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The Independent Institute
Commentary

Obama and the Wrong Road


Last Jan. 9, President Obama declared that “there is no disagreement that we need action by our government, [for example,] a recovery plan that will help to jump-start the economy.” He was wrong. A few days later, polled by the Cato Institute, some 200 economists from the best American universities answered him in a full-page ad published in the New York Times and the Wall Street Journal: “With all due respect, Mr. President, that is not true.” And then they briefly expressed their reasons: an increase in government spending in the 1930s did not liquidate the Great Depression or contribute to solving the crisis in Japan in the 1990s. To reprise that strategy was a triumph of hope over experience. What was the correct road to emerge from the crisis? No doubt, they opined, the best fiscal policy to revitalize the growth of the economy consisted of reducing taxes and the burden of government and initiating reforms that would eliminate impediments to work, savings, investment and production.

Among the signers there were three Nobel Laureates: James Buchanan (1986), the wise old man who started the theory of public election (Public Choice) and demonstrated with it how the decisions of bureaucrats and politicians are made for the same selfish reasons that move entrepreneurs, which excludes the fantasy that they act in the search of a common good, incidentally belying the superstition that the State assigns resources with greater efficacy or justice than the market; Vernon L. Smith (2002), an expert in the formulation of experiments that prove the market’s failings; and Edward C. Prescott (2004), a man who specializes precisely in economic cycles. For the purposes of this article, he is the expert who interests us most out of the three. Prescott is one of the most accurate critics of Keynesianism and its theory that inflation and unemployment function inversely. The 1970s had demonstrated that it is possible to suffer high rates of inflation and unemployment simultaneously. Also, the experience of Japan confirmed that a copious increase in the mass of currency and a dramatic lowering of interest rates did not revitalize the economy.

Where did John Maynard Keynes, the twentieth century’s most prestigious economist, err? That was explained by another giant, Robert Lucas, also a Nobel Laureate (1995), who discovered that the simple management of information changed the “rational expectations” of people and the behavior of each person, hampering the objectives the State wanted to achieve. It was not true that monetary policy could solve crises: it likely accentuated them. As soon as the citizens got wind of what the government planned to do, they changed their strategies to adapt to the new circumstances.

A magnificent example of the so-called “Lucas critique” is what’s happening in the real estate market in the United States. Faced with an avalanche of unpaid mortgages, the federal government decided to inject money into the banks and promised aid to mortgagers behind in their payments so they wouldn’t lose their homes and the value of their property would not drop. The result? Aside from the fact that keeping housing cost high is not among the State’s functions, the consumers became paralyzed waiting to learn the extent of those measures, provoking an even faster drop in the price of property due to a lack of buyers, multiplying the number of people to whom it is more profitable to lose an undervalued property and move to a rented dwelling than to deal with a ruinous mortgage. It is the State, with its intervention as a philanthropic ogre, that doesn’t allow prices to stabilize and keeps supply and demand from coming together in a natural way.

Those who today defend Keynes with an absurd ideological zeal forget that the prescriptions of this English economist (a man, it should be said, intent on saving capitalism from the horrors of Marxist collectivism) were not discredited by academicians or politicians who were intellectually hostile, such as possibly Friedrich von Hayek, who went pretty much unheeded, but by the stubborn reality. For four decades, the world experimented with Keynes’ theories and the result was oversized States, punished by inflation, in which waste and a lack of efficiency grew apace with excessive public spending and bureaucracy, until the world began to return to civil society the vigor and role stolen by the governments.

When will the crisis end? The more pessimistic economists are starting to think of 10 or 15 years. They talk about “long run.” Except that, as Keynes himself said in a tone halfway between macabre and humorous, “in the long run, we are all dead.” Maybe not so long.


Carlos Alberto Montaner is a Member of the Board of Advisors for the Center on Global Prosperity at the Independent Institute and President of Firmas Press.