Eric Laursen is an independent journalist living in western Massachusetts. He is co-author of Understanding the Crash (Soft Skull Press/Counterpoint, 2010) and author of the forthcoming The People’s Pension: The War Against Social Security from Reagan to Obama (AK Press, Spring, 2012).

Last December, Wall Street's leading banks were fighting tooth-and-nail to keep federal regulators from setting rules governing the vast market in financial derivatives contracts – the market that helped turn the 2008 mortgage-backed securities meltdown into a global catastrophe. The regulators were developing rules to implement the Dodd-Frank financial reform bill – rules that, among other things, were supposed to make the derivatives market more transparent.

Then an article appeared in the New York Times that seemed to blur the outline of this reform scenario. Titled “A Secretive Banking Elite Rules Derivatives Trading,” the article, by Louise Story, detailed how nine big banks had virtually captured the new regulatory regime before it even got started. One of Dodd-Frank's provisions called for most derivatives to be traded via clearinghouses, putting buyers and sellers in closer touch with each other and cutting out middlemen.

According to Story, nine big banks, including such familiar names as JP Morgan Chase, Morgan Stanley, Goldman Sachs, and Citigroup, had already checkmated this plan by setting up their own, secretive clearinghouse to trade credit default swaps, and cut a deal with the Chicago Mercantile Exchange that gave them effective control of another new clearinghouse. Result: nine elite banks, operating out of public view, have cemented even tighter control of the derivatives market than they had before. If anything, Dodd-Frank has helped them to do it.

Now comes The Illusion of Free Markets, a dense, groundbreaking book that explains why such things happen: why the supposedly freewheeling capitalists of the post-New Deal decades can get away with operating a tightly controlled system geared primarily to generate profits for a small group of big players. “At the end of the day, the notion of a 'free market' is a fiction. There is simply no such thing as an unregulated market,” writes the author, Bernard E. Harcourt, a professor of law and political science at the University of Chicago – ironically, one the academic hotbeds of ultra-free market theory in the '50s, '60s, and '70s.

In light of what's happened to the derivatives market, and the ease with which too-big-to-fail banks turned Washington's economic rescue legislation to their advantage in those fateful last months of 2008, Harcourt's conclusion seems obvious. (A useful companion to The Illusion of Free Markets, laying out the four decades of high-pressure politicking that enabled Wall Street to dictate terms, is Jeff Madrick's recently published Age of Greed). But the banks' success isn't just a matter of raw power, Harcourt argues. It's because we've all – lawmakers, economists, citizens – become imprinted with a universalizing ideology telling us that free markets = liberty and personal freedom, that a natural or spontaneous order is maximally efficient, and that “efficiency,” quantitatively expressed, is the most important virtue in human society.

We can argue against this implacable social vision. Many of us do, all the time. But given its basic assumptions, it's a remarkably airtight, encompassing model, one that's extremely easy to fall into. Here's an example from Harcourt's book:

“The market is the best mechanism ever invented for efficiently allocating resources to maximize production ... I also think that there is a connection between the freedom of the marketplace and freedom more generally.”

The speaker wasn't Milton Friedman, Friedrich Hayek, or any of the other prophets of neoliberalism. It was Barack Obama, on the campaign trail in summer 2008 – just as Lehman Brothers, AIG, and Fannie Mae and Freddie Mac were teetering. Obama is hardly a leftist, of course, but he was working intently to convince voters, many of whom were enraged at the financial services industry, to elect him to preside over the reform of Wall Street. Nevertheless, this was his statement of economic principles.

If free-market ideology is us, where did it come from? Harcourt attempts to explain this, and a bit more besides. His book won't appeal to most readers. It's unapologetically academic. It opens with a long section comparing and contrasting the 18^th century Paris grain market and the Chicago Board of Trade, one of the four big, present-day U.S. futures and options exchanges, the importance of which doesn't become clear until many pages later.

