Economic theory and junk science

You may have heard me mention once or twice before that Keynesian economics is junk science, but just in case you missed it I am going to mention it again. What has brought all this to mind is reading the front page story in The Oz in the context of the booming economy in the US. In The Oz we have this: Bill shock as standard of living slumps. In the United States we have this: US private sector added 250,000 jobs in Dec, vs estimate of 190,000: ADP. It also mentions that “the report helped send the Dow to break the 25,000 mark for the first time”. Of course, here in Australia we have something else instead:

Australians have endured their longest period of falling living standards in more than a quarter of a century as growth in costs outstripped earnings for the fifth consecutive quarter, leaving households worse off than they were six years ago.

The moronic focus on public spending to lift our economies is such dead stupidity, but even more dead stupidity is that economists continue with Y=C+I+G as the mantra of macroeconomic thought. I have just been sent my copyedited article that will be published in June: “Making Sense of Classical Theory”. It is an attempt to remind others that there was not only an economic theory before the publication of The General Theory in 1936, but that theory was vastly superior to the theory that disfigures our economic textbooks today.

As it happens, I have just been re-reading the third edition of my Free Market Economics. There is, unfortunately, nothing like it. Perfectly clear and as easy to read as a blog post but entirely framed around classical economic theory. The economics of John Stuart Mill, the greatest economist who has ever lived, recast for the 21st century. If you don’t want to buy it yourself, just get your library to buy a copy.

The reality remains that our living standards will continue to descend if those who make policy continue to believe that public expenditures like the Snowy Mountain Project Mark II will make the economy grow. It will, in exactly the same way as the NBN.

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35 Responses to Economic theory and junk science

  1. mh

    And the Donald is not using immigration levels to boost the US economy, unlike the Australian government.

  2. jrm

    And in the NT Michael Gunner is talking about giving us another stimulus package.

  3. Keynesianism is the economic equivalent of Lysenkoism. The reason the government pushes it in government controlled schools and universities is the “G” in Y=C+I+G. On closer examination the theory is an empty scaffolding, a potemkin village, and an attempt to measure the size and health of an economy by how much sewage comes out of the sewage pipe of demand.

  4. Sparkle Motion

    Keynesian economics is junk science

    Guess that’s true. Mainly because it’s very hard to refute the contention that “economics is junk science”.

    Although science is fast disappearing down a Bayesian “make it up as you go along” model so maybe economics will count as science one day too.

  5. Y=C+I+G

    I’ve tried to express my thoughts on this in previous threads. I’ll try again.

    That G……it doesn’t exist on its own. The government doesn’t own a gold mine where G is created. That G HAS TO BE FIRST TAKEN AWAY FROM THE C AND I.
    So assuming G is taxation equally taken from C & I, then the formula should really be
    Y = (C-1/2G) + (I-1/2G) + G.

    The true formula is Y = C + I without the G. That is when Y is largest. However we know we must have some size of government, so we have to include G in there somewhere.
    The difficulty in expressing all of this in an algebraic formula is that I is bigger than (I-1/2G) + 1/2G, and C is bigger than (C-1/2G) + 1/2G.

    Algebra and numbers are absolute, however economies of societies are not, so it is very difficult to express economies in an algebraic formula.
    The only solution I could come up with is to measure the economy in two parts. One part consumer and industry activity, and one part government activity.

    If we could do that, then we’d see clearly that the private sector is much more efficient than the public sector, hence the larger we can make the private sector by making the government smaller, the larger the economy will be.
    Or something like that.

  6. rich

    Bah Humbug the problem is the formula itself is an abomination. You cannot resolve an economy by mathematics and a formula, because it is a Markov Chain, with each link having its own preferences and direction. To try to summarize it using a formula destroys precision in the same way the Central Limit Theorum, the Yule-Simpson Effect and Lindsay’s Paradox. It would be like trying to measure temperature with a rule… maybe possible (if you have a physical object that changes length based on temperature) but nevertheless the wrong tool to measure that property.

    Reject formulas outright. They are a useful model insofar to the point that they no longer reflect reality. There is no macro economics- just economics. Macro economics is the excuse that governments give to begin trying to nudge, centrally plan and manage the economy.

  7. Steve Kates

    Ahh Mr Humbug (may I call you Baa?), your problem is that you give them too much credit for good sense. You are thinking from the supply side from which everything we buy must come. They are thinking from the demand side which is what all plunderers of our wealth like to do. By even introducing the words “activity” and “efficient” you show that you understand how an economy does work but do not understand how Keynesians think it works. They are not in any way the same thing, alas. Kind regards

  8. H B Bear

    The Australian government is happy to measure National growth at the macro level while pump priming the property ponzi scheme with Chinese cash and 200,00+ immigrants pa while carbon dioxide levels are always per capita.

