Category Archives: Law of Markets

Shifting in a Keynesian direction

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First there were two articles, one by Paul Krugman with the title, Keynes is slowly winning and the other by Tyler Cowen in reply to Krugman titled, Keynes is slowing losing (winning?). There is now a third, Krugman’s reply to Cowen, In Front Of Your Macroeconomic Nose, in which he says what I believe myself:

Cowen seems to have missed my point; I wasn’t talking about the merits of the Keynesian case, which I believe have always been overwhelming, but about the way macroeconomics is discussed in the media and among VSPs in general. My sense is that this is shifting in a Keynesian direction.

There is no other theory known to anyone other than Keynesian. You can talk about debt and deficits until the end of time, but unless you can relate it to a theoretical understanding of what needs to be done and more importantly why, there is nothing to grab onto when trying to craft policy. Keynesian economics may be ruinous, but you can find it in a million texts and it has been taught for three generations, coming up to four. Even Cowen in his pussycat weak attack on Keynes can do no better than this at the end:

It would be wrong to conclude that Keynes was anything other than a great, brilliant economist. Rather these citations, plus many of Krugman’s points, give you some beginnings for this issue. It’s not nearly “Keynes’s time” as much as many people are telling us, after all his biggest book is from 1936 and that is a long time ago. Keynes is both winning and losing at the same time, like many other people too, fancy that.

Economies are not driven from the demand side. But other than myself and a handful of others, you will find hardly anyone else to say it across the wide expanse of economics. So on we go, tilting back to public spending while real incomes descend and our economies weaken with not a clue why that might be. So at least there is Johnny Cochrane writing this in a discussion of the articles by Cowen and Krugman:

I posted this last week, but I was unaware at the time of the Paul Krugman’s “Keynes is slowly winning” post; Tyler Cowen’s 15-point response, documenting not only Keynesian failures but more importantly how the policy world is in fact moving decidedly away from Keynesian ideas, right or wrong (that was Krugman’s point); and Krugman’s retort, predictably snarky and disconnected from anything Cowen said, changing the subject from Keynesian ideas are winning to the standard what a bunch of morons they’re not Keynesians though I keep telling them to be. . . .

In that context, I added two “Facts in front of our noses.” Keynesians, and Krugman especially, said the sequester would cause a new recession and even air traffic control snafus. Instead, the sequester, though sharply reducing government spending, along with the end of 99 week unemployment insurance, coincided with increased growth and a big surprise decline in unemployment. And ATC is no more or less chaotic than ever. Keynesians, and Krugman especially, kept warning of a “deflation vortex.” We and Europe still don’t have any deflation, and even Japan never had a “vortex.” These are not personal prognostications, but widely shared and robust predictions of a Keynesian worldview. Two strikes. Batter up.

But still no theory to explain why cuts to public spending will raise economic growth while increased public spending will slowly but surely reduce our standard of living. If, however, you are interested in understanding why, there is always the second edition of my Free Market Economics.

UPDATE: One of the great anti-Keynesians has written an article for this month’s Standpoint in the UK, Don’t let the Keynesians Wreck the Recovery. He discusses the famous letter signed by 364 economists across Britain warning of the consequences of Thatcherism, that is, the consequences of fiscal discipline:

Famously or notoriously, depending on one’s viewpoint, the 364 were wrong. To quote Nigel Lawson, who would become Chancellor of the Exchequer in 1983, the timing of the recovery was “exquisite” in refuting the 364’s prognoses. Demand and output started to move upwards in the second quarter of 1981, just as the debate about the Times letter was at its most intense. Although unemployment remained high for some years, the economy gathered pace and in the late 1980s entered another boom. If this was a laboratory experiment for Keynesian economics, its results suggested that the textbook formulas were flawed. Old-fashioned principles of sound finance returned to favour in the UK, while the ratio of public debt to gross domestic product fell to manageable levels. For more than 25 years Keynesian fiscal activism was ignored or even forgotten.

