Posts Tagged ‘Friedrich Hayek’

Government Is Good!

Wednesday, April 7th, 2010

Reagan’s deepest and most profound legacy to the right wing today, to the Tea Party, to the populist right is a selection of wry quips about the inefficacy and incompetence of government told with a grandfatherly charm. “In this present crisis, government is not the solution to our problem; government is the problem!” he said. “Government is the problem!” the placards at populist right wing gatherings now read.

This grotesque anti-government view regularly embraced and advocated by the populist right is incoherent, ignorant, and idiotic. It is the intellectual equivalent of blaming “The Man” or “Them” for all problems. While a (sometimes even paranoid) distrust of centralized power has always been part of American politics, the populist right today has elevated this sentiment to their core principle. It’s great efficiency as a rallying cry is that it papers over differences between the few but influential libertarian-minded who oppose government power on principle and the more numerous right wingers who see liberal government as an attack on their culture. What they both agree on (while a Democrat is in charge at least) is that the government is the problem.

This political coalition is animated primarily by anti-government rhetoric. While on some level it is a mere ideological trope, fervently believed only by the ignorant, used to rally the base to a revolutionary fervor and to create party unity, it has taken on the patina of truth in the eyes of so many it must be challenged.

Government is not inherently bad, inefficient, incompetent, destructive of liberty, or even liberal. Instead government is probably the single most influential force for good in our daily lives, acting in ways barely noticed even as its absence and failures would be and are noticed.

Friedrich Hayek, that great right wing theorist, said in his speech accepting the Nobel prize for economics, that the government had erred in attempting to engineer society. The proper role of government, Hayek believed, was that of a gardener tending her garden rather than of an engineer creating a machine. The populist right has bastardized this critique of Hayek’s and taken to demonizing the gardener while praising the garden as the greatest great thing since great things began to get greater (as Sean Hannity often says.)

What is lost in the populist right wing view is that our society, our economy, our nation, this greatest great thing ever, would not exist without the government tending it. I have been challenged – with apparent seriousness – to name anything the government ever did that was worthwhile.

In fact, the greatest product of the government is America itself – which, though like a garden has many individual parts, is given coherence by the gardener. The government has 4 main roles in shaping our nation:

1. Government acts as a check on corporations. Corporations exist to make profits – and as such externalize as many costs as they can; history has demonstrated that given the choice between doing the moral thing and doing the profitable thing, corporations will do the profitable one. This isn’t to say they are evil – it is merely to acknowledge their nature. Thus, given a choice between polluting the communal air and taking expensive steps to reduce that pollution, corporations have chosen to pollute. The costs of their actions are diffused while the benefits and profits are concentrated. Given the vibrancy of America’s market economy and the growing power of corporations, this is perhaps government’s most important role: to ensure that corporations have the incentive to make the moral choice. Most often this is accomplished with regulation, which though demonized by the populist right, is essential to America’s vibrant society and free market. Regulation is what allows us to open a can of beans without finding a human finger, to buy a standard mortgage and know our rights are still protected to some basic degree, to eat poultry without worrying too much over food poisoning, to buy a car and know it has met certain safety requirements, to breathe fresh air and to drink clean water. We can do all of this because of government regulation acting as a check on corporate greed.

2. Government underwrites social order. While the government is not present at every moment in our lives, it underwrites a certain type of order and undertakes to ensure that certain elements of a partially unspoken social bargain are upheld. For example, the government provides courts of law to resolve disputes and employs people to prosecute crimes. It has undertaken various steps to prevent terrorist attacks. It maintains regulations as above. When there is a crisis, the government assumes greater powers and responsibilities to protect the status quo and restore order.

3. Government makes long-term investments in the nation. While corporations and individuals control most investments, the government has, since its inception, funded various long-term projects from investments in infrastructure to space travel to education to medicine to military technology. These investments have led to everything from sending men to the moon to creating the internet.

