An Exceptional Economist


When I first saw the list of “Seven Bad Ideas” by Jeff Madrick, I thought of the biblical refrain, “Woe unto them who call evil good and good evil” (Isaiah 5:20). How can he consider the Invisible Hand, Say’s law, limited government, low inflation, efficient markets, free trade, and economics as an objective science to be “bad ideas”?

Then I read the book, and came to the conclusion that Jeff Madrick is an exceptional economist. By that I mean that Madrick considers all the above ideas to be good except when they are misused by economists and government officials who engage in “dirty economics.” He is one of those economists who constantly says, “I’m all in favor of the free market, but . . .” and then lets out a litany of exceptions to the rule.

The greater the level of economic freedom, the higher the standard of living.

His first chapter sets the tone. He labels the Invisible Hand a “beautiful idea,” and waxes eloquent about Adam Smith’s “brilliant” metaphor of the market. Then he goes on the attack, criticizing laissez-faire advocates such as Milton Friedman (his favorite bête noire) for ignoring the importance of “monopolies, business power, lack of access to information, the likelihood of financial bubbles, economies of scale.” When that happens, he concludes, “The efficient Invisible Hand gets very dirty.”

Madrick protesteth too much. Adam Smith’s “system of natural liberty” consists of three elements: maximum freedom, competition, and a system of justice. If the invisible hand gets dirty, it’s only because one or more of these elements are proscribed. If all three are in place, the result is “universal opulence which extends to the lowest ranks of the people,” as Smith predicted in the early pages of The Wealth of Nations. Indeed, the Economic Freedom Indexes, produced by the Fraser Institute and the Heritage Foundation, confirm Adam Smith. They list five critical factors: size of government, legal structure, sound money, trade, and regulations. They demonstrate that the greater the level of economic freedom, the higher the standard of living.

In chapter 5, Madrick attacks the notion that “There Are No Speculative Bubbles.” Here again he begins with a positive idea, the efficient market theory (EMT), which originated from the work of Eugene Fama at the University of Chicago. Fama, who won the Nobel Prize last year, found that it’s almost impossible to beat the market and difficult to identify asset bubbles. But then Madrick spends most of the chapter highlighting the exceptions, citing Robert Shiller and other critics of EMT. “The development of the EMT is another example of how faith in the rationality of free markets was pushed too far,” Madrick says. Yet the fact remains, when the financial markets are transparent sans government interference and mismanagement, they work pretty well.

In chapter 6, Madrick attacks globalization. He begins by saying, “Opening markets to world trade can and should be beneficial.” Then comes the “but . . .”, as he cites cases of people in Asia, Europe, and Latin America who are damaged by free trade and market liberalization. He also cites Paul Krugman, for the idea that “broad swaths of the population [are] hurt by trade.” But no one says that trade doesn’t hurt some groups in the short run, and requires them to retool and change jobs. A recent study of the NAFTA free-trade agreement between Canada, Mexico, and the United States concluded that on net balance more jobs and more income were created than destroyed.

When financial markets are transparent sans government interference and mismanagement, they work pretty well.

Madrick derides the whole idea of Say’s law and the self-adjusting economy. However, he never cites directly the great French economist J.B. Say. In fact, I have the impression that he may have never read Say’s Treatise on Political Economy, published in English in 1821. Nor does he seem familiar with the work of Steve Kates, the foremost authority on Say’s law. If he had, Madrick would know that Say’s whole focus is the benefits of the supply side of the economy — technology, productive savings and investment, and entrepreneurship — which is the key to long-term growth and higher standards of living. Who could be against that?

Like Krugman, Robert Kuttner, and other Keynesians, Madrick berates “austerity” economics and the obsession with government deficits in Europe and the US. Yet he conveniently ignores examples in which austerity worked, such as Canada in the mid-1990s, when it cut government spending and laid off federal workers but managed to balance the budget in two years and then went on an 11-year supply-side run that proved a success. Today Canada is ranked no. 7 in the Economic Freedom Index, ahead of the US (no. 12).

