The second kind of existential test can be likened rather to that of researching and writing a dissertation—longer, more drawn out, with less immediate drama but presenting in many ways a more thorough and searching examination. The consequences of failure, however, can often be just as severe, even if they take longer to arrive. This second test is that of managing taxation and public finance. As writers through the ages have recognized, failure at this can ruin a polity as surely as defeat in war.

What, though, is the nature of the test, and in what sense do ruling groups fail it? Historically, ruling groups draw incomes (“rents” in the economists’ language) from the groups they control. They do this through various means, including taxes, fines, fees, tariffs, tolls, the selling of privileges and exemptions, and even outright expropriation. In return they typically provide services, most notably defense against irregular predators, a means of settling disputes, and a range of what are commonly described as “public goods,” which can cover anything from public works and infrastructure to education. Ultimately all these services have to be funded out of the revenues the rulers can gain. It is true that a shortfall can be met by borrowing, but the money lent is secured against future income and so doing this is simply a way of spending income now in anticipation of its arrival in the future.

The failure of rulers to handle this can take two forms. The simplest is when the level of taxation and other exactions is simply too high and discourages productive labor to such a degree that wealth is destroyed rather than created. If taken too far, this can actually destroy the basis for the rulers’ position. Just as a parasite that kills its host is a biological failure, so ruling classes that destroy their own productive base are clearly political failures. The more insidious failure, however, arrives when ruling groups spend more money than they take in and fund it through debt. This can go on for a long time, even indefinitely, provided the underlying economy is productive and dynamic enough and the spending is not too high. The evidence of history is that it cannot go on forever. Sooner or later a crunch will come, and the way the ruling group responds determines whether it passes or fails the test.

In 1783 the Treaty to Paris brought an end to a worldwide conflict. For Americans this was the American Revolution, when the colonies gained their independence from the British Empire. From a world perspective, however, this was only the latest round in a struggle for global leadership between Britain and France that could be traced back to the 1690s. Just as in previous episodes, the war had been financed mainly through the issuing of debt, which was added to the accumulated obligations of earlier conflicts. By 1783 the public finances of both France and Britain were in a desperate state. In many ways the British finances were in worse shape than those of the French: In 1784 total British debt amounted to 156 percent of GDP, comparable to French levels but with an economy not as large as that of France and so less able to support such a burden. However, the next six years saw the British elite address this problem. Their French counterparts did not and failed the test.

Diverging Paths

In Britain the new prime minister, William Pitt the Younger, brought the public finances under control through what was known as “economical reform.” This was a combination of extensive tax increases and major cuts in government spending, most significantly through the abolition of a large number of useless government jobs or sinecures. This had significant political implications because access to these posts was a major form of patronage and central to the political system of the time. Even so, the cuts were made.

In France the new minister of finance, Charles Alexandre de Calonne, did not address the state of the French public finances in the same way, at least not initially. Instead he floated a series of loans to bridge the gap between income and expenditure. Despite its greater wealth, the French crown had to pay twice the interest rate of the British State, because its creditors (the so-called “financiers”) had less confidence in its capacity to repay the debt and its willingness and ability to do what was necessary. Eventually Calonne proposed a series of reforms including tax increases (in particular taxes on the aristocracy and clergy), major cuts in government spending, and a move to internal free trade in France. To overcome opposition, in 1787 he persuaded the king to summon an Assembly of Notables. However, the elites opposed both the tax increases and spending cuts, and he was dismissed. The publicizing of the desperate state of the finances and the accelerating loss of confidence in France’s rulers by their creditors meant the difficulties of the crown became even more acute until, in 1789, the king in desperation called a meeting of the Estates General for the first time in over 150 years to try to break the deadlock. What followed is, as they say, history.

Contemporary America

Contemporary Americans should look back at these events with increasing nervousness. As in Britain and France in 1783, the public finances are in a parlous state. The gap between revenue and expenditure has never been wider and is even worse than the headline figures suggest when the unfunded liabilities of Medicare and Social Security are taken into account. For a long time now the American political class has been funding expenditure through borrowing, depending ultimately on the confidence of their creditors and the underlying productivity of the American people. If this confidence should waver (and there are many signs of this) the cost of this borrowing is bound to rise. If the spending and liabilities exceed the capacity of even the most heroic future productive labor by American citizens (as they clearly do) then something has to give.

Ultimately it is clear that either spending must be cut or taxes and imposts increased or some combination of the two. Just as in France, however, this depends on the willingness of both elites and ordinary people to do what is necessary. That in turn depends on a broad agreement as to the proper role and size of government. In the absence of such an agreement, just as in France in 1787, tough decisions will be ducked and matters will go from bad to worse. Arguments about taxes and the deficit are thus proxies for a deeper debate.

In her latest work, Bourgeois Dignity: Why Economics Can’t Explain the Modern World, Deirdre McCloskey argues that the critical factor was a change in how productive activities such as trade were regarded. Instead of being seen as menial, morally disreputable, and lacking in honor, they came to be regarded as respectable, dignified, and above all virtuous. This gave trade, merchants, and manufacturers (those who worked with their hands) the crucial respect formerly given only to aristocrats, priests, and even peasants. I think McCloskey gives too much weight to this explanation, but the phenomenon she identifies was undoubtedly real and important.

McCloskey identifies the Dutch Republic as the place where the cultural shift started in the early seventeenth century. In the European case this is undoubtedly true. However it was not unique. Another later but independent shift was even more self-conscious and deliberate. It happened in one of the most fascinating of premodern societies, Tokugawa Japan. (McCloskey discusses the striking similarities between Europe and Japan at this time).

