Economic Law and Catholic Social Doctrine Part I
Catholic Social Teaching, Culture, Economics — Posted by Thomas Storck on January 19, 2011 6:40 AMSince the beginning of her existence on this earth the Church of Jesus Christ has taught about both faith and morals, that is, about what we are to believe and how we should behave. Under the latter head the Church has taught much about the virtue of justice and has applied that teaching to many specific situations in human affairs. Many of these situations are complex, but that has not prevented the Church from making moral judgments about the rights and the wrongs that are involved. Since the latter half of the nineteenth century the Church has addressed the modern economy of Capitalism, and rendered judgments on many aspects of that economy. The body of these teachings is generally known as Catholic Social Teaching, and it began in an authoritative way with Leo XIII’s 1891 encyclical Rerum Novarum. Since then nearly every pope has added to the corpus of the Church’s social teaching through encyclicals or other documents, as did the Second Vatican Council in its constitution Gaudium et Spes.
Anyone who glances at any of these documents will immediately notice the fact that the various supreme pontiffs make moral judgments about economic relations. Of course one would expect that in documents that deal with right and wrong, justice and injustice. But when we begin to think about these papal teachings, we encounter sooner or later an objection to them. This is the objection offered by economics, that is by the subject or science which studies our economic behavior and purports to enlighten us about it. For this subject, as it is generally taught and studied throughout the world, at bottom does not think that ethical judgments apply to its subject matter any more than they do to chemistry or physics. Economics asserts that its findings are simply descriptive, or positive as they are called, statements about how the world works. Therefore, it is often said, those who have concerns about economic justice or injustice must respect the conclusions of positive economics in their proposals. Although this might seem like a reasonable enough demand, in fact there would seem to be little if any room for inserting judgments about justice or injustice into the assertions of economics, and thus it does seem difficult to reconcile economics as usually taught with Catholic Social Teaching. The latter seems to many economists simply the well-meaning pleas of clerics ignorant about how the economy works and about the inexorable laws which govern it.
However, those who are concerned with ethical economic behavior need not despair, for it is economics that is lacking, not the Church’s teaching. In order to understand this, let us consider first economics as it is usually understood and then how the Church conceives her social teaching to relate to human acts in the economic realm. Lastly we will see if there is any approach to economics that does not pose a conflict with the Church’s social teaching.
Most economics departments in the world teach mainstream or what is called neoclassical economics. This is a tradition of economic thought descending from Adam Smith, who of course took ideas from earlier thinkers, but was among the first to systematize them. Neoclassical economics is largely deductive in its approach. That is, on the basis of certain limited axioms about human nature, it posits general principles from which it then deduces specific applications to economic behavior. The most fundamental of these principles is the law or principle of supply and demand. This is a simple principle but can be applied to a great variety of situations and with great sophistication. In a nutshell, it means that everyone wants to profit from each economic exchange as best he can. We all want to pay as little as we can for what we buy and in turn to sell our products or services for as much as we can. And of course when we speak of selling a service, we include the personal wage labor of employees.
Although everyone wants to obtain the most he can, since others want to pay out as little as they can, there is normally competition among sellers or buyers or both. If I charge more than others want to pay for my product, no one will buy from me. The fact that people want product “x” but do not want to buy it at my price will tempt others to produce the same or a similar product and offer it at a lower price. But if what I sell is in high demand and there are few sellers, then these sellers will usually be able to command a higher price. Now this rough sketch of how a market works is true up to a point. How it is true and how it is not true we will explore later.
