By Michael Baxter 20 Jul 2010 [3 Comments | 5,739 views]
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Two words, that’s all that’s wrong. The FT is running an excellent series at the moment in which various world renowned economists argue either for or against cutting fiscal deficits. Of course, what we are seeing in the FT is no more than a reflection of a much wider debate running in pubs, bars and cafés across the developed world, and maybe much of the developing world, too. The debate is very interesting, but it misses an all important point, a point that can be summed up in two words.
What are these two words? All will be revealed. Today we take a somewhat optimistic view, and look deep beneath the economic surface.
The debate itself seems to be focusing on a handful of points.
This morning in the FT, Brad DeLong, economics professor at California Berkeley, and one of the top economists in the world at the moment, and Niall Ferguson, the well-known economic historian, made their arguments.
To summarise DeLong’s argument, he says the problem today is that much of the wealth being generated across the world is being wasted. Too much money is being pumped into financial assets, meaning insufficient demand for the production of goods and services, hence we get recession. He argued in favour of fiscal stimulus, in which the government borrows money and spends it; monetary stimulus, in which central banks create money; and banking stimulus, in which governments attempt to soak up bad debts that could otherwise crush banks across the world.
Niall Ferguson argued that the big problem with policy lies with expectations. Thanks to the massive scale of government borrowing, we expect taxes to rise, and therefore for every dollar the US government pumps into the economy, consumers and business take a dollar back. In other words, governments run up huge debts and achieve absolutely nothing.
Those who are in favour of big fiscal stimuli talk about the Second World War, and how governments ran up huge debts, but an economic boom followed. The Second World War was, from an economic point of view, like a kind of Keynesian policy by mistake. It seemed to work. Therefore, goes the argument, why can’t it work today?
Ferguson argued that the war-time conditions were different. Much of the US fiscal stimulus today is benefiting Chinese exporters, and much of US debt is funded from abroad, whereas during the last world war it was funded internally.
One economist who is especially celebrated for his anti-stimulus views is Robert Barro, an economics professor at Harvard. His argument focuses on what economists refer to as the multiplier effect of government spending. The Obama regime reckons this is around 1.5. In other words, for every dollar the US government spends on an infrastructure project, the economy gets a $1.50 boost. By contrast, Barro reckons government spending crowds out the private sectors such that, actually, the multiplier is more like 0.8. Or, for every dollar the US government spends, 20 cents is sucked out of the economy.
The likes of Barro argue that the best form of stimulus comes in the form of tax cuts. In this way, the incentive to work harder and create wealth improves, which in turn leads to higher GDP, meaning government finances can actually improve. The Keynesians might retort that the trouble with tax cuts is that the beneficiaries of these cuts may not spend their extra net income, and instead may save it. Therefore, argue the Keynesians, better for the government to spend the money on our behalf, or if it does enact tax cuts, to ensure they are aimed at poorer workers who tend to save less.
Others take this argument to the next level, and say the key to dealing with a recession is ensuring those who lose work receive generous benefit payments, thereby ensuring demand across the economy stays high. To which the other side of the debate respond by countering that unemployment benefits damage the incentive to work. The extreme anti-stimulus camp, also called Austrian Economists, argue that unemployment benefit is what causes recessions. Remove it, and minimum wages, then in a recession the cost of labour will simply fall to a level at which it becomes profitable to start recruiting.
On the other hand, never lose sight of the fact that economic growth is a new phenomenon. Before 1820 it barely existed. (Angus Maddison is the definitive source for the history of growth, if you want to know more.) Economic growth is like a fragile coating, beneath which is a seething mass of economic myopia. So, it is all very well the Austrian Economists saying that if we had a free market we wouldn’t have a recession, but how can they explain why it is that economic growth is so new? It is possible that the two key factors that provided the foundation for the last two hundred years of such spectacular economic growth were the union movement – which promoted higher wages, leading to higher demand – and a banking system based on debt.
But maybe the debate is missing something.
