November 30, 2008
The Future of Free Market Conservatism
The Future of Free Market Conservatism- Becker
I agree with Posner that the future of free market policies in the United States has been damaged by the financial crisis, and by the continuing rise in unemployment and slowdown of the American (and world) economy. The degree of damage, however, will be determined by the length and severity of this recession. If the recession does not develop into a deep and prolonged depression, there will not be a sizable retreat from the market policies that have been in effect.
The big victory of Senator Obama and the Democratic Party was not a referendum on free market policies. Rather it reflected the continuing unpopularity of the Iraq war and of the Bush administration, and months of growing concern about foreclosures, rising unemployment, and the weak economy. American voters seem to want greater regulation of the financial sector, not an abandonment of policies that generally have supported the private sector and competition. This is reflected in the economists Obama has appointed to top positions in his administration. These economists, such as Larry Summers and Paul Volker, have generally recognized the importance of competition as a way to regulate market behavior.
Nevertheless, in light of the severity of the financial crisis, greater regulation of financial institutions is merited. The challenge is to find regulations that would significantly reduce the probability of future financial crises without discouraging the valuable contributions commercial banks, investment banks, and other financial institutions make to risk management and the financing of home ownership and business investments.
Several changes do seem likely to be beneficial. Greater capital requirements (relative to assets) for all financial institutions, including investment banks and hedge funds, would help banks better weather runs on their assets. Greater transparency in the information financial institutions provide about their assets would also be useful, although modern assets are often so complicated that transparency will not always be easy to achieve. Fully privatizing Fannie Mae and Freddie Mac would help reduce the flow of mortgages to unqualified homeowners. Incomes of many fund managers and private equity leaders rose enormously, but it is difficult to prevent that from happening again without introducing controls over their salaries, stock options, and bonuses. The greatest challenge is to find ways to reduce the type of private risk-taking in which the taxpayer bails out failure, although greater capital requirements would help.
Posner advocates a pragmatic approach to the evaluation of public policies. Up to a point that approach is fine if it just means a careful consideration of all the available evidence relevant to proposed policies, including knowledge built up from the successes and failures of past policies and actions. But facts themselves are silent without being guided by an analytical framework or theory, so pragmatism is not sufficient to provide important insights into the desirability of various public policies. Conservatism, liberalism, and various combinations of these positions provide different frameworks to interpret the facts.
Posner agrees that a theoretical framework is crucial for interpreting evidence because knowledge about how particular policies worked in the past or might work in the future is seriously incomplete. This knowledge has to be supplemented with predictions about how particular policies would affect the operation of the economy, especially over aspects of the economy where evidence about behavior is very incomplete. These predictions can only come from a theory about behavior and markets that sheds light on the behavior that is not directly observed.
To take a concrete example, the consequences of imposing minimum capital requirements relative to assets on all financial institutions, including hedge funds and private equity companies, depends not only on how such a requirement would affect the operation of the financial system, but also how it would affect investments, employment, and other aspects of the real economy. To understand these consequences requires a theory of the effectiveness of competition in this sector, and an analysis of whether the present financial crisis would have been much milder if capital requirements had already been in place.
The general point I am making is that an economic theory of how markets operate is necessary to evaluate any significant new regulations and other government policies for financial markets (and more generally, for other markets as well, such as the subject of our blog two weeks ago on whether a bailout of the auto industry is justified). Some retreat from free market conservatism is to be expected an s a result of the crisis, but it would be a serious mistake if the analysis of financial and other markets that becomes dominant in Washington gives insufficient weight to the enormous contributions of business competition in raising human welfare.
The Future of Conservatism--Posner
The defeat of the Republican Party in the November election is widely thought to signal the decline of conservatism in the United States. But it is important to distinguish between the Republican Party and conservatism rather than to equate them. In a two-party system, political parties are opportunistic coalitions and hence lack ideological homogeneity, especially in a culturally heterogeneous nation, such as the United States. Apart from the many Republicans and Democrats who vote for a party out of habit or nostalgia or family tradition or attachment to a particular issue or a personal liking or loathing for the other people who vote for the party, there are ideological voters. In the Republican Party these fall into three main groups: believers in (1) free markets, low taxes, and small government; (2) believers in tough criminal laws and a strong foreign policy; and (3) social (mainly religious) conservatives, who are hostile to abortion, gay marriage, pornography, and gun control. Groups (2) and (3) converge on hostility to illegal immigrants. Groups (1) and (2) are in some tension because a national security state requires big government and therefore high taxes. Group (1) is in tension with (3) because (1) is libertarian and (3) is regulatory.
