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Our Economic Recovery Will Be A Race Between Smith (Adam), Schumpeter (Joseph) And Stupidity (Government).

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Economists have been the object of ridicule for centuries. We supposedly know the price of everything and the value of nothing. The stress on scarcity and choice within constraints is seen as raining on the hope and aspirations for a better world.

In The Four Pillars of Economic Understanding, I try to counter these criticisms by pointing out that the message of basic economics not only provides truth and light to the uninitiated would-be students of society by capturing the beauty of the complex coordination of commercial society. It conveys the hope that entrepreneurship offers for the discovery of new and fascinating products and the implementation of new rules of social interaction which enable productive specialization and peaceful social cooperation.It does so with a sense of deep compassion for the least advantaged, who most benefit from the unleashing of economic forces to alleviate extreme poverty, and raises the material standards of living of people. Economic freedom brings with it progress and peace.

Unfortunately, economics is often taught as an abstract discipline with abstract examples to illustrate. Don’t get me wrong, abstraction is a necessary intellectual tool. Our theories must be logically sound, and as such must be empirically relevant. That requires discipline of thought and expression. Economics is not poetry, and neither is moral philosophy and political economy. We must practice these distinct but related disciplines with the utmost of intellectual care.

Why must we do that, you ask? Wouldn’t it be so much more inspiring to spin fanciful tales of better worlds to inspire the youth?

I want to say NO. James Buchanan, my teacher, argued that what we needed was to articulate a vision in political economy of a “workable utopia”. Hayek earlier had argued that we need a vision of a “liberal utopia,” and that we had to excite the imaginations of the best and the brightest to explore the workings of a free society — a true radical liberalism. But in both Hayek and Buchanan, the idea was to have these “utopias” firmly grounded in the teachings of basic economic reasoning.

As Hayek argued in his 1945 essay “Individualism: True and False,” the idea was to find a social system that relied not on individuals becoming better versions of themselves for its operation, but which made use of individuals as they are — sometimes smart, more often stupid; sometimes good, but capable of being bad. In fact, the idea was to have a system not where the best and the brightest could rule over others, but where bad men if they were to find themselves in charge could do least harm. In this way, freedom could be granted to all, and not restricted to only a few.

This is why Adam Smith’s critical idea of the invisible hand is so vital to our understanding of commercial life. It is not from the benevolence of the butcher, the baker and the brewer that we can expect our dinner, but from appealing to their self-interest. We cannot rely on friendship and fellow feelings to secure for us the material progress required to lift us from the Malthusian trap of subsistence. We escape that Malthusian trap through expansions of the trade and technological innovations spurred by the gains realized from turning scientific knowledge into commercially useful knowledge as the great economic historian Joel Mokyr has so convincingly argued throughout his career. To put it another way, borrowing from Mokyr, there are always headwinds that resist the forces of progress, and tailwinds that push progress forward, and the economic history of humanity is made up of the story of this battle between headwinds and tailwinds.

That metaphor is a useful one to keep in mind when thinking about our current situation, and where the primary winds are coming from — public sector, private sector, independent sector, or some combination. What are the headwinds that seem to block the timely and honest communication of knowledge about public health issues to us, what are the headwinds that delay testing and medical innovations; what are the headwinds that keep the allocation of scarce yet critical medical resources from being allocated to their most urgent use?

On the other hand, where are the tailwinds coming from that will cut against those headwinds and push us forward to make progress against the reality of the current situation? When the history of 2020 comes to be written, obviously a serious accounting of the headwinds and tailwinds will need to take place.

After 2008, in my effort to try to communicate basic economic reasoning to make sense of the reality we were collectively experiencing, I started to utilize my own metaphors and analogies. One was to look at Michael Phelps, the great Olympic swimmer, and to ask my readers to imagine what would happen to his ability to swim across a pool if we first just tied his hands together.

Well it turns out that Phelps gets across the pool in a slower time using the breaststroke than he does freestyle, but still at amazing speed. How about if we tied his feet together as well? Well, again, Phelps is one of the best butterfly swimmers that the world has ever seen, so that dolphin kick would not be impeded by tying his feet together. But again, much slower than his freestyle. How about if we added a 250-pound weight to his waist?

At that point, he would sink to the bottom of the pool. The point I am trying to make however is that you would never say that under those circumstances Phelps’s failure to get across the pool represents swimmer failure. The failure is clearly due to the obstructions placed on his ability to swim. That, I argue, is the error we make when, in the context of highly regulated market economies, we continue as economic educators in discussing “market failure.”

Adam Smith long ago recognized that individuals can find workarounds and ingenious ways to realize gains from trade and gains from innovation even in the presence of what he identified as hundreds of impertinent obstructions which human folly may put in the way.

