Capitalism: Success, Crisis, and Reform

PLSC 270 - Lecture 5 - Property, Freedom, and the Essential Job of Government

Chapter 1. Introduction [00:00:00]

Professor Douglas W. Rae: Okay, today's discussion relies on three books, and one of them is Hayek's Constitution of Liberty, which you've seen two chapters of online. Another is Hernando de Soto's Mystery of Capital and the third, and by far most entertaining, is Aravind Adiga's, The White Tiger. In today's class we're talking about something really foundational, and it is basically a pragmatic or practical theory of freedom. It's: Why is freedom a good thing? This is a much less high-flown theory than many philosophers would give. Hayek after all was an economist. But it is a powerful one, and for me it corresponds more or less to my convictions. The most powerful aspect of it is that I can profit from your freedom, and you can profit from my mine. Freedom is a common good. Individual freedom is a common good in a way that makes a great deal of practical common sense to a lot of people, including me. We'll do it in four chunks; we'll begin by looking at Hayek's framework. We will then take up briefly the question of government and how government relates to this. Then we will look at de Soto's analysis of live and dead capital and his explanation of why undeveloped countries remain undeveloped in many cases. Then finally we'll rub our idea of freedom up against the lives of the central players in The White Tiger.

Throughout this I'm going to advert from time to time to a Yale story. Not the tragic one that is on the front page of today's paper but an equally — well no I won't say equally — another troubling story, which is the decision of Yale University Press when it agreed to publish a book about the Danish cartoons which poked fun at the prophet Mohammed. When that book was ready for printing three months ago the director of Yale University Press called me, I'm on his — I'm on the committee that decides what books they publish — and the question was: Can we pull the cartoons out of the book? These are cartoons which make devout Muslims very mad. And the answer we arrived at, very reluctantly, was: Yes pull the cartoons. And that — think of that problem, and think of what possible explanation could there be why a great university feels itself unwilling to stand up for freedom of expression in the case of these admittedly blasphemous cartoons. It turns out the answer is very practical and I'll give you my position on it by the end of class. Okay.

Chapter 2. The Hayek Framework [00:04:19]

Hayek was a charming guy and a very practical thinker; less practical perhaps then economists who work for banks, but as Nobel laureates go, very practical. He was given to thinking about hard cases; about why things were done as they were. And he was most of all an intellectual skeptic. He was most of all inclined to doubt human knowledge, to lean on fallibility and ignorance, to look at Marxist historicism, which we discussed last time, as horse feathers. He was contemptuous of not Marx alone, but of whomsoever imagines that there is a deterministic course for world history (a), and that they know what is (b); neither (a) nor (b) washes with Hayek. The reason it doesn't wash is that he believes in freedom. And in free societies, outcomes are unpredictable.

We're going to — read this for a second for yourselves. It's the worst sin in the use of PowerPoint is to put a lot of words on the screen and than read them to people. It makes me furious when I'm in the audience and people do it. So can you read it for yourselves in the back there? We'll parse it a little bit. "Civilization which no brain has designed but which has grown from the free effort of millions of individuals." The idea here is this is a very powerful idea. It is, if you say, "Who designed the world in which we live here at Yale?" How long would the list be? Or let's try this, let's take the highest ranking officials of Yale University. Let's say Roland Betts who is the chairman of the Yale Corporation, and Rick Levin who is the President of the University, and let's throw in Linda Lorimer, who is the secretary and Mary Miller who is the Dean of the College, and think of four or five others that might be important. What percentage of what goes on around here did they think up? Take a guess. Do we have a mic out there? Hand it to the woman right behind you, let's get her guess. What percentage of the way we do things at Yale is attributable to the five highest ranking officers at the university?

Student: Five.

Professor Douglas W. Rae: Five percent? You think that much? Let's pass the mic around to the — I can tell you've got something to say, go with it.

Student: [inaudible]

Professor Douglas W. Rae: Yeah, it doesn't seem to be on.

Student: Can you repeat the question?

