I’m pleased to promote another Hayek vs Keynes event at the London School of Economics:
Date: Monday 13 February 2012 Time: 6.30-8pm Venue: Sheikh Zayed Theatre, New Academic Building Speaker: Nicholas Wapshott Chair: Professor Danny Quah
Eighty years ago at the LSE, Friedrich Hayek launched an assault upon the new economic thinking of John Maynard Keynes. The clash was so bitter and vituperative that it scandalized the cloistered world of academia. Eighty years on, the differences between the two men have still not been finally resolved and their conflicting approaches to the economy continue to define the profound chasm between politicians of left and right.
The great debate between Keynesians and Austrians enters the digital age with the Mises Academy’s first ever online formal debate, between economists Karl Smith and Robert P. Murphy.
Resolved: Government Spending Can Play an Important Role in Boosting Economic Growth
Smith will argue in favor of this resolution, and Murphy will argue against.
The debate will be held by Webex, and costs $20. It will take place Friday, September 2nd at 1pm UK time, but will be recorded for later viewing.
Back in the ’30s, at the time of the original Keynes-Hayek debate, Hayek had a solid methodological system that could explain the causes of the recession of the late ’20s and early ’30s, and it’s subsequent gyrations, up and down.
The root cause was excessive credit creation by the world’s main central banks, and their fractional reserve private sector mints, the banks. This bank credit was loaned out to businesses who bought extra kit to produce goods and services more efficiently. The boom in producer sectors bid up relative prices for their resources. Higher wages for labour meant more consumption, boosting consumer sectors. This in turn pushed up relative prices in those sectors. Competition for resources bid up prices until no one believed the prices were sustainable — pop goes the mega bubble, and boom turns to bust. This is called the Austrian Theory of the Business Cycle.
At the BBC LSE Hayek v Keynes debate, Lord Skidelsky told us that everyone knew it was excess credit that caused this boom, and that this was called the “Treasury View.”
This of course is not true; the noble Lord is misinformed. The Treasury View was advanced by members of the Chancellor’s department saying, in short, that for every increase in public expenditure advocated by Keynesian types to alleviate the Great Depression effects, there would be an equivalent reduction in private sector expenditure that would mean that the net effect in the economy is zero.
Whilst I hold that this is a valid view, it is not one that gives us the theoretical tools to understand why boom and bust happen in the first place. Mises and Hayek gave us these tools with the Austrian Theory of the Business Cycle.
Neither the Treasury View, as expounded by the likes of Ralph Hawtrey, nor the Keynesian view were based on a series of logical deductions from root causes. The best Keynes could offer as an explanation for boom and bust was “animal spirits”. He is Theory Lite in this respect.
Unfazed by his shaky foundation, Keynes confidently prescribed how to correct an animal-spirit-induced bust. We are told to spend when the private sector is not spending. Who does this? The government on our behalf. The Treasury View makes clear that it’s futile to tax the private sector in order to spend, so we have the cries from modern day Keynesians to carry on borrowing and spending in order to force a correction . If you haven’t got the correction you desire, you have not borrowed enough! So say the likes of Krugman and Skidelsky, drunk on the intoxicating work of Keynes.
The faulty logic than runs underneath this way of thinking is called the “Circular Flow of Income.” This is now bread and butter in any economics text book. One person’s income, when spent on goods and services, becomes another person’s income. Cut one and you cut all. Therefore, a series of cuts or austerity measures is exactly what you should not be doing at a time of bust; you need to keep everyone’s income up.
Hayek held that relative prices and income where what mattered, not gross aggregates . If a man has an income of £100 and costs of £90, we can say he has a profit of £10. Then recession hits and he has an income of £85 and still costs of £90, so he is sunk by £5. Thus the aim of the man in question, with income of £85 is to get his costs down to under £75 and restore his profitability. As this is done, the foundations for recovery are laid. Even better, if he can get costs to £74, on lower income and a lower costs base, he is in fact more profitable than in the glorious boom times!
In the 5 mins each speaker had in this debate to present their case, some of this came across and some of it did not. Jamie Whyte and George Selgin did a fantastic job at putting forward the case for Hayek. Skidelsky sadly did not represent Keynes very truthfully, for the reasons I have outlined above. Selgin picked him up on various other errors and misrepresentations.
This debate is very relevant for today as no doubt we will be told the current market corrections are “Animal Spirits”, and that the answer is further government intervention.
The BBC tell us the debate had over 1 million listeners and was in their top 5 podcasts. In all my years studying at the LSE and as a donor to it, I have never seen three lecture theatres full of public and students alike. Not even for visiting Heads of State!
This is the debate of our times.
I am delighted to say that the program will be re-run, and they expect another 1.5 millions viewers. Our friend at the Mises Institute, Stephan Kinsella, has blogged all the details here. If you want to educate yourself a little more on these matters, or even if you think you are very familiar with all of the issues, the debate is definitely worth a listen. If you can’t wait for the next BBC broadcast, you can find it online as an MP3.
Since the original broadcast, the debate has continued online. On the 3rd of August, PrimeEconomics published a list of eight alleged fallacies in the Keynes/Hayek debate, drawing a number of responses, including some from George Selgin. On the same day, Selgin posted his own account of the debate at FreeBanking.org. More recently, on the 18th of August, Selgin took up Skidelsky’s suggestion that “no government has ever achieved a speedy recovery from a recession by clamping down on its spending or reducing its indebtedness”, citing the US recovery from a deep recession in 1920. The following day, Skidelsky published his account of the Keynes-Hayek rematch at Project Syndicate, declaring
Except to Hayekian fanatics, it seems obvious that the coordinated global stimulus of 2009 stopped the slide into another Great Depression.
You can read Selgin’s response at FreeBanking.org.
Personally, I look forward to the day when Paul Krugman will come and stand on that same stage where Hayek delivered his famous Prices and Production lectures, and engage in serious debate with Austrian economists. How many lecture theatres would that fill? What global TV audience would it draw?
For those at the BBC and for those at the LSE, I think my next Distinguished Hayek Fellowship Teaching Programme event the LSE should be just this debate, and I would be happy to support and fund whatever I can. I repeat, this is the debate of our times. Only someone of the stature of Krugman can represent Keynes, we need to move this debate up and along now.
Writing over 230 years ago, Adam Smith noted the ‘juggling trick’ whereby governments hide the extent of their public debt through ‘pretend payments’. As the fiscal crises around the world illustrate, this juggling trick has run its course. This article explores the relevance of Smith’s juggling trick in the context of dominant fiscal and monetary policies. It is argued that government spending intended to maintain stability, avoid deflation and stimulate the economy leads to significant increases in the public debt. This public debt is sustainable for a period of time and can be serviced through ‘pretend payments’ such as subsequent borrowing or the printing of money. However, at some point borrowing is no longer a feasible option as the state’s creditworthiness erodes. The only recourse is the monetarization of the debt which is also unsustainable due to the threat of hyperinflation.
Policy Implications
The fear of deflation on the part of policy makers has led to an inflationary bias which neglects or underestimates the costs of inflation.
