Is there such thing as a free lunch after all?
There’s nothing quite so dangerous as a counter-intuitive idea that is sometimes true — especially if it promises the seemingly impossible.
For instance, what if you could cut taxes and as a result raise tax revenues? It’s a theory that’s tantalised the free market Right for decades — as depicted by the famous Laffer curve (and contained within the wider theory of supply-side economics).
The theory isn’t always wrong. Onerous tax burdens act as disincentive to productive activity. So when rates are very high, cutting taxes can increase revenues by making hard work and bold investment worth the effort.
So here we have a concept that promises a substantial reward, that is demonstrably true in some circumstances and which is sufficiently hard to grasp that getting your head around it provides an ego boost.
When you’ve got a cool weapon like that in your ideological armoury, it’s likely to be overused. Which it has been — especially in the United States.
However, it’s not just the free market Right that’s prone to this sort of magical thinking. Lately, the Left — and not just the hard Left — has had its head turned by Modern Monetary Theory. This is the idea that most limits to what governments can spend are illusory because a state in charge of its own currency can simply create the money it needs. The only real limit is the build up of inflationary pressure, but this can be dealt with using taxation to manage the level of demand in the economy.
So again, there’s the mind-blowing concept; again, there’s the tantalising offer of a seemingly impossible benefit; and again, there is some evidence that there is such a thing as a free lunch (after all, we’ve had a decade or more of rampant money printing by the central banks and we’ve got away with it so far).
In a brilliantly provocative thread, Ricardo Reis of the London School of Economics argues that the pet economic theories of Left and Right have a lot more in common than either side would care to admit. Both are based on a valid insight, but then used as an indiscriminate political battering ram:
Reis hopes that Modern Monetary Theory will follow the path of supply-side economics and eventually calm down:
Of course, this is an academic perspective. In the political world the tax cutting mantra continues to corrupt conservatives — and I fear that MMT, in its crudest form, is likely to addle Left-wing brains for many years to come.
Finally, while we’re poking fun at the extremes, we shouldn’t forget that mainstream economics is itself built on concepts which are valid only in some circumstances. I’m talking about really basic stuff like efficient markets, rational agents and perfect information.
Increasingly, we’re realising just how rarely these assumptions apply to reality. The fact is that markets are often inefficient, that people are frequently irrational and that we live in a world of radical uncertainty.
Any economic theory — whether of Right, Left or Centre — that doesn’t start from a position of epistemic humility has a lot of growing up to do.