The video is about selling but if you think of the competition involved, you will see the closest imaginable parallel to politics. All parties of the mainstream are driven towards the middle. That, of course, assumes that everyone is evenly distributed along the beach. But if most potential customers are on the left and far left side of the beach, that is where the “middle” will end up.
She is being interviewed by William F. Buckley Jr. so we have two of the great defenders of freedom and the free market at one and the same time.
A review of the first edition of Free Market Economics, which is even more so than this now that it is in its second edition. This is how it starts:
Not since 1924 has there been a comprehensive yet readable book on economics aimed at the ordinary but intelligent citizen that defends and incorporates the field’s foundational principle, Say’s Law (named after Jean-Baptiste Say, 1767–1832) and its main corollaries: the primacy of production, the entrepreneur as prime mover, and prices as the commercial language that coordinates economies and their subsectors. Now we have such a book: Free Market Economics: An Introduction for the General Reader by Australian business economist Steven Kates. His prior books examined the prevalence of Say’s Law among top economists during the pro-capitalist 19th century and its abandonment by most economists in the anti-capitalist 20th century.
The handful of texts on economic principles since the 1920s that recognize the superiority of a free economy have been too technical, narrowly devoted to refuting economic fallacies, or tainted by dubious philosophy. This book avoids such flaws. Kates accomplishes what was last achieved by Oxford professor Henry Clay (1883–1945) in Economics: An Introduction for the General Reader (1924). Better still, Kates’s book offers a modern, more sophisticated, more pro-capitalist treatment than did Clay’s book, and it provides the ideas people need to grasp and refute the disastrous dogmas and policies of Keynesianism.
I am in the midst of a debate on the Elgar blogsite with the editor of the Review of Keynesian Economics over the question: How to Promote a Global Economic Recovery. The issue is the validity of Keynesian theory and policy. Such debates are strangely rare, and what is more astonishing is that there really is very little of it at the present time, even with our economies having been subjected to a Keynesian stimulus with no apparent positive results. Even Paul Krugman has insisted that the stimulus has been disastrous, but in his view because there was too little and not too much.
I, of course, represent the anti-Keynesian side of the story which, as surprising as this may seem, is not all that common. There are some who are non-Keynesian, but who do not make much if any effort to draw distinctions between their own theoretical arguments and the arguments of modern Keynesians. Whatever it is they might believe, they do not spell out chapter and verse what they believe is wrong with Keynesian theory. They argue on behalf of their own views and leave it at that. They therefore provide little assistance in policy debates to those who are trying to explain what is wrong with the single most common treatment found in macroeconomics texts across the world, and in particular, what is wrong with public spending as a means to bring recessions to an end.
There are also some who rest whatever disagreements they have with Keynes on the results of empirical investigations. They also do not specify any particular disagreement with Keynes but rely on the specifications of their own empirical results to show that the results of Keynesian policies do not lead to the outcomes that were expected. The theoretical side is either played down or ignored altogether.
Thus far there have been four posts, two from each of us.
Here are the four in order of publication.
First I weighed in on The Free Market approach which is as much a critique of Keynesian theory as can be fitted into 1700 words.
Louis-Philippe Rochon replied with “The worst infliction we can impose on our economies is to leave them to the tyranny of the markets”.
To this, I replied with “Markets… have been the single most liberating institution in possibly the entire history of the human race” which, in spite of its title, is almost entirely devoted to criticising Keynesian theory.
LPR then replied with this: “It is pure fantasy to believe that anything but demand is the driving force of economic activity” which puts the issue squarely before us. This is his opening para:
I read with much interest your most recent letter and I will confess I agree with you … we are indeed far apart! But surely this is not surprising as we both defend not only a very different vision of economic theory, but also a different vision of markets and society. At the core of our disagreement lies an understanding of markets, which you see as self-regulating, whereas I claim they are not. I view markets as chaotic and prone to instability and, quite honesty, capable of exploding (or rather deteriorating) into crises, with unimaginable consequences. Perhaps you are OK with that, but I am not. So when I said that the ‘worst infliction’ is to leave us exposed to the ‘tyranny of markets’, I meant precisely that: because of periodic crises, but also because of oft-occurring recessions, we cannot place our complete faith in free-markets. I see unregulated markets and unfettered capitalism as a scourge that must be tamed. To deny or ignore this would be a grave mistake, which would condemn us all to misery, and worse. How else would you characterize the massive inequality of income and wealth around the world and in particular in the United States, which is one of the most unequal developed economies? Is the fact that 40% of the wealth in the US rests within 1% of the population not a tyranny? Does this not shock you? It shocks me, and I will say it again: unless we address this calamity, we are bound to relive a crisis – and soon. Mark my words: another crisis is coming.
Although Keynesian theory comes in many different disguises – there is a different Keynes for every Keynesian – this is pretty close to the real thing. Any thoughts would be welcome.
I began with this in the form of a letter to Louis-Philippe Rochon, the editor of The Review of Keynesian Economics amongst other accomplishments.
Dear Louis-Philippe
There are about as many versions of Keynesian theory as there are Keynesians but all versions have two things in common. The first is that economies are driven by aggregate demand. The second is that an economy’s rate of growth and level of employment can be increased by increasing aggregate demand, either through higher public spending or lowering rates of interest. Both are wrong and the destructive consequences of these beliefs are everywhere to be seen.
The following was written by two winners of the Nobel Prize in economics just as the fiscal stimulus was being introduced.
In the middle of the Great Depression John Maynard Keynes published The General Theory of Employment, Interest and Money. In this 1936 masterwork, Keynes described how creditworthy governments like those of the United States and Great Britain could borrow and spend, and thus put the unemployed back to work. (Akerlof and Shiller, 2009: 2)
This is what I wrote at exactly the same time.
