Unfortunately Chait misses two important points. First, Keynes’s argument for why his view of fiscal policy need not mean a larger government ignores the incentives facing the politicians who must implement it. Those incentives would lead to a larger government. Second, Keynes called for the socialization of investment as part of a broader vision of how to prevent the crises that necessitate stimulus spending in the first place. The result of both arguments is larger government. Thus Chait’s claim about Keynes just ain’t so.

Chait rightly notes that while Keynes argued that deficit spending was necessary as a stimulus during recessions, he also argued that governments should run surpluses in good times to pay off the debt. Chait concludes: “This policy is perfectly compatible with any level of government and does not require higher aggregate levels of debt than maintaining a regular balanced budget.”

Indeed, in theory it is compatible, but the problem is that the theory does not comport with reality. Keynesian ideas have ruled fiscal policy for at least 50 years, fewer than five of which had budget surpluses. During this time the debt has gone up to more than $14 trillion and the size of government has expanded enormously. Surely the economy was not in recession all but those few years. Apparently Keynesian policy is not compatible with any level of government and does seem to necessitate higher levels of aggregate debt.

What Chait overlooks is that regardless of what Keynes believed government should do, what it in fact will do is another matter. As James Buchanan and Richard Wagner argued in their classic critique of Keynesian fiscal policy, Democracy in Deficit, by removing the preexisting moral and institutional constraints on deficit spending as a way to balance the economy, Keynes and the Keynesians unleashed the perverse incentives of the political process into policymaking. The problem with Keynes’s analysis is that he paid no attention to the real incentives facing politicians, who now had the green light to deficit-spend in the name of economic stability.

Buchanan and Wagner argued that vote-seeking politicians will always prefer spending to taxing because the former gets them votes and the latter does not. As long as there are no institutional or moral impediments to this (such as a balanced budget amendment or a deeply held norm against deficit spending, except during wartime), politicians will always take deficits over surpluses, especially when economists such as Keynes have given them theoretical support. The result is that rather than the offsetting surpluses Chait focuses on, politicians continue to deficit-spend even during periods of economic growth because none wish to raise taxes or cut the flow of government benefits to their prospective voters. The result is exactly what Buchanan and Wagner predicted in 1977: large and increasing deficits and debt, and a growing danger of higher levels of inflation to pay it off.

In addition it’s worth observing that government stimulus spending simply does not work. Part of the Keynesian story is that deficit-financed spending will end recessions and generate the growth that will lead to the later surpluses to pay off the deficits. But what if stimulus spending doesn’t generate growth, or even prolongs or deepens recessions? In that case deficits beget deficits, debt begets debt, and government grows out of control. When Chait wrote in May unemployment was about 9 percent three and a half years after the recession started and around two years after it officially ended. As I write this two months afterward unemployment is unchanged. Massive stimulus spending is not just the path to larger government but also to permanently low rates of growth, which will only worsen the deficit and debt.

What Not To Do

In his article Chait also claims that defenders of Hayek cannot tell us what should be done when an economy is stuck in a recession. That’s an unfair charge. First, Hayekians can tell us what not to do: engage in large-scale stimulus spending, for the reasons noted. Second, Hayekians do have positive advice: Government should get out of the way so entrepreneurs and others who have a better idea of what to do can try things and see if they work. Chait claims it’s a cop-out for Hayekians to criticize Keynesian solutions for relying on government without specifying what the alternative is. The Hayekian perspective is that neither Hayekians nor Keynesians know what to do. That’s why we have market competition, which in Hayek’s words is a “discovery procedure” that helps us figure out how to revive a moribund economy.

Finally, Chait overlooks the broader context of Keynes’s fiscal policy recommendations. These were really only stop-gap measures rather than a long-term solution to what Keynes saw as the chronic tendency of capitalist economies to fall into recession. In his view there would never be enough profitable investment opportunities to match the public’s saving. So he proposed a fix for this oversaving/underconsumption problem. That fix was the socialization of investment through the State.

In trying to argue that there’s nothing in Keynes to suggest larger government, Chait is correct, but only if he’s referring to “fiscal policy” in its narrowest sense and ignoring the political incentives discussed above. But Keynes’s fiscal policy analysis was part of a larger story of the instability of capitalism, which requires that government play a more prominent role in allocating money for investment to avoid future recessions. This element of fiscal policy clearly calls for a bigger government.

The claim that Keynesianism doesn’t necessarily imply bigger government and greater debt is shown to be mistaken when we consider the implications of Keynes’s argument for countercyclical fiscal policy, the record of Keynesian policy in the last 50 years, and the broader context of his views on fiscal policy in The General Theory.

That’s right: Despite record federal spending and unprecedented Federal Reserve intervention, the economy remains depressed. Beyond stating the obvious about the nonrecovery Krugman frets about the long-term implications of the stubbornly sour labor market. He also notes that consumers are “still burdened by the debt that they ran up during the housing bubble,” which, to my Hayek-schooled mind, sounds an awful lot like the drawn-out bust phase of a credit-fueled business cycle.

Rather than concluding that deficit spending and printing money are the wrong cures for what ails us, Krugman complains that government is not doing enough. Citing the tea-party Republicans’ “deficit obsession,” Krugman complains that government has been “pulling back [rather than] supporting the economy in its time of need.” He also cites lassitude at the Fed, claiming it’s been “intimidated by the Ron Paul types” into overreacting against potential inflation. Krugman argues the federal government should be doing much more, and its top priority should be creating jobs, not reducing the deficit.

While Krugman avoids the specifics of what such grandiose federal jobs programs would entail, he’s on the record supporting massive New Deal-style public-works spending, which would employ “armies of government workers.” Krugman also favors more monetary stimulus by the Fed to boost spending throughout the economy. In brief Krugman is saying we have not yet begun to fight the Keynesian battle of stimulus on either the monetary or fiscal fronts.

Let’s review the figures. Since September 2008 the Fed has more than tripled its balance sheet, printing roughly $2 trillion in new bank reserves, monetizing around $900 billion of U.S. government debt, and lending over $3 trillion to U.S. and foreign banks. As for federal spending—the real growth engine, in Krugman’s mind—it increased by 40 percent (29 percent in real terms) from 2007 to 2011 to a record $3.8 trillion, with half that increase coming in the recession year 2009 alone. “Stimulus” spending by itself has amounted to $666 billion so far, and federal bailouts have racked up at least $150 billion in taxpayer costs. Since 2007 gross public debt has increased from 64 to 103 percent of GDP.