But the events of the 1980s have been ignored, particularly by writers of textbooks. As Tim notes:

But university economists continued to teach Keynesian macroeconomic as if nothing had happened. Sure enough, in Britain many academics realised from the sequel to the 1981 Budget that something was wrong with Keynesianism or, at any rate, with the naive versions of Keynesianism which emphasised the blessings of fiscal fine-tuning. But in the American East Coast universities — notably the Ivy League establishments — the UK’s 1981 Budget was too parochial an event to justify rewriting textbooks and lecture notes. Such influential figures as George Akerlof and Robert Shiller of Yale, Paul Krugman of Princeton and Joseph Stiglitz of Columbia, all now Nobel prize laureates, continued to teach that an increase in the budget deficit adds to aggregate demand and a decrease deducts from it.

And so here we are, dragging our economies down by pretending we are doing them good.

Debating Keynes – part 2

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The one thing about our economies everyone can agree on is that they are in a mess. The question then is, what’s the reason for the mess they are in and what should be done to fix things up? The potential for the present dismal state of affairs to drag on for another decade or more is a genuine possibility, just it has done in Japan since it tried its own stimulus in the 1990s. Such an outcome is all the more likely given the continuous belief, fostered by standard textbook macroeconomics, that a government stimulus is essential if a recovery is to occur. It is this belief that will keep our economies in permanent disarray. There is therefore no economic issue of more importance at the present time than whether such Keynesian policies should be continued.

I am in the midst of an “exchange of letters” on Keynesian economics with Louis-Philippe Rochon, the editor of the Journal of Keynesian Economics. We had each written one letter – (my first is discussed here) – and now I have written my second, which may be found at this link under the title: “How to Promote a Global Economic Recovery? ‘Markets… have been the single most liberating institution in possibly the entire history of the human race’.” You can find all three of our letters, my two and Louis-Philippe’s reply to the first, at the link.

The letter that has just been published was, in fact, the second I had written in response to his. What follows below is the first version I wrote in reply, which is still trying to get at the same ideas but in a different way.

Dear Louis-Philippe

Thank you for your reply which I must confess was not really a reply to the issues I raised. I wrote to explain why a stimulus could not possibly have worked, emphasising the theory. Your reply has merely stated that we have not really had a stimulus since it was prematurely brought to an end and that in your view, it is the absence of a stimulus that is causing our economies to fall into deeper recession. You then go on to provide your own Keynesian program with nothing to support it other than your own set of preferences for public spending.

But if we are to examine the record, let me remind you that there has never been a single example of a Keynesian stimulus that has ever succeeded in returning an economy to full employment and strong rates of growth. Not a single one, not one, not ever.

The one example that gets trotted out from time to time was the outcome of the Kennedy tax cuts of 1962. But tax cuts are not increases in public spending, and are in perfect keeping with pre-Keynesian policy. It was the same approach that Ronald Reagan took in the 1980s and with equal success.

Increases in public spending have never succeeded in bringing an economy out of recession. The United States notoriously, in spite of the spending and deficits of the Roosevelt administration, never returned the American economy to full employment. It was only the coming of the war in 1941 that brought the Great Depression in the US to an end.

By then, the rest of the world had left the Depression behind long before. Even by the time The General Theory was published in 1936, the Great Depression had long disappeared in the UK. Unemployment was still high but the worst was well and truly over. By 1937 Keynes was worrying about inflation, not unemployment.

Moreover, the policy approach in the UK had been entirely classical. The British Chancellor of the Exchequer (ie the Secretary of the Treasury) in his 1933 budget speech specifically noted that the budget had finally been balanced, and correctly forecast that recovery would therefore soon be under way.

Where are the success stories to go with the obvious failures that were found pretty well everywhere in the 1970s and 80s, in Japan in the 1990s, or the experience of every economy that had tried a stimulus after the Global Financial Crisis in 2009. There is not a single example of a successful stimulus you can point to.

Let me also remind you of the greatest disproof of Keynesian economic policy in history. Everyone always points out that one Keynesian data point which is the so-called boom that came at the start of World War II. Not a boom at all since what most people remember about the home front was rationing and controls of every kind. And if you are thinking about the labour shortages, merely recall that around half the male workforce under thirty was drafted into the armed forces. But that’s not that point either, although it should put quite a dent into such Keynesian thought.

