Category Archives: Economic theory and policy

Defending the History of Economic Thought on e-books

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You can get my Defending the History of Economic Thought as an e-book at this link. It is the first ever book length defence of HET and was written because the History of Economic Thought was, and still is, under threat of exile from amongst economists to the History and Philosophy of Science. It thus is not just an examination of why economists must study HET to become better economists, but why economists must preserve HET if economics is itself to become a better study of how economies work. This is from the link to the e-book:

This book explains the importance of the history of economic thought in the curriculum of economists, whereas most discussions of this kind are devoted only to explaining why such study is of value simply to the individual economist. Steven Kates reaches out past the individual to explain the crucial importance of the history of economic thought in the study of economics itself; without its history at the core of the curriculum, he contends, economics is a lesser subject, less penetrating, less interesting and of much less social value.

The book has had a number of reviews which reminded me just how useful this book is, not because they agreed with me, but because they didn’t. Not that any of them disagreed with me over the importance of the subject itself, only about whether my approach to teaching HET was a sensible one or whether I had overstated the opposition to HET amongst the profession in general. But twice in five years, major societies were faced by attempts to remove HET from within the economics classification and only rearguard action by a handful of historians of economics was able to reverse these already taken decisions.

I will be speaking about the book at the History of Economic Society meeting in Montreal in June and then, at the Australian Society meeting in Auckland, there will be a symposium on the book and its message. Economists have shifted away from being part of the humanities into becoming, not just a social science but social-physics. It is mathematics and pseudo-rigour that now drive the way in which economic theory is designed. Economics cannot be mathematical since there are no data for most of the important questions economics tries to answer. One of the reasons Keynesian economics will not die is that there is a belief that you can measure the things that need to be measured since the national accounts – a set of identities, for heaven’s sake – can be used as a proxy for economic relations. The History of Economic Thought at least reminds economists that their subject once was part of the humanities and some even begin to realise it still needs to be if it is to be any use to society.

Piketty is an economic illiterate

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I have finally put my hands on a copy of Thomas Piketty’s Capital in the Twenty-First Century. And what do I find, that this world famous book, this book that is going to set our economic world on its head, in its introductory chapter makes a fundamental error in basic economic theory I would fail any first year student for making. Forget about fraudulent data. He has confused a shift in demand (ie a movement of the demand curve) with a change in quantity demanded (the effect on the number of units bought caused by a change in the price). For an economist, you cannot be more wrong than that. Here is the passage in which, of all things, he is discussing Ricardian land rents in a section he titles, “Ricardo: the principle of scarcity”:

“To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process: the mechanism of supply and demand. If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which should lead to a decline in its price.” (p.6 – my bolding)

He has here basically stated that insufficient supply (a shortage) will lead to a fall in price which you can see from the bits in bolding. An economist should immediately see the flaw, but for those not trained in the dark arts, let me explain.

1) The phrase, “if the supply of any good is insufficient” means, suppose there is more being demanded at the price than is being supplied. That is, suppose the price is below its equilibrium level so that there is upwards pressure on the price. He doesn’t say it quite that way, but only that “its price is too high” which, in theory terms, is a nonsense statement. But since he is talking about the pressure of demand on supply, he can only mean that the increase in demand is pushing the price up which is driving some people out of the market. As economists like to put it, the demand curve has moved to the right and prices have therefore gone up.

2) But because “its price is too high,” he writes, “then demand for that good should decrease.” Big, big mistake. He has shifted his meaning of “demand” from representing a movement of the entire demand curve to a movement along the demand curve. Higher prices, he is saying, cause the quantity demanded to fall. The demand curve stays put but with a higher price some people are leaving the market. That is why demand curves are downward sloping.

3) Then he writes that “demand for that good should decrease, which should lead to a decline in its price”. He has now mistaken a fall in quantity demanded, a movement along the curve, for a fall in demand, a movement of the entire curve to the left. He has confused a fall in the quantity demanded caused by a rising price with a fall in the level of demand, which is a shift of the entire curve.

This is one of the things I harangue my students about to stop them from making such elementary mistakes. Compare what Piketty wrote with the text of my Free Market Economics where I warn my students against making this absurd but common enough error, at least common enough amongst economic illiterates. From page 100:

Demand versus Quantity Demanded

People often do talk about demand as if it is a specific amount and it is therefore important to make sure that when someone is talking about “demand”, that one is aware of which meaning they have in mind.

Compare these two statements:

(1) if the price goes up demand goes down (and who would deny this is so?)

