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Irving Fisher

  Irving Fisher was one of America’s greatest mathematical economists and one of the clearest economics writers of all time. He had the intellect to use mathematics in virtually all his theories and the good sense to introduce it only after he had clearly explained the central principles in words. And he explained very well. Fisher’s Theory of Interest is written so clearly that graduate economics students can read—and understand—half the book in one sitting, something unheard of in technical economics. Although he damaged his reputation by insisting throughout the Great Depression that recovery was imminent, contemporary economic models of interest and capital are based on Fisherian principles. Similarly, monetarism is founded on Fisher’s principles of money and prices. Fisher called interest “an index of a community’s preference for a dollar of present [income] over a dollar of future income.” He labeled his theory of interest the “impatience and opportunity” theory. Interest rates, Fisher postulated, result from the interaction of two forces: the “time preference” people have for capital now, and the investment opportunity principle (that income invested now will yield greater income in the future). This reasoning sounds very much like Eugen von Böhm-Bawerk’s. Indeed, Fisher dedicated Theory of Interest to “the memory of John Rae and of Eugen von Böhm-Bawerk, who laid the foundations upon which I have endeavored to build.” But Fisher objected to Böhm-Bawerk’s idea that roundaboutness necessarily increases production, arguing instead that at a positive interest rate, no one would ever choose a longer period unless it were more productive. So if we look at processes selected, we do find that longer periods are more productive. But, he argued, the length of the period does not in itself contribute to productivity.     Fisher defined capital as any asset that produces a flow of income over time. A flow of income is distinct from the stock of capital that generated it, although the two are linked by the interest rate. Specifically, wrote Fisher, the value of capital is the present value of the flow of (net) income that the asset generates. This still is how economists think about capital and income today. Fisher also opposed conventional income taxation and favored a tax on consumption to replace it. His position followed directly from his capital theory. When people save out of current income and then use the savings to invest in capital goods that yield income later, noted Fisher, they are being taxed on the income they used to buy the capital goods and then are being taxed later on the income the capital generates. This, he said, is double taxation of saving, and it biases the tax code against saving and in favor of consumption. Fisher’s reasoning is still used by economists today in making the case for consumption taxes. Fisher was a pioneer in the construction and use of price indexes. James Tobin of Yale called him “the greatest expert of all time on index numbers.”1 Indeed, from 1923 to 1936, his own Index Number Institute computed price indexes from all over the world. Fisher was also the first economist to distinguish clearly between real and nominal interest rates. He pointed out that the real interest rate is equal to the nominal interest rate (the one we observe) minus the expected inflation rate. If the nominal interest rate is 12 percent, for example, but people expect inflation of 7 percent, then the real interest rate is only 5 percent. Again, this is still the basic understanding of modern economists. Fisher laid out a more modern quantity theory of money (i.e., monetarism) than had been done before. He formulated his theory in terms of the equation of exchange, which says that MV = PT, where M equals the stock of money; V equals velocity, or how quickly money circulates in an economy; P equals the price level; and T equals the total volume of transactions. Again, modern economists still draw on this equation, although they usually use the version MV = Py, where y stands for real income. The equation can be a very powerful tool for checking the consistency of one’s thinking about the economy. Indeed, Reagan economist Beryl Sprinkel, who was the U.S. Treasury undersecretary for monetary affairs in 1981, used this equation to criticize his colleague David Stockman’s economic forecasts. Sprinkel pointed out that the only way Stockman’s assumptions about the growth of income, the inflation rate, and the growth of the money supply could prove true would be if velocity increased faster than it ever had before. As it turned out, velocity actually declined. Irving Fisher was born in upstate New York in 1867. He gained an eclectic education at Yale, studying science and philosophy. He published poetry and works on astronomy, mechanics, and geometry. But his greatest concentration was on mathematics and economics, the latter having no academic department at Yale. Nonetheless, Fisher earned the first Ph.D. in economics ever awarded by Yale. After graduation he stayed at Yale for the rest of his career. A three-year struggle with tuberculosis beginning in 1898 left Fisher with a profound interest in health and hygiene. He took up vegetarianism and exercise and wrote a national best-seller titled How to Live: Rules for Healthful Living Based on Modern Science, whose value he demonstrated by living until age eighty. He campaigned for Prohibition, peace, and eugenics. He was a founder or president of numerous associations and agencies, including the Econometric Society and the American Economic Association. He was also a successful inventor. In 1925 his firm, which held the patent on his “visible card index” system, merged with its main competitor to form what later was known as Remington Rand and then Sperry Rand. Although the merger made him very wealthy, he lost a large part of his wealth in the stock market crash of 1929. Selected Works   1906. The Nature of Capital and Income. New York: Macmillan. 1907. The Rate of Interest. New York: Macmillan. 1911. The Purchasing Power of Money. New York: Macmillan. 1921. “Dollar Stabilization.” Encyclopedia Britannica 30: 852–853. Available online at: http://www.econlib.org/library/Essays/fshEnc1.html. 1922. The Making of Index Numbers. Boston: Houghton Mifflin. 1922. The Purchasing Power of Money. New rev. edition. Available online at: http://www.econlib.org/library/YPDBooks/Fisher/fshPPM.html. 1930. The Theory of Interest. New York: Macmillan. Available online at: http://www.econlib.org/library/YPDBooks/Fisher/fshToI.html.   Footnotes 1. James Tobin, “Irving Fisher,” in The New Palgrave: A Dictionary of Economics Vol. 2. Ed. John Eatwell, Murray Milgate, and Peter Newman. (New York: Stockton Press, 1987), pp. 369–376.   (0 COMMENTS)