The debt–inflation theory of economic crises must be considered as a viable alternative to the standard debt–deflation theory of economic crises.
In order to curtail the tendency of using the tools of monetary and fiscal policy to concentrate benefits and disperse costs, policy institutions must effectively tie the rulers’ hands.
After centuries of only fleeting success at curtailing the deficit, debt and debasement cycle of public policy, we may have to consider seriously the possibility that the only way successfully to constrain the state is to eliminate from its purview the task of monetary policy.
Writing in 1776, Adam Smith noted the following regarding public debt:
When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. … publick bankruptcy has been disguised under the appearance of a pretend payment. … When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonorable to the debtor, and least hurtful to the creditor. The honour of a state is surely very poorly provided for, when in order to cover the disgrace of real bankruptcy, it has recourse to a juggling trick of this kind … Almost all states, however, ancient as well as modern, when reduced to this necessity, have upon some occasions, played this very juggling trick (Smith, 1776, pp. 929–930).
The implications of Smith’s logic regarding public debt have come to fruition as evidenced by the violent situation in the streets of Athens, the situation facing the PIIGS (Portugal, Italy, Ireland, Greece and Spain) and the pending fiscal crisis facing US states such as California, Illinois and New Jersey. In each of these instances, the current predicament did not arise over the past year or two, but rather was the result of decades of public policy decisions resulting in fiscal imbalance. While pretend payments and the juggling of finances were able to hide the underlying realities for decades, the bill has now come due.
Over 230 years after Smith wrote The Wealth of Nations, the Great Recession has again brought debates about the public debt, and the role of government more broadly, to the forefront. The purpose of this article is to explore the relevance of Smith’s ‘juggling trick’ in the context of the dominant fiscal and monetary policies. Our central argument can be stated as follows: government spending intended to maintain stability, avoid deflation and stimulate the economy leads to significant increases in the public debt. This public debt is sustainable for a period of time and can be serviced through ‘pretend payments’ such as subsequent borrowing or the printing of money. However, at some point borrowing is no longer a feasible option as the state’s credit- worthiness erodes. This implies that the ultimate result of Smith’s juggling trick is the monetarization of the debt in order for the state to avoid bankruptcy. This too, however, is an unsustainable policy due to the threat of hyperinflation which has ravaging effects as evidenced by Russia and Germany in the early 20th century.
We proceed as follows. The next section shows how the current debates over public debt mirror the debate that took place during the 1930s between John Maynard Keynes and F. A. Hayek. We also highlight how concerns over the debt–deflation spiral emerged as part of this debate and continue to drive policy today. Section 2 discusses the mechanisms underpinning the debt–inflation cycle. We contend that the focus on deflation leads to an inflation-biased policy which neglects the cost of inflation and the logic of democratic politics that Smith highlighted in the opening quote. Section 3 lays out the dilemma we face. On the one hand we have theories indicating that active fiscal and monetary policies are necessary for recovery and growth. At the same time, we have public choice theories which indicate that increased public debt is ultimately unsustainable. Section 4 concludes with the lessons learned.
1. Back to the future
In the 1930s, the main macroeconomic debate in economic theory and policy centered around the question of who was right, Keynes or Hayek? In the wake of the Great Depression, Keynes argued that unless action was taken to stimulate aggregate demand the economy would sink further into an abyss of unemployment and lackluster economic growth. In contrast, Hayek argued that fiscal irresponsibility threatened the recovery and long-term economic health of the economy. The key to recovery and growth, according to Hayek, was private investment.
Keynes won the day in the 1930s, but in the 1970s that same debate resurfaced with a more ambiguous resolution, and since 2008 the debate has returned with a vengeance at a variety of levels. The current debate mimics the earlier one in that there is intense academic dispute about the causes of the Great Recession, as well as the best way forward. Further, as during the 1930s, the debate is also being played out in newspapers and magazines, as well as in vigorous political dialogue between conservative and liberal politicians on both sides of the Atlantic. Perhaps nothing illustrates more how the current debate mirrors that of the 1930s than the comparison of the writings in the pages of the major newspapers (see Boettke et al., 2010).
On 17 October 1932, D. H. Macgregor, A. C. Pigou, J. M. Keynes, Walter Layton, Arthur Salter and J. C. Stamp (Macgregor et al., 1932) published a letter in the Times of London noting that private spending was one of the primary causes for the continuation and severity of the Great Depression. They argued that immediate government action was necessary to counteract the fall in aggregate demand. Two days later, T. E. Gregory, F. A. von Hayek, Arnold Plant and Lionel Robbins (Gregory et al., 1932) responded in the same paper arguing that private investment was necessary to recovery and growth.
Eighty years later, a similar debate took place. On 14 February 2010, a group of economists led by Timothy Besley published a letter in the Sunday Times arguing for a credible fiscal plan to create confidence in the robustness of the UK system (Besley et al., 2010). Only by reducing the structural budget deficit, the authors argued, could the confidence of private investors be maintained. Four days later, a group of economists led by Lord Skidelsky, Keynes’ biographer, published a letter in the Financial Times arguing that the immediate concern should not be reducing the deficit, but instead ensuring robust growth through public spending (Skidelsky et al., 2010).
As the comparison of these two exchanges illustrates, the high stakes in the 1930s regarding government policy still exist decades later. However, the debate cannot be adequately understood in broad brush strokes of free market versus government intervention, or even in terms of the effectiveness of fiscal policy or monetary policy. It is much more subtle than that, even as it does turn ultimately on the question of the self-correcting capacity of the market economy. To understand the debate, one has to recognize the classic position carved out in the 1930s by Irving Fisher (1933). Fisher argued that a debt–deflationary spiral can sink an economy into a great depression unless the appropriate policies are performed to prevent the downward spiral of economic activity. Deflation, in other words, must be avoided by the monetary authorities, even at significant cost.
This preoccupation with avoiding deflation necessarily leads to an inflation-biased monetary policy. The ‘chief source of the existing inflationary bias’, Hayek wrote, ‘is the general belief that deflation … is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable’ (Hayek, 1960, p. 330). The practical problem in monetary policy under this set of assumptions results in a situation where because ‘we do not know how to keep price completely stable and can achieve stability only by correcting any small movement in either direction, the determination to avoid deflation at any cost must result in cumulative inflation’ (Hayek, 1960, p. 330).
There are at least two major policy issues with the preoccupation with deflation. First, a positive case for declining price levels can be made since deflation, if it reflects generalized productivity gains that result from technological innovation in an economy, is good, not bad (see Selgin, 1997). It is complicated, if not impossible, to sort out as a matter of public policy good deflation from bad deflation. As a result, we are back again to the situation of cumulative inflation stressed by Hayek. Second, the self-reversing of the economic errors caused by inflation can be interpreted as a collapse in spending and a corresponding decline in economic activity as resources are reallocated, and thus those who fear deflation will call for a re-inflation to forestall the debt–deflation downward spiral. Hayek argues that the problem politically is that moderate inflation will be viewed pleasantly and will be revealed to be costly only in the future, whereas deflation is immediately observable and painful. Expediency in politics will reinforce the push for inflation, whereas politics by principle would demand permitting market adjustment and the reallocation of resources however painful in the short run (see Hayek, 1973, pp. 55–71).
