History News Network

Counsel of Despair?

Over the years, I have heard many people say that the government’s adoption of a laissez-faire stance during a business recession or depression amounts to “do-nothing government”—the unstated assumption always being that it is better for the government to “do something” than to do nothing. Recommending such a hands-off stance is often described as a “counsel of despair.” Moreover, it is frequently added, in a democratic polity, the electorate will not tolerate such a policy.

Implicit in such criticism is the assumption that the government knows how to improve the situation and has an incentive to do so. If only it will take the known remedial action, people’s suffering will be relieved, and the economy will return more quickly to full employment and rapid economic growth. All that blocks such remedial action, it would seem, are outdated ideas about the proper role of government and, perhaps, the opposition of certain selfish special interests. Government need only step on the gas pedal, by means of expansionary fiscal and monetary policies, and the economic engine will accelerate. If the government is already taking such actions, it need only press down harder on the gas pedal.

Adherents of the Austrian school of economics are sometimes singled out as moss-backed exponents of the “liquidationist” position said to have been taken by Treasury Secretary Andrew Mellon after the onset of the Great Depression in the United States. According to Herbert Hoover, Mellon urged him to refrain from involving the government in the situation, in order to “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate…. [I]t will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

Although not so colorful in their policy advice, Austrian economists do recommend that the government stand aside when a business bust occurs. (They also explain how government action, especially its monetary policy, has brought about the preceding, unsustainable boom.) By so doing, the policy-induced structural distortions whose unsustainability brought on the bust in the first place will be corrected. Resources will be reallocated away from enterprises that are losing money and capital value because consumers are unwilling to support their profitable operation, and they will be put to work in other lines, where prospects of successfully satisfying present and future consumer preferences are brighter. Business bankruptcies, unemployed labor and capital, and other dire developments only attest that mistakes have been made. In order to restore sustainable prosperity, these mistakes must be corrected, not papered over.

If the government props up unprofitable firms with bailouts and cheap loans and subsidizes unemployed workers with extended unemployment-insurance benefits and other income supports, it only obstructs and delays the necessary restructuring of the economy’s resource allocation. Although it may appear to be relieving people’s pain—and, indeed, it is doing so for those fortunate enough to receive booty at the public’s expense—it is only ensuring that by falsifying the price and profit signals that tell economic actors how to act most rationally in the society’s long-term benefit, it is preserving an economically irrational allocation of resources and thereby planting a time bomb that will explode later in the form of an even worse bust.

Thus, what seems to be governmental “compassion” is scarcely true compassion, but only a spurious assistance to some at the present expense of others and, ultimately, to the detriment of almost everyone. The true counselors of despair are those who insist that the government act even though the government cannot act constructively and its actions will, at best, only produce short-term improvement in the patient’s symptoms while ensuring that in the long term, he will fall victim to an even more painful malady. If the patent is bleeding, it is scarcely compassionate to attach government leeches so that he loses blood even more rapidly. The true counselors of despair are those who hope against hope—and historical experience—that the government can and will act constructively. Such wishful thinking cries out for deeper study of Austrian economics and economic history, not to mention a more thorough understanding of the sort of people who run governments and of their reasons for exercising government power.

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Posted on: Tuesday, July 31, 2012 - 18:44

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Anna Jacobson Schwartz (November 11, 1915–June 21, 2012)

Anna Schwartz was one of the best economic historians of the past century. With Milton Friedman, she wrote (among many other works) that century’s most influential economic history book, A Monetary History of the United States, 1867-1960 (1963). Although not an economic theorist of Friedman’s caliber, she was a fine economist in her own right. Friedman’s statement that “Anna did all of the work, and I got most of the recognition” was not a mere expression of false modesty, but an honest confession that the immense body of historical evidence meticulously collected, compiled, annotated, and displayed in their landmark books was overwhelmingly the product of Anna’s efforts.

Although I never knew Anna personally, I felt as if I did because I knew so many people who knew her well and because she was always friendly and helpful when our paths intersected. She wrote positive reviews of several of my books, and when Oxford University Press published my book Depression, War, and Cold War in 2006, she wrote a laudatory blurb for the dust jacket. Previously, when David Theroux and I made plans to launch a new journal, The Independent Review: A Journal of Political Economy, in the mid-1990s, we invited Anna to become a member of the journal’s board of advisors, and she graciously agreed to do so.

Over the years, as I moved away from monetarism and toward Austrian economics, I found myself in growing disagreement with Friedman and Schwartz in regard to monetary theory in general and the causes of the Great Depression in particular. At no point, however, did I lose my great respect for Anna as a scholar and as a person. Anyone inclined to dismiss her work with an offhand quip about the wrongheadedness of monetarists has almost certainly never plowed through the painstakingly constructed footnotes and appendixes in Anna’s books. I once taught a graduate seminar at the University of Washington in which A Monetary History of the United States served as the core text, to be read in its entirety, and I assure you that the able students in this seminar had their hands full to overflowing, as did their professor. In this book we find careful, intelligent historical research displayed at its very best. Stunningly impressive as the 859-page A Monetary History may be, however, it certainly was not the only thing Anna produced, by a long shot.

Anna remained a productive researcher for decades longer than most of us ever will. Just three years ago, I was in the audience for a New York conference at which she, in her capacity as a discussant, leveled scathing criticism at the Fed’s mismanagement of monetary policy before and after the 2008 financial debacle. Although she was physically frail and needed assistance in entering and leaving the conference room, her mind was definitely firing on all cylinders, and she injected real passion into some of her critical remarks. Even in her nineties, she continued to learn, to reconsider her views, and to remain engaged in the key economic debates of the day.

If ever an economist fought the good fight, Anna certainly did so. Although her work tended to be overshadowed because of her having worked so often jointly with the world-famous Milton Friedman, she more than pulled her share of the load in their joint work, and we may hope that in time her contribution to twentieth-century economics and especially to economic history will receive its just recognition.

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Posted on: Thursday, June 21, 2012 - 19:43

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Social Science 101: Three Ways to Relate to Other People

Many years ago, in a book I’ve lost along the way (I believe it was A Primer on Social Dynamics), Kenneth Boulding described three basic ways in which a person, in the quest to get what he seeks, can approach other people. He can, as it were, say to them:

(1) Do something nice for me, and I’ll do something nice for you.

(2) Do something nice for me, or I’ll do something nasty to you.

(3) Do something nice for me because of who I am.

The first approach is that of peaceful, mutually beneficial exchange, of “you scratch my back and I’ll scratch yours,” of positive reciprocity. It is the method by which we conduct the bulk of our economic affairs.

The second approach is that of coercion, of threats to harm others unless they do as we wish, regardless of their own preferences. This is, among other things, the realm of government as we know it. When we say government, we say violence or threats of violence against all who refuse to comply with the rulers’ dictates.

The third approach is that of personal-identity relationships. One person says to another, do what I want you to do because of who I am and who you are—because, for example, I am your father or your teacher or your kinsman.

Boulding argued that all social systems are a blend of these three types of interaction among its individual members. Part of the difficulty of understanding how societies operate arises from the complex ways in which these three types of relationship become entangled with one another and how the nature of this complexity changes over time.

Boulding was an unusually broad-gauge thinker. For him, interdisciplinary thinking came easily. But for most contemporary social scientists, it comes not at all. Most economists think about how markets work, about exchange, and about all of the good and bad consequences the operation of markets may bring about. Most political scientists think about government and politics (the quest for possession or control of coercive power), and about all of the desirable and undesirable consequences of political actions. Identity relations tend to fall within the disciplinary boundaries of psychologists, for the most part. This narrow scholarly specialization has both benefits and costs. However, because professional fame and fortune flow mainly to the most outstanding specialists, the brightest people tend to specialize narrowly. There is a reason why hardly anyone outside a particular subfield of economics knows anything about the work of each year’s Nobel laureate in economics. If the labor economist knows little or nothing about monetary theory or international trade, even less does the average economist know about political science or psychology.

One area in which I have found a broader appreciation, along the lines of Boulding’s three approaches, to be essential has been in my study of ideology. This concept, developed most fully by psychologists, philosophers, and political scientists, plays a fundamental role in my explanation of the growth of government in the United States during the past century or so. My thesis is sometimes described as a “crisis theory,” but I have been at pains to explain that national emergencies would not have played out as they did had fundamental ideological changes not occurred beforehand as they did. National emergencies give rise to spurts of growth in government’s size, scope, and power that are not fully rescinded afterward—that is, they have a “ratchet effect”—only in the context of a widely entrenched collectivist ideology.

Modern collectivist ideology in the United States (and probably in many other countries, as well) is infused with another ideology, namely, nationalism. This ideology has been developing in the West for centuries, but it reached its most consequential and destructive heights only in the twentieth century, when German (international) socialists marched off by the millions to die for the fatherland in World War I, and Americans ostensibly devoted to individual liberty marched off by the millions to fight and die in the U.S. state’s foreign wars.

