This fact, however, does not imply that exposure to more economics is necessarily good. The sad reality is that economists too often present their analyses of markets in ways that confuse not only unsuspecting non-economists but also—and too often—economists themselves.

A frequently encountered instance of this confusion is economists’ discussion of competition. What introductory economics textbooks describe as “perfect” (or “pure”) competition resembles nothing that occurs in the real world. In the world of the textbooks, firms don’t differentiate their products from those of their rivals. Firms never try to win more customers by improving the quality of their products. Also, firms don’t advertise. Indeed they don’t even cut prices because each “perfectly competitive” firm is a “price taker”: It’s too small to affect the market price and so can sell as much as it wishes at whatever price prevails in the market.

These and other problems with the model of “perfect competition” have been pointed out repeatedly, especially by economists steeped in the Austrian tradition—see, for example, Hayek’s essay “The Meaning of Competition.” Yet the typical economist still clings to the notion that “perfect competition” is perfect competition. This typical economist, it must be admitted, does understand that the conditions necessary for “perfect competition” to prevail in actual markets can never exist. But the model remains the ideal against which real-world markets are judged. The closer real-world markets appear to be to textbook “perfectly competitive” markets, the more competitive real-world markets are assumed to be.

And competition being a good thing, this typical economist presumes that policies advertised as moving real-world markets closer to the “perfectly competitive” ideal are desirable.

Assumed Conclusions

But such a presumption is unwarranted, in part because many of the conclusions of the analysis are snuck into the model’s initial assumptions.

Most important among this model’s foundational assumptions is that competitive forces play out only in the form of price cuts. Therefore anything that prevents prices from being cut (down to levels that the model specifies as appropriate) is regarded as an obstacle to competition—indeed, as an element of monopoly that prevents the economy from operating more efficiently.

To this day, many mainstream economists describe any firm that can raise, even modestly, the price it charges for its product without driving away all of its customers as possessing some monopoly power.

Note the confusion: A pest-control producer that aims to increase its sales by making a better mousetrap is regarded by this model as behaving monopolistically! Competing for customers by doing something other than simply cutting prices is, according to the model, not competitive.

You can’t make this stuff up.

Another example of how economists commonly confuse themselves (and others) involves the issue of “market failure.” That same introductory economics textbook that teaches the model of “perfect competition” explains a few chapters later that markets perform suboptimally whenever some groups of people act in ways that affect other groups of people without the consent of these third parties. The textbook then explains that, happily, economists know how to design taxes or regulations to fix the problem.

Externalities and Assumptions

Such situations—economists call them “externalities”—are indeed bad. If Smith pays Jones to hit me in the head with a hammer without my consent, I—the third party—am unquestionably made worse off. (A simple, and best, solution in this case is to give me an enforceable property right in my person: No one can hit me and get away with it without my consent.)

But the stories that economists typically tell of externalities—and of how to “solve” them—too loosely sneak in illegitimate assumptions.

Here’s an example: Smith pays Jones for pork chops whose production at Jones’s pig farm next door to where I live fills my house with obnoxious odors. The economist leaps to the conclusion that I am wronged. Perhaps I am. But suppose that I bought my house knowing that it was next door to a pig farm. Am I still wronged? No: The price I paid for my house was discounted because of its location within smelling distance of the farm. Not only have I consented to endure swinish odors in my home, I’ve been compensated for doing so (in the form of a lower price than that of a similar home located in a sweeter-smelling neighborhood).

Or suppose, alternatively, that the pig farm moves into my neighborhood by surprise, after I buy my house. Now am I harmed? The answer is unclear. If the location of my house is such that homebuyers should reasonably expect the possibility that farms might set up shop nearby, then when I bought my house there was an open question about whether or not home-owners have the right to odor-free air in the neighborhood. And because this question cannot be answered by economics alone, it’s illegitimate for an economist to conclude that the farm necessarily should be taxed or regulated for the purpose of cleansing the neighborhood air of stinky odors.

The Largest Externalities

Economists are correct to point out that externalities exist. But economists are far too frivolous in going about labeling this or that effect an “externality”—and, what is even worse, are far too glib in supposing that government can be trusted to “internalize” externalities in ways that improve the allocation of resources rather than making it worse.

Don’t forget what too many economists seem never to grasp: Collective decision-making itself—from citizens voting to politicians spending taxpayers’ money—is infected with what are perhaps the largest and most intractable externalities. Costs are imposed on third parties constantly.

Economics done properly would highlight the dangers of trying to cure externalities with a process that itself is deeply infected with externalities. Unfortunately economics is too often done improperly.

First, something that is right.

With one major exception (discussed below), the typical economist, when doing economics (and regardless of political bent), doggedly avoids ad hominem explanations. That is, economists don’t explain observed reality as resulting from specific human personalities or personality traits. Instead, economists (try to) identify the constraints and opportunities that confront decision-makers and then explain patterns of human activities as being predictable outcomes of the ways that individuals—any individuals—respond to identified constraints and opportunities.

This avoidance of ad hominem explanations is the source of one of the most important lessons that economists teach: greed explains nothing. Because greed—or, more accurately, “self-interestedness”—is largely unchanging across time, no observed changes in the economy can be explained by it.

Greed can’t explain rising fuel prices, for example, given that fuel sellers (and also fuel buyers) are just as greedy when prices are lower as they are when prices are higher. Likewise with booms and busts. Because people’s greed remains constant something else must explain booms and busts. And so too for any other economic phenomena you care to name—everything from the fact that Americans are richer than Armenians to the fact that, say, big-box retailers’ market shares are growing while those of mom-’n’-pop retailers are shrinking.

Of course the particular constraints and opportunities identified by economist Doe as being most relevant for explaining some phenomenon often differ from those identified by economist Jones for explaining the same phenomenon. Doe, for example, might identify an increase in the rate of growth of the money supply as the most crucial factor for explaining an observed boom and bust, while Jones identifies an easing in government regulation of banks as the crucial factor. But neither Doe nor Jones explains the boom and bust as caused by the likes of greed or ignorance.