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Henry George

  Henry George is best remembered as a proponent of the “single tax” on land. The government should finance all of its projects, he argued, with proceeds from only one tax. This single tax would be on the unimproved value of land—the value that the land would have if it were in its natural state with no buildings, no landscaping, and so on. George’s idea was not new; it was largely borrowed from David Ricardo, James Mill, and John Stuart Mill. In his heyday Henry George was very popular, with his ideas inspiring passionate debate among young intellectuals. After George published Progress and Poverty in 1879, a political movement grew in the United States around his work. He later narrowly missed being elected mayor of New York. Most taxes, noted George, stifle productive behavior. A tax on income reduces people’s incentive to earn income, a tax on wheat would reduce wheat production, and so on. But a tax on the unimproved value of land is different. The value of land comes from two components, its natural value and the value that is created by improving it (by building on it, for example). The value of a vacant lot in its natural state comes not from any sacrifice or opportunity cost borne by the owners of the land, but rather from demand for a fixed amount of land. Therefore, argued George, because the value of the unimproved land is unearned, neither the land’s value nor a tax on the land’s value can affect productive behavior. If land were taxed more heavily, the quantity available would not decline, as with other goods; nor would demand decline because of land’s productive uses. By taxing the whole of the value of unimproved land, the government would drive the price of land to zero. George was not simply trying to design a system of taxation devoid of untoward consequences; he felt that virtually all economic problems arise from “the fact that the land on which and from which all must live is made exclusive property of some.” His goal was nothing less than to make all land common property, but he realized that, “[i]t is not necessary to confiscate land; it is only necessary to confiscate rent.” George was right that other taxes may have stronger disincentives, but some economists now recognize that the single land tax is not innocent, either. Site values are created, not intrinsic. Why else would land in Tokyo be worth so much more than land in Mississippi? A tax on the value of a site is really a tax on productive potential, which is a result of improvements to land in the area. Henry George’s proposed tax on one piece of land is, in effect, based on the improvements made to the neighboring land. And what if you are your “neighbor”? What if you buy a large expanse of land and raise the value of one portion of it by improving the surrounding land. Then you are taxed based on your improvements. This is not far-fetched. It is precisely what the Disney Corporation did in Florida. Disney bought up large amounts of land around the area where it planned to build Disney World, and then made this surrounding land more valuable by building Disney World. Had George’s single tax on land been in existence, Disney might never have made the investment. So even a tax on unimproved land can reduce incentives. As certain as George was that “the value of land can always be readily distinguished from the value of improvements,” he was aware that over a long period some improvements blend with the natural state of the land and can be “considered part of the value of that land.” George was also aware that “[a]bsolute accuracy is impossible in any system, and to attempt to separate all that the human race has done from what nature originally provided would be as absurd as impracticable.” Frank Knight argued that the entire value of land is the value of its improvements because of a need to discover it and bring it into production. Zachary Gochenour and Bryan Caplan have pointed out that while the surface value of land is more apparent, especially for farming purposes, many lands have hidden natural resources, such as gold, water, and oil. These resources require investment on the part of owners to discover and produce. “Information about the land can be considered an improvement in its own right.” To tax the entire, or even a large, value of the mineral resources would create enormous disincentives for exploration and production.1 Objections aside, Henry George may have been arguing for what is really the least offensive tax. As Milton Friedman said almost a century after George’s death: “In my opinion, the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago” (Mark Blaug. Economica, New Series, 47, no. 188 [1980] p. 472). Henry George was also a passionate advocate of free trade and opponent of protectionism. He saw clearly that protectionism is a misleading term for barriers to trade and identified whom “protectionism” hurts. George wrote: To every trade there must be two parties who mutually desire to trade, and whose actions are reciprocal. No one can buy unless he can find some one willing to sell; and no one can sell unless there is some other one willing to buy. If Americans did not want to buy foreign goods, foreign goods could not be sold here even if there were no tariff. The efficient cause of the trade which our tariff aims to prevent is the desire of Americans to buy foreign goods, not the desire of foreign producers to sell them. Thus protection really prevents what the “protected” themselves want to do. It is not from foreigners that protection preserves and defends us; it is from ourselves. (Henry George 1980, Protection or Free Trade, pp. 45–46) About the Author Charles L. Hooper holds an M.S. in engineering-economic systems from Stanford University and is a visiting fellow with the Hoover Institution. He is president of Objective Insights, a consulting company. Selected Works   1879. Progress and Poverty. 1912 ed. Garden City, N.Y.: Doubleday, Page. Available online at: http://www.econlib.org/library/YPDBooks/George/grgPP.html. 1886. Protection or Free Trade. 1905 ed. New York: Doubleday, Page. Available online at: http://www.econlib.org/library/YPDBooks/George/grgPFT.html   Footnotes 1. Zachary Gochenour and Bryan Caplan, “A Search-Theoretic Critique of Georgism, February 4, 2012”, online edition http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1999105.   (0 COMMENTS)

