Hangover theory and morality plays
My recent fit over the technocratic style in American economics was the excrescence of a long-standing complaint. The very first time I made that complaint was in a piece arguing that Paul Krugman’s dismissal of Austrian-ish “hangover theory” was overhasty. What goes around comes around. Karl Smith offers a new dismissal of “overconsumption theory”, which Matt Yglesias echoes. Smith, like Krugman, is mistaken and overhasty in dismissing “hangover theory” on technocratic terms, perhaps because he is quite rightly upset at how the theory is sometimes portrayed in moral terms. A better approach would be to understand the way in which the theory might in fact be true and useful, and to craft a morality tale that both captures what is accurate in the story and leads to more productive and just intuitions about how we should behave.
First, a technocratic issue. Here’s Smith:
[T]he overconsumption theory of recessions makes no sense… people are confusing cyclical prosperity with personal luxury. In your personal life you might feel like you are doing well because you have a new house or a new car, etc. However, this is not how we measure the cyclical wealth of nations. We measure it by employment and production. We say the economy is “doing well” when a lot of people are going to work and making stuff. For example, we say that Germany’s economy seems to be recovering. However, consumption in Germany is not rising. Consumption is flat. Working is rising. Employment is rising. That is what it means to be doing well. It means that more people are doing more work.
That last sentence is mistaken.
Smith is very right that we do not measure prosperity by consumption, but by production. We get wealthy by producing what someone values to consume. Our wealth takes either the form of current consumption or (more importantly in a deeply uncertain world) claims on others’ production whenever we might want or need it. We should never, ever measure prosperity in terms of consumption, but always in terms of production, weighted, importantly, by the strength of financial arrangements that allow us to convert unconsumed production into credible options to consume later. [*]
However, we do not measure prosperity in terms of how much work people are doing. That is a terrible error and the most vulgar form of Keynesianism. Make-work is not a path to prosperity, and effort is not production. Prosperity is a matter of the rate at which goods and services that are highly valued can be produced, whether the production is labor intensive or capital intensive, however much or little people are working. Employment is a more complicated issue than output. Under current (foolish) institutional and ideological arrangements, for most people, employment is our main source of claims on current or future production, and also a measure of our respectability and value as human beings. Holding institution and ideology constant, unemployment is harmful far beyond its effect on output. But let’s not confuse objectives. Employment and output are historically correlated, because it takes work to produce output, and also because the measured value of output is dollar weighted and there are few consumers to confer value without widespread employment. But the degree to which the production of any given thing is tethered to traditional employment is variable and technology dependent, and the ability to confer value through purchase could be distributed via means other than employment. Employment and prosperity are different things. (Please don’t confuse average and marginal values or invite ridiculous linear extrapolations by pointing to measured labor productivity. That statistic tells us nothing about the output we would get from further employment.)
We measure prosperity by production, not by work, and we measure production by value, by what people are willing to pay for what is produced.
Austrian-ish “hangover theory” claims, plausibly, that if for some reason the economy has been geared to production that was feasible and highly valued in previous periods, but which now is no longer feasible or highly valued, there will be a slump in production. It wisely asks us to consider not only the prosperity we measure today, but the sustainability of that prosperity going forward. I am not “Austrian”, and have no interest in defending specific claims regarding the roundaboutness of activity or the role of central banks in causing bursts of quasiprosperity. But as Brad DeLong wisely reminds us, it is good to be somewhat catholic in our evaluation of macroeconomic schools, and to take what is useful from each. I consider myself Keynesian at least as much as I am Austrian, but I recognize good and not-so-good offshoots of both schools. (Austrian and Keynesian ideas are more complementary than most people acknowledge. The Austrians focus on unsustainable arrangements of real capital, while the Keynesians focus on unsustainable arrangements with respect to money, debt, savings, and income. I think both approaches are fruitful.)
Smith is a brilliant guy. He gets this:
Because we bought too much it is now inevitable that we work less? Why does that make fundamental sense? Surely something is going wrong. Shouldn’t we be working more to pay for all the stuff we bought.
Some people might say that the “something” is structural readjustment. We have to move towards an investment based economy and there are frictions… Recessions in that story are not a punishment for overconsumption, they are a result of suddenly realizing that you have to shift paths. There are still problems here but they are on a deeper level about more subtle things.