Seven Bad Ideasshould be renamed The Anti-Friedman Book. It attacks the late Milton Friedman in virtually every chapter, blaming him and his "laissez-faire" policies for everything bad in the world. Madrick says that the establishment economics profession has bought into all things Friedman, and that Friedman has had his way in practically all policies, including those of the Clinton era. According to Madrick, Friedman is "the most influential American economist of the last quarter of the twentieth century.” If so, why hasn’t the US adopted a flat tax, a negative income tax, school choice, decriminalization of drugs, or privatization of Social Security or even the national parks, as Friedman advocated? Why hasn’t the US eliminated the Fed and replaced it with a computer that increases the money supply at a steady rate? If only Madrick were right and Friedman truly ruled!

Madrick conveniently ignores examples in which austerity worked, such as Canada in the mid-1990s, which balanced its budget in two years.

In his final chapter, one of Madrick’s chief complaints about the economics profession is its lack or misuse of empirical evidence to support its assertions. But sometimes he is guilty of the same error. One of the most egregious examples is this extreme statement: “By every measure, the economic improvement in the 1950s and 1960s was superior to the improvement from 1980 onwards when Friedman type-economics began to prevail.” Say again? He may have a point with some statistics, such as per capita GDP growth, or real wages in the United States. But there are plenty of countries in Asia, Eastern Europe, and Africa that have adopted Friedman free-market policies and have blossomed. And in the US, there are plenty of contrary data, such as life expectancy, leisure time, and especially new technology (personal computers, smartphones, the internet, etc.). When you include worker benefits, total compensation is still rising for the average employee. According to Michael Cox, an expert on consumption patterns at Southern Methodist University, ownership of cars, color televisions, and household appliances has risen dramatically at all income levels, and even in poor households, since 1980. The standard of living has advanced so far and has risen so rapidly for most Americans since 1980 that there is no comparison. Is there anyone who would prefer to live in the 1950s and 1960s rather than today, as Madrick’s statement implies?

Most of the time, Madrick loses his sense of balance. He devotes 90% of the book to the exceptions, making it a work full of tedious arguments and complaints that would interest only professional economists (what John Stossel calls “getting caught in the weeds”). He even takes on his Keynesian friends, such as Lawrence Summers, and lambastes them for falling into “Friedman’s folly.” Madrick still thinks Friedman is the Devil.

Editor's Note: Review of "Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World," by Jeff Madrick. Alfred A. Knopf, 2014, 254 pages.

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Who Rules the Republic?


Some years ago, in an interview with Mike Wallace, conservative commentator Fulton Lewis, Jr. stated that the federal government was run, not by elected representatives, but by the civil service; that policy was made, not by secretaries or assistant secretaries, but by non-appointed officials. He said further that the president should have authority to appoint people to agencies at whatever level policy was made. I saw the original telecast — on February 1, 1958 — and recently found it online, preserved by the Harry Ransom Center at the University of Texas at Austin.

What brought the interview to mind was Professor Angelo M. Codevilla’s recent book, The Ruling Class: How They Corrupted America and What We Can Do About It. The author complains of the administrative state, rooted in the New Deal — a federal government in which “bureaucrats make, enforce, and adjudicate nearly all the rules.” He labels as the Ruling Class those who populate the federal bureaucracy, along with elected representatives devoted to big government and hangers-on from the private sector who profit from government or who trade campaign dollars for access and favors. They are the power elite, the statist minority that rules the republic. By contrast, the author refers to the majority of Americans, those who live in the private sector and represent traditional America, as the Country Class.