To his credit, Harcourt finds space in The Illusion of Free Markets for a great deal of fascinating research, from bizarre 18^th French proposals for reform of police administration to the boom in construction of mental hospitals in the late 19^th century U.S. But two chapters on mass incarceration in contemporary America, while related, are so detailed they seem to have come from a different book. In knitting all this material together, Harcourt has perhaps not been well served by his editors at Harvard University Press.

Which is unfortunate, because The Illusion of Free Markets is a powerful demonstration of the impact of ideas – even relatively arcane economic arguments. It details the profound ideological connections between seemingly opposed politicians like Obama and Ronald Reagan. And it explains a great deal about how financial and corporate interests have been able to persuade Americans to accept close to four decades of deregulation, tax policies that favor the rich, and a justice system that essentially punishes people for being poor and of color – indeed, to regard these policy changes as inevitable. As such, it will reward a careful, patient read.

Harcourt starts with the notion of a “natural order” in society, which he traces back as far as Aristotle. But the story really begins with the Physiocrats, the group of French economic thinkers who were precursors of Adam Smith. The most important was Francois Quesnay, possibly the first to conceive of economics as a system “that functioned on its own, that had a direction of its own, that followed a necessary path – that had no liberty.” Another way to look at it was that human liberty was something enclosed within the economic system – that any attempt to achieve a social outcome outside the laws of the natural order dictated by the market is somehow illegitimate.

The Physiocrats fetishized private property. “You don't understand our laws, you say,” wrote the Marquis de Mirabeau, another of their leading thinkers. “Well, we have none other than private property, personal, chattel, and real, from which derive all other liberties that do not harm the property of others.” At the other end of the value scale for the Physiocrats was social and economic equality, which they saw as a threat to private property, “and consequently society itself.” Social inequality wasn't a social problem. Like private property, it was “inscribed in nature.”

Naturally, not everyone agreed. And so private property – and unequal privilege – would need to be defended. That's where the State came in. The Physiocrats advocated a “legal despotism,” an absolute power that would ensure “security” through the penal process.

Jeremy Bentham, the English philosopher of utilitarianism, took the next step, arguing that the idea of economic efficiency could be imported into other areas of society and government – such as prisons. He famously proposed the “Panopticon,” a model prison that would allow guards to observe the inmates without themselves being seen. The Panopticon would be cheaper than other prisons because it required fewer guards and could even bring in revenue from work done by the inmates.

That went along with Bentham's belief that human beings rationally pursue pleasure and avoid pain. It meant that the State could apply economic principles to deterring crime: how high a “price” in fines, or imprisonment, or some other penalty, would a person be willing to pay if he or she were caught? Bentham called his analysis “marginal deterrence,” and it directly paralleled the research on marginal pricing that economists were beginning to apply to markets.

So free markets and punitive government went, strangely, hand-in-hand. Harcourt provides a brief but fascinating snapshot of Jacksonian America, which absorbed both ideas. Andrew Jackson pushed for abolition of the first U.S. central bank as a way to keep power out of the hands of “a few monied Capitalists.” Instead, his followers favored a system that minimized government intervention in the economy. But the Jacksonian age was also the first period of rapid prison expansion in America.

Few people in modern society today, except for the very religious, believe in a natural order that runs – or should run – our lives. And in the century following Bentham's death, other economic and political philosophies arose: Marxism and Keynesianism, but also mutual aid-based approaches grouped together as anarchism. What rejuvenated the Physiocrats' ideas was the rise of the Chicago School, particularly a trio of economists: Ronald Coase, Richard Posner, and Gary Becker.

Coase argued that in general government shouldn't attempt to correct faults in the market, because the “harmful effects” would be greater than the gain from regulation. Posner, whose former colleague at University of Chicago Law School is Barack Obama, revived Bentham, who he credited with first understanding that “all men calculate their welfare.” Crimes, he said, shouldn't be regarded as moral wrongs but only as “a class of inefficient acts.”

