Sunday, June 26, 2011

Christian Theology and Political Economy (God the Economist, Part 4)

This post is intended to synthesize and contrast a few works I've recently read on the subject. The whole series is found here.

Theologian M. Douglas Meeks' God the Economist is primarily critiquing the classical liberal philosophical foundation of orthodox economics. Christian economists typically defend this foundation as being scripturally justifiable, with a few tweaks. They work to build a bridge toward God's preferred economy from the realm of classical liberal thought whereas Meeks and other non-economists try to build a bridge from theology to economic thought.

Two modern approaches written by trained economists that I'm familiar with are Shawn Ritenour's Foundations of Economics: A Christian View, and James Halteman's The Clashing Worlds of Economics and Faith. Ritenour's textbook (from the product description) has three goals:
to demonstrate that the foundations of economic laws are derived from a Christian understanding of nature and humanity; to explain basic economic principles of the market economy and apply them to various economic problems, such as poverty and economic development; and to show the relationship between Christian ethics and economic policy.
Ritenour, who comes from the Austrian Libertarian school of thought, believes that "economic law is part of the created order," so scarcity, individual liberty, and property rights of classical liberalism are certainly God-ordained and existed before the Fall. God's moral law, as outlined in the Torah, affirms this order in its prescriptions of property rights and freedom for dealing with scarcity. Societies that protect property rights are more prosperous than those that don't, which follows from ordering our activities in line with God's intended order.

Ritenour's view is controversial. Leviticus 25 is a crucial passage for looking at God's order for the Israelite economy. God prescribes property rights, forbidding the moving of boundaries, theft, etc. but places limits on what can be done with the property. Property is to be returned to its previous owner every 50 years because "it is Mine, and you are only foreigners and temporary residents on My land" (v. 23, HCSB). But God also allows the ownership of human beings by others (v. 44-46), with the reminder that Israelites are God's slaves (v. 55). If property rights are part of the created order, then even the bondage of one human being to another isn't problematic so long as one follows God's rules of ownership.

John Piper believes that elements of God's prescription are "not a reflection of God's ideal for His people; it was a reflection of the hardness of the human heart." In other words, God's prescription of things like property rights were necessary as the best way for sinful human beings to organize themselves after the Fall. These wouldn't be found in the absence of sin, meaning that scarcity and the property rights prescribed for dealing with it are not part of God's created order. Modern Christian economists tend to argue that, given sin nature and self-interested individuals exists since the fall, free market capitalism is the best way to order society.

Meeks, the theologian, disagrees and rejects the idea that "economic reality is determined by fate or unchanging laws" (Pg. 9). Likewise, while Meeks might acknowledge that God's law orders economic life in a fallen world, "sin cannot be made a justification for any economic system," because these systems "deny the...power of God the Holy Spirit to create human beings anew and transform the conditions in which they live" (Pg. 10).

The authors' differing views on slavery are a good example of the outflow of their theology. For Meeks, "domination" defined as "unaccountable power to command and control the behavior of others" is problematic (P. 58). For Ritenour, the domination isn't immoral whereas the owner's right to property is moral. He has no qualms praising Confederates for preaching and dying for their moral right to own slaves as the property right was threatened by a government who wanted to immorally steal that right by force.

In general, the beliefs about the extent of personal liberties and property are a reflection of one's belief about God's nature. On pages 66-69 of his book, Meeks delves into this with more detail and scholarship than I can quote here. Basically, peoples' changing concepts of God have changed their approach to exchange relationships and vice-versa, and now Christians look back and revise history in the new light of the God concept that arose in the time of Locke. For example, the definition of scarcity ascribing to humans as having "infinite" wants and needs served to replace the importance of the infinity of God. Pg. 68:
"The human being is now viewed as an infinite acquisitor,...appropriator,...antagonist against scarcity,...and consumer...this is human nature, which, according to the official doctrines of a market society, cannot be changed." As I mentioned in Part 2, arguing that scarcity, by its modern definition, was part of the created order or resembles any attribute of God is biblically problematic.

Meeks is seeking to reclaim the God concept he sees as biblical-- "God as the promiser, as the one who makes covenants, as the one who deals with human beings and sides with the poor and oppressed, as the one who is immanently present in the creation and as the one who is God precisely by constituting God's power in these ways" (Pg. 70).

The basic difference between Meeks' view of biblical economy and others' is communitarian vs. individual liberty. Meeks is a Trinitarian theologian who sees God as a triune communal being, and therefore this communal aspect permeates all of His creation and order. "The biblical traditions...render God as a community of persons dwelling....among the creation and the people who are called into being by God's power of righteousness out of the powers of the nihil (Exod. 3, Genesis 1-2, John 1)" (Meeks, Pg. 9). Individual liberty was important for people to use their God-given abilities to work and to choose, but those rights were never to allow one to gain at the cost to the rest of society. Property rights were outlined but never exclusive--for the benefit of society. For example, the poor were given the right to glean from someone else's harvest (you see Jesus' disciples doing this in Mark 2).

Halteman's book likewise looks at the communal aspects of God's economy and contrasts it to the current neoclassical assumptions. Giving up one's liberty to use private property in order to benefit the community is illustrated in practical examples of making purchasing decisions with the advice and blessing of fellow believers. In 2 Corinthians 8:12-15, Paul stresses the importance of fostering equality of material resource among the church, but does so in a way that encourages voluntary action. This seems to be in line with what Meeks says is "found in the older Christian tradition: hold all things in such a way that they may be common for all" as espoused by Thomas Aquinas (Pg. 209).

How the writings of early church fathers wrestled with the issue during Roman dominance is rather controversial, however. For example, Ritenour holds Augustine up as a defender of exclusive property rights in the created order, whereas others argue he had different criteria for the right of ownership. (Meeks' notes contain a comparison of various early church writers, including Augustine.)

How the authors deal with taxation is also an interesting contrast. If property rights are part of the divine order, than no authority has the right to acquire property by force. Ritenour's textbook clearly espouses the classical liberal idea that only voluntary transactions are legitimate and that taxes are forced. He does not acknowledge the existence of public goods, which separates him from the classical economists. His view is the more extreme Austrian Libertarian position, as even Charles Murray refuses the "taxes are theft" argument and argues for some redistribution in order to assist the poor (a negative income tax as espoused by fellow classical liberal Milton Friedman).

I think it is worth noting that we have two clear places in the Gospels where Jesus pays taxes. One to Rome, and the other to the Jewish authorities based in Exodus 30:13-15 (the "two drachma tax"). Jesus was openly critical of Jewish authorities and the structures they had erected or changed, but still paid the tax, voluntarily giving up what he saw as his apparent right not to do so.

Meeks spends almost no time on government and taxation. He notes that market forces may cause some "necessary social goods" to be kept from some, a shortfall that can be made up by the community of believers, but redistribution seems to be implied. All the authors above rule out socialism or autocratic rule as legit.

My Conclusion:
The presentations above differ in their take on the the nature of man and markets.
Option 1: Scarcity, individual liberty, and exclusive property rights were part of the created order and societies that follow this order will be the most prosperous.

Option 2: Scarcity is a result of the fall and individual liberty with exclusive property rights are the best means for organizing a society to be most productive.

Option 3: Option 2 might be correct but it ignores the ability of God to transcend scarcity and transform sinful human beings to where classical liberal assumptions of human nature no longer apply.

I reject Option 1 for reasons I spelled out in Part 2. And I find the intense focus on productivity troublesome for reasons I explained in Part 3. I believe in Option 2 with the understanding that we should work to see Option 3 as often as possible. In a tight community of Spirit-led individuals there is no reason why Option 3 can't be exercised on a daily basis.

I think that many modern Christian economists (and Christians who want to teach economic principles) accept philosophies and terminology developed by classical liberals of the 1600-1800s and then search back through Scripture and church history to find support. Being economists, they lack theological, philosophical, and historical understanding and therefore present intellectually weak arguments. Their arguments may be correct but they are poorly made.

