Category Archives: Economic theory and policy

John Stuart Mill’s Principles of Political Economy

Posted on by
Reply

I have long had a view that John Stuart Mill’s Principles of Political Economy is the best economics book ever written. But I have now also come to the view that no one is ever going to contradict me because virtually no one can any longer read the book. I have just been back over the book on a project on Mill I am just beginning and turned to Book I Chapter II which is “On Labour”. I say to you in all honesty that it is a fascinating chapter from which there is much to learn, including how little there is that is truly new that is not in Mill. But here is the opening para of the chapter from which the one thing I guarantee you will learn is how hard the book must be to read.

§ 1. The labour which terminates in the production of an article fitted for some human use, is either employed directly about the thing, or in previous operations destined to facilitate, perhaps essential to the possibility of, the subsequent ones. In making bread, for example, the labour employed about the thing itself is that of the baker; but the labour of the miller, though employed directly in the production not of bread but of flour, is equally part of the aggregate sum of labour by which the bread is produced; as is also the labour of the sower and of the reaper. Some may think that all these persons ought to be considered as employing their labour directly about the thing; the corn, the flour, and the bread being one substance in three different states. Without disputing about this question of mere language, there is still the ploughman, who prepared the ground for the seed, and whose labour never came in contact with the substance in any of its states; and the plough-maker, whose share in the result was still more remote. All these persons ultimately derive the remuneration of their labour from the bread, or its price: the plough-maker as much as the rest; for since ploughs are of no use except for tilling the soil, no one would make or use ploughs for any other reason than because the increased returns, thereby obtained from the ground, afforded a source from which an adequate equivalent could be assigned for the labour of the plough-maker. If the produce is to be used or consumed in the form of bread, it is from the bread that this equivalent must come. The bread must suffice to remunerate all these labourers, and several others; such as the carpenters and bricklayers who erected the farm-buildings; the hedgers and ditchers who made the fences necessary for the protection of the crop; the miners and smelters who extracted or prepared the iron of which the plough and other implements [30] were made. These, however, and the plough-maker, do not depend for their remuneration upon the bread made from the produce of a single harvest, but upon that made from the produce of all the harvests which are successively gathered until the plough, or the buildings and fences, are worn out. We must add yet another kind of labour; that of transporting the produce from the place of its production to the place of its destined use: the labour of carrying the corn to market, and from market to the miller’s, the flour from the miller’s to the baker’s, and the bread from the baker’s to the place of its final consumption. This labour is sometimes very considerable: flour is [1848] transported to England from beyond the Atlantic, corn from the heart of Russia; and in addition to the labourers immediately employed, the waggoners and sailors, there are also costly instruments, such as ships, in the construction of which much labour has been expended: that labour, however, not depending for its whole remuneration upon the bread, but for a part only; ships being usually, during the course of their existence, employed in the transport of many different kinds of commodities.

He does wear you out. I have visions of Mill, who wrote this thousand page book in about eighteen months while holding a full-time job in the East India Company, sitting there in his free moments with his pen, ink and paper, scratching out the text as he tried to distill his thoughts into something coherent. The man with the highest IQ in the nineteenth century, his book was the byword for economic theory for the following fifty years and then some. My copy is a discarded text from the 1920s that was still being used at the University of Melbourne. If you would like to see Mill up to date, you can read the 2nd ed of my Free Market Economics and when you see the book (unless you read it electronically) you will understand why the cover shows a water mill as its main motif.

To which from further comments I must add this:

John Stuart Mill,
By a mighty effort of will,
Overcame his natural bonhomie
And wrote “Principles of Political Economy.”

Roosevelt prolonged the depression in the US by seven years

Posted on by
Reply

Here’s a story that has only ever been unknown to Keynesian economists: FDR’s policies prolonged Depression by 7 years, UCLA economists calculate. Whether they have properly explained what exactly Roosevelt did wrong is another story, but at least there is finally some acknowledgement that his economic policies were directly at fault a mere eighty years after the fact. It is laughable to see that the authors argue that up until now we had not known the reason for the delayed recovery. But it is actually more than that. Now that they have found something that removes the blame from the Keynesian policies FDR adopted, they are finally willing to state in print that Roosevelt’s policies actually were the disaster everyone always knew they were.

