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Regime uncertainty

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Thursday, Sept. 22, 2011

Non-Keynesian (and even some Keynesian) economists refer to many man-in-the-street misconceptions about economics as "Vulgar Keynesianism." These misconceptions center on the alleged all-importance of consumer spending. "If consumers reduce their spending," the Vulgar Keynesian asserts, "recession and unemployment will result. The only cure is more government spending."

It's not for nothing that the news media report so faithfully the Conference Board's monthly report on "consumer confidence." Vulgar Keynesian economics holds that the economy goes as consumer spending goes.

Academic Keynesian economics -- launched in 1936 with the publication of John Maynard Keynes' (pronounced "Kanes") book "The General Theory of Employment, Interest, and Money" -- differs in details from Vulgar Keynesianism. Most importantly, while Vulgar Keynesians focus directly on consumer spending, Academic Keynesians focus principally on investment spending.

Keynes himself worried that, with modern Western societies as wealthy as they are, opportunities to invest in ways paying big dividends over the long run are running out. After all, even many working-class families by the start of the Great Depression owned a car, a radio, perhaps an electric toaster, and several changes of clothing for each member of the family.

A world filled with such stupendous wealth even for the masses was a world that clearly, in Keynes' clouded vision, was running out of opportunities for entrepreneurs to create new industries and new products.

Keynes didn't doubt that consumers would buy new products if such products were offered. But Keynes believed that innovation had all but run its course. Entrepreneurs' and innovators' creativity was tapped out, except in figuring out ways to reduce the cost of producing familiar goods and services such as food and automatic washing machines.

Wealthier citizens, as a result, had less and less cause to spend, so they saved a lot. Investors, with nothing much to invest in, borrowed little. Investment spending, therefore, fell short of the amounts people chose to save.

And the economy thus spiraled downward. As investment fell, employment fell, causing consumers to spend less. Reduced consumer spending in Academic Keynesian theory is caused by inadequate investment spending.

But the differences between the Academic and the Vulgar versions of Keynesianism are minor. Academic Keynesianism is rooted in the same Vulgar Keynesian notion that the key to an economy's success is total spending, and that private parties -- consumers and investors -- cannot be relied upon consistently to spend enough to keep workers fully employed. Government must help.

Perhaps ironically, one of the most powerful challenges to any Keynesian diagnosis of economic ailments also focuses on inadequate investment spending, but from a wholly different perspective. That challenge is today most closely associated with the economist Robert Higgs.

Higgs' careful look at the data on the Great Depression and World War II convinced him that (1) a U.S. economy producing genuine prosperity wasn't restored until 1946, and (2) investors hunkered down, especially from 1935-40, because New Deal regulations -- along with President Franklin Roosevelt's increasingly vocal hostility to enterprise and successful risk-takers -- created too much uncertainty about how government would treat profits and wealth accumulation.

The "regime uncertainty" -- described by Higgs as "a pervasive uncertainty among investors about the security of their property rights in their capital and its prospective returns" -- unleashed by actual and threatened New Deal interventions made private innovation and entrepreneurial effort simply too unattractive. So private investment spending largely ground to a halt during FDR's reign.

The "Great" was thus put into the Great Depression.

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