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Such is the burden of free-market economists. Having to explain again and again and again that those social and economic problems are not the consequences of capitalism but of State interventions that prevent capitalism from functionning.

My conjecture:

(1) Of the two *non-mainstream* schools, Austrians or Post Keynesians, who will appear to have won the theoretical debate over the next five years? POST KEYNESIANS. See, esp. Hyman Minsky's (1982) book, Can "It" Happen Again? Essays on Instability and Finance. I'm sorry, but that explanation will beat Mises, Hayek, and Rothbard's business cycle discussions, and also Roger Garrison's wonderful updating in his Time and Money book.

(2) Of the two non-mainstream schools, Austrians or Post Keynesians, who will win the "what should we do next?" policy debate? POST KEYNESIANS. (More likely will be the closer-to- the-mainstream New Keynesians, a la Stiglitz variety.) A more insistent call for the general socialization and regulation of aggregate investment.

Should it be this way? Will I desire such an outcome? Will I think the interpretations of the Austrian explanation will be careful and reasonable? No.

Have any Austrians tried to come to terms directly with Minsky's work? I mention it in the bibliographical essay at the end of one of my edited books, as a should read for the Post Keynesian perpective. I think Tyler acknowleged it quite a while back on his blog, but I don't recall an attempt at an Austrian criticism (certainly not a full-blown one). A specialist in Austrian Macro (Steve....) ought to take this wonderful opportunity to sustain a serious reading and argument now. Perhaps several Austians, maybe even with serious PK replies, through a special issue of the RAE (Pete....).

Finally, if I think my conjectures are correct, how can I consider this to be a "wonderful opportunity"? I'm not sure... maybe the boys can hone their skills, carefully rethink the macro theory. But, if it essentially repeats the macro theory, and essentially repeats the (obviously true to us) empirical claim that we do not have a free market economy), I think we will lose.

Ah, what the hell, let me be my own critic for a moment:

"If we don't repeat the basic theory -- which still seems to hold, Dave -- and we don't repeat our correct claim that we haven't had a free market economy for decades, what in the world do you expect us to do?"

My reply to that critic:

I am not sure. But, I believe, if we essentially repeat and repeat, we are likely to repeat our failures.


"So, you're saying we should come up with something that is further from the truth, just to trip up our opponents."


I have not implied that, let alone said it! We need to work with our "truths" and build much further upon them, rather than repeat and repeat and repeat them, Frank Knight notwithstanding to the contrary, otherwise I truly think we will lose... again.

Now off to a partridge (grouse for many of you) hunt with my boy!

"privatized profits and socialized losses" nice description of economic system ruling the world. I am just reading Rothbards's Power and Market and it really seems that the discussion is the same for decades - economists (at least the academic mainstream) promoting free market (promoting it's not a right word, because there should be no ethic conclusions in economy...) vs. the public believing in necessity of mixed economy. Despite not agreeing always with Rothbard, I believe this crisis has nothing to do with "unregulated" market...

From a casual look to the Wikipedia page on Hyman Minsky, I do not see how Minsky's explanation could beat the Austrian theory of business cycle, except for people who want to believe that capitalism is the problem and State the solution.

"Endogenous bubbles" ? "Speculative euphoria" ? But where does the money come from ? And what is the role of the rate of interest ?

I agree nonetheless with D. Prychitko that his work deserves a scientific critique from an Austrian point of view.

Hyman Minsky is already the theorist de jour. So it is a no-brainer that Austrians need to be (a) intimately familiar with his doctrines, and (b) find the holes in the argument where there are some and expose them.

But I do want to disagree with Dave --- I do not believe the post-Keynesians will win out intellectually on this episode. The policy reality is that statism has grown over the Bush years, not fallen. But even Naomi Klein is not pushing a Minskyesque interpretation of these recent events. So while Minsky is the theorist de jour, his ideas are not what is being used to explain the current crisis even among the more or less major critics of capitalism in the media. Yes, there will be an academic submovement that will holds up Minsky, but the question becomes will those ideas (a) spread to a significant portion of professional economists, and (b) will they translate into the public imagination.