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

After scrutinizing Roosevelt’s record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

“Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump,” said Ohanian, vice chair of UCLA’s Department of Economics. “We found that a relapse isn’t likely unless lawmakers gum up a recovery with ill-conceived stimulus policies.”

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

“President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services,” said Cole, also a UCLA professor of economics. “So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.”

You need to read the whole article but let me take you to the very last para which has major implications for today:

“The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes,” Cole said. “Ironically, our work shows that the recovery would have been very rapid had the government not intervened.”

It’s a strange business since the article points out what I thought was common knowledge, that Roosevelt’s policies delayed recovery. But what it doesn’t do is put the blame on public spending which is where the blame truly belongs. It can therefore, in its own convoluted way, be taken as a defence of Keynesian policies since these were not the problem. Instead the blame for the astonishingly slow recovery is placed on industry policies which no doubt played their part. Eighty years from now someone will write a paper to argue that the Obama administration had been responsible for the slow recovery of the present moment but it will be blamed on something else instead – Obamacare maybe – rather than the fiscal and monetary policies whose effects will continue to be ignored just as they are ignored today.

The interventionists within economics is down to the last 95% of the profession but at least there is progress being made. The aim now is to save Keynesian economics, and if it requires finally admitting that Roosevelt had prolonged the depression, well that is how it will have to be. Since their conclusions take Keynesian economics off the hook, these results may end up being embraced as at long last solving a “mystery” that no one should ever have actually been mystified about.

Ha-Joon Chang – please copy

Posted on by
Reply

Ha-Joon Chang seems to be the economist of the moment, with yet another book published by Penguin, Economics: The User’s Guide. But what is notable for me is that he has obviously, but only obviously to me, looked either at what I have written about Say’s Law or looked at someone else who has picked up on what I have written on Say’s Law. He does the usual ritual on “supply creates its own demand” but then adds:

“There can be no such thing as a recession due to a shortfall in demand.” [p 116]

You who have heard me harangue on this for many a moon may think nothing of this, but this is precisely the definition I use myself. It is apparently and pleasingly getting out and about. Because once the focus is in the right place and on the right thing, then we can have a genuine debate. Are recessions caused by a shortfall in demand? Because you would have to be demented to believe that the Global Financial Crisis was in any way caused by a fall off in demand. Same for every other recession in history up until now. But if one merely looks at the GFC, a fall in demand because of decisions to save has to be the least plausible of all possible explanations. In fact, Chang, and I think following my lead, goes on to describe the kinds of things that those classical economists used to look at for explanations, which again you would have to be demented not automatically to look at yourself. He writes:

Any recession had to be due to exogenous factors, such as a war or the failure of a major bank.

He thinks bank failures are exogenous [ie external to the operation of the economy, like being hit by a meteorite, say]! A bank failure is precisely what might be thought of as both endogenous and not in any way a Keynesian explanation, which is based around demand failure due to too much saving, not some kind of crisis on the production side. And you would like then to know what caused the bank to fail, and whether the problem was more widespread than a single bank, since during a financial crisis there is never only one bank going to the wall.

But then he goes on to add the usual Keynesian idiocies since economists just do not seem to be able to help themselves:

Since the economy was incapable of naturally generating a recession, any government attempt to counter it, say, through deliberate deficit spending, was condemned as disturbing the natural order. This meant that recessions that could have been cut short or made milder became prolonged in the days of Classical economics.

You really do have to wonder about these blockheads! We are the midst of what may already be the most prolonged of all recessions in history, and it is by no means over yet, and he complains about classical economists’ reluctance of try to fix things by public spending. Let me once more quote from my Quadrant piece from February 2009 which was titled, The Dangerous Return to Keynesian Economics:

Just as the causes of this downturn cannot be charted through a Keynesian demand-deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand, and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

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.

