The Economic Thought of Henry Calvert Simons

Crown Prince of the Chicago School

G.R. Steele

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351062725
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Drawing on years of research, Gerald Steele delves into the diverse ideas of Henry Simons, a neglected economist whose work in the 1930s on monetary and financial instability is extremely relevant to today's debates about commercial bank credit, the interdependence of fiscal and monetary policy, and financial regulation.

Steele describes the emergence of the first Chicago school of economics and its distinctive difference to the School subsequently associated with the Monetarism of Milton Friedman, and shows how Simons provides the basis for what is now referred to as 'the fiscal theory of the price level' and how this differs from the monetarist attempt to control prices by controlling the supply of broad money.

This book will be of interest to advanced students and researchers of the history of economic thought, economic history, macroeconomics and banking and finance.

1 Introduction

1.1 Henry Simons

As a junior colleague of Frank Knight at the University of Iowa, Simons had followed his mentor to Chicago in 1927. That a special empathy existed between Knight and Simons might be inferred from the direction of a shared interest. After Knight’s attention had shifted in the early 1930s, from cost theory to capital theory, he thereafter published only a handful of ‘technical’ articles in economics. As is true of Simons, Knight was developing a broader perspective: the application of social science to the defence of a free society. George Stigler describes the situation thus:

For most present-day economists, the primary purpose is to increase our knowledge of the working of the enterprise and other economic systems. For Knight, the primary role of economic theory is rather different: it is to contribute to the understanding of how by consensus based on rational discussion we can fashion a liberal society in which individual freedom is preserved and a satisfactory economic performance achieved.

(Stigler, 1985, p. 11)

If political freedom is to be protected, the production of resources must be determined by free enterprise and their allocation determined by individual choice, with appropriate legal institutions to promote responsibility in business decisions and to protect markets from restraints and monopoly.

Three criteria set the ethos by which Simons is driven: the highest value is placed upon liberty, ‘as both a requisite and a measure of progress’. This is followed next by equality and, finally, by the dynamics of social progress, including progress ‘in the criteria themselves’ (Simons, 1948, p. 2). Nothing enduring could be achieved without consensus, not least in regard to equality, where Simons voices a strong commitment to progressive income taxation (Chapter 10).

A brief exposition on ‘The Tax Exemption Question’, published in the Journal of Business (March 1923), and a review of The Economics of Taxation by H. Gunnison Brown, which appeared in the first published volume of the Journal of Political Economy (February 1926), indicate the tenor of Simons’s early work. That he held that focus throughout his career is evidenced by Personal Income Taxation (1938) and the discovery after his death of a manuscript, subsequently published as Federal Tax Reform (1951). His reputation in the area of taxation reached its zenith with the Report of the Royal Commission on Taxation to the Canadian Parliament (1966), where the recommendations closely follow those outlined by Simons for the US, some twenty years earlier.

On completing his graduate studies at Chicago in 1930, Simons was appointed as an instructor in economics, but he made no immediate impression. It is reported that his progress was slow and that it was only by Knight’s support that he withstood strong opposition to the renewal of his appointment.

As the academic discussion of law was increasingly undertaken in the context of contemporary society, arguments became infused with analysis drawn from the social sciences. After the Chicago Law School initiated a broad four-year curriculum for non-graduate entrants, the subject areas of economics, history, political philosophy and other related fields began to be incorporated into the syllabus. Two years after the formal adoption of that programme, Simons accepted a full-time post to teach economics to Chicago law students in 1937, when he was able to show how legal and economic problems are interrelated: problems of bankruptcy, corporate reorganization, antitrust laws, industry regulation and the liability of employers. Shortly before his death in 1946, Simons had been appointed as the first economics professor in the School.

Simons’s contributions to economics were made across a period of no more than fifteen years, following which a contemporary assessment is that

[w]hen he died June 19 in Chicago at the age of forty-six he stood at the height of his intellectual powers but had scarcely come into his own. A twenty-five-line obituary in the New York Times was deemed to tell his storey and no doubt accurately reflected his popular fame. New Deal prophets, who had felt the whiplash of his invective, of course knew of and respected him. Businessmen busy about the work of the world were largely too busy to understand his contribution to the system they never tire of eulogizing.

(Davenport, 1946, p. 6)

It is a safe comment, now made more than seventy years after his death, that only a few economists are aware of the writing of Henry Simons. Of those, still fewer have any understanding of his relevance. Indeed, there is little in current career incentives to encourage academic economists to take interest in Simons or, indeed, in the work of those whose arguments have fed the discussion of economics through the twentieth century. Not least, among those whose work in that period is widely recognised are Milton Friedman, Friedrich Hayek, John Maynard Keynes and Hyman Minsky. They are here cited, not for the merit of their work per se, but for their relevance to any serious narrative relating to Henry Simons.

