The Economy Through The Eyes Of A Keynesian

In response to a recent comment by reader RHCP, I was looking into the concept of a “post-scarcity” society. One of my friends has brought this up repeatedly in our many debates, but I have yet to find a good, thorough explanation or argument for the concept. If you know of any good academic papers or long-form articles explaining post-scarcity economics, please post them in the comments below.

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While I did some searching around, I came across this article, misleadingly called “Post-Scarcity Economics”, from the LA Review of Books, July 2013. While not what I had expected, it turns out I had come across one of the better depictions of Keynesian economics that I’ve ever seen – and I felt compelled to respond.

The author, Tom Streithorst, seems to be defining a post-scarcity world as one where demand is outstripped by supply – the productive capacity of a society being significantly higher than the actual demand for goods. In other words, a classic Keynesian problem of under-consumption/overproduction.

My intention in this post is to methodically go through his arguments, deconstructing the many fallacies that Keynesians are prone to fall prey too. Because I am responding to his points in order, my subheadings in this post will admittedly be somewhat arbitrary, so I apologize.

 

Supply, Demand, And Scarcity

Mr. Streithorst begins:

“WE LIVE LIKE GODS, and we don’t even know it.

We fly across oceans in airplanes, we eat tropical fruit in December, we have machines that sing us songs, clean our house, take pictures of Mars. Much the total accumulated knowledge of our species can fit on a hard drive that fits in our pocket. Even the poorest among us own electronic toys that millionaires and kings would have lusted for a decade ago. Our ancestors would be amazed. For most of our time on the planet, humans lived on the knife-edge of survival. A crop failure could mean starvation and even in good times, we worked from sun up to sundown to earn our daily bread. In 1600, a typical workman spent almost half his income on nourishment, and that food wasn’t crème brûlée with passion fruit or organically raised filet mignon, it was gruel and the occasional turnip. Send us back to ancient Greece with an AK-47, a home brewing kit, or a battery-powered vibrator, and startled peasants would worship at our feet.”

This is a great start, and one of very few items on which we agree. What is described here is the result of a miracle of sorts – through the accumulation of capital over the past several hundred years, the collective productive capacity of humanity has increased to such an extent that our lives would be unrecognizable to our ancestors.

The development of capitalism has lifted the masses out of poverty and provided us with luxuries that people could only dream of a couple hundred years ago.

“And yet we are not happy, we expected more, we were promised better. Our economy is a shambles, millions are out of work, and few of us think things are going to get better soon. When I graduated high school, in 1975, I assumed that whatever I did, I would end up somewhere in the great American middle class, and that I would live better than my father, who lived better than his. Today, my son doesn’t have nearly the same confidence. Back in those days, you could go off to India for seven years, sit around in an ashram, smoke pot and seek spiritual fulfilment, and still come home and get a good job as a copywriter at Ogilvy and Mather. Today kids need a spectacular resume just to get an unpaid internship at IBM. Our children fear any moment not on a career path could ruin their prospects for a successful future. Back in the 1970s, pop stars sang songs about of the tedium and anomie of factory work. Today the sons of laid-off autoworkers would trade anything for that security and steady wage.”

Again, no argument here. In the past thirty years or so, things seem to have changed. While I wouldn’t say that progress has stopped, something is certainly “off”. The cause of this change – and the solution – are where our views diverge.

“On the one hand, technology has made us all much more productive than we were 30 years ago. On the other, jobs have evaporated. Steel that used to require hundreds of men to manufacture now can be made with a dozen. A small businessman no longer needs to hire a secretary or a bookkeeper. Inexpensive software and a personal computer lets him do their jobs in a fraction of the time all by himself. The internet puts specialist knowledge that used to be almost impossible to find instantaneously on our laptops. The personal computer is doing to the office worker what the internal combustion engine did to the horse a century ago, making him obsolete.”

These are all facts, but Mr. Streithorst seems to be interpreting this all as a bad thing. This is one of the most common economic fallacies I hear, and it just doesn’t seem to die.

According to his worldview, improvements in technology eliminate jobs, leading to higher unemployment. Woe are the former bean counters who can no longer afford to eat because modern contrivances such as spreadsheets and Quicken have made them obsolete (in some contexts)! As technology progresses, more and more jobs become obsolete, more and more people become unemployed, and suddenly we have problems which require government to come in and fix things.

