Sunday, December 23, 2012

Murphy versus Huerta de Soto on the Government’s Ability to Increase Employment and Output

Robert Murphy tells us that it is not at all clear that we “should credit QE1 and/or [sc. the] Obama stimulus” with the US recovery in 2009. That reflects a most extreme view that some Austrians can now be found peddling: the idea that expansionary government fiscal policy does nothing or little to increase private investment and consumption, and that government stimulus programs do not work.

How strange it is, then, to see that other Austrians have never denied that government fiscal and monetary policies can increase employment and output.

Take this statement by Huerta de Soto (who is himself an advocate of a most extreme Rothbardian program):
“Under certain conditions, government and union intervention, along with the institutional rigidity of the markets, may prevent the necessary readjustments which precede any recovery of economic activity. If wages are inflexible, hiring conditions very rigid, union power great and governments succumb to the temptation of protectionism, then extremely high unemployment can actually be maintained indefinitely, without any adjustment to new economic conditions on the part of the original means of production. Under these circumstances a cumulative process of contraction may also be triggered. By such a process the massive growth of unemployment would give rise to a widespread decrease in demand, which in turn would provoke new doses of unemployment, etc. Some theorists have used the term secondary depression to refer to this process, which does not arise from spontaneous market forces, but from coercive government intervention in labor markets, products, and international trade. In some instances, ‘secondary depression’ theorists have considered the mere possibility of such a situation a prima facie argument to justify government intervention, encouraging new credit expansion and public spending. However the only effective policy for avoiding a ‘secondary depression,’ or for preventing the severity of one, is to broadly liberalize markets and resist the temptation of credit expansion policies. Any policy which tends to keep wages high and make markets rigid should be abandoned. These policies would only make the readjustment process longer and more painful, even to the point of making it politically unbearable.

What should be done if, under certain circumstances, it appears politically ‘impossible’ to take the measures necessary to make labor markets flexible, abandon protectionism and promote the readjustment which is the prerequisite of any recovery? This is an extremely intriguing question of economic policy, and its answer must depend on a correct evaluation of the severity of each particular set of circumstances. Although theory suggests that any policy which consists of an artificial increase in consumption, in public spending and in credit expansion is counterproductive, no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion, albeit at the cost of interrupting the readjustment process and aggravating the eventual recession.

Nonetheless Hayek himself admitted that, under certain circumstances, a situation might become so desperate that politically the only remaining option would be to intervene again, which is like giving a drink to a man with a hangover. In 1939 Hayek made the following related comments:
it has, of course, never been denied that employment can be rapidly increased, and a position of ‘full employment’ achieved in the shortest possible time by means of monetary expansion. ... All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period—perhaps the situation in which Dr. Brüning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.
Now let us suppose politicians ignore the economist’s recommendations and circumstances do not permit the liberalization of the economy, and therefore unemployment becomes widespread, the readjustment is never completed and the economy enters a phase of cumulative contraction. Furthermore let us suppose it is politically impossible to take any appropriate measure and the situation even threatens to end in a revolution. What type of monetary expansion would be the least disturbing from an economic standpoint? In this case the policy with the least damaging effects, though it would still exert some very harmful ones on the economic system, would be the adoption of a program of public works which would give work to the unemployed at relatively reduced wages, so workers could later move on quickly to other more profitable and comfortable activities once circumstances improved. At any rate it would be important to refrain from the direct granting of loans to companies from the productive stages furthest from consumption. Thus a policy of government aid to the unemployed, in exchange for the actual completion of works of social value at low pay (in order to avoid providing an incentive for workers to remain chronically unemployed) would be the least debilitating under the extreme conditions described above.” (Huerta de Soto 2012: 452–456).
First, before I come to my main point, Huerta de Soto is entirely wrong to blame “secondary depressions” solely on government intervention and “union power.” Has this man never heard of debt deflation and subjective expectations affecting the outlook of capitalists? In an environment of high private-sector debt, wage cuts would prove disastrous as the burden of debt soared, which causes bankruptcy to both debtors and creditors. And, in any case, markets lack the reliable equilibrating mechanisms so beloved by neoclassicals and Austrians, for the following reasons:
(1) the essential property of all highly liquid assets (with money as the most liquid asset) is that there is a zero or near zero elasticity of substitution between these liquid assets and producible commodities. This means that the gross substitution axiom is false and any acts of spending on liquid assets causing their price to rise will not necessarily induce substitution effects leading to more demand for cheaper producible commodities.

(2) it is unlikely that all markets have equilibrium prices (and even less likely that price setting businesses would be willing to adjust the prices rapidly anyway if they existed). The very notion of an economy with a tendency to general equilibrium, where all product markets converge to market-clearing prices, depends on unrealistic assumptions, such as flexible prices and demand and supply curves behaving with substitution effects in the absence of income effects;

(3) owing to uncertainty and subjective expectations, it is unlikely that shattered expectations of business people will change suddenly to induce the necessary level of investment in a severe recession or depression;

(4) there is thus no guarantee that savings will match investment (even if you assume a loanable funds theory of interest) or that Say’s law is much more than a fantasy;

(5) there is no such thing as some natural rate of interest that will equilibrate savings and investment;

(6) as Keynes himself argued, absence of wage and price flexibility is not the reason why neoclassical theory is flawed: even if we had complete wage and price flexibility, there would still be no guarantee of full employment.
But to return to my original point: the crucial issue here is that even Huerta de Soto states that “no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion” – no one, that is, except (apparently) Robert Murphy!

Curiously, Ludwig Lachmann went further than Huerta de Soto and saw public works spending in a depression as a genuinely useful measure:
“In the British situation of 1932, Hayek and his friends rejected the proposals of Keynes and some non-Keynesian British economists – that at the bottom of the depression the government should take certain steps, and so on. Hayek has now realised that that was wrong. That is to say, I think Austrians today would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce. And in this respect I think Austrians … would have … have ... learned.”

Huerta de Soto, J. 2012. Money, Bank Credit and Economic Cycles (3rd edn.; trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Wednesday, December 19, 2012

The Myth of Ludwig Erhard and Economic Policy in Germany in 1948

There is a myth that has grown up around Ludwig Erhard and his abolition of price controls in Germany in 1948.

That mythology is illustrated well in this section of the Commanding Heights documentary below.

First, nobody denies that Germany experienced economic chaos after 1945. The war devastated the economy. The destruction of so much of Germany’s capital stock and its severe supply problems obviously meant that special economic polices were required. Demand-led Keynesian stimulus was obviously the wrong policy in the immediate post-1945 period.

Nevertheless, let us review the myths and problems with this video:
(1) This video creates the myth that in 1948 the German economy was suddenly and completely liberalised. Nothing could be further from the truth. The West German economic miracle in the 1940s and 1950s occurred with a high degree of government intervention.