The author is among those whose ignorance of Simons was little short of total, prior to having chanced upon the following remark: ‘Simons, who was prone to melancholy, had committed suicide in despair at the onset of Keynesianism’ (Toporowski, 2010, p. 364). Instinctively and instantly, there was motivation to know more about a man who might be so moved. Recent research provides as much information as is likely to be achieved on the event of Simons’s death:

The combination of Simons mentioning suicide, Nef and Samuelson saying he committed suicide, Rose Friedman later claiming that it was “apparently” suicide, and the fact that Simons faced a devastating disappointment less than twenty-four hours before he died, all strongly suggest that Simons committed suicide. Even so, it must be acknowledged that in some ways the archival record is insufficient.

(Van Horn, 2014, p. 532)

Certainly, in the period leading to his death, Simons had been taking medication to alleviate acute depression and insomnia. Irrespective of the fatal overdose being accidental or intentional, it is plausible that the ‘melancholy’ from which Simons suffered was associated with his fear, not so much that Keynesianism was on the rise, but that the ethos of classic liberalism was being lost. At least, there can be little doubt that Simons connects the two and, in that, he is not alone. Neither Henry Simons nor Friedrich Hayek would have placed any store by the motivation that Keynes provides for having written The General Theory of Employment Interest and Money (1936):

The authoritarian state systems of to-day seem to solve the problem of unemployment at the expense of efficiency and freedom. … But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom.

(Keynes, 1936, p. 381)

Neither Simons nor Hayek was taken by the idea that government should attempt to engineer ‘the economy’ in the manner described by Keynes. Instead, and acting more or less independently, they articulated the case for, and sought the means to revitalise, the liberal ethos. In pressing for Aaron Director¹ to return to Chicago to head a ‘Free Market Project’ (alternatively termed the ‘Hayek Project’), Simons had sent a copy of a memorandum to Hayek, in which he had articulated his support. At this same time, Hayek had been contacted by Harold Luhnow of the Volker Fund, where Luhnow was attempting to persuade Hayek to produce a US version of The Road to Serfdom (1944).

Simons’s proposal for Aaron Director to return to Chicago in 1946 was the more poignant by the fact that Director had been forced to leave in 1935, following acrimonious correspondence between Paul Douglas and Frank Knight. The issues remain unclear but Simons had been badly affected. As a good friend and a close colleague, he confessed: ‘I have been, qua economist, alone since Aaron left. Certainly I am worth more to the University with Aaron around than without him’ (Simons, letter dated February 20 1939; cited from Van Horn, 2014, p. 529). Simons considered Director to have been unjustly treated. That the pending appointment of Director to Chicago had been lost through a late misunderstanding regarding tenure rendered Simons so distraught that he was unable even to write to inform Director himself. Having shouldered Lloyd Mints with that task, a letter was sent to Director on 18 June 1946, the day preceding Simons’s untimely death.

1.2 The Chicago School

That Milton Friedman and Henry Simons are both viewed as ‘founders’ of the Chicago School (Chapter 3) implies the existence of more than one school. Indeed, that is the case. Friedman was younger than Simons by thirteen years. After a year that lead to a master’s degree at Chicago in 1933, Friedman had returned to work as a research assistant for Henry Schultz during the academic year 1934–1935. Thereafter, Friedman held a series of appointments – with the National Resources Committee, the National Bureau of Economic Research, the University of Wisconsin-Madison, the US Department of the Treasury, Columbia University and the University of Minnesota – before accepting a faculty appointment in 1946 to teach economic theory at the University of Chicago, where he remained for the next thirty years.

Not least by the distance which separates the epochs in which the respective reputations of Simons and Friedman were gained, the Chicago School is now widely associated with Milton Friedman, Monetarism and the ethos of laissez-faire. Certainly, a majority of economists would now cite Friedman’s interpretation of the quantity theory of money (aka Monetarism) as the epitome of the School (Chapter 8). For a minority, an earlier School of the interwar years defines a group of economists who were reacting in a particular way to the events and issues that were brought to prominence by the Wall Street Crash of 1929. It was then that the institutional structure of commercial banking became a central concern, and there emerged a proposal for 100 percent reserve banking. That proposal quickly became known as the Chicago Plan. The background to the Plan (Chapter 4), pen portraits of the planners (Chapter 5) and the Plan (Chapter 6) are discussed.

