Now in Washington and have been for the past two days. Yesterday, the Wall Street Journal ran an article by Alan Blinder which led me to write a letter in response. Blinder’s article was titled, “The Economy Needs More Spending Now” which drew this comment from me:

I have a double barreled worry when I read articles such as Alan Blinder’s “The Economy Needs More Spending Now” in The Wall Street Journal. I worry because of the argument which is wrong but I also worry because you have published it which suggests an editorial policy in its support. There are plenty of other places one can go to for arguments supporting a continuation of public spending as a stimulus aimed at encouraging employment. What worries me is that there is virtually nowhere to go if one wishes to hear and understand the other side.

The distinction Blinder makes is between the need to encourage public spending in the short run which will eventually become unnecessary in the long run. The trouble is, he does not address the true nature of the problem which is that public spending – especially on the list of items that are considered as part of a stimulus package – are never value adding. They drain the economy rather than building it up and therefore make employment more tenuous, not less. Blinder is 100% right to note that long-run growth is supply-determined. If he would only recognise that short-run growth is identically supply-determined. All employment is based on entrepreneurial expectations that what employees are producing can be sold at a profit. To think there is some distinction over the nature of employment that makes the short run different from the long run is the very kind of muddled thinking he criticises others for having.

Blinder actually wrote an almost perfect para explaining the nature of economic activity in its relation to employment near the very start of his article:

Long-run growth is supply-determined; it depends on an economy’s ability to produce more goods and services from one year to the next. To accomplish that, you need four basic ingredients: more labor, more capital, better technology, and—if you can manage it—a better-functioning economy that utilizes inputs more efficiently. These four ingredients constitute the essential core of supply-side economics, and deficit reduction helps boost growth via the second: more capital.

Where he goes wrong in a way that every classical economist could see is that the short run is just the same. All production short or long is forward looking. Entrepreneurs will not produce unless they believe the particular goods and services they are producing will be bought so all of the concerns Blinder thinks of as long-run concerns are actually the immediate concern of every business at all moments in time. Anyway, while they didn’t publish my letter, they published the letter of my mate Jimmy Adams, the author of the wonderful Waffle Street. And what he wrote also went right to the point with this the key passage in his letter.

Mr Blinder errs in failing to recognize that demand has one, and only one, source, the production of those goods and services that can be sold at cost-covering prices. . . . This principle – Say’s Law of Markets – was broadly accepted by economists from the mid-19th century until John Maynard Keynes attacked a straw-man version in his General Theory in 1936.

I could not have said it better myself and very nice to have seen it in the WSJ.

From Catallaxy 10 July 2013.

As I knew I would do, as soon as I came across Mark Blyth’s Austerity: the history of a dangerous idea that I would buy it. Not all the way through it yet, but to help you understand just how useful it is, let me note first that on the back cover the very first of the people quoted to expain why someone ought to buy the book is written by John Quiggin. “An essential guide for anyone who wants to understand the current depression”. How austerity can be used to explain anything over the past five years up until the end of last year I will try to work out in making sense of the book.

As to its contents, this is the only reference to Say’s Law, found on page 137:

The policy objective of these institutions was therefore the encouragement of ‘achievement competition’ rather than ‘impediment competition,’ whereby the quality of products manufactured would create the demand for them, in a modern supply-side restatement of Say’s Law.

Is life really long enough for me to read the rest?

From Catallaxy on 3 July 2013.

Say’s Law has entered the world of literature. No longer is it mere economics but is now embedded in an extraordinary story that is both enlightening, instructive and funny all at the same time. The book is titled Waffle Street: the Confession and Rehabilitation of a Financier, it’s by a chap named James Adams and it is now into its second edition.

The story is this and is basically a first person adventure based on his own personal experience during the post-2009 crash. Jimmy Adams goes from hedge funds to a Waffle House [think a downmarket Pancake Parlour], from a seller of securities to a server of hash browns and grits. Along the way he learns some actual lessons about how economies work, Say’s Law being at the top of the list. It’s a book that you will read for its entertainment alone, but the message is very clear – and it is not a message found between the lines but in almost every chapter. Only adding value creates jobs, growth and the ability to demand.

The video is the trailer for the book and has been put together by John Papola of the Keynes-Hayek Rap. And if that’s not enough to get you to go off and order your copy, there is Doug French, the President of the Mises Institute, who has written a truly insightful review of his own which you can find here. The core quote from Doug:

But Adams does scrap with John Maynard Keynes in the pages of Waffle Street, lamenting, ‘How far we’ve fallen’ in the area of economics education. Pointing out that Say’s Treatise was once the top economics textbook in America, he explains that now, ‘Instead of learning sound doctrine, today’s undergraduates are inundated with principles that will not bear the scrutiny of common sense and experience.’

