How Keynesian economics came to dominate told by Keynesians

The papers from the History of Economics section at the US Conference of Economists during the session on “Keynesianism: Its Rise, Fall, and Transformation in Europe and North America”. So long as Y=C+I+G is central to how macro is taught at all levels of study, the notion that there has been any kind of a fall is ludicrous. No economists taught Keynesian macro ever finds their way to understanding how an economy actually works. These were the papers presented.

Keynesianism in France

Goulven Rubin

University Paris 1 Panthéon-Sorbonne


According to Pierre Rosanvallon (1987), Keynesianism arrived very late in France but its triumph was complete. It offered a common language to a very large group of senior officers and engineers working in public administration and nationalized firms. It reconciled the French tradition of Colbertism with the necessity of a modern State. Richard Arena (2000) insists also on the fact that Keynesian ideas spread in a hostile context and initially outside universities and academia where typically French economic traditions dominated. The situation in universities started to change in the 1970s and 1980s when curricula in French universities began to incorporate macroeconomic courses based on IS-LM and with the development of disequilibrium economics. The paper retraces the unfolding of this historical process and insists on the variety of heterodox interpretations of Keynes that flourished in the French context like the works of Bernard Schmitt and the circuitists.

Keynesianism in Germany

Harald Hagemann
University of Hohenheim


Keynes had been a central point of reference in debates on economic theory and policy in Germany ever since his Economic Consequences of the Peace (1919), as, e.g., in the controversial debates on the wage-employment relationship at the end of the Weimar Republic. No wonder that the first foreign-language translation of the General Theory was published in German. With the great resonance Keynes had in Germany in the interwar period it is no surprise that from the early 1950s onwards neoclassical synthesis Keynesianism became the dominant approach at West German universities. More astonishing is the fact that with Erich Schneider at Kiel, a former student of Schumpeter played a key role in this process. In economic policy, however, Keynesianism gained a rather late entry in the recession of 1967 and only lasted until 1974-75.

Keynesianism in Canada

Robert W. Dimand
Brock University


Canada was one of the first countries to commit to a Keynesian goal of maintaining high and steady levels of employment after World War II with the 1945 White Paper. Keynes’s former students A. F. Wynne Plumptre and Robert Bryce were prominent in the Federal Government, notably the Department of Finance, in the quarter century after the war, but others, notably Mabel Timlin, author of Keynesian Economics (1942), also helped spread Keynesian ideas among Canadian economists. William A. Mackintosh, both as an academic and a wartime temporary civil servant, was a central figure, drafting the 1945 White Paper and seconding Keynes’s motion to accept the final act of the Bretton Woods conference. Bank of Canada Governor Gerald Bouey’s 1975 embrace of monetary aggregate targeting signaled the decline of Keynesian influence on Canadian public policy.

Keynesianism in the United States

Mathew Forstater
University of Missouri-Kansas City


Two issues are at the heart of Keynesian economics in the United States, one theoretical and the other practical. The theoretical issue regards whether Keynes’s demonstration in the General Theory of Employment, Interest and Money that there can be involuntary unemployment in macroeconomic equilibrium requires an assumption that wages, prices and/or interest rates are “sticky” (inflexible) downward, or some other market imperfection. The practical issue is related to the theoretical one. Keynesians have tended to be pragmatic when it comes to economic policy, preferring to use fiscal and monetary policies to pursue macro goals of full employment, price stability, and stable economic growth rather than focusing on efforts to remove the imperfections, which would permit market forces to work out the short-term Keynesian troubles. The most recent mainstream incarnation, so-called “New Keynesian” economics, has all but abandoned the important remaining economic and political legacies of the tradition.

No such thing as “the level of demand” at an aggregate level

Through the whole of the Costello years as Treasurer, I would say that everyone would live through these exceptionally good economic times, but no one would learn a thing. And it’s not just that we had balanced budgets, but had ZERO DEBT. Only country ever to do this and we floated on air. So then we elected Labor and then we had the GFC, and then we had the advice from Treasury to go early and go hard, and so here we are today, in a crumbling economy with living standards heading south. Which is a preamble to this: Peter Costello and later treasurers right to stress benefit of surpluses. Not so sure about those later treasurers, but Peter was the legitimate article, Australia’s greatest Treasurer.

