Many people view economics primarily through the lens of market settings. However, at its core, economics is the human science. Insights from economics can penetrate the realm of emotional intelligence. A recent book, The Courage to Be Disliked, by authors Ichiro Kishimi and Fumitake Koga demonstrate some fundamental economic lessons making their way into the philosophy of happiness. In one chapter, the authors emphasize that feelings of inferiority are personal subjective assumptions. The two main characters reflect upon their physical characteristics.  The teacher was short- and while originally upset about being small, came to appreciate his ability to allow people to relax. His height served his goals in life, allowing him to succeed. He used this example to point out that one’s personal characteristics are not inferior or superior unless people place that value upon themselves. This insight appears to mirror the insights of the Marginal Revolution. One major puzzle in economics was “why value in use” was separated from “value in exchange”. Why are diamonds expensive when water is cheap? Like the teacher, economists recognize that value (and values) are subjective. A good, such as a personality trait, is not beneficial or harmful in a vacuum. Instead, a good’s value depends on the demand of individuals, which change, depending on the attitude of those involved. The idea that valuing oneself is a choice challenges the idea that people are stuck in a cycle of low self-esteem. By contrast, the teacher’s view suggests the primacy of individual choice and agency, of change, rather than stasis. Without a market, systems are unable to take advantage of people’s individual preferences and subjective beliefs. The second economics lesson that’s made its way into the book is that of separating tasks. The teacher claims that those who are “ultimately going to receive the result brought about by the choice that is made”, are those who are responsible for doing tasks. Giving the example of a child, the teacher expresses that the child is ultimately going to face the consequences of deciding whether to study- and should be the one most responsible for doing so. This division of emotional labor speaks to the issue of property rights and the principal-agent problem. People tend to follow their own interests. If they are responsible for making decisions affecting themselves, they are going to act in ways that benefit themselves. Property rights work, combining the responsibilities of the property with the associated benefit. However, when people take on other’s tasks, they decouple responsibility with effect, creating the principal-agent problem. The principal-agent problem takes place when a principal delegates control of assets to an actor who may have different interests. Politicians tend to spend lavishly with taxpayer funds, and renters tend to be more willing to trash rental properties, than the respective owner. This idea culminates towards the end of the book, with the provocative claim that, “freedom is being disliked by other people…. It is proof that you are exercising your freedom and living in freedom”. When one can make unpopular decisions, they live freely. The implication of this claim, interpersonally, is that one needs to be autonomous to be free. In a similar vein, whatever system that’s set up for providing human happiness needs to be elastic enough to allow people to dislike each other, while allowing people to be accountable for their decisions. This lends itself to combining private property with markets is the logical step towards building an emotionally intelligent, happy society.   Isadore Johnson is a campus free speech advocate, an economics and philosophy student, and regional coordinator for Students for Liberty. (0 COMMENTS)

Chances are higher that France is the future of America than the contrary. Hence, even an American should not disregard this post. The featured image shows a big pile of uncollected garbage on boulevard Saint-Michel, in Paris, on Thursday. Many garbage collectors, already assured of a generous state-paid pension at 62, are on strike to protest the increase of the retirement age to 64. Unknown to them is that they may have to retire even later if the bankrupt state pension system is not mended by even deeper reforms. The author of the attempted reform is the centrist president Emmanuel Macron. The political center in France is about where Joe Biden stands on the standard political spectrum in America. The center moves toward where the most political powerful extreme pulls. I will grant that Macron, a former banker, does not match either Biden’s or Trump’s economic ignorance. (As the French Civil Code maxim goes, “À l’impossible nul n’est tenu,” from the Latin Impossibilium nulla obligatio est, which translates into “the impossible is no legal obligation.”) Macron knows that assets below liabilities necessarily implies that the remainder, the owners’ net value (the future retirees’ pension value, in this case), is negative. Two-thirds of French voters are opposed to the reform, that is, they want more of their pensions to be paid by the other third; or they don’t have a clue. Macron realizes this but argues, quite sensibly, that the majority would not want any of the alternatives either, such as higher current or future taxes, lower economic growth, or a more dramatic crash of the pension system along perhaps with general prosperity (see “Macron Government Bypasses France’s National Assembly to Pass Pension Overhaul,” Wall Street Journal, March 16, 2023—especially the accompanying video for Macron’s words). The problem of Social Security in America is only less massive than in the French system. In both countries, the inability of “democratic” choices to deal with the problem is the same. Such is the failure of “democracy” as we know it. Instead of a procedure for changing the rulers without violence or civil war and thus hopefully constraining their self-interest and folly, democracy is viewed as a system in which the majority can “legitimately” decide anything it wants and impose its desires and greed on the minority. (See my forthcoming Econlib review of Friedrich Hayek’s The Political Order of a Free People.) This sort of political philosophy ignores the discoveries of the Public Choice school of economics which has studied phenomena such as the incoherence of unconstrained majoritarian choices, the rational ignorance of the individual voter, and the triumph of organized interests which manipulate puppet politicians and voters. A mob is seldom, if ever, libertarian. Boulevard Saint-Michel in Paris, March 16, 2023Photo credit: Charlotte Lemieux (0 COMMENTS)