I don't take White's original quote that Horwitz relied on to start his post as "repeating one more time with feeling" the old and tired Austrian argument. I see it as being just plain old economics. Remember while there may be macroeconoimc problems there are only microeconomic explanations and solutions!!! Greed doesn't cut it, neither does "everyone got stupid at once" work.

Who will control the interpretion of the events will be that person (or persons) who have the most detailed command of the facts and is able to shift those facts through the lens of correct economic theory.

In short, it is not going to be the generation of economists from Horwitz forward that will determine the fate, it will be the economists currently entering the profession (and will do so over the next 10 years) that will. It is among those entering where we will see the new work --- that takes what was previously done (e.g., Hayek 1931, 1939; Garrison 2000, Horwitz 2000) and translates that work into something new and for a new set of problems. Economic science is not backward looking, but always forward looking as an ongoing process of intellectual evolution.

Lets hope we have the talent and courage among the new generation of economists who can correct the errors. As Henry Simons once put it: "economics is useful as a prophylactic against popular fallacies." Right now the 'condum factor' has had some 'product tampering' in the production process which must be addressed and eliminated. We have our work cut out for us.


Steve links to two blog posts by Robert Higgs. In one, Higgs worries about "the abyss of . . . full-fledged, Mussolini-style economic fascism." You bet. And not only *economic* fascism. We will see, very soon perhaps, political actors loudly protesting that only good security risks should be considered good credit risks. I fear such calls will be answered and that the Department of Homeland Security will intervene in credit markets. We are moving toward a fully politicized market the dangers of which are hard to exaggerate.

Well, to be more persuasive, you have to write a careful and in-depth analysis of the crisis and its causes. Mere "desperate" ideological cries / sloganeering will not suffice. :(

Is it so clear that the market doesn't share any blame in what is happening? Sure the political failure was obvious and severe, but financial markets have a lot of externalities, and failure in them as well doesn't seem unlikely.

With public choice in mind, it doesn't seem prudent to recommend a political solution just because a market fails, but that doesn't mean we can't admit to problems in financial markets.

Also, what to do about the "too big to fail" phenomenom:

"The most troubling aspect of financial consolidation is its effect on “systemic risk” (i.e., the risk that the failure of a major financial institution will severely disrupt the financial system and have adverse “spillover” effects on the general economy). Over the past three decades, large U.S. banks have consistently adopted more aggressive strategies as they have grown in size and complexity. Throughout this period, compared with smaller banks, major U.S. banks have operated with higher leverage, less liquidity and a more risky asset-liability mix. This correlation between bank expansion and increased risk is not a uniquely American phenomenon. A recent study concluded that the largest banks in twenty-one developed nations (including the U.S.) engaged in more risky activities and faced a greater probability of insolvency during 1988-98.

The willingness of governments to protect uninsured depositors and payments system
creditors of “too big to fail” (“TBTF”) banks undoubtedly encourages major banks to assume greater risks. Studies have shown that the TBTF policy confers a significant implicit subsidy on big U.S. banks, because (i) it allows them to pay below-average rates to depositors and other creditors, and (ii) it shields them from effective market discipline, despite their below-average capitalization and above-average risks."

Arthur E. Wilmarth, Jr.: Controlling Systemic Risk in an Era of Financial Consolidation, pg. 13,

Should we prevent banks etc. from becoming "too big to fail" in the first place (i. e. antitrust rules on mergers)?


I think a lot depends on what you mean by market failure. Without the bogus monetary policy, you would not have had this mess. The bogus monetary policy, it is true, allowed the human frailty of market participants to increase the harm. But that frailty does not explain the temporal clustering of errors characterizing the crisis. Basically, I'm denying there was market failure, but agreeing that you had a lot of bad private decision making out there. That's not a contradiction because only the government failure let such bad decision making cluster and therefore exacerbate policy-created problems. I hope that's too cryptic.

Since I did not read any Austrians railing out during the last five years as this Misesian catastrophe was coalescing, why do you think you deserve any credibility now?

Mises laid out the theory and the events of the last five years followed
his theory word for word.

Where were you then??

Milton Friedman, an interview with Gene Epstein:

FRIEDMAN: I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.

