I

ArticlesFrank H. Knight on Market
Thinking
Reflections on the Logic and Ethics of
the Capitalist Economy

Yasuhiro Sakai

Shiga University / Professor Emeritus

What Money Can
and Cannot Buy:
An Introduction

1-1. Sandel on the Moral Limits ofMarkets
For everyman in the street, it is so important
to distinguish between what money can buy
and what money cannot buy. These two things
are clearly different and should not be confused. It seems very strange to see, however,that there are many modern economists who
tend to forget the differences, thus simply applying the logic of buying and selling to thewhole aspects of life.
Michel Sandel is a famous professor of political philosophy at Harvard University. His
famous 'Justice' course has been the first Harvard course made freely available online and on
television.1) In a very popular book, Sandel(2012) once remarked:

As the cold war ended, markets and market
thinking enjoyed unrivaled prestige, understandably so. No other mechanism fororganizing the production and distribution of
goods had proved as successful as generating affluence and prosperity. And yet, even as
growing number of countries around the world
embraced market mechanisms in the operationof their economies, something else was happening. Market values were coming to play agreater and greater role in social life. Economics was becoming an imperial domain. Today,
the logic of buying and selling no longer applies to material goods alone but increasingly
governs the whole of life. It is time to ask
whether we want to live this way.
(Sandel (2012), pp.5-6)
1) Sandel's Harvard course was also easily available on

Japanese television. Its style was so appealing and influential that it was nicknamed "Sandel's exciting lecture."
It seems that his emphasis on justice and equity impressed very much those Japanese economics students
who were tired of repeated talk on money and efficiency.

032

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Let us recall the 1950s and the 1960s when
the general equilibrium theory was firmly established by the three eminent economists,
Lionel W. McKenzie (1919-2010), Kenneth J.
Arrow (1921-2017) and Gerard Debreu (19212004). Interestingly enough, if we collect theinitials of these economists, we would form thecatch word MAD. Therefore, some cynicalpersons might say that we then lived in the
MAD Age, or perhaps another name of theGolden Age. We would like to investigate how
powerful (or perhaps mad) the general equilibrium way of thinking once was, and also discuss
how and to what degree it continues to be soeven today.

gal fees, and so forth. Since many persons arelooking for mates, a market in marriages can besaid to exist. (Becker (1976), p.10)
This article sounded to me a thunderbolt
from a clear sky. Although I got married with alovely girl a year before, any kind of pecuniary
calculations over benefits and losses nevercrossed to my mind. My marriage had noting
to do with the Becker way of market thinking.
Besides, the change of my place of employment
from an American university to a Japanese university resulted in a reduction of my yearly
income by half. I was then in a mood to accept
it: I did this because of my family obligation to
old parents living in the land of the Rising Sun.

1-2. Gary Becker on an Economic
Approach to Marriage
Gary S. Becker (1930-2014) was a Nobelwinning scholar of economics and sociology.
He was working for the University of Chicago,and greatly contributed to raising the good(and possibly bad) reputations of the Chicago
School in modern times. He was a famed
scholar of remarkable impact beyond the academic world.
In a very interesting book, Becker (1976)
once remarked:

1-3. Knight versus Friedman:
Uzawa's Remark
Hirofumi Uzawa (1928-2015) was one of themost famous economists in postwar Japan: he
was once working for the University of Chicago before he came back to the University ofTokyo, Japan. In a very popular book, Uzawa(2013) once made a very important remark inJapanese. Although it was a bit long sentence,
let us attempt to write its English translation
down below:

According to the economic approach, a person decides to marry when the utility expectedfrom marriage exceeds that expected from remaining or additional search for a moresuitable mate. Similarly, a married person terminates his (or her) marriage when the utility
anticipated from becoming single or marringsomeone exceeds the loss in utility from separation, including losses due to physical separationfrom one's children, division of joint assets, le-In the 1950s and the 1960s, the central figureof the so-called Chicago School was Friedman,with a supportive role being played by Hayek.
In contrast, Knight thoroughly condemned
the atomic bombing by the U.S. over Hiroshima and Nagasaki in 1945 for the worst crime
ever committed by mankind. Knight gave serious thought to the problem of competitionand ethics: he was really an outstanding economist. In my opinion, Knight was entirelyFrank H. Knight on Market Thinking

