Category Archives: Economic theory and policy

How I think of my own economics text

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Why would you write a book if you didn’t think what you had to say was different from what others had to say? This is part of a letter I have written to my publisher who is about to publish the third edition of my Free Market Economics: an Introduction for the General Reader.

I will just restate that I think this book is the best introductory economics text in the world. It is the only book from which someone can actually learn how an economy works. It does so by being the only book that takes the economics taught back to classical times and explains economic theory in the way it was explained by the first great economists, from Adam Smith to John Stuart Mill. I have now been teaching from this book for nine years and my students (around 1400 so far) truly do get it and since I teach a graduate course, two thirds of them have already done an economics course. I watch the mess that modern macro has created across the world with the various stimulus packages leaving major wreckage in their wake and have had no reason in all that time to reconsider a single word of anything I have written. That others who come to my text after having learned from some modern framework – whether Keynesian, monetarist or Austrian – cannot see the point is part of the problem since preconceptions and presuppositions make it almost – but not totally – impossible to see things in a different way. But the thing for me about this book is that its very existence gives me hope that others will eventually see the point. In some ways you might think I am teaching the economic theory of the past, but in my view I am teaching the economic theory of the future.

Modern economics is preferred by governments since it allows them to parcel out oceans of money disguised as economic stimulus. The failure of our economies and the fall in living standards which is becoming unmistakable is in no small part due to modern economic theory which was specifically understood in classical times as fallacious to its very core. I live in the modern world of economic mismanagement but mostly read textbooks which are now almost always at least a hundred years old if not much older than that. Here for your interest is the link to my article on the hundredth anniversary of Clay’s Economics which was published last year. This is the abstract:

Clay’s Economics was first published in 1916 with no pretensions to be anything more than just a summary of the state of economic theory as it then was. Yet so well was it written that it became one of the most widely used economics texts of its time, found on reading lists from workers’ colleges and mechanic’s institutes through to the leading universities of the world. Its interest today is therefore twofold. It is, firstly, a near-perfect summary of pre-Keynesian economic theory, incorporating Say’s Law, J.S. Mill’s theory of value and the classical theory of the cycle, along with many other of the most important features of the standard classical model. Secondly, the text makes clear how wrong Keynes in The General Theory had been in his description of what the economists he had described as “classical” had actually believed and taught. Even a century later, Clay’s Economics may well remain the single best introduction to economic theory ever written.

So if you don’t want to read my version you can always read his. And if you don’t like either, you can always try your luck with Mill.

Waste not, want not is not a socialist slogan

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This is from the comments thread at Tim Blair. The point being made was that the money wasted paying Soupstain and Triggs is mere chicken feed compared with the amount of money being wasted on maintaining the desal plant in NSW which is $500,000 a day. Hence this comment:

“Yet still it costs around $500,000 per day to keep this monument to climate panic in functioning order.”

Victoria would love to have this problem…….our mighty desal plant costs us $1.7M per day (yep you read that right) to produce……nothing.

Did Tim say leftists are good with OPM.

Which then led to this comment which really does make you even more angry:

If their Premier could just cancel a freeway then he can just cancel the de-sal plant payment’ ………………….Oh, wait.

Maybe they can pump it into the Murray so they don’t have to keep stealing water from the farmers.

If these voters on the left truly understood how their lives are being blighted by the governments they elect we really would have a revolution. They are lucky to get back ten cents on the dollar, but the ten cents is visible and the dollar is made up of the goods and services they will never enjoy because the economies in which we live are so badly mismanaged.

If it’s not value adding it does not add to growth

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Let me go back to something I have managed to avoid for a while, the absence of penetration in modern economic theory. Governments waste spectacular amounts of our productive resources on projects that will never turn a dime and are then surprised when the economy goes nowhere. This is from yesterday’s Oz: After the boom, pay packets are on a flatline for all. And this is what it said:

Our wage growth, the third weakest in the developed world, is fuelling simmering political discon­tent about everything from house prices to inequality and energy prices. This will have profound political consequences.

The living conditions of Australians are rising at the slowest pace in more than a generation. Wage growth fell off a cliff in 2012 as the resources boom petered out, and it hasn’t recovered. The torrent of foreign cash washing over the economy has receded, leaving a high-wage, heavily regulated economy struggling to compete. . . .