Classical liberals tend to be big fans of the argument from evolution. To say that a particular social tradition or market outcome was the result of an evolved process, or an emergent outcome, or a spontaneous order, is to establish a sort of strong presumption in favor of its legitimacy or usefulness. This isn’t meant to be an absolute proof, of course, but it does serve to shift the burden of proof strongly to the advocate of overturning the evolved order. Yet, some on the political left think there is a contradiction in this approach. Classical liberals and libertarians, they point out, are often extremely skeptical and critical of various political institutions like the FDA or the Labor Department. And yet, they argue, these institutions themselves are part of the evolved political order, emerging over time just as market outcomes or social traditions emerge. Shouldn’t this grant these political institutions the same presumption of legitimacy or usefulness that classical liberals grant in these other cases? Short answer, no. But on the off chance you’re interested in a longer answer, let’s shift gears for a second and talk about memes. I don’t mean memes as the term is usually used today, meaning something like “a picture on the internet with a funny caption.” I mean memes as the idea was originally described by Richard Dawkins – a way to model the spread of ideas as though ideas themselves were alive and used human minds to replicate themselves. If you have a handful of minutes to spare, this video does an excellent job describing how the process works, although rather than using the term “meme” it instead refers to “thought germs.” But the idea is the same. What does memetic theory have to do with why the argument from evolution doesn’t apply to political institutions the way it applies to market processes or social traditions? Because it highlights a key point James Buchanan made – specifically, Buchanan’s point about how order is defined by the process of its emergence. This means simply pointing out than an order is emerged or evolved doesn’t have the same implications in all cases. It’s also important to consider the process of evolution which brought that order about in the first place. Different orders evolve under different selection pressures, which is why orders that emerge under a system of public choice will evolve according to a systematically different logic than those evolving under private choice. In the case of memetic theory, ideas most successfully reproduce themselves (that is, are more likely to be shared and spread) when they are emotionally engaging, and especially when they inspire anger. There is no reason to believe, and excellent reasons to doubt, that an evolutionary pressure that causes the most anger-inducing ideas to spread will also produce the ideas that most accurately reflect reality. The fact that an idea has been highly successful at evolving under mimetic evolutionary pressures, especially in the age of social media, gives a strong presumption in favor of discounting its reliability. And the same is true for the evolutionary logic under which state institutions evolve. Anthony de Jasay, in his book Social Contract, Free Ride explains why the argument from evolution (Institutional Darwinism, in his terms) follows a similarly unhappy logic when applied to institutions of the state. He argues that the evolutionary pressures of state institutions create a sort of Institutional Gresham’s Law, where ineffectual and inefficient institutions drive out effective and efficient ones: If institutions were selected for the characteristics favorable to their own survival, as in plain Darwinism, the surviving ones might not well be the ones most conducive to making the host civilization prosper and grow…Their survival and growth, however, are fostered precisely by their inefficiency…For a variety of reasons, we should expect survival-of-the-fittest-to-survive to produce a population of institutions with many monsters and with no bias towards the benign and the instrumentally efficient. When competing for survival, the latter may well be driven out by the former. It is well in line with this expectation that there is no marked tendency in history for societies equipped with benign institutions to “prevail.”…Institutional Darwinism would work in the benign fashion ascribe to it, and “nice” civilizations would spread, if the subject being selected by the environment for its characteristics that best help it to survive were the whole symbiotic set of host society with its complementary institutions. For this to be the case, single parasitic institutions in the set should have to lose more by weakening the host society than they gain by feeding on it. Gresham’s Law would then cease to operate, for “non-nice” institutions would either not survive the adverse feedback they suffer from their own parasitic actions which weakens their host society, or they would change their spots by a process of mutation-cum-selection. There is no evidence whatever to bear out supposition of this sort. Thomas Sowell gave a real-world example of this process when he was interviewed by Salon magazine years ago. He described how early in his career he was working for the federal government, trying to figure out if high unemployment in Puerto Rico was due to minimum wage laws or hurricanes damaging the local sugar crops. He worked out a way to