This basic notion of supply and demand is the basis for the ubiquitous demand curve that economists employ with so many variations. Let us consider just one example of how this is applied to concrete situations. In the textbook that is one of the citadels of neoclassical economic theory, Paul Samuelson’s and William Nordhaus’s Microeconomics, (2001 ed.), there is a chapter, “How Markets Determine Incomes.” Incomes are said to be merely,
a special case of the theory of prices. Wages are really only the price of labor; rents are similarly the price for using land. Moreover, the prices of factors of production are primarily set by the interaction between supply and demand for different factors – just as the prices of goods are largely determined by the supply and demand for goods. (p. 229)
Different salaries or wages of different types of workers can be explained by means of the principles of supply and demand. Since “the supply of surgeons is severely limited [and] [d]emand for surgery is growing rapidly…surgeons earn $270,000 a year on average.” On the other hand, “fast-food…jobs have no skill or educational requirements and are open to virtually everyone. The supply is highly elastic…. Wages are close to the minimum wage because of the ease of entry into this market, and the average full-time employee makes $12,000 a year.” (p. 236) In fact, a conclusion frequently drawn from this understanding of wage determination is that each worker is paid as much as he possibly can be, since if an employer offered less than the employee was worth (his marginal product), then other employers would be glad to hire him at a higher wage.
Now is there anything wrong with this explanation of the difference in incomes between surgeons and fast-food workers, and by extension for all income disparities always and everywhere? For if Samuelson is right, then the Church’s call for a living wage for every adult worker encounters a serious obstacle. While Samuelson is correct that if you take for granted our present economic arrangements, supply and demand does pretty much explain the difference between incomes of surgeons and fast-food workers, as a general explanation of income or wage differences it is sadly lacking. It is lacking not so much because what it says is wrong, but because what it says is merely a special case, and a case that is largely arbitrary at that. When considering income determination what Samuelson does not address, and indeed has little or no interest in, is the role of power and of institutions, using this latter term in its broadest sense. I will explain what I mean by that below. But first let us consider the question of power.
An easy way to disprove Samuelson’s assertion, it seems to me, is to set forth the case of the extraordinary rise in CEO income in the late 1990s and since. Now if Samuelson is right, their income should be based on the demand for CEOs who can successfully manage a corporation and make it more profitable. CEOs who fail would, on this account, lose their jobs or at least receive reduced incomes. But as a matter of fact, this is often not what happened. Consider these instances. Although Apple Computer’s “shareholders’ return declined by 34 percent” CEO Steve Jobs received $78 million, and although Lucent’s “shareholder return declined by more than 75 percent” Pat Russo was paid $38 million. Even more telling is the case of Disney’s Michael Eisner. Eisner, “after he failed to clear his bonus hurdle two years running, his board lowered the performance bar, and then…he finally cleared it. An Olympian effort worth $5 million.”[i]
So how can this happen? Why would anyone be rewarded for failure? Why do the owners of the corporations, that is, the stockholders, tolerate this?
So why, you may wonder, aren’t investors up in arms over these jaw-dropping retirement giveaways? The answer is that hardly anybody knows about them. The complex details surrounding executive pensions are typically buried deep within a company’s SEC filings, far removed from the salaries, bonuses, and stock options that dominate the headlines.[ii]
These CEO incomes are not the result of market forces, the forces of supply and demand. Instead they are the result of the CEOs’ ability, with the help of their cronies, to take advantage of the complex corporate legal structure. In other words, the corporate insiders have power which they exercise to their own advantage and despite the fact that, according to the supposed laws of economics, such executives would no longer have their jobs.[iii] Admittedly this example is among the more extreme, but it serves to disprove the comfortable assertion that it is markets that determine incomes always and everywhere. Rather, markets are merely one factor that help to determine incomes, and not always even the most important factor.
Above I said that power and institutions are two elements that Samuelson does not take into consideration in his economic theories. Let us consider them further. In fact they are connected, for those with sufficient power will shape the institutions to favor their interests. Now by institutions I mean not only organizations or agencies of various kinds, but a society’s legal system, including its tax structure, the way that its technology has developed, and even its cultural norms, since these last affect all the other types of institutions. How are power and institutions related? In a normal capitalist enterprise, those with capital hire workers to perform a task and pay those workers an agreed wage. The capitalists of course are responsible for paying all other expenses in addition to the wages. But beyond that they get to keep the profits. And those profits can be considerable, much more considerable, in proportion, than the wages paid to the workers. That is why the rich are most often the capitalists. But suppose that a society, via its government or some intermediate body, offered groups of workers easy access to start-up capital so that they could establish their own firms, and subsequently borrow capital from lenders for their needs? In that case, the workers would be the owners and they would keep the profits after the capitalists had received the agreed upon interest payments. Is there anything in the nature of economics preventing such a scenario? No, but for the most part, workers have not commanded enough power to obtain such an arrangement. It is doubtless true that in many cases they have not been interested in such worker-owned companies, but that also is the result, in part at least, of cultural norms. Regardless of this last point, however, it is a false claim that it is in the nature of economics that profits accrue to the Capitalist owners. Rather profits accrue to whoever is the owner, and this can vary considerably depending on the law.
