Economists, particularly those of the ascendant Chicago school of free
market enthusiasts, were in a triumphant mood at the beginning of this
decade. Speaking at the annual meeting of the American Economic
Association in 2003, Nobel Laureate Robert Lucas went so far as to say
that macro-economics -- with its focus on the stable maintenance of
national economies -- could safely be retired. "The central problem of
depression prevention," he said, "has been solved for all practical
But if the technical challenge of depression prevention has rudely
announced itself unsolved, the current crisis has also reawakened a
long-obscured, but far more profound debate about the very nature of
cyclical capitalism. That is: Are economic contractions, like the one
we're currently experiencing, a good thing?
You won't hear this question asked in most mainstream political
discussion of the crisis. It would be career suicide for any elected
official to suggest that the widespread stress, misery and heartache
being wreaked by the precipitous contraction were are a good thing. But
scratch the surface a bit and you'll find a surprisingly vibrant school
of thought, one that reaches back all the way back to the Great
Depression, that holds precisely this view.
Famed economist Joseph Schumpeter said that "a depression is for
capitalism like a good, cold douche," one that rinses off accumulated
dysfunction. Robber baron Andrew Mellon (who served as Herbert Hoover's
treasury secretary) welcomed the Great Depression with these infamous
words: "It will purge the rottenness out of the system. High costs of
living and high living will come down. People will work harder, live a
more moral life. Values will be adjusted, and enterprising people will
pick up the wrecks from less competent people"
It's not hard to find this same view among bankers, financiers and
sundry Wall Streeters today. Recently a bond trader told me he hoped
that the Fed would raise interest rates and plunge economy into a truly
deep, painful (but he hoped, quick) depression. "I don't think that
would be good for you," I said. "Oh, I'd be fine," he responded. ( I
meant politically: as in, there'll be people with pitchforks at your
door. We were talking past each other I suppose.)
There's no question that economic contraction feels quite different
to a bond trader and an unskilled worker. A spike in unemployment hits
those on the margins of the labor market the hardest, while
contractions also usher in deflation, which has a strong tendency to
make the rich richer. But the faith in the salutary effects of economic
misery also derives from a puritanical view of the economy, one that
can manifest itself on both the left and right. Under this view
contractions are collective punishment for our trespasses; we are
sinners in the invisible hands of an angry God.
The stakes for this argument are very high: if steep economic
contractions are like forest fires, a necessary part of the system's
self-calibration, we should more or less let them burn. If they are
more like five-alarms raging through dense city neighborhoods, we
should call in the fire department.
Newsweek and Washington Post columnist Robert Samuelson is perhaps the most prominent and outspoken Mellonist writing today, and his last manifesto The Great Inflation and Its Aftermath: The Past and Future of American Affluence is best understood as a brief for the particular form of deregulated
global capitalism that emerged in the wake of the stagflation of the
1970s, accelerated triumphantly through the last three decades, and is
now crashing down around our ears.
At its root, the book is a morality tale of hubris and comeuppance,
the macro-economic version of Icarus' flight. The story goes something
like this: In the wake of the Great Depression, economists came under
the sway of certain technocratic faith in the perfectability of the
American economy. They believed business cycles were a thing of the
past and that all downturns could be remedied with an injection of
The liberal technocrats of the Kennedy and Johnson administrations
believed in the Phillips curve, an inverse relationship between
inflation and full employment. And since the downsides of the
unemployment were more obvious and immediate than those of inflation,
they pushed the economy to maintain full employment as inflation crept
Samuelson calls this the "full employment obsession" and the effect, he claims was to spoil American workers beyond repair:
Booms and busts, recessions and depressions had long been
considered and unavoidable aspects of industrial capitalism. But once
people accepted the idea that the business cycle could be mastered,
then the self-restraint that had silently kept prices and wages in
check gradually crumbled.
We became, in Samuelson's words, "progress junkies." A wage-price
spiral took hold in which higher prices pushed unions to bargain for
higher wages, which in turn put more money in people's pockets and sent
prices upwards. Eventually as the public came to expect increased
government spending and loose monetary policy, Samuelson contends, the
positive effect on unemployment waned, having already been priced in,
and the result was high inflation and stagnating growth.
It's unclear however, whether the persistent inflation of the time
was the result of the nature of the social contract, or a confluence of
factors: a very long debt-financed war in Vietnam, combined with a
loose monetary policy. And it is almost certainly true (and hardly
controversial) that stable prices, while necessary for strong economic
growth, are certainly not sufficient: George W Bush presided over one
of the lowest average inflation rates of any post-war American
president, yet his term left average wage earners worse off while precipitating the worst financial crisis in 80 years.
But for Samuelson, inflation is enemy number one, so much so that
wringing it out of a system makes recessions look not so bad.
"Recessions also have often-overlooked benefits," he wrote in his Newsweek
column last year, echoing, in an albeit softer tone, Mellon and
Schumpeter. "They dampen inflation. In weak markets, companies can't
easily raise prices or workers' wages. Similarly, recessions punish
reckless financial speculation and poor corporate investments. Bad bets
don't pay off."