But if this were accurate, would not the world be a better place (economically speaking) if we rolled back technology a bit? Think about the masses who could be employed if we didn’t have giant machines that can dig massive holes and we needed to go back to good ol’ shoveling! And why lament the single bookkeeper who loses his job while ignoring the millions whom were never employed by the greedy small businessman in the first place? Wouldn’t it have been more effective to force him to hire two, three, or a thousand accountants in order to create jobs?

Technology doesn’t take away from some abstract pool of “jobs”. On the contrary, technology frees up resources that were being used in a less efficient way so that they can be employed more effectively elsewhere. Yes, the “seen” effect is the laborer losing his job to a robot, but what is “unseen” is that the pool of real resources has increased, leading to greater prosperity for all. Again, the miracle of capitalism that we began with.

We may feel sympathy for the worker who loses his job to technological improvements and the hardships he may face because of this. But this is simply the way the world works – were we to use the force of government to “rectify” the situation, we would simply condemn ourselves to the backwards, brutish existence of our technologically inferior ancestors.

“It is a paradox: our ever-growing productivity and our more insecure lives. Our understanding of economics is stuck in the past, in a world of scarcity, a world without advertising, where making things rather than selling them was the fundamental economic problem. Technology and the free enterprise system, to an extent that would amaze our ancestors, have solved much of the problem of supply. Our homes are more solid, our clothes more fashionable, our food tastier than our grandparents would have dreamed. In a world where even the residents of housing projects own more computing power than NASA did when they put a man on the moon, we cannot think that making stuff is the problem.”

Here, Mr. Streithorst introduces his conception of post-scarcity. Look at all the cool things we have available! We have more than enough supply of goods and services!

I don’t dispute the fact that we’ve made amazing strides in the process of production that has led to an increased supply of goods. But saying that we’ve “solved much of the problem of supply” is a bit premature. In fact, the only way something could be post-scarce, or have no supply “problem”, is if everyone could get as much of that good as they would like at no cost. This may be true for, say, air under normal circumstances, but it is clearly false with respect to nearly anything else.

How this is not trivially obvious to everyone is beyond me. We may have a vastly larger food supply than our ancestors, but people are still starving. People still need to buy food – it doesn’t just manifest itself whenever you want it. He continues:

“Ask any entrepreneur, and he will tell you making stuff, be it specialty steel, a low budget movie, saltimbocca a la romana, a collateralized loan obligation, a back massage, or an oil tanker is the fun part. It is selling it that keeps you up at night, breaks your heart, drives you into bankruptcy. That is why salesmen get paid more than engineers. Our problems today are purely problems of demand.”

Ignored is the crucial question: what is it that ought to be produced in the first place? I could vomit into a jar fairly easily, and yes, trying to sell that vomit would indeed be the difficult part of my fictitious business model. Mr. Streithorst would like you to believe that the problem lies in the fact that there isn’t enough demand for my vomit.

Clearly, this is absurd. We can produce many things, but people only value some of them, and only to a limited extent. The point of economics is to study how resources are allocated in the face of scarcity. Ideally, resources will be used as efficiently as possible in order to produce goods that are in the highest demand. Keynesians seem to think the problem is to create demand for already existing products, but this is not the way to a healthy economy. Instead of finding a way to create demand for my vomit, a good economic system will try to dissuade me from selling my vomit, and instead to devote my energies to creating real value for others.

“Picture an empty restaurant. The maître d’ standing by the till, faking confidence, trying to will customers through the door. The waiters sweeping nonexistent breadcrumbs from immaculate tablecloths. The sauces are prepped, the fish purchased at dawn glisten, waiting to be pan-fried. A couple approaches, peruses the menu, looks through the window, and walks away. The chef runs numbers in his head, calculating how much money he owes, how he can manage to meet his next interest payment. All that preparation, all that investment, all that energy and potential, for nothing. Until a customer decides to spend his money, it is for naught. Marx knew it. Keynes knew it. More to the point, every businessman knows it. Lack of demand is the Achilles heel of modern capitalism.”

This is a sad story, of course. But let me change it ever so slightly; imagine that when the couple looks at the menu, they see “Vomit: $50”. Read through that last paragraph again. No longer so tragic, right?

In real life, of course the restaurant isn’t serving vomit, but in this case, they may as well be. Resources have been used to create this restaurant, but people don’t actually value what the restaurant provides. For whatever reason(s), consumers are not being satisfied by this restaurant – and yet the restaurant continues to use society’s limited resources.

