In the same week that the 2nd edition of my Free Market Economics has been published, which I began specifically in response to the stimulus that followed the GFC and the certainty that it would fail because of the principles that underlie Say’s Law, I have received copy of a review of a book titled, Seven Bad Ideas. The book is by Jeff Madrick while the review is by none other than Paul Krugman. And here once again we find Say’s Law, as the second worst idea in economics, just after the number one bad idea, “the invisible hand”. If you think the invisible hand is the worst idea economists have ever come up with, you are near enough not an economist, more a charlatan but then he has the Nobel Prize so who’s to argue. This is what Krugman thinks the invisible hand means amongst economists:

Today the phrase is almost always used to mean the proposition that market economies can be trusted to get everything, or almost everything, right without more than marginal government intervention.

What “everything, or almost everything” might consist of is a quite bizarre notion. The reality is that no one thinks an economy will run without institutional intervention at almost every facet of an economy’s operation. Every economist is perfectly aware of the absolute necessity of an institutional structure, much of it at the hands of government, and much of it based on legislation and regulation. There are debates about the sorts of regulation needed and the kinds of legislative penumbra that has to surround an economy. But the notion an economy requires only “marginal” intervention is nonsensical and straightforwardly untrue.

But so what if there are economists who think this. The absolute reality is that every economy has regulation up to its eyeballs. If some of us think less regulation would be better is hardly evidence that the economy is doing poorly because of its absence. You would have to be utterly out to lunch to think the regulation of any economy in the world could be described as light-handed. There must be quite a few gullible types out there if the kind of statement that Krugman makes can carry any weight at all.

But it is the second supposedly bad idea that is an old story. It is what is known as Say’s Law which in its micro form states that demand is created by value adding supply and in its macro form states that no economy ever goes into recession because of a lack of demand and that an economy in recession cannot be resurrected by a stimulus made up of non-value adding forms of expenditure. The macro version condemns just the kinds of expenditure every single stimulus has consisted of. The issue isn’t crowding out. The issue is that public spending uses up more value than it creates. If you waste your resources, your economy will shrink. That is what has happened universally since the “stimulus” and Krugman has not a clue in the world what has gone wrong. Here is what he wrote:

No. 2 on Madrick’s bad idea list is Say’s Law, which states that savings are automatically invested, so that there cannot be an overall shortfall in demand. A further implication of Say’s Law is that government stimulus can never do any good, because deficit spending by the public sector will always crowd out an equal amount of private spending.

But is this “mainstream economics”? Madrick cites two University of Chicago professors, Casey Mulligan and John Cochrane, who did indeed echo Say’s Law when arguing against the Obama stimulus. But these economists were outliers within the profession. Chicago’s own business school regularly polls a representative sample of influential economists for their views on policy issues; when it asked whether the Obama stimulus had reduced the unemployment rate, 92 percent of the respondents said that it had. Madrick is able to claim that Say’s Law is pervasive in mainstream economics only by lumping it together with a number of other concepts that, correct or not, are actually quite different.

Economists can say all they like that the stimulus lowered the unemployment rate but the fact of the matter is there cannot be any actual evidence one way or the other. That the models used by economists almost universally say that a stimulus will reduce unemployment is of itself the only “proof” that it has. The logic goes:

Major premise: a public sector stimulus will reduce unemployment below the level it would otherwise have reached

Minor premise: most economies introduced a public sector stimulus

Conclusion: the stimulus reduced unemployment below the level if would otherwise have reached.

That is, A causes B. There was A so therefore B. There is no evidence since there are no controlled experiments. All this is by assumption only. Well two can play at that game.

Major premise: a public sector stimulus consisting of non-value adding forms of expenditure will keep unemployment higher than it would otherwise have been

Minor premise: most economies introduced a public sector stimulus consisting of non-value-adding forms of expenditure

Conclusion: the stimulus has kept unemployment higher than it otherwise would have been.

And the fact of the matter is that the American labour market has not returned to the level it was at in 2008. Unemployment is a disaster without the slightest evidence that matters are on the mend.

Paul Krugman has not a clue. He is stuck in that Keynesian bunkum from which no actual evidence from the real world will ever dislodge him. The American economy continues to sink because of the straight out ignorance of basic economics of pretty well the entire economics profession (approximately 92 percent). Nothing can be done about it in the short term, but the smug smarmy superiority in the face of the immense harm that he and his likeminded colleagues have caused makes me very angry indeed.

Krugman is obviously a hopeless case. But I will simply state that economic theory will never provide useful guidance during recessions until Say’s Law is once again seen as the fundamental principle it is. And if you are interested in what it means and why it matters, the 2nd edition of my Free Market Economics is the place to start finding out.