The Ghost of Economics Past

What would the world's economics Nobel Prize laureates make of Barack
Obama's response to the financial crisis?

BY THOMAS KARIER | OCTOBER 8, 2010

By all accounts, President Barack Obama and his party may be in big trouble.
The Nov. 2 U.S. congressional elections, judging by the latest polls, are shaping
up to be a pointed response to the Democrats' stewardship of the economy.
More precisely, they are a referendum on Obama and his predecessor's big
economic bets, grounded in 70-odd years of economic theory: the bailout of
the financial system and auto companies, the economic stimulus package,
regulations reining in Wall Street, and George W. Bush's tax cuts for the
wealthiest Americans.

With Goldman Sachs predicting that the economy is going to be "fairly bad"
or "very bad" over the next few months, Obama could probably use a little
smart advice. So now that Peter Diamond, Dale Mortensen, and Christopher
Pissarides have been named the winners of the 42nd Nobel Prize in economics,
let's take a look at what previous Nobel laureates have contributed to our
understanding of the current economic crisis -- and what they might have
made of the solutions that have been attempted or proposed so far.
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One question arising out of the recent economic turmoil is whether the bailout
of the country's largest banks and automobile manufacturers was prudent.
From one side of the debate, we hear that the bailouts were an unnecessary
expansion of government into the private sector. No doubt Friedrich Hayek
(1974 Nobel laureate) would agree and warn us that bailouts violate the
principle of private enterprise, threatening to put the country on a dangerous
path toward socialism. The Tea Party would have found a kindred spirit in
Hayek -- and indeed, its more erudite members refer to him often.

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James Buchanan (1986) offers a less philosophical case against the bailouts.
The government, he would argue, is populated by self-interested bureaucrats
who always put themselves first -- how can such self-promoting officials
objectively choose which banks to bail out and which to abandon? Will they
base their decisions on the public good or on their own private interest?

On the other hand, Paul Samuelson (1970) would likely have pointed out the
similarities between the current situation and the banking crisis of 1933, when
the government had to shore up the financial system long enough to allow the
private sector time to recover. Letting one bank fail may make sense on a
microeconomic level but letting many large banks fail can be catastrophic on a
macroeconomic level. The failure of one large bank can bring down another in
a cascading effect that can create chaos in the financial sector.

Even a successful bailout, however, may create problems in the long run if
banks start to believe that the government will bail them out in the future. As a
consequence, these banks may be more likely to make risky investments, a
concept described by Kenneth Arrow (1972) and Joseph Stiglitz (2001) as
moral hazard.

What about the stimulus package, with its massive increases in government
spending? Did that provide a boost to the U.S. economy? Economic models by
Edward Prescott and Finn Kydland (2004) would probably show no benefit at
all. The real business cycle model they developed generally doesn't respond
positively to government deficits in the short run or the long run. However, a
model by Lawrence Klein (1980) would have shown a positive benefit because
his equations were derived from the theories of the influential macroeconomic
theorist John Maynard Keynes. In a Keynesian model, government deficit
spending energizes a depressed economy and can stimulate investment and
consumption in the private sector.

What about the tax cuts in the stimulus package -- were those beneficial?
James Tobin (1981) was a member of the Council of Economic Advisers in the

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1960s that convinced President John F. Kennedy to cut $11 billion in personal
and corporate taxes to combat a small recession. The stimulus worked, and
became an essential component of Keynesian policies, inspiring the stimulus
package of 2009. During the current crisis, Paul Krugman (2008) has
endorsed spending increases and tax cuts, but argues that the actions
contained in the stimulus package were insufficient given the severity of the
crisis.

Using fiscal policies like these to fine-tune the economy has always been
controversial. By the theories of Edmund Phelps (2006) and Milton Friedman
(1976), they're at best irrelevant -- the unemployment rate is fixed in the long
run, Phelps and Friedman argue, and no amount of government spending or
tax cuts can change that fact. Even if a stimulus package temporarily reduced
unemployment, in this theory, it would be entirely ineffective over the long
haul.

Tobin's thinking on tax cuts was less black and white. Although he favored the
measure in the Kennedy years, he had nothing good to say about the Reagan
tax cuts, which he thought did little more than "redistribute wealth and power
to the wealthy and powerful." It is unlikely that he would have supported
extending the Bush tax cuts -- which the Democrat-led U.S. Congress seems
poised to do today -- for an upper class that has become arguably wealthier
and more powerful than it was in the 1960s. You would expect to find Robert
Mundell (1999), a prominent proponent of supply-side economics in the
1980s, on the opposite side of the argument: According to Mundell, tax cuts
for the rich provided an incentive for them to invest more and work harder,
thus benefiting the entire economy.

Then there's the Federal Reserve, which has played a major role in combating
the economic crisis by injecting large sums of money and liquidity into the U.S.
economy. Franco Modigliani (1985) was one of the first Keynesians to endorse
an expansionary monetary policy like this under conditions of high

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unemployment. The strategy seemed to work, long enough that it eventually
became a standard tool for the Federal Reserve, one the bank deployed in
2008.

But Friedman would likely have objected strongly to any attempt by the Fed to
increase the money supply in the name of fighting a recession. The result of
such a misguided strategy, according to his monetarist theory, would be
inflation, not economic recovery. (There is one notion here, however, on which
most economists might agree: the Fed's role as the lender of last resort. When
panic strikes financial markets, aggravated by temporary shortages, the central
bank has a unique opportunity to provide liquidity -- this was, after all, one of
its original purposes.)

