But one of the Great Recession’s unexpected benefits is the manner in which it has reignited a range of economic debates that have needed attention for some time. One is a widespread questioning of the methods and priorities of mainstream economic science. Another discussion concerns the conduct of monetary policy. The decisions of the Federal Reserve and the European Central Bank, for instance, are now subject to micro-scrutiny by not only governments and the financial industry but also by increasing numbers of skeptics with serious reservations about the very manner in which modern central banks operate. Closely related to this are questions about the long-term viability of fiat money: the means of exchange that has dominated the world since the end of the gold standard.

As the Latin word fiat (“let it be done”) suggests, fiat money is a state-issued means of exchange which a government simply declares to be anything which, when presented as payment, extinguishes a debt owed to another. More specifically, as John Maynard Keynes stated in his Treatise on Money (1930), fiat money is “created and issued by the State, but is not convertible by law into anything other than itself, and has no fixed value in terms of an objective standard.” In short, it has no intrinsic value in itself inasmuch as fiat money is not representative of a fixed and known amount of a commodity such as gold or silver. Instead fiat money is ultimately backed, as the U.S. Treasury states, “by all the goods and services in the economy” as well as a confidence that the issuing government can ultimately pay its debts.

Here we should note that fiat money’s viability relies heavily upon the concept of legal tender. This expresses the legal obligation of individuals to accept payment of debt in terms of the currency issued by the state. Indeed, the ideas of legal tender and fiat money are inseparable inasmuch as legal tender provides fiat money with the legal force it needs if it is to be mandated as the means of extinguishing debt in a given jurisdiction.

Contemporary fiat money represents the end of a long process of development whereby governments have used their power of legal tender to use money to pursue various policy goals. Prior to the introduction of paper money, governments were more than willing to debase gold and silver coinage to artificially reduce their debts. Adam Smith pointed out in his Wealth of Nations (1776) that “when national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid.” Smith then added that “the liberation of the public revenue, if it has ever been brought about all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”

Smith was thinking of circumstances in which governments shirked their debts by debasing the currency, thereby evading formal bankruptcy while legally diminishing what they owed their creditors in real terms. The introduction of paper money made this process even easier, if only because printing more paper was less complicated than diluting the amount of gold or silver mixed into a given coin. As the economic historian Norbert Olszak writes in his Histoire des banques centrales (1998), the Bank of England’s first banknotes were described as “certificates of deposit.” They attested to the holder’s claim on a deposit of gold or silver held by the bank. By the mid-eighteenth century, however, the same documents were being formally described as “promissory notes.” The change in wording was deliberate: the purpose was to diminish in peoples’ minds and in the eyes of the law the strict link between the commodities and the paper that was supposed to redeem them.

For part of the nineteenth century and early twentieth century, the linkage of national currencies to the gold standard meant that the value of currencies as well as the amount of currency in circulation was somewhat stabilized by the fact that the paper monies issued by central banks such as the Bank of England were convertible into a fixed amount of gold. But after most countries left the gold standard in 1914 in order to fund unprecedented war expenditures, the prospect of fiat money became more real, despite the attempts of many politicians and economists to reestablish some link between gold and currencies in the inter-war years. Following World War II, the Bretton Woods agreements resulted in many nations setting their exchange rates relative to the American dollar, on the basis that the United States (which then held over half the world’s gold) would peg the dollar’s price to 1/35^th of a troy ounce of gold. The idea was that all currencies pegged to the U.S. dollar would therefore indirectly enjoy a fixed gold value. The tendency, however, of successive post-war American governments to issue more dollars than their holdings in gold could back in order to fund programs such as Lyndon Johnson’s Great Society, the Korean and Vietnam wars, and containment of an expansionist Soviet Union eventually made the system untenable and fiat money a reality in 1971.

This brief excursion into economic history hints at some of the deeper economic—not to mention moral—problems associated with fiat money. One is, as noted, the greater ease with which it permits governments to devalue currencies, thereby reducing the wealth of those with assets denominated in that currency. This surely constitutes an injustice to those individuals and businesses that have saved and behaved in a fiscally responsible manner while simultaneously letting the fiscally imprudent off the proverbial hook.

This underscores the second problem associated with fiat money: its facilitation of systemic moral hazard throughout entire economies. Moral hazard describes those situations whereby people are encouraged to take excessive risks because of the implied assurance that someone (usually the state) will bail them out if the enterprise or investment fails. From this standpoint, fiat money’s very existence arguably encourages the development of moral hazard throughout every sector of the economy. The high level of the U.S. federal government’s public deficit, for example, is at least partly premised on the unspoken supposition that the Fed (which is, after all, a government institution that operates within legal parameters set by Congress and whose members are nominated by the President) can simply print more money in paper or electronic form if creditors become worried that the U.S. government’s borrowings cannot be covered by anticipated taxation revenues, foreign borrowings, and its existing resources. This in turn encourages more people and governments to buy U.S. government debt in the form of bonds, which permits more deficit-spending, thereby encouraging a cycle of ever-spiraling public debt.

Thus, prior to the delinking of the American dollar from gold in 1971, the money supply between 1960 and 1970 grew by 47%, while the public debt grew by approximately 34%. In the decade after the dollar’s delinking from gold, however, a rapid acceleration occurred with the money supply growing by approximately 87% while the public debt increased by almost 139%. Between 1980 and 2005, the pace further accelerated at the respective ratios of 254% and 753%. The absence of some form of “golden brake” (even the pseudo-gold standard that existed between 1946 and 1971) is surely part of the reason for the accelerating increase in public debt.

A third and related problem of fiat money concerns the way that it encourages the illusion that governments and central banks can somehow “manage” multi-trillion dollar economies. The international obligations accepted by all countries adhering to the gold standard (even in its debased post-World War I forms) placed some limits on governments’ capacity to use their legal tender powers to pursue any number of macroeconomic objectives. With fiat money, however, any such restrictions are removed. Instead government and central bank officials can increase or decrease the money supply as they see fit in response to any number of economic phenomena. Sometimes it works (as in the case of Paul Volcker’s successful fight against inflation in the late-1970s and early-1980s), but it also often fails. A good example of this is the Fed’s easy money policies which sought to ease the effects of the dot-com bubble’s implosion in 2000, but which also played a major role in inflating America’s housing market between 2001 and 2007. In other words, the state’s efforts to manage fiat money means that monetary policy is far more dependent on the decisions of fallible human beings who cannot possibly know all the consequences of their choices, rather than the functioning of the rules of something like the gold standard, which, for all its imperfections, provided more predictability about the economy’s likely direction.

As a formal monetary institution, the contemporary system of fiat money is just thirty-nine years old. We are thus only at the beginning of this experiment. If, however, America and Europe’s economic tribulations continue to worsen and an endless cycle of devaluations, deficits and debts ensues, then the case for fiat money will become harder to sustain. That is what makes the articulation of alternatives to our present status quo even more urgent.


Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty, his prize-winning The Commercial Society, and Wilhelm Röpke’s Political Economy.

Copyright 2010 the Witherspoon Institute. All rights reserved.

It is important to remember that monetary policy reflects the state’s choice to prioritize one set of economic possibilities (e.g., long-term monetary stability) over other options (e.g., the government’s ability to use its money-supply monopoly to bolster employment during recessions). These trade-offs, however, don’t just involve technical economic arguments. They also come down to questions of principle.

The case, for example, for fiat money managed by modern central banks is linked to the conviction that the state’s control of the money-supply should be used to realize particular goals. This helps to explain why part of the Federal Reserve’s charter includes the objective of “maximum employ­ment.” The underlying principle is that economic justice requires the state to go beyond maintaining the rule of law, promoting monetary stability, enforcing contracts, protecting private property, and preserving minimal safety nets.

What, then, are the principles underlying the gold standard? To grasp these, we should recall how the classical gold standard worked in its heyday between 1870 and 1914. During this period, the gold standard gradually linked the different currencies of major trading powers such as Germany, America, Britain and France insofar as all notes and coins of countries adhering to the gold standard were underwritten by and redeemable in specific weights of gold.

The effects were twofold. First, the gold standard facilitated an unprecedented stabilization of prices. Thus, as noted by Lewis E. Lehrman and John D. Mueller, “between 1879 to 1914, average annual CPI inflation [in America] was 0.2 percent, with average annual volatility (up or down) of only 2.2 percent. No other standard comes close in combining low average inflation with low volatility.” A second effect was that each unit of the currency circulating in a country could be equally used for payments in other countries. A common and stable universal currency was therefore created without any need for an international monetary authority.

Apart from generating monetary stability, the gold standard also automatically adjusted balance-of-payment deficits. If a country overextended itself by importing more than it exported, gold left the deficit country to cover the imbalance of payments against nations with surpluses. The money supply in the deficit country subsequently fell, thus reducing demand and providing a brake against inflation. The fall in demand also forced deficit countries to become more competitive. In surplus countries, the gold imports increased the money supply, augmented demand, reduced competitiveness, and thus gradually diminished the original causes of the gold inflows.

Central banks played a critical role in this process. Indeed the entire system relied on close cooperation between the world’s central banks. In surplus countries, the gold standard required central banks to lower the discount interest rate charged to members of the domestic money system in order to reduce the gold inflow. This resulted in gold flowing back to deficit countries. Conversely, central banks in deficit countries would raise the discount interest rate, thereby reducing demand, and averting potential inflation.

Consequently, under the pre-1914 gold standard, modern China could not have built up and maintained its presently large currency reserves. Similarly, neither the Bush nor Obama Administrations would have been able to run huge deficits. Nor would it have been as easy for American consumers to acquire such irresponsibly high personal debt levels.

There were several economic advantages to the gold standard. For one thing, its workings were driven by known rules. Monetary decisions by central banks could therefore be foreseen to a certain extent and were thus more predictable. One downside to the gold standard was the slowness with which the gold supply adjusted to real changes in demand. This impaired gold’s ability to function as a regulating mechanism. Ironically, however, it was soon realized that the gold standard’s regulating effects could be accelerated by measures that removed impediments to the ability of economies to adjust quickly to change. The gold standard therefore created incentives for trade liberalization, competition, and entrepreneurship.

A number of principled considerations were, however, also operative. The gold standard placed a high premium on economic security by reducing the uncertainty and risk that flows from fluctuations in the value of money that have nothing to do with the relative valuation of different goods and services. Constant oscillations in the value of currencies undermine our ability to discern what we find marginally preferable to what is marginally inferior.

Another commitment at stake was the conviction that stable money meant greater economic prosperity for increasing numbers of people. Greater monetary certainty spurred productivity and investment, not least because many long-term contracts benefited from a confidence that prices would remain relatively constant over time. Then there were the ways in which the gold standard bolstered the economic well-being of particular marginalized groups. Monetary stability helps, for example, those who lack the financial sophistication to navigate the shoals of inflation, or who are on fixed incomes (e.g., the elderly and disabled).

At the same time the gold standard also encouraged governments to promote the common good instead of narrow sectional interests. Within nation-states, for instance, the gold standard diminished opportunities for the state to manipulate monetary policy in order to favor those with an interest in inflationist policies.

Likewise, the gold standard also generated a commitment on the part of governments to promoting the international common good. As the German economist Wilhelm Röpke once wrote, the gold standard relied upon the unwritten agreement of central banks and governments “to behave in matters of monetary and credit policy in such a way that this fixed and free coupling remained an undisputed permanent institution, irrespective of trade fluctuations.” This required central banks and governments to prioritize the global economy’s long-terms needs over the short-term exigencies of national economies. It also entailed a willingness to resist popular pressures to revert to a type of monetary nationalism in the face of the fluctuations in employment and growth sometimes generated by the gold standard’s adjustment mechanisms.

We should wonder, though, whether the gold standard demanded too much from governments. As the economist and financial historian Michael D. Bordo pointed out in 1981, most countries on the classical gold standard did not follow the rules of the game. During economic downturns, governments were sorely tempted to escape those strictures of the gold standard that facilitated the process of downward correction that adjusted general living standards to the reality of a lower level of economic well-being. Even before 1914, governments knew that abandoning the gold standard would allow an expansion of credit and public spending not possible under the pre-1914 gold standard.

This situation was exacerbated by two factors. First, in the conditions of democracy, monetary authorities became more susceptible to popular pressures to use monetary policy to provide short-term fixes to immediate economic problems. Second, the rise of neo-Keynesian economic theories encouraged politicians and central bankers to adopt monetary policies and interventionist strategies that routinely violated the gold standard’s disciplinary boundaries. In his Tract on Monetary Reform (1923), Keynes demanded that Britain abandon the gold standard because, in his view, it required countries to pursue deflationary policies just when expansionary measures were needed to combat rising unemployment. On these grounds, Keynes dismissed the gold standard as a “barbarous relic.” Underlying Keynes’ argument was a political concern: that liberal democracies might falter under the impact of mass unemployment. Others, however, such as the distinguished French economist Jacques Rueff disagreed. Against Keynes, Rueff insisted that unless the gold standard was allowed to work its anti-inflationary magic, many people would turn to demagogues to save the social order from inflation’s destructive effects.

Is a restoration of something like the pre-1914 gold standard possible? The domestic opposition from those with vested interests in inflationist and interventionist policies would be formidable. Even if that was overcome, the gold standard’s reinstatement on an international level would require a nucleus of countries to agree to adhere to it—something which happened rather spontaneously in the nineteenth century through a series of unilateral decisions by individual countries. Once this had occurred, adherents of a re-established international gold standard would have to insist upon all members maintaining maximum monetary discipline as well as freedom and stability in foreign exchange markets. Countries unwilling to adhere to these rules could not be admitted to the club.

There is of course no such thing as a perfect monetary system. All involve trade-offs. Each has its disadvantages. Nor is something like the pre-1914 gold standard the only alternative to the present fiat money system. Today most politicians, central bankers, and economists regard the gold standard as neither desirable nor possible.

What cannot, however, be denied is that the case for the gold standard goes beyond efficiency arguments. It embodies an emphasis on limiting arbitrary state action, promotes the longer-term economic well-being of less powerful groups, encourages prudence and a concern for lasting stability over urges “to just do something” (however ineffective or counterproductive), and generates a concern for the national and international common good over more narrow sectional interests.

Such principles and commitments should surely be demanded of any monetary system.

Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty, his prize-winning The Commercial Society, and Wilhelm Röpke’s Political Economy.

Copyright 2010 the Witherspoon Institute. All rights reserved.

In doing so, these governments are finally acknowledging a truth initially obscured by the crisis of the euro: that for all the disarray generated by the euro’s recent tribulations, Europe’s economic woes have more systematic causes.

One cause is several decades of low economic growth. As the Czech president Václav Klaus recently observed, “average annual economic growth in the eurozone countries was 3.4 percent in the 1970s, 2.4 percent in the 1980s, 2.2 percent in the 1990s and only 1.1 percent from 2001 to 2009.” “A similar slowdown,” Klaus added, “has not occurred anywhere else in the world.”

A second problem is Europe’s profound demographic decline. On current projections, for example, Spain’s over-65 population is set to increase from its present level of 17 percent to 25 percent by 2030. That means fewer people working to support growing numbers of pensioners.

When low economic growth and declining demography are combined with European welfare states—generous state-provided health and unemployment insurance; early retirement and liberal state pensions; large public sector employment; legislation that emphasizes job security over labor market flexibility—something eventually has to give. Greece has reached that point. The rest of Europe is struggling to avoid following Greece into the abyss.

Even so, many European governments are proceeding down the reform path with barely disguised reluctance. In France, for example, President Sarkozy’s government wants to raise the official retirement age from 60 to 62. That will not strike many as a radical reform. By contrast, Spain’s Prime Minister Zapatero is already cutting pensions, civil servants’ wages, and social programs. He has also promised labor market reform, something the IMF has identified as desperately needed in Spain. Yet, as the Economist correctly notes, Zapatero “shows no willingness to force reforms past the unions. He will do what he has to do, but always the minimum and without enthusiasm.”

No doubt, this reflects a disinclination of many European politicians—on the left and right—to concede that the post-war European effort to use the state to provide as much economic security as possible has encountered an immovable obstacle in the form of economic reality. Yet it is arguable—albeit highly politically incorrect to suggest—that it also reflects the workings of a potentially deadly nexus between democracy (or a certain culture of democracy) and the welfare state.

One justification for democracy is that it provides us with ways of aligning government policies with the citizenry’s requirements and of holding governments accountable when their decisions do not accord with the majority’s wishes. But what happens when some citizens begin viewing these mechanisms as a means for encouraging elected officials to use the state to provide them with whatever they want, such as apparently limitless economic security? And what happens when many elected officials believe it is their responsibility to provide the demanded security, or, more cynically, regard welfare programs as a useful tool to create constituencies that can be relied upon to vote for them?

The end result should surprise no one: a spiral of expanding welfare that neither politicians nor the expanding number of welfare beneficiaries have any real desire to stop until things become so unmanageable that there is no alternative.

