This is John Papola replying to critics of his video on some website over the course of a few days. It is astonishing that he never takes a wrong turn, gets it right even in the middle of the most complex arguments and explains the classical position on Say’s Law to perfection in a way that no modern economist could ever hope to do.

John December 7, 2012 10:56 PM

I don’t care about what economists write to each other behind JSTOR paywalls and in language and equations that nobody understands. I care about what economists, pundits and politicians say to the general public. I care about what’s driving our cultural understanding about the way an economy works and grows. Since these two things are at odds with one another, I put particular emphasis as a filmmaker on the latter since it matters, and not the former.

And an overwhelming number of them talk about how consumer spending can ‘drive growth’ because ‘consumer spending is 70% of GDP’. That is a fallacy. And when Nobel-prize winning Keynesian economists are saying that consumption grows the economy, I have every right to criticize that position for the fallacy that it is. The fact that they publicly contradict the technical literature and even their own work has nothing to do with my intellectual honesty and everything to do with theirs.

Consumption doesn’t grow the economy. Period. Consumption uses stuff up. It shrinks the stock of value. And I’m fully aware of the technocratic tweak about demand for money and the ideal of nominal spending stability. I’m unaware of any sudden nominal shocks that weren’t reactions to some inciting phenomenon like a rash of business failures. People don’t just suddenly hoard cash for no reason. And regardless, if they do, money supply should be increased to meet that demand. I included this in my 2010 video with Larry White. It’s got nothing to do with this video. It would confuse people to attempt including it.

It’s not an academic paper, Daniel. And thank god… because nobody reads those and no politicians either. Hence we hear that UI benefits are a stimulus and tax cuts for those who have to spend every nickel on consumption are better than those for people who might save the money. That’s the point. That’s what matters because it’s what the public is actually told about policy. It’s false. It’s nonsense. So I honestly and openly criticize it. I’m open and honest about my position. It’s clear. I stand by it 100%. [My bolding]

And continuing two days later

John December 9, 2012 10:53 AM

Yes, in the sense of the ‘supply side’ I’ve enumerated above, real growth is all about the ‘supply side’. It’s about Say’s law and classical econ with productivity and value-added production at the center of the story. But even the framing of ‘supply side’ and ‘demand side’ is wrong in my view, UNLESS you’re distinguishing the ‘supply side” as ‘real’ and the ‘demand side’ as nominal. Why? Say’s law!

Demand, when it’s not generated purely through the printing press, is constituted by supply first. We’re all suppliers/producers, trading with each other. We produce so that we can consume. Production is the means to our consumption ends. That is the secondary message of the video. We produce with the goal of consuming in mind, lest we wouldn’t bother. Nobody wishes to work for work’s sake (unless it is a passion project and thus arguable a consumption activity in it’s own right, like painting or writing, etc).

There is no such thing as a distinct ‘aggregate supply’ separate from ‘aggregate demand’ except as a model to understand the role of monetary policy. In real terms they are one-and-the-same. Every trade at a price which composes total economic activity is both an act of supply and demand at the same time by both trading parties. There aren’t real AS and AD curves that interact. It’s an imperfect model that somewhat abuses the insights drawn from the Marshallian graph. But it can be useful when putting money in the middle and introducing the loose joint of money and monetary policy is what allows the ‘demand side’ to become understandable as separate from exchange between producers. Perhaps I’m redefining these models in my own terms. If so, so be it. This is how I understand macro phenomena.

As Lars Christensen once wrote, another influence of mine, macro and monetary policy is about allowing Say’s law to work, by ensuring that supply creates demand for something other than hoards of cash. And yes, even that is only necessary because of “sticky” wages. If there were less nominal rigidity in the labor market, in large part through government policies that push up minimum and reserve wages, even hoarding would be less of a problem. Guess who else has helped me understand this stuff? Brad Delong. He wrote the ‘missing macro playbook’ where he explained that Say’s law works great unless people increase cash holding to a serious deflationary degree, pointing to John Stuart Mill for support. He even noted that the key was to increase the supply of ‘safe assets’ to meet demand as the answer. He simply went off the rails by claiming that those safe assets should be treasury bills instead of dollar bills. I don’t know why, but I assume it’s about the liquidity trap. He was, after all, among those claiming that the Fed was out of bullets in 2008 and 2009. Man was he wrong on that count, but I’ll leave Sumner to that critique. Anyway…

And then later after someone wrote that he didn’t see what Say’s Law had to do with long-run growth:

John December 9, 2012 10:13 PM

Right here you are tapping into what I view as the root issue.

Say’s law has everything to do with long-run growth because it demonstrates why increased productivity (supply) opens up new markets and grows the economy. The economy grows by finding ways to increase the supply of salable goods.