Another instance of how institutions determine economic outcomes may be found in the case of the corporate CEOs discussed above, whose compensation is determined by their boards of directors. But there are many ways that such compensation could be determined. The whole body of stockholders could vote on it, for example, in which case it is unlikely that those who were presiding over failing corporations would receive such generous benefits. Another example of the key role of institutions consists in the limited liability laws governing corporations, by which their stockholders are protected from civil and even more from criminal judgments. Such limited liability laws could be changed, however, and doubtless, if they were, that would have profound effects on how corporations behaved, for then their stockholders would be liable to prison terms based on corporate misdeeds. Similarly, in the United States, government spending on all levels has created a society dependent on the automobile. That money could as easily have gone into mass transit. But automobile and oil companies, and their many subsidiary and supplier firms have had sufficient power, including power to shape cultural norms via advertising, so that our society was willing to put immense sums into road building and related projects and relatively little into mass transit. Even the mass transit systems, such as streetcars and interurbans, that existed in the past were dismantled, in some cases, such as in Los Angeles, deliberately due to automotive industry power.
These examples will be enough, I hope, to show that the simplistic understanding of the workings of supply and demand is false. Certainly the principle of supply and demand is valid, but it always operates within legal and other institutional norms, and it is subject to being manipulated by those with sufficient power or skill to do so. Market forces are not mechanical or chemical laws. They are human acts, and even though there are certain constant tendencies in human behavior, they are filtered through so many other factors that it is difficult to make statements about the economy that will hold true in every case.
In part two of this article, I will consider Catholic Social Teaching and examine whether there are approaches to economics that seem to harmonize better with the Church’s doctrinal approach.
[i]. Peter Carlson, “A Few Blips in the Search for Unsung Life Forms” Washington Post (April 22, 2003) p. C1.
[ii]. Janice Revell, “CEO Pensions: The Latest Way to Hide Millions” Fortune (April 28, 2003) p. 68.
[iii]. At one point Samuelson does address the question of why “some top executives at poorly performing companies have received salaries and bonuses totaling $50 million or more,” and seems to realize that there might be more to income distribution than the automatic workings of the market. He explains that “insiders may vote themselves large salaries, expense accounts, bonuses, and generous retirement pensions at the stockholders’ expense” (p. 192). But Samuelson does not seem to realize that this one counterexample destroys his thesis that it is markets that determine incomes.
Digg It
Bookmark
Stumble
10 Comments
Hilaire Belloc in The Servile State rightly asserts that capitalists, in order to secure and increase their profits, will often (perhaps invariably) find ways to violate the market by implementing the methods you suggest above. When doing so begins to violate the freedoms of workers we are in a developing servile state.
I’ve articulated this to several die-hard, neo-con, capitalist friends and their perpetual response is: “Whenever a person seeks to violate the free market, they cease to be a capitalist.” They thusly shrug off my critique of capitalism and shut the door on distributism.
Do you have any response to this argument? The capitalist belief in “the market” as an infallible thing when left without interference seems to be unassailable but untrue. “The market” can’t exist without humans and humans don’t operate outside of human nature. However, the moment I suggest that fallible human beings are part of the system, they dismiss their errors as being fundamentally outside the system.
It’s like calling yourself a monarchist and defining monarchy as that system in which a perfect man governs perfect men, then asserting that every instance that history calls monarchy was actually tyranny on account of the king’s fallible nature.