The problem, as Alexis de Tocqueville noted in Democracy in America, is that public opinion, especially what he called “common opinion,” is “the dominant power” in democracies. The contemporary French philosopher Pierre Manent goes even further to claim that in democracies “it is not dogma that comprises shared opinion; it is shared opinion that is dogma.” It follows that if enough people want expansive welfare programs in a democracy, the capacity for politicians to oppose, for example, the desire of 51 percent of the population to progressively loot the other 49 percent, is limited. To resist is to court electoral rejection or, as we have seen, rioters running amok in the streets of Athens.

A number of twentieth-century scholars have sought to address this problem of democracy and ever-expanding state welfare. In the third volume of his book Law, Legislation and Liberty (1979), for example, the Nobel Prize-winning economist Friedrich von Hayek outlined a series of constitutional rules that he thought might limit the democratic state’s tendency to drift in this direction. Several decades earlier, German market-orientated economists such as Walter Eucken, Franz Böhm, and Wilhelm Röpke elaborated a whole system of constitutional principles they believed would render democratic states strong enough to resist capture by interest groups, but also limited enough to prevent governments from expanding their economic powers beyond a number of core functions.

But if the twentieth century has taught us anything, it is that even the most robust of constitutional arrangements have not been able to achieve such ends in democracies that lack politicians and citizens who grasp the essential wrongness of using the state to support themselves at the perpetual expense of others. Moreover, implementing such policies does not even require solid majority support from the population. In most democracies, people can only gain political power by cobbling together large enough coalitions of support based on a range of often incompatible promises made to sometimes very different interest groups. After being elected, democratic governments are under enormous pressure to use their political power to favor their various supporters if they want to avoid having their erstwhile followers turn against them.

The bartering of privileges and grants to different groups is thus almost inevitable in a democracy if a government wants to retain its coalition of support. In these circumstances, expanding the welfare state to reward particular adherents is a difficult temptation to resist. As Röpke commented: “To expand the welfare state is not only easy but it is also one of the surest means for the demagogue to win votes and political influence, and it is for all of us the most ordinary temptation to gain, at no cost to ourselves, a reputation for generosity and kindness.”

Likewise, democratic governments attempting to reduce the welfare state run the risk of alienating particular groups within their supporting coalition. This may be enough to ensure a government’s defeat at the next election. This is precisely what happened to Gerhard Schröder’s Social-Democrat-Green government in Germany after it implemented welfare reforms between 2003 and 2005. Not surprisingly many governments opt instead to retain the status quo, despite often being aware of the long-term economic consequences. Unfortunately for Europe, that status quo is no longer fiscally sustainable.

Does this mean that shrinking the welfare state requires a diminishment of democracy? The answer is no. Most authoritarian regimes ranging from Hitler’s Germany to Chavez’s Venezuela have proved more than willing to use generous welfare schemes to mollify large segments of the population. In other words, it is not as if democracy is unique in being coupled with welfare states, and so the cure need not lie in reducing democratic norms or institutions.

The beginning of a proper response is to recognize that a democracy’s ability to resist the long slouch towards the soft despotism of the welfare state requires two things. The first is to shift the incentives for economic mobility and security so that they lie in the private sector rather than in becoming a recipient of state largesse. This task is very difficult when much of the population already enjoys some measure of state income. Yet it is dwarfed by the immensity of the second challenge: developing a moral and political culture which underscores the undesirability of politicians and citizens using the state to live at others’ expense.

If opinion polls are correct, it may well be that, culturally speaking, it is too late for much of Europe. The modern European welfare state goes back to the late nineteenth century when Otto von Bismarck, Imperial Germany’s ruthless “Iron Chancellor,” introduced state social insurance in an undisguised attempt to placate the growing German industrial working class and the ever-increasing number of Social Democrats they elected to the German legislature. Far too many Europeans now simply assume a munificent welfare state as part of the economic landscape. Indeed the increasing number of older West Europeans today has no incentive to change. Their attitude might be described as “Après moi, le déluge.”

America, however, is a different story. The sheer intensity of resistance to the Obama Administration’s healthcare legislation was about many things. But it surely reflected the fact that millions of Americans are simply unwilling to go the way of Western Europe. Successful long-term resistance, however, is going to depend upon Americans understanding that the link between democracy and the welfare state has to be broken, and that the only way to achieve this objective over the long term is through recommitting the United States to some of the very best aspirations of its Founding—a love of liberty, an embrace of the virtues needed to sustain freedom, and an unwillingness to delegate to the state the responsibilities that free men and women owe each other.


Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty, the prize-winning The Commercial Society, and Wilhelm Röpke’s Political Economy.

Copyright 2010 the Witherspoon Institute. All rights reserved.

In one of his last collections of essays, Le Péché Monétaire de l’Occident (1971), Rueff sharply criticized Western governments’ apparent inability to put their currencies in order. The root causes of the inaction, in Rueff’s view, did not lie in prudential disagreements about the technicalities of securing monetary stability. Instead the “sin” lay in the constant manipulation of monetary policy by politicians pursuing short-term and, in many instances, self-interested goals, while simultaneously claiming to be deeply concerned about monetary stability.

Rueff knew what he was talking about. In 1958, Rueff engaged in a more or less singlehanded and ultimately successful struggle against the French political establishment to balance France’s budget and secure the franc’s convertibility. This followed the French economy’s near collapse after years of dirigiste policies and lost colonial wars in Vietnam and Algeria. Successful reform, Rueff stressed, involved being absolutely honest about the policy changes needed and their associated costs. Fortunately, Rueff was able to persuade the one man who mattered—France’s new head of government, General Charles de Gaulle—that the achievement of monetary stability was worth the pain of austerity in the form of dramatic social security cuts, drastic reductions in government subsidies to industry, and the dismantling of trade barriers.

Contemporary Europe could well use far-sighted monetary economists such as Rueff when it comes to addressing some of its present economic problems. Sound monetary policy could not, Rueff understood, be premised on falsehoods. Yet this is precisely the sin presently wreaking such havoc in the euro system today.

Since euro coins and banknotes entered circulation on January 1, 2002, many benefits have flowed from their adoption by many EU member states. The euro has helped them integrate their financial markets, facilitated price transparency across national boundaries, and reduced exchange-rate risks and the costs of currency conversions. The associated creation of the European Central Bank in 1998 with a clear mandate for fighting inflation has aided nations with long histories of monetary instability—such as Italy, Greece, Spain, and Portugal—in escaping the inflation spirals to which they were once susceptible.

But from the euro’s very beginning, it was tarnished by a high degree of fudging of public finances by EU member states anxious to be admitted to the currency. Member states seeking admission were required to have a budget deficit level of less than 3 percent of GDP and a debt ratio of less than 60 percent of GDP. To meet this requirement, some governments employed what might be generously described as “creative accounting” or simply misrepresented their fiscal position. In 2004, Greece’s then-finance minister George Alogoskoufis confessed, “It has been proven that Greece’s budget deficit never fell below 3 percent since 1999.” In the end, most applicant countries were admitted to the euro despite having debt levels exceeding 60 percent. Italy and Belgium, for example, were permitted entry despite having debt ratios of over 120 percent.

Over the long term, the European Stability and Growth Pact (SGP) was supposed to maintain fiscal responsibility in the euro zone by limiting government budget deficits to 3 percent of GDP and their debt to 60 percent. These provisions were, however, quickly violated by countries such as Italy and Portugal but also, ironically, by those nations (Germany and France) who had lobbied the hardest for rigid adherence to these thresholds. The European Commission continues to act as if violation of the SGP is a serious matter. But as Alberto Alesina and Francesco Giavazzi wrote in their book, The Future of Europe (2006), today “the large countries in Europe can do just about anything they please with deficits.”

The effects of this mishmash of untruths, fiscal fudges, misrepresentations and the refusal of sovereign states to be bound by their freely undertaken international obligations are only likely to be magnified by Europe’s present financial and economic problems. This is especially true when it comes to the European Central Bank, its independence, and its role of maintaining the euro’s stability.

Ever since its foundation in 1998, the ECB has been a whipping boy for European politicians from the left and right who argue that the ECB’s legally mandated priority of maintaining price stability has kept productivity and economic growth rates in the EU far below those of America. In reality, these problems have little to do with monetary policy and everything to do with low rates of entrepreneurship, unsustainable levels of welfare expenditure, an aversion to competition, high rates of public sector employment, and structural rigidities associated with some of the world’s most inflexible labor markets. Indeed, it is probable that the ECB’s avoidance of the low interest-rate policies adopted by the Federal Reserve in the 2000s may have made the 2008 recession in Europe more bearable than it might otherwise have been.

Against considerable political pressures, the ECB has hitherto doggedly defended its independence. All that, however, changed when the European Union decided to set up its 750-billion-euro bailout fund in early May 2010 to stabilize financial markets and rescue not only the holders of Greek government debt, but also, implicitly, the holders of any EU government debts that seemed shaky.

One of the more obvious difficulties associated with this package is that it further deepens the moral hazard problem that governments in Europe and America have at best paid lip service to over the past two years. In the long term, protecting governments from the consequences of their failed economic policies by socializing their losses is unlikely to deter the same governments from fiscal irresponsibility in the future. And while the rescue package might give some breathing space to countries such as Greece, it may also result in their governments putting off the harsher but essential elements of the austerity measures they need to take to reduce their sovereign debts.

But the more serious and longer-term damage of the package has been to the independence of the European Central Bank. As the economist John Taylor astutely pointed out in a recent Financial Times article (May 11, 2010), part of the deal involves the ECB buying “the debt of the countries with troublesome debt burdens, just days after it said it would not engage in such purchases.” Clearly the ECB was pressured by EU governments to follow a line similar to that adopted by the Federal Reserve over the past two years.

At present, the ECB is not engaging in “quantitative easing”—i.e., printing money—to fund these purchases. But it is difficult to imagine that the ECB will be able to continue to buy such debt over the long term without engaging in what some European government leaders now call “money creation” (yet another euphemism for printing money). That’s why the ECB’s decision to buy the government debt of some weaker economies amounts to a stunning volte face on the part of a central bank famed for its tough anti-inflation stance. The shock was such that it provoked a rare public criticism of the ECB’s decision by Germany’s central bank president, Axel Weber, in Börsen-Zeitung, a German financial newspaper.

As a result of these decisions, the ECB now has a serious credibility problem. No doubt, the ECB and some European politicians will insist that it remains as independent as ever. This, however, is surely one of those instances of promoting a falsehood about the economy that Jacques Rueff warned against. For the truth is that the ECB’s independence has been compromised. Hence we have every reason to expect those European politicians who have argued for precisely such a diminution of the ECB’s autonomy to view this as a precedent for further compromises.

Even more seriously, there is a question as to whether the ECB’s recent actions are compatible with its legally mandated priorities and responsibilities. No doubt the ECB will argue that its particular role in the implementation of the EU’s very own TARP for bankrupt governments is in the interests of long-term monetary stability.

This, however, would constitute yet another misrepresentation. The more the ECB involves itself directly in supporting European governments’ fiscal policies, the less independent it will be in appearance and practice, and the less it will be able to resist exhortations to adjust monetary policy to fit goals dictated in part by the short-term horizons of elected officials. As the Economist (May 11, 2010) recently stated, “The central bank’s credibility relies in part on a reputation for living up to its pledges and partly on its disdain for political expediency. On both counts, then, [the ECB] has lost something.”

Like politics, economic policy is a messy affair. This is especially true in mass democracies like those of Western Europe, in which permanent economic security is now regarded as a God-given right. Inevitably, there will be compromises. But this is all the more reason for those formulating EU monetary policy to resist being economical with the truth or claiming they are not doing something that everyone knows they are doing.

In his most important book, L’Ordre Social (1945), one of Jacques Rueff’s last exhortations to his readers was: “Be liberal, be socialist, but do not be liars.” It’s advice that Europeans directing monetary policy would be wise to listen to today.


Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty, his prize-winning The Commercial Society, and Wilhelm Röpke’s Political Economy.

Copyright 2010 the Witherspoon Institute. All rights reserved.

Writing in the fourth century B.C., the Greek philosopher Diogenes described money as the legislators’ game of dice. Almost 2000 years later, the scholastic theologian Juan de Mariana wrote an entire treatise, De monetae mutatione (1609), assailing governments for depreciating currencies in pursuit of dubious ends. For his pains, Mariana was charged with treason and sentenced to life imprisonment in a Franciscan monastery. 152 years after Mariana’s death, Adam Smith lamented in his Wealth of Nations (1776) that “in every country in the world . . . the avarice and injustice of princes and sovereign states abusing the confidence of their subjects, have by degrees diminished the real quality of the metal, which had been originally contained in their coins”.

These observations are not mere historical asides. They reflect an on-going problem with governments’ management of the supply of money. Sometimes this has devastating consequences. Few today, for example, would question the contributions of flawed monetary policy to the Great Depression. Many remember the debilitating stagflation of the 1970s that owed much to the neo-Keynesian monetary policies pursued by governments after World War II. Today scholars such as the historian of the Federal Reserve Allan Meltzer suggest that the Federal Reserve’s present strategy for preventing future inflation is seriously flawed and setting us up for significant problems in the future.

It is not as if alternatives have not been considered. The now-common model of relative central bank independence arose partly from a desire to dilute the ability of politicians with short-term horizons to influence monetary policy. Likewise, one of the chief attractions of the gold standard which functioned in increasingly diluted forms until President Nixon terminated the dollar’s direct convertibility into gold in 1971 was its ability to constrain governments’ ability to succumb to demands for cheap money.

Along these lines, suggestions have been made to remove government from the business of money-supply altogether. In his well-known monograph The Denationalization of Money (1976), the Nobel Prize economist Friedrich von Hayek sketched a powerful economic argument for ending the state’s monopoly of the money supply. This has been developed by economists such as Jesús Huerta de Soto, whose Money, Bank Credit, and Economic Cycles (1998) contains a comprehensive plan for privatizing the money supply.

The technical details of these and other measures for checking governments’ ability to manipulate the money supply for nefarious purposes continue to be debated. A separate question, however, is whether there is a principled reason for governments—either directly or through central banks—to monopolize the money supply. The fact that governments sometimes perform their designated functions ineffectively or even occasionally abuse them is not in itself a reason to strip the state of a given responsibility.

One reason traditionally given for the state’s monopoly of the money supply is that it is an expression of national sovereignty. While sovereignty’s meaning is endlessly debated, there is considerable agreement that sovereignty expresses a given government’s supreme authority over a given territory. In the mid-fifth-century B.C., for example, Athens compelled her allies to adopt Athenian coinage—a move that signaled Athens’ expanding sense of the territorial boundaries of its sovereignty. The scholar who most developed the concept of sovereignty in the modern era, Jean Bodin (1530-1596), identified the right to issue coinage as a key element of sovereignty. In our time, some of the most contentious debates surrounding the euro have concerned its diminution of the national sovereignty of EU member-states adopting this transnational currency.

But is a state monopoly of the money supply truly essential to sovereignty? When Smith listed the “only three duties [which] according to the system of natural liberty, the sovereign has to attend to,” he did not include the supply of money. It was not until 1914 that the United States legislated to mandate that only one bank would be privileged by the government to issue legal tender.

Some clarification of the issues involved begins to emerge when we consider the purpose of money. Money’s most basic function is to serve as a medium of exchange. From this is derived money’s three other functions: a store of value, a unit of account, and a standard of deferred payment.

It is not immediately clear why any of these functions necessitate a state monopoly of money. Money is certainly a commodity unlike any other economic good. But there is no obvious reason why attempts to undermine money’s ability to perform these functions could not be addressed through the ways we address most other economic crimes. As noted by the distinguished nineteenth-century English jurist and civil servant Lord Farrer, contract law, tort law, and criminal law are more than sufficient to adjudicate such matters without invoking any special law of legal tender.

A different understanding of money, however, is often used to justify the state’s monopoly of the money-supply. This is the idea that, besides the aforementioned functions, money is also a tool for the state’s management of an economy. This occurs through methods such as setting official interest rates or what today is euphemistically called “quantitative easing” (i.e., printing money). None of these techniques for regulating the amount of money in circulation would exist if governments did not enjoy a monopoly of the money supply.

This is further predicated upon the (much disputed) claim that the state can effectively steer an economy so that it serves the common good. The link to sovereignty is the state’s need to invoke a unique authority that allows it to claim responsibility for managing economic activity within a defined set of territorial boundaries.

The problem is that there are many occasions when the state’s regulation of the money supply involves the pursuit of goals that undermine money’s ability to perform its other economic functions. The state’s inflation, for example, of the money supply to reduce public deficits or finance a war economy can undermine money’s ability to serve as a stable unit of value over long periods of time. Prominent modern examples include Germany after each world war or France during its Indo-China and Algerian wars.