The concern of deflation, and the neglect of inflation, have continued to the present day as evidenced by a recent speech by Federal Reserve Chairman Ben Bernanke (2010) in which he noted:
the FOMC [Federal Open Market Committee] will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation.
Recognizing Fisher’s concern for the debt–deflationary spiral is crucial because while the debate between Keynes and Hayek focused largely on fiscal policy, the fear of deflation shifted focus to monetary policy. The combined result was, and continues to be, a policy characterized by a proactive Keynesian case for fiscal policy to stimulate growth, and a proactive monetarist (and proto-monetarist) policy to avoid deflation. This, however, puts us in the very situation raised by Smith in The Wealth of Nations. How do we avoid the natural tendency of politicians and policy makers to engage in the juggling trick that hides the true costs of these proactive fiscal and monetary policies through increased borrowing and the monetarization of debt which can ultimately destroy an economy?
2. The public debt–inflation cycle
Smith’s recognition of the juggling trick regarding public debt is especially prescient because it correctly recognized the incentives facing elected officials well before the public choice revolution of the 1960s. This focus on basic incentives was lost with the Keynesian revolution. As Zingales (2009a) notes, ‘Keynes studied the relation between macroeconomic aggregates, without any consideration for the underlying incentives that lead to the formation of these aggregates. By contrast, modern economics base all their analysis on incentives’. This is a crucial point because fiscal and monetary policy is not designed in a vacuum. Instead, we must consider the incentives at two levels. First, we must understand the incentives facing policy makers when they design policy. Second, we must consider the incentives created by those policies. Let us consider each of these incentives in turn.
The logic of Smith’s ‘juggling trick’ insight was based on the basic incentives facing elected officials. Government can raise revenue in three ways: taxation, debt and inflation. To maintain popularity, governmental leaders prefer not to raise explicit taxes, so the preferred method of revenue generation is to borrow and then pay debts back with debased currency (an implicit tax). The democratic bias is to concentrate the benefits of public policy on well-organized and well-informed voters in the short run, and disperse the costs of public policy on the ill-organized and uninformed masses in the long run. The least informed and organized interest group at any point of time is future generations. Hence, the natural proclivity for the ruling regime is to run deficits that result in accumulated public debt, which is paid off with debasement. Throughout history this governmental habit of deficit, debt and debasement is what has brought down regimes and with that sometimes civilizations (see Groseclose, 1961, pp. 57–76; Rothbard, 1990 [1963], pp. 63–64).
It is this logic that has historically underpinned calls for an independent central bank, and various constraints on the policy discretion of both the treasury and the central bank. Ideally, rules must be designed to prevent policy cooperation ⁄ collusion between the fiscal and monetary policy makers precisely because we know the history of the political temptations to be seduced by the opportunity to engage in the juggling trick that Smith so long ago identified.
However, the problem goes beyond the incentives facing policy makers. The process of engaging in Smith’s juggling trick also creates perverse incentives in the private arena as proactive fiscal and monetary policies have led to increased efforts on the part of private actors to influence these policies for their personal gain. This raises the return to lobbying and rent-seeking activities relative to productive entrepreneurial activities, which are necessary not only for immediate recovery, but for long-term growth.
This interplay between the incentives facing policy makers and private businesspeople has resulted in a ‘vicious circle’ of favouritism and a lack of trust in financial and political institutions by citizens (see Zingales, 2009b). Politicians are intertwined with private markets as the logic of special interests discussed above (see Smith et al., forthcoming). At the same time, politicians seek to signal to citizens that they are independent of private interests. They do so by adopting strong policies against those private interests in the wake of crisis – increased regulation, threatened and actual taxes and fines, etc. This attempt to send a strong signal, however, has the unintended effect of creating an uncertain environment for subsequent investment which further exacerbates the fundamental problem of encouraging private investment for recovery and growth.
3. Misdiagnosing the sickness and cure
We are faced with a dilemma. On the one hand, the dominant theories of economic crises indicate that government must play a proactive role in getting the economy out of the depressed state of affairs. Active fiscal policy must be used to stimulate aggregate demand while active monetary policy must be used to avoid a deflationary spiral. However, we also have public choice theories dating back to Adam Smith which indicate that these very government actions are unsustainable and economically destructive.
The trends seem to support the Smith ⁄ public choice line of reasoning. In Capitalism and Freedom, Milton Friedman (1962, p. 75) pointed out that the primary justification of the expansion of public expenditure since the Second World War has been the ‘supposed necessity for government spending to eliminate unemployment’; an idea, Friedman goes on to argue, that has been thoroughly discredited by theory and practice. But, as he points out, ‘The idea may be accepted by none, but the government programs undertaken in its name, like some of those intended to prime the pump, are still with us and indeed account for ever-growing government expenditures’ (Friedman, 1962, p. 76). Close to 20 years later, Friedman noted that little had changed from when he first made those observations. ‘The repeated failure of well-intentioned programs is not an accident. It is not simply the result of mistakes of execution. The failure is deeply rooted in the use of bad means to achieve good objectives.’ But in spite of the overwhelming record of failure, these programs continue to expand. ‘Failures are attributed to the miserliness of Congress in appropriating funds, and so are met with a cry for still bigger programs’ (Friedman and Friedman, 1980, pp. 87–88).
Further, in the 25-plus years since those words were written little has changed in the day-to-day operation of politics, though Friedman was successful in transforming the rhetoric in the direction of market-economics language. At best, the growth of government was slowed, but it is important to stress that neither the Reagan nor Thatcher administrations reversed the trend line, and in the subsequent years even that slowing of the growth of government was reversed, especially after the 11 September 2001 terrorist attacks and the ensuing military conflicts and enhanced domestic security measures.
It is important to stress this because one of the great mythologies is that the Great Recession is evidence of the failure of unregulated capitalism. A similar mythology arose concerning the Great Depression. As Friedman and Friedman summed it up:
The depression convinced the public that capitalism was defective; the war, that centralized government was efficient. Both conclusions were false. The depression was produced by a failure of government, not of private enterprise. As to the war, it is one thing for government to exercise great control temporarily for a single overriding purpose shared by almost all citizens and for which almost all citizens are willing to make heavy sacrifices; it is a very different thing for government to control the economy permanently to promote a vaguely defined ‘public interest’ shaped by the enormously varied and diverse objectives of its citizens (Friedman and Friedman, 1980, pp. 85–86).
Failing to distinguish between unregulated capitalism and state-led capitalism, or mercantilism, has two negative consequences. The first is that it runs the risk of misdiagnosing the problem. If failures are attributed to capitalism when they are in fact the result of distortions caused by fiscal and monetary policies, this will lead to an incorrect diagnosis of the actual problem. The second, and related, consequence is that it runs the risk of misdiagnosing the solution. If, in fact, the cause of downturns is distortions caused by past fiscal and monetary solutions, then it is incorrect to assume that these same policies are the solution to the very problem they caused.
