Looking Beyond Neoclassical Paradigm

by Colin Gustafson
Mon, 11 Feb 2008 at 10:24 AM

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When American economists debate economic development policy in Third World nations, they traditionally follow two prevailing schools of thought: the free market argument or the interventionist belief.

But as blogger Yves Smith notes (Naked Capitalism), the prevailing two-school debate has obscured the fact that other, nontraditional "frameworks" of economic development theory are also valuable.

"It's important to recognize biases" in traditional theory; "otherwise you have no hope of correcting for them," he writes. Citing a recent article by Thomas Palley, Mr. Smith notes that the free market argument, or so-called Chicago School, claims that free markets, not public policy, can improve the development of foreign economies. By contrast, the interventionist argument, or so-called MIT School, argues that real world economies are afflicted by market failures, which policy interventions can help solve.

While acknowledging the value of both arguments, Mr. Palley believes they both assume there is one "economics" and therefore fail to give due credence to other disagreements about development, trade, and globalization.

"The great challenge is not to admit that there are many recipes" for economic development, Mr. Palley writes, "but rather to create space for other perspectives on economic analysis and policy."

TURNING TO NORWAY FOR ANSWERS With the subprime meltdown spreading to other sectors of the economy, Americans should consider taking a page from the Scandinavian playbook to dig themselves out, market researcher Barry Ritholtz writes.

In a Web log entry (The Big Picture) yesterday, he notes that the deterioration of the American financial situation shows many of the same features, including loose capital regulations and strong lending growth, that were present at the onset of the 1987 Norwegian banking crisis.

"We seem to have drunk the same heady and dangerous brew here in the U.S." Mr. Ritholtz writes. "I call it a Long Island Financial Iced Tea — five liquors mixed with reckless abandon, invariably producing a pounding hangover."

In Norway, the government refused to bail out speculators and allowed the markets to figure out their own solutions, including writing capital down to zero before intervening with public funds. In the process, he writes, the Norwegians avoided moral hazard.

In America, the government may be wise to follow a similar path, only intervening on behalf of monoline insurers such as Ambac and MBIA after the market fails tofinda solution,Mr.Ritholtz adds.

"The alternative leads us to a situation where grossly speculative profits remain private, but systemic risk is public," he writes. "This would be a wholly unsatisfactory conclusion."

For more insight from the country's leading economics blogs, go to nysun.com/blogs.php.

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