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Jeremy Bentham

  British economist Jeremy Bentham is most often associated with his theory of utilitarianism, the idea that all social actions should be evaluated by the axiom “It is the greatest happiness of the greatest number that is the measure of right and wrong.” Counter to Adam Smith’s vision of “natural rights,” Bentham believed that there were no natural rights to be interfered with. Trained in law, Bentham never practiced, choosing instead to focus on judicial and legal reforms. His reform plans went beyond rewriting legislative acts to include detailed administrative plans to implement his proposals. In his plan for prisons, workhouses, and other institutions, Bentham devised compensation schemes, building designs, worker timetables, and even new accounting systems. A guiding principle of Bentham’s schemes was that incentives should be designed “to make it each man’s interest to observe on every occasion that conduct which it is his duty to observe.” Interestingly, Bentham’s thinking led him to the conclusion, which he shared with Smith, that professors should not be salaried. In his early years Bentham professed a free-market approach. He argued, for example, that interest rates should be free from government control (see Defence of Usury). By the end of his life he had shifted to a more interventionist stance. He predated Keynes in his advocacy of expansionist monetary policies to achieve full employment and advocated a range of interventions, including the minimum wage and guaranteed employment. His publications were few, but Bentham influenced many during his lifetime and lived to see some of his political reforms enacted shortly before his death in London at the age of eighty-four. Selected Works   1787. Defence of Usury. London: T. Payne and Son. 1789. An Introduction to the Principles of Morals and Legislation. London: T. Payne and Son. 1802. The Theory of Legislation. 1818. Defence of Usury. 4th ed. London: Payne and Foss. Available online at: http://www.econlib.org/library/Bentham/bnthUs.html (The fourth edition was the last published in Bentham’s lifetime.) 1823. An Introduction to the Principles of Morals and Legislation. London: Clarendon Press, 1907. Available online at: http://www.econlib.org/library/Bentham/bnthPML.html (This is a reprint of the 1823 edition, the last published in Bentham’s lifetime, which was corrected and modified by Bentham.)   (0 COMMENTS)