That is classical economics forecasting almost six years ago the prolonged recession every economy in the world is in the midst of and cannot shake off. If you would like to understand more fully what classical economists actually believed, you cannot do better than this.

Government must get out of the way

Posted on by
Reply

Keynesian economic theory has turned out to be a device for the rich to rob the poor, for the unproductive to raid the incomes of those who work. We are supposedly all to be made better off through massive diversion of the wealth of our nations into the pockets of the crony capitalist friends of our ruling elites and union leaders who fleece their members in the name of protecting them from the employers who gave them their jobs.

Rupert Murdoch has spoken on this to the G20, the first person not from a government to be allowed to make such a presentation. Paul Kelly discusses Murdoch’s speech under the heading, Equality at risk in the West, says Rupert Murdoch. It’s a damned sight more than just equality that is at risk, but our very prosperity. We are being made poor across the broad expanse of our communities because governments are now the chief agents for dispensing purchasing power. Obama was right: you didn’t earn it. The government earned it, and you will only be allowed to keep what it decides you should keep. This is part of what Murdoch said:

“In America, the most highly paid 1 per cent now pay 46 per cent of all income tax.” . . . “In Britain, the top 1 per cent pay 28 per cent of all income tax. That is a massive shift from what our society looked like 30 years ago. We should all be concerned about this polarisation which was never the intent of policy but is certainty a consequence.

“Quantitative easing has increased the price of assets, such as stocks and real estate, and that has helped first and foremost those who already have assets. Meanwhile, the lack of any real wage increase for middle-income workers means growing societal divisions and resentment.”

Quantitative easing is a disaster but you will not find out why by reading any economics book that I know of, other than mine. The last two chapters deal with what had once been stock standard economics before the General Theory. Even Keynes dealt with the money rate of interest (the price of credit) and the natural rate of interest (the price of actual resources, such as bricks and mortar), but that was in his 1930 Treatise on Money, which he wrote before he was sidetracked by Say’s Law. We are ruining our economies in the belief that we are actually doing them good by higher levels of public spending and lower interest rates to encourage investment. But we are ruining them, which is a fact that is obvious to everyone. The only thing invisible is why. But what Murdoch proposed is absolutely right:

The significance of his nine-page speech is his argument about the limits to both monetary and fiscal policy and the imperative for a new approach based upon the need “for government to get out of the way”. Mr Murdoch called for: labour market reform; lower and more competitive corporate taxes; a crackdown on multinationals — naming Google — for not paying taxes where they make their profits; a rethink on excessive bank regulation, warning “you would have to be mad to join the board of a bank these days”; and recognition that high taxes and over-regulation were damaging economic growth and the public interest.

But if you start from Y=C+I+G you cannot make any sense of what he suggests. Read Chapters 16 and 17 of my Free Market Economics second edition if you would like to understand the classical explanation for what is happening right before your eyes and why these kinds of reforms are needed. I do find it odd that this is the only book I know of, at least one that has been written since the 1930s, that can explain what was once obvious to every economist in the world. But odd or not, that is how it seems to be.

If the government spends the money then you can’t

Posted on by
Reply

When the government does the spending the rest of us are pushed out of the way. Governments cannot create demand, they can only divert it into the production of their own preferences instead of ours which are sometimes, but not always, the same. The notion that their soaking up our resources somehow magically adds to the sum total available to everyone is the most monstrous of all of the monstrous untruths now found in modern economic theory. Here is an article about the United States that would have a sharp resonance across the world. 7 things the middle class can’t afford anymore is its title. I will only reproduce the first of them. You can then read the whole thing for yourself.

Vacations

A vacation is an extra expense that many middle-earners cannot afford without sacrificing something else. A Statista survey found that this year 54% of people gave up purchasing big ticket items like TVs or electronics so they can go on a vacation. Others made sacrifices like reducing or eliminating their trips to the movies (47%), reducing or eliminating trips out to restaurants (43%), or avoiding purchasing small ticket items like new clothing (43%).

