Three Handed Economist: Introduction
President John F. Kennedy once said, “Let us not seek the Republican answer or the Democratic answer, but the right answer.” […]
Economic philosophies have meandered through the entire landscape of human thought for hundreds of years. People have sought ways to better themselves, the lives of others, and to produce goods more efficiently. From Karl Marx to Adam Smith and modern day economists, hypotheses and theories have inspired great thinkers to present their ideas and leaders to enact their will. Ideas born from the minds of great people have grown from mundane thought and inspired ingenious solutions. Economic theories have evolved from simple barter and exchange to complex monetary and fiscal interventions that are inundated with important details, tradeoffs, and as yet undiscovered consequences. Yet even with the immense number of various philosophies, we still reduce economics to three basic models, building walls around our own particular philosophy and faulting those who disagree. After feudalism, free market models ruled nations for centuries, leading to increasing wealth gaps (the wealth difference between rich and poor) that often deepened levels of poverty. Poor economic conditions motivated peasants to demand more socialized solutions and gave birth to socialism. The Great Depression changed the way every government, even the laissez-faire regimes, viewed the unfettered markets and their role in the economy changed accordingly. Mixed approaches began swaying the political landscape.
Pure, free market economics requires an unbridled trust in the incentives produced by capitalist activities. One must accept that every action of every market participant will be in their own best interest, as well as the interests of society since goods and services will automatically flow toward their highest valued use. Through market-led economic structures, all the needed information will disseminate through the system, and with perfect efficiency it will lead to accurate pricing and better rationing of goods and services. As people become wealthier, incentives drive them to find ways to improve themselves with the creation of new inventions and employment of new innovations. Entrepreneurs will emerge to search for their own riches, investing in improved productivity and employing those who were previously unemployed as they rise to their ivory heights. Capitalists argue that markets can effectively push wages and prices to their sustainable, fair, and livable equilibrium state; the business cycle will be averted as the market automatically adjusts after-shocks and distortions, and a long-run state of level growth will be achieved. The claim of the free market capitalist is that there is no need for interventions into market activities; the market will self-regulate toward the most desirable outcome for everyone. As weaknesses emerge, markets will rise to void the imperfection. So on one hand, the capitalist hand, if governments would get out of the way of market activities, natural corrections would correct distortions and push economies back toward full employment, stable prices, and long-run economic growth.
Weaknesses in market-based solutions led to the creation of socialism. Socialist thought led some to believe that market structures were not sufficient to end the plight of so many who were suffering from low wages and capitalist-led worker abuses. Karl Marx, who gave a voice to socialist leanings and ultimately inspired its extreme form, communism, believed that government-directed economies would be the only way to reduce the income gap between rich and poor and an equitable distribution of goods and services could be reached. With the assumption that average workers would be sufficiently motivated with the knowledge that they were bettering everyone equally through their efforts, Marx argued that government should control or regulate all aspects of production, thus ensuring an equal share to every citizen. Workers should unite, take over ownership of industry and farming, and redistribute wealth from rich to poor. Through increased equity in wealth, better outcomes could be attained. The greatest weakness of free market capitalism, Marx believed, is best stated by Hernando DeSoto who wrote, “The great contradiction of the capitalist system is that it creates its own demise because it cannot avoid concentrating capital in a few hands.” If the government was in control of the means of all production, then equitably and efficiently distributing the wealth of society could be easily accomplished without the need for free market activity to direct prices and employment; the emergence of magnates could be mitigated, and the gathering of obscene levels of riches to any one person or family could be avoided. On the socialist hand, the claim is that governments would employ the working aged population and easily direct production levels to full employment, prices would be stable via government planned pricing, and growth would only require choosing proper investments as needs became evident.
There are any number of gradations between capitalism and Marxism, but here they will be consolidated under the simple heading of mixed-market economies. Ignoring the possibility of Market-Socialism, John Maynard Keynes argued that the business cycle was not a natural event that the free market could mitigate on its own. In fact it was well known that until the Panic of 1907 the business cycle had been increasing in frequency and in severity. Since the free market had not functioned to slow or reduce the depth of the recessions or the peaks of accompanying growth, it was thought that government intervention in the markets might be necessary. In 1929 the stock market crashed, the markets failed to self-correct giving rise to ever-increasing levels of poverty among industrialized nations, and interventionist fiscal policy was born. Keynes argued that it was not governments who created the business cycle but the whims of market participants – what he referred to as the animal spirits. When aggregate demand is below normal, like during a recession, expansionary fiscal policy was prescribed. Conversely, when aggregate demand is higher than normal, such as during an economic expansionary period, the order of the day would be contractionary fiscal policy. On the Keynesian hand, the argument is that government should spend during downturns to boost demand and contract spending during upturns to steer the economy back toward full employment, stable prices, and long-term growth.