Economists’ refusal to use always-popular (and often half-baked) romantic notions about human behavior to explain economic phenomena goes a long way toward making economics a genuine science, and it accounts for much of whatever good economists have managed to bestow on society.

What’s Wrong

Turning now to something that is wrong with economics, much of the harm that economists inflict on society is a direct result of the one area in which economists too often embrace such ad hominem explanations: analyzing government involvement in the economy.

Despite a long-established tradition in economics of studying the “public” sector using the same analytical tools that we use to study the private sector—and despite two founders of this Public Choice tradition being awarded Nobel Prizes (George Stigler in 1982 and James Buchanan in 1986)—far too many economists persist in sloppy, unanalytical ad hominem thinking about government.

For too many economists government is assumed to be able to escape many of the constraints that unavoidably bind and trip up people in the private sector. Asymmetric information, moral hazard, and adverse selection, as well as confirmation bias and the legions of other alleged “irrationalities” identified by behavioral economists, are just some of the “imperfections” economists find in markets and then too frequently simply assume can be dealt with effectively by government.

Overlook here the fact that many of the problems alleged to be unavoidable in the private sector are in fact handled quite well by human beings acting without government who exhibit far more ingenuity than the typical economist believes is possible in private-sector settings. (It’s notable that Elinor Ostrom, the first woman to win the Nobel Prize in economics, isn’t a professor of economics but instead of political science. She won the prize in 2009 for her work showing how creative people in private settings often overcome obstacles—such as free-rider problems—that most economists naively assume can be overcome only by government.)

Unanalytical Assumptions

Focus instead on economists’ bizarre stumble into an unanalytical assessment of government. That stumble goes like this: “Omigosh! There’s an imperfection in this private-sector market! My textbooks and the many refereed journal articles I’ve read and written make quite clear—with lots of difficult mathematics—that this market will therefore fail. My textbooks and journal articles also imply, and in many cases explicitly state, the conclusion that the government—and only the government—can solve the problem. Models prove this conclusion.”

Such stumbling is common. From today’s insistence that America needs more stimulus spending, through the support that many economists express for the new Consumer Financial Protection Bureau, to economists’ overwhelming belief that countries need central banks, too many economists unscientifically reach their conclusions about the alleged efficacy of government intervention without first asking how the information available to government officials, and how the incentives these officials face, will affect government decision-making.

In short, economists mysteriously conclude that desirable public-sector outcomes follow from the praiseworthy intentions that economists assume motivate most public officials.

Nowhere does this mystery run more deeply than in fiscal policy. Even if it were true that increased government spending can hasten an economy’s escape from a recession, the large number of economists who today endorse such spending is discouraging. Seldom do these economists inquire into the incentives facing government officials in charge of spending. The assumption is that these officials will spend the money in ways sure to promote the public interest. Also, seldom do these economists inquire into the information asymmetries and other constraints that might hamper even well-meaning officials’ efforts to carry out fiscal policy effectively.

Save for the relatively few economists steeped in Public Choice economics, the typical economist today remains a political naif—and a dangerous one at that. He is bloated with unjustified confidence in models which show that if government officials behave in the public interest and if these officials are immune to the same decision-making quirks and knowledge limitations that afflict decision-makers in private markets, then government can perform all manner of marvels. This economist then uses his authority to support interventions that are utterly unjustified by genuine scientific standards.

It’s shameful.

Few questions in economic history are discussed and debated as much as this one. Even if you happen to be among the small number of people who regret what historian (and Freeman columnist) Steve Davies calls “the wealth explosion” of the past couple of centuries, you must nevertheless find this question intriguing, for it asks about the causes of what is surely the single greatest change in human history.

For at least 70 millennia the standard of living of the vast majority of us humans was at, or very near, subsistence. Then all of a sudden (in the great sweep of history)—boom! Starting in the eighteenth century living standards shot upward not only for royalty and the landed nobility but for everyone. And to this very day our standard of living—including our life expectancy and measures of healthfulness—continues to rise.

Why?

A question so momentous elicits plenty of answers. Among the well-known answers that have been offered over the years are capitalist exploitation of workers; capitalist exploitation of colonies; religious beliefs that promoted savings and risk-taking; and England’s 1688 Glorious Revolution, which is said to have made property rights more secure. And new answers continue to be offered, such as economist Gregory Clark’s thesis, explained in his book A Farewell to Alms, that genes equipping human beings especially well for carrying out enterprise and commerce were passed down from the English nobility into the English middle classes—thus equipping the bourgeoisie finally to do its thing.

Some of these answers are more plausible than others (with Clark’s being among the least plausible). But not a single one is satisfactory. None explains why the Industrial Revolution began where it began (northwestern Europe) or why it began when it began (the eighteenth century). Another explanation is needed.

And another explanation has indeed just been offered: a change in rhetoric. This rhetoric-based thesis comes from the great economist and historian Deirdre McCloskey in her 2010 book Bourgeois Dignity. It’s a book that, like only three or four others I’ve read, caused a major change in my thinking.

McCloskey reviews with awesome thoroughness all the major (and many not-so-major) explanations for the Industrial Revolution. She finds them all wanting.

Some of these explanations are more obviously flawed than others. Capitalist exploitation of workers, for instance, fails spectacularly as an explanation on a variety of fronts, not the least of which is that the very people from whom the newly created wealth is supposedly extracted (the masses) are the same people who have benefitted most from this wealth explosion.

If capitalist wealth was wrenched from the bent backs and sweaty brows of the working class, then surely workers as a group would today be much poorer rather than (depending on how you count) 10 to 100 times wealthier than were their pre-industrial peasant ancestors. As McCloskey emphasizes, “[M]odern economic growth did not and does not and cannot depend on the scraps to be gained by stealing from poor people. It is not a good business plan.”

