Saturday, May 24, 2008

American Social Democrats and the Fallacy of Rationality

The fundamental strategy of American social democrats*, beginning with the late nineteenth century Mugwumps through today's progressives has been the introduction of experts via state planning agencies to improve fairness and encourage stability and growth. The Mugwumps were a liberal, limited government group in the late nineteenth century who believed that the boss system could be reformed by the introduction of a civil service. At the federal level the Pendleton Act that implemented a rudimentary federal civil service and was passed during Chester Alan Arthur's administration in response to the assassination of President James Garfield was one of their achievements. As Robert Wiebe argues in The Search for Order the key step in the transformation of movements like Populism and social gospel Christianity into Progressivism was the evolution of these ideas into a concept of bureaucracy. Nancy Cohen shows in her Reconstruction of American Liberalism that the origins of today's social democratic ideas were in the Mugwumps' emphasis on rationalization of municipal administration, ending the boss system and replacing the spoils system with a civil service based on merit. As well, the Mugwumps were interested in establishing academic, legal and other professions and were the first American movement to emphasize professional interests. In Europe, Max von Weber made his ideal of bureaucracy a cornerstone of his sociological system. The idea that rationality implies efficiency was fundamental to late nineteenth century progressivism and remains to this day a cornerstone of both the fossilized Progressivism of the Republican Party and the aged New Deal social democratic ideas of the Democratic Party. The bureaucratic philosophy was implemented in the Progressive era through Roosevelt's adoption of laws like the Hepburn Act which aimed to replace market processes with public decision making. This bureaucratic approach intensified in the 1930s with the social democrats' advocacy of Keynesian economics, which argues that the money supply can be manipulated to ensure full employment. This in turn led to further steps toward bureaucratization of the economy.

The intellectual reaction to the bureaucratic philosophies of the Progressives and the social democrats reveals much about the relationship of bureaucratic power to the economic interests of the professional class. Although bureaucratization claims the mantle of rationality, the reaction reveals that at root it is as much a rationale for professional privilege and power as it is an effort to improve the functioning of society. The reactions to the bureaucratic social democratic philosophy were evident by the 1940s. In sociology, Robert Merton observed that bureaucracy became an end to itself, that rules became a fetish, and so the efficiency principle was undermined by bureaucrats' obsession with rules. Also in the 1940s, Friedrich Hayek, building on the ideas of Ludwig von Mises, pointed out that information and knowledge in an economy is too complex for the mind of any cadre of experts, or super-computers for that matter. Because the information available in society is quantitatively infinite and qualitatively incomprehensible, central planners cannot grasp the most rudimentary issues confronting the economy. For instance, in recent decades the Federal Reserve Bank in the United States expanded credit, making it available to real estate developers. In turn, farmers sold their land for real estate development. The stimulus to real estate development encouraged banks to make credit available to people who could not afford to repay the loans. The farmers sold their land to developers, receiving the newly minted Fed money to people who could not afford it. The Fed could not anticipate that banks would be unable to assess credit risk intelligently and that the land being developed had economically better use than real estate development. The result was food shortages in the early 2000s, starvation in Third World countries and a "subprime" crisis whereby large numbers of home buyers and real estate speculators have been unable to repay the banks. The Fed's failure is but one example of the inability of bureaucrats to grasp the subject matter in which they claim expertise. The Fed officials have been intelligent men. Their failure is not one of policy or of ability but rather of the underlying bureaucratic principles behind the Fed.

Merton's critique of bureaucracy in the context of efficiency and Hayek's critique of the ability of bureaucrats to rationally plan the economy were joined in the late 1950s by Herbert Simon and James March, who wrote a seminal book entitled Organizations. One of the key themes in Organizations is the idea that economics excessively assumes the ability of decision makers to think rationally. They argue that decision makers face bounded rationality. The management and organization field has positioned this critique as one of the assumptions of neo-classical economics. They argue that economists assume that decision makers aim for optimal solutions (such as that firms aim to maximize profit or that consumers aim to maximize pleasure or utility) and that economic actors act rationally in the pursuit of optimal solutions. This model, March and Simon argue, is incorrect not just because decision makers are not able to obtain the information necessary to think rationally but also because time and search costs "bound" rationality and place cognitive or mental limits on rationality.

The relative fates of Hayek and March and Simon in business schools is revealing. Both make similar arguments about limits on rationality and March and Simon refer to Von Mises and Hayek in the final chapter of their book (see Nicolai Foss in the organization and marketsblog for this point). Hayek wrote prior to March and Simon. Hayek's "Use of Knowledge in Society" appeared in 1945 and Organizations appeared in 1958. If March and Simon are right about cognitive limits on rationality in organizations than Hayek must be right about rationality in the economy because the problems confronting planning for an entire economy are considerably, perhaps infinitely, more complex than problems confronting planning for a single organization. Yet while March and Simon's analysis became a fundamental cornerstone of organization theory, Hayek's analysis was hardly recognized and remains at the fringe of public policy thinking to this day. In other words, the state of today's academy and modern social thinking is that (a) it is impossible for executives to think rationally about how to market Coca Cola or how to optimize profits in doing so, that firms must satisfice, that is, act in a way that reaches only a satisfactory as opposed to an optimal level of profits, but (b) it is possible for bureaucrats to think rationally about how to optimally decide the level of interest rates, how much money to print, whether Microsoft is really a monopoly and whether tariffs should be raised. That is, when thinking about organizations, business schools have been quick to elevate a critique of executives' abilities to the center of management theory, but when thinking about the much more difficult problem of utilizing information in an entire economy business schools have ignored the parallel critic of social democratic and bureaucratic ideas.