From 1467 to roughly 1570 Japan went through what became known as the Sengoku, or “warring states,” period of its history. The central authority was weak to nonexistent and warfare was almost constant. Between 1568 and 1603 there was the Momoyama, or unification, period in which Japan was unified by several astute leaders. The last of these, Tokugawa Ieyasu, defeated his rivals at the Battle of Sekigahara in 1600 and established the Tokugawa Shogunate, which would rule Japan until 1868. Tokugawa Japan was simultaneously deeply conservative and yet dynamic. The Tokugawa Shoguns, particularly after the 1630s, banned almost all contact with the outside world (the losing side at Sekigahara had generally favored greater links). Internally they sought to encourage and enforce a strict conservatism. One aspect of this was a firm insistence on traditional social hierarchies of esteem and status: emperor, shogun, daimyo, samurai, peasant, artisan, merchant. In general the countryside was seen as morally superior to the city. Another aspect was a revival of interest in Confucianism, particularly by the samurai, with development of an elaborate moral code and philosophy known as bushido—the way of the warrior.

The other side of Tokugawa Japan, however, was rapid economic development. Population grew swiftly after the 1690s, and this went along with dramatic urbanization: By the late eighteenth century the capital Edo (now Tokyo) and other centers such as Osaka and Kyoto were among the largest cities on the planet. There was also a great growth of internal trade and manufacture, as well as some trade with the outside world via a small colony of Dutch merchants on an artificial island in Nagasaki harbor. This also went along with interesting cultural developments. The merchant class in Japan did not simply concern themselves with business and physical pleasure, accepting their lowly status, as is often supposed. Instead they also explored Confucian and other ideas. In doing so they developed their own philosophy and culture, that of chonindo—the way of the townsfolk.

The essence of chonindo was developed and articulated by a series of thinkers from the later seventeenth century onward in the mercantile centers of Japan and particularly in Osaka. (Osaka had been the center of the Toyotomi clan, the rivals of the Tokugawa and the losing side at Sekigahara).

The crucial event in many ways was the founding of the Kaitokudo academy in Osaka in 1726 by Miyake Sekian and Nakai Shuan. This was a private educational institution, funded by the great merchant and trading houses of Osaka, for the exploration of Confucian ideals and in particular the establishment of the connection between productive work, trade, and virtue. The founders and teachers of the Kaitokudo argued that hard work, skill, craftsmanship, and physical labor were virtuous and forms of human excellence. More dramatically, given the traditional hostility toward it in much Confucian thought, they argued that profit was itself virtuous and that its pursuit was not only compatible with a moral life but moral in itself. The deeper argument was that there was no contradiction between the traditional virtues of restraint, loyalty, honor, and magnanimity and the life of labor and commerce. Instead all these virtues were both necessary for success in that kind of life and embodied in the successful living of such a life. What was wrong was dishonest and predatory behavior in any way of life.

Another aspect of the urban life of Tokugawa Japan that had a close relationship to all this was the notion of the “floating world” as represented in the artistic genre of Ukiyo-E, the well-known woodblock prints of urban life. In its physical sense the “floating world” referred to the pleasure and entertainment sectors of the new cities of Japan. As such it is often thought of as a cult of hedonism and something opposed to both bushido and chonindo. Sometimes this was true but more often there was a connection between the ideals of the floating world and those of chonindo. The common element was the belief, also found in Enlightenment Europe, that this physical world was good, not cursed, and that physical pleasure and well-being were admirable and worth seeking rather than barriers to virtue. The connection with chonindo was through the idea that in fact greater comfort and physical pleasures encouraged virtue (while discouraging predatory or vindictive behavior) and were the outcome of following the virtues of the merchant or townsman.

We may think that today the arguments of people like Adam Smith in Europe or the teachers of the Kaitokudo in Japan are unimportant because they are so obviously true and uncontroversial. Nothing could be further from the truth. Rather they are now as unfashionable and deprecated as when those Japanese merchants got together and set up their academy in Osaka almost 200 years ago. Because they faced such a hostile culture they were in many ways more explicit and systematic in their arguments than their European counterparts were. (Arguably they also had a more congenial intellectual tradition to work with in many ways). Today too many of the arguments for a free economy and society are made on the basis of efficiency. Such arguments may be true but they butter no parsnips when faced with a moral rejection of the idea of profit and commerce. The argument that a free economy is a moral economy is one that needs to be made and won more than ever.

We should read people like Ito Jinsai, Nishikawa Joken, Miyake Sekian, Nakai Shuan, Tominaga Nakamoto, Goi Ranju, Nakai Chikuzan, Nakai Riken, Kusama Naokata, and Yamagata Banto as much as we do Adam Smith, David Hume, Lord Kames, and Milton Friedman.

In this context a key technique and one of the most important foundations of the modern State is the map. The apparently neutral art of cartography is actually one of the main sources of modern political power. The most important aspect of this is the cadastral map or survey. Unlike a topographical map, it does not simply record the natural features of the terrain. It also captures, in a radically simplified and systematized form, a huge amount of knowledge of such matters as ownership, rights and entitlements, values, social relations, and obligations.

Cadastral Surveys

Maps and surveys of this kind were found to some degree in the ancient world but they disappeared with much else of the governing power of the great empires of antiquity during the sixth and seventh centuries. Such maps began to reappear during the late Renaissance, initially in Italy, latterly in the Netherlands, Germany, France, and the United Kingdom.

Before the creation of a cadastral survey this knowledge existed in the form of dispersed and tacit knowledge, scattered among many people and only accessible to those in a locality and then only partially. In this situation many kinds of action by rulers, particularly taxation but also control and regulation of the physical environment and people’s use of the land, were difficult or even impossible.

Cadastral surveys do not capture all this dispersed knowledge or even the greater part of it. They do, however, capture a significant part in a way that makes it simplified, standardized, and systematically organized or structured. This enormously increases the ability of rulers to act on society and control or direct human interactions, and so in turn to have great influence on the outcome of those interactions, whether intentionally or unintentionally. This point is explored by James C. Scott in his work Seeing Like a State.

The history of the United States shows this last point clearly. One of the first things undertaken by the government of the newly established republic in 1785 was a cadastral survey of the Northwest territories, which was subsequently expanded to all of the territory of the United States apart from the original colonies. This was the Public Lands Survey System, which has become a model for similar systems in many parts of the world. The initial idea was to use this capacity to create a society of independent freeholders. However, it has been used both consciously and unintentionally to very different ends.

