November 16, 2010

Recovery Requires Rethinking

Justin Katz

An excellent article about government economic policy and our current crisis by Reuven Brenner and David Goldman (initially published in First Things) is well worth reading in its entirety. The essay's underlying conclusion is that the focus on this or that manipulation of the economy as an explanation for our current predicament effectively misses the critical point:

The policy debate is a blame game, but one played by blind men with an elephant. Some say that if the Federal Reserve had not kept interest rates so low for so long, there would have been less credit expansion and fewer defaults. Others say that if the Fed had paid more attention to the external value of the dollar than to price indices or GDP, it would have suppressed the developing bubble in home prices. Still others argue that without official support for subprime securitization, the vast subsidies provided by government-sponsored mortgage funders, and the monopoly position of the heavily conflicted rating agencies, the securitized debt bubble might have been contained. Yet others argue that the proprietary trading focus of deposit-taking institutions made the payments system vulnerable to panic.

All these observations are true, and all of them are misleading, for the crisis arose not from any of these errors as such but rather from the Keynesian mindset of policy makers and regulators that prevented them from identifying these problems before they combined to threaten the financial system and the long-term health of the economy.

It's not only a problem of spotting errors; it's also a problem of misconceiving the likely effects of policies:

The collapse of the credit expansion raises the prospect of deflation, and the Keynesian elite now proposes to ward off this danger by returning to the inflationary policy that brought about the crisis in the first place. The International Monetary Fund's chief economist, Olivier Blanchard, offered what he called a "bold innovation" in February 2010, proposing that central banks pursue 4 percent inflation. Evidently Blanchard thinks that people will happily accept a 22 percent reduction in their wages over five years and a 48 percent reduction over ten years. Professional deformation on this scale attests to the triumph of Keynes over common sense. The reasoning of proponents of such policies - Paul Krugman advocates even higher inflation rates - is that the fear of inflation would lead people to spend money before its purchasing power declined. The Keynesians did not stop to ask how Americans could begin a spending spree after the colossal wealth destruction of the past several years, just before the largest retirement wave in American history.

Perhaps it's a matter of a wealthy elite not understanding the decisions and motivations of the masses, or perhaps it's just an inability to intellectualize the relative weight of every likely consequence of policies. The important point is the fundamental misunderstanding of economists' and politicians' ability to manage a global economy. The economy cannot be steered by policy; it's an unwieldy vehicle with many hands on the controls — the hands of every person with resources and talent (i.e., everybody). At best, policymakers can throw large, blunt objects in the path as obstacles and smooth roads that might be taken.

Brenner and Goldman further support my frequent contention that economic advancement must come from somewhere:

As an advocate of emergency measures during the 1930s, Keynes, as we have said, deserves some credit. His legacy in economic theory, though, has been malignant. It is easy to explain why he drew support during the 1930s. It is harder to explain why the Keynesian model, with its inherent tendency to drive off the road, has survived so long.

Part of the answer is that countries devoted to "Keynesian" policies had a run of good luck that covered up the systematic errors of economic policy. And the memory of this run of good luck still beguiles politicians and their advisers, who yet hope that the easy times will come back.

A major source of that good luck was the migration of capital and talent spurred by troubles elsewhere. Until 1989, most of the world suffered under communist or other dictatorial regimes prone to violent political upheaval. Whatever talent and capital was able to escape from the dictatorships arrived on the shores of a handful of Western countries, foremost among them the United States. The export of human and financial capital to the United States and a few other countries helped cover up accumulating mistakes. In politics as in business, competitors survive not because they are clever but because the competition is stupider.

A minor adjustment that I'd make is that the politicians and advisers aren't "beguiled" by past success so much as enthralled by the power that Keynesian policies aggregate to government. It isn't that they are sure the policies will work, in other words, but that they want the policies to work because they benefit by them. The more important point, though, is that economic growth must have a source, and it cannot often be identified from distant capitals or predicted in advance by politicians.

Ultimately, the wisest action for those in power is to create the conditions in which their countrymen can innovate in their own spheres and steer their own economic futures. It's messy and unpredictable, but the only thing predictable about central planning is that it will fail on an increasingly spectacular scale.

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Krugman gets paid to pontificate.he got a Nobel Prize,further proof of the deterioriation of quality in awarding it.
The biggest worry Krugman has is getting soup on his beard.
The odious "klaus" on Kmareka has a mancrush on Krugman.

Posted by: joe bernstein at November 17, 2010 5:23 AM
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