Tuesday, January 22, 2008

President Diocletian

Chad the Elder of Fraters Libertas notes that the Democrats
"are trying to out-demagogue each other on the horrible state of the economy and how the only answer to our woes is government, government, and yes MORE government."


"Most of the Republican candidates aren't much better. From the populism of Huckabee to the corporatism of Romney, there's not a lot for a free marketeer to get excited about."

Chad goes on to note that fiscal stimulus plans borrow from Smith to pay Jones, and from Jones's grand-children to pay Jones. The greatest generation has saddled the baby boomers with dismal Social Security benefits, and the baby boomers have saddled generation Y with enormous federal debt, dollar depreciation, unfunded retiree health insurance and even worse Social Security benefits.

Chad notes that

"An indiscriminate spurt in "aggregate demand" is essentially irrelevant to longer-term economic problems"


"Given the weakness of the dollar and some other frightening signs that we're already slumping towards a Seventies style era of stagflation, a rate cut by the Fed is not what I would prefer from a policy perspective. But as someone who's been trying to sell a house in a soft market and hopefully purchase another one soon, lower interest rates sound pretty damn appealing right now."

Chad's blog is good, but only intimates the worst long term risk to the economy in the last paragraph. According to the prisoner's dilemma, people have trouble colluding to maximize their well being. Rather, they minimize their maximum loss.

In the prisoner's dilemma, the cops have caught two crooks. They are interrogated separately, just like on Law and Order or The Wire. If neither talks, they both get three years. If either talks, one gets 4 years and the other gets 0 years. If both talk, they both get two years. Game theorists argue that they will both talk because the talking strategy dominates the non-talking one. I have played a simulation game called The Oil Pricing Exercise with my conflict and negotiation classes at NYU and Brooklyn College for the past eight years. I have done it close to thirty times, and the vast majority, ninety percent, indeed arrive at a suboptimal solution (I doubt more than 10% arrive at jointly profit-maximizing approach) even though sub-optimal (which game theorists argue is most rational for each individual but not most rational for society as a whole) means a lower grade.

The economy is a prisoner's dilemma. If we all collude and respect free markets, in the long run we will all be better off. There will be more innovation and a more productive economy, so we will be wealthier on average. If special interests or well meaning progressive-liberals interfere with the economy, wealth is shifted from its most productive uses, and the long run effect is that we are all poorer, although a few may be richer than they would have been in a free market (hence the much-observed income inequality). Given the incentives for special interests to extract favors from the government, and politicians' interest in short-term solutions that benefit today's "prisoners" at the expense of their children, free markets are at a political disadvantage in a free economy, even though in the long run they would make everyone better off. One of the bitterest flaws of Herbert Croly's and the Progressives' ideas (not to mention socialists, fascists, etc.) is that they did not realize that by freeing the public will from the restraint of limited government, in the long run society will become poorer and income inequality will increase. We are seeing the inevitable process before our eyes. The solutions that the Republicans and Democrats offer will make us poorer over time. We are leaving our great grandchildren a more modest living standard than could have been.

Chad's post illustrates this. His need to sell his house means that he has a vested interest in inflation, i.e., in reduced interest rates. In the long term, the inflation will harm those who do not own homes and who do not get salary raises. Chad knows this, but the money is too sweet to resist.

If you generalize this across the economy, and into areas of the economy like hedge funds or Wall Street where $100 or $200 thousand represents a restaurant bill, the motives for lobbying for lower interest rates are profound. There is no recession. Instead, Wall Street has paid its executives high salaries for years while it has destroyed economic value. Non-productive industries lobby for lower interest rates at the expense of the productive sectors of the economy.

Stronger moral education and better education about free markets would considerably help. It would probably take several decades to wring out the inefficiencies in the American economy and replace our lazy, speculative mentality with one based on initiative, productivity and thrift.

I fear that we are on a downward spiral and much will have to happen before America turns itself around. If ever. Rome didn't turn around after Diocletian's "government, government and more government" solutions*. It lasted another 100years.

*Diocletian believed that going forward under the current system of Roman Imperial government was unsustainable. He initiated a number of reforms to prevent a return to the disorder of previous generations and maintain the viability of the Empire. These included splitting the Empire into two in order to be more manageable, creating a new system of Imperial succession, ruling as an autocrat and stripping away any remaining fa├žade of republicanism, and economic reforms aimed at the problem of hyperinflation..."

"...Further, in 301, Diocletian attempted to curb the rampant inflation with his Edict on Maximum Prices. This edict fixed prices for over a thousand goods, fixed wages, and threatened the death penalty to merchants who overcharged. Instead of curbing inflation, the edict's price controls drove goods onto the black market and created shortages. In some areas, the edict was simply ignored, and it was soon withdrawn in failure."

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