Even the Keynesian version of Say’s Law, that “supply creates its own demand”, gets you at least towards the core idea. More accurately, and using the language of the classics, it is “demand is constituted by supply”. To buy something you must first produce and sell something. The selling is what gets you the money, but the production of value adding output is what first allows you to sell. Without value adding activity, there is nothing to sell and therefore there is no basis for demand.
As for Keynes, he argued you could leave out the middle part of the process, that you could raise demand without having first produced something that added value. Just spend and the value adding production will follow. What we are finding at the moment, however, and in every country in the world, is that this is infinitely not the case. There has been plenty of stimulus money spent, but almost none of it has been value adding. The results are massive deficits in every economy that attempted a serious stimulus but with no revenue streams to repay any of the debts incurred. This is just what anyone who understood Say’s Law would have forecast with perfect clarity.
Paul Krugman has written an article for The New York Times in which he discusses how the production of the iPhone 5 will now bring a boost to GDP of something like half a percent. It may or it might not, but that’s not my issue. It is that he uses the production and sale of a very much value adding item of technology to prove that Keynes was right when what he is really doing is proving that Keynes was wrong and that Say’s Law is right. This is what Krugman says:
So is the new phone as insanely great as Apple says? Hey, I’ll leave stuff like that to David Pogue. What I’m interested in, instead, are suggestions that the unveiling of the iPhone 5 might provide a significant boost to the U.S. economy, adding measurably to economic growth over the next quarter or two.
Do you find this plausible? If so, I have news for you: you are, whether you know it or not, a Keynesian — and you have implicitly accepted the case that the government should spend more, not less, in a depressed economy.
Well, I have news for Paul Krugman. Whether he knows it or not, he’s a classical economist. He has argued that when a private sector firm produces a value adding good or service that it adds to economic growth. This is not Keynes, this is classical economics which always looked at economics from the supply side. Keynes’s “innovation”, a disaster of the highest order, was to argue that you could stimulate an economy from the demand side by simply buying things without having had value adding production first.
Krugman should pay close attention to this example, one he invokes himself, to understand what classical economic theory, and Say’s Law in particular, actually said. My Free Market Economics: an Introduction for the General Reader would be just the place for him to start.
Where to get the book: I am happy to see there is some interest in the book but unless you are library, don’t buy the hardback edition. There is a paperback edition and you can can find it on the Edward Elgar website. If you do a search, eventually you come to this:
Kates, S. Free Market Economics
‘A refreshing theoretical counterattack to the established Keynesian world view that has left the West financially overpromised, disastrously broke, and vulnerable to crank ideas. Professor Kates has … read more…
Hardback £95.00 on-line price £85.50
Paperback £29.95 on-line price £23.96
£24 is about $36. I have now been through it for the eighth time with my students since I wrote it in the first semester in 2009 and for the third time since it was published in 2011. And while there were a few gremlins that crept in that have now been fixed, and there are a few bits I might have wished to explain a bit better, it still says what I think needs saying.
I’ve also mentioned this before but I do find its uniqueness the most remarkable part of all. I thought the book would be one of many anti-Keynesian introductory tracts that would be published after the failure of the stimulus but to my knowledge it remains the only one of its kind. As an extra bonus, it is the only book written since 1937 that explains at an introductory level the classical theory of the cycle. If any of you do read it, suggestions for improvements or changes would be very welcome.
The iPhone5 exports would be expected to increase (X-M), which Keynesians classify as stimulatory.
But as I noted in a thread last week, capital flight also boosts (X-M), because of floating exchange rates.
Keynesian analysis simply can’t tell the difference between these two things.
Was going to buy your book but got smashed by the $160 price at Amazon. Is it available in paperback? do you know anywhere cheaper? (I like to hold physical)
Some follow up thoughts:
http://sabhlokcity.com/2012/10/towards-a-theory-of-innovation-2/
Max, that’s also the only reason I haven’t got a copy. To me, this is just plain gouging by Amazon.
And after the last 9 months of not getting my Kindle to work, I finally used it for target practise with a Mini Ruger.
Got it packaged up to send back to Amazon with a rude letter to the “most customer centric company in the world.”
If you have a android phone/e-book reader, google play is selling Kates’ FME for $29…my wife won’t let me buy it until I get through my ‘bargain basement reading list: Lachmann – capital and it’s structure; Wicksell – lectures on political economy; Kirzner – market theory and the price system; Ropke – crises and cycles; Robbins – an essay on the nature and significance of economic science; Haberler – prosperity and depression. All of those e-books I picked up for less than $4 each…
Back on topic…will this gaffe by Krugman be seen as the seminal moment where Keynes fades from view, like the changes between Haberler’s first and third editions of P&D signalled the ascent of Keynes? We can only hope, but I think not. Being the true social democrat he is, Krugman will lie and obfuscate…
No paperbacks in stock on that site Steve.
