Economic Wisdoms in the Cassidy Interviews

|Peter Boettke|

I would introduce many qualifications to my endorsement of the full range of opinions represented in John Cassidy's interviews with Chicago economists.   But for the most part, I have to admit that I find the economists providing the readers with many pearls of wisdom about the way the world works, and the journalist/interviewer revealed to have a rather surface level understanding of the issues in economic theory, empirical analysis, and the applicaiton to public policy.  One example is revealed very early on in the set of interviews after Hechman describes how the incentives from government policy were confused and yet Cassidy insists that this proves Hayek was wrong about the price system communicating information efficiently.  It is as if Cassidy has no idea that Hayek authored a business cycle theory that at its core relied on distortions in the price system to mislead economic actors into a cluster of errors.  The idea of prices as a signal wrapped in an incentive doesn't really resonate with Cassidy's world-view.  As is evident in his questions and efforts to steer the conversation in these interviews, and even more so in his book, How Markets Fail, Cassidy has a vision of the debate which depicts his intellectual adversaries as holding a position about markets as perfect machines and their opposition to government as based on whim rather than careful comparative institutional analysis.  

Not only does Cassidy not understand Hayek, he fails to understand the contributions of James Buchanan. And his efforts to grasp the thrust of the teachings from Coase, Friedman, and Stigler is not much better.  He has a view of what Lucas wrote and what Fama wrote, and he infers that back on to these other writers with the purpose to condemn not to understand the theoretical subtleties, empirical nuances, and policy details and qualifications.

In my opinion, these sort of intellectual misteps by Cassidy (e.g., the critique of Hayek) and important points about theoretical subtleties, empirical nuances, and policy details (and comparative institutional analysis) made by the economists can be found throughout the interviews.

James Heckman --

"I think the part of the Chicago School that has been justified is the claim that people react to incentives, and that incentives are important. Nothing in what has happened invalidates that idea. People did react to incentives—clearly they did. It turned out that the incentives they were reacting to weren’t socially beneficial, but they definitely reacted to them" ... "Look, I could subsidize people to murder children, and if I offered enough money I don’t think I would find much trouble finding a ready supply of murderers."

Gary Becker --

"What I have always learned to be the Chicago view, and taught to be the Chicago view, is that free markets do a good job. They are not perfect, but governments do a worse job. Again, in some cases we need government. It is not an anarchistic position. But in general governments do a worse job. I haven’t seen any reason to change that other than, yes, we’ve seen another example where free markets didn’t do a good job: they did a bad job. But to me there is no evidence the government did a good job either, leading up to or during the process."

"The people who argue that markets were always efficient and there was no problem, that was an extreme position—something a lot of people at Chicago had recognized before. The weaker notion that markets, particularly financial markets, usually work pretty well, and it’s very hard to beat them by investing against them, that I think is still very powerful."

"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 in how you state it."

John Cochrane --

"The government set up some regulations. The banks were very quick to get around them. Lots of people did not think enough about counterparty risk, because they thought the government will take care of it. But this was hardly a libertarian paradise gone wrong."

[In response to a question that wonders how much is left of the intellectual case for rational expectations and efficient market hypothesis]

"I think everything. Why not? Seriously, now, these are not ideas so superficial that you can reject them just by reading the newspaper. Rational expectations and efficient markets theories are both consistent with big price crashes. If you want to talk about this, we need to talk about specific evidence and how it does or doesn’t match up with specific theories."

"Efficient markets doesn’t say markets will never crash. It certainly doesn’t say markets are clairvoyant. It just says that, at that moment, there are just as many people saying its undervalued as overvalued. That certainly seems to be the case.

Ok, now you know what “efficient markets” means. What is there about recent events that would lead you to say that markets are inefficient? The market crashed, to which I would say, we had the events last September in which the President gets on television and says the financial markets are near collapse. On what planet do markets not crash after that?"

"Look, evaluating economic models is a lot harder than just staring out the window and saying, “This is going on. Keynes was right.” Nothing in the incoming data has removed the inconsistencies that plagued Keynesian economics for forty years until it was thrown out. I mean, we threw it out for a reason. It didn’t work in the data. When inflation came in the nineteen-seventies that was a major failure of Keynesian economics. It was logically incoherent.

What happened is the government wanted to spend a lot of money. They said “Keynesian stimulus” and people got excited. What event, what data says we’ve got to go back to Keynesianism? Again, I’m going to throw it back on you. What about it other than that Paul Krugman thinks we need another stimulus tells us that this is an idea to be rehabilitated?"

"It’s a long logical leap from the fact of unemployed resources to the proposition that the federal government borrowing another trillion dollars and spending on pork is going to make those resources employed again."

