Author Archive for Peter G. Klein

Peter Thiel on Monopoly and Competition

220px-Peter_Thiel_TechCrunch50Entrepreneur and venture capitalist Peter Thiel has an interesting Wall Street Journal piece on innovation, firm growth, and market structure, misleadingly titled “Competition Is for Losers.” Thiel’s essay is ostensibly about the defense of “monopoly” — the large market shares achieved by successful firms — over “competition,” by which he means perfect competition, the neoclassical economist’s fantasy world in which tiny, identical firms exist in a kind of stasis, not doing anything and not earning any economic profits.

Actually, without meaning to, Thiel gives us a thorough and persuasive critique of mainstream monopoly theory and its bizarre, counterintuitive, and misleading concepts of “monopoly” and “competition.” The business behaviors Thiel praises — innovating, creating economic value, out-competing rivals, and increasing sales and profits — are thoroughly competitive, in the Austrian (and common-sense) notion of of competition. If Thiel had followed the Austrians in defining competition as the absence of legal restraints on entry and exit, he could framed his essay as an explanation of how innovation and entrepreneurship benefit society, rather than making it look like a critique of competition per se. A better title: “Perfect Competition Theory Is for Losers.”

The Endangered Species Act and the Double Coincidence of Wants

9063391401_65324bf5e5_k-e4401aa96f3946385507ca36fddb5e5956ec2ca0-s4-c85This year’s silly Copenhagen Zoo controversy reminded us that, when it comes to animal care, people have difficulty thinking clearly. NPR’s Planet Money ran an interesting piece this morning about animal barter among zoos. The US Endangered Species Act and  global treaties such as the Convention on International Trade of Endangered Species of Wild Fauna and Flora make it a crime to buy and sell zoo animals like other commodities. This makes it difficult for zoos not only to obtain new animals, but also to get rid of existing, unwanted ones. (Hence the fate of poor Marius the giraffe.)

To get around these rules, zoos have adopted a complex and cumbersome barter system. Zoos are, under the law, allowed to make animal-for-animal swaps. But, as economists such as Carl Menger explained more than a century ago, barter is hampered by the double coincidence of wants: to trade with you, it’s not enough that I want what you have; you also have to want what I have. Money eliminates the double coincidence of wants by introducing a third commodity that serves as a generally accepted medium of exchange. Unfortunately for the zoos, money is off the table. And hence: 

The New England Aquarium in Boston was recently in the market for some lookdown fish, and they knew of an aquarium in North Carolina that was willing to trade some.

The folks in North Carolina wanted jellyfish and snipe fish. The New England aquarium had plenty of jellyfish — but no snipe fish.

Steve Bailey, the curator of fish at the New England Aquarium, wound up making a deal to get snipe fish from an aquarium in Japan, in exchange for lumpfish. Then he sent the snipe fish and some jellyfish to North Carolina. In exchange, he finally got his lookdown fish.

Allowing zoos to buy and sell animals using money, rather than complex and inefficient barter arrangements — why, that’s inhumane!

New Essays on Kirzner

KirznerThe newest issue of the Review of Austrian Economics features a symposium on Israel Kirzner’s contributions to the Austrian school. My own essay with Per Bylund, “The Place of Austrian Economics in Contemporary Entrepreneurship Research,” appears in the symposium, along with essays by Peter Boettke, Mario Rizzo, and Henry Manne. Kirzner himself also offers some reflections on his career.

Re: Mises University

David, I liked this Facebook post from another student, on opening night: “I had the opportunity to listen to a very insightful discussion between an Israeli journalist and a Muslim business owner. They were discussing the challenges of extremists in both their cultures and how government intervention only exacerbates those extreme views. Only at Mises. I love it here already!”

