Catholic Social Teaching and Conventional Economics

And we come to the end of Thomas Storck's series on Catholic Social Doctrine. But, fear not! There will be an article on Distributism every day at 12.00!

From Practical Distributism

by Thomas Storck

Anyone who has spent much time trying to promote Catholic social teaching has probably met with a response something like this. "What you say is very fine and certainly evidence of good will.  But, you see, most of what you are asking for is simply impossible. Society would break down.  For there are economic laws which it is as foolish to try to circumvent as those of gravity.  We certainly ought to try to eliminate poverty and all that.  But this can only be done if we obey the laws of economics.  If you study economics a bit, you'll soon see why you're barking up the wrong tree."

And it is easy to understand why economists or those who have studied economics say this.  For mainstream economics does teach a simple yet powerful approach to all of the multifarious questions arising from man's relations of producing, buying and selling, lending and borrowing, and so on.  Everyone wants to maximize his welfare, the desire to produce and sell can be matched against the desire to buy and consume since there are market forces which balance these two exactly, and even if they do not always result in what Christians would call justice, to interfere in their workings is to bring about (ultimately) inefficiency, waste and poverty.

According to this conception, then, economic activity works more or less according to a few simple principles, which can be applied over and over again with great sophistication to analyze a wide variety of behavior.  And to try to escape from the inexorable working of these economic principles is to court disaster.  For example, one might think that some workers are underpaid, and that this problem could be easily solved by passing a law requiring that all workers be paid a minimum wage.  But, no, that would result only in more unemployment.  It may be a shame that some get paid so little, but there is nothing that can be directly done about it.  Certainly passing minimum wage laws is the last thing we would want to do.

Economics, therefore, describes what will happen if you do a certain thing.  It is a predictive science, able to tell you that if you do A, B will result.  It is thus reduced to something like mechanics, a sort of mechanics of human behavior.  This approach is well illustrated by Milton Friedman in his famous 1953 essay, "The Methodology of Positive Economics."

I venture the judgment, however, that currently in the Western world, and especially in the United States, differences about economic policy among disinterested citizens derive predominantly from different predictions about the economic consequences of taking action - differences that in principle can be eliminated by the progress of positive economics - rather than from fundamental differences in basic values.... An obvious and not unimportant example is minimum-wage legislation.  Underneath the welter of arguments offered for and against such legislation there is an underlying consensus on the objective of achieving a "living wage" for all, to use the ambiguous phrase so common in such discussions.  The difference of opinion is largely grounded on an implicit or explicit difference in predictions about the efficacy of this particular means in furthering the agreed-on end.  Proponents believe (predict) that legal minimum wages diminish poverty by raising the wages of those receiving less than the minimum wage as well as of some receiving more than the minimum wage without any counterbalancing increase in the number of people entirely unemployed or employed less advantageously than they otherwise would be.  Opponents believe (predict) that legal minimum wages increase poverty by increasing the number of people who are unemployed or employed less advantageously and that this more than offsets any favorable effect on the wages of those who remain employed.                 

According to this conception of economics, economists must chiefly engage in manipulating graphs, mathematical formulas and the like to predict the results of actions.  Things either happen or they do not. Though it may be more difficult to discover what will happen because of the multiplicity of variables, in principle there is no more room for discussion then if it were a matter of asking what happens when we drop a ball of a certain height and weight or project something with a certain force against some obstacle.

Friedman's discussion of the minimum wage that I just cited is a good entry point to begin to unravel such economic dogmas.  It is easy to understand the logic behind Friedman's argument.  Like most arguments in the economic tradition descending from Adam Smith, the notion that "minimum wages increase poverty by increasing the number of people who are unemployed or employed less advantageously" by increasing employers' costs has an obvious plausibility.  But yet one may question it on several grounds.  Aside from the fact that there is little recognition here that in something as complicated as human affairs it is unlikely that one can pronounce once and for all about something such as the minimum wage, more importantly there is an assumption of a certain legal structure which is simply accepted as given.  For whatever side of this question mainstream "positive economics" may eventually take, such a judgment presupposes a specific legal and social framework.  The distribution of income and economic power that mainstream economics apparently accepts as a given depends more on human law and custom than on any immutable laws of economics.  What I mean can be illustrated by the well-known story of the Antigonish cooperatives in Nova Scotia in the 1930s, as recounted in B. B. Fowler’s 1947 book, The Co-operative Challenge.