Keynesian theory pretends that if the government spends more of your money, you will end up better off. Are people really that stupid to believe such a thing?

QE – the case against

Posted on by
Reply

Scott Johnson at Powerline has put up a post in which he quotes a mate of his which is In Defense of QE. It is a defence put together by a “professional investor” using “investor” in its modern sense as someone who takes people’s money and invests it in some form of monetary instrument, not someone who actually builds productive assets. No doubt QE has made him a tonne of money. Shame about everyone else.

I will make only two points since this gets into such esoteric argument that no one can follow any of it.

Firstly, a long part of the supposed defence is a defence of central banks and the role of the Fed during the height of the GFC. Well when it comes to that, the actions taken by the Fed during the GFC seemed essential to me at the time and on thinking things over ever since, I have had no reason to think otherwise. It was a very fast moving story but all told, you could not let the conflagrations in financial markets just burn themselves out on their own. QE had nothing whatever to do with the Troubled Asset Relief Program, the TARP. With QE we are not talking about troubled assets or dealing with an emergency. It is just straight out inflation.

Second, inflation has now come to mean rises in prices when once it meant printing money. The Keynesians switched the terminology to movements in prices in the 1930s so that their policies would no longer be immediately described as inflation (discussed in the 2nd ed of my Free Market Economics [FME2] pages 406-408). But let’s not quibble about this. What ought to be understood instead is that the effect of inflating the money supply to fund public spending has a number of possible effects of which higher prices is only one. Without militant unions and continuous labour market pressures to push wages up, inflation in the form of price increases is subdued. And whatever else may be the case at the moment pretty well everywhere, only those in very protected environments are in the mood to be pushing for significantly higher wages that would put their jobs at risk.

The real issue is that the way in which the re-direction of expenditure to the public sector is and will continue to manifest itself in a crumbling capital stock (see FME2: p410). The economy of the United States is falling to bits. It will take a longish time since it has a massive asset base but it is being eroded fast enough, which is evident in the median income data and elsewhere. The data are from the Federal Reserve.

median income us

QE is just part of the wreckage that the shift of aggregate expenditure from private investment to government waste is causing. I don’t normally quote from the World Socialist Website, but these are again data from the Federal Reserve which, based on the actions it has taken, is probably itself now a member of the Socialist International:

The yearly income of a typical US household dropped by a massive 12 percent, or $6,400, in the six years between 2007 and 2013. This is just one of the findings of the 2013 Federal Reserve Survey of Consumer Finances released Thursday, which documents a sharp decline in working class living standards and a further concentration of wealth in the hands of the rich and the super-rich.

The US economy, along with most other economies, is falling apart and there is hardly an economist in the world uninfected by the Keynesian virus and therefore hardly an economist able to understand what is going on. If for no other reason than just to get this other perspective, let me again recommend my FME2, “a must read for serious economists” as one reviewer described it, and that was the first edition. This one is better.

Don’t worry, I won’t let anybody tell me

Posted on by
Reply

It’s not even that she is so stupefyingly ignorant that is so remarkable but that it is apparently a winner for her to say it. This is the story of the video above and the title of the post it comes from exactly restates what the next Democrat to run for president intends to argue: ‘DON’T LET ANYBODY TELL YOU’ THAT ‘BUSINESSES CREATE JOBS’.

There may be some way for an interpretation of the most destructive piece of arithmetic in history – Y=C+I+G – to enter more vacuous territory, but it’s hard to see how. For her, her husband apparently and all too many on her side of the fence, it is government spending, not productive businesses, that causes economies to grow and individuals to be employed. (To understand the reference to arithmetic, you need to go to the video.)

You think the American economy will recover? With people as out of it as she is at the helm, the US economy will never recover, not ever. And if we give her the benefit of the doubt and assume she actually knows better but her supporters do not, what comfort is there in that? Personally though, I think she is saying what she believes. What then for living standards a decade from now?