test the competing ideas and reported it to his superiors. This is how he describes their reaction: I expected to be congratulated. And I saw these looks of shock on people’s faces. As if, “This idiot has stumbled on something that’s going to blow the whole game!” To me the question was: Is this law making poor people better off or worse off? That was the not the question the labor department was looking at. About one-third of their budget at that time came from administering the wages and hours laws. They may have chosen to believe that the law was benign, but they certainly weren’t going to engage in any scrutiny of the law. This is an example of institutional Gresham’s Law at work. Given that so much of the Labor Department’s budget is for the purpose of carrying out wage and hour laws, institutional Darwinism would select in favor of a version of the Labor Department that protected their budget by ignoring harm caused by the laws they administered and select against a version of the Labor Department that did the opposite. Similarly, versions of the TSA or FDA that overhype minor or imaginary risks will be selected over versions operating according to a more realistic assessment of risk requiring a lighter touch and a smaller budget. To bring it back to that line from James Buchanan again, order is defined by the process of its emergence. The outcomes of economic competition in a free market operate by a different evolutionary logic than the spread of thought germs, or by the evolution of political institutions. You can’t simply import the argument used for social and economic evolution and apply it to state institutions. Well, I suppose you can, but when that move falls totally flat, you’ll at least know why. (0 COMMENTS)

Should social scientists read a book on classical liberalism written by a great novelist? Many would be skeptical, assuming that a novelist, no matter how great, can hardly contribute an original perspective on matters concerned with economic and political ideas. Yet in the case of Mario Vargas Llosa they would be wrong, as proved by Javier Fernandez-Lasquetty in a beautiful review for our sister website, Law & Liberty. Lasquetty is the former Vice President and Dean of the School of Political Studies at Universidad Francisco Marroquin and now the Regional Minister of Economy and Finance of the Madrid Region. The book by Vargas Llosa he is reviewing is The Call of the Tribe, which was just recently translated into English. It is a gallery of portraits of giants in classical liberalism, selected by Vargas Llosa because they influenced him and the making of his own political thought. This is hardly the first of Vargas Llosa’s perusals in such waters: in 1990, Vargas Llosa run for the presidency in his native Peru (after what seemed a triumphal electoral march, he was defeated in the second round by the then unknown Alberto Fujimori). His political adventure began when he opposed bank nationalisations in the country: a hardly popular cause, particularly these days, but in the late 1980s Peru it sparked a libertarian political movement. Vargas Llosa’s Peruvian agenda centred upon securing property rights and market freedom for the poor, that he saw as the true losers in a corporatist economy. He authored a long Introduction to Hernando de Soto’s The Otro Sendero. The title was a reference to left-wing terrorists then strong in the country; the book was an analysis of the vibrant informal economy and the failure of ‘official’ institutions to allow people to leverage on it. Vargas Llosa is certainly the most authoritative voice for classical liberalism in the Spanish speaking world, and the only one among the literati. He has been very generous with his time to classical liberals throughout the world and chairs the Fundacion Internacional Para la Libertad, an umbrella organization of free market think tanks in the Spanish speaking world. The speech he gave when he was awarded the Irving Kristol Award is still a wonderful introduction to his political thought. But his ideas also emerge from a number of articles, essays, as well as from some of his novels. Think only of “The War at the End of the World”, perhaps his masterpiece and the best book to understand Latin American populism. The Call of the Tribe is a declaration of love to classical liberalism. The only drawback I can find is that it makes the historian of ideas envious, because rarely has the history of ideas been written so beautifully. As Daniel J. Mahoney explains in another thoughtful review for Law & Liberty, the book is modeled upon “To the Finland Station, published in 1940 by the literary critic Edmund Wilson. That book provided an artful (if one-sided) account of the development of European socialism from the nineteenth-century French historian Jules Michelet to Lenin’s terribly consequential arrival at the Finland Station in St. Petersburg in April 1917″. Writes Lasquetty: Vargas Llosa also talks to us about the enemies of classical liberalism. The most important is constructivism. It is in his chapter on Hayek where he most emphatically denounces “the fatal desire to organize the life of the community from any center of power.” No less sharply, he rejects that other, much more devious, enemy of classical liberalism: mercantilism. Pointing to Hayek and Adam Smith, he contrasts capitalism with the mercantilist schemes of certain businesspeople and politicians who act to protect themselves from competition by regulations and protectionist politics. Mario Vargas Llosa’s book is full of joy and optimism. Freedom does not lead to chaos, rather it generates that Hayekian spontaneous order based on free choice and individual responsibility. It is individualism that leads Vargas Llosa to be optimistic, in contrast to the pessimism that Ortega’s mass-man produces and who is merged into a collective being where he surrenders his individuality. For Vargas Llosa, freedom does not exist if it is not comprehensive: there can be no freedom without political freedom, economic freedom, and freedom of