Solow on Posner & the Market Failure Crisis
Throughout the course of systemic controversies, individuals line up on different sides of a controversy and typically remain there permanently. Sometimes there are defections, but usually not of major figures on either side. It is rarely that a major intellectual figure representing the gold standard on one side of the controversy switches sides. But that’s what has happened now. Richard Posner, the law and economics guru and federal appellate judge, has written a book on our economic woes. This book contains a passage that will surely shock anyone familiar with Posner’s work over the past thirty years, and will surely delight his perennial critics. Here’s the passage:
Some conservatives believe that the depression is the result of unwise government policies. I believe it is a market failure. The government’s myopia, passivity, and blunders played a critical role in allowing the recession to balloon into a depression, and so have several fortuitous factors. But without any government regulation of the financial industry, the economy would still, in all likelihood, be in a depression; what we have learned from the depression has shown that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails. The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.
Richard A. Posner, A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression (2009) quoted in Robert M. Solow, “How to Understand the Disaster,” 56 NY Rev. of Bks. No. 8, May 14, 2009.
In concluding his review, he quotes Posner as asserting: “As far as I know, no one has a clear sense of the social value of our deregulated financial industry, with its free-wheeling banks and hedge funds and private equity funds and all the rest.” According to Solow:
That is already a hint that he thinks its social value is limited. As Posner sees it, talk about greed and foolhardiness is comforting but not useful. Greed and foolhardiness were not invented just recently. The problem is rather that Panglossian ideas about “free markets” encouraged, on one hand, lax regulation, or no regulation, of a potentially unstable financial apparatus and, on the other, the elaboration of compensation mechanisms that positively encouraged risk-taking and short-term opportunism. When the environment was right, as it eventually would be, the disaster hit.
With any luck Posner’s defection might suggest to those who thoughtlessly invoke the mantras of “free markets” and “deregulation,” for once to stop and consider the empirical evidence why markets–the financial and banking markets especially–need to be effectively and intelligently regulated.
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