The Chicago Counter-revolution and the Loss of the Classical Liberal Tradition

David Colander ∗∗∗ and Craig Freedman

The founders of the Chicago School both presented and regarded themselves as the heirs of a longstanding Chicago tradition, a tradition that closely reflected a still older Classical approach to economics. In the decades since the rise of the Chicago School, the profession has muddied these distinct traditions to the point that most economists today would be at a loss to differentiate one approach from the other. Instead, all such approaches would be identified with extreme laissez faire perspectives, strong anti-Keynesianism, and predictable support for market fundamentalist policies. In this paper we argue that these associations, while commonly accepted, are seriously misleading. Though such categorizations are easily made, they manage to distort both the Chicago and Classical tradition and by doing so fail to recognize what distinguishes the Chicago School from these broader and older traditions. Such confusion is particularly dangerous since in this case those differences and distinction may be far more important than any points held in common between these approaches.

We structure the paper as follows. First, we provide the main theme that organizes our argument. Then we briefly discuss a post war landscape that germinated the forces driving the Chicago counter-revolution. To clarify their departure from older traditions, we next outline the defining characteristics of Classical liberalism. Having developed this necessary background, we then trace out the subsequent evolution of the older Chicago approach and distinguish it from the post war Chicago School. Next we discuss our central argument-- that in moving away from the older Chicago tradition, the creators of the Chicago School crafted the equivalent of a Faustian bargain. Though their intellectual firepower and marketing legerdemain ultimately enabled their Chicago School views to triumph in the short run, the leaders of this movement achieved their success by abandoning the core methodology that formed a common bond between the Classical Liberal and the older Chicago tradition. 1

We conclude with the suggestion that there were viable alternatives being forged during this period, such as that developed by one of Frank Knight’s other top students (James Buchanan), or by later additions to Chicago, such as Ronald Coase. Both of these cleaved more closely to the Classical liberal method and the Chicago tradition. Thus in our view, Buchanan or Coase come far closer to representing the spirit of the older Chicago approach than do those who spearheaded the more ideological counter-revolution, namely Friedman and Stigler.

Our Central Hypothesis

Our central hypothesis proposes that the method employed and advocated by the Chicago and Classical traditions is their defining aspect rather than any specific set of policy prescriptions. This focus on method provided them with a release from the type of

∗ Corresponding author: ( [email protected] ) This paper is, in part, based on a series of recorded conversations which Craig Freedman had with economists associated with the Chicago school. These conversations are referred to in the text as Conversations. 1 We are not arguing that there was any deliberate hypocrisy or intention to deceive. We find no evidence which would lead us to doubt the Chicago conviction that they were acting within the broad Liberal tradition. We are questioning the concrete manifestations of their deeply held beliefs. In practise, the Chicago School clearly deviated from the essence of the Liberal method. The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition straightjacket usually associated with the later Chicago School. Adopting this distinctive analysis allows us to nest the Chicago tradition snugly within the broad embrace provided by the Classical approach. Both were firmly committed to a method that encouraged dissent and strictly separated economic scientific theory from applied policy. Within this Classical liberal methodological framework, economists, acting as scientists, were incapable of directly drawing any specific policy conclusions from their scientific theories. Economists would need to put on a quite different hat, namely that belonging to a widely educated statesman who would arrive at any applicable policy conclusions only after successfully integrating non-economic issues into the analysis. 2 For economists working in a Classical liberal tradition, meaningful policy statements were based on the fundamentals of economic science combined with an acknowledged set of values and a sensibility of relevant non-economic complications. 3 To be clear, we are not arguing that either tradition shied away from adding values to theory when devising policy positions. Instead, we are highlighting the fact that their underlying methodology called for them to be as clear as possible in specifying what followed from scientific theory, and what did not. When involved in policy making, economists were to do so in their role as economic statesmen, not as economic scientists. They often failed to make this distinction, but doing so was their underlying methodological approach.

The Chicago tradition followed the boundaries set by this Classical method, but grafted on to it a particularly aggressive and confrontational in your face approach to argumentation. 4 This in your face pose complemented the wide ranging skepticism that had characterized Classical methodology, though clearly departing from the intrinsic politeness embedded in the work of such luminaries as John Stuart Mill. 5 The undeniable aggressiveness did not necessarily detract from the heart of the tradition. This variant then could be fairly categorized as a legitimate continuation and development of the original approach. More importantly, in this ‘nothing sacred’ approach, all positions, including and even especially one’s own, were labeled ‘fair game’.

In the tumultuous post war period the Chicago tradition evolved into a distinctive and distinguishable Chicago School , nurtured under the watchful eyes of Milton Friedman,

2 See Colander, (2009, forthcoming a) for a further discussion. 3 In more recent times this argument has been put most succinctly by the distinguished applied policy economist with a classical turn of mind, Alexander Cairncross: When it comes to action, economic theory is only one input among many. It has to be combined with a grasp of political and administrative feasibility and above all has to take advantage of experience and observation, not rely wholly on logic. As has often been remarked, logic can be a way of going wrong with confidence (quoted in McCloskey 1994:50). 4 Arguments in this paper are in part based upon unpublished interviews that Craig Freedman conducted with members of the Chicago school in 1997. Where relevant we will refer to these in the paper. When he asked Friedman about this method of argumentation Friedman responded “I think you’re getting at something that is (a) the atmosphere at Chicago, and (b) intensified by Knight. That an academic is concerned not with being diplomatic, not with trying to avoid hurting people’s feelings, but an academic is concerned with saying what’s right. Telling the truth, or trying to get at it. And if you disagree with somebody you don’t say, ‘Well, now there may be something in what you say.”… You say, “That’s a bunch of nonsense” (Conversation with Milton Friedman, Rose Friedman and Aaron Director, August 1997). 5 As was his wont, George Stigler accurately, and of course sardonically, pinpointed this difference: [John Stuart Mill] was perhaps the fairest economist who ever lived: he treated other people’s theories at least as respectfully as his own, a mistake no other economist has repeated (Stigler 1988b). You might say that the Chicago tradition turned this inside out by treating all theories, including its own, with equal disrespect. 2

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

George Stigler and Aaron Director. 6 The Chicago School continued to cultivate this brash in your face argumentation style, but, for reasons we will address below, used it asymmetrically. By doing so it deviated from the spirit of both the Chicago and the Classical tradition, coating the confrontational style of argument with a distinctively pit-bull flavor (going for the jugular and attempting to win debates no matter what the associated costs). 7 This transformation implied argumentation that never retreated when engaged in an academic battle. 8 As a consequence, the “embrace dissent” approach that formed a central element of the Chicago tradition was essentially abandoned. Hunting out and destroying heretical viewpoints replaced the older, more ecumenical approach. 9

It is our contention that this change in method distinctly sets the Chicago School apart from the broader Chicago tradition, which despite using a similar grammar of confrontation embraced a noticeably different gestalt. In the older Chicago tradition, confrontation was designed to efficiently weed out faulty logic and ideas that were protected by social niceties, to place everything under a blow torch of skepticism. As reformulated by the Chicago School, the intention became one of protecting a particular market formulation and associated policy stance while utterly discrediting and destroying opposing approaches. 10 This

6 Some writers like to distinguish a first Chicago School belonging to the interwar period and organized around Knight, Simons, Viner and Douglas; from a second Chicago School, centered on Friedman, Stigler and Becker. Given the diversity of the first school, its connection to a broader Chicago tradition that began with the founding of the department by Laughlin, and the fact that before the 1940s the profession did not consider Chicago economists as belonging to a separate school, we find the Chicago tradition a preferable nomenclature to describe this earlier period. Thus, we will restrict the use of the term ‘school’ to the post war era alone. 7 This pit bull aspect transformed discussion and debate into the type of combat more reflective of the courtroom than the seminar room. In legal battles the objective is never truth or justice but simply which side can triumph by telling the more convincing story. As the quote attributed to Coach Vince Lombardi put it, ‘Winning isn’t the most important thing, it’s the only thing.’ 8 George Stigler makes this clear by identifying scholars with the story telling ability and overall persuasiveness of preachers. The tenacity with which people hold the ideas in which they have a proprietary interest is not due simply to vanity. A scholar is an evangelist seeking to convert his learned brethren to the new enlightenment he is preaching (Stigler 1988a: 211). 9 For the Chicago School, being self-critical became equivalent to unilateral disarmament. Under this regime, to poke fun at or ridicule one’s own endeavors made as much sense as displaying one’s wit at airport security checkpoints. Stigler writes: Some of these traits of intellectual leaders are caught in the statement that they lack a sense of humor. I mean by this, not the inability to laugh at the right point when hearing a joke, but the ability to view oneself with detached candor. Ridicule is a common weapon of attack but amused self-examination is a form of disarmament; one so endowed cannot declaim his beliefs with massive certainty and view opposing opinions as error uncontaminated by truth (Stigler 1988b: 213-14). 10 Stigler’s ruling objective wasn’t essentially to evaluate heresies that he sensed to be a threat to price theory as much as to douse them with kerosene, incinerate them and then spit on the smouldering ashes. Stigler however parted with his close friend Milton Friedman in refusing to proselytise policy positions, though it can easily be argued that his work implicitly supplied a foundation for a remarkably consistent strain of approved policies. Milton Friedman: There’s no problem. It’s true, that George did want to change things. Aaron Director: But he preferred to study them, not to change them. MF: He preferred to say that he preferred to study them. Rose Friedman: He preferred … AD: He preferred to study them. I should quit this argument. MF: It was partly a long-running difference between him and me. AD: You’re right. MF: And he liked to stress, “I just want to understand the world and Milton wants to change it.” AD: That’s right. And predominantly I think that George was correct. RF: You would have to have them both psycho-analysed. AD: Yes. That’s right. 3

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition difference is subtle (and thus easily overlooked) but it remains central to a correct understanding of the fundamental nature of the Chicago School and its, at times, tenuous connection to the broader Chicago tradition. The in your face aggressiveness defining Chicago from its inception required participants to be as harsh on its own arguments as it was wont to be on others. The pit bull argumentation style defining the Chicago School, while definitely in your face , was essentially only a one-sided form of skepticism. Pro-market arguments, which Chicago School economists strongly supported, would face a much milder inquisition than would holders of alternative theories.

This surprisingly illiberal result flowed directly from the two irreconcilable objectives that powered the post war Chicago counter-revolution. Restoring classical liberalism had somehow to be reconciled to the sense of urgency surrounding the perceived threat posed by collectivism in the Cold War period. For hardened Chicago stalwarts, a move to anything resembling a more planned economy could only be considered as a fatal wedge which inevitably would dissipate hallowed liberal ideas. The consequences would thus pose a direct and imminent danger to freedom and individualism. Given this ineluctable anticipation of the direst of consequences, they found no difficulty in justifying the use of illiberal means to protect those fundamental liberal values which alone were capable of saving a just and humane society from what they saw as impending peril.

