Tag Archives: keynesian economics

Why focus on Say’s Law?

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This was not written to me but I was copied in on the reply that was sent to Michael:

Michael

You asked about the article in the latest Quadrant by Steve Kates on “The Dangerous Return of Keynesian Economics – Five Years On”. On the use of “Keynesian” stimulatory policies, I think he is right to draw attention to their failures and the idea that budgetary action to stimulate demand works. This is apparent from recent and past experience, such as the failed Roosevelt policies in the 1930s cf to the Premiers plan of budgetary cuts, which helped get Australia out of the recession much more quickly than the US (I think I have written to you about this before). However, don’t forget that Keynes himself said at the time not to risk budget deficits and that he also changed his advice to Roosevelt ie Keynes did not in practice necessarily stick to his textbook (published I think in 1936, half way through the recession). It is amazing that Australia’s experience in the 1930’s is still said to reflect Keynesian “stimulatory” action: Rudd ran that line when he became PM and used it to justify his stimulatory policies during the GFC.

I prefer not to get involved in the Say’s law argument like Kates does [my bolding]. It is simpler, I think, to focus on what is the likely response of the private sector to budgetary stimulus action. As suggested, recent experience supports the view that it is not likely to result in any sustained increase in spending (ie there may be a temporary surge but not a lasting one). Treasury had to publish a correction to the budget papers about the claimed success. [But why didn’t it work?]

What about “stimulation” through monetary policy? The recent experience in the US and some other countries again suggests this doesn’t work. It may be claimed that it has worked in the sense that Bernanke may have prevented the US from going into recession. But what would have happened to interest rates if there had been no abnormal increase in the supply of money and the market had been allowed to determine interest rates without central bank intervention? My guess is that they would still have fallen to similar low levels because the private sector would not have been invited to finance additional spending by borrowing, just as it wasn’t under the Bernanke policy.

I have also written to you about what caused the GFC. I won’t venture further on that here other than to say that central banks allowed the supply of credit to increase at far too rapid a rate.

In his article Kates also includes a graph on the US unemployment rate calculated by including in it labour force drop outs since 2009 and showing that (on this basis) the rate has not fallen at all from the 11% reached in 2010. Kates uses this as one indication that the stimulatory policy in the US hasn’t worked. With press releases and letters I have been trying (unsuccessfully) to get across a similar message here and that the unemployment rate is not on its own an effective measure of the state of the labour market and the regulations thereof ie including drop outs our unemployment rate in Australia is much higher than the published one.

So my reply.

I much appreciate Des’ comments but if I might, would like to add my own perspective. And what is most important here is why I do dwell on Say’s Law which I do not just because it is the most accurate way of thinking about macroeconomic issues which I will come to in a moment. But why Say’s Law.

First, Say’s Law was Keynes’s own issue. The General Theory is written as a book-length refutation of Say’s Law which Keynes is at pains to show. The key passage in the General Theory so far as explaining Keynes’s intentions are found on page 32:

The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since 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 furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas. [My bolding again]

The one innovation of The General Theory that remains embedded in all macroeconomics today is aggregate demand. The existence of aggregate demand as an independent force in economics was absolutely denied by pre-Keynesian economists. The denial was summarised in the propositions “demand is constituted by supply” and “overproduction is impossible” which were the specific meanings associated with Say’s Law, along with there is no such thing as a general glut. Demand deficiency, so far as classical economic theory is concerned, is never a realistic explanation for recession and therefore demand stimulation is never a solution for recessions when they come.

If you use aggregate demand in any context to explain anything about the state of the economy, in my view you have sold the pass. You can never recover since you have accepted Keynes’s basic premise to argue against Keynesian theory. And once you have done this, you really have no firm foundation that will allow you to turn back the Keynesian tide. In fact, if you think of aggregate demand as actually independent from aggregate supply, and therefore a force for raising the level of economic activity and employment, there is no reason not to apply a stimulus of some kind during recessions. It is only if you understand that such a stimulus cannot possibly work that you would oppose a stimulus as a set of actions that will certainty harm our economic prospects whatever brief relief it might do over the initial one or two quarters.

