Monday, December 01, 2008

Keynesian Spending Coming

On CNBC NPWE (Nobel Prize Winning Economist) Paul Krugman was giddy about the probability and size of future Federal Spending that Obama has hinted is in the pipeline. The government multiplier, if it worked, sure has not shown itself to increase GDP per capital or alleviate business cycles (Japan had a massive new fiscal stimulus package every two or three years from 1990 to 2005, and it did not work). But in any case, the logic of the government multiplier is rather straightforward partial equilibrium economics. It basically says, since people spend 60% of what they make, when the government spends $1, it actually creates $2.5 via the iteration of following that dollar through the economy (1+0.6+0.6^2+0.6^3+...). Thus, government spending basically pays for itself, because if you tax $2.5 by 40%, you get your initial dollar back!

This only works when we are below 'potential' GDP, which is the GDP if everyone were fully employed at the job of their choosing, which means never in real time (though economists look back wistfully at the 1960's and 1940's). An economic solution without a trade-off is surely too good to be true, and it was, as economies in the West all broke the bank in the 1960's and 1970's, and it just resulted in high amounts of debt, inflation, and lower productivity growth.

The idea that government spending has these multiplicative benefits irrespective of the cost-benefit of the actual government program is ridiculous. Plus, the only way to generate instant spending is not building bridges or roads because of the planning, logistics, and environmental impact issues, so if you have to actually write checks next year, you have to spend it on total patronage featherbeading: white collar bureaucrats who help implement jobs administering social work programs. It would be more honest and less annoying to pay them to join a UAW Jobs Bank (at least those people leave us alone).

Keynes was a good writer and no fool, but that does not mean his biggest ideas are any good. It is rare and admirable to be clever, but rarer still to be that and correct on things that are important. The net net of his General Theory is blather, as if the economy were a hydrodynamic pump; incentives, expectations, government borrowing, and the nature of government spending, did not matter. Tyler Cowen is blogging on the General Theory, but while a seminal work, its also wrong. There are lots of formerly popular theories from the past that don't work, so reading them for historical reasons is pretty unhelpful (like other signature books that were wrong: Coming of Age in Samoa, Silent Spring, Sexual Behavior in the Human Male, The Ego and the Id).

Keynes' Big Point was the dismissal of Say’s law, that supply creates its own demand, as opposed to the new theory, which is that government spending, properly managed, can keep an economy at “full employment.” So what has demand management wrought? Inflationary spirals and their inevitable cataclysms, a rationale for greater government spending, and a general waste of time looking at business cycles at the expense of growth theory. To Keynes, entrepreneurship and wealth creation were descriptions of any investment process whether managed by a politburo, a despot, or an energetic profit maximizer. Nancy Pelosi, Bill Gates--what's the difference? Clever, yes. Wise, no.

Schopenhauer said all truth passes through three stages. First it is ridiculed. Next it is violently opposed. Last it is recognized as self-evident. Conversely with proposed profundities that rationalize the current intellectual zeitgeist: first hailed as revolutionary, next found to have no empirical assertions that are true, and last recognized as merely 'inspirational'.

Many economists think that in spite of the contradictions, and some rather unfortunate wording about 'euthanizing the rentier' (this when Kulaks in Russia were being really euthanized), it was great because it created macroeconomics as we know it, and so could 'handle' the Great Depression. I think prior depressions, and regular recessions, were handled much better pre-1936 than post.

As stated by von Mises (see here):
His contribution consisted rather in providing an apparent justification for the policies which were popular with those in power…His achievement was a rationalization of the policies already practiced.

The Economist's economist, Paul Samuelson, said it best, describing Keynes' The General Theory as follows:
It is a badly written book, poorly organized… it is arrogant, bad-tempered, polemical… it abounds in mare's nests and confusions: involuntary unemployment, wage units, the equality of savings and investments, the timing of the multiplier, interactions of marginal efficiency upon the rate of interest and many others… flashes of insight and intuition intersperse tedious algebra. An awkward definition suddenly gives way to unforgettable cadenza. When it is finally mastered, we find its analysis to be obvious and at the same time new. In short, it is a work of genius.

