On Corporations and People

One of the favorite leftist arguments is the idea that corporations are supposedly absolutely distinct legal persons, not people, and that thus their freedom is far less valuable. While this reasoning seems superficially correct, I will try to show that it is mistaken.

Any undissolved corporation has ultimate owners who consciously stand behind it at any moment in time unless the corporation becomes insolvent, i.e. shareholders. Now it does not mean that each of potentially many shareholders agrees with all the decisions made on her behalf by either the majority of shareholders, or the management. But does the fact the shareholders agree to such an arrangement mean that they do not actually have property in the corporation and only have debt claims of some sort (which would mean that the corporation is absolutely legally distinct from its shareholders)?

Let us look at a non-corporate analogy. Suppose that I own a house and hire a guy to dye its walls and go to another place during the works. Does the fact that the guy who is dying the walls may draw swastikas on them against my wishes mean that I have ceased to be the owner of the house? Not at all. My property in the house involves my right to take risks with respect to the house. I would not want some third-party enforcer of property rights to ensure that every or most physical actions of  third persons with respect to my house is in strict compliance with my wishes at the particular moment. This would make my property in the house far less valuable to me. I would rather want third-party persons to act without my explicit request only in cases where they have very good reasons to believe that my property rights are being violated.

The same holds true for corporations and shareholders. The so-called legal personhood of  a corporation is not a restriction of the property rights (and ultimately freedom) of its shareholders. It is, rather, an integral part of such property/freedom. That the content of risks that a typical shareholder faces differs from the one faced by an owner of the house does not change the principle.

UPD: I should not have used the word ‘legal’ in the first sentence of this post which creates a wrong impression that I am denying the existence of certain legal rules governing corporations (e.g. the rule that the claims against the corporation may not generally be satisfied out of the property of its shareholders).


A Follow-Up on IS-LM

To follow up on IS-LM, I think some clarification and more generalized criticism are needed. Also my title for that post went a bit too far (as I later realized) which I rectified.

The first major flaw of the model is that it does not differentiate between interest rates demanded by savers from banks and the interest rates demanded by banks from entrepreneurs undertaking investment projects. If the model did differentiate between those two kinds of interest rates there could be no IS curve.

Also, even if we abstract from the problems with curves, what I meant in the previous post but did not express exactly correctly is that the volume of investment loans is not determined solely by the savers’ income and liquidity preference. Savers may have high liquidity preference and demand high interest rates from banks for foregoing the hoarded money but if entrepreneurs can offer investment projects which are productive enough for banks to finance banks can offer savers the right interest rates.*

If entrepreneurs cannot offer such projects it means that hoarding is entirely normal from the economic standpoint. It means that hoarders do not want to buy more than the economy currently produces at the prices at which the additional consumer goods would be offered. Thus, prices should fall. Attempts to get someone else to spend instead of hoarders are essentially redistribution plain and simple.

Thus, the IS-LM model by its very design completely ignores one of the two decentralized mechanisms that can take the economy out of the recession without redistribution – entrepreneurial innovation.

On my second point from the previous post, I was somewhat sloppy when I talked about a straightforward contradiction. According to the model, if the LM curve is taken into account, income determines not saving but actually how much consumption the receivers of monetary income will forgo. The rates they will demand from banks are determined by their liquidity preference.

This already presents a problem for IS-LM because it renders the IS-LM graph meaningless in terms of how things actually happen in time. In other words, IS-LM attempts to make synchronous three phenomena happening asynchronously under the very logic of the model. Under the logic of the model people first forgo consumption, then face the choice of whether to hoard the money or invest it according to their liquidity preference and only as a result of their choice the exact volume of investment is achieved. The representations of those three phenomena on the same graph creates a dynamic nightmare. It can then be asked whether it even makes sense to talk about people first forgoing consumption and then making a decision whether to hoard or invest it but this is too much to demand from such a comparative-statics model.

But the deeper issue is that the decisions to forgo consumption are modeled as mechanical and exogenously determined. People just do not consume some part of their income according to the exogenously set marginal propensity to consume. Of course the marginal propensity to consume postulated by the model might change and it may be said to account for changes in saving but that marginal propensity to consume may itself be not an exogenous variable but may itself partly depend on income. In such a case (which is quite plausible) the whole edifice of IS-LM collapses because a scenario can be easily imagined when as a result of hoarding by some people the total income falls in the first period but then the reduced income may lead to more consumption in the second period out of the received income.

