The Free Thinker

Over-Interpreting the Golden Age

It has long been customary for conservatives to look back to the 1950s as a Golden Age. Lately, this has become a habit among economists who are somewhat heterodox and/or left-leaning. Thus, Paul Krugman, in The Conscience of a Liberal, appeals to the 1950s as a better, more egalitarian time, with high taxes and more equality. Dani Rodrik, in The Globalization Paradox, holds up the Bretton Woods regime of the post-WWII years as an era of "moderate globalization," in favorable contrast to the "hyper-globalization" that began in the 1980s and accelerated in the 1990s. Robert Skidelsky, in Return of the Master, dates the decades immediately following WWII as an era when Keynes was the "coach," and contrasts them favorably to the time since then.

Skidelsky, by the way, makes the indefensible move of dating the end of the Keynesian era from 1973 in order to make the Keynesian era look good. Actually, the 1970s were the heyday of Keynesianism: it was 1971 when Nixon said "I am now a Keynesian." It was with Volcker and Reagan that Keynesianism began to be eclipsed, and it was only in the 1990s that a new anti-fiscal-policy consensus seems to have emerged. Include the 1970s and the Keynesian era doesn't look so good. But I digress.

All these authors use the post-WWII boom to support their view, by showing that growth was quite strong in that period. Generally, they are advocating a position which there are good theoretical reasons to believe to be anti-growth. Thus, Keynesianism discourages savings, which in the medium to long run must discourage investment, which slows growth. Again, globalization of finance and trade should yield benefits from diversification, economies of scale, comparative advantage, and so on which should raise the level and (at least in the short run, perhaps permanently) growth rate of GDP per capita, as well as (arguably) a more equal distribution of GDP globally. And Krugman's proposed high tax rates should obviously be expected to reduce the incentives to work, trade, save, and invest which grow the economy. Instead of acknowledging and responding to strong theoretical arguments that their preferred policies are anti-growth, they make the empirical point that when the policy regime was closer to their desiderata, growth was strong. It's rhetorically effective. But it will not do.

Two objections must be made. First, there are some big, obvious reasons for the strong post-WWII boom, and once these big, obvious reasons are considered, it's not clear that there's anything left to explain. Second, if one allows an atheoretic, empirical appeal to the 1950s and 1960s to count as a valid argument, one legitimizes other arguments that have the same form.

The big obvious reasons for the post-WWII boom are:

1. Recovery from the war (and depression). World War II was enormously destructive. So was the Great Depression before it. By the end of World War II, the world was a lot poorer than it knew how to be. You could get a lot of growth just by returning to normalcy at that point. (This argument applies especially in Asia and Western Europe, but in America too.)

2. Demography. Because of the baby boom after World War II, the population was unusually young. Young people tend to learn, or "accumulate human capital," faster, and consequently enjoy rising productivity. Also, with a smaller population of old people to support, it was much easier for governments to balance their books, with money to spare for public works projects.

I think there's also a third, subtler reason for the post-WWII boom: the West was still benefiting from the technological momentum of the late 19th and early 20th centuries, the golden age of innovation, the factory etc., the Age of Henry Ford, which had peaked in the 1920s, but had continuing to cast up new technologies which the conditions of depressions of war had not been able to exploit. A lot of low-hanging fruit had, so to speak, grown on the technology tree which a nation distracted by depression and war had not been able to exploit.

All this suggests that by the 1970s and 1980s growth had become a lot harder. Recovery from the war was complete, we were pushing up against technological frontiers, and demography was less favorable. So to compare the growth rate in 1980-2007 with that of 1945-1980 (even if you don't cheat by throwing the 1970s into the later period!) is not really a fair comparison. A growth slowdown was inevitable. Good thing Thatcher and Reagan came along, or it might have been a lot worse! (As, in fact, it was in France, Germany, and later Japan-- anywhere that didn't make a turn towards free markets about that time.)

The other problem is that if your argument is "growth was better in the 1950s and 1960s, we're not sure why, but it might be x" then you open the door to arguments like the following:

1. The civil rights movement caused the growth slowdown. The system of racial segregation before the mid-1960s was ugly, but efficiently protected the social capital of the white bourgeoisie, while the breakup of that system through anti-discrimination of laws was invasive and highly inefficient, depriving firms of quick, rough-and-ready methods of gauging employee compatibility. The cost of racial justice-- perhaps one well worth paying!-- was slower economic growth and rising economic inequality.

2. Feminism and the entry of women into the workforce caused the growth slowdown -- or perhaps, to be more exact, the productivity slowdown, by increasing the denominator of productivity statistics, person-hours of work, without increasing the numerator proportionally. Housework and breadwinning are complements. A man is both more able and more motivated to do good work on the job if a housewife is making his meals, cleaning his clothes and his house, and raising his kids. Breadwinners for a family are likely to place more value on cash relative to the intrinsic rewards of fun or interesting jobs, and that helps productivity, too. Also, when men's and women's roles are more clearly defined and prescribed by society, economic complementarity in marriage is much easier to acheive (just as it's easier to shop for electronics when all houses are equipped with the same style of plug). The cost of women's liberation and gender equality-- again, perhaps one well worth paying!-- was slower economic growth and rising income inequality.

