The inevitability of classical economics

Suppose the world had somehow skipped the political and economic imperatives of 1945-2007 and come straight to 2008 from 1946. What would have been the level of government intervention in economies? What should it be now?

After this virus fuss is over, the question will have to be answered over the following few years because those 61 years were an aberration from the previous four billion years. What we came to regard as “the normal” was anything but normal because the state, like nature, wasn’t in the business of compassion and equity. The level of intrusion which these things necessitated was left to religion.

As a result, before the Second World War, governments had a negligible role in microeconomic outcomes. The three main markets — labour, capital, and product — were left mostly unmolested.
 

Of course, this produced a lot of misery in bad times, which is why in the mid-19th century it led Marx to advocate state ownership of everything. As a riposte to this in the mid-20th century, it led Keynes to advocate massive government help to the various markets when there was a collapse in or any one of them.

J P Morgan had made the same argument for financial markets during 1907-12. That led to the setting up of the US Federal Reserve. Franklin Roosevelt had gone a step further in 1933 to counter the Great Depression with his New Deal. Keynes codified all this in an acceptable intellectual framework in 1936. 

Some countries adopted Marx. Some countries adopted Keynes. And some like India adopted both. 
 

The first lot, like the USSR, completely failed to avoid misery. The second lot, like the US, Europe, Australia, New Zealand, etc postponed it. The third lot, which is the rest of the world, alleviated it a bit for a while but not by much. The reasons for all this are well known.
 

The point is this: Over this period only the nature and extent of government intervention changed, not of people’s misery. The Gini coefficient alone provides enough proof that replacing Church with State makes no difference. 

End of the road

Now we may have come full circle wherein governments have reached the limits of intervention because they require a lot of money, which they don’t have, and a lot of cross-border transference of costs, which is not possible any more.

Governments are broke after 67 years of excess. The cross-border transference of costs — via colonisation or exchange rate manipulation or quasi-monopolies in tradable goods — is no longer easy, if not impossible. 

Put simply, the world has suddenly changed. The question now is this: How long will it take for politics and economics to recognise this and accept it? Also, which of these will lead the way? 

The urge to intervene — and distort markets— came from two sources in the 20th century: Competing politicians and patronage-seeking economists. They reinforced each other and still do.

The politicians dress their competition in morality. The economists disguise it in their “scientific” quest for data. Both are humbugs. Caught in the middle are the bureaucrats, who desultorily stir the mud in the water.

Before Robert McNamara — in atonement for his sins in Vietnam — converted the World Bank into a branch of the Salvation Army, formal economics seldom included morality and compassion as an inevitable objective of public policy. 

The result of doing so is a dog’s breakfast of self-contradicting market regulation. There are thousands of examples of this in India alone. 

Everyone has forgotten what Adam Smith said: Morals are for individuals. They cannot be induced, as McNamara thought they could be, by governments. 

The solution

Since 1946, governments have come to believe that the solution to economic distress is flooding their economies with money as though economic distress is an infection and money is the antibiotic.
 

The truth is that there is only one solution to economic distress: Efficient markets that sort themselves out, not “efficient” government that screws up. Hence the future need to stop meddling. 
 

However, it’s very unlikely that politicians will change how they think about persistent economic distress. So, as in the previous two centuries, the intellectual case will have to be made by economists. The emphasis will have to revert from equity to efficiency.

Marx and Keynes have both outlived their usefulness because the times have changed and, along with them, the facts as well. It is time to pay belated attention the classical economics tradition of Irving Fisher, Friedrich Hayek, and Milton Friedman, not to mention a host of Indian economists that India has shunned after 1950. 

After all, wasn’t it Keynes who said when the facts changed he changed his mind? As habitual Keynesians we need to do that now.