Saturday, March 7, 2009

Why Hayek and Marx Might Agree with Each Other and Disagree with the Economic Rescue Package!

One of the many ironies of the current global financial crisis is that the largely unarticulated positions of the left and right coincide in disagreeing with the various stimulus and bailout packages proposed and implemented in the United States, Canada, and elsewhere. The standard defence for bailing out (say) banks who've screwed up and, therefore, should presumably have to pay for their mistakes is that the consequences of not doing so would be worse. So, even if we don't like those fat cat bankers who've gotten us into this mess, we have to hold our nose and help them out, and hope they don't get into the same or a bigger mess again.

Now the various critiques of bailing out the banks, in particular, usually boil down to some version or the other of what economists call the moral hazard problem: that is, bailing out someone who has behaved recklessly will make him more likely to be reckless in the future, because he knows that you're going to bail him out again. It's a species of economic problem that occurs when information is imperfect, or, to be more precise, asymmetric. Moral hazard is a problem of hidden action; the other classic such problem, adverse selection, occurs when there is hidden information. Both were probably at play in the case of the banks, but let's stick to moral hazard for the moment. The simplest example of moral hazard, that I always use on my college freshmen (and which appeals to them, for some strange reason): If every time you go to the casino, and you win money, you keep it, but, when you lose, your parents pay off your markers, will you be more or less likely to gamble more recklessly next time you go?

Now there's another version of this critique, which the gambling example fits as well, that says that bailing out bad banks (but not taxing them heavily say when they make fat profits) is "privatizing profits" and "socializing losses". This sort of behaviour would tend to exacerbate the moral hazard problem, as with my freshmen gamblers.

But all of this elides, or rather scants, the more radical critique of such bailouts, that, ironically enough, come from both left and right, although, of course, with somewhat different rationales. Let me sketch this out for you.

Someone on the right, a full-flooded libertarian who's a follower of Hayek or Friedman, would say that it's the nature of capitalism to be inherently volatile. Tampering with this inherent volatility of the capitalist system, trying to attenuate it, is a bad idea, because it dampens the creative entrepreneurial juices that keeps capitalism vibrant and gives us ongoing technological advance and higher economic growth in the long run. (This relates to an older debate, to which my colleague Nick Rowe and I have contributed, on whether business cycles are good or bad for growth, but that's for another time.) Don't forget that Hayek opposed any government intervention during the Great Depression itself. He would surely be opposed to the current bailout packages.

One should be careful at this point to distinguish bailing out the banks versus other affected sectors of the economy, such as the auto industry. It is the peculiar nature of banking that makes completely private sector banking with no or minimal government regulation inherently fragile and excessively volatile, because of the possibility of bank runs, for instance, which is why governments have figured out that they need to serve as a lender of last resort to banks. In other words, Hayek probably wouldn't have liked the status quo much either, and so the question is moot, I guess, on what he would have thought of bailing out the banks.

But for a normal industry, say the auto industry, the argument is much more clear-cut. The big 3 US automakers, and their Canadian susbsidiaries, clearly didn't adapt to the changing economy, and got stuck in a mode where they made big gas-guzzling cars, and cut deals with the unions in which they essentially shared monopoly rents with them. That would account for the ten paid spa days, apparently, that every auto worker at GM is entitled to. I don't think I need to convince you that the automakers, quite simply, screwed up, and so it is a fair question to ask, a la Hayek, why we should be expected to bail them out. If we do, we'll just subsidize their inefficiency, and prevent them from either going bankrupt and being replaced by something more efficient. Or maybe we should just stop producing autos altogether in North America and import them from China, Korea, India, and Brazil, where they're cheaper to make? Comparative advantage would suggest that.

Obviously, the political economy of the auto industry will preclude doing nothing. They employ two many people in Michigan and Ontario, in particular, people who vote, and are likely to be decisive in the next round of state and provincial and down the road federal elections in the US and Canada. So all the relevant branches of government have to, at least, be seen to be doing something, if they really don't want to, and, like Hayek, would prefer that the market sorted itself out. Interestingly, Canada's Finance Minister Jim Flaherty speaking from Washington the other day came as close to saying this as any politician recently.

So much then for the critique from the right. How about the folks on the left? I've picked Marx for obvious reasons as a focal character, although maybe I should have picked Lenin as he and Hayek were contemporaries, sort of. No matter. He would agree, up to a point: Yes, capitalism is inherently volatile, and the market, left to itself, will tend to go to excesses of one sort or another. But ... and here's the big different with the reformist centrist -- he would almost surely have opposed succour to the wounded bulls of Wall Street. Because it's only when capitalism gets into a major crisis that the socialist revolution that's meant to sweep it away will occur. And you can't have a socialist revolution if you keep intervening to save capitalism from itself.

Now I don't think anyone, at at least in the mainstream media, had had the courage to articulate the true left critique of the stimulus packages, being contented to bleat that it just bails out the fat cats on Wall Street and is unfair to Main Street. Here, I think there's something of a reversal of roles, and the the right, for once, is taking an intellectually more honest approach in articulating its objections to bailing out the banks. At least, that's what I'm thinking at the moment.

Now time to start making some pesto sauce in time for dinner this evening and let Hayek and Marx agree in disagreeing with the bailout!

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