This led me to articulate another example in hopes of communicating an important economic lesson. To capture the idea of gains from trade and gains from innovation in the face of those impertinent obstructions, I asked readers to envision a horse race between three horses — one named Smith (for gains from trade), a second one named Schumpeter (for gains from innovation), and a third one named Stupidity (for those government-imposed obstructions).

My basic ideas was, following Smith, that as long as the Smith and the Schumpeter horses were running ahead of the Stupid horse, tomorrow will be better than today. The counter-factual is this: what if the Smith and Schumpeter horses were able to run freely, without that Stupid horse biting at their heels and bumping into them rather than staying in their lane.

What I think is important to get from this illustration that is relevant for today is that we aren’t letting the Smith and Schumpeter horse run! They are currently locked in the barn, or trapped behind the start gate. This is why I don’t think the usual Business Cycle story of a cluster of errors being revealed in the bust, and thus a recalculation of ensuing labor and capital is applicable to our understanding of the current situation. It is important for students of economics to remember that in the Austrian theory of the business cycle, the recession is the correction, and the reason is that during the bust phase there is a recalculation of labor and capital to reflect better the preferences and savings and investment trade-offs that individuals are willing to make.

This is decidedly not what is going on at the moment if for no other reason than that the capital and labor is locked up in that barn with Smith and Schumpeter. Don’t misunderstand me, there are serious financial fragilities in the global capitalist system due to policy errors and the manipulation of money and credit combined with fiscal irresponsibility, but that isn’t what is going on right at this precise moment in my humble opinion.

What we are witnessing right now is macroeconomic volatility caused by an exogenous shock due to a public health crisis combined with a policy response that has shut down the economy. Back to my metaphor, while Smith and Schumpeter are trapped in the barn, or at least stuck at the starting gate, the Stupid horse is running freely and getting a lap lead.

Thankfully, those Smith and Schumpeterian horses are younger, fitter, faster and more nimble. Once they are unleashed, it is my sincere hope that they will burst out and catch up quickly to that dumb old hag of a horse Stupidity. They will leave Stupidity in its wake, the accumulated surplus fund will be replenished, and tomorrow will be better than today.

So, let’s get those tailwinds blowing harder than the headwinds, stop tying down our entrepreneurs, and let those Smith and Schumpeter horses run freely. We have to solve a public health crisis, one that requires creative ingenuity and innovation.

We have to restart a stalled economic system; that requires creative and imaginative entrepreneurs. In both cases, our greatest reason for hope is to be found not in bumbling bureaucrats who attempt to lead from ossified institutions of authority, but in the erring entrepreneurs who have their judgements constantly contested by others and only the most nimble and creative are able to negotiate the turbulent times to provide the solution to our woes.

Peter J. Boettke is a Senior Fellow with the American Institute for Economic Research, and this article first appeared at aier.org. He is a University Professor of Economics and Philosophy at George Mason University, as well as the Director of the F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and BB&T Professor for the Study of Capitalism at the Mercatus Center at George Mason University.

Economics For Individuals: Economics Is about The Individual, Not The Collective

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Despite what we may hear from mainstream economists, the study of economics is by and large for and about the individual.

Each time we are confronted with economists in the media, we are bombarded with charts and graphs and overly-complicated terms all meant to make us feel as though we need these “experts” to understand economic concepts like production, consumption, and the transfer of wealth. But this is hardly the case. And while these experts will often make us feel like the sky is falling unless we follow their advice, much of this is just a sign of elitism and a love of central planning.

As Hunter Hastings writes:

“We are taught in school that economics is about grand aggregations of statistics like Gross Domestic Product, and the employment level, and the inflation rate, and how government designs and implements policies to affect these aggregates. That’s just an excuse for government intervention, regulation, taxation, and the continued employment of economists as policy advisors.”

In reality, economics is not, or at least should not be, about central planning or policy that serves the “collective good,” because if we are honest with ourselves, there is no way to identify the wants and needs of groups of people. We can only identify the wants and needs of each individual actor, which is why all economic decision-making must begin with the individual human being — a  concept lost on many state actors.

Unfortunately, many economists make the mistake of looking at economics in terms of the collective, forgetting that the individual is the basis for which all things are possible. And that groups of people are, in reality, not a tangible unit of measurement.

Methodological Individualism

Economics is very much a social science that looks at how producers and consumers interact with one another to best meet each other’s needs. But these interactions happen on the individual level. And unless we start small, observing the individual’s role in this process, we cannot hope to understand the economy as a whole.

For producers to adequately determine the needs of the consumer, they must understand the wants and needs of the individual consumer first. After all, there can be no collective without the individual units of which it is comprised.

In economic terms, this is described as methodological individualism, which is the theory that explains that “social and economic phenomena can be explained by reference to the actions of individuals rather than groups or collectives.”

