Saturday, September 6, 2008

Using economics to talk policy

A few years ago I took a course called "Economics of OECD Countries" with a wonderful teacher, Gavin Cameron, who sadly passed away recently. It was really an economic history course; we took a few big, general, flexible models from macroeconomics and used them to talk about the last hundred years in the rich countries of the world - the Great Depression, oil shocks, the 'Golden Age' of growth, the rise of computers, productivity. It wasn't an especially politicized class, just nuts and bolts economics, but I'll be forever grateful not just for learning a bit of history but for learning that a little model goes a long, long way.

For instance: the BBC website had a piece a while back about the presidential candidates' economic policies with this passage:

Mr McCain has endorsed "supply side economics", calling for more tax cuts for business to boost economic growth and sharp cuts in spending programmes.
Mr Obama, on the other hand, wants more domestic spending, particularly on health care, and has indicated that he is not averse to higher taxes on the rich to pay for it.

Again, I'm not going to start analyzing policy, but I really like - no sarcasm here, I promise - that the same debates that have cropped up again and again through the history of economic policy as an actual thing are still here. A crude characterization would be to call Obama Keynesian, on the strength of what the article is saying; it's the famous injection of spending by the government to try to prop everything up, the great policy success of the original Keynesian era. That was the one that dragged America out of the Great Depression. 

Or did it? Surely a bold stroke to open the government's wallet when the whole country is broke, but, of course, there's plenty of wiggle room for debate. One of the many things we talked about in our course was the role of war spending in providing a natural bounce out of the Depression. Same concept, different reasons. 

McCain's being painted in the BBC article as a supply-sider, which is something of a dirty little epithet around the Dem-leaning economics faculties of the world. Paul Krugman made his journalistic bones (as opposed to his impressive academic record) with "Peddling Prosperity", a big chunk of which was devoted to a critique of what came to be called supply-side economics. Perhaps I'm reaching a bit here, but you could plausibly argue that supply-side policy grew out of monetarism, which was itself the big weapon against the oil-shock driven recession of the 1970s. Keynesianism versus monetarism was the big debate in economic policy, and it lives still into the 21st century.

As a teacher, the beauty of these debates is that they don't need fancy techniques, or math, or number crunching, to be explained. Naturally some of the academics who've spent their careers on policy questions are doing very complicated things, but to explain - in simplified form, but correctly - what was driving the problems of the 30s, the 70s, or whenever, and the logic behind the policies that were tried, is easy. It takes a bit of clear reasoning and is even easier if we are willing to use a few simple diagrams, both commodities that go a long, long way in economics. It's possible, even, to boil the whole mixture off to a supply-and-demand story. Don't roll your eyes, though: there's a reason why that's the most famous, most reproduced little model in economics, and how awesome that we can use it to talk about the biggest policy issues of the last century.

Many economics courses are 'tooling up' courses, where you learn those models, the diagrams, the math; what is even more crucial are those courses like the one Professor Cameron taught me, the ones where we use those tools to think about interesting things. It's truly staggering how simple the tools are that we used, truly gratifying to learn how far even the simplest little insight can go. 

1 comment:

bill greene said...

Economics and the KISS Principle

I agree that economics can be kept simple and the laws of supply and demand do explain most of the fundamental principles. It is essential to remember that "economics" is merely the attempt to summarize what real people are doing in the marketplace--and that those peoples' motivation, their freedom to act, and the supply constraints in place, determine outcomes. The cardinal rule for economists should be to interfere minimally with those participants actions

Acadenic economists have come to rely on excessive abstractions that confuse the realities of the marketplace. That is why the case method--looking at actual situations and results--provides the best insight into how markets work.

The biggest case studies in history can be easily examined to derive some over-riding conclusions to guide our thinking:
I have examined the "laboratories of history" such as Phoenicia, Greek city states, Italian Renaissance cities,the Hanseatic League, 17th Century Holland, early American history, Hong Kong, and Singapore and found that economic freedom for at least a majority of citizens "allows" or "enables" progress--because it unleashes the initiative and energy of many ordinary people whose motivations are to attain affluence.

There are many case studies of the opposite environments where stagnation, low mobility, and little free enterprise limited affluence to just the elites at the top. Indeed, such stagnation dominated almost all nations throughout history--In such cases, progress was estopped for the following reasons: the autocratic rulers never allowed the common people to act independently, the elites seized the fruits of their peoples' toil destroying any motivation among the citizenry to be efficient, the religious and/or philosophical culture stressed obedience and order rather than innovation and change, or the elites imposed such heavy regulation, central controls and oppressive taxation that enterprise was stifled by the resdulting burden imposed on individual action.

These historical principles led to the common proverb that the government is best that governs least. However, there are numerous government functions that are essential to empower all members to enter and contribute positively to the economy. These have to do with maintaining a just and equitable legal system to protect contracts, property, and resolve disputes. Regulation and prosecution is needed to minimize abuses that distort "the level playing field." But government policy should always be judged by whether it encourages or discourages the security and free activity of the participants--the millions of producers and consumers who make it all work.

The biggest failure of economists is the arrogance that comes from reliance on abstract theories. It is not clear that their obsession with controlling the money supply, or interest rates, or foreign exchange rates,has helped or hurt over the recent half-century. Certainly the recurring bail-outs of bankers and borrowers alike has created injustices and rewarded irresponsible behavior. The complexity of the tax code and governmental subsidies has distorted economic behavior, punished thrift, and rewarded aberrant behavior. So-called punp priming through increased government spending has encouraged spending for its own sake and usurped the private sector. It can be generally expected that those funds not taken from the people by the government will be spent more wisely by themselves than by the government administrators.

Economists would do well to heed this postings cautions and consider the impact of their policies on what counts: the individual motivations of the people, the laws of supply and demand, the frequency of undesirable unintended consequences whenever government acts, and the importance of minimizing any obstacles to individual enterprise.