Category Archives: Law of Markets

This is classical economic theory

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No one can really see it yet but classical economic theory is coming back. This post at Instapundit by Mark Tapscott is presented and discussed in exactly the way economics would have been discussed by the great classical economists between 1776 and 1936. The issue is not about demand. It is about the redeployment of actual physical resources – capital goods – from less productive and even non-productive uses into more productive and positively productive uses. You may think you have heard this said before, because you think that is how economic theory and policy should be discussed, but I keep an eye out for it and this is the first time I have come across anything discussed in that way.

I have posted this paper before – Making Sense of Classical Theory – which is a pre-print of a paper that will appear in the April 2018 edition of the Journal of the History of Economic Thought. If you are at all interested in understanding how pre-Keynesian economists thought about the structure of an economy and what made it grow and flourish, you should read that paper. It describes in theoretical terms how Mark Tapscott explains the sudden flourishing of the American economy. This is exactly how classical economists looked at things.

TRUMP’S FIRST-YEAR BOOM IS LARGELY DUE TO DEREGULATION BUT THINK ABOUT THIS: Merely cancelling an expensive federal regulation doesn’t immediately convert the compliance cost into a potentially productive new investment. The capital has to be reallocated and some time is required for the new investment to produce sufficient return to offset the former compliance costs. Huh?

In other words: “It takes time for the economy to recover the costs of excessive regulatory compliance and to redirect capital to productive uses, so the gains seen during Trump’s first year are likely attributable in significant part to the expectations generated by his slashing the red tape. The full impact of the deregulation is still to be felt.”

And remember, the Trump tax cuts aren’t in effect until February. Wayne Crews of the Competitive Enterprise Institute estimates regulatory compliance cost the U.S. economy $1.9 trillion. Trump can’t repeal all federal regulations but what if his tax cuts and the continuing positive impact of deregulation in coming years produces an economic boom that far exceeds the Reagan era? Ponder that one a bit!

The value of tax cuts is in their ability to divert resource use away from consumer goods and governments into the hands of productive business who are then able to invest. Cuts to regulation play their role by reducing wasted efforts within business in complying with government directions and instead use the resources at their disposal to create value. It works like magic, because to a modern macroeconomist it is magic since they have no means of explaining what was once perfectly well understood by everyone.

C’mon, who’s really clueless about trade?

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From Forbes, the kind of thing you find in among Chamber of Commerce types: Trump’s Tariffs Are A Reminder He’s Clueless About Trade. Sure he is, and the evidence keeps piling up day by day. If we lived in a crony-capitalist-free world, and no one ever cheated in their trade relations,* maybe such blanket statements would make sense. But truly lacking in any penetration is the manipulation of arithmetical statistical identities as if they were actual theoretical constructs where a change in one variable is the cause of a change in another. In reality, with such identities, these are accounting balancing items which have no effect on actualities in the real world, but are only a record of what took place.

Now here is where the simple analytics of the trade deficit can be used to prove the cluelessness of the Trump trade team on “trade,” of all things, and the utter futility of its policy prescriptions having any impact on America’s aggregate trade deficit. In economics, identities play an important role. These identities are obtained by equating two different breakdowns of a single aggregate. Identities are interesting, and usually important, by definition. In national income accounting, the following identity can be derived. Indeed, it is the key to understanding the trade deficit.

(Imports – Exports ) ≡ (Investment – Savings) + (Government Spending – Taxes)

Given this identify, which must hold, the trade deficit is equal to the excess of private sector investment over savings, plus the excess of government spending over tax revenue. So the counterpart of the trade deficit is the sum of the private sector deficit and the government deficit (federal + state and local). The U.S. trade deficit, therefore, is just the mirror image of what is happening in the U.S. domestic economy. If expenditures in the U.S. exceed the incomes produced in the U.S., which they do, the excess expenditures will be met by an excess of imports over exports (read: a trade deficit).

This is the same as fiddling with Y=C+I+G and pretending that an increase in G can cause an increase in Y. Complete sophistry. There is much more to say about free trade and I have been meaning to say it for a while. This might therefore be what finally stirs me to spell it out in more detail, but this will have to do for now.

* See, for example, Australia takes Canada to WTO over rules on selling wine. My dual nationality obviously makes it impossible for me to see the rights and wrongs of this, but let me say that no Australian will ever understand the liquor laws of Canada, which were introduced as temporary measures during World War I. There’s a lesson in there as well.

