The great Austrian economist and political philosopher, Friedrich von Hayek, published The Road to Serfdom in 1944, arguing against socialism, planning and collectivism, and in favour of individual liberty, the market system and capitalism.
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Much later, on the eve of the collapse of Communism in Eastern Europe, in 1988, he published The Fatal Conceit, which expands and builds upon arguments he had been articulating for a half-century. (This latter work was edited by philosopher William Warren Bartley, and there is a scholarly dispute as to whether he was more author than editor, with Hayek already ailing at that time.)
The title of the latter work comes from a celebrated passage in The Theory of Moral Sentiments (1759) by Scottish economist and political philosopher Adam Smith, better known for his classic The Wealth of Nations (1776).
This passage by Adam Smith is so rich, and so prescient, that it deserves to be quoted in full:
“The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.“
Smith offers us nothing less than a critique of ‘scientific socialism’, a doctrine that was to emerge almost two centuries later. This theory asserts that a benevolent government may achieve the social good, or, at any rate, socially desirable ends, through planning and directing a society and its citizens by means of legislation, rules, regulations and administrative fiat.
India was to experience a version of this under the licence-permit-quota raj that was at the core of Nehruvian socialism and the country’s five-year plans, and most Western countries experienced a version of it in the form of the post-war turn toward Keynesian business cycle management and government regulation to rein in competitive market forces.
Smith’s critique identifies the essence of the fatal conceit of central planning: the “man of system” treats human beings as chess pieces, that may be moved at will by the hands of the chess master, and that they have no behavioural impulse or response of their own.
This contradicts the fundamental tenet of economics, that human beings purposefully choose their own actions to achieve their own ends, and therefore, their behaviour responds to incentives and disincentives (whether emanating from the market or otherwise) and, critically in this case, responds to the incentive/disincentive structure created by government planning itself.
As applied to economic policy, this insight goes by several names: the ‘Lucas critique’ in macroeconomics, named after Nobel economist Robert Lucas; and the ‘offsetting principle’ in microeconomics, coined by economist Sam Peltzman—both economists from the University of Chicago.
Put simply, human beings will react to government policy aiming to shape their behaviour, and this reaction will often serve to negate or offset the intended aim of that policy. Government intervention in the economy is, therefore, often self-defeating, precisely because human beings are not pawns on a chess board, but react purposefully to such intervention, exactly as Smith understood almost 300 years ago.
The doctrine of scientific socialism may have been thrown on the ash heap of history when communism collapsed in Eastern Europe and the former Soviet Union, but it lives on in its progeny, which are the various forms of technocracy that have taken root and flowered in recent years, especially this past year after the outbreak of the covid pandemic.
The contemporary incarnation of the fatal conceit is exemplified by the idea of lockdown, which aims to curb the propagation of viral infection through “stay at home” orders, the closing of public places, curfews, restrictions on public and private gatherings, and the barring or imposition of severe restrictions on the operation of private businesses.
Epidemiologists who argue in favour of lockdowns as a cure for the spread of covid commit a version of the fallacy that Hume identified—their “agent-based” models typically do not incorporate the public’s behavioural response, which may involve working around lockdowns rather that adhering to them. Likewise, mandating mask use may create a false sense of security and encourage other risky behaviours—exactly as in Peltzman’s famous work, which showed that mandating seat belts in automobiles could induce rash driving, thus offsetting the policy’s intended effect.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.