The very act of capturing information in this way and the power it gave to rulers to direct and control the use of the land by private individuals and corporations meant that decisions made by the political class now had a huge influence on the course of settlement and development. All kinds of possibilities were excluded while others could be encouraged or directed. Thus the decision to divide the land surveyed into regular rectangular blocks produced a particular kind of urban settlement and development that would not have occurred had the dispersed local knowledge worked through informal institutions and private agreement. A whole range of government functions, in particular the control and regulation of much economic activity, is only possible because of the information captured in the maps and surveys.

Scott indicates that maps of this kind, by capturing a simplified version of the tacit knowledge of the local population, enable remote outsiders to have at least some knowledge of what the situation is on the ground (literally). This opens up a range of otherwise unavailable options for them. For example, it makes possible large-scale urban planning and redevelopment of the kind that became common in the United States after World War II. Instead of the spontaneous urban development described by Jane Jacobs, we have had the large-scale planned reconstruction advocated by her arch-nemesis Robert Moses. As Scott points out, this technique has also made possible catastrophic social “experiments” such as Soviet collectivization of agriculture and the Tanzanian “Ujaama” system of land reform.

Maps and surveys of this kind are not the only techniques that have aided the transformation of government, of course. Another, equally important, is the kind of accurate decennial census established in 1790 in the United States. Census-taking has a long history (as most of us will gather from reading the Gospels), but again it became much more systematic, extensive, and important from the early modern period on. Today a lot of what government does depends on the accuracy and completeness of the census, which is why taking part in it is enforced by such stringent penalties.

Limits of Knowledge

However, this also shows the ultimate limits of such techniques and the modern State that is based on them. Governments around the world today face increasing problems of noncompliance with and resistance to the census. Even if these difficulties can be overcome, there is an even more basic problem that affects maps and surveys even more. Although a cadastral survey is a powerful way of capturing and distilling tacit knowledge, it is inevitably imperfect. Much of the local, dispersed knowledge is never captured. What is captured is radically simplified and much of the subtlety and nuance are lost. This does not matter so much if the government activity is relatively simple. However, complex activities will simply not work.

In other words, although modern techniques give rulers and elites enormous powers that their predecessors did not have, they are still limited in what they can do effectively by the nature of knowledge and the limits of the tools and techniques at their disposal. Today large organizations—private ones, too, but above all government—are operating at or beyond the limits of their capacity in terms of what their foundational techniques will allow them to do effectively. This is one of the main reasons many programs and agencies are seen to be simply not working, and it is also why so many politicians and officials experience not power but frustration. Time to simplify and take a more modest view of what things like maps make possible in the modern world.

Moreover, the ferment and vitality of Scots society at this time was not confined to purely intellectual pursuits. The same period also saw a flourishing of the arts and literature, in areas such as painting (Allan Ramsay), architecture (Robert Adam), poetry (Robert Burns), and prose fiction (Tobias Smollet and later James Hogg). It was also the society that produced figures such as James Watt and Thomas Macadam, who contributed to advances in technology and engineering.

Most dramatic however was the economic transformation of Scotland into one of the most dynamic and prosperous parts of Europe. By the end of the eighteenth century Scotland was at the forefront of the nascent Industrial Revolution.

None of this would have been predicted by anyone who looked at the condition of Scotland at the end of the seventeenth century. It was poor and backward, with an agricultural sector that had not joined in the innovations pioneered by the Dutch and adopted south of the border. There had been a series of armed rebellions and civil wars between 1637 and 1690 that had brought loss of life and large-scale emigration (both forced and voluntary) in their wake. In the 1690s famine and harvest failure carried off at least an eighth of the population. Most dramatically, in the same decade most of the nation’s liquid capital had been squandered on the Darien Scheme, a foolish idea to plant a Scottish colony on the isthmus of Panama.

Scottish Miracle

Given this kind of starting point, the subsequent flourishing and transformation of Scottish society becomes even more remarkable. Indeed it was partly awareness of this dramatic metamorphosis that inspired the investigations of Smith and his contemporaries. Can the Scottish Enlightenment be explained or must we write it off as one of history’s mysteries? Certainly there is something ultimately mysterious about brilliant intellectual efflorescences in a particular place, but we can cast some light on the Scottish case.

The key was the union of Scotland and England in 1707—but not in the way commonly supposed. The Union, as intended, benefited Scotland by giving her merchants access to the larger markets of England and her colonies. The unintended consequences had the most profound effect, however, and this tells us something about the origins of episodes of intellectual and cultural flourishing.

The Scottish side entered the Union, which was brought about by political maneuvering and bribery, with no great enthusiasm. The collapse of the Darien Scheme forced its hand. The English side was driven by pure calculation of high politics, in particular the possibility of Scotland refusing to go along with the English Parliament’s decision that on the death of Queen Anne the crown would pass from the House of Stuart to that of Hanover—raising the prospect of the Scots sticking with the Stuarts and so dissolving the union of the crowns of the two kingdoms and maybe even restoring the “Auld Alliance” of France and Scotland.

The motives for the Union meant the English government had no real interest in Scottish affairs other than to check the continued support there for the exiled Stuarts. Given the relative size of the two countries, the merger of their Parliaments effectively abolished the Scottish Parliament. Because of the continued strength of Jacobitism and peculiar features of Scottish electoral law, elections from Scotland to the Westminster Parliament were deeply corrupt, involved a small (and shrinking) electorate, and were controlled by the Whig oligarchy that ruled Britain from 1715 onward. So political careers were no longer possible in Edinburgh.

Moreover, in 1708 the government of the new United Kingdom did something as significant as abolishing the Scottish Parliament. For essentially short-term and trivial reasons the government also abolished the Scottish Privy Council, the center and main instrument of executive government in Scotland for several hundred years. Meanwhile the distinct Scottish legal system survived, as it does to this day.

