On the Abuse of Big Words

The second point on Schopenhauer's list^* of 38 ways to win an argument, is 

"Use different meanings of your opponents words to refute his or her argument."

Economics has lots of words with multiple interpretations that are subject to this kind of trickeration. I avoid the word "Capitalism" most of the time. "Keynesian" is another oft abused word. 

During the Cold War, Capitalism was a convenient shorthand for the economic system of the West that was not what countries in the Soviet sphere did. While the Soviets did central planning, the U.S. and allies relied on markets to make production and allocation decisions. Hayek emphasized the information difficulties of central planning that markets could overcome, though Hurwicz* pointed out that "decentralized" could have many meanings, and the government still had a role to play.

Most economist have a loose vision of capitalism that includes industrialization, markets, international trade, technology, entrepreneurs etc. etc. Government is necessary to establish property rights and enforce contracts and generally making people feel safe.

The most restrictive definition of Capitalism is the libertarian, minimal state version exemplified by Nozik. Free markets are a lynchpin of any such theory, but libertarians tend to be a bit too impressed. Reading Nozick as an economist is an odd experience since his intelligence and erudition are at an extraordinarily high level, but his economics analysis is simplistic.

I just read some chunks of Thomas Sowell's book Basic Economics that gives straightforward, very well-written descriptions/celebrations of the workings of markets. There are discussions about adverse selection, moral hazard and pollution, which might require some limited government action, though he rushes to point out the cost of regulation in each case.

Most notably, there is no mention of the adverse selection problems with health insurance**. Without government intervention, healthy people don't want to pay for insurance, and insurance companies don't want to cover the old and the sick, which is the reason most countries have some kind of nationalized health care. The U.S. is a notable exception, of course.

Most economists part company with the uber-libertarian visions of capitalism over market failures like these. Markets are great because you don't need a King or a Czar or a government bureaucrat to decide how many acres of soy beans to plant, but there are certain markets like health care and finance where the government needs to step in.

Keynesian also means different things to different people. The crude version says Keynesians want the government to spend a lot. The somewhat less crude version is that the government should use fiscal policy as its primary tool for stabilizing the economy. Many (most?) U.S. economists in the 50s and 60s fit this description.

John Maynard Keynes' General Theory is actually about the rather specific circumstances of the Great Depression when the connection between savings and loans to businesses broke down. The textbooks now call this situation a liquidity trap (see Chapter 6 or the Primer), where interest rates hit zero and act as a price floor, when more funds flow into banks than come out as loans. The gold standard was in place during the first part of the Great Depression, so rates were above zero, but the economy suffered because of the same saving/investment troubles. When countries left the gold standard, their recovery began almost immediately, see Bernanke.

Keynes' recommendation in favor of fiscal stimulus not a solution that applies always and everywhere. It is his solution to the liquidity trap. FDR made a rather feeble attempt at spending, but the Depression truly ended with WWII, the largest fiscal stimulus in history.

The Cowles Commission, which strived to set of a model of the entire U.S. economy for use by the government, certainly fit under the Keynesian umbrella when it moved to Yale in 1955. The initial version of the model had some issues, most notably the use or the old version of the Phillips Curve (see here) without expectations or a natural rate. This version was criticized by Milton Friedman and Edmund Phelps, and the Great Inflation of the 1970s proved them spectacularly correct. When people say Keynesian models failed, this is what they are (should be) talking about.

The Cowles Commission learned from their mistakes and fixed up their model, and it continues to chug merrily along. Among academic economists, however, the failure led to the rational expectations revolution, real business cycle models, etc. etc.

Micro-founded models with rational expectations have ruled academic macro ever since, but Keynesians could play that game, too. Now we have New Keynesian economists like Michael Woodford who wrote the bible on monetary policy. The macro world came full circle when Christiano, Eichenbaum and Rebelo demonstrated the intuition behind fiscal stimulus in a liquidity trap in a model with all the modern bells and whistles, including rational expectations.

So Capitalism and Keynesian have many meanings. Capitalism gets tossed around as an amorphous boogey man on the left, and on the right it is the self evident solution to everything. If it is always something to so many, best to avoid the word altogether.

Crude representations of Keynes also persist, usually saying he prefers the government over the private sector. If you find yourself faced with such sentiment in conversation, one solution is to ask, "Do you think the zero lower bound on interest rates matters." This usually forces some dormant neurons to fire.

Which is not a bad intermediate goal. Better than putting too much effort into winning arguments....

*Unfortunately, much of Leonid Hurwicz's non-technical work is in books and is not readily available online, though his Nobel Prize speech is.

** Sowell does mention adverse selection and moral hazard but only as difficulties for insurance companies to overcome, not as barriers to allocational efficiency.