The Hesitant Hand This page intentionally left blank The Hesitant Hand T a m i n g S e l f - I n t e r e st i n t h e H i st o r y o f E c o n o m i c I d e a s Steven G Medema Princeton University Press  Princeton and Oxford Copyright © 2009 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, Oxford Street, Woodstock, Oxfordshire OX20 1TW All Rights Reserved Library of Congress Cataloging-in-Publication Data Medema, Steven G The hesitant hand : taming self-interest in the history of economic ideas / Steven G Medema p.  cm Includes bibliographical references and index ISBN 978-0-691-12296-0 (cloth : alk paper) Free enterprise—History Economic policy—History Economics—History Economic history I Title HB95.M43 2009 330.1—dc22   2009004860 British Library Cataloging-in-Publication Data is available This book has been composed in Galliard Printed on acid-free paper b press.princeton.edu Printed in the United States of America 10 For Carolyn This page intentionally left blank [B]y directing [his] industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention Nor is it always the worse for the society that it was no part of it By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it —Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations [T]he working of self-interest is generally benef­ icent, not because of some natural coincidence between the self-interest of each and the good of all, but because human institutions are ar­ ranged so as to compel self-interest to work in directions in which it will be beneficent —Edwin Cannan, Economic Review, July 1913 The invisible hand which guides men to promote ends which were no part of their in­ tention, is not the hand of some god or some natural agency independent of human effort; it is the hand of the lawgiver, the hand which withdraws from the sphere of the pursuit of self-interest those possibilities which not harmonize with the public good —Lionel Robbins, The Theory of Economic Policy in English Classical Political Economy This page intentionally left blank Contents Acknowledgments xi Prologue Chapter One. Adam Smith and His Ancestors Chapter Two. Harnessing Self-Interest: Mill, Sidgwick, and the Evolution of the Theory of Market Failure 26 Chapter Three. Marginalizing the Market: Marshall, Pigou, and the Pigovian Tradition 54 Chapter Four. Marginalizing Government I: From La Scienza delle Finanze to Wicksell 77 Chapter Five. Coase’s Challenge 101 Chapter Six. Marginalizing Government II: The Rise of Public Choice Analysis 125 Chapter Seven. Legal Fiction: The Coase Theorem and the Evolution of Law and Economics 160 Epilogue Everywhere, Self-Interest? 197 References 201 Index 225 216  references in Classics in the Theory of Public Finance, edited by Richard A Musgrave and Alan T Peacock London: Macmillan Originally published as “Contributo alla teoria del riparto delle spese pubbliche.” Rassegna Italiana, October 15, 1883; 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Possibility Theorem and, 133–34; Social Choice and Individual Values, 133 Baird, Douglas, 174 Bastiat, Frédéric, 32 Baumol, William, 27, 80; on Coase, 119n32 Becker, Gary, 191–92, 196; “Crime and Punishment,” 171; Economics of Discrimination, 171 Bentham, Jeremy, 28–29, 31nn10–11, 34, 171; Introduction to the Principles of Morals and Legislation, 28 Bergson, Abram, 137 Bernd, Joseph, 148 Black, Duncan, 131–35; Theory of Committees and Elections, 134 blackboard economics, 120 Boisguilbert, Pierre de, 1, 14, 16 Borda, Jean-Charles de, 131 Bork, Robert H., 167–68, 174 Boulding, Kenneth, 125 Bowman, Ward, 167 Brams, Steven, 132 Breit, William, 157 Buchanan, James M., 78, 94–95, 101, 126, 147, 150; Calculus of Consent, 134, 137, 138; “Externality,” 75; on public choice analysis, 127–28, 140–42; on the Thomas Jefferson Center, 143–44 See also public choice analysis Cairnes, J E., 31 Calabresi, Guido, 170 Calculus of Consent (Buchanan, Tullock), 134, 137, 138, 141, 150 Cambridge school, 33, 54, 76, 77; efficiency and, 99–100; Pigou and, 