(Note: For the last few weeks, we have been asking people with expertise and passion about free markets to write material for the Idaho Freedom Foundation. Today, we are pleased to present you the first of these articles from Dr. Peter R. Crabb of Northwest Nazarene University in Nampa, Idaho.)
In the 1960s were heard the rally cry of “give peace a chance”. As was also true in that decade, the rally cry today is to give government spending more of a chance. Apparently, we are all Keynesians once again.
To be a Keynesian suggests support for a theory that has never been fully tested. John Maynard Keynes wrote his General Theory as a response to a deepening economic recession of the early thirties. At the time of its writing, the idea of a depression was unknown.
Support for combating a recession through government intervention began with the New Deal. Prior to this the promotion of Keynes’ theories the government had little involvement with what is known as the business cycle – recessions and economic booms. For example, there was no specific government action to combat an earlier recession of 1920 and 1921. Regardless, the economy definitely recovered in the 1920s.
The testing of Keynes theory therefore began in earnest but the debate as to its effectiveness continues nearly 80 years later. What is missing in this debate is that all of our previous experiments with Keynesian economics are incomplete.
First, we have yet to test the other side of what Lord Keynes proposed – that governments will run budget surpluses throughout periods of positive economic growth. Before 1930, the U.S. government had a budget surplus in two out of every three years. In the subsequent 78 years we have seen only twelve.
Also, Keynesian theory is based on an identified relationship between aggregate demand and total employment for which we have measurement error and few sample observations. Both of these data instruments are estimates. We never fully know all that is purchased or consumed in an economy. We never fully know who is working or who wants to work. Each data set is based significantly on surveys.
For these reasons and more there has yet to be a full test of the General Theory, and thus an understanding of the Keynesian multiplier – the theoretical measure of the change in overall economic demand from a change in fiscal policy. Many economists and policymakers today are quoting a 1.57 multiplier, but some studies show only 50 cents for every dollar of tax cut, because of a desire to save, and data from the World War II period suggests only 80 cents for every additional dollar of government spending.
With so little evidence for Keynesian economics, why not give the free-market a chance? It hasn’t been tried in nearly 100 years. We live in a mixed-capitalist system that for at least a century has not seen how well free markets can work.
In general, the United States economy is characterized by markets with little government involvement. But the U.S. government has tremendous influence on conditions in key areas such as the financial markets and international trade. Ineffective policy in both these markets has been shown to be a cause of the Great Depression.
One accepted argument for why a bad recession became a depression in the early 1930s is that the government raised tariff barriers. Why not try the opposite today? The United States should cut its tariffs rates unilaterally and across the board. To further show global economic leadership the U.S. could further reduce restrictions on the international movement of labor.
The United States has long argued for other countries to open their borders to our goods, but we remain relatively closed to the service for which most other countries have ample supply – labor. The U.S. hypocritically keeps strong barriers on the free movement of labor services in place while arguing for greater and greater access for our exports.
Another argument often presented as a mistake of the 1930s was a reduction in the money supply enacted by the Federal Reserve, which led to tougher lending conditions in the financial markets and contributed to the large number of bank failures. The government is trying the opposite today, but with only limited success so far.
A free market solution to this problem lies in rescinding government-granted, monopolistic control of the money supply. This can be accomplished in a simple act. The legal requirement that contracts are fulfilled only through the exchange of Federal Reserve notes can be quickly changed by legislation.
Individuals and businesses in a truly free market should be allowed to conduct economic transactions using any medium of exchange they trust. This can include paper currency offered by any recognized government, charted bank, or known commodity, such as gold or silver. We do not need to establish a gold standard, which previously was difficult to sustain politically. We need only establish greater competition in this important market for economic growth.
In a competitive money market bad policies would be quickly corrected. If the government responded with too tight of supply like it did in the 30s, economic activity would transfer to other forms of currency. If instead, the government responded with too loose of a policy as it appears is happening now, economic activity would transfer to a more trustworthy form of money.
(Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.)