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Eugen von Böhm-Bawerk

Eugen von Böhm-Bawerk was one of the leading members of the Austrian school of economics—an approach to economic thought founded by Carl Menger and augmented by Knut Wicksell, Ludwig von Mises, Friedrich A. Hayek, and Sir John Hicks. Böhm-Bawerk’s work became so well known that before World War I, his Marxist contemporaries regarded the Austrians as their typical bourgeois, intellectual enemies. His theories of interest and capital were catalysts in the development of economics, but today his original work receives little attention. Böhm-Bawerk gave three reasons why interest rates are positive. First, people’s marginal utility of income will fall over time because they expect higher income in the future. Second, for psychological reasons the marginal utility of a good declines with time. For both reasons, which economists now call “positive time-preference,” people are willing to pay positive interest rates to get access to resources in the present, and they insist on being paid interest if they are to give up such access. Economists have accepted both as valid reasons for positive time-preference. But Böhm-Bawerk’s third reason—the “technical superiority of present over future goods”—was more controversial and harder to understand. Production, he noted, is roundabout, meaning that it takes time. It uses capital, which is produced, to transform nonproduced factors of production—such as land and labor—into output. Roundabout production methods mean that the same amount of input can yield a greater output. Böhm-Bawerk reasoned that the net return to capital is the result of the greater value produced by roundaboutness. An example helps illustrate the point. As the leader of a primitive fishing village, you are able to send out the townspeople to catch enough fish, with their bare hands, to ensure the village’s survival for one day. But if you forgo consumption of fish for one day and use that labor to produce nets, hooks, and lines—capital—each fisherman can catch more fish the following day and the days thereafter. Capital is productive. Further investment in capital, argued Böhm-Bawerk, increases roundaboutness; that is, it lengthens the production period. On this basis Böhm-Bawerk concluded that the net physical productivity of capital will lead to positive interest rates even if the first two reasons do not hold. Although his theory of capital is one of the cornerstones of Austrian economics, modern mainstream economists pay no attention to Böhm-Bawerk’s analysis of roundaboutness. Instead, they accept Irving Fisher’s approach of just assuming that there are investment opportunities that make capital productive. Nevertheless, Böhm-Bawerk’s approach helped to pave the way for modern interest theory. Böhm-Bawerk was also one of the first economists to discuss Karl Marx’s views seriously. He argued that interest does not exist due to exploitation of workers. Workers would get the whole of what they helped produce only if production were instantaneous. But because production is roundabout, he wrote, some of the product that Marx attributed to workers must go to finance this roundaboutness, that is, must go to capital. Böhm-Bawerk noted that interest would have to be paid no matter who owned the capital. Mainstream economists still accept this argument. Böhm-Bawerk was born in Vienna and studied law at

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James M. Buchanan

James Buchanan is the cofounder, along with Gordon Tullock, of public choice theory. Buchanan entered the University of Chicago’s graduate economics program as a “libertarian socialist.” After six weeks of taking Frank Knight’s course in price theory, recalls Buchanan, he had been converted into a zealous free marketer. Buchanan’s next big conversion came while reading an article in German by Swedish economist Knut Wicksell. The obscure 1896 article’s message was that only taxes and government spending that are unanimously approved can be justified. That way, argued Wicksell, taxes used to pay for programs would have to be taken from those who benefited from those programs. Wicksell’s idea contradicted the mainstream 1940s view that there need be no connection between what a taxpayer pays and what he receives in benefits. That is still the mainstream view. But Buchanan found it persuasive. He translated the essay into English and started thinking more along Wicksell’s lines. One of the products of his thinking was a book he coauthored with Gordon Tullock titled The Calculus of Consent. In it the authors showed that the unanimity requirement is unworkable in practice and considered modifications to the rule that they called “workable unanimity.” Their book, along with Anthony Downs’s An Economic Theory of Democracy, helped start the field of public choice and is now considered a classic. Together, Buchanan and Tullock also started the academic journal Public Choice. Perhaps Buchanan’s most important contribution to economics is his distinction between two levels of public choice—the initial level at which a constitution is chosen, and the postconstitutional level. The first is like setting the rules of a game, and the second is like playing the game within the rules. Buchanan has proselytized his fellow economists to think more about the first level instead of acting as political players at the second level. To spread this way of thinking, Buchanan even started a new journal called Constitutional Economics. Buchanan also believes that because costs are subjective, much of welfare economics—cost-benefit analysis, and so on—is wrongheaded. He spelled out these views in detail in Cost and Choice, an uncommonly impassioned economics book. Yet Buchanan has not persuaded most of his economist colleagues on this issue. Buchanan was awarded the 1986 Nobel Prize in economics for “his development of the contractual and constitutional bases for the theory of economic and political decision making.” Buchanan was born in Murfreesboro, Tennessee, and has spent most of his academic life in Virginia, first at the University of Virginia, then at Virginia Polytechnic Institute and State University, and most recently at George Mason University. In 1969 Buchanan became the first director of the Center for the Study of Public Choice. He was president of the Southern Economic Association in 1963 and of the Western Economic Association in 1983 and 1984, and vice president of the American Economic Association in 1971. Selected Works   1962 (with Gordon Tullock). The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor: University of Michigan Press. Available online at: http://www.econlib.org/library/Buchanan/buchCv3Contents.html. 1968. The Demand and Supply of Public Goods. Chicago: Rand McNally. Available online at: http://www.econlib.org/library/Buchanan/buchCv5Contents.html. 1969. Cost and Choice. Chicago: Markham. Available online at: http://www.econlib.org/library/Buchanan/buchCv6Contents.html. 1973. “Introduction: L.S.E. Cost Theory in Retrospect.” In James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost. London: Weidenfeld and Nicolson. Available online at: http://www.econlib.org/library/NPDBooks/Thirlby/bcthLS1.html. 1975 (with Robert P. Tollison). The Limits of Liberty. Chicago: University of Chicago Press. Available online at: http://www.econlib.org/library/Buchanan/buchCv7Contents.html. 1977. Freedom in Constitutional Contract. College Station: Texas A&M University Press. 1980 (with Geoffrey Brennan). The Power to Tax. Cambridge: Cambridge University Press. Available online at: http://www.econlib.org/library/Buchanan/buchCv9Contents.html. 1962+ The Collected Works of James M. Buchanan. Available online at: http://www.econlib.org/library/Buchanan/buchCContents.html.   (0 COMMENTS)

