Tag Archives: Steve Kates

Still more on Say’s Law and Austrian economics

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The debate on the Coordination Problem website continues but see here, here and here for the prior discussion. Personally, but what do I know, those on the attack have ground to a halt, with these the latest posts:

Oh, my. Where to begin?

Kates says that Say’s Law emerged out of the general glut debate. A debate requires two sides. So there were economists who advocated “Keynesian-type solutions.” Sismondi, to name just one.

Kates fails to distinguish between long-run (equilibrium) and short-run (dynamic) propositions in classical political economy. JS Mill and many other classicals had a dynamic theory of economic crises. Barkley’s characterization is on the mark.

Then there is the problem of fifty years of missing economic history. Economists on the eve of the Keynesian Revolution were not classical economists, but neoclassicals. They were Austrians, Walrasians, Marsahllians, etc. so, Haberler was an Austrian, not a classical economist.

By the time of the GT, Keynes had an embarrassingly large number of precursors for Stimulative fiscal policy. Indeed, Keynes was a latecomer. The Chicago School was a hotbed of such policies. Friedman explains that Chicago was inoculated to Keynesian economics because of that.

In The New Economics and the Old Economists, J. Ronnie Davis details the pre-Keynesian origins of what we call Keynesian policy. Rothbard details how many economists supported pump-priming under Hoover and later under FDR. All before the General Theory. Ditto Steve Horwitz’s work on Hoover.

Fisher represented another strand of thought. His debt deflation theory of the cycle is one in which a fall in nominal values has real effects. The obvious solution is reflation. The issue is not whether Fisher was correct, but that there were many, many demand-driven policies to cure recessions before Keynes.

Kates seems to just leave out any ideas that do not fit his thesis. Other ideas are simply fitted onto his Procustean bed.

Posted by: Jerry O’Driscoll | July 19, 2015 at 09:51 PM

First let me thank Jerry O’Driscoll for dealing with some matters I would have otherwise. I agree in full with his remarks.

On Steve’s post before that, two things. One is that he is like Keynes in way overstating the importance of Say’s Law. It was never the “foundation of economic theory,” although maybe J.S. Mill thought it was.

The second is that Steve embarrassingly botches his discussion of Smith’s view. I think one can indeed find a variation of Say’s Law in WoN, but this is a joke. Productive versus unproductive labor has nothing to do with the idea of value added, beyong the trivial point that if something does not add value it does not add value, duh. In fact, Smith’s focus on material production was later carried over by Marx, and one could find this distinction between productive and unproductive labor in Soviet income and product accounts, although it might be useful in regard to rent seeking. As it is, one can easily imagine a “menial servant” providing valuable input even into a material production process. This whole thing is silly and has Kates making Smith look silly. Yikes!

On the later post, sorry, Steve, you do not remember your history. We debated this matter on the internet before your first book was out, and I told you then about Say’s views. But, this is just trivial and boring.

You continue to avoid the main arguments by both Mill and Keynes about the sources of macro fluctuations, which focused on financial crises and collapses of capital investment, not shortfalls of consumption. While Keynes ridiculed what he called Say’s Law and defended the possibility of general gluts, that was not really the focus of his theory, which had more to do with the collapse of animal spirits of business people.

Your efforts to dismiss Say simply look ridiculous. In fact, his examples against the law were already in his first edition. You have trouble reading, don’t you, for such a great scholar of Say. But we already know how worthless Say was and can ignore him, especially given that he actually supported government spending on public works projects during the downturn after the end of the Napoleonic wars.

Again, I am not going to bother arguing with you about the many cases where most economists would say that there was an increase in aggregate demand that pulled the economy out of a slump as we have already seen what you will say, which is simply to declare everything that happened that had any effect to be supply side.

I am glad, I guess, to see that you thought maybe something might be done by government to help get out of the Great Recession, although it would appear that you wish to get all worked up again about public spending that involves “value added” versus that which is not. Yeah, sure, pretty much everybody would prefer to see productive public spending on useful infrastructure or whatever rather than the old joke Keynes digging holes in the ground and filling them up again, although I suspect you have either forgotten or did not know what that famously repeated-out-of-context quote was really about.

And as for your big final question, why should anybody care and of what importance is it? Sorry, none, although I am not going to argue with your claim that it was Fred Taylor who first coined it, woo woo woo.