And Krugman’s argument again? Government is not printing and spending enough. This fetish for unlimited spending juxtaposes strangely against a backdrop of perhaps the most fiscally profligate decade of American history, but I’ll give Krugman credit for boldness. However, the figures themselves, shocking as they are, mask the real question: Can more government spending actually encourage productive employment that promotes overall economic welfare?

Stimulus enthusiasts like Krugman are sure it can. And their first big task for the new labor armies is to go forth and fix America’s broken infrastructure. Haven’t you heard? America’s roads, bridges, sewers, airports, and more are in total disrepair—so says the infrastructure lobby. But these folks—an assortment of large construction, manufacturing, and transport companies, and their unions—have been carping about infrastructure being underfunded for the last 30 years. No surprise here: like any special-interest group, they want a continued and enlarged flow of federal funding. Hence my Public Choice nerves twitch at every mention of “crumbling infrastructure.”

But let’s concede that they’re right: that our infrastructure is in a sad state and more federal spending would be a wise investment. Using the infrastructure lobby’s figure of 18,000 new jobs for every $1 billion in government spending, doubling federal infrastructure spending would reduce the unemployment rate to 8.3 percent. And this ignores the matter of timing, as infrastructure projects require years of planning and regulatory hurdle-jumping before they’re “shovel-ready.” Nonetheless, even the most unrealistically generous assumptions about infrastructure spending indicate that if you want to get the economy back to full employment, it’s going to take a lot more than just public works.

But stepping back from labor army fantasies, there’s something absurd about using infrastructure “investment” as a jobs program. To the extent that federal funding of infrastructure is economically advisable, “good government” would require minimum expenditure (read: minimum employment), lest said public works turn into a black hole of rent-seeking—public spending to enrich private interests.

Infrastructure spending is not immune to the institutional inefficiencies that beset all government programs. But questioning the value and efficiency of public works is only half the matter. Call me a conservative stick in the mud, but the little question of how the government is going to pay for all this largess strikes me as relevant these days.

Krugman of course sees no problem here. He is on record favoring larger deficits, seeing historically low interest rates as a go-ahead for even more federal borrowing. Oddly enough, others in the economy, such as Standard & Poor’s, see a quite large problem with continuing government debt growth. It’s called insolvency: If you have too much debt and you can never pay it off, bad consequences ensue. (I wonder if Krugman would advise a family with $325,000 in credit card debt on an income of $50,000 a year to go ahead and open up a new credit card account simply because it came with a 0 percent teaser rate?) While Krugman, with his stale brand of vulgar Keynesianism, appears increasingly oblivious to it, other recent events have revealed in stark fashion what our real economic problem is—excessive government debt, a direct consequence of excessive government spending.

The fixation on ever-bigger government stimulus programs to “fix the economy” reveals the basic fallacy with Krugman and the Keynesians. They view “the economy” and “the government” as distinct entities—as if poor little Johnny Economy would be just fine if only rich, stingy old Uncle Sam would open up his wallet and give Johnny a job! The reality is that the economy is us—the government exists within the U.S. economy, not apart from it. To “support” the economy the government must take resources from the very same economy. This can only confer a net increase in productive activity if government bureaucrats and politicians a) are truly benevolent, suppressing their representation of private interests in favor of “the general welfare” and b) know better than individual entrepreneurs throughout the country how to wisely invest scarce resources.

Since the days of Hume and Smith, economists have rightfully heaped skepticism on such assumptions. Politicians and bureaucrats are neither angelic nor omniscient; simply increasing their ability to print and spend is not a formula for prosperity. The fact that the United States is currently suffering the lingering effects of a complex recession and government debt crisis does not change these lessons, but confirms them. To adapt a phrase from a president who understood this (even if he couldn’t quite enact it): In our present crisis government spending is not the solution to the problem; government spending is the problem.

In his State of the Union address earlier this year, President Obama spoke of the need for the federal government to help boost the economy by making “investments” in a wide variety of areas, including construction jobs, high-speed rail, education, biomedical research, “clean energy” technology, and even high-speed wireless Internet access. But this “investment” is just a code word for more spending on pet programs. This will only lead to more economic stagnation, not economic recovery, because the wealth-consuming nature of public investment is fundamentally different from the wealth-creating nature of private investment. Taxpayers ignore this difference at their peril.

President Obama’s form of investment promises to “create countless new jobs for our people,” but he does not stop to ask from where the money to pay for all these new jobs will come. It must be taken from others “of our people,” either today, through tax increases, or tomorrow, through borrowing (which will harm the economy in the future and delay the ultimate recovery). Of course, taking money from taxpayers to fund these new jobs means there is less money left in the private sector to invest in new jobs and business growth.

The crucial difference between the public sector and the private sector is that the public sector cannot create wealth; it can only shift resources from one group of people to another (after skimming some off the top to placate special-interest campaign donors and support bureaucratic inefficiency, of course). In the private sector, job growth—and economic growth generally—occurs when firms create something that consumers value. In the public sector, government growth occurs whenever government can appropriate more money from the people, and these funds are directed to whatever politicians desire.

The government’s “investment” in green energy startup Solyndra Inc. is a case in point. Last May, President Obama visited the Fremont, California-based solar panel maker in a highly publicized photo-op to hail it as the kind of business in which he thinks the country should invest. And that’s just what the government did. In September 2009 the administration announced that it was awarding Solyndra $535 million in taxpayer-funded loans to finance the construction of a new solar-equipment factory. The following June, just one month after the President’s visit, the company cancelled its initial public offering, and its CEO quit the following month. In November 2010 the company announced it was abandoning its plans to expand its Fremont facility (and the planned hiring of a thousand workers) and would even have to close another factory in the East Bay, eliminating nearly 200 additional workers. That’s some investment.

Throwing Good Money after Bad

This episode did not prevent Obama from visiting another green-energy company two days after delivering his State of the Union address to tout the benefits that surely would come from investing in such technology. During his trip to renewable-energy firm Orion Energy Systems in Manitowoc, Wisconsin, Obama lamented that the United States was falling behind the investment of even more centrally planned economies: “China’s making these investments and they have already captured a big chunk of the solar market, partly because we fell down on the job. We weren’t moving as fast as we should have. Those are jobs that could be created right here that are getting shipped overseas.” While China has made great strides toward a more open economy in the past couple decades, the communist country is hardly a model for economic policy. China’s growth is due to its economic liberalization, not the arbitrary decisions of the ruling elite, yet these command-and-control elements of economic planning that remain in China seem to be Obama’s model of the ideal. This does not bode well for economic liberty and growth here in the United States.

