The Virtuous Invisible Hand of Alan Blinder
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By John Komlos
Alan Blinder’s review of Jeffrey Madrick’s Seven Bad Ideas. How Mainstream Economists Have Damaged America and the World (Knopf, 2014)[1] is critical of Madrick’s characterization of the role of economists in the financial meltdown of 2008. Madrick suggests that their role was “central”, while Blinder claims that only conservative economists contributed and contribution was limited to a “bit”. I think that Madrick’s characterization is much closer to the truth and so does Joseph Stiglitz who said in a lecture: “I have to blame my colleagues in the economics profession. Not all economists got it wrong; but a lot of them did and they provided arguments that politicians used, people in the industry used for stripping it [regulation] away…. The basic argument was a very simple one, a variant of Adam Smith that markets, unfettered markets always lead to efficient outcomes…. they [regulators] were just doing what they said economic theory said you ought to be doing.”[2]
Thus, Blinder—an influential mainstream centrist economist at Princeton University—has turned a blind eye to the dominant spirit of our times. The ascendency of this market fetishist world view can be traced back to the immense influence of Milton Friedman’s concerted effort to discredit government’s legitimate role in the economy in his influential PBS series “Free to Choose” broadcast in 1980, aired again in 1990, and accompanied by his best-selling book of the same title. Friedman may well have been “far to the right” as Blinder suggests, but he nonetheless had immense influence also on the center and made even liberals such as Bill Clinton endorse the Financial Services Modernization Act of 1999—which repealed Glass-Steagall Act of 1933. At that time Clinton’s Council of Economic Advisors was chaired by non-other than a liberal economist by the name of Janet Yellen. There is no denying that the almost religious faith in the self-regulating mechanism of the market was promoted not only by conservative types such as Alan Greenspan and Phil Gramm but many liberal economists as well and thus this world view came to dominate the Zeitgeist on Main Street.
In fact, the main message taught to millions of economics students year in and year out due to the global dominance of a limited number of (essentially US) textbooks is that regulation of the free market is, in the main, not only superfluous but decreases efficiency, stifles investments and innovation, and is therefore detrimental to economic growth. Certainly, there are some moments devoted to addressing the exceptions to this generalization but they are treated as epiphenomenon and as Madrick and Stiglitz emphasize, the takeaway is that the government is a boogeyman that stifles markets and the entrepreneurial spirit. Without such a chorus of economists singing the praises of laissez faire, as though markets descended straight from heaven, the decades’ long process of deregulation would have been unthinkable. It was this process of deregulation that gnawed away at the stability of the financial system created under FDR and ended what Paul Krugman calls “boring banking”. Blinder should really watch again the film Inside Job which outlined so well the succor economists of all persuasions—and not only conservative ones—provided to the deregulation hype–a condition sin quo non of the fragility of the financial system and of the Meltdown of 2008.
Not only conservative economists taught and practiced these principles. It is fair to say that Larry Summers is a liberal economist; yet he eagerly aided and abetted Alan Greenspan in running Brooksley Born out of D.C. after she dared to defy them and attempted, albeit unsuccessfully, to begin to regulate derivatives in 1998. There were those, such as Hyman Minsky, who warned of the inherent instability of the financial sector unless the government maintained its constant vigilance. However, they were ridiculed and even ostracized by most everyone in the profession including Blinder’s colleague, Ben Bernanke who is not known as a staunch conservative.[3] Bernanke disdainfully dismissed such warnings by writing, for instance, that, “Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system, but in doing so have had to depart from the assumption of rational economic behavior.”[4] In other words, there is no need to worry about the ideas of people as bizarre as that…. Thus, it seems to me that it is fair to infer that the virtues of deregulation were widely accepted. Consequently, the deep-seated belief that Wall Street—guided by sophisticated quants from the Ivy League—can and should take care of itself without government meddling in its affairs was widespread among economists of various political persuasion. In other words, Blinder is dead wrong to suggest that liberal economists were not supporting the deregulation hype on the basis of the invisible hand metaphor.