A more plausible explanation is one associated most familiarly with the Nobel economist Douglass North and his frequent coauthor Barry Weingast. It’s an explanation I once accepted. According to North and Weingast, the replacement of the Stuart monarchs by William and Mary in the late seventeenth century resulted in more secure property rights in England, which in turn sparked the Industrial Revolution.

While everyone with a modicum of sense understands that the Industrial Revolution would not have happened if private property rights in England weren’t secure, McCloskey argues persuasively that the Glorious Revolution—for all of its undoubted benefits—did not bring about much of a change in England’s property laws or in the security of private property rights. Here’s what McCloskey writes on page 318:

England when at peace, which was the usual case throughout its history, was a nation of ordinary property laws, no more or less corrupt than Chicago in 1925 or the American South under segregation, places in which innovation flourished. It was so, for example, even when the Stuart kings were undermining the independence of the judiciary in order to extract the odd pound with which to have a foreign policy in a new age of standing armies and floating navies. And the amounts extracted, contrary to the Northian suggestion that the king owned everything, were by modern standards pathetically small. The figures offered by North and Weingast themselves imply that total government expenditure under James I and Charles I was at most a mere 1.2 to 2.4 percent of national income. . . .

[T]he Stuart kings, grasping though they were, and emboldened (as were many monarchs at the time) by the newly asserted divine right of kings, were nothing like as efficient in predation as modern governments—or indeed as were the Georgian kings of Great Britain and Ireland who eventually succeeded the Stuarts. [Original emphasis.]

Indeed so. This explanation fails.

The mainstream economist’s long-preferred explanation is capital accumulation. It fares no better than does the capitalist-exploitation thesis and the North-Weingast thesis.

According to the capital-accumulation thesis, people (for any of a variety of different reasons) began to save more. These savings were transformed into capital goods whose use increased the productivity of labor. And so the Industrial Revolution happened.

But as McCloskey points out, history is full of instances in which people saved just as much as in northwestern Europe at the dawn of the Industrial Revolution, but without unleashing any revolutionary industrial forces. Moreover—and contrary to a thesis still fondly held by many people from Marxists to Reagan Republicans—economic growth does not require substantial capital accumulation. It can be, and has been, funded largely out of retained earnings.

What does best explain why the Industrial Revolution began in northwestern Europe in the eighteenth century is that for the first time in history people then and in that part of the world began to talk about the bourgeoisie with respect. This new “habit of the lip” (as McCloskey calls it) replaced the older habit of talking about entrepreneurs and merchants as being, at best, contemptible functionaries whose services society might need in some measure but whose importance to society fell far below the services supplied by warriors, royalty, noblemen, and priests.

With merchants and entrepreneurs in eighteenth-century Holland and England finally accorded widespread dignity, society’s best and brightest no longer avoided the world of private business to pursue careers at court or on the battlefield. The power of the bourgeoisie in these countries with tolerably secure private property rights was thus finally unleashed to revolutionize the economy—first in northwestern Europe and, continuing to today, the rest of the world.
In my next column I will reflect on some implications of McCloskey’s thesis.

Unfortunately Farmer’s idea is as bad as it is big—and it’s very big. Central to his idea is his notion that investor “confidence” is an economic “fundamental”—along with factors such as tax rates, supplies of magnesium, and the prospect of war in the Middle East. If confidence is too high people try to live beyond their means, causing prices to rise. If confidence is too low people spend too little, causing aggregate demand and employment to fall. Being a fundamental, confidence can be at any level, regardless of the state of other fundamentals. So the economy needs some means of managing confidence lest it get stuck at a level that is economically destructive—and Farmer wants central banks to do this.

More specifically, Farmer believes investor confidence is most powerfully affected by equity prices: The higher equity prices are (as reflected in the price of a stock index) the higher confidence is. So a central bank can manage investor confidence by targeting the price of an all-inclusive index of the shares of the nation’s corporations. The immediate goal of active buying and selling by the central bank would be stabilizing average equity prices. By keeping investor confidence from sinking to dangerous lows or soaring to dangerous highs, the central bank would ensure stability.

Sounds simple, but Farmer accepts too much conventional wisdom about macroeconomic history in general and the Great Depression in particular to trust his analysis and prescription.

For example, he asserts that U.S. “banks were often subject to panics” because they “made illiquid loans [and therefore] typically had much less cash on hand than they needed to meet their liabilities in the form of deposits.” Farmer seems unaware that restrictions on branch banking in the United States prevented banks from adequately diversifying their portfolios, making them more subject to runs. So one historical illustration Farmer offers for why a loss of confidence can spread like a contagious disease is poorly grounded.

Farmer also ignores two other important streams of research that cast doubts on his analysis. The first is Robert Higgs’s work on “regime uncertainty.” Higgs marshals a great deal of evidence that during the 1930s Franklin Roosevelt and his New Dealers scared away private investors by creating economy-wide uncertainty. The length of the Great Depression was indeed the result of a loss of confidence, but it had nothing to do with animal spirits or market imperfections that prevent job seekers from matching up smoothly with employers; it had everything to do with unprecedented enterprise- and investment-killing government intrusions into the economy.

The second line of research I’ll describe broadly as “market-process macroeconomics.” This research includes the Austrian theory of the business cycle and the monetary-disequilibrium theory favored by my former teacher Leland Yeager, as well as what EconLog blogger Arnold Kling calls the “recalculation” theory. Although these three accounts of economy-wide fluctuations differ, they all look beyond conventional aggregates (such as aggregate demand) and focus instead on the incentives and constraints that confront individuals, households, and firms.

Had Farmer absorbed the lessons of this scholarship, he might have been less eager to propose such a radical expansion of central-bank power.