There are not many places you can go to find out about Say’s Law in the world today and there’s much else besides. You can read my book or you can read Jimmy’s. Preferably you will read both but Jimmy’s is much funnier than mine.

[Originally posted on Catallaxy on 19 August 2011]

At the very start of the GFC and the stimulus there was a debate at The Economist Online about what should or should not be done, revolving around Keynesian theory and policy. We now, of course, know who won the debate so far as policy is concerned but I still wonder whether it was not also won so far as theory goes as well. The arguments against were from John Cochrane of the University of Chicago who wrote:

Nobody is Keynesian now, really. Keynes distrusted investment and did not think about growth. Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity. Keynes and his followers famously did not understand inflation, leading to the stagflation of the 1970s. We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise. A few months before his death in 1946 Keynes declared:1 “I find myself more and more relying for a solution of our problems on the invisible hand [of the market] which I tried to eject from economics twenty years ago.” His ejection attempt failed. We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.

Really, the only remaining Keynesian question is a resurrection of fiscal stimulus, the idea that governments should borrow trillions of dollars and spend them quickly to address our current economic problems. We professional economists are certainly not all in favour. For example, several hundred economists quickly signed the CATO Institute’s letter2 opposing fiscal stimulus.

Why not? Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend.3 The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies. It has not appeared in graduate programmes or professional journals since. Policy simulations from Keynesian models disappeared as well, and even authors who call themselves Keynesian authors do not believe explicit models enough to use them. New Keynesian economics produces an interesting analysis of monetary policy focused on interest rate rules, not a resurrection of fiscal stimulus.

Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus.

Robert Barro’s Ricardian equivalence theorem was one nail in the coffin. This theorem says that stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today’s consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of. It also raises the fascinating question of why our Keynesian government is so loudly announcing large and distortionary tax increases if it wants stimulus to work.

There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem. Quack medicine seems to work, because people take it when they are sick. We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing.

Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets. Policy needs first of all to focus on the credit crunch. Rebuilding credit markets does not lend itself to quick fixes that sound sexy in a short op-ed or a speech, but that is the problem, so that is what we should focus on fixing.

The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be.

Of course we are not all Keynesians now. Economics is, or at least tries to be, a science, not a religion. Economic understanding does not lie in a return to eternal verities written down in long , convoluted old books, or in the wisdom of fondly remembered sages, whether Keynes, Friedman or even Smith himself. Economics is a live and active discipline, and it is no disrespect to Keynes to say that we have learned a lot in 70 years. Let us stop talking about labels and appealing to long dead authorities. Let us instead apply the best of modern economics to talk about what has a chance of working in the present situation and why.

Here is some Keynesian wisdom I think we should accept.

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

“How can I accept the doctrine, which sets up as its bible, above and beyond criticism, an obsolete textbook which I know not only to be scientifically erroneous but without interest or application to the modern world?”

“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

Not much of an argument. It merely did the usual macro trick of saying that the spending will shift from the private sector to the public. What doesn’t get said is why that might be a problem for both growth or employment. Leaving out value added leaves out everything that matters. But since it is a measure that cannot be captured in statistical series – how do you tell if an expenditure will repay all of its costs which can only be known at some future date – there is no means to measure. And if Barro is the height of the anti-Keynesian theoretical argument, there really is no argument worth the name at all. Without Say’s Law the anti-Keynesian case is all nonsense.

John Papola – the producer of the Keynes-Hayek Rap – has posted a further article on Say’s Law at the PBS website. You should read the lot, but this at the start gets right to the heart of the matter:

Ironically, none of the foundational greats in the history of economic thought could get into Harvard University’s Ph.D. economics program today.

This is not because of radical advances in our understanding of economics. To paraphrase Milton Friedman, we have only advanced one step beyond David Hume in our understanding of economics. Rather than advance real understanding, the economics profession, bewitched by a century-long envy of the physical sciences, has collapsed into an esoteric and pointlessly hyper-mathematized maze of confusion. The result is an economic mainstream so disconnected from reality that we must resurrect 1800s debates over whether consumption, which by definition uses up our wealth, can somehow increase society’s supply of wealth as a result.

We are living in a dark age of economic understanding.

