At times of recession, like we have today, a range of dodgy economic ideas that have been refuted several times over during the last 200 years are recycled with fresh enthusiasm, requiring us to refute them once again.
Chimera 1: prosperity through stealing and spending
Our political masters follow the lead of the economists. Recently we heard this statement from our Culture Secretary, the Rt Hon. Jeremy Hunt MP,
There are people who say that doing a project like this is a massive Keynesian boost to the economy. That is definitely the case, in terms of money being spent.
The message is clear: if we spend money, we will end up getting wealthier. That’s nice and simple then. What are we waiting for? If £39bn of spending is going to create more than £39bn of wealth, we should not be shy! Why not spend £339bn? In fact, choose any number!
It is remarkable that an educated man like Hunt cannot see that if we extract £39bn in taxes from the private sector and give it to the Olympic development people to spend, we have just moved money that people would otherwise have spent on goods and services they actually want, and directed it instead to the government’s preferred expenditure? The net gain is zero, at best.
This was clear enough to Jean-Baptiste Say in 1803, when he wrote A Treatise on Political Economy:
But this advantage is to be derived from real production alone, and not from a forced circulation of products; for a value once created is not augmented in its passage from one hand to another, nor by being seized and expended by the government, instead of by an individual. The man, that lives upon the productions of other people, originates no demand for those productions; he merely puts himself in the place of the producer, to the great injury of production, as we shall presently see.
Say had a great letter exchange with his English contemporary Malthus. Like Hunt today, Malthus believed public expenditure was essential to keeping the economy going. He argued that the payroll of the state — in modern terms, the army of teachers, nurses, civil servants, and quango staff — should be maintained across the economy, for the benefit of all.
Say pointed out that if no extractions were made from the private sector, the public labour force would soon get redeployed. If the tax collector did not collect, no-one would struggle to find better ways to spend their money!
In his letters to Mr Malthus, Say reminds us that spending is only half of the equation. Value must be traded for value, and production must precede consumption:
When I advance that produce opens a vent for produce; that the means of industry, whatever they may be, when unshackled, always apply themselves to the objects most necessary to nations, and that these necessary objects create at once new populations and new enjoyments for those populations, all appearances are not against me. Let us only look back two hundred years and suppose that a trader had carried a rich cargo to the places where New York and Philadelphia now stand; could he have sold it? Let us suppose even, that he had succeeded in founding there an agricultural or manufacturing establishment; could he have there sold a single article of his produce? No, undoubtedly. He must have consumed them himself. Why do we now see the contrary? Why is the merchandize carried to, or made at Philadelphia or New York, sure to be sold at the current price? It seems to me evident that it is because the cultivators, the traders, and now even the manufacturers of New York, Philadelphia, and the adjacent provinces, create, or send there, some productions, by means of which they purchase what is brought to them from other quarters.
We produce in order to support our own demand for goods and services. We can’t produce just anything. We must be focused on producing things our fellow citizens want. This happens naturally in an unhampered market economy. If we consume without producing, we will eventually burn through all our capital and have no ability to demand anything further in the future. Spending alone is never the solution. The key is prior production.
So much for the Rt Hon. Jeremy Hunt’s plan to boost wealth by stealing and spending.
Chimera 2: prosperity through printing and spending
A more senior political master, the Chancellor, acquiesces to his Governor of the Bank of England: they will make more money units, freshly minted digital ones, specifically to create a Keynesian stimulus! The letter from the Governor to the Chancellor laying this proposition out concludes
the Committee judged that it was necessary to inject further monetary stimulus into the economy.
I have spent 22 years in devotion to satisfying consumer demands, and thus creating wealth. It is done as follows:
- As an entrepreneur you look for the most urgent needs of consumers.
- You work out how to fulfill those needs.
- Painfully, at the beginning of your enterprise, sometimes to pay more to your staff, you go without wages yourself and refrain from consumption — in short you save.
- Thus you deploy your savings or borrow the savings of others to take command over the various factors of production — land, labour and capital — and mix them into better and more capital-intensive combinations to provide the goods and services that the customers want.
- More capital deployed in the right intensity creates more productivity, allowing cheaper goods and services.
- This takes place over time.
More money units may create the illusion of wealth, leading to temporary euphoria, but when reality bites, you rapidly go back to square one, perhaps having made some unwise decisions along the way.
We are currently experiencing a money deflation, which the authorities are attempting to counteract by putting more money units in circulation. All stops have been pulled to prevent prices from falling into line with what consumers want. The money printers are obsessed with aggregate spending, when they should be concerned about profits.
If you had a company with £1m of capital invested in the capital structure, with revenues of £10m p.a. and profits of £250k and by dumping low-margin, loss-making work, you could move to a £1m capital intensive enterprise with £8m revenues and £500k of profit, would this not be better? The capital deployed would now be generating twice as much. I often give this analogy to people who have consumption spending fetishes, showing that it is not the top line, but the bottom line that we should all focus on.
Another analogy I give is of the salesman who reports to you that he has sold £1m of kit and does not mention at what net margin. How does he compare to the one who says he has sold £1m of kit at 10% net margin? It will almost be apodictic that the latter will have sold for more profit while the former, not concentrating on the bottom line and not even mentioning it, will have sold for less profit. Profit (in cash terms) is the only thing that matters at the end of the year.
Crudely put, the mass of Keynesians relate GDP, which measures largely the consumption side of the economy (ignoring the larger production side), as the revenue of goods and services sold for money in a particular period (usually a year). There are many problems with this, but for now note that a lowering of prices means a lowering of GDP. If prices fall thanks to productivity improvements we have the basis for a recovery, but GDP-obsessed planners will instead see disaster.
