Category Archives: Economic theory and policy

The Venezuelan experiment – proving what everyone already knew

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The Venezuelan experience is an example endlessly repeated about how the politics of resentment, the natural home for the socialist ethos, leads to ruin for everyone within such communities, aside from its political leaders or their friends. And so Venezuela, which is an example in so many different ways, but here we are looking only at price control:

Two years before his death, Hugo Chavez tried to repeal the law of supply and demand. . . . Chavez despised the law because he believed it robbed the poor and unjustly profited producers. . . .

In its place, he persuaded the Venezuelan legislature to enact the 2011 Law on Fair Costs and Prices, a price-setting mechanism to ensure greater social justice. A newly created National Superintendency of Fair Costs and Prices was empowered to establish fair prices at both the wholesale and retail levels. More than 500,000 price edicts have been issued. Companies that violate these price controls are subject to fines, seizures and expropriation.

And the results. This is from The Guardian who may report but being good leftists probably don’t really understand what’s gone wrong:

“Battling food shortages, the Venezuelan government is rolling out a new ID system that is either a grocery loyalty card with extra muscle or the most dramatic step yet towards rationing in Venezuela, depending on who is describing it. . . .

Registration begins at more than 100 government-run supermarkets across the country on Tuesday and working-class shoppers – who sometimes endure hours-long queues at the stores to buy cut-price groceries – are welcoming the plan.

“The rich people have things all hoarded away, and they pull the strings,” said Juan Rodriguez, who waited two hours to enter the government-run Abastos Bicentenario supermarket near downtown Caracas on Monday, then waited three hours more to check out….

Patrons will register with their fingerprints, and the new ID card will be linked to a computer system that monitors purchases. The food minister, Félix Osorio, said it will sound an alarm when it detects suspicious purchasing patterns, barring people from buying the same goods every day.

Re The Guardian story, what is most revealing of all is its last para:

Defenders of Venezuela’s socialist government say price controls imposed by the late President Hugo Chávez help poor people lead more dignified lives, and the United Nations has recognised Venezuela’s success in eradicating hunger.

Do you think the idiot who wrote this story and ended it this way has learned a thing. He lives somewhere else but in spite of the evidence he has reported still thinks what Chavez did helped the poor. With morons like this around, the next Venezuela is just around the corner.

Keynes and the coming Chinese recession

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I realise I haven’t been haranguing you about the menace of Keynesian economics for a while so thought I’d remind you of its enduring horrors as there is unanimous agreement that Australia has to get its fiscal house in order. The origins of that disorder are, of course, in the Keynesian policies put in place during the GFC. Just hearing about Kevin Rudd’s 48-hour decision process for the pink batt adventure is a reminder of just how useless, in terms of productivity and real growth, almost all government spending is. A perfect paradigm example. Past the first ten percent, government spending is unproductive whatever other benefits there may or may not be.

As for a recantation from the economics community, not so much as a word. You do have to wonder if they are ever going to get it right. And if they don’t get it right, how policy is ever going to get it right. The latest episode of wrongheaded analysis shows up on the ABC with this story not about Australia but about China. Apparently the problem with the Chinese economy is debt:

In recent times, the boom has been sustained by an explosion in lending by banks and so-called “shadow banks”. If the current scale of lending proves to be unsustainable, could that end the boom and result in China becoming the next country to succumb to the impact of unproductive debt? [my bolding]

Ah, “unproductive debt”! What, pray tell, is that? It is, in fact, exactly what every pre-Keynesian classical economist warned against. It’s spending on non-value-adding forms of production, the usual object of government spending in virtually every one of its forms. There it is, the problem right before their eyes but invisible all the same. Whether one thinks of it in money terms, so that debt is taken on for forms of production which ultimately do not earn sufficient revenue to repay what is owed, or it is thought of it as using up productive resources in ways which do not replace the capital that has gone into that particular form of production, one way or the other the economy is going backwards and not ahead. Keynesian economics is poison but who’s to know? This is what the Chinese did:

The program clearly lays out how the Chinese leadership responded to the prospect of a global financial crisis and possibility of a world-wide depression. The response focused on a spending and investment program carried out on a scale never seen before in human history. Over the past five years, a new skyscraper has been built every five days in China – along with 30 new airports and 26,000 miles of motorways.

