On September 15, 2008 Lehman Brothers Holdings Inc., a global financial services firm, headquartered in New York, with regional headquarters in London and Tokyo, and with offices located throughout the world, filed for Chapter 11 bankruptcy protection following a massive exodus of most of its clients, drastic losses in its stock, and devaluation of its assets by credit rating agencies. The filing marked the largest bankruptcy in the history of the United States. As a classical liberal political economist, I experienced sadness for those adversely affected, but qualified optimism for laissez-faire capitalism. After all, this is how markets are meant to work, with bankruptcy serving as a cleansing agent in the process of creative destruction that underpins wealth creation under competitive conditions. My qualifications concerned only the robustness of this outcome. Would government, in a state capitalist system driven by special interest politics, actually allow Lehman to go down? My public choice instincts correctly told me that the story had only just begun.
Well, the demise of Lehman surely was only the early beginnings of a fascinating journey that would descend into the lowest depths of special interest politics, that would challenge the most fundamental precepts of individual freedom under the rule of law, and that would confirm my judgment on the validity both of the Virginia political economy program and of the Austrian economics perspective on the nature of the business cycle. For many post-Hayek, post-Friedman Chicago economists, however, September 15, 2008 and its aftershocks were viewed in an entirely different manner; as ‘The End of Days’, or as ‘The Day of Judgment’.
Chicago economists, for the most part, had long abandoned Friedrich von Hayek’s focus on the limitations of knowledge and the associated coordination problem in market process and the inevitability (and value) of periodic booms and busts in a market economy. Under the unsophisticated leadership of Robert Lucas, they now adhered to the nostrum that all business cycles are real, that all are caused by supply shocks, and that economies proceed at full Pareto-optimality through the short-term adjustments that follow outside shocks. They had rewritten the histories both of the Great Depression and of the 1981-83 recession to fit the fable that the American workforce had simply enjoyed extended vacations while searching for the best available deals among a fully satisfactory range of job opportunities. Soup kitchens, what were soup kitchens, other than as opportunities for recreational meetings?
Chicago economists, for the most part, had long abandoned Milton Friedman’s love of liberty, replacing it with George Stigler’s and Richard Posner’s love of wealth as the highest ethical value of mankind. They had re-written recent history to embrace the growth of the giant corporation and to rejoice in the growing inter-relationships between corporations and governments in a wealth-creating symbiosis. How they had rejoiced in the 1999 dismantling of the Glass-Steagall Act, legislation that had unnecessarily impeded the merging of retail banking with casino investment banking to the detriment of Wall Street profit-making! ‘Accumulate, accumulate! That is Moses, and all the Prophets!’ Karl Marx, Das Kapital
Chicago economists, for the most part, had long forgotten the deep suspicion of the coercive power of government written into the genetic codes of Hayek and Friedman. Instead, they had imbibed deeply from the hallucinogic potions of George Stigler, Gary Becker and Donald Wittman that imbued them with Panglossian visions of the wealth-maximizing qualities of democratic politics and of the wondrous healing nature of Ricardian- equivalence with respect to accumulating budget deficits.
So, when the Day of Judgment finally arrived, Chicago economists, for the most part, were shocked and ill-prepared. Slowly it began to dawn upon them that the corporatist lunch to which their tastes had become so well -adjusted might be high cost rather than free, that the grass really might be greener on the laissez-faire side of the street, and that individuals really might behave better under conditions of competitive capitalism than under conditions of a social market economy. But these were merely feelings; and emotion should play no role in a discipline that was dedicated to the primacy of rational choice. What to do, what to do?
Well, Robert Lucas, perhaps wisely, decided to head for cover, and to avoid potentially embarrassing interviews with aggressive journalists, now loaded for Chicago bear. Eight others allowed themselves the mixed blessing of interviews with John Cassidy, an ‘American Idol’ exposure to the progressive-leftist columns of The New Yorker. Let me close the discussion with a balanced and representiative set of statements emanating from two of these interviews, one with Richard Posner, the other with Gary Becker, identifying the far left and the moderate right positions on the Chicago faculty:
Cassidy to Posner: ‘Has your critique of the efficient markets hypothesis made you rethink your view of markets outside of finance?
Posner to Cassidy: ‘Even before this, I had become less doctrinaire about markets. For example, one of the topics Gary Becker and I debated on our blog was New York City’s ban on transfats. I supported that. The country has an obesity problem. I didn’t think that just listing the amount of transfats on a menu would deal with it – people don’t know this stuff. I thought a ban, even though it violated freedom of contract, made sense.’ (my italics)
Cassidy to Posner: ‘What about Chicago economics in particular? At this stage, what is left of the Chicago School?
Posner to Cassidy: ‘Well, the Chicago School had already lost its distinctiveness. When I started in academia – in those days Chicago was very distinctive. It was distinctive for its conservatism, for its 1968 fidelity to price theory, for its empirical studies, but not so much for formal modeling. We used to say the difference between Chicago and Berkeley was Chicago was economics without models, and Berkeley was models without economics. But over the years, Chicago became more formal, and the other schools became more oriented towards price theory, towards micro. So, now there really isn’t a great deal of difference….I’m not sure there’s a distinctive Chicago School anymore.’
Cassidy to Becker: ‘Posner says that the government’s interventions have staved off another Great Depression.’
Becker to Cassidy: ‘it’s been long recognized that there are situations when you need very strong, temporary government intervention. [Policy-makers] did come in here, and they did help. It was a very mixed bag of different policies. I don’t blame them too much for that. It was a novel situation and they were experimenting a lot. I definitely think they helped, though, overall, in averting a much more serious recession.’
