Roughly speaking classical political economy, or economic orthodoxy, taught the following: private property, freedom of contract and trade, sound money, and fiscal responsibility. For our purposes we refer to this set of policies as the lassize-faire principle. Of course throughout the history of economic ideas there were always subtle differences of opinion within orthodoxy, and fine points of disagreement in method and methodology. But these paled in comparison with the broad consensus on matters concerning the nature and signficance of economics and political economy. Yes, John Stuart Mill had exceptions to the laissez-faire principle that one could drive an intellectual truck through, but re-read how he sents up that discussion and the importance he places on the laissez-faire presumption.
Orthodoxy from Adam Smith onward was suspicious of the claims of those who argued that deviations from the laissize-faire principle were required, and especially so if the claim was made that they should have the power to act in violation of that principle. Think of the laissze-faire claim as basically saying: individuals should be free to choose within the bounds of a system of property, contract and consent, and that within that rule regime markets are self-regulating to such an extent that errors are detected and corrected, and inefficiencies will be weeded out, and the gains from trade and the gains from innovation will constantly guide the processes of exchange and production toward the efficient solution. Economic forces are forever working in the selective process of the market economy to improve the material well-being of the consumer as they judge that for themselves.
Throughout the history of the discipline many voices rose in opposition to this message, but while many were heard, none changed the core teachings of economic orthodoxy. Not Malthus, not Marx, not Veblen. But Keynes proved successful where the others did not, and his efforts resulted in a great intellectual shift in the way the teachings of the classical political economists were thought of, and the way that modern economics was taught, practiced and applied. What was once held with suspicion, was now the norm, and what was once the norm, was now viewed with suspicion.
Keynes was not, I should stress, arguing that we should abolish the private property market economy as say Marx did. He simply said that markets are prone to financial instability, that there is no reliable self-regulating mechanism in those situations, and that governmental intervention into the system can fix the problem. Whereas the classical political economists were optimistic about the market's self-regulating capacity, and pessimistic about government's ability to intervene effectively (for a combination of incentive issues and informational issues), Keynes and the Keynesians argued the opposite --- they were optimistic about government's ability to intervene to manage aggregate demand, and they were pessimistic about the market to self-regulate in the face of a liquidity crisis to maintain full employment levels of output.
The relative optimism/pessimism issue is in many ways the critical issue involved in these debates. And we should keep that in mind always when discussing The Clash of Economic Ideas [btw, best book you can read on the modern history of thought and its relevance to the disputes our day]. I am a classical political economist in my balance of optimism about the market, and pessimism about politics. If someone was to label me a classical political economist, then I could hardly complain though of course this would be inaccurate on subtle points of doctrine. It would not be an insult to me, but in some broad brush sense painting me accurately. So I don't consider it a cheap shot or insulting when I label folks "Keynesians". If the shoe fits, then wear it. If you believe that markets are prone to macroeconomic instability that will not be self-corrected, and you believe that positive actions by the government can in fact fix the situation, then broadly speaking you are adopting the Keynesian stance.
It is in this spirit that I wrote my op-ed last week about Janet Yellen and her ascendency to the head of the Fed. There is no doubt that Yellen is an economists of great accomplishments within scientific and public policy economics. All of us who are ambitious and enter into the competitive game of professional economics would dream of a such a successful career in these different realms. But she is a Keynesian economist and she will do in her position of power what a Keynesian economist would do. She believes markets are prone to failure, and that government can engage in pro-active measures to fix the failure. She is pessimistic about markets, but optimistic about politics.
How do we adjudicate between the different balancing of optimism/pessimism? Especially if we take seriously the problems with assuming unambiguous statisical testing of theories in the sciences, what are we to do to make progress? Well, the first test is theoretical coherence, the second is correspondence. It is about weighing theory and history, and trying to think through what argument or evidence would persuade you to the opposite so that you don't just suffer from confirmation bias. It isn't as easy as everyone outside of the science believes it to be, but that is true for natural scientists as well as social scientists. Science and scholarship are endeavors of ongoing discovery and quests for truth tracking. I sincerely believe that my balance of optimism/pessimism is justified by theory and history, and I am pretty sure that Prof. Yellen would say that as well. Fortunately for me, my intellectual mistakes result only in my downgraded professional reputation. But for Prof. Yellen, her intellectual mistakes can downgrade an entire economy. So as she weighs her optimism/pessimism I'd like to suggest she contemplates 2 quotes from the main representatives of the classical political economy perspective in the second half of the 20th century -- F. A. Hayek and Milton Friedman.
"[T]he main point about which there can be little doubt is that Smith's chief concern was not so much with what man might occasionally achieve when he was at his best but that he should have as little opportuity as possible to do harm when he was at his worst. It would scarcely be too much to claim that the main merit of the individualism which he and his contemporaries advocated is that it is a system under which bad men can do least harm. It is a social system which does not depend for its functioning on our finding good men for running it, or on all men becoming better than they are now, but which makes use of men in all their given variety and complexity, sometimes good and sometimes bad, sometimes intelligent and more often stupid. Their aim was a system under which it should be possible to grant freedom to all, instead of restricting it, as their French contemporaries wished, to 'the good and the wise'." F. A. Hayek, Individualism and Economic Order, 1948, pp. 11-12.
"Any system which gives so much power and so much discretion to a few men that mistakes -- excusable or not -- can have such far reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic -- this is the key political argument against an 'independent' central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an 'independent' central bank. To paraphrase Clemenceua, money is too important a matter to be left to Central Bankers." Milton Friedman, Capitalism and Freedom, 1962, pp. 50-51.
I don't expect these quotes to shake Prof. Yellen's faith in Keynesian solutions, but I can hope it might make her trace back the modern political economists concern with rules versus discretion back to the classical political economists concerns with the "man of system" and especially the danger implicit in the situation when those who assume that position of power actually "have the folly and presumption enough to fancy himself fit to exercise it."