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Brooks Wilson's Economics Blog: Barro on Economic Recovery: Market or Government Led?

Tuesday, April 6, 2010

Barro on Economic Recovery: Market or Government Led?

Markets trump government in the ability to create wealth and prosperity through individual liberty and responsibility.  That is the reason that nearly all economist strongly support reliance on markets for the provision of goods and services.  It is ironic that many who profess a desire to see our nation rely more on market and less on government ordering of resource allocation do not fully understand the vitality of markets.  True the unemployment rate has stagnated at 9.7% as the recession is ending but rather than taut the ability of markets to adapt, they instead focus on problems government policies have caused and argue that the economy will not recover.

The economy will recover because of market adaptation.  Entrepreneurs will find profitable opportunities.  Investment will increase.  Unemployment will eventually fall and full employment will be reached.  Market led growth is not the question.  The question is did the Troubled Asset Relief Program (the bailout), the American Recovery and Reinvestment Act (the stimulus), health care reform, and other measures helped or hindered the recovery?

Robert Barro, one of the nation's best macroeconomists, provides some insights gleaned from studying how policy impacted economic recovery and growth during the Great Depression and WWII in "The Lessons of the Great Depression" published by FiveBooks

The first histories, often written by New Dealers, summarize the Great Depression as starting with the market crash that was greeted by a hands laissez-faire guided inspired policies of the Hoover administration, and ending with the transformation of the economy by the Roosevelt administration.  A variation of this history is that Roosevelt's fiscal policy was sound but too small and that the large deficits created by WWII finally lifted us out of the Great Depression.  Is a sound economy as simple as active fiscal policy?
Barro offers a different view.
It’s clear that a lot of the policies that were put into place were negative, but as to sorting out how important they were, that’s a much more challenging question. And I think Roosevelt at the time recognized ex-post that some of the things he tried were failures and then his attitude was, “OK, it’s a failure. I’ll stop doing it.” Which is actually pretty positive.

For example, some of the things he did was try to organize labour unions and also businesses essentially promoting monopoly – I don’t think that was a plus. He was trying really hard to keep wages and prices from falling with direct influence and that was a negative. The effect of the expenditure programs is less clear. In the mid-1930s with the New Deal there was an unusual amount of infrastructure-type of expenditures. But it’s not actually big enough to sort out in a statistical sense – to figure out how much it mattered in terms of the recovery after the trough in 1932-33. I don’t think we know that that was a mistake, but it’s not clear that it was all that important.
He notes that war expenditures were large enough to be statistically measurable. 
I don’t think you can reliably say what the effect is. But conceptually you’d expect the wartime spending to have a bigger effect for various reasons on the GDP than the equivalent amount of expenditure in a non-war situation. And the wartime effect you can estimate pretty precisely, and the multiplier is clearly less than one, even in World War Two – it’s in the order of 0.6, 0.7, something like that.
Barro does not believe that the stimulus was good policy.
I think the stimulus package was very stupid; it was awful. It’s just a tremendous waste of money and it’s going to cause some trouble in terms of a bigger public debt; it’s just wasting resources. But the more important thing is the financial system, and the housing related aspects. So on that, despite a lot of floundering around, mostly I think what they were doing is in the right direction. I think they made a big mistake by not bailing out Lehman Brothers – I think they recognized that two days later. That was Paulson’s individual fault and responsibility from what I can gather.

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