Posts Tagged 'Ron Batchelder'

Susan Woodward Remembers Armen Alchian

Susan Woodward, a former colleague and co-author of the late great Armen Alchian, was kind enough to share with me an article of hers forthcoming in a special issue of the Journal of Corporate Finance dedicated to Alchian’s memory. I thank Susan and Harold Mulherin, co-editor of the Journal of Corporate Finance for allowing me to post this wonderful tribute to Alchian.

Memories of Armen

Susan Woodward

Sand Hill Econometrics

Armen Alchian approached economics with constructive eccentricity. An aspect became apparent long ago when I taught intermediate price theory, a two-quarter course. Jack Hirshleifer’s new text (Hirshleifer (1976)) was just out and his approach was the foundation of my own training, so that was an obvious choice. But also, Alchian and Allen’s University Economics (Alchian and Allen (1964)) had been usefully separated into parts, of which Exchange and Production: Competition, Coordination, and Control (Alchian and Allen (1977)), the “price theory” part, available in paperback. I used both books.

Somewhere in the second quarter we got to the topic of rent. Rent is such a difficult topic because it’s a word in everyone’s vocabulary but to which economists give a special, second meaning. To prepare a discussion, I looked up “rent” in the index of both texts. In Hirshleifer (1976), it appeared for the first time on some page like 417. In Alchian & Allen (1977), it appeared, say, on page 99, and page 102, and page 188, and pages 87-88, 336-338, and 364-365. It was peppered all through the book.

Hirshleifer approached price theory as geometry. Lay out the axioms, prove the theorems. And never introduce a new idea, especially one like “rent” that collides with standard usage, without a solid foundation. The Alchian approach is more exploratory. “Oh, here’s an idea. Let’s walk around the idea and see what it looks like from all sides. Let’s tip it over and see what’s under it and what kind of noise it makes. Let’s light a fire under it and just see what happens. Drop it ten stories.” The books were complements, not substitutes.

While this textbook story illustrates one aspect of Armen’s thinking, the big epiphanies came working on our joint papers. Unusual for students at UCLA in that era, I didn’t have Armen as a teacher. My first year, Armen was away, and Jack Hirshleifer taught the entire first year price theory. Entranced by the finance segment of that year, the lure of finance in business school was irresistible. But fortune did not abandon me.

I came back to UCLA to teach at the dawn of personal computers. Oh they were feeble! There was a little room on the eighth floor of Bunche Hall where there were three little Compaq computers—the ones with really tiny green-on-black screens. Portable, sort of, but not like a purse. Armen and I were regulars in this word processing cave. Armen would get bored and start a conversation by asking some profound question. I’d flounder a bit and tell him I didn’t know and go back to work. But one day he asked why corporations limit liability. Whew, something to say. It is not a risk story, but about facilitating transferable shares. Limit liability, then shareholders and contracting creditors can price possible recovery, and the wealth and resources of individual shareholder are then irrelevant. When liability tries to reach beyond the firm’s assets to those of individual shareholders, shareholder wealth matters to value, and this creates reasons for inhibiting share transfers. You can limit liability and still address concern about tort creditors by having the firm carrying insurance for torts.

Armen asked “How did you figure this out?” I said, “I don’t know.” “Have you written it down?” “No, it doesn’t seem important enough, it would only be two pages.” “Oh, no, of course it is!” He was right. What I wrote at Armen’s insistence, Woodward (1985), is now in two books of readings on the modern corporation, still in print, still on reading lists, and yes it was more than two pages. The paper by Bargeron and Lehn (2015) in this volume provides empirical confirmation about the impact of limited liability on share transferability. After our conversations about limited liability, Armen never again called me “Joanne,” as in the actress, Joanne Woodward, wife of Paul Newman.

This led to many more discussions about the organization of firms. I was dismayed by the seeming mysticism of “teamwork” as discussed in the old Alchian & Demsetz paper. Does it not all boil down to moral hazard and hold-up, both aspects of information costs, and the potential for the residual claimant to manage these? Armen came to agree and that this, too, was worth writing up. So we started writing. I scribbled down my thoughts. Armen read them and said, “Well, this is right, but it will make Harold (Demsetz) mad. We can’t say it that way. We’ll say it another way.” Armen saw it as his job to bring Harold around.