4. Government provides certain services. From subsidies for the elderly (Social Security) to disability and unemployment benefits to disaster relief to cheap postage, to – soon – a transparent and standardized marketplace for health insurance – the government provides a selection of valuable services that are important yet under-served by the marketplace dominated by corporations looking for large, quick profits and non-profits that are often underfunded.

The internet itself is a great example of the role government plays in our lives. It was based on technology created by government scientists. It was enabled by government regulators who prevented AT&T from blocking access to their infrastructure which would have choked off the internet before it began. Access to the internet making it more widespread has been enabled by government programs as well as individual and corporate decisions. (For a neat list of how the government affects everyone on a daily basis, take a look at this article by Douglas J. Amy.)

This view of government is inherently liberal, even as the goods provided can be more broadly appreciated. Without government, there would be no rule of law, no free market, no corporations (which are government-created entities), no property, no freedom of speech or religion or assembly. Individuals without the protection of government have the freedom their power allows them to seize. With the careful use of government though, restrained and judicious, individuals can be empowered.

Liberalism, like the conservatism of William F. Buckley, Friedrich Hayek, Edmund Burke, Dwight Eisenhower, and even Ronald Reagan, is not about extending the role of government everywhere. It is the path between seizing the commanding heights of the economy and the anti-government hysteria of the populist right in which the government is used to empower individuals:

Liberalism in a market-state must exhibit a preference for the individual over the corporation and government and must empower individuals against bullying and coercive measures of these large institutions.

Sometimes that means the government must be constrained; and sometimes that means it must use its power to balance against other forces such as large corporations.

Government, used wisely, is good and the creator of free markets and the guardian of individual freedoms. This isn’t just a liberal idea or a conservative one. It is an American idea – indeed, the base of our American system.

[Image by Pittsford Patriot licensed under Creative Commons.]

*I have only been using the term, “government” here – but I mean, the federal government. I have used the terminology this way so it may better function as a response to the populist right which generally speaks of “the government” when they mean only the federal government.

Theories of the Financial Crisis: Misjudging Risk

Tuesday, April 28th, 2009

The bankers – whose enormous salaries were earned based on their skills at judging risk and making money – caused a financial cataclysm because they disastrously misjudged the riskiness of the complex financial instruments they created and sold.

This was the lesson I learned in the immediate days after the financial crisis – and it still explains a great deal of what happened. (Of course, there was also a good deal of outright fraud and the perversity of short-term incentives in which bankers could profit exorbitantly if they made profits regardless of how their investments turned out over the long-term.)

Cognitive errors may have contributed to the misjudging of risk. Megan McCardle for example gave a compelling description of different cognitive errors which contributed to the financial crisis – including the recency effect which she describes:

People tend to overweight recent events in considering the probability of future events.  In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high.  Now I rate it as much lower.  Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it’s much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan.  My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.

These cognitive errors were so damaging because they were programmed into the models for minimizing risk that the “quants” created to divvy up mortgages and just about everything else that could be bought and sold. 

Michael Osininski tried to claim some share of the blame in a recent New York magazine article – as one of the top “quants.”  Osininski described how he had an inkling of the disaster ahead:

[T]he world I had helped create started falling apart. I hadn’t anticipated it, but at the same time, nothing about it surprised me.

Last month, my neighbor, a retired schoolteacher, offered to deliver my oysters into the city. He had lost half his savings, and his pension had been cut by 30 percent. The chain of events from my computer to this guy’s pension is lengthy and intricate. But it’s there, somewhere. Buried like a keel in the sand. If you dive deep enough, you’ll see it. To know that a dozen years of diligent work somehow soured, and instead of benefiting society unhinged it, is humbling. I was never a player, a big swinger. I was behind the scenes, inside the boxes. My hard work, in its time and place, merited a reward, but it also contributed to what has become a massive, ever-expanding failure.

