Category Archives: Economic theory and policy

This is classical economic theory

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No one can really see it yet but classical economic theory is coming back. This post at Instapundit by Mark Tapscott is presented and discussed in exactly the way economics would have been discussed by the great classical economists between 1776 and 1936. The issue is not about demand. It is about the redeployment of actual physical resources – capital goods – from less productive and even non-productive uses into more productive and positively productive uses. You may think you have heard this said before, because you think that is how economic theory and policy should be discussed, but I keep an eye out for it and this is the first time I have come across anything discussed in that way.

I have posted this paper before – Making Sense of Classical Theory – which is a pre-print of a paper that will appear in the April 2018 edition of the Journal of the History of Economic Thought. If you are at all interested in understanding how pre-Keynesian economists thought about the structure of an economy and what made it grow and flourish, you should read that paper. It describes in theoretical terms how Mark Tapscott explains the sudden flourishing of the American economy. This is exactly how classical economists looked at things.

TRUMP’S FIRST-YEAR BOOM IS LARGELY DUE TO DEREGULATION BUT THINK ABOUT THIS: Merely cancelling an expensive federal regulation doesn’t immediately convert the compliance cost into a potentially productive new investment. The capital has to be reallocated and some time is required for the new investment to produce sufficient return to offset the former compliance costs. Huh?

In other words: “It takes time for the economy to recover the costs of excessive regulatory compliance and to redirect capital to productive uses, so the gains seen during Trump’s first year are likely attributable in significant part to the expectations generated by his slashing the red tape. The full impact of the deregulation is still to be felt.”

And remember, the Trump tax cuts aren’t in effect until February. Wayne Crews of the Competitive Enterprise Institute estimates regulatory compliance cost the U.S. economy $1.9 trillion. Trump can’t repeal all federal regulations but what if his tax cuts and the continuing positive impact of deregulation in coming years produces an economic boom that far exceeds the Reagan era? Ponder that one a bit!

The value of tax cuts is in their ability to divert resource use away from consumer goods and governments into the hands of productive business who are then able to invest. Cuts to regulation play their role by reducing wasted efforts within business in complying with government directions and instead use the resources at their disposal to create value. It works like magic, because to a modern macroeconomist it is magic since they have no means of explaining what was once perfectly well understood by everyone.

C’mon, who’s really clueless about trade?

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From Forbes, the kind of thing you find in among Chamber of Commerce types: Trump’s Tariffs Are A Reminder He’s Clueless About Trade. Sure he is, and the evidence keeps piling up day by day. If we lived in a crony-capitalist-free world, and no one ever cheated in their trade relations,* maybe such blanket statements would make sense. But truly lacking in any penetration is the manipulation of arithmetical statistical identities as if they were actual theoretical constructs where a change in one variable is the cause of a change in another. In reality, with such identities, these are accounting balancing items which have no effect on actualities in the real world, but are only a record of what took place.

Now here is where the simple analytics of the trade deficit can be used to prove the cluelessness of the Trump trade team on “trade,” of all things, and the utter futility of its policy prescriptions having any impact on America’s aggregate trade deficit. In economics, identities play an important role. These identities are obtained by equating two different breakdowns of a single aggregate. Identities are interesting, and usually important, by definition. In national income accounting, the following identity can be derived. Indeed, it is the key to understanding the trade deficit.

(Imports – Exports ) ≡ (Investment – Savings) + (Government Spending – Taxes)

Given this identify, which must hold, the trade deficit is equal to the excess of private sector investment over savings, plus the excess of government spending over tax revenue. So the counterpart of the trade deficit is the sum of the private sector deficit and the government deficit (federal + state and local). The U.S. trade deficit, therefore, is just the mirror image of what is happening in the U.S. domestic economy. If expenditures in the U.S. exceed the incomes produced in the U.S., which they do, the excess expenditures will be met by an excess of imports over exports (read: a trade deficit).

This is the same as fiddling with Y=C+I+G and pretending that an increase in G can cause an increase in Y. Complete sophistry. There is much more to say about free trade and I have been meaning to say it for a while. This might therefore be what finally stirs me to spell it out in more detail, but this will have to do for now.

* See, for example, Australia takes Canada to WTO over rules on selling wine. My dual nationality obviously makes it impossible for me to see the rights and wrongs of this, but let me say that no Australian will ever understand the liquor laws of Canada, which were introduced as temporary measures during World War I. There’s a lesson in there as well.

