TCS Daily

Seen vs. Unseen

By James K. Glassman - January 6, 2003 12:00 AM

As I write, the U.S. economy has grown 3 percent over the past 12 months (average for the post-World War II period), unemployment is 5.7 percent (also average), and inflation is 1.5 percent (well below average). Those are pretty good numbers. Yet something is clearly wrong. There's no oomph to the economy. Businesses aren't investing in new machines, plants, and technology; consumers and investors are listless. What's going on? Two dead economists can provide some insight.

The first is Frederic Bastiat (1801-1850), whose big idea was this: "In the economic sphere, an act, a habit, an institution, a law produces not only one effect, but a series of effects." Usually, one effect is seen, the others are unseen.

Bastiat's famous example involved a broken window: a kid breaks his father's window. Dad pays a glazier six francs to repair it. The glazier gets six francs in income. Thus, more economic activity! Not so fast. That's the "seen" part. The "unseen" part is that Dad would have used the six francs to buy new shoes, so the shoemaker is deprived of the money. We can call it a wash. But it's worse. If the accident hadn't happened, the Dad "would have spent six francs for new shoes and would have had the enjoyment of a pair of shoes as well as of a window." The "unseen" can be important too.

Now, consider the corporate scandals that broke about a year ago, and the legislative remedies that were enacted last summer. What's "seen" is a new corporate-accounting oversight board, new criminal penalties for misleading investors, and various changes in securities law that are all meant to increase the confidence of investors. What's "unseen" is the effects these reforms have had on corporations: first, the extra costs of complying with the new rules and, second, a more profound unseen effect, for which we need to turn to the second dead economist.

He is John Maynard Keynes (1883-1946), probably the most influential policy intellectual of the twentieth century. Lord Keynes got many things wrong, but one of the things he got right was the intriguing concept of "animal spirits." He wrote:

"Most...of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits -a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."

Animal spirits comprise the forces that impel people to take risks that might not make sense mathematically but that end up benefiting the economy and society enormously. One of the unseen consequences of the hysterical rush to pass new laws in the wake of corporate scandals is that the laws-not to mention the pervading atmosphere-have had a severely depressive effect on animal spirits. The effects on the economy are bad, and may get worse.

Here is an example of what I mean by "pervading atmosphere": A series of front-page articles in the Washington Post in mid November, whose purpose was to set readers straight about "the new economy," claimed it "wasn't all real, and... certainly wasn't enduring," as wrote Steven Pearlstein, author of the initial piece.

Other articles went after investment bankers, venture capitalists, and the Nasdaq stock market, which was called a "casino" because it "encouraged and enabled thousands of small, highly risky companies to list their shares." In fact, the economic growth that occurred in the 1990s was as real as economic growth ever gets. It was a period of stability (GDP annually fluctuated within a remarkably narrow band of around 4 percent), powerful employment growth, low inflation, and spreading prosperity. Yes, many companies went broke: That's the way it's supposed to work in a robust capitalist economy.

Some scolding has good effects: greater candor by corporate executives and more discrimination by investors. But scolding has unseen effects, too, and they are powerful. Throughout the economy, animal spirits have gone into hibernation, and the economy is now dominated by an establishment without the inclination, or the need, to take risks.

My guess, as an eternal optimist, is that this miserable situation will change. Americans don't like sitting on their hands. Keynes, while a Brit, described very well the desire to plunge into the unknown future, whatever it takes. "It is our innate urge to activity," he wrote, "that makes the wheel go around."

A version of this article appeared in The American Enterprise magazine.


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