How the Early Capitalists Saved Europe From Starvation – Ludwig von Mises

Two hundred years ago, before the advent of capitalism, a man’s social status was fixed from the beginning to the end of his life; he inherited it from his ancestors, and it never changed. If he was born poor, he always remained poor, and if he was born rich-a lord or a duke-he kept his dukedom and the property that went with it for the rest of his life.

As for manufacturing, the primitive processing industries of those days existed almost exclusively for the benefit of the wealthy. Most of the people (ninety percent or more of the European population) worked the land and did not come in contact with the city-oriented processing industries. This rigid system of feudal society prevailed in the most developed areas of Europe for many hundreds of years.

However, as the rural population expanded, there developed a surplus of people on the land. For this surplus of population without inherited land or estates, there was not enough to do, nor was it possible for them to work in the processing industries; the kings of the cities denied them access. The numbers of these „outcasts“ continued to grow, and still no one knew what to do with them. They were, in the full sense of the word, „proletarians,“ outcasts whom the government could only put into the workhouse or the poorhouse. In some sections of Europe, especially in the Netherlands and in England, they became so numerous that, by the eighteenth century, they were a real menace to the preservation of the prevailing social system.

Today, in discussing similar conditions in places like India or other developing countries, we must not forget that, in eighteenth-century England, conditions were much worse. At that time, England had a population of six or seven million people, but of those six or seven million people, more than one million, probably two million, were simply poor outcasts for whom the existing social system made no provision. What to do with these outcasts was one of the great problems of eighteenth-century England.

Another great problem was the lack of raw materials. The British, very seriously, had to ask themselves this question: what are we going to do in the future, when our forests will no longer give us the wood we need for our industries and for heating our houses? For the ruling classes it was a desperate situation. The statesmen did not know what to do, and the ruling gentry were absolutely without any ideas on how to improve conditions.

Out of this serious social situation emerged the beginnings of modern capitalism. There were some persons among those outcasts, among those poor people, who tried to organize others to set up small shops which could produce something. This was an innovation. These innovators did not produce expensive goods suitable only for the upper classes; they produced cheaper products for everyone’s needs. And this was the origin of capitalism as it operates today. It was the beginning of mass production, the fundamental principle of capitalistic industry. Whereas the old processing industries serving the rich people in the cities had existed almost exclusively for the demands of the upper classes, the new capitalist industries began to produce things that could be purchased by the general population. It was mass production to satisfy the needs of the masses.

This is the fundamental principle of capitalism as it exists today in all of those countries in which there is a highly developed system of mass production: Big business, the target of the most fanatic attacks by the so-called leftists, produces almost exclusively to satisfy the wants of the masses. Enterprises producing luxury goods solely for the well-to-do can never attain the magnitude of big businesses. And today, it is the people who work in large factories who are the main consumers of the products made in those factories. This is the fundamental difference between the capitalistic principles of production and the feudalistic principles of the preceding ages.

The development of capitalism consists in everyone’s having the right to serve the customer better and/or more cheaply. And this method, this principle, has, within a comparatively short time, transformed the whole world. It has made possible an unprecedented increase in world population.

In eighteenth-century England, the land could support only six million people at a very low standard of living. Today more than fifty million people enjoy a much higher standard of living than even the rich enjoyed during the eighteenth-century. And today’s standard of living in England would probably be still higher, had not a great deal of the energy of the British been wasted in what were, from various points of view, avoidable political and military „adventures.“

These are the facts about capitalism. Thus, if an Englishman-or, for that matter, any other man in any country of the world-says today to his friends that he is opposed to capitalism, there is a wonderful way to answer him: „You know that the population of this planet is now ten times greater than it was in the ages preceding capitalism; you know that all men today enjoy a higher standard of living than your ancestors did before the age of capitalism. But how do you know that you are the one out of ten who would have lived in the absence of capitalism? The mere fact that you are living today is proof that capitalism has succeeded, whether or not you consider your own life very valuable.“

In spite of all its benefits, capitalism has been furiously attacked and criticized. It is necessary that we understand the origin of this antipathy. It is a fact that the hatred of capitalism originated not with the masses, not among the workers themselves, but among the landed aristocracy-the gentry, the nobility, of England and the European continent. They blamed capitalism for something that was not very pleasant for them: at the beginning of the nineteenth century, the higher wages paid by industry to its workers forced the landed gentry to pay equally higher wages to their agricultural workers. The aristocracy attacked the industries by criticising the standard of living of the masses of the workers.

Of course-from our viewpoint, the workers’ standard of living was extremely low; conditions under early capitalism were absolutely shocking, but not because the newly developed capitalistic industries had harmed the workers. The people hired to work in factories had already been existing at a virtually subhuman level.

The famous old story, repeated hundreds of times, that the factories employed women and children and that these women and children, before they were working in factories, had lived under satisfactory conditions, is one of the greatest falsehoods of history. The mothers who worked in the factories had nothing to cook with; they did not leave their homes and their kitchens to go into the factories, they went into factories because they had no kitchens, and if they had a kitchen they had no food to cook in those kitchens. And the children did not come from comfortable nurseries. They were starving and dying. And all the talk about the so-called unspeakable horror of early capitalism can be refuted by a single statistic: precisely in these years in which British capitalism developed, precisely in the age called the Industrial Revolution in England, in the years from 1760 to 1830, precisely in those years the population of England doubled, which means that hundreds or thousands of children-who would have died in preceding times-survived and grew to become men and women.

There is no doubt that the conditions of the preceding times were very unsatisfactory. It was capitalist business that improved them. It was precisely those early factories that provided for the needs of their workers, either directly or indirectly by exporting products and importing food and raw materials from other countries. Again and again, the early historians of capitalism have-one can hardly use a milder word-falsified history.


The Fear of Robots – Pedro Schwartz

One morning a week I take part in a discussion programme on a Spanish radio station that specializes in economic and business matters. Just before we come on air we hear the day’s expected events and statistics read by a new journalist in the firm: Sarah Bot, a very young robot with a strange voice. For the time being she has not displaced me and taken over my job.

I know I use robots continuously. I start with the iPhone that wakes me up in the morning, then read the mail I receive on my laptop, chase down on the internet the information I need to write my stuff (after all, Wikipedia is half run by machines!), send my ‘copy’ through the ether, so to speak, and read the newspaper where my article will be ‘printed’ also from far away. I well remember when I used to dictate my articles over the phone to patient tachygraphers at a cost perhaps higher than what I was paid for the piece. Still, like many others, I feel a vague disquiet at the as yet benign invasion of the robots.

Say’s Law

To allay my fears I remind myself, first, of Say’s Law and second, of the fate of horses. Let me start with Jean Baptiste Say (1767-1832). He was the French economist who introduced Adam Smith to French public opinion and to the learned classes of the European continent, most of whom read French rather than English. Say was born in a Protestant family that had taken refuge in the Swiss city of Geneva, fleeing persecution in France. The family returned to the textile city of Lyon, where Jean Baptiste was born. As a young man, he was sent by his father to England to see for himself how England was industrialising. It was not his only visit to the land of economic progress. Later in life he met and befriended the great economists of the time—David Ricardo, Thomas Malthus, James Mill, and John Ramsay McCulloch—and corrected and bettered some of the classical theories of English political economy. He published his successful Treatise of Political Economy in 1803. Napoleon invited him to dinner to try to make him correct some anti-protectionist and anti-statist passages in the book. Say, a moderate republican and a defender of individual liberty, did not comply. At different moments in his life, Say tried his hand at business—banking, insurance, cotton spinning, and sugar—variously succeeding and failing as an entrepreneur. In 1828-29 he published an ambitious Course of Political Economy in no less than six volumes. Say made signal contributions to economics. In price theory, he introduced utility into the demand side of price formation. He corrected Adam Smith by including services in the definition of wealth. Notably, he introduced the figure of the entrepreneur in the explanation of economic progress. Finally and in parallel with James Mill, he codified what is known as ‘Say’s Law’, to which I now turn in search of hope and consolation in a world beset with robots.[1]

One of the fears caused by robots is that total production in the economy will so increase that demand will not be sufficient to take it up, especially if people have become unemployed due to competition from non-humans. Could this bring about a general glut of the whole system? Would there then a crisis of overproduction, which might cause more unemployment? What Say’s law sets down is that the very fact of bringing goods to the market amounts to demanding goods in exchange. In the case of overproduction, the economy will tend to return to equilibrium if supply prices are flexible and are allowed to fall. This may take time, since the alarm caused by falling prices may lead to a period of money hoarding. In the long run, however and as Ricardo said, „there is no limit to demand,“ surprising or even shocking though this may sound to people who hate our consumptionist civilisation. This whole idea was summed up by Say in the following phrase: „Supply creates its own demand“.[2]

Disproportionate production

Say and his classical companions of course accepted that there could temporarily be excess production in one industry and shortages in another whose products were more demanded. This would be the case with path-breaking technological advances, such as steam threshing machines or mechanical knitting frames in the early 19th century (or robots today). Though not leading to general under-consumption, those advances would for a time bring technological unemployment in their wake, as workers were displaced by the new, more productive methods or by free trade. What is called ‘sunk capital’ can also be affected, so there may also be resistance put up by the owners of capital or land endangered by shifts in supply through new productive methods or through trade.

The revolts of workers who saw their wages fall because of competition from new machines are now a part of the social history of capitalism. In the years around 1810, summers were very wet in England, badly affecting crops. Also, the general blockade of trade with Britain decreed by Napoleon in Berlin and Milan in 1806 and 1807 throttled the import of grain and made bread unwontedly expensive. The wages got by threshing wheat from November to February in England gave employment in the lean winter months. Hostility to the new-fangled steam threshing machines erupted in an epidemic of machine breaking by crowds allegedly led by a legendary ‘Captain Ludd’—hence the name ‘Luddites’ applied to workers who wanted the competition of new machinery stopped. A repeat movement happened in the summer of 1830, dubbed the ‘Swing Letters’. Again, times were harsh in the hungry thirties. It was a time of political turmoil, what with the campaign for Parliamentary reform in England and the Revolution in France. Landlords who were known to use threshing machines in the Southern English counties received letters signed by a certain Captain Swing, threatening to break the threshers up and demanding higher wages.

