Marx, Engels, and Keynes; Stalin, Mao, and Greenspan

History is full of politicians and policymakers who justify government policies by invoking political and economic theorists. They often act with good intent. Unfortunately for their citizens, the theories they put into practice often have disastrous results. We need look no further than Karl Marx and Friedrich Engels to see those results.

Marx and Engels promulgated some insightful concepts in The Communist Manifesto. They shed light on the struggle between economic classes, including between the laborers who do the work and the owners of capital who control the means of production. Vladimir Lenin invoked Marx and Engels’ ideas in the creation of the centralized economic system of what would become the Stalinist Soviet Union. Admitting that history is complicated, and that Lenin’s and Stalin’s interpretation and implementation of those ideas were flawed, it still seems fair to say that in its deployment of communist theory, the Soviet Union managed to cause immense suffering and death to large portions of its own population and those of its neighbors, while also threatening to destroy human civilization in possible nuclear war with the United States. Likewise, tens of millions of Chinese suffered grievously under Mao’s disastrous Great Leap Forward and Cultural Revolution, which were partly based on Mao’s interpretation of Marx and Engels. All told, historians estimate that communism in the Soviet Union and China directly caused the deaths of tens of millions of people.

When I ask people why they think communism failed, they usually tell me you don’t get significant economic growth without capitalism because capitalism is the only way to motivate entrepreneurs to start and grow businesses that grow the overall economy. I don’t doubt that’s a major factor. It’s hard to imagine high levels of innovation without a large chunk of the resulting economic benefits flowing directly to the innovators themselves.

But there is a bigger problem with communism: it eliminates the price signal, which is the very heart of economics. Without a system in which consumers and producers meet freely in a market to discover the clearing price of a good, suppliers will have no idea what goods to produce or in what quantity. Ludwig von Mises and Friedrich Hayek, two giants of the Austrian school of economics, highlight the importance of the price signal in works such as Socialism (Mises 1922)⁴² and The Use of Knowledge in Society (Hayek 1945).⁴³ They argue that in a complex economy (which describes the modern world), it is impossible for any individual or group to gain the expertise required for an efficient allocation of all products and services traded in such an economy. On the supply side (the side of the economy that produces useful stuff), such an all-knowing person or group would have to develop deep expertise in the design, manufacturing processes, and supply chain dynamics of every single product and service produced in the economy. In reality, it takes a diligent and intelligent manager of a business decades of experience to master the production of just a single good or service. Yet in order for a centrally planned economy to succeed, there has to be someone or something—a person, a centralized group of government bureaucrats, a software algorithm—capable of applying that kind of expertise to the production processes of all goods and services in the economy, and of being able to assess the aggregate demand for those products and services, including which consumers might use them, how they would be used, and in what quantities. Mises recognized that communism was destined to fail because no planned economy could complete such economic calculations.

Before Mises and Hayek diagnosed this problem, Adam Smith had identified the solution: the “invisible hand” of the marketplace, which uses the price signal to match buyers and sellers, and also drives entrepreneurs and investors to allocate their time and their capital in such a way as to optimize the production and provision of goods and services in order to meet consumers’ demands.⁴⁴ It is the trial and error of independent entrepreneurs, backed by investors motivated by a desire for profits, that drives innovation and also allocates more capital to those goods and services demanded by consumers. As Mises articulated in Human Action, the consumer signals her preferences with her pocketbook, and the entrepreneurial capitalist finds a way to efficiently meet her demand. The surplus created in the process, which accrues partly to the consumer and partly to the producer, enriches society. Any society that lacks the price signal that enables this highly productive system is doomed to poverty.

There is perhaps no better modern example of the critical role of the price signal than China’s rapid economic rise. More people have risen out of poverty and into the middle class in China than in any other country in history. This rapid transformation did not occur by accident. After Mao’s disastrous policies in the 1950s and 1960s, Deng Xiaoping recognized the importance of the price signal and realized that private enterprise was China’s best (and possibly only) route to development. China’s transition toward capitalism began in the late 1970s with Deng’s economic reforms. Having largely completed the transition, China is now a single-party autocracy that allows a significant level of capitalism in order to drive economic growth. Its government is top-down and highly centralized, but much of its economy operates on the principles of the free market. Whether China can innovate at the level of democratic capitalist societies like the United States remains to be seen. But there is little doubt that China has achieved significant economic growth, and that a portion of that growth has been caused by innovative entrepreneurial enterprise driven by both self-interest and price signals.

If Marx and Engels brought us Stalin and Mao, then John Maynard Keynes brought us Alan Greenspan, who served as Chairman of the Federal Reserve from 1987 to 2006. In stark contrast to the economists of the Austrian school, Keynes promulgated the theory that central banks and governments could smooth out the peaks and valleys of the business cycle by actively managing the economy at a macro level.⁴⁵ An economic downturn could be mitigated by increasing government spending (fiscal stimulus) and increasing the money supply (monetary stimulus). Once the economy was back on its feet, the fiscal and monetary stimulus could be removed. Unfortunately, as with communism, the devil is in the details, including the mechanisms and the incentives of those wielding power.

The major problem with fiscal stimulus is painfully obvious. Politicians set budgets. Since they are elected on two-year, four-year or six-year cycles, they have to deliver economic goodies to their voters in real time. And as long as bond markets will support the growing liabilities accrued with deficit spending, the temptation to promise short-term economic benefits to voters is too great. A member of Congress who fails to deliver the fiscal goods to voters now is unlikely to see another term in office. This “pork barrel” problem is well known, and considering the incentives, it’s no surprise that politicians are willing to mortgage the future in order to feed their constituents today. While Democrats and Republicans differ in their approach to deficit spending—Democrats prefer to increase spending on social programs, while Republicans cut taxes and increase military spending—both parties have agreed on the expediency of the government spending more than it collects in taxes.

The political power of the baby boomer generation, which has managed to dominate politics for decades, suck financial benefits out of the system, and leave the younger generations with the bill, has exacerbated the problem. Since one of the reasons I wrote this book was to educate my clients and family members, and since quite a few of my clients and family members are baby boomers, there is a reasonable chance that you, dear reader, are in this cohort. I hope you don’t take personal offense at my characterization of the situation. The vast majority of baby boomers I know are wonderful, ethical, kind, loving people, and that probably includes you. Moreover, I suspect that a large portion of the baby boomer generation isn’t aware of the scale of the wealth it has transferred from younger generations to itself.

One of the most significant future political conflicts I foresee is that between the younger generations and the older ones. While such tension has existed in all societies, the scale of the wealth transfer in this case will likely raise this conflict to a higher magnitude if left unsolved. I can envision a narrative in which the Generation X and Millennial generations come to think of the older generations like their dinner partner who inconveniently goes to the bathroom right before the check arrives.

If ever-increasing fiscal stimulus (deficit spending) were occurring in isolation without the help of monetary stimulus, the problem might find itself contained by the bond market. Investors in government debt (who lend to the government through their purchases of bonds) would demand higher interest rates to compensate for the risk that deficit spending might result in the government’s reduced ability to repay the debt. The cost of borrowing money due to higher interest rates would impose fiscal rectitude and decrease reckless spending sooner rather than later. But budget-busting politicians have had a willing and able partner supporting their spending habits: The Federal Reserve under Alan Greenspan, Ben Bernanke, Janet Yellen, and Jay Powell.