Ekonomia Wolnego Rynku

The case for raising interest rates

By Charles Hugh Smith

Here’s the recipe for endless prosperity, central planning version: start with a little inflation to plump up asset values, encourage spending and make debt easier to pay off in the future, then add in declining interest rates to encourage expansion and reward buyers of bonds. (As interest rates drop, the value of the bond rises.) Lastly, run some big government deficits to stimulate spending and toss in expanding money supply so there will always be plenty of dollars to borrow and spend.

Our central planners—the Federal Reserve and the U.S. Treasury—have furiously combined these ingredients, and the world watches anxiously to see if the results will be

• A return to cheap-money prosperity;

• A Japan-style no-growth deflation;

• Argentine-style debt repudiation and currency devaluation.

Despite the assurances of Bernanke and associates, the recipe can turn out badly: you can drop interest rates to nearly zero and still get deflation and no growth in the real economy. Alternatively, reckless expansion of cheap money and government deficits undermine the nation’s currency and creditworthiness, triggering debt repudiation and ruinous devaluation.

Some are saying that the U.S. is following the path to doom even as the Fed insists that Japan-style deflation and the devaluation of the dollar are impossible. (What else can central planners say? The five-year plan to eternal prosperity is failing? That would be a quick ticket to Siberia—by which I mean the Commerce Department.)

Forecasting the direction of all these moving parts is like predicting the outcome of a 3-D chess match with multiple players randomly moving pieces. So let’s focus on interest rates, the only force over which the market really has any sway.

If central planners only create money and give it away, the results are predictable: an oversupply of “free money” leads to inflation. Instead, they manage the business cycle by manipulating the supply of and demand for money. If the Goldilocks Economy is getting a tad overheated, the Fed withdraws money and raises short-term interest rates. Businesses and consumers borrow and spend less, and Goldilocks breathes a sigh of relief. If the economy catches a chill, then the Fed “injects liquidity” and lowers interest rates, encouraging more borrowing and spending.

This seems to work pretty well, until it doesn’t. Japan has been borrowing a truly insane 40 percent of its government spending for years and has kept its interest rates so near zero that the prospect of a mighty one-quarter percent increase causes panic. So who’s going to bury money in a bond paying a dime of interest a decade? Well, government, of course, because it can create the money to buy its own bonds. And other investors will, too, if they fear all other investing options will only drop in value. That’s a sad statement about the prospects for real estate and new enterprises in Japan.

But super-low interest rates and massive government borrowing require something special: a huge pool of surplus capital that can be sunk in no-return government bonds. How dumb does money have to be to do that year after year?

The explanation of Japan’s weird stability in going nowhere is partly cultural, which is why drawing parallels between the U.S. and Japan is perilous. In Japan, Big Business, banks, insurance companies, and the government aren’t just in bed with each other: they tuck each other in and put mints on each others’ pillows. Thus super-low interest rates and liquidity are only available on an institutional level. The average small business in Japan can’t borrow unlimited sums at near-zero interest, but global institutional buyers borrowed trillions of yen at low interest and invested the money elsewhere at higher returns: the infamous “yen carry trade.”

The other cultural factor at work is Japan’s prodigious savings rate, which for many years hovered above 20 percent——though it is now dropping as times get tough—compared to a zero or even negative rate in the United States. With opportunities to invest overseas restricted, Japanese savers had limited options: take a gamble on deflating real estate and stocks or buy government bonds. Given that unappealing menu, they chose the bonds.

While Japanese-style government-Wall Street collusion is clearly growing in the U.S., we don’t have the key ingredients of Japan’s balancing act. There is no giant pool of domestic savings, and battered American investors still have options that may be more appealing than a 2 percent yield on a Treasury bond.

Without a domestic cache of surplus capital on the same scale as its borrowing needs, the U.S. Treasury has to borrow stupendous sums from overseas “investors”—Asian central banks, oil exporters, etc. These buyers have tremendous incentives to keep U.S. consumers, their customers, afloat on a sea of low interest and easy money, so the game has been managed thusly: as the ability and/or willingness of these buyers to acquire more of America’s debt wanes, the Federal Reserve steps in and buys Treasuries directly. That’s not just placing a mint on the pillow—that’s fluffing the pillow, too.

Despite all this maneuvering, however, the fundamentals of supply and demand still apply. If there is a huge supply of new debt for sale and little demand, then the Treasury will have to entice buyers with higher interest rates. The U.S. central planners now face a Hobson’s choice: if rates rise, that eventually increases mortgage rates—a bad thing in a recession, according to conventional wisdom. On the other hand, if the Fed creates a few trillion dollars a year to soak up all this new Treasury debt, then the global bond market will start pricing in the risk of inflation or devaluation occurring as a result of this explosion of dollars. The net result is that interest rates rise anyway, regardless of the massive intervention by the Fed.

This is the reason some are muttering darkly about the Argentina Model: when central planners borrow and print money recklessly, outside of outlier Japan, there are only two end-points—hyperinflation or devaluation of the currency, either of which wipes out the income and wealth of the citizenry.

That can’t possibly happen here, or so we are reassured. The dollar is the world’s reserve currency—except now other nations are tiring of our monopoly on printing money and passing it off without consequence. What does all this mean for average Americans? There are two basic results, both pernicious.

Super-low interest rates may be wonderful for borrowers, but they are terrible for savers and those needing healthy long-term returns. Virtually all the pension funds and life insurance companies in the U.S. need annual long-term returns in the 7-8 percent range; 1-2 percent returns doom them to eventual insolvency. Their only choice in a low-rate environment is to demand more cash from their contributors and the insured—a movement that is already visible as public pension plans are notifying cash-strapped cities, school districts, and agencies that their pension contributions are about to skyrocket. That ends up taking huge chunks of money out of consumers’ pockets, the exact opposite of what central planners intend.

Borrowers—especially those institutions in bed with the Fed and Treasury—have a major incentive to borrow money cheap and speculate with it—the U.S. version of the old “yen carry trade” in Japan that reaped billions for institutional players and nothing for the real economy. Indeed, many believe the current global stock-market rally is nothing but hot money borrowed from central bankers gushing into speculative markets for a quick return. Give people vast sums of essentially free money, and, remarkably enough, they tend to play fast and loose with risk. (File next to “subprime mortgage mess.”)

This “free money” phenomenon is also dangerous for homebuyers. Now that the loose lenders Fannie Mae and Freddie Mac have been throttled by insolvency, the central planners are expanding operations at the two remaining state lenders: FHA and Ginnie Mae. Get your guaranteed mortgage with 3.5 percent down right here! While that is marginally better than zero, it sure isn’t 20 percent. In other words, the same old game of low downpayments and easy mortgage money is being played, sweetened by an $8,000 credit for new homebuyers. No wonder housing is “recovering.”

Is risk being properly priced when money is cheap and new loans are practically given away? Of course it isn’t. Eventually, the global bond market will become uneasy about the government game of printing money to buy its own debt and the purposeful injection of nearly free money.

Supply and demand still matter. According to analysts, global governments are borrowing $5 trillion this year to fund their vast stimulus packages. Then there’s private-sector demand for business loans, mortgages, consumer credit, local government bond issues, and so on. Considering that some $35 trillion in global wealth has vanished in the past two years and corporate profitability has plummeted, it’s fair to ask what happens if there’s not enough global surplus capital to fund the explosion of public demand for borrowing.

Economies with immense reserves of cash, opaque central banks, and a citizenry of prodigious savers obviously have the wherewithal to fund massive stimulus spending without worrying too much about global bond markets’ assessments of risk and return. But the U.S. has only one of those “assets”: an opaque central bank. Given the pathetic interest earned on savings accounts, Americans aren’t creating pools of capital, they’re paying down old debt. Much of what the government counts as savings is actually going to reduce costly debt—a rational decision when savings earn 1 percent and credit-card debt costs 18 percent.

At some point the risk of flooding the world with essentially free money will be priced into bond yields, and investors will wake up to the fact that once interest rates are effectively zero, there’s no upside left in bonds’ future appreciation. In fact, the specter of rising rates makes bonds a risky investment because rates and value are on a see-saw: if rates rise, the value of the bond drops. A sharp rise in rates would eviscerate the market value of all existing bonds.

