Jonathan Finegold Catalán on Idle Resources 2

Jonathan Finegold Catalán has written a response to my criticisms here:

Jonathan Finegold Catalán, “Government Spending and Idle Resources: A Response,” April 28, 2011.

I will reproduce some of his comments here and respond to them.

(1) “I argue that within the coordination framework of the market — which finds its basis in the fact that individuals are constantly arranging and re-arranging a palette of means amongst chosen ends — the notion of ‘idle resources’ is ludicrous.”

And it is precisely that notion of a coordination mechanism in the market that Post Keynesians reject. Say’s law does not work, and the neoclassical idea of full employment equilibrium is a fable.

Catalán might care to acknowledge that even some Austrians reject the notion of plan/pattern coordination in free markets, so even his own economic school is divided on that issue.

Anyone who rejects the belief that the free market has a coordination mechanism will see that there is bound to be a waste of resources and involuntary unemployment in such a system. It is the denial of the reality of “idle resources” that is ludicrous.

(2) “He then goes on to say that I would probably respond with something about morality. Well, if you’ve read anything on morality that I’ve written, I actually reject the concept of natural rights. So, we can effectively ignore that part of Lord Keynes’s post.”

The problem of involuntary unemployment has severe human costs. This weak attempt at evasion does not answer my question. A rule utilitarian or Kantian might contend that the human cost of high and long-term involuntary unemployment is unacceptable, and that government intervention is required.

How can Catalán respond to that? As I have said before, all he can do is get drawn into a debate on ethics.

Does Catalán:

(1) Think there is a convincing objective theory of ethics, and

(2) What theory does he support?

The issue cuts right to questions about philosophy of ethics. If two people (an Austrian and Keynesian, say) wanted to seriously debate, they would have to ask:

(1) Is there an objective theory of ethics?

If one person does not believe in objective ethics, then the debate is already over: it would become an argument about whether ethics is objective or subjective. Also, anyone who believes that morality is subjective can just appeal to David Gauthier's Morals by Agreement and come up with some contractarian theory in which, if a majority of people assent to living by certain rules, then this is perfectly defensible ethics.

If one takes David Gauthier’s Morals by Agreement as a method for ethics, then modern social democratic states already have a majority that supports basic principles like progressive taxation, so it appears to have ample justification.

(2) If both people agree that ethics is objective, then what ethical system is true?

Our morality cannot be justified by an appeal to nature: that is why most natural rights/natural law based ethics collapse, and why natural rights ethics in the Rothbardian or Randian tradition won’t fly. Catalán says he rejects natural rights ethics. What theory does he support?

(3) “I do think labor markets can clear, and I do think that government legislation introduces a lot of price rigidity in labor markets that would otherwise not exist (for example, minimum wage, labor laws, et cetera). I don’t agree with John Keynes (the dead one, not the blogger) that in a free market downward price movements would face resistance from workers, and I think that there is plenty of empirical evidence that disproves this particular facet of Keynes’s argument (note the relative speed at which wages fell in the early 1930s, as compared to the rigidity faced between 1929–1931, for example).”

Catalán is bizarrely unaware of the empirical evidence against him. The problem of wage stickiness is a well known one in modern economics. Workers object to having their nominal wages cut. Even managers often dislike across-the-board pay cuts. Recent studies suggest that employers avoid pay cuts because they diminish workers’ morale, and then falling morale reduces productivity. Catalán can read T. F. Bewley,Why Wages Don’t Fall During a Recession (Cambridge, MA., 1999) for a good empirical study of this phenomenon.

The economic theory that drastic cuts in wages will be able to cure depressions quickly (a feature of neoclassical economics and the Austrian school) is simply a fantasy that takes no account of the empirical evidence from the real world. As I have also said above, yet another impediment to this belief that markets will clear is that Say’s law is a myth.

(4) “The market enjoys a mechanism which has been developed through the division of labor that tends to distribute wealth to those who best serve the consumer — I cover this in an article published before ‘Government Spending is Bad Economics’. Bad entrepreneurs suffer losses, good entrepreneurs make profits.”

Capitalism has markets for commodities and financial/real assets. Money as a store of value, liquidity preference, and these financial markets are a spanner in the works that destroy this fantasy view of capitalism. A great deal of wealth is not used to “serve the consumer” – it is wealth tied up on secondary markets for financial assets or real assets. Capitalism does not necessarily “distribute wealth to those who best serve the consumer.” Real world capitalism - where it exists without effective financial regulation - is plagued by asset bubbles, financial crises, and debt deflationary collapses that come about when these asset bubbles burst. Capitalism in the 19th century was regularly hit by crises of this type. We managed largely to eliminate this type of business cycle after decent financial regulation was introduced in many countries in the 1930s and 1940s, until it was attacked in 1980s and 1990s under the influence of the New Classical macroeconomics. The result was severe asset bubbles in the 1990s and 2000s, and the financial crisis of 2008, and the debt deflation many nations are now experiencing.