But there are other reasons for bringing Say’s Law into it. Because when I do, I am invoking the conclusions reached by all of the great economists of the past: David Ricardo, John Stuart Mill, William Stanley Jevons, Alfred Marshall, Henry Clay and Allyn Young. This takes me across a period from 1820 through to 1928 and thus encompasses economists from the first days of economic theory through until almost the very day of publication of The General Theory. No economist of any stature denied the validity of Say’s Law until it was swept away by Keynes. Please see my Say’s Law and the Keynesian Revolution if you would like to go through the entire sordid story how Say’s Law disappeared from economic discourse.

But the theory is what’s important, and for this you would need to go to my Free Market Economics. Very hard to summarise but the two elements that make this kind of economic theory different are firstly the essential role of the entrepreneur and secondly the embedding of value adding into the very core of economic thinking.

The order in which everything occurs within an economy 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. Governments 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. And because such activities were non-value-adding, the effect on employment at the going wage was certain to be negative as time went by.

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. All economic activity draws 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. You have used up resources and are less wealthy than you had previously been.

3) The need for economic activity to be value adding is essential. Production is value subtracting. It uses up resources. When whatever is being produced finally 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. And only if the net effect of such investment has left behind an economy capable of producing more than it previous could do can one say that the economy has grown.

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 and was ever likely to be. 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 above the costs. 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.

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

Classical economic theory and the modern world

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A post in two sections.

Section I

The March issue of Quadrant has an article of mine which has just been put up online. In the magazine itself the title is, The Dangerous Return of Keynesian Economics – Five Years On. What it is five years on from is an article of mine that found its way into the March 2009 issue which dealt with that very dangerous return of Keynesian economics in the form of the worldwide stimulus that economies across the world were beginning to apply. The original title was The Dangerous Return to Keynesian Economics for which this was the single most important passage:

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 this outcome was absolutely assured in my own mind is, of course, not the same as it being absolute assured in reality. And indeed, it is not too much to say that 99% of the economic opinion of the world went quite the other way. The best example of this attitude may be seen in this comment made to me by Senator Doug Cameron during my appearance before the Senate Economic References Committee in September 2009.

Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?

This is, of course, a question I ask myself but also one for which I have an answer. The odd part is that no one else asks this question although it is the question that ought to go to the heart of the matter. Which takes me to the second part of this post.

Section II

The economics I use I did not invent but am near enough unique in applying it to economic questions in the modern world. This is the economic theories of the cycle as developed by classical economists which was the theory accepted universally across the profession prior to the coming of the Keynesian Revolution in 1936. So to see things as I see things about the nature of this theory, let me take you to the opening part of a form I have just sent to my publisher on how to advertise the second edition of my Free Market Economics. It was a book whose first edition I wrote at white heat over the twelve weeks of the first semester in 2009, from March to May, to explain in more detail why the stimulus would with certainty fail, as fail it did.

1. Please describe the book in non-technical layman’s terms (in no more than 150 words). Include brief details of the book’s main objectives and conclusions.

Have you ever wondered why no public sector stimulus has ever worked? You are holding in your hands a book that is unique in our times. It is a text on economic principles based on the economics before Keynesian theory became dominant in macroeconomics and equilibrium analysis became standard in micro. It looks at economics from the perspective of an entrepreneur making decisions in a world where the future is unknown, innovation occurs at virtually every moment, and the future is being created before it can be understood.

Of particular significance, this book assumes Keynesian theory is flawed and policies built around attempting to increase aggregate demand by increasing non-value-adding public spending can never succeed but will only make conditions worse. The theories discussed are the theories that dominated economic discourse prior to the Keynesian Revolution and are thus grounded in the economics of some of the greatest economists who have ever lived.

It is, of course, possible that I might have been right for the wrong reasons, but it might also be the case that I was right for the right reasons. I go on about Say’s Law, John Stuart Mill and classical theory, but you know, when have they ever let me down? The world, so far as the evidence shows, works exactly like their theory says it does. And it’s not even that I picked this downturn as a one-off instance, but I also picked the upturn that followed the massive cuts to public spending after the Costello budget in 1996. Who else did that then? What theory is there other than the classical theory of the cycle that could even explain it let alone predict it? And there is no other text anywhere in the world written more recently than the 1920s that can tell you what that theory is other than mine.

You could, of course, buy the first edition right now or you can wait until the much improved second edition is published in July or August.

The art and science of debate

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Let me start by taking up a couple of issue as examples of the lack of reasoned debate in our society.

