Economists of all stripes for the last generation have demonstrated their audacity time and time again, holding dearly onto their attempts to make Economics a hard science. Though good intentioned, the attempt to convince everyone that economics is a hard science has likely caused as much trouble as organized religion has in the last era.
Prior to the 1850s, economics, as we know it today, operating on a national and international scale was never considered a science, but was rather considered a speculative study rooted in politics, philosophy, psychology, and accounting -- the strict, arcane, and often impenetrable mathematical language was hardly seen in the literature until more modern times. Economics derives its name from the Greek word oikos which means household, and originally meant the study of optimizing the household, its limited resources, its labor, and its production. The economics of nations took on the more prudent term of political economy, which studied the distribution of wealth and power, as well as the linkages between the two. Adam Smith's treatise was acknowledged to help convince Great Britain, by then a great mercantile economy buckling under the weight of its own possessions, that free trade was far superior than protected trade. However, though Smith's "liberal" treatise turned out to be useful for the British Empire at the time, it was never accepted as doctrine by other political economists or government ministers, though "on the margin" it did improve efficiency.
Economics took its turn towards ideology with the development of Marxist economics, which advocated that labor was the fundamental unit of analysis in economics or the fundamental concern, rather than taking into account a mix of capital, labor, rent, and raw materials among other factors. With the rapid development of physics, and the illumination of sciences such as chemistry and phenomena such as electricity which had previously been considered by the ignorant to be magic, witchcraft, and therefore evil, it is understandable that economists wanted to follow suit and formulate hard rules based on simple mathematical relations. Unfortunately, this spelled disaster for the world, unseen since the rise of the wars of religion.
Marxism could not admit any other information into its program of analysis, and the result was that nations which took on Marxism as its ideology could not tolerate the existence of non-Marxist states in the world. Hence the communist international which dedicated itself to overthrowing all imperial-capitalist states in the world, and the long wars between the Soviet Bloc and the "Free" world.
Though western economists did not attempt to create a monolithic study of economics, as the western tradition of liberalism and tolerance had taken root by then, they too were infected with a desire to turn economics into a science with hard and fast, inviolable mathematical rules. While the economists themselves often qualified their analysis, and did not take their prescriptions as doctrines, the generalists and common minds who took their advise did not always understand the limits and caveats present in their analysis and equations.
In contemporary times, we can see this operating on the two parties, with a net cost to the flexibility of the real economy. A cursory survey of the branches of economic thought which have guided our national policies over the last generation demonstrates the difficulties faced by politicians and peoples who use economics as an ideology. These schools of thought include Liberal and Neo-Liberal Trade Theory, Keynesian Theory, Supply-Side economics, and Austrian Economics.
Regan's policies were based on supply side economics, or the trickle down theory, in which he believed that by cutting taxes and putting money into the hands of those who were "the most" productive (the rich and the corporations) the economy would grow and the middle and lower classes would naturally benefit from the wealth of the upper class. While the American economy as a whole did benefit during his Presidency, and Supply sider's claimed the same sort of Pyrrhic victory which Alan Greenspan later also claimed, the facts are that there were too many confounding factors for any serious economist to believe that Regan's policy choice was the key to American prosperity.
Some of these factors include the end of the Cold War, which many claimed proved the superiority of Regan's political moves, though it was more a demonstration of the result economic ideology can have upon a political and social system. The Soviets had suffered under a centralized, Marxist system of state capitalism for move than 5 decades, and the distortions in the economy had long ago sapped the morale of the managers and workers who saw that everyone was equal, though some more equal than others. Furthermore, Paul Volcker, had also set the stage for prosperity after a period of high inflation and low economic growth, by raising interest rates to double digit percentages. This forced capital to flow back into the United States in search of higher returns and laid the foundation of capital accumulation which Regan unleashed through his low tax and high debt policies. By borrowing from future generations and enriching his contemporary electorate, he was celebrated for making "Morning in America again." However, by bringing about the dawn of America, he also set the stage for the dusk and night we are currently experiencing.
The free-market ideology of the Republican party, and really both Parties in the last generation, was just that, an ideology. There was a false attribution of ideology to fundamental structure and circumstance. The fall of communism, the reform of China, and the rise of semi-conductor technologies had more to do with the economic growth seen in the last generation than supply side economics. These technological foundations occurred during an economic tightening which forced individuals to be more productive with scarce capital. When the cost of capital was lowered through Regan's policies, the innovations were unleashed with a fury.
Unfortunately, the low cost of capital for an entire generation has encouraged what low cost capital also encourages: inflation and speculation -- both forms of capital destruction. By the end of the generation, we have seen the results of capital destruction, with a domestic economy which is based on drugs, ordinance, and finance as the major exports of the US. This, ironically, mirrors the structure of North Korea which exports more counterfeit drugs and US dollars than any country, and is also a leading arms producer. Of course, this is an exaggeration since the US economy is also highly diversified and produces legitimate drugs and legitimate (at least legal tender) US dollars.
The Bush years of ground wars helped to fuel the boom by stimulating the manufacturing industry at home, whose capital was heavily invested in the production of weapons. This war stimulus, as measured by GDP, which does not measure total productive capital formed in an economy, but rather total economic activity regardless of whether it is capital destroying or capital creating, helped the economy continue to appear prosperous despite the massive amounts of capital destroyed by the internet bubble. The War bubble sustained the US until the Real Estate Bubble could take hold.