In the early period of the Chicago School (the 1940s-1960s), this key distinction was not immediately obvious since the pro-market views its members espoused were clearly dissenting positions swimming against the economic mainstream of the time. Perhaps ironically, it was during this period that the Classical liberal approach to policy was largely abandoned by the then economic mainstream and replaced with an alternative neoclassical method .11 The new regime would fail to draw the strong distinction between economic science and what John Stuart Mill and J.N. Keynes had called the ‘art of economics’. Instead, practitioners began to draw policy conclusions directly from theoretical economic models. Welfare economics became the unabashed policy branch of economics and the Classical art of economics was all but abandoned.

It was this change that we see as precipitating the dilemma faced by Chicago School economists. Under the sway of this altered methodology, economic theory now had direct implications for policy. The prevailing mainstream orthodoxy of the day seemed to insist that the science of economics broadly supported direct state intervention (both at a micro and macro level). The basis for such a logical leap rested upon a particular understanding of Pigovian welfare economics and the acceptance of a corresponding approach championed by neo-Keynesian economics. In the eyes of Chicago School economists this support of state intervention was unarguably wrong, and was being used substantially to justify ideological aims. Since policy, in this post war view, followed directly from theory, the obvious implication demanded that the economic thinking upon which bad policy was based had to be wrong as well. They therefore felt themselves justified in using any means available to undermine such dangerously incorrect theorizing. Thus, in our view, it was the abandonment of the Classical method of strictly separating policy from theory that most encouraged the

RF: Or hypnotised. MF: Added to that, well a lot of George’s attitude came from Aaron. I think you had a lot of influence on what he said. AD: I don’t think so (Conversation with Milton Friedman, Rose Friedman and Aaron Director, August 1997). 11 We say ironically, because the prevailing mainstream would provide the counter-revolutionaries with one of the keys required to slip successfully into the stronghold of the post-war neo-Keynesian consensus. 4

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Chicago School to implicitly assume that the Classical method needed to be jettisoned, at least in part. Every rhetorical device and marketing advantage within their power would need to be marshaled to undermine such deleterious, if not downright destructive, views. To state the obvious cliché, here was an instance of fighting fire with fire to accomplish a greater good.

Because it had inextricably linked theory to policy, the post war mainstream presented Chicago with a perfect Achilles heel at which to aim. 12 Chicago economists saw themselves as toppling bad theory (the existing mainstream ideas). Even more so, attacking faulty thinking became almost a moral obligation. Before such inadequate theory could become too thoroughly entrenched, it behooved these self-appointed, clear-sighted economists to stage a focused counter-attack. Such an ambitious objective was not to be undertaken by the fainthearted. Only a self-selected loyal ‘band of brothers’, limited to a great extent to those at Chicago, were sufficiently capable and motivated to effectively fight this post war tide of perverse theory. 13 They believed that concocting a more fundamental and a more plausible theoretical framework would almost automatically lead to more acceptable polices. In some sense their task reduced to an almost imperative need to become better story tellers, ones that would naturally dominate the existing mainstream economists

In practical terms, Chicago saw what had become mainstream economics as the captive of a distinctly ‘statist’ ideology. This unacknowledged capture had allowed the economics profession, in their considered opinion, to become the unintentional (or perhaps not so unintentional) stalking horse for the forces of collectivism. Given the political nature of the post war era, they felt that the unfortunate nature of this capture justified, and indeed demanded, a powerfully formulated response. Indeed the methodological positivism of Stigler and Friedman was a distinct attempt to validate such expediency while also putting an end to a potential dangerous debate over methodology. 14 Paul Samuelson expressed this view as follows: It’s partly a license for self-indulgence. You don’t have to have a correspondence between a theory and the facts, or a close correspondence. In fact, the theory is all the better if it doesn’t fit the facts closely. And I think that there are some profound errors in that form of positivism, but it is there for a purpose. It serves a purpose (Conversation with Paul Samuelson, October 1997).

As the history of the 1960s unfolded, support by the mainstream of economics for activist government policy definitely waned. The growing experience of government failure combined with the gathering strength of Chicago-style arguments succeeded in accelerating this transition. As this transformation continued, Chicago dissent began evolving further into what would blossom as a distinctly new pro-market policy mainstream, coming to fruition in

12 The idea that neo-Keynesian economists provided the counter-revolutionaries with a devastating weapon to use against them is reminiscent of the quote long attributed to Lenin. "The capitalists will sell us the rope with which to hang them." 13 It is important to point out at this early stage that as Samuelson and others noted in conversation, the Chicago School cultivated an almost deliberate sense of a brotherhood fighting against the odds, engaged in a battle of good against evil. “There’s an in-group of the good guys and the much larger out-group” (Conversation with Paul Samuelson, October 1997). 14 We need to indicate here that we are also taking the same ‘as if’ stance that has become identified with Friedman and Stigler. We are not arguing that they were consciously devious or manipulative. Their virtuous aim was achieving the good of society, and they felt that the need to triumph was particularly urgent at this critical stage of history. Whether they accepted that their opponents might hold similar aims is another question. 5

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition terms of US economic policy with the election of Ronald Reagan. 15 Chicago was no longer battling against, but rather helping to shape the direction of mainstream economic thought.

Like any successful counter-revolutionaries, this triumph carried with it an unfortunate dilemma for those at Chicago in sorting out their methodological and policy beliefs. Embracing the consistently skeptical approach defining the Classical tradition would have led Chicago to turn its laser-like rhetorical skills back on its own pro-market arguments. This would encapsulate the core Classical liberal notion of incorporating a consistent ethic that ‘embraced dissent’. When faced with such a choice, the Chicago School, with Friedman and Stigler representing its most revered and trusted prophets, had no choice but to baulk at proceeding down that particular path. Instead, those at Chicago chose to retool their confrontational style, turning it into a devastating defensive weapon which could be effectively employed to protect their favored market ideology against any perceived danger or effective challenge. 16

The Best and the Brightest – The Post war Landscape

Understanding the transformation that characterized the Chicago School requires an accurate sense of the prevailing mood of the post war era, namely the contours of the emerging economic consensus of that period as well as the concomitant changes in theory. By the 1940s, Paul Samuelson had constructed an acceptable face for mathematical economics, allowing a new theoretical approach to gain prominence. 17 Where Marshall, and Classical economists before him, had deliberately eschewed long chains of reasoning, this new Samuelsonian approach welded a Pigovian-style of logic to a Walrasian general equilibrium framework using those very links that had been previously disdained and dismissed. 18 In doing so, mathematized economics inevitably eradicated the flavor of Classical liberalism from the profession, which neoclassical economists of a more Marshallian strain had tried doggedly to maintain. Certainly Chicago economists such as Simons and Knight clearly subscribed to this older methodological approach. 19 Marshall,

15 The lengthy taped conversation of the Chicago counter-revolutionaries recorded and edited by Kitch (1983) and appearing in the Journal of Law and Economics has an openly triumphal flavour to it. 16 Claire Friedland, George Stigler’s long time research assistant put this mindset succinctly: Much of his work centered around saving the damsel in distress, neoclassicism, from her attackers: hence his work on the economics of information and his enthusiasm for the Coase theorem (Friedland 1993:780). 17 Samuelson’s Walrasian mathematical approach would quickly become a matter of derision to the Chicago cohort both in public and private. In a letter to Milton Friedman, George Stigler waspishly dismissed Samuelson’s efforts: It may merely be prejudice, but I’m inclined to write him off as an economist. Two of his recent jobs … were pure mathematical exposition, as is also his current Economica item (Hammond and Hammond 2006:97). Nor was Stigler any less willing to skewer Samuelson for his mathematical approach in public print: On Samuelson’s definition, I suppose, one writes an essay on mathematics; on the conventional definition, one writes an essay on economics (Stigler 1949a: 100). 18 It should come as no surprise that Marshall was best able to sum up this attitude succinctly: (1) Use mathematics as a shorthand language, rather than as an engine of enquiry. (2). Keep to them till you have done. (3) Transfer into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) if you can’t succeed in 4, burn 3 (Marshall1996 [1906]:130). 19 This approach so clearly favored by Simons or Knight would later be eschewed by their own department and even by Knight’s own student. A second trait was a strong concern for the preservation and enlargement of individual liberty. An interesting thing about this belief, is that it was not vividly and continuously reinforced by the skilful demonstration of the efficiency of competitive markets in performing a thousand tasks. 6

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition almost by definition, was neoclassical in his use of tools and concepts, but he remained Classical in terms of his method. As a result, his policy views were not drawn directly from economic models but from broader reasoning that used economic models as only one input. 20

Under the sway of this post war methodological upheaval, economic policy strayed decisively from its traditional abode within moral philosophy, finding a more convenient residence within the realm of economic theory. The older Classical approach, which acknowledged that “policy is very messy and in large part non-economic” and hence could not flow directly from theory, became a relic of a more pessimistic (and more modest) past. 21 Possibilities at the dawn of what was widely perceived to be a bright new era seemed unlimited. Following the government’s role in directing a successful war effort, and by doing so lifting the nation out of the depths of a seemingly endless depression, the ruling spirit of the time now viewed government as some sort of master engineer and planner, a ‘Mr Fixit’ that formed an essential component of the post war ‘can do’ methodology. In reaction to the ingrained pessimism holding sway for more than a decade, accomplishment in these years largely appeared to depend on a simple willingness to roll up one’s sleeves and apply the right scientific approach to any problem.

In much that same spirit, applied statistics in the form of econometrics offered a transformed economic profession the hope of a re-energized world where the discipline would turn away from a dubious reliance on assertion and deductive logic and forge a new path paved with the bedrock of empirical science. Armed with such a pragmatic and empirical foundation, the social sciences would be able to systematically improve society in much the same way as the physical sciences had transformed every-day life. According to this popular fable, economics, more than any of the other contenders, possessed this vital capacity to pioneer a new direction. It alone could lay claim to the required rigorous foundations that formed the bedrock of the scientific method. Seduced by such siren songs, foundations found themselves unable to resist financing this assured vision of a brighter economic tomorrow. Grants became expressions of a belief in a broader and intrinsically more optimistic vision, one that was widely held by many of the major funds. The Ford Foundation, for instance, was actively engaged in deliberately underwriting research intended

There were elements of such an argument in Knight’s famous essay on social cost, but the support was philosophical rather than functional (Stigler 1976: p.5). Moreover, a somewhat disillusioned Knight in 1932 would present a paper entitled “The Case For Communism: From the Standpoint of an Ex-Liberal”. Imagining someone from the later Chicago School doing something similar is difficult to conceive. 20 A case can be made that Marshall’s personality, forged by a rather difficult personality, transformed him into an invariable hedger and qualifier. The Classical approach would provide him with a natural home. Well, that was Marshall’s character, which really wasn’t very admirable. But it is understandable. I argue it’s the way he was brought up by his father. I mean you can always hear the swish of the birch (Conversation with Ronald Coase, November 1997). 21 The rise of econometrics during this period (despite Keynes’ more classically derived disdain for Tinbergen’s work) seemed to provide the scientific tool that would allow that leap from theory to policy prescriptions. Cost/benefit analysis provided yet another precise device for quantifying applied alternatives. By Christmas 1963, George Stigler in his role as incoming AEA president (Stigler 1964) could lay out a vision of a Brave New World where Marshallian hedging became a quaint custom relegated to the museum attics of the profession. It was just that he [George Stigler] was so enthusiastic about quantitative measures. He thought that he was going to change the world. I was sitting with Aaron Director at the time when he gave his Presidential address and we did look at one another at the time to try to see what each one thought about all of this (Conversation with Ronald Coase, November 1997).