This was not the only example of harsh technological competition suffered by manual workers. By 1830 the livelihood of some 400,000 handloom weavers was being threatened by the power-looms and knitting machines in the cotton mills. Those weavers were whole families who worked at home for merchants who ‘put out’ work at growingly extortionate rates, given the higher productivity of large factories. Petitions rained on Parliament. By 1840 the number of handloom weavers had fallen to 100,000, mainly specialised in silk fabrics and the more expensive cloths. The recourse to the 1834 Poor Law was felt to be a paltry remedy, since Poor Houses were organised on the principle that their standards should be less attractive than the least paid employment. A Royal Commission was formed to examine the plight of these workers, chaired by the economist Nassau William Senior. Famed for his understanding of the rapidly increasing productivity of the factory system when other classical economists saw England „within a hands breadth of the stationary state,“ Senior saw there was not much that could be done. Attrition had a human cost, but in the end an open door to radical technological change was the only answer. It is thus that the hungry 1830s and 40s turned into the more prosperous second half of the 19th century—helped by Robert Peel’s decision in 1844 to repeal the Corn Laws. The social safety net of today is much more comfortable than Dickensian poor houses. The opportunities of gainful employment, much greater.

What happened to horse-power?

When I say that the plight of working horses brings me some consolation as I think of the possible effect of robots on employment, I do not mean to belittle their centuries’ long contribution to the productive or destructive efforts of humanity. They were used in peaceful transport. Also, in all wars up to the middle of the 20th century, pack animals were used and sacrificed on the battlefields by their cruel and warring masters. I myself did my peacetime military service in a mounted regiment, where I learnt to ride the friendly beasts. In Hyde Park in the centre of London there stands a most affecting monument to the horses, mules, and donkeys misused by all armies in history. Anybody visiting London should take time to stop before it.

What I mean by linking the case of humans menaced by robots with that of horses displaced by the internal combustion engine is that there you have an example of job destruction by technological advance. The point I want to make is that horses could not and did not learn to drive motorcars and lorries. We men and women can learn new trades, albeit with some difficulty when we get older. Luddites are a danger to the very people they want to help because in the end progress will prevail.

The benefits of growth for the individual

Here is the crux of the matter. Technical advance makes for growth. The increasing use of robots is but a continuation of the story of triumphant capitalism. The countries of what we call the West have experienced a singular and unexpected two centuries of growth that is pulling the entire population out of poverty and into prosperity as never before in history. Now the rest of the world is joining in the ride, which we hope will last. There have been periods of growth in history that did not extend to the entire population of the world and ended in ruination. The examples that come to mind are those of Mesopotamia, Egypt, Rome, China, and the Aztec and Inca empires in America. In all of them the flame of growth died or was snuffed out by military disaster. Something quite different, however, happened in Britain around the beginning of the 19th century and then spread to continental Europe and North America. Productivity increased by leaps and bounds and was not even stopped by two world wars.

The size of these developments in the capacity to produce more with less are difficult to measure precisely. William Nordhaus, whose first claim to fame with the general public was his joint authorship with Paul Samuelson in the later editions of Economics, the textbook which has been the initiation rite of so many into the queen of social sciences. More recently, he has become one of the high priests of the new religion of climate change. Whatever the disagreements one might have with that textbook and this alarm, he is an outstanding professional economist. I want to draw attention to the striking way in which he has presented the growth of real wages from 1800. To calculate real wages he has to take nominal wages and deflate them by a price index. He finds much to query about the price indices normally used to do this calculation. He shows that price increases over the years are much exaggerated by not properly accounting for improvements in the quality of goods due to technological progress. The case he uses is that of lighting. Prices per ‘lumen’ (the measure of light intensity) have fallen much more quickly than shown by ordinary price indices. If the same method he uses for the true price of light is applied to general consumption (so as to take account of the incredible improvement of goods and services over the last hundred years), then real economic growth will turn out to have been much greater in the United States and Western Europe than is generally thought. „In terms of living standards, the conventional growth of real wages has been a factor of 13 over the 1800-1992 period.“ If the downward bias is corrected as Nordhaus thinks it should be on the lines of the cost of lighting, „real wages have grown by a factor of 970.“ Some growth! [3]

Let me show a graph I have used in a previous column, since it comes from so respected a pen as that of Angus Maddison. It shows the sudden increase in per capita production in the United States and the United Kingdom around 1840. The inflation adjustment is of the conventional kind: the productivity surge would be much larger if we used the Nordhaus method.

Figure 1. GDP Per Capita


Note: A graph compiled from Angus Maddison’s data comparing the GDP per capita of a few major economies since 1700 AD. Source: M Tracy Hunter: Own work, CC BY-SA 4.0,

A tax on robots?

Recently, Nobel laureate Robert J. Shiller has taken up the idea, characteristically hatched in the European Parliament, that a moderate tax should be laid on robots so as to put a brake on robot use. This tax would „slow the adoption of disruptive technologies“. He seems to be worried about the effects of robots in increasing inequality and considers the tax would „accord with our natural sense of justice“. The produce of the tax could then be used to finance an insurance fund to help the displaced workers who need time to change their calling. Professor Shiller seems to be another of those Nobel laureates who speaks outside his field of speciality, which in this case financial economics, not economic growth.[4]

What Shiller does not do is underline the trade-off between technical progress and anti-market regulation. In his future pronouncements in favour of a tax on robots he should pay some attention to worries generally expressed about the trend of economic growth in the United States and the rest of the Western world, especially Europe. I recently watched a TED talk by Professor Robert J. Gordon of Northwestern University.[5] As he has been doing for a number of years, he worried about the fall in the long term growth rate of the American and the world economy due to the lack of great technical innovations. He showed us pictures of 19th and 20th century transformative innovations that, he says, are not happening any more—water closets, electrical appliances such as washing machines and refrigerators, the internal combustion engine, airplanes or telephones—but he pictured no robots. Professor Gordon may turn out to be right in discounting robots and artificial intelligence as engines of growth, if the likes of Professor Shiller have their way. Luddites all!


[1] See Thomas Sowell’s doctoral thesis: Say’s Law. An Historical Analysis. Princeton University Press, 1972.

[2] One could not think of a view more contrary to the Keynesian idea that the main macroeconomic problem in a downturn is a failure of aggregate demand. Crises caused by the failure of misapplied investment suddenly revealed by a technical shift are characterised by a general thirst for cash or money hoarding. Capitalist growth is inevitably cyclical. It can be made less volatile by trying to keep the money supply stable, as Milton Friedman proposed. But this question is for another day.

[3] William D. Nordhaus: „Do Real Output and Real Wages Measures Capture Reality? The History of Lighting Suggests Not.“ NBER. PDF file.

[4] Robert J. Shiller: „Why robots should be taxed if they take people’s jobs“The Guardian, March 27, 2017.

[5] Robert J. Gordon, „The death of innovation, the end of growth,“. TED 2013.

The Rise, Fall, and Renaissance of Classical Liberalism – Ralph Raico

Originally published over several months in 1992, Raico’s brief history of classical liberalism was written in memory of Roy A. Childs, Jr. You can read the original here in three installments.

Part 1

Classical liberalism — or simply liberalism, as it was called until around the turn of the century — is the signature political philosophy of Western civilization. Hints and suggestions of the liberal idea can be found in other great cultures. But it was the distinctive society produced in Europe — and in the outposts of Europe, above all, America — that served as the seedbed of liberalism. In turn, that society was decisively shaped by the liberal movement.

Decentralization and the division of power have been the hallmarks of the history of Europe. After the fall of Rome, no empire was ever able to dominate the continent. Instead, Europe, became a complex mosaic of competing nations, principalities, and city-states. The various rulers found themselves in competition with each other. If one of them indulged in predatory taxation or arbitrary confiscations of property, he might well lose his most productive citizens, who could “exit,” together with their capital. The kings also found powerful rivals in ambitious barons and in religious authorities who were backed by an international Church. Parliaments emerged that limited the taxing power of the king, and free cities arose with special charters that put the merchant elite in charge.

By the Middle Ages, many parts of Europe, especially in the west, had developed a culture friendly to property rights and trade. On the philosophical level, the doctrine of natural law — deriving from the Stoic philosophers of Greece and Rome — taught that the natural order was independent of human design and that rulers were subordinate to the eternal laws of justice. Natural-law doctrine was upheld by the Church and promulgated in the great universities, from Oxford and Salamanca to Prague and Krakow.

As the modern age began, rulers started to shake free of age-old customary constraints on their power. Royal absolutism became the main tendency of the time. The kings of Europe raised a novel claim: they declared that they were appointed by God to be the fountainhead of all life and activity in society. Accordingly, they sought to direct religion, culture, politics, and, especially, the economic life of the people. To support their burgeoning bureaucracies and constant wars, the rulers required ever-increasing quantities of taxes, which they tried to squeeze out of their subjects in ways that were contrary to precedent and custom.

The first people to revolt against this system were the Dutch. After a struggle that lasted for decades, they won their independence from Spain and proceeded to set up a unique polity. The United Provinces, as the radically decentralized state was called, had no king and little power at the federal level. Making money was the passion of these busy manufacturers and traders: they had no time for hunting heretics or suppressing new ideas. Thus, de facto religious toleration and a wide-ranging freedom of the press came to prevail. Devoted to industry and trade, the Dutch established a legal system based solidly on the rule of law and the sanctity of property and contract. Taxes were low, and everyone worked. The Dutch “economic miracle” was the wonder of the age. Thoughtful observers throughout Europe noted the Dutch success with great interest.

A society in many ways similar to Holland had developed across the North Sea. In the 17th century, England, too, was threatened by royal absolutism, in the form of the House of Stuart. The response was revolution, civil war, the beheading of one king and the booting out of another. In the course of this tumultuous century, the first movements and thinkers appeared who can be unequivocally identified as liberal.

With the king gone, a group of middle-class radicals emerged called the Levellers. They protested that not even Parliament had any authority to usurp the natural, God-given rights of the people. Religion, they declared, was a matter of individual conscience: it should have no connection with the state. State-granted monopolies were likewise an infringement of natural liberty. A generation later, John Locke, drawing on the tradition of natural law that had been kept alive and elaborated by the Scholastic theologians, set forth a powerful liberal model of man, society, and state. Every man, he held, is innately endowed with certain natural rights. These consist in his fundamental right to what is his property — that is, his life, liberty, and “estates” (or material goods). Government is formed simply the better to preserve the right to property. When, instead of protecting the natural rights of the people, a government makes war upon them, the people may alter or abolish it. The Lockean philosophy continued to exert influence in England for generations to come. In time, its greatest impact would be in the English-speaking colonies in North America.

