Tonight, I want to . . . lay out a blueprint for an economy that’s built to last. . . .

Considering that an economy (a free one, that is) is just people engaging in exchanges for mutual benefit, it defies blueprinting, which sounds ominously like central planning. The last thing an economy needs is an architect, especially one with the legal power to use aggressive force.

The best energy policy is no energy policy.

FEE Timely Classic
“Energy Policy: Wisdom or Waste?” by Roger McKinney

This misapprehension is helped along by a good part of the economics profession, many of whose members see themselves as the aspiring mechanics.

To state the obvious: an economy isn’t a machine. The term is an abstraction, even a metaphor, and we always get ourselves into trouble by taking metaphors literally. As F. A. Hayek was fond of pointing out, the word “economy” has its roots in the Greek word for household. (Remember those home-economics courses?) Even though a household is composed of individuals, it can usefully be thought of as a unit in the sense that its financial affairs are largely arranged around a single set of ends. (There’s a limit,of course, to how far that can be taken.) We go astray the moment we apply this description to larger collections of people. As soon as we begin talking about the city’s, state’s, or nation’s economy we have severed our moorings from reality because those groupings do not have a single set of ends.

That is why Hayek preferred the word “catallaxy” to “economy”; it comes from the Greek word for “exchange.” A catallaxy is “not a single economy but a network of many interlaced economies” (Law, Legislation, and Liberty, volume 2).

Another economist and Nobel laureate who is sensitive to this matter is James Buchanan, one of the pillars of the Public Choice school of political economy. His concerns are collected in the Liberty Fund volume What Should Economists Do? In the title essay (originally an address given in 1963) Buchanan identifies what can only be described as the central collectivist premise of most economics, namely: some entity larger than the individual—usually the nation—must allocate scarce resources.

Many heavyweights in twentieth-century economics—not just socialists—regrettably let that premise stand, Buchanan points out: Lionel Robbins never identified the allocator; Frank Knight attributed economic activity to the “social organization”; and even Milton Friedman held that (Buchanan quoting) “economics is the study of how a particular society solves its economic problem.” Not that those men did not realize that groups consist of individuals. But as economists, Buchanan fears, they too readily left the impression that economics deals with a collective’s solution to an allocation problem. It’s a short step from a collective to a machine.

That’s not how Buchanan sees economics. In contrast to the view that the economy is a “means of accomplishing the basic economic functions that must be carried out in any society,” he believes “The market or market organization is not a means toward the accomplishment of anything. It is, instead, the institutional embodiment of the voluntary exchange processes that are entered into by individuals in their several capacities.” He adds: “This is all that there is to it.”

Contemplate how different this conception of economy is from the general impression. As Buchanan writes, “Individuals are observed to cooperate with one another, to reach agreements, to trade. The network of relationships that emerges or evolves out of this trading process, the institutional framework, is called ‘the market.’ It is a setting, an arena, in which we, as economists, as theorists (as onlookers), observe men attempting to accomplish their own purposes, whatever these may be.”

In such a conception of economy, where is there room for words like “overheated,” “cooled down,” and “stimulus”?

Economic Subjectivism

In another essay in his book, “General Implications of Subjectivism in Economics,” Buchanan flaunts his affinity with the Austrian school of Hayek and Ludwig von Mises. Here he writes, “The principle that exposure to economics should convey is that of the spontaneous coordination [of individuals] which the market achieves. The central principle of economics is not the economizing process.” And he warns that economics will “become applied mathematics or engineering” if its practitioners think it is.

Subjectivism in economics is the recognition that economic phenomena emerge from what human beings believe, think, and do, and not from data they may know nothing about or rarefied statistical aggregates and averages. Subjectivism is good insurance against seeing the economy as a machine and the government as its vital attendant. Or as Buchanan puts it, “to the extent that subjectivism tends to concentrate attention on the interaction among persons and away from the ‘economic problem,’ an understanding of the principle of order is facilitated rather than retarded.”

Subjectivism can be seen most starkly in the notion of costs. Much economic theorizing (and bureaucratic meddling) regard costs as objective. That perspective encourages social engineering. After all, if those who would move us about the national chessboard had to confess that they cannot know the costs of their maneuverings, they would have a harder time justifying their power.