Posted by: Barkley Rosser | July 20, 2015 at 02:14 AM

BTW, I shall agree with Steve Kates that Ricardo’s discussion in the general glut debate does look somewhat Austrian in his emphasis on misdirected production that needs to be reallocated, and I have said that in a forthcoming paper on “History of Economic Dyhamics” to appear in the Handbook of the History of Economic Analysis and currently available on my website.

I should also say that while Jerry identifies Haberler as an Austrian, he is sort of as Schumpeter was. His great book is very eclectic and even handed in its accounting of many views, many of which have been forgotten even though quite interesting and worthy of reconsideration.
Posted by: Barkley Rosser | July 20, 2015 at 02:20 AM

It is hard to gauge where I stand since no neutral has bought in to indicate what they think themselves. Anyway, here is my reply to Barkely. I will reply to Jerry after.

Essentially, Barkley, what you have done is call the classical theory of the cycle “Keynesian” and declared victory. If I really do have to demonstrate that Keynes was trying to show that demand deficiency was the cause of recession, we are at such a primitive level of debate that it is almost impossible for me to work out where we can find some kind of solid ground on which we can agree so that we can work out between us where our differences lie.

This making it up as you go along version of Keynes is quite astonishing. Do you really believe that “while Keynes ridiculed what he called Say’s Law and defended the possibility of general gluts, that was not really the focus of his theory, which had more to do with the collapse of animal spirits of business people”? Here is what Keynes actually argued and right at the start of the book as he is trying to give an overview of what is to come:

“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.” (GT: 32)

I think Keynes in this instance is absolutely right about the nature of economic theory right up to his own time. The General Theory is about deficient aggregate demand and designed to refute Say’s Law. For you not to know this you must somehow have avoided the Keynesian-cross diagram, leakages and injections, IS-LM, AS-AD along with Y=C+I+G, versions of which may be found in every single Samuelson clone and which are still taught to just about everyone. If what you call “Keynesian” is some package of inferences from the later chapters of The General Theory that ignore what you can find at the front, well feel free to go on with your private understanding of what Keynes really meant, but it is not the Keynesian theory that now disfigures virtually every first-year macro text in the world, nor the one that informs policy.

And as for ignoring what Keynes thought was the cause of the recession of his own time, he is perfectly clear about it in the GT:

“The post-war experiences of Great Britain and the United States are, indeed, actual examples of how an accumulation of wealth, so large that its marginal efficiency has fallen more rapidly than the rate of interest can fall in the face of the prevailing institutional and psychological factors, can interfere, in conditions mainly of laissez-faire, with a reasonable level of employment and with the standard of life which the technical conditions of production are capable of furnishing.

“It follows that of two equal communities, having the same technique but different stocks of capital, the community with the smaller stock of capital may be able for the time being to enjoy a higher standard of life than the community with the larger stock; though when the poorer community has caught up the rich — as, presumably, it eventually will — then both alike will suffer the fate of Midas.” (GT: 219)

I know this is dead set stupid, and not at all like the sophisticated arguments of Mill, but if you are going to defend Keynes, this is what you must defend. “The fate of Midas” is, of course, a situation where everyone is so wealthy that they stop buying and save instead. This is why Keynes thought the world had gone into depression, because he sure wasn’t discussing the 1920s, or at least not the “roaring ‘20s” of the United States.

That you disdain the need for spending to be value adding is quite clarifying so far as this exchange of views is concerned. You do represent a modern view of what Keynesian policy makers believe. You do not think that such expenditure has to be value adding to lead to faster growth and employment. Economists have, indeed, been taught that spending on anything at all will add to growth and employment. And you say this even with the labour market in the US as moribund as it is, where the only reason for the fall in the unemployment rate is the even faster fall in the participation rate.

The economics of John Stuart Mill is so superior to this unbelievable nonsense that you make every effort you can to associate your views with Mill’s while disassociating yourself from what Keynes really wrote. And it is no wonder why, because what Keynes wrote is such nonsense. But it is this Keynesian theory that has informed the Keynesian policies that were tried 2009-2011, which are now being abandoned. There is a need for policy guidance that will explain to policy makers what needs to be done, since they certainly cannot find any such thing in our modern Keynesian-saturated texts. But they could find it in Mill, if they only knew enough to look.

At this stage, all I can hope is that some of those who pay attention can see the point, or at least that there is a point. It is beyond me how anyone can continue to defend modern textbook theory when it never delivers what it promises. But in this instance, the notion that Keynes was really arguing some dynamic theory of adjustment, that is, arguing what Mill had been arguing, and not trying to overturn Say’s Law is just ludicrous. But since no one knows any history any more, what someone might end up believing is anyone’s guess.

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.