Beyond Economics 101

This post on Economics 101 reminds me yet again how useless modern economic theory is at working through almost any economic issue at all. It’s about the theory of comparative advantage, I think, and the role of free trade in creating a high standard of living. But let me first go to this question at Quora: What are 25 economics books that you would recommend (preferably classical and neoclassical)? My answer:

If you are seriously interested in understanding economics you need to understand classical economic theory, the economics of the period from the publication of Adam Smith’s Wealth of Nations in 1776 until the marginal revolution began about a hundred years later in the 1870s. And if you are interested in understanding classical economic theory, you should read the third edition of my own Free Market Economics: an Introduction for the General Reader.

Modern economic theory has fallen into very hard times since its classical period, and is now incapable of explaining almost anything that matters. My FME third edition is entirely supply-side, explaining how classical economists understood the operation of an economy which is how an economy actually does work.

From the marginal revolution with its focus on marginal utility, through to the Keynesian Revolution of the 1930s with its introduction of aggregate demand, economic theory has looked at economies from the demand side. And while it has a superficial appeal, no economy is driven by demand. All economies are driven from its production side. People buy more where more is produced. If you want to understand what allows people to demand, you first have to understand what makes them capable of producing.

I will just add that if you try to read classical theory without some preparation for the changes in the terminology between economics today and economics then, you will miss the point. This is a paper you can find at SSRN which will help you get past what is a quite formidable barrier.

Classical Economics Explained: Understanding Economic Theory Before Keynes

Steven Kates

Abstract

Since the publication of The General Theory, pre-Keynesian economics has been labelled “classical,” but what that classical economics actually consisted of is now virtually an unknown. There is, instead, a straw-man caricature most economists absorb through a form of academic osmosis but which is never specifically taught, not even as part of a course in the history of economics. The paper outlines the crucial features that differentiate modern macroeconomics from classical theory, with the emphasis on what an economist would have understood as The General Theory was being published. Based on the differences outlined, a model of classical economic theory is presented which explains how pre-Keynesian economists understood the operation of the economy, the causes of recession and why a public-spending stimulus was universally rejected by mainstream economists before 1936. The classical model presented is an amalgam of the final edition of John Stuart Mill’s 1848 Principles of Political Economy published in his lifetime and Henry Clay’s influential 1916 Economics: an Introduction for the General Reader, a text which was itself built from the economics of Mill.

Here’s the link to the paper.

Classical Economics Explained: Understanding Economic Theory Before Keynes

As for comparative advantage and free trade, if you’d like a very good explanation of its classical meaning, you won’t do better than my Free Market Economics, an analysis I have not changed a word of since the first edition. It is naturally taken from the economics of John Stuart Mill who had himself taken it from David Ricardo, who wrote it up in 1817. It’s a great first approximation for all those economic types who are actually addicted to mercantilism, whereby economies are driven from the demand side and economies grow by increasing their level of exports. I know, who could believe such a thing, but let us assume just for now that there really are morons who harbour such views. How did Mill and Ricardo explain what was wrong with such notions? By pointing out that the best way to improve one’s standard of living is to produce what one does best and exchange one’s own forms of supply for the goods and services produced by others. You know, goods buy goods. You know, Say’s Law. You know? Perhaps not.

But you know what was also current then? The gold standard. There are many ways this process of comparative advantage breaks down, but with the abandonment of the gold standard and fixed exchange rates, there are all kinds of ways to cheat in foreign trade relations that are not discussed as part of the basic theory. This is the definition of “currency manipulation” found at Google:

It occurs when a government or central bank buys or sells foreign currency in exchange for their own domestic currency, generally with the intention of influencing the exchange rate and trade policy outcomes.

“Influencing” as in making one’s own situation better at the expense of someone else. It can be done, and is done. And there’s more. For most economies, a devaluation occurs naturally with deficits but not with the $US which is the world’s reserve currency. And let me also add this, that there is no trade war imaginable unless others decide to retaliate. And why would they if the only damage of increased tariffs in the US is to its own economy? Let the US suffer for its actions, right? Why poke yourself in the eye if they want to poke themselves in the eye?

There is so much more that can be said but will leave it to some other time.

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

27 Responses to Beyond Economics 101

  1. Bruce of Newcastle

    These two articles may be relevant to US thinking.