What it misses is the fundamental factor driving the economy. At the moment, demand seems to lag behind potential capacity. Why is this?
The answer could be summed up by two words: ‘Moore’s Law.’
In this context, Moore’s Law is being used as a kind of metaphor for any form of rapid change in technology, and not just in its literal sense of referring to computers doubling in speed every 18 months or so.
Here are two examples of Moore’s Law in the context being used here: the Internet and genetics.
How is it possible for the Internet not to change the global economy in quite profound ways? There are two major advantages, at least from an economics point of view.
First of all it promotes trade and specialisation, which economic theory tells us are key to wealth creation. (By the way, the Net may be the single most important factor in driving globalisation, too.)
Secondly, by promoting communication between scientists and engineers, it promotes innovation.
So that’s the Internet. Now, turning to genetics, just consider what Craig Venter did this year. He created synthetic life. As Venter said, it is the “first self-replicating species that we have on the planet whose parent is a computer”. Now, just like with the Internet, there are lots of dangers in genetics. But consider the opportunities. Advances in genetics could ultimately lead to cures for heart disease and cancer, could permanently solve the energy crisis, and could be used to create an abundant source of food.
With new technology we tend to make two mistakes. We tend to be over optimistic about the effect it will have in the short run, and overly pessimistic about the long-term effect.
The dotcom crash illustrates our short-run optimism perfectly.
Maybe the current crisis is in part down to our tendency to underestimate the long-term effect.
The dotcom com crash made investors, the media, economists and the wider public cynical about the Internet’s economic value.
The Internet is now at the level that in the days of the pre dotcom crash, markets were looking forward to eagerly. It is creating wealth.
There are parallels with the 1930s. The 1930s followed a period of remarkable technical innovation, from dynamite, the mass use of electricity, the telephone, motor car, penicillin and mass production, and yet the world hurtled into economic depression.
Technical innovation is often followed by recession. New technology can make old jobs obsolete. Profits tend to flow to capital, bypassing labour. During such a period, demand lags way behind potential supply. The last time we were in such a position, it took a world war to rescue us.
This time around, the solution seems as elusive as ever.
But maybe the Internet can do it again. Just as the Net may make some jobs obsolete, because of the remarkable pace of communication it promotes, it can create new jobs and create new opportunities just as fast as it destroys old ones.
In such an environment it is important that demand is kept high, that the money supply grows, and the labour force is flexible and well educated enough to embrace the new opportunities that emerge.
If policy makers cannot provide the policies that promote the above environment, then everything else is irrelevant.
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The growth that has endured since the mid 1800’s is down to fossil fuels. Throw a spoonful of sugar into a Petri dish, and watch the buggers grow. Now we’re near to the end of the sugar rush.
But hey,what a ride it was
An interesting argument, but it seems to beg the following question. If Moore’s Law has been wrongly left out of the deficits debate then, were it to be included, whose argument would it support? You say the Law suggests that demand should be kept high, money supply growing, and the labour force educated and flexible. But both sides of the ‘spend or cut’ debate would, I think, say that theirs is the right recipe to obtain these outcomes over time.
So how do you think Moore’s Law actually impacts on the big immediate questions over deficits? I doubt that you really mean us to accept your final remark that ‘everything else is irrelevant’. Everything? Including whether we do or don’t borrow another £100 billion?
David
I don’t think government spend per se is required for further technical innovation. But rising consumer demand is essential. Saving, especially when the money being saved is not invested in business, but instead is thrown at bonds and gold, is counter-productive. The Keynesian theory behind government fiscal stimulus is that in an economic depression, our natural inclination is to save more; but high savings can make the depression worse. Therefore, the government should borrow money and spend our savings on our behalf.
The snag is, what’s right for the global economy is not right for all countries. Globally the problem is too much saving, and not enough demand, and this in turn could stifle technological progress. But this may not be the problem for the UK.
I don’t have a major problem with the UK austerity drive. But my concern relates to the fact that austerity is being applied globally. And this could be catastrophic.