The dogmatic insistence on property rights by Ritenour strikes me as the opposite of what is exhorted of Believers in the New Testament (Matt 5:38-42, 1 Cor. 6:7) and the reality of property outlined by God for His people (Leviticus 25:3). The exaltation of liberty echoes the classical liberal notion that "Each person owns himself," (Murray, paraphrasing John Locke, Pg. 6) but is directly contradicted by Paul: "Or do you not know that your body is a temple of the Holy Spirit who is in you, whom you have from God, and that you are not your own? For you have been bought with a price: therefore glorify God in your body" (1 Cor 6:19-20 emphasis mine of course).

In general, I find it problematic that so many Christians unquestioningly build their economic foundation on philosophers who did not see God as the primary life-giver or reason for existence. David Hume, Adam Smith, or Murray Rothbard did not espouse anything resembling today's evangelical orthodoxy and would probably cringe if they knew their ideas were held up as inherently Christian. I cringe when I routinely see Christian pastors encouraging congregants to read non-Christian works as a way to understand "God's desired political economy" (Wayne Grudem the latest example).

The attempt to tweak or reconcile the philosophies with biblical teaching has led many to ignore history, particularly church history. Where one adopts Rodney Stark's position that Christianity was the inspiration for classical liberalism one still has to dance around various contradictory positions of early church writers and the clear example we have of God's economic outline in Leviticus.

The problem becomes compounded when the economic arguments are turned into political dogma which fosters a political activism that uses the resources of Christians. This isn't a problem in communities where Christians are openly excluded from the market, as early Pauline Christians were. Those early heavily persecuted Christians had to create their own economy. Paul doesn't seem to express his wishes that Caesar would free his hand so that the market could produce more. They expected that Jesus would one day return and restore God's created order but until they would submit to authorities and work hard to take care of one another.

In a future post, I will look at a couple examples of the American church's preaching of classical liberal tenets and point out some problems that creates for non-believers.

Book Review (#16 of 2011)

What It Means to Be a Libertarian: A Personal Interpretation by Charles Murray.

Since the M. Douglas Meeks' book I just reviewed made an argument that classical liberalism was incompatible with Christian thought, I wanted to read a modern espousal of the philosophy of classical liberals and then use it as a springboard for general comparison of Christian views on political economy. (I could compare philosophies better if I had read these books in an e-book format where my notes could be saved in the cloud for all time. One book's binding fell apart while reading it.)

Murray makes it clear he's not a "capital l" Libertarian--he's a classical liberal. His primary heroes are Adam Smith, J.S. Mill, Robert Nozick, Richard Epstein, Friedrich von Hayek, and Milton Friedman. He finds overlap with the work of the Austrian economists and the Ayn Rand-ites, but acknowledges that Rand's philosophy is "distinct from the classical liberal tradition and at outright odds with much of this book" (172).

(It's worth noting now that Chuck Colson has repeatedly warned Christians that Rand's "Objectivist" Libertarian philosophy is anti-biblical, important because certain Republicans may or may not be influenced by her writing.)

Murray is Harvard and MIT educated. I'm well aware that he is openly called a "cross-burner" by some on the left, and has been recently taken to task by other libertarians for some sloppy writing, and I remembering piling on as well at the time.

Classical liberals believe (Pgs 6-7):
  • "Each person owns himself" (italics the author's)
  • “In a free society individuals may not initiate the use of force against any other individual or group”
  • Voluntary exchange benefits both parties so people in a free society may not be impeded from engaging in voluntary and informed transactions.
  • Everyone has the freedom to associate without whoever they would like, no exceptions.
Classical liberals (CLs, henceforth) ascribe the government three legitimate uses:
  • Restraining others from injuring each other.
  • Enforcement of contracts and property rights.
  • Provision of pure public goods and regulation of natural monopolies.
  • (National defense is given by Smith and others as a proper role, but Murray doesn't broach the subject. It basically falls under the first two categories above.)
So, the first quarter of the book reads like any Principles of Microeconomics text. Murray deals with the standard difficulties of defining pure public goods (which Austrians and capital L Libertarians deny exist) and problems of regulating natural monopolies.

CLs believe that “Mindful human beings require freedom and personal responsibility to live satisfying lives” (Pg. 18). This would seem to jive with Meeks and is almost a universal idea. God created us with active and creative minds, and gave Adam and Eve freedom of choice even in the absence of sin. Israel in the absence of a king had more freedom than when it submitted to a king. Individual liberty is a recurring theme in the NT. Love requires freedom for it to truly be love, and the Bible makes clear that we are all personally responsible-- no matter our lot.

Murray makes the argument that where freedom flourishes, so does personal responsibility, including the responsibility of taking care of the less fortunate:
"The genius of free human beings is that, given responsibility, they join together to take care of each other-- to be their brothers' keepers when their brother needs help" (Pg. 138)

Personal responsibility reaps satisfaction that endures. Progress only comes when government gets out of the way so that people are given the freedom to fulfill their own potential as individuals. "Responsibility is not the 'price' of freedom, but its reward" (Pg. 31).

Murray bemoans America's abandonment of that path. Rather than allowing our society to work out its issues over time, we have slowly built a government that we expect to solve our problems for us. We have created a government that crowds out private giving by providing for social needs itself. And it funds this activity by coercion--forcing the payment of taxes, and then limiting the freedom of how the recipients can use those funds (like food stamps). (Note: Murray does not say "all taxation is theft" like hard-core Libertarians and Austrians do.)

The government has engaged in these egalitarian efforts with good intentions but bad consequences: The data say that the Civil Rights Act of 1964 had no effect on the trend of minority employment. Lowering the national speed limit to 55 mph in 1974 correlated with a slowing of the decline of automobile deaths, while raising the limit correlated with a decline in deaths. Murray nicely discusses the problems of analyzing effects vis-a-vis univariate and multivariate regressions, his point is that it's not obvious that any Progressive policies have led to obviously better outcomes.

Murray gives his basic outline of an "ideal" government. The EPA, Justice Department, and State Department still exist but little else. The EPA would set emission limits and fines but it would be up to the companies to decide how to meet them. The Justice Department would perform a similar role to today, but there would be no prosecution of discrimination (freedom of association also means freedom to not associate). The U.S. would greatly increase education funding, but it would do so with a $3,000 (or more) voucher for every child to give to the school of his own choice. Schools could organize themselves independently or by community, whatever the locals prefer, but locals would no longer fund schools through property taxes. There would be no regulation of private monopolies unless they qualify as a natural monopoly. All efforts would be made to increase competition as a first resort.

Murray points to the 19th century as a time of great cultural richness in the U.S., with enclaves of all races and stripes, which he feels the modern welfare state has probably quelled by its laws encroaching on freedom of association (and disassociation). Drug use was common and legal then, but there was no national epidemic of concern. Private charities were perhaps more numerous and active than today given the size of the population and level of income. The government was small and not expected to do much, therefore economic progress and innovation was rapid.

Where Murray differs from Christian libertarians is where to draw the line at what is considered a harmful act against society. Murray contends that people "must" be allowed to harm, even kill, themselves (Pg. 102). To override another's preferences is "totalitarianism," because we do not know what is best for any other person. While some self-interested behavior is truly harmful to society, Murray says these can only be prevented in either a totalitarian or a completely free one, but since we live in the middle we're going to have some problems deciding on those behaviors.

The issue of freedom and assisted suicide came up recently in the media and blogosphere. Ross Douthat, a practicing Catholic, argued that a person who wants to die may suffer from a mental illness like clinical depression and not be thinking rationally. She might not always wish to die, and allowing her to die might be a serious mistake-- something she would have changed her mind on later. It also hurts society-- the mourning friends and family--so, government outlawing their option would be the same as government outlawing, say, battery. Douthat:

"Absent a totalitarian police state (and not really even then), a presumption against suicide doesn’t usually prevent people who really, really want to kill themselves from finding a way to do it. But neither does it empower any authority, whether public or private, to claim that they know the last word about any human heart."

This gets to an important crux of the matter-- libertarianism assumes that "mindful" adults are rational in their behavior and reach the correct conclusions. Even when I think someone else's behavior is irrational, I have no way of knowing for certain and therefore no right to tell them what they are doing is wrong. The assumption of responsible behavior follows closely to this. Can we assume that a free people will always be responsible to work together to build a better society?

