This I Believe. (The Non NPR Version)

Edit: Yes, I wrote this at work on a Word Doc.

I am trying to put together a coherent vision of what I believe. Although it will most likely end up as a list of bullet points, I think I am also going to try and put together some things that are slightly (but not much) more comprehensive, less ranty, and hopefully more systematic and lucid than some of my previous posts or fights with RS in the comments. I understand that you few loyal friends out there probably read the blog because you're bored as hell and/or are looking for an occasion to make Chinese jokes…but I don't know where anywhere else I could think out loud like this, so I'm doing it here. I'd like for you to read it, if only to let me know if these things are coherent, striking a chord, whether they seem biased, and whether or not it's interesting, which I hope it is. (These things are certainly fun to write.)

So today's post is a whopper of an issue, and it could be framed in a variety of ways (none of them entirely accurate):

• Deregulation v. Regulation
• Reaganomics v. Clintonomics
• Milton Friedman v. John Maynard Keynes
• Pure Free Market Capitalism v. Slightly-Less-than-Pure Free Market Capitalism
  

So here's a little introduction that I'm going to quickly pound through (that's what she said) off the top of my head, just in case the context of the argument isn't the type of thing you generally give a shit about.

So...by the late 70s, we were embroiled with an existential struggle with Communism around the globe, witnessing devastating effects to societies and economies around the world as totalitarian dictatorships seized the means of production and tried to implement state-run-state-controlled economies. America grappled with stagflation, financial crises, oil crises, and the like. Conservatism had also molded itself into a formidable intellectual movement with respectable principles and people who were clearly neither stupid nor cynical: they were serious and very smart. (I note here that a wonderful article entitled "The Perils of Populist Chic" from the WSJ discusses the current state of that line of conservatives.) Economists like Milton Friedman from the Chicago School made powerful economic arguments about the power of free markets and the burden of government interference. Then ascendancy: Margaret Thatcher and Ronald Reagan were elected in 79 and 80.

Reagan believed that government and regulation were the problem. If you reduced taxes, people would have more money and the economy would grow faster. If you cut down on regulation and bureaucracy, then businesses have less obstacles to flourish and be productive. Get the inefficient and bureaucratic government out of the way of American business, and America would prosper. As a corollary, this is good for everyone because as the rich get richer and richer, the wealth would "trickle down" to the poor. Everyone wins. Basically, free up the markets, allow people to keep their money and freely spend it and invest it, and the American economy would grow faster and all people across the spectrum would be better off as market mechanisms self-correct and distribute the wealth.

The overt goal during the Reagan Administration was thus to deregulate and dismantle as much of the federal government as possible, with the exception of defense and the military. The problems of the world and economy would all be eliminated by eliminating government regulation and lowering taxes. Freedom from the government was the solution. Just to make this point clear, no matter what the subtleties of the philosophy may have been, it became little more than unabashed hostility to the federal government. Notably, this was the explicit governing philosophy of the Bush Administration and continues to be a major force in the debate over the financial crisis ("No Bailouts!"). This philosophy also continues to dominate the conservative movement. Introduction over, this is where my discussion begins.

I would like to start by invoking current events, sort of. One of the weakest invectives from the last election cycle is the invocation of Obama as a Socialist. It didn't stick. The Baby-Boomer-Cold-War-Vietnam-Fear-Mongering failed across the board this year. The generational torch has passed and half of them can put their stupid 1960’s battles in a pipe and smoke it, while the other half can lament and declare war on it. Let me point out that a 3% increase in income taxes for the top 1% of the country is definitely NOT the dividing line between freedom and socialism. Please stop.

More broadly, the ideological battle between capitalism and socialism is no longer relevant. Market capitalism has prevailed. There is no longer a meaningful or useful debate about whether market forces and the creative forces of economic freedom are far superior in creating value and allocating resources efficiently than centrally-planned economies. They are. By fostering market mechanisms, namely preserving profit motive and private decision-making for capital allocation, economies have expanded globally, lifting millions out of poverty in the past 20 years. Even redistributive societies recognize that freer markets are necessary to generate enough wealth growth for tax and redistribution.

But despite their ascendancy and efficacy, the limitations and preconditions of free markets cannot be ignored. Economic models presuppose perfect information – the real world does not provide perfect information. Well-functioning economies require the rule of law: contract laws, property laws, and an independent judiciary to enforce the laws. Market actors do not properly price in negative or positive externalities, resulting in problems like excessive environmental degradation and too little investment in non-industrial pure sciences. Market failures are abound in economic models, ranging from monopoly pricing to poverty traps. The development of human capital does not provide adequate returns to properly educate a society. Infrastructure like roads, railroads, airports, power, water, and communication require public spending and investment, and serve as necessary preconditions to economic growth. In short, well-functioning markets require a well-functioning government: The freedom of free markets cannot be falsely conflated with the pure libertarian freedom espoused by believers in deregulation.

We have spent far too much energy battling this false dichotomy between deregulation and regulation. Instead we should be focusing on how to regulate. Enforceable contracts are good regulation. An independent judiciary is good regulation. Consolidated oversight of financial institutions is good regulation. Capital adequacy standards for banks is good regulation. Telling banks who to lend to is bad regulation. Bailing out zombie industries without a policy goal is bad regulation. Allowing economic power to compound by allowing it to control political power is bad regulation. Property rights are good and necessary regulation.