Well there was certainly an enormous quantum of resources used up which, incidentally, also happens in highly productive investments. In this case, however, there are the office building, there are the roads, there are the airports, but none of them will generate the revenue to repay their costs. A Keynesian program to the back teeth with predictable results, or at least predictable if you start with Say’s Law. Starting from Keynes it is all a mystery with no explanation. And where do they think it will end up:

Interviewing key players including former American Treasury Secretary Henry Paulson, former Chairman of the Financial Services Authority Lord Adair Turner and Charlene Chu, a leading Chinese banking analyst, reporter Robert Peston reveals how China’s extraordinary spending has left the country with levels of debt that many believe can only result in an economic crash with untold consequences for the world – particularly resource-driven economies like Australia.

If you thought the last five years were bad, apparently the next five will be even worse. Meantime, ending the reign of Keynes and return to classical economic theory would be a start in even understanding what’s going on never mind actually getting our economies untracked.

Parkinsons’s disease

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If you keep a Keynesian as Treasury secretary you are going to get Keynesian advice. If you take advice from a Keynesian, you will never get the economy working properly again.

I have just seen this story at Andrew Bolt and it is a report of a speech given by the Treasury Secretary, Martin Parkinson, on what the government needs to do. Here is how it starts.

Treasury boss Martin Parkinson says the goods and services tax will have to be boosted or broadened if the budget is to have any hope of returning to surplus.

He must be from the same school of advisors who told the first President Bush to break his “no new taxes” promise. Paying for public service waste with higher tax revenues is both an economic loser and even worse, a political loser.

Stop fixating on the deficit. Do the specific things that make the economy work better. Lower public spending. Reduce regulation. Fix up IR. Encourage private industry in every way you can.

If you start raising taxes you will be out on your ear at the next election.

Balanced budget amendment

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It is good to see that at least someone notices the problems with deficits and public spending even if economists are not amongst them. It appears that some kind of critical mass may have taken place in the United States over whether enough states have passed a balanced budget amendment that must lead to a constitutional convention which will determine whether or not the federal government of the United States must by constitutional law maintain a balanced budget. The article is titled, Balanced budget convention gains steam as congressman calls for official evaluation and this is how it begins:

Rep. Duncan Hunter on Tuesday asked Congress to evaluate whether enough states have officially called for a constitutional convention to propose a balanced budget amendment — marking the next step toward what could be an historic gathering.

Mr. Hunter, California Republican, said Congress should take stock of where things stand after Michigan last week approved an official call for a balanced budget amendment convention. According to some analysts, Michigan’s move makes it the 34th state to request a convention.

For something as unconventional as the notion of a balanced budget amendment to have passed at different times and in different states through 34 different legislatures shows there is an understanding of the problems that runaway federal spending has caused. The disasters that have befallen one economy after another due to the insane levels of public spending after the GFC are due almost in their entirety to the spending that followed the financial crisis and not to the crisis itself. But you almost have to be a non-economist even to notice. Economists still think that C+I+G provides them with some form of understanding about what to do in recessions, with no lessons learned from the past five years.

And since we will be having a vote on amending the constitution at our own next election, I cannot see why we shouldn’t include one on a balanced budget as well.

If it’s not in itself value adding don’t do it

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I share Judy’s exasperation at the push for more infrastructure spending which is a code word for more government waste. If it is government spending, it will never repay its costs. Occasionally a government will grab hold of some natural monopoly – Telecom in the old days – from which even with all of the usual incompetence they were able to take in more money than they paid out. But past those few and far between projects, I cannot think of a single instance where governments take on projects which leave us economically better off. So this from The Australian this morning fills me with tremendous foreboding:

Joe Hockey says state treasurers will find it “very hard to resist” a federal proposal to recycle government-owned assets and boost spending on infrastructure.

State treasurers are in Canberra this morning to discuss spending on infrastructure and the carve-up of the good and services tax.

The federal Treasurer expressed optimism about the discussions ahead of today’s meeting.

The Abbott government is pushing for a deal that will unlock billions of dollars from the privatisation of state government assets to be reinvested in significant new infrastructure projects.

It’s understood proposals put to state treasurers will include new incentive payments from the commonwealth which will be linked to qualification deadlines.

“I have no doubt that the states will find it very hard to resist what the commonwealth is prepared to offer them,” Mr Hockey said.

Mr Hockey said the proposal would be “for the recycling of state government assets and investment in new productive infrastructure that is going to create jobs and improve the capacity of the economy”.

Governments do not create jobs. If you believe that government spending leads to an outcome where there are more jobs in an economy than there would have been had the government not indulged in this kind of spending, or that the economy will end up stronger and more productive, you will never understand a thing about how an economy works. And as an added extra, with increased government spending there will be lower real earnings as well. So let me repeat what Judy said below:

The bigger issue is with all this talk of INFRASTRUCTURE, what we are about to witness is just a monumental waste of taxpayer money on politically popular and excessively expensive projects for which there have been inadequate assessments. Just a continuation of Albo, really, who ramped up infrastructure spending from 1 to 2 per cent of GDP.

