More evidence on what government is.

In this post some commenters wish I provided more evidence for my assertions that government is an institution that is used to solve externalities and seek rents and prey on others.

Come on people, this shouldn't be that hard.

What are some things government produces or purchases to provide to the public?:
- National security (qualities of a public good)
- Interstate highways (network good - positive externality)
- Information for consumers (information asymmetry - negative externality)
- Basic research (positive externality)
- WIC (principal agent problem - negative externality of sorts)
- Medicare/Medicaid (lots of market "failures" that are reviewed here)
- Postal service (network good - positive externality - and now that it is less of a positive externality there are quite sensible calls to get rid of the Post Office)
- Education (positive externality, principal agent problem)
- Police protection (qualities of a public good)
- Macroeconomic stabilization (collective action problem/public good)
- Environmental regulation (negative externality)
- Deposit insurance (negative externality)
- The administration of justice (qualities of a public good)

What doesn't the government play any real role in producing?:
- Bread
- Furniture
- Laptops
- Appliances
- Cars
- Alcohol
- Books
- Music
- Herb gardens

You see a pattern here? I just thought through some major, obvious government goods and they all have obvious externalities or public goods qualities associated with them. I thought through some obvious normal goods that we come across on a regular basis with no widely remarked on externalities associated with them, and by and large these don't seem to be produced by the government.

Why?

Humans are not dumb. I know you all have this idea in your head that Keynesians think the common man is an idiot, but you're simply wrong when you say that (and more than a little condescending when you accuse us of it). I firmly believe that humans are not dumb and that thousands of years of interaction between humans has lead to the emergence and evolution of institutions that solve human problems. Humans know the market works. Humans know what the market is less capable of accomplishing, and they understand what things require more collective action to produce more optimally. There are lots of ways to act collectively. The state is one of many.

The apparatus of the state, over the entire course of its emergence, is obviously tempting to people. People can earn rents by bending the state to their own purposes. The state's use of coercion can be (and has been) used against innocent populations and citizens. The predation of the predation of the state has to be an essential element of any theory of government.

But clearly some states are more predatory than others. So what makes a particular political economy/state/non-state governing institution, etc. "robust"? Lot's of things. Normative regulation of the governing order (see Elinor Ostrom), clear residual rights contracting (see Oliver Hart), shifts in rhetorical treatment and understandings of certain actions (see Deirdre McCloskey), and meta-rulemaking or constitution writing (see James Buchanan). Each of these things are accomplished with a wide range of success. Successful institutions survive and succeed, unsuccessful institutions either die or they weaken themselves by preying on the market and other non-state institutions (the church, the family). The United States has been relatively successful in balancing these things for a number of reasons. Please note that the fact that the United States isn't some idealized form or perfect example doesn't invalidate any of this because I'm not talking about idealized forms - I'm talking about tendencies and roles of the state that all observed cases provide imperfect examples of.

*****

I have one addendum that was not incorporated into my initial theory of the state: inequality. A big part of what the state does is address inequality. This isn't entirely an externality issue (although there are major reasons why we should think externalities exascerbate inequality). It also isn't entirely a predation issue, although it has similar elements to that as well. But it's a very strange kind of predation. The weak prey on the strong. Or - in a lot of cases - the strong weaken themselves to strengthen the weak. This is a major function of the state and of other non-state, non-market institutions (think soup kitchens, churches, charities, etc.). An easy way of addressing this now is just to say "the state tries to ameliorate inequality too", but that seems like a somewhat incomplete theory of this element of the state. I imagine it's worth thinking through some evolutionary biology too - it's my understanding that in other species a certain degree of egalitarianism is evolutionarily fit. If you have issues with egalitarianism on a philosophical or ethical level, please don't raise them here. That's another conversation entirely. My point here is to try to present a theory of the state. An adequate theory of what the state is seems like it has to be broader than (although still inclusive of) rent-seeking and predation.

*****

This paper by Daron Acemoglu looks quite relevant. I seem to remember reading soem Theda Skocpol writing on these themes: Politics and Economics in Weak and Strong States.

Losing my contractarianism...

