RALEIGH — One of my favorite book titles of all time was Dennis Avery’s Saving the Planet with Pesticides and Plastic. As it happens, the book itself was spectacular, as well, making a strong argument for the humanitarian benefits of high-yield farming and global free trade.
The title grabbed readers’ attention by challenging the conventional wisdom. Everyone knows that man-made pesticides and plastics must be bad for human health and the environment, right? Nope. Avery demonstrated that such “knowledge” was widespread but empirically false. A more recent example would be the loudly asserted health benefits of organic produce that turn out to be derived not from actual data but from wishful thinking and ideological fervor.
At the risk of straining the analogy to the breaking point, the debate about how best to promote economic growth in modern capitalist economies is also characterized by loudly asserted conventional wisdom, much of it based on Keynesianism claptrap from the 1930s that bears little relationship to real-world experience. A Foreign Policy columnist fingered Paul Krugman the other day as a particularly egregious practitioner of this kind of conventional-wisdom pandering. Confronted with the example of the Baltic states, which responded to the Great Recession by straightening out their balance sheets and are now posting solid growth rates, Krugman continues to decry “austerity” measures that rob economies of the demand stimulus they need.
The truth of the matter is that, when it comes to following wise economic policies, government should not act all that differently from households or businesses. If you experience a drop in income, or even an indication that rough times are ahead, you should avoid taking on new fiscal responsibilities and starting paying down the ones you already have. Borrowing for emergency needs is not unreasonable, but if you have no real prospect of paying the loan off rapidly and avoiding its repetition, you are better off not taking it out. Instead, you should cut your operating costs and sell low-priority assets to repair your balance sheet.
To Keynesians, of course, this all sounds like madness. The paradox of thrift, they argue, is that while it might be good for individuals in particular, it is bad for economies in general. If too many households, businesses, and governments cut back during a recession, they reduce “aggregate demand” and thus make the recession even worse. So if households and businesses adopt thrift, governments must counterbalance its harmful effects with temporary spending hikes or tax cuts, financed by debt.
One problem with their policy is that it has proven wickedly difficult to implement the way Keynes and his followers describe it on paper. That is, it’s not hard to convince politicians to borrow and spend their way through recessions. It is far harder to convince them to run surpluses afterwards to pay down the resulting debt.
The other problem with their policy is that it is wrongheaded. Recessions aren’t unforeseen accidents or acts of God from which governments needs to insure their citizens with deficit-spending schemes. Recessions are the inevitable result of mismatches that develop during economic booms between what producers are making and what consumers want to buy.
Booms like those of the late 1990s and mid-2000s are fueled by excessive growth in the money supply, which holds interest rates artificially low and distorts the relationships between them. As a result, more of the nation’s investment capital flows into asset classes – dot-coms in the case of the 1990s and real estate in the case of the 2000s – than would have been justified by their economic fundamentals.
When the bubbles burst, real recovery can take hold only when investment capital flows where it should have gone in the first place, resulting in new jobs and businesses with real growth prospects. By balancing their budgets and paying down their debts, households, businesses, and governments help to make this reallocation occur more rapidly.
Perhaps free-market economists could get policymakers to understand this better by offer an advice book entitled Saving the Economy Without Stimulus and Plastic.
Hood is president of the John Locke Foundation and author of Our Best Foot Forward: An Investment Plan for North Carolina’s Economic Recovery.