For Keynesians, Too Much Is Never Enough

The New York Times has an article on the “stimulus attempt” in Japan in the 1990s. The article describes two points of view: American economists who think that it partly worked, but did not go far enough, and everyone in Japan, who thinks it was a colossal waste, which they will have to repay for decades, and a waste which turned their economy into one large public works project.

The article also provides some insight into how large a stimulus these American economists think is necessary to get the economy moving. A little bit of math shows that their target size would be even more massive than anything we’re currently debating, and would cripple the economy, not stimulate it.

The article explains:

After years of heavy spending in the first half of the 1990s, economists say, Japan’s leaders grew concerned about growing budget deficits and cut back too soon, snuffing out the recovery in its infancy, much as Roosevelt did to the American economy in 1936. Growth that, by 1996, had reached 3 percent was suffocated by premature spending cuts and tax increases, they say. While spending remained high in the late 1990s, Japan never gave the economy another full-fledged push, these economists say.

They also say that the size of Japan’s apparently successful stimulus in the early 1990s suggests that the United States will need to spend far more than the current $820 billion to get results. Between 1991 and 1995, Japan spent some $2.1 trillion on public works, in an economy roughly half as large as that of the United States, according to the Cabinet Office. “Stimulus worked in Japan when it was tried,” said David Weinstein, a professor of Japanese economics at Columbia University. “Japan’s lesson is that, if anything, the current U.S. stimulus will not be enough.”

If Japan’s economy is half the size of the American economy, then these economists would suggest that we spend at least $4.2 trillion over four years, or more than $1 trillion per year. To not “cripple the stimulus in its infancy,” we’d have to sustain this for significantly longer than just four years. Deficit financed public works costing more than $1 trillion per year, over, let’s say, eight or ten years – this is supposed to stimulate the economy? This would obviously cripple the economy! When spelled out like this, it is hard to imagine any economist seriously suggesting that America should, or could, borrow that kind of money and create that kind of long-term public sector employment.

Instead, it seems that Keynesian economists are simply running out of excuses as to why previous experiments in spending “stimulus” plans have failed to produce good results.

Tried and Failed Policies Resurfacing as Stimulus

(Cross-posted in part at Heritage)

The “cash for clunkers” plan recently proposed in Congress would provide subsidy for a new car purchase to anyone willing to have their current car destroyed. But the economic rationale is eerily similar to the New Deal program most widely agreed to be a catastrophic failure: his agriculture plan that slaughtered pigs. The reasoning goes like this:

Crushing the old car has two benefits. First, it ensures that the consumer's purchase of a more efficient vehicle actually has a net environmental benefit. Second, it prevents a glut of used cars on the market, which would reduce trade-in values for new car buyers, which would cut into the sales incentive effect.

This was the same misguided reasoning that led to the slaughter of six million pigs and plowing under of about half the crop area under cultivation. The head of the Agricultural Adjustment Administration argued that:

People who believe that we ordered the destruction of food are merely the victims of their prejudices and the misinformation that has been fed to them by interested persons. What we actually did was to stop the destruction of foodstuffs by making it worth while for farmers to sell them rather than to destroy them.

In other words, the destruction of crops and livestock would ultimately lead to less waste because prices would be lifted, and so farmers would have more incentive to produce. However, despite vigorous defense by the administration, it is now known that most of the meat went to waste and it was an abysmal failure. Government cannot do a better job than the market in setting prices, and government’s destruction of output will never lead to increased output. It was a failure of economic reasoning – which is now coming back in vogue.

Another failed policy being considered is the mandate to buy American:

The stimulus bill passed by the House last night contains a controversial provision that would mostly bar foreign steel and iron from the infrastructure projects laid out by the $819 billion economic package.

This policy is almost precisely the one put into force during the period of railroad subsidies. According to The Myth of The Robber Barons, transcontinental railroads receiving subsidies had charters that required they only buy American-made steel. But American rails, made with American steel, were of lesser quality than some foreign brands, and this drove their maintenance costs up. This was one of many reasons why subsidized railroads performed extremely poorly compared to private ones.

Yet, here we are again using subsidies that distort incentives, and adding to the problem by passing mandates that will drive up costs and produce inferior products. This new “hope and change” we’re seeing is simply a return to the failed economic reasoning of the New Deal.

Obama Invokes Keynes and FDR, and Promises a Return to Central Planning

(Cross-posted at Heritage)

While he spoke about moving forward, and promised change as we look toward the future, in fact President Obama’s inaugural address was firmly entrenched in discredited policies of the past; policies that never worked.

For example:

Now, there are some who question the scale of our ambitions — who suggest that our system cannot tolerate too many big plans. Their memories are short. For they have forgotten what this country has already done; what free men and women can achieve when imagination is joined to common purpose, and necessity to courage.

