Classical economic theory presents perennial truths that economists once knew but have completely forgotten

The perfect statement of classical economic theory, from David Uren in The Australian today: Get used to the new normal – booming rates of growth are gone.

Over the year to December, growth was only 2.3 per cent and, short of massive revisions by the Australian Bureau of Statistics, Treasury’s forecast of 2.7 per cent growth this financial year looks unattainable

It is time Treasury let go of its vision of an extended burst of rapid growth around the corner.

After a decade in the slow lane, this may be as good as it gets.

It is not such a bad place to be — employment growth has been strong.

It was a staple within classical economic theory that economic growth is unrelated to employment. And there we see it before our eyes, low rates of economic growth and high levels of employment growth. All that is discussed in my Quadrant article this month: The Dangerous Persistence of Keynesian Economics. There at the very end of the article we find the then-Treasurer of the UK, Winston Churchill, discussing the futility of public spending to add to employment in the wake of their attempt in the 1920s to stimulate employment through high levels of public works:

“For the purposes of curing unemployment the results have certainly been disappointing. They are, in fact, so meagre as to lend considerable colour to the orthodox Treasury doctrine which has been steadfastly held that, whatever might be the political or social advantages, very little additional employment and no permanent additional employment can in fact and as a general rule be created by State borrowing and State expenditure.”

Ninety years later we demonstrate once again what once upon a time every economist knew which now no one knows. Read the Quadrant article if for no other reason than to get another perspective.

What will kill an economy stone cold dead

Quite interesting discussion today on what’s wrong with socialism and why don’t we teach what’s wrong with socialism. The consensus at the end – which I might add I am not part of – was that we do teach what is wrong with socialism but not in the way that I think it should be taught. OK, maybe. But on this there was complete agreement – this was my last slide.

Each of these will kill an economy stone cold dead – from I, Mechanical Pencil:

  1. If economic decisions are made from the centre and not by entrepreneurs
  2. If finance and national savings are allocated by the government
  3. If prices are administered by the government
  4. If guiding an economy according to profitability is sharply restricted, if not actually eliminated
  5. If heavy-handed and inappropriate regulations are issued by governments
  6. If property rights are abolished or else strictly curtailed.

If there is consensus on this, then this should be taught to every student who goes through an economics course, and to everyone else as well.

Meanwhile the socialist trope travels farther and wider with not all that much getting in its way. Some recent examples.

There is a phenomenal amount of ignorance in what she says, but at the end, with her statement that it is the workers who create the wealth [to much applause] we are dealing with a quasi-Marxist conception if not actually full-on Marxist since the entrepreneur has no explicit function.

The problem in dealing with “socialism” is that it has a range of meanings, from a very light-on forms of the welfare state all the way to central planning and the complete nationalisation of the means of production. Whatever else it might mean, however, is that it is a desire to have something different from the present. Two items to help think about things. First this, which is from a comment from a post at Powerline.

And before I get to it, I will just note that he leaves out, and indeed seems not to know, anything about the Socialist Calculation Debate, which states categorically that an economy without a price mechanism determined within the market by entrepreneurs who respond to the world as they find it and prices as they are generated in the market, is doomed to fail. That of itself will ensure the economy cannot function.

Most commonly, “socialism” is being applied to a vision rather than an ideology or methodology, a vision where the great wealth created by an economy is distributed more widely so that the people with the least money get more benefit from the economy. In the wealthier countries of Europe and Asia, that vision is carried out with a welfare state and high level of command in an economy that is still based on private ownership and on free exchange. People in the UK or in Japan may still choose their occupations and their businesses are privately owned. There’s a large range of salaries among those who work for wages or salaries. Those who have somewhat larger incomes pay much higher taxes to subsidize welfare-state subsidies of those who make less money. You also have the panoply of labor laws that stifle economic development but do not kill it outright and you have a lot of petty laws, almost tyrannical laws, passed by the duly elected representatives of the very people who carp about high unemployment, high taxes, stagnant economic development, and the wickedness of the wealthy. But this system is not socialism as an economic system; it does less harm and it does it more slowly.

A near-command economy with the ownership and much of the profits of economic activity still in private hands is the fascist model. Since the owners connect closely with the political powers and since the owners still want profits, this brand of command economy will make efforts to keep up profits but those efforts will be misguided because command economies are inherently limited in their responsiveness. Beyond the inherent limits of attempting to run an economy by committee, every command economy has also wound up listening to the loudest and most influential voices but those voices rarely know or care about the broadest benefit for their societies….