If you want to understand how an economy works you need to understand classical economic theory

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So long as Keynesian economics remains the mainstream, there is no possibility of taking down the crony capitalist system of economic management. Because Keynesian theory is the mainstream which everyone learns, economists are taught from their very first days in class, that routinely syphoning our wealth into the hands of governments and their friends will create a net increase in the number of jobs while making everyone better off. It isn’t true, and ought to be seen as obviously untrue, but since the pretence makes governments and their crony capitalist friends immensely rich, it just goes on. So more fool you for accepting Keynesian theory.

The argument that an economy is driven by the level of demand, irrespective of what is being demanded, works very well for those receiving handouts from governments, but harms everyone else. All production uses up resources while only a small proportion adds anything back in. It is now invisible in the way economics is currently taught why all of that matters. In writing as I do I am doing nothing more than repeating what was obvious to every great economist before The Keynesian Revolution but is utterly unknown other than to a handful of economists who have actually studied the classics.

At the link may be found a pre-print of an article of mine that will appear in the June 2018 issue of the Journal of the History of Economic Thought: Making Sense of Classical Theory. This is the description of its contents.

The fundamental problem discussed is the shifts in the conceptual base of economic theory that followed the publication of The General Theory, along with various technical terms being given different meanings, which have made it almost impossible for modern economists to comprehend classical theory. Yet it is in the classical theory of the cycle where the most profound understanding of the nature of recession and cyclical unemployment is found.

The paper’s not long but it takes you into the heart of the differences between modern economics and the classical theory that had existed prior to the publication of The General Theory in 1936. This is now the sixth paper in a series that began with the publication of my article on Mill’s Fourth Proposition on Capital in 2015. That earlier paper was criticised by an economist in the UK by name of Roy Grieve, whose criticism of my paper attracted a series of comments by an American economist, James Ahiakpor.

I can only hope that the core point found in the attached paper, explaining why classical theory works and Keynesian economics does not, will be clear. But as this brief paper points out, there have been so many changes in the terminology and presuppositions within economic theory since classical times that it remains almost impossible for a modern economist to follow what the great economists of the past had said. But not only can it be done, but you will only understand how an economy works if you do.

Productive and unproductive spending

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A very classical distinction that is lost on most economists today.

There is this grand distinction between an individual borrower and a borrowing government, that, in general, the former borrows capital for the purpose of beneficial employment, the latter for the purpose of barren consumption and expenditure.

— J. B. Say

From his Treatise on Political Economy dealing with “Of the Consumption of Wealth”.

Two letters on Say’s Law

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Once someone gets Say’s Law, the reality of what is going on in an economy becomes so obvious that it is impossible to go back to the pallid and utterly inadquate nonsense that passes for modern theory. The following is a letter I received the other day from someone I have been corresponding with for a while, and after that is my reply to him.

Hope you are well. Yes I read (and watched) all you have given me. [I even read (and bought) your conversation with Gregoire Canlorbe ‘Say’s Law, between Classical, Keynesian and Austrian Interpretations (2016)’ (from De Gruyter)].

I read your ‘200 years of Say’s Law (2003)’. Another thought provoking gem.

Back in the early 2000s I undertook 3 and a half years of bible college. I learnt the importance of hermeneutics and exegesis. Today, I am not surprised Economics scholars also struggle with proper interpretation of another author and can fall into eisegesis. The four scholars, arguing against Say’s Law, could only attack the many straw men (eg. ‘supply creates its own demand’, or Say’s economy is barter-only economy, or Say’s Equality, or change Savings’ definition) and reduce its meaning, or, read something of Say’s Law which wasn’t really there and added their own meaning (eisegesis). Misinterpreting is common, unfortunately, across disciplines as you well know. Let me illustrate my two theological favourites, however. If you can you find anywhere in the bible where it says “Money is the root of all evil” or “The truth will set you free” I will happily give you/anyone $15,000 cash and clean one’s house for a year! The point is: if we omit the few words before these popular phrases then the originator’s point is changed and COMPLETELY lost. Sound familiar?

