Government Intervention Could Make the Economy Worse

In 1929, the worst depression in economic history began in the United States. It was the Great Depression of the world economy. Stock prices collapsed, the stock market crashed, bank reserves were depleted, and lending came to a halt. As banks stopped lending, companies one after another faced the threat of bankruptcy, and countless people lost their jobs and were driven onto the streets.

In 1930, terrified people made the economic panic even worse by withdrawing bank deposits en masse. In 1931 alone, as many as 2,300 banks failed, and by 1933 the number of unemployed had reached nearly 16 million. The economic panic that began in the United States spread to other countries and pushed the entire world into the abyss of depression until the late 1930s.

Hayek and Keynes, the leading economists of their time, identified the causes of the Great Depression as “the failure of monetary policy” and “a lack of effective demand,” respectively. One side argued that the economy collapsed because the government pursued excessive monetary policy in response to business fluctuations, while the other argued that demand was insufficient relative to overproduction.

The two scholars also presented opposing prescriptions for escaping the Great Depression. This is where so-called “modified capitalism” and “neoliberalism” emerge. Keynes argued that the government should actively intervene in the market to solve problems. Keynes’s economics is called Keynesianism, or modified capitalism. Hayek, by contrast, saw a recession not as “a lack of demand” but as “a process of correcting overinvestment.” In other words, in a market economy, economic expansion tends to produce overinvestment, and the process of unwinding that overinvestment is precisely what a recession is.

“A lack of demand” and “a process of correction” are naturally very different. The former is something that someone must step in and buy as quickly and aggressively as possible, whereas the latter may be compared to the pain of a bird breaking out of its shell. It is painful and agonizing, but it is a process that must be undergone, a stage that must be endured with patience and passed through.

Hayek believed that the incompleteness of human knowledge and the structural ignorance of society can never be fully overcome, and that only prices formed in the market reflect the most rational and comprehensive information. Therefore, he argued that adjustment during a recession should be left to market prices, and opposed government intervention in the market on the grounds that it would only create further distortions.

He also argued that government efforts to reduce unemployment would ultimately distort the allocation of resources and labor and thereby cause mass unemployment. Therefore, rather than intervening in the market for the sake of short-term stimulus effects, the government should focus from a long-term perspective on maintaining monetary stability and preserving market mechanisms. Hayek’s argument became the very foundation of neoliberalism.

When an economic crisis occurs, most countries prefer interventionist policies. However, deliberate government intervention in the market has been the shortest path to wholly unexpected results—the worst possible results. Fiscal and monetary policies aimed at reviving the economy by increasing government spending and lowering interest rates had major side effects and, in the long run, proved to be failures.

Our economy is now facing a crisis of steadily declining competitiveness. Rather than solving the structural problems of the economy, the government has continued to postpone them through interventionist approaches. The lessons of history remind us once again that government interventionism ultimately ends in failure. Without finding a fundamental solution, it seems difficult for our economy to regain its vitality.

Sung-no Choi, President of the Center for Free Enterprise (CFE)

---

Original title: 정부 개입, 경제 더 망칠 수도

Author: Sung-no Choi

Date: 2020-10-15

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=23171