Most of our soi-disant “socialists” are actually welfare-state nanny-bullies. Their policies and theories are not geared to collective ownership but to collective pillaging. In terms of discussion and dealing with the special brand of s-word that is socialism, it matters that that is not what is on the floor. We need to address the s-word of welfare-state nanny-bullyism because that is what is actually on the floor.

And then this: Young Americans are embracing socialism.

61% of Americans aged between 18 and 24 have a positive reaction to the word “socialism” — beating out “capitalism” at 58%. Overall, 39% of Americans are well-disposed toward socialism, but the gulf remains wide for men and those aged over 55.

It’s only a word. At the moment across the whole of society there are still 61% who react positively to the word “capitalism”. But that is if you are older and male.

Someone to take care of me

There is a phenomenal amount of ignorance in what she says, but at the end, with her statement that it is the workers who create the wealth [to much applause] we are dealing with the Marxist form of socialism since the entrepreneur has no explicit function.

The problem in dealing with “socialism” is that it has a range of meanings, from a very light-on forms of the welfare state all the way to central planning and the complete nationalisation of the means of production. Whatever else it might mean, however, is that it is a desire to have something different from the present. Two items to help think about things. First this, which is a comment from a post at Powerline.

And before I get to it, I will just note that he leaves out, and indeed seems not to know, anything about the Socialist Calculation Debate, which states categorically that an economy without a price mechanism determined within the market by entrepreneurs who respond to the world as they find it and prices as they are generated in the market, is doomed to fail. That of itself will ensure the economy cannot function.

One of our problems has a lot to do with terminology. Maybe several of our problems have a lot to do with terminology. When someone says, “There’s a mess on the floor in the kitchen,” the lucky soul who will deal with the mess needs to know more about the mess. Of perhaps substitute a certain s-word for the word mess, but typing “a certain s-word” a bunch of times will tire me out.

The word “socialism” is being applied to many kinds of messes but they are not all socialism, just as people only sometimes mean s-word when they refer to “that s-word.”

Most commonly, “socialism” is being applied to a vision rather than an ideology or methodology, a vision where the great wealth created by an economy is distributed more widely so that the people with the least money get more benefit from the economy. In the wealthier countries of Europe and Asia, that vision is carried out with a welfare state and high level of command in an economy that is still based on private ownership and on free exchange. People in the UK or in Japan may still choose their occupations and their businesses are privately owned. There’s a large range of salaries among those who work for wages or salaries. Those who have somewhat larger incomes pay much higher taxes to subsidize welfare-state subsidies of those who make less money. You also have the panoply of labor laws that stifle economic development but do not kill it outright and you have a lot of petty laws, almost tyrannical laws, passed by the duly elected representatives of the very people who carp about high unemployment, high taxes, stagnant economic development, and the wickedness of the wealthy. But this system is not socialism as an economic system; it does less harm and it does it more slowly.

A near-command economy with the ownership and much of the profits of economic activity still in private hands is the fascist model. Since the owners connect closely with the political powers and since the owners still want profits, this brand of command economy will make efforts to keep up profits but those efforts will be misguided because command economies are inherently limited in their responsiveness. Beyond the inherent limits of attempting to run an economy by committee, every command economy has also wound up listening to the loudest and most influential voices but those voices rarely know or care about the broadest benefit for their societies.

Fascist societies are usually welfare states to bribe the common people — people like me.

Socialism involves the ownership of the economic entities by their workers. Now, strange to say, this can actually work if the businesses remain private and the government mostly keeps its hands off. If the workers and retirees of GM and Ore-Ida Foods owned the enterprises and still had to compete effectively with Ford and Tyson, the workers would have lots of reason to increase their productivity, improve their products, lower their costs, and otherwise operate for the enterprise’s benefit. In theory, at least, an economy could thrive this way and the workers might indeed have their standards of living rise and become somewhat more equal across the skills that the enterprise needs. A socialist economy could be a free exchange economy with nearly all the blessings of such an economy and perhaps relieving some of the problems that come with all economies.

Problem with this model is, history shows no examples of societies that have organically evolved worker-owned enterprises that compete as private businesses. The US has gone a few steps down this path but only a few. We don’t know if the theoretical success of such a system would turn up in real life because there’s such a huge push to immediately distribute the goodies and so the geese that lay golden eggs get slaughtered and you find out there’s no actual gold in the geese.

Communism, the ultimate command economy with state ownership of all major production and distribution and “equal” sharing of the fruits of the economy, has failed even worse than other command economies. I can’t figure out the relationship between having to impose communism by force and its invariable failures, but I am sure the two factors are linked. Perhaps a circle has neither beginning nor end.