In the tradition of Hayek’s name calling of some scholars to be ‘quasi-scientific’ (p 20) I thought I could respectively/humbly/comically generally refer to those ‘against’ Say’s Law as:

1. ‘One-side of the ledger Economists’: Aggregate Demand (and full employment) is their God, and ignoring the complexity of the supply side is welcome by their herd. Not sure why some Economists think they can ignore one side of a transaction when professional Accountants get fired for it.
2. ‘Unsustainable-loving Economists’: They are at peace to see government spending on unproductive consumption even if it alters the dynamics of the economy and reduces its viability to stand on its own feet.
3. ‘Second-rate Economists’: It is written “All things are [permissible], but not all things are beneficial” Amplified version. Maybe most complacently see policies in action and gravitate to think that must be the best option. Just because a policy is enacted doesn’t mean it is the most beneficial. Most don’t stand for a strong economic view- so they fall for any.
4. ‘Ignore the opportunity-cost-type of Economists’
5. ‘Short term-ism Economists’
6. ‘I missed school that day they taught ‘the cause-and-effect principle’ Economists’ (or ‘Symptom-is-a-cause Economists’)
7. ‘Blinker Economists’: They focus on only that scope of economic activity which supports their limited explanation.
8. ‘Soft-love loving Economists’… as opposed to hard-love=real love (but you get the idea).

I asked my successful business owner brother-in-law how much he has in idle cash (hoard). He answered it was a lot less than 1% because “you try to put all your money to the best use in every way”. I’m sure if I asked my trader friends what makes them buy and sell a specific trade I am sure they would respond “there is always a reason” rather than Littleboy’s reference of Keynes’ “…people, typically investors, spontaneously change their mind…” (p 160). Ask any banker what they do with savings deposits and they definitely do not lay waste any dime above the ratio reserve law. And I remember asking a wealthy person once as to what keeps him going? The context was why he wants to keep making more and more money. I will never forget his response. “Choices! I can choose to work when I want, or not work when I want” was his reply. Not sure why Keen says capitalists build up money for the sake of it. There is always a reason and it eventually comes back to enriching their lifestyle in some way – whether buying larger home, braces on kids’ teeth, buy another business, securing their wealth/freedom more concretely etc. Lifestyle is the end- not money. Finally, I have been working in the financial sector for the last 4 years. Not sure why this sector is the leakage from the expenditure/circular flow model. We are all charging fees and employed and spending our incomes… maybe we can add ‘Different planet Economists’ to the above list.

Recently I threw a simple question at my demand-worshipping colleagues: “Name one thing you can spend money on that hasn’t been produced?”. They could only resort to the usual retorts: “you have weird economic ideas” preceded by “spending will always be the driver of the economy”.

I am now off to read your 3rd edition Free Market Economics. I only read about half of the 2nd edition nearly a year ago preparing for my anti-Keynesian essay. I have read a quarter of Smith’s Wealth of Nations, but, you are right, these can be difficult to read- I need a break.

All the best Steve and thanks for a wonderful discourse. I am still totally addicted to this issue. Chat soon.

Regards

This was my reply.

That is the most original and possibly insightful non-strictly-economic explanation of Say’s Law I have ever come across. Looking at Say’s Law within the framework of the theory of knowledge is something I do not think I have come across before and may never have been previously done. Also not having come across eisegesis before (and neither has my spell check apparently) I can only emphasise that it is a very useful conceptual distinction that really does help get to the heart of the issue. I, of course, share your frustrations in trying to make others even become aware of the problem. When you ask them to name a product they have bought that had not already been produced (which naturally implies a very lengthy structure of production that must go back a considerable distance in both time and space) the only reaction you are likely to get is that even if they don’t know the answer themselves, someone else does because how could it be possible that you have asked something so penetrating that the entire company of modern economists have no answer for. But they don’t have an answer other than to say that buying something will mean that a replacement item will have to be produced to put on the shelf so it will encourage more production. Except that this new order, if there is a new order, can only be filled if the producer had already made the decision to produce this additional replacement item long before you bought what you bought. But for them to go there would mean they had already seen the problem and understood that it is not demand that causes the supply, but that supply is created in anticipation of some future demand. So you will just have to keep teasing them just for your own satisfaction but do not be surprised if the scales fail to fall from their eyes anytime soon (I hope I have not mis-used the metaphor).

I also found your classification system astonishing and accurate. It is also funny but finding it so on the money, its ironical intent seems more serious than anything. The list truly does begin with the implied words, “Look stupid . . .” but where you go from there I do not know. Well actually, where you go is you write this up in some more polished form and try to get it published. There is no Journal of Irony and Economics but I would not want you to mess with the vision you have shown here or try to diminish your satirical intent. You should just expand what you have written and see what follows.

