How a stubborn misreading of classical economists -- combined with a hyper-partisan Republican Party -- haunts the U.S. economy
The story of where we are is a story of the destructive ideas that guided us here. Bad ideas about how capitalism works--ideas that fail to describe how economies actually function--have combined with conservative politics to promote policies that stifle growth, redistribute what growth there is upward, skew our fiscal outlook, and handcuff our policy process.
We are like travelers who have followed a road map to a destination that promised bliss but instead delivered stagnation and joblessness to many and political dysfunction to all. The economic geography behind that roadmap is a misreading of the original mapmakers--the founders of free markets--which eventually morphed into the deeply damaging belief that markets never fail and always self-correct; and therefore, government actions can only distort otherwise self-correcting markets.
Adam Smith and J.S. Mill never held this view. Of course it's true that Smith's brilliant insight was that unfettered price signals coordinate individuals' actions in markets in ways that deliver optimal outcomes. But he and later thinkers never let that distract them from the fact that, left to their own devices, markets would underinvest in public goods, pollute the environment, and generate unacceptably high levels of inequality and poverty. While there are contemporary macroeconomists that still teach their students that market bubbles are impossible, these early thinkers were intimately familiar with credit bubbles and did not for a second believe financial markets could self-regulate. (John Cassidy's book, When Markets Fail, is essential reading on these points.)
Hyper-rational economics promoted by hyper-partisan lobbyists is squeezing the middle class
Yet some of our top university professors, winners of Nobel prizes, and central bankers who are the subjects of adoring books, still preach the hyper-efficiency of self-correcting markets. They demonize the actions of policy makers who try to intervene to help offset demand contractions (as in the Recovery Act), impose regulatory structure on key markets (financial regulatory reform), strengthen social insurance (health care reform), invest in public goods (infrastructure spending), or pursue industrial policies to better position our national economy (President Obama's clean energy agenda).
The intellectual actions of these extreme free marketeers do not take place in a vacuum. They interact with a political structure comprised of lobbies and pseudo think-tanks to promote policies that, while wrapped in the cloak of promoting free markets, ultimately serve to redistribute growth to the top of the wealth scale. "Efficient market hypotheses" and "rational expectations"--the idea that absent government interference, market participants will make optimally efficient decisions--leads directly to supply-side tax cuts, deregulation of financial markets, the formation of financial bubbles, the acceptance of income stagnation, and disinvestment in public goods. And these measures, in turn, have delivered levels of income and wealth inequality not seen since the late 1920s, along with policy handcuffs that today have us arguing about how to reduce, rather than strengthen, regulations.