(2) if demand goes down the price goes down (and similarly, who would deny this?)

This becomes the following conclusion if the two statements are run together:

(3) if the price goes up [demand goes down; if demand goes down] the price goes down.

That is, if the price goes up the price goes down. A higher price is the cause of a lower price. Obvious nonsense, but it comes from using the word “demand” in its two different meanings.

In (1), this is using the word demand to mean a movement along the demand curve when the price happens to rise. In (2), this is using the word demand to mean a shift of the entire demand curve when one of the underlying factors has changed.

It is therefore essential to always make sure which meaning of demand is intended. You can usually tell from the context of what is being said, but the words here are slippery and can lead you into trouble.

This is trouble, all right. I find it absurd that Piketty cannot tell the difference between a shift of the demand curve and a movement along the demand curve.

To trust anyone’s economic judgment on serious economic matters who makes such a fundamental error would be ridiculous. He has 650 pages of stats and data but almost literally doesn’t know the first thing about economic theory?

The sentiment of a large majority of the active business community

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Reading classical economics for me is to be in the company of economists who understood how economies worked. I have of late been reading Simon Newcomb’s “The Problem of Economic Education” which was published in The Quarterly Journal of Economics in July 1893. And what he does is go through the kinds of economic illiteracy that was all too common in the general population of his time, with a decidedly pessimistic view of whether these ideas can ever be eradicated amongst the population in general. And this was even though there was then universal understanding amongst economists about how fallacious these fallacious ideas were. An example:

From the economic point of view, the value of an industry is measured by the utility and cheapness of its products. From the popular point of view, utility is nearly lost sight of. . . . The benefit is supposed to be measured by the number of laborers and the sum total of wages which can be gained by pursuing the industry. . . . Here legislation only reflects the sentiment of a large majority of the active business community. A man’s economic usefulness to society is supposed to be measured by his expenditure of money and consumption of goods. He who spends freely is pointed out as a benefactor; while the miser, who invests his income, is looked upon as a selfish being, mindful only of his own aggrandizement. (p. 7)

Well, that was in 1893 for goodness sake. Who today would think spending is good and saving bad? From The Australian today:

CLIVE Palmer wants the age at which Australians can access their superannuation lowered, saying it will boost domestic demand for goods and services and increase economic growth. . . .

“I think we should be allowing people to access their super at 50 if they want to.

“It’s up to them, it’s their savings … we want to get that money released from the super funds.”

On this, Newcomb wasn’t even close to being pessimistic enough. Now, and since 1936, even economists think saving is a bad thing and spending is good.

The case for capitalism

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I have just received through the post a first edition copy of Hartley Withers, The Case for Capitalism. The preface is found below but comes with this one warning which to modern sensibilities can set them off in every direction but towards trying to understand what the author was saying. This was written when the most wealthy countries in the world were the capitalist economies of the British Isles, northern Europe, North America along with Australia and New Zealand. His reference to the Anglo-Saxon nations only refers to their social and economic organisations which anyone else is free to adopt, as some have since the 1920s, with exactly the results he describes. But the effect is moral rather than just economic since, as he makes clear, people who are challenged to do their best become better people. This is a moral statement even more than an economic. Written in 1920 just after the Russian Revolution, the book has not lost a beat in its ability to articulate why free enterprise is beyond all doubt the only system capable of providing prosperity and human freedom, not just together but you cannot have either without a free market economy in place.

PREFACE

To make a better world we want better men and women. No reform of laws and institutions and economic systems will bring it unless it produces them. Institutions and systems that turn men and women into machines working under the control of officials or of monopolies will not make them better even if, as is very far from likely, they make them better off. It is only through facing life’s problems for ourselves, making our own mistakes and scoring our own hits, that we can train and hammer ourselves into something better. Individual freedom, initiative and enterprise, have been the life-blood of the Anglo-Saxon nations and have made it what it is, pre-eminent among the nations of the world because its men and women can think and act for themselves. If we throwaway this heritage because we think that regulation and regimentation will serve us better, we shall do a bad day’s work for ourselves and for human progress. And yet this seems to be the object to which many earnest and sincere reformers are now trying to lead us, when they ask us to accept nationalization of industry or its organization under Guild monopolies, as a remedy for the evils which are evident in our economic system. If they succeed life will cease to be an adventure and become a drill; the tendency to variation which, as science teaches us, is the secret of development, will be killed or checked, and we shall be standardized, like Government boots.