One might say that these men acted as they did simply because they were drafted or threatened with a draft, but that claim must be placed in the wider context of these men’s submission and involuntary service. Until recent decades, very few men fought because the military paid better than their civilian alternative, but many private contractors came forward to equip and arm these men for fighting only because they found the prospective payoff attractive. The draftees faced a choice between army and prison, so coercion certainly played a vital part in inducing them to report for military service as ordered. Yet many more might have evaded or avoided the draft had their identities been different. Many considered themselves to be, above all, Germans or Americans, and as such they felt that they should obey the national government’s draft call. To do otherwise would be to betray their very self-identity, not to mention the hostility and ostracism they might expect to elicit from family members, friends, and neighbors psychologically wedded to the same nationalism. Thus, the creation and supply of massive armies illustrate well how exchange, coercion, and ideology/identity factors combine and interact in bringing about a definite social outcome.

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Posted on: Wednesday, June 13, 2012 - 17:21

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Politics and Markets: A Highly Misleading Analogy

Proposition: Putative “public demand,” especially as expressed by voting, drives the political-governmental system. Elected officials and hence the bureaucracy subordinate to them may be viewed as perfect agents of the electorate.

Adherence to this proposition characterizes the bulk of all analysis dealing with the growth of government in the West, regardless of analytical tradition or ideological leaning. (Specific citations seem unnecessary, but see virtually any issue of Public Choice, as well as the widely cited articles by Meltzer and Richard [1978, 1981, 1983], Peltzman [1980, 1984, 1985], Becker [1983, 1985], and Borcherding [1977, 1985]. The most recent and most extreme contribution along these lines is by Wittman [1989].)

This approach displays a professional deformity related to the economist’s basic tool of analysis―the theory of markets, with its component theories of demand and supply. Economists, applying their familiar tools to the analysis of politics, immediately look for analogues. What is the “good” being traded? Who is the “supplier,” and who is the “demander”? What is the “price”? The answers seem obvious to economists. Public policy is the good; the elected legislators are the suppliers; the voters are the demanders; votes are the currency with which political business is being transacted. Thus, voters “buy” the desired policies by spending their votes; the legislators “sell” policies in exchange for the votes that elect them to office. (See Benson and Engen 1988 for a straightforward application of such analogues.)

Economists view consumer demand in ordinary markets as ultimately decisive for the allocation of resources; hence, they speak of consumer “sovereignty,” thus importing a political metaphor into economics. Applying their familiar apparatus of thought to politics, economists tend to think that the political system ultimately gives the voters what they want. In the words of the authors of a recent survey of economic theories of the growth of government, “Voters decide which goods the government will provide and which negative externalities the government will correct” (Garrett and Rhine 2006, 18, emphasis added). Therefore, if the government grows, it does so because that is what the people want (Musgrave 1985, 306; Stiglitz 1989, 69). Demand creates its own supply. Voting is ultimately all that matters for determining the growth of government. As Dennis Mueller has observed, “In the public choice literature the state often appears as simply a voting rule that transforms individual preferences into political outcomes” (1987, 142).

It is easy—and probably healthy—to mock this view of the political process. Joseph Schumpeter called it “the perfect example of a nursery tale” (1954, 429). There are, after all, many significant differences between ordinary markets and the “political market” (Higgs 1987a, 14–15; Boudreaux 1996, 115–19). Even Benson and Engen, adherents of this model, describe their output variable as “somewhat artificial and very restrictive” and their price variable as “clearly an incomplete proxy” (1988, 733, 741).

Not least of the problems is that voters rarely vote directly for or against policies. Rather, they vote for candidates who run for office. Winning candidates subsequently enact a multitude of policies, many of which neither the voters nor their representatives had considered at the time of the campaign. It is not enough that voters know something about office seekers’ general ideological reputation (à la Dougan and Munger 1989); the devil is in the details. Besides, notwithstanding the elaborate theoretical and econometric attempts to show that politicians are perfect agents (Becker 1983, 1985; Peltzman 1984, 1985; Wittman 1989), we can easily demonstrate that political representatives frequently act in ways that must necessarily run counter to the dominant preference of their ostensible constituents. We see this disconnect in the U.S. Senate, for instance, every time the two senators who represent the same state split their votes—and such splitting occurs commonly (Higgs 1989c). Remarkably, and quite damningly for models that presume tight linkages between voters and their elected representatives, many of the vote-splitting senators are reelected time and again. So elections are reliable neither as an ex ante check nor as an ex post check on the substantial autonomy of officeholders.

Perhaps the most important case in which legislators and other officials (including many nonelected functionaries) act independently of control by the voters concerns political action during crises. How many voters could possibly have known in the election of 1940 what the elected federal officials would do during their upcoming terms in office, which were to include, depending on the office, some or all of the years of World War II? How many voters in the election of 1972 had any idea how they wished their representatives to deal with the “energy crisis” of 1973–74 or even that such a crisis would arise? Who anticipated that George H. W. Bush would send U.S. troops to the Persian Gulf to eject the Iraqis from Kuwait? How many, when they cast their ballots for George W. Bush in 2000, anticipated the military invasions and the long, bloody occupations of Afghanistan and Iraq? During crises, government officials, lacking any reliable means of discovering dominant constituent preferences, necessarily exercise considerable discretion. But even if leaders cannot know what “the people” desire, they act nevertheless, often in dramatically important ways.

Once those actions have been taken, the course of events is changed irrevocably in a world of path-dependent historical processes (Brennan and Buchanan 1985, 16, 74; Higgs 1987a, 30–33, 57–74). (Rasler and Thompson [1985] confirm statistically, using Box-Tiao tests, the increasing growth of government spending associated with participation in global wars.) If U.S. voters in 1940 had preferred that the nation not go to war, it was too late to rectify the legislators’ mistake in the election of 1942―the fat was already in the fire. If they preferred the removal of U.S. troops from Iraq in 2004, they were out of luck because neither candidate for the presidency espoused that alternative.

Further, political actions are usually accompanied by carefully crafted rationalizations, excuses, and propaganda emanating from the politicians and their friends who initiated or supported the actions. (How often do politicians admit policy mistakes?) From this vantage point, it is easy to see how political preferences, public opinion, and even the dominant ideology may be altered, becoming more congruent with what has been done and thereby reversing the direction of causality usually assumed in political models. (On ideology and policy as interactive, see Higgs 1985, 1987a, 67–74, 1989b, 96–98, 2006, 202–5.)

*****

Source: The foregoing is a slightly revised version of material that appears in my book Neither Liberty Nor Safety (2007), pp. 41-43, and, in a still earlier version, in my article “Eighteen Problematic Propositions in the Analysis of the Growth of Government,” Review of Austrian Economics 5 (1991): 3-40. Readers who would like to find complete citations for the references cited here can find most of them in the RAE version, which is available online, the others in my book.

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Posted on: Thursday, June 7, 2012 - 17:47

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Axioms of Political Geometry

1. Straight talk cannot get a politician from a current point A to the point B at which he really wishes to arrive.

2. To extend a growth-of-government line, project it indefinitely in a line straight to hell.

3. To describe how politicians approach the real solution to a social or economic problem, trace the circle described by a fixed radius of substantial length from the solution point.

4. All right and left angles are morally equal to one another.

5. Politics and morality are parallel lines and never meet.

6. Democratic and Republican policies that are essentially equal to the same thing are also equal to one another.

7. If equal amounts are added to the government’s debt by Republicans and Democrats, the increases in the debt are equally inconsistent with the general public interest (if any exists).

8. If equal amounts of economic rationality are subtracted from economic policy, then the number of incumbents reelected to Congress is equal to the number reelected in the previous election.

9. Politicians who coincide with one another, such as Republicans and Democrats who support “bipartisan” measures, are equally dishonorable.

10. The whole of society is greater than the part that government officials can comprehend, and much greater than the part that they can manage for the attainment of a desirable end.

11. The path of political evolution is spherical and expanding: any course of political events brings society back to the point at which it started, but upon its return, the problem has been made much worse.

12. The shortest distance between a free society and a totalitarian society passes through war.

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Posted on: Monday, June 4, 2012 - 21:19

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Want to Rip Off Your Neighbor? Form a Government

Facts of the case: My wife and I live in an area with one neighbor nearby. One day, I knock on my neighbor’s door and demand that he give me $10,000. He wants to know what the devil I am talking about.

I explain that the people—most of them, in any event—in our area have seceded from St. Tammany Parish, the state of Louisiana, and the United States of America and formed a new government whose territory comprises his property and ours. We have also written and ratified, with our own votes of approval, a constitution for the new country, which we have decided to call Southland. We have also conducted elections in which a 2/3 majority of the eligible voters elected Elizabeth and me to fill all of the new government’s offices, including tax collector (I won this vote myself).

My neighbor protests that he has never heard of any of these developments and wants nothing to do with them, to which I reply that he has no choice in the matter because the constitution of Southland gives its government the power to tax, I am the duly elected tax collector, and he is at fault for not following the news more closely and not participating in public affairs. Moreover, the constitution provides for an army to enforce Southland’s laws (I have been duly appointed chief of staff), and if he refuses to pay his tax, the authorities will have no choice but to use violence against him to compel payment.

He protests that this whole scheme is madness, that I have gone mad, too, and that he will not give us a dime. Elizabeth and I then form up the ranks of Southland’s army: I constitute the infantry, armed with my trusty shotgun, and she leads the army band, which consists of herself with her flute. We march to our neighbor’s house and threaten to kill him if he does not give us the $10,000 tax (authorized in a statute enacted by Southland’s new government). When he decides that a $10,000 loss is better than being killed by violent maniacs, we march home to the Treasury (it’s at our house) with our revenue—a sum whose use will be determined by the Southland legislature, in which Elizabeth and I are the duly elected lawmakers.

