For those who enjoy trying to figure out what important thinkers might have thought about specific issues they never faced (and I am one of them!), the following letter I discovered will prove interesting and perhaps disconcerting to some.
Below is a brief excerpt from a letter that F.A. Hayek wrote to the journalist and political theorist Walter Lippmann in 1937.* The subject was the large modern corporation which Lippmann thought was prone to developing various degrees of monopoly power. This was a view shared by Frank H. Knight at this time, and Hayek may have agreed, at least to some extent.
The issues were: (1) Why was this the case? and (2) Was it consistent with (classical) liberalism for the government to do something about it?
Hayek was not sure about the causal factors contributing to the large size of corporations. Therefore, he was reluctant to jump to the conclusion that, as advocated by Lippmann, the rights of corporations to grow beyond a certain size — by reinvesting retained earnings — should be limited.
Nevertheless, Hayek believed that the precise contours of property and contract rights were not fixed for all time. Therefore, while the rule of law necessititated each of these realms of rights, it did not rule out all changes.
Hayek’s critical words are:
“But the whole matter is one of extreme complexity and difficulty, and I cannot say, that I have definitely made up my mind. My main doubt is whether it really is the corporate law which has given rise to corporations bigger than they would become under the . . . free market, or whether it is not largely the greater influence on the political machine, which the great corporation exerts, which has favoured its growth.”
In the first place, it must be pointed out that “corporate law” is not simply the exercise of contract and property rights among natural persons. The reason for this is that the corporate form is a legislatively constructed form of individual interaction. Most obviously, it is a form with limited liability and special tax treatment, among other things. So the growth of corporate entities is not independent of its specific legislated form.
More interestingly, Hayek recognized the political-influence character of corporations.
Fast forward to today’s world and to the issue of big banks as “too-large-to-fail” entities. I do not think Hayek would have been altogether shocked by the Venn diagram of political influence I posted recently.
Therefore, I suggest that Hayek today would be open to curbing the growth of banks in a world permeated by moral hazard. The expected and actual political insurance of losses is not only a factor in the current size of banks, but it is a threat to the stability of the monetary system.
Somehow we need to return to a situation where the private bearing of losses and the potential failure of big banks is a real possibility. One bad alternative is to micro-manage the behavior of banks. This, in the long run, is a loser — because of continual financial innovation and the capture of the regulators by the regulated. This alternative also will no doubt violate basic principles of the rule of law as the regulators are given wide discretion to do “good.” [Read Dodd-Frank.]
Another alternative is to simply let the big banks fail. If I could be convinced (and I am not) that there are no large systemic risk dangers, I would say let them fail. (The oft-touted alternative of applying bankruptcy law to banks may not work as those who know more about this than I have said.)
So there we are: To preserve the rule of law, in the very nasty and imperfect world in which we live, we may have to do the previously-unthinkable.
Yet before people react to such a suggestion as a violation of contract and property rights, it is important to recognize that these rights have been exercised in a legislatively constructed context that had only a pragmatic justification. The politicization of the banks has made their growth, as well as their impact on the economy, not a feature of the free market.
Classical liberals must be willing to distinguish berween crony capitalism and the free market. If not, the free market is doomed.
(*The letter appears in Ben Jackson, “Freedom, the Common Good and the Rule of Law: Lippmann and Hayek on Economic Planning,” Journal of the History of Ideas, 73 (2012), forthcoming. Unfortunately, I am not at liberty to provide a link to the manuscript.)