In his book on Australian treasurers, Bowen describes Costello as the country’s first post-Keynesian treasurer, rejecting the idea that taxes and spending should be used to manage the level of demand in the economy, with that task left to the Reserve Bank. The pursuit of a budget surplus was seen as evidence of good economic management and became an end in itself. Costello was able to distil his political message into a simple message: “Surpluses are good and Liberals deliver surpluses,” Bowen writes.

Half way there. There is no such thing as “the level of demand” at an aggregate level. You cannot manage it. You cannot cause it to go up and down. Aggregate demand has no separate existence apart from aggregate supply. It is Keynesian junk theory whether it is spending or adjusting rates. It will not work and never has, ever. Modern macro is false from end to end. As John Stuart Mill put it, and found in my Free Market Economics where it is explained at great length: “demand for commodities is not demand for labour”. That was written 170 years ago. The idea that there is progress in economic theory is just plain wrong.

PLUS THIS: From Max in the comments:

“Austrian theorist Henry Hazlitt argued that aggregate demand is ‘a meaningless concept’ in economic analysis. Friedrich Hayek , another Austrian, wrote that Keynes’ study of the aggregate relations in an economy is ‘fallacious’, arguing that recessions are caused by micro-economic factors.”

“The Keynesian is a collectivist methodologically. He looks at aggregates. He recommends government programs that affect aggregates.”

“Keynes argued, and his disciples still argue, that the cause of unemployment is insufficient aggregate demand. This is another way of saying that the cause of unemployment is excessive aggregate supply. The fact that Keynesians never put it this way does not affect the analytical truth of the argument.”

Absolutely dead on. Is this the source: Illegal Aliens and Unemployment: Causes and Effects by Gary North?

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.

Keynes vs the classics

A reminder that there will be a debate – more I suspect sequential talking points – between Alan Oster, the NAB’s Chief Economist, and myself on “Stimulus versus Austerity”. This is taking place on Wednesday August 19 @ 5:30 pm at the Imperial Hotel on the corner of Spring and Bourke Streets in Melbourne. If you are interested in coming, email to let him know.

Of course, the reason I’m coming along is because I cannot actually think of how to defend the stimulus at this late stage. Back in 2008-09, even though a Keynesian stimulus had never worked anywhere else, not ever, we might have ended up lucky this time. It’s in all the texts, everyone learns Y=C+I+G, so how could every single economics text in the world have been wrong? But that was then. So I have been tossing around various thoughts on what Alan might say, what I might try to argue if I were defending the stimulus. This is kind of a Paul Krugman/Ken Henry version of all the lame things that might be part of such an argument. And I emphasise, the bailing out of financial institutions is not on the table. The financial crisis was over by May 2009. I am only interested in the public spending side of it. Here are my thoughts:

1) The stimulus worked a treat – we would have been back in the Great Depression if nothing had been done. As dismal as things seem, it is a better outcome than the alternative would have been had nothing at all been done.

2) The imperative was to use up those unused savings. No one was investing. The bottom was falling out of our economies. Savings were going to waste. This is still a problem as can be seen from all those unused bank accounts. People still aren’t spending so the government must do it for us.*

3) The theory was all right but the execution was badly done. A stimulus could have worked but the money was poured into the wrong kinds of activities.

4) We didn’t spend enough. A half-hearted stimulus would not only fail to solve the problem but would discredit the very idea of a stimulus.

5) The problems run even deeper than we originally thought. We are into a secular stagnation, not just a temporary fall off in demand.

6) Let me show you the stats to prove how fantastic things turned out relative to our forecasts at the time.

7) Fiscal policy might have been relatively weak but monetary policy has made a major difference by keeping rates low and encouraging investment.

