Not just about Say’s Law but also why almost the whole of modern economic theory is useless

You may think such a thing is impossible, and certainly impossible to prove, and even more certainly impossible for me to prove, but before you say that first you have to watch the presentation yourself. The venue is Los Angeles.

I also replied to the fellow who had invited me and sent the video because he wrote that “I suggest the phrase Supply Creates the Means to Demand” which is his own way of explaining Say’s Law to himself. And this is the way someone brought up in a Keynesian environment will understand these issues because it has become second nature to think in relation to demand. But unless you can break the habit that thinking an economy is driven by demand and not supply, it becomes impossible to understand classical theory, and in my view impossible to understand how a market economy works. So I wrote back with this:

Your note does remind me how difficult it is to understand since the issue of spending never seems to go away, which a supply-side economist, like Mill and myself, see as about as irrelevant to aggregate economic outcomes as it is possible to be. If you tell me that in a recession there is some kind of panic and credit freezes up and business ventures are not commenced at the same rate as in good times, I will say of course, but so too did JSM.

Thinking in money flows and in relation to spending will stop you from understanding Mill and thus, in my view, from understanding how an economy adjusts. Once you are thinking about whether people will spend their money and not whether entrepreneurs will try to open new businesses and expand old ones, you fall into the Keynesian trap from which economic theory has been unable to emerge for more than eighty years. A financial crisis stops the flow of credit but does not stop the desire of business people to set up new firms or expand the ones they already run, nor does it stop wage earners from trying to find jobs. A really bad downturn can take 2-3 years to get back to normal but things do re-arrange themselves. Having a government stimulus on top of all of the other disruptions in the flow of capital and labour into their most productive forms of contribution can extend the recession outwards for a much longer period of time, and like the situation right now everywhere round the world, it can prevent a serious recovery from ever gathering pace. The Japanese lost decade of the 1990s is now 25 years long! The notion that buyers will stop buying for years on end and businesses will stop trying to find ways to earn profits because there has been a downturn is not just incoherent but contrary to every historical situation in which a downturn has ever occurred. It might be what an academic would do – just give up and wait for a government subsidy – but it is not the kind thing people who make a living by running businesses are apt to do. A stimulus can kill off a recovery but it can never cause one. All this is perfectly obvious to me, but very difficult to explain. This is my own variant on demand for commodities is not demand for labour: employment varies directly with productivity and inversely with the real wage. I developed the theory as an employer advocate in our national wage cases in the 1980s and then when I found the same thing in Mill, which is his explanation for his fourth proposition on capital*, I had found the parent stem for everything which I now believe, and see demonstrated everywhere I go.

Mill noted that even in his own time how difficult it was to keep these things straight, and every economist of his time had read his text. Much more difficult now because of the Keynesian presuppositions and terminology that infuse modern theory with virtually no supply-side economics to be found anywhere at all.

* Mill’s fourth proposition on capital – the Fermat’s Last Theorem of economics – states that “demand for commodities is not demand for labour”. Universally accepted by mainstream economics in Mill’s lifetime, even described in 1876 as “the best test of a sound economist”, which it is. You can read my entire paper on it if you are interested: MILL’S FOURTH FUNDAMENTAL PROPOSITION ON CAPITAL: A PARADOX EXPLAINED.

Classical economics rediscovered

I have come across a summary of David Simpson’s The Rediscovery of Classical Economics written by David Simpson himself and published by the Royal Economic Society. Before I quote more extensively, I will note where he wrote:

I refer to an intellectual tradition that began with Adam Smith, was continued by Marx, Menger and Marshall, Schumpeter and Hayek and in the present day is represented by theorists of complexity.

It never surprises me to see the name of John Stuart Mill missing from such lists since Mill is the most difficult of all of the classical economists to access for any one schooled in modern theory. Yet it was Mill who set the standard for the second half of the nineteenth century and was explicitly followed by Marshall and even Hayek even as they turned economics into the more familiar form we find today. I might also mention that what makes Marx interesting even now is found in Mill only with much more common sense as well as a far deeper economic understanding. Mill is the high point of classical thought, and in many ways the high point of economic thought. But who amongst any of you would be able to contradict me, you followers of Keynes and marginal analysis, who barely know Mill’s name never mind have any idea of what he wrote? This is Simpson’s description of the economics that has all but disappeared.