3. The cultural and sexual revolution of the 1960s caused the growth slowdown. Tradition isn't always right but it tends to carry with it a lot of the moral values-- honesty, self-reliance, hard work-- that parents try to inculcate in children. The rebelliousness of the 1960s undermined these values, and made it distasteful to young people to emulate old heroes of industry like Henry Ford. They wanted to be rock stars instead. And the sexual revolution in particular diverted a lot of energy, for better or worse, into hedonistic sexual pursuits.

Now, I'm not endorsing (1), (2), or (3). And I think it would be very difficult to develop these speculations into rigorous theories that could stand up to critical testing and also perform well empirically, not just in "explaining" (or being consistent with) one or two big macro facts, but in detail. But I think it would be pretty easy to write books that developed these themes (and others) in an atheoretic way, and then pre-empt objections with a hand-waving appeal to empirical history. Such books are unlikely to be written, or at least unlikely to be read, because they are politically incorrect, but it's much more satisfying to say to such arguments, "No, your appeal to the 1950s and 1960s growth record in support of your argument is not persuasive, because that's sufficiently well explained by demography and the recovery from wartime destruction that there's really no mystery left to solve." And that's the same answer I'd give to Rodrik, Krugman, and Skidelsky.

Unemployment

Unemployment became a big problem in theoretical economics with Keynes. Economists had certainly thought about it before, but Keynes insisted that traditional approaches to unemployment were risibly inadequate and unemployment must be front and center in economic theory.

But is the concept of unemployment adequately defined, philosophically speaking? In particular, are economists correct in identifying the unemployment figures reported by the BLS with the economy being below the production possibilities frontier?

Above is an example taken from my slides for ECON 105 of a production possibilities frontier with a point representing unemployment. In the usual style of comically simple textbook examples, it assumes there are only two goods, industrial robots and pizzas. Of course, the model could be extended to n goods, only it couldn't be represented graphically in that case, only mathematically. Point U represents a situation of unemployment. That's one definition of unemployment. Call it unemployement in Sense A.

The other definition of unemployment is that calculated by the BLS: people who are actively looking for work but can't find a job. Call that unemployment in Sense B. It tends to be casually assumed that these two definitions are roughly synonymous.

But it's easy to imagine situations where the economy has unemployment in Sense A but not in Sense B. Suppose Bill is a top-notch computer programmer, and a pretty good entrepreneur, too, but he's working at McDonalds for $10/hour. He could be producing $100K; he is producing $20K. Bill is unemployed in Sense B, but not in Sense A. Call this the Diamonds-in-the-Rough case.

It's also possible that the economy has unemployment in Sense A but not in Sense B. Suppose Jack is looking for a job, but there is really nothing he can do that anyone would be willing to pay him for. He is a "zero marginal product" (ZMP) worker, to use a concept advocated by Tyler Cowen. Jack is unemployed in Sense B, but there is no unemployment in Sense A, since Jack is not an economic resource. What is confusing here is that technological change can render a person economically useless who formerly had value, and whose skills are intact. Jack might be great at doing sums, for example, but is rendered useless by the availability of various calculating devices (smartphones, computers, etc.). I am less interested in the ZMP case, however, than in the Diamonds-in-the-Rough case.

Unemployment in Sense B may be a social problem, in the sense that people's self-esteem depends on having a job. That wasn't always the case: there have been prestigious leisure classes in history. Whether the stigma we attach to unemployment is good or bad is an interesting question. It could be inefficient, if people accept lousy jobs to avoid the stigma of unemployment, when a bit more search could raise their marginal product substantially.

Unemployment in Sense A is a problem in a truer sense: it represents a real social loss, an inefficiency. I wonder if we worry too much about unemployment in Sense B, and if that concern is self-defeating, because the best way to keep down unemployment in Sense B is to keep unemployment in Sense A down. If the Diamonds-in-the-Rough realized their full value, they'd create a lot more jobs for others.

Sorry, this is all quite vague. Just brainstorming here.

Dani Rodrik vs. Free Markets

Dani Rodrik writes:

But Friedman also produced a less felicitous legacy. In his zeal to promote the power of markets, he drew too sharp a distinction between the market and the state. In effect, he presented government as the enemy of the market. He therefore blinded us to the evident reality that all successful economies are, in fact, mixed. Unfortunately, the world economy is still contending with that blindness in the aftermath of a financial crisis that resulted, in no small part, from letting financial markets run too free.

The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact, the kind of markets that modern economies need are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance.

Markets are the essence of a market economy in the same sense that lemons are the essence of lemonade. Pure lemon juice is barely drinkable. To make good lemonade, you need to mix it with water and sugar. Of course, if you put too much water in the mix, you ruin the lemonade, just as too much government meddling can make markets dysfunctional. The trick is not to discard the water and the sugar, but to get the proportions right. Hong Kong, which Friedman held up as the exemplar of a free-market society, remains the exception to the mixed-economy rule – and even there the government has played a large role in providing land for housing.

Dani Rodrik's powerful mind has packed in a lot of insight here; but he also suppresses valid dissent, and suggests that the social-democratic view is more coherent and compelling than it really is. Just because governments do meddle even in most of the advanced economies doesn't mean they should. Rodrik musters the most legitimate arguments available, but they're not unanswerable.

