Tuesday, September 27, 2005

Greenspan, economic flexibility and institutional economics

Greenspan just gave a speech about economic flexibility. http://www.federalreserve.gov/boarddocs/speeches/2005/20050927/default.htm

Essentially, he is saying America should respond to an economic shock by doing nothing, especially not protectionism. The economy will take care of itself.

Pretty much what the rest of the world is saying, for example, Australia:


The market loved it, it went up


Of course, the market is people whose interests don’t align with America’s. I get nervous when people like that start reacting favorably to an American officials speech.

Greenspan is right, as far as the domain he is considering (central banking theory).

Another, mainstream branch of economics (new institutional economics) has studied these issues extensively,

Institutions are the social and contractual norms for an economy; the ultimate origin of that invisible hand Greenspan thinks is protecting the markets. New Institutional economics studies the relationships between institutions and the economy.

It is beyond the scope of this blog to explain NIE, (google Greif or Mahgribi to get some ideas) but the upshot is. It’s a “destroy the village to save it “ scenario


Greenspans policies will work., at the cost of abandoning a significant percentage of the American population and destroying the institutions they are part of. Greenspans okay with creative destruction, it isn’t any institutions that affect him, but there remains two questions.

The first is best illustrated by what happened when this sort of policy was applied to the airline industry.



Some customers benefited, some lost. Problem is, the central tenet of a democracy is that all members are equal in the view of the state. Can America survive classifying large numbers of citizen’s institutions as second class, regardless of the good intentions of the policy?

The second is practical. The underclass just has millions of new members added to it. Just how many do we need to add before we end up with an Iraqi style civil war or 1960’s style riots?

I’m scared. I remember the 1960’s riots. They involved a LOT less people than we are talking about here.


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