Business Insider

PETER R. CRABB: It's time for U.S. to give free markets a chance

It may never be enough. The Federal Reserve is keeping the banking system fresh with cash. The federal government and many state governments continue to run budget deficits, spending much more than they receive in tax revenue. But some economists are still looking for more stimulus spending.

Nobel prize-winning economist Paul Krugman says the American Recovery and Reinvestment Act of 2009 was too small, and we need to do more. In a blog post this fall, Krugman argued that the reinvestment act amounted to only 1.6 percent of gross domestic product, and its effect was short-lived. According to this view, we didn’t do much, and we should do a lot more if we want the economy to grow.

The idea that governments can speed up economic growth through increased spending began in earnest with the New Deal of the Roosevelt administration in the 1930s. At the time, the theories of John Maynard Keynes were coming into vogue, but the so-called “Keynesian Economics” program was never fully implemented or tested.

As an economic program, Keynesianism is incomplete. Keynes proposed that governments run budget surpluses throughout periods of positive economic growth. The federal government has run a surplus only 12 times since 1930.

For this reason and others, there has yet to be a full test of the Keynes theory and thus an understanding of the Keynesian multiplier — the theoretical measure of the change in overall economic demand from a change in fiscal policy. Economist Robert Barro of Harvard has shown that if this theoretical multiplier actually exists, it could be less than one. That is, government stimulus spending loses money. Using data from the World War II period to now, Barro found only 80 cents of economic output for every additional dollar of government spending.

Despite such counter evidence, government spending has been on the rise in the U.S. and other developed countries for some time now. At the same time, the economic growth rate of the world is declining.

Government expenditures in wealthy countries as a percentage of national income declined between 1995 and 2006 while the world economy grew at more than 5 percent a year. This trend reversed in 2007, and now the world economy is expected to grow at only 3.6 percent in 2014, according to the International Monetary Fund.

With so little evidence for Keynesian economics, why not give the free market a chance? It hasn’t been tried in nearly 100 years. We live in a mixed-capitalist system that for at least a century has not seen how well free markets can work.

The U.S. government has tremendous influence on conditions in key areas such as the financial markets and international trade. Two accepted arguments for why a bad recession became a depression in the 1930s are that the Federal Reserve restricted bank cash and the government raised tariff barriers.

The Fed is doing the opposite today when it comes to the banking system, but not so for the federal government and trade policy. To show global economic leadership, the U.S. could reduce restrictions on trade and/or the international movement of labor.

We don’t need the additional spending and market intervention Krugman and others call for today. Let’s give free markets a chance.