This book is written to show that the greater output of goods and services on which material progress depends cannot be expected with certainty under any form of Socialism that has yet been proposed; that Capitalism, though a certain amount of robbery goes on in its backyard, does not itself rob anybody, but has wrought great benefits for all classes; and that, if improved and expanded as it may be without any sudden change in human nature such as other systems demand, it may earn for us the great material advance that is needed to provide us with a better, nobler, and more beautiful world.

HARTLEY WITHERS.

London, January 1920.

Piketty and scientific fraud

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scientific method phd comics

The diagram above works just as well for climate change as it does for almost every left-of-centre political meme based on some kind of scientific conclusion. But I mention it because of Piketty and his apparently fraudulent data on income distribution. It doesn’t surprise me that hiding the decline is a universal practice on the left. But the real issue is that it should not matter.

You have to be ignorant as the day is long not to know that capitalism has made us wealthy beyond all possible expectation, even going back thirty years never mind three hundred. We now have a vast number of people who do not work because we produce at such a prodigious rate that it just doesn’t require more than about a quarter of the working population to produce enough for us to maintain a 1950s and better lifestyle for those who choose not to bother actually earning an income. In our society who hasn’t got a phone, a car, a colour TV, enough to eat, clothes to wear and a place to live. There are always people on the fringe who circumstances have dealt a bad card, but really we are beyond any issue of deprivation that had existed for the entire course of human history up until say around that same 1950s mark.

So Piketty lied. The people who line up behind the book will care about that as much as they did about Climategate. It is about power and wealth, with the facts of the case as close to a non-issue as it is possible to be. The only interesting question about wealth distribution to these people is that they would like more of our wealth distributed to themselves.

A policy experiment in the South Pacific

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Apparently we ran an experiment in economic policy here in the South Pacific which is described here:

[New Zealand] Treasurer Bill English said last week that he would cut public spending as a share of gross domestic product by more than twice as much as the Abbott government has announced.

In fact, without a minerals boom to line government coffers and despite a huge repair bill from two devastating earthquakes, New Zealand’s budget will be back in surplus by $NZ400 million ($370m) next financial year, rising to $NZ3.5bn by 2018.

English, now in his sixth year as New Zealand’s Treasurer, commendably chose not to emulate the world’s greatest treasurer Wayne Swan and kept a tight leash on public spending before and after the global financial crisis, preferring to cut income taxes and lift consumption tax. The Key government, facing election again later this year, is now reaping the rewards.

It wasn’t just our Wayne who took this road to ruin. Virtually everywhere was the same, with the US leading the way into an economic darkness it is impossible to see ending any time soon. But try to tell someone that Y=C+I+G is an economic death trap. But if you doubt it, look at the comparison with Australia.

The culmination of almost two decades of mainly populist budgets, the Abbott government will spend $6200 a person on cash welfare next year, over 25 per cent more than New Zealand’s government will on each of its citizens (converting all amounts to Australian dollars).

Education spending, at $2900 a person, is 10 per cent more generous in Australia but health expenditure is torrential by comparison: Australian state and federal governments will lavish more than $4600 a person to keep Australians alive and healthy, almost 50 per cent more than is spent in New Zealand. No methodological quibble could bridge such stark differences.

The relative splurge extends to hiring, too. Australia’s population of 23.5 million is about 5.2 times New Zealand’s, but as of June last year we had 8.4 times as many public servants: 1.89 million across our state, federal and local governments compared with New Zealand’s 226,000. . . .

Apart from a bloated public sector and a wellspring of whingeing, what does Australia get for its vastly more indulgent public spending? Much higher taxes, for one thing. The marginal income rate most Australians will pay from July — 34.5 per cent — will be higher even than New Zealand’s top 33 per cent rate, which makes a mockery of our 49 per cent top rate, which will be higher than China’s and France’s.

Undisciplined government spending will pull an economy into the dust. Such spending is a disaster both economically and then politically as governments try to pull things right.

And then there is also the delusion that low interest rates will propel an economy upwards, yet another Keynesian bequest.

Even rising interest rates have been unable to dent record high confidence levels among New Zealand households and businesses.

There is no “even” about it. High interest rates, or at least high enough to shut non-productive borrowers out of the money market, are a major factor in keeping an economy on track and growing. Economic theory today is comparable to the theories Adam Smith was writing about criticising in 1776 if not actually worse.

A skill testing question in economics from 1886

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The mail has just brought me my own copy of Simon Newcomb’s great 1886 economics text, Principles of Political Economy. Just for fun, I offer you one of the questions at the end of one of the chapters that no modern student of economics ever gets asked or would likely have a ready answer to.

