Tag Archives: keynesian economics

Debating Keynesian economics with a Keynesian

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We are slowly but ever so surely finding our standard of living slipping away. In spite of all that public spending and the deficits and mounting debt – well actually because of all these things – we are slowing going under. Most of us find we are doing without some things we took for granted not that long ago. Whether you look to the US, the UK, Europe, Japan or Australia, a return to rising real incomes and full employment continues to look ever more remote.

And it’s not for lack of public sector “stimulus”. Those deficits continue and even so the money market geniuses keep worrying about deflation. What are we to do? More QE? More debt? More government subsidies for projects that cannot be funded through the revenues they are expected to earn? These are the textbook answers from the textbooks provided to every economic student in the world.

It is all the same Keynesian rot that has not only never worked on any occasion that it has been tried, it has always with no exception made economic conditions worse. If you know of some example where public spending led to recovery, please let me know. For myself, I can give you chapter and verse on all of the failures, and yet nothing seems to be more everlasting than a textbook theory that is simple, plausible and wrong.

I am now in the midst of an online debate with Louis-Philippe Rochon, an Associate Professor of economics, founding co-editor of the Review of Keynesian Economics and co-editor of New Directions in Post-Keynesian Economics. It has been organised by Edward Elgar between two of its authors, and I have just had my first go in an exchange of letters. I have also discussed this debate at Quadrant Online.

The problem remains for me remains as it always was:

What I can tell you from personal experience is that the notion of aggregate demand as a driver of economic activity is now so universally believed that it is nearly impossible to get anyone even to see that it might possibly be wrong, that there is another way of thinking about things. But before Keynes came on the scene, no economist, other than a handful of cranks, ever thought that economies were driven from the demand side.

To deny the independent existence of aggregate demand is so conceptually disorienting to an economist educated any time over the past half century that it is near impossible to get them even to see what you mean. But I have had my go and I expect Louis-Phillipe to answer in the next day or so. I am pleased that he has taken this on, but I remain curious how he will respond. I can only say that no one has ever been brave enough to take this on before. I have had plenty of slanging and ignorant comment. But if it is possible to show that aggregate demand for anything however wasteful can ever promote economic growth and higher employment – NBN, mothballed desal plants, bridges to nowhere – I hope to hear it now.

The consequences of a Keynesian stimulus

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These are really 15 consequences of using a Keynesian stimulus to turn your economy around. Wasteful spending blows your productivity on useless junk while passing purchasing power over to the people on the receiving end of government payments who almost never create value with the funds they receive. The genius is that while our political elites help out their friends, they can pretend they are doing it all to help the people who they harm the most. This is a depressing list, which the linked article goes into with some depth.

1: Wage Stagnation.

2: Most people still haven’t recouped what they lost in the crash: Typical Household Wealth Has Plunged 36% Since 2003.

3: Most working people are still living hand-to-mouth.

4: Millennials are Drowning in Red Ink.

5: Downward mobility is the new reality.

6: People are more vulnerable than ever.

7: Working people are getting poorer: The Typical Household, Now Worth a Third.

8: Most people can’t even afford to get their teeth fixed.

9: The good, high-paying jobs have vanished.

10: More workers are throwing in the towel: Labor Participation Rate Drops To 36 Year Low.

11: Nearly twice as many people still rely on Food Stamps than before the recession.

12: The ocean of red ink continues to grow.

13: No Recovery for working people.

14: Most people will work until they die.

15: Americans are more pessimistic about the future.

It is astonishing to see how rapidly the deterioration has overtaken even so strong an economy as the United States. But at the centre of this disaster is the Keynesian theory that has allowed it to happen with virtually no one any longer able to understand the nature of the problem.

Debating Keynes

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The single most timely piece of economic writing I ever managed to put together was for Quadrant which was published online in February 2009 just as the various stimulus packages were being rolled out across the world. The title it was given, much more aggressive than I might have chosen myself, was The Dangerous Return to Keynesian Economics. And while the whole thing could have been written today without the need for a single change to bring it up to date, the passage I have quoted time and again is this:

What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.

Keynesian economics is, was and always will be a disaster wherever it is applied. That virtually no one understands why that is after three generations of economists have gone through their economics education with standard Keynesian macro at its core is to be expected. What is far less expected is that there has been no serious effort to examine more closely what went wrong after the failures of the stimulus.

