Do Depressions Have a Silver Lining? Posner

The costs of a depression in lost output, reduced incomes, and anxiety almost certainly exceed the benefits, and can have disastrous long-run consequences--had it not been for the Great Depression, it is unlikely that Hitler would have become chancellor of Germany. But that is not to deny that there can be some benefits, as our current depression illustrates. (The use of the word "recession" to describe any contraction less severe than the Great Depression is a triumph of euphemism over clarity.) A depression is an essential backup to efforts to moderate the business cycle. The housing bubble could not expand indefinitely; leverage could not keep growing indefinitely. The government was doing nothing to prick the bubble or to limit leverage. The longer the world economy went without a depression, the worse the collapse would be when it finally, inevitably, came. The saving grace of catastrophes is averting worse catastrophes: imagine if, instead of attacking the United States with commandeered airliners, al Qaeda had waited a few years and attacked with suitcase nuclear bombs. We would not have been on guard, as we are now because of the 9/11 attacks. A depression increases the efficiency with which both labor and capital inputs are used by business, because it creates an occasion for reducing slack.One might think that a firm that has slack in good times will have as much incentive to reduce it as it would in bad times; slack (failing to maximize profits) is an opportunity cost, which in economics has the same motivational effect as an out-of-pocket expense. But firms are organizations, and organizations experience agency costs, which are more difficult to control in good times than in bad. If a firm's profits are growing, it is easier for the firm's executives to skim some of the profits, pocketing them in the form of excessive compensation or perquisites, than when the firm is shrinking. In the former case, stockholders will be doing well, so the pressure they exert through the board of directors to minimize the extraction of rents by executives and other employees will be less intense than when the firm is at risk of collapse. When the depression ends, the firm will have lower average costs, though they will drift upwards as the firm re-grows. Government is rife with agency costs as well. The depression will induce states, cities, and the federal government, all of which will be experiencing sharply reduced tax revenues, to provide public services more efficiently. It will accelerate the very desirable trend toward privatization of government services such as toll roads and airports. By increasing unemployment, a depression increases the demand for education by reducing the opportunity cost of it (forgone income is the largest cost of higher education); and education produces positive externalities. It might seem that the depression would also reduce the income gains from being educated; but those gains accrue over a lifetime and so are little affected by a depression during a person's school years. A depression is a learning experience. The banking industry has certainly learned a great deal from the current financial crisis about the risks of leverage and the downside of complex financial instruments intended to diversify risk more effectively than by traditional means such as retaining highly safe liquid reserves to buffer any unexpected decline in the bank's loan revenues. The current depression has depressed commodity prices. Of particular importance has been its dramatic effect on the price of oil, which has fallen by about 40 percent in the last six months. The price spike of last spring seems to have been due primarily to a shortage of supply; the industry could not expand production fast enough to keep pace with surging demand, particularly in China and India. The fall in price seems to have been due primarily to a worldwide reduction in demand for oil caused by the global depression. The combination of low prices with low demand is optimal from the standpoint of U.S. (and probably world) welfare. The low demand reduces the amount of carbon emissions, thus alleviating (though only to a slight extent) the problem of global warming. The fall in the price of oil has reduced the wealth of the oil-producing nations—a goal that should be central to U.S. foreign policy because of the hostility to us (Russia, Iran, Venezuela), or the political instability (Iraq, Nigeria, Algeria), of so many major oil-producing nations. By undermining faith in free markets, the depression opens the door to more government intervention in the economy and eventually to higher taxes (though probably not until the economy improves). These are not necessarily bad things. Obviously neither the optimal amount of government intervention nor the optimal level of taxation is zero. There are compelling arguments for greater government intervention to deal with the threat of global warming, to improve transportation and other infrastructure, to reduce traffic congestion, and to protect biodiversity. Though in principle the money needed for such programs could be obtained from cutting wasteful government programs, that is politically infeasible. So taxes will have to rise. Federal taxes as a percentage of Gross Domestic Product are no higher today than they were in the 1940s, 1950s, and 1960s—periods of healthy economic growth. The marginal income tax rate reached 94 percent in 1945 and did not decline to 70 percent until 1964 (it is 35 percent today). A modest increase in marginal rates from their present low level would increase tax revenues substantially, probably with little offset due to the distortions that any tax increase is bound to produce. Taxes should not be increased during a depression, but as we come out of it they can be raised modestly to finance infrastructure investments and other investments in public goods, such as reducing carbon emissions. The anxiety, reduced consumption, and reduced incomes during a depression are real costs and very heavy ones, but on the other hand the excessive borrowing that precipitated the depression enabled, for a period of years, higher consumption than the nation could actually afford. Thus the current drop in consumption is in part an offset to the abnormal level of consumption earlier. Indeed, since people loaded up with cars, fancy dresses, etc., while times were good (illusorily good because the nation was living beyond its means), the current reduction in the purchase of durables, while hard on sellers, may not be a great hardship to consumers. (Nevertheless, people quickly get habituated to a high level of consumption, and a decline from that level is very painful.) A related point is that the experience of a depression will induce greater thrift, increasing the formation of investment capital after the depression abates. Finally, the depression will stimulate fresh thinking by the economics profession. The profession's embarrassing failure to foresee the depression, and the failure of the Federal Reserve Board, of deposit insurance, and of other regulatory institutions and requirements to avert the near collapse of the banking industry, will stimulate fresh thinking about and research in macroeconomics and financial economics; and the regulatory responses initiated by the Bush Administration and those that will be undertaken by the Obama Administration will generate valuable data about the effects of economic regulation. Economists will learn from the bad policies adopted in response to the depression (and some are bound to be bad) as well as from the good ones.