Scratch that.
Steve said; “Keynes’s “innovation”, a disaster of the highest order, was to argue that you could stimulate an economy from the demand side by simply buying things without having had value adding production first”.
Steve, could you explain how one can simply buy “things without having had value adding production first”?? Keynes was addressing over supply relative to demand.
Tim – suppose he was. How would that explain the need for a stimulus in 2009 when the last thing you would do is describe the problem as it existed then as over supply relative to demand? The classical explanation of misdirected investment and distortions in the structure of production are almost perfect descriptions of what happened.
Here is the original JP Morgan note that Krugman used to build his article. It was written before the iPhone 5 was released and was pretty speculative. JP Morgan based its assumptions on 8 million iPhone 5s sold in Q4 2012. Given that Apple sold 5 million in the first three days (including two to the entropy household), that target may be exceeded.
I made the mistake of looking at the comments on the Krugman article. All about politics rather than the implications from an economic perspective. I remember when I originally read that JP Morgan article thinking that it was a demonstration of Says Law, and thought I might mention it on the open forum for Dr Kate’s interest, but never got around to it. Now I see a Nobel Laurette has a completely different interpretation.
>Now I see a Nobel Laurette has a completely different interpretation.
The sooner people start seeing a Nobel Laureate as an indication of specialisation in a particular field, the better off we are going to be. Just having a Nobel prize doesn’t make one an Oracle.
I wouldn’t necessarily take oncology advice from Barry Marshall, no matter how groundbreaking his work in gastro.
Having a Nobel is just another form of argument from authority, which doesn’t confer magic status on the holder. Especially in the case of Krugman, who just runs a partisan blog catering to his NY audience.
Isn’t this just a case of borrowing from future – hoped-for – production? Bringing forward demand from the future, and hoping that future production will pay for it?
There is no doubt throwing a lot of printed/borrowed money at a market will drive a short burst of sales, as people try and convert the currency into real things. But it will not, does not, cannot turn into long term prosperity. Just look at the extremes – if it works so well, why not give one person in every town a million dollar bonus cheque from the Fed?
Steve, help me out here.
When you have a recession, the economic climate is often framed in terms of declining demand — not just by the Krugmans and Quiggins of this world, but also by companies and banks and industry groups. They’ll say consumer confidence is low, sales are declining, customers are saving not spending. So we’re gonna close stores and cut production, until the cycle returns to normal.
If you add up these sentiments among all, or most, industry sectors, you appear to have something like falling aggregate demand — as in standard 1st/2nd year Macro. What’s wrong with this picture?
How can Say’s Law help us deal with falling consumer confidence in the short-term?
(Just for the record, I’m not much of a believer in Keynesian fiscal policy, and certainly don’t believe the ALP’s bullshit about how they saved the Australian economy following the GFC. But I don’t see a problem with activist monetary policy.)
Piett – The most obvious characteristic of recession is that goods pile up in shops unsold. The question is why. If you think the GFC was caused by a sudden desire to save across the world, you can join the Keynesians in the quest to prove spending those unused savings is all that is now needed to restore growth.
An activist monetary policy, in the meantime, tries that same Keynesian stimulus but this time using an increased supply of money to get people to buy things that have not yet been produced. My best advice to you is to see Chapters 16 and 17 of my book, although if you are more adventurous, you can read the original arguments in the pages of Knut Wicksell (1898) translated into English in 1936. This isn’t a bad summary, though.
Thanks, Steve: Keynes would never have embarked on the 2009 fiscal stimulus programme, as none of the necessary preconditions (eg high and rising unemployment) was in place. He was a monetarist before he became a Keynesian and would have endorsed the steps to taken to safeguard Australia’s banking industry from the Lehman Bros contagion.
“If you add up these sentiments among all, or most, industry sectors, you appear to have something like falling aggregate demand”
It’s most, not all. There is no such thing as a general glut.
New capacity constraints are encountered, which were previously not a problem due to different preferences as expressed by the old prices. Investment is required to move these new constraints outward, to use more of the spare capacity elsewhere.
Perhaps the government or the market could look at why there is falling consumer confidence.
I can think of one reason straight off the top of my head as to why I haven’t bought an iPhone, or any other luxuries, – trying to pay off my house with my savings before the Lying Slapper gets her hands on my money. And she will.
The issue is how much I can get first.
