Liberal Principles and Economic Practice

Liberal Principles and Economic Practice

I begin by trying to distil the essence of the liberal position in a form which I hope will be recognizable to all liberals.

Liberalism begins with an important ontological assumption. There is no society which is independent of the individuals who compose it. Individuals have tastes and preferences and endeavour to 'better their condition', as Adam Smith put it, within the limitations imposed by lack of resources and knowledge and by the uncertainties of life. That is a broad description of reality, to the liberal at least, but underlying this concept of the autonomously acting individual is an ethical principle, namely that the individual is the best judge of his/her own welfare. That being the case, any coercive action can only be justified if by circumscribing the actions of individuals the 'natural liberty' of all is improved. In defining the role of the state, the task is to identify those circumstances in which the actions of individuals conflict and to devise laws which resolve such conflicts but still give individuals equal rights to pursue their own interests. Within the framework of the 'rule of law', the individual is not accountable for his actions to society at large. Therefore, the modern concept of a 'social welfare function' is suspect to liberals - for further discussion, see Rowley and Peacock (1975) and Barry ( 1986).

In applying these general principles to the problem of the role of the state, there are significant differences of emphasis among liberals, which must now be explored.

The first problem is that not everyone may be persuaded that the rule of law is in their interests. If the natural human condition were, as Hobbes described it, 'war of all against all', then a liberal society would be virtually impossible, but this view is, at least implicitly, rejected by liberals. It will be against the interests of most individuals to conduct a 'war of all against all', and, indeed, it was held by liberals from Hume onwards that the growth of commerce and trade represented a cultural influence which reduced the temptation to use force in resolving international conflict. However, it would be absurd to go to the other extreme and allow individuals the absolute right to defend their property by force or to risk allowing individuals to employ private armies. Defence and law and order were proper functions of government, though one had to be careful not to allow the producers of these services to determine the extent of these services and close attention would have to be paid to the formulation of their tasks. There is clearly room for argument about the amount of resources to be compulsorily acquired in order to perform these functions, but this is not a problem to be faced only by those propounding a liberal philosophy of government.

The second problem concerns the distribution of property rights. On the one hand, why need it be assumed that the optimal distribution of income and wealth would emerge from the process of free exchange? On the other hand, state intervention in order to redistribute income and wealth could be regarded as 'the immoral seizure of legitimately acquired property' (Barry, 1986). There are three liberal attempts to resolve this dilemma, and they are not mutually exclusive. The first is to argue that the problem of inequality, in the long run at least, is not that important. The freely working market system does not
manifest some distributional struggle in the form of a zero-sum game, but promotes co-operation which offers the expectation of gains to all. This may not result in growing equality in the distribution of income and wealth, but this is not even accepted as a necessary condition for the achievement of the aims of rival political philosophies. The second argument avers that individuals' perceptions of their satisfaction normally embrace caring for the unfortunate with a consequential wish to allocate part of one's income or wealth to support them. The third argument recognizes that there could be circumstances in which major inequalities of wealth and income would endanger individual freedom through the power of the more over the less fortunate, and this would call for some form of intervention in the distributional outcome of the market process. Again, apart from selecting which particular argument appeals to individual liberals, the problems of implementation of distribution policy are formidable.

Even those liberals who envisage a substantial role for the state in distributional
aims have disagreed strongly on methods .

Should the government confine its role to support of private charity, for example through tax relief? At the other extreme, should governments be the main providers of services with a redistributory content, e.g. health and education, and should they offer such services free?

The third problem is an extension of the second. Once it is accepted that government is necessary to enforce the rule of law, then liberals cannot be indifferent to how governments are appointed and how they are to be controlled. The liberal aim is clearly to circumscribe the activities of government, but that cannot be guaranteed if property rights extend to giving all adults the vote. As de Tocqueville predicted, introduction of universal suffrage, coupled with large differences in income between few rich and many poor, is a recipe for a large expansion of the public sector, as the majority, the poor, can exploit their power to transfer resources to them from the rich minority. The Classical economists appreciated the dilemma that this presented. Whereas the concept of economic freedom seemed to suggest political freedom as a necessary complement, there was no guarantee that political freedom, secured through the extension of the franchise, would guarantee votes for free market principles. The resolution of the dilemma was to time the extension of the franchise to match a widening dispersion in the distribution of property as the market economy expanded -for further discussion, see Peacock, 1992. The rent-seeking propensity of voters has stimulated public choice economists, such as the Nobel Laureate James Buchanan, to design constitutional constraints which would restrain majoritarian democracy, constraints which the majority itself would accept as 'fair rules of the game' governing the decision-making process. The classic liberal dilemma remains that a political dimension to personal freedom can be at odds with the preconditions for economic freedom - a small and economically run public sector with minimum interference in the personal and business affairs of the individual.

