Heroes of Heterodoxy in Economics (Left and Right)

Back in early 2006, the prescient Dean Baker wrote about “The Menace of an Unchecked Housing Bubble.” He’s recently observed why so many economists failed to criticize the bubble:

Just apply economics to economists. The honchos in the profession (Paul Krugman excepted) said everything was fine. Agreeing with the honchos will never get you in trouble. You will never lose your job or even miss a promotion because you made the same mistake as all the leading lights in the profession.*

On the other hand, if you go against the honchos and end up being wrong, well you should be prepared to be sent to oblivion. You are obviously a raving lunatic who has no business being taken seriously as an economist. Even when you end being right against the honchos you can’t count on any great reward, since the honchos so control the profession and the media that “nobody could have seen” will be repeated at least frequently as the fact that some people did see.

Baker is often seen as a man of the left, but the libertarian right offered its own predictions of collapse. Peter Schiff, an avowed adherent to the Austrian school of economics, battled with various hype-mongers on television. I heard a great interview with him where he basically asked: what is the real economic foundation of American prosperity? what are we producing that other people want? Like Kevin Phillips, he mocked the dreams of Rubinomics, helpfully summarized by Madison Powers here:

Rubin’s widely expressed view before things fell apart was that as long as the U.S. dollar remains strong, often by depressing real wages both domestically and abroad, then the U.S. economy would grow in wealth primarily through the machinations of the financial sector. Indeed, U.S. household wealth grew at a stunning rate, vastly outstripping its traditional proportional relationship to the medium household wage. In nine years, household wealth grew to 9.7 times the mean annual family income. That compares to 6.4 times income just a few years before and 2.4 in 1982.

Economists concerned with rising income inequality in the U.S., as well as developmental economists who focused on similar patterns of declining wages globally became suspicious. Americans were not saving, and wages were not keeping apace of what would be necessary to finance the homes that increasingly constitute the bulk of this brand new “wealth effect.” Moreover, there were good reasons to believe that this new American wealth was not only illusory but causally related to the global trends toward greater income inequality, primarily through the policies that propped up the U.S. dollar, outsourced American jobs to countries who competed for increasingly lower wages, while simultaneously being hit by the deflation of their own currency under pressure of the U.S. dollar.

All this leads me to the uncomfortable conclusion that the main currents of economic thought may be unable to guide us out of the current crisis. Back when Baker’s article came out, I commented that the housing bubble ought to be viewed through Robert Frank’s lens of positional competition. Housing prices often appear to reflect little about the actual utility of the underlying asset; rather, they’re driven by interest rates, financing options, social norms about the proper percentage of income to spend on housing, and panics (both to buy and to sell). Laws designed to stop risky financing are not mere paternalism; rather, they properly undermine both “arms races” and ensuing busts.

The question now is to what degree can the two groups work together to stop misguided policies like the artificial propping up of housing prices. Some on the right will oppose the new fad of a 4.5% mortgage rate because it’s one more governmental distortion of the market; others on the left might note that the 66% or so of Americans who own houses are by-and-large better-off than the third or so who don’t. I find some hope in the fact that one of the premier heterodox economists, Robert H. Frank, was featured in George Mason’s Econ Journal Watch, and in turn “takes libertarian concerns seriously.” Cato Unbound has also featured an excellent article by Roderick Long on possible points of convergence among heterodox economists:

[C]orporations have been frequent beneficiaries of U.S. military interventions abroad, from the United Fruit Company in 1950s Guatemala to Halliburton in Iraq today.

Vast corporate empires like Wal-Mart are often either hailed or condemned (depending on the speaker’s perspective) as products of the free market. But not only is Wal-Mart a direct beneficiary of (usually local) government intervention in the form of such measures as eminent domain and tax breaks, but it also reaps less obvious benefits from policies of wider application. The funding of public highways through tax revenues, for example, constitutes a de facto transportation subsidy, allowing Wal-Mart and similar chains to socialize the costs of shipping and so enabling them to compete more successfully against local businesses; the low prices we enjoy at Wal-Mart in our capacity as consumers are thus made possible in part by our having already indirectly subsidized Wal-Mart’s operating costs in our capacity as taxpayers.

