Holte's corner

the presuppositions of A Comfortable Suburb

John Maynard Keynes was a great Economicist. But his challenging of the dogma of his day was not popular with businessmen and is still not popular with their spokesmen in economics and Government. Worse, he's been ill served by his successor economicists, from Milton Friedman to more recent ones. The result is that some people who are confused about economics project their confusion onto him. Which is a real shame because the kind of "Keynes" they set up and knock down is a strawman Keynes who has nothing to do with the real life economicist and his solid theories. His theories were describing the why of a phenomenom of his times. Great Depressions. His explainations are uncomfortable to libertarian and libertine laissez faire capitalists who feel that the "invisible hand" of God drives the economy and gives them license to pillage and steal from the rest of us -- and no responsibility.

In order to tar him they have to thoroughly misrepresent him and then "knock down" that representation. In the process they are advancing theories that he already discussed and explained why they won't work. But never let that stop them from going full steam forward anyway. Somehow these people manage to dominate some quarters of economic discussions. I don't know how they do it. Their economics is "pseudo-economics."

First Keyne's was not a "Keynesian." His theory is much maligned for attacking the assumptions of the "Sayes" law:

"The paradox of Say's Law is thus that capital, the "supply side," is
the only real means of improving the human condition -- both the
capital to create new production and the capital to create greater
productivity -- while "social" spending or regulation to artificially
promote demand through high wages, the "demand side," can easily
produce, or perpetuate, widespread poverty and misery. Thus the
Soviet Union reproduced the economic poverty as well as the political
privilege of a mediaeval state, even as Herbert Hoover and Franklin
Roosevelt, with glowing rhetoric about the common man, lodged the
wealthiest nation in history in a full decade of unprecedented
unemployment. The mythology of the New Deal and the Keynesian
rejection of Say's Law still distort American politics and
economics."

What this author says distorts what Keynes was talking about and sets
up the strawman that he completely rejected Says law, leading to the
conclusion that Keynesianism and Roosevelt "caused" the nation to
remain in unemployment for the period of the Great Depression. He
also ignores the role of the Smoot Harley Act, international economic
weakness and most of the real main causes of the Depression in his
analysis. But I don't want to digress to attacking my pet subject
(bogus current economic theories).

Says Law is true most of the time.

"Say's law, that the aggregate demand price of output as a whole is
equal to its aggregate supply price for all volumes of output, is
equivalent to the proposition that there is no obstacle to full
employment. If, however, this is not the true law relating the
aggregate demand and supply functions, there is a vitally important
chapter of economic theory which remains to be written. (p. 26)"

Keynes didn't deny the long term truth of Says law under most
conditions. But he did critique it:

http://www.worldandi.com/public/1988/may/mt7.cfm
"Keynes realized that investment may not respond to declining
interest rates during a depression. The decision to invest may be
influenced as much by the mood of the times, and by expectations
about the future, as it is by the interest rate. He wrote:"

"[T]here is the instability due to the characteristic of human nature
that a large proportion of our positive activities depend on
spontaneous optimism rather than on mathematical expectation, whether
moral or hedonistic or economic. Most, probably, of our decisions to
do something positive… can only be taken as a result of animal
spirits--of a spontaneous urge to action rather than inaction, and
not as the outcome of a weighted average of quantitative benefits
multiplied by quantitative probabilities."

"…Thus if the animal spirits dim and the spontaneous optimism
falters, enterprise will fade and die."

During "recessions" one of the things that drives the recession is
that investor money "dries up." It dries up for multiple reasons. One
of those reasons is that investors are simply not stupid. Who is
going to invest in a company that is going to lose money for the next
six months to a year, when a cold calculation tells one that holding
on to one's money (putting it in a cookie jar) for a few months will
let one buy the same stocks or businesses or buildings at fire-sale
prices? People make their bets based on expected return, their
estimates of what reality is or will be, not necessarly what it
actually will be.

Right now they are probably putting their money into the very
treasury bills that are being issued to let them do this. That may
turn out to be a mistake.

Perversely, money also dries up because it's "velocity" slows as
Friedman folks would say, or it's "multiplier" (as Keynes described
it) works in reverse. That is every dollar circulated generates
virtual dollars as the dollars go from hand to hand, while money held
back sits idle. If you are rich and there is trouble, you take your
money out of "unsafe" things and put it where you can watch it.
Indeed traditionally during such times rich people would put their
money into Gold, Jewelry, real-estate, Cigarrettes, anything that
would preserve it's value.

But none of these things get investment going again. And as the much
maligned Keynes noted, nothing will get investment going as long
as "capacity" for production is excess, unutilized, and and "over-
capitalized." During the most recent bubble, miles of glass fiber
that had been worth millions was suddenly not even worth recycling.
When the next telecom crises occurs the same thing might happen to
all those miles of assets hanging in the air outside your home.

In depressions, factories sit idle, Hotels become homes for the
homeless or for "urban spelunkers", things that had had value just a
few years before become worthless piles of junk. Investor wealth may
not totally disagree but the "baloon" of apparant wealth shrinks to a
floppy shell of what it once was. Supply side doesn't work under
those conditions. Unless capitol investments are used and put to work
they are worthless. In Argentina people were reduced to bargaining
services because the money supply was useless. In Russia the system
was massively junked because the 'investors' didn't have any desire
to keep the old machines of the Socialist State running, and weren't
willing to invest in replacing them with new machinery.