Confused yet? It should be clear by now that if you seek clear, unambiguous
policy guidance, the Nobel laureate roster is probably a bad place to look --
economic theory, even when honored with the top prize in the field, is brutally
contested terrain. Unlike physics, chemistry, physiology and medicine, the
Nobel Prize in economics seldom delivers a vetted and verified discovery, but
rather highlights novel and interesting ideas. At their best, however, Nobel-
winning economic theories can inspire policies that protect the environment,
reduce poverty and unemployment, subdue inflation, ensure prosperity, and of
course, avoid economic depression. Let's hope for the best.

China's Burden of Shame

Today's Nobel Peace Prize announcement is a reminder that the Chinese
people will never earn the full respect of the world until their
government respects them first.

BY KWAME ANTHONY APPIAH | OCTOBER 8, 2010

Liu Xiaobo is a brave man who loves his country. It was an honor to have been
among those to nominate him for the Nobel Peace Prize. It's a great thrill
that he got it. Now we have to hope that this moment becomes another
stepping stone on China's long march toward greater freedom.

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This is a crucial moment in China's history, as the Norwegian Nobel
Committee clearly understands. Liu rightly wants to underline how far his
country has to go to secure the basic democratic freedoms of speech and
association. But we also need to remember how far it has come. In the 1960s
and 1970s, during the Cultural Revolution, a whole generation of intellectuals
was uprooted. Millions were displaced. The situation today is very different in
ways both heartening and discouraging. Now we can identify somewhere
between 40 and 50 writers and bloggers whom the Chinese state has
imprisoned simply for peacefully speaking their mind.

Of course, the number of those incarcerated represents a tiny fraction of those

silenced by their example. A vast apparatus of government censorship -- the
"Great Firewall" -- remains in place. We have to work to support those in the
regime who can already see that this is not only wrong, but also
counterproductive. Human rights are everybody's business. And we can't have
the productive dialogue with China that it wants -- and the world needs -- if its
government is abusing its own people. We outside need to hear all of China's
voices, just as the Chinese do.

As we honor and celebrate Liu's more than two decades of peaceful work for
human rights in China, though, he wouldn't want us to forget that he is one
among many. One of his many achievements was to participate in the creation
of Charter 08, a document outlining the changes China needs to make if it is
to become a real democracy. More than 10,000 people have signed this
document in the last two years, despite the fact that Liu and many others of the
300-plus original signers have been arrested or harassed by the police.
And then there are people like Gao Zhisheng, the army veteran and human
rights lawyer who hasn't been seen since this April. Gao -- whose struggle to
achieve an education began in a cave in Shaanxi province, where he was born
to a peasant family -- has been tortured and imprisoned in the past. And all
because he has learned the law, committing great volumes of the Chinese legal

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code to his formidable memory, and used it to fight corrupt officials and the
suppression of religious minorities. While we celebrate Liu, let's also ask the
Chinese government where Gao is and what has happened to him.

Or take Chen Guangcheng, another self-taught lawyer. Chen is blind, but he

too has used the courts to defend the rights of ordinary rural people. He didn't
learn to read until he was in his 20s. But once he did, he filed a lawsuit
drawing attention to the suffering of women forced into abortions by officials
in Linyi county in Shandong province. So he, too, has been imprisoned. He was
released after a four-year sentence just a month ago. Naturally, he is still under
surveillance. Let's make sure he also gets our support.

We need to help the Chinese government to see that these people are not, as
the regime's spokesmen keep insisting, ordinary criminals, but national
treasures. They are seeking to give voice to the aspirations of millions of
people. We need to help the Chinese Communist Party understand what it took
a long history of struggle for us to learn in the Western world: A government
that cannot hear from its people cannot govern well. My friend Amartya Sen,
an economics Nobel laureate, has shown, in essence, that famines don't occur
in democracies. A government that hears its people can serve them better.
Democracy makes some things more difficult -- but mostly they're things, like
corruption and the abuse of human rights, that ought to be difficult.

There's actually a long history of outsiders helping China's leaders make moral
advances. In the late 19th century, many among the literati who governed the
country were persuaded to abandon the 1,000 year old practice of foot-
binding, in part through a productive dialogue with Protestant missionary
critics. That dialogue worked, I believe, because the critics took the trouble to
understand China's traditions and show that their concern for China grew not
out contempt for its civilization, but out of a profound and informed respect.

It's my privilege to be the current president of the PEN American Center, one
of the 145 PEN International centers around the world, members of the

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literary community working together to support free expression and
international cultural exchange. In our work in support of Liu Xiaobo, we are
guided at every step by our colleagues in the Independent Chinese PEN Center,
insiders who are working, as he has done, to serve the cause of freedom in
their country. With their guidance, we are able to participate from outside
China in shaping its development. We can do so in part because the Chinese,
like all people, want to be respected in the community of nations. Yet such full-
hearted respect is denied them when the regime denies the rights of its own
people, and that forces government officials to deal with the fact that they are
denying themselves the respect they need.

Yesterday, a Chinese exile told me that what she feels when she reads about
the abuses of people like Liu is shame. We have to work with China's human
rights community to lift that burden of shame, so that the Chinese can have the
respect of all of us because they have done what it takes to deserve it. Honor
and shame are powerful motivators. Honoring Liu Xiaobo supports him in his
work. But the shame of what the government of China is doing to him is
driving many of his fellow citizens to line up alongside him.