...I haven't entirely yet, but I feel as if it is looming. I'm attempting a controlled descent into this pragmatism business, which I feel is warranted. James, after all, willed himself to believe in God and argued that he had warrant for doing that. This idea that beliefs are functional and we can pick up beliefs like we pick up hammers or rakes - trying them out, assessing their utility - seems to give me warrant to do this. If there is no chance of conclusively establishing a correspondence between perception and reality, all that we have available to us is to assess experientially the value of certain beliefs in navigating the every day world we live in.

One belief I have consciously "kept" is a contractarian emphasis on property rights (because it's easier to talk about how rights function if you conceive of all rights as a sort of property right). Social contract theory has always bothered me tremendously, and although I've always agreed with Bentham on rights ("nonsense on stilts"), we certainly act as if rights meant something, even if they are fundamentally meaningless. That seemed to make them more productive than the idea of a social contract, which we don't even pretend is real (or so I think). So I've been interested in talking about democratic self-governance in contractarian terms in order to justify the common sense of how democratic self-government works without slipping into a naive libertarianism (i.e. - "I didn't agree to be governed so the state is illegitimate"). A lot of these attempts in the past have been "government of the gaps" attempts, similar to "God of the gaps" apologetics. I find both of these to be unsatisfying. It seems both insufficient and something of an insult to your subject of inquiry. "Government of the gaps" proofs amount to a litany of market failures. "God of the gaps" proofs amount to fillers for where science hasn't made a case (yet). But you can also understand why people might make these attempts. With the tremendous progress of science, they hypothesis of God (to uses Laplace's formulation), no longer seemed necessary. Anyone truly interested in justifying the idea of God had to reckon with this. There was no point in denying the science. The same goes with market economics. No modern non-Marxist economist wants to overthrow market economics. The advances are obvious, and yet there is an intuition that this doesn't simply negate the state. But the state can't be justified on claims that do violence to our insights about the market. If I were given the choice, I would choose the market - hence a "government of the gaps" argument emerges. But that just doesn't seem right. A lot of us don't feel like the government is naturally opposed to the market the way naive libertarians suggest, but because of the way the argument is structured it can be hard to explain why. So in my attempt at understanding why democratic self-government is "justified", but not on the basis of a "government of the gaps", I've hit on a few basic reasons that I find to be convincing and not "government of the gaps":

1. Macroeconomic instability - Keynesian democratic socialization of investment. Macroeconomic stability emerges because of aggregation issues and monetary issues as a problem distinct from microeconomic stability and efficiency, which property rights and free exchange are able to guarantee.

2. Temporal autarky - Jefferson referred to it as "swindling futurity". We are coerced by generations that come before us and we coerce generations that come after us, so a contractarian system grounded on contemporary rights and exchanges is necessarily a coercive system. Democratic self-government is tasked with reducing these coercions.

3. Necrocratic political economy - Our system of political economy is necrocratic - it is ruled by the dead. Property rights crystallize past inequalities and pass them on to future generations by the roullete wheel that is birth. Coercion in the past only takes one generation to legitimize itself. This is also a major concern of Jefferson and Paine*.

These start to provide, without losing a contractarian perspective at all (indeed with introducing what I think is a more robust contractarianism), a basis for democratic self-government that may be coercive from a naive contractarianism, but which is ultimately a reduction of coercion. It provides a broad basis particularly for (1.) investments, (2.) egalitarianism, (3.) education, and (4.) social stabilization. Add to this basic agreed upon justifications for police powers, and you largely have a picture of that which American democratic self-government had taken for itself.

But it also provides the seeds of the unraveling of contractarianism. What you start to see is that "property rights" are historically contingent and are themselves inherently coercive (democratic self-government is, after all, a response to the coercion of the property rights regime). As Dewey wrote "this relativity of liberty to the existing distribution of powers of action, while meaning that there is no such thing as absolute liberty, also necessarily means that wherever there is liberty at one place there is restraint at some other place. The system of liberties that exists at any time is always the system of restraints or controls that exist at that time. No one can do anything except in relation to what others can do and cannot do. These... points are general. But they cannot be dismissed as mere abstractions. For when they are applied either in idea or in action they mean that liberty is always a social question, not an individual one. For the liberties that any individual actually has depends upon the distribution of powers or liberties that exists, and this distribution is identical with actual social arrangements, legal and political - and, at the present time, economic, in a peculiarly important way."

