4.1 — Historical & Institutional Schools

# 4.1 — Historical & Institutional Schools
## ECON 452 • History of Economic Thought • Fall 2020
### Ryan Safner Assistant Professor of Economics <a href="mailto:safner@hood.edu">safner@hood.edu</a> <a href="https://github.com/ryansafner/thoughtF20">ryansafner/thoughtF20</a> <a href="https://thoughtF20.classes.ryansafner.com"> thoughtF20.classes.ryansafner.com</a>

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# Outline

## [The German Historical School](#4)

## [American Institutionalism](#10)

## [Thorstein Veblen](#10)

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# Heterodox Economics

.smallest[
- We have focused thus far solidly on “orthodox economics”
  - British Classicals through marginalist revolution
  - A clear trajectory to modern economic theory (but they’re not *identical*!)

- Today we look at some famous .hi[heterodox] writers gaining traction at the same time as the marginalist revolution (mid—late 19th century in to early 20th century)

- Critical of “neoclassical” economics (Classical & marginalist synthesis)
  - Critical of methodology and scope
  - Critical of worldview and ideology
]
]

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# Heterodox Economics

- Two (broad) heterodox schools of thought during two key eras:

- .hi[German Historical School] in central Europe
  - “Older” school in 1840s-1870s
  - “Younger” school in 1870s-1900
  - Famous “*Methodenstreit*” with Menger & Austrians in 1880s
  - Dies off by 1930s

- .hi[American Institutionalists] in United States (1890s-1930s)
  - Dies off by 1930s
  - New Institutional Economics (1970s-Present)
]
]

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# The German Historical School

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# The German Historical School

- English Classical (and marginalist) economics did not penetrate into central Europe

- Diverse group of writers throughout 19th century in German-speaking states
 - “Germany” not united until 1871

- Broadly speaking: generally placed more stock in concrete historical analysis, skeptical of “universal” principles or abstract models
]

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# The German Historical School

- .hi[“Older School”]: Wilhelm Roscher, Karl Knies, Bruno Hildebrand (c.1840s—c.1870s)
  - anticipated by Friedrich List
  - theories of “stages of development” of countries

- .hi[“Younger School”] dominated by Gustav von Schmoller (c.1870s—1900s)
  - rejection of universal laws of economics & deductive method
  - inductive and comparative, focused on time and location
  - focus on State-led policy & reforms

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.pull-right[
.center[
![:scale 90%](../images/germanconfederation.png)
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# Predecessor: Friedrich List

1789—1846
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- Impressed by the American system protecting infant industries in America

- Became perhaps the most famous protectionist

- 1841 *The National System of Political Economy*
  - Became the Bible of protectionists, as the *Wealth of Nations* was to free traders

- Later returned to Germany, helped create the *Zollverein* and push for unification
]

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# Friedrich List

1789—1846
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.right-column[
.smallest[
- Criticized Adam Smith for being too cosmopolitan, putting the interests of the *world* first, not the interests of the *nation*
  - Though Smith *did* argue free trade would benefit *Britain* (as well as the world)

- Rejected Classical economic theory, focused more on historical study

- List was concerned with .hi-turquoise[national economic power], not just the increase of wealth and prosperity

> “The power of producing wealth is...infinitely more important than wealth itself!”

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# Friedrich List: Importance of *National* Orientation

1789—1846
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> “[A] nation would act unwisely to endeavour to promote the welfare of the whole human race at the expense of its particular strength, welfare, and independence. It is a dictate of the law of self-preservation to make its particular advancement in power and strength the first principles of its policy”

]

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# Friedrich List: On Production

1789—1846
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.smallest[
- Thinks Classicals focused too much on consumption, government should focus on *production*
  - “[P]roduction renders consumption possible.”
  
- Largely endorsed mercantilist policies, privileging manufacturing

> “It may be stated as a principle that a nation is richer and more powerful, in proportion as it exports more manufactured products, imports more raw materials, and consumes more tropical commodities.”