Government has never been particularly good at picking economic winners. Consider, for example, the government “investments” in Amtrak, which has never turned a profit since it began service in 1971 and has lost about $35 billion in its 40 years of operation—or the U.S. Postal Service, which lost a record $8.5 billion last year alone and has projected an additional $6.4 billion loss this year.

The reason for this failure of government investment is not simply poor leadership (although this is certainly endemic and does not help matters) but rather an inability to determine value in the public sector. There is no market price system in government, so there is no measure of profit and loss. As Mises noted in Human Action, “There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were.” In Bureaucracy he added, “Bureaucratic management is management of affairs which cannot be checked by economic calculation.”

Value

In a free market prices are determined by supply and demand, by changing consumer preferences, differing knowledge and evaluations of market information, and the risk-taking of entrepreneurs. A greater desire for a good or service will be reflected in consumers’ willingness to pay more for it and bid up the price.

In the political sphere “value”—such as how much to spend on a particular government program—is determined by the force and influence politicians, bureaucrats, and special interests can exert to extract money from taxpayers and divide it up as these elites please. There is rarely even any semblance of competition for the provision of these services and thus little incentive to maximize productivity and service quality or minimize costs. Since there are no price signals to reveal people’s preferences for one thing or another, there is no good mechanism to determine if programs are useful or satisfying constituent demands.

In the absence of a true market price mechanism, how do you tell if an investment is profitable? And where is the incentive to avoid unprofitable investments? If a government program is deemed successful, there are calls to provide more funding. If it is a failure, we are told we must double down on the spending in order to turn it into a successful program.

Private investment means putting your own money at risk in anticipation of realizing a gain later; public “investment” means taking and spending someone else’s money to support your idea of how you think they should live, or to satisfy the special interests that help get you reelected. Private investment requires putting off spending today so that you may (hopefully) earn more in the future; public “investment” is all about spending today.

Unfortunately, the federal government has not learned the lessons history has tried to teach us about subsidizing business and illusory job growth. This ignorance is especially on display when politicians react to the onset of a recession. The prescription made famous by economist John Maynard Keynes is to “stimulate” the economy through government spending and job creation (otherwise known as “make-work”). Never mind that this means fighting a problem of too much debt by incurring even more debt. As Freeman columnist Robert Higgs, senior fellow in political economy at the Independent Institute and author of Crisis and Leviathan, has said, “Every drunk understands this way of fighting depressions.”

Lost Decade

In the 1990s—and beyond, as it turned out—Japan faced a financial crisis as asset bubbles in the real estate and stock markets, stoked by the central bank’s expansionist monetary policy of the late 1980s, burst and prices came crashing down. The ensuing government response and policy errors paralyzed the economy and ultimately led to a series of economic recessions. Japan followed the Keynesian remedy—with disastrous results—and the country still has not recovered to this day. During the 1990s, Japan passed ten fiscal stimulus packages, focused largely on public works. When one construction plan did not work (meaning it did not return the economy to rapid growth), another was tried. Altogether the Japanese government spent about $6.3 trillion on construction-related projects between 1991 and 2008. Those plans did not revive the economy, but they did saddle the nation with a mountain of debt that postponed any recovery at all for many years, leading the period to be dubbed Japan’s “Lost Decade.”

The construction jobs for the government’s infrastructure projects were not sustainable and did not lead to systemic economic growth. Public debt skyrocketed, unemployment actually doubled, and the economy remained stagnant. (Does any of this sound familiar?) As Gavan McCormack, Pacific and Asian history professor at the Australian National University, noted in his book The Emptiness of Japanese Affluence, “The construction state is in some respects akin to the military-industrial complex in Cold War America (or the Soviet Union), sucking in the country’s wealth, consuming it inefficiently, growing like a cancer and bequeathing both fiscal crisis and environmental devastation.”

The Great Depression

Even during the Great Depression, often held up as a great example of government creating jobs to help get the nation out of an economic recession, President Roosevelt’s massive spending program, which actually had its roots in the Hoover administration, did not stimulate the economy. Despite all that spending and all those jobs programs, unemployment remained extremely high. Prior to the stock market crash in 1929, the unemployment rate stood at a little over 3 percent. By 1933, in the midst of massive spending and public-works projects, it had risen to 25 percent. Even after years of New Deal programs unemployment remained around 15 percent or higher through 1940. It was not until World War II that unemployment dropped back to the low single digits (and then only because millions were drafted into military service).

This led Henry Morgenthau, treasury secretary under Roosevelt, to make a startling admission in 1939:

We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. . . . I say after eight years of this administration we have just as much unemployment as when we started. . . . And an enormous debt to boot! (Morgenthau Diary, Roosevelt Presidential Library)

The fact is that economic recessions—and even more serious depressions—need not be so severe or so long-lived. It is government policies that prevent the natural pressures and incentives of the market from purging bad investments and other economic decisions and returning to a path of stable growth. As Murray Rothbard wrote in the introduction to the third edition of his book, America’s Great Depression,

Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce [Herbert] Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough; by the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived. When the stock market crash arrived in October, 1929, Herbert Hoover, now the president, intervened so rapidly and so massively that the market-adjustment process was paralyzed, and the Hoover-Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire—a strict policy of non-intervention by the government—is the only course that can assure a rapid recovery in any depression crisis.

After more than two and a half years and trillions of dollars worth of bank and auto industry bailouts, stimulus packages, and Federal Reserve interventions, the American economy remains sluggish and unemployment is still about 9 percent. According to Federal Reserve Chairman Ben Bernanke, it could take another four or five years for the labor market to “normalize fully.” Unless the government’s interventionist policies are abandoned and reversed, it appears that the United States is headed for its own Lost Decade.

The United States’ $14 trillion federal debt and annual deficits of over $1 trillion are reducing productivity and hindering economic growth. It is time we learned the repeated lessons of the past that government spending, particularly when used to try to stimulate an economy, is simply a bad investment.