    Will the voting mushrooms catch on this time?

  9. Irreversible

    The greatest of moronic assertions is that economics is science. It is ideology, nothing more or less.

  10. Ray

    Baa Humbug and Steve Kates need a quick lesson in economics.

    In the equation Y = C + I + G, the C represents the amount of monies spent on consumption, in other words, this is the residual households actually consume after savings and taxes are deducted from their income. To deduct G/2 from both C and I simply double counts the effect of taxation and that displays a complete misunderstanding of the function.

    There are many reasons to criticize Keynesian economics but, in order to do so, you should first understand the ideas it represents. Failing to do so simply marginalizes your arguments and the rest of the economics profession will have considerable justification for ignoring your input altogether.

  11. Steve Kates

    Ray, Ray, Ray. Do you really think I need lessons in Keynesian economics? My Chapters 13 and 14 are about as good an overview of modern macro as you will find anywhere, and they have the added advantage in being explained by someone who is its most complete enemy, as in “know thine enemy”. The modern definitions of saving and consumption are completely vacuous but you are not to know since you have never had the advantage of seeing the alternative. As I say, Chapters 13 and 14, and you might even read the chapter that comes before that discusses the Keynesian Revolution.

  12. Nathan

    Surely Mill comes a distant second to you Steve? Your work is so unique and your writing is so perfectly clear after all.

  13. Tel

    It would be like trying to measure temperature with a rule… maybe possible (if you have a physical object that changes length based on temperature) but nevertheless the wrong tool to measure that property.

    That’s exactly how the thermometer on my wall works. Same with meteorological thermometers going back to the early days, as far as you want to go.

    It only changed recently with electronic thermometers, but even then they measure a resistance, or sometimes (as in a pyrometer) they measure radiation. Nobody ever measures temperature directly. Kind of difficult to directly measure upwards of a billion degrees of freedom.

  14. Ray

    Steve, why would I read your book when you have marginalized yourself by allowing ideology to dominate your economics to such an extent that you cannot bother to understand what should be plain to any first year economics student.

    Baa Humbug made an erroneous call on the output function and you agreed with him without bothering to engage your brain. The point is that consumption is the residual after tax and savings, it does not need to be adjusted again for government expenditure. After all, households cannot consume what they do not have and if they pay their taxes then that money is no longer available to them for consumption. This should be obvious to any economist if they are at all honest with themselves.

    As for understanding Keynesian economics, I have read the General Theory and understand it. Most importantly I have sufficient understanding to recognize the real flaws in that approach rather than the superficial complaints which you tend to concentrate upon. Indeed, you make the same mistakes which Keynes himself is guilty of, creating a straw-man argument for your opponents and then attempting to rip this apart with spurious rebuttals which make no sense to rational economists.

    If you want to have a real discussion about the problems with Keynes then by all means let us have that, but let us leave you baseless ideology at the door.

  15. Steve Kates

    You ask why would you read my book. It is lucky that a pair of comment here on a blog post by myself and Mr Humbug are so enlightening for you that no further research is needed. The point of the post is to make the not all that astonishing comparison between the very non-Keynesian approach of Mr Trump and the Keynesian approach of others, most notably the governments of Australia. No doubt you find the supply-side driven recovery in America perfectly consistent with Keynesian theory because there has been an increase in spending. But we have had all that wonderful spending too, on the NBN, desal plants, the tramway in Sydney, the train in Melbourne, and guess what? Real incomes are falling and a jobs boom seems to elude us. This c+i+G seems to only work selectively. Can you work out the reason why? Probably not, but don’t let it get you down?

  16. sdfc

    The true formula is Y = C + I without the G.

    That displays a complete misunderstanding as to what GDP(E) is.

    GDP(E)=(I)=(P).

  17. The Pugilist

    Y=C+I+G is merely an identity. It is not a function or a formula. It is true by definition but utterly meaningless for understanding the dynamics of an economy and the interrelationships between the components.
    Steve is absolutely correct though. G is not a perfect substitute for I or C.

  18. Ray

    As usual Steve, you just don’t get it.

    You make two major errors here. First you assume that because I question your understanding of economics that I am a Keynesian. Nothing could be further from the truth. The difference between us is not that we disagree on Keynes but that we disagree on economics, or at least we would if there was anything remotely resembling economics which appeared in your comments.