These two classes represent the fundamental political division across the country. Members of the Ruling Class occupy the “commanding heights of government,” convinced that they own the secret of our deliverance and hungry for power to prove it. This class constitutes a “machine” that transfers “money, jobs, and privileges” to its clients. The results of its domination are an extension of the culture of dependency, an assault on the family, on religion, and on conventional morality. This class has bent science and reason to the service of power. It has placed public schools beyond the reach of parents, filled our cars with inscrutable gadgets, and thrown away billions on economic bailouts. And worse, it has led us into a procession of wars, expensive in blood and treasure but without clear purpose or outcome.

Codevilla covers the spectrum of complaints about big government — the problems of public education, the Kelo decision, the global-warming necromancy, the absurd regulatory minutiae, crony capitalism, alliances with labor unions (especially those of government workers), the abetting of family disintegration, and the complexity and favoritism in our laws.

Still, the author sees hopeful signs. The discontent of Republican voters with their party suggests that the Country Class is getting restless, and the Tea Party movement is stark evidence of its discontent. Many of its members want to “restore a way of life that has been largely superseded.” For Codevilla, the “signature cultural venture” of the Country Class is the homeschool movement. It represents the reassertion of parental prerogatives and, I might add, a back-of-the-hand to public education, which Mises warned must inevitably become indoctrination. But why haven’t Republicans — members of America’s “conservative” party — acted to expose the incompetence of the Ruling Class? Author Codevilla answers — they’re “salivating” to join that class.

That the Tea Party movement elevated the anxieties of the American Left wasn’t surprising, but the response of prominent Republican David Frum to Codevilla’s book was troubling. Reviewing The Ruling Class on Frum Forum, he referred to the author as a “grumpy old man,” neglecting the possibility that there was something to be grumpy about. He faulted the book for being short on substance. But clearly, it was intended to raise an alarm rather than provide a paradigmatic analysis. Frum worries about the Republican Party. He frets over the loss of the young and educated, never suspecting that their education may be to blame — that academics tend to produce Democrats. Professor Codevilla perceives the relationship between the universities, the power elite, and its preferred political home — the Democratic Party.

Why haven’t Republicans — members of America’s “conservative” party — acted to expose the incompetence of the Ruling Class? Because they’re salivating to join that class.

But he isn’t traveling a fresh path. Consider a comment from Democracy in America. In the chapter discussing European governments, de Tocqueville added a footnote, which I quote in part: “As the functions of the central government are multiplied, the number of officials serving it increases in proportion. They form a state within each state, and since they share the stability of government, increasingly take the place of the aristocracy.” Earlier in the same masterpiece, I find the following: “When I arrived in the United States, I discovered with astonishment that good qualities were common among the ruled, but rare among the rulers.” Codevilla refers to the Ruling Class as a bunch of “pretentious, incompetent, losers” — in other words, they lack good qualities.

In Free to Choose, Milton and Rose Friedman warned us of a new power elite: “The new class, enshrined in the universities, the news media, and especially the federal bureaucracy, has become the most powerful of special interests. The new class has repeatedly succeeded in imposing its views, despite widespread public objection, and often despite specific legislative enactments to the contrary.”

Earlier, James Q. Wilson had described the history and development of the federal bureaucracy in his essay “The Rise of the Bureaucratic State.” He identified the fundamental problem — the transfer of authority from elected representatives to an “unaccountable administrative realm.” In the process, client relationships develop between certain sectors of the economy and government agencies. Regulatory agencies gain broad powers derived from the need to make “binding choices without clear standards of choice.” Thus the “new class” forms bureaucratic alliances with and gains power over the private sector. Wilson pointed out the fact that all democratic regimes tend to enlarge the administrative side of government and move “resources” from the private to the public sector. This is the very centralizing tendency in democratic governments that so concerned de Tocqueville.