Intolerant US Professors Call Out China for Intolerance

91729433_8b0420c6da_oOne of the least tolerant places around is the US university campus, with its speech codes, disdain for dissenting social and cultural opinions, voluntary self-censorship, and slavish devotion to political correctness. “Diversity” is the mantra, but diversity of opinion on economics, history, and politics is generally unacceptable. So, what are US professors worried about? China, of course. The Association of American University Professors recently issued an official statement of concern about Confucius Institutes, Chinese government-affiliated nonprofits that promote Chinese culture on US university campuses such as Stanford, Chicago, Texas A&M, UCLA, Michigan, and many others. “Confucius Institutes function as an arm of the Chinese state and are allowed to ignore academic freedom,” says the AAUP, most of whose members work for state universities or are paid from government grants and other funds. “North American universities permit Confucius Institutes to advance a state agenda in the recruitment and control of academic staff, in the choice of curriculum, and in the restriction of debate.” Perhaps they learned from the CIA, which has many years of experience advancing US state interests in the guise of educational and cultural programs. In any case, the irony of the largely intolerant US professoriate calling out the Chinese for intolerance has been lost on most observers.

Rebuilding Detroit

Detroit,_USA_Taken_From_Windsor,_CanadaEverything valuable that economics textbooks describe as a “public good” has, at one time or another, been provided on the market by individuals and private firms. Even today, capitalists and entrepreneurs are rebuilding public spaces in Detroit, positive externalitites be damned:

Whether or not they’re expecting to profit, Gilbert and other capitalists — large and small — are trying to rebuild the city, even stepping in and picking up some duties that were once handled by the public sector. Shop owners around the city are cleaning up the blighted storefronts and public spaces around them. Only 35,000 of Detroit’s 88,000 streetlights actually work, so some owners are buying and installing their own. In Gilbert’s downtown, a Rock Ventures security force patrols the city center 24 hours a day, monitoring 300 surveillance cameras from a control center. Gilbert is proposing to pay $50 million for the land beneath the county courthouse and a partly built jail near his center-city casino, with the intention of moving the municipal buildings to a far-off neighborhood; his goal is to clear the way for an entertainment district that flows south, without interruption, from the sports arenas past his casino and into downtown. Detroit’s new mayor, Mike Duggan, told me he had no problem with the private sector doing so much to shape his city: Other metropolises had their entrepreneurs and deep-pocketed magnates who built and bought and financed things. With a state-appointed emergency manager overseeing various aspects of Detroit’s operations, with many civic services inoperable for years and with a dire need for investment, Duggan said he felt lucky that his town was getting its turn.

Thanks to Craig Newmark for the pointer.

The True Purpose of “Competition” Policy

Ad_apple_1984“Competition policy” is one of those great Orwellian terms that means the opposite of what it seems to mean. In most countries, antitrust policy is designed not to enhance competition, but to stifle it, by protecting privileged incumbents from upstarts or from their established rivals. A great example of the latter comes from today’s headlines: “Apple Invites FTC To Probe Google.” Having recently settled a case brought by the FTC about in-app purchases on iOS, Apple is now urging the FTC to investigate Google’s policies on in-app purchases on Android. All in the name of “leveling the playing field,” of course. In the tech sector in particular, many of the most important antitrust and regulatory actions against leading firms are initiated by rivals, using whatever means necessary to bash competing firms.

Does War Promote Innovation?

Silver_into_bulletsThe belief that war, and government spending more generally, fosters economic growth by spurring innovation is one of those fallacies that won’t die, no matter how often it is challenged and refuted. Today’s New York Times gives us the usual spiel:

Fundamental innovations such as nuclear power, the computer and the modern aircraft were all pushed along by an American government eager to defeat the Axis powers or, later, to win the Cold War. The Internet was initially designed to help this country withstand a nuclear exchange, and Silicon Valley had its origins with military contracting, not today’s entrepreneurial social media start-ups. The Soviet launch of the Sputnik satellite spurred American interest in science and technology, to the benefit of later economic growth.