But they cannot know those costs. “The costs that influence ‘choice’ are purely subjective and these exist only within the mind of the decision-maker,” Buchanan writes. When one confronts two alternatives, one is really confronting two mental projections of what the world might be like in the future. Either or both projections could be wrong. At best they are educated guesses. And since one of those imagined worlds will never be realized, the chooser will never know if he was wrong about that one. But that world forgone is the true cost of the alternative chosen because that’s what the chooser gives up to achieve it. We often think of costs as money paid. But while money is indispensable for making calculations, it does not express the true opportunity cost of a choice. No one wants money for its own sake, but only for what it can buy now or later.

An economy is people cooperating to better their situations. Thus a “stimulus package” is fundamentally objectionable not because of anything that may be in the bill. (Tax cuts are always welcome.) It is objectionable because of its rationale. Government should endeavor to stay out of the way of productive activity at all times, not just when various numbers are deemed too high or low.

From the Hill:

Republicans have so poorly positioned their party that they have a huge political interest in the jobless rate rising and the economy falling. Good news for America becomes bad news for Republicans.

The problem for Republicans, and their great weakness going into the 2010 elections, is that they are so dominated by right-wing factions, and so obsessed with President Barack Obama failing, they are locked into politics that only succeed if America fails.

The rhetoric isn’t new–Limbaugh and others made similar arguments in the run up to the 2006 and 2008 elections–and as always, it is nothing more than arrogant sound and fury repeated by grotesquely partisan idiots.

If we’re going to have a reasonable political discourse in this country we have to acknowledge that success is in the eye of the beholder. A successful America for Democrats is far different from that of Republicans and Libertarians. So it makes no sense to talk about success and failure independent of the definition held by the respective parties and factions.

This is the sign of a primitive mentality. In reality economic laws exist, reality sets limits, and good feelings can’t create prosperity out of nothing, especially when government stubbornly stands in the way.

It seems odd that we should ever have to worry that there aren’t enough jobs. Have we all become ascetics? Did we all wake up one morning and decide we no longer want to consume? No, we all want goods and services that must be produced by human beings using capital equipment. Our wish lists exceed our budgets — which is to say we live in a world of scarcity.

Even if we reduce current consumption so that we can save, it’s because we want to consume more in the future than we could have consumed had we not saved. Entrepreneurs and investors know this and (if left free) can be expected to try to anticipate what we will want and to invest at early stages of production — and hire employees — so the final goods will be ready when we are.

Thus there should be a shortage of workers not jobs. In general, employers should be competing for employees and not the other way around. There’s always work to do, and it will be done if people are willing to pay enough to attract laborers. If things aren’t turning out that way, something is interfering with the operation of the market process.

What could that be? The visible fist of government, of course. Nothing else could create such a perverse effect as a nationwide job shortage in a world of scarcity.

Effect, Not Cause

The downward employment spiral we have witnessed is an effect, not a cause, of economic trouble. People were laid off and consumption slowed down, with rippling effect, because of earlier bad policies. In the current case, government housing policy and Federal Reserve conduct united to create unsustainable distortions in finance, construction, and allied industries. When the boom came to end and the bubble burst, what looked like rational investments were revealed as errors that needed to be corrected so that the market process could get back on its natural track. This takes time. Decisions cannot be instantly and costlessly reversed. There’s too much construction equipment and not enough of something else, but that cannot be rectified overnight. Capital was wasted in the boom, and new saving is needed not just to replenish the capital stock but to make sure it’s the right kind of capital.

But the policymakers won’t let the market heal itself. Why? Because letting it happen means doing nothing—or rather undoing lots of things—and politicians are incapable of that. Imperative No. 1 is to get reelected. Whether a politician understands economics or not, the electorate for the most part does not. So he caters to the economic illiterates by appearing to boldly take on problems that were created by his earlier takings-on. Almost any policy he backs will be opposite of what ought to be done.

The two things that government needs to do are exactly what politicians find so distasteful. It must 1) dramatically lighten its burden on the people and 2) abstain from causing producers to wonder what new burdens may be around the corner.

