President Obama gave one excellent speech yesterday explaining the economy and why he is doing what he is doing – and a statement today about overhauling the tax system to make it fairer. For those who never took economics and just don’t get it (like the so-called ‘tea baggers’), here is a short lesson on the difference between the two opposing theories of economics and why one really works better than the other:
First and foremost, economic ‘equilibrium’ is always the goal.
Under the very pragmatic Keynesian theory of economics, government spending is done with an eye to restoring and maintaining equilibrium. Once equilibrium is achieved, government should recapture enough money, through some taxes on the increased economic activity, to pay back the treasury and have a cushion/surplus for the next downturn.
In his 1981 book, Reaganomics: Supply-Side Economics in Action, Bruce Bartlett opens with a discussion of Say's Law: “The essence of Say's Law, named for the French economist Jean Baptiste Say, is that goods are ultimately paid for with other goods. Thus, production limits the satisfaction of human wants, not the ability to consume. Jean Baptiste Say, in 1803, argued that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we see that production alone furnishes those means. Thus, it is the aim of good governments to stimulate production, and the aim of bad governments to encourage consumption.”
Say's Law was the cornerstone of economic theory, until mortally wounded by John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest and Money. One of the most important ideas of 20th century economics was Keynes demonstration that Say's Law does not hold true for large economies. Jean Baptiste Say argued that economies will right themselves and find equilibrium without help. Keynes showed that all too often an economy rights itself only by sinking to the bottom.
Yet, Republicans, through Reaganomics, hold onto Say’s theory as if it were God’s Truth.
The idea that an economy can only stabilize after a severe crash to the bottom was Keynes’ reason for publishing his book about government spending during a downturn. Keynes observed that "one man's expenditure is another man's income." This means if everyone stops buying, there will be fewer jobs, less income, which means less buying, which means even more incentive for businesses to wait for cheaper labor and production. In a deep recession, or a depression, prices never seem to fall enough to get the economic engine going again. That is why the huge amount of government spending for WWII is what pulled us out of the Great Depression. It takes large amounts of government spending to pull us out of a deep downturn. This is why Roosevelt’s work programs were only partly effective; the spending was not of sufficient magnitude.
When disequilibrium takes hold, it is necessary for the government to stimulate the economy and bail out the economic engines (banks, mortgage companies, etc). This must include providing relief to people who made bad decisions. Since it is impossible to go through and decide on a case by case basis whether a person made a risky, but reasonable, decision, it is better to set rules that the majority finds reasonable, and then have relief even for those who might have been outside those boundaries. Government must provide restructuring, basically forgiving sins and wiping the slate clean. This usually means helping everyone so that while people might lose all or most of what they have, they are not so wiped out economically as to be out of the game entirely. Those who are out of the game are the source of an economy spiraling downward.
The policies of the Republicans have been pro-cyclical. Republicans run deficits when times are good, throw fuel on the inflation fire, and create bubbles that people can chase. Pro-cyclical policies, liberals have been pointing out, are unsustainable, because when crisis comes, counter-cyclical action will be needed. This is why hearing now from people who are concerned about running up the deficit is insane. Where were they when it was time to reduce deficits and build up a surplus during the last administration? Many were calling for further tax cuts to return money to the taxpayers (meaning the rich).
We are not in a typical down cycle – we are presently in a “reset” mode.
As progressives call for broader action to remove the sources of disequilibrium from society, the wealthy just want someone else, not themselves, to pay for the cost of having the instability removed, and then they want to have things go back to the way they were before. But it isn't enough just to get back to where things were before because the way things were before was what created the mess in the first place. But giving tax cuts to the wealthy does not work because the wealthy will mostly buy unproductive labor. That is, they will buy things like expensive art, gold, land, high priced items, or buy out competitors and put them out of production. They may employ a few more servants and other forms of labor which does not help to increase the wealth of society. Thus, according to Keynesian economics, that is why tax cuts do not work. When an economy needs a stimulus, government is a better "buyer of last resort" than the wealthy because the money is spent where it is needed.
The key to government spending during an economic collapse is to divide it into very different kinds of spending. One is to just keep citizens from going bankrupt and not being ever able to participate in the middle class again. The second type of spending is restructuring. If government did not spend at this time, we could not bring about equilibrium, as economist Paul Krugman pointed out in his "Depression Economics" editorial in the New York Times, because the result is a downward spiral that will destroy economic trade within the country and around the world.
Federal Reserve Chairman Ben Bernanke told lawmakers recently that massive government spending and bailouts are necessary to revive the economy because when people and businesses pull back someone has to fill the void or the economy goes straight into a very deep depression. Government is the only entity that can do this on a large enough scale. He made this statement even though he shares the concern about aid for ailing companies like AIG. Bernanke said, "We are better off moving aggressively today to solve our economic problems. The alternative could be a prolonged episode of economic stagnation that would not only contribute to further deterioration in the fiscal situation, but would also imply lower output, employment, and incomes for an extended period."
To put it simply: it takes money to make money.
Our economy was circling the drain when President Obama took the oath of office. After the Federal Reserve's unprecedented moves to aid the financial sector, and after the stimulus package has started to filter down to cities and counties, Fed Chairman Ben Bernanke said yesterday that the programs are having the intended effect of lowering the cost and increasing the availability of credit to American consumers and businesses. And if you ask why people are still losing their jobs – it’s because unemployment is a lagging factor. The banks and stock market always turn around first; then the general economy begins to get better – then last, always last, employment begins to increase.
The Tarp is beginning to work. Two banks, Wells Fargo and Goldman Sacs, have announced that they are now able to begin paying back the money. Most states have set aside plans to lay off teachers and policemen for the next year.
The Congressional Republicans and followers, some ‘conservative’ Democrats, and Fox News just do not get it. It’s time to send them back to school for Economics 101.