As I noted in a recent Mises View, this sort of argument is devoid of any economic analysis. First, it confuses technological innovation (impressive to engineers) and economic innovation (valuable to consumers). Second, it confuses gross and net benefit — of course, when government does X, we get more X, but is that more valuable than the Y we could otherwise have had? (Frédéric Bastiat, call your office.) Third, it confuses treatment and selection effects of government spending — government typically funds scientific projects that would have been undertaken anyway, such that a main benefit of government spending on science and technology is to increase the wages of science and technology workers. Fourth, as writers like Terence Kealey have pointed out, if you look carefully at the details of the sorts of programs lauded by the Times, you find they were grossly inefficient, ineffective, and potentially harmful.

I addressed these claims in more detail in Free Market article from last year (and also in this talk, starting around 1:37). The Times writer’s claims are simply ex cathedra pronouncements, not arguments backed by evidence.

Rothbard the Quant

8483100875_a11b4496e7_zMurray Rothbard was a foremost defender of apriorism in economics and a critic of positivism, empiricism, and scientism (1, 2, 3). But he was not opposed to quantification, particularly in the study of economic history. In fact, he strongly supported the use of statistics in doing applied economics. I was reminded of Rothbard’s view of data when rereading Strictly Confidential for this week’s Rothbard Graduate Seminar. Consider this passage from his lengthy and detailed review (1961) of George B. DeHuszar and Thomas Hulbert Stevenson’s History of the American Republic:

[A] critical defect is the almost complete absence of any quantitative or numerical data. It is often difficult to find the dates at which happenings occur, so vague and imprecise is the narrative. Apart from a few references to population figures, there are virtually no statistics of any kind in the work.

Now, I am an open and long-time condemner of the overuse of statistics, and I deplore as much as anyone the new trend in “scientific” economic history to hurl vast quantities of processed statistics at the reader, and conclude that one has captured the “feel” and essence of the past. But some statistics, surely, are necessary; and it becomes annoying to read constant references to “increases” in steel production, or living standards, or whatnot, when not the foggiest quantitative notion is presented to the reader of how large these increases and movements are. There is also an almost desperate need to present government budget statistics, so that the reader will know how large government in relation to the private economy has been in any given era; but neither in this nor in any other area does DeHuszar give a shred of quantitative data.

Rothbard is equally critical of the authors’ conceptual framework (more precisely, their lack of a consistent conceptual framework) and their failure to bring to life the grand sweep of American history. But this emphasis on the need for quantification may surprise some of Rothbard’s critics, and some of his defenders too.

Splitting the Pizza

pizzaApple underwent a 7-1 stock split last night, such that shares that traded at $645 yesterday opened this morning at $92. Much of the media coverage took a playful tone, e.g., “Don’t freak out. Here’s why Apple’s stock is below $100.” I was particularly intrigued by the brief story on today’s NPR Morning Edition. As the host explained, it’s not that Apple is worth less, just that Apple’s total market capitalization is being divided into a larger number of shares. “It’s like a pizza. If you cut it into 8 slices instead of 6, you don’t get a larger pizza, just smaller slices.”

How ironic, coming from a news outlet that embraces fully the naive, sophomoric, “vulgar Keynesianism” that dominates today’s economic policy discussions. NPR’s researchers, writers, hosts, and guests are 100% convinced that dividing the economy’s stock of real wealth by a larger number of paper tickets gives us, well, more real wealth!

Rothbard Graduate Seminar

Picture1The Rothbard Graduate Seminar, our signature event for advanced students in economics and related disciplines, began this morning with a terrific session on economic methodology. The week-long event combines plenary lectures on core Austrian concepts with student-led roundtable discussions that bring out the nuances, applications, challenges, and new directions. The text is selected chapters from Murray Rothbard’s collection Economic Controversies, along with supplemental readings from Rothbard’s Strictly Confidential. The full schedule is here. Graduate students and other scholars doing work in the Austrian tradition, plan to apply for next year’s version!

