The nastier this recession gets, the more people will talk about the discrediting of markets and the failure of deregulation. So the next time the Dow dives off a cliff, splash your face with ice water and remember two things: This end-of-capitalism talk is bunk, and it distracts us from the debate we should be having. The real question is how to manage the necessary shift in the balance of our mixed economy. Outlandish though it may sound now, red-blooded capitalism must be part of the answer.
Even before the financial crisis, government was expanding. Public spending as a share of the economy jumped under President Bush, and regulation increased, too, notably in the form of the Sarbanes-Oxley law on corporate financial disclosure. Commentators trumpeting the abrupt death of free-market, small-government Republicanism appear to have slept through the Bush years.
Yes, the financial crisis has triggered an added surge in government. But this has happened in every recession since 1980 and does not represent an intellectual U-turn. Mainstream economists have always been pro-market, but they have also always recognized numerous qualifications and exceptions. The crisis has triggered two important ones.
The first is that, in an acute recession, government spending has to expand aggressively to make up for weak private spending. As a top adviser to Bill Clinton in the 1990s, Larry Summers supported reducing the deficit; as a top adviser to Barack Obama now, Summers supports massive deficit spending. This is not a flip-flop. Summers favors crisis spending now because we are in a crisis. In five years, he will again preach budget discipline. There is no paradox, no tarnished ideology.