This brief review affords too little space even to list the many problems infecting Farmer’s proposal—a sampling must suffice. Why should the central bank focus on the value of corporate equity rather than, say, on the value of other assets, such as real estate? Also, given widespread daily reporting of stock indexes, such as the Dow Jones Industrials, it’s likely central banks would be pressured by politicians to manipulate such indexes for electoral purposes—even when those purposes run counter to the well-being of the economy.

Most importantly, if government enacts destructive legislation that changes real fundamentals in ways that drastically reduce the value of corporate equities, even a depoliticized central bank is unlikely to allow the target value of its stock index to fall by enough to reflect this unwise change in tax or regulatory policy.

While I hope Farmer’s proposal goes no further than the pages of his book, I nevertheless recommend it to readers seeking a clear overview of the development of mainstream macroeconomic thinking during the past century. In that, Farmer excels. As for policy, he fails—big time.

Nor are the boundaries of acceptable simplification breached by saying that modern American “liberals” believe the national government to be sagacious, sure-footed, and righteous when it meddles in the U.S. economy, but ignorant, bumbling, and corrupt when it meddles in foreign-government affairs.

This striking contradiction in political viewpoints has not, of course, gone unnoticed.

I was prompted to ponder this contradiction not long ago after I read an op-ed in the Washington Post by the neoconservative William Kristol calling on Uncle Sam to attempt to influence the outcomes of the recent popular uprisings in North Africa and the Middle East. My ponderings produced a hypothesis: Modern conservatives and “liberals” are obsessively fixated on bad guys (just different ones).

For both conservatives and “liberals” the world is full of problems caused by bad actors—greedy, heartless, power-hungry autocrats who deploy illegitimately acquired power to trample the rights and livelihoods of the masses. Ordinary men and women seek liberation from these tyrants, but—being ordinary and oppressed—the typical person cannot escape the overlords’ predation without help. Their liberation requires forceful intervention by well-meaning and courageous outsiders.

For “liberals” the oppressed masses consist of workers and the poor, and the oligarchs who do the oppressing are business people and private corporations. What encourages this oppression are free markets and their accompanying doctrine of nonintervention by government into the economy.

However, contrary to the “liberals,” nonintervention rests on at least three truths: First, the complexities of modern economies are so great, and hard to discern, that it is absurdly fanciful to suppose that government officials can intervene without causing more harm than good. Even the most well-meaning government is akin to a bull in a china shop: Out of its natural element, even government’s most careful actions will be so sweeping and awkward that the net result will be unintentionally destructive.

Second, even if economic intervention begins with the best of motives, it degenerates into a process of transferring wealth from the politically powerless to the politically powerful. The interventions continue to sport noble names (such as the “Great Society programs” and the “Fair Labor Standards Act”) and to be marketed as heroic efforts to defend the weak against the strong. But these, however, are nothing more than cynical and disingenuous political marketing efforts aimed at hiding from the general public the actual, unsavory consequences of these interventions.

Third, many situations that appear to well-meaning outsiders to be so undesirable that someone simply must intervene to correct them are understood by many of the people most closely affected by these situations to be superior to likely alternatives.

“Unequal income distribution” is perhaps the foremost such situation. While most “liberals” are obsessed with the “distribution” of income and believe that people of modest means must be especially disturbed by the fact that some other people earn more than they earn, in fact the typical American of modest means is far less bothered by “unequal” income “distribution” than are members of the “liberal” academy and punditry. This latter fact only further confirms to the “liberal” mind that ordinary Americans need third-party intervention to save them from their own naiveté; ordinary Americans just don’t know what glories they are denying themselves by acquiescing in the prevailing economic power structure.

Modern “liberals” dismiss these three objections to economic intervention as being fanciful excuses used by the economically powerful—and, even worse, also by the economically naive free-market faithful—to provide (flimsy) intellectual cover for predations by capitalist bad guys. The realistic assessments by modern “liberals” indicate to them that economic intervention is necessary and righteous.

A nearly identical debate plays out on the foreign-policy front, but with the sides switched.

For modern American conservatives the oppressed masses consist of foreign peoples yearning for American-style freedom and political franchise. But these unfortunate foreigners are oppressed by oligarchs who happen to control their governments. “Liberals” (and liberals) who adhere to a doctrine of U.S. government nonintervention in foreign affairs raise the same three objections that conservatives (and liberals) raise against government intervention in the economy.

First, the complexities of foreign governments’ relationships with their citizens are so great and hard to discern that it is absurdly fanciful to suppose that Uncle Sam can intervene without causing more harm than good. Even the most well-meaning intervention is akin to a bull in a china shop: Out of its natural element, even Uncle Sam’s most careful actions will be so sweeping and awkward that the net result will be unintentionally destructive.

Second, even if foreign intervention begins with the best of motives, it degenerates into a process of transferring wealth from the politically powerless to the politically powerful. The interventions continue to enjoy noble names (such as “Operation Iraqi Freedom”) and to be marketed as heroic efforts to defend the weak against the strong. But these, however, are nothing more than cynical and disingenuous political marketing efforts aimed at hiding from the general public the actual, unsavory consequences of these interventions in which corporations such as Halliburton and Blackwater rake in huge, undeserved profits at the expense of the American taxpayer and the foreign populations ostensibly being helped.

Third, many situations that appear to well-meaning outsiders to be so undesirable that someone simply must intervene are understood by many of the people most closely affected by these situations to be superior to likely alternatives. As oppressive as Saddam Hussein’s Iraqi regime genuinely was, it’s not at all clear that merely disposing of this particular bad guy has liberated Iraqis from oppression. Saddam’s rule was very much a result—and certainly not the principal cause—of Iraq’s anti-liberal culture and dysfunctional social institutions, not to mention earlier U.S. intervention.

Foreign countries’ political, economic, and social institutions are too complex and too deeply rooted in unique histories to be adequately grasped by American politicians and military leaders. Therefore American intervention—which is inevitably ham-fisted—adds to this mix only confusion and turmoil.

