David Emanuel Andersson

Ted Burczak’s Market Socialism April 9, 2009

Posted by David in Economics, Politics, The Social Sciences.
Tags: Frank Knight, Gus diZerega, Hayek, Israel Kirzner, Jerry Gaus, Ted Burczak
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I have been spending time reading “Socialism after Hayek” lately, a book by Ted Burczak. It’s a heroic effort to synthesize the disparate ideas of two very different thinkers: Friedrich Hayek and Karl Marx. I usually think that socialist utopias rest on total misconceptions of the role of markets in society, but Burczak is a rare exception. He understands the role of the market process better than the run-of-the-mill neoclassical economist. This does however not mean that he has converted me into an advocate for his socialist utopia. But I am willing to concede that he does raise a number of interesting questions.

 

Below is the first draft of a paper that discusses Burczak’s two key proposals: redistribution of wealth and a market of worker-owned cooperative firms. The paper lacks but probably needs some kind of introductory section that summarizes my arguments and outlines the relationships of the different sections. But I think my discussion and critique of Burczak’s proposals make sense from the perspective of subjectivist economics.  

 

More specifically, I’m trying to address the question of whether classical, egalitarian, or technocratic liberals can learn anything from Burczak. My contention is that the egalitarians and technocrats would be well-advised to learn the Hayekian lessons that Burczak is imparting, while the classicals should focus on the non-neutrality of markets as long as entrepreneurs have unequal access to credit. I’m however not at all convinced by the alleged superiority of cooperatives over conventional capitalist firms.

 

Justificatory and substantive liberalisms

 

As a political philosophy, liberalism has had a greater impact than any rival school of thought. It provides the ideological foundation of representative democracy, global markets and modern science, which all were to some extent inspired by 18^th and 19^th century liberals such as Adam Smith, David Hume, and John Stuart Mill. But an unintended consequence of the liberal success story is that the term “liberal” now denotes a wide variety of policy preferences. In the English-speaking world, liberalism is today more closely associated with ambitious government programs than with free markets. By contrast, most people in Europe still associate liberalism with pro-market policies. Even so, most main political parties in the western world do not label themselves as liberal, preferring vaguer and supposedly more inclusive terms such as Democrat, Christian Democrat, or Social Democrat, which all denote coalitions that mix elements of liberal, conservative, and socialist thought rather incoherently.

        Is there then any commonality among those individuals who refer to themselves as liberals? The liberal philosopher Gerald Gaus (forthcoming) argues that there is an underlying justification principle that all liberals at least implicitly share. He argues that “justificatory liberalism” is the foundation of more substantive liberalisms such as classical or egalitarian liberalism. First, all of the leading liberal thinkers subscribe to the Political Liberty Principle:

 

1.       A citizen is under no standing obligation to justify her actions to the state;

2.       All use of force or coercion by the state against the persons of its citizens requires justification; in the absence of such justification such force or coercion by the state is unjust. (Gaus, forthcoming, n.a.)

 

The Political Liberty Principle implies that governments must justify their actions – and the justification must be more receptive to individual objectives than elusive references to the national interest or the will of the people. Gaus (ibid.) proposes a Public Justification Principle that states that “L is a justified coercive law only if each and every member of the public P has conclusive reason(s) to accept L as binding on all.”

According to Gaus, the Political Liberty Principle together with the Public Justification Principle can be used to derive the normative contents of more substantive liberalisms. While Gaus’ discussion of exactly what kind of liberalism is best at meeting the demands of the Public Justification Principle lies beyond the purpose of this paper, the value of justificatory liberalism in the present context lies elsewhere: it provides us with a clear demarcation between liberal and illiberal political philosophies: most self-professed conservatives and socialists would consider the two principles either irrelevant or – at most – of limited applicability.

Liberals disagree among themselves regarding the range of activities for which government interventions are legitimate or desirable. But both classical and egalitarian liberals like to invoke hypothetical social contracts as a device for demarcating those state actions which are legitimate from those which are not. In “The Calculus of Consent,” James Buchanan and Gordon Tullock (1962) argue that individuals – with their different objectives and resources – will accept a political constitution as long as they expect the flow of future benefits to be greater than the flow of future opportunity costs. This ensures that people accept individual post-constitutional policies that they are against, since this would be perceived as an unavoidable cost that has been factored into the total cost-benefit calculation. In this version of classical liberalism, legitimate government activity is likely to be limited to efficiency-motivated policies. Examples include the provision of public goods such as law enforcement and the prevention of third-party spillover effects such as air pollution. The scope for redistributive policies is limited, since each individual is cognizant of her human and material resource endowments, although in an uncertain world it is still possible that a modest safety net could command unanimous approval.

The leading egalitarian liberal John Rawls (1971) also proposes that individuals should reach a hypothetical contractual agreement. But in Rawlsian contracting, individuals know even less about themselves: Buchanan and Tullock’s “veil of uncertainty” becomes a “veil of ignorance.” Not only do the participating individuals not know the exact shape of the future, they also do not know anything about what human or material resources they benefit from in their social interactions. They are however aware of the heterogeneity of human objectives and desires, with the implication that society must be tolerable for people with a wide range of philosophical, religious, and aesthetic views. Rawls uses his “veil of ignorance” argument to support redistributive measures to benefit the poor and unlucky, even if this were to produce less aggregate wealth or average benefits than some less egalitarian polity. In effect, Rawls produces a liberal justification of a comprehensive welfare state.