Yasuhiro Sakai033

different from what people loosely called theChicago School. ......
Friedman and his circle continued to devote
themselves to moneymaking. As Knight
seemed to think that this was not the rightthing to do, he once said to many colleagues
around him, "It is true that Milton Friedman
and George Stigler finished their doctoral dissertations under my direction. I would like tosay, however, that their recent behaviors were
too much for me. So I would rather like to declare that they are no longer my students". Thiswas presumably a sort of the declaration of expulsion. I can recall that he was then an old
man over 80 years, yet such a good and wonderful person. (Uzawa (2013), pp.35-36.)
Uzawa's remark aforementioned clearly indicates a striking difference between Knight andFriedman from an ethical point of view. Concerning the relationship between the logic andethics of the market economy, Knight was very
cautions against falling into the trap of themarket logic first and nothing else: in fact, heemphasized that ethics and social philosophy
should play a critical role in protecting frompossibly devastating consequences of excessivecompetition. Contrary to such teachings of his
mentor, Friedman became a strong believer in"market fundamentalism without ethics." It
would not be fair to say that Knight and Friedman belonged to the same school of economic
thought, namely the Chicago School. Alternatively, we could say that Knight early led theoriginal Chicago School, and Friedman latermodified the morals of the school in a different
direction. .
The contents of this paper is as follows. In
Section 2, we will outline the solid framework
2) For details, see McKenzie (1999). Personally speak-ing, my academic relation to McKenzie, a mentor at
Rochester, carried over to Pittsburgh. I myself madeSakai (1972), my own lecture note on general equilibrium theory, by occasionally consulting McKenzie (1969)
and adding some original materials. For the life andwork of Kakutani whose theorem of fixed point was034

of general equilibrium theory which wasstrongly promoted by McKenzie, Arrow and
Debreu, and point out the unique ethics andideology lying its background. In Section 3, we
will turn to the reassessment of Knight's strong
objections against the market fundamentalism.
In order to escape from mathematical jungles,
we will make use of graphical illustrations asmuch as possible. It is hoped that our visualand intuitive way of presentation will work out
beautifully.

II

The Ethics and Ideologyof General Equilibrium
Theory2-1. The Life and Work of"Professor Fixed Point"
In the 1960s, the campuses of many Japanese
universities and colleges were so noisy: there
were so many political gatherings and strike activities. Some of the active youth wanted to go
abroad, and could continue to do their graduate studies. I myself was one of those ambitious
students, thus applying for admission of graduate schools at American universities. Very
fortunately, in 1968, I was admitted to the
Graduate School of Economics, the Universityof Rochester.
There was a very prominent professor at the
Rochester Economics Faculty, who was mainly
responsible for the establishment of the outstanding graduate program in economics. The
name of that famous professor was Lionel W.
McKenzie. He was one of those pioneers who
together with Kenneth Arrow and Gerard Debreu succeeded in introducing advanced
mathematics such as differential topology into
economics. One of his favorable mathematicalfondly used by McKenzie, see Hirota (2004).
3) McKenzie (1969) was the handwritten lecture note heused in a graduate seminar in general equilibrium theory
at Rochester. It was a loosely written manuscript full ofcorrections and imperfections. Fortunately, it was later
typewritten by his efficient secretaries and eventually