Perhaps, before we decide on an anti-Ruling Class strategy, it might be a good idea to consult another critic of government, the late John T. Flynn. In The Road Ahead: America’s Creeping Revolution (1949), he foresaw what now so obviously confronts the republic — a conspiracy to increase the size and power of government. Flynn saw the conspirators as American versions of the British Fabian Socialists. He drew up a list of ten imperatives that he believed necessary to halt the drift toward socialism. I present them here without the author’s elaborations, though the latter are well worth consulting. All are contained in the final chapter of The Road Ahead. In the 60 years since this remarkable chapter first appeared, America’s creeping revolution has crept on and on, with much of the country either indifferent to, or benefiting from, the encroachments of government. This, in Flynn’s words, is how to stop them:

I. We must put human freedom once again as the first of our demands. There can be no security in a nation without freedom.

II. We must stop apologizing for our Capitalist society.

III. Not one more step into socialism. Hold the line for the American way of life.

IV. Get rid of compromising leaders.

V. We must recognize that we are in the midst of a revolution — that it is war — and that we must begin to fight it as such.

VI. We must put an end to the orgy of spending that is rapidly bankrupting the nation.

VII. We must put an end to crisis government in America.

VIII. We must stop “planning” for socialism and begin planning to make our free system of private enterprise operate at its maximum capacity.

IX. We must set about rebuilding in its integrity our republican system of government.

X. We cannot depend on any political party to save us. We must build a power outside the parties so strong that the parties will be compelled to yield to its demands.

Any questions?

Flynn, John T. The Road Ahead: America’s Creeping Revolution. New York: Devon-Adair, 1949.
Friedman, Milton, and Rose Friedman. Free to Choose: A Personal Statement. New York: Avon, 1981.
Frum, David. “How the Elites Became Tea Party Enemy #1.” Frum Forum (Sept. 19, 2010).
Kurtz, Howard. “Conservative David Frum Loses Think-Tank Job After Criticizing GOP.” Washington Post ( March 26, 2010)
“Mike Wallace Interview: Fulton Lewis, Jr., 2/1/58.” The Harry Ransom Center, University of Texas at Austin.
Mises, Ludwig von. Human Action: A Treatise on Economics, 3rd. Revised Ed. Chicago: Contemporary Books, 1966.
Tocqueville, Alexis de. Democracy in America. Trans. George Lawrence. Ed. J. P. Mayer. New York: Anchor, 1969.
Wilson, James Q. “The Rise of the Bureaucratic State.” National Affairs (Fall 1975).

Editor's Note: Review of "The Ruling Class: How They Corrupted America and What We Can Do About It," by Angelo M. Codevilla. Beaufort Books, 2010, 147 pages.

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Safety Nets and Slippery Slopes


There’s been a theme hammered in dull thuds recently by the establishment media: anyone who opposes expansion of the welfare state is a hypocrite because everyone is on the dole. The New York Times has run several such stories; lesser outlets have followed suit.

Before you gag on this rancid bit of partisan meat, let me say that I think this is a hopeful sign. The hacks are framing the argument in this way because they expect criticism of the welfare state to pick up through the course of this election cycle. As it should. They hope to inoculate the administration against such criticism; in the process, though, they’ll draw attention to related issues that don’t help their cause. These related issues include:

  • the sloppy logic and language of welfare advocacy,
  • the growing role of moral hazard in public policy,
  • the effect of high marginal tax rates on productivity, and
  • the slippery slope of unintended consequence.

Let me sketch out quickly how these all connect with one another.

The recent charges of hypocrisy are merely the latest example of the establishment media’s obtuseness and doublespeak on the topic of welfare. In the statist catechism, the terms “safety net” and “earned entitlement” are supposed to refer to sharply distinct sorts of programs — the former involves straightforward income redistribution, the latter involves a group of programs into which beneficiaries have paid. But the two are often confused. The headline of one Times article reads “Even Critics of Safety Net Increasingly Depend on It.” The article proceeds to focus on the effects of growing middle-class dependence on Social Security and Medicare, which are supposed to be “earned entitlements” and not part of the “safety net.”