Is there any way to resolve this tension between what might be called the “state-centered” and “market-orientated” views of money’s functions? The irony is that concerns about sovereignty are diminishing quickly among “centralizers,” just as they have long disappeared among “privatizers.”

In 2009, for example, a UN panel of experts on restructuring the global financial and economic system chaired by another Nobel economist Joseph Stiglitz proposed the creation of a global reserve currency. This implies all nation-states ceding some of their sovereignty to an international organization, much as many EU members have done to the European Central Bank. Indeed the panel recommended giving responsibility for managing such a currency either to the IMF or to a newly created “Global Reserve Bank.”

In one sense, the centralizers are pushing at an open door. Economic globalization has already diluted national governments’ ability to use their control of the money supply to “manage” domestic economies. Fluctuating exchange rates and the ability of traders to transfer billions across national boundaries by pressing a keyboard have also reduced most governments’ ability to control their national currencies. In short, sovereignty is becoming a moot point.

The difficulty for centralizers such as Stiglitz is how they address the fact that the record of a Global Reserve Bank’s management of monetary policy for the world economy is likely to be as undistinguished as the record of most national central banks in directing monetary policy for national economies. No matter how sophisticated the statistical information and mathematical resources at their disposal, it is simply impossible for any group of central bankers to know, for example, what is the optimal interest-rate for the world in the present, let alone nine months into the future. Mistakes, sometimes with enormous consequences, would inevitably be made.

The contribution of flawed monetary policy (especially by the Federal Reserve System) to the 2008 financial crisis presently appears to be creating some momentum for the international-centralizers. But perhaps the silver lining of this particular cloud is that decreasing worries about sovereignty are clarifying what is really at stake when it comes to creating the stable monetary frameworks upon which economic prosperity depends. Is the key to successful long-term monetary stability the further centralization of control of the money-supply? Or should we investigate decentralizing options, which treat money much as we treat most other essential commodities (such as food) and rely upon market-orientated solutions?

Given the historical record of state-centered strategies of economic management, prudence suggests that we should at least seriously investigate private options. But we may have to await more catastrophic errors by central bankers, national or international, before we allow ourselves to think—and perhaps do—the presently unthinkable.


Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty, his prize-winning The Commercial Society, and Wilhelm Röpke’s Political Economy.

Copyright 2010 the Witherspoon Institute. All rights reserved.

Financial relationships raise acute moral issues that suddenly appear to be at the heart of the problem. Why should burdensome obligations come with a duty to repay? Is it good to be in debt?

This isn’t a new story. In the early 1930s, the world went through a period of debt-deflation, in which the compulsion to repay forced down prices and increased the real level of debt. Today, we face a milder version of the same phenomenon as banks cut back lending to rebuild their capitalization. The resulting credit difficulties create downward pressure on prices and make for higher and less sustainable debt levels.

The problem is severe. Deflation produces radical anti-capitalism and a demand for a cancellation of debt. Revulsion against the market economy often takes the form of a specific condemnation of debt and debt instruments.

The Saudi cleric Grand Mufti Abdelaziz Al al-Sheikh made the case that the cause of the crisis is interest on debt, and that the sharia principle of risk participation would eliminate the problem. This is a very old answer. The Old Testament famously recommended a cancellation of debt every forty-nine years in a “jubilee.” The medieval church attacked usury. Such arguments are not built on simple obscurantism. Both the medieval church and Islam distinguish between debt that is exploitative, in which individuals are tied in debt servitude, and the relationship that arises out of a sharing of entrepreneurial risk. This tradition invites us to think about how debt today may inhibit free choice and the free development of the human personality.

These critics, ancient and modern, see debt as leading to a fundamental moral flaw. Today debt is much more prominent than it was in medieval Europe. Consumers in advanced industrial countries (and in particular the United States) rely on debt in order to buy. Treasury Secretary Paulson complained that the credit crunch was “making it more expensive for families to finance everyday purchases.” But dependence on debt polarizes societies. Bailout proposals run into opposition from those who are not so highly indebted and see an overall solution as a subsidy for the improvident.

One interpretation of modernity is that we borrow from one another on an increasingly grand scale for a reason, because we are convinced that our utility schedule is more important than someone else’s. If I see a beautiful piece of jewelry or a bright new car in a shop, I am convinced that it should be mine and that it can be more usefully employed in my possession than in that of someone else. In that way greed feeds on a kind of pride or self-regard. This problematical character of debt is captured in an ambiguous phrase of the Lord’s Prayer that refers not only to spiritual offense but to actual debt and was often in the past translated as “forgive us our debts.”

The meltdown of capitalism produced a big blame game both in the 1930s, when industrial capitalism broke down, and today, when it is financially driven capitalism that has gone awry. Today the collapse is widely thought to be the responsibility of poor regulators and monetary policy makers, or unscrupulous mortgage originators, or greedy bankers. Popular commentators like to go back to stereotypes from earlier eras, such as the figure of Gordon Gekko in Oliver Stone’s movie Wall Street who memorably proclaimed that “greed is good.”

The attributions of blame do not contemplate why a little bit of greed can produce such bad effects. Greed works as a doctrine of management because it is endlessly replicated in everyday behavior, by neighbors who borrow because they want to match other people’s consumption patterns, or buy bigger houses out of a competitive spirit. Wall Street moved prices by means of a “thundering herd,” but it is not the only locus of greed. We might equally look to popular culture, to game shows, or to shopping behavior. In November 2008, the same instincts that drove financial markets produced the post-Thanksgiving shopping consumption-intoxicated herd which trampled a store clerk to death in a Long Island Wal-Mart.

Solutions to the crisis include a simplification of finance, a return to lower levels of debt, and a reduction of flows across long distances. Some natural law traditions point in a very radical direction and demand regular cancellations of debt like the “jubilee.” But how can any of this be achieved?

A less radically intrusive approach would end the incentives that created powerful motives for households and corporations to increase their debt. In particular, the tax deductibility of mortgage-interest payments led to an excessive level of household debt; and tax deductions for interest led to high levels of corporate leverage. Some countries have already experimented with ending or reducing the levels of permissible mortgage-interest deduction.

Debt reduction is not only a good way of avoiding the constant repetition of the kind of disaster that emerging markets went through in the early 1980s and the late 1990s, and the whole world has experienced after 2007. It is also an example of the way in which the application of some natural law principles might lead to a healthier economy.


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.

Copyright 2010 the Witherspoon Institute. All rights reserved.

Skepticism about governance regimes based on corporate social responsibility, or “CSR,” apply a fortiori to the shift in attention toward “financial stability.” What is especially pernicious about the G-20 dynamic is the manner in which the free market is in effect ceding economic control over to a global assembly of twenty nation-states, several of which fail to subscribe to the notion of a free-market economy to begin with.

All of this makes about as much sense as entrusting a team of avowed atheists with designing the curriculum content for an orthodox religious academy. And yet sage representatives hailing from principalities like Argentina, Indonesia, Russia, and Turkey were impaneled to supervise Wall Street executives to ensure their remuneration stays within appropriate bounds. Consider the irony of Argentina’s Cristina Fernandez de Kirchner judging the moral propriety of reaping too much personal financial gain, in light of her ties to the infamous maletinazo (suitcase scandal) and her appropriation last year of $29 billion from private pension funds to restock municipal coffers she and her husband had used up.

Even the staunchest critics of activist-led CSR programs often find themselves concurring with not only the spirit but also the substance of their underlying proposals. Helping businesses to play their proper role in the advancement of environmental sustainability, and improvement of labor conditions and respect for human rights in the developing world are admirable goals. What is objectionable, however, is the notion that parties having no role in the creation of profit should be accorded the authority to dictate the precise contours of corporate social responsibility. Similarly, in the case of the G-20, whereas broad objectives such as reining in incentives for financial misconduct, preventing hedge fund abuses, and establishing some reasonable oversight of the “shadow banking system” are generally praiseworthy, the scurrilousness of the process and the dangerousness of the pattern being set are alarming. The U.S. GDP is equivalent to thirteen of the G-20 members put together, and the U.S. accounts for approximately twenty-four percent of the world’s economy, yet it has one-20th of a say in this forum. The market-based democracies of the world are unwittingly taking steps to establish a global economic governance regime that seriously jeopardizes individual financial freedom and imperils worldwide prospects for renewed and sustainable wealth.

Delivering a good deal of blatherskite and patching together basically vapid protocols amounts to window-dressing, undertaken by President Obama and the other leaders he invited to Pittsburg to manufacture an illusion of achievement in orchestrating a worldwide economic recovery. If only it were so simple. In fact, there are many deep-rooted differences in corporate governance systems across nations, making coordination of them unrealistic. Some of them are utterly backward. Others are autocratically controlled. Consider, for instance, that Russia was socialist up until only twenty years ago. When the Soviet Union disintegrated, managers essentially helped themselves to the spoils of formerly state-owned enterprises. In Germany, where unions sit on the board of directors, business firms are much more regulated than in the United States. Moreover, executives around the world perform very different tasks, according to the laws of the country in which they operate.

Instead of convening more of such summits, a better approach is to abandon the fantasy that governments can be relied upon to establish sustained economic growth. Instead of mounting an attack upon entrepreneurs and market-based economies, both of which have enabled tremendous levels of wealth to be created across the globe, the representatives of the G-20 ought to own up to the reality that excessive governmental intrusion into the private mortgage market via the syndicated debt of Fannie Mae and Freddie Mac was a major contributing cause to the financial crisis, and that the private sector is where we need to look for sound economic advancement.

Some of the factors that led to the economic crisis are rooted in a deep-seated set of moral-cultural malaises.  It is difficult to say what led to excessive financial innovation and complexity, executive compensation, and neglect of moral hazard, but among the causes are factors such as technocratic, dehumanized economic thinking, egoistic individualism, greed, short-termism, repudiation of objective moral values, and a highly speculative culture. These underlying moral-cultural trends cannot be resisted or reversed simply by increased law and regulation, especially not from any directives arising from the G-20 summit.

The cultural causes of the crisis must be addressed by more nuanced ethical thinking and collective activity grounded in virtue, regard for the common good, and greater attention to the cultivation of intangible capital assets such as reputational and social capital Our thinking needs to be more sensitive to the complexity of relationships between ethics and economics and attuned to the importance of trust, truth and transparency, along with the need to establish localized and “spontaneous” social structures that are better equipped to foster such elements in business conduct than stepped-up regulation could ever be expected to do.

In the Nicomachean Ethics, Aristotle explains that human happiness arises from having chosen virtuous actions. A virtuous action falls within the golden mean, which rests midway between two vices that make up the extreme endpoints of any trait of character: deficiency and excess. For example, Aristotle states that people should be generous, meaning that they should neither be too wasteful nor ungenerous. They ought to strive to be temperate. As such they will prevent having their lives dictated by irrational appetites like envy and lustfulness.

Some types of executive compensation arrangements that are now being placed in the spotlight from the financial collapse—that is to say, schemes that offer inducements to cheat, perpetrate fraud, and cook the books in an effort to fabricate levels of reported corporate performance in order to elicit exorbitant payoffs—reward businesspeople for the immoral practices they carry out. Accordingly, such executive compensation plans are squarely counter-Aristotelian and contrary to virtue ethics. Executive compensation plans that motivate managers to manipulate performance levels rather than to engage in conduct aimed at building genuine value for their firms fail to promote virtue; instead they encourage and reward vice, namely the character deficiency of “acquisitive ungenerosity,” which for Aristotle amounts to the dishonorable worship of profit.

It must be remembered that democracy, the rule of law and a free-market economy in the United States have made this country great. Attempts to respond to the financial crisis with global governance regimes like the G-20 summit will not help in mustering the enlightened leadership required to advance beyond the crisis toward a preferable situation of a sustainable free market.

Let the market remain free from meddlesome mandates handed down from finance ministers and central bank governors hailing from communist, corrupt, and despotic states and instead channel attention towards reputational accountability of individual firms for standards of sound business that have developed from the traditions of market economies operating under democracy and the rule of law. The result of this shift in emphasis will be to reward virtue and punish vice in the respective practices of business enterprises.

Where corporate misconduct takes place, let the scoundrels be “named and shamed” according to established principles of enlightened business. Such an approach is preferable to assembling a global-financial-hit-squad whose membership includes heads of states committed to ideologies contrary to the ideals of ordered liberty and the free market held by our nation’s founders. In this regard, the current economic scandal provides a special opportunity to rethink moral standards for market participants. Rather than ceding our freedom by responding with excessive regulation, we need to look to moral reform.


Kevin T. Jackson is Professor of Law and Ethics at Fordham University’s Schools of Business in New York City, and a Senior Fellow of the Witherspoon Institute. He is the author of Building Reputational Capital and sits on the Editorial Board of Public Discourse.

Copyright 2009 the Witherspoon Institute. All rights reserved.

The recent G-20 summit convened in Pittsburgh represents a dramatic new escalation in the push for global governance of corporate financial affairs. The body’s efforts to promote international economic teamwork will not only attempt to curb excesses and set executive pay in accordance with the long-term plans of a firm, but also weigh in on issues as varied as sustainability, food policy, and corporate social responsibility.

At first glance, it all sounds like a promising idea: establish an international body that can provide robust oversight and regulation to foster greater stability in the financial world. But in fact the G-20’s Financial Stability Board (FSB) is sowing seeds that pose significant dangers for world economic freedom. Of particular concern is the danger that lies in ceding pseudo-legal authority to institutions such as the FSB to establish international norms for executive compensation and other corporate governance arrangements, which forcefully intrude into the internal functions of private firms while at the same time cranking up rules covering everything from accounting to climate change.

The problem with such a move is that it represents a stark departure from the general trend in global governance constituted by the emergence of “soft law,” or civil regulations. Within the past several decades, substantial changes in global governance and business regulations have been taking place in accordance with the process of globalization. The growing corpus of transnational civil regulations utilizes private, non-state and market-based regulatory regimes to govern multinational enterprises and global supply networks. For the most part, the regulations have been influencing the manner in which global companies and markets bear on human rights practices, labor conditions, environmental sustainability, and community development, particularly in less developed countries. The mounting influence of the stakeholder view of corporate governance together with the emergence of corporate social responsibility (CSR) reveals an intensifying influence of the so-called “global public domain” in molding public policy and regulation toward business enterprises. Scholarship indicates that the regulatory power of the state is accordingly undergoing extensive decentralization. Thus, a blend of state and market, public and private, traditional and self-regulatory institutional structures characterized by alliances built among nation-states, private nongovernmental actors (activists, NGOs) and business enterprises is replacing the traditional mode of hierarchical command-and-control regulation with regard to economic actors.

However, in the eyes of some, the march toward instituting global civil regulations for international business firms has been advancing on thin ice in the sense that it is unclear just how such emergent systems of economic governance—sometimes referred to as “governance without government”—are to be reconciled with the connected ideas of democracy, the rule of law, and legal accountability.

It can be difficult to discuss or understand “democracy” in the world arena. Corporate accountability to environmental, labor, and human rights standards—and now executive pay structures as well—is strongly decentralized and diffused. Elections, sometimes called “procedural representation,” are being replaced with functional representation by technical experts, and purported moral representation is being asserted by social groups and NGOs. Such developments increase the number of political players, creating a diffraction of political legitimacy.

As for the concept of the rule of law, corporate officers, public authorities, and the heads of non-profit enterprises are all subject to legal accountability for their behavior through established transnational mechanisms of administrative and criminal law. The World Trade Organization,  the Dispute Settlement System, the Hague International Criminal Tribunal for the Former Yugoslavia, the International Criminal Tribunal for Rwanda and the International Criminal Court represent institutions set up to enforce legal accountability in the global context. Of course, an agent’s failure to conform to standards of legal accountability will typically trigger reputational sanctions as well, and maintaining a solid record of compliance with legal accountability frequently provides for its own reputational rewards.

Yet many of the emerging forms of civil regulations for transnational business enterprises frequently operate more on the grounds of persuasion than by the force of coercion that is characteristic of domestic law and the traditional concept of the rule of law that undergirds it. International standard-setting bodies like the G-20 differ from recognized international economic institutions in that the former have numerous non-legal characteristics.  Such standard-setting institutions do not enjoy a distinct legal personality established by nation-states; they lack authority to conclude treaties, and are bereft of international legal immunities. Instead, they amount to nonformal groupings composed of state representatives and technical experts convened to speak to particular problems and to address sundry matters of special concern. Although these bodies lack competence at both national and international levels as far as hard law-creation goes, nevertheless the soft law norms that they are adopting have a perceptible effect on the conduct of states and influence the public policy debates about global financial governance.