The first of these is global warming. There has been an across-the-world debate on whether the planet is in the midst of unsustainable warming due to increased greenhouse gases. Even though I have had my doubts from the start, what you do is examine the arguments others bring up to see what truth content there is and you look at the evidence that’s presented along with the theoretical explanations. And OK, for a while, the temperatures were going up, which was a correlation but not proof. I, like others, therefore kept an open mind and watching brief. But then, around fifteen years ago, temperatures stopped rising even while atmospheric carbon continued to increase. As a result, my scepticism has been maintained and I think of such scepticism as fully justified. Yet I do not know of a single person of the green persuasion who has come to the conclusion that perhaps they might have been wrong?

Or take another of my areas of interest, Keynesian economics. I have, for theoretical reasons, strong doubts about modern macroeconomics and its focus on aggregate demand. In my view, Say’s Law is valid while the whole of modern macro is built on a well known classical fallacy. And what is the the fallacy: that increases in public spending will increase aggregate demand and therefore return an economy to low unemployment and faster growth. OK, comes the stimulus, I set down in print my expectation that it would fail on a grand scale, that it would make economic conditions far worse than they were, and would not return our economies to strong growth and full employment. And had our economies, contrary to my expectation, recovered I would have had to give up my opinions, not least because everyone would have reminded me of what I had written. But instead, the world’s economies have unfolded almost exactly as I expected they would. But has any Keynesian actually said that, well, you know, perhaps modern macroeconomics is wrong after all. If there is, I have not heard of a single instance.

This brings me to a very high level and interesting discussion on why arguing with people on the left is not the same as debating, more like talking to a wall. Beyond that, as Captain Capitalism, the name he calls himself, points out, a proper debate is about advancing the truth, whereas dealing with the left merely ends up with abuse but little advance of knowledge. A long post on the art and science of debate but here is one part of which the whole is well worth the effort:

Aurini . . . delves into detail explaining the “debate” structure of grammar, logic, and rhetoric. Grammar basically meaning you all have to agree on the definitions and meanings of words. Logic meaning you have to be intellectually honest and adhere to associative rules and other logical concepts that ensure integrity. And rhetoric meaning you apply it in the real world or test one another’s arguments with anecdotes from reality. If both parties in a debate or even a discussion have these three things, then the conversation/debate is much more productive and progresses towards an inevitable “conclusion,” “reality” or agreement.

What’s funny though is for the longest time I never viewed debate as a cooperative effort, but rather an adversarial one. One of competition. One where you had an enemy that needed to be defeated. Of course, this was the sad consequence of growing up with the mentally deficient people that populated my generation. Parties I attended in my 20’s I was regularly attacked and berated for being a conservative. Debates in college (or even post college) were filled with emotion and vitriol. And in nearly 100% of the cases my opponents degraded into name calling, ad hominem attacks, accusations of “ism,” or being a nazi, etc.

And then a little later in his article there is this:

The majority of people are weak-minded. They are also lazy. However, they are also egotistical . . . and so their mind reaches for something that will not only allow them to claim some kind of intellectual “superiority” or “achievement,” but also allow them to do so with no work.

Going green
Protesting
Claiming they’re a caring liberal
Joining a religion
Going vegan
Becoming a professor
etc.

This not only results in them living in a delusional, non-real world, but also makes them emotionally and egotistically invested in keeping up their ideological facade. Thus, when you make impassionate, logical, stoic arguments of fact, math, and statistics you (consciously or not) pierce their ego, expose their charade, and therefore trigger a visceral, emotional, and often hate-laden response from them.

The left tend to deal in feelings rather than facts and proof. It actually seems that facts and proof are no part of anything they propose. They believe what they wish to believe because it makes them feel better, not because it is actually valid or demonstrable to reason and common sense.

Half way there

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Yesterday I discussed a comment on the History of Economics website about the growing need to be wary about Keynesian economics and today there’s an article at the Wall Street Journal about the same thing, this one titled, Worse than Obamacare which it is. Let me pull out two bits before I get to my main point:

In February 2009, he got $831 billion of stimulus spending. Not even seismographs can detect the results. Every speech he outputs about “middle-class folks” offers them the same solutions: more public spending on education, on public infrastructure projects and, even now, on alternative energy. As he tirelessly repeats what remain promises, the Labor Department’s monthly unemployment-rate announcement on Friday mornings has become a day of dread.