Australian private sector wages rose only 1.8 per cent last year, not much above consumer prices, which edged up 1.5 per cent. That’s the slowest pace since the Australian Bureau of Statistics started tracking hourly wages in 1997. Average weekly earnings, which don’t factor in changes in the number of hours worked, rose 2.2 per cent for full-time workers to $1533, the slowest pace since World War II.

According to the OECD, a Paris-based club of rich countries, Australians’ average real wages, which adjust for inflation, shrank by 1.1 per cent in 2015, more than any of the other 33 countries bar Portugal and Mexico.

Real wages can only rise if we are producing the goods and services wage earners wish to buy, or can trade what we do produce with others for these kinds of things instead. The NBN is merely an example of the kinds of government unproductivity that leads to what you see.

A modern case study on the evils of socialism

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Venezuela is the most important case study on the evils of socialism in the world today which is why you hear so little about it. But this did come up today: Venezuela has a bread shortage. The government has decided bakers are the problem.

Facing a bread shortage that is spawning massive lines and souring the national mood [!!! – this reporter really is beyond pathetic], the Venezuelan government is responding this week by detaining bakers and seizing establishments.

In a press release, the National Superintendent for the Defense of Socioeconomic Rights said it had charged four people and temporarily seized two bakeries as the socialist administration accused bakers of being part of a broad “economic war” aimed at destabilizing the country. . . .

Two bakeries were also seized for 90 days for breaking a number of rules, including selling overpriced bread.

However, there is a response from someone frustrated by all of this who has a simple and perhaps obvious solution.

Juan Crespo, the president of the Industrial Flour Union called Sintra-Harina, which represents 9,000 bakeries nationwide, said the government’s heavy hand isn’t going to solve the problem.

“The government isn’t importing enough wheat,” he said. “If you don’t have wheat, you don’t have flour, and if you don’t have flour, you don’t have bread.”

He said the country needs four, 30-ton boats of wheat every month to cover basic demand.

Yes, that’s it. Import more wheat. Why hadn’t they thought of it themselves? Given the state of the media today, it is amazing to see this reported at all even though the reporter is naturally clueless about the cause and effect. You will look high and low for an explanation of what has caused this wheat/flour/bread shortage, and if bread is in short supply, you may be certain everything else is as well. The report goes on its its own inane way.

The notion that bread could become an issue in Venezuela is one more indictment of an economic system gone bust. The country boasts the world’s largest oil reserves but it has to import just about everything else. Facing a cash crunch, the government has dramatically cut back imports, sparking shortages, massive lines and fueling triple-digit inflation.

Come on, what’s the problem? Explain the situation. Provide some kind of analytical depth. Tell us why is this happening???? Alas, this is all you get instead. Socialism can never be criticised even if people are starving.

Earlier this week, President Nicolás Maduro launched “Plan 700” against what he called a “bread war,” ordering officials to do spot checks of bakeries nationwide. In the plan, the government said it would not allow people to stand in line for bread but it’s unclear how it might enforce the order.

“The government is doing everything in its power to end the bread lines,” Crespo said, “but they’re looking at the whole thing backwards.”

Crespo said he’d been in touch with several union members in Caracas and that most said they’d passed the inspection by simply opening their pantries.

But there is an upside of sorts: Venezuela Discovers The Perfect Weight Loss Diet.

In a new sign that Venezuela’s financial crisis is morphing dangerously into a humanitarian one, a new nationwide survey shows that in the past year nearly 75 percent of the population lost an average of 19 pounds for lack of food.

The extreme poor said they dropped even more weight than that.

The 2016 Living Conditions Survey (Encovi, for its name in Spanish), conducted among 6,500 families, also found that as many as 32.5 percent eat only once or twice a day — the figure was 11.3 just a year ago.

This is a story that should be known to everyone everywhere. Instead it is known to virtually no one anywhere, and even where it is, no one is given the slightest clue why any of it is happening at all.

Rates are on the rise

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The reporter is asking for coherence and economic sense. Bad luck to her. The right answer is that Yellen is a Democrat and is trying to undermine Donald Trump. So what if the economy is still stuck in the slow lane and jobs growth is only just starting to improve. So on she goes in the most dreary way with one series of empty phrases following another. But what does she care? The best part is that while her aim is to damage Trump and hasten a return to a Democrat as president, the consequence of higher rates will be a stronger economy. She doesn’t know that, but then she’s a Keynesian.