I see the deep problem beginning with this notion that there are ‘demanders/consumers’ and ‘suppliers/producers’ as distinct groups. There isn’t. There is production and exchange. The two ‘sides’ are not really ‘supply’ and ‘demand’, but one supply for another. Exchange occurs when two people bring value to the table which the other values higher. Both are bringing production, in a real sense, to the table. As Mill said ‘commodities exchange for commodities’ (I’m pretty sure that’s the exact quote).

There is no demand without first supplying value to the market. For most people, they supply their labor and that supply enables them to demand other goods and services. But their supply comes first. There is no income for a good while it is in the process of being produced. It is only AFTER it is produced that it can be sold.

Imagine you and I on a desert island. We both have endless wants and needs. Food, water, shelter, entertainment, healthcare, etc. We have nothing. Now, imagine that you get to work fishing while I do nothing but sunbath. You know for a FACT that I am going to be hunger. You can surely anticipate my potential demand for fish. But if I don’t first produce something for you, no exchange is going to take place. Supply enables ‘demand’. You fish and I loaf around – no dice. No demand. No trade. Even though it’s totally clear that I have a biological need to eat and you could reasonable predict that need.

So ‘Demand’ is not something distinct from supply in real terms. The only way to separate demand from supply is to think purely in monetary terms. When money is in the mix, it can be supplied and demanded as well, but since there is no market for money except as a medium of exchange for other goods, the impacts of changes in the demand for money ripple out to the economy as whole. But let’s leave that to the side for a moment and dig into what my exposition of Say’s law helps us understand.

And then some more from John in which he summarises the issues in four points:

John December 9, 2012 10:14 PM

1. Consumption does not grow the economy.

Consumption is the end, but not the means. Production on each side is the means. We don’t need to worry about consumption AS MACROECONOMISTS. Yes, individual businesses are obsessed with serving customers. But that’s not macroeconomics. And those businesses won’t sell anyone anything if they haven’t earned the money to buy it, through supplying value to others.

Consumption uses stuff up without making us better at producing more tomorrow. It’s ‘unproductive’. Consumption is the ends, not the means. If people decide to consume less, that’s not a macroeconomic problem in and of itself. It’s nothing to worry about, nor is consumption something to b actively encouraged. It NEVER needs encouragement form a macroeconomic perspective. Never.

That’s the fallacy I’m attacking in the video. That we can get richer by taking our money and consuming stuff. Cash for clunkers made America POORER, as just one especially horrible example. An understanding of Say’s law makes that clear.

2. Unemployment benefits may be humanitarian, but they are NOT stimulus.

Imagine we’re a tribe of 10 people. All of us contribute through our hunting, fishing, sowing, building, etc, so that the community may trade and consume the fruits of each one’s production. Each must produce more than they need or produce that which they don’t wish to keep if they are to be contributing to the tribal economy. One of our tribespeople becomes blinded in an accident. The tribe is now poorer for the lack of that person’s contributions. It’s poorer still as a whole for the fact that he is now consuming the productions of the others while not producing anything of greater value (the whole mutual benefit of trade). I’m not saying that the community shouldn’t supper their blind friend. We should. But it’s not stimulus. We aren’t richer for his consumption of our work. We’re poorer, materially. Richer in spirit perhaps. But that’s it.

3. Increasing our production per person grows the economy, and that needs savings.

Increasing productivity is the source of growth because the more we produce, the more we can consume. How do we do this? Through taking the time to invent better mousetraps and apply capital and ingenuity to problems. That process doesn’t generate income immediately. It takes investment. Either the individual or company forgoes consumption in order to fund that investment (stores up fish so that they have time to construct a net) or they leverage the savings of other people, through debt or equity sales. Say’s law, tells us that productivity is central to growth and savings is central to increasing productivity.

4. Recessions are usually production failures first.

The failure of producers to add value in their production is the main cause of recession. This is way firms fail and profits collapse BEFORE the increases in demand for money start to occur, and are a reactive secondary issue. The aggregate level of production is not what matters. It’s that we’re producing goods that will trade at cost-covering prices, revealing that we’ve added value in the production process. If we can’t sell at a profit, that means we’ve destroyed value. Recessions occur when there is a cluster of production errors. Classicals suspected that the monetary system was likely to cause such coordinated failures and the Austrians systematized that insight, noting the centrality of interest rates is coordinating the structure of production.

So Say’s law and the centrality of value-adding production as the enabler of all real demand and growth is embedded in classical theories of the cycle.

The monetary hoarding issue, which Keynes focused in on as a primary cause, is for classicals an important but secondary concern. Say himself wasn’t good on this issue but JS Mill was as was Hayek. We should address monetary disequilbirium by increasing the supply of the good actually demanded – money – and not tricking ourselves through excessive aggregation into believing that any ‘spending’ will do, including and especially consumption.

