Why Friedrich Hayek is Making a Comeback
By Russ Roberts
This article originally appeared in the Wall Street Journal on June 28, 2010.
He was born in the 19th century, wrote his most influential book more than 65 years ago, and he's not quite as well known or beloved as the sexy Mexican actress who shares his last name. Yet somehow, Friedrich Hayek is on the rise.
When Glenn Beck recently explored Hayek's classic, "The Road to Serfdom," on his TV show, the book went to No. 1 on Amazon and remains in the top 10. Hayek's persona co-starred with his old sparring partner John Maynard Keynes in a rap video "Fear the Boom and Bust" that has been viewed over 1.4 million times on YouTube and subtitled in 10 languages.
Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?
Hayek is not the only dead economist to have garnered new attention. Most of the living ones lost credibility when the Great Recession ended the much-hyped Great Moderation. And fears of another Great Depression caused a natural look to the past. When Federal Reserve Chairman Ben Bernanke zealously expanded the Fed's balance sheet, he was surely remembering Milton Friedman's indictment of the Fed's inaction in the 1930s. On the fiscal side, Keynes was also suddenly in vogue again. The stimulus package was passed with much talk of Keynesian multipliers and boosting aggregate demand.
But now that the stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it's natural to turn to Hayek. He championed four important ideas worth thinking about in these troubled times.
First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn. If those school teachers aren't buying more houses, construction workers are still going to take a while to find work. Keynesians like to claim that even digging holes and filling them is better than doing nothing because it gets money into the economy. But the main effect can be to raise the wages of ditch-diggers with limited effects outside that sector.
Second, Hayek highlighted the Fed's role in the business cycle. Former Fed Chairman Alan Greenspan's artificially low rates of 2002-2004 played a crucial role in inflating the housing bubble and distorting other investment decisions. Current monetary policy postpones the adjustments needed to heal the housing market.
Third, as Hayek contended in "The Road to Serfdom," political freedom and economic freedom are inextricably intertwined. In a centrally planned economy, the state inevitably infringes on what we do, what we enjoy, and where we live. When the state has the final say on the economy, the political opposition needs the permission of the state to act, speak and write. Economic control becomes political control.
Even when the state tries to steer only part of the economy in the name of the "public good," the power of the state corrupts those who wield that power. Hayek pointed out that powerful bureaucracies don't attract angels—they attract people who enjoy running the lives of others. They tend to take care of their friends before taking care of others. And they find increasing that power attractive. Crony capitalism shouldn't be confused with the real thing.
The fourth timely idea of Hayek's is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He'd like to do the same with the energy market. Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions.
Hayek understood that the opposite of top-down collectivism was not selfishness and egotism. A free modern society is all about cooperation. We join with others to produce the goods and services we enjoy, all without top-down direction. The same is true in every sphere of activity that makes life meaningful—when we sing and when we dance, when we play and when we pray. Leaving us free to join with others as we see fit—in our work and in our play—is the road to true and lasting prosperity. Hayek gave us that map.
Despite the caricatures of his critics, Hayek never said that totalitarianism was the inevitable result of expanding government's role in the economy. He simply warned us of the possibility and the costs of heading in that direction. We should heed his warning. I don't know if we're on the road to serfdom, but wherever we're headed, Hayek would certainly counsel us to turn around.
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Is the Dismal Science Really a Science?
By Russ Roberts
This article originally appeared in the Wall Street Journal on February 26, 2010
For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what's going to happen next.
Is the mess we're in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter?
So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward.
There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry.
It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more.
But in economics, theories that were once discredited surge back into favor. John Maynard Keynes and the view that government spending can create prosperity seem immortal. I thought stagflation had put a stake in the heart of this idea back in the 1970s. Suddenly, he's a genius once again. F.A. Hayek, Keynes's more laissez-faire sparring partner, is drawing interest. There are various monetarists to choose from, too. Which paradigm is the "right" way to think about the boom and the bust? Or are they all wrong?
I once thought econometrics—the application of statistics to economic questions—would settle these disputes and the truth would out. Econometrics is often used to measure the independent impact of one variable holding the rest of the relevant factors constant. But I've come to believe there are too many factors we don't have data on, too many connections between the variables we don't understand and can't model or identify.