As it happens I am at the start of an online debate with Louis-Philippe Rochon, Associate Professor of economics at Laurentian University, the founding co-editor of Review of Keynesian Economics and co-editor of New Directions in Post-Keynesian Economics which is an Edward Elgar book series. One presumes that if anyone can defend Keynesian economics he is the one to do it.

I, however, have been the one to open the batting. Keynesian economics has so many different disguises that unless I could narrow the lines of the debate to within some kind of practical dimensions there would have been no hope of limiting the range of where such a conversation might end up. Elgar has now published the first of these exchanges, How to Promote a Global Economic Recovery? The Keynesian vs. Free Market Approach. Crucially, the delimiting of the debate was the first essential. I therefore began with this:

There are about as many versions of Keynesian theory as there are Keynesians but all versions have two things in common. The first is that economies are driven by aggregate demand. The second is that an economy’s rate of growth and level of employment can be increased by increasing aggregate demand, either through higher public spending or lowering rates of interest. Both are wrong and the destructive consequences of these beliefs are everywhere to be seen.

What I can tell you from personal experience is that the notion of aggregate demand as a driver of economic activity is now so universally believed that it is nearly impossible to get anyone even to see that it might possibly be wrong, that there is another way of thinking about things. But before Keynes came on the scene, no economist, other than a handful of cranks, ever thought that economies were driven from the demand side. What they believed instead was this:

Certainly a government can itself employ, or can buy from others causing those others to employ. And those additional employees can use their incomes to buy things from others still. And so, for a brief period of time, we can say there has been an increase in employment relative to how many might otherwise have been employed.

But unless whatever has been produced is value adding, as time goes by these additional employees merely drain away the productive capacity of the economy. Savings are indeed absorbed but the value left behind is lower than the value used up during production. The economy not only remains stagnant, it winds even further down as its resource base is diverted into wasteful forms of expenditure.

This is the classical pre-Keynesian view of how an economy works and why a stimulus never will. That the classical theory so perfectly captures the economics world we see around us should at least make someone stop and think about the macroeconomics we teach. There should therefore have been at least some consideration that giving politicians and public servants the power to direct such large proportions of our economic resources could not possibly have improved economic outcomes but would only make conditions worse. These are people who, except in the rarest of circumstances, have absolutely no ability to direct a productive enterprise in a value adding way, as they have shown at every turn. It has therefore been astonishing to see that thus far there has been virtually no re-consideration of Keynesian theory and the policies it underwrites, given the evident failures of the stimulus everywhere it has been introduced.

In a week’s time, Louis-Philippe will provide his reply to what I have written. I will naturally post what he writes since I am extremely curious to find out whether there is something I have missed, some bone-crunching reply to the issues I have raised. Although I have looked everywhere for some such reply, thus far I have found nothing, but we shall see.

Obviously, my arguments cannot be properly explained in a brief note of a thousand words. If you are interested in understanding not only why Keynesian economics provides no solutions to our economic problems, but also what should be done instead, read the second edition of my Free Market Economics: an Introduction for the General Reader. There is literally nothing else like it anywhere, which is itself a large part of the problem we have.

Krugman’s intro to The General Theory

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This is Brad De Long’s edited version of Paul Krugman’s 2006 introduction to The General Theory:

In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries…. Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased.

Over the past 70 years The General Theory has shaped the views even of those who haven’t heard of it, or who believe they disagree with it. A businessman who warns that falling confidence poses risks for the economy is a Keynesian, whether he knows it or not. A politician who promises that his tax cuts will create jobs by putting spending money in peoples’ pockets is a Keynesian, even if he claims to abhor the doctrine. Even self-proclaimed supply-side economists, who claim to have refuted Keynes, fall back on unmistakably Keynesian stories to explain why the economy turned down in a given year….

It’s probably safe to assume that the “conservative scholars and policy leaders” who pronounced The General Theory one of the most dangerous books of the past two centuries haven’t read it. But they’re sure it’s a leftist tract, a call for big government and high taxes…. [T]he arrival of Keynesian economics in American classrooms was delayed by a nasty case of academic McCarthyism. The first introductory textbook to present Keynesian thinking, written by the Canadian economist Lorie Tarshis, was targeted by a right-wing pressure campaign aimed at university trustees. As a result of this campaign, many universities that had planned to adopt the book for their courses cancelled their orders, and sales of the book, which was initially very successful, collapsed. Professors at Yale University, to their credit, continued to assign the book; their reward was to be attacked by the young William F. Buckley for propounding “evil ideas.”