In this regard, it should be noted that although the G-20 is for the time being only equipped to deploy moral suasion against nation-states deemed noncompliant with their edicts, there has nevertheless been chatter in some circles suggesting the possibility of impending sanction authorization. Yet to the extent that organizations embarked on crafting international financial standards perpetuate a misrepresentation of the character and status of those standards as, on the one hand, either completely noncompulsory suggestions that need not be taken seriously or, on the other hand, as binding coercive norms carrying the full force and effect of law, the substance of their guidelines will harbor the potential to hamper economic progress and financial growth.

The possibility of such a negative influence can be seen in the failure of international regulatory standards issuing from the array of financial norm-setting bodies (i.e, the “Gs” ranging from the G-7 and G-10 up to the G-20) to protect adequately the global financial system from the financial crisis. It was in part the incapability of such associations to foresee the potent risks generated in the financial system during the past decade that has sparked such widespread condemnation of both the organizations and their committees (such as the G-10’s Basel Committee on Banking Supervision) for a lack of transparency and accountability in their decision-making structures, as well as for their negligent oversight of the international standard-setting methodology.

It will therefore be important going forward for global civil society to specify carefully not only the nature of the authority, but also the degree of professional competence and credibility that emerging sources of global financial soft law must carry concerning institutional structures of decision-making set up in the name of attaining financial stability and economic growth.

More often than not, the motivations for business enterprises to comply with soft law stem more from the need to protect intangible reputational assets of the firm than from the avoidance of any physical pain or loss of liberty of the sort produced by conventional legal sanctions wielded against human persons. We might term this sort of compliance dynamic the “rule of reputation.” Indeed, it is arguable that the regime of global civil regulations and their accompanying “rules of reputation” are no less significant or effective than systems of domestic or international law; such corporate governance systems are backed by the force of reputational sanctions the nature and extent of which are not always fully comprehended by legal experts and economists alike.

As we contemplate new efforts to create worldwide standards for corporate governance, the concept of reputational capital needs to be squarely incorporated into our thinking. In the interest of preserving personal freedom and economic sovereignty, the overall process should be one inspired by corporate self-regulation grounded in moral virtue, not by excessive governmental intervention of politicians and international technical experts. It goes without saying that efforts at imposing more laws and restrictions cannot possibly be effective so long as the prevailing mindset of business managers is to find loopholes for any regulations that stand in their way or prove to be unbeneficial.  By establishing more bureaucracy, barriers, and complexity in the business world it becomes more difficult for wealth-creating entrepreneurs to pave their way and pick themselves up during and after the crisis.

Failing moral standards in business and across society are a major invisible force behind the financial crisis. Moral principles should be integrated into systemic governing bodies and corporate actions to ensure the common good. Market participants must realize that they are responsible not only for their own contribution but for how their contribution impacts the entire financial system. There must be mutual respect and a spirit of pursing the overall good of the firm and the human community, not just a narrow focus on correcting details of individual performance. Yet bodies such as the G-20, populated by officials and their delegated bureaucrats, many of whom remain clueless about the specifics of how successful business firms operate in competitive environments, the way trustworthy companies are able to generate real wealth, the fine art of creating lasting jobs, benefits, salaries, and building equity in products and services that make up the value that business delivers, tend to direct their attention towards fixing technicalities and minimizing risk. In order to establish enlightened leadership for business it is more important to look at broader root causes and to propose solutions likely to foster the forthrightness in commercial activity that is required to restore the moral deportment of many well established business enterprises around the world.  Rather than staking our hopes on increased regulatory intervention, what we need to realize is the simple truth that in the world of business, both today and since antiquity, reputation rules.


Kevin T. Jackson is Professor of Law and Ethics at Fordham University’s Schools of Business in New York City, and a Senior Fellow of the Witherspoon Institute. He is the author of Building Reputational Capital and sits on the Editorial Board of Public Discourse.

Copyright 2009 the Witherspoon Institute. All rights reserved.

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.

Copyright 2009 the Witherspoon Institute. All rights reserved.

As time passes, more people may recognize that the financial crisis owed much to factors that had little to do with markets as such. As several scholars illustrated in the 2009 monograph Verdict on the Crash, the causes included regulations that encouraged irresponsible behavior by banks, imprudent central bank policies, not to mention outright collusion between politicians and government-sponsored enterprises such as Fannie Mae and Freddie Mac.

Unfortunately for promoters of free markets, knowledge of these facts will take time to counter the widespread perception that economic liberalism—manifested in financial liberalization, privatization, deregulation, and increased competition—contributed significantly to the 2008 crisis.

In the meantime, those committed to economic liberalism have a chance to rethink and reformulate the case for markets. Certainly the efficiency arguments for economic freedom will be revisited, refined, and rearticulated. But it’s also an opportunity for economic liberals to reexamine what is often a weakness in their position—the principled case for markets.

As David Henderson comments in The Changing Fortunes of Economic Liberalism (2001), economic liberals have encountered several recurring problems in advancing their views. First, unlike socialist and nationalist movements, economic liberalism has never acquired mass support. Second, Liberalism requires counter-intuitive reasoning (such as the notion that free markets create economic order) that isn’t easy to grasp and which doesn’t lend itself to sloganeering. Third, economic liberalism threatens many established interests. These include over-mighty unions, guilds, politicians who use welfare programs to create tame electoral constituencies, and businesses who like corporate welfare and resent competition.

Another obstacle, however, faced by economic liberals are the difficulties they often experience in making arguments not based primarily on efficiency and utility. Even the most econometric economist would probably admit that man does not live by efficiency or utility alone. Yet the number of economic liberals willing to stray outside this territory when arguing for markets remains small. The truth is that economic liberalism has long been largely detached from “thick” conceptions of human flourishing and too often unnecessarily associated with rather flimsy notions of the good.

One reason for this is that free marketers have invested enormous intellectual energy in policy debates. Policy engagement was critical to the successful economic reforms that saved many Western countries from the stagflation into which they collapsed in the 1970s. But the cost may have been neglect of the deeper arguments that intellectually nourish the very same policy positions.

This does not fully explain, however, why many economic liberals are tongue-tied at best when it comes to principled defenses of markets or, in some cases, positively hostile to such reasoning. Surveying the literature on this subject, one most commonly encounters unapologetically utilitarian arguments. In crude terms, these amount to the following: free markets maximize economic utility; hence they are morally superior to inefficient non-market arrangements.

Examining the historical record, there’s no question that economic liberalization has helped lift ever-increasing numbers of people from poverty. Millions of contemporary Indians and Chinese can attest to this. Some conservatives—especially those presently exploring non-socialist alternatives to markets—are far too quick to dismiss these realities. Nevertheless, if humans are creatures with more than material interests and aspirations, then economic utility-maximization arguments are necessary but insufficient in building a normative defense of markets.

More thoughtful economic liberals have long recognized this. Some, such as John Stuart Mill (who eventually moved away from economic liberalism), tried to ground economic liberalism upon a type of utilitarianism. But as scholars from a host of different philosophical schools have noted, all forms of utilitarianism are deeply flawed because they assume the impossible: that humans can somehow foresee and weigh all the known and unknown consequences of particular actions or rules.

Then there are appeals to “progress.” This was central, for example, to Friedrich Hayek’s case for economic liberty. Progress, Hayek maintains, does not normally occur through people seeking to resolve problems in a coerced or collective manner. Progress comes when individuals freely act upon their abilities and particular knowledge of their unique circumstances while pursuing their own chosen purposes.

That Hayek makes an important point about economic development is not in question. Yet Hayek has surprisingly little to say about the content of progress. In his famous Constitution of Liberty (1960), he concedes that progress “in the sense of the cumulative growth of knowledge and power over nature, [progress] is a term that says little about whether the new state will give us more satisfaction than the old.” Such a question, Hayek comments, is “probably unanswerable.” But for Hayek, this is irrelevant. More important is “successful striving for what at each moment seems attainable,” or “movement for movement’s sake.”

This response leaves unanswered some very important questions. Towards what are people moving? What are we becoming in the process of doing so? In many responses to such queries, one detects Mephistopheles’ retort in Goethe’s Faust: “The future creates what is moral.”

Other economic liberals have employed social evolutionary arguments to bolster their position. These may be found in some of Hayek’s works and some contemporary libertarian circles. The market, it is held, reflects a type of natural selection process with which humans are wrong to interfere.

The innovation and competition encouraged by markets does of course gradually render many technologies (e.g., typewriters) and industries obsolete. This “creative destruction” is, as Joseph Schumpeter noted, how entrepreneurship improves aspects of people’s quality of life over time. But the problem with evolutionary arguments is that they cannot provide a principled reason for anything. Moreover, if, as a matter of positive science, societies simply evolve, then evolutionarily-inclined economic liberals cannot morally object to governments “evolving” to assume increasing control over the economy. For who could claim on evolutionary grounds that there is something intrinsically wrong with ever expanding government?

If this analysis is accurate, then economic liberals need to consider non-utilitarian, non-progress-for-the-sake-of-progress, non-evolutionary, principled defenses of market economies. One such argument is that economic liberty and its associated institutions provide a bulwark against unwarranted expansions of state power and thus helps minimize undue coercion—a vital prerequisite for human flourishing, moral or otherwise.

A second is that free markets have proved remarkably successful in allowing people to tackle the problem of scarcity in a peaceful manner that encourages people to consider the economic needs and wants of others. In short, markets address an issue which, if left unresolved, will facilitate tremendous social disorder. The alternatives are command economies, economies centered on theft, or economies based on altruism. Reason and history tell us that neither command nor theft-based economies are options. Likewise Aristotle’s and Aquinas’s insights that common ownership produces social tension and that people treat privately owned things better than they treat things owned in common suggest that there are limits to altruism’s ability to serve as the primary principle of economic organization in complex societies.

These are reasonable positions that illustrate how free markets contribute to key non-economic dimensions of the common good, but economic Liberalism’s case would be further bolstered if its advocates were willing to expand their arguments about how markets facilitate moral growth. The manner in which entrepreneurship fosters and requires virtues ranging from prudence to courage is one example. Another is how free trade and exchange can promote forms of human association with intrinsic value beyond their economic dimension. One could also underscore the opportunities commercial societies provide to pursue a rich variety of moral goods in ways closed to many people in pre-commercial orders.

Some economic liberals, however, resist reasoning based on more –than material concepts of human flourishing. Sometimes this reflects a utilitarian or positivistic outlook that struggles to acknowledge human life’s non-material aspects. Other economic liberals worry that attention to the good as such  opens the door to undue state coercion in the name of encouraging human moral development.

In this regard, modern advocates of economic Liberalism might consider reexamining elements of the pre-nineteenth century philosophical roots of their thought. These partly lie in the early modern natural law tradition associated with people such as Hugo Grotius and Juan de Mariana. Their market-orientated economic writings are infused with a concern for the good life. The most important philosophical tradition that undergirds the moral case for economic liberty, however, is the Scottish Enlightenment

Too often primarily interpreted through the lens of the skeptical proto-utilitarian David Hume, the Scottish Enlightenment includes figures such as Gershom Carmichael, Francis Hutcheson, Lord Kames, William Robertson, and Hugh Blair who understood and supported the economic case for commercial societies but saw no reason why this should be separated from robust accounts of the good. This is equally true of Adam Smith. Modern Smith scholars such as James R. Otteson have illustrated that the author of the Wealth of Nations was deeply concerned with humanity’s moral growth in the context of emerging market economies in ways that went beyond utility maximization.

We live in an era in which pressures to expand government intervention in the economy are enormous. Paradoxically, however, successful long-term resistance to such trends may require economic liberals to resist the temptation to invest their energies in activism. As Harold James states, “The only way of dealing with a collapse in values is to rebuild values.” This suggests that economic liberals should direct considerable attention to the difficult, long-term task of rebuilding a powerful case for economic liberalism based as much on full-bodied conceptions of the good as it is on sound economics.


Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. His forthcoming book, Wilhelm Röpke’s Political Economy, will be published in early 2010.

Copyright 2009 the Witherspoon Institute. All rights reserved.

No reasonable conception of the good can be limited to the economic realm, let alone utility. Unfortunately many contemporary economists do not see this, precisely because they are more-or-less utilitarian and positivistic in their outlook. In this regard, they differ from the founder of modern economics, Adam Smith. This much is evident from reading the corpus of Smith’s works, which traverse jurisprudence, philosophy, astronomy, and rhetoric, as well as economics. But while prepared to countenance particular forms of protectionism in a very small number of instances, Smith was not convinced that significant restrictions of trade within and between nations would help facilitate human flourishing within communities. Neither am I.

McDaniel suggests that there are good reasons derived from considerations for both utility and human flourishing to insulate economies partially from movements in international markets. One is the concern that, in an interdependent world, such insulation may diminish the impact of significant global market failures upon those economies that choose one or more forms of protection. He also maintains that there would be other benefits, such as the innovation he associates with craftsmen who pride themselves on producing locally made quality products. The same partial insulation, he suggests, may even place some nations in a position to help those negatively affected by global economic downturns.

Several difficulties mar each of these arguments. First, there is no evidence that various forms of insulation, ranging from tariffs to subsidies, do much to mitigate the effects of global recessions upon countries adopting such measures. If anything, they inhibit countries from quickly responding to the new circumstances and thus prolong the downturn’s negative effects.

Nor does it seem to be the case that partial insulation from the global economy fosters much innovation or productivity. History suggests that efforts at partial economic insulation tend to encourage economic insularity. This is exemplified by guilds. As a form of economic and social organization, guilds often began with a concern to produce a certain product of a certain quality. But they invariably became preoccupied with determining who could and could not engage in certain occupations or produce certain goods and services. Being what we would call today “closed shops,” they disliked free trade and competition—domestic or foreign—because it threatened their monopolies and often made available to consumers better, newer, and less-expensive products than those produced by guilds. A similar logic was recently at work with the recent effort of organizations such as the United Steelworkers to persuade the Obama Administration to raise tariffs on Chinese-made tires for the next three years.

The same insularity encouraged by various forms of protectionism also actually discourages nations from worrying about other countries’ economic problems. A good example is the fierce resistance of European and American farming lobbies to permitting developing countries wider access to European and American markets. Many developing nations would escape their poverty far more quickly if the highly protected American and European agricultural markets were “de-insularized.” But this would mean removing the legal and economic privileges presently accorded to many American and European farmers. They will never give up these privileges without a fight, no matter how much such measures impede developing countries’ emergence from poverty.

More significantly, however, McDaniel asks us to reflect upon the consequences for economic decision-making if political reasoning was concerned with “integral human development” or “all-round human flourishing.” McDaniel correctly observes that it would radically change the way that most present-day policy-making occurs.

I myself would welcome a shift in this direction. First, it accords with the demands of reason. Second, it holds out the potential for the development of an understanding of politics that provides the workings of government and law with a far more coherent rationale than that provided by Millian or Rawlsian Liberalism.

I am less convinced, however, that a politics committed to promoting integral human flourishing means that governments should implement policies that significantly inhibit free trade. Naturally there are some things whose nature provides strong reasons to inhibit or completely prohibit their trading. Legitimate national security considerations, for example, should significantly limit the trading of certain forms of sophisticated weaponry or military technology. Likewise human trafficking is an evil in itself and ought always to be prohibited.

But beyond these and similar instances, policies that undermine free trade in goods and services arguably diminish opportunities for the type of flourishing that McDaniel and I value. Let me explain why using the example employed by McDaniel and myself: a fictional Scottish wine industry.

McDaniel suggests that, as part of a legitimate desire to promote a variety of moral goods, some Scots may decide that, despite the enormous economic disutility involved, they want to start a wine-growing industry in Scotland. Enough patriotic Scots may also want to support this industry by purchasing this home-grown wine and would be consequently willing to pay more than they would otherwise pay for better quality, less expensive Italian vintages.

If such an industry succeeded under its own volition, then this is all well and good. My objection, however, would be to using the state to subsidize such an industry or protect it from foreign competition. Leaving aside arguments based on utility, the price of using the state to prop up such an industry over the long term will likely be quite direct—and sometimes more-or-less intentional—damage to the ability of those in other communities to flourish.

Perhaps the damage is to those Scots who request no government subsidies for their freely chosen profession but who discover that a large proportion of their taxes, which could be used to improve, for example, Scottish education levels (and thus participation in the good of knowledge), are being directed towards subsidizing highly uncompetitive Highland vineyards. In this instance, the communal integrity (of Scotland) that McDaniel rightly values would be significantly impaired.

More remotely, the damage might be to a group of Chilean winemakers. Instead of taking government subsidies to produce Chilean whiskey, this community determines its comparative advantage lies in Chile’s soil, climate and their own wine-making skills. Through their own entrepreneurial volition, they subsequently create a self-sustaining, profitable wine industry and, in doing so, provide tremendous opportunities for all-round flourishing for many Chileans working in the business. Then they discover that barriers have been erected to inhibit their entry into the Scottish wine market—and any number of subsidized, protected Western wine markets. This limits the Chilean industry’s capacity to grow and provide expanding opportunities for human flourishing inside and outside Chile.

