Old Versus New Chicago School of Economics

|Peter Boettke|

 

James Buchanan's talk at the Summer Institute at University of Richmond.

HT: The always energetic and intellectual dynamo Sandra Peart, who along with David Levy created the very important Summer Institute.

Comments

[Mario Rizzo]

I watched this last Saturday. The big problem I have with Buchanan's talk is that he uses the word "institutions" loosely. This is important. He says there is a presumption that markets will work if the institutional framework is "right." But there is no such presumption if the institutions are not right. Institutions are public goods, etc.

My point is this: Are the financial innovations of the past decade new institutions that evolved from a market-like process or are they market-products that came out of an institutional framework.

One could easily argue the latter. Then perhaps the problem is not with new institutions but with the old institutions. For example, institutions that encouraged excessive risk taking because of the likelihood of government bailouts.

Overall, I would say the "old" Chicago school was an intellectual mess. That is why it died. Knight couldn't decide what kind of political-economic system he could live with. Everything had problems. Ok. But where did that get us?

The old Chicago school was plagued with self-doubt, it accepted too much of Keynes's critique of the market, and was incompetent in its defense of the market.

[Barkley Rosser]

But, Mario, clearly he is right that the insitutions matter, even if we are not clear about exactly how they should be set up or which of existing institutions are good or not good. Maybe you prefer the "intermediates," namely Friedman, Stigler, and Becker, whom he mostly said little, to the two he talked about, the Old School of Knight, Viner, and Simons versus the New School led by Lucas and those coming after him.

I for one think there was more going on in the recent problems than just the expectation of bailouts. Did the London-based subsidiary of AIG expect bailouts, the outfit that perhaps more than any other was the ultimate lynchpin to the worst of the crashes?

[Richard Ebeling]

The "older" Chicago School seemed to be (classical) liberal and free market only in comparison to socialists, and some traditional Keynesians of the time.

Yes, they spoke about "rules vs. discretion" (Simons), but in general their "rules" were for more reasonable and "predictable" government intervention and regulation -- whether this applied to monetary policy, or anti-trust, or redistribution of wealth, etc.

Knight, as Mario says, could not decide what he wanted or what he believed. He talks about the protection of freedom through markets, and then trashes every economic and philosophical justification of markets. And he talks about incentives and efficiency in markets, but then rationalizes the "injustice" of income inequality and the need for redistribution.

Knight is most "cranky" and inconsistent in this way in his many book reviews. He just cannot come out and say he thinks a book is good and useful; no, he has to find something to attack that leaves the reader thinking the work is worthless.

For example, when he reviewed the English translation of Mises' "Socialism," he refers to it as an important work that challenged central ideas in the case for socialism, but then says it is a passe and not "really" important work and he cannot understand why anyone bothered to translate it.

Knight defended a version of an "a priori" deductive conception of the "logic of choice" in several of his own writings, but when he came to review Robbins' "The Nature and Significance of Economic Science" (he reviewed both the first and second editions) he has to find fault after fault with anyone who thinks about economics in that way. Suddenly this is too stark an approach that assumes away too much without an institutional and cultural context. While he, himself, defended such an "stark" approach against historicism and positivism both before and after reviewing Robbins' book.

So you go away from Knight with the conclusion that the market economy is wonderful -- except for this "failure," and this "failure," and this "failure" . . . All of them needing the corrective hand of government.

You leave Knight with the impression of the seemingly "market friendly" economist who "concedes" the need for government intervention all over the place.

With friends like these, well, the market economy didn't need enemies in those middle decades of the 20th century.

Richard Ebeling

[Mario Rizzo]

Barkley,

I absolutely agree that instutions matter. My problem with this talk is that it was never clear whether the financial crisis, on Buchanan's reading, was a failure of the market or a failure of institutions. He talked about institutions (I assume he meant new financial products) that were the outcome of market-like processes. For these "institutions" there was no presumption that they would be beneficial.

The argument seems to turn on whether financial innovations are properly called new institutions or simply market products.

I find this all very confusing.

[Mario Rizzo]

Richard,

Knight was clearly brilliant but he was obviously moody, contrarian, and I would guess, insufferable. Or at least that is how he comes across in his articles and reviews. I feel as if someone should have shook him and said: Hey, the world is coming apart at the seams and you simply bemoan everything. Grow up.