Anyway, we can discuss when you come to visit which you MUST do if you have the time. I will also pass on a copy of my Economics for Infants discussed here on my blog:

http://catallaxyfiles.com/2017/12/02/the-book-no-child-should-be-without/

As I mention, it is the only children’s book that incorporates Say’s Law, which is indeed an actual feature of the text and the fantastic picture that comes with it.

I do look forward to catching up, but as a kind of cautionary note before we meet I will just say that we had a School retreat the other day where at the dinner we were asked to come as our favourite literary character and I came as the much maligned and mis-understood Edward Casaubon.

With kindest best wishes

The book no child should be without

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If you are looking for Christmas ideas, you might consider Economics for Infants, the only book of its kind.

A perfect book to read to your children and grandchildren! How do you explain the complexities of the economic order to a child? This retro-inspired illustrated book attempts this task in storybook form. A basic primer on economics for the youngest of readers.

For myself, what I like best about the book are its pictures which illustrate the points with an astonishing clarity. There is no children’s book anywhere, past or present, that has illustrated Say’s Law so incredibly well along with so much more. In a recent pee’er reviewed study, 97% chose Economics for Infants as their favourite book (astonishingly, the same as the proportion of climate scientists who believe global warming is caused by humans!). The above photo was taken during that study and is conclusive proof that if your child is to succeed in getting into the best kindergartens and play groups, this is the book you will need to ensure they have read and its contents absorbed. You can see how the other books were ignored while Economics for Infants held the attention of this particularly bright child not entirely chosen at random.

And let me also say this. There may be parents of young children whom you may feel need a refresher course in the economics of the market. Give a copy to their children and contemplate the pleasure it will give in reading about how the capitalist system works for the betterment of all, that is, the pleasure it will give you contemplating their parents vetting the book while deciding whether to pass it along.

Here’s where you may order the book and have it still arrive in time for Christmas.

Macro Follies returns

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The only movie that has ever been made from a book I wrote. The movie was put together by that genius, John Papola, producer of the greatest economic video ever, The Keynes-Hayek Rap. And as noted in the credits for Macro Follies, there I am found in truly stellar company:

Special Thanks to Russ Roberts, Steven Kates, Larry White, Steve Horwitz, James Adams and Steve Fritzinger

As for the book, if you are looking for a Christmas present, let me recommend my Free Market Economics which is the book from which the movie was made. It is the only economics book written in approximately the last 150 years that is built on classical economic principles. As it says at the Book Depository website

“In this thoroughly updated third edition of Free Market Economics, Steven Kates assesses economic principles based on classical economic theory. Rejecting mainstream Keynesian and neoclassical approaches even though they are thoroughly covered in the text, Kates instead looks at economics from the perspective of an entrepreneur making decisions in a world where the future is unknown, innovation is a continuous process and the future is being created before it can be understood. Key Features include: * analysis derived from the theories of pre-Keynesian classical economists, as this is the only source available today that explains the classical pre-Keynesian theory of the business cycle * a focus on the entrepreneur as the driving force in economic activity rather than on anonymous `forces’ as found in most economic theory today * introduces a powerful though simplified model to explain the difference between modern theory of recession and classical theory of the business cycle * great emphasis is placed on the consequences of decision making under uncertainty * offers an introductory understanding, accessible to the non-specialist reader. The aim of this book is to redirect the attention of economists and policy makers towards the economic theories that prevailed in earlier times. Their problems were little different from ours but their way of understanding the operation of an economy and dealing with those problems was completely different. Free Market Economics, Third Edition will help students and general readers understand classical economic theory, written by someone who believes that this now-discarded approach to economic thought was superior to what is found in most of our textbooks today.”

You can order a copy here. For anyone who wants to get a sense of how an economy works, and also why government intervention beyond a minimum creates harm, this is the place to go. Of course, you might instead decide to save your money and have an even better Christmas next year, but you might also instead just think of it as helping to build your own human capital, as well as helping you to contain your rage watching Malcolm and Co butcher economic policy before Bill and Co are allowed to take over who will do even worse.

Made it to Instapundit!

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Here’s the link.