What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome. (Kates 2009)
You be the judge. Who was right? We had the stimulus and the unemployed have not been put back to work. We are instead in the sixth year of recessionary conditions which have indeed been deep, prolonged and which will still take years to overcome.
In the 1990s, Japan, at the time the most dynamic and amongst the fastest growing economies in the world, attempted the same kind of Keynesian stimulus. Its economy has remained comatose ever since.
And then, of course, there was the Great Stagflation of the 1970s brought on by the direct application of Keynesian theory to the problems of the time.
You would think after such consistent failure people would begin to understand that the problem is Keynesian theory, the common factor in each case. But so powerful has been the grip of the theory of aggregate demand that in spite of everything, the theory has virtually never been questioned.
If anyone knows anything about what Keynes wrote, it is that recessions are caused by too much saving. Public spending is therefore needed to soak up those savings, which businesses either cannot borrow because expected returns are too low or won’t borrow because interest rates have not fallen far enough. Here was Keynes’s advice on the kind of response that was therefore needed:
If the Treasury were to fill old bottles with banknotes, bury them . . . and leave it to private enterprise . . . to dig the notes up again . . . there need be no more unemployment. . . . It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (Keynes 1936: 128-129 and quoted with approval exactly as shown above in Temin and Vines 2014: 50)
This has been the essence of Keynesian theory from that day to this.
There is unemployment because the community is saving too much. Something must be done to put those savings to work. For various reasons, the private sector cannot be depended on to use those savings and interest rates cannot be lowered far enough. Therefore, public expenditure to soak up these savings must be increased and it is irrelevant whether such expenditure is in itself value adding. Even if a government increases expenditure on projects that are purely wasteful, this spending will increase the total level of aggregate demand. The increase in aggregate demand will then lead to an increase in national wealth and a fall in unemployment.
The specific point made by Keynesian economists is that spending on anything will restore an economy to full employment and raise living standards.
A century ago it was obvious to every economist alive why a stimulus of this kind could not work. Today the problems with such an approach are invisible and apparently incomprehensible.
Certainly a government can itself employ, or can buy from others causing those others to employ. And those additional employees can use their incomes to buy things from others still. And so, for a brief period of time, we can say there has been an increase in employment relative to how many might otherwise have been employed.
But unless whatever has been produced is value adding, as time goes by these additional employees merely drain away the productive capacity of the economy. Savings are indeed absorbed but the value left behind is lower than the value used up during production. The economy not only remains stagnant, it winds even further down as its resource base is diverted into wasteful forms of expenditure.
Moreover, the resource base of the economy is not just misdirected into the particular goods and services sought by governments, but the inputs, whose production has also been encouraged by the “stimulus”, become a further distortion of what was already a grossly misdirected structure of production.
The structure of the economy has thus become even more misshapen than it had been when the stimulus began and the problem cannot be cured until the non-value adding components of the stimulus are wound back. You can call the process “austerity” if you like. But the fact is that there can be no solution to the problems the stimulus has caused until the various non-value-adding projects the government has introduced are withdrawn.
The adjustment process is inescapably painful, far more drawn out than recovery from the original recession would have been, but there is no alternative if an economy is ever to regain its strength. But because they think in terms of aggregate demand, no Keynesian ever understands what needs to be done.
Let me approach this in a different way. This is the fundamental equation of Keynesian economics (leaving aside foreign trade):
Y = C + I + G
Aggregate demand (Y) is the amount spent by consumers on consumer goods (C) plus the amount spent by businesses on investment (I) plus total spending by governments (G). The underlying presumption is that the higher the level of Y, the higher the level of output and employment.
In a recession business investment goes down, and as Y goes down, employees lose their jobs. To lift Y back up and therefore raise employment, the policy recommended by Keynesians is to raise the level of government spending on absolutely anything at all.
What you then have is less investment by business and more spending directed by governments. The proportion of expenditure on productive forms of output has been reduced while spending on less productive and often totally unproductive forms of output has increased.
No one wants recessions and the unemployment recessions bring. But a Keynesian response that attempts to lift aggregate demand without first increasing value-adding supply can never succeed. There is no mechanism that can lead from higher levels of wasteful expenditure to higher living standards and more employment.
That so many seem unable to learn from experience, or any longer understand the reasons why wasteful spending can never be a solution to recessions and unemployment, is the most astonishing part about having watched events unfold since the GFC.
Obviously, none of this can be properly explained in a brief note of a thousand words. If you are interested in understanding not only why Keynesian economics provides no solutions to our economic problems, but also what should be done instead, read the second edition of my Free Market Economics: an Introduction for the General Reader</em>. There is literally nothing else like it anywhere.
Best wishes,
Steve
This was the reply:
Dear Steven,
Thank you for your letter, which I was happy to read. I must confess, however, that we seem to have very different memories of this crisis (a word, by the way, that never appears in your letter) and an extremely different interpretation of the history of macroeconomics. I also don’t quite understand your passion against anything Keynesian. My recollection of Keynesian policies is quite different: they contributed to 3 wonderful decades of growth following WWII – what we fondly call the Golden Years of capitalism. Keynes is quite evidently the greatest economist of the 20th century who saved capitalism from self-destruction. For that, he is remembered as one of the greatest thinkers. By contrast, starting from the 1980s, with the monetarist debacle and the real business cycle shenanigans, we ended up with less average growth and higher average unemployment rates. As you say, ‘you be the judge’.