I feel like I've chased contractarianism to its implications, and come back out at something like social contract theory! I'm losing my contractarianism. If this gets pursued far enough, clearly the same old problems with social contract theory are going to come up.

So what does one conclude? Well, precisely the point that these are just beliefs that we use because they are useful, not because of any correspondence with reality. Rights are a convenient fiction. When we pretend that we are real and think about them long enough as if they are real, we run into all sorts of self-contradictions that force us to conclude that system of private property rights is necessarily coercive. The solution, however, is social and coercive as well. This is largely where I've come out; my respect for abstractions like "property rights" and "self-government" has both dwindled and been reinforced. It's dwindled because their fundamental fictive nature seems more or less obvious to me now. But it has been reinforced because I'm starting to see how the interplay of these two fictions produces real results. We have a guide of sorts for when self-government reduces and when it increases coercion. We have a guide for when property rights reduce and when they increase coercion.

Writing this is in many ways just an attempt to think through all these ideas again... I will be going to "debate" Jan Helfeld later today, and I am increasingly of the opinion that his method does not get to the heart of the issue... although I'm concerned I won't be able to adequately express why. We shall see.


* I recently came across an interesting post by Gavin Kennedy on Adam Smith that has a great passage from Cantillon emphasizing this "necrocratic political economy" problem: "It does not appear that Providence has given the Right of the Possession of Land to one Man preferably to another: the most ancient Titles are founded on violence and Conquest. … But howsoever people come into the property and possession of Land we have already observed that it always falls into the hands of a few in proportion to the total inhabitants"

Christopher Hitchens on electoral politics

Excellent as usual. Here's an excerpt:

I could introduce you to dozens of enthusiastic and intelligent people, highly aware of "the issues" and very well-informed on all questions from human rights to world trade to counterinsurgency, to none of whom it would occur to subject themselves to what passes for the political "arena." They are willing to give up potentially more lucrative careers in order to work on important questions and expand the limits of what is currently thinkable politically, but the great honor and distinction of serving their country in the legislature is only offered to them at a price that is now way too steep.

Consider: What normal person would consider risking their career and their family life in order to undergo the incessant barrage of intrusive questioning about every aspect of their lives since well before college? To face the constant pettifogging and chatter of Facebook and Twitter and have to boast of how many false friends they had made in a weird cyberland? And if only that was the least of it. Then comes the treadmill of fundraising and the unending tyranny of the opinion polls, which many media systems now use as a substitute for news and as a means of creating stories rather than reporting them. And, even if it "works," most of your time in Washington would be spent raising the dough to hang on to your job. No wonder that the best lack all conviction.

My family has lived in Arlington, Virginia - just about as close to D.C. as you can get without living in it - for five generations, and there hasn't been the slightest inclination among anyone in my family tree to get into electoral politics or even to work on Capitol Hill, with one exception - my great grandad ran for and won a spot on Arlington County School Board a couple times (he helped integrate Arlington County schools in the 1950s, and for those efforts the state legislature in Richmond revoked the right of Arlingtonians to elect their own School Board - so needless to say, no electoral politics after that). When you live this close to the sausage factory you don't really want any part of that.

Public Goods and the Role of the State

Frances Woolley has a good post in reaction to this Olbion fire department situation reminding us that (1.) fire fighting is not a public good and (2.) actual public goods are very, very rare. I think this is important to highlight and think about because so many people have this automatic reaction that public goods in some sense provide the economic justification for what the state does, and anything that's not a public good is (according to economics) not an appropriate area for state action.

I've never really thought of it that way (although perhaps that's because I've never taken an official "public economics" class). I've always thought about the rivalry/excludability cross-tab more as a pricing strategy typology than a blueprint for a political philosophy. "Club goods" gravitate towards a different pricing strategy than private goods - they introduce innovations on how to price goods. "Common pool goods" usually gravitate towards different rationing or supply strategies than private goods. A good resource for this is of course Elinor Ostrom (her Nobel Prize lecture is a good start).

