By Doug Gentry, on September 12th, 2011
 Say’s Law or Keynes’? If we can peel away the political posturing, there is an important argument in the issue of how best to generate a recovery in our country’s economy. Put simply, the question is whether producers (employers) are the answer and we should do everything we can to encourage them, or whether we should do something to encourage demand for their products.
Jean-Baptiste Say gets naming rights for the law that says that production will encourage demand and thus more production. Proponents of Say’s Law argue that producers can ramp up production which will in turn foster demand for those products, and that demand will flow to greater production elsewhere. The law assumes that business will not hoard capital funds, but will invest them in greater production. In today’s dialogue, when we hear calls to reduce business taxes or relieve business of the uncertainty or burden of government regulation, it is the ghost of Say who is speaking. This position holds that unfettered business will invest in more production and growth, and that will, in turn, generate new jobs and economic opportunity. It is roughly accurate to put the label of supply side economics with this group.
In the other corner is John Maynard Keynes. Keynes argued that the economy depends on the demand for goods and services, and that when necessary the government should encourage that demand through added spending or tax cuts. Keynes felt that encouraging demand, by placing more money in the hands of consumers, would stimulate businesses to ramp up production, which in turn increases employment. Today, Keynesian proponents argue for more government spending, and broad based tax cuts (not the kind of cuts targeted only at businesses).
Both approaches have some grounding in economic theory. The Keynesian approach has a better track record in real life, and there are signs in our current, sluggish recovery, that business is not following the assumptions built into Say’s Law. When President Hoover was faced with the early years of the Great Depression, his advisers followed the main stream economic thinking of the time, which was Say’s Law. In addition, main stream economic thought in the late 1920s/early 1930s felt that the economy was naturally cyclical and would eventually mend itself. Hoover pressed his political base, the producers and manufacturers, to ramp up production. They would have none of it. President Roosevelt took his cue from Keynes’, adding government spending and employment to Federal policy, as a way to pump money into the hands of consumers, which then increased demand for goods and services. For the Great Depression, the Keynesian approach seemed effective while the Say’s approach was not.
Today, many commentators note that corporate America is sitting on large cash reserves, and that they are waiting for consumer demand to strengthen before investing in more production or growth. If that is the case, then more business tax cuts or incentive programs are not likely to speed up the recovery.
As students and citizens, we will do well to consider the conflicting economic theories at work here, and ignore the emotional baggage that hinders civil dialogue.
By Doug Gentry, on April 29th, 2011
Freidrich Hayek and the Austrian school of economic policy argue for a laissez faire approach to the economy – emphasizing individual actions and criticizing government intervention. John Maynard Keynes acknowledged that economies could, over time, correct themselves, but argued that government had a responsibility to intervene and stimulate demand when the economy is in a slump. This video is a sequel to Fear the Boom and Bust, also produced by Econstories.tv
For my students, see how many of today’s economic issues you can find in this video and compare them to our look at the Great Depression.
By Vipin Veetil, on June 25th, 2009
In the Times of India I hear is all about “infotainment”, with more information less entertainment in economic times. So as far ET columnists go hardly can one hold them the standards of an academic debate, loose ends are quite natural. But what about sheer inconsistency, or gross error?
Swami ET article today is titled “Beware: Recession maybe Hayekian”. My faint smile on reading the title soon disappeared when I read this
“The current recession looks more Hayekian than Keynesian. A Keynesian recession represents a sudden fall in demand, and can be remedied within six months by pumping enough purchasing power into the economy. A Hayekian recession, however, is caused by misallocation of resources over a long period, driven by unrealistic interest rates, ending in a bust that requires years of structural adjustment. Such a recession can last a decade (as in Japan in the 1990s)”.
Swami goes on to argue that many a crises have been Keynesian and successfully solved by government spending. My contention here is not that Keynesians are wrong, that point I have already made. But that one cannot argue that some recessions are Keynesian others Hayekian!
The Hayekian method involves a complete reject of the aggregate demand and supply framework. Hayek rejects and warns us against the very idea of “capital” as a homogenous commodity at the very beginning of “Pure Theory of Capital”, turning our attention to the structure of capital in a system of production.
Moreover Swami makes no mention of why there might be a fall in aggregate demand in the first place to cause a Keynesian recession. And since we are talking about a Keynesian syndrome, the cause must be independent of central bank policies. For people like Krugman, Stiglitz the cause may lie in “animal spirits”, which is consistent with their political philosophy. But what about Swamy who won the Bastiat Prize.
Also note that though he says this recession is Hayekian, there is no mention of “central banking”, “centrally determined price of capital”, etcetera.
Infotainment is all good, but an article with absolutely no academic grounding is a real pity. And I am not entirely sure whether such writing does Austrian economics and libertarian politics any good. Your call.
Also read my earlier critique of a Swami ET piece here.
And another incorrect portrayal of Hayek by Meghnad Desai (he offered a Marx-Hayek solution to US crisis) here.
By Vipin Veetil, on February 6th, 2009
The eventful happenings of last year or so have not only unleashed a crisis on the world economy, but also unveiled what is probably an even greater problem – a crisis within economics itself! In the two decades or so before 2007, the primary proponent of anti-Keynesianism within the mainstream tradition was the Rational Expectations School (RES). Lucas, Prescott, Sargent et al, were the “best” macroeconomists, and their work is the staple diet of masters and PhD programs.
The basic idea behind RES is that “perfectly rational individuals” with “complete information” will react to government policies by adjusting their own behaviour, thus nullifying its impact. So for instance, if government increases its expenditure (fiscal stimulus), people will figure that taxes will go up in future since government is incurring a deficit which will have to be reduced later, so the net effect is 0.
