Monday, January 25, 2010

The False Choice

Newsweek argues that because of the financial crisis, there will be a shift from free market economics to interventionist economics. In the sense that the crisis has created more support for government intervention and more actual government intervention that is a correct account.

But the article goes beyond that and also argues that this is right because the crisis showed that the Chicago School account of markets as being completely efficient (as in flawless) was wrong. And while it is true that this meant that the Chicago School doctrines were again shown to be false, this does not mean that free market economics is discredited, because there is a sounder alternative in the form of the Austrian School, whose theories does not assume that markets are "perfect", only that market mechanisms are better (or less bad) than the alternative of government interventions.

And contrary to the implicit assumption of the article, markets were hardly entirely free, with for example (this is the most important, but not the only example) short-term interest rates set by a government agency, the central bank. As always when governments fix prices, the fixing of the price of short-term credit did cause the predictable problem of too much credit when the price was set arbitrarily low.

This illustrates why free market advocates that use the New Classical/Chicago School theories are often doing more harm than good. By presenting themselves as the alternative to Keynesianism, they allow the Keynesians to present themselves as the most realistic alternative in the false choice between New Classical/Chicago Shool theories and Keynesian theories.