1. "Governments must invest in transport and communication networks." I argue in Principles of a Free Society that streets are not quite rightly understood as government-provided public goods; rather, they are places where many non-exclusive transit rights overlap. Of course, toll roads are possible, and private enterprise can lay broadband. It was private enterprise that build the railroads in the 19th century, sometimes but not always with government support.

2. "Counteract asymmetric information, externalities, and unequal bargaining power." Externalities are only a partial exception to noninterventionism, since the best solution is to turn them into property-rights issues, and whether the government actual does any good, on net, when it tries to handle them any other way is questionable. Asymmetric information is not a problem a government can often deal with, since the information that private sector agents don't have that makes the market not work well is often not available to the government either; beyond that, it's a question of interpreting contracts. "Unequal bargaining power" sounds like a way to put regulation of natural monopolies-- sometimes good-- under the same heading as government protection of union rights-- virtually always bad. These exceptions to free markets have a little force, in theory, but are usually abused, and most of their appropriate applications fit a noninterventionist policy anyway.

3. "Moderate financial panics and recessions." A pretty strong case has been made by macroeconomists in the last half-century, and especially by Milton Friedman, that this should consist of nothing except managing the money supply.

4. "And respond to popular demands for safety nets and social insurance." Why, pray tell? Because markets are "not self-legitimizing?" But that begs the question. Some voters use political power to take away the property of other voters and give it to themselves. It does not follow that they should, or even that they might not be persuaded not to, by, say, Milton Friedman. My own view is that the moral case for a welfare state within a rich country is morally bankrupt, and when combined with immigration restrictions is positively iniquitous; in fact, it is the chief injustice in our world; and I would claim that this conclusion is robust to the choice of philosophically defensible meta-ethical assumptions.

Rodrik wants to take part of the case for free markets and stuff the rest of it back in the box. He has a tenable case for doing so, but far from compelling.

Keynes the Heretic

J.M. Keynes' admiring biographer, Robert Skidelsky, writes in Return of the Master:

In my biography of Keynes I called him an 'unusual economist.' I would now go further. Deep down, he was not an economist at all. Of course, he could 'do' economics-- and with the best. He put on the mask of an economist to gain authority, just as he put on dark suits and homburgs for life in the City. But he did not believe in the system of ideas by which economists lived, and still live; he did not worship at the temple; he was a heretic who learned how to play the game. In former times he would have been forced to recant, perhaps burnt at the stake. As it was, the freedoms of the exigencies of his times enabled him to force himself on his church. Only a person of colossal self-confidence, outstanding intellect and passionate concern for his countrymen and humankind could have set himself the task of rewriting a large chunk of the Western intellectual tradition. Yet this is what Keynes set out to do. One can only marvel that he got as far as he did. He mesmerized and fascinated his contemporaries; for thirty years after his death they lived in his intellectual and moral afterglow. But to the technicians who inherited his mantle his ideas seemed strangely alien to the main themes of their subject. They tried to assimilate them, but found it difficult and made a mess of it; and the next generation gave them up altogether. Orthodoxy won out; the economic temple was shaken, but still stood.

I find this very astute, though my attitude towards it a bit different. I might substitute "blinding egoism" for "colossal self-confidence," and it was a crisis of self-confidence, rather than the "freedom" of his times, which gave Keynes his opening. "Burnt at the stake" is gratuitous hyperbole: orthodoxies rarely do such things to heretics; I am almost tempted to say that genuine orthodoxies never do; certainly orthodox economists never have. It is far more typical for heretics to burn orthodox at the stake. This claim will be opaque to the typical modern person as regards the history of religion, but it is obvious enough in economics, where all the ideologically motivated murder has been the work of disciples of heretics like Marx, and never of Hayekian free-marketeers. But the word "heretic" is right on. "Heresiarch" would be even better, though perhaps general audiences would not understand it.

Let me draw attention to the fact that there is such a thing as "Keynesian economics," but one never (or hardly ever) speaks of "Marshallian economics" after Alfred Marshall, "Friedmanian economics" after Milton Friedman, "Arrovian economics" after Kenneth Arrow, "Fisherian economics" after Irving Fisher, or even "Smithian economics" after Adam Smith; Frank Knight, David Ricardo, J.S. Mill, Gary Becker, Francis Edgeworth, William Stanley Jevons, John von Neumann, Vilfredo Pareto, and Robert Lucas are others who I think shrewd insiders would probably rank as equal in brilliance with Keynes. (Actually it's subtler than that; some really informed people would probably rank them much superior, while many economists would give Keynes a small edge in deference to convention, but anyway. There is one other "economist," if he deserves the name, that has a school named after him: Karl Marx. But Karl Marx was so thoroughly wrong, and by now everyone knows it, that economists just ignore him. Keynes still has influence.)