The two kinds of intervention situations aren’t analogous in all details; differences exist. But these differences are small when compared to the similarities. “Liberals’” confidence that domestic markets can be improved by battalions of bureaucrats charged with keeping bad guys in line is surprisingly similar to conservatives’ confidence that the welfare of foreigners can be improved by battalions of U.S. military troops charged with keeping bad guys in line.

By their nature, most peeves are small. For example, I bristle at the failure to use hyphens correctly. As my late, great teacher Fritz Machlup pointed out, a foreign exchange student is typically not a foreign-exchange student. The first is a student studying temporarily in a foreign country, while the second is a student of international currency transactions. (I can’t resist recalling a classified ad whose author offered for sale a “black-man’s bowling ball.” I’m quite sure that this hyphen was misused.)

Some peeves, however, are large. These are ones that spark over-the-top irritation. One of my largest peeves is the frequently heard assertion that because personal consumption expenditures are currently (say) 70 percent of GDP, our standard of living will fall if personal consumption expenditures fall below that level.

This notion is Keynesianism at its most naive—Keynesianism that, though rejected or slathered with conditions by most or all Keynesians in the academy, motivates the (mis)understanding of too many reporters, pundits, and politicians who speak on economic issues.

I avoid here any discussion of the many conceptual problems involved in measuring economic output and in classifying expenditures. (Okay; I’ll mention just one such problem: A large chunk of “personal consumption expenditures” in the United States is on medical care, which is financed massively by government. As Michael Mandel points out, “[I]t’s misleading to say that ‘consumer spending is 70 percent of GDP’, when what we really mean is that ‘consumer spending plus government health care spending is 70 percent of GDP.’”)

The fundamental error woven throughout such naive Keynesian arguments about the importance of a particular level of consumer spending to the economy is that there is no “correct” or “optimal” level of consumer spending apart from whatever is the level that results from individuals freely choosing to spend and to save.

The Precious Aggregate

Suppose Americans for the past several years spent 70 percent of their incomes on consumer electronics, Las Vegas vacations, and massage therapy, while saving the remaining 30 percent for retirement. There is in this pattern of spending and saving nothing inherently natural or precious. It’s simply the measured aggregate result of how hundreds of millions of Americans chose to allocate their resources over the past several years.

What happens if this year Americans’ preference for saving changes so that they now spend only 60 percent of their incomes on consumer electronics, Vegas vacations, and massage therapy, while saving 40 percent for retirement?

One effect is that producers and importers of consumer electronics will earn less money than before, as will masseuses and owners of Vegas hotels and casinos. Another effect is that some workers in these industries will lose their jobs.

Naive Keynesians focus like lasers on this effect. They worry that workers—some of whom are laid off and all of whom now (the naive Keynesians tell us) are more anxious about their economic futures—will reduce their spending even further. And because workers reduce their spending, investors (it is alleged) will reduce their investing.

It’s a spiral downward. The economic rot spreads.

And because before consumers changed their behavior, personal consumption expenditures were 70 percent of GDP, naive Keynesians—after intoning that “consumption is 70 percent” of the economy—will demand government action to restore that level of consumption.

But the fact is that, in this example, personal consumption expenditures are not any longer 70 percent of GDP. They are lower. And there’s nothing wrong or undesirable about this fact.

When income earners change the amounts they spend relative to the amounts they save, they of course change the pattern of economic activity. One trouble with naive Keynesians is that they assume the earlier pattern of economic activity—the one that prevailed before the “disruptions” when the level of employment was high—is somehow special. They take that earlier pattern as defining some sort of standard that ought not be disrupted—and if disrupted, ought to be restored.

With people now spending only 60 percent of their incomes on consumption goods and services, while saving 40 percent, naive Keynesians assume that—in the absence of government intervention—the economy will shrink, jobs will disappear, and people will become poorer. The reason is that some chunk of necessary consumer expenditure is now going into savings.

“How can the economy recover,” ask naive Keynesians, “if the 70 percent of it that is personal consumption expenditures is not all used for that purpose?”

Naive Keynesians commit too many errors even to list in the space allotted to me in this column. Perhaps foremost among these errors is their mistaken presumption that the practical imagination and initiative of entrepreneurs is as narrow and as anemic as their own in fact is.

If it were true that entrepreneurs were so dull that none of them could ever figure out how to employ a greater supply of saved resources in ways that improve the operational efficiency of a factory, increase the quality of a consumer good, and enhance worker training so that more will be produced in the future when those higher retirement savings are drawn down, then perhaps increased savings would always spell economic trouble.

Precluding Economic Change

But that would be a world in which any economic change spelled trouble. It would be a world in which, even if people merely changed the kinds of consumer goods they purchased (rather than changed the total amount they purchase), entrepreneurs would be unable to figure out how to adjust to such changes in consumer preferences.

Any change would spell damnation, releasing spooky animal spirits that scare everyone into withdrawing as much as possible from the economy.

Open-eyed observation of the commercial world in which we live should be sufficient to dispel these naive-Keynesian presumptions and fears. Entrepreneurs are forever on the lookout for ways to improve efficiency, to make their products more attractive to consumers, and to introduce totally new products.

Change is a natural and ever-present part of the competitive market process. So just because naive Keynesians can’t imagine how increased savings might be productively employed to make the economy stronger—just because they can’t imagine what capital goods the economy would produce if consumers changed their preferences and started saving more—does not mean that pattern of spending and saving which existed in the recent past is better than any one that will emerge in the future.

It is true that the U.S. government imposed relatively heavy tariffs on American purchases of foreign-made goods throughout the nineteenth century. After steadily falling throughout the 1830s, 1840s, and 1850s, tariff rates began to rise again in the 1860s. A pinnacle of sorts was reached with the McKinley Tariff of 1890, which imposed what were then the steepest tariff rates in U.S. history.