That is not to say that economists influence all policy in Congress. Blinder gives a number of examples to the contrary, but that is hardly Madrick’s main point. Rather, Madrick suggests that there are a number of crucial principles which are widely held and taught by economists. These principles have put their stamp on both popular culture and the Weltanschauung of the policy elite. However, they are both incorrect and hazardous to the health of the nation. Among these is the deep-seated but pernicious belief in the efficient workings of the invisible hand, a metaphor that can be traced back to Adam Smith. Yet, ironically, Smith used the metaphor en passant only once in The Wealth of Nations.
The metaphor is used today in order to imply that the actions of selfish individuals will ultimately and inadvertently benefit society. However, Greenspan and the circa thousand economists working for the Fed simply forgot that the invisible hand does not work well at all with imperfect information. I think that no one would argue today that Dick Fuld’s or Angelo Mozilo’s invisible hands benefited society; yet the metaphor lives on—in and out of classrooms in spite of Joseph Stiglitz’s repeated warnings that the metaphor is no more than that and should not be taken seriously: “the reason the invisible hand often seemed invisible was that it was not there…. Markets by themselves do not lead to economic efficiency.”[5]
Yet, Blinder challenges Madrick’s characterization of the invisible hand by suggesting that “Throughout recorded history, there has never been a serious practical alternative to free competitive markets as a mechanism for delivering the right goods and services to the right people at the lowest possible costs. So it is essential that students learn about the virtues of the invisible hand in their first economics course.” But what about those for whom the free market does not deliver enough of the “right goods and services” to meet even their basic needs? Blinder’s mentality is precisely what Madrick is arguing against, inasmuch as this is the wrong way to teach economics.
“Free competitive markets” have not existed for very long at any time anywhere, except on blackboards, because they are not stable forms of social organization. As importantly, certainly have absolutely nothing to do with today’s real existing economic system dominated by giant oligopolies and too big to fail financial conglomerates with immense influence in the halls of Congress. In contrast to the markets in Smith’s time, the global marketplace today is rampant with systemic risk, opportunistic behavior, and asymmetric information that enables the strong to take advantage of the weak.
Blinder’s description of the invisible hand as virtuous in this context is in itself a value judgment. It would not be supported by Madrick, nor by the inhabitants of some neighborhoods in the South Bronx—with a median income of $8,700—not per month, but per year.[6] In fact, Madrick argues that we should be instilling in our students from the outset the point that markets that are not well regulated are dangerous. Without sufficient countervailing power the invisible hand becomes an invisible fist that cruelly keeps a substantial portion of the population from a decent life. So Blinder’s virtuous invisible hand should by no means be the default model taught to Princeton undergraduates; instead we need to stress that only with adequate oversight will markets provide equitable outcomes in a stable economy. Perhaps it would be best to forget about the invisible hand metaphor altogether; after all, as Stiglitz suggests it is an outdated metaphor for our time.
[1] Alan Blinder, “What’s the Matter with Economics?” New York Review of Books, December 18, 2014.
[2] Joseph Stiglitz Lecture “Freefall” at the Commonwealth Club of California, February 22, 2010. http://fora.tv/2010/02/22/Joseph_Stiglitz_Freefall Accessed December 18, 2014.
[3] John Komlos, What Every Economics Student Needs to Know and Doesn’t Get in the Usual Principles Text (New York: M.E. Sharpe, 2014).
[4] Ben S. Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review, June 1983, pp. 257-276; here p. 258.
[5] Joseph Stiglitz, “Doctor of Honoris Causa Ceremony Speech,” University of the Basque Country, Bilbao, Spain, May 23, 2006. See also his Nobel Prize lecture: Joseph Stiglitz, “Information and the Change in the Paradigm in Economics,” Stockholm University, Aula Magna, December 8, 2001.
[6] Arun Venugopal, “Census Pinpoints City’s Wealthiest, Poorest Neighborhoods” WNYC News Thursday, December 08, 2011 http://www.wnyc.org/story/174508-blog-census-locates-citys-wealthiest-and-poorest-neighborhoods/ accessed August 31, 2014.
From: pp.8-9 of World Economics Association Newsletter 5(1), February 2015
https://www.worldeconomicsassociation.org/files/Issue5-1.pdf