April 8, 2016

A Keynesian, Libertarian Government

Finally... we have arrived at the actual answer to the question: what does government look like under the combination of libertarian moral principles and Keynesian economic analysis?

To summarize the theoretical foundation for this question:
  • Libertarianism implies a minimal government, focused entirely on the protection of life, liberty and property. It is the government that Robert Nozick refers to as "minimal", distinguishing it from the ultra-minimal state in that the minimal state also has a monopoly on the use of force. 
  • Keynesianism implies a government that has one and only one role in the economy, namely to address and minimize macroeconomic - or fundamental - uncertainty. 
In order to build any political theory on the role of government, we need both a theory of political philosophy and an economic theory.

These two do not necessarily align, especially if we demand empirical validity of our economic theory, but that is not really a problem. Theories of political philosophy are prescriptive in nature and therefore do not necessarily have empirical validity; it is not the prime directive of political philosophy to describe reality as it is.

Economic theory is different. Its first and foremost role is to describe and analyze the real world in such a way that we - the users of that theory - can then prescribe economic policies. The purpose of those policies will be to maximize general prosperity and individual opportunity, and to give government whatever role is necessary within the context of that purpose.

As mentioned, political philosophy and economic theory do not necessarily align in terms of what government they prescribe. This becomes apparent when trying to unify libertarianism and Keynesianism under one umbrella.

So why choose these two theories in the first place? Because taken individually they are the best of their kind: libertarianism prescribes a maximum of individual freedom; Keynesianism conditions the organization of our society - and, on a more daily basis, economic policy - based on the most realistic perception of reality.

Libertarianism, again, minimizes government to what colloquially has been known as the "night watchman state". Specifically, it has one and only one assignment: to protect life, liberty and property, all of which are linked together as life is given meaning through the liberty to pursue happiness, and the right to the proceeds of one's pursuit of happiness is unabridged.

This is the "sanctity triangle" within which the individual cannot be violated. Government cannot engage in any activity that violates any part of it, e.g., the property right. At no point can the individual be forced to give his time, his capital or any other of his property to another citizen. In other words, income redistribution is prohibited.

Keynesianism demands a larger government. However, it is worth pointing out right here, right now that this "larger" government does not have anything to do with the kind of welfare state or frivolous spending that is often associated with Keynes and his economic theory. Those are add-ons, tagged on to his theory by socialists who use a skewed version of Keynesian economics to validate their own political views.

It is also worth pointing out here that a libertarian government fits within a Keynesian government; without solid protection of life, liberty and property there can be no ordered economic activity in any society. It is the government beyond that purpose that causes a conflict between libertarianism and Keynesianism.

That government is the one that takes the economy out of depressions and, perhaps, provides appropriate measures to help it avoid sliding into a depression in the first place. This government is not involved in the everyday activities of the economy, but intervenes with discretion as a force of last resort.

An economy gets stuck in a depression because no agent of the private sector wants to take the lead and pull the economy out of its misery. Uncertainty is so pervasive that the only rational decision at the individual level is to try to save oneself for the future. This means minimizing one's actions and maximizing one's savings, entirely according to the principle that "he who hesitates is saved to make a decision another day". Yet the collective outcome of their rational individual decisions is to everyone's detriment: disastrously low levels of consumer spending and business investment are coupled with destructively high levels of unemployment.

To break this vicious circle, government does not need to launch its own spending programs. That is where both libertarians and socialists have (purposely?) misinterpreted Keynes. Instead, it is a sufficient condition for a successful government that it puts a cap on risk taking.

Even in the depth of a depression, there are private entrepreneurs who are willing to test new ideas and pursue what they see as opportunities. In order to do so, though, they need access to financing, which they will not get through private financial institutions. The risk associated with lending for the purposes of new business ventures is simply too large.

Here is where government can step in. A sufficient condition for government to successfully turn around a depression is that they cap the risk that private entrepreneurs have to expose themselves to. This transformation of the risk environment comes in two steps:

1. The business willing to try a new idea needs to be able to borrow at a reasonable interest rate, or else it will not even have a remote chance of turning a risky idea into a profitable project. Therefore, they need a capped interest rate on the funds they can borrow.
2. A cap on the interest rate is directly counter-productive to lenders in times of depression. For this reason, they need to minimize the capital they themselves put to risk in the face of the depression.

Government's role in this would be the following:

a) To provide investment capital replacing the private lender's own capital. Government would put up funds for lending to businesses that can present ideas with reasonable chance of success.
b) The supply of these government funds would not come from taxpayers (for reasons explained below) but from citizens who buy small "depression bonds". These bonds, in turn, are issued by government precisely to raise funds for the purpose described under item (a).
c) The obvious question at this point is: how does government guarantee that its depression-bond funds are not used irresponsibly by pie-in-the-sky business endeavors? The answer is simple: the private lenders who did not want to lend any of their own capital become the suppliers of these loans. On behalf of government they make reasonable assessments of the potential success of business projects, then lend the "depression bond funds" adding a regulated, limited mark-up for their own participation.

The big question, of course, is what happens when businesses fail to pay back their loans under this model. Even if the risk environment has been transformed, and decisions on funding and investment are made as if the economy was in a regular recession rather than a deep depression, businesses are going to default on their loans. If we move back through the chain from the debtor to the buyer of the depression bond, the ultimate loser here is the average household that just wanted a small but safe return on their precious savings until the economy returned to growth again.

Here is where Keynesian economic theory really parts with libertarianism. Yet in order to be able to get the economy out of the crippling grip of fundamental uncertainty, government will have to take measures to protect buyers of the depression bonds. Technically, in order to guarantee the savings that go into a depression bond, government would have to guarantee a buy-back at a certain point of time. This guarantee would also secure a low but safe interest on the bond.

But the really tricky question is how government is going to fund its bond buyback when the money has been loaned out to someone who went bankrupt. Government can either use future tax revenue, or monetize the buyback by borrowing money from the Federal Reserve. Of these two options, the monetization would be the least intrusive alternative upfront, though at some point government is going to have to reduce its debt to the central bank as well.

This is far from a picture-perfect program for government intervention into a depression-stricken economy. It is doubtful that it would have any strong national effects on the economy. However, as a program for local businesses it could very well work, and in that capacity it could prove to be a catalyst for a recovery built from the ground up.

There is not a lot of research on what policies actually work in pulling an economy out of a recession. We know more about what does not work, such as the massive public-works programs during the Franklin D Roosevelt administration, or the harsh austerity policies in the Scandinavian countries in the late 1980s and early 1990s - not to mention Greece during the Great Recession. However, this should not refrain economists from studying the issue in greater detail. Especially the experiences from the Great Recession show that old ideas of how to deal with depressions simply do not work. 

No comments:

Post a Comment