Visible Hands in the Economy
1. Visible versus invisible hands

Masha, a Russian student on an athletic scholarship, comes to the front of the class. It's 2008, nearly twenty years after the break up of the Soviet Union. Though in recent years things have notably improved, many Russians are still experiencing a difficult transition from a centrally planned economy to a free market economy.

Masha (visibly agitated): You told us how wonderful markets are. But in my country markets have created nothing but chaos. The Russian people are suffering. Free floating prices mean high prices for us, especially for basic necessities such as milk and bread. In the meantime a few people are getting rich, while the masses have no income. I really do not see how you economists can be so pleased with free markets. Maybe the Russian people are not ready for free markets. We may need a strong government after all.

Bayla: Wait a minute. Your so-called "strong governments" in Eastern Europe were tyrannies, benefiting members of the Communist Party, not ordinary people. Haven't you heard stories from your mother about half the day spent standing in line for the little meat there was? Now Eastern Europeans from Russia to the former East Germany live in free countries. And they have meat.
The teachers get into the mix:

McCloskey: Sure, the transition from a centrally planned economy to a free market economy can be painful. But the Russians made it much worse than it was in formerly Communist Poland or the formerly Communist Czech Republic by not taking the steps---that even the once crazily Communist China has taken---to let markets work. Russians cannot to this day buy agricultural land, for example. So the land is still badly used. To speak in the terms of the previous chapter on markets, the Russian economy is in a state of disequilibrium right now; it will take time to reach a new equilibrium. Things were bad in the 1990s in Russia. Now they are good---though I worry about opinions like Masha's, widespread there, that government should be a "firm hand." A new tsar.

Klamer: I don't share your optimism. Masha has plenty of reasons to be skeptical about markets. Markets work, yes, but not always. When they don't, the government should intervene.

Ziliak: I'm optimistic about a future mixed economy in Russia. If by "government intervention" you only mean the definition, assignment, and enforcement of private property rights, institutions for making trades of goods and services, banking rules and regulations, and a stable domestic currency and international exchange rates and the like, great! But the game was rigged against peasants and working poor-again. The state should have distributed shares of ownership in industry from farming to oil to each citizen.

McCloskey: Exactly what a free-market economist like me would propose, Steve! Then let the market work.

Ziliak: But the government did not so distribute shares of ownership. So the market game was inhumanely rigged. Russia still needs incentive-based social welfare provisions, subsidized health care, and the like, if it is to be humane.

McCloskey: I think the market works better than the government - which after all, is run by imperfect people like us, and as Masha is claiming is run in Russia by people who are worse than "imperfect." They are thugs and thieves.

Klamer: You had your turn in the previous chapter. Now it's our turn. We're going to illustrate some economic reasons to distrust markets and we'll consider some ways that government and non-government intervention may be able to help.

Rodney: Okay [rubbing his hands]. This will be fun! A real conversation-bring it on.

Some definitions:

The invisible hand is the price mechanism - the price-guided process of unintended cooperation among buyers and sellers that operates in markets.

A visible hand is any authority---such as a government or a monopoly firm---that inhibits or supercedes the market's invisible hand in the coordination of market activities.

When Adam Smith advocated the virtues of the invisible hand he argued against the intervention of all authorities in the market. Smith wasn't against every government intervention. For example, he saw some need for tax-financed assistance to the poor, and he strongly supported state schools for children. And in fact in his old age he took a governmental post enforcing the taxes against imports from abroad that he had spent large parts of The Wealth of Nations attacking! effectiveness as a tool for enhancing human well-being.


Markets may not exist.

Some desirable products and services do not have a market on which they can be traded for profit. Examples are fire protection, police protection, and charity for the poor. The same can be said for certain undesirable things, such as water pollution and loud stereo music next door. When markets do not exist, there is no economic mechanism to communicate people's desire to have more or less of something.

McCloskey: I'd say that the problem is often a failure not of markets but a failure to apply markets. You have a property right to a peaceful neighborhood. If someone is running his stereo at top volume he's disturbing the peace. You can enforce your property right by calling the police, or in extreme examples by suing the jerk.

Ziliak: Milton Friedman got a couple of generations of economists and policymakers thinking from his Capitalism and Freedom (1962) that fire and police protection, education, and even charitable works could be privatized.

McCloskey: Yeah. After all, Friedman said, they were mainly private in the 19th century, and no worse for it. Furthermore, he said, privatization has the merit of efficiently steering private wants toward private goods.

Ziliak: But Friedman did not do the historical economic research that would be necessary to prove his claim. The truth is that religious, ethnic, and racial tensions were so high in Philadelphia and Chicago and other cities that a neighboring fire department would not help to put out a fire, even though available. Similarly, one group's charity would not lend a hand to members of another group.

McCloskey: I agree. Public welfare has been around Europe and America since the 17th century. In the early 1600 fully ten percent of the population of Amsterdam, the financial and commercial capital of the Western world at the time, was on some sort of public relief.

Ziliak: In the 19th century, early and late, reformers tried to completely abolish public welfare. But England, Germany, Russia, and the United States were much better at abolishing relief for the poor than they were at helping to create economically sizeable and sustainable charitable institutions. The life chances of the poor were no better under the privatized system and were, in some ways, much worse.

