Category Archives: Law of Markets

A query on Keynesian economics

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I have received a brief email from one of my students:

Dear Dr Kates,

First let me thank you for the emails guiding us through the course.

On a personal note, I am curious as to how and why you believe that we should beware of the Keynesian approach (theories that we all have been taught at some point). Is there a book or some articles I could read to in order to understand why the pre-Keynesian era is more relevant to our current economy?

Thank you.

Kind regards

This I can tell you is not an every-day occurrence in the life of an academic. I have now replied:

You don’t know how much you have gladdened my heart in writing to me with your query. As I try to emphasise, I do not ask anyone in an introductory course to choose which side is right and I teach both. You have no doubt which side I think is valid, but I also teach Keynesian economics as accurately as anyone I know, all the more so since I understand it so well since I have studied it for so long. Nevertheless, you may be in the only classroom in the world that is taught the other side as comprehensively as you will find in this course.

But you ask where you might find some literature on the non-Keynesian classical side. I have, as it happens, just completed an 1800-page, two volume collection of every article critical of Keynesian economics written since the publication of The General Theory in 1936. But if you are looking for what I think of as the best criticism available, the best I can offer are two articles I wrote myself, the first one written at the end of 2008 and published at the beginning of 2009 just as the various stimulus packages were getting under way. The second was a five-year review of the first article written in 2014.

This is what was published in 2009 under the title, “The Dangerous Return to Keynesian Economics”.

This is what was published five years later under the title: “Keynesian Economics’ Dangerous Return – Five Years On”.

Both somewhat long, but both are straight to the point and were written so they could be understood without an economics training. Given how things are going, I am not anticipating much improvement on things when I come to write the ten-year review in 2019.

Again, I thank you for your query and I hope these articles will provide you with the insight into the material you are being taught. And, let me remind you, there is also the course text which covers these same issues in greater theoretical depth.

With kind regards.

The Australian School of Economics

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There really is a different way of looking at economic issues in Australia, which is why we are still one of the most successful economies in the world. Two items from the news today, both of which go entirely against the world consensus on economic management. First, from The Australian, Rate cuts failing to bite: RBA. The opening paras:

INTEREST rate cuts are losing the ability to stimulate the economy, with the Reserve Bank warning that it is up to the government to take measures to help revitalise growth.

In a frank admission of the limits to the influence of central banks, Reserve Bank deputy governor Philip Lowe said consumers, businesses and governments were not responding to the extraord­inarily low interest rates that would once have sparked an inflationary debt boom.

The notion that interest rates can be too low is something almost no one can follow if you start with a standard macro model. Arbitrarily lowering interest rates will, in fact, make things worse but who any longer understands even why that might be the case. And if you are looking for what is truly unique about how we go about things, think about this, from the new Secretary of the Treasury, John Fraser:

[Fraser] declared to the Senate Economics legislation committee: “I do not resile from the point that I do not think spending our way out of lower economic activity is the way to go.”

Once, such a view was uncontroversial. Today, practically every international economics organisation preaches the opposite.

How against the consensus grain is all of this. If you want to find your way out of recession, keep interest rates up and lower public spending. And if you are looking for a theoretical explanation of why this is so, there is nowhere else to go other than the second edition of my Free Market Economics. And if you would like some idea of just how unique this book is, this is from an article I am in the midst of writing on the role of the entrepreneur in economic theory:

I have examined each of the following introductory texts because they happened to be on the shelf in our library, and there is either no reference to the entrepreneur found in the index, or the text contains only a perfunctory mention, never continuing for more than a page: Abel and Bernanke (2005); Blanchard (2006); Lipsey and Chrystal (2007); Mankiw (2007); McConnell and Brue (2008); McTaggart, Findlay and Parkin (2006); Parkin (2008); Samuelson and Nordhaus (1995); Sloman and Norris (2010); Stiglitz and Walsh (2006). It is clearly possible to discuss the operation of a modern market economy without mentioning the single most important function in allowing the economic system to work. There is not the slightest doubt that even if the most recent editions had been to hand, nothing would have been in any way different.

The Australian School of Economics can explain the role of higher interest rates, balanced budgets and the entrepreneur and with these concepts in hand explain how an economy works and what needs to be done to get recovery firmly in place.