Comments

[Vince]

Neilehat,

What is so unjust when the prosperous pay more as their 37% tax payment increase in 2005? Like Posner you choose to dismiss the impact of rates on behavoir even in the face of clear evidence that a lower rate produced much higher revenue. Is it just to tax person A's $1 dollar on income at different rate than person B's $1 dollar of income? If we believe all men are created equal, then why would we discriminate over their level of economic output?

[jbolaw]

Why do these same old, tired apologists for the capitalist, market economy never realize they have been riding a dead horse for decades. Wake up guys, even Alan Greenspan finally saw the light.

What the current depression provides is an opportunity for the citizens of the U.S. to become participants in a real ownership society. An ownership society where the people take controlling interest in the economic behemoths that determine the nation's economic health, sharing in their profits during the good times, instead of only being allowed to particpate in their losses, through taxpayer financed bailouts. Meanwhile, the grossly overpaid buffoons currently placed in charge of these semi-public corporations, continue to amass their obscene wealth at the expense of the public.

Becker and Posner continue to be the apologists for this sordid economic system and champions of its unjust distribution of rewards.

[Chris Graves]

I completely agree with Professor Posner’s finding benefits to a recession (depression). I think since the Great Depression we have been all too ready to find nothing but loss in a recession and nothing but gain in growth. I believe this Received View of economic downturns to be superficial. Judge Posner goes some way to correct this simplistic view of recessions and recoveries. As with any thing or activity in the world, there are upsides and downsides that must be considered. For example, if there were no hurricanes, then the temperature of populated areas closer to the Equator would build up so much heat that they would become unlivable. So, while hurricanes can be disastrous ( as I am well aware of first hand since I have lived in New Orleans and Florida), they have definite but overlooked benefits. We have been all too quick to overlook the importance of economic corrections. We must consider the economy as well as any other social organization as an organic system as we think of the eco-system.

At the same time as we consider the hidden benefits to a recession or depression, I do acknowledge that the Great Depression was a horrific, long-lasting event in our history that permanently harmed many lives. My mother lived though the Great Depression and to this day feels its effects.

But the overall theme of my post here is my agreement with Judge Posner’s exercise of finding silver linings to recessions. I have a number of them here in addition to the ones Judge Posner discusses with which I fully agree. The first is purely economic as markets clear and resources are redirected to their most efficient use as determined by the effective demand of consumers. The interest rate, if allowed to be determined by the market for loanable funds, has a chance to bring savings and investment into equilibrium so that sustainable economic growth can have the chance to reassert itself. Long term investments can then be upheld over time as the pool of savings is continually replenished by savers responding to a rate of interest that affords them adequate returns for deferring consumption. All of this is possible if the Federal Reserve would only restrain itself from the temptation to re-inflate the money supply to head off a temporary downturn in the economy that was brought on by the Fed’s own earlier action of holding the interest rate below where the market would have set it. Those earlier actions of holding the interest rate down artificially as the Fed injected more money into the American economy was motivated by an aversion to recession that has culminated in the present crisis.

