“I am a Keynesian,” Bowen declares proudly

These people don’t get it. They just don’t get it. I want to write, “such idiots they are”, but I am much too polite for that. From Paul Kelly’s column today on Keating and Swan loom large in Bowen’s thinking:

“I am a Keynesian,” Bowen declares proudly. “I would take a Keynesian approach to fiscal management. We can’t rule out the need for a government to stimulate domestic demand sometime over the next decade.” It is an unambiguous statement of belief.

Given Australia’s lower economic growth and doubts about economic recovery, Bowen as treasurer resorting to fiscal stimulus would be a live option. It reminds us that Bowen is a politician formed by the 2008-09 global financial crisis and is a champion of the huge fiscal stimulus put in place by Kevin Rudd and Wayne Swan at that time. . . .

In his book The Money Men, Bowen rejects the main criticisms of the Rudd-Swan stimulus. While admitting the outcome was “imperfect”, Bowen says Swan was tested like no treasurer since Labor’s Ted Theodore during the 1930s and concludes that Swan, in relation to the GFC, “got all of the big calls right”.

The evidence of cloth between the ears never gets more evident than dealing with someone who actually sat in Parliament first through the Costello years and then through the years of economic management under Wayne Swan and thinks that Swan got it right. Those Costello years, when everything was going so well because the world economy was so placid. Like through the Asian Financial Crisis and the Dot-Com bust, you mean. They went well here because, for a change, we didn’t have a Keynesian in charge. How really out of it do you have to be to say this:

As Bowen says, Labor’s $46 billion second stimulus package of February 2009 triggered a debate that dominated “at least the next five years of Australian politics”.

It dominates us now because the deficits and debt will remain a problem for years on end. And now this clown wants to come back into government and add to the problems in the same way that they did the last time we gave them the chance. And if you really want to start to worry, try this on for size:

For Bowen, economic growth is the mission. He wants a competitiveness strategy “sector by sector”, says it is “not the job of Canberra” to determine where the new jobs come from but identifies the sectors that he sees as a priority and the skills deemed to be ­essential.

Picking last year’s winners is a tried and true strategy of failure, but back it will come if we give these people the chance to turn the Australian economy into the same kind of wreck that Obama has managed in the United States.

Keynesian policy in the United States

july 4 washington

In Washington, and went to the Mall last night for the fireworks. The best fireworks display I have ever seen, the sky was at the end entirely covered with colour and sound. They were even able to send up in the middle of it a set of rockets that, when they burst, spelled out “USA”. But the very few chants of “USA” also died away as quickly as the fireworks. There’s too much reality around at the moment.

As to reality, there is, of course, this:

Even after another month of strong hiring in June and a sinking unemployment rate, the U.S. job market just isn’t what it used to be.

Pay is sluggish. Many part-timers can’t find full-time work. And a diminished share of Americans either have a job or are looking for one.

The rest of the article is fumbling idiocy as the journalist tries to explain away the actual reality of the American labour market. You need to contrast this great Keynesian disaster with the last time a classical policy was applied in the US.

Beginning in January 1920, something much worse than a recession blighted the world. The U.S. suffered the steepest plunge in wholesale prices in its history (not even eclipsed by the Great Depression), as well as a 31.6% drop in industrial production and a 46.6% fall in the Dow Jones Industrial Average. Unemployment spiked, and corporate profits plunged.

What to do? “Nothing” was the substantive response of the successive administrations of Woodrow Wilson and Warren G. Harding. Well, not quite nothing. Rather, they did what few 21st-century policy makers would have dared: They balanced the federal budget and—via the still wet-behind-the-ears Federal Reserve—raised interest rates rather than lowering them. Curiously, the depression ran its course. Eighteen months elapsed from business-cycle peak to business-cycle trough—following which the 1920s roared.