No one any longer expects an upturn in the American economy. Long, slow and tortured is now the way things are. And finally people are getting around to thinking that it may well be Keynesian theory that is in itself the problem:

You know the theory here: Spend a public dollar and you get $1.50 of economic output. It hasn’t happened, but Barack Obama is gonna crank his old Keynesian Multiplier, created during the 1930s in the era of the Hupmobile, until it sputters to life.

Well, you’ve been hearing from me from the start that it was never going to work and for some reason it has taken five years for the penny to drop. It was never going to work because the underlying Keynesian theory is false from surface to core. But it’s only obvious if you understand the economics that existed before Keynesian economics entered the scene and return to the specific proposition that Keynes derailed.

There are others who think they can see Keynesian economics off the lot through some other means but I don’t believe it. It is only if you understand the classical theory of the cycle and Say’s Law can you make sense of why the stimulus did not achieve a single one of its aims. Stimulating demand cannot work because you cannot stimulate demand by increased spending on anything at all. You can only increase economic activity through increases in value adding supply, the very thing no government can ever do. What governments do is waste and the effect is to deaden the economy, and the more waste there is, the deader it becomes.

In seeing that Keynes must go we are only half way there. The other half is to restore the economic theory that Keynesian economics replaced.

[My thanks to Julie for the WSJ link.]

The economics equivalent of Godwin’s Law

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This is a correspondence that began on the Societies for the History of Economics (SHOE) website that originally dealt with wages and productivity. But as the thread developed, the issues drifted over towards Keynesian economics, and not I emphasise because of anything I had contributed. So on November 15, there was the following contribution which began with a quote from something that had been written by James Ahiakpor:

It was with much amusement that I read Michael Ambrosi’s comments. Amusement because I remain puzzled as to why some historians of economic thought can’t seem to shed their Keynesian beliefs in the face of analysis clearly contradicting them … I’m getting to the point of accepting that some people just can’t be helped with arguments or clarifications. It’s just a waste of time. Would that I did not encounter them in the academic refereeing process …

Following which the following question was asked:

There are ex-Marxists and ex-Keynesians: where are the ex-Austrians?

So on the very same day, I wrote the following response:

Rob asks an interesting question which I think is worth a thread of its own:

‘There are ex-Marxists and ex-Keynesians: where are the ex-Austrians?’

Austrian economics was one strand of pre-Keynesian classical economic theory but an important strand today since it is the only strand that survived the Keynesian Revolution. I don’t classify myself as an Austrian but as a classical economist which gives me an overlap of around 75% with the Austrian School and about 10% with modern neoclassical macro. And there is almost nothing in Mises and Hayek I ever find myself in serious disagreement with.

There are, no doubt, ex-Austrians but I suspect none of them end up in any of the modern strands of economic theory. I often mention Mill but a more modern and accessible version of the classical school can be found in almost any text pre-1930. My favourite for a variety of reasons is Henry Clay’s 1916 Economics: an Introduction for the General Reader but there are many to choose from. Haberler’s Prosperity and Depression published in 1937 moves you closer to the depth and breadth of the classical theory of the cycle.

I have for many years found Keynesian demand side analysis utterly wrong but where was the evidence? Now we have had a radical experiment in economic policy across the world and if it is not obvious beyond argument that a Keynesian stimulus will not work then I don’t know what conceivable evidence there could ever be that would convince anyone just how poorly structured the underlying Keynesian theory is. Y=C+I+G in my view and the view of many others provides no insights into either the causes of recession nor what to do when they happen.

There are therefore no ‘ex-Austrians’ in the same sense as ex-Marxists or ex-Keynesians because the world continues to behave more or less as we classical/Austrian economists expect it to. Classical theory does explain and it does provide policy answers which we are seeing put in place under the name of austerity as an attempt to restore balance after the Keynesian excesses of the past five and more years. Those who are taking this road are guided by intuition without textbook answers but are doing pretty well what a classical economist would have recommended. That is, they are doing exactly what the UK, Australia and others did to take our economies out of the Great Depression.