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tools was the Fixed Point Theorem which wasestablished by great mathematicians including
L.E.J. Brouwer (1881-1996) and Shizuo Kakutani (1911-2004). So it would be quite natural
to see that McKenzie was nicknamed "Professor Fixed Point." 2)
The way in which McKenzie taught generalequilibrium theory at Rochester was legendary.
Every time, he distributed to a selected groupof graduate students his hand-written manuscripts, which contained a lot of mathematicalsymbols and complicated equations. The symbols and equations were rather loosely written
and sometimes almost incomprehensible. Occasionally, he spoke the names of some Japanese
economists in heavy English accents, Morryshe-ma (exactly, Michio Morishima), Woozawer (Hirofumi Uzawa), Inner-da (Ken-ichi
Inada), Knee-kwaido (Hukukane Nikaido),
and Nay-gee-she (Takashi Negishi).
I still remember the occasion when McKenzie did not feel well and unfortunately got
struck in a mathematical jungle. This incident
happened exactly when he was about to finish
the proof of general market equilibrium solution. He knows that the mathematical tool
needed was no less than the effective use of the
Fixed Point Theorem. Then he stopped walking and began to fold his arms, holding a pieceof white chalk with his right hand. After fiveminutes or so, his cheek suddenly got morebrighter than before, and nodded his head tohimself, "I've got it!" And after completing theexistence proof successfully, he convincingly
yet rather quietly muttered with sigh, "Oh, it's
so beautiful!" This was only faintly heard tome: I was lucky enough to sit on the front row.
A will-o'-the wisp would be burning and sneer
at us forever! 3)

2-2. The Brouwer Fixed Point
Theorem
L.E.J. Brouwer (1881-1966) is a famous
Dutch mathematician, who worked in topology, measure theory and complex analysis. He
proved a number of mathematical theorems including what mathematicians later called the
Brouwer fixed point theorem.
In what follows, let us briefly explain the
Brouwer fixed point theorem. Let us consider
a set X and a function f from X to X , namely
a transformation of X into itself. We find itvery interesting to find the existence of an element x* such that x* = f (x* ), namely, anelement which does not move in the transformation. Such an element is particularly named
a fixed point of the function f . 4)
Let us assume that X is a non-empty, compact, convex set of Rn, then n-th dimensional
real space. It is well-known that in the real
space, a compact set is equivalent to a bounded
and closed set. If we consider a unit closed interval [0, 1], it is indeed non-empty, compact,
and convex. For an illustrative purpose, let us
consider the following continuous function
from [0, 1] into itself.

became a hard-covered book, namely, McKenzie (2002).
The time span between the lecture note and the complete book is amazingly 33 years. Time f lies like an arrow!

4) Debreu (1959) and Takayama (1974) are very useful inunderstanding the Brouwer fixed point theorem and its
related topics.

Frank H. Knight on Market Thinking

Yasuhiro Sakaif (x) = x2 − x + 3/4(1)Then as is seen in Fig. 1, the curve f mustcross the 45 degree line at least once. Such acrossing point Q* constitutes a fixed point,
namely, f (x* ) = x* (= 1/2).
More formally speaking, we can establish thefollowing simple yet powerful theorem which
was first proved by Brouwer (1910) more than
100 years ago:

035

Theorem 1 (the Brouwer fixed point
theorem)
Let X be a non-empty, compact, convex setof Rn., and f be a continuous function from X
to itself. Then f has a fixed point: namely,
there is an element x* of X such that x* = f (x*).
Although the Brouwer fixed point theorem
seems very powerful, it should never be alm i g h t y : n a m e l y, i t d o e s n o t h o l dunconditionally. A clear yet rigorous proof isprovided by Nikaido (1970). We are only content here to confirm that the following four
conditions must be satisfied for applicability ofthe theorem.
(i)	The function f must be continuous on
the set X.
(ii) X must be a closed set.
(iii)	X must be a bounded set; namely, X
must have upper and lower bounds.
(iv) X must be a convex set.
Fig. 2 shows that if one of those four conditions is not met, the fixed point theorem is nolonger applicable. In Panel (A), the curve f is
not continuous at x = 1/2, whence f does notcross the 45 degree line. Panel (B) stands forthe case in which the set X is an open unit inter va l (0,1), wh ich demonstrates nonintersection of f and the 45 degree line. In
Panel (C), since X is an infinite interval [0,∞),
it is no longer bounded above. If the curve funder question is always increasing above the
45 degree line, then there should be no crossing point between these the curve and the line.
Finally, Panel (D) indicates the situation underwhich X is not a convex case. Suppose that X
is the union of the two closed sub-intervals
such that X = [0,1/3] ∪ [2/3,1]. Then if the036

curve f jumps at x = 1/3 and x = 2/3 as is seen
the panel, there should be no crossing point.