It is the coming of peace in 1945 that is the grand refutation of Keynesian economics. At the end of the war, in the space of a year millions who had been overseas fighting, or had been part of the war effort at home, were suddenly in the labour market looking for work. Think of these as millions of people who had suddenly lost their jobs all at once. Many women who had taken jobs while the men were overseas also remained in the workforce. The Keynesians were continually badgering Truman to maintain war-time deficits since, they said, if he did not the US would go straight back into the depression which in the United States had ended only four years before.

Truman, however, having had a business background, was adamantly opposed to deficits and as a result the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures, balanced its budget and in so doing set off the greatest economic boom in world history, a boom that lasted straight through until ground into the dust by the war on poverty, and dare I say it, the unfunded, deficit-financed war in Vietnam.

Thinking about macroeconomic issues from the demand side is amongst the biggest mistakes anyone in economics can make.

Given its perfect record of failure, why does Keynesian macro persist? Why is it still taught in our textbooks? Aside from being very simple to understand, it remains in place because, disastrous though the policies Keynesian theory promotes may be, it is loved by governments, the bureaucracy and that brand of entrepreneurial activity that today goes under the name of “crony capitalism”. Keynesian policies may not do much for the poor and unemployed but it brings amazing dividends to our economic and political elites.

Before Keynes, governments knew their limits. There was no pretence that beyond a narrow range of activities, there was little a government could do that would be value adding. It was universally appreciated that during recessions governments could take various steps to reduce unemployment and that there was a limited role for governments to have projects available that could soak up some of those who lost their jobs. Nothing new in that.

Today, with macro so drenched in Keynesian conceptions, government spending of all kinds on just about anything, is seen as wealth creating. Politicians, who know nothing about running a business, nevertheless believe themselves capable of making billion dollar decisions because they believe that whatever they spend on will, of necessity, raise the level of economic growth and add to communal prosperity.

The confidence with which governments devised expenditure programs following the GFC in the apparent belief that recovery would follow soon after was incredible to those few of us who understood that it is impossible to increase growth by increasing public waste of resources.

In his introduction to The General Theory, Paul Krugman summed up Keynes’s message in four points, which are almost identical to my own description of Keynesian economics:

“1. Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment

“2. The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully

“3. Government policies to increase demand, by contrast, can reduce unemployment quickly

“4. Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach.”

This is the theory that is drummed into every introductory student in economics and which maintains its grip unless specifically taught that these four propositions are fundamentally wrong.

And within the worldwide community of economists, no more than around two in a hundred are ever taught to reject such beliefs, and even with this two percent only a small proportion ever come to understand what is actually wrong with the macro they have been taught. The rest more or less accept the theory as it comes, which is why when the Global Financial Crisis struck, there was virtually no opposition to the stimulus from within the economics community.

Even now, as governments struggle to deal with the debt and deficits they have created in their various expenditure programs – almost none of which will ever have a positive return – there is still no general understanding of what went wrong or how to fix what is clearly broken.

The four fundamental principles of Keynesian economics are so ingrained that most economists are not even aware that before Keynes, such beliefs were recognised as utterly fallacious and the mark of an economic illiterate.

Again, I can do no more than remind you of the second edition of my Free Market Economics which discusses both the Keynesian and the classical theories of the cycle. Here I can do not much more than raise your interest in these wrongly discarded theories of the cycle. If you would like to know more about what they said, and why modern macro is so deeply flawed, it is to my text you must go.

Yet another Keynesian success – the twenty years and counting Japanese lost decade

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There has never been a single Keynesian success in any place at any time. David Stockman does a review of Japan as it goes into its third recession since the 1990s. But what is notable is that the Japanese seem incapable of learning from their mistakes.

In short, these Keynesian apparatchiks have created a straw man that suits the purposes of their political masters on the fiscal front by rationalizing the monetization of endless amounts of public debt; and it empowers the state’s central banking branch to engage in plenary manipulation of the entire financial system on the misbegotten theory that fiat credit and bubble wealth can cause real production, incomes and wealth to rise.

Stated differently, Keynesian fiscal policies and central banking regimes have buried the public sectors of most of the world’s major economies in unsustainable debt. Now they propose to double down on more of the same because an entire generation of politicians have been house-trained in permanent fiscal profligacy and endless kicking of the fiscal can down the road.