You also suggest that Keynesians were wrong in their predictions of the duration of the crisis and you are undoubtedly right about Akerlof. But many other Keynesians were also predicting a long and worrisome recovery. And may I add, virtually no one in the mainstream of the profession, including Austrians, Libertarians and neoclassical economists, predicted this crisis. They were too busy with their badly-designed models to pay any attention to the real world. So, yes, I point a finger to neoclassical economists who believe in the Efficient Market Hypothesis which even denies such a crisis can occur. For that reason, they could not even see the crisis until it was right under their noses. Funny enough, at conferences a few years after the crisis began, those same economists were back to business as usual as if the crisis never happened. Surely, you are not asking me to have faith in the same theories that directly contributed to the greatest crisis in over 75 years.
As a “post”-Keynesian (not to be confused with ’Keynesian’ new, neo or other), I too predicted at a talk I gave at UNAM in Mexico in 2009 that this was going to be a long, dragged-out crisis, and even stated at the time that it was going to take at least a decade to recover. Many of my colleagues on the left made the same arguments. And, here we are seven years later. But now, I think I may have been wrong: I think it will take much longer.
But the reasons I gave then are even truer today: while governments did put into place Keynesian aggregate demand policies in 2009, they quickly abandoned these policies in 2010 in favour of austerity measures. You say, “we had the stimulus” but forget to mention that the stimulus policies were completely reversed a mere year after they were introduced. And make no mistake: that stimulus was working. We were well on our way to recovery until governments got spooked by those who were warning against high deficits and debt levels, and who bought into the fear-mongering propagated by the right that governments were going to go bankrupt if they spent beyond their means. Well, we know what happened, don’t we?
First, the embarrassing gaffe (to put it mildly) by Carmen Reinhart and Kenneth Rogoff, whose paper, ”Growth in a time of Debt”, was widely cited as empirical proof that too much debt can harm growth. Well they were quickly defrocked and their research exposed for what it truly was by an honest doctoral student from University of Massachusetts, Amherst, Thomas Herndon, who took the time to properly dot the i’s and cross the t’s. So that myth was clearly debunked. In fact, UNCTAD just released a new report indicating that among the top 7 countries with the worse austerity measures are Italy, Spain, Portugal, Greece and Ireland – all countries facing a dire economic situation. You be the judge.
Second, we now know that any country with a sovereign currency can never go bankrupt since a sovereign central bank can always buy all the required government debt.. And financial markets and speculators know this. The proof is in the pudding: while the US, the UK and Japan’s debt levels were much higher than many other countries, their interest rates were much lower. Clearly, financial markets know exactly this to be the truth and did not turn away from the US when the debt levels were climbing.
The worst infliction we can impose on our economies is to leave them to the tyranny of the markets. We now know with conviction that markets are by their very nature unstable and prone to crises, and must be regulated. Unfettered markets only lead to recessions and crises at which time governments must swoop in and clean up the mess.
The driving force behind economic growth both in the short run and the long run is aggregate demand, pure and simple. When the private sector is not spending, governments have the moral responsibility to intervene and ensure the spending is sufficient to encourage investment. Yes, that’s right: more government spending leads to more investment. It’s a crowding-in effect! When you look at aggregate demand today, it is at best anemic. Consumers are saddled with debt, and private investment has flatlined; austerity measures are being imposed everywhere. There is no room for growth. That leaves only exports to ensure a recovery. But with Europe on the verge of deflation, the BRIC countries slowing down, the prospects for exports are dimming. So where will growth come from? I am afraid that without aggressive fiscal deficit spending, we are dooming future generations and ourselves to another decade or more of weak economic growth. This secular stagnation is the direct result of a lack of fiscal spending advocated by austerity voodoo doctors and charlatans.
So what do we need to get the world economy back to prosperity? Here is my four-prong solution:
First, we must replace private debt with public debt. This can only occur with a well coordinated fiscal stimulus among the leading economies. Here in Canada, our infrastructure is crumbling and in desperate need of massive public investment. I can think of a number of places that need investment: our health care system, our education, our national parks, our roads and bridges, and why not create national day care to help struggling families. In the US and elsewhere around the world, there are plenty of examples of much needed infrastructure spending and public investment projects. If there is ever a good time to borrow, now is the time as interest rates are at historically-low levels. Governments engaging in austerity should be held criminally negligent for their actions.
Second, we must put job creation above all other goals. Work offers dignity, which every person deserves. This requires governments to adopt a policy of full employment. This would require as well a prolonged period of low interest rates, with an injection of fiscal cash. I am always in disbelief when I witness the cavalier-indifference policy makers have towards the unemployed. This must end.
Third, we must deal head on with the problem of income inequality, which is at the very core of the crisis in aggregate demand. Interestingly enough, income inequality was as pronounced right before the crash of 1929 as it was right before the crisis began in 2007. This leads me to suggest that income inequality is one of the causes of the financial and economic crisis. If governments do not address this problem, we are doomed to repeat the problems of 2007 before long. For starters, we need to have a higher marginal tax rate on the rich, a high wealth tax, an important increase in the minimum wage; we must also at all cost reign in corporate bonuses and inflated CEO paychecks, eliminate practices such as buy backs, and raise the corporate tax.
Fourth, with respect to Europe, well that’s a mess of a different colour. Yes, austerity has veered its ugly head there as well, but they also have to deal with the shackles of a common currency. They must either adopt the proper federal institutions to deal with the problems facing the Southern countries, or get rid of the Euro all together. This will undoubtedly create some short-term angst, but the consequences of the status quo are a few decades of deflation. The Euro was an ill-planned policy: you cannot have a monetary union without a political union.
So I end here by staying that had we had more Keynesian aggregate demand policies, we would probably not be in this mess today, which is entirely the result of anti-Keynesian, short-sighted policies designed to benefit the very few rather than the masses.
So my dear Steven, we disagree on many issues. I look forward to your reply.
