Tag Archives: Keynesian economic theory

Government must get out of the way

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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

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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

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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

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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.