Is it just that Keynes is more famous? I don't think so. It's that the most important contributions of Smith, Marshall, Fisher, Knight, Ricardo, Edgeworth, etc. are just mainstream economics. Their ideas were often very original. But one may say they fit into the existing framework of economic thought, and their ideas are now thought without reference to their originators. I think the heart of the matter is this: their ideas made sense, and that was what made them orthodox, for that is what an orthodoxy does, it makes sense. It may insist on certain mysteries (in economics the word "assumptions" is sometimes an allusion to these), but it does not force faulty logic on anyone. For that matter, it does not force its mysteries on anyone either. Frank Knight is an interesting case here, for he, too, was an irreverent and thorough skeptic about homo economicus, a radical who urged people (sarcastically?) to vote Communist, yet because of his humility and discipline he remained a representative of orthodoxy, the teacher of Milton Friedman, George Stigler, James Buchanan and Paul Samuelson.

Skidelsky said that Keynes' successors "tried to assimilate [his ideas], but found it difficult and made a mess of it." Not exactly. Keynes' ideas themselves were a mess. Hicks, Samuelson, and others made an order of them, to some extent; they codified and clarified and formulated and explained; but in the end this intellectual edifice dissolved. It was the proverbial house built on sand, or as economists sometimes say, a theory built without microfoundations. "New Keynesians" like Greg Mankiw salvaged what was worth salvaging; reactionary Keynesians today like Paul Krugman, Joseph Stiglitz, or George Akerlof are merely using Keynes' still-great name as cover for arrogant and politically-motivated revisionisms that would not stand up to critical scrutiny without it. The economics profession, I aver, simply responded to Keynes in the wrong way. It treated him as an oracle when it should have treated him as a provocateur.

I plan to back these claims up with a series of quotes from the General Theory (but I might not follow through, since there is always other business). But here's one to start with (from p. 164 of my edition):

For my own part I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organizing investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.

So essentially, Keynes seems to be advocating state control of the commanding heights of the economy. The government, not the private sector, should build factories. Why? Because the volatility of financial markets makes them unsuitable for allocating capital to its most productive uses. An economist as brilliant as Keynes is reputed to be would know better than to write this. Many countries have tried policies a bit like this since, especially in the Communist bloc and the Third World. The results are uniformly wretched: the capital is wasted, the products are lousy. Hayek, Mises, or I suppose Frank Knight could have guessed this in advance. They knew that the state is certainly not in a position to determine the best uses to which capital can be put; it lacks the data, which is fundamentally the subjective experience of consumers, and is revealed by the response of budget-constrained consumers to the price mechanism, and no other way; and anyway, it lacks the incentives to manage capital well. Meanwhile, Keynes much exaggerated the inefficiency of private financial markets. Indeed, I would be surprised if any important economist today would endorse this passage.

Is Economics a Science?

McConnell, Brue, and Flynn's textbook, Macroeconomics, 19th edition, makes the claim, on p. 5, that economics is a science which uses the scientific method. This is often claimed and is part of the way economists legitimize themselves.

I dissent, however.

Some economic "laws," such as the Law of Demand (that people will demand less of a good when the price goes up, ceteris paribus), could stand up to pretty rigorous testing. Other key concepts, such as the concept of market equilibrium and the market clearing assumption, probably could not be formulated in such a way as to be vindicated through rigorous testing. There are even key concepts, such as the assumption that "markets clear," which are in a sense directly refuted by the facts: the supermarket shelves are never "clear," there are always a lot of goods waiting to be sold. Yet economists are justified in continuing to use the assumption for many purposes (although they may sometimes overuse and misinterpret it). Why?

Economics-- or so I would claim-- is not a science in the same sense that the natural sciences are. It is at a disadvantage in one way, but has a secret weapon to compensate. It is at a disadvantage because human beings are not deterministic: they have free will, they make choices, they cannot be predicted, at least not comprehensively and reliably. If you are philosophically committed to determinism, (I think you are wrong but) you can arrive at a similar insight by another way, namely that since we are human beings, we can never predict ourselves, because the information that we use as the basis for predicting our own behavior will also affect our behavior so as to falsify the prediction. If the world's greatest genius in predicting the stockmarket deduces that the Dow will rise by 500 points tomorrow, he may be right; but if he says so, he will be wrong, because his words will change what happens to the market. I cannot predict the invention of the wheel, because if I am able articulate what a wheel is, I have already invented it. Another way of putting the point is that human beings are too complex for science to predict them.

So much for the disadvantage. The secret weapon is that, since we are human beings, we know some things by introspection. If some utterly alien race were to observe the Earth, I do not see how it would be possible to know that human beings are purposive, or that resources are insufficient to satisfy their wants. Certainly, economists do not begin by setting aside (somehow) their introspective knowledge of rationality and scarcity, and then attempting to deduce it from the purely external kind of observation that natural scientists must rely on. They establish rationality and scarcity by appealing to introspection, and proceed from there. Theoretical models in economics have the character of tautologies: they make a set of assumptions, and deduce things from the assumptions. Sometimes this is a fault, in that the models are too abstract to be applied, but not always. It is possible to derive useful conclusions from mere logic starting with mere introspection, bringing in the real world only in the form of the loosest stylized facts, and making predictions which are precise only in the model and which when applied to the real world are too vague ever to be really tested in a rigorous way, letting mere experience leavened with common sense suffice to confirm the (rough) truth of the theory. Thus the Econ 101 supply and demand model, for example.

