"If we lived in a State where virtue was profitable, common sense would make us good, and greed would make us saintly. And we’d live like animals or angels in the happy land that needs no heroes. But, since in fact we see that avarice, anger, envy, pride, sloth, lust, and stupidity profit far beyond humility, chastity, fortitude, justice, and thought, and have to choose, to be human at all . . . why, then we must stand fast a little–even at the risk of being heroes”
~ Thomas More in Robert Bolt's play, A Man for All Seasons

"If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary."
~ James Madison, Federalist # 51

"Greed -- for lack of a better word -- is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms -- greed for life, for money, for love, knowledge -- has marked the upward surge of mankind. And greed -- you mark my words -- will not only save Teldar Paper, but that other malfunctioning corporation called the USA."

"Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."
~ Gordon Gecko in the movie Wall Street

"Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."

"The decadent international but individualist capitalism in the hands of which we found ourselves after the war is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn't deliver the goods."

"For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still."
~Economist, J.M. Keynes

"In Italy for 30 years under the Borgias they had warfare, terror, murder, and bloodshed, but they produced Michelangelo, Leonardo da Vinci, and the Renaissance. In Switzerland they had brotherly love - they had 500 years of democracy and peace, and what did that produce? The cuckoo clock."
~Harry Lime in the movie The Third Man

"Virtue is more to be feared than vice, because its excesses are not subject to the regulation of conscience"

"Happiness never lays a finger on its pulse."

"The real and effectual discipline which is exercised over a workman is that of his customers. It is the fear of losing their employment which restrains his frauds and corrects his negligence."
~Adam Smith

Link to Textbook

READINGS: (None required, all strongly recommended)

Paul Krugman / Robin Wells -- ECONOMICS -- Chapter One

Economics has two great, but often forgotten, insights. The first is that virtue will not necessarily lead to happiness. The second is that the public interest -- a.k.a. collective rationality -- is not the simple sum of individual interests -- a.k.a. individual rationality. Conventional Wisdom* would tell you the opposite. Virtue -- acting morally -- will eventually lead to happiness. For example, most people believe that

  • Hard work will be rewarded and laziness will be punished;
  • Saving is responsible and spending is irresponsible;
  • Main Street Good, Wall Street Bad;
  • Capitalism & Democracy not only protect individual freedom, but deliver wealth to the greatest number of people.
  • What's Good for General Motors is good for America

Perhaps the famous short statement of this is Aesop's fable, "The Ant & the Grasshopper" where the virtuous Ant is survives the winter, while the Grasshoper who played all summer perished in the winter cold. Better to be an Ant than a Grasshopper. A shorter way to express this point is the expression that "there is no such thing as a free lunch." The fundamental economic problem is one of unlimited desires and limited resources. Therefore, we must make choices and tradeoffs. Charity and virtue come at a price.

The second insight notes that the whole is not equal to the sum of the parts. There are many things that are "smart for one, dumb for all" or "dumb for one, smart for all." For example, when in a burning building, the smartest thing for each individual is to rush to the exits to escape the fire, but if all do it at the same time, everyone ends up trampling each other trying to get to the door. Similarly, if one person stands up at a sporting event or musical performance, they may get a better view, but if everyone stands up, no one gets a better view. Individual choices have "externalities," so we cannot simply sum up each person's individual interest to determine the public interest.


In ancient times, a good harvest meant a good economy and a good harvest depended on the cooperation of nature to send the right amount of rain, sun, and soil. If the people did not behave morally, god/nature would send drought, plague, pestilence, or make you wander in the desert for 40 years. To appease the gods and restore prosperity, people offered contrition in the form of human or animal sacrifices ("scapegoats"). Happiness depended on good harvests; good harvests depended upon good behavior. This is the logic behind the Chinese "mandate of heaven," the Hindu idea of Karma, and Western notions of "suffering for sins." Most myths, fairytales, and fables all end with the good being rewarded and the bad being punished. If you ever thought that bad luck was coming your way because you were mean to someone, thank your primordial ancestors for your guilt complex.