But Keynes was no socialist – he came to save capitalism, not to bury it. And there’s a sense in which The General Theory was… a conservative book…. Keynes wrote during a time of mass unemployment, of waste and suffering on an incredible scale. A reasonable man might well have concluded that capitalism had failed, and that only… the nationalization of the means of production – could restore economic sanity…. Keynes argued that these failures had surprisingly narrow, technical causes… because Keynes saw the causes of mass unemployment as narrow and technical, he argued that the problem’s solution could also be narrow and technical: the system needed a new alternator, but there was no need to replace the whole car. In particular, “no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.”… Keynes argued that much less intrusive government policies could ensure adequate effective demand, allowing the market economy to go on as before.

Still, there is a sense in which free-market fundamentalists are right to hate Keynes. If your doctrine says that free markets, left to their own devices, produce the best of all possible worlds, and that government intervention in the economy always makes things worse, Keynes is your enemy. And he is an especially dangerous enemy because his ideas have been vindicated so thoroughly by experience.

Stripped down, the conclusions of The General Theory might be expressed as four bullet points:

1. Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment

2. The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully

3. Government policies to increase demand, by contrast, can reduce unemployment quickly

4. Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach

To a modern practitioner of economic policy, none of this – except, possibly, the last point – sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable….

So now let’s talk about the core of the book, and what it took for Keynes to write it…. In Book I, as Keynes gives us a first taste of what he’s going to do, he writes of Malthus, whose intuition told him that general failures of demand were possible, but had no model to back that intuition: “[S]ince Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to provide an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain.”… That need to “provide an alternative construction” explains many of the passages in The General Theory that, 70 years later, can seem plodding or even turgid…. When you’re challenging a long-established orthodoxy, the vision thing doesn’t work unless you’re very precise about the details….

Keynes’s struggle with classical economics was much more difficult than we can easily imagine today. Modern introductory economics textbooks – the new book by Krugman and Wells included – usually contain a discussion of something we call the “classical model” of the price level. But that model offers far too flattering a picture of the classical economics Keynes had to escape from. What we call the classical model today is really a post-Keynesian attempt to rationalize pre-Keynesian views…. The real classical model… was, essentially, a model of a barter economy, in which money and nominal prices don’t matter, with a monetary theory of the price level appended in a non-essential way, like a veneer on a tabletop. It was a model in which Say’s Law applied…. One measure of how hard it was for Keynes to divest himself of Say’s Law is that to this day some people deny what Keynes realized – that the “law” is, at best, a useless tautology when individuals have the option of accumulating money rather than purchasing real goods and services….

There’s a widespread impression among modern macroeconomists that we’ve left Keynes behind, for better or for worse. But that impression, I’d argue, is based either on a misreading or a nonreading…. If you don’t read Keynes himself, but only read his work as refracted through various interpreters, it’s easy to imagine that The General Theory is much cruder than it is…. Let me address one issue in particular: did Paul Samuelson, whose 1948 textbook introduced the famous 45-degree diagram to explain the multiplier, misrepresent what Keynes was all about? There are commentators who insist passionately that Samuelson defiled the master’s thought. Yet I can’t see any significant difference between Samuelson’s formulation and Keynes’s own equation for equilibrium employment, right there in Chapter 3: [29]. Represented graphically, Keynes’s version looks a lot like Samuelson’s diagram; quantities are measured in wage units rather than constant dollars, and the nifty 45-degree feature is absent, but the logic is exactly the same.

The bottom line, then, is that we really are all Keynesians now. A very large part of what modern macroeconomists do derives directly from The General Theory; the framework Keynes introduced holds up very well to this day.