*I neglected this aspect for simplicity but this logic applies to the decisions of entrepreneurs whether to hoard or reinvest their profit. Their decision whether to hoard or reinvest it will depend not just on their liquidity preference but also on whether they can think of sufficiently productive investment projects that they may undertake.

IS-LM Criticism

Before this moment I never really ventured deeply into the IS-LM model because it is a primitive simultaneous equations model based on identities. But then I realized that some macroeconomists, including of course Krugman, still think that this model is a good description of the economy at some level of simplification. So I decided that I would look into it.

What I discovered, exceeded my worst expectations. First of all, the model implies that real interest rates represented by variable r are not dependent on the rates of return on investment. This seems superficially correct if one looks only at the credit markets and forgets their interconnections with the ‘real’ sector. But if one does not forget that then it becomes clear that expected rates of return must be an important factor in the determination of real interest rates. When a bank decides whether to lend X dollars to project A or project B, the most important thing it must take into account is the expected profitability of the project. The demand for loans will also depend on that factor.

Now it is true that the interest rates at which banks will be prepared to provide loans will also depend on the interest rate they must pay to savers. But this dependence does not mean that the only way to counter money hoarding if hoarders want high interest rates is for someone to spend instead of them. If sufficiently ex ante productive projects are offered by entrepreneurs for financing banks can offer hoarders sufficient reward for giving their money to them. If no such projects can be offered it means that the relevant state of the economy with people hoarding money is a normal market situation that does not require any external meddling.

But this is not the worst thing about IS-LM. The worst thing about it is that what is attempted to be said with the mathematical metaphors contains a straightforward logical contradiction, unless savings are thought of as a mechanical response to income. The model starts from distinguishing income from planned expenditure. Income supposedly determines r and r supposedly determines the planned expenditure. All is well, until we come to the discussion of the market for loanable funds where it is casually said that if savings rise, the real interest rate will fall. This can be reconciled with a narrow interpretation of the model where savings behavior is a mechanic response to the changes in income but it is obviously not what the modern proponents of IS-LM like Krugman have in mind.

I am not making this obvious contradiction up. Krugman himself in a post on IS-LM for dummies explains that the model attempts to reconcile the two standard approaches to the determination of real interest rates – the standard loanable funds approach and the liquidity preference approach. He obviously means here not that people save mechanically but that they might start saving if their attitude to the future has changed.

Strange salary premiums for college graduates and signalling

Bryan Caplan wrote another post defending the signaling model of higher education as opposed to the human capital explanation. To bolster his case he brings up the data that there is a salary premium associated with college education even for jobs that few would think people would have in mind when going to college.

I think Caplan’s conclusion in the post is mistaken. As is the signaling model as a whole. The model implies that every choice for getting higher education must be rational in the strong sense, i.e. in the sense that no mistakes are made about the need for education. Thus, to reconcile the model with reality, a very dubious assumption is made that people go to college just to get the diploma, and, more importantly, that employers hire college graduates only on the basis of the signal provided by their diplomas.

First, if the assumption of strong rationality of consumers is relaxed, one may have lots of explanations why students may choose to go for it, beside the clearly erroneous one that they just all go for it for the guaranteed specific job skills. They might even take this road for fundamentally uncertain goals. Some students quite probably choose college to try to understand what they want in life. Others might just be after the nice experience that it now often offers. Still others might really want to get knowledge of certain subjects. So even if the diploma works only as a signal, the college-goers may not choose college only (or even primarily) for the signal. 

Secondly, the data Caplan invokes only support his case on the employer side if interpreted as saying that college graduates immediately get higher pay in the relevant occupations than their degree-less colleagues. And Caplan provides no reason to think that it is so. Thus, it might well be that people with college education get pay raises later because they really do on average work better than their degree-less colleagues. Either because they actually acquire useful skills in college, or, more plausibly, just because they are more competitive from the start.  

The false dichotomy between the state and noble savages

James Scott wrote a highly critical review of Jared Diamond’s latest book concerning what we can learn from non-westernized societies that have existed and still exist on the face of the Earth. Scott makes three main interrelated points.

1. Diamond is deeply mistaken in his attempts to infer truths about the social organization of prehistoric hunter-gatherer/nomadic (non-agricultural) societies from the way the present such societies exist.

2. The way such societies exist now and how they interact with other such societies (including high incidence of violent conflict) has very much been determined by the interaction of such societies with states from the moment of their entrance into the scene.