Have I left anything out? Anyway, come along on Wednesday. For my part, I am going to present a short version of my Liberty Fund postings on “Reassessing the Political Economy of John Stuart Mill”, that is, real classical economics versus Keynesian inanities. We each get twenty minutes and then it is thrown open to the floor. And being Policy in the Pub, there is alcohol as well if that’s your sort of thing.

* Just today, in the AFR, Saul Eslake was arguing more spending is needed to put “idle” capital and labour back to work.

More on Say’s Law and Austrian economics

The conversation on Say’s Law continues at The Coordination Problem website. These were posted following my own post yesterday. Neither of the posts are anything other than assertions with no actual text references, but they do raise issues that are raised all the time. But the second, from Barkley Rosser, gets into the issues that truly matter.

Actually, Hayek viewed Say’s Law as an equilibrium concept. He argued it did not hold in a monetary economy because money allows there to be demand without supply. One could say the denial of Say’s Law in a monetary economy undergirds Hayek’s monetary theory of economic fluctuations.

It is not clear that the Law originated with Say. It already appears in the Wealth of Nations.

Then there is the question of whether Say changed his mind. In the fifth edition of the Treatise, never translated, Thomas Sowell argues that Say changed his mind about the Law.

Finally, Mill’s Fourth Fundamental Proposition Respecting Capital is at the heart of Hayek’s cycle theory. Hayek clarifies that in an Appendix to The Pure Theory of Capital. And I analyzed its relevance in Economics as a Coordination Problem. It is not a forgotten concept.

Posted by: Jerry O’Driscoll | July 18, 2015 at 02:43 PM

The quote that Kates provides from Mises is peculiar. It is clearly a criticism of Keynes, but aside from declaring that Keynes failed to disprove Say’s Law, he really provides no defense of it or how it fits into Austrian economics.

I am interested to see that Steve Horwitz basically that the main Austrians said very little about it, and one has to go such figures as Hutt to find much, with followups by Steve himself and some others.

I think Jerry is right that Hayek probably did not accept it in a monetary economy.

Mill took it very seriously and spent much time talking about it and relying on it in his arguments.

Regarding Say himself, he may have changed his mind on it, but from the very beginning he always recognized that it did not universally hold and gave various examples of how and when it might not hold, most of these involving people hoarding money for some reason or other, such as in the Ottoman Empire not to have to spend more on taxes if one engaged in conspicuous consumption, although one can find numerous quotes from him in various places where he certainly states some version of it. As it is, I think it was James Mill who coined the term and promoted it in the English literature, thus making it not too surprising that his son would also be an advocate of it, although I may be mistaken on this last point (and I accept that versions of it may well have been around earlier).

Posted by: Barkley Rosser | July 18, 2015 at 05:31 PM

Understanding Say’s Law may be as difficult an issue as it is possible to find in a world where every economist is taught Keynesian aggregate demand as their first approach to thinking about the nature of recession. Say’s Law is the essence of supply side economics. At the aggregate level, demand has absolutely no role to play. What demand there is originates with supply and can come from no other source. Public spending unbacked by real production is no more a stimulus than the printing of counterfeit money. I have therefore put up the following post:

The fact that this fundamental principle of pre-Keynesian economic theory is named “Say’s” Law has been one of the more damaging aspects of both the history of economics and of economic theory itself. Here is something to contemplate about the true origins of the Keynesian Revolution. The term “Say’s Law” was invented by Fred Manville Taylor and entered into common usage on the American side of the Atlantic in the 1920’s with the publication of Taylor’s Principles of Economics. How, it may be asked, did the term get into The General Theory? Say himself never understood Say’s Law properly. If you do want to understand it properly you need to go to John Stuart Mill and those among the classical school who followed after. J.E. Cairnes is the most accessible source.