Elaborating on this, Libertarianism.org explains that this theory:

“…does not claim that only the individual human being is real or that social phenomena do not exist. It simply holds that the individual human being alone is able to think, feel, and act. We can impute actions, purposes, and values only to individuals; when we apply these terms to society, we enter the domain of metaphor.”

While this theory was originally developed by Joseph Schumpeter, it was his predecessor, Carl Menger, who founded the Austrian school of economics, who truly originated the idea. In 1889, he wrote, “There is no economic phenomenon that does not ultimately find its origin and measure in the economically acting human and his economic deliberations.”

Health Care Policy

There is, perhaps, no greater example of how detrimental it is to view economic policy in terms of the collective, rather than the individual, than health care. The entire premise for Obamacare and other versions of universal medicine are based on the presumption that the collective good is more important than the individual.

But, in reality, this “collective good” does not actually exist. And by assuming that the best health care policies must be crafted on the basis of what is good for groups of people instead of what each individual health care consumer wants and needs, you cannot logically hope to make any progress in this field.

It is for this reason that these policies have been such a failure. The government assumes that cost is the bottom line for health care consumers and have operated on this premise. Cost is one component in an individual’s hierarchy of needs, but there are many more elements, especially when there is urgent need for care. Focusing exclusively on cost completely negates the subjective wants of each individual person. No state apparatus can determine this for the collective. Only the producer, working in tandem with the consumer, can create options that truly fulfill their needs.

It is for this reason that we have seen the rise in services like direct pay care, where physicians take out the middleman, whether that be an insurance provider, government, or both, and instead work with actual patients to agree on the cost of care and what services are valued the most. Once producers work with individual consumers to better understand these wants, this concept can be expanded to include more individuals. But it is important to note that even large groups of people are really just several individual units. This idea that as a collective we think and act as one is not only wrong, but it greatly distorts the market process. There is no collective, there are only individuals, and when economists ignore this most important fact it is at their own peril.

As sociologist Georg Simmel said, “Groping for something tangible, we found only individuals and between them nothing but empty space.”

Amazon Prime Killed Sears and Consumers Should Be Grateful

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Nothing lasts forever, and this is especially true in the world of commerce. As the world advances, goods and services once deemed revolutionary will inevitably become outdated and replaced by something newer and better. And each time this process of creative destruction repeats itself, consumers benefit by getting access to better goods and services.

We’ve seen it with Blockbuster when it was replaced by Netflix and other streaming platforms. And we have seen it recently with Toys R Us, which could not compete with the age of internet retail. And we have even seen this with the entire newspaper industry, which is being replaced by online news platforms. Now, we are experiencing creative destruction once again with the closure of Sears department stores.

For the last 125 years, Sears has been a staple of American capitalism. But last week, it was revealed that the once great giant of American consumerism would be filing for bankruptcy and possibly closing all 142 of its stores forever. This has caused many Americans to feel extremely sentimental about Sears. And why shouldn’t they? After all, it completely changed the way Americans shopped.

Sears: An American Institution

In the late 1900s, Sears had blown Americans minds by making household items more accessible to the growing middle class. And in addition to the low costs, Sears would deliver whatever items you wanted right to your door, and in just a few weeks. Today, waiting a few weeks for a package might seem rather archaic, but before the internet era, this was a real gamechanger.

Sears was a one-stop shop for the American family. Its catalogs were shipped to households all across the country and the pages were filled with any item you could possibly want. From clothing to kitchenware and even larger household appliances, Sears had it all. In fact, few people actually remember that at one point in time, the company also sold homes. Consumers would pick the model they wanted and send in their payment and Sears would ship them the supplies to be assembled by the buyer. In fact, many of these homes are still in existence today, further proving the quality Sears provided to its customers.

The catalog also revolutionized black America after the Civil War. When Jim Crow laws were reeking havoc and dividing the South, regular trips to the store became a nightmare for many black Americans. But shopping from the Sears catalog allowed them to bypass having to shop at stores owned by racists and enabled them to do their shopping without fearing for their wellbeing.

And while Sears truly revolutionized the American shopping experience, it just can’t compete with the world of online retail.

Who Killed Sears?

Innovation is a perpetual quest without end and consumers should be thankful for this. Can you imagine how boring our lives would be if innovation had stopped at the radio? Instead of searching for the next best thing int he world of tech, we would all still be huddled around large, outdated radios waiting to get our news and entertainment. Likewise, imagine how truly absurd it would be for us to have stopped innovating transportation after the advent of the horse and buggy. Instead of having cars to get us where we need to go quickly, we would all be delayed because we were forced to use outdated means of transportation.