With global demand for surplus capital rising just as global assets and income have dropped precipitously, it’s inevitable that the demand-supply imbalance will be resolved with higher rates. The only alternative open to central planners is to print money, but doing so will not fool anyone: interest rates will still rise because free, easy money will lead to either inflation or devaluation, and the bond market is aware that there is no free lunch—not even for the dollar.

Although higher rates are presumed to spell disaster for the debt-laden U.S. economy, in which total public and private debt is already 350 percent of GDP, the plus side—rational incentives to save and invest—is rarely noted. Perhaps we should be cheering for higher interest rates as a return to sanity rather than fearing them as some sort of unnatural plague.

Just don’t mention that if you’re a Fed apparatchik—you might get shipped to Siberia

A ghost story

Oliver Marc Hartwich

It was not always like this. At the beginning of neoliberalism, when the term was invented, it was quite the opposite of what we think of it today. The shallowness with which we use neoliberalism in a pejorative way corresponds inversely with the depth of thought by its original users. Even more surprisingly, the original ‘neoliberals’ have little in common with those who are nowadays called ‘neoliberal.’

Crisis and neoliberalism

Times of crisis naturally induce a wide-ranging critique of hitherto unchallenged concepts. So it is unsurprising that times of economic crisis, too, have provoked re-examinations of the way markets work. Two quotes may exemplify this.

There is one author who writes about the economic turmoil of his time: ‘[The crisis] has called into question the prevailing ... neo-liberal orthodoxy that has underpinned the national and global regulatory frameworks that have so spectacularly failed to prevent the economic mayhem which has now been visited upon us.’ He goes on to claim that ‘in the past year we have seen how unchecked market forces have brought capitalism to the precipice’ and concludes: ‘Neither governments nor the peoples they represent any longer have confidence in an unregulated system of extreme capitalism.’

Another commentator is equally clear. He diagnosed the ‘chaos of a pluralist, predatory economy’ and the ‘failure of economic liberalism.’ What was needed, he insisted, was ‘a strong state, a state above the economy, above the interest groups where it belongs.’

Although both commentators seem to come from similar points of view, they could not be more different. They are separated not only by some 70 years but also by their political persuasions, professional backgrounds, and nationalities. Furthermore, the first author claims to be a fierce critic of neoliberalism while the second one is the original inventor of the term neoliberalism.

To solve this riddle, let us lift the curtain and reveal their identities. The first quotes are taken from the essay ‘The Global Financial Crisis’ by Australian Prime Minister Kevin Rudd, which he published in the journal The Monthly in early 2009. It was seen as Rudd’s broad sweeping attack on neoliberalism.(4)

The second commentator is Alexander Rüstow, a German sociologist and economist, and the quotes are from a speech(5) he delivered to the Verein für Socialpolitik (Social Policy Association), a German economics association, in 1932 and the title of one of his books that was published in 1945.(6) It was the very same Alexander Rüstow who, in 1938, coined the term neoliberalism.

If Rudd and Rüstow sound so similar, yet one of them rejects the concept of neoliberalism while the other invented it, then either there must be some sort of misunderstanding or the term itself has undergone a transformation over the past decades.

In a way, one could argue that what happened in a small, far-away country almost a century ago (i.e. early twentieth century Germany) should hardly matter for contemporary Australian politics. The world has moved on and today’s debates are not the same as, say, those of the 1930s. On the other hand, it is more than just a vain exercise in intellectual archaeology when we are dealing with the birth of neoliberalism. We can see that early neoliberalism recognised both the power of markets and their limitations. Today’s critics of ‘neoliberalism’ are probably unaware that one of the defining feature

of early neoliberal conceptions was to put a check on unfettered markets and market power. This may well hold some ideas for policy makers today simply because neoliberals distinguished between areas in which the state could and should intervene and others in which it should not.

The invention of neoliberalism

The year in which the neoliberal program was first formulated was 1932. Germany’s leading economics association, the Verein für Socialpolitik, had invited the young economist Alexander Rüstow to its annual conference in Dresden. The Verein’s long-serving president was Werner Sombart, the leader of the so-called Kathedersozialisten (‘catheder socialists’) from the Historical School of Economics. Sombart, an open supporter of national-socialism, lacked any sympathies for liberalism. He had planned to make the Dresden meeting a rallying cry for his cause. But to his dismay, the relatively little known Rüstow delivered the most noticed speech at the conference, which was later published and republished many times. Until the present day, it is widely regarded as the founding document of neoliberalism.(7)

The speech was titled ‘Freie Wirtschaft, starker Staat’ (Free Economy, Strong State), and in these four words we can already see Rüstow’s basic economic creed. Far from supporting Sombart’s national-socialist visions, Rüstow blamed excessive interventionism for the economic crisis. He also warned of burdening the state with the task of correcting all sorts of economic problems. His speech was the clear rejection of a state that gets involved with economic processes. In its place, Rüstow wanted to see a state that set the rules for economic behaviour and enforced compliance with them. It was a limited role for the state, but it required a strong state nonetheless. Apart from this task, however, the state should refrain from getting too engaged in markets. This meant a clear ‘No’ to protectionism, subsidies, cartels—or what today we would call ‘crony capitalism,’ ‘regulatory capture,’ or ‘corporate welfare.’ However, Rüstow also saw a role for a limited interventionism as long as it went ‘in the direction of the market’s laws.’

Throughout his later life as an academic Rüstow further developed this vision of neoliberalism, as he himself called the idea, and published numerous books and essays in which he elaborated the system of a market economy under the rules of law and limited government. Many of them were written in exile: After the Gestapo, Hitler’s secret police, had searched Rüstow’s home in 1933, he decided to leave Germany and accepted a teaching position in Istanbul. He remained in Turkey until he returned to (West) Germany in 1949 to lecture at the University of Heidelberg.

In his essay ‘Between Capitalism and Communism’, Rüstow explicitly argues for a ‘Third Way’ between the two ideologies.(8) He acknowledged that markets generally worked well under complete competition. However, he accused Adam Smith of holding a polemical grudge against the state that had made him neglect the necessary state-determined institutions of markets. This, so Rüstow claimed, caused the degeneration of the market economy into a system of untenable capitalism. In a long footnote, he went on to explain that he needed to insist on a differentiation between ‘the truly free market economy of complete competition’ and its ‘subventionist-monopolist-pluralist degeneration,’ which he thought of as a ‘pathologically degenerate variety’ of true market competition and for which he suggested the term ‘capitalism.’

If laissez faire and Adam Smith style liberalism were so bad according to Rüstow, would he then have preferred a planned economy? His answer was a resounding no. With the same rhetorical verve he used to condemn capitalism, he equally rejected the promises of socialism and communism. They were no viable economic systems, and they were also incompatible with democracy, freedom, and human dignity.

All of this led him to call for a middle way between laissez faire and socialism, a ‘Third Way.’ ‘We should be happy,’ Rüstow wrote, ‘that we do not have to make a difficult choice between “capitalism” and “communism”, but that there is a “Third Way”.’ Ironically, it is the very same logic that makes today’s critics of neoliberalism claim that one no longer had to choose between Hayek and Brezhnev, as Prime Minister Kevin Rudd expressed it in an address to the Centre for Independent Studies in 2008.

Although contemporary supporters of a ‘Third Way’ claim to be fighting neoliberalism, to Rüstow this very same ‘Third Way’ was neoliberalism. He called it neoliberalism to differentiate it from earlier liberalism, for which Rüstow frequently used derogatory terms such as ‘vulgar liberalism,’ ‘Manchester liberalism,’ or ‘paleo-liberalism.’ Rüstow wanted to break with this old liberal tradition to put a new liberalism in its place—hence the prefix ‘neo’.

Rediscovering neoliberalism
We should see the current attacks on neoliberalism in this wider historical context.

It seems to be a reflex to blame problems in the markets as problems of the markets. On closer inspection, some of the perceived market failures may well turn out to be failures of economic policy. Where Rüstow and the German neoliberals, for example, thought that cartelisation and monopolisation of the economy were the result of a degenerate market economy, historical analysis rather shows that they were the direct consequences of protectionism and interventionism—which Rüstow and his colleagues heavily criticised.