How an Economy Grows and Why It Crashes is Peter Schiff’s most recent effort in that regard. Bypassing the academic crowd and avoiding an eye-glazing academic approach, Schiff and his brother Andrew have tried to grab readers’ attention with an amalgam of allegorical storytelling and current events. They aim to promote real economic comprehension.

The book’s introduction starts with a lucid explication of the key elements of Keynesian economics—showing how John Maynard Keynes, by making “something simple seem hopelessly complex,” paved the way for acceptance of “some very stupid ideas about what makes economies grow.” In chapter 1 the authors shift into allegorical mode, weaving a tale about a Crusoe-type economy based on fishing. Here they introduce the reader to the rudiments of capital theory. The story progresses logically from there. The use of capital leads to both greater wealth and income inequality. Then comes a cogent discussion of the counterproductive effects of forced income redistribution.

Next they turn to the role of saving—how it serves as the source of credit and a cushion permitting people to get through emergencies and how, contra Keynes, it is the true key to economic growth. In addition the authors correct the common misinterpretation of deflation—not as the disaster depicted by Ben Bernanke and his ilk, but as a key channel through which prosperity spreads. They proceed to describe the benefits of free trade, dissecting the canard that it is a job-killer and pointing out that “it is not the aim of an economy to simply provide jobs, but to create jobs that maximize labor productivity.”

Notable in their discussion of government is an endorsement of restricting voting to those who pay taxes, an idea going back at least to John Stuart Mill. They argue that retreat from this stipulation accelerates a nation’s downward trajectory into an inflationary welfare state. The Schiffs elucidate the unaccounted-for implications of the many popular policies dragging economies down this path. Included among those are the replacement of a commodity standard with fiat money, subsidization of loans to politically favored sectors of the economy, and so-called “stimulus” spending—all central elements of Keynesian monetary and fiscal policy.

They finish their allegory with the inevitable upshot of those policies (given the lack of political will to incur the short-term pain that would stave it off): the decision of our international creditors to cease enabling our profligate ways by redeeming our dollars, unleashing massive price increases, and pushing our standard of living off a cliff.

It’s well argued, but I wonder if the book is written at the right level for its intended audience. It is clearly not aimed at academics, which is too bad because many of them could use it the most. Rather it is aimed at noneconomists. Yet for the totally uninitiated I fear that it may throw too much at them too fast, without sufficient explanation. One can only hope they will be interested enough to seek the requisite explanations from other sources rather than throwing up their hands in frustration.

Also, I found the pervasive fish metaphor tiresome—not to mention that fish are too perishable to ever be used as a monetary commodity. (On p. 159 the Schiff brothers do mention the advantages of precious metals as money.) While I realize this is an allegory in which some literary license is permitted, the cost of this aspect of the story in reader confusion and lack of credibility may be high.

On the other hand I do like the way each allegorical chapter is followed by a takeaway that uses the principles presented to shed light on real-world events. Knowing that the authors of this book wrote it to share the economic insights that enabled them to predict the onset of our current recession, I hope my misgivings are unfounded because the lessons are ones all of us need to master.

Regardless of how political actors in the 1960s might have sought to exploit economic analysis to gain a plausible public-interest rationale for their proposed programs, the most prominent body of economic analysis in those days—the sort taught by the leading lights at Harvard, Yale, Berkeley, and the other great universities—virtually cried out to be exploited in this way. During the mid-1960s the so-called Neoclassical Synthesis achieved its greatest hold on the economics profession.

This term “synthesis” refers to the combination of a microeconomic part, which contains the theory of individual markets that had been developed over the preceding two centuries, and a macroeconomic part, which contains the ideas about national economic aggregates advanced by John Maynard Keynes in his landmark 1936 book The General Theory of Employment, Interest, and Money and further developed by Keynes’s followers during the three decades after the book’s publication.

On the microeconomic side, the Neoclassical Synthesis incorporated the so-called New Welfare Economics that had been developed during the 1930s, 1940s, and 1950s. In this form microeconomic theory advanced a general-equilibrium theory of the economy’s various markets, identified the conditions for the attainment of equilibrium in this idealized system, and demonstrated that various “problems”—springing from external effects, collective goods, less-than-perfect information, and less-than-perfect competition, among other conditions—would cause the system to settle in a state of overall inefficiency: The value of total output would fall short of the maximum that would have resulted from systemic efficiency, given the economy’s available resources of labor and capital and its existing technology.

Attainment of such an inefficient state was characterized as a “market failure,” and economists expended enormous effort alleging the existence of such market failures in real-world markets and in proposing means (mainly taxes, subsidies, and regulations) by which the government might, in theory at least, remedy these failures and thus maximize “social welfare.”

Had economic theorists rested content with using the microeconomics of the Neoclassical Synthesis strictly as a conceptual device employed in abstract reasoning, it might have done little damage. However, as I have already suggested, this type of theory cried out for application—which, in practice, was nearly always misapplication. The idealized conditions required for theoretical general-equilibrium efficiency could not possibly obtain in the real world; yet the economists readily endorsed government measures aimed at coercively pounding the real world into conformity with these impossible theoretical conditions.

Closely examined, such efforts represented a form of madness. As the great economist James Buchanan has observed, the economists’ obsession with general equilibrium gives rise to “the most sophisticated fallacy in [neoclassical] economic theory, the notion that because certain relationships hold in equilibrium the forced interferences designed to implement these relationships will, in fact, be desirable.”

Great Society measures such as the Elementary and Secondary Education Act (1965), the Higher Education Act (1965), the Motor Vehicle Safety Act (1966), and the Truth in Lending Act (1968), as well as many of the consumer-protection and environmental-protection laws and regulations, found ready endorsement among contemporary neoclassical economists, who viewed them as proper means for the correction of purported market failures.

The assumptions that underlay these economic interpretations and applications, however, could be sustained only by wishful thinking. Economists presumed to know where general equilibrium lay, or at least to know the direction in which the quantities of various inputs and outputs should be changed in order to approach general-equilibrium efficiency more closely. But neoclassical economists cannot move the earth with a mathematical lever because they have no place to stand—no “given” information about (presumably fixed) property rights, consumer preferences, resource availabilities, and technical possibilities. What neoclassical economics takes as given is, in reality, revealed only by competitive processes.

If the microeconomic side of the Neoclassical Synthesis fostered government measures to remedy a variety of putative market failures, its macroeconomic side endorsed government measures to remedy the greatest alleged market failure of all—the economy’s overall instability and its recurrent failure to bring about a condition known as “full employment.”

