Category Archives: Law of Markets

A skill testing question in economics from 1886

Posted on by
Reply

The mail has just brought me my own copy of Simon Newcomb’s great 1886 economics text, Principles of Political Economy. Just for fun, I offer you one of the questions at the end of one of the chapters that no modern student of economics ever gets asked or would likely have a ready answer to.

Trace the economic effect of the frugal New England population putting their money into savings banks. What do savings really consist in?

Even the notion of a frugal population is pretty antique. But all the difference in the world lies in the answer to that question.

Say’s Law and the failure of Keynesian economics

Posted on by
Reply

I am very happy to say that the best paper I have ever written was just yesterday accepted for publication. It’s on John Stuart Mill’s Fourth Proposition on Capital which he published as part of his Principles of Political Economy in 1848. In his own lifetime it was never challenged. Leslie Stephen (who incidentally was Virginia Wolf’s father) described it in 1876 as “the best test of a sound economist”. And yet by 1890 and ever since, although some of the great minds of economics have had a go at it, no one has been able to make straightforward sense of what Mill had meant. And when I say some of the great minds of economics, I am including Alfred Marshall, Friedrich Hayek and Allyn Young.

I should also add that understanding Mill may be amongst the most important issues of our time. Keynesian economic theory, which argues the exact opposite of what Mill had written, has had a devastating effect on every economy in which a Keynesian policy has been applied. Our economies are sinking under the weight of useless public spending and misdirected expenditures under the delusion that such spending will actually do us some good. Mill and every one of his classical contemporaries perfectly well understood that wasteful non-value-adding spending would not only do no good, it would actually do positive harm.

So what was this Fourth Proposition. It may not look all that formidable but in it there lies a truth that may yet save our economies. What Mill wrote was this: “Demand for commodities is not demand for labour.” Or restated using the jargon of today: an increase in aggregate demand will not lead to an increase in employment. The principle stated here is the classical pre-Keynesian meaning of Say’s Law, which has vanished from amongst economists and been replaced by the Keynesian theory which had been specifically designed to refute Say.

For me, the disastrous outcome of the application of Keynesian policies was a certainty. It was beyond any doubt in my mind that the stimulus would not just fail but bring ruin in its wake. I put my views into print in February 2009 just as the stimulus programs were being put into place and my five-year review was published in March this year. In 2009 it was mostly just theory although there had been plenty of Keynesian failures before that. By 2014, the evidence has become so overwhelming that there should no longer be the slightest doubt that a Keynesian stimulus will sink your economy into a coma and leave it that way for years on end. If you want to know why, you can read Mill, or if you find a thousand pages of mid-nineteenth century prose a bit on the heavy duty side, you can read this instead.

When the Money Runs Out – the government’s guide to policy

Posted on by
Reply

Simultaneously reading today’s papers on the Commission of Audit report and the Economist and The Financial Times 2013 book of the year, Stephen D. King’s When the Money Runs Out: the End of Western Affluence, I can see what the latest fashion in economic policy has become. Here I heave a sigh of despair. This from page 54 sums it up:

With poorly performing asset markets and much lower prospective economic growth, our entitlements are about to take a hammering. On current plans, only wishful thinking on economic growth stops government debt from spiralling out of control in the decades ahead. If the wishful thinking proves to be wrong, we will be in serious trouble.

And if you doubt that the wise heads of Treasury and the Government have not been reading this book, this is how it is described by the publisher:

It’s not just the end of an age of affluence, he shows. We have made promises to ourselves that are achievable only through ongoing economic expansion. The future benefits we expect—pensions, healthcare, and social security, for example—may be larger than tomorrow’s resources. And if we reach that point, which promises will be broken and who will lose out? The lessons of history offer compelling evidence that political and social upheaval are often born of economic stagnation. King addresses these lessons with a multifaceted plan that involves painful—but necessary—steps toward a stable and just economic future.

And so here we are.