7

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition to save the world in quite a literal way (Craufurd Goodwin, 1989). Goodwin describes the initial relationship between economic science and the Ford Foundation as the equivalent of a ‘love affair’ and in support quotes a commission study outlining the direction the Foundation’s purpose should take. “It would seem fitting indeed if the Ford Foundation should give primary emphasis to encouraging and advancing the same scientific attack on problems of human relations which produced such spectacular advances in natural sciences” Goodwin 1989:160-161). Foundations convinced themselves, at least initially, that in this ‘brave new world’, professionally trained economists would be best suited to steer this unstoppable engine of imminent reforms that would be sanctioned and led by government facilitators.

As mentioned, military and economic success had fostered a widespread belief in the power of scientifically directed government projects to achieve just about any given objective. 22 As a result, Classical liberal values, which traditionally had been grounded in a strong distrust of government solutions, were being fundamentally challenged when not openly overturned. Government spending during World War II had not only defeated a serious threat to an ‘open society’ but had also pulled the economy out of a seemingly intractable depression. In stark contrast, markets in the 1930s had failed to deliver. Consequently government intervention, planning and control were now seen as providing positive goods. 23 As an understandable response, activities formerly ceded to the marketplace were being steadfastly relocated to government agencies and to their functionaries. Individual risk and responsibility shifted, as a universal government safety net, in the form of social security and other welfare benefits, came to fruition. Cold war fear, engendering booming levels of defence spending, subsidized extensive ‘scientific’ economic research. As a result, government budgets were increasing, as were taxes, reflecting society’s newly formed expectations and hopes for a brighter future through the instrument of government planning. Corresponding to this post war fixation on a managerial approach to the economy was the distinct rise of a theoretical move towards a mathematical ‘economics of control’, beginning in the 1930s and continuing through the 1970s. This formulation was then supplemented by a second movement—a change in people’s perception of government that occurred after World War II (see above). Before the war, a world economy that seemed mired in depression had seemed to contradict the more pragmatic Classical argument that championed the market conditioned by a laissez faire approach. 24 Government in its new

22 This particular view would gather strength, reaching its zenith in the Kennedy administration. The self- nominated ‘best and the brightest’ believed that they could systematically solve any problem confronting the nation as seen by Kennedy’s pledge to put a man on the moon by the end of the decade or embedded within Johnson’s war on poverty. The disillusionment of the Vietnam War and the seventies stagflation effectively ended such heady dreams. To some degree this paralleled the turn of the century rise of progressivism in the US and its subsequent fall from grace during the Wilson administration. This optimism, verging on engineering arrogance, was also reflected in the dominance of the ‘new economics’ that characterized the profession during the sixties. Most of us younger people think that the macroeconomic problem has been solved by the generation of Samuelson, Modigliani and Arrow. Our students have never seen a cycle. If there are cycles, it’s because the governments are stupid enough not to follow the advice of the economists (Lester Thurow quoted in Levi 1973:103). 23 John Maynard Keynes (1963a)) playing the provocative pamphleteer had already attempted to bury the idea of radical individualism in his 1926 essay, “The End of Laissez-Faire”. Despite his disenchantment with the more questionable simplicities of Bentham, Keynes placed himself squarely in the Classical Liberal tradition, though one that had evolved from its 19 th century incarnation. He (1963b) raises these still relevant political issues in “Am I a Liberal?”(1925). 24 As John Maynard Keynes makes clear: 8

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition engineering and planning role was widely viewed as having saved the economy from the ravages of the depression into which the economy, seduced by the market, had fallen. Bold government action had also rescued democracy from the cataclysmic threat posed by the totalitarian Axis countries. Thus the two underpinnings of Classical liberal philosophy, prosperity and freedom were now seen by the public as largely flowing from government action rather than from either entrepreneurial individuals or unregulated markets.

The conversion to a more mathematical economic theory led to less emphasis on policy nuance. The large policy areas, colored gray in the Classical liberal topography, became neighborhoods of black and white within the emerging neoclassical method. The pragmatic intuitive approach that allowed divergent policy views to find a home in a widely pitched big tent, a crucial element of the Classical liberal laissez faire tradition, was replaced by much more constricted, and often ideologically defined, tents in which theory produced specific policy outcomes. Within this modern carnival, to disagree on policy became equivalent to rejecting commonly accepted theory. Under this new methodology, the subtleties of Classical liberal arguments supporting laissez faire became transmuted (and casually dismissed) as simple minded pro-market passivism. In contrast, successful government activism seemed firmly rooted in the very best scientific models that economics had to offer. In this radical reversal, the traditional Liberal approach to policy, championed by Mill and carried forward by Sidgwick and Marshall, was largely lost. What had vanished was a type of laissez faire economics that allowed for varying degrees of government activism. In its place appeared a generalized economic theory that was interpreted, in an unduly facile manner, as providing a sound, theoretical rationale for an expanded government role. This spreading post war stance encouraged less subtle economists (of whom there is never a lack) to dismiss market supporters as biased and hopelessly out of date. Claims such as these, tinged as they were with an almost irritating arrogance, provoked a predictable reaction from self-proclaimed liberal thinkers such as Director, Hayek, von Mises and others. What they conceived as a calamitous, and potentially dire, state of affairs left no other choice than to be expeditiously addressed. Something simply had to be done before intellectual debate deteriorated precipitously. 25 Together, these self-proclaimed liberals had become convinced that the economics profession was explicitly embracing unsubstantiated ideas that were both dangerous and collectivist. As a result, this cancerous governmental growth would consequently undermine not only Classical liberal views, but more importantly the very type of civil society that depended upon individual choice and liberty.

It is not a correct deduction from the Principles of Economics that enlightened self-interest always operates in the public interest … We cannot, therefore, settle on abstract grounds, but must handle on its merits in detail, what Burke termed “one of the finest problems in legislation, namely, to determine what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion” (Keynes 1963a [1926]:312-313). 25 There is an important distinction here that Hayek makes in a paper delivered to his intellectual compatriots of the Mont Pelerin Society. He deliberately distinguishes between the objectives and behaviour of liberals as opposed to their erstwhile allies, conservatives. Hayek, whether accurately or not, places himself firmly in the liberal camp. The acid test for him seems to be measured by one’s faith in markets. Looking forward it [the conservative mind] lacks the faith in the spontaneous forces of adjustment which makes the liberal accept without worry changes even though he does not know how the necessary adaptations will be brought about (Hayek 1957:3).

9

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Faced with this situation, Director and his newly cultivated protégés, Friedman and Stigler, came to believe that mounting and winning arguments supporting markets and raising serious doubts about the efficacy of any government intervention was now exigent. The prevailing mathematical models, providing the justification for this newly accepted behavior, needed to be strenuously questioned and ultimately rejected. The underlying pro-government rhetorical bias inherent in economic theory, which was then being widely taught, provided unwarranted and dangerous support for expanding the already perilous level of government intervention. The currency of such intellectual arguments needed to be countered and exposed for its intellectual flimsiness.

As the commencement of this counter-revolution against the post war economic consensus, the odds against this small band of self-styled marketeers appeared overwhelming, if not insurmountable. For example, as the battle lines were forming, one of the stalwarts of the classical liberal faith summed up the post war situation in these bleak tones. The outlook at Chicago, if better than elsewhere, is not very promising. Our divisional dean has no apprehension of economic liberalism and a distinct hostility toward it and the same is true of most persons in the other social science departments. … In the Department [of Economics] we are becoming a small minority (Henry Simons quoted in Coase 1993:245).

In a similar vein, James Buchanan describes how Warren Nutter had virtually surrendered to the post war tide of ideas. He had given up trying to save classical liberal ideas, and argued that all that remained was a valiant attempt to “save the books.” (Buchanan, 2000). Even the irrepressible Milton Friedman was unable to see any hope for redemption in those immediate years. Certainly he had no inkling of being present at the birth of a new regime.

Under these circumstances, true believers could only see the future of a free society as hanging perilously in the balance. At this juncture, Milton Friedman and George Stigler (as well as others) who saw themselves as the heirs of Knight and Simons rose to the challenge and refused to stand idly by. They would not abandon the US to such a fate. With so much at stake, arguably almost any method which helped achieve such a fundamental goal could be easily justified in this struggle for freedom and liberty. 26 If pro-government activists were going to rationalize statist economic policies with economic models, they would do so as well. This would require the development of models which showed that free markets inevitably led to desirable solutions. Doing so meant that they had to abandon the Classical liberal methodological approach of separating policy and theory. Abandonment however was not a radical departure from the post war prevailing status quo, but rather an incorporation of the prevailing mode. The profession, for the most part, had already abandoned the more

26 The question remains whether they were conscious of deserting their professed Liberal principals. There is at least room to think that they were blissfully unaware of any such transgressions. The ability to hold contradictory stances is a very human trait. Moreover, it can be strongly argued that they really did believe that the world worked in the way their models suggested. As Sam Pelzman notes: But as I said, he really believed in the rational mind. You’d show him some example of an irrational behaviour … there’s a lot of this sort of work going on now it just so happens … and he would show you that it can’t be true. Almost by definition ... Almost. Almost. It’s getting more and more, more and more part of him as he got older actually, this whole view. He insists it’s rational. He would tell you, ‘There is some rational explanation for it. It’s just that you haven’t looked completely into it and found it’ (Conversation with Sam Peltzman, November 1997). 10

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Classical approach when embracing the mathematical economics that lay beneath the Walrasian general equilibrium framework. 27 To this departure, the Chicagoans would then graft the pressing imperative of rescuing the US from indulging in any more serious policy mistakes. Such unquestioned necessity would naturally facilitate rationalizing almost any expedient tactics.

