Five Questions for a Keynesian

Steven Horwitz, the Charles A. Dana Professor of Economics at St. Lawrence University, has five questions for a Keynesian:

1. Why did Keynes think savings was bad if when people save through financial intermediaries they give control over resources to the banking system, which in turn will lend that out to firms to create capital and new jobs?

2. How does government spending create jobs and wealth if the resources that government spends must ultimately come from the private sector, through taxes or reduced borrowing due to government borrowing more (or inflation), and the private sector would have spent it either on consumption directly or on investment through savings anyway?

3. If one of the problems of the housing boom is that we put too many resources into housing and finance, how will a Keynesian government spending package know where that spending should have gone instead?

4. Keynes frequently wrote about the importance of the uncertainty of the future and the way that made things difficult for private investors and for the connection between savings and investment. Why doesn’t that same uncertainty prevent governments from knowing exactly how much and where they should be spending in a recession, especially because markets have prices and profits as signals to help entrepreneurs navigate that uncertainty while government bureaucrats do not have similar signals?

5. Given the enormous role that government interventions played in causing the current recession, from the expansionary policies of the Fed to GSEs like Fannie and Freddie, to misguided regulations in housing and banking, why should anyone believe that the same government actors will know how to solve it?

For the answers to these and other questions, be sure to read Professor Horwitz’s interview with Free Market Mojo.

Government Safety Fail

It should come as no surprise that the federal government is using GM as an outlet for its rampant paternalistic urges.  The most recent example, coming from the Wall Street Journal, is particularly disturbing given the potential safety problems it will create.

Starting Jan. 4, General Motors Co. plans to do something unprecedented in the U.S. car industry: It will run its assembly line here around the clock on a permanent basis.

While common in other industries, not even car-efficiency benchmark Toyota Motor Corp. operates its plants routinely with more than two shifts. Car-assembly lines need too much scheduled maintenance and restocking for such intensive production to make sense, many industry experts say.

The Obama administration auto task force that oversaw GM’s reorganization last spring was startled to learn that the industry standard for plants to be considered at 100% capacity was two shifts working about 250 days a year. In recommending that the government invest about $50 billion in GM, the task force urged the company to strive toward operating at 120% capacity by traditional standards.

This situation is not without precedent. Government regulations frequently move behavior in the opposite direction of public health and safety. Increased regulations on average MPG for automakers results in lighter cars and, as a consequence, a higher number of fatalities. While government safety regulations for cars increase costs and incentivize consumers to keep older cars longer, resulting in greater emissions. At the very least, however, the preceding examples of government paternalism had some roots in good intentions. Running GM plants at 120% capacity has the potential to cause deaths for the sake of providing jobs and stimulating the economy. Unfortunately, such Keynesian policies do not provide jobs and do not stimulate economies. So the result of this latest act of paternalism will simply leave us with decreased safety and increased economic inefficiencies.

HT: Cafe Hayek

A More Efficient Form of Waste

Dave Prychitko at The Economic Way of Thinking has devised a expedient way to spend the stimulus money and avoid the heavy transaction costs associated with any Keynesian-style economic revival. He also manages to point out some of the absurd aspects of the stimulus along the way:

By lottery, give away one million dollars to one million U.S. citizens. There’s around 300 million of us.  It will likely be considered less fair than the first-best proposal (“Why should the money go to those who already have jobs?”), but so be it. Here, the chances of winning are lower — 300 to 1 — but still remarkably better than a state lottery ticket.

If Keynes is correct, it doesn’t matter to whom the money goes, as long as it is spent. My plan is better:  think of the cost savings compared to the present plan of the administration.  No rent-seeking problems, no bureaucratic waste to oversee spending projects, no delays in how to allocate the proceeds.

I think I’m joking here — I’m against aggregate demand management in any form, I don’t think it works to improve things, and in fact on net it is negative.  But if the government is going to spend a trillion bucks to stimulate the economy, my proposal is less costly and would put cash immediately into the hands of a million citizens, citizens who spend their own money better than politicians and bureaucrats.

Milton Friedman: ‘Keynes was a great economist’

This blog is very critical of Keynesian economics, due to the fact that it is wrong. However, we’re not so critical of John Maynard Keynes. Thankfully, we’re not alone in our opinions:

Keynes was a great economist. In every discipline, progress comes from people who make hypotheses, most of which turn out to be wrong, but all of which ultimately point to the right answer. Now Keynes, in The General Theory of Employment, Interest and Money, set forth a hypothesis which was a beautiful one, and it really altered the shape of economics. But it turned out that it was a wrong hypothesis. That doesn’t mean that he wasn’t a great man!

~ Milton Friedman

Know Thy Enemy

While I believe Keynesian economics to be both flawed and immoral, John Maynard Keynes gives a very chilling account of how inflation can destroy a capitalist system.