But even more fundamentally, such policies generally represent a significant injustice—and justice is a key precondition for any society’s promotion of human flourishing. They unreasonably compromise freedom of association and the access of all peoples—especially the poor—to the goods of the earth. Some of the early promoters of the idea that free trade was a demand of justice, such as Hugo Grotius and Francisco de Vitoria, were so insistent on this point that they actually regarded denial of free trade as a legitimate casus belli. Moreover, from the standpoint of human flourishing, the ability of all people to maximize their opportunities for integral human development often lies just as much in expanding access to opportunities that transcend and traverse national boundaries as in rootedness in local communities.

Here it is worth adding that many small and medium-sized communities actually impede human flourishing. Some such societies often embody characteristics such as provincialism, irrational hostility towards outsiders and foreigners, ignorance of the wider world, and customs that unjustly restrict opportunities for integral development by some individuals and groups belonging to these communities. Some of globalization’s positive effects are to broaden horizons, diminish prejudices, and provide opportunities to pursue integral human flourishing in ways that often cannot be accommodated in relatively isolated groups.

Similar critiques could be made of some of McDaniel’s other specific suggestions. But let me conclude by stressing my agreement with McDaniel that much contemporary economic science and economic policy-making fails to do justice to the reality that human flourishing is about far more than utility-maximization. Many economists and economic policy-makers effectively cut themselves off from consideration of such matters. This partly reflects the present hyper-specialization of much higher education, but also the influence of positivism and what the economists Wilhelm Roepke and Friedrich Hayek called “scientism”—the indiscriminate application of the methods and concerns of the natural sciences to the humanities and social sciences.

This contrasts with Adam Smith’s outlook. Smith was deeply conscious of the moral challenges posed by the emerging commercial society of his time. Rather than seeking to resolve real and imagined conflicts between human flourishing and market-oriented economic development through government intervention, however, Smith sought to achieve a similar end through infusing this new society with a synthesis of commercial, classical, and Christian virtues. As Ryan Patrick Henley illustrates in his excellent book, Adam Smith and the Character of Virtue (2009), Smith was convinced that human flourishing was possible for people living in modern commercial societies that embraced free trade with relatively few caveats. So am I.

To be sure, not everything for which Smith argues is completely consistent with the vision of integral human development that McDaniel and I advocate. But I would suggest that Smith—in whom we certainly find significant streams of virtue ethics and non-utilitarian argumentation—is one starting point for rethinking questions of political economy such as free trade in a manner that takes both the demands of integral human flourishing and the insights of modern economic science seriously.

Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. His forthcoming book, Wilhelm Roepke’s Political Economy, will be published in early 2010.

Copyright 2009 the Witherspoon Institute. All rights reserved.

Second, and more provocatively, freedom to trade goods and services is a defeasible but still important human right. Gregg adduces two main arguments in support of this: Francisco de Vitoria’s argument that the right of peoples to trade is part of a more general right to freedom of association and Hugo Grotius’ argument that the universal destination of the earth’s goods (and, it would seem, services) requires international markets. Such markets are the only reliable means to “spread the wealth around” to all the peoples of the world. Viewed from this point of view, protecting free trade is (as Gregg quotes Edmund Burke as saying) a matter of justice, not merely utility.

Gregg’s article is full of compelling good sense; I wish to offer supplementary thoughts rather than a refutation.

The least controversial part of Gregg’s argument is the (broadly speaking) utilitarian one: free trade makes us all richer. After Adam Smith, this is intuitive and seems to be amply borne out by history. But one should also consider the risk of creating a dangerous interdependence. As modern society and economy have developed, there has been a striking decline in self-sufficiency at every level of social organization. Nations, regions, cities, towns, and neighborhoods depend, for the most part, far more critically on externally provided goods and services for basic functioning than they did two hundred years ago. If the British blockaded Manhattan today, they would win in half a week without firing a shot.

This should be worrying for at least two reasons. The first is fairly straightforward: things can go suddenly and catastrophically wrong in any system, and the vaster, more complex, and more decentralized the system, the harder it is to control the damage. This is because it is harder to understand the chain of cause and effect and because it is harder for any authority to be effective in coordinating necessary remedial actions. It seems wise for communities of all sizes to insulate themselves partially from the effects of failures in larger markets, even at the price of gaining fewer benefits from participation in those markets. Maintaining such circumscribed but porous economies decreases but does not eliminate competition. Furthermore, it tends to nurture the local pride that can inspire good and creative work. We could therefore expect continuing innovation and growth in productivity within each economy, even if at a reduced rate. And such partial insulation is not merely self-interested, because, after all, one semiautonomous economic community can often provide assistance from a position of strength when another experiences internal failure. Loving your neighbor is rarely the same thing as chaining yourself to him.

The second reason hinges on a controversial judgment about the requirements for healthy polity. It is a judgment that may be risible or even unintelligible to those with very different political imaginations from mine, but it is important to propose it. Public authorities and legislators should promote integral human development. That is to say, development involving all the many, complex aspects of existence that make for a full human life. Deciding to seek integral human development does not lead automatically to any specific policies but (what is more radical still) changes the very language and patterns of reasoning followed in discussing policy options. If decision-makers chose to be explicitly responsive to all the various values in play when organizing the lives of their communities, political discourse would change almost beyond recognition.

Now, when it comes to making decisions about economics, a crucial value is generally overlooked: human beings are happiest when they belong to several concentric or overlapping communities, each with a distinctive way of life (enduring, usually, across many generations) and each enjoying a degree of organic wholeness; that is, the sense of being a demarcated ‘little world’ adequate (at least potentially) to provide the elements of a good, distinctly human life. Economies are deeply intertwined with concrete ways of life, and are crucial to establishing organic wholeness—they are not merely patterns of production to be judged only by their productivity and efficiency. Communities without somewhat circumscribed, partly independent economies of their own tend to have increasingly abstract and finally unreal existences.

Consider a household in which even mundane tasks are routinely “outsourced”—older siblings never babysit, parents never clean house or mow the lawn, no family members entertain each other on instruments or cook for each other. Although this household may be efficient and may greatly increase the Keynesian multiplier, making everyone richer, it is impoverished qua household. It will be diminished as a group of persons sharing a common good achieved in part by joint management of community resources. This is why there may be good reason to pay one’s own child to mow the lawn, even if someone else does it better and more cheaply.

There must obviously be due proportion in all things. Regions are not families, and still less are nations. The lesser degree of community will make economic relations within them less personal, less organic—and properly so. Still, even these levels of community may sometimes be given proportionate support by partly protecting their economies. Gregg points out that it is much harder to grow grapes in Scotland than in Italy. From this he concludes that it makes little economic sense for Scots to buy their own wine when they can buy Italian wine and redirect their energies. But let us say that that there were rewarding challenges and special, fascinating knowledge involved in making Scottish soil yield decent grapes; let us say that an admirable, humanly fulfilling way of life had grown up around this endeavor. An individual who esteemed the art of growing Scottish grapes and felt fondness for the famous grape-growing villages that dot the landscape, to one of which (let us say) all four of his grandparents belonged, and who thought of it as a great national institution that showed the rugged creativity of the Scottish people would not be stupid or wicked if he supported this comparatively disadvantaged industry by purchasing its produce at a higher price. If enough Scots felt this way, they might decide, after public deliberation, to collectively “pay more” for Scottish wine by subsidizing it. The ability to entertain seriously such contra-market choices is an important sign that an organic community has not devolved into a mere administrative department.

Look at the matter from a slightly different angle: Economic relationships, even when they include prices (as they often must), are most human when the law of supply and demand is not the only factor, when there is some degree of personal interest, knowledge, and concern between buyer and seller. The more open the economy, the less buyers and sellers are likely to know or care about each other in any given transaction. There will be more alienating bureaucracy and anonymity. Some such relationships seem unavoidable under modern conditions, and are, in any case, arguably worthwhile because of the benefits they provide. But surely economic life (which, lest we forget, is a large part of “Life” writ large) should not be dominated by such relationships. (It is worth noting in this connection that international trade is itself at its most comprehensively rewarding as a fully human activity when foreign goods are bought not merely because they are cheaper, but because they are associated with, and are the organic product, so to speak, of a locale and way of life that interests the buyer.)

Turning briefly to Gregg’s arguments that free trade is a right, I must agree with his points but suggest further considerations along the lines of what I have just been saying. Like de Vitoria, I think that free trade is part of free association, which is a real but defeasible right. Like Grotius, I think that international markets are vital in giving everyone a greater share in the world’s bounty. The question is, what are the full range of values that could, in theory, defeat (or at least limit) the prima facie right to free association, or defeat (or at least limit) the prima facie imperative to share the world’s bounty?

It is obvious to most people that limiting the freedom of association of prisoners is justifiable when public safety requires it. But, more interestingly, there is also general support for the limitations Amish communities place on their members’ freedom of association for the sake of communal integrity. Is it possible that a somewhat similar rationale could justify somewhat similar policies on the national level?

Because of the terrifying tendency of the modern state to abuse its coercive power, and because it is unhealthy and dangerous to compare nations too closely to religious communities, it is certainly hard to think of a case in which very strict state control of, say, travel or information would have any sane man’s support, whatever the reasons tendered for these restrictions. But creating another North Korea is not legislators’ only alternative to laissez-faire.

It may well be reasonable, for instance, to ban importation of certain foreign items, or of such items in certain quantities, or at least to put heavy duties on them, in order to prevent or limit the justly undesired social changes associated with them. After all, not everything for sale is worth having. It seems still more reasonable to use economic regulations to limit the social dislocation caused by the large movements of peoples associated with globalization. This can be done without coercion by measures such as impeding the free functioning of international labor markets through heavy duties on imported and exported labor.

My purpose here is not to support or oppose any nation’s international trade policies, and it is certainly not to propose any of my own. It is rather to insist that complex communal goods should never be ignored, even when other goods should obviously take precedence. It is crucial to do so, because by the very fact of attending to them we reinforce a properly nuanced conception of human flourishing—and therefore of the true nature of politics.

Stefan McDaniel is an assistant editor at First Things. Samuel Gregg’s response to this article will appear on Friday.

Copyright 2009 the Witherspoon Institute. All rights reserved.

Estimates vary, but according to the IMF, total world trade in goods and services will decline by 12.2% in 2009. Accompanying these developments have been fears of resurgent protectionism. The Economist argues, however, that such worries have proved to be overrated. In one sense, this is true. If by protectionism we mean the raising of tariff barriers, then we have not seen anything like the 1930 Smoot-Hawley Tariff Act that limited foreign access to America’s markets and helped facilitate the Great Depression. Indeed, some countries, such as Australia and China, have actually reduced import duties.

On the other hand, the European Union and the United States have introduced new farm subsidies to already outrageously subsidized agricultural sectors. Moreover, there are other ways to impede or distort the relatively free access of individuals and businesses to global markets. One example is the early 2009 stimulus package passed by the American Congress. It contains “Buy American” provisions that actively discriminate against foreign imports.

Yet another instance of creeping impediments to free trade is the recent demand by several United States senators that any cap-and-trade bill contain “a longer-term border adjustment mechanism”—in other words, a tariff—to protect American industry against competition from countries that refuse to adopt expensive carbon-emission measures similar to those contained in the Waxman-Markey bill passed by the House of Representatives. Some European Union countries, most notably France, have insisted that “economic measures” should be taken against those countries that don’t enact carbon-emission requirements like those embraced by the EU. India and China have already told the United States they have no intention of adopting such policies on the grounds that they would drastically impede these nations’ ongoing rise out of poverty—one of the economic miracles of our time.

But why, some might ask, are these emerging barriers to free trade so worrying? Shouldn’t governments encourage “economically patriotic” policies? Surely a government should “look after its own.”

There are two reasons why free trade should be protected and promoted. The first concerns free trade’s profound contribution to global economic prosperity. The second is that free trade is a human right—not an absolute right, but a right that governments should only circumscribe in the most adverse of circumstances.

The economic case for free trade was codified by Adam Smith when his Wealth of Nations was published in 1776. He challenged the then-reigning mercantilist orthodoxy that one country could only become richer at other nations’ expense. “The modern maxims of foreign commerce,” Smith wrote, “by aiming at the impoverishment of all our neighbors, so far as they are capable of producing their intended effect, tend to render that very commerce insignificant and contemptible.” Observing the political and economic conflict between the eighteenth century’s two great powers, France and Britain, Smith commented that “If those two countries . . . were to consider their real interest, without either mercantile jealously or national animosity, the commerce of France might be more advantageous to Great Britain . . . and for that same reason that of Great Britain to France.”

Smith’s point was simple yet revolutionary: free trade would, in the long term, mutually enrich everyone. For one thing, free trade encouraged an ever-increasing depth and sophistication of the division of labor. This facilitated technological development and the ability to grow ever-increasing amounts of wealth. Free trade also created an ever-widening space for individuals, businesses, and entire nations to find, develop, or even change their comparative advantage. As Smith put it, “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.”

It was certainly possible, Smith noted, for a country like Scotland to grow grapes. The financial cost, however, of doing so compared to, for example, growing grapes in Italy, made that an economically foolish choice for Scots. By contrast, individuals, businesses, and countries in a global free market would be encouraged to focus on doing what they did best and would not be incentivized by protectionism into developing industries that, in the long run, couldn’t compete in the marketplace, even with extensive tariffs.

Appeals to economic efficiency and prosperity are enough for some, but just as human beings are more than homo economicus (and Smith himself never thought that human life could be reduced to economics) so too are purely economic arguments insufficient for governments to adopt particular policies, even those concerning economic subjects. But if governments have some responsibility to protect their citizens’ rights, then perhaps they may wish to consider the claim that the liberty to trade goods and services across national boundaries is not a privilege but rather a right.

Excessive rights-talk disfigures much contemporary political discussion, but compared to most modern rights-claims, the idea of free trade as a right has both a much older lineage and a more coherent rational basis. The first to apply the word “right” to free trade was the sixteenth-century scholar Francisco de Vitoria (1492-1546) in his De Indis et de Ivre Belli Relectiones (1532).

According to Vitoria, the right to free trade was derived from the natural right of free association enjoyed by all people. Free association, to Vitoria’s mind, was essential for human flourishing, and he did not believe national boundaries should unreasonably limit people from freely associating with others, including for economic reasons. Interestingly, Vitoria developed this line of argument in the context of claiming that the New World’s native peoples should not be prevented from freely trading with European merchants by either their indigenous rulers or European monarchs. Such were Vitoria’s convictions against mercantilist policies that he even depicted laws unduly limiting free trade between nations as “iniquitous and against charity.”

The Dutch philosopher and jurist Hugo Grotius (1583-1645) also built a rights-based case for free trade. As a target, Grotius aimed at the Portuguese claim to a monopoly of the trade routes to the East Indies. In Mare Liberum (1609), Grotius employed uncharacteristically insistent language to maintain, as an “unimpeachable axiom of the Law of Nations . . . the spirit of which is self-evident and immutable,” that “Every nation is free to travel to every other nation, and to trade with it.”

Grotius’ argument for free trade as a right was based on the premise that nature did not supply every place with the necessities of life. Moreover, Grotius observed (foreshadowing Smith’s economic analysis) that it was clear that “some nations excel in one art and others in another.” These factors meant that if the goods of the world were truly to serve everyone, then free trade was a necessity. Grotius notes that his argument was hardly novel, as it could be found in the works of Roman philosophers such as Seneca (4 B.C. – 65 A.D.). Almost a century after Grotius’s death, we find the same position stated in the most important eighteenth-century text on international law, Emer de Vattel’s Le droit de gens (1758). This book insists that the “obligation,” as Vattel describes it, of nations to engage in mutual commerce, means that those “privileges and tolls, which obtain in many places, and press so heavily upon commerce, are deservedly to be reprobated.”

To be sure, none of these thinkers considered free trade to be an absolute right. Grotius and Vattel believed, for example, that states engaged in a legitimate war could justly prohibit its citizens from trading with citizens of enemy powers. Nor was Smith an absolutist about free trade. In some circumstances, he was willing to approve certain subsidies for particular industries. Generally, however, Smith insisted that the onus of proof for the wisdom of interfering with free trade lay with those proposing a restriction or subsidy.

Will free trade, either as a right or an empirically validated economic argument, ever gain universal acceptance? Smith himself concluded there was so much resistance to free trade arising both from economic ignorance and also established interests determined to protect themselves from competition by whatever means necessary that “to expect . . . that freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or Utopia should ever be established in it.”

One of Smith’s contemporaries and greatest admirers, the English philosopher and politician Edmund Burke, once wrote that “Free trade is not based on utility but on justice.” Certainly the economic argument for free trade’s long-term economic utility and protectionism’s detrimental effects is difficult to refute. Yet it may be that free trade’s greatest hope in the long term will be that enough people recognize there is something fundamentally unjust about unduly impeding the ability of all the world’s resources to serve all human beings in an increasingly globalized world in which nation-state borders mean less and less.



Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. His forthcoming book, Wilhelm Röpke’s Political Economy, will be published in early 2010.
Copyright 2009 the Witherspoon Institute. All rights reserved.

Greed and sheer imprudence played a role, but so too, Kaletsky argued, did those (unnamed) economists who posited that their models proved that events such as the collapse of Lehmann Brothers in 2008 or Long Term Capital Management in 1998 were mathematically likely to happen once every billion years.

Kaletsky’s broader point was that contemporary mainstream economics had been sufficiently discredited by the financial crisis that the entire discipline required what he called an “intellectual revolution,” or it risked being dismissed as a rather suspect sub-branch of statistical analysis and mathematical modeling.

Kaletsky is hardly alone in arguing that economists need to rethink key aspects of their discipline. Though unwilling to call for a total paradigm shift, the Economist recently opined that the financial crisis has raised profound questions of coherence about two areas of economics: macro-economics and financial economics. “Few financial economists,” the Economist observed, “thought much about illiquidity or counterparty risk, for instance, because their standard models ignore it.” Likewise, the Economist commented, “Macroeconomists also had a blindspot: their standard models assumed that capital markets work perfectly.”

All this is certainly true. But the key expression to note here is “their standard models.”

Since John Maynard Keynes’s time, mainstream economics has undergone a steady process of mathematization. Anyone doubting this need only peruse their nearest copy of the American Economic Review and observe the plethora of algebra, mathematics, and abstract modeling that is central to most mainstream economists’ argumentation—regardless of whether they are committed neo-Keynesians or proponents of the efficient markets hypothesis.

Of course there is, as Nobel Prize economist Myron Scholes notes, a difference between the academic economists creating the models and the Wall Street financial engineers applying these models in the marketplace. Indeed many economists who support the efficient market hypothesis have introduced numerous qualifications—based, for example, on their willingness to import insights from other disciplines—to explain apparently irrational economic behavior by individuals and institutions.

Much of this work will bear fruit over time. It is telling, however, that there appears to be little inclination on the part of some contemporary economists to ask some searching questions about their heavy reliance on mathematical logic and argumentation. This may well be because doing so would raise some rather profound questions about the very nature of post-Keynesian economic science.

One who posed precisely these questions was the German economist Wilhelm Röpke (1899-1966). Röpke is well-known as an intellectual architect of post-war West Germany’s path from collectivist economic oblivion to market-driven economic miracle in the ten years following its economic liberalization in 1948.

Less attention, however, has been given to Röpke’s fierce critiques of the post-war Keynesian consensus. On one level, this was driven by Röpke’s belief that Keynesian policies would inexorably reduce political and economic freedom. But another source of Röpke’s angst was his conviction that Keynes and his disciples had corrupted economics as a social science.

In Röpke’s view, Keynes was “a representative of the geometric spirit of the 20^th century” and “an exponent of positivistic scientism,” for whom “economics was part of a mathematical-mechanical universe.” While Röpke assigned more blame to Keynes’s disciples, he insisted that Keynes’s approach to economics had created an “old economics” and a “new economics” in which the sense of one was nonsense in the other.

According to Röpke, the neo-Keynesian new economics was inclined to reduce economics to mathematical and statistical formulas and analyses. Röpke may have been thinking of Paul Samuelson’s 1947 effort to reconfigure economics on the basis of mathematical language. For Röpke, such efforts conflated the object of economics with one tool of economic analysis. Opening a post-Keynes economic textbook, Röpke suggested, made readers wonder if they had stumbled upon a chemistry curriculum.

Mathematics is a form of language based upon symbols. Its origins lie in facilitating the study of the natural sciences. But mathematics is less adequate when it comes to analyzing things which are unquestionably real and have implications for economic life such as traditions, institutions, and values. Röpke believed that mathematical formalism addressed these realities by generally ignoring them. Economics thus became a quantitative exercise that “teems with equations in ever-increasing profusion” and focused upon developing models and patterns of aggregate behavior by whole populations.

While accepting that the new economics enhanced the use of macroeconomic concepts, Röpke complained that Keynes had effectively “declared the method of thinking in aggregates to be the only one, both now and in the long run.” Economics consequently lost sight of its essence which is not macro-aggregates but the choices of individuals and institutions. On this basis, Röpke believed that the “new economics” was destroying economics as “a ‘moral science’ in the sense that it deals with man as an intellectual and moral being.”

In Röpke’s view, sound economics certainly allows the use of mathematics to explain certain relationships that have quantitative characteristics. Nevertheless the more economics drifted in a mathematical-statistical direction, the less attention it paid to that which is un-mathematical and which does not always behave predictably—human beings. Though Röpke believed that mathematics can help describe relatively stable and uncomplicated economic relationships, he was unconvinced it could handle the full complexity and instability of actual economic life. The eventual result, Röpke stated, was not only that “with all our cleverness, we have become decidedly less wise, while knowing more and more about less and less,” but also the “dehumanization of economic science.”

Worries about these developments were not confined to convinced free marketers. One of Keynes’s earliest followers and first biographer, Sir Roy Harrod, commented that many economists’ effective replacement of attention to basic economic principles with an immersion in mathematics and aggregates had led him to conclude that “we should be better off with the old political economy.”

Reflecting upon the expression political economy might not be a bad place to start for those interested in rethinking economics’ foundations in a post-crisis era. In Adam Smith’s Wealth of Nations, the term acquires three meanings.

The first is the commonly accepted positive sense of political economy as the scientific study of “the nature and causes of the wealth of nations.” More broadly, however, Smith’s political economy also embraces the study of the interrelationship between economic theory and the political ideas and movements of a given time. Lastly, there is the sense in which Smith understood political economy in terms of what we today call economic policy: “a branch of the science of the statesman or legislator” whose objective was “more properly to enable [people] to provide such a revenue or subsistence for themselves; and . . . to supply the state or commonwealth with a revenue sufficient to the public services.”

On one level, the Wealth of Nations does involve abstract analysis of economic life. Smith carefully dissects the claims of prevailing economic thought, presents a fresh theory about how wealth is created, and elaborates on what should be done in policy-terms if wealth creation and society’s overall material enrichment are deemed desirable. But in doing so Smith also attempts to develop a powerful normative argument for an economy based around private property, free competition, and limited government over and against the mercantilist systems that dominated eighteenth-century Europe.

As the economic historian Emma Rothschild reminds us, Smith sees economic liberty as something to be approved and pursued partly because of its capacity to liberate people from many forms of oppression. For Smith, the move from mercantilist to market economies was not only a matter of following the promptings of scientific economic reasoning focused on wealth-creation. Smith also regards market economies as superior to previous economic arrangements on grounds of the greater efficiency and liberty they accorded to ever-widening numbers of people to seek human fulfillment.

Unfortunately, with some notable exceptions, this Smithian conception of political economy did not persist after Smith’s death in 1790. By John Stuart Mill’s time, political economy was being defined as studying the behavior of homo economicus, a creature whose nature is far removed from that of the more complex, not-always rational being found in Smith’s writings. From here, it was only a short step towards the reduction of much economics to a branch of applied mathematics, however valiantly this trend has been resisted by the Austrian and Public Choice schools.

Obviously there are many aspects and tools of modern economics with which we would not want to do without. But a renewed focus upon political economy in Smith’s three senses might provide a rich starting point for economists interested in the deep rethinking advocated by Kaletsky. It would maintain economics’ strong empirical-positive dimension, but blend it with a deeper appreciation for human complexity, and thus engender more humility about economics’ predictive power—a virtue all of us could use more of in our post-crisis era.

Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. His forthcoming book, Wilhelm Röpke’s Political Economy, will be published in early 2010.

Copyright 2009 the Witherspoon Institute. All rights reserved.

It was not just that Merkel decided not to speak in the hushed, polite tones that politicians usually reserve for any discussion touching upon central banks’ conduct of monetary policy. Merkel’s Berlin speech drew attention for two reasons: first, her forthright criticism of the policies currently being pursued by the Federal Reserve and the Bank of England; second, her claim that the independence of some central banks, including the ECB, has been compromised as a result of political pressures.

Merkel’s first set of criticisms echo the deeply anti-inflationist approach to monetary policy consistently pursued by Germany’s central bank, the Deutsche Bundesbank, since its foundation in 1957. Even today, Germans remember that rampant inflation twice wiped out the savings of Germany’s middle-classes after World War I, thereby helping to open the path to power to Adolf Hitler’s National Socialists. It is no coincidence that two German members of the ECB board, including Axel Weber, the present Bundesbank president, have publicly warned in recent weeks about the potential for loose monetary policy to create future inflationary problems and asset-price bubbles.

In political terms, Merkel’s comments also reflect her determination to restrain European Union member-states from adopting neo-Keynesian deficit-spending programs on the scale presently being pursued by the Obama Administration. As Federal Reserve Chairman Ben Bernanke recently noted, the overall effect of these and other measures will be to raise America’s debt-to-GDP ratio to 70% by 2011. This represents an increase from 40% in 2008. This may explain why Merkel was perhaps the most forthright dissenter at the recent G-20 meeting when President Obama urged the world’s leading economic powers to adopt policies similar to his own in response to the global recession.

But it was, however, Merkel’s concerns about possible compromises to the independence of central banks that drew the most attention. “We must”, Merkel insisted, “return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time”. Her position contrasts with that of other European centre-right leaders such as France’s Nicholas Sarkozy who, not long after being elected president in 2007, expressed the desire to diminish the ECB’s independence.

Such remarks may simply reflect France’s ingrained dirigiste instincts. Over the past 15 years, the trend has actually been toward increasing central banks’ independence. One of the Blair Labor government’s first decisions following its election in 1997 was to grant the Bank of England operational control over monetary policy. This trend, however, should not blind us to the fact that politicians have many reasons for wanting to exercise strong influence over central banks. It is hard for governments to resist the temptation to try to manipulate interest rates in order to maximize their re-election chances. It also gives governments the option of letting the inflation genie out of the bottle in order to boost short-to-medium-term employment at the expense of devaluing savings, shattering price stability, and undermining long-term employment growth.

One of the financial crisis’ long-term effects will be to raise questions about central banks’ ability to maintain an independent monetary policy during periods of economic stress: that is, precisely when such independence is most important. Of course, no institution can be rendered completely immune from political and public pressures. But over forthcoming months, central banks are going to be faced with making decisions unlikely to please governments and legislatures worried about being reelected.

Though the Obama Administration has tried to avoid creating any public perception that the Federal Reserve is merely doing the Treasury’s bidding, it is unclear how the Administration and Congress will react when the Federal Reserve chooses to reduce the chance of future inflation by winding back some of the measures it has taken since the onset of the financial crisis last year. As David Wessel remarked recently in the Wall Street Journal (06/04/09), Chairman Bernanke “may find Fed lending so intertwined with the Treasury’s bailouts that the Fed lacks the flexibility and independence it needs. Or he may find tightening tough while Congress is contemplating changes to the Fed’s governance and powers.”

The bigger political question, however, is the place of central banks in democratic political orders. Insulating central banks from excessive political influence reflects recognition of the truth that even in a democracy there are many public-policy decisions that should not be made by legislative or popular votes. Most democracies, for example, embody constitutional limits on the ability of governments and legislatures to interfere with the judiciary’s operations. This is usually derived from awareness that the common good normally requires some separation of powers in order to prevent excessive centralization of power.

The problem is that when it comes to the economy, governments have legitimate reasons for being concerned about and involved in the development of economic policy. This inevitably raises questions about how to maintain the autonomy of central banks and what ought to constitute the content of that autonomy. Governments committed to pursuing populist and socialist policies have no qualms about dramatically limiting or even abolishing such autonomy. This is why Venezuela’s Hugo Chavez has steadily eroded the independence of his country’s central bank, describing its autonomy in a 2007 address as a “neo-liberal idea” obstructing his long march towards “new socialism.”

A more traditional way for governments to resolve these questions has been to charter the central bank’s specific responsibilities, and then generally limit the government’s formal involvement in monetary policy to periodical meetings between the government and central bank governors, appointing members of the central bank’s board at legislatively-specified intervals and arriving at memoranda of agreements with the central bank about inflation targets. The intended effect is to create a situation of “independence within government.” Thus, according to European Union law, the ECB’s prime objective is “to maintain price stability.” It also has the responsibility —“without prejudice to the objective of price stability”— to “support the general economic policies” of the European Union, these being specified by Article 2 of the Treaty on European Union as “a high level of employment and sustainable and non-inflationary growth.” The ECB therefore has the luxury of having a prime objective to which the other goals are subordinate.

By contrast, the Federal Reserve has the responsibility of “conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.” It is thus legislatively charged with realizing goals that are not only ascribed equal importance but which may be incompatible in some circumstances. As the experience of the early 1980s illustrated, the Federal Reserve’s pursuit of stable prices (i.e., fighting inflation) could only be achieved by accepting high unemployment for three years. In retrospect, this was surely the right decision, but whether it reflected the Federal Reserve adhering to all its legislatively-mandated responsibilities is another matter.

In the end, it may be that the only way to protect central banks’ ability to conduct monetary policy in ways that truly insulate them from excessive political pressures and the distorting effects of internally incoherent legislation is to cut the links between them and governments. This is the argument contained in Professor Tim Congdon’s recent thought-provoking monograph, Central Banking in a Free Society (2009), published by the Institute of Economic Affairs.

Among other things, Congdon reminds us that the Bank of England was a private bank from its foundation in 1694 until its effective nationalization by the Attlee Labour Government in 1946. Looking at the present, Congdon maintains that central banks should be “privatised and owned by the banking system, not by the state,” primarily because he holds that “central banks in private ownership would be subject to a better pattern of incentives, with checks and balances that would be more likely to keep them on the right course, than if they remain in the state’s hands.” In this scenario, the capital for central banks would be directly provided by commercial banks rather than governments.

One advantage of this approach is that the central bank would acquire a primary objective—monetary stability—uncomplicated by secondary goals or other state-mandated primary purposes. Another benefit is that the task of maintaining monetary stability would be even further insulated from direct and indirect political influences—if only to the extent that all other private businesses enjoy some protection from government pressures.

In the present political and economic climate, proposals for radically rethinking central banking are unlikely to achieve either popular or elite acceptance. Governments’ natural survival instinct during recessions is to try to augment their influence over monetary policy. This is especially true when governments are anxious to prove to economically-battered and politically-angry electorates that they are doing something, even if they themselves know that what they are doing is more than likely to have deleterious long-term economic consequences. But if we take seriously the advice of President Obama’s Chief of Staff Rahm Emanuel to “never let a serious crisis go to waste,” then now is as good a time as any to rethink the practices and institution of central banking.

Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. He is a contributor to Public Discourse.

Copyright 2009 the Witherspoon Institute. All rights reserved.

Relations between the disciplines have not always been so distant. Scholastic natural lawyers trained in the tradition of Aristotle and Aquinas developed defenses of private property and free trade that influenced authors such as Grotius, who in the seventeenth century laid the groundwork of the modern law of nations and thus the basis of modern trade. John Locke subsequently wrote an incisive account of the natural right to property as the source of economic prosperity, and Adam Smith, who wrote a treatise of moral philosophy before authoring The Wealth of Nations, described what he called a system of natural liberty as the matrix of genuine wealth. Although in the nineteenth century both moral philosophy and economics in the English-speaking world developed under the influence of utilitarianism, contemporary theory in both natural-law moral philosophy and economics emphasizes the centrality of the human person and the practical choices he makes concerning human goods or values. In this regard, the question of the relation of natural law to economics is on the one hand the extent to which economic calculations can be based on notions of objective good established by practical moral reason, and on the other hand the extent to which practical judgments by individuals about their good can be informed by an awareness of global consequences.

While conference participants did not arrive at a consensus on these issues, I think it is fair to say that the conversations identified an intellectual space defined by three dimensions. The first involves the question of the rational foundation of inquiry, announced by the opposition between natural law and utilitarianism. Is the measure of good intrinsic to human activities as known by experience and critical reflection, or is the goodness of human actions determined by the sum of their consequences, that is, by their utility? To the natural law philosopher, the utilitarian is needlessly vague in identifying the good, or supposes a commensurability among various goods that does not in fact exist, or defers too readily to subjective claims of good that can be shown with a little reasoning to be mistaken. To the utilitarian, the natural lawyer is peremptory in his pronouncements and inattentive to genuine differences among persons in their subjective experience of goodness. Besides, too complex an account of incommensurable goods precludes analysis of aggregate effects before it begins, though such analysis is obviously needed to explain, for example, the establishment of price equilibria or the behavior of markets. If the distinction between natural law and utilitarianism is fundamental in principle, though, it may not always be unbridgeable in practice. Natural lawyers agree that knowledge of the probable consequences of one’s actions is crucial to sound moral decision-making, denying only that the measure of consequence can guide choice without first examining whether the preferences at issue are morally acceptable. Utilitarian economists, on the other hand, while able to explain the behavior markets in crime and contraband, nevertheless admit the distinction between a legitimate and an illegitimate market based on the nature of the supposed good in the exchange.