What Rawls shares with classical liberal theorists such as Buchanan or Friedrich Hayek is a consequentialist[1] evaluation of alternative policy packages. Given the Political Liberty Principle and the Public Justification Principles, what are the policies that a group of rational and appropriately disinterested humans could be expected to endorse? Since classical liberals tend to subscribe to more skeptical theories concerning the unintended consequences of the workings of democratic governments, they also tend to be more skeptical of the ability of government to promote people’s well-being than egalitarian liberals. The egalitarians tend to have a more optimistic interpretation not only of the motives of politicians, but also of the knowledge of politicians, administrators, and voters.  

Gus diZerega (2008) draws attention to how the liberal movement split into three parts around the year 1900. He writes that “liberalism fractured during the late 19^th through first half of the 20^th centuries: separating into three broad and often antagonistic traditions: classical, egalitarian, and technocratic. Each emphasized a part of the liberal tradition ignored or slighted by the others.” (diZerega, 2008, p. 13). Classical liberals explored and promoted the benefits of market processes, while egalitarians and technocrats[2] praised the virtues of democracy and science, respectively.

 

Hayekian social theory and classical liberalism

 

One classical liberal who paid careful attention to the interdependencies between markets, science, and democracy was Friedrich Hayek. Unlike most twentieth century economists, he warned against the heroic assumptions regarding human knowledge and even omniscience that underpin the models of welfare economists and the toolkits of government policy-makers.

        In a journal article entitled The Use of Knowledge in Society (Hayek, 1945), Hayek puts dispersed knowledge and widespread ignorance as the most important feature to consider in the choice of whether to use markets or governments in attempts to coordinate the economy. Hayek’s economics is about how market prices affect the dissemination of knowledge. Therefore, he concludes that neoclassical models that assume perfect knowledge of all relevant economic facts assume away the most central problem in economics – the division and coordination of knowledge. Knowledge is dispersed because each individual carries a unique set of (articulated and tacit) knowledge that reflects personal cognition, inter-personal networks, and personal spatiotemporal location trajectories. Because of the limits to human cognition, Hayek asserts that it is impossible to communicate the entire content of such individual knowledge to any subset of individuals that are responsible for economic planning.

        In an economy with indirect exchange, the process of parallel and sequential exchanges involving production or consumption goods and money create exchange ratios, that is to say, market prices. Such prices disseminate signals about perceived relative resource scarcities to other individuals and firms participating in the same markets, which economizes on the knowledge they need for resource allocation that takes the opportunity costs of other market participants into account. There is simply no need to know that the demand for oil has increased in the United States, while it has decreased in France. Prices supply distilled knowledge about perceptions of overall scarcity among a multitude of market participants, which in the case of globally integrated markets encompasses the entire world.

        In the 1950s, Hayek became interested in cognitive psychology, which resulted in the publication of The Sensory Order (Hayek 1952). There, he explains the cognitive cause of the inferiority of central production planning as compared with decentralized market exchanges. He asserts that the cognitive limitations of human beings make it impossible for any central planner to collect all the relevant economic data. This is due to the limits of individual information-processing to structures that are less complex than an individual human mind: “the capacity of any explaining agent must be limited to objects possessing a degree of complexity lower than its own” (Hayek 1952, 185).

Even if production planners desire to allocate resources in a way that mirrors consumer preferences in their jurisdiction, there is no way for the planners to know when resources should be reallocated to new production processes or new consumer goods or services, since that would subject the planner to excessive cognitive requirements. Harnessing the innovative potential of the population would imply that they have access to the preferences, ideas, skills, and whims of every constituent individual. They would also need to be able to judge how all these new bits of individual knowledge will be received (and ultimately demanded) by the rest of the population.

        In the Hayekian view of the market process, the most important of its functions is its role as a communication network that transmits distilled information (market prices) about the perceived marginal opportunity costs of various resources. Any government interference with the price system therefore dilutes and distorts this signaling system. There can never be any guarantee that so-called “administered prices” – that is, prices that are imposed by central planners – correspond to market prices. Price determination at the center is unable to take most local individual knowledge into account. Even if planners freeze market prices at current levels, the price will eventually be too high or too low, as a result of changing consumer preferences, technology, innovation, resource availability, or market-influencing institutions. Queuing and shortages should therefore always be expected for goods with government-set prices and unchanging product quality, or else the quality of the product will improve or deteriorate to reflect changing market conditions (this latter example will either imply a distortion of market processes from price to non-price competition, or – alternatively – that the regulation has no effect, which usually implies an unnecessary transaction cost associated with the creation and enforcement of the superfluous regulation).

        One of the main features of the market order that explain its success at meeting the diverse objectives of millions or even billions of people is that it is structured yet pursues no overriding objective of its own. Hayek (1960, 1979) therefore claims that the market is a “spontaneous order,” by which he means that abstract procedural rules structure a discovery process that brings the local knowledge of order participants into greater mutual coherence over time. For markets, the key signaling device – or what diZerega (2008) calls the “systemic resource” – is money, which offers the benefit of both distilling all the relevant economic information into a number, thereby providing market participants with the possibility of calculating revenue-cost ratios as they are perceived by all those whose actions have an impact on demand and supply conditions, however small the individual impact. All in all, Hayek’s writings about local knowledge, cognitive limits, and spontaneous orders offer strong arguments against the sort of government interventions that is associated with both egalitarian and technocratic liberalism. If the only alternative to market coordination were the central planning board of a one-party state, the Hayekian knowledge problem, as it has become known, would have amounted to the best-argued repudiation of the state as an entity. But with democracies the evidence is suggestive rather than conclusive.