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Ronald H. Coase

  Ronald Coase received the Nobel Prize in 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.” Coase is an unusual economist for the twentieth century, and a highly unusual Nobel Prize winner. First, his writings are sparse. In a sixty-year career he wrote only about a dozen significant papers—and very few insignificant ones. Second, he uses little or no mathematics, disdaining what he calls “blackboard economics.” Yet his impact on economics has been profound. That impact stems almost entirely from two of his articles, one published when he was twenty-seven and the other published twenty-three years later. Coase conceived of the first article, “The Nature of the Firm,” while he was an undergraduate on a trip to the United States from his native Britain. At the time he was a socialist, and he dropped in on perennial Socialist Party presidential candidate Norman Thomas. He also visited Ford and General Motors and came up with a puzzle: how could economists say that Lenin was wrong in thinking that the Russian economy could be run like one big factory, when some big firms in the United States seemed to be run very well? In answering his own question, Coase came up with a fundamental insight about why firms exist. Firms are like centrally planned economies, he wrote, but unlike the latter they are formed because of people’s voluntary choices. But why do people make these choices? The answer, wrote Coase, is “marketing costs.” (Economists now use the term “transaction costs.”) If markets were costless to use, firms would not exist. Instead, people would make arm’s-length transactions. But because markets are costly to use, the most efficient production process often takes place in a firm. His explanation of why firms exist is now the accepted one and has given rise to a whole literature on the issue. Coase’s article was cited 169 times in academic journals between 1966 and 1980. “The Problem of Social Cost,” Coase’s other widely cited article (661 citations between 1966 and 1980), was even more pathbreaking; indeed, it gave rise to the field called law and economics. Economists before Coase of virtually all political persuasions had accepted British economist Arthur Pigou’s idea that if, say, a cattle rancher’s cows destroy his neighboring farmer’s crops, the government should stop the rancher from letting his cattle roam free or should at least tax him for doing so. Otherwise, believed economists, the cattle would continue to destroy crops because the rancher would have no incentive to stop them. But Coase challenged the accepted view. He pointed out that if the rancher had no legal liability for destroying the farmer’s crops, and if transaction costs were zero, the farmer could come to a mutually beneficial agreement with the rancher under which the farmer paid the rancher to cut back on his herd of cattle. This would happen, argued Coase, if the damage from additional cattle exceeded the rancher’s net returns on these cattle. If, for example, the rancher’s net return on a steer was two dollars, then the rancher would accept some amount over two dollars to give up the additional steer. If the steer was doing three dollars’ worth of harm to the crops, then the farmer would be willing to pay the rancher up to three dollars to get rid of the steer. A mutually beneficial bargain would be struck. Coase considered what would happen if the courts made the rancher liable for the damage caused by his steers. Economists had thought that the number of steers raised by the rancher would be affected. But Coase showed that the only thing affected would be the wealth of the rancher and the farmer; the number of cattle and the amount of crop damage, he showed, would be the same. In the above example, the farmer would insist that the rancher pay at least three dollars for the right to have the extra steer roaming free. But because the extra steer was worth only two dollars to the rancher, he would be willing to pay only up to two dollars. Therefore, the steer would not be raised, the same outcome as when the rancher was not liable. This insight was stunning. It meant that the case for government intervention was weaker than economists had thought. Yet Coase’s soulmates at the free-market-oriented University of Chicago wondered, according to George Stigler, “how so fine an economist could make such an obvious mistake.” So they invited Coase, who was then at the University of Virginia, to come to Chicago to discuss it. They had dinner at the home of Aaron Director, the economist who had founded the Journal of Law and Economics. Stigler recalled: We strongly objected to this heresy. Milton Friedman did most of the talking, as usual. He also did much of the thinking, as usual. In the course of two hours of argument the vote went from twenty against and one for Coase to twenty-one for Coase. What an exhilarating event! I lamented afterward that we had not had the clairvoyance to tape it.1 Stigler himself labeled Coase’s insight the Coase theorem. Of course, because transaction costs are never zero and sometimes are very high, courts are still needed to adjudicate between farmers and ranchers. Moreover, strategic behavior by the parties involved can prevent them from reaching the agreement, even if the gains from agreeing outweigh the transactions costs. So, why were economists so excited by the Coase theorem? The reason is that it made them look differently at many issues. Take divorce. University of Colorado economist H. Elizabeth Peters showed empirically that whether a state has traditional barriers to divorce or divorce on demand has no effect on the divorce rate. This is contrary to conventional wisdom but consistent with the Coase theorem. If the sum of a couple’s net gains from marriage, as seen by the couple, is negative, then no agreement on distributing the gains from the marriage can keep them together. All the traditional divorce law did was enhance the bargaining position of women. A husband who wanted out much more than his wife wanted him in could compensate his wife to let him out. Not surprisingly, divorce-on-demand laws have made women who get divorces financially worse off, just as the absence of liability for the rancher in our example made the farmer worse off. Coase also upset the apple cart in the realm of public goods. Economists often give the lighthouse as an example of a public good that only government can provide. They choose this example not based on any information they have about lighthouses, but rather on their a priori view that lighthouses could not be privately owned and operated at a profit. Coase showed, with a detailed look at history, that lighthouses in nineteenth-century Britain were privately provided and that ships were charged for their use when they came into port. Coase earned his doctorate from the University of London in 1951 and emigrated to the United States, where he was a professor at the University of Buffalo from 1951 to 1958, at the University of Virginia from 1958 to 1964, and at the University of Chicago from 1964 to 1979, when he retired. See also: externalities. Selected Works   1937. “The Nature of the Firm.” Economica 4 (November): 386–405. 1938. “Business Organization and the Accountant.” Reprinted in James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost. London: Weidenfeld and Nicolson, 1973. Available online at: http://www.econlib.org/library/NPDBooks/Thirlby/bcthLS5.html. 1959. “The Federal Communications Commission.” Journal of Law and Economics 2 (October): 1–40. 1960. “The Problem of Social Cost.” Journal of Law and Economics 3 (October): 1–44. 1974. “The Lighthouse in Economics.” Journal of Law and Economics 17, no. 2: 357–376.   Footnotes 1. George Stigler, Memoirs of an Unregulated Economist (New York: Basic Books, 1988), p. 76.   (0 COMMENTS)