3. The thesis of Steve Pinker also endorsed by Diamond that we owe the current high level of civilization to the states, or, more specifically, that without the states the humanity would have been much worse is unfounded because it is based on comparisons of the modern states with modern non-agricultural societies that suffered terribly from the former. Implicit is the idea, that had some humans not chosen settled agriculture, the humanity could have achieved a higher level of civilization.

I am not even remotely an anthropologist, so I will not tackle Scott’s claim (1) here. Rather I will make five different points of my own related to Scott’s (2) and (3).

1) Scott implicitly contradicts himself at least two times in the article. While he claims that we cannot know anything for certain about prehistoric non-agricultural societies, he himself appeals to the lifestyle of modern hunter-gatherers to claim that the prehistoric ones were the original affluent society. He also appeals to the history of Celtic and Germanic peoples who fought terribly among one another only because of the presence of the Roman Empire and that thus without states prehistoric hunter-gatherers would not have.

2) As I mentioned Scott thinks that prehistoric hunter-gatherer societies were the first affluent societies (because they had abundant food and a lot of leisure). But then he perfectly demonstrates that the members of such societies were not (and are not in the present days) really satisfied with their plight. The examples that Scott invokes seem to suggest that whenever some neighbors of such societies start to live better than them they start to try to plunder. One is tempted to ask here if it were not for such misguided attempts to plunder instead of imitate and trade that those societies that discovered and embraced agriculture were driven mistakenly (as I will claim further) to create the state.

3) Scott makes it sound as if the choice for agriculture necessitated the creation of the state. He probably has something like Wittvogel’s irrigation theory of the state in mind. However, it does not seem that the choice for agriculture necessitated the state, it only made its emergence possible through the emergence of agricultural surpluses. The choice to create the state was quite probably dictated by exaggerated fear of non-agricultural peoples and by religious dynamics. I cannot find the source yet but a couple of years ago I read about the theory that the state emerged from the religious practice of providing gifts to priests that eventually became institutionalized. Various historical facts lend credence to the hypothesis that the first states were thoroughly theocratic. And it does not seem to be a coincidence that a religious justification was necessary to create states. As Michael Huemer demonstrates in his superb book on the problem of political authority, what state agents routinely do would never have been recognized as legitimate if people stuck to their moral intuitions that it is wrong to murder, steal, hijack people, etc. It probably required no less than divine justification to overcome the force of those moral intuitions.

4) The fact that non-agricultural societies have throughout history turned violent wherever their neighbors become wealthier suggests that there is probably something about such societies that makes their members unable to appreciate the advantages of innovation, production and exchange and casts grave doubt on the idea that had they been left alone they would have given rise to an even higher civilization than we know. This something is probably just primitivism of life in such societies, of a life under which everyone did the same stuff. The advent of agriculture allowed some people time to concentrate on thinking, rather than on getting food, and the precursors of modern science, the geographers and long-distance traders soon followed. The rest is history.

5) This leads us to the final point. Scott is correct to doubt the civilizing influence of the state. But it would be too quick a logical jump to attribute the high level of civilization achieved by modern societies with states to the states. In fact a strong case can be made that this level of civilization has been achieved in spite of the states, and in spite especially of slavery which was probably humanity’s greatest mistake. It has been achieved because the states have not managed everywhere to extinguish the creative power of the quest for knowledge, improvement of one’s lot and exchange. Thus, the dichotomy between happy savages who might have developed into something greater and predatory states is at least prima facie false. Had prehistoric people shown the middle finger to the chief-priests with their claims to semi-divine status, the humanity would have probably achieved much greater heights.

Is ABCT a neoclassical theory?

In one of Facebook discussions on his wall Peter Boettke wrote that the Austrian Business Cycle Theory is a pre-WW2 neoclassical theory in response to a claim by Daniel Kuehn that the Austrian school is thoroughly neoclassical but is just in denial about it.

Indeed, as I tried to show in my paper on the realistic reconstruction of ABCT in its original versions by Mises and Hayek ABCT has a lot of affinity with Wicksell-style neoclassicism. It relies entirely on the notion of natural interest rate and equilibrium constructs for attempting to explain business cycles.

However, in the same paper, I tried to show that the actual insight underlying the theory does not have much to do with aggregate constructs and is not even primarily about interest rates. In other words, perhaps since Wicksell the thinking about inter-temporal coordination seems to have been focused excessively on interest rates while ignoring the price dynamics for intermediary goods, and focused on them in not exactly the right way.