As we started working on this paper (Alchian and Woodward (1987)), I asked Armen, “What journal should we be thinking of?” Armen said “Oh, don’t worry about that, something will come along”. It went to Rolf Richter’s journal because Armen admired Rolf’s efforts to promote economic analysis of institutions. There are accounts of Armen pulling accepted papers from journals in order to put them into books of readings in honor of his friends, and these stories are true. No journal impressed Armen very much. He thought that if something was good, people would find it and read it.

Soon after the first paper was circulating, Orley Ashenfelter asked Armen to write a book review of Oliver Williamson’s The Economic Institutions of Capitalism (such a brilliant title!). I got enlisted for that project too (Alchian and Woodward (1988)). Armen began writing, but I went back to reread Institutions of Capitalism. Armen gave me what he had written, and I was baffled. “Armen, this stuff isn’t in Williamson.” He asked, “Well, did he get it wrong?” I said, “No, it’s not that he got it wrong. These issues just aren’t there at all. You attribute these ideas to him, but they really come from our other paper.” And he said “Oh, well, don’t worry about that. Some historian will sort it out later. It’s a good place to promote these ideas, and they’ll get the right story eventually.” So, dear reader, now you know.

This from someone who spent his life discussing the efficiencies of private property and property rights—to basically give ideas away in order to promote them? It was a good lesson. I was just starting my ten years in the federal government. In academia, thinkers try to establish property rights in ideas. “This is mine. I thought of this. You must cite me.” In government this is not a winning strategy. Instead, you need plant an idea, then convince others that it’s their idea so they will help you.

And it was sometimes Armen’s strategy in the academic world too. Only someone who was very confident would do this. Or someone who just cared more about promoting ideas he thought were right than he cared about getting credit for them. Or someone who did not have so much respect for the refereeing process. He was so cavalier!

Armen had no use for formal models that did not teach us to look somewhere new in the known world, nor had he any patience for findings that relied on fancy econometrics. What was Armen’s idea of econometrics? Merton Miller told me. We were chatting about limited liability. Merton asked about evidence. Well, all public firms with transferable shares now have limited liability. But in private, closely-held firms, loans nearly always explicitly specify which of the owner’s personal assets are pledged against bank loans. “How do you know?” “From conversations with bankers.” Merton said said, “Ah, this sounds like UCLA econometrics! You go to Armen Alchian and you ask, ‘Armen, is this number about right?’ And Armen says, ‘Yeah, that sounds right.’ So you use that number.”

Why is Armen loved so much? It’s not just his contributions to our understanding because many great thinkers are hardly loved at all. Several things stand out. As noted above, Armen’s sense of what is important is very appealing. Ideas are important. Ideas are more important than being important. Don’t fuss over the small stuff or the small-minded stuff, just work on the ideas and get them right. Armen worked at inhibiting inefficient behavior, but never in an obvious way. He would be the first to agree that not all competition is efficient, and in particular that status competition is inefficient. Lunches and dinners with Armen never included conversations about who was getting tenure where or why various papers got in or did not get in to certain journals. He thought it just did not matter very much or deserve much attention.

Armen was intensely curious about the world and interested in things outside of himself. He was one of the least self-indulgent people that I have ever met. It cheered everybody up. Everyone was in a better mood for the often silly questions that Armen would ask about everything, such as, “Why do they use decorations in the sushi bar and not anywhere else? Is there some optimality story here?” Armen recognized his own limitations and was not afraid of them.

Armen’s views on inefficient behavior came out in an interesting way when we were working on the Williamson book review. What does the word “fair” mean? In the early 1970’s at UCLA, no one was very comfortable with “fair”. Many would even have said ‘fair’ has no meaning in economics. But then we got to pondering the car repair person in the desert (remember Los Angeles is next to a big desert), who is in a position to hold up unlucky motorists whose vehicles break down in a remote place. Why would the mechanic not hold up the motorist and charge a high price? The mechanic has the power. Information about occasional holdups would provoke inefficient avoidance of travel or taking ridiculous precautions. But from the individual perspective, why wouldn’t the mechanic engage in opportunistic behavior, on the spot? “Well,” Armen said, “probably he doesn’t do it because he was raised right.” Armen knew what “fair” meant, and was willing to take a stand on it being efficient.