Lack of demand isn’t the problem; the waste of resources on creating a product that people don’t want is what’s wrong with this picture. The solution? The restaurant suffers losses, eventually goes out of business, and liquidates its assets. When the assets are sold off, hopefully they will be used in a way that is more satisfying to consumers.

 

Business Cycles And Aggregate Demand

“A recession, by definition, is a lack of aggregate demand, an unwillingness of firms and households to consume as much as the society can produce. It is a sign of the incredible capacity of capitalism that our fundamental problem is we make more stuff than we want to buy.”

No, Mr. Streithorst, the problem isn’t that we make more stuff than we want to buy. The problem (in a recession) is that we have been making the wrong stuff to begin with.

A simple example will help illustrate this. Let’s say there are a certain amount of building materials at a construction site (and we’ll assume that more cannot be procured). The blueprint that the manager is using to construct the new building requires more resources to complete than are actually available. In this case, the sooner the manager realizes that he can’t construct the building as designed, the better. The longer that construction continues, the more time and resources are wasted on a project that is destined to fail. But when the construction stops (good thing), the construction workers will be temporarily unemployed as the architect revises the blueprints (“good”/necessary, but unfortunate).

A recession is not simply a matter of overproduction that can be resolved by encouraging people to spend. Rather, it is the healthy process of unwinding the malinvestments created during the previous boom phase, like the building with insufficient materials.

For more on how the business cycle works and why it exists, see this, this, and this.

“The empty restaurant, writ large, is the predicament of the world economy today. No war, no hurricane has destroyed the productive capacity we had during the halcyon days of the boom. But consumers are not spending, firms are not hiring, households are paying off debt, corporations are sitting on piles of cash, banks are cautious about lending, and governments are hoping to reduce their deficits.”

Again, this is stated as though the behavior of the actors in this situation is a bad thing. Oh no, people are paying off their debts! Banks with shaky finances aren’t throwing money at anything that breathes – are they mad?! Consumers are being frugal during hard times – what boneheads! Corporations aren’t investing in risky projects during uncertain economic times – how dare they?

The scenarios described here are simply the prudent decisions that ought to be made when an economy is in recession. You wouldn’t advise someone who just lost their job to buy a Mercedes, would you? But this is exactly what the Keynesians would have you do.

“Indeed, solving the problem of demand has been the essential capitalist dilemma of the past 80 years. As productivity rises, we can make more with the same level of inputs. Demand has to rise just as fast or the economy shrinks. For an economy to be at full employment, demand needs to equal the society’s productive capacity. If it does not, then supply will shrink to meet demand and millions of workers will become redundant. To achieve full employment, we must find a way to instead push demand up to meet the economy’s productive capacity. Since the Great Depression, we have solved this problem of demand three different ways: war, rising wages, and debt.”

The most absurd sentence in this excerpt: “Demand has to rise just as fast or the economy shrinks.” Let’s try to unpack this. Some sort of change happens, leading to increased productivity. Previously, each worker could produce one widget per day, and now they can produce two. If the demand for widgets does not also double, then half of those employed in widget production will lose their jobs.

This is all true so far as it goes. But the Keynesian takes it one step further by claiming that this kind of situation can happen economy-wide, leading to a glut in production in general. The market is flooded with goods that people simply don’t have the resources or will to demand (buy). In other words, there is more production in ALL fields of production than exist resources to use in order to consume these products.

But how can this be possible? Ultimately, we produce solely in order to consume. In order to “demand” something, one must first supply something else to exchange it for. When you produce something, you necessarily become either the consumer of your own production, or you use your product to exchange for someone else’s which you will consume. It is simply impossible for there to be a general state of overproduction/under-consumption. This is not to say that there can’t be overproduction of a specific kind of good – remember my vomit example. That vomit is overproduced, but this is balanced out by some other good(s) being under-produced. To quote David Ricardo:

“Productions are always bought by productions, or by services; money is only the medium by which the exchange is effected. Too much of a particular commodity may be produced, of which there may be such a glut in the market as not to repay the capital expended on it; but this cannot be the case with respect to all commodities.”

This is the famous and controversial Say’s Law – one which Keynes was quite proud of himself for “refuting”. Of course, he did nothing of the sort. This is an incredibly important point, so I strongly suggest you read Hazlitt’s discussion of Keynes’s failure to understand Say’s Law properly. I have not covered every angle of it here, but Hazlitt does a great job of addressing common misconceptions about this subject.