Wal-Mart also keeps its costs low by paying low salaries; but what makes those low salaries possible is the absence of more lucrative alternatives for its employees—and that fact in turn owes much to government intervention. The existence of regulations, fees, licensure requirements, et cetera does not affect all market participants equally; it’s much easier for wealthy, well-established companies to jump through these hoops than it is for new firms just starting up. Hence such regulations both decrease the number of employers bidding for employees’ services (thus keeping salaries low) and make it harder for the less affluent to start enterprises of their own. Legal restrictions on labor organizing also make it harder for such workers to organize collectively on their own behalf.

Like David Cay Johnston, Long realizes that state and market are so intertwined that it is often deeply misleading to talk about either entity as separate from the other. Of course, this is old news to anyone schooled in the works of the American legal realists:

Morris Cohen’s Property and Sovereignty, and Jaffe’s and Hale’s articles on the law of contract all seemed to show that rules of private law could be seen as regulatory, that contract law could be seen as the delegation of public power to private actors and that even the most “private” activities could be described so as to invoke the public interest. On the level of practical politics, most of the agencies of the New Deal could not neatly be classified in terms of the classical liberal dichotomy of public and private. What for example, was the Tennesee Valley Authority? At the high point of this movement, in the case of Shelley v Kraemer, the Supreme Court actually accepted the argument that the mere enforcement of private contracts by the state courts counted as state action–a ruling that implicitly subjected every private law relationship to constitutional scrutiny.

Such a viewpoint might seem antithetical to the libertarian ideal of pure private ordering. But it also stands as a fruitfully cautious corrective–just as libertarian warnings about capture and governmental favoritism have to be part of left-heterodox reasoning. Smart challengers of the economic status quo realize this, and argue for the right kind of government favoritism rather than eschewing it altogether (as Robert Kuttner does here:)

As part of his plan to restructure the auto industry, rebuild infrastructure, and create new green industries and jobs, he will be committing industrial policy. And this will create a head-on collision with one of the cherished dogmas of market fundamentalism — “free trade.”

This clash is long overdue. For several decades, American elites of both parties have been preaching the same gospel of free trade. Supposedly, if we just leave markets alone, different countries will produce and export what they naturally do best, and import products at which their partners excel. In the tidy and oversimplified textbook world, there is no room for questions about pollution, labor standards, product safety, financial engineering, or industrial policy.

But the real world doesn’t work like the Econ. 101 fable. In much of the rest of the world, governments help their industries develop. However, in the hierarchy of America’s diplomatic priorities, countries like China that subsidize industries (and violate human rights) get a free pass.

Any suggestion of an industrial policy is probably going to outrage many on the heterodox right. But what both left and right heterodox economists ought to agree on is the centrality of values to economic choices. Neither the Austrian School nor fans of industrial policy will get its program through a political process where truth is so often bent to existing concentrations of power. But each urge us to make considered choices about the true value an economy produces, and to suspect the types of artificial “wealth creation” that modern seignoriage relies on.

*Given how much I enjoyed reading C. Wright Mills’s The Power Elite, I was wondering—how many honchos are there? Fortuitously, David Colander’s new book (The Making of an Economist) provides something like an answer:

[E]lite [graduate schools of economics] compete vigorously for top students. They invite accepted candidates to campus, wine and dine them, have them meet with faculty members, and work hard to sell their school to them. . . . Once they graduate, these students tend to dominate the profession: they are the majority of members on American Economic Association (AEA) boards, and they are the economists called upon when a reporter is seeking economists’ view on an issue.

Of course, not all of these graduates manage to remain in the elite, but it is from this group that the majority of the elite come. How large is this elite? There are probably around 100 to 150 of the definitely elite, 700 to 800 of the elite, and another 1,500 economists might be seen as peripheral elite. All have Ph.D.’s, and most have academic appointments, although some move back and both between academia and government. [emphasis added]

Colander might also challenge any effort to portray economists as a whole as a monolith; he notes that:

What were taken as requirements of research in the 1980s are no longer requirements in the 2000s; the holy trinity of greed, equilibrium, and rationality has been replaced by a looser trilogy of purposeful behavior, sustainability, and enlightened self-interest. I could extend the list enormously, but there is no need to do that here. My point is simply that economics has changed and will continue to change, making it impossible to call the existing profession neoclassical any longer.

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