When in 2000 France's socialist government reduced the "legal" work week to 35 hours the main plea was that this will spread the available work among more people, i.e. reduce unemployment, which of course it did not. It increased costs and caused much disruption. On the other hand, when in 2008-2009 a large proportion of German employers reduced both the work week and wages, the result was that German unemployment rose significantly less than that in neighbouring countries. Could this be a negation of the French experience? It was nothing of the sort; it was simple that other things were not equal, in one experience labour costs increased, in the other they did not. Micro and macro are fairly unanimous that you do not increase the demand for labour by making it more expensive. Higher unemployment pay has no direct incidence on wage cost, because it is paid out of general tax revenue and leaves unemployment insurance rates (a kind of payroll tax) unchanged. However, wherever the incidence of a higher cost first hits the economy, the indirect incidence will inevitably work through to labour cost, too.
The contemporary quarrel between micro and macro rages around the sustainability of growing government debt, the potential of the fiscal stimulus to induce growth and create jobs, and the risks of unorthodox central banking. In all these areas, the instinctive, micro-oriented "know-nothings" confront the educated Keynesians. The latter keep desperately trying to hammer into the thick skulls of the former the basic blueprint of John Maynard Keynes's system. More government spending (i.e. dissaving) generates income that is greater than the spending itself, with part of the income being consumed and part saved to generate the saving that matches the government dissaving. In Keynesian parlance there is the multiplier effect and it is greater than 1. As long as there is spare capacity (unemployment) in the economy, the government ought to go on spending more, working through the multiplier, because the extra private saving takes care of the government dissaving and the extra consumption is, so to speak, a welcome windfall gain. Timidly refusing to generate it is criminal waste.
Despite truculent voices to the contrary, the Keynesian logic is faultless in that the conclusions do follow from the assumptions. Why it does not really work and why it singularly failed to work in 2009-2010 and maybe beyond, is that other things do not remain equal. Part of the extra spending stimulus fails to stimulate domestic income because as much as 0.3 of the multiplier might leak out through extra imports. Much of the rest may be offset by industry taking fright of the rising budget deficit and reducing investment, and consumers striving to reduce their indebtedness producing some saving to balance the government's dissaving. The total effect of higher imports and lower investment might be a multiplier barely higher, or maybe even lower, than 1 and the stimulus stimulating nothing except the national debt. This is not the fault of Keynes but of those whose macro-economics exist in a fantasy land.
This is instinctively understood by the know-nothings, but rather harder to accept by the kind of public instructed in the rudiments of economics. Sex education these days begins at 8 and economics is taught as early as 15. These may be necessary, or necessary evils, but seem premature all the same. Economic education much before economic experience may well act as the little knowledge that is worse than none. It is this public that is a sucker for the fantasy economics peddled in profusion today that borrows the language of economics but has no roots in either micro or macro logic.
One of the charms of fantasy economics is that it fits so well into metaphors. Industry and commerce are benign activities, but when they go across frontiers, they become warfare where our side loses because the other side is not fighting fair. There are many remedies against this unfairness. Outright protection is no longer politically correct and must be dressed up as something else to be respectable. International co-operation, however, is always a good thing; there is never too much of it. It also provides occasions for pointless summit meetings where jetlagged politicians and their long tails of assistants can listen to each other's prepared statements. Currently, one proposal for international cooperation is that Germany ought to restrain its exports and increase its consumption to let its neighbours have a chance. On a similar vein, Beijing ought to cooperate by somehow persuading American consumers to buy fewer Chinese T-shirts and tennis racquets. More broadly, no country should allow its current account balance to exceed 4 per cent of its national product. In Fantasyland, governments can achieve these things if only they will agree to cooperate.
In Fantasyland, it seems obvious that China has injured America by cunningly fixing the official exchange rate of their currency, the yuan, so low as to make their T-shirts irresistibly cheap, and hoarding the US dollars they received for them. The upshot was that China accumulated $2.5 trillion o"reserves", an amount that still keeps growing with every month's US trade deficit. The effect is tantamount to China making America a free gift of $2.5 trillion worth of merchandise, for what else can they do with these astronomical "reserves" than keep them on the books of their central bank forever?
Fantasy economics as a study of warfare or at best a bitterly fought football game helps to understand the self-inflicted pain most of Europe is currently suffering in the "crisis" of the euro—a "crisis" that is increasingly looking like a quasi-permanent state of affairs. The euro replaced national currencies in 1999 partly because it was promised to raise economic growth rates "in the region by 5 per cent or more, and partly because it would enable Europe "to look the dollar in the face" or, better still, to become its equal as a global reserve currency. Milton Friedman was convinced that, failing fiscal unification, the euro experiment will collapse in a matter of months. Instead, it is still subsisting, though it has signally failed to fulfil the promises of growth and especially of prestige that had been made for it. It is being maintained by the Herculean efforts of the more solvent of the member states who seem determined to throw good money after bad to save their nearly insolvent fellow members without admitting that at least some of this money can be regarded as already gone down the drain. The mystery is that doing this is unanimously acclaimed as wise, constructive and necessary because it preserves the integrity of the eurozone. There is ominous talk of "fragilisation" and "contamination" from Greece to Ireland, Ireland to Portugal, Portugal to Spain and so on, ending in some unspecified but catastrophic collapse. Nobody feels the need to ask why such language is the right one to use, and why the "integrity" of the zone and its common currency is so precious as to warrant the most painful economic and political contortions. Heavily loaded metaphors suffice to convince us that Greece, Portugal, Spain or Italy reverting to their own separate currencies would be a bad thing for anyone, let alone (as is being asserted) for everyone.
Let us briefly conclude by glancing at the Christmas wish-list that forms the core agenda of the G20 powers for the coming year. A new world monetary order is to be designed, the volatility of commodity prices and the instability of markets remedied, bank regulation further intensified and "financial" (i.e. naughty) transactions Tobin-taxed (see James Tobin). It is a safe enough bet that this agenda will bring about nothing worse than mind-numbing chatter in expensive meetings. What is saddening is that it is not solid understanding of micro and macro theory, the depressing history of exchange controls, fixed rates and commodity price stabilisation schemes, not the vacuity of fantasy economics that will preserve us from these hoary panaceas, but rather the sheer unlikelihood of reaching unanimous agreement among sovereign states on anything substantive, however foolish it may be.