Fig. 1 The Brouwer fixed point theorem(A) f is not continuous(B) X is not a closed set:

at x = 1/2

X = (0,1)(C) X is not bounded:(D) X is not convex:

X = [0,∞)X = [0, 1/3] ∪ [2/3, 1]

Fig. 2 The four cases where the fixed point theorem
are not applicable

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2-3. The Equivalence between the
Walras Existence Theorem and the
Brouwer Fixed Point Theorem
The Brouwer fixed theorem is one of themost beautiful theorems in modern times. Although the theorem per se is a pure brain
product, it has many applications to otherfields such as economics and game theory. 5)
In the 1950s and the 1960s, there reemergeda bulk of mathematical economists who foundmuch interest in giving a rigorous proof for the
existence of multi-market equilibrium a la Leon Walras (1874), a lonely French pioneer.
Among those economists were Arrow (1951),
Arrow & Debreu (1954), Debreu (1959), McKenzie (1954, 1955,1959), Gale (1955), andNikaido (1956). Unquestionably, the Brouwer
fixed point theorem and its generalizations
such as the Kakutani fixed point theorem havebeen the most powerful mathematical tools
employed by those economists. 6)

The purpose of this sub-section is to show
the equivalence between the Walras existence
theorem and the Brouwer fixed point theorem.
Uzawa (1962) was the first person to point out
such equivalence in a very exact form. In what
follows, let us attempt to give an elementary
proof by help of simple figures.
In what follows, we would like to pick up avery simple, one-good market equilibrium
model a la Walras (1874) in order to establish
following theorem:
Theorem 2 (equivalence between the fixed
point and the market equilibrium)
The fixed point implies the market equilibrium, and vice versa.

5) See Wald (1936) and Von Neumann & Morgenstern(1944) for instance.
6) From the 1970s onward, very useful advanced text-

books in general equilibrium theory have been appeared.
So systematic presentations of the Fixed Point Theorems
and their economic applications are now available to any

Frank H. Knight on Market Thinking

Let the demand function and the supply
functions of good x respectively be denoted byx = d (p) and x = s (p), where p stands for theunit price of x . For simplicity, assume that thefunctions d and s are both continuous andsmooth. Then we can write down the excess
demand function e of good x as follows:e (p) = d (p) − s (p) .

(2)

Common sense tell us that when the price ofa good x rises, the demand for the good decreases and the supply increases. Consequently,
on the one hand, if the price p is low enough(namely, p = pL), the excess demand for x occurs , so that eL = dL − sL> 0. On the other, incase the price p is high enough (i.e., p = pH),minus the excess demand (namely, the excess
supply) for x takes place, whence eL = dL − sL <0. Let put P = [pL, pH]. Then evidently, P is a
closed interval; whence it is a non-empty, compact, closed set.
Now, let us consider the following mappingfrom P into itself:Φ(p) = p + α・e (p)(3)
It is noted here that α stands for a fraction,
namely, a constant between 0 and 1. the mapping Φ(p) indicates a sort of Walrasian priceadjustment process. For example, Let us put
α= 1/2. Then if the excess demand for x occurs(i.e. α > 0), we find Φ(p) = p + (1/2) e (p),meaning that the price p must go up by 50%.
By the same token, if the excess supply takes
place, then p must go down by 50 %.
Clearly, the mapping Φ: P → P is continuous.
So if we apply the Brower fixed point theorem

eager graduate student. For instance, see Nikaido (1970),
Arrow & Hahn (1971), and Takayama (1974). Comparedwith those works, McKenzie (2002) was a belated product, yet presumably showing the culmination in thisfield.

Yasuhiro Sakai

037

here, we may find the fixed point, namely, p*such that Φ(p*) = p*
In the light of Eq. (3), we can immediately
obtain the following equivalent relation:
Φ(p*) = p* ⇔ e(p*) = 0.

