I gave my presentation on “Classical Economic Theory and Supply Side Economics” on Friday and from my perspective it could not have gone better. And what made it work for me is that I heard things that have helped me clarify in my own mind what needs to be stated with the greater emphasis. There were a few things that came out, but let me deal with the most important which you will not be surprised to find is about how to explain the problem of Say’s Law and why it is important.

So let me state it again: Say’s Law means, quoting Keynes, that it is “impossible for effective demand to be deficient”. In spite of the existence of recessions and frequent periods of high unemployment, if you understand Say’s Law then you understand that the problem is never a deficiency of demand. It may look that way to you and to many producers. Businesses may feel grateful that government spending helps sell what might otherwise have sat on the shelves. It is why Keynesian economics has a plausibility that has allowed it to survive its constant failures for seventy years and counting.

Nevertheless, if you cannot state and explain why recessions are never caused by demand deficiency (a general glut as it was once known), you cannot in my view even begin to refute Keynesian theory. You can argue that the economy works in some other way and can go up hill and down dale with counter-explanations. But unless you can and do make the statement that “demand deficiency does not cause recessions”, then you can never overturn Keynesian economics because you have not engaged with the other side which says that recessions are caused by demand deficiency. As long as it is universally accepted that recessions are caused by a deficiency of demand – as long as we continue to teach that Y=C+I+G and that more G will lead to more Y – it will remain impossible to explain why a demand stimulus will only make matters worse. The only argument then is to point out each time a stimulus has been tried that it has failed. But unless you make it your aim to explain why that is, there is no winding Keynesian economics back.

The problem goes deeper. Public spending in almost all circumstances is seen as creating growth and jobs. The NBN is such a catastrophe yet is hardly ever given its due credit as a vast open drain on Australia’s wealth and our standard of living. From Henry Ergas today:

By the time it was booted out of office, NBN Co’s revenues were 91 per cent short of the 2011 corporate plan’s objective, while operating expenses, calculated net of payments to Telstra and Optus, were running at twice the levels the plan envisaged.

In terms of actually building the network, the number of premises to which fibre was effectively available was 89 per cent below the plan’s target. And as a wave of disputes with contractors ground deployment to a halt in four states, the NBN looked well on its way to being dead before arrival.

This is just seen as more G leading to more Y leading to more jobs. You cannot use any part of modern macro to explain just how harmful this is to the national economy. If it adds to demand, it is all to the good. So I say to you that unless you can explain why the NBN is a catastrophe in spite of all of the “demand” it creates – something neither Malcolm nor Bill are able to do – you are unable to understand how an economy actually works.

This is a trial run for a paper I will be delivering next month, first at Freedomfest in Las Vegas and then at the Chinese Economic Society Australia meeting in Cairns. Supply-side economics is classical economics. If you are going to understand the first you can only do it by understanding the second. The details:

You are warmly invited to School of EFM Research Seminar presentation by our Associate Professor Steve Kates. Your host is Dr Ananta Neelim.

Title: Political Economy in Crisis: Were the Classical Economists Right After All?

Abstract: There are, generally speaking, five streams of macroeconomic thought that compete for allegiance in the modern world.

• Keynesian which comes in many varieties all of which argue recessions are due to failure of aggregate demand and which deny the validity of Say’s Law
• New Classical based on rational expectations but with no embedded theory of recession
• Austrian which typically ignores aggregations, where activity is driven by marginal utility and which builds a theory of recession based on structural imbalances caused by financial dislocation
• Marxist and other forms of socialist theory whose aim is to centralise economic decisions and whose main focus of analysis are exploitation of the working class and concern with inequality
• Classical which emphasises the supply-side of the economy, focuses on the role of the entrepreneur, sees recessions as due to structural imbalances which may come from a variety of causes and explicitly incorporates Say’s Law.

The aim of the paper is to argue that economic theory reached its deepest and most profound level in the writings of the late classical economists which flourished over the period from the publication of John Stuart Mill’s Principles in 1848 through until the publication of John Maynard Keynes’s General Theory in 1936. The paper will discuss the classical framework and contrast this approach with the alternatives that today compete for the allegiance of economists.

Date: Friday 17 June 2016

Venue: RMIT University Building 80, Level 11 Room 9 – 445 Swanston Street between Franklin and A’Beckett Streets

Time: 10.30am-12.00pm; Seminar runs 11.00am to 12.00pm

Morning tea will be served at 10.30am. If you would like to come, please RSVP through email esther.ng@rmit.edu.au

Steven Kates presents the Ludwig von Mises Memorial Lecture at the 2010 Austrian Scholars Conference. Includes an introduction by Joseph T. Salerno. The ASC is the international, interdisciplinary meeting of the Austrian School, and is for scholars interested or working in this intellectual tradition. Held at the Mises Institute, Auburn, Alabama, March 11-13, 2010.

Understanding the nature and importance of Say’s Law is the single most important issue in economics today. If you don’t understand it, you cannot understand what is wrong with modern macroeconomic theory and policy. Here is Keynes in 1936 explaining why Say’s Law is false and has to be replaced. Just because he doesn’t use the words “Say’s Law” should not distract you from what was his central point. Here he calls it “Ricardo’s doctrine” but it is to reject exactly this that is at the centre of The General Theory.