Say’s Law states that you can never make an economy grow from the demand side. Mill’s version is a direct refutation of Keynesian economics: “demand for commodities is not demand for labour”. Mill and the classics said you could not make an economy grow by increased expenditure; Keynes said you could. All modern macro continues to argue that it can be done and is to that extent entirely Keynesian. That there is no real world evidence that increases in aggregate demand lead to increases in output and employment confirms in every instance a stimulus has been applied that Say’s Law is valid. If you would like to see my explanation in short form, you have my articles at the Liberty Fund to go to. If you would like to see the longer and more extended version, you could try the second edition of my Free Market Economics. I will just leave you with Ricardo’s reply to Malthus in the midst of the general glut debate (the first attempt to introduce “Keynesian” economics during the 1820s): “men err in their productions, there is no deficiency of demand”. This is the classical and Austrian theory of recession. There has been a disorganisation of markets that has led to recession and unemployment (that is, men have erred in their productions). The problem is not over-saving and a lack of aggregate demand.

Will anyone get it? It is such a frustration.

Criticising Keynes

People worry about many aspects of the economy, and about their future security and income, but there is hardly enough worrying going on specifically about Keynesian economics, today’s mainstream version of what used to be the theory of the cycle. Keynesian theory has done an immense amount to undermine our potential for growth, and has made billions of people around the world insecure about the future, ironically based on the promise of higher incomes and greater security if one merely follows the prescriptions laid out by “Keynes”. The number of versions of “Keynes” there are is, of course, approximately equal to the number of Keynesians there are, but that’s another matter.

As it happens, I am at the final turn in producing what will be a two-volume, 1600-page collection on the critics of Keynes. The collection is complete, in that I am unlikely to add any additional articles. There is therefore only the introduction to write, which I have set aside the next three months to complete. Sometime thereafter, in 2015, the two volumes will be published. I cannot guess how many people will seek to read it, but the one criterion I laid down was that each article had to be accessible. The number of books on how wonderful Keynesian theory is remains amazing to me, and they keep pouring off the shelves. Even this year, there have been yet more of the same, when you would have thought Keynesian economics would be in deep retreat. It is a phenomenon.

My latest venture into dealing with Keynesian economics came from this query by Andysaurus: “This article which argues that governments have bottomless purses seems unlikely to me. Do you have anything with which I may refute it please? Thanks.”

The article was at The Conversation, and although my first instincts was merely to reply in-house, having written what I did I sent it off to The Conversation, which from the note I received, is apparently closed to new articles on economics until January 5 next year. So I sent it off to Quadrant Online instead, where it is now posted under the title, Seduced by Keynes’ Sweet ‘Nothings’. Why “sweet ‘nothings'” you may ask? Here is what I think of as the central para in the article I was replying to:

“Times like these represent opportunities for the government to finance productivity improving infrastructure and provide much needed services for nothing. I know it sounds too good to be true but this is the reality of a fiscally sovereign government.” (author’s emphasis)

It sounds too good to be true because it is. Here is part of the answer I wrote but I know that for a Keynesian this is the kind of thing that just pings off their armour, an attitude reinforced with virtually every macro text published today.

The belief that a government has any idea where value-adding activities can be found is one of the dopiest notions ever concocted. Governments can certainly spend the money they create, and some of what they do is value adding, but hardly everything. To believe that what governments produce automatically has greater value than the resources they use up is so nonsensical it is hard to believe any economist would ever peddle such a notion.

Take our own Rudd-Gillard stimulus. The two major projects were pink batts and school halls. Ask me if we are better off with more and better insulated houses and a better school infrastucture, I am happy to say that, all things being equal, we are. But if you ask me whether we have seen a return of more than $43 billion on our outlay – the approximate price tag of this spending – then the answer is that we have not had anything like that amount of benefit.

You may delude yourself from now until the end of time that these benefits were provided “for nothing”, but have you not seen our own reality: the dollar is falling, our standard of living is being dragged down, unemployment is on the rise. Ah, but where is that inflation? For most, real incomes are not rising, so however small the official inflation rate may be, it is plenty high enough to erode our ability to demand. Have you tried to buy a house lately, to cite but one example?

Keynesian economics has a lot to answer for. When I think of how sensationally prosperous we could all be, each and every one of us, had governments not seen it as their role to divert trillions into useless projects of their own choosing, it does make me despair. Not all government spending is useless, of course, but there are only so many roads and schools you can build, and almost every government project comes in over-budget and under-delivered. Anyway, the next three months will be devoted to thinking these issues through as my own small contribution to a better world.

