Economists Tackle the Economic Crisis: II

A good, old-fashioned crisis of capitalism – a disruption that rocks the whole system – produces one salutary result: wiser heads, serious students begin to re-examine widely held assumptions and popular theories of political economy. For those few, this may mean dusting off old copies of the works of Keynes, Schumpeter, or Minsky, and – only too rarely – Marx. For the honest observer, the crisis is an opportunity for a deeper understanding of the capitalist mechanism and its direction.

But others cling to the comforting views of infallible markets and perfect rationality that prevailed until recently, while amending their theories with warning labels touting the current crisis is a special case falling outside of the economic canon. Most economists, pundits, and policy makers fall into this latter category. They got it wrong and they continue to get it wrong. They have too great of an investment in the ideologies, careers, and honors of the past.

There is now a long list of books and papers offering explanations, in part or wholly, of what went wrong with the global economy. The worst of these offer simple and immediate answers: evil bankers, irrational borrowers, lax regulators, etc. The best offer longer and deeper views that locate problems in the evolution of capitalism and its inner mechanisms. They contest the too human urge for simple answers and easy solutions. This is the second in a series of commentaries on the views of various economic writers on the economic downturn. Zoltan Zigedy

A recent article in the New York Review of Books gives an opportunity to examine the views on the economic crisis of three different writers (“Two Roads to Our Financial Catastrophe”, 4-29-10). Benjamin M. Friedman, William Joseph Maier Professor of Political Economy at Harvard, offers many of his views while discussing current books by John Cassidy, a staff writer at The New Yorker (How Markets Fail: The Logic of Economic Calamities, 2010) and John Lanchester, a UK novelist and journalist (I.O.U: Why Everyone Owes Everyone and No One Can Pay, 2010).

Friedman emphatically dispenses with some of the closely held myths of modern capitalism: the responsible governance of corporate management and self-regulation. He thoughtfully sketches the evolution of banking from high liability partnerships - personally funded and personally liable to risk - to complex, multi-functional, risk-happy behemoths playing with “other people’s money”. His useful account emphasizes the departure from the textbook explanation of banking as funding economic activity, the “basic economic function of providing capital to either individuals or businesses”, in his own words. What he does not emphasize is the actual, less seemly, goal of banking, namely, making a profit. Thus, he is left with an arresting story of the transformation of banking from the early eighteenth century until today, but with no cause for that development. The changes from low, to limited, to virtually non-existent liability; the movement from self-financing, to joint stock financing, to massive assumption of debt (“other people’s money”); the development from risk-aversion, to calculated risk, to risk abandon; seem, on his account, to be mere historic accidents flowing from the peculiarities of the minds of bankers. In fact, we know, and undoubtedly Friedman knows, that the force producing these changes is an unbridled drive for greater and greater profits and – if Marx is right – a desperate attempt to combat the tendency for the rate of profit to decline.

Speaking the unspoken – the critical role of profits in banking -challenges the textbook explanation of banking and suggests the dangerous questions: Doesn’t funding vital economic functions conflict with profiteering? Do we really need profits in “providing capital to either individuals or businesses”? And most dangerously, shouldn’t the banks be publicly owned? Friedman does not wish to address these questions; instead he prefers to regulate the banks – save capitalism from the capitalists.


John Cassidy

“To John Cassidy, a fine journalist with a long standing interest in economic and financial matters, the explanation [of the crisis] is intellectual; the increasingly dogmatic and unquestioning belief, on a priori grounds, in the efficiency – indeed, the rightness – of free markets and the outcomes they produce.”, recounts Friedman. Cassidy castigates what he calls “utopian economics”, blaming such iconic writers of the right as von Hayek, Milton Friedman, Ayn Rand, and the hand maiden of these devilish ideas, Alan Greenspan. The problem with this explanation – like all explanations that pin blame for an historic event on individual figures – is that it purchases easy agreement and a comfortable scapegoat at the expense of deeper understanding, context, and the play of social forces. One could as easily attribute the repression of the nineteen fifties to Joe McCarthy, while ignoring the growth and influence of a massive anti-Communist, anti-working class offensive after World War II. A proper explanation would go deeper and explain the causes and conditions that gave rise to this offensive. Similarly, the causes of the financial crisis no doubt owe some debt to the influence of these neo-liberal figures blamed by Cassidy, but their ideas have been around for some time. Why did they gain near dominance at this time? What were the social and political circumstances that allowed their ideology to plant deep roots in the thinking of the governing class, the media, the academy, and much of the public?

Equally, the notion that the behavior – or misbehavior - of the corporate world runs on a track determined by “intellectual strands” overestimates the influence of the views of public figures, even a Federal Reserve chief, and underestimates historic changes in the trajectory of US capitalism, a trajectory determined by previous crises, historical changes (see Lanchester below), shifting balances in social and political forces, and, in the final analysis, capitalism’s thirst for profits.

Friedman takes up what he calls the “centerpiece of Cassidy’s analysis”, the popular susceptibility to “rational irrationality”. Friedman describes this as “a situation in which each influential actor does only what makes perfect sense from an individual perspective, but the combined effect of everyone’s acting in this way leads to outcomes that make sense to no one”. This sounds tantalizingly close to a point I made in the first installment of this series, citing a common error by academic economists that I dubbed the “fallacy of aggregation”. But it is not the same point.