Ancient philosophy did little better than religion. In Plato's most famous book, The Republic, he has Socrates arguing that a virtuous person can only be found in a virtuous city and virtuous cities had only virtuous people. A just person could not exist in an unjust world, nor an unjust world exist when people acted justly. Aristotle, in his books Eudaimean & Nicomachean Ethics argued that only a virtuous person could be happy. Aristotle also observed that happiness is an activity, not an object. One could "be happy," but one could not "have happiness." Having possessions or money could not make one happy, one must be able to love or be happy first and this depended on being just and virtuous. The Stoics argued virtue and happiness were united, so that even someone wracked with a disease or tortured on the rack could be happy as long as they remained virtuous. Others could take your possessions, but they could not take your virtue. The Epicureans argued that virtue was to avoid pain and pursue pleasure was virtuous; if it made you feel good, it could not be wrong.


A critical break in this line of thinking is the Book of Job. Even if you are not religious, this story is worth reading and knowing because it is among the first "modern" stories. It tries to explain why bad things can happen to good people and why bad things exist in a world that was created by a just, all-knowing, all-powerful god, or, for our purposes, why can bad things happen to good economies.

The story begins with the devil, having travelled the world, plopping down on god's couch in heaven. God asks the devil if he had seen his good servant Job on his journeys. In a modern setting, I visualize this as the devil as some stoner-slacker who comes home after curfew to be confronted by an impatient parent, played by god.

Devil: "I'm home"
God: "Why can't you behave like your older brother, Job?"
Devil: "Dude . . . why you bustin' my cabbage patch? . . . Job only does what you want because you gave him the keys to the Audi, the latest model Blackberry, and tickets to the Warped Tour, not to mention that no-limit credit card. If you took those away I don't think Mr. Goody-Goody Two-Shoes would act so nice."
God: "I don't think so . . ."
Devil: "Wanna put your money where you mouth is?"
God: "Deal"

My homage to the movie Chasing Amy
So god and the devil make a bet. The devil can do anything he wants to Job except kill him and if Job curses god, the devil wins. So the devil afflicts Job with disease and sores, destroys all his flocks and fields, and has lightning strike his mansion killing all his family inside. Act II shows Job as a homeless beggar living off the streets. His remaining friends come to visit him and urge him to repent, thinking like all early people that bad luck resulted form bad behavior. He must have done something really, really, really wrong for god to have sent this much bad luck his way. Job argues that he has nothing for which to apologize.

Act III has Job, unaware of the wager between god and the devil, a little fed up with god and begins to question the divine wisdom and justice. God replies, like many parents do when teenagers think the world is unfair, "I brought you in this world, I can take you out. Who are you to question my judgment?" The story ends with the devil losing the bet and God restoring Job's possessions.

Meanwhile, in Greece, similar stories like Oedipus, Agamemnon, and Medea give rise to the Tragedy ("goat songs") which also try to explain why bad things happen to good/great people. In a famous book titled The Birth of Tragedy, the scholar- philsopher Friedrich Nietzsche -- who plays a major role in creating the modern world we live in -- explains as the combination of the orderly world of Apollo where virtue and happiness are united with the chaotic, irrational world of Dionysius. Meanwhile, Plato writes Euthrypo asking the impertinent question of whether God likes good behavior because it is good, or, is it good behavior because God likes it?


The Middle Ages saw the rise of what is known today as a "moral economy." In bad times, Lords took less from their serfs and vassals, people should receive a "just and fair wage," and it was immoral to lend money with interest ("usury"). The contemporary arguments that criticize Wall Street because they do not produce anything tangible, or fault companies for shipping jobs overseas to exploit workers in the 3rd World and destroy the environment are modern versions of this way of thinking. Economic relationships were embedded in moral and ethical relationships. Virtue and Happiness were again one.

However, beginning with the Renaissance, various thinkers began to doubt this conventional wisdom. Machiavelli famously argued that the "end justifies the means," suggesting that virtue was unimportant as long as the result was good. For example, if everyone in a class received an "A" provided one person received a "F" Machiavelli would say that the collective benefit justified the injustice to a single person. In addition, some have argued that torture is acceptable as long as the information saved lives. Whether one is Machiavellian or not, Machiavelli's point was that virtue and happiness are separable and must be calculated separately. Later, French social critic Bernard de Mandeville wrote a long poem entitled the "Fable of the Bees" that described a hive of selfish and immoral bees who were nonetheless better off because each pursued their own self-interest. When an outsider tries to impose morality on the hive, they soon find themselves in penury. The formula of "privates vices, public virtues" became a common theme of the Enlightenment. Finally, the social contract theorists such as John Locke, Thomas Hobbes, and Jean Jacques Rousseau countered the conventional wisdom supporting the divine right of kings. God appointed the King and so the King's interests were also the public interest which was also the best interest of the King's subjects. The idea of a social contract, where the people could replace an unjust or incompetent king, implied that the public interest and the private interest were not the same.

