Tuesday, February 20, 2018

Financial historian discusses economic downturn

JOHN MURPHY ’15

CONTRIBUTING WRITER

On Monday October 15th, Trinity College hosted leading financial and business history author John Steele Gordon. Gordon spoke as part of the Shelby Cullom Davis Endowment Series, and discussed the origins of the recent economic downturn.

 Gordon, whose great-grandfather was a member of the class of 1828, is an expert in financial and business history. He has had articles published in, among others, Forbes, Forbes ASAP, Worth, the New York Times and The Wall Street Journal Op-Ed pages, the Washington Post’s Book World and Outlook. Since 1989, he has been a contributing editor at American Heritage, where he has written the “Business of America” column. He has appeared on numerous other radio and television shows, including New York: A Documentary Film by Rick Burns, Business Center and Squawk Box on CNBC, and The News Hour with Jim Lehrer on PBS. Gordon was educated at The Millbrook School in Millbrook, New York and has a bachelor of arts in history from Vanderbilt University. After college he worked for six years as a production editor for Harper & Row (now HarperCollins) before leaving to drive a Land Rover from New York to Tierra Del Fuego- a nine-month journey of thirty-nine thousand miles and approximately forty flat tires. This trek resulted in his first book, Overlanding. All together Gordon has driven through forty-seven countries on five continents. At Trinity, he discussed how the financial crisis happened due to “a failure on the part of economists to understand their subject.”

 

Gordon’s argument focused on the fact that economists have been using the wrong paradigm for the last two centuries, often with disastrous consequences. First, Gordon contends that the economy is not a machine or a ‘Copernican universe,’ to use Keynes’s phrase, but rather an ecosystem. Second, human nature, one of the natural and therefore ineluctable forces in the human universe, has largely been ignored by economists, who have been unable to translate human nature and its profound consequences into equations.

 

Gordon criticized three major flaws in Keynesian economic theory.

 

First, Keynes viewed the economic universe as economists have always viewed it, as a machine. This ‘Copernican universe’ is a system by which all of the elements of the economic universe are kept in their places by mutual counterpoise and interaction. According to Gordon, Keynes’ model has dominated economic thought for a while, despite the fact that it has proved to be inadequate and often quite useless in predicting events in the real world. The reasoning Gordon provides is that the economy is not a machine that cycles endlessly, but rather something that is dynamic and nonlinear. Gordon argues a far better model for an economy is the ecosystem of modern biology, where each part influences and changes every other part. He reasons that ecosystems do not cycle, but in fact evolve in inherently unpredictable ways. Gordon debunks the economy as a machine paradigm, as taxes, spending, or monetary policy will have a given and predictable result. He uses the analogy of how putting pressure on a gas pedal will always makes a car move faster, and that the additional speed is proportional to the additional pressure. But the basic parts of an economy are often unpredictable and are always self-interested human beings, not bits of machinery mindlessly obeying the laws of physics.

 

The second fatal flaw in the Keynesian system is that timely and reliable information on the state of the economy is essential for politicians to make correct policy decisions. Gordon talks about how final figures of even basic statistics such as GDP come out three years after the period they measure. Preliminary economic data are available in a few weeks, but they are highly unreliable and frequently revised in the ensuing months and years. Gordon further argues that the way people perceive the economic universe is unreliable. For example, the CPI (Consumer Price Index) may well overstate real inflation by as much as a full percentage point. The CPI serves as the marker when adjusting wages, pensions, and social security benefits. Gordon argues that guiding a modern dynamic economy the way Keynes envisioned is essentially like trying to fly an airplane on instruments when the instruments tell the pilot at best what the situation was an hour earlier, and may be giving the pilot false data.

 

The third flaw in Keynes’ theory lies in human nature itself. Gordon says that Keynes completely ignored the element of human nature and the force of its power in the real world. For the Keynesian system to function, Gordon says it must be applied dispassionately. Taxes must be cut and spending must increase in poor economic times. In strong economic times, however, taxes must be increased and spending must be cut. Gordon suggests that these ideas may work in the despotism of Platonic myth, but not in a democracy like the United States. Spending programs always create powerful political pressures to maintain and expand them, while opposition to them is diffused among the rest of the population who must pay for them. Tax increases, are always politically unpopular, especially if they are designed to raise money from a broad segment of the population. The result, of course, is the ever-increasing deficit since the publication of The General Theory in 1936. Gordon stressed that human nature predisposes us to recognize depression easily and quickly, but prosperity, like happiness, is most easily seen in retrospect. Gordon described the situation in the 1980s, which, today is recognized as a period of prosperity in the United States. It was a time where the GNP (Gross National Product) rose by 35 percent in real terms and an economy the size of Germany was added to the one the U.S. already had. However, the media at the time reported on stories about farmers losing their land, the big-three auto companies of Detroit were taken to the cleaners by Japan, and the first stock market crash in nearly sixty years.

 

In an economy as vast as the United States, recession will always affect one region of the country or one sector of the economy, even if the overall U.S. economy is healthy.

 

According to Gordon, the central flaw of Keynesian theory is the promise of a world without depression. Economists flocked to this school of thought and within a decade of the publication of Keynes’ The General Theory, it was the overwhelmingly dominant school of economic thought throughout the profession. Gordon, the fiscal conservative, believes Keynesian theory, once thought to be the best and most highly functioning form of economics, may very well move aside in the future for a different school of economics.

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