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Comments on E. Schlicht's on custom in the economy - 1998

American Journal of Economics and Sociology, The, April, 2002 by Mark Blaug

MARK BLAUG *

I find myself so sympathetic to the arguments of this book, and particularly its central thesis, that I find it difficult to offer any critical comments other than: bravo! But let me begin with one or two slightly pedantic remarks. First, I was surprised that the word "trust" is never mentioned in the text and that the concept of trust is never discussed at all. It is true that the twin notions of "obligations" and "entitlements" in contractual relations are frequently mentioned and, of course, they are grounded in reciprocal feelings of trust. Nevertheless, the idea of trust as an integral feature of every economic transaction is the simplest way of demonstrating one of Schlicht's favorite theses, namely, that markets and customary behavior meld together, combine chemically and not mechanically (pp. 276-277), at every stage in every society, whether primitive or advanced.

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Second, Mill's quoted view that economic life is characterized by some combination of custom and competition, and that the effects of the latter may be fruitfully analyzed by abstracting from all influences of the former (pp. 22-23), was bolstered in his day by the prevailing belief that the economic history of the civilized world was a history of the transition from a society based on status to a society based on contract; in Tonnies' famous phrase, it was the transition from gemein-schaft to gesellschaft. In other words, markets had become the dominant mode of economic organization and, therefore, to abstract from the influence of custom was merely to mimic reality itself. Whatever the historical validity of this thesis, it promotes a starved picture of how market exchange actually functions in even the most economically sophisticated societies: I can hardly buy a loaf of bread from my baker without "trusting" his "reputation" for cleanliness, a reputation established by past experience, which by now has be come so "habitual" or "customary" that it is part of my "tacit knowledge" of the art of shopping. Here, as elsewhere in economics, the wrong turning was taken long ago by Adam Smith: he wrote one book about The Theory of Moral Sentiments based on what he called "sympathy" (and what we would now call "empathy") and another book about The Causes of Wealth of Nations, based on "self-interest," without explaining in either book how they were related to each other. He went on to show in The Wealth of Nations (BKI, chap. 6) that the relative prices of beavers and deer in an "early and rude state of society" would be determined entirely by relative labor costs if and only if beaver and deer hunters were free to take up each others' occupations. He failed to point out, however, that they would also have to trust each other because either one of them could do better by stealing the other's catch than by engaging in voluntary exchange.

To the old dichotomy of custom and competition, we have now added "command" as a third principal mode of economic organization, in part because of the influence of Coase's famous 1937 paper on "The Nature of the Firm," an influence, it is worth remarking, that took over 30 years to make itself felt. From this point of view, a firm is a command economy in miniature, an island of authoritarian administration floating in an ocean of market transactions. Adam Smith's famous example of the pin-making factory as a paradigm case of how the specialization of tasks can increase the productivity of labor confused the fundamental difference between the inter-firm and the intra-firm division of labor. The former is coordinated by market competition, but the latter is in fact coordinated by administrative commands. All previous writing on the division of labor, right back to Plato, had always regarded the specialization of tasks among individuals as a prelude to the phenomenon of exchange, and hence the determination of r elative values in competitive markets. This is precisely what Adam Smith proceeded to do after Chapter 3 of Book I of the Wealth of Nations. But in the first three chapters, the discussion of the advantages of the division of labor inside firms is all about what he believed to be the engine of economic growth in a "commercial society." When he does mention "labour-abridging machinery," which most of us would think has much more to do with explaining economic growth than the division if labour, it is as a by-product of the intra-firm specialization of tasks. But that is grossly misleading because virtually all the great mechanical inventions of the Industrial Revolution, and indeed all those that characterize technical progress right down to the modern computer chip, emerged as product innovations by new firms, not as process innovations inside old firms. If we want to understand technical change under capitalism, Schumpeter is a better guide than Adam Smith.

But we have drifted too far from our topic of custom in the economy. The role of custom is intimately associated with the role of norms, conventions, trust, reputation, asymmetric information, explicit and implicit contracts in principal-agency relationships and the like, all of which form a rich soup of ideas lying outside the orthodox conception of competition as a struggle or rivalry between anonymous economic agents. Anonymity, sometimes called "atomicity," is the very hallmark of mainstream theorizing about markets, meaning that the psychological idiosyncrasies of economic transactors and their purely personal relationships are not only ignored but are proudly ignored, lest the dreaded bogey of indeterminacy of equilibrium rear its ugly head. Now, for the purpose of answering some simple questions in comparative statics, atomicity is perfectly justified: for example, Will a tax on butter producers raise the price of butter? Will road pricing reduce road congestion? Will museum charges reduce museum atten dance? et cetera. But for hundreds of other infinitely more important questions, atomicity kills off al the relevant answers before the analysis has even begun. Why are there firms? asked Coase. Because of transaction costs, he replied, which sometimes make it profitable to suppress markets. What are transaction costs? They are the costs of drawing up contacts and of monitoring and policing the implementation of contracts. Now it is true that these costs would exist even if all agents were faceless. But the level and incidence of transaction costs surely depend on who the other party in the contractual relationship is, who is being monitored, and who is doing the policing. In short, atomicity kills off any concern about transaction costs and, since competition without transaction costs have no counterpart in reality, effectively discourages analysis of how real-world competitive markets actually function.

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Comments on E. Schlicht's on custom in the economy - 1998

American Journal of Economics and Sociology, The, April, 2002 by Mark Blaug

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