In Defense of Usury Laws

I just put an ad on the site, for payday cash advances; you can see it if you scroll down a bit on the right. I had mixed feelings about putting it there; I don't need the money so badly at the moment and anyway it isn't much, but I was so curious about how advertising on blogs works that I wanted to do it just as an experiment. The thing is that I'm wary of payday lending. But I suppose it's an occasion for setting down my views on usury laws.

The medieval Catholic church forbade "usury," which at one point included all interest; Islam forbids it, nominally at least, to this day. Gottfried Feder, an ideologist of the Nazi Party, also passionately opposed interest, and abolition of interest was a Nazi slogan. The prohibition has been common to many civilization. To a contemporary economist, all this opposition to interest is nothing but a simple-minded fallacy. Interest seems "unfair" because the lender receives back "more" than he gives. But economists know that funds-at-time-t are not the same good as funds-at-time-t+1. Funds-at-time-t are typically more valuable, since the economy usually grows and there are always opportunities to invest. So the lender is not "exploiting" the borrower; they are engaged in a mutually beneficial exchange.

Recently, though, behavioral economists have started to observe that people tend to have "hyperbolic" preferences, a particular mathematical form of preferences over present and future consumption that is characterized by "time-inconsistency": one tends to favor consumption right now over future consumption in a way that is inconsistent with one's relative valuation of future dates that are far enough away so that one is not biased by the pressures and impulses of the moment. While I'm suspicious both of some of the methods by which this result is obtained and of some of the implications that are drawn from it, it's probably true that people have a systematic bias in favor of instant gratification, which it takes willpower to overcome.

In that case, lending at interest may, after all, be predatory in some cases, though certainly not in all cases: it frequently happens, too, that people have very good reasons for having different relative valuations of funds-at-time-t and funds-at-time-t+1, and that some people will quite rationally go into debt to finance some plan or project and be glad in the long run that they did. What you would want morality, and probably law too, to do is to discourage or forbid the kind of lending that exploits instant gratification, while tolerating and approving the kind of lending that finances valuable education and judicious entrepreneurship. The tools available to players in the sphere of private morality, especially churches as well as families, schools, clubs, etc., and those available to policymakers, are quite different. Private morality could exhort lenders to examine their consciences, to take into consideration the effects on their clients, etc.; and could try, perhaps, to identify exploitative lenders and shame, ostracize, and expose them. Policymakers have the difficult task of defining the legal boundaries of exploitative and entrepreneurial lending. No specific interest rate could mark the difference. A rational entrepreneur might sometimes have good reasons for borrowing at 10% or 20% or even 50%; a loan made at 7% might still be a case of instant gratification. Usury laws can presumably never be written just right and will always ban some good lending and permit some bad lending. But it's still probably worth having them on the books.

I don't vouch for the advertiser below; I know nothing about them. I'm just curious as to whether the mechanics of e-commerce, in whether money will actually show up in my PayPal account on the basis of having a link on my site. Another interesting thing: even though I haven't been posting here regularly, traffic doesn't seem to have gone down. I guess there's a certain inertia in internet traffic.

The Keynesian Fallacy

"Debt alarm over stimulus spending":

The enormous public cost of fighting the global crisis is haunting governments and unnerving investors.

Even as President Barack Obama declared Tuesday that the United States must continue to “spend our way out of this recession,” international ratings agencies sent shivers through markets with warnings that spiralling budget deficits and soaring debt levels are putting sovereign ratings at risk.

Analysts do not expect a return to fiscal stability soon, and some countries continue to rely on stimulus spending to support fragile economies.

"To support fragile economies."  The Keynesian fallacy has become embedded in the language.  We passed the stimulus, unemployment rose, and yes the economy recovers a bit, as it always tends to do with or without "support," but weakly and not before sinking further.  You'd hope this experience might induce journalists to rephrase a bit, to write, say, that "some countries continue to burden fragile economies by increasing spending."  But the Keynesian fallacy is too embedded in the language.

It should be noted that the only real empirical "success" of Keynesianism is that military spending does seem to raise GDP.  But there's no need to appeal to a Keynesian model to explain that.  Suppose the government spends $X in a purely wasteful manner: will you work more or less?  Probably more, because since the government, now or later, is going to take some more of your money to pay for the $X expense, you're prospectively poorer, so your marginal value of money relative to labor rises and you work more.  War makes us poorer but raises GDP because we have to produce more to make up for what we destroyed.  Keynesian macro is theoretically flawed and has scant if any empirical support.  But how do we purge it from casual journalistic language?

Monasticism

My article, "The Economics of Monasticism," was just published at the ARDA Working Paper Series, see here: http://www.thearda.com/workingpapers/monasticism.asp.  Here's the abstract:

Since their emergence in ancient times, Christian monasteries have proven to be among the most durable of all human institutions, and in the medieval centuries made enormous contributions to the emergence of Western civilization. They are organized internally on socialist lines: monks own no property and owe total obedience to the abbot, making the monastery a miniature ‘centrally planned economy.’ A puzzling contrast exists between the longevity of monasteries and the transience of secular socialist communes. This paper presents a theoretical model which shows why voluntary socialist communes might be viable despite ‘shirking’ problems, yet fail due to turnover, and how worship, which induces people with high ‘spiritual capital’ to self-select into the monastery and then grows that spiritual capital through ‘learning-by-doing,’ can solve the turnover problem and make a worship-based socialist commune—a monastery—stable. Monasticism, like the market, is a form of ‘spontaneous order,’ but unlike the market, it does not depend on third-party enforcement (e.g., by a state) to function: this explains why monasticism (unlike capitalism) was able to thrive in the anarchic Dark Ages. Monasteries, in principle and largely in practice, are a form of society based on consent of the governed, unlike liberal states which preach but do not practice consensual governance, and it is interesting to juxtapose the real, live ‘social contracts’ of the monasteries with the notional social contracts of liberal political theory.

