Theory and Crisis

By Richman, Sheldon | Freeman, January/February 2009 | Go to article overview

Theory and Crisis


Richman, Sheldon, Freeman


What might be even more distressing than the current buildup of the corporate state in response to the supposed economic crisis is the way some self-styled advocates of the free market are willing to cast aside the economic theory they once claimed to embrace.

If you are a glutton for cable news-talk shows, you know it's been little more than a parade of "experts" declaring the absolute imperative of government bailouts. Many of these experts preface their remarks by saying how much they hate the idea of government intervention to save business from its mistakes. "I'm a free-market, small-government advocate, but. . . ." The tenor of their remarks is that the free market is great when things are going well, but this is an emergency and we don't have the luxury of theory. Statements like this were most common during the frantic week between the House's rejection of and reversal on the ever-changing Troubled Asset Relief Program, or TARP.

Right off the bat we can see a problem. Any bailout plan that is believed to be potentially effective must be based on a theory. If you asked a TARP advocate why the intervention is necessary, he might say that when the government borrows $700 billion in order to buy banks' bad mortgage-backed securities or shares of stock, it will inject liquidity into the credit markets and improve the economy. But that is a theory. (It's a bad theory, but it is a theory.) So the apparently bold thrusting aside of all theory in the name of pragmatic action is a mere pose. The move is as theory-bound as free-market opposition to the bailout is.

The debate, then, is a contest of theories. Freemarket theory can explain the cause of the crisis government intervention in the mortgage market through promotion of easy home-buying and implicit guarantees to lenders and underwriters, including its privileged creatures, Fannie Mae and Freddie Mac. Given that genesis of the problems and the general theory of markets, the solution is for government to back off-way off-and to let the economy adjust to real conditions and recover without subsidy, guarantee, or regulation. What is the alternative theory used by those who have jettisoned free-market theory in "this time of crisis"? Why should we believe that things will be fine only if the government has the discretionary power to transfer resources from those who haven't screwed up to those who have?

Ludwig von Mises had a thing or two to say about theory. For Mises the laws of economics (more broadly, human action) are derived by spinning out the logical corollaries of the inescapable concept action, of which we have apodictic "a priori" knowledge. (This means the self-evident and universal nature of purposeful behavior is not discovered through empirical testing; empirical testing presupposes purposeful behavior. The corollaries include, among others: means and ends, value and preference, marginal utility, cost, time preference, and profit and loss). As he wrote in "Social Science and Natural Science":

Economics therefore is not based on or derived (abstracted) from experience.

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