        While Hayek did generalize his ideas about spontaneous orders to other fields, notably English common law and science, he always treated the state as akin to an instrumental organization. This is however a mistake for multi-party democracies, since the rules and signaling devices of democracy shows that democracies are, in fact, also spontaneous orders (diZerega, 1989). The rules include freedom of speech and periodic elections, and the systemic resource consists of votes.

        This does not mean that the market and democracy are anywhere near perfect substitutes in their role as orders that attempt to solve the problems of social coordination. David Emanuel Andersson (2008a, p. 66, italics in original) writes that “both [i.e. markets and science] deal with ways of creating and disseminating knowledge about priorities in a global sense. The market process sorts endowment-weighted, fine-grained, individual priorities. Democracy sorts priorities that are egalitarian, coarse, and aggregated.”

        From a liberal point of view (no matter of which type), market priority sorting offers the general benefits of fine-grained and disaggregated responsiveness to individual objectives. Democracy, on the other hand, offers the benefit of weighting the local knowledge of each individual equally, rather than on the basis of the combined effects of skill, luck, and inheritance. From the individual’s point of view, the choice between market and democratic coordination boils down to a comparison between the expected net benefits within the domain of activity that is the object of choice. If the expected net benefit of permitting individual choices of custom-tailored “policy packages” is greater than the expected net benefit of ensuring that the local knowledge of each citizen is taken into account with equal weight, the conclusion would be a preference for market over democratic decision-making. On the other hand, if the expected benefits of redressing the possibly great inequalities of wealth and income (and the loss of local knowledge that this entails) are greater than the benefits of choice that is both disaggregated and flexible, then it stands to reason that the individual holding such an expectation should express a preference for a democratic political choice.

        One of the most disturbing features of many existing economies is that the local knowledge of many people cannot be transformed into entrepreneurial ventures because access to credit often depends on an individual’s accumulated wealth. This is the cornerstone of Theodore Burczak’s incisive arguments for a decentralized version of market socialism in “Socialism after Hayek” (Ann Arbor: University of Michigan Press, 2006). While some of Burczak’s Marxian interpretations of class interests and the alienation of wage workers is unlikely to be taken seriously by liberals who prefer to focus on population diversity rather than on identifying allegedly representative classes of people with identical group interests, this by no means implies that liberals and other non-socialists can safely ignore Burczak’s book. What Burczak does is pose one very disturbing question that goes to the heart of the classical liberal defense of markets. More surprisingly, given his socialist ideology, he also uses Hayek’s work to repudiate both central planning and anti-market sentiments. While faith in central planning and hostility to markets is more closely associated with socialist than with liberal thought, there are still many egalitarian and technocratic liberals who believe in sector-specific government planning and tighter government regulation of existing markets. Since Burczak’s Hayekian arguments against central planning follow Hayek’s own arguments rather closely, it is to Burczak’s questioning of classical liberal conclusions that we turn next.

          

The Burczakian Challenge

 

Unlike most socialists, Burczak has fully integrated the Hayekian critique of central planning into his proposal for what he believes is a workable version of market socialism. Unlike the “market” socialist proposals of an earlier era (see, for example, Lange and Taylor, 1948), there is no need for quotation marks when designating the Burczakian version. Burczak’s understanding of Hayek’s thought is not the caricature that the uninformed reader might have expected in view of the contributions of twentieth century socialist economists; it should therefore come as no surprise that the book was well received by a number of leading contemporary Austrian economists (for example Horwitz, 2007; Storr, 2007).

        But the Burczakian challenge that is most potent from a liberal point of view is not really derived from Hayek’s writings at all. While he criticizes Hayek’s assumption of the legal objectivity of common law judges as discoverers of relevant precedents (59-66), this critique loses much of its normative force unless one makes the additional assumption that the subjective biases of judges are more serious than the subjective biases of elected officials. It is instead his discussion of the effects of credit rationing on entrepreneurship that raises the most disturbing questions from a classical liberal perspective. He criticizes the asset neutrality assumption of Israel Kirzner’s (1973) theory of entrepreneurship, which Kirzner views as an extension of Hayekian insights into how market processes bring about a dissemination of knowledge:

 

According to Kirzner, in a market economy that places no statutory limits on the economic activities in which an individual may participate … every person has in principle the same opportunity of acting on an entrepreneurial insight as any other. Specifically, ownership of wealth provides no entrepreneurial advantage: a poor person who notices an opportunity for entrepreneurial gain is in principle no less able to seize this opportunity than is a wealthy person. Kirzner’s conclusion reinforces Hayek’s notion that a market economy improves the life chances of any person chosen at random. Kirzner reaches this conclusion because he believes that credit markets in a free economy do not systematically discriminate among types of borrowers. This belief has been called into question by credit rationing models demonstrating that asset-poor individuals who are not able to provide collateral to lenders will be unable to obtain credit, no matter the interest rate they pay. (67-68).