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# Friedrich List: Regulations Must be *Targeted*

1789—1846
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> “It is bad policy to regulate everything and to promote everything by employing social powers, where things may better regulate themselves and can be better promoted by private exertions; but it is no less bad policy to let those things alone which can only be promoted by interfering social power.”

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.source[List, Friedrich, 1841, *The National System of Political Economy*]

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# Friedrich List: On Protecting Manufacturing

1789—1846
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- This only works for specific circumstances:

> “The system of protection can be justified solely and only for the purpose of the *industrial development* of the nation...Measures of protection are justifiable only for the purpose of furthering and protecting the internal manufacturing power, and only in the case of nations which through an extensive and compact territory, large population, possession of natural resources, far advanced agriculture, a high degree of civilization and political development, are qualified to maintain an equal rank with the principal agricultural manufacturing commercial nations.”

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.source[List, Friedrich, 1841, *The National System of Political Economy*]

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# Friedrich List: On Protecting Manufacturing

1789—1846
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- List is *always* in favor of free trade in everything *except* manufactured goods

- Only thinks that large, powerful, temperate, advanced countries can extend their development by protecting manufacturing and industrializing

- Largely from his study of Britain and the United States as leading examples

- Sees the progress of great nations as a sequence from free trade to protectionism (for manufacturing), and then back to free trade

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# Friedrich List: On Protecting Manufacturing

1789—1846
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> “History teaches us how nations which have been endowed by Nature with all resources which are requisite for the attainment of the highest grade of wealth and power, may and must...modify their [commercial] systems according to the measure of their own progress: in the first stage, adopting free trade with more advanced nations as a means of raising themselves from a state of barbarism, and of making advances in agriculture; in the second stage, promoting the growth of manufactures, fisheries, navigation, and foreign trade by means of commercial restrictions; and in the last stage, after reaching the highest degree of wealth and power, by gradually reverting to the principle of free trade and of unrestricted competition in the home as well as in foreign markets.”

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.source[List, Friedrich, 1841, *The National System of Political Economy*]

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# Following English *Practice*, Not Classical *Theory*

1789—1846
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.right-column[
.smallest[
- Classicals can *preach* all they want about Free Trade in the *abstract*, but *actual* British policy was still largely protectionist

- This protection is what made England wealthy

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.quitesmall[
> “Had the English left everything to itself—'Laissez faire, laissez aller', as the popular economical school recommends—the [German] merchants of the Steelyard would be still carrying on their trade in London, the Belgians would be still manufacturing cloth for the English, England would have still continued to be the sheep-farm of the Hansards, just as Portugal became the vineyard of England, and has remained so till our days, owing to the stratagem of a cunning diplomatist. Indeed, it is more than probable that without her [highly protectionist] commercial policy England would never have attained to such a large measure of municipal and individual freedom as she now possesses, for such freedom is the daughter of industry and wealth.”

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# Friedrich List: Free Trade is the Eventual Goal

1789—1846
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> “The system of protection, inasmuch as it forms the only means of placing those nations which are far behind [dominant England]...the system of protection regarded from this point of view appears to be the most efficient means of furthering the final union of nations, and hence also of promoting true freedom of trade...In order to allow freedom of trade to operate naturally, the less advanced nations must first be raised by artificial means to that stage of cultivation to which the English nation has been artifically elevated.”

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.source[List, Friedrich, 1841, *The National System of Political Economy*]

]

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# The Infant Industries Argument

.smallest[
- List is only perhaps the most popular historical figure making what economists call the .hi[“infant industries argument”]

- Promote .hi-purple[import substitution]: specific key industries should receive special protection (via tariffs, quotas, subsidies etc.) that discourage competition (from more efficient foreign imports)

- Eventually, once the industry matures (is no longer in the “infant” stage), it can stand on its own and compete with the rest of the world, protection can be lifted
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.pull-right[
.center[
![:scale 100%](../images/infantindustriescartoon3.jpeg)
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# Schmoller and the Younger Historical School

1838-1917
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- *Dominated* all central European academic social science in late 19th century
 - One could not obtain a professorship without Schmoller’s approval!