This is not to say we cannot learn a lot from reading and studying Knight, but it is a chore.

[Richard Ebeling]

Mario,

I absolutely agree that taking the time to read Knight is a valuable exercise. In spite of my frustrations I've learned a lot from his writings.

But he seems to have been so fearful of being "pidgin holed" by any label or ideological category that, as you say, he is a moody (I would even say cranky) contrarian, and "insufferable."

I recall (maybe you will, too) Hayek once saying that at the University of Chicago he attempted after awhile to avoid Frank Knight. Hayek wanted to discuss political philosophy or economic theory with him, but Knight would turn most conversations into a renewal of their "debate" and disagreements over capital theory. And Hayek just did not want to constantly refight that battle over and over, again.

When I was an undergraduate at California State University, Sacramento, I had a professor who had studied with Frank Knight at Chicago, and had taken him for the history of economic thought. I asked him what it was like. He replied that it was the history of Frank Knight's thought!

Richard Ebeling

Richard

[Barkley Rosser]

Mario,

I would agree that Jim was kind of vague when it got down specifically to what institutions were responsible for recent problems or what should be done. He expressed some skepticism about the current financial reform bill without being specific, but at the same time seeming to say that "something" should be done. In the Q&A he did at one point say that he thought "big banks" should be broken up and threw in a defense of the Glass-Steagall Act, and also seemed to express disdain for both rational expectations and some of the more exotic of derivatives. But that would seem to be about it.

[amv]

Did Buchanan say that new Chicago disregards externalities? Or what is the partitioned consumption set about? Does anyone believe that any New Chicago Boy has forgotten Smith's dictum that self-interest translates into general prosperity if and only if institutions are viable? Buchanan's account of the EMH is a bit ... well, nobody believes that markets solve everything everywhere. To the extent New Chicago suffers defects, Buchanan fails to point them out.

[Jerry O'Driscoll]

I listened only to Buchanan's actual talk and not the lengthy question period. He spoke more about rules than institutions. I found his critique of the notion of a market for rules to be compatible with a Hayekian approach to the evolution of rules. So, too, were his strictures against the extension of rationality to rules.

To Mario's question. I interpret what he said about rent-seeking within bad rules to be applicable to the recent financial crisis. Bad rules and institutions led to the excessive risk taking.

I note that most comments on the Old Chicago School invoked Knight. In the beginning of his presentation, however, Buchanan identifies Henry Simons as "the best expositor of the Old Chicago School." Hayek considered Simons a kindred spirit and defended Simons against his critics. Hayek described Simons' death as a great loss to classical liberalism.

In the New Economics and the Old Economists, J. Ronnie Davis described the Chicago School as Keynesian before Keynes. They early on advocated fiscal policy in the Great Depression (while Keynes made common cause with Fisher in favor of a monetary policy response). They never accepted Keynes' theoretical apparatus.

My question is where did the Friedman-Stigler generation fit in Buchanan's history? Old or New? Buchanan talks of the 1970s as the turning point, but had Lucas in mind.

[Barkley Rosser]

Jerry,

Jim specifically described the middle group as "transitional" at several points in his talk, but never really evaluated them one way or the other, and basically said very little about them.

amv,

It is not so much externalities as classic collective consumpton goods as defined by Samuelson in 1954,which he says rules and laws and institutions are, and which are the "non-partitionable goods" to which he was referring. Not everybody agrees with that, especially harder line Rothbardian anarcho-capitalists, for whom institutions are up in the air to be determined however, and for whom there are no true "public goods." In that regard, Jim's remark in the Q&A about Coase's views on lighthouses was somewhat curious.

The newer Chicago people, particularly on the finance side such as Fama and Cochrane (and Jim mentioned Fama in particular) have indeed pushed a pretty much EMH line all the way that is independent of any institutions or rules. Everybody has ratex, and there will be no loose $20 bills lying around to pick up, an example that Jim spent some time ridiculing.

[Richard Ebeling]

Jerry,

I've read a good amount of Henry Simons.

At his best, he could be a clear and principled defender of free trade, the market economy, and against vested interests (particularly trade unions, such as in his article on syndicalism).

But . . .

As Leland Yeager very pointedly expressed it, when he read Simons' "A Positive Program for Laissez-Faire," he found a quiet a bit of a "positive program," but not much laissez-faire.