Is it possible in theory to have a recession causes solely by a money-demand shock or money supply collapse? I guess. Am I aware of any at all? No. If you are, please tell me, because every recession in the US I’m aware of was triggered by real events, especially inflationary bubbles bursting as profits tank.

The conversation continues:

John December 9, 2012 10:53 AM

For the general public, the focus on the importance of consumer spending by an army of Keynesian economists, pundits and politicians is a highly destructive cultural drag. It’s a bad thing for growth that US savings rate fell from its 1950s and 60s highs of 12% all the way down to 0% and even now isn’t back up to that thrifty time. I fault demand-siders in part for that change.

So the general is my audience. Yes, I’m a skeptic of social benefits derived from modern macro and to the extent that fallacious ideas like consumption growing the economy emerge from it, I’m going to continue taking those on for the benefit of our general understanding of what creates the wealth of nations and what uses that wealth up.

The technocratic precision of macroeconomics appears to me to exist mostly within the very large margin of error. It’s a fatal conceit. It’s the pretense of knowledge. And when that work undermines deeper truths, it becomes downright destructive. I don’t know what, if any, good has come from the field of macroeconomics for society. On balance, it appears to have made our understanding of the world worse compared with the classical era of Smith and Ricardo. When I hear Tim Geithner talking about how the Chinese need to increase their consumption so that there is a more ‘balanced’ growth, whatever that means, my conclusion is ‘he doesn’t understand where growth comes from at all’. The focus on the short run and short circuited basic Smithian insights.

As a side note, I don’t dispute and haven’t that Keynes explanation for the cause of a downturn is a collapse of investment spending. This too is a straw man critique that has been made here and elsewhere of my work. Remember, the lyrics from Fear the Boom and Bust (2010) went as follows:

“Business is driven by the animal spirits
The bull and the bear, and there’s reason to fear its
Effects on capital investment, income and growth
That’s why the state should fill the gap with stimulus both…”

Got it. Got it from the beginning. Investment is the volatile driver of the business cycle. Austrians see the same thing and blame it on interest rate elasticity of investment spending (that nexus of savings and investment which Keynes denied existed) rather than an appeal to causeless mass psychological changes as businessmen just lose their nerve.

What Keynes and Keynesians did and DO say is that we can consume our way out, that consumption spending can fill the ‘gap’ for investment spending. It is said ALL the time. Bob Murphy has my short list of exemplars if you’re interested in support for this claim (it was a comment in a former post here):

Papola Has a Barrel of Ink

THAT is what I continue criticizing besides the general idea that using up consumer goods can grow the economy, recession or not.

There is then a query about demand for goods and services to which John replies again:

John December 9, 2012 11:50 PM

I already replied to this. As John Stuart Mill noted, the demand for commodities is not the demand for labor [my bolding but how extraordinary it is to see this in print]. We’ve seen that quite clearly in this recession, where consumer spending recovered and was met by increased productivity and output even as unemployment flatlined (especially when looking a labor force participation).

Firms will do whatever they can to meet demand, including increasing prices, employing more efficient capital equipment, and yes, hiring more people. But, as a small business owner, I can tell you first hand that hiring people is a big commitment and not something I’m likely to do in response to short-term increases in demand. The decision to hire is NOT some hydraulic reaction function of aggregate demand. It’s a complex decision impacted by many factors including the availability of people with the needed skills for the task. There’s a human capital complementarity issue. People aren’t homogenous.

If I recall, the whole idea of stimulus is to restore full employment is it not? The last time I checked, we can have inflation (excessive aggregate demand) AND high unemployment. So demand can cause prices to rise and/or production to increase and/or new workers to be hired. But none of it is hydraulic or guaranteed or reasonably modeled by ex ante computers.

The conversation then turns to the writings of Robert Reich. John again enters into the debate:

John December 10, 2012 10:18 AM

Thanks for posting this. Reich is not an aberration by any stretch either. He’s just an especially crude exemplar of Keynes-inspired consumptionism. This type of rhetoric is pervasive.

Alas, with this post I think you’ve cleared things up for me. I absolutely disagree with your point of view and my video is unequivocally aimed at challenging it with regard to the role of consumption in recovery and macro in general. You’re celebrating as correct the very assertions which I believe to be false from Reich. The entire point of including Keynes and having his lyrics written in the way they are is to draw attention to the notion of consumption as a solution. I’ve been attacked because Keynes said investment was the problem, but that was never in question. I’m attacking consumption as the solution.

‘Second, they’re of course right that increasing consumption will help output.’

Wrong. Consumption doesn’t increase output. It uses it up. The very statement that consumption increases output is, shocking to me. That’s what consumption is. The only way I can understand that we’re at such cross-purposes in our dialog is the issues surrounding aggregation endemic in a Keynesian spending-centric approach vs. what Arnold Kling refers to as a PSST approach.