The burden of government is great. This is to be measured not in taxes alone, but in total spending, mandates, regulation, and Federal Reserve distortion. Politicians and special interests have lived as though the burden could be increased indefinitely with impunity. We see now that it can’t. Spending must be substantially cut — departments and agencies abolished — so that resources can be left in the productive sector. Taxes must be reduced sharply — better yet, repealed. The heavy hand of bureaucracy must be lifted from production. Government is a destroyer, not a creator, of value. It must stop.

The progressives don’t get this, but neither do many conservatives. They want to goose the economy with stimulative tax credits and payroll-tax holidays—without spending cuts. This would increase the already intolerably large budget deficit. Like the right-Keynesians so many of them are, they underestimate the budget-deficit danger, despite frequent rhetoric to the contrary. What we need are tax and spending cuts, for as Roger Garrison points out, deficit spending creates its own uncertainty (the “debt bomb”) about how the debt will be paid off in the future. Will there be new taxes? If so, on whom? Will the Fed monetize the debt? If so, what then? No one can say for sure who will bear how much of the brunt of the government’s fiscal recklessness. This affects decision-making.

Uncertainty about future government policy has a chilling effect on investment and job creation—that is, on serving consumers. Entrepreneurship is, first and foremost, risk-taking—the execution of a plan based on expectations about the uncertain future. Consumer tastes and other aspects of life are unpredictable enough without also having to worry about what crippling regulations, taxes, and inflation the State might set in motion with during the period of production. Will Washington enact cap-and-trade and a new financial regulatory regime next year? Why make commitments before we know? The only thing worse than uncertainty about future government impositions is certainty about them. With costly health-insurance nationalization almost surely in the offing, entrepreneurs have new burdens to keep in mind as they do their business calculations.

No More “Stimulus”

What government should not do is more “stimulus” spending or jobs programs paid for with borrowed money. At best they merely displace private-sector jobs by soaking up scarce resources. At worst they finance politicians’ ego projects, corruption, and things no consumers would pay for voluntarily. As the Washington Post reports, a “sizable sum [of 'stimulus' money] has gone to federal contractors in the Washington area who are helping implement the initiative—in effect, they are being paid a hefty slice of the money to help spend the rest of it.” And while there is dispute over how many jobs the $787 billion “stimulus” bill has created or saved (though  most of the money still hasn’t be spent), we can be sure that many of the jobs are government or government-dependent positions, not the product of consumer-oriented projects.

Jobs are not ends in themselves. They are means to the things consumers want. Government could create full employment by building pyramids and drafting all young people for combat in the Afghan adventure. But would that be productive?

How about rebuilding the infrastructure? The problem here is that infrastructure is the politicians’ playground. Lacking market signals, they can’t be trusted to get it right. And why does it take high unemployment to get politicians thinking about roads and bridges? They’ve shown themselves to be bad stewards. Better to transfer these assets to the private sector, where business, not political, judgments will guide decision-making.

The root problem is the privilege-ridden corporatist economy that shifts power to politicians and the politically connected. This has only gotten worse in recent years, with the Fed and Treasury directly guiding the flow of capital to favored companies. Abolish the privilege, the subsidies, the barriers to entry, the impediments to self-employment, the currency manipulation — and watch a stable and growing economy appear — one based on freedom rather than privilege, mutually  beneficial exchange rather than exploitation.

Once again the best course for government is: Get out of the way!

But an even bigger problem is the use of the term “fundamentalist.” I understand Christian fundamentalists to be people who, as Bryan Caplan writes in The Myth of the Rational Voter, “ignore or twist the facts of geology and biology to match their prejudices.” So wouldn’t a market fundamentalist be someone who distorted facts to make the case for markets? We can certainly imagine such a person, but I’m not one—nor are many of the people who are strong advocates of free markets. It’s not that I think markets will always work perfectly. It’s just that they work so much better than the coercive solutions that are proposed by those who call me a “market fundamentalist.” Of course, there are times when standard free markets might not work well, but in many of those cases, voluntary charitable activity and simple fellow feeling fill the gap. We don’t think of it as a market transaction, for example, when a stranger in a strange city gives me directions to my hotel. But it certainly is an exercise of his freedom, and it generally works pretty well.