creation and thought. When the book came out in Spanish, I reviewed it, together with Jesse Norman’s book on Adam Smith, in Economic Affairs. This was my take away: by putting together the authors he picked and by emphasising a common thread that unites them all, Vargas Llosa is pointing to a certain view of liberalism: a liberalism whose lack of faith in interventionism is founded on scepticism towards whatever superior wisdom rulers may boast of; a liberalism that cares for rules of the game that ‘privilege always the consumer over the producer, the producer over the bureaucrat, the individual against the state and the living and real of here and now against that abstraction with which totalitarian thinkers justify all their violence: future humanity’ (p. 111). This liberalism looks not unlike a philosophy for the common man in commercial societies. It stresses the long-term benefits of ‘market-tested betterment’ (to borrow McCloskey’s phrase), believes in progress when it comes to practical matters, that is, contrivances of human ingenuity, but is weary of it when it comes to great political schemes; it supports ‘spontaneous orders’ because it maintains that history is a never-ending quest. This is a liberalism strongly concerned with spreading prosperity all the more as the working classes are those who, in the long run, will benefit the most. Such liberalism looks at history as a product of evolution, of human actions and unintended consequences, indeed as Smith did. It is therefore not surprising, though it would please the Smith student, that Vargas Llosa’s book was planned as an essay that, ‘starting in the small Scottish village of Kirkcaldy with the birth of Adam Smith in 1723, will describe the evolution of liberal ideas by their most relevant exponents’ (p. 11). (0 COMMENTS)

(Photo by Justin Sullivan/Getty Images) On CBS’s Sunday morning interview show, Face the Nation, Treasury Secretary Janet Yellen stated clearly that the federal government would not bail out the failed Silicon Valley Bank. Many of us took that to mean that there would be no bailout. But Yellen said in the same interview that the feds would try to meet the needs of depositors. Translation: there would be a bailout, not of the shareholders of SVB, but of depositors. This would include those whose deposits were above the FDIC-insured limit of $250,000. The bailout is a terrible idea. It increases moral hazard. It creates uncertainty about the rules. And it suggests to participants in a market economy that if they have ins with the people in power, they will get special treatment. The bailout adds, in short, to what philosophical novelist Ayn Rand called the “aristocracy of pull.” These are the opening two paragraphs of David R. Henderson, “Why Bailing Out SVB Is A Bad Idea,” Defining Ideas,  March 16, 2023. Another excerpt: On March 12, former treasury secretary Lawrence H. Summers tweeted, “This is not the time for moral hazard lectures or for lesson administering or for alarm about the political consequences of ‘bailouts.’ ” Actually, it is exactly the time for all of that. And: But imagine what would have happened if the federal government had stuck to the rules. Yes, there would have been pain. Yes, several Silicon Valley companies would have had trouble meeting their payrolls. But the reason that SVB was not counted as a “too big to fail” bank was that the federal government had judged that there would not be a system-wide run on banks if SVB’s depositors had taken a large haircut. The impact would almost certainly have been regional, not national. In short, “contagion” likely would have been limited. Then banks, depositors, and others would have thought much harder in the future about what to invest in. The FDIC, Janet Yellen, and the rest of the feds who were involved had a chance to do something good for the economy: stand firm on existing FDIC rules. They blew it. Read the whole thing. (0 COMMENTS)

In my previous post, we saw how George Akerlof’s argument can persuade us that markets fail- from the perspective of microeconomics. This brings us to the “window” of price theory, from which we can observe that instead of demonstrating the case of market failure, Akerlof is also illustrating the exact opposite in the very same paper! How can this be the case? As James Buchanan points out, different windows can direct our attention to concentrate on different aspects of the same phenomenon. By his own admission, Akerlof states that “private institutions may arise to take advantage of the potential increases in welfare which can accrue to all parties” (1970: 488). Such “counteracting institutions,” as he refers to them, are consistent with an account told by price theory, one in which a market failure represents a profit opportunity for entrepreneurs to correct for a market failure. These include, for example, guarantees, brand names, or other forms of advertising that are consistent with non-price competition. Such a window is consistent with F.A. Hayek’s understanding of the price mechanism (1945), which provides entrepreneurs high-powered incentives to act on their particularized and subjective knowledge, not vice-versa as Akerlof’s account would suggest. But as Hayek also argues, the communicative function of relative prices is predicated on non-price forms of competition, such as advertising, which serves to communicate economic knowledge about the availability of substitute goods and services, their quality, and the reputation of its sellers, thus allowing for price adjustments in a manner reflective of underlying information. As Hayek argues, “equilibrium analysis can really tell us nothing about the significance of such changes in knowledge, and it would also go far to account for the fact that pure analysis seems to have so extraordinarily little to say about institutions, such as the press, the purpose of which is to communicate knowledge. It might even explain why the preoccupation with pure analysis should so frequently create a peculiar blindness to the rôle played in real life by such institutions as advertising” (Hayek 1937, p. 53). To conclude, why, then, does Akerlof’s paper continue to be identified as an example demonstrative of “market failure”? I would argue it is because of the distinct difference in the windows that microeconomics gives us about how markets ought to work, rather than price theory giving us a window from which to see how markets actually work.     Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and a Program Director of Academic and Student Programs at the Mercatus Center at George Mason University.   Acknowledgements Special credit is due to Peter Boettke, who first provided me the idea upon which this series is based. Any remaining errors are entirely my own.   (0 COMMENTS)