A series of responses followed this, some reply to Rob and others to me. But the largest complaint about what I had written was not about Keynesian theory but whether I had gone to far in stating that the failures of the Keynesian stimulus had been “obvious”. That the stimulus has made things worse in every economy it has been tried seems so self evident that I still don’t know how the obviousness of the mess the stimulus has caused can be question. Nevertheless, this is what I wrote in reply on 16 November:

I should not have said ‘if it is not obvious beyond argument that a Keynesian stimulus will not work etc etc’ since it is not obvious. But even here in Australia, where for a variety of reasons we probably experienced the least damaging downturn following the GFC, the general assessment is that the stimulus has left us with massive problems that will require a repair job going over many years. No one goes around talking about how well the stimulus turned out and even as unemployment has now returned to its post-GFC high and still heading north, our new government is attempting to cut spending and bring the budget into balance just as the previous government attempted to do. And on this we are not alone.

So it is not obvious what went wrong, merely a conundrum: this is what it says in the textbooks and this is what we feel we need to do. Why are they different?

Every economist seems to be in some ways eclectic. They put their own worldviews together built around one of the existing frameworks that for individual reasons appeal to themselves. And over time they shift and change as they learn more and observe. But with macro just about everyone starts from AS-AD which has now become a major dividing line. Keynesians versus Austrians is the way it is often portrayed but this is a short form which leaves out much of what is relevant.

But however you would like to describe the nature of this divide, we as economists should in my view be having some kind of in-house review on the relevance of AS-AD to the formation of policy. It’s true that AS-AD is a very seductive concept, not obviously wrong. But still, starting from casual empiricism and then working through the econometric work of Alesina, say, but also others, and with theoretical considerations also then brought into this discussion, alternatives to AS-AD might eventually emerge in our textbooks. In the meantime, ever fewer policy makers are willing go near AS-AD to work out what ought to be done in the real world. That much anyway is obvious. Given that our economic texts ought to be a guide to economic policy, all this should be seen as something of concern to the profession.

The only reply since then has been to say this:

If I may offer just one more quote from some people who care about the evidence. Jordà, Òscar and Alan M. Taylor, 2013:

The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy

[W]e have a measure of the multiplier that explicitly accounts for failures of identification due to observable controls. Our estimates … suggest even larger impacts than the IMF study when the state of the economy worsens. … It appears that Keynes was right after all.

As Steve now allows, it is *not* obvious that the fiscal responses to the Great Recession invalidate Keynesian claims about the role of aggregate demand. Not in the least.

To prove using a Keynesian model that Keynesian theory delivers the goods in the face of the massive disasters that ought to be the unarguable evidence that the US economy is sinking, only proves there are some people who cannot see because they will not see.

There really needs to be an equivalent to Godwin’s Law in economic discussion. Whoever is the first to bring empirical results into an argument about economic theory automatically loses.

An Austrian course on Keynesian economics

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I have been hassling my Austrian friends for quite some time that it is not enough to be pro-Hayek and pro-Mises but they also have to be anti-Keynes. Unless they specifically present their own pre-Keynesian classical views as a direct counterweight to the Keynesian wreckage, they have no hope of seeing Keynesian economics finally removed from our texts. It still remains a mystery that the events of the past five years have not even commenced a massive overhaul of mainstream economics. It does seem as if the mainstream continues to believe they are on top of it all. But if mainstream economists still think that Y=C+I+G can explain what caused the recession in the first place or what is needed to create recovery, not only is their economic understanding now worthless but so too is their credibility.

But this morning I have received a notice from the Mises Institute that it is about to run a six-week online course on Keynesian economics:

Beginning Monday, November 11, William Anderson will be teaching ‘The Ghost of Keynes’ at Mises Academy. This six-week online course will examine how and why many economists and governments continue to ignore the numerous fallacies that accompany Keynesian thinking even as the Keynesian-influenced economies around the world continue to flounder in high unemployment and low growth.

Whether this will include a discussion of Say’s Law I do not know but it absolutely needs to. You can watch my presentation to the Mises Institute above on Keynesian economics and Say’s Law. But even though there is an appreciation amongst Austrian economists that the two are related, the importance of Say’s Law is not yet completely embodied in the way Austrians discuss economics. They, of course, do not reject Say’s Law but they also do not fully embrace it.

Nevertheless, I encourage you to sign up for this six-week course. You can enroll here.