I am the last person in the world to argue that wasteful and unproductive spending can go on forever. Cut waste. Live within your means. Do what is required to cut non-value-adding expenditure. But this book is half the story of what needs doing or possibly even less, just as the Commission of Audit doesn’t to my mind get there either. So far I have not come across a single sentence in the book that indicates the importance of the “private sector”, “the role of business” or “entrepreneurial activity”. The words don’t show up in the index and nothing in the contents goes anywhere near these issues. It is all about government policy, the financial system, the level of entitlements and containing outlays on entitlements. Nothing about what is needed for growth, and as the subtitle suggests, “The End of Affluence”, is entirely pessimistic about our economic possibilities.

And if you follow the guidelines found in the book, you would have to agree. We can no longer afford our way of life, our living standards must contract and therefore the only thing governments can do is cut various entitlement programs but strangely leave public sector infrastructure spending more or less as it is. No discussion of cuts to public waste, those useless money-losing operations that are everywhere absorbing our scarce savings for a negative return. If the real economy is discussed at any point along the way, I have not come across it. It’s all money, finance and interest rates. Encouraging business investment, cost containment, reducing government regulation – of these there’s not a word.

You want growth, cut back on government take up of resources. I love the headline on this story because of its cluelessness: UK AUSTERITY TO STAY DESPITE GROWTH PICK-UP. This is re-stated in the first para:

Austerity will remain the U.K. government’s mantra, Treasury chief George Osborne said Wednesday — even as he lauded the stronger than expected economic recovery.

The people who write such stories think “austerity”, the name its enemies give to cutting back on public sector waste, is bad for the economy, and because of their Keynesian mindset can only be harmful. They have no idea that it is the austerity itself that has led to the higher than expected growth. They cannot even understand what possible connection there could be. Moreover, a return to a stronger economy is not a warrant for higher public spending. The lesson that ought to learned and understood is that non-value-adding outlays slow an economy down. Reducing those outlays allow the economy to re-adjust towards faster growth. And already the Treasurer is talking about personal tax cuts in the lead-up to the next UK election. If only the same would happen here.

What’s the matter with our own economic managers in this country? If they really do want to take Australia down into some kind of American never-ending recession, then maintain or possibly even increase public sector outlays, raise taxes and do next nothing to encourage private sector growth. That way, the money most surely will run out but it didn’t have to be that way at all.

Post-Crash Economics

Posted on by
Reply

The secret is getting out. And what secret might that be? That modern economic theory is next to useless, or at least useless if your interest is either to understand what’s going on or to manage the economy in a productive way with high employment and low inflation. This is from the introduction to The Report which has been issued by the Post-Crash Economics Society in the UK, organised round a group of students at Manchester University:

Economics education is monopolised by a single school of thought commonly referred to as neoclassical economics. Crucially, very few economists working within this mainstream predicted the Financial Crisis. Afterwards many concluded that the best predictions came from those economists that had been marginalised by the mainstream. Despite this alternative perspectives are still close to non-existent in undergraduate programmes. We demonstrate this through a detailed analysis of Manchester’s syllabus, which itself is representative of economics syllabuses around the UK. This lack of competing thought stifles innovation, damages creativity and suppresses the constructive criticisms that are so vital for economic understanding and advancement. There is also a distinct lack of real-world application of economic ideas, with the focus being on abstract modelling that often seems devoid from reality. Finally, the study of ethics, politics and history are almost completely absent from the syllabus. We propose that economics cannot be properly understood with all these aspects excluded.

I have just the book for them, the second edition to be co-published in July by the Institute of Economic Affairs in London. In fact I have two books since The Report makes a point of stressing how important studying the history of economic thought is to understanding economics.

There is a write up of all this in an article, Bank of Englands’s Haldane Backs Broader Economics, found in the Wall Street Journal. Economics must change and I am extraordinarily pleased to see the revolution is finally about to begin.