In a similar way, we ought to be careful when it comes to identifying the causes of the current crisis. Again, there are good reasons to look at both suspects, the government and the market. While there are good reasons to assume that there was indeed some market failure leading up to the crisis, there are at least as many reasons to think that they were preceded by government failures. Even where and when markets fail, however, this does not give governments a blank cheque to correct market results. First, it would need to be demonstrated that corrections can actually improve the situation.

It is a fine balance that needs to be found between the state and the economy. Although there are good reasons to be critical of the German neoliberals’ original historical analysis, their policy prescriptions nevertheless remain valuable discussion points. Rüstow’s differentiation between the state as the guarantor of economic order, as the rule-giver that stands above economic processes, and the failed interventionist state that meddles with economic processes and gets easily captured by special interests, are still valid. It would be worth to rediscover them, especially today.

The discussions about the proper political reactions to the global financial crisis are, sadly, not as nuanced as they could be. For example, when we read Kevin Rudd’s ‘anti-neoliberal’ essay we find some strong language right from the first paragraph where he blames ‘free-market fundamentalism,’ ‘extreme capitalism,’ and ‘excessive greed’ for our economic problems.

Nevertheless, if we look behind this rather shrill rhetoric, we can read in Rudd’s essay about his recognition of ‘the great strengths of open, competitive markets.’ In fact, Rudd explicitly warned not to ‘throw the baby out with the bathwater’ as ‘the pressure will be great to retreat to some model of an all-providing state and to abandon altogether the cause of open, competitive markets both at home and abroad.’

Taken together, the criticism of laissez faire plus the recognition of the power of markets and scepticism of state power is the core of the neoliberal project as it was once formulated. This would almost make the Prime Minister a neoliberal in the original meaning of the word, although he would probably be surprised if he found out. However, Rudd’s policies suggest that he is less aware of the limits of government than he is aware of the limits of markets.

If there is one lesson that we could draw from dealing with the early history of neoliberalism for our political debates today, it is this: Neoliberalism is a far richer, more thoughtful concept than it is mostly perceived today. First and foremost, it emphasised the importance of sound institutions such as property rights, freedom of contract, open markets, rules of liability, and monetary stability as prerequisites for markets to prosper and thrive. It seems that the global financial crisis has once again demonstrated how important these core insights of neoliberalism are.

To those criticising neoliberalism today, the answer may well be just that: We need more of this kind of neoliberalism, not less. What we would need less of is only the rhetorical abuse of neoliberalism for political purposes.

This is an extract from Neoliberalism: The Genesis of a Political Swearword. The full version can be viewed at www.cis.org.au/temp/OP114_Neoliberalism.pdf

Peter Baldwin

4th May 2009

Despite America's move to the left under Obama, it's still assumed that Europe and America are fundamentally different: in their economies, societies and values. But this is a myth

Talk about upending accepted certainties! While Europe is now in the hands of right-of-centre parties (France, Germany, Italy, Sweden, Denmark and David Cameron pacing restlessly in the wings), America has “gone socialist.” Nationalising the financial sector by the back door, considering massive subsidy of production industries, increasing state spending on healthcare and education, promising big investments in all manner of greenery, and limiting executive salaries: is Barack Obama beating Europe at its own game? “We are all socialists now,” Newsweek trumpeted in February, predicting that, “as entitlement spending rises over the next decade, we will become even more French.” General Jack D Ripper, Dr Strangelove’s nemesis, who fulminated against fluoridation of the water as another of communism’s nefarious advances, must be rotating in his Valhalla.

How quickly things change. It seems just a few months ago that the presidency of the younger Bush—unilaterally going to war, refusing to submit to international treaties, disparaging the seriousness of global ecological catastrophe—convinced bien pensant opinion that the gulf between the US and Europe was stark and growing ever wider. Indeed, old and well-worn mental ruts are hard to steer out of. It remains a staple of political discourse on both sides of the Atlantic that Europe and America are worlds apart. Everyone knows this.

The “wide Atlantic” thesis claims that there are fundamental differences between Europe and America. These are the contrasts: America believes in the untrammelled market, Europe accepts capitalism but curbs its excesses. Social policies either do not exist in America or are more miserly than in Europe. America’s lack of universal health insurance means that many people die young and live miserably. Because the market dominates, America’s environment is less cared for. Since social contrasts are greater in America, crime is much more of a problem than in Europe. Meanwhile Europeans are secular; Americans are much more likely to believe in God and accept a role for religion in public life. The two societies are thus divided along several faultlines: competition vs co-operation, individualism vs solidarity, autonomy vs cohesion.

This is all familiar. But is it true? With the Obama administration moving the US to the left there is a perception of the Atlantic narrowing again, to the dismay of American conservatives—being “too European” is a stick Obama’s opponents are fond of beating him with. But were the contrasts between Europe and the US ever as great as both sides imagine?

One way of answering this question is to look at the quantifiable evidence. Not all differences can be captured by numbers, but statistics allow us a first pass over the terrain and to compare reliably. If we compare four areas: the economy, social policy, the environment and—hardest of all to quantify—religion and cultural attitudes, the evidence in each case allows two conclusions. First, Europe is not a coherent or unified continent. The spectrum of difference within even the 16 countries of western Europe (which is what we are mainly looking at here) is far broader than normally appreciated. Second, with a few exceptions, the US fits into this spectrum. Either, then, there is no coherent European identity, or—if there is one—the US is as European as the usual candidates. Europe and the US are, in fact, parts of a common, big-tent grouping—call it the west, the Atlantic community, or the developed world.

It is universally observed that America is an economically more unequal society than Europe, with greater stratification between rich and poor. Much of this is true. Income is more disproportionately distributed in the US than in western Europe. In 1998, for example, the richest 1 per cent of Americans took home 14 per cent of total income, while in Sweden the figure was only about 6 per cent. Wealth concentration is another matter, however. The richest 1 per cent of Americans owned about 21 per cent of all wealth in 2000. Some European nations have higher concentrations than that. In Sweden—despite that nation’s egalitarian reputation—the figure is 21 per cent, exactly the same as for the Americans. And if we take account of the massive moving of wealth offshore and off-book permitted by Sweden’s tax authorities, the richest 1 per cent of Swedes are proportionately twice as well off as their American peers.

What about poverty, not the same thing as inequality? Because inequality is greater in America, relative poverty is by definition also higher. But absolute poverty rates look different. If we take absolute poverty to be living on the actual cash sum equivalent to half of median income for the original six nations of the EU, we see that many western European countries in 2000 had a higher percentage of poor citizens than the US; not only Mediterranean countries, but also Britain, Ireland, France, Belgium, the Netherlands, Finland and Sweden. Unemployment benefits in the US, often portrayed as derisory in the European media, are actually higher than in many European nations. Greece, Britain, Italy and Iceland spend less than the US on unemployment, measured per capita.

The US welfare state is often portrayed as miserly and undeveloped compared to Europe. And so it is, if the standard is taken to be Sweden or Germany. But if we look at the span of social policy across Europe, a different picture emerges.

Of course, America has no universal system of health insurance. Michael Moore’s 2006 film Sicko will ensure that no one forgets that. As a result, 15 per cent of its population is not covered. There is no question that being uninsured is unfair and brutal, nor that the lack of universal health coverage is the most pressing problem of American domestic politics. The true disgrace of American healthcare is that infant mortality is higher than anywhere in Europe. President Obama seems determined not to let the financial crisis sidetrack his promise to improve access to health insurance.

Yet despite the too large fraction of those who are not insured, Americans are relatively healthy and well-serviced by their healthcare system—to judge by disease survival rates. For diabetes, heart and circulatory disease and strokes, the incidence rates and the number of years lost to sickness are firmly in the middle of the European spectrum. And for the four major cancer killers (colorectal, lung, breast and prostate), all European nations have worse survival rates than the US.

Looking also at other forms of social policy, we see that the US fits broadly into the lower half of the European spectrum. As with its unemployment assistance, US spending on disability benefits is higher than in Greece and Portugal per capita, and practically at the same level as France, Italy, Ireland and Germany. (All figures used for comparison here account for differences in costs of living). State pensions in the US may fall into the lower half of the European spectrum. But examine instead the total disposable income of the retired in America as a percentage of what the still active receive. Only in Austria, Germany and France do the elderly fare better.