Most of our soi-disant “socialists” are actually welfare-state nanny-bullies. Their policies and theories are not geared to collective ownership but to collective pillaging. In terms of discussion and dealing with the special brand of s-word that is socialism, it matters that that is not what is on the floor. We need to address the s-word of welfare-state nanny-bullyism because that is what is actually on the floor.

And then this: Young Americans are embracing socialism.

61% of Americans aged between 18 and 24 have a positive reaction to the word “socialism” — beating out “capitalism” at 58%. Overall, 39% of Americans are well-disposed toward socialism, but the gulf remains wide for men and those aged over 55.

It’s only a word. At the moment across the whole of society there are still 61% who react positively to the word “capitalism”. But that is if you are older and male.

The Making of Modern Economics

From someone who gets Keynes and Say’s Law.

Greetings from Mark Skousen to my friends in the Mont Pelerin Society.

As you know, socialism has suddenly become all the rage with the rise of Senator Bernie Sanders and Congresswoman Alexandria Ocasio-Cortez (whom I call Castro-lite) here in the United States and in Europe.

Don’t think for a moment that the New Socialists are a flash in the pan.

The Green New Deal, Modern Monetary Policy, Medicare for All, and Free College are all being taken seriously by students, politicians, and media, unworkable and inflationary as they are.

Sanders is running for President in 2020 and would consider Ocasio-Cortez as his running mate, if she were eligible (she’s only 29 years old).

How do you fight a bad idea? With a better idea!  It’s time to start a campaign to promote the best of capitalism and free-market economics.

The Economist is convinced that pro-market forces “have all too often given up the battle of ideas” (Feb 22 issue of “The Rise of Millennial Socialism”)

Let’s hope not!

How to fight back?   I’ve started a campaign to promote my book,

“The Making of Modern Economics: The Lives and Ideas of the Great Thinkers.”  

Now published by Routledge in a new third edition, it’s been endorsed by Milton Friedman, Roger Garrison, Peter Boettke, Ken Schoolland and many other members of the society.

It tells the unique story of Adam Smith, the founder of free-market capitalism, and how his “system of natural liberty” comes under attack by the Marxists, Keynesians, and socialists, and is often left for dead, but then is resuscitated by the French laissez-faire school, and the Austrians and the Chicago school, and triumphs in the end.

It has five chapters that rip apart the arguments that the Socialists and the Keynesians make.

It has converted many Marxists to free-market capitalists, and one reviewer calls it “the most devastating critique of Keynesian economics ever written.”

Most importantly, my book introduces the reader to the great defenders of free-market capitalism, including Adam Smith, the French laissez-faire school, and the Austrian and Chicago schools (as represented by Mises, Hayek and Friedman).

Last November, I started the campaign by purchasing a full page ad in The Economist and received hundreds of orders from around the world. You can see the ad here: http://mskousen.com/2018/11/the-economist-publishes-new-ad-for-making-of-modern-economics/.

The Ayn Rand Institute recently ranked it the #2 most important book ever written about economics (just behind Henry Hazlitt’s “Economics in One Lesson”).

It won the Choice Book Award for Outstanding Academic Excellence.

It’s been translated into six languages — in Chinese (twice), Spanish (Union Editorial), Turkish, Mongolian, Vietnamese, and Arabic.

Students, fellow economists, and business leaders are fans. Professor Roger Garrison (Auburn U) says, “My students love it.  Skousen makes the history of economics come alive like no other textbook.”

“Skousen gets the story ‘right’ and does it in an entertaining fashion, without dogmatic rantings.” – Peter Boettke, George Mason University.

The late Milton Friedman wrote, “All histories of economics at BS –Before Skousen!  Lively and accurate, a sure bestseller.”

John Mackey, CEO, Whole Foods Markets, said, “I have read it three times. It’s fun to read on every page. I love this book and have recommended it to dozens of my friends.”

And the late William F. Buckley Jr. told me, “I champion your book to everyone.  I keep it by my bedside and refer to it often.  Every student should have a copy.”

The story behind this book is quite extraordinary. You can read it here: http://mskousen.com/2018/10/adam-smith-and-the-making-of-modern-economics/.

“The Making of Modern Economics” is a 500-page book available in hardback, paperback, Kindle, or audio.  The quality paperback retails $53.95 by Routledge and $43.74 on Amazon, but you can buy it for only $35 directly from Skousen Books, including postage. I will autograph each copy and mail it for free. (For orders outside the US, add $30 for airmail shipping.) To order, call Harold at Skousen Books, 1-866-254-2057. Or order online at www.skousenbooks.com.

I was interviewed on C-SPAN Book TV about “The Making of Modern Economics.” Watch the 20-minute interview here:  https://www.c-span.org/video/?307279-1/the-making-modern-economics.

We can win the battle of ideas. Let the campaign begin!