There are of course various ways to contest the broad idea. But at the moment, policy makers have ignored the rational expectations guys on the simple grounds that their assumptions are entirely “unrealistic”. And this brings us to the bigger issue of what was the point of spending so much time and energy in deriving the results of RES, of teaching it around the world, if it is of no use when the we get an economic crisis. A compass is useful because it points to the north! Check out what RES has to say now here.
The Austrians have of course been doing much better. Within the Austrian Business Cycle Theory the present crisis originates from the low interest rate policy followed by Fed in the post dot com bust scenario. Natural rate of interest is the rate at which two individual will voluntarily be willing to lend and borrow from each other.
There is no such thing as “the” natural rate of interest, but many such rates. But let us for analytical ease assume there is one such rate, and its 5%. When a central bank (RBI did this too) fixes the rate at say 3%, we get two problems.
1. How to produce?
Entrepreneurs begin to investment in more long term production facilities, since the same quantity of monetary resources can now fund longer term projects. So I can begin building a factory which will take 10 years to complete and 10,000 tons of steel at 3% interest, but would have had to build a factory which takes 6 years to complete and uses 70,000 tons of steel at 5% interest. In other words, the time structure of production is artificially skewed.
2. What to produce?
Many goods which would have been unprofitable to produce at 5% interest, become profitable at 3%. In the very short term, low interest lowers cost of production but prices of final output remain the same. So we get goods which would not have been produced under natural conditions. At 3% households are saving less than at 5%, entrepreneurs are borrowing and investing more than at 5%. Less savings mean more consumption. More consumption and more investments pull the economy in opposing directions, we get inflation, central bankers panic, interest rates are hiked (remember the last months of the Y V Reddy regime), many projects become unfeasible because of rising cost, recession!
Note that since the cause of the crisis is misallocation of resources, we would like economy wide churning. Firms must readjust production processes, some firms will have to reduce employee count, these people will then be employed elsewhere (the time lag between the two registers a high rate of unemployment), some firms will have to shut down, other firms will have to produce new products (less luxury villas, more apartments for instance), and so on. And soon enough we will be back to a rather normal state of affairs.
Not understanding this process is the root cause of many dangerous proposals floating around in the press. Take A. K. Arun’s Economic Times article for instance, he says,“What is rational for individual enterprises could spell gross irrationality at the level of the economy. Job cuts at a large number of companies in the wake of the slowdown, is a good example of this phenomenon. As individual companies try to cut costs and reduce the impact on their bottom lines by laying off workers, the cumulative result is to depress demand for what all companies produce in the aggregate. This accelerates the slowdown, and releases further pressure to cut costs. There must be intervention at the macro level to stop this vicious cycle.”
Any government intervention will only further delay the process of economy wide churning which is the only way to recover with or without a fiscal stimulus. Arun proposes “a tax break for companies that do not lay off staff”, and says the tax break itself maybe a certain percentage of a firms “wage bill”. So we have an economy where there is been gross misallocation of resources, plenty of capital is been destroyed (10 year factories will have to be torn down, 6 year ones build), and instead of encouraging firms to become more efficient, employ least cost methods of producing goods so that there are more resources available for economy wide reconstruction, we encourage firm to increase wage bill, i.e. increase cost!
In fact what we really need is more savings, and it’s a good thing that household reduce consumption and increase savings during recessions, we need more resources to restructure production. But its not just Arun’s article really, the problem is with the whole of Keynesianism which is pretty much just the 20th century name for mercantilism!
By J.D. Seagraves, on January 14th, 2009
To partisans of the Austrian theory of the business cycle, the cause of the current financial crisis is as plain as day — and that’s why we’ve been predicting it for years. You would think that the neo-Keynesians, monetarists, and Marxists who made fun of us Austrians in 2006 and 2007, and said we’d never have a housing meltdown and financial crisis exactly like the one we’re having now, would come over to our way of thinking — or at least acknowledge that we were right in this one case. But instead, they continue to make fun of us and deride the gold standard as “quackery.” Have they no shame?
Apparently not. And it shouldn’t be surprising. After all, followers of non-Austrian schools are practitioners of non-reality based economics. To them, economics is a religious faith. Since everything is make-believe, they can just pretend that the Austrian school didn’t predict this crisis years ago and that they weren’t poo-pooing those predictions. They can pretend that the Phillips Curve has validity and that stagflation is impossible. They can even delude themselves into thinking that Herbert Hoover was a laissez-faire “do-nothing” and FDR’s New Deal “got us out of the Depression” — or worse yet, that war is good for the economy!
Believing in any of these bogus ideas is akin to medieval doctors practicing the humoural theory of medicine. It was the official doctrine of the church, and therefore, it was accepted even when it was clearly false. Today, the state has replaced the church and Keynesianism is the official state religion.
Why don’t more economists recognize the reality staring them in the face? Well, for one, they’re educated in government-controlled schools. Only two universities in the entire United States do not accept federal money, and as central banking and fiat money are vital tools of Big Government, little else is going to be taught. What’s more, over 50 percent of professional economists in the United States work for the government, with 32 percent working directly for the feds. How can we expect economists to be objective on the question of central banking when their paychecks are monetized by the Federal Reserve? Heck, a huge share of the world’s economists are employed directly by central banks!
So it’s no surprise that “respected” economists — propagandists, really — are pro-Fed. Only one central-banking critic has ever won the Nobel prize: F.A. Hayek of the Austrian school. The greatest economists of the 20th century — Ludwig von Mises and Murray Rothbard — never got the recognition they deserved. But as the predictions they made continue to come true, one has to wonder how long the general public will maintain its faith in the high-priests of economic voodoo that dominate the economics profession.
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