To be sure, in putting off Japan’s day of fiscal reckoning once again, this time until 2017, Prime Minister Abe is proving himself to be a certifiable madman. In short order, however, he will have plenty of company all around the planet.

That was the conclusion; now go read the rest.

The endless supply of Keynesian nonsense

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I have now received Louis-Philippe Rochon’s reply to my critique of Keynesian economics which was the lead comment in an exchange we are having on Keynesian economics. His reply comes under the heading, How to Promote a Global Economic Recovery? “The worst infliction we can impose on our economies is to leave them to the tyranny of the markets”.

Thus, from the very heading I can see how far apart we are. There are an astonishing number of techniques and approaches that can be used to manage an economy with public spending to get an economy out of recession only one amongst this vast array of possibilities. If you are going to start with the assumption that not trying to spend your wasteful way to recovery is the same as laissez-faire then there is no possibility of ever understanding how badly our economies are now being mismanaged. But perhaps that is just the title. What more does his letter say? Let me pick up his argument point by point, starting with this misbegotten piece of theory.

The driving force behind economic growth both in the short run and the long run is aggregate demand, pure and simple. . . . Yes, that’s right: more government spending leads to more investment. It’s a crowding-in effect!

Nothing to lift an economy like public investment! Every business like the post office. Every investment another Solyndra. All subsidised with nothing self-sustaining through the revenues it earns. Dig a hole and get fill it in again. Don’t worry about earning a greater return than the funds outlayed. Just close your eyes and spend. Don’t worry, it will all work out once that magic multiplier cuts in. If this is all there is to the theory, there is nothing there but wishes and wind. But there is also your recollection of those magic Keynesian moments at the end of World War II.

My recollection of Keynesian policies is quite different: they contributed to 3 wonderful decades of growth following WWII – what we fondly call the Golden Years of capitalism. Keynes is quite evidently the greatest economist of the 20th century who saved capitalism from self-destruction. For that, he is remembered as one of the greatest thinkers.

First, the General Theory was published in 1936, three years after the Depression had come to an end in every economy but the United States, where it dragged on until the coming of the war to the US in 1941. And, of course, those three wonderful post-war decades were preceded by the decision of the United States in 1945-46 to balance its budget immediately. The massive wartimes deficits were instantaneously brought to an end and a balanced budget put in its place even with millions returning to the workforce after being mustered out of their wartime military service or from their jobs in wartime industries. The Keynesians of 1945 all wanted a continuing deficit but Truman turned them down.

How does a Keynesian explain that, I wonder? We are instead reminded of the supposedly woeful economic outcomes of the 1980s, which I must confess not to remember in quite the same way as this:

By contrast, starting from the 1980s, with the monetarist debacle and the real business cycle shenanigans, we ended up with less average growth and higher average unemployment rates.

It is a contrast, of course, but the contrast of importance is with the 1970s, the greatest period of Keynesian disaster until the one we are in the midst of now. The catastrophic stagflation of the 1970s, where deficits and spending only led to high unemployment and a blowout in inflation that could only ultimately be controlled by a fierce monetary policy that finally did regenerate a period of prosperity that continued for another two decades. But what about the period after the GFC when governments were spending hand over fist on one stimulus after another.

While governments did put into place Keynesian aggregate demand policies in 2009, they quickly abandoned these policies in 2010 in favour of austerity measures.

A one-year stimulus, was it? The US is the paradigm example. Despite Congressional attempts to slow the growth in the deficit, the attempt to contain public spending in the US only seriously began with the sequester in 2013!
And indeed, the White House specifically dates the commencement of the sequestration from the first of March that year. If ever a stimulus was given time to work itself out, that was then. The disastrous response of the American economy to the stimulus is perfectly in line with my own argument. The very belief that conditions were improving up until the sequestration began can only mean we are living in a parallel universe.

But how much we differ on the timing when restraint finally began, we can certainly agree on the current disaster. He may think it’s because the stimulus was brought to an end too soon. I think of it as the inevitable consequence of a Keynesian policy.

