A Few Scattered and Preliminary Notes on Comparative Economic Theology: Wednesday Focus: June 11, 2014

Lars P. Syll sends us to Joseph Stiglitz’s 2009 Minsky Lecture: The ‘Neoclassical Synthesis’–A Religious Belief: “The advocates of free markets in all their versions…

…say that crises are rare events, though they have been happening with increasing frequency as we change the rules to reflect beliefs in perfect markets. I would argue that economists, like doctors, have much to learn from pathology.We see more clearly in these unusual events how the economy really functions. In the aftermath of the Great Depression, a peculiar doctrine came to be accepted, the so-called “neoclassical synthesis.” It argued that once markets were restored to full employment, neoclassical principles would apply. The economy would be efficient. We should be clear: this was not a theorem but a religious belief. The idea was always suspect…

The thing is that the originator of what Joe Stiglitz calls “the neoclassical synthesis”–the *fons et origo of what Stiglitz regards as a major intellectual error–was none other than John Maynard Keynes himself:

In some other respects [my] foregoing theory is moderately conservative…. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary…. Our criticism of the accepted classical theory of economics has consisted… in pointing out that its tacit assumptions are seldom or never satisfied…. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment… the classical theory comes into its own again… then there is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed… there is no objection to be raised against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition respectively… there is no more reason to socialise economic life than there was before….

The result of filling in the gaps in the classical theory is not to dispose of the ‘Manchester System’, but to indicate the nature of the environment which the free play of economic forces requires…. But there will still remain a wide field for the exercise of private initiative and responsibility. Within this field the traditional advantages of individualism will still hold good.

Let us stop for a moment to remind ourselves what these advantages are…. The advantage to efficiency of the decentralisation of decisions and of individual responsibility is even greater, perhaps, than the nineteenth century supposed…. Individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that… it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life… the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices… colours the present with the diversification of its fancy; and, being the handmaid of experiment… is the most powerful instrument to better the future.

Whilst, therefore… adjusting to one another the propensitv to consume and the inducement to invest would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…

There are, I think two lessons that can be drawn from big depressionz. You can draw the Keynes lesson, which is also the Milton Friedman lesson, that if only you can stabilize the trend of aggregate demand (and compensate for externalities either through clever Pigovian taxes or ingenious Coaseian carving of property rights at the joints) then the competitive market system does absolutely fine. You can draw the Stiglitz lesson–which is that such a gross market failure in the large tells us that every single market everywhere in the world is probably riddled with smaller-scale market failures, and that comprehensive and detailed governmental structuring of institutions at ever level–macro, mess, and micro–is necessary in order to properly promote the general welfare.

In some ways the difference can be overstated. As Ariel Rubenstein and Michele Piccione likes to point out, the “jungle” equilibrium in which the strong do what they can and the weak suffer what they must has as strong a claim to Pareto-optimality as does the market equilibrium, and the frameworks of property, contract, tort, and criminal law that underpin the market equilibrium are all by themselves extraordinary and mighty governmental and societal regulatory interventions vis-a-vis whatever bellum omnium contra omnes one might call the “state of nature” in libertarian theology.

But I, at least, cannot help but interpret the declining intellectual fortunes of Milton Friedman’s doctrine over the past generation as in large part a reflection of the fact that the Friedman-Keynes position is unstable: that one either follows today’s Republican Party and Prescottian Chicago School and becomes a market fundamentalist and thus for consistency deny that the government can do any good, or one moves toward a comprehensive skepticism of markets without an additional clever technocratic layer of regulation imposed in addition to property, contract, tort, criminal, and clever macroeconomic policy to make Say’s Law true in theory even though it is not true in practice.

Why this is the case I do not know. I am trying to think about it…