McCloskey: I agree. Friedman did his homework on the history of money---though in the end I think he got that wrong, too---but not on the history of public goods. Other libertarian scholars, such as Daniel Klein on turnpikes and Terry Anderson on western-U. S. land policy, have made Friedman-like arguments that private is better than governmental, with much more persuasive evidence.

Markets, even when they exist, do not always work.

Like the people who populate them, real-life markets are rarely perfect. Prices may be unstable or slow to adjust, or a small group of buyers or sellers may be able to gain control of the market by exercising monopoly power, reducing supply and artificially raising prices above cost, as for example in today's international oil market, in which Saudi Arabia exercises such power. Sometimes small groups of government- or non-governmentally-sponsored sellers mix with single ethnic or racial groups, and exercise both monopoly and violent power, as in Chechnya and other parts of the former Soviet Union. In each of these cases, the invisible hand will not fulfill its impartial coordinating role.

Rodney: There are neighborhoods, Professor, in which you'll find evidence of the "visible foot."

Maria: "Visible foot?"-what is that?

Rodney: A kick in the head!

McCloskey: That's right. A street gangs can take over, running a drug market in front of the local elementary school, shooting old ladies on their front stoops, making it unprofitable to open a big chain store with low prices, or making it impossible to get a mortgage to buy a house. But those are not "failures of markets." They are failures to apply and support markets. The city is not doing its job of enforcing rights to private property. Violence is the alternative to markets, not a consequence of markets.

Klamer: That last remains to be seen.

The visible foot interferes here with your view of Mount Rushmore. Government-regulation solution? Call a cop. Market solution? Establish property rights in a view of Mt. Rushmore, and then call a cop. Centralized socialist solution? If the foot is a member of the Communist Party, don't complain. If not, call a cop, and have him shot.

Markets, even if they exist and work well, may be unfair, or unethical.

People may be treated unjustly or unethically in a market. That's what Masha suggests when she talks about hard working Russians who are barely able to feed themselves. To her this is not fair: everyone ought to be able to buy food. Further, it is illegal, and in some people's eyes unethical, to buy or sell certain goods---or we should say so-called "goods"--- such as heroin, human slaves, sexual favors, human DNA, U.S. passports, or a person's vote in the next presidential election.

Klamer: Yes. When everything is for sale the invisible hand becomes the opposite of its glorious promise. Like an octopus it reaches up from the sewers to seek out and strangle the economically vulnerable.

McCloskey: You people are getting awfully heated up!

Ziliak: Quite right to get heated. Because "everything for sale" includes everything: the services of women and children and the Holy Eucharist. It's bad for everyone, including the moneychangers in the temple. Here's a real world example, the "vendue" system. From colonial times in America to the end of the 19th century, it was legal in some states for a free man to "sell" at auction his wife and children. Strange though it sounds, the auction was a form of public welfare. It was a Dutch auction, so bids would start high and work their way down until the lowest bidder wins. The lowest bidder got to take home the auctioned child or woman or family and would receive from the county treasury in addition to the human prize a sum of money equal to his (low and therefore economical) bid. The idea was to maximize welfare while minimizing cost. It is somewhat similar to the system of foster parents now.

McCloskey: The problem with vendue was the government, not the market. If poor women and children were damaged by the transfer, the government should have stepped in to enforce the side conditions of the contract---which presumably ensured that the women and children would not, say, be set to excessively hard labor, or killed.

Klamer: Ah: Chicago-School economist admits a role for government!

McCloskey: I never said that the government had no role in enforcing contracts.

Klamer: How can you separate the two? That's what Ziliak and I are saying. Markets reflect laws and institutions, and laws and institutions reflect markets. No one put a gun to those poor people and said: "Sell! Sell! Sell your children!" They volunteered to do it. Real profit-motivated humans lobbied their governments to gain permission to sell women and children.

Maria: Maybe they didn't have a choice but to sell.

McCloskey: Short of the gun, Maria, people always have a choice. I do not advocate selling humans. I don't know the details, but I suspect that the vendue was in design a reasonable arrangement for saving people from worse---starvation in their original home, for example. Everyone worked hard in 1890. But if it was bad for the women and children I suspect that it was a political, not an economic, failure.

Ziliak: Sorry: the facts are against you. There was nothing reasonable about the vendue. I say this as a person who is in theory hugely in favor of free exchange. But think historically: take away vendue and what did you get?-a privatization of public welfare movement that ended twenty years down the road not with lamb's leather on invisible hands but with the dirty cold cement and barred barracks of poorhouses, almshouses, and prisons-publicly funded. The politics hurt the poor.

McCloskey: Well, sure. What do you expect? We have a sad, ironic joke in the Chicago School: "What's the Golden Rule?" "Those who have the gold, rule." We think that's rotten.

Ziliak: Here left and right agree, blue states and red. When times are tough for the puritanical and aristocratic branches of the middle class, the impoverished suffer even more, and not a little for the middling attempts to "control" them.

Klamer: It sounds like the 1990s round of welfare reform in the United States.

McCloskey: Oh, I don't think so. The reform was successful.

Ziliak: So you say.