Question for the student: Except with regard to scale (and voting by a woman), how does the preceding account differ in any essential way from the situation brought about by the formation of the United States of America? (Hint: look up Whiskey Rebellion or read something that challenges the orthodox history of taxation.)

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Posted on: Monday, May 7, 2012 - 14:59

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The Systematic Organization of Hatreds

In the mid-1970s, I began to do consulting work in addition to my academic work. By that time, I had become familiar with how economists generally analyze cooperation and competition, in both the economy and the political realm. Economists put great weight on gains from trade. Nobody, they like to say, walks past a $20 bill he sees lying on the sidewalk. If a situation contains the potential for a trade or other arrangement that will bring gain to a decision-maker, he will embrace that trade or arrangement. This market process leads, in the theoretical extreme, to the happy condition known as the Pareto Optimum—the situation in which all potential gains from trade have been captured.

Notice that this view of mankind causes us think of people as self-interested, but not as vicious. Individuals are seen as, in effect, indifferent to the welfare of their trading or cooperating partners, but intent on making themselves as well-off as possible. They do not seek to harm others, but only to benefit themselves (and those about whom they happen to care).

As I launched into my consulting work, which involved various efforts by Washington state and the U.S. government to resolve disputes and to increase the harvestable resource in the Washington salmon fishery and the federally-regulated offshore salmon fishery in the Pacific Ocean, I quickly learned that the politicians in Olympia did not fit the model I had mastered in my education as an economist. To be sure, they sought to feather their own nests, by hook and by crook. But, in many important cases, they acted simply to hurt their political and personal enemies—whose ranks, in some cases, were quite large. Often, it seemed, Mr. P was clearly “out to get” Mr. Q, and he was not simply seeking this objective, other things being the same; he was actually out to get Mr. Q even if he had to bear a cost in doing so.

So, despite the formal models and informal rhetoric that economists and other academic specialists wield in their research and writing about politics and government, a critical element tends to be completely overlooked: the powerful role of aversion, dislike, and hatred. Economists represent individual preference orderings as rankings of valued options: good thing A > good thing B > good thing C, and so on. But for political actors, the preference ordering often looks more like: good thing A > hurt person X > good thing B > hurt person Y > good thing C, and so on.

This sort of preference is the political sentiment Vladimir Lenin expressed when he remarked: “My words were calculated to evoke hatred, aversion and contempt . . . not to convince but to break up the ranks of the opponent, not to correct an opponent’s mistake, but to destroy him.” Closer to home, Henry Adams observed that “politics, as a practice, whatever its professions, has always been the systematic organization of hatreds.”

We see the importance of this element of politics clearly in the contemporary conflict between Democrats and Republicans. Given that these two parties are but two wings of the same predatory one-party state that rules the United States, we might well wonder why their intramural feuding often reaches such vitriolic extremes. The short answer is that despite the two parties’ general similarity of fundamental positions, they comprise somewhat different sorts of people—different in regard to religious conviction (or the lack thereof), typical social position, culture, background, occupational distribution, urban-rural composition, and ethnic makeup, among other things—and the two groups tend to dislike each other; indeed, in many individual instances, they despise one another. And their political representatives, though more inclined to conspire and cut deals with the other side, also represent their supporters along the hatred dimension. Occasionally, when a politician does not realize that the microphone is live, we hear some honest expression of his true feelings about his political opponents—“enemies” is the more accurate word.

In view of the foregoing, we are well advised to consider that whenever we seek to move a type of decision-making from private life to the realm of politics and government, we are very likely moving it from a world in which hatred is incidental and avoidable to a world in which hatred is central and inescapable. Because a government imposes one rule, one outcome, one state of affairs on everyone subject to its rule, the hatreds that go into the making of that outcome become generalized and infused throughout the entire society. Thus, what economists label a “public good” is often, in the most substantive way, a “public bad.” Even if a person does not share any of the component hatreds that politic actors express and deploy, no one can avoid living in a politicized world fashioned in such large part by the organized expression of hatred. It is, therefore, small wonder that some of us view the entire apparatus of politics and government as the living embodiment of evil.

Even a devout Christian has no small difficulty in following Christ’s admonition to “love your enemies and pray for those who persecute you.” But when we live and act in the private realm, we can make our best attempt to love others or at least to tolerate them in peace, and we have many options for avoiding or running away from hateful people and situations; occasionally we may even be able to lead someone, or ourselves, to substitute love, or at least understanding, for hatred.

In politics and government, however, the institutional makeup fosters hatred at every turn. Parties recruit followers by exploiting hatreds. Bureaucracies bulk up their power and budgets by artfully weaving hatreds into their mission statements and day-to-day procedures. Regulators take advantage of artificially heightened hatreds. Group identity is emphasized at every turn, and such tribal distinctions are tailor-made for the maintenance and increase of hatred among individual persons who might otherwise disregard the kinds of groupings that the politicians and their supporters emphasize ceaselessly.

With a sigh, many people accept that politics and government are, at best, necessary evils. I have great doubt that they are necessary, at least in their present form, but I am certain that in this form they are evil.

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Posted on: Sunday, May 6, 2012 - 19:27

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"The Current Models Have Nothing to Say"

In the 2011 annual report of the Federal Reserve Bank of Dallas’s Globalization and Monetary Policy Institute, we find a report on the 10^th annual Advances in Econometrics Conference, sponsored jointly by the institute and the department of economics at Southern Methodist University. This conference focused on dynamic stochastic general-equilibrium (DSGE) modeling.

As the report notes,

DSGE models have become an essential part of economists’ empirical toolkit in recent years. These models have their origins in the seminal contributions of Kydland and Prescott (1982) and Long and Plosser (1983), which revolutionized empirical econometrics. . . . Subsequent work by Christiano, Eichenbaum and Evans (2005) and Smets and Wouters (2007) laid the foundations for these models to become the workhorse frameworks for policy analysis in most central banks.

After describing the papers presented at the conference, the report concludes:

The conference confirmed that New Keynesian DSGE models are useful tools for understanding business fluctuations in closed and open economies and also for thinking about important monetary policy questions. However, the current models have nothing to say about how the financial system impacts the real economy; given the events of the past few years, that must now be a top priority for research. Also, to date, there have been relatively few attempts to develop open-economy versions of these models . . . . With globalization defining the environment in which monetary policy is now made, models that take seriously international trade and financial linkages will be crucial to the policy process. (emphasis added).

For mainstream economists, reports of this sort are commonplace. They nod in agreement: yes, we’ve got some fine models, but much work remains to be done to develop them and, perhaps someday, to make them applicable to economic reality. No rush, though. We need only keep the grant money flowing to the researchers and their institutions.

People outside this protected enclave of idiot savants, however, might well be astonished to learn that “the workhorse frameworks for policy analysis in most central banks . . . have nothing to say about how the financial system impacts the real economy” and in most versions are inapplicable to the analysis of events in a globalized economy.

Some readers may recall how, a few years ago, the recently announced Nobel laureates in economics, having been asked by journalists for their views on various pressing issues related to the current economic crisis, seemed to be struck dumb by the questions. They really had nothing to say, because their work as economists pertains to building models that make no genuine contact with economic reality. Such has been the ultimate result of the methodological revolution that began in economics between the world wars and swept the field in the 1950s, transforming mainstream economics, especially macroeconomics, from a serious effort to understand economic reality to an extended exercise in mathematical diddling with only a nominal connection to economic reality.

Small wonder that when the economic crisis hit in 2008, mainstream economists seemed dumbfounded by its occurrence and at a loss as to what might be done about it—except to retreat to the basic Keynesian nostrums that elementary textbooks had been serving up to beginning students since Paul Samuelson’s revolutionary text appeared in 1948. A trainload of advanced research in macroeconomics seemed, in the crunch, to avail these mathematical wizards nothing at all—which was to be expected, because macroeconomics had long since severed its connections with economic reality, its practitioners preferring to monkey with models, all the while telling themselves and their students that real scientific understanding and optimal economic policies lay just beyond the research horizon.

What a waste of time and talent

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Posted on: Thursday, March 22, 2012 - 18:57

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The Specter of Centrally Planned Economic Fascism Continues to Hover over the United States

During World War II, the U.S. government created and operated a system of fascist central planning. (I have described this system in my books Crisis and Leviathan and Depression, War, and Cold War.) After the war, much of this system was abandoned, but it was revived in large part during the Korean War, and it was retained afterward in the form of statutory authority for its reinstatement whenever the president might so order under the authority of the Defense Production Act of 1950, as amended. As I wrote in Crisis and Leviathan (p. 246), after the Korean War “[t]he wartime wage-price and production controls lapsed, although the authority to reinstate the production controls remained”—that is, the Defense Production Act was never repealed, and it has been in force continuously since its initial passage, though amended from time to time. Under this statute, the president has lawful authority to control virtually the whole of the U.S. economy whenever he chooses to do so and states that the national defense requires such a government takeover.

The latest executive order to stipulate in detail how the president will exercise these standing powers over energy, transportation, human resources, raw materials, and so forth—stating in particular the subordinates to whom he will delegate various specific powers, among other things—was issued last Friday, March 16, 2012. It shows plainly that private control of economic life in the United States, to the extent that it survives, exists solely at the president’s pleasure and sufferance. Whenever he chooses to put into effect a full-fledged operational fascist economy, controlled from his office, he has the statutory power to do so; all he has to do is to murmur the words “national defense” and give the orders. In this regard, as Paul Bengala’s infamous saying puts it, “stroke of the pen, law of the land, kinda cool.”