Salutary Neglect

The result of all this was that eighteenth-century Scotland, just like the contemporaneous American colonies, experienced “salutary neglect.” The imperial government in Westminster did not legislate affairs north of the border in any detail. What was left was an increasingly efficient and honest legal system together with the Church of Scotland and a system of local government that was much less active than its counterpart in England.

Decreasing Political Domination

All this had a number of effects that contributed to the sudden dynamism and innovativeness of Scottish society. Talented and ambitious people now looked for other outlets for their energy besides politics and government. In short, they were left to their own devices to sort out their problems and explore their opportunities in a system of law without having to contend with an active political power. Intellectual life was less and less dominated by the political (and religious, since the two were so connected) disputes that had dominated it in the previous century.

At the same time Scotland, like the rest of the world at that time, experienced sustained population growth because of the gradual improvement of the planet’s climate and the impact of new crops such as the potato. This led to innovation in the context of a society no longer dominated culturally by the values and outlook of a ruling warrior aristocracy—indeed the aristocracy (including the Jacobite ones) now turned increasingly to innovation and “improvement.”

The transformation of Scotland in the eighteenth century and the intellectual flowering that it led to was in part the outcome of an unintended experiment: the removal of much of politics and government from Scotland by the Act of Union and its aftermath. We can conclude that in any society, even the most apparently unpromising, there is an enormous reserve of talent, ingenuity, and insight that can find expression when law and property are stable and government keeps out of the way.

Even a brief look at the contemporary media or political debates—or conversations with acquaintances—quickly reveals how much this understanding is needed. Put simply, the level of ignorance of basic economic insights is staggering. Elementary fallacies such as the “broken window” argument pop up regularly and are apparently widely shared.

All of this has obvious and damaging effects on public debate and ultimately on public policy. To the extent that policy and debate actually reflect widespread misunderstanding of economic principles, among both the general public and the opinion-forming elite, they will be misguided—at best futile, at worst damaging and counterproductive. When results are disappointing, the reasons will not be understood and the frequent response will be to push even further down the wrong route and to reinforce failure.

One view is that ’twas always thus. According to this school of thought, the evidence we have from social surveys and mass observation is that the economic way of thinking is counterintuitive and difficult for the majority to grasp. Some argue that this reflects how we are hardwired as a species to think about the world in certain ways that in turn predispose us to look at economic matters in a particular fashion. So we see only intended results and ignore unintended ones, underestimate the benefits of trade and are wary of strangers, see the costs of change more readily than the benefits, and so forth. If these perspectives are widely held, then a democratic system that reflects popular predilections will always tend in an economically harmful direction.

It Wasn’t Always Thus

However, the evidence of history suggests that this condition is not predetermined or inevitable. Even if there is some kind of biological predisposition, it is not so strong that it cannot be overcome by education and propaganda (in the original, good sense of the word). The record also suggests that this is true for intellectual and political elites as well as the general public. The evidence for this is the history of the early nineteenth century in both Britain and France, as well as the United States, when economic ideas were widely understood and were a major part of popular culture and public discussion.

The works of Smith, Malthus, Ricardo, and Nassau Senior were all widely read and discussed. In France, Say’s 1803 Treatise of Political Economy was one of the best-selling books of its time. The works of their popularizers made their ideas accessible to the mass of the public.

An early example of this in England was Jane Marcet (1769–1858), who published a successful introduction to economics (particularly Say and Ricardo) in her 1824 Conversations on Political Economy. Even more prominently, the great classical-liberal feminist and pioneer sociologist Harriet Martineau (1802–1876) published a series of short stories that illustrated and explained economic principles, collected as Illustrations of Political Economy (1831). Sold in a low-cost format, these were the best sellers of the time. Martineau followed up with further series on such topics as reform of the Poor Law, which was equally successful. Later in life she wrote regular editorials for the Daily News, a popular paper, many of which were concerned with economic exposition and argument. John Stuart Mill also combined the roles of economic thinker and popular expositor. His Political Economy was a popular as well as intellectual success.

Educated Public, Educated Policy

All this had a significant effect on public opinion as reflected in popular culture and entertainment, letters to the press, and voting patterns. On issues such as free trade, government regulation, the Poor Law, and government finance, there was a clear movement toward support for economically sensible policy, limited government, and sound money. Thus demands for the repeal of the income tax, for stringent reductions in government spending, and for complete free exchange (which meant general laissez faire and not just free trade) became a staple of British radical working-class politics and liberal politics generally, as reflected in the policy of Gladstone as both chancellor and prime minister. Moreover, these attitudes and the underlying understanding persisted. When a campaign began to restore protection in the early1900s, the response was a popular countermovement that culminated in the landslide victory of the Liberals on a free-trade platform in 1906.

Of course there were also plenty of rejoinders and hostile responses to this successful spreading of economic ideas. The two most prominent exponents of this reaction were Thomas Carlyle and John Ruskin. It was Carlyle who coined the phrase “the dismal science” to describe economics—on grounds that economic thinking led to support for the abolition of West Indian slavery, an institution he supported. He and Ruskin did not put forward a form of economics of their own. Rather, they attacked economic reasoning as such. In this they were more clear-sighted and intellectually honest than many contemporary authors.

How It Was Lost

So if we compare the situation for much of the twentieth century and today with what went before, we have to ask, “What happened?” There are many explanations of why economic reasoning fell out of favor, such as the rise of mass media. Three seem particularly pertinent, however. First, from about the 1890s onward economics became increasingly mathematical and, as such, abstruse and inaccessible for many people. At the same time it was affected by the general movement of intellectual life into the academy, with its associated specialization.

A second factor was the movement to make economics into a value-free social science. It lost its earlier connection to political and social philosophy and its moral element, which had been one of its main features. Arguments about efficiency are simply less moving than ones that combine this with a moral perspective (as Martineau’s work did, for example). Finally, functioning as both cause and effect was a general shift of public discourse to a position that denied constraints, one based on the passionate conviction that everyone could have his cake and eat it too—as a right. Since a central insight of economics is the necessity of tradeoffs, economic argument found itself at odds with this sentiment and found fewer receptive listeners.

