Thursday, August 04, 2011

Fear Itself: Economics Version

-- Posted by Neil H. Buchanan

My new column for Justia's Verdict commentary section steps back from the recent political crisis regarding the debt limit, asking how we ever reached the point where everyone on both sides of the issue had accepted the premise that cutting deficits by slashing federal spending is a wise -- or even a sane -- response to our current perilous economic situation.

The understanding that still forms the core of most economic thinking about fiscal policy is Keynesian Economics: short-term deficits are necessary to strengthen weak economies, and long-term deficits are important and useful to fund public investments. (I write about those issues quite often, of course.) The Keynesian view is anything but radical, especially the short-run part of it. It is the presumptively true theory against which all other theories are measured. When the economy went in the toilet in 2008, even most of the deficit scolds approved of stimulus spending, insisting only that it be temporary and effective. (It was temporary, but because of budgetary insanity on both sides of the aisle, it was not large enough to be noticeably effective.)

Even so, the Republicans (even the non-Tea Party remnants of that party), President Obama, and nearly all elected Democrats have adopted an utterly simplistic idea about government finances, which holds that the answer to all of our economic problems begins and ends with "getting our fiscal house in order." Even though the editorial board of The New York Times, along with a few other commentators, continues to remind us that now is the worst time for fiscal austerity, even straight news coverage treats deficit/spending reductions -- of whatever kind, and at any time -- as so obviously virtuous that they need not be challenged or justified.

Whereas some current academic economists genuinely believe that Keynes's theory itself is wrong, the vast majority continue to believe that his approach is the best way to understand the economy, especially in the short run. The problem with today's politicians is that most economists (and others who know better, including legal scholars who write on these issues) have collaborated in a particularly damaging spiral of insanity. Politicians want simple answers, economists and others give the politicians what they want, and all caveats and nuances are washed away in the rush to simplify the story even further.

My Verdict column is, therefore, ultimately about the culpability of my two groups of professional colleagues -- economists and legal scholars -- in enabling and failing to challenge the growing, harmful anti-government orthodoxy. Even though a big part of the explanation is careerism, with all the incentives aligning to tell anyone with ambitions to toe the line on fiscal austerity, the story need not be cynical. In that regard, economists and legal scholars need not be different from well-meaning politicians, who make strategic compromises and must always wonder where to draw the line.

The bigger problem, I think, is that economists are ultimately engaged in political calculations, for which they are completely unprepared and untrained. In fact, professional economists consider it a badge of honor that their models are not "normative," with the standard comment being that "politicians and philosophers" can grapple with the big questions of morality, while economists just give them the facts and tools necessary to make clear-eyed choices. As one very good and well-meaning economist put it at a conference on global warming, anything beyond explaining the costs and benefits of environmental policies is "above my pay grade."

Such modesty is touching, but it is also naive. Economists have been elevated to the status of oracles (and they love it!), and politicians view economics not as their tool but as their salvation. If they can hide behind economics, politicians do not have to take responsibility for their actions. And if the silly "supercommittee" solution to the debt-limit crisis demonstrates nothing else, it is that politicians do not want to have to take responsibility for anything.

Moreover, economists inevitably end up making political and philosophical judgments all the time. Here, I am not talking about the judgments underlying their choices of what to study (the "limits of thinkable thought"), but rather the way economists discuss policy options. Not having any training to understand how certain policies are deemed "off the table," or how once-shunned ideas become acceptable, economists cast about for guidance about how to frame and package their policy prescriptions. Because of the shared delusion that economists do not "do politics," they cannot even ask for help.

Consider the plight of fiscal policy experts. Everyone knows that, ultimately, all uses of economic resources foreclose other uses of those resources. Yet economists watch in horror when the political discussion seems to embrace the idea that we can get something for nothing. Tax cuts pay for themselves? Yeah, right. (If you are advising a Republican presidential candidate, you hope not to be the one who has to make that argument.) Reagan proved that deficits don't matter? Yikes! Surely, everyone has lost their minds. How can people not see that choices have consequences, and any responsible fiscal policy has to have upper limits to spending and lower limits to taxes?!

How do we motivate people to think more clearly? The only thing that economists have learned in the classroom is to explain with symbols and numbers the way simplified economies work. Yet policy advice is given in a world where people are afraid to use dependent clauses, much less to refer to a theory that requires background knowledge in statistics. What is an economist to do? Decisions being made today seem to be leading the world toward disaster, but no one seems to be worried.

Well, if people are not scared, then maybe we should scare them! With increasing frequency, I have heard economists say that the answer to our fiscal policies is to "open people's eyes" by telling them the scary truth about the economy. We thus have a group of professional economists -- nearly all of whom sneer at mere psychologists and political scientists -- adopting an utterly simplistic theory of social psychology: Scared people change what they are doing, whereas complacent people do not. (To make ourselves feel better, economists call this an analysis of "incentives," which allows us to talk about psychology without admitting as much.)

