Wednesday, July 29, 2009

Recessions are all different

Arthur Laffer (of Laffer curve fame) served under Ronald Regan, and was a huge fan of the economics of both Regan and Bill Clinton - the latter because he apparently cut government spending as a proportion of GDP by more than any other president. Naturally, he doesn't like the Keynesian effort to prime economies through government spending, in particular because he says it will fuel inflation. He thinks the solution to the current global recession is for the government to give everyone a full holiday from federal taxes for 12 months.

But there are a lot of traps in his suggestion. First, he phrased it as a "let's try this" proposal, which rather suggested it is less a well-developed plan than a finger in the air. For all their claims to scientific method, economists are working in a complex, constantly changing milieu which is difficult to treat with full rigour. Second, there is an ideological basis to his idea. Such a tax holiday inevitably benefits people and companies according to their hit - as such, it is a completely regressive proposal - that is, it benefits the high earners vastly more than the low earners. Third, as a counter to the fuelling of inflation, it is rather specious for two reasons: reserve banks these days use interest rates as a level to keep the lid on inflation; also, these are currently particularly deflationary times anyway.

The BBC radio programme on which I heard this carried a quote from Keynes from the 1930s about government counter-recessionary spending.

But I think what Keynes may not have appreciated, and what Laffer ignored, was that economics and economies evolve, and for that reason every recession is different from the last. In Keynes' day, the depression was deep and people were poor. Any financial benefits most people got would be spent fairly quickly. Nowadays, however, there is likely to be much more discretionary power in spending: in other words, the ability to save is stronger, so there is an inherent slowdown in the velocity of that stimulus money - so the effect of direct stimulus spends is weaker than it would have been in the 1930s. Ironic, because a direct feed of money to people is said to result in faster circulation than infrastructure spends. (I would suggest that a way out of this would be masses of small-scale infrastructure spends - on, say, measures that reduce carbon emissions, such as energy efficiency. This has in fact been happening.)

Changing circumstance is something economists usually don't account for: mostly, they cite past evidence - or counter-examples - as justification for advice. And that is only ever part of the story.

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