Let me therefore end with a quote from Henry Hazlitt, my predecessor in putting together a collection of criticisms of Keynesian economics back in 1960. The following was written in 1984 when he was over ninety:

At this point I hear someone say: “Why are you still whipping a dead horse? The criticism of the last quarter-century has done its work. Keynesianism has already been discredited in the minds of economists.”

Of most professional economists, perhaps. But it is still the prescription of the great majority of politicians, and is at least still acquiesced in by the majority of voters. The undiminished prevalence of punitive graduated income taxes, the steady increase of other redistributive measures, the persistence of government monetary authorities in trying to hold down interest rates, and the endless and mounting budget deficits of the last half-century–these are Keynesianism rampant.

Keynesian economics is more rampant than ever, in spite of everything that has happened since.

OTHER LISTS: This is a list on critics of Keynes put together by Tom Woods that has been forwarded to me. If you see how thin this list is, you can see more clearly how hard such books and papers are to find.

Critiques of Keynes: Here’s a List

5th March 2012Tom Woods14 COMMENTS

A reader wrote to ask what he could read that challenged Keynes and his system. On a popular level, there’s Hunter Lewis’ book Where Keynes Went Wrong. Henry Hazlitt’s book The Failure of the “New Economics”: An Analysis of the Keynesian Fallacies goes through and critiques the General Theory line by line. It’s a valuable book and a great achievement, but my own opinion is that it gets so caught up in line-by-line minutiae that the reader never really gets the big-picture critique. Mark Skousen edited a good collection of essays called Dissent on Keynes: A Critical Appraisal of Keynesian Economics, which you can read for free online.

Murray Rothbard wrote the lengthy memo “Spotlight on Keynesian Economics” when he was only 21. Also worth reading are Robert P. Murphy’s “The Critical Flaw in Keynes’s System” and George Reisman’s “Standing Keynesianism on Its Head.”

The only one on the list that I think of serious use was Mark Skousen’s Dissent on Keynes. I may have gone through a thousand articles and book on the way to my PhD but that was far and away my favourite. It exactly captured what I thought myself and I kept his book on hand and out of the library for a year after the thesis was done, with the intention of writing to him to tell him how much I admired what he had written. In the end, I just couldn’t bring myself to do it, so I gave the book back to the library. And on the very next morning, there were, like an apparition, two emails to me from Mark Skousen, who was then writing his history of economic text and had run across my Say’s Law and the Keynesian Revolution, the title I gave my thesis when it was published by Elgar. Mark had read it, and wrote to me to say what I had wanted to say to him. It remains the single most mystical experience of my life.

Government must get out of the way

Keynesian economic theory has turned out to be a device for the rich to rob the poor, for the unproductive to raid the incomes of those who work. We are supposedly all to be made better off through massive diversion of the wealth of our nations into the pockets of the crony capitalist friends of our ruling elites and union leaders who fleece their members in the name of protecting them from the employers who gave them their jobs.

Rupert Murdoch has spoken on this to the G20, the first person not from a government to be allowed to make such a presentation. Paul Kelly discusses Murdoch’s speech under the heading, Equality at risk in the West, says Rupert Murdoch. It’s a damned sight more than just equality that is at risk, but our very prosperity. We are being made poor across the broad expanse of our communities because governments are now the chief agents for dispensing purchasing power. Obama was right: you didn’t earn it. The government earned it, and you will only be allowed to keep what it decides you should keep. This is part of what Murdoch said:

“In America, the most highly paid 1 per cent now pay 46 per cent of all income tax.” . . . “In Britain, the top 1 per cent pay 28 per cent of all income tax. That is a massive shift from what our society looked like 30 years ago. We should all be concerned about this polarisation which was never the intent of policy but is certainty a consequence.

“Quantitative easing has increased the price of assets, such as stocks and real estate, and that has helped first and foremost those who already have assets. Meanwhile, the lack of any real wage increase for middle-income workers means growing societal divisions and resentment.”