 

Burczak’s critique of Kirzner’s theory is based on the work of Samuel Bowles and Herbert Gintis (1986), which shows that lenders have a rational fear of moral hazard (incentives for imprudently risk-loving behavior from the lenders’ point of view) and adverse selection (incentives for undesirable borrowers to disproportionately apply for loans) in an environment with imperfect information about credit risks. An individual’s access to resources that she can transform into forward-looking entrepreneurial ventures thus reflects some combination of her savings, her access to loans, and her ability to persuade others to pool their resources with hers. What this implies is that poor people – whether in terms of wealth or entrepreneurially useful connections to others – have fewer entrepreneurial opportunities than the rich. It has the further systemic implication that many people with useful local knowledge cannot disseminate that knowledge because they do not have sufficient resources to influence market prices[3].

        Burczak’s critique of Kirzner’s theory is suggestive of some of the deeper problems associated with Kirzner’s repeated assertions that entrepreneurs are alert discoverers of pre-existing price discrepancies, which allows him to separate the entrepreneurial from the capitalist function. This separation is only possible if we abstract from transaction costs, which are those costs that arise from individuals’ imperfect knowledge and information. Not even pure arbitrage (Kirzner’s benchmark) is possible to profit from for an individual with neither tangible nor intangible resource ownership. Even an entrepreneur who notices and understands a simple discrepancy in the price of an identical good in two locations (net of transportation costs) may need to learn the transaction technology and institutions of the relevant markets. This means that the entrepreneur requires human resources beyond the momentary and costless entrepreneurial alertness to which Kirzner repeatedly refers. Kirzner skirts this problem by simply assuming “free entry.”

        When we increase the complexity of the entrepreneurial decision, transaction costs increase too. A new idea about how to earn profits from transforming the inputs of ideas, workers, and capital into, say, a new shopping mall is not sufficient for making the mall a reality. Without collateral, it may be possible to access a microcredit loan, but major investments depend on substantial ownership of resources or good personal connections to others with such ownership.

        There is also the additional problem that the notion of “entrepreneurial discovery” is singularly unsuited to processes that involve an open-ended, uncertain future. Kirzner attempts to generalize his theory from arbitrage to speculation and innovation. The introduction of a time component complicates matters, however. Gerald O’Driscoll and Mario Rizzo ([1985]1996) draw attention to the Newtonian time of simple and reversible mathematical models and the “real time” of irreversible economic processes. In “real time,” knowledge must change (Lachmann, 1986). Consumption causes individual consumers to learn new aspects and characteristics of consumer goods, which may lead them to revise their preferences and demand. Production experiences cause workers to learn or forget skills and become more productive or sluggish, which changes the availability of resources. Sometimes they discover new ways of combining ideas, which has the potential of changing the technological possibilities. It is therefore misleading to claim, as Kirzner does, that entrepreneurs discover future prices. In a world of “real time,” entrepreneurs judge imaginative conjectures about an uncertain future.

        Any realistic theory of innovative or speculative entrepreneurship must take the structural uncertainty of the future into account. Frank Knight’s (1921) early account of entrepreneurship does this; and he explicitly joins entrepreneurship to the ownership of resources. Where knowledge is difficult to communicate, the key entrepreneurial problem is that it may be impossible for the prospective entrepreneur to persuade others to subscribe to her perception of a future profit opportunity. It may also prove impossible to communicate how she wants to combine and recombine heterogeneous resources in the pursuit of that opportunity. Knight (1921, p. 251) describes the attempt to communicate the causal factors of an entrepreneurial judgment as fraught with difficulties, since these factors originate so deep inside the mind of “the person making the decision that the ‘instances’ are not amenable to objective description and external control.” If human cognitive limits make the transaction costs of such communication prohibitive, the entrepreneur “cannot be an employee, but will instead start his own firm. The existence of the firm can thus be explained by a specific category of transaction cost, namely, those that close the market for entrepreneurial judgment” (Foss et al., 2007, p. 1174).

        Kirzner’s theory thus suffers from two main shortcomings. The first is its assumption of asset neutrality, which Burczak discusses at length. This forms the basis for his proposal of lump-sum wealth redistribution. It is to this topic we turn next. The second flaw in Kirzner’s theory is that it assumes that the future is out there somewhere, to be discovered by alert but passive entrepreneurs. But speculators and innovators have to deal with the structural (non-probabilistic) uncertainty of the future, which implies that real-world entrepreneurs deal with this by making judgments and earning the profits or suffering the losses that represents the variability in revenues around the contractual compensations to the owners of labor, land, and capital goods (entrepreneurs earn or pay the so-called “residual claims”). Burczak does not address this second flaw, which has implications for the second plank of his socialist proposal: the prohibition of wage labor and a resultant market of worker-owned cooperatives. We shall turn to the problems associated with wage labor prohibitions after discussing the problems of government-mandated redistribution.

 

The pros and cons of redistribution: a Hayekian pattern prediction

 

In many societies, the distribution of property rights has deep historical roots. All tangible resources – including capital and consumer goods – are ultimately derived from combinations of labor and land (Schumpeter, 1934). While labor sticks to people in a non-slave-owning free-market economy, land in the form of natural resources does not attach in any inevitable way to people. In most societies, land ownership reflects a historical, path-dependent process of acquisition through some mixture of homesteading, might-makes-right coercion, market exchange, and government redistribution. In some societies, a small group of powerful people had the firepower to claim almost all of the land as their property, while denying land ownership to the majority of people. In such societies, the local knowledge of the landless majority has benefited others to a lesser extent than if everyone had started out with equal shares of real estate and natural resources.