Recently, though, there are the first faint signs that economics is once again becoming a part of wider culture. There is the success of a new generation of popularizers, including Russ Roberts, who has followed the example of Martineau in using the fictional mode. This can only be a good thing, and we must try to ensure that politics and public discourse, from all points on the ideological compass, once again become economically aware.

Today professional sports is an important business and a major social phenomenon. It is a staple of casual conversation, a topic that most people have opinions about (even if only that they hate it), and a large part of both television and print media. The Super Bowl is America’s most-watched television program, and the World Cup and Olympic Games attract a truly worldwide audience. There are many kinds of organized competitive sports, with no fewer than seven widely played kinds of football, for example. Most of these have formal governing bodies and elaborate rules both for playing and for settling disputes. There is even a sporting “world court,” the Court of Arbitration for Sport in Lausanne. Typically sports have a complex technical language, which is often impenetrable to someone not familiar with the game in question–as generations of Englishmen have discovered when trying to explain cricket to baffled Europeans and Americans.

This vast array of practices, institutions, and rules is generally taken for granted: Few ever ask how it came about. The story, however, is fascinating. While there certainly was purposeful action, and many rules and institutions were consciously created, organized sports are not cases of straightforward, “top down” planning.

Take football. In the Middle Ages most parts of Europe had a game that was usually called “football”; it was played on major feast days such as Shrovetide. Typically there were no limits on the number of players on either side or on what could be done with the ball; the aim was to get the ball over an agreed line. The events were often extremely violent and were closer to what we would regard as a melee or riot rather than a sporting event. Sometimes variants had more precise rules, such as Calcio Fiorentino in Florence. Generally speaking each locality or small region had its own variant, and there was no code of rules applied over a wide area.

Then a crucial innovation occurred in England. From the later sixteenth century on, schools began to play a more organized form of the game with specific numbers of people on each side and more elaborate rules. These initially evolved informally, on a case-by-case basis, but eventually were codified and written down. Thus in 1845 the famous Rugby school had three of its pupils codify the rules of the variety of football played there. Typically in the eighteenth and early nineteenth centuries each school would have its own set of rules. During this time, however, two other things began to happen. First, more and more sporting clubs formed to play varieties of football on a regular basis outside of academic institutions. These were purely free associations. Again, each one would typically have its own agreed set of rules.

Second, when the turnpikes and railroad lowered the cost of transport, games were arranged between different schools and clubs. But each side had its own rules. Games could have been played according to one of the sets of the rules, but this was unsatisfactory for more than occasional games. So quite spontaneously, on a local and ad hoc basis, two solutions appeared. The first was for all teams involved to agree to use the rules of an outside club or school. Thus the rules produced by the Rugby school were widely adopted, leading to the appearance of “Rugby football.”

The second solution was for a number of teams to get together and voluntarily agree to a common set of rules in what we might call a “sporting contract.” This happened in the case of “Association football” (hence “soccer”).

Next came competition among rules (“codes”). The more teams that agreed to adopt a particular set of rules, the more incentive there was for others to do so because it increased the range and number of possible competitors. On the other hand, since the precise content of any set of rules would produce a particular kind of game, some preferred one set over the others. So some school- or club-based rules became widely adopted while others never caught on. At the same time, the variation among different codes led to increased differentiation and eventually the clear emergence of several distinct kinds of football.

The next stage of the evolution was the formation of national or (in the United States) regional leagues in which clubs would agree to play each other in organized competition. This in turn led to the appearance of a permanent organization both to run the competition and to define and enforce the common rules. Subsequently international regulatory bodies were set up, such as FIFA in 1904. All of these were created not by governments but by free association among the sporting clubs or associations that agreed to be governed by the body they had established.

Racket Games, Too

The same kind of story could be told for other sports, including racket games, hockey in both its major forms, and cricket. The development of each shares some noteworthy features: It was spontaneous, unplanned, and bottom-up, with large, complex organizations produced by free association and agreement–and with a secession option. There was competition among different rule systems. In many cases a key role was played by particular entrepreneurial individuals or organizations. Thus the distinctive American form of football came about largely because of the innovations made by the Yale football coach Walter Karp. Innovation in the rules of the games, their organizational structure, and the tactics employed within those rules have remained a constant feature. One of the most striking phenomena is the way that rule changes can have dramatic and unexpected effects. Thus, the introduction of the forward pass in American football in 1906 led to a radical change in the nature of the sport, which was not anticipated or intended when it was introduced.

Sport is a major part of many people’s lives today all over the world and a significant social phenomenon. It is perhaps the biggest simple example of social order based on and produced by free spontaneous processes. Is it any wonder that, generally speaking, modern sport is far better run than the political order?

Take the standard account of the Great Depression and the New Deal. In many ways the New Deal itself was one result of another historical myth: the widely received account of what had happened to the German economy in the first half of the twentieth century, particularly during World War I and the Third Reich. That myth probably did more harm than almost any other in that century.

In the case of the Third Reich, the widely held perception even now is that whatever else may be said about his regime, Hitler managed to bring about a dramatic revival of the German economy. After 1933 Hitler and his finance minister Hjalmar Schacht stabilized the economy and managed to solve the huge unemployment crisis that had destroyed the Weimar Republic’s legitimacy. This was partly due to Schacht’s imaginative monetary policy and partly to massive public works programs, such as the autobahnen. There was a sharp move away from free markets to a much more interventionist economy that worked better than what had gone before. During World War II this economy was able to achieve great success in terms of war production, notably under Hitler’s armaments minister, Albert Speer.

