Category Archives: Economic theory and policy

Economics is quite simple and straightforward

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By this stage, if you still accept Keynesian economics as a legitimate approach to understanding how an economy works, or how to find our way out of recession, you are basing everything on authority and simple faith. It’s in all the texts, but you would think that by now there would be a growing level of dissatisfaction about the irrelevance of textbook theory for making sense of the actual events of an economy. Kevin Williamson has written an article, Economics may be dismal, but it’s not a science, which refers back to an article written by Niall Ferguson, The Rise and Fall of Krugmania in the UK. So we have a journalist quoting an historian on the uselessness of economic theory.

Economists have never in all their endeavors managed to deliver a truly useful and broadly applicable model to policymakers, which is to say a model that is prospective, connecting policy changes to real-world outcomes in a predictable, accurate, and reliable manner. Given the complexity at work, that probably is an impossible task, and the record of economists for making predictions is not good; Krugman’s record is arguably worse than average, despite his straight-faced insistence: “I (and those of like mind) have been right about everything.” Right about everything would be a very high standard for a marine biologist or an astronomer — but for an economist?

Krugman is trying to set a kind of standard of sorts, for being able to deny reality longer than anyone else. You know that Keynesian inanity about changing one’s mind when the facts change. Keynesian economics will disappear around the same time that the left gives up on socialism and we all know how long that will take. These people will just have to be ignored, in the way they are in the UK.

Economics does provide useful models, ones that really do work and you can use to frame policy. But all such models start on the supply side and revolve around the specific efforts of entrepreneurs living in a world of innovation and uncertainty. In that sense, economics is quite simple and straightforward. The trick is to get 50%-plus-one to vote for policies that make everyone prosperous by making some people quite well off.

“U.S. economy likely shrank in quarter one, but fundamentals strong”

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The quote is from Reuters which maintains the delusion that all is well with the American economy. As with the data on unemployment, there are people across the American Government, throughout the public service and at every level of the left media whose job it is to pretend all is well so long as Democrats are in charge. If the White House changes hands in 2017, we will hear a different story. But until then, the good times will continue to be around the corner, as they have been for the past six years.

But some things you cannot hide, which is that U.S. economy contracts in first quarter. The national accounts are, unfortunately, a truly inadequate measure of what you would like to know. If one economy grew by 10% and another by 2%, which one has a higher standard of living? The fact that you cannot tell is one of the signs that the number really doesn’t get to what is actually of interest. And here is a question that is less easy to answer than you think it ought to be. If an economy grew by 10%, just what exactly is 10% bigger this year than it was last year? Again a difficult question that few are ever taught. But it is not what you really want to know if you are interested in prosperity and jobs.

Almost all of our economic measures are incompetent if the aim is to understand present economic conditions and current trends. But there is no disguising this one. A contraction in economic activity is not part of the story of an economy in recovery.

It’s not my fault, says Bernanke

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Well, actually, yes it is. The economic establishment is floundering, trying to work out what went wrong. They are, I’m afraid, clueless in their Keynesian beliefs. This is from The Oz: Ben Bernanke: ‘Lack of stimulus to blame for rates’. But before we turn further to Dr Bernanke, let me just draw your attention to a recent article about the success of the “austerity” program in the UK, written by Niall Ferguson:

Long before the United Kingdom’s recent general election, which the Conservatives won by a margin that stunned their critics, the facts about the country’s economic performance had indeed changed. Yet there is no sign of today’s Keynesians changing their minds.

With these thoughts in mind, let us turn to the views of the previous Chairman of the Fed.

The most influential central banker in a generation, who guided the global economy through the biggest financial crisis since the Great Depression, has pinned the blame on governments for the ultra-low interest rates that are playing havoc with exchange rates, asset prices and incomes around the world.

In sweeping and optimistic ­remarks about the economy, made in Sydney yesterday, former US Federal Reserve chairman Ben Bernanke said central banks had been compelled to slash interest rate to unprecedented low levels because governments had dragged their feet in providing essenti­al stimulus measures.

This is all after-the-fact. Now that they are actually witnessing the wreckage that has befallen the world’s economies, and in particular the United States, they are looking for reasons why their policies didn’t bring the recovery they said it would. Bernanke, like Krugman, are mystified. They really have no idea why things have unfolded as they have. Bernanke who made such a fetish of having done so much scholarly work on the Great Depression to work out what to do this time round, finds that whatever he thought he knew, whatever it was he did, that the sum total of their efforts have been a disaster.

