September 8th 2011 – A New Direction or More of the Same?

on Saturday, 03 September 2011. Posted in Chris Clancy

John Maynard KeynesOn September 8th President Obama is going to make a speech. The content of that speech is going to have a profound effect on all of us, one way or the other.

If it’s a new direction then we have some hope.

If it’s “more of the same” we pass the tipping point.

This essay tries to explain why “more of the same” should not be an option.

This means writing about the dreaded ‘K’ word — KEYNESIANISM!

But please! Don’t stop reading at this point. I promise I won’t launch into economic-speak. I’ll keep it descriptive and only use one simple formula.

OK?

Right — here goes.

Keynesian economics has been with us for a long time.

A question comes to mind immediately. How could something so fundamentally flawed have lasted for so long?

It’s an interesting question.

It’s not as if it didn’t have its critics. It did. But up until a few years ago they were few and far between.

Now it’s rampant.

“One of the greatest naiveties upheld throughout [the current] episode consisted in the thinking that reckless spending and budget deficits, when they occurred in third-world countries, were a sign of irresponsible government, but that somehow when adopted by developed countries it became "fiscal stimulus."

We are now witnessing the failure of Keynesianism on a grander scale than has ever been experienced — never before has the impotence of Keynesian policy been demonstrated so comprehensively. … [I]t is clear that the undoing of Keynesian economic theory is now complete and unequivocal, and one of the greatest frauds ever perpetrated on the public under the guise of economic science has finally been put to rest.” David Lee.

Strong stuff.

Its popularity was probably due to the fact that it was, on an intuitive level anyway, so accessable. The circular flow of income, with its injections and leakages etc., all seemed so straight-forward, so simple and so obvious.

Almost seductive.

You can even sum it up in a formula.

Y = C + I + G + (X – M)

For the purposes of this essay let’s dispense with the pesky (X – M).

Which leaves us with this little minx:

Y = C + I + G

It’s just a tease really — it shows a bit of leg but that’s all — it flatters to deceive.

So what does it say?

Well, in plain English: Y represents total spending in the economy. The higher this figure the more people who should be employed.

It’s value is determined by adding three other totals together: consumer spending (C), investment spending (I) and government spending (G).

So how does the thing work?

Well, let’s use an example. Assume the economy is in a position where everyone who wants a job, and is able to get a job, has got a job.

Economically speaking everything is hunky dory.

Now assume that, for whatever reason, spending by the great unwashed, C, falls. This means less demand for goods and services, which means less people are needed to provide them, which in turn means jobs are lost. If C falls then Y must also fall.

Things are no longer hunky dory.

So what can be done to remedy the situation as quickly as possible?

Step forward the government.

According to the formula they have to increase G by enough to compensate for the fall in C.

So all the government has to do is replace the money which has leaked out by shoveling an equivalent amount back in!

Once this is done Y is restored to where it was before, jobs are restored and everyone is happy.

Job done?

No.

Not quite … in fact, not at all.

This kind of economic thinking is not just naive and ignorant in the extreme – it is absurd!

Yet this, in essence, is what is meant by “stimulus spending”.

Which brings us to the first major flaw in Keynesian economics. It ignores the incredible and unbelievable complexity that makes up an economy.

No one person, group or organization can ever effectively plan an economy — it is an impossibility.

In his classic essay, I Pencil, Leonard Read takes the simplest object he can think of to illustrate this point. And he does so brilliantly.

Keynesian economists treat an economy as if it were a machine of some kind. All you have to do is “fix” the bit that’s broken. There’s no time dimension. Their analysis is static, like pieces in a jigsaw — sunk in concrete.

They think everything can be reduced to Y = C + I + G !

By contrast, Austrian economists regard it as being more like an ecosystem. It is dynamic — left alone it evolves over time — it finds its own balance. Interfere with it and a series of chain-reactions are set off. How long, how far, how wide and how deep they go is simply unknowable.

“In the real world the question may come down to whether we should accept a couple of years of painful market adjustments or decades of recession caused by the blunt instrument of politics. Devastating unintended consequences and unseen effects will follow government attempts to clean up a mess made in great measure by its own hand. Why? Because no one possesses a God’s-eye view of the economy. Government intervenes within the system as part of it, not from outside of it. Nor is the economy an instrument to be manipulated to positive effect—at least not over the long term. That is why Keynes got it so terribly wrong and why the economy must heal itself from within in a distributed, holistic way.” Max Borders.

In other words, there’s no “quick fix”.

Which brings us to the second major flaw in Keynesian economics.

It focuses its attention on consumer spending, C.

Why?

Because they tell us that C is the largest component of total spending — about 70 percent — and as such this is what drives an economy.

“The truth is that consumer spending is not the mainstay of the U. S. economy. Investment is. Business spending on capital goods, new technology, entrepreneurship, and productivity is more significant than consumer spending in sustaining the economy and a higher standard of living. In the business cycle, production and investment lead the economy into and out of a recession; retail demand is the most stable component of economic activity.” Mark Skousen.

To return to the machine analogy, it’s like trying to fix the thing by repairing the wrong part!

Skousen continues:

“Granted, the ultimate function of business activity and entrepreneurship is to fulfill the needs of consumers, and the most successful firms are those that satisfy their customers. But more important, who discovers the new, improved products that consumers desire? Who is the catalyst that determines the quantity, quality, and variety of goods and services? Did the consumer come up with the idea of personal computers, SUVs, fax machines, cell phones, the Internet, and the iPhone? No, these technological breakthroughs came from the genius of creative entrepreneurs and the savers/capitalists who funded their inventions.”

He puts it very well.

Instead of “more of the same” the government needs to get out of the way and let the private sector do what the government cannot do — create real jobs.

We await with trepidation the words of the President on September 8th.

Chris Clancy lived in China for seven years. Most of this time was spent as associate professor of financial accounting at Zhongnan University of Economics and Law in Wuhan City, Hubei Province. He now lives in Thailand where he spends his time reading, writing, lecturing and, whenever he gets the chance, doing his level best to spread Austrian economics.

Copyright © 2011 Chris Clancy. Used with Permission.

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