Obviously there is some truth in this account, or else it would not be credible. There was indeed a sharp move in the direction of a more state-controlled economy. In fact few people realize just how interventionist—even socialist—the policies of the Nazi state were (although the full name of the party should give some indication of this). However, the picture overall is mostly wrong. Adam Tooze conclusively debunked this account in his masterful work, The Wages of Destruction: The Making and Breaking of the Nazi Economy. Tooze shows that the public works programs had little effect on unemployment and wasted resources; that the 1930s saw constant financial and foreign-exchange crises for the Reich; that by 1939 the condition of the German economy was desperate and that this was in fact a major factor in Hitler’s increasingly aggressive policy; that the supposed success of Speer simply did not happen; and that overall the regime was so crippled by its economic incompetence that it is nothing short of a miracle that it had as much military success as it did.

Fortunately, while Nazi Germany’s economic policy and its supposed success had some influence in the 1930s (not least among some New Dealers), it had none after 1945. However, an earlier episode in German economic history had much greater consequences and influence—both entirely malign. When war broke out in July 1914 the German government and High Command planned and hoped for a short and decisive war. Things of course did not work out that way and by the fall of 1916 it was clear that this strategy had failed, while the British blockade grew ever more stringent. In the face of impending defeat, the German Empire’s government was effectively taken over by the military in the person of the army’s quartermaster general (and effective chief of staff) Erich Ludendorf. His thinking and policy were set out in his 1935 work and apologia, Der Totale Krieg (The Total War).

Ludendorf argued, first, that all the human and physical resources of a nation made up its military capacity, or Wehrkraft. To ensure victory and survival in the zero-sum game of nations, all these resources had to be controlled and directed to a single purpose. Who was to do this? The answer for him was simple: Since the goal was victory in conflict, it had to be the military. What this meant in practice was a form of planned economy in which all economic activity was directed by the general staff through a series of planning boards and detailed regulations and targets.

The main point was to remove the profit motive—Ludendorf never tired of ranting against unpatriotic profit seekers and selfish individualists—and replace it with structured command relations. In one sense the aim was to transform the entire economy and society into an army, with the typical command-and-control structure of the modern military. In another sense the goal was to turn German industry into one giant corporation by a process of planning and cartelization. One important aspect of the regime created by Ludendorf, just as for Nazi Germany, was a close alliance between the military, the political and bureaucratic classes, and the managerial elite of large corporations, or at least some of them.

Ludendorf’s policy was a disaster. Production actually declined or was wasted, and the financial methods led to severe inflation, which of course became even worse after the war. The policy also led to increasing resistance from the population, as his ever-more-furious outbursts revealed. Eventually the increasingly desperate situation led to the gamble of the huge spring offensive of 1918. Its failure meant the war was definitively lost.

However, the policy of Germany after 1916 was not seen at the time or for long after as the enormous mistake that it was, even from the High Command’s point of view. Instead it was thought to have been a huge success. Strangely this view became even more widespread after 1918—not least among the victorious powers. A myth took hold: that the organization of the economy under Ludendorf was a model for other nations in peacetime.

This belief had disastrous consequences. It certainly did in Germany itself since it provided much of the basis for the economic policies of the Third Reich, as well as providing yet another justification for slave labor and the systematic plunder of subject populations. In milder form this received view had a major impact in both Great Britain and the United States during the interwar years.

However, its most significant effect was felt in the east. When the Bolsheviks came to power in 1917 they had no real idea of what socialism would look like. Their initial effort, so-called war communism, proved utterly catastrophic and was reversed with the introduction of the New Economic Policy in 1921. What followed was a huge debate as to what kind of model to adopt. The “center” argument that eventually triumphed under Stalin was to adopt the supposedly successful model of the World War I German war economy. So the Soviet economy was in many ways the product of a mistaken idea about Germany’s war economy and how it had worked.

Misunderstandings of what is actually happening in economic affairs do not only have immediate consequences. When they shape the politicians’ and public’s view of history, their effects can be immense, sometimes comically, but more often tragically.

In a large park in the heart of the Indian city of Jamshedpur, however, stands an exception to this story: a statue of and public memorial to Jamsetji Tata. Jamsetji Tata was truly a hero and indeed the founder of what we may call a dynasty of heroic figures who have played a major part in the history of modern India and, increasingly, the world. Born into a Parsee family in 1839–when Britain still ruled India–young Tata came to live in Bombay (now Mumbai) when his family moved there and set up in the cotton trade. He worked in the firm and established trading links to Hong Kong and east Asia. In the 1860s the firm went bankrupt due to the disruption caused by the American Civil War. However, he refounded the company and went into manufacturing, setting up a large cotton mill at Nagpur.

Early Liberal and Visionary

As a successful businessman by the end of the 1870s, he became involved in public life in India and was associated with the early classical liberal elements of Indian nationalism as represented by people such as Dadabhai Naoroji and Pherozshah Mehta. He also came to have four great goals or visions. These were to build a truly world-class hotel in Bombay, to create a top educational institution, to set up hydroelectric power in India, and to create a profitable domestic steel industry. He devoted the rest of his life to realizing these, with the help of his cousin Ratanji Tata and his sons–particularly the elder, Dorabji.

In 1903 he opened the Taj Mahal hotel in Bombay, built at a cost of $250,000. In 1901 he and Dorabji hired American technical experts to search for sources of iron ore and coking coal in a suitable location for building a steelworks. The search began seriously in 1904 but Jamsetji died while visiting Germany that May. Dorabji carried on the search and in 1907 discovered an ideal site and a virtual hill of iron ore at the village of Sakchi, about 150 miles west of Calcutta. The Tata Iron and Steel Company was incorporated that year. Unable to raise capital on the London market but undaunted, Dorabji and Ratanji returned to India and raised what was needed by subscription from more than 8,000 domestic investors. The first steel ingots rolled out of the new plant in 1912. Meanwhile another of Jamsetji’s goals had been realized with the formation of the Tata Power Company in 1911 to provide the required power. The firm also had to construct its own railroad, locomotive, and railroad-engineering works.