Mr. Streithorst continues:

“According to conventional models, long-term unemployment was inconceivable. Most economists at the time believed that markets, if left alone would inevitably self-equilibrate. Unemployment would drive wages down until, at some certain level, workers would be so cheap to hire that once again, men would be put to work and growth could return.

Keynes saw the fallacy in this reasoning. He recognized that workers, after all, are also consumers. Drive down their wages, you also drive down their ability to purchase goods and services. Lowering wages was no panacea; it would just knock demand even further down.”

It is certainly true that decreasing wages will necessarily drive down workers’ ability to purchase goods and services. The Keynesians believe that this leads to a downward spiral in aggregate demand: some workers become unemployed, they spend less money, the businesses that the original workers would have spent money on lose revenue and need to lay off some of their own workers, who then can’t spend as much, and so on.

But why wouldn’t wages simply decrease enough until employment reached a new equilibrium? According to Keynesians, it is because wages are “sticky” – there is an inherent resistance to decreasing peoples’ nominal wages. For some reason, this doesn’t apply to real wages; it is assumed that someone will not accept a nominal pay cut from $10/hour to $8/hour, even if the price level deflates by 20% or more – as though workers are too dumb to assess their own financial situation.

Besides the fact that this is mildly insulting to employees, it is also not the whole story. For starters, wages are made sticky in large part by government policy and is not an inherent feature of the market; for instance, during the Great Depression, Hoover forcefully intervened in business and did not allow them to cut wages. The most obvious other way is through unemployment benefits, which subsidize workers who choose to hold out for higher wages for a longer period of time. On top of that, there are unions, whose bargaining power allows them to hold wages above equilibrium levels.

One must wonder why wages would be sticky but other prices wouldn’t be. For instance, store owners doesn’t seem to have a problem with decreasing the price of the products that they sell if they need to move their inventory, even though the prices they charge are precisely the revenue that they bring in. If someone makes their money selling hot dogs and is willing to drop the price of hot dogs, why would a worker be unwilling to take a pay cut?

To be fair, wages are sometimes made sticky due to contractual obligations. That being said, many contracts stipulate that pay can indeed be adjusted based on circumstance, and most people aren’t hired at the same time, so contracts will expire on a rolling basis, allowing pay to be adjusted. In addition, most contracts aren’t in force for longer than a year, so for them to be a significant force, there would need to be a substantial change in demand in a fairly short period of time.

 

Economic History Since World War 2

“World War II finally ended the Depression and proved Keynes right. New Deal deficit spending was too small, too timid to restore the animal spirits of entrepreneurs battered by years of debt deflation. War is the least productive, most destructive of human activities with negative economic benefit, but the US government, by printing money and using it to hire workers knocked unemployment, which had been close to 20 percent in 1938 down to barely over 1 percent six years later.

It is important to understand that making bombs and blowing up cities is not what shrunk unemployment. It was the printing of money, the hiring of workers, the creation of demand by deficit spending. Had the US government spent as much as it had on fighting Hitler on promoting the arts, or building schools or even digging ditches and then filling them, it would have had just as beneficial an economic effect as did the war.”

I find it incredible that people can somehow believe that war is actually beneficial for the economy. But somehow, due to the Keynesian technique of aggregating everything, this can appear to be the case on a very superficial level.

Consider the claim above, where the unemployment rate dropped from 20% to just over 1% in a few years. This makes perfect sense when you consider that all men of military age were drafted – and thus became “employed” – during this time. But while the aggregate number shows “improvement”, it is all meaningless. Having millions of soldiers doesn’t create real wealth, so who cares? For more detailed analyses of why WW2 did not end the Great Depression, see this and this.

Even ignoring the draft, Mr. Streithorst claims that it is the printing of money and deficit spending which reduced unemployment. Like many of his claims, this one is true yet beside the point. He takes this reduction in unemployment and, for no reason at all, conflates this with having a beneficial effect on the economy.

But this is patently absurd, and in this passage, the intellectual bankruptcy of Keynesian economics is on display for all to see. According to Keynes (he actually wrote this in his General Theory) and Mr. Streithorst, employing workers to dig holes in order to fill them up is a good idea and helpful for the economy. It’s truly incredible that I even need to dignify such an assertion with a response, but alas, people simply don’t understand economics…or common sense.