The society that emerged in England after the victory over absolutism began to score astonishing successes in economic and cultural life. Thinkers from the continent, especially in France, grew interested. Some, like Voltaire and Montesquieu, came to see for themselves. Just as Holland had acted as a model before, now the example of England began to influence foreign philosophers and statesmen. The decentralization that has always marked Europe allowed the English “experiment” to take place and its success to act as a spur to other nations.

In the 18th century, thinkers were discovering a momentous fact about social life: given a situation where men enjoyed their natural rights, society more or less runs itself. In Scotland, a succession of brilliant writers that included David Hume and Adam Smith outlined the theory of the spontaneous evolution of social institutions. They demonstrated how immensely complex and vitally useful institutions — language. morality, the common law, above all, the market — originate and develop not as the product of the designing minds of social engineers, but as the result of the interactions of all the members of society pursuing their individual goals.

In France, economists were coming to similar conclusions. The greatest of them, Turgot, set forth the rationale for the free market:

“The policy to pursue, therefore, is to follow the course of nature, without pretending to direct it For, in order to direct trade and commerce it would be necessary to be able to have knowledge of all of the variations of needs, interests, and human industry in such detail as is physically impossible to obtain even by the most able, active, and circumstantial government. And even if a government did possess such a multitude of detailed knowledge, the result would be to let things go precisely as they do of themselves, by the sole action of the interests of men prompted by free competition.”

The French economists coined a term for the policy of freedom in economic life: they called it laissez-faire. Meanwhile, starting in the early 17th century, colonists coming mainly from England had established a new society on the eastern shores of North America. Under the influence of the ideas the colonists brought with them and the institutions they developed, a unique way of life came into being. There was no aristocracy and very little government of any kind. Instead of aspiring to political power, the colonists worked to carve out a decent existence for themselves and their families.

Fiercely independent, they were equally committed to the peaceful — and profitable — exchange of goods. A complex network of trade sprang up, and by the mid-18th century, the colonists were already more affluent than any other commoners in the world. Self-help was the guiding star in the realm of spiritual values as well. Churches, colleges, lending-libraries, newspapers, lecture-institutes, and cultural societies flourished through the voluntary cooperation of the citizens.

When events led to a war for independence, the prevailing view of society was that it basically ran itself. As Tom Paine declared:

“Formal government makes but a small part of civilized life. It is to the great and fundamental principles of society and civilization — to the unceasing circulation of interest, which passing through its million channels, invigorates the whole mass of civilized man — it is to these, infinitely more than to anything which even the best instituted government can perform that the safety and prosperity of the individual and the whole depend. In fine, society performs for itself almost everything which is ascribed to government. Government is no further necessary than to supply the few cases to which society and civilization are not conveniently competent.”

In time, the new society formed on the philosophy of natural rights would serve as an even more luminous exemplar of liberalism to the world than had Holland and England before it.

Part 2: Triumphs and Challenges

As the nineteenth century began, classical liberalism — or just liberalism as the philosophy of freedom was then known — was the specter haunting Europe — and the world. In every advanced country the liberal movement was active.

Drawn mainly from the middle classes, it included people from widely contrasting religious and philosophical backgrounds. Christians, Jews, deists, agnostics, utilitarians, believers in natural rights, freethinkers, and traditionalists all found it possible to work towards one fundamental goal: expanding the area of the free functioning of society and diminishing the area of coercion and the state.

Emphases varied with the circumstances of different countries. Sometimes, as in Central and Eastern Europe, the liberals demanded the rollback of the absolutist state and even the residues of feudalism. Accordingly, the struggle centered around full private property rights in land, religious liberty, and the abolition of serfdom. In Western Europe, the liberals often had to fight for free trade, full freedom of the press, and the rule of law as sovereign over state functionaries.

In America, the liberal country par excellence, the chief aim was to fend off incursions of government power pushed by Alexander Hamilton and his centralizing successors, and, eventually, somehow, to deal with the great stain on American freedom — Negro slavery.

From the standpoint of liberalism, the United States was remarkably lucky from the start. Its founding document, the Declaration of Independence, was composed by Thomas Jefferson, one of the leading liberal thinkers of his time. The Declaration radiated the vision of society as consisting of individuals enjoying their natural rights and pursuing their self-determined goals. In the Constitution and the Bill of Rights, the Founders created a system where power would be divided, limited, and hemmed in by multiple constraints, while individuals went about the quest for fulfillment through work, family, friends, self-cultivation, and the dense network of voluntary associations. In this new land, government — as European travelers noted with awe — could hardly be said to exist at all. This was the America that became a model to the world.

One perpetuator of the Jeffersonian tradition in the early 19th century was William Leggett, a New York journalist and antislavery Jacksonian Democrat. Leggett declared:

“All governments are instituted for the protection of person and property; and the people only delegate to their rulers such powers as are indispensable to these objects. The people want no government to regulate their private concerns, or to prescribe the course and mete out the profits of their industry. Protect their persons and property, and all the rest they can do for themselves.”

This laissez-faire philosophy became the bedrock creed of countless Americans of all classes. In the generations to come, it found an echo in the work of liberal writers like R L. Godkin, Albert Jay Nock, H. L. Mencken, Frank Chodorov, and Leonard Read. To the rest of the world, this was the distinctively, characteristically American outlook.

Meanwhile, the economic advance that had been slowly gaining momentum in the Western world burst out in a great leap forward. First in Britain, then in America and Western Europe, the Industrial Revolution transformed the life of man as nothing had since the neolithic age. Now it became possible for the vast majority of mankind to escape the immemorial misery they had grown to accept as their unalterable lot. Now tens of millions who would have perished in the inefficient economy of the old order were able to survive. As the populations of Europe and America swelled to unprecedented levels, the new masses gradually achieved living standards unimaginable for working people before.

The birth of the industrial order was accompanied by economic dislocations. How could it have been otherwise? The free-market economists preached the solution: security of property and hard money to encourage capital formation, free trade to maximize efficiency in production, and a clear field for entrepreneurs eager to innovate. But conservatives, threatened in their age-old status, initiated a literary assault on the new system, giving the Industrial Revolution a bad name from which it never fully recovered. Soon the attack was gleefully taken up by groups of socialist intellectuals that began to emerge.

Still, by mid-century the liberals went from one victory to another. Constitutions with guarantees of basic rights were adopted, legal systems firmly anchoring the rule of law and property rights were put in place, and free trade was spreading, giving birth to a world economy based on the gold standard.

There were advances on the intellectual front as well. After spearheading the campaign to abolish the English Corn Laws, Richard Cobden developed the theory of nonintervention in the affairs of other countries as a foundation for peace. Frederic Bastiat put the case for free trade, non intervention, and peace in a classic form. Liberal historians like Thomas Macaulay and Augustin Thierry uncovered the roots of freedom in the West. Later in the century, the economic theory of the free market was placed on a secure scientific footing with the rise of the Austrian School, inaugurated by Carl Menger.

The relation of liberalism and religion presented a special problem. In continental Europe and Latin America, freethinking liberals sometimes used the state power to curtail the influence of the Catholic Church, while some Catholic leaders clung to obsolete ideas of theocratic control. But liberal thinkers like Benjamin Constant, Alexis de Tocqueville, and Lord Acton saw beyond such futile disputes. They stressed the crucial role that religion, separated from government power, could play in stemming the growth of the centralized state. In this way, they prepared the ground for the reconciliation of liberty and religious faith.

Then, for reasons still unclear, the tide began to turn against the liberals. Part of the reason is surely the rise of the new class of intellectuals that proliferated everywhere. That they owed their very existence to the wealth generated by the capitalist system did not prevent most of them from incessantly gnawing away at capitalism, indicting it for every problem they could point to in modern society.

At the same time, voluntary solutions to these problems were preempted by state functionaries anxious to expand their domain. The rise of democracy may well have contributed to liberalism’s decline by aggravating an age-old feature of politics: the scramble for special privilege. Businesses, labor unions, farmers, bureaucrats, and other interest groups vied for state privileges — and found intellectual demagogues to rationalize their depredations. The area of state control grew, at the expense, as William Graham Sumner pointed out, of “the forgotten man” — the quiet, productive individual who asks no favor of government and, through his work, keeps the whole system going.

By the end of the century, liberalism was being battered on all sides. Nationalists and imperialists condemned it for promoting an insipid peace instead of a virile and bracing belligerency among the nations. Socialists attacked it for upholding the “anarchical” free-market system instead of “scientific” central planning. Even church leaders disparaged liberalism for its alleged egotism and materialism. In America and Britain, social reformers around the dawn of the century conceived a particularly clever gambit. Anywhere else the supporters of state intervention and coercive labor-unionism would have been called “socialists” or “social democrats.” But since the English-speaking peoples appeared for some reason to have an aversion to those labels, they hijacked the term “liberal.”

Though they fought on to the end, a mood of despondency settled on the last of the great authentic liberals. When Herbert Spencer began writing in the 1840s, he had looked forward to an age of universal progress in which the coercive state apparatus would practically disappear. By 1884, Spencer could pen an essay entitled, “The Coming Slavery.” In 1898, William Graham Sumner, American Spencerian, free-trader, and gold-standard advocate, looked with dismay as America started on the road to imperialism and global entanglement in the Spanish-American War: he titled his response to that war, grimly, “The Conquest of the United States by Spain.”

Everywhere in Europe there was a reversion to the policies of the absolutist state, as government bureaucracies expanded. At the same time, jealous rivalries among the Great Powers led to a frenzied arms race and sharpened the threat of war. In 1914, a Serb assassin threw a spark onto the heaped-up animosity and suspicion, and the result was the most destructive war in history to that point. In 1917, an American president keen to create a New World Order led his country into the murderous conflict “War is the health of the state,” warned the radical writer Randolph Bourne. And so it proved to be. By the time the butchery ended, many believed that liberalism in its classical sense was dead.