(2) We are told that Ludwig Erhard decided to abolish “all price controls.” That is simply not true. Ludwig Erhard’s abolition of price controls was hardly complete. The “Law of Guiding Principles” that outlined Erhard’s reform reveals a very different program from the myth created in this documentary. For example,
(1) food and raw materials remained under control;

(2) textiles, clothes, shoes and soap continued to be rationed, and

(3) prices for staple foods, raw materials, and rents were also still subject to regulation. (Mierzejewski 2004: 71).
(3) There is no doubt that moderate liberalisation of prices eliminated the black market in many goods. But the speed with which goods “reappeared” is exaggerated in the documentary; it did not happen “overnight.” In fact, it took weeks for goods to reappear in serious quantities (Mierzejewski 2004: 72), and one consequence of the reform was that unemployment rose (Mierzejewski 2004: 72).

Arguably, three other factors did far more for the German economic recovery from 1948. First, the currency reform of 1948 and the introduction of the new Deutsche Mark (on 20 June 1948) was an important step, since the old Reichsmark was near worthless.

Secondly, the industrial and economic problems in Germany were partly caused by the “industrial disarmament program” pursued by the Allies from 1945 that involved actual removal of capital goods equipment and an import embargo on raw materials. The abandonment of that policy was a major step in the economic recovery.

Thirdly, the Marshall aid program did more to provide consumer goods in Germany after 1945 than the liberalisation of price controls. Germany’s import needs were greatly depend on Marshall aid: 70% of imports in 1946–1947, 65% in 1948 and 43% in 1949 (Hitchcock 2010: 164). When the recovery of 1948 caused a balance of payments crisis, Marshall aid covered the deficit.

Also, government earnings from the sale of Marshall aid goods were used by the government to finance public investments in electricity, coal mining, agriculture, housing, railways and shipping (Hitchcock 2010: 164).

(4) The soaring inflation and difficulty many people had in obtaining basic consumer goods caused what can only be described as a volte face by Erhard.

By September 1948, Erhard oversaw an intervention called the “Everyman Program” designed to control the inflation unleashed by his liberalisation. In this program, raw materials were directly allocated to producers of consumer goods, so that these businesses would charge prices deemed fair by the government. The public had access to consumer goods such as clothing, shoes, and kitchen utensils at prices well below what were being charged on unregulated markets, and the type of goods subject to control varied as circumstances dictated (Mierzejewski 2004: 75). That program did not end until 1951.

(5) Erhard happily accepted Marshall aid which, crucially, overcame the balance of payments constraint in post-WWII Germany and provided the imports of consumer goods and capital goods that the Germans badly needed given their crippled economy (Mierzejewski 2004: 76). Needless to say, Marshall aid was hardly a “free market” policy.

(6) Also, much is made in this documentary of the fact that the German economy overtook that of the UK in the post-war period, as if this had to do with Germany’s alleged laissez faire policies. In fact, Germany, had always been the largest economy in Europe from the early 20th century, and its return to that position by post-1945 economic growth was nothing but the natural consequence of its reconstruction and the recovery of its export-led growth sector.

(7) Another paradox is that it was Ludwig Erhard who popularised the term “social market economy,” the term that described the West German mixed economy after 1945. Mises spits bile at West Germany’s “social market economy,” and regarded it as just another interventionist state that would allegedly lead to totalitarian socialism. One wonders how Austrians could seriously point to West Germany as an example of their brand of economics.

(8) One final statement in the documentary is that after 1945 “most countries preferred to plan their economies” (in contrast to West Germany), a gross exaggeration. West Germany had the same fundamental mixed economy as most other Western nations. The mixed economies in the capitalist West – even those with some nationalised industries – were hardly “planned economies,” for that phrase, if it is to have any meaning, must refer to communist command economies.
What about other aspects of West German economy policy after 1948?

Although the West German government practised fiscal restraint in the 1950s, the mass destruction of so much of Germany’s capital stock allowed good returns from investment in capital for many years, and the growth of the post-war era was a function of reconstruction. Germany required a great deal of reconstruction, much greater than, say, the United States and even the UK.

Germany policies in the 1950s essentially drove the economy back to its export-led growth model, though one consequence was that Germany suffered a serious problem of unemployment in the 1950s: unemployment was shockingly high at the beginning of this decade and only gradually fell from about 10% to 3% during the course of the decade. At the same time, the 1950s saw a great expansion of the welfare state in West Germany, and social outlays provided automatic stabilisers to some degree.

But the economy was hardly an example of a free market paradise. Even in the 1950s, a vast swathe of German industry was still owned by the government: about 40% of coal and steel, 66% of electricity production, 75% of aluminium and most German banks. For example, Volkswagen was owned by the West German state until 1961 when the government sold its majority stake in the company (a move which was part of a privatisation program by Konrad Adenauer that had begun in 1957). The German government also prevented foreigners from taking over German automakers.

By the mid-1960s, the post-war boom ended, and German governments turned to overt Keynesian policies to stimulate demand.

In general, though I have not read these German works, Berger (1997) and Nützenadel (2005) detail how there was a great deal of macroeconomic management of the West German economy by the government from the early 1950s.

Allen, Christopher. 1989. “The Underdevelopment of Keynesianism in the Federal Republic of Germany,” in Peter Hall (ed.), The Political Power of Economic Ideas: Keynesianism Across Nations. Princeton University Press, Princeton. 263–289.

Berger, Helge. 1997. Konjunkturpolitik im Wirtschaftswunder : Handlungsspielräume und Verhaltensmuster von Bundesbank und Regierung in den 1950er Jahren. Mohr Siebeck, Tübingen.

Hitchcock, W. I. 2010. “The Marshall Plan and the Creation of the West,” in Melvyn P. Leffler and Odd Arne Westad (eds.). The Cambridge History of the Cold War. Volume I. Origins. Cambridge University Press, Cambridge. 154–174.

Mierzejewski, Alfred C. 2004. Ludwig Erhard: A Biography. University of North Carolina Press, Chapel Hill, N.C. and London.

Nützenadel, Alexander. 2005. Stunde der Ökonomen: Wissenschaft, Politik und Expertenkultur in der Bundesrepublik 1949–1974. Vandenhoeck & Ruprecht, Göttingen.

Monday, December 17, 2012

Mises versus Lachmann on Equilibrium Prices

Here is Mises on equilibrium prices:
“The characteristic feature of the market price is that it equalizes supply and demand. The size of the demand coincides with the size of supply not only in the imaginary construction of the evenly rotating economy. The notion of the plain state of rest as developed by the elementary theory of prices is a faithful description of what comes to pass in the market at every instant. Any deviation of a market price from the height at which supply and demand are equal is – in the unhampered market – self-liquidating.” (Mises 2008: 756–757).
This is a strident statement, and not just limited to Mises’s entirely fictitious evenly rotating economy (ERE), for Mises invokes the “plain state of rest,” a temporary state in which all desired transactions are completed and no further trades are conducted (e.g., the end of a trading day in the stock market).

For Mises, the “unhampered market” would produce prices caused by the dynamics of supply and demand curves, and deviations would lead to self-liquidation and market-clearing prices.

Yet even this vision is little more than ideological fantasy. Even in undergraduate economic classes, students will usually learn that the law of demand cannot really be universal, for Veblen goods and Giffen goods (perhaps often perceived as anomalies) already rule out an absolutely universal law of demand. And, even if government “distortions” could be eliminated, what about businesses that engage in price setting/price administration?

