IEA Blog

I go to Singapore to teach every six months, which is always instructive. On this occasion, I discovered something I didn’t know and would never have guessed - that the growth rate in GDP over the most recent period had eased to a more accommodating 16.9%. It has, I admit, come down from the highest growth rate ever, but still you can get by with doubling national income every four or five years. These are growth rates so outlandish they have almost no logical meaning in economies so very different from Singapore’s.

These trips are also different because when I am there I rely in part on the International Herald Tribune for my news, which means I am relying in part on The New York Times, not something I often do. So what I also learned on this trip was that the destruction of the American economy and the jobs market has been so intense that even those who love the American President are forced now and then to draw attention to it.

On this occasion, amongst the columns from the usual gang of commentators, there was one by Bob Herbert. Under the title, “The Horror Show”, he began his column with these words:

“The employment situation in the United States is much worse than even the dismal numbers from last week’s jobless report would indicate.”

And there is no doubt they were dismal. Undoubtedly, as with the rest of the crew at the NYT, the reason for accurate reporting for a change is to help the Obama Administration sell its second stimulus package, something the rest of the country, exhibiting common sense, is reluctant to support. In his column, Herbert wrote:

“At some point we Americans are going to have to claw our way out of this denial. With 14.6 million people officially jobless, and 5.9 million who have stopped looking but say they want a job, and 8.5 million who are working part time but would like to work full time, you end up with nearly 30 million Americans who cannot find the work they want and desperately need….”

“…[T]here are now 3.4 million fewer private sector jobs in the U.S. than there were a decade ago.”

Given that, you would think that they might start to work out that Keynesianism is actually poison rather than a stimulus to faster growth and more jobs. But as Samuelson accurately observed, once something gets into the textbooks, it is almost impossible to get it out again.

Keynesian economics is the instruction manual for our economic elites which they use to trash the economy believing they are doing good. It is too much to hope they will eventually work out that leaving things to the market is an infinitely better way to proceed. But at least they might finally recognize that public spending on worthless projects is not the way to get an economy to grow.

You don’t have to be Einstein to recognise that insanity is doing the same thing over and over but expecting a different result, although as it happens it was Einstein who said it first. But if they really do apply a second stimulus in the US, with all the evidence of failure right before their eyes, in what other way would you describe such decisions or the people who made them?

Philip Booth interviews Eamonn Butler, author of Ludwig von Mises – A Primer.

It has become increasingly clear that interventionism played a significant role in precipitating the 2008 financial crisis. The Austrian School is more than capable of providing the free market theoretical framework needed to understand why governments and central banks helped bring about the bust.

Jesus Huerta de Soto’s book offers a comprehensive yet concise overview of the Austrian school, an increasingly influential branch of economics. It succeeds in contrasting the most important elements of Austrianism with the Monetarist and Keynesian paradigm and draws from seminal Austrian texts to stress the importance of subjectivist methodology.

As the title suggests, a large portion of the book is dedicated to entrepreneurship, which the author describes as “the driving force behind Austrian economic theory.” The concept of entrepreneurship, he points out, is conspicuously absent from mainstream economics. Entrepreneurship in the Austrian form is a process whereby an entrepreneur discovers new information. This new information is then able to manifest itself as a profit opportunity. Such activity allows for the transmission of new information and, importantly, brings coordination.

A chronological account of the Austrian School is eloquently put together in the later chapters. Although many believe that Austrian economics began with Carl Menger, Huerta de Soto makes a convincing case that the forerunners of the Austrian School were in fact scholars from the Spanish Golden Age.

This book is ideal for those seeking to understand the key principles of Austrian economics and for academics and students looking for a different perspective to mainstream economic methodology. Moreover, Austrian economists and free-marketeers alike will find the fresh historical interpretation intriguing. Overall, this is another excellent book by one of the Austrian school’s leading figures.

The Austrian School: Market Order and Entrepreneurial Creativity is now available as a free download.

For those too young to remember, the mid-1970s witnessed the first demise of Keynesian economics as the much-worshipped Phillips Curve turned positive in depicting the relationship between the rate of unemployment and the rate of price inflation, and as economic growth collapsed in response to government spending. As the spectre of stagflation stalked the land, political leader after political leader thrice denied his Saviour and turned to other economic deities for ultimate salvation. In the United Kingdom, Labour prime minister James Callaghan summarised the new consensus in a candid 1976 denunciation:

“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting public spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”

In 1981, confronted by a serious economic recession in the United Kingdom, Margaret Thatcher responded by raising taxes and cutting public expenditure in order to protect the budget. In an infamous letter to The Times, 364 economists denounced her government’s actions and demanded increased spending. I was one of a small number of free-market economists worldwide (no more than 50) who signed a counter-letter to The Times supporting the government’s actions. Events proved us right and the large majority wrong, as the British economy quickly recovered and as a vibrant United Kingdom shed its former mantle as the sick man of Europe.