At the heart of the paper is a fairly simple economic model of monasticism.  It starts from individual utility maximization, and builds up to show (on certain assumptions) why monasteries can "compete" for members with "the world," and why only voluntary socialist communities with a religious basis are likely to prove stable, which is consistent with the facts.  And yet the paper is very ambitious in a vague and somewhat noncommittal way.  If you wanted to take a maximalist interpretation of its message it suggests that everything that sets the West apart from the rest, technology and economic growth and political freedom, is an effect of Christianity in general and in particular the nexus of monasticism that lay at the heart of it for over a thousand years.  Though I don't use the phrase, it expresses an idea that has haunted me for a long time, the Christian republic, an entity that is even in a sense political-- it has laws, loyalties, and leaders-- yet wholly, or if not wholly then at least typically and characteristically, noncoercive, and prophecied in various sayings of Our Lord: "My kingdom is not of this world"; "Upon this rock I will build My church, and the gates of hell will not prevail against it"; "Heaven and earth shall not pass away, but My words will not pass away."  And indeed, so it has turned out.  Yet it is in the nature of monasticism to flee from the world, and if the Church doesn't exactly do that, nonetheless if one looks at it from the point of view of secular history, it never has as high a profile as the conquerors who have come and gone while the Church remains.  And it is in the monastic rules that order without coercion is embodied par excellence.  I think one could read my article and even agree with my hypothesis without accepting either the truth or the importance of Christianity... but I think the paper just my shake an agnostic's faith slightly.  However, at this point it's at the level of theory.  How I would like to use the theory as a means of writing a history of monasticism!  Someday...

Publicity for "Economic Contractions in the United States: A Failure of Government"

From my co-author Charles Rowley, in the Daily Telegraph: "Adam Smith would not be optimistic in today's economic world: Adam Smith once commented that "there is a great deal of ruin in a nation". He meant that bungling governments imposed only a limited check on the economic performance of a Great Nation."  This article accompanies the launch of Economic Contractions in the United States.  For regular readers of this blog I'll stop to point out my... differences of emphasis... as appropriate:

As Nathanael Smith and I show in our study of US economic contractions, Adam Smith would be much less sanguine were he confronted by today's financial crisis and the US government's response. Indeed, it is not impossible that the US will experience the kind of economic collapse from first- to third-world status experienced by Argentina under the national socialist governance of Juan Peron.

"Not impossible" is so weak that it makes the claim innocuous, I suppose, but this seems like an exaggeration, and it seems to conflict with the 7th chapter of Economic Contractions, where we predict that "profligate deficit-spending and interventionism" will produce disillusionment and a conservative revival (p. 97)-- a prediction that events seem to be bearing out.

The US economy suffers from a growing culture of indebtedness that has increasingly contaminated the federal government since 2001 and has spilled over dramatically into private household behaviour. The combination of the ill-conceived fiscal-furnace fired by President Bush and the US Congress and the reckless monetary-furnace fired by Alan Greenspan and Ben Bernanke throughout the period 2001-2007, created unsustainable housing market and stock market bubbles whose collapse brought on the financial crisis and economic contraction of 2008-2009.

I would put the charge in more measured terms.  Fiscal policy under George W. Bush was less expansionary (smaller deficits as a share of GDP) than under Ronald Reagan, even though the US was at war in the Bush years and not in the Reagan years.  (At a time when Obama and the Democratic Congress are redefining "reckless" in the upward direction at a rate of $100 billion a month or so, it seems strange to use the term for the Bush administration, though the Bush administration should certainly have known better.)   And while interest rates stayed low in 2003-04 for too long after recovery had begun, they then rose steeply, so "throughout the period 2001-2007" seems to make the charge too broad.  Even the low interest rates of 2003-04 seem more like a serious technical mistake combined with having the wrong Fed policy rules-- housing should have been included in the CPI-- than "reckless."  And dating the problems to 2003-04 would seem to absolve Bernanke and concentrate responsibility on Greenspan. 

What led to the bubble was that (a) fiscal and monetary policy were expansionary at the same time for the first time since the 1970s, and (b) house prices were-- we argue, mistakenly-- excluded from the price index, causing the Fed to see "low" inflation at a time when house prices were rising at well over 5% per year.  What I find ironic is that, in a sense, the crisis is Osama bin Laden's revenge.  Bin Laden wanted to deal a devastating blow to the US economy.  Determined to deprive him of this victory, Bush and Greenspan adopted expansionary fiscal and monetary policies that lifted the economy out of what could, and maybe should, have been a deep recession in 2001.  As a result, they inflated a debt bubble and made the next crisis sooner and deeper.  Fortunately, al Qaeda was ruined by the war in Iraq, so bin Laden's victory is Pyrrhic.  But if the government had let the 2001 recession play itself out naturally, there might not have been any 2008 crisis.