Simons advocated regulation of industry through anti-trust; redistribution of income to diminish income equality; he supported aggressive monetary policy to "fight" the depression; and was suspicious of "private power" in the market place (i.e., an unregulated market).

Hayek did praise Simons attempt to go beyond "laissez-faire," and to have a "positive program" for a renewed liberalism that would preserve private property and a generally open, competitive market.

Walter Lippmann's "The Good Society" (1937) made the same arguments. The first part of the book is an eloquent and clear defense of individual freedom and the market economy against collectivism (and explicitly relies heavily on Mises and Hayek's critiques of socialist central planning, which are footnoted in the book). But the second part of the book is on all the limits and flaws and imperfections in an unregulated market that requires enlightened (though limited and "rule-based") regulations of the market, and some safety nets and redistibutions through the State.

Lippmann's book has unfairly not been given the attention it deserves in terms of the literature of the time, both for its brilliant restatement of the case for freedom and the market economy in general (including an argument about knowledge in the market similar to Hayek's in "The Use of Knowledge in Society") and the influence it had on setting part of the tone for limited government liberals who were searching for the type of "middle way" between the unhampered market and central planning that in Europe Wilhelm Roepke developed with his distinction between market-conformable and market-unconformable interventions.

Simons was joined, also, in his "agenda" by Frank Graham of Princeton University in his "Social Goals and Economic Institutions" (1948), published a year before Graham died. He, too, presented a policy perspective much like Simons.

Graham got into an angry fight with Ludwig von Mises at the first Mont Pelerin Society meeting in 1947. Mises challenged the idea that monopoly was much of a serious problem except when government intervention either regulated a monopoly into existence or instituted trade barriers that hindered foreign competition.

Graham became clearly angry and declared that this was that type of view that "harmed" the case for the market. Now, how is one to interpret this?

Did Graham mean that Mises harmed the cause of economic freedom because he was wrong about monopoly? Or that Mises may not be wrong, but saying that type of thing publicly gave ammunition to those on the "left" who say, "You see, they don't believe in 'any' government regulation, and are just extremists to be ignored."

Mises actually got into the same type of verbal argument with Alexander Rustow at the "Colloquium Walter Lippman" in Paris in 1938. And over the same point, with Rustow also saying that Mises' point of view "hurt" the cause of liberalism by saying that monopoly was only a real problem when it was fostered or supported by government intervention.

The fact is that Hayek accepted much of this "middle way," limited, "rule-based" system of "market-conformable" interventionism in "The Road to Serfdom" (he had already hinted at it in his 1933 lecture on "The Trend of Economic Thinking"), and certainly in much of part 3 of "The Constitution of Liberty."

Richard Ebeling

[Jerry O'Driscoll]

Richard,

I think you correctly characterized the position of liberals in the 1930s. Most had more in common with Simons than Mises. Monopolies bothered most and inequality many.

Now we have Buchanan going back to his Old Chicago roots in reaction to what he sees as a new view that has gone too far in reliance on market reasoning. (Posner has done something similar, but he rediscovered Keynes.)

So what are Austrian/subjectivists to make of this? Whom are our allies in the debate? I was sympathetic to Buchanan's talk (and to two of his recent articles focusing on money and the financial crisis). But there was considerable criticism of it offered up here.

[Richard Ebeling]

Jerry,

I fear that we are rather "short" of allies in the economic profession, in terms of an "Austrian/subjectivist" approach.

First, Lord Acton and, then, Hayek (again, in his 1933 lecture) pointed out that often the true friend of liberty finds himself isolated or in the company of some who he, otherwise, would not consider to be on his "side."

In the 1952, Victor Klemperer (a German Jew who survived the war in Nazi Germany) published a book on "The Language of the Third Reich."

He argued that all people in Germany had been Nazis, even the opponents and victims of the Nazis. Why" Because virtually every one in the society had accepted and thought in terms of the ideas and language of the National Socialist regime. Thus, the Nazis controlled all discourse, since their ideas and words were the context in which everyone reasoned -- even the "enemies" of the Nazi State. (Klemperer's later two-volume work, "I Will Bear Witness," based on his diary of life in the Third Reich, amplifies his argument.)

The fact is supporters and opponents of macroeconomic interventionism (Keynesianism broadly defined) all think in terms of the macroeconomic (or Keynesian) framework -- the language, the models, the assumptions about how to think about the economy -- and, thus, it molds and restricts how they understand the reality of the market, how it works, why it seems to "fail," and what can restore output and employment to the "long run trend line" (which itself is a macro-confining way of thinking about the economy "as a whole.")

