Thursday, December 29, 2011

When Economic Disputes Turn Political and Why

I'm not certain what to make of disputes between top economists. I mostly get that they tend to be academicians, that is, attached to a university or employed by a government or NGO entity, or the Fed or ECB. Top-level economists weigh in on the micro level -- the way households and firms make decisions about supply and demand and affect prices and output -- or the macro level -- how whole economies, whether regional, national or global, perform and behave. Micro reflects the bits and pieces of economic behavior, while macro reflects the aggregate behavior of markets, nations, and the globe.

I also understand that economics creates or theorizes models, which help us to understand what is likely to happen if we do something. If these models are tested and they work, then they can be more or less trusted to help predict or direct certain behavior. If the models don't make sense, economists judge them to be of little or no value and abandon them.

There are also various theorems and laws that have been proposed over the years, and some make sense while others don't. Unsurprisingly, there are political and policy ramifications depending on which theorems and laws you subscribe to.

The disputes that arise have consequences for the science as well as for the way these economists can influence policy. Some have larger pulpits than others. In general, though, most politicians either don't understand economics or become one-trick ponies that rely on think tanks for their talking points. Many of these talking points are so much rhetoric or outright lies, often referred to as zombie lies because you have to shoot them in the head or drive a stake through their hearts to get them to stop. Even then, you'll hear politicians repeat endlessly expressions like "job-killing tax increases" and "class warfare against the job creators and small businesses like IBM and Bechtel." It's really irritating. Yet sometimes the disputes between professors and Nobel laureates are important, and if not important, then at least stimulating.

Two that have come up recently are the Ricardian Equivalence Theorem and Say's Law, both of which seem to be two faces of the same side of an economic argument. RET says that if a government goes in debt to finance, say, infrastructure projects to stimulate the economy, it won't work because consumers, the savvy lot they are, will not spend the income they earn from the economic activity engendered by the infrastructure projects but instead will save an equivalent amount of their income to be ready to pay the future taxes required to pay off the debt. So, in the end, it's a wash. I don't know about you, but that's hogwash. Ricardo said he was unconvinced by his own hypothesis.

Say's Law, on the other hand, dictates that if you take money from person A and give it to person B, total output is unchanged. Oddly, Say advocated public works to remedy unemployment.

Economists who have a stake in demonstrating that government stimulus doesn't work tend to buy the RET argument or the Say's Law argument. On the other hand, those who believe in government spending as a means to increase aggregate demand, don't buy RET.

I tend to align with the Keynesians, like Paul Krugman, who see government expenditures as stimulative and recommend those expenditures when an economy is in or near recession.

If the government goes into debt to create $1,000 of demand -- maybe it builds a highway system -- a worker gets $1,000 in pay, which he spends, or mostly spends, on food, rent, and clothes. At the end of the enterprise, there is at least $1,000 of economic activity generated by the government spending. If aggregate demand goes up, there is more economic activity that increases tax revenues with which to pay for the debt incurred to pay for the highway system. Let's not forget that the government, besides the wages paid to the highway construction worker, also spends money buying the materials for the project, which then stimulates the market for concrete and gravel, and so on.

I easily see how economic activity begets economic activity that then has a multiplier effect, growing, as they say, the economy. If I earn a dollar, I spend that dollar. As that dollar moves through the economy, it performs in various ways. If I spend it at Safeway, the good that I bought needs to be replaced, causing more production of that product, which leads to a portion of wages dedicated to that function. The replacement product requires shipping through the system and back to the shelf where I acquired it. This multiplier effect can be exaggerated, but it does exist.

Again, those who argue against this maintain that the construction worker will save whatever amount of his $1,000 he rationally anticipates needing in the future to pay for the taxes required to cover the cost of the highway project. This is RET.

Do you behave this way? I never have. I spend money when I have it, though I admit that as I've grown older, I also tended to save more because I wanted money around when I'm no longer earning as much. The closer I got to retirement, the less I spent and the more I saved. I behaved this way -- rationally -- because I could. People whose earnings don't exceed their bills don't save money. It doesn't matter whether they act rationally or not. They do what they have to do and end up not being able to retire. If they get too old to work, they retire in poverty.

Social Security was created to reduce the extent or likelihood of poverty in old age. Medicare was created for exactly the same reason. To reduce either of these two programs is to increase poverty in old age, whether you want to say "we've got to face reality" or not.

There are reckless exceptions to how these economic rules work: alcoholics, gamblers, imbeciles. But they are fringe elements to a system that works the way it works.

Economists whose beliefs dictate that government spending, whether financed from debt or tax increases, cannot increase or alter economic output tend to hold this position because they do not favor government involvement in the economy. Those who see an important role for government tend to favor government involvement and therefore advocate for monetary and fiscal stimulus.

Then there's the whole belief system about markets and how they behave. Those who don't favor government regulation tend to belief that markets are rational and sort out how business is meant to be transacted, requiring little or no government regulation.

Those who believe that markets are often irrational crave government regulation in order to avoid the chaos and destructiveness of market failures. Again, those on the opposite side have a greater fear of governmental failure. They anticipate government harming markets through interference and have determined that government failure is more dangerous than market failure.

This leads to some pretty crazy stuff. If I observe -- as I did -- a housing bubble promoted by easy money and predatory lending practices, I become a true believer in government intervention. I want government regulation of banks to increase, not decrease.

If, on the other hand, I made a bunch of money making loans to people who were buying houses they couldn't afford, then I'm likely to blame Fanny Mae and Freddie Mac and laws favoring minority ownership for the housing crisis because these were actions precipitated by the government and thus make the point that government intervention is what caused the housing bubble. Long after the data is analyzed and the case against the government is thoroughly debunked, the zombie myth of causality lives on because, well, just because government is the problem, not the solution because, well, because.

Anyway, all the back and forth between the Keynesians and neo-Keynesians, and the classicists and the neo-classicists inevitably reflect political differences. I'd like to think, since most of the economists are connected to the academy, that these were actual policy differences. Alas, wherever they set up shop, economists know on which side their bread is buttered and act accordingly. Except for my side -- Paul Krugman, Dean Baker, Joseph Stiglitz, et al. They're all as righteous as the day is long. Well, maybe not righteous, just right.

To drive the point home, let's hear the words of John Maynard Keynes himself:
the market can remain irrational longer than you can remain solvent.
Ain't that the truth. That is, if you're a Keynesian. I am.

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