Part 3: The 20th Century

The First World War was the watershed of the twentieth century. Itself the product of antiliberal ideas and policies, such as militarism and protectionism, the Great War fostered statism in every form. In Europe and America, the trend towards state intervention accelerated, as governments conscripted, censored, inflated, ran up mountains of debts, co-opted business and labor, and seized control of the economy. Everywhere “progressive” intellectuals saw their dreams coming true. Thee old laissez-faire liberalism was dead, they gloated, and the future belonged to collectivism. The only question seemed to be: which kind of collectivism?

In Russia, the chaos of the war permitted a small group of Marxist revolutionaries to grab power and establish a field headquarters for world revolution. In the nineteenth century, Karl Marx had concocted a secular religion with a potent appeal. It held out the promise of the final liberation of man through replacing the complex, often baffling world of the market economy by conscious, “scientific” control. Put into practice by Lenin and Trotsky in Russia, the Marxist economic experiment resulted in catastrophe. For the next seventy years, Red rulers lurched from one patchwork expedient to another. But terror kept them firmly in charge, and the most colossal propaganda effort in history convinced intellectuals both in the West and in the emerging Third World that communism was, indeed, “the radiant future of all mankind.”

The peace treaties cobbled together by President Woodrow Wilson and the other Allied leaders left Europe a seething cauldron of resentment and hate. Seduced by nationalist demagogues and terrified of the Communist threat, millions of Europeans turned to the forms of state worship called Fascism and National Socialism, or Nazism. Though riddled with economic error, these doctrines promised prosperity and national power through integral state control of society, while fomenting more and greater wars.

In the democratic countries, milder forms of statism were the rule. Most insidious of all was the form that had been invented in the 1880s, in Germany. There Otto von Bismarck, the Iron Chancellor, devised a series of old-age, disability, accident, and sickness insurance schemes, run by the state. The German liberals of the time argued that such plans were simply a reversion to the paternalism of the absolutist monarchies. Bismarck won out, and his invention — the welfare state — was eventually copied everywhere in Europe, including the totalitarian countries. With the New Deal, the welfare state came to America.

Still, private property and free exchange continued as the basic organizing principles of Western economies. Competition, the profit motive, the steady accumulation of capital (including human capital), free trade, the perfecting of markets, increased specialization — all worked to promote efficiency and technical progress and with them higher living standards for the people. So powerful and resilient did this capitalist engine of productivity prove to be that widespread state intervention, coercive labor-unionism, even government-generated depressions and wars could not check economic growth in the long run.

The 1920s and ’30s represent the nadir of the classical-liberal movement in this century. Especially after government meddling with the monetary system led to the crash of 1929 and the Great Depression, dominant opinion held that history had closed the books on competitive capitalism, and with it the liberal philosophy.

If a date were to be put on the rebirth of classical liberalism, it would be 1922, the year of the publication of Socialism, by the Austrian economist Ludwig von Mises. One of the most remarkable thinkers of the century, Mises was also a man of unflinching courage. In Socialism, he threw down the gauntlet to the enemies of capitalism. In effect, he said: “You accuse the system of private property of causing all social evils, which only socialism can cure. Fine. But would you now kindly do something you have never deigned to do before: would you explain how a complex economic system will be able to operate in the absence of markets, and hence prices, for capital goods?” Mises demonstrated that economic calculation without private property was impossible, and exposed socialism for the passionate illusion it was.

Mises’s challenge to the prevailing orthodoxy opened the minds of thinkers in Europe and America. F.A. Hayek, Wilhelm Roepke, and Lionel Robbins were among those whom Mises converted to the free market. And, throughout his very long career, Mises elaborated and reformed his economic theory and social philosophy, becoming the acknowledged premier classical-liberal thinker of the twentieth century.

In Europe and particularly in the United States, scattered individuals and groups kept something of the old liberalism alive. At the London School of Economics and the University of Chicago, academics could be found, even in the 1930s and ’40s, who defended at least the basic validity of the free-enterprise idea. In America, an embattled brigade of brilliant writers, mainly journalists, survived. Now known as the “Old Right,” they included Albert Jay Nock, Frank Chodorov, H. L. Mencken, Felix Morley, and John T. Flynn. Spurred to action by the totalitarian implications of Franklin Roosevelt’s New Deal, these writers reiterated the traditional American creed of individual freedom and scornful distrust of government. They were equally opposed to Roosevelt’s policy of global meddling as subversive of the American Republic. Supported by a few courageous publishers and businessmen, the “Old Right” nursed the flame of Jeffersonian ideals through the darkest days of the New Deal and the Second World War.

With the end of that war, what can be called a movement came into being. Small at first, it was fed by multiplying streams. Hayek’s Road to Serfdom, published in 1944, alerted many thousands to the reality that, in pursuing socialist policies, the West was risking the loss of its traditional free civilization. In 1946, Leonard Read established The Foundation for Economic Education, in Irvington, New York, publishing the works of Henry Hazlitt and other champions of the free market. Mises and Hayek, now both in the United States, continued their work. Hayek led in founding the Mont Pelerin Society, a group of classical-liberal scholars, activists, and businessmen from all over the world. Mises, unsurpassed as a teacher, set up a seminar at New York University, attracting such students as Murray Rothbard and Israel Kirzner. Rothbard went on to wed the insights of Austrian economics to the teachings of natural law to produce a powerful synthesis that appealed to many of the young. At the University of Chicago, Milton Friedman, George Stigler, and Aaron Director led a group of classical-liberal economists whose specialty was exposing the defects of government action. The gifted novelist Ayn Rand incorporated emphatically libertarian themes in her well-crafted best-sellers, and even founded a school of philosophy.

The reaction to the renewal of authentic liberalism on the part of the left — “liberal” — more accurately, social-democrat-establishment was predictable, and ferocious. In 1954, for instance, Hayek edited a volume entitled Capitalism and the Historians, a collection of essays by distinguished scholars arguing against the prevailing socialist interpretation of the Industrial Revolution. A scholarly journal permitted Arthur Schlesinger, Jr., Harvard professor and New Deal hack, to savage the book in these terms: “Americans have enough trouble with home-grown McCarthys without importing Viennese professors to add academic luster to the process.” Other works the establishment tried to kill by silence. As late as 1962, not a single prominent magazine or newspaper chose to review Friedman’s Capitalism and Freedom. Still, the writers and activists who led the revival of classical liberalism found a growing resonance among the public. Millions of Americans in all walks of life had all along quietly cherished the values of the free market, and private property. The growing presence of a solid corps of intellectual leaders now gave many of these citizens the heart to stand up for the ideas they had held dear for so long.

In the 1970s and ’80s, with the evident failure of socialist planning and interventionist programs, classical liberalism became a world-wide movement. In Western countries, and then, incredibly, in the nations of the former Warsaw Pact, political leaders even declared themselves disciples of Hayek and Friedman. As the end of the century approached, the old, authentic liberalism was alive and well, stronger than it had been for a hundred years.

And yet, in Western countries, the state keeps on relentlessly expanding, colonizing one area of social life after the other. In America, the Republic is fast becoming a fading memory, as federal bureaucrats and global planners divert more and more power to the center. So the struggle continues, as it must. Two centuries ago, when liberalism was young, Jefferson had already informed us of the price of liberty.

Beyond GDP, A New Way To Measure The Economy – Mark Skousen

By Dr. Mark Skousen. First appeared on Forbes in 2013.

Starting in spring 2014, the Bureau of Economic Analysis will release a breakthrough new economic statistic on a quarterly basis.  It’s called Gross Output, a measure of total sales volume at all stages of production. GO is almost twice the size of GDP, the standard yardstick for measuring final goods and services produced in a year.

This is the first new economic aggregate since Gross Domestic Product (GDP) was introduced over fifty years ago.

It’s about time. Starting with my work The Structure of Production in 1990 and Economics on Trial in 1991, I have made the case that we needed a new statistic beyond GDP that measures spending throughout the entire production process, not just final output.  GO is a move in that direction – a personal triumph 25 years in the making.

GO attempts to measure total sales from the production of raw materials through intermediate producers to final retail.  Based on my research, GO is a better indicator of the business cycle, and most consistent with economic growth theory.

GO is a measure of the “make” economy, while GDP represents the “use” economy.  Both are essential to understanding how the economy works.

While GDP is a good measure of national economic performance, it has a major flaw:  In limiting itself to final output, GDP largely ignores or downplays the „make“ economy, that is, the supply chain and intermediate stages of production needed to produce all those finished goods and services.  This narrow focus of GDP has created much mischief in the media, government policy, and boardroom decision-making. For example, journalists are constantly overemphasizing consumer and government spending as the driving force behind the economy, rather than saving, business investment, and technological advances.  Since consumer spending represents 70% or more of GDP, followed by 20% by government, the media naively concludes that any slowdown in retail sales or government stimulus is necessarily bad for the economy.  (Private investment comes in a poor third at 13%.)

For instance, the New York Times recently reported, “Consumer spending makes up more than 70% of the economy, and it usually drives growth during economic recoveries.” (“Consumers Give Boost to Economy,” New York Times, May 1, 2010, p. B1)  Or as the Wall Street Journal stated a few years ago, “The housing bust has chilled consumer spending – the largest single driver of the U. S. economy…” (“Home Forecast Calls for Pain,” Wall Street Journal, September 21, 2011, p. A1.)

Or take this report during the economic recovery:

“Friday’s estimates of second-quarter gross domestic product [1.3%, well below consensus forecasts] provided a sobering look at how a decline in public spending and investment can restrain growth….The astonishingly slow growth rate from April through June was due in large part to sluggish consumer spending and an increase in imports, which subtract from growth numbers. But dwindling government spending also held back growth.”  (“The Role of Government Spending,” New York Times, July 29, 2011.)

In short, by focusing only on final output, GDP underestimates the money spent and economic activity generated at earlier stages in the production process. It’s as though the manufacturers and shippers and designers aren’t fully acknowledged in their contribution to overall growth or decline.

Gross Output exposes these misconceptions.  In my own research, I’ve discovered many benefits of GO statistics.  First, Gross Output provides a more accurate picture of what drives the economy.  Using GO as a more comprehensive measure of economic activity, spending by consumers turns out to represent around 40% of total yearly sales, not 70% as commonly reported. Spending by business (private investment plus intermediate inputs) is substantially bigger, representing over 50% of economic activity.  That’s more consistent with economic growth theory, which emphasizes productive saving and investment in technology on the producer side as the drivers of economic growth.  Consumer spending is largely the effect, not the cause, of prosperity.

