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Friday, March 19, 2010

James Kwak has it in for Richard Posner, and so do I

Enormous damage was done by the economic consensus of the past 30 years. The crash and current depression should have cleared it from the field. But a vigorous rear-guard action is being conducted by the entrenched interests, but also by the know-nothings who are gradually and incompletely converting to some kind of bastard Keynesianism.

Richard Posner is the crown prince of these know-nothings. Severe and continuing damage continues to be done on our society as a result of not discrediting these guys completely. James Kwak does his part. You should do yours.

Richard Posner Has Another Book?
James Kwak
The Baseline Scenario
March 16, 2010

Fresh on the heels of A Failure of Capitalism, the new title is A Crisis of Capitalist Democracy. Maybe the next will be The Downfall of Everything Good in the World.

I haven’t read it. BusinessWeek has a curious review (curiously titled “Slapped by the Invisible Hand” . . . which is the title of Gary Gorton’s book). Here’s the funny bit:

“Posner, who less than a year ago began his dissection of the crisis of 2008 with A Failure of Capitalism (Harvard, May 2009), has enormous credibility when he casts a skeptical eye on Wall Street. As an influential free-market thinker, he helped shape the antiregulatory ideology that inspired so much public policy since 1980. Belatedly he admits error.”

Wait a sec. Being wrong for decades gives you “enormous credibility”? So if, say, James Inhofe were to admit that he is wrong and that climate change is occurring, then he would suddenly be an important voice on what to do about it?If James Gilleran (former director of the OTS) were to write a book about the problems with lax regulation and what needs to change, would you buy it?

This particular marketing angle is probably not Posner’s fault, but he should still be embarrassed by it. Here’s what he said in an interview:

“1. The general wisdom is that you switched from a laissez-faire approach to one that accepts the role of government regulation to stabilize the economy. What has changed your view of capitalism?

“This has really been only since September 2008—since the crisis, when I took another look at everything. There was erroneous monetary policy and much too low interest rates, which encouraged excessive borrowing. And then there’s this very lax regulation of financial institutions, which reflects a failure to recognize that the financial industry is very unstable and requires regulation. It is connected to everything in the economy—consumers and businesses alike depend on it—so when it collapses, you’ve got real problems. A lot of people failed to see that. The financial backbone of the economy is a corner of capitalism that requires more intrusive and careful regulations than a lot of economists thought. Because of the centrality of credit in a capitalist economy, a capitalist economy is inherently unstable. This instability can become catastrophic unless you have something in place to mitigate it. Unfortunately no one seems to have very many great ideas on how to do this.”

A lot of people failed to see that? More intrusive and careful regulations than a lot of economists thought? No one seems to have very many great ideas? Posner wants to pretend that this was some deep, dark mystery, like relativity; it’s hard to criticize physicists before Einstein for not figuring out relativity. But it wasn’t. There has been a debate over free market principles and their applicability to the real world (including finance) for decades (see the books by Justin Fox, John Cassidy, or Joseph Stiglitz for more), and Posner was on the wrong side of that debate. He wasn’t a Newtonian physicist who wasn’t quite as smart as Einstein. He was part of the problem, and he made it worse.

Readers may wonder why I have it in for Richard Posner, of all people. The reason is that I am in law school, and as a result I have had to read multiple opinions in which Posner smugly reflects on the production of efficient equilibria through the operation of incentives, without bothering to sully his logic with the faintest scrap of empirical evidence. Posner is also in part responsible for the hegemony of the law-and-economics theory of vast areas of the law, which I described on an exam this way:

“What you end up with is judges who know little about economics making uninformed guesses about economic tradeoffs, and then being upheld by appeals courts who (a) know just as little about economics and (b) wouldn’t find reversible error in any case.”


  1. I also have to agree that Posner misses the fact that their are great ideas about how to mitigate the possibility of future crises. One is a simple return to Glass-Steagall. Second is a use of reserve deposits by central banks. These would take capital from banks and hold it in the central bank. This has the effect of reducing the banks working capital and its ability to lend excessively. This could be with the Federal Reserve, though since they never see bubbles anywhere this looks like a useless option in the US. Until you have a regulator that does their job then that is unlikely.

    There are other measures that could be used such as financial product reform so that consumers cannot be hoodwinked into taking more risk than they want.

    Tax reform so that capital gains are treated on the same basis as income. That would stop so much effort going into rigging accounts to show false profits so gaining tax advantages.

    Fixing national statistics so that they very rarely change. If governments can change definitions of unemployment for example to avoid the painful reality of the failure of their policy then that would allow people to actually see what works.

    Posner is wrong on the fact that there are no great ideas. The problem is that they are objectionable for political reasons not economic reasons.

  2. Posner sees no great ideas because he has been trained and co-opted into market fundamentalism. Perhaps it is a good sign that he has had some change of heart. The good ideas of Stiglitz, Galbraith and others are invisible to him by reason of his own blinders, not because they do not exist.