Attempts to prop up GDP by printing more money units will not increase real wealth, but they will cause further distortions to an economy that’s already out-of-sync with consumer preferences, and stoke new asset bubbles. The injections of cash will not address any of the causes of monetary deflation.
Over the last two decades, credit has been created to the extent that our money supply has tripled and asset prices have soared. These prices need to come down. When they come down, people will start to pick up bargains and start spending again. Companies will then invest to satisfy the renewed demand.
No politician will allow this painful adjustment to happen. They are in thrall to the circular flow of income fallacy.
What would Say say?
Say pointed out, as we have seen in the examples above, that it is production that allows you to trade for other goods and services. Production and consumption can’t be out of sync in an unhampered free market. Why do we have recessions like today’s, with shops and factories with too much to sell and too little demand? The only answer can only be that prices are too high. These goods and services, and indeed the factors of production that create these goods and services, are offered for too much money. Prices need to come down.
Prices were a subject of lively debate in the letters between Say and Malthus. Malthus, wedded to the erroneous Labour Theory of Value, alleged that if prices fell too low, wages would not be paid and the problem would get worse as labour would become idle, there would be less spending, and we would spiral into the abyss. This is what virtually all economists tell us today.
Here’s what Say had to say, in 1821:
Give me some just ideas on the price of things?
A potter is in want of a loaf of bread, which sells for a shilling: he is obliged, in order to obtain it, to sell a vase which is worth a shilling. If the price of the loaf should rise to two shillings; and if the potter is obliged to sell two vases in order to obtain these two shillings, which he must pay for the loaf, the dearness of the bread is real. If the potter can obtain these two shillings by the sale of a single vase, the dearness of the bread is only nominal. He has in both cases exchanged only one vase against one loaf, whatever may have been the denomination of the intermediate value. It is the value of the money which is depreciated, that of the bread has remained the same.
No: that which is real is the depreciation which has taken place in the value of the merchandise in which his income is stipulated to be paid: that is, in the fall of the money. He who pays the income, by acquiring at less expense this merchandise, gains in this case what the other loses.
You have said that if, when I am obliged to give two shillings to buy a loaf, I am able to obtain these two shillings, on the same terms that I before obtained one, the loaf has not become dearer; but if to obtain two shillings, that is, the price of one loaf, I am obliged to give two vases instead of one, then the bread will have really become dearer?
They have fallen if they can be obtained for half the expenses of production: that is, if means have been found to create, at the same charge of production (which consists as we know of the workmanship, interest of capital and profit) two vases instead of one.
If, by means of a knitting frame, I can make a pair of stockings for three shillings, instead of expending six shillings on them, he who grows wheat can obtain a pair of stockings for one half the quantity of wheat which he had before been accustomed to give for them. That is, if he was before obliged to sell thirty-six pounds of wheat in order to obtain a pair of stockings, he would now sell but eighteen. But the eighteen pounds have required on his part only one half the expenses of production which the thirty-six pounds would have required.
It is the same whatever is the production with which we are occupied. It may be said, that when an article really falls in price, not only those who produce it, but every body else, obtains it at the price of the reduced charge of production.
You have said besides that the riches of society is composed of the sum total of the values which it possesses: it appears to me to follow, that the fall of a product, stockings for example, by diminishing the sum of the values belonging to society, diminishes the mass of its riches.
The sum of the riches of society does not fall on that account. Two pairs of stockings are produced instead of one; and two pairs at three shillings are worth as much as one pair at six shillings. The income of society remains the same, for the maker gains as much on two pairs at three shillings, as he did on one pair at six shillings.
But, when the income remains the same, and the products fall, the society is really enriched. If the same fall takes place on all products at once, which is not absolutely impossible, society by obtaining all the objects of its consumption at half price, without having lost any part of its income, would really be twice as rich as before, and could buy twice as many things.
This does not generally happen, but it has happened to a great number of products, which have fallen from the price they were formerly at, some a tenth, some a fourth, a half, three-fourths, as silver, and even in a greater proportion as silks, and probably many other articles.
To many causes: but principally to the progress of intelligence and industry. It is to their progress that we owe, both the discovery of countries in which there is a greater abundance of products, and also a means of transporting them less hazardous and more economical. To that progress also we are indebted for processes more simple and more expeditious, the use of machinery, and in general a better adaptation of the productive faculties of nature.
There are some, but very few, and only those the demand for which has increased in consequence of the progress of civilization, without the means of production having increased in the same proportion. Such as butchers’ meat and poultry, and almost all the useful animals which are raised at less expense in less civilized countries.
The errors, the fears or the passions of men, or unforeseen events, cause disorder and confusion in values which are merely relative: that is, when any merchandise rises or falls with respect to others, in consequence of circumstances foreign to its production. Late frosts increase the price of the last years wines, whatever may have been the charges of their production.
When the wine doubles its price, he, who, to purchase a piece of wine is obliged to sell six bushels of wheat instead of three, which should have purchased a piece of wine is poorer by all that the wine merchant is richer.
The key thing to note is that a rise in productivity means the same goods are produced at a lower cost, and profits go up, allowing more demand to be expressed in the economy. Productivity rises can be facilitated by allowing taxpayers to retain more of their wealth. Adding more money units simply creates asset bubbles.
Over the next few days I will post copies of some of the best refutations of Keynes’s supposed refutation of Say’s Law. The wisdom of the older economists is in short supply, and we will do our bit to promote that wisdom.