The supposition that mass unemployment constitutes or reflects a market failure came easily to economists who had reached maturity during the Great Depression. By the early 1950s Keynesian ideas had entrenched themselves among the leading lights of the mainstream economics profession. Since then, some species of Keynesianism has been either in the professional saddle or clamoring to get there.

In the 1960s few economists disputed this general framework of analysis. Even critics such as Milton Friedman accepted it, arguing only that certain second-order aspects of the model differed from what the Keynesians assumed.

Few macroeconomists looked to monetary-policy changes as important means of pushing an economy out of what they viewed as a mass-unemployment equilibrium. For the typical macroeconomist of those days, fiscal policy—changes in government spending, taxing, and borrowing—held the key to keeping the economy on a steady growth path. By employing these instruments policymakers could effectively select from a menu of inversely related rates of inflation and unemployment, a tradeoff schedule known as the stable Phillips Curve. As if to certify the completeness of Keynesianism’s conquest, in December 1965 Time magazine put an image of Keynes on its cover and featured a long, laudatory article titled, “We Are All Keynesians Now.”

The Great Society programs, whether for microeconomic remedy of alleged market failures or for macroeconomic fine-tuning, had an important element in common: the presumption that technocrats possessed the knowledge and the capacity to identify what needed to be done, to design appropriate remedial measures, and to implement those measures successfully. In short, the Great Society amounted to social engineering—or worse, to sheer, groping social experimentation—on a grand scale. People ought not to have been surprised when its attainments failed to match its pretensions.

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.

This massive money injection is supposed to work as follows: buying up Treasury bonds will make their prices rise, and their yields—hence long term interest rates in general—fall. (Recall that previous monetary stimulus has already pushed short-term rates close to zero.) Lower interest rates mean investment capital will be even cheaper than it already is, pushing idle investment money “off the sidelines” and into productive, labor-demanding business activity. And because all the fresh money starts its life as bank reserves, banks will be in a position to extend new loans six ways from Sunday.

Keynesians insist that this kind of massive stimulus is the only weapon the monetary authorities have left in their struggle to cure unemployment. This is a short-term fix, mind you; all economists realize that printing money does not call new goods or services into existence, and not even Keynes himself would tell you that straight-up money printing is a recipe for long-term prosperity. But can printing money induce entrepreneurs to expand output? Can it make unemployed resources suddenly employable? The answer depends on why those resources became unemployed—“underutilized” in Fedspeak—in the first place. This is precisely the question that Austrian economists are asking: What exactly went wrong in the economy such that so many resources are now not being utilized? By addressing this crucial question, only the Austrian perspective can adequately dissect the very concept of “underutilization” and offer a coherent critique of this mad-hatter monetary stimulus.

Let’s deconstruct this notion of resource “underutilization.” Resources are only resources to the extent that they have value, or usefulness, to somebody. Resources, properly speaking, are components of a broader plan of entrepreneurial action that brings more and better goods into existence, which people can use to improve their lives. Not all things are resources—things that can’t be used to enhance life aren’t resources, just objects; things that used to be resources but are now worn out, obsolete, or otherwise have lost their usefulness aren’t resources. They’re just junk.

Context matters when we’re talking about resources. The mere fact that a good was produced at some point and sold for some price does not mean it is still as valuable as originally anticipated. For example, if I took the trouble to fatten 100 steers in hopes of selling 50 tons of beef, only to later discover that everyone has become a vegetarian in the meantime, the beef I produced, economically speaking, would not be a resource. Nor would the beef-producing equipment, tools, and knowledge I invested in have the same value to me once I found out the true state of people’s dietary preferences. While some cattle-raising equipment could be converted to other uses, much of it—like the squeeze chute used for medicating and branding cattle—was highly specific to beef production and would be worth no more than its scrap-metal value in a world where nobody wanted to consume beef. My plan to be a cattleman turned out a big mistake entailing a loss on investment. Losing investments mean economic waste has occurred—to some degree, resources have been turned into junk.

This example may be ridiculous, but is it really that far-fetched? It is highly unlikely that people’s preferences would change so drastically or that entrepreneurs would be so clueless at forecasting market trends. But a strong enough outside influence might induce enough entrepreneurs into misreading the true state of the market such that they become overoptimistic and invest too much. If, for instance, politicians were dedicated to stimulating the beef industry and promoting beef consumption, and built policy on policy to that purpose over the decades—a labyrinthine mixture of subsidies, tax breaks, and cheap credit—they just might generate an investment boom in beef production. The boom, however, would be destined to end as soon as the policy changed or, more likely, the oversaturation of the market became evident.

At this point, with declining beef prices and (now-apparent) excess capacity in beef production, market forces would oust marginal producers from the industry and induce even the large, established operators to scale back production. As for the now “underutilized” resources, it would take some time and a lot of extra work to melt down those excess squeeze chutes, to convert cattle pasture into other crops, and for the reluctant surplus cowboys to eventually accept city jobs mopping floors, answering phones, ringing up sales, and so on.

The value of capital—both capital equipment, or physical capital, and people’s knowledge, experience, and training, or human capital—is critically dependent on how well it can fit into the structure of actual consumer demands and the structure of existing complementary capital (both physical and human). It is precisely this kind of interconnectedness among different kinds of resources that mainstream economists tend to disregard. Yet the extent of economic losses revealed by the recent financial crisis and recession is making the malinvestment (waste) of resources hard to ignore. Even at the Fed, some people show signs of understanding the relevance of the structure of capital resources, as opposed to sheer quantities or supposed dollar values. As Naranya Kocherlakota, president of the Minneapolis Fed, recently stated: “[T]he Fed does not have a means to transform construction workers into manufacturing workers. . . . Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.”

In other words, no amount of money-printing will change the real relationship of any particular object to its economic context. But the term “mismatch” implies mistakes have been made—entrepreneurial error—and raises the question: What went wrong to cause such massive mistakes in the first place? Again, Austrian capital theory provides the answer: The Fed itself, with its cheap money, along with a host of government “affordable housing” policies, severely overstimulated the housing construction market in the years of the boom.