Inequality and Envy


Henry Hazlitt

Inequality seems to be the prime concern of Right Thinking People everywhere. But almost no one is drawing out the connections between inequality and envy. As Henry Hazlitt wrote in 1972, “[t]here can be little doubt that many egalitarians are motivated at least partly by envy, while still others are motivated, not so much by any envy of their own, as by the fear of it in others, and the wish to appease or satisfy it.” Indeed, contemporary discussions of income and wealth distribution, progressive taxation, the “long-run return to capital,” and the like would greatly benefit from careful study of great works like Helmut Schoeck’s Envy and Bertrand de Jouvenel’s Ethics of Redistribution. Murray Rothbard’s “Freedom, Inequality, Primitivism and the Division of Labor” should be required reading as well.

An important point coming out of this literature is that envy is generally strongest when inequalities are small, rather than large. Huge inequalities of wealth, income, or consumption are considered irrelevant; smaller inequalities are seen as remediable through state action. As noted yesterday by Peter Schiff, consumption inequality is probably far lower today, in Western countries, than in most societies in human history. The average Roman didn’t think often about Crassus, but the average American — part of the global 5% — thinks a lot about the wealthier Americans across town.

As Hazlitt noted, de Tocqueville saw modest inequality as the driving force behind the French Revolution. “The most popular theory of the French Revolution is that it came about because the economic condition of the masses was becoming worse and worse, while the king and the aristocracy remained completely blind to it. But de Tocqueville, one of the most penetrating social observers and historians of his or any other time, put forward an exactly opposite explanation.” Hazlitt quotes the French historian Emile Faguet:

Here is the theory invented by Tocqueville. . . . The lighter a yoke, the more it seems insupportable; what exasperates is not the crushing burden but the impediment; what inspires to revolt is not oppression but humiliation. The French of 1789 were incensed against the nobles because they were almost the equals of the nobles; it is the slight difference that can be appreciated, and what can be appreciated that counts. The eighteenth-century middle class was rich, in a position to fill almost any employment, almost as powerful as the nobility. It was exasperated by this “almost” and stimulated by the proximity of its goal; impatience is always provoked by the final strides.

The surge of interest in inequality among today’s pundit’s and politicians is likely driven by the fact that inequality, in the sense that matters to most people in Western countries, is far lower than its historical average.

More on Grad School

I appreciate Walter’s useful advice on surviving graduate school as an Austrian economist or libertarian or both. (I’ve also discussed graduate school strategies, and more general career issues, at Mises University; here is a talk from 2010.) I do have one disagreement, however. Walter writes: “Don’t take any part time jobs; don’t be anyone’s research assistant. Don’t be a teaching assistant. Don’t teach any courses. Just study to pass your courses with the best marks possible, and pass your oral or comprehensive exams.”

There are two problems with this. First, it is difficult to get a tenure-track position at a college or university without any teaching experience. I agree with Walter that grad students should not do a lot of teaching, either as primary instructors or teaching assistants, because this interferes with the dissertation. But having some teaching experience, and good student evaluations, can help on the job market.


Second, working as a professor’s research assistant usually leads to a better dissertation. Academic research is difficult and, like other skilled crafts, is often best learned through an apprenticeship model. You cannot learn how to be a good researcher just by listening to lectures and reading articles and books. You learn from experience. By working with a professor — hopefully on an article — you see how the sausage is made. You learn to formulate research questions, to evaluate existing literature, to collect and analyze data if appropriate, to write up results, and to deal with journal editors and reviewers. Moreover, students who don’t already have a dissertation topic can often find one as a spin-off of a professor’s existing project. Of course, grunt work — e.g., entering data into a spreadsheet — should be avoided if possible. But assisting a more experienced researcher is usually the best way to learn the craft.

Austrian Economics and the Firm

FK_2002_coverNicolai Foss and I have worked on many projects together, including our 2012 book Organizing Entrepreneurial Judgment. Foss is an eminent scholar whose expertise ranges from strategic management and entrepreneurship to Austrian capital theory, human resource management, business model innovation, and many other subjects. (Here is his 2012 Hayek Lecture at the AERC.)

One of our earliest collaborations was a 1998 conference in Copenhagen on Austrian economics and the firm. The conference proceedings were published in 2002 by Edward Elgar as Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization. As the blurb says: “While characteristically ‘Austrian’ themes such as entrepreneurship, economic calculation, tacit knowledge and the temporal structure of capital are clearly relevant to the business firm, Austrian economists have said relatively little about management, organization, and strategy. This innovative book features 12 chapters that all seek to advance the understanding of these issues by drawing on Austrian ideas.”