        However, even an equal starting point does not guarantee that approximate equality will endure. The entrepreneurial market process yields profits for some and losses for others, implying that the knowledge of the previously successful and their descendants counts for more than the previously failed. The detrimental effect of such “inequality accumulation” depends on the degree to which natural monopolies arise as well as the extent to which the state protects artificial monopolies. While a redistribution of land and accumulated capital goods may equalize the initial resource access of a population, it is still inevitable that an entrepreneurial process that relies on profit-and-loss signals will generate new material inequalities over time. Andersson (2008b: 77) has proposed a two-fold pattern prediction regarding the knowledge-disseminating properties of a market process.

        On the one hand, one should expect the total amount of local knowledge that price signals disseminate to be greater the closer market participants is to a situation where they start out with equal resource access, other things being equal. On the other hand, more local knowledge can be expected to be disseminated if all market participants receive undistorted profit-and-loss signals that are at the mercy of decentralized and voluntary market exchanges. There is thus an unavoidable tension between the desirability of equal entrepreneurial opportunities and unequal entrepreneurial rewards, exacerbated by the absence of any natural division between starting point and market process.

        Our lack of knowledge about the systemic effects of various redistributive policies implies that it is impossible to “optimize” the mixture of egalitarian redistribution and undistorted market processes in order to achieve the greatest aggregate dissemination of local economic knowledge. But it is extremely unlikely that the institutional structure that generates the most knowledge is either purely egalitarian or purely libertarian, even if it is impossible identify any specific superior structure. Burczak’s endorsement (133) of a very specific redistributive “stake holder grant” of $100,000 that all United States citizens receive on their 18^th birthday is a rare lapse into the sort of constructivism that he is otherwise adept at avoiding in much of the rest of the book.

        This does however not imply that the “Hayekian liberal with Burczakian glasses” cannot suggest anything at all. First, the overall analysis suggests an important role for market prices, predictable property rights, and some redistribution of resources from the resource-rich to the resource-poor. Second, it is important to keep in mind that different forms of redistribution differ in the degree to which they dilute the knowledge-disseminating property of market prices.

A one-off redistribution of land, for example, does not affect such knowledge dissemination. Instead it replaces one array of individual opportunity sets with a new one, which results in market prices and opportunity costs that are possibly very different, while preserving the knowledge content of the subsequent market process. For the same reason, a simple redistribution of income from high-income to low-income individuals is less subversive of knowledge dissemination than the transformation of income tax revenues into school vouchers, while school voucher programs are less subversive than programs where students are allocated according to inflexible geographical catchment areas. The more closely a government directs the allocation of resources, the less individual citizens will be capable of signaling their local knowledge through market exchanges. Indeed, the centralized allocation of students to public schools or of patients to public hospitals represents sector-specific central planning, which illustrates how local Hayekian knowledge problems may co-coexist with market processes in other sectors.

        A workable mix of laissez-faire market processes and redistribution that enhances entrepreneurial opportunities is impossible to pinpoint and should be expected to vary according to local conditions. The spatiotemporal specificity of institutional performance is due to a variety of factors such as land ownership structures, intellectual property right regimes[4], and the prevalence of both philanthropic giving (a policy substitute) and rent-seeking behavior (a policy corruptor). Policy initiatives therefore amount to a trial-and-error process, which points to the importance of experimentation and decentralized jurisdictions.  

         

The problem with enforced worker cooperatives

 

Burczak’s brand of socialism hinges on the Marxian notion of wage labor as a wasteful and degrading exploitation. His explicit arguments in favor of prohibiting wage labor derive from David Ellerman’s (1992) labor theory of property. Ellerman’s theory is a socialist natural-rights theory, which in itself indicates its irrelevance for liberal consequentialism. Burczak argues that “people should be held legally responsible for their results of their action, [which] is readily accepted in the case of a crime, no matter what kind of contract the criminals have agreed on” (113). From a consequentialist perspective this is beside the point, which is most clearly illustrated by the lack of personal responsibility for soldiers that happen to inflict “collateral damage” resulting in the killing of civilian bystanders (they are not prosecuted for manslaughter). The consequence of always enforcing personal responsibility for supposedly inalienable intentional action would make the military defense of a territory either extremely slow or prohibitively expensive, and probably both.

        While natural-rights socialism is unlikely to persuade people unless they have a preconception that accords with Ellerman’s original formulation, there is still a need to consider Burczak’s other arguments. First, Burczak believes that an economy of “labor-managed firms” will not run afoul of any Hayekian knowledge problems (118). More importantly, he suggests that an economy without wage laborers will be less wasteful than a conventional capitalist economy:

 

Hayek’s idea of the importance of tacit, local knowledge in the production process suggests … efficiency-promoting benefits of labor-appropriating firms. There is reason to think that the labor-appropriating firm will give more workers incentive to report their subjective perceptions of economic opportunity – such as more efficient technologies, since they share in the profits these technologies might allow. Insofar as capitalist firms often do not provide incentives to all employees to notice and report improvements in a firm’s technology, the labor-appropriating firm may be more innovative than the capitalist firm. (119)

 

