(Via The Washington Independent, Rand and Greenspan)
When he was young, Alan Greenspan suckled at the bony breasts of Ayn Rand, drinking in as his mother’s milk libertarian and Objectivist thought. After being furthered mentored by Milton Friedman, Greenspan rose to ranks of policy making until he became Federal Reserve chairman. In that position he was the world’s pre-eminent advocate of neo-liberalism, always quick to lecture on the need for deregulation so that markets could do their magic.
And now with the current global financial crisis something completely unexpected has happened. Greenspan, age 82 and a very old dog indeed, has learned something new: that markets don’t always give you the best result.
Grilled by members of the U.S. Congress, Greenspan admitted “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.”
Greenspan further confessed, “”I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works. That’s precisely the reason I was shocked… I still do not fully understand why it happened and obviously to the extent that I figure where it happened and why, I will change my views. If the facts change, I will change.”
Aside from commending Mr. Greenspan for still being open to new facts and theories, it might be worth asking where he went wrong and what other books he should have been reading apart from Ayn Rand and Milton Friedman.
Over at Crooked Timber, John Quiggin pinpoints pinpoints one of the flawed models that Greenspan was relying on, the Efficient Markets Hypothesis. As Quiggin helpfully explains: “In its most relevant form, the EMH states that prices observed in asset markets (for stocks, bonds, foreign exchange and so on), reflect all known information, and provide the best possible estimate of the value of earnings that assets will generate.”
Quiggin provides a summary of whats wrong with the EMH and where the failure of this model leaves us:
The EMH implies that, provided governments get prices right (avoiding distorting taxes, internalising externalities and so on) it’s impossible to improve on the allocation of investment capital generated by private markets. The converse doesn’t hold automatically. Even granting that private markets are subject to bubbles and fads, and that their investment decisions may not make sense in the light of publicly available information, it doesn’t necessarily follow that governments can do better. Still, for large scale infrastructure systems, the case for leaving investment planning as, in Keynes words ‘the by-product of the activities of a casino’, looks a lot weaker now than in did before this crisis. Of course, for anyone who cared to look, the ludicrous investment decisions made during the dotcom boom had already undermined the EMH.
Once the EMH is abandoned, it seems likely that markets will do better than governments in planning investments in some cases (those where a good judgement of consumer demand is important, for example) and worse in others (those requiring long-term planning, for example). The logical implication is that a mixed economy will outperform both central planning and laissez faire, as was indeed the experience of the 20th century. I’ve written a more detailed version of this argument here here.
So, Greenspan (and those who think like him) should take a remedial economics course and start boning up on Keynes.
A few other suggestions are in order: the great problem with neo-liberalism is that it’s a fundamentally ahistorical mode of thought. Trying to apply 18th century models of equilibrium and harmony to the modern economy, neo-liberals typically fail to notice that modern corporations are nothing like the private firms that Adam Smith studied. Of course, there is a formidable body of thought that does try to think about economics historically, emphasizes the reality of crisis rather than equilibrium, and is very sensitive to the shift from entrepreneurial enterprises to early corporations to global capital: Marxism, particularly as its been revised by writers like Ernest Mandel, Robert Brenner, and David Harvey.
I doubt that Greenspan will crack open any of the modern Marxist classics. What he might find more palatable are books by moderate social democrats who from the 1930s onward have called attention to the fact that the managerial class that runs the modern corporation has its own agenda, and often works to enrich its own coffers and perpetuate its own powerbase at the expense of the shareholders and the larger public. I’m thinking here of writers like Adolph Berle and John Kenneth Galbraith. The great achievement of these theorists is that they saw modern capitalism as a matter of institutions, rather than just markets.
These institutional theorists were of course enormously influenced by the Great Depression and they (along with Keynes) helped build the regulatory state that allowed capitalism to regain its footing. This regulatory infrastructure led to the golden age of modern capitalism, the period from 1945 to 1973, when a mixed economy led to the greatest improvement of the lives of ordinary people in the history of the world.
Alan Greenspan, its worth recalling, enjoyed his early manhood during this golden age (he was 19 years old in 1945). Indoctrinated by ideologues like Rand and Friedman, Greenspan thought that the economic prosperity of the period was the product of the free market, rather than the mixed economy. So Greenspan spent his life working to undermine (usually very successfully) the regulatory infrastructure that moderate social democrats had so carefully built. That was the root of the “flaw” in his thinking that he now has to come to terms with, as do we all.