The fourth problem concerns the possibility that the market economy, by itself, will not generate the preconditions for consumer sovereignty, namely the continuing presence of competitive forces. Liberals have differed among themselves about what is essentially an empirical matter. Some have maintained that a government competition policy is unnecessary and that the best protection for competition is non-intervention in the market, including eschewal of such instruments as tariffs and subsidies. Others, notably members of the Euckenkreis already referred to, have maintained that a constitution designed to guarantee individual liberty must contain clauses which outlaw cartels and control mergers.

I have not forgotten that the primary interest of this chapter is in Keynes's position, though, as I have argued, an examination of liberalism is a necessary preliminary. However, Keynes enters the story earlier when we consider the fifth problem encountered by liberals which originates with Keynes himself. Running through our discussion is a transparent thread of argument, namely that liberal support for the state, albeit sometimes reluctantly, arises from the recognition of the 'externality effects', as we call them today, resulting from individual actions which affect others. Whereas some of these effects may be positively beneficial, in the form of gains from trade, others are perceived as negative. Keynes's 'paradox of saving', which some regard as his distinctive contribution to macroeconomics - see Meade, 1975 - is a striking example. According to the Keynes of the General Theory, individuals may perceive that they will be better off if they save, having taken account of greater opportunities to consume in the future. However, this is an example of the fallacy of composition. If the aggregate effect is to increase new saving with respect to a given present level of income, then aggregate consumption will fall, which will reduce demand, and therefore investment and ultimately output and employment. Individuals' attempts to 'better their condition' through saving for the future will, in aggregate, leave the community worse off.

The Keynesian 'underemployment equilibrium' thesis confronted liberally minded economists with a major dilemma. If they accepted the diagnosis, then they would be hard put to it not to accept that the cure must lie in further state intervention. If they did not accept the diagnosis, then they would have to come up with an alternative, publicly convincing, explanation of the causes of the Great Depression. The deep divisions between liberal economists have lasted until today. Some like Lionel Robbins bit the bullet and generously agreed that Neo­classical explanations were at least incomplete. Commenting on his role in presenting Keynesian ideas to Ministers concerned with post-war employment policy in the famous 1944 White Paper, he states.

1 should like to make it clear... that these functions were very willingly performed. It would not be true to say that then, or at any subsequent period, 1 had become Keynesian in the sense of accepting au pied de la lettre all the analytical propositions of the General Theory. Although I had greatly benefited by the intellectual shake-up in studying them, I found many that were confused and wrong-headed in their formulation. ... But if all that is involved by that description is a conviction that, in a free society, the fluctuations in aggregate demand must not be left to look after themselves and that it is an important function of government, national and international, to pay attention to such matters, then indeed that is now my position. I had long realised that my earlier diagnosis of the causes of the Great Depression has missed the mark.... My activities in connection with the White Paper therefore may be regarded as an attempt at reparation for erroneous advice offered at an earlier period. (Robbins, 1971)

Divested of the more emotional outbursts against Keynes, mainly on the grounds that, as Schumpeter remarked, he was following the profligate ways of a Madame Pompadour by his support for public works, those who rejected his diagnosis and accordingly his policy proposals have argued that Keynes was right to relate the growth of mass unemployment in the late 1920s to the 'over­valued exchange rate', but betrayed the liberal cause by developing remedies other than devaluation which presupposed that the only solution open to government was to exploit economic nationalism. The Neo-Classical theorists he attacked were straw men and the attack levelled against their orthodoxies was an irrelevance (see Johnson, 1975). Today, the more committed libertarians, having recovered their wind, have argued that crises of the kind associated with extremes of inflation and deflation are best avoided by keeping the government budget small and balanced, coupled with the denationalization of money - for a typical expression of this view, see Dowd, 1988. It is ironic that this position is now regarded as both a formidable and a radical attack on Keynesian orthodoxy.