Professor Douglas W. Rae: Okay, third repetition. The question is: Take the five highest ranking officers of the university; take everything that goes on around Yale; what percentage of it can we attribute to them thinking it out?

Student: I'd say less than one.

Professor Douglas W. Rae: I'd say way less than one, and I think they would say way less than one. It's because the university has been invented a piece at a time over the centuries. It's reinvented every day. What you do in the classroom is part of reinventing Yale, what you do elsewhere is part of it. And the notion of a free society that Hayek wants to put in front of us is one where agency, the right to make decisions, is widely disbursed. You can imagine societies in which that isn't true. In fact, many exist. One would be an authoritarian society, an autocracy, where a ruling elite pretty much says what happens. Another would be traditional society or a theocratic society where there are standing rules, they are more or less followed, and they restrict agency in a sharp way. A New Haven colony in the years 1637 to 1665 was a strict theocracy, and the rules were laid down in the Bible, solum scripturem [correction: sola scriptura] was the idea. They made no laws. All they did was interpret the Bible, and enforce it harshly.

Hayek has in mind something very different from that, and the idea that society is in some sense a great learning machine, or that a free society is a great learning machine, is the powerful idea in Hayek's work. If we think of — you know, I'm given to these extravagant charts — historical time on this dimension measured, let's say in centuries, or in human generations if you prefer, and on the vertical axis the total shared store of knowledge that that society accumulates, knowledge as trivial as how to manufacture a toothbrush or as complex as how to operate a great university. The accumulation of that knowledge is, Hayek says, accelerated exponentially by disbursed agency, by freedom. The rate of accumulation grows in an exponential curve with a free society. He doesn't talk about demography, but I would say that a free society which has passed through the world demographic transition so that people live long lives, lives in which a great deal of learning can go decade after decade, that such a society, embedded in the institutions of a free society, would have the sharpest upward curve in the accumulation of shared knowledge. The other side of that story, and here I've added a second axis on the right, which represents the percentage of a society's knowledge which one very competent person can capture.

Who's the most competent? Rick Levin is very competent. Never brilliant; always thoroughly competent. It's really true. I mean, it really is true. I mean, part of why he's so good is he never tries to be brilliant. He never — have you ever heard him anything that was even vaguely edgy? I've known him forty years; we used to ride home together at night. He's never anywhere near the edge but he's never, never, never crazy. He's just — he's the most thorough — it's the personality profile for an airline pilot, a heart surgeon, and maybe the president of a university. It's a very steady, very competent persona. And Hayek's big point is that no individual, however competent, can know any major fraction of what — of the knowledge accumulated in a free society over time. And that, first of all that's humbling. It's terrifically humbling.

And part of what the sort of education all of you are getting is about learning what you don't know, and learning where to find out the things you don't know which through time you need to know. It is not imagined that this or any other college can create graduates who master any large fraction of what is known in the United States or the western world, much less the world at large. As knowledge accelerates the individual fraction of that knowledge becomes smaller and smaller, and individuals become more and more dependent on things discovered and known by others. Take the toothbrush. Who's got a mic here? Let's go to the gentleman in the red t-shirt. If it were your assigned task in your first job to set up a manufacturing plant for ordinary plastic toothbrushes with nylon bristles, how would you go about it?

Student: I wouldn't really have a good idea. Probably start looking on Wikipedia.

Professor Douglas W. Rae: Okay, that incidentally is where this photograph came from. Okay, so you go to Wikipedia. Do you think Wikipedia's got a design for a toothbrush factory?

Student: No, maybe Wikihow, or —

Professor Douglas W. Rae: Okay, what you would begin doing is reaching out to others. You would probably have to reach out to several others, and those others — the others who actually make these toothbrushes are — do you suppose those plants are located in New Jersey?

Student: I'm not really sure.