For all his reputation as a conservative, Armen was very interested in Earl Thompson’s ideas about socially efficient institutions, and the useful constraints that collective action could and does impose on us. (see, for example, Thompson (1968, 1974).) He had more patience for Earl that any of Earl’s other senior colleagues except possibly Jim Buchanan. Earl could go on all evening and longer about the welfare cost of the status rat race, of militarism and how to discourage it, the brilliance of agricultural subsidies, how no one should listen to corrupt elites, and Armen would smile and nod and ponder.

Armen was a happy teacher. As others attest in this issue, he brought great energy, engagement, and generosity to the classroom. He might have been dressed for golf, but he gave students his complete attention. He especially enjoyed teaching the judges in Henry Manne’s Economics & Law program. One former pupil sought him out and at dinner, brought up the Apple v. Microsoft copyright dispute. He wanted to discuss the merits of the issues. Armen said oh no, simply get the thing over with ASAP. Armen said that he was a shareholder in both companies, and consequently did not care who won, but cared very much about what resources were squandered on the battle. Though the economics of this perspective was not novel (it was aired in Texaco v Pennzoil few years earlier), Armen provided in that conversation a view that neither side had an interest in promoting in court. The reaction was: Oh! Those who followed this case might have been puzzled at the subsequent proceeding in this dispute, but those who heard the conversation at dinner were not.

And Armen was a warm and sentimental person. When I moved to Washington, I left my roller skates in the extra bedroom where I slept when I visited Armen and Pauline. These were old-fashioned skates with two wheels in the front and two in the back, Riedell boots and kryptonite wheels, bought at Rip City Skates on Santa Monica Boulevard, (which is still there in 2015! I just looked it up, the proprietor knows all the empty swimming pools within 75 miles). I would take my skates down to the beach and skate from Santa Monica to Venice and back, then go buy some cinnamon rolls at the Pioneer bakery, and bring them back to Mar Vista and Armen and Pauline and I would eat them. Armen loved this ritual. Is she back yet? When I married Bob Hall and moved back to California, Armen did not want me to take the skates away. So I didn’t.

And here is a story Armen loved: Ron Batchelder was a student at UCLA who is also a great tennis player, a professional tennis player who had to be lured out of tennis and into economics, and who has written some fine economic history and more. He played tennis with Armen regularly for many years. On one occasion before dinner Armen said to Ron, “I played really well today.” Ron said, “Yes, you did; you played quite well today.” And Armen said, “But you know what? When I play better, you play better.” And Ron smiled and shrugged his shoulders. I said, “Ron, is it true?” He shrugged again and said, “Well, a long time ago, I learned to play the customer’s game.” And of course Armen just loved that line. He re-told that story many times.

Armen’s enthusiasm for that story is a reflection of his enthusiasm for life. It was a rare enthusiasm, an extraordinary enthusiasm. We all give him credit for it and we should, because it was an act of choice; it was an act of will, a gift to us all. Armen would have never said so, though, because he was raised right.


Alchian, Armen A., William R. Allen, 1964. University Economics. Wadsworth Publishing Company, Belmont, CA.

Alchian, Armen A., William R. Allen, 1977 Exchange and Production: Competition, Coordination, and Control. Wadsworth Publishing Company, Belmont, CA., 2nd edition.

Alchian, Armen A., Woodward, Susan, 1987. “Reflections on the theory of the firm.” Journal of Institutional and Theoretical Economics. 143, 110-136.

Alchian, Armen A., Woodward, Susan, 1988. “The firm is dead: Long live the firm: A review of Oliver E. Williamson’s The Economic Institutions of Capitalism.” Journal of Economic Literature. 26, 65-79.

Bargeron, Leonce, Lehn, Kenneth, 2015. “Limited liability and share transferability: An analysis of California firms, 1920-1940.” Journal of Corporate Finance, this volume.