Yet there were, of course, important things that Keynes missed or failed to anticipate. The strongest criticism one can make of The General Theory is that Keynes mistook an episode for a trend. He wrote in a decade when even a near-zero interest rate wasn’t low enough to restore full employment, and brilliantly explained the implications of that fact – in particular, the trap in which the Bank of England and the Federal Reserve found themselves, unable to create employment no matter how much they tried to increase the money supply. He knew that matters had not always been thus. But he believed, wrongly, that the monetary environment of the 1930s would be the norm from then on…. In the United States the era of ultra-low interest rates ended in the 1950s… Yet the United States has, in general, succeeded in achieving adequate levels of effective demand. The British experience has been similar. And although there is large-scale unemployment in continental Europe, that unemployment seems to have more to do with supply-side issues than with sheer lack of demand…. [Keynes] underestimated the ability of mature economies to stave off diminishing returns. Keynes’s “euthanasia of the rentier” was predicated on the presumption that as capital accumulates, profitable private investment projects become harder to find…. [T]he euthanasia of the rentier does not seem imminent. But there’s an even more important factor that has kept interest rates relatively high, and monetary policy effective: persistent inflation, which has become embedded in expectations…. [E]ven now, when inflation is considered low, most of the 20-year rate reflects expected inflation rather than expected real returns.

The irony is that persistent inflation, which makes The General Theory seem on the surface somewhat less directly relevant… can be attributed in part to Keynes’s influence, for better or worse. For worse: the inflationary takeoff of the 1970s was partly caused by expansionary monetary and fiscal policy, adopted by Keynes-influenced governments with unrealistic employment goals…. For better: both the Bank of England, explicitly, and the Federal Reserve, implicitly, have a deliberate strategy of encouraging persistent low but positive inflation, precisely to avoid finding themselves in the trap Keynes diagnosed….

What makes The General Theory truly unique… is that it combined towering intellectual achievement with immediate practical relevance to a global economic crisis…. There has been nothing like Keynes’s achievement in the annals of social science. Perhaps there can’t be. Keynes was right about the problem of his day: the world economy had magneto trouble, and all it took to get the economy going again was a surprisingly narrow, technical fix. But most economic problems probably do have complex causes and don’t have easy solutions….

Ha-Joon Chang – please copy

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Ha-Joon Chang seems to be the economist of the moment, with yet another book published by Penguin, Economics: The User’s Guide. But what is notable for me is that he has obviously, but only obviously to me, looked either at what I have written about Say’s Law or looked at someone else who has picked up on what I have written on Say’s Law. He does the usual ritual on “supply creates its own demand” but then adds:

“There can be no such thing as a recession due to a shortfall in demand.” [p 116]

You who have heard me harangue on this for many a moon may think nothing of this, but this is precisely the definition I use myself. It is apparently and pleasingly getting out and about. Because once the focus is in the right place and on the right thing, then we can have a genuine debate. Are recessions caused by a shortfall in demand? Because you would have to be demented to believe that the Global Financial Crisis was in any way caused by a fall off in demand. Same for every other recession in history up until now. But if one merely looks at the GFC, a fall in demand because of decisions to save has to be the least plausible of all possible explanations. In fact, Chang, and I think following my lead, goes on to describe the kinds of things that those classical economists used to look at for explanations, which again you would have to be demented not automatically to look at yourself. He writes:

Any recession had to be due to exogenous factors, such as a war or the failure of a major bank.

He thinks bank failures are exogenous [ie external to the operation of the economy, like being hit by a meteorite, say]! A bank failure is precisely what might be thought of as both endogenous and not in any way a Keynesian explanation, which is based around demand failure due to too much saving, not some kind of crisis on the production side. And you would like then to know what caused the bank to fail, and whether the problem was more widespread than a single bank, since during a financial crisis there is never only one bank going to the wall.

But then he goes on to add the usual Keynesian idiocies since economists just do not seem to be able to help themselves:

Since the economy was incapable of naturally generating a recession, any government attempt to counter it, say, through deliberate deficit spending, was condemned as disturbing the natural order. This meant that recessions that could have been cut short or made milder became prolonged in the days of Classical economics.

You really do have to wonder about these blockheads! We are the midst of what may already be the most prolonged of all recessions in history, and it is by no means over yet, and he complains about classical economists’ reluctance of try to fix things by public spending. Let me once more quote from my Quadrant piece from February 2009 which was titled, The Dangerous Return to Keynesian Economics:

Just as the causes of this downturn cannot be charted through a Keynesian demand-deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand, and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.

That is classical economics forecasting almost six years ago the prolonged recession every economy in the world is in the midst of and cannot shake off. If you would like to understand more fully what classical economists actually believed, you cannot do better than this.

