Wednesday, January 25, 2012

Vulnerability to rent-seeking means you're not as robust as you could be

Steve Horwitz has a great comment on this post, and I would restrict my response to that thread, except there are two really important points I want to make - which I think merits a new post. First, he agrees the burden of proof is on free bankers. On the institutional robustness point, I think this is definitely right, simply because they've proven less robust. I take more issue with his second and third point. He writes:

"...the increased role played by government in money production, whether in the form of NBS type regulation or true central banks, were the result not of failures of free banking but of rent-seeking by private interests and/or the desire of government actors to have access to revenue through money creation. I'm quite confident that the cases where pretty free systems became central banks fit this pattern."

This is an odd point to raise, I think. if you're vulnerable to rent-seeking in this way it means you're not a very robust institution! Communists often complain that totalitarian-minded rent-seekers spoiled the worker's paradise. We usually don't take this to be a good argument supporting the institutional robustness of Communism! If you need angels to get a system of free-banking to work, then you're out of luck - because men aren't angels.

Next Steve writes that free bankers should:

"Do what White, Selgin, and Lastrapes have done and demonstrate that generally accepted macro outcomes have been worse under central banking than more free systems. Again, I think a real preponderance of the evidence is on the side of free banking here."

White, Selgin, and Lastrapes do have an interesting paper, but coming from the world of labor market program evaluation it's always been hard for me to know what to make of it. It's essentially a pre-post test, which would never get any creedance elsewhere. What you really want is some way to identify the counter-factual, because there are lots of reasons to believe that the twentieth century was very different from the nineteenth century, and had different requirements of its monetary and financial system.

One solution I've noodled over before is reproducing the White, Selgin, and Lastrapes analysis but with Great Britain as a paired economy in a difference-in-differences analysis, a common approach in labor economics and virtually the only viable counterfactual I can think of for the sort of policy analysis they're attempting. Details on difference-in-differences estimators can be found here. The idea is that Britain had a central bank through this whole period, so if you difference out the difference between the British economy post-1913 and the British economy pre-1913, you can identify the impact of the Fed. Maybe. It's still a dicey proposition.


  1. Daniel, I too feel we can not really compare benefits of free banking vs. benefits of modern banking when -

    a) strictly businessmen, well-funded organizations, and high net worth individuals once used banking facilities in the early days of free banking


    b) such people were obviously more likely screen banks and more likely to understand problems of moral hazard.

    Hence, it's a different place and a different time. Whether free banking wasn't too unstable then does not mean it will be the case now.

    Now, truth be told, Hong Kong residents might be the only example. Hong Kong banks once had a crisis. The depositors lost much of their life savings. Henceforth, Hong Kongers developed a stringent discipline in investigating banks before depositing, because of the lessons in moral hazard.

    But Hong Kong is a highly educated, highly socially mobile city. Do we believe - say - that an average family in a standard Second World or Third World region can afford such losses or has the knowledge to screen banks before depositing?

  2. Very good point on rent-seeking. Libertarians often became frustrated with non-libertarians because, seemingly, they fail to realize that critics are often talking about what their plans would produce *in actuality*, whereas as they are focused on how their plans produce in their vision of what they would like those plans to produce. So that a libertarian is likely to respond to your point, "Ah, but in the plan *in my head*, we have eliminated rent-seeking!"

    As you note, simply fantasizing that problem X or Y or Z is gone is not much of a plan.

    1. Man, that was one messed up comment. And I wasn't even drinking or anything! But I think my idea sort of came across.

    2. I understood what you were saying, I don't agree necessarily, but then you probably figured that.

      Strangely, I have found some of my "drunk comments" in the past to be very lucid... Well, up to a point. It's amazing, I've looked back at some of my comments around the net and thought to myself, "that's genius", only to realize that I was completely snookered when I wrote them.

      Funny that.

  3. But if a central bank is the result of rent-seeking, shouldn't we at least try to fight it (i.e. try to establish free banking)?

    1. The alternative is to construct and regulate a central bank and charge it with public purposes.

      Someone better versed in the history than me could probably challenge some of the senses in which this is "rent seeking". To take a more recent example, certainly people can make the case that TARP was a case of "rent seeking". But there was also public good done through the problem - the stabilization of the financial system. So what do we want? A non-interventionist system where interventions like TARP and TALF are dictated by the inevitably rent-seeking banks - or an interventionist system where free people democratically determine the scope and process for stabilization policy?

  4. Quickly: part of "robustness" has to be the state of play in the world of ideas. Even the best constitutional protections that seem to provide robustness will be worthless in the face of a populace who rejects the ideas that undergird the constitution. No preferred world will be robust if it doesn't have ideological legitimacy. So I'm not sure libertarians are any more vulnerable in this regard than anyone else.

  5. A populace that rejects constitutional protections because they reject the underlying ideas may still theoretically be sated by an alternate set of protections - even if those protections were in totality "100% taxes are great, destroy infrastructure and replace it with worse; also beat up your neighbor tonight!" In this case we have found a consensus for Bizarro World. In that case, there is a disconnect between what may be objectively judged (as far as possible) worthwhile, and what they prefer which is at odds with that goal. It is possible therefore to use half a definition of robustness and satisfy the "legitimacy" concern, but fail to be actually robust, whereas inherent to a good definition of robustness are both plausibility of achieving outcomes and popular acceptance. (The people of Bizarro World are always happy; even if they aim too high or low, they will always have something to fight about.)

    Of course, to the Europeans who have been promoting austerity as a form of enhanced robustness, I have made essentially this point, except that in those cases there is very clearly a public sentiment that the people have not been entrusted to vote on the issues.

    For me the test in supporting further democratization of fiscal matters in Europe, but so far resisting calls to end the Fed, was not "did somebody raise the possibility on an abstrusely ethical grounds that it may possibly be disliked by the public" but rather "the policy is very clearly not being implemented democratically, yet is having an impact on the order of people's lives."

    As daunting a balancing act as the jenga tower idea of MMT "only inflation, no taxes" presents, if they were able to demonstrate that outcome sustainable it would have resulted in wins on multiple fronts. Alas.

    There is some small destabilizing factor inherent in establishing a free market, and that is incidentally a great reason for preferring robustness to runaway asymmetrical wealth gathering. Of course robustness, as "stability," has often served as code for central planning (true of modern China, for example), and I have noticed that often democracy and stability are being put at cross purposes. Even so, if you ask the average person on the street what their economic goals are, promoting stability will probably be consistently one of the highest ranked, so I would not underestimate peoples' ability to snuggle up to a vaguely coercive governmental order.

    However, with the free market of ideas still functional in this country, all the libertarians have to do is convince the voters that it will be in their interests to do away with a central banking mechanism.

    I think that President Jackson's criticisms of central banking were lucid enough, but I also think most people would argue that the problems it presents are outweighed by the good, and it is additionally not a case of willing evil to do good. I also think common experience trawling the internet will show that their beliefs are informed too highly by inflation worries and other non-topical issues - an occupation with strategic, long-term issues like the structure of debt and inflation is commendable, but the Fed is a tactical creature.

  6. "of MMT 'only inflation, no taxes'"

    That is more of the Greenbacker attitude, the MMTers actually prefer to use taxes as an anti-inflationary tool. I am no fan of this, but MMTers certainly aren't opposed to taxation. It is central to their system (at least as far as I understand it). If anything, their program is inflation with the opposite corollary of taxation. It is kind of like their own little equilibrium condition.

  7. Joseph, take a gander at this Bill Mitchell interview, especially the second and third paragraphs of his response to the first question.


All anonymous comments will be deleted. Consistent pseudonyms are fine.