Saturday, August 7, 2010

Keynes vs. Smith?

Last week, President Obama made a visit to Michigan in order to celebrate the fact that the Big Three American automakers — GM, Chrysler and Ford — were all operating at a profit again. He even went so far as to make a bold declaration that American car companies had not only rebounded from their deep structural problems that had driven the industry into decline for years, but that they were on the road to resuming their place as global leaders once again.

In one part of America, Democrats and auto industry executives viewed this moment as a remarkable vindication for the Obama Administration's aggressive moves in 2009 to become controlling owners in two of the three companies.  The folks in this camp cited the extraordinary turnaround for the car companies in an industry on the brink of collapse when President Obama took office, thanks to federal taxpayer help that kept the companies alive and industry adaptation that was ordered by the federal government overseers.  And in a nice bit of coordinated messaging, GM officials emboldened the Obama celebration when they proudly announced that the company is now ready for the public stock offering that will allow them to repay the U.S. Treasury for their equity investment and return the company to full private ownership.

In another part of America, Republicans and fiscal conservatives viewed the moment with quiet disdain.  The folks in this camp point to the enormous outlay of capital that was put at risk by the Obama Administration, capital that is of course generated by taxpayer dollars, in order to expand the size and role of the federal government in a way that was never intended by the founders.  These Americans have nothing but contempt for the Obama Administration's move to expand the size of government and point to the equity investments in the auto companies as a "poster child" example for runaway spendoholics throwing the people's money at every economic problem.

Interestingly, there is little disagreement over the facts here -- a major American industry was in financial crisis, the federal government invested taxpayer money and took controlling interest in the private companies, the companies were ordered through a bankruptcy process and required by federal officials to make specific business changes, the companies have now emerged as profitable and are ready to return to private ownership.  So how can there be such a gulf-sized disagreement over the implications of this economic story and, simply put, whether it was a Good thing or a Bad thing?

In my view, the answer to this complex question is found in an understanding of the differing economic theories of Adam Smith and John Maynard Keynes.

As a quick refresher, Adam Smith was an 18th century economist most famous for his seminal book, The Wealth of Nations (1776).  Smith's idea of "the invisible hand" brought us the fundamental economic concept of supply and demand.  In essence: the more supply you have of something, the less demand there is for it, which causes less to be made, which causes the supply to drop, which in turn causes demand to go up, and the cycle repeats itself all over again. Smith's view was that this natural phenomenon of market economics takes care of everything on its own -- prices will adjust based on supply and demand, labor will adjust based on supply and demand, etc. -- and the free market will regulate itself as if there were an invisible hand steering the boat.

Smith's paradigm was pretty much unchallenged as macro-economic theory until Karl Marx came along and proposed a different understanding of how economic cycles work with his landmark treatise, Das Kapital (1867).  Marx, who was a German economist (not a Russian communist, as is often presumed), suggested a "theory of dialectical materialism" in which free markets would inevitably lead to consolidation of wealth in the aristocracy and ultimately alienation of the working class.  His theory was that this alienation would ultimately lead the working class to revolt and seize the economic apparatus, rendering free market capitalism a thing of the past.

Although Smith and Marx were economists who viewed history through opposite lenses, John Maynard Keynes has turned out to be the foil to Adam Smith for most contemporary American political observers.  Keynes was a 20th century economist whose book, The General Theory (1936), explored the relationships between markets, foreign trade, private sector spending and public sector spending.  Keynes' central thesis was that, in times of economic difficulty, central governments needed to recognize their ability to stimulate economic growth by "priming the pump" of the economy in the form of government spending and other federal capital infusion.  Due to the historical times in which he was writing, Keynesian economic theory came to be known as shorthand for the belief that the government can be the only way an economy in contraction (i.e., Great Depression) can find its way out.

For those who are capable of relative objectivity about these things, it's clear that none of these camps of economic theory are inherently "right" or "wrong" -- they're just different ways of viewing history and offer different prescriptions for what each of their authors view to be the inevitable course of human events.  Yet somehow, they have come to be synonymous with political movements -- Smith the Free Market Champion, Marx the Communist and Keynes the Government Spender.  These sorts of labels are silly, but they just tend to reflect the peculiar American need to place people in camps so we can choose up teams to join.
What is baffling, though, is the late-20th and early-21st century American debate over which model really works best, Smith's free markets or Keynes' government spending (Marx having been set aside in a nation that prefers two teams on the field at one time).  It's baffling on two levels.  First of all, there is something absurd about the contention that free markets exist in America -- that ship sailed a long time ago and the idea that Smith's unfettered markets are making a comeback is somewhere between unlikely and delusional.  So in one sense, we're not really debating between Smith and Keynes so much as we are Keynes and a little less of Keynes.
But more to the point of last week's events, it's baffling because there is a mythology in our political culture that either "laissez faire" policies or "government interventionist" policies work.  The truth is that both approaches work, the difference is FOR WHOM they work.  The textbook example here is the 1980s in America, a time when President Reagan's supply-side economic policies were credited for significant economic growth and wealth creation in the private sector, but were also blamed for a substantial widening of the rich/poor gap and the greatest period of unequal distribution of wealth since Herbert Hoover.  One can imagine a New York investment banker citing the Reagan era as proof positive that Smith was right and a South Los Angeles single mother citing the exact same era as her closing argument that Keynes is the man with the plan.
A more intellectually honest debate on the American political scene would be to shift away from trying to find the team with the correct argument -- Keynes vs. Smith -- and toward an open conversation about the moral values we hold most dear.  Do we want our economic model to most favor the wealthiest among us, the most educated among us, the most organized among us, the most needy among us, etc.? That is a question about which reasonable people in a representative democracy can disagree -- and then let the ballot box serve as the ultimate referee of who wins the debate.
It's not a question of which economist is right, but a question of who wins and who loses from each approach to government intervention into the marketplace.  I suspect that the working class folks in Michigan have a pretty clear idea of how they feel about Keynes and Smith.

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