The resurrection of the New Economics

To read The Samuelson Sampler in the shadow of the Great Recession is to gain a glimpse into the mindset of a bygone era. The sample is of the late Paul Samuelson’s weekly columns for the magazine Newsweek from 1966-1973.
Samuelson, a Nobel laureate, was the doyen of American economists: his famous textbook, Economics went through 14 editions in its author’s lifetime, introducing future economists worldwide to the rudiments of their craft. If not the sole originator, he was the great popularizer of the “neoclassical synthesis” – the mix of neoclassical and Keynesian economics that defined the mainstream of the field for 50 years.

Samuelson was a convinced Keynesian, though in a limited sense. He dismissed most of Keynes’s attack on the orthodox economics of his day as unnecessary, writing “had Keynes [started] with the simple statement that he found it realistic to assume that money wages…were sticky and resistant to downward movements…most of his insights would have remained just as valid.” For Samuelson, Keynes’s real contribution was the tools he gave governments to prevent depressions.

Reading The Samuelson Sampler, it is extraordinary to realize just how confident economists of his generation were that the New Economics (as the Keynesian approach was called in America) had solved the problem of depression and mass unemployment. As Samuelson put it in his 1973 introduction, “the specter of a repetition of the depression of the 1930s has been reduced to a negligible probability.”

Yes, there would still be small fluctuations; but, as he wrote in 1966, “Great Depressions – cumulative slumps that feed on themselves – are indeed extinct.” The reason was that governments now had the tools, especially discretionary fiscal policy, to check any incipient downturn. “What is important about the budget,” he said in 1970, “is whether it is inflationary or deflationary, not whether [it is] balanced or unbalanced.” In other words, “A deficit in a good cause is good business.” How many economists or politicians believe this today?

Because governments knew how to stop depressions, voters would insist that they use this knowledge. “If printing bits of green can save banks and business from ruin,” he argued in 1966, “today’s electorate will ensure that either party in power will [so] act.”

This was irrespective, Samuelson thought, of the ideological preferences of those in power. The Republican Richard Nixon was elected US President in 1968 on a platform of scaling down the Democrats’ expensive Great Society programs. “I am not an economic determinist,” Samuelson wrote in November 1968, “But I can predict with confidence that Richard Nixon will be using the New Economics if only for the reason that new times make it inescapable.”
And so it turned out. Rather than deflating the economy, Nixon took America off the gold standard in 1971 and imposed wage, price, and import controls, proclaiming bluntly, “I am now a Keynesian in economics.”

But that was the last of Samuelson’s successful predictions. Less than a decade after his Newsweek columns ended, the New Economics, which he had extolled as a permanent addition to knowledge, was in flight from the ideological assaults of Ronald Reagan and Margaret Thatcher. Despite his faith that voters would not allow a return to depression, Thatcher’s third election victory, in 1987, came just after unemployment in the United Kingdom had peaked at three million, the highest level since the 1930s.

So what went wrong? “Still to be argued out within the guild [of economists],” Samuelson wrote in 1969, “is the proper quantitative potency of monetary versus fiscal policy.” This question eventually was resolved in favor of monetary policy.

More important, as he pointed out in 1970, was that “even Keynes could not guarantee that mankind would live happily ever after. He left us with an unsolved problem. How can we have full employment and also price stability?” Reluctantly, Samuelson concluded that there needed to be permanent controls over prices and wages to stop cost-push inflation. “Our mixed economy,” he wrote in 1970, “does not know how to have a satisfactory incomes policy that will back up monetary and fiscal policy….Here then lies the unsolved frontier in modern economics.”

It was the same frontier that Friedrich von Hayek first surveyed in The Road to Serfdom in 1944. Hayek feared that deliberate policies to maintain full employment would lead to increasing state encroachment on the free market and political liberty. It was this fear that led, from the 1980s onwards, to the piecemeal abandonment of the policy system of the mixed economy – indeed, to the dismantling of the mixed economy itself.

Samuelson was half right: Governments do know how to stop a slide into another Great Depression. They used this knowledge in the autumn of 2008 and 2009, which is why we had only a Great Recession.

But, contrary to what Samuelson believed, governments are haunted by fears of large fiscal deficits. With few exceptions, they have not been prepared to use fiscal policy to jolt their economies out of post-crisis stagnation. Instead, they have relied on monetary expansion, which is politically more acceptable, but also much weaker in its effects, as it is undermined – just as Keynes predicted – by “several slips between the cup and the lip.”

More important, governments have abandoned the goal of full employment; as a result, all of those bits of interventionist policy previously thought necessary to keep economic activity on an even keel have gone by the wayside as well. The New Economics may be temporarily resurrected to deal with extreme situations, but policymakers no longer take precautions to prevent extreme situations from arising. How to do this, while preserving freedom and efficiency, is now the “unsolved frontier in modern economics.”

This article is published in collaboration with Project Syndicate. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords.

Image: Pedestrians walk inside a train station in Tokyo November 14, 2006. REUTERS/Yuriko Nakao.