Economic theory’s version of Fermat’s Last Theorem now finally explained

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I have just had an article published that has taken five years to finally see the light of day. More formally, “Steven Kates (2015). MILL’S FOURTH FUNDAMENTAL PROPOSITION ON CAPITAL: A PARADOX EXPLAINED. Journal of the History of Economic Thought, 37, pp 39-56.” This is the abstract:

John Stuart Mill’s Fourth Fundamental Proposition Respecting Capital, first stated in 1848, had become an enigma well before the nineteenth century had come to an end. Never challenged in Mill’s own lifetime and described in 1876 as “the best test of a sound economist,” it has become a statement that not only fails to find others in agreement, but fails even to find an internally consistent interpretation that would make clear why Mill found it of such fundamental importance. Yet the fourth proposition should be easily understood as a continuation of the general glut debate. Economists led by Malthus had argued that demand deficiency was the cause of recession and a body of unproductive consumers was needed to raise the level of demand if everyone who wished to work was to find employment. Mill’s answer was that to buy goods and services would not increase employment, or, in Mill’s own words, “demand for commodities is not demand for labour.”

That observation by Leslie Stephen in 1876 was literally the last time anyone had ever made such a positive statement about Mill’s Fourth Proposition. After that, it had been worked over by Alfred Marshall, A.C. Pigou, F.W. Taussig, Allyn Young, Friedrich Hayek, J.M. Keynes and Harry Johnson amongst many others, none of whom could make it make sense. I will write it down again, because it is the essence of Say’s Law. Understanding what Mill meant is the only means I can think of to refute Keynesian theory:

Demand for commodities is not demand for labour.

From the moment I read it in Mill, which I was just reading for fun, I was convinced by both the conclusion and the logic that had come before. I had no idea that it would change my life and give a shape to all of my economics thereafter. It simply says that buying of itself never creates economic momentum, but it is the logic of the argument that is required if you are to see the point. Everyone understood both the proposition and the logic for the entire period from the time of Adam Smith right through to the marginal revolution in the 1870s, but from that moment on has made no sense to anyone, other than me. How odd is that!

So now I have the paper in print, but I doubt anyone will get it anyway. You really do have to go back to Mill and the classics to see not just what they meant, but why it’s true. The alternative is to read my Free Market Economics which is classical economics for the twenty-first century. It is also the first book since the 1870s that has actually discussed and defended Mill’s fourth proposition, indeed all four propositions. I say this as honestly and sincerely as I can. You will never understand how an economy works unless you understand what Mill meant. There is no difficulty in seeing the point since I have been teaching it successfully as part of my course since the start of the GFC, but I also recognise how hard the point is to grasp and hold to in the midst of controversy. But if you can do it, it is worth the effort since Mill’s Fourth Proposition truly is the best test of a sound economist.

No one has learned a thing

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From an editorial in The Economist (14/2/15) with the title, “The German Economy. No new deal”. If you think anyone has learned anything from the past six years, please see below:

A first mistake is to insist that troubled euro-zone countries such as Greece not only make structural reforms to their economies, but simultaneously cut spending and borrowing (depressing demand). But a second is domestic. Given low interest rates, now would be a golden opportunity to borrow and invest more at home, boosting the economy and providing a Keynesian stimulus to the entire sluggish euro zone.

Their advice to the one European economy that has come out of the GFC relatively all right is to start copying every one of the idiocies perpetrated by the others.

It all depends on who you mean and what you mean by dead

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An article on “Why we should listen to dead economists”, which I do agree with in principle, but it all depends on who you mean and what you mean by dead. I posted this comment just because, not that anyone who has gone through the scientology-based economic-theory teaching framework of the modern day will understand:

In the long run, every economist is dead. But in the meantime, you have to know which amongst those dead economists to choose. The problem, though, with Keynes is that while he has gone to his great reward, his theories are very much alive and continue to plague us still. But if we are going to look back even at the economists of Martin Wolf’s choice, it is Bagehot we should look at. Chapter 6 of his Lombard Street – “Why Lombard Street is Often Very Dull, and Sometimes Extremely Excited” – is a straight up account of the classical theory of the cycle, and incomparably better than anything you will find in a macroeconomics text today.

Choosing Keynes as a dead economist whose views we should examine, as if he were some obscure entity from the distant past, now known only to specialists, is a particular kind of peculiar. Chapter VI of Lombard Street, however, is as modern as the GFC.

Keynesian plunder

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What our elites like most about Keynesian economics is that the wealthy get to plunder everyone else while the government can pretend it is trying to generate recovery. As the title says, For Most Of Us, There’s No “Recovery”, us in this case being in the US.

From 1820 through 2000, real (inflation-adjusted) gross domestic product grew at an average annual rate of 3.6 percent. Last year was the ninth consecutive year in which the economy grew less than 3 percent.

Real GDP has grown 13.6 percent since the recovery officially began in June 2009. The average rate of growth at this point in the recoveries from the four recessions since 1975 was 21.9 percent.