Yours for peace, prosperity, and liberty, AEIOU.

A modern course in economics will not tell you what’s wrong with socialism

“Socialism” is an elastic term, with a different meaning and connotation for everyone, which lets every believer in a socialist future off the hook since they can always say that’s not what I have in mind and it’s not what I mean. Moreover, I leave out the politics which is what everyone normally thinks about, since every socialist state – except the one that socialists imagine in their minds and discuss in public before they set one up – is about milk and honey for everyone, equality for all, and happiness to the fullest extent that human life can create. It is a fantasy world entirely removed from the reality of life.

Here I will define socialism as a system in which the economy is directed by the government through some kind of centrally-determined plan, rather than the economy being allowed to run on its own by itself through the decisions made by the individual owners of businesses. Nationalisation, massive levels of public sector spending, price controls and heavy-handed regulation of whatever is left in private hands are the mainstays of a socialist economy. If all it were was the normal operation of an entrepreneurial-driven market economy then there would be no need to set up anything new. Since socialists never specify beyond pie-in-the-sky what they intend to do – only the outcomes they promise to achieve – the best we can do is see what is found in the socialist literature of the past and present, as well as the practice of various socialist states, also both past and present.

I will add that macroeconomics as it is now taught, which sees only a positive role for large levels of public spending and thinks that an economy is perennially in danger of a failure of demand because of decisions to save rather than spend, are nine-tenths of the journey towards an acceptance not only of socialism, but of its necessity. The role of government in managing the economy and filling in the expenditure gaps with its only massive levels of expenditures is mainstream theory taught all over the world.

The basis for the presentation is my belief that a modern course in economics, based on standard economic texts in which the standard economic theories are presented, will leave a student without an adequate understanding of why a socialist economy cannot work, and in many cases with no such understanding at all.

This is based on my observation that very few – whether an economist or otherwise – can explain why socialism inevitably leads to poverty, although anyone willing to look can see this is true. There are innumerable political and philosophical reasons for fearing socialist ideas:

  • centralised political control
  • extraordinary power granted to government
  • loss of political freedom
  • diminished personal responsibility
  • diminished independence
  • encourages sloth

The presentation is based on my just-published, “I, Mechanical Pencil” which has been put out by the CIS and which you can find a copy of here.

My approach to the presentation is first to list the six absolutely essential elements of an economy, the absence of any one of which will cause the economy to cease working other than in the most rudimentary way. These six are:

(1) entrepreneurs who make decisions for themselves
(2) an independent financial system
(3) an operating price mechanism
(4) business profitability as the major determinant of what is produced and how it is produced
(5) sound government regulation, and
(6) a robust defence of property rights.

(1) Entrepreneurs

Every productive enterprise must be run by someone. There are many decisions to be made, all of which require a constant ability for someone to respond both to opportunities that present themselves and the problems which are both frequent and inevitable. In a market economy, productive enterprises are run by individual members of the community who do so because that is how they seek to earn their incomes. No entrepreneur is a government employee, nor are they chosen by governments to run these firms. Instead, entrepreneurs are the individuals who truly care about the welfare of the business, partly because every mistake takes money from their pockets, but also because the business is their creation in the same way that a work of art is the creation of an artist.

Entrepreneurs are not mere managers nor can they be replaced by managers. They are the individuals for whom the business is their own, and which they spend their lives trying to shape into as good a business as it can possibly be. It is not just a job. It is a vocation.

Yet no text on economics discusses the role of the entrepreneur. You can do ancillary courses in which the entrepreneur is discussed, and these are almost entirely courses that focus on innovation. The actual superintendence of a business is seen as of almost no relevance to the operation of a firm.

It is also the entrepreneur who determines what will be produced, and is entirely responsible for the commercial introduction of innovation onto the market.

(2) An independent financial system

Similarly, finance is not discussed as part of the education of an economist. There is money, banking, interest rates and the role of saving that do get a run through, but the determination of which firms are determined to be potentially the most viable by those who make lending decisions is at most a paragraph worth of discussion.

More crucial, the very issue at stake in the decisions that go behind finance is the allocation of a nation’s available saving among all the alternative uses that savings might be channelled towards. And here there are two massive blunders which almost totally obscure what it taking place.

Saving is discussed almost entirely (perhaps entirely) as a flow of money. And in a standard macro analysis, it is made up of the difference between current income and current consumption: S = Y – C.

Then, beyond this, the level of saving is taken to be the sum of money that is generated during the course either of the quarter or the current year, but whatever period is chosen, the present, or near present is all that counts.