Free Market Economics and Say’s Law

Posted on by
Reply

This post is the second of a series I am writing on the second edition of my Free Market Economics that has been published in association with the Institute of Economic Affairs in London. This post focuses on the single most important principle in economics which now goes under the name Say’s Law. But it is a principle that was deliberately eliminated from within mainstream economic theory by Keynes in his General Theory and has disappeared from virtually all economic discourse since that time.

The book was itself written because there is literally no economics text of any kind anywhere that discusses Say’s Law. Yet it was this principle that made it perfectly obvious that the stimulus being applied across the world from the end of 2008 would lead to an economic stagnation that would last years on end. That is why I immediately began to write the book then and there, but it is also why I had published in February 2009, just as the stimulus was getting under way, an article with the title, “The Dangerous Return to Keynesian Economics”. The article specifically discussed the crucial disappearance of Say’s Law and included this forecast:

“Just as the causes of this downturn cannot be charted through a Keynesian demand-deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand, and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

“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.”

While virtually the whole of the economics profession remains flummoxed by what has happened since the stimulus, neither my students nor myself have been in any doubt. It has been as obvious as the noonday sun, but invisible to anyone brought up on modern macroeconomics which has embedded the theory of aggregate demand, Keynes’s disastrous contribution to economic theory.

Say’s Law specifically stated that demand deficiency, that is, a deficiency of aggregate demand, could never be the cause of a recession (or in the archaic language of the classics, “there is no such thing as a general glut”). It then specifically told governments that while some additional public expenditure during recessions might do some small good, such a stimulus would never restore an economy to robust health but would, instead, do serious damage, and the larger the stimulus the more damage it would do.

The book explains the nature of Keynesian economics but also explains why a stimulus could not possibly have returned our economies to rapid rates of growth and low unemployment. The experience of the past six years ought to have made all this supremely evident in practice. But without an understanding of Say’s Law, there is not a chance in the world anyone will understand why the stimulus has been the colossal failure it has been.

Although named Say’s Law after the early nineteenth century French economist J.-B. Say, it was a principle that was part of the bedrock foundation of economic theory right up until 1936. But what will never be told to you by any Keynesian economist (in large part because they don’t even know themselves) is that the term Say’s Law was invented in the twentieth century by an American economist who thought it was absolutely essential for clear thinking in economics and brought into active use only in the 1920s.

If for no other reason, I commend my book to you because it is the only place where one can have Say’s Law explained in a way that makes you understand what economic theory has lost. It will also explain why the stimulus did not work and what must be done instead, reasons enough to buy the book I would hope. But there are also others which I will come back to in later posts.

Classical economics rediscovered

Posted on by
Reply

I have come across a summary of David Simpson’s The Rediscovery of Classical Economics written by David Simpson himself and published by the Royal Economic Society. Before I quote more extensively, I will note where he wrote:

I refer to an intellectual tradition that began with Adam Smith, was continued by Marx, Menger and Marshall, Schumpeter and Hayek and in the present day is represented by theorists of complexity.

It never surprises me to see the name of John Stuart Mill missing from such lists since Mill is the most difficult of all of the classical economists to access for any one schooled in modern theory. Yet it was Mill who set the standard for the second half of the nineteenth century and was explicitly followed by Marshall and even Hayek even as they turned economics into the more familiar form we find today. I might also mention that what makes Marx interesting even now is found in Mill only with much more common sense as well as a far deeper economic understanding. Mill is the high point of classical thought, and in many ways the high point of economic thought. But who amongst any of you would be able to contradict me, you followers of Keynes and marginal analysis, who barely know Mill’s name never mind have any idea of what he wrote? This is Simpson’s description of the economics that has all but disappeared.

The hallmarks of this classical tradition are principally three. The first is the belief that the growth of the economy, rather than relative prices, should be the principal object of analysis. Coupled with that belief is an understanding of the market economy as a collection of processes of continuing change
rather than as a structure, and that the nature of this change is self-organising and evolutionary. Finally there is a conviction that economic activity is rooted in human nature and the interaction of individual human beings.