Prices set by businesses are not equilibrium prices. As Lee says, “administered prices are not market-clearing prices and nor do they vary with each change in sales (or shift in the virtually non-existent market or enterprises ‘demand curve’)” (Lee 1994: 320, n. 18).

Matters are different when we turn from Mises to Ludwig Lachmann, who did indeed understand the existence of fixprice markets. First, an anecdote Bruce Caldwell tells about Lachmann is quite instructive:
“I first met Ludwig M. Lachmann on February 4, 1982 at the first spring semester meeting of the Colloquium in Austrian Economics at New York University. ….

During that first meeting I had an exchange with Mario Rizzo about the concept of market-clearing. I argued that though the speed of adjustment problem was an empirical issue, it was not something that could be tested as a general proposition. I drew the implication that one’s view of the rapidity of clearing was a matter of faith, nothing more than a metaphysical assumption, though obviously a crucial one. Lachmann nodded his head vigorously as I was finishing up, which pleased me immensely.” (Caldwell 1991: 140).
Secondly, Lachmann’s own judgement on the usefulness of equilibrium prices:
“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).
This is yet another divergence between Lachmann’s brand of Austrian theory and the other branches of Austrian economics.


Caldwell, Bruce J. 1991. “Ludwig M. Lachmann: A Reminiscence,” Critical Review 5.1: 139–144.

Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.

Lee, F. S. 1994. “From Post Keynesian to Historical Price Theory, Part 1: Facts, Theory and Empirically Grounded Pricing Model,” Review of Political Economy 6.3: 303–336.

Mises, L. von. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Mises Institute, Auburn, Ala.

Saturday, December 15, 2012

Robert Murphy on MMT: An Unimpressive Critique

Robert Murphy supposedly “exposes the fallacious reasoning, slight-of-hand [sic] semantics, tautologies, and other tricks employed” by MMT here:
I am rather astonished to say it, but I was pleasantly surprised by this interview.

Murphy’s understanding of MMT has improved; some points are constructive (e.g., on the sustainability of the trade deficit).

Nevertheless, on the whole, the interview does not really refute MMT. In fact, we hear again and again that MMT is “technically correct”! Then when Murphy goes on to dispute the usefulness or validity of MMT analysis (despite many things being “technically true”) his counterarguments are rather feeble.

The interview mostly focuses on Warren Mosler and his book Seven Deadly Innocent Frauds of Economic Policy. Murphy puts the emphasis on Warren Mosler as the leading figure of MMT. While one cannot deny that Warren Mosler is a prominent exponent of MMT (and I do not wish to downplay his role), nevertheless, if we were to consider MMT as a macroeconomic school, Murphy fails rather spectacularly to notice that MMT has some other important academic economists as its intellectual leaders: the outstanding Bill Mitchell and L. Randall Wray.

Other problems with this interview:
(1) At one point the interviewer seems to think that MMT advocates spending without limit or without taxation. That is obviously false.

(2) I see Murphy revisits his “government-debt-will-rob-our-children” debate. On this issue, Murphy is unconvincing. His comments on how retired people would sell their bonds in the future to people with money they have saved does not refute the idea that bond repayment in the future simply redistributes wealth.

First, curiously, Murphy ignores inherited wealth that people hold and do not wish to spend on consumption (there can be no foregone wealth involved in saving if a person never wanted to spend his/her inherited wealth on consumer goods). Secondly, his argument could be used against all private sector saving! We could show how any process by which someone chooses to save for retirement and sells private sector financial assets to other people in the future involves making some people poorer by their acts of saving. We could actually show how any private sector financial assets to be sold in the future must rob some people in some sense!

(3) On the issue of government deficits adding to savings, here Murphy says it is technically true. Then he resorts to the “government-taxation-is-fraud!” argument (falling back on ethical objections rather than strict economic or national accounting objections), an issue that is dependent on dubious ethical theories and, anyway, begs the question, for Murphy never explains what moral theory he uses. His attempt to dispute the MMT accounting view of saving by using Google as an example is utterly unconvincing, for Google is nothing like a government. The whole point is precisely that the government is a unique entity, unlike any private sector agent.

(4) On social security, Murphy’s contention is that the program is insolvent under the standard rules of private sector accounting. That is vacuous, precisely because the standard rules of private sector accounting do not apply to government programs like this (despite the fiction created in the 1930s that they do). Furthermore, government obligations under social security are not due all at the same time, but over many decades.

On the issue of demographic change, I think we have increasing evidence that in the course of this century we will see some rather spectacular productivity growth, owing to automation, robotics and artificial intelligence. The imbalance between retired people and workers will not be a problem if huge productivity and output growth happens. I suspect that even if merely moderate productivity and output growth occur, it still will not be a problem.

(5) On the trade deficit, Murphy in essence agrees with Warren Mosler! There is no refutation of MMT here.

(6) On the issue that investment adds to savings, this is not even a new argument. It is essentially standard Keynesianism, and it is true. I do not see any real refutation of it by Murphy. Investment does bring forth savings.

Furthermore, with fractional reserve banking and negotiable credit instruments it is obvious that any economy not at full employment (that is, with idle resources) can engage in investment without prior monetary saving. Loanable funds theory is a misleading model of the modern financial system anyway.

(7) At the end, I am surprised how Murphy seems to not really even understand the core of MMT. As far as I can see, MMT has always said that there are real constraints to government spending, but that the conventional financial constraints (deficits are funded by borrowing from the private sector) are a myth.

Thursday, December 13, 2012

Critics of the Classic Hayekian Business Cycle Theory

Daniel Kuehn raises the question of who the major critics of the Hayekian business cycle theory were (or are).

My list:
(1) Piero Sraffa:
He was really the first and possibly the most important in these articles:
Sraffa, P. 1932. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932. “A Rejoinder,” Economic Journal 42 (June): 249–251.
See also:
Kurz, H. D. 2000. “Hayek-Keynes-Sraffa Controversy Reconsidered,” in H. D. Kurz (ed.), Critical Essays on Piero Sraffa’s Legacy in Economics. Cambridge University Press, Cambridge. 257-302.

Lawlor, M. S. and Horn, B. 1992. “Notes on the Hayek-Sraffa exchange,” Review of Political Economy 4: 317–340.

Lachmann, L. M. 1986. “Austrian Economics under Fire: The Hayek-Sraffa Duel in Retrospect,” in W. Grassl and B. Smith (eds.), Austrian Economics: Historical and Philosophical Background, Croom Helm, London. 225–242.
(2) Karl Gunnar Myrdal:
Myrdal, G. 1933. “Der Gleichgewichtsbegriff als Instrument der geld-theoretischen Analyse,” in F. A. Hayek (ed.), Beitrage zur Geldtheorie, Vienna. 361–487.
(3) Paul Rosenstein-Rodan:
However, I don’t think his criticisms were ever published (I could be wrong), but were certainly conveyed to Ludwig Lachmann in conversations in the 1930s as reported in this Austrian Economics Newsletter (AEN) (an interview with Lachmann):
AEN: You have talked a number of times about the importance of expectations in business cycle theory. What first drew your interest to expectations as far as the business cycle question was concerned.