(4)

Needless to say, this relation is a mathematical restatement of Theorem 2. Therefore, theBrouwer fixed point theorem implies the Walras market equilibrium, and vice versa. Take alook at Fig. 3. The point Q* and the point R*
respectively indicate the fixed point and themarket equilibrium. It is very obvious fromthis figure that the existence of Q* in the upper
figure implies the existence of R* in the lower
figure, and vice versa. The proposition that the
fixed point equals the market equilibrium constitutes one of the very fundamental ideas
underlining the core of general equilibrium
theory.

III

Welfare Implications ofGeneral Equilibrium

3-1. The Impact of the Cold War on
the Economics Profession
Just after the Second World War, we were engaged in another world war named the Cold
War. There emerged many political, military,
and ideological tensions between the Western
Capitalist Bloc (the United States, its NATO
allies, Japan, and others) and the Eastern Socialist Bloc (the Soviet Union, its Warsaw
Treaty allies, China, and others). The term"Cold War" was intentionally employed since
there was no longer large-scale "hot fighting"directly between those two blocs. The importance of the "ideological struggles" , however,should not be underestimated.
In the field of economics profession, a sort of"Economics Cold War" took place between
what we called modern economics and what
we named Marxian economics. It should berecalled that Marxian economics was not only
the official economics taught in the Eastern
Bloc, but also a more or less popular subject in

Fig. 3 Equivalence of the fixed point Q* and the market equilibrium point R* : Φ (p*) = p* ⇔ e (p*) = 0

038

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the Western Bloc except the United States. In
Japan, most of the major universities were thendominated by Marxian socialists, with modern
economists taking a back seat.
Under the circumstances mentioned above,
especially in the United States, general equilibrium theory has played a very special role inestablishing the proposition that the capitalist
economy really works al least as efficiently as its
rival, socialist economy. A great number of research projects on mathematical economics
were very generously supported by the National Science Foundation, Naval Research
Logistics Project, and the like.7)
The thinking of Immanuel Kant (1785), a famous German philosopher, has influenced
moral philosophy a great deal. According to
his philosophy, there are three important value
judgments in human behavior. They are truth,
good and beauty. In line with the philosophyof Kant, general equilibrium theory has taught
us that the market economy works, and indeed
works very beautifully.
It is really remarkable to see the following
theorem has been established by Arrow (1951),
Hurwicz (1960), and others.
Theorem 3 (the fundamental theorem of
welfare economics)
Let us suppose that an exchange economy be"normal." Then it possesses the following properties:(i)	Every market equilibrium achieves Pareto-optimality.
(ii)	Ever y Pareto -optimal state can beachieved as a market equilibrium position.

7) Newman (1968) was a nice collection of outstanding

The rigorous proof of this theorem is omitted here. We note that in a "normal economy",
an increase in the quantity of any good increases the total utility of every person but decreases
his/her marginal utility. Besides, in a Paretooptimal economy, it is not possible to make any
one person better off without making the otherworse off. Whether and to what extent Pareto
optimality really represents the "ideal state" ofthe economy remains to be debatable.8)
3-2. The Market Equilibrium andPareto Optimality
The relation between the market equilibrium
and Pareto optimality may easily understoodby the box diagram a la Edgeworth (1881). Let
us take a close look at two panels in Fig. 4.
Panel (A) shows Property (1) of Theorem 3 :every market equilibrium achieves Pareto optimality. In order to understand this, let us
arbitrarily pick up the initial endowment point
W and the budget set B (p ) passing through W.
Then the point Q lying on B (p) achieves theequality of demand and supply for the twogoods, good 1 and good 2, since it is really apoint in the box diagram. Moreover, it is apparently a point at which the two persons, Ms.
A and Ms. B, can achieve her utility maximization subject to the budget constraint since atthe point Q. Now let us simply look at such asituation and forget the presence of the budget
set for a while. Then we immediately see thatthe two indifference curves IA and IB just touchat Q. This shows that Pareto optimality is now
achieved at Q.
In contrast, Panel B indicates Property 2 ofTheorem 3; Every Pareto optimal state can beachieved by a market mechanism. Let us pickup a point Q on the contract curve O AO B.
8) The concept of Pareto optimality was first introduced

papers on mathematical economics. The reader could
easily understand how effectively many scientific research funds were used in the 1950s and the 1960s.

by Pareto(1906). For a nice discussion for the relation
between the market equilibrium and Pareto optimality,
see Negishi (1960) and Quirk & Saposnik (1968).