Professor Douglas W. Rae: I'm pretty sure. I don't even know this, but I'd be willing to offer a substantial bet that the vast majority of toothbrushes are manufactured somewhere in Asia or the southern hemisphere; probably Asia. I would also bet that no one in this — does anyone in this room have a clue how you'd go actually about it? Injection molded plastic — right? No one knows, and yet each of us profits in a small way from tens and hundreds of thousands of bits of knowledge like that. Let's examine this chart. Now I think maybe if we work cooperatively in the room we could learn what it's about. I have no idea — I certainly can't read these labels. Anyone here who can read them? Cool! Go for it — let's get her a mic so we don't this.

Student: The first one is wool product, the second one is non-wool product, and the third one is original material, the fourth one means food material, and then the last one means products that are being exported again.

Professor Douglas W. Rae: Okay, re-export. This is a history of British exports in a complex bar chart, and the fact that — are there other people who knew how to do it and didn't raise their hands? What we see here, this is kind of a division of labor story. It's a little like Adam Smith and the pin factory; that we rely on others as storehouses of knowledge useful to us, or at least imaginably so in my example. This is the Model T Ford, and it was produced for the first time in numbers between 1910 and 1917, and it was a revolutionary machine. By 1917 it was — when it began it was selling for about $1,000, which would be a lot more than $1,000 today. By 1917 the Ford Motor Company had figured out how to make this car and make money on it by retailing it for $360, and they had done that by combining many small pieces of engineering from other fields, and by using a moving conveyor belt, which carried the car along, and workers who stayed in position, each with an assigned task, each coordinated in a very efficient way. And the larger implication of that for the American and world economy, the knowledge embodied in it, was enormous. It was wholly unoriginal.

Ford was not a brilliant engineer. Some of the people he hired were damn good engineers. By and large though, they were just regular smart people who worked in a cooperative team way, a division of labor about ideas. There was an older idea called the American system, and the American system was interchangeable parts. It was parts made so precisely identical that you could take the left front wheel drum off one Model T and put it on any other Model T and expect it to fit. And that idea — and that's actually one of the revolutionary ideas that's involved in the vertical spike of world affluence, and which has been disbursed everywhere in the globe. You can't manufacture anything in a competitive way if you don't understand and execute on interchangeable parts. The earliest alleged case was actually New Haven. It was the Eli Whitney gun factory, the waterfall on Whitney Avenue, the little building there, Eli Whitney had a contract with the federal government to make 10,000 muskets. He set out to do it with interchangeable parts, and what's fascinating is if you go out there, they've got a couple hundred of these things in the drawers. He got most of them just a little wrong, so he would file them, or his workers would file them and chivy them, to make them interchangeable. But from the point of view of the military, the idea of interchangeability was huge, because when one part of a weapon jammed, you could take another one and interchange it, and the efficiency of the logistics were enormously improved.

The military is not mainly what that idea is about. Anybody have a clue who this is? Fair enough; there's no reason you should. This is the guy, Norman Borlaug, correct, who did the critical work on developing high growth, high productivity, and disease resistant seeds — most of the work done fifty or sixty years ago, he died last week — which increased agricultural yields on a world basis. There is still hunger in the world but it's all manmade. That is, there are no cases in the world now where there isn't enough food to feed everybody. There's always enough food. If it doesn't get to the right places that's something to do with human agency or institutions. And all of us benefit from that work, and that work in turn benefitted from generation after generation of botany and husbandry. All this process of building the social store of knowledge is what Hayek's idea of freedom is about.

This is Dean Mary Miller, and by now I've beaten this horse to death — she's wonderful, she's absolutely terrific. What fraction of the curriculum she supervises would she need to have direct knowledge of? Do you think she knows what we do in here? She would only know if I were in a lot of trouble, or you were. There are hundreds of courses, even thousands, and the dispersion of agency, the — last summer I sat at my summer house in Northern Vermont with a stack of books about that high, picking the books for this course. She didn't supervise that; neither would I have been pleased if she had. But the effect, if she has the right people doing it and trusts them, is very like Adam Smith's pin factory and the division of labor and the power it produces.