The Classical Liberal Tradition

Our claim then is that the Chicago School, whether consciously or not, abandoned the Classical liberal method. Any methodological considerations were undoubtedly overshadowed by a perceived need to save society from a growing wave of anti-market and collectivist forces that they concluded would undermine the Classical liberal commitment to individual freedom. That claim rests heavily on the accuracy of our characterization and understanding of Classical economics itself. The logical next step of our argument then is to outline a satisfactory picture of the tenets of Classical liberalism. We take as our model the economics formulated by Smith, and later defined by John Stuart Mill. This approach was incorporated into the subsequent development of economics through the offices of Marshall and Sidgwick. Both attempted to preserve the Classical liberal tradition when formulating their own particular brand of neoclassical economics. 28

Classical liberalism was a philosophy that transcended economics. It provided not an economic defense for markets and laissez faire, but a philosophical and historical defense. It was a nuanced defense that justified the market in much the same way that many have justified democracy—a default system that is only preferable given the even less salubrious alternatives available. 29 Markets were neither deified nor fetishized. Laissez faire was justified in much the same way—not as a theoretically derived optimal policy, but as a policy that took into account the limitations and inherent difficulties of satisfactorily accomplishing specific objectives through the intermediation of the state. What loomed as a distinct possibility instead was an uncomfortably large likelihood that any state actions, no matter what their stated intentions, would deviate considerably from their conceivably beneficial aims. 30

27 In his later years especially, George Stigler, in his quest for consistency formed a minority view that moved closer to the Classical policy position of separating economic theory from policy, at least in some aspects. As Claire Friedland notes: Something he was thinking about was how to reconcile consumer sovereignty, or voter sovereignty, with his previous notions of inefficient government. Can we say this is illegitimate if the public wants it? Is that consistent with our extreme position on consumer sovereignty, which is that no matter what horrible things the public wants, as free market economists we can never question it. That’s certainly one of the basic principles of neo-classical economics. Consumer sovereignty is both the end of the story and the beginning (Conversation with Claire Friedland, October 1997). 28 Marshall was the master of qualified analysis, what his detractors might with less goodwill describe as a compulsive need to fudge. As Keynes noted, ‘Jevons chiselled in stone while Marshall knitted in wool.’ Or perhaps, not unlike Henry James, Marshall chewed more than he bit off. 29 Winston Churchill, perhaps harking back to Plato’s Republic , cleverly summed up the problem: No one pretends that democracy is perfect or all-wise. Indeed, it has been said that democracy is the worst form of Government except all those other forms that have been tried from time to time (Churchill, Winston (1947). 30 Smith would have had in mind Robert Clive and the parliamentary investigation into his activities acting under the aegis of the East India Company, a government chartered monopoly to which England essentially contracted out the running of India. Clive himself is reported to have responded to charges against him by saying, ‘"By God... I stand astonished at my own moderation". 11

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

There is, in fact, no recognized principle by which the propriety of government interference is customarily tested. People decide according to their personal preferences. Some, whenever they see any good to be done, or evil to be remedied, would willingly, instigate the government to undertake the business; while others prefer to bear almost any amount of social evil, rather than add one to the departments of human interests amenable to governmental control (Mill 1947[1859]:9)

Classical liberals tried to deal with this ambiguous prescriptive side of economics by strictly separating the science of economics from economic policy (what Mill refers to as the ‘art of economics’). The science of economics was about logic—it involved a search for the truth and was essentially a matter of logical deduction. Intrinsically it could lead to no specific policy position whatsoever. Thus, we see Nassau Senior, the first Classical economist to write seriously about methodology, clearly state: (An economist’s) conclusions, whatever be their generality and their truth, do not authorize him in adding a single syllable of advice. That privilege belongs to the writer or statesman who has considered all the causes which may promote or impede the general welfare of those whom he addresses, not to the theorist who has considered only one, though among the most important of those causes. The business of a Political Economist is neither to recommend nor to dissuade, but to state general principles, which it is fatal to neglect, but neither advisable, nor perhaps practicable, to use as the sole, or even the principle, guides in the actual conduct of affairs. (Senior 1836: 2-3)

For Senior, and for most early Classical economists concerned with methodology, the economic science of the time was a branch of logic.31 In the pure science of economics of that period one did theory, which meant that one developed theorems from almost self-evident first principles. But, as Senior makes clear, economic theory was not meant to provide a direct jump to policy prescriptions. 32

To move from the theorems developed by the science of economics to the precepts useful to policy-relevant economics, Classical economists believed that one had to rely on common sense judgment and institutional knowledge. Discussing policy in an applicable manner simply involved different skills than those required when constructing economic theories. 33 On the other hand, Classical liberalism also assumed than an individual was

31 As Myrdal points out, “Cairnes, the last of the great classical writers, put the point even more vigorously. The end of political economy, Cairnes said is ‘not to attain tangible results, not to prove any definite thesis, not to advocate any practical plan, but simply to give light, to reveal laws of nature, to tell us what phenomena are found together, what effects will follow from what causes”(Myrdal 1954 [1930]:3). 32 It is important to note here that these Classical economists would not have accepted the Friedman/Stigler brand of positivism. Rather, they were concerned with the soundness of the assumptions made. For example, Myrdal writes: John Stuart Mill and subsequently Cairnes, both of whom were better versed in philosophy than Senior, were eager to stress that economic theory is a ‘hypothetical science’. The truth of any deduction was supposed to depend upon the adequacy of the assumptions. Senior, on the other hand, stressed that the assumptions need not be arbitrarily chosen. Instead, valid generalizations ought to be formulated on the basis of empirical reality (Myrdal 1954 [1930]:7). 33 This theory/policy divide can also be found in J.N. Keynes’ famous summary of economists’ methodology at the turn of the 19 th century (J. N, Keynes 1891). Like Senior, J.N. Keynes also separated what he labeled the applied policy branch from what he deemed to be positive economics, a relatively narrow branch of the discipline. Senior saw this applied study as comprising the more complex art of economics. He argued that the two branches needed to be separated because they had quite different methodologies. He wrote that, “a 12

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition intrinsically most qualified to recognize what lay in his or her best interest. This approach distinctly rejected the awkwardness of paternalism—the belief that some outside power knew what was best for others. In fact, liberalism’s intrinsic commitment to individual freedom required this implacable belief in each individual’s recognition and knowledge of self- satisfaction. Liberalism’s acceptance of the superiority of individual choice thus formed a core element of its moral philosophy, one that focused on individual responsibility. But at the same time, even such a central assumption in no way flowed from the tenets of its economic theory. 34

Classical economics then is consistent with what Melvin Reder (1982), in his analysis of the Chicago School, has described as defining a ‘Tight Prior’ approach. The core of this idea holds that individuals are capable of handling their own problems as best as is feasibly possible. 35 Starting from this foundation, government intervention can only be listed as a reluctant last resort, though once again, it is not a deduced conclusion flowing directly from theory. Theory, for such Classical liberals, did not prove that a laissez faire approach was superior to other alternatives. It simply provided a framework which strongly questioned whether government intervention would do any good. The common thread to all liberal policy remained a core insistence on liberty and a concentrated focus on the desired removal of outside compulsion, which did translate into a default acceptance of a laissez faire position. But by barring convenient direct jumps from theory, concrete policy proposals could differ on the degree and nature of government intervention required, while still holding to their belief in the fundamentals of non-intervention. This conclusion flows automatically once the sufficiency of universal laws or theories are no longer seen as sufficient for policy applications. As Mill deftly points out, other considerations are required: No one who attempts to lay down propositions for the guidance of mankind however perfect his scientific acquirements, can dispense with a practical knowledge of the actual modes in which the affairs of the world are carried on, and an extensive personal experience of the actual ideas, feelings and intellectual and moral tendencies of his own country and of his own age (Mill quoted in Bronk 209:54).

Given this methodological approach, the Classical tradition did not consequently impose a theoretical straightjacket in terms of permissible policy positions. As Steven Medema (2009) and others point out, Classical economists were not inherently anti- government in their policy positions. Thus, we should not be surprised when Murray Rothbard reacts viscerally by glibly labeling Adam Smith a socialist for his refusal to take a

definitive art of political economy, which attempts to lay down absolute rules for the regulation of human conduct, will have vaguely defined limits, and be largely non-economic in character.” (J. N. Keynes 1891: 83) 34 Hayek strongly rejected conservatism, as well as collectivism, for its inherent distrust of individual choice. This timidity and fear to trust to the uncontrolled working of social forces is closely connected with two other characteristic attributes of conservatism: Its authoritarian or paternalistic leanings and its dislike and consequent lack of understanding of the operation of economic forces. As it distrusts both abstract theories and general principles it neither understands the spontaneous forces on which a policy of freedom relies, nor has it a basis for formulating principles for policy (Hayek 1957:4). 35 More precisely, Reder states: In essence the Chicago View, or what I term “Tight Prior Equilibrium” theory (TP), is rooted in the hypothesis that decision makers so allocate the resources under their control that there is no alternative allocation such that any one decision maker could have his expected utility increased without a reduction occurring in the expected utility of at least one other decision maker (Reder 1982:11). 13

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition narrow ideological line on government intervention.36 Rejecting this aspect of Classical liberalism proved to be something less than a daunting task for the more ideologically determined. Thus, the Chicago School could deftly rationalize its driving objective with traditional liberalism by turning an essential feature of that creed into a weakness, an error that simply needed correction. We should accordingly not raise an eyebrow when George Stigler (1971) fails to connect with Classical consciousness by taking his idol (Adam Smith) to task for not reducing legislation to narrow self-interest. In this way, narrow ideology could be made consistent with Classical liberal doctrine simply by labeling any earlier incongruous parts as mistaken viewpoints. 37

Unlike those who later aspired to the title, John Stuart Mill and his Classical liberal compatriots frequently supported different sides on policy debates, even while sharing a common theoretical framework. What they did hold in common however, was a strong concern about the government’s ability and even its desire to do good. They believed that government intervention, by changing market contractual arrangements, too often became a tempting mechanism for special interests to secure monopolies and limit competition. But they also believed that the market was far from perfect, and it was legitimate to argue for governmental action.

Therefore in our categorization of classical liberalism, even a seeming outlier like John Maynard Keynes can be made to reside comfortably in this Classical liberal tradition, though representing a more activist side of this flexible school of thought. In many ways, Keynes is the mirror image of the Chicago school. By that we mean that while Keynes was committed to Classical liberalism, he was quite willing to bow to expediency and temporarily suspend the Classical commitment to pluralism and openness in the short run while using his rhetorical powers to support his favored view (the ‘pamphleteer side of his character). Like his Chicago school counterparts Keynes proved particularly adept at connecting theory and policy in non-Classical liberal ways, using his considerable rhetorical skills to weave a persuasive story. He could justify this by a belief that the bridge so constructed supported a policy that he believed could alone save a market system trapped in the trough of a depression. In his opinion the alternatives were either the stupidities spouted by conservatives

36 Dismissing an economist as a Socialist avoids having to deal with the details of specific theories or approaches. Milton Friedman proved less than shy in using this tactic. Responding to a draft of George Stigler’s (1949b) ‘The Economists and Equality’, Friedman unwittingly dismisses liberalism in almost an afterthought, ‘Didn’t Mill end up a socialist?’ (Hammond and Hammond 2006:78). 37 Over his career, George Stigler would twist and turn over the exact connection between theory and applied policy in Classical Economics. He would dismiss Hollander’s objections to Ricardo’s abstractions by tarring all economists of that error with the same brush. He [Hollander] complains about over-simple bases of recommendations of policy, as if by this implicit standard all of Ricardo’s contemporaries were not playing the same game (Stigler 1978:597). Yet earlier in his career when addressing Hayek and the London School of Economics, he attempted to rescue the policy practices of the Classical Economists by noting their predilection for examining case specific evidence. The discrepancies between pronouncements and practice are notorious in the field of methodology; can it not be so also in the theory of value? In writing their treatises, may not the classical economists have employed an apparatus which is different and in modern eyes inferior to that which they employed to analyse concrete problems (Stigler 1949c: 25-26). One way to make sense of potentially conflicting statements is to recognize the difference between tactics and strategies. The aims Stigler was pursuing in that particular lecture need not have been exactly in synch with broader, overarching aims. Life doesn’t offer editors that check individual speeches for continuity. For Stigler’s aims at the London School of Economics see Freedman 2008. 14

