The unemployment rate as a measure of a physical property of a spatially dispersed population

We are set upon the task of devising a way of visualizing a smallscale physical model of a nation's population of people, showing its spatial arrangement at each of a succession of moments in time, and thus something about how a thing of this kind develops and evolves over the course of time. In this model, as we have imagined it to be, each member of the population would be represented by a small, thin disk that is initially undifferentiated. We are now to consider what this developing configuration may be supposed to look like when the disks representing the members of the population are differentiated so as to show their respective momentary employment statuses. We shall think of this differentiation as being done by color: a transparent disk representing a person who is not at the moment a member of the labor force; a green disk if the represented person is an employed member at that time; and a red disk if the person is an unemployed member.

If one can bring himself to suppose that these three categories–nonmember, employed member, and unemployed member–can be well enough defined so that census enumerators would be adequately instructed upon how to classify the real people constituting the nation's population at any moment, he may at least imagine having at hand the requisite data for constructing a model sequence showing what this component of the economy πt will have looked like in fact, developing as it actually did develop during some selected period of time.

The sense in which a norm is said to exist

In continuing with our effort to identify the things to be described, and the suppositions required for the intelligibility of the talk about those things, we shall keep before us the quotation cited earlier as Knight's allusion to the fundamental peculiarities of economics as a descriptive science (1947d: 182–3). He there stated the problem – which I shall take to be that of specifying those idealized states of things to which such names as full employment, price stability, equitable income distribution, and the like are given–to be an intellectual but not scientific one. I think these two terms do not express clearly the contrast that he intended to place emphasis upon. He indicated his usage of scientific by observing that “medicine itself is ‘scientific’ only to the extent that men agree on the meaning of health and disease,” that “in this field, the degree of agreement which is practically requisite may be taken for granted,” but that “in ‘social medicine,’ the case is distinctly to the contrary,” that “the main problem” facing persons jointly responsible for “realizing social health is that of defining it” – that is, of agreeing upon a description of it-but that it is to misconstrue the facts of the situation for one to regard a legislative discussion of what a “healthy state of things”

Introduction

There is a standard model of economic behavior, the Arrow-Debreu general equilibrium model of perfect competition. While this model may not be entirely adequate as a description of economic reality, it is most useful as a standard of comparison. For in equilibrium in this model, subject to the careful qualifications of Pareto optimality, peoples' lives are as pleasurable as they possibly can be, given their tastes and productive capabilities. Consequently, to understand why peoples' lives are not as pleasurable as they might be (in the Pareto sense), it is necessary only to know why the real world fails to correspond to the Arrow-Debreu Utopia.

In the real world, contrary to the assumptions of Arrow and Debreu, information is neither complete nor costless. On the contrary, given the cost of information and the need for it, people typically make predictions about the behavior of the economy and the behavior of individuals based upon a limited number of easily observable characteristics. We say that such a prediction is based upon an indicator; an econometrician would call it a prediction using the method of instrumental variables. This paper shows the distortions caused to examples of the A-D (Arrow-Debreu) model by the introduction of indicators.

There are two types of examples of the use of indicators in the models that follow. One sort of indicator owes its existence to the potentially useful economic information provided.

Introduction

In a study of social relations among workers at a utility company in the eastern United States, George Homans [1953, 1954] observed that a small group of young women (doing a job called “cash posting”) exceeded the minimum work standards of the firm by a significant margin (i.e., on average by 15 percent). Most of these women neither desired nor expected promotion in the firm in return for their troubles. Why did they do it?

Section II shows that the standard neoclassical model cannot simultaneously explain both the behavior of the firm and the behavior of the cash posters. But, as shown in Section III, application of a standard sociological model does explain the behavior of both the young women and their employer. According to this model, in their interaction workers acquire sentiment for each other and also for the firm. As a consequence of sentiment for the firm, the workers acquire utility for an exchange of “gifts” with the firm – the amount of utility depending upon the so-called “norms” of gift exchange.

