Book review: The Logic of Economic Calamities

Book: The Logic of Economic Calamities
This looks like the killing-the-king ritual. Leftists, socialists and other such assorted groups who have never believed in the power of markets to decide the fate of humans, have declared it open season on free market beliefs. John Cassidy, who writes on finance for the New Yorker, has written a book to explain why the free market belief now lies in ruins.

Cassidy’s book for the most part is the history of economic thought, but with a focus on markets. He structures his argument in three parts.

First, he goes over the theories of old world economists like Adam Smith, David Ricardo, Freidrich Hayek, Leon Walras and Vilfredo Pareto, and explains how in spite of inventing the “invisible hand” or self-interest theory, Adam Smith, and indeed even David Ricardo, recommended a healthy role for government. For instance, Ricardo supported bank nationalisation. And in 1848, John Stuart Mill set laissez faire (or the free market theory) as default. The British repealed the corn laws which protected their farmers through a system of tariffs.

Cassidy points out that there was a good reason for this sort of thinking: It was rooted in the philosophy of self-reliance and freedom of choice. John Stuart Mill wrote in On Liberty: “...the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others.”

Such beliefs took a beating when the Great Depression hit in 1929, and when World War II broke out; both events needed government action in a big way. Cassidy points out how a pro-market Freidrich Hayek was ignored because while his theories explained why the crisis happened, it was left to Keynes to provide a solution.

Keynes’s formula reiterated the central role of the state in revving up deflated animal spirits.  He himself never thought a silver bullet would solve real-life economic problems. He understood that the model of rational human beings making informed choices does not extend to areas that have high uncertainty about them; for instance, securitised home loan mortgages. He is said to have observed wryly after meeting American followers in 1944, “I was the only non-Keynesian there.”

This is the most fundamental point in the book, where he shows why older economists like Keynes, Smith or Ricardo understood that economics was an interplay of politics, sociology and quantitative analysis. The elegance of high theory has to be adjusted through pragmatic real-world policies.

He points to Harvard economist Francis Bator’s 1958 paper, ‘The Anatomy of Market Failure.’ Bator was no anti-free market theorist. He had popularised Kenneth Arrow’s theories that explained why markets generated outcomes that left everyone better off. Yet, in that 1958 paper, he said that there were many areas like monopolies, or the period after an economic bust, where markets did not achieve their purpose.

He was ignored and the Chicago School — of “efficient markets” fame — became powerful.
Cassidy then applies all that economic thought to show why the subprime crisis appeared. He says that the pure free market has disgraced itself in full public view for the second time since the 1930s.
Unfortunately, the book doesn’t have any great solutions apart from parental guidance (more regulation). It explains how we got here, but doesn’t tell us which thinkers could help us come up with interesting alternatives. Or, indeed, if there is an alternative to free market theory.

By Shishir Prasad/Forbes India

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