If it weren’t for gains made by the well off, there wouldn’t be a “recovery.” Five years after it began, the top 1 percent of earners (more than $366,623 a year) had garnered 81 percent of its fruits. The incomes of the top one-tenth of 1 percent (about $8 million a year) grew 39 percent.

The incomes of the bottom 90 percent declined, according to University of California-Berkeley economist Emmanuel Saez. Real median household income was $54,417 in December, 5.1 percent lower than in January 2008 ($57,317).

Most of us get nearly all our income from our jobs. Only 44 percent of adults work 30 hours or more a week, according to Gallup’s survey of the work force. Ten million fewer are working now than when Barack Obama became president.

It took until last March to create as many new jobs as were lost during the Great Recession. For every person who’s found a job, two have left the labor force.

An email on Say’s Law

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On Friday, I received the following email.

Dear Professor Kates,

As perhaps the only lay person in the United States to have read the two books by Sowell and Hutt, as well as Anderson’s book and some of the articles you cited in your book, I consider myself pretty knowledgeable about the logic and rationale behind Law of Markets and I must say, yours is the best I have seen on the subject.

Your classical views pretty much line up with Austrian theory, especially in their criticism of the “lack of aggregate demand” theory accepted today as being the root cause of recessions, although it would not appear that you are totally sold on their link of recessions with “expansion of money supply” and consequential “malinvestment” in production– leading to the proverbial “cluster of errors” referred to by Robbins. You seem to believe that the malinvestment can occur without the expansion of the money supply. Austrians would agree, but they would maintain that malinvestment would not cause anything but micro level adjustments or perhaps a mild slowdown and not an outright macro-recessionary period. Dispute seems to be more about degree and semantics on how to define recessions rather than serious dispute on substance. Clearly, you and Austrians do not buy the general glut argument.

Your book was excellent overview of history of economic thought, at least from early 19th C. onward. It points out how wrong Keynes was on history of economic thought, either by ignorance, or as I believe, by design. He set up a false historical narrative in developing his straw man to make it easier to take down.

Your point that the acceptance of the “lack of aggregate demand” theory by economists since 1936 has set the science of economics on a terrible path cannot be understated. Failure to understand cause will almost always result in bad policy, as can be seen by measures taken in recent years by the “policy makers”. J.B. Say: “Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption”. Contrast that with:

“Simply put, we live in a world in which there is too much supply and too little demand,” star economist Nouriel Roubini of New York University …

Ugh! That is the media’s “star”. How far the profession has fallen. Unfortunately, guys like Roubini, Stiglitz and Krugman now rule the day.

I have been working on a book for several years challenging most all of modern day macroeconomic theory, with one of the first fallacies being the lack of aggregate demand theory. (The deflation bogeyman is another.) I also bought your “Free Market Economics” and just started it last night. It looks like you beat me to the punch. Keep up the good work.

Kind Regards

So today, I wrote back.

Thank you very much for your kind and encouraging letter. We are so obviously on the same wave length that it is uncanny. I had thought that once the failure of the stimulus had become perfectly clear to everyone, there would be a groundswell of some kind to think through what had gone wrong, and that, perhaps, there would be a closer re-examination of the Keynesian macro that has ruined economic theory along with most of our economies. I must therefore confess to no little astonishment to discover that Keynesian economics is even more embedded within economics than ever. I suppose that to confess to such a massive error, as would need to be done if economists rose up and said, “come to think of it, Say’s Law seems to have been right after all and Keynesian economics wrong”, would have been a gigantic step too far. But even if not that, some kind of re-thinking about how an economy works, and whether valueless public spending really can generate growth, might have been in order. Such is not how it’s been. It is therefore not a little frightening that the cures continue to be administered from the demand side.

About the way I look at the cycle, “mal-investment” gives the impression that if entrepreneurs had been more clear-eyed about the future, that the downturn would never have occurred. For me, the recession that I grew up on was the downturn that followed the OPEC oil boycott of the 1970s which was followed by a massive inflationary pulse that led to an international wage explosion. The dislocations that rolled across the world were neither caused by nor could have been cured by monetary policy. Certain categories of investment – such as those that depended on low-cost energy – were left high and dry by these major changes in the economic environment in ways that no one could have foreseen. I also think that it helps me see these things because I live in one of the more remote provinces, where domestic monetary policy will seldom be the cause of a downturn. I therefore see recessions as a consequence of government policy generally and the effects of major international instability. The GFC started in the US, and while I think we in Australia should for the most part have ignored it so far as policy went, there was never any chance we were not going to be affected irrespective of the monetary policies we might have run, either before or after. My main point is that recessions are structural and not caused by too much saving (or supply!). My chapter 14 on the cycle is a summary of the classical view, which I have synthesised from Haberler. Chapter 15 looks at the role of government, which was not a classical perspective but it is mine.