In 1981, President Reagan responded to the Volcker recession with permanent cuts in corporate and personal marginal tax rates and with cuts in non-defence spending. By 1983, the US economy moved into a sustainable recovery that would bless the United States for the following 16 years of the Great Moderation.

Presidents Bush and Obama and Prime Minister Gordon Brown turned their backs on this accumulated knowledge, over the period 2007-2010, with the disastrous debt and stagnation consequences that now confront the United States and the United Kingdom. A new British government once again acknowledges the irrelevance of Keynesian economics and is returning governance of the public finances to orthodox classical principles. The recent meeting of the G20 countries has endorsed this judgment, with the singular exception of the United States.

President Obama is an economics illiterate who has surrounded himself with deadbeat hydraulic Keynesian economic advisers. Like FDR before him, he wreaks havoc on the economy of the country that he is supposed to preserve and protect. Unlike FDR, however, the public is now awakened to the failure of so-called stimulus policies. Retribution will be served upon his socialist government in November 2010; and his own final political curtain will close in November 2012.

For Keynesian economists worldwide, the second curtain is about to close. Let us hope that it proves to be the final curtain.

Visit Charles Rowley’s blog to read the original version of this article.

You’re gouging on your prices

If you charge more than the rest

But it’s unfair competition

If you think you can charge less!

A second point that we would make,

To help avoid confusion:

Don’t try to charge the same amount

For that would be collusion.

(From The Incredible Bread Machine by R. W. Grant)

Under barter the fact that two participants exchange means that each party has different preferences for the commodities involved. However, the degree of preference may be different in each transaction; the same commodities could be exchanged by two other participants on entirely different terms because their relative preferences are different from those of the first two. Nobody would suggest that the terms of trade for one exchange should be forced upon those for another. That would clearly be wrong because it would reduce aggregate satisfaction.

The invention of money (by the private sector of course) opened up far greater trading facilities. You can sell your apples to somebody who grows pears even if what you really want is oranges. Also you have the option to wait and make a purchase later. Once again, there is no reason why one exchange should use the same terms of trade as another. The fact that money is a wonderful means of exchange does not alter the different relative preferences of different traders for the goods involved.

However, the more numerous are the participants and the commodities available, the more likely it becomes that the terms of trade, now fully in the form of money prices, will be replicated by various participants. The fact that more trades are carried out means that more people will know more about them, which again tends to produce common prices for each commodity (of the same quality, availability, and so on).

Nevertheless relative preferences will still be there, so that a common price will not produce common satisfactions. It is merely that the benefits of a universal price system, always changing but always up-to-date, overcome the drawbacks of different levels of satisfaction. On this latter point, and only this latter point, is the common price system a disadvantage. 

What we see here is another form of “consumer surplus”. This, relatively well known to economists, usually refers to the fact that a consumer pays the same price for a second glass of wine as he did for the first, even though his needs/desires are already partly satisfied. Here, we are now recognising additionally that the first glass on its own means more to some than to others even though they pay the same price. 

There are several market exceptions to this rule. For example, differential pricing is sometimes adopted in respect of old-age pensioners, in various areas such as ticket prices at sports events. This is not philanthropy; rather it is a business calculation or estimate that the total gate money will increase. (Public sector items such as free bus passes and cheaper winter fuel are neither philanthropic nor business calculations; those who make these decisions are using taxpayers’ money rather than their own.)

It seems to me that auctions, Dutch or otherwise, are an excellent example of catering to this type of consumer surplus. They are a genuine way of making more money for the auctioneers by tapping in to the fact that individual propensities to buy are different.

Yet by all modern standards of conduct according to state regulators, surely auctions must be an abomination. How on earth can greedy capitalists fix prices in this way, preying on those who are prepared to pay the most? What impertinence! 

The truth is that state regulators are there to apply their type of justice, not ours – hence the quotation at the beginning of this submission. If they don’t get you in one way, they’ll get you in another.  