It is also true that the nineteenth century was one of steady industrialization and great economic growth. According to Nobel laureate economic historian Douglass North, in 1820 America’s agricultural workforce was nearly seven times larger than her nonagricultural workforce. By the late 1890s, however, the number of nonagricultural workers surpassed the number of Americans working on farms.

And real per-capita income also rose steadily during this time. In 1900 it was about three times higher than it was in 1840.

Was this industrialization and significant improvement in Americans’ incomes the consequence of high tariffs? Or at least can we say that high tariffs did no harm to America’s economy during the 1800s?

No and no.

Facts on other fronts undermine protectionists’ claims that the nineteenth-century experience with high tariffs was positive.

Begin by noting that throughout the 1800s tariff revenues were a major source of operating funds for Uncle Sam. But tariffs that could significantly reduce imports would also reduce government revenues. After all, the very purpose of a “protective tariff”—as opposed to that of a “revenue tariff”—is to dramatically decrease the occurrence of the thing being taxed: imports. (In the extreme case, even a very high tariff rate on imports yields no government revenue if that rate causes Americans to stop importing completely.)

Because sustained budget deficits were practically out of the question in the nineteenth century, genuine protective tariffs arguably kept government in general smaller than it would otherwise have been by keeping revenues lower than they would have been under revenue (rather than protective) tariffs.

Smaller government, in turn, meant less intrusion into the economy. The resulting freedom of entrepreneurs and consumers, and lower likelihood of government handouts (and bailouts!) to favored interest groups, promoted healthy economic growth.

More generally, except for high tariffs, the U.S. economy of the nineteenth century was relatively free. Labor unions enjoyed no special legislative protections; outright industrial and agricultural subsidies were rare; nontariff taxes were either low or nonexistent; antitrust obstructionism wasn’t even possible until 1890, with the passage of the Sherman Act (and even then, it was largely held in check by the courts for a few more years); and there was no SEC, FDA, FTC, EPA, or any of the other alphabet-soup bureaucracies that haunt the economy today. (The first such agency—the Interstate Commerce Commission—wasn’t created until 1887.)

Real Growth Factors

Low taxes and minimal regulation paved the way for entrepreneurs to create, investors to invest, and consumers to reap the resulting benefits. America’s economic growth in the nineteenth century owed a great deal to this freedom.

One particular unregulated feature of the economy was immigration. Substantial immigration, especially during the last few decades of the 1800s, infused the American economy with productive human power and creativity. This immigration also expanded the size of the market able to be served by domestic firms, permitting these firms to take advantage of economies of scale that would otherwise have been unavailable to them because of restrictions on trade with foreign markets.

Economists Cecil Bohanon and T. Norman Van Cott reported, in a 2005 paper published in The Independent Review, that America’s policy of open immigration went a long way toward minimizing the harmful effects of high tariffs.

In addition to the immigrant-fed growth of the U.S. population in the nineteenth century, there was the growth of U.S. geography. By the end of the nineteenth century, the United States stretched from the Atlantic to the Pacific, and from Canada to Mexico and the Gulf. This enormous geographic area was a free-trade zone. Consumers and producers in frigid New England could specialize and trade with producers and consumers in sunny Florida and even faraway California.

The different geographic features that are among the reasons why trade among different small countries is so beneficial were present within this one sprawling and geographically diverse country.

Home of the Free(-Trade Zone)

So America’s impressive economic growth during the nineteenth century was in fact the result of free trade—trade unhampered within the expansive boundaries of a country that was huge, growing, and diverse in both its geography and its population.

If the protectionist logic was correct, then even greater wealth—or at least as much—would have been produced had each U.S. state adopted its own policy of protecting in-state producers from out-of-state competitors. But I know of no serious scholar who laments the fact that the United States, from its origins, has truly been a zone of free trade.

Of course, the fact that America’s economy grew impressively during the 1800s despite Uncle Sam’s restrictions on foreign trade does not mean that these restrictions weren’t harmful. They no doubt were. The restrictions stopped specialization from going ever further; they diminished the intensity of competition from the levels that consumers would have enjoyed without high tariffs; and they hampered the ability of American producers and consumers to tap into the creativity of non-Americans who did not immigrate to America.

Fortunately, though—or is it unfortunately?—nineteenth-century America’s other advantages were so great that the bounty they made possible blinds many people to the harm caused by that era’s high tariffs.

There was a time when I worried that the dependency and inefficiency caused by government interventions would create a vicious, self-reinforcing cycle that fueled more calls for even greater intervention—a process that would continue until the State suffocated all individualism and initiative. But I no longer believe that such a progression—or, better, retrogression—is inevitable.

Two reasons explain my change of mind. The first is observed reality, and the second is what I (perhaps too vainly) believe to be a better understanding of society, politics, and economics.

Let’s first look at reality. From at least the 1930s—or as scholars such as Arthur Ekirch argued, from a much earlier time—government’s role in the American economy has expanded dramatically. And yet we continue to grow more prosperous. Beyond any doubt, Americans of 2010 are better fed, clothed, housed, informed, educated, medically cared-for, traveled, rested, and entertained than were Americans of 1930—or even of 1980. Despite some tax relief and deregulation since the late 1970s, these improvements in our living standards occurred with government taxing and regulating and redistributing as never before in the United States.

Look also at other countries. Although ordinary people in nations such as France and Sweden aren’t as wealthy as ordinary Americans, they are nevertheless extraordinarily wealthy by historical standards. And they’re getting wealthier despite their governments’ heavy interventions in their economies.

It’s a fact that real and growing prosperity is not necessarily quashed by government intrusion.  This does not mean, of course, that these intrusions do not reduce the level of prosperity and the rate of economic growth. I’ve no doubt that they are harmful—that ordinary men and women would be wealthier and more secure (and freer) were the State to remove its tentacles and tax collectors from the economy.

But these tentacles and tax collectors are not necessarily fatal.