Entrepreneurs always have many options for how to employ their time, labor, and capital. During the housing boom the amazing increase in home prices relative to construction costs made projects like new home construction and even flipping condos seem an obvious profit opportunity. Following the price signals, people expanded their investments appropriately: Young entrepreneurs learned about real estate and construction management, and new workers learned construction trades; building companies were started and existing companies expanded, purchasing more new equipment like nail guns, Skilsaws, and pickup trucks; upstream suppliers similarly expanded investment in things like cement plants, timber plantations, sawmills, and the like.

Regardless of whether these workers and entrepreneurs were cognizant of the temporary, cheap credit- and subsidy-induced nature of the boom, the lure of high prices and high profits proved irresistible. In retrospect it is easy to see how the Fed’s cheap money policy, along with a host of government subsidies to homebuyers and lenders, set the stage for an unsustainable boom—a boom that did not match well the actual, long-term consumer demand and for which the credit that financed it was not fully funded by actual savings. (For an excellent explanation of the government’s role in the housing boom and bust, see Peter Boettke and Steven Horwitz’s FEE publication “The House That Uncle Sam Built” [PDF]). Nonetheless, the slew of political interventions into the housing market led these entrepreneurs on for years before the inevitable market correction occurred. The net result was that too much investment capital went into home building, and not enough into other economic activities—a mistake of grand proportions.

The housing bust revealed that many of the capital investments of the boom period—from concrete trucks on up to skilled construction tradesmen—were actually malinvestments whose value turned out to be less (in some cases much less) than anticipated. The capital resources created to build houses are, to varying degrees, ill-suited to other tasks. They will necessarily be underutilized relative to the boom era, precisely because they have lost value (usefulness) in light of the new economic reality. Indeed, economic reality in the bust indicates that many of these resources will have to find other ways to be productive, as attested by the overbuilt housing market. (According to National Association of Realtors figures, there were between 1.02 and 1.77 million “excess” homes as of September. Supply was converted into excess units on the basis of six-to-eight months’ supply representing “normal” conditions.)

But this adjustment takes time, and the more specialized the resource, the longer the wait. Some excess concrete trucks can be sent overseas or converted to other industrial uses, but many will simply sit, awaiting the next boom or the scrap heap. Indeed, in some cases, when a particular resource loses its usefulness, leaving it idle can be its optimal “use.” Likewise, the surplus low-skilled construction laborers can perhaps get jobs washing dishes, but skilled tradesmen, engineers, and jobsite managers must retrain to find different jobs that match their boom-era earnings. Not surprisingly, some choose to wait (and take unemployment benefits) rather than risk retraining. For those who have thrown in the towel on a construction career, retraining and reemployment can take years. No amount of money-printing can change this reality.

Political efforts to “stimulate” economic activity will necessarily alter the capital structure of the economy. Government-based stimulus for industry Z necessarily detracts from what the market would have provided industries A through Y. Even a nonspecific stimulus, if such a thing is possible, will only stimulate the investment fad du jour; there is no such thing as neutral government policy. The key policy implication of Austrian capital theory is that any attempt to stimulate the economy will, by spurring malinvestment, doom some resources to superfluousness. From a statistical standpoint this may look like underutilization; from an economic standpoint, however, it’s simply the waste that results from too many investment plans gone bad. Attempting to undo the waste by further stimulus will only exacerbate the problem: more stimulus, more malinvestment, more wasted resources.

So what should the wise and munificent monetary central planners do? Ironically, the optimal monetary policy is not to have one, but to let the competitive market process function for money and credit the way it does for countless other goods. If we must have central banking, the ideal policy is simply this: First do no harm.

Yet some data and sound theory, which take into account more than simple macroeconomic aggregates—higher GDP good, lower GDP bad—indicate that the U.S. economy has not fully recovered. The official unemployment rate is still over 9 percent, private long-term investment remains at low levels, and even GDP growth has been weak, in spite of the great increase in government spending for final goods and services (which adds directly to GDP, defined as consumption plus investment plus government spending plus net exports).

The weak recovery is clearly recognized by policy-makers, who have advocated and implemented additional fiscal and monetary stimulus by the Obama administration and perhaps the Federal Reserve. They seem to take for granted that an unexpectedly slow recovery requires even more expansionary government policies to keep the economy on track.

The slow recovery from the recession presents an analytical challenge, provoking debate among macroeconomists and pundits. As usual, there are many diverse explanations, some complementary, some contradictory. To an important extent these divergences reflect different conceptions of the business cycle. I will describe and briefly analyze four of the most common explanations.

The Keynesian Story

Let us start with the Keynesian story, filtered through the writings of Paul Krugman. (There are much more nuanced versions of Keynesianism than Krugman’s.) In his weekly column and popular blog at the New York Times, Krugman declares that the slow recovery and the persistence of high unemployment arise from a “lack of aggregate demand,” which is the main cause of the poor sales by private businesses and hence of the high unemployment rate.

In his characteristic self-confident argumentative style, Krugman asserts, “Businesses aren’t hiring because of poor sales, period, end of story.” This sentence is followed by a graph showing a substantial increase since late 2008 in the percentage of small businesses that named “poor sales” as their “single most important problem.” The remedy for this malaise is, of course, more public spending: “[T]he best thing government could do to help business would be to spend more, increasing demand.”

However, as many economists have written in recent years, Krugman’s focus on aggregate demand is simplistic, to say the least. First, one needs to ask, why is the growth of aggregate demand so weak? It may very well be that spending less and saving more is a healthy reaction to the previous unsustainable boom. Thus weak demand might be an inevitable consequence, not the deep cause, of the current bust.

Furthermore, what particular parts of the economy—which markets or industries—suffer most from low sales? As Austrian economists argue, we need to disaggregate the macroeconomic picture to understand what is going on. Nevertheless, such disaggregated analysis does not seem to be important for some Keynesians, such as Krugman and Brad DeLong. In November 2009, DeLong wrote, “At this point, anything that boosts the government’s deficit over the next two years passes the benefit-cost test—anything at all.”

The Monetarist Story

The monetarist story of Milton Friedman’s followers is usually presented as the free-market alternative to the Keynesian interpretation. However, these explanations have important though subtle points in common.

In simple terms the monetarist thesis focuses mainly on sudden bank credit contraction. Monetarists argue that the accumulation of vast amounts of excess reserves by banks—which basically means that instead of lending money to the private sector, they are keeping it to themselves—has negative effects for the whole economy. Given that credit is usually considered the economic equivalent to the human body’s blood circulation, a credit contraction is seen as invariably dangerous. If a person suffers a sudden loss of blood, the cure would be to inject blood into him. The same cure applies to credit, the monetarists claim.