These ideas matter to economics because until one can distinguish happiness from moral behavior, economic choices are the same as moral choices. Just do what you are told. Similarly, until one can distinguish the public interest from the private interests of individuals, there is no reason why one should not listen to a wise philsopher-king or government planner instead of your own determination.


Adam Smith is often credited as the founder of modern economics and his book, The Wealth of Nations, published in 1776 outlined the main features of the modern world. The Wealth of Nations is a classic -- a book that everyone refers to and few have actually read. Most of the "good stuff" is found in the first few chapters where he identifies the three key elements of modern capitalism: the DIVISION OF LABOR, the "INVISIBLE HAND," and the "LABOR THEORY OF VALUE." It should be noted that there is no reason to associate capitalism with a particular size of government. Capitalism -- and Socialism -- is consistent with both large and small, strong and weak governments. While Smith criticized Mercantilists for equating the national welfare with the balance of trade, Smith provides many instances where regulation is beneficial and necessary to promote economic welfare. However, first we should explain the three legs of the capitalism stool.


Smith argued that most gains in economic productivity were the result of the division of labor. The division of labor is a little like the idea of teamwork. On a team, one player cannot do everything, even if they are the best in every area. Each player has a role and must play that role for the team to suceed. The division of labor is when a job is broken down into many different tasks and each worker specializes in a single task. For example, if the job was to put together a bike, one worker would put on the wheels, another would apply the chain, another would cast the frame, another provides the raw materials, and so on. Each worker improves their skill at their given task. No one loses time changing from one task to another and every one uses the specific technology to accomplish their task (a screwdriver can be used as a hammer, but it is much better used as a screwdriver). Workers organized by a division of labor are much more productive than each would be alone (Economic Insight # 2: The whole is not the sum of the parts).

The advantages of the division of labor can be seen if we compare the modern industrial mode of production with the way things were done previously. Before the Industrial Revolution, most people were independent farmers living in small but self-sufficient villages. They not only grew their own food, but they also made their own clothes, built their own houses, provided their own entertainment, and make their own furniture. While premodern individuals were no doubt more skilled and intelligent than their modern counterparts -- a point made by Jared Diamond in his book Guns, Germs, and Steel -- the reason that modern humans "have more cargo" is that while it is difficult to be a good farmer, cook, carpenter, seamstress and entertainer, it is much more difficult to be proficient at all at the same time.


The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labor." ~ Adam Smith


Even if the division of labor makes us much more productive, we still may produce too much of something we do not want, like pollution and too little of something we do want, like underwear. Don't laugh, in the 1980s, there was a high level economic meeting in the Soviet Union to discuss the production of women's nylon stockings. If too many people make cars and not enough people make food, the consequences could be dire. After the Chinese Great Leap Forward (1950s), 20 to 30 million people died of hunger because farmers were given orders to operate small iron furnances instead of growing food. The Great Leap Forward made China much more productive, but not in the things people wanted or needed in the proper proportion. Additionally, if people can choose what they want to do, what is to prevent too many people becoming doctors and teachers and not enough becoming engineers or nurses?

In the past, most people did not have to worry about these decisions; they just did what they were told. Under the Hindu caste system, you did what your parents did and most other places did the same because of custom and tradition. Under European feudalism, vassals and serfs did what they were commanded to do by their lords. Most societies placed a high moral and ethical value on performing one's given role: Warriors should be Warrirors; Bakers should be Bakers; Farmers should be Farmers -- and these divisions were enforced by dress codes, manners of speaking, and guild restrictions. Pity the Farmer who had the temerity to behave like a Noble and wear purple! While these mechanisms were adequate for simple, agricultural societies, they probably were inadequate for complex, industrial societies.