Zachary,
If pro-free-marketers refuse to look at how the economy actually operates, it appears to me to be a sign of an opinion held on (irrational) faith, not on reason. Belief in the “logic of the market” is stronger now than ever, it appears. For those whose minds are closed, it’s difficult to reach them. Perhaps one could ask if things such as fraud ever occur or not? If fraud can occur, so can many other things that show how market logic is untrue to reality.
The Steve Jobs example might be a little dated. Apple’s stock has done quite well recently and of course Job claims that he has never been paid more than a dollar a year. He doesn’t mention the jet he recieved (which I believe is the dollar figure you quote) or all of the billion dollars worth of stock he owns. Nevertheless I would argue that apple shareholders are pretty happy with Jobs these days with the success of the ipad and iphone 4.
Mr. Storck, do you actually believe what you wrote about changing limited liability laws so that stockholders could be imprisoned for their company’s wrongdoing? Think about what that would mean if generally applied. (This is aside from the practicality of such a proposal.) You could go to prison if: your city, county, or state government did wrong (assuming no sovereign immunity); your union, professional organization, or, as you might like, your guild did; and possibly even if your church did, as with the priestly abuse scandals. It seems to be very selective reasoning to attribute specifically to Corporate Capitalism what is in fact widespread outside it.
You also, IMO, paint with too broad a brush after you’ve shown how CEO’s and other executives get more than a fully market-based system could justify. That’s true, i think, but are there that many other examples? There are cases of economic rent due to licensing laws, but those are imposed by governments, usually at the behest of professional and trade organizations. Other than those, supply-and-demand does seem to me to explain a great deal. As to whether that is just is a quite different question. The fact that one person is far more skilled than another seems no reason to give the former far more wealth than the latter.
One possibly minor point in conclusion, although it seems quite important to me. You’re right about there being no iron law dictating that workers can’t own a firm if they can only obtain the capital. But why do they need to do that? It would be just as valid a set-up to have the workers own the company while investors were “hired” at set rates of interest. That would be truly a non-capitalist system, as opposed to: State Capitalism (Communism); Absentee Capitalism (our current system); and Worker Capitalism (most Distributist theories).
Viking
Viking,
Thanks for your comments and questions. As to corporations and limited liability laws, if you look at what I wrote, I merely used this as an example of how the legal culture affects economic outcomes and how the laws of economics – so called – operate within that culture. Moreover, I was speaking only of corporations in the business sense, in which the shareholders are legally the owners. If you look at the history of corporate law in the U.S. from the early 19th century you will see that the present favored status of corporations vis-a-vis their legal rights and liabilities, they have usurped a place of extraordinary power, absurdly claiming the rights of persons under the Constitution. I recommend (with a few reservation) a book, Gangs of America on this point. So, yes, I would favor changes in corporate law, though not necessarily the one you mention.
The example of corporate CEOs proves only that the wage mechanism – markets determine wages – is not always true, and thus gives scope for the ethical mandates of the popes that wages must be just. If we can show that wages are not necessarily mechanistically determined, then we have room to look at how to implement wage justice.
Your last point is correct as a theoretical point, but I think very few investors would back an employee-owned company with no track record.
@Mr. Storck
> Perhaps one could ask if things such as fraud ever
> occur or not? If fraud can occur, so can many
> other things that show how market logic is untrue
> to reality.
There are separable ideas here. I’ll address the second first. When you say “so can many other things that show how market logic is untrue reality” you’re complaining that models don’t fully account for human frailty. A model of anything requires simplifying assumptions. I am unwilling to call classical microeconomics models “flawed”; rather they are maps drawn to a crude scale but they don’t say the world is flat.
That said, the most stunning thing I think I have ever witnessed was Alan Greenspan’s public admission that he never DREAMED that an executive team would put its own interests ahead of their companies’ interests. There is a military aphorism “When the map and the terrain disagree, believe the terrain”. Greenspan evidently believed the map.
