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Making religion of economics
The arguments of market fundamentalists don't fit the facts of our economy. So they ignore the facts
 
Brad DeLong
Brad DeLong

In the past month I have had a number of conversations with economists who belong to the Pointless Pain Caucus — a group that believes fervently that Americans must be punished with low wages, high unemployment, and reduced government services if the economic outlook is ever to brighten. The rationale for this belief — which requires cutting government spending at a time of consumer retrenchment, ensuring that demand remains low and joblessness high — is akin to those for donning hair shirts on religious holidays: If it hurts it must be good.

In these conversations, I've noted the bizarre fact that members of the Pointless Pain Caucus occasionally make a sharp turn and say: "Well, if you really cared about reducing unemployment you would be lobbying for a reduction in the minimum wage!"

Since almost all of our extra cyclically unemployed made significantly more than the minimum wage at their last job — and will make considerably more than the minimum wage at their next job — this line of argument has always struck me as strange.

The debate proceeds thus:

Economists sometimes shut their eyes to reality. They are very good at that.

Them: Further monetary or fiscal expansion would not put anybody extra to work. The problem is that, on top of our standard 6 million cyclically unemployed, we now have 8 million additional unemployed who have no skills — who aren't able to produce enough value for it to be worth someone's while to hire them, at least not at today's minimum wage. These 8 million are going to stay unemployed for a long time. And if we try artificially to trick the market into hiring them via unsustainably low interest rates or unsustainably high accumulations of government debt, we will be sorry.

Me: But if the 8 million really are fundamentally unemployable, the fiscal stimulus and monetary expansion that we have already applied should have produced rising inflation. And we don't see that.

Them: I think we do. Housing prices have fallen by a third from their unsustainable bubble levels. That decline should have produced some fall in retail prices and in wages. We should have seen deflation — healthy deflation. Instead, the minimum wage, along with artificial fiscal and monetary stimulus, has prevented that and produced a bunch of inflation relative to the proper baseline. And it will produce more inflation if we don't immediately shift to austerity policies, including cutting government debt.

Me: But we had no trouble employing the 8 million back in 2007...

Them: That was because we overestimated their true marginal product in construction. Back then — because of subsidies from Fannie Mae and Freddie Mac — builders thought they could employ the unskilled 8 million pounding nails in Nevada and they would produce value. Now we have realized that nobody really wants more houses in Nevada, and so there is nothing productive the 8 million can do that covers the cost of employing them — at least not until we cut the minimum wage.

Me: But the housing bubble peaked in 2005. Construction employment collapsed in 2006 and 2007. The economy had no trouble employing all the workers exiting the construction sector — no trouble at all. Employment collapsed in late 2008, after Bear Stearns and Lehman Brothers went down. It was not the recognition that workers were unproductive but the collapse of confidence in finance and the resulting flight to quality that crushed the flow of demand for currently produced goods and services and that wedged the economy in its current state.

And so on and so on and so on ...

From my perspective, I have three decisive arguments on my side:

1. Back in late-2008 the Pain Caucus was predicting that even the inadequate and halfhearted fiscal and monetary stimulus we were about to undertake would produce sky-high interest rates on government debt — not just Greek debt but all debt — and a real acceleration of consumer price inflation. We had a test of their theory against mine over the past two years. They lost. They cannot now pretend amnesia and move the goalposts.

2. The timing is off on their story. If the Pain Caucus was correct, employment in the economy as a whole would have collapsed in early 2006 — when the housing and construction industry fell off a cliff — not two and a half years later when Bear Stearns and Lehman Brothers folded.

3. The timing is right for my story. The financial collapse preceded the collapse of employment. It did not follow it. The financial collapse was not a response to the fall in employment by 8 million. It was its cause.

From my perspective, these three points are absolutely decisive.

From their perspective — well, it is hard to say. It is not that they or their funders have any material interest in prolonged depression. It is no longer the case that there are many rich people who hold their wealth in bonds and so profit from deflation and do not lose from unemployment and idle capacity: Everybody's portfolio today is much more diversified than that. Today, in a depression everybody loses.

Rather, it is ideological — nay, religious: The Market is good; the Market giveth; the Market taketh away; blessed be the name of the Market. Knowing that the market is good, their task is to figure out why a good market has decreed that employment in America needs to fall by 8 million relative to trend. (It's not unlike grappling with a just and all-powerful God who doesn't mind a tsunami every so often.)

The workers-have-no-productive-skills explanation is the only one that makes sense, if we first start from the premise that the market is all-good. Never mind that we have a lot of evidence that the market is not good — that we have been periodically suffering from these finance-driven grand mal seizures of the body economic that we call the industrial business cycle for 185 years.

Nevertheless, you can shut your eyes — and economists are very good at doing so. It was Joseph Schumpeter, one of the smartest economists of three generations ago, who began a lecture with: "Gentlemen! A depression is a healthy shock! It is like an ice-cold douche!"

 

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