    Second, and this correlates directly with your understanding of economics, is that Y = C + I + G is nothing but a model used to describe the relationship between four economic variables. That income is broadly distributed to consumption, investments and government expenditure in a closed economy is simply an observation of what happens in the real world. It is not, and never has been, a justification for Keynesian intervention or any other type of policy response. To recognize this relationship does not make one a Keynesian, or anything else for that matter. You should and probably do know this and you do discredit to the profession to over simplify economics in the manner in which you do.

    To put it simply, your interventions on these pages are little more than self gratification. Few readers will gain any insight from your comments and we run the risk of many being misguided by your simplistic and ideological approach to issues which are obviously beyond your limited economic abilities.

    As noted I am not a Keynesian. However, we can oppose the damaging effects of Keynes by using economics or populist claptrap. I prefer the former but it is obvious that you would rather dwell on the latter.

    Here it is worthwhile pointing out that the problem with Keynesian economics, or rather the new neoclassical synthesis into which it has morphed in recent years, is that it is short term by nature and so looks to the management of nominal rigidities rather than long term growth. That these rigidities exist is a simple observation, however, how these vary over time is beyond the understanding of economists at present. As a result, economic models make estimates of the effect of nominal rigidities on past performance and fail to predict where these will be in the future. As a result, policy responses are invariably solving yesterdays problems, but worse, are creating tomorrows problems as well given that policy intervention invariably creates distortions which reduce investment and hence affect longer term growth.

    To come back to Y = C + I + G, this relationship is not the problem. The real issue is how Y changes over time, nothing else. If we increase G then we must decrease I, if we decrease I then we will see lower Y in the future. This is why the function is not Keynesian, it is a simple model which helps us understand why the economy may respond in the way it does. In this context, it tells us that Keynesian economics is wrong rather than the other way around. All we really need to do is fully comprehend what the function is telling us.

  19. sdfc

    G is not a perfect substitute for I or C.

    That’s a strawman.

    The GDP identity tells us a great deal about the dynamics of an economy. MCM.

  20. JC

    In the equation Y = C + I + G, the C represents the amount of monies spent on consumption, in other words, this is the residual households actually consume after savings and taxes are deducted from their income. To deduct G/2 from both C and I simply double counts the effect of taxation and that displays a complete misunderstanding of the function.

    Oh God.

  21. sdfc

    Ray

    If we increase G then we must decrease I

    Not in the short run Ray. In a downturn increasing G may well increase I.

    Ray is right there JC. Baa does double count.

  22. JC

    No he’s not, SDFC. He’s breaking down identities as though they reflect the real behavior of the economy at large. He sounds to me like a MMTer.

  23. sdfc

    You don’t know what double counting means, do you JC?

    G=G-T. By deducting G from C and I, he is double counting.

  24. JC

    SDFC

    True, I don’t know what double counting means as i need you to explain it. You were MMTer from way back too.

  25. sdfc

    MMT is operationally correct but I’m not an MMTer. MMT would turn into an inflationary disaster over the long term. You do know that your support for MM basically makes you a Keynesian?

  26. JC

    You do know that your support for MM basically makes you a Keynesian?

    SDFC, it was only a few years ago when Dot and I had to smack MMT out of you otherwise you were fast becoming an MMT crank. It’s good that you didn’t and that we stopped it.

    No, MM is not Keynesian in any way unless you think Hayek was also a keynesian.

  27. sdfc

    You’re hallucinating JC. I’ve never been an advocate of MMT.

    But you are a supporter of Keynesianism.

    Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest![5] For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. JMK Notes on the Trade Cycle. GT.

  28. JC

    SDFC.

    You don’t appear to understand Keynes nor MM. No one of influence advocating MM suggests using fiscal policy to manage economic activity. Keynes did. In fact monetary policy under Keynesian economic is to be used to used in the implementation of fiscal policy.

    MM does not. MM suggests targeting NGDP or in Hayek’s case nominal income (almost the same thing) through monetary policy and monetary policy guidance. How this is Keynesian is too absurd to even discuss.

    And yes, you were an MMT crank and trying very hard to be. The threads are there to see.

  29. JC

    MMT is operationally correct

    There you go again.

  30. sdfc

    Of course it’s operationally correct. You don’t understand much do you?

  31. JC

    Identities are representations, which means they represent! Nothing in a representative primitive model is operational.

  32. Thanks to all those who responded to my comment and sorry for the late reply. ‘Tis the season.

    Regarding my understanding of the formula (model) Y = C + I + G

    Imagine a very small community living on an isolated island, going about their daily business of catching fish, gathering fruit etc. The model for their economy would be Y = C + I. There is no government as such so there is no G. G is not necessary to describe this economy.