Adam Smith argued that the organization of economic society was coordinated by a price system, also known as the "Invisible Hand." Individuals did not provide goods and services because they were running a charity operation, or serving a social function, or driven by a moral or ethical code, or they were following orders from a higher authority. They did it because they pursued their own self-interest. The Brewer, Baker, and Butcher did not provide us food because we are hungry, they do so because they want to increase their own wealth. Still, ordinarily, they do not wait for direct orders to produce their goods and services. Cattle Ranchers in Oklahoma do not call New York Restaurants to see how many prime rib steaks they require. They knew what I wanted because of the PRICE SYSTEM. The hungrier I am, the more I am willing to pay for food. This would raise the price of food and food producers would see that signal and produce more. If the price becomes to high for me, I will buy less and the price will go down. No one told me to consume more or less or the the farmers to produce more or less, we were all guided by the "INVISIBLE HAND" that guided all of us in the path to serve the common welfare.


It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest . . . they intend only their own gain, and they are in this, as in many other cases, led by an invisible hand to promote an end which was no part of their intention. Nor is it always the worse for the society that it was no part of it. By pursuing their own interest they frequently promote that of the society more effectually than when they really intend to promote it." ~ Adam Smith

To have reliable prices, you need markets, where our "natural propensity to truck, barter, and trade" allows us to make mutually beneficial exchanges. In addition, because we bear the full costs and benefits of producing and consuming different goods and services, we will all make better decisions about how to use our limited resources to satisfy some of our unlimited desires. (Economics Insight # 1: There is no such thing as a free lunch)

The third element of Adam Smith's concept of capitalism is the LABOR THEORY OF VALUE. In short, Smith argued that the value of any item was equal to the amount of work that went into producing it. For example, the value of wood is not its intrinsic usefulness; it has no value until a person chops down the tree and carries it to market. The labor, measured in time, determines how valuable the good or service is. If one wanted to know the relative value of two items, one simply had to compare and take the ratio of labor taken to produce the two items. For example, if an ounce of gold took 40 hours to mine while a bushel of corn took only 1 hour to harvest, then one ounce of gold could purchase 40 bushels of corn. For Smith, and most early economists, the value of an item was grounded in its objective inputs. If one worker was more productive than another, they were entitled to higher wages. Now, this did not mean that everyone's time was worth equal amounts and not everyone produced tangible commodities (think teachers, inventors, doctors, etc.). Part of the cost of producing an item is the time invested in training and education that presumably made you more productive. In this manner, Smith's thinking was entirely conventional for a Scot of the late 18th century. John Locke (although not a Scot) had written about the creation of property resulting from the admixture of human labor with natural resources, hence the role of the government to protect "life, liberty, and property." *However, Smith had a problem. Writing in 1776, it was all too clear that many individuals did not have control over their own labor. Slavery still existed in most Western European countries and their colonies in the Americas. In Eastern Europe, quasi-serfdom still existed in Russia. As a result, it was common for the original advocates of capitalism to also be strident abolitionists. Perhaps the greatest example of this was the support of the laborers in the textile mills in Manchester and Liverpool, England for the Union during the Ameican Civil War. They were adversely affected by the cotton embargo of the South, but they also realized that workers could not be free anywhere unless slavery was abolished everywhere. In addition, many, since Karl Marx first presented this interpretation, have looked at the American Civil War as a conflict between the industrial, capitalist North and the agricultural, semi-feudal South and not about slavery, union, etc. that is common discussed in American history textbooks. *The LABOR THEORY OF VALUE is usually contrasted with MARKET THEORIES and "ADDING-UP" theories of economic value. In market theories, prices (and therefore value) are set by the "Laws of Supply and Demand" where equilibrium prices are set at the intersection of the supply and demand curves. Alternatively, equilibrium prices are set where the marginal cost equals the marginal product. However, at the time of Adam Smith, marginal analysis and the use of supply and demand curves is still a century in the future. The "adding-up" theory argued that an item's value equaled the relative shares of the three major factors of production: land (a.k.a. natural resources), labor, and capital (machines, technology & money). Add up all the inputs and you have the price the composite product should cost. There are problems with this idea: just because an item took more raw materials, more labor, greater investment and craftmanship (as many students have learned by doing homework) does not mean empirically or normatively that their compensation will be commensurate.*The other key implication of the labor theory of value is the need for property rights. Individuals must have control over their labor for them to deploy it well. Therefore, there must exist a political and legal system that clearly defines the rights and obligations of individuals (rental contracts, wage agreements, titles, leases, etc.) otherwise, the productive exchange and use of the factors of production will be impossible. This position has been most forcefully argued recently by Peruvian economist, Hernando de Soto in his book, The Mystery of Capital. De Soto argues that the main difference between the developed and the developing world is the presence or absence of property rights. *The video below, taken from the 1949 movie The Treasure of the Sierra Madre, illustrates the LABOR THEORY OF VALUE with respect to the price of gold. Gold, argues the old prospector is not valuable because it is useful or scarce. It is valuable because of all the labor-power invested into digging up from the earth.