However, the real revolution may be here: On June 1st The Deep State Will Move To Overthrow Trump when the debt ceiling is reached. The American Government folds because it cannot pay its bills. Is the left this crazy? Probably along with the anti-Trump Republicans who hate him even more than the Dems.

[Both via Zero Hedge]

Donald Trump, conservatism and free trade

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I realise we live in a world of economic solipsism, where virtually nothing of the past endures while the most superficial gloss passes for deep profundity. The reason I bring it up is that occasionally I am accused of misunderstanding conservative principles because I fail to condemn Donald Trump’s attempt to protect American workers from the open borders vandalism of others. Here I have an excerpt on free trade from a website called “The Imaginative Conservative” titled, The Economics of Prudence: Roepke, Ricardo, and Free Trade. That virtually no one today would have the slightest idea who Wilhelm Roëpke was is just how it happens to be. But he was in his time as important as Hayek, an important part of the conservative tradition from the 1930s through to the 1960s. The post is, however, by Ralph Ancil who is described as “the President and Economist for the Roepke Institute.” You are welcome to read his entire post, which was written in 2010, thus well before Donald Trump was even on the horizon. He is discussing free trade with this his central point:

Mainstream economic theory has traditionally relied on the principle first articulated by David Ricardo in the early 19th century England. Ricardo’s famous example to illustrate this was trade between two countries: Portugal producing wine and England producing linen. The free trade argument concludes that nations jointly maximize their levels of consumption to their mutual benefit when firms within the nations are allowed to engage in trade unhindered by arbitrary interventions by government especially those intended to shield some industries from foreign competition. Hindering such trade through the imposition of tariffs or quotas is called protectionism. His principle and approach have been the basis for subsequent expansion and development of the free trade idea, and are still taught in principles textbooks.

However, in the hands of politicians or economists with a certain axe to grind the discussion loses sight of the major prerequisite for the benefits of free trade to hold: it is assumed that capital and labor stay within each country. They are reallocated within a country, but not between them. That means that outsourcing of, say labor, is not an example illustrating free trade nor are those who object to outsourcing promoting protectionism. In short, maintaining the Ricardian prerequisite is not anti-free trade.

The key concept which drives this conclusion is the distinction between comparative and absolute cost advantages. A country may be able in absolute cost terms to produce something more cheaply than its trading partner (using fewer workers, for example). However, it still may find it advantageous to let its trading partner produce this good, if its own alternative uses of (labor) resources allows it to be still more productive. Subsequent trade between the two countries will be to their mutual benefit. The essence of the free trade principle then is comparative not absolute advantage. Yet when corporations scan the globe for the cheapest labor to move their factories to or hire their services from, they are looking for absolute not comparative advantage–a situation that goes beyond the bounds of the free trade principle. It is not a tenet of free market economics that losing one’s productive assets is beneficial for the nation, however much it may benefit a particular corporation. Current US experience makes the point very clear: the middle class continues to shrink while paupers and billionaires continue to grow. This is not the hallmark of a healthy economy.

Armed with this distinction we are liberated to adjust policy (within limits) without losing our economic integrity to free markets. We can, for instance, admit that there are situations where a complete free trade or laissez-faire approach is unwise. These are situations not considered in the Ricardian analysis but which subsequent work has shown complicate the picture of benefits and costs arising from international trade and which do call for prudent policy interventions.

Trump certainly understands all of this intuitively. Making free trade the touchstone of conservative means one has understood neither the nature of conservative philosophy nor the principles that underlie the operation of free markets. It also means the distinctions between conservative and libertarian perspectives remain completely invisible. And I might mention that the biography of Roepke provided above is by Russell Kirk, possibly the greatest conservative scholar produced by the United States during the whole of the twentieth century.

And let me add this about my collection of blog posts on the American election. The most astonishing part for me in reading them through was to discover how consistently conservative I am in the true sense of the word. If you are interested in what conservative means, you could try reading the book.

“Supply-side” ignorance

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A supply-side approach means to leave it to the market to sort things out. Supply-side does not mean telling suppliers the wages they must pay their workers. Here is a piece of academic literature that only emphasises to me that we are never going to get our economies working again: Supply-Side Policies in the Depression: Evidence from France. This is the abstract with some bits in bold:

The effects of supply-side policies in depressed economies are controversial. This Working Paper sheds light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. The authors present time-series and cross-sectional evidence that these supply-side policies, in particular the 40-hour law, contributed to French stagflation. These results are inconsistent both with the standard one-sector new Keynesian model and with a medium-scale, multi-sector model calibrated to match the authors’ cross-sectional estimates. They conclude that the new Keynesian model is a poor guide to the effects of supply-side shocks in depressed economies.