The disaster that overcame the Victorian economy in the dismal Cain-Kirner years were built on just those same “hollow logs” they thought they could tap into. If it’s not value adding – that is, if it does not pay for itself after every cost is taken into account – it makes us worse off, not better. Call it charity or welfare or whatever else signifies that it draws down on our productivity if you must do it. But for heaven’s sake, don’t pretend it is a contribution to economic growth.

UPDATE: Here is the Treasurer’s press release, Treasurers agree to boost infrastructure.

The Commonwealth’s incentive will be 15 per cent of the assessed value of the proposed asset being sold for capital recycling. If proceeds are used by the States and Territories for the retirement of debt or other purposes, rather than for agreed, new productive infrastructure, they will not be eligible to receive payments under the initiative.

This is an important initiative to remove debilitating infrastructure bottlenecks, stimulate construction and drive real activity in the economy when it is most needed, as investment in the resources sector declines.

Infrastructure Australia estimates that at least $100 billion in commercial infrastructure assets are currently tied up on government balance sheets and could be sold.

The partnerships could overcome the fiscal constraints Governments face to increase the pipeline of projects and improve Australians’ quality of life, tackle congestion, reduce business costs and help firms better link with their employees and customers.

Those who think this will be of the roads-rail-and-sewers variety of expenditure will just have to wait to see what gets floated instead. At least on the up-side, the States will have to sell up various capital assets to private owners to secure the funds so it’s not all bad.

Educated ignorance

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This is about American foreign policy and foreign policy advisors but it is just as true about economics and economists.

Most of these smart young people really don’t know anything. Oh, don’t get me wrong, they had great SATs and went to top schools and have mastered the art of sounding smart, attaining admirable fluency in that unnatural dialect known as Beltway-speak, but as for any deep knowledge about any particular subject relating to how the world really works, that’s about as rare in this crowd as unicorns and Bigfoot. There should be no surprise that Chekists are winning handily these days.

That said, it’s important to note that the ignorance of reality found among our Bright Young Things in DC is hardly their own fault. It can be attributed to their deformed education, especially among those who have studied International Relations, memorizing Game Theory and related unreality when what they needed to be doing was studying languages and history and getting out of the Beltway more.

Experts in game theory, clueless about history and the actual dynamics of the real world. Everything comes back to first principles which are never checked against reality. It is astonishing just how impervious the American foreign policy establishment is to the events of the past few years in the same way that the economic establishment has been impervious to its own disasters of the past few years.

There is then the media who come from the same cohort of over-educated highly intelligent ignoramuses. This is from Rush Limbaugh where I’ve quoted only his first and last lines. You can go to the original to see what comes in between:

I think the mainstream media is pig-ignorant of practically every discipline except party discipline. . . . We talk about low-information voters. We’ve got low-information media, and they are not aware of what they don’t know. They are so arrogant about their all-knowingness that they can’t conceive that they don’t know anything — and, when they encounter it, they’re just flummoxed.

But really, there’s so much going wrong all at once that it’s hard to know either what the problem is or what anyone could do to fix it.

First link via Small Dead Animals

First use of aggregate demand and aggregate supply

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Robin Neill put the following question up on the Societies for the History of Economics (SHOE) list last night:

Colleagues:

Who and when was the terms “aggregate demand” and “aggregate supply” first used?

I have now written both to the list and to Robin. Here is what I wrote to Robin:

Dear Robin

You have put the cat amongst the pigeons with your question, if only they knew. Using superhuman restraint, I did not point out that the use of aggregate demand was forbidden amongst economists precisely because they had all absorbed Say’s Law. If you understand that demand is constituted by supply, then so far as aggregates go, there is no aggregate demand separate from aggregate supply, and anyways, it is the structure of production, i.e. the structure of supply, that matters and not the aggregate. Not that the classics ignored such aggregates. John Stuart Mill was pretty straightforward, but on behalf of the classical view, to wit, “[aggregate] demand for commodities is not demand for labour”. Again a complete contradiction of modern macro. I don’t know if you’ve seen either, but I discuss AD in both my Say’s Law and the Keynesian Revolution and my Free Market Economics. The 2nd ed of FME will be coming out in a few months so if you haven’t seen it yet, I’d wait for that. But in short form, I have argued in every place I can that the introduction of AD was Keynes’s big contribution which has ruined economic theory, macroecvonomics and the theory of the cycle ever since.