The biggest disconnect between the fresh-water economists and the salt-water economists has to do with the timeframe they concern themselves with. The fresh-water economists take a (very) long view, the salt-water economists don’t. This brings up the famous quip by the witty salt-water economist John Maynard Keynes:
“This long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”
Keynes sought to prevent the tempest, the Austrians ignored it. When the executive teams put their own interests ahead of their organizations’ interests they were basically arbitraging time. They and their organizations did well in the short run. Compensation design is a hot topic but so long as there is great cronyism on corporate boards I don’t expect an “Austrian” solution.
So here’s a question for Distributists: is an “Austrian Solution” to executive compensation possible? If it is possible, doesn’t the notion of Subsidiarity demand that the Government refrain from involving itself? A wand-waving answer “Well, under Distributism this wouldn’t be a problem because there would be no large scale operations” won’t do. Here is where we are, how shall we get there?
You’ve got your explication of “the laws of supply and demand” backwards. It goes rather like this: if it is true that when trading with one another that people try to get the best deal for themselves, we can model their interaction by combining a model of suppliers’ willingness to sell with another model of buyers’ willingness to buy. This gets the order right.
But I say there is no “law of supply and demand” — this is a made-up term and though polemicists use it all the time, I have never heard an economist use. There really are no “Economic Laws”; they are not “laws” like “laws of physics”. There is nothing humanity can do to change the gravitational constant, but demand curves change all the time, strictly due to human activity and changes in human thought.
> I think very few investors would back an
> employee-owned company with no track record
Investors back people — they’ll back an (experienced) executive team starting up a new company which has (by definition) no track record. But the team has. This is why kids should be trained in business management from a very young age.
@Zachary
“the moment I suggest that fallible human beings are part of the system, they dismiss their errors as being fundamentally outside the system”
It is outside the model. The best reply is to do as Mr. Storck suggests and show that the model is incomplete. There is a branch of microeconomics that tries to deal better with what is called “bounded rationality” and other aspects of human nature: http://en.wikipedia.org/wiki/Behavioral_economics
When you’re dealing with Libertarians (and most Austrian School economists are Libertarians) the trouble you’ve got is that they recognize no duty to anyone else. The less doctrinaire of them say there may be un-contracted moral duties but the state has no business enforcing or even facilitating their performance.
You (and Mr. Storck) might be interested in Public Choice Theory and its sibling Social Choice Theory:
http://en.wikipedia.org/wiki/Public_choice_theory
If we manage to convince our population that CST represents the best foundational principles for judging our industrial organization, we’ll begin to see Public Choices to put this into effect. We certainly can charter corporations differently than we do now. We don’t have to go out of our way to remove any diseconomy of scale. (My favorite example of this is ERISA). Because the USA was founded originally on ideas of Federalism and distributed power, some of this will look politically conservative. But to consider it so is a grave error…
Anyhow, I don’t mean to write a book. What I plead for is “getting it right” and avoiding polemic.
t
Mr. Leith,
Thanks for your thoughtful comments. As to models, you wrote, “A model of anything requires simplifying assumptions. I am unwilling to call classical microeconomics models “flawed”; rather they are maps drawn to a crude scale but they don’t say the world is flat.”
There is a difference, I think, between simplifying something and distorting it. Any scientific – in the widest sense of that word – enterprise must abstract from many particulars, but it need not distort, in the sense of leaving out essential components. I would argue that the economic tradition descending fro Adam Smith does leave out essential factors. In fact, it has wrong starting points in that it constructs the model of the self-regulating market at the outset, and then, perhaps, admits that it doesn’t always work the way it is supposed to. Smith, as I’m sure you know, was more honest about this than are some economists. Cf. his famous remark that merchants never get together but they create some conspiracy against the public good. But if this market model were presented as simply one factor in the economic process, instead of as the sole or central factor, that would fundamentally change the way we approach economics.
Yes, demand curves change all the time, but a particular demand curve is not a law of economics. Rather the fundamental notion underlying any and all demand curves is. I’m not wedded to the term “economic law.” In fact, they’re shorthand for certain constants in human nature, but constants that, as I said, don’t operate in a vacuum.