Keynes versus Hayek once again

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alex on keynes and hayek

I suppose that’s one way to look at it: Keynesian economics as a make-work project for anti-Keynesians. On the other hand, if the notion that digging holes to fill them in again doesn’t strike you as the epitome of an insane economic policy then what hope is there for any of us other than for the hole-digging and hole-filling industries, along with businesses in shovel and overalls production. But Alex does get the nature of Keynesian economics 100% right. It is just what Keynes recommended and Krugman to this day supports.

[My thanks to Robert for sending this along. How could I have missed it?]

I’m not a Niallist

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I read Niall Ferguson’s three posts on Paul Krugman which are generally summarised in this critique of Krugman and titled, “Much Bigger Than The Shutdown: Niall Ferguson’s Public Flogging Of Paul Krugman“. And you may be sure that nothing would be of greater interest to me than a proper take down of Krugman and the Keynesian theory that lies behind it. But while this critique may work in the world of non-economists it doesn’t work for me. There is nothing in it I feel I can refer to as an actual dissection of Krugman’s views. It certainly won’t affect any of Krugman’s own beliefs nor that of any modern economist.

Krugman’s position might really be brought down to three propositions:

1) To get out of our current recession it was, and is, necessary to have a full blown Keynesian stimulus.

2) Obama’s actual stimulus was too small. It was large enough to appear large enough but it was too small to actually achieve its ends and so will only discredit Keynesian theory and policy rather than demonstrate its effectiveness.

3) And for Austrian critics, where’s the inflation that is supposed to follow this wasteful expenditure since prices have been dead flat if not tending towards deflation? You may have pointed out that inflation that followed the spending of the 1970s but now there’s none so an Austrian analysis is completely wrong.

Ferguson made no headway on any of this. Instead, he stepped back and wrote:

I am not an economist. I am an economic historian. The economist seeks to simplify the world into mathematical models – in Krugman’s case models erected upon the intellectual foundations laid by John Maynard Keynes. But to the historian, who is trained to study the world ‘as it actually is’, the economist’s model, with its smooth curves on two axes, looks like an oversimplification. The historian’s world is a complex system, full of non-linear relationships, feedback loops and tipping points. There is more chaos than simple causation. There is more uncertainty than calculable risk.

Well great. This is not just Keynesian economics it is all economics that Ferguson takes aim at. By its nature, economics is about simplification, sometimes using smooth curves on two axes (e.g. supply and demand). And while I am a critic of economic theory along many dimensions, including the way in which the uncertain future is almost invariably swept away by many forms of modern analysis, this is so superficial and wrong headed that it leaves me absolutely cold. Krugman can ignore it because it in no way touches anything that matters in his economics and analysis. This is no answer at all.

But then to go on about how beastly Krugman is in how he attacks his opponents, and to praise Keynes as the contrast, is to show a fantastic ignorance of Keynes and the polemical nature of The General Theory. This is Ferguson attacking Krugman:

Finally – and most important – even if Krugman had been ‘right about everything,’ there would still be no justification for the numerous crude and often personal attacks he has made on those who disagree with him. Words like ‘cockroach,’ ‘delusional,’ ‘derp,’ ‘dope,’ ‘fool,’ ‘knave,’ ‘mendacious idiot,’ and ‘zombie’ have no place in civilized debate. I consider myself lucky that he has called me only a ‘poseur,’ a ‘whiner,’ ‘inane’ – and, last week, a ‘troll.’

Here Krugman is doing no less than Keynes did himself. Keynes famously initiated a slash and burn on the economics of his predecessors and attacked them not just intellectually but personally, most notably his own mentor at Cambridge, A.C. Pigou. Keynes said it was to ensure that attention was paid to his book since the issues were so important, but Pigou was clearly aggrieved and said so in the opening words of his review of the The General Theory:

WHEN, in 1919, he wrote The Economic Consequences of the Peace, Mr. Keynes did a good day’s work for the world, in helping it back towards sanity. But he did a bad day’s work for himself as an economist. For he discovered then, and his sub-conscious mind has not been able to forget since, that the best way to win attention for one’s own ideas is to present them in a matrix of sarcastic comment upon other people. This method has long been a routine one among political pamphleteers. It is less appropriate, and fortunately less common, in scientific discussion. Einstein actually did for Physics what Mr. Keynes believes himself to have done for Economics. He developed a far-reaching generalisation, under which Newton’s results can be subsumed as a special case. But he did not, in announcing
his discovery, insinuate, through carefully barbed sentences, that Newton and those who had hitherto followed his lead were a gang of incompetent bunglers. The example is illustrious: but Mr. Keynes has not followed it. The general tone de haut en bas and the patronage extended to his old master Marshall are particularly to be regretted. It is not by this manner of writing that his desire to convince his fellow economists (p. vi) is best promoted.