Burczak’s ability to reach this sort of conclusion rests both on a misunderstanding of risk as it is presented in one of Kirzner’s examples as well as on an implicit acceptance of Kirzner’s disregard of the uncertainty-bearing role of entrepreneurs, which is quite different from problems associated with the asset neutrality assumption. Burczak illustrates his reasoning by using one of Kirzner’s (1989) examples:

       

Kirzner seems to suggest that workers who do not employ their entrepreneurial facilities to direct a productive enterprise prefer to take fewer risks than those who do. He asks us to imagine two men, Jones and Smith, who each own no resources but who both believe that cab driving is a rewarding economic activity. Kirzner contrasts the case of Jones, who borrows money to rent a taxicab to become an independent cab driver, with the case of Smith, who rents his labor time to an owner of a fleet of taxicabs. Both the independent contractor Jones and the wage-laborer Smith act entrepreneurially when deciding to work in the taxi-driving industry… The only difference between Jones and Smith appears to be that [only] Jones is willing to take the risk of running his own firm. (71-2).

 

The reason that Jones and Smith are both “entrepreneurs” in the Kirznerian theory is that they have both presumably earned pure profits from the difference between the returns in the taxi industry and the returns in Jones’s and Smith’s second most remunerative known employment of their labor, respectively (i.e. their opportunity costs). Burczak then relies on a peculiar interpretation of entrepreneurship – a sort of Kirznerian entrepreneurship with a Burczakian twist – which fortunately (for Burczak) implies that some of the very real problems associated with his desired prohibition of wage labor are obscured:

 

There are two problems with Kirzner’s analysis and conclusion. First, in this example, the amount of risk incurred by Smith and Jones is not very different, contrary to Kirzner’s claim. Since Jones borrowed the money to finance the purchase of his cab, if the cab business is not profitable, all he runs the risk of losing is the labor time he devoted to the enterprise. The lending bank or capitalist bears all the risk if Jones does not generate enough revenue to pay back his loan. This is the same exact loss to which Smith is exposed. If the fleet owner Brown goes out of business and is unable to pay Smith his wage, Smith will have lost perhaps the same amount of labor time as Jones. However, if the cab business proves to be extremely successful, Jones will gain entrepreneurial profit, while Smith will recover no more than his contracted wage. What then, prohibits Smith from starting his own cab-driving business? For that matter, if Kirzner is right that factor owners are all making the same kind of entrepreneurial judgments, why would anyone ever choose to work for someone else if credit is easily accessible to all? (72)

 

While we may be critical of Kirzner’s exclusion of resource ownership in his theory of entrepreneurship, in this example Kirzner is indeed right to imply that the choice between being an independent cab driver and an employee may reflect relative risk aversion as it is usually interpreted in other fields than entrepreneurship theory. For the sake of argument, let’s assume that business failure is associated with a monetary return of $0. Let’s further assume that the potential monthly profit of Jones is $1,000 while Smith’s monthly wage is $100. If the expected monetary net return is p₁R₁ + p₂R₂, where p is probability and R is return, then it is possible that Jones and Smith both perceive their alternatives in the following way:

 

Self-employment: E(R_s) = (0.91)($0) + (0.09)($1000) = $90

Wage labor: E(R_w) = (0.1)($0) + (0.9)($100) = $90;

 

which would imply equal expected returns for a risk-neutral individual. Thus, if Smith decides to become a wage laborer rather than a self-employed cab driver (assuming that credit is readily available), it would imply that Smith ranks the ex ante utility associated with the wage labor alternative (U_w) as superior to the expected utility of being an independent cab driver (U_s). In this case, the inequality U_w>U_s implies that Smith is risk-averse, while Jones self-employment choice implies risk-loving behavior. Although the assumption that Jones and Smith have an identical set of expectations is unrealistic, the example shows that it is possible and not at all unrealistic to choose wage labor over self-employment, even if credit were available on equal terms to all potential borrowers.

        But risk is itself an unhelpful notion when dealing with entrepreneurial decisions. Following Knight (1921), the usual treatment of risk is as a known probability distribution associated with a set of unequally valued outcomes. This is not the situation that an entrepreneur faces, since she has to make her decision in the face of a structurally uncertain future, where the set of potential outcomes is open-ended. There is thus no way in which an entrepreneur can maximize her expected utility in a way that an outside observer such as an economist can analyze. It is thus possible for both Jones and Smith to be equally risk-averse, the difference being that Jones is convinced that he will succeed – which implies a high payoff with no “risk” – whereas Smith is more pessimistic about his entrepreneurial fortunes. The only way to capture objective risks is through the construction of highly structured non-entrepreneurial situations, such as the difference between an owner and an employee of a casino with captive customers.

        In a realistic theory of entrepreneurship, where entrepreneurship is inextricably linked with resource ownership, it becomes clear that real losses would accompany the loss of the wage labor option, which implies an economy that is less responsive to the subjective preferences of individuals. What then would be the position of the individual worker in an economy with asset-owning entrepreneurs?

