This post is one of an occasional series inspired by Ha-Joon Chang’s iconoclastic and very readable book 23 Things They Don’t Tell You About Capitalism. The quote below is from ‘Thing 16’.
“People do not necessarily know what they are doing, because our ability to comprehend even matters that concern us directly is limited – or, in the jargon, we have ‘bounded rationality’. The world is very complex and our ability to deal with it is severely limited. Therefore, we need to, and usually do, deliberately restrict our freedom of choice in order to reduce the complexity of problems we have to face. Often, government regulation works, especially in complex areas like the modern financial market, not because the government has superior knowledge but because it restricts choices and thus the complexity of the problems at hand, thereby reducing the possibility that things may go wrong.”
Ha-Joon Chang (2012), 23 Things They Don’t Tell You About Capitalism, p.168
The argument that humans have ‘bounded rationality’ and experience uncertainty (as opposed to calculable risk), in which they simply do not know what is going to happen in the future, illustrates the importance of a range of institutions in modern society. These both constrain and enable human activity. The market is an institution, but one of many, even in what is often called a market economy.
For me the term market economy is misleading in that it portrays only part of the economic system in which we live. For example, markets require legal systems under the supervision of states to function at the national level, and we also rely to some extent on global institutions such as the WTO, IMF and World Bank. These may be imperfect, but the answer to that is reform rather than abolition. Those who would undermine the rules-based post-war international order seem woefully ignorant of its benefits. The depression and chaos of the inter-war period of the 1930s were a lesson to post-war policy-makers.
Another term for our modern economic system is capitalism, which draws attention to the accumulation of capital, or investment, which drives expanding wealth and income. For Marx, the key relationship is the conflicting one between the capitalist and working classes in the workplace and his magnum opus was even called Capital. Markets are part of this system, but they have been in existence for far longer than capitalism, so they cannot be used to define it by themselves. They are now widespread in developed nations, but a richer definition of capitalism is necessary, which describes more than simply market exchange.
Private property and the exchange of goods and services on the market may be unavoidable in any large-scale complex economy, as institutional economist Geoffrey Hodgson has argued. He points out that both mainstream neoclassical and Marxist economics argue for ahistorical universals and a ‘pure capitalism’, and deny varieties of capitalism, which is what we observe across the world and in recent history. There is thus a denial of the existence of a variety of institutions, which he argues is a more realistic analysis. He defines an institution as an integrated system of rules that structures our social interactions. Examples are behavioural norms, social conventions and legal rules. These will often evolve as economic development proceeds, and can constrain it if they do not, hence the term ‘institutional sclerosis’.
The modern economy is increasingly complex and depends not just on the accumulation of capital, but also the accumulation of knowledge and skilled labour. Knowledge and skill can be embodied in the individual but also collectively; for example, in firms, industries and states. Their accumulation is thus at least partly dependent on institutional factors.
No one individual or institution can determine the complex outcomes we observe under capitalism, which suggests that collective planning for the economy as a whole, as has been attempted in socialist states, is doomed to failure. Narrow goals such as sending a man into space may be possible under such a regime, but producing a vast and complex range of products requires a range of institutions, including markets and states. Those social functions which necessarily involve market exchange require other such institutions to function well. Capitalism is not just about the market and it is misleading in thought and damaging to policy-making to think so.