So we're back to Smith; Smith had the idea that by dividing labor so that one person doesn't undertake the whole complex task of manufacturing a pin, if you divide the labor among many who get good at specific aspects of the task, you can make it cheaper and more efficient then otherwise it would have been. Hayek's idea is more loosely jointed than that. Hayek's idea is that you don't even assign roles to people; you let them find their own roles. That if you want to go out and start a toothbrush factory using a novel technology, invented late at night over beer with your roommate, what's the likely outcome? The likely outcome is that you will fail. Your toothbrush will be too expensive and not very good. Right? Isn't that the likely thing? If you think about a market economy as literally hundreds of thousands of people who make decisions like that — go/ no go — with a new model toothbrush, the accumulated knowledge from that is enormously powerful. If you begin to make money with your new model toothbrush, then a couple of things will happen. One, capital will flow toward you. People will say, we would like to own part of this. And our subject next Monday is the joint stock corporation, which is all about that.

And capital will flow toward you, and so will competition. As soon as you begin to succeed people will attempt to get as close to your product as the patent and copyright laws permit, and to compete with you on the basis of quality or price. And that process, you can think of it is as enormous diversified portfolio; the whole economy. No one directs the whole economy or says where the capital goes, though sometimes it feels as if Goldman Sachs comes close to that. The decision process is highly decentralized and un-programmed.

Indeed, Hayek, if you'll look closely, says that what we're trying to do is create the opportunity for the unexpected to happen. "Liberty is essential in order to leave room for the unforeseeable and unpredicted. We want it because we have learned to expect from it the opportunity of realizing many of our aims." The core idea is disbursed power of action. Now Hayek is entirely dependent on the idea that we are of limited intellect. If we were, as this quote says, omniscient, page 29, the green quote here, there would not be so strong a case for freedom. I think there would be other cases, but the core case that Hayek is making is that freedom is a way of overcoming our own fallibility, and of allowing others to fill the holes in our individual stores of knowledge.

Now Hayek, early in the section you read, focuses on the question of a rock climber. It's kind of a jarring reference when you see it, it's around page twelve. I read, "Most people will still have enough feeling for the original meaning of the word free to see that if" — no, sorry — "In this sense freedom refers solely to the relation of men to other men," — or persons to other persons, "The only infringement of it is coercion by men. This means, in particular that the range of physical possibilities from which a person can choose at a given moment has no direct relevance to freedom. The rock climber on a difficult pitch who sees only one way out to save his life is unquestionably free. Most people will still have enough feeling for the original meaning of the word free to see that if the same rock climber were to fall into a crevasse and were unable to get out he would only figuratively be called unfree."

Now that's a big — a lot rides on that claim. Hayek defends it unevenly. If you look closely at the way he defines coercion, you'll find that the rock climber story is the clear and easy case, and by the end of our slides today, we'll begin to look at some harder cases and some of those hard cases are raised by The White Tiger book. Now this is more my kind of rock climber, hanging on barely. I'm terrified of any height greater than five feet. What's behind this story? What — Hayek isn't sneaky here. Anybody want to tell us why he makes this argument? Because he is arguing in an environment where Communism is a very live option, and the Marxist position about freedom is that it's a Bourgeois delusion, and that only by giving everyone the same access to material rewards, to money, wealth, and the like; only by downward redistribution of money, wealth, and the like can real freedom be shared by everyone. Hayek wants desperately to head off that argument.

Now, whether that argument is right or wrong is actually more semantic than anything else, and we'll actually close with a slide about this. That is to say, can you be free and at the bottom of society, unable to do many things? Unable to effectively exercise your freedom; one view is that the two dimensions, freedom and wealth or power are entirely independent. Another view is that without some degree of market power, some degree of ability to interest others in your needs through exchanging your skills and your labor for what it is that you need, or for the money which will buy what it is that you need or want; only with some degree of market power can freedom be fully realized. And I'm of that second view. I am of the view that the wide dispersion of relative affluence is part of making freedom real.