Let’s say you and I were stuck on an island, when suddenly Mr. Streithorst washes ashore. He observes our prior economic arrangement, which involved spending a few hours a day catching fish and gathering coconuts, while we spend the rest of the day lounging around catching some sun. He tells us: “No, no, no! You’re doing it all wrong! Can’t you see that you are unemployed for half the day? Would it not be far better for your island economy to have you [points to me] dig some holes in the sand with your hands, and for you [points to you, dear reader] to fill them up as he goes? Your unemployment problem is solved!” Then he will pat himself on the back for having demonstrated the proper way to end our current “recession”.

Clearly, this ignores the fact that jobs are not what matters – production does. If we are employed doing something useless – such as digging holes and filling them up again – we are producing nothing. This is no better than leisure, but it is something that we’d prefer not to do. This makes us worse off, not better.

“But the economy soon [after the post-WW2 recession] recovered and for the next 25 years, the world experienced the greatest growth in its history. The fundamental source of Golden Age growth was rising incomes that brought millions out of poverty and into the middle class. Their demand for luxuries that were fast becoming necessities created a mass consumer market, and corporations grew rapidly by satisfying it.”

And why, Mr. Streithorst, did incomes rise? Do you think, perhaps, it could have something to do with increasing productivity of labor? Since that is the only way real wages can rise in aggregate, I sure do. But apparently, you do not:

“The rich grew richer during the Golden Age, but so did everyone else. Golden Age policies of progressive taxation, unionization, regulation are the opposite of what conservatives advocate today, but they were much more successful than the supply side policies that have dominated our more inequitable era. Inflation adjusted GDP growth was greater in the 1950s, 1960s, and even 1970s, than it ever has been since.”

I would love to hear an explanation of how progressive taxation, unionization, and regulation can increase the productivity of labor. Progressive taxation, and taxation in general, reduce investment, which reduces the accumulation of capital, which means that labor productivity will not grow as quickly as it otherwise would. Unions can get wages to increase for members of that particular union, but not across the board. In fact, if a business needs to hire workers at “union wages”, they will not be able to hire as many employees, and thus unemployment will increase. You could make an argument that safety regulations might increase worker productivity by preventing injuries…but then businesses would already have the incentive to regulate themselves in order to obtain higher profits. Regulations merely impose higher costs on businesses – a cost that is also paid for by reduced employment and reduced investment.

“In the 1970s, for a variety of reasons, corporate profitability went south. The positive feedback loop that raised the income of workers and businessmen alike fell apart. The Golden Age depended on capital and labor cooperating, and both profiting. In the 1970s, their social pact fell apart. The inflation of that era can be seen as capital and labor each trying to shift the cost of oil price hikes to the other. At first, organized labor won that battle and grabbed a larger share of the pie. Workers, especially organized workers did well in the 1970s. Wage growth, even taking inflation into account, was greater than it ever has been since.”

Or perhaps inflation was related to Nixon closing the gold window in 1971. Wouldn’t price increases be explained far better by the massive amount of money printing that took place at that time?

Mr. Streithorst then goes on to describe some changes that happened in the 80s to increase the power of corporations over unions and workers, and how that has led to falling wages and (oh no!) falling aggregate demand. The solution? Increase debt.

“For the past 30 years, we have solved the problem of creating demand in a world of stagnant wages by going ever deeper into debt. In 1965, private sector interest payments as a percentage of GDP were around 5 percent. At the top of the bubble, they were close to 25 percent.

Going into debt allowed families to keep consuming more even as their wages did not grow. This willingness to absorb higher levels of debt meant that lower wages did not mean lower demand. This required a profound change in attitudes toward borrowing. Golden Age workers, children of the Great Depression, had a horror towards spending more than they earned. They would rather do without than place themselves in a situation in which they might have difficulty repaying their debts. By the 1980s, this attitude evaporated. Saving became passé, having huge amounts of credit card debt nothing to be ashamed off. If the origin of capitalism, according to Max Weber, was in the willingness of Protestant entrepreneurs to forgo immediate gratification in order to save and invest in productivity enhancing machinery, today capitalism requires us to spend more than we make.”