    China warns Taiwan it won’t tolerate separatist activities (today)

    China threatens triggering Anti-Secession Law, war over pending US-Taiwan bill (2 Mar)

    Countries which are at war tend not to trade with each other. Unfortunately the long peace has allowed China to grab a lot of productive capacity which the US has domestically allowed to wither. Add in Xi’s new imperial reign-for-life and the recent pushback on North Korea and you can see that the pundits in Washington might have some concerns that the economic landscape may change overnight.

    World View: China Angrily Demands That the U.S. Retract Latest North Korea Sanctions (25 Feb)

    No new iPhones will be a catastrophe for the Millenials. They won’t know what to do with themselves!

  2. stackja

    Keynes is the solution? Why is there still a problem?

  3. Sinclair Davidson

    The throry of comparative advantage is wrong because the world no longer holds to the gold standard?

  4. max

    by Frédéric Bastiat:
    Here’s the last part of Bastiat’s economic parable that features the discussion between the mayor and French prefect (regional governor):
    As a result, between the two rivals, there took place the strangest discussion in the world, the most bizarre dialogue ever heard, for you should know that the regional governor was a peer of France and a fiery protectionist. So that all the benefits that the governor attributed to a national tariff, the mayor took to defend the tariff for the city of Énios, and all the disadvantages that the Governor attributed to the city tariff, the mayor turned against a national tariff.
    Regional Governor: What! You want to prevent woolen cloth from the surrounding areas from entering your city of Énios!
    Mayor: You are preventing woolen cloth from surrounding countries from coming into France.
    Regional Governor: That is very different; my aim is to protect national employment.
    Mayor: And mine to protect city employment.
    Regional Governor: Is it not right for the French Chambers of Peers and Deputies to defend French factories against foreign competition?
    Mayor: Is it not right for the municipal council of Énios to defend the factories in Énios against external competition?
    Regional Governor: But your tariff is damaging your trade; it is crushing consumers and does not increase work, it displaces it. It stimulates new industries, but at the expense of the old ones.
    Mayor: That is exactly what the theoreticians of free trade say about your restrictive measures at the national level.
    Regional Governor: Free traders are utopians who see things only from a general point of view. If they limited themselves to considering each protected industry in isolation, without taking account of consumers or the other branches of production, they would understand the full usefulness of trade restrictions.
    Mayor: Why are you then talking to me about the consumers in Énios?
    Regional Governor: Because in the long run your tariff will damage the very industries you want to favor, for by ruining consumers you are ruining their customers, and it is the wealth of the customers that makes each industry prosper.
    Mayor: This is another thing that free traders object to you. They say that to want to develop one sector of work through measures that close off foreign markets and which, although they guarantee customers within the country for this sector, constantly impoverish these customers, is to want to build a pyramid by starting with the top.
    Regional Governor: Mr. Mayor, you are a nuisance, I do not need to give you my reasons and I am overturning the deliberation of the city council of Énios to enact a city tariff.
    The Énios mayor sadly went back to his village, cursing men who have double standards, who blow hot and cold and think very sincerely that what is truth and justice in an area of 20 square miles becomes false and iniquitous in an area of 200,000 square miles.
    When he reached Énios, the mayor summoned the city council to tell them in a pitiful voice about his misfortune. “My friends,” he said, “we have all lost our fortune. The Governor, who votes in favor of national trade restrictions each year, has rejected trade restrictions at the city level. He has overturned your deliberation and delivers you defenseless to foreign competition. However, one resource remains to us. Since the flood of foreign products is stifling us, since we are not allowed to reject these goods by force with tariffs, why do we not reject foreign goods voluntarily? Let all the inhabitants of Énios agree between themselves never to purchase anything from outside the city.”
    But the inhabitants of Énios continued to purchase goods from outside the city the goods that cost them more to make in the village, which confirmed the mayor in the view that men naturally tend toward their ruin when they have the misfortune to be free.

  5. max

    American job losses are not the result of freer trade and an excess of imports over exports, but of government policies that prevent capital accumulation in the United States, among them policies that limit imports. An essential part of any economic policy that would truly help to “make America great again” is to avoid preventing imports.