The main question I ask in the paper is how credit expansion may result in multiple entrepreneurs mistakenly undertaking unsustainable investment projects (which is the central prediction of ABCT) and why they do not do the same mistakes in cases when the increase in credit available for investment comes from an increase in voluntary savings. The difference, in my view, is that in the latter case a fall in demand for some consumer goods causes some intermediary goods used for their production to become sufficiently cheaper to make some investment projects involving those goods ex ante more profitable than before. Those entrepreneurs who have such projects in mind thus have an incentive to go to the banks who now have more money to lend and ask them for money. Since such projects are also more profitable for banks than shorter projects, the supply and demand for credit meet and the credit will tend to be channeled into the right projects. Notice that interest rates do not play any important role in the inter-temporal coordination here at all. They will not even necessarily fall on average.

Not so in the case of fiat-money-based credit expansion. In such case no projects have in themselves become more profitable according to the objective market conditions, and thus the crucial element of the inter-temporal coordination mechanism is absent from the start. Thus, banks need to lower interest rates on the loans involving the newly created money to induce entrepreneurs to borrow. However, the longer investment projects still have the advantage for the banks here, since loaning the same amount of money several times over a period ceteris paribus involves more costs than loaning it to one project for the same period. Thus, the newly created money will tend to be allocated to longer projects. This creates a plausible possibility that the sellers of intermediary goods for which the longer investment projects will compete with the shorter ones will not realize that the market conditions have changed and will not reflect the change in the initial prices. If the sellers of intermediary goods indeed make such mistakes, the entrepreneurs undertaking longer projects will initially think that they will be able to acquire them at much lower prices than is dictated by the market conditions. This will go into calculation of the conditions of the loans. Then, when prices of such intermediary goods finally reflect the distortion, some projects may turn out to be unsustainable. Again, even in this story interest rates play only a secondary role.

The central role is played by potential mistakes of the sellers of intermediary goods. It is those mistakes that are necessary for a cluster of unsustainable investment projects to be undertaken. Without such mistakes, the prices of intermediary goods will tend to reflect the increased demand from the start and will negatively compensate the lowered interest rates. And the mistakes of the sellers that I mentioned cannot be accounted for by equilibrium theorizing. In such theorizing they are precluded by definition.

Thus, you hopefully can see that ABCT in terms of its valuable insights is not a Wicksellian neoclassical theory.

The Justification of Libertarian Property Rights

Bas van der Vossen published a serious of very good posts at Bleeding Heart Libertarians (see in chronological order here, here and here) disputing the popular position (voiced in this particular case by Kevin Vallier) that property rights constitute a special kind of rights requiring special justification, in contrast to, say rights to personal liberty and bodily integrity.

Kevin Vallier bases his position on public reasons ethics which I am not going to criticize in detail here. Suffice is to say that I believe that ethical statements like murder is wrong can ultimately be either either true or false, or meaningless. Any attempt to qualify them by saying that they are true to the extent God or some idealized agent said (or would say) so, or that people have sufficient reasons to endorse them in their position, deprives ethical statements of ethical content (you may want to replace the word “ethical” in the previous sentences with the word “physical” to see my point).

However, Vallier’s worry about property may be voiced without appealing to public reasons. The point is that property rights imply that it is moral for their holders to repeal attempts to physically affect their property without their consent with proportional physical force. In this sense, other persons are apparently being treated as objects to protect not the personhood of others but merely their control over physical objects.

Van der Vossen correctly suggests that similar worries may be raised about other rights but I think a better defense may be provided. In order to see why, we need to recall that our bodies undergo the process of continual replacement of cells over the course of our lives. Thus, most of the matter that comprises our bodies at a given point in time has not been in us from birth but was acquired later from the external world.

This means that at least some property rights over external physical objects must be ethically justified in order for a person to enjoy self-ownership. Otherwise, we would not own our bodies because we would not own the matter of which they are constantly being remade.

Now, obviously, this does not give us a justification of libertarian property rights but, as Roderick long put it very well in this lecture, one’s body is just one of one’s projects. Thus, if property rights are justified in respect of it, they are prima facie justified with respect to one’s other projects. The burden thus must be on the opponents of libertarian property rights to prove that they are not ethically justified. And their prospects of proving that do not look very bright, especially in light of the Austrian economic theory that shows convincingly that maintenance of such rights brings good consequences from the standpoints of other ethical virtues (apart from justice in the Smithian sense) such as benevolence.