And this is what I wrote to SHOE:

The question really is who can take us back before Keynes? So here, from The General Theory page 25:

“Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z = φ(N), which can be called the Aggregate Supply Function. Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D = f(N), which can be called the Aggregate Demand Function.”

And then there is this from page 32:

“The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas.”

I have seen the phrase aggregate demand used before that but in a kind of aimless way. But I am interested in its use prior to 1936 as well.

The examples others have come up have been just as I described, random uses in an aimless way. But now we use AD as the basis for stimulating our economies and are then astonished that the real world does not follow textbook theory. The real world actually does follow textbook theory, but of course you have to use the right textbook.

Down and out in Paris but not London

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The French economy is a mess but what this article alludes to as well is that it is running down its capital so that, at some stage not too far off, the true horrors of its deterioration will finally be fully exposed. It’s titled, Down and out: the French flee a nation in despair. This is the choicest morsel but it is a generally meaty article worth the read:

What went wrong, says Régniez, was a bill passed by the then socialist Lionel Jospin government reducing the working week to 35 hours. “Where our competitors, especially the Germans, saw the need to keep prices and costs down, France spent money she couldn’t afford.” The entire system, he explains, tilted fatally to the side of salary hikes, perks and a lowering of retirement age, in the face of every observable demographic trend. Investment slowed down in the private sector, and almost stopped in the public one. “Each year, France has missed out on four GDP points of capital investment. By now, after a decade-and-a-half, we are not only lagging behind, it’s not certain we can make up for it. It would cost a 4.5 per cent hike in VAT, and other significant hikes in payroll taxes. That, quite simply, is not realistic.”

Even France’s vaunted infrastructures – those trains, roads, telecoms cables, the once ultra-performing electrical grid, the nuclear plants, the delayed 4G network – have taken a severe hit.

A French businessman who moved to London last year and asked not to be quoted by name, “because my tax audit would be even more retaliatory than what I’m currently being subjected to”, compares July’s Brétigny train crash, France’s worst rail disaster in a quarter of a century that killed six and injured 100, to the Paddington and Potters Bar derailments. “The rolling stock is ageing, the tracks are in a constant state of disrepair, even the TGVs now have regular delays because of catenary failure.”

The ageing rolling stock, a metaphor for the entire crumbling stock of productive capital that is being neither updated nor replaced. It’s the story of everywhere right now and it is hard to see how it can be unwound given the institutional obstacles in place. The contrast with the UK is quite astounding because who would have thought that England would, of all things, become one of the strong economies of Europe. Everyone needs a decade of Thatcherism once every ten years.

[Picked up at Smalldeadanimals]

A reply to a reviewer of my DHT

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My comment to a friend who sent me his forthcoming review of Defending the History of Economic Thought. The Feyerabend quote I refer to below is “the history of a science becomes an inseparable part of the science itself . . . essential for its further development a well as giving content to the theories it contains at any particular moment” (Against Method p 21).

Dear Anthony

It’s good to see the book being reviewed and it could not be in better hands than yours. And I have learned quite a number of things about my own book by reading your review. But perhaps because of the battles I have been through I see this differently from you and in the end you do not answer the one question that matters: should HET remain within the economics classification and be counted as a social science or should it be removed to the history and philosophy of science and become part of the humanities? And I also do not know whether you think I have made a useful case for studying HET by an individual or for ensuring that there are historians of economics dotted throughout the discipline to keep the others on their toes.

Economics as we teach it is the shifting outcomes of research agenda with the latest manifestations rising to mainstream textbook level, with all of its history embedded in even these answers, but with many other answers given over the entire history of economic thought still in contention amongst some blocs of economists. You cannot make a physicist or a chemist a better physicist or chemist by teaching them the history of their subject but as your own testimony of your own students shows, you can with economics. The sentence you quote on p viii, for example – that HET is economics in and of itself – is a sentence that is explained in the rest of the para which seems perfectly true to me. Having watched the failure of the stimulus over the past five years, and especially in the United States, you may be sure that every aspect of John Stuart Mill’s statement, that “demand for commodities is not demand for labour”, has been more than confirmed for me. Mill to me is not HET but live theory with genuine real world implications you cannot find in your average textbook although you will find it in mine (Free Market Economics: an Introduction for the General Reader whose title I took from Henry Clay (1916) – have you seen it?).