I have been teaching the devastating consequences of low interest rates since the start of the GFC. All in the second edition if you are interested. But any economist who believes that an economy can be resurrected from the demand side is a danger to any economy they provide advice to. So here is Bernanke’s latest prediction:

“Some slowing in China is both inevitable and probably ­desirable … (but) a hard landing is not a high probability at all,” he said

Given his track record, if that doesn’t make you worry, I don’t know what would.

If you are looking for some serious pessimism try this

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Two articles about a pretty bleak economic future driven by the usual combination of leftist ignorance and envy. The first is on Impoverishment: America’s New Normal. It’s not just America’s but will be shared out among the formerly first world economies of the once free-market West.

The defining American middle class is devolving toward poverty. The 1970’s brought an undeniable economic retreat: the disappearance of the traditional middle class housewife into the workplace. A declining standard of living was heralded as a feminist triumph. The linked map illustrates the accelerated middle class economic decline since the 2008 financial crash; today, 20% of American families include no workers and most Americans receive government benefits….

Rather than awaiting recovery, the people and even more, the government, need to learn again what is needed to survive in a world where others have risen up to compete. Until then, impoverishment seems likely to be the new normal for America and for similar reasons, for much of the rest of the world as well.

That was the good news story. There is then this second article. Let me start with the final para which is not as farfetched as you might like to think although it goes a step or two too far even for me. But who’s to say this is not actually possible:

For us Westerners, living standards equality with the Third World appears inevitable, probably within the next 20 years. The only question is whether emerging markets will in turn acquire Western “barnacles,” thereby reducing the entire planet’s living standards to a level at which the Industrial Revolution might just as well never have happened.

Well, we will still have our TVs and iPhones so there will be something. But it will not be the kind of flush economic security that we were all once so used to. Our political and economic understanding is so pitiful and we are driven by a short-term shallowness that is terrifying if you have the kind of vision discussed.

U.S. productivity growth declined from 2.8% per annum in the period 1948-73 to 1.8% per annum in 1974-2010 to 0.6% per annum in 2011-15 – almost entirely owing to regulation rather than to public sector bloat, which has increased only moderately since 1970. However the EPA and other big regulatory agencies date to the 1970s, and coincide eerily with the end of the post-war U.S. productivity bonanza. Monetary policy, by distorting the free market’s asset allocation process, undoubtedly bears part of the responsibility for the further post-2011 slump in productivity, but there’s no question the Obama administration’s thirst for regulation has made matters worse. Only in retrospect will we be able to allocate blame accurately between the two factors.

As well as a bloated public sector and excessive regulation, there are other ways in which rich countries increasingly diverge from the free-market ideal. Infrastructure projects’ costs are outrageous in modern Western economies, a large multiple in real terms of their costs 50 or 100 years ago.

That’s not because we have got less efficient at laying concrete or building bridges. It’s because of the tangled mass of regulations on safety, environmentalism, workforce and other matters, none of which are costed properly, each of which adds substantially to the expense and delay in building infrastructure, and the combination of which is devastating.

There’s quite a bit more which you might read for yourself. This last bit is something I also agitate about but how few now have any idea what he is even talking about.

Finally the ultra-low interest rates of the last 7 years have sapped Western savings (a tendency exacerbated by generous welfare systems). With savings inadequate, the capital endowments of Western economies have shrunk and have also been diverted into unproductive speculation and asset investment. Anyone who thinks the current level of London house prices does anything at all for the true wealth and productivity of the British economy is living in economic dreamland.

We may find it all unravelling more rapidly and more comprehensively than anyone is currently prepared to believe. And because of the way our political systems are designed, there will be not a thing anyone will be able to do.

Please, Joe, stop looking for consumer demand to lead the recovery

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Joe was Great! There was not a moment in the whole of Q&A tonight that I thought he was behind, and this is enemy territory. But most importantly, this was even when the one-eyed Labor Party stooge, Tony Jones, tried to sandbag the Treasurer with a NATSEM study that had not been released EXCEPT TO THE ABC!!! And without showing the level of disgust he no doubt felt at such obvious ALP-ABC gotcha attempts to undermine the Treasurer, he simply turned it aside. He embarrassed the ABC for its obvious duplicity.

But I would have left this alone, except that there is one thing I think the Treasurer needs to tighten up on. He is trying to get there, in fact he is almost there, but his Keynesian minders or whoever it is that surrounds him, don’t quite let him see through to the point he is obviously trying to make. But if he gets there, he will be impregnable.

He was asked something like this, which I almost thought of as a friendly question, from Gai I think it was:

Why is household debt good but public debt bad?

Why are you encouraging people to borrow and spend at low interest rates when they may end up in serious trouble when interest rates go up?