I've started asking economists if they can name a study that applied sophisticated econometrics to a controversial policy issue where the study was so well done that one side's proponents had to admit they were wrong. I don't know of any. One economist told me that in general my point was well taken, but that his own work (of course!) had been decisive in settling a particular dispute.
Perhaps what we're really doing is confirming our biases. Ed Leamer, a professor of economics at UCLA, calls it "faith-based" econometrics. When the debate is over $2 trillion in additional government spending vs. zero, we've stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France?
Facts and evidence still matter. And economists have learned some things that have stood the test of time and that we almost all agree on—the general connection between the money supply and inflation, for example. But the arsenal of the modern econometrician is vastly overrated as a diviner of truth. Nearly all economists accept the fundamental principles of microeconomics—that incentives matter, that trade creates prosperity—even if we disagree on the implications for public policy. But the business cycle and the ability to steer the economy out of recession may be beyond us.
The defenders of modern macroeconomics argue that if we just study the economy long enough, we'll soon be able to model it accurately and design better policy. Soon. That reminds me of the permanent sign in the bar: Free Beer Tomorrow.
We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended.
If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That's hard enough. But they can't tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness.
We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions.
The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one's thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don't know and what we may never know. Admitting that publicly is the first step toward respectability.
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Congressional Testimony, December 10, 2009
By Russ Roberts
This is the text of my testimony before the Joint Economic Commitee on December 10, 2009. It differs from the text in the Congressional Record that was submitted in advance. This is the actual text I delivered. Video of my testimony (along with Joseph Stiglitz's testimony, opening statements by the committee members, and the Q and A) is available here. My testimony starts at 58:15.
A man once asked his doctor how much weight he’d lose if he skipped his daily breakfast of a bagel with butter, about 350 calories. The doctor said if you can do that every day for a month, you’ll lose three pounds.
After ten days of skipping breakfast, the man came in to see how he was doing. To the doctor’s surprise, the man’s weight was unchanged. The doctor said good thing you stopped eating breakfast. Otherwise you’d have gained a pound. When I made my prediction, I didn’t realize how bad your situation was.
Unfortunately, the doctor’s analysis was flawed. He didn’t realize the man was eating a bigger lunch because he was hungry after skipping breakfast.
I think about that doctor when I think about the CBO estimates of the impact of the American Recovery and Reinvestment Act of 2009, the stimulus package. The CBO estimates that there are between 600,000 and 1.6 million extra jobs in the economy compared to what would have happened in the absence of the stimulus.
That’s an embarrassingly imprecise estimate. But it’s not really an estimate at all. It’s just a repeat of the forecast that the CBO made at the beginning of the process, like the doctor who predicts that skipping breakfast reduces your weight.
We have no idea of how many jobs have been created or lost because of the stimulus. As the CBO admits, to know the real impact of the stimulus, we’d have to know the path of the economy in the absence of the stimulus. And that is unknown to the CBO just as the lunch habits and metabolism of the patient might be unknown to the doctor.
What we do know is that since March, the economy has lost another 2.7 million jobs. When the stimulus was passed, we were told that without it, unemployment would reach 8.8%. Well, with the stimulus, unemployment went over 10%.
There is no reliable way of knowing whether the stimulus has averted a worse situation or whether it’s part of the problem. There’s no consensus in the economics profession on this question and no empirical evidence to settle the dispute.
But it wouldn’t be surprising to discover the stimulus has had little or no effect, or even made things worse.
Of the $235 billion spent to date, more than a third of that has been a temporary tax rebate. Just as with the Bush Administration tax rebates in February 2008, most of the money was saved rather than spent and had little impact.
The direct spending component has been $145 billion. Of that $145 billion, the four government agencies receiving the most money—the Departments of Health and Human Services, Department of Labor, Department of Education, and the Social Security Administration, account for over 80% of the spending.
Those agencies don’t have many shovels.
The money has gone to increase funding for Alzheimer’s research, to bolster the tax revenues of states so that teachers can continue to be paid, to digitize medical records and to continue paying unemployment benefits. Some of the money went to give raises to workers. Pleasant for them, but not so helpful for job creation.
Roughly one half of the job losses since December of 2007 are in construction and manufacturing. A better understanding of Alzheimers and more efficient medical record-keeping are good things. But they do little or nothing for the bulk of the workers looking for work.