As Meeks points out, the CLs also depend on perfect competition, and this is always in the background of Murray's book. Murray assumes workers will always be free to choose a new job of equal quality, and employers new employees if the government just gets out of the way. That only works in perfect competition, which we never see in real life, no matter the level of government. Monopolistic competition prevails and information asymmetries abound, therefore the level of output and the price may not necessarily be "right," even given freedom by all parties. People may not always be rational, so resources may not be allocated efficiently, wages may be slow to adjust to shocks, unemployment and other issues still exist...the libertarian world is still no economic utopia.

Murray explains recent financial crises as the result of partial deregulation. The government took away limits on what risks banks could take while also leaving in government-licensed deposit insurance, creating a moral hazard disaster. This conceivably could have been prevented if the government had gotten rid of both sides of the regulation-- the banks would have taken less risk because they would have properly aligned incentives to do so. But if you've seen the move "Inside Job," you know that many Wall Street execs are Type A and power-driven, pushing the limits of risk in their own lives with prostitution and cocaine in an ego-trip competition against competing executives. Rational behavior is a lot to ask of those types of people.

I give this book 3.5 stars out of 5. Succinct in its explanation, a pretty easy read.

Since this post went so long, I will do one last post comparing the differing Christian systems of political economy that have been presented at some point in the future.

Thursday, June 23, 2011

God the Economist. Book Review Part 3

Part 1 and Part 2.

I have previously looked at how Meeks argues the classical liberal concepts of liberty, exclusive property rights, and scarcity conflict with the ideas of the biblical economy. But Meeks does not examine the potential consequences of some of his ideas. Today I address the idea that production is the primary purpose of an economic agent.

Chapter Five includes a theology of work, redeeming the concept of work from both the Greek ascetics who looked down on it as something to avoid, the post-Enlightenment Puritans who saw work as a sign of salvation, and the modern world where work is the means by which we chase goods for status and well-being.

The classical economists believed that the wealth of a nation was determined by its productivity-- how much its people produced. Modernly, we try to measure the amount of goods and services produced domestically, it's called gross domestic product (GDP). GDP measures both income and output of a nation, and since 1941, GDP per capita is seen as the simplest measure of a nation's well-being or standard of living. Every textbook contains a Robert Kennedy quote on the limits of GDP-- GDP doesn't tell us how happy we are, or how spiritual, or how creative, or how free, etc. Several countries are considering attempting to dethrone GDP with an index that includes happiness and other measures. I think one reason for this is that the rate of GDP and productivity (output per worker) growth has slowed in several Western countries and this is seen as some failure of various economic policies, which naturally call for a solution. Replace the index with one that measures other things, and the lack of economic growth doesn't look so bad.

Tyler Cowen's Kindle Single The Great Stagnation contains some hypotheses about the U.S. productivity slump since 1973. He notes that the rate of major technological progress has slowed down since the late 1800s. The refrigerator was a huge technological leap, but since then we've only come up with fancier, only marginally better, refrigerators. Cowen would prefer to see the stagnation end. He recommends opening up to more trade so that there can be wider markets and more specialization, and a societal shift from honoring "unproductive" (Smith's term) workers like athletes, actors, and politicians to honoring scientists and entrepreneurs (so that more people will want to be productive). Cowen notes, however, that people may be becoming content to produce and earn less. For example, Internet access is relatively cheap but provides seemingly endless streams of entertainment and knowledge.

We know that the West experienced this productivity boom (and the East is currently experiencing it) due to a movement to the market system-- liberty, democracy, property rights, and a price mechanism--and away from absolutism. As Brad Delong pointed out with this chart on his blog, we've seen what happened in this century when countries eschewed markets, it robbed them of "80-90% of their productivity." Material Well-Being in 1991: Matched Countries on Both Sides of the Iron Curtain:

GDP correlates with other variables related to well-being: literacy, education, health, political freedom, etc. If we're concerned about certain peoples' exclusion from prosperity (as Meeks is), we should be advocating for increasing their access to markets, not eliminating the market. However, Germany and Mexico above had wider income inequality than Cuba or the USSR. Meeks is bothered by this inequality in capitalism as it shows "domination" can occur in a market system. But is the inequality important or the overall level of income? The poorest German was much better off than the poorer Cuban by just about any measure of well-being. In Cuba and the USSR, the absolutist state dominated, something I'm glad Meeks also rejects as a good way to organize society.

As I discussed in my last post, nobody argues that the market is a panacea or creates income equality, but rather that it stands the best chance of allocating scarce resources more efficiently and improving the lot of the whole of society in a way that history has shown socialism and central planning does not.

So, the market system = greater GDP. But, should this matter? Should we be focused on increasing GDP per capita or something else?

I would imagine that God would have been unhappy if the Israelites had measured GDP. God forbade taking a census-- he did not want Israel to look at itself in a mirror and admire its perceived might. God wanted Israel to rely on Himself for strength, rather than itself. This idea seems to be echoed in God's anger with Israel's insistence in having a king (1 Samuel 8). Some people use this passage as biblical support for the classical liberal idea of liberty-- God is warning Israel not to trade liberty for security because it's a false trade. God indeed warns Israel that they will be dominated and exploited by their kings. But Israel wasn't rejecting their liberty overall, they were rejecting God (v. 7-8). They were rejecting God's economy and leadership, in order to be like the other nations around them (v. 5).

God also directly forbid certain forms of technological progress that seemingly would decrease Israel's dependence on God (Joshua 11:6, 2 Samuel 8:4). Hamstrung horses aren't as useful as non-hamstrung. God also forbids that Christians look at individuals through the prism of wealth (James 2:1-9). Much of Jesus' ministry was about telling the poor, the sinners, the children, and other seemingly unimportant, unproductive, propertyless people that they were invited to enter the Kingdom (Meeks' Chapter Four covers this).

This matters to me because there are a lot of Christians in America who are complaining and casting blame on various politicians for our slow economic growth. Yet at the same time, they are also calling for women to return to homemaking, fathers to spend less time at the office, and an end to consumerism and debt. This is a logically inconsistent position. One reason for the rapid economic growth we had overall from the late 1800s to 1973 was because of the large increase in women and minorities being accepted into the workforce-- formerly "idle" workers in terms of GDP were suddenly active. Production and income increased. Most married households are now two-income households.

But, was that a good thing? Many Christians make the argument that it's not. But what they don't seem to realize is that national output and income would decrease dramatically from its current level if mothers suddenly stayed home or if households gave up their eager pursuit of goods and income. This doesn't seem to jive with their political statements away from the pulpit.
The reaction I have when reading liberal Christians who want to eschew markets totally is "We would never have made it much beyond subsistence living if these people had what they wanted." There would be no telephones or internet. No "green revolution" of Norman Borlaug and improved crop yields. Vastly lower life expectancy. There was starkly little technological progress in the millenia from Genesis to the fall of Rome compared to the rapid progress that was made in just the last few centuries. Technological progress only really took off after the fall of the Roman Empire's autocratic control (see Rodney Stark's book, or even Jared Diamond's Guns, Germs, and Steel).

But if at the same time we were closer to the biblical economy of Leviticus 25, or of the very early church in Acts, would that be a bad thing? Would you trade your iPad for that? (This is a seriously tough concept for me to wrestle with.)

Matthew 16:26: "For what will it profit a man if he gains the whole world and forfeits his soul? Or what will a man give in exchange for his soul?" Could we replace "man" with "nation"?

As Meeks points out, the market system relies on humans with unlimited wants and needs. As certain needs and wants are met, more arise as a result, and the market allocates resources continually to achieve them ad infinitum. Being able to continue economic progress as measured by output is the point of having a market system.

(It's interesting that economists from Ricardo to Keynes envisioned a "steady state" where we would achieve so much technological progress that there would be nothing left to invent or need. They couldn't imagine we'd keep inventing things. Keynes even envisioned this result for our current times.)

But as Part 2 pointed out, we can only achieve that kind of satiation in Christ. So, I think God would rather his Church be satisfied with Him and inviting others into that satisfaction than worrying about whether America is going to outpace China or India.

So long as we're operating in a neoclassical world with fallen men which therefore live in the presence of scarcity, democratic capitalism is the best way to organize our society as it will ensure the greatest amount of production and income. If the goal is to alleviate poverty in Bolivia or Bangladesh, increasing their access to property and markets is the way to go. My personal preference for a central bank that pursues a NGDP target makes sense-- that's the best way to achieve the goal of stable economic growth and low unemployment.

