Posted by
john on Thursday, February 26, 2009 4:47:00 PM
A little more than a hundred years after Mr. Chief Justice Marshall's immortal quip regarding the power to tax, the great economist John Maynard Keynes expounded his epochal General Theory, and his timing was providential, from a certain point of view. It was the middle of the Great Depression, and the New Deal was in full flower. The New Dealers, recall, were a tribe of Utopian dreamers and schemers, with visions of agricultural collectives and nationalized utilities dancing in their heads. Among other things, they actually believed that the G.D. was caused by low wages (you read that correctly) and cash hoarding. Many had made the pilgrimage to Josef Stalin's paradise to gain their inspiration. All believed unreservedly in the capacity of enlightened, educated people (such as, well, themselves!), given enough authority and money, to fix the world. Certainly, modesty was not their hallmark.
You can imagine their delight when Lord Keynes revealed the Gospel of Aggregate Demand. The government, you see, can pull the economy out of a slump by taking it upon itself to boost aggregate demand! How to do this? A magic wand? A magic bullet? No. It's much simpler than that. All you need to do is organize useful projects and hire the unemployed to staff them. Where does the money come from? You borrow it. You see, sometimes the economy needs its "pump primed". You can pay off the debt later, once recovery kicks in, and the tax receipts come gushing. And did you know about the "multiplier"?
As you may now grasp, Lord Keynes' groundbreaking and brilliant (I mean that) work on aggregate demand provided the intellectual cover for busy-bodies and do-gooders throughout the land to congratulate themselves as they spent other peoples' money (or maybe even money that doesn't exist yet) on their pet schemes. Might there be shortcomings in this approach (see Today's History Lesson, infra, November 23, 2008), in the form of the long-run effects of taking on debt to pay for projects of unknown utility that private investors might have shunned? Sure, but the ever-insightful Keynes had an answer for that: "in the long run, we are all dead".
By the 1970s, the long-run had arrived, and, as he predicted, Lord Keynes had passed on. Efforts to manage the business cycle through manipulation of aggregate demand, however, were alive and well, though President Nixon's famous remark on the subject ("We are all Keynesians now") may have been an Ultimate Contrary Indicator. Nonetheless, Keynes' Cover had predictably led to social engineering through the tax code and other onerous regulations. Further, years of attempts to manage aggregate demand, and the widespread belief in the Phillips Curve (which held that there is an inherent and unbreakable link between inflation and unemployment such that more of one necessarily means less of the other) caused policymakers to accept more and more inflation in the hope of controlling unemployment. Once inflation inevitably got out of hand, interest rates skyrocketed, bringing high unemployment. This was the era of stagflation. The Phillips Curve was a dead letter, and many economists threw up their hands.
But the Two Giants, Reagan and Volker, had an plan. They would kill inflation through tight money (also suporting the dollar), and that, along with tax cuts and regulatory reform, would drive down unemployment. By the conventional wisdom of the Phillips Curve, this was an absurdity and bound to fail. But Keynes' aggregate demand model had some big holes in it, which the Two Giants recognized. First, Keynesian stimulus is effective only to the degree to which it is unexpected: to the degree markets see it coming, they learn to discount it in the form of higher interest rates. Second, the Keynesian model took no cognizance of the notion that perhaps government spending might be tinged with cronyism and other assorted inefficiencies that would undermine stimulus. Third, and most importantly to President Reagan, the Keynesian model took no cognizance of the role of incentives in economic life. Very simply, if you let people keep more of their money, and hassle them less, their appetite for risk will increase, as will overall economic activity. That this truism is even debated astounds me.
All of this seems common-sensical, and the results spoke for themselves. Yet these principles have been fought savagely, including by our current president, against all reason. Why? Simple. Ronald Reagan spoiled their fun. More money for tax payers and risk takers means less for "community organizers" to work their wonders. To the extent you put your faith in "economic activists", and the dreams of energetic people, you implicitly devalue the "contributions" of community organizers, government planners, social workers, political staffers, and the like. You've just told a lot of do-gooders that you don't think they do much good. Ouch!
To stand up against this type of entrenched interest, and to do so knowing that your approach would bring a brutal recession before causing the country to emerge much stronger than ever, is the definition of political courage. Current "leadership" could learn a lot, but won't. For reasons I'll delve into in the near future, our current president is constitutionally incapable of placing his faith in the dynamism of the American people. He will bitterly cling to the flat-earth creed of government knows best. He will be a failure.