The laissez-faire recession response

About a year and a half ago I wrote a blog post arguing the best public policy response to a recession was simply to let it run its course. I attempted to make the case that recessions are a necessary phenomenon, which can allow the economy to position itself for renewed growth -- provided politicians don't get too involved:

Last week I was chatting online with a friend of mine who works in finance who opined that "we need a deep recession to fix things." To many people this might sound strange or abhorrent, but it's actually quite a good point.

Recessions are a good sign that too much investment has been made in bad parts of the economy and need to be reallocated to more efficient uses. For example, the recession that occurred in 2001 was in large part a product of the hangover from too much money going to dot-coms that had nonviable business models. The current recession -- and yes, at this point I am going to go ahead and call it that -- is a product of a housing boom founded on easy credit. Recessions are a time for the economy to cleanse itself of these impurities and lay the foundations for future growth by shifting resources to more productive areas.

In fact, the biggest danger to future growth is that politicians in a bid to gain office may put in place programs -- in the name of saving jobs -- that retard this process of retooling and reallocating resources. While this may seem harsh, some jobs just aren't meant to be. We simply don't need as many realtors at the moment. If U.S.-based automakers go belly-up it's a sign that Toyota and other manufacturers should be doing the job instead while Americans should shift to more productive endeavors.

I bring this up because of two columns this week which make similar points. The first is from Bradford Cornell, an economist at Cal Tech:

The current recession is as deep as the misalignment of specialized plans, relations, and contracts is extensive. Construction workers cannot become software developers overnight. Automobile companies cannot adjust immediately to a change in consumer preferences regarding what type of cars they want to purchase, or how frequently. Would-be financiers cannot adjust to these plans overnight.

An obvious question is whether the government can do anything to speed the restructuring process or reduce its cost. If the government could identify how the economy needed to be restructured and provide incentives to move resources more quickly in that direction, a properly designed program could alleviate and shorten the recession. But, if the government could do that, central planning would be a good deal simpler.

Moreover, just as a command economy is invariably less efficient at resource allocation and production than a market economy, a general stimulus program will, in all likelihood, lead to highly inefficient allocations, effectively burning resources at a time when they are scarce and particularly vital to restart and re‑align our beleaguered economies. To the extent that it is used to prop up declining industries, the stimulus could even prove harmful by delaying necessary adjustments.

Similar points are made by Bill Flax, who works in the banking industry:

The recession is how the market redefines itself to the new paradigm. Downturns should ricochet into recoveries. The longer Washington attempts to alleviate the recession with interest rate manipulation and deficit spending, the longer weaknesses perpetuate. Propping-up the failures of the past prevents the successes of the future.

Saving dying companies deprives scarce resources from growing companies responding to the market's evolving demands. Subsidies only delay re-engineering. Bailouts incarcerate capital in flawed business models or production focused on consumer's old wants. TARP and the nationalization of the GSEs ensure risk and return will remain disjointed leading to future malinvestment.

Public works projects or bloated government bureaucracies employ some, but their viability depends on political whim for perpetuity. What happens when budget priorities change? Encouraging additional malinvestment into green energy or other politically correct machinations won't stimulate recovery.

There is little benefit in subsidizing the housing market, especially where we already have abundant houses sitting vacant. Mortgage modifications trap people in locations where the jobs have vanished. Unemployment benefits idle human capital. Unemployment has risen and lengthened in conjunction with rising and lengthening benefits at their longest and most generous levels ever.

Incendiary class-warfare rhetoric threatening heavy taxes and regulatory nightmares stymie new business creation. As capital hides or gets funneled through Washington, business decisions cater to politics rather than markets. Do we really want lobbyists and bureaucrats redistributing our capital or dictating what we may do with what Washington leaves us?

This was the longest recession since WWII because it was also the most interventionist recession. In the eleven previous corrections the average fiscal deficit had been 2.3%. In 2009, the federal deficit exceeded $1.4 trillion, which was almost 10% of GDP. Both numbers represent postwar records already being eclipsed this year when the deficit could reach $1.6 trillion despite a "recovery."

Government spending merely reflects a statistical palliative superficially extending GDP. Too much of the economy has grown dependent on Washington so even as we are now "recovered" their interference persists. That government spending is forecast to continue rising testifies that it was more addictive than curative.

These policies prolonged the downturn and now reflect an albatross weighing down our recovery.

Exactly. If the Obama Administration serves any use, perhaps it will be to provide people with a renewed appreciation of the dangers of statism and virtues of the free market. Just as classical liberal theory would predict, government interventions in the economy are producing vast amounts of waste while increasing uncertainty which is further delaying economic recovery. Simply doing nothing (or better yet, scaling back government) would have been a far superior approach. It's just unfortunate that this lesson is coming at such a high cost.

Update: Businesses cite government taxes and regulations as two of the top three greatest problems they face.

Update: Don Boudreaux on why government stimulus does not work.