Without a doubt, increased debt will lead to higher aggregate demand, at least temporarily. And to the Keynesian, this is all that matters. Sure, a worker may not be able to pay off their credit card bills, and may have to default or otherwise have their life ruined by profligate spending habits, but who cares, so long as they “stimulate the economy”?

“That today’s youngsters want to spend more than they earn is not that surprising. What does require an explanation is the reason banks were eager to lend. The answer, and the key to the growth paradigm of the period 1982-2007, is asset price inflation. Since 1971, when Richard Nixon severed the final link between money supply and gold, the quantity of money in the world has skyrocketed. According to the standard textbooks, this should have caused an explosion of inflation. It hasn’t because of globalization. Globalization is essentially a deflationary phenomenon. It destroys pricing power. Corporations can’t charge more for their goods because a factory in China can make it cheaper. Meanwhile increasing job insecurity means that workers cannot demand higher wages.”

Since 1971, the dollar has lost almost 83% of its purchasing power (see BLS inflation calculator). This using the CPI, which is a seriously flawed measurement that has undergone changes starting in the 1980s that artificially reduce the official inflation rate. In other words, the dollar has realistically lost somewhat more purchasing power than that. Does this sound deflationary?

On top of this, the potential increase in cost of living caused by the radical increase in the money supply has not been reached. Much of this extra money has gone into inflating asset prices (rather than consumer prices), causing the many bubbles we’ve seen in recent times. The money can also be “hoarded” as cash, rather than spent or invested, and thus will not increase prices. And as the world’s reserve currency, huge amounts of dollars are held abroad and aren’t spent on dollar-denominated goods in America. If and when those dollars return home – perhaps due to lack of confidence in the dollar or strategic moves by Russia and China – we will see a massive increase in consumer prices, and perhaps even hyperinflation.

But yes, the effects of globalization that were described in this quote are correct; there is indeed a tendency for it to lower prices. The division of labor can be extended even further, increasing efficiency. This is a good thing.

Mr. Streithorst then goes on to describe how, as I mentioned above, this increase in the money supply led to a massive asset price inflation – things like real estate and stocks began to have soaring valuations, which encourage further bank lending. His chain of reasoning, which I largely agree with, goes like this:

“So the chain of causality goes like this: globalization – low inflation – central banks set low interest rates – easy money – asset price inflation – strong collateral – more loans – easy money – asset price inflation. And it all adds up to debt-fuelled consumption.”

But here’s where he begins to go wrong again:

“From 1982 to 2007 when the last bubble finally popped, it was debt-fuelled consumption that allowed the global economy to grow. If an American did not max out his credit card, a factory in China closed. With wages stagnating, wage growth could not keep demand growing at the pace of supply.”

No, debt didn’t cause the economy to grow – at least not in a meaningful way. It certainly increased GDP, a flawed aggregate metric of total production. Yes, production increased during that time, but production of what? The increase in the money supply caused price distortions that alter the structure of production, such that investments that would not otherwise have been made (perhaps due to not having enough real resources to fund them) are embarked upon. And then yes, when the bubble bursts, these malinvestments must be liquidated. Close down all the vomit factories!

“One common, and naïve, notion blames Alan Greenspan for the financial crisis. This argument states that had he not cut interest rates in the wake of the dot-com bust, he wouldn’t have sparked the real estate bubble and so the subsequent bust could have been avoided. But had Greenspan kept rates high after 2000, then the Great Recession would have just occurred seven years earlier.”

It is without a doubt true that had Greenspan not lowered interest rates, we would have had a recession seven years earlier. But it would not have been anywhere near as severe, because there would have been seven fewer years of malinvestments and distortions to unwind.

Consider the economic depression that occurred in 1920-1921. Chances are, unless you are an economics nerd, you’ve never heard of this aspect of economic history; the Great Depression is far more historically significant in most peoples’ minds. The reason you’ve never heard of it is that, while there was an incredibly sharp depression in 1920 (unemployment shot up from 4% to 12% and GNP decreased by 17%), the government cut its budget in half and did not increase the money supply, and the whole thing was over by 1921 (see here and here for more info on this period). In other words, when the government gets out of the way, the economy recovers much more quickly and effectively.

Had the government learned the lessons of the forgotten depression of 1920, there would have been a swift recovery. Instead, the artificially low interest rates led to economic distortions that finally came home to roost in 2007 when the economy collapsed. And, of course, interest rates have been kept low since then, so any “recovery” that the economists and government keep telling us is happening is just another illusion, and will need to be unwound again in the future.