Second, GO is significantly more sensitive to the business cycle.  During the 2008-09 Great Recession, nominal GDP fell only 2% (due largely to countercyclical increases in government), but GO collapsed by over 7%, and intermediate inputs by 10%.  Since 2009, nominal GDP has increased 3-4% a year, but GO has climbed more than 5% a year.   GO acts like the end of a waving fan.  (See chart below.)


I believe that Gross Output fills in a big piece of the macroeconomic puzzle.  It establishes the proper balance between production and consumption, between the „make“ and the „use“ economy, and it is more consistent with growth theory.   As Steve Landefeld, director of the BEA, and co-editors Dale Jorgenson and William Nordhaus state in their work, A New Architecture for the U. S. National Accounts (University of Chicago Press, 2006),  “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare.  Both are required in a complete system of accounts.”

Historical Background

The history of these two economic statistics goes back to several pioneers.  Two economists in particular had much in common – they were both Russian Americans who taught at Harvard University, and both won the Nobel Prize.  Simon Kuznets did breakthrough work on GDP statistics in the 1930s.  Following the Bretton Woods Agreement in 1946, GDP became the standard measure of economic growth.  A few years later, Wassily Leontief developed the first input-output tables, which he regarded as a better measure of the whole economy.  I-O accounts require examining the “intervening steps” between inputs and outputs in the production process, “a complex series of transactions…among real people.”

I-O data created the first estimates of Gross Output.  However, GO was not emphasized as an important macroeconomic tool until my own work, The Structure of Production, was published in 1990 by New York University Press.  In chapters 6 and 9, I created a universal four stage model of the economy (see the diagram below) demonstrating the relationship between total spending in the economy and final output.


In chapter 6, I made the point that GDP was not a complete picture of economic activity, and compared it to GO for the first time, contending that GO was more comprehensive and more accurately revealed that business investment was far bigger than consumption in the economy.

Since writing Structure, I discovered that the BEA’s Gross Output does not include all sales at the wholesale and retail level.  The BEA only includes value-added data for commodities after they become finished products.  Gross sales are ignored at the final two stages of production.  David Wasshausen, a BEA staff researcher, offers this rationale:  since “there is no further transformation of these goods…to the production process, they are excluded from wholesale/retail trade output.”

Therefore, in the 2nd edition of Structure, published in 2007, I created my own aggregate statistic, Gross Domestic Expenditures (GDE), which includes gross sales at the wholesale and retail level and is therefore significantly larger (more than double GDP).  For a comparison between GDE, GO and GDP, see my working paper.

The BEA has been compiling GO statistics from input-output data for years, but the media have largely ignored these figures because they came out only every five years (known as benchmark I-O tables).  Since the early 1990s, the BEA has been estimating industry accounts annually.  Even so, the data was never up-to-date like GDP.  (The latest input-output industry accounts are for 2011).

That has gradually changed. Under the leadership of BEA director Steve Landefeld, the BEA now has the budget to report the input-output data, including Gross Output, on a quarterly basis, and has already begun publishing quarterly data prior to 2012.  This is a major breakthrough involving the cooperation of the Bureau of the Census, Bureau of Labor Statistics, the Federal Reserve Board, and other government agencies.

Controversies Over This New Statistic

Several objections have been made over the years to the use of GO and GDE. Economists are especially fixated over the perceived problem of “double counting” with GO and GDE.  I am the first to note that GO and GDE involve double counting.  A commodity is often sold repeatedly as it goes through the resource, production, wholesale and retail stages.  Why not just measure the value added at each stage rather than double or triple count? they ask.  GDP eliminates double counting and measures only the value added at each stage.

There are several reasons why double counting should not be ignored and is actually a necessary feature to understanding the overall economy.  As accountants and financiers know, double counting is essential in business.  No company can operate or expand on the basis of value added or profits only. They must raise the capital necessary to cover the gross expenses of the company – wages and salaries, rents, interest, capital tools and equipment, supplies and goods-in-process.  GO and GDE reflect this vital business decision making at each stage of production.  Can publicly-traded firms ignore sales/revenues and only focus on earnings when they release their quarterly reports?  Wall Street would object.  Aggregate sales/revenues are important to measure on an individual firm and national basis.

In my own research, I find it interesting that GO and GDE are far more volatile than GDP during the business cycle.  As noted in the chart above, sales/revenues rise faster than GDP during an expansion, and collapse during a contraction (wholesale trade fell 20% in 2009; retail trade dropped over 7%).

Economists need to explore the meaning of this cyclical behavior in order to make accurate forecasts and policy recommendations.  Double counting counts.

Another objection involves outsourcing and merger/acquisitions.  Companies that start outsourcing their products will cause an increase in GO or GDE, while companies that merge with another company will show a sudden decrease, even though there is essentially no change in final output (GDP).

That’s a legitimate concern.  Similar problems occur with GDP.  When a homeowner marries the maid, the maid may no longer be paid and therefore her services may no longer be included in GDP.  Black market activities often fail to show up in GDP data as well.  Certainly if a significant trend develops in outsourcing or merger & acquisition activity, it will be reflected in GO or GDE statistics, but not necessarly in GDP.  It bears further investigation to see how serious this issue is.  No aggregate statistic is perfect, but GO and GDE offer forecasters an improved macro picture of the economy.

In conclusion, GO or GDE should be the starting point for measuring aggregate spending in the economy, as it measures both the “make” economy (intermediate production), and the “use” economy (final output).  It complements GDP and can easily be incorporated in standard national income accounting and macroeconomic analysis.  To see how, take a look at the 4th edition of my textbook, Economic Logic (Capital Press, 2014), available in paperback and Kindle.

Mark Skousen is editor of Forecasts & Strategies and a Presidential Fellow at Chapman University in 2014.  He is the author of The Structure of Production (New York University Press, 1990, 2007), which introduced the concept of Gross Output as an essential macroeconomic tool.  

Housing: Too Good to Be True – Mark Thornton

Reprinted from Mises InstitutePosted on 06/04/2004 by Mark Thornton.
It’s incredibly important to note the DATE on this article. This was published only a few months into the rise in subprime lending and private label securitization – which means it was written, probably, only a month or two into it. „Subprime“ was barely a thing and Thornton is already warning of a bubble.

Signs of a „new era“ in housing are everywhere. Housing construction is taking place at record rates. New records for real estate prices are being set across the country, especially on the east and west coasts. Booming home prices and record low interest rates are allowing homeowners to refinance their mortgages, „extract equity“ to increase their spending, and lower their monthly payment! As one loan officer explained to me: „It’s almost too good to be true.“

In fact, it is too good to be true. What the prophets of the new housing paradigm don’t discuss is that real estate markets have experienced similar cycles in the past and that periods described as new paradigms are often followed by periods of distress in real estate markets, including foreclosure sales, bankruptcy and bank failures.

The case of Japan’s real estate bubble is instructive. Japan had a stock market bubble in the 1980s that was very similar to the U.S. stock market bubble in the 1990s. As the Japanese stock market started to bust, the real estate market continued to bubble. One general index of Japanese real estate shows that prices rose for almost two years after the stock market crashed with prices staying above pre-crash levels for more than five years. The boom in home construction continued for nearly six years after the stock market crash. Prices for commercial, industrial, and residential real estate in Japan continue to fall and are now below the levels measured in 1985 when these statistics were first collected.

It has now been three years since the U.S. stock market crash. Greenspan has indicated that interest rates could soon reverse their course, while longer-term interest rates have already moved higher. Higher interest rates should trigger a reversal in the housing market and expose the fallacies of the new paradigm, including how the housing boom has helped cover up increases in price inflation. Unfortunately, this exposure will hurt homeowners and the larger problem could hit the American taxpayer, who could be forced to bailout the banks and government-sponsored mortgage guarantors who have encouraged irresponsible lending practices.

More Greenspam

Once again, Fed Chairman Alan Greenspan has created a new-age economic panacea, and earlier this year he applauded his contribution to the economic recovery: „very low interest rates and reduced taxes, have permitted relatively robust advances in residential construction and household expenditures. Indeed, residential construction activity moved up steadily over the year.“

The key to this panacea is the process of „equity extraction“ that occurs when people refinance their homes; they take equity out and spend it to increase their standard of living. However, because variable rate mortgages are so low, their payments actually go down so they have more of their income to spend, or they can upgrade to a more expensive house.  As Greenspan explained:

Other consumer outlays, financed partly by the large extraction of built-up equity in homes, have continued to trend up. Most equity extraction—reflecting the realized capital gains on home sales—usually occurs as a consequence of house turnover. But during the past year, an almost equal amount reflected the debt-financed cash-outs associated with an unprecedented surge in mortgage refinancings.

As is the norm, Greenspan hedges his statements. He also considers some of the potential drawbacks and pitfalls on the horizon for the new paradigm in housing, but in the end he concludes that we really have nothing to worry about. Low interest rates, rising home prices, and lower financing costs mean that we actually can have our cake (homes) and eat it too (equity extraction).

To be sure, the mortgage debt of homeowners relative to their income is high by historical norms. But as a consequence of low interest rates, the servicing requirement for the mortgage debt of homeowners relative to the corresponding disposable income of that group is well below the high levels of the early 1990s. Moreover, owing to continued large gains in residential real estate values, equity in homes has continued to rise despite sizable debt-financed extractions. Adding in the fixed costs associated with other financial obligations, such as rental payments of tenants, consumer installment credit, and auto leases, the total servicing costs faced by households relative to their incomes are below previous peaks and do not appear to be a significant cause for concern at this time.

The Housing Bubble

I first reported on the housing bubble in the U.S. at the beginning of this year when the bubble was already well under way, if not in full bloom. As the chart below indicates, real residential investment has jumped far above both its historical trend and even above its cyclical channel. This indicates to me that there is a bubble in residential real estate. The data for this chart stop at the beginning of 2003. We now know that investment in housing increased by 8.8% last year. This is a historically high rate of construction, but far from a record rate increase. However, 2003 marks the ninth year in a row that housing investment was positive, the first time that has ever occurred since the statistic has been collected. Frank Shostak and Christopher Mayer have also written very informative articles on the Housing bubble.

