Who is Really in Charge of Economic Results?

Last Monday, the Wall Street Journal published a letter from Professor Donald J. Boudreaux of George Mason University in Fairfax, Va.  The professor was commenting on an op-ed column written by economist Alan Blinder in the Journal a few day earlier.  Economist Blinder was apparently defending the health care law based on its good intentions.  Professor Boudreaux said:

In the 18th century economics began as a discipline when Adam Smith explained that intentions are not results, and that the complexity of a real-world economy nearly always overwhelms and confounds the hubris-intoxicated “man of system” who aims to improve matters through government intervention.

Adam Smith lived and wrote that nearly 200 years ago.  Assuming it was accurate then, is it still a valid observation today?  How much have we learned in the last 100 years or more?  Well, it’s difficult to argue with the idea that intentions are not results.  But has not the knowledge of the “men of system” come a long way in the last 100 years?

My father graduated with a degree in commerce from the University of North Carolina.  He used to talk about a course that he had there called Business Cycle Theory.  The Theory apparently was that the economy and business activity will have its ups and downs – it will cycle through periods of boom and bust.  The worst down cycle that any in my lifetime remember was the Great Depression of the 1930s.  Before that time, most people apparently believed that Adam Smith was correct – that the government should not be expected to “manage the economy”.  Government’s job was primarily to provide a stable monetary system and that it should not be expected to manage business cycles. (My father also had a course titled “Money and Banking”, which to my regret, was not offered when I was in business school.)  That all began to change during the Great Depression.  First the government got blamed (we always want someone to blame) for doing things which made the cycle worse.  Then the government started a program (The New Deal) with the intentions of getting the economy going again.  The New Deal started in the early 30s and then in the late 30s John Maynard Keynes published the his chief work which basically intellectualized the New Deal activities into an economic theory that suggested that government could significantly influence the level of the macro-economy through its fiscal policy (taxing and spending).

Did the New Deal end the depression? This has been a question debated regularly since the 30s.  From the overall data that I have seen from that period, the economy never completely recovered until WWII and the war changed everything.  But what would have happened without the government intervention is still a matter of conjecture.  Would it have been worse without the New Deal or would it have been the same or better.  There is obviously no way to answer that question.  In the meantime, Keynes theories gained acceptance in economic circles.  The period from the end of WWII until the early 60s saw a basically sound economy without significant need for government intervention.  By the 1960s, computer technology was allowing the development of mathematical models that would not have been practical without the computational speed of the new technology.  In the 60s, the McNamara Defense Department became known for some of these.  But people were also beginning to build macro economic models to help predict the future direction of the overall economy.  It’s not surprising that in this environment, economists were invited to be part of the government administration to make recommendations of future government activities.  Economic Professionals who had been relegated to teaching economic theories in the class room were being invited to Washington to help run the economy of the country.  What an ego boost that had to be.

Now comes the Great Recession, and the culture has changed so that everyone expects the government to solve the problem.  (And the government seems to have successful blamed the problem on business – or at least the financial institutions.)  The government initially took steps to stabilize the monetary system – something that Adam Smith would probably agreed that the government needed to do.  Then there was an attempt to use fiscal policy to stimulate employment.  Unfortunately, since the budget was running a deficit to begin with, there have been some limitations on the amount of fiscal stimulus.  So the Federal Reserve has been given the charge to stimulate the economy.  (This is not really a part of the Keynesian model and what would Milton Friedman, the monetarist, have said to this idea?)  Results here have not been dramatic either, although things seem to be getting slowly better.  The Fed is now debating when and how to back off some of its “temporary policies”.

The Fed Policy minutes from the October meeting were released last week and the Wall Street Journal reported that the minutes reflected that the officials had spent hours debating how to handle phasing out these policies because of “unexpected developments” that indicated that people might not react as well to this as they had thought.  They were apparently “surprised” during the summer when markets did not react well to their discussions and public discussions on ending the programs.

If all this were now a “science” and we have econometric computer models to predict results, why would this be a surprise?  Perhaps it’s because there are people involved.  And people don’t always react the same way to events.  There were apparently people who did not use some of those models who were not surprised.  Maybe those folks were giving more – albeit intuitive – consideration to how individuals were going to react to what is really an unprecedented situation.  But aren’t most of these situations – cycles – unique in some way?  The economy and large sectors of it – like financial sections and the health care system are large and complex with lots of variables.   And the government’s position when these things happen is rarely the same either – such as the whether the federal government has been running a balanced budget or not.   I’m not sure you can mathematically model human behavior well enough to reliably predict results to some these programs.  Just about the time we think we have a handle on it, something else changes.

Intentions are not results and sometimes even good intentions get bad results.  Maybe Adam Smith is still correct.  “Men of system” will never be up to the task of engineering the economy.  We may have been better off before we began to expect the government to “fix” everything.

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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