“When you are strapped for cash and owe more than you can afford, reducing your expenditures is a sensible response. Unfortunately, when everyone is cutting back, the economy slows. When consumers stop spending, firms have no reason to invest in increased capacity, no reason to hire more workers. And when workers fear for their jobs, they cut consumption even more. In 2007, the debt-based feedback loop that had kept the economy ticking went into reverse.”

Ahhh, the good ol’ “paradox” of thrift! Supposedly, while thrift may be beneficial to an individual, it is detrimental when everyone is being thrifty – when everyone stops spending money, aggregate demand collapses.

But this completely ignores what happens when people save. To the extent that an individual’s savings flow into investment, someone’s income (the recipient of the investment funds) is increasing due to the individual’s thriftiness. Switching from spending to saving merely changes the demand from consumption goods to investment goods. This isn’t any different than if I spent money on one gym membership and then switched to a different gym.

What about when people “hoard” money rather than saving/investing it? In this case, yes, aggregate demand will drop in nominal terms. Presumably, people are hoarding for a reason – they derive some value from having more cash on hand. Perhaps they appreciate the security that it gives them in times of financial uncertainty…an uncertainty that is often a consequence of loose monetary policy. In any case, hoarding money has no impact on the actual capital flows that are relevant when discussing something like the paradox of thrift. If I stuff a bunch of money under my mattress, this will merely increase the purchasing power of the rest of the money that is circulating. In other words, the nominal amount of investment will decrease if I hoard money, but the investment in terms of real capital need not.

For more on why the paradox of thrift is bogus, see here and here.

“The interaction between falling house prices, mortgage-backed securities, and third party repo agreements was the trigger of this disaster, but the larger lesson is that we are in this mess today because our post-scarcity world economy cannot produce sufficient effective demand required to keep everybody employed. From 1938 to 1945, war created that demand. From 1945 to 1973, prosperity, rising wages, and advertising created that demand. From 1982 to 2007, debt fuelled consumption financed by ever rising asset prices created that demand. In 2007, as fear roiled the markets, banks stopped lending, and when we could no longer spend beyond our means, the economy collapsed.”

If we truly lived in a “post-scarcity world”, then there would be no need for employment at all. Everyone could get whatever they want for free. But besides Mr. Streithorst’s misuse of the term, his assertion that we “cannot produce sufficient effective demand required to keep everybody employed” is completely off the mark. As I’ve explained before, aggregate demand isn’t the be all and end all; by ignoring the critically important structure of production, Keynesians have pulled a clever misdirection on us. We don’t want to keep everyone employed, but rather employed in a way that satisfies the wants of consumers.

“The most important thing to remember about the faux-prosperity of the last 30 years is that it was manufactured on the basis of paper profits. If my house was worth £3000 in 1973 and £1.5 million in 2012, it is still essentially the same house and gives me the same pleasure to live in. If we could manufacture demand by making bombs and if we could manufacture demand by making houses quadruple in price, then we can manufacture demand in other ways, perhaps more satisfying ways as well.”

How does Mr. Streithorst not see the obvious contradiction staring himself in the face in this passage? He is right that much of the “prosperity” of the past 30 years is fake, or just on paper. But then he turns around and says that making bombs or making houses increase in price are effective ways of stimulating aggregate demand (if not the most useful ways), and thus making us more prosperous. The “prosperity” that results from producing bombs isn’t real, just as the “prosperity” that results from massive vomit factories isn’t real.

Prosperity comes from satisfying consumer wants. This can only be done through a market-based price system, free from distortions.

 

How Do We “Fix” The Economy?

“In the short run, the first thing we should do to emerge from this debacle is to increase government deficits and focus this spending on infrastructure and education. These investments in our future create jobs today, and by putting money in workers wallets, give the private sector reason to hire and invest in increasing capacity.”

And why is this the case?

“The need for increased government spending is basic Economics 101. Gross national product equals consumption plus investment plus government spending. If households are consuming less and firms are investing less, government has to increase spending if the economy is not to shrink.”

