With the presidential race already in full swing, candidates have began to release their economic proposals. On the Republican side, it’s all pretty much the same: Tax cuts, spending cuts, and appropriately vague promises of deregulation and “smaller government”. For someone like me with a couple of degrees in economics, the populism gets pretty cringeworthy at times.
While overall conservatives have a better understanding of economics than liberals, the anti-intellectual turn that the conservative movement has taken in recent years has meant that the difference is smaller than before.
Without further ado, here are four things that conservatives need to understand about economics and about economic policy:
1) Recessions are a (vague) symptom, not a cause. This is something liberals need to understand too, but I don’t expect that much from them.
Simply put, we need to stop talking about recessions as if they are a disease. People talk about “curing” recessions, and as any qualified honest economist (that is; not Paul Krugman) will tell you, that’s absolutely nonsensical.
A recession is a symptom, and it’s a very vague one at that. The medical equivalent would be a headache: A headache can be caused by stress, depression, bad posture, nerve injury, physical trauma, and of course more serious things like a tumor or a stroke. If you ask a doctor how to cure a headache, you’ll invariably be told that it depends on the source of the headache. If the source is stress, you should make yourself some tea and go lie down for a minute. If it’s bad posture, you should change it. And if it’s a tumor, you’ll probably need to make an appointment with a surgeon.
If you got a stress headache and your friend told you “You should try chemotherapy, I had a headache once and that did it for me”, what would you tell him? Probably that his experience isn’t relevant since your headache isn’t caused by a cancerous tumor.
What if you had a tumor giving you a headache, and a friend told you “96 % of all headaches go away with aspirin, you should give it a shot”, what would you tell him? Again, the fact that it works in 96 % of all cases doesn’t matter, because 96 % of the time the source is different than it is in your case.
Recessions are the same.
A recession is just a symptom that something is wrong in the economy. That is why it’s nonsensical to argue about why recessions happen, because the truth is that it varies from case to case, and every recession needs to be evaluated on a case by case basis.
The Keynesian explanation as for why recessions happen is basically that consumers get scared, stop spending, and the economy tanks, causing worse fear, less spending, and an even worse economy – a death spiral of self-fulfilling prophecies. As someone who is not a Keynesian, I disagree with their policy prescriptions – however, I will happily admit that Keynesian recessions can and do happen. The early 1990’s recession in the US was mainly caused by depressed consumption as consumers were fearing another oil crisis due to the crisis in the middle east that culminated with the gulf war.
Recessions can also be caused by overborrowing, typically caused by artificially low interest rates and/or government subsidies. When interest rates become normal, consumption has to fall as consumers have to set aside more money for repayment of loans, causing the economy to shrink.
Recessions can also be caused by fundamental changes to the economy – a tsunami wiping out half the factories, or a drought destroying the agricultural sector (developing countries are especially vulnerable for obvious reasons). A fall in the rate of innovation (whatever the reason) can also cause a recession, since a significant component of the growth rate comes from innovation.
And of course, recessions can be “man-made” – caused by disastrous policies like a shock hike in taxes or a nationalization spree that causes private investment to flee the country. A recession can be caused by war-related destruction (Germany’s GDP in 1945 was back at levels last seen in the 1880’s), or by the state failing to maintain basic functions such as having a police force that can uphold property rights.
How do you treat a recession? It depends on the cause. That’s why it’s really not that meaningful to say “Look at Ireland, they went through austerity and they’re back to growth, that proves austerity works” or “Look at Greece, they’ve gone through austerity and their economy’s shrinking, this proves austerity is a disaster” – it’s possible for a treatment to work for one country going through one type of recession, and not for another country going through another type.
Now, I realize you’re all asking “Does this mean that there are situations where Keynesian policies are justified?”. And the answer is, theoretically yes. If a recession is in fact caused by an irrational adverse change in expectations, Keynesian policies can be helpful. The problem of course is that first of all, such recessions tend to be very brief (consumers may panic, but if there is no underlying reason to panic they tend to snap out of it quite quickly), and second of all, it’s very hard to know if a change in expectations is in fact irrational – politicians tend to want to believe that every recession is caused by consumers and businesses “going hysterical” for no reason because that means the politicians can’t be blamed for it. Also, Keynesianism gives a carte blanche to expanding government programs (regardless of whether those programs actually stimulate the economy) and more seriously restrict freedom of speech in an effort to control animal spirits. There are several reasons therefore to be cautious with the use of Keynesian policies, even when economic theory suggests it may help.