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Arthur Frank Burns

  Arthur F. Burns is best known for having been chairman of the Federal Reserve System from 1970 to 1978. His appointment by President Richard Nixon capped a career of empirical studies of the economy, and particularly of business cycles. In a 1934 study based on his Ph.D. dissertation, Burns had noted the almost universal tendency of industries to slow down after an initial growth spurt. Burns pointed out that this tendency did not imply slow growth for the whole economy because new industries continued to appear. Measuring Business Cycles, coauthored with Wesley Mitchell and published in 1946 by the National Bureau of Economic Research (NBER), is a massive empirical study of previous business cycles. In it, Burns and Mitchell distilled a large number of statistical indicators of recessions and expansions into one signal of turning points in the U.S. business cycle. The NBER, a private nonprofit research institute, is now the organization that announces when recessions begin and end. Much of the institute’s approach is based on work done by Burns and Mitchell. Their book, more than any other single accomplishment, gave Burns a reputation as an expert in business cycle forecasting. Burns earned all his degrees at Columbia University. He began teaching economics at Rutgers University in 1927. In 1945, he became became a professor at Columbia University and, in 1959, became the John Bates Clark professor of economics. From 1953 to 1956 he was chairman of President Dwight D. Eisenhower’s Council of Economic Advisers. He was president of the NBER from 1957 to 1967, and president of the American Economic Association in 1959. From 1981 to 1985 Burns was the U.S. ambassador to the Federal Republic of Germany. Selected Works   1934. Production Trends in the United States Since 1870. New York: National Bureau of Economic Research. 1946 (with W. C. Mitchell). Measuring Business Cycles. New York: Columbia University Press.   (0 COMMENTS)

