Egypt PM, Japan's JBIC head explore deeper cooperation    Egyptian pound wavers vs. USD in early trade    SCZONE showcases investment opportunities to eight Japanese companies    Egypt urges Israel to accept Gaza deal amid intensifying fighting    Egypt, ADIB explore strategic partnership in digital healthcare, investment    Egypt's PM meets Tokyo governor, witnesses signing of education agreements    Egypt welcomes international efforts for peace in Ukraine    Al-Sisi, Macron reaffirm strategic partnership, coordinate on Gaza crisis    Egypt's Sisi, France's Macron discuss Gaza ceasefire efforts in phone call    Contact Reports Strong 1H-2025 on Financing, Insurance Gains    Egypt, India's BDR Group in talks to establish biologics, cancer drug facility    AUC graduates first cohort of film industry business certificate    Egypt to tighten waste rules, cut rice straw fees to curb pollution    Egypt prepares unified stance ahead of COP30 in Brazil    Egypt recovers collection of ancient artefacts from Netherlands    Egypt harvests 315,000 cubic metres of rainwater in Sinai as part of flash flood protection measures    Egypt, Namibia explore closer pharmaceutical cooperation    Fitch Ratings: ASEAN Islamic finance set to surpass $1t by 2026-end    Renowned Egyptian novelist Sonallah Ibrahim dies at 88    Egyptian, Ugandan Presidents open business forum to boost trade    Al-Sisi says any party thinking Egypt will neglect water rights is 'completely mistaken'    Egypt's Sisi warns against unilateral Nile measures, reaffirms Egypt's water security stance    Egypt's Sisi, Uganda's Museveni discuss boosting ties    Egypt, Huawei explore healthcare digital transformation cooperation    Egypt's Sisi, Sudan's Idris discuss strategic ties, stability    Egypt to inaugurate Grand Egyptian Museum on 1 November    Greco-Roman rock-cut tombs unearthed in Egypt's Aswan    Egypt reveals heritage e-training portal    Sisi launches new support initiative for families of war, terrorism victims    Egypt expands e-ticketing to 110 heritage sites, adds self-service kiosks at Saqqara    Palm Hills Squash Open debuts with 48 international stars, $250,000 prize pool    On Sport to broadcast Pan Arab Golf Championship for Juniors and Ladies in Egypt    Golf Festival in Cairo to mark Arab Golf Federation's 50th anniversary    Germany among EU's priciest labour markets – official data    Paris Olympic gold '24 medals hit record value    A minute of silence for Egyptian sports    Russia says it's in sync with US, China, Pakistan on Taliban    It's a bit frustrating to draw at home: Real Madrid keeper after Villarreal game    Shoukry reviews with Guterres Egypt's efforts to achieve SDGs, promote human rights    Sudan says countries must cooperate on vaccines    Johnson & Johnson: Second shot boosts antibodies and protection against COVID-19    Egypt to tax bloggers, YouTubers    Egypt's FM asserts importance of stability in Libya, holding elections as scheduled    We mustn't lose touch: Muller after Bayern win in Bundesliga    Egypt records 36 new deaths from Covid-19, highest since mid June    Egypt sells $3 bln US-dollar dominated eurobonds    Gamal Hanafy's ceramic exhibition at Gezira Arts Centre is a must go    Italian Institute Director Davide Scalmani presents activities of the Cairo Institute for ITALIANA.IT platform    







Thank you for reporting!
This image will be automatically disabled when it gets reported by several people.



The unreality of the "real" business cycle
Published in Daily News Egypt on 25 - 01 - 2009