If you read what Pius XI actually said when he enunciated the principle of subsidiarity, it’s hard to argue that any particular thing is or isn’t always and everywhere explicitly forbidden by him. It’s a principle that needs to be applied in light of Catholic tradition. It is by no means self-explanatory in how it should be applied. If corporations are permitted to operate in all 50 states and no state law can prevent that or effectively regulate them, then it follows that federal law must deal with their behavior. If we returned to the 19th century idea of corporations, chartered for operation within one state for a (perhaps) limited length of time, then state and local law could be allowed to deal with them. It’s not honest for corporations to claim exemption from local and state law and then complain when the federal government tries to regulate them.
Hmmmm.
I see you’re not really taking issue with classical models constructed to explain certain social phenomena, you’re complaining that the notion “self-regulating” is being idealized or exaggerated especially by Libertarians, that the models are being used outside their “designed scope”, and that the “is” is being held up as the “ought”. If there is distortion going on it is here. Do we agree?
Corporations (and everyone else) complain when anyone tries to regulate them, especially when clumsily done. They’re dishonest when they design regulations that don’t really regulate and then tell the public they’re regulated. My favorite economist George Stigler described the problem of Regulatory Capture. Other of my favorite economists (http://bit.ly/igheu0) also study the effect of social institutions on economic development and behavior. It simply isn’t true that economists don’t talk about this stuff, even in undergraduate courses. High School teachers and journalists are another question.
We have a hard row to hoe — liberty is the highest political good for Americans and our economic institutions reflect this to a large extent. We’re saying “no, it isn’t”. Until we reform our thinking we’ll not reform our institutions.
I hope that Solidarism will get a fairer hearing as the last of the Cold Warriors and their kids die off. I know you’re familiar with Pesch ;-)
Mr. Leith,
You said of me that I’m “not really taking issue with classical models constructed to explain certain social phenomena.” Well, I don’t deny that the desire to buy cheap and sell dear has its roots in human nature. But as the fundamental explanation of economic activity, I think it’s wrong. It’s simply one factor.
With reference to your comment that even undergraduate texts deal with the anomalies that I bring up – yes, usually in the later chapters after the grand model has been presented. Often the later chapters are omitted or made optional, if the instructor is pressed for time. In any case, these exceptions are presented as just that: exceptions to the general rule, rather than as more or less constant occurrences.
I think the desire to gain from trade is the fundamental explanation of economic behavior. Whether one hopes to gain social solidarity or material goods or temporal power or eternal bliss doesn’t matter. But we’re not going there. If you think something else is fundamental I’d like to hear what it is and what evidence you’ve got for it.
I don’t know what happens “often” in undergraduate economics courses — what I can tell you is my instructors pointed out every limitation in the assumptions underlying the models as they were introduced and these limitations were not presented as “anomalies” in something that is not quite perfect. Of course, my instructors were better at calculus than I am, and I was an engineering student. They had a real understanding of what they were teaching. Things might not be so good up at the community college.
I’ll tell you one little story: I’d been attending the Friday afternoon seminars in the econ department — there was a talk plus Q & A. Some talks were better than others, and they had different purposes. One kind of talk was called a “job talk” — prospective junior faculty came to impress the senior faculty in hope of joining them. After one of these talks I was pretty confused: I didn’t know what the presenter was talking about and expressed this to Professor Benham. His reply? “Don’t worry Tom, neither did he.” Classic!
I can believe that introductory macroeconomics courses are often bad and that they introduce a model and talk abut “anomalies” later on. I think this is because macroeconomists don’t know what they’re talking about, as has been recently admitted by another of my favorite economists:
http://www.rmm-journal.de/downloads/010_buchanan.pdf
On this much I think we’ll wholeheartedly agree: macroeconomics doesn’t yet rise to the level of a science. And I’m sure you’ll like Buchanan too, if you don’t know him already.
On a little personal note, I’ve read you off and on over the years and have admired a lot of your work, even work published in The Remnant. I can’t tell you how great it is to get to interact with you as an author: my wife can tell you that I yell back at the radio and have been known to stomp around exasperated all night over a book chapter or something that seems loused-up to me. This way I can get it out of my system. ;-)