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition or the barbarities perpetrated by communists. Still, his quicksilver mind adapted to objections and arguments when they were convincingly constructed. 38

In summary, Classical liberalism, as should be apparent, did allow for government action, but only within a broader laissez faire context, that saw it as a last resort. The overarching imperative behind the methodology firmly classified government intervention as something to be avoided whenever possible, but the line of demarcation about what intervention could be justified was gray and would have to be decided on a case by case basis in which non-economic issues by necessity played important roles. 39

The contrast between the Classical approach and the Chicago School is then quite telling. The spirit imbuing this more modern movement, as exemplified by someone like George Stigler, jumped effortlessly from the abstract world of the blackboard to that of everyday life. Like some sort of latter day Hegelian, Stigler seemed to have as his fixed pole the assumption that ‘Das Deken ist das Sein’. His abiding interest continued to be the development of a general theory that could be universally applied. Specifics and particulars consistently failed to catch his interest. As Harold Demsetz noted: Well George did not think that differences were so important for economic analysis. You wanted to understand prices, demand and supply? You could use the same kind of model no matter where you applied it and you didn’t have to have a really special model for it. I think that was why he was not a fan of the 1930s and ‘40s industry studies. They thought every industry was unique. I think that was one of the consequences of the Chamberlin monopolistic competition model and he didn’t see any useful generalization coming out of that. He was always interested in generalizations. And he was not interested in explaining the particular as much as he was in the generalization that you could deduce (Conversation with Harold Demsetz, October 1997).

Pragmatic concerns, not theory, underlay the policy views of Classical economists. 40 It was the weight of past examples and available evidence that seemed decisive to most Classical liberals when concluding that government policy was to be supported only as a last resort. But such beliefs were not intended to effectively shut down debate, nor did these economists, for the most part, explicitly try to do so. They recognized that their approach had an inherent bias against state action, and to counter the anti-government policy structure of

38 Notice though Keynes continued insistence, even in the short run, on embracing dissent. In the well-known quote attributed to him, he responded when twitted about changing his mind, “When the facts change, I change my mind. What do you do sir?” Facetiously one might conclude that when members of the Chicago School ran into this problem, they looked for new facts. 39 It is no surprise then to find Simons and Knight calling for temporary government spending during the depths of the thirties depression while still holding strict liberal tenets. Paul Samuelson points this out. He states; “Henry Simons, on the other hand, was part of the University of Chicago group which was in favour of deficit spending when that was still unfashionable” (Samuelson 2011a:991). 40 Paul Samuelson for all his contributions to modernism in economics would seem to be channelling this classical pragmatism in a revealing debate held with George Stigler. There are no rules concerning the proper role of government that can be established by a priori reasoning (Samuelson 1963:37). In stating this general principle, Samuelson is harking back, whether intentionally or not to an earlier Classical compatriot. It appears to me that the most fatal of all errors would be the general admission of the proposition that a government has no right to interfere for any purpose except for that of affording protection, for such an admission would be preventing our profiting from experience and even from acquiring it (Nassau Senior quoted in Reisman, 1990:55). 15

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition their laissez faire position, the tradition not only tolerated, but actively encouraged dissent. 41 That dissent was necessary to determine where that wavering line in the gray boundary could safely be drawn.

The Birth of the Chicago Tradition

Having spelled out our understanding of the Classical liberal tradition, we now turn our attention to its original Chicago formulation. For approximately the last 60 years, the economics profession typically has distinguished an identifiable Chicago School, which often stood in sharp contrast with the approach taken by others. This perception of a ‘Chicago School’ evolved out of what might best be called an older Chicago tradition. The very first head of the department, John L. Laughlin, fostered and defined the essence of this new Chicago approach. It was Laughlin who helped create the appearance of an ultra-conservative department with a predilection for ideologically tinged policy prescriptions. Laughlin, an inveterate stirrer, was also the embodiment of the second element of the Chicago tradition. We label this the dog and fire hydrant approach to scholarship—an irresistible urge to treat the existing institutional structures and beliefs as fire hydrants and accord them with a requisite degree of respect.

As the guiding spirit of this newly hatched department during its formative years, Laughlin seemed to live for and breathe in controversy with an ease natural to his disposition. He skillfully managed to alienate much of the professional establishment by scorning the recently initiated American Economic Association, while having the concomitant gall to set up his own house organ, The Journal of Political Economy (1892) in deliberate competition with the only legitimately acknowledged voice of economics, namely The Quarterly Journal of Economics (1886). This scholarly effort was produced by members of the undisputed ruling deity of the profession, the irreproachable choir of gentlemen from Harvard. Laughlin, seeking to gain quick notoriety, as well as widespread recognition, deliberately positioned Chicago as a sort of academic refuge, one willing to take in the profession’s outsiders, especially those with somewhat maverick leanings. Thorsten Veblen, an early member of the department, was undoubtedly a classic example, encapsulating in a multi-dimensional way what it meant to be on the outside looking in.

This embrace of the renegade position would work to Chicago’s advantage in the years leading up to and immediately after World War II. The relative tolerance exhibited during these years (as opposed, for instance, to the Anti-Semitism displayed by many universities such as Harvard) enabled Chicago to snare European refugees as well as somewhat gauche, but sharp witted, and pointy elbowed, provincial young men. 42

41 John Stuart Mill had no doubt about the importance of opposing ideas as providing one of the founts of wisdom. In the case of any person whose judgment is really deserving of confidence, how has it become so? Because he has kept his mind open to criticism of his opinions and conduct. Because it has been his practice to listen to all that could be said against him: to profit by as much of it as was just, and expound to himself, and upon as much of it as was just, and upon occasion to others, the fallacy of what was fallacious (Mill 1947[1859]:20). 42 Paul Samuelson notes the importance of this lack of anti-Semitism at Chicago. ‘Henry Schultz got a call to the University of Chicago in late 1920s. Chicago was not free of anti-Semitism, but it was relatively free in those days. And as a result, I think that explains in part, its greater pre-eminence in those years, the early Hutchins years; the years just before Hutchins and up until, say, the end of the 1930s’ (Conversation with Paul Samuelson October 1997) 16

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Much of the strength of the Chicago tradition continued to be built upon the importance of openness and of providing a home to outsiders of all stripes. These defining characteristics imply that the department could have travelled down a variety of paths in the post war era, since, as Reder (1982) points out, many members of the Chicago faculty through the 1940s were not particularly pro-market or ideologically single-minded 43 . A number of non-Chicago policy types were in residence during this period. For example, Veblen and Mitchell exemplify the Laughlin period, while Douglas, Schultz and Lange also grace this category in the thirties and forties. (Even the future arch conservative Aaron Director, the eminence gríse of Chicago, originally came to the Southside as a PhD student after working for the Oregon State Federation of Labor. He later served as a research assistant to Paul Douglas with whom he published (1931) The Problem of Unemployment . These events were prior to his subsequent conservative apotheosis under the influence of Frank Knight.) 44

The Birth of the Chicago School

There was, in our view, no inevitable progression from the Chicago tradition, even in its thirties incarnation, to the post war formulation that evolved into the Chicago School. For example, the Cowles Commission, which was located at Chicago initially, shared appointees like Don Patinkin and Jacob Marshak. The Chicago School also had its departmental Keynesians such as Lloyd Metzler, who provided intellectual and ideological ballast to the department. A tradition that encouraged an openness to dissent led Chicago in 1947 to make an offer to Paul Samuelson, who despite support from Schumpeter had been passed over by Harvard. 45 Much to the delight of a newly arrived Milton Friedman, Samuelson rejected the offer. He states: In 1947 I heard a call from Chicago. Thinking, wrongly thinking, that there I might encounter better students over my career, I accepted for 24 hours. As soon

43 A towering intellectual figure of the interwar period like Viner, though a strong supporter of markets remained an eclectic thinker, supporting what were considered to be heresies at the time, and recommending former students viewed in the McCarthy period as fellow travellers if not outright communists. Though ostensibly exemplifying the ‘in your face’ attitude cultivated at Chicago, that stance seemed, to a great degree, the product of his environment. He invoked fear and even terror in graduate students taking his famous 301 class in economic theory. Yet once he removed to Princeton, his characteristic ferocity largely melted away. Let me only say that Jacob Viner, never known for his diplomacy or sweetness, was something of a saint in getting along with Knight. (Only in his eighth decade did Viner permit himself to say privately: “I always felt we should have treated Frank as if he were on the verge of a nervous breakdown in the 1930s (Samuelson 2011d:591). 44 Like Stigler, Director would later break away from the ideas of Knight who was consistently conservative but never doctrinaire. Milton Friedman: Well, Frank Knight had a particular influence on the people who came close to him, including Aaron. Aaron was a disciple of Knight’s as well, much more so, in a way. Would you say you were more or less so Aaron than George was? Aaron Director: Maybe for a while, but not for long. Milton Friedman: For a while I would say you were more so, I would think. Aaron and Knight once jointly owned a farm in Indiana. But Knight had a very peculiar, a very real influence on those who became his disciples, which George broke from in the main (Conversation with Milton Friedman, Rose Friedman and Aaron Director, August 1997). 45 Samuelson’s failure to get an offer from Harvard is widely thought to reflect the prevailing anti-Semitism in the Harvard Department (see Reder (2000) in this regard). Samuelson himself neatly sidesteps the issue: Legend and history never get things quite right. At no time had Marion and I expected much from Harvard. There were no fervent promises later reneged on (Samuelson 2011b:964). 17

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

as I made the bad decision, I knew it was a mistake and immediately cut my losses (Samuelson 2011b:967).

If we hunt for landmarks, it was the hiring of Milton Friedman (who, despite the proffered low pay, accepted a position initially earmarked for George Stigler) that marked the true beginning of the Chicago School. Friedman, who was both Jewish and an abrasive renegade, fit the Laughlin outsider tradition nicely. 46 However, the passing of the Classical liberal baton to Milton Friedman initiated a transformation of a tolerant Chicago tradition into a decidedly more stringent formulation and a School militant stance characterizing the new Chicago. Of course a change of such momentous magnitude does not occur instantaneously. The notion that what would become widely acknowledged as the Chicago School had an expected period of transition garners strong support from both sides of the ideological aisle. For example, Stigler writes, “There was no Chicago School of Economics when the Mont Pelerin Society first met at the end of World War II” (Stigler 1988b:148). Jacob Viner concurs; he writes: It was not until after I left Chicago in 1946 that I began to hear rumors about a ‘Chicago School’ which was engaged in organized battle for laissez faire and ‘quantity theory of money’ against ‘imperfect competition’ theorizing and ‘Keynesianism’. I remained sceptical about this until I attended a conference sponsored by University of Chicago professors in 1951. The invited participants were a varied lot of academics, bureaucrats, businessmen, etc. but the program for discussion, the selection of chairmen, and everything about the participants were so patently rigidly structured, so loaded, that I got more amusement from the conference than from any other I ever attended. Even the source of the financing of the Conference, as I found out later, was ideologically loaded (Jacob Viner quoted in Patinkin 2003[1969]:112).