When you look at aggregate demand today, it is at best anemic. Consumers are saddled with debt, and private investment has flatlined; austerity measures are being imposed everywhere. There is no room for growth. That leaves only exports to ensure a recovery. But with Europe on the verge of deflation, the BRIC countries slowing down, the prospects for exports are dimming. So where will growth come from? I am afraid that without aggressive fiscal deficit spending, we are dooming future generations and ourselves to another decade or more of weak economic growth.

On this much we can agree, that the world’s economies are in a mess. Consumers deep in debt, savings eaten away by low productivity government spending, and private investment going nowhere. And I didn’t just say the stimulus would not work; I said the stimulus would make things much much worse. You describe what I see, but I expected things to end like this from the start. You could only start to recognise a problem more than a year later, and only because by then it was obvious to all and sundry that in every place the stimulus had been introduced economic conditions had become much worse. You nevertheless continue to believe that the problem is not enough government spending.

This secular stagnation is the direct result of a lack of fiscal spending advocated by austerity voodoo doctors and charlatans.

I understand that the principle of cause and effect never applies to Keynesian theory. The plain fact is that there has never been a single instance in the whole of the period since the General Theory was written that a public sector stimulus has been able to bring a recession to an end. There is not one single solitary example, with the coming of World War II the only supposed example when unemployment ended mostly because half the male population under 30 was put into the military.

It is not aggregate demand that matters, but value adding aggregate supply. You must do more than build brick walls, you must build where what is built actually contributes to future prosperity. To think more holes dug up and then refilled can generate recovery because it constitutes “fiscal spending” is the essence of economic illiteracy. And for true economic illiteracy, it’s hard to go past your program for recovery:

First, we must replace private debt with public debt.

Second, we must put job creation above all other goals.

Third, we must deal head on with the problem of income inequality, which is at the very core of the crisis in aggregate demand.

Fourth, with respect to Europe . . . they must either adopt the proper federal institutions to deal with the problems facing the Southern countries, or get rid of the Euro all together.

That is to say: we must socialise our economies.

Private debt is incurred by private sector firms. To replace this debt with public debt would so obviously drive us into us deep recession that it is almost impossible to understand how this is not perfectly obvious to you.

If such a program appeals to you merely because of this aggregate demand incantation of yours, I’m afraid, your program would be part of the problem and in no way part of any solution. I fear, however, that three quarters of a century after the publication of The General Theory, economics is now at such a low ebb that what you have written will look like perfect good sense, even as every attempt to do what you have suggested would make things worse than they already are.

In times gone by, before Keynes, economists talked about “effective demand”, that is, what had to happen to turn desire for products into an ability to buy those products. Now it is aggregate demand – the total level of demand – which has leached the original concept of any understanding that for everyone to buy from each other, they first have to produce what each other wish to buy. If that is not obvious, then common sense has gone from the world.

But I say again. A short post cannot state everything that needs to be said. For a more complete explanation of these issues and what needs to be done, you must turn to the second edition of my Free Market Economics. It’s still not too late, but it is getting later all the time.

Debating Keynes

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The single most timely piece of economic writing I ever managed to put together was for Quadrant which was published online in February 2009 just as the various stimulus packages were being rolled out across the world. The title it was given, much more aggressive than I might have chosen myself, was The Dangerous Return to Keynesian Economics. And while the whole thing could have been written today without the need for a single change to bring it up to date, the passage I have quoted time and again is this:

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.

Keynesian economics is, was and always will be a disaster wherever it is applied. That virtually no one understands why that is after three generations of economists have gone through their economics education with standard Keynesian macro at its core is to be expected. What is far less expected is that there has been no serious effort to examine more closely what went wrong after the failures of the stimulus.

As it happens I am at the start of an online debate with Louis-Philippe Rochon, Associate Professor of economics at Laurentian University, the founding co-editor of Review of Keynesian Economics and co-editor of New Directions in Post-Keynesian Economics which is an Edward Elgar book series. One presumes that if anyone can defend Keynesian economics he is the one to do it.