As Judge Posner’s reflections go further than purely economic considerations, I now move to other less obvious advantages of a recession. I touched on the first of these in my post last week on the opportunity cost being greater during an economic boom for time away from work spent on social activities such as cultivating personal relationships with family and close friends. Researchers have found that in times of rapid economic expansion the time spent in personal conversations on any one subject dramatically declines, so that conversations change topics several times per minute. Music speeds up so that slower, more reflective, poignant songs are less popular. People tend to neglect personal relationships and spend more time at work. They also spend less time on personal development such as education, demanding hobbies that require study and effort, or even personal appearance. Furthermore, people smoke more during a boom and are more prone to drink excessively. They drive faster and more aggressively. In prosperous times, people are less likely to take care of their physical health by watching their diet, exercising, and visiting their doctor when they start noticing symptoms of health problems (see the research of Christopher J. Ruhm, professor of economics at the University of North Carolina at Greensboro). They are more subject to diseases caused by stress. They are also less religiously observant, which affects their regard for other people as well as their own integrity.

People need a balance among a variety of the motivations of excitement, tranquility, and transcendence. It seems that boom times overly excite people so that they are more likely to engage in risky, stimulating behavior that can be not only self-destructive but dangerous to others with whom they engage in business deals or personal relationships. It has been assumed by Professor Becker, Judge Posner, and other commentators that human nature is constant and so are the destructive tendencies to such imbalances of the soul as greed. While I do agree that human nature is constant throughout history since we all share the same essential nature, I disagree that our propensity to fall into emotional disequilibrium is fixed. Aristotle observed that greed is an imbalance of the soul as it becomes overly stimulated to seek out financial gain at all costs. There is something about boom times that overly excites people, and perhaps some people more than others, to seek out thrills and risk to the exclusion of other human pursuits. Part of this process is simply being exposed to an up-tempo pace of life that becomes unconsciously infectious. Consider the effects mentioned above of up-tempo music and conversation that is less substantive as well as the neglect of personal relationships that anchor a person inducing feelings of care and responsibility. Another source of stimulation is likely to found in seeing others making large sums of money or seeing the conspicuous consumption in which they so publicly indulge. One feels the pressure to keep up or lose out. Even if one is not so materialistic or status conscious, one finds that over time, housing and other necessities are priced out of their reach so that they are pressured into entering the competitive fray or risk losing a certain social and material minimum. So, even if people are naturally greedy in what they are capable of, they can be affected by their surroundings to inflame that passion or to bring it into balance with other human potentials that are equally present in their make-up. It seems that boom times stir only one aspect of what people are capable of, viz. excitement, accomplishment, and taken to unhealthy extremes, greed, lust, lust for power. Qualities that are foregone in this milieu include those fostered by human needs for tranquility and transcendence such as depth, intimacy, reflection, understanding, style, beauty, conservation of the natural or cultural world in which people live, appreciation, savoring, dwelling, love, friendship, godliness, faith, honor and integrity. These goods that we humans have the potential to cultivate are less likely to be developed at breakneck speeds. These other pursuits require the time and quiet that is less possible during times when people are feverishly stimulated to act in the moment or risk feeling that they have lost out on some grand opportunity.

