Obama's State Capitalism: A Failure of Modesty

Michael Barone

8/12/2010 12:01:00 AM - Michael Barone

"The pace of economic recovery is likely to be more modest in the near term than had been anticipated." Those were the carefully chosen words of the Federal Reserve Board after its meeting Tuesday. Translation into English: We wuz wrong.

So were a lot of people, including departing White House economics adviser Christina Romer, who wrote that the Obama Democrats' February 2009 stimulus package would hold unemployment below 8 percent.

It wasn't just administration spokesmen who expected a solid recovery. California economist Bill Watkins in newgeography.com recalls a conference last fall in which all the other economists presented rosy scenarios and only he forecast extended malaise. He was relieved that his colleagues didn't pelt him with tomatoes.

It's easy for Republicans to make partisan hay of all this. They can point out, as Bush administration economist Larry Lindsey does in the Weekly Standard, that the congressional Democrats' stimulus package was not the timely, targeted and temporary measure recommended by national economic director Larry Summers.

They can add that the threat of pending regulations interpreting the health care and financial regulation bills and of pending tax increases as the Bush cuts expire have created a climate of uncertainty in which consumers don't consume, banks don't lend and businesses don't create jobs.

All true. But in this summer of unrecovery, it's still important to understand how so many smart people got so much so wrong.

One answer comes from economist Arnold Kling writing for american.com. Kling argues that the collapse of the housing market and the financial crisis disrupted what had been "a sustainable pattern of specialization and trade" and that we need to let the market economy develop a new one.

Instead, the policies of the Obama Democrats have been aimed at propping up the old order -- holding up housing prices and the mortgage market, keeping the Detroit auto companies in place, maintaining the lush standard of living of public employee union members (the purpose of the $26 billion the House was summoned back to Washington to approve Tuesday).

Maintaining unsustainable patterns of production, Kling writes, prevents the trial-and-error process of private investment that creates new jobs and patterns of production that will be sustainable.

Across the Atlantic, Marc De Vos, director of the Itinera Institute, a Brussels think tank, advances similar arguments in his book "After the Meltdown." The financial crisis, he argues, has brought a revival of "state capitalism," in which governments "have an increased and distorting role in economics."

"The state should be the partner of the market, not the owner or manipulator of the market," he writes. "Governments should not pick economic winners and losers. The state may be back, but the politicians should be modest."

Modesty, unfortunately, is not the dominant character trait of a president who predicted that his election would be seen as "the moment when the rise of the oceans began to slow and our planet began to heal."

But facts are stubborn things. The fact that the private sector economy has not responded as administration economists expected and confidently predicted should be a wake-up call.

It shows the limits of expert knowledge and the ability of political actors to make optimal economic choices.

The intellectual firepower of this administration may be high. But so was the intellectual firepower of the postwar British Labour governments that nationalized steel, auto companies and the railroads.

That didn't turn out so well, and for decades, the British economy lagged behind those of America and its European neighbors. State capitalism has been tried before. It didn't work.

Market capitalism works better because it doesn't depend on one set of actors to make all the choices. Entrepreneurs with a vision for the future can take their chances, and most may fail. But some will turn out to be Bill Gates or Steve Jobs, who change our world in ways that 99 percent of economic experts were unable to predict.

In the meantime, American voters seem prepared to return a negative verdict on the Obama Democrats' version of state capitalism. Bailout favoritism and crony capitalism, it turns out, are not vote-winners.

The open question is whether Republicans will present and advance public policies that leave the way open for market capitalism to find its way to a new sustainable pattern of production, as it has done before. Let's hope for that kind of change.