This then was my reply:
Dear Louis-Philippe
Thank you very much for clarifying so much in your letter. But from its very subheading – “The worst infliction we can impose on our economies is to leave them to the tyranny of the markets” – I can see how far apart we are. To think of markets as a “tyranny” when they have been the single most liberating institution in possibly the entire history of the human race puts us very far apart indeed.
And to assume that we might even remotely disagree on the need for market regulation can only mean you have not understood what I wrote. There are an astonishing number of techniques and approaches available to manage an economy, with public spending to get an economy out of recession only one amongst this vast array. If you are going to start with the assumption that not trying to spend our way to recovery is the same as laissez-faire then there is no possibility of ever understanding what critics of Keynesian economics are saying.
Perhaps that is just the title. What more does your letter say? Let me look at a number of your assertions, starting with this.
The driving force behind economic growth both in the short run and the long run is aggregate demand, pure and simple. . . . Yes, that’s right: more government spending leads to more investment. It’s a crowding-in effect!
This is merely a statement without benefit of theory. Raising aggregate demand has a superficial appeal to those who don’t understand how an economy works. But if you said that people who counterfeit money and spend it are also promoting economic growth and employment, everyone would immediately see the flaw in your reasoning. The great error in Keynesian economics is to assume that expenditures without the backing of real value adding production can in any way raise living standards and increase employment.
The fact is there is no substantive theory to back your assertions. There is that piece of arithmetic – Y=C+I+G+(X-M) – and there are a handful of diagrams. But there is no actual way to explain why spending on wasteful projects will cause an economy to expand. There is famously no micro to go with Keynesian macro. There is no theory to explain at the level of human interaction how any of this would work in the real world.
You say instead we have historical experience as evidence. You wrote:
My recollection of Keynesian policies is quite different: they contributed to 3 wonderful decades of growth following WWII – what we fondly call the Golden Years of capitalism. Keynes is quite evidently the greatest economist of the 20th century who saved capitalism from self-destruction.
You may assert all you like that Keynes saved capitalism but what are the facts? First, The General Theory was published in 1936, three years after the Depression had come to an end in virtually every economy, which, moreover, was achieved through the application of classical economic policies which included cuts to public spending. In the United States, however, the Depression dragged on until the coming of the war in 1941, a delay due in large part to Roosevelt’s attempts at a prototype Keynesian stimulus.
But think of this. Those three wonderful post-war decades were preceded by the decision of the United States in 1945 to immediately balance its budget. The massive wartime deficits were brought to an end right then with no delay, and a balanced budget put in its place even with millions returning to the workforce after being mustered out of their wartime military service or from their jobs in wartime industries. The Keynesians of 1945 all wanted a continuing deficit. Truman turned them down flat.
How does a Keynesian explain any of that? Why should demand have been more “pent up” in 1945 than it was in 1935? We are instead reminded by you of the supposedly woeful economic outcomes of the 1980s, which I must confess not to remember in quite the same way as this:
By contrast, starting from the 1980s, with the monetarist debacle and the real business cycle shenanigans, we ended up with less average growth and higher average unemployment rates.
The real contrast, of course, is with the 1970s, the greatest period of Keynesian disaster until the one we are in the midst of now. How could you leave those years out – the catastrophic stagflation of the 1970s? What do you have to say about the 1970s?
Meanwhile, the only reason you can offer for the stimulus not working following the GFC is because it ended too soon.
While governments did put into place Keynesian aggregate demand policies in 2009, they quickly abandoned these policies in 2010 in favour of austerity measures.
One could only wish the stimulus had merely lasted a single year. The US is the paradigm example. Despite Congressional attempts to reduce deficit spending, the attempt to contain public expenditure in the US only seriously began with the “sequester” in 2013!
And indeed, the White House specifically dates the commencement of sequestration from the first of March that year. If ever a stimulus was given time to work itself out, it was then. The disastrous response of the American economy to the stimulus is perfectly in line with my own expectation. Your belief that conditions were improving until the sequestration began can only mean we are living in a parallel universe.
But how much we may differ on the timing when restraint finally began, we can certainly agree on the current disaster. You may think it’s because the stimulus was prematurely brought to an end. I think of it as the inevitable consequence of a Keynesian policy. You think it is deficient aggregate demand, that empty bit of Keynesian rhetoric. I think the problem is structural.
The theory you evade is recognition that our entire economic structures are now so distorted through public spending and “quantitative easing” that our economies are having great difficulty finding a productive base. To think this is deficient demand is to mistake the symptoms for the cause.
So on this much at least we can agree, that the world’s economies are in a mess: consumers deep in debt, savings eaten away by low productivity, government spending, and private investment going nowhere. And I didn’t just say the stimulus would not work; I said the stimulus would make things worse. You describe what I see, but I expected things to end like this from the start.
You only began to recognise a problem more than a year later, and only because by then it was obvious to all and sundry that in every place the stimulus had been introduced economic conditions had continued to deteriorate. You nevertheless still continue to believe, in spite of the evidence, that the problem is not enough government spending.
This secular stagnation is the direct result of a lack of fiscal spending advocated by austerity voodoo doctors and charlatans.
The plain fact is that there has never been a single instance in the entire period since The General Theory was published where a public sector stimulus has been able to bring a recession to an end. There’s not a single example, not one, with the coming of World War II the only supposed example when unemployment ended mostly because half the male population under 30 was put into the military.
It is not aggregate demand that matters, but value adding production. You must do more than build brick walls, you must build where what is built actually contributes to prosperity. To think more holes dug up and then refilled can generate recovery because it constitutes “fiscal spending” is the essence of economic illiteracy. And if we were looking to make matters worse, it’s hard to go past items 1-3 of your program for recovery:
First, we must replace private debt with public debt.
