Throughout the third quarter of the twentieth century, the Chicago School played an indispensable intellectual role in defending laissez-faire capitalism from the predations of state capitalism and socialism. As a by-product, the Chicago School also became a foremost defender of economic liberty. The Chicago School advanced this innovative program of ideas through reliance on a sensible rational choice approach, the pre-eminence of private property rights and the rule of law for sustainable economic development, sound microeconomics, and macroeconomics reflective of classical political economy insights adjusted for the adverse experience of the Great Depression. Under the indisputed intellectual leadership of Friedrich von Hayek and Milton Friedman, with the support of Ronald Coase, Harold Demsetz, William Landes, Sam Peltzman, Harry Gordon Johnson, Richard Epstein, Al Harberger, and many younger rising stars, Freshwater Economics engaged and defeated Saltwater Economics in a bloody battle for the soul of the discipline.
Even during that crucial quarter of a century, however, Chicago was spawning the seeds of its ultimate demise, with the hiring of less subtle thinkers such as George Stigler, Eugene Fama, Gary Becker, Robert Lucas, and Richard Posner, each of whom seized eagerly upon the new ideas of their more creative colleagues and progressed within the economics profession by pushing those ideas too far. George Stigler forgot his own important insights on the limits of knowledge and ended up by deconstructing political economy into a near-tautology that ‘what is is efficient’. Eugene Fama became so impressed with the quality of his own mind that he forgot reality and advanced the notion that capital markets are strong-form efficient. Gary Becker became so enamored with his mentor George Stigler that he joined him in the new Chicago Political Economy program by analysing interest group behavior as welfare-enhancing agents of the public good. Robert Lucas carved out a Nobel niche for himself by pushing rational expectations thinking to insane limits. And Richard Posner – well how can I describe the contributions of Richard Posner in a column designed for family readership?
So the seeds for decline and fall were well-embedded into the Chicago economics program by the mid-1970s, awaiting only the exodus of Hayek and Friedman in order to explode into dominance. By the mid-1980s, the new Chicago was in full flood, now dominated by Stigler, Becker, Lucas, Posner and Fama. Democratic political markets were not just politically efficient, but wealth maximizing for society. Interest groups were agents of the public good. Capital markets were universally strong-form efficient. Western macroeconomies were Pareto-optimal throughout the real business cycle. The common law had evolved (in the United States at least) into a wealth maximizing agent of economic development. Think about the Hubris of such shallow thinking, Dear Readers, and just know that Nemesis was out there waiting in the wings.
Well, Nemesis moved center-stage in September 2008. In tomorrow’s column I shall begin to address just where those Chicago over-achievers and their new accolytes have ended up, following the shattering of their ill-founded fantasies.
Tags: Chcago School Economics, Chicago School Political Economy, interest groups as agents of the public good, rational expectations, strong-form efficiency of capital markets, the wealth maximizing common law, what is is efficient