But if we're operating in a God-fearing world where people are in the Vine (John 15), and following God's definitions for property rights, freedom, and scarcity, then GDP growth just isn't important. Where there is lack from human weakness, God will supply. Rather than relying solely on our productivity to meet our needs, we rely on God.

Wednesday, June 22, 2011

God the Economist. Book Review Part 2

Part 1 is found here.

Meeks' critique of modern market theory is centered on its foundation of classical liberal philosophy, which Meeks finds incompatible with the community-based economy of the Old and New Testaments-- where freedom was restrained for the benefit of community, property was held loosely and not exclusively, and righteousness replaced scarcity.

Meeks devotes Chapter Five to property rights: "Property rights are complicated." I recently blogged on property rights here, as a follow-up to a longer post on Augustine and property rights here. For now, I will stick to the John Piper quote that summed it up for me:

“there are laws in the Old Testament that are not expressions of God’s will for all time, but expressions of how best to manage sin in a particular people at a particular time...And Jesus says here that this permission was not a reflection of God’s ideal for his people; it was a reflection of the hardness of the human heart. 'Because of your hardness of heart he wrote you this commandment.'"

The Church are to treat properly and exchange differently than the calculating, rational, self-interested individualist of classical liberalism and neoclassical economics. I have written several times about what I perceive to be the difference between Spirit-led behavior and rational behavior in our churches. As such, the standard models of microeconomics should not apply to Christian behavior. For our fallen society where few are Spirit-led, I think the market system of property rights and a price mechanism is the best to organize society which will lead to the least dominance and exploitation and the maximization of overall welfare. Meeks doesn't disagree with this, he really just argues that in a free market system some domination and inequality will remain, the market isn't a panacea (and is not superior the biblical economy). I don't know of any even hard-core libertarians who disagree with this, so perhaps Meeks is tearing down a straw man.

But I do know Christians who argue that the individual freedom of classical liberalism is built upon a Christian foundation that all men are equal before God, and that property rights are God-ordained or at least not God-condemned when they are invoked in several places in Scripture (Acts 5:3-4, for example). Scarcity is seen as a given since Genesis 3, and property rights are necessary to deal with that scarcity.

Meeks agrees that property rights are necessary to deal with scarcity, but it's the very presence of scarcity that he questions. In my property rights post, I said the problem of scarcity remained-- I could not fathom how some people argue that scarcity is a "myth." Meeks' Chapter Seven helped me understand the argument a bit better.

I know someone who hypothesizes that scarcity existed before the Fall. If all we mean by "scarcity" is the number of hours of daylight in a day, or the fact that certain things needed to be done (God created work for man to do long before the Fall) then yes, scarcity existed. But this isn't the definition of scarcity that neoclassical economics is built on. Scarcity presupposes unlimited wants and needs. In the presence of God, how is it possible not to be satisfied unless he is not perfect and all-satisfying? If He has need of nothing (Acts 17:24-25), in His presence in the absence of sin, how could we not be all-satisfied? Even with whatever tasks God gave man to accomplish, in the absence of death there was unlimited time to accomplish them. As we were "naked and not ashamed," there was no insecurity or even a sense that something may be inadequate.

In the New Jerusalem, one sees the same picture. God's presence provides physical illumination, so that a sun or moon aren't even needed (Rev. 21:22-23). As Meeks says, we won't be in some eternal rocking chair enjoying retirement, God will provide work to do just as He did Adam before the Fall. But our needs will be eternally met and there will be no scarcity and no need for a system to allocate limited resources to unlimited wants and needs.

Here in our fallen world, however, scarcity is very real. Even if we have an abundance of "stuff," we can always think of something else we could use or want. One could perhaps point to this as evidence that way back in our genetic history we were once completely satisfied, but then something happened (the Fall) that ended the satiation.

Meeks isn't pleased with the notion that this is just how it has to be. He points out that multiple times in Scripture, God provides exactly what people need for the here and now. The manna of Exodus 16:
This is [l]what the LORD has commanded, ‘Gather of it every man [m]as much as he should eat; you shall take [n](W)an omer apiece according to the number of persons each of you has in his tent.’” 17 The sons of Israel did so, and some gathered much and some little. 18 When they measured it with an omer, (X)he who had gathered much had no excess, and he who had gathered little had no lack; every man gathered [o]as much as he should eat.
The excess spoiled or melted. We're exhorted over and over again to find our contentment in Christ, to consider all else as "loss" for the sake of knowing Him. So, in Christ we shouldn't have unlimited wants and needs. Meeks:
"The only need human beings have is for the reign of God's righteousness. Everything else human beings need is given with righteousness...God's destruction of scarcity through God's righteousness creates a new human being, the creature who finds satisfaction in serving God's righteousness and justice. Faith in the God of "enough through justice" does not relieve the human being of all hungers but transposes them into the hunger after righteousness."

On the supply side, God sends manna from heaven, oil and flour from thin air, and feeds thousands of people with a few loaves and some fish. Scarcity doesn't apply to God. Meeks: "The righteousness of God destroys artificial scarcity." As Jesus teaches us to pray "Your will be done on earth as it is in heaven," might not that include satiation of our needs and wants as it is in heaven?

Where God's righteousness is, scarcity is not.-- this is how I think about it, and it has profoundly affected me.

Where Meeks says "God's destruction of scarcity through God's righteousness creates a new human being," this is a necessary precondition to be freed from the bondage of scarcity. It is not possible to be rid of unlimited wants and needs unless you are born again (John 3) and attached to the vine of Christ (John 15). This leads me to desire to invite people on the outside fringes into the Kingdom, just as Jesus did (which is how Meeks describes Jesus' ministry). We cannot impose the conditions of the Kingdom on those outside it, nor can we remove the reality of scarcity for those who do not know Christ. (this is where I separate myself from my more liberal Christian friends who seemingly want to remake society in God's image without the necessity of everyone in that society absolutely submitting to Christ). We are called to live differently and experience a different economy and a different reality from "the world" and invite others to join us in that experience.

However, this concept has implications for how we think about macroeconomic growth and development. My next post will deal with those.

God the Economist. Book Review (#15 of 2011) Part 1

God the Economist: The Doctrine of God and Political Economy by M. Douglas Meeks.

This book may take several blog posts to scratch the surface. The notes and bibliography make up about 20% of the book, and the breadth of sources is incredible. It is a 5 star book for its scholarship alone.

Meeks is currently a theologian at Vanderbilt, associated with the Methodist Church as well as the United Church of Christ. He examines philosophy ranging from Aristotle to Hegel. He cites economists from Smith to Veblen. He looks at the Torah and he looks at the early church fathers. Every sentence in this book requires unpacking and contemplation, and it may be the most difficult book I've read in ten years. Mostly because it is philosophical rather than practical.

I would describe Meeks as a theologian attempting to build a bridge between theology and economics. He is approaching from the theology side and admits that it's "painfully obvious" he is not an economist. The closest book I've read to this is Halteman's Clashing Worlds of Economics and Faith, which one can see as building the bridge from the economics side, but that book has about 1/10 the depth of this one.

Meeks' attack on my moorings is unflinching, mainly because he knows more about biblical history and philosophy than I could ever hope to. His assault is mainly focused on liberal philosophy which came out of the Enlightenment and the neoclassical economic theories that built on it.

He does not examine many actual events or give many illustrations. This is not Rodney Stark's book, and while I think Meeks could agree with Stark's hypothesis that the Enlightenment built on Christian principles of equality which fostered the importance of individual freedom and property rights leading to capitalism and economic development, Meeks would disagree that individual freedom and property rights as defined by classical liberals is compatible with the biblical concept of property rights. Hence, as Europe developed a market system based on a modern concept of property rights and individual freedom it became a godless place marked by inequality, greed, and spiritual confusion. (Meeks doesn't say this about Europe, these are my conclusions drawn from his logic.)

Questions that arose as I read the book:

1. Are Christianity and neoclassical economic thought compatible?
2. How should we approach scarcity? Is the idea of scarcity compatible with Christian living?
3. Are Christianity and libertarianism compatible?
4. How now shall we live?