“Thank you Mr President for your inspiring speech”

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Trump declares the U.S. is ‘open for business’ in Davos, as he tells global bigwigs ‘America First does not mean America alone. Speeches on the vid begin around 4:45 in. PDT at around 8:30.

  • President Donald Trump defended his aggressive trade posture before world leaders and business moguls in Davos
  •  He declared the U.S. ‘open for business’
  •  Trump also tried to explain how he would cooperate with other nations
  • Trump has said he’ll withdraw from global climate pacts and trade deals 
  • ‘I will always put America First. Just like the leaders of other countries should put their countries first also’
  • Pitches investment in the USA 
  • ‘America is roaring back and now is the time to invest in the future of America’
  • Says he’ll ‘denuke the Korean peninsula’ 
  • Hails retaking ISIS territory ‘once held by these killers in Iraq and Syria’

The words in the heading are from the President of the World Economic Forum.

UPDATE: The text of Remarks by President Trump to the World Economic Forum.

If you want to understand how an economy works you need to understand classical economic theory

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So long as Keynesian economics remains the mainstream, there is no possibility of taking down the crony capitalist system of economic management. Because Keynesian theory is the mainstream which everyone learns, economists are taught from their very first days in class, that routinely syphoning our wealth into the hands of governments and their friends will create a net increase in the number of jobs while making everyone better off. It isn’t true, and ought to be seen as obviously untrue, but since the pretence makes governments and their crony capitalist friends immensely rich, it just goes on. So more fool you for accepting Keynesian theory.

The argument that an economy is driven by the level of demand, irrespective of what is being demanded, works very well for those receiving handouts from governments, but harms everyone else. All production uses up resources while only a small proportion adds anything back in. It is now invisible in the way economics is currently taught why all of that matters. In writing as I do I am doing nothing more than repeating what was obvious to every great economist before The Keynesian Revolution but is utterly unknown other than to a handful of economists who have actually studied the classics.

At the link may be found a pre-print of an article of mine that will appear in the June 2018 issue of the Journal of the History of Economic Thought: Making Sense of Classical Theory. This is the description of its contents.

The fundamental problem discussed is the shifts in the conceptual base of economic theory that followed the publication of The General Theory, along with various technical terms being given different meanings, which have made it almost impossible for modern economists to comprehend classical theory. Yet it is in the classical theory of the cycle where the most profound understanding of the nature of recession and cyclical unemployment is found.

The paper’s not long but it takes you into the heart of the differences between modern economics and the classical theory that had existed prior to the publication of The General Theory in 1936. This is now the sixth paper in a series that began with the publication of my article on Mill’s Fourth Proposition on Capital in 2015. That earlier paper was criticised by an economist in the UK by name of Roy Grieve, whose criticism of my paper attracted a series of comments by an American economist, James Ahiakpor.

I can only hope that the core point found in the attached paper, explaining why classical theory works and Keynesian economics does not, will be clear. But as this brief paper points out, there have been so many changes in the terminology and presuppositions within economic theory since classical times that it remains almost impossible for a modern economist to follow what the great economists of the past had said. But not only can it be done, but you will only understand how an economy works if you do.

Classical economic theory and the American recovery

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UPDATE ABOVE: Birthday pressies from the family who seem to know me quite well.

Modern economics explains to governments how they and their crony capitalist mates can steal from you while pretending they are doing you good. And before we go any farther, here is something you should know before you listen to another word from anyone in government: Government spending never creates a net increase in employment. Government spending only creates jobs in one place at the expense of jobs somewhere else, and does it by giving money to the government’s best friends to run projects no firm, based on profit and loss, would ever undertake. And if the project is loss making, which government projects almost invariably are, it has taken the economy backwards – that is, people in general invariably become less well off than they otherwise would have been had these projects not gone ahead – even if those to whom the government has paid money are better off, which they almost invariably are. Government spending, unless there is a genuine and calculated return above the cost, is a ripoff, and it is you who are being ripped off. They pick your pockets and pretend they are doing you good.

