Monthly Archives: September 2010

Back to a mixed economy

Economist Brad DeLong gives a short intellectual history of economic paradigms in the United States. In the nineteenth and early twentieth century there were the laissez-faire economists. With the arrival of the Great Depression and World War II in the thirties, however, it became quite evident that the government needed to participate more vigorously in managing the economy. John Maynard Keynes brought a dose of reasonableness to the field with his theory of a “mixed economy” in which governments dampen recessions and increase levels of employment through fiscal policy.
Beginning in the seventies, however, laissez-faire principles had their revenge with Milton Friedman.
Friedman proposed that with one minor, technocratic adjustment a largely unregulated free-market would work just fine. That adjustment? The government had to control the “money supply” and keep it growing at a steady, constant rate-no matter what. Since money was what people used to pay for their spending, a smoothly-growing money supply meant a smoothly-growing flow of spending and, hence, no depressions…
However, as we are seeing today, keeping the money supply growing is not entirely under governments’ control. Adjusting interest rates and regulating the printing of money is not enough.
When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the “money supply.” Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.
It was not possible to ward off the current recession by adjusting interest rates and printing more money.
So increasingly over the past year, the central ministries of the globe have taken extra measures: they have guaranteed debts, they have partially or completely nationalized banks, they have forced weak institutions to merge with stronger ones, they have expanded their balance sheets to an extraordinary extent. And yet this, too, has not been enough.
There is nothing else to do than to return to a more reasonable “mixed market” approach. Monetary policy must be combined with strong fiscal policy.

Economic progress and the middle class

Apparently, economic progress rides the tails of a middle class that spends. This insight is often attributed to Henry Ford. He reputedly gave his workers relatively higher wages so that they could afford to purchase the automobiles they labored to make.

Last Thursday in the New York Times, Bill Clinton’s former secretary of labor Robert Reich wrote an Op-Ed claiming that the reason that the United States’ economy continues to sputter is because the middle class no longer has the means to spend. The average male worker in the US earns less, when his wages are adjusted for inflation, than he did thirty years ago.

Over the past three decades, the economy continued to grow because the middle class found ways to increase their spending even though wages had essentially stagnated. First, women increasingly entered the workforce contributing to households’ disposable incomes. Second, men and women worked more hours than before. And finally, households got into debt in order to be able to keep on spending.

If the growing economy did not result in increasing middle-class wages (not in real terms), then who was benefitting? The rich were. This is a problem because the rich do not spend like the poor and middle class do. Henry Ford and his wealthy friends were not going to buy up all of the automobiles that were built in his factories.

Spending is the true motor of economic growth. Investing (or saving), what the rich often do with a significant portion of their money, only functions if others are spending. Economic growth will continue to be meager, argues Reich, until middle class worker once again have the means with which to spend.

Why is it that Canada has weathered the recession better than the United States? It certainly has something to do with the tighter regulation of banks north of the border. Following Reich’s arguments, I would suggest that it also might have a lot to do with the fact that in Canada the middle class is comparatively a lot stronger than it is in the US.