Frank H. Knight on Market Thinking

Yasuhiro Sakai

039

(A)The equilibrium point Q achieves
Pareto optimality(B)The optimal point Q achieves a market equilibrium with W

Fig. 4 The market equilibrium and Pareto optimality

Since point Q is a Pareto-optimal point, it
must be the point in which the two convex indifference curves I A and I B just touch eachother. We can then find a separating line B(p)and an initial endowment W. It is now clearthat the Pareto optimal point P becomes amarket equilibrium point with the initial endowment W and the common budget lineB(p).
I still remember how some graduate students
reacted when I energetically taught the nice relation between the market equilibrium andPareto optimality at the University of Pittsburgh in the early 1970s. A clever female
student from Turkey had the courage to ask aquestion to me: "Dr. Sakai, I was really impressed by your lecture to inform me that theMarket Economy is a sort of the Earthy Paradise. The three virtues of true, good and beauty
seem to be perfectly achieved there. I would
like to tell you, however, that I am from a lessdeveloped country located between Asia andEurope. I wonder whether and to what extent

040

your today's talk is relevant to the present stateof my poor country." I was then really shocked
by this question: it seemed to be a bolt out of
the blue. I took a short pose, and eventually
managed to answer it. " This is really a very
good question. As you know, I am also fromthe country of tradition and culture like you.
Now, all my fellow students, let us together
think of the validity and limitations of generalequilibrium theory. Man is a thinking reed!"
This was part, though by no means the whole,of the reason for the change in my research areafrom general equilibrium to risk and uncertainty.

IV Frank Knight's Strong

Objections against
the Capitalist Economy

4-1. Knight's Pluralist InsightFrank H. Knight was perhaps one of the
deepest thinkers and the most critical economists in the 20th century. When I joined the

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economics faculty at Pittsburgh in the 1970s, I
was surrounded by many people who had
mixed feelings for general equilibrium theory
and fondly talked about Frank Knight's philosophical pluralism.9)
Knight was often called the "Grand Old
Man" of Chicago, playing a central role in setting the character of "the early Chicago
School." Interestingly enough, Patinkin (1973)vividly recalled the days when Knight was ateacher at the University of Chicago (1941-47):
A the Chicago of my student days it was,ironically enough, the socialist Oskar Lange
who extolled the beauties of the Paretian optimum achieved by a perfectly competitivemarket–and Frank Knight who in effect taught
us that the deeper welfare implications of thisoptimum were indeed quite limited. (Patinkin(1973), p.801)
At Chicago in the 1940s, there were the two
economics giants: Oskar Lange and Frank
Knight. While the market socialist Lange ext o l l e d th e b e a uti f u l e q u i va l e n c e o f acompetitive equilibrium and Pareto optimality,
the reluctant capitalist Knight raised serious
objections against it. Lange simply believedthat human behavior was rational in the sensethat a consumer maximizes his/her utility subject to the budget constraint while a producer
maximizes his/her profit subject to the technological constraint. In contrast, Knight's view ofhuman nature was more complicated and more
realistic than such a simple-minded view. As
Boyd (1997) noted, the intellectual legacy ofFrank Knight was a study in paradox. Although he could be regarded as an outstanding

scholar in neoclassical economics, he nevertheless stood high as it harsh critic as well.
In this connection, Knight (1925) once remarked:
It is time to admit that while the craving fora monistic view of the world is real, the projectof resolving either minds or objects into theother type of existence is futile. ...... Both realism and idealism are, in the vernacular, "thebunk"; monism is moonshine! In the humanand social sciences, most clearly, the only possible point of view is pluralistic. (Knight (1925),
p. 255; Knight (1999), p.121)
Generally speaking, there are two views of
the worlds, a monistic view and a pluralistic
view. According to Knight, monism is too simplistic, and tends to view the world either
white or black. The situation, however, is not amatter of black and white. Between black andwhite, there should be many complicated colors. If monism is regarded as weak moonshine,
pluralism is sunshine and sheds a stronger andmore colorful light into the world.
4-2. Knight's Strong Objections
against the Market Economy
Throughout his career, Knight never regarded the capitalist system as ethically defensible.
In fact, he fondly adopted his pluralistic viewin order to critically investigate the ethicalfoundations of the market economy. According to Knight (1935), we can enumerate thefollowing twelve reasons why the market economy cannot be defended from a moral point ofview.
(i) The assumption that the economy ismade up of freely contracting individuals is9) The philosophy and economics of Knight was inten-

sively discussed in Sakai (2010, 2015).

