The Clash of Economists and Cultures

 I am currently reading Keynes Hayek:The Clash That Defined Modern Economics.  The descriptions of the personalities involved adds some color to the sometimes dry ideas of macroeconomics that were debated by these two giants and that are still much in debate today. What seems missing to me in our current debate is an understanding of the limits of these ideas when they are followed in the extreme.

The default of Greece comes to mind here. While Keynes' arguments about raising demand in the economy during a downturn by injecting government spending has some merit, it seems to be oversimplified. For instance, it seems to imply that the government itself is somehow outside the economy rather than a part of it and subject to many of the same issues that industry faces; things like overhead costs, efficiency and waste, and so on. Government spending is less efficient in promoting demand than if the government were actually outside the economy since only a portion of each intended dollar actually reaches its targeted use due to these costs. This tends to offset the 'multiplier' effect of government spending that Keynesians like to promote. Also, deficit spending raises the cost of government. Government competes for consumer dollars just like business,and bigger government raises that cost. If that cost is born by borrowed money, then the interest must be paid for additional overhead and raises the cost of government still more. The Keynesians act as if it need never be repaid but Greece has demonstrated that there is a limit beyond which the government cannot borrow without setting off huge inflation. What is that limit? There is no clear definition of that but we have examples from many defaulting nations in the last 25 years (Greece is the latest, but there was Russia, Argentina, Brazil and others). The cost of government can only get so high before it, like a business, becomes too expensive and collapses. No one seems to have good handle on when that happens, but it clearly does happen.

Some have offered the idea that we need to return to a manufacturing economy, as if that were a matter of mere choice rather than a result of market forces. Many seem to think that the post World War 2 prosperity of America was due to manufacturing prowess when in fact the main impetus was the fact that the war had destroyed manufacturing for the entire developed world everywhere else. America could not avoid prospering in that environment, and we cannot return to that situation by a simple choice. We now have to compete, and many parts of the world are simply willing to work for less money, at least for now. Some who are more in Hayek's camp in favor of letting the market do its work during a recession have offered ideas of stimulating manufacturing without recognizing this reality.

Meanwhile the economists are in no position to talk about how policy changes behavior in other ways than just consumer demand for goods and services. How does it change the motivation to work? Or morality? We have seen the emergence of a seemingly permanent underclass that lacks the skills for employment even in a strong economy, and much of this seems supported by (if not caused by) a welfare society. Once that mindset is established, how does government reduce its 'stimulus' after a strong economy returns? In Europe they have shown that they cannot reduce it until crisis ensues. Our persistent deficits even in good times seem to show that government spending for welfare  as well as the exploding Medicare and Social Security costs lead not just to continued deficits but to exploding,unsustainable deficits. When do we define a 'drop dead' point beyond which we cannot go in spending?

It seems to me that the Keynesians refuse to accept that their prescriptions have limits than cannot be exceeded without severe repercussions and refuse to estimate what those limits are; the free market advocates seem to ignore that we lived in a 'rigged' market after World War 2 and are now enduring the pain of adjusting down to a level that more reflects a competitive world market instead of a rigged market in which we had no meaningful competition outside America for a generation or more. Neither want to talk about the social consequences. The Keynesians don't want to talk about the welfare mentality; the free marketers don't want to talk about the pain inflicted on people who cannot compete in a world market. Neither want to talk about the pain that lies ahead to rein in Medicare and retirement costs.

There are no easy answers. Some pain is inevitable. Historically, war has intervened in circumstances like this when the level of pain rises. War has become increasingly apocalyptic as time goes on. Let us pray it does not come to that.