Economic Management Without
December 16, 2011
(This item originally appeared in Forbes.com on December 16, 2011.)
Last week, we talked about “Keynesianism,” which is really the
application of two policies in the face of recession: expanded
government spending, and some form of “easy money” policy. A brief
perusal of the newspapers shows that these Keynesian ideas account
for about 90% of the economic policy discussions today.
These can have some apparent short-term positive effects – but so
does morphine. From a broader and more fundamental perspective,
their effects are negative. The expanded government spending tends
to go toward total waste, and causes larger deficits and a larger
debt load. This often soon leads to higher taxes, which are an
economic negative. All forms of “easy money” eventually amount to a
form of currency devaluation, even if that is not their overt goal.
In effect, this makes wages decline, because wages are paid in a
currency of declining value. How can a country become wealthier by
causing wages to decline? It doesn’t work.
“Keynesianism” is really today’s version of Mercantilism, which has
been around in some form probably for millennia, but became more
codified in Europe beginning around 1600. In contrast to the
Keynesian approach has been the “Classical” approach, which tends to
favor as little government waste as possible, balanced budgets to
avoid the consequences of excessive debt, low and efficient taxes,
and stable money. From our broader and more fundamental
perspective, all of these policies improve the long-term functioning
of the economy.
However, the Classical group has, historically, been rather silent
about what to do during a recession. This is when the Keynesians
grab the stage with their deficit-spending and money-jiggering
proposals. In the past, the Classical group has tended to rely on
“it will get better eventually” arguments, which indeed have some
merit but are often completely insufficient for the situation at
Often, it doesn’t get better eventually. Why is that? Usually, it is
because of some fundamental issue that is not being addressed, or
perhaps is getting worse. For example, if a recession has been
caused by an explosive increase in tariffs, then obviously nothing
is going to “get better eventually” unless the problem – high
tariffs – is remedied by lowering tariffs.
Often it is the Classical group itself that is creating new
problems. Worried about the decline in tax revenue and resulting
deficits caused by recession, they often have an excessive focus on
the supposed virtues of a balanced budget, and raise domestic taxes
radically. This causes the economy to deteriorate still further, and
the budget situation often then becomes worse rather than better.
Sometimes there are currency issues. If the currency is going
through some kind of trauma, then things are not going to
automatically get better unless the currency issue is addressed and
Sometimes there are systemic problems, often related to the
financial system. There could be issues with things like price
controls, cartelism, inflexible labor arrangements, and other
regulatory things. Today, we have a number of other long-standing
issues that have begun to cause immediate difficulties, for example
relating to excessive compensation for government employees, and a
grotesquely overpriced and ineffective healthcare system.
So, a more enlightened Classical approach would be to identify the
problems, and then solve them. This fixes and improves things on a
fundamental level, which is much better in both the short and long
term than trying to kick the can with a “stimulus” injection of
Keynesian morphine. It is also much better than ignoring the
fundamental issues and making a series of doctrinaire “it will get
better eventually” arguments, which will simply fail if the
fundamental issues are not addressed, or are in fact getting worse.
In addition to the fundamental issues that are perhaps directly
related to the economic downturn, there are some other options
available. For example, today’s problems, in the U.S., have little
to do with changes in the tax code. The most recent tax code
changes, the 2001-2003 Bush tax cuts, were generally positive.
Although some people blame them for the expanded government deficit,
in fact this tax code produced revenue of 18.5% of GDP in 2007,
almost the exact average for the period since 1950, and the same as
the 18.4% of GDP received in 1995. The more recent decline to 14.4%
of GDP estimated for 2011 is mostly due to the recessionary
environment, and corresponding high unemployment.
Federal expenditures for 2011 are estimated at 25.3% of GDP. This
has been inflated somewhat by expenditures related to the recession,
such as payments for unemployment insurance. The difference between
revenues and expenditures is thus estimated at 10.9% for 2011, a
very large number. However, if revenues increased naturally due to
recovery, returning to about their 18.5% historical average, and
expenditures decreased a few points to perhaps the 19.6% of GDP
spent by the Federal government in 2007, then we would have a
deficit of only 1.1% — which was, actually, the Federal deficit in
Thus, I would say that we do not have a major deterioration in the
tax system today in the U.S., compared to the relatively prosperous
1990s for example. This is very different than Greece or Japan, both
of which have pounded their economies with big tax increases in
recent years. And they wonder why things don’t automatically get
better. (Tax rates have risen at the state and local level in the
U.S., so things are not quite all rosy.)
However, as we have seen among a couple dozen flat-tax adopters over
the past decade, the positive effects of transitioning to a much
more efficient and beneficial tax system are so great that they can
do a lot to resolve economic difficulties. You still have to
identify and fix the existing problems, but major fundamental
improvements like a tax reform can add huge benefits which are much
more “stimulative” than all of the Keynesian remedies put together.
So, a good Classical approach would be both to fix the existing
problems, and also to address some broader issues, such as tax
reform, which are not really causing the present difficulties but
offer great opportunities for improvement.
If you chew over these issues for a while, it becomes apparent that
there are so many things to do, fixing and improving the fundamental
operating conditions of the economy, that a “do nothing” approach
seems completely nonsensical.
Today, in the United States, I would say that the present recession
is related to excessive debt mostly among individuals and the
government (the “debt supercycle”); an inevitable repricing of real
estate – and perhaps equities and bonds as well — to more normal
levels; a grossly bloated, overcomplicated, corrupt and parasitic
financial industry which is fundamentally insolvent; regulatory
issues related to the financial industry; issues related to
excessive sovereign debt, particularly in Europe and Japan today but
possibly relating to the United States within a few years; and an
excessive reliance upon Keynesian “easy money” policies which will
probably cause more overt problems before all this is done.
You could add a few other things which have come to the fore
recently, such as: long-standing issues relating to healthcare and
pensions for the now-retiring Boomer generation; excessive costs for
university education; excessive healthcare costs across the board;
and absurd compensation for many government employees. I would say
these issues are not directly related to the present economic
difficulties, but the time has come to address them nevertheless.
This is the first step: identify the problem. Then you solve the
problem. Economics doesn’t have to be any more complicated than
Once you begin focusing on identifying and solving real problems,
then causing new problems with Keynesian morphine becomes totally
repugnant. Don’t we have enough problems already?