The way I would argue that with Hayek is that, conceptually, the concept of coercion is extraordinarily slippery. Let's consider the guy in the crevasse. He's stuck, but you and I are walking by on our way to a picnic, and he calls to us, and we say sorry we're late to the picnic. It would be not — you wouldn't have too much twist the language to say that that was an implicit act of coercion on our part. Then the slope gets dangerous and complex. If he had diabetes, and we withheld from him the treatment for diabetes, would that violate his freedom? All I want you to do — what I really want you to do is get the power of Hayek's idea in your heads and get the complexity of applying it in your heads. Now the reason I think some degree of affluence, or some degree of market power is part of the deal, is that Hayek's examples all depend on it. The things which he tells us about in the second chapter are all ones where people have enough education, enough physical health, and enough skills, that they can be real players.

Now the Adiga questions — and this is Adiga's social class we're seeing in this slide — are different. We're going to go to Adiga in a few minutes, but let's pause and talk about the Danish cartoons, which I'm not going to show you. You can see them, all you have to do is Google them. And they are, from an Islamic point of view, blasphemous, and they are, from a western secular point of view, they are in some ways funny. This cartoon, which is a cartoon about cartoons, captures the idea that the scriptural blasphemy seen by the Muslim here is on the same plain with the secular blasphemy seen by the advocate of free speech. John Bolton, he's a Yale alum, I even know him a little, he was Bush's representative to the UN and he's a radical libertarian, and he's on the warpath against Yale over our not publishing the cartoons. Let's stop and talk practice for a minute. Have we got — pick somebody out — can you imagine any circumstance — the few, the proud, the moose. I like it! — can you imagine any circumstance under which you would say that we should tell the University Press not to publish the cartoons in the book? The book will be out in about a week but without the cartoons.

Student: I can imagine this is a pretty strong case for doing that, given that there were good reason to believe that publishing the cartoons would — there was some specific threat that publishing the cartoons would result in harm to the university or to people here.

Professor Douglas W. Rae: Okay, you cut straight to the chase, very well done. The point just made is that the university consulted experts, and the question to the experts was: "What's the probability of a terrorist attack launched against Yale in response to the publication of the cartoons?" The answer came back that it was not insubstantial. Now why would that be? Would you — you got to grab it and talk to it — would you be inclined to take the libertarian position and say, "Yale is the kind of place which stands up for freedom of expression?"

Student: I think you could make the case Yale stands up for freedom of expression in a lot of cases, but not all.

Professor Douglas W. Rae: Okay let's see — have we got a true gospel libertarian in the room? We got somebody who wants to say, "Dammit! You should have published them." I don't mind being criticized. Yeah — yes we need to — if you'll come forward a little it's going to make it easier.

Student: I would say yes, I see the cartoons no differently than I see all of those Darwin cartoons that were around for Darwin day or the pictures of the Christian fish with feet on it walking on to land. I mean, if you can criticize one religion then you have to be able to criticize all. I think that the best approach would have been probably to try to create an academic exchange whereby every University displayed the cartoons in some public place because I believe that freedom of speech is absolutely sacred.

Professor Douglas W. Rae: You're the kind of guy Rick Levin's scared of. Thanks that was good. The — Richard —

Student: I don't need the microphone. If the argument is that the right to life is going to outweigh the right to freedom of expression, a cartoon like this would in fact raise the probable chance of a terrorism attack. Bolton's counterargument would be that it's a slippery slope. The minute you give into this sort of appeasement towards that potential threat, down the road the potential that you're giving up a multiple or a societal amount of freedoms to appease an aggressor, you only gradually bring an even greater existentialist right to free speech.

Professor Douglas W. Rae: I agree that that would be one of the counters, and it is a persuasive one, it's important. The issue here gets to be — it comes down in my view, to the effective ability to defend the institution. When I say defend, it I mean defend it.