#1 is hugely important because neoclassical economic thought underpins about 90% of what's taught in schools today. You are either part of the "neoclassical synthesis" or a heterodox economist (Marxist, Austrian, a few others, who are basically philosophers and not "economists" by a modern definition.)

The foundation of neoclassical thought comes primarily from the works of the "classical economists," the "moral philosophers" from the late 1600s to mid 1800s: Locke, Hume, Rousseau, Smith, Ricardo, Say, etc. These are the founders of "classical liberalism," from which our modern Libertarians come from. Some of the fundamental tenets of classical liberal philosophy and classical economic theory (these are my crass words):

1. Individuals have certain unalienable natural rights, and individual freedom is of utmost importance. All men are equal in the eyes of God (a Christian spin on it).

2. We have a limited number of resources for an unlimited amount of wants and needs-- ie: scarcity. (The fundamental question every society faces is what to produce and for whom to produce it for.)

3. A free market allows free, self-interested individuals to organize their society effectively without the need for a monarch or central authority to rule over and exploit them.

4. A free market is the best system for allocating scarce resources to satisfy the unlimited wants and needs of individuals and maximize the overall welfare of the society.

5. The wealth of a nation is measured by how much it produces.

Meeks, like Halteman, states that the Trinity, Israel, and the Church are all communitarian. There are no radical individualists in Scripture, everyone is part of a greater fellowship. God's guidelines for Israel's economy all involved how individuals were relating to their community, with God at the center. So, the classical liberal approach of putting the freedom of an atomistic individual at the center of the economic rules is contrary to Scripture.

"The individual should be understood as an intrinsically communal being" (58). "(However,) [t]his does not mean by any stretch of the imagination giving up market mechanisms and many other advances in modern economy. But it does mean learning how to discern those spheres of economic power that must be made accountable to popular will" (57).

Because Meeks does not see the free market delivering what it promises (#3 above)-- a way to organize society without domination. Because capitalists accumulate wealth--surplus--as a means for obtaining more wealth (as Adam Smith describes in WoN), which others will not have access to. As certain wealthy people begin to control access to means of production, they enjoy a power others do not (sort of what we'd call "market power" today) and may attract a " enlist command and obedience on a vast scale." Propertlyless persons become dependent upon the wealthy for livelihood. Furthermore, because modern property rights allow owners to refuse others the use of property, those with the most property will dominate (Pg. 59-61).

Meeks admits that the market system "emancipate(d) society from harsher precapitalist modes of domination: slavery, serfdom, and the absolutist state" (61). But real equality is only found in perfect competition-- which is almost never found in real life. If a country moves toward privatization, how it assigns property rights initially will have an influence on inequality (see 1990s Russia, though the Coase Theorem has something to say here).

Meeks also makes a Marxist-style argument that surplus accruing to capitalists is derived from production and not the exchange. Workers are separated from the product they are producing, the right (like patents) to produce it belongs to the owner, thus creating inequality. "Workers maintain the right of exit but lose the essential right to make choices about their lives and the community in which they live" (Pg. 63). Again, in a world of perfect competition workers are perfectly free, they have unlimited options to choose from to find employment. But the real world doesn't look like this. Someone threatened with termination has lost her liberty because the costs of losing the job could be much higher than a lost wage.

"Whatever the value of the liberal argument that market exchange enhances democracy, it is also true that unaccountable control and domination within market exchange deters democracy. Market theory, however, asserts that whatever happens in the market has its justification because of human nature."

This type of "domination" is shown as the antithesis of biblical community. There were rich and poor in Israel, but the poor were given access to property that belonged to the rich-- they were allowed to collect grain to satisfy their need before the harvest, allowed to pick up the fallen grain, and allowed the edges of the field. (If you argue that this was an exclusive right, you could undermine Meeks here as showing that God allowed for some "exclusive" rights, and thus some form of inequality existed in the biblical system.) Land was returned to its original owners every 50 years. Lending at interest (ie: for profit) was forbidden.

Basically, an Israelite wasn't allowed to use his property in a way that harmed members of the greater community. Members of the community were allowed access to his property but with the understanding that no one was to take advantage of the other. Personal freedom had its limits, and libertarians would find anathema the vast amount of regulations that existed for Israelites in regards to what they could not do with their property (regulations on eating, washing, etc.).

So, the classical liberal idea of individual freedom being more important than the welfare of the community and being the center of building a market should be alarming to Christians.

I will address the issues of scarcity and measuring the wealth of nations in subsequent posts.

Turkey Highlights

A couple of my favorite bloggers have linked to Turkey articles recently. Tyler Cowen recently visited Anatolia and found it fascinating:

Central Turkey is more economically advanced than I had expected. It is downright nice here, and standards of living are reasonably high. Imagine the per capita income of Mexico or Brazil but with greater equality and stronger social cohesion. Food is even better than in Istanbul, namely it is spicier and has fresher raw ingredients.
His post has several links of note. Reihan Salam also comments on a Spiegel Online profile of Turkey and its politics. It's a good read for a look at the good and the bad. But the interesting thing is that Turkey's growth is causing some repatriation, as Europeans are "flocking to 'Istancool.'"

The Brookings Institution, a Washington-based think tank, ranks Istanbul at the top of its list of the 30 most dynamic cities in the world...New skyscrapers, each one more avant-garde than the next, are constantly going up in Istanbul's business districts, while the satellite towns on the outskirts are continually growing as more people migrate to the city. Most of these new arrivals are able to find work.

Europeans and Americans have also discovered 'Istancool,' the most modern city in the Islamic world, a city that never sleeps. Among the new arrivals are people whose parents and grandparents once emigrated to faraway Germany in search of a better life...When she flew to Istanbul with her family two years ago, Stegemann was overwhelmed by the wealth of cultural contrasts, the galleries, exhibitions, designer outlets, mosques and bazaars. She was offered a job in a private hospital. She accepted, and today she earns more than she did at home in Hanover... The number of Turkish-Germans returning to the country of their forefathers has long outnumbered the number of Turks heading to Germany.

A BusinessWeek profile last week gives some figures:

In the last decade, Turkey, a country of 80 million people, has become the 17th largest economy in the world. Since 2003 its gross domestic product has more than doubled from $304 billion in 2003 to $734 billion in 2010. Exports have more than tripled from $31 billion in 2001 to almost $114 billion last year. According to the International Monetary Fund, Turkey's economy grew by 8.9 percent in 2010...

Europe remains the biggest market for Turkish products, accounting for 50 percent of the country's exports. Most go to Germany, France, and Britain, where the Turks are among the leading producers of cars, televisions, and home appliances. Turkey is the world's largest cement exporter and its construction sector is second to China's. That's because Turkish companies have a no-frills, formality-be-damned mentality that allows them to get projects done faster than their European counterparts, say many Turkish businessmen. "All we need is this," says Mustafa Mente of the Turkish Exporters' Assembly, pointing to his cell phone.

All is not guaranteed to be rosy economically, as I pointed out previously. But right now Turkey is in a much better position than most other countries in the world, and in probably the best position in the Muslim world.

Monday, June 20, 2011

Book Review (#14 of 2011)

Supply-Side Economics: A Critical Appraisal. Edited by Richard H. Fink, George Mason University.
Why did I devote four different blog posts to this book? Because I'm convinced most people blogging and pundit-ing today are about my age, and they don't remember the details of policy debates from 30 years ago. Many of the essays in this book could have been edited and easily re-printed today. The people advising the candidates for office are likely much younger than me, and probably were born after Reagan left office.

For example, Tim Pawlenty is running for President and made this claim recently (emphases mine):
"So as people look back to the historical examples, there's been other chapters where tax cuts have been enacted, and almost always they raise revenues if you just isolate the effect of the tax cuts...When Ronald Reagan cut taxes in a significant way, revenues actually increased by almost 100 percent during his eight years as president. So this idea that significant, big tax cuts necessarily result in lower revenues -- history does not [bear] that out."

