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Chapter 26: The Chicago School

I must say that the more I read the general, all-around works of the “Chicago school” of economics, the less I am impressed.

A good example of the approach of this school is Clark Lee Allen, James M. Buchanan, and Marshall R. Colberg, Prices, Income, and Public Policy.1 As you will see, I was impressed neither by the technical economic analysis nor by the more politico-economic sections.

Let us take the broader or more “political” sections first. First it must be said that on the two great foci of attack on the free-market economy by left-wingers—the Keynesian problem of “cyclical instability” and unemployment, and the alleged problems of “monopoly,”—Allen, Buchanan, and Colberg take up the hue and cry against the market with the rest of the “pack.” Oh, very gently and very moderately, compared to most other textbooks, it is true; but still the essence of the charges is there, and the case has been given away.

In the “national income” field, the authors enlist themselves wholeheartedly as what we may call “moderate Keynesians.” The crucial thing here is that they accept the fundamental Keynesian point and accept it blithely as above discussion: that the free market, left to itself, has no mechanism for keeping its aggregate self in balance, for avoiding business cycles, depressions, unemployment, etc. Government, then, must step in to regulate the system: to keep the price level stable, to pump in money in depressions in order to cure unemployment, to tighten up money in booms. Government is considered the natural and indispensable regulator. The free market has no way of keeping national income high enough or savings and investment in balance. Thus, the fundamental Keynesian point has been conceded.

It is true that surrounding this hard core, the authors put in “conservative” modifiers: they prefer the government to use monetary policy in its contracyclical efforts rather than fiscal policy, and they even hint the latest Friedman line that they might prefer automatic monetary rules to managed, discretionary monetary policy. But while an improvement over most textbooks, this is not good enough. The authors, in the usual Chicago tradition, show themselves completely ignorant of the Misesian theory of the business cycle, and loftily dismiss the gold standard as hardly worthy of note—never even considering that they might find the monetary automaticity they are seeking in the gold-coin standard. But the most important flaw is their conceding the fundamental Keynesian point.

The authors worry a lot, also, about monopoly. Of course, they think that monopoly can abound on the free market—we cannot expect any economist to take the revolutionary step of denying that proposition. But they can be condemned for not even getting as realistic about the market as Chamberlin or, from another direction, Lawrence Abbott, whose seminal book is ignored by these authors as well as everyone else. In fact, the authors cling to the absurd and dangerous Chicago model of “perfect” or “pure” competition, which they persist in considering the normative ideal.

Of course, empirically, they overlaid this terrible flaw with some good remarks: indicating that they believe that the most important empirical instances of monopoly power are caused by government intervention, attacking the fair-trade laws, etc. But these good qualifiers are hardly enough to save the day. On the contrary, what the authors do is to say: “Well yes, we admit that the whole market is interlarded with ‘monopoly power,’ and this is unfortunate but really unimportant, except that. ... And here, the authors feel free to engage in sudden hit-and-run attacks on cases which they, for some reason, feel are important instances of monopoly power that should be busted or regulated by government. Thus, the authors are strong for the antitrust laws, and want to see them strengthened further and enforced more stringently. They have the gall to call the decision outlawing basing-point pricing a great “victory for society,” and they endorse the FTC’s desire to get the power to enjoin any mergers in advance. Using the “perfect competition” model, the authors also show great hostility toward the alleged great “wastes” of advertising.

The authors are pretty good in criticizing the “monopoly power” of unions, but here again their case is greatly weakened by their conceding validity to the absurd and fallacious “problem of monopsony,” which somehow makes out employers to be as inherently monopolistic as unions. They also concede that “natural monopolies,” such as public utilities, have to be regulated by government, even though they point out, very well, many of the pitfalls and inconsistencies inherent in public utility regulation. But the force of the latter are, once again, vitiated by their concession to the opponents of freedom of their fundamental point: that public utilities simply have to be regulated by government.

The authors also endorse all the fallacious arguments for government action such as the “collective goods” argument and the free-rider, or external-benefits, argument. Thus, they endorse public education because of the alleged long-run benefits to everyone, which people are too shortsighted to pay for voluntarily. On the theory of exchange rates, they are good as far as they go in pointing to the functions of the free exchange market and the perils of exchange control, but they seem to be completely ignorant of the purchasing-power-parity explanation of the determinants, on the free market, of what makes the exchange rates what they are.

On foreign aid and underdeveloped countries, they are surprisingly poor and weak, their section on underdeveloped countries saying very little and including none of the Bauer insights, and actually endorsing both the economics and politics of foreign aid to these countries.