There is reason to believe that both types of misdiagnosis are at work in the current crisis. Zingales (2009a) notes that Keynesian policies have not only failed to avoid the current crisis but instead were a contributing factor to its onset. He writes that ‘The Keynesian desire to manage aggregate demand, ignoring the long-run costs, pushed Alan Greenspan and Ben Bernanke to keep interest rates extremely low in 2002, fuelling excessive consumption by the household sector and excessive risk-taking by the financial sector’ (Zingales, 2009a). Similarly, Taylor (2009) has documented how easy monetary policy combined with government programs that unintentionally shifted the incentives for risk taking caused and prolonged the current crisis. Finally, Rajan (2010) highlights how the role of loose monetary policy and the political push for easy housing credit contributed to the current crisis.
Prior to the onset of the crisis, economists too quickly identified the lack of macroeconomic volatility with the perfection of central banking, rather than seeing policies in terms of Smith’s juggling trick whereby fiscal and monetary policies paper over (literally) the efforts by market forces to correct for the misleading signals of the previous period of manipulation of money and credit in the economy. The Fed ‘getting off track’, to borrow Taylor’s (2009) apt phrase, was due to efforts to keep the previous misguided set of economic activities afloat rather than permitting the necessary adjustment to economic reality by market participants.
To the extent that Zingales, Taylor and Rajan are correct that past fiscal and monetary policies were a factor in causing the current situation, what confidence do we have that those same policies can now solve the existing predicament they helped to create? Further, to the extent that these policies are successful, they will only be so in the short run as they are just a continuation of the juggling trick. As the debt crises around the world illustrate, while payment can be delayed, eventually the bill becomes due.
4. Lessons learned
What have we learned from the Great Recession? We would like to highlight three lessons which we hope will be the subject of subsequent debate and discussion.
First, the debt–inflation theory of economic crises must be considered as a viable alternative to replace the debt–deflation theory of economic crises. Under the debt–deflation theory policy makers interpret every downturn in economic activity as a potential deflation, and therefore counteract it with easy monetary policy. When this happens market corrections will be cut short, and the previous boom is recreated through the manipulation of money and credit.
Ludwig von Mises (1966 [1949]) and F. A. Hayek (1979) were early expositors of an expectation-based macro-economics arguing that efforts to offset economic downturns through monetary policy enter a dangerous game of expectations and anticipated inflation. As Hayek argued, ‘We now have a tiger by the tail: How long can this inflation continue? If the tiger [of inflation] is freed, he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished!’(Hayek, 1979, p. 110, emphasis added) It is this theory of the ‘crack-up boom’ (see Mises, 1966 [1949], pp. 426–428) that very well may be what we have seen manifesting itself in reality with the onset of the Great Recession in 2008. If this is accurate then the policy steps taken to date have merely reinforced, rather than ameliorated, the problem as a market correction to previous malinvestments has been turned into a global crisis by the very steps taken to prevent the market correction from occurring.
Second, to curtail the tendency of using the tools of monetary and fiscal policy to concentrate benefits and disperse costs, policy institutions must effectively tie rulers’ hands to eliminate the possibility of engaging in the juggling trick that Smith warned against. The importance of establishing credible and binding constraints on monetary authorities and government spending is by no means a new idea. However, modern history has demonstrated the elusiveness of the quest to establish binding and credible constraints on monetary and fiscal authorities.
This has important implications because the relevant question is not if constraints should be established, but instead whether binding constraints can be established within the existing institutional framework. If that institutional framework is vulnerable to the inevitable errors committed by policy makers – either innocent or malevolent – then the problem is not in the framework, it is the framework. Milton Friedman (1962, pp. 50–51) recognized this possibility when he wrote:
Any system which gives so much power and so much discretion to a few men that mistakes – excusable or not – can have such far reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic – that is the key political argument against an ‘independent’ central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an ‘independent’ bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers.
Similarly, Buchanan and Wagner are pessimistic of the ability to restrain the state from engaging in juggling tricks leading them to conclude that, ‘politically, Keynesianism may represent a substantial disease, one that can, over the long run, prove fatal for a functioning democracy’ (Buchanan and Wagner, 1977, p. 56, emphasis added).
This leads to our third and final lesson. After centuries of only fleeting success at curtailing the deficit, debt and debasement cycle of public policy, we may have to consider seriously the possibility that the only way successfully to constrain the state is to eliminate from its purview the task of monetary policy. Rather than a centralized and government monopoly control of the money supply, perhaps more decentralized and competitive institutional arrangements might have to be relied upon. Of course, what is required is the attention of economists to examine such institutional arrangements in depth and with all their critical attention. What cannot continue is the standard practice of looking at central banking theory and practice as if they were to be done by fully informed agents who act only in the public interest. Instead, a robust theory of the institutions of the monetary framework must be developed.
References
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Besley, T., Davies, H., Goodhart, C., Marcet, A., Pissarides, C., Quah, D. et al. (2010) ‘UK Economy Cries Out for Credible Rescue Plan’, Sunday Times, 14 February, p. 26.
Boettke, P. J., Smith, D. and Snow, N. (2010) ‘Been There Done That: Political Economy of Déjà vu’, mimeo.
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Smith, A., Wagner, R. E. and Yandle, B. (forthcoming) ‘A Theory of Entangled Political Economy, with Application to TARP and NRA’, Public Choice.
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John Papola and Russ Roberts, of EconStories, gave themselves a difficult problem when they created their first incredible Keynes vs. Hayek video.
It was like your first girlfriend being Miss World, your first rugby match being the World Cup final between England and Australia, or your first cricket match being an Ashes decider starring Freddie Flintoff.
How do you top that?
Well, it’s just about impossible. But you can at least attempt to match it, and in doing so, you may even surprise yourself, sneak up on the outside, and outdo the original without really meaning to.
So, here’s the latest video in the sequence.
While you decide if Mr Papola and Mr Roberts have matched (or even possibly bettered?) their first contest between Keynes and Hayek, look out for the Chairsatan himself, the Ben Bernank, whose dissembling conference yesterday pushed gold up to new record heights:
Here’s the EconStories description of the video above:
According to the National Bureau of Economic Research, the Great Recession ended almost two years ago, in the summer of 2009. But we’re all uneasy. Job growth has been disappointing. The recovery seems fragile. Where should we head from here? Is that question even meaningful? Can the government steer the economy or have past attempts helped create the mess we’re still in.
John Maynard Keynes and F. A. Hayek never agreed on the answers to these questions and they still don’t. Let’s listen to the greats. See Keynes and Hayek throwing down in “Fight of the Century”.
(This talk was delivered at a debate on whether “America Should Adopt the Gold Standard,” sponsored by the Atlas Economic Research Foundation and the Forum for Citizenship and Enterprise, held at Northwood University on March 29, 2011)
The severity of the current economic crisis has been serving as a catalyst for reconsideration of some fundamental questions about economic policy. This has included the size and role of government in society, the national debt burden and the unsustainability of various entitlement programs, and the relevance of fiscal “stimulus” for economic recovery.