At the end of my Say’s Law presentation to the Keynesian symposium I attended at Dartmouth I was asked to explain why a classical policy works, which it does. And the fact is, the presuppositions are so different that it is almost impossible to latch onto the differences. If these things interest you – and I am all too aware how few actually, really are – go to my lead article at the Liberty Fund and carefully read the section that deals with the diagram I have there. There you will find macroeconomics before Keynes summarised in less than 1000 words. This is the theory that sat under the policies of the early 1920s. Hoover, and then Roosevelt in spades, a decade later would introduce “Keynesian” policies, the first of many such failures in a policy that has never had a success.

Debating Keynes – part 2

The one thing about our economies everyone can agree on is that they are in a mess. The question then is, what’s the reason for the mess they are in and what should be done to fix things up? The potential for the present dismal state of affairs to drag on for another decade or more is a genuine possibility, just it has done in Japan since it tried its own stimulus in the 1990s. Such an outcome is all the more likely given the continuous belief, fostered by standard textbook macroeconomics, that a government stimulus is essential if a recovery is to occur. It is this belief that will keep our economies in permanent disarray. There is therefore no economic issue of more importance at the present time than whether such Keynesian policies should be continued.

I am in the midst of an “exchange of letters” on Keynesian economics with Louis-Philippe Rochon, the editor of the Journal of Keynesian Economics. We had each written one letter – (my first is discussed here) – and now I have written my second, which may be found at this link under the title: “How to Promote a Global Economic Recovery? ‘Markets… have been the single most liberating institution in possibly the entire history of the human race’.” You can find all three of our letters, my two and Louis-Philippe’s reply to the first, at the link.

The letter that has just been published was, in fact, the second I had written in response to his. What follows below is the first version I wrote in reply, which is still trying to get at the same ideas but in a different way.

Dear Louis-Philippe

Thank you for your reply which I must confess was not really a reply to the issues I raised. I wrote to explain why a stimulus could not possibly have worked, emphasising the theory. Your reply has merely stated that we have not really had a stimulus since it was prematurely brought to an end and that in your view, it is the absence of a stimulus that is causing our economies to fall into deeper recession. You then go on to provide your own Keynesian program with nothing to support it other than your own set of preferences for public spending.

But if we are to examine the record, let me remind you that there has never been a single example of a Keynesian stimulus that has ever succeeded in returning an economy to full employment and strong rates of growth. Not a single one, not one, not ever.

The one example that gets trotted out from time to time was the outcome of the Kennedy tax cuts of 1962. But tax cuts are not increases in public spending, and are in perfect keeping with pre-Keynesian policy. It was the same approach that Ronald Reagan took in the 1980s and with equal success.

Increases in public spending have never succeeded in bringing an economy out of recession. The United States notoriously, in spite of the spending and deficits of the Roosevelt administration, never returned the American economy to full employment. It was only the coming of the war in 1941 that brought the Great Depression in the US to an end.

By then, the rest of the world had left the Depression behind long before. Even by the time The General Theory was published in 1936, the Great Depression had long disappeared in the UK. Unemployment was still high but the worst was well and truly over. By 1937 Keynes was worrying about inflation, not unemployment.

Moreover, the policy approach in the UK had been entirely classical. The British Chancellor of the Exchequer (ie the Secretary of the Treasury) in his 1933 budget speech specifically noted that the budget had finally been balanced, and correctly forecast that recovery would therefore soon be under way.

Where are the success stories to go with the obvious failures that were found pretty well everywhere in the 1970s and 80s, in Japan in the 1990s, or the experience of every economy that had tried a stimulus after the Global Financial Crisis in 2009. There is not a single example of a successful stimulus you can point to.

Let me also 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 male workforce under thirty was drafted into the armed forces. 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, in the space of 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. Think of these as millions of people who had suddenly lost their jobs all at once. 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 which in the United States had ended only four years before.

Truman, however, having had a business background, was adamantly opposed to deficits and as a result the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures, balanced its budget 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 macroeconomic issues from the demand side is amongst the biggest mistakes anyone in economics can make.