With the unemployment sword of Damocles hanging over their heads,
workers will think twice about asking for a raise, and all of this will
lead to a robust kind of capitalism for the capitalists: one with low
inflation, low interest rates and very high return to capital. If that
sounds familiar, it's an apt description of the economy of at least the
last two decades, a kind of capitalism recently proven far less stable
than it may have appeared, but one for which Samuelson is an
unapologetic partisan: "The new economic order," Samuelson writes, "is
indeed inferior to the imagined and romanticized version of the old order. But it's superior to the old order as it actually operated."
Paul Krugman, to put it mildly, disagrees. In 1999 he published a book with the prescient title the The Return of Depression Economics.
While folks like Samuelson and Robert Lucas were celebrating the fruits
of neoliberalism, a strange thing was happening: Financial crises of
larger and larger scale and scope were wreaking havoc on the global
financial system. Mostly, as Krugman notes, we ignored the tremors.
The original edition of Krugman's book offered a tour of a series of
financial crises that rocked the world in the late 1990s (Japan,
Mexico, South East Asia, Russia), and the new edition includes expanded
treatment of some that came after the publication date (like Argentina
in 2001) before getting the to the main event: our present troubles.
These crises tended to have a few things in common, but at the heart
of many were central banks, governments and international lending
institutions that had learned the lessons glossed in Samuelson too
well. Low inflation became a central obsession of the so called
"Washington Consensus," the term given for the uniform prescription of
stiff free-market medicine -- balanced budgets, privatization of
government services, and tight monetary policy -- that dominated global
economic policy in the 1980s and 1990s.
What animated much of this advice was not just a rigid and dogmatic
economic consensus, but also the puritanical normative assessment that
a wicked economy must now pay its penance. (Of course said penance was
never paid by those who caused the crisis: It was paid out of the
pockets of the starving, the poor and working class.)
It's exactly this notion that Krugman seeks, above all, to dispel.
To do so he repeatedly returns to the true story of a baby-sitting
co-op in Washington, D.C.'s Capitol Hill neighborhood. The co-op
allowed couples with young children to have babysitters for nights out
in return. In order to track people's credits, the co-op issued scrip:
a coupon good for one night out. But a funny thing started to happen.
People wanted maximal flexibility and so started hoarding their
coupons, meaning there were too many people wanting to supply
baby-sitting, and not enough who wanted to use the service. The co-op
ground to a halt.
Why, Krugman, asks did this happen?
It was not because the members of the co-op were
doing a bad job of baby-sitting ... It wasn't because the co-op
suffered from "Capitol Hill values" or engaged in "crony
baby-sittingism" or had failed to adjust to changing baby-sitting
technology as well as its competitors. The problem was not with the
co-op's ability to produce, but simply a lack of "effective
demand...The lesson for the real world is that your vulnerability to
the business cycle may have little or nothing to do with your more
fundamental economic strengths and weaknesses.
"[B]ad things," Krugman concludes, "can happen to good economies."
In the developing world in particular, a neighboring country's
crisis can quickly become your own for no rational reason. Even in
places where crises are caused by a panoply of deep structural problems
(like, for instance, here), the initial shock is easily magnified
through a positive feedback loop: People panic so they start selling
their assets, which depreciates the price further, which causes more
people to panic, who then try to sell, etc ... These are the "animal
spirits" that Keynes famously invoked, people's hopeful optimism about
the future of their dark fears both of which often become
More broadly, Krugman's point is that, contra Samuelson, recessions,
and depressions and assorted downturns are not useful, cleansing
opportunities to "purge the rottenness out of the system," but more
often vicious cycles, auto-catalytic processes that result in massive
amounts of human suffering, and waste human capital and an economy's
productive capacity. More like the forest fire caused by a careless
camper than the natural cleansings produced by mother nature.
The technical implication of this view for crisis management is that
when an economy is stuck in a deep recession, like the one in which we
are now mired, normal bromides of Chicago-style economics, those to
which Samuelson clings so closely, cease to apply. Milton Friedman
famously wrote "there's no such thing as free lunch," but when an
economy slips into "depression economics" this is no longer the case.
Here, then, is where we hit the heart of the conflict. Equilibrium,
with its sparkling promise of calm, is the promise of functioning
markets. In Samuelson's view, that equilibrium can be counted on so
long as the government doesn't interfere, artificially pushing
government money. Indeed, under this view recession, perhaps even
depression, are crucially part of that equilibrium. That is to
say, suffering is necessary for a functioning capitalist economy.
Krugman sees economic equilibrium as tenuous and elusive. And precisely
since it is so hard to come by, deft and active management is
necessary. Suffering is no badge or courage, but a sign of failure.
The intellectual tension here, though, runs parallel to a political
one. Much of economic management, outside of avoiding obvious folly, is
a political question: one of distribution and trade-offs. The economy
of Keynes was very good for the (white) middle class, and perfectly
fine for the rich. The economy of Friedman was bad for the middle
class, but very good for the upper class and corporations. And the
hybrid Greenspanism was an orgy for the rich and now is a disaster for
all of us.
As Krugman persuasively argues, economies need management and policy
to maintain some kind of equilibrium. If we agree they need to be saved
from their own tendency to spiral into disaster, to cycle through booms
and busts, then it will be politics, not technical expertise, which
provides the principles and rules that regulate. Samuelson and those of
the Mellonist school have an innate distrust of politics; meddlesome
and vulgar and prone to demagoguery. Lately the political system as
seemed to be working over-time to confirm their worst fears.
But ultimately there is not economics without politics, and as
terrifying as this may be, economists can't save us from this crisis.
Only politicians can.