All three groups have been hurt by recent events, and all three are moving apart because of the hits on the others. The financial crisis has hit economic libertarians in the solar plexus, because the crisis is largely a consequence of innate weaknesses in free markets and of excessive deregulation of banking and finance, rather than of government interference in the market. Believers in a strong foreign policy have been hurt by the protracted and seemingly purposeless war in Iraq (the main effects of which seem to have been discord between the United States and its allies, increased recruitment of Islamic terrorists, and the strengthening of Iran and of the Taliban in Afghanistan and of al Qaeda in Pakistan) and the Bush Administration's lack of success in dealing with Iran, North Korea, Afghanistan, Pakistan, and the Arab-Israeli conflict. And social conservatives have been hurt by the stridency of some of their most prominent advocates, who all too often give the appearance of being mean-spirited, out-of-touch, know-nothing deniers of science (e.g., evolution, climate change).
The efficiency gap between the competing presidential campaigns created the appearance of a competence gap between the parties. As the campaigns progressed, a surprising number of conservatives switched their support to Obama. Thoughtful conservatives, already disturbed by the accumulation of blunders of the current Administration (the Iraq WMD, Katrina, the Justice Department scandals), culminating in its uncertain response to the financial crisis, were appalled at the iconic status that Joe the Plumber attained in the Republican campaign, the wild rumors spread by the conservative bloggers and talk-radio hosts, and the intellectual vacuity of many Republican candidates and advocates. The Republican Party seemed to have descended to anti-intellectualism--to deriding highly educated people who speak in complete sentences as "elitists," as compared to the down-to-the-earth ignorance of Joe and his ilk--which sorts badly with the strong intellectual tradition of conservatism. It is a self-defeating strategy of conservatives to argue that "all" intellectuals are liberal and therefore conservatives should think with their guts rather than their brains.
For myself, I would be happy to see conservatism exit from the political scene--provided it takes liberalism with it. I would like to see us enter a post-ideological era in which policies are based on pragmatic considerations rather than on conformity to a set of preconceptions rooted in a rapidly vanishing past. We have accumulated a substantial history of liberal and conservative failures. The liberal failures include underestimating the cost of egalitarianism and of social engineering by judges (the Warren Court, Roe v. Wade, the near abolition of capital punishment), and the benefits of discipline, of punishment, of enforcing principles of personal responsibility, and of military force. The conservative failures include overestimating the efficiency of unregulated markets, the efficacy of military force, and the beneficent effects of religiosity. Liberals are wrong to promote unions (described by one wag, albeit with some exaggeration, as the parasites that kill their hosts) and conservatives to promote abstinence as a substitute for condoms in preventing teenage pregnancy.
Now I know that it isn't really possible to think without preconceptions. As Bayesian decision theory teaches, a rational decision maker starts with a prior probability of some uncertain event (that a credit crunch will turn into a major depression, for example), but adjusts that probability as new evidence comes to his attention--which means that his prior belief, his preconception, may, depending on the strength and direction of the evidence, affect his ultimate decision, which will be based on his posterior probability that the event will occur. Nor do I mean to deny the value of theory, in particular economic theory, in guiding policy. But there is a difference between rational preconceptions, based on theory and experience, and rigid emotional preconceptions, such as dogmatic libertarianism or egalitarianism or ungrounded hopeful beliefs such as that everybody in the world is yearning for and ready for democracy, that tell one more about the thinker's personality than about the quality of his thought and that may be impervious to reconsideration in the light of new evidence. We should be skeptical of world views rooted in emotion that insulate people against inquiry into the foundations of their beliefs. Concretely, there is a range of perfectly respectable economic theorizing, at one end (the interventionist) typified by Paul Samuelson and at the other end (the libertarian) by Milton Friedman, but it would be a mistake to commit to one or the other end since neither can be proved to be correct. The libertarian end of the range failed to grasp the danger of deregulation of financial markets and underestimated the risk and depth of the current economic crisis--an economic shock that appears to be severe enough to trigger a genuine depression.
But the point I particularly want to stress is that the recent failures of conservatism are not a vindication of liberalism. Both can fail, and as long as the failures are recognized, the United States can do fine.