Mises Daily Articles
Political Power and Economic Ignorance
Georges Bush's recent speech in defense of his bailout plan was quite a tour de force. Indeed, it managed to explain the pending recession of the US economy by a previous situation of "easy credit" without mentioning the monstrously inflationist policy of the Federal Reserve — which reached its climax in 2003 and 2004, when it lent dollars at a negative short-term interest rate, and resulted in the creation of more dollars in a seven-year period (2000–2007) than had been created cumulatively in the two centuries since the founding of the United States.
According to the 43rd President, the fault rests entirely on "foreign investors" willing to profit from the competitiveness of the US economy. Logically, the lengthening of the structure of production brought by net investment should have resulted in aggregate profits and economic growth — but not this time. For some reason (which the president deems useless to explain) low interest rates were a curse that somehow led all financial entrepreneurs to dissipate their capital in hopeless ventures and loans.
Because of fractional-reserves policies and the de facto international dollar standard, even the billions of units of the US currency spent abroad are duplicated and sent back to America, where they encourage credit. But George Bush did not mention that.
Finally, he concluded that
the Federal Reserve should have its powers extended far beyond their current scope, notably over all financial enterprises, not just banks, and
a massive bailout of taxed funds was necessary — as an exceptional intervention and some sort of public investment which would help the economy recover and be paid afterwards.
Not all "experts" agreed. One commentator on CNN even acknowledged that the impending recession was a consequence of Alan Greenspan's "lax money policy."
Nevertheless, if some grasped the connection between these present effects and that past cause, few of them seem to have grasped that resorting to the same policies at present will necessarily have the same consequences in the future: to delay the recession, and worsen it.
Is there anything we can learn from such demonstrations of ignorance?
Economic knowledge and political ignorance
As Carl Menger explained, men's knowledge of the causal connections between natural phenomena determines the extent to which they control their own lives. The outcome of their actions is only partly the product of individuals. It also depends on other factors that they do not know how to (or do not have the power to) employ as means towards their ends. Indeed, their knowledge only determines the extent to which men control their own lives theoretically. Practically, their actual control depends on the capital they have accumulated.
The causal connection between the increasing employment of higher-order goods and the increasing quantity (or quality) of 1st-order goods produced lies in the fact that the first increases the number of factors of a given causal process of production that have goods-character — i.e., extends to less proximate ones our power to direct its various factors to the satisfaction of our needs.
Conversely, men's ignorance of the causal connections between natural phenomena — as well as their preference, ceteris paribus, for present satisfactions, which limits their saving — determines the extent to which they do not control their own lives, but rather depend for the satisfaction of their needs on side causes present in their environment.
We can extend this Mengerian analysis and say that men's ignorance of the causal connections between human actions determines the extent to which their control over their own lives and striving towards its improvement is limited by the present side effects of past political interventions.
Indeed, the less they grasp their future consequences, the more they tend to favor policies that seem to permit the immediate attainment of their ends — through coercion.
There is a TV commercial that says, "Imagine if firefighters ruled the world." We see Congress, packed with firefighters, one proposing policies, the others supporting them unanimously. It seems so obvious!
"Do you want more schools?"
"Do you want health care for everyone?"
It only takes thirty seconds. Then the chief concludes joyfully, "That's the easiest job I have ever had…"
Is it not that obvious and that easy? Do we want jobs for everyone? Then let's make it illegal to fire employees. Do we want everyone to be rich? Then let's distribute wealth…
Yes, we may in fact all share the same goals, in the sense that Ludwig von Mises pointed out: interventionists and partisans of laissez-faire seek the same general and "obvious" ends. But as the author of Human Action noted, the laissez-fairists do not advocate the same means, because the policies promoted by the interventionists overlook two things:
the causes of the evils they pretend to fight
their own future consequences
The causes of the present evils are the effects of similar interventionist policies of the past. The future consequences of present interventionist policies are similar to (but worse than) the present evils they fight.
Still, so complete a lack of understanding is all too common — not only on the part of "the man in the street," but also among those who pretend to teach economics.
You will not believe what I found in an "Advanced Placement" economics test, only a few days ago.
The following is number 7 of a series of "macroeconomics" multiple choice questions:
To counteract a recession, the Federal Reserve should
- raise the reserve requirement and the discount rate
- sell securities on the open market and raise the discount rate
- sell securities on the open market and lower the discount rate
- buy securities on the open market and raise the discount rate
- buy securities on the open market and lower the discount rate
And the answer is supposedly E.
Notice that the question is not, "Should the Federal Reserve do anything, and if so, what?"
No, the question assumes that the Federal Reserve should do something.
What this question really asks is, what intervention of the Fed will have the immediate effect of stopping a recession? It does not ask, what are the causes of recessions? It does not ask, what will be the long-term effects of the Fed's actions?
From such a perspective, it does seem obvious that aggregate losses today mean diminishing economic activity, compared to the previous period, and a policy of inflation that pumps into the economy the equivalent of the aggregate loss will permit us to maintain as high a level of economic activity as before. And such a policy is "easy": the Federal Reserve only has to turn out more green bills.
But this will only "counteract the recession" and maintain the economic activity, immediately — i.e., it will not maintain it at all. On the contrary, it will result in a new recession — more distant in time, but worse than the present one — which a similar policy originated in the past.
Conclusion: The Iron Law of Economic Ignorance
The worse and more widespread the ignorance of the causal connections between human actions, the higher the level of political intervention in society. The more one understands the causal connections between human actions and grasps the effects of political interventions, the more one opposes the more "obvious" and "easy" policies.
George Bush was certainly the spokesman of a more common attitude when he argued that, even if he opposed interventionism "as a general rule," he favored (as an exception) a massive taxation and inflation plan, because of exceptional circumstances. This only proves a lack of understanding of the fact that a causal connection is a necessity — even in "abnormal" conditions. Once we understand that causes of the same type have always and everywhere the same type of effects, we have to extend to all cases the praxeological principle according to which more of the same type of intervention only delays and worsens the evils it supposedly counteracts.
There is a sad irony to economic ignorance — on top of its disastrous effects. Let's call it the Iron Law of Economic Ignorance: the value of economic knowledge increases with its scarcity. That is, economic knowledge gets more valuable as the economy worsens; but the economy worsens according to the level of political intervention — which is a function of economic ignorance.
 Carl Menger, Principles of Economics, I, 5.
 Advanced Placement Program, Economics, May 2004, The College Board.