It is commonly known that the American state does not help out much in terms of family provision. Parental leave is not statutory and there are no guarantees that women can reclaim their jobs after pregnancy. Family allowances as such do not exist. On the other hand, if one counts resources channelled via the tax credit system, as well as outright cash grants and services, and if one measures them as a percentage of GDP, the US ranks higher than Spain, Greece and Italy for family benefits. Public spending on childcare (daycare and pre-primary education) puts the US into the middle of the European scale. Total spending on pre-primary care per child is higher than anywhere but Norway.

True, public social spending in America—that is, monies channelled through the state—is low compared to many European countries. But other avenues of redistribution are equally important: voluntary efforts, private but statutorily encouraged benefits (like employee health insurance) and taxes. Given all of these, the American welfare state is more extensive than is often realised: the total social policy effort made in the US falls precisely at the centre of the European scale.

And if we shift our focus to education, the contrasts across the Atlantic are, if anything, reversed. A higher percentage of Americans have graduated from university and from secondary school than in any European nation. America’s adults are, in this sense, better educated than Europe’s. And the US lavishes more money per child at all levels of education than any western European nation. Europeans often believe that good US schools are private and serve only an elite. Yet American education is, if anything, less privatised than most European systems. Public education was among the first social programmes to receive massive public funding in the US and this has remained the case ever since.

Simone de Beauvoir was convinced that Americans do not need to read because they do not think. Thinking is hard to quantify; reading less so. And Americans, it turns out, do read. The percentage of illiterate Americans is average by European standards. There are more newspapers per head in the US than anywhere in Europe outside Scandinavia, Switzerland and Luxembourg. The long tradition of well-funded public libraries in the US means that the average American reader is better supplied with library books than his peers in Germany, Britain, France, Holland, Austria and all the Mediterranean nations. They also make better use of these public library books than most Europeans. The average American borrowed more library books in 2001 than their peers in Germany, Austria, Norway, Ireland, Luxembourg, France and throughout the Mediterranean. Not content with borrowing, Americans also buy more books per head than any Europeans for whom we have numbers. And they write more books per capita than most Europeans too.

American popular culture is fascinated by violence, much as Japanese culture is by suicide. Whether in The Godfather or the television series The Wire, the image America broadcasts about itself is crime-ridden and violent. Most foreigners have been content to accept that analysis at face value. Not that it is entirely untrue. A horrendous number of murders are committed in the US, almost twice the per capita rate of the nearest European competitors, Switzerland, Finland and Sweden. Nor is there any doubt that the US imprisons a far higher percentage of its population than any of its peers. But in other respects, America is a peaceful and quiet place by European standards. US burglary rates are fairly high, but below the Danish and British. The incidence of theft is lower than in six western European countries. Assault is in the middle, on a par with Swedish and Belgian rates. Rape levels are high, but other sexual assault rates are moderate. Only Denmark, Belgium and Portugal have lower rates; Austria suffers three times the American rate.

American drug use is quite high too, but still—excepting cannabis where the figures are a smidgen above Britain’s—within the European scale. American white-collar crime is at the middle to low end of the spectrum. The French suffer over six times the American rate of bribery. And the total American crime figures are in the low middle of the pack. Indeed, only relatively small countries—Finland, Austria, Switzerland and Portugal—are less crime-ridden than the US.

But what about other aspects of the social environment? In ecological terms, America is thought to be a wastrel. Big cars, big houses, long commutes, cold winters, hot summers, profligate habits: such perceptions of the country have combined with the Bush administration’s cosy relationship with the oil industry and its refusal to sign the Kyoto Protocol to paint the nation as an environmental black hole. Once again, the numbers tell a somewhat different story.

Although oil use per capita is high in America, measured as a function of economic production (in other words, putting the input in relation to the output) it remains within European norms, and indeed lower than in Portugal, Greece, Belgium, Luxembourg, the Netherlands and Iceland. Between 1990 and 2002, America’s carbon dioxide output rose, but per unit of GDP it fell by 17 per cent—a greater reduction than in nine western European countries. In its output of renewable energy, the US is middle of the spectrum on all counts, whether biogas, solid biomass energy, geothermal or wind. Only Austria, Denmark, Italy and the Netherlands have higher levels of spending (public and private) on pollution abatement and control as a percentage of GDP than America. Despite the myths of a hyper-motorised nation, Americans own fewer passenger cars per head than the French, Austrians, Swiss, Germans, Luxembourgers and Italians. Per capita, Americans rely on their cars more than Europeans. But adjusting for the size of the country, automobile usage is lower only in Finland, Sweden and Greece. Similarly, Americans produce a lot of waste per head, though the Norwegians are worse, and the Irish and Danes are close competitors. But they recycle as well as the Finns and the French, and better than the British, Greeks and the Portuguese. Since 1990, Americans’ production of waste has scarcely gone up per capita, while in all European nations for which figures are available, there have been big increases—70 per cent in Spain, almost 60 per cent in Italy and over 30 per cent in Sweden.

“The old world developed on the basis of a coalition—uneasy but understood—between humanity and its surroundings,” the Guardian reassures its recycling readership. “The settlement of the US was based on conquest, not just of the indigenous peoples, but also of the terrain.” Yet, despite such common European conceptions, American conservation efforts are strong by European standards. The environmental activist Jeremy Rifkin insists that Europeans, unlike Americans, have “a love for the intrinsic value of nature. One can see it in Europeans’ regard for the rural countryside and their determination to maintain natural landscape.” Actually, the percentage of national territory protected in the US is about double that of France, Britain or even Sweden. And conventional American farmers are far less “chemicalised” than their European colleagues. Thanks partly to their use of GM crops, they use pesticides sparingly. The Italians use over seven times as much, the Belgians even more.

Despite perceived differences in its economy and care for the environment, perhaps the most fundamental assumed gap between the US and Europe is in values. Americans are said to be nationalistic and religious, while Europeans are post-nationalist and secular. But even here there is reason to doubt the stereotypes.

Yes, Americans are patriotic and nationalistic, but according to the World Values Survey, undertaken between 1999 and 2001, not more than some Europeans. Unsurprisingly, Germans are least proud of their nation, and rather unexpectedly, the Portuguese—not the Americans—are most, with the Irish tied for second place. Granted, Americans are more likely to think that their country is better than most others. But more Portuguese, Danes and Spaniards feel that the world would be improved if other people were like them, and a larger fraction of Americans admit that there are aspects of their country that shame them than do the Germans, Austrians, Spanish, French, Danes and Finns.

Even on religion, there is reason to question an absolute polarity between the US and Europe. “Religion is palpable in US schools, places of work and public institutions,” claims the Guardian. “God is invoked by soldiers and politicians in a way that would seem inappropriate in Britain.” Puzzling, then, that Britain’s head of state is known as the “Defender of the Faith,” and the established church has 26 seats in the upper legislature. The American observer of Europe is often baffled at European claims to secularism since official expressions of religion are so public, and yet—apparently—so taken for granted. A 10th-century depiction of the crucifixion, for example, is part of every Danish passport, regardless of whether its bearer is, as many nowadays are, a pious Muslim.

American church attendance and religious belief is not off the European scale if one compares them with Europe’s Catholic regions. A smaller percentage of Americans consider themselves religious than the Portuguese and Italians. Proportionately fewer Americans say they believe in God and always have than the Irish and Portuguese. Moreover, sociologists tend to explain high American church attendance as the outcome of market forces as much as spiritual ones. Greater competition has led to a richer variety and higher quality of offerings, while Europe’s state-monopoly religions struggle to provide for their citizens’ spiritual needs. If the issue is thus one of supply and less of demand, the contrast between Europe and America may not be between religious and secular mindsets, but between how—if at all—largely equivalent spiritual needs are fulfilled.

This is certainly a conclusion suggested by looking at attitudes to science across the Atlantic. Without question, Americans are more likely to believe in creationism than Europeans. Yet the modern American creationist, interestingly enough, no longer takes scripture as sufficient reason to believe the biblical account of the origins of the world. The debate is instead conducted on the turf of science, with creationists attempting to argue the fine points of the age of the fossil record, suggesting that orthodox evolution has gaps as a seamless explanation, and otherwise indicating their acceptance that the modern world speaks the language of science. The realm of scientific quackery in Europe, on the other hand, is much wider than in the US. Consider the sway of self-evidently daft positions like anti-vaccinationism among the Hampstead Bildungsbürgertum, or the equally irrational rejection of the fruits of scientific reasoning, like the anti-GM movement. Astrology is more widely believed in several European nations than in the US, and homeopathy is relied upon much more often in Europe.

