How Mainstream Economists have damaged America and the World

Economists were indeed set back on their heels by the financial crisis of 2008 and by the depth of the recession and the levels of unemployment that followed. Though not well implemented, the aggressive financial rescue efforts of the government in 2008 nevertheless kept matters from getting far worse that year. Were it not for the social programs started in the New Deal of the 1930s and expanded in the 1960s, including Social Security, unemployment insurance, and Medicare, and those adopted later, including the earned income tax credit and food stamps—the great embrace of government, not its denigration—the nation would likely have entered a full-fledged depression by 2009. For all the criticism, President Obama’s roughly $800 billion stimulus package of government spending and tax cuts was also a vital contributor to a softer landing for the economy in 2009. Non-laissez-faire economics saved the day.

One of the more reasonable of the orthodox economists, Olivier Blanchard wrote with colleagues “Rethinking Macroeconomic Policy,” a short mea culpa published two years after he had proclaimed macroeconomics to be in such good shape. Although he supported temporary government stimulus to enable economies to recover, he had hardly changed his central views. “It is important to start by stating the obvious,” he asserted, “namely, that the baby should not be thrown out with the bathwater. Most of the elements of the precrisis consensus, including the major conclusions from macro-economic theory, still hold.”

The key assumption of the new laissez-faire consensus was that it is the natural order of things that economies rise from recession almost automatically. In recessions, prices rise slowly or fall; likewise, wages stagnate or fall, and interest rates slide downward, setting the stage for more buying by consumers, more hiring by businesses, and more capital investment. It’s an intoxicating idea. Economies rarely get too far out of balance, goes the thinking— they are far more likely to be stable than not at any given moment. Such economies require only modest government intervention, mostly to control inflation and relieve suffering as jobs are lost, or maybe just a little push from lower interest rates, but the fewer such government policies the better. Most of the time, government can only do harm. This was the new but deeply incorrect consensus.

Many orthodox economists noted that poverty rates had fallen in the developing world. But the claims were misleading. Most of the poverty reduction was in China and, to a lesser extent, India, neither of which followed the free-market policies prescribed by the West.

The free-market economics that had been in vogue were now failing badly. The old remedy advocated by John Maynard Keynes to cure recession—federal spending that would lead to a temporary budget deficit—had been accepted momentarily but was again soon disdained by many. Since the inflationary 1970s, a federal budget deficit was increasingly seen as the culprit, even among Democratic economists, and this view has been hard to shake completely even after the major recession. The thinking was that a deficit often, even usually, created too much demand for goods and services, thus pushing up prices. It created more demand than the wages and profits the economy itself was generating, requiring borrowing to do so. Once slack was taken up, it was believed, a deficit resulted in an overheated economy. Keynesians typically argued with the new free-market orthodoxy over whether full employment had been reached and whether the capacity of the economy was fully utilized. It was said that the debt financing that pushed up interest rates also left less room for businesses to borrow.

To call economists overconfident during the modern laissez-faire experiment understates their hubris. The susceptibility of economists to new fashions in thinking, their opportunistic catering to powerful interests, and their walking in lockstep with the rightward political drift of America are disturbing for a discipline that claims to be a science.