The Strong Economy Fallacy

By Evan Storms

On November 3rd, the Federal Reserve announced its commitment to purchase an additional $600 billion in Treasury securities through mid-2011. Fed Chairman Ben Bernanke defended the decision, arguing that it was necessary to maintain historically low long-term interest rates to spur economic activity and reduce unemployment. “On its current economic trajectory, the U.S. runs the risk of seeing millions of workers unemployed or underemployed for many years,” he claimed in a November speech. “As a society, we should find that outcome unacceptable.” Here Bernanke echoes a specific, widely accepted conception of the economy—a conception that we should find unacceptable, society or no.

That conception hides beneath its own ubiquity; it is generally unnoticed precisely because it is so generally accepted. We hear it from President Obama when he speaks of “our shared mission of building a strong economy for the long run.” We hear it from Republicans in when they promise “to advance policies that promote…national economic prosperity” in their “Pledge to America.” And we hear it from Democrats where Pelosi stresses their “commitment to providing the middle class with a tax cut to grow the economy and create jobs.” That conception is implicit in the political rhetoric of job creation, of economic stimulus, and of financial stability. Its most basic form is the aim for “a strong U.S. economy.”

To understand explicitly what this conception of the economy entails, let us break down the implicit premises in Bernanke’s argument. He justifies maintaining low interest rates on the grounds that we “as a society” should be opposed to an economic arrangement in which “millions of workers” are without work. It follows that we, through the Federal Reserve, ought to intervene to avoid it coming about. We see similar logic behind Pelosi’s comments. Because we want a strong economy, we, through Congress, should use middle-class tax cuts to encourage spending and growth.

The common theme is the conception of the economy as a social interest. Bernanke, Obama, and Pelosi, along with most politicians and economists, accept the view that society has a collective stake in seeing the economy achieve some undefined condition of strength, and that the government therefore ought to intervene to ensure that this condition is met. The economy, in this view, is a public object to be publicly managed, even if the individuals and property comprising it are private. (I leave them to explain how a system of private ownership can be publicly managed.)

Lest anyone think that this abstract conception is mere verbiage on the politicians’ part, note that it has been the justification for some of the most important legislation passed in the last few years. The stimulus bill is so called precisely because it was an attempt, in the Keynesian tradition of economists such as Paul Krugman, to increase economic activity in the wake of the 2008 recession. Its partner TARP was designed to, in the words of Treasury Secretary Timothy Geithner, “prevent the catastrophic failure of financial institutions that would damage the broader economy.”

I will not argue here about the consequences of such policies. Rather, what I want to focus on is the deeper flaws in the social conception of the economy that makes these policies possible.

To start, let us look back on the state of the U.S. economy in 2006. Unemployment was comparatively low by historical terms at 4.6%. GDP grew approximately 3%. The S&P 500 index increased 13.62%. By all standard metrics, this was the type of strong economy that today’s policymakers are desperate to restore. But it is not that simple. Much of that increase in the S&P was driven by gains in the housing market, which in turn were driven by credit expansion caused by the lower interest rates caused by the Fed doing exactly what Bernanke has it doing now—that is, buying large shares of U.S. Treasury bills to maintain a low interest rate. At the same time, 2006 also saw an increase in financial derivatives trading, and at least part of the GDP growth is attributable to large gains in the financial sector as firms such as Goldman Sachs posted their most profitable years to date. In retrospect, we can see that the strength of the 2006 economy rested on the nascent foundations of the 2008 recession.

This leaves us with something of a paradox. Was the 2006 economy actually strong? Or was it simply that its weakness was obscured by unsustainable gains? Conversely, was the economy in fact weaker when the recession hit and the standard metrics became so grim? Or was this actually the economy correcting for those prior unsustainable gains and so becoming stronger? There is no indication that anyone in Washington has an answer. Bernanke and Obama seem focused on restoring the same metrics—namely GDP growth and the unemployment rate—that were so deceptive several years ago.

To be fair, I cannot offer an answer either. In fact, I think there is no answer—because the question itself contains a false premise. Asking whether the 2006 economy was strong implies that there is some overall notion of strength that describes the collective object of the economy. But an economy is a system of interactions among agents seeking to satisfy their respective private interests. If I engage in a mutually beneficial trade with you, you and I are both better off, but the system of trading has not gained or lost; it has only been used.

The same holds, on a much broader scale, for the U.S. economy. Metrics such as GDP approximately measure the volume of trade, how much money is changing hands. They tell us nothing of the underlying satisfaction of the millions of agents involved, nor or the consequences of their economic activity; much economic activity took place in 2006, but I find it hard to argue that it all represented real gains. Conversely, the 2008 recession brought a decline in GDP; but if this was the consequence of liquidating bad investments in the housing market, it indicates a move towards a more efficient investment allocation in projects delivering higher real returns.

That said, even if we were to accept GDP and similar metrics as a (necessarily problematic) proxy for the gains of an economy’s constituents, it would still be erroneous to speak of the “strength” or “health” of the economy itself. Unlike the agents that participate in it, an economy has no preferences for one state over another. It does not operate with some aim in mind as a corporation operates to generate profits. An economy is a structure; it can only be efficient or inefficient to the extent that it facilitates optimal arrangements of production and exchange. Requiring Americans to work weekends would likely increase economic activity; there would be more production and more exchange. GDP would increase, to the applause of some economists. Yet if everyone is forced to work more than he or she would like, everyone is worse off. There is no counterbalancing social or collective economic interest.

Who is it, then, that benefits from all of the policies aimed to strengthen the economy? For most policies, the answer is: whichever interest groups happen to be positioned to take advantage of them. A law mandating increased hiring would certainly lower unemployment and benefit those looking to find work but impose great cost on the businesses forced to hire. I doubt anyone would argue such a policy creates a stronger economy. But, fundamentally, all economic intervention delivers benefits to some only at the expense of others.

During his campaign, Obama challenged a die-hard Republican restaurant owner frustrated with a decline in business with the question: “Who’s been in charge of the economy for the last eight years?” The owners conceded: “You have a point.” Actually, Obama had two. While the slight to Republicans was the more obvious, the more interesting was the implication that the economy is something the government is “in charge” of, that the economy is collective property made either strong or weak according to how well it is managed. The deep illogic of that position fundamentally misunderstands the concept “economy.” Correcting it is a prerequisite of intelligent economic discussion in U.S. political dialogue—something which we, as a society, could decidedly use.

This entry was posted in Articles for Volume 4, Issue 2, Winter 2011. Bookmark the permalink.

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