Hirshleifer, Jack, 1976. Price Theory and Applications. Prentice hall, Englewood Cliffs, NJ.

Thompson, Earl A., 1968. “The perfectly competitive production of public goods.” Review of Economics and Statistics. 50, 1-12.

Thompson, Earl A., 1974. “Taxation and national defense.” Journal of Political Economy. 82, 755-782.

Woodward, Susan E., 1985. “Limited liability in the theory of the firm.” Journal of Institutional and Theorectical Economics. 141, 601-611.


Milton Friedman, Monetarism, and the Great and Little Depressions

Brad Delong has a nice little piece bashing Milton Friedman, an activity that, within reasonable limits, I consider altogether commendable and like to engage in myself from time to time (see here, here, here, here, here , here, here, here, here and here). Citing Barry Eichengreen’s recent book Hall of Mirrors, Delong tries to lay the blame for our long-lasting Little Depression (aka Great Recession) on Milton Friedman and his disciples whose purely monetary explanation for the Great Depression caused the rest of us to neglect or ignore the work of Keynes and Minsky and their followers in explaining the Great Depression.

According to Eichengreen, the Great Depression and the Great Recession are related. The inadequate response to our current troubles can be traced to the triumph of the monetarist disciples of Milton Friedman over their Keynesian and Minskyite peers in describing the history of the Great Depression.

In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

This interpretation makes a certain kind of sense, but it relies on a critical assumption. Friedman and Schwartz’s prescription would have worked only if interest rates and what economists call the “velocity of money” – the rate at which money changes hands – were largely independent of one another.

What is more likely, however, is that the drop in interest rates resulting from the interventions needed to expand the country’s supply of money would have put a brake on the velocity of money, undermining the proposed cure. In that case, ending the Great Depression would have also required the fiscal expansion called for by John Maynard Keynes and the supportive credit-market policies prescribed by Hyman Minsky.

I’m sorry, but I find this criticism of Friedman and his followers just a bit annoying. Why? Well, there are a number of reasons, but I will focus on one: it perpetuates the myth that a purely monetary explanation of the Great Depression originated with Friedman.

Why is it a myth? Because it wasn’t Friedman who first propounded a purely monetary theory of the Great Depression. Nor did the few precursors, like Clark Warburton, that Friedman ever acknowledged. Ralph Hawtrey and Gustav Cassel did — 10 years before the start of the Great Depression in 1919, when they independently warned that going back on the gold standard at the post-World War I price level (in terms of gold) — about twice the pre-War price level — would cause a disastrous deflation unless the world’s monetary authorities took concerted action to reduce the international monetary demand for gold as countries went back on the gold standard to a level consistent with the elevated post-War price level. The Genoa Monetary Conference of 1922, inspired by the work of Hawtrey and Cassel, resulted in an agreement (unfortunately voluntary and non-binding) that, as countries returned to the gold standard, they would neither reintroduce gold coinage nor keep their monetary reserves in the form of physical gold, but instead would hold reserves in dollar or (once the gold convertibility of sterling was restored) pound-denominated assets. (Ron Batchelder and I have a paper discussing the work of Hawtrey and Casssel on the Great Depression; Doug Irwin has a paper discussing Cassel.)

After the short, but fierce, deflation of 1920-21 (see here and here), when the US (about the only country in the world then on the gold standard) led the world in reducing the price level by about a third, but still about two-thirds higher than the pre-War price level, the Genoa system worked moderately well until 1928 when the Bank of France, totally defying the Genoa Agreement, launched its insane policy of converting its monetary reserves into physical gold. As long as the US was prepared to accommodate the insane French gold-lust by permitting a sufficient efflux of gold from its own immense holdings, the Genoa system continued to function. But in late 1928 and 1929, the Fed, responding to domestic fears about a possible stock-market bubble, kept raising interest rates to levels not seen since the deflationary disaster of 1920-21. And sure enough, a 6.5% discount rate (just shy of the calamitous 7% rate set in 1920) reversed the flow of gold out of the US, and soon the US was accumulating gold almost as rapidly as the insane Bank of France was.