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Kenneth Arrow

In 1972 American economist Kenneth Arrow, jointly with Sir John Hicks, was awarded the Nobel Prize in economics for “pioneering contributions to general equilibrium theory and welfare theory.” Arrow is probably best known for his Ph.D. dissertation (on which his book Social Choice and Individual Values is based), in which he proved his famous “impossibility theorem.” He showed that under certain assumptions about people’s preferences between options, it is always impossible to find a voting rule under which one option emerges as the most preferred. The simplest example is Condorcet’s paradox, named after an eighteenth-century French mathematician. Condorcet’s paradox is as follows: There are three candidates for office; let us call them Bush (B), Clinton (C), and Perot (P). One-third of the voters rank them B, C, P. One-third rank them C, P, B. The final third rank them P, B, C. Then a majority will prefer Bush to Clinton, and a majority will prefer Clinton to Perot. It would seem, therefore, that a majority would prefer Bush to Perot. But in fact a majority prefers Perot to Bush. Arrow’s more complicated proof is more general. Arrow went on to show, in a 1951 article, that a competitive economy in equilibrium is efficient and that any efficient allocation can be reached by having the government use lump-sum taxes to redistribute and then letting the market work. One clear-cut implication of this finding is that the government should not control prices to redistribute income, but instead, if it redistributes at all, should do so directly. Arrow’s insight is part of the reason economists are almost unanimously against price controls. Arrow also showed, with coauthor Gerard Debreu, that under certain conditions an economy reaches a general equilibrium—that is, an equilibrium in which all markets are in equilibrium. Using new mathematical techniques, Arrow and Debreu showed that one of the conditions for general equilibrium is that there must be futures markets for all goods. Of course, we know that this condition does not hold—one cannot buy a contract for future delivery of many labor services, for example. Arrow was also one of the first economists to note the existence of a learning curve. His basic idea was that as producers increase output of a product, they gain experience and become more efficient. “The role of experience in increasing productivity has not gone unobserved,” he wrote, “though the relation has yet to be absorbed into the main corpus of economic theory.” More than forty years after Arrow’s article, the learning curve insight has still not been fully integrated into mainstream economic analysis. Arrow has also done excellent work on the economics of uncertainty. His work in that area is still a standard source for economists. Arrow has spent most of his professional life on the economics faculties of Stanford University (1949–1968 and 1980–present) and Harvard University (1968–1979). He earned his B.A. in social science at the City College of New York and his M.A. and Ph.D. in economics from Columbia University. Selected Works   1951. Social Choice and Individual Values. New York: Wiley. 1954 (with Gerard Debreu). “Existence of a Competitive Equilibrium for a Competitive Economy.” Econometrica 22, no. 3: 265–290. 1962. “The Economic Implications of Learning by Doing.” Review of Economic Studies 29 (June): 155–173. 1971. Essays in the Theory of Risk-Bearing. Amsterdam: North-Holland. 1971 (with Frank Hahn). General Competitive Analysis. San Francisco: Holden-Day.   (0 COMMENTS)