Thus, the very concept of saving is totally lost. What is actually being determined by finance decisions is completely misstated. Saving is not a sum of money, saving is that stock of productive assets (eg machines and buildings) and available labour that can be used to build additions to the nation’s capital stock. What those who provide finance actually do is determine to whom to give sums of money that allow particular businesses to purchase in the various forms of capital and labour with which they can complete their own investment projects.

More destructive still is the imbedded Keynesian belief that recessions are caused by excess saving. The entire and madly destructive theory that explains recessions as a sign of that savings levels are higher than businesses wish to invest has led to decisions across the world for governments to engage in largely wasteful and unproductive spending to soak up those savings, as if sums of money sitting in bank accounts or in some other way left unspent is evidence that our savings are being left unused.

The reality is that virtually every form of saving (capital equipment and labour) are owned by someone who does everything they can to ensure that the capital and labour they own (the labour is, of course, their own labour) are being put to work. There are periods of transition when capital and labour are idle – factories close and people lose their jobs for all kinds of reasons – but unemployed workers along with whomever owns the capital will do everything they can to find alternative forms of work. We systematically ruin our economies by following Keynesian models and prescriptions.

(3) An Operating Price Mechanism

This is the one that counts since it is both the most obscure but also the most important. This was the issue at the heart of the “socialist calculation debate” that went on from the 1920s and through until the 1950s and then ceased. No one, other than in a few classes here or there, is ever taught anything at all about any of this.

More to the point, in a world in which there are infinitely more uses for most of the resources that are available, and also many ways that any particular output could be produced, there is an absolute need to ensure that some means to choose the least resource-intensive means to produce each good or service. Unless you understand why a business cannot decide which way to produce using the fewest resources if there is no price system in existence, you will never be able to undermine socialism. Here is a made-up example for the production of a number of units of X.

X = 2A + 3B + 4C + 9D
X = 3A + 4B + 3C + 7D
X = 7A + 5B + 2C + 4D

All of these might be ways to make the same number of units of X but unless you know in a realistic way how much A, B, C and D cost, you cannot determine which way to produce at the lowest cost. These are not technical questions but entirely economic.

What is the relative value of a tonne of steel in comparison with a tonne of copper? Is it cheaper to build a wall out of plaster or out of wood? Only in a market system, where the producers of every single input have to price what they sell to earn a positive return on their outlays, can there even be an estimate made of which array of inputs would provide the lowest cost to the economy in providing the same utility to the buyer.

As in the above example, you will still get X irrespective of which combination of inputs is chosen, but some of those resources are rare and have other more valuable alternative uses. Without a price mechanism based on the proper relative valuation of the output, that can only be determined in a market setting by entrepreneurs, a central planner cannot even begin to decide how to go about producing anything.

And it has ever been thus in every attempt to introduce socialism. Every socialist economy immediately loses its bearings because it has no means to decide which alternative would use up a smaller proportion of the resource base of the economy, and if it cannot do that, it will choose means of production that will waste prodigious amounts of resources on each particular item so that fewer items in total can be produced.

There was a long debate over whether central planners could manufacture a reasonable facsimile of relative prices that happen naturally through entrepreneurial pricing on the market. It was at one time understood even among the defenders of socialism that an answer to this question was crucial if a socialist system was to function. And the fact is, that this issue was never properly resolved, as was evident by the collapse of the Soviet Union in the late 1980s.

The most astonishing example was the different standards of living in East and West Germany. The differences were immense since the East Germans could not even remotely maintain the same living standards, and this was even though they tried to determine costs by using the relative prices generated in West Germany and apply these to their own production techniques. But as close as they were both geographically and culturally, the relative price structure generated automatically in the West were near useless to the central planners in the East since they did not in any way reflect their own production costs.

(4) Business Profitability

For reasons that I will not explain here, but every economist is taught, the ideal model of the operation of an economy is described as PERFECT Competition, and is contrasted with all other forms which are described as Imperfect Competition. For some reason, the ideal form of market structure is one in which, as it says below, “no one earns a profit”.

Perfect Competition – No One Earns a Profit

In perfect competition, the market is the sum of all of the individual firms. The market is modelled by the standard market diagram (demand and supply) and the firm is modelled by the cost model (standard average and marginal cost curves). The firm as a price taker simply ‘takes’ and charges the market price (P* in Figure 1 below). This price represents their average and marginal revenue curve. Onto this we superimpose the marginal and average cost curves and this gives us the equilibrium of the firm.

