A Classical Economic Response to the Coronavirus Recession

I find myself astonished to be writing on the pages of the American Institute for Economic Research which was founded by one of the great economists of all time, Edward C. Harwood. I am in the midst of putting together a two-volume set of readings of all of the great anti-Keynesian economists who have written to address the harm done by Keynesian theory since the publication of The General Theory in 1936. Harwood’s writings from the 1930s are amongst the earliest and most incisive. Others who follow in his wake are found among the present writers on this site, and I am very pleased to be joining them.

We are in the midst of one of the strangest moments possibly ever experienced, the deliberate shutting down by governments of our economies because of a gigantic fear that a plague on the order of magnitude of the Spanish flu that followed the end of World War I is about to descend upon us. For myself, I find the response over the top – to use another World War I metaphor – but that is neither here nor there. What I merely wish to discuss is the widespread misuse of the term “stimulus” to describe what is being done.

“Stimulus” is one of many modern-day economic terms whose meaning has been distorted beyond recognition in ways that make it almost impossible to discuss the nature of an economy and the proper policy approaches that need to be taken as events unfold.

Our economies have been wilfully driven into recession because of an aim to flatten the spread of the coronavirus. The method employed is to increase “social distance” so that the rate of infection is reduced. In this way not only do we lower the number of deaths, but also do what we can to ensure that we do not overrun our ability to cope with the growth in the number of patients and stretch the use of our medical facilities beyond their capabilities. The aim is thus to keep people far enough apart so that the number of persons infected is diminished. 

All this has led to the closing of businesses across the world in which large numbers of people might congregate. Restaurants and cafes along with theatres and major sporting events have been forcibly shut. It feels like the return of the Puritans to Shakespearean London.

But let me focus on the economics of what is being attempted. If you try to make sense of any of it using modern macroeconomic theory you will not understand a thing. A Keynesian, and thus the entire stretch of modern macroeconomic theory, is built around the notion of aggregate demand. The more people buy, the stronger the economy is and the more jobs will be created.

But if job creation were the aim then why the shutdowns? It is utter nonsense to believe that any of what is being done is done in aid of making the economy stronger and towards creating more jobs, since the actual aim has been to bring large swathes of the economy to a halt and to create higher unemployment as a deliberate act of policy.

Let me take you back to the economics before Keynes, to when economists understood the nature of the cycle. Let me bring you back to when Harwood was himself writing his own text on the business cycle in the 1930s.

Recessions in those days were rightly understood as due to structural faults in the economy. A recession occurred when the bits did not properly mesh. Some parts of the economy were no longer able to run at a profit because of structural changes in the economy, sometimes on the demand side but more often on the supply side. There, therefore, needed to be some shifts in the entire apparatus of production. What turned the adjustment process into a recession occurred when the adjustment process required was too large to occur as in normal times when as one business would close down another would open.

During recessions, for whatever the reason might be, the number of businesses closing would exceed the number opening, and along with the slowing of production in total, there would be a rise in unemployment. It was a common enough experience, and the one absolute among the economists of the time – going back to the early nineteenth century – was that whatever might be taking place, it was not a failure of demand. That is what the analytics behind Say’s Law were meant to explain.

If ever there has been a downturn that cannot in any way be explained as a fall in demand it is the forced closures that have followed the coronavirus panic. The downturn is entirely structural in nature, even if, as is the usual case, the problem has been driven by government actions and decisions.

That is why when I hear discussions of the need for a stimulus I am even more than usual amazed at how beyond sense economic policy has become. What is needed, and what is largely being done, are measures to hold both capital and labour in place until the closures are brought to an end.

There are businesses that will open the moment the law allows. There are millions of jobs that will be immediately filled again the moment these businesses reopen, which will see their customers flooding back. The aim of policy is therefore to maintain a holding operation on business and to ensure workers who are being temporarily displaced can purchase necessities.

It will turn out to be a very expensive policy in the long run, and may yet set off an inflationary spiral that may become its most long-term result. In the meantime, policy must provide incomes to displaced workers and allow businesses that have been shut down to pay for the maintenance of their capital.

Given what governments have already done to cause this recession, that is the least they can do. But it is also the most they should do. The last thing we need now is a Keynesian-type “stimulus” where government spending on wasteful junk takes over from actual productive firms.

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