Classical economic theory and the modern world

A post in two sections.

Section I

The March issue of Quadrant has an article of mine which has just been put up online. In the magazine itself the title is, The Dangerous Return of Keynesian Economics – Five Years On. What it is five years on from is an article of mine that found its way into the March 2009 issue which dealt with that very dangerous return of Keynesian economics in the form of the worldwide stimulus that economies across the world were beginning to apply. The original title was The Dangerous Return to Keynesian Economics for which this was the single most important passage:

Just as the causes of this downturn cannot be charted through a Keynesian demand deficiency model, neither can the solution. The world’s economies are not suffering from a lack of demand and the right policy response is not a demand stimulus. Increased public sector spending will only add to the market confusions that already exist.

What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.

That this outcome was absolutely assured in my own mind is, of course, not the same as it being absolute assured in reality. And indeed, it is not too much to say that 99% of the economic opinion of the world went quite the other way. The best example of this attitude may be seen in this comment made to me by Senator Doug Cameron during my appearance before the Senate Economic References Committee in September 2009.

Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?

This is, of course, a question I ask myself but also one for which I have an answer. The odd part is that no one else asks this question although it is the question that ought to go to the heart of the matter. Which takes me to the second part of this post.

Section II

The economics I use I did not invent but am near enough unique in applying it to economic questions in the modern world. This is the economic theories of the cycle as developed by classical economists which was the theory accepted universally across the profession prior to the coming of the Keynesian Revolution in 1936. So to see things as I see things about the nature of this theory, let me take you to the opening part of a form I have just sent to my publisher on how to advertise the second edition of my Free Market Economics. It was a book whose first edition I wrote with immense intensity over the twelve weeks of the first semester in 2009, from March to May, to explain in more detail why the stimulus would with certainty fail, as fail it did. It turned out I had quite a bit to say about micro as well.

1. Please describe the book in non-technical layman’s terms (in no more than 150 words). Include brief details of the book’s main objectives and conclusions.

Have you ever wondered why no public sector stimulus has ever worked? You are holding in your hands a book that is unique in our times. It is a text on economic principles based on the economics before Keynesian theory became dominant in macroeconomics and equilibrium analysis became standard in micro. It looks at economics from the perspective of an entrepreneur making decisions in a world where the future is unknown, innovation occurs at virtually every moment, and the future is being created before it can be understood.

Of particular significance, this book assumes Keynesian theory is flawed and policies built around attempting to increase aggregate demand by increasing non-value-adding public spending can never succeed but will only make conditions worse. The theories discussed are the theories that dominated economic discourse prior to the Keynesian Revolution and are thus grounded in the economics of some of the greatest economists who have ever lived.

It is, of course, possible that I might have been right for the wrong reasons, but it might also be the case that I was right for the right reasons. I go on about Say’s Law, John Stuart Mill and classical theory, but you know, when have they ever let me down? The world, so far as the evidence shows, works exactly like their theory says it does. And it’s not even that I picked this downturn as a one-off instance, but I also picked the upturn that followed the massive cuts to public spending after the Costello budget in 1996. Who else did that then? What theory is there other than the classical theory of the cycle that could even explain it let alone predict it? And there is no other text anywhere in the world written more recently than the 1920s that can tell you what that theory is other than mine.

You could, of course, buy the first edition right now or you can wait until the much improved second edition is published in July or August.

This entry was posted in Classical Economics, Economics and economy. Bookmark the permalink.

18 Responses to Classical economic theory and the modern world

  1. Andrew

    You were wrong for the right reasons.

    History records that we did not have a recession – it has not yet recorded that this was IN SPITE is Swannism.

    Europe followed your prediction of a prolonged depression through their adoption of Swannism. (In fact, our stimulus was modelled on the Spanish one).

    We would have followed had commodity prices not tripled – adding twice as much to GDP as Swannism detracted.

  2. danger mouse

    Steve,

    Next time you are in Singapore, I’ll get you to sign both editions..

    DM

  3. .

    Steve,

    Have you ever done a thorough analysis of the costs of occupational licensing (now completely over the top now) in Australia?

    Your point about the macroeconomic benefits of Costello’s consolidation has never been answered by the Australian left.

  4. Greg Byrne

    Steve refers to “the economic theories of the cycle as developed by
    classical economists” but what he calls the classical theory of the trade
    cycle was refuted by Gerry Jackson who proved that the real theory was
    completely at odds with what Steve claims. If Jackson is wrong then Steve
    should explain why.
    http://gerardjackson.com/the-real-classical-school-theory-of-the-trade-cycle-2/

  5. brc

    Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?

    The answer is as simple as can be. Because they are exclusively composed of people who find joy in spending other people’s money.

    The true question is : why can no other entity, be it individual, family, company, community or corporation, borrow and spend its way to prosperity, but national governments somehow possess this capability? Where is the magic line that crosses when this behaviour turns from ruinous to virtuous? It’s certainly not related to geography, population, culture or timing. Yet, prudent national budgets and economic freedom cross ethnic, cultural, population and geographic lines and produce prosperous states, every single time.

  6. .

    Why have the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world, why have they got it so wrong and yet you in your ivory tower at RMIT have got it so right?