The book is unfortunately rather pricey, but Elgar has just added it to Elgar Online, so that the front matter, introduction, and index are available as free downloads. Some readers will have access to the full text via university or commercial libraries.

Rogoff on the Advantages of Paper Currency

Ken Rogoff offers a series of powerful arguments in favor of retaining paper currency. (Of course the feasible alternative, for Rogoff, is not commodity money, but 100% fiat electronic currency.) In particular, the widespread use of paper currency (1) makes it hard for central banks to push interest rates below zero (they would have to rely on some weird scheme for taxing currency, a la Silvio Gesell), and (2) allows people to conduct transactions securely and privately, without monitoring and expropriation by the state.

However, as Rogoff points out, there are important drawbacks of retaining paper currency. (3) The anonymity of paper money makes it popular, and strong demand for money gives the central bank plenty of opportunity to expropriate wealth through seigniorage. Moreover, (4) if a government were to eliminate its own paper currency, people might start using other forms of non-traceable money (Rogoff mentions paper currency issued by foreign central banks, but private commodity or even private fiat currency is another, far more attractive, alternative). As long as people are reasonably satisfied with the government’s currency, they are less likely to develop alternatives. Replacing government-issued fiat paper money with government-issued fiat electronic money might help push people toward superior, private solutions.

Oh, wait, I got that backwards. Rogoff mentions (1) and (2) as costs of keeping paper currency, (3) and (4) as benefits. If you reverse the signs, his analysis is quite insightful.

Stanley Fischer Joins the Echo Chamber

fischer_1918777cThe Senate has confirmed Stanley Fischer to the Federal Reserve Board of Governors, where he will soon become the Fed’s #2 official as Vice Chair. Fischer is an eminent mainstream macroeconomist and former Governor of the Bank of Israel (he was also chief economist at the World Bank and a top official of the IMF). His monetary policy views are largely indistinguishable from those of Ben Bernanke and Janet Yellen. He strongly favors the current Fed policy of keeping short-term interest rates near zero while gradually reducing the Fed’s bond purchases (“quantitative easing”). He is a bit more moderate than Bernanke and Yellen on so-called forward guidance, a euphemism for the Fed’s attempt to manipulate investors by announcing its supposed long-term plans in advance. But his overall understanding of how the economy works, the theories and models that lie behind his thinking, and his general policy views, are more or less the same as Bernanke’s and Yellen’s. (Not too surprising as he was Bernanke’s PhD supervisor at MIT.)

The Board of Governors, as described in official Fed publications, “supervises and regulates the operations of the Federal Reserve Banks, exercises broad responsibility in the nation’s payments system, and administers most of the nation’s laws regarding consumer credit protection.” (The Federal Open Market Committee, which conducts monetary policy, includes the Board plus the presidents of the regional Fed banks.) The Board performs these duties by conducting “thorough analysis of domestic and international financial and economic developments.” However, unlike effective governing boards at private institutions, diversity of opinion is not welcome on the Board of Governors.

A basic principle of good organizational governance is that board members should have a variety of backgrounds, areas of expertise, theoretical or philosophical perspectives, and experiences. The board as a whole can then analyze issues from different points of view, pooling complementary sets of knowledge and skills to get a balanced and holistic perspective on problems and their possible solutions. If the Fed is supposed to provide “scientific,” politically neutral analysis and administration, wouldn’t you expect some diversity on the Board?

Of course, I’m not expecting the Fed to appoint an Austrian economist as Governor. But there are a number of plausible, politically feasible candidates who would have provided balance to Yellen’s somewhat extreme views. John Taylor is the most obvious candidate, along with Glenn Hubbard or even Larry Summers. (OK, maybe Summers is too controversial, politically, and Hubbard was chided for not disclosing all his consulting contracts — though Fischer’s three-year tenure as Vice Chairman of Citigroup didn’t seem to hurt his nomination.) Instead, the Board will add Stanley Fischer to its echo chamber.

