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.

If you are an economist who looks at things from the demand side, then this is a puzzle:

Most Australians have not had a pay rise in real terms in years in the face of an assault on wages which has policy makers, unions and business groups worried. The typical Australian family takes home less today than it did in 2009, according to the latest Household Income and Labour Dynamics survey released this week. Just on Friday the Reserve Bank cut its economic growth forecasts by half a percentage point for the rest of this year after confirming wages remain at their lowest share of total income in half a century.

I won’t dwell on the obvious – at least the obvious to those who look at these matters from the supply side – but the starting date for this bit of analysis should give you a clue. The GFC was the start but the stimulus was the actual cause. A stimulus that does not add to value-adding output will pull an economy backwards and ultimately slow real wages growth. What are we to do with this?

The mining boom and Rudd/Gillard government’s multi-billion-dollar stimulus spending may have helped shield the economy from the worst of the GFC.

But since 2012 and 2013, Australian workers have felt stuck in a holding pattern of slow wages growth. Wages for the whole economy increased by 1.9 per cent in the year to March just in line with inflation.

No idea of cause and effect. Come along on Tuesday for a different way of looking at these things. No classical economist would be surprised.

This is the notice that has just been sent out from the School about a seminar I am about to present on Tuesday. You are welcome to come along but please first email Sveta to say you are intending to come: sveta.angelopoulos@rmit.edu.au

Brown Bag Seminar – Associate Professor Steve Kates

You are warmly invited to attend the School of EFM Brown Bag Seminar Series presentation by Associate Professor Steve Kates

A Classical Critique of Modern Economic Theory

This may be the nicest thing that has ever been said about me in print and it has just been said in a major economic journal:

Steven Kates is probably the best-known present-day proponent of the old “classical” macroeconomics of Jean-Baptiste Say, James Mill, David Ricardo, and John Stuart Mill. He affirms his belief in Say’s Law—a theorem that was “accepted by every economist for more than a hundred years up until 1936, [but has] apparently [become] an impassable obstacle in the modern world,” thus blocking present-day theorists’ access to earlier understanding (Kates 2014, p. 9). Kates has “written books and papers, monographs and articles” (ibid.) in a long-sustained effort to persuade the economics profession to see its way around that “obstacle.” Most recently, in this journal (“Mill’s Fourth Proposition on Capital: A Paradox Explained” [Kates 2015]), he has focused on Mill’s puzzling “fourth fundamental proposition on capital.” The proposition states notoriously (in the modern reader’s view) that “demand for commodities is not demand for labour.” Kates evidently means to settle, once and for all, the status of that contentious proposition by providing an explanation and defence of it.

Kates makes much of the fact that economists writing after Mill—eminent theorists such as Alfred Marshall, Friedrich von Hayek, Allyn Young, and Samuel Hollander— cannot make sense of Mill’s fourth proposition.1 Their difficulty he attributes to a theoretical “discontinuity” separating their vision of the functioning of the economy from that of Mill and his contemporaries. There may indeed be a discontinuity, but that is not the point. The point is that Kates apparently does not even think of the possibility that modern theorists cannot make sense of Mill’s “paradoxical” proposition for the reason that its basic premise is no longer deemed acceptable: the fourth proposition is simply wrong.

With so many economic failures at every turn, who is to say who is right or wrong? Every one of the following is wrong if where you start is with classical theory which is what the presentation is about.

A national economy is driven from the demand side
Classical economists did not accept the existence of involuntary unemployment
Classical economists had no theory to explain recessions
Recessions can be caused by demand deficiency
Thinking of national saving as a flow of money makes sense
Lowering interest rates will increase economic growth
Unproductive public spending can make an economy grow
Profits are maximised where Marginal Revenue equals Marginal Cost
Supply and demand explains what businesses do and how markets work
You can discuss economics without discussing the role of the entrepreneur in detail

Venue: 445 Swanston Street (Between A’Beckett and Franklin), Level 10 Room 44 & 45

Date: Tuesday 8 August

Time: 1.00 – 2.00 pm

My paper criticised in the June 2017 Journal of the History of Economic Thought: KATES ON MILL’S FOURTH PROPOSITION. I particularly like the start:

KATES ON MILL’S FOURTH PROPOSITION
ON CAPITAL: WHY ALL THE FUSS?
BY
ROY H. GRIEVE

Steven Kates is probably the best-known present-day proponent of the old “classical” macroeconomics of Jean-Baptiste Say, James Mill, David Ricardo, and John Stuart Mill. He affirms his belief in Say’s Law—a theorem that was “accepted by every economist for more than a hundred years up until 1936, [but has] apparently [become] an impassable obstacle in the modern world,” thus blocking present-day theorists’ access to earlier understanding (Kates 2014, p. 9). Kates has “written books and papers, monographs and articles” (ibid.) in a long-sustained effort to persuade the economics profession to see its way around that “obstacle.” Most recently, in this journal (“Mill’s Fourth Proposition on Capital: A Paradox Explained” [Kates 2015]), he has focused on Mill’s puzzling “fourth fundamental proposition on capital.” The proposition states notoriously (in the modern reader’s view) that “demand for commodities is not demand for labour.” Kates evidently means to settle, once and for all, the status of that contentious proposition by providing an explanation and defence of it.

Kates makes much of the fact that economists writing after Mill—eminent theorists such as Alfred Marshall, Friedrich von Hayek, Allyn Young, and Samuel Hollander—cannot make sense of Mill’s fourth proposition.1 Their difficulty he attributes to a theoretical “discontinuity” separating their vision of the functioning of the economy from that of Mill and his contemporaries. There may indeed be a discontinuity, but that is not the point. The point is that Kates apparently does not even think of the possibility that modern theorists cannot make sense of Mill’s “paradoxical” proposition for the reason that its basic premise is no longer deemed acceptable: the fourth proposition is simply wrong.

From Kates’s explanation it emerges clearly that Mill is offering a proposition that derives from his obsolete “supply-side” (Say’s Law) approach to understanding the economy. Kates can explain what Mill is at, because he shares Mill’s basic “supply-side” understanding (to wit, that supply does create demand—the mere availability of productive resources ensures their utilization in supporting labor in production). From that perspective, the fourth proposition is in no way paradoxical. But that is of no relevance today. What Kates (like Mill) cannot understand is that in the real world of uncertainty, resources are invested to support labor in employment on the basis of expectations—forecasts as to conditions in the markets for the output that labor will produce. If prospects appear unpropitious, funds may be retained in liquid form rather than committed to specific real assets. Both the volume and direction of production do depend on demand. Mill’s proposition is evidently nonsense.

Ironically, Kates’s elucidation of Mill demonstrates the opposite of what he intended. The puzzle is not why there are no takers for Mill’s proposition, but why Steven Kates is so committed to its defence.

1 Kates’s perspective reminds one of that of the fond mother watching her soldier son on parade: “they’re a’oot o’ step but oor Wullie.”

REFERENCES
Kates, Steven. 2014. “Keynesian Economics’ Dangerous Return.”
https://quadrant.org.au/magazine/2014/03/dangerous-return-keynesian-economics-five-years/. Accessed 28 December 2016.

———. 2015. “Mill’s Fourth Proposition on Capital: A Paradox Explained.” Journal of the History of Economic Thought 37 (1): 39–56.

And for a longer, more extended version: KEYNES, MILL, AND SAY’S LAW: THE LEGITIMATE CASE KEYNES DIDN’T MAKE AGAINST J. S. MILL

I am doing a presentation in Los Angeles at the end of the week which I have titled “A Beginner’s Guide to Say’s Law”. At the centre of this presentation there is a slide that reads as shown below. And the point I am making, and will then set out to prove, is that not only was not one of these propositions accepted by John Stuart Mill nor by any of his mainstream classical contemporaries, but demonstrating that the classical economists were right is far easier than you might think. This is the slide:

Economics is filled with nonsense no economist before the marginal revolution [1870], never mind the Keynesian Revolution [1936], would have believed:

A national economy is driven from the demand side

Classical economists had no theory to explain involuntary unemployment

Recessions can be caused by demand deficiency

Thinking of national saving as a flow of money makes sense

Unproductive public spending can make an economy grow

Profits are maximised where Marginal Revenue equals Marginal Cost

Supply and demand explains what businesses do and how markets work

You can discuss the operation of an economy without discussing the role of the entrepreneur in detail

Nor is it that our modern ways of thinking had never occurred in classical times. Every one of these propositions had their fringe-dwelling supporters but not only were none of these accepted by the classical mainstream but each and every one was also actively opposed. Today, of course, every one of these is mainstream. So what makes you actually believe in progress when economic theory was far more sound and acute 150 years ago than it is today?