Becker, who eventually received a Nobel Prize in economics, published an enormously influential paper in 1968 proposing that there's no need to consider any other factor than economic gain or loss to understand why people commit crimes – not “anomie, psychological inadequacies, or inheritance of special traits.” Anyone would commit a crime, he argued, as long as the benefits outweighed the costs.

The Chicago School economists didn't believe in “natural order.” But like their intellectual godfather, Hayek, they believed in “the spontaneously formed order of the markets.” Bypassing the market in some way – by stealing, or by attempting to regulate the market – is “inefficient,” and therefore shouldn't be allowed. “Criminal law,” according to the Chicago School, “is best understood as that which prevents this kind of market evasion.” Ultimately, “all human relations are analyzed through a transactional lens and can be evaluated in terms of efficiency and utility.”

The problem is, it doesn't work – even in the fields closest to home. As an example, Harcourt compares the 18^th century Paris grain market and the Chicago Board of Trade. The former operated under a vast set of government regulations aimed at preventing price fixing and profiteering. The latter is self-regulating: the members of the exchange set the rules and control who can trade and who can't. But the officials who regulated the Paris market took a light hand and were often ignored. The small clique of member firms that run the CBOT, by contrast, exercise tight control over trading and lobby vigorously to eliminate anyone who might challenge them. Regulation happens – the only real issue is, who benefits?

“Efficiency,” nevertheless, is used to justify many things, Harcourt observes – such as racial profiling; zero-tolerance, mandatory sentencing, and “three-strikes” laws; and a vast increase in surveillance and data collection in police work. To these could be added education “reform” built around mandatory standardized testing and teacher performance ratings. Today, enormous amounts of data are crunched in a broad range of fields, in a quest to determine their degree of efficiency – or, better yet, whether they tend to promote efficiency. Harcourt calls this the Actuarial Society, but it could be termed just as properly the Econometric Society, because concepts and tools derived from business and economics have come to be applied to so many other aspects of human life.

It could also be termed the Punishment Society. Just as a vast expansion of state penal apparatus followed the spread of the Physiocrats' ideas, so has the Prison Industrial Complex followed the rise of the Chicago School. Harcourt's chapter on the recent growth of prison populations and prison building will stagger even readers who think they are familiar with the problem. He also lays out evidence that other industrialized countries that have adopted neoliberal economic policies more recently have started to throw people into prison at rising rates as well.

Politics, of the conservative-populist variety, explains why. Starting with Barry Goldwater and then Ronald Reagan, Harcourt points out, conservative politicians joined the free market to the Prison Industrial Complex in a more crudely effective way than any academic economist could. Goldwater and Reagan ran on platforms that emphasized both freeing up the capitalist economy and cracking down on crime. But what kind of crime? Harcourt unearths a remarkable statement by Lee Atwater, campaign adviser to both Reagan and George H.W. Bush.

“There are always newspaper stories,” Atwater observed, “about some millionaire that has five Cadillacs and hasn't paid taxes since 1974 ... And then they'll have another set of stories about some guy sitting around in a big den saying so-and-so uses food stamps to fill his den with booze and drugs. So it's which one of these that the public sees as the bad guy that determines who wins.”

Getting the public to regard the white-collar offender as somehow less offensive than the drug dealer is a lot simpler if people have been inoculated with the ideology of efficiency derived from ultra-free market economics. What's most damaging is that this prevents people from asking much more important questions. Any economic system, Harcourt writes, must be evaluated “on distributional grounds, not on the basis of any illusory metric of liberty.” That's difficult today “because of the deafening and dominant discourse of natural order and market efficiency.”

Harcourt calls The Illusion of Free Markets a “prolegomenon” – a first step in creating a new analysis that asks who benefits from the supposedly “free” economic system that's been built to regulate us. The next step, of course, is to figure out what we want instead. By exposing the flawed ideological roots of what's taken for “expert” social and economic thinking today, Harcourt's book may help us avoid the pitfalls in getting there.