This piece was written for The Cobden Centre by Vishal Wilde. Vishal Wilde is a finalist studying for a BSc (Hons) in Philosophy, Politics & Economics (Economics major) at the University of Warwick. He wishes to spend his life fighting for and defending freedom. He is a Freelance Journalist (writing, most recently, for the Market Mogul), he writes Poetry, Science-Fiction and Fantasy and conducts independent academic research in Economics, Political Science and Philosophy. He is a Research Consultant for Fantain Sports, Pvt Ltd. (a tech startup based in India). He has previously written research articles and blogged for the Adam Smith Institute.
‘The Civilisation of Capitalism’: Schumpeter on Rationality and its relevance to the ideal of a free society
In Joseph Schumpeter’s (1942) Capitalism, Socialism & Democracy , Chapter 11 is entitled ‘the Civilisation of Capitalism’. There, he argues that the culture fostered by Capitalism has been responsible for the ‘rationalisation’ of society, as we know it. Rather than quoting Schumpeter word-for-word, I’d encourage people to read that short chapter. We can derive inspiration from Schumpeter’s thoughts in making the case for free markets and a free society.
Intuitively, one would expect the individual living in a free society to be more intelligent and rational than his counterpart in a hypothetical, centrally planned Utopia (like Plato’s Republic). In a predominantly centrally planned economy, where there is deprivation of civil liberties, choices have already been made on our behalf whereas in a free society, people have more choices. The typical individual in the former will, most likely, be more naïve than his counterpart in a freer society and in the latter more rational. The freer society is, the greater the sphere in which people can develop the appropriate mental faculties for optimising outcomes.
Therefore, total freedom of thought is only really attainable in a free society with free markets. Restricting individuals’ freedoms prevents them from being the best people they can be and therefore prevents the best possible outcome for society as a whole.
It is a fundamental premise in Economics that all economic problems are rooted in the scarcity of resources. In Physics, understanding how to manipulate matter is considered somewhat of a holy grail. A certain depth of understanding with respect to matter would solve the problem of scarcity completely. However, if we indirectly restrict individuals’ thoughts by preventing them from living in a freer society that is conducive to such scientific discovery, we are shooting ourselves in the foot twice since Economics necessarily deals with this problem of scarcity that the other sciences might be able to relieve us of.
In a free society, the enhancement of mental faculties that accompanies increased freedom of thought enables individuals to deal with the problem of scarcity more intelligently, creatively, innovatively and rationally.
The Civilisation of Capitalism pt. 2: Malleability of segmented expectations via policy
In a previous post on The Civilisation of Capitalism, it was argued that Schumpeter had a good point when he suggested that Capitalism has been responsible for the ‘rationalisation’ of society because the freer a society is, the greater are the choices available to individuals (whereas in centrally planned economies, choices have already been made for agents) and this requires those same individuals to become increasingly rational (having been presented with more information that accompanies more choices), creative, innovative and intelligent. In the same way that we can draw inspiration from Schumpeter for arguing for a freer society, we can take account of Schumpeter in the context of modern economic theory.
Modern economic theory is often criticised for assuming homogeneous agents with rational expectations (where all agents will always use the available information optimally) and this simplification, useful though it may be, leads to a model of an unrealistic world with, therefore, skewed results. However, rational expectations is far more realistic than simple, linear adaptive expectations (wherein peoples’ predictions of important variables, say, inflation this year, is exactly equivalent to the recorded inflation in the previous year) and naïve/static expectations (where expectations of a particular variable remain the same, regardless of variations in the observed values – so the agent may believe that inflation rate may be 2% across all time periods, regardless of empirically observed disparities with this).
Hommes’ (2013) application of Chaos Theory and Complexity Theory to Economics and Finance attempts to amalgamate rational, adaptive and naïve expectations but this remains within an overarching framework of cost-minimising rational choice (though, by the author’s own admission, the book only introduces simple modelling techniques and Hommes, presumably, probably uses more advanced models to make his forecasts); however, the overarching framework of rationality in the determination of heterogeneous expectations leaves one wanting.
Intuitively, it’s obvious to see that not everyone is rational (in the economic sense) with respect to everything; one may be naïve in their forecast of the price of a chocolate bar (for example), adaptive with respect to inflation expectations and rational with respect to the expected price of goods and services that they are heavily reliant on for their livelihood (hence, the degrees to which expectations are segmented and the degree to which this segmentation changes – its malleability – would obviously depend on the characteristics of each agent).
Moreover, it is easy to see why policy might affect how many things one is rational toward a particular variable, one is adaptive toward another etc.; so if one is naïve, there is the possibility for becoming more adaptive or even rational if there is a change in circumstance that prompts this. For example, if an individual believes that the government’s safety standards with respect to food is trustworthy, they might naively believe that all items sold in marketplaces they often frequent actually adhere to these standards and, indeed, that adherence to those same safety standards imply the food’s adequacy for consumption.
If, on the other hand, the government were to remove its ‘safety standards’ and other such requirements, consumers would naturally seek to expend more energy in being more rational (e.g investigating, using the available information, what determines certain foods’ suitability for consumption, whether the firms are meeting them etc.) and, presuming that consumers would prefer to minimise the costs involved in expectations-formation (as Hommes (2013) supposed), producers would also seek to ensure that consumers have to expend less energy in making consumption decisions; thus, private agencies would develop for this purpose and some would be more trusted than others depending on the individuals’ preferences. Couple this with the fact that the time required to obtain a licence, to maintain the standards and so on obviously add to production costs, the amount of industry that policies inhibit and therefore, the lost tax revenue (both directly from expenditures and indirectly from the loss to industry) is mind-boggling.
Of course, one may argue that people would simply become exhausted if they expended more energy in becoming increasingly rational. Another counter to this (besides the growth of firms seeking to reduce the need for individuals to be rational) comes from an evolutionary perspective; that is, individuals adapt to changing environments and, furthermore, the argument presumes a fixed amount of energy available for expenditure and a lack of innovation in the expenditure-methods.
Individuals could, conceivably, in the face of higher energy requirements, generate more energy in the first place or use the existing energy in more efficient ways; they say “practice makes perfect” – well, part of the reason for this is that, though practice of the activity may be initially exhausting, both physical and mental conditioning allows one to expend less energy (i.e more efficiently) in doing that same activity and, eventually, to improve the outcome of that activity as well.
Thus, it is quite clear to see that much policy, by inhibiting the incentive to become increasingly rational, restricts industry and, more importantly, peoples’ scope for developing into the best people they can be in a true and proper free society.