Jordan Ellenberg described how these models that purported to minimize risk actually just compressed the risk into “one improbable but hideous situation” in a manner similar to that of the 400 year old sucker bet, the Martingale. For example, Wall Street bankers combined hundreds of mortgages into securities in the belief that while some of the mortgages might default – most would not. The more mortgages you combined, the safer the investment was – as only a small percentage of mortgages typically defaulted. Unless something went very wrong. Comparing Wall Street bets to the Martingale, Ellenberg described the bet Wall Street was making:

(0.99) x ($100) + (0.01) x (catastrophic outcome) = 0

Wall Street bankers thought that the collective assets they were trading were worth $99 each in this estimate – rather than $50 as they would be if each asset were judged individually. 

One of the few people who saw this misjudging of risk as the inevitable cause of a financial crisis was Nassim Nicholas Taleb who wrote that Wall Street had consistently ignored the possibility of what he called “Black Swans” and what Ellenberg described as an “improbable but hideous situation.” Taleb has placed a great deal of blame on the mathematical models used by the quants and on the hubris of the bankers and traders who believed that they were created wealth when they were instead building an elaborate house of cards.

While he was running his own hedge fund in the 1990s, he turned his own knowledge of his lack of knowledge – and others’ lack of knowledge – into enormous profits. It came at the expense of losing a little money 364 days of the year – but making enormous profits in that one remaining day. He would bet on market volatility – which he understood financial firms repeatedly underestimated.

Taleb was castigating Wall Street barons for years as they hubristically bet greater and greater sums of money – making leveraged bets that the market would continue to rise.

Taleb’s key insight is that we know very little of the world itself – and will be more often fundamentally wrong than right. The example he uses is the Black Swan as described by David Hume:

No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

This fundamental unknowability of the world must inform our actions, and perhaps points to some solutions. Taleb himself recently wrote a list of steps we should take to create a world more resistant to Black Swans. But his overall philosophy insists that we must attempt to resolve this crisis by tinkering with different solutions, and seeing what works, while being mindful that our actions will inevitably have consequences we do not imagine. And remember – at any point – a black swan could come around and reshape our world suddenly – as 9/11 did, as the assassination of the Archduke Ferdinand to start World War I, as did the invention of the personal computer, as has this financial crisis. The solution will not come from our determined application of fixed ideas, but by our openness to the possibility that we may be wrong, even as we are determined to act. We must see the shades of gray and acknowledge that we do not fully understand the world, yet still act – tinker, if you will. 

In this, Taleb seems to have reached a philosophical end point similar to the famous libertarian economist Friedrich Hayek who in his Nobel Prize speech explained that “we needed to think of the world more as gardeners tending a garden and less as architects trying to build some system.”

To tinker, to garden, to nudge – all of this points to a more modest liberalism, a market-state liberalism.

[Image courtesy of robokow licensed under Creative Commons.]

Clive Crook’s “Everything For Nothing”

Monday, March 9th, 2009

Clive Crook in his new Financial Times column faults Obama for:

telling almost all taxpayers they can have everything for nothing.

This is his second column on the subject – and he bases this claim on a small portion of Obama’s overall plan. He does not fault Obama for proposing to increase the top marginal tax rate from 35% to 39%, as Bush’s tax cut legislation actually mandates unless it is amended; he does not fault Obama for pusing for health care reform; he does not fault Obama for pursuing cap-and-trade legislation; he does not fault Obama for any range of allegedly “socialist” policies – rather he takes issue with the fact that Obama plans to cap the deduction for charitable contributions, so that those making over $250,000 get the same percentage credit for a charitable contribution as someone making less than $250,000. 

In addition to this rather minor tweak of our tax system (which Crook points out will generate a large amount of revenue thanks to the extreme concentration of wealth in our society), Crook raises the more substantial issue of how health care reform and cap-and-trade legislation, both of which he favors, are being paid for:

[T]he revenues from cap and trade are spent mainly on wage subsidies and tax cuts tilted toward the working poor. The down-payment on the cost of healthcare reform is financed by an additional tax increase on the rich.