Last month the FT’s Martin Wolf asked a simple question, “Does Austrian economics understand financial crises better than other schools of thought?” After admitting that neo-classical models did “a poor job in predicting the crisis and in suggesting what should be done in response”, he points out that the following Austrian arguments have held up well: “inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global ‘malinvestment’ explains the subsequent financial crash.”

Unfortunately Wolf goes on to make the error of confusing the causes of the crisis to the policy debate regarding the recovery: “Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing.”

Firstly, if you are looking towards Austrian business cycle theory to provide a complete theoretical explanation for (i) the artificial boom, (ii) the economic recession and (iii) the appropriate policy response to generate new growth, you may well be disappointed. But if it is unreasonable to expect one (relatively unknown) school of thought to unambiguously settle each of these issues, it is also unreasonable to reject the parts that do stand up to scrutiny purely because they don’t explain everything.

The Austrian insights are predominantly a theory of unsustainable credit-induced booms. Therefore they are not equally applicable to all “boom-bust” cycles, and originally didn’t even attempt to investigate the recovery process (Hayek labelled this part the “secondary deflation”, implying that something else – the malinvestment of capital goods – was the primary problem). The famous “Austrian” histories of the Great Depression were more concerned with the boom than the bust – Lionel Robbins’ The Great Depression was published in 1934, and Murray Rothbard’s America’s Great Depression stopped at 1932. I would suggest that Wolf stops viewing Austrian ideas as substitutes for all other explanations, and takes a more opportunistic view – Austrian ideas explain the boom, Keynesian and monetarist ideas are also required to explain the bust.

Secondly, Wolf misrepresents what Austrians do say about depressions. The “liquidate” thesis is false, since many Austrians acknowledge that avoiding a monetary contraction would prevent a deflationary spiral leading to depression. Because of the complexity of this policy, the argument tends to shift from monetary policy to monetary regimes, as Austrians do have a positive programme for banking reforms that would prevent future crises. The problem is that only Austrians confront head on the harsh economic reality that there is no such thing as a free lunch. Once malinvestments are made, they are costly to correct. This does not imply that politicians “do nothing” necessarily; just that efforts are concentrated around the ability of markets to function as they should.

Indeed, consider Paul Krugman’s response to Wolf’s question, “why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?” Well there is unemployment during the boom – according to a recent study, 2.65m private sector jobs are lost every year in the UK (but we don’t tend to notice because even more are being created). Focusing on the “aggregate” level of employment misses the relative adjustments that are being made, as people move between jobs due to changing economic conditions. Indeed Krugman also seems to be implying that the “boom” should correspond with “overinvestment”. Whilst this isn’t entirely incorrect, the Austrian argument is that it leads to “malinvesment” – subtleties that aggregate variables gloss over.

The problem is that neoclassical economists believe in a circular flow model that abstracts away from time. Austrians, by contrast, appreciate that capital investment occurs over time. As Roger Garrison says, “the specificity and durability of the long-term capital does not allow for a general timely reversal.” Or as Arnold Kling says, “booms are slow and crashes are sudden” (note that John Hicks made the same error in his criticism of the Austrians; it seems that Krugman is unaware of this and the secondary literature it has generated).

In short, whether Austrian ideas have something to add depends on whether you view the pre-crisis economy as fundamentally sound. As Garrison points out, there are two alternative views: “did the collapse occur (a) in the midst of a period of healthy growth because of sheer ineptness of the central bank or (b) near the end of a policy-induced boom that was unsustainable in any event and in the midst of confusion about just what the problem was and how best to deal with it?”

If you answer (a) you’re a monetarist, and there’s no surprise that Austrian ideas seem alien. But if you believe (b) then I would encourage you to learn more about the economic theory that explains economic crises so majestically.

With the opinion polls pointing to a close result and the prospect of a hung parliament, turnout is expected to be relatively high in today’s election. Yet for economists this presents a bit of a puzzle.

Given that the chance of any single vote being decisive is so small, particularly outside a handful of highly marginal seats, the individual act of voting is arguably irrational – especially since costs are incurred, such as time and effort wasted on the trip to the polling station.

Moreover, one can only vote for a crude package of proposals, which in practice is likely to be changed significantly when it comes to implementation. The political process is extremely inefficient at responding to individual preferences compared with the fine differentiation of markets.

Worse still, various authors from the rational choice school (for example, Olson and Stigler) have shown that policy tends to be determined by special interests rather than the preferences of voters. The “logic of collective action” means that small concentrated groups have a far stronger incentive to commit resources to lobbying politicians and bureaucrats than large dispersed groups such as general taxpayers.