    Except they didn’t, LOL.

  7. sabrina

    I long for the day when you Economists can sort out your differences and come up with something universally aceptable!
    Is that too much to ask Dot?

  8. .

    Is too much to ask of you to stop bullshitting and trolling?

  9. Packy

    Steve
    I hope classical economics is dead right but can the theory explain why inflation does not seem to have jumped in the US in particular + in many other countries also running loose monetary and fiscal policy. I thought the theory predicts loose monetary policy generates inflation

  10. LABCR-TV

    Totally agree with you, Steve.
    Not because I am an economist, I’m not.
    But because of real world evidence, in the form of Iceland. The smart people of Iceland refused to go along with ‘the IMF, the OECD, the ILO, the treasuries of every advanced economy, the Treasury in Australia, the business economists around the world’.

    They refused the ‘too big to fail’ fascist mantra of the USA. They allowed their banks to fail, as one would be expect in a free market, and gaoled their bankers. They disbelieved the Ben Bernanke theory of monetarisation. They refused Keynesian theory.

    Now look at Iceland’s economy: very little debt remaining, decent growth, no bail ins or bail outs, and no debasement of their currency. That last point should make their retirees very happy, unlike us poor sods in the west.
    As for Cameron, what a joke! It is well known that leftists cannot even balance a budget, let alone act fiscally responsible.

  11. The Pugilist

    The economics I use I did not invent but am near enough unique in applying it to economic questions in the modern world. This is the economic theories of the cycle as developed by classical economists which was the theory accepted universally across the profession prior to the coming of the Keynesian Revolution in 1936.

    Steve, I think a slightly more precise way of expressing this sentiment is to say that most classically trained economists agreed on the broad framework. That is, recessions were always caused by structural issues in the first instance but there was a wide variation as to the causal factors that classical economists used to explain the origins of the underlying the structural imbalances. Some resorted to monetary imbalances, others stressed the lumpiness of capital formation and technical progress. But virtually no-one resorted to a general deficiency of demand for all goods and services. Also, long lasting recessions sometimes resembled the symptoms of a general glut, but a recession could never be caused by a general glut in the first instance. They were the result of a crisis of confidence.
    In sum, almost all classically trained economists agreed that recessions were structural and could be worsened by government interference or central bank errors but there was robust debate as to the causes of structural imbalances. That’s how I would sum up the literature prior to Keynes’ general theory…

  12. John Montgomery

    Well said Steve. I argued similar points in my book: Upwave, City Dynamics and the Coming Capitalist Revival, written in 2009 but not published until 2011. Except I also explore why technological innovations are not almost constant but occur in long waves. Also, I argue that most innovation, creativity and new wealth is generated in cities and city regions or in the process of trade between such regions. This last economic downturn was indeed unusual, but then it was caused by the sub-prime crisis and had nothing to do with the terms of trade or levels of profitability.

  13. Old School Conservative

    brc – thanks for the trip down memory lane to 1970 and Economics 101 at UNSW: national governments can spend and borrow as much as they like because……they are national governments! I was young and naive and I accepted that dubious argument. It took a lot of paying taxes over the years to work out the fallacy. Slow learner.

  14. The Pugilist

    BTW, my comment above is not intended as a criticism. I have just noticed some of the criticisms that others have made of previous posts on this topic. I agree with you Steve that to understand business cycles, you need to understand Say’s law. Sometimes though, you tend to leave yourself open to criticism by not impressing upon people how widespread the acceptance of Say’s law was and the variations that are possible within that framework. Unfortunately, you have to treat most people as if they know none of this, especially if they are trained economists, because the truth is, they have been fed a nonstop diet of strawmen and crude caricatures when it comes to pre-Keynesian theory. Those that do know this have a strong vested interest in keeping it suppressed…

  15. ProEng

    Well said Steven, I did some economics at University and read about some of the financial bubbles and depressions in the past. In Australia, Henry and Garnaut must rate as some of the worst economic advisers to Government and Swan as one of the most incompetent Treasurers.
    I would have thought that you might have mentioned John Key in NZ as attempting to over ride bad advice from their Treasury. Has not New Zealand performed better over the last 4 years without having a mining boom and inspite of some disasters?

  16. Andrew

    ProEng, opening another can of worms there. NZ had a shallow and brief recession – the kind we should have had rather than waste 15% of GDP averting a 1% shrinkage. They bounced back very fast, due in large part to quadrupling trade to China under a FTA. Everyone knows teh FTA will destroy the economy, just like it has in the case of, um, never.

  17. Geoff

    Hey steve just wondering what you mean by:

    Have you ever wondered why no public sector stimulus has ever worked?

    I was thinking the increase in spending as a result of the second world war starting would be an example of this, since it ended the decade long recession that followed the Wall st crash. If you compare the post GFC period to the great depression it seems that economic activity returned to somewhat normal levels in a shorter time. I think it’s fairer to compare policy use in two similar periods to judge the results of stimulus, rather than say 1996 in the wake of Costello’s spending cuts.

  18. .

    This last economic downturn was indeed unusual, but then it was caused by the sub-prime crisis and had nothing to do with the terms of trade or levels of profitability.

    What about falling labour productivity?

Comments are closed.