I am continually amazed at the amount of nonsense that I’ve been reading on the subject of moral hazard. Here are a few examples:1.  Moral hazard played no role with SVB because the shareholders and bondholders were wiped out.  (nonsense)2.  Moral hazard isn’t an issue because average people don’t think about the safety of a bank when making deposits.  (nonsense) 3.  Moral hazard isn’t an issue because average people are unable to evaluate the risk of various banks.  (wrong) 4.  A run on bank deposits could cause a recession.   (wrong) If you see anyone making the first two arguments above, just stop reading.  They literally do not know what moral hazard is.  The fact that a business failed and the owners lost everything has no bearing on the issue of moral hazard.  Here’s Matt Levine: Schematically, a bank consists of shareholders taking $10 of their own money and $90 of depositors’ money and making some bets (home loans, business loans, bond investments, whatever) with that combined pile of money. If the bets pay off, the shareholders get the upside (the depositors just get their deposits back). If the bets lose, the shareholders lose money (the depositors get their money back before shareholders get anything). If the bets lose really big — if the bank bets $100 and ends up with $50 — then the shareholders lose all their money, but the depositors get their money back: If the bank is left with only $50, the government gives the depositors the other $40. If you are a rational bank shareholder (or, more to the point, a bank executive who owns shares and gets paid for increasing shareholder value), this structure encourages you to take risk. If you bet $100 on a coin flip and you win, the bank has $200, and the shareholders keep $110 of that, a 1,000% return. If you lose, the bank has $0, and the shareholders lose $10 of that, a -100% return. The expected value of this bet, for the shareholders, is positive. The expected value for the depositors is neutral: Either way they get their $90 back, either from the bank or from the government. The expected value for the government is negative: If the bank wins, the government gets nothing; if the bank loses, the government pays the depositors $90. But the shareholders — really the executives — are the ones who get to decide what bets to take. Deposit insurance gives bank executive an incentive to take socially excessive risks.  In some cases the risks won’t pay off.  But that doesn’t mean executives don’t have an incentive to take excessive risks.   Things didn’t pan out for SVB.  But that doesn’t mean their executives made an unwise gamble.  It’s very possible that SVB’s strategy had a very high expected payoff, and they were simply hit by bad luck (rising interest rates.)  Of course from a social perspective their decisions may have been bad, but not necessarily from a private perspective.  “Heads I win, tails part of my losses are borne by taxpayers”.  Of course I’d take more risk with those odds. And yet despite this clear explanation of how moral hazard works, Matt Levine follows a description of how SVB went bankrupt with this head scratcher: And so the question is: Is that moral hazard? Well, not for shareholders and executives and bondholders. No!  The fact that things didn’t work out for the executives doesn’t have any bearing on the question of whether moral hazard distorted decision-making at SVB. The second misconception above also illustrates a basic lack of understanding of moral hazard.  Yes, people don’t tend to pay attention to bank balance sheets when making decisions on where to put their money.  But that’s exactly what you’d expect to happen if moral hazard were a major problem.  People would stop caring about bank risk, and highly risky banks would understand that they could attract deposits every bit as easily as conservative, well-run banks.  Clueless depositors are not evidence of a lack of moral hazard; they are evidence that moral hazard exists. At this point people often shift their argument.  They say, “Yes, it’s unfortunate that depositors don’t discipline banks, but you certainly cannot expect average people to evaluate the safety and soundness of large complex banks.”  Really?  Are these claims also true? 1. Most average people don’t read academic papers and attend lectures at lots of universities, hence you cannot possible expect average people to know that Harvard and Stanford are better that South Dakota State and Western Michigan University. 2.  Most people are not able to evaluate the quality of carburetors, anti-lock brakes, and fuel injection mechanisms, so they couldn’t possibly be expected to know that a Mercedes is better than a Ford. 3.  Most people are not able to evaluate the quality of surgeons, so they cannot possible be expected to know that Johns Hopkins is better than Missouri Valley Hospital. Yes, modern Americans pay little or no attention to the relative safety of various banks.  Why should they?  But I assure you that back in the 1920s people cared a great deal about bank safety.  Banks knew this, and managed their balance sheets far more conservatively than do modern banks.  That’s why big city banks used to look like massive Greek temples; they had to convince depositors that they had the capital to survive hard times.  