Sunday, July 31, 2011

A Structure Is Only as Durable as Its Foundations

Almost two weeks ago I had the privilege of speaking at a supporters reception hosted by the Institute for Principle Studies (IPS). IPS is a research and educational organization analyzing public policy from a distinctly Christian world view. At the reception I briefly explained my conviction that our current economic problems are due in large part to ideologies and ethics built on faulty foundations. A building supported by a crumbling foundation will not have very long to stand. So it goes with economic society.

We see evidence of this from the mouths and pens of well-respected members of the economics profession. It was Ben Bernanke who, fearful of deflation in the middle of last decade, convinced then Fed chairman Alan Greenspan to pursue serious monetary inflation during the mid-2000s. Paul Krugman continually calls for ever greater government spending to get us out of our current economic banana. To do his part, current Fed chairman Bernanke has increased the monetary base by $1.4 trillion. Recently, Christina Romer argued that if you want to reduce the budget deficit, raising taxes would be less painful than lowering government spending, because the multiplier is smaller for taxes that it is for government spending.

The common ideology that drives all of the above is what Robert Higgs called vulgar Keynesianism. In a nut shell, this economic ideology asserts that the economy is driven by spending--especially consumer spending. Additionally, the economy is conceived as merely the sum total of various aggregate variables. The simple Keynesian system asserts that Aggregate Demand = C + I + G, where C is consumption spending, I is business investment in physical production, and G is government spending. In equilibrium, this aggregate demand is equal to output, or aggregate supply equals aggregate demand.

As Higgs notes, one of the major failings of this conception is that all spending is considered equal. $1 million spent on baseball tickets is economically equivalent to $1 million spent on desktop computers. $1 million in corporate subsidies is equivalent to $1 million spent on housing construction.

Another key part of vulgar Keynesian ideology is that the chief end of the state is to provide full employment. If there is a drop in consumption spending or business investment that is significant to push us to an equilibrium income too low to sustain full employment, the state should stand by ever ready to fix the problem. It should either increase government spending, or increase the money supply to lower interest rates, thereby increasing business investment. Both would raise incomes and therefore also increase consumer spending. Because spending is spending, there is no concern that the money is spent productively.

When weighed in the scales of sound economics and ethics, vulgar Keynesianism is found wanting. An important reason why is that this pernicious ideology dehumanizes economics. It fails to recognize that all economic phenomena is the result of actions by persons made in the image of God. Human beings are rational actors who therefore engage in purposeful behavior. They are not merely cogs in a machine.

Our contemporary policy makers act as if they think they are economic masters of the universe. It is as if Geithner can pull the spending lever in just the right way and Bernanke can raise the monetary thermostat to just the right level so that all things will be coming up roses and daffodils. The economy, however, is not a hydraulic machine made up of inanimate cogs and tubes. It is a vast network of voluntary exchange by people who have wills that are free to do what they want.

Economic policy prescriptions are truth claims. As such, they are only as good as the economic theory upon which they are founded. Because economics is the study of human action, economic theory is only as good as the conception of human action upon which it rests. Likewise, an understanding of human action will only be as good as one's understanding of the nature of man, which means that, ultimately, sound economic policy advocacy depends to a greater extent than most people realize on our philosophy and theology. If we get our anthropology wrong, our economics will be less than satisfactory, which will lead, at some level, to errors in economic policy. 

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