The jargon is all so imprecise and indirect that the headline-writing mediocrities at the Times might be forgiven for getting confused.

Of course, there might be a more devious impulse at work — intentionally confusing programs into which people have paid with those into which they have not might be an attempt to blur important distinctions. To make “middle-class” recipients of earned entitlements the moral equivalents of the “poor” recipients of safety-net money. And if everyone’s the same, statist catechism goes, no one can criticize.

The “moral” in this equivalence gets to my next point. The sloppy logic and fuzzy language — intentional or not — may create only an ersatz version of moral equivalence but it encourages very real moral hazard.

Moral hazard has been an interest of mine for a number of years. It takes various forms in various circumstances, but the common conclusion is simple: If people are insulated from the effects of bad outcomes, they produce more bad outcomes.

In matters of public policy, the most evident example of moral hazard is a high marginal tax rate. And this is more closely related to welfare policy than it might seem on first glance.

On the low end of the income spectrum, a high marginal tax rate creates a permanent underclass; on the high end of the income spectrum, it encourages productive people to go Galt. More important, the moral hazard of taxing people stupidly creates a slippery slope; when a person drops down the socio-economic ladder, it becomes harder for him to climb back up.

If a person’s annual income falls from $40,000 to $20,000 because of a lost job or a business reversal — but that person picks up $15,000 in benefits as a result — he’s being insulated from the effects of his lower income. The benefits, which he’ll lose if his income recovers, become part of the effective marginal tax rate that discourages the climb back to $30,000 or $40,000. He’s more likely to accept his reduced circumstances and welfare benefits. Said another way: the same mechanism that acts like a safety net to someone sliding down the slope can act like a barrier to someone scrambling back up.

The problem with managing marginal tax rates is that tax systems are crude tools. The U.S. income tax tables create a roughly-hewn “stair-step” system of increasing rates. And the government benefits made available to low-income earners exaggerate the steps. At some points, a slight increase of income results in a much larger effective tax rate. In these cases, the slope isn’t just slippery — it’s negative. One solution to a negative slope would be modify the tax table to include thousands of tiny steps rather than a few rough ones; another would be to reject the step system entirely and move to a nonlinear formula for calculating the income tax rate each earner pays.

If the establishment media is right and everyone is on the dole, we need to criticize the welfare state more. Not less.

In the 1970s, Milton Friedman suggested a third option that he called the “negative income tax” (based on earlier proposals by Henry Hazlitt and Juliet Rhys-Williams). This negative tax would replace all other benefits; instead of numerous programs subsidizing food, shelter, child care, health care, etc., there would just be one lump-sum payment which would be phased out gradually as a person’s income increased. His idea was mauled and transformed into what we know today as the Earned Income Tax Credit; but the current incarnation is a far cry from what Friedman had in mind. His goal was to minimize bureaucracy and control fraud in the welfare apparatus. Our system today, an income redistribution scheme that pretends to be an “earned entitlement” program, maximizes all of that.

We’ve always known that income redistribution strips all parties — sponsors and beneficiaries — of their humanity and, especially the beneficiaries, of their dignity. Forty years ago, Daniel Patrick Moynihan predicted that the U.S. welfare state would damage beneficiaries, precisely as it has. If the establishment media is right and everyone is on the dole, we need to criticize the welfare state more. Not less. And we need to get rid of any administration that enables it, even if the alternatives aren’t inspiring.

This sharp truth will cut through hacky charges of hypocrisy from outfits like The New York Times.

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The Fed's Easy Money


The Federal Reserve has heeded calls for more “quantitative easing.” It will create still more high-powered (bank-reserve) money by buying more government bonds. That is a bad policy.

Perhaps untypically, the current recession is not of a sort that more easy money would remedy. A liquidity shortage is not the problem, and worries about actual deflation are curiously short-sighted. Already the banking system could multiply the stock of ordinary bank-account money on the basis of the stock of reserve money already greatly expanded by the Federal Reserve. That could and would happen if bankers and borrowers had confidence in business and regulatory conditions.