Source

The conception to reach this conclusion is so entirely static that it is absurd to think of this as in any way representative of the operation of a market economy. The very existence of profit shows, so far as economics is concerned, that the economy is not running at peak efficiency. There are also questions of an improper distribution of income since in a truly competitive economy, and in the long run, a larger return than the absolute minimum somehow implies that the market is not functioning at its optimal level. All other market structures, which in reality represents about 98% of the economy, are inefficient because firms are able to adjust their level of supply to earn a profit above the efficient minimum. But the existence of profit, as defined within an economics text, is a negative.

(5) Sound Government Regulation

There are schools of economic thought for which the very notion that government regulations have any role to play is anathema. There is no doubt that there can be over-regulation, and we experience just that everywhere today. The principle seems to be that if someone can think of some negative potential in some action, that it will either be examined to death or forbidden. But the opposite principle is just as bad, that business should just be allowed to get on with things without any scrutiny or direction from government.

The point here is not just that regulation is essential, but that regulation must be limited to just those forms of control that will actually pass some kind of cost-benefit test. Here the issue for modern economics is not that there should be regulation. That is much of what an economics course now is – a discussion of market failure and the need to remedy the errors of the market. So in this instance, the point here is to recognise that some regulation is essential.

This is from Mises’s Human Action. And while it is clear that Mises is reluctant to state that there is such a role for governments because of the principle of give-them-an-inch-and-they-will-take-a-mile, nevertheless, he does accept that government does indeed have such a role.

There are certainly cases in which people may consider definite restrictive measures as justified. Regulations concerning fire prevention are restrictive and raise the cost of production. But the curtailment of total output they bring about is the price to be paid for avoidance of greater disaster. The decision about each restrictive measure is to be made on the ground of meticulous weighing of the costs to be incurred and the prize to be obtained. No reasonable man could possibly question this rule. (Mises [1949] 1963: 748)

Regulatory overkill has been a disaster for the functioning of our economies. I truly never understand how the entrepreneurial types I know put up with it. You would think that those who set the rules are doing so with the intent of killing businesses off.

(6) Property Rights

Socialist governments are notoriously opposed to the private ownership of the means of production. “Expropriate the expropriators” is the ancient expression. Nationalisation of the commanding heights of the economy and whatever.

Whether this is driven by envy or by some unstated economic rationale, the aim to achieve something described as “equality” is the mantra. The result is that those who produce are taxed to provide incomes to those who produce less or produce nothing at all. And in the socialist commonwealth, the levelling is complete, with the masses living in poverty and those at the top living upon the meagre levels of wealth the economy might be capable of producing.

If property rights are included in a standard text, it has escaped me. There is nothing in how modern economics is taught, with it abstract and often mathematical discussion of the operation of the various forces to produce the strangest economic notion of all – equilibrium – that anywhere mentions that only if the producers of capital believe they will maintain the ownership of what they have crafted, will that capital come into existence in the first place.

Which would be worse?

Which would be worse?

[A] Doubling the size of the deficit with public spending cut in half, or [B] balancing the budget with the level of the deficit doubled in size from where it presently is.

Neither would be great, but for me A would be vastly preferable to B.

There is no way one could ever find out since no economic model could be trusted to give an accurate model. But on this score, my guess would be that most modern macro models would show B preferable to A.

Are there degrees of ‘socialism’?

I had a brief query from a friend the other day:

This is probably a red-herring but I did wonder if there are degrees of ‘socialism’ in which some degree of government ownership and control of the means of production is acceptable but with private sector ownership and incentives the dominant force. I’m thinking of the so-called ‘mixed’ economy concept.

Here in NZ we are having a debate about how we should frame objectives for the economy, with a shift away from a predominant focus on growth (in GDP) towards a ‘well-being’ framework (currently being developed by the NZ Treasury. I don’t think most economists are persuaded by this but it’s politically appealing because it appears to offer more emphasis on distributional fairness and the environment.

Well, I do go on a bit, but the question is an interesting one and important. My reply, off the top of my head, but more consideration still needed.

Interesting issue since everyone who now declares themselves a socialist doesn’t define socialism in the same way. There are plenty of “socialists” who think socialism is a heavy duty form of the welfare state. It’s fantastically costly, and in rich economies like ours, we typically allow plenty of free riding which will eventually have to be paid for one way or another. We are ruining ourselves because we think we are richer than we are, to subsidise plenty of people who ought to be contributing to their own upkeep. But once you get into the various forms of attempting to create greater equality, you are in an endless spiral since you can never create enough of it since there are always going to be income differences, many of which have no cosmic justification but just are what they are.