Bruce Bartlett was there. He helped author the Kemp-Roth tax cut bill. He reminds Pawlenty (emphases mine):

In point of fact, this assertion is completely untrue. Federal revenues were $599.3 billion in fiscal year 1981 and were $991.1 billion in fiscal year 1989. That’s an increase of just 65 percent. But of course a lot of that represented inflation. If 1981 revenues had only risen by the rate of inflation, they would have been $798 billion by 1989. Thus the real revenue increase was just 24 percent. However, the population also grew. Looking at real revenues per capita, we see that they rose from $3,470 in 1981 to $4,006 in 1989, an increase of just 15 percent. Finally, it is important to remember that Ronald Reagan raised taxes 11 times, increasing revenues by $133 billion per year as of 1988 – about a third of the nominal revenue increase during Reagan’s presidency.

The fact is that the only metric that really matters is revenues as a share of the gross domestic product. By this measure, total federal revenues fell from 19.6 percent of GDP in 1981 to 18.4 percent of GDP by 1989. This suggests that revenues were $66 billion lower in 1989 as a result of Reagan’s policies.

Bartlett points out that Sen. Mitch McConnell (R-KY) has also repeated the similarly false claims that the Bush tax cuts were self-financing. The data firmly disagree. In a different article, Bartlett notes that "there’s no evidence that the 2003 tax cut did anything to stimulate corporate investment," another crucial claim of supply-siders and current GOP candidates. "(N)either taxes nor spending by themselves are the most important government contribution to the investment climate; it’s the budget deficit. Consequently, a reduction in tax revenue which raises the deficit is unlikely to stimulate domestic investment..."

Where I disagree with Bartlett is the claim that "no one in the Reagan administration ever claimed that his 1981 tax cut would pay for itself or that it did." Technically, Art Laffer and Jude Wannisky didn't work for the Reagan administration. But Laffer's ideas were what everyone in the Reagan administration pointed to as the basis for cutting taxes, and his essay clearly says the tax cuts would be self-financing and balance the budget within four years. Those were the numbers that David Stockman presented to Congress.

But the problem worsens. The Heritage Foundation, which in 2001 erroneously predicted the Bush tax cuts would create an economic miracle, similarly predicted the Ryan Plan would create one of the biggest investment (and housing) booms in history and drive the unemployment rate to 2.8% by 2020 without increasing inflation-- a supply-side miracle never seen before. Economist Menzie Chinn took the analysis apart and found "Laffer Redux." It's the same type of bogus claim that ignores hundreds of years of economic thought and historical evidence just as Laffer & Co. were doing 30 years ago.

Let's not forget that Laffer was also extraordinarily wrong on monetary policy, claiming that tighter money and raising interest rates would cause capital flight and inflation in 1981.

Laffer also laughed off the idea of a housing bubble and impending recession back in 2007. How'd that work out?

I'm convinced that there are many people teaching in business schools today, influencing generations of entrepreneurs, accountants, investment advisers, lawyers, and politicians, who believe that "Ronald Reagan proved that tax cuts pay for themselves. Art Laffer was right. Tax cuts always boost investment and grow the economy," with very little understanding that the data firmly say otherwise.

Many people of all political stripes are pining for a mythological "better time" in American history and seem easily duped by pundits and politicians promising easy solutions and a return to that mythological "better time." That makes it easy to paint political opponents as obstructionists who stubbornly refuse to let us go back to the "paradise" we once knew. For the Left it's the 1950s and early 1960s. For the Right it's usually 1984, or in some cases 1784.

Those who don't know their history are condemned to be constantly frustrated.

Saturday, June 18, 2011

For Scott Sumner

"What should the Fed be doing? The type of announcement I would like to see would state the target of monetary policy in terms of a path of nominal GNP...What we can promise through the use of a sensible long-run monetary policy use monetary instruments to keep nominal GNP growth at a reasonably high level, that is, not undergo sharp recession, and yet, reduce this growth gradually to a non-inflationary level...We shouldn't be afraid of money growth, if the reason we need it is growth in real GNP...We can get out of the box by announcing a nominal GNP target instead of a money growth target. So far, the (Reagan) administration's position has been incomplete in this area."

Robert Hall as published in his essay "The Reagan Economic Plan," in Supply-Side Economics: A Critical Appraisal (1982).

Reagan, Volcker, Art Laffer, and the Monetary Policy Debate of 1980 (or "Once Upon a Time, the OMB Had a Preferred NGNP Target")

This is a continuation of my reading of Supply-Side Economics: A Critical Appraisal, a 1982 collection of essays published by George Mason University. My previous post examined the 1980 debate over fiscal policy and the "Laffer Curve." Today, I look at the monetary policy debates in the book and try to examine the evidence of what actually occurred.

Missing from many of the essays was the pressing issue of inflation and the role of the Federal Reserve given the Reagan tax cuts-- the central bank is always the second-mover. A couple authors noted that the Fed would have to dampen demand as a result of the potential deficits, which would make Laffer's tax revenue projections a moot point. Manuel H. Johnson's essay "Are Monetarism and Supply-Side Economics Compatible?" gives the political context of 1980-- Reagan's advisers were divided between monetarists and supply-siders, and there were probably at least two camps in each group (Pg. 405). Both groups agreed on the need for tighter monetary policy. The Volcker Fed was (supposedly) targeting the growth rate of M1. Reagan's OMB Director, David Stockman, even testified before Congress as to what the Reagan administration's preferred growth rate targets of M1 were, targets even more strenuous than what the Volcker Fed was supposedly pursuing.

The Fed's stated policy was to reduce the annual growth of M1-B from 7.3 percent in 1980 to 4.3 percent by 1986 (Pg. 408).
Stockman and the Administration projected a decrease in the annual growth of M1-B from 6.4 percent to 3.4 percent by 1986, with inflation projected to fall from 9 percent to 4.9 percent over that period (Pg. 417).

Johnson uses a couple of Administration documents to create this chart, which is worth reproducing (sources: A Program For Economic Recovery, Feb 18, 1981 and Mid-Session Review of the 1982 Budget, OMB):
Reagan Administration's Forecast:
Note that the Reagan Administration wanted the Fed to achieve NGNP growth just over 9 percent by 1986. (Maybe Newt Gingrich is right to long for Reagan-era monetary policy. I'm really hoping a "quasi-monetarist" can comment on this post. *Update*- in the same book, Robert Hall has an essay calling on the Fed to follow a nominal GNP target. ) The Fed would constrain money supply growth and inflation while the Reagan tax cuts would boost productivity, velocity, and RGNP growth.

Keynesian Nobel Laureate James Tobin's essay "The Reagan Economic Plan: Supply-Side, Budget and Inflation" puts it thus: "Reagan is hitching a Volcker engine at one end and a Stockman-Kemp locomotive to the other and telling us the economic train will carry us to full employment and disinflation at the same time...Our President promises disinflation without tears, indeed with prosperity" (Pg. 337-338).

The Administration's monetarists vehemently disagreed with the official projections, arguing, like Tobin, that the tax cuts and Volcker Fed could not boost velocity in such a fashion. Basically, the Administration monetarists (Beryl Sprinkle) argued that velocity (V) was relatively stable. While it may fluctuate in the (very) short run, on a year-to-year basis it would be reliably stable (3.2 percent). Tobin remarks "these (projected) increases in velocity are beyond historical experience, even in the recent decade of unprecedented financial innovation...if the inflation and interest rate projections of the administration were realized, velocity would slow down" (Pg. 338, emphasis mine-- you'll see later that velocity did slow down).

Treasury Department supply-siders like Paul Craig Roberts and Norman Ture disagreed. They cited evidence that RGNP growth and velocity growth are correlated, and since the Reagan tax cuts were going to permanently boost productivity and RGNP growth to a new trend, velocity would permanently increase as well. They expressed skepticism at the Fed's ability to control monetary aggregates and were "willing to consider... the adoption of a price rule, " but seemed to believe the Fed could control inflation if it was committed (Pg. 408-409).

Where the supply-side camp split, however, was in its faith in the Fed. Art Laffer, Jude Wanniski, and Lewis Lehrman advocated an immediate return to the gold standard. Laffer's reasoning for this is just bizarre:
1) Tightening the money supply and raising the discount rate was "equivalent to imposing a tax on the activities of these banks."
2) Banks would raise the interest rates on the loans they were making, moving them up to an elastic point on the demand for loanable funds-- causing bank revenue and profits to decrease.
Then, in Laffer's own words (Pg. 409, emphasis mine):

"Both demanders and suppliers of credit will substitute out of dollars held...into Eurodollar accounts, foreign currency...indexed accounts, and gold. In short, the Fed's actions have reduced the viability and attractiveness of the dollar...As such, the Fed's actions per se have increased the prospects for inflation, in spite of the fact that their actions clearly will result in a slower growth in measured quantity of money."