Lachmann: Talking to Paul Rosenstein-Rodan, who was then a lecturer at University College, London – not technically in the London School of Economics – but he gave a course on the history of economic thought to which all of us who were research students then went.
It was Rosenstein-Rodan who in discussing Austrian trade cycle theory with me said, ‘Ah yes, but whatever happens in the business cycle is in the first place determined by expectations.’ And then he told me of the work that had been done in Sweden.”
Ludwig Lachmann, “An Interview with Ludwig Lachmann,” The Austrian Economics Newsletter, Volume 1, Number 3 (Fall 1978),
Rosenstein-Rodan was possibly referring to Gunnar Myrdal’s work listed in (2) above.

(4) John Maynard Keynes:
Keynes’s criticisms were in a response to Hayek’s review of his earlier work, and mostly in his private correspondence with Hayek:
Keynes, J. M. 1931. “The Pure Theory of Money. A Reply to Dr. Hayek,” Economica 34 (November): 387–397.

Ingrao, B. 2005. “When the Abyss Yawns and After. The Correspondence between Keynes and Hayek,” in M. C. Marcuzzo and A. Roselli (eds.), Economists in Cambridge. A Study Through their Correspondence, 1907–1946. Routledge, London. 236-256.

Ingrao, B. and F. Ranchetti. 2005. “Hayek and Cambridge: Dialogue and Contention,” in M. C. Marcuzzo and A. Roselli (eds.), Economists in Cambridge. A Study Through their Correspondence, 1907–1946. Routledge, London. 392-413.

Moggridge, D. (ed.). 1973. The Collected Writings of John Maynard Keynes (vol. 13). Macmillan for the Royal Economic Society, London.
It was in Keynes (1931) that he delivered his rather harsh verdict on Prices and Production:
“The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it beginning with page 45 … It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.” (Keynes 1931: 394).
(5) Ludwig M. Lachmann:
Lachmann, L. M. 1943. “The Role of Expectations in Economics as a Social Science,” Economica n.s. 10.37: 12–23.
(6) Frank H. Knight:
Knight, Frank H. 1935. “Professor Hayek and the Theory of Investment,” Economic Journal 45.177 (March): 77-94.
Here is one of Hayek’s responses to Knight:
Hayek, F. A. von. 1936. “The Mythology of Capital,” Quarterly Journal of Economics 50.2: 199-228.
See also:
Boettke, P. and K. Vaughn. 2002. “Knight and the Austrians on Capital and the Problem of Socialism,” History of Political Economy 34: 155–176.

Cohen, A. J. 2003. “Hayek/Knight Capital Controversy: The Irrelevance of Roundaboutness, or Purging Processes in Time?,” History of Political Economy 35.3: 469-490.
(7) Nicholas Kaldor:
Kaldor, N. 1939. “Capital Intensity and the Trade Cycle,” Economica n.s. 6.21: 40–66.

Kaldor, N. 1940. “The Trade Cycle and Capital Intensity: A Reply,” Economica n.s. 7.25: 16–22.

Kaldor, N. 1942. “Professor Hayek and the Concertina-Effect,” Economica n.s. 9.36: 359–382.
(8) George L. S. Shackle:
Shackle, George L. S. 1981. “F. A. Hayek, 1899– ,” in D. P. O’Brien and J. R. Presley (eds.), Pioneers of Modern Economics in Britain. Macmillan, London. 234–261, at p. 240.
(9) Gottfried von Haberler:
Haberler, G. 1986. “Reflections on Hayek’s Business Cycle Theory,” Cato Journal 6: 421–435.

Reprinted in Haberler, G. 1991. “Reflections on Hayek’s Business Cycle Theory,” in John Cunningham Wood and Ronald N. Woods (eds.), Friedrich A. Hayek: Critical Assessments (vol. 4). Routledge, London. 249–262.
(10) Gordon Tullock:
Tullock, G. 1988. “Why the Austrians are Wrong About Depressions,” The Review of Austrian Economics 2: 73–78.
(11) David Ramsay Steele
His views (quite insightful) are described in this comment:
I am not certain, but there may be some more discussion of the ABCT in David Ramsay Steele’s book From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (Open Court, La Salle, Ill., 1992).

(12) Allin Cottrel:
Cottrell, A. 1993. “Hayek’s Early Cycle Theory Re-examined,” Cambridge Journal of Economics 18: 197–212.
(13) Ulrich Witt:
Witt, U. 1997. “The Hayekian Puzzle: Spontaneous Order and the Business Cycle,” Scottish Journal of Political Economy 44: 44–58.
(14) Tyler Cowen:
Cowen, Tyler. 1997. Risk and Business Cycles: New and Old Austrian Perspectives. Routledge, London.
(15) Robert P. Murphy:
Although I suppose Murphy sees himself as a defender of the ABCT, nevertheless his work here is nothing but a critique of the classic Hayekian theory (where Hayek uses the Wicksellian natural rate of interest):
Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”
(16) Robert L. Vienneau:
Vienneau, R. L. 2006. “Some Fallacies of Austrian Economics,” September

Vienneau, R. L. 2010. “Some Capital-Theoretic Fallacies in Garrison’s Exposition of Austrian Business Cycle Theory,” September 4
A very good work on this issue is Constatinos Repapis, “Hayek’s Business Cycle Theory during the 1930s: A Critical Account of its Development,” History of Political Economy 43 (2011): 699–742.

The list above is far from complete. I may update it after further thought.

In addition, here are some criticisms of Mises’s version of the ABCT:
Vasséi, Arash Molavi. 2010. “Ludwig von Mises's Business Cycle Theory: Static Tools for Dynamic Analysis,” in Harald Hagemann, Tamotsu Nishizawa, Yukihiro Ikeda (eds.). Austrian Economics in Transition: From Carl Menger to Friedrich Hayek. Palgrave Macmillan, Basingstoke. 196–217.

Vasséi, Arash Molavi. 2010. “The Foundation of Ludwig von Mises’s Business Cycle Theory: Real Analysis as a Chain of Tautologies,” SSRN paper, June 5, 2012.

E. K. Hunt on Equilibrium Prices in Neoclassical Economics

E. K. Hunt in his book the History of Economic Thought: A Critical Perspective (2002; although a new edition [Hunt and Lautzenheiser 2011] is now available, I quote from the 2nd edition) identified three problems with neoclassical theory:
(1) its conception of the entrepreneur,

(2) its conception of the nature of production, and,

(3) its conception of the process by which markets supposedly attain their competitive equilibrium prices (Hunt 2002: 373).
In particular, problem (3) above is directly relevant to the alleged “economic (mis)calculation” problems that so concern Austrians.

Hunt discusses point (3):
“The third principal obfuscation of neoclassical theory was its conception of the process by which competitive equilibrium prices were determined. In this theory, each consumer, each owner of a factor of production, and each entrepreneur were passive ‘price takers.’ All prices were determined by the competitive market completely independently of the actions taken by any individual or business firm.

Despite the considerable amount of attention that this problem received after the publication of Walras’s Elements, the neoclassical theorists did not substantially improve on Walras’s attempts to solve it. They could assert that these equilibrium prices were arrived at through a process of ‘groping,’ but they were never able to give any convincing empirical or theoretical argument to show that such groping would not take the economy farther away from equilibrium rather than closer to it. They could rely on Walras’s useful fiction of the crier [that is, the Walrasian auctioneer – LK], but such an obvious resort to a useful fiction as a deus ex machina designed simply to hold the theory together reduced the effectiveness of the theory’s ideological defense of free market capitalism.