This was exactly the scenario against which Hawtrey and Cassel had been warning since 1919. They saw it happening, and watched in horror while their warnings were disregarded as virtually the whole world plunged blindly into a deflationary abyss. Keynes had some inkling of what was going on – he was an old friend and admirer of Hawtrey and had considerable regard for Cassel – but, for reasons I don’t really understand, Keynes was intent on explaining the downturn in terms of his own evolving theoretical vision of how the economy works, even though just about everything that was happening had already been foreseen by Hawtrey and Cassel.

More than a quarter of a century after the fact, and after the Keynesian Revolution in macroeconomics was well established, along came Friedman, woefully ignorant of pre-Keynesian monetary theory, but determined to show that the Keynesian explanation for the Great Depression was wrong and unnecessary. So Friedman came up with his own explanation of the Great Depression that did not even begin until December 1930 when the Fed allowed the Bank of United States to fail, triggering, in Friedman’s telling, a wave of bank failures that caused the US money supply to decline by a third by 1933. Rather than see the Great Depression as a global phenomenon caused by a massive increase in the world’s monetary demand for gold, Friedman portrayed it as a largely domestic phenomenon, though somehow linked to contemporaneous downturns elsewhere, for which the primary explanation was the Fed’s passivity in the face of contagious bank failures. Friedman, mistaking the epiphenomenon for the phenomenon itself, ignorantly disregarded the monetary theory of the Great Depression that had already been worked out by Hawtrey and Cassel and substituted in its place a simplistic, dumbed-down version of the quantity theory. So Friedman reinvented the wheel, but did a really miserable job of it.

A. C. Pigou, Alfred Marshall’s student and successor at Cambridge, was a brilliant and prolific economic theorist in his own right. In his modesty and reverence for his teacher, Pigou was given to say “It’s all in Marshall.” When it comes to explaining the Great Depression, one might say as well “it’s all in Hawtrey.”

So I agree that Delong is totally justified in criticizing Friedman and his followers for giving such a silly explanation of the Great Depression, as if it were, for all intents and purposes, made in the US, and as if the Great Depression didn’t really start until 1931. But the problem with Friedman is not, as Delong suggests, that he distracted us from the superior insights of Keynes and Minsky into the causes of the Great Depression. The problem is that Friedman botched the monetary theory, even though the monetary theory had already been worked out for him if only he had bothered to read it. But Friedman’s interest in the history of monetary theory did not extend very far, if at all, beyond an overrated book by his teacher Lloyd Mints A History of Banking Theory.

As for whether fiscal expansion called for by Keynes was necessary to end the Great Depression, we do know that the key factor explaining recovery from the Great Depression was leaving the gold standard. And the most important example of the importance of leaving the gold standard is the remarkable explosion of output in the US beginning in April 1933 (surely before expansionary fiscal policy could take effect) following the suspension of the gold standard by FDR and an effective 40% devaluation of the dollar in terms of gold. Between April and July 1933, industrial production in the US increased by 70%, stock prices nearly doubled, employment rose by 25%, while wholesale prices rose by 14%. All that is directly attributable to FDR’s decision to take the US off gold, and devalue the dollar (see here). Unfortunately, in July 1933, FDR snatched defeat from the jaws of victory (or depression from the jaws of recovery) by starting the National Recovery Administration, whose stated goal was (OMG!) to raise prices by cartelizing industries and restricting output, while imposing a 30% increase in nominal wages. That was enough to bring the recovery to a virtual standstill, prolonging the Great Depression for years.

I don’t say that the fiscal expansion under FDR had no stimulative effect in the Great Depression or that the fiscal expansion under Obama in the Little Depression had no stimulative effect, but you can’t prove that monetary policy is useless just by reminding us that Friedman liked to assume (as if it were a fact) that the demand for money is highly insensitive to changes in the rate of interest. The difference between the rapid recovery from the Great Depression when countries left the gold standard and the weak recovery from the Little Depression is that leaving the gold standard had an immediate effect on price-level expectations, while monetary expansion during the Little Depression was undertaken with explicit assurances by the monetary authorities that the 2% inflation target – in the upper direction, at any rate — was, and would forever more remain, sacred and inviolable.