Thus, only in retrospect can we see the hiring of Milton Friedman as a turning point of a counter-revolution that would see a fully-fledged Chicago School triumphant in the eighties. Two additional steps would bring this as yet indefinite beginning to fruition. Once accomplished, the essentially liberal characteristic of actively embracing dissent would fall by the wayside. However, through the late 1940s and mid-1950s, the older Chicago tradition still dominated. The focus remained firmly fixed on hiring outsiders of different persuasions. For instance, there was a concerted push by Oscar Lange to bring in Abba Lerner. That attempt didn’t eventually make it to the offer stage, but as mentioned, a bid to bring in Paul Samuelson did.

Viewed from inside the Chicago department it certainly was not clear that Chicago was becoming a pro-market bastion. In fact, it seemed to Friedman that it was clearly swinging leftwards. For example, in 1946 Friedman bitterly lamented the rising Keynesian tide in the department. 47 He writes:

46 “He [Milton Friedman] had the usual poor immigrant parents, and went to cheap and nearby schools. At Rutgers (where he met, studied under, and form a durable friendship with Arthur F. Burns) he financed himself by breaking the college bookstore cartel and waiting on tables” (Stigler ms of speech on the occasion of Friedman’s birthday February 2, 1969). But Friedman was not simply an outsider by birth but also by disposition. His time spent as a graduate student at Chicago had nurtured his natural combativeness. “Now Milton had certain troubles, because of two things. Anti-Semitism, but also people were afraid of him. His corrosiveness and so forth” (Conversation with Paul Samuelson, October 1997). 47 In a story told many times, George Stigler had been selected for the position only to be vetoed at the last moment by the President of Chicago standing in for Vice Chancellor Hutchins who was ill on that fateful day. 18

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

The Samuelson matter was again forced to a head – by Douglas - & thanks mainly to his efforts we lost badly. The dep’t has voted to make Samuelson an offer. We don’t yet know the end of the story. But whatever it is, I am very much afraid that it means we’re lost. The Keynesians have the votes & mean to use them. Knight is bitter & says he will withdraw from active participation in the dept. Mints, Gregg, & I are very low about it (Hammond and Hammond 2006:46, Letter from Milton Friedman to George Stigler November 27, 1946). This offer though, would turn out to be the low ebb of those sharing Friedman’s beliefs. From the moment that Samuelson turned down that offer and caught within an almost irresistible current thereafter, the dissenting element that had defined the Chicago tradition faded, and the fealty to pro-market ideology inexorably grew.

The growth of the Chicago School was augmented and even spurred by successfully sending offshoots to both the Chicago Law and Business School. With the suicide of Henry Simons, his newly created position within the Law faculty had become vacant. Just as Simons had been saved from a precarious position within the economics department, another one of Knight’s protégées, Aaron Director, would have his career rescued through a comfortable exile among the legal minds of the University. As we will discuss below, this appointment was made possible by the manner in which the success of Hayek’s attempt at a prophetic book subsequently attracted grants from the Volker Fund. As Ronald Coase points out: In the end it was agreed to appoint Director for five years as research associate with the rank of professor to conduct what was called in the memorandum sent to the Volker Fund, “a study of a suitable legal and institutional framework of an effective competitive system.” However, before the final arrangements were made, Simons died, and Katz asked that the terms of the Volker grant be modified to allow Director to do some teaching (Coase 1993:246).

Although Director never published much during his long career, his influence seemed inversely related to his paucity of articles. He was one of the few people who clearly affected the thinking of George Stigler during Stigler’s last 33 years at Chicago. 48 Director operated as an almost hidden strategist carefully shaping the counter-revolution mounted by his compatriots at Chicago. Though Director’s hand could be discerned only by those insiders who presented the more public face of the project, often it was his hand that proved decisive. Both in and out of the classroom, Director was extremely effective as a teacher, and he had a profound influence on the view of some of his students and also on

George has told the story in his Memoirs , far better than I can, of his being rejected for a position at Chicago by then President Ernest Colwell because he was too empirical, and of my subsequent appointment to it, presumably because I was not. He claimed thereby that President Colwell and he “had launched the New Chicago School”! (Friedman, Milton (1993) “George Stigler: A Personal Reminiscence”, Journal of Political Economy . 101(5): 768-773) 769) 48 The close relationship between Milton Friedman and George Stigler is largely taken for granted. However, fewer realize the larger influence that Aaron Director had on Stigler’s thinking. Milton Friedman: Added to that, well a lot of George’s attitude came from Aaron. I think you had a lot of influence on what he said. Aaron Director: I don’t think so. Milton Friedman: Between you and me, you were more influential. But of course, you know, people get into patterns of what they say and it doesn’t always correspond to what they do (Conversation with Milton Friedman, Rose Friedman and Aaron Director August 1997). By the last part of his life, whether in the last half or the last third, it was my impression that George was of the opinion that laissez-faire itself pretty much approximated to tolerably effective competition. And I think Aaron Director was the prime source of this view (Conversation with Paul Samuelson November 1997). 19

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

those of some of his colleagues at the University of Chicago both in law and economics (Coase 1993:245-246). 49

The Chicago hire that allowed the department to break decisively from the tradition of dissent, and led to the final transformation of the Chicago tradition to the more narrowly defined Chicago School, came with the appointment of George Stigler as the Charles R. Walgreen Professor of American Institutions in 1958. This addition not only shored up the Economics Department but also sent a hearty and decisive offshoot to the Business School. Like, Friedman, George Stigler was an outsider in the sense that he remained the perennial provincial. 50 He was also brilliant, well read and strongly pro-market. These three linchpins coalesced on the occasion of the first Mont Pelerin meeting, establishing a mutual self- reinforcement of ideas, and an unshakable belief that they had a better handle on the truth than did most other economists. That mutual reinforcement allowed them to sustain a belief in the market as a theoretical and fundamental principle that would come to define the department. Their corresponding missionary role was to convey the truth, as they were privileged to divine it, to the rest of the profession. What would mature into a fierce rhetorical imperative demanding that these disciples triumph at all costs, was cemented into a much more ideologically constrained Department.

The older Chicago approach, which had previously embraced renegades of all persuasions, was now only a poorly remembered history. Its replacement was what would constitute and be widely recognized as the Chicago School. With all the key players in place, the ruling triumvirate of Friedman, Stigler and Director could then use their considerable rhetorical skills to defend the market from those who were deemed dangerous. The instruments employed to do so, demanded the strategic capture of the high ground and the subsequent shaping of the terms of debate through a series of slashing attacks. 51 From then on, legitimizing any new hire would involve the presence of a sufficient measure of

49 Others were more sceptical of Director’s contributions: Aaron Director was extremely conservative. Why, I don’t know. By the time I knew him he was already like that. And he was an iconoclast. But he didn’t develop new data with respect to industrial organisation. He didn’t develop any articulate new theories. He just said that the conventional belief wasn’t so (Conversation with Paul Samuelson November 1997). 50 Certainly Stigler, born to immigrant parents and raised in Renton, Washington outside Seattle also fitted this mould. Moreover he shared Friedman’s natural aggressiveness nurtured by his study under Knight. But he resolutely remained an outsider even after his academic and public acclaim. His letters sent while overseas hark back to Mark Twain’s Innocents Abroad . Another story about George, I’ve always found it to be a problem, which is how incredibly American he was. I used to be shepherding these Latinos through and here they would come to some question in his Price Theory examination. ‘Explain something, something about the Dred Scott Decision’ (Conversation with Arnold Harberger October 1997). 51 The standard story told by Chicago School economists has not emphasized the in your face dissident tradition, as we do, but instead has suggested that there was a historical tradition of policy views that fit their pre-existing stances. For example, Friedman battled Don Patinkin for a number of years with his attempt to link his quantity theory of money with an ersatz oral tradition supposedly thriving in Chicago during the thirties. (See Freedman (2006) for an investigation examining the roots of this creation and the reasons behind it.) Friedman however wasn’t impressed by Miller’s original formulation of the Chicago School in his JPE article. Miller’s piece is, as you say fairly innocuous & I cannot for the life of me see why Harry [Johnson] accepted it … Had Miller been more critical & offensive, I would understand it far better. Even then, such a piece is not of the kind that should be published in J.P.E. (Letter from Friedman to Stigler, August 2, 1961). 20

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition ideological soundness. Only those deemed to be ‘sound’ would have a likely chance of being selected. 52

This new Chicago School of Economics ostensibly continued to support the idea of nurturing dissent, at least in principle, but in practice, allowable dissent was much more limited than in the past. The encouragement turned out to be decidedly one-sided. 53 They acknowledged dissent, but only that which ran parallel to their own efforts against the post war economic consensus. Opposing views were more often treated as a plague deserving only eradication. These Chicago stalwarts often appeared to operate under the principle that anyone who did not support the market must be ideologically biased or deliberately obtuse. At a surface level, just about every academic will support embracing dissent. But putting that support into practice, when it means supporting someone whose politics one disagrees with, is difficult, if not impossible.

Like any other institution, the Chicago School could not be perfectly and uniformly consistent. In a sense this flawed consistency backlighted the market fundamentalism at the heart of the department. Robert Solow, whom Stigler attempted to recruit to Chicago, seems to be a clear deviation from the School’s categorical imperative of stamping out dissent at all costs. 54 However, what at first appears to be an aberration is easily explicable as a matter of

52 In their minds those proposing or supporting heterodox theories were almost automatically suspected of practicing a shoddy brand of economics. Furthermore, a number of other contemporaries, such as Lester Telser, described this as an ‘us’ versus ‘them’ mentality, a band of brothers opposing the forces of darkness. If a rigorous mathematical analysis is reinforced by an exemplary econometric study in asserting some relationship R, and Aaron Director on reflection denies the relationship, I would consider it rash beyond forgiveness to venture 5 cents on the existence of relationship R. (Stigler, George J. (1976) Those directly involved would have not recognized any inbuilt bias. They would instead discover an unfortunate bias within society, one that was erroneously augmented by the economics profession, against the beneficence provided by markets. Representative of this view is the rather sharp reaction of a close colleague of the Friedman, Stigler, Director triumvirate, Harold Demsetz. He bemoaned the fact that the economics as practised at UCLA had been unfairly tarred, and even victimized, by this bias in an LA Times article. Not only does [the reporter] describe the Department as possessing a political viewpoint, but he attributes the strength of propagandizing to resources made available to it from outside business interests for precisely that purpose. The Department has had to live with its conservative image for a long time, but during the last few years we had achieved real quality, have hired from the East coast, and have placed student on the East Coast, and never had the Department been accused of more than being overbalanced in its conservative belief (Letter from Harold Demsetz to George Stigler, May 14, 1978). Of course the changes in the level of acceptance granted UCLA (often called Chicago-West by other departments) which are noted by Demsetz, also reflected the rising acceptance of the Chicago approach within the profession. 53 Their scepticism, though timely as far as it went, was decidedly one side by nature. Perhaps their fellow Chicago graduate, Paul Samuelson, placed the dilemma in a useful context. It was President Truman who called for a one-armed economist. Not for him, the adviser who says, “On the one hand this. On the other hand that.” My experience requires me to reply thus: With respect, Sir, you really cannot want a one-armed economist. For in economics, one- armed experts come in two varieties: those with a right arm only, and those with only a left. And then, Sir, you have to call in a two-armed eclectic like me to adjudicate between the zealots. My most precious trait is the important gift of “Maybe” (Samuelson 2011c:418). 54 Chicago of course was a contentious arena. For instance, George Stigler’s famous industrial organization workshop treated discussion as a ‘take no prisoners’, blood sport. 21

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition personal chemistry. Solow had gained Stigler’s abiding friendship by meeting him head to head and by being equally sharp witted and well read. Despite his forbidding image, the personal often overrode Stigler’s professed principles. As Gary Becker noted: I raised this issue with him in a slightly different guise. When George was sceptical as I said about the altruism issue I said, ‘Look George, look how generous you are to your children. Are you doing that out of self-interested motives? Who are you kidding? You’re not doing it out of that.’ And he looked at me and he didn’t answer and he knew he wasn’t doing that out of self-interested motives. He was actually very generous with his family, as he was with people in general. So, I think George, when pressed hard like I did there, would admit there is a motive beyond simply selfish self-interest (Conversation with Gary Becker November 1997).