But the most forlorn picture lay in northeastern Nova Scotia and the island of Cape Breton.  Along the coast lived the fishermen.  Their catch of fish and lobsters was handled by local dealers who in many cases kept the fishermen in a state of peonage.  While Maine fishermen were getting about fifteen cents a pound for lobsters, the Nova Scotian fishermen were receiving as little as two cents a pound.  All other prices were scaled down in the same ratio.  For everything they bought, however, from their scanty food purchases to nets and lines, they paid top prices, with the result that they were invariably bowed down with a load of debts.  Appalling poverty, illiteracy, poor health and the worst possible housing conditions existed throughout this section.

After priests from St. Francis Xavier College had begun to educate the fishermen and others in the philosophy of cooperatives, a

few lobster fishermen got together and made up a crate of lobsters which they shipped express to a commission agent in Boston.  When the mail brought a check the group sat around, afraid to open it.  So much depended upon that check; upon its size rested their hopes for better prices and better living. Probably there had never been a more momentous moment in all their lives than that moment when one of the boys finally opened the envelope and took out the check.  After all shipping charges and commissions had been paid, there remained fifteen cents a pound for their shipment.

                    
The point of this story is that the distribution of income follows the distribution of economic power, which in turn depends in large part upon the legal and social structure.  Doubtless one could have found economists who would have said that the penury of the fishermen while they were at the mercy of the middlemen of their province simply reflected the inevitable laws of economics and that the price they received for their lobsters faithfully reflected the economic contribution they made and therefore the two cents per pound was simply the equilibrium toward which they were forced as if "by an invisible hand."  But this obviously was not the case.  Rather, it faithfully reflected certain economic and legal arrangements and structures, which, as it turns out, could be changed.

This same argument can be made about the question of minimum wages.  As long as the employer/employee relationship, the essential note of capitalism,[1] is the common method by which labor is engaged, then the desire of employers to reduce costs can and probably sometimes will conflict with their ability to hire more workers at a statutory minimum wage.  But this reflects not unchanging laws of economics drawn from the nature of reality or human society, but rather certain legal, social and cultural arrangements which are by no means immutable.

The unequal power of employer and employees, especially of unorganized employees, our societal ideals which deny that there is any just or reasonable amount of profits with which an employer or firm should be satisfied, our general incorporation and limited liability laws - all these create a situation where Friedman's dilemma, or rather the dilemma he sets up for society, has some plausibility.  But how if some or all of these legal and cultural norms were changed?  How if, as in the case of the Antigonish fishermen, the framework in which these economic transactions occur were changed?  For example, how if employees themselves became owners, as so often recommended by the Popes?[2]

These types of considerations should lead us to see that perhaps the framework that conventional economics presupposes is not the only possible framework.  That is, with a different legal system, different cultural and societal norms, different personal goals and expectations, many of the so-called laws of economics would appear not as universal laws of human behavior, but as limited by place and time, as taking for granted certain institutions, incentives and motives which are far from being universal principles of human society or action.

My thesis is that Catholic social principles will often seem at odds with economic facts as long as we accept mainstream neoclassical economics as descriptive of how the world actually operates.  But as soon as we begin to question orthodox economics, then all this can be looked at in a new light.  And there are in fact many reasons to suppose that orthodox economics is not descriptive of how the real world operates.  Let us look at a few more examples.

The notion that economics can be based on market forces, such as a more or less constant tendency toward equilibrium, etc. seems to depend on the prior notion that people are motivated primarily by economic motives, that is, by the desire to buy cheap and sell dear, to increase their material wealth as much as possible.  But it seems to me that history, as well as our own experience, tells us that reality is much more complex.  Often people or firms do not strive to maximize their profits or income, as even such conventional economists as Laurence Miners and Kathryn Nantz, associates of the late Paul Samuelson in preparing introductory economics texts, admitted in their 2001 Study Guide to accompany Samuelson’s textbook.  Sometimes this is because it is too irksome to do so, other times because people prefer leisure to increased wealth and are content with simply a sufficiency.  Sometimes habit and custom dictate a standard with which people are satisfied. They may shop in the same store even though it is more expensive because they are accustomed to do so.  To say, as Samuelson might, that this is an example of imperfect competition because the two stores differ in some way, is to try to prove too much, because then everything becomes a matter of economics.  Certainly people are always motivated by a desire for their happiness, but to say that this human striving for happiness is always an example of economic behavior and ought to be analyzed according to economic criteria, would be to make economics, rather than ethics, the architectonic science of human behavior.

