In a previous post, I argued that the economy is constantly in a state of flux and, in the modern world, will continue to change rapidly. This makes economic policy decisions very difficult because something that worked in the past will not necessarily work now. Even if one can identify some of the changes in the economy that have happened since the last time a remedy was applied, no one could identify all of the changes that have happened and the new dynamics that may have developed.
In my adult lifetime, I can remember two occasions when I heard economic experts proclaim that we had entered into a “new economy.” One time was leading up to the dot-com bubble, and the other time was leading up to the current recession. In both instances, these experts were claiming that our economy had become so stable and prosperous and our understanding of its workings so good that we would never again experience a major downturn. In retrospect, such proclamations were clearly wishful thinking.
I would argue that such proclamations will always be wishful thinking. The economy is always changing, but it will never become perfect because that would require the perfection of mankind. Economic relationships are just a subset of all interpersonal relationships. And just as interpersonal relationships are plagued by our sinfulness, economic relationships will always be tainted with selfishness, greed, and mistrust.
Charley Dewberry, a tutor at Gutenberg College, has suggested that the economy is analogous to an ecological system. An ecological system has a natural (albeit dynamic) equilibrium. If it gets out of balance, natural mechanisms kick into action bringing it back to balance. But that balance is a delicate one. When a big change gets it way out of balance, it can take a long time to find a new equilibrium. Human activity is so powerful that it can get an ecological system way out of balance, and continuing human activity can get in the way of the recovery.
An economic system is similar in that there seems to be a natural (also dynamic) equilibrium in economics. This was what Adam Smith found so amazing and is the subject of his book, the Wealth of Nations. He recognized that if a society’s economy is adequately decentralized and well governed, then it functions amazingly well. The result is a measure of general prosperity that improves the lives of all and is significantly greater than in societies where these conditions do not exist. Classical economics has sought to delineate the principles that enable a society to be adequately decentralized and well governed.
One of the valued principles of classical economics is competition in an economic system. A healthy economy, like a healthy ecological system, is brought about by a competitive environment. Competition instills a discipline that forces people to be productive and attentive to the demands of the marketplace. But in order for that competition to foster economic health, it needs to be fair. It is the good and proper role of government to make sure that the competition is fair. Friedrick Von Hayek, in his book the Road to Serfdom, describes what constitutes the proper role of government in the economy. He describes economic activity in a society as being similar to a game. In order for the game to work, there need to be rules. Those rules need to set the parameters of the game but not be partial to any person or group of people. Those rules also need to be enforced, justly and consistently. So the proper role of government is to be a referee who keeps the players faithful to the established rules.
In any competitive game, there will always be a huge temptation to gain an unfair advantage. All players are to one degree or another inclined to cheat. This is no less true in a competitive economy. Some of the biggest opponents of an even economic playing field are well established, prosperous economic entities. These may be corporations; they may be unions; they may be associations. What they share in common is that they have gained a place in the economy and don’t want their position challenged by upstarts. So they use their power and influence to get the government to violate its role as impartial referee and act in their favor. They are in favor of regulations that make it hard for their competition, but they oppose regulations that impinge on their activities, even when those activities are harmful to society.
The other main opponents of an even economic playing field are everyone else. We all want the government to act in a way that benefits us, even if it is to the detriment of the economic environment as a whole. We want entitlements; we want collective bargaining; we want minimum wage laws; we want government subsidies; we want economic security. So we elect representatives who will deliver, and we put pressure on the government to act in a way that will benefit us. After all, it is government’s duty to serve us!
Consequently, there is huge pressure on the government to act not as a fair referee but rather as a grantor of favors. To the extent that the government gives into this pressure, it ceases to be a referee and becomes a player. This transformation is doubly dangerous. Firstly, it is dangerous because society loses its referee, and there is no other entity capable of fulfilling that role in the government’s stead. Secondly, it is dangerous because the government is not just any player; it has resources that make its participation in the economy unique. Like a whale in a swimming pool, its slightest move generates huge waves.
If we return now to the analogy of the economy being like an ecological system, the government’s impact on the economy has the potential of throwing it way out of balance. The more the government is involved, the greater that potential. So we are in a very dangerous situation. We, the members of our society, are naturally inclined to constantly urge the government to become a player in the economy. To the extent that we are successful in this, we mess up the natural economic equilibrium. To the extent that the government messes up the economic equilibrium, the economy becomes less and less functional. To the extent that the economy becomes less functional, we increase the pressure on the government to “fix” it. All of this gets us further and further from any kind of healthy equilibrium. I don’t know if an economy can be ruined beyond repair, but I would prefer to not find out.
This analysis, if correct, suggests two important implications for economic policy.
First, everyone in our society needs to respect the economy and to encourage government to play its proper role. There has been an emphasis in professional sports in recent years that I find very interesting. Leagues are working to clean up their sports. They seem to be working to curtail serious injury and acts of disrespect for referees and members of the opposing teams. If teams are allowed to pursue winning at all costs and are not kept within reasonable parameters, they will destroy the sport for everyone. For example, if teams are allowed to intentionally injure the opposing quarterback, they will quickly find themselves in a situation where everyone who has the ability to play quarterback well will be carried off the field. We all know that that would make the game far less interesting. So leagues are realizing that if they don’t maintain the integrity of their sport, everyone involved in the sport will suffer. Hence the emphasis on “respecting the game.” Similarly, we need to recognize the need for all of us “to respect the economy.”
Second, we need to recognize that the economy is so complex that no one knows what the cumulative impact of new enactments will be. We also need to recognize that the government is a huge factor in the economy, even when it is just playing its proper role as referee. When government becomes a player in the economy, its impact is even greater. So whenever the government acts, its impact on the economy is magnified. Since the economy is so big and complex, we don’t know what the repercussions of any given act will be. Good intentions are not enough to assure good policy. History is filled with examples of well-intended policies leading to extremely bad results. Nevertheless, since the economy is constantly changing, the rules of the game need to be constantly adjusted. But this analysis suggests that it would be prudent to change economic policy incrementally so as to allow policy makers time to observe the impact of the first incremental change before they institute the next incremental change. Incremental change would require patience on the part of the populace, and such patience would only be possible if the populace understood clearly the reason and the importance for the patience.
Both of these implications are especially difficult in a democracy because political power ultimately rests in the hands of the people as a whole, and abiding by these principles requires a great deal of understanding, discipline, and patience from the populace. I don’t know if we, as a society, have this kind of maturity. I guess we will see.