Economic policy for idiots

Here’s a misleading headline: Interest rate cuts causing pain for no substantial gain. The reality is that interest rate cuts have done substantial harm to the economy, but at least people are beginning to see just how harmful these cuts have been.

The letter challenges the central bank’s strategy as it struggles to meet its inflation target and follows a groundswell of disquiet with the direction of monetary policy — including from former treasurer Peter Costelloformer RBA governor Ian Macfarlane and a trio of Liberal backbenchers.

The cuts have also sparked alarm for reigniting house prices in Sydney and Melbourne without boosting economic growth, or household or business confidence.

Mr Costello — Nine chairman — said record low interest rates and tax cuts had failed to stimulate consumer spending, which had hit advertising spending.

It’s this modern macroeconomic junk science that never ever gets anything right. I will again mention my Free Market Economics, Third Edition An Introduction for the General Reader where in its final two chapters sets out the flaws in Keynesian monetary policy as clear as you might like. Keynesian economics has evolved into the modern form of socialism, giving blanket approval to public spending, massive deficits and incompetent monetary policy. Think how incredible it is that the approaches taken to fix the Global Financial Crisis have never worked in a single instance in any country in the world. For an abbreviated version of all of this see The Dangerous Persistence of Keynesian Economics which begins with these two quotes:

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.
—Steven Kates, Quadrant, March 2009
Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?
—Question to Steven Kates from Senator Doug Cameron, Senate Economic References Committee, September 21, 2009

Great question. For the answer see my text. I might also mention that I have just sent off to the publisher my “Classical Economics for the Modern Economy” but that won’t be around till next year. But these central bankers and Treasury economists do only harm every time they touch the economy. And just for the record, infrastructure spending, beyond a minimum – and we are well beyond that minimum – will only make things worse.

The basis for value

For a Keynesian, value is determined by demand. For classical economists it is production costs in relation to scarcity that determines the exchange value of a good or service.

More to the point, however, do they mean value in use or value in exchange? Unless you know, both the question and the answer are meaningless.

And as for the answers given, the one thing that never determines exchange value are consumers by themselves. Ever seen a supply curve?

Classical economics explained by someone who thinks classical economic theory was the most accurate economic theory ever devised

I have finally submitted the manuscript for my Summary and Translation of Classical Economic Theory into a format that can be read by a modern economist. This is part of the note that went with the submission.

I think and hope I have now completed everything I need to do to submit my manuscript. I have adjusted the title, but am still looking for something that really says in compact form what I mean, which is that if you want to understand how an economy works, you will have to return to the economic theories of the classical economists. That is what the book is about, plus also being about how to understand a classical text since one must first work through how economic terminology has changed since classical times. If you read the word “saving” as a Keynesian does, you will not only not understand a classical text, you will also not be able to make sense of how an economy works.

The embedded notion that is almost explicit in the text is that only by understanding classical economic theory can one understand how an economy works, which also says, and the text discusses, that you cannot understand the operation of an economy using mainstream theory, any version of socialist economic theory, New Classical economics, Austrian economics or, for that matter, the economic theories of the early classical economists, such as Adam Smith and David Ricardo.

It is only with the publication of John Stuart Mill’s Principles in 1848, and then from within his last edition published during his lifetime in 1871, can one discover the actual operation of an economy. What that theory is no one any longer knows, other than a few specialists who number fewer than 100 across the world. And then, amongst those, there is oddly only a single one who believes that Mill’s text is the lost ideal of economic theory. I perfectly well understand how ridiculous it is to believe any such thing, but I do. The classicals laid it all out before the arrival of the Marginal Revolution which turned economics from the supply side to the demand side. But what has completely collapsed economic theory as a sound means to make sense of an economy was the advent of the Keynesian Revolution in the decade after the publication of The General Theory in 1936, where not only was everything overturned, but a new set of technical terms was introduced whose use makes a classical text all but incomprehensible to a modern economist. You will need my text to understand classical economic theory. You cannot do it on your own since you won’t know either the meaning of the terms or the presuppositions that underpinned the theory.

Our economies have managed, but only just, to maintain the role of the entrepreneur in directing our private sector firms, but the pretence found in modern macro that public spending – G – is as productive or as value-adding as private investment – I – is tearing our economies down, with no understanding of what is happening, least of all among our economists. That capitalists have been transformed into crony capitalists, who are now among the major welfare recipients taken from the massive tax revenues collected by governments, is a large part of the problem. What to do is hard to say, but first the problem needs to be recognised. That is what this book attempts to do.

