The Financial Crisis and the Challenge of Natural Law


Is the current financial crisis simply a technical failure, or does it derive from some more basic problem? Economists may need to begin addressing fundamental questions concerned with value, and for that, they may turn to the natural law tradition.

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One of the fallouts of the global financial crisis, especially in the wake of the Lehman collapse in September 2008, has been a questioning of the value of much economics, whether as delivered by the mathematical adepts of sophisticated financial modeling in the business world, or by academia. Both kinds of economics promised a rational world of ever-increasing happiness and stability. But now that tool box appears to be rather empty.

Many observers have commented that much conventional economics has failed empirically, in that it ignored themes such as financial instability or the possibility of multiple equilibria leading to sub-optimal outcomes. Such prominent figures as Paul Krugman have joined in the orgy of recrimination and castigation (though rarely self-castigation).There is no doubt about the extent of the empirical shortcomings, and that many prominent economists followed the maker of the rational choice revolution, Robert Lucas, in erroneously claiming that improved economics made financial crises an impossibility. Consequently, many people, including many economists, have complained that “economic theories failed just when we needed them most.”

As a result, the crisis has led to a battery of worrying policy initiatives. Will temporary surges in state spending to deal with the aftermath of banking crises lead to permanently higher levels of government spending and indebtedness? How can they be financed? Is there a danger of inflationary developments as a consequence of ballooning public sector deficits? Citizens should ask precisely what is worrying in the new policy initiatives: only with an articulation of that concern will it be possible to formulate legitimate policies. Often, complaints about the inadequacy of economics are linked to advocacy of some policy position in response to the crisis. Such policy positions are fiercely contested, and many of them appear linked to particular and powerful interests: banks and financial services, lawyers, automobile producers and automobile trade unions are all groups that have tried to assert that a general good depends on the subvention and rescue of their particular kind of activity.

Most recently, the issue of executive compensation has dominated national and international debates. What sorts of compensation level are appropriate, and how should these levels be determined? What criteria can be used in setting levels of compensation? Or is this an activity which the state should not be involved in at all, and which should be left as the outcome of market processes? The most divisive issue at the G-20 Pittsburgh meeting concerned precisely the appropriate response to the problem of remuneration in the financial sector. Most Americans are prepared to argue that high pay levels are not appropriate where losses mean that financial institutions need to be bailed out with public money. Some others argue that a distorted incentive system in the past led bankers to take inappropriate risks, and that consequently, for pragmatic reasons, the incentives should be better adjusted to mirror long-term performance (and also long-term social or general gains). By contrast, some European governments and thinkers suggested that excessive pay levels were in themselves wrong—regardless of whether they led to losses and inappropriate gains or not.

None of these controversies really address the causes of the perceived failure of conventional economics. The question remains whether this is simply a technical failure, or whether it derives from some more basic problem. Is there a more general failure because of an unwillingness among economists to discuss fundamental questions concerned with value?

What are the value of public goods such as currency stability? Why should we place a value on open markets? For what reasons should people have the opportunity of undertaking employment?

Sometimes discussions of such motivations revolve around concepts of natural rights: a right to employment, to a fair income, or to access to markets. What is the source of such rights, and how can conflicts of rights be arbitrated?

It is not surprising, then, that there is a new concern of some economists with justice and with ways of interpreting justice that do not necessarily involve the clash of two or more conflicting rights but rather as a way of developing potentials that are inherent in human beings. One interesting consequence of this new concern has been a revived interest in how different cultures have handled the problem of clashes of interest, as in Amartya Sen’s new book The Idea of Justice. Often the idea of precepts that can be derived from reason is traced back to Greek philosophy, especially to Aristotle, and especially as mediated in medieval philosophy in the writings of Averroes and Aquinas. But Sen has pointed out how Indian thinkers evolved a rather parallel discourse to that of Aristotle; Arthur Waldron has identified the same debate in China over two millennia ago.

It is reasonable to think that the crisis in empirical economics and the broader crisis in values are connected. This is where natural law thinking can be a powerful corrective. For in the natural law tradition, a body of guiding principles can be derived from the application of reason. But integrating the natural law tradition with contemporary economics may prove difficult.

One outstanding problem is that differing traditions of analysis have no way of speaking directly to each other. Moral philosophy is normative, while economics self-consciously avoids the creation of norms, and instead analyzes the relationships inherent in empirical data. The different approaches look as a consequence like endless parallel bars, inviting impossible intellectual and moral gymnastics between is and ought.

Both disciplines in consequence have their own very distinct version of a crisis. For moral philosophers, the world of the market does not behave as they hold it should, while economists have discovered that the market does not behave as they think it will.

There are also different views of the time framework for analysis, each of which presents its own peculiar problems. The concepts of justice are eternally valid, with the result that many will ask how they should adjust to a world which is constantly changing and generating new problems that require new analyses. By contrast, the problem of utility is that it may be a very short-term concept. Indeed, much of the literature on happiness has been devoted to showing that many forms of consumption generate only a short term surge in happiness without leading to a long-term increase in wellbeing. As a result, many argue that a truer measure of felicity would need to examine long-term contentment. Latin distinguishes very clearly between the short-term state of happiness (felix) and the longer-term state (beatus).

The most basic issue in the debate on the contribution of natural law thinking to economics is the question of the realization of human freedom. Over the past thirty years, a prominent theme of much analysis has been that political and economic freedom produce benefits, in particular gains in well-being. Sophisticated measures such as those provided annually by Freedom House are used to establish the empirical veracity (over fairly narrowly defined time periods) of this social-science claim. A parallel stream of thought tried to make the claim that religious practice was desirable and beneficial because—again as demonstrated empirically—it was associated with gains in income and wealth. The social-science analysis of religion in this kind of way goes back at least to Max Weber’s famous identification of the Protestant ethic with the “spirit of capitalism.”

The empirical argument for faith and freedom can be deeply distorted and quite destructive. Freedom has a value—or represents a truth—in itself. Religious values are not derived from their potential material benefits but from a transcendent order. Even though it may be true that faith and love represent a powerful tool in tackling poverty, they do that because of their intrinsic value as expressions of what is truly human. The greatest contribution that the natural law tradition provides is its powerful insistence on a hierarchy of value, in which value as such is recognized, rather than appearing as an instrumental tool for some other purpose.

Harold James is Professor of History and Public Affairs at Princeton University. He is a Senior Fellow of the Witherspoon Institute, where he is also the Director of the Program in Ethics, Culture, and Economic Development. His most recent book is The Creation and Destruction of Value. He sits on the editorial board of Public Discourse.

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