We already do an incredible amount of redistribution from those with high incomes to those with lower incomes. But if you take from some who earn high incomes they will provide less output to the common pool. And funny enough, if you give to people with lower incomes, they too will provide less to the common pool. Very destructive of an economy based on personal incomes related to one’s own contribution to the total. In a bygone era, most individuals felt a responsibility to remain as productive as possible for as long as possible, so we invented a system of welfare to assist those who fell by the wayside. Now there are so many who sit by the wayside picking up whatever they can, and this is now made much much worse by the increasing numbers who never intend to contribute anything but intend to be subsidised merely for existing. You can call that socialism if you like. It is immensely destructive, but since we have so much productive capital to run through it may take a while before we really notice. By then, alas, it will be too late. An inbred lack of industriousness in the midst of a crumbling economic structure is what you have right now in California which has more people on welfare proportionately than any other American state. And as rich as they are, it will not survive another decade before some kind of collapse overtakes them. Already the productive are escaping to other states. Unfortunately they are taking their welfare mentality with them.

As for the more traditional forms of socialism, virtually no government now seeks to take over the commanding heights of the economy, other than idiots like in Venezuela. There it took around a decade for the full horror to manifest itself, but now that it has, everyone has backed off from that version, at least for the time being. The version we are in the midst of is what I think of as the “crony capitalist” version, which is based on governments squeezing the last dollar of tax revenue, plus whatever they can extort from their central bank money creation process, to direct spending in a politically advantageous direction. Australia is at the start of a fall in living standards that is in large part based on the notion that all public spending adds to demand and therefore is positive. Which is augmented here by a superstitious belief that bringing in many many migrants makes the economy rich because we have to build infrastructure and housing for them to live in. Quite insane, but if you really think economies are driven by C+I+G, you cannot see the problem until the economy finally does fall apart and even then won’t understand the problem although it will be right before their eyes. The RBA and Treasury keep expecting the economy to turn around, and are ever-amazed when it does not.

Mises discusses government regulation

Mises’ Human Action is an austere no frills explanation of not just how a market economy works, but also why only a market economy can work. There are the members of a community who have material desires they would like satisfied and personal services they would like to engage. Most of what individuals want is dependent on what has already been produced and sold in the past, although of those desires are for goods and services that have only just been made available.

There are also individuals who earn their own living by running businesses that produce these goods and services in the hope that others will buy them, and in so doing pay enough in total amongst all purchasers to cover the costs of production.

There are also entrepreneurs who run businesses that produce inputs that are used within other businesses. Ultimately, however, all production is focused on satisfying the demands of final consumers. It is in this sense that consumers call the shots. What people are willing to pay for determines what will be produced since only those enterprises that produce goods and services that earn a profit can stay in business.

But what people will be willing to pay for is an unknown that can only be discovered if an entrepreneur makes the decision to produce some good or service and put it on the market. Only then can it be discovered whether whatever has been produced can be sold at a profit. Once it has been determined that a profitable enterprise can be established to produce these particular goods and services, many other firms may then follow along and try to produce the same product or even better versions.

This is how the market works through the trial and error efforts of entrepreneurs to find products that can be sold at a profit. If a community is content never to change any of the products it chooses to buy, and there are never any interruptions or changes in the supply conditions for the inputs used in production, the economy can enter a steady state which can repeat endlessly the same routine. But since in the real world there are new innovations taking place all the time, and changes in the supply conditions for inputs, a steady state outcome is an impossibility.

Therefore to ensure an economy continually improves the products produced, and can adjust to new conditions in the supply of inputs, a market mechanism is essential. No other mechanism will work if a community is intent on improving its standard of living or wishes to accommodate changes in the conditions of supply.

The question then is whether there is any role for government oversight and regulation in such an economy. And while it is clear that Mises is reluctant to state that there is such a role for governments because of the principle of give-them-an-inch-and-they-will-take-a-mile, nevertheless, he does accept that government does indeed have such a role. This is from Human Action:

There are certainly cases in which people may consider definite restrictive measures as justified. Regulations concerning fire prevention are restrictive and raise the cost of production. But the curtailment of total output they bring about is the price to be paid for avoidance of greater disaster. The decision about each restrictive measure is to be made on the ground of meticulous weighing of the costs to be incurred and the prize to be obtained. No reasonable man could possibly question this rule. (Mises [1949] 1963: 748)

There ought to be no doubt from this passage that there are circumstances for which government regulation is warranted. It is a cost-benefit calculation in which regulations are laid down, which have a cost in lost production, but in which there is a positive return in the prevention of an even more costly outcome whose probability of occurrence has been reduced.

His reluctance to state in a more fulsome way that such regulations have a role in economic management is based on his no doubt correct judgement that from the example of this unquestionable use of government regulations to diminish the possibility of a much more costly outcome has been a thin edge of the wedge to justify an enormous and monstrous regulatory regime across all the economies of the world. If anything has occurred, the meticulous examinations that now occur are to determine if there is absolutely no possible harm that might occur if some regulation is not introduced and enforced. The weight of evidence has now been placed on those who wish to reduce such regulations where outcomes with a small probability of occurrence are not made the basis for such rules.

