Lawrence J.

Haas

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April 28, 2009

The Cost of Capitalism: We’re Having a Minsky Moment

Do you wonder what caused the deep global economic downturn, how the nation’s best economic minds did not see it coming and why the government’s response has been somewhat incoherent?

The answer: We’re having a “Minsky moment,” says Robert J. Barbera, author of The Cost of Capitalism, who believes the teachings of the late economist Hyman Minsky hold the key to today’s mayhem and that, unfortunately, economists and policymakers have not absorbed them into their thinking.

Minsky believed two things. First, a healthy economy convinces people to take more risks. Second, when many people assume more risk, small setbacks in the economy can have enormous consequences.

If Barbera is right about Minsky’s relevance, the implications are huge: Economists must broaden their views about what makes the economy tick, and policymakers must apply Minsky’s insights to their efforts to repair the global economy in order to prevent another 2008-style calamity.

If nothing else, policymakers should recognize that the current downturn is not the once-in-a-lifetime event that conventional wisdom suggests. Rather, it reflects the market mayhem that has grown all too common in recent years – from the stock market crash of 1987 to the savings-and-loan crisis of the early 1990s to the Asian panic of the 1990s to the technology boom and bust of the late 1990s.

In the current crisis, mortgage lenders provided more opportunities for more Americans to buy larger homes than ever before, with their mortgages premised on a continuing rise in home prices that would enable borrowers to cover the larger payments they would face in later years.

When the housing bubble burst, prices fell, borrowers couldn’t make their payments, defaults soared and mortgage companies as well as other financial firms with lots of mortgages on their books grew shaky.

Barbera’s intriguing thesis is reason enough to read The Cost of Capitalism. But lest you feel intimidated by economic writing, here’s some good news: The book is engaging, occasionally funny and always accessible.

In essence, Barbera seeks to create a new paradigm for economic thinking, melding the theories of economic icon Joseph Schumpeter with those of Minsky, who studied under Schumpeter after World War II.

Schumpeter praised the risk-taking and entrepreneurial spirit of capitalism that drive productivity and, in turn, long-term growth and higher living standards. Minsky offered the caution that growth nurtures excessive risk-taking, eventually generating serious hardship when economic conditions begin to deteriorate.

Unfortunately, Barbera writes, while economists and policymakers have readily adopted Schumpeter’s triumphalism, they have short-changed Minsky’s caution. The reasons are at least two-fold:

First, the Reagan revolution for free markets and against government intervention has dominated policymaking for nearly 30 years.

In too many circles, support for free markets morphed into a worship of them (as Barbera puts it, “belief in Adam Smith’s ‘invisible hand’ gave way to enthusiasm for the market’s ‘infallible hand’”). That Ayn Rand enthusiast Alan Greenspan chaired the Federal Reserve for most of that period seems appropriate.

Second, policymakers (particularly at the Federal Reserve) focused on wage and price pressures and assumed that keeping them under control was the key to economic health – all the while viewing the increasingly common financial crises as episodic events that should not shake their thinking.

Because financial crises have grown endemic to modern capitalism, Barbera argues, the Federal Reserve has to broaden its views. Controlling market excesses must become as important as controlling wages and prices.

Where does that leave us?

“[W]e all need to think differently about free market capitalism if we want to preserve it,” Barbera concludes. “Periodic market mayhem . . . is a cost we incur for allowing free markets to be in charge of our investment capital.

“We don’t need to abandon our reliance on financial markets, but we do need to come to grips with this flaw,” he adds. “Once policymakers, economists and investors accept this undeniable reality, we can shape strategies that will reduce both the severity of financial system excesses and the costs, in real economy terms, of financial crises.”

It’s a powerful argument from a convincing book. In this time of economic turmoil, those who seek to reinvigorate capitalism so that it can begin to again extend prosperity to more people in more places should take note.

© 2009 North Star Writers Group. May not be republished without permission.

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