The anti-stimulus argument

Why Keynesians should think again

In 1965, Milton Friedman, the scion of right-wing economics, famously declared, “We are all Keynesians now.” If he were alive today, Friedman might add, “And we are all Keynesians still.” The view of mainstream economics (and myself) is that the United States is suffering from a lack of aggregate demand, and the solution to our economic woes is economic stimulus, i.e., some combination of tax cuts, government spending, and an expansion of our monetary supply.

Still, if Friedman were to make his statement today, “we” would have to be a much more limited pronoun than it was back in 1965; while most economists are Keynesian, most of the Republican field is not. George W. Bush began and ended his presidency with major stimulus bills; his 2012 doppelganger, Rick Perry, regards stimulus as little more than a political parlor trick to pass present pain on to future generations.

It’s hard to dismiss the non-Keynesians out of hand; economics is not a field where alternative hypotheses can be thrown away so lightly, since empirically proving anything is difficult, if not impossible. We can’t even say for certain that the first round of stimulus actually created any jobs; estimates of the stimulus’ impact, such as that of the Congressional Budget Office, rely upon models that take Keynesian dynamics as a given.

Perhaps it’s worth asking, “What is the non-Keynesian explanation of our economic situation, and what are its policy prescriptions?” Here is one such answer:

From the Desk of Arthur B. Supplysider

Keynesians want us to believe that there’s some economic switch out there, and if we toggle it, we’ll go back to how things were before the crash. The truth is, this is the new normal. Our pre-crash economy was an illusion. We vastly overestimated our own productivity, and made that self-deception feel real by living far beyond our means. Our current estimate of our productive capabilities, derided as “recessionary,” is much more realistic — why should we think that there is a larger economy to rebound to? Our educational system has been stagnant for nearly half of a century. Of the resources available to us over the past decades, we’ve invested only a vanishingly small fraction for the future, choosing to consume rather than save. And of what we’ve decided to save for the future, large chunks of it have been misallocated — most recently we put trillions of dollars worth of labor, capital, tools, and material into the creation of houses rather than factories, tools, machines, training, and so on. It should come as no surprise that, having eaten our seed corn in previous years, we go hungry today.

Of course, any claim that this is the new normal must give some explanation of why unemployment is so high. After all, a high unemployment rate suggests that we could be producing much more than we currently do, simply by putting the job seekers back to work. So why are people out of work, and what would be the effect if they were put back to work?

With a realistic assessment of our productivity comes realistic wage offers from the free market. Were the unemployed put back to work, they would receive a good deal less in compensation than the inflated amounts they received before the crash. They haven’t taken these low-paying jobs for a variety of reasons — perhaps their reservation wage (the wage that is just high enough to convince a person to work) is higher than their new market wage, or employers are statutorily barred from offering accurate wages.

What then is the policy solution? On the unemployment front, the policy needed is the exact opposite of what the left recommends. They call for increased unemployment benefits, but such benefits raise a worker’s reservation wage. They call for debt forgiveness, but such moves would only remove impetus to choose labor over leisure. They support minimum wages, but such regulations only serve to bar job-seekers from obtaining employment.

On the GDP side of things, the way out of the hole is simple: invest more, and invest it wisely. Keynesian proposals to fix the economy only compound the problem. “Stimulus” is just another way to misallocate society’s resources; firstly because it promotes consumption over saving, and secondly because it takes the task of investing out of public hands and places it in those of government planners, who have a miserable record of investing wisely. A good example is the recent bankruptcy of Solyndra, a solar energy company once touted by the president himself as an exemplary model of government-supported enterprise. It now looks like the taxpayer will be on the hook for the greater part of the over $500 million loan guarantee offered by the government.

But Solyndra is only the most recent and embarrassing of the government’s misadventures in industry. Whether it involves companies such as General Motors, AIG, FNMA, or FDMC, the past couple years have seen the government make inadvisable bets with billions of scarce investment dollars. Nor does direct governmental control of the investment make matters better. Investment in transportation infrastructure, for example, is widely touted by the left wing, but in terms of return on investment, roads and bridges are nothing to write home about — in most cases, society would be better off if the resources devoted to extra infrastructure were instead left in private hands.

There is not so much of a gulf between us, supply siders, and the Keynesians — if you were to ask a Keynesian what the government should do to promote economic growth in the long term, they’d likely give you the same answer that we do: the government should improve incentives to work, save, and invest. Get a Keynesian past his cult of “short-term” borrowing and spending and you’ve got a reasonable fellow. The tragedy is that Keynesians never think they’ve gotten out of the short term. We’re three years into a recession, with unprecedented fiscal and monetary stimulus come and gone, and they’re still convinced that utopia awaits with just a push of a button.

They’re in for a rude awakening. Still, it would be better if they woke up sooner rather than later — the only way we’re going to get out of this mess is with hard work and a long view, and waiting on a magic recovery that will never come only distracts us from the task at hand.