Economists from this perspective usually refer to how the velocity of money—the average frequency with which a unit of money is spent in a specific period—collapsed in the second half of 2008. To compensate for this reduction, monetarists recommend an expansionary monetary policy by the central bank.

Although one might think that Fed Chairman Ben Bernanke’s strategy has been to respond precisely in this way, some economists, such as Scott Sumner, argue otherwise. Sumner claims the Fed’s monetary policy since the end of 2008 has actually been contractionary relative to what the economy needed at that time. Bernanke should have been more aggressive, Sumner argues, to avoid the contraction of nominal GDP that finally occurred.

This explanation suffers from several problems, similar to the shortcomings of the Keynesian story: (1) excessive aggregation of key concepts—making extensive use of GDP as the key indicator of the cycle does not allow the monetarists to explain the crux of the matter, which is the real microeconomic distortions in the productive structure of the economy that had been created during the boom; (2) the analysis of the crisis and the sharp credit contraction as exogenous shocks, rather than consequences of the previous unsustainable credit expansion. From Sumner’s point of view, it seems that the fall in nominal GDP was something to be avoided.

The Austrian Story: The Adjustment Problem

For economists drawing on the Austrian story, GDP contraction was a symptom of the bust, the inevitable hangover after a credit spree that led to bad decisions—malinvestments and excessive leverage. As the Austrian business cycle theory emphasizes, the economy has to go through a process of adjustment that cleanses the massive errors resulting from economic decisions taken in the past. This restructuring involves not only reallocating factors of production (capital and labor), but also reducing debt a significant amount (deleveraging), which has contractionary effects on demand and aggregate economic activity.

This consideration leads to the first element of the best explanation for the prolongation of the recession: the fact that the necessary adjustment process has not been completed. As a recent report by the Bank for International Settlements (BIS) concludes, the debt reduction of private economic agents still has a long way to go. But as the Spanish economist J. R. Rallo argues, keeping interest rates extremely low for a prolonged period, as the Federal Reserve has, creates incentives for people not to reduce debt and adjust to the new circumstances. Moreover, government “stimulus” policies may have made things worse by massively increasing federal government debt.

Furthermore, the necessary reallocation of the factors of production—both intersectoral (from sectors overexpanded during the bubble to sectors that will yield higher profits in the future) and intrasectoral (among different products and services in the same sector) may take a long time, especially in the labor markets. Apart from the fact that the adjustment in relative prices and wages may take longer than desirable because of rigidities, there are additional issues worth considering.

Research on markets with search frictions—which won Peter Diamond, Dale Mortensen, and Christopher Pissarides the 2010 Nobel prize in economics—may fit in this context. For several decades mainstream neoclassical economists have depicted the market as a mechanism that perfectly and instantaneously coordinates supply and demand. The Nobel laureates, however, have emphasized that economic agents often have to spend time and resources in making that adjustment (search frictions). Moreover, finding satisfactory employment for people who have just lost jobs may require the acquisition of substantially different skills and capabilities. The features of this process depend on the degree of specificity and complexity of the economy’s capital structure. Thus not only physical capital but also human capital has to go through an adjustment process. All this takes time.

Regime Uncertainty

The second main piece of the puzzle of the recession’s duration is the “regime uncertainty” argument formulated by Robert Higgs. He first elaborated this concept to explain why the Great Depression lasted so long, finding that the Roosevelt administration, with its constant attacks (in rhetoric and in policies) on the free-enterprise system and its threats to private property, was largely responsible for the failure of long-term private investment to recover fully until World War II ended.

Not surprisingly, in a series of commentaries since 2008, Higgs has found parallels in the Obama administration’s actions and in the stagnant private investment that help to explain why sustained economic recovery has not yet taken place.

Higgs points to several particular causes: the surge in the federal deficit and debt; the likely introduction of new taxes to finance the recent massive public spending, or changes in existing tax rules; the potential burdens on businesses brought about by environmental and energy regulations; and the still uncertain real effects of Obamacare and the new financial regulatory framework.

Problems related to the adjustment process, along with the existence of regime uncertainty, might form a relatively complete explanation of why the U.S. economy is still suffering from the Great Recession, complementing the analysis expressed in the Mises/Hayek business cycle theory.

The importance of this debate, and how current economic events are interpreted, can hardly be exaggerated. As economist Mario Rizzo has noted, the resolution of this puzzle “will affect economics and public perceptions for a long time to come,” just as the debate between Hayek and Keynes in the 1930s had profound (and unfortunate) consequences for the future of the economics discipline. Let us hope that the outcome will be different this time.

Specifically, Krugman defends the claim that World War II got us out of the Great Depression, because “this is a situation in which virtue becomes vice and prudence is folly; what we need above all is for someone to spend more, even if the spending isn’t particularly wise.” Even spending on something destructive like war, he argues, is what is needed to solve the problem, especially when the “political consensus for [domestic] spending on a sufficient scale” is not available. In Krugman’s version of Orwell’s Newspeak, destruction creates wealth, and war, though not ideal, is morally acceptable because it produces economic growth.

Thankfully, we can get behind his Newspeak to see the fallacy of his economics. To believe that spending—any kind of spending—is the cure for what ails us is to ignore the subjective nature of wealth and the microeconomic basis of economic growth in favor of an absolute reification of economic aggregates such as GDP and unemployment. Spending trillions of dollars fighting a war can certainly bring idle capital and labor into employment, driving up GDP and lowering unemployment. But this does not mean we are any wealthier than before.

Wealth increases when people are able to engage in exchanges they believe will be mutually beneficial. The production of new goods that consumers wish to purchase is the beginning of this process. When instead we borrow from future generations to spend on goods and services connected not to the desires of consumers, but rather to the desire of the politically powerful to rain death and destruction on other parts of the world, we are not allowing individuals the freedom to do the things they think will make themselves better off. And we are certainly not extending that freedom to those killed in the name of our economy-enhancing war. At a very basic level, the idea that any kind of spending is desirable overlooks the fact that spending on war (and, I would argue, public works as well) actively prevents people from enhancing their wealth through production and exchange linked to consumer demand.