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Posted on: Tuesday, March 20, 2012 - 19:53

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Likely Fiscal and Monetary Legacies of the Current Crisis

I am not a prophet, nor do I play one on TV. Nevertheless, I will hazard some conjectures here about certain likely legacies of the current crisis. I focus on fiscal and monetary matters. In a future post, I will deal with regulatory and ideological matters. I will try to avoid mere guesses or hunches about what the future will bring. Instead, I will try to proceed in the spirit that Joseph Schumpeter expressed seventy years ago:

What counts in any attempt at social prognosis is not the Yes or No that sums up the facts and arguments which lead up to it but those facts and arguments themselves. . . . Analysis, whether economic or other, never yields more than a statement about the tendencies present in an observable pattern. And these never tell us what will happen to the pattern but only what would happen if they continued to act as they have been acting in the time interval covered by our observation and if no other factors intruded. (Capitalism, Socialism and Democracy, p. 61)

My speculations rest in part on my past analyses of national-emergency crises and the ratchet effects they produced in various dimensions of economic, social, political, legal, institutional, and ideological life in the United States. We have no assurance that past patterns will continue to prevail in the aftermath of the current crisis, but several broad similarities to this point suggest that we may not be entirely misled if we look to the past as a rough guide to the future.

Certainly one of the most important features of the present crisis is the large increase in federal spending. Between fiscal years 2008 and 2009, net federal outlays increased by almost 18 percent. Outlays dipped slightly in fiscal 2010, but rose again in 2011, reaching a level almost 21 percent greater than the level in 2008. Viewed in the context of the growth of outlays in the decade before the onset of the full-blown crisis in the fall of 2008, outlays since that time appear to have ratcheted up to a higher trajectory, about $300 billion or more above the amount they would have reached if the pre-recession trend had prevailed since 2008. Of course, outlays might eventually converge to their pre-recession trend line, but if so, they would be departing from the pattern followed in previous crises since World War I.

While federal outlays were increasing rapidly, federal revenues were falling equally rapidly. Between fiscal years 2008 and 2009, federal receipts declined by almost 17 percent because of the decline in income and employment. The upshot was that the federal budget deficit exploded, rising from slightly more than 3 percent of GDP in 2008 to about 10 percent of GDP in 2009. Therefore, the government had to borrow about $1.4 trillion in fiscal year 2009. Continued deficits of more than a trillion dollars in each of the following years have sent the public debt skyward almost like an ICBM taking off. As the figure below shows, the debt has increased by about 100 percent in less than five years (between January 2007 and July 2011). Projections indicate that federal debt will certainly continue to increase rapidly in the near term, notwithstanding frequent political promises to bring down the annual budget deficits.

The government’s rapid run-up of debt has proved possible notwithstanding the extraordinarily low yields on its securities for two main reasons. The first is that foreigners, who in many countries had to contend with monetary and fiscal policies just as bad as or even worse than those in the United States, fled the uncertainties of their own situations for the relatively safe haven of U.S. government securities as a means of protecting at least the bulk of the capital value invested. As the chart below shows, federal debt held by foreign and international investors increased from about $2.2 trillion at the beginning of 2007 to more than $5 trillion in October 2011—an increase of 127 percent in less than five years. As a result, such investors now hold almost half of the federal debt in the hands of the public.

In view of the currently negative real yields on most U.S. Treasury securities, foreign holders may well desire to terminate their purchases as fear subsides and government policies are improved in their home countries and as prospects dim for the dollar’s exchange value—that is, the accumulations occasioned by the foreigner holders’ “flight to safety” may be drawn down. If the Treasury loses its usual horde of foreign buyers, it may find itself hard pressed to finance its huge annual deficit without substantial increases in the yields of its bonds.

Pressed between the rock of unwilling bond buyers and the hard place of paying higher rates of interest, the government may well turn to the bottomless pit known as the Federal Reserve System. Indeed, it has already done so in recent years in a big way. As the chart below shows, the Fed first drew down its holdings of Treasuries at the onset of the crisis in swaps and other arrangements aimed at bailing out banks and other institutions that found themselves holding private and agency (GSE) securities with shrunken and in many cases extremely uncertain values. In 2009, however, the Fed increased its holdings of U.S. government securities from $492 billion in the first quarter to $769 in the third quarter. In the latter part of 2010, the Fed began another rapid buildup of its Treasury holdings, and by the third quarter of 2011, it held about $1,665 billion, or an amount equal to roughly 17 percent of the amount in the hands of the public. These two surges pushed the Fed’s portfolio of Treasuries to more than twice the amount it held before the onset of the crisis.

When the government sells bonds and the Fed acquires government bonds, the effect is the same as printing money and handing it to the Treasury. If we view the Fed as a part of the government, which for many purposes is the most appropriate way to view it, the operation is tantamount to the government’s issuance of “greenbacks” (U.S. Treasury notes) during the War Between the States. This sort of action has great potential for general price inflation, and even if significant price inflation does not occur, as it has not during the present crisis so far, the partial (or “other things being equal”) effect of such increases in the monetary base is to diminish the value of previously existing dollars. The chart below shows that the monetary base—roughly the amount of currency plus commercial bank reserves in the Federal Reserve Banks—has ballooned since late 2008, increasing by 211 percent between September 10, 2008, and March 7, 2012.

As the chart also shows, the monetary base had changed slowly and steadily before the current crisis, and the Fed’s actions that caused its explosion during the past three years have no precedents in nature or magnitude. Indeed, if a monetary economist had been given (by divine miracle) a preview of the chart above in, say, 2007, he would probably have concluded that the Fed’s managers were destined to go mad in the near future. I daresay no economist expected such an action (or set of actions). Now that it has occurred, however, it places the Fed in an unprecedented—and extremely dangerous—situation.

So far the potential hyperinflation that this explosion of the monetary base might normally have been expected to produce has not occurred because the banks have simply absorbed almost all of it in the form of increases in their reserve balances at the Fed. As the chart below shows, commercial banks historically held their excess (that is, not legally required) reserves close to zero, because such reserves had no yield and hence entailed an opportunity cost equal to the yield the banks could realize by using those funds to make loans and investments. With the onset of the crisis, however, the demand for bank loans has fallen greatly and the banks’ fears about the safety of loans and their worries about their balance sheets have grown, with the result that as the Fed has pumped money into the financial system by purchasing securities, the sellers have deposited the proceeds of those sales in their banks accounts and the banks have parked the money at the Fed, which sweetened the deal slightly, beginning in late 2008, by paying a small rate of interest (which soon settled at 0.25 percent). Thus, more than $1.5 trillion now sits in excess reserves at the Fed.

Because the banks have acted so bizarrely during the past three years, the money stock has not grown very much. As the chart below shows, M2 increased substantially during the macroeconomic contraction, then leveled off in late 2009 and early 2010 before resuming a more rapid rate of increase in late 2010. Between September 29, 2008, and February 20, 2012, M2 increased by 22.6 percent. This increase in just 41 months is not negligible, but it is only a tiny fraction of the increase that would have occurred if the banks had acted in a normal way during this interval.

The increase in M2 that has occurred since the onset of the recession has had little effect on the general price level because the public’s demand for money to hold has increased substantially. Equivalently, we may say that the velocity of monetary circulation—the ratio of GDP to money stock—has fallen substantially. As the chart below shows, M2 velocity has fallen by about 16 percent since the recession began, and it now stands at the lowest value it has attained since the 1950s. We live in unusual times, indeed. An increase in the public’s demand for money to hold also occurred in previous postwar recessions, but not to the extent that it has occurred recently.

In view of the foregoing evidence, what should we conclude about the likely fiscal and monetary legacies of the current crisis? First, the federal government is unlikely to reduce the budget deficit very much as long as it can continue to sell its bonds at anything near their current high prices (and consequently low yields). Even if foreigners grow skittish about the dollar’s exchange value or regain their courage enough to make more investments in their home countries rather than parking their money in Treasuries, the government will continue to run extraordinarily large budget deficits—and therefore to sell extraordinarily large amounts of bonds—as long as it can sell its debt to the Fed; that is, as long as it can effectively monetize the debt.

The Fed shows complete willingness to continue bankrolling the Treasury. The Fed’s gigantic accumulation of Treasuries—more than $1 trillion in the past three years—speaks much louder than anything Ben Bernanke might say about an “exit strategy.” Indeed, the Fed seems to have painted itself into a corner. If the public begins to wind down its current extraordinary demand for money to hold and pushes the velocity of monetary circulation back toward its pre-recession levels, the Fed will face accelerating general price inflation. To slow this inflation, it will need to sap money from the financial system. But how can it simultaneously withdraw money (to slow inflation) and inject money (via purchase of new federal debt)? Moreover, as the commercial banks begin to feel more comfortable about their balance sheets, they may dive into their mountain of excess reserves at the Fed and increase the volume of their loans and investments, which will add additional fuel to the fire breaking out because of increasing monetary velocity. How the Fed will resolve this dilemma I do not know. At present, the Fed’s managers talk as if the problem either does not exist or will be easy to deal with when the need arises, but such talk amounts to whistling past the cemetery.

