Wednesday, March 04, 2009

Not all economists are Keynesians

Business Times - 05 Mar 2009

Not all economists are Keynesians

Many economists, including Nobel laureates, disagree with the Obama administration's economic recovery strategy


PRESIDENT Barack Obama has insisted that the majority of mainstream American economists support the general premises underlying his economic policy and, in particular, the notion that the federal government should have a central role in stimulating the economy and helping end the recession.

'There is not disagreement that we need action by our government, a recovery plan that will help to jumpstart the economy,' Mr Obama said on the eve of his inauguration in January.

Indeed, the conventional wisdom these days is that, frightened by the recession and the credit crunch that produced it, 'most economists' are now embracing public spending to repair the damage, including many of those economists who have long resisted a significant government role in a market system; and that the only real debate that is taking place revolves around what type of spending would produce the best results, or what mix of spending and tax cuts.

As the cliche du jour puts it: 'We're all Keynesians now.'

But in fact, while famous economists, including Nobel Prize winners, have backed the Obama administration's Keynesian strategy aimed at resolving the economic crisis, many famous economists, including other Nobel Prize winners, are on the opposite side of the debate about the stimulus package and what should be done about the recession.

Hence, the Cato Institute, a free- market-oriented think tank in Washington, took out a full-page ad in several national newspapers in January, which was signed by more than 200 economists, including several Nobel laureates, telling President Obama that he was wrong on the economic stimulus package and that it was not true that most economists were calling for increased government spending.

'Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we the undersigned do not believe that more government spending is a way to improve economic performance,' the ad said.

'More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s,' it noted, adding that 'more government spending did not solve Japan's 'lost decade' in the 1990s.'

The economists, including Nobel laureates James Buchanan, Edward Prescott and Vernon Smith, suggested that 'it is a triumph of hope over experience to believe that more government spending will help the US today'.

And they proposed that in order to improve the economy, 'policymakers should focus on reforms that remove impediments to work, saving, investment and production, by embracing such fiscal policy tools as lowering tax rates and reducing the burden of government'.

Hence, the notion that the opposition to Mr Obama's ambitious economic plans comes mainly from exasperated Republican lawmakers on Capitol Hill and a few fringe right- wing economists is very misleading. Economists who belong to the Chicago and Austrian schools continue to adhere to the free-market principles espoused by Milton Friedman, Friedrich Hayek, and Ludwig von Mises, and are not about to be won over by Keynesian economic philosophy anytime soon.

Indeed, in the same way that the Iraq War served as a testing ground for two schools of foreign policy thought - Neoconservatism vs Realism (the Realists had won) - the current economic crisis is going to test two schools of economic thought: Keynesianism vs Friedmanism/Hayek- ism.

While it is true that most economists do agree that the current American (and global) economic downturn was caused by the bursting of the housing bubble, there are clearly major disagreements about 'what do we do now?' between the Keynesians and the members of the Austrian and Chicago schools and Keynesians who are the driving force behind Obamanomics.

Noting that during a recession, spending and investment is below the requirement for full employment, Keynesians assert that the government needs to restore the flow of credit into the economy through spending in order to make up for the underperformance on the part of consumers and businesses, and to help employ unused labour and capital.

But free marketers from the Austrian and Chicago schools put an emphasis on the role played by the central bank in helping produce the recession through excessive credit creation, and they suggest that it needs to stop doing that. This would allow the price of the overvalued housing market to fall to equilibrium, creating the conditions for renewed economic growth.

The role the government should play in the recovery should be minimal, mostly by lowering some taxes in order to create incentives for new investments.

At the same time, warn conservative and libertarian economists, the rise in government spending coupled with continuing credit creation by the central bank as part of an effort to revive the financial system could prove to be a prescription for rising inflation and an ensuing decline in the value of the US dollar - not to mention the need in the aftermath of the recovery to pay for the government spending through an increase in taxes on businesses and consumers.

'The central tenets of Obamanomics appear to be that access to credit will enable people to borrow money to buy stuff, the spending will spur production and employment, and thus the economy will grow,' according to libertarian economist and investor Peter Schiff.

But consumption is made possible by production and credit is made possible by savings, Mr Schiff insists. 'The sad truth is that the productive capacity of the American economy is now largely in tatters,' he argues, adding that 'introducing freer-flowing credit and more printed money into such a system will do nothing except spark inflation.'

From that perspective, the worst- case scenario could be a failure by Washington to contain the economic downturn combined with rising inflation, which could threaten the economy with stagflation.

But the economists advising President Obama are operating under the assumption that Washington needs to 'do something' and seem to be confident that the government spending they propose will help increase employment and spending, and that ensuing economic growth will produce more tax revenues that will end up paying for expanded deficit.

Their ideological adversaries among 'Austrians' and the Chicago school remain sceptical about the ability of government to fine-tune the economy through fiscal policy. In particular, they warn of inevitable bureaucratic and political pressures that will make it likely that taxpayer money could be diverted to wasteful projects. They are concerned that government spending will crowd out investment by the private sector.

But Obamanomics, which is the most current version of Keynesianism, is clearly going to guide the policies of this administration in the next four years. If these policies succeed in rolling back the economic recession while stabilising the financial system and opening the road towards economic recovery and growth, the Keynesians are going to emerge as the winners - and the Austrian/Chicago schools will be seen as the losers - in this latest war of economic ideas.

But if President Obama fails in managing the economic crisis, in the same way that George W Bush failed in managing the Iraq War and American policy in the Middle East, will the free marketers be back in fashion? Or perhaps the economic thesis and its antithesis will merge in a new synthesis?

Who knows? Perhaps a new economic school of thought will come to the forefront.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


MikeK said...

The problem is that you can pick out virtually any statement or plan, and say "many economists, including Nobel laureates, disagree with it". Such is economics.

I'm also surprised so many economists are still commentating so enthusiastically, given how loudly they were cheering us on as we walked straight into this apparently unforseeable mess.

Anonymous said...

A president ROMNEY doesn't sound so bad NOW does it?