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

Even the notion of a frugal population is pretty antique. But all the difference in the world lies in the answer to that question.

How not to reform economics

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Even though I end up disagreeing with what he wrote, Tim Thornton had a quite interesting article in The Age the other day which I have just written a comment on for Quadrant Online. His article was on “The Problem in the Way we Teach Economics” which led to my own response, The Real Problem In Teaching Economics. But Tim’s article is not really about what we teach but about the nature of textbook economic theory, and going on from there, deals with the kinds of economists our way of teaching economics produces. He lists three problems:

Firstly, there is generally no required study of economic history or the history of economic thought. . . .

Secondly, contemporary economics students will rarely encounter any of the schools that compete with the neoclassical school. . . .

Thirdly, the curriculum fails to incorporate crucial insights offered by other disciplines such as politics, philosophy, history, sociology and psychology.

Fair enough. But what Tim wants to do, if he cannot get satisfaction from the mainstream, is start up an alternate school from which a new generation of economists can be grown. And given that he wants to call his new discipline “political economy”, there is little doubt from whence he is coming. As I write at QoL:

Typically, those who would like to root out our modern neo-classical inheritance do so for some quasi-Marxist reason. They are seeking answers to different questions. Their interest is in explaining the distribution of power within a society. This is, of course, politics or sociology, but it is not economics, since even if you knew the answer to any of the questions a political scientist or sociologist might ask, you still wouldn’t understand how goods ended up being produced, what economic structures give you the greatest output, how the community’s command over goods and services could be increased, what to do in recessions, or even what causes recessions in the first place. Instead, what would be taught is some variant on the unfairness of the system and how it needs to change to ensure those who have the least wealth, which typically means those who have contributed the least to our communal flow of goods and services, can get a larger share of the pie.

There is all too much so-called economics around at the moment which presupposes capitalist growth and economic prosperity from which it seeks to extract some kind of rent on behalf of some nominated favourite group. But if they do not understand as a matter of first principles that the only way to run an economy is to have private entrepreneurs running their individual businesses, with as little government interference as possible in what they do or how much they earn, they have no genuine solutions to any actually existing economic problem. So far as understanding how an economy works, it is not only hard to see any value in shifting in the kinds of directions they propose, it is quite easy to see quite a bit of harm.

Das Kapital in the Twenty-First Century

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The issue of inequality of wealth is the last refuge of the left. All of the other issues raised through the years – the immiseration of the working class, the crisis of capitalism, world revolution etc – have come to nothing. There is not a single issue raised by the left that has ever had any historical validity, Inequality is the last baton to beat the drum with and they are beating it as hard as they can.

Capital in the Twenty-First Century by Thomas Piketty written in French and now translated into English has weight of pages to compensate for the weightlessness of the argument. The politics of envy are an old story.

Cass Sunstein discusses the book under the quite sensible heading, What’s so wrong with economic inequality? What’s wrong, indeed?

Inequality of wealth is almost irrelevant to the core issue of production and income. Take the example of someone building and then owning an apartment building with 100 apartments put out to rent. If you want to look at it in terms of inequality of wealth, one person owns 100% of the capital and the, let us say 100 renters, have no capital. But the 100 renters also have a place to live, and if there are other apartments available to hold down rents, where’s the problem? As Sunstein writes:

Thomas Piketty’s improbable best-seller, Capital in the Twenty-First Century, has put the question of economic inequality into sharp relief. As just about everyone now knows, Piketty contends that over the next century, inequality is likely to grow. In response, he outlines a series of policies designed to reduce wealth at the very top of society, including a progressive income tax and a global wealth tax.

But Piketty says surprisingly little about why economic inequality, as such, is a problem. He places a lot of reliance on his epigraph, which comes from France’s Declaration of the Rights of Man and the Citizen: “Social distinctions may be founded only upon the general good.” To say the least, that is a highly controversial proposition. With respect to economic disparities, nothing of the kind can be found in the US Constitution, or the Universal Declaration of Human Rights, or even the International Covenant on Economic, Social and Cultural Rights.

The entrepreneurial drive is like any human trait, unequally distributed across the population. But like many other social abilities, it is good for us all that some few amongst us have them. That some who have such abilities get rich as a result is no different than the wealth that can come to actors, athletes, writers and others. But in this case, the benefits to the rest of us are so immense, our gratitude should be boundless. Alas, the politics and economics of envy never rests.