The Chicago School is well recognized within academia for its creativity in advancing the School’s research paradigm, which is grounded in the hypothesis of economic rationality and the power of market forces. But to the world beyond academia it is best known for its advocacy of public policy reforms.

 

The “Chicago View” is essentially an anti-statist one and its continued influence can be gleaned from the fact that, in the aftermath of the global financial crisis of 2008 and despite widespread anger at Wall Street bailouts, there has been no great upsurge of left-wing populism in response. Even President Obama’s recent “State of the Union Address” is heavily subdued in its “populist” appeal. The only coherent populist voice to date comes from the right-wing Tea Party, whose main target is the regulatory state that seeks to protect ordinary people from financial speculators. Something similar is true in Europe as well, where the left is anemic and right-wing populist parties are on the move.

 

Competition is Good for Intellectual Debate

 

The left-wing has failed to mobilize because theirs is a failure of ideas. The left has not been able to make a plausible case for an agenda other than a return to an unaffordable form of old-fashioned social democracy. Obama’s economists had to resurrect discredited Keynesian policies in a futile effort to jumpstart the economy. In Europe, despite repeated assaults on the Euro, Germany has continued to uphold fiscal austerity in deference to conservative policy ideas.

 

The ideological high-ground on economic issues has been held by a libertarian right, whose narrative continues to provide a comprehensive articulate account of social, political and moral issues. While I am in sympathy with the Chicago narrative, I do not think that the absence of a plausible counter-narrative is healthy, because competition is good for intellectual debate just as it is for economic activity.

 

In this context, it is interesting to consider the development of the Chicago view, which sprang from two closely related but distinct rationales for anti-statism: one of these is positive, the other normative.

 

The positive rationale adheres to the hypothesis of economic rationality and the power of market forces. This rationale is accepted by virtually all Chicago economists today. The state is considered an agent of the public, and one that is exceedingly difficult to monitor or to control. Therefore the state is necessarily an inefficient and unreliable instrument for achieving any given objective and it is better to achieve objectives privately. Those objectives that cannot be achieved except through the state should be scrutinized carefully and skeptically. There is strong suspicion that either the political process will frustrate the achievement of goals altogether, or will drastically alter them in the process of achievement and, in any case, waste resources.

 

This positive economics rationale leads to an adverse view of government intervention that is based on empirical scientific evidence. It is imperative for any reformer, regardless of normative persuasion, to acknowledge the evidence on the adverse effects of government intervention.

 

The normative rationale for anti-statism holds that it is wrong to entrust the control of resources to government officials no matter what social objectives they may be pursuing (even when pursued faithfully and efficiently). Control of resources, and the power that goes with it, ought to be retained by their owners. Even if property owners should wish (as such wishes are revealed through a democratic political process) to alienate resource control to the state and its functionaries, such alienation should be resisted as wrong. This view distinguishes laissez-faire conservatives from mere skeptical economists of government intervention and puts them solidly behind Lord Acton’s view that “power corrupts and absolute power corrupts absolutely.”

 

The two strains of anti-statist thought are not easily disentangled. The normative strain was promoted by a small subset of Chicago economists which included most of the original group affiliated with Frank Knight, one of the key figures in the Chicago School’s formation. Older members of the Knight affinity group — Lloyd Mints, Aaron Director and Henry Simons — were effective promoters of the group’s policy ideas and advocated the public policy reform measures that are associated with the Chicago School. However, in the public’s eye they never attained the prominence of the younger members of the affinity group who were all positivists — Milton Friedman, George Stigler, and Allen Wallis.

 

All three men were extremely good expositors and advocates, and they drew a sharp distinction between positive economics and the normative economics of their older peers. While Simons used the classroom to disseminate his views as expressed in A Positive Program for Laissez Faire (1948), the younger group believed that the proper role of economics at the university was to teach positive economics. I learned later that this was at Friedman’s insistence: the academic pulpit should not be used as a forum to brainwash students. As a student in Chicago during the 1970s, I never heard any of my professors discuss their normative views in class. By then the older members of the Knight affinity group had already retired from Chicago.

 

Nonetheless, the older Knight affinity group were strong advocates of public policy reform measures that became associated with the Chicago School.

 

(a) Monopoly and the State

 

Ever since the 1930s, Chicago economists have been opposed, resolutely, to government engaging in the regulation of private business, fixing of prices, or direct production of goods and services with the usual grudging exceptions for traditional public goods, e.g., defense, maintenance of public order, etc.

 

Among older members of the Chicago School, Henry Simons was more willing to tolerate government ownership of natural monopolies and regulation of corporate size and financial structure in order to limit inequality, both of income and of power. But this element of “populism” is no longer held by the younger members of the School, who are more worried about the threat of government expansion through the regulation of corporations. Gary Becker pointed out as early as 1958 that “It may be preferable not to regulate economic monopolies and to suffer their bad effects, rather than to regulate them and suffer the effects of political imperfections”.

 

A few years later, Friedman wrote: “There is unfortunately no good solution for technical monopoly. There is only a choice among three evils: private unregulated monopoly, private monopoly regulated by the state, and government operation…. It seems impossible to state as a general proposition that one of these evils is uniformly preferable to another. … [T]he great disadvantage of either governmental regulation or governmental operation of monopoly is that it is exceedingly difficult to reverse. In consequence, I am inclined to urge that the least of the evils is private unregulated monopoly wherever this is tolerable (1962).”

 

The Chicago tolerance for the costs of private monopoly was promoted by a belief that empirically estimated costs were low. Thus, the perceived cost of government action outweighed the marginal benefit of the reduced inequality of “income and power” that Henry Simons desired to combat.

