Chicago Schooled The visible hand of the recession has revitalized critics
of the Chicago School of Economics.
By Michael Fitzgerald, AB’86
Photography by Dan Dry
On a sunny day this spring, more than 1,000 people streamed into the Sheraton near the Gleacher Center for a conference on the Future of Markets. Its keynote panel, headlined by Nobel laureate Gary S. Becker, AM’53, PhD’55, featured six Chicago economists with differing viewpoints. The stock market was in the early part of a rally that would yield its best quarter since 1998. Stock-market turnarounds usually signal better times coming, but in an economy contracting 6 percent, better was relative.
A fierce skeptic of government and a Chicago School pillar, Milton Friedman remains a powerful presence in economic debates.
So the rally didn’t change the feeling among the free-market enthusiasts at the University of Chicago Booth School of Business management conference that market economics was on shaky ground: most of the financial industry, they felt, had been nationalized in all but name. Two of the three U.S. automakers looked like they would follow suit. The government was capping pay in the financial services. What in the name of the Chicago School was going on?
The central idea of the Chicago School of Economics holds that economies work best when markets operate freely, with limited government participation. The Chicago School, a phrase coined in the 1950s, championed an old idea: 1870s neoclassical economics. Yet in the wake of the Great Depression and World War II, it was a radical proposition. It went against the ideas of John Maynard Keynes, who believed government should play an important role across an economy. At the time, the U.S. government was viewed with reverence, as the force that beat the Depression, won World War II, and was girding to rebuild Europe. Keynesianism held “a virtual monopoly,” says James J. Heckman, the Henry Schultz distinguished service professor of economics and 2000 winner of the Nobel Memorial Prize in Economic Sciences. “People thought markets couldn’t work, incentives weren’t important.”
The Chicago School took almost the opposite tack, expressing near disdain for government. Some of that disdain was echoed during May’s Future of Markets keynote panel by Kevin Murphy, PhD’86, who holds an endowed chair named for 1982 Nobel laureate George J. Stigler, PhD’38, a pillar of the Chicago School, along with Milton Friedman, AM’33. Wearing his habitual baseball cap despite the suits and ties all round him, Murphy ticked off the challenges facing the nation. When he got to the problem of remaking General Motors, he paused. “Who in their right mind would put the government in charge of that task?” Titters came from the audience, then applause.
Another crowd might have booed—say, at Columbia University, current home of economist Joseph Stiglitz, who won the 2001 Nobel Prize for work on how markets misfire. Stiglitz threw this bomb via a Bloomberg News article last winter: “The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self-adjusting and the best role for government is to do nothing.”
In his 2003 book The Roaring Nineties, Stiglitz recounts how, in the four-year period between 1997 to 2001, private companies and capital markets invested $65 billion into building telecom networks. They lost $61 billion of it. The episode is his version of Murphy’s question above: “Who in their right mind would put markets in charge of that task?”
Salon commentator Andrew Leonard also called out the Chicago School, writing in an April 29 column, “The direction in economic thought pioneered by Milton Friedman and enthusiastically adopted by Ronald Reagan and his Republican successors helped to get us where we are today—in the worst economic contraction in 50 years, characterized by an increasing concentration of wealth in the top tiers of society.”
“Who in their right mind,” Kevin Murphy asks, “would put the government in charge” of remaking General Motors?
The 2008 market collapse shocked the global economy like nothing since the Great Depression. Given the breadth of the failures involved, casting blame at a single school of thought may seem overly simplistic. But the Chicago School’s ardent championing of market forces, says Ross Emmett, a Michigan State University economist who studies the Chicago School and heads an oral history of it, makes it “a convenient locus” for anger.
Chicago’s market focus developed as the original Frank Knight/Jacob Viner Chicago School—also anti-Keynesian but skeptical of markets’ efficiency and mathematical models—waned along with World War II. The government’s influence on the University’s scientific-research funding disturbed then-president Robert Maynard Hutchins, according to Philip Mirowski, professor of economics and the history and philosophy of science at Notre Dame, and coeditor of the new book The Road from Mont Pelerin. (The Mont Pelerin Society was a Friedrich Hayek–led debating organization dedicated to advancing free-market ideals, including markets’ ability to efficiently show information.)
In 1946 Chicago already had a neoclassical presence: the Cowles Commission for Research in Economics, funded by Alfred E. Cowles III, scion of one of the Chicago Tribune’s owners. Cowles’s postwar staff at Chicago included nine future Nobel laureates, among them Kenneth Arrow and Tjalling Koopmans, who won Nobels in economics before Friedman. Cowles promoted an economics more scientific than the theoretical type that dominated the field at the time. But he was left-leaning. Hutchins wanted specifically anti-statist thinkers, Mirowski says, enlisting help from the now-defunct libertarian William Volker Fund to hire, among others, Aaron Director at the Law School, Friedman (Director’s brother-in-law) in economics, and Hayek at the Committee on Social Thought (the economics department nixed Hayek). Cowles would decamp to Yale in 1955.
The new group created a whole new Chicago School, focused more strongly on markets and more skeptical of government. Over the next two decades their research would spearhead a revolution in economic thought.
The University community has never been of one mind about the Chicago School of Economics. Witness the ruckus last year over the creation of a Milton Friedman Institute for Research in Economics. Protesters argued, in part, that in choosing to name the research institute after Friedman, the planners were ignoring how in the 1970s the Chicago School’s free-market ideas went awry in developing nations when the Chicago Boys—a group of Chicago-trained Chilean economists—worked for the brutal dictator Augusto Pinochet.
Despite its controversial side, the Chicago School’s faith in markets gained wide influence in both public opinion and fiscal policy. Current government behavior in the United States and elsewhere, however, shows fewer signs of that influence. Beginning in fall 2008, world leaders moved quickly to intervene in markets, prop up banks, lend money to struggling firms, assemble stimulus packages. The U.S. government, in many economists’ opinions, has effectively nationalized the banking system, a no-no in Chicago School thinking.
Becker, the University professor in economics and sociology, concedes that the market collapse has damaged the Chicago School’s influence. But it didn’t, he argues, undermine the school’s principles. “I don’t think any of the major ideas were wrong,” he says in an interview. “If you look at the role of markets and competition in promoting economic growth over the last 25 years, things look very well, even if you factor in this serious recession.”
Robert Lucas devised the standard model for studying economic systems.
In those 25 years, Becker says, market forces have lifted many people out of poverty in places like China, India, and Brazil. Markets make mistakes, but “you have to take some of the bad with by far the good.” Even if we’ve lost wealth during the recession, he says, most people remain better off than they were a quarter century ago. It’s the same with the Chicago Boys: their policies did create greater income inequality in Chile, but they also, Becker has argued, helped spur economic and political change across Latin America.
Becker is willing to withhold judgment on the Chicago School’s role in the current crisis. We may not know for a few years if it deserves blame, he says. Yet true purists hold that the Chicago School has nothing to apologize for.
(to be continued)