The ratchet in the government’s outlays probably will not be eliminated in the near or intermediate term. The president, Congress, and the leadership of both major parties are firmly wedded to the government’s spending as much as it can get away with. Political leaders talk about reining the government’s profligacy, but their actions belie their words. Every cow in the budget turns out to be sacred when someone tries to wield an ax.

The prospect in the aftermath of the crisis—which, to be sure, is not yet over and may take a nasty second-dip before it ultimately passes—is for significantly bigger government in fiscal terms (and, as I shall argue elsewhere shortly, in regulatory, statutory, and ideological terms as well). Federal taxes may return to their postwar average of 18 percent of GDP, but with the federal government’s outlays stuck at 23 or 24 percent of GDP, we will have to endure deficits of 5-6 percent of GDP for a long time.

We will also have to endure a huge, ever growing amount of federal debt and, sooner or later, a grave threat that the Fed, in monetizing additions to the debt, will be unable to keep the lid on accelerating general price inflation. Therefore, probably the best we can hope for is stagnation: slow or no real economic growth, probably accompanied by chronically large numbers of unemployed and underemployed persons sustained in part or entirely at taxpayer expense. The worst outcome would be hyperinflation, which would be utterly ruinous. The most likely outcome in my view is for a long period of stagflation: little or no real economic growth, accompanied by troublesome (and probably quite variable) rates of general price inflation—something like the 1970s, though with less real growth. How this scenario fits into the currently more globalized economy is anyone’s guess. Much depends on how irresponsible foreign leaders will be in their policy actions—and we may count on most of them to be as horrible as possible. In these circumstances, Americans will have to put up not only with unsatisfactory performance of the economy, but also with great uncertainty about what the next quarter or the next year may bring. All in all, our most likely prospect seems fairly ugly, but with luck we may escape complete ruin.

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Posted on: Friday, March 9, 2012 - 10:51

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Cessation of Labor Force Growth since 2008

The United States has a long history of population growth and concomitant labor force growth. As the chart below shows, the number of men in the civilian labor force (men either working in paid employment or actively seeking work) increased fairly steadily over the past half-century—at least, until the onset of the current recession.

For the past five years, however, the number of men in the labor force has fluctuated around a fairly level trend line at approximately 82 million. This cessation of growth came on the heels of a 6-million-man increase during the previous seven years.

In the post-World War II era, the number of women in labor force grew even faster than the number of men, and also tended to grow fairly steadily. When the current recession began, the female labor force continued to grow, increasing by about a million women between the officially designated beginning and end of the recession (December 2007 - June 2009). In the second half of 2009, however, this grow stopped, and a slight reversal occurred, putting the total on a lower, fairly level trend line throughout 2010 and 2011, albeit still at a higher level than the female labor force had reached before the recession began.

Labor economists and others have been puzzling over what has happened. Although labor force growth tended to slow or even to halt momentarily during past recessions of the postwar era, the current cessation of growth has no precedent in that era, and hence analysts have found its explanation to be a challenge.

Whatever the answer(s), one thing is clear: unless the labor force resumes something like its historically normal growth, we cannot expect a resumption of historically normal economic growth. Labor inputs are major contributors to the production of goods and services. Increases in labor productivity are only a partial substitute unless the rate of productivity growth can be made much greater than observed historically over long periods.

One also wonders: how are the millions of people who normally would have been in the labor force occupying themselves? Who is supporting them? What are their expectations and plans? Their extended stay outside the labor force joins a number of other puzzling features of the present recession, during which the patterns of economic changes and policy responses have differed significantly from those observed during previous macroeconomic busts. We are living, as the cliche has it, in interesting times. Unfortunately, many of the developments that make these times interesting also make them worrisome.

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Posted on: Tuesday, March 6, 2012 - 20:11

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Short-term Employment Changes in Longer-term Perspective

Many commentators have noted in recent years that Americans have been leaving the labor force. Their departure has made interpretation of unemployment statistics more difficult, and because the Bureau of Labor Statistics (BLS) publishes six variants of the unemployment rate, considerable debate has occurred about the “real” rate of unemployment. Much of this confusion can be avoided by examining not data on unemployment, however measured, but data on employment, which are substantially less ambiguous.

When we examine the ratio of employment to population (reported by the BLS for the civilian noninstitutional population age 16 and over), we find that indeed the overall employment ratio has fallen considerably since the onset of the current recession. In 2007, the ratio for both sexes combined was about 63 percent. In 2008, it fell steadily, and by December it had reached 61 percent. In 2009, it continued to fall steadily, and by December it had reached 58.2 percent. At that point, it more or less stabilized at its recession low point, and during the past two years it has remained in the range 58-59 percent. The most recently reported ratio, for January 2012, was 58.5 percent.

As the chart shows, however, this ratio had been even lower between the late 1940s and the late 1970s. Starting in the mid-1970s, the employment-population ratio trended upward, increasing from about 57 percent to more than 64 percent by 2000. Note, too, that the ratio is pro-cyclical, rising during macroeconomic expansions and falling during macroeconomic recessions. The cyclical drop during the present recession has been larger than preceding ones, however, and it has also stuck at the bottom, whereas preceding declines were followed by quick rebounds.

The tendency of the employment-population ratio to rise during the last quarter of the twentieth century was driven entirely by an increase in the ratio for females. As the chart below shows, the employment-population ratio for women increased steadily from the late 1940s to 2000, rising from about 31 percent in 1948 more than 57 percent in 2000. It remained at a high level until the onset of the current recession, and between December 2007 and January 2012, it declined only from 56.5 percent to 52.9 percent.

The historical path of the employment-population ratio for men looks quite different. As the chart below shows, this ratio has been trending downward since the early 1950s—for roughly sixty years—although the downward trend was hardly noticeable during the quarter-century before the onset of the current recession. During this macroeconomic bust, however, the ratio for men has dropped precipitously, declining from almost 70 percent in 2006 to a low of only 63.3 percent in December 2009. Since then it has rebounded only slightly; in January 2012, it was 64.5 percent.

Thus, we see that the current recession has brought about an exceptionally steep drop in the ratio of employment to population for the entire civilian noninstitutional population age 16 and over, and that the decline has been roughly twice as great for men as for women. Both of these changes, however, should be viewed in a longer-term perspective, which shows that the employment ratio for men has moved downward for a long time, whereas the ratio for women has increased for a long time. Women have constituted a growing share of the total labor force for more than half a century, and during the present recession, that change has only surged further.

The changes described and depicted here have a variety of demographic, social, and economic causes, and labor economists and others have made great efforts to explain them. Such analysis lies outside the scope of this brief commentary. I hope, however, that the data alone contribute something toward the reader’s appreciation of recent and longer-term changes in U.S. employment.

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Posted on: Wednesday, February 29, 2012 - 12:15

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The Fed’s Immiseration of People Who Live on Interest Earnings

As I have noted previously, the Fed’s policy of acting to hold interest rates well below free-market rates in recent years has had the effect of greatly diminishing the earnings of people who rely on interest income. Such people include especially many retirees who do not wish to hold risky assets with substantial variability of earnings. In the past, many retired people have held the bulk of their wealth in the form of bank certificates of deposit, bonds, and bond-heavy mutual funds, hoping that their incomes would be secure and predictable when they were no longer working. The Fed’s actions in recent years have taken a heavy toll on such people’s earnings.

As the graph above shows, personal interest earnings rose substantially from 2004 to 2008, then dropped precipitously when the Fed’s new policies took effect in the last quarter of 2008. During the past year, such earnings have more or less stabilized in the neighborhood of $1 trillion. However, the present amount is approximately the same as the amount that was earned in the year 2000—eleven years ago.

These data, however, are given in nominal dollars, whose purchasing power has declined substantially over the past decade. As the graph below shows, the price index for personal consumption expenditures has risen since 2000 by approximately 28 percent. Therefore, the current flow of personal interest income has purchasing power equal to only about 78 percent of the purchasing power of the personal interest income earned eleven years ago. Of course, the decline since the peak in 2008 has been much greater—in the neighborhood of a one-third drop in real terms.

Defenders of the Fed historically have argued, among other things, that central-bank monetary policies have a sort of neutrality: they affect aggregate demand, the overall price level, and other macroeconomic variables, but they do not attempt to carry out the kind of micromanagement of the economy that Soviet-style central planning attempts. This argument has always been bogus because monetary policy was never—indeed, could not be—neutral. It always had differential effects on different classes of people and different sorts of economic activity, depending in part on who received new infusions of central-bank money first, second, and later in the process and on how these persons’ actions affected ongoing real economic processes. Nonetheless, defenders of the central bank might have argued that at least the Fed did not attempt in any direct way to determine definite changes in the distribution of income, either personal or functional.

Such defenses now ring unmistakably hollow. Even apart from the Fed’s entry into clear credit-allocation activities (e.g., buying mortgage-backed securities rather than Treasury bonds alone), it is plain that the Fed is acting in a way that impoverishes a definite class of persons—those heavily dependent on interest earnings for their income—and, moreover, that a policy of keeping interest rates on low-risk assets near zero must eventually wipe out such persons’ incomes completely. In that event, people who worked and saved over a working lifetime, taking personal responsibility for guaranteeing their self-sufficiency during their elderly, nonworking years, will be able to survive only at the mercy of the providers of private and public charity.