I was given a copy of John Kenneth Galbraith’s 1975 junk science treatise which goes by the name of Money: Whence it Came, Where it Went. And there on pages 218-19 we find this:

Until Keynes, Say’s Law had ruled in economics for more than a century. And the rule was no casual thing; to a remarkable degree acceptance of Say’s Law was the test by which reputable economists were distinguished from the crackpots. Until late in the ’30s no candidate for a Ph.D. at a major American university who spoke seriously about a shortage of purchasing power as a cause of recession could be passed. He saw only the surface of things, was unworthy of the company of scholars. Say’s Law stands as the most distinguished example of the stability of economic ideas, including when they are wrong.

Well let me say three things about this. The first is that the initial statement is absolutely right. Before the Keynesian Revolution, denial of the validity of Say’s Law placed an economist amongst the crackpots, people with no idea whatsoever about how an economy works. That the vast majority of the economics profession today would have been classified as crackpots in the 1930s and before is just how it is.

Second, Galbraith not only doesn’t understand the meaning of Say’s Law, he doesn’t even understand Keynes. The one thing that both the classical side and Keynes agreed on was that a shortage of purchasing power is never the cause of recession. It is not whether people have the purchasing power that is at issue, but whether they spend it. That is why saving is such a major issue in the Keynesian model. People could spend their money but choose not to. It is never argued that they never had the money in the first place which was not the issue of Say’s Law either. How disgraceful it is that one of the leading Keynesians has no idea of one of the fundamental ideas behind The General Theory.

Third, if we are looking for some crackpot notion that stands as a truly distinguished example of the stability of economic ideas, including when they are wrong, there is virtually nothing in the history of ideas quite as incredible as Keynesian economics itself. Inane to the point of vacuity, destructive of prosperity on every occasion it has been applied, utterly useless as a guide to policy, Keynesian economics is the ultimate in crackpot ideas that stay long past their welcome in spite of every form of evidence that it is entirely mistaken about how an economy works and what needs to be done when recessions occur.

[My thanks to Peter S for Galbraith’s tome.]

Over at Macrobusiness we find the quite accurate statement by Rumplestatskin that “Say’s law seems to be making a resurgence”. He does not regard this as a positive step but nevertheless he does take note that there are a few of us around who seem to look on this development with favour. He even crosses to a post of my own which really only disappoints since nothing I have written seems to make the slightest dent. Such is life.

And to tell the truth I’m not all that keen to get into this yet again. How stupid these people must believe our ancestral economists to have been to make such obvious blunders that even they can see them. The things they say economists used to believe are quite incredible. But I am drawn back in because I received in the post today a book I had ordered that I didn’t even recall having asked for but how wise I was to make the purchase. It is a reprint of John McVickar’s Outlines of Political Economy, the first American text in economics, published in 1825. And the very first bit I read was about value added and the nature of the production process, the very thing I had been teaching my class today, having first noted that nothing like this is found in any textbook of the modern era. Economic theory has so regressed in the past 200 years that we are now more primitive than the mercantilists that Adam Smith used to make fun of. We disguise our ignorance by putting it all into maths.

Mt Statskin, of course, has no idea what Say’s Law is about so goes about comprehensively demolishing a construction of his own devices. But if he is ever to work out what the real meaning is, what he needs to do is recognise that the following two statements are 100% compatible and if you understand Say’s Law, 100% valid:

. a general glut is impossible
. recessions are not uncommon and when they occur last a long time.

Let me therefore quote a bit from Mr McVickar which seems relevant to economics today. Were he to have advised our political leaders it might have been possible to constrain their headlong rush into useless, unproductive spending, and we might have been spared the many years in the wildnerness we are about to endure. This is McVickar writing in 1825 (pages 167-68):

It is a fallacy and an absurdity to suppose that production can ever be encouraged by a wasteful consumption of the products of industry. A man is stimulated to produce when he finds a ready market for the produce of his labour, that is, when he can readily exchange them for other products. And hence the true and only encouragement of industry consists, not in the increase of wasteful and improvident consumption, but in the increase in [value adding] production. (Italics in the original)

Mr Statskin, whose beliefs are as fallacious and absurd as the rest of his crowd, seems to believe that such views represent an “ideology, because these writers cannot translate their beliefs into practice.” Oh but we can. Try this for some practical advice. Governments must reduce their spending, balance their budgets and never attempt to revive an economy from the demand side. Seems practical enough to me but no doubt everything Mr McVickar is trying to explain will fly right over Mr Statskin’s head. But nevertheless, Say’s Law will continue its resurgence whether he likes it or not, whether he understands it or not.