The principle should therefore not be seen as a blanket ban on government regulation per se, but as the need for those who wish to impose such regulations to demonstrate that the potential risk is large and that the market would not be expected to provide its own cure if left on its own to work things out.

If, for example, individuals who wish to built houses in the middle of flood planes that are expected to flood only once in fifty years should be permitted to do so, but also told that if they do, they must cover the cost of insurance themselves and not expect a government to make good any losses they might endure because of flood damage.

And while there is need for licensing for doctors and electricians, since no consumer can be expected to research into the competencies of individuals who declare themselves a doctor or electrician, there is no need for regulation in endless other occupations, with hairdressers as the most notorious example of regulatory overkill.

But there is a further issue in relation to regulation. Within political debate, to argue that no regulations are ever justified will instantaneously lose the public debate. No one will accept that the market can be left to itself without oversight and regulation. Finding the balance is important, but not to recognise an important social function of regulation by governments, specially by governments under popular control, is to throw the baby of good economic management out with the bathwater of heavy-handed control.

Mises, Ludwig von. [1949] 1963. Human Action: A Treatise on Economics. Fourth Revised Edition. San Francisco: Fox and Wilkes.

The persistent failure of economic theory

I see the RBA today froze at the thought of raising rates in the midst of an economy as stone cold dead as this one. They are, of course, clueless about why this is, just as Treasury is equally clueless. So let me take you to my article just published at Quadrant on The Dangerous Persistence of Keynesian Economics. Here’s how it starts.

OUTSIDE the United States, no economy has fully recovered from the downturn that followed the Global Financial Crisis in 2008-09. The crisis came and went in half a year, but just about every economy continues to have problems generating growth, increasing employment and raising real incomes. As I was writing my article on “The Dangerous Return to Keynesian Economics” in 2009, I commenced working on an economic textbook, now in its third edition, to explain why modern macroeconomic theory is utterly useless, why no one using these economic models as a guide to policy would ever succeed. And here we are, ten years later, and everything discussed in that earlier article, explained in far more detail in my text, has come to pass.

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Just as the causes of this downturn cannot be charted through a Keynesian demand deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.
What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.
—Steven Kates, Quadrant, March 2009

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Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?
—Question to Steven Kates from Senator Doug Cameron, Senate Economic References Committee, September 21, 2009

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Why did I get it so right? Because nearly everyone else thinks economies are made to grow through increases in demand, while in reality, as was once universally understood, economies can only be made to grow through improvements in supply-side conditions. Demand has absolutely nothing to do with making an economy grow. Demand of course is crucial to how many units of any particular good or service will sell, but has nothing whatsoever to do with how fast an economy in total will grow, or how many workers will be employed.

Does being right count for anything? Not a bit. Still, you can go back to my original article from ten years ago, The Dangerous Return to Keynesian Economics, and see how well what I said then stacks up with how things now are.

Let me add that if you are not already a subscriber, you should be. Subscribe here.

Socialism: promising prosperity but delivering poverty

“Need to put pencil to paper to tell what it will do to the economy.”

More here: Larry Kudlow: ‘We Have to Put Socialism on Trial’. But the point made is that no matter how good things are no one is fully satisfied. There is always a struggle and there are always others doing better than we are. Envy and dissatisfaction are everywhere and universal.

If logic worked, there would no longer be a single socialist in the world. So why are they still there and growing in number? Irrationality is rife, and there are many in the world who to advance themselves see leading the masses as their only way to power and wealth.

At the centre are the entrepreneurs who guide the individual units of a capitalist economy through their moment-by-moment attendance to the businesses they run. This is a passage about Tolstoy in an article on the novel that has great relevance:

In one essay, he retold a story about the Russian painter Bryullov, who corrected a student’s sketch. “Why you only touched it a tiny bit,” the student exclaimed, “but it is a completely different thing.” Bryullov replied, “Art begins where that ‘tiny bit’ begins.” Tolstoy elaborates:

That saying is strikingly true not only of art but of all life. One may say that true life begins where the tiny bit begins—where what seem to us minute and infinitely small alterations take place. True life is not lived where great external changes take place—where people move about, clash, fight, and slay one another—it is lived only where these tiny, tiny, infinitesimally small changes occur.

“All of life” includes the lives of those who run a business. Socialists argue that a central plan can replace the individual attendance of those who own, run, manage and earn an income from running a firm. But there, too, each of those “tiny bits” affects the whole. That is also part of why socialism must fail.