It’s my birthday, and my younger son has given me a present. You can see whose house he was brought up in. And while it may spoil the joke a bit by adding some commentary, you never know in this day and age what others will and will not see. The first picture is straightforward, however. You hear the equivalent said all the time in every economy.

The second is the subtle one. The government has chosen projects that will never repay their costs which means that the economy, so far as these expenditures go, will end up less well off at the end than it was before. Other projects, almost invariably from the private sector, will usually make up for this loss. But non-value-adding projects pull an economy backwards. If you are getting fewer units of output back compared with the number of units used up in production, living standards must contract. But as the picture shows, lots of people are employed. They are just not employed in projects that create net wealth, which includes those employed in industries supplying inputs.

Because Keynesian economics is all aggregates, the structural problems created by this expenditure is invisible both in theory and in relation to the actual circumstances of the economy. People are, to all appearances, working and producing. The problem remains that what is produced has less value than the resources used up. One day, as the debts pile up and deficits grow, the expenditure must be withdrawn with the result that the entire structure of production must then be reconfigured in a way that allows productivity to grow. That reconfiguration is infinitely more painful than things would have been had you let the economy adjust in the first place.

My son is neither an economist nor a graphic designer. The message is nevertheless sound and coherent with the presentation clarity itself.

And the world is changing. I have just been sent this from The Spectator: The one thing most people think they know about economics is wrong with the subheading, “Keynesian deficit spending makes sense – but over and over again it has not worked”. My What’s Wrong with Keynesian Economics? was sent off for production on Friday. Most people, especially economists, do indeed still think Keynesian theory “makes sense”, they just cannot work out why it never works. If they actually understood how an economy does work, they would understand why Keynesian theory is complete nonsense.

And because the manuscript has now gone off, I am heading off and away for my version of lying by the beach. Blogging may therefore be more intermittent than usual.

Some ideas just will not die, no matter how much damage they do. Keynesian economics is one of those. So let me say it again: NO Keynesian stimulus has ever succeeded in bringing about a recovery. Not one, not ever. Go on, you Keynesians out there. Name one, anywhere, any time. Name a single occasion when an increase in public spending brought a recession to an end and returned an economy with high unemployment to full employment. The General Theory was published in 1936. Since then, there is not a single occasion when an increase in public spending led to an economic recovery. Every pre-Keynesian economist would have understood not just this fact, but also why it was so. But such is the dead hand of received ideas, that economists continue to push for an increase in public spending to bring recessions to an end.

So here is the latest set of economic instructions, this time from Canada. The headline reads Economy needs bigger deficit spending with the sub-head, “economist tells Ottawa now is the time to spend, not worry about balanced books”. And this is how it begins:

Ottawa should not be afraid to spend a lot of money it doesn’t have quickly in order to give the economy a shot in the arm, an influential economist says.

That was the gist of a note Thursday from David Rosenberg, the chief economist and strategist at Toronto-based money manager Gluskin Sheff Inc.

During the recent election campaign, the Liberals ran on a pledge to run “modest” deficits in the $10-billion range for the next few years, in an attempt to stimulate the economy.

Debt-to-GDP can come down even with deficits, economists say
But Rosenberg says more drastic measures are warranted, noting that Ottawa could run deficits of up to $24 billion a year all the way until 2020 and still be below the average 70 per cent debt-to-GDP ratio among OECD nations.

Canada’s debt-to-GDP ratio currently stands at 31 per cent.

“What is Ottawa waiting for?” Rosenberg wrote.

“If the government wasn’t spending years strengthening our nation’s balance sheet to use it as a weapon against downside economic risks as is the case today, then what was the point of it all?”

Rosenberg says it is time for the federal government to get off the sidelines and start “fighting the economic forces” instead of leaving the heavy lifting to the Bank of Canada, in the form of monetary policy.

This is identical to the advice that Ken Henry gave Kevin Rudd, with the usual disastrous results. But it’s advice that has an older pedigree than that. Let me take you back to my 2009 classic, The Dangerous Return to Keynesian Economics, where you will find the identical advice offered to Japan in the 1990s.

