Tuesday, May 4, 2010

Is Krugman's Economy Stupid?

Keynesian economists believe that much of what drives private investment in the economy falls into the "animal spirits" category, and those "spirits" make for volatile investing habits. (You have to remember that Keynesians see "investment" as being useful only in that investors are "spending." That we have capital formation really means nothing to the average Keynesian, as he or she believes that production is a rather meaningless and detached part of the economy, and that enough "spending" will magically create the goods that will be demanded.)

In a blog post entitled, "Is It The Economy, Stupid?", Krugman plays into that whole psychology nonsense which states that if consumers are optimistic, they will spend more and that will create prosperity. He posts a graph (shown below) and then comments on the results.

He then writes:
From a short-term economic point of view, this may be a self-fulfilling prophecy, as optimism raises consumer spending.

Will it have political implications? Is economic optimism arriving just in time to save Democrats from a midterm disaster?
From where does consumer spending come? In Krugman's world, consumers just start spending, and out of that comes the recovering economy. In reality, it does not work that way.

This week, I will be covering Say's Law in my principles of macroeconomic classes, which would be anathema to Krugman. Say demonstrated in his 1803 book on political economy that all of our "spending" must have a source: our production.

It makes sense. Economies that produce a lot of goods that people want also are economies with lots of consumer spending. Think about it; all of use work to produce a good or service that others want, and by being paid with money, we then can find a way to "trade" what we have produced so that we can gain goods and services that others have made.

Krugman and Keynesians, on the other hand, see no meaningful connection between production and consumption, and this dichotomy not only is central to Keynesianism, but also to Marxism, socialism, and Institutionalism (of the old variety as developed by Thorstein Veblen more than a century ago). To a Keynesian, we produce goods and then hope that the producers have enough money and the will to spend so they can "buy back the product" they created when they become consumers.

Sometimes, this really becomes ridiculous, as shown by this example. Around 1908, Henry Ford doubled the pay of the workers at his Dearborn, Michigan, plant from $2.50 a day to $5. According to the Keynesians and others, by doing so, Ford "turned his workers into consumers and created the American middle class."

Why is this notion ridiculous? Think about it. If all Ford did was to double the pay of his workers, doing so would have doubled his labor costs, which would have meant that in order to make a profit, he would have to sell his cars at much higher prices than he already was doing.

However, we know that Ford cut the price of the Model T to under $300 after a while, which fulfilled his goal of making the automobile available to nearly anyone. So, this notion that he raised wages to give his workers more money so they could "buy back" the cars they made simply makes no sense. None.

What happened was this: the assembly-line work was monotonous, and Ford had huge, costly turnover problems. By doubling wages, which then were the highest industrial wages in the world, he solved the turnover issue and those cost savings more than made up for the higher labor costs. Furthermore, by ensuring that his workers would be available and anxious to keep their high-paying jobs, Ford could turn his attention to the quality issues that had been plaguing the production of the Model T.

In the end, Ford said that what he did was a "cost-saving" measure, as he took into consideration ALL of his opportunity costs of production, not just the simple wages. Now, most people can understand this explanation, but because Keynesians are so stuck on the "buy back the product" mentality, this bit of logic escapes them.

As for our current "recovery," I am sorry, but there is no meaningful recovery out there. The Obama administration is forcing up business costs, but does nothing to encourage new investments in those product lines that can lead us out of the recession.

Instead, the administration touts its heavily-subsidized "green energy" nonsense that literally destroys wealth in the name of creating it. Yes, "green energy" will "create jobs" in some subsidized industries, but it does so ONLY by damaging the healthy, profitable firms and putting those workers out of jobs.

Krugman, unfortunately, is so partisan that he actually can praise this "recovery" only because Obama, a Democrat, is president. Would he be saying the same thing about this "recovery" if a Republican were in charge? I doubt it.

No, I have no desire to shill for the Republicans, but nonetheless I would like to see an economist be something other than a political operative.


charliemax said...

When will "economists" who follow Keynes,Marx be disproved, denounced in the "main stream"? Thank you Wonderland, this Keynesian dogma is obvious and yet anyone who doesn't "believe" in it must be a kook. This is how political correctness disconnects people from reality.

Chris W said...

Krugman's hypothesis is no less ridiculous than the classic The Underpants Gnomes' business plan

Phase 1: Collect Underpants
Phase 2: ?
Phase 3: Profit

Sebastian said...

Chris W, if you think about it carefully, the Underpants Gnomes' business plan makes way more sense than Keynesian economics. They were only missing an intermediate step. Krugman et al have the whole thing backwards.

I am delighted to see that there are still people out there that know the real meaning of Say's Law. Unfortunately, try telling a Keynesian that the only way we can acturally "demand" anything is by first having something to "supply" and they will most probably block their ears and chant "na, na, na, can't hear you".

Bill, it might be a bit hard to get hold of in the US, but Steven Kates wrote a great book about Say's Law, which I think would be a good one to place on your students' recommended reading list - in addition, of course, to your own essay on the subject.

Bob Roddis said...

In any discussion with a Keynesian, I think it's essential to immediately emphasize that stuff (goods and services) trades for other stuff. Low "aggregate demand" (which is a garbage concept anyway) just means that people are poor and have no stuff with which to effectuate trading. Handing them funny money merely hands them the purchasing power that someone else actually earned.

Secondly, I always point out that the Keynesians have a simple minded notion of "the economy" as a turntable or machine stuck in neutral (or worse) without government "stimulus" to start it spinning.

Their "model" is infantile and absurd and it ignores (purposefully?) how human beings ACT in the real world.

Tyler said...

My Macro Teacher would always say that Says law was B.S. so im glad to hear about what it actualy was instead of just "supply creates it's own demand".

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