The vast majority of big banks survived the Great Depression.  US GDP in 1929 was about $100 billion and deposit losses during the Great Depression were $1.3 billion.   Today, a 50% fall in NGDP (as in 1929-33) would wipe out almost our entire banking system.  Modern bankers are far more reckless “despite” regulation.  The negative effects of deposit insurance are far more important than the positive effects of regulation. When people think about moral hazard, they often exhibit a lack of imagination.  If you read a great deal of history, you often find yourself asking, “How could people have behaved that way?  What were they thinking?”  Take an example from the 19th century.  One aristocrat insults another at a well-attended dress ball.  How would you react?  Now think about how you would react if you had been born in 1820.  You might respond to the rude comment with a challenge to a duel.  Pistols at 20 paces, 6am the following morning.  We can’t imagine living this way, because we never experienced this world. A world without deposit insurance is not that far away.  When I was 10 years old (1965), Canada had no deposit insurance and got along just fine.  People who live in that sort of world know how to behave.  They know enough to put their money in safe banks, not reckless banks.  I wish Canada had never adopted deposit insurance.  (I suppose their decision to do so represented the misguided big government liberalism of the late 1960s.) Of course, the US system is much different from the Canadian system.  Prior to FDIC, we had lots of bank failures.  This was due to the almost incredibly undiversified nature of our system, which resulted from some pretty insane branch banking restrictions.  Here’s Elmus Wicker: The number of commercial banks in the United States nearly tripled during the first two decades of the 20th century, reaching 30,000 in 1920. The vast majority of these were unit banks as required by their national and many state charters. Illinois had nearly 2,000, and Nebraska, with a population of 1.3 million, had a bank for every 1,000 residents. Failures averaged about 70 banks per annum, or one of every 300 existing banks, during those two decades. The agricultural depression of the 1920s raised the failure rate to more than 600 banks per annum, or one of 50. Failures showed few signs of abating as the decade drew to a close, and the banking system, especially in rural America, entered the Great Depression in a fragile state. LOL at Nebraska.  Given the large size of families back then, that’s roughly one bank for every 250 families! Contrary to widespread opinion, (even among many economists), the bank failures of this period did not lead to much contagion.  The only real “panic” occurred for entirely different reasons, when there was (well-justified) fear that the US would leave the gold standard.  Otherwise, lots of inefficient small banks failed and life went on. The Canadians were much smarter.  They allowed large well-diversified banks, and thus have looked on with bemusement as the US reels through one banking crisis after another.  Here’s the Financial Post: Despite investor jitters, concerns for the Big Six were limited. Unlike SVB, which catered to a niche market funding tech start-up companies, Canada’s big banks dominate their home market and are diversified across industries and business lines. “From a Canadian perspective, not only should the failure of SVB not have significant negative implications for our banks, but this crisis should actually be viewed as further vindication of the Canadian banking model, which is dominated by a few large and diversified players,” Bank of Nova Scotia analyst Meny Grauman said in a March 13 note. In the US, both left and right wing politicians favor the smaller banks.  Big is viewed as bad.  Matt Yglesias is one of the few progressives that understands the value of big banks, and today he has an excellent post on the issue: America needs more giant banks The moral of Silicon Valley Bank’s collapse is that the real danger comes from the medium-sized ones How do we get to Yglesias’s utopia?  Abolish deposit insurance (he wouldn’t agree).  You’ll see a massive shift of deposits toward the larger, more diversified banks, making our system resemble the Canadian system. Most people, and even most economists, know nothing about our banking history.  They’ve never bothered to read Elmus Wicker, Larry White, George Selgin, or any of the other experts.  They get their ideas from films like “It’s a Wonderful Life.”  They view our banking system as a fragile house of cards that would collapse without FDIC.  (Funny how the Canadian house of cards avoided any major problems in the century before 1967.)  Actually, it’s a house of cards created by FDIC. The final misconception involves the effect of banking crises on the macroeconomy.  It’s true that banking crises are often associated with recessions, but not always.  Industrial production soared 57% between March and July 1933, despite many of America’s banks being shut down to check their balance sheets.  In fact, in a fiat money system causality generally goes from the business cycle to banking distress, not the other way around.  The US entered recession in December 2007.  The recession got much worse after June 2008.  The banking crisis occurred in late September 2008.   As long as the Fed adjusts monetary policy to keep expected NGDP growth at a healthy level, bank failures should have no significant impact on economic growth.  In any case, creating moral hazard doesn’t prevent banking crises, it simply pushes the problem into the future. FDR opposed deposit insurance, as he (correctly) feared it would create moral hazard.  Unfortunately, Congress refused to listen to his good advice. PS.  Some other misconceptions:  “FDIC fees are not a tax on the public.”  Yes, they are.  “We aren’t bailing out bank executives”.  No, we are not bailing out SVB executives, but we are (implicitly) bailing out their competitors. (0 COMMENTS)

