Bloomberg View (the editorial page) has an article today entitled: “When Market Incentives Undermine Morality” by economists Daniel Friedman and Daniel McNeill, authors of Morals and Markets: The Dangerous Balance, of which the piece is an excerpt.

The article claims to offer an example of how “markets” can “degrade” our “moral behavior.” The particulars concern anemia drugs that have made billions but which may not do any good for kidney patients and may actually cause harm. The authors describe a system in which drug companies pay for a government issued  patent on a substance, then spend an average of $1 billion getting FDA approval, after which they enjoy a government enforced monopoly. Older drugs not approved for the specified use and in particular natural substances, which cannot be patented and are therefore  ineligible for FDA approval, may not make any disease claims or otherwise compete. If anyone violates the monopoly, they may face not just fines, but jail.

None of this has anything to do with the “market.” We haven’t had a real market in healthcare for decades. Yet Friedman and McNeill don’t hesitate to  blame the resulting inefficiency, deceit, and corruption on the “market” or “market incentives.”This is truly Alice In Wonderland thinking. How can anyone confuse a market system with a government run crony capitalist monopoly system run by the FDA, which is itself increasingly funded not by taxpayers but directly by drug companies, whose staff hopes to move on to highly paid drug company jobs, and whose expert panels are full of drug company “consultants.”

McNeill is also the author of a book called Fuzzy Logic, which presumably he is against. But confusing markets with government enforced monopoly is not just fuzzy logic. It is complete moral myopia.

Here is a remarkably accurate analysis of modern mainstream economics.

Senior Economist of the Italian Parliament says Mises was right about inflation all along.

Robert Lenzner of Forbes advises that you and I will be blindsided by the next financial crisis. Lenzner bases his reasoning on Yale economist Gary Gorton’s recent book Misunderstanding Financial Crises, Why We Don’t See Them Coming . According to Gorton the old-fashioned bank run is back, only in a different form. The recent financial crisis was different from earlier ones in that it was not initiated by bank depositors scrambling to withdraw their funds. Rather it was precipitated by a “run” among short-term lenders who had purchased banks’ commercial paper or lent money to banks through “repos” (repurchase agreements). When these lenders suddenly tried to liquidate these assets by selling them or not renewing the loans, their actions deprived banks of the short-term funds that the banks had been using to finance their long-term lending and investments.

As Lenzner describes the evolution of the crisis:

What transpired in 2007-08 “resembled the bank runs of the pre-Federal Reserve era. These were primitive expressions of panic by people trying desperately to sell assets, driving the price of those assets down, and causing other people to panic as well and try to get out at the same time. The panic spread from short-term instruments like repos and commercial paper to bonds and stocks and commodities and real estate. The wave of fear sweeps from short-term investments to longer term obligations. [There is an open quotation mark in this passage before "resembling" but no closed quotation mark to indicate where the quotation from Gorton ends.]

Lenzner goes on to warn:

The playbook in the next crisis will be the same as it was in past crises from 2008 to 1987, 1929, 1907, 1893, 1857 and so on. The run on the banks becomes systemic as no one institution is spared. Credit markets freeze, the economy goes south, millions lose their jobs, and other millions have their savings decimated. It happened time and time again in the 19th century before there was a central bank, and panics didn’t stop after the Fed appeared in 1913. . . .

Expect it to happen again. Gorton warns clearly that “there is no mechanism for determining when there actually is a crisis.” In fact, there was no panic by depositors in Citibank, BankAmerica, Wells Fargo that would have alerted the nation. It required the Fed to realize how over-leveraged, under-capitalized and insolvent major banks had become before it acted to rescue them with huge monetary bailouts.

So, in other words, federal deposit insurance no longer works to discourage or mitigate bank runs, because it does not cover short-term lenders. It will take massive money creation and bailouts by the Fed to defend against and cope with future bank runs by skittish investors.

All this is a great source of worry to Lenzner who pessimistically concludes:

We cannot afford for the market to lose confidence and for lenders (not depositors) to pull all their funds from one or more banks. Without the steady substantial continuation of short term funds the major banks cannot meet their longer term liabilities, and you could very well have another crisis begin. The unavoidable conclusion is that we have to focus on the continued stability of funding for the banks as much as strengthening their capital resources.

This is welcome news, indeed, to those advocates of free banking like myself who see the ever-present threat of bank runs as the one and only effective means of discouraging fractional-reserve banks from issuing un-backed deposits, or “fiduciary media,” and systematically mismatching the maturity profiles of their liabilities and assets (“borrowing short and lending long”). It is the creation and lending of fiduciary media that falsifies the interest rate and thereby causes the recurrence of booms and busts. If the Fed and the financial elites are unable to figure out a way of ensuring “stability of funding for the banks,” the scam will be up and the turbulent and destructive era of fractional-reserve banking will come to a rapid and well-deserved close.

It was nice of Noah Smith to mention the Austrian school in his recent Atlantic column on the poverty of mainstream macroeconomics. It would have been even better, however, if he had the slightest understanding of what Austrian economists do.

Smith rightly points out that mainstream economists are increasingly regarded as little better than witch doctors. “Surveys have shown that the public has very little confidence in their predictions. They argue bitterly on op-ed pages and can’t seem to agree on the most basic issues.” True enough. Most of contemporary macroeconomics is worthless. For Austrians, this is the predictable (pun intended) result of a slavish devotion to crude positivism. Smith, being unfamiliar with any other approach, thinks this is simply the nature of the beast:

Essentially, [economic theorists] make models, which are mathematical tools that are supposed to describe how the economy functions. The problem is that economists haven’t really built a model of the whole economy that works. A lot of smart people have spent a lot of time creating tools with names like “dynamic stochastic general equilibrium.” But as of this moment, those models can’t really forecast the economy like our meteorologists can forecast the weather.