Also, Frank Partnoy´s book "Infectious Greed: How Deceit and Risk Corrupted the Financial Markets" seems pretty much relevant. See i.e. this review:

Mr. Partnoy has well-argued recommendations for reform, most aimed at allowing the markets to police themselves. As he points out repeatedly, the ratings agencies had been falling down on the job long before Enron, catching on to massive losses months too late. Mr. Partnoy suggests lowering the barriers to entry to bring in fresh talent, and de-privileging credit ratings as a way of deciding which bonds can be bought by institutional investors. Removing barriers to short-selling would help to end the upward bias in stock prices, as would allowing insiders to provide tips about negative-but not positive-information. Mr. Partnoy also urges regulators to "treat derivatives like other financial instruments …. As long as 'securities' were regulated, but similar 'derivatives' were not, derivatives would be the dark place where regulated parties did their dirty deeds." He argues for replacing narrow rules which are easily avoided with standards encouraging "a culture of honesty." Perhaps most importantly, Mr. Partnoy asks that the government aggressively prosecute complex financial frauds. As it is, the more complex the scheme, the less likelihood of any punishment whatsoever.


Over at EconLog, Arnold Kling talks about some of the collective-action problems associated with financial risk. It seems to me that there are many sorts of circumstances that markets cannot handle very well. Even if those circumstances are primarily arrived at via poor policy, it still seems a bit intellectually dishonest not to call them what they are: circumstances where markets fail (in the general definition of the term).

There are some people and organizations that benefited from this mess, so it seems clear to me that markets could have done better than they did.

Maybe what I'm trying to distinguish between is market failure, and a failure of the free market. The latter wasn't the case, because there was no free market, but that doesn't mean markets didn't fail.

Markets can "fail" when the rules of the game are structured in such a way that they provide incentives for behavior that leads to "failure" and other socially harmful results. Yes, we're still talking about markets, but when the rules include regulations that create socially harmful incentives, we are not talking about the failure of the free market.

The problem with this whole mess was at the level of the rules of the game. As Larry White said, greed is a constant and, I would add, we still had markets. What was wrong was that the greed was channeled by poor rules in ways that led to damaging unintended consequences.

I will keep pressing the "it wasn't free markets that failed" point until I'm blue in the face. The optimist in me thinks this is a chance to really make clear the importance of the rules of the game and perhaps get across some really important distinctions.

Steve Horwitz:

I tend to agree with your point, but could you be please more specific as to exactly what "bad" rules of games do you mean (i.e. accounting, disclosure etc. rules, "tradition" of bailouts, TBTF ...)?

My hat is off to DPrychitko; very few Austrians have the courage to suggest that we need to give Hyman Minsky's work a more serious reading. I think he is absolutely right.

And I am not so sure about Pete Boettke's interpretation of the influence of recent work in the economics literature. I haven't seen Naomi Klein's book mentioned anywhere else outside libertarian blogs, and this is not surprising. Why would a non-libertarian reply to her thesis? She is basically giving Milton Friedman an uncharitable reading. Nothing new is really introduced in her book. It is a dud. Don't waste your time.

Minsky, however, is still receiving an enormous amount of attention by people directly involved in financial markets. Ask anyone who trades stocks what he believes to be the two most powerful theories of financial bubbles and he will say (1) George Soros (reflexivity) (2) Hyman Minsky. Every financial trader is familiar with Minsky's work, and for good reason. Economists are still getting there, and this is why DPrychitko's post was so apposite to the context in which we currently find ourselves.

A serious reading of Minsky's work, and the intellectual background from which he emerged, will, as DPrychitko says, show that the Mises-Hayek theory of the business cycle comes up short. Minsky basically extended Keynes' theory of the Inducement to Invest, which, for Keynes, was the essential ingredient in determining the level of employment and output. Minsky's basic conclusion, in perfect agreement with Keynes' analysis, is that markets are just too damn unstable to function properly. Austrians refuse to believe this, and they resort to arguments that Keynes explicitly addresses in his 1936 book. Now most of the seasoned veterans recognize these criticisms by Keynes, but I don't think anyone has successfully refuted them. (This is NOT to say, however, that I think this Austrian work is without value. Roger Garrison is an excellent economist and the most competent follower of Hayek's business cycle theory; and I also think Butos and Koppl have done interesting work on the theory of expectations.)

