Why Stimulus Does Not StimulateTags Booms and Busts
Congress is hard at work on a stimulus bill. Doubtless their efforts will pay off. Does anyone stop to ask what it is about stimulus that stimulates? And what, exactly, does it stimulate? Start by spending a lot of money that the government does not have, borrow the difference, and the central bank prints the difference and buys up the debt. But does that increase the production of useful things? To answer this, we look at an unlikely friend, Keynes and his General Theory.
The British Austrian school economist William Harold Hutt penned a devastating critique of the new economics, The Keynesian Episode: A Reassessment. In this book, Hutt explained why Keynes’s views were able to gain a foothold in the Britain of 1937. The economy was stuck in an intransigent slump of many years’ duration. The cause of the problem? Many workers were priced out of the labor market by unrealistically high wage demands. A welfare system that enabled them to remain unemployed contributed to the problem. The wages that were too high had been negotiated by labor unions using the threat of strike, and the full awareness that the government would look the other way when unions employed coercive measures. Other workers were forced into underemployment, doing something less remunerative or a job they cared for less.
Say’s law is the observation that each supply of a good to the market constitutes a demand for some noncompeting good. As workers add to supply, they add to demand. In reverse, when workers withdraw their services, they cease their contributions to supply and in so doing withdraw their ability to demand to the same degree. The withdrawal of demand made conditions worse in other industries not constrained by labor union contracts, and made the more marginal workers in those industries unnecessary (or at best able to work only at a lower wage).
The solution—according to Hutt—was that statesmen and economists should have told the public the truth. Naming and shaming the antisocial behavior of the price-fixing labor unions and calling for cuts to the public benefits that encouraged nonparticipation were called for. Visionary leaders could have fought the good fight for free labor markets, participation in labor by all who wished, more production, and lower prices. A rising standard of living would have ensued.
However, bold moves were at the time considered “politically impossible.” The phrase was a way of saying that those who could have spoken out but did not would have sacrificed their political careers, even if they had moved public opinion toward the truth. The message would have required more than a bit of political skill to sell the idea to the public. On the same issue, Hayek wrote that Keynes assumed that “a direct lowering of money wages could be brought about only by a struggle so painful and prolonged that it could not be contemplated.”
No doubt the harsh message—that those on the dole would have been required to lift their sorry backsides off the couch and pull their own weight—would have been unpopular at first. But it would have been in service of the greater good.
Instead, the Keynesian policy of inflation won. Inflation can clear out markets in surplus. Sort of. Not very well. But if the prices of goods that businesses sell were to rise faster than wages, labor would become more affordable to business. This is a bit like a decline in nominal wages while the money supply remains unchanged. If the process worked exactly as intended, real wages would fall and surplus labor would be put back to work. One possible reason that things went as intended in Britain in 1936 is that the wages in the unionized parts of the labor market were set by long-duration agreements between industry and the unions. There were no such restrictions preventing consumer prices from rising or falling, so the inflation would tend to act on consumer prices and wages would lag, at least until the next round of contract negotiations.
And that is what happened the first time. When the labor unions figured it out, and demanded inflation indexing in their contracts, or annual cost-of-living adjustments, it stopped working. Hutt makes a distinction between unanticipated and anticipated inflation. In the latter case, market actors front run inflation by raising their asking prices before the money is created. Deliberate inflation from that time forward produced only what Hutt called “purposeless inflation”—an inflation that created many negative effects but did nothing to bring idle resources back into productive use.
Absent the special conditions present in Britain in 1936, Keynesian economics would not have been even plausible. If wages could keep up with prices, inflation would not bring idle resources back into employment. Today, in the United States, are we in the same situation as Britain in 1936? The US economy does have an excess of unemployed workers, empty storefronts, and idle resources of all kinds. Why not give it a go? A bit of stimulus could not hurt.
Not. So. Fast.
While the first part is true—we have a lot of idle resources—the problem is not a pricing problem. The problem is that businesses have been prohibited from operating. As The Onion explains, “Study Finds Most Restaurants Fail within First Year of It Becoming Illegal to Go to Them.” In a similar vein, the Babylon Bee published “California Ends Exploitation of Workers for Good by Banning All Jobs.” Resources are not priced out of the market. People and businesses are instead banned from producing. This is a problem that pricing cannot solve because the transactions are not allowed. Venues can legally operate only at a reduced capacity at which they are not profitable. We have a “making it illegal to produce things” problem. And stimulus can’t do anything about that even if you are stupid enough to be a Keynesian.
The inflation policy might have worked once, and only once, but even then not well. In Britain in 1937, due to a perfect constellation of factors, inflation had its fifteen minutes. The institutional arrangements of the time prevented wages from not only falling but also rising quickly; there was relatively unregulated markets for goods; and the public was not conditioned to expect inflation and had not prepared for it. The conditions for its success had been exploited. Fooled once, the public got smarter. Unions began to bargain for inflation indexing. Wall Street front runs the Fed. Financial markets now rise in anticipation of central bank asset purchases.
Yet the Keynesian revolution gave us stimulus as a permanent policy option. Stimulus is now untethered from its roots. At one time it was a cynical response to institutional conditions that prevented wages from keeping up with prices. Today, no longer a particular response to the unique conditions in one place and time, stimulus has become a universal solvent to heal all economic ills. Stimulus has become 1) wish for something, 2) print money, 3) profit.