Richard Posner --

"I think there is a question of whether modern economics, including Chicago economics, is too formal and too abstract. Another question is whether modern economists have lost interest in or feel for institutional detail that might be very important. I don’t know how many of these economists really knew anything about how modern banking operates, how the new financial investments operate—collateralized debt obligations, credit default swaps, and so on."

"

You don’t want to characterize all of economics in that way. What we tend to think of as the Chicago approach is great skepticism about government and faith in the self-regulating characteristics of markets: that’s the essential outlook of Chicago. In addition, there is the increasing mathematization of economics. That is not necessarily Chicago-led. Chicago once resisted that—people like Ronald Coase and George Stigler. Even Gary Becker—he’s more mathematical than they are, but he’s not as mathematical as, say, M.I.T. and Berkeley economists.

Modern economics is, on the one hand, very mathematical, and, on the other, very skeptical about government and very credulous about the self-regulating properties of markets. That combination is dangerous. Because it means you don’t have much knowledge of institutional detail, particular practices and financial instruments and so on. On the other hand, you have an exaggerated faith in the market.

That was a dangerous combination.

But that is not all there is in economics. There is also behavioral economics, which has made a lot of progress. It’s about challenging the assumptions about markets because of human irrationality. I don’t much like it myself, because I think they are very vague about what they mean by rationality. They use terms like “fairness,” which are really contentless. But some of their skepticism is warranted. And behavioral finance, I find very convincing. It’s obvious if you look at how people trade in markets: they are not calculating machines that flawlessly discount future corporate profits.

I put a lot of emphasis on the Frank Knight (a famous Chicago economist who taught at Chicago from the nineteen-twenties to the nineteen-sixties) and Keynes view of uncertainty. That makes economists very uncomfortable, because it is very hard to model. Once you introduce uncertainty, it means that a lot of consumer behavior is not going to be easily modeled as cost-benefit analysis."

[in response to a question on whether he views himself a reviving Knightian economics]

"Not only that, but there is a curious link between Keynes and Coase, even though they are at opposite ends of the political spectrum. I never heard Coase mention Keynes, but I am sure he would have regarded him as a dubious left-wing character Coase is very, very conservative. But they are very similar in their informality. Coase was always saying that he didn’t believe in utility maximization. He didn’t believe in equilibrium. Both of them, they are not concerned with the kind of axiomatic reasoning where you start with human beings assumed to have rational calculators inside them. They are much more likely to take people as they are.

And Knight was not at all a formal economist. His book “Risk, Uncertainty, and Profit,” I read it for the first time. It really was excellent. There’s no math. Coase in his later work: no math. Keynes in the General Theory: some math, but it’s not central to his argument."

"

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 interest in empirical studies, but not so much in 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.

Ronald (Coase) is alive, but he’s very, very old. He’s not active. Stigler is dead. Friedman is dead. There’s Gary (Becker) of course. But I’m not sure there’s a distinctive Chicago School anymore. Except there are probably a higher percentage of conservative people here, but not all. Jim Heckman—not particularly conservative at all. He’s very distinguished. Steve Levitt—he’s very famous. I don’t think he’s conservative. You’ve got people like (Richard) Thaler. So probably the term “Chicago School” should be retired.

There were people—people like Stigler and Coase, Harold Demsetz, Reuben Kessel, and people at other schools like Armen Alchian. They were people rebelling against the very liberal economics of the nineteen-fifties—very Keynesian, very regulatory, very aggressive anti-trust, little faith in the self-regulating nature of markets. Francis Bator, who’s a very distinguished Harvard economist, he wrote a famous essay entitled “The Anatomy of Market Failure.” And he gave so many examples of market failure that you couldn’t believe a market could exist. You have to have an infinite number of competitors, full information, you can’t have any economies of scale, and so on. It was too austere. That was what the Chicago people, with their more informal approach, rebelled against. So we had our moment in the sun, but by the nineteen-eighties the basic insights of the Chicago School had been accepted pretty much worldwide."

Comments

[TGGP]

Frank Knight wasn't the ideological opposite of Coase. I read once someone saying that "Knight didn't believe in God, but he was sure Keynes was the Devil"! He came up with the name for the Montpelier Society. In some respects his view was like Arnold Kling's: "Markets fail. Use markets."

[TGGP]

Whoops, that's "Mont Pelerin" Society.

[Niko]

@TGGP:
I think it was about Keynes being at the oposite ...
And I'm not sure that Knight came out the name, he voiced some concerns.

I've read an introduction by Coase to a Armen Alchian book, and it praised Keynes a lot I think. Probably he had to perform the ritual in order to be aloud to enter a classroom or something so not a lot of moral courage on his part.