Chapter 3. The Nation State Framework [00:39:14]

And the next topic for us, if I've got the slides organized right, is the nation's state system, and what we have here is a question of narrow gauge state failure. The guy pictured is Thomas Hobbes, his great book The Leviathan, came out at the same time as the settlement to the Thirty Years War, more or less and they were two faces of the same thing. Hobbes' central idea of the leviathan was a power so great, and so well disciplined, that it could monopolize force and violence in society, and keep people from attacking one another, and put down a general set of rules of law which allowed people to know what was coming next. If the leviathan were fully effective, I would favor publishing the cartoons. My reasoning would be similar to the reasoning back left, that freedom is freedom, and freedom includes bad taste. I think blasphemy is very bad taste toward any religion. It's bad taste, but the fact that I deem it bad taste doesn't make it inappropriate, and inappropriate exercise of freedom for those who take a different view. That's the whole idea of freedom.

Now what's missing here is that in some fundamental way the Al Qaeda events worked. They did in some degree work. We all pay rent on them every time we fly. I mean, think about the person hours consumed taking shoes on and off, and the perfectly good bottles of water or shaving cream which are confiscated. The critical aspects of state performance: The rule of law reliably enforced, zones of freedom, for example, within our property here at the university, corruption minimized, and the monopoly on force and violence effective. Now what 9/11 was about was an attack on our culture and a demonstration that even the mightiest nation in the world, nay the mightiest nation in the history of the world, was open to violent attack, especially if you were willing to die in the process. And we have been convinced by that.

If you actually think about defending the Yale campus against — just imagine a single person willing to die or spend his life in prison for attacking Yale in the most spectacular possible way, what would we have to do to the campus to rule that out? Call the New Haven police department? You must be kidding. I mean, they don't have anything like the resources to do it, and our own police force doesn't come close to being able to do it. The campus is built on the premise that the monopoly on force and violence works. It is built to deal with petty criminals, the locking gates and that kind of thing, but the locking of gates is entirely useless against a terrorist. I soberly thought about this and I thought I would much rather take the ringing first amendment point of view, and I was only one of many people involved in this judgment, but ultimately I couldn't bring myself to undertake that risk on behalf of all of you. Richard Pestelli is correct that that represents a loss of something and a step on a slippery slope. I think that's really true, but it's real. The virtue of Hayek's way of thinking is that it's not all or nothing. It is a pragmatic judgment about how best to organize society.

Chapter 4. The De Soto Framework [00:44:14]

Now Hernando de Soto, third topic, The Mystery of Capital, it's a middle difficulty book. It's not very difficult, and it's all built on one point. The one point is the distinction between formal and informal property. The photo I showed you before is a favela, near Rio in Brazil, and it's all informal property. The people who built those houses don't really own them. They own them according to a set of informal rules that operate among the people in the favela. They don't have formal documentation for them, so it is informal property. Every building in New Haven is formal property, even community gardens are formal property. There is a deed written down, you can trace it, and you can show it to a bank. de Soto's major idea is that informal property is dead capital, and formal property where the power of the state stands behind your ownership is live capital. His claim is that poor people in developing societies own a vast amount of capital in informal forms, and that, just as capital is formed in advanced market societies by combining many small assets into a smaller number of big assets, so too can capital be formed in poor countries by formalizing property and allowing people to make investments by taking on debt which is secured by formal property. His further claim is that many of the worst economies in the world are the worst economies in the world because the number of hurdles to form — that stand in front of you when you want to formalize your property — are wildly excessive.

I'm going to do The White Tiger at the beginning of class next time. I urge you — one of you came up to me at lunch today and said, "Wow this is fun!" It is one of the great novels of this era, and I promise you, if you'll just give it an hour, you're going to love it. We'll start with The White Tiger on Monday and then we'll go to the joint stock corporation. The reading for Monday is on the web now in Classes V2. It's the Alfred Chandler piece about railroads. You will need to go to RIS when we get to the Harvard cases, there are three Harvard cases, we're going to give you all the Yale cases because we're nice people but Harvard is going to insist on selling them to you so you've got to go to RIS and buy a little packet of Harvard cases.

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