Government Fundamentalists

What should we call people who seem to regard government as the solution regardless of the evidence? I propose the term “government fundamentalists.” How would you identify a government fundamentalist? One characteristic would be a tendency, after the person points out market failures, to argue for government intervention as the solution. Rarely does anyone who proposes a government solution spell out how the incentives will be set up so that the government will actually solve the problem. Even many economists who are strongly committed to free markets will agree that economic freedom can underprovide defense from foreign attackers because of the notorious free-rider problem: Those who refuse to pay will get the same defense as those who pay, giving all an incentive not to pay. The possible result is that national defense is underprovided. But I’ve yet to find an advocate of government provision of defense who can explain how incentives will be set up so that government actually defends us and doesn’t simply engage in national “offense,” picking fights with a dictator in Iraq or a demagogue in Panama, to cite two examples of the U.S. government’s so-called defense.

But given that even some passionate advocates of economic freedom approve of government solutions to problems caused by market failure, we need another characteristic to distinguish government fundamentalists. Here’s the characteristic I propose: a tendency to advocate government solutions even in the face of evidence that those very solutions have not worked.

Take the tax on gasoline. The original idea for taxing gasoline was that users of roads would pay for them. Even at its best, though, the gas tax was not a great solution. The revenues were put in a big pool and politically allocated. There was no necessary connection between where people valued having roads and where roads were built, a connection that automatically would have existed had the revenues been collected with tolls. Tolls, after all, are prices not taxes.

It got worse. In the late 1960s, governments started diverting some gasoline-tax revenues to other uses. The first big diversion was to government-run mass transit that couldn’t survive on its own without subsidies. Later, more funds were diverted for bicycle lanes and lanes on roads and freeways that were dedicated to money-losing bus service. So the whole idea of user-supported roads has been steadily undercut.

Moreover, in response to higher gasoline prices, people have reduced their driving and shifted towards higher-fuel-economy vehicles. Because the federal tax on gasoline is in cents per gallon, revenues fell slightly, from $21.053 billion in fiscal year 2007 to $20.982 billion in fiscal year 2008, a drop of $71 million. In most years, by contrast, revenue grows as the number of drivers grows.

What should be done? If you notice how politicized road construction is, if you notice that a gasoline tax that was supposed to be used only for roads is now used for other things, and if you notice that the shift to higher fuel economy is reducing the growth of revenues for road-building, you might consider a market solution. You might consider taking the issue out of politics, allowing private entrepreneurs to build roads and charge tolls for their use. You might realize that doing so would forever free road construction and maintenance from the vicissitudes of gasoline tax revenues and from the politically powerful governments that grab the funds for their money-losing projects.

More Government Will Fix Failed Government?

But what do many people advocate when they notice this problem? Higher gasoline taxes. If you assume that government solutions are better than free-market solutions, you would naturally conclude that the gasoline tax should be increased. But if you are to avoid being a government fundamentalist, shouldn’t you actually look at the evidence on how well or badly gasoline taxes and government provision of roads have performed? Shouldn’t you also look at the how well or badly toll roads work?

That’s not what many people have done. Take political writer Thomas Frank. In a January 28 article in the Wall Street Journal, “Toll Roads Are Paved with Bad Intentions,” Frank wrote that few state governments “are willing to raise the gasoline taxes which pay for the repairs” to government-owned roads. In other words, Frank sees that there is no necessary connection between the need for repairs and the willingness to raise gasoline taxes. Isn’t this failure to fund roads a strike against government-funded roads? Not in Frank’s mind. He points out a problem with an incomplete system of toll roads: Tolls will price some drivers out, and some of these drivers will then spill over to nontoll roads. But this wouldn’t be a problem if all roads were toll roads. Frank, though, does not consider such a system.

Economist Jeff Hummel recently captured the essence of government fundamentalism this way: If markets don’t work, have government intervene. If government intervention doesn’t work, have government intervene further.

Notice the irony. Many free-market economists like me are quite willing to admit that markets don’t work perfectly and to examine and accept government solutions if their advocates can show how governments can be motivated to actually carry them out. And yet we are called market fundamentalists. On the other hand, many people who call us that are unwilling to change any of their views about the efficacy of government intervention no matter how badly the intervention works. Who are the fundamentalists here?

The state of the economy calls for action, bold and swift, and we will act — not only to create new jobs, but to lay a new foundation for growth. We will build the roads and bridges, the electric grids and digital lines that feed our commerce and bind us together.