However, Solow wasn’t tempted by the Chicago offer in part because of the other elements of the Chicago tradition—the in your face method of arguing, and also the highly ideologically tinted approach. In a sense, the Chicago insistence on consistency created something of a self-selection process that in turn insured that its uniformity remained inviolate. Solow himself was much more comfortable operating in an environment reflecting a gentlemanly academic tradition. Responding to a question concerning whether his accepting that offer might have had much of an effect, Solow states: Oh, I don’t think it would have much effect … I’m a very counter-suggestible person. It might have changed me methodologically a little, but I don’t think I would have been happy because being involved in intellectual … in controversy with one’s colleagues all the time is never a formula for relaxation. I also think probably I might have been more productive at the University of Chicago, more productive in terms of volume although I’m not so sure in terms of quality. It’s the ethic here. It has always been a little more laid back, a little more relaxed. So, I don’t think it would have turned me into a conservative, or a monetarist or any of those sorts of things. Or a, you know, a gung-ho free marketer (Conversation with Robert Solow November 1997).

Essentially, once Stigler came on board in 1958, the triumvirate of Stigler, Director and Friedman reinforced each other’s views, and led them to believe that almost anyone who did not hold their views either wasn’t thinking or was incapable of thought. As Paul Samuelson points out, sharing their position became a requirement for being theoretically sound: They defended each other. Now, Aaron Director, for example, would never have written a good letter of recommendation for somebody who wasn’t a staunch conservative but neither would Milton. And I remember for years after I left the University of Chicago, when they were contemplating influential appointments they would ask me about the person, ‘Is he really sound?’ (Conversation with Paul Samuelson October 1997).

The Road Back – Moving Markets Back to Centre Stage

People had their knives out. I participated in some of them. I think people were using George’s example. No prisoners were taken in other words. And everybody just jumped in. It was just chaos those workshops (Conversation with Sherwin Rosen, October 1997) . However, though specific disagreements were fierce, the fundamental tenets defining the Chicago School were never really up for debate. To members of the Chicago school, these pro-market tenets were practically self- evident. 22

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

As we have argued above, the Chicago school was involved in a concerted effort to shift the intellectual terms of debate away from what it considered to be an unreasonable, if not irrational, bias toward government intervention, to what they viewed to be a sensible leaning toward laissez faire. This was a conscious effort, and the beginning of this attempt is perhaps best symbolized by the first Mont Pelerin meeting in April 1947. 55 This initial gathering quickly followed the start of the Cold War as a former wartime ally, the Soviet Union, once again became categorized as a deadly enemy threatening the basic freedom and liberty of western nations. Only a year had passed since Winston Churchill had announced, on March 5, 1946, the start of these new, inevitable, hostilities in his "Sinews of Peace," address (the "Iron Curtain Speech ") at Westminster College in Fulton, Missouri. “From Stettin in the Baltic to Trieste in the Adriatic an iron curtain has descended across the Continent.”

Both George Stigler and Milton Friedman attended that first Mont Pelerin meeting, under the tutelage of Aaron Director and Frank Knight. If we carefully shift through their work prior to and after this date, the event would seem to have noticeably transformed the tone and even the precise direction that their research would take subsequently. 56 The unifying belief of that gathering was a shared perception that planned economies (and certainly the belief in them) were becoming not only intellectually acceptable, but the accepted norm. To those forming the Mont Pelerin Society, the slide toward a totalitarian state, only recently arrested in the last war, and now a threat once again under the guise of communism, seemed inevitable unless those of good sense were roused to action. That the catalyst for this first gathering of conservative eagles was Friedrich Hayek is hardly surprising. The Road to Serfdom (1944) served as an unmistakable warning to those worried about eroding freedoms in the post war era. The volume itself became something of a Bible for those regrouping on the right. 57

The ostensible goal of this historic meeting was to preserve and strengthen the virtues of a style of classical liberalism reflecting the values of John Stuart Mill. These were the very ideas that those attending the meeting claimed were in danger of being discarded, given the

55 Members were unified in their belief that left-wing intellectuals (the mouthpieces of collectivism) had captured the post-war high ground of debate and must of necessity be dislodged. (A classic strategy found in von Clausewitz’ Principles of War. ) At that very first meeting they were not always in agreement on details. Von Mises for instance accused Hayek of being a socialist. However the advent of the Cold War certainly had added a clear note of urgency to their objectives as is clearly indicated in their statement of purpose. The central values of civilization are in danger. Over large stretches of the Earth’s surface the essential conditions of human dignity and freedom have already disappeared. In others they are under constant menace from the development of current tendencies of policy. The position of the individual and the voluntary group are progressively undermined by extensions of arbitrary power. Even that most precious possession of Western Man, freedom of thought and expression, is threatened by the spread of creeds which, claiming the privilege of tolerance when in the position of a minority, seek only to establish a position of power in which they can suppress and obliterate all views but their own (Mont Pelerin Society website). 56 Their early work (prior to this date) could hardly be described as having a clear ideological base. A number of George Stigler pieces, especially for the NBER were strictly empirical as were a few by Friedman. On his early work, Friedman himself noted that he was surprised, on rereading it, to discover how Keynesian this output was in approach. 57 More prosaically, The Road to Serfdom , either in its original version or the Reader’s Digest condensation, became a best seller. The work brought Hayek to the notice of H.W. Luhnow of the Volker Fund. It was this fund which would bankroll many of Hayek’s projects, including that first meeting of the Mont Pelerin Society. Approaching seventy years after its initial publication, the volume once again is required reading for many of the current Tea Party adherents. 23

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition engineering style of optimism that characterized the planning aspect of the Keynesian revolution. The Mont Pelerin project, and subsequently the creation of a Law and Economics program in the Law Faculty at Chicago, seemed the very embodiment of Henry Simons’ aspirations to re-establish a beachhead of liberalism and thus an effective antidote to the wave of creeping collectivism. Simons envisioned institutions that would serve as incorruptible redoubts of liberal values; namely those embodying freedom, individual choice and liberty. He hoped for a functioning organization that … should not be mainly concerned with formal economic theory nor should it engage substantially in empirical research. It should focus on central, practical problems of American economic policy and governmental structure. It should afford a center to which economic liberals everywhere may look for intellectual leadership or support (Henry Simons quoted in Coase 1993:244).

Almost inevitably, Hayek and Director became the key figures pushing for the establishment of a Law and Economics program while attempting to validate that field as a serious source of economic research. The pair had discovered in each other a congenial meeting of minds during Director’s visit (1937-38) to the London School of Economics. In the following decade, Director would find himself able to influence the publication of Hayek’s classic by the University of Chicago Press. The book then generated the Volker Fund money that would not only underwrite the Mont Pelerin meeting, but also the Law and Economics program within the Law Faculty.

The counter-revolution launched from this Swiss platform essentially promoted a market fundamentalist understanding of economics, one that discovered no difficulty in making an unambiguous leap from markets to liberty. In this vision, unfettered markets intrinsically could solve all problems, and externalities were demoted to matters of minor importance, as was monopolistic competition and any other deviation from perfect competition. This unyielding insistence that markets inevitably promoted economic liberty and individual freedom, fortuitously struck a responsive chord in policy circles during the virulent anti-communist campaigns defining the McCarthy era. 58 The ideology of free markets and laissez faire perfectly complemented a rising wave of fear and suspicion of enemy subversives.59

58 Stigler and Friedman would fiercely defend academic freedom from the excesses of the left in the 60s and 70s. Greater tolerance of government intrusions seemed to be extended during the McCarthy period when it is natural to think that they would have taken the threat to free expression on campus a bit more seriously. Curiously enough, while they had little difficulty with the externally driven crusade of the fifties, they found themselves ringing the alarm bells in reaction to the more internally generated issues of the sixties and seventies. But it wouldn’t surprise me that he [Stigler] had a schizophrenic attitude to attacks on intellectual leadership depending on which direction it came. A lot of right-wing people must have found McCarthy to be vulgar, brutal but basically less of a problem than the alternative. But they considered him to be basically on the right side of the issues. Not unlike what you read that people said about Hitler, in the early 30s, when he was on the rise. Yes, he’s a gangster. Yes, he’s a hooligan but he’s anti-communist. He’s going to keep back the communists and control trade unions. These are benefits. And they didn’t realise that they were rearing a Frankenstein’s monster who would eventually chop off their own heads. A lot of people were sympathetic, who would have been horrified if they had foreseen what would happen (Conversation with Mark Blaug May 1998). 59 A similar trend could be discerned in the post-World War I period characterized by the Palmer raids. Once again the government (led by Attorney General Palmer) used a burgeoning threat from groups of loosely defined subversives to crack down on vocal opponents of both the status quo and the idea of unfettered capitalism. 24

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

To get people to support an ideology of free markets, these aspiring counter- revolutionaries needed to undermine the ruling ideology of government intervention, which had become an intrinsic component configuring the canonical economic model of policy formation. This pro-government interventionist approach can best be categorized as an ‘economics of control’ policy view. Abba Lerner (1944) in his Economics of Control nicely articulated this understanding of the role of government. Lerner’s work would serve as a text for many graduate programs in the 1940s and would provide the organizational structure of Paul Samuelson’s principles textbook (first published in 1948). The ‘economics of control’ approach to policy consisted of two parts. The micro component extended Pigou’s Welfare Economics framework (Pigou, 1920) to definitive rules about policy interventions— redefining the justification of policy from broadly philosophical and loose arguments, in which economics had only a supporting role, to a precise theoretical substantiation which specified optimal policies as achieving appropriate marginal conditions. This change in policy justification established a mandated theoretical role for government action. Correcting the many externalities that existed in any economy became the springboard for decision- making.