Again, there is nothing nefarious about this line of thinking. If you see people driving toward a wall, screaming at them seems like a good idea. The simpler the message, the better.

What we have experienced over the last few decades, and especially over the last few years, is the consequences of this visceral notion among economists that fear is the best motivator. Even though one of the most famous lines in American political history is that "we have nothing to fear but fear itself," our professional economists and allied policy analysts have intensified their screaming. "Hit the brakes!" is the right answer in some situations, but not when we need to speed up.

The U.S. policy environment has, therefore, come to be dominated by one implicit theory of human behavior. We should have known all along, however, that this particular theory -- if you want to stir people to action, scare the life out of them -- has a dangerous downside. Scared people do take action, but their actions are neither predictable nor carefully considered. Extremist movements arise among scared people who have stopped thinking rationally. Which brings us back to U.S. politics in August 2011.


Michael C. Dorf said...

Excellent column and post, Neil. I'd add three factors to explain the embrace of austerity:

1) Having played a substantial role in causing the 2008 collapse through overrating junk bonds, the ratings agencies overcompensated by threatening to downgrade U.S. Debt--a threat they may yet carry out not withstanding the cuts. They have made debt/GDP ratios the lodestar, and have apparently decided to ignore the GDP side of the ratio.

2) The widespread adoption of austerity in Europe gives it a semblance of conventional wisdom, even though there it is explained by a confluence of idiosyncratic other factors: German obsessiveness with respect to inflation due to memory of Weimar; German disdain for the perceived profligacy of it's southern neighbors; and, in the case of England, which has its own central bank, the same political dynamic as the U.S.

3) China has been understood to be pressuring the U.S. Towards austerity. I don't quite get why, because slack demand for Chinese goods surely hurts China more than the minuscule chance of a haircut on existing bonds, but the answer probably lies in the domain of Chinese feelings towards Americas roughly paralleling the feelings of Germans about Greeks.

Charles said...

Way to casually dismiss Monetarism, Public Choice and Rational Expectations, all schools of thought that have made invaluable contributions explaining why Keysenisans doesn't work in practice. They certainly have something to say why stimulus after stimulus fails to revive the economy and why futile efforts such as "cash for clunkers" is now considered a failure. Attempting to boost aggregate demand is simple in theory but never works in practice.
Tax cuts are important for growth and spending cuts free up more resources in the private sector. Reagan's tax cuts led to more government revenue; the deficits were caused by too much spending. Canada cuts tax rates on all income ranges from 2000-2008 and revenues went from $116 to $167 billion.

This country was founded on anti-government sentiment and should be considered a healthy thing considering how harmful centralized power can be.

egarber said...

Hey Neil, you should write a future blog post about the supercommittee -- particularly the issue of establishing the proper baseline for determining the effects of any proposals.

Paul Ryan's cynical jockeying on the matter is almost laughable. As I understand it, he says the CBO should use current law as the baseline, which means we should assume all the Bush tax cuts will expire. In that context, any Dem effort to extend the cuts for the middle class would drive up the deficit (because it shrinks revenues).

But how insane is that? If baselines are supposed to be the best estimate of how the real world will look, the corollary would be that Republicans actually believe all the cuts will expire. [If that were the case, the actual deficit would come down 40%, given the central role the Bush tax cuts have played in creating shortfalls.]

Of course, Ryan's real goal is the exact opposite: he wants to create an uphill battle for those wishing to untether the top rates from the rest of W cuts -- i.e., head off any attempt to do that within the committee, even though we know for certain Republicans would never let all rates expire.

This makes me believe that the committee won't even get out of the starting gate. So more and more, I see the next meaningful battle to be over the expiration of the Bush cuts themselves. I foreseee a scenario where they all expire, and then, assuming Obama gets re-elected, the president immediately sends a middle class tax cut bill to Congress in early 2013.

At that point, if Republicans vote against the package, they really would be sacrificing average Americans to protect the very wealthy; the default paradigm will have shifted, in that all rates will be higher pending passage of that middle class tax cut.

The big wildcard is how Republicans plan to use the debt limit again. If our credit rating is held hostage during what I describe, how do Democrats respond? Maybe Obama as a second-termer will at least keep handy a constitutional option, so we're not watching helplessly as the hostage has a gun held to his head.

And of course, the outcome of the election itself will matter too. If voters rebel against tea-partiers, it's possible Congress will be more friendly.

So please solve all of this in a future post. :)

Blud Bitter said...

WOW Gold John Ryan's doubtful jockeying on the topic is almost laughable. As I comprehend it, he says the CBO should use present law as the basic, which indicates we should think all the Plant tax slashes will end. In that situation, any Dem attempt to give the slashes for the middle-class would generate up the debts (because it minimizes revenues).

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