I gave my presentation yesterday on “Classical Criticisms of Modern Economic Theory”. I might also have called it “The Top Ten Reasons Why Modern Economics is Useless in Understanding How an Economy Works”. Therefore, at the rate of four minutes per reason, not very likely to persuade anyone who doesn’t already have an inclination to abandon modern textbook theory. But there was one issue that remains at the core of the classical perspective that met with resistance. I treat it as obvious beyond needing to elaborate, but it may be more difficult than I think.
Modern economic theory is based on the belief that increases in demand drive the economy forward. The Classicals were all supply-siders with immense disdain for the notion that demand has anything to do with aggregate output or the level of employment. And central to their theory of growth was that the sum total of all economic activity had to be value adding if the economy were to increase its ability to produce. Most forms of production – consumer goods, government welfare expenditures, loss-making businesses, non-productive forms of public expenditure – were not value adding. They drew down on the economy’s resource base but added nothing back. Only those investments – both public and private – that added to the economy’s ability to produce would lead to higher living standards.
Value subtraction does not mean zero value has been created. It means less value has been created than had been used up. If a project provides output worth a billion dollars once it’s built it is still only value adding if the value of resources used up were less than a billion. You cannot make an economy grow by promoting loss-making projects.
My examples were pink batts, school halls and the NBN. I could have added solar panels and wind farms. Does anyone doubt these make us less wealthy as a nation? Do economists?
If you want to know why real incomes in Australia are falling, understanding the role of non-value government spending is a very good place to start.