In this post, I would like to contrast the price theory I previously described with “microeconomics,” which is what James Buchanan refers to as the “science of choice” (see also Buchanan 1969). In microeconomics, the logic of human choice is not a subset of economic theory, but its defining characteristic. Microeconomics, as it practiced today, is understood as an exercise of constrained maximization within which prices serve not as variables of human choice, but as constraints to which individuals passively respond like a set of marching orders. A choice-theoretic approach to economic theory is one that collapses the optimizing activity of an agent onto the conditions of general competitive equilibrium. Such a conflation implies a direct link between the rational agent and an equilibrium outcome, which is simply an aggregation that can be directly reduced to the individual “choice” of individuals. In microeconomics, where perfect competition occupies the foreground of analysis (rather than the background as in price theory), individuals are all price takers, not price makers. The irony of microeconomics, in which perfect competition is in the driver’s seat of analysis, is twofold. First, human “choice” is defined out of existence, since the optimal choice is dictated by equilibrium prices, to which individuals passively respond. Secondly, and counterintuitively, the only margin upon which individuals make decisions is in terms of price. But because competition in the active sense of the term doesn’t exist, since all the gains from trade have been exhausted, all other margins of competition are considered unnecessary or redundant, in terms of advertising, quality differences, or recognition of differences in consumer preferences (Hayek 1948, p. 96; Boudreaux 1990, p. 47). Hence, if individuals are guided by “false prices,” which are inconsistent with perfectly competitive equilibrium, a market is said to “fail” to achieve optimal conditions. Much of what I’ve said may seem to be purely a difference of degree, rather than of kind, and indeed this might be a fair conclusion, since often times the terms “price theory” and “microeconomics” are used interchangeably by economists. The difference in these different “windows” of economic theory can be best illustrated by the argument in George Akerlof’s seminal paper, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism” (1970). This paper demonstrates how a “market failure” can arise to due asymmetric information between buyers and sellers, utilizing used car markets (as well as other markets) as an example. Without stating so explicitly, Akerlof’s argument is based on the premise that prices are analogous to a public good, in the sense of providing information that is non-rivalrous and non-excludable. Like any public good, the claim is that private markets will underprovide such a good due to free-riding. According to Akerlof, “good cars and bad cars must still sell at the same price – since it is impossible for a buyer to tell the difference between a good car and a bad car” (emphasis added; 970, p. 489). This assumption is consistent with the microeconomic “window” I outlined above, since the premise of this argument is that there is uncertainty over the quality of cars, but buyers can’t distinguish good cars from bad cars (or “lemons”) based solely on price, and hence, according to Gresham’s law, the “bad” cars tend to drive out the good cars. This is because, as Akerlof states, since both good cars and “lemons” must sell at the same price, “there is incentive for sellers to market poor quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller” (1970, p. 488). Thus, without the ability to credibly signal high quality of the car, the seller who knows that a car is “good” incurs a concentrated cost, with little benefit to his credibility as a reputable seller by acting on his subjective knowledge that the car was truly of high quality. This is because, as Akerlof points out elsewhere, the “cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence” (1970, p. 495). Thus, in a market for “lemons,” dishonest car dealers can freeride on the good will on honest car dealers, given that car dealers acting as price takers generate an outcome consistent with a “market failure” to due asymmetric information over the quality of cars. Note that Akerlof’s argument is completely valid, but one that follows from a microeconomic window of how markets “fail.” This does not imply that microeconomics only illustrates market failure; it indeed illustrates the efficiency of markets under perfect competition. However, looking at markets through this window, in both cases, whether we are demonstrating that markets are optimal or suboptimal according to the conditions of perfect competition, “the  heuristic value of equilibrium is sacrificed.  By ignoring the dynamics  of  disequilibrium,  both  traditions [of market failure and market optimality] obscure  the  possibility that real-world  market institutions may have coordinative properties even in the presence  of dispersed  knowledge, pervasive  ignorance, the irreversibility  of  time,  and  changing  conditions” (emphasis original; Boettke 1997, p. 24).   Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and a Program Director of Academic and Student Programs at the Mercatus Center at George Mason University. (0 COMMENTS)