The link between the Fed’s policies and this undeniable effect is too direct and too obvious for anyone, including the Fed’s managers, to overlook or misunderstand. We may only conclude, then, that the Fed’s managers either (1) want to wipe out the retirees and others who rely heavily on interest earnings or (2) consider these people’s immiseration an acceptable price to pay in order to achieve other objectives. Can any decent person approve such policy making?

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Posted on: Friday, February 10, 2012 - 16:49

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U.S. Employment Woes Continue Despite Small Improvements

After the headline rate of unemployment (U-3) reached 8.5 percent in December 2011 ( the most recent month reported), some commentators began to talk as if the employment situation is now improving rapidly. Some have gone on to suggest that those of us who have emphasized the role of regime uncertainty in retarding the current recovery are now barking up the wrong tree, if indeed we ever had a valid point. To speak of employment woes as old news, however, is highly premature.

The Labor Department has recently made public its preliminary estimate of nonfarm employment for 2011. I have added the department’s data for previous years, back to 1999, to construct this table.

Employees on nonfarm payrolls, 1999-2011

(annual average, in thousands)

Year Total Private

1999...... 128,993 108,686

2000..... 131,785 110,995

2001...... 131,826 110,708

2002...... 130,341 108,828

2003...... 129,999 108,416

2004...... 131,435 109,814

2005...... 133,703 111,899

2006...... 136,086 114,113

2007...... 137,598 115,380

2008...... 136,790 114,281

2009..... 130,807 108,252

2010...... 129,818 107,337

2011(p).. 131,159 109,080

The good news is that private nonfarm employment has grown since its recent trough in 2010: the increase in 2011 amounted to 1.6 percent. This is not much, but it’s better than continued decline.

The bad news, however, is that private nonfarm employment in 2011 was still 5.5 percent, or 6.3 million persons, below its peak number in 2007. Moreover, looking back farther, one sees that private nonfarm employment in 2011 was less than the corresponding number in 2000. For private employment, the past ten years have been, indeed, a lost decade.

In contrast, private nonfarm employment grew by almost 22 percent between 1990 and 2000, and by almost 23 percent between 1980 and 1990. Americans need to understand that private employment is “where the babies come from.” Make-work jobs on the government payroll are not a good substitute. To keep the flow of genuinely valued goods and services growing at anything like the historical norm, private employment must grow substantially, at least over the medium term, yet in this regard the past decade has been a complete wash. Moreover, at the present rate of increase (1.6 percent per year), it will take almost 4 years just to get back to the private employment level in 2007, before the current recession began.

Stagnation or slow, on-again-off-again growth in the economy’s most important productive input is not the sort of thing of which sustained economic growth is made. Despite the recent, slight employment gains, the U.S. labor market is not even close to being out of the woods, nor is the overall economy, which continues to labor under major threats of government regulation, taxation, and other damaging intervention in the market process.

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Posted on: Friday, January 20, 2012 - 20:08

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Why Your Dog Doesn’t Own Your Entire House, and the Government Doesn’t, Either

I wrote recently about some views expressed by Elizabeth Warren and certain politicos of a previous era to the effect that the government has every right to take at least a big chunk of your earnings and, in some expressions, even your entire earnings for purposes the rulers stipulate.

Nearly ten years ago, the great political philosopher Anthony de Jasay wrote a charming little essay related to this matter called “Your Dog Owns Your House.” There, he spells out some of the ways in which such sweeping claims—by your dog or the rulers—are incoherent, absurd, and indefensible, and he sketches how to think more sensibly about the issue.

One sees upon even a small amount of reflection that the kind of reasoning advanced by Warren and her predecessors proves too much. Yes, if your dog did not ward off burglars, you might have lost all your household possessions; hence your dog’s diligence in some sense accounts for everything you have. Likewise, à la Warren and her ilk, if the fire department did not keep your town from burning to the ground, you would have earned nothing; hence your (government) fire department in some sense accounts for everything you have. And so forth for the police force, the army, the water department, the public health department, and all the others who provide an input without which your earnings would be zero—in the worst case, because you’d be dead. Because each such provider is essential to everything you produce, each has a claim to everything you produce. So the reasoning goes, at least.

Set aside for the moment the not-inconsiderable difficulty that if each has a just claim on everything you earn, all together they have a claim on a large multiple of everything you earn. For present purposes, however, let’s forget about Fido and lump all of the others together, again à la Warren and Co., as the “government,” whose contribution to your earnings is essential and therefore warrants a claim on everything you earn.

Even with this generous concession, a major difficulty remains: absent your effort, your earnings would also have been zero, notwithstanding the government’s contribution of all the infrastructure and protective services emphasized by Warren and others. No work, no product, no earnings. And you did, after all, do the work.

The error here is an old one in economics. It once plagued economists in their attempts to explain the distribution of the social product between suppliers of the various factors of production—land, labor, capital, and so forth, depending on the precise specification of factors. The puzzle was finally solved, more or less, by something known as the marginal productivity theory of distribution.

The operative word is marginal. Here, as in so many other places where erroneous economic reasoning crops up, the mistake comes from all-or-nothing thinking. In our case, no dog, no house; no fire department, no earnings; no police force, no earnings; and so forth, including, please recall, no work, no earnings. To make headway one must recognize that many inputs of services contribute jointly to the production of a good or service. But it is absurd to suppose that because each of them is essential—in the sense that if it were completely withdrawn, no product would be produced—each of them has a valid claim to the entire output.

The marginal productivity theory of distribution maintains that if each factor supplier is paid the value of the marginal product of the factor service provided, each will be rewarded in accordance with a coherent concept of the extent to which his factor supply accounts for the output, and together the rewards received by all factor suppliers will add up to exactly the amount of the output produced by the joint efforts of all. (This theory work perfectly only under the assumption of a particular production technology, known as constant returns to scale, but that difficulty does not invalidate completely the basic idea the theory expresses, especially in regard to marginal productivity as the key concept.)

This sort of explanation is known in economics as imputation theory. Among other things, it explains why factor values depend on (are “imputed” from) consumer valuations of final outputs, not vice versa, as the classical labor theory of value and other theories maintain.

In any event, an understanding of marginal productivity and imputation theory undermines the sort of facile claims made by Elizabeth Warren, leading politicos associated with the New Deal, and all too many others, both inside and outside the political apparatus. Of course, if the rulers can’t claim that they deserve everything you’ve earned by using this sort of bogus reasoning, they’ll surely come up with another equally bogus reason for doing what all rulers and their stooges seek to do—to plunder you to the fullest feasible extent.

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Posted on: Saturday, January 7, 2012 - 18:18

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Government Officials Want You to Know that Your Earnings Belong to Them

Elizabeth Warren, the Democratic candidate for the U.S. Senate in Massachusetts, recently created a media flap when she said:

There is nobody in this country who got rich on his own. Nobody. You built a factory out there — good for you!

But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police forces and fire forces that the rest of us paid for. You didn’t have to worry that marauding bands would come and seize everything at your factory, and hire someone to protect against this, because of the work the rest of us did. Now look, you built a factory and it turned into something terrific, or a great idea—God bless. Keep a big hunk of it.

But part of the underlying social contract is you take a hunk of that and pay forward for the next kid who comes along.

Conservatives and libertarians took offense at Warren’s claim that the government has a superior claim to “a hunk” of people’s earnings merely because every individual lives in and benefits from a society to whose creation many other people have contributed.

The critics might well have been grateful for small blessings, however. Warren was prepared, rhetorically at least, to let people keep “a big hunk” of their earnings.

U.S. government officials in earlier times were sometimes unwilling to admit that people had a right to retain any of their earnings, and forthright in their declarations that everything people possessed really belonged to the government.

Striking examples of such views may be found in the recently published book by Burton Folsom and Anita Folsom, FDR Goes to War. There the Folsoms present a meaty discussion of the congressional debate that occurred in 1943 in regard to bills eventually enacted in compromise form as the Current Tax Payment Act of 1943—the statute that, among other things, established income-tax withholding at the source. In that debate, the following statements were made in Congress:

Rep. Emanuel Celler (D-N.Y.)—The government can at any time make income taxes as thumping big as the necessities of war require. Thus, if any plan does not raise enough money, taxes can at any time be increased. The government always has a moral if not actual lien on all our income. (p. 200, emphasis added)

Sen. Happy Chandler (D-Ky.)—[A]ll of us owe the government; we owe it for everything we have—and that is the basis of obligation—and the government can take everything we have if the government needs it. . . . The government can assert its right to have all the taxes it needs for any purpose, either now or at any time in the future. (p. 200, emphasis added)

Rep. Wilbur Mills (D-Ark.)—The public, with money in its pockets, will inevitably try to use this money to buy what it wants, what it may need. . . . [T]o check the forces making for inflation, we must direct our tax policy toward diverting an ever larger part of the funds of persons above subsistence levels into the Public Treasury. (p. 201, emphasis added)

So, lighten up, small-government friends. Be grateful that you must contend only with Warren, and not with the likes of Celler, Chandler, and Mills. Maybe there is progress after all.

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Posted on: Thursday, December 29, 2011 - 14:05

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Why Do So Many People Automatically and Angrily Condemn Historical Revisionism?

