The Bear’s Lair: The decline of good economics

William Hogarth - Gin Lane

There are many reasons why the Industrial Revolution happened in Britain in 1775-1850, but among the most important is the quality of economic thought among British policymakers of that period. Adam Smith, Thomas Malthus and David Ricardo gave them an excellent grounding in free market economics, and few statesmen of that period opposed their doctrines. Alas, over the last two centuries the quality of economic discourse has steadily declined. Spurious economic theories have appeared, and statesmen seem determined to avoid the correct ones.

The deterioration in economic discourse is intellectually very odd. It is as if physicists had moved from quantum mechanics to Newton’s gravitation to the Ptolemaic theory of epicycles. Like modern economics, the Ptolemaic epicycle theory was highly complex — God forbade the ellipse and the sun went around the Earth, so planets moved in circles centered on other circles. The theory would indeed have lent itself very nicely to modelling on a modern supercomputer. Also like modern economics however, the Ptolemaic theory was wrong. Unlike physics, chemistry and other sciences, economics appears to have proceeded from truth to error; it is not really clear why.

William Pitt the younger, Charles Jenkinson, first Earl of Liverpool and his son Robert Banks Jenkinson, second Earl of Liverpool were the statesmen primarily responsible for Britain’s Industrial Revolution (or at least in power when it happened) and they all had a sound and substantial grasp of classical economics. Pitt held several seminars for Adam Smith himself to instruct Pitt and the other younger Cabinet members on economic theory, while Jenkinson had read Smith when it was published and then became Britain’s foremost expert on trade and currency through eighteen years as President of the Board of Trade.

The second Earl of Liverpool read Smith as a teenager and was educated thoroughly by his father, then guided the country successfully through the most economically difficult years of war spending and post-war depression and returned Britain to the Gold Standard, before overseeing a gigantic economic boom, with taxes on income low and much revenue raised through “sumptuary” excise taxes on luxuries. Finally, in the last years of his Prime Ministership, he anticipated the Austrian economists by forecasting a crash resulting from over-speculation, then reorganized the British banking system to guard against it happening again.

It wasn’t just the government. Bankers and industrialists of that era were also educated in the basics of free market economics and conducted their businesses accordingly. The Industrial Revolution depended on the scientific advances of the seventeenth century, to be sure, and on Britain’s advantages of cheap coal and expensive, skilled labor, but above all it rested on the “commercial” nature of the business class and even of property-owners and on the knowledge of basic economic principles spread throughout the society by 1820.

The first deviation from economic good sense among British policymakers was their move after 1846 to a policy of unilateral free trade. Free trade itself had been pioneered by Liverpool, based on principles enunciated by Smith and Ricardo, but he never contemplated leaving British agriculture vulnerable to competition from the rolling plains of the U.S. Midwest, let alone subjecting British industry to depredation by protected foreign competitors. After 1846, blinkered Whig statesmen eliminated first the Corn Laws and then British tariffs, keeping free trade even as other countries turned protectionist after 1860.

The Bessemer steel process, for example, was invented in Britain, expounded in Cheltenham in 1856, but by the end of the century British steelmakers were uncompetitive against U.S., producers, who were enabled to expand by their vast protected domestic market and to compete against British producers devoid of protection in British Empire markets such as Canada and Britain itself. The result was a gradual erosion of Britain’s competitive position, eventually worsened by two world wars, but avoidable entirely had better economic policies been followed.

In the early 20th century, two world wars expanded government while the malign influence of Maynard Keynes degraded economic policymaking. Government spending had expanded to 34% of GDP in 1813, but the wise statesmen of the post-war period had returned to the Gold Standard and made heroic efforts to cut spending back. After World War I however, even though the debt level was still much lower in terms of GDP than in 1815-20, no such effort to cut back government was made, and ever greater shares of the economy were thereby condemned to unproductive activities.

Keynes’ influence was malign in two other ways beyond encouraging government sloppiness. First, he popularized the idea that the Gold Standard was an “outdated relic” so condemning us to a century of perpetual inflation and unstable money. Second, he popularized the habit of governments running budget deficits, which allowed politicians to promise actuarially unsustainable social benefits and in recent years have grown completely out of control. In the 1980s, it appeared that Keynes’ influence was at last waning, but alas, the last twenty years have seen a resurgence in his indiscipline, especially on budgetary matters.

Even worse than Keynes, and approximately contemporaneous with him, was the belief, popularized by the British Labour party and the U.S. Progressives, that a larger government could own and control large segments of the economy, as well as simply steering and affecting it. The apotheosis of this belief came with the 1945-51 Attlee government in Britain, which nationalized large sectors of the productive economy as well as creating the ubiquitous National Health Service. As a result of this theory, vast sectors of bloated inefficiency were spread across the economy; they were cut back somewhat by Margaret Thatcher and her contemporaries, but since 2000 their advance has resumed, with the United States, for so long the last bastion against socialism, now seeming likely to fall to it.

Until the last decade, it appeared that the degradation of economic literacy among policymakers had bottomed out. Then came the financial crisis of 2008, and an appalling new error: what is now known as modern monetary theory. Under this nonsense, it is impossible for a state to go bust (shades of Citibank CEO Walter Wriston in the 1970s) because its central bank can simply finance its spending by printing money. Indeed, under extreme versions of MMT there would be no need for any taxation at all; the entire budget deficit could be put on the central bank’s credit card. MMT then waves its hands when it comes to the inflationary effects of all this, and on its unfortunate effects on savers, the downtrodden of the Keynesian world, when their purchasing power is deliberately eroded in this way.

Needless to say, MMT is setting us up for an immense financial crash, as overinflated asset prices return to Earth and governments discover that their debt capacity is not infinite. It is essentially the same mistake John Law made in 1718-20 and the French Revolutionaries made with their assignats in the 1790s; statesmen of Liverpool’s generation knew only too well the doom to which it led.

Then finally, among a plethora of new bad ideas there is Rep. Alexandria Ocasio-Cortez (D.-NY)’s idea of a Green New Deal. This new Congresswoman may well represent the Democrat Party of the future; because of her flair for publicity her ideas certainly open Overton Windows on the left. Under a Green New Deal, the use of all carbon fuels would be abolished within a 12-year period; the government would spend whatever was necessary to accomplish this.

With Ocasio-Cortez we are come full circle; her ideas would unwind the key breakthroughs that brought us the Industrial Revolution. Instead of fossil fuels we would go back to naturally occurring wind and air – and you can bet, a fair amount of human and possibly equine muscle. This would recreate the old days, all right, but with a global population of close to 9 billion in 2030 it would if globally adopted lack the capacity to feed us. Our living standards, also, would be those of 1730, and not the pleasant Augustan bits of 1730, but the squalid Hogarthian ones.

The development of statesmen’s economic ideas over the last 200 years is indeed remarkable. If time ran backwards, we could rejoice in the amazing enlightenment and intellectual progress that over that period had caused such dark clouds of economic ignorance and error to roll away and be replaced with an era of rationality and sound economic management. Alas, time runs forwards.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)