Recently I came across a piece of anecdotal evidence of a housing bubble. Last Sunday afternoon, a friend of mine put a „For Sale by Owner“ sign in the front lawn of a small house he owned on a side street. It wasn’t listed with a real estate agent or in the newspaper, but he nonetheless had a couple of calls that afternoon, with many more to follow, and within a couple of days he had multiple offers before finally accepting a bid that was over his original asking price.

Mainstream economists who discount the possibility of a housing bubble would dismiss such evidence. But they also ignore all the macro evidence of the current housing boom and see it as a positive development. For example, the number of new homes being constructed is at an all-time high, despite a „soft“ labor market. In the graph below, the annualized rate of new home construction is shown to have surpassed the two surges of the 1970s when inflation was out of control.

The prices of houses are also up, but mainstream economists have generally ignored this development as well; and as noted above, Greenspan sees this as a positive development. Some economists can even point to the Consumer Price Index which shows that the housing component in the CPI is steady or falling. And yet reports are coming out nearly every day saying that housing prices are up dramatically and setting records all across the country. Record prices have been recently reported in the San Francisco Bay Area, Denver, Boston, Las Vegas, the state of Washington, and even Buffalo, New York.

Nationally, the price of a median family home was up 15% between 2001 and 2003, with regional increases of 30% in the Northeast, 8.5% in the Midwest, 14.4% in the Southeast, and 20.4% in the West. Over the last year, increases have been reported as 18.7% in the Northeast, 1.9% in the Midwest, 3.8% in the Southeast, and 10.7% in the West, or 6.5% for the nation as a whole. Interestingly, the median price has actually dropped 7.2% in the Midwest and 7.3% in the South since peaking in the 3rd quarter of 2003, while prices have been generally flat in the West. Statistics from the last couple of quarters might therefore suggest that the housing bubble may have topped out, or at least temporarily cooled down, in most of the country.

Why have home prices been increasing? David Lereah, chief economist with the National Association of Realtors, explained: „It’s a simple matter of supply and demand…We continue to have more home buyers than sellers in most of the country, which results in tight housing inventories and higher rates of home price appreciation.“ Of course the cause of higher home prices is that the Federal Reserve has kept interest rates, and thus mortgage rates, at historically low rates so that people find it easier to finance homes. In fact, despite an 18% increase in home prices since 2001, the median monthly payment remained the same at $789/month and the „median payment as a percentage of income“ has actually fallen. This is the magic of monetary inflation, courtesy of Alan Greenspan.

Price inflation follows monetary inflation

The price of just about everything I buy is going up these days. Gasoline is higher, dairy products are higher, paper products and just about everything else—higher. Mainstream economists have sounded surprised by the recent upturn in price inflation and they have offered us every excuse to ignore signs of inflation: Ignore rising oil prices. Ignore rising food prices. Ignore rising health care costs. Ignore higher taxes and government fees. And then there is their dirty little secret about housing prices.

Higher price inflation should not have been a surprise given that the Fed has increased the money supply by 25% during the period 2001–2003. In addition, the price of basic commodities has been rising for many months and these higher commodity prices eventually turn up in the price of goods and services. One leading indicator of higher commodity prices is the Dow Jones Commodity Index (stock prices of major commodity producers). It has been rising since the fourth quarter of 2001 and has doubled in value since that time. This stock index is now higher than it has ever been, outside of the blip that occurred in mid-2002.

Only recently have commodity prices begun influencing government price indexes like the Producer Price Index and the Consumer Price Index. For the first four months of 2004 CPI-inflation increased at an annual rate of 4%, which is a higher rate than we have „experienced“ in the last few years. The Producer Price Index actually decreased in 2001, but has increased in 2002 and 2003. Over the last year, prices for finished producer goods increased 3.7% while at earlier stages of production the prices for intermediate goods increased by 5.1% and the prices of crude materials index surged 20.4%. This would suggest that there is plenty of price inflation still in the pipeline. The experience of the 1970s would suggest that price inflation adds fuel to housing bubbles because tangible assets like homes serve as a hedge against inflation.

The Dirty Secret

While this price inflation did not surprise me, the delay in its arrival did. That is, until I came across the dirty little secret in the CPI. With prices increasing all around us, there is one thing in Auburn, Alabama that seems to be in abundance with stable, if not declining prices. This „good“ is now being advertised on most streets throughout the town, whereas in the past it did not require much, if any, advertising over the twenty-plus years I have lived in this college town. This abundant good is apartments and rental houses.

It is a truly odd market when houses and apartments move in opposite directions. After all, houses and apartments are just different products in the same „market for housing.“ In Auburn, it is nearly impossible to find the kind of house you want to buy despite frantic building by construction companies, and yet rental properties (which include many smaller houses) seem to be readily available in all shapes and sizes. Has the population changed? Have people become anti-rent? Or are we just in a „new housing paradigm“? Is this a „new era“ of homes?

Greenspan’s low interest rates have driven renters to become homeowners and knocked the market out of equilibrium. Underneath this Fed-inspired distortion rests the dirty little secret of how the cost of housing has served to limit increases in measured inflation. The Consumer Price Index has underreported price inflation because the government uses the rental value of housing, rather the actual price of houses, in their index.

In the basket of goods used to calculate CPI, the goods that have increased slower than housing include food and beverages, recreation, and education, which total to about a 30% weighting of the CPI basket of goods. Housing accounts for 42% of the basket, with housing „prices“ representing almost 25% of the entire basket. However, housing prices are calculated with „Owner’s equivalent rent“ which is an estimate of the rent that people would have to pay for their houses. With home prices rising and rental rates stagnant, CPI underestimates the real rate of price inflation over the last year by about 50%.

Do Housing Bubbles Burst?

Housing prices never, or rarely, go down. That is the conventional wisdom and the conventional wisdom is correct. Housing is always a good investment, isn’t it? It’s an inflation hedge and it’s an investment that you get to use everyday, plus you get a great tax break. And the home, after all, is a big part of the American dream.

However, government can screw up just about everything. Given enough power and time it will screw up everything. Housing and real estate in America is just the latest example. The Federal Reserve and the Mac-May family (Freddie, Fannie, Sallie, etc.) have conspired to create a housing bubble in the U.S. and as the old saying goes, „what goes up must come down.“ It’s only a matter of time.

Housing bubbles typically do not pop like a balloon; they don’t even crash like stock markets. Rather, the air in housing bubbles tends to leak out slowly—painfully slowly—while in commercial real estate markets there is a more noticeable hiss. We really don’t know the current value of our homes until we sell them. They are not traded on a daily basis, like shares of stock in Wal-Mart. Some never get exchanged in the market, but are passed on within a family from generation to generation. The market value of a home may drop 20% and the owner might never realize it.

Worse yet, when the market for real estate collapses, prices are less likely to collapse because when buyers fail to make offers houses simply don’t sell. Sellers often resist cutting their prices in favor of just leaving the house on the market or taking it off the market. Traditionally the market adjustment to a collapse in real estate markets has come from the quantity side, not the price side—fewer houses are sold—while price reductions tend to come gradually. This doesn’t mean that housing bubbles can’t exist or that the bust is any less painful, only that it doesn’t make as much noise.

It is difficult to predict how long bubbles will last and when they will go bust. The best indicator is interest rates, because when the Fed forces rates down it tends to create bubbles, and when rates are forced upward bubbles tend to pop. My guess is that Greenspan will raise rates after the election. The rates of interest on long-term bonds have already „spiked“ up from their historical lows. The chart below shows the recent increase in the interest rate on 10-Year Treasury bonds to the highest levels in almost two years.

Prior to this spike up, interest rates had been falling since the early 1980s. As mentioned above, lower rates have coaxed people into refinancing their homes and drawing equity out of their homes to spend on other purchases, like cars, boats, renovations, vacations, or even investments in the stock market. As a result, owner equity as a percentage of real estate value is now at an all-time low.

Here is the unmentioned problem with Greenspan’s panacea. What happens to all these „equity poor“ homeowners if the return of monetary inflation establishes a new trend of higher prices and higher interest rates over the coming years?

An ever-increasing proportion of mortgage financing has come in the form of variable-rate mortgages, where the payment increases as interest rates increase. In my experience, variable-rate mortgages come with a „cap“ that only allows the variable rate to increase by a certain amount. Even with the cap, however, your mortgage payment could increase by around 50%. I have recently learned that many variable-rate loans are now offered without a cap. If rates were to explode upward, mortgage payments for these folks could double or triple. And if this did happen, the housing market would collapse with sellers swamping buyers.

Given the government’s encouragement of lax lending practices, home prices could crash, bankruptcies would increase, and financial companies, including the government-sponsored mortgage companies, might require another taxpayer bailout.

Of course inflation might not materialize. Interest rates could stay low. In a recent column, I reported on a new book that even predicts that deflation will reign in our financial future. Greenspan has suggested that his economic panacea has given American homeowners greater economic „flexibility.“ I would suggest that it is not flexibility he offers, but the shackles to an economic nightmare. Stick with the fixed-rate mortgages, keep the equity in your homes, or go get one of those cheap apartments.

Are the Austrians Too Harsh? – John P. Cochran

Reprinted from Mises Institute

Randall W. Forsyth, writing for Barron’s early spring 2009, wrote about Austrian economists, „Their ideas warned us of the bubble; their prescription for the bust is too harsh, however.“1 Now that the NBER has announced that the current „Great Recession“ ended in June 2009, after 18 months, let’s reexamine this claim. First, the end date clearly indicates that the 2009 stimulus had no discernable impact on either the timing or the depth of the trough. Subsequent economic activity clearly should cause one to question whether the $800 billion package sped recovery at all.