A second dimension concerns the form of economic relations and stretches between the free market on the one hand and socialism on the other. Here things are complicated by the fact that natural law and utilitarianism have been invoked in support of both positions. The classic tradition of natural law grew out of a tradition of political philosophy that began with Platonic communism, and although Aristotle’s critique of common property (and Plato’s own recognition in his Laws of its impracticality) quickly became canonical, natural law was traditionally defined in terms of the common good, which seemed to suggest some need for authoritative distribution or redistribution of the wealth of the city, or at the very least for public provision of goods that can be shared by all. Modern natural rights thinking, by contrast, stresses the primacy of individual goods and thus the naturalness of the market, though on some accounts these natural rights prove brittle, yielding to the government instituted to protect rights plenary authority to revise them. Although the differences between classic natural law and modern natural rights can be a source of confusion, several authors bridge this gap: the later scholastics, such as Tomas de Mercado and Francisco de Vitoria, developed a tradition of natural rights based on Thomistic categories that in some ways anticipates Lockean thought, while Scottish Enlightenment authors such as Gershom Carmichael and Francis Hutcheson sought to synthesize or balance Locke and Aquinas. In brief, natural law, far from being a source of doctrinaire prescriptions, is a vital form of practical reasoning, seeking guidance for human action in an understanding of human nature itself—and is no more settled than our knowledge of ourselves.

Globalism versus localism defines the third dimension at issue. Indeed, the precipitant for the conference was a recent article in International Affairs by Harold James of Princeton University suggesting that the friends of global trade and liberalization would find in the discourse of natural law a better guide and guard than in functionalist economics or imperialist realism. Natural law offers an intellectual framework that might facilitate dialogue and exchange among peoples with different, even clashing, cultures, attending to “the fundamental values that follow from our acknowledgement of the intrinsic dignity of humans.” Precisely because it begins with human dignity, much scholarship in natural-law moral philosophy in recent years has concentrated on the rights and duties of the person, particularly those involved in sexual morality and the formation of families. No one who follows these issues will be surprised to learn that differences quickly appeared among conference participants on questions about the impact of the globalizing economy on family life or about the need for families to prepare their children for participation in the larger world. Mediating between the family and the world at large, the state and the various institutions of civil society play important roles in establishing and maintaining moral communities. They bring along, of course, their own traditions and acquire texture from their choices and their circumstances—but, again, natural law reasoning is flexible enough to recognize most of these and in fact to encourage them as the concomitants of liberty. The challenge is to ensure that amidst cultural difference genuine human rights are respected and the commerce and interaction of peoples can flourish in a condition of general peace. Questioning whether this outcome would be better assured by spontaneous market forces and evolving business practice or by expanded institutions of global governance occasioned lively debate.

Lest these latest remarks sound hopelessly utopian, one should remember that the natural law tradition includes an account of just war, not speculation about perpetual peace. Nevertheless, the mood of the conference might be described as cautiously optimistic, despite the enormous economic and political challenges of the current moment. In contrast to the pragmatism, alternately wide-eyed and grim, that seems today to reign in high councils, the natural law tradition seeks out steady principles to steer human action in the midst of rapid change and looks for balanced development rather than spectacular reversal in human affairs. It is neither tolerant of man-made disaster nor expectant of humanly engineered salvation. I have used the metaphor of dimensions that construct imagined space to indicate the room available for research, reflection, deliberation, and choice as we seek to comprehend natural law and formulate economic policy in our contemporary predicament. “No free government, or the blessings of liberty, can be preserved to any people but by a firm adherence to justice, moderation, temperance, frugality, and virtue, and by frequent recurrence to fundamental principles,” wrote the revolutionary Virginians in their 1776 Declaration of Rights, in many ways the model for the Declaration of Independence a month later and for the French Declaration of the Rights of Man and Citizen a decade or more afterwards. Our circumstances and our institutions now are not a little different from theirs then, but the spirit of natural law—jealous of liberty, confident in virtue, attentive to principle—endures. Couple this spirit with evidence—also presented at the conference—of sound economic understanding in a debate among Chinese scholars dating from 81 B.C. and you get a sense of the possibilities that ought to be explored.

James Stoner is Professor in the Department of Political Science at Louisiana State University. He sits on the editorial board of Public Discourse. The papers presented at the Natural Law and Economics Conference can be found on-line at the conference website.

Copyright 2009 the Witherspoon Institute. All rights reserved.

The topic of Murray’s talk was well chosen. Whatever one thinks of its virtues, socialism on a scale that would have been unthinkable just two years ago is already the law of the land. We see government asserting de facto rights of ownership over our largest financial firms. We have seen a sizeable portion of the economy being brought under direct government control, financed by trillion-dollar borrowing. We have made steps to undermine the Fed’s independence that could bring about inflation that would make the 1970s look tame. Some are beginning to raise tentative but credible questions about the security of America’s sovereign debt. And the top two items on the legislative agenda this year will be near-irreversible first steps toward socialized medicine and a giant new energy tax disguised as environmental regulation.

America shows all the signs of entering a generational political crisis such as we haven’t seen since the Great Depression. It is now an open question whether we will continue to be a quasi-capitalist nation, in defiance of fashionable international opinion, or follow the example of our European betters and become a quasi-socialist nation.

Of course, the European welfare state is both demographically and economically unsustainable. But that isn’t news, and Murray’s contribution on the subject lies elsewhere.

Murray argues that, even aside from its demographic and economic flaws, the European welfare state undermines the aspects of civilization that make for “a life well-lived.” By a life well-lived, he means a life characterized by a lasting and justified satisfaction that one’s life was worth living. He identifies himself with the Aristotelian preference for seeing human beings fully “flourish,” and argues that this, as opposed to mere hedonism, is what Madison had in mind when he wrote that “the object of government” is “the happiness of the people.”

Only a limited number of human activities can serve as sources for this kind of deep satisfaction. Murray identifies three characteristics that all such activities must have: they must be important, they must be difficult, and they must involve individual responsibility for consequences. Activities that are trivial, effortless, or disconnected from consequences can be fun, but cannot make for a life well-lived.

Murray asserts that there are only four areas of life where such activities take place: family, community, vocation, and faith. The assertion is plausible, if only because Murray is careful to define these concepts broadly—a “community” need not be a neighborhood but can be geographically expansive, and “vocation” can include avocations or, more nebulously, “causes.”

The crux of Murray’s case is that the European-style welfare state undermines all four of these areas of life—and on a deeper level than even most conservatives now appreciate. The welfare state doesn’t just eat away at the material preconditions of these activities, but also detracts from their ability to provide a life well-lived.

“Almost everything government does in social policy,” he says, “can be characterized as taking some of the trouble out of things.” Sometimes that’s good; Murray notes that police take some of the trouble out of walking home safely. But the welfare state takes too much of the trouble out of meeting the needs of your family, helping the members of your community, conducting your vocation, and sustaining the visible manifestations of faith (Murray points to the heavily subsidized European churches that are empty seven days a week). If it’s too easy, it fails to meet the difficulty criterion for deep satisfaction.

Moreover, removing the difficulty criterion cultivates a hedonistic outlook that undermines the importance criterion. In other words, make a thing too easy and it soon comes to be seen as trivial. Why have children? Why pay attention to your neighbors? Why seek out meaningful work? Why worship an old-fashioned God? What’s the point of those things, anyway? Most of the time they’re not much fun.

In the lecture’s most powerful passage, Murray discusses how this deeper dynamic has been at work destroying the family in America’s poor urban communities—where something approaching a European-style welfare state already exists. Welfare makes it much harder for the family to be a source of deep satisfaction for men in these communities:

A man who is holding down a menial job and thereby supporting a wife and children is doing something authentically important with his life. He should take deep satisfaction from that, and be praised by his community for doing so. Think of all the phrases we used to have for it: “He is a man who pulls his own weight.” “He is a good provider.”

If that same man lives under a system that says that the children of the woman he sleeps with will be taken care of whether or not he contributes, then that status goes away. I am not describing some theoretical outcome. I am describing American neighborhoods where, once, working at a menial job to provide for his family made a man proud and gave him status in his community, and where now it doesn’t.

Welfare removes the difficulty from providing for the family, and therefore the importance of the husband and father.

And notice how, once family is undermined, two other areas of deep satisfaction—vocation and community—are undermined as well. The menial job loses its significance, and the now-superfluous father is no longer an important part of his community.

Murray is not saying that the welfare state removes absolutely all deep satisfaction from these areas of life. But the empirical evidence before our eyes, both in Europe and in our own poor urban neighborhoods, ought to convince us that the negative impact of the welfare state is extremely damaging.

This analysis is insightful and very much needed, as far as it goes. But an important piece of Murray’s puzzle is missing.

Take another look at his three criteria for deep satisfaction: importance, difficulty, and responsibility for consequences. Murray draws our attention to several activities that meet those criteria and provide deep satisfaction. But there are other activities that meet those criteria and don’t provide deep satisfaction. Winning an Olympic gold medal by outperforming all other athletes in your sport involves importance, difficulty, and responsibility for consequences. But so does winning by bribing the judges. Yet winning by bribery doesn’t give you the deep satisfaction you get from winning legitimately.

In short, activities don’t provide deep satisfaction if they’re morally wrong. (Aristotle, whom Murray invokes, has a thing or two to say about this subject.) Murray says the activities that provide deep satisfaction are “the kinds of things that we look back upon when we reach old age and let us decide that we can be proud of who we have been and what we have done. Or not.” Activities that are morally wrong don’t pass the “look back from old age with pride” test.

It would be charitable, and plausible, to assume in Murray’s favor that he simply took moral goodness for granted when compiling his list of criteria. But the omission weakens his entire analysis.

For example, faced with Murray’s argument that the welfare state makes everything too easy, a socialist might well retort: Should everything therefore be made more difficult, so you can have the deep satisfaction of overcoming difficulty? If the welfare state is bad, why are police good? Why not abolish the police so that walking home safely requires more effort (such as arming yourself) and can thereby become a source of deep satisfaction?

We can’t ultimately answer this question without distinguishing between morally legitimate and illegitimate ways of making things easier. Policing the streets makes our civilization more conducive to deep satisfaction because it is right. Coercive redistribution of wealth makes our civilization less conducive to deep satisfaction because it is wrong. Able-bodied people who live on welfare for extended periods are cheating—just as much as an athlete who bribes the judges. That’s why the welfare state has the corrosive effects it does.

Consider an even more ominous example. Murray argues that the advance of scientific knowledge will increasingly undermine the case for the welfare state by showing that people are born with relatively fixed and stable natural endowments and predispositions. (“Science is proving beyond a shadow of a doubt that males and females respond differently to babies. You heard it here first.”) In other venues, such as his recent book on education policy, Murray has gone further than I would go in elevating the importance of nature over nurture. But one doesn’t need to go as far as he does to recognize that nature does in fact impose boundaries on the efficacy of nurture, and that this is bad news for socialism.

But the same science Murray is counting on to save American individualism may well prove to be its undoing. You can’t have science without engineering. Once we know how human nature works, we will probably figure out ways to tinker with it. Eventually we may figure out how to make people as malleable as socialists wish they were. Once we have that ability, socialists will want to use it.

If Murray’s argument against socialism is that it doesn’t comport with the demands of human nature, how will he oppose the demand to change human nature? In fact, nothing can oppose that demand except a transcendent moral law. (This point will be familiar to anyone who has read C.S. Lewis’s The Abolition of Man, the clearest and most concise statement of this case that I know of.)

Murray’s lecture represents an important, difficult, consequential, and morally good achievement, and he should take deep satisfaction from it. The observation that the European-style welfare state is financially unsustainable will not by itself be sufficient to stop our elites from adopting it, and Murray deserves our thanks for broadening and deepening the case for economic freedom.

But the case Murray makes, important and insightful though it is, will not be sufficient. Those who are now building the socialist utopia around us are convinced that their way is morally superior, and increasing numbers of Americans (especially in the rising generation) are beginning to think that they’re right—especially as they come to see unbridled capitalism as morally hollow and corrosive. The moral case for economic freedom—the rightness of capitalism in the context of an ethical culture—is indispensable if the disaster Murray rightly warns us against is to be averted.

Greg Forster is program director for American History, Economics and Religion at the Kern Family Foundation and the author of The Contested Public Square: The Crisis of Christianity and Politics.

Copyright 2009 the Witherspoon Institute. All rights reserved.

It might seem as if nothing could be less important to social conservatives than transportation. The Department of Health and Human Services crafts policies that affect abortion, the Department of Justice and the Federal Communications Commission play crucial roles in determining how prevalent obscenity is in our society, but the Department of Transportation just funds highways, airports, and railroads, or so the usual thinking goes. But decisions about these projects and how to fund them have dramatic and far-reaching consequences for how Americans go about their lives on a day-to-day basis. Transportation decisions have the power to shape how we form communities, families, religious congregations, and even how we start small businesses. Bad transportation decisions can destroy communities, and good transportation decisions can help create them.

Sadly, American conservatives have come to be associated with support for transportation decisions that promote dependence on automobiles, while American liberals are more likely to be associated with public transportation, city life, and pro-pedestrian policies. This association can be traced to the ’70s, when cities became associated with social dysfunction and suburbs remained bastions of ‘normalcy.’ This dynamic was fueled by headlines mocking ill-conceived transit projects that conservatives loved to point out as examples of wasteful government spending. Of course, just because there is a historic explanation for why Democrats are “pro-transit” and Republicans are “pro-car” does not mean that these associations make any sense. Support for government-subsidized highway projects and contempt for efficient mass transit does not follow from any of the core principles of social conservatism.

A common misperception is that the current American state of auto-dependency is a result of the free market doing its work. In fact, a variety of government interventions ensure that the transportation “market” is skewed towards car-ownership. These policy biases are too numerous to list exhaustively, but a few merit special recognition:

-If a state is interested in building a new highway, the only major regulatory obstacle is completing an Environmental Impact Statement (EIS). After this, the federal government will typically pay for a large portion of the project, and leave the details of its planning and construction to the state’s Department of Transportation. If a state or municipality is interested in a transit project like a subway, a streetcar, or a bus system, however, not only must it complete an EIS, it must also clear a barrage of regulatory hurdles, including a cost-effectiveness analysis, a land-use impact analysis, and a comparison with other transit systems. None of these requirements is necessarily bad in itself (though many of these regulations were designed only to make it harder to build transit systems), but highways aren’t subject to any of them. Naturally, states therefore find it easier to channel transportation dollars into highways.

-As a 2003 report by the Brookings Institution points out, “federal funding for highway projects is more secure and generous than for transit projects; making highway projects easier to finance.” The Department of Transportation will typically match 80% to 90% of state funds directed towards highway repair or construction. Those same funds directed towards transit usually receive less than a 60% federal match, and carry further burdensome requirements for local funding that highway projects do not need to meet.

-Zoning requirements in most municipalities mandate that shops and houses must be separated. It is widely illegal to build the old small-town main street with the mix of shops, houses, and apartments that many find charming (so charming that some of these towns have been turned into tourist attractions). Furthermore, in most states it is mandatory for new schools to be built next to hundreds of acres playing fields, and thus far away from residential neighborhoods (see this report and this paper for a fuller discussion of policies that affect travel to school). These and similar regulations ensure that there are no shops or schools—that is, major household destinations—within walking distance of the average American’s home, which in turn requires the average American to own and use a car, not merely to commute to work but to perform basic tasks like picking up a gallon of milk or sending the kids off to school in the morning.

We often hear complaints that transit systems do not earn profits. This is true (with a few exceptions), but this does not mean that transit systems are a waste of money. When was the last time you heard someone complain about how a local road never manages to turn a profit? If we held roads and transit projects to similar standards of profitability, we would build very few roads indeed. Transportation infrastructure is a public good, and few dispute that the government should play an active role in providing it. In spite of the problems with thinking about transit as if it were business, however, transit- and pedestrian-oriented transportation projects would actually benefit if transportation decisions were guided entirely by market forces, because the pro-automobile biases in current policies at the local, state, and federal levels, would be eliminated.

Pro-highway, anti-transit, anti-pedestrian policies work against the core beliefs of American conservatives in another and even more important way: they create social environments that are hostile to real community. Once again, the ways in which automobile-oriented development prevents communities from forming are too numerous to list exhaustively. They range from the very obvious to the very subtle.