Economist Joseph Schumpeter described this process of the new replacing the old as creative destruction. Elaborating on this, he wrote:

“The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

In order for entrepreneurs to innovate and provide consumers with better options in the marketplace, outdated products have to replaced by something better. And as innovative as Sears was in its heyday, it just cannot compete with the services Amazon Prime offers today. In fact, in many ways, Amazon Prime is the newer version of Sears.

Sears provided convenience to shoppers at the end of the 19th-century by allowing them to shop from their homes. Amazon, utilizing the technological advances that have occurred since the since Sears was founded, was able to take this step even further. Instead of waiting weeks for something to be delivered, Amazon can get it to you within an hour via Amazon Now. And while Amazon might not be selling homes yet as Sears did, they have just about everything else from clothing, to groceries, to food delivery services. In fact, in many ways, Amazon Prime is the modern-day version of Sears, providing convenience to consumers in a way they had never before experienced.

In fact, Sears is not the only retailer to be beaten by Amazon Prime. Many brick and mortar retailers, Toys R Us included, have had to exit the marketplace entirely because they simply do not have the means to compete with Amazon Prime. But this does not make Amazon the enemy, despite what its critics might say.

Right now, Amazon is succeeding because its services are so revolutionary. But we have no idea where innovation may take us in the future. Sears enjoyed over a hundred years of market success before it was finally replaced by something better, and it is likely that the same will happen to Amazon eventually. This is just the way the market works. And we should all be grateful.

To again quote the brilliant Schumpeter, “At the heart of capitalism is creative destruction.” So instead of mourning the loss of Sears, let us celebrate how lucky we are to live in a world where the market is constantly evolving and allowing consumers access to better goods and services. 

Creative Destruction and the Closing of Toys R Us

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Last weekend, I noticed more than a few friends posting to their Facebook pages about going to pay one final visit to Toys R Us. Like many brick and mortar retailers, the famous toy store has found itself drowning in a market now dominated by online retailers. This news has pulled at the heartstrings of many, who have fond memories of the toy store, as my newsfeed can attest.  

It’s understandable to see why so many adults are getting sentimental about this closure. As children, Toys R Us was almost as exciting as Disneyland. The store had everything you could ever dream of wanting to play with as a child. Even if nothing was being purchased, just strolling down each aisle was a true pleasure. 

But just because Toys R Us is leaving doesn’t mean we have cause to mourn. In fact, the death of the toy store symbolizes the beginning of a new era where tech and online shopping have made the store irrelevant. And this creative destruction is all part of the of the market process.

Creative Destruction

For the average person, a massive store like Toys R Us closing can stir up a lot of emotions. In addition to the sentiment, a big company closing means that many people will now be out of a job. Not to mention, this only adds to the hysteria surrounding the closure of many other brick and mortar establishments. In fact, Trump has, on many occasions, proposed taxing online retailers like Amazon because of the impact they are having on other physical businesses. 

But the world is not stagnant. The market always changes. And with those changes comes the opportunity for new innovation. And where old jobs are done away with, new jobs are always created.

When the news of Toys R Us closing was first released, many headlines told stories of national concern over what was to happen to the 33,000 people who would soon be out of a job. And while job loss is never something that should be celebrated, there is another angle here that is not being discussed: creative destruction.

The term creative destruction was coined by economist Joseph Schumpeter and is described by Investopedia as:

“The process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This occurs when innovation deconstructs long-standing arrangements and frees resources to be deployed elsewhere.”

And that is exactly what is happening with Toys R Us. As economist Antony Davies commented:

“Think about the young parents who are buying toys for the kids. Where are they buying them? They are buying them from eBay, from Amazon, so at the same time we are losing jobs at Toys R Us we are gaining jobs there….It is something economists call creative destruction. That is, we lose some jobs in one place, but we gain others somewhere else.”

Commenting on creative destruction further, Schumpeter once wrote:

“The function of entrepreneurs is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on.”

This makes perfect sense when we look at the current market for toy consumers. As Davies says:

“In the great scheme of things, this isn’t surprising because what we have is the first generation that has grown up with the internet. They’re old enough, they’re starting to have babies, and they’re looking for toys and what do they do naturally? They go to the internet.”

Additionally, it is so much easier to buy toys online than it is to load the kids in the car and haul them across town to the local toy store. Amazon and other online retailers have made it more convenient than ever to shop for toys. And while kids today might not have the same memories of strolling through the aisles of Toys R Us as their parents did, they will be making their own new memories.

Each time an older, perhaps outdated, business bites the dust, there is ample opportunity for a new, better idea to take its place. And with new innovation comes the need for new jobs.

Toys R Us isn’t likely to be the last brick and mortar casualty of the virtual revolution. But we needn’t be discouraged by these changes. The market will always evolve and change to meet the needs of consumers. And while jobs might be temporarily lost, new jobs will always be created as part of the market process.

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