Over the years, especially in writing for the general public, as opposed to my professional peers, I have been struck repeatedly by the frequency with which certain conclusions or even entire classes of conclusions elicit not merely skepticism, but angry denunciation. Again and again, I have been called a fool, a traitor, or an America-hater because of my commentaries on history and public affairs. Although I take no pleasure in these denunciations, I find myself not so much depressed by them as curious about them. I wonder why people react as they do, especially when my commentary rests—as I hope it generally does—on well-documented facts and correct logic.

I surely do not consider myself immune to errors, of course. But if my facts are incorrect, the critic has an obligation to say why my facts are incorrect and to state, or at least to point toward, the correct facts. If my logic has run off the rails, the critic has an obligation to state how I fell into fallacious reasoning. More often than not, however, the critic resorts immediately to name-calling and to wild characterizations of my statements and my person. Thus, I have often been called a socialist, a Marxist, a conservative, an apologist for corporations or the rich, a (modern left) liberal, or something else that by no stretch of the imagination properly describes me or my intellectual or ideological position.

Certain topics are virtually guaranteed to elicit such reactions. When I write about the welfare state and especially about government programs ostensibly aimed at helping the least-well-off members of society, I confidently expect that critics will assail me as a fascist or as an ivory-tower dweller who has no understanding of how poor people really live and no compassion for them. When I write about the Japanese attack on Pearl Harbor in relation to U.S. economic warfare in 1939-41, I invariably attract angry personal abuse from people of delicate nationalistic sensibilities, from those chronically on the look-out for traitors, and from those who cannot imagine that the nation’s leaders, in general, and President Franklin D. Roosevelt, in particular, might have deliberately provoked a Japanese attack or refrained from warning U.S. commanders in Hawaii that an attack was coming.

When people are offended or otherwise greatly displeased by historical analysis, they often employ the term “historical revisionism” as a synonym for falsified, distorted, or doctored accounts that fly in the face of what they, their history teachers, and perhaps even the most respected university historians believe to have been the case.

The irony of such use of the term “historical revision,” which makes it practically a swear word, is that revisionism is and always has been an integral part of historical research and writing. As a rule, professional historians do not seek simply to pile up more and more evidence for what historians already generally believe. Historians who proceed in this way cannot expect to make much of a name for themselves. Instead, historians try to find new evidence and new ways of interpreting old evidence that change the currently accepted view. That is, they seek to revise the current orthodoxy. In doing so, they need not be ideological mavericks, although those who are may have an additional reason for their revisionist efforts. In short, revisionism is an unremarkable aspect of workaday historical research and writing. Why then do so many readers go ballistic about it?

One reason why revisionists are sometimes seen as subversives stems from the tendency of historians in general to accept the most fundamental aspects of their own society as right and desirable. So, however much political historians may dispute the details of particular campaigns, elections, and policy-making by elected officials—and such disputation runs rampant, to be sure—one hardly expects these historians to conclude that the democratic process itself is little more than a snare and a delusion, a vast apparatus for fooling the masses into believing that they have genuine control over how they are ruled. And however much military and foreign-policy historians may argue with one another about how various wars were entered into and conducted, one hardly expects these historians to conclude that wars almost invariably hurt the mass of the people and benefit, if anyone at all, only the national leadership, its supporting elite, and a ragtag band of hangers-on (which includes, we might note, the “court historians”).

When a historian strays outside the 40-yard lines within which the bulk of the historical writing and teaching takes place, however, he is likely to be met with the dreaded accusation that he is not an honest, competent, or “respected” historian, but a revisionist—a writer who seeks to propagate socially destructive and utterly unfounded ideas in order to rend the fabric of national unity and undermine the nation’s virtues. Thus, one who challenges the standard account of Pearl Harbor can expect not simply to be disbelieved, but also to be personally condemned and vilified. Readers will say that he dishonors the brave men who gave their lives to preserve our freedoms, and so forth. Many people possess a loaded ideological gun with a hair trigger, and the slightest shake suffices to cause them to fire away. Moreover, they shoot first and reserve their fact-checking and more careful thought for later, if indeed they ever reach that stage.

One is tempted to suspect that such quick-draw reactions reveal an underlying lack of confidence in their own beliefs. If my views are so manifestly stupid and anti-social, why respond to them at all? Is it not more sensible to ignore them than to spend time in lavishing calumny on their author? In the age of the Internet, however, many people seem to get their kicks by denouncing and insulting anyone who offends their own sensibilities and their own cherished beliefs. Anyone who seeks examples of ad hominem arguments may easily collect them by the thousands and perhaps by the millions at the websites that feature news and commentary on public affairs. Every other species of logical fallacy may be found there in abundance as well, but my guess is that the ad hominem fallacy occurs more often than any other. Moreover, few people—even seemingly well-educated people—seem to be able to stay on point. So if a revisionist’s argument cannot be refuted, his critics freely set up and knock down straw men that they represent as the offender himself. Careful reading is not the most notable activity of those who engage in such flailing away. Many attackers do not even complete their reading, but begin their assault on an author immediately, after having read only a few sentences or paragraphs, as they sometimes admit.

Well, nobody ever promised the revisionist a bed of roses, especially if he challenges ideas that are widely accepted and valued. Americans want to believe that their nation is the greatest that ever was, that they themselves are better than other people in almost every way, including morally. They want to believe that at least some of their government leaders were virtuous and heroic, that their soldiers sacrificed more nobly than the enemy’s did, that their country is the last, best hope of humanity, blah, blah, blah. Much of this catalogue of taken-for-granted outlooks and beliefs is ludicrous, but woe unto the writer who laughs out loud at it. “Revisionist, revisionist!” the mobs will cry, expressing the demand that he “get out of the country” and the hope that every species of bad luck and personal misfortune will befall him. If I were one of those social psychologists who enjoy labeling any ideological trait they dislike as a form of mental illness, I might declare that the hair-trigger enemies of historical revisionism are a gaggle of sickos.

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Posted on: Thursday, December 8, 2011 - 13:38

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The Government Is Expropriating Private Wealth at a Rapid Rate

About a month ago, I posted in regard to what I called “the euthanasia of the saver.” This comment had to do with the fact that nominal interest rates in the United States for financial investments such as bank certificates of deposit and bank savings accounts—the kinds of investments traditionally employed by retired persons and small savers, who wish to gain income without exposing their funds to great risk of capital loss—now fall considerably below the rate of inflation, and hence the real (or inflation-adjusted) yield on such investments is negative. That is, the nominal payoff is insufficient to offset the loss of purchasing power of the money invested.

About a month before I wrote my commentary, my old friend Richard Rahn had, without my noticing, written on the same issue in a commentary article published in the Washington Times, but he had gone beyond the simple point I made. Rahn notes that besides suffering the loss of wealth occasioned by the negative real yield on such investments, the investor has to pay tax on the nominal yield—truly a case of the government’s adding insult to injury. He notes that given the currently prevailing the rates of interest, rate of inflation, and tax rate, a small investor who earns a nominal yield of 1% and pays a 20% marginal tax rate, while the rate of inflation is 3.5 %, actually ends up paying a real tax rate of 370%. For example, an investor buys a $100,000 CD, earns $1,000 in annual interest, pays a tax of $200, and incurs a loss of $3,500 in purchasing power on the invested principal. Total (nominal) income is $1,000; total real tax (nominal tax plus inflation tax) is $3,700.

This expropriation of private wealth is not accidental. It is the joint product of the Fed’s near-zero interest-rate policies, the Fed’s money supply increases that underlie the current rate of inflation, and the tax rates established by Congress and administered by the IRS, including the taxation of nominal interest earnings even when they amount to real losses of capital, rather than genuine earnings. The government clearly aims to expropriate private wealth on a massive scale. The only plausible alternative interpretation of these policies requires us to believe that the government officials who set these policies are complete idiots about basic economics.

The expropriation amounts to a huge sum. For example, the value of the Non-M1 component of the monetary aggregate M2—consisting of savings and small time deposits, overnight repos at commercial banks, and non-institutional money market accounts—currently amounts to more than $7.5 trillion. If investors lose 2.7% on this investment each year (nominal yield minus the sum of the amount lost via taxation of nominal interest and the amount lost via the inflation tax), the loss amounts to about $204 billion. Because this type of investment is not the whole of the investments subject to this effect, the total amount the government is expropriating comes to a much larger sum. Because this taking continues year after year, so long as current conditions persist the continuation of this expropriation for another year or two will bring the cumulative amount expropriated in this fashion to more than $1 trillion since the onset of the recession and the Fed’s adoption of the near-zero interest-rate policies, along with its allowance of substantial growth of the money stock and the consequent decrease in the money’s purchasing power. This is a rough calculation for the purpose of illustration. My point does not hinge on a precise estimate, because any well-founded estimate is sure to amount to a gigantic sum.

In sum, the government’s monetary and fiscal authorities are currently engaged in the expropriation of private wealth on a vast scale. Entire classes of investors—especially people who saved during their working years and expected to live on interest earnings on their accumulated capital during their retirement years—are being steadily wiped out. Astonishingly, this de facto robbery is being committed by a government that misses no opportunity to shed crocodile tears over how single-mindedly it seeks to protect the weak and helpless among us.