For some reason, people in the past, for example in the last “Gilded Age” or the Renaissance, capitalism fueled a cultural, scientific, artistic, literary, educational, and philosophical explosion. People demanded greater freedom to express themselves in responsible and creative ways. For some reason, as economic growth as expanded opportunities for people in recent decades, it seems that only in the scientific and technological areas have we witnessed the responsible and fruitful expression of human potential. The popular culture of one-hundred years ago far exceeds what we are subjected to nowadays. We simply do not produce or, if they are out there, honor people such as Enrico Caruso, Sarah Bernhardt, Picasso, Oscar Wilde, and others who shaped the popular mind of a generation 100 years ago. Now freedom is confused with license and irresponsibility. It might take another depression to begin to require more of the young who have shaped popular culture with their free time, interests, and independent sources of income that were not so prevalent in the past. The unbridled expression of sexual impulses of any sort, the coarseness that results from constant stimulation seeking even more and more extreme intensities of stimulation, the depersonalizing effects that these raw pursuits of pleasure have on people over time are more likely to be moderated and redirected if people feel the press of constraints on their actions. Limits in accessibility to increasing amounts of stimulation as well as more time to absorb the subtleties produced by more delicate pleasures distill the human psyche so that it is more receptive to the higher end of the diminishing marginal utility of pleasure curve. In this process of slowing down and focusing more on what there is less of, a chance to refine tastes can occur.

Charles Sanders Peirce, writing one hundred years ago, coined an intriguing triplet of what he termed, “Firstness,” “Secondness,” and “Thirdness.” Firstness is the pure experience without reflection. Peirce goes so far as to characterize it as “blind compulsion.” Secondness is when one hits a roadblock or feels jolted from his immediate expectation of what he is experiencing as one bumps into actuality. Secondness is reaction to a cessation or interruption of pure experience. Thirdness is the reflection upon the loss of immediacy in firstness and the frustration or shock of encountering secondness. Without secondness, we would never reflect and reconsider ourselves, others, or our environment. We would be like mere animals. Thirdness is where we develop intellectually, emotionally, and spiritually. Culture, customs, laws result from thirdness. It is the shock and disappointment of secondness that makes development possible. As Peirce comments, “Secondness is existence.” Recessions and depressions can serve as the necessary secondness that jolts us out of our protective cushion created by excessive wealth forcing us to look at ourselves and the world around us as it is, not as the fantasy we have deluded ourselves into as we were stuck in unabated pursuits of wealth and euphoric splurges of consumption. This is the main reason that I oppose bailouts per se. They only protect us against secondness and thirdness, where our personal development can unfold.

As we become mired in only firstness, we are prone to become inauthentic. To the extent that we think of ourselves and others at all in any substantive way, we tend to overestimate ourselves and overlook the flaws of others to avoid conflict or discomfort. I am afraid that type of person shaped by the business ethos of cooperation at any cost, as long as I am making money, is corrosive to truth. While there is a role for buying and selling goods and services and seeking common ground in business transactions, the truth need not be sacrificed. But if one’s only goal is to make money and to buy an easy life, then it is all too easy to sell one’s integrity to enter the dream world of unrelenting firstness. We can see how and why a drug culture has emerged in a generation growing up in affluence. The price to be paid, if one can manage to achieve this chimera, is honesty. I mean the honesty to see oneself as who one is, to see others as they are, not as we wish they were, and to see the world, socially and naturally, as it is. Recession or depression can reintroduce reality into a person’s experience so that they can live in the world and with others as they really are. Authentic people tend to be raw at times. This feature may be bad for business in a particular moment as well as very politically incorrect, but over time, it is what makes us human and leads to genuine freedom.

We can especially see this type of self-deception in a person’s relationship with God. As we neglect a sense of the transcendent, our relationship with God fades from our direct awareness into obscurity. Blaise Pascal noticed that people go further than simply overlooking God. They actively seek to suppress it since the awareness of God is likely to damage one’s sense of self-esteem as well as one’s self-sufficiency—God is holy and I am not; God is omnipotent and I am not—I need God and other people. Pascal observed that if people can find the means to do so, they will actively seek to distance themselves from God and then create “diversions” to protect themselves from the recognition that someday they will die and all on earth will be lost to them. If they have rejected God throughout their lives, then they will naturally find themselves in Hell, which is the absence of God. In Hell, God grants them an eternity without his presence as they have chosen in their “revealed preference” for a relationship with him (or lack thereof). Here, once again, we can see the advantage of “the saving grace of a catastrophe” as Judge Posner puts it where “one catastrophe avert[s] worse catastrophes.” We have found that as people encounter troubles, including economic troubles, they are more likely to turn to God. Again, existence is found not in undisturbed pleasure, but in suffering and disappointment. That is, if people choose properly in the respite of thirdness as they take time to reflect on their spiritual standing before God. Depression, the economic and even the psychological variety, can provide this respite from the frenetic activity produced by a financial bubble.