Two additional ideas of Katz and Kahn in their Social Psychology of Organizing also lead to fundamental criticism of the bureaucratic model. First, the idea of an open system. In the Progressive and bureaucratic models of organizations, organizations are viewed as closed systems that require rational optimization of task efficiency in order to yield the best results. In contrast, Katz and Kahn argued, organizations are open systems that interact with their environment. Because organizations interact with their environment, Progressive ideas like scientific management need to be applied judiciously. Market shifts, changes in technology, and fluctuations in the quality of labor all impinge on the ability of planners to base solutions to production problems on expertise.

Second, Katz and Kahn applied the idea of Arturo Rosenbleuth and Norbert Wiener in their article Behavior, Purpose and Teleology ** concerning feedback loops to organizations. Organizations can learn only through failure. This same notion was applied by Oskar Lange to his theory of socialist economic planning. However, bureaucratic organizations have difficulty with change. This occurs for two reasons. First, as Merton pointed out in his article, the bureaucratic rules become an end into themselves. Employees become fixated on the propriety of bureaucratic rules and so resist efforts to change them even when they do not work. Second, as Mancur Olson shows in his Rise and Decline of Nations and as George Stigler shows in his article Economic Theory of Regulation, rules create economic interests which resist change. Thus, feedback loops are impeded by civil service and bureaucratic rules. This means that rationality is curtailed in public sector decision making even under Oskar Lange's claim of the ability of socialist entities to experiment to obtain optimal outcomes. Experimentation is curtailed precisely by the ritualization of bureaucratic rules, the inability of central planners to react in a timely way to change and their inability to begin to grasp the critical economic variables, and by economic interests of constituents, who will fund opposition to change because it threatens private gains that social democratic policies create.

There are additional reasons as well. The experts' training becomes institutionalized and ideological. Thomas Kuhn's Structure of Scientific Revolutions argues that scientific paradigms become ingrained for long periods of time and require significant intellectual upheaval before they are replaced. In academia, interest groups form around ideological solutions such as Keynesian economics or radical sociology and such paradigm- or ideology-driven solution sets are entrenched for economic as well as ideological reasons. A critique of social democratic rationality would need to integrate the failure of American universities to anticipate and explain important shifts in society and the economy and to remain rooted in passe solution sets that reflect the economic and intellectual interests of the professoriate.

Thus, the Progressives and social democrats both began as movements to encourage rationality through expertise. But there are contradictions inherent in the methods that they applied, namely the hiring of experts to replace market processes and the claim that central planners can experiment and act rationally. Where there has been no political or economic agenda (or an agenda that is consistent with the claim that rationality is absent) such as in the case of business corporations, academics and experts have been quick and aggressive in claiming the inability of corporate executives to act rationally. However, where the problem is most acute, public sector and governmental decision making about the economy, academics, experts and professionals have resisted introduction of basic ideas about limits on rationality and feedback loops. This resistance reflects both the intellectual baggage of paradigms to which academics and their social democratic allies are loyal as well as the professional and economic interests of the interest groups that support social democracy, namely, the professions, government employees, some big business groups, high finance, and the media.

*By social democrats I refer to the movement that began with Franklin D. Roosevelt's New Deal, integrating earlier Progressive and Mugwump ideas, and adding elements of socialism. At various points social democrats have called themselves "liberals" and at others "progressives". They also claim that they are "pragmatic". Social democrats advocate expansion of state power toward an undefined and ever-receding maximal point while claiming an ultimate global convergence to a "mixed economy". But social democrats rarely if ever advocate elimination of governmental programs that fail while they aggressively emphasize the failure of markets. The joint themes of market failure and governmental efficiency remain constant in social democratic ideology.

**Arturo Rosenblueth, Norbert Wiener and Julian Bigelow, Behavior, Purpose and Teleology, Philosophy of Science, Vol. 10, No. 1 (Jan., 1943), pp. 18-24


hereticalpolemicist said...

I have postulated that macro-economic theory is flawed becasue it is unrealistic in formulating the REAL influence of greed and abuse that are equal facotrs in decision making as are the classical homilies given in "101 Econ" classes.

Your conclusion resolves around what main points?


Mitchell Langbert said...

Dear Hereticalpolemicist--thanks for your thought. My thesis is favors anarchy.

hereticalpolemicist said...

My thesis favors revolution as ultimate reset and defaulting of the system unable to make the necessary social corrections. Revolution is as much a market force as elasticity and inelasticity.