Adam Smith
Incantations over dead roosters
ECONOMICS 101 REDUX
An essay by Carter Jefferson
Still dizzy from wondering why the world economy crashed? This essay recommends books that may help you figure that out.
Despite the protests of at least a hundred faculty members and the grumbling of a good many alums, the University of Chicago plans to build a $200 million research center named for Nobel Prize winner Milton Friedman, surely the most influential economist of the late twentieth century. No doubt the university will build it, and thousands of campus visitors will be muttering “Friedman’s Folly” whenever they see the building.
If you took Econ 101, or whatever they called it in your day, odds are you got the full dose of free-market religion shoved down your throat. And your 401(k), not to mention your house, is now worth about thirty cents, because Friedman’s believers ran Wall Street for thirty years.
But it’s pretty clear now that George H.W. Bush was right when he spoke of “voodoo economics.” It’s easy to believe nothing short of incantations over dead roosters could have produced the meltdown we’ve seen over the past few months. The real reason, however, is that a phalanx of economists made some mistakes, and nearly everybody else went along.
How did it happen?
For the basics, read Adam Smith’s The Wealth of Nations (1776) and John Stuart Mill’s On Liberty (1859). Both of them argued that the mercantilist system that governed world trade in their days prevented economic growth by keeping production in the imperial homeland rather than letting anyone, anywhere, produce whatever he could produce more easily and cheaply, and then trade with all the others. But even Smith favored taxing the rich more than the poor, which modern free-traders deplore.
Free trade worked well—but not for everybody. It was the foundation of industrialization, with its great goods and almost equally great ills. Still, as Lord Chancellor Francis Bacon said, “There are never wanting some persons of violent and undertaking natures, who, so they may have power and business, will take it at any cost.” Smith and Mill never quite took account of that, though the evidence was easy to find.
“We’ve had panics since we’ve had trade.”
It’s no surprise that no matter what the reigning economic philosophy, we’ve had panics since we’ve had trade. One damn thing after another—the tulip mania of 1637 and the South Sea bubble (1720) get the most play, but they are just the stars. Check out Charles P. Kindelberger’s Manias, Panics, and Crashes: A History of Financial Crises (1978).
Leaving tulips behind, read Read Alan Tractenberg’s The Incorporation of America: Culture and Society in the Gilded Age. In that day, when the Panic of 1893 came along, President Grover Cleveland asked J. P. Morgan, the greatest capitalist of them all, to solve the problem, and he did, by borrowing gold and lending it to the government. By then we already had the Sherman Act (1890), but that was not enough. The muckrakers came along: Ida Tarbell is the star—she almost singlehandedly put a stop to John D. Rockefeller’s attempt to monopolize the nation’s oil production. Steve Weinberg’s new book Taking on the Trust, reviewed here in May 2008, does a fine job for her. Others, like Jacob Riis, Ray Stannard Baker, and Lincoln Steffens, all helped Teddy Roosevelt—a Republican—become known as a “trust-buster.” They all have biographers, and deserve them. If you think they exaggerated, read Upton Sinclair’s The Jungle (1905). It might remind you of some pig farms not far from where you live.
Here’s Roosevelt, in 1912, after he’d left the White House and decided to run as a “Progressive”:
The present conditions of business cannot be accepted as satisfactory. There are too many who do not prosper enough, and of the few who prosper greatly, there are certainly some whose prosperity does not mean well for the country.
That was after he’d broken more than thirty trusts. Edmund Morris has written two volumes of a biography: the first, The Rise of Theodore Roosevelt (1971), which won a Pulitzer prize, and Theodore Rex (2001). There are dozens of others that concentrate on various aspects of Roosevelt’s career.
The battle wasn’t over. Probably more has been written about the “Great Depression” that started in 1929, and Franklin Delano Roosevelt’s attempts to bring about a recovery, than any other economic event. Roosevelt ran on a platform that wasn’t spectacular, but he didn’t have to promise much; President Herbert Hoover was nearly as unpopular as George W. Bush is now. Once in office, he moved fast and virtually revolutionized the business climate.
Roosevelt introduced a host of new regulations on the market as well as a litter of social programs. His “New Deal” included the establishment of the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), and the Federal National Mortgage Association (Fannie Mae). Sen. Robert Wagner’s legislation gave unions more power to organize. Even with those moves, and all his social programs, Roosevelt wasn’t able to cure unemployment, even though his administration had pulled it down from historic highs. It still stood at 19 percent as late as 1938. Not until the US started helping the British and preparing for World War II did the depression actually end. Economist John Maynard Keynes, author of The General Theory of Employment, Interest and Money (1936), the guiding spirit of the world of economics between the wars, insisted that only government intervention could contain the horrors of periodic economic debacles.
To get the full picture read Jean Edward Smith’s FDR, the most recent biography. The Forgotten Man: A New History of the Great Depression by Amity Shlaes appeared in 2007, but The Great Crash of 1929 by John Kenneth Galbraith (1955) is a classic.
There were ups and downs through the period from 1950 to 1980, but ugly fights, first over civil rights and then over Vietnam , finally resulted in the election of Ronald Reagan and the beginning of the dismantling of Roosevelt’s reforms. By then proponents of the free market had gradually won over most economic thinkers. Most politicians simply followed the “experts.”
Economics is really a serial thriller.