It has also thrown up into sharp relief some crucial flaws in the nature and workings of the prevailing monetary system. The central question, I would argue, is whether or not we should continue to leave monetary and banking policy in the discretionary hands of central banks and the monetary central planners who manage them.
Central Banking as Monetary Central Planning
And make no mistake about it. Central banking is monetary central planning. The United States and, indeed, virtually the entire world operate under a regime of monetary socialism. Historically, socialism has meant an economic system in which the government owned, managed, and planned the use of the factors of production.
Modern central banking is a system in which the government, either directly or through some appointed agency such as the Federal Reserve in the United States, has monopoly ownership and control of the medium of exchange. Through this control, the government and its agency has predominant influence over the value, or purchasing power, of the monetary unit, and can significantly influence a variety of market relationships. These include the rates of interest at which borrowing and lending goes on in the banking and financial sectors of the economy, and therefore the patterns of savings and investment in the market.
If there is one lesson to be learned from the history of the last one hundred years – during which the world and the United States moved off the gold standard and onto a government-managed fiat, or paper, money system – is the fundamental disaster of placing control of the money supply in the hands of governments.
Government Abuse of Money and the Benefits of the Gold Standard
If is worth recalling that money did not originate in the laws or decrees of kings and princes. Money, as the most widely used and generally accepted medium of exchange emerged out of the market transactions of a growing number of buyers and sellers in an expanding arena of trade. Commodities such as gold and silver were selected over generations of market participants as the monies of free choice, due to their useful characteristics to better facilitate the exchange of goods in the market place.
And for almost all of recorded history, governments have attempted to gain control of the production and manipulation of money to serve their seemingly insatiable appetite to extract more and more of the wealth produced by the ordinary members of society. Ancient rulers would clip and debase the gold and silver coins of their subjects. More modern rulers – whether despotically self-appointed through force, or democratically elected by voting majorities – have taken advantage of the monetary printing press to churn out paper money to fund their expenditures and redistributive largess in excess of the taxes they impose on the citizenry. Today the process has become even easier through the mere click of a “mouse” on a computer screen, which in the blink of an eye can create tens of billions of dollars out of thin air.
Thus, monetary debasement and the price inflation that normally accompanies it have served as a method for imposing a “hidden taxation” on the wealth of the citizenry. As John Maynard Keynes insightfully observed in 1919:
By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose.
It is the corrosive, distortive, and destructive effects from monetary manipulation by governments that led virtually all of the leading economists of the nineteenth century to endorse the “anchoring” of the monetary system in a commodity such as gold, to prevent governments from using their powers over the creation of paper monies to cover their budgetary extravagance. John Stuart Mill’s words from the middle of the nineteenth century are worth recalling:
No doctrine in political economy rests on more obvious grounds than the mischief of a paper currency not maintained at the same value with a metallic, either by convertibility, or by some principle of limitation equivalent to it . . . All variations in the value of the circulating medium are mischievous; they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious . . .
Great as this evil would be if it [the supply of money] depended on [the] accident [of gold production], it is still greater when placed at the arbitrary disposal of an individual or a body of individuals; who may have any kind or degree of interest to be served by an artificial fluctuation in fortunes; and who have at any rate a strong interest in issuing as much [inconvertible paper money] as possible, each issue being itself a source of profit. Not to add, that the issuers have, and in the case of government paper, always have, a direct interest in lowering the value of the currency because it is the medium in which their own debts are computed . . . Such power, in whomsoever vested, is an intolerable evil.
Under a gold standard, it is gold that is the actual money. Paper currency and various forms of checking and other deposit accounts that may be used in market transactions in exchange for goods and services are money substitutes, representing a fixed quantity of the gold-money on deposit with a banking or other financial institution that are redeemable on demand.
Any net increases in the quantity of currency and checking and related deposits are dependent upon increases in the quantity of gold that depositors with banking and financial institutions add to their individual accounts. And any withdrawal of gold from their accounts through redemption requires that the quantity of currency notes and checking and related accounts in circulation be reduced by the same amount. Under a gold standard, a central bank is relieved of all authority and power to arbitrarily “manage” the monetary order.
Many critics of the gold standard consider this a rigid and inflexible “rule” about how the monetary system and the quantity of money in the society is to be determined and constrained. Yet, the advocates of the gold standard have long argued that this relative inflexibility is essential to discipline governments within the confines of a “hard budget.”
Without the “escape hatch” of the monetary printing press, governments either must tax the citizenry or borrow a part of the savings of the private sector to cover its expenditures. Those proposing government spending must either justify it by explaining where the tax dollars will come from and upon whom the taxes will fall; or make the case for borrowing a part of the savings of the society to cover those expenditures – but at market rates of interest that tell the truth about what it will cost to attract lenders to lend that sum to the government rather than to private sector borrowers, and therefore, at the social cost of private sector investment and future growth that will have to be foregone.
In other words, it prevents the government from “monetizing the debt” to cover all or part of its budget deficits. The borrowed sums cannot be created out of thin air through central bank monetary expansion. The government, under a gold standard, can no longer create the illusion that something can be had for nothing.
As Austrian economist, Ludwig von Mises, expressed it:
Why have a monetary system based on gold? Because, as conditions are today and for the time that can be foreseen today, the gold standard alone makes the determination of money’s purchasing power independent of the ambitions and machinations of governments, of dictators, and political parties, and pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called “sound money.”
Milton Friedman’s “Second Thoughts” About the Benefits of Paper Money
It must be admitted that even some advocates of economic freedom and limited government have been advocates of paper money. The most notable one in the second half of the twentieth century was Milton Friedman. Over most of his professional career he argued that maintaining a gold standard was a waste of society’s resources. Why squander the men, material and machinery digging gold out of the ground to then simply store it away in the vaults of banks? It is better to use those scarce resources to produce more of the ordinary goods and services that can enhance the standard and quality of people’s lives. Control the potential arbitrary recklessness of central banks, Friedman proposed, by setting up a monetary “rule” that says: Increase the paper money supply by some small annual percent, with no discretion left in the hands of the monetary managers.
But it less well known is that in the years after Friedman won the Nobel Prize in Economics in 1976, he had second thoughts about this monetary prescription. In a 1986 article on, “The Resource Costs of Irredeemable Paper Money,” he argued that when looking over the monetary mismanagement and mischief caused by governments and central banks during the twentieth century, it was “crystal clear” that the costs of mining, minting and storing gold as the basis of a monetary system would have been far less than the disruptive and destabilizing costs imposed on society due to paper money inflations and the booms and busts of the business cycle brought about by central bank manipulations of money and interest rates.
In his 1985 presidential address before the Western Economic Association on “Economists and Public Policy,” he said that Public Choice theory had persuaded him that it would never be in the long-run self-interest of governments or central bankers to manage the monetary system according to some hypothetical “public interest.” Those in government or holding the levers of the monetary printing press will always be susceptible to the temptations and pressures of short-run political gains that monetary expansion can fund. He admitted that it had been a “waste of time” on his part to try to get governments and central banks to follow his idea for a monetary rule.
And in another article in 1986 (co-authored with Anna Schwartz) on, “Has Any Government Any Role in Money?” Friedman said that while he was not ready at that time to advocate a return to the gold standard, he did conclude that “that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.”
