©Deirdre Nansen McCloskey | COPYRIGHTED MATERIAL

Smith, Entry, Samuelson, and Why Economics Should Teach Good Old Chicago School Economics

by Deirdre McCloskey
April 2011
Filed under editorials

University of Chicago campus
Adam Smith professed moral philosophy, and posited a balanced human exercising the virtues of prudence, temperance, courage, justice, and the human parts of love (he tried without entire success to omit the other virtues, of the transcendent-the love, hope, and faith for Economics or Baseball or My Brilliant Career which give human life its point). In other words, contrary to the misreading in George Stigler (say), Our Blessed Smith rejected the notion of a Machiavellian-Hobbesian-Mandevillian-Benthamite-Samuelsonian-Beckerian maximizer of utility specialized in the one virtue of prudence only.

The core of Smithian economics, further, is not Max U. It is entry and exit, and is Smith's distinctive contribution to social science. Many others before Smith had devised sound classifications of productive effort (Aristotle and Aquinas did) or posited a prudence-obsessed actor (Hobbes, Mandeville) or noted the circular flow (the Physiocrats). Joseph Schumpeter's disdain for Smith's originality is directed at such matters. But only Smith carried economic argument into the second and third acts of the drama. (His affection for dramatism, as in The Theory of Moral Sentiments, may figure here.) He was the first to ask what happens in the long run when people respond to desired opportunities. Smith for example argues in detail that wage-plus-conditions will equalize among occupations, in the long run, by entry and exit. At any rate they will equalize unless schemes such as the English Laws of Settlement, or excessive apprenticeships, intervene. Capital, too, will find its own level, and its returns will be thereby equalized, he said at length, unless imperial protections intervene. (By the way, when he detects interventions in "the obvious and simple system of natural liberty," Smith's prose heats up. He saw such interventions in human autonomy as unjust, not merely imprudent, a matter of mere bad "police." He regarded arbitrage as prudence and justice. Aagin: Smith was early and late a professor of moral philosophy)

Smith's idea of entry and exit proved to be widely applicable, becoming the characteristic argument of classical economics (as in Ricardo and Malthus) and then of evolutionary biology, and then in varied fields such as science studies. Entry and exit, as Darwin realized with a jolt in the 1830s by way of Malthus, do the same job as a maximizing Creator. The individual entrant to an ecological niche or to an economic industry or to a new scientific idea does not need to be individually rational, or under the direction of a rational planner (or Planner). The rationality of the outcome comes through success or failure in the market, not through regulation or referee reports. Innovations can be random, as in natural selection, or imperfectly rational, as in human affairs, and yet achieve in the end the evolution of, say, a whale without notable forelimbs or a car factory with quite a few robots or a physics with considerable quantitative oomph-by exit of the proto-whales or proto-factories or proto-theories that offered the market or the production line or the nuclear physics a significantly mistaken formula.

Samuelsonian economics, out of Jevons and Edgeworth, and its offspring in game theory, is a quite different scientific program. It stresses rational maximizing at the level of the individual and downplays the anonymous, strategy-free market interactions in the second and third acts beloved of the Good Old Chicago School. It posits a maximizing man known as Max U facing another such partial human being, mano-a-mano.

Doubtless some of the world works that way. It was not foolish to see how far it could be pushed. But the focus on individual prudence turns away from Smith's characteristic insight that in the second and third acts the actors produce a result which was not any part of their intention. The central game illustrating a Samuelsonian outcome is the prisoner's dilemma. Neat. Yet repeatedly in experiments and in the field the model has failed in great part-the part that the Samuelsonian model strictly implies is impossible. People do vote, when a game theoretical model says they should not. They do trust others, when Samuelsonian calculations would expect them not to. They do cooperate in solving local problems of water management. They do go over the top at the Somme. The failures of game theory since 1980, and the longer-running failure of the wider Samuelsonian program, have arisen from repeated showings that an axiom of Prudence Only doesn't account for individual behavior and that anyway it isn't relevant to most market outcomes. Individuals cooperate more than Max U implies; and anyway economics is a social, not an individual, science.

An economics After Game Theory would return to Smith (and Menger and Marshall: not Walras or Jevons) in stressing evolution, which is to say the rapid evolution entailed in entry and exit in conscious or spontaneously ordered pursuit of gain. Giving up Max U as an all-purpose weapon of economics would allow a modest and ethical actor to flourish in the model, and in the science. Evolutionary game theory does not need to posit a wholly prudent actor: its results come from the interactions in the second and third acts more than from the unreasonable postulate of perfect foresighted reason. Reason-prudence-is not the only virtue, and it is unreasonable to continue doing economics and political theory as though it is. Such a Smithian economics would disarm the social engineer in his arrogance-since one cannot in this world lay down the future of innovation ("Prediction is hard," said Yogi Berra. "Especially about the future.") Rational expectations is only an extreme version of Smithian entry and exit: if you are so smart, oh economist theorist, why aren't you rich? Why hasn't entry spoiled your game? (Yogi Berra, on the social implications of entry and exit: "Nobody goes there any more. It's too crowded.")

Smithian economics sees the limits of economic expertise, in predicting the future of the stock market or hem length or mathematics. The market results of Good Old Chicago School economics would be retained in an ethics-driven and predictively modest model, since ethics beyond Max U in an employer (say) would merely shift the demand curves for labor. She's still influenced by wages, but wages for people who don't engage in sexual harassment, say, or who (not so nice) are not Jewish. One could do microeconomics acknowledging game theory in the relatively rare cases of strategic interaction, acknowledging in praising Rationality the relatively rare cases when the best laid (and Samuelsonian) plans o' mice and men don't gang aft aglay. The relatively common cases of ethical commitments within a drama of human relations could be acknowledged inside an economics with a Smithian emphasis on entry and exit as they cannot in the economics of 1948-1998. A re-instatement of a fully ethical economic actor, in a drama scripted by Our Author, Adam Smith, would permit, in a word, a humanomics.