Let us look at the alternative. The turnaround in the American economy over the past year is astonishing and almost unprecedented; you might have to go back to Harding in 1921 to find a parallel. No modern macroeconomist can explain it. The supply-side of the economy is not only invisible to almost every economist miseducated today, but so far as their demented demand-side models go, is irrelevant to raising growth and employment. Here is what I wrote in November 2016, with the only bit I got wrong being how quickly things have turned around.

Getting a recovery from here, from within the mess that Obama has left behind, will be a task of such Herculean difficulty that only because Trump is president do I think it is even possible. And one of the most important virtues he may have is not listening to economists such as this one discussed in the article at the link: The brilliant economist who designed the failed 2009 stimulus plan tells us that Donald Trump’s economic plans are going to fail. Here we are dealing with Harvard economist, i.e. Keynesian economist, Lawrence Summers, about whom the article states:

At this point, we have to note that the esteemed Dr Summers was the architect of President Obama’s 2009 stimulus program, the American Recovery and Reinvestment Act of 2009, an $831 billion boondoggle which was promised to hold unemployment to a maximum of 8%; it reached 10.0% in October of 2009, and stood at 9.2% in June of 2011, when it was projected to be below 7%. There are many economists who still justify the stimulus bill by saying that while the effects of the recession were worse than estimated, they’d have been worse yet without the ARRA. That, of course, is unprovable, but when the designer of such a huge, failed program tells me that someone else’s economic plans won’t work, I have to look at his statements with a jaundiced eye.

Trump has spending plans of his own that aside from The Wall, which if it significantly reduces the size of the American welfare bill may pay for itself many times over, will also add to the burdens on the economy. But he also intends to cut energy costs, improve decaying infrastructure, free up the regulatory framework that suppresses industry, renegotiate trade deals that are intended to work for American industry, and lower government outlays generally. He will also remove Obamacare, which has raised the cost of full-time employees, while lowering the cost of health insurance. Interest rates will also start to rise which should assist in the shifting of resources into more productive areas of the economy, and will also add to the willingness of many to save.

I definitely do not say it’s easy, and no one can guarantee things will turn round rapidly enough to show results soon enough to work politically, specially in the midst of the hostile media circus Trump will have to deal with. But at least I feel that for the most part the changes that will be introduced will generally shift things in the right direction. Here is the alternative Summers has in mind:

I have long been a strong advocate of debt-financed public investment in the context of low interest rates and a decaying U.S. infrastructure, so I was glad to see Trump emphasize it. Unfortunately, the plan presented by his advisers, Peter Navarro and Wilbur Ross, suggests an approach based on tax credits for equity investment and total private-sector participation that will not cover the most important projects, not reach many of the most important investors and involve substantial mis-targeting of public resources.

There is no learning from history other than that economists never learn from history. You also know that Congress will fight like cats to maintain expenditure since that is almost entirely what they have to maintain their support. Whether there is a constituency for re-building the private sector is still to be discovered, but at least with Trump you know he will want to try.

You really do have to wonder whether economists will learn a thing from what they’ve just seen. Given the experience of the past, there is not the most remote chance in the world that they will. But what you’ve seen has been the result of following classical economic policy – the economics of John Stuart Mill – in just the way it would have been done before Keynes published his General Theory, a book that has destroyed the coherence of economic theory for three generations of economists and counting.

Keynesian economics is the greatest racket ever invented

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This is how they steal from you while pretending they are doing you good. Here then is something you should therefore know before you listen to another word from anyone in government: Except during recessions, an economy always creates as many jobs as there are people who are able to fill them. Government spending never creates a net increase in employment. Government spending only creates jobs in one place at the expense of jobs somewhere else, and does it by giving money to the government’s best friends to run projects no firm, based on profit and loss, would ever undertake. And if the project is loss making, which government projects almost invariably are, it has taken the economy backwards – that is, people in general invariably become less well off as a result – even if those to whom the government has paid money are better off, which they are almost invariably are. Government spending, unless there is a genuine and calculated benefit above the cost, is a ripoff, and it is you who are being ripped off. They pick your pockets and pretend they are doing you good.

Capitalism is the only economic system that works

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Wandering through the city’s bookshops yesterday I came across this: Is Capitalism Obsolete? with the subtitle, “A Journey through Alternative Economic Systems”. I live in hope that there will be at least one volume somewhere that has no for an answer. Haven’t seen anything in years. The above is my picture of the back cover. If you read how they advertise the book, you will find the least unexpected turn in the history of modern publishing.