A book on economics for people who want to understand how an economy actually works

Part of a note I wrote to a friend about the completion of my manuscript on classical economic theory.

I will also just mention that I have finally, only yesterday, finished my manuscript on classical theory. I will send it off to the publisher on Monday. For your interest, this is the Table of Contents.

Chapter 1: The Purpose of this Book and Why Only I could Write It

Appendix 1: John Stuart Mill. “Of the Influence of Production on Consumption”
Appendix 2: The Dangerous Persistence of Keynesian Economics

Chapter 2: The Background
Chapter 3: The Keynesian Revolution and Classical Theory
Chapter 4: Understanding Classical Presuppositions, Terminology and Concepts
Chapter 5: The Classical Theory of Value and the Marginal Revolution
Chapter 6: Keynesian Theory Overruns the Classics
Chapter 7: The Basis for Keynes’s Success: Why Keynes was Able to Succeed
Chapter 8: Classical Theory and the Role of Government
Chapter 9: Austrian Economics and Classical
Chapter 10: An Overview of Classical Economic Theory

An accurate title still eludes me. It needs to say in concise form something like: “Economic Theory Reached its Peak with the Economics of John Stuart Mill and has since been Subverted Firstly by the Marginal Revolution and then by the Keynesian Revolution Leaving Behind a Useless Husk of Empty Nonsensical Theory that Provide Virtually Nothing of Value in Framing Policy”. If you know what I mean. It also strikes me, now that I have looked over at the Table of Contents, that I don’t there mention Say’s Law, but you need have no fear that the book leaves it out.

And this is a note to another friend telling him the same news.

I have finished off my manuscript on Classical Economics for Idiots which cannot be the final title, unfortunately. It is far and away the best thing I have written as I judge things. It will also be the last thing I ever write that will be as polished as this one is, since I found this such a grinding process. Here, at least every time I thought of some addition that needed to go into it, I still had the will and strength to do the work. On the printed out draft I handwrote the following which I think is true:

“There is no doubt that if you read the book you will be convinced there is something to what is said. The challenge for me is to get you to read the book.”

What gives the book its value is that I have classical economic theory as the frame against which modern theory can be judged. Other than Austrian or Marxist theory, there is no other frame of reference available. I have now thus added a third frame of reference into the mix and in my view, the most accurate frame of reference from which to see what’s wrong with modern theory since classical theory was the theory that existed when capitalism was new and fresh and where an understanding of how a market economy operates reached its peak. I can only say how happy I am to have finally finished the manuscript. Now I have to work out, as I wrote above, a way to get others to read it. Getting them to believe it will be a bridge or two too far.

Hayek v. Mises

Sinclair’s post and the John Papola video on Mises v Marx was a really interesting but I doubt will have the same penetration as did his early video on Keynes v Hayek. This continues to provide some kind of ground for understanding the economic policies of our time, and the disasters of a demand-side approach to managing an economy. Central banks are now the major carriers of the disease.

As it happens I am in the last stages of completing my manuscript on Classical Economics and what is needed for a modern economist to follow the classics, which studying modern theory makes virtually impossible. This is the draft opening to the chapter on Austrian economic theory for your interest. Comments welcome.

Although Carl Menger initiated the Marginal Revolution with the intent to find a unified theory of value, the names now most closely associated with the Austrian School are Friedrich Hayek and Ludwig von Mises. And while both are seen from a distance as almost one and the same, up close they were quite different from each other. There are many ways to highlight their differences, but here their approaches will be compared through their attitudes to John Stuart Mill, since both specifically identified themselves with the classical liberal tradition.

Where it matters is in the social aims an economist might hold. The essence of Mill’s approach to economic theory was to attempt to answer the question, what ought to be done to create the greatest amount of good for the greatest number of people? Uppermost in his mind was the question of what can be done to raise the living standards and economic wellbeing of the individual members of the community. Yet while he called himself a “socialist”, it was the kind of socialism that by today’s standards would have had him grouped among the most market-oriented political theorists of the present day. In particular, he would find modern macroeconomic theory, and the policy matrix that accompanies its Keynesian basis, completely false. While he saw a definite role for government involvement in the economy, the basic framework was that everything that can be left to the market should be, while also understanding that not everything can be left to the market. He saw a clear but limited role for government regulation.