With that kind of reasoning, we are all merely several beers away from genius. For some reason, really smart mathematicians are highly susceptible to those who seem intelligent but show no doubt, as if they reverse reason that the only way someone as smart as X could believe Y with such certainty, is that Y is true! Much of what we are taught as the high intellectual history of the social sciences is based more on the magnetism and impenetrable self-assurance of thinkers than on minor issues like whether they were right or not.


  1. Anonymous10:35 PM

    great post, thanks

  2. Anonymous8:18 AM

    ok, keynes was a kook and “in the long run we’re all dead” means “screw the next generations, they’ll pay our debt. i’m old, bitter and childless, so i don’t give a shit.” typical baby boomer thinking. it’s just bad morality and here’s something else for you. japanese managers have a huge problem now because young’uns don’t want any responsibility. only want to put 9-5 and go home. why? because they saw what happened to their parents who got screwed while banks got “recapitalized”.

  3. Eric
    Great post. I have been saying the same things to my friends for years. Most of the accomplishments of so-called intellectuals are primarily due to their mastery of their native language and their absence of doubt and humility. They sold their ideas so well that it does not matter that many of those ideas flamed out. Their reputations live on because the current generations of intellectuals, those who cut their teeth on their nonsense, possess all of the academic chairs.

    As for Keynes in particular, his greatest “accomplishment” was a critique of the classical model. He claimed that a “liquidity trap” could cause the entire model to fail. It was all of the justification the politicians needed to push us down the path to socialism, never mind that he never proved we were in a liquidity trap and never mind that it is highly doubtful we EVER were in a liquidity trap. As Arnold Kling wrote on his blog on 11-20-08:

    “…if anybody tries telling you that we are in a liquidity trap, tell him to shut his trap.”

    We do not need systems of equations and Cramer’s Rule to understand which economic theories will work, just common sense. Who believes that government bureaucrats can spend economic resources more efficiently than atomistic individuals? Keynesian economic stimulus spending only takes resources from the people who are productive (successful entrepreneurs and their hard working employees) and distributes it to the people who have proven that they are not productive (GM, Ford, the UAW, and extended unemployment benefits). And, the bureaucrats get a large cut of those resources on top of it all. Can someone please explain to me how taking resources out of the hands of productive people, giving a cut to bureaucrats, and then placing what is left in the hands of the unproductive will make the economy more productive?

  4. Anonymous7:55 PM

    We're below potential output. We could just push pallets of money out of helicopters. But even though much of it might be used inefficiently, we might as well use some of it to make sure our bridges don't collapse.

  5. Anonymous11:15 AM

    The quickest way to get consumer spending back in line is to give money to people who need it and have a propensity to spend it immediately. The worst way to stimulate the economy is to dump money into a sinking ship of outdated capital investments and historically bad thinking demonstrated by an arrogance so absurdly out of whack as to think a large corporation could create it's own market by producing large volumes of outdated, oversized junk marketed to an insistance on ignorance and a spiteful brand of pride. Need I say big 3?

    Long term market growth is only going to be realized by true market forces: one tenet being bad ideas will fail and good ideas will take their place. Let innovators take their rightful place and let innovation be need driven. Let the big 3 fail and let the network of resources behind them now scramble to produce a new economy of new ideas. Don't cozy up with failure. It makes no economical sense. Likewise, it makes no sense to reward the financial institutions for stupidly promoting property flipping and fostering a real estate market which has become atmospheric compared to payroll. Stupid! The liars and predators in our financial sectors should lose their jobs and be replaced by a work force and culture that is actually ethical! Then they can buy themselves a nice forclosere and make a life for themselves - maybe even hold on to the house for more than two years.

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