Second, we must put job creation above all other goals.
Third, we must deal head on with the problem of income inequality.
That is to say: we must socialise our economies.
Private debt is incurred by private sector firms. To replace this debt with public debt would so obviously drive us into deep recession that it is almost impossible to understand why this is not perfectly clear to you. And as for creating jobs – which everyone seeks to do, not just Keynesians – the fantastic proposition that governments will be able to choose productive value-adding forms of expenditure is an illusion. Your plan is to redirect the source of expenditure to the people least capable to choosing where the most productive investments would be found.
I’m afraid your program would be part of the problem and in no way part of any solution. I fear that three quarters of a century after the publication of The General Theory, economics is now at such a low ebb that what you have written will look like perfect sense to all too many, even as every attempt in the past to do what you have suggested has made things worse than they already were.
In times gone by, before Keynes, economists talked about “effective demand”, that is, what was required to turn the desire for products into an ability to buy those products. Now it is aggregate demand – the total level of demand – which has leached the original concept of any appreciation that for everyone to buy from each other – to raise aggregate demand as you might put it – they must first produce what others wish to buy. A freshly dug hole that is immediately refilled will not do even if money is paid for the work. If that is not obvious, then common sense has gone from the world.
But I say again. A short post cannot state everything that needs to be said. For a more complete explanation of these issues and what needs to be done, you must turn to the second edition of my Free Market Economics. It’s still not too late, but it is getting later all the time.
Kind regards
Steve Kates
And now Louis-Philippe’s reply to my second letter.
My dear Steven,
I read with much interest your most recent letter and I will confess I agree with you … we are indeed far apart! But surely this is not surprising as we both defend not only a very different vision of economic theory, but also a different vision of markets and society. At the core of our disagreement lies an understanding of markets, which you see as self-regulating, whereas I claim they are not. I view markets as chaotic and prone to instability and, quite honesty, capable of exploding (or rather deteriorating) into crises, with unimaginable consequences. Perhaps you are OK with that, but I am not. So when I said that the ‘worst infliction’ is to leave us exposed to the ‘tyranny of markets’, I meant precisely that: because of periodic crises, but also because of oft-occurring recessions, we cannot place our complete faith in free-markets. I see unregulated markets and unfettered capitalism as a scourge that must be tamed. To deny or ignore this would be a grave mistake, which would condemn us all to misery, and worse. How else would you characterize the massive inequality of income and wealth around the world and in particular in the United States, which is one of the most unequal developed economies? Is the fact that 40% of the wealth in the US rests within 1% of the population not a tyranny? Does this not shock you? It shocks me, and I will say it again: unless we address this calamity, we are bound to relive a crisis – and soon. Mark my words: another crisis is coming.
You seem to view markets as “the single most liberating institution in possibly the entire history of the human race.” Well, I can see where we disagree indeed. Markets are where goods are produced and sold, where incomes are determined. But they are not efficient, in the way that they do not always produce an optimum result; that is why we need some regulator and some other institution to intervene when markets fail. I would go further, I would argue that markets never allocate efficiently, and never perform optimally, so that there is a permanent and on-going need for the State to precisely regulate the cycles and minimize the pains that recessions and crises can inflict upon us, and to reduce the injustice of inequality. You say this is socialising our economies. I assume you say this in a derogatory way. I am by no means a socialist; like Keynes, I want to save capitalism from itself. But I will wear that label proudly if you meant it as somehow to denigrate. Rather, I see it as the only way of making capitalism work for mankind. In that sense, I stand proudly on the shoulders of Keynes and others who have defended that very notion. I will proudly stand and argue, supported by a vast literature of empirical research that the State is in a unique position, given its power to spend, to create wealth and prosperity for all.
You then suggest that my claim that economies grow from demand, both in the short and long term, is a mere statement devoid of a theory. Of course, you will pardon me if I did not, in less than 1,500 words, write a complete theoretical treatise on the economics of aggregate demand. But there is a vast literature on this topic, with which you are familiar I am sure, and well-developed theories, with considerable empirical support to buttress the argument.
But why are you so dismissive of Keynesian policies? The problem here, I believe, is your interpretation of what consists of Keynesian aggregate demand policies. Twice now you mention Keynes’s assertion that we should bury bottles full of banknotes as representative of Keynesian policy. My dear Steven, Keynesian economics is much more than that, and to isolate that sentence as representative of Keynes is both misleading and, well, dishonest. Keynes of course said much, much more, and Keynes was being more sarcastic than anything.
In fact, Keynes was clear, a bit later in the same often-quoted passage, that “It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing” (GT, p. 129). Did you not read that part of the General Theory?
Keynes’s message was that ideally, it would be better to build houses, or roads and bridges than to do nothing, the latter condemning us to misery and, yes, the tyranny of the markets. Keynes’s point about the bottles is that even something as silly as that would be better than doing nothing.
I suspect your insistence of that quote as an example of Keynesian economics is perhaps more sinister, knowing full well of course that the population would instantly be opposed to the silliness of that policy. So you must admit, there is some treachery afoot in your argument. If we are to have a dialogue, you cannot reduce the Keynesian edifice to ‘wasteful projects’. I know that you know that Keynesian economics is more than digging holes: there are large infrastructure projects and public investment. I suspect if we explained to the masses that Keynesian policy is about infrastructure, investing in the future, social justice and building civilizations, then I am convinced that they would see the wisdom residing within it.
Now regarding that ‘piece of arithmetic’, which you call the Y = C + I + G + (X – M), I am afraid that is simple national accounting, no more no less. But more than that, for me it is a point of pure logic: when consumers, private firms or governments spend, that increases the demand for goods, which firms must produce. Please, tell me where the flaw in that logic is? And when the private sector is incapable or unwilling to spend, governments must above all step in to sustain that level of demand, which will be hopefully met by the private sector producing.