Gabriel Kolko (1932-2014)

41YNNuF0igL._SY344_BO1,204,203,200_Gabriel Kolko, the influential New Left historian whose Railroads and Regulation (1965) and The Triumph of Conservatism (1963) offered a radical challenge to the prevailing, “public interest” account of business regulation, died yesterday. Murray Rothbard admired Kolko and helped popularize Kolko’s view that “progressive” regulations were nearly always the joint work of protectionist business leaders and self-aggrandizing politicians. As Rothbard wrote in “Left and Right”:

Orthodox historians have always treated the Progressive period (roughly 1900-1916) as a time when free-market capitalism was becoming increasingly “monopolistic”; in reaction to this reign of monopoly and big business, so the story runs, altruistic intellectuals and far-seeing politicians turned to intervention by the government to reform and regulate these evils. Kolko’s great work demonstrates that the reality was almost precisely the opposite of this myth. Despite the wave of mergers and trusts formed around the turn of the century, Kolko reveals, the forces of competition on the free market rapidly vitiated and dissolved these attempts at stabilizing and perpetuating the economic power of big business interests. It was precisely in reaction to their impending defeat at the hands of the competitive storms of the market that business turned, increasingly after the 1900′s, to the federal government for aid and protection. In short, the intervention by the federal government was designed, not to curb big business monopoly for the sake of the public weal, but to create monopolies that big business (as well as trade associations smaller business) had not been able to establish amidst the competitive gales of the free market. Both Left and Right have been persistently misled by the notion that intervention by the government is ipso facto leftish and anti-business. Hence the mythology of the New-Fair Deal-as-Red that is endemic on the Right. Both the big businessmen, led by the Morgan interests, and Professor Kolko almost uniquely in the academic world, have realized that monopoly privilege can only be created by the State and not as a result of free market operations.

Mainstream Macroeconomists Grapple with Hayek and Keynes

hayek-vs-keynesA new NBER Working Paper by Paul Beaudry, Dana Galizia, Franck Portier uses a contemporary modeling technique (a kind of decentralized trading model popularized by Robert Lucas) to compare “Hayekian” and “Keynesian” accounts of the business cycle. The authors have only a cursory understanding of the Austrian literature — despite the title, “Reconciling Hayek’s and Keynes Views of Recessions,” the paper contains no references to anything written by Hayek or Keynes — but is interesting nonetheless.

The authors apparently got their understanding of Hayek from Nicholas Wapshott’s wildly inaccurate book Keynes Hayek: The Clash that Defined Modern Economics, so they characterize malinvestment as overinvestment (“capital over-accumulation”), reduce Hayek’s complex and subtle views to “liquidationism,” and so on. Still, the authors are trying to get at the fundamental idea that capital structure matters, and that the bust is somehow related to actions taken during the preceding boom. In this sense they depart from most modern macroeconomic treatments. Also, before introducing their model, they include a section with “Some motivating facts,” pointing out that their measure of capital over-accumulation (cumulative investment over 10 years divided by total factor productivity and detrended) is positively correlated with recession depth and length of recovery for the US postwar period. Their model includes both consumption goods and durable investment goods and it is possible for agents to have “too much” of the durable good (so that “liquidation” can be beneficial). In other words, the authors recognize the drawbacks of conventional Keynesian models in output and employment are systematically (and simplistically) driven by aggregate demand, with no role for capital and production and no possibility of capital misallocation.

In other words, while the paper doesn’t particularly advance the Austrian understanding of the business cycle, the fact that the authors are thinking along these lines (and disseminating their thoughts through the NBER working paper series) tells us there may be some hope for modern macroeconomics.