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

Did the stimulus work?

Jeffrey Miron and Russ Roberts tackle the question of whether or not the stimulus worked. Their answer? Not quite.

Miron:

Research finds more evidence for the efficacy of monetary as opposed to fiscal policy in ending recessions. And the studies on fiscal stimulus have shown more impact from tax cuts than from spending increases.

We also do not know whether the positive G.D.P. growth resulted partially or mainly from natural equilibrating mechanisms, rather than from monetary or fiscal policy. Much discussion of the recession presumes it will end only because government comes to the rescue.

In fact, the U.S. economy recovered from significant recessions before 1914, when monetary and fiscal policy had not even been invented. Economies can and do recover on their own, and intervention might make things worse by generating uncertainty and distorting the economy’s allocation of resources.

Roberts:

I once thought that spending money was the government’s strong suit. But as of October 20, only $120 billion of the $290 billion available so far from the stimulus package has been spent. Despite the early rhetorical emphasis on shovel-ready projects, the Department of Health and Human Services, the Department of Labor, and the Department of Education accounted for two-thirds of the total spent.

The Department of Transportation, a source of spending that is likely to be rich in shovels, has $30 billion available but has only managed to spend $4 billion. So perhaps it is not surprising that construction workers and manufacturing workers (who make up half of the job losses since the beginning of the recession) are struggling to find jobs.
I think the Keynesian narrative is right about one thing — consumers lack confidence. The crucial question is whether a large increase in government spending financed with borrowed money that swells the deficit to $1.4 trillion is good for confidence or bad for it. No one knows the answer.

The arguments against the stimulus are rooted in basic economics. Unfortunately, basic economics rarely make for an inspiring campaign speech.

Bigger Governments Produce Worse Recessions

In his August 9ts column , Nobel Prize-winning economist Paul Krugman stated:

So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government. . . . [W]e appear to have averted the worst: utter catastrophe no longer seems likely. And Big Government, run by people who understand its virtues, is the reason why.

Alan Reynolds of the Wall Street Journal has a response:

This is certainly a novel theory of the business cycle. To be taken seriously, however, any such explanation of recessions and recoveries must be tested against the facts. It is not enough to assert the U.S. economy would have experienced a “second Great Depression” were it not for the Obama stimulus plan.

Even those who think government borrowing is a free lunch can’t possibly believe the government has already done enough “stimulus spending” to explain the difference between depression and recovery.

CNN Money recently calculated that the stimulus plan has spent just $120 billion—less than 1% of GDP—mostly on temporary tax cuts ($53 billion) and additional Medicaid, food stamps and unemployment benefits. Less than $1 billion has been spent on highway and energy projects. Commitments for the future are much larger, but households and firms can’t spend commitments.

Proponents of Big Government can’t say we avoided the next Great Depression due to hypothetical stimulus money that is mostly unspent. So they argue it’s more important that the federal government merely continued spending and didn’t “slash” spending as in the early 1930s. But the federal government didn’t slash spending in the early ’30s. Federal spending rose by 6.2% in 1930, 7.7% in 1931 and 30.2% in 1932. Since prices were falling, real increases in federal spending were huge during the Hoover years.

A 1999 study in The Journal of Economic Perspectives by Christina Romer (now head of the Council of Economic Advisers) found that “real macroeconomic indicators have not become dramatically more stable between the pre-World War I and post-World War II eras, and recessions have become only slightly less severe.” Ms. Romer also noted that “recessions have not become noticeably shorter” in the era of Big Government. In fact, she found the average length of recessions from 1887 to 1929 was 10.3 months. If the current recession ended in August, then the average postwar recession lasted one month longer—11.3 months. The longest recession from 1887 to 1929 lasted 16 months. But there have been three recessions since 1973 that lasted at least that long.

The relative brevity of recessions before the New Deal is particularly surprising since the U.S. economy was then dominated by farming and manufacturing—industries far more prone to nasty cyclical surprises than today’s service-based economy.

To believe Big Government explains why this extremely long recession was not even longer, we need to find some connection between the size of government and the depth and duration of recessions. There is no such connection in U.S. history, or in recent cyclical experience of other countries.

On the contrary, recessions have become longer as the U.S. government (and the Fed) became larger, more expensive, and more involved in the economy. Foreign countries in which government spending accounts for about half of the economy have also suffered the deepest recessions lately, while economic recovery is well established in countries where government spending is a smaller share of GDP than in the U.S.

In short, bigger government appears to produce only bigger and longer recessions.

In my humble opinion, a belief in Keynesian economics seems to be based more on faith in the power of government than historical or empirical evidence.

Eight Reasons Why Big Government Hurts Economic Growth

The Cato Institute‘s Center for Freedom and Prosperity Foundation has produced a short video outlining the negative consequences of Keynesian economic policies.

HT: Cafe Hayek