Rather than multiply examples of flaws further, I think it important to emphasize that this book brings home as few have done to me how much can go wrong if one’s philosophical approach—one’s epistemology—is all wrong. At the root of almost all the troubles of the book lies the weak, confused, and inconsistent positivism: the willingness to use false assumptions if their “predictive value” seems to be of some use. It is this crippling positivist willingness to let anything slip by, to not be rigorous about one’s theory because “the assumptions don’t have to be true or realistic anyway,” that permeates and ruins this book.

For example, the authors are keen enough, in the monopoly sections, to sense that there in something very wrong with the whole current theory of monopoly, that it is even impossible to define monopoly cogently, or define monopoly of a commodity. But while they see these things, they never do anything about it, or start from there to construct an economics that will stand up—because they are thoroughly misled by their positivist attitude of “well, this might be a useful tool for some purposes.” Hence their clinging to the absurd “ideal” of perfect competition, etc.—and in many other ways.

This same grave philosophical confusion permits them to suddenly slip their own ethical judgments into the book, undefended and practically unannounced. Suddenly, they say that the outlawing of basing-point pricing was a great “social victory.” I said that this was gall because they had never bothered to construct or present a cogent ethical system on which to make such a remark. Similarly, they feel free, while cloaking themselves in the robes of scientists, to say suddenly that of course there has to be compulsory egalitarianism, with the government enforcing some equality through taxes and subsidies. Why? Simply because it seems evident to them that a little more equality would be better, and that we can’t let the weak be “liquidated.”

And they have even the further colossal gall to denounce “price discrimination” (e.g., doctors charging more to the rich than to the poor) because it is, for some reason, terribly unethical for private people to engage in their own strictly voluntary redistribution of wealth. Apparently, and they say so explicitly, it is only legitimate for the government to effect this redistribution by coercion. This ethical nonsense they don’t feel they have to defend; it appears self-evident to them. It is this kind of slipshod, unphilosophic, sophomoric “ethics” that is again typical of the Chicago school in action.

The pervading positivist epistemology pervades the technical economic analysis as well. The usual fashionable jargon of the “short-run” cost curves of the firm, etc., are used, despite the recognition by the authors that it is all rather arbitrary; this they brush aside with the retort that it can have some “predictive value.” The term that I think best describes the shoddiness and eclecticism induced by this philosophic approach is “irresponsibility.” For if a theory or analysis doesn’t have to be strictly true or coherently united to other theory, then almost anything goes—all to be justified with “predictive value” or some other such excuse.

Happily, I can illustrate what I mean in a little exchange of letters that I had last week with Jim Buchanan about one minor piece of technical analysis in this book. I was appalled by the construction of a so-called “fixed demand” curve, which was clearly thrown in so as to have something geometrically symmetric with the standard, and perfectly proper, fixed-supply curve for the immediate market. The authors said that a fixed, vertical demand curve is illustrated by the government’s demand for soldiers, and that if not enough people volunteer, the government will draft the rest. Now this is pure nonsense, since drafting cannot be illustrated by a demand curve. But what struck me is that even on the authors’ own terms, the analysis is nonsense, since, if say the government wants 100,000 men in the army and its “demand curve” is therefore vertical at this amount, but if so many people are 4-F or exempt that only 60,000 can possibly be hired or drafted, we then have a vertical supply and vertical demand curve which never intersect. On the authors’ own premises, then, no one would be in the army, which is clearly absurd.

So I wrote to Jim Buchanan asking him to clear up this point, and saying that maybe I was overlooking the happy and obvious solution. What interests us here, as revelatory of Buchanan’s philosophical irresponsibility, was his reply. The reply conceded my point in full. Yes, his model does lead to absurd conclusions. Here is Buchanan’s justification:

Your letter points up the limitations of applying too literally many of our analytical tools. You are quite right in saying that the solution ... under your assumptions is absurd. But this is really the same in all of those cases in which we make rather extreme assumptions. ... At best, the fixed demand and fixed supply models are useful in that they isolate certain forces, and in few cases, the models themselves are useful for predictive purposes.

He goes on to say that he tried to find a case of fixed demand as a counterpart to the usual fixed supply case, and could only think of the draft example as remotely suitable.

Now, it seems to me that this kind of philosophy, this positivistic approach to economic theory, corrupts it, if I may use so strong a term, at the very core, and that no theory of lasting merit can emerge from this sort of cauldron. And this book of Allen, Buchanan, and Colberg is a particularly clear example of how this positivistic “corruption” ruins almost every key section of the book.

[Letter to Ivan R. Bierly, Volker Fund, February 3, 1960. Reprinted in Strictly Confidential: The Private Volker Fund Memos of Murray N. Rothbard, David Gordon, ed. (Auburn, Ala.: Mises Institute, 2010), pp. 295–301.]
  • 1. Second edition (New York: McGraw-Hill, 1959).