The differences between classical theory and equilibrium theory can be summarised in the following terms. Classical theory focuses on change and growth within open, dynamic nonlinear systems that are normally far from equilibrium. Equilibrium theory, on the other hand, analyses the theory of value within closed, static linear systems that are always in equilibrium. As to the essential nature of economic activity, classical economics makes no distinction between micro- and macroeconomics. Patterns of activity at the macro level emerge from interactions at the micro level. Evolutionary processes provide the economy with novelty, and are responsible for its growth in complexity. In equilibrium theory micro-and macroeconomics remain separate disciplines, and there is no endogenous mechanism for the creation of novelty or growth.

The behaviour of human beings in classical theory is analysed individually. People typically have incomplete information that is subject to errors and biases, and they use inductive rules of thumb to make decisions and to adapt over time. Their interactions also change over time as they learn from experience. In equilibrium theory, individual behaviour is assumed to be homogeneous and can be modelled collectively. It is assumed that humans are able to make decisions using difficult deductive calculations, that they have complete information about the present and the future, that they make no mistakes and have no biases, and therefore have no need for adaptation or learning.

Simpson finishes by discussing where economics now needs to go under the heading, “The Implications for Economic Theory”. I think this is both very limited in what is sought but also almost impossible to imagine being taken up within the profession. I’m not so sure about the need for non-linear algebra, but at least with this we have the commencement of a program for change:

First of all, courses in economic history and in the history of economic thought should be a required part of the curriculum for every student of economics. The study of economic history, like the study of complex systems, reveals the importance of context in understanding economic behaviour. The study of the development of economic thought helps us to appreciate the weaknesses as well as the strengths of a theory. Macroeconomics should be downgraded, and give way to the study of business cycles.

Secondly, more space should be found for the analysis of dynamic processes at the expense of static theory. The study of the processes of economic growth should be restored to centre stage. This probably means a greater emphasis on nonlinear algebra.

At the same time, the limitations inherent in applying mathematics to economics need to be acknowledged. The importance of the human factor and of human institutions in economic activity means that more attention needs to be given to non-quantitative methods of analysis.

With the scale of disaster that has befallen us since the GFC, there is something radical that needs to be done. And if you are interested in seeing a twenty-first century update on Mill and classical theory, you can always try this.

Saving and investment as understood in 1886

Posted on by
Reply

This is from a note I have just written discussing the 2nd ed of my Free Market Economics. What is most interesting perhaps is the question that was found at the back of a chapter in an economics text published in 1886. Note the assumption that higher saving leads to higher growth, and more mysteriously, that money placed in a bank is not what savings really consist of. All very routine in 1886, now near incomprehensible.

The book being so far from the standard, even people who are potentially sympathetic to what it is trying to explain will be puzzled because of the way in which economic theory is currently taught. I have had the experience now for the past ten semesters in seeing students who don’t get it at the start, specially if they have done economics before, suddenly catching on. What now establishes the course material is that everyone is perfectly aware that neither the stimulus nor the low interest rate regime have brought recovery with it but cannot understand why. So I point out that if you were a classical economist, the economics you would have been taught would have explained all that already, and then I explain what every good classical economist would have known. The question below is one of my favourite questions for this part of the course.

What did Simon Newcomb mean when he asked this question in his 1886 Principles of Political Economy text:

“Trace the economic effect of the frugal New England population putting their money into savings banks. What do such savings really consist of?”

a) for a community the amount of money in banks is not what is meant by saving
b) the economic effect is that a larger proportion of its resources are made available for investment
c) high saving would mean high unemployment
d) money facilitates exchange but resources are what matters
e) the New England economy would be expected to grow only very slowly

It’s useful to me since I try to emphasise that I didn’t make this up but that there is a long pedigree to what I teach. It’s only that since 1936 there has been such a discontinuity in economics that the kind of question found at the end of an introductory text in 1886 would be virtually unanswerable using modern theory. “What do such savings really consist of?” is near on incomprehensible to anyone who has only learned modern macro.