The damaging feature of fractional reserve banking is that it ‘facilitated and encouraged the use of short-term financing in business generally’ (Simons, 1936, p. 10; 1948, p. 168); and it continues to do so across Western economies. Simons opposes the use of short-term debt as the instrument to support both sovereign and corporate activities. With the implementation of the Chicago Plan, short-term lending by commercial banks would be phased out. Although the relevance of Islamic banking to such concerns has no association with the Plan, or more generally with economic events in the 1930s, empirical studies that compare the performance of Western and Islamic banking in the aftermath of the 2008 Credit Crunch raise related issues. The greater resilience to cyclical downturns that is perceived to arise where Islamic precepts govern banking and finance is not so far removed from the motivations of those who endorsed the Plan (Chapter 11).

For the implementation of the Plan, commercial banks would be transformed to become more like investment trusts, holding only two types of assets: long-term bonds and central bank base money (i.e., banknotes and reserves). By implication, lending and investing institutions would then focus upon the provision of ‘long-term capital in equity form’. Although the Chicago Plan sits ever upon the ‘back burner’, from time to time there is recurring interest. Recent examples include a study commissioned by the authorities in Iceland (Sigurjonsson, 2015) and the close examination afforded by a former Governor of the Bank of England (see King, 2016, pp. 261–77). An associated detail relates to open-market operations, where a central bank creates base money in order to purchase interest-bearing sovereign bonds. This activity has conventionally been applied to short-dated bonds, but, as the zero lower bound for short-term interest rates is approached, central banks have seen fit to operate further up the yield curve. The new jargon is ‘quantitative easing’. As a central bank creates base money, which it then spends in purchasing long-term bonds, yields fall. Simons argues that this measure is unlikely to counter deflation, and it is here that we find arguments that mark a difference between the principals of the respective Chicago Schools, Simons and Friedman (Chapters 7 and 8). The difference is that, where Simons is implicitly concerned with sovereign indebtedness (i.e., bonds and base money), Friedman’s analysis is directed towards broad money aggregates. A citation in Chapter 7 unambiguously shows Simons to have articulated the conceptual basis from which has arisen the fiscal theory of the price level (aka, Fiscal Monetarism).

In the coalescence of the lines of thought that produced the first Chicago School, the roles taken by Hayek and Simons are appraised by Van Horn and Mirowski (2009). Where Hayek is described as ‘the prime external contractor’, Simons is considered more important as ‘the prime architect’. In commenting upon that assessment, Bruce Caldwell explains that it is Simons who transformed an invitation to write ‘an American Road to Serfdom … into a wholly different vision, the formation of an institute that would establish the University of Chicago as a base for free market ideas’ (Caldwell, 2011, pp. 303–305). That same feature is emphasised by David Laidler as the distinctive attribute of Chicago analysis in the 1930s (Chapter 8).

Although Simons has credit as the principal mover in shaping and disseminating details of the Chicago Plan, his intellectual contributions extend beyond that area. A broad appreciation of his relevance must focus as much upon the influence that he brings to the work of others, as upon his direct contributions. The one clear feature of that broader perspective is that it reflects a staunch pragmatic libertarian philosophy (Chapter 2). Yet, it disturbs many that Simons embraces libertarian principles as he argues for progressive taxation to achieve greater income equality. If income inequality is to be mitigated, then Simons insists that taxation is preferable to an array of restraints upon free trade. In an epoch where high unemployment bred support for extremism at both ends of the political spectrum, there is a plausible argument that the edifice of a liberal economic system is more secure in the absence of poverty. Taxation need not place inhibitions upon freedoms. Businessmen may pursue profit, the prosperous may exercise power and market competition may determine prices. Where the focus is upon achieving greater income equality, the primary policy consideration is that of weighing the negative impact of progressive taxation upon work incentives (Chapter 10).

1.3 Fiscal policy

With Simons’s persistence in arguing the relevance of fiscal deficit spending (Chapter 7) as the means to counter deflation, many conflate his arguments with the more familiar rationale as propagated by Keynes. With a full-bloode...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Preface
• 1 Introduction
• 2 Libertarian Philosophy
• 3 Economics and the Chicago School
• 4 The Chicago Plan: the background
• 5 The Chicago eight, plus four, plus one
• 6 The Chicago Plan
• 7 Monetary rules
• 8 Monetarism and Fiscal Monetarism
• 9 Business, bankers and bubbles
• 10 Taxation
• 11 Islamic banking and finance
• 12 Final comments
• Index