Are you right? Or .... left?

Once upon a time, the world was ruled by just a few powerful people called “King” and “Queen”. That period was called “Feudalism”. However, the system did not function well. There had been many revolutions around the world, but little success. Everybody was waiting for a big change, a new solution and a hero to come and help them. In 1776, the hero appeared. His name was Adam Smith. His ultimate weapon was the legendary sword “The Wealth of Nations”. Many great warriors followed him, such as David Ricardo, JB Say, J.S. Mill, … Together, they put the end to the “Feudalism”, and built a new country: “Capitalism”. Its capital was called “Laissez-Faire”. The founding fathers are now considered as “Classical Economists”. The country developed rapidly and almost dominated the world. But just 150 years later, a disaster came and changed everything. In 1929, the world suffered from the Great Depression. Adam Smith successors failed to predict it and help the world recover. When the traditional “doctors” failed, there came a new one: J.M.Keynes. After rescuing the world, Keynes invaded the “Laissez-Faire” capita and destroyed it. “The End of Laissez-Faire”. However, Keynes was not a Saint. There were many people who didn’t see eye to eye with him. One of them was Hayek, warrior of Liberalism. Since that time, the world was divided into 2 sides: the right and the left. The right represents Classical Economics and Hayek. The left advocates Keynes. Welcome to the greatest battle in economy, the battle between the right and the left.

So, who is the right? And who is the left? To what extent are they different from each other?

The Right: representatives of Liberalism.

The left: Laissez-Faire hit man.

+On market efficicency

The right sees people as largely rational, doing the best they can given the constraints they face. One of their jokes goes:  “An economist walking on the street suddenly found a $100 on the street. After thinking for a while, he continued walking, not taking the money.” Why? Because he believed that everybody was rational. How come there was a $100 on the street? The money must be fake or a trap. Otherwise, someone must have taken it already. One of their members, the Chicago School, is the father of one of the most influential theories used in stock market: Market efficiency. We cannot beat the market. There are no such things as stock experts. In stock market, we can only win if we have information that other ones do not have [asymmetric information]. Otherwise, we are all just lambs of God, betting on our fate and luck.

The left sees people making SYSTEMATIC errors and believe that it is the government role’s to protect people from their own mistakes. The left believes that systematic errors are the root of the so-called “bubble” in economy.  A bubble is somewhat similar to Ponzi Pyramid. When a commodity receives too much attention, a bubble appears. Then when some investors decide to sell out, the bubble bursts. The most common commodity bubble in the economy is in the real estate market [we can witness it in emerging markets such as China, Vietnam, Russia, …]

The right sees competition as a pervasive feature of the economy and market power as typically limited both in magnitude and duration.

The left sees large corporations with substantial degrees of monopoly power that need to be checked by active antitrust policy.

+On market failure: externalities and monopoly

The Right sees externalities as an occasional market failure that calls for government intervention, but sees this as relatively rare exception to the general rule that markets lead to efficient allocations.

The left sees externalities as more pervasive.

+On Government’s role

The right: Warriors of Laissez-faire. The right sees government as a terribly inefficient mechanism for allocating resources, subject to special-interest politics at best and rampant corruption at worst. To them, the government should do … nothing in the economy. Ideally, all they have to do is only about national defense. If government has to intervene, it is just because the economy is suffering from so much externalities and monopoly. [Wait, the idea of completely no government is somewhat like idea of ideal socialism, if I’m not wrong]

The left sees government as the main institution that can counterbalance the effects of the all-too-powerful marketplace.

On budget

The right: there should never be budget deficit.

The left: government should run a budget deficit in crisis. In the period of booming economy, the budget should be surplus. It means more government spending in crisis and less spending when the economy is good.

On solving crisis

The role of government also appears in the way these 2 schools deal with crisis.

What should government do in order to help recover the economy?

The right: generally, nothing. If the crisis results from budget deficit, all the government helps to do is to balance the budget. Otherwise, they should do nothing and pray. Or they can invest more in technology, in order to increase productivity.

The left: tons of things to do. First, run a trade deficit. Second, inject money into the economy. Third: more regulation for the financial sector. Fourth, increase government expenditure. Why? To stimulate the aggregate demand. It is better if the private sector increases the aggregate demand than the government [because of government corrupt]. But in a crisis, hardly anyone wants to spend more [though it is the best way to help the economy. How “rational” we are].  They want to save. Keynes cannot wait till the consumer expectation recovers. So, the government should do it itself. Increasing government expenditure in crisis is not only a way to help raise aggregate demand but also a signal to the market implying “Hey, we will go to great length to clean up this mess”.

There is one last issue that divides the right and the left—perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it?

If you side with the Right, you advocate Laissez-Faire. You believe large deadweight losses associated with taxation and, therefore, are worried about the growth of government as a share in the economy. It means you will vote for the candidate in the president election who will cut the tax of the rich, so that resources are allocated more efficiently.

The left sees smaller elasticities of supply and demand and, therefore, is less worried about the distortionary effect of taxes. If you are rich, I suggest you should not side with them because they have tendency to raise tax on you.

Now, I guess you all realize some significant differences between these schools. The right believes that supply curve rules. The left, in contrast, believes that demand plays a more important role than supply does. But which is better? The right or the left?

There is no exact answer for this question. There has been a debate over this for many years. The right introduces us to an ideal world where everything works correctly and human is rational. No one can deny that Laissez-faire together with market mechanism is the best way to allocate resources. On the contrary, the world, to the left, is less perfect. Human is irrational. Human is greedy. One’s luck can be other’s misfortune. So, it is necessary that government intervene, counterbalance the effects of the all-too-powerful marketplace. But too much government intervention often leads to central-planning government, or say, to some extent, part of socialism [though it has never been Keynes’s idea]. These schools are not wrong. They are not completely right, neither. To decide which theory is better, it is important to take the economic conditions into account. It means sometimes the left is right and sometimes the right is right, depending on the economic conditions. The battle between the right and the left in economy will never finish. It is like the battle between religion and science, materialism and idealism, capitalism and socialism. Not until a new theory appears and wipes out all the recent concepts and belief can these battles end. Every coin has 2 sides, and so do theory, concept and belief.

May, 2011.

Kz.

Special thanks to professor Greg Mankiw.

For you.

[If you are wondering what side you are with now, imagine you are facing a problem. If you think of a solution related to the demand side such as increase or decrease demand instead of a solution to raise output, productivity, or say, the supply side, you are a Keynesian. Most of Keynesians belongs to the left.]