- Called *Kathedersozialist* (Socialist of the chair)
  - focused on State-led policy changes
  - “The intellectual bodyguard of the house of Hohenzollern”
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# Schmoller and the Younger Historical School

.center[
![:scale 60%](../images/germanempireproclamation.jpg)
.quitesmall[
Proclamation of the German Empire in the Hall of Mirrors of Versailles (1871)
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# The *Methodenstreit*

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- .hi[*Methodenstreit*] (strife over methods) between Gustav von Schmoller & Carl Menger
  - Menger: universal economic laws exist
  - Schmoller: they don’t

- Schmoller derides Menger & his followers as “The Austrians”

- Debate mostly a distraction, but forces Menger & followers to focus on methodology
   - Focus both on theory and empirics

.source[Menger, Carl, 1883 *Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere* (Investigations into the Method of the Social Sciences with Special Reference to Economics)]

]

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# American Institutionalism

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# American Institutionalism

.pull-left[
.quitesmall[
- American economists were also skeptical of British classical (and marginalist) economics

- Americans getting Ph.Ds from Germany (Historical school)
  - e.g. Clark was a student of Karl Knies

- Developed their (broadly speaking) approach: .hi[institutionalism]
  - critical of abstract models & assumptions about human behavior (i.e. rational-maximizers & equilibrium)
  - focus on the role and *evolution* of social institutions, and how they affect humanity

- Largely inspired by Thorstein Veblen
  - Others: John R. Commons, Wesley C. Mitchell
  - Much later: New Institutional Economics (1970s-Present)
  
- Connected with Progressive Era ideas
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.pull-right[
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![:scale 100%](../images/goodgovernance.png)
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# Some Context: Progressive Era I

.left-column[
.center[
![:scale 80%](https://www.dropbox.com/s/4559f5e3iph2h2g/fredericktaylor.jpg?raw=1)

Frederick Winslow Taylor

1856-1915
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- **Progressive Era** (1890-1920), rise of Big Business

- .shout[Taylorism] and .shout[Efficiency Movement]: industrial efficiency by methods of *scientific* management
    - Apply scientific tools to study optimal production techniques, standardization, eliminate waste

- Workers as cogs in a well-oiled machine
]

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# Some Context: Progressive Era II

.left-column[
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![:scale 80%](https://www.dropbox.com/s/5cu2p8j4zz3kaka/theodoreroosevelt.jpg?raw=1)

Theodore Roosevelt

1858-1919

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- **Progressive Era** (1890-1920), rise of Big Business

- Activism aimed at rationalizing society, economy

- Activist government fine-tuning markets: antitrust, minimum wage, externalities

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# The Progressive Era (c.1890-c.1920)

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# The Progressive Era (c.1890-c.1920)

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# The Progressive Era (c.1890-c.1920): Big Business

.left-column[
.center[
![:scale 35%](https://www.dropbox.com/s/viqkhpmebwyysre/adolfberle.jpg?raw=1) ![:scale 45%](https://www.dropbox.com/s/1dr94mb275hi05k/gardinermeans.jpg?raw=1)

R: Gardiner Means (1896-1988)

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> “We now have single corporate enterprises employing hundreds of thousands of workers, having hundreds of thousands of stockholders, using billions of dollars' worth of the instruments of production, serving millions of customers, and controlled by a single management group. These are great collectives of enterprise, and a system composed of them might well be called 'collective capitalism,”

- Separation of ownership (shareholders) and control (management) in corporations

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# The Progressive Era (c.1890-c.1920)

- Economic legislation to “rationalize” and regulate market economy
  - Antitrust laws
  - Labor laws: unions, child labor laws, minimum wages, health and safety
  - Monetary changes: Federal Reserve, creation of income tax (13th Amendment)

