Larry Summers and the Crisis of Economic Orthodoxy

Larry Summers and the Crisis of Economic Orthodoxy

Larry Summers and the Crisis of Economic Orthodoxy

The establishment’s repeated failures are creating room for heterodox ideas.

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For Larry Summers, the post-Covid spike in inflation was a godsend. It gave the former Treasury secretary a chance to polish his tarnished brand and make a political comeback. Although Summers had been a dominant voice on Democratic Party economic policy for decades, in recent years his reputation had been in tatters because of a series of personal scandals (he was a longtime crony of convicted child rapist Jeffrey Epstein) and the results of his neoliberal policies (Summers’s prescriptions can fairly be blamed for both the 2008 economic meltdown and the anemic recovery that prepared the ground for Donald Trump’s presidency). After Joe Biden secured the Democratic nomination in 2020, Summers made a concerted effort to worm his way back into favor as a Washington éminence grise. This prompted an outcry from progressive groups, with Summers himself being kept at arm’s length throughout the early days of Biden’s administration.

But inflation proved the perfect issue to enable Summers to regain the spotlight. Intellectually, Summers had been deeply formed by the monetarist revolution instigated by Milton Friedman in the 1970s—which held that a key way to hold down inflation was to raise interest rates in order to increase unemployment (and thereby keep wages in check). In early 2021, Summers began sounding the alarm that the stimulus spending Biden and the Democrats had used to keep the economy afloat during Covid was going to lead to a sharp rise in inflation. When inflation did in fact rise, Summers basked in the role of the prophet vindicated.

But Summers’s rehabilitation rested on an illusion. As Eric Levitz notes in a recent New York magazine article, all evidence suggests that while Summers was right to predict inflation, he was completely wrong about both the causes of that inflation and the best means to fight it. Speaking at the London School of Economics in June 2022, Summers said that “we need five years of unemployment above 5 percent to contain inflation—in other words, we need two years of 7.5 percent unemployment or five years of 6 percent unemployment or one year of 10 percent unemployment.” This is the standard Friedman prescription of a short, sharp shock of unemployment to defeat inflation—the same remedy followed by Paul Volcker in the late 1970s and early ’80s. Those policies, of course, led to the long-term defeat of American labor unions and the rise of Reaganite neoliberalism.

But that scenario was not repeated under Biden. As Levitz reports, Summers’s

call for austerity was premised on the notion that only a sharp increase in unemployment could prevent a ruinous wage-price spiral. In reality, both wage and price growth have been slowing for months, even as unemployment has remained near historic lows. Summers’s failure to anticipate this outcome should lead us to reconsider just how prescient his analysis of the post-Covid economy ever was.

The core problem, Levitz adds, is that

from the beginning, [Summers’s] analysis was predicated on the idea that excessive stimulus would lead to unsustainably low unemployment and thus wage-driven inflation. There has never much reason to believe that the labor market was the primary driver of post-Covid price growth. And at this point, it’s abundantly clear that, in 2023 America, a tight labor market will not inevitably trigger a wage-price spiral.

If the Federal Reserve follows Summers’s advice and keeps raising interest rates until the economy hits “five years of unemployment above 5 percent,” then millions of people will suffer for absolutely no reason other than as human sacrifices to a discredited economic theory.

Far from vindicating Summers, inflation is yet another case where he got a big issue wrong. It joins a long list of such errors. As Binyamin Appelbaum documented in his fine book The Economists’ Hour (2015), while serving as deputy Treasury secretary in 1998, Summers took it upon himself to bully staffers who were pushing for the regulation of credit derivatives—the banking practice that led to the housing bubble and 2008 crash. Summers even called one staffer, Brooksley Born, the head of the Commodity Futures Trading Commission, into his office to scream, “I have 13 bankers in my office who tell me you’re going to cause the worst financial crisis since the end of World War II.” Ironically, it was Summers’s own failure to heed Born’s advice that caused that very crisis. In 2005, Summers derided critics of the deregulated credit default swap market as “slightly Luddites.”

Summers remains the public face of economic orthodoxy, which is why mainstream media outlets continue to treat him as a sage. But repeated policy failures and false predictions have discredited that orthodoxy, creating a public appetite for alternative approaches.

A recent New Yorker profile by Zachary Carter of Isabella Weber, an economist at the University of Massachusetts–Amherst, illustrates just how receptive the public is to heterodox economics. In December 2021, Weber wrote an article for The Guardian arguing that instead of austerity, “strategic price controls” could be a tool to fight inflation. The premise of Weber’s article—and her academic work—was that inflation wasn’t actually driven by rising wages but by corporations using the shortages created by Covid to excuse price gouging. As such, price controls, similar to policies used during World War II, could solve inflation without creating the misery of mass unemployment.

As Carter notes, Weber’s article turned her “into the most hated woman in economics.” No less an avatar of liberal economics than Paul Krugman described her as “truly stupid.” Krugman would later apologize. Subsequent events, in particular the economic shock following Russia’s invasion of Ukraine, gave renewed credence to the idea that inflation was being driven by events rather than by rising wages.

The initial treatment of Weber as a heretic was evidence of how much establishment economics has become an insular cult. As the London-based economist Dominik Leusder observes, Weber’s core idea that “profit-driven entities [use] market concentration and attendant pricing power to increase prices in a supply shock enough to keep margins steady…has so much prior plausibility [and] requires so few assumptions that dismissing it out of hand is just odd.”

Carter details how events forced many to consider Weber’s claims:

The onset of war in Europe marked the beginning of a new phase for the global economy. Weber had been arguing for months that the supply shocks of the pandemic were akin to those typically seen in war. Now an actual war had arrived, and the resulting economic dislocation was difficult to interpret as a case of flush consumers spending the economy into oblivion. It was hard to see how the orthodox approach—increasing unemployment through higher interest rates—would help solve the problem. In mid-September, Weber received an urgent note from the German Ministry of Economic Affairs. Would she be interested in serving on an official government commission to contain gas and heating prices? She took the job, and, within a few weeks, the commission had settled on her price-control plan as the solution.

The growing audience for Weber is the flip side of the discrediting of Summers. Mainstreams economists are very worried about the rising public interest in heterodox economic theories (seen in everything from modern monetary theory to Neo-Brandeisians’ anti-monopoly ideas and the Democratic Party’s renewed interest in industrial policy). They blame the flourishing of such ideas on sensationalistic media coverage.

It’s true that economic heterodoxy is not uniform in quality. From a socialist point of view, it’s worth noting that most heterodoxy remains firmly within the ambit of liberalism, aimed at reforming capitalism rather than transcending it. But the rise of heterodox thinking isn’t a media-driven phenomenon: It’s the natural result of the crisis of orthodoxy. After all, if Larry Summers is the most visible orthodox economist, who can blame the public for considering alternatives?

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