Laffer's view was that reining in the growth of the money supply and raising interest rates would cause a decrease in demand for money (increase in velocity) and capital flight, and the only solution was a gold standard to "restore confidence in the dollar." (I'll come back to this later.) Johnson summarizes: "Gold standard supply-siders...assert that monetarism is destabilizing because the policy tools employed by monetarists cause prices to move in the opposite direction from the quantity of money. But this position falls outside the mainstream of economic thought and is not shared by supply-siders holding policy-making positions in the government." Laffer was basically scoffing at several hundred years of economic thought and the quantity theory of money. (Laffer's theories paint the Fed into a no-win debate: If it increases money growth, it's causing inflation. If it decreases it, it also causes inflation.)

Monetarists like Milton Friedman (who opposed the gold standard) saw a less-rosy scenario than the Administration. As stated in his interview in the book and PBS series The Commanding Heights (Google Video), the only way you could wring inflation out of the system was to have a temporary recession. In the same video, Paul Volcker agrees with this assessment, he just didn't realize at the time how high interest rates and unemployment would have to go to get the job done.

William P. Orzechowski's essay "Monetary Aspects of Supply-Side Economics" claims that "Monetarists object to supply-side tax cuts...(because) supply-side economics does not portray budget deficits as inconsistent with economic growth and low inflation." (Pg. 428). Monetarists tended to recognize that the Reagan tax cuts would not produce the promised instant increase in productivity and would be inflationary in the short-term, and then the Fed would be under enormous pressure to monetize some of the debt.

Orzechowski, however, presents data from a cross-section of countries from 1977-1979 as evidence that there is no relationship between deficits and inflation, and that "budget deficits and slow monetary growth do not necessarily mean crowding out of private investment as the 'fiscal conservatives' allege."

So, what actually happened to monetary policy and the economy during the period from 1980-1986? As graphed out in the previous post, and pointed out in Paul Krugman's book Peddling Prosperity (1994) and Tyler Cowen's Kindle Single The Great Stagnation (2011), there was no permanent increase in productivity growth as a result of Reagan policies.

(If any of the below is amiss, just let me know. Thanks.) Here's a graph of M1 growth starting in 1976 (the first year of the series) and going to January, 1987. From 1976 to 1980, M1 growth averaged 7 percent. From 1980 through 1986, M1 growth averaged 9 percent. It was nowhere near the Administration's projections. It peaked at 13 percent from 1985-1986, a time when the Administration had projected in 1980 only 3.4 percent growth.

The growth rate of M1 velocity (the inverse of demand for money) also came nowhere close to Reagan Administration projections. You can see the stable trend in the 1970s that monetarists believed would continue, and then what actually happened:
Alan Blinder details the numbers and monetarists' and supply-siders' shock about velocity in his 1987 book Hard Heads, Soft Hearts.

Nominal GNP growth from 1980 through 1986 averaged 7.9 percent. Real GNP growth:The economy entered a nasty recession to kill inflationary expectations as standard economic theory had predicted. RGNP growth was about a percentage less than the Administration had projected in each of the last three years of its forecast (see chart above). But if you count that roaring back from the "greatest recession since the Great Depression," at least one year was way better than Reagan economists had initially dreamed.

What about Art Laffer's claim that Volcker's tight money/ higher interest rate policy would cause capital flight and decrease confidence in the dollar?

Effective federal funds rate:
Trade-weighted exchange rate value of the dollar (broad):

As you can see, as interest rates rose and the rate of inflation fell, the dollar appreciated. This is in line with hundreds of years of economic thought that Laffer ignored.

The Volcker Fed succeded in bringing inflation down to a lower rate faster than the Administration (or anyone else) had projected:

But contrary to the supply-side prognostication, the personal savings rate fell from 9.8 percent at the beginning of 1980 to 6.5 percent at the beginning of 1987:
Real private domestic investment increased, on average, 3 percent from 1/1/80 to 1/1/87. No great boon at all. The Reagan/supply-side promise was that reducing government investment in public infrastructure would spur private investment to take up the slack (Pg. 344). This promise was not achieved.

Tobin bemoans the monetarist bent on targeting a monetary aggregate "invariant to...other macroeconomic circumstances," such as when investment is lower than desired (Pg. 342-343). He believed that the Administration should have pursued policies that would have pulled investment decisions further into the present rather than waiting for them to materialize with the hypothetical increases in productivity and decreases in inflation.

Tobin was proven incorrect that no progress would be made on any front by the Reagan plan-- the dragon of inflation was slain (a worldwide phenomenon). Saudi Arabia pumped more oil, giving us the real supply-side boost of the 1980s. Economic and employment growth did resume extremely rapidly after the Fed relented, and the U.S. avoided another major recession until 2007. The "Great Moderation" was so influential that many seem to have forgotten 1982 ever happened, and the Reagan years are often remembered for many other mythical things.

Monetarist belief in very stable velocity would not survive the Reagan years. The Fed's inflation-fighting credibility was forever established. Real business cycle theory would replace most of the above in academic macro. Supply-side thinking would continue to live on forever in think tanks. The Great Stagnation of productivity growth since 1973 would continue.

Thursday, June 16, 2011

The Laffer Curve, JFK, Tax Cuts, Supply-Side Economics, and Snake Oil

Continuing my reading of Supply-Side Economics: A Critical Appraisal, a 1982 collection of essays by authors ranging from Hazlett to Tobin published by GMU. One thing I gleaned from the book is that 1970s policymakers were having the same debates that think tanks are having today: What is the cause of the current deficit -- the Kennedy (Bush) tax cuts, or the (bipartisan) increase in government spending? Which mix of tax hikes and/or spending cuts is the best way to close that deficit? Many of the analyses in these essays could have been written today. But one proposal has been (hopefully) discredited-- that you can balance the budget simply by cutting taxes. This post will deal with the tax/fiscal policy debate. My next (much shorter) post will deal with the monetary policy debate of the time.

Since Art Laffer is considered the caricature of the supply-side movement, I was eager to read his essay "Government Exactions and Revenue Deficiencies" (free PDF at Cato) first. Laffer's theoretical argument about tax cuts is a bit more complicated than recognized, he presents a standard production function with capital and labor as inputs within a closed economy, and illustrates the effects on both variables given a change in taxes on one or both. He uses a standard microeconomic substitution and income effect analysis. His model draws five conclusions (P. 191):
1. Lower tax rates correspond to higher output.
2. Lower tax rates on either factor increase employment of both factors.
3. With government spending held constant, the constellation of tax rates affects output. How taxes are collected is important.
4. Lowered tax rates on any factor may or may not lower total revenue.
5. With revenue held constant, changes in the pairing of tax rates may shape the distribution of after-tax spending power, but only indirectly...when one factor's tax rate is raised and the other's is lowered, the second factor will end up in worse economic shape.

(I confess that even after reading his underpinnings #5 doesn't make much sense to me, particularly in a closed economy. )

Laffer then proceeds to analyze the "Kennedy" tax cuts of 1962-1965 to determine whether they boosted economic output and, crucially, to determine their effect on tax revenues. Laffer then compares the situation of 1962 to 1980 to make a policy recommendation.

The major differences between 1962 and 1980 (P. 194-195):
Defense spending 46.2 percent of the federal budget.
Transfer payments 25.2 percent of the federal budget.
1980 (1979):
Defense spending 21.3 percent of federal budget.
Transfer payments 41.2 percent of federal budget.

The major similarities between 1962 and 1980:
Capacity utilization estimated around 83 percent.
Elevated unemployment.

Laffer purports that the effective tax rate was higher in 1980 than the 1960s because of (1) inflation-induced "bracket creep," (2) inflation-induced understatement of true economic depreciation of capital and overstatement of capital gains, and (3) increases in the social security tax rate and wage base. Indeed, tax receipts constituted 36 percent of GNP in 1979 compared with 28.3 percent in 1963.