    ~ George Reisman

    The number of jobs in the steel is exceeded many times over in industries making steel products, from automobiles to oil rigs, refrigerators, locomotives, etc., etc. Tariffs that save jobs in the steel industry mean higher steel prices, which in turn means fewer sales of American steel products around the world and losses of far more jobs than are saved.

    ~ Thomas Sowell

    The primary reason for a tariff is that it enables the exploitation of the domestic consumer by a process indistinguishable from sheer robbery.

    ~ Albert Jay Nock

    Thus the new tariff law has resulted in this: The protected industry now makes a high profit to which it is not justly entitled. The average French citizen has been duped out of five francs by his government, and must therefore do without the article or service he would have bought with it. One segment of the economy has profited at the expense of many others. True enough, because of the artificial price increases, new jobs have been created in the protected industry. But what is not seen is the fact that the extra money now spent for iron must necessarily result in reduced spending for other products and services, and thus fewer jobs in those industries. And worst of all, the people have been encouraged to think that robbery is moral if it is legal.

    ~ Frédéric Bastiat

    https://mises.org/wire/against-trumps-tariffs-0

    and by the way:

    Us Steel Imports:

    Canada 16%
    Brazil 13%
    South Korea 10%
    Mexico 9%
    Russia 9%
    Turkey 7%
    Japan 5%
    Taiwan 4%
    Germany 3%
    India 2 %

  6. Entropy

    I came to he comments looking for the comment by Malcolm

  7. struth

    There are a lot of theory over real world knob jockeys on this blog.

    Reality hits them and they quote a book they’ve read, a scenario not in anyway relevant to the scenario we see before us.

    Never a comment on why some goods are cheaper, just concerned about the fact they are, no matter how criminal the activity that led to the cheap price, and the consequences of it in the long run.
    Theoretical space cadets.
    Economical infants.

  8. Judith Sloan

    Give it up Steven. Your man’s a dud.

  9. Nathan

    You think your opinion is free from theory struth? If you dispute the theory, then the problem is not that it is theory but that it is wrong theory. What criminal activity do you refer to? Ad hominem’s sure don’t do anything to invalidate any theory.

  10. None

    I remember a visiting American academic remarking at my old sandstone how Keynes seemed to be popular in Australia. It is also why we are in the poo as most ocy advisers and senior public servants have been churned out by our abysmal Keynesian institutions.

  11. Iampeter

    Somebody take the shovel away from Steve already.

    Help him stop digging this hole any deeper.

  12. struth

    You think your opinion is free from theory struth? If you dispute the theory, then the problem is not that it is theory but that it is wrong theory. What criminal activity do you refer to? Ad hominem’s sure don’t do anything to invalidate any theory.

    If it isn’t criminal activity to put restrictions on one country’s ability to compete fairly( by the U.N.), while allowing it’s favoured corrupt socialist countries to remain free of those restrictions, (all because apparently global warming is only caused by the west) then I don’t know what you’d call it.

    I’m not saying the theory is wrong, if the world was a utopia of fairness.
    I’m saying sticking to a theory when the world isn’t a utopia of fairness, and your trading partners are benefitting through corruption, is suicide.

    It’s really not that hard if you have the smarts to take in a wider picture of what is going on, then just focussing on one little part of a big picture and screaming about it because it goes against your “theory”

  13. struth

    Somebody take the shovel away from Steve already.

    Help him stop digging this hole any deeper.

    Such a profound statement and a real poser for us all to contemplate.

  14. Irreversible

    Apparently the band on the Titanic kept playing as it sank.

  15. Sinclair Davidson

    Just had a quick read through the first edition of Free Market Economics and find all sorts of arguments in favour of free trade and a very nice explanation of comparative advantage with no talk that it’s old hat now that the gold standard has been abandoned.

  16. max

    Sinclair Davidson you say:
    “The throry of comparative advantage is wrong because the world no longer holds to the gold standard?”


    he better write thesis to explain his theory or better a book.
    start promoting and asking return to gold standard.

    or start explanation with rich entrepreneur who wants to open new factory, and what is stoping him to open this factory in america or australia and he goes to china.