Quantitative easing is a disaster but you will not find out why by reading any economics book that I know of, other than mine. The last two chapters deal with what had once been stock standard economics before the General Theory. Even Keynes dealt with the money rate of interest (the price of credit) and the natural rate of interest (the price of actual resources, such as bricks and mortar), but that was in his 1930 Treatise on Money, which he wrote before he was sidetracked by Say’s Law. We are ruining our economies in the belief that we are actually doing them good by higher levels of public spending and lower interest rates to encourage investment. But we are ruining them, which is a fact that is obvious to everyone. The only thing invisible is why. But what Murdoch proposed is absolutely right:

The significance of his nine-page speech is his argument about the limits to both monetary and fiscal policy and the imperative for a new approach based upon the need “for government to get out of the way”. Mr Murdoch called for: labour market reform; lower and more competitive corporate taxes; a crackdown on multinationals — naming Google — for not paying taxes where they make their profits; a rethink on excessive bank regulation, warning “you would have to be mad to join the board of a bank these days”; and recognition that high taxes and over-regulation were damaging economic growth and the public interest.

But if you start from Y=C+I+G you cannot make any sense of what he suggests. Read Chapters 16 and 17 of my Free Market Economics second edition if you would like to understand the classical explanation for what is happening right before your eyes and why these kinds of reforms are needed. I do find it odd that this is the only book I know of, at least one that has been written since the 1930s, that can explain what was once obvious to every economist in the world. But odd or not, that is how it seems to be.

A query on Say’s Law

Here is a very pleasing letter I have received from someone who read my article in Quadrant on the fifth anniversary of the publication of the Dangerous Return of Keynesian Economics.

Dear Dr Kates

I read your article in the March Quadrant. It was a great source of information and I have used it to refute a couple of Keynesians on facebook discussions I am involved in. I have a few queries.

1. I have been thinking about Mill’s idea “demand for commodities is not demand for labour.” Initially I balked at it, but after a bit of pondering I think I may have it. I want to run my interpretation past you to make sure I’m correct. Here it its: ‘Just because someone wants a product or a service, doesn’t mean they will pay any price to get it. There is a limit to the amount of human labour, measured through paid wages – is worth. If you understand this, you’ll understand why demand for labour cannot be increased by increasing the demand for goods and services.’ Have I got that right? Was Mill talking about the concept of the law of diminishing returns?

2. What I want to be able to do in my little debates is make claims like:

*Keynesian economics doesn’t promote growth, it stifles it.

*Where Keynesian economics have been applied its been shown to not have worked.

*The economic consequences of Keynesian policies are disastrous.

Where can I find evidence to support those claims. A hyperlink to websites/studies would be particularly valuable.

Thanks in advance. Please keep writing these articles for Quadrant. They are great for laymen like me. If I may make one small, respectful suggestion when you make claims and affirmations about the negative consequences of Keynesian stimulus, please give some basic evidence or backing so that I can use this in discussions.

Kindest regards

So I have replied

Dear Matthew

The thing that is still astonishing is that there are any Keynesians left for you to argue with but I guess they’re still out there living in silent resentment about how little appreciated they are. I have, of course, written an entire book on this stuff – Free Market Economics – which is not all that expensive – paperback around $40 through the Elgar website. Alas, your approach to understanding Mill will not get you to what I think you need to understand if you are to have a solid foundation in dealing with Keynesian arguments. The order in which events happen in an economy is not people wanting things and then they are supplied. It is the way we teach micro, with demand first and then supply, but that is not the order in which events occur in reality.

The order in which everything occurs is that entrepreneurs come to conclusions about what they might produce and sell at a profit, then go through the many stages of setting up their businesses which requires a tremendous amount of outlay before they earn a single cent of positive return, and then, when the goods or services are brought to market, buyers may or may not choose to buy enough to repay all of the previous costs. Demand, to be strictly technical about it, is the relationship between price and quantity demanded for an existing product that is already on the market. All production, however, is future orientated and while past sales may provide some clues about what might sell in the future, it is hardly the most important consideration in the minds of entrepreneurs in trying to decide what they will do next. Wasting a tonne of money on pink batts and school halls is great in the short term for pink batt and school hall producers but distorts your economy away from productive activities, raises input costs across the economy and provides no clear direction about the nature of demand say eighteen months ahead.

