Orthogonal mindsets

February 12, 2009

by Sandy Ikeda

At the Colloquium lunch on Monday, one of my esteemed colleagues wondered aloud whether Paul Krugman’s insistence that the humongous stimulus package needs to be much bigger wasn’t evidence of madness. Then, something came up during the actual colloquium – with Larry White, with whom we were discussing a chapter, dealing with Hayek versus Keynes in the 1930s, from his forthcoming book on the “clash of economic ideas” in the 20th century – that helped a non-macro-guy like me better understand, from a sociological perspective, why economists on different sides of the bailout/stimulus debate often just don’t seem to get each other.

Keynes in his General Theory evidently was little concerned with the causes of the Great Depression, at most invoking the “animal spirits” of private investors to explain the volatile behavior of capitalist economies, which essentially means there really is no rational explanation. Given that, he radically changed the terms of the debate by arguing that the most important thing is to do whatever is necessary to overcome these irrationalities and not worry so much about their causes. He then harnessed his considerable intellect to find interventionist strategies to do just that. Call this the “Keynesian mindset.”

But Hayek and other economists at the time saw their main job as precisely to come up with a theory of the boom and the turning point, e.g., monetary manipulation resulting in unsustainable malinvestment. Moreover, Hayek and most of those today working within the Austrian tradition view the downturn as the inevitable consequence of the boom as well as a period of recovery. Thus they zero in on the incentives and rules of the game that generate the boom and lead to the bust. Call this the “Austrian mindset.”

In his first press conference the other night President Obama, informed by his economic advisors, was emphatic in stating that with respect to the debate over the stimulus bill what he called “doing nothing” is not a respectable option (which implies that doing anything would be better) after eight years of failed “free-market policy. But of course Austrians do basically recommend what might unfairly be called “doing nothing,” just as often the best advice to someone suffering from a hangover is to just sleep it off. Deliberate adjustments to ward off a secondary depression perhaps, but nothing approaching the enormity of the just-passed stimulus package.

Perhaps there’s nothing exceptional in any of this. But I think seeing these fundamentally different mindsets as still underlying two sides (I guess there are others) of the bail-out/stimulus debates reveals another source of the deep frustration on one side and the dismissiveness on the other. (Not hard to guess which is which.)

So while there’s heated argument, there’s really no “clash of ideas” because the debate at a deeper level, the level of mindsets and assumptions, has not been joined. Instead, heads shake on each side at the utter, seemingly willful, blindness and stupidity of the other. The other side isn’t mad or stupid though — it just looks that way.

http://econ.as.nyu.edu/docs/IO/9833/White,_Roaring_Twenties_and_ABCT-1.doc

7 Responses to “Orthogonal mindsets”

  1. James Kibler Says:

    Thank you for posting this. I have found myself wondering at the disparity of opinion in the public debate among economists. I’ve actually been quite disheartened by the level of discourse and the failure, as you point out, to actually engage in productive debate.

    I am relatively new to serious thought about things like this, but it seems that there are 2 other fundamental areas where a consensus would be necessary before productive debate could emerge. First, some agreement as to what a good outcome would look like would need to exist. Second, and critically, some kind of agreement on the relevant time horizon would be needed.

    Barring agreement here, the already immensely complex question becomes impossible to answer coherently–and clearly economists (as opposed maybe to economics) have failed to come up with a coherent consensus. The ad hominem attacks in various ecomomists’ recent public writings highlight this point.

  2. TJ Goss Says:

    I, like James , am relatively new to the economic way of thought and have begun to read and try to find some type of theory that will help explain the lack of unity shown by economists with the problems in our economy today. The most attractive to me at this point is the “Austrian School” although it does not seem to have gained much traction through the years, and is being taken very lightly by those in power today. This is a problem addressed in Thomas Sowell’s book “A Conflict of Visions”. His terms for these mindsets are constrained(Austrian Mindset) and unconstrained(Keynesian mindset). How do those of you who define yourselves as “Austrians” explain the lack of interest in economic theories that seem to me very intuitive?