Employing people to dig holes and fill them up again, or to build bombs that will blow up Iraqis, will certainly reduce unemployment and increase GDP, but it won’t increase wealth. The problem of economics is the problem of coordinating producers and consumers. This coordination happens when we produce what consumers want using the least valuable resources possible. That is why it is wealth-enhancing to dig a canal using earth-movers with a few drivers rather than millions of people using spoons, even though the latter would generate more jobs.

Sending soldiers off to war is a waste of human and material resources, and is almost by definition wealth-destroying, no matter what it does to GDP or unemployment rates. The only way one can view economics amorally, as Krugman wishes to, is if one is only concerned with total GDP and not its composition. However, it is the composition of GDP, in the sense of how well what we’ve produced matches consumer wants, that ultimately matters for human well-being. It’s easy to create jobs and generate spending, but those do not constitute economic growth, and they are not necessarily indicators of human betterment.

So yes, Professor Krugman, it does matter how we try to get ourselves out of depressions. The world is not upside down and vices aren’t virtues. War isn’t peace and destruction isn’t creation. The real solution to digging out of a recession is to remove the barriers to the free exchange and production that actually comprise wealth creation. Borrowing trillions more from our grandchildren to spend on building the equivalent of pyramids or on blowing up innocents abroad only digs the hole deeper. And when one is reduced, as Krugman is, to saying we “needed Hitler and Hirohito” to get us out of that hole in the 1930s, one has abandoned morality to worship at the altar of economic aggregates.

No critic of free-market economics can ever again accuse us of being irrational and immoral when it is Paul Krugman who says destruction creates wealth, and war is an acceptable second-best path to economic growth. Don’t let Krugman’s Newspeak fool you: War and destruction are exactly what they appear to be. To argue as Krugman does is to abandon both economics and morality. Big Brother would be proud.

In October Barack Obama said this in defense of his opposition to extending the 2001 and 2003 tax-rate reductions for people making more than $200,000 a year. The government guesses that not extending them—that is, raising taxes—would bring in $700 billion over a decade.

Let’s break the statement down.

If we were going to spend $700 billion . . . The “we” isn’t you and I. It’s him and his army of bureaucrats. There is no collective decision made by the nation. A group of identifiable individuals, backed by armed personnel, will decide how those resources will be used. How did they get those resources?

Imagine a mugger eyeing a potential victim, thinking, “I could spend that guy’s money by leaving it in his pocket, or I could spend it myself right away. Now which would be the better way to spend it?”

Anyone can see what’s wrong. But change the context to government, and all the rules are thought to change. Why? Because the government represents us? But it doesn’t really. The people who run the government say it represents us, but they don’t know what they’re saying. True, they can be voted out of office by a majority. But no individuals can opt out. So while the politicians are in office, they represent only themselves and their patrons.

. . . it seems it would be wiser having that $700 billion going to folks . . . Does it now? On what grounds are we to conclude that Barack Obama—or anyone else in political office—is qualified to say what a wiser use of such a sum of money would be? It’s hard enough deciding what’s a wise use of one’s own meager resources. The future is uncertain and the choices are many. It is the height of hubris—a pretense of knowledge, to use Hayek’s phrase—to invoke wisdom while asserting the power to dispose of that money.

. . . who would spend that money right away. There you go. He has a good reason after all. He says the money will go to people who will spend it in a hurry. Of course, he doesn’t actually know that. The money would just be distributed across the budget, funding the same old boondoggles or starting some new ones. Part of that $700 billion would surely go to military contractors to make something irrelevant to Americans’ welfare and inimical to the welfare of some non-Americans. We don’t know how quickly those recipients would spend the money. The wealthy executives of the contracting companies may be the same people who would have held on to the money if the tax-rate reductions were extended. A lot of it will go to government employees, who have higher wages than people in the private sector. This is one of those talking points that sounds as though it makes sense until you . . . think about it.

But let’s assume the people who get the money would spend it right away. Why is that better than simply letting the people who make the money keep it? The theory is that people making over $200,000 a year don’t spend enough of their incomes to stimulate the economy. So it’s Keynesianism that Obama is espousing here. The economy’s in a ditch. Consumer spending would get it out, but consumers are afraid to spend, so the government must spend for them.

But Keynesianism gets it wrong on so many counts. The fundamental economic problem is not that aggregate demand is too low. Individuals are doing things—and not doing things—for particular reasons in response to what’s going on around them. Consumers are holding back because they’ve lost their jobs or fear they may do so. People are losing their jobs because a government-produced inflationary boom went bust and malinvestments need to be liquidated so resources can be realigned with consumer demand. But that’s not happening (fast enough) because unpredictability over what the government may do next and other factors make entrepreneurs and investors cautious.

Once the reasons are understood, the remedy becomes clear. The burdens of government must be lifted quickly and people must be confident they will stay lifted.

* * *

Congress created the Privacy and Civil Liberties Oversight Board to assure the people their freedom is safe. Was it just a device to lull people into believing their freedom is safe? James Bovard says that’s closer to the truth.

Patents and copyrights can do some serious damage to genuine property rights and innovation. But they can also yield some funny stories. David Levine has a few.

New diseases are being invented (not discovered) all the time. They are the product of collusion among the medical profession, the pharmaceutical industry, and the government—not a combination to inspire confidence, writes Wendy McElroy.

Vested interests are powerful political forces, but not as powerful as ideas. Isaac Morehouse explains.

America’s attempt to prohibit the manufacture and sale of alcoholic beverages was a failure on so many levels that it was called off after little more than a decade. Douglas Rogers examines those years via the latest scholarship on Prohibition.

Insider trading sounds like a terrible crime that strikes at the very foundation of the economy. Warren Gibson says it’s more like much ado about nothing.

Wilhelm Röpke was at the first meeting of the Mont Pelerin Society with Ludwig von Mises, F. A. Hayek, Milton Friedman, and Leonard Read. For many years his book A Humane Economy was recommended reading for libertarians. Yet he had some differences with American free-market advocates—differences interesting enough to get the attention of Joseph Stromberg.

As our columnists were saying . . . Donald Boudreaux shows that tariffs did not create America’s nineteenth-century economic growth. Burton Folsom tells the story of a boat-building entrepreneur. John Stossel points to early cracks in Obamacare. Walter Williams says people express preferences among human differences all the time. And Steven Horwitz, reading Paul Krugman’s assertion that war can stimulate an economy, proclaims, “It Just Ain’t So!”

This issue’s book reviewers dissect tomes on the Constitution, revisionist history, socialism, and the New Deal.