Austrians need to get past this intellectual impasse in which they have found themselves for the last 20 years. Austrian economics is not a complete theory. We are doing a great disservice to the school by believing that all we need to do is focus on applied work and restatements of Mises and Hayek. That attitude will get you nowhere. I have talked with one of my favorite economists (can you guess who?) through email and (s)he(?) has said that one gets the impression from talking with Austrians that they are primarily interested in defending the "party line" and quoting Hayek as if it were the scripture. I think this is all very accurate.

Our aim as young Austrians should not be, contra Boettke, to "translate" old (Austrian) work into new problems, but to fundamentally re-work the foundation upon which Austrian economics is based.

DPrychitko is right on the money!!!

Oh, and one more thought on the connection of Austrian economics to the philosophy of free markets. When I think of champions of laissez-faire, I do not think of Austrian economists; I instead go to the work of Harold Demsetz. YOUNG AUSTRIANS: Please read Harold Demsetz if you want to understand how a strong defense of free markets can (and should) be made. He is a powerful, powerful thinker, and it is a pleasure to follow him and see how he reasons his way through problems. Nothing comparable is found in the work of Austrians, and this is because their approach to economics is very different. Austrian economists are concerned with problems of methodology, epistemology, and rationality. Now this is all very exciting and intersting stuff, but it doesn't translate to ideas of the free market AS WELL AS the approach taken by Demsetz and his colleagues.

Austrian economics is not libertarianism par excellence. Its roots are far deeper and more profound than that. However, if you are interested in free markets, your time would be better spent reading Harold Demsetz's work.

I admit to having only read a bit of Hyman Minsky (he didn't seem interesting enough for me to bother reading an entire book on his theories), but to me his theory of the business cycle reminded me of ABTC without the underlying explanations.

He seems to identify the "bubble investors" that pop up in all bubbles well. I can't remember if Keynes gave them a specific name, but anyone involved in business or investment with an ounce of sense knows them: The guys who bet on an asset rising because they think other people will bet on its rising; the long-term value is irrelevant when the investment can be flipped.

For the life of me, I can't understand how "bubble investors" can come into being without expansions of liquidity into the market.

Can you link to a summary of his business cycle theory?

The "rules of the game" I was thinking of here were not just the moral hazard created by past bailouts, but the whole regulatory structure surrounding the mortgage/finance industries. Freddie and Fannie are government creations with implicit guarantees, the Community Reinvestment Act and other moves by the Clinton administration forced/encouraged banks to make loans to riskier borrowers, the Fed pumped funds in to make it possible, etc..

Grant said, "Maybe what I'm trying to distinguish between is market failure, and a failure of the free market. The latter wasn't the case, because there was no free market, but that doesn't mean markets didn't fail."

I think it *does* mean that markets didn't fail. But now we're probably quibbling over words. I would also say that I think pro-market economists have tended to underestimate the difficulties of deregulation. The current crisis was caused by bad monetary policy, not deregulation, which we have not had. But I want to acknowledge that we have tended to think deregulation is easy when it is, in fact, hard. (I say just a few words about that toward the end of "Computable Entrepreneurship" in the current number of _Entrepreneurship Theory and Practice_.) Vernon Smith is an important exception to this rule. His discussion of deregulation in electricity markets is great. You must *design* deregulation and that's hard to do.

As a lay-man perhaps in over my head, I am not sure the argument in the lead paragraph works: just because greed is a constant does not mean that it is not the cause of the recent (or non-recent) economic troubles. As gravity is to flying so greed is to free-markets? Greed (as opposed to properly odered self-interest?) is the thing to be overcome and when we fail it takes over and causes us to crash, often in dramatic fashion. The paragraph seems to want to set all discussion about greed to one side simply because it is a constant. Yet I think it remains as central to the discussion as gravity must be to discussion about flying. This is a morality play--it always is at some level simply because greed (and other virtues and vices) are always present. Is this wrong?

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