Did they not see what would follow? I just hope that policy is somewhat better today, but you can’t be sure.

The wages of ignorance

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I have been following this business about wages with no little amazement. Here is the story that sums it up but it was in all the papers today:

A demoralised government put in a dismal performance in parliament today. In Question Time and the debate that followed, Malcolm Turnbull was constantly on the defensive on an issue that is a gift for Bill Shorten — pay cuts for workers.

There was a time when I was Chief Economist for the Chamber of Commerce that a decision like this would have been recognised by a Coalition Government as a reprieve for the economy and very good news for workers. Naturally, the Labor side would have talked about workers losing pay etc, but the government would have stood there with small business and the unemployed, reminding everyone that economic growth and higher wages can only come from a stronger economy. So let’s look at some more of this story and then come back to the issues again.

The government looks frozen in the headlights as this dire political threat approaches. Unions are mobilising with a potent message to ordinary workers — whether there are 700,000 or 285,000 hurt by the cuts.

This was a shared humiliation for the Coalition. Barnaby Joyce was difficult to understand, despite his volume. Julie Bishop offered a mundane answer about strong exports from Western Australia, doing nothing to turn pressure back on Labor. Scott Morrison went through the economic growth figures but barely stirred the backbench.

Turnbull had no answer on penalty rates other than to attack Shorten’s history at the AWU. The Prime Minister seemed to be losing his voice as he ploughed on through Question Time and the suspension motion. He was also losing traction.

And the Coalition backbench did nothing to help. Staring at their mobile phone screens or their paperwork, MPs and ministers barely offered a murmur of support. There were no cheers, no interjections. It was a huge contrast with the Labor benches, where MPs are fired up over penalty rates.

In the month of the GFC the unemployment rate was recorded at 3.9%, which I always remember since it was the first time I had seen it fall below four in all the years I had been in Australia (the number has since been revised to 4.2%). The latest unemployment rate is much higher, at 5.7%, and real earnings are falling. A fall in penalty rates is an unmitigated good thing for the economy. It might end up being a minor retreat for a relative handful of employees but looking at the larger story, it is all to the good. It will make our industry stronger, create more jobs, and add to future prosperity. If nothing else, it is a decision that not only can be defended, it ought to have been.

The long faces on the Liberal side is the most comprehensive sign that these people have more than lost their way. They have no idea this side of the next Newspoll which way is up, with the Prime Minister the worst of the lot. They stand for nothing and most definitely do not stand for private sector growth. This is a decision that they ought to have embraced and welcomed, not run from. That they have no idea why living standards are falling – to them it’s in spite of the NBN and not because of it – tells me how far out in the economic wilderness they are.

Energy illiteracy a subset of economic illiteracy

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And it’s not just energy illiteracy, fewer and fewer any longer know much of anything about how products come into existence and then find their way to buyers. I’ve just had my first class of the semester which I always begin with a presentation which includes this:

In 1900 there were no cinemas in England. In 1914 there were more than 5000. What had to happen for those 5000 cinemas to come into existence?

Here is the wrong answer: cinemas came into existence because there was a demand for movies and more entertainment.

The video is from Canada via Small Dead Animals. And if like that you might like this.

CANZUK

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This is from Canada’s Financial Post: In the Trump era, the plan for a Canadian-U.K.-Australia-New Zealand trade alliance is quickly catching on. Here is the point but it’s an interesting article from end to end. These are the first and last paras:

Erin O’Toole, one of the candidates for the Conservative Party leadership, has made one of the key planks of his campaign his determination to “pursue a Canada, UK, Australia, New Zealand trade and security pact.” The idea of creating a “CANZUK” zone of free trade and free movement of labour is catching on elsewhere, too. . . .

The post-Cold-War alliances and assumptions are obsolete. NAFTA is dead. The EU will soon lose one of its largest members. Trump might downgrade NATO, abandon the WTO and even diminish the UN. It’s tempting, in a world of change, to try to cling to as much of the old certainties as possible. But if we look up and out, something new beckons. Free trade, free movement and a new security partnership between countries of shared culture and natural affinity. CANZUK is the global deal of tomorrow.

The Empire strikes back.