I, however, have been the one to open the batting. Keynesian economics has so many different disguises that unless I could narrow the lines of the debate to within some kind of practical dimensions there would have been no hope of limiting the range of where such a conversation might end up. Elgar has now published the first of these exchanges, How to Promote a Global Economic Recovery? The Keynesian vs. Free Market Approach. Crucially, the delimiting of the debate was the first essential. I therefore began with this:

There are about as many versions of Keynesian theory as there are Keynesians but all versions have two things in common. The first is that economies are driven by aggregate demand. The second is that an economy’s rate of growth and level of employment can be increased by increasing aggregate demand, either through higher public spending or lowering rates of interest. Both are wrong and the destructive consequences of these beliefs are everywhere to be seen.

What I can tell you from personal experience is that the notion of aggregate demand as a driver of economic activity is now so universally believed that it is nearly impossible to get anyone even to see that it might possibly be wrong, that there is another way of thinking about things. But before Keynes came on the scene, no economist, other than a handful of cranks, ever thought that economies were driven from the demand side. What they believed instead was this:

Certainly a government can itself employ, or can buy from others causing those others to employ. And those additional employees can use their incomes to buy things from others still. And so, for a brief period of time, we can say there has been an increase in employment relative to how many might otherwise have been employed.

But unless whatever has been produced is value adding, as time goes by these additional employees merely drain away the productive capacity of the economy. Savings are indeed absorbed but the value left behind is lower than the value used up during production. The economy not only remains stagnant, it winds even further down as its resource base is diverted into wasteful forms of expenditure.

This is the classical pre-Keynesian view of how an economy works and why a stimulus never will. That the classical theory so perfectly captures the economics world we see around us should at least make someone stop and think about the macroeconomics we teach. There should therefore have been at least some consideration that giving politicians and public servants the power to direct such large proportions of our economic resources could not possibly have improved economic outcomes but would only make conditions worse. These are people who, except in the rarest of circumstances, have absolutely no ability to direct a productive enterprise in a value adding way, as they have shown at every turn. It has therefore been astonishing to see that thus far there has been virtually no re-consideration of Keynesian theory and the policies it underwrites, given the evident failures of the stimulus everywhere it has been introduced.

In a week’s time, Louis-Philippe will provide his reply to what I have written. I will naturally post what he writes since I am extremely curious to find out whether there is something I have missed, some bone-crunching reply to the issues I have raised. Although I have looked everywhere for some such reply, thus far I have found nothing, but we shall see.

Obviously, my arguments cannot be properly explained in a brief note of a thousand words. If you are interested in understanding not only why Keynesian economics provides no solutions to our economic problems, but also what should be done instead, read the second edition of my Free Market Economics: an Introduction for the General Reader. There is literally nothing else like it anywhere, which is itself a large part of the problem we have.

Business conditions jumped by a record amount in October

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You never know what surprises are in store if you get the budget under control and encourage the private sector. Merely a straw in the wind but the direction is right. These are the results from the latest National Bank monthly survey.

BUSINESS conditions jumped by a record amount in October, hitting their highest level since early 2008 on the back of a strong start to the fourth quarter, according to a private survey.

National Australia Bank’s monthly business survey showed a sharp jump in business conditions — the largest monthly increase in the history of the survey — up 12 points on the index, to a reading of 13.

But NAB chief economist Alan Oster said the improvement may still be an aberration, considering the downward trend in business confidence.

The survey showed business confidence continuing to erode, as firms remain uncertain over near-term demand. The index dropped 1 point to a reading of 4, its lowest level since a pre-election jump in mid-2013.

But looking beyond monthly volatility, business conditions still came in with a reading above the long-term trend, Mr Oster said.

While confidence levels vary greatly across industries, the services sector has been the most consistently optimistic.

Mr Oster said despite consumer caution and rising unemployment, it was particularly surprising to see retail conditions lift strongly, up 15 points, albeit to still low levels.

The mining sector also saw an improvement in both confidence and conditions, recording the largest jumps in both, but still remained the sector with the lowest overall conditions reading.

The large jump in business conditions pointed to a strong start to the fourth quarter, Mr Oster said.