But you'll notice I don't usually talk about "public goods" when I talk about the government - usually what I'm talking about is an externality. That's not to say I don't think public goods are important when thinking about the government, they simply aren't exhaustive. Externalities introduce a situation where the market has no ability to right itself (contra Jonathan Catalan) because the problem is in the nature of the property rights regime. You could always pay BP not to pollute the ocean, but then you would be paying them not to impose a cost on you when they should be paying you if they want to impose a cost. You could argue that tort law forces BP to take these externalized costs into account, but then BP would still get to decide whether to act or not - it would not be a mutual choice between you and BP - that's coercion. So externalities provide some basis for state action even when we're talking about externalities in non-public goods. But obviously an externality on its own doesn't give the state license to act (see Coase on this point) - it's not sufficient. But large, extremely generalized externalities that can be addressed adequately by the government and inadequately by some other institution provide a strong case.

The other thing that affects the role of the state is humanitarianism and the ability to pay. I'm no welfare economist, and I haven't looked at this in detail (I know others have), but on the face of it the problem with a Walrasian approach to welfare economics is that because a person's income is commensurate with their marginal productivity, their ability to satisfy their utility is going to be constrained by their productivity. Human welfare, in other words, is proportional to human productivity. There's a point where this is unavoidable, of course. We don't see it as a crime that less productive humans a thousand years ago lived in a poorer state than we do. That's just how it goes. But for our contemporaries, does this raise any ethical issues for us? It probably should. A child is born to a poor family, and doesn't get adequate nutrition or education, to say nothing of an inheritance. That child will be less productive and will earn less money. Market capitalism, for all it's allocative efficiency, will by virtue of its dependence on the property rights regime constrain that child's ability to live as well as another child born under better circumstances.

So how do we react to this? First - we don't react in a radical way. The allocative efficiency of market capitalism still provides this child with the opportunity to use whatever productivity it does have to better effect than any other system we have come up with. It also provides the child with the best opportunity to enjoy the fruits of the productivity of others in an efficient way. The only real problem is that it imposes limits or obstacles to the child's fulfillment as a human being because of the same property rights regime that drives all the good things we like so much about markets.

If we have an ethical framework where we think that human beings are essentially equally worthy of living a reasonably comfortable life, this may suggest that we have a social imperative to augment market outcomes. I have a fridge full of healthy food and a roof over my head. I believe people should receive only what they earn, but I also believe that any human being without healthy food and a roof over their head is living an unjustifiably unfulfilled life. Providing them with a basic amount of food and shelter does not change the fact that they should earn their marginal productivity and set those earnings equal to the marginal benefit they get from consumption. So far this is only a justification for charity, but if these ethical standards are sufficiently generalized and agreed upon, private charitable intuitions can naturally evolve into public agreement on basic standards and public provision. This is natural - after all, the state is the ideal way to equally spread the pain of poverty which we think of as being somewhat random and not determined by a person's own life choices. The state is not some alien institution. It's an emergent institution just like any other human institution. Presumably what the state might provide in this case - food, medical care, shelter, etc. - is not a public good at all! Which brings me full circle back to the point that we need to be careful when we talk about "public goods". The concept of a public goods tells us something about viable and unviable pricing strategies, but it doesn't furnish us with a political philosophy.

My view is that political philosophy should be done with the property rights regime in mind. The property rights regime is largely artificial - natural rights are "nonsense on stilts" after all. They are useful and even justifiable and legitimate, though. The fact that they're artificial doesn't mean they're contestable. But we have to have a political philosophy that recognizes the limits of the framework of rights that a given society has evolved: hence my emphasis on externalities and ability to pay, rather than public goods.

Violence and the State

What do people think of this point that if you're not willing to haul someone off at gunpoint for something then it's not a legitimate concern of the state? For the life of me I can't understand why everyone is so impressed with this blog post. Kevin Williamson starts out whining about a dissenting letter to the editor in The Economist. He then goes on to say that if you won't use violence for something the state shouldn't do it.