That HET is both history of economic ideas (HEA) and intellectual history (IH) is clear enough to me but Winch’s example, which I haven’t read so don’t know, would be part of that history and philosophy aspect which is no more than half of HET and probably less. But it is the other half and more – which you capture with the lovely Feyerabend quote which I’d never come across but will use ever after – is also HET and it is that that needs to be preserved and recognised for what it is. So in your terms, I am trying to preserve HEA as a subset of economics but recognise that IH is also part of HET. And if you think Samuelson is part of IH, then what to do with that killer quote, that to be an academic success “you must read the works of the great economists”. This seems completely to be making the point I am making. Indeed, your conclusion on Heyne, which you state that my view is “not incompatible” with his, but what difference does it make for me here since the book is aimed at another issue, which is the need to study HET if one is to be a better economist and the need to keep HET within the economics curriculum if the economic theory itself is to thrive.

In trying to deal with this issue, a major problem I have found with the academic world is that for all the departmental politics that goes on, academics are politically in the wilderness. My days as a lobbyist really did matter. I am trying to put together a book that defends the position of HET which will wither and die if it is relegated to history and philosophy of science. We have the disdain of the mainstream to contend with while even some of our own stellar lights – Margaret Schabas and Roy Weintraub for example – are trying to remove HET in just that direction. What your review has said is that there are two kinds of HET, this one and that one, and that I did not make this distinction well enough. But since you agree that HET is important to the study of economics, which is the first sentence of the intro, why are you not supporting this? Why are you not saying somewhere that Kates is onto something important and even while it might have been better if it had been done in some other way, at least it has been done, and imperfect though it may be, is a welcome addition to the literature. In real politics, finding agreement is the most important part of what we do. In the academic world, unfortunately, finding disagreement is our bread and butter.

Anyway, I am thinking of having a session on my book at the HES in Montreal which I am going to, funding permitting. If you are going to be there as well, would you be interested in being part of a session that discusses the book? It is a funny thing that we in Australia have been so on this issue from the start, which I attribute to John Lodewijks, who has continually stirred us into action. And funny again, there have been enough genuinely politically minded people who have been able to work together to achieve common objectives on a few occasions. I will copy my reply to you to Robert Leonard who is organising the conference. I’m usually quite happy to stand at the back of the room – a speciality for lobbyists – but on the question of the preservation of HET I can see that if I don’t do it there is no one else who will. Maybe there’s no danger and I am over-reacting, but if you look at the story of the European Research Council, which was as recent as 2011, I would not be all that certain that these same troubles might not arise again.

Anyway, I thank you for the review, and specially for the Feyerabend and Samuelson quotes which are perfect for me. Had I known of them, each would have been at the front of some chapter. And I do hope to see you in Montreal.

With kindest best wishes.

Steve

Just don’t do it

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Two articles at opposite ends of today’s AFR both discuss public spending on infrastructure but with a different message from each. There is firstly on the front page, Project spree risks AAA rating ,which begins:

The government’s AAA credit rating may be at risk if it embarks on major infrastructure initiatives before sweeping changes to how projects are funding are made, according to the ­Productivity Commission.

The rest is behind the paywall but the article discusses the views of Peter Harris, the Chairman of the Productivity Commission, who is trying to get the government to think long and hard before it spends our money. Infrastructure is seldom the best use of our resources and before we commit to such spending there needs to be a very thorough cost-benefit analysis undertaken with a real intent to ensure we are getting value for money.

Pet projects have been an ongoing disaster. There is only one reason for a government to enter into such expenditure and that is because there is a net dividend to the economy. If you think, for example, that Building the Education Revolution contributed anything at all to the Australian economy, you should not be making infrastructure judgments. Only if you are able to articulate why the BER was an almost total waste of money and resources could you be trusted to assess our future infrastructure needs.

Then at the back of the paper we have Peter Sheehan with an opinion piece, The new Keynesians: accident or design?. And his point: however it may have come about the Abbott government is about to launch into a Keynesian stimulus which he thinks is a great idea. As he writes:

Strong underlying growth cannot be assumed. The Keynesian response is clear: there needs to be a major program of infrastructure investment. This should be large-scale additional spending of 1.5 per cent to 2 per cent of GDP a year for five years.

If the government listens to this kind of thing they will end up as bad as Labor. They should dwell instead on this before they start spending money as if we are in some deep depression, also from today’s AFR:

Employment jumped in February by the most in almost two years, led by an oversized 80,500 surge in full-time work, Australian Bureau of Statistics data shows.

Some small part of government spending is productive, some is necessary because it provides assistance to those who are in need, but for the most part government spending is a drag on the economy not a stimulus. Cut the deficit. Get unions out of the road. Reduce unnecessary regulation. And leave recovery to the private sector which is already starting the process we need to continue along.