Frank H. Knight on Market Thinking

Yasuhiro Sakai

041

quite questionable. All minors, the aged, andsome others must be taken care of by adult persons. The family, but not an individual, is still
the unit in consumption and production.
(ii) An individual is in large measure a product of the cultural environment. Humanbeings are not accurate mechanisms of desire
satisfaction: human activity is largely impulsive, a relatively unthinking and undetermined
response to external stimulus and rumors.
When the family is the social unit, the inheritance of wealth and educational advantages
tend toward the progressive increase of inequality. Therefore, the results which acompetitive economy bring about are often far
from being ethically ideal.
(iii) The traditional assumption that all
goods and services are perfectly divisible andfreely mobile is based on mere supposition,
thus being far from the actual economy.
(iv) One of the most important prerequisites to perfect competition is complete
knowledge on the part of every individual. A
perfect market would involve perfect, instantaneous, and costless intercommunication among
all the traders. This would be existent only in a
fictitious world.
(v) Competition further assumes that every
buyer of every good knows very accurately its
properties to satisfy his/her want. The competitor must perfectly foresee things as they
will be, a too unrealistic assumption.
(vi) We have to find the proper relation between efficiency and equity. The social ordermust be judged ethically rather by the wants
which it generates than by its efficiency in satisfying wants.
(vii) The workings of competition educate
men progressively for monopoly. This is being

042

achieved not merely by producers, but by laborand in many branches of agriculture. In short,free competition will destroy itself !
(viii) In reality, what is desired is more largely a matter of human relations than goods as
such; we want things because other people
have them, or cannot have them. A typical illustration is the improvement or use ofproperty in ways which may add or subtract
value from neighboring property.
(ix) An exchange system cannot work at all
according to theory without a control unit.
With the use of credit highly developed, thecontrol of banking and currency involves alarge measure of control over all business, butreally free banking would soon reduce all exchange relations to chaos.
(x) An economic organization must employ
its available productive power in part to provide for present needs of society and in part toprovide for future growth. In an individualistic
system, provision for progress depends on theinterest of present individuals in future individuals, which is being engendered to uncertain
extent and with uncertain consequences by achange of the social and historical condition.
(xi) All human planning and execution involve uncertainty, and a rational social ordercan be realized through individual action only
if all persons have rational attitude toward risk
and uncertainty. As can be seen in gamblingand speculative behavior, however, the generalhuman attitude tends to non-rational, andmuch social limitation is required.
(xii) We have to closely examine the ethicalfoundations and consequences of unbounded
individualism and competition. In the capitalist economy, productive contribution can havelittle or no ethical significance from the stand-THE HIKONE RONSO

Autumn / Sep. 2017 / No.413

point of absolute ethics. For instance, no one
contends that a bottle of old wine is ethicallyworth as much as a barrel of flour, or a fantastic
evening wrap for a powerful person's mistressas much as a substantial dwelling house. Besides, Knight has noticed that the ownership of
personal or material capacity is based on acomplex mixture of inheritance, luck, and effort, probably in that order of relative
importance.
4-3. Inheritance, Luck and Moral
HazardKnight do not believe that individualism can
automatically bring about an ideal utilizationof economic resources. He contends that thewelfare results of trading are based rather on
initial endowment and chance, than on hardwork.
According to Knight, all human planningand execution can be realized through individual action only if all persons have a rational
attitude toward risk and chance. The generalhuman attitude, however, is not necessarily
very rational, and individual knowledge ismore or less limited. The traditional assumption that every buyer of any good perfectly
knows its properties to meet his/her want
would not be satisfied in reality.
One of many interesting problems is how werelate quality uncertainty to the market mechanism. As Akerlof (1972) noted, the existenceof a single good with several grades may pose avery serious problem for the working of a market. In this case, there emerges the possibility
that a seller has an incentive to tell a lie to abuyer: he/she may supply a poor-quality good
rather than a good-quality good. As a result,dishonest dealings may tend to drive honest