The most obvious characteristic of recession is that goods pile up in shops unsold. The question is why. If you think the GFC was caused by a sudden desire to save across the world …
No, I think the GFC was caused by a bunch of factors related to the US financial and housing markets — including many regulatory mistakes — which then induced a sudden desire to save among a lot of people.
(The desire to save being the product of a crash in the value of their assets, or worries about the future possibility of unemployment.)
You have a better explanation?
An activist monetary policy, in the meantime, tries that same Keynesian stimulus but this time using an increased supply of money to get people to buy things that have not yet been produced.
So monetarists, including real champions of the free market like Friedman, are completely wrong and peddling false economics? Hmm.
It’s most, not all. There is no such thing as a general glut.
2dogs, are you saying this as a matter of empirical fact, or theory, or ideology?
Let’s say, hypothetically, everybody decides to change their time preferences with regard to consumption — consuming less today in exchange for more tomorrow. And let’s say this counts across all types of goods and services.
You’d have a short-term general glut, no?
Of course, how and why such a change in time preference might occur is the difficult question. But if there were a sharp rise in expected future unemployment, maybe it would have that result, as people deferred current consumption in order to build up a financial buffer.
Piett – You think monetarists seek an activist monetary policy? Back to the books, my friend, back to the books.
Steve,
It’s been a while since I did my BEc, and I’m not using the terminology with precision, I admit!
But a quick jump to Wiki suggests a little support for what I was saying (or maybe the page needs a major re-edit!).
Re activist monetary policy, wouldn’t some monetarists countenance it in emergency? After all, Greenspan heavily lowered rates following the Asian financial crisis, and again after the dot-com bubble collapsed.
“Let’s say, hypothetically, everybody decides to change their time preferences with regard to consumption — consuming less today in exchange for more tomorrow. And let’s say this counts across all types of goods and services. You’d have a short-term general glut, no?”
A change in time preferences would mean that capital goods would be favoured over current consumption goods.
This would not be a general glut, but a possible constraint in the production of capital goods and spare capacity in the production of current goods.
“2dogs, are you saying this as a matter of empirical fact, or theory, or ideology?”
Theory.
2dogs, I thought that ‘general glut’ referred only to consumption goods, but I could very well be wrong about that!
If it does include capital goods, there are still 2 issues:
1) You assume that S = I always, leaving out the possibility that S gets shipped overseas or simply hoarded.
2) “Constraint in the production of capital goods” should translate into obvious regional and/or sectoral pockets of low unemployment — the places and/or sectors where capital goods are produced.
There doesn’t seem to be evidence of that in the States, or in Europe. Some places, like Texas, are better than others, but nowhere seems to be at full employment, as Austrian (and Katesian?) theory would predict.
1) You assume that S = I always, leaving out the possibility that S gets shipped overseas or simply hoarded.
When I say there is a capacity constraint, or there is some spare capacity, it may be overseas. Always do the global economic analysis first, then allocate to countries based on incentives. You might have gotten good results doing a one country analysis years ago, but economies are too open now. S=I globally.
“2) “Constraint in the production of capital goods” should translate into obvious regional and/or sectoral pockets of low unemployment — the places and/or sectors where capital goods are produced.”
The exact opposite! This is a capacity constraint – those producing the constrained goods are fully occupied. We need to train more – i.e. “investment” is required in the human capital.
This is a capacity constraint – those producing the constrained goods are fully occupied. We need to train more – i.e. “investment” is required in the human capital.
So those industries would be screaming out for (trained) workers, they’d be poaching staff off each other, universities would be setting up extra courses to train people, with very high employment % for the grads. This would all be quite visible.
If there are such industries in the US or Europe, name them! Healthcare/nursing is the only possible contender I can think of. Everything else still seems to be in the doldrums.
The mining industry was like that here, but that was a special case of feeding off demand from a much bigger country.
Just to deal with your “hoarding” point, if you leave the money in the bank, the bank needs to find somewhere to invest it. Business lending gets expanded. Capital goods get purchased.
Even stuffing notes under the mattress has the same result, as notes are central bank liabilities, and central banks hold reserves in respect of them.
Just to deal with your “hoarding” point, if you leave the money in the bank, the bank needs to find somewhere to invest it. Business lending gets expanded. Capital goods get purchased.
Well, unless the banks just hand the money back to the central bank, because they can’t find suitable lending opportunities, as is apparently the case with around US$1 trillion at the moment.
http://upload.wikimedia.org/wikipedia/en/8/81/EXCRESNS.png
“If there are such industries in the US or Europe, name them!”
Okay, I need to make a distinction here between the GFC slowdown, from which there was some recovery, and the new slowdown which is emerging now in 2012.