So if Americans are, on the whole, more religious than most Europeans, it does not follow that they have less overall faith in science. Societies with a strong faith in science can also have strong religious beliefs. True, proportionately fewer Americans firmly agree with the Darwinian theory of evolution than any Europeans other than in Northern Ireland. But in other respects, Americans believe in the Enlightenment project of human reason’s ability to understand and master nature. They fall in the European middle ground in approving animal testing to save human lives. Perhaps most tellingly, more American pupils agree with the statement that science helps them to understand the world than in any European nations other than Italy and Portugal.

They may be scientific, then, but Americans are also thought of as diehard individualists who live in a society of sharp elbows and an ethos of live and let live. They are imagined to be unusually anti-governmental in their political ideology; practically anarchists by European standards. Yet a Pew Foundation survey in 2007 found that proportionately fewer Americans worried that the government had too much control than did Germans and Italians, with the French at the same level and the British just a percentage point lower. And a higher percentage of Americans trust their government than all Europeans, except only the Swiss and the Norwegians (although no people, truth be told, demonstrate much faith in their elected representatives.)

But talk is cheap, and these findings may indicate desire as much as reality. The trust of Americans in their state apparatus, then, can be measured more concretely by their willingness to pay taxes. Unlike many Europeans, Americans pay the taxes required of them. Only in Austria and Switzerland are the underground economies as small. Tax avoidance is over three times the American level in Greece and Italy. The archetypal Montana survivalist—so beloved of the European media—holed up in his shack, determined to resist the government’s impositions, is as uncharacteristic of America as the Basque or Corsican separatist, ready to kill for his cause, is of Europe.

These are just a few examples of the way in which the presumed chasm dividing the Atlantic is not, in fact, nearly as deep as opinion among the chattering classes and their mouthpieces believes. Why, then, does this notion persist? For one thing, the European press wants the juicy, titillating lowdown. And America certainly dishes that up. Is there any other nation that washes its dirty laundry so publicly? Hence that genre of such fascination to the European chattering classes: the tedious travelogue by the sophisticated European, whether BHL, Baudrillard or Borat, observing American yokels and reporting back with the smug assurance of superiority to other sophisticated Europeans.

Moreover, Europe’s various cultures are ones still steeped in the lore of national stereotypes and quite happy to wring whatever elixir can be had from them. Who can forget Edith Cresson, Mitterrand’s prime minister, convinced that no Frenchman was gay, while the English were all limp-wristed poofs? Or consider the extent to which no Europeans, however otherwise politically correct, can be shaken in their conviction that the Roma really are shifty and thieving. Having a transatlantic whipping boy is convenient and serves politically useful purposes, especially if there is little else that you can agree on. The purveyors of anti-Americanism in Europe appear to have rediscovered the truism that nothing unites like a common enemy. And the Bush administration played into their hands by serving up caricatures by the spadeful. It will be interesting to see how the European pundits deal with Obama once he does something they do not like. While Bush could be portrayed as an ignorant cowboy, which of the available stereotypes will they dare lambast Obama with?

Here, we come to the grain of truth to the Atlantic divide. If there is anything that most separates American society from Europe, it is the continuing presence of an ethnically distinct underclass. Even as other outsiders have successfully assimilated, the tragic resonances of slavery in the black urban ghettos of America continue to prevail. Indeed, take out the black underclass from the crime statistics and American murder rates fall to European levels, below those in Switzerland and Finland, and even squeaking in under Sweden. Child poverty rates, which are scandalously high in the US, fall to below British, Italian and Spanish levels if we look at the figures for whites only. PISA scores for American whites (ranking secondary school proficiency) come above every European nation other than Finland and the Netherlands. This is not to excuse the atrocious negligence with which the problems of racism have been dealt in the US. But it does suggest that, far more than any grand opposition of worldviews or ideologies, it is the still unresolved legacy of slavery that distinguishes—to the extent anything does—America from Europe. Whether Obama’s election will mark a turning point in this respect remains to be seen.

And if it is this distinct urban underclass that most distinguishes the US from Europe, Europeans should take notice. Europe’s birthrates have plummeted and immigration continues unabated. It is a demographic certainty that an ethnically and religiously distinct lower class in Europe will grow in the decades to come. Perhaps Europe will turn out to have been lucky. Having instituted universalist social policy, highly regulated labour markets and redistributive fiscal policy in the belief that it was all, so to speak, being kept “in the family,” Europe may weather the expansion of its social community. On the other hand, the social fabric may fray.

No one is arguing that America is Sweden. But nor is Britain, Italy, or even France. And since when does Sweden represent “Europe”—at least anymore than the ethnically homogenous, socially liberal state of Vermont does America? Europe is not the continent alone, and certainly not just its northern regions. With the entrance of all the new EU nations, it has just become a great deal larger. These new entrants are not just poorer than old Europe. They, like Europe’s many recent immigrants from Asia and Africa, are religious, sceptical of a strong state, unenthusiastic about voting and allergic to high taxes. In other words, from the vantage of old Europe, they are more like Americans. And so as Europe expands, the argument made here for western Europe—that the differences across the Atlantic have been exaggerated—will become irrefutable.

The data in this article comes mostly from those organisations that provide internationally comparable figures: the UN, Unesco, Unicef, WHO, the IMF, the World Bank, Eurostat, the Sutton Trust, the World Values Survey, the ILO, the International Agency for Research on Cancer, the International Association for the Study of Obesity, the World Resources Institute, the International Energy Agency, the International Social Survey Programme and, above all, the OECD.

By ROBERT H. FRANK

Published: July 11, 2009

IF asked to identify the intellectual founder of their discipline, most economists today would probably cite Adam Smith. But that will change. Economists’ forecasts generally aren’t worth much, but I’ll offer one that even my youngest colleagues won’t survive to refute: If we posed the same question 100 years from now, most economists would instead cite Charles Darwin.

Darwin, renowned for the theory of evolution, was a naturalist, not an economist, and his view of the competitive struggle was different from Smith’s in subtle but profound ways. Growing evidence suggests that Darwin’s view tracks economic reality much more closely.

Smith is celebrated for his “invisible hand” theory, which holds that when greedy people trade for their own advantage in unfettered private markets, they will often be led, as if by an invisible hand, to produce the greatest good for all. The invisible hand remains a powerful narrative, but after the recent economic wreckage, skepticism about it has grown. My prediction is that it will eventually be supplanted by a version of Darwin’s more general narrative — one that grants the invisible hand its due, but also strips it of the sweeping powers that many now ascribe to it.

Smith’s basic idea was that business owners seeking to lure customers away from rivals have powerful incentives to introduce improved product designs and cost-saving innovations. These moves bolster innovators’ profits in the short term. But rivals respond by adopting the same innovations, and the resulting competition gradually drives down prices and profits. In the end, Smith argued, consumers reap all the gains.

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species.

In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles with other males for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods.

In Darwin’s framework, then, Adam Smith’s invisible hand survives as an interesting special case. Competition, to be sure, sometimes guides individual behavior in ways that benefit society as a whole. But not always.

Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race. In the marketplace, such reward structures are the rule, not the exception. The income of investment managers, for example, depends mainly on the amount of money they manage, which in turn depends largely on their funds’ relative performance.

Relative performance affects many other rewards in contemporary life. For example, it determines which parents can send their children to good public schools. Because such schools are typically in more expensive neighborhoods, parents who want to send their children to them must outbid others for houses in those neighborhoods.

In cases like these, relative incentive structures undermine the invisible hand. To make their funds more attractive to investors, money managers create complex securities that impose serious, if often well-camouflaged, risks on society. But when all managers take such steps, they are mutually offsetting. No one benefits, yet the risk of financial crises rises sharply.

Similarly, to earn extra money for houses in better school districts, parents often work longer hours or accept jobs entailing greater safety risks. Such steps may seem compelling to an individual family, but when all families take them, they serve only to bid up housing prices. As before, only half of all children will attend top-half schools.

It’s the same with athletes who take anabolic steroids. Individual athletes who take them may perform better in absolute terms. But these drugs also entail serious long-term health risks, and when everyone takes them, no one gains an edge.