Monetary Mismanagement versus Markets and Gold
But it is not only the political dangers arising from government mismanagement of paper money that justifies the establishment of a gold standard. It is also and equally the fact that monetary central planning is unworkable as a means to maintain economy-wide stability, full employment, and growth.
Especially since the 1930s, many economists and policy makers influenced by Keynes and the Keynesian Revolution have believed markets are potentially unstable and susceptible to wide and prolonged fluctuations in employment and output that only can be prevented or reduced in severity through “activist” monetary and fiscal policy.
But in reality, the causation runs the in the opposite direction. It is central bank manipulations of money, credit and interest rates that have generated the instability and periodic swings in economy-wide production and employment.
The fact is financial institutions and interest rates have important work to do in the market economy. Banks and other financial intermediaries are supposed to serve as the “middlemen” who bring together those who wish to save portions of their earned income with others who desire to borrow and invest that savings in profit-oriented productive ways that generate capital formation, technological improvements, and cost-efficient production of new, better and more goods and services to satisfy consumer demands in the future.
Market-determined interest rates are meant to bring those savings and investment plans into coordination with each other, so the amount of invested capital and the time-shape of the investment horizons undertaken are consistent with the available real savings to support them to maintainable completion.
Monetary expansion by central banks creates the illusion that there is more actual investable savings in the economy than really exists. And the false interest rate signals generated in the banking system by the monetary expansion not only misinforms potential investment borrowers about the amount of real savings available for capital projects, but creates an incorrect basis for determining the present value calculations that influence the time horizons for the investments undertaken.
It is these false monetary and interest rate signals that induces the misdirection of resources, the mal-investment of capital, and the incorrect allocation of labor among employments in the economy that sets the stage for an inevitable and inescapable “correction” and readjustment that represents the recession stage of the business cycle that follows the collapse of the artificial boom.
The monetary central planners can never be more successful in determining a “optimal” quantity of money or the “right” interest rates to assure savings-investment coordination than all other socialist planners were when they tried to centrally plan agricultural production or investment output for an entire society. All such attempts at monetary planning and management by central bankers are instances of what Friedrich A. Hayek called in his Nobel Lecture a, “pretense of knowledge,” that they can know better and do better than the outcomes generated by competitive interactions of the market participants, themselves. And as Adam Smith warned, nowhere is such regulatory power “so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it.”
There is no way of knowing the optimal amount of money in the economy other than allowing market participants in the competitive exchange process to decide what they want to use as money – which has historically been a commodity such as gold or silver. And there is no way of knowing what interest rates should be other than allowing the market forces of supply and demand for lending and borrowing to determine those interest rates through the process of private sector financial intermediation, without government or central bank interference or manipulation.
The Return to the Gold Standard as a Monetary Constitution
Finally, how do we return to a functioning and workable gold standard? Under the current government and central bank-controlled monetary system the simplest method might be for the monetary authority to stop creating and printing money and credit. Over a short period of time a fairly reasonable estimate could be made about the actual quantity of a nation’s currency and checking and related deposits that are in existence and in circulation. A new legal redemption ratio could be established by dividing the estimated total quantity of all forms of these money-substitutes into the quantity of gold possessed by the government and the central bank.
A country following this procedure would then, once again, be on the gold standard. Its long-run maintainability, of course, would require the government and the central bank to follow those “rules of the game” that no increase in the quantity of money-substitutes may be created and brought into circulation unless there have been net deposits of gold in people’s accounts with banking and other financial institutions.
Can we trust governments and central banks to abide by these rules of the game? The temptations to violate them will still remain strong in a political environment dominated by ideologies of wealth redistribution, special interest favoritism, and numerous “entitlement” demands.
It is why the real long-run goal of monetary reform should be the denationalization of money. That is, the separation of money from the state by ending of central banking, altogether. In its place would emerge private, competitive free banking – a truly market-based money and banking system.
But nevertheless, in the meantime, a gold standard can serve as a form of a “monetary constitution” setting formal limits and imposing restraints on those in government who would want to abuse the monetary printing press, similar to the way political constitutions, however imperfectly, are meant to limit the abuses of power-lusting monarchs and the plundering majorities in functioning democracies.
If it fails, it should not be for want of trying. And a gold standard can be one of the positive institutional reforms in the attempt and on the way to a fully free market monetary system.
Several thoughts pirouetted across my mind as I watched the coverage of Saturday’s protest and riots.
I wondered why anti-capitalists were wearing clothing with prominent labels (don’t they know their Naomi Klein?); I wondered why defenders of the public sector were attacking publicly owned banks; I wondered how one protester could say, when interviewed, “Of course, we all know there need to be cuts” while a sea of people drifted past her waving signs saying ‘No cuts’; I wondered why Ed Miliband, a bloke without an alternative, was addressing the March for an Alternative.
But most of all I was struck by what a boon this all was for the economy, or so some would tell you. The standard Keynesian narrative of the Depression of the 1930’s, for example, holds that it was all about a collapse in aggregate demand which was only solved by, first, New Deal spending, and then war spending. As Paul Krugman once put it
Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes — who was very much a builder of little models. And what they said was, “This is a failure of effective demand. You can cure it by pushing this button.” The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right
The fact that large swathes of the planet’s human and physical capital was blown to atoms represented simply an ‘opportunity for growth’.
So surely all the random destruction in the West End should be a good thing? Perhaps not. Back in 1850, Frédéric Bastiat asked “Have you ever witnessed the anger of the good shopkeeper, James B., when his careless son happened to break a square of glass?” In his classic, Economics In One Lesson, Henry Hazlitt took up the story
A young hoodlum, say, heaves a brick through the window of a baker’s shop. The shopkeeper runs out furious, but the boy is gone. A crowd gathers, and begins to stare with quiet satisfaction at the gaping hole in the window and the shattered glass over the bread and pies. After a while the crowd feels the need for philosophic reflection. And several of its members are almost certain to remind each other or the baker that, after all, the misfortune has its bright side. It will make business for some glazier. As they begin to think of this they elaborate upon it. How much does a new plate glass window cost? Fifty dollars? That will be quite a sum. After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $50 more to spend with other merchants, and these in turn will have $50 more to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be, if the crowd drew it, that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor.
Now let us take another look. The crowd is at least right in its first conclusion. This little act of vandalism will in the first instance mean more business for some glazier. The glazier will be no more unhappy to learn of the incident than an undertaker to learn of a death. But the shopkeeper will be out $50 that he was planning to spend for a new suit. Because he has had to replace a window, he will have to go without the suit (or some equivalent need or luxury). Instead of having a window and $50 he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window and no suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer.
The glazier’s gain of business, in short, is merely the tailor’s loss of business. No new “employment” has been added. The people in the crowd were thinking only of two parties to the transaction, the baker and the glazier. They had forgotten the potential third party involved, the tailor. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye.