Given its perfect record of failure, why does Keynesian macro persist? Why is it still taught in our textbooks? Aside from being very simple to understand, it remains in place because, disastrous though the policies Keynesian theory promotes may be, it is loved by governments, the bureaucracy and that brand of entrepreneurial activity that today goes under the name of “crony capitalism”. Keynesian policies may not do much for the poor and unemployed but it brings amazing dividends to our economic and political elites.

Before Keynes, governments knew their limits. There was no pretence that beyond a narrow range of activities, there was little a government could do that would be value adding. It was universally appreciated that during recessions governments could take various steps to reduce unemployment and that there was a limited role for governments to have projects available that could soak up some of those who lost their jobs. Nothing new in that.

Today, with macro so drenched in Keynesian conceptions, government spending of all kinds on just about anything, is seen as wealth creating. Politicians, who know nothing about running a business, nevertheless believe themselves capable of making billion dollar decisions because they believe that whatever they spend on will, of necessity, raise the level of economic growth and add to communal prosperity.

The confidence with which governments devised expenditure programs following the GFC in the apparent belief that recovery would follow soon after was incredible to those few of us who understood that it is impossible to increase growth by increasing public waste of resources.

In his introduction to The General Theory, Paul Krugman summed up Keynes’s message in four points, which are almost identical to my own description of Keynesian economics:

“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.”

This is the theory that is drummed into every introductory student in economics and which maintains its grip unless specifically taught that these four propositions are fundamentally wrong.

And within the worldwide community of economists, no more than around two in a hundred are ever taught to reject such beliefs, and even with this two percent only a small proportion ever come to understand what is actually wrong with the macro they have been taught. The rest more or less accept the theory as it comes, which is why when the Global Financial Crisis struck, there was virtually no opposition to the stimulus from within the economics community.

Even now, as governments struggle to deal with the debt and deficits they have created in their various expenditure programs – almost none of which will ever have a positive return – there is still no general understanding of what went wrong or how to fix what is clearly broken.

The four fundamental principles of Keynesian economics are so ingrained that most economists are not even aware that before Keynes, such beliefs were recognised as utterly fallacious and the mark of an economic illiterate.

Again, I can do no more than remind you of the second edition of my Free Market Economics which discusses both the Keynesian and the classical theories of the cycle. Here I can do not much more than raise your interest in these wrongly discarded theories of the cycle. If you would like to know more about what they said, and why modern macro is so deeply flawed, it is to my text you must go.

The endless supply of Keynesian nonsense

I have now received Louis-Philippe Rochon’s reply to my critique of Keynesian economics which was the lead comment in an exchange we are having on Keynesian economics. His reply comes under the heading, How to Promote a Global Economic Recovery? “The worst infliction we can impose on our economies is to leave them to the tyranny of the markets”.

Thus, from the very heading I can see how far apart we are. There are an astonishing number of techniques and approaches that can be used to manage an economy with public spending to get an economy out of recession only one amongst this vast array of possibilities. If you are going to start with the assumption that not trying to spend your wasteful way to recovery is the same as laissez-faire then there is no possibility of ever understanding how badly our economies are now being mismanaged. But perhaps that is just the title. What more does his letter say? Let me pick up his argument point by point, starting with this misbegotten piece of theory.

The driving force behind economic growth both in the short run and the long run is aggregate demand, pure and simple. . . . Yes, that’s right: more government spending leads to more investment. It’s a crowding-in effect!

Nothing to lift an economy like public investment! Every business like the post office. Every investment another Solyndra. All subsidised with nothing self-sustaining through the revenues it earns. Dig a hole and get fill it in again. Don’t worry about earning a greater return than the funds outlayed. Just close your eyes and spend. Don’t worry, it will all work out once that magic multiplier cuts in. If this is all there is to the theory, there is nothing there but wishes and wind. But there is also your recollection of those magic Keynesian moments at the end of World War II.

My recollection of Keynesian policies is quite different: they contributed to 3 wonderful decades of growth following WWII – what we fondly call the Golden Years of capitalism. Keynes is quite evidently the greatest economist of the 20th century who saved capitalism from self-destruction. For that, he is remembered as one of the greatest thinkers.

