A Failure of Capitalism
Summer (and Fall) Reading
The Atlantic (Washington, DC)
Correspondents
July 5, 2009
By Richard A. Posner
I would like to draw my readers’ attention to four recent important
contributions to the debate over our economic crisis.
The first, which unfortunately will not be published until the fall,
is a book by Robert C. Pozen entitled Too Big to Save? How to Fix the
US Financial System. A lawyer, a lecturer at the Harvard Business
School, and the chairman of a large asset-management firm, Pozen is an
immensely experienced and acute student of the financial system. His
book is not only a detailed yet thoroughly lucid and accessible study
of the financial crisis; it is also, and more important, the best
critique I have seen of the government’s responses to the crisis and
its recent blueprint for financial regulatory reform. I hope that his
analysis can somehow be conveyed to the Administration and Congress
before the government makes irrevocable mistakes in its response to
the crisis.
The second contribution is a special issue of the journal Critical
Review (vol. 21, issues 2-3, 2009) entitled "Causes of the Crisis."
(It is about to be published, and can be ordered at the following web
site: ml. It is a
collection of essays dealing with the causes of our current economic
crisis. The long introduction by the journal’s editor, Jeffrey
Friedman, entitled "A Crisis of Politics, Not Economics: Complexity,
Ignorance, and Policy Failure," is a particularly good summary of what
can at this early stage in our understanding be said with some
confidence about the causes of the mess. Without meaning to denigrate
any of the other essays, all of which are useful, I found particularly
welcome the acknowledgement by economists, including Daron Acemoglu
and David Colander, of what Colander and his coauthors call the
"systemic failure of the economics profession." This is a point that I
stressed in my book but that has received insufficient recognition by
the economics profession (naturally).
I do wish, however, to take exception to a tendency in Professor
Acemoglu’s essay to belittle the current global depression.. He says
that "despite the ferocious severity of the global crisis–and barring
a complete global meltdown–the possible loss of GDP for most
countries is in the range of just a couple of percentage points–and
most of this might have been unavoidable anyway, given the
overexpansion of the economy in prior years. In contrast, within a
decade or two, we may see modest but cumulative economic growth that
more than outweighs the current economic contraction."
There are, it seems to me, three errors in the passage that I have
quoted. The first is the suggestion that the only cost of a depression
is a temporary, and relatively minor, decline in GDP. This ignores the
profound psychological effects of a depression, including the
anxieties of those who lose their jobs or their homes or their
retirement incomes or fear losing them (a series of costs that tenured
professors tend to underestimate because they are largely immune from
them). It ignores long-term economic effects–the aftershock danager
that I keep emphasizing–as a result of the immense costs that
governments are devoting to measures for halting the economic decline
and speeding recovery.And it ignores political effects with economic
consequences, such as increased size and intrusiveness of government.
The second error in the passage that I quoted is the suggestion that
the fact that "most of [the loss of GDP] might have been unavoidable
anyway, given the overexpansion of the economy in prior years,"
somehow mitigates the severity of the downturn. The idea may be that
people were living high on the hog because of excessive borrowing and
this is repayment time. But probably most of the people hurt are
people who were not living high on the hog during the boom years; and
even those who were may have lost more than they had gained during the
he suggestion that when GDP returns to its pre-depression level, the
cost of the depression will be wiped out. That ignores the fact that
many and perhaps most of the beneficiaries of the higher GDP will not
be the same people who lost in the bust. This is underscored by the
phenomenon of "job destruction." Many jobs lost in a depression never
come back; their occupants are not rehired and must therefore either
leave the workforce altogether or find other types of job, which
usually pay less. And few of the people whose jobs are destroyed will
have been contributors to the economic collapse and therefore
appropriately punished by a fall in their permanent income.
The third contribution is a soon to be published article by two law
professors, Saule Omarova and Adam Feibelman, "Risks, Rules, and
Institutions: A Process for Reforming Financial Regulation," 39
University of Memphis Law Review 881 (2009). The article discusses a
number of proposals for financial regulatory reform, but its main
significance is its careful attention to the process of effective
regulatory reform. The authors properly emphasize the importance of
careful, step-by-step program design, based on a solid body of
knowledge. The Administration could with profit heed their
suggestions.
Last, a website called is well worth reading.. It
describes the project of the Committee to Establish a National
Institute of Finance. The Institute would be responsible for gathering
and analyzing data concerning systemic risk. The proposal is
consistent with my belief that the essential need is better monitoring
of systemic risk; the regulatory powers of the Federal Reserve, the
SEC, and other regulators of financial institutions probably are
adequate, though perhaps some relatively minor statutory changes would
be desirable. The problem is not power but knowledge.
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