UPDATE: Some further comment of my own based on the thread at Catallaxy:

For me there are a few issues of comfort in spite of some sense of pessimism.
.
First, I am just happy to see the logjam of modern neoclassical economics finally broken. This is the first step in a much needed process even to have a declaration of disquiet about the way economics is taught. I cannot think it could get any worse than it is. They may not call themselves socialists but economic theory as currently taught is for all practical purposes a form of centralised economic management, with the level of G the most important driver.
.
Second, that the coming Chief Economist of the Bank of England and Steve Davies of the Institute of Economic Affairs are willing to buy in on this gives me some sense that this is not some Marxist thought based around expropriating the expropriators. But whatever the basis of the theory, the issue is to force the mainstream to defend their theory and its practical value.
.
Third, and very oddly, Post-Keynesian economic theory, so far as the business cycle is concerned, is almost identical to the classical theory of the cycle. Very odd to me to find this but I have even begun to write a paper on this very issue. I’m not sure they even are aware of the difference it makes, but in much that is written, they substitute effective demand for aggregate demand which means they are actually restoring Say’s Law since Say’s Law was the core of the explanation behind what made demand effective. It is no longer just a total but in this way becomes a theory of economic activity.
.
Fourth, bringing back the history of economics and economic history can only be positive. The attempts to shut these out are attempts to shut down various forms of debate.
.
Fifth, we shall see.

Pre-budget nerves – my list of dos and don’ts

Posted on by
Reply

I am getting a bit nervous about the budget that’s brewing, no longer behind the scenes but with a few strategic leaks breaking into the news. As you may know, I am no Keynesian but I went back and took a look at my own Free Market Economics text since I could not remember whether I even mention the word “deficit”. The index has it listed once, three pages from the end on page 332.

Here are my thoughts on things. Why they left a Labor-supporting Keynesian to manage Treasury in the single most important budget they will ever introduce is beyond me. Anyway, here are my thoughts.

It’s not the deficit per se that matter but the level of public spending.

If you want to fix the economy, resources must migrate from being under the direction of the public sector and into the hands of the private sector. Therefore, the focus should be on cuts to non-value-adding forms of public spending. If it doesn’t show a positive return within a reasonable period of time, cut it off. This, by the way, is not an anti-welfare message although welfare too must be affordable. I am talking about infrastructure and the many forms of waste and mis-regulation that are found at every turn.

The economy will grow, employment will grow, real wages will grow if and only if economic activity is directed by private sector entrepreneurs. It will shrivel under the direction of government. Do not even imagine anything much beyond the first 10 percent of what you are already spending will create economic growth. Cutting public spending will create growth, not maintaining existing levels.

Raising taxes to fund public spending is a deadly mistake and wrong twice over:

. Higher taxes will allow you to maintain the level of public sector direction of our scarce economic resources.

. Higher taxes will reduce activity in the private sector.

The core aim must be to encourage entrepreneurial activity. There is no budget problem that cannot be fixed by:

. Reducing the level of unproductive public spending

. Fostering private sector growth (where unproductive spending has its own very brutal cure).

If the strategy is to balance the budget in ways that will diminish private sector investment and entrepreneurial activity, it will make things worse, not better. Economic conditions have been improving since the change of government with nothing much at all having been done. Leaving things alone is better than introducing new programs or raising taxes to fund existing forms of waste. Step back, get out of the way, cut your own take up of resources. But for heaven’s sake, don’t apply some bizarre Keynesian budget-surplus strategy by funding the existing level of public spending at the expense of the private sector.

The Basic Axioms and Principles of a Free Market Economy

Posted on by
Reply

I didn’t even know this existed until today but have just come across it. It is a presentation I gave at the IEA in London in 2011 just as my Free Market Economics was being published. The sound is not that good but the points are a good deal less fluffy than the kinds of things you usually hear in such lists. This is not a homily about how economic activity involves trade offs or that incentives are important. This is about how the world is filled with uncertainty and that governments are hopeless at directing our resources in a productive way. This is about do’s and don’ts which is what a good economics book needs to set out.

My 1000th post

Posted on by
Reply

Started on September 23, 2012 and today number 1000. Mostly unread with a few who seem to come regularly but still for my own indulgence. I had the largest number of hits ever on this site through a casual reference from Mark Steyn and the traffic went to five times the previous high and then over the course of the week fell back to normal. It reminded me that even if that were the number of people who came here regularly, it would still be mostly a private blog of no interest to anyone. Mostly for fun and while I do blow through an enormous number of hours doing this, it is still a labour of love. Most people who show up on this site have googled something and been referred to some earlier post of mine that I had forgotten all about so reading those again after a period of months, and now even sometimes from more than a year ago is quite pleasant and interesting. Anyway, hi Joshi. Still reading?

