One frequent response to President Obama's political disaster in Massachusetts has been: "Well, he should have focused on jobs, jobs, jobs instead of health care and other extraneous efforts."
Maybe so. But. From a political point of view, the Democrats in 2010 and the president in 2012 will be judged not on their focuses, but on their accomplishments. And from an economic point of view, restoring American jobs is going to take a lot more than focus: even with the most carefully designed and best implemented policies, it is going to take a long time to reduce unemployment to the 4-5 percent level at which we feel comfortable.
The problem is not with the administration's policies. It is because there is a real economic world out there, and policy can do less than most policymakers and commentators assume. Public policy did not cause the Great Recession, nor can policy reverse it or avoid similar downturns in the future. It can meliorate the worst effects, but little more.
Generalizing that idea with regard to economics and other matters is something I want to write about soon, but its application to the current crisis is a good start, and examining it in the light of economic history is a good means.
This article is not about the immediate cause of the bubble that triggered the crisis, or the needed changes in regulation and other policies, or the macroeconomics of restoring employment and growth. To set a context, however, my own views on these matters, stated but not defended here, are that:
The bubble and its collapse were abetted by under-regulation by both Democratic and Republican administrations. The bubble stemmed in part from the sincere belief by many politicians that they had found a way to extend home ownership much further down into the income structure than had been possible.
More and better regulation of financial institutions may keep such bubbles down in size, but it cannot prevent them; they have been recurring for three centuries.
Macroeconomic policies--monetary policy to make funds available at low interest rates to investors and consumers, and fiscal policy to substitute government deficit spending for decreased private demand--can and should minimize the effects of downturns in employment and growth initiated by the collapsed bubble. I am a Keynesian: I put the stress on fiscal policy.
But measures such as these can meliorate, not reverse or prevent. During and after the Great Depression, considerable economic and political discussion revolved around two terms, pump-priming and secular stagnation. Pump-priming was the belief among Keynesian economists and New Deal politicians that government deficit spending would start a stream of private spending which would then take up the burden. In FDR's first term, it seemed to be working, so the administration cut back on deficit financing, thus causing a new recession-on-depression in 1937-8. That in turn caused economists, led by Keynes's leading American disciple, Alvin Hansen of Harvard, to contend that the U.S. was encountering secular stagnation, a long-run shortfall of private demand that had to be compensated for by long-run public deficit spending.
The massive deficit spending of World War II intervened, sweeping all before it, and the contending concepts disappeared. The good years with no more than mild recessions from 1945 to 2009 (with the special exception of the bad decade of the 1970s, to be discussed elsewhere) disproved any concept of permanent stagnation,
The postwar years also provided evidence for another theory, set forth by Joseph Schumpeter, an Austrian-American Harvard professor who, with Keynes, was one of the two seminal economists of the 20th century. Schumpeter suggested that economic growth comes in cycles, particularly many-decades-long waves of innovation, carried out by entrepreneurs who introduced radically new kinds of economic activity, engendering "creative destruction" of old industries and ways of doing business, making way for the new. The waves and cycles begin with boom years based on increased productivity and accelerated investment, but these inevitably overshoot and go into decline.
Schumpeter noted historical waves beginning with the steam engine and industrial revolution, followed by railroads and the telegraph, then one based on electricity/automobiles/ airplanes/assembly lines. He died shortly after World War II, but the robustness of his theory was demonstrated by the postwar electronics/nuclear/TV wave and most recently the computer/information technology (IT) wave.
The IT wave provides an example both of the Schumpeterian theory and the small relevance of the kinds of government policy on which discussion now centers. IT entrepreneurs were driven not by considerations of the marginal tax rates of supply-side economists, interest rates on borrowed money, or Keynesian aggregate demand. The stars in their eyes were the immense wealth to be obtained from successful IPOs and subsequent dizzying growth. A few made it, many more failed; the silly follow-on dot.coms began the downturn of the wave.
Government did have a lot to do with it, as it had with the railroad wave 150 years earlier. Both the electronics/etc. and the IT waves stemmed in large measure from military spending in World War II and the cold war, together with concomitant policies like the interstate highway system. But these were not macroeconomic or other cyclically-motivated policies. The booms--and busts--were their unintended consequences.
All this represents a real economy not driven by the kinds of economic policies now being debated. Such policies can cushion the worst effects. But the dangerous implication of the current debate is that it assumes the quick success of a new effort at pump-priming. "The first stimulus package was not sufficient, so we should renew it for another year", say liberal economists. More dangerously, almost all Republican politicians and too many Democrats contend that stimulus has failed, so we should quit and focus on reducing the deficit.
In fact pump-priming is likely to be as insufficient as it was in the 1930s; secular (but not permanent) stagnation may be again upon us. It will be cured, hopefully not by world war this time, but by a new wave of radical innovation.
If I knew when that is coming or where from, I would not be wasting time writing this article.