Thus, Keynes' "conquest" was complete and still dominates the arena of debate.

This is why economists, in general, "hear" what Hayek says, but they do not "understand" what he is saying when they take the time to read some of his writings on money, the business cycle, or even his critique of Keynes' macro-approach.

It is an "alien" language and conceptual framework that in its essential aspects is "untranslatable" standard Macro-Think.

Thus, to paraphrase Keynes in the "General Theory," it will be a long struggle for economists and others to escape from the Keynesian "orthodox" under which they have grown up.

Richard Ebeling

[TGGP]

A paper from the 80s on the “old” monetarism of Milton Friedman (Marshallian, partial-equilibrium) vs “new monetarism” of Lucas & co (Walrasian, general equilibrium):
http://dukespace.lib.duke.edu:8080/dspace/bitstream/10161/1921/1/Hoover_two_types_of_monetarism.pdf

[mboyd]

In the future please consider giving speakers a lapel mic to reduce bad acoustics & echoing.

[Nikolaj]

In Buchanan's view, finding the optimal institutional framework for the functioning of the market is not a matter of a strict application of some fixed principles, but an outcome of a process of "social experimentation" with different sets of government regulations and controls. The catchword "institutions" describes the government controls and restrictions of the free exchanges which are deemed "optimal" from a central-planning, "expert" point of view.

That is an old, 1930s Chicago School, almost Fabian, approach which in a characteristic Orwellian double-speak describes the socialism of a mild sort (socialization of investment, trust-busting, partial nationalization of industries and railroad etc) as a "laissez-faire". Simon's equally Orwelian phrase "positive program for laissez-faire" and Hayek's warm support for this program reflected the idea of the time that increased government control and regulation was a vehicle for "increasing the freedom". You have the same idea bluntly expressed in "Road to Sefdom" where Hayek calls the old laissez-faire a stupid dogma that must be rejected by "neoliberals" in order to develop a better argument for freedom in the new circumstances. Frank Knight was a follower of Werner Sombart, and at one point he even accepted the communism and Nazi-like dictatorship as superior to both the "democratic socialism" and the laissez-faire.

So, yes, Buchanan's arguments are a part of that tradition of the Old chicago School, and its 1930s semi-socialistic "neoliberalism" ala Simons, or the Knightian fascism. I only doubt that anybody today who generally supports the ideas of free markets (an Austrian, Chicago or whatever) should draw the inspiration from that poisonous source.

[Barkley Rosser]

mboyd,

Jim did have on a lapel mic. He just speaks rather softly and slowly.

Nikolaj,

I find the opposition to anti-trust among many here to be a bit weird. I would note that Hayek was allied to the Ordo-Liberals, who after the war supported the breaking up of certain large corporate entities into smaller ones that had been especially supportive of the Nazi regime, such as I.G. Farben.

[Nikolaj]

Barkley,

"I find the opposition to anti-trust among many here to be a bit weird."

The opposition by the free market guys to government regulation and interference with the market, promoted by the unholy alliance of the progressive socialist reformers and protectionist business interests from 19th century on? Really weird. :)

Hayek had to throw under the bus his own economic theory, including the theory of competition and his brilliant critique of the perfect competitive markets (the model invented by frank Knight and used as a rationale for antitrust) in order to remain the fateful semi-socialistic, reformist "neoliberal" in politics. Hayek was the first-rate economist and very lousy political philosopher. He even agreed with the socialist Jhon Rawls. In the foreword of the Law, Legislation and Liberty he said that there was not much difference between the conclusions of his book and Rawls's Theory of Justice.

So, in my view, Hayek's acceptance of antitrust is not an indication that such a policy should be deemed a part of the free market approach, but rather a direct evidence of how far Hayek actually was from the genuine free market position in many respects.

[Jerry O'Driscoll]

To Richard's assessment:

Public Choice is surely a natural ally of Austrian/subjectivism. PC has its own language, often not understood by mainstream economists. And the response of many monetarists to the current crisis has been sympatico with an Austrian one. In short, it is time to make common cause and not accentuate differences. (I would argue the same thing about the internal disputes among Austrians.)

