Monday, February 18, 2008

Commanding Heights Documentary

Last night, I watched episode one of the PBS documentary Commanding Heights: The Battle for the World Economy. It's based on a book with the same name and there's a good wikipedia entry detailing the history and controversy around it.

Episode one is titled The Battle of Ideas. It covers the evolution of Communism, Socialism, and Capitalism during the 20th century against the backdrop of war, depression, and globalization. John Maynard Keynes and Friederich von Hayek emerge as the two personalities fighting in the battle of ideas. The documentary includes interviews with Hayek, Milton Friedman, Dick Cheney, Bill Clinton, Margaret Thatcher, and many others.

The entire documentary is available for online viewing. I haven't watched episode two and three yet, but I really liked episode one. The timing for me was perfect because I am currently halfway through Hayek's The Road to Serfdom, which is one of the most important economic and political books of the 20th century.

In a time when a very popular left-wing economist like Paul Krugman says that we're all Keynsians now and compares teaching Hayek instead of Keynes to teaching creationism instead of evolution, it's very important that people understand what these economists stood for and what happened when their theories were applied. My generation didn't suffer through the stagflation of the 1970's brought about by applying Keynesian principles of inflation, economic stimulus, and heavy government regulation to the free markets. The documentary details the pain and suffering created in the United States and the United Kingdom by these policies. And they were only reversed when the theories of Hayek and Friedman were applied by Paul Volker and Ronald Reagan.

The battle of ideas continues and it takes looking no further than our Presidential candidates (both Republican and Democrat) to see that we're moving towards the principles of Keynes, government planning, and socialism. The outcome of this is already known as history is littered with examples of how prosperity is destroyed when governments interfere in the market place. Many people believe the current credit and housing crisis are a result of lack of government regulation, but they actually were caused by various government policies, most importantly how Alan Greenspan kept short-term interest rates far below the market rate for years and created moral hazard with the promise of future bailouts (the "Greespan Put").

My favorite part of episode one is Chapter 9 which discusses the economy of postwar Germany.

NARRATOR: The war left Germany in ruins. Its economy had disintegrated. Markets had broken down. Shops were empty. Already the Russians occupied East Germany and were waiting for the rest to fall into their lap. In the American and British occupation zones, raging hyperinflation had made the German currency worthless.

In the winter of 1948, the Allies appointed as director of economic affairs a rotund, cigar-chomping economist named Ludwig Erhard. A staunch anti-Nazi, Erhard was a free-market economist who shared many of Hayek's beliefs and ideas. He also believed the Allies' economic rules were making a bad situation worse.

MILTON FRIEDMAN: The occupying authorities had imposed a system under which there were extensive wage and price controls, supposedly to control inflation, but of course wage and price controls never control inflation. And you had essentially an economy that was brought to a halt.

ALFRED BOSCH, Economist and Friend of Hayek: In this situation the black markets formed, and American cigarettes were its form of currency.

MILTON FRIEDMAN: Nobody smoked cigarettes. They were for small transactions. Cognac was a medium of circulation for large transactions.

NARRATOR: The Allies introduced a new currency, the Deutsche Mark, to replace the worthless German money. But for Erhard, that was not enough. So without informing the Allies, Erhard went on the radio and made a startling announcement.

KARL OTTO POHL: Ludwig Erhard, a legendary man, he decided, without asking anybody and against the will of the American occupation powers, he decided to give up all price controls.

NARRATOR: Next day, Gen. Lucius Clay, the man in charge of occupied Germany, demanded to know what Erhard thought he was doing.

ALFRED BOSCH: Clay said, "What have you done? You have changed the Allied price controls." Erhard replied, "Herr General, I haven't changed them; I've abolished them." And Clay said, "My advisors tell me it is a big mistake." Erhard replied, "Herr General, my advisors tell me the same thing."

NARRATOR: Overnight the black market disappeared. People stopped hoarding, and goods not seen for 10 years went on sale.

MILTON FRIEDMAN: It started the markets working, with free prices. Instead of nothing being in the windows of the shops, everything started to come up. And that began the German economic miracle.

NARRATOR: Germany's "social market economy" combined free markets with a strong welfare state. Within a few years, Germany's social market economy overtook Britain's more planned economy.

But back then, nobody wanted to model themselves on Germany. Most countries preferred to plan their economies.

This is a great example of the principles of Austrian Economics. First, government intervention in the free market, no matter how well-intentioned, always results in lowering overall prosperity. Second, money is a creature of the market and not created by the state. When the state tried to interfere with the market by setting price controls, people abandoned government money and commodity money spontaneously materialized in the form of cigarettes and cognac. Third, free markets always outperform managed markets. Germany, a country ravaged and destroyed by war, overtook Britain's planned economy.


lee said...

Can we please not claim victory for the free market in politicians like Ronald Reagan?
Yes, Volcker letting a recession come on to fight inflation was a good thing. Doing away with ridiculous price controls worked. Maybe even cutting taxes helped.
But a president who didn't balance the budget and raised the national debt from $700 billion to $3 trillion?
And who privatized health care, which is not a free market, so that it went from a flawed system to being the catastrophe we have today?
Especially eerie was the cameo by former Reagan staffer Dick Cheney, who later let Enron "deregulate" energy, also not a free market. Cheney, who said, "This is how markets work," when energy deregulation made energy prices 10-20% higher, because it didn't function as a free market.
Reagan talked a good talk, but Clinton did a better job of shrinking government spending.
It's hard to take fiscal conservatism seriously with heroes like Reagan.

jaimeayn said...

Reagan's tax cuts, the biggest in history, led to huge deficits. But, the economy started to grow steadily again.

"There's no doubt in my mind that those actions of Reagan--lowering tax rates, plus his emphasis on deregulating--unleashed the basic constructive forces of the free market, and from 1983 on, it's been almost entirely up." Milton Friedman