osewalrus (osewalrus) wrote,

Do Markets "Heal" themselves? Not Anytime Soon.

I continue to be appalled at how people are not looking at the economy as a complex system or understanding the time frames and costs involved here. I continue to feel that we are trapped between the Economic Christian Scientists, who believe that "confidence" (substituting for prayer and Christian readings) will cure us, and Chiurgeons who believe that what we need is more bleeding and leaches to purge the bad humors.

Part of this, of course, is motivated by the great philosophical division between the Chicago School and the Keynesian school: whether the economy exists outside the government and all government effort to influence the economy is an artificial "distortion" of the true underlying state of the market, or whether the the government is an actor in the market that can, and should, play a role outside the standard business cycle so as to moderate the negative impacts of the business cycle -- accepting as a cost of this that highs will be less high while lows will be less low.

But the utter ignorance of the press, political leaders, and the public turn what could be a genuine debate about how our economy should work into a series of dysfunctional half-measures that keep us in perpetual neutral.

My apologies for huge oversimplification.

There is great consternation that the jobs report shows that the recovery has basically ended and we are slowly sinking back into the natural state of an economy with fairly small manufacturing base, a real estate market that is keeping liquidity trapped and home owners paralyzed, and a consumer market in which consumers are simply unable to sustain levels of consumer spending. Mind you, the actual prediction for this month, 100,000 jobs added, was already pretty dismal (but was to be a substantial leap over last month). Instead, we have 18,000 jobs added and unemployment is continuing its slow march upward. Also of note, it turns out that last month's equally dismal job numbers were not a fluke of weather. This appears to be the trend.

What is puzzling is that no one can ever tell me why we should have expected anything different. Modest growth in manufacturing, on which we had pinned our hopes, was tapering off. Everyone knew gas prices and food prices had gone up (although inflation otherwise remained low). The decline in first time unemployment claims does not indicate job creation, simply that the loss of jobs has slowed or stopped. But for some reason, economists surveyed (and reporters repeated) that things should start improving, albeit slowly. When pressed, the only thing I ever hear these experts say is that it ought to be improving because things have "stabilized."

In other words, these experts assume the natural course of the economy is to grow. Once things "stabilized," i.e., we stopped getting nasty financial surprises that had triggered the free fall, things should get back to "normal" and the economy should grow at what is considered the "normal" rate of about 3%.

The other indicator is that large publicly traded businesses have been doing well in terms of profits, and that IPOs are raking in big bucks again. A number of people think that should indicate a healthy economy and that these businesses will reinvest this capital into productive ventures that create jobs. That is, after all, how it used to work with financial markets. Companies sold stock to raise capital so they could expand operations and make more profit.

Historically, when the federal and state governments played little role in the overall economy, the bust part of the boom-bust cycle lasted years, not quarters. The bust after the Panic of 1873, for example, lasted until 1879. Furthermore, key elements have typically come together to get the economic engine going. New technologies that change the economics of productivity, increased demand from other economies, something to break out of the status quo.

So if we have "stabilized," there is no reason to imagine that productivity will magically increase -- especially if the "stability" situation contains significant weakness such as the drag of the real estate market and underwater homes. Businesses with capital will not invest that capital unless they see a clear connection between investment and profit. But if WalMart is making money overseas, it will not open new stores (and create more service jobs) in the U.S., it will do so oversees. If Qualcomm has its production facilties in Thailand, expansion of those facilties creates jobs in Thailand, not the U.S.

Keynes' theory was that the government, as an actor with unusual powers and interests outside the business cycle in positive ways. Government had the power to stimulate the economy when the business cycle stalled. Government could print money and act as a purchaser of goods and services to provide other people with money so that they could purchase additional goods and services. In addition, government could directly prohibit the most risky activities by which a handful of actors could crash entire sections of the economy. The government could also take steps to reduce panic in times of emergency, thus ensuring that capital did not flee the economy precisely when needed most.

Also critically, government could redistribute wealth to avoid unhealthy levels of wealth concentration. When wealth is concentrated, it is not productive. Individuals, no matter how great their personal excess, have a limited capacity to spend money that cannot compare to placing the same money in the hands of a much larger number of people. One person with $10 million can produce some very impressive individual economic activity, but 1 million people spending ten dollars each is likely to be more productive for the economy as a whole. Of course, all this must be tempered with the need to create sufficient economic stability to encourage long-term investment and our general principles of equity and ownership of property. But from the perspective of "what can government do to keep economic activity going," progressive income tax (those with more wealth pay more as a percentage, not just in absolute terms), estate taxes, and other "progressive" taxes that allow government to fund the purchase of goods and services, essentially transferring the money to a much larger number of people with much lower income allowing them to put that money into productive economic use.

In the 1950s and 1960s, a number of criticisms of Keynes emerged. Some had to do with the ability of centralized decision makers to make appropriate economic decisions. Concentrate economic decisionmaking in the government, argued Hayek, and you maximize the negative impact of bad decisions. In addition, we saw the rise of the argument over the "real economy." Championed by the University of Chicago School, the idea went beyond Hayek's criticism that government would inevitably make bad decisions (since all decisionmakers inevitably make bad decisions) to the idea that government efforts to counteract the natural business cycle were inevitably bad. In this view, economic forces are like physics. Activity is naturally efficient or inefficient, and markets naturally gravitate to the most efficient outcomes. Government efforts to alter this cycle are as fruitless as efforts to prevent the tides from coming in, and more dangerous. The longer the government interferes with the "natural" efficiencies of the market, the worse the inevitable backlash will be. Attempts to use Keynsian mechanisms to encourage the market to go where it is not naturally going will only "distort" the market, leading to "arbitrage" by those who can bridge where the government is dictating that the market go and where the market naturally wishes to be.

Although modern economics has moved on from the stark choice between Keynes and Chicago School, the essential philosophical choice between these approaches still animates policy. And, in policyland and punditry, the University of Chicago has achieved an utter mastery. But neither policyland or punditry want to accept the consequences of embracing the Chicago School approach. Under the Chicago School theory, if the market is heading to collapse, then that's where it needs to go. The only thing to do is ride out the bad times and wait for the market to start growing again in response to whatever "natural" stimulus will cause growth. This was essentially what the IMF and World Bank told developing nations to do in the 1990s. Suffer through the economic collapse and then the good times will follow when you rebuild. (Curiously, the economies leading that growth did not use pure U of C "self-healing," but relied on a mix of government policies and market mechanisms. Brazil being the most obvious example.)

So Policyland and Punditry invent all sorts of reasons why things will recover in quarters instead of years. The Confidence Fairy will spur us to invest. We must reduce the deficit to purge the bad humors from the economy. Above all, the federal government must take no steps that would "distort" the market and prevent it from healing itself.

Eventually, I suppose, the market will heal itself. Just as it has done after previous busts in the business cycle. But i would not look for relief any time soon.

  • Post a new comment


    Anonymous comments are disabled in this journal

    default userpic

    Your IP address will be recorded