Hayek’s approach is similar to Mill’s (and I would say my own). Hayek discusses the economics prior to the publication of Menger’s Principles of Economics in 1871, noting that this was only “a mere twenty-three years since the great restatement of classical economics by John Stuart Mill (Hayek 1992: 96-97). He continues:

“It is important for proper appreciation of Menger, that we do not underestimate what had been achieved before. It is misleading to think of the preceding period, 1820-1870, as simply dominated by Ricardian orthodoxy. At least in the first generation after Ricardo there had been plenty of new ideas. Both within the body of classical economics as finally expounded by John Stuart Mill and even more outside it there had been accumulated an array of tools of analysis from which later generations were able to build an elaborate and coherent structure of theory after the concept of marginal utility provided the basis of the unification. If ever there was a time in which a quasi-Ricardian orthodoxy was dominant, it was after John Stuart Mill had so persuasively restated it. Yet even his Principles contain very important developments which go far beyond Ricardo. (ibid.: 97)

The point was that Mill had provided much of the raw material that the marginalists had been able to consolidate into a more unified whole. Hayek stops to state that

“It is indeed quite difficult to understand how a scholar of the penetration and transparent intellectual honesty of John Stuart Mill could have singled out what was so soon felt to be the weakest part of his system for the confident assertion that ‘there is nothing in the laws of value which remain for the present or any future writer to clear up; the theory of the subject is complete.” (ibid.: 98)

That Mill, the greatest utilitarian scholar of his generation, had no interest in making utility the core of his own theory of value may have been a conundrum to Hayek, although it might also have suggested that utility had been considered by Mill but then rejected. Yet the core point here is that there is no question that Hayek had a profound and extremely high regard for the economics of Mill, self-proclaimed “socialist” though he may have been. This is opposite to the attitude taken by Mises.

The economics of Mises is astonishingly detailed and profound. But what makes his approach so austere is its narrow focus on economic issues almost entirely outside the social and political arena. Hayek, like Mill, was continuously thinking through how economic conditions could be improved using as many arms as policy as possible, while always understanding the limits that are placed on the various possibilities available by the laws of gravity of economic theory which forbid various approaches to be adopted. Mises, on the other hand, thought that only an absolutely rigid adoption of market-based economic theory was acceptable. And unlike Mill, who even in 1848 could see how economic policies would be constrained by popular pressures to alleviate economic pressures and to use governments to temper economic outcomes, Mises accepts no compromise with the hard-edge views of how a market economy must operate. Here he discusses his views of John Stuart Mill in his Liberalism in the Classical Tradition (Mises 1985).

“John Stuart Mill is an epigone of classical liberalism and, especially in his later years, under the influence of his wife, full of feeble compromises. He slips slowly into socialism and is the originator of the thoughtless confounding of liberal and socialist ideas that led to the decline of English liberalism and to the undermining of the living standards of the English people. Nevertheless – or perhaps precisely because of this – one must become acquainted with Mill’s principal writings:

Principles of Political Economy ˆ(1848)
On Liberty (1859)
Utilitarianism (1862)

“Without a thorough study of Mill it is impossible to understand the events of the last two generations. For Mill is the great advocate of socialism. All the arguments that could be advanced in favor of socialism are elaborated by him with loving care. In comparison with Mill all other socialist writers – even Marx, Engles and Lassalle – are scarcely of any importance.” (Mises 1985: 195)

An indication of how adamantine Mises’s political judgements are may be recognised in the following comment from the preface he wrote for Liberalism in 1962.

“In England the term ‘liberal’ is mostly used to signify a program that only in details differs from the totalitarianism of the socialists.” (ibid.: xvi)

At any rate, no actual socialists have ever cited Mill as the source of their views on how an economy ought to be managed. Yet Mises’s concerns over the drift of economic theory and government policy remain a vivid warning of how dangerous economic theory has become, both economically and politically.

The illegitimate spawn of a relic from the Great Depression

From Judy yesterday: A Keynesian solution even Keynes would have tossed. A program Keynes came up with during the Great Depression when unemployment was 25% is still being applied by moron economists 80+ years later who are ruining our economies while rewarding their friends. Crony capitalism is the illegitimate spawn of a depression level theory, that was useless even back then. She begins:

I thought active demand management or fine-tuning the economy had gone out with the ark — or, to be more precise, in the 1970s. Stagflation — high rates of unemployment and inflation — put paid to that party trick.

Of course, the idea of central authorities or governments controlling the pace and nature of economic growth was preposterous. Mind you, you could understand the reasons for this naive belief, particularly among those affected by the hardships associated with the 30s Depression.

