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A High Profile Convert to Keynsianism

When I started law school, I learned something rather quickly–Richard Posner is one of the most popular and cited judges in the United States. As such, it is no surprise that as a student, I read more of Posner’s opinions than just about any circuit judge in the land. Law school professors found Posner’s legal reasoning to be particularly unique, interesting and relevant in teaching the evolution of common law. What sets Posner apart is his application of the rational choice theory to law itself. In legal circles, Posner became synonymous with cost-benefit analysis as applied to a wide variety of legal issues. His disciple, Frank Easterbrook (who is not quite as cool as his brother Greg, of Tuesday Morning Quarterback fame) similarly rose to prominence for the integration of economics into legal analysis. Ronald Reagan appointed both mentor and disciple to the Federal Circuit and George W. Bush considered nominating Posner to the Supreme Court. Posner is a man of unquestioned conservative and free-market credentials.

In late September however, Judge Richard Posner wrote an article for the New Republic declaring his conversion to Keynsianism and now he is out with a book entitled The Crisis of Capitalist Democracy. This is a shocking, and some would say extreme, step for one of the most prominent Chicago School free-marketers in the country. Posner’s adoption of Keynsianism marks a cataclysmic change in both the legal and economics world. In his September article, Posner had the following to say about the contrast between Keynsianism and the rational choice theory:

People are assumed to make rational decisions across the entire range of human choice, including but not limited to market transactions, by employing a form (usually truncated and informal) of cost-benefit analysis. The older view was that economics is the study of the economy, employing whatever assumptions seem realistic and whatever analytical methods come to hand. Keynes wanted to be realistic about decision-making rather than explore how far an economist could get by assuming that people really do base decisions on some approximation to cost-benefit analysis.

The General Theory is full of interesting psychological observations–the word “psychological” is ubiquitous–as when Keynes notes that “during a boom the popular estimation of [risk] is apt to become unusually and imprudently low,” while during a bust the “animal spirits” of entrepreneurs droop. He uses such insights without trying to fit them into a model of rational decision-making.

What I find most revealing about Posner’s change of heart is the fact that such a prominent economist, who bought into the notion that Keynsianism had been disproved and was merely a relic of the past had not actually READ Keynes. I find it reassuring that at the ripe young age of 70 years old, he put his ego aside and paid homage to The General Theory; however, I cannot help but ask: “what took you so long? And how is it possible that one of the foremost economic minds in our country never read Keynes for himself?” To merely accept at face-value the dismissal of one of the world’s most important economists without having read it is inexcusable for a renowned scholar.

Posner applied his legal theory under the assumption that in aggregate, all decisions are based on rational actions. Did he not know the Keynsian truism that “markets can remain irrational longer than you can remain solvent?” That very idea disproves a component of rational choice. Keynes did an outstanding job incorporating psychological and mathematical models in order to compose a coherent guide to macroeconomics.

Yesterday, Damien Hoffman, over at Wall Street Cheat Sheet offered the following question:

In law school many of my professors had erotic tones in their voices when uttering the name “Richard Posner“. But is Posner sleeping around while still living at home?

…He was a neoclassical economic thinker who is credited with projecting economic theory into the realm of jurisprudence. However, since former Fed Chairman Alan Greenspan’s light bulb went off during the global economic meltdown, Posner has become a zealous inquisitor of extremist free market thought.

Thus far, Alan Greenspan’s mea culpa has yet to lead to a seismic shift in the landscape of economic theory. It will be interesting to see whether Posner’s shift has a greater impact in legal circles. Moreover, I am curious as to whether Posner’s new book stimulates a larger discussion as to what the predominant and operating economic policy should be in the United States moving forward. Personally, I think the area in which many get lost is believing that we either need complete laissez-faire free markets, OR Keynsianism and that the two are mutually exclusive. That idea in part stems from F.A. Hayek’s slippery slope argument in The Road to Serfdom, in which Hayek declares any government involvement in the economy as the first step on the slippery slope to totalitarianism. Slippery slopes are a logical fallacy.

More realistically, I believe the correct approach to economics moving forward would be an amalgam of principles in which a balance between government regulation and laissez-faire allows for free markets to operate while minimizing the negative externalities that result from the emotive nature of economic cycles. These are some themes that I will look to discuss in greater length as time moves on.

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