Alas, it did turn out that this was indeed the best way to influence his fellow economists and it is a template that Keynesians have followed ever since. Krugman’s style and form of attack – stupid, ignorant, incompetent bungler that he is (two can play at this game, I suppose) – is patterned after Keynes who was as arrogant as anyone who has ever written on economic matters as well as being amongst the most incompetent. An actual economic ignoramus who did his undergraduate degree in philosophy and notoriously, on Joan Robinson’s say so, never understood basic micro – “Maynard never spent the half hour necessary to learn price theory” – which is a pretty large gap in any economist’s knowledge base. That in trying to refute Say’s Law he fell right into the oldest fallacy in economics but then took the entire profession along with him is just one of those very unfortunate events that history is filled with. Every economist of his generation with no exception thought The General Theory was end-to-end nonsense. But the economics they knew has now disappeared as have those economists and is now replaced with the poisonous nonsense peddled by Krugman.

This is what Niall Ferguson does not discuss because he doesn’t understand it himself. But you would need a combination of an actual historical understanding of the development of economic theory up to the publication of The General Theory along with a reasonably sound understanding of why it was superior to what we find today. Alas, it is a relatively rare combination but some at least do have it. But if you try to say this to Keynesians in public, they will shout you down and threaten to remove your license to practise economics. Yet it is the Keynesians of the modern text – the people who think Y=C+I+G actually makes economic sense – who are the barbarians ruining our economies right before our eyes.

The black knights of Keynesian economics

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July Sloan has an article in today’s Australian she titles, “Robust views build better debate, so let’s have them“. I don’t mean to quibble but there is plenty of debate, just little engagement. No one who visits this site can be in any doubt that there are critics of economics around as not a few of us here bound into the various inanities that are prevalent everywhere.

I have written books and papers and blog posts about Keynesian economics but no one amongst those economists wishes to take me up on any of it or at least not for the past three years. Even Judy, in her article, never mentions Keynes and Keynesian economics although she lists “the wisdom of the fiscal and monetary policies implemented in the US since the global financial crisis” as her number one problem and uses Paul Krugman as Exhibit A of an engaged economist.

In fact, both so far as politics and policy are concerned, the Keynesians have been routed. I would be glad to hear from any of them who in 2013 would like to repeat in public all of that nonsensical “Keynes the Master” we not so long used to hear about ad nauseum. The stimulus has been an unmitigated disaster everywhere it has been applied with no exception. And slowly everyone is withdrawing the spending (except in the basket case economy of the US), even though all have high rates of unemployment, as they edge their way towards a return to prosperity. From Greece to China, in Australia and across the world, Keynesian theory is dead except in our economics texts.

And it’s not just in macro that the academic world of economics is fading. In my Free Market Economics I go after the marginal revenue-marginal cost analysis as shallow to the point of vacuous. I teach marginal analysis, of course, but heaven forfend that I should inflict any of that on my poor unsuspecting students. I also get not a little vexed about the term “perfect competition” which so far from being perfect (not to mention literally impossible as defined) is the kind of world in which no Microsoft, Apple or BHP could every exist. In my view I teach one of the finest economics courses in the world. But engagement from other economists over anything I write, never a word is said or written.

And then again re Keynes, I have written in a published article how he poached immense amounts from others in putting together The General Theory. No one has ever written a reply. I bring it up in conversations and no one even thinks even to attempt to rebut what I say. Try this on yourself if you are an economist. The term “Say’s Law” and the phrase “supply creates its own demand” are not classical in origin. Both are twentieth century, the first entering into common discourse in 1921 and the second first found in a book published in 1933 which Keynes is absolutely 100% certain to have read while writing The General Theory. So how did they get into the book? You tell me without having to acknowledge that there are things about how The General Theory was written that I know and no one else does or if they do know feel free to ignore.

And lastly, as far as individuals declaring themselves Democrat or Republican in the US, everyone registers with one side or the other so that they can vote in the primaries.