MANSON AND THE TOTALITARIAN TEMPTATION: “The potential for entire social movements to end up sympathizing with visibly pathological murderers with swastikas carved in their foreheads is a persistent potential. All you have to do is let down, for a brief moment, your simplest sense of right and wrong, perhaps because you pride yourself on being upset about some social issue….”

Read the whole thing.

15Posted at 1:44 pm by Ed Driscoll 

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And as always some interesting commentary.

Say’s Law @ Zero Hedge

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I asked Dan Nivens, my new best friend, where he had come across what I had written and he sent me here, to Zero Hedge: Say’s Law And The Permanent Recession. There we find the following:

Steven Kates explains in his book Say’s Law and the Keynesian Revolution (subtitled How Economics Lost its Way), Keynes failed in his attempt to overturn Say’s Law. Kates shows beyond any dispute that Say and his fellow classical economists were well aware that there could be unemployed resources, and that Say’s Law was still valid in that case.

In the book I actually go much further. I outline just how wrong Keynes, and just about every economist since his time, has been about classical economic theory. There is virtually nothing discussed in the Zero Hedge post that is not found in my book and there’s plenty more that’s not mentioned. Any economic theory that does not specifically start from the entrepreneur is almost certainly deeply misleading and more than likely false. There are no market forces not embodied in individual decision making on the supply-side of the economy. It is the role of entrepreneurs to work out, in advance, what buyers would buy if it were supplied at prices that covered all production costs and then supply them. The role of buyers is merely to choose amongst the products available once entrepreneurs have put them up for sale. Their role is no greater than that. That is how a market system works.

But the second aspect of the Zero Hedge post I find significant is that it was “submitted by Robert Blumen via the Ludwig von Mises Institute”, meaning that it had come from an Austrian source. That is truly pleasing as far as it goes, but it is a major problem that only a minority among Austrian economists understand the major significance of the disappearance of Say’s Law. Hayek’s first foray into these issues was written in German in 1929 and published in English over two parts in 1931 and 1932. This is what these articles were about:

Chronic underconsumption is an idea most often associated with Keynes. But while the infamous English economist published his General Theory in 1936, Hayek’s 1929 article “The ‘Paradox’ of Savings” analyzes a similar theory advanced by two Americans a decade before. While the two authors have nearly vanished from history, the insights contained in Hayek’s nearly forgotten article are more necessary today than ever.

Unfortunately, it is also Hayek’s article that has vanished from history as well. Yet there he explained in great detail why demand deficiency as a theory of recession and unemployment is nonsensical. Because it is so deeply wedded to marginal utility, it is a problem for many Austrians to focus on supply-side theory to the extent that is required if a revolutionary shift in economic theory is to happen.

“In case you are not familiar with Kates . . .”

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The video is Economics for Independent Thinkers which discusses the way economics is discussed outside the mainstream. There are many many reason for watching the above video from end to end, but this especially works for me, starting at the 14:30 mark.

“The lesser known terms are mostly thanks to the Australian economist Steven Kates. In case you are not familiar with Kates, Kates wrote possibly the most thoroughly researched of the studies showing that there was a fairly strong consensus before the Keynesian Revolution about how the business cycle worked.”

And not only that, I explain in modern terms what that theory was. And as strange as you may find this, there is no other modern source where you can find classical theory explained.

The presentation was to The Heritage Foundation in Washington. This is the synopsis and I could not agree more with what he says:

Too many mainstream economists view the world as a collection of equilibrium models, without concern for when these models fail to explain real-world risks. In Economics for Independent Thinkers, author Daniel Nevins scours under appreciated corners of the economics and investment worlds for more realistic thinking. What results is a no-nonsense approach to economics that appreciates the importance of credit and banks in business cycles, and provides a different perspective on Keynesian stimulus and the consequences of government debt accumulation.

The speaker is Daniel Nevins.

Daniel Nevins, CFA, has invested professionally for thirty years, including more than a decade at both J.P. Morgan and SEI Investments. He is perhaps best known for his behavioral economics research, which was included in the curriculum for the Chartered Financial Analyst® program and earned him recognition as one of the founders of “goals-based investing.” He has an economics degree from the Wharton School of Business and a degree from the University of Pennsylvania’s engineering school.

And you know what? Till now I did not think it was possible but you never know the way things are going. We may yet rid ourselves of this Keynesian economic mess, but to do that we will need to understand economic theory before Keynes. Speaking of which, have I mentioned my introductory text before: Free Market Economics, now in its third edition?