When people go through experiences, frequently their loyalties, or their values, change. I call these value-changing experiences “loyalty filters.” This paper considers the case where these values are partially, but not totally, changeable. In addition, persons, by having a choice over their experiences, can exercise some choice over their values; or perhaps more typically, persons may choose for their children experiences that will lead them to have desired values. Insofar as this occurs, values are not fixed, as in standard economics, but are a matter of choice. Economic theory, which is largely a theory of choice, then becomes a useful tool in analyzing how these values are chosen. Most persons attempt to choose values for their children (and perhaps also for themselves) according to their economic opportunities that allow them to get along economically. According to Robert Coles' Children of Crisis, not only the wealthy (who will be discussed at some length in Section II), but also the poorest of the poor – immigrants, sharecroppers, and mountaineers – consciously teach their children values aimed at leading them best to survive economically.

The Wealth of Nations concerned itself with the issue of how the economy would behave if everyone were to behave selfishly. Adam Smith's famous answer to this question in terms of the invisible hand is the key result in economic theory.

An introductory statement of the descriptive task undertaken

For a general introduction to the chapters of this Part II, I refer the reader to Sections 1.4 and 1.5; and with this reference, I shall proceed to the work at hand.

We have interpreted certain of Professor Schultz's remarks, recorded in Exhibit A at the end of the preceding chapter, as an invitation that his audience raise to mind a visualization of an economy developing over a time span of some five years while fully employed and in a state of price stability. Whatever this specialist advisor may have consciously had in mind, we shall take this as a request that the idealized states of these two aspects of the economy be tentatively specified and depicted–states of things that choosers of the law can be brought by rational discourse to agree upon as states not reasonably reacted adversely to. And it shall be our task to try to find sensible steps that practitioners of our science might tentatively take toward constructing what we shall call standard forms that depict such norms. To describe what a population or process of events looks like in fact as it develops over time is a straightforward problem with which anyone is familiar. To describe what those factual features of it are that are conveying to responsible choosers of the law a sense of dubious performance of a currently operating economic system is a somewhat more involved problem. To describe what those features of it would look like were they such as would not induce a rationally arrived at sense of disapprobation is yet more involved.

What free means, as in free society, and the descriptive problems entailed

Apropos of our starting place in Chapter 1 – Adam Smith's characterization of economics as “the science of the legislator” – and to further relate this with the thought and writings of Knight from whom I think have come the ideas that I am trying to develop, I shall first comment upon two distinctly different meanings of freedom as this author used that word. My intent is to lead up to an expression of the doubt that I have come to feel for the usefulness of such terms as free market system, free enterprise system, laissez-faire – or their supposed contrasts or opposites, planned, mixed, socialist, communist, and the like – as names of alternatives subject to being chosen by or on behalf of a people. Freedom, in the sense of absence of overt constraint, does not now seem to me to be an applicable concept, in that this sense of freedom is not accurately descriptive of what human beings actually experience as freedom and constraint – whereas the actuality of a people's freedom in this other sense does inherently pose the conceptual and descriptive problems of Smith's science.

So far as I understand it, the sense of Knight's usage of the term free society (Knight 1946b: 217), in that usage that is essential to our present inquiry, is in effect the same as the sense of Karl Popper's usage of the term open society (Popper 1971: 173–5). In these contexts, these are the authors' names by which they designate a developed form or “species” of human society.

The advantages of a negative income tax are easy to describe. Such a tax typically gives positive work incentives to even the poorest persons. With some forms of the negative income tax there are no incentives for families to split apart to obtain greater welfare payments. Furthermore, individuals of similar income are treated in similar fashion, and therefore it is fair and also relatively cheap and easy to administer.

In contrast to these advantages of a negative income tax, the advantages of a system of welfare made up of a patchwork of different awards to help various needy groups are less easy to describe and also less well understood. Such a system uses various characteristics, such as age, employment status, female head of household, to identify (in my terminology to “tag”) groups of persons who are on the average needy. These groups are then given special treatment, or, as the economist would view it, they are given a special tax schedule different from the rest of the populace. A system of tagging permits relatively high welfare payments with relatively low marginal rates of taxation, a proposition which will be explained presently and discussed at some length.