Influential books paved the way. The Road to Serfdom (1944), F.A. Hayek’s passionate defense of freedom against socialism, communism, and fascism, has been read almost since its publication as an attack on “liberalism,” despite the fact that Hayek insisted he was not a conservative. Unfortunately, there’s not much room anymore for what he claimed to be: an “Old Whig,” a follower of Edmund Burke (Reflections on the Revolution in France, 1790). Burke has, rightly or wrongly, become another icon of the free-market believers. Hayek’s own explanation of his position, from The Constitution of Liberty (1960) is here. If modern free-market enthusiasts had read that, they’d have been gobsmacked. In 1957, Ayn Rand’s Atlas Shrugged seduced a great swath of readers who accepted Rand’s vision of a completely unregulated financial world.
President Reagan didn’t much like government. By that time Milton Friedman, who died only two years ago, had almost conquered the world of professional economics. His most famous book, Capitalism and Freedom (1962), is still a classic. By the 1970s his followers began to dominate the world of economics, and they have ever since. To him, any regulation of markets was anathema. One of those followers, Alan Greenspan, until recently chairman of the Federal Reserve system, has said he was “shocked” at the extent of the current unpleasantness.
Bill Clinton’s presidency did almost nothing to slow the tide of deregulation. A bill to wipe out close to the last of the anti-trust regulations imposed by the Glass-Steagall Act, which established the FDIC under Roosevelt, came up in 1999. Democrats first opposed it, but when it came out of the conference committee, it passed with a vast majority and Clinton signed it. I couldn’t find any mention of that in Clinton’s 1,008-page memoir (My Autobiography, 2004). That’s understandable—not many people had even heard of sub-prime mortgages in 2004. Little is left of the pre-Reagan pattern of regulations, though it seems that enough restrictions on trusts remain to slow down a proposed merger of Yahoo and Google for a while.
Today’s problem started with sub-prime loans, which many Democrats liked and lobbied for because they let people without much money buy houses, and everybody else liked because those loans kept money pouring in for everybody connected to the building industry, including both bosses and workers. Sure, it’s stupid to buy a house with a loan you can’t keep up the payments on, but it didn’t look that way when house prices went up, up, up, and never seemed likely to go down. Not only gullible buyers, but real estate agents and banks are paying for their failure to save for a rainy day—it’s snowing now. Add to that the market for derivatives, so-called securities made up of bundles of loans, credit-default swaps, and other esoteric financial creations that were said to be worth billions. Unfortunately, many of them turned out to be worth nothing at all. Almost nobody understands them, certainly not holders of a mere B.A. in economics from a long time ago like me, and apparently a lot of hedge fund managers who bought them didn’t understand them, either. But when one bundle went belly-up, that was the crash heard ’round the world. Loan money to somebody who has no idea how much collateral he has? Not a chance—not even if the guy asking for credit is from the biggest investment bank in the world.
Not everybody, not even all the professional economists, went along with Friedman and his so-called Chicago School. Joseph Stiglitz, Nobel prize winner and former chief economist of the World Bank, has been fretting for quite a while in the pages of The New York Times. Nouriel Roubini for years regularly predicted disaster in various articles. Naomi Klein violently attacked the free marketers beginning years ago; her book The Shock Doctrine, in which she blames Friedman’s “Chicago boys” for world-wide fiscal and political manipulations since the 1970s, appeared in 2007, and was reviewed here in January.
James Galbraith, son of the famed liberal economist John Kenneth Galbraith, also has excoriated the majority, and for some time has been giving liberals a hard time for going along with the Bush administration. His new book, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, published in August, offers a scathing critique of the Bush administration’s policies and a detailed plan for government action he believes would help end the current crisis.
Paul Krugman, this year’s Nobel winner, screamed bloody murder for several years. Here’s what he said about Friedman in the New York Review of Books:
In the aftermath of the Great Depression, there were many people saying that markets can never work. Friedman had the intellectual courage to say that markets can too work, and his showman’s flair combined with his ability to marshal evidence made him the best spokesman for the virtues of free markets since Adam Smith. But he slipped all too easily into claiming both that markets always work and that only markets work. It’s extremely hard to find cases in which Friedman acknowledged the possibility that markets could go wrong, or that government intervention could serve a useful purpose.
Warren Buffet, the richest man in the country, called the new derivatives “toxic” several years ago. Not many people listened to him. Charles R. Morris wrote The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash last year; it was published in March. Most economists and politicians ignored the attacks on Friedman’s doctrines. Now that these predictions have come true, there will be lots more books that explain the disaster—or try to.
But what really happened was that vast numbers of well-meaning people, including Milton Friedman, did what they thought was best. A few who matched Bacon’s definition of “persons of violent and undertaking natures” took advantage of others, but most of the true believers were not that. Barnum knew what to call them, and, sad to say, dozens of them must have been born every thirty seconds during the past century.
Most undergraduates seem to think economics is a bore. Read up on it, however, and you’ll find it’s really a serial thriller. Unfortunately, I can’t tell you how the meltdown and its results will all come out, but nobody else can, either. Keep turning the pages. Just remember what the comedian Will Rogers is reported to have said: “An economist’s guess is liable to be as good as anybody else’s.”
Carter Jefferson, editor of The Internet Review of Books, has a B.A. in economics from The George Washington University and a Ph.D. in history from the University of Chicago, both BFE (Before the Friedman Era).
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