There is no singular economic policy that is good under all conditions – that is the theme of this book. Free markets sometimes function efficiently and are very effective under the right circumstances. When free markets fail to address certain failures then fiscal directives might become necessary. When capitalism leads to worker abuses or other violations of citizens’ implied rights then even extreme interventionist policies can be justifiably prescribed.
An unbridled, slow reacting, unregulated, market-driven economy has its merits and will always direct civilization toward a preferable outcome, if it is given enough time. For thousands of years humanity has existed with one form of market or another, and there is no reason to seriously consider that the unregulated, market-driven economy would not work again. When cycles emerge and corrections are needed there is no doubt the market will find the right solution eventually, but sometimes it takes too long to address potentially irreparable consequences in the process. The purely free market is easily exploited and rarely provides the protections it promises will eventually emerge, at least not in a timely fashion.
The purely Keynesian interventionist policy was designed to slow or eliminate the business cycle through counter-cyclical policies. Proponents of Keynesian interventionism hope to control the uncontrollable animal spirits through the use of fiscal policy. Often, however, interventionists exacerbate the peaks and valleys of the business cycle they hope to mitigate. Politicians have to debate policies, enact laws, and wait to see the effects of those policies, and that takes time. Unfortunately the timing must be perfect and information must be accurate for fiscal policies to effectively direct the economy back toward long-run, full employment levels. Without intervention the markets may adjust naturally, and there may have been no need for the fiscal policy Congress enacted, thus creating further distortions. Other times the information lag between the downturn and congressional action is too long and action occurs too late to mitigate the downturn or to slow a swift, and potentially harmful, upturn; thus the policy action is impotent. Furthermore, there may be political resistance to slowing a quickly growing, perceivably strong economy or even to boosting a weak or slow growing nation. Countercyclical policy requires expansion in bad times and contraction in good times, the political will to adopt sometimes unpopular policies, and the data to correctly predict where we are and where we are going. The tools of fiscal economic policy – changing tax rates or spending levels – are powerful, but political will to raise taxes or reduce spending in expansionary phases of the business cycle is often absent. Political influence ignores an important aspect of fiscal interventions; politicians are usually willing to adopt expansionary government policy but not the contractionary measures necessary to prepare for the next crisis.
Marx’s ideology promised a central plan that would provide for a utopian world, organize the impossibly large and complex marketplace, and ultimately, on its own, it proved fatal to most of the economies it parented. With the exception of China – which suffered during its purely Communist era and is only now improving under more market orientated social policies – no socialist economy has ever proven successful in the long-term. Perhaps the problem lies in incentives as so many claim, or maybe it lies in the seclusionist nature of socialist regimes and nations. One thing is certain: growth during communist regimes is usually slow, invention and innovation are easily stifled by government claims over ownership, and investment is difficult when property rights are not formally defined or politically protected.
That does not mean each system does not also have its own set of virtues. The free market has certainly created the right incentives to grow business and create jobs. New inventions improve production and increase our standard of living. Innovative new uses for capital have improved efficiency and helped the economy grow faster and more powerful. Keynesian fiscal policies helped stabilize the business cycle throughout the Great Depression, gave rise to huge science and technology programs initiated by the federal government during most of the Cold War, and most recently helped keep the world from another depression when fiscal policy was coupled with monetary policy. The inflationary nature of fiscal policy makes existing debt cheaper in the future, and pressures wages to increase over time in order to meet new levels of inflation. The bubbles that are sometimes created will eventually burst, but they give rise to growth and investment that may not have occurred otherwise. Some sustainable investments occur, as well as some unstable or frivolous ones, but overall we see a net gain in the long term. While those bubbles may not be real economic growth, they can motivate real growth. As markets self-correct and adapt to new economic conditions as they arise, and as bubbles grow and burst throughout the business cycle, opportunities are created and the population benefits. Bubbles create “disruptive” conditions that are favorable to the introduction of good and bad inventions and innovations and allow the market an opportunity to direct resources to their highest valued use. There are also benefits to socialist mechanisms in an economy. The state can utilize fiscal policy to invest in roads, national defense, research and development, and more growth-promoting activities the free market may have ignored. When these systems are deemed desirable by society and adopted under a primarily market-driven economy, mixed-market economies emerge.
The state also has an obligation to address market failures. It is important to regulate certain industries the markets have failed to properly regulate, for example, when citizens or the environment are being exploited or irreversibly damaged. The negative externalities (costs borne by someone other than the market participant – things like air pollution, chemical dumping, etc.) produced by some industries can only be addressed by governments, since market mechanisms might ignore the problems for so long that a tipping point can finally be reached. Irreparable damage might be done and long-term economic impacts, impacts that could not have been anticipated or priced into the markets, might be realized. Government regulation is the only mechanism for stopping such actions.