If male elk could vote to scale back their antlers by half, they would have compelling reasons for doing so, because only relative antler size matters. Of course, they have no means to enact such regulations.

But humans can and do. By calling our attention to the conflict between individual and group interest, Darwin has identified the rationale for much of the regulation we observe in modern societies — including steroid bans in sports, safety and hours regulation in the workplace, product safety standards and the myriad restrictions typically imposed on the financial sector.

Ideas have consequences. The uncritical celebration of the invisible hand by Smith’s disciples has undermined regulatory efforts to reconcile conflicts between individual and collective interests in recent decades, causing considerable harm to us all. If, as Darwin suggested, many important aspects of life are graded on the curve, his insights may help us avoid stumbling down that grim path once again.

The competitive forces that mold business behavior are like the forces of natural selection that molded elk. In each case, we see instances of socially benign conduct. But in neither can we safely presume that individual and social interests coincide.

Robert H. Frank, an economist at Cornell, is a visiting faculty member at the Stern School of Business at New York University

From: www.aldaily.com

What is economics? Is it a science? Haven't all its failures of prediction and political guidance proved its lack of respectability? The current financial crisis also reveals a deep crisis of economics. We seem to be witnessing the dismantling of an approach that, at least in its shallow mainstream version, has to make a series of absurd assumptions in order to reach any conclusion — with both the assumptions and the conclusions being astonishingly out of touch with reality. Its scholars have come to use mathematical logic as some sort of l'art pour l'art, falling into the trap of technicality rather than aiming at the wider horizon of an all-encompassing social science.  

"Competent economists are the rarest of birds...The master-economist must possess a rare combination of gifts...He must be mathematician, historian, statesman, philosopher — in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man's nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician."  

We owe this job description to John Maynard Keynes and the situation hasn't changed since he wrote it nearly a century ago. The scarcity of good economists has indeed been a constant plague of humankind. 

This is not to say that all economists are by nature technocrats who fail to recognise the relevant questions. This would just not be true. The verdict of narrowness and non-scientific shallowness cannot be directed against those economists who have made their career outside the mainstream, the so-called "orthodoxy" — in institutional economics, for example, or in public choice, in law and economics, game theory and behavioural finance. In these relatively new and innovative fields, scholars have been endeavouring to fill the gaps in mainstream theory, hoping to contribute to what should one day be a better and more fruitful mainstream. The goal is a body of theory that would be able to answer more relevant questions about how mankind can peacefully live together in society, granting personal autonomy and economic progress for all, building on the institutional achievements of Western civilisation, such as individual liberty, the free market and the rule of law.

It therefore seemed worthwhile to interview as many as possible of the living recipients of the Nobel Prize for Economics, as I have done in my new book Roads to Wisdom (Elgar, 2009). Nobel laureates are terrific subjects of analysis if one seeks to grasp the backgrounds and inspiration that create true excellence, especially in a field such as economics, where fruitless and shallow technical brilliance can turn out to be so harmful. The Nobel Prize in Economics does not really deserve its name. It was instituted as late as 1968, by the Swedish Riksbank and its full name is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. The man who invented dynamite, made a fortune and dedicated it to the ongoing promotion of scientific excellence, clearly seeking not to leave the world with a merely destructive legacy, had not included the field of economics in his will. Actually, he hated economics, as he said, "from the bottom of my heart". For a physical scientist, to whom hard data and precision were vital, this is quite understandable. Economics, as a social science, cannot discover eternal laws. It has to deal with ever-changing and inherently complex phenomena.

The fake genealogy of the Nobel Prize in Economics doesn't however impair its importance. The prize is, of course, no guarantee of quality. But it is better than many other indicators, because the phenomenon of self-perpetuating elites plays itself out less negatively here than elsewhere in academia. In order not to misjudge whether some areas of research or some pieces of work have really had a measurable impact on economics, the prize tends to be handed out very late in an individual scholar's career. A welcome side effect of this is that career choices are not being corrupted. On average, Nobel laureates in economics are 67 when they receive the prize. The oldest to receive it was Leonid Hurwicz, at the age of 90, in 2007.

This does make the Nobel Prize a relatively good indicator of excellence. For this reason, it is useful and inspiring to turn to the Nobel laureates and ask them about their personal journeys — leaving behind the more pedestrian issues of publication indexes, citation cartels and networks. It is much more interesting to have outstanding scholars describe their individual roads to research, originality and excellence, and to ask them about their own character traits, family backgrounds and worldviews. How have they come to be what they are? What is it that triggered curiosity about economics? What does it take to have a promising career? Where do path-breaking ideas come from? What were their sources of inspiration? 

Actually, most Nobel laureates in economics have come to that field because they were attracted by its questions, which they felt an imperative urge to answer in order to improve the world. Those are the missionaries. People with this trait usually have a "vision", as Joseph Schumpeter once said. Among my subjects, Douglass North says that he is "still trying to save the world" today. Gary Becker talks about his youth referring to his emerging "desire to do something for society". On the other hand, there are some born technicians, who easily possess themselves of the proper (mathematical) "technique", as Schumpeter puts it, and who take a while to discover their more profound interest in "people and policies": those laureates have come to economics via their mathematical talent. To some extent, this is the case with Vernon Smith. Blessed with a talent for mathematics, he started out studying physics and electrical engineering at the California Institute of Technology, where he was confronted with the social sciences more or less by accident. He stumbled over Paul Samuelson's new textbook, which was revolutionary in presenting the subject matter in mathematical terms. "Samuelson's book indicated that economics was just physics," he said. He has since found that economics is not like physics — but the newly discovered field stuck nevertheless. 

There may be a humility bias in how much one ascribes to chance, looking back on one's life — but it is probably also true that the dice are not yet fully thrown at the age of 16 or 17. Decisions made at such a young age are made with a great deal of uncertainty. Hence, we may take it seriously when most laureates claim that they have more or less stumbled into economics. 

Even for the "missionaries", economics wasn't a fully unequivocal choice before they saw it in class. In Vernon Smith's case, for example, it was chance exposure to economics at Caltech that proved decisive. Paul Samuelson says that he "came to Chicago only because of location" and that it "was an accident that I liked the subject". Kenneth Arrow and James Buchanan were simply lured by a scholarship. 

This brings me to the influence of family backgrounds. Edmund Phelps certainly hit the nail on the head when he remarked that it is not straightforward — not impossible, but more difficult — to become an economist if one doesn't grow up in a somewhat bourgeois setting. Absent major crises that affect virtually everybody, economic issues do tend to subside into the fuzzy background of social life unless one lives in a context that brings with it some regular intellectual exposure to questions of this kind. 

Phelps grew up in precisely what he calls a "somewhat bourgeois setting", both parents being oriented towards business and coming from relatively wealthy backgrounds. Gary Becker's case is similar, his father having been a pretty well-to-do businessman. The same is true for Douglass North, whose father was a successful insurance manager, and even for Paul Samuelson, whose father had his own pharmacy and whose family had accumulated a relative degree of affluence but had to watch it gradually dissipate when the Florida land bubble burst in the 1920s. 

The situation was, however, altogether different for Vernon Smith, whose parents left school at 14. His father provided the work ethic and can-do knowledge, while his mother was active in political and social affairs in the community. Financial problems forced the family to practise self-sufficiency on a farm for a couple of years. The situation of James Buchanan was similar to Smith's. His family lived on a farm throughout his youth. His father had gone through two years of university training ("and played football"). His mother, however, had been a schoolteacher. She was endowed with an exemplary work ethic and a voracious intellectual appetite. Both character traits, as it seems, have left an important and lasting impact on the son. 

Even without much schooling, therefore, parents can provide their children with intellectual appetite and a motivation for achievement. Discussions at the dinner table, or other regular family gatherings, are extremely important — and it doesn't matter much how high-powered the arguments are. What is crucial is that the awareness is raised-awareness about the importance of certain topics relating to economics and economic policy, to anything that touches social questions and of course the appetite to learn more about them. 

This is an experience that most laureates share. Smith was fascinated to discover at college that the topics that had been debated at the dinner table were actually "things you could study, that it needn't be only a matter of opinion. You could actually base your opinions on analysis, on investigation, on some kind of understanding about how society and how the economy work". In the Buchanan household, discussions were more about politics. 