“The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas.” (Keynes 1936: 32)

That is exactly right. No classical economist ever used the notion of deficient effective demand because every one of them thought of it as utterly fallacious. This is John Stuart Mill in his Principles of Political Economy trying to explain – in 1848 – how inane Keynesian economics is. The Keynesian fallacy was a very old story by the time it became mainstream economic theory, which it remains to this day.

The point is fundamental; any difference of opinion on it involves radically different conceptions of Political Economy, especially in its practical aspect. On the one view, we have only to consider how a sufficient production may be combined with the best possible distribution; but, on the other, there is a third thing to be considered—how a market can be created for produce. . . . A theory so essentially self-contradictory cannot intrude itself without carrying confusion into the very heart of the subject, and making it impossible even to conceive with any distinctness many of the more complicated economical workings of society. [Mill 1848: Book III – Chapter XIV – final para]

That is Keynesian theory, “how a market can be created for produce” which we now describe as raising aggregate demand. Every mainstream economist from the 1820s right through to the publication of The General Theory agreed with Mill, and with no exception. You have lived through the disaster of the stimulus packages that followed the GFC which have been a failure in every single instance. Isn’t it time you perhaps began to consider that Say’s Law is maybe after all a valid principle of economic theory and Keynesian economics is just as fallacious as Mill and every other classical economist thought it was?

I have a book coming out in August, What’s Wrong with Keynesian Economic Theory?, which includes six of the world’s greatest Austrian economists. They all know perfectly well that Keynesian economics is pure nonsense that will with certainty rot out your economy from the inside. But it required me to put together such a collection when such articles should have been flying off the presses from the very start of the stimulus in 2009. Why this has been left up to me remains a puzzle even for myself, but that is how things happen to be.

I am finishing off a paper on supply-side economics, which I argue is only represented by classical economic theory, and is not fully embodied in Austrian theory since its focus is on marginal utility as the central driver of activity. It is also a problem – to me, anyway – that Austrian theory does not incorporate Say’s Law, again because it is demand-side driven. Your thoughts would be welcome on this, as well as on this passage from the paper:

In the modern versions of Austrian economics, the approach often taken is to reject all interventions in the market and to leave the market to fulfil its role in allocating resources without government involvement. This is not a necessity within the theory itself, but as noted by Holcombe, is to a large extent the political preferences of those who focus on Austrian economic theory.

“Economic purists might argue that Austrian economics and libertarian politics are completely separate, but casual observation confirms that self-proclaimed members of the Austrian school tend to have more libertarian political views than the general population. This connection follows from the idea that the economy and society more generally, is a self-regulating complex system that is the result of human action but not of human design, and that attempts to intervene in that system are likely to result in negative unintended consequences.” (Holcombe 2014: 108)

Yet this is not entirely consistent with the views of Mises himself, who was more “classical” in his approach, or at least was in some of his earlier writings.

“If government buys milk in the market in order to sell it inexpensively to destitute mothers or even to distribute it without charge, or if government subsidizes educational institutions, there is no intervention. However, the imposition of price ceilings for milk signifies intervention.” (Mises [1929] 1977: 20)

I completely agree with Mises [1929] on this, but I wonder if that would still be part of the approach of an Austrian economist today.

Low interest rates kill off economic growth. Australia has maintained high rates over most of the period since the GFC, and even with the recent cuts our rates remain higher than the international standard. And how are we going?

The Australian economy is expanding at a much stronger clip than anticipated, with one analyst saying the latest GDP figures put doomsayers firmly in the corner as expectations of another rate cut were trimmed.

Meanwhile, back in the US of A, the land of near-zero rates: Shock Report on Jobs Signals Obama Economy Is on Brink of Recession.

If you step back and look at the whole business sector, a case can be made that the United States has been in a mild business recession for as much as a year, if not longer.

Take business fixed investment in equipment, software, plants, buildings, and so forth. This has been slowing for six straight quarters. It even went negative in the first quarter on a year-on-year basis. . . .

Core capital goods, including orders, shipments, and backlogs, have turned negative over the past three months and across the past year. This is a proxy for business investment, and it’s not a good omen.

Finally, the closely watched ISM reports for manufacturing and services are barely above 50. In other words, they point to the front end of a recession. On the manufacturing side, key indicators like production and employment are below year-ago levels. New orders are flat. On the services side, the overall index is below year-ago levels, as is employment and new orders.

The entire article is incoherent to an exceptional extent. In fact, economic policy is incoherent to an exceptional extent. But if you are looking at incoherence, this part of the Australian story is hard to beat:

JP Morgan chief economist Sally Auld questioned the [Australian] growth indicators and expects the RBA to cut rates to a new record low in August.

She said domestic final demand, which is the total amount of spending in the economy, only rose by 0.1 per cent in the quarter and 0.9 over the year.

Ms Auld said all price indicators in the quarterly release were very weak, vindicating the Reserve Bank’s decision to cut rates to 1.75 per cent last month.

“The headline GDP numbers are going to continue to be flattered by very strong net exports. Which will mean that GDP looks good, but it’s not the sort of growth that actually generates any inflation for you,” she said.

She wants inflation! Inflation is apparently good for growth. These people will ruin us yet. With Glenn Stevens gone, there is no certainty that we any longer have a steady hand on the monetary tiller. A rate cutter Glenn was not, but I suspect that even though they all watched him operate, and can see his success before their eyes, they are now going to bring rates down. Mistake, mistake, mistake if they do. If you would like to understand what’s wrong with artificially lowering rates, you would have to go back to economic texts written a hundred years ago or more, unless you would like to read my own, which is about to go into its third edition next year.