Thoughts on economics and liberty

“Where economic man dwells”, a short essay by Harold Demsetz

Continuing from a previous blog post, I'm providing (moderately condensed) colour-annotated extracts from the first chapter of Demsetz's book, From Economic man to Economic System. I've given sub-headings for the convenience of the reader who is in a hurry.

Chapter title: Where economic man dwells
Let me introduce you to economic man. But, wait, you know him already. He is Scrooge before being reformed by ghosts of past and future times. He is the landlord in Puccini’s La Boheme, who has the audacity to ask his poor, unemployed, and fun-seeking artist tenants for the rent due him. He is the banker who pressures a destitute widow to make the due mortgage pay­ment. He is Veblen’s predatory businessman of the 1890s, skilled at calculating and at pressuring rivals into submission. He thinks only of himself and, mainly, only of his wealth. He is ridiculed by critics who see him as a caricature of a real person, and who, therefore, drum him out of the human species by reclassifying him as Homo economicus. Yet, he is present within each of us.
First, however, I note the following three points:
(1) The task of understanding market processes is different from that of understanding a human being and even from that of under­standing issues that are not ordinarily resolved through market processes. Except with respect to human intelligence, economics does not describe a person in a way that might serve the needs of biologists, sociologists, and philosophers. It did not, until fairly recently, give much thought to the workings of institutions other than markets. I make this clear even though I suspect that the economic analysis of the marketplace has much to offer in these regards.
Other social sciences are focused on problems that differ in var­ious degrees from problems of the marketplace, and, appropriately enough, they view a person somewhat differently from the way economists do. Each of these different perceptions about human behavior are to be thought of as tools that serve specific purposes, not as complete, accurate descriptions of people. Failure to recognize this has been a major source of confusion.
(2) Although self-interest means serving one’s own wants, it does not specify these wants. For reasons given below, this essay, for the most part, will assume that these wants do not include the well-being of others; the assumption is not an imperative of the economic model of human behavior but it allows this essay to deal with the caricature of economic man created by the model’s critics.
There is bias in this caricature. Consider again the persons depicted in Puccini’s opera. The landlord is cast as a dolt and narrow-minded seeker of rent; no matter that he has invested con­siderable sums in providing living spaces to those in need of them. His artist-tenants, on the other hand, are viewed as kind, fun-loving pleasure seekers. They acquire such pleasures by delaying payments of the rent due the landlord, which is narrow-mindedly seeking to use the funds of someone else, and by succeeding in bilking an elderly, past lover of coquettish Musseta. Now, I ask you, which of these two classes of characters is the more narrow­mindedly self-seeking? They both seek their self-interests. The difference between them is in the methods employed.
The landlord supplies living space and offers contractual arrangements to use this space, expecting thereby to receive funds from tenants. The elderly lover buys lunch for others out of past remembrances of romance and present hopes of renewing this romance. The artists, on the other hand, pursue self-interests in duplicitous ways, delaying per­formance on the rental agreement that provides them with living space and deceiving an elderly seeker of romantic engagement. Critics of economic man generally visualize the landlord-type as the only person who fits the caricature they have fashioned.
(3) Human behavior does reflect concern for others. We know this from life within the family, interactions within the workplace and military platoon, and so on. Conscious cooperation with and personal feelings toward others are important in these areas of human activity.[1] Yet, it is precisely the narrower interpretation of human behavior, as motivated by concern for one’s own wants, that makes the economic model of behavior so useful in the study of activity in the marketplace. And it is the marketplace that is the arena of behavior most relevant to what, historically, has been the central problem of economics. 
The core puzzle of economics
Economic man remains alive in economics because he is very help­ful to the resolution of what arguably is the most important puzzle economists faced during the first 150 years during which their dis­cipline matured into a social science. This puzzle has been aptly described in contemporary times by F. A. Hayek (1988) as that of “spontaneous order”: “spontaneous” because no person or group of persons, and no institution, determines how resources will be allocated in the liberal economy; a “puzzle” because, despite the absence of managed, conscious control there seems to emerge a “sensible” allocation of resources.
This puzzle not only shaped the discipline of economics, it also distinguished economics from the other social sciences. It plays no important role in other social sciences, not in anthropology, political science, or sociology, and, if these be social sciences, not in psychology and neuroscience. Not even in biology.
The model of human behavior used in economics is a tool applied to gain an understanding of how the decentralization puzzle is resolved, and, like any tool, it is specialized to its primary task. It emphasizes some aspects of human behavior while repressing oth­ers. Concern about one’s own wants is emphasized; concern for the wants of others is slighted. Critics of economic man often express a preference for a model of human behavior that is more broadly conceived, one that incorporates all, or most, aspects of human behavior; it would meld concern for one’s own wants with concern for the wants of others. No consensus has yet emerged about the formal nature of such a model, but there is no necessary advantage to a comprehensive model of human behavior. A tool fashioned to hammer nails is not made more useful by attaching a screwdriver to it.
Extensive decentralization, characterized by independently act­ing private owners of resources, describes the core of the sponta­neous order problem. The marketplace, in turn, is the dominant arena in which independently acting persons interact with each other in deciding how the resources they own are to be used. The virtue of the economic model of man is that it is well suited to the task of exploring behavior in this arena, whether this is located in a solidly capitalistic economy or in a solidly socialistic economy.
Transactions between UNKNOWN people are the building blocks of economics