On the numerous criticisms of the old classical liberalism of the 1930s: right though they may be, they define liberalism in a particularly American way as libertarianism. If you speak to contemporary European liberals, you will find they are still influenced by Ordo liberalism. Even if they have moved beyond that, they are perhaps not prepared to accept the American variant in its full-blown purity.

Back in America, many traditional conservatives remain natural allies in the broader quest for free markets. They have been discouraged by the ascendency of neo-conservatism and dispirited by war. Debt and deficits have moved to the top of their economic agenda.

[Richard Ebeling]

Jerry,

I completely agree that the closest ally of the Austrians from a broad political economy outlook is the "Public Choice" approach, particularly people like James Buchanan, Richard Wagner, etc.

And you are certainly right that American libertarianism is far to the "right" not only in comparison to many of the (classical) liberals in America in the 1930s and 1940s, but in relation to classical liberals in Europe today, as well.

European liberals are really "ORDO Liberals." (If I may, in my book, "Austrian Economics and the Political Economy of Freedom," Elgar, 2003, I have a chapter on 'The Limits of Economic Policy: The Austrian Economists and the German ORDO Liberals,' in which I compare and contrast the two approaches.)

Indeed, American libertarianism harks back to an older European classical liberalism of the early part of the 19th century, especially as found many of the French liberals of that time. To have a good sense of this, Benjamin Constant's "Principles of Politics" should be read, or his famous lecture at the University of Paris in 1819 on, "The Liberty of the Ancients Compared to the Moderns."

It also had more of its roots in Wilhelm von Humboldt's "The Limits of State Action."

This has been blended with the historically unique characteristics of the "American experience" as captured in that Lockian idea of natural rights as presented in the Declaration of Independence, and that strange and original "individualism" about which de Tocqueville wrote in "Democracy in America," but which both fascinated him and worried him.

The Europeans have never had anything like this, compared to America.

Richard Ebeling

[Jerry O'Driscoll]

Richard,

Very concise statement.

Another difference between liberals today in America and Europe is our revolutionary heritage. For us, revolution was the path to liberty and we celebrate it. For Europe, revolution was upheaval and, particularly in France, the path to terror.

Europeans (at least in "Old Euroope") want to avoid social upheaval. They are willing to pay a price for "solidarity." The solidarity tax is now bankrupting them, and they are getting upheaval anyway. Greece is the leading edge.

[Barkley Rosser]

Nikolaj,

Frank Knight was not the father of anti-trust. The Sherman Act was passed in 1890. Its most significant use in the US was in the breakup of Standard Oil in 1911. Would you have opposed breaking up Standard Oil in 1911?

[Nikolaj]

Barkley,

On your question, my answer is - absolutely and unambiguously - yes. I have read Armentano's and hanry Mann's work on Standard Oil and more generally about that fairy tale of "predatory competition", and that was enough to convince me.

My counter-question for you: would you support the breakup of a company which has been diminishing the prices and costs, and increasing the production over the span of two decades (i.e. Standard Oil)?

As for Frank Knight I know that he personally did not invent the antitrust, but his model of perfect competition has been used by the economists as a rationale for antitrust ever since it has been introduced by Knight.

[Regis Servant]

Nikolaj,

To my knowledge, Hayek does not accept antitrust laws. He does not disapprove monopolies per se, only legally protected monopolies or cartels.

Since Hayek has a process-oriented rather than state-oriented conception of competition, a monopoly is good so long as there is free entry in the industry, in Baumol’s sense we can say – see the second volume of Law, Legislation and Liberty.

Free monopoly is not legitimate in only one case according to Hayek: when the resource is vital for the people – for example an Oasis in the sahara (The Constitution of Liberty).

As regards his relation to John Rawls, Hayek’s quote in the foreword of the second volume of Law, Legislation in Liberty, does not show evidence of socialist influence.

Hayek, of course, does not agree with the Maximin outcome of Rawls’s contractualism. He only agrees with Rawls concerning the concept of veil of ignorance, which he found useful.

Moreover, Hayek agrees with Rawls on the precise idea that, from the moment people agreed on institutions, they will play the game, the result of the game will be amoral, neither just nor unjust. It is also the idea of Nozick, right?

Finally, Hayek seems to have changed his opinion on Rawls, he moved away from his theory, since he saw very well that Rawls's theory tried to rebuild what he tried to demolish.

Regards,
Régis.