The Kronies

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John Papola on the Michael Loftus show in the US. An amazing piece of TV and there, on episode 7, was John discussing some of his creations with The Kronies amongst his latest. His first rise to fame was with the Keynes-Hayek Rap, the single most watched video on an economic matter ever produced, and one which sadly remains still relevant and important. I show it to my four classes each semester, along with the brilliant Deck the Halls with Macro Follies, and no matter how often I watch them, I never find it has been one time too many. Students get the point.

More on Big G and the Kronies:

John Stuart Mill’s Principles of Political Economy

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I have long had a view that John Stuart Mill’s Principles of Political Economy is the best economics book ever written. But I have now also come to the view that no one is ever going to contradict me because virtually no one can any longer read the book. I have just been back over the book on a project on Mill I am just beginning and turned to Book I Chapter II which is “On Labour”. I say to you in all honesty that it is a fascinating chapter from which there is much to learn, including how little there is that is truly new that is not in Mill. But here is the opening para of the chapter from which the one thing I guarantee you will learn is how hard the book must be to read.

§ 1. The labour which terminates in the production of an article fitted for some human use, is either employed directly about the thing, or in previous operations destined to facilitate, perhaps essential to the possibility of, the subsequent ones. In making bread, for example, the labour employed about the thing itself is that of the baker; but the labour of the miller, though employed directly in the production not of bread but of flour, is equally part of the aggregate sum of labour by which the bread is produced; as is also the labour of the sower and of the reaper. Some may think that all these persons ought to be considered as employing their labour directly about the thing; the corn, the flour, and the bread being one substance in three different states. Without disputing about this question of mere language, there is still the ploughman, who prepared the ground for the seed, and whose labour never came in contact with the substance in any of its states; and the plough-maker, whose share in the result was still more remote. All these persons ultimately derive the remuneration of their labour from the bread, or its price: the plough-maker as much as the rest; for since ploughs are of no use except for tilling the soil, no one would make or use ploughs for any other reason than because the increased returns, thereby obtained from the ground, afforded a source from which an adequate equivalent could be assigned for the labour of the plough-maker. If the produce is to be used or consumed in the form of bread, it is from the bread that this equivalent must come. The bread must suffice to remunerate all these labourers, and several others; such as the carpenters and bricklayers who erected the farm-buildings; the hedgers and ditchers who made the fences necessary for the protection of the crop; the miners and smelters who extracted or prepared the iron of which the plough and other implements [30] were made. These, however, and the plough-maker, do not depend for their remuneration upon the bread made from the produce of a single harvest, but upon that made from the produce of all the harvests which are successively gathered until the plough, or the buildings and fences, are worn out. We must add yet another kind of labour; that of transporting the produce from the place of its production to the place of its destined use: the labour of carrying the corn to market, and from market to the miller’s, the flour from the miller’s to the baker’s, and the bread from the baker’s to the place of its final consumption. This labour is sometimes very considerable: flour is [1848] transported to England from beyond the Atlantic, corn from the heart of Russia; and in addition to the labourers immediately employed, the waggoners and sailors, there are also costly instruments, such as ships, in the construction of which much labour has been expended: that labour, however, not depending for its whole remuneration upon the bread, but for a part only; ships being usually, during the course of their existence, employed in the transport of many different kinds of commodities.

He does wear you out. I have visions of Mill, who wrote this thousand page book in about eighteen months while holding a full-time job in the East India Company, sitting there in his free moments with his pen, ink and paper, scratching out the text as he tried to distill his thoughts into something coherent. The man with the highest IQ in the nineteenth century, his book was the byword for economic theory for the following fifty years and then some. My copy is a discarded text from the 1920s that was still being used at the University of Melbourne. If you would like to see Mill up to date, you can read the 2nd ed of my Free Market Economics and when you see the book (unless you read it electronically) you will understand why the cover shows a water mill as its main motif.

To which from further comments I must add this:

John Stuart Mill,
By a mighty effort of will,
Overcame his natural bonhomie
And wrote “Principles of Political Economy.”

Roosevelt prolonged the depression in the US by seven years

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Here’s a story that has only ever been unknown to Keynesian economists: FDR’s policies prolonged Depression by 7 years, UCLA economists calculate. Whether they have properly explained what exactly Roosevelt did wrong is another story, but at least there is finally some acknowledgement that his economic policies were directly at fault a mere eighty years after the fact. It is laughable to see that the authors argue that up until now we had not known the reason for the delayed recovery. But it is actually more than that. Now that they have found something that removes the blame from the Keynesian policies FDR adopted, they are finally willing to state in print that Roosevelt’s policies actually were the disaster everyone always knew they were.