That seems absurd. Violence is an extreme recourse, even for a state, isn't it? What about private citizens that own guns? Ultimately, when the cards are down, they'll put someone at gunpoint to get something they want. It's an extreme reaction and it's a reaction that they rarely engage in, but ultimately the use of violence is the ultimate defense and enforcer for a private citizen, is it not? That's why we have the Second Amendment - so the government can't weaken that absolutely essential method of recourse. But you don't say "if a private family isn't willing to get something at gunpoint they have no business doing it". Kevin Williamson is suggesting that the law of the jungle is all there is and that we should judge institutions by the absolute most extreme action they might take. What a poorly reasoned argument!

Why don't we talk that way about private citizens? Why don't we say that private citizens should only be doing what they're willing to defend at gunpoint? Because we live in a society governed by contract, institutions, and norms of behavior. That's what allows us to transcend the law of the jungle. The thing is, the government exists in that society as well. Indeed, with the police force and the courts the government is part of the vast web of emergent institutions that make things like contracts possible.

Kevin Williamson's intellectual sloppiness reveals one of the biggest problems with modern libertarianism: it's obsession with "the state". Nobody talks about government more than libertarians. Why? Because they see it as some sort of alien institution rather than an emergent institution. They think about the state categorically, that blunts their arguments, and they sound ridiculous in the process and don't even realize it; instead, they think stuff like this is deep and insightful.

This is the problem with "road to serfdom" type thinking as well. As soon as you let this piece of categorical confusion in "the road to serfdom" follows easily - it's not exactly a tough argument to piece together. And you get people like Kevin Williamson sputtering about social democracies and Economist letter writers: "Well, bully for northern Europe and journalists with anecdotes! It’s not as though gunpoint politics has no history in Europe: Wait for the next all-European war and let me know how the Dutch and the Danes do."

Now he's just sounding like a garden variety conservative. I'll acknowledge good libertarian arguments when I hear one. There's a lot about the state that cannot be defended and I don't try. This isn't one of those good arguments and I'm baffled that so many people are linking it favorably.

On Secession

Three blog posts recently on secession:

- OK, the first is technically on nullification - the Mises Institute interviews Tom Woods on his new book on state nullification. For those of you not familiar with him, Tom Woods is an Austrian-oriented historian that I have a big problem with when it comes to the 1920-21 depression. But that's another matter. His new book is on nullification.

- David Ribar, a fairly liberal economics professor at UNC, an alum of my alma mater (William and Mary), former professor at my other alma mater (The George Washington University), and one-time co-panelist at a Southern Economic Association conference, does a round-up of recent secession-happy Republicans, and reviews one case in particular.

I actually think secession isn't as unreasonable a position as a lot of people think it is. I don't see how you can admire the founders and admire Jefferson and the Declaration of Independence in particular and not be ethically and legally fine with secession. We cannot be a nation of, by, and for the people if the people are not free to withdraw their consent to their government (an enormous irony of Lincoln's famous address).

Nullification, I think, is a different matter. It may have been a tenable position in the early antebellum period, when the institutions of governance were being worked out. But decisions were made, institutions developed, and social contracts (much as I hate that term) were forged. Nullification now is repudiation of that institutional evolution. You cannot remain in the Union and repudiate the terms of Union at the same time. To a certain extent, then, I suppose all I'm really saying is that nullification amounts to secession. I oppose the very idea of nullification as a course of action that stands independent of outright secession.