One example of the way that habit often makes us satisfied with customary gain is mentioned by Max Weber in his classic work, The Protestant Ethic and the Spirit of Capitalism.

Until about the middle of the past [i.e. nineteenth] century, the life of a putter-out was, at least in many of the branches of the Continental textile industry, what we should to-day consider very comfortable.  We may imagine its routine somewhat as follows:  The peasants came with their cloth, often...principally or entirely made from raw material which the peasant himself had produced, to the town in which the putter-out lived, and after a careful, often official, appraisal of the quality, received the customary price for it. The putter-out's customers, for markets any appreciable distance away, were middlemen, who also came to him, generally not yet following samples, but seeking traditional qualities, and bought from his warehouse, or, long before delivery, placed orders which were probably in turn passed on to the peasants.  Personal canvassing of customers took place, if at all, only at long intervals.  Otherwise correspondence sufficed, though the sending of samples slowly gained ground. The number of business hours was very moderate, perhaps five to six a day, sometimes considerably less; in the rush season, where there was one, more.  Earnings were moderate; enough to lead a respectable life and in good times to put away a little.  On the whole, relations among competitors were relatively good, with a large degree of agreement on the fundamentals of business.  A long daily visit to the tavern, with often plenty to drink, and a congenial circle of friends, made life comfortable and leisurely.

                            
It would seem that the constant desire to maximize income or output simply does not exist without a cultural imperative to that effect. 

Another area in which we may question the descriptive nature of conventional economics concerns the role of market forces in allocating income.  The allocation of economic rewards does not always come about because of market forces, rather, whoever holds economic power generally receives more economic rewards, as in the conspicuous example of CEO compensation.  The remarkable fact about CEO compensation in the United States in recent years is that certain CEOs have received large compensation packages even though the companies they headed were losing money or going into bankruptcy.  Why then did they receive these salaries and benefits?  Because of market forces?  Hardly.  It was because they were able to appoint their cronies to the compensation committees of their boards of directors.  Their salaries and other compensation were almost entirely insulated from the market forces of supply and demand for executives.  Let us look at a few specifics.

As described in The Washington Post, April 22, 2003, while Apple Computer's "shareholders' return declined by 34 percent" CEO Steve Jobs received $78 million, and while Lucent's "shareholder return declined by more than 75 percent" Pat Russo received $38 million (Carlson 2003:C1).  Even more striking is the case of Disney's Michael Eisner.  Eisner, "after he failed to clear his bonus hurdle two years running, his board lowered the performance bar, and then...he finally cleared it.  An Olympian effort worth $5 million"

An April 2003 article in Fortune magazine explained another method by which much CEO compensation is hidden from shareholders, the legal owners of the corporation.  Delta Air Line's CEO, Lee Mullin, after the company lost $1.3 billion and laid off thousands of workers, in response to criticism, grandly announced that he was going to give up 25% of his salary and other compensation.  But what he did not mention was his pension plan.

You see, Mullin has been employed by the airline for only five years and eight months.  But a special pension plan that Delta's board created for top executives has credited him...with another 22 years of service.  Thanks to those phantom years, the 60-year-old CEO could walk away from the airline today and be entitled to receive a payout of about $ 1 million a year, starting at age 65, for the rest of his life.  And if the airline goes bankrupt, no problem:  Special Delta-funded trusts protect the pensions of Mullin and 32 fellow executives from creditors.

(This by the way while Delta's workers' pensions were being cut.) This same article details many more examples of CEO's receiving exorbitant pensions while their companies went bankrupt, lost stockholder value or cut workers' pensions.  And the article goes on to ask the reasonable question:

So why, you may wonder, aren't investors up in arms over these jaw-dropping retirement giveaways?  The answer is that hardly anybody knows about them.  The complex details surrounding executive pensions are typically buried deep within a company's SEC filings, far removed from the salaries, bonuses, and stock options that dominate the headlines.

Both the example of Disney's Michael Eisner, whose board kindly made it easier for him to get (I will not say "earn") an extra $5 million, and the fact that boards hide the details of CEO retirement so that shareholders will have trouble finding out about them, illustrate my point:  Market forces are not the only or even the most powerful forces operating in the economy, and moreover market forces always work within a legal, socio-cultural and technological framework.  It is a CEO's cronies on the compensation committee of the board of directors that determine his compensation, not impersonal market forces.  If we changed the law so that CEO salaries were decided by a free vote of the stockholders, not many of them would get these huge salaries and retirement packages, especially when their companies were failing and stockholders were losing the value of their investments.

