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economic policy re the recession « Previous | |Next »
July 3, 2009

The battle lines drawn over economic policy in the context of the global financial crisis and recession are well known--its either the government or the market.The Washington Monthly's special report The Next Frontier addresses this conflict.

In the Introduction to the report Paul Kedrosky spells out the two polarized sides of the debate and offers another option. He says that on one side there are those who advocate that:

government stimulus spending will be the primary force in our eventual recovery. This view holds that the key to exiting economic downturns is countercyclical public spending to keep the U.S. economy closer to its optimal level of activity. You should deficit-spend when the economy is operating at less than its full capacity; you should shrink spending and manage debts when the economy is back to normal. It is, in short, the Keynesian view, named for economist John Maynard Keynes and widely held by congressional Democrats. And there’s some truth to it. Massive government spending can cushion the blow when an economy shrinks as severely and as quickly as this one [ie., the US] has. But imagining that a fiscal stimulus, however outsized, can compensate for indebted consumers hell-bent on saving their way back to (relative) solvency is high-definition dreaming.

This Keynesian position is the one adopted by the Rudd Government, which claims that it's stimulus softens the negative effects of the recession whilst the big spend on infrastructure gets things going again until China picks up its economic growth.

On the other hand there is the view that:

greater government spending only leads to higher tax rates, hence to declining incentives for investors to take risks. Better, in this view, to allow the economic crisis run its course, permit large firms to collapse, and let entrepreneurs pick up the pieces and create new companies, jobs, and wealth. This is the "Hayekian" view (à la Austrian economist Friedrich von Hayek), widely held by congressional Republicans, and there’s some truth in it, too. Higher tax rates will, at some point, undermine investment incentives (though the evidence suggests that we’re not very close to that point yet). Downturns—especially severe ones—do disrupt markets and provide opportunities for innovators. Microsoft, Allstate, Morgan Stanley, and many other companies rose from the wreckage of economic downturns. Small companies have been the primary source of job creation in the United States over the last few decades. Unless you expect that trend to change, start-ups and small companies must, by definition, play a major role in any meaningful recovery.

This laissez-faire overlooks the vital role government has played in opening up new entrepreneurial opportunities.

Kedrosky's argument is that if it is the case that growth is riding on entrepreneurs, then the best hope for entrepreneurs may be riding on government. Economic crises create the opportunities for new platforms on top of which entrepreneurs could generate economic growth. Energy provides one new platform in that economic growth can come from companies exploiting new technologies and from innovations that solve real-world problems.

It is this kind of economic policy that is missing from the Rudd Government as it has allowed itself to be locked into protecting the old fossil fuel industries and has done very little to provide a platform for energy entrepreneurs to generate economic growth by exploiting renewable energy technologies.

| Posted by Gary Sauer-Thompson at 7:01 AM | | Comments (2)


The Roosevelt Administration assumed office in 1933 at the height of the Great Depression and adopted a policy of stimulus spending, running a budget deficit. By early 1937 the Dow Jones Industrial Average had exceeded the level that it had had at the beginning of 1927.

Then Roosevelt was persuaded to run a balanced budget and the DJIA, which had reached 188 in March 1937, reached a low point of 103 13 months later. It did not get back above 188 until after the end of the war.

Correlation does not prove causation and the DJIA is an imperfect indicator of national economic well-being. Even so, this history provides food for thought.

Even with the Keynesian measures adopted by most governments, with the notable exception of Germany, the economic downturn (US unemployment at highest level for 26 years) is severe. If downturns do provide opportunities for innovators, there should now be plenty of opportunities about.

all the data from the US indicate that a deeply indebted US is in a very bad way in terms the depth of the economic recession, indebted consumers, individual states face daunting fiscal prospects (eg., Califorrnia) and the federal government's fiscal books being fundamentally out of balance.

In their An Update on the Economic and Fiscal Crises: 2009 and Beyond William G. Gale and Alan J. Auerbach say that:

the United States will soon be compelled to confront its fiscal future. Although huge deficits are not desirable in the short term, they are nonetheless understandable. Once the economy recovers, though, the need to impose fiscal discipline – which used to be considered a “long term” problem – will be a short-term and urgent problem that will require difficult choices that policy makers have so far refused to make. Worse still, if the economy recovers only very slowly or not at all, those decisions will still need to be faced, but in the context of a weaker economic situation.

In spite of the innovations by companies such as Apple and Google the US is a declining economic power. It may need to be bailed out by the IMF!