If he means to say that a healthy economy is one that has as high of a GNP as possible, then his prescription is correct: government spending is certainly the way to go. Of course – and I suspect I may be beating a dead horse at this point – if the government spending is to create 10,000 new vomit factories, this increase in the GNP is meaningless in terms of making people better off. Perhaps the GNP itself is a flawed concept for measuring economic well-being…

Of course, Mr. Streithorst isn’t suggesting the government build vomit factories. He wants to invest in infrastructure and education, which I’m sure is a far better idea. But how do we know what is the proper proportion to be investing between them? Should the government finance a bridge in Washington State or New Jersey? Should the education funding go towards cultivating the most promising students or to helping the others catch up? Should it go to elementary education or higher education? In what proportions? And how much should be invested in these projects in aggregate?

It is the market – the system of free-floating prices between all kinds of goods – that determines the answers to these questions. When the government is allocating resources, it does so in a purely arbitrary manner, as opposed to market forces allocating them based on consumer preferences.

The fact is, the money used to finance these projects has to come from somewhere, even if it is debt. And that “somewhere” is always going to involve taking money out of the hands of those with the most knowledge of their own preferences and put it into the hands of bureaucrats with little incentive and no knowledge of how to spend it wisely and effectively.

“But in the longer run we need to figure out a better way to stimulate demand than either war or going into debt to buy more stuff. Personally, I favor government spending targeted on making the lives of citizens richer and more cultured. Some may say, this is elitist of me, to which I reply, what is wrong with elitism? Call me bourgeois, but Tolstoy is better than Adam Sandler and playing the piano more uplifting than playing Call of Duty 2. Consumer capitalism in its current form nurtures our basest urges, from unseemly spending to internet porn. From that commercial perspective, all spending is equal, all spending is good, and YouPorn is as valid as Shakespeare.”

Mr. Streithorst really gives himself away here. What is wrong with elitism? Really? Of course, if only Mr. Streithorst were the one in charge of allocating society’s resources, the world would be perfect!

It is not true that all spending is equal. Spending that satisfies consumer wants is preferable to spending which does not. YouPorn is more “valid” than Shakespeare if that is what the consumer wants. Ask any horny and illiterate man. Many people will prefer Shakespeare, and these people are welcome to attend the theater and spend their own money there. Similarly, many people like porn – what is wrong with these people spending their own money on it? Neither is culturally superior to the other, because culture is determined by the people who comprise it. It is not a decision to be made by government and passed down to the rest of society.

 

Conclusion

Keynesian economics is all smoke and mirrors. While on the surface, Keynesian explanations for economic phenomena can be convincing, this is because they depend on misdirection and trickery. A Keynesian policy may create a benefit in some specific area, and the Keynesian economist will draw your attention there. Meanwhile, you must pay no attention to the destruction these policies create in every other area of the economy.

One must, unfortunately, understand Keynesian economics in order to understand the way the world works; the most “important” people in society buy into the Keynesian worldview. Getting into their head is rather helpful, but dear lord is it also frustrating!

For those of you looking for the intellectual ammo to fully take down just about any Keynesian argument, look no further than Henry Hazlitt’s brilliant work, The Failure of the New Economics, where he decimates Keynes’s arguments line by line. It’s about as gratifying an experience as I can imagine.

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Comments

  1. The post-scarcity argument will be due to technology. Some new jobs/productivity might be created. Not enough to sustain jobs for the entire world population though. This mini-documentary explains it pretty well: https://www.youtube.com/watch?v=7Pq-S557XQU

    What also confuses me is you think Greenspan shouldn’t have lowered interest rates. But Greenspan was a hardcore libertarian, a disciple and friend of Ayn Rand. His actions are all heavily influenced by libertarian economic understanding.

    • Thanks for the link – I’ll try to watch that when I can.

      Greenspan was a libertarian, and then he became Fed chairman. His actions as Fed chairman were in no way influenced by anything libertarian, and I’m not sure why you would think this is the case. If I were to (somehow) become president of the US, you wouldn’t say that my anarchist past implied that my presidency was anarchic in any way. Greenspan is one of the biggest traitors to libertarianism; his position and his actions while he held that position were in direct contradiction to anything he believed in during his Randian days.

Trackbacks

  1. […] The way the term “job” is bandied around these days creates the impression that a job is a product, like a car or a computer. There is a perception that by pushing the right levers and dials, government policy can “create jobs” – the same way that a car company can produce a car. This ridiculous and false perception is responsible for numerous popular economic fallacies. […]

  2. […] a car company can produce a car. This ridiculous and false perception is responsible for numerous popular economic fallacies. (the foregoing was excerpted from an article posted at Strike the Root on […]

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