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Posted on: Tuesday, November 29, 2011 - 10:54

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The Welfare State Neutralizes Potential Opponents by Making Them Dependent on Government Benefits

From time immemorial—from Etienne de la Boitie to David Hume to Ludwig von Mises—political analysts have noted that because the number of those in the ruling elite amounts to only a small fraction of the number in the ruled masses, every regime lives or dies in accordance with “public opinion.” Unless the mass of the people, no matter how objectively abused and plundered they may appear to be, believe that the existing rulers are legitimate, the masses will not tolerate the regime’s continuation in power. Nor need they tolerate it, because they greatly outnumber the rulers, and hence whenever they become subjectively fed up, they have the power—which is to say, the overwhelming advantage of superior numbers—to oust the regime. Even if the regime possesses a great advantage of coercive power, its employment avails the rulers nothing if they must kill or imprison 90 percent of the population, because such massive violence would reduce them to the status of parasites without hosts.

This consideration long seemed to make sense as a critical element of political analysis, and even today one often encounters it. Something akin to it seems to motivate the current Occupy Wall Street movement and its spin-offs in other venues when they represent themselves as members of the (exploited) 99 percent, in opposition to the (exploiting) 1 percent.

Certain long-established trends in the welfare state, however, have progressively weakened the force of this analysis. The main element of these trends is the tremendous growth in the number of people (and in their proportion in the population) who are directly dependent on government benefits to a substantial degree. Researchers at the Heritage Foundation have been tracking this development for several years and have pushed their analysis back for several decades. An index of dependency based on this research increases from 19 in fiscal year 1962 to 272 in fiscal year 2009.

The Heritage index uses information on almost three dozen important federal programs on which Americans depend for cash income and other support—including housing assistance, Medicaid, Medicare, Social Security, unemployment insurance benefits, educational benefits, and farm-income supports—but it is scarcely a comprehensive measure, inasmuch as the total number of federal programs with dependents is gigantic at present. Of course, each such program has government employees and contractors who run it and hence depend on it to earn much, if not all, of their income. Government civilian and military retirees add millions more to the ranks.

The Heritage researchers found that in 1962, 21.7 million persons depended on the programs they included in their index for benefits. By 2009, the corresponding number of dependents had grown to 64.3 million. Adding dependents not included in the Heritage study might easily increase the number to more than 100 million, or to more than a third of the entire population. Thus, the parasites verge ever closer to outnumbering their hosts.

It would be a mistake, of course, to lump all of these dependents into the ruling (exploiting) class. The elderly recipients of old-age pensions, the recipients of unemployment insurance benefits, and the beneficiaries of temporary assistance for needy families are, as a rule, as far from the ruling class as one can get. However, to the extent that those who depend on government programs for substantial parts of their income enter the calculus of ruling and being ruled, they are likely to become, in effect, cyphers. They have approximately zero influence on the real rulers, yet they exert virtually no weight in opposition to those rulers, either. Fear of losing their government benefits effectively neutralizes them in regard to opposing the regime on whose seeming beneficence they rely for significant elements of their real income. Of course, for whatever voting may be worth, they vote directly or indirectly in overwhelming proportion for the continuation and budgetary enlargement of the government programs on which they depend. Hence, they help to produce seeming legitimacy for those at the top of the ruling hierarchy—a token of their appreciation for the crumbs their political masters drop on them.

As the ranks of those dependent on the welfare state continue to grow, the need for the rulers to pay attention to the ruled population diminishes. The masters know full well that the sheep will not bolt the enclosure in which the shepherds are making it possible for them to survive. Every person who becomes dependent on the state simultaneously becomes one less person who might act in some way to oppose the existing regime. Thus have modern governments gone greatly beyond the bread and circuses with which the Roman Caesars purchased the common people’s allegiance. In these circumstances, it is hardly surprising that the only changes that occur in the makeup of the ruling elite resemble a shuffling of the occupants in the first-class cabins of a luxury liner. Never mind that this liner is the economic and moral equivalent of the Titanic and that its ultimate fate is no more propitious than was that of the “unsinkable” ship that went to the bottom a century ago.

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Posted on: Saturday, November 26, 2011 - 16:34

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Robert Higgs’s Tocqueville Award Acceptance Speech (November 15, 2011)

Distinguished honorees , co-chairs, and honorary co-chairs, Mr. and Mrs. Theroux, ladies and gentlemen.

It is a great honor to have been selected to receive the Alexis de Tocqueville Award on this occasion. For many years, I have been working with David Theroux, the founder of the Independent Institute, and Mary Theroux, the Institute’s senior vice president, striving to make the world a freer, more peaceful, and more prosperous place. I wish to pay the highest possible tribute to them for everything they have done―and it is much more than any of you is likely to know―to promote greater scholarly and public understanding of the values and institutions that undergird a truly free, peaceful, and prosperous society. They have fought the good fight, never flagging, never yielding to despair, never hesitating to take the next step, and the next and next, toward the goal of a world in which every human being is accorded the freedom and dignity to which each is justly entitled.

Over the years, as a teacher and scholar, I have striven to uphold high standards of honesty, accuracy, and professional competence in my efforts to enlighten my students, professional colleagues, and members of the public. However, I have disdained many of the beliefs and practices common in the ranks of professors and commentators on public affairs. I have been, no doubt, too frank for my own good, and I would not be surprised to learn that many of my colleagues have found me, at least on occasion, obnoxious as a result.

For one of the ways in which I have made myself obnoxious, however, I make no apology: I have forthrightly raised the banner of individual liberty again and again, even among associates and fellow citizens who esteemed other values much more than they esteemed liberty. Although few Americans openly oppose individual liberty in the abstract, it is obvious from their frequent willingness to sacrifice liberty in a quest for other goals that they do not place individual liberty very high in the rank-order of their preferences about how social life should be lived. In contrast, I unashamedly love liberty. For society as a whole, I wish nothing more fervently than I wish that it should be as free as possible. For me, freedom is not simply the highest-ranked value with regard to public affairs; it stands on a level by itself, far above all the others.

I espouse individual liberty in this “extreme” fashion for two reasons, which in my mind complement one another. The first is that freedom is the optimal condition for each individual’s engagement in society. To be driven, bullied, abused, disregarded, treated with contempt and dishonor―these are bad things in themselves, not only for me, but for every human being. We ought to recoil from them, regardless of whether the perpetrator is a local cop or the government in Washington. Yet all too many of us become accustomed to such official cruelties and take them in stride without much conscious thought that they are wrongs and ought to be stopped, regardless of their source.

Individual liberty, however, is also an instrument for the creation of many of the conditions, goods, and services that constitute material abundance and relieve many of the anxieties and pains that once accompanied social life for almost everyone. Virtually everyone favors economic development, especially inasmuch as it reduces or eliminates extreme poverty. Individual liberty is a necessary condition for sustained economic progress. The specific conditions of a free society―private property rights, secure contracts, a reliable rule of law―are prerequisites for the ongoing creation of wealth in the long run. At this late date, after we have witnessed the personal horrors and economic disasters brought about by socialist central planning, it should not be necessary to go on preaching the gospel of private property and the market economy, yet we all know that many people still do not understand these essential matters and often act politically to thwart the operation of a genuinely free society.

Therefore, for those of us engaged in research, teaching, and public dissemination of our knowledge with regard to the operation of just, peaceful, and prosperous societies, much work remains to be done. Indeed, even after a great number of people seem to have achieved an understanding of freedom’s importance, the gains may be largely swept away in the panic of a national emergency, when political leaders invariably come forth promising relief and protection, if only we will sacrifice more of our liberties to accommodate their exercise of new powers. Crisis and Leviathan, the title of a book of mine published in 1987, encapsulates a recurrent type of reversal in what might otherwise be a society’s steady march toward greater and greater freedom. Frightened people clamor for a savior, a leader who will relieve them of responsibility for their personal security and economic well-being.

This temptation we must resist if we are to preserve and ultimately to enlarge our liberties. If we do not resist, the legions of frightened citizens, political and economic opportunists, and would-be demagogues will carry the day, and the boundaries of our liberties will be constricted further with each episode of crisis. This struggle requires education, constant awareness, and the courage to think, speak, and act forthrightly among our more conciliatory fellows who would rather take the easy way of going along to get along, even when society at large is going along toward a plunge into complete tyranny or a long, steady descent toward totalitarianism. Americans should not reassure themselves that it cannot happen here. To a great extent, it has already happened here, and worse things lie in store unless many more of us rouse ourselves to resist.

The foregoing views – especially my devotion to individual liberty and to the struggle against everything that moves us away from the free society — explain, I believe, why I am being honored here tonight with the Alexis de Tocqueville Award. I am pleased to accept this award on behalf of all those who share my ideals and who struggle to defend and promote the free society. Like Lord Acton, we believe that “Liberty is not a means to a higher political end. It is itself the highest political end.”

As we carry on our resistance to every idea and action that threatens individual liberty, we recognize a fact that Somerset Maugham expressed 70 years ago when he wrote: “If a nation values anything more than freedom, it will lose its freedom; and the irony of it is that if it is comfort or money that it values more, it will lose that too.” I would only add that if it values security more than freedom, it will lose that, too, because a nation that values security more than freedom almost certainly will be neither free nor secure. Indeed, in the end, it will lose every decent and humane thing that human beings hold dear, reducing itself to little more than a mass of cowardly protoplasm.

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Posted on: Friday, November 18, 2011 - 13:54

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