Consider how small businesses are affected by Americans’ dependency on cars. Since businesses are obliged by zoning restrictions to locate far away from residential areas, most Americans drive to every store they visit. This means that store visits are often discrete trips that must be undertaken consciously and planned out ahead of time. As a consequence, shoppers will want to visit stores that carry the most diverse inventory—Wal-Mart, Costco, et al.—and avoid shops that specialize in one particular kind of good—the local paint store or flower shop, for instance. Moreover, since small shops cannot afford to spend large sums on advertising, they can’t buy the enormous signs and billboards that direct shoppers to large retail outlets, nor gin up hype for their products with coordinated television spots. Perhaps if their potential customers could walk by their storefronts they would have a chance to notice window-displays and similar kinds of small, careful advertising. At 60 miles an hour with the AC cranked up, the attention of their potential customers is focused elsewhere.

As the market diminishes for these specialized stores, so too does opportunity for small-scale entrepreneurship. If opening a small business were a viable option in more markets, more Americans would be interested in starting them. The current situation, where only very large stores can compete in most retail environments, makes starting a business impossible for the vast majority of Americans.

Perhaps more importantly, the employees of big-box stores rarely conceive of their jobs as passions or callings. You’re much likely to find yourself in a conversation about the relative merits and demerits of non-volatile-organic paint at Morris Maple’s Hardware down the street than at Home Depot. The local shopkeeper with a comprehensive knowledge of and interest in her wares is flourishing in a way that the clerks at big box stores, merely putting in time for a paycheck, are not.

Small, local businesses can also reinforce the quotidian trust that is a precondition of community. When I find myself without proper change at a book-store near where I live, the owner tells me to give it to him next time. We do not know each other’s names, but we recognize each other and trust each other enough not to quibble about quarters here and there. Needless to say, the cashiers at Borders would be fired for similar behavior. This quotidian trust is also reinforced in small ways that the physical environment can promote or discourage. In neighborhoods where it is easy to walk, residents see their neighbors often, and are given ample opportunity for spontaneous or chance encounters. Community is built out of many weak inter-personal links, and seeing your neighbors informally, episodically, but frequently reinforces these links.

Car-dependency also requires the nuclear family to become a primary transportation resource. Parents must shuttle their children to school, soccer practice, and even their friends’ houses until the children can shuttle themselves (at peril to their lives) in late adolescence. Not only does this overburden families themselves, it prevents the participation of community members in sharing the burdens of child-rearing. Conservatives sometimes mock Hillary Clinton’s infamous aphorism that “it takes a village to raise a child,” but surely this is in fact what conservatives actually believe. Otherwise, why would conservatives care about a culture that promotes irresponsibility and license? Social conservatives, at least, recognize that children flourish best not merely as members of a household but as participants in a culture, and that families themselves have more purposes than logistical support.

Dense, walkable settlements are not just a pleasant lifestyle choice. They are a precondition of the strong, inter-connected communities that social conservatives desire. It is not difficult to envision how these communities can make our lives comprehensively better. Americans are not obliged by any law of nature or rule of the market to live in mediocre, anti-social places. With changes in public policy, over time we can begin again to create neighborhoods that promote real community.

David Schaengold is a research associate at the Witherspoon Institute in Princeton, NJ and assistant editor of Public Discourse. Previously, he researched transportation policy at the Center for Neighborhood Technology in Chicago, IL.

Copyright 2009 the Witherspoon Institute. All rights reserved.

A little discussed question, however, is whether Keynesian-inspired policies are more likely in the long-run to actually foster one of the major causes of the current financial crisis. Among other things, Keynes is famous for his remark that “in the long-run, we are all dead.” To be fair to Keynes, this comment from his Tract on Monetary Reform (1923) is invariably cited out of its original context. But there is no escaping the fact that Keynesian policies ignore a major factor underlying our present economic problems: moral hazard.



Moral hazard is a term commonly used to describe those situations when a person or institution is effectively insulated from the possible negative consequences of their choices. This makes them more likely to take risks that they would not otherwise take, most notably with assets and capital entrusted to them by others. The higher the extent of the guarantee, the greater is the risk of moral hazard. 



The mortgage lenders Fannie Mae and Freddie Mac are prominent examples of this problem. Implicit to their lending policies was the assumption that, as government-sponsored enterprises with lower capital requirements than private institutions, they could always look to the Federal government for assistance if an unusually high number of their clients defaulted. In a 2007 Wall Street Journal article, the Nobel Prize-winning economist Vernon Smith noted that both Fannie Mae and Freddie Mac were always understood as “implicitly taxpayer-backed agencies.” Hence they continued what are now recognized as their politically-driven lending policies until both suffered the ignominy of being placed in Federal conservatorship last September. 



Consider, too, the legal protection of limited liability. On one level, this arguably encourages managers and investors to take full advantage of the massive wealth-creating potential often associated with high-risk endeavors. But at the same time, limited liability also tends to shelter these individuals from a major incentive not to take excessive risk: the prospect of personal bankruptcy. As observed in 1971 by another Nobel Laureate in economics, Kenneth Arrow, limited liability regulation creates incentives for people to do things that they might not do if they were subject to the provisions of unlimited liability. “The law,” Arrow wrote, “steps in and forces a risk shifting not created in the market-place.”



At the level of government policy, a prominent instance of moral hazard was what some call the “Greenspan doctrine” of 2002. This involved the U.S. Federal Reserve stating that, while it was powerless to prevent the emergence of asset bubbles (such as the dot-com and housing booms), the Federal Reserve would do everything that it could to soften the effects of an imploding bubble. This included providing investors with the option of selling their depreciated assets to the Federal Reserve at a time of crisis. Not surprisingly, the result was a surge in excessive risk-taking by investors confident that, if everything did not proceed as planned, they could recoup their losses at someone else’s expense. In his recent book, Fixing Global Finance (2008), the financial journalist Martin Wolf underlines “the distortions introduced by government guarantees to risk-taking.” These, he writes, “create an overwhelming incentive to privatize gains and socialize losses.” 



In many respects, the “Big Three” American car companies are (barely) living examples of what sometimes happens to specific industries when the danger of moral hazard is underplayed. When the Carter Administration chose to rescue Chrysler in 1980, this action conveyed a message to the three Detroit-based car manufacturers: they could take the risk of producing cars that fewer and fewer consumers apparently wanted to buy; they could also risk refraining from confronting the serious inefficiencies introduced into their companies’ operations by years of automobile executives acquiescing in outlandish demands from the United Automobile Workers union. Why? Because if the car companies subsequently found themselves facing economic Armageddon, they had high expectations—based on an established policy-precedent—that the Federal government would bail them out. 



Thus, no one should have been surprised to find the chief executive officers of the now not-so-Big Three—accompanied by a legion of lobbyists and the ever-present UAW—appearing before the United States Congress in late 2008 requesting assistance in order to avert bankruptcy. Does anyone doubt that the next time the Big Three skirt the edge of insolvency, they will once again request protection from the consequences of bad decisions? Such is the logic of disdaining moral hazard.



While there is a great deal of literature on the economics of moral hazard, the same material contains curiously little reflection on why the adjective “moral” is attached to the word “hazard.” Indeed, when economists started studying the subject of moral hazard in the 1960s, their analysis rarely included an explicitly ethical dimension. For the most part, this remains true today. So why do we not simply describe these situations as instances of “risk hazard”? 



It may be that the word “moral” reflects some innate, albeit largely unexpressed, awareness that there is something ethically questionable about creating situations in which people are severely tempted to make imprudent choices. To employ a loose analogy from the realm of moral theology, the one who creates “an occasion of sin” bears some indirect responsibility for the choices of the person tempted by this situation to do something very imprudent or just plain wrong.



If governments and businesses took moral hazard seriously, they would make an effort to identify those state and non-state structures, policies, and practices that create incentives for people to take excessive risks with their own and other peoples’ assets. They would then do what they could to minimize these instances of moral hazard. The economic price might be fewer booms. But economic growth over time would likely be steadier. The chances of mild or severe recessions would also be reduced. 


This brings us to back to the Keynesian policies that most governments are adopting to address the current crisis. In a 2007 Financial Times column, a prominent member of the former Clinton and now Obama Administration’s economic team, Larry Summers, argued that we should beware of what he called “moral hazard fundamentalism.” This was, he said, “as dangerous as moral hazard itself.” By this, Professor Summers meant that ruling out significant government economic intervention on the grounds that it might encourage moral hazard would itself be irresponsible.



The problem is that the Keynesian-interventionist outlook involves, by necessity, a degree of systematic denial of the reality of moral hazard. In an attempt to maintain full employment in perpetuity, Keynesian policies embrace measures ranging from keeping interest-rates artificially low, partially nationalizing industries, to engineering large public works programs. An unfortunate effect is that many businesses as well as ordinary consumers become somewhat insulated from many of the negative consequences of poor decisions and bad investments. As a result, some will become complacent, which is the road to economic stagnation. Others, however, are likely to take risks that become increasingly irresponsible over time until we find ourselves in situations similar to our current predicaments. 



Of course, as long as human beings are fallible creatures, many will take excessive risks at different points in their lives. For some people, it will be with their marriage. Others will behave in an excessively risky manner with their own and others’ financial resources. As a consequence, some people will suffer losses. In a society where right reason and the ethic of loving one’s neighbor reigns, individuals and communities should be ready to help those in genuine need. Law also has a potentially important role to play. As the legal philosopher John Finnis observes in Natural Law and Natural Rights (1980), a sound bankruptcy law can meet all the demands of justice—legal, commutative, and distributive—while respecting the dignity of all those effected, especially the dispossessed, but also those at fault. But neither we nor governments do anyone any favors by creating circumstances or incentives that encourage people to behave imprudently and recklessly in the worlds of finance and industry.



In his many works, the German economist Wilhelm Röpke noted that we should never forget the economic implications of one of the famous pensées of the seventeenth-century French mathematician, philosopher, and physicist Blaise Pascal: “L’homme n’est ni ange ni bête, et le malheur veut que qui veut faire l’ange fait la bête” [Man is neither an angel nor a brute, and the misfortune is that he who wants to make the angel makes the brute]. Röpke’s point was that basing economic policies on the pretence that humans are angels is likely to encourage some rather un-angelic behavior. 

This is advice that governments should keep in mind if they do not want their response to the present recession to sow the seeds of a future economic crisis. Taking moral hazard seriously would be a welcome first step.




Samuel Gregg is Research Director at the Acton Institute. He has authored several books including On Ordered Liberty and his prize-winning The Commercial Society. 

Copyright 2009 the Witherspoon Institute. All rights reserved.

What, then, is good about free markets?

First, free markets generate and spread wealth—not by redistributing what people have, but by providing the conditions that reward individual effort and foster human enterprise. To speak broadly, ancient policy emphasized the distribution or redistribution of a city’s wealth among its people (not to mention acquisition by imperial conquest), but modern policy has promoted the development of commerce among peoples with the promise that the fortunes of all are raised. In tandem with the progress of global science, which it catalyzes and by which it is in turn transformed, the free market has generated unprecedented prosperity and previously unimaginable technological achievement. While tolerating inequalities beyond what were prescribed by ancient writers, modern market society has made available to the least well-off levels of nourishment, comfort, education, and health care that were once out of the reach even of society’s elite. This effect, evident in the rise of the middle class in nineteenth-century Europe and the United States, has been repeated in the latter half of the twentieth century, as domestic barriers fell for those previously excluded from full participation in market society—witness the growth in the U.S. of the African-American middle class—and as whole countries like China and India gradually introduced free market reforms and earned economic growth. While it is easy to see the shortcomings of global progress—not least because of electronic media that the market has enabled—the real accomplishments of global capitalism in improving the standard of living of masses of people should not be taken for granted.

Second, markets achieve a kind of rough justice in establishing prices for goods and services, rewarding sustained effort and prudent venture while correcting their opposites. As Friedrich Hayek showed, it is impossible that any central authority could gather as much information about what is plentiful and what is dear as is conveyed by prices established in an open, competitive marketplace. If the equilibrium of compensation often seems less than satisfactory, I think it is an open question whether that represents the failure of the market or a distortion caused by the presence of large corporate and state bureaucracies, which cushion market pressures at the top and suppress them throughout. If opportunity remains open, markets ought to correct for unjustly high prices or low compensation, not only on the model of the rational actor, but in the context of common sense: though customers like low prices, they want a good product from a firm with a reputation for just dealing. Effort and prudence can be justly rewarded only if sloth and recklessness are allowed to fail.

Third, free markets are valuable not only for the wealth they generate and distribute, but for the opportunities they make possible and the activities they enable. Here I refer not only to strictly economic opportunities for material gain and physical benefits, but to the whole range of institutions and practices that constitute civil society. Families, churches, schools, and many other institutions of culture cannot be adequately understood on a market model or supported as mere market entities, but they thrive when property rights are safe and self-direction is permitted. Indeed, they moralize the market, so to speak, often supplying the true ends of economic activity and forming persons who are not mere wealth-maximizers but well-rounded human beings. It is nobler to make that extra gain to support one’s family than to indulge oneself. Many a successful entrepreneur turns to philanthropy when his fortune exceeds his needs. The market itself teaches certain virtues—self-discipline and civility, self-control and the deferral of reward, fair-dealing so as to secure a customer base—and it is further humanized and refined when surrounded by other virtues. The institutions that promote these and the practices that reinforce them often depend on internal forms of authority that are different from those anchored in the law of supply and demand, but a free marketplace and the plenty it promises give these forms the conditions to thrive.

Fourth and finally, the freedom of the market is valuable in its own right, not only for its consequences for material wealth or cultural development. As many have remarked, the ability to choose one’s own way in the world—to develop and share one’s skills or services, or to make and market a product or a work of art—is a mark of human dignity, a basic human right. Free markets are not the only locus for the development of talents, and not all talents are readily or rightly marketed, but many are served by access to the marketplace, and the freedom to choose how to develop one’s gifts is essential to the gifts themselves and only possible in a society with substantial market freedom.

Now each of these justifications of the market suggests market limitations as well as freedoms and so can guide regulation. All agree that sound markets need just courts, willing and able to protect the rights of property and the obligations of contract. Numerous other rules have evolved through the practice of merchants and have been ratified by law; maintaining a proper balance between fairness and freedom is essential, as well as a balance between openness to innovation and security for the tried and true. Though “24/7” is handy when the work is done by computers and robots, markets often need regulations that establish their days and hours, permitting an equilibrium between time for trade and activity and time to pause and reassess—not to mention time to remember that there is more to every balanced life than work and trade. Because society should protect non-economic goods as well as economic ones, some sorts of trade should be suppressed, for example in sexual favors or stolen property. A sound sense of the value and limits of markets is a better guide concerning when and how to regulate commerce than an aimless pragmatism that lumbers from crisis to crisis or than ideological blinders, either those that see nothing that cannot be marketized or those that would collectivize all. “Two cheers for capitalism” seems to me to get it just about right.

What about government? Government provides, literally and figuratively, the public space where all citizens can gather, and it superintends the whole. Its responsibilities include not only regulation of the market and correction of its failures, but also protecting society against threats to its safety from outside and from within, supporting the rule of law, and maintaining the basic moral order or culture that underlies social trust and makes possible human freedom. In a free society, government has to be circumscribed in its overall extent as well as specifically restrained from interfering with certain basic rights, but the size of government is not the only relevant question to be asked about it. The American Founders spoke of “good government,” by which they meant government that was capable and just, even “energetic,” in its exertion of public power, while limited in what it can rightly do: lean and fit, not meddlesome and clumsy. There is a scandal of government waste both when government undermines market efficiency and when government fails in the tasks to which it is rightly appointed. In an era of burgeoning demand for government solutions beyond the bounds of government competence, “less government” is a good rough-and-ready rejoinder, but “good government” is the true principle and one that conservatives should not be ashamed to embrace.

One failing of conservatism in recent years has been the tendency to think of politics itself in market terms: political scientists have developed a whole “economic theory of democracy;” politicians grant access and measure influence by campaign contributions, even to one another, and voters expect representatives to bring home federal projects and programs as well as pass laws. It is not that politics can or even ought to proceed without consideration of real interests—as James Madison wrote in Federalist 10, “the regulation of these various and interfering interests forms the principal task of modern legislation”—but that building political organizations as ever more efficient machines for the aggregation of majority interests undercuts the ambition to articulate the public interest. Such a view has had disastrous effects, from the failure to recognize genuine corruption—witness the Abramoff scandal, which cut closer to the heart of modern conservatism than most Republicans have been willing to admit—to the squandering of the idealism of the young, whose interests are not yet fixed and who naturally long to test their talents in and become a part of something larger than themselves.

The cause of the free market is paradoxical in a way that is rarely recognized by its advocates and regularly exploited by its enemies: free markets require a public-spirited defense, but they generally reward private-spiritedness. In the debates ahead, the friends of freedom need to make their case in public, explaining the virtues of market society, acknowledging its vices, and focusing on those things that government can rightly do—and how it can do them well.

James Stoner is Professor in the Department of Political Science at the Louisiana State University. He sits on the editorial board of Public Discourse.

Copyright 2009 the Witherspoon Institute. All rights reserved.