As for Say’s Law here’s a brief outline.

1) If you pay some people to dig a hole and then pay other people to fill them in again nothing of value has been created so no matter how much money you pay them thinking only of this group there is nothing for them to buy.

2) Every form of economic activity uses up resources. They thus draw down on the available productivity of the economy. Keynesian economic theory thinks of the drawing down as in and of itself stimulatory. No classical economist would have been so stupid. Drawing down on resources – even in some activity that will eventually provide you with a positive return – makes you worse off.

3) The need for economic activity to be value adding is essential. Production is value subtracting. It uses up resources. When whatever has been produced becomes available, it is either just consumed or it becomes part of the productive apparatus of the economy. It is those additions to the productive parts of the economy that are the essential for growth and prosperity. Only if the value of what these newly produced capital assets is greater than the value of the resources that have been used up can the activity be counted as value adding.

4) Only value adding activities create growth and employment over anything other than the short term. Timing is everything, but the flow of new productive assets coming on stream (and it may take years of value subtracting investment for any particular project to become productive) is the only thing that can make an economy more productive, raise living standards, add to employment at the going real wage and then, thereafter, increase the real wage.

5) Why Say’s Law? Amongst the many lessons that Say’s Law provides, and this is from the classics, is that “demand is constituted by supply”. Because of the low state of economic theory today, I now make it explicit what classical economists had meant, “demand is constituted by value adding supply”. Unless what is produced is value adding – that is, it adds more to output than the resources that have been used up in their production – then it cannot add to employment at the going real wage.

6) No stimulus program in the world was value adding. Virtually no government activity, other than some roads and a few infrastructure projects, is value adding. All draw down on resources but do not provide a net addition either in the short term or in the long. NBN is such a prime example, as is the Desal plant in Victoria. We are not better off for spending the money and using up the resources because there is no return. That the construction workers went out and bought goods and services with the money they were paid do not make those projects in any way beneficial to the economy. They are pure waste.

7) Private sector activity often misfires on an individual basis which is what bankruptcy is about. But a properly structured free enterprise economy, where financial institutions lend to the most promising projects for which funds (ie resources) are sought, provides you with the only structure that will provide an overall net rate of growth and an accumulation of capital assets across an economy that will build prosperity.

8) You want to understand what’s wrong with Keynesian economics, it offends against Say’s Law which makes it absolutely clear that only value adding activity adds to growth – demand is constituted by supply. If you keep all that in mind, I can’t see how you could go wrong.

Kind regards

Keynesian economics is on the way out

A neat and sensible assessment of where Keynesian economic theory is today. I suspect there are many who think like this but are reluctant to say so in public. This is accurate and to the point. It comes from the History of Economics discussion website and was posted by Doug MacKenzie.

The historical facts of this debate, and of the policy itself, are quite clear, and it does not simply boil down to proving that the multiplier is (or is not) zero.

1. Keynes himself recognized (in the GT) that the multiplier is not stable and can be ineffective. To quote Keynes:

“It would seem (following Mr. Kahn) that the following are likely in a modern community to be the factors which it is most important not to overlook (though the first two will not be fully intelligible until after Book IV. has been reached):

(i) The method of financing the policy and the increased working cash, required by- the increased employment and the associated rise of prices, may have the effect of increasing the rate of interest and so retarding investment in other directions, unless the monetary authority takes steps to the contrary; whilst, at the same time, the increased cost of capital goods will reduce their marginal efficiency to the private investor, and this will require an actual fall in the rate of interest to offset it.

(ii) With the confused psychology which often prevails, the Government programme may, through its effect on “confidence”, increase liquidity-preference or diminish the marginal efficiency of capital, which, again, may retard other investment unless measures are taken to offset it.