So I actually wouldn't be as critical as Ribar is, but I wouldn't be as enthusiastic as Woods is. My question for secessionists isn't so much "how could you think this is legal or ethical", as it is "how could you possibly think this is necessary or desirable"? They are treating the dumbest move on the part of the South like it was its greatest triumph. I'm not as dismissive of the Confederacy as a lot of people are, and I hold a fairly nuanced view of the Civil War. But even a "less dismissive than average" view of the Confederacy I think can still be nothing more than a qualified disapproval. Even those positively disposed towards the South as a civilization have to recognize the attending evils of the Confederacy, and not just the evils but the unforgivable blunders. And secession is among those blunders. It's not a question of "can they do that?" for me. They can. It's a question of "why would you do that?". The leaders of the secessionist movements in the antebellum South need to be regarded, even by sympathetic Southerners, with "impotent fury" (to quote Harper Lee). One might defensibly say "with Lincoln's army marching and threatening my home, I'll pick up my gun and fight". One cannot defensibly argue that secession was intelligent, or well-advised, or in the interests of the South. It's even more infuriating that so many secessionists, then and now, uphold Washington specifically as an icon; Washington! - one of the greatest examples of what it means to be a "Union man".

Anyway, I'm not lawyer but the legal niceties of secession never bothered me all that much. The right to secede seems to me to follow naturally from the right to incorporate a state in the first place. Any statute on the books that would oppose that right simply begs the question. After all - it's precisely that statue book that presumably one is seceding from! The question of why one would even consider the prospect of secession, so long as the United States remains such a paragon of republicanism, liberty, and democratic representation - that is a question that I simply can't answer.

Fascism in America

This is not a Jonah Goldberg or a Noam Chomsky rant - both of whom I consider to be clowns. Chomsky is at best a marginally more plausible clown, but only marginally. But this post is not a rehashing of those arguments...

...I am, once again, collecting and reading more about Lovecraft's views on political economy. Fascism plays a major role in his thinking on the economy - and he explicitly calls it "fascism". There are a lot of people, like Keynes for example, that people try to accuse of being fascist with little success. Lovecraft self-identified as one, and he was by no means the only person to self-identify as one during the interwar period.

So I'm reading about American fascist thought in the interwar period, and I had a thought - I am guessing that not even World War II, but the Holocaust specifically, more than anything else, prevented the spread of fascism in the Western world. Really, the fascism that Lovecraft and others advocated was different from Nazism from the beginning. It was an advocacy for a strong-man polity and a planned economy to be sure, but it was fundamentally different. These sorts of "fascism-lite" boosters in America, as well as elsewhere, were able to romanticize German and Italian fascism through the twenties, thirties, and even into the forties because of their fundamental ignorance. The Holocaust, however, put a decided end to anything like that, and these days you couldn't have a guy like Lovecraft self-identify as a fascist.

Interwar American fascists were able to romanticize Germany and Italy because they:

1. "Made the trains run on time"

2. Beat back the Bolsheviks (von Mises calls the fascists the "saviors of Europe" for this feat in the 1920s).

3. Provide a sense of order and pride after the disarray of first the Great War, and then the Great Depression.

None of this made a bit of difference after the Holocaust. Invading sovereign states was forgivable - democracies, monarchies, dictatorships, tribes, and socialist collectives had been doing that for eons. But wholesale slaughter and genocide was a different matter entirely. This is not to say the human beings aren't capable of sweeping genocide under the rug - they are. But when systematic genocide is thrust upon them, when they are not allowed to ignore it, we humans will not waver on the verdict.

Without the Holocaust, I think things would be very different. We would see a lot more Hitler apologists out there. Racism and anti-semitism would be considerably worse, because it would not be so closely tied in with the image of actual extermination. The pseudo-scientific veneer might even be maintained. Joe McCarthy, Richard Nixon, and Henry Kissinger even might have self-identified as fascists (of course denouncing the excesses of those first generation of German and Italian fascists). With that sort of base, any number of modern politicians: Dick Cheney, Sarah Palin, etc. might have taken up the fascist banner. The neo-conservative movement, with its roots in Trotskyism and the New Left, perhaps might have avoided drifting into the fascist fold, but then again - perhaps not. Neo-conservatism has taken quite a fall since its early days.

All these developments are reasonably plausible. Why didn't that happen? Because the Holocaust made fascism and Nazi apologetics absolutely untenable. I'm guessing that tragedy alone explains why fascism fizzled in the West. I still think it's possible we could see fascism in America, but I think we need a major, major jolt for it to happen. The Tea Party definitely won't cut it, despite Chomsky's hand-wringing over them. If the 60s or even simply 1968 didn't catapult us into fascism, it will take quite a bit to. A nuclear attack. A prolonged depression (!!!). A pivotal assassination. I could see it happening, but not without a major, major trigger.

