November 9, 2010
One of the oldest, most controversial issues in economics is how active government should be in managing the economy. Views on this have varied greatly through the ages, and we are in the middle of yet another large change in attitudes about the proper role of government.
President Obama’s historic 2008 victory and the government’s response to the Great Recession seemed to augur a return to a brand of government activism not seen since the New Deal. But last week’s elections that swept Republicans back into power in the House, and narrowed the Democrats’ hold on the Senate, marked a stunning repudiation of Obama’s agenda – and an unmistakable rejection of the government’s more muscular economic and regulatory policies.
Why did the public reject the president’s economic policies and activist government more generally? Polling conducted before and after the midterm elections revealed a general perception that the administration’s $814 billion stimulus package of spending and tax breaks didn’t work. An October poll by the Pew Research Center showed that a vote in support of Obama’s stimulus package topped the list of reasons why Americans said they wouldn’t vote for a candidate. The public perceived that the fat cats got bailed out,
while they lost jobs, retirement and education savings,
and equity in their houses.
Government projections about the effects of the stimulus were based upon an overly optimistic forecast of the severity of the recession, and things turned out much worse than expected. As a result, even though the stimulus helped to avoid an even worse outcome, it was much too small, and what the public saw was a government that did not live up to the promises it made.
There was also considerable and justifiable anger over the bank bailout. The public perceived that the fat cats got bailed out, while they lost jobs, houses, retirement and education savings, equity in their houses, and so on. Nearly two-thirds of voters participating in a Judicial Watch poll - said the new Congress should never again use taxpayer funds to bail out or buy out a privately owned company.
The counterargument that an actual depression might have occurred without the bailout is hard for the average American to imagine or is not believed, and the public feels they got the short end of the bailout stick. The government could have adopted a policy that was harder on banks and bank managers without putting the bailout at risk, but failed to see the political importance of doing so.
Views about how active government should be have changed through time, and they can be separated into four time periods. The first was the Mercantilist era, lasting from 1500 through the mid-1700s. The Mercantilists wanted to boost the inflow of gold and silver, and they adopted a highly interventionist approach designed to maximize exports and minimize imports.
Adam Smith’s Wealth of Nations (1776) marked a change in this line of thought, and the start of a second era. By Smith’s time, government was intertwined in nearly every aspect of economic life, to the detriment of economic growth, and Smith promoted a more laissez faire approach as the key to maximizing the wealth of a nation. Economists who followed Smith developed and reinforced these ideas and, though there were short-run deviations from these ideas along the way, the laissez faire approach continued through the economically turbulent 1800s and early 1900s. During this time, large bank failures and depressions were relatively commonplace, but the idea that the government could intervene to overcome these problems had not yet taken hold.
This changed with the Great Depression. The publication of Keynes’ General Theory in 1936, explaining how government policy could lift the economy out of a depression, and the validation of those ideas when deficit spending during World War II ended the Depression, marks the beginning of a third time period and a return to more activist government.
The 1970s marked the fourth major change in ideas. During the 1970s, the application of Keynesian policy led to high inflation and high unemployment, and this policy failure led to the beginning of a new trend toward less active government. But Keynesian ideas were not ready to go down without a fight. New Keynesian theorists within the economics profession pushed against New Classical ideas, and the election of the Obama administration seemed to be a sign that the movement toward classical ideas that began in the late 1970s was ending. The response to the Great Recession was a chance to cement activist ideas in place. But as the polling data and results of the election show, that didn’t happen. Capitalism is the best system yet discovered for
promoting economic growth, but it is also a system
that creates large booms and busts along the way.
What does this mean for the future? I believe we are headed for a continuation of the trend toward less activist government that began in the 1970s. The Obama administration had a chance to change that trend, but failed to do so, and may have helped to reinforce the movement in the other direction.
We will be much less likely to use fiscal policy in the future, particularly government spending – much to the detriment of any future generations caught in a large downturn. As for the Fed, it still has considerable independence and a job to do in managing the economy, and it will continue to do that job. But the Fed will be far less willing to take bold steps to try to alter the direction of the economy, and far less likely to get the support from Congress it needs for another bailout to prevent a financial meltdown. And if the degree of independence the Fed currently enjoys is reduced through Congressional action, a very real possibility with people like Texas Rep. Ron Paul , a libertarian, as potential members of key oversight committees, even the routine management of the economy by the Fed could be affected.People should not be left to fend for themselves when
they are hit by large negative economic shocks they
had no hand in creating….
I’d be less worried about this if I thought the trend away from deliberate, activist policy would be offset through the enhanced use of automatic stabilizers, i.e. policies that kick in automatically when problems arise, without the need for policymakers to make any sort of active decision. However, concerns over the national debt will, if anything, lead to less rather than more automatic protections.
Capitalism is the best system yet discovered for promoting economic growth, but it is also a system that creates large booms and busts along the way. The ability of governments to smooth economic shocks with monetary policy, fiscal policy, automatic stabilizers and social insurance is one of the great innovations of the last 100 years. While we have been far from perfect in the use of these tools, they have done far more good than harm, and it’s scary to contemplate a world where those protections have been substantially eroded away.
People should not be left to fend for themselves when they are hit by large negative economic shocks they had no hand in creating, and let’s hope that somehow, despite the emerging trend toward a more hands-off approach and pressures from rising national debt levels, that outcome can be avoided.