Worldviews also play a role in instigating academic research. As Schumpeter put it, worldviews enter the "pre-analytic cognitive act" or "vision" that "supplies the raw material for the analytic effort". To some extent, a person's worldview is usually shaped at home, in the family, actively and passively, perhaps also during dinner table conversations. This "initial endowment" may however fade away as new influences come in later in life. Interestingly, in the case of the ten Nobel laureates I interviewed, the initial ideological endowments were mostly socialist. There is a saying that a person who, as a youngster, is not a socialist, has no heart — and a person who still remains a socialist in later years has no brain. There may be something to it. Smith comes from a socialist background. Becker was a socialist, just like his father, who "although he was a pretty successful businessman, strongly supported interventionist-type candidates". North was an outright Marxist. Arrow regarded himself as a socialist ("not a communist"). Buchanan doesn't make such a fine distinction. He came from a populist background, but when he turned to economics, his peer group lured him over to socialism. "I would have signed up immediately to the Communist Party had a recruiter come along," he says. As predicted by the popular saying, however, those initial ideological endowments indeed didn't last. In Buchanan's case, it was the University of Chicago that turned him around, "and in a hurry". 

The same happened to Becker, who remembers that two things pulled him away from socialism: Milton Friedman and economics. When North got his first job at Seattle, he relearned theory — and, as he says, this "was the last step in my getting rid of Marxism. As I relearned theory, I became a very rigid neoclassical, Chicago-type economist". As the Nobel laureates moved on with their schooling and academic training, they came across teachers and mentors who, in most cases, played a decisive role. These mentors managed to entice their intellectual appetite even more, opened up interesting new fields for them, gave them good advice and urged them ultimately to stay in academia. The role of teachers is as important as it is psychologically interesting. Teachers provide the intellectual socialisation, and they are role models. This is clear from Becker's experience with Milton Friedman at Chicago. "He was by far the greatest living teacher I have ever had," Becker says. But Becker ultimately had to defend his intellectual autonomy some years later, deciding to move on to Columbia University. Buchanan was in Frank Knight's wake, while in Smith's case, Wassily Leontief and Gottfried Haberler and especially Edward Chamberlin, left their mark. 

Events also leave their marks on people and on their theories. Scholars pick up on catastrophes and cataclysms, trying to understand and explain them, and theory changes correspondingly. All economic theory is thus historically bound, both in terms of the real-life events behind it and the trajectory of theory itself, as Schumpeter points out. Looking back at the past century, there are only a couple of events from an economic point of view that qualify as having had this kind of importance. The first, and foremost, was the Great Depression. Samuelson, Phelps, Solow, Arrow and Smith all cited it as the most serious economic catastrophe so far. It will be interesting to see whether the current crisis will have a comparable motivational impact on academia. 

Can you survive as a lone wolf in academia — or do you have to be a group animal faithful to the tribe? How much co-operation and interaction is needed in order to be successful? My interviews show that "anything goes", as Paul Feyerabend put it. Samuelson, for example, certainly isn't a lone wolf. He has co-authored a lot, and much of his work — if not most — has been triggered by other people's papers. Buchanan co-authored extensively, too, and derived from it as much inspiration as despair, usually having to bring the discipline to bear. Smith clearly isn't a lone wolf: he has always worked out his experiments within groups. Reinhard Selten, however, the one German laureate in the group, denies that kind of disposition. "I'm not so dependent on external inspiration," he says. And North is "sure I have learnt a lot from other people...but in terms of where my ideas come from, I have been very much a loner". In an age of globalisation when co-authoring has become the rule rather than the exception in academia, the lone wolf may be on the verge of extinction.

The muse also kisses whomever and whenever she chooses. Crucial ideas are a gift. They tend to be inspired by the most unlikeliest things, at the most unlikely moments. Buchanan traces back his approach mainly to a dusty old book he stumbled on by chance in the library: Knut Wicksell's Finanztheoretische Untersuchungen. Smith owes his inspiration to a course taught by Edward Chamberlin, but the ensuing illuminating idea came later: "In the middle of the night, in 1956 at Purdue, I wake up and I have this idea." Becker remembers puzzling about the "economics of marriage" while sitting on his own in a hotel room. North tells the story of how some serious criticism by a student prompted him to stay up all night drinking brandy and reflecting on the topic. Arrow remembers how painfully long it was before he left the starting blocks, yet in the end, his dissertation came "just like that". And Samuelson acknowledges that many of his topics came up because somebody else had written something that he felt an irresistible urge to straighten out. 

And finally, the area of research seems to be to a large extent predetermined by individual character. From the point of view of self-marketing, it is more promising to place oneself in a new field or even to create one from scratch: who would not prefer to be a big fish in a small pond rather than to be a small fish in a big pond? In order to prevail in academia, one should try to come up with a truly pioneering idea, a fruitful approach that one can expand. But breaking free from the mainstream is a risky investment, and few scholars have the guts to undertake it — although becoming the mainstream should be a big reward. To differing degrees, most Nobel laureates have indeed been rebels against the established mainstream at some point. Becker rose against the narrow scope of economics. Smith rebelled against the black or empty holes in general equilibrium theory. Buchanan spoke against the missing regard for the public sector and collective decision-making. In Selten's case as well, his rebellious character predisposed him to swim against and beyond the mainstream wherever he went. As he admits, "I have always mistrusted majority opinion." 

The decisive truth in this observation, which also helps to answer the initial question about economics as a science, is that it is always outside a given "orthodoxy" that human reason finds the most difficult — and therefore also the most promising — challenges. All such "heterodoxy" in fact requires mental freedom, an independent mind, self-confidence and perhaps a rebellious character. It takes courage to be a dissident. Enlightenment does indeed wait at the end of the road for those intellectual entrepreneurs who are not only equipped with intelligence, curiosity and patience, knowing how to ask relevant questions and how to use their insights in a well-balanced way, but who also follow a more universal scholarly impulse, leading to a broader perspective. 

As Friedrich August von Hayek said, "An economist who is only an economist is likely to become not only a nuisance but a positive danger." With the current crisis, both of the economy and economics, we have just experienced the enormity of this positive danger. It comes with an unhealthy combination of mainstream conformity and conceit. In order to circumvent it, economists must relearn humility. They need to shield themselves not only against the illusion that humankind can fix all things, but also against romantic illusions about the possible scope of human knowledge in the first place. A role model is James M. Buchanan. In spite of his high scientific ambitions, which he follows wholeheartedly, he remains humble and always keeps his feet on the ground. All scientific knowledge can be but transitory, he insists, and progress is necessarily relative. "There are whole realms of discourse out there that we cannot reach, by definition. There are always going to be limits beyond which we cannot go. Knowing that they are there, you can always hope to move a little closer — but that's all."

Economics must also again be understood as an encompassing social science, deeply ploughing the rich common ground with philosophy, sociology, politics and history. The use of formal mathematical methods should certainly be part of this approach — but not their long practised senseless misuse, with many mainstream scholars indulging in an obsession with mathematical virtuosity for its own sake, forgetting to ask the relevant questions. It is only such a cure of technical sobriety and wider perspective that will make economics a truly worthwhile avenue of research again, interesting for the individual scholar and useful for society as a whole. It is only this that may re-establish confidence that economics is not dismal, but indeed a science — a science that does have valuable contributions to make that will permit us better to understand human interaction, devise appropriate institutions, and to more wisely assess and advise public policy

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The man who saw the meltdown coming had another troubling insight: it will happen again

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Since the global financial system started unraveling in dramatic fashion two years ago, distinguished economists have suffered a crisis of their own. Ivy League professors who had trumpeted the dawn of a new era of stability have scrambled to explain how, exactly, the worst financial crisis since the Great Depression had ambushed their entire profession.

Amid the hand-wringing and the self-flagellation, a few more cerebral commentators started to speak about the arrival of a “Minsky moment,” and a growing number of insiders began to warn of a coming “Minsky meltdown.”

“Minsky” was shorthand for Hyman Minsky, a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck, and he remains a shadowy figure in the profession. But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through. A contrarian amid the conformity of postwar America, an expert in the then-unfashionable subfields of finance and crisis, Minsky was one economist who saw what was coming. He predicted, decades ago, almost exactly the kind of meltdown that recently hammered the global economy.