The policy responses to the debt bubble demonstrate crude political consideration rather than economic understanding. If excessive government indebtedness is a major source of the problem, why increase the government debt? Why encourage households to go yet further into debt?

The prognosis is catastrophic if projected government policies are not cut back. According to the White House's own estimates, the federal budget deficit in 2009 will be $1.6 trillion, approximately 11.2pc of the overall economy, the highest on record since the end of the Second World War. In 2019, the national debt will represent 76.5pc of the US national economy, the highest proportion since just after the Second World War. In such circumstances, the international reserve status of the US dollar will not survive. As it fades, so interest rates on government securities will rise and the real burden of servicing the debt will increase. In such circumstances, the US economy will teeter on the edge of a black hole.

Hmm... why bring in "the international reserve status of the US dollar?"  I don't remember anything about that in the monograph.  Do we have-- does anyone have-- a theory relating government debt to the viability of a reserve currency?  Personally, if there were some way to transition out of a dollar regime without global chaos, I think it might be nice not to own the world's reserve currency: I think being able to print the world's reserve currency causes a form of "Dutch disease," undermining the competitiveness of our industries and fueling excessive growth of government.  Also, why would more debt cause the US economy to "teeter on the edge of a black hole," rather than, say, acting as a drag on growth and depressing living standards for decades-- as it has arguably done in Japan?  Government debt in Japan and Italy is way above 76.5% of GDP; both countries have suffered malaise rather than crisis.

Prosperity and full employment in the US will only be restored by a return to laissez-faire capitalism. Our study outlines a radical, but politically feasible, approach. Monetary policy should be expansionary. But, on the micro-economic side, tariffs and other trade barriers should be repealed unilaterally; a "Right-to-Work" Act should reduce the minimum wage and curtail the powers of unions; and business regulation should be reduced. Individual banks and their counterparties should not be bailed out, although the system should be protected by ensuring that failing banks are wound up in an orderly fashion – this is the only way to restore market discipline.

A little late not to bail out individual banks, no?  Rather say that laws and policies should be rewritten so as to prevent future bailouts (except of insured deposits through the FDIC).  And is it really "politically feasible" for "tariffs and other trade barriers [to] be repealed unilaterally?"  Maybe!  I wouldn't rule out the possibility that bold, visionary political leadership can make the politically impossible possible -- after all, Obama seems to have made people dislike unions and appreciate the health care status quo! -- but that is as much as to say that the range of the "politically feasible" is very broad.

Rowley and I found enough to agree on to put a book together, but he might have a tendency to overclaim. 

MORE: "Barack Obama accused of making 'Depression' mistakes: Barack Obama is committing the same mistakes made by policymakers during the Great Depression, according to a new study endorsed by Nobel laureate James Buchanan." (Daily Telegraph):

"Endorsed by Nobel laureate James Buchanan."  That's brilliant marketing.  But it's not false advertising, for here is Buchanan's Frontispiece:

A comprehensive and coherent assessment of the current economic contraction, one that largely rebuts attribution of failure to capitalism or the market. The targets become practicing politicians of all parties, whose cumulative mistakes have now hurt us all. We have learned some things to reduce the severity of the current contraction. But we have made no progress toward putting limits on political leaders, who act out their natural proclivities without any basic understand of what makes capitalism work.

Anyway, here's what Edmund Conway of the Telegraph has to say:

His policies even have the potential to consign the US to a similar fate as Argentina, which suffered a painful and humiliating slide from first to Third World status last century, the paper says.

There are "troubling similarities" between the US President's actions since taking office and those which in the 1930s sent the US and much of the world spiralling into the worst economic collapse in recorded history, says the new pamphlet, published by the Institute of Economic Affairs.

In particular, the authors, economists Charles Rowley of George Mason University and Nathanael Smith of the Locke Institute, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run. They say that by employing deficit spending and increased state intervention President Obama will ultimately hamper the long-term growth potential of the US economy and may risk delaying full economic recovery by several years.

Excellent.  The title of the Telegraph piece may slightly overplay the 'Depression' analogy -- while we do identify some similarities with policies from the Depression era, monetary policy is (no thanks to Obama) just the opposite, and we haven't seen anything like the crazy tax hikes of Hoover and FDR yet though there are some ominous signs -- but this last paragraph nicely captures a central argument of the book.  Conway continues:

The study represents a challenge to the widely held view that Keynesian fiscal policies helped the US recover from the Depression which started in the early 1930s. The authors say: "[Franklin D Roosevelt's] interventionist policies and draconian tax increases delayed full economic recovery by several years by exacerbating a climate of pessimistic expectations that drove down private capital formation and household consumption to unprecedented lows."