Here is the abstract for those who want the gory details:

Reconciling Hayek’s and Keynes Views of Recessions
Paul Beaudry, Dana Galizia, Franck Portier
NBER Working Paper No. 20101, May 2014

Recessions often happen after periods of rapid accumulation of houses, consumer durables and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions mainly reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed. In contrast, ever since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. In this paper we reexamine the liquidation perspective of recessions in a setup where prices are flexible but where not all trades are coordinated by centralized markets. We show why and how liquidations can produce periods where the economy functions particularly inefficiently, with many socially desirable trades between individuals remaining unexploited when the economy inherits too many capital goods. In this sense, our model illustrates how liquidations can cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes’ and Hayek’s views of recessions may be much more closely linked than previously recognized. In our framework, interventions aimed at stimulating aggregate demand face the trade-off emphasized by Hayek whereby current stimulus mainly postpones the adjustment process and therefore prolongs the recessions. However, when examining this trade-off, we find that some stimulative policies may nevertheless remain desirable even if they postpone a recovery.

Happy Birthday, Hayek!

Today is F. A. Hayek’s birthday (and, incidentally, mine). Hayek, the eminent economist and social theorist who was Mises’s younger colleague, Keynes’s great opponent, and 1974 Nobel Laureate, would have been 115 today.

Here is my entry on Hayek for the 1999 volume Fifteen Great Austrian Economists. Below is a short tribute video. And check out the Hayek items in the Mises Store.

A Note on “Human Capital”

BGCTC601Like Peter LewinWalter BlockMario Rizzo, and Peter Boettke, I greatly admire the late Gary Becker, a pioneer in many areas of economics and sociology, a strong proponent of economic and personal freedom, and by all accounts a terrific teacher, mentor, and colleague. But I confess that I have always had qualms about the concept of “human capital,” along with the analogous constructs of social capital, knowledge capital, reputation capital, and so on. These are metaphors for capital in the narrow sense, and I worry that the widespread use of “capital” to denote anything valuable and long-lived obscures important issues about actual, physical capital that can be divided up, measured, priced, and exchanged. Witness the confusion over “capital” as Thomas Piketty uses the term. Here is something I wrote before:

[O]ne of my pet peeves [is] the expansive use of “capital” to describe any ill-defined substance that accumulates and has value. Hence knowledge, experience, and skills become “human capital” or “knowledge capital”; relationships become “social capital”; brand names become “reputation capital”; and so on. I fear this terminology obfuscates more than it clarifies.

I don’t mind using these terms in a loose, colloquial sense: By going to school I’m investing in human capital or diversifying my stock of human capital; if this gets me a high-paying job I’m earning a good return on my human capital; as I get old I forget new things, so my human capital is depreciating rapidly; and so on.

But we shouldn’t take these metaphors too literally. In economic theory capital refers either to financial capital or to a stock of heterogeneous alienable assets, goods that can be exchanged in markets and analyzed using price theory. Their rental prices are determined by marginal revenue products and their purchase prices are given by the present discounted value of these future rents. Knowledge is not, strictly speaking, capital, because it is not traded in markets does not have a rental or purchase price. What markets trade and price is labor services, and it is impossible to decompose the payments to labor (wages) into separate “effort” and “rental return on human capital” components. Some labor services command a higher market price than others because they have a higher marginal revenue product. Some of this wage premium may be due to intelligence or experience, some due to complementarities with other human or nonhuman assets, some due to hard work, and so on. But these are all determinants of the MRP, and hence the wage, not different kinds of factor returns.

Moreover, the entrepreneur needs cardinal numbers to compute the value of his capital stock, to know if it is increasing or decreasing in value, and so on. I can’t measure my stock of human capital, I don’t know for sure if it is increasing or decreasing over time, I can’t calculate the ROI of a specific human-capital investment, etc., because there are no prices and no measurable units. Knowledge may be “like capital,” in the sense that it lasts, that you can add to it, that you benefit from it, etc., but it isn’t literally a capital good like a machine or a refrigerator.

If we think going to school is valuable and increases lifetime earnings, why don’t we just say, “going to school is valuable and increases lifetime earnings,” rather than, “there is a positive return on investments in human capital”? Is there a good reason to prefer the latter, besides scientism?