Some argue that it doesn’t matter what we spend the money on. People will spend the money they receive which creates jobs and puts more money into people’s hands and so on. Ironically, this Keynesian story works best when the economy is healthy.
But consumer spending is down because people are rightfully worried about the future. When people are scared, they’re going to save more and spend less compared to when they are optimistic about the future. So fiscal policy that counts on the multiplier doesn’t work any better than monetary policy in that famous liquidity trap. This is particularly true of temporary increases in income. So both fiscal and monetary policy are constrained by the anxiety people have about the future.
Unfortunately, policy makers have been doing a lot to create anxiety rather than dispel it.
The deficit last year was $1.4 trillion.
People know that tax increases are coming but they do not know how big their share will be. The prospect of tax increases discourages spending and offsets some or all of the stimulus.
The size of the debt is creating worries about default or inflation.
The government continues to intervene in ad hoc ways in the auto industry and the financial sector. Major changes are on the table for how the government regulates health care and energy.
We need new businesses to start and old businesses to expand. But if their owners can’t be sure of what the rules of the game are going to be—the tax rates they might face, the interest rates they might face, the inflation rate they might face, the health care mandates they might face, the emissions regulations they might face—then it’s not surprising that business are likely to sit on the sidelines to see how things will turn out.
In a recent survey of employers released this week by Manpower, Inc., 73% said they plan no change in staffing for the first quarter of 2010. That is the highest level of “no change” since 1962. Employers are sitting on the sidelines waiting to see what the rules of the game are going to be.
So what is to be done?
Most people presume that there is something that can be done, something to get people back to work faster. That may not be possible. Government policy induced an unnatural expansion of the housing sector. We built way too many houses. That naturally drew a lot of people into construction. Fully 25% of the job losses have been in construction. The workers who no longer hold those jobs need to find other things to do. They will want to take time deciding what they should do instead. Unfortunately, it is natural that unemployment lingers.
If you must do something, look for effective ways to spend money and reduce policy uncertainty.
Stop giving away money to states with no strings attached. Why has a major goal of policy so far been to preserve state employment while the private sector takes a beating? Let the states deal with their past recklessness by cutting spending.
Don’t treat any unspent TARP funds as free money. It isn’t. Don’t waste it the way the stimulus money was wasted.
Instead of spending randomly, cut the payroll tax. Cutting the payroll tax makes workers less expensive, at least in the short run. Cut it by 25% for the next five years. That will reduce revenue by about $250 billion per year, but at least it has a chance to create jobs.
To reduce uncertainty and fear, stop fiddling with every aspect of the economy. Maybe this is not the best time to be trying to radically change the health care system and the energy market while propping up banks and the auto industry and borrowing trillions of dollars.
• Stop issuing short-term debt. That’s what got Wall Street in trouble. The government rescued Wall Street. There is no one to rescue us.
• Reduce some aspect of government spending to show that the grown-ups are in charge. Get rid of corporate welfare. Cut tariffs and quotas which are a silent tax on the consumer.
• Stop propping up losers. Let people who were reckless go out of business. Otherwise, we are throwing good money after bad and setting the stage for future recklessness.
F. A. Hayek said that “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” It would be good to recognize our limits about what we imagine we can design. We cannot steer the economy. Or the labor market. Recognizing our limitations is a step in the right direction.
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Congressional Testimony, October 28, 2009
By Russ Roberts
What follows is my testimony before the House Committee on Oversight and Government Reform, delivered October 28, 2009. The topic was executive compensation and the Special Master for TARP Compensation, Kenneth Feinberg, who was determining compensation at the firms who had not repaid their TARP funds.
Chairman Towns, Ranking Member Issa, and Distinguished Members of the Committee:
Americans are angry about executive compensation.
The executives at General Motors and Chrysler don’t deserve to make a lot of money. They made bad products that people didn’t want to buy.
The executives on Wall Street don’t deserve to make a lot of money. They were reckless. They borrowed huge sums to make bets that didn’t pay off. And they wasted trillions of dollars of precious capital, funneling it into housing instead of health innovation or high mileage cars or a thousand investments more productive than more and bigger houses.
Everyday folks who are out of work through no fault of their own want to know why people who made bad decisions not only have a job but a big salary to go with it.