I was struck at how different we interpret history, and recent history at that. I must admit I am at a loss for words. Keynes once famously said, “When the facts change, I change my mind. What do you do, sir?”, but I fear that no matter what I say, or in fact anything you read anywhere by anyone won’t change your mind. I think perhaps if you got away from digging holes as representative Keynesian policies would be a good start.
In closing, let me address what I consider the biggest lie in economics at the moment: the idea that reductions in government spending will lead to higher economics growth. This is pure theoretical poppycock. For instance, in Europe, it has proven to be disastrous. Austerity never works. After a few years of austerity, Europe is no closer to sustained economic growth as before. For instance, in France, after imposing several fiscal cutbacks, the government expected deficits of 2.2%. Austerity now translated into deficits running at double that, at 4.4%. This is because of that piece of arithmetic: austerity leads to depressed demand and economic activity that then deflates the entire system, more proof that demand is what matters. Policies based on supply do not work, never work, and never shall work. It is pure fantasy to believe that anything but demand is the driving force of economic activity. So we may not all be Keynesians now, but the real world is, and it operates along lines described by Keynes and Keynesians. And the General Theory, while written over 75 years ago, like you point out, remains to this day the best guide to successful macroeconomic policy we have. Granted, it needs updating, but the basic logic of the book is as relevant and as important today as it was back when it was published.
You say that what we need is value-adding production, and not just building brick walls as you put it. I completely agree. But, my dear Steven, that is what Keynesian spending does: by contributing to infrastructure building, by contributing to crowding-in, it value-adds to society.
In conclusion, the empirical evidence is squarely on the side of Keynesian economics and the importance and vital role of aggregate demand and the State. To advocate for free markets under the illusion of the efficiency dogma is pure nonsense and self-delusional. As Keynes said, that would be disastrous if we tried to apply it to the facts of experience. The real world is government by Keynesian laws, and any attempt to deny and interfere with those laws can only result in more hardship.
Finally, let me leave you with this wonderful quote by Keynes: “the man who regards all this [public expenditures] as a senseless extravagance which will impoverish the nation, as compared with doing nothing and leaving millions unemployed, should be recognized for a lunatic.” (Collected Writing, Volume XXI, p. 338).
Best wishes,
Louis-Philippe
——
There is apparent surprise that real incomes are falling after years of public sector waste and the diversion of our resource base into junk expenditure (NBN, pink batts, school halls, etc). But who understands any of this since now the Treasurer, seeing things going badly, has stated there will be no more cuts to public spending. That’ll fix it.
Really, he is a captive of the ultra-Keynesian Treasury and nothing is going to change.
“We have always got to live within our means but we’re not going to have cuts — new cuts — to make up for revenue shortfall due to external challenges,” the Treasurer said.
From The Oz: Don’t let Santa down, urges Hockey:
DON’T let Santa – or Joe Hockey – down. Get out and spend up big this Christmas.
THE federal treasurer has urged consumers to put the deteriorating federal budget out of mind these holidays.
“Don’t let Santa down, go and spend for Christmas,” the treasurer said on ABC radio.
“Household consumption is actually one of the biggest drivers of economic growth.”
Just weeks before the release of Mr Hockey’s mid-year economic review, Deloitte Access Economics has forecast a worse than expected 2014/15 deficit of $34.7 billion.
Mr Hockey is calling for calm despite the blowout, saying the Australian economy is “back on track” and showing real signs of momentum.
The government remains absolutely committed to returning the budget to surplus, he said.“It’s not a time for panic, it is a time for a rational approach to the challenges that are before us,” he said.
My thanks to Alex for drawing the article to my attention.
First there were two articles, one by Paul Krugman with the title, Keynes is slowly winning and the other by Tyler Cowen in reply to Krugman titled, Keynes is slowing losing (winning?). There is now a third, Krugman’s reply to Cowen, In Front Of Your Macroeconomic Nose, in which he says what I believe myself:
Cowen seems to have missed my point; I wasn’t talking about the merits of the Keynesian case, which I believe have always been overwhelming, but about the way macroeconomics is discussed in the media and among VSPs in general. My sense is that this is shifting in a Keynesian direction.
There is no other theory known to anyone other than Keynesian. You can talk about debt and deficits until the end of time, but unless you can relate it to a theoretical understanding of what needs to be done and more importantly why, there is nothing to grab onto when trying to craft policy. Keynesian economics may be ruinous, but you can find it in a million texts and it has been taught for three generations, coming up to four. Even Cowen in his pussycat weak attack on Keynes can do no better than this at the end:
It would be wrong to conclude that Keynes was anything other than a great, brilliant economist. Rather these citations, plus many of Krugman’s points, give you some beginnings for this issue. It’s not nearly “Keynes’s time” as much as many people are telling us, after all his biggest book is from 1936 and that is a long time ago. Keynes is both winning and losing at the same time, like many other people too, fancy that.
Economies are not driven from the demand side. But other than myself and a handful of others, you will find hardly anyone else to say it across the wide expanse of economics. So on we go, tilting back to public spending while real incomes descend and our economies weaken with not a clue why that might be. So at least there is Johnny Cochrane writing this in a discussion of the articles by Cowen and Krugman:
I posted this last week, but I was unaware at the time of the Paul Krugman’s “Keynes is slowly winning” post; Tyler Cowen’s 15-point response, documenting not only Keynesian failures but more importantly how the policy world is in fact moving decidedly away from Keynesian ideas, right or wrong (that was Krugman’s point); and Krugman’s retort, predictably snarky and disconnected from anything Cowen said, changing the subject from Keynesian ideas are winning to the standard what a bunch of morons they’re not Keynesians though I keep telling them to be. . . .