        First, the individual worker, as the original owner of her own labor, decides whether to be self-employed or to be an employee under the direction of others. The original owner of individual labor – in the sense of being the one who has ultimate control over the variability in the value of her labor – is therefore always the worker, and she is therefore an entrepreneur when deciding how to deploy her own labor. When an employee decides to work as an employee for a fixed income, she delegates judgment to the firm’s owners, just as owners delegate firm-specific judgment when they hire managers. The employee pays an implicit price for the contractually guaranteed compensation: the potential profits that arise from the marginal variability in output value that is due to her efforts. The economic function of the firm with fixed-income employees is to take on a temporary insurance function. An individual may decide to become an employee rather than a self-employed worker because of insufficient access to resources, but this is not the only possible reason. It could also be caused by uncertainty aversion (i.e. the fear of the unknown rather than a measurable risk) or a lack of confidence in her own entrepreneurial judgment.

        The owners of a firm that employs wage labor will only remain employers if they expect their undiluted judgment about resource use to cause revenues in excess of their opportunity costs, which includes the cost of monitoring employees. If this were not so, they would prefer that the employees claim part of the variation (profits or losses) in the firm’s capital value, transforming the workers into part-owners and part-entrepreneurs. A common example is a manager who is partly compensated through stock ownership, which tends to reduce the value of the fixed salary to take expected profits from capital gains and dividends into account. The original owners will resort to shared ownership with workers if they expect the benefits of the additional motivation among workers, the lower monitoring costs, and the greater influence of the workers’ local knowledge to exceed the additional costs of persuading co-owners and negotiating joint entrepreneurial judgments.

        Burczak’s “labor-managed market” therefore suffers from a lack of flexibility compared with a market that permits both capitalist and cooperative firms. This will inevitably lead to systemic knowledge losses if it is the case that there is a positive correlation between entrepreneurial self-appraisement and entrepreneurial performance. A positive correlation does not mean that entrepreneurial employers are always right. Burczakian socialism would imply knowledge losses as long as the entrepreneurial judgments of self-selected entrepreneurs are only slightly better than the entrepreneurial judgments of self-selected employees. And even if entrepreneurial success is entirely random, enforced worker cooperatives would imply that some uncertainty-averse individuals would be worse off than with more flexible contracting opportunities. But both the division of knowledge and the institutional bounds of human ignorance make it likely that those who specialize in entrepreneurial profit-seeking tend to have better-than-average knowledge regarding the prospects of their self-selected industry. The future is uncertain, but not shapeless.

        While the liberal would be well advised to carefully consider Burczak’s argument in favor of opportunity-enhancing redistributive policies, there is little in his proposed prohibition of wage labor that makes sense if one does not accept the evils of wage labor as self-evident. This does of course not imply that worker cooperatives are necessarily inferior to capitalist firms. But there is a trade-off that should be familiar to anyone that has ever chosen a less remunerative salaried position over the higher but more uncertain payoffs associated with entrepreneurial start-ups. Some people do choose the security of being a management professor over the possibly greater incomes of a freelance management consultant. Perhaps even more pointedly, some specialists work better when temporarily isolated from the ups and downs of market evaluations, while others thrive when relentlessly pursuing profits.

       

The key question: What can liberals learn from Burczak?

 

It is ironic that it takes a socialist coming from a Marxian tradition to appreciate how market processes promote the growth of knowledge, regardless of one’s ideological preferences. The step should be smaller for egalitarian or technocratic liberals, with their tradition of justifying government interventions by referring to benefits accruing to individuals as they see themselves rather than as embodiments of class interests. That most egalitarian or technocratic liberals still have not learned the Hayekian lesson is testimony to the enduring influence of abstract economic models that assume away the dispersion of knowledge and the subjectivity of interpretation. Burczak’s book provides the ideal antidote to the pretense of knowledge among liberals enamored with supposedly welfare-promoting social engineering. It represents the realization by someone further removed from classical liberalism – an egalitarian collectivist – that markets are necessary even if one were to pursue aspirations such as the elimination of exploitation, alienation, and class interests as defined by Karl Marx.

        But there is also a lesson for classical liberals: markets are not neutral devices that serve all interests equally. While markets are indispensable for the modern division of labor and knowledge, they do not always generate rewards that reflect aggregate social benefits. And this is not just a question of defining property rights better so as to prevent externalities. Burczak’s detailed analysis of the entrepreneurial opportunity and local knowledge losses that are associated with credit rationing provides classical liberals with an understanding that redistribution is not always akin to “leaking buckets,” even though many of the currently popular government programs may indeed amount to sector-specific central planning or, worse, redistribution from the masses to well-organized interest groups. Classical liberals would benefit from being as observant of market pathologies as they are of the democratic pathologies associated with rent-seeking and voter ignorance.

        While Burczak provides a stimulating analysis that raises several interesting questions, there is no need for liberals to take on board Marxian notions of class interest or natural-rights theories that prohibit delegating responsibilities from workers to owner-entrepreneurs. Liberalism is rooted in individualism, subjectivism, and pluralism. This lies behind the liberal appreciation of unplanned spontaneous orders such as markets, democracy, and science. Liberals could do worse than heed diZerega’s advice for healing the liberal rift: the open-minded development of Hayekian social theory. A future assessment of milestones in such a development will surely include “Socialism after Hayek” as one of the most provocative specimens that challenge liberals to reassess their theories about social processes. In diZerega’s words,

 

The Hayek-inspired model … has the potential for reuniting liberal social theory around the intertwined concepts of emergent orders as institutional expressions of liberal values … The principles that generate emergent social orders [e.g. markets, democracy, science] are intrinsically liberal ones: equality of status, voluntary cooperation, and the importance of persuasion and agreement. These values are honored, if often with different emphases, by all three fragmentary traditions … [I]t gives them a common vocabulary as well as hopefully immunizing them from the anti-liberal forces who have preyed upon this division. (diZerega, 2008: 17)

 

 

 

References

Andersson, David Emanuel. 2008a. “The Double-edged Nature of the Hayekian Knowledge Problem: Systemic Tendencies in Markets and Science.” Studies in Emergent Order 1: 51-72.

