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June 07, 2009

The Great Test Of Economic Intervention

John Carney

Managing Editor - Clusterstock, Business Insider

Summary

One of the constant refrains of the new boomsayers, rally-rompers, and green shootists is that we’re not likely to experience a redux of the

One of the constant refrains of the new boomsayers, rally-rompers, and green shootists is that we’re not likely to experience a redux of the Great Depression. This time things will be different, largely because we have a much different kind of government than we had in 1930.

Unfortunately, there is little reliable data or theory to tells us the economy is not heading toward a repeat performance of the Great Depression. Of course, no one wants to see a situation where the real gross domestic product in the United States declines 27 percent and unemployment soars to 25 percent, as it did in the worst years of the Great Depression. Our recession is already tough enough. But wishing is not analysis, and we are already running the danger of a foolish overconfidence about the strength of our economy.

A key factor that feeds the confidence that it is different this time is that our economy has many built-in safeguards that did not exist when the Great Depression struck. It’s assumed that government policies such as unemployment insurance, Social Security, and federal deposit insurance will cushion the fall.

We know that our policies cannot prevent a recession, however. What makes us think that they can prevent another depression? Frighteningly, these policies have never been severely tested. They may be intended to cushion the blow but the intentions of a policy and its results are often miles apart.  What’s more, both the origins of the policies and their implementation have been far more affected by special interest politics than commonly acknowledged.  To put it too briefly, all too often government policies that are supposed to serve the common good wind up merely serving special interests and don’t do much about the problems they allegedly address.

Let’s just take the example of banking. The Federal Reserve and the FDIC were supposed to exercise oversight that would prevent bank failures or lower the costs of failures. Deposit insurance was supposed to be a bulwark against failure. But none of these worked the way it was supposed to. Bank supervision failed, banks found ways to go broke even without a run on the bank, and the FDIC’s role in shutting down unstable financial institutions was destroyed by the TARP’s bank bailout.

The assumption that we’ll avoid a depression just because we have policies and leaders that contrast starkly with the allegedly laissez-faire policies and leaders of the 1930s is unwarranted. In the first place, the much-maligned Herbert Hoover was not the free-market fundamentalist he is often made out to be. In fact, he implemented policies that the supporters of Barack Obama would recognize as their own today.

Second, this assumption hasn’t been tested, and no economic theory exists to tell us that these policies and these leaders are the right ones we need. Even interventionist theories—such as those of Keynes—don’t tell us that the policies we actually have in place will fix the economy. Our political leaders have taken a number of extraordinary steps, but the economy has continued to sink. We might conclude that they need to do more but on what grounds do we conclude that they have the ability or knowledge to do the right things?

It’s customary for a columnist to end a column chock full of sobering—perhaps even frightening—analysis with a ray of sunshine. I’ll comply with the custom by noting that the kind of entrepreneurial ingenuity and determination of rugged Americans may be enough to overcome even the worst policy errors. Even if we’re too confident we’ve got the right policies, we’re probably not too confident about that deeper factor: having the right people. The Great Depression was bad but it was eventually overcome. We shall overcome again. Probably.