However, with the pop of the real estate bubble, neither monetary, nor foreign policy could sustain the economy, which by the middle of the last decade had consumed much of its capacity to grow in a healthy sustainable manner. Thus, the final answer available was seemingly a Keynesian stimulus, which adherents of Austrian economics vehemently argued against. While the stimulus did spare the world from a single shot of painful "shock therapy" the term used by the Harvard based economists (many of the same darlings of who currently run the political economy of the US) for the disastrous policies undertaken by the newly democratized soviet bloc. Ironically, the manner of privatization advocated by these economists would have greatly pleased the tea-party, with the sudden withdrawal of the state from the economy. The end-state was a gangster state. The countries which did not follow economist's advise -- the reformed Marxist states in the east, turned out to have done pretty well, though if the laws of physics are correct, the managed economy of China will likely take a hard tumble at some point along its growth.
The Keynesian stimulus was disappointing, effective, but disproportionately costly for America, likely because though it did spare much pain to the economy, it also spared the rotting sectors of the economy from its inevitable destruction. Yet, a libertarian, free market approach, in such a complex economy would likely also have led to disaster. The problem with the Keynesian approach was that it rewarded cancerous sectors of the economy, without forcing the changes needed to spur innovation and private initiative. China, which had taken a gradualist approach towards decentralizing its economy, succeeded because it did unleash individual initiative, and provided laborers with access to capital to a far greater degree than before, though in China, this meant that villagers could make decisions about their own land, or where to market their vegetables, rather than the far more complicated reforms and access to capital on an individual scale our own economy needs.
Consider the structure and incentives of the current economy. Capital is by and large controlled by large, hierarchical, command style organizations which operate in a manner quite similar to the soviet bureaucracy, though market transactions do occur between firms. However, within firms, individual initiative is largely constricted by diktat, and promotions to the highest levels are based as much upon an individuals merit, as his connections. This extends to the capital markets in general where an individual or firm is often granted access to bank capital or venture capital, more because of his or her connections (ivy league education, banking experience, etc) than the merit of their idea. While to some degree, this is more efficient, in that it reduces the risk to capital destruction (at least theoretically), it also centralizes production and control of the "heights of the economy" to a very specialized class with a homogeneous experience and mindset. This works spectacularly well during a boom, and spectacularly poorly during a bust, creating a herd mentality which is difficult to break, even with the most "diverse" workforce available.
While those who are able to find positions within the economic bureaucracy of America enjoy relative security, with foreign markets available for conquest, individual initiative is slowly choked off, as innovations in the economy require amounts of capital which are out of reach from the common inventor operating out of his or her garage. Though some successes have occurred such as facebook, and groupon, nothing has fundamentally altered the economic base since the invention of the internet.
A tax cut, and a cut in spending will not create more jobs. A tax cut will only further concentrate wealth in the hands of those who have lost the ability to innovate as they chase after careerist incentives which mirror the nomenklatura system. Those who do have the incentive to innovate likely do not have much income to begin with. Taxes are only relevant when one is making money. A cut in spending will decrease the fertility of the people from which innovative ideas spring, since they will be too busy trying to find the next hustle to think of any sustainable ideas or a small scale, capable of changing their communities or satisfying the needs of their neighbors, since most of their neighbors will be busy trying to satisfy their most basic requirements.
The US and the world economy has reached a state which has maximized its level of production within the confines of the current level of technology. Some might even argue that the current state of technological development has also leveled off because it too has reached its maximum capacity within the structure of the economic system. Further stimulus and centralized redistribution will be just as useless as a general tax cut, since both only serve to solidify the current uneven distribution of capital within the hands of the least innovated, and most removed class of individuals. When individuals who are most removed from the needs and preferences of the consumer, are running the economy, the economy becomes warped, and distorted, and serves the least number of individuals in a household.
In a dynamic system of 3 factors or more, simple relationships and cause and effect becomes invalid. However, economists continue to operate on a linear regression mode of thinking which led the vast majority of economists to believe the US housing market would never decline. When a dynamic system reaches its tipping point, the changes are sudden and drastic, as we will all begin to witness with respect to the climate system. Because the current system is unlike any other in the past, though it is also similar (the key characteristic of a dynamic system), the past ideological economics will likely fail in its analysis of how to proceed. However, one general rule of thumb, seems to hold true throughout economic history: decentralization during periods of economic crisis has often resolved the contradictions in an economy and allowed the economy to progress forward.
This is why I would advocate a reform which lowers information costs and creates a parallel banking system of decentralized capital for small scale innovation while preserving the current large scale command corporations. By taking a gradualist approach to economic reform, without subscribing to either the fundamentalist policies of the Right or Left, private initiative may once again be unleashed among the underemployed and unemployed of our society without destroying the productivity of those who are entrenched in the current economic system. However, this cannot be achieved through taxes or regulations of current banks, since this only tweaks with a system that is already ossified and mature, and does not change the production possibility frontier (PPF in economics jargon) which determines the theoretical capacity of an economy. Instead, it only pushes us closer to the theoretical limit, which we have already reached. Only by creating fundamentally new forms of finance, and capital distribution can we expand the PPF, and make the economy grow rather than simply expand (boom) and contract (bust) around a steady state.
In many ways, the technological innovations of the last generation have paved the ground for such an innovation, since information is now free to flow to almost any individual with the motivation to look for it. The infrastructure of decentralized economic decision making (the internet) is well developed, and has already created revolutions in the retail sector which has allowed anyone to become a merchant or speculator. However, the opportunities for decentralization must be expanded to the production sector. A microfinance system for the developed world would go a long way towards unleashing the private initiative which has saved the US economy time and time again from the edge of ruin, without destroying the progress in social welfare or the developed sectors of the economy which economic fundamentalists are dangerously advocating these days. Whether the country is willing to make such a reform in the economy is a question which remains shrouded in the fog of the future. The outcomes though, are certain: either we follow the course of stagnation and collapse, or we follow the course of innovation and prosperity. Despite the obvious desirability of the latter course, history shows that the former course is far more likely for a well developed civilization -- particularly one which has a Republican form of government that has developed unshakable foreign and domestic interests.