In the more esoteric literature of professional journals, the neoclassicists demonstrated that the existence of such a set of equilibrium prices was not logically impossible, given their initial assumptions. This demonstration was taken as a reasonable justification for the textbook practice of simply assuming that this set of equilibrium prices existed and was known to ail individuals and business firms.

This was a particularly critical assumption because the three pillars of the neoclassical ideological defense of free market capitalism were the marginal productivity theory of distribution …, the invisible-hand argument, and the belief, held purely on faith, that the free market forces of supply and demand automatically and efficaciously take the economy to a full employment equilibrium … . None of these three ideological props for capitalism could be defended if the market did not automatically create equilibrium prices.” (Hunt 2002: 374).
This analysis conveys how fundamentally bound up the argument for free markets is with the idea that real world markets do have a tendency to create equilibrium prices in each commodity market.

Of course, the metaphor of the Walrasian auctioneer was always a most bizarre and unrealistic part of the neoclassical theory, because prices in a market economy are most decidedly not formed by some auctioneer clearing markets in a centrally organized auction. What can you say about a pro-free market model that analyses decentralised market activities as if they were overseen by some kind of central planner? (which is what the Walrasian auctioneer really is).

While one can point to certain flexprice markets where traders or business people do need to adjust prices rapidly to clear their stock, such as producers and wholesalers who sell perishable goods (e.g., fresh seafood), or alternatively to clearance sales that retailers hold to clear stock, other markets have prices set. The latter are fixprice markets. The empirical reality is that in many fixprice markets businesses engage in price administration or price setting. They are price makers, not price takers. And this is before we even get to the issue of prices as set by oligopolies, cartels and monopolies.

Many firms quite deliberately set prices. They act to ensure their survival and grow their business and market share. By looking more at the long-term state of demand, the price of many products is often not affected by short-term changes in demand. Short-term increases in demand can be met by holding stocks of their product and by having excess capacity. The most important cause of price adjustments are changes in the costs of factor inputs and wages.

Empirical studies show that, outside given limits, businesses find that variations in their set prices produce no significant change in sales volume, and, above all, when prices are cut, this does not necessarily lead to changes in short term market sales (Gu and Lee 2012: 462). And experiments with prices adjusted downwards to a significant extent show that this causes a severe blow to profits, so severe indeed that enterprises quickly abandon such experiments (Gu and Lee 2012: 461).

Prices set by businesses are not equilibrium prices. As Lee says, “administered prices are not market-clearing prices and nor do they vary with each change in sales (or shift in the virtually non-existent market or enterprises ‘demand curve’)” (Lee 1994: 320, n. 18).

The neoclassical and Austrian view (or at least a view held by some Austrians) of universal supply and demand dynamics governing all prices which gravitate to their equilibrium values thus becomes untenable.

Curiously, the existence of fixprice markets and its implication for economics was taken up by the Austrian economist Ludwig Lachmann:
“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).
The lesson Lachmann learnt, however, was never learnt by Mises, Rothbard and other Austrians who continue to analyse most prices unrealistically in terms of demand curves and equilibrium prices.


Gu, G. C. and F. S. Lee. 2012. “Prices and Pricing,” in J. E. King, The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 456–463.

Hunt, E. K. 2002. History of Economic Thought: A Critical Perspective (2nd rev. edn.). M.E. Sharpe, Armonk, N.Y.

Hunt, E. K. and M. Lautzenheiser. 2011. History of Economic Thought: A Critical Perspective (3rd edn.). M.E. Sharpe, Armonk, N.Y.

Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.

Lee, F. S. 1994. “From Post Keynesian to Historical Price Theory, Part 1: Facts, Theory and Empirically Grounded Pricing Model,” Review of Political Economy 6.3: 303–336.

Stephanie Kelton on Modern Monetary Theory

A nice interview here on Capital Account with Stephanie Kelton on Modern Monetary Theory (MMT) and the fiscal cliff.

Wednesday, December 12, 2012

Vulgar Austrians, Economic Calculation and Capitalist Economies


Ignorant internet Austrians have a habit of invoking the “socialist calculation debate” and the idea of economic (mis)calculation as if these provide some irrefutable argument against Keynesian macroeconomic management of a capitalist economy. I am principally thinking of this person.

There are two issues here:
(1) the alleged “economic (mis)calculation problems” that a capitalist economy with modern monetary and fiscal policy and some degree of government intervention might be subject to in Austrian theory, and

(2) the core issue of Mises’s socialist calculation debate from the 1920s–1940s.
The original core idea, or problem, of Mises’s socialist calculation debate was that “rational economic calculation” was impossible in a planned, command economy, because the lack of market prices for capital goods eliminated those markets which produce prices for the means of production, and capitalists need these prices to calculate profit and loss. That is to say, a command economy has completely abolished private ownership and production of capital goods, yet the prices of those goods (and other factor inputs) are required to establish costs of production and whether you have made a profit from sales of goods produced.

But it is obvious how that issue cannot be a serious one for modern nations with Keynesian economics, because in these systems the vast majority of capital goods are owned and produced privately, and prices do exist for these means of production and factor inputs. Profit and loss is obviously calculable in the way that it is not in a Communist command economy.

I will repeat this important concept: the point here was, and always has been, that the original issue in the socialist calculation problem (no market prices at all for capital goods eliminating producers’ goods markets) is not what modern Austrians must mean when they complain about “economic (mis)calculation” in a Keynesian economy, for prices for capital goods and factor inputs do exist, and even if Austrians think some of those prices might be “distorted” that is a different issue from saying that there are no prices whatsoever with which to calculate profit and loss.

Fundamentally, “rational economic calculation,” in the sense of the original socialist calculation debate, is possible in a market economy with Keynesian policies. To prove this, we need only note how even Mises conceded that a syndicalist system of production was possible:
Mises agrees that rational economic calculation is possible under syndicalism or under any other producer cooperative-based system where the cooperative bodies are the owners of the means of production. Thus, there is some kind of group-collective private ownership, what the Maoists during the Chinese cultural revolution used to criticise as Yugoslav group-capitalism. Group-capitalism is also capitalism and allows rational calculation.” (Keizer 1987: 113–114).
So Mises admitted that rational economic calculation was possible under syndicalism since he argued that there was a group-collective private ownership of capital goods in such a system.

It follows a fortiori that a modern capitalist state even with Keynesian macro-management where private ownership of capital goods is the norm must also be capable of “rational economic calculation” in the original sense of Mises’s socialist calculation debate.

Now, when confronted with this point, vulgar Austrians will say that it is other alleged “economic (mis)calculation problems” that they are talking about, as follows:
(1) the alleged miscalculation problems caused in the Austrian business cycle theory (ABCT). But even here the issue is alleged price distortions in capital goods, not the non-existence of such prices or lack of private markets for capital goods and other factor inputs.