Following this the Tata firms continued to grow and develop, although they only survived the 1930s economic slump because Dorabji and other family members pledged their entire wealth as security. Dorabji died in 1932. In 1938 Ratanji’s son J. R. D. Tata stepped in to run the firm. He would remain chairman until 1991. He was the first qualified Indian pilot and a pioneer of aviation. He founded India’s first airline in 1932. It became Air India in 1946 before being nationalized by the Nehru government in 1953. When J. R. D. took over, the Tata group contained 14 companies. It had grown to 95 by the time he retired, with expansion into areas such as chemicals, automobiles, and tea. In 1945 he realized the last of Jamsetji’s goals by creating the Tata Institute of Fundamental Research, now one of India’s leading universities. Unlike many of his contemporaries, who became hugely wealthy by exploiting the so-called “permit-raj”–the nightmare of regulations and permits created by the Nehru administration–J. R. D. refused to give bribes to politicians or use the black market. He insisted instead on high ethical standards, first-class performance and customer service, and concern for the welfare of employees.

Real Heroes of Indian Independence

The Tata group, now headed by J. R. D. Tata’s son Ratan Tata, is of course still very much with us. Tata Steel is now the world’s sixth largest steel company, while Tata Power is the largest private electric power producer in India. In fiscal year 2009 the group grossed $72.5 billion and it continues to expand and innovate. Thus in 1998 it launched Westside, a major retail chain, and in the same year launched the Nano, a car priced at just $2,200. The village of Sakchi, which became the site of the original steelworks, is now a small part of the city of Jamshedpur, which has a population of over one million. The company built the entire city from scratch and still runs it. Unlike other major Indian cities, it has reliable supplies of electricity and potable water. Politicians have moved to set up a municipality but have met resistance from the local population, which values the honesty and efficiency of the current administration. Jamshedpur is perhaps one of the largest examples in the world of the provision of a huge range of “public goods” by a private entity. Among other things, it is a model for environmental protection, despite still being the home to a huge steelworks and many other massive manufacturing plants.

In a sane world this family would receive the kind of kudos that scholars give to politicians and soldiers. The objection of course is that these are mere businessmen (and businesswomen–Simone Tata is the head of Westside, for example). In fact the stories of Jamsetji, Dorabji, and J. R. D. Tata show the qualities of classical virtue, which we traditionally associate with heroism. They had a vision that they pursued and realized in the face of seemingly insuperable difficulties, obstacles, and setbacks. They achieved their vision not through the use of force or fraud or by compelling people by threats, but by open, free exchange and agreement. It was done and continues to be done by providing products and services of high quality that people buy voluntarily. Throughout, there has been an emphasis on honesty and high standards.

Jonathan Swift famously observed that the man who made two blades of wheat grow where but one grew before did more for humanity than the entire tribe of philosophers and politicians. Who has done more for India over the last hundred years? The Tata family shows that we should never forget that commerce and business at their best are virtuous activities more worthy of respect than many kinds of activity that get far more attention.

It would seem that thinking of this kind has a deep appeal to human beings, that we may even be hardwired by evolution to be attracted to it. Seemingly the idea of a future that is somehow knowable and determinable eases anxiety and makes the world seem safer and tamer. (This also explains the persisting appeal of conspiracy-based theories of history and current affairs. Apparently many people would rather believe that the world is run by incredibly cunning and evil people than admit that no one is “in charge.”)

No One Knows

The claim to be able to predict or direct the future is wrong, and to the extent we believe it, we will do incredibly dangerous things. In some ways we can make predictions about what will happen—if we couldn’t, life would simply be impossible. Thus on the basis of what has happened already, we can predict fairly confidently that the sun will rise in the east tomorrow. We can be almost as confident that the Chicago Cubs will not win the World Series—or can we? The problem with the second kind of prediction is that it works on the basis of past regularities or statistical aggregates involving human interaction. Most of the time these predictions pan out, but not always.

One major problem is unforeseen and (more importantly) unforeseeable events, which completely change what can reasonably be anticipated and make nonsense of what looked like sound expectations. Another problem is that people will change their behavior on the basis of what they confidently expect to happen. Sometimes this makes the anticipated event even more likely, but occasionally it has the opposite effect and confounds all the confident prognostications. In reality, while we can guess at bits of it and have reasonable expectations in some areas, the human future is ultimately radically unknowable merely on the basis of past experience, on both a micro and a macro level.

It is also true that all of us seek to influence the course of future events. Simply by living and acting we have an influence to some degree. This, however, is largely not a matter of definite purpose on our part. We influence the future in ways we do not anticipate or intend. Beyond that we often consciously try by acting in certain ways to make particular outcomes more likely and others less so. In other words, we make plans assuming that our actions will have the results we anticipate and desire. Sometimes things work out, but often they do not. The more elaborate and longer-term the plans, the greater the likelihood that things will not work out as expected. This applies to both individual and collective action.

All of this has an obvious bearing on economic thinking and on what we can reasonably expect from public policy. Essentially, we should have modest and humble expectations of what it can achieve. We should be prepared to accept that most policies will fail; that is, they will not bring about their anticipated outcomes. We should also expect that in many cases public policy will have consequences that were not only unforeseen by those advocating them, but could not have been foreseen—even by critics.

Above all, this means that the idea of using political power to plan or guide the course of events is ultimately a fantasy, one that can only end in disappointment. Sometimes government policies will work out the way they were intended to, but more often something will derail them or they will produce unexpected and often unwelcome results. This is of course one of the central arguments made against government planning by the Austrian school of economists, most notably Mises and Hayek. The solution for them is to use the outcome of the interactions of individuals in markets and other social institutions to generate signals, such as prices, that correct errors and provide some degree of guidance as to what course of action one should follow to achieve a desired result. One of the most important aspects of this process is insurance, essentially a series of transactions (bets, effectively) that provide a rough guide to the chances of certain undesirable events happening.

The Austrian analysis, moreover, does not only apply to government. It also applies to private institutions. Thus much of the planning by large private firms or churches or charities fails in the same way that government planning does. It is less dangerous or apparent because firms and other private organizations, while organized on a nonmarket basis internally, are embedded in a wider system of market relations that swiftly reveal when plans are not working out. Therefore they are corrected more swiftly.