First, the General Theory was published in 1936, three years after the Depression had come to an end in every economy but the United States, where it dragged on until the coming of the war to the US in 1941. And, of course, those three wonderful post-war decades were preceded by the decision of the United States in 1945-46 to balance its budget immediately. The massive wartimes deficits were instantaneously brought to an end and a balanced budget put in its place even with millions returning to the workforce after being mustered out of their wartime military service or from their jobs in wartime industries. The Keynesians of 1945 all wanted a continuing deficit but Truman turned them down.

How does a Keynesian explain that, I wonder? We are instead reminded of the supposedly woeful economic outcomes of the 1980s, which I must confess not to remember in quite the same way as this:

By contrast, starting from the 1980s, with the monetarist debacle and the real business cycle shenanigans, we ended up with less average growth and higher average unemployment rates.

It is a contrast, of course, but the contrast of importance is with the 1970s, the greatest period of Keynesian disaster until the one we are in the midst of now. The catastrophic stagflation of the 1970s, where deficits and spending only led to high unemployment and a blowout in inflation that could only ultimately be controlled by a fierce monetary policy that finally did regenerate a period of prosperity that continued for another two decades. But what about the period after the GFC when governments were spending hand over fist on one stimulus after another.

While governments did put into place Keynesian aggregate demand policies in 2009, they quickly abandoned these policies in 2010 in favour of austerity measures.

A one-year stimulus, was it? The US is the paradigm example. Despite Congressional attempts to slow the growth in the deficit, the attempt to contain public spending in the US only seriously began with the sequester in 2013!
And indeed, the White House specifically dates the commencement of the sequestration from the first of March that year. If ever a stimulus was given time to work itself out, that was then. The disastrous response of the American economy to the stimulus is perfectly in line with my own argument. The very belief that conditions were improving up until the sequestration began can only mean we are living in a parallel universe.

But how much we differ on the timing when restraint finally began, we can certainly agree on the current disaster. He may think it’s because the stimulus was brought to an end too soon. I think of it as the inevitable consequence of a Keynesian policy.

When you look at aggregate demand today, it is at best anemic. Consumers are saddled with debt, and private investment has flatlined; austerity measures are being imposed everywhere. There is no room for growth. That leaves only exports to ensure a recovery. But with Europe on the verge of deflation, the BRIC countries slowing down, the prospects for exports are dimming. So where will growth come from? I am afraid that without aggressive fiscal deficit spending, we are dooming future generations and ourselves to another decade or more of weak economic growth.

On this much we can agree, that the world’s economies are in a mess. Consumers deep in debt, savings eaten away by low productivity government spending, and private investment going nowhere. And I didn’t just say the stimulus would not work; I said the stimulus would make things much much worse. You describe what I see, but I expected things to end like this from the start. You could only start to recognise a problem more than a year later, and only because by then it was obvious to all and sundry that in every place the stimulus had been introduced economic conditions had become much worse. You nevertheless continue to believe that the problem is not enough government spending.

This secular stagnation is the direct result of a lack of fiscal spending advocated by austerity voodoo doctors and charlatans.

I understand that the principle of cause and effect never applies to Keynesian theory. The plain fact is that there has never been a single instance in the whole of the period since the General Theory was written that a public sector stimulus has been able to bring a recession to an end. There is not one single solitary example, with the coming of World War II the only supposed example when unemployment ended mostly because half the male population under 30 was put into the military.

It is not aggregate demand that matters, but value adding aggregate supply. You must do more than build brick walls, you must build where what is built actually contributes to future prosperity. To think more holes dug up and then refilled can generate recovery because it constitutes “fiscal spending” is the essence of economic illiteracy. And for true economic illiteracy, it’s hard to go past your program for recovery:

First, we must replace private debt with public debt.

Second, we must put job creation above all other goals.

Third, we must deal head on with the problem of income inequality, which is at the very core of the crisis in aggregate demand.