Stanley Fischer, who in 1998 was the First Deputy Managing Director of the IMF, was very clear on the need for the massive increases in spending. Addressing a symposium in Tokyo in April that year, he said:

Japan’s economic performance is of course a matter of grave domestic concern. But given the prominent role of Japan in the world economy, and especially in Asia, it is also a legitimate matter for concern by Japan’s neighbors and by the international community. There is little disagreement about what needs to be done. There is an immediate need for a substantial fiscal expansion …

On fiscal policy, the recent suggestion of a package of 16 trillion yen, about 3 per cent of GDP, would be a good starting point. But, unlike on previous occasions, the program that is implemented should be close to the starting point. The well-known reservations about increases in wasteful public spending are correct: that is why much of the package, at least half, should take the form of tax cuts. Anyone who doubts the effectiveness of tax measures need only consider the effectiveness of last year’s tax increases in curbing demand.

The IMF is not famous for supporting fiscal expansions. And it is true that Japan faces a long-term demographic problem that has major fiscal implications. But after so many years of near-stagnation, fiscal policy must help get the economy moving again. There will be time to deal with the longer-term fiscal problem later.

Another example of the same kind of advice is found in a February 28, 1998, editorial in The Economist under the heading, “Japan’s feeble economy needs a boost”:

The [Japanese] government says it cannot afford a big stimulus because its finances are perilous. It is true that Japan’s gross public debt has risen to 87% of GDP, but net debt amounts to only 18% of GDP, the smallest among the G7 economies. The general-government budget deficit, 2½% of GDP, is smaller than its European counterparts’. Rightly, the Japanese are worried about the future pension liabilities implied by their rapidly ageing population. But now is not the time to sort the problem out. Far better to cut the budget later, when the economy has recovered its strength.

I need hardly point out that Japan’s “lost decade” has continued for more than twenty years yet in all the investigations over what had gone wrong, the increase in public spending has never even been glanced at. Modern macroeconomics is a disaster continuously in wait for its next victim. If you would like to understand why, once again I cannot suggest anything written more recently than 1936, other than, of course, this.

[My thanks to SMc for alerting me to the advice being offered to the Canadian PM, who will, no doubt, now take it.]

Government waste is the greatest scourge every economy must face. The Chinese economy is trying to reverse the effects of its Keynesian stimulus, whose diabolical effects can no longer be denied. The projects of 2009-10 are showing up dead and the debts created cannot be repaid. Fixing what has gone wrong first requires you to understand what has gone wrong. The following “analysis” is mesmerising for its inanity:

China’s economic and financial market management credentials are drawing international criticism after a weak inflation result raised the prospect Beijing will be forced to slash interest rates to boost growth. . . .

Beijing reported at the weekend that China’s consumer price index rose by just 1.4 per cent over the year compared to the 3 per cent objective the government had put in place for the economy in order for it to achieve its annual growth target.

It’s real growth we are looking for, right? The inflation rate is just the difference between the nominal growth rate and the real growth rate. How inflation is supposed to give an economy faster real growth is the great conundrum. Perhaps they mean that higher inflation would be a sign of higher demand. But if that is the way it is being thought about, Keynesian economics has reached even lower depths than I had thought possible.

Still, that’s not all there is on the economic inanity front. There is also this: Turnbull needs community of believers for northern growth which begins as follows.

The Turnbull government has announced plans to boost growth and development across northern Australia, including the possible use of commonwealth loan guarantees for infrastructure projects.

As soon as this was hinted it was decried in certain corners as yet another example of misguided “industry assistance” — just an attempt by government to pick winners. I have been as critical as anyone about the perils of government winner-picking. It’s a fool’s errand at best, and a colossal waste of taxpayer money at worst.

If after years of pink batts and BER, never mind the NBN, doesn’t convince economists that governments have NO role in guiding our resources productively, then who will do it? There are many reasons for government spending, including some limited levels of infrastructure outlays. But grand visionary projects that absorb billions are idiocy of the highest order. They will make us poor. The Chinese have at least recognised that Keynesian-type expenditures are a menace to public finances and economic prosperity. Would Malcolm only do the same. Apparently, such expenditures on developing the North “is supported by very modern and very sound economics.” Modern it may well be. Sound, I’m afraid not. I will restrict myself to merely the first of the points made.