However, this self-correcting mechanism can break down. One problem is the one I touched on in a previous column (“The Recurring Crisis,” www.tinyurl.com/de214b): the distorting effects of the government monopoly of money. As money is the medium in which prices are expressed, distortion of its supply will have systemic effects and delay corrections from taking place, making the problems more severe than they need be. This is exacerbated by another phenomenon that is purely private in origin and reflects the human weakness for certainty alluded to earlier. Just like the Romans, our own society has its class of augurs and fortune tellers, but now they appear as economic forecasters and academics. Individuals who take their omens and prophecies seriously will believe that they can know and control the future and act on that basis. This is bad enough, but it’s made worse by another flaw in human psychology: our propensity for crowd manias. The combination of these traits with the government monopoly of money is what has produced a global financial crisis.

In the last ten to fifteen years a curious form of intellectual hubris came to possess the professions of economics and finance. Many participants came to believe that complicated mathematical modeling made it possible to estimate risks so accurately that the future was truly knowable in the sense that any possible outcome was somehow taken account of. The result was a misplaced confidence that led people to make highly risky bets on the basis of an assumed knowledge of the future returns on investment and growth in the value of various classes of assets. When combined with the mistaken monetary policy of the Fed, the result was disaster once things did not work out as expected.

What should we take from this? Mainly that we need to be more humble and aware of the limitations of human knowledge. Above all we should remember that government is no wiser and in many ways less well informed than private actors.

At one time British-owned auto manufacturers were world leaders. In 1952 the merger of Austin and Morris to form the British Motor Corporation (BMC) created the world’s fourth-largest producer of cars. By the 1960s, however, the British auto industry faced growing problems. The main firms had lost an increasing share of the market to foreign-owned competition both at home and abroad. The profitability of many firms was steadily declining. This reflected a number of problems, such as old-fashioned or low-quality products or those, like the iconic Mini, that were triumphs of design but whose production costs made them unprofitable. Also, the management of many firms was both incompetent and hindered by chaotic organization of sales and production. Most seriously, the industry was plagued by bad labor relations, with frequent strikes and disputes and rigid enforcement of job demarcation.

Faced with this, British governments intervened to encourage mergers and the takeover of the failing firms by the remaining successful ones. This led ultimately to almost all the remaining British-owned firms being brought into one firm in 1968 with the creation of British Leyland (BL) via a state-sponsored merger of BMC and Leyland Motor Company. The underlying problems were not addressed, however, and the labor relations and chaotic management in particular became even worse. In the early 1970s the Heath administration gave financial assistance despite having opposed aid to failing firms during the 1970 election. By 1975 British Leyland was insolvent and on the verge of going out of business.

To Nationalize or Not to Nationalize

At this point the British government had a choice. It could allow BL to go bankrupt, with many of its 40 plants closing and the remainder being sold off, or it could act to prevent this. The government decided to take the firm into public ownership. The idea was to invest several billion pounds in the firm, and several hundred million pounds were indeed put in. The taxpayers also took on most of the outstanding debt. This did not stop the losses, however. The firm (with various name changes) continued to decline while soaking up a steady stream of government money. Several parts of the business were sold off, and eventually the core (the old BMC) was sold by the government in 1988. It never made money and finally closed in 2005—during a general election. In other words, the British government (or rather the taxpayers) spent 23 years and a fortune trying to preserve an enterprise that went out of business anyway.

This was a classic case of trying to prevent the inevitable. The parts of the original firm that survived would almost certainly have done so in any event, as they were always profitable and would have found purchasers had BL been allowed to go bankrupt in 1975. Some might argue that at least jobs were preserved—for up to 30 years in some places. This is wrong for two reasons. First, the number of jobs actually preserved for that length of time was quite small because there was a steady loss from 1975 onward as a succession of managements made desperate efforts to keep the ship afloat.

Even more serious were the hidden costs of this bailout. All the money put into BL and its successors was capital that could have been employed profitably, creating work somewhere else. Instead it was simply wasted. The British-owned auto industry was essentially doomed by the mid-1970s. Trying to resist this did nobody any favors in the long run and simply prolonged the agony of re-adjustment to a painful and disruptive change.

Ominous Parallels

The parallels with the current position of the Big Three are not exact, but they are disturbingly close. The firms in question are also run down by a generation or more of bad management decisions, bad investments, and crippling wage, healthcare, and pension costs. It is not that auto manufacturing in America is unviable. Honda, Toyota, and others manufacture very profitably in the United States, just as Nissan does in the UK. There is nothing to suggest that giving the Big Three the massive amounts of money they want will do anything other than delay their demise and create a slow and lingering death rather than a swift one. In fact, so dire is the position of General Motors and Chrysler that even with assistance they are unlikely to survive as long as parts of British Leyland did. Meanwhile, all the money given to these firms will be money that could have been used to more effect elsewhere in the economy.

The U.S. political class is probably aware of this, even if it does not realize it will simply be repeating on a much larger scale what the British government did 30 years ago. They are motivated by two main concerns. The first is economic nationalism—the fear that if these firms and their suppliers go out of business, the United States will be weakened. The answer to this is straightforward, no matter how unpalatable it may be to nationalists: The aim of production is consumption, not national power and prestige. In the longer term policies that weaken productivity (which any diversion of capital will do) will actually reduce the power of the nation-state (if that is your main concern).

The second concern is for the many who would lose their jobs and the communities that would lose most of their employment. This comes down to an argument about whether concerns of this kind (which are serious and important) should be a matter for government action. Even if you think they should be, however, it does not follow that the right course is for Uncle Sam to support these firms financially. The example of Britain shows that the much more effective policy would be to let the firms be wound up and use the money to try to revitalize the local economy of places like Michigan. As people here in England watched the goings-on in Washington and Detroit, there was an overwhelming urge to shout, “Don’t do it!” Sadly, even if the folks in Congress had heard, I doubt they would have followed the advice of history.