Fourth, with respect to Europe . . . they must either adopt the proper federal institutions to deal with the problems facing the Southern countries, or get rid of the Euro all together.

That is to say: we must socialise our economies.

Private debt is incurred by private sector firms. To replace this debt with public debt would so obviously drive us into us deep recession that it is almost impossible to understand how this is not perfectly obvious to you.

If such a program appeals to you merely because of this aggregate demand incantation of yours, I’m afraid, your program would be part of the problem and in no way part of any solution. I fear, however, that three quarters of a century after the publication of The General Theory, economics is now at such a low ebb that what you have written will look like perfect good sense, even as every attempt to do what you have suggested would make things worse than they already are.

In times gone by, before Keynes, economists talked about “effective demand”, that is, what had to happen to turn desire for products into an ability to buy those products. Now it is aggregate demand – the total level of demand – which has leached the original concept of any understanding that for everyone to buy from each other, they first have to produce what each other wish to buy. If that is not obvious, then common sense has gone from the world.

But I say again. A short post cannot state everything that needs to be said. For a more complete explanation of these issues and what needs to be done, you must turn to the second edition of my Free Market Economics. It’s still not too late, but it is getting later all the time.

Roosevelt prolonged the depression in the US by seven years

Here’s a story that has only ever been unknown to Keynesian economists: FDR’s policies prolonged Depression by 7 years, UCLA economists calculate. Whether they have properly explained what exactly Roosevelt did wrong is another story, but at least there is finally some acknowledgement that his economic policies were directly at fault a mere eighty years after the fact. It is laughable to see that the authors argue that up until now we had not known the reason for the delayed recovery. But it is actually more than that. Now that they have found something that removes the blame from the Keynesian policies FDR adopted, they are finally willing to state in print that Roosevelt’s policies actually were the disaster everyone always knew they were.

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

After scrutinizing Roosevelt’s record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

“Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump,” said Ohanian, vice chair of UCLA’s Department of Economics. “We found that a relapse isn’t likely unless lawmakers gum up a recovery with ill-conceived stimulus policies.”

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

“President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services,” said Cole, also a UCLA professor of economics. “So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.”

You need to read the whole article but let me take you to the very last para which has major implications for today:

“The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes,” Cole said. “Ironically, our work shows that the recovery would have been very rapid had the government not intervened.”

It’s a strange business since the article points out what I thought was common knowledge, that Roosevelt’s policies delayed recovery. But what it doesn’t do is put the blame on public spending which is where the blame truly belongs. It can therefore, in its own convoluted way, be taken as a defence of Keynesian policies since these were not the problem. Instead the blame for the astonishingly slow recovery is placed on industry policies which no doubt played their part. Eighty years from now someone will write a paper to argue that the Obama administration had been responsible for the slow recovery of the present moment but it will be blamed on something else instead – Obamacare maybe – rather than the fiscal and monetary policies whose effects will continue to be ignored just as they are ignored today.

The interventionists within economics is down to the last 95% of the profession but at least there is progress being made. The aim now is to save Keynesian economics, and if it requires finally admitting that Roosevelt had prolonged the depression, well that is how it will have to be. Since their conclusions take Keynesian economics off the hook, these results may end up being embraced as at long last solving a “mystery” that no one should ever have actually been mystified about.

Say lives

I don’t know about the rest of the economics world, but where else but here at the J.-B. Say Congress would one find this:

Entrepreneurship has become a specific field of research in Economics since the beginning of the 1980s. This period was characterised by two linked phenomena: (1) the end of economic growth (“The Glorious Thirty 1945-1975”) and (2) the failure of Keynesian policies. A new economic dynamics should be ensuing from a radical economic and political change. Thus, the challenge was to find a new economic dynamics based on a new institutional structure, aimed to promote free markets and private initiative.

This is from an editorial in the local research institute into industry and innovation newsletter, Innov.doc No. 54 dated Septembre 2014. The spirit of Jean-Baptise Say has not yet been extinguished, although it has been exiled to the far north west of France, as had Say himself.