While Machiavelli, Mandeville, Adam Smith and others criticized the equivalence of virtue with happiness, their main point was that virtue did not imply happiness. Good ends could come from bad means. There is no necessary relationship between being a good person and being a happy (or wealthy) one. This was not a case for vice. None of them insisted on being greedy or dishonest or violent; they only noted that certain means were not taboo and that they needed to be justified by what they accomplished. However, the early classical economists of the early 19th century England began to make the case that vice was virtuous and behaviors and decisions that would normally be beyond the pale were not only acceptable, but praiseworthy. This analysis all derived from the idea that there is "no such thing as a free lunch." If you did something charitable, like give a hungry person a meal, you were taking food away from someone else because the cost was borne by someone else in the economy. If you gave one student a grade better than their performance or abilities you were harming some other student who should have received that mark. A full analysis of these ideas can be found in Karl Polanyi's excellent work The Great Transformation, especially "Chapter 9: Pauperism and Utopia" and "Chapter 10: Political Economy and the Discovery of Society."

external image malthus0.jpgThe first of the these classic economists was Thomas Malthus, who wrote his Essay on Population in 1798. Since we will cover Malthus in detail later, a few words here will suffice. Malthus observed that resources (i.e., food) grew arithmetically, while population grows geometrically (exponentially, think bunnies). Eventually, we would overshoot the earth's capacity to provide our sustenance. Malthus had noticed that while England had, due to the Industrial Revolution, quickly became the richest nation in the world was also witnessing widespread penury. At the time, there were generous poor laws that provided food and shelter for the unemployed. Malthus argued that this policy was mistaken. If individuals could not provide for themselves, they should not receive assistance from others or the government. This food was only coming from someone else's table. Plus, it would invite "moral hazard," i.e. if you give someone food for free, they have no incentive to work for their own food. This would lead to less food being produced, more mouths to feed -- a sure recipe for environmental degradation and disaster. All modern environmentalists from Paul Ehrlich to Donella Meadows owe Malthus a great deal of their view to his analysis. Anyone who uses the word "sustainability" conjures the ghost of Malthus. Ultimately, our unlimited desires would run afoul of our limited resources. Therefore, we must be willing to be heartless now to save countless millions later.


Another classical economist was David Ricardo, who took many of Adam Smith's insights and expressed them in mathematical terms, examined the problem of trade and specialization. At the time, England placed high tariffs, called the "Corn Laws," on foreign food because the powerful English nobles owned most of the land and stood to benefit from forcing English workers to buy food grown on their large estates (think of Irish peasants subsisting on potatoes leading to the Great Irish Famine). Politicians called upon Englishmen to "Buy British" and not buy cheaply produced French and American grain. This lead to high food costs and high wages to pay for basic necessities. This is similar to current policies that urge use to "Buy American" and not cheaply made Chinese goods, however, the best current example are the high Japanese tariffs on imported rice. A 5 lb. bag of rice in Japan can cost $50 to $60, while it costs less than $5 in the US. Japanese politicians claim that the Japanese have "unique" stomachs that cannot digest foreign grown rice. Above and beyond these claims, these policies protect domestic workers and most people would rather protect the jobs of their countrymen than foreigners. However, Ricardo argued that countries should not keep out foreign goods. If the English could buy cheap foreign grain they would have more money to spend on other things made by English industries. This may be bad for the landed English nobility, but it would be good for England. The video below gives a brief overview of Ricardo's ideas.