French President François Hollande startled many of his supporters last week, along with fans of evidence-based economics everywhere, when he rejected modern economics in favor of the sayings of an early 19th-century French economist. After winning the election on a platform that the government needed to fill the gap in demand created by the collapse of asset bubbles, Hollande repeated the old line from Jean-Baptiste Say that "supply creates its own demand."
While the appeal to French national pride may be touching, it is completely out of touch with modern economics. His plan to cut spending will have serious consequences. We should have known at least since Keynes that economies can be subject to prolonged periods of high unemployment due to inadequate demand. The problem is that the private sector does not necessarily generate enough demand to buy back everything it produces, leaving large numbers of workers unemployed and vast amounts of productive capacity sitting idle.
From an economic standpoint this is an incredible waste of resources. Economists often concern themselves with distortions created by quirks in the tax code or barriers to trade, but the losses from having an economy operate below full employment dwarf these inefficiencies. In the United States alone we are looking at more than $5tn in lost output to date, as a result of the downturn. The losses would be even larger inEurope where economies are operating much further below their levels of potential output.
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