I’m taking you to Austin – then I’m gonna lock you up. So sang the Man in Black, Mr. Johnny Cash, it the classic Austin Prison. He also sang of a Ring of Fire. Today, the Chairman of the Council of Economic Advisors, Dr. Austin Goolsbee announced that he is jumping out of the ring of fire that is the Administration’s economic policy, and going back to Chicago to teach.
Hopefully, the departure of Dr. Goolsbee and most of the senior members of the President’s economic team will allow the Administration to appoint people with a broader perspective. Goolsbee, like the rest of the Administration’s economic team has tied his economic card to a single – one might say doctrinal – vision of economics. Known as the Keynesian approach, this theory of economics suggests that the economy is basically driven by demand, and that the government can affect markets by either stoking or moderating demand. While there is much to be said about Keynesian economic thought, there is also a problem with a strict doctrinal approach to economics.
By relying exclusively on Keynesian theorists like Dr. Goolsbee, or for that matter Christina Romer, or Larry Summers, the Administration has received very narrow advice on how to respond to the country’s economic problems. It would be like relying only on the style advice of hairdressers. While they may give great advice about the top of one’s head, they have little to say about shoes, or accessories or jackets. This lack of a broad perspective has hampered the Administration’s ability to effectively respond to the country’s changing economic situation.
Economics is not like physics or chemistry. There are no hard and fast laws like gravity or thermodynamics. In fact, most economic theories are reflections of the historical and political situations of the time and place in which they were conceived. They may do a very good job of explaining historical economic events, but in and of themselves may not provide appropriate answers to today’s economic problems.
As I see it there are 4 basic approaches (what we call schools) in economics. They are about 80 percent the same, but each differ in their details.
The Classical approach to economics was developed in Europe during the start of the Industrial Revolution and its theories reflect a world of small, competitive entrepreneurial producers and a great deal of competition in most markets. Most of modern economic theory owes homage to classical economists like Adam Smith and David Ricardo, who came up with important concepts like supply and demand. In short, the Classical school of economics suggests that markets generally work, and that most government interference in markets will lead to problems.
The Socialist approach to economics is an offshoot of the classical school. Developed first by Karl Marx in the mid-1860s it suggested that the perfectly competitive world of Adam Smith had been replaced by an uncompetitive form of monopoly capitalism. In fact, this was exactly what had happened in most of Europe and the Americas by the 1960s. Large industrial trusts controlled most major markets and were able to set prices and output with little regard for consumers or competition. This school of economic thought suggests that market economies are inherently uncompetitive and that large-scale government control is necessary to stop the exploitation of consumers and workers.
By the turn of the 20th century, much of what the Socialists had predicted had come true, and governments had instituted a number of controls to prevent markets from becoming monopolies. In this environment rose the Neo-Classical or Marginalist approach to economics. Fostered by the economist Alfred Marshall in Cambridge. Simply put, Neo-classical economics takes the Classical theories of Smith or for that matter Marx, and applies them to a world with imperfect competition – it was also the first school of economic thought to focus attention on the important aspects of consumer demand, not just production.
The Keynesian economic approach was developed during the Great Depression by the English economist Sir John Keynes. It was very different from the other theoretical schools in that Keynesian economics focuses on demand rather than supply. Keynes suggested that the world could be brought out of Depression through government spending, which could be used to either stimulate or retard demand – and through this, economic growth.
Each of these approaches has a lot to teach us about the current economic situation. The smart economist will try to use what they can learn from each to examine the empirical data and to develop theories and policy options to address concerns like lingering unemployment, inflation or trade deficits.