His words here are very reminiscent of Roosevelt’s words at the start of the Great Depression. But, our memories are indeed short, if we forget that Roosevelt’s plans were actually huge failures.

Next, Obama invokes J. M. Keynes to support his call to planning, once again invoking a discredited idea from the past:

What the cynics fail to understand is that the ground has shifted beneath them — that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works — whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified.

Keynes argued that the inefficiency of government spending compared with private spending did not apply during periods of recession. He reasoned that when the economy was not at full-employment (i.e. during a recession) government was “better than nothing.” Government could inject the economy with money, by borrowing and spending it, and put the unemployed to work.

Of course, even if borrowing is helpful during these periods, it could still be spent privately (with tax cuts). So, Keynes had to argue that tax cuts are too slow, and that people saving the money, as they might do when given a tax cut, is not as good as government spending the money. However, Keynesian theories have not been supported by reality, and his proofs have long ago been abandoned by economists. Yet, Obama is embracing this new trend toward the past.

Finally, Obama promises that the programs that work will remain and those that fail will be discontinued: “Where the answer is yes, we intend to move forward. Where the answer is no, programs will end.”

Supposedly, this is a major difference from the past – when, apparently, government cared less about whether the programs were working. Of course, it is rare that a government program is ever ended. As Reagan put it, “There is nothing more permanent than a temporary government program.” It is also impossible to know whether a program is “stimulating the economy.” Those that benefit from them can make this known to all, but those that suffer cannot know or prove that it is the program that makes them suffer: the damage is indirect because it caused by high taxes, the crowd-out of private business, and so on. So, a true cost-benefit analysis of any given program is impossible.

Obama has promised nothing more than a return to the 1930s; to the old discredited economic theories and the old discredited policies of central planning.

A Collective Delusion

Pete Boettke, over at AE, posted about the Keynesian legacy. I have some thoughts on that, in particular, I agree that belief in those models represent the economists' collective delusion. I question why we have fallen for them - for private joy or public purse - and I fear that our policies are still colored by them.

I fear that economists have a herding mentality that grasps onto popular figures and then economists cling to the models of these "brilliant" chosen ones. But those who are chosen are not brilliant, they are only popular -- they generally have, like Keynes or Marx, gotten the ear of government. They come up with simplistic models that are easily used to churn numbers or explain phenomena, even though a child could see right through them.

When I took intermediate macro we used Mankiw's book. It was filled with Solow, Keynesian AS/AD, phillips curve, and on and on. I could barely believe that it was for real. None of it made any sense, none of it had any microfoundations (read: basis in reality).

I spent class time with a horrified gawking stare frozen on my face, wondering about the future of mankind if these were our leading economists, and asking the most basic of questions ("If savings is what drives growth according to the Solow model, then wouldn't communism work just as well or better than capitalism? Where are policies and institutions in this model?") and get answers such as "Well, this is just to simplify and explain the basics. Those details can be added later."

And I would be left wondering, about Solow and Keynes: who decided that the aggregate level of saving is more important than whether an individual, or a collective or government owns that savings? Who decided that aggregate investment is more important than whether it is private investment or investment by government in make-work programs? Doesn't it matter if the economy is split 90/10 private or 50/50 private or 10/90? When these models were being made economies spanned that whole spectrum, and yet these guys did not seem to think it mattered who was consuming resources - government or private consumer - who was investing or saving, just so long as the aggregate totals fit into the equations and made them balance nicely.

There were other problems - contradictions about what was better, savings or consumption? and so on - but the idea that private and public spending could be considered equal after the experiment with socialism and the interventionist state was well under way was just crazy. How could anyone think these models were useful at all? These seemed like child's play, fantasy, mind candy maybe. But not important, not something economists or policymakers should be using.

Why would economists fall for these models? And perhaps even worse: why do so many economists still cherish them, and hold them in esteem? What is this collective delusion? Is it that they love the "logic game" of it? Or is it the political clout they love? If they feed politicians with what they want to hear, they will be famous and win a Nobel -- isn't that better than being a no-name who sticks to reality? Isn't it more fun to make convoluted logic games, and be out in the public square?

Clearly for personal gain it is better for economists to engage the delusion. But this kind of absurd modeling still finds voice, and still drives our policies: "President-elect Obama's economic team is counting on investment in America's wind energy infrastructure to create thousands of jobs in a wide range of industries and help preserve existing jobs in other areas, particularly manufacturing."

Our government officials must "create jobs" by subsidizing or publicly providing work in specific targeted sectors. This will spur consumption (aggregate demand) and prevent collapse. This is all based on aggregate factors, and entirely devoid of microeconomic factors. We're also planning on propping up sectors despite their paying 3x normal salaries, by taxing regular workers, without concern over the need for the industry or the company to fail if it isn't profitable. We prevent jobs from "going overseas" as if trade is a bad thing.

Have we learned nothing about the failure of these models? Is this all political, is it useless to appeal to common sense?