More on the Structural Downturn

I’m in no position to weigh the merits of the competing Keynesian and neoclassical schools of economics, the subject that occupies the bulk of his op-ed, but I do want to underscore one point made by Nobel Prize-winning economist Edmund Phelps in the Financial Times. Dr. Phelps intones:

These fallacies [i.e. extreme Keynesianism or extreme neoclassicism] lull analysts into the false sense that, one way or another, a full recovery lies ahead – thanks to government spending or to self-correcting market forces. As I see it, the poor state of balance sheets in households, banks and many companies augurs a “structural slump” of long duration. Employment will recover, quickly or slowly, only as far as investment demand will carry it. It is highly uncertain whether government spending on infrastructure would help, after taking into account the employment effects of the higher tax rates to pay for it.

That’s an assumption that seems to underpin the Obama Administration’s strategy in dealing with the economic downturn and it’s one of which I’m very skeptical. As I noted yesterday, we’ve been digging this hole for a very long time, under Democratic administrations and under Republican administrations, and so far we haven’t lifted a single spadeful to try to fill it up again.

I guess it’s as true with fiscal imprudence as it is with alcohol or gambling or any other addiction: the first step on the road to recovery is recognizing that you have a problem and for that you’ve got to hit rock bottom.

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  • Interestingly Robert Higgs has a different take. He sees the problem as one of excessive government size. And that the nature of government is to grow over time, not shrink. The only real solution is that eventually government will get too big to support itself off of its citizens. Its pretty grim, his view is that there isn’t any way for a democratic state to admit it has a problem and start trying to get out of the hole it has dug. Instead it keeps digging until the sides of the hole collapse in on the State.

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