(2) distortions of prices away from their equilibrium values (as postulated by (4) below) by government spending, deficit spending, central bank fiat money creation, price controls, subsidies etc.

(3) distortions of prices away from their equilibrium values (as postulated by (4) below) by government interventions allegedly leading to Cantillon effects

(4) in general, obstructions to flexible wages and prices and therefore to a price vector that will clear all markets (with flexible wages clearing the labour market), as in this quotation of Hayek:
“The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).
It is obvious how the problems from (2) to (4) are all very similar to ideas from Walrasian neoclassical theory, and its idea of a tendency to a price and wage vector that would clear all markets.

But the most bizarre thing is that the same vulgar Austrian thinks that Hayek’s equilibrium structure of wages and prices “has nothing to do with ‘market-clearing Walrasian price vectors!’” We have here ignorance of the highest order at work.

First, by the late 1920s, Hayek was influenced by neoclassical economics and Walrasian general equilibrium (GE) theory. It was not until 1937 in his paper “Economics and Knowledge” (Hayek 1937) that Hayek discarded the notion of a set of equilibrium prices for the alternative idea of equilibrium he called “plan coordination.” The notion of a set of equilibrium prices (as we see in the quotation of Hayek above) is derived from Hayek’s beliefs during the time he was under the influence of Walrasian theory.

Secondly, Hayek’s remarks in the quotation above were made on April 9, 1975 in a talk that Hayek gave to the American Enterprise Institute in Washington DC. The real paradox here is that Hayek was using ideas broadly similar to those from Walrasian GE theory at a time when in his other written work he was moving away from GE as a useful concept and had already made strong criticisms of it. Even by the time of The Pure Theory of Capital (1941), Hayek asserted that it was necessary to “abandon every pretence that [sc. equilibrium] … possesses reality, in the sense that we can state the conditions under which a particular state of equilibrium would come about” (Hayek 1976 [1941]: 28). If nothing else, the statement of Hayek from 1975 is just further proof that Hayek was inconsistent in his attitude to GE theory, certainly in the 1970s.

One of the reasons that Hayek abandoned GE theory was that his opponents in the socialist calculation debate had used it to counter the arguments of the Austrians, and to argue that rational economic calculation was possible in a socialist state.

Hayek’s ultimate rejection of GE theory in the context of the socialist calculation debate can be seen towards the end of his life in an interview as transcribed in the book Nobel Prize-Winning Economist: Friedrich A. von Hayek (1983, pp. 187-188):
“HIGH: To what extent do you think that general-equilibrium analysis has contributed to the belief that national economic planning is possible?

HAYEK: It certainly has. To what extent is very difficult to say. Of the direct significance of equilibrium analysis to the explanation of the events we observe, I never had any doubt, I thought it was a very useful concept to explain a type of order towards which the process of economics tends without ever reaching it. I’m now trying to formulate some concept of economics as a stream instead of an equilibrating force, as we ought, quite literally, to think in terms of the factors that determine the movement of the flow of water in a very irregular bed.”
This issue raises the point that there is a schism in Austrian economics between those who accept the basic view that markets have a tendency to an equilibrium state and those who do not, as I have shown here.


Hayek, F. A. von. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A. von Hayek. American Enterprise Institute, Washington.

Hayek, F. A. von. 1976 [1941]. The Pure Theory of Capital. Routledge and Kegan Paul, London.

Keizer, W. 1987. “Two Forgotten Articles by Ludwig von Mises on the Rationality of Socialist Economic Calculation,” Review of Austrian Economics 1.1: 109–122.

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Tuesday, December 11, 2012

A Note on Prices and Say’s Law

In neoclassical theory, the equilibrium price is the price in a particular commodity market that equates the demand for that commodity with the supply, so that the market is cleared. It can be understood as a market-clearing price.

By contrast, in Classical economics, the equilibrium price (or natural price) is derived from costs of production (wages, other factor inputs, rent, and profits). That is, factor inputs are capital goods (where the return is profit), labour (the return is wages), land (rent) or raw materials (cost of purchase).

Now let us turn to how later Classical economists defined or formulated Say’s law, according to Thomas Sowell (1994: 39–41):
(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).
I have pointed out before that many modern studies have concluded that it was the Classical economists Adam Smith and James Mill who had a major role in developing Say’s law, in terms of the propositions listed above, not necessarily Jean-Baptiste Say himself.

Indeed Thweatt (1979: 92–93) and Baumol (2003: 46) conclude that Adam Smith was in fact the father of Say’s law in Classical economics, and that James Mill was the first to express it properly in 1808.

What is the significance of this?

It is as follows: propositions (1) and (4) above seem to me to show the influence of the Classical price theory: the notion that the equilibrium price (or natural price) is derived from costs of production, and indeed that prices are normally or generally equal to the costs of production.

For how else it is possible to argue, as in proposition (1), that the “total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output”? If this is supposed to mean the total factor payments received before the sale of a given volume (or value) of output, there is a problem.

That Say’s law does think in terms of Classical equilibrium price is confirmed by the way that sectoral imbalances are allowed and explained by the theory:
“There could be, Say argued, a temporary glut of some commodities, but this would result from the fact that market equilibrium had not been attained. Some prices would be too low and others too high, relative to their respective long-run equilibrium prices or costs of production. In this case, there would be a glut of those commodities whose prices were too high and simultaneously a shortage of those commodities whose prices were too low. The gluts and shortages would exactly cancel out in the aggregate.” (Hunt and Lautzenheiser 2011: 137).
But already before we get to other critiques of Say’s law, it is vulnerable to the observation that this is not how prices are formed in the real world: in many markets for newly produced goods and services, especially in industrial markets, prices are administered or set by corporations and businesses, according to normal production costs plus a profit markup. Because of the profit markup, there is some degree of stability of profits that results from price administration (Gu and Lee 2012: 461). Stable profits in turn allow stable margins for internal financing of investment (Melmiès 2012).

But once the profit markup is factored into real world prices, the Classical price theory falls apart: prices in the real world are seldom the Classical equilibrium prices derived from costs of production, but the prices for many commodities exceed the costs of production. In the aggregate, the sale price of the aggregate supply of commodities will be well above the costs of production, and so the idea that the “total factor payments received for producing a given volume ... of output are necessarily sufficient to purchase that volume ... of output” before actual purchase is false. It is also false to say that in “real terms, supply equals demand ex ante [= before the event],” if by this one means that aggregate costs of production including wages or purchases of factor inputs will equal the aggregate cost of the output when purchased. The latter – the aggregate cost of the output when purchased – will exceed the total factor payments before sale.

Of course, if one wants to define Say’s law as the idea that the income from aggregate sales plus factor payments is sufficient to purchase that output in a given period, perhaps one can evade this criticism, but the point is there seems to be ambiguity about how Say’s law is defined.

Are total factor payments received for producing a given volume of output defined as ex ante or ex post payments, i.e., before or after the actual sales of those products?


Baumol, W. J. 2003. “Retrospectives: Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham; Northampton, Mass. 39–49.

Gu, G. C. and F. S. Lee. 2012. “Prices and Pricing,” in J. E. King, The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 456–463.