Two words used above need explaining. “Recession” means more here than just the downward phase of the business cycle. Even after the economy has hit bottom and has begun recovering, it is still in recession as long as subpar business conditions drag on. This is the popular use of the word. The word “untypically” draws a contrast between the current recession and most earlier ones. Those apparently did trace to a slowdown or reversal of money-supply growth.

Actually, too loose a Federal Reserve policy seems to have figured in the background of the current recession, along with artificial pro-home-ownership policies that contributed to a speculative housing bubble. The latter was a real factor — “real” in a sense contrasting with “monetary” and more fully explained below.

Now, notoriously, businesses and consumers are hanging onto money and near-moneys (cash and equivalents) instead of spending them at a rate that would restore prosperity. The velocity of money — the income to money-supply ratio — has fallen, whatever one plausibly counts as money. This demand to hold money has strengthened only passively, however. Individuals and companies, by and large, are not deliberately restraining their expenditures to build up cash balances they consider inadequate. Instead, they are postponing expenditures for lack of attractive opportunities. Meanwhile, they are left holding cash and equivalents by default.

These sources of uncertainty are real, not just monetary. Real factors explain why some countries are economically advanced and others economically backward.

But why this postponement? Worry about how long a recession will drag on is an old story.  Now, moreover, uncertainty prevails about how government policies will raise business costs and erode job and profit prospects. Health care, financial regulation, cap and trade, various “green” pressures and subsidies, taxes, deficits and debt, widespread economic ignorance, and a perceived hostility toward big business are causes for concern. One hears about this crippling uncertainty from all sides (as from business executives interviewed by Charles Gasparino).

These sources of uncertainty are real, not just monetary. Real factors explain why some countries are economically advanced and others economically backward. These real factors determining production and growth include more than just material ones such as labor supplies and skills, natural resources, and technology. They also include entrepreneurial alertness, competitiveness, mobility of labor and other resources among employments and places, taxes and regulations, and various other institutions and policies that promote or impair intersectoral and intertemporal economic coordination. Real factors determine the “natural rate of unemployment,” the frictional unemployment that persists even during prosperity.

Now, a sound old tenet of monetarism — the monetarism of Warburton, Friedman and Schwartz, Brunner and Meltzer, and others — is that monetary policy cannot remedy real impediments to prosperity and growth (except perhaps only temporarily and unsatisfactorily, as noted below). Far from celebrating any wondrous potentials of monetary policy, monetarism warns about the damage that bad policy can cause and often has caused. It warns against destructive stop-and-go oscillation between fighting unemployment and (belatedly) fighting inflation. Monetary policy should concentrate steadily on what it can do, on preserving the value of money.

Admittedly, a sufficiently expansive monetary policy could offset a fallen velocity of money, even of the present fear-based passive sort. People’s willingness to accept and just hold money is not unlimited. The Federal Reserve could make the economy so awash with money that people would spend it even though they worried about real conditions and because they feared inflation. Banks would activate their ample idle reserves, so creating more money.

The equivalent of Milton Friedman’s metaphor of helicopters dropping bale upon bale of freshly printed money could reinforce the great potential for money creation and spending expansion that already exists. But how unsatisfactorily! More monetary expansion would threaten severe price inflation, causing distortions and discoordinations of its own. At worst the dollar would collapse as foreign central banks unloaded their great holdings of US bonds.

Finding the proper dosage and timing of aggressive monetary expansion would be a hopeless challenge. Already it is hard to see how the Federal Reserve might find an “exit strategy” from its swollen balance sheet.

In summary, easy money (like fiscal “stimulus,” by the way) is no cure for “real” defects of economic structure and policy. Bewailing the lack of jobs, though amply justified, is no diagnosis and no remedy. Lack of a politically easy way to undo bad policies is no excuse for making things worse.

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