IT was FA Hayek, an economics Nobel prize winner of immeasurably greater distinction than Paul Krugman, who put it best. In his book the Fatal Conceit, he launched a devastating attack on those who believe that elites can mould and control humanity’s destiny. Central direction is impossible, a limitation those in authority never accept.
Past fatal conceits include the view that private property and markets can be abolished, and replaced by pure socialism and central planning, whereby a small group decides what is produced, what is consumed and who works where and gets what. But we remain plagued by many other, contemporary fatal conceits. Here are two especially pernicious ones.
The first is the belief that governments can endlessly create growth out of thin air by manipulating aggregate demand – cutting rates, printing money or borrowing and spending more. Of course, such actions can have a huge effect. Monetary policy can be extremely potent; the cost of borrowing is the most important price in the economy and the quantity of money, and the speed at which it circulates, is fundamental to the health of an economy, because money is used in every single exchange. It may well have made sense to cut interest rates in China, for example, as the Beijing authorities did yesterday for the first time since 2008. Varying public spending to manipulate GDP, however, is pretty useless at the best of times.
But there are two problems: the first is that macroeconomic policy is itself a soft form of planning, and as such falls foul of the incentive and knowledge problems outlined by Hayek. How can a central authority know what the right price of money is? It doesn’t know what the “right” price is for other commodities, so what is different about money and credit? And what about policymakers’ incentives? Why do we assume that they are angels? But there is a more immediate issue. It is one thing to try and use macroeconomic policy while being aware of its limitations – the traditional approach pursued by the humbler central banks – but it is completely another to imbue it with super-natural characteristics and believe that it can be used to cure all evils.
It is increasingly clear that weak growth in the US and the recession in the UK have little to do with monetary policy. There are real, supply-side and other factors at play. The economy simply isn’t capable of growing at anything faster than a snail’s pace given the skills of the population, incentives, the tax and regulatory burden, extremely high levels of public spending, crippling private and public leverage, excessively tight rules on bank capital and liquidity, and competition from more dynamic economies. Such is life: printing more money, or cutting rates even further, or borrowing even more won’t change any of these fundamentals. That is why, for all their faults, the Bank of England and the Federal Reserve did the thing right yesterday: they didn’t cut rates or boost QE.
The other fatal conceit is the euro – and the view that political will can overcome everything. But politics is about what a group of people would like to do – and economics is about what they can do. Economics is the reality check, the human equivalent of gravity; it sets the constraints. The world can only consume what it produces. You can’t have a workable single currency without labour market flexibility. Spain’s three-notch downgrade is just the latest blow to the conceited elites; there will be many more to come. Slowly but surely, reality will reassert itself – in the most painful, ego-busting way possible.