I’d suggest that commodities generally fared well in the GFC as people sought that which was “real” instead of “paper”. Australia has an easy GFC not only because of sound banks but also because we are mostly a commodity producer. Salaries of, say, resource geologists skyrocketed , and there were notable capacity constraints at our ports.
It should be noted that an awfully large amount of the redirected investment of the GFC slump went to the developing world, which is why I am not inclined to even discuss the US or Europe.
I am having trouble discerning the constraints on the 2012, because I’m not sure what the new developing world wealth is looking to buy.
Saying the GFC caused a general rise in savings – while true – overlooks the fact that there was (and is) a lot of wealth destruction as well. Asset prices of all types changed quite quickly. I would argue that this had more of a dampening effect than solely the increase in savings.
The real question here is : it’s obvious that human behaviour moves in crowds and is chaotic in nature. Therefore, the idea that ups and downs in the economic cycle can be smoothed out is wrong, because it assumes a smoothing out of human behaviour.
Piled up savings may dent current demand and current production, but rebuilding of balance sheets is essential for growth to be experienced again. The continual avoidance of recessions by paying it forwards with artificially low interest rates is not a long term strategy. Keynes knew this, that’s why he copped out with the non-answer ‘we’re all dead’ – in other words – not my problem, mate.
“Well, unless the banks just hand the money back to the central bank, because they can’t find suitable lending opportunities, as is apparently the case with around US$1 trillion at the moment.”
Well, if they’re handed back, the central bank would credit a depository account like an ES account, and the central bank would also need that to be covered by securities in reserve.
In better circumstances, it would be finding itself hard pressed to find good securities with so much in deposits. The RBA was in that situation around 2005 and it had to start buying mortgages on what they called “REPO” – repurchase obligations.
But that was when we had budget surplus.
It is a tragedy that with all that money is going into the US Fed, that there are still US govt bonds to be bought with it. So much US govt debt has been created that the Fed can just keep buying it and not think about investing anywhere else.
“Therefore, the idea that ups and downs in the economic cycle can be smoothed out is wrong”
I am inclined to disagree somewhat. The downs involve reorganisation around new constraints. Governments can assist in this process by deregulating, even if only as a temporary measure. The focus should be on cutting lead times for approvals, easing occupational licenses to allow more work to be done by trainees, etc.
There was an enormous credit boom before the GFC, right? So doesn’t the very existence of the GFC suggest that stimulus doesn’t work?
And aren’t the mathematics broken? As a simple example, anything I spend now I can’t save. Anything I can’t save, I can’t spend later. So the borrowing doesn’t increase my total lifetime consumption, unless I die with substantial debt or in other words, default. If I default the cost of borrowing/lending increases, which I would expect “soaks” the excess consumption on my part by damping consumption on the part of others.
If you borrow and then produce, you repay your debt and prosper. If you borrow and don’t produce, you must eventually default. So stimulus would work if and only if it increases production; again, everything runs from the production side and the economy grows only if production grows.
Aggregate demand, then, is essentially an artefact. It’s a derived number. Driving the economy by driving aggregate demand is like treating a fever by dunking the thermometer in cold water.
Sigh!
Sorry Steve, but to read your book electronically on my smartphone, I would need to install a THIRD reading app.
Damn it all, what is wrong with the industry?
I have ONE PAIR of eyes, with which I can read any physical book I pick up – even if it’s not English text. Foreign language material may remain incomprehensible to me, but the physical object is not unreadable.
However, to save space in my luggage, or at my bedside, and to enjoy the convenient portability of ebooks, I have to install a variety of reader apps, which consume my limited resource – main phone memory.
wreckage,
The Keynesian response to that would be in terms of “smoothing out” the business cycle. What you spend now, you can’t save for later — certainly. But if you spend it now, and ‘now’ happens to be a recession, you reduce the depth of the recession. You don’t have it for later, but if ‘later’ is a boom period, you reduce the height of the boom.
So instead of GNP graphs looking like wild up-and-down fluctuations — boom and bust cycles — it gets smoothed out to steady growth.
That’s the theory, anyway. That’s what the RBA tries to do with monetary policy — which is implicitly based on a Keynesian model of the economy.
Steve K has a different conceptual underpinning entirely, but I’ve never been quite sure what the practical implications of his economics are. Would a Katesian RBA just keep the interest rate at one fixed number throughout the business cycle, come hell or high water? I don’t know.
In terms of monetary policy, setting interest rates means the currency is pinned to debt, just like it used to be pinned to gold.
I’d much rather it was pinned to the market portfolio. It would be more representative of value as we come to determine that from time to time, and we would have less (nominal) risk.