Now the only people who come out ahead are millionaire recipients of the money paid out for the various projects governments come up with. Judy again:

And let’s not forget the waste in so much government spending. Can anyone forget the fiasco of the pink batts scheme: four deaths, and hundreds of millions of dollars to remediate the problems? Or what about the school halls program where the cost of building the new structures was at least 20 per cent greater than the efficient price?

Value for money from government! The idea is as nonsensical as it gets.

I also liked this from David in the comments, of which everything he says is true:

I’m not expert but it is one of the great ironies of world economics to me that the 1980’s were spent identifying inflation as the enemy of the economy and taking all measures possible to lower it and now the world experts want inflation back and can’t get it. What is more when it was at its highest most governments quietly changed the method of measuring inflation so now we have the position where officialdom says inflation is low but we in the streets who go to buy anything know how prices have risen considerably if not dramatically in many areas. But they are doing so without increase in real production the secret to any good economy.

I will finish off with a bit more from Judy:

Then there are the many ill-­educated media commentators and finance sector “economists” who dismiss concerns about ongoing budget deficits and rising government debt. The government must take action, according to this tribe. Clearly, they never understood anything beyond Macroeconomics 101.

And for myself, it would make hardly any difference had they gone on to graduate school since almost everything now taught in an economics course is valueless bilge.

Distributing incomes to match what each of us deserves

I received a very kind note from someone I had spoken with at the Historians of Economics conference the other day which I had discussed here. She sent me two articles, one from the economist Greg Mankiw, and the other from a philosopher, Peter Bauman. Mankiw was trying to justify the distribution of income in a market economy, and the philosopher, oddly, was almost trying to defend Mankiw. Neither, however, satisfied me, so this is what I wrote back.

Had a quick read of the two articles. Mankiw was such superficial nonsense I could barely stand it. I was pleased that the reply by the philosopher picked out some of what I thought. It was not what I thought you had meant since we were talking about pricing in a market economy, which does have a major ethical dimension since if you try to manage an economy without using the market mechanism you end up like Venezuela. Not understanding that and having such folly turned into national policy has left millions destitute and in the hands of tyrants everywhere.

As for distribution of income, the core issue of an economy is how do you get people to undertake the various jobs that need to be done, such as cleaning blocked sewage pipes. And then if you are looking at questions like how do we make economies grow and how do we get innovation, well there are additional questions that need to be answered.

As a first approximation, which you may not like, as I was reading the articles, it occurred to me that the greatest injustice – far beyond anything related to incomes – is the injustice that the teams each of us follow almost never win the Grand Final. Some people therefore get fantastic pleasure in life while the rest of us have to get by supporting losing teams, often for years and years on end. Seems very unfair to me. You may not think that is much of an analogy, but it is closer than you think. As Bauman was trying to point out, the nature of the world makes it difficult to relate economic contribution to reward.

I see all those folks who read Marx when he was first published for whom nothing could have even possibly been done at the time to make their lives one tenth more prosperous and less difficult than lives turned out to be half a century later, although these were different lives. And lives became even better half a century after that by 1960, and then half a century later we are where we are today, living much better than anyone in the 1860s. And still so many are dissatisfied. Income distribution is a misery index with no practical value since however you slice it, the distribution of income in a market economy is closely related to the production of goods and services. Disturb the first and you disturb the second, and not only is no one better off, but tens of millions become much worse off. Did I mention Venezuela?

The politics of envy has ruined more lives than almost any other human trait, other than the lust for power.

The RBA is run by incompetents

Really beyond stupid. Purely destructive, but I suppose you can’t expect them to know any better since they are all students of modern macro: RBA cuts official cash rate to 0.75pc at October meeting. They continue with all of their economic insanity expecting that the next time it will work out. Pathetic.

I am running a seminar here at the University tomorrow about which I have sent a note to the History of Economics discussion thread in response to a book review just published praising some tract commemorating the 80th anniversary of the publication of Keynes’s General Theory. Let me firstly just remind you that Keynes was the source of this stupidity that lower rates will stimulate growth. No classical economist ever believed anything so nonsensical This is what I sent.

I hope I will be forgiven for buying into this but it does astonish me that with an unbroken record of failure going back to the 1920s that Keynesian economics continues to hold such allegiance among economists. Is there no one who will rid us of this turbulent presence? And perhaps it is only because I am about to present a seminar to our own School here in Melbourne that I find myself once again so irritated by reading of yet another volume of praise heaped on Keynesian theory, now refined into post-Keynesian, but Keynesian all the same. Let me just add these to the discussion.