Nor are such interventions the leading edge of totalitarianism. As obnoxious and as intrusive as, say, the IRS and the FDA are, modern America is not remotely comparable to the Soviet Union under Stalin (or even under Gorbachev). Americans are incomparably more free than were the subjects of the Soviet regime.

Some readers of this magazine will dispute my observations of the real world. I report them not to be controversial but merely to be honest.

Assuming that my empirical observations are sound, what explains these facts? Why haven’t 80 years of a national government unmoored from constitutional restraints—and with an unending itch to poke, prod, and tax nearly every aspect of Americans’ lives—resulted in economic stagnation and Big Brother of the kind that haunts the characters in George Orwell’s great novel 1984?

I believe that the answer is the power of freedom.

Freedom is a beautiful flower with more robustness than crabgrass. Freedom is not delicate or easily uprooted. Like crabgrass, freedom is not indestructible; it can be killed. But freedom is not a frail institution that collapses and dies the moment it is attacked by some element foreign to its nature. If it were, we all would long ago have been well and truly enslaved.

The human spirit seizes opportunities to flourish even with less-than-maximum scope; it naturally resists being confined to the arbitrary will of others. We do not all fall in line behind the commissar or Congress’s commands simply because we’re ordered to do so. (How many Americans really care if the busboy at a restaurant is an “illegal” alien?) And even when we abide by the letter of legislation, we are wonderfully crafty at violating its spirit if that legislation is felt to be inappropriate.

So, too, with the free market. It is perhaps the most remarkably vigorous of all human institutions. Heavily taxed and loaded with arbitrary regulations, the market keeps on keeping on. Entrepreneurs creatively find ways around government intrusions or they discover techniques for reducing the intrusions’ ill effects.

Everyone who understands the logic of markets knows that, say, the unexpected destruction of a factory by an earthquake will barely slow the market’s relentless push to improve living standards. We understand that markets are remarkably resilient at dealing with—and reducing the bad effects of—natural obstacles such as mountains that separate suppliers from customers, or weather disasters that destroy existing inventories and supply lines.

Although we’d be even wealthier if these obstacles and weather disasters never materialized, their existence does not condemn us to everlasting poverty. Entrepreneurs—given sufficient freedom—are guided by prices and profits to overcome these obstacles. Likewise, entrepreneurs—given sufficient freedom—are guided by prices and profits to overcome government-erected obstacles.

The vital question here is, how much freedom is sufficient? I have no answer, except to say, ”Freedom is sufficient for economic growth even when it is far less than we should have and are capable of having.”

Many libertarians will read this column and wince, thinking I’m discounting the importance of freedom. But they would be mistaken.  In fact, the theme of this column is to celebrate the great and creative power of freedom. To point out that freedom can be hobbled and hamstrung by a predatory State and nevertheless continue to shower blessings on ordinary men and women is to praise freedom—to applaud it loudly and lovingly.

Additionally, those persons who recognize the resilience and vigor of freedom and free markets gain even greater credibility when insisting that the role of the State should be reduced. If it were true that the slightest burden government placed on freedom led inexorably to tyranny and poverty, then anyone who champions freedom might be thought to do so for purely pragmatic reasons. But the champion of freedom who recognizes that the economy might still be reasonably dynamic in the face of government regulations, and who doubts that such regulations will lead to his or her being tyrannized, is an even more believable spokesperson for freedom, for that person can speak more from principle than from narrow pragmatism.

He or she can say, ”Look, even though eliminating this tax or repealing that regulation will not mean the difference between poverty and plenty, I still believe that the tax should be eliminated or the regulation repealed. The reason is that they are immoral. There’s a practical case for reducing government’s role, but even when practical considerations do not loom large, ethical considerations do. Even though this tax or that regulation won’t condemn us to a material hell, they nevertheless violate human rights that ought never be violated.”

Careless language (or, even worse, verbal legerdemain) often turns words or phrases with positive connotations into Trojan horses that sneak mistaken, vague, or confusing notions into our thought processes.

A familiar example is the word “fair.” By definition, “fair” denotes something desirable. So by attaching the word to any noun or verb, a speaker anoints the thing as something good. The speaker is subtly instructing the listener simply to accept without question that the thing described by the word is good. A careless listener, then, is at high risk of accepting a conclusion that, with careful thought or without having heard the word “fair,” he might not accept.

Consider the frequently heard phrase “fair wage.” If Sen. Jones explains his support for raising the legislated minimum wage, he’s sure to insist that his goal is for low-skilled workers to receive a “fair wage.” Scholars seeking to explain the consequences of minimum-wage legislation objectively then have to overcome the emotional bias that the word “fair” smuggles into the conversation.

Another example is the phrase “secure our borders.” Opponents of open immigration frequently allege that illegal immigrants are proof that America’s borders aren’t “secure” and that those of us who wish to abolish numerical limits on immigration are insensitive to the need for government to “secure our borders.”

Such allegations, however, sneak in so many implicit presumptions that rational discussion becomes quite difficult.

The very phrase “insecure borders” conjures an image of government failing at its most fundamental responsibility—namely, protecting citizens from invading marauders. People see in their minds’ eyes an America increasingly at risk of being conquered by foreigners, leaving Americans at the mercy of invading rapists, plunderers, and murderers.

Immigrants, however, aren’t invaders, much less warriors in a conquering army.

Reasonable people can disagree over what kinds of national-security protections should exist on America’s borders and what sorts of screening of would-be immigrants should be done to reduce the risks of terrorist attacks on American soil. But it is not reasonable to imply that immigration is chiefly, or even mostly, an issue of national security. Unfortunately, such an unreasonable implication is precisely what people who frame immigration as a matter of border security sneak into the discussion.

For perspective, ask if America’s borders were insecure until 1921 when, with the Emergency Quota Act, Uncle Sam first began seriously to restrict the number of immigrants allowed into the United States. Were Americans, until just 90 years ago, living in peril of their lives and livelihoods because U.S. borders were “insecure”?