I do hope you write your own book. The one thing I know from having written what I have is that you only truly understand what you think yourself by trying to write it all down. The things that end up on the page often surprise even you. Please let me know how you go. And if I may, I will attach a paper I did on the origins of the Keynesian Revolution. Just to be able to mention Fred Manville Taylor and Harlan McCracken is often a showstopper for someone trying to argue with a Keynesian. Try it out and see how you go.

With kind regards and many thanks again.

Three million new jobs after 13 million lost

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It may be nowhere else, but at least it’s on Fox and Drudge. We are talking here about the United States – Gallup CEO: Number of Full-Time Jobs as Percent of Population Is Lowest It’s Ever Been. There has been no recovery of any kind worth the name. From the text:

“The number of full-time jobs, and that’s what everybody wants, as a percent of the total population, is the lowest it’s ever been… The other thing that is very misleading about that number is the more people that drop out, the better the number gets. In the recession we lost 13 million jobs. Only 3 million have come back. You don’t see that in that number.“

A deficit-led, government-spending-generated recovery is an impossibility. More proof, in case more proof was needed, that Keynesian economics is junk science.

Forty years an Australian

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But also sixty-plus years a Canadian. That is the way it is with us migrants.

Today is the fortieth anniversary of my arrival in Australia. Very few decisions are as momentous as choosing to shift countries, even from within one part of the Empire to another. But there are few decisions I have ever made that I feel as content with, yet I also feel all of the loss of the closeness of family and friends.

I was also part of the first cohort who was required to get a migrant visa, the new law having come into effect on 1 January 1975. And the one part of my interview with the chap from the embassy I have always remembered was that, my having pronounced Nullarbor wrong, he corrected me on where the accent went, and then said that there are some who think the Romans might have been here, since ‘null arbor” is Latin for no tree. A fantastic coincidence if true, although only if it actually is an Aboriginal name.

Rate cuts and unemployment

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You would think by now that the dismal economic recovery in the United States would alert others to what doesn’t work, but seems not. So down interest rates have gone to record lows at 2.25%. No doubt the banks will be browbeaten into passing the cuts along, but hopefully not.

This is all part of the Keynesian idiocies. Try to revive an economy from the demand side. Make it easier (cheaper) for governments to fund their debt. Deepen the misallocation of resources, and distort the economy just a little more.

And like with public spending itself, it has the superficial look of doing something positive that will allow those who do not understand how an economy works – voters say, or Treasury officials – to think something useful is being done.

As for how well our economies are responding to treatment, there is this from Jim Clifton who is the Chairman and CEO at Gallup in the US. This is someone who might just perhaps know something about surveys, and this is what he says about unemployment data in the US. We have discussed this before, but for a change it is up on Drudge. It’s not the kind of thing that opposition parties make much of either, since they one day will become the government themselves. But here is Jim Clinton pointing out the well-known statistical facts:

Right now, we’re hearing much celebrating from the media, the White House and Wall Street about how unemployment is “down” to 5.6%. The cheerleading for this number is deafening. The media loves a comeback story, the White House wants to score political points and Wall Street would like you to stay in the market.

None of them will tell you this: If you, a family member or anyone is unemployed and has subsequently given up on finding a job — if you are so hopelessly out of work that you’ve stopped looking over the past four weeks — the Department of Labor doesn’t count you as unemployed. That’s right. While you are as unemployed as one can possibly be, and tragically may never find work again, you are not counted in the figure we see relentlessly in the news — currently 5.6%. Right now, as many as 30 million Americans are either out of work or severely underemployed. Trust me, the vast majority of them aren’t throwing parties to toast “falling” unemployment. . . .

There’s another reason why the official rate is misleading. Say you’re an out-of-work engineer or healthcare worker or construction worker or retail manager: If you perform a minimum of one hour of work in a week and are paid at least $20 — maybe someone pays you to mow their lawn — you’re not officially counted as unemployed in the much-reported 5.6%. Few Americans know this.

Yet another figure of importance that doesn’t get much press: those working part time but wanting full-time work. If you have a degree in chemistry or math and are working 10 hours part time because it is all you can find — in other words, you are severely underemployed — the government doesn’t count you in the 5.6%. Few Americans know this.

The supposed recovery in the labour market he describes as lies. They are, but if it’s the Media Party lying, you are never going to know.