Sunday, March 16, 2014

Mises Meda: Why Your Grandfather's Economics Was Better Than Yours

For much of Steven Kates career he was the head economist for the Australian Chamber of Commerce. In this capacity he had to present the case for Australian business in contrast to the labor arguments for higher wages. This work influence much of his thinking on economics and led him to the viewpoint that modern Keynesian  economics is flawed compared to classical economic thinking.

National wage case – At one point something like 90% of wages in Australia were determined by a central body, the Australian Industrialization Commission.

Businesses would go before the commission and argue against raising wages and unions would argue for raising them.

One of the arguments that unions would put up was that you should raise wages in order to stimulate demand.

Steven Kates put together the business case against this argument that this really did not make sense: You cannot stimulate demand by taking money from business giving it to someone to spend and have those people spend money in your business as if you are better off for it. You simply cannot create demand by taking money out of someone's pocket and giving it back to them.

Kates read John Stuart Mill and he came across exactly the same argument:

It is not necessary, in the present state of the science, to contest this doctrine in the most flagrantly absurd of its forms or of its applications. The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be "like the dews of heaven, which return again in prolific showers." It is no longer supposed that you benefit the producer by taking his money, provided you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasonings of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided he expends it all again at the same shop, is a benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman's fortune.  

Library of Economics and Liberty - Of the Influence of Consumption on Production by John Stuart Mill

This essay by Mills in 1844 was part of a culmination of a great debate in economics General Glut Controversy. - The General Glut Controversy

In 1803, Jean-Baptiste Say examined, in his book, the evolution of trade between Great Britain and Brazil. He realized that the only way for Brazil to buy British goods was to supply Brazilian goods to Britain in order to obtain the sterling necessary to demand English goods. Say extended this to a single economy in claiming that a demand for a particular set of goods can only be expressed by an equivalent supply of another set. An easier example can make this clearer: how does a shoemaker get hats? He can either make them himself (which he really has no skill or knowledge to do at low cost) or he can simply make more shoes and exchange them for hats. Supply, therefore, "creates" demand.

Almost all of Classical and most Neoclassical theory, is based, to a lesser or greater degree, on this simple, even tautological, assertion. In a simple shoe-hat world, at any one time, three possible situations may arise: (1) there may be a sufficient amount of shoes and hats to satisfy all demand; (2) there may be too many shoes offered on the market - implying too great a demand for hats; and (3) there may be too many hats and not enough shoes. Situations (2) and (3) are situations when markets have not made precise the allocations. However, the essence of Say's Law is that there can never be too much of both shoes and hats. A shoemaker would not make more shoes if he did not desire more hats. Therefore, Say's Law concludes, general gluts cannot exist.

It turns out that the wage case that Kates had been making was the same argument used by Mills and they both relate to Say's Law:

Investopedia - Say's Law

An economic rule that says that production is the source of demand. According to Say's Law, when an individual produces a product or service, he or she gets paid for that work, and is then able to use that pay to demand other goods and services.

Kate argues that Say's Law says that high levels of public spending do not encourage industry. Nowadays, people are so inundated with Keynesian theory that they tend to just assume that government spending is good for industry but way back in 1844 they knew that this was not so. Spending in and of itself does not create growth and employment. You cannot make an economy prosper through expenditure but only through value adding production. Demand does not drive and economy forward and neither does demand deficiency cause recessions.This was the very core of what John Stuart Mill was arguing in 1844. It was an argument that was generally accepted by economist all the way up until Keynesian economic replaced it in 1936.

The Keynesian economic revolution in the 1930's dismissed Saye's Law. Keynesian economics was revolutionary because it was meant to be a refutation of Saye's Law. While Keynes claimed that he came up with the ideas for the General Theory himself, he actually got his ideas from reading Malthus.

Keynes was the most famous economist of his day. His fame stemmed from his book, The Economic Consequences of the Peace.

Like Keynes, Malthus was the most famous economist of his day. His fame stemmed from his essay, An Essay on the Principle of Population. - General Theory

The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo's doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of effective demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas.

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