On the macro side of Lerner’s ‘economics of control’ approach, the same method held. The market was flawed and the problem could only be solved if government undertook an activist role, namely in providing a ‘functional finance’ stabilization policy. Within this economics of control macro framework, full employment was an unarguable goal that could be achieved only through the appropriate government policy.

The ‘economics of control’ approach employed the logic of externalities to underwrite its validity. Their existence provided the leverage for government intervention. Thus, to counter the persuasion provided by this ‘economics of control’ approach, opponents had to somehow either dismiss externalities out of hand or at least trivialize their importance. As a first resort, they argued that externalities were empirically unimportant, but that argument failed to convince many people. Consequently they were forced to turn to an alternative argument that proved to be more fruitful. Specifically, George Stigler seized on the ideas of Ronald Coase, transforming aspects of those ideas into a pithiness suitable for textbook realization. Stigler’s Coase Theorem held that the market was capable of solving externality problems on its own. The elegance of this Coase Theorem allowed those of the Chicago School and their camp followers to use price theory as the unconditional, theoretic underpinning of an approved laissez faire approach.

The Paths Not Followed: A Coasian Classical Chicago?

The use of the Coase theorem to support a narrow market approach provides a useful example of the argumentation style that formed an essential part of the Chicago School. The emphasis here is on the tactical advantage to be gained rather than on any potential explanatory benefits, given that the Coase Theorem, as stipulated, is not what its creator, Ronald Coase, had in mind when he first constructed his argument. Considering how the Coase theorem went on to become a key building block in subsequent policy debates, a closer examination is instructive in stipulating how far the Chicago School came to deviate from Classical liberalism. 60

60 Another Chicago trained economist who remained much more consistent with the Classical liberal tradition was James Buchanan and his Constitutional approach to economic theory. Buchanan did not try to rhetorically 25

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

In 1964, Ronald Coase migrated to Chicago from the University of Virginia. He was the designated and appropriate successor to the law school position previously held by Aaron Director. Coase was (and remains) a Classical liberal, writing and working in that tradition. As part of that approach, he argued that the entire Pigovian framework missed the nuance of arguments for and against the market, and in a seminal article argued that since the model did not take into account transactions costs, it could not be directly used in policy analysis. This argument eventually was published in the Journal of Law and Economics , as “The Problem of Social Cost” (1960).

In his autobiography, George Stigler relates the story of a dinner, held at the house of Aaron Director, where Coase single-handedly changed the minds of the assembled cohort of Chicago economists. In Coase’s understanding, his argument was primarily focused on transactions costs. The Pigovian model assumed away such costs, but then inappropriately analyzed the problem as if transactions costs were simply absent. 61 What Coase argued was that if one made an assumption of no transactions costs, then one would expect that any externality could be handled by inter-agent agreements. If there are no transactions costs, there is no need for government intervention. Externality problems would be simply internalized by the inter-agent agreements.

Coase specifically did not interpret his argument to imply that no government intervention was needed. He fully recognized that if there were no transactions costs, not only would there be no need for government intervention, there would be no need for the market. It too could be replaced by inter-agent agreements. Neither of these arguments could be directly applied to policy since transactions costs always existed, often to a significant extent. This meant that the appropriate policy procedure would need to be case specific. Coase’s argument was a challenge to the Pigovian welfare economics framework, not an argument for or against government intervention.

For Coase, economic theory had nothing directly to say about whether the government should intervene or not. That insight makes Coase’s approach entirely consistent with the Classical liberal view. His argument was that any model that did not include transactions costs was not going to specify whether government intervention mattered or not, because it assumed away the very costs that were central to making that decision. Instead, any considered decisions about policy would have to be evidence based, made on a case by case basis. 62

In Coase’s approach, there was room for both too much as well as too little government. This was very much in the Classical tradition—theory and models were used as aids to judgment, not definitive guides to policy. Coase was clear that this was his intent. His dislike of jumping from theory to policy was evident.

support markets with models, but instead made broader arguments supporting free markets and laissez faire. But precisely because he did that, his arguments had less influence. His public choice work, which could be integrated into a mathematical economic analysis of politics, consequently had a much greater impact. 61 Pigou was careful to note the limitations of his framework. Later users of his welfare framework, such as Lerner, were less careful. (Pigou, 1951; Colander, forthcoming-a) 62 Coase could only honestly conclude that theory did not provide specific answers. I wrote that “direct government regulation will not necessarily give better results than leaving the problem to be solved by the market or the firm. But equally there is no reason why, on occasion, such governmental administrative regulation should not lead to an improvement in economic efficiency” (Coase 1994:62). 26

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Blackboard economics is undoubtedly an exercise requiring great intellectual ability and it may have a role in developing the skills of an economist, but it misdirects our attention when thinking about economic policy (Coase, 1988:19).

Stigler however seized upon this Coasian argument against the Pigovian approach of moving directly from theory to policy, and transformed it into an alternative argument that also moved directly from theory to policy. The difference was that the reformulation of Coase’s argument, which Stigler called the Coase theorem, buttressed a policy that Stigler himself supported—leave the market alone, since the market left along would achieve an efficient outcome. 63 Thus, instead of interpreting the argument as Coase did, as an argument against the use of models that left out transactions costs to derive policy results, Stigler interpreted it as an argument against externalities. 64 For Stigler this demonstrated that the market was capable of taking care of such issues on its own. Using his version of Coase’s work, Stigler adapted Coase’s argument to serve as a bulwark against government intervention. Coase’s insight became the impregnable Coase’s Theorem, insisting that in the absence of transactions costs, externalities were not a problem. The Pigovian externality thorn in the side of market fundamentalism could now be effectively extricated, and price theory could be directly utilized to support laissez faire policy. While technically true, the Coase Theorem was also irrelevant for direct application to policy because in the absence of transactions cost, there would be no need for markets—people would just freely negotiate all agreements. But for the mainstream to argue that, they also had to backtrack by arguing that Pigovian framework was similarly irrelevant for direct application to policy. To effectively defeat the Chicago position they had to be willing to surrender their own.

The Stigler invention of a Coasian theorem inevitably became highly contentious given its role as a rhetorical ploy. Practically, both market and government solutions inevitably have a whole set of specifics attached to them. So, instead of promoting the reasonable Coasian position, that when examining the real world, decisions need to be made on a case by case basis, the ‘through the looking glass’ Theory offers policy absolutes. Coase’s Classical liberal position became transformed under Stigler’s skillful hands into a rhetorical argument for the market that the mainstream model could only counter by undermining its own underpinnings. 65

63 That Stigler chose to title that chapter of his autobiography ‘Eureka!’, easily reveals a not so well hidden agenda. Samuelson also saw a bit of sleight of hand as being performed by the Chicago contingent. But Stigler and Friedman jumped on to Ronald Coase and felt that the Coase doctrines about transaction costs and property rights - just get the property rights right then laissez-faire could be relied upon - was the lifeline that they sought. Now, all that I know about this part of the story is what’s called the Coase Theorem. And that’s a coinage of Stigler’s. I don’t think Coase knew what his theorem was. There’s great argumentation as to whether there is a theorem (Conversation with Paul Samuelson, October 1997). 64 Stigler’s long time researcher, Claire Friedland best sums up Stigler’s views on externalities. George was focused on the way the market marches in to eliminate the externalities, to work around them to make them a market problem instead of a non-market problem. I think I’ve quoted him in my memoir as saying something like, ‘externalities are what the market has not yet eliminated.’ (Conversation with Claire Friedland November 1997). He described externalities as that for which there are no transactions at the present time (Friedland 1993:781). 65 In a private conversation (October 1997), Coase suggested that at that famous dinner it was only Arnold Harberger who had seriously grasped both his intentions and the associated employment of marginal analysis. When asked about the ‘Coase Theorem’ he agreed that Stigler had transformed his argument into something that wasn’t exactly there. Coase stated “He was always very nice and kind and helpful in many ways. Always. But I often wondered how far he agreed with what I was saying. I think he thought I was all right, but a little odd” (Conversation with Ronald Coase, October 1997). 27

The Chicago Counter-revolution and the Loss of the Chicago Liberal Tradition

Conclusion : The Paradox of Chicago Style Liberalism

The story of the rise of the Chicago School is not a story of good guys versus bad guys, much less a Miltonian epic pitting the forces of good against those of evil. Rather it is a story of a prisoner’s dilemma in which both sides are trying to do what they see as proper, but in order to save the greater good, feeling they must violate some methodological principles. What we discover upon examination more closely resembles the flawed offspring from an illegitimate marriage between economic theory and policy. These wedding banns could only lead to the sundering of the strict stance separating theory and policy that had characterized Classical liberalism. The history of the Chicago school demonstrates the problems that result when economic theory and policy are too closely combined. This unfortunate association had its roots in the Lerner-Samuelsonian transformation of the Pigovian welfare formulation into an ‘economics of control’ approach. The result of their labors made it appear as if economic theory could be used directly to support government intervention. This was the controversial contention that helped spark Chicago School economists into developing a pro-market theory that perfectly shadowed that pro-government approach. The Chicago School succeeded, but only at the cost of surrendering both the Classical liberal and older Chicago methodological traditions, while providing even greater credence and importance to the art of story-telling, the skillful use of the devices and tools of marketing.

Our view is that this Southside fable suggests that the profession needs to consider returning to the Classical methodological tradition of Mill and Sidgwick. This would require both pro-market and pro-state economists to take more care in directly drawing policy conclusions from their formal models. Such a Classical revival would recognize the purpose of models as guiding intuition, not as providing set paths for policy. The end result would be a useful admission that economists can reasonably come to many different positions on policy. Modesty could once again achieve a legitimate place within the profession.

In general, the urge to commit neoclassical policy leaps either in favor of, or against, government action on the basis of a formal model needs to be recognized as almost always unwarranted. Economics provides useful insights but not definitive policy recommendations. If economic theory is tied too closely to policy recommendations, its insights can be lost. General theory can provide limited guidance to policy analysis, but produces applicable policy precepts only when combined with moral philosophical judgments, and deliberately integrated with all relevant non-economic considerations. As Classical economists strongly believed, economic policy, which holds more interest for those outside of the profession, lies, for the most part, beyond the strict boundaries set by science, and in the realm of what J.S Mill and J.N. Keynes have aptly labeled the ‘art of economics’.

References

Bronk, Richard (2009) The Romantic Economist . Cambridge: Cambridge University Press. Buchanan, James M. (2000) “The Soul of Classical Liberalism” Independent Review , 5(1): 111-119 Churchill, Winston, (1947) “Speech”, Hansard . 11 November: col.206). Coase, Ronald H. (1960) “The Problem of Social Cost”, The Journal of Law & Economics . 3(1):1-44. Coase, Ronald H. (1988) “The Firm, the Market, and the Law”, in The Firm, the Market and the Law . Chicago: University of Chicago Press, pp. 1-31. Coase, Ronald H. (1993) “Law and Economics at Chicago”, The Journal of Law & Economics . 36(1):239-254.

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