So anyway, that's just a speculative thought on how the Holocaust ultimately did in the prospects of fascism. None of this is directly related to Lovecraft's economics - which is going to be delicate in this area. Planning and interwar American fascism are more nuanced issues than a lot of disparaging modern retrospectives give credit for. It's not something a rational person can embrace, to be sure - but it's not Nazism either. Making that distinction is very tricky. It's very much like Orwell's socialism, in that sense. The difference being, of course, that we have a long record of Trotskyism and anti-Stalinist socialism (and before that, anti-Marxist socialism) to highlight that kind of distinction. In contrast, the life of this brand of fascism was cut short. For the sake of humanity, that is a very good thing - but it makes researching it much harder.

Much ado about austerity

There’s been a lot of talk recently about austerity as a spur for growth. Much of it has revolved around the work of Alberto Alesina, a Harvard economist. Bloomberg summarizes his position this way:

“Alesina argues that austerity can stimulate economic growth by calming bond markets, which lowers interest rates and promotes investment. In addition, he says, deficit-cutting reassures taxpayers that more wrenching fiscal adjustments won't be needed later. That revives their animal spirits and their spending. Alesina says that as a way to shrink deficits, spending cuts are better for growth than raising taxes.”

Bruce Bartlett highlights other work in this vein in The Fiscal Times.

Like so many arguments made by respectable economists, on one level this logic is perfectly fine. I have no doubt that fiscal conservatism can spur growth. I would be surprised to find anything else, in fact. But there is an important difference between:

(1.) Increasing GDP growth rates and spurring recovery, and
(2.) Spurring recovery in an economy with depressed aggregate demand and spurring a recovery in an economy suffering from other problems

For some reason, time after time, people act as if all downturns are created equal. If an economy is suffering from a demand shortfall, removing more demand exacerbates the problem. What isn’t a particular concern in an economy that doesn’t exhibit a notable shortfall in demand (say, the American economy of the early 1920s) becomes a major problem in an economy where demand is already quite weak.

The primary mechanism through which austerity operates for Alesina is the bond market. Austerity calms the bond markets, “which lowers interest rates and promotes investment”. No Keynesian would quibble with the importance of this mechanism. The point they raise (highlighted in the Bloomberg article) is that interest rates are already quite low. If nothing else, this suggests that bond markets aren’t concerned about government debt (removing the primary “confidence” argument that Alesina utilizes). So, perhaps cutting spending would lower rates somewhat more – but who honestly believes that government borrowing is propping up interest rates right now? If interest rates are a problem, the source is either (1.) a zero lower bound on interest rates, or (2.) lack of investment demand.

To believe Alesina you have to believe that fear of the U.S. government’s ability to pay back its debt is a bigger factor than unwillingness to make investments, and you have to believe that a zero lower bound on interest rates is not a serious constraint right now (perhaps because you think inflation will make that zero lower bound non-binding as a constraint on real interest rates). Both of those cases seem untenable to me, which is why I really don’t think this argument makes sense at a time like this, at least (it would certainly hold true under different conditions). The primary problem is investment demand. Cutting demand further doesn't address this primary problem. If there were another primary problem, I probably wouldn't have these sorts of doubts.

The other version of the Alesina argument is not a bond-market story but a taxpayer story, and it’s known as “Ricardian Equivalence”. Robert Barro suggested that taxpayers would recognize that increasing deficits would be mean higher taxes down the road, leading them to curtail spending in anticipation. To a certain extent this amounts to assuming his own conclusions. The only reason why they would anticipate higher taxes down the road (as opposed to the same taxes imposed on a larger economic pie) is if they expected deficits not to increase output. In other words, Ricardian Equivalence essentially says “deficit spending cannot stimulate the economy if it does not stimulate the economy” (because if it did stimulate the economy, taxpayers would expect that the government could pay off the debt with lower taxes on a broader tax base). So it’s somewhat nonsensical (or at least tautological) on that point alone. But Paul Krugman points out another problem. He writes:

“If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.