Instead, Friedman and Cassidy are referring to the influence of incomplete or unshared knowledge in individual decision making, a problem that, according to economists of one school of thought, thwarts markets from achieving completely rational or efficient results. In Friedman’s words, “Cassidy is pointing to problems of collective action. Individuals, acting purely on their own, can’t arrive at outcomes that they would all prefer if they had ways of sharing information, making joint decisions, and coordinating their actions. The problem is a classic staple of economic analysis…”

But if they had complete knowledge, made joint decisions, and coordinated their actions, their behavior would be collective rather than individual! In other words, one cannot rescue the individual, self-serving behavior of capitalist enterprises from the charge of irrationality, by simply acknowledging that their behavior would be rational if they would work together. This merely begs the question. If lions would not devour their prey, they would not be lions; and if capitalists would share information, make joint decisions, and cooperate, they would not be capitalists. And we would be warranted in asking the question: who needs them?

For both Friedman and Cassidy, the default position is to assign the role of referee to the government. Government regulation is the magic coordination that will convert rational, self-interested behavior into equally rational, other-directed behavior, breaking the grip of the fallacy of aggregation. Through the mechanism of government intervention, individual pursuit of self-interest will generate the collective interest.

But both writers assiduously sidestep the issue of who owns the government. If, as the details of the crisis strongly suggest, the influence of the most powerful corporations, a desperate fear of their failure, widespread corruption, and a money-driven two-party system determines the referees, then government regulation will fail as surely as it has over the last, many decades. Without addressing this problem, regulation is a mere chimera.


John Lanchester

In spite of not being a professional economist – no, because he is not a professional economist – Lanchester provides a fresh, unique, and deeply insightful perspective on the economic crisis. His transcends the often wooden, conventional approach writers acquire from drinking from the same academic well. His views are – quoting Friedman – “more deeply rooted in the political evolution of our contemporary Western society.” Further, Friedman elaborates, “Lanchester believes that the ‘essential precursor’ to what happened [the crisis] was the collapse of international communism, including in particular the demise of the Soviet Union.” From Lanchester’s book, quoted in the NYRB article:

The way in which the financial sector was allowed to run out of control… took place not in a vacuum but in a climate. That climate was one of unchallenged victory for the capitalist system, a clear ideological hegemony of a type which had never existed before… The good guys won, the beauty contest came to an end… The Wall came down, and, to various extents, the governments of the West began to abandon the social justice aspect of the general postwar project… Under these circumstances, it could have been predicted that the financial sector, which presides over the operation of capitalism, was in a position to begin rewarding itself with a disproportionate piece of the economic pie.

Though these would not be my words, I have not seen anything like this thesis in print anywhere outside of my own writings. Blinded by deeply ingrained anti-Communism and anti-Sovietism, economic historians pass over the disappearance of the world’s second biggest economy without seeing any profound effect upon the course of economic history. Shuttered by the dogmas of academic economics, they do not notice how awkwardly the Soviet socialist economy fit into the global capitalist market. Mired in triumphalism, they overlook how the Soviet Union influenced economies, not only in the socialist community, but in many developing countries. In a world of IMF and World Bank loans, they forget that socialist economies offered credits, often resembling barters, which were vastly different from the exchange relations defining market transactions. Well over a third of all economies participated to some degree in these relations. Yet for the typical economic writer, these awkward facts bear no impact on the post-Soviet period.

Lanchester deserves high praise for intruding his perspective into the smug world of Nobel laureates, policy makers, and pundits, but he only touches upon the broad implications of the Soviet Union’s demise for the direction taken by the world economy over the last two decades. It is not just the victory of one rival opening the floodgates to rapacious behavior, but also the opening of vast new markets to capitalist penetration. It is also the removal of impediments to trade and the creation of new instruments lubricating the flow of goods and capital. It is new relations between labor and capital and a shift in the balance of power between them. New divisions of labor between nation-states have emerged as a consequence of the demise of a unique social system offering alternative economic relations. All of these factors help shape the current economic moment; all of these factors are largely ignored by those studying that moment, explained, instead, by the slippery and vacuous notion of “globalization”.

We need much more research into the economic upheavals in the wake of the Soviet collapse and their consequences for the world economy, but I am skeptical that conventional economists will make the effort.

Lanchester is a skillful wordsmith, penning memorable metaphors: “Assume that capital is like a virus and its motivation is to replicate; it wants to grow.” I think Marx would like that…

Giving Friedman and Lanchester the next to last word: “But if Lanchester is right – if the underlying force at work is the mindset resulting from the triumphant emergence of Western-style finance capitalism as the credible way to organize economic activity – then prospects for meaningful reforms anytime soon are surely limited. As Lanchester puts it, ‘The rich are always listened to more than the poor, but that’s now especially true since, with the end of the Cold War, there is so much less political capital in the idea of equality and fairness.’”

Then it is surely time to opt for a different “mindset” that embraces “equality and fairness” – the mindset of socialism.

April 27, 2010
Zoltan Zigedy
zoltanzigedy@gmail.com