66 Cannan, Edwin, 60, 65 Carattere teorico dell’economia finanziaria (De Viti de Marco), 79–80 Cardozo, Benjamin, 162 Carlton, Dennis, 174 Center for the Study of Public Choice, 147–49; graduates of, 149 “Centralisation” (J S Mill), 41 Chicago school, 2–3, 4, 143, 161, 197; Coase and, 102, 160, 168, 169–70; Critical Legal Studies movement and, 194–95; legal-economic interaction and, 164–69, 174, 186; price-theoretic tradition and, 165–66 Coase, Ronald, 3, 126, 146, 168, 172, 196; on Adam Smith, 25; Bass v Gregory and, 110–11; classical welfare theory and, 112; contributions of, 124; externalities and, 105–7, 115–17, 118–19; farmer and cattle rancher example and, 107–9; “Federal Communications Commission,” 103–4, 112–13, 115; harm, reciprocal nature of, and, 104–7; methodology and, 120–21; “Nature of the Firm,” 113, 115–16; nirvana fallacy and, 119–20; on Pigou, 114, 116–17, 118–21; on Posner, 188; “Problem of Social Cost,” 102, 104, 113, 127, 160, 169–70, 172, 175, 188–89; on Simons, 165–66; Sturges v Bridgman and, 110; transaction costs and, 113–14 Coase theorem, 111, 174–91; alienable rights and, 178, 180–81; challenges to, 179–80; Coase and, 188–89; common law and, 182–83; effects of, 187–88; implications of, 180–82; legal rights, market context and, 183–86; mimic the market and, 185, 186n65; new institutional economics and, 188; normative implications of, 184–86; Polinsky and, 176; results of, 176–78; Stigler and, 176; transaction costs and, 178, 180, 182 Colbert, Jean Baptiste, 14 226  Commons, John R., 163, 183–84 Condorcet, Marquis de, 131 Considerations on Representative Government (J S Mill), 41 Constitutional Political Economy (CPE), 158 consumer surplus, 55–56, 59–60, 63 “Corn” (Quesnay), 16 Cowles Commission, 133n18 “Crime and Punishment” (Becker), 171 criminal activity, economics and, 171 Dam, Kenneth, 167 David, Paul, 151 Davis, Otto, 155 Debreu, Gerard, 190 “Decline of Law as an Autonomous Discipline” (Posner), 195 Director, Aaron, 104, 166–68, 196; students of, 167 doctrinalism, 161–62 Dodgson, C L., 131 Douglas, Paul, 166 Downs, Anthony, 132; Economic Theory of Democracy, 134, 136; on public choice analysis, 137–38 Easterbrook, Frank, 174 Economia delle Scelte Pubbliche, 158 Economic Analysis of Law (Posner), 171–72 “Economic Chivalry” (Marshall), 70 economic(s) imperialism, 82n10, 125–26, 189, 191–94 Economics of Discrimination (Becker), 171 Economics of Justice (Posner), 173 Economic Structure of Tort Law (Posner, Landes), 172–73 Economics of Welfare (Pigou), 64–65, 72–73, 121–23 Economic Theory of Democracy (Downs), 134, 136 Economist, 33 Einaudi, Luigi, 80; on Pantaleoni, 84, 86n20 Ekonomska Politika, 149 Elements of Pure Economics (Walras), 66 Epstein, Richard, 174 Essay on the Nature and Significance of Economic Science (Robbins), 192–93 European Journal of Political Economy, 158 index “External Economies and Diseconomies in a Competitive Situation” (Meade), 73–75 “Externality” (Craig, Stubblebine), 75 Fable of the Bees (Mandeville), 18 “Federal Communications Commission” (Coase), 112–13, 115 Finanztheoretische Untersuchungen (Wicksell), 78, 92, 126 First Principles of Public Finance (De Viti de Marco), 77 Fischel, Daniel, 174 Foundations of Economic Analysis (Samuelson), 190 Friedman, Milton, 104, 166; “Methodology of Positive Economics,” 136 Galton, Francis, 131 game theory, 132, 190 “General Maxims for the Economic Government of an Agricultural Kingdom” (Quesnay), 16 Gertzog, Irwin, 139 Goetz, Charles, 147– 48 Gordon, Kermit, 145 Gossen, Hermann Heinrich von, 83n12 Gournay, Vincent de, 1, 14 Graaf, J de V., Theoretical Welfare Economics, 75 Greeks: commercial activity and, 7; economic growth and, 6–7; participatory governance and, 8; private property and, 10; role of government and, 7; self-interest and, Hale, Robert Lee, 165 Hamilton, Walton, 165 Harsanyi, John, 137 Hayek, Friedrich, 144, 166; Road to Serfdom, 166 Herndon, James, 148 Holmes, Oliver Wendell, 160, 162 Hovenkamp, Herbert, 168 Industry and Trade (Marshall), 55 