If you listen carefully, you can hear Milton Friedman – the father of neo-conservative economic theory – turning over in his grave. Milton, who believed markets to be rational, perfectly transparent, and generally smart enough to look after their own interests argued vigorously against government regulation or government intervention in economic policy. In Milton’s world, corporations would be smart enough to avoid an economic crisis, and if one occurred, they would be able to pull themselves out of it. Alas, the 2008 economic crisis seems to have successfully unsettled his basic premises and derailed a half century neo-conservative economic policy and dogma.
Friedman’s onetime idol and conceptual opposite was John Maynard Keynes. Keynes was the most influential economist of the 30s and argued that in cases of catastrophic economic crises, corporations and markets may not be capable of pulling themselves out of the “death spiral”, resulting in a recession or even depression much deeper with more severe societal dislocation than would otherwise be necessary. In the direst cases, strong government intervention was the only solution to ending economic collapse. In fact, massive government spending and employment did successfully end the great depression.
So who is ultimately right?
They both were in a sense. The challenge with Keynes was that he argued for consistent and regular government meddling in short-term economic swings, which ultimately led to the stagflation of the 70s. Ultimately, Friedman was correct in the respect that short term meddling in unemployment rates and economic growth lead to unintended consequences. But he – like Allan Greenspan – was wrong to think that corporations can operate at optimal efficiency without government regulation. This being proven by the failure of:
- AIG: One of the largest insurers of the world
- Fannie Mae and Freddie Mac : The largest mortgage originators of the world
- Lehman Brothers: One of the largest investment banks
- Merrill Lynch (near failure): The largest investment bank in the world
- Citigroup (near failure): One the the largest banks in the world
So in a big picture sense, the US government should:
- Recognize the situations where market and corporate irrational behaviors have the potential for massive negative consequences and put in effective regulation, so we can avoid the situations that create an economic crisis
- Stay out of the way of the economy where possible
- Keep an eye out for developing bubbles and “pop” them if necessary to avoid a massive economic crisis
- And when all else fails, in the case of massive impending economic crisis and collapse, step in and vigorously manage the economy.
According to this plan, now that were stuck in the worst case scenario – the most severe economic crisis and collapse since the great depression – what is called for is aggressive government action.
First Things First, “Why are we in an economic crisis?”
There are a couple of underlying causes in the current collapse. First, people were buying houses they couldn’t afford, and banks were irrationally lending those buyers money. When this housing bubble collapsed, home prices started depreciating. People couldn’t afford their mortgages and stopped paying banks. The banks were then left with a ton of bad debt on their books and started going bankrupt or teetering on the verge. These same banks stopped lending money, and businesses started feeling the squeeze. These businesses then started laying off workers.
All this was bad enough, but then Paulson famously and stupidly, and maybe famously stupidly, came out and started screaming about the next great depression. At this point, consumers panicked and consumer spending – accounting for over 2/3 of the US economy – ceased. This caused businesses who saw the evaporating demand to start laying off. Then more people who sensed their jobs were at risk started spending even less. And so it continues today.
How do we fix the economic crisis?
It’s quite simple, honestly. First, the US government needs to do everything possible to stabilize the financial sector. It’s already working aggressively to stabilize the banking sector, which is a step in the right direction.
Second, it needs to focus on jobs. The economy, especially the US economy, cannot recover until people feel secure in their income and start to spend again. Period. Economic crisis is as much about emotion and psychology as reality, and that’s the case here. Historically speaking, that has meant massive public works projects that are in the national interest. It’s a short-term win-win. The government makes the investment in the long-term competitiveness of the country. At the same time, workers get job security and income and start spending again. The good news is that we have no shortage of strategic projects that need investment:
- Massive mobilization to secure our energy independence and simultaneously save the planet from global warming. We should make immediate and massive investments in nuclear power, solar, wind and other power generation plants. At the same time, we should invest massively in more energy efficient technologies like hybrid cars, better insulation, etc.
- Tactical investments in our crumbling roads, bridges, etc, to the extent that it improves commercial transportation or improves the free flow of labor.
- Medical modernization. The United States spends more per-capita on health-care than anywhere else in the world, but our life expectancy lags dozens of countries. We need to find ways to improve efficiency.
Finally, and most controversially, the economic crisis could be dramatically worsened if a major employer like GM, Ford or Chrysler failed. Yes, these companies deserve to fail. Just not right now.
So Mr. Obama, you have inherited the worst economic crisis since the great depression. But your path is clear. Go forth and save the United States!