During World War II, the modern militaries of the United States and Japan fought for territory in the Pacific theatre where many indigenous peoples had been left behind by the Industrial Revolution. Massive amounts of military equipment and supplies arrived on the islands shortly after the soldiers came ashore. After the war, the soldiers left the islands. The islands also stopped receiving military cargo from airdrops and airlifts. Knowing nothing of industrial factories, the natives came up with a spiritual explanation and the Cargo Cults were born.
The Cargo Cults believed that the airdropped cargo was a gift from the gods. They believed that the cargo would return if they imitated the rituals performed by the soldiers. Followers of the Cargo Cults built airstrips, wore clothing resembling military uniforms, and made fake radios out of local supplies. Although most of the Cargo Cults have disappeared, a few are still around today. To those of us living in industrialized nations, the Cargo Cults seem ridiculous. Building airstrips does not cause cargo to fall from heaven by parachute. However, the human mind is easily fooled.
The economic policies of many modern nations share a lot in common with the Cargo Cults. Many politicians, policy experts, and economists seem to believe that it is possible to create prosperity without really understanding how wealth and prosperity are created. These people seem to think that we can create prosperity by imitating some of the attributes of a prosperous economy. Ultimately, these attempts at imitation pervert the nation’s economy and lead to problems like the current economic crisis.
Among liberals, the Keynesians are the dominant Cargo Cult Economists. The Keynesians believe that inefficiencies in a free-market system lead to the booms and busts of the business cycle. The Keynesian proscription for fixing these inefficiencies is for government to intervene to smooth out the booms and busts. One of the big problems with this proscription is that you have to assume the politicians and bureaucrats in Washington are a hell of a lot smarter than the businessmen and consumers on Wall Street and Main Street. The bigger problem is with how Keynesians attempt to smooth out the booms and busts.
Like the followers of the Cargo Cults that saw the arrival of cargo from heaven after the soldiers built airstrips, the Keynesians saw the rise in demand for goods during the booms and the decline in demand during the busts. To smooth out business cycle, Keynesians advocate smoothing out the cycle in demand by increasing government spending during the busts and increasing taxes during the booms. The problem with this policy is that demand in the macroeconomic sense does not create prosperity. The busts in the business cycle don’t happen because people suddenly decide they don’t want to buy stuff. The busts happen because of the misallocation of resources during the boom. When the market comes to its senses, the prices that were bid up to the stratosphere during the boom plummet back to Earth. The bust is the process for reallocating resources that were poorly allocated during the boom, and a lot of people that invested poorly lose a lot of money in the process. Demand doesn’t decrease during the bust because people decide not to buy stuff. Demand decreases because people are broke, and there are stronger incentives for saving and investing wealth than spending.
A lot of wealth is destroyed during the boom even as people think they are getting rich, and during the bust there is a lot less wealth available to invest in productive businesses. People with jobs in the previously booming sector also have to find more productive ways to earn a living during the bust. The Keynesian solution to this problem is for government to come along and start haphazardly spending money. At just the time when people need to be saving capital to invest in the productive businesses, government goes on a spending spree and increases the money supply. Inflation caused by the increasing money supply decreases the incentives for saving and short-circuits the recovery.
There are also usually bailouts for those industries that are hardest hit during the bust. In many cases, these are the same industries that caused both the boom and the bust. These are exactly the industries that need to shrink rather than grow. Too many resources were misallocated into these industries during the boom. Propping up the failing industries further prevents resources from being reallocated to productive businesses.
Just as the Cargo Cult fetish for airstrips has done nothing to bring prosperity to the indigenous peoples in the South Pacific, the Keynesian fetish with macroeconomic demand will not bring us economic prosperity. Unlike the mostly harmless rituals of the Cargo Cults, the Keynesian imitations of prosperity are making us poor.