Exactly. But instead of recognizing that human beings aren’t molecules and social systems aren’t like meteorological ones — which even Donald Kagan recognizes — Smith concludes that the best economists are those who admit they don’t really know anything. “[W]hen an economist tells you something that is based on a theory or a model, you should be very, very skeptical.” Well, I’m OK with that.

But Smith reserves special contempt for economists, like the Austrians, who think their theories are actually true. “[T]hough mainstream economists may not have it all figured out, they are far better than most of the groups who lurk outside the mainstream. For example, spend an afternoon reading the ideas of so-called ‘Austrian’economists, who believe that we only need logic to understand how the economy works, and that data and evidence are useless.” Smith links to a brief article on Mises’s apriorism, but is blithely ignorant of the context, which has to do with general statements about human action. Certainly no Austrian economists has ever maintained that one can provide a detailed analysis of actual business cycles, or monetary policy, or any aspect of applied economics without careful, detailed, empirical study. It might surprise Smith to know that Mises wrote detailed empirical studies of prewar business cycles and European monetary policy, that Rothbard produced a 368-page treatise on the Great Depression, and that contemporary Austrians have written about the credit collapse, quantitative easing, and just about anything else in recent economic policy. Noah, use the Google!

Murray Rothbard anticipated the concept of “rent seeking,” generally associated with Gordon Tullock. In Man, Economy and State, he says:  “Furthermore, the more government intervenes and subsidizes, the more caste conflict will be created in society, for individuals and groups will benefit only at one another’s expense. The more widespread the tax-and-subsidy process, the more people will be induced to abandon production and join the army of those who live coercively off production. Production and living standards will be progressively lowered as energy is diverted from production to politics and as government saddles a dwindling base of production with a growing and more top-heavy burden of the State-privileged. This process will be all the more accelerated because those who succeed in any activity will invariably tend to be those who are best at performing it. Those who particularly flourish on the free market, therefore, will be those most adept at production and at serving their fellow men; those who succeed in the political struggle for subsidies, on the other hand, will be those most adept at wielding coercion or at winning favors from wielders of coercion. Generally, different people will be in the different categories of the successful, in accordance with the universal specialization of skills. Furthermore, for those who are skilled at both, the tax-and-subsidy system will encourage and promote their predatory skills and penalize their productive ones.” (Scholar’s Edition, p.942)

A similar passage can be found on p.1256. The latter is from Power and Market, which was not published until 1970; but Rothbard completed the manuscript of MES and Power and Market, which were written as part of a single work, in 1959. MES was published in 1962, and Tullock’s seminal article appeared in 1967.

The following is a remark that Ludwig von Mises made in his famous NYU seminar, as recorded in the notes of seminar attendee Bettina Bien Greaves on September 26, 1957:

{A}uthors who are commonly considered friends of freedom–and they are certainly very sincere and fine economists–want to tell us again and again that even Adam Smith and some of his contemporaries were in favor of interventionism. Such a book was already written 60 years ago by the last, i.e., the youngest, student of Carl Menger, Richard Schueller. . . . Then 60 years after Schueller the same book was written by Lionel Robbins {The Theory of Economic Policy in English Classical Political Econoomy} and in between many [other] people wrote the same book. Their idea is, ‘Look how foolish you are, you anti-interventionists. Even Adam Smith was in favor of certain interventions. Why are you not? Do you want to be more orthodox than Adam Smith?’ To this I answer, ‘I am the liberal and not Adam Smith. The liberals are not some imitators of the heroes of the past. We have no scripture to interpret. The Wealth of Nations is not the bible of liberalism.’

N.B. Mrs Greaves’s interpolations are in brackets; my interpolations are in curly brackets.

In a speech discussing the future of liberal education, delivered on the occasion of his retirement as Sterling Professor of Classics and History at Yale, Donald Kagan struck a Rothbardian note:  

But hasn’t the scientific method made its way into other disciplines, and can’t its benefits be obtained through them? Where the attempt has been made most seriously, in the social sciences, it has been a failure. It is increasingly obvious that trying to deal with human beings, creatures of independent will and purpose, as if they were objects like atoms, molecules, cells, and tissues, produces unsatisfactory results. The social sciences, far from producing a progressive narrowing of differences and a growing agreement on a common body of knowledge and of principles capable of explanation and prediction, like the natural sciences, has seen each generation undermine the beliefs of its predecessors rather than building on and refining them. What we see is a war of methodologies within and between fields. In fact, the fundamental idea of the whole enterprise, the attempt to remove values from the consideration of human behavior and simply to apply the scientific method, now seems most implausible.

Unlike clients of a government agency, customers of a commercial enterprise really are customers, representing potential profit, not cost. In contrast to the DMV sign I shared the other day, consider the sign below, spotted at a small restaurant (via Niels van der Linden).

Supply-side economist Nathan Lewis discusses the differences between Supply Side Economics and Austrian Economics (with respect to monetary policy) in Forbes. At first he goes on to attack the Austrians but ultimately he extends an olive branch in the form of the Classical pre-1913 Gold Standard.