Cowen on Keynesians on China

Internet debates on economic policy, economic thought, and current events are frustrating. Today’s exhibition: Tyler Cowen on Keynesians on China.

Cowen, of Marginal Revolution fame, recently published a timely essay at the New York Times on how different schools of economic thought interpret the coming economic slowdown in China. Keynesians, he writes,

would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending, or deploy some of its $3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back.

Austrians, on the other hand, would probably suggest that

there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.

There is an interesting point in this essay about Austrian economics perhaps being more applicable in China than in the developed West. But this is overshadowed by Cowen’s subtle bait-and-switch. Keynesians probably believe that Beijing has the tools to stoke aggregate demand, yes. But most sensible Keynesians (and certainly those who Cowen has in mind) also probably believe that stoking aggregate demand is itself not enough to avoid the coming “economic crackup,” for most of the very reasons that Cowen has attributed to the Austrians. Don’t take it me. Get it right from the source from Nouriel Roubini or Paul Krugman.

Maybe these Keynesians would be more optimistic about China’s ability to “bounce back” this if they weren’t so busy observing that the very tools that the Chinese need to employ are made impossible by financial repression, massive corruption, and opaque decision making. But that’s an altogether different conclusion.

Perhaps these Keynesians are focusing merely on the Chinese economy’s ability to avoid a crisis in the short term by stoking aggregate demand, without passing judgment about whether the specific tools employed would be sustainable over the long term. That too is a different conclusion. And after all, we actually know what would happened had China stoked aggregate demand in 2008-09. They did. It worked. In the short term.

Cowen seems convinced that there is some fundamental reason why Austrians can see the reasons for coming ruin in China, but Keynesians cannot, even though he admits that “economists of all stripes agree that China may be in for a spill.” But this does not survive even a cursory reading of Keynesian policies, or of their contemporary advocates diagnoses of China’s problem. It’s a mistake to turn this into a battle between the Keynesians and the Austrians. If China cracks up, it’s not a victory for the Austrians and a defeat for the Keynesians. And similarly, if China doesn’t, both the Keynesians and the Austrians have some explaining to do.