The country must encourage or create incentives, sometimes through spending, to grow economies of scale and encourage investment into important technologies and industries that are simply too expensive for the free market to address. Only the government can protect private property rights, civil rights, public health, and the environment. Only the government can afford to invest in highways, sea-ports, national defense, universal education, and wide-reaching research initiatives and universities. Where private markets fail, governments fill the void.
Governments can, unfortunately, also violate citizens’ rights and destroy their economies through their actions. There are countless examples of such problems around the world and even inside the United States during eras of oppression over certain groups or activities. Certainly government action can adopt counter-productive policies that increase unemployment, decrease investment, and cause outrageous levels of inflation. Government action is not free; all programs must be funded from tax dollars, industries must pay to comply with new regulations, and higher prices sometimes emerge in the markets due to increased compliance costs. Governments that misunderstand monetary policy or citizens who also ignore its implications can, for example, demand more money be distributed within the economy, giving rise to ludicrous amounts of inflation and ultimately doing more harm than good. When governments fail, they fail spectacularly. When the free market fails, it usually fails with a whimper.
Under the right conditions there would not be a need for regulation or government action. The central point of this book is that there is a forum for all ideas, an environment where every solution proves correct, and an environment where every solution proves incorrect. Finding that solution after identifying the conditions surrounding particular economies is what Jeffrey Sachs refers to as a “differential diagnosis,” comparing economic prescriptions to that of doctors and pharmaceuticals. Enlightened thought, vigorous discussion, and, ultimately, an opened mind will leave room for all possible solutions to the day’s problems and catastrophes, ensuring that every possibility is explored and the best answer to our difficult problems is employed. Perhaps unchecked, the free market is prone to failure and exploitation… or not. Perhaps over-zealously adopted interventionist policies can oppress or overheat a market and destroy an economy… or not. Perhaps central planning is overly complex when adopted with hopes of controlling every aspect of every life, family, and corporation… or not. Perhaps every policy should be considered before it is totally ignored on ideological grounds… this is my premise and there is no “or not.”.
Left to reasonable rules a free market has the potential to grow indefinitely. Though fiscal policy or heavy handed regulations can cause harm, interventionist and countercyclical policy can reduce the effects of the business cycle, promote improved aggregate demand, and push nations into further eras of greater economic growth. When markets have been destroyed, have naturally failed, or have failed to emerge to begin with, sometimes only central planning can correct the failures and finally push an economy to become a global participant. Given the right conditions each argument can be relevant.
Isaac Newton’s famous third law of motion, “For every action there is an equal and opposite reaction,” is equally applicable in economic policy making. Countries are not acting alone in some closed laboratory. There are other countries and peoples to consider when policy makers write laws. Like a game of chess, when one player makes a move, the opponent will next make a move. Good players may make logical plays while less experienced or poor players may move irrationally. A nation may opt for primarily free markets without subsidies, only to find some other nation is unfairly competing in world markets. States may decide on subsidizing one industry over another, only to discover the market was not ready for such investment and would not support the infant industry. Governments may adopt ownership over the means of production, hold on to power over production for far too long, and find their command and control system was only a temporary means to an ultimately free market end.
When considering a nation’s policies, other nations’ reactions cannot be ignored. Unilaterally deciding to adopt complete deregulation or absconding from world politics could be deleterious to any country’s interests, economic or otherwise. Harry S. Truman once stated, “Give me a one handed economist. All my economists say on the one hand… on the other.” His economists were probably offering him the benefits and consequences of every policy he was considering, most likely whittling his options down to two policies for consideration and no real direction. Truman may have desired a more direct answer to the problems he faced, one with fewer caveats and complications from the levers he was pulling, but his wish was even less desirable than the alternative. With a rich philosophical, economical, and geopolitical landscape, the world is an interconnected and complicated place that cannot be reduced to simple answers. Harry Truman needed a Three-Handed Economist.
In, “Three Handed Economist,” I take you on a journey through time, trekking from Mercantilism, gold-backed currencies, laissez-faire governments and broken markets, into fiat currencies, capitalist and Marxist experimentation, and finally mixed economies and the development of impoverished nations. The future requires a balanced approach between freedom and regulation, free markets and socialism, and the proper mix of capitalism and government regulation within such topics as monetary policy and healthcare. Finally, it concludes with a novel idea on development economics – a view on how broken markets can be repaired through the adoption of geopolitically unpopular economic policy. The logical way into the future, to benefit from great prosperity, is to first remember our recent past.
The above story is a small selection from my book, “Three Handed Economist: Interior Solutions in an Ideologically Cornered World,” available here. If you would like to get news of more posts like this one, follow me on Twitter @memarf1, visit my blog, “Modern Sense and Economics,” here, and like my Facebook page, here.