Spending is not what you want. Joe, listen to me. Spending is not what you want to encourage. Growth and employment is not a the result of spending. Growth and employment are the result of VALUE ADDING production. That is, the result of production where the value of what is produced will, within a reasonably short period of time, create an income flow even greater in value than the value of the resources used up. That is the meaning of value adding.

Private households do not create value ever. A household uses up value, but it is not from households that economic growth occurs (except for the occasional plumber that gets called in). Growth comes from business. If you confuse personal spending with business spending you will never get these things clear in your head. There is personal consumption, which is the point of economic activity. And there is business activity which is continually trying to add value to the resources they use up. Please, Joe, stop looking for consumer demand to lead the recovery. It cannot be done.

One more reminder in the video below about the difference between those bad Keynesians, who used to be in government, and who thought about spending, versus you supply-siders, bless your hearts, who have replaced them, who are concentrating on value adding production.

Losing economic ground

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Poverty doesn’t spring up all at once. It is a relatively rapid transformation, but it still takes about a decade to really unfold. The disastrous American future, and of our own, is being prefigured even now as the ability of the American economy to maintain living standards is rapidly falling away. This describes the present, but it is a present that will overtake more and more as their ability to afford diminishes as the productivity of the US economy itself diminishes. New Grads Can’t Really Afford To Live Anywhere, Report Finds. This is still a curiosity, but it is not far from being the reality of an American economy that is losing ground:

Life after college graduation is thrilling… until you try to find somewhere to live. Entry level salaries coupled with sky-high rents in the country’s most desirable cities often makes finding a place more of a headache than a happy ending.

As experts at Trulia found, new grads can’t really afford to live anywhere among the country’s 25 largest rental markets. While the median annual income for new grads ranges from about $16,000 to about $41,000 in these cities, the income needed to afford median rent is two to three times that — assuming grads don’t want to spend more than 31 percent of their income on rent.

You can see this on the map below: A purple circle is how much money recent grads typically make, and a yellow circle is how much they’d need to make in order to afford median rent. The bar chart tells precisely how much more they’d need to make to afford rent — and the numbers are not pretty.

At worst, this effect means just .1 percent of rentals are affordable to new grads in Portland, Oregon. At best, it makes just 18.6 percent of rentals affordable in St. Louis, Missouri.

Any way you slice it, it’s a pretty rough welcome to the “real world.”

This is not just recent grads, of course, but will be a problem that anyone moving house is going to have to face. They just won’t be able to afford what everyone could not all that long ago everyone could.

The United States will become less wealthy every year for the next decade

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It is positively incredible to watch but no one has a clue what they are doing wrong. From Drudge today, but not major issues, just part of the news:

‘EARLY WARNING’: 32 STATES FACE FISCAL CRISIS…

SURVEY: 40% of unemployed have quit looking for jobs…

109,930,090 Americans on Federal Food Assistance…

The first story, for which the underlying story is titled, “For Many American States, It’s Like the Recession Never Ended”, begins:

Six years after the recession ended, many U.S. states are hard pressed to balance budgets because of a sluggish recovery and their own policy decisions. The fiscal fragility raises questions about how they will weather the next economic downturn.

A majority of states are making cuts, tapping reserves or facing shortfalls despite an improving national economy and stock markets at record levels, according to Standard & Poors and the Nelson A. Rockefeller Institute of Government. State revenue hasn’t rebounded to a prerecession peak adjusted for inflation, and other factors are putting pressure on budgets.

The United States is going backward, but because it depends on various forms of Keynesian analysis to explain economic situation to itself, cannot even understand that the reason things are getting worse is because of the economic policies they are using to repair the damage.

The Economist still thinks our economic problems are due to a shortfall of spending!

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economics hides its head

Like so many others, I have the answers to the dilemma economic theory is now in. My answers centre around the classical economics that was the core of theory before Keynes brought ruin to the heart of economics with his General Theory. Clear as a bell to me the havoc this has caused, but there are other views as well, some of whom, according to The Economist, are put forward by other economists as part of their blogs. Here’s how I can tell that most of the bloggers and economists they focus on are absolutely wrong:

America is suffering from a shortfall of spending. Both market monetarism and the neo-chartalists are right about that. They disagree about whether the best response is monetary or fiscal. The market monetarists argue that fiscal stimulus should be redundant, because a central bank can always revive spending—if it sets its mind to it. If the Fed’s efforts have disappointed, it is not because market monetarism is wrong, but because the Fed is not sufficiently committed to the cause. [my bolding]

Of course, both monetary and fiscal are important: the imperative is to raise interest rates and cut spending. But I don’t think that’s what they mean.