Free Market Economics and Say’s Law

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This post is the second of a series I am writing on the second edition of my Free Market Economics that has been published in association with the Institute of Economic Affairs in London. This post focuses on the single most important principle in economics which now goes under the name Say’s Law. But it is a principle that was deliberately eliminated from within mainstream economic theory by Keynes in his General Theory and has disappeared from virtually all economic discourse since that time.

The book was itself written because there is literally no economics text of any kind anywhere that discusses Say’s Law. Yet it was this principle that made it perfectly obvious that the stimulus being applied across the world from the end of 2008 would lead to an economic stagnation that would last years on end. That is why I immediately began to write the book then and there, but it is also why I had published in February 2009, just as the stimulus was getting under way, an article with the title, “The Dangerous Return to Keynesian Economics”. The article specifically discussed the crucial disappearance of Say’s Law and included this forecast:

“Just as the causes of this downturn cannot be charted through a Keynesian demand-deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand, and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

“What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.”

While virtually the whole of the economics profession remains flummoxed by what has happened since the stimulus, neither my students nor myself have been in any doubt. It has been as obvious as the noonday sun, but invisible to anyone brought up on modern macroeconomics which has embedded the theory of aggregate demand, Keynes’s disastrous contribution to economic theory.

Say’s Law specifically stated that demand deficiency, that is, a deficiency of aggregate demand, could never be the cause of a recession (or in the archaic language of the classics, “there is no such thing as a general glut”). It then specifically told governments that while some additional public expenditure during recessions might do some small good, such a stimulus would never restore an economy to robust health but would, instead, do serious damage, and the larger the stimulus the more damage it would do.

The book explains the nature of Keynesian economics but also explains why a stimulus could not possibly have returned our economies to rapid rates of growth and low unemployment. The experience of the past six years ought to have made all this supremely evident in practice. But without an understanding of Say’s Law, there is not a chance in the world anyone will understand why the stimulus has been the colossal failure it has been.

Although named Say’s Law after the early nineteenth century French economist J.-B. Say, it was a principle that was part of the bedrock foundation of economic theory right up until 1936. But what will never be told to you by any Keynesian economist (in large part because they don’t even know themselves) is that the term Say’s Law was invented in the twentieth century by an American economist who thought it was absolutely essential for clear thinking in economics and brought into active use only in the 1920s.

If for no other reason, I commend my book to you because it is the only place where one can have Say’s Law explained in a way that makes you understand what economic theory has lost. It will also explain why the stimulus did not work and what must be done instead, reasons enough to buy the book I would hope. But there are also others which I will come back to in later posts.

Disproving Keynesian economics once and for all

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I don’t allow comments on this blog mainly because I am not up to policing what other people say. But I read them and this today, from Rob, was stunning. Referring to my little rant on the uselessness of economic theory today, he wrote:

But at least it has advanced enough to tell us that for more growth, we need …. more broken windows:

The Lack of Major Wars May Be Hurting Economic Growth

Tyler Cowen is a professor of economics at George Mason University

I mean, what would a dead white male like Frederic Bastiat know anyway?

Tyler Cowen is, of course, a live white male, but given there are such things as negative knowledge – things that if you believe them make you dumber than if you knew nothing at all – it is possible for him to know less than Frederic Bastiat, dead though he may be. Let me quote from the opening of that column:

The continuing slowness of economic growth in high-income economies has prompted soul-searching among economists. They have looked to weak demand, rising inequality, Chinese competition, over-regulation, inadequate infrastructure and an exhaustion of new technological ideas as possible culprits.

An additional explanation of slow growth is now receiving attention, however. It is the persistence and expectation of peace.

Let me put it this way. There is bad economics, there is unbelievably stupid economics, and there is the belief that growth has slowed because there are no wars.

It is neither here nor there that there’s not all that much peace around anyway. But let me remind you of the greatest disproof of Keynesian economic policy in history. Everyone always points out that one Keynesian data point which is the so-called boom that came at the start of World War II. Not a boom at all since what most people remember about the home front was rationing and controls of every kind, and if you are thinking about the labour shortages, merely recall that around half the labour force under thirty was drafted into the army. But that’s not that point either, although it should put quite a dent into such Keynesian thought.