The hallmarks of this classical tradition are principally three. The first is the belief that the growth of the economy, rather than relative prices, should be the principal object of analysis. Coupled with that belief is an understanding of the market economy as a collection of processes of continuing change
rather than as a structure, and that the nature of this change is self-organising and evolutionary. Finally there is a conviction that economic activity is rooted in human nature and the interaction of individual human beings.

The differences between classical theory and equilibrium theory can be summarised in the following terms. Classical theory focuses on change and growth within open, dynamic nonlinear systems that are normally far from equilibrium. Equilibrium theory, on the other hand, analyses the theory of value within closed, static linear systems that are always in equilibrium. As to the essential nature of economic activity, classical economics makes no distinction between micro- and macroeconomics. Patterns of activity at the macro level emerge from interactions at the micro level. Evolutionary processes provide the economy with novelty, and are responsible for its growth in complexity. In equilibrium theory micro-and macroeconomics remain separate disciplines, and there is no endogenous mechanism for the creation of novelty or growth.

The behaviour of human beings in classical theory is analysed individually. People typically have incomplete information that is subject to errors and biases, and they use inductive rules of thumb to make decisions and to adapt over time. Their interactions also change over time as they learn from experience. In equilibrium theory, individual behaviour is assumed to be homogeneous and can be modelled collectively. It is assumed that humans are able to make decisions using difficult deductive calculations, that they have complete information about the present and the future, that they make no mistakes and have no biases, and therefore have no need for adaptation or learning.

Simpson finishes by discussing where economics now needs to go under the heading, “The Implications for Economic Theory”. I think this is both very limited in what is sought but also almost impossible to imagine being taken up within the profession. I’m not so sure about the need for non-linear algebra, but at least with this we have the commencement of a program for change:

First of all, courses in economic history and in the history of economic thought should be a required part of the curriculum for every student of economics. The study of economic history, like the study of complex systems, reveals the importance of context in understanding economic behaviour. The study of the development of economic thought helps us to appreciate the weaknesses as well as the strengths of a theory. Macroeconomics should be downgraded, and give way to the study of business cycles.

Secondly, more space should be found for the analysis of dynamic processes at the expense of static theory. The study of the processes of economic growth should be restored to centre stage. This probably means a greater emphasis on nonlinear algebra.

At the same time, the limitations inherent in applying mathematics to economics need to be acknowledged. The importance of the human factor and of human institutions in economic activity means that more attention needs to be given to non-quantitative methods of analysis.

With the scale of disaster that has befallen us since the GFC, there is something radical that needs to be done. And if you are interested in seeing a twenty-first century update on Mill and classical theory, you can always try this.

John Stuart Mill and the logic of economics

I have just been confronted by two articles I have refereed, both on the economics of John Stuart Mill, that I rejected because they have no idea what Mill is trying to explain or the logic of what he is getting at. Both, however, are likely to be published no matter what I might think. Here was Mill, the man with the nineteenth century’s highest IQ, the author of the book on logic that was used for two generations across the English speaking world, a book still eminenty worth reading to this day, yet both of these papers criticise Mill for contradicting himself and faulty logic.

Mill’s Principles of Political Economy is far and away the best book on economic theory ever written. My own book on Free Market Economics (now in its second edition) is Mill brought up to date with a few modern gadgets. Also brought into the text and heavily criticised are the various additions to economic theory that have made economics far worse as a tool of analysis and a basis for policy, most notably MC=MR and Keynes.

All I can say is how exasperating it is to read these critics of Mill who cannot even begin to understand the problems with their interpretations. But what is the peculiar bit is that in being possibly the only economist in the world who thinks of Mill as the best economist who has ever lived, there is not a soul alive who I can turn to for support. I am not the smartest person on the world today, but I do come closer to understanding Mill than anyone else writing on economics. The massacre of our economies by the modern doctors of economic theory is as obvious to me as it is invisible to them. So on it will go but the certainty is that if we keep up in the way we have, we will never ever generate a recovery worth having and living standards will continue to fall.