After communism collapsed in the former Soviet Union, capitalism seemed to many observers like the only game in town, and questioning it became taboo for academic economists. But the financial crisis, chronic unemployment, and the inexorable rise of inequality have resurrected the question of whether there is a feasible and desirable alternative to capitalism. Against this backdrop of growing disenchantment, Giacomo Corneo presents a refreshingly antidogmatic review of economic systems, taking as his launching point a fictional argument between a daughter indignant about economic injustice and her father, a professor of economics.

Is Capitalism Obsolete? begins when the daughter’s angry complaints prompt her father to reply that capitalism cannot responsibly be abolished without an alternative in mind. He invites her on a tour of tried and proposed economic systems in which production and consumption obey noncapitalistic rules. These range from Plato’s Republic to diverse modern models, including anarchic communism, central planning, and a stakeholder society. Some of these alternatives have considerable strengths. But daunting problems arise when the basic institutions of capitalism—markets and private property—are suppressed. Ultimately, the father argues, all serious counterproposals to capitalism fail to pass the test of economic feasibility. Then the story takes an unexpected turn. Father and daughter jointly come up with a proposal to gradually transform the current economic system so as to share prosperity and foster democratic participation.

Capitalism means a system of production in which the ownership of firms is in the hands of private individuals who use the capital they buy, rent or own, while directing the employees they hire, to produce goods and services in a lawful way to sell what they have produced to others in order to earn a profit for themselves. There are lots of variations on the theme but that is essentially it. Nothing else has ever worked, nothing else will ever work, however many fools and their fictional daughters there may be who think they have come up with something else.

Economic theory and junk science

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You may have heard me mention once or twice before that Keynesian economics is junk science, but just in case you missed it I am going to mention it again. What has brought all this to mind is reading the front page story in The Oz in the context of the booming economy in the US. In The Oz we have this: Bill shock as standard of living slumps. In the United States we have this: US private sector added 250,000 jobs in Dec, vs estimate of 190,000: ADP. It also mentions that “the report helped send the Dow to break the 25,000 mark for the first time”. Of course, here in Australia we have something else instead:

Australians have endured their longest period of falling living standards in more than a quarter of a century as growth in costs outstripped earnings for the fifth consecutive quarter, leaving households worse off than they were six years ago.

The moronic focus on public spending to lift our economies is such dead stupidity, but even more dead stupidity is that economists continue with Y=C+I+G as the mantra of macroeconomic thought. I have just been sent my copyedited article that will be published in June: “Making Sense of Classical Theory”. It is an attempt to remind others that there was not only an economic theory before the publication of The General Theory in 1936, but that theory was vastly superior to the theory that disfigures our economic textbooks today.

As it happens, I have just been re-reading the third edition of my Free Market Economics. There is, unfortunately, nothing like it. Perfectly clear and as easy to read as a blog post but entirely framed around classical economic theory. The economics of John Stuart Mill, the greatest economist who has ever lived, recast for the 21st century. If you don’t want to buy it yourself, just get your library to buy a copy.

The reality remains that our living standards will continue to descend if those who make policy continue to believe that public expenditures like the Snowy Mountain Project Mark II will make the economy grow. It will, in exactly the same way as the NBN.

Productive and unproductive spending

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A very classical distinction that is lost on most economists today.

There is this grand distinction between an individual borrower and a borrowing government, that, in general, the former borrows capital for the purpose of beneficial employment, the latter for the purpose of barren consumption and expenditure.

— J. B. Say

From his Treatise on Political Economy dealing with “Of the Consumption of Wealth”.

An economic story for the ages

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From Drudge, with these as the sidebars:

 

One can support the Democrats and oppose Trump only if one believes in voting for a living and not the desire to live freely. It is not tax cuts as such that matter, but that the onus for growth is now being placed on the private sector. Over time, the proportion of the economy directed by government will recede along with the regulations that have slowed and in many places stopped productive activity.

The pressures it will place on others will be through the power of example rather than that the US will grow to anyone else’s detriment so others will be forced to match these policies or see their economies shrivel. Everyone will grow, but some more rapidly than others. This is how it’s done. No matter how much anyone else produces, whatever anyone else add themselves will make their own economy more prosperous.

That is, Keynesian economics is dead, at least for now.