We don’t need a reason to consume. It can be assumed.

This post, for better or worse Daniel, only further reinforces for me that the grounds on which you attack Say’s law are rooted in a deeply different understanding of the nature of economic relations compared with the classical view.

When has there every been a case where we’ve run out of need in the world? I’ve never heard of such an event. And when we get there, when all our wants are fulfilled, this will not be a problem, it will be nirvana. The framework implicit here is that we should all be thankful that people consume because without it we’d have nothing to do. But we are all producers. If everyone ceased needing consumption, producers would cease needing it too and thus would have no reason to produce for themselves.

We are all producers. We produce so that we can consume. We do NOT consume so that we may produce.

And he continues in reply to the suggestion that production follows demand:

John December 10, 2012 10:39 AM

Wrong. We need other people to produce things that we want. Money is the medium of exchange. The ‘consumer’ is a producer first. That’s how they have something of value to offer in exchange for what we produce. Consumption is the motivating end for us all, but it’s never the means. Production and exchange is the whole story (with the caveat of monetary equilibrium).

And the debate continues. More from John:

John December 10, 2012 2:30 PM

Your promise to pay is predicated on your ability to earn income through some value-adding activity. Moreover, the money you borrow was income generated by someone else who already produced value for others. I stand by it.

This IS economics in the real world. In the real world, ‘output’ is actual goods and services and ‘consumption’ is the using up of those goods and services. What is measured as ‘spending’ is trade between producers. Each person’s ‘demand’ is constituted by the value they or someone else has already contributed to the market.

What makes ‘demand’ a loose joint from supply is money. It doesn’t change the facts, it just abstracts them. So one can, through monetary expansion, create ‘demand’ out of this air without first increasing supply. But the result of this will tend to be inflationary unless there is an excess demand for money. Hence I have always caveated that Say’s law requires monetary equilibrium. That equilibrium does NOT suggest that consumption is important or can grow the economy or increase output. And, from an employment standpoint, we’ve already seen quite clearly that excess demand can occur, producing inflation even with unemployment. High inflation and high unemployment has happened all around the world at different times. The ‘slack capacity’ and ‘output gap’ talk masks the structural issues that make stagflation possible because of excessive aggregation. It’s that same failure to dig in and distinguish between resource consumption that increases productivity and final goods consumption that uses up output for personal satisfaction that is clearly at the heart of this ‘consumption drives the economy’ fallacy. And, yes, it is a fallacy.

What is NOT economics is claiming that ‘consumption increases output’. That is utterly contradictory nonsense.

I have to step away from the debate for now, since I actually do run a real small business and unless we produce, we can’t consume a damn thing. Nobody needs to encourage me to consume. My body demands that I eat, sleep, go to the doctor when I’m sick. My family needs a roof over their head. My son needs to go to school. There isn’t a single policy that should be put in place that encourages consumption. Not one. Zero. Never. Ever.

‘Demand-side’ issues are all about monetary policy. The level of aggregate demand is a monetary phenomena. The fact that Keynesians so deeply misunderstand what’s happening in the actual real world of exchange by fixating on nominal spending is what has clearly, perhaps fatally, damaged our understanding about the way the world works. My videos are aimed at restoring that understanding, because it’s clearly been lost.

The argument continues, this time pointing out that buying presupposes someone else has already produced and sold their goods and services in exchange for money:

John December 10, 2012 2:35 PM

Right. And it’s not even possible for that consumer to buy without someone ELSE producing, unless they got the money printed for them. After all, if they borrowed the money, it came from someone else’s savings which was earned by producing value.

Commodities are paid for with other commodities.

Economists hasn’t advanced since John Stuart Mill. It’s clearly been retarded in deep and disturbing ways by the Keynesian confusion of monetary phenomena with real trade and exchange patterns.

JohnDecember 10, 2012 11:12 PM
‘John seems to believe the opposite though, that we shouldn’t consume what we can produce.’

I have no idea how you arrived at this conclusion. None. It’s totally unrelated to anything I’ve ever written or said.

It’s not the job of economic analysis to say what individuals ‘should’ or ‘shouldn’t’ do. People will consume what they wish to consume and have the means to consume at the price they deem worth paying. But they only have the means to consume because they’ve either produced something for their own consumption or produced something for someone else and traded it for what they want or the money to buy what they want to consume.

Consumption can and should be both assumed and ignored. Our real incomes are the result of effective production. The question we must always be asking is “are we producing the right stuff?”.

The fact that these simple insights are hard, and that many on this blog seem to talk about saving without even realizing they’re talking about saving, only underscores for me how deeply destructive the Keynesian framework is for understanding foundational economic mechanisms. It’s not merely that production and exchange are relegated to ‘micro’. No, they’ve been totally ruined. Consumption increases output, rather than using it up? I clearly have my work cut out for me with the next set of videos.