"Trickle down" only happens if money is directly spent to at least
tide people over until the junk is junked and companies start needing
to buy new material again. If such a crises is looming, borrowing
money to forstall it will only make the inevitable worse when
the "iceberg" hits. This is what happened to Argentina, to Russia,
and is now happening to us. Obsolescence is setting in and we aren't
doing much to prepare for "post-obsolescence" and investors don't
know where to put their money.

Once you understand this, then one can see how Keyne's case fits in with "Say's law." Which is not a law, but a theorum, which applies generally -- in the long run but not necessarilly in the short run. Thus we come back to the sloppy thinking of the first article:
"The paradox of Say's Law is thus that capital, the "supply side," is
the only real means of improving the human condition"

And recognize that this is true in the long run. And that "supply side" capital is more than formal businesses but indeed is the result of the entire font of human effort, ingenuity, and creativity and that in the short run major things can block or prevent Say's law from applying.

" -- both the capital to create new production and the capital to create greater
productivity -- while "social" spending or regulation to artificially
promote demand through high wages, the "demand side," can easily
produce, or perpetuate, widespread poverty and misery."

And again, one can see that the weakness of this logic is that the author is assuming that social spending is artificially stimulating demand and setting up a causality that is not demonstrated. The important thing is that supply and demand for capital be balanced. Artificial prices can dry up capital, but so can artificially high quantities of surplus investment goods and machineery, runs on banks. If people are employed in jobs that generate high valued goods, then high wages are justified. If people are "eating the seed corn" or spending money instead of investing it, then that will perpetuate long term poverty and misery.

The second author notes this in his article:

"In the General Theory, Keynes developed a model of capitalism radically different from that of classical economists. He saw capitalism as inherently unstable and incapable of spontaneously maintaining full employment. According to Keynes, a decline in national income will bring about a decline in the demand for labor. Because of downward wage rigidity, unemployment will persist. With people out of work, the demand for consumption will be low; with business depressed, the demand for investment will be low. As Keynes saw it, the free-market economies of Britain, America, and France could not escape the Depression unless they changed their fiscal policies."

"Keynes advocated a full-scale program of central economic planning. According to his plan, the market should be guided or fine-tuned by government-employed experts. Government policies should be concerned with more than low interest rates and deficit spending--they should also directly influence the levels of private consumption and investment. On controlling consumption, Keynes wrote:"

"'The state will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the interest rate and partly, perhaps, in others ways. (p. 378)'"

All of which have been "normalization" practices of the Fed and the US since the 40's.

"Believing that capitalism will not automatically turn savings into investment, Keynes contemplated a nationalization of investment. The idea of government control of investment appears throughout the General Theory. He explained:"

"'I expect to see the State, which is in the position to calculate the marginal efficiency of capital-goods on long views and on the basis of general social advantage, taking an ever greater responsibility for directly organizing investment. (p. 164)'"

"I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands. (p. 320)"

"I conceive, therefore, a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment. (p. 378)"

The author then concludes:

"In order to save capitalism from its own destruction and the threat of national socialism, Keynes proposed to give government control of all investment, give it the power to spend more than it took in as taxes, and give it the power to influence private consumption patterns. In short, to save capitalism from socialism, Keynes proposed to socialize capitalism!"

The author misrepresents what Keynes is talking about and what Socialism is in this passage. Effectively Keynes is talking about "regulation." He wanted to somehow get investment efficiently into the "right hands" where it would do the best for society. This is not the same as "socializing capitalism" so much as socializing the public part of capitalism associated with the banking system. Effectively this was implemented without overt socialism by the State when it started World War II and organizations like Fannie Mae, Freddie Mac and others in order to ensure that ordinary people had the money to buy homes, start small businesses, or attend College. Without these organizations our country never would have managed some 60 years of relative stability compared with it's previous history.

The author goes on quoting: "At the end of the book, he defended his policies as necessary for individual freedom. He stated:"

"Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to investment, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as a condition of the successful function of individual initiative. (p. 380)"

The author, having set up his "straw" argument then proceeds to demolish it:

"The General Theory is a complex and fascinating work. However, the message that capitalism can only be saved if it is socialized, and that freedom can only be guaranteed if it is taken away, is Orwellian doublespeak at its best. How could a person as brilliant as Keynes have reached such seemingly contradictory conclusions? The answer to this question can be found in what his first biographer and friend, Sir Roy Harrod, called "the presuppositions of Number 6 Harvey Road" (p. 192-93)."

But Keynes was describing a very real reality of his times. To attack his modest proposals for some socialization of investment as "Orwellian" doublespeak is itself Orwellian propaganda. The destitution of workers and the inability of the country to pull out of rescession were not theoretical abstract side effects of the need of the economy to 'adjust' to changing times but were realities that threatened the existence and stability of the state and that the business community was neither inclined to do anything about nor capable of doing anything about. Other economicists, many of who never heard of Keynes, had the same ideas by trial and error. For example Mariner Eccles, who was a New Deal thinker was proposing similar ideas in the thirties, and later "confessed in later years he had not read him except in small extracts." (page 245-246 Franklin Delano Roosevelt and the New Deal by William E. Leuchtenberg) The author's own presuppositions are getting in the way of accepting the observations of John Maynard Keynes.

Posted by cholte at November 18, 2004 11:05 PM