That’s the “hangover” story right there. Those more “subtle things” — wealth-destroying misuse of real capital, dependency on skewed and misguided claims to production — are the source of the hangover, not high consumption per se. There is no school of economic thought I know of that suggests increased prosperity and consumption in and of themselves require a painful purge. The claim is that some patterns of economic activity create the appearance of prosperity and enable temporary consumption that cannot be sustained, and that moving from a period during which such patterns obtain to a more “sustainable pattern of specialization and trade” involves adjustments that are difficult. Recovery is hard, both because there is uncertainty about what is to be done, and because powerful incumbents resist changes and block useful action. Only critics of “hangover theory” claim the theory implies that idleness is just desserts. Proponents do claim that poverty in the sense of diminished consumption, painful financial losses, and “creative destruction” of cherished institutions usually attend the adjustment process, and they recognize all this is usually associated with unemployment. But hangover theorists argue that adjustment is worth doing despite the cost in employment, consumption, and disruption, not because those costs are good things. When they do argue that “pain is good”, it is along very conventional lines of moral hazard. It is not that the macroeconomy “deserves” to suffer, but that foolish lenders and borrowers, specific misallocators of capital and overconsumers, ought to suffer disproportionately pour encourager les autres. Hangover theorists, like smart Keynesians, promote policies intended to shorten depressions when they occur. Austrians ask that bad claims quickly be recognized and devalued, so that economic activity can go forward without a debt overhang. Keynesians urge government action that conjures financial income from thin air, risking devaluation of old claims by inflation. There are different tradeoffs between moral hazard, sharp incentives, and political feasibility among the two approaches, but both seek to repair balance sheets and create a clean slate going forward. Hangover theorists are suspicious of booms that might not be sustainable. They are quick to urge that we “take away the punch bowl” — defined as any macroscale stimulus to economic activity that cannot last — not because they dislike a party, but because they prefer a party that might go on indefinitely to one they expect will be punctuated by agony. Rather than ridiculing hangover theory, we ought to apologize to hangover theorists like Dean Baker, who warned against an obvious housing bubble and predicted catastrophe while his betters partied on oblivious.
So back to that morality play. Smith again:
The overconsumption theory by contrast says that the recession is natural because we bought too much stuff during the 2000s. Too many houses. Too many big screens. That’s why you are not working now. Its balance.
Steve Waldman says I shouldn’t tell people that economics is not a morality play. How about this then — that morality play is completely F-ed up. That morality play says that we should sit on the couch and rest our backs because that way we’ll learn not to drink so much. You bought too much so now you have to work less. How does that balance anything?
On what planet is it your just desert that after partying all night you are forced to sit on the couch rather than get the rest of your work done. Maybe in some perverse Brewster’s Millions kind of way. But, I don’t think that what the universe has in mind.
If suddenly everyone stopped buying big screen TVs and started building factories, investing in the future and laying the path for the next generation then there would be no recession.
Steve Waldman agrees entirely. The problem isn’t that there is a morality play, but that the morality play Smith describes is a bad, stupid, dumb, even evil morality play that needs to be challenged on moral terms. (As Smith is doing, by the way.) No one claims what Smith is ridiculing, that on an individual level overconsumption should be punished with unemployment. But people do claim that in aggregate “we” deserve and must endure a period of recession because “we” overconsumed and invested poorly. The right response to that story is, “Who the fuck are this ‘we’ of which you speak, kemosabe?”
At an individual level the correlation between past consumption and recent unemployment is obviously negative. The people who have sinned are not by and large the people being punished. Some people overconsumed relative to their income, and some people invested poorly. Those who overconsumed have mostly faced consequences for their misbehavior — they are either deeply in debt, or they have endured foreclosure or bankruptcy. But the people who invested absurdly, especially “savers” who lent money but permitted themselves ignorance and indifference to how their wealth would be mismanaged, have not suffered the costs of their recklessness. Instead, they have been almost entirely bailed out. It is lenders and investors more than any other group who determine the patterns of our macroeconomy. There are always people willing to overconsume or gamble on foolish enterprises. We do and must rely upon those with resources to steward to ensure those resources are used wisely. They did not, and their recklessness has brought us to catastrophe. But rather than condemn them for negligence and permit their claims to be appropriately devalued, we applaud them for “prudence” and let government action be bound by commitments to sustain their destructive and ridiculous claims. You don’t counter that sort of villainy with technocratic arguments about liquidity traps. You point out that the motherfuckers who are calling themselves prudent, who are blocking both writedowns and government action that might risk inflation, are hypocrites and thieves. You state clearly that their claims are illegitimate and will be written down one way or another, unless we can generate sufficient growth to ratify them ex post, which would require claimants to behave less like indignant creditors and more like constructive equityholders. It is not technocratic economists who will win the day and pull us out of our cul-de-sac, but angry Irishmen and Spaniards who challenge, on moral terms, the right of German bankers to impose vast deadweight costs on current activity because they lent greedily into what might easily have been recognized as a property and credit bubble.
[*] The caveat about financial arrangements is important with respect to Germany’s apparent prosperity. Germany, like China, is less prosperous than it seems, because its surplus production is geared to sale for claims that cannot credibly be redeemed for what the country’s citizens would want should they exercise their option to consume.