Ironically, the 1962 Kennedy tax cuts were promoted by Democrats and opposed by Republicans concerned with the deficit (as pointed out in Bruce Bartlett's essay in the book). Democrat Wilbur Mills gave the original supply-side speech on the house floor, arguing that the tax cuts would result in "the federal budget being balanced sooner than would be the case in the absence of these tax cuts... these lower rates of taxation will bring in at least $12 billion of additional revenue" (Pg. 278).

The Kennedy tax cuts consisted of investment tax credits, more favorable depreciation schedules, and lower corporate and personal income tax rates. There is little disagreement among economists today that the tax cuts spurred economic growth and boosted employment. No one disagrees that incentives matter, and taxing someone at a 91% marginal rate reduces their incentive to work. Laffer presents the changes in marginal personal income tax rates across all brackets (there were 25 personal income tax brackets in the 50's and 60's): (Pg. 197)

From 1963 to 1966, unemployment dropped from 5.6 percent to 3.8 pecent while real GNP grew at an annual rate of 5.7 percent (consistent with the trend since World War II, not pointed out by Laffer). The ratio of government spending to GNP fell slightly.

Laffer admits that "whether this expansion in economic activity and the general tax base...was sufficiently large enough to offset the tax rate reduction's negative revenue effects, is subject to considerable debate" (Pg. 198, emphasis mine). Laffer cites a Wall Street Journal article giving "anecdotal evidence" that tax revenue from the highest brackets increased every year from 1962 to 1965. However, Laffer admits that it appears taxpayers as a whole were on the wrong side of the "Laffer Curve," overall revenue decreased.

Laffer then doubles down-- he cites a study by Canto, Joines, and Webb using an ARIMA univariate time-series model that forecasts "what revenues would have been if the economy had continued to evolve along its normal path and the Kennedy tax cuts not been enacted." The authors found that revenues fell by almost $30 billion less than Kennedy's Treasury had projected: "These results... suggest that it is as likely that the federal tax cuts in 1962 and 1964 increased revenues as that they reduced them" (Pg. 199).

Evidence in hand, Laffer immediately pivots to 1980: "[T]he tax rate cut proposed by the Reagan administration (30 percent across-the-board, to be phased in over three years), is modest... The expansion of the economy that would occur... (and) the revenue feedback effects from across-the-board tax rate reductions are likely to be greater than those experienced fifteen years ago" (Pg. 201, emphasis mine).

Laffer ups the ante:
"It is reasonable to conclude (the tax cuts) would be self-financing in less than two years... By the third year of the tax reduction program, it is likely that the net revenue gains from the plan's first installment would offset completely the revenue reductions...Thus, the proposed Reagan tax cut has a far better chance of balancing the budget while restoring vitality to the American economy than programs attempted by the Carter administration" (Pg. 201, emphases mine). Note how this echoes Wilbur Mills remarks 20 years earlier.

David Henderson's essay (free PDF via Cato) takes Laffer to task for the sloppy empirics. He points out that the naive time-series forecast done by Canto, Joines, and Webb obviously doesn't control for other factors such as the expansion of the tax base due to the increase in Baby Boomers entering the workforce and the increased amount of international trade (Pg. 227). The omitted variables may be important, and probably don't exist in the context of 1980 (the low-hanging fruit was already picked).

It was a lot to sell an economic policy to Congress on (it was the Kemp-Roth bill). I noticed how in several essays, including Laffer's, newspaper articles were cited for support instead of academic papers. Thomas Hazlett wrote a critique of supply-side thinking from the Austrian perspective, and had this zinger: "The supply-side argument is unique: its 'theoretical' works have been written by journalists... supply-side economists have spent no time theorizing while the supply-side journalists have been breaking their backs with the heavy chore of model-building..." (Pg. 94).

Max Moszer's essay approaches the Laffer Curve from a Keynesian AD perspective. While he notes that he would certainly support tax relief, he feels that Laffer's revenue assumptions are theoretically unsound (Pg. 204). Moszer points out that there is no evidence the Kennedy tax cuts boosted productivity, which gets to the heart of the supply-side promise: the resulting increase in productivity will boost GDP and tax revenues while holding down inflation. From an AD perspective "For the supply effects of the Laffer Curve to work... the multiplier effect has to be large. A tax cut to an effective average rate of 10 percent would require a jump in real output to $2240 billion just to (hold tax revenue constant)... This yields a multiplier requirement as large as 10" (Pg. 222, emphasis mine). Most econometric models of the time (and today) had multipliers no larger than 2.

Moszer proposes an alternative: continuing with deregulation would likely yield better productivity gains and tax returns than the Reagan tax cuts. Henderson simply argues that "there are many other good reasons for cutting taxes. Taxation...denies our freedom... (and) civil liberties and reduces our material well-being. Taxation has made it easier for the government to wage war abroad..but the argument for tax cuts on the basis of the Laffer Curve is a castle made of sand" (Pg. 228, emphases mine).

Reihan Salam points us to a 1982 New Yorker piece on supply-side economics, where Laffer comes across "humble" about his assertions, and supposedly even supportive of Keynesian AD stimulus during a depression. But the point of his essay and his comments in 1980 are clear: The Reagan tax cuts would stimulate growth, tax revenues, and lead to a balanced budget even without a decrease in government spending.

And so the Kemp-Roth Bill became the law of the land-- tax brackets were consolidated and tax rates were lowered in 1982 (history here, free PDF):
The top marginal rate became 50%, the bottom was cut to 0%. $85,600-- the top bracket for married filing jointly -- is equivalent to $190,808 today. (Note that today we have a debate on whether to raise taxes on households married filing jointly earning $372,951 to a marginal rate above 35%. Our effective tax rate in 2009 was lower than at any time since 1950.)

From the National Review archives: Reagan's adviser, Paul Craig Roberts (who also has an essay in the book), submitted a white paper in February, 1981 projecting that the government would run a budget surplus by 1984.
Although federal revenues as a percentage of gross national product were projected to fall from 21.1 per cent in 1981 to 19.3 per cent in 1984, the dollar amount of budget receipts was expected to increase from $600.2 billion in the former year to $772.1 billion in the latter. In the same period, federal outlays were to rise from $654.7 billion to $771.6 billion, although falling in relation to GNP from 23.0 per cent to 19.3 per cent. In essence, this budget policy represented an effort to bring receipts and outlays in relation to GNP more nearly in line with the average postwar experience.
Unfortunately, tax revenue failed to rise as projected, and Reagan-era spending rose faster than projected:
Although the growth in federal outlays, in both nominal and real terms, slowed materially from fiscal 1980 through fiscal 1989, total outlays substantially exceeded those proposed in every Reagan budget. As a result, even had the revenues projected in the White Paper been realized, the budget would have failed to come into balance in 1984, when actual outlays of $851.8 billion were $80 billion more than had been contemplated.

Paul Krugman gives us this chart:
"(T)he revenue track under Reagan ...: a drop in revenues, then a resumption of growth, but no return to the previous trend. This is exactly what you would expect to see if supply-side economics were just plain wrong: revenues are permanently reduced relative to what they would otherwise have been."

You can get the data from the St. Louis Fed, but for time's sake Barry Ritholtz takes us to this chart:
And while it would be easy to blame the deficits on a Democratic Congress, there is some evidence to the contrary. From

But what about the real heart of the supply-side argument-- that productivity would increase as a result of the tax cuts -- just as Laffer believes happened from 1962-1965? As David Beckworth illustrates:

The Reagan tax policy's effect on productivity is certainly not obvious (or at least not until the Clinton administration, as some really strain to claim). If the Kennedy tax cuts boosted productivity within 3 years, and the Reagan policy cut an effective tax rate in 1980 that was higher than it was in 1962, then Laffer's hypothesis is apparently disproved by the lack of productivity growth in Reagan's eight years.

It is worth noting that Reagan later raised the payroll tax, the same sort of increase that Laffer considered a major reason effective tax rates had risen during the 1970s, and would later sign several other tax increases into law due to concern over deficits.

My next post will deal with the monetary policy debate of the time, since obviously the Fed-induced recession was a major factor in economic growth and tax revenues. Art Laffer comes out even worse on his monetary theories, quite frankly.