  17. max

    struth say:
    “If it isn’t criminal activity to put restrictions on one country’s ability to compete fairly( by the U.N.)”

    yes, blame guys behind a tree.
    blame is on us –you,me.. –people who elect present and past politicians.

    we are greedy do not want to work for peanut,
    we want clean water and air, no pollution
    we want safety

    well You can’t have your cake and eat it (too).

    We have met the enemy and he is us. —- but people like you need some else to blame.

  18. Nathan

    If it isn’t criminal activity to put restrictions on one country’s ability to compete fairly( by the U.N.), while allowing it’s favoured corrupt socialist countries to remain free of those restrictions, (all because apparently global warming is only caused by the west) then I don’t know what you’d call it.

    I’m not saying the theory is wrong, if the world was a utopia of fairness.
    I’m saying sticking to a theory when the world isn’t a utopia of fairness, and your trading partners are benefitting through corruption, is suicide.

    No country is obligated to follow the U.Ns dictates regarding CO2 mitigation. That is self inflicted. Is that the extent of your criminal activity claim?

    If the theory doesn’t fit the real world then it is bad theory.

  19. tgs

    Could you please provide any argument whatsoever that comparative advantage is only relevant under a gold standard?

  20. Greg

    With reference to Sinclair according to Samuelson if you are better at agriculture than manufacturing you should concentrate on agriculture and sell agricultural products to purchase manufactured products.

    I fail to see what the gold standard has to do with it Sinclair.

    WE are better off selling primary products to world markets and importing motor cars than restricting primary products to try to build motor cars. Of course one has to be sensible and pick good primary products but a motor car industry will never work in Australia for a variety of reasons. The car industry is a proven failure. But the same can be said for many other manufacturing industries that are almost as bad. The same can be said of coal which is a real winner as far as Australia is concerned. How Shorten could seriously propose nobbling Adani for Green votes beggars belief.

    [I think you are confusing Steve with me. Sinc]

  21. Malcolm

    Steve do you force your students to buy your book? Do they get extra credit for buying your book? A book that argues for free trade and against Trump.

  22. Malcolm Thomas

    What Judith and Sinc said: stop digging Steve.

  23. struth

    yes, blame guys behind a tree.
    blame is on us –you,me.. –people who elect present and past politicians.

    Multiculturalism, opening borders, agenda 20/30 compliance, or many other U.N. rulings that are being complied with were never voted on by any of us.
    People are only now waking up to what is going on.
    How our politicians are Dastyari-ly selling us out to China.
    How our politicians have thrown the rule book, the constitution out the window.

    Our politicians are being bought and sabotaging the wealth of the west, it’s power generation, it’s ability to compete.

    There is no guy behind a tree.
    They are telling us this is so.
    There is no conspiracy theory.
    Look who is the secretary general of the U.N.

    So leave off with the pompous ignorance.
    There is enough not hiding behind any tree, for me to be able to lay the charge of it being a corrupted market with total confidence.

    Are you seriously going to suggest it isn’t?

  24. struth

    Can you please tell me who voted to hand over our taxes to the Clinton foundation.
    When Julie Bishop did it.
    Did conservatives vote for that?

  25. struth

    we are greedy do not want to work for peanut,

    For most of the time the USA has been a super power with huge production levels, it’s had the highest standard of living in the world.

    Nobody in any country wants to work for peanuts, and you don’t need workers to work for peanuts if the government isn’t taxing like ravenous vampires.

  26. struth

    That is self inflicted. Is that the extent of your criminal activity claim?

    To act to destroy the country of which you sit in parliament, by traitorously and secretly doing deals with the U.N. and or China is criminal activity, would you not say?
    Sect 44.?

  27. From the marginal revolution with its focus on marginal utility, through to the Keynesian Revolution of the 1930s with its introduction of aggregate demand, economic theory has looked at economies from the demand side.

    So, we should have stuck with the labor theory of value?

    For most economies, a devaluation occurs naturally with deficits but not with the $US which is the world’s reserve currency.

    So then, why does the euro trade at $1.24 US when it has, in the past, traded below parity? Deficits, maybe?

    And why would they if the only damage of increased tariffs in the US is to its own economy? Let the US suffer for its actions, right? Why poke yourself in the eye if they want to poke themselves in the eye?

    Easy… because they also believe the stupidity that they can help their economies by limiting imports. If they understood Austrian econ, they would simply laugh and carry on,

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