26 March 2012

Hysteresis


More grim ruminations on our economic prospects: What if recessions do permanent damage, diminishing a nation’s productive capacity?
As I wrote on Thursday, recessions are commonly understood as disruptive rather than destructive to the economy as a whole. But a paper presented Friday at the Brookings Institution warns that recessions may do lasting harm, like an untended house that not only needs a good dusting, but has also started to rot.
The term for this possibility sounds perfectly harsh: hysteresis. (The definition is more benign; it simply means that the past affects the present.)
The proper antidote to hysteresis, the authors write, is an increase in government spending. They write that under current conditions there is a good chance such spending would be self-financing, as tax revenues from resulting economic activity would outweigh the cost. But there is little prospect that Congressional Republicans will revisit their opposition to stimulus this year. Which means that our current experiment will run to completion: If hysteresis is real, we will know it by its consequences.

Of course past actions and behaviors affect the present, often negatively. But there are, just as often, positive consequences, as well as neutral consequences.  This is how economic tradeoffs work, in the long run, at a macro level. The call for government intervention, though, does not follow from the premise.
In the first place, harm cannot be determined until after the fact, and harm is a subjective value (though it should be noted that it can be an objective term).  Production capacity is not, in and of itself, a worthy end goal, particularly if higher production is inefficient relative to its alternatives.  Furthermore, no economic occurrence is inherently harmful; it is only ever harmful to some party.  What one party finds harmful another may find beneficial, and so Bastiat’s lesson of the broken window ignored once again.

In the second place, government intervention is not guaranteed to solve the problem.  It would seem that the history of government intervention would show, on the whole, that most forms of intervention are net-negative, often benefitting a politically-connected, generally at the expense of the masses.  While the technocratic solution to various economic problems can hypothetically be both correct and possible, in practice government intervention is generally more skewed to incentive distortion and political corruption, to use a phrase, the theory doesn’t jive with the real world.

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