The resilience of palpable nonsense is staggering. If, as Bastiat and Hazlitt demonstrate, the idea that the trashing of businesses is good for business, then consider what Clinton-era Treasury Secretary Larry Summers said about the Japanese earthquake recently
It may lead to some temporary increments ironically to GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake Japan actually gained some economic strength
This is crass rubbish. Lots of new building activity may take place in Japan but they will simply be restocking on, say, housing. Rebuilding the house you have just watched destroyed does not make you better off.
Yet this drivel has the imprimatur of The Master himself who wrote in The General Theory
Pyramid-building, earthquakes, even wars may serve to increase wealth
That will no doubt come as a great comfort to West End workers and homeless Japanese.
Having recently sold my food business, life is moving at a much slower pace, which gives time for thought and reflection before I undertake my next venture or ventures. One thought was: what did I learn from academia that I applied to my business dealings?
I concluded that my behaviour was moved by my instinct and alertness to opportunity, and my ability to provide strategic leadership to people and give them vision. With my actions over the years I was always Hayekian in outlook.
I could not say for sure if my reading of Hayek made me behave and structure my business as I did, or if I just did it because common sense always told me that local management, with profit and loss responsibility handed down to the smallest units possible, and as little reliance on the central head office function as possible, was the only way forward. In fact, to the day I sold, I never did have a head office. This perplexed bankers, accounts etc, but no one else.
I also used to say to my people, “if the man from Mars (read: management consultant, banker, accountant, anyone who’s good at spreadsheets and sits at a desk) came down and looked at our business, he would say we are mad”. We would sometimes send three vehicles to deliver fish down the same road to different people at different times of the day — we should surely consolidate these deliveries, and send one vehicle only. Also, we would buy some of the same species of fish from all the ports of the land, indeed from all over the world, and but not consolidate our buying power. “You are mad”, the Martian would say, “you are running an inefficient business”. To this I’d respond that the proof is in the bottom line of the P&L. We made more money than any of our competitors, by far. So do not worry, I told my people, with reason and conviction I knew our approach was right.
The Keynesian approach would be the opposite of the Hayekian, and would be just what my hypothetical man from Mars would advocate. The aggregation for efficiencies by central agents would have destroyed my business, as I saw happen with my major competitors once the spreadsheet whallas got involved.
Dispersed knowledge, collected locally and applied intelligently, told us that our customers were prepared to pay more for very convenient just-in-time deliveries. Some of our customers opened up their business for a lunch service that required delivery early in the morning; others were evening service only. Some were open 24 hours; others were night only. So we catered to all, as opposed to saying “we are only in this area from time X to time Y, on such and such a day”. This meant vans going out 1/4 full and “inefficient”, but up to three times a day with a higher margin payload delivering up more profit.
Dispersed knowledge, collected locally and dealt with intelligently, told us that buying wild-hunted local fish from various ports and harbours, and selling it locally having bought at different cost prices (rather than using our buying power to leverage the best deal with the cheapest central seller) actually meant we could sell fish to the local restaurant and hotel marketplace for more margin and hence more profit was delivered to the P&L.
The aggregating and centralising “Keynesian” approach would have been the end for us.
One influence that I must also add to this little reflective piece is Michael Oakeshott. His On Human Conduct has probably had more influence on me than Human Action by Mises. This being an economics-orientated web site, I think this is the first time I’ve mentioned the great political philosopher.
Tradition, intimation, and latent knowledge and talent are often hard to observe. Cooking a recipe is following a simple set of instructions, just like cutting fish. Some of us can perform only moderately well (even with lots of training), and others, like Gordon Ramsey, outstandingly. This talent is latent and cannot be written down and copied. It can’t be rationalised. It is the aim of most of the world’s all-encompassing philosophies to be rationalistic in outlook. Applied to business, there were many skills I could not objectify that key members of my staff displayed. If they produced a profit, I left alone. This is not to say you should not always attempt to fully understand what is going on, and why people do things in certain ways; you always should. My Oakeshottian contribution was to exhaust this process of understanding, only gently change if it was deemed wrong by me, and love and cherish it if it was a little bit off piste and entrepreneurial. This is why my bottom line was always bigger than my competitors.
Oakeshott famously criticised his LSE contemporary Hayek by saying that his political philosophy, as expounded in The Road to Serfdom, of less planning was just as much a rationalist ideology as the central planners he cautioned against, even if it may be a better approach. Irrationality, “quirkiness”, hidden skill, and entrepreneurial talent are all things that do not fit in the box. These I always sought to preserve and encourage in the business. So my rational leadership and vision was always tempered by respect for this insight of Oakeshott. This is also why I am a liberal philosophically, tempered with good doses of conservative wisdom and leanings.
Readers, if you saw the first EconStories.tv video of Hayek v Keynes and the explanation of their key contributions in the rap format, then watch this Part Two, you will love it. If you haven’t seen the original, I urge you to watch Part One.
The Labour Party will eventually get back in power again. There is a very good chance it will be led by David Miliband.
In the FT yesterday he wrote: “Framing the debate as a choice between the public and private sectors is certainly good politics, but it is bad economics. The Budget will force 600,000 public sector workers into unemployment”. You can see the full article here. This demonstrates that Miliband is a slave to the underconsumptionist crank Keynes. He does not understand the role of costs and savings in society that was recently explained so well by Prof Guido Hulsmann. I draw your attention to my notes explaining the two underconsumptionist “Elephants in the room.”
Mr Milliband, please note.
Slide 9
Sophism 1: A “leak” in the circuit of spending? – In Glory of Hoarding
To Keynes, an act of savings is a leak from the economy. If I choose to sit on all my money under a mattress then I increase the purchasing power of all the money in ownership of others not under my mattress. I enrich people by an act of hoarding as their money units have more command on the same level of goods offered for sale.
Sophism 2: “The Paradox of Savings” – Circular Flow of Income
One man’s spending is another man’s income. Save, i.e. cut back on spending in the economy as a whole, and the workers’ income will fall. This will cause a depression. If the arguments in the above do not solve this then you must add; what matters is not that income will fall, but the relative difference between the level of costs and profits is the thing that really matters. If incomes all fall and thus the costs of labour has fallen, companies’ costs positions go down in a greater percentage to their overall cost base so they remain profitable, then there is no system-wide depression as this adjustment process (bringing costs into line with expenditure and making business profitable once more) takes place. Relative cost and income matters, not absolute cost and income.
Milliband says:
I am an economic realist….The government also has no plan for jobs…. Instead, it should focus on the jobs deficit: the 2.5m people looking for work. Sweden made halving unemployment its priority during its 1990s fiscal consolidation.
Jobs for sure should be the centrepiece of any economic policy and I will come back to this later….
Sadly he demonstrates that his knowledge of economic history is very poor. For example:
Britain is repeating Japan’s response to its crisis: pulling stimulus too early, raising value added tax and relying too heavily on monetary policy – leading to unemployment and stagnation.