Subjective expectations in the investment decision can destroy business confidence for years, in an environment of fundamental uncertainty.

One Austrian response to this is to construct a mythical, totally unreal version of what they think capitalism should be like - one that has never existed in the real world. Some Austrians think that fractional reserve banking (FRB) must be abolished, since they blame it for asset bubbles and the business cycle. They are right that FRB can be inherently unstable and contribute to the business cycle.

But anti-FRB Austrians such as Murray Rothbard hold a position that is incoherent and would require restriction of free contract and private enterprise, so in fact such Austrians - by their own demand for pure laissez faire – demand an “evil”, collectivist, anti-freedom ideology requiring limits on private liberty. The pro-FRB Austrians are in fact the only ones who really do have a logically consistent argument for free markets, economic freedom, and free contract.

Fractional reserve banking is an invention of the free market and has been a fundamental part of capitalism for over two centuries. By demanding its abolition and admitting it can cause severe problems, anti-FRB Austrians have effectively refuted the idea that the unhampered market is the best system possible, and have inadvertently waved the white flag of surrender.

I will end this argument by making some additional comments on Catalán’s original post (see “Government Spending Is Bad Economics,” Mises Daily, March 31, 2011).

(1) “The continuous process of allocating resources throughout society is simply an aggregate of the ongoing calculation that takes place on an individual basis. These individual actions coordinate on a macroeconomic scale through the pricing process and through the division of labor. Producers are rewarded or punished through profit and loss, creating a tendency for capital to flow to those who use it the best (those who satisfy the consumer the most). This is the market method of rewarding ‘efficiency.’”

This is part of Catalán’s defence of the idea that the free market has a coordination mechanism. Yet again one sees the flawed inability to understand the role of non-neutral money, money as a store of value, financial asset markets, private debt, debt deflation, and subjective expectations.

What happens when capital flows into asset speculation? When the economy is saturated with private debt? When asset bubbles burst and debt deflation happens? When business confidence is shattered? When the economy is hit by what Hayek later called secondary deflation?

(2) “It is worth mentioning that governments tend to exacerbate the degree to which resources are left ‘idle’; thus, one could make the argument that the problem of idleness is to a large extent artificial. However, this would imply that there could nonetheless be some degree of idleness on the market and that this presents some type of problem. The correct answer to this question is the one that explains why the supposed problem of ‘idle resources’ is actually not a problem at all, because resources are not purposelessly left idle. Economic goods are constantly economized within the means-end framework of the individual market agent. That some goods may not be applied toward the attainment of a specific end does not mean that these resources are now idle and valueless. It simply suggests that these resources are better saved for the attainment of another end.”

And what end would that be? In conditions of recession, depression or high involuntary employment and unused capacity, it is precisely that the private sector is not employing them for any end that makes them idle! There is a classic non sequitur.

(3) “One can reasonably expect an increase in the quantity of ‘idle resources’ during periods succeeding phases of prolonged intertemporal discoordination. During the length of intertemporal discoordination, the structure of production grows around the distorted profit signals caused by monetary expansion.”

Most of the rest of Catalán’s section on “idle resources” requires Austrian business cycle theory (ABCT), a flawed and untenable theory of the business cycle. It follows that anyone who has good arguments against ABCT will have no reason to accept the arguments here.

For the sake of argument, let’s ask: does ABCT explain the recession of 2007–2009? The answer is: it certainly does no such thing. Therefore objections to fiscal policy based on ABCT are irrelevant.

Addendum

There is a critique of this post here:

Daniel Kuehn, “On Coordination Mechanisms and the Market,” April 29, 2011.

Kuehn argues:

“Let’s be very careful here, ‘Lord Keynes’. The market does have a coordination mechanism and I don’t think even Post Keynesians reject that. You have an effective demand schedule, do you not? You have a supply schedule, do you not? OK - you have market coordination. What you mean is that you don’t always have a clearing market or an optimizing market. But you do have coordination. Investments aren't made and prices aren’t set by throwing darts at a dart board. Prices coordinate.”

Fair enough. But it seems to me that Catalán was using “coordination mechanism” in sense of plan/pattern coordination in free markets.

But the issue still comes right back to whether Say’s law works, and whether there is a mechanism that causes free markets to result in full employment equilibrium and optimum use of resources. I think most my comments stand.


BIBLIOGRAPHY

Akerlof, G. A. and R. J. Shiller, 2009. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press, Princeton.

Bewley, T. F. 1999. Why Wages Don’t Fall During a Recession, Harvard University Press, Cambridge, MA.