Crook seems to be trying to conjure that bane of neo-liberals and conservatives alike – class warfare! All of this based on the assumption contained in the beginning, that Obama is “telling almost all taxpayers they can have everything for nothing.”

But is this so? Crook bases his argument on the presumption that the status quo is fair. He says that if Obama is planning on paying for health care reform without levying any additional taxes on the majority of Americans, then this majority is getting something – or in the exaggerated vernacular of those who make opinons for a living, “everything” – for nothing. 

But this same majority of Americans getting “something for nothing” here allows a very small minority to control a far disproportionate amount of resources. The legitimacy of these social bargains – whereby those with power and wealth are allowed to keep their power and wealth peaceably – rarely enters into the minds of those who benefit most from the bargain until we enter periods of unrest and instability. In many parts of the world – China, Pakistan, Russia, Latvia, Bulgaria, Iceland – the current crisis is calling into question the legitimacy of their social bargains in fundamental ways. In America, this crisis is calling into question the historically recent amendments to our social bargain from the Reagan revolution of the 1980s. 

The crisis might have prompted a sort of reactionary liberalism that sought to rollback the Reagan revolution in its entirety – much as Reagan’s reactionary conservatism sought to undo the Great Society. But instead, liberalism is guided by Barack Obama whose liberalism accepts some of Reagan’s most profound critiques and incorporates them into a new liberalism, leavened with both the wisdom of Edmund Burke and Friedrich Hayek.

Clive Crook’s invocation of the lazy masses being offered everything for nothing strikes me as a more refined take on Rick Santelli’s famous rant about the “losers” who took out loans they could not pay for. What strikes me about both sentiments is the sense of who the “losers” are – not the corporations and Wall Street bankers who lost the most. To call them “losers” may be morally appropriate but rings hollow when you’re speaking about those who benefited the most from our societal bargain. These “losers” may be feeling the pressure from our flagging economy but having benefited disproportionately during the boom of the past thirty years – and especially the Bush recovery – are still quite well-off. Those who “lost” the most also had the most – and still, after losing so much, often have more than the majority of the population. The real “losers” in the complete derogatory sense of the word as the individuals who took on mortgages they could not afford and now will be left with nothing but bad credit and the knowledge that they too contributed to the financial meltdown.

In other words, the real losers are not those whose prosperity (based on fees generated from borrowed money) is diminished, but those whose prosperity was never quite achieved as they borrowed money (generating the above-mentioned fees) to acquire some portion of their American dream of prosperity.

Crook while complaining about those being offered everything for nothing fails to acknowledge the system itself which has been redistributing wealth upwards for some time now. What – a different version of Crook might ask – did the 95% of Americans receive for allowing the top 5% to control most wealth? They received the promise of a growing economy that would lift everyone up – and the assurance that certain basic services would be provided, even to the least of our citizens. So, if the wealthy will be paying $4.10 more per day to help maintain the stability of the society which has provided them with the opportunity to become so wealthy, I wouldn’t call that something for nothing.

A Scientific Approach To The Economic Crisis

Tuesday, February 17th, 2009

There are relatively few serious political figures who argue that our economy does not need fiscal stimulus at this time – few political figures are comfortable advocating inaction while serious disruption occurs. But there are a significant minority who do take this position – including, it seems likely, some number of Republicans who though publicly are not advocating this extreme course, position themselves to oppose what Obama is doing in whatever ways are feasible.

The majority of Republicans in power seem to advocate stimulus by enormous tax cuts while railing against deficit spending (although the proposed tax cuts cost more than the proposed spending). This piece does not address their concerns – although independent, non-partisan Congressional Research Service did – explaining why the economic consensus was that tax cuts stimulated less and less quickly than spending – and I will address them again later today. A significant number of other Republicans simply have a bad feeling about the stimulus and are looking for which approach best suits them to oppose it.