The false dichotomy of regulation and deregulation has left the arena of legitimate ideas and is now the province of wealthy cynics and the sippers of their Kool-Aid. I can never respect it any more than I respect “intelligent design” (which is actually quite similar because they both begin with "Poof!" and end with “Perfection!”) I can fully engage in discussion about the size of the federal government. We can disagree about the prudence of certain entitlement programs. I can get on board with the idea of decentralizing power to preserve local freedom, e.g., federalism. I can also have an intelligent discussion about the dangerously fragmented financial regulatory system of the U.S., and how the manner of regulation the various agencies practice is misguided and detrimental. We can talk about whether environmental regulators should remain hands off, or set strict guidelines on emission levels, or use judicially enforceable standards, or be implemented by complex science-based regulatory agencies. But for God’s Sakes, can we stop this dogmatic nonsense that the mere existence of regulation and government is the problem?

Moving on to the financial side...

An exceptional op-ed piece entitled "Human frailty caused this crisis" in the Financial Times by Richard Thaler and Cass Sunstein further this critique of classical free market theory by pointing out that the classical neoliberal economic model is non-behavioral, in short that it has no role for human nature. Anyone who begins the study of economics immediately stumbles upon the assumption that all people act rationally, wrestles with it uneasily, and then is promptly told to ignore the assumption because it is required for modeling. This non-behavioral strain of economic thinking is also the underlying premise of deregulatory conservatives: If people didn't act the way they did in the economic models, the outcomes wouldn't be as good as the models predict.

The op-ed points out two "human frailties" that render the rational economic actor assumption useless: limited rationality and limited self-control. The first piece, limited rationality, is obvious to anyone who happens to be human: we are limited in our perceptions and capacity to be totally rational. Choosing to brush past this basic fact, ideologues often claim that sophisticated investors will correct the system by making optimal decisions. Even conceding that this is true for simple financial instruments like a single mortgage, it is provably false for modern financial instruments, like synthetic collateralised derivatives many degrees divorced from the mortgages. No one understands these financial instruments. No one can price them. The computer models used to create them turned out to be dead wrong. Greenspan himself, the patriarch of current free market philosophy, admits that the most sophisticated investors in the world did not understand the instruments the markets created.

Question: "Do you feel that your ideology pushed you to make decisions that you wish you had not made?"

Greenspan: "Yes, I've found a flaw. I don't know how significant or permanent it is. But I've been very distressed by that fact. . . . This modern risk-management paradigm held sway for decades…The whole intellectual edifice, however, collapsed in the summer of last year."

The second piece, limited self-control, is also obvious to anyone who happens to be human. We smoke cigarettes, we eat cake, we drink too much, and we desire too much. Sure, greed is an impulse for productivity and hard work, but greed is also the impulse for dropping a month's paycheck in a casino. None of that is rational, and most of it is simply the inability to resist temptation and exert perfect self-control. Temptation and limited self-control lead to irrational investment decisions, in our current situation, most notably in the pile-on that took place in mortgage-backed derivatives, despite the fact that no one knew what they were or how they worked. (They were literally designed by astrophysicists and math whizzes on computers.)

The conclusion? Well-functioning markets are incredibly complex and delicate and require intelligent regulation. Financial regulation and monetary policy cannot be based on classical economics unless it accounts for human limitations. Human frailty will forever be the free radical preventing the system from operating the way it does in a textbook, and to ignore the human side of the equation, or in other words, to ignore the protestations of reality, is nothing less than dogma. It is calling for increased the State economic control in 1989 Russia.

What we need to do is to distill the essence of what makes markets work. It's not simply "freedom," and thus the answer is not simply deregulation. Broad economic freedoms are an absolutely necessary component, but determining which economic freedoms are the most central to functioning markets is the key. I don't think a shifting band of marginal tax rates are a determinative factor (e.g., the US and Germany). On the other hand, I believe that moral hazard and central planning could very well destroy markets. I don't think a reasonable minimum wage will stunt economic growth. On the other hand, I do think excessive labor regulations enforced by a bureaucrat in D.C. can hinder growth. Meaningful and intelligent debate should be furiously taking place over the prudence of mark-to-market accounting v. historical cost accounting, not whether accounting regulations should exist at all. Some types of decisions should be made privately, and some can validly be made publicly. We need to distill the essence of effective free markets, and focus our energy in developing ideas and methods to nurture the right impulses and control the wrong ones.

Unlike Communism, we don't want government making production decisions. But we do want government engaging in broader policy like punishing fraud and creating mechanisms for detection, like disclosure and accounting. And we can do this. There are hundreds of systems around the world from London's light regulation of finance coupled with universal health care to France's heavy regulation of finance coupled with a heavily redistributive system to China's system of government directed market capitalism to North Korea's moronic jackassery. There are hundreds of tax and revenue systems: VATS, sales taxes, income taxes, dual taxes, resource taxes, estate taxes, and tariffs. We have tools with various degrees of coercion and subtlety, and we have the ability to design appropriate institutions.

The broad and sweeping hostility to regulation and government is a relic of the past. Move on. There are harder and far more relevant questions to consider. I'm shuttering Reaganomics away with Stalinomics and Maonomics and moving on.

Note on Libertarianism:
So I do want to note that this does not mean that I don't respect libertarian beliefs, which I believe are different. Conservatives speak of liberty primarily (though not completely) as a means to an end: increased growth and higher standard of living. This is the claim I find specious. Libertarianism values individual liberty as both the means and end. To be free is to be free to succeed as well as to fail. If that is the case, you are forced to acknowledge and fully accept the potentially devastating consequences a libertarian system would produce with respect to issues like poverty and inequality, and the subsequent social fall out. And that is totally respectable, because a moral philosophy predicated on individual liberty is very appealing and justifiable, I get it. If liberty itself is worth more than all of the potential consequences of its free exercise, then I can totally be at peace with your values. I just am making the point that you cannot argue that the negative consequences won't happen because the markets will correct themselves and somehow spit out positive social outcomes. It's a new twist on an old cliché: freedom is not free, so stop pretending that it is.

That's all. That must have sucked to have read all of that.