Wednesday, July 7, 2010

What is the Free Market solution?

David Frum thinks that Krugman is wrong about government spending as a solution to our problems. But what, then, is the free market solution? Cutting unemployment benefits? What about cutting taxes--even though we tried lots of that in the 2000s, without apparent success?

First of all--you can easily turn the last issue. How can government spending be the way out of our mess if we tried lots of government spending for the last ten years without getting good results either?

But more seriously--yes, there are plenty of free-market solutions for dealing with the really very bad consequences of a serious deflationary recession:

1. Wage subsidies: I've argued how to make them work here. Basically, we have unemployment because workers are less productive during bad times, yet employers can't pay them any less because wages don't tend to move down. What we can do, instead, is keep paying workers the same amount, but let employers pay less, by having the government pick up the difference. A simple payroll tax cut should do it. As the cost of hiring goes down, companies now hire more. Singapore and other European countries have tried these policies to an extent, and they seem to work pretty well.

2. Speed Bankruptcy: The aftermath of financial crises are very difficult times because of the buildup of toxic assets which stay on firm balance sheets. It is possible to wipe those out through bankruptcy, and let firms begin lending again. I describe this a bit here. This way, you don't have as many so-called balance sheet problems, and can start with a clean slate.

3. Better Monetary Policy: I'll just refer you over to Scott Sumner's blog, where he has been arguing for some time now that looser monetary policy now could dramatically boost the economy, without incurring deficits.

4. Get Capitalists to Act like Capitalists: I go into this a bit here. Basically, instead of thinking that we need to get the government to buy up all sorts of "stuff"; we should come up with targeted ways to boost the value of business assets and investments. We can tweak the tax code to do this; and the LibDem-Tory government in England is planning on doing so, even as they enact austerity cuts.

I'll grant that there are a lot of divisions among even free-market conservatives on these issues. Raghuram Rajan, for instance, would like to tighten monetary policy and make labor markets more rigid. I happen to think he's mistaken on those issues, as a similar set of policies created the Great Depression. But it shows the diversity of thought among right-center thinkers. There are options other than "spend government money."

In fact, if anything, I'd say that it's liberals who don't have a great plan for getting out of these messes. Even if austerity is a bad idea, Keynesian spending has never really lifted a country out of a bad situation. Not for Nazi Germany, not America in the Great Depression, not for Japan. Of course, it was Krugman himself who pointed out how futile Japan's attempts at expansionary fiscal policy in the '90s, and how they should switch to a monetary stimulus.

And of course, large gobs of spending doesn't work at all unless you are America--a country facing large problems, but low interest rates. Other European countries are looking at austerity measures not because they are insane, but because some of them are actually facing bond vigilantes.

The only thing I can conclude from Frum's question is that he pays no attention to free market economists at all. People like Alex Tabarrok and Edmund Phelps have argued for wage subsidies; Milton Friedman and Scott Sumner for better monetary policy in large recessions; folks like Garret Jones have argued for speed bankruptcy; and so forth. These are all very libertarian-minded people. Has Frum really never cracked open Milton Friedman?


TGGP said...

I didn't think Edmund Phelps was libertarian-minded. He was just a Keynesian who dissented from the mainstream on the Natural Rate of Unemployment. As a result he was lumped in with Milton Friedman, but not by his own choice. I would say though that he is someone many on the right respect. He discussed his career with Russ Roberts in this episode of EconTalk.

Arpit Gupta said...

That's a fair point. However, his recent comments here do seem to place him closer to the right than the left.