In fact a better question is the one raised by the Wall Street Journal, in „A Tale of Two Recoveries“: Did Keynesian policies do more harm than good? The Journal, sounding much like Robert Higgs, answers in the affirmative. „Our view is that hyperkinetic government policies have done more harm than good, leading to uncertainty and higher costs that have undermined business and consumer confidence and slowed the economy’s otherwise natural recuperative powers.“2

The Journal, then, granting NBER’s chronology, contrasts the current recession and „recovery“ with the almost equally long (16 months) and severe (unemployment peaked above 11 percent) recession of July 1981–November 1982 and subsequent recovery. Their conclusion is that the different policy circumstances significantly explain the drastically different recovery paths: following the trough in late 1982, the economy rapidly surpassed the prerecession levels of output. But currently, nearly 15 months past the trough, our economy is still significantly below prerecession levels.3

Most telling is the numbers on Gross Private Domestic Investment (GPDI). Approximately one year past the November 1982 trough, GPDI was up over 8 percent from the prerecession peak. In contrast, in April 2010, nearly 11 months past the June 2009 trough, GPDI was down 21 percent from the prerecession peak. The policy differences are falling marginal tax rates and reductions of regulatory burdens across the economy in the early ’80s compared to the current expansion of government, the increasing likelihood of significantly rising tax burdens, increasing burdens of regulation from Obamacare, and recent finance-reform legislation that increases the burden on firms (both financial and nonfinancial) while also adding great uncertainty. Current regime uncertainty is only increased by card check and cap and trade, which are possibilities — if not through legislation then through regulatory sleight of hand.

While what the Austrians have said about the cause of the boom and bust is, per Forsyth, gaining increasing recognition and acceptance, what the Austrians have said about recession and recovery is either ignored or grossly distorted. The distortions are based both on misunderstandings of theory and misinterpretations of the historical record. The Austrian understanding of recession and recovery is firmly rooted in the best microeconomics and tied to a capital-structure-based approach to macroeconomics.4

The Austrian understanding also has significant support in properly interpreted historical events.5  Booms are created when money and credit creation misdirect resources and production — the boom is the result of a central-bank-driven mini–calculation failure. The transition from boom to bust begins as the inconsistencies in business plans become apparent. Because of this distortion of the capital structure, „the recession periods of the business cycle then become inevitable, for the recession is the necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources.“6

Recessions are the discovery-of-error phase of the cycle. Unemployment results, not from deficient aggregate demand, but, per Hayek, from „a discrepancy between the distribution of labor (and other factors of production) among industries (and localities) and the distribution of demand among products.“7 During a recession, errors are discovered and resources are released and made available for use in potentially higher-value production processes.

Recovery is the phase of the cycle where misallocated resources are redirected to uses more consistent with consumer preferences. The process of reabsorbing an economy’s various unemployed resources into new or expanding enterprises (i.e., economic recovery) potentially begins in the same moment that the discovery of and adjustment to previous errors and resource misallocations takes place (i.e., recession). If all resources were perfectly homogenous and all prices, wages, and interest rates perfectly flexible, then the recession and recovery phases would indeed be a single process. But declines in economic activity are coupled with factors like nonhomogenous, often task-specific capital goods, price rigidities, and time lags in adjustment processes. This means that the recession phase precedes the recovery, which is a second and lagging phase. As will be discussed later, recession is even further prolonged (and recovery further delayed) by interventions, especially by policies or reforms that create an environment of „regime uncertainty.“

Recovery, like growth and development, requires forward-looking planning. Here, perhaps the best guide to policy comes from the developing literature examining the institutions that best support economic growth and development.8 What best makes societies rich is also what is most likely to bring about recovery and to return the economy to sustainable growth. Austrian capital theory implies that a significant portion of current economic activity is directed not to current, but to future consumption.9 Planning and calculation include decisions on reinvestment to maintain current levels of production into the future as well as new investment for expansion and new enterprises, all of which are future oriented.

Recovery, like sustained growth, requires an environment that facilitates the planning and development of projects (which will create current jobs), most of which will be directed toward future consumption. Austrians have historically emphasized impediments to adjustment caused by the by the nonhomogenous nature and varying specificity of many capital goods and some „human capital“ misdirected during the previous boom. These are a given aspect of any restructuring of an economy and they are unique to each crisis.

These malinvestments do have the potential to create losses and impede reallocation, but there is no necessary connection between the length of the boom, the degree of misallocations, and the actual severity of the recession and the length of the recovery process. One also has to take into consideration whether markets are being allowed to work, whether the „regime“ is certain — stable, predictable, and consistent with stated policy — and whether the policy is conducive to entrepreneurship and prudent risk taking. Policies that impede competition and impose excessive tax burdens — or that in any way simply add to costs, reduce expected returns, or increase the uncertainty of the results and returns from business activity — are seen as the most important factors in forestalling recovery and turning economic corrections into stagnation, stagflation, or depression.10

Historically, policies and actions that threaten property rights create „regime uncertainty“ or „regime worsening.“ Such policies have a two-pronged negative impact on the economy: they prolong the recession phases and they delay recovery.

Economic history and institutional analysis give us good insights into what impedes recovery and/or retards growth. Theory supported by that history indicates that an institutional framework of sound money, easy and predictable taxes, a stable legal environment built on rule of law and contract enforcement, regime certainty,11and broadly competitive markets encourage successful long-run planning and development.

What then would be the Austrian policy recommendations for today’s problems? First, according to Hayek and Rothbard, stop the credit creation and inflation.12 Then, per Hayek, prevent a secondary deflation. Further, remove all government impediments to effective entrepreneurial planning by avoiding protectionist measures and allowing prices and wages to adjust as needed to restore market equilibrium. Cut tax rates, as was done in the incomplete reforms of the 1980s and during the crisis of 2001–2003, and drastically reduce the government budget.13 To prevent future boom-bust episodes, reform the monetary system from the current government monopoly to a market-determined medium of exchange.14

What is actually being done to mitigate the recession and promote recovery? Is it consistent with a framework that promotes entrepreneurial planning and job creation? Or is it more closely aligned with failed policies of the past that have retarded recovery and promoted stagnation? The Fed balance sheet is at $2 trillion and growing. The crucial question is, does the current monetary-policy response create significant problems moving forward? Does it set up significant future price-inflation problems, a possible collapse of the dollar, stagflation, and/or another boom-bust sequence?

Complicating the picture of moving forward and „unwinding“ the Fed’s current position is pressure from some to target not price stability but a 5–6 percent inflation rate in the CPI. Some economists believe that the correct target for the federal-funds rate should now be significantly negative and with an actual effective limit of zero, pushing the Fed to undertake operations over and beyond the traditional targeting of the federal-funds rate.15

Instead of fiscal constraint and tax decreases, there is a massive expansion of government spending both actual and proposed, a guaranteed massive tax increase when the 2001–2003 tax cuts expire automatically at the end of 2010, targeted tax increases on the rich (those making over $250,000), and a proposed cap and-trade-policy to fight global warming (which policy is in fact a massive tax increase on productive and consumption activity that uses fossil fuel energy).

Instead of privatization, government is organizing takeovers and bailouts of private business in the automotive, health, and financial sectors. Many of these actions have been conducted in ways that violate contracts and the rule of law. There are proposed wasteful government misdirections of production through subsidies and directives, such as an energy policy that promises „green jobs.“ Even more significant is a concerted verbal assault on economic freedom and therefore the threat of „regime worsening“ on a large scale.16 Combined, these factors have predictable long-run negative impacts on the economy.

In the absence of real reform, Rothbard saw the alternatives for the American economy in the 1980s as a choice between a 1929-type depression and an inflationary depression of massive proportions.17 Among possible alternatives, the most likely outcome today is a return of a 1970s-style decade-long period of high unemployment and inflation. Also possible are a decade-long Japanese-style stagnation and a permanent Eurosclerosis. There is, however, still time to turn course and follow the Austrian path to sustainable prosperity. End government intervention in the economy and return to a sound money policy. Such a policy has been dubbed as harsh or too draconian; but the pain of a short, severe recession followed by renewed, sustainable growth and prosperity may actually be „comfortable and moderate compared to the economic hell of permanent inflation, stagnation, high unemployment, and inflationary depression“ that is the likely outcome of a continuation of our current policy.18