The youtube video above, by the way, I have taken from a blogging colleague who used it to commemorate his 2000th post. I hope he won’t mind. But for something more my style and reflecting my own personal history as well we have Peggy Seeger and Pete Seeger in concert.

A tale of two airports

Posted on by
Reply

Government spending absorbs national saving. Unless those resources are used in a value-adding way, the economy becomes worse off rather than better off. Spending of itself is not the road to growth. Only spending that creates more value than is used up during production leaves you ahead. We in the supposedly capitalist economies of the West are systematically ruining our economies because our governments waste our resources at prodigious rates rather than creating value or leaving those resources to be used by those who can. The United States is in the midst of turning itself into the Argentina of the twenty-first century. And as Exhibit A, let me take you to these passages from a recent column by Peter Costello, a great Treasurer because he understood these issues intuitively and with great clarity. Here he is discussing what was unmistakeable on a fight from New York to Hong Kong:

The real thing that was troubling me on that long flight to Hong Kong was why countries like the United States do infrastructure so badly when places like Hong Kong do it so well. When I flew out of New York’s Kennedy Airport, the Airtrain wasn’t working. Passengers had to bus from one Terminal to another. People were squeezed in excess of safety limits, more like battery hens than human beings. The security staff were surly and difficult. The planes were late and the terminal was rundown.

Flying into Hong Kong was like returning to the developed world. The terminal is connected to the city centre by a fast rain. Massive purpose-built suspension bridges and tunnels link it by road. Hong Kong reclaimed the land to build the airport from the sea — just as it has for other major developments.

Both these airports are owned by government authorities. Before someone tells you that we need higher taxes to pay for more infrastructure just remember that Hong Kong, with its airport and its first-class Mass Transportation System, has one of the world’s lowest tax rates, with a top income tax rate of 17 per cent and no GST.

I suspect that Hong Kong airport may be like the Moscow subway, a much more ornate facility than would be justified by the return alone and heavily subsidised as a showpiece to the world. Whether other less visible infrastructure spending in Hong Kong is equally substantial I would have my doubts. But the airport in New York is falling to bits because the capital required for mere maintenance is unavailable because so much of it is already being wasted by governments. There is an immense amount of capital in the US to get through, but Obama and the Democrats, ably assisted by the Republicans, are wasting their inheritance. Ten more years of this and it will be a poor country, as much of the country already is. There are huge lessons for us if we have the wit to understand them. I only say again that modern textbook economic theory will explain almost none of this.

Picked up at Andrew Bolt.

Economists then and now

Posted on by
Reply

Not often a blog post begins with a statement that I find profoundly true and important, but there was this the other day:

Economic Illiteracy and Global Economic Worries

An economist used to be a person who was able to explain why the economy works well without interference by the state, and, indeed, better than if such meddling were to be effected. Nowadays, an economist is a person who affirms that the economy can only work properly thanks to interventions by the state.

The economist – versed in knowledge about the invisible hand – has metamorphosed into a staunch proponent of economic policy, the politician’s advisor ambitious to steer the visible hand.

Which then continued as follows which was even more pleasing:

Steve Kates writes in his superb Free Market Economics. An Introduction to the General Reader:

The approach taken to teaching economics has become one in which the market mechanism is … taught only so that there is a basis for explaining why markets … [do] not operate properly. The market mechanism is seldom explained as what it is: the sole means to achieve prosperity and the basis for a continuing improvement in living standards for an entire population [p.284]. … [F]ew are any longer taught that economies have major properties for self-adjustment and are able to recuperate on their own without major government involvement. [p.287]

One of the great dangers of a state monopoly in education is that it provides inordinate leverage for uniform patterns of thought.

The massive distortions in the leading modern economies do seem to be intimately related to the prevalence of the politically both subaltern and ambitious(-for-power-and-status) “economics” of market failure and dirigiste conceit.