In recent months Minsky’s star has only risen. Nobel Prize-winning economists talk about incorporating his insights, and copies of his books are back in print and selling well. He’s gone from being a nearly forgotten figure to a key player in the debate over how to fix the financial system.

But if Minsky was as right as he seems to have been, the news is not exactly encouraging. He believed in capitalism, but also believed it had almost a genetic weakness. Modern finance, he

argued, was far from the stabilizing force that mainstream economics portrayed: rather, it was a system that created the illusion of stability while simultaneously creating the conditions for an inevitable and dramatic collapse.

In other words, the one person who foresaw the crisis also believed that our whole financial system contains the seeds of its own destruction. “Instability,” he wrote, “is an inherent and inescapable flaw of capitalism.”

Minsky’s vision might have been dark, but he was not a fatalist; he believed it was possible to craft policies that could blunt the collateral damage caused by financial crises. But with a growing number of economists eager to declare the recession over, and the crisis itself apparently behind us, these policies may prove as discomforting as the theories that prompted them in the first place. Indeed, as economists re-embrace Minsky’s prophetic insights, it is far from clear that they’re ready to reckon with the full implications of what he saw.

In an ideal world, a profession dedicated to the study of capitalism would be as freewheeling and innovative as its ostensible subject. But economics has often been subject to powerful orthodoxies, and never more so than when Minsky arrived on the scene.

That orthodoxy, born in the years after World War II, was known as the neoclassical synthesis. The older belief in a self-regulating, self-stabilizing free market had selectively absorbed a few insights from John Maynard Keynes, the great economist of the 1930s who wrote extensively of the ways that capitalism might fail to maintain full employment. Most economists still believed that free-market capitalism was a fundamentally stable basis for an economy, though thanks to Keynes, some now acknowledged that government might under certain circumstances play a role in keeping the economy - and employment - on an even keel.

Economists like Paul Samuelson became the public face of the new establishment; he and others at a handful of top universities became deeply influential in Washington. In theory, Minsky could have been an academic star in this new establishment: Like Samuelson, he earned his doctorate in economics at Harvard University, where he studied with legendary Austrian economist Joseph Schumpeter, as well as future Nobel laureate Wassily Leontief.

But Minsky was cut from different cloth than many of the other big names. The descendent of immigrants from Minsk, in modern-day Belarus, Minsky was a red-diaper baby, the son of Menshevik socialists. While most economists spent the 1950s and 1960s toiling over mathematical models, Minsky pursued research on poverty, hardly the hottest subfield of economics. With long, wild, white hair, Minsky was closer to the counterculture than to mainstream economics. He was, recalls the economist L. Randall Wray, a former student, a “character.”

So while his colleagues from graduate school went on to win Nobel prizes and rise to the top of academia, Minsky languished. He drifted from Brown to Berkeley and eventually to Washington University. Indeed, many economists weren’t even aware of his work. One assessment of Minsky published in 1997 simply noted that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.”

Yet he was busy. In addition to poverty, Minsky began to delve into the field of finance, which despite its seeming importance had no place in the theories formulated by Samuelson and others. He also began to ask a simple, if disturbing question: “Can ‘it’ happen again?” - where “it” was, like Harry Potter’s nemesis Voldemort, the thing that could not be named: the Great Depression.

In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century. But where most economists drew a single, simplistic lesson from Keynes - that government could step in and micromanage the economy, smooth out the business cycle, and keep things on an even keel - Minsky had no interest in what he and a handful of other dissident economists came to call “bastard Keynesianism.”

Instead, Minsky drew his own, far darker, lessons from Keynes’s landmark writings, which dealt not only with the problem of unemployment, but with money and banking. Although Keynes had never stated this explicitly, Minsky argued that Keynes’s collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff.

This insight bore the stamp of his advisor Joseph Schumpeter, the noted Austrian economist now famous for documenting capitalism’s ceaseless process of “creative destruction.” But Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises.

Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers - what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.

Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment - what was later dubbed the “Minsky moment” - would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

From the 1960s onward, Minsky elaborated on this hypothesis. At the time he believed that this shift was already underway: postwar stability, financial innovation, and the receding memory of the Great Depression were gradually setting the stage for a crisis of epic proportions. Most of what he had to say fell on deaf ears. The 1960s were an era of solid growth, and although the economic stagnation of the 1970s was a blow to mainstream neo-Keynesian economics, it did not send policymakers scurrying to Minsky. Instead, a new free market fundamentalism took root: government was the problem, not the solution.

Moreover, the new dogma coincided with a remarkable era of stability. The period from the late 1980s onward has been dubbed the “Great Moderation,” a time of shallow recessions and great resilience among most major industrial economies. Things had never been more stable. The likelihood that “it” could happen again now seemed laughable.

Yet throughout this period, the financial system - not the economy, but finance as an industry - was growing by leaps and bounds. Minsky spent the last years of his life, in the early 1990s, warning of the dangers of securitization and other forms of financial innovation, but few economists listened. Nor did they pay attention to consumers’ and companies’ growing dependence on debt, and the growing use of leverage within the financial system.

By the end of the 20th century, the financial system that Minsky had warned about had materialized, complete with speculative borrowers, Ponzi borrowers, and precious few of the conservative borrowers who were the bedrock of a truly stable economy. Over decades, we really had forgotten the meaning of risk. When storied financial firms started to fall, sending shockwaves through the “real” economy, his predictions started to look a lot like a road map.

“This wasn’t a Minsky moment,” explains Randall Wray. “It was a Minsky half-century.”

Minsky is now all the rage. A year ago, an influential Financial Times columnist confided to readers that rereading Minsky’s 1986 “masterpiece” - “Stabilizing an Unstable Economy” - “helped clear my mind on this crisis.” Others joined the chorus. Earlier this year, two economic heavyweights - Paul Krugman and Brad DeLong - both tipped their hats to him in public forums. Indeed, the Nobel Prize-winning Krugman titled one of the Robbins lectures at the London School of Economics “The Night They Re-read Minsky.”

Today most economists, it’s safe to say, are probably reading Minsky for the first time, trying to fit his unconventional insights into the theoretical scaffolding of their profession. If Minsky were alive today, he would no doubt applaud this belated acknowledgment, even if it has come at a terrible cost. As he once wryly observed, “There is nothing wrong with macroeconomics that another depression [won’t] cure.”

But does Minsky’s work offer us any practical help? If capitalism is inherently self-destructive and unstable - never mind that it produces inequality and unemployment, as Keynes had observed - now what?

After spending his life warning of the perils of the complacency that comes with stability - and having it fall on deaf ears - Minsky was understandably pessimistic about the ability to short-circuit the tragic cycle of boom and bust. But he did believe that much could be done to ameliorate the damage.

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve - what he liked to call the “Big Bank” - step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke - like Minsky, a scholar of the Depression - it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

Minsky’s other solution, however, was considerably more radical and less palatable politically. The preferred mainstream tactic for pulling the economy out of a crisis was - and is - based on the Keynesian notion of “priming the pump” by sending money that will employ lots of high-skilled, unionized labor - by building a new high-speed train line, for example.

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government - or what he liked to call “Big Government” - should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else’s wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

While economists may be acknowledging some of Minsky’s points on financial instability, it’s safe to say that even liberal policymakers are still a long way from thinking about such an expanded role for the American government. If nothing else, an expensive full-employment program would veer far too close to socialism for the comfort of politicians. For his part, Wray thinks that the critics are apt to misunderstand Minsky. “He saw these ideas as perfectly consistent with capitalism,” says Wray. “They would make capitalism better.”

But not perfect. Indeed, if there’s anything to be drawn from Minsky’s collected work, it’s that perfection, like stability and equilibrium, are mirages. Minsky did not share his profession’s quaint belief that everything could be reduced to a tidy model, or a pat theory. His was a kind of existential economics: capitalism, like life itself, is difficult, even tragic. “There is no simple answer to the problems of our capitalism,” wrote Minsky. “There is no solution that can be transformed into a catchy phrase and carried on banners.”

It’s a sentiment that may limit the extent to which Minsky becomes part of any new orthodoxy. But that’s probably how he would have preferred it, believes liberal economist James Galbraith. “I think he would resist being domesticated,” says Galbraith. “He spent his career in professional isolation.”

Stephen Mihm is a history professor at the University of Georgia and author of “A Nation of Counterfeiters” (Harvard, 2007).

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