Introduction to the Principles of Morals and Legislation (Bentham), 28 invisible hand, 1–2, 5, 19–20, 199; Pigou and, 63, 67–68; Robbins on, 32 Italian tradition, 78–92; efficiency and, 99–100; good government model and, index  83–90; government failure models and, 90–92; individualism, self-interest, and the state and, 81–83; optimal public equilibrium and, 83–92; Wicksell and, 95–98 See also specific authors Jevons, William Stanley, 81, 83 John M Olin Foundation, 168n29, 186 Journal of Economic Literature, 159 Journal of Law and Economics, 104, 160, 168, 169, 175, 183 Journal of Legal Studies, 172 Katz, Wilber, 164 Keynes, John Maynard, 56 Kitch, Edmund, 167 Knight, Frank, 21, 118, 143, 165, 166–67 laissez-faire: Buchanan on, 101; J S Mill and, 42; Marshall and, 55–56; Philosophic Radicals and, 31; Physiocracy and, 25n31; Pigou and, 60, 65; Sidgwick and, 44–46 Landes, William, 174; Economic Structure of Tort Law, 172–73 LaPlace, Pierre Simon, 131 law, economic analysis and, 169–74, 184–86 Lazear, Edward, 193–94 Lectures on Jurisprudence (Smith), 24–25 legal realism, 162–63; institutionalism and, 163–64 Levi, Edward, 167, 169 On Liberty (J S Mill), 34, 41 Liebeler, Wesley J., 167 Llewellyn, Karl, 163, 168–69 Logic of Collective Action (Olson), 134 Lowe, Robert, 26 Lowry, Todd, Malthus, Thomas R., 32, 60n11 Manchester school, 33 Mandeville, Bernard, 1; Fable of the Bees, 18 Manne, Henry, 140, 151, 167, 168, 174 Manual of Political Economy (Pareto), 66 marginal revolution, 27, 45, 78, 161; Italian tradition and, 81 Marshall, Alfred, 3, 198–99; on Adam Smith, 58; consumer surplus analysis and, 55; corruption in government and, 56–57, 59; “Economic Chivalry,” 70; 227 Industry and Trade, 55–56; laissez-faire and, 55–56; market failures and, 56; on Pigou, 64n14; Principles of Economics, 54, 198–99; role of government and, 57–59 Mathematical Applications in Political Science, 158 Matthews, Donald, 136 Maxwell, Clerk, 66 Mazzola, Ugo, 78–80, 82; good government model and, 86–88; price formation and, 87–88; private versus public goods and, 86–87 McCulloch, J R., 31 McGee, John S., 167 Meade, James: “External Economies and Diseconomies in a Competitive Situation,” 73–75; on public choice analysis, 138 Menger, Carl, 87 mercantilism, 11–13; natural law and, 13; precious metals and, 11–13; role of government and, 12–13 “Methodology of Positive Economics” (Friedman), 136 Methods of Ethics (Sidgwick), 42 Mill, James, 30–31 Mill, John Stuart, 3, 27–28, 30–31, 33–42, 101; Bentham and, 34; “Centralisation,” 41; conflicting inconveniences and, 47n; Considerations on Representative Government, 41; democracy and, 41; expediency and, 37; externalities and, 35–36, 40; government functions and, 33, 37–38, 40–42, 50, 51; laissez-faire and, 42; On Liberty, 34, 41; nonauthoritative actions and, 40, 48; Principles of Political Economy, 34; on property, 38; self-interest and, 38–40; versus Sidgwick, 53; spillovers and, 35–37, 51; systematic colonization and, 38–40; utilitarianism and, 51 Milne, R S., 137 Mitchell, Joyce M., Political Analysis and Public Policy, 150 Mitchell, William, 134; Political Analysis and Public Policy, 150 Montemartini, Giovanni, 82–83; coercion, political process and, 90–92, 98; efficiency and, 99 Musgrave, Richard, 30n7, 46n52, 77–78 228  Nanson, E J., 131 National Science Foundation, 150, 157 natural law, 5–6; mercantilism and, 13; Physiocracy and, 15–16, 17; Smith and, 24n30 “Nature of the Firm” (Coase), 113, 115–16 Newing, R A., 132 Nutter, Warren, 126, 143, 166 O’Brien, D P., 3, 30n7, 46n52 Olson, Mancur, 151; on Calculus of Consent, 141, 159; Logic of Collective Action, 134; on nonmarket decision making, 153–55 Ordeshook, Peter, 132, 140–41 Ostrom, Vincent, 152 Pålsson Syll, Lars, 92 Panteleoni, Maffeo, 78–80, 82; Adam Smith and, 85; good government model and, 83–86; legislative outcomes and, 84–85; maximization approach and, 83–84; Principii di economia pura, 79 Papers on Non-Market Decision Making (Thomas Jefferson Center), 156–57, 158 Pareto, Vilfredo, 