Conditions in the marketplace differ from those within the family, neighborhood, and political bureaucracy. Exchange in the marketplace is treated as exchange between persons who are essentially unknown to each other. Indeed, in the highly organized marketplace, people, buyers and sellers, do not face each other. They face prices. There is no personalized inter­action between buyer and seller; each simply acts independently in responding to an impersonally determined market price, making his or her decisions on the basis of this price and his or her own wants. Think of the offer to purchase or sell shares of stock on an organized exchange.
Markets in a real economy often differ somewhat from the eco­nomic conception of a highly organized market. They sometimes involve familiarity between people, but the degree of familiarity is less than that which would normally exist within households and firms. Owners and customers of local grocery stores, dry-cleaning establishments, and other such businesses are acquainted. So are doctors and patients, and so on.
Frequent interaction between the same people makes for some familiarity and perhaps for more per­sonalized concern. So, yes, the highly organized market gives a somewhat distorted view of the “neighborhood” setting, but the neighborhood setting is not that of the spontaneous order puzzle. Moreover, by how much is the local setting distorted by the eco­nomic model of human behavior? Do sympathetic feelings between buyer and seller have a large influence on decisions involved in neighborhood shopping? Have you offered the local grocer more for his goods than the price he posts or asks, or do you search among competing neighborhood grocers for best values? Do you offer more if the grocer is on the verge of bankruptcy? How much more, how often, and for how long?
Although economists have not ignored localized arenas of human behavior, I have yet to see an empirical study that is made more powerful because it substitutes dealings between “Sam the tailor” and “Jane the successful busi­nesswoman” for dealings between persons who are strangers.[2]
The German buyer of American wheat does not know, and does not care to know, who produced the wheat. He has no desire to pay more than the market price for wheat, and those who supply wheat have no desire to ask a price lower than is available on the market. 
My point is by now quite obvious. In coming to an understanding of spontaneous order there is considerable methodological useful­ness in minimizing the attention one gives to emotionalism and concern for others.
A desire, expressed by many persons of good will, to make dealings in the marketplace more like those between neighbors and between family members, simply fails to compre­hend the impossibility of this if good will is meted out mainly to those with whom one is familiar.
Suppose that buyer and seller do personally meet while engaging in a transaction. If the buyer offers a price higher than is needed to conclude the transaction, doing so in an act of good will toward the seller, then he will make members of his family worse off for bringing less “bacon” home than he could have secured.
The view I have just presented confronts the caricature used by critics of the economic model. People who engage in exchange across highly organized markets, also make contributions to causes that they think worthwhile but that do not directly add to, and generally subtract from, their wealth. Focusing on this behavior is a cumbersome way to resolve the spontaneous order problem; “decentralization,” after all, means independent decision making by those who do not know each other. Order that emerges from dependent interaction seems too uninteresting; an employer tells an employee what to do and, generally, it gets done. How­ever, viewed on a scale that could be described as central planning, dependent interaction presents a serious and complicated puzzle, one that we are not close to resolving.
It is impractical to know everyone whose produce we use 
Interaction between strangers – even we recognize this as an extreme condition of markets – often is a close approximation to reality. This closeness comes from the fact that specialization of economic activity is an important source of productivity for many human activities, and especially for market-relevant activities.
Specialization stands in opposition to self-sufficiency. Dealing with large numbers of buyers makes it impractical to estab­lish personalized relationships between producer and consumers. People seeking automobiles would find their personal involvement in producing an automobile wasteful of their time and efforts. They prefer instead to purchase it at lower cost (or higher quality) from someone, from a firm, that specializes in manufacturing and selling automobiles. The purchaser cannot maintain a highly personalized relationship with the specialists who have produced the plastic, steel, cloth, rubber, wire, and glass that go into the product, nor can he or she know those who assemble, check, and transport the vehicle. Nor can the own­ers and managers of the firm that specializes in automobile produc­tion personally know the thousands of persons who purchase the firm’s product.
Productivity cannot be realized if exchange is to take place only between people who are very familiar with (and sympathetic toward) each other. Potential gains from specialization bring forth not only markets and dealings between strangers, but also the laws, customs, and cultures that reduce suspicions of and antag­onistic actions toward strangers.
It is not so much the result of persuasion by moralists, intellectuals, and religious leaders that is the source of civil society as it is the productivity gain offered by scale-favoring specialization. The “price” of admission to the market is acceptance of the market’s trading requirements.
Institutional mechanisms are put into place to make people comfortable in dealing with strangers.
Morality of the marketplace is more about the morality of freedom
To conclude this essay, I note that, though I think the marketplace is a valuable institution through which to allocate resources, the essay itself is not driven by moral judgment about the marketplace. My argument is simply that human behavior, good and bad, is well explained by modeling it as pursuing narrowly defined “own” wants when dealing with interactions across markets; “own” wants, instead of “sympathetic” wants, call the tune because of the con­siderable gains in productivity that are realized through the use of scale-favoring production techniques.
None of this implies that the goods produced and exchanged are justifiable in moral terms; they simply are wanted goods. When exchange takes place, people get more of what they want, not necessarily more of what is good or bad for society or good or bad for them.
The morality of rely­ing on the marketplace (or on the polling place) depends in large part on the moral value that we attach to actions taken freely and interactions engaged in voluntarily.

[1] Indeed, my colleague Armen Alchian and I cooperated in writing an article (1972) that stressed the importance of team production to the organization of the firm.

[2] I refer to normal economic conditions here, not interactions that might follow a devas­tating earthquake or some other catastrophe. Behavior does become different, but only very temporarily, in such special settings, but these are inappropriate to the study of spontaneous order. 

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Sanjeev Sabhlok

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