Special interests also engage in “agenda manipulation” to frame policy debates in particular ways and exclude perspectives that are detrimental to their cause. Indeed, Schumpeter went as far as to suggest that politicians and interest groups “are able to fashion and, within very wide limits, even to create the will of the people.” While this may be going too far, a strong case can certainly be made that such strategies further undermine the notion that voting “makes a difference.” (And in some cases, elite interests may simply ignore the wishes of voters, as with the ratification of the Lisbon Treaty).

So why do people continue to vote in large numbers? One hypothesis is that voters find it difficult to calculate probabilities and therefore don’t realise their individual vote is unlikely to make any difference. Another idea is that people vote because they value the preservation of the wider democratic process – they act out of duty and/or altruism. Neither explanation is very satisfactory from a rational choice perspective.

The IEA is delighted that Gary Becker will be giving the Hayek Lecture on June 17th this year. Gary Becker attended Hayek’s evening seminars at the University of Chicago, thus making a nice link to F.A. Hayek, who was the inspiration behind the founding of the IEA.

Becker is, of course, renowned for applying economic ideas to unconventional areas and won the Nobel Prize in 1992. His research programme has examined sociology, demography, human capital, criminology, the economics of the family and so on. At the lecture in June he will be specifically discussing migration.

Gary Becker’s research programme is founded on the idea that the behaviour of an individual adheres to the same fundamental principles in different areas. The same explanatory model should thus, according to Becker, be applicable in analysing different aspects of human behaviour.

Becker’s approach has been criticised for reducing human behaviour to unrealistic axioms and base economic motives. However, this is a mistake. In many, ways it is Becker’s critics who are reductionist and, certainly, they have a very incomplete view of many policy issues if they neglect Becker’s arguments. Becker never argues that self interest is the only motivating factor for a particular action: he argues that individuals make rational choices, motivated by a range of preferences which will include self interest.

Let us take crime as an example. Many people will never commit a serious crime – however great the benefit to them from doing so. But, for those who are willing to commit a crime because they are not restrained by their moral views, their behaviour will surely be affected by economic incentives. What is the pay off? What is the probability of getting caught? What is the sentence?…And so on. This does not just apply to murderers and robbers but to a much larger number of people who might be willing to commit (say) a speeding offence to catch a ferry for which they are late. And this reasoning can obviously be applied to a large number of other fields – the welfare state, whether footballers commit fouls etc.

In other words, whatever our moral views, we ignore the economic motivation, which is often important in particular circumstances, at our peril. Gary Becker is well worth listening to…

Click here for full details of the event.

There is a video doing the rounds at the moment under the name, the “Keynes-Hayek Rap”, although more formally titled, “Fear the Boom and Bust”. It has had a million hits and if nothing else it has brought economics into households that would never normally pay the slightest attention to issues in the history of economic thought.

Keynes is, of course, the author of the twentieth century’s most influential book on economics – although it might be noted that the economist who has been most influential on the economies of the twentieth century is more likely to have been Karl Marx. But Marx wrote in the century before. In the twentieth century, the laurel goes to Keynes.

Hayek was the counterfoil to Keynes in the economics world of the 1930s (although he lived on into the 1990s while Keynes died in 1946). During the 1930s Hayek spent a good deal of his time demonstrating that Keynes’ ideas were unsound, but strangely, and much to his own regret, he never properly dealt with the General Theory when it first appeared in 1936. The economics of Hayek is described as “Austrian”, a school of thought that originated in the 1870s. The Austrian School is the single largest segment of pre-Keynesian economic thought that remains alive today.

On a related matter, I have now returned from presenting the Ludwig von Mises lecture at the Mises Institute in Auburn, Alabama. The Keynes-Hayek Rap provides a contrast of the theories and associated policies of Keynes and Hayek and in its own way delves into the history of economics. My presentation also dealt with the history of economics, but for me the relevant history was how Keynes ended up falsely accusing his classical predecessors of having no explanation for involuntary unemployment. Keynes then used this accusation as a vehicle to undermine the classical theory of the cycle with a theory of his own, a theory which pre-Keynesian economists were virtually unanimous in recognising as fallacious.

If you are interested in this little known story in the history of ideas, which also discusses the pre-Keynesian theory of the cycle, this is my presentation:

The grip of Keynesian theory on governments, which gives them the authority to spend our money copiously, stupidly and in any way they please, is going to be hard to break. But the two presentations, as different as they may be in style and content, are attempts to explain why this most urgently needs to be done.