This principle of the importance of non-market factors is true throughout the economy.  Without labor unions workers received low pay and had poor working conditions and benefits.  Unions helped them to achieve gains in all these areas.  This was because it helped to give the workers power to offset that of their bosses, not because the law of supply and demand had been changed.

All of these instances of economic behavior presuppose certain norms, generally both cultural and legal.  Without limited liability laws, for example, corporations could not exist, at least in their present form.  Without patent, trademark and copyright laws, the provision of inventions and other kinds of intellectual property would doubtless be very different.  Moreover, the kind and degree of taxation, technology, the physical infrastructure - all these affect to a great degree the workings of the economy.
    
Markets and market forces, then, are always embedded in social, legal and cultural systems.  Economic forces, such as the equilibrium of supply and demand, are certainly real, but seldom if ever the most important forces operating in an economy.  Thus the objection to Catholic social teaching based on the notion that it violates the assured findings of economic science is not valid.  Rather, economic outcomes depend on power, cultural and legal institutions, and other factors.  Since laws and institutions can be changed, there is in fact ample room in economics for a consideration of ethics.  Thus those who seek to promote Catholic social doctrine should acquaint themselves with those economic schools, chiefly the German historical school and the institutionalists, whose conception of the economy recognizes that it does not operate like clockwork, but is chiefly determined by who holds economic power, which in turn is chiefly determined by law and custom.  Clarence Ayres wrote with regard to institutionalism in a discussion in 1957 in The American Economic Review:

...the object of dissent is the conception of the market as the guiding mechanism of the economy or, more broadly, the conception of the economy as organized and guided by the market.  It simply is not true that scarce resources are allocated among alternative uses by the market.  The real determinant of whatever allocation occurs in any society is the organizational structure of that society - in short, its institutions.  At most, the market only gives effect to prevailing institutions.  By focusing attention on the market mechanism, economists have ignored the real allocational mechanism. 

As soon as one considers this, its truth should be obvious:  the human desire for happiness certainly very often includes the desire to maximize material gain and minimize loss, but this desire is channeled through existing customs and institutions, and to a great extent even shaped by them.  So that a conception of "economic man" which isolates him and posits certain things about him which are then universalized, is erroneous.

Similar criticisms were made by the German historical school.  As described in the well-known reference source, The New Palgrave: a Dictionary of Economics, this school of thought faulted the

classical school's deductive method...as being too abstract [and] puts the emphasis on the inductive method.  Historians point out that economic development is unique, so there can be no `natural laws' in economics.... Instead of searching for generally applicable laws, the historical school therefore tried to describe the particulars of each era, society and economy.

Since the human institutions within which economic activity occur undoubtedly vary widely over time and place, and to some extent, even the human desire for gain takes on different forms according to custom, it would seem rational to include such historical factors in economic analysis, and further, that any economic analysis that omits or downplays them is not dealing with the real world.  Conventional neo-classical economics, however, largely does just that.  If its defenders regard it as the only acceptable scientific form of economics, we must point out to them that any economic science that strives more for mathematical precision and consistency than conformity with the real world has deeply misunderstood its task. Thus there is a simple way out of the intellectual trap that is set for Catholic social teaching.  We do not have to abandon our intellectual rigor or scientific orientation.  Rather we can retort that it is our critics who are unscientific.  But above all we should begin to bring the insights of heterodox economics into the debates over social doctrine.  Without them, the critics of Catholic social teaching will always claim that they alone understand economics.  For to attempt to defend Catholic social teaching while explicitly or implicitly accepting conventional neo-classical economics is not only to allow one's adversaries to set the terms of the debate, but it is to adhere to an economic methodology which distorts facts and attempts to compress reality into a straitjacket.

Notes:

[1] This way of characterizing capitalism comes from the encyclical of Pope Pius XI, Quadragesimo Anno (1931).  Pius speaks of "that economic system in which were provided by different people the capital and labor jointly needed for production" (no. 100, Paulist translation).

[2] Those papal documents which recommend widespread property ownership include Rerum Novarum, nos. 4, 10, 26, 35; Quadragesimo Anno, nos. 59-62, 65; Mater et Magistra, nos. 85-89, 91-93, 111-115; Laborem Exercens, no. 14.