79; efficiency and, 99n39, 100; Manual of Political Economy, 66 Parsons, Talcott, 155 Pauly, Mark, 158 Peacock, Alan, 77–78 Philosophic Radicals, 30–31 Philosophie Rurale (Quesnay, Mirabeau), 14–15 Physiocracy, 14–17; agricultural versus manufacturing production and, 15–16; economic conditions and, 14; laissez-faire and, 25n31; mercantilism and, 16; natural law and, 15–16, 17; role of government and, 16–17; self-interest and, 17 Pigou, A C., 3, 54, 59–72, 120–21; Coase on, 114, 116–21; Economics of Welfare, 64–65, 72–73, 121–23; economic welfare and, 60n10; empty boxes debate and, 66; externalities and, 62–63, 101–2; investment in capital improvements and, 61–62; invisible hand and, 67–68; laissezfaire and, 60, 65; legacy of, 72–76; marginal net products and, 60n11; market failure in practice and, 65–72; market failure in theory and, 60–65, 101; market system evils and wastes and, 67–68; Mar- index shall and, 64n14, 70; national dividend and, 60n11; prima facie case for State action and, 68–72; production returns and, 63–64; representative assemblies, shortcomings of, and, 70–71; role of government and, 65; Sidgwick and, 60, 72; spillovers and, 62–63; “State Action and Laisser-Faire,” 69, 121–23; Wealth and Welfare, 64, 72–73; welfare economics and, 59–60 Plant, Arnold, 169 Plato, 6–8 Plott, Charles, 158 Polinsky, A Mitchell, 176 Political Analysis and Public Policy (W C and J M Mitchell), 150 Positive Program for Laissez Faire (Simons), 165 Posner, Richard, 167–68, 170, 174, 188; on common law, 172; on contract law, 185; “Decline of Law as an Autonomous Discipline,” 195; Economic Analysis of Law, 171–73; Economics of Justice, 173; Economic Structure of Tort Law, 172–73; on legal realism, 195–96 Pound, Roscoe, 162 pragmatism: Coase and, 117–21; selfinterest and, 30–33 preferences, stable, 135, 191 Principii di economia pura (Panteleoni), 79 Principles of Economics (Marshall), 54, 198–99 Principles of Political Economy (Mill), 34 Principles of Political Economy (Sidgwick), 42 “Problem of Social Cost” (Coase), 102, 104, 113, 127, 160; economic analysis of law and, 169–70, 172, 175–76, 188–89 psychological hedonism, 28–29 Public Choice, 148, 157–58 public choice analysis: behavioralism and, 139; bureaucracy and, 130; catallactics and, 128; conferences and, 150–52, 155; Continental public finance tradition and, 131; definition of, 127–28, 131; early reactions to, 135–42; extant political science paradigm limitations and, 139–40; game theory and, 132; nonmarket phe­ nomena, study of, and, 152–53; pre­ cursors of, 131–35; publications and, 156–59; Public Choice Society and, 152; index  right-wing bias and, 141–42; selfinterested rational actor assumption and, 137; self-interest and state action and, 126–31; voting and, 129–30 Public Choice Studies, 158 Puviani, Amilcare, 82–83, 90; efficiency and, 99 Quesnay, Franỗois, 1417; Corn, 16; General Maxims for the Economic Government of an Agricultural Kingdom,” 16; Philosophie Rurale, 14–15; Tableau Économique, 15 RAND, 132–33 rational choice theory, 132, 140, 155–56, 158, 190, 191–92, 197 Rawls, John, 151 Ricardo, David, 30–31, 38–40; abstract reasoning and, 52 Richenberg, L J., 136 Riker, William, 134; on political science, 140–41; Theory of Political Coalitions, 134 Riqueti, Victor, Marqui de Mirabeau, 14–16 Road to Serfdom (Hayek), 166 Robbins, Lionel, 3, 30, 32, 197; Essay on the Nature and Significance of Economic Science, 66–67, 192–93 Rogers, W Hayward, 136 Rosenberg, Nathan, 153 Rowley, Charles, 158 Samuels, Warren, 3, 30n7 Samuelson, Paul, 101, 166; Foundations of Economic Analysis, 190 Sandelin, Bo, 92 Say’s Law, Scalia, Antonin, 174 Schmid, A Allen, 153 Schneider, Friedrich, 158 Scholastics, 10; commercial activity and, 9; monetary issues and, 9–10; role of government and, 10 Scitovsky, Tibor, 75–76 Senior, Nassau, 31 Shannon, Edgar, 145 Shapley, Lloyd, 132 Shubik, Martin, 132 Sidgwick, Henry, 3, 27–28, 42–50, 72, 229 101, 171; abstract reasoning and, 52–53; on Adam Smith, 43; conflicting inconveniences