2) Recognize behavioral economics and learn to use it. Conservatives generally fall into two overlapping categories: Those who do not know about behavioral economics, and those who dismiss it. Conservatives today are generally sceptical of all social sciences, with the sole exception being economics. But even then, conservatives generally only favor neoclassical economics – the type of economics that assumes that the market is perfect and that consumers are essentially robots: Unaffected by emotions and limitations on willpower.
This is a topic where I could really just link back to my past articles and be done with it, since I’ve been hammering this point for several years.
To recap: Every irrational behavior among consumers and companies can also be found among government officials. Government attempts at regulating “bad” behavior among consumers have been known to backfire in spectacular manners – even if you can get people to stop buying the large soda, you have no way to prevent them from getting a chocolate bar (with more calories than the soda) as “compensation” for the soda they are no longer getting. Just like you can force people to wear seatbelts, but you can’t stop them from driving faster (which seatbelt-wearers are known to do). There is also evidence to suggest that people like having choices, even inferior ones – freedom itself seems to generate happiness (“utility” in economics terms), which means that well-intentioned regulations intended to remove such bad choices may end up making us less happy.
3) The greatest weakness of the capitalist system is its lack of political sustainability, and the greatest enemy of capitalism are the capitalists. What do I mean by lack of political sustainability? I mean that it’s very hard to uphold free-market capitalism, because everyone benefits from not upholding it if everyone else is upholding it. It’s a classic prisoner’s dilemma – if everyone acts in the interest of the group as a whole, then every single individual within the group is better off by cheating. Of course, if everyone cheats, the group as a whole (and everyone within it) will suffer. This is the problem with capitalism: Every company supports free markets in theory, but at the same time they also want the government to subsidize their product, or ban their competitors, or give them a bailout when they are in trouble. And if every company got their wish, we’d essentially end up with socialism.
And that is also why the greatest enemy of capitalism remains the capitalists. Daniel Hannan has written about how when he arrived in Brussells as a newly-elected member of the European Parliament, he was surprised to find out that big businesses are at least as likely to lobby in favor of regulations as against them. This makes sense when you understand that the worst thing that can happen to a big business is that a small business replaces them and steals their market share, and that regulations mainly hurt those small businesses, preventing them from growing and consolidating the big businesses’ market share.
As conservatives, we should be pro-market, but being pro-market does not necessarily mean being pro-business. We have to keep in mind that while our interests may sometimes align with that of big business and wall street, this is far from a given, and at the end of the day these businesses do not have any ideological core beliefs – they’re in it to make money, any way they can. If they’ll make more money with HRC in the White House than they will with the GOP nominee, that’s whom they will support, and vice versa.
4) Tax cuts almost never increase tax revenue. Ever since Reagan, one of the most popular arguments conservatives have used in favor of cutting taxes has been that by doing so, we can actually increase revenue.
In theory, this is sometimes correct. Basically, reducing taxes means you get less taxes for the same level of economic activity, but you also typically increase economic activity. Whether or not a tax cut increases revenue depends on whether or not the increase in economic activity is enough to offset the reduction in revenue.
And usually, that’s not the case.
Those who point to the Reagan tax cuts tend to forget that when he took over, the top marginal tax rate was more than twice what it is today. “Tax cuts increase revenue” tends to be true only when taxes are really, really high.
Now you may think that taxes are really high in the US today, but you’re wrong. The US, relative to the rest of the OECD, is lightly taxed. The only exception is your corporate tax rate, but then virtually no-one ends up paying the 35 % rate, so it’s a moot point. It’s like when a shop with low prices reduces their prices even further – it doesn’t have the same effect on demand as it would if prices were high to begin with.
Rather, the truth is that tax cuts typically don’t end up being as expensive in reality as they are on paper – a $100 billion tax cut may end up costing $80 billion when all is said and done. And, vice versa, a $100 billion tax hike may end up only increasing revenue by $80 billion.
But a just as important reason why we shouldn’t use this argument is that quite frankly, by doing so, we are accepting the left’s worldview: That everything politicians do should be done for the benefit of the state, not the people. The best argument for cutting taxes is that by doing so, money – and with it, power – moves from the hands of the politicians to the hands of average workers and entrepreneurs. If we accept the framing of the left, we’ve already lost the debate before it’s even begun.