It is the coming of peace in 1945 that is the grand refutation of Keynesian economics. At the end of the war, within a year millions who had been overseas fighting, or had been part of the war effort at home, were suddenly in the labour market looking for work. Many women who had taken jobs while the men were overseas also remained in the workforce. The Keynesians were continually badgering Truman to maintain war-time deficits since, they said, if he did not the US would go straight back into the depression. Truman, however, having had a business background, hated deficits and the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures and in so doing set off the greatest economic boom in world history, a boom that lasted straight through until ground into the dust by the war on poverty, and dare I say it, the unfunded, deficit-financed war in Vietnam.

Thinking about economic issues from the demand side is the single biggest mistake anyone can make in economics. In fact, if you do think that way, you aren’t even an economist since Say’s Law was once considered the best test of a sound economist. Not many of them around any more, I fear.

Here is the message. An economy is driven only by real value adding supply. Nothing else. This is the message of Say’s Law, supposedly discredited by Keynes but as accurate a statement of economic principle as there has ever been.

Fixing economics

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There is an article by Tim Thornton in today’s Age with the title I might have written myself, The problem with the way we educate economists. He thinks the problem is neo-classical economics which is the standard mainstream taught to everyone who seeks to become an economist. In saying he doesn’t like the way we teach economics, he is really saying he doesn’t like the standard theory found today or more particularly, the quality of the economics profession itself. These are the three problems with the way we teach he lists which are problems with the people who make economic policy:

Firstly, there is generally no required study of economic history or the history of economic thought. This produces graduates with dangerous levels of historical amnesia in regard to the world and to the discipline they assume they understand.

Secondly, contemporary economics students will rarely encounter any of the schools that compete with the neoclassical school: institutional, post-Keynesian, behavioural, Marxian, Austrian, feminist or ecological. These economics schools, which come from all points of the intellectual and ideological compass, make crucial contributions to building up our understanding of a complex and ever-changing economic and social world.

Thirdly, the curriculum fails to incorporate crucial insights offered by other disciplines such as politics, philosophy, history, sociology and psychology.

With any discipline what you teach depends on the question you want to answer. If you are interested in knowing how goods and services end up produced, incomes earned and output distributed, neo-classical theory is pretty reasonable. I say this even having major differences with the mainstream. The course I teach and the book I wrote cover all three of issues raised. I embed my course in history and the history of economic thought. I contrast modern theory with its classical alternative so no one comes away thinking there is only one answer to any question. I introduce politics, philosophy and history, although I must admit seeing little value in either sociology or psychology in answering any of the questions economists have traditionally asked.

Typically, those who would like to root out our modern neo-classical inheritance do so for some quasi-Marxist reason. They are seeking answers to different questions. Their interest is in explaining the distribution of power within a society. This is, of course, politics or sociology but it is not economics since even if you knew the answers to any of the questions a political scientist or sociologist might ask, you still wouldn’t understand how goods ended up being produced, what economic structures would give you the greatest output, how the community’s command over goods and services could be increased, what to do in recessions, or even what causes recessions in the first place. Instead what would be taught is some variant on the unfairness of the system and how it needs to change to ensure those who have the least wealth, which typically means those who have contributed the least to our communal flow of goods and services, can get a larger share of the pie.

Economics emerged as a separate study over two hundred years ago when our societies were extremely poor as they had been since the beginning of time. Now we, who live in economies where markets predominate, are astonishingly wealthy by any and every standard that an economist two hundred years ago might have listed as an aim and ambition. And because of the innovation machine that has been set in place by these same economic structures, we have a reasonable expectation that our wealth will continue to grow.

If someone has a better answer to the questions economists wish to answer, then they must convince other economists first. To take your ball and bat and go off somewhere else may make it easier to find someone to agree with what you say, but then you are talking into an echo chamber of your own construction. There is lots wrong with economics – lots – but to ask for a separate discipline, or encourage a schism within economic theory because you have a different view, is not the way these issues will ever be resolved.

But where I can overwhelming agree is that the economics establishment has built an edifice as strong and formidable as the one built by mediaeval theologians. The answers it gives to many questions seem wrong to me and many others. I hate to show disrespect to Her Majesty, but when she asked after the GFC why no one had forecast the recession, she was asking a question for which there will never be a solution. Recessions happen and it is precisely because they are unexpected that they turn out so badly.

What economists can, however, do is explain why that is, and try to provide answers on how to recession-proof our economies as best we can and hasten recovery when they turn down. Neo-classical theory, being drenched in Keynesian structures, will unfortunately never be able to find the answer to either question which is why a genuine review of economic theory and policy is so urgently required. But because a bunch of twenty year olds are dissatisfied with the answers that modern economic theory has devised is the worst possible reason for looking out for new answers to old questions, which in their case really turns out to be looking for old answers to different questions.