LONDON: Testifying recently before a United States congressional committee, former Federal Reserve Chairman Alan Greenspan said that the recent financial meltdown had shattered his "intellectual structure. I am keen to understand what he meant.
Since I have had no opportunity to ask him, I have to rely on his memoirs, The Age of Turbulence , for clues. But that book was published in 2007 - before, presumably, his intellectual structure fell apart.
In his memoirs, Greenspan revealed that his favorite economist was Joseph Schumpeter, inventor of the concept of "creative destruction. In Greenspan's summary of Schumpeter's thinking, a "market economy will incessantly revitalize itself from within by scrapping old and failing businesses and then reallocating resources to newer, more productive ones. Greenspan had seen "this pattern of progress and obsolescence repeat over and over again.
Capitalism advanced the human condition, said Schumpeter, through a "perennial gale of creative destruction, which he likened to a Darwinian process of natural selection to secure the "survival of the fittest. As Greenspan tells it, the "rougher edges of creative destruction were legislated away by Franklin Roosevelt's New Deal, but after the wave of de-regulation of the 1970's, America recovered much of its entrepreneurial, risk-taking ethos. As Greenspan notes, it was the dot-com boom of the 1990's that "finally gave broad currency to Schumpeter's idea of creative destruction.
This was the same Greenspan who in 1996 warned of "irrational exuberance and, then, as Fed chairman, did nothing to check it. Both the phrase and his lack of action make sense in the light of his (now shattered) intellectual system.
It is impossible to imagine a continuous gale of creative destruction taking place except in a context of boom and bust. Indeed, early theorists of business cycles understood this. (Schumpeter himself wrote a huge, largely unreadable book, with that title in 1939.)
In classic business-cycle theory, a boom is initiated by a clutch of inventions - power looms and spinning jennies in the eighteenth century, railways in the nineteenth century, automobiles in the twentieth century. But competitive pressures and the long gestation period of fixed-capital outlays multiply optimism, leading to more investment being undertaken than is actually profitable. Such over-investment produces an inevitable collapse.
Banks magnify the boom by making credit too easily available, and they exacerbate the bust by withdrawing it too abruptly. But the legacy is a more efficient stock of capital equipment.
Dennis Robertson, an early twentieth-century "real business-cycle theorist, wrote: "I do not feel confident that a policy which, in the pursuit of stability of prices, output, and employment, had nipped in the bud the English railway boom of the forties, or the American railway boom of 1869-71, or the German electrical boom of the nineties, would have been on balance beneficial to the populations concerned. Like his contemporary, Schumpeter, Robertson regarded these boom-bust cycles, which involved both the creation of new capital and the destruction of old capital, as inseparable from progress.
Contemporary "real business-cycle theory builds a mountain of mathematics on top of these early models, the main effect being to minimize the "destructiveness of the "creation. It manages to combine technology-driven cycles of booms and recessions with markets that always clear (i.e., there is no unemployment).
How is this trick accomplished? When a positive technological "shock raises real wages, people will work more, causing output to surge. In the face of a negative "shock, workers will increase their leisure, causing output to fall.
These are efficient responses to changes in real wages. No intervention by government is needed. Bailing out inefficient automobile companies like General Motors only slows down the rate of progress. In fact, whereas most schools of economic thought maintain that one of government's key responsibilities is to smooth the cycle, "real business-cycle theory argues that reducing volatility reduces welfare!
It is hard to see how this type of theory either explains today's economic turbulence, or offers sound instruction about how to deal with it. First, in contrast to the dot-com boom, it is difficult to identify the technological "shock that set off the boom. Of course, the upswing was marked by super-abundant credit. But this was not used to finance new inventions: it was the invention. It was called securitized mortgages. It left no monuments to human invention, only piles of financial ruin.
Second, this type of model strongly implies that governments should do nothing in the face of such "shocks. Indeed, "real business-cycle economists typically argue that, but for Roosevelt's misguided New Deal policies, recovery from the Great Depression of 1929-1933 would have been much faster than it was.
Equivalent advice today would be that governments the world over are doing all the wrong things in bailing out top-heavy banks, subsidizing inefficient businesses, and putting obstacles in the way of rational workers spending more time with their families or taking lower-paid jobs. It reminds me of the interviewer who went to see Robert Lucas, one of the high priests of the New Business Cycle school, at a time of high American unemployment in the 1980's.
"My driver is an unemployed Ph.D. graduate, he said to Lucas. "Well, I'd say that if he is driving a taxi, he's a taxi-driver, replied the 1995 Nobel Laureate.
Although Schumpeter brilliantly captured the inherent dynamism of entrepreneur-led capitalism, his modern "real successors smothered his insights in their obsession with "equilibrium and "instant adjustments. For Schumpeter, there was something both noble and tragic about the spirit of capitalism. But those sentiments are a world away from the pretty, polite techniques of his mathematical progeny.
Robert Skidelsky, a member of the British House of Lords, is Professor emeritus of political economy at Warwick University, author of a prize-winning biography of the economist John Maynard Keynes, and a board member of the Moscow School of Political Studies. This commentary is published by DAILY NEWS EGYPT in collaboration with Project Syndicate (www.project-syndicate.org).


Clic here to read the story from its source.