No wonder they’re angry at Wall Street,
But if we keep getting angry at Wall Street, we’ll miss the real source of the problem. It’s right here. In Washington.
We are what we do. Not what we wish to be. Not what we say we are. But what we do. And what we do here in Washington is rescue big companies and rich people from the consequences of their mistakes. When mistakes don’t cost you anything, you do more of them.
When your teenager drives drunk and wrecks the car, and you keep give him a do-over—repairing the car and handing him back the keys—he’s going to keep driving drunk. Washington keeps giving bad banks and Wall Street firms a do-over. Here are the keys. Keep driving. The story always ends with a crash.
Capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Is it a surprise that when the government takes the losses, instead of the investors, that investing gets less prudent? If you always bail out lenders, is it surprising that firms can borrow enormous amounts of money living on the edge of insolvency?
I’m mad at Wall Street. But I’m a lot madder at the people who gave them the keys to drive our economy off a cliff. I’m mad at the people who have taken hundreds of billions of taxpayer money and given it to some of the richest people in human history.
I’m mad at President Bush and President Obama and Secretary Paulson and Secretary Geithner and Chairman Bernanake. And I’m mad at Congress. You helped risk-takers continue to expect that the rules that apply to the rest of us don’t apply to people with the right connections.
You have saved the system, but it’s not a system worth saving. It’s not capitalism but crony capitalism.
Using a Special Master for Compensation to get our money back is too little, too late.
Many people argue that because the government handed out the money, the government has a right to dictate how it is spent. It’s a reasonable thought in personal relations. If I offer you money, I have a right to attach strings to my generosity. But in a constitutional democracy like ours, it is not the government that has rights. We, the people, have rights. The Constitution exists to restrain government, not to empower it.
Whether government has the right to limit pay isn’t the question. The question is whether it’s a good idea for the government to have the power to set compensation. Despite our anger, the answer is no.
F. A. Hayek, the Nobel Laureate economist, said: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
The Special Master imagines he can design compensation packages that “align incentives” while “retaining key talent.”
But it is impossible for any one person—no matter how wise—to anticipate the consequences of such decisions. Certainly the Special Master does not possess that knowledge.
The Special Master doesn’t even know who is key and who is not. Some of that talent should leave and some of those firms need to disappear. But he does not know enough to decide correctly.
Nor does he have any incentive to acquire that knowledge. He has no skin in the game.
A single individual has been given enormous arbitrary power with insufficient accountability or transparency. This is not good for the rule of law, democracy or capitalism.
By focusing on those who owe the government TARP money, the Special Master distracts us from other firms that benefited from government rescue such as Goldman Sachs and JP Morgan Chase.
The comfort we receive from seeing compensation reduced distracts us from the policies that created the problem in the first place—the rescue of Wall Street from its own recklessness.
It is a charade of political window dressing to make crony capitalism look respectable.
I want my country back.
Let’s get the government out of the auto business, out of the banking business and out of the compensation design business. We need explicit timetables to disengage from government ownership including a plan for how the Federal Reserve will draw down its balance sheet. Most of all, we need to stop trying to imagine we can design housing markets and mortgage markets and financial markets and compensation.
I want my country back.
I want a country where responsibility still means something. Where rich and poor, Main Street and Wall Street live by the same rules. We don’t need a Special Master to level the playing field. We just need to take the crony out of crony capitalism so we can get back to the real thing.
How Little We Know
By Russ Roberts
Here is my take on financial reform from the latest issue of The Economists' Voice.
Will Time Prove Ben Bernanke Wrong?
By Russ Roberts
(This piece appeared on NPR.org on 8/25/09)
President Obama has reappointed Federal Reserve Chairman Ben Bernanke, praising his creativity in preventing another Great Depression.
Talk about damning with faint praise.
It's true that we appear to have avoided the worst-case scenarios of the last year, but at what price?
Back in March of 2008, Bernanke and Treasury Secretary Henry Paulson engineered a rescue of Bear Stearns. A single suitor, JP Morgan Chase, was chosen to receive a sweetheart deal in the name of avoiding a credit freeze. The freeze came anyway. The Bear Stearns rescue was the beginning of an unprecedented expansion of power in the hands of the Fed and the Treasury with a level of opaque decision-making that is not appropriate for a democracy.
Even today we have heard little justification for the expansion of the Fed's power and the Fed's balance sheet.
