Monday, 18 June 2012

Capitalism and Keynesianism (Left and Right)

Market capitalism is an economic system based on free competition. In theory, it is a system that guarantees automatic market equilibrium and the optimal allocation of resources over the long term. In the short run disequilibrium is a recurrent feature of the system that is permanently corrected through competition.

To put it simply, excessive supply is reduced through diminishing profits and insufficient supply is raised up by entrepreneurs in the lookout for profit opportunities created by such shortages. Unfortunately, this process of automatic adjustment is not instantaneous and in practice market capitalism is naturally bound by cycles in business activity, popularly known as recessions and booms.

Keynesianism is a set of policies advocated by Keynes to smooth such business cycles. Writing in the aftermath of the crisis of 1929, Keynes proposals were aimed at deep and prolonged recessionary phases when the entrepreneurs drive for action, which he termed “animal spirits”, was so depressed that they were unable to restore growth by profiting from the opportunities created by supply destruction.

For these circumstances he advocated a demand shock through monetary and fiscal easing, or just increased government spending for economies caught in a so-called liquidity trap (when interest rates were close to zero). Using a medical analogy, Keynesianism advocates the prescription of hard drugs to treat a severe depression.

It is obvious why his economic stimulus therapy is necessarily controversial. Similarly to hard drugs, more public spending has many negative side effects (most importantly, it may reduce the share of market capitalism in the economy and its competitiveness). Just as doctors may disagree on the severity of a particular depression and the efficacy of soft treatments like exercise and therapy, economists also disagree on the effectiveness of soft supply-side treatments such as more training, deregulation and labour market flexibility to treat severe recessions.

Regrettably, these controversies are inevitably more tainted by ideology in economics than in medicine. So, those more collectivist-driven will see in any mild reduction in economic activity (say a quarterly decline in GDP or a rise in unemployment) a justification for more government intervention. Likewise, when faced with a severe recession (e.g. four or five consecutive quarters of economic contraction), those terrified by the danger of collectivism will repudiate any intervention and ask for more patience to give time for the automatic forces of competition to wake up.

On the collectivist side we often find leftist politicians. And, not surprisingly, Keynesianism is often confused with a left-wing ideology. This is compounded by the fact that some of the most famous Keynesians (e.g. Joan Robison in the past and Paul Krugman today) are influential leftist ideologues.

This is obviously a mistaken perception, because we have many collectivist advocates on the right. Most notably, among them we have the advocates of state and managerial capitalism including many right-wing Corporatists and Christian-democrats.

Indeed, Keynesianism is not about left or right but about wisdom and common sense. That is, economists and politicians should be able to assess in a dispassionate way when to give up on the automatic resumption of growth through the self-correcting mechanisms of competition and to be able to carefully design stimulus packages that do not hypothecate the future of market capitalism.

Common sense must be based on simple benchmarks. For instance, demand-management policies should only be adopted when unemployment exceeds a given range (say, 8% for collectivists and 12% for libertarians). Currently, using such criterion, we need Keynesianism in Southern Europe but not in the rest of the Eurozone. This is obviously a difficult but not impossible task in the context of a monetary union.

To conclude we need Keynesianism as a temporary solution for special circumstances. But we are left without knowing if Keynesianism also can be used in a pre-emptive way to face anticipated external shocks (e.g. a breakup of the Euro Zone). This controversial issue is left for a future post.

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