Cassidy to Becker: ‘Two of the big theories associated with Chicago are the efficient-markets hypothesis and the rational-expectations hypothesis, both of which, some say, have been called into question. How do you react to that?‘
Becker to Cassidy: ‘Yeah, markets aren’t fully efficient. Expectations go wrong. We’ve seen many other episodes in the past where expectations have gone wrong, where it looks like there were bubbles that happened. Certainly, in the housing market it did look like there was a bubble going on, and people were anticipating prices still going up. Nevertheless, the notion that people are forward looking and try to get things right, and often they do get things right – I still think that comes through O.K. You just have to be more qualified and more careful how you state it.’
Cassidy to Becker: ‘Lots has changed at Chicago in recent years. What if anything is distinctive about Chicago economics these days?
Becker to Cassidy: ‘It’s not as distinctive as it was when I graduated with my Ph.D from Chicago. In those days, there was a great belief in the price system, in people’s incentives, and in linking theoretical research to empirical research. That wasn’t common at most of our competitors. Both in micro and in macro, there were major differences. Chicago was hostile to Keynesian economics when I was in graduate school. Now there’s been a lot of convergence, particularly on the micro side of things. Chicago is less unique than it used to be.’
Cassidy to Becker: ‘How do you think that the financial crisis will change economics? The nineteen-thirties revolutionized economics. Do you see that sort of change?’
Becker to Cassidy: ‘No, not of that magnitude. If this recession had got a lot worse, we would have seen two major changes: much more government intervention in the economy and a lot more concentration in economics in trying to understand what went wrong. Assuming I’m right and, fundamentally, the recession is over – a severe recession but maybe not much greater than the 1981 recession, or those in the nineteen-seventies – I think you are not going to see a huge increase in the role of government in the economy. I’m more and more confident of that. And economists will be struggling to understand how this crisis happened and what you can do to head another one off in the future, but it will be nothing like the revolution in the role of government and in thinking that dominated the economics profession for decades after the Great Depression.’
Cassidy to Becker: ‘Some people in Chicago don’t accept the too-big-to-fail doctrine. They say, “Let them go.”‘
Becker to Cassidy: ‘I think in this crisis we had to do it (bail them out). I don’t accept the view that in this crisis we should just have let everything fall where it may. Yeah – the economy would have picked itself up, but I think it would have been a much more severe recession.’
‘And we’ll tak a cup o’ kindness yet, for auld lang syne.’ Robert Burns, A Scottish Poem, 1788
Tags: Day of Judgment for Chicago economics, New Yorker interview with Gary Becker, New Yorker interview with Richard Posner, the loss of wisdom
April 27, 2010 at 11:06 am |
Did I miss your discussion of ricardian equivalence?
Deficits? Who cares about them? Cutting marginal tax rates will improve efficiency. If this results in less revenue, cutting government spending might be better than not, but failure to do so just means private saving rises. (Of course, from the Stigler perspective, it must be that we value the government projects more than the private consumer goods we will be sacrificing.)
April 27, 2010 at 12:29 pm |
Bill:
As usual, you are spot on. I had over-looked Ricardian equivalence. I have slipped the point into the text of this column, following up on your thoughtful reminder. Thank you very much!
April 27, 2010 at 9:22 pm |
“…had long abandoned … love of liberty, replacing it with … love of wealth as the highest ethical value of mankind….”
If there was one sentence, Prof. Rowley, that expresses the entirety of the struggle, this is it.
The “Left” complain that those that want fiscal conservatism are really “money hungry” and unwilling to protect the disadvantaged if it costs a dime.
And with a core change in the philosophy of virtue as you’ve highlighted, they are exactly right.
The “Right” look upon the Left as economically illiterate and rally – not on arguments of freedom and liberty – but only on arguments of money! “You will bankrupt us!”, the “Right” cries. And they are right.
But both sides have forgotten that without liberty – we are already bankrupt morally.
And Liberty stands without defense as these two sides artillery lays waste to the home of the free.
Brilliant post, sir!
April 29, 2010 at 12:32 am |
@BlackFlag, actually you are quite wrong on all accounts, especially in your understanding of a movement that is neither Left nor Right, but Middle of the Road. You are wrong when you claim it is just about money and you are wrong in your claims that those who are standing up to be counted are doing so out of some sort of greed.
These people recognize that there is only so much money available in the pot. If the Govt increases taxes then that is money that is not available for either Savings or Investment. These are the people that have seen their 401(k)s diminish rapidly. Even here in Australia we are having the same kind of problems with our superannuation savings. My husband has taken a very big hit over the past 2 years.
However, let me get back to the point regarding the relationship between G(ovt) and Private Industry. When T increases there is less money available for re-investment and when there is less money available for re-investment that inevitably leads to a decrease in employment, especially when old equipment becomes so old that it needs replacing but cannot be replaced because of the lack of investment. Also, when T is raised there is less money available to create new private sector jobs.
The private sector is necessary because it is only through the private sector that we see an increase in competition. Even when competition is not perfect it is better than having either a monopoly or oligopoly – think here about the oligopoly of the oil industry (OPEC) because they have a lot of control over both the price and production of oil.
The money hungry are not the fiscal conservatives. In fact the money hungry are usually those leftist rapacious governments that spend taxes by wasteful means. It is truly quite the opposite to what you state.