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

After scrutinizing Roosevelt’s record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

“Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump,” said Ohanian, vice chair of UCLA’s Department of Economics. “We found that a relapse isn’t likely unless lawmakers gum up a recovery with ill-conceived stimulus policies.”

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

“President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services,” said Cole, also a UCLA professor of economics. “So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.”

You need to read the whole article but let me take you to the very last para which has major implications for today:

“The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes,” Cole said. “Ironically, our work shows that the recovery would have been very rapid had the government not intervened.”

It’s a strange business since the article points out what I thought was common knowledge, that Roosevelt’s policies delayed recovery. But what it doesn’t do is put the blame on public spending which is where the blame truly belongs. It can therefore, in its own convoluted way, be taken as a defence of Keynesian policies since these were not the problem. Instead the blame for the astonishingly slow recovery is placed on industry policies which no doubt played their part. Eighty years from now someone will write a paper to argue that the Obama administration had been responsible for the slow recovery of the present moment but it will be blamed on something else instead – Obamacare maybe – rather than the fiscal and monetary policies whose effects will continue to be ignored just as they are ignored today.

The interventionists within economics is down to the last 95% of the profession but at least there is progress being made. The aim now is to save Keynesian economics, and if it requires finally admitting that Roosevelt had prolonged the depression, well that is how it will have to be. Since their conclusions take Keynesian economics off the hook, these results may end up being embraced as at long last solving a “mystery” that no one should ever have actually been mystified about.

Ha-Joon Chang – please copy

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Ha-Joon Chang seems to be the economist of the moment, with yet another book published by Penguin, Economics: The User’s Guide. But what is notable for me is that he has obviously, but only obviously to me, looked either at what I have written about Say’s Law or looked at someone else who has picked up on what I have written on Say’s Law. He does the usual ritual on “supply creates its own demand” but then adds:

“There can be no such thing as a recession due to a shortfall in demand.” [p 116]

You who have heard me harangue on this for many a moon may think nothing of this, but this is precisely the definition I use myself. It is apparently and pleasingly getting out and about. Because once the focus is in the right place and on the right thing, then we can have a genuine debate. Are recessions caused by a shortfall in demand? Because you would have to be demented to believe that the Global Financial Crisis was in any way caused by a fall off in demand. Same for every other recession in history up until now. But if one merely looks at the GFC, a fall in demand because of decisions to save has to be the least plausible of all possible explanations. In fact, Chang, and I think following my lead, goes on to describe the kinds of things that those classical economists used to look at for explanations, which again you would have to be demented not automatically to look at yourself. He writes:

Any recession had to be due to exogenous factors, such as a war or the failure of a major bank.

He thinks bank failures are exogenous [ie external to the operation of the economy, like being hit by a meteorite, say]! A bank failure is precisely what might be thought of as both endogenous and not in any way a Keynesian explanation, which is based around demand failure due to too much saving, not some kind of crisis on the production side. And you would like then to know what caused the bank to fail, and whether the problem was more widespread than a single bank, since during a financial crisis there is never only one bank going to the wall.

But then he goes on to add the usual Keynesian idiocies since economists just do not seem to be able to help themselves:

Since the economy was incapable of naturally generating a recession, any government attempt to counter it, say, through deliberate deficit spending, was condemned as disturbing the natural order. This meant that recessions that could have been cut short or made milder became prolonged in the days of Classical economics.

You really do have to wonder about these blockheads! We are the midst of what may already be the most prolonged of all recessions in history, and it is by no means over yet, and he complains about classical economists’ reluctance of try to fix things by public spending. Let me once more quote from my Quadrant piece from February 2009 which was titled, The Dangerous Return to Keynesian Economics:

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.

That is classical economics forecasting almost six years ago the prolonged recession every economy in the world is in the midst of and cannot shake off. If you would like to understand more fully what classical economists actually believed, you cannot do better than this.