Andersson, David Emanuel. 2008b. Property Rights, Consumption and the Market Process. Cheltenham: Edward Elgar.

Bowles, Samuel. Gintis, Herbert. 1986. Democracy and Capitalism. New York: Basic Books.

Buchanan, James M. Tullock, Gordon. 1962. The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor: Ann Arbor Paperbacks.

De Soto, Hernando. 2000. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. London: Bantam Press.

diZerega, Gus. 1989. “Democracy as a Spontaneous Order.” Critical Review 3: 206-40.

diZerega, Gus. 2008. ”New Directions in Emergent Order Research.” Studies in Emergent Order 1: 1-23.

Ellerman, David. 1992. Property and Contract in Economics. Oxford: Blackwell.

Foss, Kirsten. Foss, Nicolai J. Klein, Peter G. Klein, Sandra K. 2007. ”The Entrepreneurial Organization of Heterogeneous Capital.” Journal of Management Studies 44: 1165-86.

Gaus, Gerald. Forthcoming. “Coercion, Ownership, and the Redistributive State: Justificatory Liberalism’s Classical Tilt.” Social Philosophy & Policy.

Hayek, Friedrich A. 1945. “The Use of Knowledge in Society.” American Economic Review 35: 519-30.

Hayek, Friedrich A. 1952. The Sensory Order. Chicago: University of Chicago Press.

Hayek, Friedrich A. 1960. The Constitution of Liberty. Chicago: University of Chicago Press.

Hayek, Friedrich A. 1979. Law, Legislation and Liberty. Chicago: University of Chicago Press.

Horwitz, Steven. 2007. “Leftists for Hayek: What Happens When a Socialist Applies the Insights of Austrian Economics. Reason (July).

Kirzner, Israel M. 1973. Competition and Entrepreneurship. Chicago: University of Chicago Press.

Kirzner, Israel M. 1989. Discovery, Capitalism and Distributive Justice. Oxford: Blackwell.

Knight, Frank H. 1921. Risk, Uncertainty, and Profit. Boston: Houghton Mifflin.

Lachmann, Ludwig M. 1986. The Market as an Economic Process. Oxford: Blackwell.

Lange, Oskar. Taylor, Fred M. 1948. On the Economic Theory of Socialism. Minneapolis: University of Minnesota Press.

O’Driscoll, Gerald P. Jr. Rizzo, Mario. [1985] 1996. The Economics of Time and Ignorance. London: Routledge.

Rawls, John. 1971. A Theory of Justice. Cambridge, Mass: Belknap.

Samuels, Warren J. 1981. “Maximization of Wealth as Justice: An Essay on Posnerian Law and Economics as Policy Analysis.” Texas Law Review 60: 147-72.

Schumpeter, Joseph A. 1934. The Theory of Economic Development. Cambridge: Harvard University Press.

Storr, Virgil Henry. 2007. “Review of Theodore A. Burczak’s Socialism after Hayek.” Review of Austrian Economics 20: 313-16.

Notes

[1]  Consequentialist theories are compatible with different policy preferences across individuals, even if all the individuals share the same beliefs as to what are the relevant consequences. The reason for this is that different people may have different theories about democratic and market processes. A practical consequence concerning economic policy is that many classical liberals have aligned themselves with conservatives, while many egalitarian liberals have worked together with democratic socialists. But the underlying liberalism of an individual usually becomes evident in situations that involve less complex issues such as freedom of expression or the treatment of political refugees. In this sense, there is a closer philosophical fit between classical and egalitarian liberals than between consequentialist liberals and natural-rights libertarians.

[2] Liberal political philosophers, political scientists, and philosophically inclined economists have been overwhelmingly of the classical or egalitarian persuasions. Technocratic liberalism is often more implicit than explicit, but still permeates the work of quantitative welfare economists and “new Keynesians,” which have been influential in shaping the policy proposals of a great number of “pragmatic” and “centrist” politicians. 

[3] Basic economic data, such as prices, revenues, and costs, are a function of the distribution of property rights, since individuals typically differ in their preferences and in their income elasticity of demand for various goods and services. This implies that a comparison of economic data such as country A having a higher per capita GDP than country B may reflect a greater wealth-weighted aggregate valuation of material accumulation over leisure among property right holders in A, rather than a more “efficient” economic system in A. Economic efficiency is undefined before the assignment of property rights, and it is thus – strictly speaking – invalid as a measure for evaluating the relative “efficiency” of different institutions, since different institutions guarantee different distributions of property rights (Samuels, 1981).

[4] Intellectual property rights represent state-enforced monopolies that often give rise to highly skewed income distributions as well as barriers to entrepreneurial entry. While concentrated ownership of enforceable property rights over land is a key inhibitor of widespread entrepreneurial opportunities in many third-world economies (De Soto, 2000), problems associated with enduring monopolies over ideas, designs, and compositions have had an increasing impact in post-industrial regions of the world (Andersson, 2008a).