]

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# The Progressive Era (c.1890-c.1920)

- Social legislation to enhance democracy:
  - Women's suffrage (19th Amendment)
  - direct election of Senators (17th Amendment)
  - Primaries in party politics (to end political machines)

]

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# The Progressive Era (c.1890-c.1920): Eugenics

- But at same time, focus on **scientific expert control of society**
  - Eugenics, scientific racism, forced sterilization of "imbeciles"
  - Prohibition of alcohol (18th Amendment)

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# The Progressive Era (c.1890-c.1920): Eugenics

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> “Less well known is that a crude eugenic sorting of groups into deserving and undeserving classes crucially informed the labor and immigration reform that is the hallmark of the Progressive Era..Reform-minded economists of the Progressive Era defended exclusionary labor and immigration legislation on grounds that the labor force should be rid of unfit workers, whom they labeled “parasites,” “the unemployable,” “low-wage races” and the “industrial residuum.” Removing the unfit, went the argument, would uplift superior, deserving workers,” (pp.207-208)

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.source[Leonard, Thomas, 2005, “Retrospectives: Eugenics and Economics in the Progressive Era,” *Journal of Economic Perspectives* 19(4):207–224]

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# The Progressive Era (c.1890-c.1920): Eugenics

.quitesmall[
> “Sidney and Beatrice Webb (1897 [1920], p. 785) put it plainly: ‘With regard to certain sections of the population [the “unemployable”], this unemployment is not a mark of social disease, but actually of social health.’ ‘[O]f all ways of dealing with these unfortunate parasites,’ Sidney Webb (1912, p. 992) opined in the Journal of Political Economy, ‘the most ruinous to the community is to allow them to unrestrainedly compete as wage earners,’” (p.213)

> “Seager (1913a, p. 9) wrote: ‘The operation of the minimum wage requirement would merely extend the definition of defectives to embrace all individuals, who even after having received special training, remain incapable of adequate self-support.’” (p.213).

]

.source[Leonard, Thomas, 2005, “Retrospectives: Eugenics and Economics in the Progressive Era,” *Journal of Economic Perspectives* 19(4):207–224]
]

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# The Progressive Era (c.1890-c.1920)

- New independent agencies
  - **Interstate Commerce Commission** (1887) to regulate railroads, trucking, telegraph & telephones
  - **Federal Trade Commission** (1914) for antitrust, consumer protection

- Science of .hi[public administration]: substitution of democracy and markets with rule by technocratic **experts** insulated from politics and public opinion

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# Some Context: Progressive Era II

Woodrow Wilson

1856-1924

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> "The field of [public] administration is a field of business. **[It] lies outside the proper sphere of politics**...Although **politics sets the tasks for administration**, **it should not be suffered to manipulate its offices**"

> "[P]ublic attention must be easily directed, in each case of good or bad administration, to just the man deserving of praise or blame. **There is no danger in power, if only it be not irresponsible.** If it be divided, dealt out in share to many, it is obscured."

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# Thorstein Veblen

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# Thorstein Veblen

1857—1929
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- Highly influential critic of orthodox economics

- A student of John Bates Clark (who himself was a student of German historicist Karl Knies)

- Major founding influence of American institutionalism

- Coined the term .hi[“neoclassical” economics] — thought classical and new marginalist economics suffered from the same problems

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# Thorstein Veblen

1857—1929
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- Found it hard to assimilate into American mainstream economics profession

- Obtained Ph.D in philosophy from Yale

- Academic struggles, moving from college to college teaching

- AEA eventually offered him presidency, but rejected it

> “He was like a man from Mars observing the absurdities of the economic and social order with satirical wit” — Landreth & Colander (p.327)

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# Thorstein Veblen

1857—1929
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- Critique of both economic theory and the instititions of capitalism
  - did not create an alternative system to rival

- Focus on institutional analysis, motivated by Darwinian scientific approach
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