[Reader]

".. The fall in the price of oil has reduced the wealth of the oil-producing nations—a goal that should be central to U.S. foreign policy ..."

The goal of the US is to reduce wealth of countries we don't like? "Good guys - bad guys" economics?

[Jim]

I agree with Chris Graves in large measure. In addition might I suggest that economists consider moral implications in their musings and pronouncements. They might begin with the principalist theory of autonomy, beneficience, nonmalefecience and justice but as you know there are other theories of morality which could be considered. I am sure that should they include "morality" yhey would be accused by their collegues of "polluting the art (not science)".

[neilehat]

Vince, Are you guys still advocating that tired old regressive tax scheme of equality of tax. Say five percent on the dollar. So what's the percentage of tax on the gross income of say 5,000 dollars a year versus 21 million? The Progressives killed that off years ago with a progressive tax scale.

Get with the program, what I'm advocating goes beyond an archaic Income Tax structure and reformulates it on a whole new basis. Fitting in perfectly with the likes of the new Heterodox Economic Systems. Such as Thermoeconomics, Bioeconomics, Ecological Economics, etc.. Welcome to the New School Of Economic Theory, tailor fitted to the needs of the 21'st Century, not the 19th or 20th. As some wise man once said, "It has come time to think anew and act anew."

[Brian Davis]

Dan, before this thread succumbs to the archives, be advised that if Congress chose to float ruinous debt in furtherance of the public welfare, they could confiscate any private property deemed necessary to back repayment as a function of constitutional full faith & credit. To elide individual property owners' Fifth Amendment "takings" claims, Congress could issue scrip as compensation to the (former) owners. New Deal precedents like the Gold Clause Cases (1930's) opened the door to the United States of Argentina, even Cuba, if that's where our elected politicians decided to take us.

Assume nothing beneficial to your standard of living or your economic opportunities from federal government bailouts, past, present, or prospective. This is dangerous stuff.

[St. Darwin Assisi's cat]

"pretty dresses and fancy cars" -- such Posner writing. Where is Maureen Dowd when we need her. It is quaint for Judge Posner to believe there are silver linings to a 2008/2009 depression. We stand from where we sit. The comments to this post are educational. Becker is more realistic and down to earth about this situation. Glad to see JP is using the word depression rather than recession. What good are economists anyway? To me it seems they are just educated authors. Judge Posner pretty much hit it on the head when he said that the 'economists' didn't see this coming....like they are some special periodic table of the element product unlike the rest of us. (Lawyers like to think this way, like they are the only ones who can think and whose opinion matters.)

[Chris Graves]

Saint, what we need now is more pretty dresses on femmes who like to look pretty. For years now, many women as well as men have let their appearance go to pot. That general sloppiness could come from the success of the computer industry, not known for their sense of style. It could also come from the influence of people seeking the lowest price and forgetting about quality as well as the opportunity cost of fixing oneself up to go out. I suppose it is part of the social slack that needs to be worked out of the system. That is another reason that we need a correction.

I am thankful for Judge Posner's lack of PC awareness. Part of the joie de vivre is to admire pretty girls.

[Dan]

Brian, if Congress tried to take the 401(k) retirement savings of the Baby Boomers and give it to Social Security, we would see a Grey Panthers revolutionary movement that would put the Black Panthers and Weathermen to shame.

I see little old ladies detonating remote devices with their "I've-fallen-and-can't-get-up" necklaces, seniors engaging in drive-bys via three-wheeled scooters, a retired Air Cav officer looking at the smoking wreckage of Washington saying, "I love the smell of joint balm in the morning!"

So if you're going to talk about raw political muscle, my money is on the American elderly, not Congress.

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".. The fall in the price of oil has reduced the wealth of the oil-producing nations—a goal that should be central to U.S. foreign policy ..."

what is this kind of foreign policy? we people all belong to this globalized economic earth. usa should responsible more than any other country else as the greatest power we are of.(ED Hardy,ED Hardy)

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