Yes, we have avoided a depression. But let us count the costs.
Financial firms that made irresponsible and imprudent decisions have been rescued, propped up and bailed out.
AIG has received about $180 billion. That is almost $2,000 for every American household. That money has gone to sustain the bonuses of AIG and the financial health of its counterparties, such as Goldman Sachs. This is an obscene travesty.
The Fed currently holds $600 billion worth of Fannie, Freddie and Ginnie mortgage-backed securities. I am not optimistic about how that will turn out.
The Fed has injected hundreds of billions of reserves into member banks. This will fuel future inflation unless Bernanke is willing to raise interest rates when the recovery begins. There will be tremendous political pressure on him not to do so. So inflation is likely to come along with any recovery.
Worst of all, Bernanke, Paulson and Timothy Geithner have continued the disastrous policy of sustaining bondholders and creditors of reckless financial institutions. Capitalism is a profit-and-loss system. The profits encourage risk-taking. The losses encourage prudence. The bondholders and creditors are the single most important check on imprudence. They care only about one thing: solvency. By making them whole, their incentive to restrain recklessness has been greatly weakened. This sows the seeds of the next financial crisis.
I feel sorry for Bernanke. In one sense, as the world's greatest living authority on the Great Depression, he is the best man for the job. But because he is the world's greatest living authority on the Great Depression, another catastrophic economic debacle of a similar magnitude would be particularly embarrassing were it to occur on his watch. I believe he has gone too far in the other direction.
The Great Depression was caused, or at least greatly worsened, by too little liquidity. Bernanke has avoided that mistake. He has instead committed the opposite mistake of too much liquidity and too few failures. Obama has praised him. How history judges him will be the real test.
Halve The Deficit? Good Luck, Obama
By Russ Roberts
(This piece appeared on NPR.org on 2/25/09)
In his first address to a joint session of Congress, President Obama pledged to cut the federal budget deficit in half in four years.
Keeping that pledge won't be easy.
The Congressional Budget Office is forecasting a deficit for this year of $1.2 trillion.
That forecast does not include the spending package Congress just passed and Obama signed that will add hundreds of billions of dollars to the deficit over the next four years. And that doesn't include unforeseen spending increases in further bailouts for Fannie and Freddie or AIG or Bank of America or GM or the state of California or whoever else shows up in Washington with a hand out.
So Obama probably needs to cut spending or raise taxes by at least $700 billion a year. To give you an idea of how much money that is, that's about the amount the payroll tax currently collects. The payroll tax is about 15 percent, shared between employer and employee. Doubling that rate to 30 percent would add an extra $700 billion if — and it's an impossible if — if a tax rate of 30 percent didn't lead employers to reduce their number of employees or force workers to reduce their hours.
Besides, Obama also promised Tuesday night that 98 percent of American families, those earning less than $250,000, would not pay an extra dime in taxes. So to cut the deficit in half, he needs to raise taxes on the richest Americans and look for spending cuts.
He claims to have found $200 billion per year in spending we can do without. Assuming those spending cuts actually materialize, that still leaves $500 billion in higher taxes for the richest Americans.
In 2006, the latest year we have data for, the top 2 percent of tax returns yielded around $500 billion in revenue. So to cut the deficit in half, Obama will have to roughly double the tax rates on the top 2 percent. I don't think that strategy will be politically viable or economically productive.
What I think will happen instead, is that he will simply settle for running larger deficits for a while, continuing to borrow money from our fellow citizens and from foreigners, and hoping that the interest rates we offer on those loans don't start to rise because people start to realize that no asset, even treasuries, is risk-free.
The cheery scenario is the economy grows like gangbusters and tax revenues surge without increases in rates. Could happen, but I am not optimistic. Too many unknowns lie ahead.
Every president who inherits a deficit promises to cut it somewhere down the road. Only one president in recent years has kept that promise — Bill Clinton. But he was helped by six years of Republicans in the House and Senate. When the White House and the Congress are from the same party, it's very hard to say no to key constituencies that expect rewards for past support. If Obama is really serious about cutting the deficit down the road, he will almost certainly have to fight with his own party.
Russell Roberts is an economics professor at George Mason University, a distinguished scholar in the Mercatus Center and a research fellow at Stanford University's Hoover Institution. He is the host of the weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity.
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