Larry Summers: neo-Keynesian aristocrat

By W.W. | IOWA CITY

LARRY SUMMERS is a laissez-faire zealot. Or so says documentary filmmaker Charles Ferguson in a half clueless, half insightful article in the Chronicle for Higher Education. In Mr Ferguson's story, Mr Summers, a former president of Harvard, former treasury secretary, and soon-to-be-former director of the White House National Economic Council, never saw a regulation he didn't want to annihilate. Thus, Mr Summers and his market-fundamentalist colleagues helped immanentise the financial eschaton.

Mr Ferguson writes:

Starting in the 1980s, and heavily influenced by laissez-faire economics, the United States began deregulating financial services. Shortly thereafter, America began to experience financial crises for the first time since the Great Depression.

This is tediously common trope in left-leaning circles. But it's just wrong. As economists Peter Boettke and Steven Horwitz have pointed out in a lucid short paper on the causes of the "Great Recession", between 1980 and 2009, four new regulatory policies were imposed on the financial sector for each regulatory policy lifted. It's simply inaccurate to describe this period as an era of deregulation. It was, on the whole, a period of decidedly increasing regulation. In any case, toting up regulations is a bit of a mug's game. The relevant question is rarely how much regulation there is, but how a particular regulatory scheme facilitates or impedes productive exchange, stabilises or destabilises markets, by shaping the incentives facing firms. More regulation doesn't help if they're the wrong regulations. (Compare: more drugs won't help a sick man if they're the wrong drugs.) Indeed, the proliferation of new regulatory rules increases the chance of unforeseen, harmful interaction between regulations. In addition to reducing red tape, deregulation can make markets easier to supervise. Of course, it's dangerous to get rid of the regulations we do need. Regulatory Manicheanism, left and right, just makes us stupider.

But this isn't what I wish to focus on. At the centre of Mr Ferguson's piece is a deep, under-appreciated truth:

By now we are all familiar with the role of lobbying and campaign contributions, and with the revolving door between industry and government. What few Americans realize is that the revolving door is now a three-way intersection. Summers's career is the result of an extraordinary and underappreciated scandal in American society: the convergence of academic economics, Wall Street, and political power.

This is spot on. Yet Mr Ferguson's inability to spy daylight between Larry Summers and Ludwig von Mises—his apparent conviction that orthodox academic economics as such is a hothouse of laissez-faire ideology—leaves him unable to offer the most plausible account of this corrupting three-way intersection of elite economics, Wall Street, and Washington. Let me try to help.

John Maynard Keynes claimed to be as comfortable at Whitehall as Cambridge, or so it is said. If we wish to understand Mr Ferguson's intersection, and Larry Summers' frequent trips across it, we need to look at it through a Keynesian lens.

Larry Summers wasn't a proponent of laissez-faire economics when he worked for Bill Clinton, and he isn't one now. It's true: if anyone embodies the consensus of elite, orthodox academic economics, it is Larry Summers. But that consensus wavers only ever so slightly between conservative and liberal versions of neo-Keynesian economics. Mr Summers is not just another neo-Keynesian economist. He is neo-Keynesian royalty. He is a nephew of two of the 20th century's greatest left-leaning economists, Paul Samuelson and Kenneth Arrow. Due to the immense influence of his textbooks, Mr Samuelson was second only to Baron Keynes himself in promoting the now-familiar role of the macroeconomist as the technocratic steward of the national economy. And Mr Summers is second to none in embodying the role of elite Keynesian guru.

This role is the key to Mr Ferguson's troubling intersection and it is essential to Keynesian ideology. Keynesianism tells us market economies will run themselves into the ground without expert government intervention. This strongly encourages the idea that elite academic macro- and monetary economists constitute a sort of secular priesthood. Only they are privy to the mysteries of the business cycle. Only they are armed with the esoteric knowledge necessary to tame an otherwise disastrously turbulent economy. It's only natural that these same men and women should be granted positions of considerable powers within government. It's only natural that they should be called upon as invaluable, and thus handsomely compensated, expert advisers to the nation's largest private financial concerns. And this is a recipe for corrupt and/or dangerous conflicts of interest.

Mr Ferguson's confusion about the politics of professional economics leads him to get a few things almost back to front. For example, University of Chicago professor, and former IMF chief economist, Raghuram Rajan appears in the piece as a good guy opposed to Mr Summers's crazed anti-regulatory zeal.

In 2005, at the annual Jackson Hole, Wyo., conference of the world's leading central bankers, the chief economist of the International Monetary Fund, Raghuram Rajan, presented a brilliant paper that constituted the first prominent warning of the coming crisis. Rajan pointed out that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people's money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a "full-blown financial crisis" and a "catastrophic meltdown."

When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a "Luddite," dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector.

Now, my sense is that Mr Rajan is a rather more free-market sort of economist than is Mr Summers. And Mr Rajan's observation that certain compensation practices may have knocked the incentives of financial executives out of whack with everybody else's interests has no clear ideological upshot. It's just a good point—a too-rare instance of attention to the effects of micro-level incentives on the stability of the whole system. Mr Summers' intemperate reaction certainly seems benighted, but I'm not inclined to chalk it up to an over-abundance of laissez-faire zeal. Once we see Mr Summers for what he is—doyen of the neo-Keynesian technocratic aristocracy—it seems rather more likely that his reaction reflected the wounded pride of a social engineer who personally helped design and vet these institutions; he was insulted by Mr Rajan's impertinent suggestion that they don't check out.

Mr Ferguson is right to shine a light on the corrupting confluence of elite academic economics, the financial industry, and national politics. But the problem just isn't Larry Summers's ideological aversion to government intervention. The problem is that the Keynesian ideology of expert intervention makes a fattened aristocracy of economic experts inevitable.

(Photo credit: Bloomberg)