Australia is suffering from “secular stagnation”, a phenomenon recently popularised by former US Treasury Secretary Larry Summers.

Summers postulates, and unfortunately the evidence supports his view, that the potential rate of growth of advanced economies has fallen so that GDP growth in the 2 per cent range is the new normal. The economic speed limit of advanced economies has almost halved.

This is because there is a huge surplus of global savings chasing too few productive investment opportunities. Just think about sovereign wealth funds along with all those billionaires looking for something to do with their money.

No doubt Malcolm is thinking about nothing other than our sovereign wealth funds, so if you are worried about your financial future, this is the time to make it clear that the government is to keep its hands off our money. Loan guarantees – that is, a promise of making good every losing market bet – will bring Solydnra-like projects out of the woodwork in such vast numbers that it will make you dizzy to watch.

But to believe that there is a massive pool of saving available that no one is tapping into is the very essence of Keynes. Our problem is an absence of saving. We do not have enough. I cringe when I see such arguments, but if you start with Y=C+I+G, you have no explanation for recession and stagnation other than deficient demand caused by over-saving. And as long as you believe that, you will never understand what to do to make an economy grow.

This was my self-nomination for the Best Paper Award in the history of economics published during 2015. There are many other excellent papers that were also published so it is a very low probability entry. All the same, I believe the paper has genuine merit, as discussed in the note I sent to the Committee. I should mention that Mill’s Fourth Proposition on Capital states that “demand for commodities is not demand for labour”. If Mill is right, all modern macro is completely false.

Although my article is found in JHET and will therefore be automatically considered for the 2015 Best Paper award, I thought I would call attention to it since there are a number of aspects to it that may not be fully appreciated. The article is:

Kates, Steven. 2015 “Mill’s Fourth Fundamental Proposition on Capital: a Paradox Explained.” JHET. Vol 37, Number 1, March 2015, pp. 39-56.

Purely in terms of HET, the article explains in a completely natural way an issue that had been dealt with by some of the greatest economists of the past who could not fully make sense of what it meant. The proposition was first stated by John Stuart Mill in 1848, was never challenged in his lifetime and was described by Leslie Stephen in 1876 as “the best test of a sound economist”. Yet only fourteen years later, Alfred Marshall could not explain it, nor could Friedrich Hayek in 1941, both of whom tried to defend it in their own way. The proposition was attacked relentlessly by others. Keynes, for example, raises it twice within five pages in The General Theory (359n, 364n). It had last been looked at with any depth in HOPE in 1975 where the sub-title was “A Paradox Revisited”, emphasising the difficulty in making sense of the words. And yet, once the proposition is viewed within the context of the General Glut debate and within a classical understanding of Say’s Law, its meaning is apparent, indeed I would say obvious. It is thus not often that an issue that had remained unresolved since 1876 has been finally brought to an end. I compare Mill’s Fourth Proposition in the article to Fermat’s Last Theorem which, for economists, it is.

Second, the article does what I think HET ought to do – not exclusively, of course – but what it ought to do, at least where it is relevant, is use the economic theory of the past to illuminate economic issues of the present. The question whether increases in aggregate demand will lead to improvements in production and employment is a crucial issue in economics, never more so since the stimulus packages following the GFC have not led to a return to full employment and rapid growth. One does not have to agree with Mill to at least recognise that he has something to add to our contemporary debates. What if it is the case that an increased demand for goods and services does not lead to an increased demand for labour? This was not just Mill’s view, but was repeated as the “Treasury view” as late as the 1930s. Merely because macroeconomic theory today has rejected this conclusion does not mean that it is therefore certainly wrong. Some of the greatest economists who have ever lived accepted this conclusion. What this paper does is revisit this conclusion and puts the alternative perspective back into consideration.

It was also not my only paper published last year since I published two others, both on the role of the entrepreneur in economic theory. But this one was far and away the best.