Hunt E. K. and Mark Lautzenheiser. 2011. History of Economic Thought: A Critical Perspective (3rd edn.). M.E. Sharpe, Armonk, N.Y.

Melmiès, J. 2012. “Price Rigidity,” in J. E. King, The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 452–456.

Mill, James. 1808. Commerce Defended. An Answer to the Arguments by which Mr. Spence, Mr. Cobbett, and Others, have Attempted to Prove that Commerce is not a Source of National Wealth. C. and R. Baldwin, London.

Sowell, T. 1994. Classical Economics Reconsidered. Princeton University Press, Princeton, N.J.

Thweatt, W. O. 1979. “Early Formulators of Say’s Law,” Quarterly Review of Economics and Business 19: 79–96.

Monday, December 10, 2012

Rise of the Robots?

Yes, this is already the title of a recent post by Krugman here:
Paul Krugman, “Rise of the Robots,” December 8, 2012
I have to say I feel rather vindicated, since I made similar points over two years ago in this post:
“Automation and Robotics: The Future of Manufacturing?,” September 12, 2010.
Krugman notes that the strong trend towards industrial automation is good news for American manufacturing. Indeed, it is, and we can expect to see some return of manufacturing to the US and Western nations from East Asia and other developing, low wage countries. As Krugman says, robots “mean that labor costs don’t matter much, so you might as well locate in advanced countries with large markets and good infrastructure.” This means that the US should see a fall in its unbalanced trade deficit with other nations.

But what about the possible problems it will cause? Firstly, I want to qualify everything I say below with the clear statement: I do not oppose the trend to automation; I welcome it. Labour saving machinery was the key to the industrial revolution and the many increases in productivity growth we have seen over the past two centuries. The problem is that a new era of mass automation requires macroeconomic policies to deal with its perverse negatives consequences.

The media already reports that some economists think mass automation might not necessarily benefit everyone, but the analysis there is poor because it is based on the fantasy of neoclassical general equilibrium models.

In contrast, Krugman focuses on the implications for income distribution: away from workers to capital. First, the wealthy have a lower marginal propensity to consume (or alternatively a higher marginal propensity to save), and they are likely to buy financial assets on secondary markets with their extra money, not final goods and services.

Secondly, America and many Western nations already have a chronic unemployment problem, which, without proper fiscal expansion, will continue for years. What will happen when that persistent unemployment problem is exacerbated by large-scale structural unemployment owing to mass automation in industry?

Factors (1) and (2) above already strongly suggest a serious aggregate demand shortfall in the future. Keynesian demand management and income distribution are going to be more important than anyone ever dreamed. Government must step in and provide employment programs or funds to employ those who are unemployed and who seek employment. (In fact, structural unemployment induced by technology was already a problem in the 19th century and even as strong a defender of laissez faire as Jean-Baptiste Say – the inventor of Say’s law – advocated public works as a solution to such unemployment. See Appendix 1 below.)

No doubt additional jobs will be created in new private businesses, but it is unlikely to be enough. Free markets do not guarantee full employment, nor does Say’s law work. Employment in tradable goods and services in many countries will probably fall dramatically. Our employment future will probably be mainly in services, education, and most probably in employment programs funded by government or in government-sector jobs. There will probably be a great reduction in the hours that people need to work as well and more leisure.

It might well be that much of the government-funded labour force will be in education (e.g., universities), sciences, research and development, or other services. I suspect a much greater labour force working in basic sciences and applied R&D would mean a much more rapid advancement of science and technology too – a virtuous circle.

As we move down the route of radical automation in the course of this century, equally radical Keynesian demand management will be necessary to maintain demand for goods and services, income equality, and continuing rises in living standards.

Some other points that occur to me as an afterthought:
(1) Eventually automation and structural unemployment will affect even services. Artificial intelligence is not far fetched, and it is undoubtedly the way of the future. Already when you ring some companies you can find voice recognition software doing the work of people.

(2) Perhaps we will see a very strong deflation in the prices of many industrial goods, especially those where at present high wages are a major factor input cost.

(3) Some more relevant news and commentary here:
Paul Krugman, “Robots and Robber Barons,” December 9, 2012.

Christopher Matthews, “Can Robots Bring Manufacturing Jobs Back to the U.S.?,”, September 27, 2012.

Will Knight, “This Robot Could Transform Manufacturing,” MIT Technology Review, September 18, 2012.

Vivek Wadhwa, “The End of Chinese Manufacturing and Rebirth of U.S. Industry,”, 23 July, 2012.


In his discussion of the introduction of labour saving machines, Say recognised that this would create short term unemployment, and in a footnote actually advocated public works spending by government:
“Without having recourse to local or temporary restrictions on the use of new methods or machinery which are invasions of the property of the inventors or fabricators a benevolent administration can make prevision for the employment of supplanted or inactive labour in the construction of works of public utility at the public expense as of canals, roads, churches or the like …” (Say 1832: 87).
This must come as a shock to Austrians and libertarians who so frequently cite Say’s law with approval.


Say, J. B. 1832. A Treatise on Political Economy; or, the Production, Distribution, and Consumption of Wealth (4th edn; trans. C. R. Princep and C. C. Bibble), Grigg & Elliott, Philadelphia

Sunday, December 9, 2012

Paul Davidson on the Keynes Solution

A great talk here from Paul Davidson, a leading American Post Keynesian and the editor and co-founder of the Journal of Post Keynesian Economics.

A good introduction to Post Keynesian theory and an analysis of the current economic malaise.

Did Keynes Hate Saving?

The cry often goes up that Keynes “hated saving” or “crafted a theory that condemned living for tomorrow and deferring gratification”.

These strange characterisations of Keynes and Keynesian theory seem to stem from an inability to separate micro from macro phenomena.

On the micro level (that is, in terms of the individual) did Keynes hate saving? I doubt it. Even though one does find talk in Keynes’s writing of the hoarding of money as an immoral thing (Keynes called money saved but not spent on capital goods investments “idle funds” or “hoards”), this was really about the macroeconomic effects of aggregate saving of money without investment (if anyone can find references in Keynes’s work to individual saving/hoarding as bad or immoral per se I would like to see such references).

But most obvious way to approach the question whether Keynes hated saving in terms of the individual act is to ask: did Keynes spend his life as a spendthrift, spending every pound he ever earned? Did he die a pauper with no, or little, savings?

Not exactly: Keynes’s net worth in 1945 was £411,238 (Moggridge 1992: 585) and according to Skidelsky (2000: 479) after his death (on 21 April, 1946) his net wealth was £479,529, about £400,000 in securities alone.

In inflation-adjusted 2011 pounds (in terms of goods and services) £400,000 would be roughly the equivalent of £13,745,000. After 1929, Keynes’s investments included car company shares, gold shares, American utilities and aircraft stock.

Was a man who died with a net worth of about 13 million pounds a person who hated saving? Clearly not.

Meanwhile, there is no doubt that Keynes was concerned about the macroeconomic effects of saving when it was not matched by an equal amount of investment. This was his criticism of neoclassical economics (what he called the “classical theory”): Keynes questioned the neoclassical belief that savings and investment are automatically equilibrated.

He saw negative effects on output and employment from an increase in savings unmatched by sufficient investment.