But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.”

This gets back to my initial point that the impact of deficits on GDP growth rates is different from the impact of deficits on recovery. Even if you believe in Ricardian Equivalence, even if you believe there is exactly zero stimulus effect of government spending (i.e. – a multiplier of 1). Hell – even if you believe there is a multiplier of less than one, you still have the consumption smoothing effect of counter-cyclical deficits! They may do nothing for the net present value of wealth, but they can help out with the roller coaster ride that is the modern industrial economy.
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So if we’re thinking in terms of interest rates and bond markets, Alesina’s point doesn’t seem to apply to this particular downturn very well at all. If we’re thinking in terms of tax payers and public debt, Alesina’s point doesn’t seem to apply to any downturn. After those two, distinct critiques what we’re left with is that keeping a lid on public debt can improve long-term secular growth.
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Big whoop – you don’t need a Harvard economist to figure that one out.

Note: If you're a fan of George Mason economics, you might be interested in James Buchanan's critique of Robert Barro's argument here (sorry, can't find an ungated version). His concerns are along somewhat different lines.

"Plug the Damn Hole"

A little while back I considered responding to this post on Economic Thought, which argued: "Had BP been liable for all the damages done, I am sure that they would do everything possible to avoid similar accidents in the future."

The thrust of the post was great - Jonathan Catalán argued that limiting the liability of oil companies makes them less careful than they would otherwise have been. It's a point that co-blogger Mattheus von Guttenberg made more recently as well. That is all well and good, and it's an insight that broad swaths of economists agree on. But is it accurate to say that "they would do everything possible to avoid similar accidents in the future"?

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I don't think so. One of the merits of markets is that they rarely converge on what economists call a "corner solution" - they never put all their eggs in one basket. Life is full of trade-offs, and a robust set of trade-offs usually means that the optimal choice involves a mix of different goods. BP's goal is to maximize profits. That is achieved by minimizing costs and maximizing revenue. You can't maximize profits without taking some risk that you're going to have another accident or spill, otherwise you'd be spending all your money on safety measures and none of it on exploration and production. Markets are great things but we can't ascribe things to them that they won't provide - and one thing they cannot provide is a single-minded pursuit of a particular end.

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Of course, the government can provide this single-minded pursuit (or at least can come closer to it than a private company). Usually this isn't such a good thing! We like the market because it's so good at arbitrating tradeoffs between millions of different options. We don't like corner solutions... usually. But to quote President Obama, sometimes you just need to "plug the damn hole". Catalán argues that the spill is costing BP dearly, that they have an interest in fixing it. Fine, but that interest is still going to be mediated through a cost-benefit analysis that is going to trade-off the very high costs of fixing the spill against the benefits of getting the spill fixed. There is no guarantee of what Catalán proposes - that BP "would do everything possible to avoid similar accidents in the future". In fact, based on what we know about the market, we can almost certainly expect that they will not do "everything possible". They will do less than what is possible because they will not find the corner solution of extreme caution to be profit-maximizing. This isn't an indictment of BP at all of course - it's just a statement of fact. There is no guarantee that the government will fix this problem or prevent future problems too, but the government has an incentive structure that frees it to express and act on sentiments like "plug the damn hole" in a way that an oil executive never could.

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As I said, usually corner solutions are not the ideal outcome. But on the occassions that they may be, we need to adjust the way we think about the state and the market, precisely because of how both are equipped to respond to corner solutions. More generally, whenever we think that a prioritarian ethics is appropriate or applicable, we have to question the implications of market outcomes. Even those who don't personally claim to be utilitarians have to recognize that the market operates on a utilitarian basis, where the utility of no agent is prioritized over another. All agents operate on the basis of their own subjective valuations. Usually this is fine, but when legitimate priorities do exist, the market is inevitably going to be limited in its response.

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UPDATE: The Onion says it better than I can: "BP Pledges to Continue Being Huge Profitable Corporation" - as well they should be, all jokes aside. Let's just not pretend they can pledge much beyond that. Profit maximizers maximize profits... that's all we should expect or ask of them.