|by Jerry O’Driscoll
At the Coordination Problem, Pete Boettke drew our attention to James M. Buchanan’s paper, “Economists Have No Clothes”. It’s a short piece, chock full of insights. I want to draw on some not raised by Pete.
Buchanan observes that protagonists are prone to claim “that ‘the market’ (or ‘capitalism’) either works or does not work without constraints, a claim that is demonstrably unsupportable…” He reminds us that Adam Smith’s “whole effort” was aimed at identifying the right laws and institutions, so that self-interested behavior would lead to outcomes that were generally beneficial.
The Wealth of Nations is filled with examples of malfunctioning markets due to bad laws and institutions. Smith never defended business or businessmen per se, indeed had nothing good to say about them. He defended the simple system of natural liberty, whose meaning he specified over hundreds of pages.
The modern heirs to Smith are the property rights and Public Choice theorists, who examine the rules, laws and institutions necessary to make markets work. And they analyze what happens when those institutions are absent.
Buchanan then turns his attention to money and finance and asks what I think is the essential question. “Why have political economists, in particular, been apparently so willing to accept as sacrosanct the monetary framework in being? Why has not more attention been paid to alternative structures, to differing rules and institutions?”
Buchanan makes clear that the financial crisis was not just a crisis of the monetary and financial system, but of the prevailing economic theory that takes the existing system as “sacrosanct.” He describes the crisis as “a Pareto-inferior shift in which all persons in the nexus were made worse off by their own utility calculation.”
He offers up some ideas on what needs to be done to reform the monetary and financial system. I don’t necessarily share his exact prescription, though I think each part of it deserves consideration and debate. I do endorse his call for an institutional or constitutional approach to reform.