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Thursday, January 01, 2009

"When the Normal Rules are Turned Upside Down..."

Samuel Brittan:

The problem with all this economic doom and gloom, by Samuel Brittan, Commentary, Financial Times: ...I cannot claim to have foreseen the financial blow-out. But I did warn in my column of February 1 2008 of the danger of talking ourselves into a depression... President Franklin Roosevelt put it more elegantly when he said: “We have nothing to fear but fear itself.”

The most alarming feature at present is the fatalistic public mood. ... All the popular talk is of retrenchment, cutting down and spartan savings of all kinds. It should not take a genius to appreciate that such activities can only make the situation worse and aggravate a downward vicious spiral. I would be the last to argue that people should spend recklessly for patriotic reasons, but nor should they stint themselves.

A slump is a tragedy for those who lose their jobs and also for those who fear to lose them. But it is also a logical absurdity that there should exist unsatisfied wants side by side with idle workers willing to supply them. The natural condition of mankind is one of scarcity, and conflicts are often about the allocation of scarce resources. You cannot usually have endless amounts of both guns and butter. ...

But in a slump the rule of these copybook maxims is temporarily suspended. You can have more of A without sacrificing B. You can have environmental investment without sacrificing consumer satisfaction. Indeed the slump arises because not enough is being spent. We are in a kind of parallel universe familiar to cosmologists, when the normal rules are turned upside down and the traditional prudential warnings no longer apply. ...

For what it is worth, policymaking is essentially more straightforward than it was a little while ago. Of course there are problems about the exact means by which purchasing power should be stimulated and about the relationship between fiscal and monetary weapons. But these are second-order compared with the dilemma that previously existed between fighting recession, which called for expansionary measures, and rising inflation, triggered off by explosive increases in oil and commodity prices, which called for restrictive measures. Inflation has now turned down with a vengeance...

One of the main objections to what I am saying is the size of debts governments accumulate in anti-depression spending. ... It is an exaggeration to say in a single country, as the early Keynesians did, “we owe it to ourselves”, but it is still true of the industrial world as a whole. Thus Gordon Brown, the UK prime minister, is right to argue for a multilateral approach.

A different kind of objection is that recessions are said to have a purpose. They accelerate the destruction of misplaced activities and overspeculative investment. It is what the Austrian economist Joseph Schumpeter called “creative destruction”. Yes, up to a point. But this does not justify the secondary and tertiary destruction of perfectly viable activities because purchasing power has fallen... Indeed Schumpeter himself ... suddenly panicked in the 1930s depression and urged a very large fiscal stimulus. Friedrich Hayek, who was a different kind of Austrian, distinguished in his remarks in the 1970s between inevitable recessions and a “secondary depression” caused by a cumulative loss of purchasing power throughout the economy. But there is no evidence that he made this distinction in the 1930s when he taught at the London School of Economics and was one of Keynes’s principal opponents.

There will be a time to return to the copybook virtues. But it is not yet. As the writer of Ecclesiastes put it:

“To every thing there is a season and a time to every purpose under the heavens.”

It is hard to get people who are used to thinking about tradeoffs and opportunity costs to realize that when there are idle workers, idle financial capital, and unmet needs, putting these resources to work meeting those needs does not sacrifice other objectives, it enhances them.

But let me turn to something else. In a recession or depression, measured GDP can overstate the fall in the actual output of goods and services if idle workers use the time to make needed repairs or other activities at home, i.e. they engage in household production that, because it does not pass through organized markets, is not counted in GDP statistics. Some people may sit around doing nothing much besides watching sports on TV, the consumption of advertising dollars may very well be their highest utility choice, but others may paint the bedrooms, fix the cracks in the driveway, build a deck in the backyard, etc., etc. To the extent that people take advantage of idle work time to get other things done, the fall in actual output of goods and services is smaller than the measured fall.

And there is nothing that stops the idle workers from getting together as a group and meeting community needs. They could build a playground at a school, pick up litter, build a homeless shelter, and so on. And, similarly, there is nothing that stops groups of individuals from getting together and completing private projects, a group might build the deck at one house, then move on to do something at the house of another member of the group.

Nothing to stop them, that is, except the funds to do these things - decks cost money and the person is unemployed - and the inherent coordination problem involved in such projects. How do you bring the groups of people together and get them working on the highest value projects in either the private or the public sectors?

That is where the government comes in. It serves two roles here, one is to provide the funding (and also, by offering wages, giving people the incentive to do the work instead of watching sports), but it is also important for the government to coordinate activity as well, to bring people together to work on the highest value projects in the community in whatever sector - public or private- those projects might be in. The coordination role is important and often overlooked in these discussion, recessions and depressions are times when the normal coordinating factors such as price signals break down, and public goods won't be provided by the private sector in any case. It isn't completely overlooked of course - it's part of what people mean when they argue that government needs to be careful in selecting the projects that will be pursued with public money - but that discussion is generally stated in efficiency terms rather than as a need to coordinate idle resources into productive activity of some sort.

Keynesians also note that even if the government spending has zero value initially, e.g. paying half the idle workers to dig ditches, and the other half to follow behind and fill the ditches in again, as those workers spend their new income in the community it will generate productive private sector activity. Thus, even if the initial projects are of little or no value, it can still be the case that we are better off having the government intervene than we would be if we did nothing at all. The government should do everything that it can to pursue the highest value projects, but the fact that there may be some waste in the process does not, in and of itself, mean that we'd be better off leaving those resources completely idle and doing nothing at all.

    Posted by on Thursday, January 1, 2009 at 01:26 PM in Economics | Permalink  TrackBack (0)  Comments (29)


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