 

Henry Simons condemned trade unions on normative grounds as another form of monopoly and on positive grounds as generators of inflation. Both condemnations have been abandoned by the younger members. The positive case against trade unions is now based on its adverse effects on employment and income distribution. The fear of unions as generators of inflation has been abandoned as reflecting an incorrect view of the determination of inflation.

 

The older Chicagoans feared and sought to limit concentrations of private economic power — both in unions and large corporations — as well as in government. Among later Chicagoans, fear of government became greater, or fear of concentrated wealth less, with the result that the spirit of populist reform became swamped by a general aversion to government activity beyond the essential minimum.

 

This aversion to government expansion is not difficult to understand. Among the industrialized economies, the average share of government expenditure on subsidies and transfers as a percent of GDP in 1870 was 1.1%. It rose to 4.5% in 1937 and then to 23.2% in 1995. The egalitarian revolution of the twentieth-century has been called the “Age of Equality” not without reason.

 

(b) Income Distribution

 

Simons’ hostility to corporate bigness was closely allied to his desire to make the distribution of income more equal through progressive income taxation. Since Simons’ death, Chicago interest in income distribution has been almost exclusively positive. Milton Friedman criticized the establishment of barriers to entry into occupations as worsening the distribution of income. Gary Becker’s pioneering work on human capital theory emphasized the role of education and training in affecting the distribution of income. James Heckman further focused on early childhood education as a determinant of the distribution of opportunity and income. Younger members of the Chicago School have been more interested in contributing to the debate over the appropriate distribution of income and wealth that is descriptive rather than normative.

 

(c) Immigration

 

Chicago economists are fairly divided on the issue of freedom of immigration. From the perspective of positive economics, free immigration is a requirement of worldwide productive efficiency. It is also an ethical precept that has great appeal for classical liberals. But Simons was vehemently opposed to it. He argued that free trade may and should raise living standards everywhere. Free migration would level standards, not to mention bring sociological and political problems of assimilation. He did not favor equal treatment in immigration policy, or abandonment of discrimination, but argued for tough-minded realism and practical sense. Simons’ egalitarianism stopped at the national border.

 

Friedman is more sensitive to the ethical claims of potential immigrants than Simons. However, he tempers his advocacy of free entry with the qualification that the existence of welfare programs that provide guarantees of minimum income regardless of productivity makes free immigration undesirable.

 

Applying Friedman’s logic, Gary Becker would support allowing mainland mothers to enter Hong Kong to give birth to their children if they were prepared to compensate through some means not only the full cost of hospitalization, but also the expected full value that the entitlement of residency would transfer to their children, which could easily be several million dollars in benefits each. On the other hand, it is not obvious what would be Simons’ position since Hong Kong and the mainland are not separated by a national border so we cannot simply refuse entry; but it is unlikely he would object to charging the full cost of residency including assimilation costs.

 

Milton Friedman is also well known for advocating many specific proposals for socio-economic reform — negative income tax, substitution of education vouchers for direct provision of public schools, making participation in social security voluntary, abolishing licensure for doctors, volunteer army in lieu of the draft, decriminalization of drugs and prostitution, etc. All of these reform proposals involve either increased use of the price system, substitution of private for public production, replacement of legal compulsion by voluntary private cooperation (supplemented with financial inducements) or a mixture of all three. The force of Friedman’s ideas has been very strong not only at Chicago but also around the world.

 

If Friedman had restricted his advocacy to economic issues only, he would probably have been much less controversial, but at the same time, it would not have brought the Chicago School into such great prominence and public awareness. Friedman’s swiftness of thought, talent for debate, enormous energy and dedication to his policy ideas made his preaching doubly effective. 

 

The older and younger “Chicago Views” were not identical despite many common elements. Whether the “populist” strain in Henry Simons A Positive Program ever truly reflected a consensus of the views of the younger members of the Knight affinity group is not known. Surely it did not reflect Knight’s own views which did not have populist tendencies. But since the younger members never disavowed Simon’s work in the 1930s and 1940s, it can be presumed that they largely shared a common view.

 

Friedman as Teacher

 

The key to the development and prominence of the “Chicago View” on public policy was the unity of Friedman, Stigler and Wallis on the Chicago faculty. Friedman took over the intellectual leadership of the School. His vigor in debate and the content of his arguments set the tone and public image of Chicago economics for at least a quarter century. The remarkable success of the Chicago School during the third quarter of this century was due in large part to the fact that it was able to take a leading role both in scientific research and in providing a rationale for political conservatism that was in disarray at the end of the Great Depression and the Second World War.

 

After the mid-1940s, Stigler’s intellectual development diverged from Friedman’s. Stigler’s research came to focus upon the interaction between political and economic variables — or political economy. He became increasingly unwilling to analyze problems that assumed the economist-reformer could move the economy in a desired direction simply by persuading a beneficent ruler, presumed to be omnipotent, to behave appropriately. In particular, Stigler objected to the assumption that a ruler, and a fortiori a reformer, could ignore the need to obtain political support and the effect of economic policies in attracting that support.

 

When Deirdre McCloskey was a second-year assistant professor at the University of Chicago she overheard a coffee-room dispute between Milton Friedman and George Stigler that made a great impression on her. She wrote an interesting account of what took place:

 

Milton was complaining about protectionism. George said, “Milton, you’re such a preacher! If people wanted efficiency they could have it.” Milton replied, “But people are misled. I want to teach them.” “Teach! Don’t waste your words.” …. Stigler believed “the persuasive power of conversation is negligible.”

 

According to Stigler it was futile to persuade decision makers. If so, why bother with policy advocacy? Friedman was wasting his own time. Stigler’s work led to the emergence of the Chicago School of Political Economy. At the same time there were parallel emergences of the Rochester School of Positive Political Theory and the Virginia School of Political Economy (or Public Choice). This is the subject of next week’s article.

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