With the rise of social media (especially Twitter), it has becomes easier to observe changes in the zeitgeist. Over the past few years, I’ve seen the following trends:
1. Claims that increases in the minimum wage do not have negative side effects.
2. Claims that we don’t have to worry about big budget deficits when the interest rate is low.
3. Claims that changes in the money supply don’t impact inflation.
4. Claims that neoliberalism no longer works, and that we need an industrial policy.
In each case, trendy pundits rejected long established economic principles. And now the chickens are coming home to roost.
1. In a recent post, Kevin Corcoran discussed a study by Seth Hill, which found that minimum wage increases led to more homelessness. Can we be certain that this study is correct? Clearly not; social science has a replication crisis. But that’s equally true of studies claiming that the minimum wage did not reduce employment. Other studies by highly respected researchers found that the minimum wage does reduce employment. In my view, all of these studies miss an important point. The worst effect of wage, price and rent controls is that they make society more cruel. With rent control, landlords have an incentive to be mean to tenants. With minimum wage laws, bosses have an incentive to become jerks. Anyone who ever visited a communist country quickly discovers that “customer service” abysmal. (I was married in a communist country.) I have enough problems; please don’t make our society even more annoying.
2. I have some sympathy for those who suggested that we didn’t need to worry about budget deficits when interest rates were low. At the time, I argued against this view on the basis that interest rates might rise in the future. But even I did not expect rates to rise as sharply as they have over the past few years. Now we are discovering that debts incurred at a very low interest cost in the late 2010s and early 2020s must be rolled over at a much higher rate. Yes, it is true that we never actually pay off the national debt. But we do pay off individual Treasury securities, and refinance this debt at current market rates.
The other reason I have some sympathy for those who discounted the danger of budget deficits is that there had been so much “crying wolf” over previous decades. Throughout almost my entire life, I’ve heard the budget deficit called a ticking time bomb. And yet for the most part the national debt remained relatively low as a share of GDP. Something changed in the late 2010s, when the US went from being a responsible nation to something akin to a banana republic. There were no more “grownups in the room” to scold Congress when reckless fiscal policies were adopted. The budget deficit doubled during an economic boom, a period where it would normally be falling as a share of GDP. These policies (spend more and tax less) proved popular with the general public and were maintained (and even extended) when a new administration took power in 2021. And now the wolf is here, we really do have a debt problem. Unlike during the Reagan years, this really is unsustainable:
Future generations will face some very unpleasant choices due to the irresponsible behavior of the Federal government over the past 6 years. I would not wish to be elected president in 2024.
3. The money supply is not an ideal indicator of the stance of monetary policy. Velocity can change over time. But many pundits drew the wrong inference from those facts, completely discounting the importance of monetary policy. Now we are seeing the high inflation from the reckless decisions made by the Federal Reserve back in 2021 and 2022, which led to a surge in the money supply. And don’t be fooled by the recent drop in the headline inflation rate—the problem is far from over. It would not surprise me to see headline inflation begin moving higher again.
Inflation and excessive borrowing share one common feature—the longer we wait to address the problem, the more painful the cure.
4. After the 2008 financial crisis, neoliberalism seemed to go out of style. Perhaps people just got bored with it. “You say it was the biggest ever reduction in world poverty seen, by far? Yawn, what have you done for me lately?” The US, Europe and China all began moving in a more statist direction. Pundits assured us that we needed to copy China’s industrial policy, least we fall behind that nation of 1.4 billion people. (Left unsaid is why the US should copy a nation that has a per capita GDP roughly equal to that of Mexico.)
Now we are being told that China’s economic model is sputtering. And the recent so-called Inflation Reduction Act is creating a set of grotesque distortions and inefficiencies. Even worse, the massive subsidies will also boost the national debt, forcing future tax increases that will further slow economic growth. Statist policies are like a time bomb; the most pronounced negative effects occur down the road.
But what about global warming? Didn’t something need to be done? Here it’s worth noting that the approach most favored by economists (a carbon tax) would have actually reduced our budget deficit. That would have been the logical approach. Instead we went with a set of open ended subsidies that boosted the budget deficit. Even worse, we favored local producers over imports, even if imported goods could address global warming more effectively. We were told that global warming was such a big problem that we could no longer rely on a free market economy, but then implemented mercantilist policies that prioritized subsidizing domestic special interest groups over addressing global warming.
Apparently global warming was merely a pretext for industrial policies that were being implemented for other reasons. The same is true of industrial polices aimed at competition with China. If we were serious about this issue, we’d bring thousands of Taiwanese and Chinese engineers to America to help us rebuild our chip industry. Instead, these projects are floundering due to a lack of skilled labor. Trump and Biden have an instinctual preference for mercantilism—China and global warming are handy excuses to exercise those preferences.
To summarize, stay away from trendy economic fads. The eternal verities never change:
1. Price controls are bad (whether on wages, prices rents or interest rates.)
2. Large budget deficits are bad, even if interest rates are low at the time.
3. Persistent inflation is always and everywhere a monetary phenomenon.
4. Free market economies do better than statist economies. Emulate Denmark, not Argentina.
PS. Veronique de Rugy discusses the Foxconn fiasco in Wisconsin, a previous attempt at industrial policy that occurred during the Trump administration. Hope springs eternal.