In that context, I added two “Facts in front of our noses.” Keynesians, and Krugman especially, said the sequester would cause a new recession and even air traffic control snafus. Instead, the sequester, though sharply reducing government spending, along with the end of 99 week unemployment insurance, coincided with increased growth and a big surprise decline in unemployment. And ATC is no more or less chaotic than ever. Keynesians, and Krugman especially, kept warning of a “deflation vortex.” We and Europe still don’t have any deflation, and even Japan never had a “vortex.” These are not personal prognostications, but widely shared and robust predictions of a Keynesian worldview. Two strikes. Batter up.
But still no theory to explain why cuts to public spending will raise economic growth while increased public spending will slowly but surely reduce our standard of living. If, however, you are interested in understanding why, there is always the second edition of my Free Market Economics.
UPDATE: One of the great anti-Keynesians has written an article for this month’s Standpoint in the UK, Don’t let the Keynesians Wreck the Recovery. He discusses the famous letter signed by 364 economists across Britain warning of the consequences of Thatcherism, that is, the consequences of fiscal discipline:
Famously or notoriously, depending on one’s viewpoint, the 364 were wrong. To quote Nigel Lawson, who would become Chancellor of the Exchequer in 1983, the timing of the recovery was “exquisite” in refuting the 364’s prognoses. Demand and output started to move upwards in the second quarter of 1981, just as the debate about the Times letter was at its most intense. Although unemployment remained high for some years, the economy gathered pace and in the late 1980s entered another boom. If this was a laboratory experiment for Keynesian economics, its results suggested that the textbook formulas were flawed. Old-fashioned principles of sound finance returned to favour in the UK, while the ratio of public debt to gross domestic product fell to manageable levels. For more than 25 years Keynesian fiscal activism was ignored or even forgotten.
But the events of the 1980s have been ignored, particularly by writers of textbooks. As Tim notes:
But university economists continued to teach Keynesian macroeconomic as if nothing had happened. Sure enough, in Britain many academics realised from the sequel to the 1981 Budget that something was wrong with Keynesianism or, at any rate, with the naive versions of Keynesianism which emphasised the blessings of fiscal fine-tuning. But in the American East Coast universities — notably the Ivy League establishments — the UK’s 1981 Budget was too parochial an event to justify rewriting textbooks and lecture notes. Such influential figures as George Akerlof and Robert Shiller of Yale, Paul Krugman of Princeton and Joseph Stiglitz of Columbia, all now Nobel prize laureates, continued to teach that an increase in the budget deficit adds to aggregate demand and a decrease deducts from it.
And so here we are, dragging our economies down by pretending we are doing them good.
The one thing about our economies everyone can agree on is that they are in a mess. The question then is, what’s the reason for the mess they are in and what should be done to fix things up? The potential for the present dismal state of affairs to drag on for another decade or more is a genuine possibility, just it has done in Japan since it tried its own stimulus in the 1990s. Such an outcome is all the more likely given the continuous belief, fostered by standard textbook macroeconomics, that a government stimulus is essential if a recovery is to occur. It is this belief that will keep our economies in permanent disarray. There is therefore no economic issue of more importance at the present time than whether such Keynesian policies should be continued.
I am in the midst of an “exchange of letters” on Keynesian economics with Louis-Philippe Rochon, the editor of the Journal of Keynesian Economics. We had each written one letter – (my first is discussed here) – and now I have written my second, which may be found at this link under the title: “How to Promote a Global Economic Recovery? ‘Markets… have been the single most liberating institution in possibly the entire history of the human race’.” You can find all three of our letters, my two and Louis-Philippe’s reply to the first, at the link.
The letter that has just been published was, in fact, the second I had written in response to his. What follows below is the first version I wrote in reply, which is still trying to get at the same ideas but in a different way.
Dear Louis-Philippe
Thank you for your reply which I must confess was not really a reply to the issues I raised. I wrote to explain why a stimulus could not possibly have worked, emphasising the theory. Your reply has merely stated that we have not really had a stimulus since it was prematurely brought to an end and that in your view, it is the absence of a stimulus that is causing our economies to fall into deeper recession. You then go on to provide your own Keynesian program with nothing to support it other than your own set of preferences for public spending.
But if we are to examine the record, let me remind you that there has never been a single example of a Keynesian stimulus that has ever succeeded in returning an economy to full employment and strong rates of growth. Not a single one, not one, not ever.
The one example that gets trotted out from time to time was the outcome of the Kennedy tax cuts of 1962. But tax cuts are not increases in public spending, and are in perfect keeping with pre-Keynesian policy. It was the same approach that Ronald Reagan took in the 1980s and with equal success.
Increases in public spending have never succeeded in bringing an economy out of recession. The United States notoriously, in spite of the spending and deficits of the Roosevelt administration, never returned the American economy to full employment. It was only the coming of the war in 1941 that brought the Great Depression in the US to an end.
By then, the rest of the world had left the Depression behind long before. Even by the time The General Theory was published in 1936, the Great Depression had long disappeared in the UK. Unemployment was still high but the worst was well and truly over. By 1937 Keynes was worrying about inflation, not unemployment.
Moreover, the policy approach in the UK had been entirely classical. The British Chancellor of the Exchequer (ie the Secretary of the Treasury) in his 1933 budget speech specifically noted that the budget had finally been balanced, and correctly forecast that recovery would therefore soon be under way.
Where are the success stories to go with the obvious failures that were found pretty well everywhere in the 1970s and 80s, in Japan in the 1990s, or the experience of every economy that had tried a stimulus after the Global Financial Crisis in 2009. There is not a single example of a successful stimulus you can point to.