Frank H. Knight on Market Thinking

dealings out ; indeed, the market per se may
shrink and will eventually vanish. This is what
Akerlof has wisely called the lemons principle.
We must bear in mind, however, that far backin the 1930s, Knight already did a significant
contribution to this field, so that he could also
be thought as one of important founders.

V

The Disappointing
Performance of
the Economics Profession:
Final Remarks

Later in 2008, the world banking system collapsed and we found ourselves involved in the
biggest economic crisis after the Great Depression of the 1930s. In a popular book, Richard
A. Posner (2009) has recently remarked:
My focus is on the causes, and offered curesof the depression. But I also emphasize somepoints that have received relatively little coverage in other accounts: the depression's politicaldimensions, the disappointing performance ofthe economics profession in regard anticipating and providing guidance to responding to
the depression, how ideology can distort economic policy, the inherent limitations ofdepression economics, how the self-interested
decisions of rational businessmen and consumers can give rise to a depression...... (Posner(2009), Preface, p. xiv)
Posner's remark aforementioned is both very
serious and greatly challenging. We all haveseen the disappointing performance of the economic profession in regard to the breakdownof the market economy. The two great economists, Knight (1921, 35, 99) and Keynes (1936),

Yasuhiro Sakai

043

made outstanding contributions on the ethicalfoundations and consequences of a competitive
economy. Now, we need a Knight, and also a
Keynes.

⦿Kant, I. (1785) Groundwork of the Metaphysics of Morals(Grundlegung zur Metaphysik der Sitten.)

⦿Keynes, J.M. (1936) The General Theory of Employment,Interest and Money. Macmillan.

⦿K nig ht, F. H. (1921) Risk , Uncertaint y and Prof it,

Houghton Mifflin Company.

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librium for a Competitive Economy," Econometrica,
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havior, University of Chicago Press.

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044

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Frank H. Knight on Market Thinking

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045

Frank H. Knight on Market Thinking
Reflections on the Logic and Ethics of the Capitalist Economy

Yasuhiro Sakai

The purpose of this paper is to shed a newlight on the working and performance of themarket economy from a pluralistic viewpoint.
To this end, we first pay attention to the general equilibrium theory a la L.W. McKenzie, K. J.
Arrow and G. Debreu. Whereas this theory
seems to be established on the foundation ofsolid logic and advanced mathematics, the existence of special ethics and ideology behind thescenes should not be forgotten. We next reexamine the thought of Frank H. Knight, who
has raised an strong objection against glorification of the market economy.
In the late 1960s, I was a graduate student at
the University of Rochester. I still recall thetouching moment when Professor McKenzie,
finally succeeding after a long struggle to provethe existence of a competitive economy by helpof a mathematical theorem of fixed point,
posed a bit in a class and said quietly, "It’s sobeautiful! ". The world was then in the midst ofCold War and divided into the two powerful
blocs, the socialist bloc dominated by the Soviet Union and the capitalist block led by theUnited States of America. McKenzie's complacent whispering sounded like the victorydeclaration of capitalism over socialism.

046

Around 40 years have passed since then. It
seems that the "academic Cold War" between
Marxian economics and modern economics isnow over. At the same time, the ethics and ideolog y of general equilibrium looks surely
fading away although it is not completely vanished. It is our regret, however, that the new,synthetic social science which can replace theexisting dogmatic doctrines is not in sight yet.
A completely new approach like a second
Knight or a second Keynes would urgently beneeded.
Key words: Knight, market thinking, generalequilibrium, ethics, ideology

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Autumn / Sep. 2017 / No.413

Frank H. Knight on Market Thinking

Yasuhiro Sakai

047