  • 1.Forsyth, Randall W. „Ignoring the Austrians Got Us in this Mess,“ Barron’s, March 12, 2009.
  • 2.„Review and Outlook: A Tale of Two Recoveries,“ The Wall Street Journal. Tuesday, September 21, 2010, p. A20. For samples of Robert Higgs’s excellent running commentary on the current economic climate, see “Credit Shortage or Regime Uncertainty.”
  • 3.See the following figures for GDP, private sector jobs, and retail sales.
  • 4.An Austrian interpretation of recession and recovery is discussed more fully in my upcoming 2010 paper: Cochran, John P. „Capital in Disequilibrium: Understanding the „Great Recession’ and Potential for Recovery.“ The Quarterly Journal of Austrian Economics. Much of what follows draws heavily on parts of that paper, which was drafted in the spring and early summer of 2009.
  • 5.How inappropriate policy of the type discussed in this article created depressions, prolonged recessions, and delayed recovery is well documented in work by Rothbard, Higgs, Ohanian, Gallaway and Vedder, Smiley, and Murphy. This includes the great depression and the depression within a depression, the 1936–37. The „forgotten depression“ of 1920–21 (Woods) and the depression that was not — 1946 (Gallaway and Vedder and Higgs) provide strong evidence of the effectiveness of Austrian medicine as does the „German miracle“ (White). See the list of additional readings.
  • 6.Rothbard, Murray N. America’s Great Depression. Auburn, AL: Ludwig von Mises Institute, 2000 [1963], p. xxvii.
  • 7.Hayek, Friedrich A. Unemployment and Monetary Policy: Government as Generator of the „Business Cycle.“ San Francisco, CA: Cato Institute, 1979, p. 8.
  • 8.The period from 1980 to 2005 illustrates how well markets can perform when freed even marginally from some of the collectivists’ constraints of the past. Shleifer characterizes this period as the „Age of Milton Friedman.“ Shleifer, Andrei. „The Age of Milton Friedman.“ Journal of Economic Literature, 47:1, 2009, pp. 123–135. Per Shleifer „Between 1980 and 2005, as the world embraced free market policies, living standards rose sharply, while life expectancy, educational attainment, and democracy improved and absolute poverty declined“ (p. 123). He then asks, „Is this a coincidence?“ After reviewing competing claims he concludes, „On strategy, economics got the right answer: free market policies, supported but not encumbered by the government, deliver growth and prosperity“ (p. 135). I thank Steve Hanke for this reference. Capital structure as a key component of economic development is explored in detail and in a historical context in Shenoy, Sudha R. „Investment Chains Through History; or, An Historian’s Outline of Development: ‘Using Goods of Ever Higher Orders.'“ Indian Journal of Economics and Business, Special Issue. 2007, pp. 185–215.
  • 9.See Skousen Skousen, Mark. The Structure of Production; with a New Introduction. New York and London: New York University Press, 2007 [1990], pp. xi–xxxix) for an excellent summary. Skousen recommends moving toward a measure of Gross Domestic Expenditures to get a more realistic picture of the importance of business spending (future oriented) in total current economic activity. Whereas consumption appears to be approximately 70 percent of the economy based on GDP, measures of economic activity more in line with a capital-structure view of the economy drop this number closer to 30 (p. xvi).
  • 10.For a similar argument see Becker, Gary S., Davis, Steven J, and Murphy, Kevin M. „Uncertainty and the Slow Recovery.“ Wall Street Journal, January 4, 2010, p. A 17.
  • 11.Higgs, Robert. „Regime Uncertainty: Why the Great Depression Lasted so Long and Why Prosperity Resumed After the War,“ The Independent Review. 1 (4), 1997, pp. 561–90; Shleifer, Andrei. „The Age of Milton Friedman.“ Journal of Economic Literature, 47:1, 2009, pp. 123–135
  • 12.Rothbard, Murray N. America’s Great Depression, pp. 185–86; Hayek, Unemployment and Monetary Policy, pp. 15-19.
  • 13.Rothbard, America’s Great Depression, pp. 185–86.
  • 14.„I do not believe that we would have major industrial fluctuations if it were not for the present banking system, which in turn depends on the government monopoly of the supply of money. I have been driven into proposing the denationalization of money. “ Hayek continues, „Anyhow, depressions are not the result of the operation of the market. They are the result of government controls, particularly in the sphere of monetary policy.“ Hayek quoted in Pizano, Diego. Conversations with Great Economists. Jorge Pinto Books, 2009, p. 10. See also the concluding section in Garrison, Roger W. „Interest-Rate Targeting During the Great Moderation.“ Cato Journal, vol. 29, no. 1 (Winter) 2009, pp. 187–200.
  • 15.See Ducca, DiMartino, and Reneir. „Fed Confronts Crisis by Expanding Role as Lender of Last Resort,“ Economic Letter: Insights from the Federal Reserve Bank of Dallas, vol. 4, no. 2, February/March 2009 for a well-presented overview of the extraordinary recent activities of the Fed. See also Ceccheti, Stephen G. „Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis.“ Journal of Economic Perspectives. Vol. 23, Number 1 (Winter) 2009, pp. 51–75; Garrison, „Interest-Rate Targeting“; and Taylor, John B. „The Financial Crisis and the Policy Response: An Empirical Analysis of What Went Wrong.“ Unpublished 2008.
  • 16.Powell, Benjamin. „U. S. Recession Policies: Nothing New Under the (Rising) Sun.“ The Intercollegiate Review, (Fall) 2009, pp. 13–21.
  • 17.Rothbard, America’s Great Depression. p. xxiii.
  • 18.Rothbard, America’s Great Depression. p. xxvii.

The Intellectual Yet Idiot – Nassim N. Taleb

Author: Nassim Nicholas Taleb

What we have been seeing worldwide, from India to the UK to the US, is the rebellion against the inner circle of no-skin-in-the-game policymaking “clerks” and journalists-insiders, that class of paternalistic semi-intellectual experts with some Ivy league, Oxford-Cambridge, or similar label-driven education who are telling the rest of us 1) what to do, 2) what to eat, 3) how to speak, 4) how to think… and 5) who to vote for.

But the problem is the one-eyed following the blind: these self-described members of the “intelligentsia” can’t find a coconut in Coconut Island, meaning they aren’t intelligent enough to define intelligence hence fall into circularities — but their main skill is capacity to pass exams written by people like them. With psychology papers replicating less than 40%, dietary advice reversing after 30 years of fatphobia, macroeconomic analysis working worse than astrology, the appointment of Bernanke who was less than clueless of the risks, and pharmaceutical trials replicating at best only 1/3 of the time, people are perfectly entitled to rely on their own ancestral instinct and listen to their grandmothers (or Montaigne and such filtered classical knowledge) with a better track record than these policymaking goons.

Indeed one can see that these academico-bureaucrats who feel entitled to run our lives aren’t even rigorous, whether in medical statistics or policymaking. They can’t tell science from scientism — in fact in their image-oriented minds scientism looks more scientific than real science. (For instance it is trivial to show the following: much of what the Cass-Sunstein-Richard Thaler types — those who want to “nudge” us into some behavior — much of what they would classify as “rational” or “irrational” (or some such categories indicating deviation from a desired or prescribed protocol) comes from their misunderstanding of probability theory and cosmetic use of first-order models.) They are also prone to mistake the ensemble for the linear aggregation of its components as we saw in the chapter extending the minority rule.

The Intellectual Yet Idiot is a production of modernity hence has been accelerating since the mid twentieth century, to reach its local supremum today, along with the broad category of people without skin-in-the-game who have been invading many walks of life. Why? Simply, in most countries, the government’s role is between five and ten times what it was a century ago (expressed in percentage of GDP). The IYI seems ubiquitous in our lives but is still a small minority and is rarely seen outside specialized outlets, think tanks, the media, and universities — most people have proper jobs and there are not many openings for the IYI.

Beware the semi-erudite who thinks he is an erudite. He fails to naturally detect sophistry.

The IYI pathologizes others for doing things he doesn’t understand without ever realizing it is his understanding that may be limited. He thinks people should act according to their best interests and he knows their interests, particularly if they are “red necks” or English non-crisp-vowel class who voted for Brexit. When plebeians do something that makes sense to them, but not to him, the IYI uses the term “uneducated”. What we generally call participation in the political process, he calls by two distinct designations: “democracy” when it fits the IYI, and “populism” when the plebeians dare voting in a way that contradicts his preferences. While rich people believe in one tax dollar one vote, more humanistic ones in one man one vote, Monsanto in one lobbyist one vote, the IYI believes in one Ivy League degree one-vote, with some equivalence for foreign elite schools and PhDs as these are needed in the club.

More socially, the IYI subscribes to The New Yorker. He never curses on twitter. He speaks of “equality of races” and “economic equality” but never went out drinking with a minority cab driver (again, no real skin in the game as the concept is foreign to the IYI). Those in the U.K. have been taken for a ride by Tony Blair. The modern IYI has attended more than one TEDx talks in person or watched more than two TED talks on Youtube. Not only did he vote for Hillary Monsanto-Malmaison because she seems electable and some such circular reasoning, but holds that anyone who doesn’t do so is mentally ill.

The IYI has a copy of the first hardback edition of The Black Swan on his shelves, but mistakes absence of evidence for evidence of absence. He believes that GMOs are “science”, that the “technology” is not different from conventional breeding as a result of his readiness to confuse science with scientism.

Typically, the IYI get the first order logic right, but not second-order (or higher) effects making him totally incompetent in complex domains. In the comfort of his suburban home with 2-car garage, he advocated the “removal” of Gadhafi because he was “a dictator”, not realizing that removals have consequences (recall that he has no skin in the game and doesn’t pay for results).

The IYI has been wrong, historically, on Stalinism, Maoism, GMOs, Iraq, Libya, Syria, lobotomies, urban planning, low carbohydrate diets, gym machines, behaviorism, transfats, freudianism, portfolio theory, linear regression, Gaussianism, Salafism, dynamic stochastic equilibrium modeling, housing projects, selfish gene, election forecasting models, Bernie Madoff (pre-blowup) and p-values. But he is convinced that his current position is right.

The IYI is member of a club to get traveling privileges; if social scientist he uses statistics without knowing how they are derived (like Steven Pinker and psycholophasters in general); when in the UK, he goes to literary festivals; he drinks red wine with steak (never white); he used to believe that fat was harmful and has now completely reversed; he takes statins because his doctor told him to do so; he fails to understand ergodicity and when explained to him, he forgets about it soon later; he doesn’t use Yiddish words even when talking business; he studies grammar before speaking a language; he has a cousin who worked with someone who knows the Queen; he has never read Frederic Dard, Libanius Antiochus, Michael Oakeshot, John Gray, Amianus Marcellinus, Ibn Battuta, Saadiah Gaon, or Joseph De Maistre; he has never gotten drunk with Russians; he never drank to the point when one starts breaking glasses (or, preferably, chairs); he doesn’t even know the difference between Hecate and Hecuba (which in Brooklynese is “can’t tell sh**t from shinola”); he doesn’t know that there is no difference between “pseudointellectual” and “intellectual” in the absence of skin in the game; has mentioned quantum mechanics at least twice in the past five years in conversations that had nothing to do with physics.

He knows at any point in time what his words or actions are doing to his reputation.

But a much easier marker: he doesn’t even deadlift.


From the reactions to this piece, I discovered that the IYI has difficulty, when reading, in differentiating between the satirical and the literal.


The IYI thinks this criticism of IYIs means “everybody is an idiot”, not realizing that their group represents, as we said, a tiny minority — but they don’t like their sense of entitlement to be challenged and although they treat the rest of humans as inferiors, they don’t like it when the waterhose is turned to the opposite direction (what the French call arroseur arrosé). (For instance, Richard Thaler, partner of the dangerous GMO advocate Übernudger Cass Sunstein, interpreted this piece as saying that “there are not many non-idiots not called Taleb”, not realizing that people like him are < 1% or even .1% of the population.)

Post-Post Postscript

(Written after the surprise election of 2016; the chapter above was written several months prior to the event). The election of Trump was so absurd to them and didn’t fit their worldview by such a large margin that they failed to find instructions in their textbook on how to react. It was exactly as on Candid Camera, imagine the characteristic look on someone’s face after they pull a trick on him, and the person is at a loss about how to react.

Or, more interestingly, imagine the looks and reaction of someone who thought he was happily married making an unscheduled return home and hears his wife squealing in bed with a (huge) doorman.

Pretty much everything forecasters, subforecasters, superforecasters, political “scientists”, psychologists, intellectuals, campaigners, “consultants”, big data scientists, everything they know was instantly shown to be a hoax. So my mischievous dream of putting a rat inside someone’s shirt (as expressed in The Black Swan) suddenly came true.