Where are the critics of Keynes?

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I put the following post up at the History of Economics list the other day because it exactly reflects a problem I am having.

I am doing some work on Keynesian economics in the period following the Global Financial Crisis. It just may be that I do not know where to look but I am having trouble finding articles of any kind criticising Keynesian models and the theory behind public sector spending and the stimulus. Can anyone help?

And as an additional query, although Mises, Hayek and Friedman are seen as “anti-Keynesian” whatever that may mean, again there seems to be a dearth of articles by them critical of Keynesian theory as it relates to public sector spending and the stimulus. So again, can anyone help?

Responses both online and offline would be greatly appreciated.

There are other economic traditions, from Austrian to Marxist, but each keeps to itself without bothering to actually criticise explicitly what they think is wrong with Keynesian analysis. And for many of the traditions, public spending in recessions is the least of their aims in changing the nature of policy based on the theories proposed. And while there have been a number of useful suggestions that have been sent to me offline as well as discussed online, there is no great cache of anti-Keynesian material anywhere that anyone has been able to unearth.

It would be one thing if the stimulus had been a no-questions-asked success, or even a mid-level so-so success, but instead it has been the most abject failure with every economy struggling to untrack from the debt and deficits the stimulus has caused. So where are the critics?

Keynes and the coming Chinese recession

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I realise I haven’t been haranguing you about the menace of Keynesian economics for a while so thought I’d remind you of its enduring horrors as there is unanimous agreement that Australia has to get its fiscal house in order. The origins of that disorder are, of course, in the Keynesian policies put in place during the GFC. Just hearing about Kevin Rudd’s 48-hour decision process for the pink batt adventure is a reminder of just how useless, in terms of productivity and real growth, almost all government spending is. A perfect paradigm example. Past the first ten percent, government spending is unproductive whatever other benefits there may or may not be.

As for a recantation from the economics community, not so much as a word. You do have to wonder if they are ever going to get it right. And if they don’t get it right, how policy is ever going to get it right. The latest episode of wrongheaded analysis shows up on the ABC with this story not about Australia but about China. Apparently the problem with the Chinese economy is debt:

In recent times, the boom has been sustained by an explosion in lending by banks and so-called “shadow banks”. If the current scale of lending proves to be unsustainable, could that end the boom and result in China becoming the next country to succumb to the impact of unproductive debt? [my bolding]

Ah, “unproductive debt”! What, pray tell, is that? It is, in fact, exactly what every pre-Keynesian classical economist warned against. It’s spending on non-value-adding forms of production, the usual object of government spending in virtually every one of its forms. There it is, the problem right before their eyes but invisible all the same. Whether one thinks of it in money terms, so that debt is taken on for forms of production which ultimately do not earn sufficient revenue to repay what is owed, or it is thought of it as using up productive resources in ways which do not replace the capital that has gone into that particular form of production, one way or the other the economy is going backwards and not ahead. Keynesian economics is poison but who’s to know? This is what the Chinese did:

The program clearly lays out how the Chinese leadership responded to the prospect of a global financial crisis and possibility of a world-wide depression. The response focused on a spending and investment program carried out on a scale never seen before in human history. Over the past five years, a new skyscraper has been built every five days in China – along with 30 new airports and 26,000 miles of motorways.

Well there was certainly an enormous quantum of resources used up which, incidentally, also happens in highly productive investments. In this case, however, there are the office building, there are the roads, there are the airports, but none of them will generate the revenue to repay their costs. A Keynesian program to the back teeth with predictable results, or at least predictable if you start with Say’s Law. Starting from Keynes it is all a mystery with no explanation. And where do they think it will end up:

Interviewing key players including former American Treasury Secretary Henry Paulson, former Chairman of the Financial Services Authority Lord Adair Turner and Charlene Chu, a leading Chinese banking analyst, reporter Robert Peston reveals how China’s extraordinary spending has left the country with levels of debt that many believe can only result in an economic crash with untold consequences for the world – particularly resource-driven economies like Australia.

If you thought the last five years were bad, apparently the next five will be even worse. Meantime, ending the reign of Keynes and return to classical economic theory would be a start in even understanding what’s going on never mind actually getting our economies untracked.