Let me also remind you of the greatest disproof of Keynesian economic policy in history. Everyone always points out that one Keynesian data point which is the so-called boom that came at the start of World War II. Not a boom at all since what most people remember about the home front was rationing and controls of every kind. And if you are thinking about the labour shortages, merely recall that around half the male workforce under thirty was drafted into the armed forces. But that’s not that point either, although it should put quite a dent into such Keynesian thought.
It is the coming of peace in 1945 that is the grand refutation of Keynesian economics. At the end of the war, in the space of a year millions who had been overseas fighting, or had been part of the war effort at home, were suddenly in the labour market looking for work. Think of these as millions of people who had suddenly lost their jobs all at once. Many women who had taken jobs while the men were overseas also remained in the workforce. The Keynesians were continually badgering Truman to maintain war-time deficits since, they said, if he did not the US would go straight back into the depression which in the United States had ended only four years before.
Truman, however, having had a business background, was adamantly opposed to deficits and as a result the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures, balanced its budget and in so doing set off the greatest economic boom in world history, a boom that lasted straight through until ground into the dust by the war on poverty, and dare I say it, the unfunded, deficit-financed war in Vietnam.
Thinking about macroeconomic issues from the demand side is amongst the biggest mistakes anyone in economics can make.
Given its perfect record of failure, why does Keynesian macro persist? Why is it still taught in our textbooks? Aside from being very simple to understand, it remains in place because, disastrous though the policies Keynesian theory promotes may be, it is loved by governments, the bureaucracy and that brand of entrepreneurial activity that today goes under the name of “crony capitalism”. Keynesian policies may not do much for the poor and unemployed but it brings amazing dividends to our economic and political elites.
Before Keynes, governments knew their limits. There was no pretence that beyond a narrow range of activities, there was little a government could do that would be value adding. It was universally appreciated that during recessions governments could take various steps to reduce unemployment and that there was a limited role for governments to have projects available that could soak up some of those who lost their jobs. Nothing new in that.
Today, with macro so drenched in Keynesian conceptions, government spending of all kinds on just about anything, is seen as wealth creating. Politicians, who know nothing about running a business, nevertheless believe themselves capable of making billion dollar decisions because they believe that whatever they spend on will, of necessity, raise the level of economic growth and add to communal prosperity.
The confidence with which governments devised expenditure programs following the GFC in the apparent belief that recovery would follow soon after was incredible to those few of us who understood that it is impossible to increase growth by increasing public waste of resources.
In his introduction to The General Theory, Paul Krugman summed up Keynes’s message in four points, which are almost identical to my own description of Keynesian economics:
“1. Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment
“2. The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully
“3. Government policies to increase demand, by contrast, can reduce unemployment quickly
“4. Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach.”
This is the theory that is drummed into every introductory student in economics and which maintains its grip unless specifically taught that these four propositions are fundamentally wrong.
And within the worldwide community of economists, no more than around two in a hundred are ever taught to reject such beliefs, and even with this two percent only a small proportion ever come to understand what is actually wrong with the macro they have been taught. The rest more or less accept the theory as it comes, which is why when the Global Financial Crisis struck, there was virtually no opposition to the stimulus from within the economics community.
Even now, as governments struggle to deal with the debt and deficits they have created in their various expenditure programs – almost none of which will ever have a positive return – there is still no general understanding of what went wrong or how to fix what is clearly broken.
The four fundamental principles of Keynesian economics are so ingrained that most economists are not even aware that before Keynes, such beliefs were recognised as utterly fallacious and the mark of an economic illiterate.
Again, I can do no more than remind you of the second edition of my Free Market Economics which discusses both the Keynesian and the classical theories of the cycle. Here I can do not much more than raise your interest in these wrongly discarded theories of the cycle. If you would like to know more about what they said, and why modern macro is so deeply flawed, it is to my text you must go.
Tony Abbott has asked nervous government MPs to maintain internal discipline in the face of the ABC funding controversy and bad polling, reassuring them he will knock “one or two barnacles off the ship” before Christmas.
Other than with the title, I’m not sure there is much of a lesson for us moderns other than that sensibilities do indeed change. This is from 1935. Anything similar is unimaginable today although I was shocked to see Olive Oyl playing the field as she does. But for all that, thinking of our leader of the opposition as Barnacle Bill does have an appeal specially when presented as a menace as he is here.
Should also mention how well the PM’s speech was yesterday. In fact, I was sitting next to a minister assisting the minister and was saying just that to him when he said why don’t you say it to Tony. And there he was passing by as he was leaving, so I said it again to him. The speech was reported in this morning’s AFR with the headline, “Abbott puts the onus on business”.
Tony Abbott on Wednesday night appealed to the business community to help the government sell its economic agenda following a decision to dump or water down key budget measures and new evidence the budget is far more vulnerable than previously thought.
The Prime Minister told the Australian Chamber of Commerce and Industry’s Australian Business Leaders’ dinner last night that the success of his government depended partially on strong business backing.
“My hope is that you won’t just be interested but engaged in 2015. You matter and your voice is heard,” he said in a similar plea issued recently to the Business Council of Australia. “Reform or stagnation, budget repair or endless deficits. More tax or less. Your choices and your statements count.”
Prosperity travels through business; there is no other way. Crony capitalism is not the free market; it is a reversion to the mercantilism Adam Smith is supposed to have seen off the lot. Barnacle Bill is playing with fire. They created the mess that will sink our living standards while they pretend it has been those who are trying to repair the damage at fault.
UPDATE: The imagery is complete. Viva [many, many thanks] in the comments noted that Abbott is being portrayed as Popeye by Moir in his cartoons!
Law of Markets 