  3. Sandy Ikeda Says:

    I agree with you completely, James, about the necessity of agreement on the criterion of success and the time horizon. The other night Obama mentioned the goal of creating OR saving “4 million jobs.” Even if he gives a deadline, which I don’t think he did, the “or” lets him off the hook, since if only, say 2 million jobs are observed created, he can always argue, “look at the other 2 million folks who WOULD HAVE lost their jobs but didn’t but for the stimulus” and I’m not sure you can test that.

    TJ, I like Sowell’s book, and you’re probably right that looking at the broader ideological picture there is a conflict between the constrained and unconstrained visions (wrt human capabilities). Moreover, it may well be that it’s a conflict between those visions that underlies the one I’m writing about here, although I’m not sure that that has to be the case.

    But my object was just to point out that it’s easy for each side to dismiss the other when the problem-situation they define is orthogonal to the other.

  4. Joe Calhoun Says:

    Sandy,

    I’ve been thinking of a way to satisfy both sides of the debate. Can a way forward be devised that satisfies both sides? I think there is from an economic standpoint if you think about what both sides want. In my mind, the two sides can be divided as demand side and supply side. If a better plan that addresses both could be devised, would they compromise? Here’s an example:

    1. Cut corporate and personal income taxes by 50%.
    2. Cut cap gains by 50%.
    3. Reduce payroll taxes by 50%.
    4. Introduce a sales or value added tax to replace the lost revenue.
    5. Set a firm date in the future for the implementation of the sales or VAT.
    6. Include tax credits for the poor to offset some of the sales or VAT to keep taxation progressive.

    There are other variations you could do with that. Reduce the lag of implementing the VAT or sales tax and include some infrastructure spending. There are many plans that would be superior than the current bill.

    The point is that a plan like that addresses the economic concerns of both sides. It forces people and businesses to spend in the short term before the sales or VAT is implemented. It raises disposable income. It takes some of the tax burden off capital and accelerates the capital accumulation phase that is needed for long term recovery. It works for the short term and the long term. It’s not perfect and I can think of objections from both sides, but its a lot closer to satisfying both sides than the crap they are passing today.

    Of course, to really satisfy the Austrians you would need to implement a gold standard and get rid of fractional reserve banking, but most supply siders would be happy as long as the capital and income tax reductions were permanent. The Keynesians would be happy because it forces spending in the short term.

    The question is, would either side agree with this? I have my doubts because the current argument isn’t as much about economics as it is about politics. Political economy with deep thought about how to actually solve problems is dead (was there ever a time when that was true? I like to think so).

    But the economics of each side is adopted to address their political ideals. While I like to think the Austrian side is purely about economics, I will admit that it is hard to seperate from the libertarian nature of the political philosophy. The Keynesian side has the same problem.

    Sorry to be so long winded; my webserver is down and I can’t blog right now.


  5. Sandy – very on the mark comment.

    My question is though that since Austrians/Hayekians might perhaps be within a minority of economists able to foresee the disastrous consequences of the inevitable bust, why were so few voices raised in protest against the chronic credit inflationary policies of Greenspan from 1995-2005?

    Financial market practitioners inspired by the Austrian school such as Marc Faber, Robert Prechter, Jim Rogers, Kurt Richebacher, Bill Fleckenstein and Jim Walker had a loyal following and correctly predicted the catastrophe we are in now.

    But I don’t recall seeing a single piece by Austrian economists in the academic or policy world warning about the dangers of such a policy in the contemporary context. It certainly doesn’t seem to have been a focus, even though it turns out the consequences of the bust are such that 2007 might mark a pivotal multi-generational swing away from markets towards governments in the same way that 1929 did.

    Instead it seems that questions of monetary policy, capital theory and the business cycle became completely unfashionable, and many of the leading lights of the Austrian world preferred to study more interesting and prestigious topics.

  6. Sandy Ikeda Says:

    Laeeth,

    You raise a fair if uncomfortable point, at least for me. I certainly didn’t see it coming — mine being the (presigious?) area of the economy of cities. Others may have, however, but I’m not in a position to say right now who or when. Perhaps others are? In any case, this deserves further airing.


  7. […] comment from Laeeth Isharc on an earlier post raises a fair but, at least for me, uncomfortable point: …Austrians/Hayekians might perhaps […]


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