There is no contradiction in saying that saving is good and beneficial to individuals (at the micro level) and that people will clearly need to save in the course of their lives, but at the same time that saving can possibly be deleterious in its macroeconomic effects in some circumstances.

The macroeconomic reality is that strong government spending to create and maintain full employment and economic prosperity actually helps many individuals to save for the future. That is to say, saving as a micro phenomenon of benefit to individuals will be strongly aided and increased by Keynesianism, not hindered.

It is rather easy to prove this. All we have to do is look at the historical data for the US personal saving rate:
The data in this graph begins in 1959. During the last years of classic Keynesianism in the US (1946–1973) the saving rate seems to have been increasing. At any rate, the historical average for the 1946–1973 period was between about 8–10%; certainly the savings rate was stable in this period, not falling.

Then after full employment and Keynesianism were abandoned in the late 1980s and the revived neoclassical economics infected policy makers and central banks, the savings rate plunged – and spectacularly so in the 1990s – as people were driven into private debt as real wages fell under neoliberalism, and the plague of speculative asset bubbles hit the economy.

Why did the savings rate fall so sharply after about 1985? The reason, I think, is that the effects of the fall in real wages that began in the 1970s (itself a function of neoliberal policies) started to be felt and people had to dip into their savings to maintain living standards. But this is not the only reason, of course. Part of the reason might be reduced income uncertainty as married women entered the workforce from the 1970s and 1980s (and families had more security from having two incomes, although this was itself partly a function of the fall in real wages).

But the most important reason in my view was the explosion in the availability of easy credit as financial institutions were deregulated after about 1980. Lending standards fell, and it became much easier for households to run up debt for consumption, and as a solution to their money problems. But this created the perverse effects that savings could be drawn down even more for spending (in the expectation of more credit to deal with the debt load) and then as an effect of the need to service a much greater burden of personal debt.

The neoliberal economic model was one that substituted private debt for Keynesian public spending as the engine of growth in Western economies.

The results are now here for all to see:
(1) the huge unsustainable asset bubbles in the 1990s and 2000s,

(2) the vast private debt to GDP ratios,

(3) the financial crisis of 2008,

(4) the subsequent crisis of deleveraging and debt deflation (or what Richard Koo calls the “balance sheet recession”), and

(5) the continuing and general economic malaise with high unemployment, because not enough has been done to fix the private debt crisis. Furthermore, the need for large-scale public investment spending to help the private sector delever (and to provide employment and income) is unmet.
So, if we want to blame anything for the collapse of the US personal saving rate after about 1985, it is neoliberalism, not Keynesian economics.

Keynesianism actually allowed a stable – possibly even a rising – personal savings rate.

And Keynes – far from hating saving – saved a lot of money in his time!


Moggridge, D. E. 1992. Maynard Keynes: An Economist’s Biography. Routledge, London.

Skidelsky, R. J. A. 2000. John Maynard Keynes: Fighting for Freedom, 1937–1946 (vol. 3), Penguin Books, London.

Revolution in Energy Production Imminent?

Apparently it is, or, at least, according to this article on the price revolution in extraction of oil and gas from shale owing to horizontal drilling and fracking:
Nigel Lawson, “Thought we were running out of fossil fuels? New technology means Britain and the U.S. could tap undreamed reserves of gas and oil,”, 7 December 2012.
The really important news:
“[sc. it] ... emerged a few weeks ago that the U.S. will overtake Saudi Arabia as the world’s largest oil producer in 2017.

America is already the world’s largest natural gas producer, and it is estimated that, by 2035, almost 90 per cent of Middle East oil and gas exports will go to Asia, with the U.S. importing virtually none.

For decades, the West in general, and the U.S. in particular, has had to shape, and sometimes arguably to misshape, its foreign policy in the light of its dependence on Middle East oil and gas. No longer: that era is now over.

For decades, too, Europe has been fearful of the threat that Russia might cut off the gas supplies on which it has relied so heavily.

No longer: that era will very soon be over, too. Thanks to the shale gas revolution, the newfound energy independence of the West is a beneficent game-changer in terms of world politics as much as it is in the field of energy economics.”

Deck the Halls with Macro Follies: When Economics is Reduced to Farce

... In this video, which, I admit, has some value as humour, though not anywhere near as much as the earlier Keynes versus Hayek song. The trouble is that the producers think they are making some serious points against Keynesianism, when all they do is attack a caricature of it.

Despite what is said, consumption is part of a healthy, expanding economy, but Keynesianism has always been concerned with private investment. As I have said, the major Keynesian method to restore the health of an economy historically has been stimulus programs that take the form of public infrastructure/public investment.

Saturday, December 8, 2012

The Essence of Keynesianism is Investment

There is much talk at the moment from libertarians who misrepresent Keynesianism. They reduce Keynesian theory to a caricature version which, they say, supposedly only, or mainly, focuses on consumption.

This is not true, and there is a simple antidote to such caricatures of Keynesianism. It is available in (of all places!) an “Austrian Economics Newsletter” of 1983, where George L. S. Shackle summed up the essence of Keynes’ theory. I reproduce it here:
[sc. Keynes’s] ... theory of involuntary unemployment is perfectly simple and can be expressed in a paragraph, or in a sentence. If you express it in a sentence, you simply say that enterprise is the launching of resources upon a project whose outcome you do not, and cannot, know. The business of enterprise involves investment, the investing of large amounts of resources--huge sums of money--in things whose outcome you cannot be certain of, which could perfectly well turn into a disaster or a brilliant success.

The people who do this kind of investing are essentially gamblers and they can lose their nerve. And if they decide to withdraw from trade, they sweep their chips up from the table. If they decide it’s too risky, if their nerve gives out and they can’t bring themselves to go on investing, they cease to give employment and that is the explanation.
When business is at all unsettled--when there’s any sign at all of depression--or when there’s been a lot of investment and people have run out of ideas, or when their goods are not selling quite as fast as they have been, they no longer know what the marginal value product of an extra man is—it’s non-existent. How can you say that a certain number of men have a certain marginal productivity when you can’t know what the per unit value of the goods they would produce if you employed them would sell for?”

“An Interview with G.L.S. Shackle,” The Austrian Economics Newsletter, Spring 1983.
This is actually a splendid summing up of what Keynes’s theory is about: rises and falls in the aggregate level of investment.

There are many things that affect the level of that investment, but a crucial one is the expectations of people make the investment decision. Their expectations are, in the end, subjective.

When investment collapses the question then becomes: how can that private sector investment be restored? Is there a substitute for it in the meantime to increase employment, income and output?

The answer is yes. And consumption is certainly one factor, but not the only one. In fact, the major Keynesian method to restore the health of economies historically has been stimulus programs that take the form of public infrastructure/public investment.

Steve Keen on the Fiscal Cliff

Steve Keen talks here on the fiscal cliff and the risk of a renewed crisis of deleveraging and debt deflation in the US. The talk was arranged by Dennis Kucinich.

Monday, December 3, 2012

Steve Keen on Debt in Neoclassical Economics

Another talk from Steve Keen, and this time given in Berlin (1 December, 2012).

This talk examines the issue of debt in a capitalist economy, and loanable funds versus endogenous money theory.