In a recent piece, Financial Times columnist Rana Foroohar eulogizes the American “regulators” who are becoming a model for European ones. I put regulators in scare quotes because what we are speaking of has little if anything to do with homeostatic or cybernetic autoregulation or with general rules of law. In reality, the bureaucrats and politicians in question are coercive controllers as Ms. Foroohar admits by invoking “criminal as well as civil penalties for violators.” Reporting of a recent American-European conference among such regulators, she writes (“America Is Toppling the EU From Its Regulatory Throne,” Financial Times, March 6, 2023): It was the energetic crop of young American regulators who were the rock stars of the event. … Team USA seemed to be thinking bigger and broader than its EU peers. FTC commissioner Rebecca Slaughter stressed that her agency was making policy based on how “people participate in the economy as whole people”, not just as consumers. The Justice Department officials in attendance made it clear they were going after entirely new areas. … American regulators … view their work not in technocratic but existential terms; a battle against the risk of corporate oligopoly which threatens liberal democracy. … Until quite recently, it was assumed that Europe would lead the way in regulating the world’s largest and most powerful corporations. That’s now shifted. Since Ms. Foroohar column was published more than one week ago, before the demise of three American banks, the implications for banking and finance are interesting. To quote Foroohar again: In bank regulation, too, Americans are taking a more aggressive tack than their European peers. The Fed vice-chair for bank supervision, Michael Barr … pointed out that the lack of bank failures since the pandemic began has less to do with financial institution strength than government backstopping of the economy. We see that when the government starts “backstopping” the economy, it cannot stop front-ruling it, as it were, since it always needs further interventions to correct the consequences of its past interventions, its own mess, notably in creating moral hazard. Europeans know something about that. It is also nearly certain that the current problems of banks partly comes from the federal government’s attempts to correct in a swoop the inflation it had generated through money creation and which it denied during all of 2021. Another factor is the historical fragility of the heavily regulated American banking system, a product of two centuries of state and federal regulation. (See also a recent post of my co-blogger Scott Sumner.) So much for the government backstopping the economy. Finally, after quoting a 1936 speech of Franklin Delano Roosevelt, Foroohar concludes: The new and more robust American regulatory response harks back to an era when power mattered more than price and politicians weren’t afraid to take on big business. That takes the cake! (C’est le bouquet, we would say in French.) Forward to the past! With due respect for the respected columnist, one wonders if, despite being a mature person, she learned economics in a woke classroom. Ignoring three centuries of economics, a field of analysis that helps think about such matters, her approach is distressingly similar to current political intuitions, for mere intuitions and superstitions is what they are. Looking a bit farther in the past than the 1960s or FDR’s progressivism, one realizes that the “era where power mattered more than price” covers millennia—a few hundred thousands of them—was when ordinary people were dirt poor and at the mercy of brutal rulers or stifling customs. The end of this ordeal came slowly. To make a long story short, we may start with the commercial city-states of the late Middle Ages, go to banking and finance at the beginning of the modern era, and finally to the Great Enrichment that followed the Industrial Revolution (see chart below for a peek). Prices finally started start replacing power. Markets replacing the tribe or Leviathan. On this, see, among other works, the delicious short book of Nobel laureate John Hicks, A Theory of Economic History (Oxford University Press, 1969—the link is to my review of the book, a poor substitute). Maddison Project. Chart reproduced from Pierre Lemieux, “A Culture of Growth,” Regulation, Summer 2018 (0 COMMENTS)

And your new gas stove. Ever since Jerry Ford’s administration, federal regulators have been trying to make, and have succeeded in making, various appliances less useful. President Trump’s people put a pause to some of that. Biden’s employees have started it going again. The latest is washing machines. They already use less water than their counterparts of 20 years ago. Biden’s regulators want to require that new washing machines use even less water. This would mean that washing your clothes will take longer and/or that your clothes will come out dirtier. Collin Anderson writes: Biden’s Energy Department last month proposed new efficiency standards for washing machines that would require new appliances to use considerably less water, all in an effort to “confront the global climate crisis.” Those mandates would force manufacturers to reduce cleaning performance to ensure their machines comply, leading industry giants such as Whirlpool said in public comments on the rule. They’ll also make the appliances more expensive and laundry day a headache—each cycle will take longer, the detergent will cost more, and in the end, the clothes will be less clean, the manufacturers say. The proposed washing machine rule marks the latest example of the administration turning to consumer regulations to advance its climate change goals. Last month, the Energy Department published an analysis of its proposed cooking appliance efficiency regulations, which it found would effectively ban half of all gas stoves on the U.S. market from being sold. The department has also proposed new efficiency standards for refrigerators, which could come into effect in 2027. “Collectively these energy efficiency actions … support President Biden’s ambitious clean energy agenda to combat the climate crisis,” the Energy Department said in February. How exactly does using less water “confront the global climate crisis?” Are his regulators even aware that the main user of water in the United States is agriculture? Allowing farmers to sell the water allocated to them rather than use it in low-value uses would make water more plentiful to us consumers. The water saved if the new regulations even achieved their stated goal would be a small fraction of one percent of the water that could be saved if farmers cut their usage by only one percent. Co-blogger Scott Sumner gives some of the data on water usage here. (0 COMMENTS)