It is the aim of this paper to explore the nature of the optimal negative income tax with tagging and to compare this tax with the optimal negative income tax in which all groups are treated alike.

Introduction

There are many social customs whose disobedience under the right circumstances is of pecuniary advantage to the person who disobeys. Furthermore, if the sin of not following a social custom is considered less serious if disobedience is more common, in all likelihood the values responsible for the observance of a social custom are less likely to be passed on from one generation to the next the greater is the disobedience. It might be expected, in consequence, that even in a state of the world in which the beliefs underlying a social custom are universally accepted, some persons with unusual tastes will be attracted by the pecuniary gain from breaking it; this breaking of the social custom will, at least to some extent, undermine the beliefs responsible for its observance; and this undermining of belief will in turn provoke more disobedience, etc. – in such a sequence of increasing disobedience and erosion of belief that in the long run the social custom disappears.

Introduction

Much economic analysis is based on stylized relations between the nature of economic processes and the functions economists use as their tools of analysis. For example, if production processes are duplicable, constant returns to scale production functions are obtained. The student of elementary economics is told that if goods are difficult to substitute, their demand is inelastic; if easy to substitute their demand is elastic. In similar fashion it is the purpose of this paper to categorize the nature of jobs and to show that it has implications for the elasticity of demand for labour with respect to the wage.

We see a job as like a dam site. A dam which underutilizes a dam site, even though productive in the sense that water is usefully stored or electricity is usefully produced, will nevertheless be costly in the sense that the valuable dam site is wasted. Even at zero cost (and hence a benefit/cost ratio of infinity) it may not pay to use a dam which underutilizes the site. We picture jobs and workers in the same way. Jobs are pictured as being like dam sites and workers of different skills as being like the potential dams on the dam site. Workers of sufficiently low skills will not be able to get jobs even at zero wages, not because their output on those jobs is negative, but because they underutilize the jobs themselves.

The object of the inquiry that these chapters report upon is to identify and clarify the basic concepts and suppositions of the subject field in which the primary practice of economists lies; and it is our belief that we have proceeded in this inquiry along a line of thought of F. H. Knight. “It would hardly seem to call for argument,” Knight remarked, “that the methodology of economic theory should be worked out in relation” to the problems that gave rise to it and that sustain an interest in it. “The first fact for emphasis,” he continued, “regarding the relation between economic theory and action … is that the activities for which it … furnish[es] guidance are those of the citizen and statesman, not those of the individual as a wirtschaftender Mensch. Its practical problems are those of social policy. And the first requisite for ‘talking sense’ about social policy is to avoid the nearly universal error of regarding the problem as in any sense closely parallel in form to the scientific-technological problem of using means to realize ends. The social problem, and the only problem which should properly be called social, is that of establishing a social consensus on matters of policy…. The social action which the study of economics has as its function to guide, or at least to illuminate, is essentially that of making ‘rules of the game’ in the shape of law, for economic relationships” (Knight 1956a: 174).

Introduction

This paper relates quality and uncertainty. The existence of goods of many grades poses interesting and important problems for the theory of markets. On the one hand, the interaction of quality differences and uncertainty may explain important institutions of the labor market. On the other hand, this paper presents a struggling attempt to give structure to the statement: “Business in underdeveloped countries is difficult”; in particular, a structure is given for determining the economic costs of dishonesty. Additional applications of the theory include comments on the structure of money markets, on the notion of “insurability,” on the liquidity of durables, and on brand-name goods.

There are many markets in which buyers use some market statistic to judge the quality of prospective purchases. In this case there is incentive for sellers to market poor quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller. As a result there tends to be a reduction in the average quality of goods and also in the size of the market. It should also be perceived that in these markets social and private returns differ, and therefore, in some cases, governmental intervention may increase the welfare of all parties. Or private institutions may arise to take advantage of the potential increases in welfare which can accrue to all parties. By nature, however, these institutions are nonatomistic, and therefore concentrations of power – with ill consequences of their own – can develop.