See how fortunate you are to be able to come to this blog and find out what is wrong and what to do. The problem is that both central banks and government spending are diverting our very scarce productive resources into a series of wasteful outcomes that are making us progressively less wealthy. The gross stupidity of thinking that the cause of our currently slow rates of activity and high levels of unemployment is a shortfall of spending shows that the curse of Keynes is going nowhere soon.

[An article from 2011 sent to me from a friend for comment. Economics is not about to change is my only answer.]

Australia’s supply side revolution

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I don’t mean to be pedantic – well I guess I do mean to be pedantic – but the problem with bracket creep has nothing to do with whether the economy will recover. The increases in personal taxes are the necessary requirement to pay for all of the expenditures loaded on the economy by Labor. As the story says, Employees lose $25bn to creep as Labor blamed for blocking savings. Everyone will have to chip in to pay for Labor’s waste, and so, those annual personal tax cuts that Peter Costello used to deliver, are for the future. But here is where I wish to differ:

Treasury secretary John Fraser­ warned last night that fiscal drag was “a worry” that needed to be addressed and higher taxes would hurt growth.

The one thing that won’t be hurt by a gently rising personal tax burden is growth. The pervasive Keynesian mindset where the economy is looked at from the demand side, and that it is consumer demand that drives 60% of the economy, and et cetera, is just plain wrong. Just keep reducing public service waste, get that budget back into surplus, do everything you can to make the private sector grow, and it will all take care of itself. And under no circumstances let “aggregate demand” enter into any part of the policy matrix. It is value

Keynes the big loser in UK election

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Here’s a story that I can only hope our local right of centre party takes to heart: The UK Labour party should blame Keynes for their election defeat, written by Niall Ferguson no less. From yesterday’s Financial Times:

Credit where credit is due. Lynton Crosby is getting the plaudits for the Conservative party’s successful election strategy, but the real architect of this victory was surely George Osborne, the chancellor. Leave aside Labour’s collapse in Scotland, arguably the election’s most striking result. In England, the Conservatives won because Mr Osborne was right and his critics were wrong.

The comedian Russell Brand was not alone in having his celebrity endorsement of Labour roundly ignored by the voters. Even more ignominiously humbled were the Keynesian economists who have spent so much of the past five years predicting that the economic consequences of Mr Osborne’s policies would be disastrous.

In the vanguard of the Keynesian attack was Paul Krugman of The New York Times. In August 2011 he denounced the “delusions” of the chancellor whose “experiment in austerity” was “going really, really badly”.

Why? Because, in seeking to bring the government’s deficit under control, Mr Osborne was worrying needlessly about business confidence. “The confidence fairy” was the term Mr Krugman coined to ridicule anyone who argued for fiscal restraint.

Unfortunately for Mr Krugman, the more he talked about the confidence fairy, the more business confidence recovered in the UK. In fact, at no point after May 2010 did it sink back to where it had been throughout the past two years of Gordon Brown’s catastrophic premiership.

Mr Krugman was equally relentless in predicting that austerity would lead to recession; indeed, he insisted that the UK’s economic performance would be worse than during the Great Depression. In April 2012 he warned darkly that Britain would “continue on a death spiral of self-defeating austerity”.

It was, he lamented, a “policy disaster” that would cause a double-dip recession and “cripple the UK economy for many years to come”.

In fact, there was no double-dip recession. The UK had the best performing of the G7 economies last year, with a real gross domestic product growth rate of 2.6 per cent. In 2009, the last full year of Labour government, the figure was minus 4.3 per cent. Moreover, far from being in depression, the UK economy has generated more than 1.9m jobs since May 2010. UK unemployment is now 5.6 per cent, roughly half the rates in Italy and France. Weekly earnings are up by more than 8 per cent; in the private sector, the figure is above 10 per cent. Inflation is below 2 per cent and falling.

I’m not often into book burning but these Keynesian texts, with their Y=C+I+G as the cornerstone of theory and policy, are genuine candidates. If reality actually matters, which it may not actually do, Keynesian theory must now disappear. It is already disappearing from policy. Eventually economic theory must catch up, eventually.

UPDATE: Niall Ferguson has done another similar bit of writing on his blog, which he titles, The Rise and Fall of Krugmania in the UK. But it’s not Krugman, it is Keynes who remains everywhere, just as he did after the “death of Keynes” in the 1980s after the Great Inflation, which could not happen, or at least could not according to Keynesian theory. Report of Keynes’s death are greatly exaggerated, in no small part because no economist can function without aggregate demand by their side.