First, it’s not as if pubic spending didn’t have a constituency before Keynes, and yet, when it was tried, it turns out that the “Treasury View” was absolutely correct, and has been every time “fiscal stimulation” has been tried – see the GFC for the latest example. Winston Churchill was the British Chancellor of the Exchequer and this is from 1929, from well before the stock market crash in October.

“Churchill pointed to recent government expenditure on public works such as housing, roads, telephones, electricity supply, and agricultural development, and concluded that, although expenditure for these purposes had been justified:

‘For the purposes of curing unemployment the results have certainly been disappointing. They are, in fact, so meagre as to lend considerable colour to the orthodox Treasury doctrine which has been steadfastly held that, whatever might be the political or social advantages, very little additional employment and no permanent additional employment can in fact and as a general rule be created by State borrowing and State expenditure.’” (Peden 1996: 69-70)

There is then this not-very-well-known quote from Keynes’s post-humus article in The Economic Journal from 1946, at least not well-known enough. That he was said to have stated that “I am not a Keynesian” is easy to believe when you see that he wrote the following.

“I find myself moved, not for the first time, to remind contemporary economists that the classical teaching embodied some permanent truths of great significance, which we are liable to-day to overlook because we associate them with other doctrines which we cannot now accept without much qualification. There are in these matters deep undercurrents at work, natural forces, one can call them, or even the invisible hand, which are operating towards equilibrium. If it were not so, we could not have got on even so well as we have for many decades past’.”

This is the note I sent out to the School to see if I can get anyone to come along.

I am all too aware of how uninterested a modern economist is in the classical economics of 150 years ago. Nothing must seem more remote from the economic needs of the twenty-first century. So I will just say this.

  1. Classical economic theory provides a much better understanding of how an economy works than anything found in a modern text.
  2. Classical economic theory has infinitely more insight into how to create growth in a less developed economy than does modern economic theory.
  3. Both the Marginal and especially the Keynesian Revolutions have made economic theory less insightful. There is almost nothing worth knowing, beyond the absolutely obvious, from marginal theory, while Keynesian theory is just plain wrong. Almost none of it will help anyone make sense of the operation of a modern economy.
  4. Even if none of that were true – although all of it is true – if you wish to be a completely well-rounded economist, you should at least know something about the economic theories of the classical economists. This presentation will explain things to you that almost no one any longer has even the remotest idea of.
  5. The attachment [not provided here] is made of up a series of quotes taken directly from Denis O’Brien’s Classical Economics Revisited (1975, updated 2002). All of what he writes is accurate. None of it is any longer taught to anyone.

The economic resistance speaks out

Peter Costello was Australia’s greatest Treasurer bar none. Today in The Oz there is a front page story that reminds me just how much this is so: RBA cuts won’t help the economy, says Peter Costello, with the subtitle, “Former Treasurer urges Coalition to Resist Infrastructure Splurge”. And it’s not just rate cuts that are useless.

Future Fund chairman Peter ­Costello has brushed off suggestions that further cuts in official interest rates will help the economy, while urging the government to resist calls to ratchet up infrastructure spending, saying it should tackle the “hard” issues of structural reform.

He ran the economy for eleven years, and among the best forecasts I ever made was to say that we will all live through it, see how well a policy of balanced budgets and zero debt actually works, and not learn a thing. Come the GFC, and that fiscal incompetent Kevin Rudd grabbed the stimulus tray with both hands and now, more than a decade later, we cannot get our economy untracked. And it’s not just balancing the budget that matters.

So let me bring you back to the economics of the classics and tell you what needs to be done: (1) leave growth to the private sector and (2) keep interest rates high enough to stop our resources being ploughed into unproductive projects (eg the NBN, desal plants, streetcars down George St, billion dollar train stations at places no one goes to).

The problem remains that Keynesian macro and every introductory text – except mine – pushes stimulus spending and low rates of interest, the perfect recipe for staying in the doldrums for a very long time.

And by structural reform, the proper meaning, which I assume is the same as Peter’s, is to let the economy adjust so that we are producing value-adding goods and services that will actually make a profit in the market. And if we do that, strangely enough, it will also add to the economy’s capacity to provide higher levels of public spending, even though it is a smaller proportion of total output.