A New Paper Shows Just How Right Hawtrey and Cassel Were

I was pleasantly surprised to receive an email a couple of weeks ago from someone I don’t know, a graduate student in economics at George Mason University, James Caton. He sent me a link to a paper (“Good as Gold?: A Quantitative Analysis of Hawtrey and Cassel’s Theory of Gold Demand and the Gold Price Level During the Interwar Period”) that he recently posted on SSRN. Caton was kind enough to credit me and my co-author Ron Batchelder, as well as Doug Irwin (here and here) and Scott Sumner, for reviving interest in the seminal work of Ralph Hawtrey and Gustav Cassel on the interwar gold standard and the key role in causing the Great Depression played by the process of restoring the gold standard after it had been effectively suspended after World War I began.

The thesis independently, but cooperatively, advanced by Hawtrey and Cassel was that under a gold standard, fluctuations in the gold price level were sensitive to variations in the demand for gold reserves by the central banks. The main contribution of Caton’s paper is to provide econometric evidence of the tight correlation between variations in the total gold holdings of the world’s central banks and the gold price level in the period between the end of World War I (1918) to the start of Great Depression (1930-32). Caton uses a variation on a model used by Scott Sumner in his empirical work on the Great Depression to predict changes in the value of gold, and, hence, changes in the gold price level of commodities. If central banks in the aggregate are adding to their gold reserves at a faster rate than the rate at which the total world stock of gold is growing, then gold would be likely to appreciate, and if central banks are adding to their gold reserves at a slower rate than that at which the world stock is growing, then gold would be likely to depreciate.

So from the published sources, Caton constructed a time series of international monetary gold holdings and the total world stock of gold from 1918 to 1932 and regressed the international gold price level on the international gold reserve ratio (the ratio of monetary gold reserves to the total world stock of gold). He used two different measures of the world gold price level, the Sauerback-Statist price index and the gold price of silver. Based on his regressions (calculated in both log-linear and log-quadratic forms and separately for the periods 1918-30, 1918-31, 1918-32), he compared the predicted gold price level against both the Sauerback-Statist price index and the gold price of silver. The chart below shows his result for the log-linear regression estimated over the period 1918-30.


Pretty impressive, if you ask me. Have a look yourself.

Let me also mention that Caton’s results also shed important light on the puzzling behavior of the world price level immediately after the end of World War I. Unlike most wars in which the wartime inflation comes to an abrupt end after the end of the war, inflation actually accelerated after the end of the war. The inflation did not actually stop for almost two years after the end of the war, when a huge deflation set in. Caton shows that the behavior of the price level was largely determined by the declining gold holdings of the Federal Reserve after the war ended. Unnerved by the rapid inflation, the Fed finally changed policy, and began accumulating gold rapidly in 1920 by raising the discount rate to an all-time high of 7 percent. Although no other countries were then on the gold standard, other countries, unwilling, for the most part, to allow their currencies to depreciate too much against the dollar, imported US deflation.

Jim is also a blogger. Check out his blog here.

Update: Thanks to commenter Blue Aurora for pointing out that I neglected to provide a link to Jim Caton’s paper.  Sorry about that. The link is now embedded.

Nunes and Cole Write the E-Book on Market Monetarism

This post is slightly late in coming, but I want to give my fellow bloggers and valued commenters on this blog, Marcus Nunes and Benjamin Cole a shout out and my warmest congratulations on the publication, last week, of their new e-book Market Monetarism: Roadmap to Economic Prosperity.

I have not yet read the entire book, but I did read the introductory chapter available on Amazon, and I was impressed, but not surprised, by their wide knowledge and understanding of monetary economics as well as their clear, direct and engaging style. I was also pleased to find that they gave due recognition to Gustav Cassel, Ralph Hawtrey, and James Meade for their important contributions. Nor do I hold it against them that they quoted from my paper on Hawtrey and Cassel, though they did forget to mention the name of my co-author, Ron Batchelder.

Way to go, guys.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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