    It is not until one lazy smartass conman in the community convinces the others that he’d be able to help with the various trades between the islanders and keeping track of who owes what to whom etc -but in doing that he won’t be able to go out fishing or climbing coconut trees, therefore everybody could just give him a very small percentage of their catch and gatherings -that we need to introduce a G to the formula (model). Y = (C-1/2G) + (I-1/2G) + G. Mathematically this is the same as Y = C + I + G, but in an economy it is not the same.
    The size of the economy of that island community just shrank a little bit because of G.

    Which is why we appear to have a double counting conundrum (I believe it is a conundrum).
    It is a conundrum because Y = C + I + G is a model that describes, rather than a precise formula. As I said in my comment;

    The difficulty in expressing all of this in an algebraic formula is that I is bigger than (I-1/2G) + 1/2G, and C is bigger than (C-1/2G) + 1/2G.

    Algebra and numbers are absolute, however economies of societies are not, so it is very difficult to express economies in an algebraic formula.

    The problem is is that buffoons use it as a precise formula. That’s why when there is an economic slowdown (such as in 2007/8) governments believe they can boost Y by increasing G.
    In a mathematical formula, it is absolutely true that you can increase Y by increasing G, but it doesn’t work that way in a real economy.

    In a real economy, taxing away from C and I in order to inject more G doesn’t make sense. [And borrowing money instead of taxing away from C and I to increase G only kicks the can down the road].

    Anyway, I’m rambling now. I think The Boxer got it spot on when he commented…

    The Pugilist
    #2601884, posted on January 5, 2018 at 10:41 pm

    Y=C+I+G is merely an identity. It is not a function or a formula. It is true by definition but utterly meaningless for understanding the dynamics of an economy and the interrelationships between the components.

    There are terrible real life consequences when buffoons use it (the formula/model/identity) as a how to guide in boosting economic activity.

  33. rich

    That income is broadly distributed to consumption, investments and government expenditure in a closed economy is simply an observation of what happens in the real world… it is a simple model which helps us understand why the economy may respond in the way it does… All we really need to do is fully comprehend what the function is telling us.

    Let me repeat again. I detest that function, because it is a Markov Chain, with each link having its own preferences and direction. To try to summarize it using a formula destroys precision in the same way the Central Limit Theorum, the Yule-Simpson Effect and Lindsay’s Paradox does. There is an implicit assumption that C, I and G are independent variables, when they are not. The key one is “I” because there are dead weight losses from converting I into G through taxation, and misalignment. Note also JS Mill’s observation that today’s wages are paid using yesterday’s capital… hence I is prime and the production of more of which is what drives the economy (capital accumulation).

    The point is that consumption is the residual after tax and savings, it does not need to be adjusted again for government expenditure.

    See above. It assumes C, I and G are independent variables, when G actually imposes additional deadweight losses and overhead on I. That’s why the government subtracting from I to “dig holes and fill them in again… while paying someone to administer it” does not allow for perfect substitution.

    you have marginalized yourself by allowing ideology to dominate your economics to such an extent that you cannot bother to understand what should be plain to any first year economics student…. misguided by your simplistic and ideological approach… populist claptrap.

    This is the Biased Umpire Fallacy- rather than having an argument, you call Steve’s argument “ideological.” Not an argument.

    how these vary over time is beyond the understanding of economists at present…. policy responses are invariably solving yesterdays problems, but worse, are creating tomorrows problems as well given that policy intervention invariably creates distortions which reduce investment and hence affect longer term growth…. The real issue is how Y changes over time, nothing else.

    Sir John Copperthwait did his best to impede bureacrats in Hong Kong from collecting economic statistics because he knew they would be tempted to intervene if they did. You cannot model a Markov Chain using a formula, and any attempt at policy will have the long term consequence of shrinking I, no matter how badly the government wants to call projects like the NBN “I”.

    G is not a perfect substitute for I or C.

    That’s a strawman.

    No it isn’t because of deadweight losses. The “double counting” issue is a poor man’s attempt to account for the deadweight losses.

    GDP(E)=(I)=(P).

    The GDP identity tells us a great deal about the dynamics of an economy. MCM.

    The problem with GDP is that it’s a measure of consumption, not capital production.

    If you think logically about it, you could eat your seed crop, count it as high GDP, then starve to death the year later. You can’t measure the health of an economy by the amount of effluent leaving society’s sewage pipe.

  34. rich

    Another thing to add is that the “Keynesian multiplier” is a myth, related to the parable of inflation. In the short term it looks like work is “stimulated” but, once the vendors realise that the gain is illusory (and that the government by printing money, has put business owners on a treadmill) there is a correction where they stop investing and it stagnates.

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