Japan has had the biggest increases in its money base and the largest sustained fiscal expenditures thrust upon it. It is the Keynesian belief in demand management that has all failed over the last 20 years. Yes – 20 years. This nation has been postponing its reckoning for two decades. When you find that the Imperial Palace in Tokyo (3.5 km sq patch of land) was worth more that the whole value of property in California, the word “bubble” comes to mind. For sure, there are still many system-wide adjustments that need to take place before that nation emerges out of its fiscal and monetary incontinence. With Miliband under such delusions we should be getting worried that this no doubt well-meaning politician could do so much damage to us as a nation, just like his old boss. That nightmare just finished and I do not want to go back there soon!
He has identified five steps to renew Britain.
Step 1: Create a British Investment Bank.
This is very irritating indeed; we have a whole slew of banks, private equity and venture capital. The last thing we need is the State becoming the allocator of capital. Professional investors or lenders lend to opportunities that have a very good chance of creating wealth. The only purpose of having a State owned bank is so that it can lend based on political criteria, otherwise why do it? This will cause more bad investment and slow down the process of the liquidation of the bad investments we have already. This really is far too important an area of society for the government to get involved with; they simply do not have the skill or understanding.
If he really wants to lift the lid off growth and release the true creativity of all entrepreneurs he should consider the following:
Abolish Corporation Tax in full so that all businesses can use their own retained profits to facilitate further investment in them and not be reliant on bank funding. This was how things were done in the Industrial Revolution.
Abolish Capital Gains Tax in full so that entrepreneurs are incentivized to create more businesses with our reward of getting a tax free gain. Sir Gus O’Donnell initiated, via Gordon Brown, the most favourable CGT regime in living memory. I was staggered at the time that a Labour government could actually have such great vision. It put the business community right at the heart of Labour. Miliband would do well to remember this, should he wish to get the support of business again.
Abolish Inheritance Tax in full. This will stop the crazy incentive of having to avoid tax by going into exile, or doing some very fancy and expensive tax planning so you can build great intergenerational wealth that is built upon and passed down through generations for the ongoing benefit of many people. This nation was built on great big industrial and financial fortunes created this way. The more the State confiscates and sets up perverse incentives to avoid and leave the nation, the more impoverished we will become.
This line of thinking applies to all of those taxes.
Corporation Tax is due to be around £35 bn and the other two raise approx £5bn in total. This is currently also what we pay in terms of interest payments for the national debt, a burden which significantly increased under the last Labour government.
This July the two big State owned banks, RBS and Lloyds, missed the lending targets set by their last political masters by nearly £17 bn.
We pay nearly 6 million people in this country to do nothing, being either unemployed or on incapacity benefit. What a colossal waste of human resources, and a staggering affront to human dignity. If each one of them with all their benefits was costing us £6,667 per year, this would be £40bn a year. If the private sector was released from the corresponding tax burden, it would have the means to create jobs and wealth. £40 bn a year more in the hands of businesses would prompt a jobs revolution that could well take most of these people off benefits and into work.
This is what Miliband and indeed all politicians should be brave enough to be thinking, but the Miliband plan shows no such enlightenment …
Step 2: Get 60% of people into University
This is often said by well meaning well educated middle class people. They want to see Oliver Twist blossom. There is, of course, nothing wrong with this, indeed all people should be encouraged to achieve their potential – but so should the Artful Dodgers. It is not possible for all people to be like the middle class, well-educated Miliband. Where is the respect for the artisan? Where are the technological colleges to educate our carpenters, butchers, mechanics, fishmongers, and plumbers. All these critical skills are severely undervalued and are being worked by an increasingly imported in work force which does value these skills.
Instead, Miliband should be thinking about doing the following:
Abolish the minimum wage for all people aged under 21 years old and let employers pay anybody anything if they can prove that they are putting a young person through a artisanal skill based training program that could well lead to a job. A young lad living with his mother aged 16 is largely no use to man nor beast until he has gained experience and at £240 per week (plus NI etc) a plumber would not bother to take him on as he would not produce that benefit for maybe a couple of years which would make it worthwhile to invest in the employment and training of this person.
The next gem from Miliband involves the magical mystery multiplier:
Step 3: Deploy the public sector “to invigorate local economies by maximizing the multiplier effect of public services
I tell you no lie! I will not even bother to comment on this suggestion. The thought of those crack troops of bloated inefficiency trying to organize a fairly lean private sector will send us into the dark ages.
Miliband would do well to read this article which also shows why the multiplier is a myth. Here is one quote from it:
If I have £100 and I spend it on goods and services, my demand to hold cash or my money demand goes down by £100 and I receive goods and services in exchange. The person(s) who sold me the goods and services receives the £100 in exchange for those goods and services and his demand for a cash balance, or money demand has gone up. Where is the multiplier in this? It does not exist
Meanwhile, back in Miliband land …
Step 4: Increase productivity “and the quality of work in low pay, low value sectors of the economy.”
I am not sure what this means but I could not disagree with the desire to increase productivity. This is the only aim of capitalist entrepreneurs. I try to use the existing factors of production in better and more efficient ways over time to get better products and services for my customers. The only thing that gets in the way of this is endless pronouncements and laws from various government departments here and in Europe. If Miliband is advocating a total abolition of all this garbage, then great. Somehow I suspect he is advocating better meaning meddling, which will have exactly the opposite effect.
I suspect the low quality and value sectors comment is political rhetoric. Needless to say, 100 years ago if you had electricity you were a prince among men. Now, I would think it is 99.9% of our country. The onward accumulation of wealth, built upon the shoulders of our ancestors via the operation of private business – and not government – ensures that the maximum number of people are lifted out of poverty. Not allowing the creative talents of people to freely express themselves, by having things like the minimum wage, is an affront to the Judeo-Christian ethic upon which this society is built and will ensure that Miliband’s objectives are hampered. If paying people more were the answer, we could stop poverty today by not just having a minimum wage of £5.93 per hour but £593 per hour. The absurdity of this is plain to see. However, not so plain to Miliband who is obsessed with the underconsumptionist fallacies mentioned above.
Step 5: Produce an industrial strategy, “marshalling the state’s tools of procurement, regulation, planning and taxation to attract the private sector where it is needed most”
He goes on to say: “We can learn from Portugal’s initiative on infrastructure for electric car-charging, a viable commercial case for investment in manufacturing. Germany’s renewable energy policy combined feed-in tariffs with regional development areas and research, creating more than 300,000 jobs. Israel’s incentives-based approach to commercializing university research has taken it to the top of the innovation charts. Globally, governments are helping to expand the economic pie.”
The government can only take what the private sector generates. It does not own factories producing things that create wealth. It spends wealth that would otherwise have been spent by the private sector on things that people actually value.
He concludes
At the last election Labour could not find a single business to support its economic policy. I am determined to put this right – and lead Labour into again becoming the party of spreading wealth creation, not just spreading wealth. It is not good politics to have bad economics.
Sadly for Miliband I suspect that that will still be the case should he get in power! I hope his period in opposition allows him to reflect on why the people have put him out in the cold. I hope he learns a bit of economics as well, and visits factories, enterprises, banks, and other businesses at the coal face, and talks to people who are involved in the creation of the wealth of our nation. I hope he asks them how they would go about creating more wealth. If he does this, and reflects sincerely, he must surely realise the secret to our nation’s future prosperity lies not in what government can do, but in what it can stop doing.