Heh.  If Rowley and I get credit for debunking the myth that FDR's Keynesian New Deal got us out of the Great Depression, that would be as unfair as Columbus getting credit for debunking the myth that the world is flat.  To our cost, this myth remains potent at the popular level, but among economists I don't think even Paul Krugman would defend it.  Rather, Keynesians claim that WWII got us out of the Great Depression.  This is also debatable -- "GDP" grew, but should bombs and guns and tanks count as GDP, when they don't contribute to human happiness; or if they do count as GDP, don't we need some more appropriate way of measuring the economy's contribution to human well-being, which would likely put paid to the odd notion that WWII was an economic golden age? -- but it has no bearing on the episode Rowley and I deal with, namely the 1930s.  It's rather odd that at this late date anyone can make headlines with what ought to be a truism, namely that the New Deal exacerbated, rather than "got us out of," the Great Depression, but if that's still news to a lot of people, then those headlines need to be made.  Conway continues:

Although the authors support the Federal Reserve's moves to slash interest rates to just above zero and embark on quantitative easing, pumping cash directly into the system, they warn that greater intervention could set the US back further...

And then proceeds with quotes from Rowley and Buchanan, already quoted above in this post.  I'm glad that the message is clear that we support quantitative easing.  On that point we're basically Milton Friedman-type monetarists.  Too bad our advocacy of immigration reform and Social Security reform doesn't seem to be making it into the reviews so far!

How Keynesianism Survives

"Why the Stimulus is Helping the Economy, But Not Obama" (Time)

Proving a negative is always a challenge, but there's mounting evidence that the controversial $787 billion stimulus bill is achieving one of its major goals: shortening the recession. Economists at Goldman Sachs say that the bill, officially called the American Recovery and Reconstruction Act, has resulted in a 2%-3% boost to annual GDP in the second and third quarters of this year, turning what could have been a worsening recession into potential growth. For President Barack Obama, whose poll numbers have dropped precipitously from around 65% to around 50% as Americans have become worried about government spending and health-care reform, that should be good news: he fought hard against Republican opposition to push the bill through Congress as one of his first legislative acts, and the fact that it's working should be a vindication.

But it's not that easy. Recent polls show widespread disapproval of the stimulus bill: 51% of Americans polled last month by USA Today and Gallup said they thought the government should be spending less under the plan, while 44% said they thought the government was spending the right amount, or should be spending more. If anything, it seems, the stimulus plan is hurting the President even as it helps the country.

The most obvious reason for that disconnect is jobs: despite the signs of a turnaround, unemployment remains stubbornly high at 9.7%, with employers cutting 216,000 jobs in August. While jobs always trail economic rebounds, the unemployment number is higher than economists thought it would be, even in the worst case scenario forecast by the Treasury department's "stress tests" last spring. The point is not lost on Republicans, some of whom have argued lately that no more of the stimulus money should even be spent. "The metric of this bill was job creation," says Don Stewart, spokesman for the Senate's top Republican, Mitch McConnell, "and it hasn't done that."

Still, one would think that the mere infusion in six months of $88 billion into the economy — that's how much the government has spent so far...

Journalists, it goes without saying, are not very smart (maybe they suppress it because it impedes their ability to slice a complex world into neat stories) but a cruder, more flagrant example of the post hoc ergo propter hoc fallacy would be hard to find than the above.  It seems quixotic, or Sisyphean, to remind people of the truism of economic history that it's normal for the economy to recover, that it always does so, even-- nay, especially-- when the government does nothing.  The last time the US government did nothing in a recovery-- in the recession of 1920-21-- the recovery was especially robust.  Again, in 1997-8, when the IMF forced East Asia to adopt austerity measures in the midst of recession, it earned itself the contempt of East Asians but rapidly restored growth to its former booming rates for another decade.  By contrast, Keynesian policies failed in the US in the 1930s, in Japan in the 1990s, and dragged post-WWII Britain down from being the world's economic leader to a desperate, stagflation-ridden basketcase in the generation after the British economics profession surrendered to Keynes, before it was rescued by Thatcher.

So how does Keynesianism survive?  Because of articles like the above, because of journalists committing the post hoc ergo propter hoc fallacy, while economists like Brad DeLong and Paul Krugman, who want bigger government because their values are different from the mainstream and want to use their technocratic credentials to sell big government to people who would not support it if they understood its true effects, back them up.  Keynesian economics is like fortune-telling: shrewdly vague, it exploits a perennial fallacy, namely people's chronic inability to understand that the economy can recover on its own.

In this case, the journalist provides the key fact that makes the "stimulus worked" case implausible: only $88 billion has been spent, just over 10% of the whole stimulus package, and only about 0.6% of GDP, and all of that after the worst of the crisis-- October 2008-- had already been mitigated.  By contrast, Ben Bernanke's Fed has bought hundreds of billions of dollars of private and federal debt, and the Bush administration "spent"-- albeit with a fair prospect of recovering-- $700 billion or so through the TARP program.  If any stimulus is working, it's that of Bernanke and Paulson, which was not mere Keynesian spending-for-spending's-sake but a timely intervention by highly competent technocrats (we won't see such expert competence from neophyte Obama, but fortunately, we might not need it) targeted to the specific problems at the heart of systemic failure.  That's not to give unqualified approval to Paulson.  He's a tragic hybrid of hero and anti-hero: he probably did save the US from a more shattering crisis, but the fallout from the Paulson Plan is likely to be a more politicized financial sector and hugely increased incentives and opportunities for rent-seeking for years or decades to come.  There's something to be said for the House GOP who voted against him, too.

For now, the American people seem to be displaying a sensible incredulity about the "stimulus is working" message.  But don't count on it to last.