For those who do oppose any form of stimulus, James K. Glassman’s article in Commentary has proven to be a rallying cry. But it has also provided ammunition to many others who seeking to oppose Obama by any available means. Cited by House Minority Leader John Boehner and many others, this article has found a large audience despite Glassman’s previous infamous prediction (as an author of Dow 36,000) that the stock market was undervaluing companies in 1999 at the height of the tech boom. I addressed some of the questionable historical claims Glassman made to build his case in an earlier post, but now I’m going to address his broader, more basic argument.

Glassman makes two points which leads him to label fiscal stimulus a folly repeated throughout recent economic history:

  • Economics is a limited profession and we can never quite understand the market enough to affect it the way we intend to; which is why, “Government simply cannot know enough to direct an economy successfully.”
  • “Meanwhile, left alone, what Hayek called ‘spontaneous order’ will find its way forward;” meaning the market is self-correcting as long as the government does not interfere.

The inherent contradiction is obvious. If we do not understand the market enough to affect it deliberately, how can we predict how it will act. If economics is such a limited profession that it cannot provide us with enough information to affect the economy in any predictable way, how can we trust an economist’s presumption to do nothing? The market – as Glassman describes it – is a kind of god who we must have faith in. Letting our economy slide deeper into recession while taking no is the economic equivalent of a “leap of faith.” Given this understanding, economist are little more than priests of the free market – who cannot predict or effect their god’s will – but whose job is to assure us that this god will bless us eventually with plenty in its own good time, but only if we trust it and restrain sinful (government) interference.

But Glassman then says something extraordinary given the two above statements and the inaction he is advocating now:

[I]n the 1930’s, “something in the normal regenerative process was missing.”

He doesn’t offer an answer to this – but the economist he derides throughout, John Maynard Keynes, does.  My meager understanding of Keynes suggests he believed the economy, like an engine, would need to be primed from time to time to prevent it from stalling – and he saw the best means of doing this as stimulus spending. The spending boom of the Second World War, for example, can be seen from a Keynesian perspective, as finally getting the world economic engine started again.

Obama however seems to have incorporated Hayek’s admonition that he “cannot acquire the full knowledge which would make mastery of the [economic] events possible” with a cautious Keynesianism. For those who believe that grand challenges such as possible financial collapse demand a grand ideological vision, Obama’s approach will disappoint. But the kernel of wisdom in Hayek (as well as many other truly conservative thinkers) is that grand visions are as likely to fail as minor tinkering projects – except when they fail, they will cause far more damage than the tinkering. 

Obama’s approach to the crisis is in this mold; some call his bill too cautious and too small; some call his stimulus bill an ideologically mixed up mash with a little of everything; some are frustrated his bailout approach focuses more on process than results. But all of this makes sense if Obama is approaching this crisis as a tinkerer. 

Hayek believed that the economy was a mysterious thing and that, to quote another philosopher/economic thinker, we shouldn’t “disturb complicated systems that have been around for a very long time [as w]e don’t understand their logic.” This other thinker, Nassim Nicholas Taleb, believes that if we must act, we should “tinker” to use his word. As “[w]e have the ability to identify our mistakes eventually better than average,” we can avoid the worst outcomes, and potentially latch onto the best innovations:

Look at the three big inventions of our time: lasers, computers and the internet. They were all produced by tinkering and none of them ended up doing what their inventors intended them to do…We choose the iPod over the Walkman. Medicine improved exponentially when the tinkering barber surgeons took over from the high theorists. They just went with what worked, irrespective of why it worked.

Instead of the paralysis and faith preached by Hayek, Taleb offers us a path forward – one of action tinged with doubt, of trial and error, of identifying mistakes quickly, of evaluatinr results honestly. His approach to economics is, at its base, science, in it’s most basic and primitive form. 

This seems to be the approach Obama is taking – pragmatic, cautious, aware of the wisdom of both Hayek and Keynes. He’s tinkering. And that’s exactly what we need.