and, 47; externalities and, 43–45; future generations and, 45–46; government functions and, 48–50, 72; incentive to cheat and, 46; individualist minimum versus socialistic interference, 46–47; versus J S Mill, 53; laissez-faire and, 44–46; machinery of transfer and, 48n55; marginal principle and, 83n12; Methods of Ethics, 42; on natural liberty, 32; natural resources and, 44–45; Pigou and, 60; Principles of Political Economy, 42; on Ricardo, 43, 52; role of government and, 46–50; self-interest and, 42–44; on socialism, 50; utilitarianism and, 51–52, 53 Siegan, Bernard H., 167 Simon, Herbert, 137 Simons, Henry, 77–78, 164–66; Positive Program for Laissez Faire, 165 Smith, Adam, 1, 17–25, 101, 197; government agents and, 21–22; invisible hand and, 1–2, 5, 19–20, 32, 63, 67–68; laissez-faire and, 24–25; Lectures on Jurisprudence, 24–25; mercantilism and Physiocracy and, 20–23; Physiocracy and, 18; role of government and, 22–24; selfinterest and, 18–19, 20–21, 25; Theory of Moral Sentiments, 18; Wealth of Nations, 1–2, 19, 21, 26, 65 Social Choice and Individual Values (Arrow), 133 Social Science Research Council, 151–52, 153, 155 sociological jurisprudence, 162 “State Action and Laisser-Faire” (Pigou), 69, 121–23 Stigler, George, 104, 166, 196; Coase theorem and, 111, 176; on individual liberty, 40; on Simons, 165 Stubblebine, W Craig, “Externality,” 75 Sykes, Alan, 174 Tableau Économique (Quesnay), 15 taxation, equal-sacrifice rule of, 93 Theoretical Welfare Economics (Graaf), 75 Theory of Committees and Elections (Black), 134 Theory of Moral Sentiments (Smith), 18 Theory of Political Coalitions (Riker), 134 230  Thomas Jefferson Center for Studies in Political Economy, 142–47; Committee for the Analysis of Nonmarket DecisionMaking, 145; Ford Foundation and, 145; graduates of, 149; Papers on Non-Market Decision Making, 156–57, 158; staff and scholars of, 144–45; university administration and, 145–46 Tollison, Robert, 158 Tullock, Gordon, 78, 94–95, 126, 147; Calculus of Consent, 134, 137, 138, 141, 150; on politicians, 129; on public choice analysis, 127–28; Vines on, 135–36 See also public choice analysis Ulmer, Sidney, 137, 139 utilitarianism, 28–29; J S Mill and, 51, 53; Sidgwick and, 51–52 See also Bentham, Jeremy utility, theory of degree of, 83 Vanberg, Viktor, 158 Viner, Jacob, 13, 165, 166–67; on Adam Smith, 24 Vines, Kenneth: on political science, 138–39; on Tullock, 135–36 Virginia school, 2–3, 4, 126, 197 See also Thomas Jefferson Center for Studies in Political Economy index De Viti de Marco, Antonio, 78–80, 81–82; Carattere teorico dell’economia finanziaria, 79–80; First Principles of Public Finance, 77; good government model and, 88–90; private versus public goods and, 89; public finance theory and, 88 Wagner, Richard, 158 Wakefield, Edward Gibbon, 39 Walras, Léon, 81, 83; Elements of Pure Economics, 66 Ward, Benjamin, 153 Wealth of Nations (Smith), 1–2, 19, 21, 26, 65 Wealth and Welfare (Pigou), 64, 72–73 Wellisz, Stanislaw: on externalities, 102; on the Pigovian tradition, 121 Whinston, Andrew, 146–47 Wicksell, Knut: equal-sacrifice rule and, 93; Finanztheoretische Untersuchungen, 78, 92, 126; government failure models and, 97–98; Italian tradition and, 95–98; on Mazzola, 92; optimal equilibrium and, 97; political processes and, 98–99; public choice analysis and, 131; unanimity rule and, 93–95, 96, 99 Wilson, John, 33 Winch, Donald, ... Reserved Library of Congress Cataloging -in- Publication Data Medema, Steven G The hesitant hand : taming self- interest in the history of economic ideas / Steven G Medema p.  cm Includes bibliographical... analysis the economics of politics; and the evolution of law and economics Both of the latter endeavors are significant for bringing self- interest into the policy-making arena the former showing the. .. phenomena, and the results of the analysis often called into question the received view of government and the market The focus of this book is the interplay of self- interest, market, and state in economic