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OB

Armen A. Alchian

Armen Alchian, an American economist born in Fresno, California, is in many ways like ronald coase. Like Coase, Alchian has published only a few articles, but very few are unimportant. And like Coase’s, many of Alchian’s articles are widely cited. Many students and others who read economics are disturbed by economists’ assumptions that companies maximize profits. One of their objections is that managers of companies do not know enough to be able to maximize profits. In 1950 Alchian presented a thoughtful response to this objection in his first major article, “Uncertainty, Evolution and Economic Theory.” Alchian argued that even though all companies may not maximize profits, those that survive will be ones whose managers, by luck or by design, came close to maximizing profits. Therefore, those that we observe will have maximized profits. So for the long term at least, argued Alchian, for economists to derive the standard conclusions from the profit-maximization assumption, they do not need to show that all companies try to maximize profits. While in the U.S. Army Air Forces during World War II, Alchian did some of the early work on the learning curve—the curve that relates unit costs to cumulative output. His article on the learning curve in aircraft production was based on statistical work he did during the war, but it could not be published until 1963 because it was based on classified information. Alchian is also known for University Economics (now called Exchange and Production), coauthored with William R. Allen, a textbook that is unique in economics. It is much more literary and humorous than any other modern economics textbook that deals with complex issues for an undergraduate audience. Example: “Since the fiasco in the Garden of Eden, most of what we get is by sweat, strain, and anxiety.” It also welcomes controversy rather than shying away from it, in the process daring the reader to disagree. Take, for example, the book’s discussion of violence: Before condemning violence (physical force) as a means of social control, note that its threatened or actual use is widely practiced and respected—at least when applied successfully on a national scale. Julius Caesar conquered Gaul and was honored by the Romans; had he simply roughed up the local residents, he would have been damned as a gangster. Alexander the Great, who conquered the Near East, was not regarded by the Greeks as a ruffian, nor was Charlemagne after he conquered Europe. Europeans acquired and divided—and redivided—America by force. Lenin is not regarded in Russia as a subversive. Nor is Spain’s Franco, Cuba’s Castro, Nigeria’s Gowon, Uganda’s Amin, China’s Mao, our George Washington. Because of its literary quality and complexity, the textbook generally did not work with undergraduate or even M.B.A. classes. But its impact was out of all proportion to its sales. Many graduate students, particularly at the University of California at Los Angeles, where Alchian began teaching in 1946, and at the University of Washington (where Alchian student Steven Cheung taught), learned their basic economics from this book. Some of the University of Washington students went on to write best-selling textbooks that made many of Alchian and Allen’s insights more understandable to an undergraduate audience. Alchian and Allen’s textbook was truly a public good—a good that created large benefits for which its creators could not charge. And while Alchian played the role of selfish cynic in his class, some who studied under him had the feeling that he put so much care and work into his low-selling text—and into his students—because of his concern for humanity. Other than through his text, Alchian’s largest impact has been in the economics of property rights (he wrote the article on property rights in this encyclopedia). Most of his work in property rights can be summed up in one sentence: You tell me the rules and I’ll tell you what outcomes to expect. In their textbook, for example, Alchian and Allen ask why the organizers of the Rose Bowl refuse to sell tickets to the highest bidders and instead give up wealth by underpricing the tickets. Their answer is that the people who make the decision on ticket prices do not have property rights in the tickets, so the wealth that is given up by underpricing would not have accrued to them anyway. But the decision makers can give underpriced tickets to their friends and associates. Thomas Hazlett, former chief economist at the Federal Communications Commission, used this same line of reasoning to explain why Rep. John Dingell blocked the Federal Communication Commission’s early attempts to auction off the electromagnetic spectrum and instead favored giving it away. Alchian also used the analysis of property rights to explain the incidence of discrimination. In a paper coauthored with Reuben Kessel, Alchian, who was himself subject to discrimination as an Armenian, and Kessel pointed out that discrimination was more pervasive in private firms whose profits were regulated by the government, and then explained that this is what the analysis of property rights would predict. Discrimination is costly—not just to those discriminated against, but also to those who discriminate. The discriminators give up the chance to deal with someone with whom they could engage in mutually beneficial exchange. Therefore, argued Alchian and Kessel, discrimination would be more prevalent in situations where those who discriminate do not bear much of the cost from doing so. A for-profit company whose profits are not regulated would see the cost of discrimination in its bottom line in the form of lower profits. A company whose profits are limited and that is already at the limit would face no cost from discriminating. Alchian and Kessel used this analysis to explain why regulated utilities discriminated against Jews and why labor unions discriminated against blacks. This analysis explains why Alchian has never trusted government—but has trusted free markets—to reduce discrimination. Before teaching at UCLA, Alchian was an economist with the RAND Corporation. Selected Works   1950. “Uncertainty, Evolution and Economic Theory.” Journal of Political Economy 58 (June): 211–221. 1965. “Some Economics of Property Rights.” II Politico 30: 816–829. 1972 (with W. R. Allen). University Economics. Belmont, Calif.: Wadsworth. 1977. Economic Forces at Work. Indianapolis: Liberty Press.   (0 COMMENTS)

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PORTRAIT

Maurice Allais

  In 1988 Maurice Allais became the first French citizen to receive the Nobel Prize in economics. He won it for his contribution to the understanding of market behavior and the efficient use of resources. Allais also showed that his insights could be applied to help set efficient prices for state-owned monopolies, of which France had many. Allais’s work paralleled, and sometimes preceded, similar work done by English-speaking economists Sir John Hicks and Paul Samuelson. He also proved a result in growth theory in 1947 that had been credited to Edmund Phelps (in 1961). Allais did not get credit as early as his English counterparts because his work was in French. “Had Allais’ earliest writings been in English,” commented Samuelson, “a generation of economic theory would have taken a different course.” Allais also helped revive the quantity theory of money (monetarism). In utility theory, Allais discovered and resolved a paradox about how people behave when choosing between various risks that is now called the Allais paradox. From 1937 to 1944, Allais worked in the French stateowned mine administration. In 1944 he became a professor at the Ecole National Supérieure des Mines de Paris and spent his career there. He is also the research director at the National French Research Council. He was named an officer of the Legion of Honor in 1977. Selected Works   1965. “The Role of Capital in Economic Development.” In The Econometric Approach to Development Planning. Amsterdam: North-Holland. 1966. “A Restatement of the Quantity Theory of Money.” American Economic Review 56 (December): 1123–1157. 1969. “Growth and Inflation.” Journal of Money, Credit and Banking 1, no. 3: 355–426.   (0 COMMENTS)

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