Or ask this question: Does the fact that Uncle Sam imposes no numerical limits on foreign visitors to the United States mean that American borders are insecure? Short of the U.S. government’s imposing draconian restrictions (to be enforced with draconian measures) on visitors—say, admitting only 1,000 visitors annually, each of whom must first get a high-security clearance from the State Department—it’s almost impossible to see how numerical restrictions on foreign visitors would make America’s borders more secure. Therefore, anyone who would now seriously suggest that the lack of numerical restrictions on foreign visitors to America is evidence that U.S. borders are “insecure” or “broken” would justifiably be ridiculed.

Keep these points in mind when you encounter debates over immigration policy.

My proposal is to return to the policies under which anyone who wanted to immigrate to America could do so as long as he or she had no serious communicable disease and was not a terrorist.

That policy was much like the one we have today for foreign visitors to the United States: Anyone may visit America as long as he or she likely poses no serious threat to Americans. So, too, before 1882 anyone could immigrate to America as long as he or she posed no serious threat to Americans. (This policy actually continued largely unchanged until 1921, with the horrid exception of would-be immigrants from China. Starting in 1882 Uncle Sam imposed severe restrictions on Chinese people’s ability to immigrate into America.)

In fact, the security of American borders—if by this phrase we mean genuinely decreased risks to Americans’ persons and property—would almost certainly rise with open borders.

Points of immigrants’ entry, such as Ellis Island, would be reestablished. All peaceful persons immigrating to America would flow in through these points, be checked for communicable diseases and for ties to terrorist organizations, and, if cleared on both fronts, enter the United States. Uncle Sam would no longer spend hundreds of millions of dollars policing the borders, catching “illegal” immigrants, deporting them back to Mexico, and monitoring employers who might have hired “illegal” immigrants. Those resources could be used instead to seek out and to apprehend terrorists.

Because all legitimate steps to secure the borders would aim only at reducing Americans’ risk of being violated in their persons and property, government’s policing efforts would—with the open-borders regime I recommend—focus on this goal. Such worthy efforts would not get mixed in with, or be confused with, efforts to prevent peaceful people from coming to America and finding gainful employment here.

With government enforcement efforts concentrated on securing us from criminal violence and theft, we would be more secure than we are now with so many resources and so much manpower instead concentrated on “protecting” us from people whose only crime is to seek out better economic opportunities.

Dobbs spits his vituperation at two groups. The first is “Corporate America” (the capitalization is his): rich, greedy, heartless bigwigs who fire workers in America and replace them with low-paid workers in the Third World. This strategy is driven by the bigwigs’ need to maximize short-run profits. The second group is free-trade advocates: ideological, heartless eggheads and politicians whose “blind faith” in free trade and the market provides intellectual cover for the greedy bigwigs to continue to “export jobs.”

Dobbs loathes this alliance, for it means that our “blind” adherence to free trade might go on long enough to rid America of her middle class. Sounding very much like the leftist Thomas Frank, who argues that the many middle-class Americans who vote for cutting taxes, reducing regulation, and increasing their freedom to trade have been duped, Dobbs just knows that “outsourcing” of American jobs is destructive and wicked. He is outraged at outsourcing and astonished that more Americans don’t share his rage.

He cries: “We should be worrying about the prospect of more jobs and more businesses being wiped out by cheap foreign labor, and even more worried about those who blindly advocate free trade for its own sake—well, actually for the sake of powerful U.S. multinational corporations.”

He uncovers ominous developments: “And corporate logos in many cases have more powerful symbolic importance than national flags.”

He puts matters in perspective: “I don’t think helping consumers save a few cents on trinkets and T-shirts is worth the loss of American jobs.”

Mostly he fulminates: “But the simple truth is that our multinationals and our elected officials who support them without reservation are callously and shamelessly selling out the American worker.”

No coherent theory underlies Dobbs’s concerns and accusations. He’s as naive on matters of trade as one can possibly be. In Dobbs’s view, when Americans buy foreign product or services, other Americans are harmed because expenditures abroad mean less demand for American output and, hence, less demand for American workers. The result is unemployment and lower wages. This downward spiral in American prosperity won’t stop until most American workers are paid wages equal to the paltry wages paid in Third World countries—unless, of course, Congress steps in.

Dobbs never stops to ask, “Why are foreigners so eager to earn U.S. dollars by exporting goods and services to Americans?” Nor does he ask why private investment in the United States has been so much higher over the past few centuries—continuing to this very day—than it is in Third World countries.

In a marvelous, if unintended, testament to the success of free-trade ideas, Dobbs nevertheless rejects the label “protectionist.” (This rejection is dishonest, for a protectionist is exactly what he is.) He describes himself as a “balanced trader.”

By “balanced trade,” Dobbs means trading relationships in which the United States runs neither a trade surplus nor a trade deficit with the rest of the world or even with any individual country. Even I, who wasn’t expecting much real analysis from Dobbs, was surprised that he is completely unaware of what “trade deficit” means and that there’s an inherent balance in trade accounts. Any trade deficit (more precisely, any current-account deficit) is exactly balanced by a capital-account surplus. That is, if the United States runs a $500 billion current-account deficit this year, it runs a $500 billion capital-account surplus—which means that foreigners are investing at least this amount in American assets.

Dobbs’s obsession with what he mistakenly identifies as “balanced trade” is especially annoying because he declares that Adam Smith would agree with him. That is unlikely, given that Smith declared in The Wealth of Nations: “Nothing, however, can be more absurd than this whole doctrine of the balance of trade . . . ”

Friends of free trade will find no arguments or data in this book to challenge their presumptions or theories. Opponents of free trade will find no arguments or data to support their presumptions or theories. All that anyone will find is ranting and raving, as uninformed as it is self-righteous and as hysterical as it is mistaken.