(iii) In an open system with foreign-trade relations, some part of the multiplier of the increased investment will accrue to the benefit of employment in foreign countries, since a proportion of the increased consumption will diminish our own country’s favourable foreign balance; so that, if we consider only the effect on domestic employment as distinct from world employment, we must diminish the full figure of the multiplier. On the other hand our own country may recover a portion of this leakage through favourable repercussions due to the action of the multiplier in the foreign country in increasing its economic activity.

Furthermore, if we are considering changes of a substantial amount, we have to allow for a progressive change in the marginal propensity to consume, as the position of the margin is gradually shifted; and hence in the multiplier. The marginal propensity to consume is not constant for all levels of employment, and it is probable that there will be, as a rule, a tendency for it to diminish as employment increases; when real income increases, that is to say, the community will wish to consume a gradually diminishing proportion of it.” JMK chapter 10 GTEIM

So one can admit to possibilities that planned saving and planned investment don’t always line up correctly when implemented, without concluding that fiscal policy works in a reliable and useful fashion. Crowding out effects are real and Keynes knew all about it.

2. There is zero evidence of Lerner’s functional finance working as planned. Politicians have most definitely not run surpluses during booms, but have accumulated debt. Buchanan and Wagner have provided plausible explanations of debt-bias in policy.

3. Friedman’s Long and Variable Lags argument has stood the test of time, Keynesians have no substantive answer to this challenge. Given the length of a ‘normal recession’ politicians in a democracy are not at all likely to implement appropriate fiscal policy in a timely fashion.

4. Estimates of the actual fiscal multiplier come in at very low levels anyway. Data indicates that fiscal policy has little or no effect. Barro leans towards saying its no effect (see here), Krugman says there is still a small multiplier effect. Nobody finds the strong and reliable effect that Keynesians originally hoped to use in “fine tuning the economy”.

The 2008-2013 experience is highly relevant because the slump has been long enough to negate the Long and Variable Lags issue – politicians have had more than enough time to act, they have acted with historic monetary and fiscal “stimulus” and the effects were less than originally predicted. After the fact speculation by Mark Zandi that things could have been worse and by Krugman that the deficits should have been larger are not based on hard statistical facts, but are the product of faith and shaky analysis.

I don’t see how anyone can look at relevant theory and the data both and walk away thinking that there is a strong case for activist fiscal policy. It has not worked. The overall case is at best very weak.

D.W. MacKenzie, Ph.D.
Carroll College, Helena MT

Keynesian economics is such junk science

It’s not that Greece has forecast a budget surplus that matters but that it has forecast a return to growth and stability going forward. That’s the story in the AFR and although this is all you can see at the link, this is pretty informative as it is:

The government has presented a draft budget for next year forecasting a tenuous return to growth, offering the first real hope that Greece could emerge from a six-year recession.

Well fancy that. They cut spending with a cleaver and the next thing you know they are forecasting a return to economic growth. No riots, no blood in the streets, just a quiet reversal of fortune.

I, of course, mention it because this is such a prime example of how useless Keynesian economic theory is that it is a scandal we haven’t had a mass book burning of all our macro texts. Where besides here are you going to find anyone to explain to you why cutting spending in the midst of recession is good for growth.

Now the story does go on to say that the economy has shrunk by a quarter since 2007. But it’s not the economy that has shrunk but the measured level of GDP. Since most of that shrinkage was in public sector waste, the economy did not shrink at all but actually expanded. With each cut in non-value-adding expenditure the actual effect has been positive. Our macroeconomic data, structured around a Keynesian framework as they are, provide not only zero information about the state of the economy, they may even provide negative information, telling you that things are getting bad when they are in fact on the mend.

The unemployment rate is now going to fall from 27% to 26% which is horrific all round no matter how you look at it. But what they had was unsustainable since most of the jobs lost did not pay for themselves from their own productivity. Now jobs will have to pay their own way. It’s not as pleasant as coasting on the value adding activity of others but it is the only way to create long term growth and stability.

Keynesian economics is such junk science.