat your spouse, you will have unpleasant arguments or even a divorce; if you have irrational views about how to run a business, you will soon go bankrupt. In other words – reality provides a corrective against irrational views, or at least tries to!

The dirty secret about government is that replacing the market with its “democratic” control – be it public institutions or regulations – ends up removing this corrective mechanism and encouraging irrational behavior. No one wants to suffer the negative consequences of their own irrational behavior, whether it be an illness resulting from not having taken care of their health, or having a child they can’t support, or setting up a business to sell a line of products for which there is no demand. But democracy is inherently a system where people can make bad decisions and then vote to expropriate the consequences of those decisions to everyone else via the tax system. Those people who conform to reality by building products and providing services that meet the real needs of other people will essentially be punished for good behavior when the tax man comes around to expropriate their gains to pay for rent seekers and vagrants. This creates a tendency towards more costly, irrational behavior and less beneficial, rational behavior in society relative to what there would be on a free market. Over the long term, everyone will be disadvantaged on the whole, including those who seemingly profit from exporting the negative economic consequences of their actions to the body politic because the society they live in will be far less prosperous.

• 1. I note that some economists, following Ludwig von Mises, take the position that people are always rational. What they mean by that is that all human behavior is goal-directed behavior and that when someone makes a choice they are choosing what they think will make them achieve that goal. (Mises: “A historian can say... In invading Poland Hitler and the Nazis made a mistake... All that another man can say about it is: I would have made a different choice.” – Theory and History) In my view that is a very specialized usage of the world rational, so I am going with the more commonly used understanding of the term. 
• 2. See, for example, Caplan, B. (2007) “The Myth of the Rational Voter.”