Thursday, December 6, 2012

Is Government a Bottomless Well of Wealth Creation?

Having essentially adopted the MMT position on "endogenous" monetary creation by the U.S. Government, Paul Krugman goes whole hog in claiming that economies themselves are near-totally dependent upon government spending. To put it another way, government spending (in Krugman's view) is the source of wealth creation.

Now, Krugman does not use terms like "wealth" because, in his view, an economy is a mechanism by which people have jobs, spend money and buy things. Those "things" simply appear on store shelves put there by people who are employed, and as long as people are employed, they will have money to buy those things and clear the shelves so that they can make more things for people to buy in the future.

While macroeconomists might call this the "Circular-Flow" model, I would say it more resembles circular reasoning. As long as people continue to spend, then the model can flow freely, but if people stop spending, then the economy breaks down. So, the argument goes as follows: (1) People quit spending which then causes the economy to slow down, and people then lose their jobs; (2) Why did they quit spending? (3) Because they either lost their jobs or were afraid they would lose their jobs, so they needed to save money.

The reasoning problem here is obvious, but let us move on. When people stop spending, and when the "animal spirits" of investors turn investors from tigers to pussycats, then it is government to the rescue. Government reaches into its own currency well (as in the case of the USA, where its official money is monopolized by the government) and spends (we call it "fiscal policy") until people have jobs again and start spending confidently.

As Krugman and other Keynesians note, this is "counter-cyclical" policy. Government spends a lot when the economy is in the tank and adopts more "austerity" when the economy is doing well.

A lot of Keynesians and fellow-travelers have told me that the real problem is that when times are good, governments still continue free-spending habits. Hey, no joke! When the economy is good, tax takes are higher, and the prospect of more revenue then feeds the spending habits of politicians. Why is this such a surprise?

So the government then is supposed to resort to what essentially are gimmicks, such as "Operation Twist" or QEWhatever, in which the Federal Reserve System purchases assets that the market already has declared worthless in order to try to prop up their prices. The idea is that if the government can prevent prices from adjusting downward (or should I say, correcting downward) the economy won't go bad, since everyone knows that falling prices are not an effect of a downturn, but a cause. (More interesting causal logic from the Keynesians.)

Out of all this comes Krugman's view that government wealth creation is endogenous, that is, economies grow because government spend money. (Because people save money, i.e., don't spend all of their income immediately, Keynesians believe market economies are always in peril of imploding, so the only thing that can keep that from happening is for governments to spend, and that is how economies grow.)

The problem with Krugman's view is that in reality, economies grow when entrepreneurs over a wide scale have the freedom to bring resources from lower-valued uses to higher-valued uses as ultimately determined by consumers. During that process, other resources can be applied to those uses that previously were being neglected.

In the Keynesian view, governments flood the markets with new money (or new spending) and stuff just appears out of thin air. Capital just happens. Investment just happens. All it takes is a new injection of money.

As I read Krugman over and over again, I see that there are three things he clearly does not understand: (1) Opportunity Cost, (2) Capital, and (3) Entrepreneurship. To Krugman, an entrepreneur is someone who makes something in a garage, and his or her actions have little to do with the economy. He already has noted that to him, the real value of capital is the spending required to create it, and anyone who believes governments can create prosperity by printing money does not understand opportunity cost.

So, from where I sit, it seems that Krugman is saying that government endogenously can reignite an entire economy by spending on those things that, frankly, are tied to political connections, such as "green energy," which is nothing more than an industry on federal life supports. Yet, Krugman insists that by draining profitable ventures and redirecting resources into failing industries, the entire economy can be reborn!

29 comments:

Anonymous said...

Your criticisms always fall flat because, despite Keynesianism and Krugman's deep flaws that are revealed in each article or blog post, you instead seem to prefer to take out your Krugman strawman (which by now must be very old and worn-out) from the shelf and give another round of public beating...

Neither Keynes nor Krugman (or anybody else outside a Communist Party meeting) think the Government is the source of wealth and that is self evidently insane... Yet you have used it as _the_ main specific criticism of Krumans articles on about 2/3 of your posts ...

How about criticizing Keynesianism for what it actually says? you know, idle resources, magneto problems and all that stuff, instead of this faux-Marxism you seem to impute on it?

Chris Barcelo said...

I thought the article was pretty explanatory. I don't see a straw man problem. Keep writing, it's enjoyable.

William L. Anderson said...

The point I am making is that economies must create wealth in order to grow. Krugman is talking about consumption, that economies must consume in order to grow.

The "idle resources" line is a red herring, for it does not address the reason the resources are idle in the first place, other than to say they are idle because people quit spending.

ALima said...

If it's idle, it's not a resource.

ALima said...

Magneto trouble?
Krugman identifies the financial sector as the broken part.
Do Keynsians ever look at government as part of the problem? It's just a question of which policy is the correct one for them. They never think that no "correct" policy exists. That could be economics great accomplishment of the 21st century. Just admit a government is not an effective institution for running an economy.

JG said...

"The point I am making is that economies must create wealth in order to grow. Krugman is talking about consumption, that economies must consume in order to grow."

My consumption is your income, and vice versa. Without my consumption you cannot grow. Why is this such a difficult concept for you anti-Keynesians to grasp?

Bala said...

"My consumption is your income, and vice versa."

False right there. Why do you whatever-Keynesians find it this difficult to grasp the point that the income to factors of production employed in producing goods happens PRIOR TO consumption? Why do you so miserably fail to understand the simple point that incomes of everyone except the lowest stage capitalists comes from capitalist saving and not from consumption? We Austrians do understand the importance of spending on consumers' goods but why do you people absolutely, absolutely fail to comprehend the simple fact that production precedes consumption?

Bala said...

JG,

The day you can comprehend Fig 41 in "Man, Economy and State with Power and Markets" (pp 369), come back for a discussion. Until then, you will only continue making a fool of yourself (as you are now).

Joseph Fetz said...

Bala, we don't even need to go that far, we can instead just refer JG to the Crusoe Model.

There is no doubt that spending (consumption) can indeed be the income of the receiver of that sum, but the problem comes when people make the claim that consumption is the catalyst of economic growth and prosperity, or completely ignore the opportunity cost associated with the individual who holds that income. Certainly, if all that existed within an economy was consumption, then all capital would be consumed, as well. Eventually, you would have no resources to either consume or spend, there would be exactly zero spending, zero resources, zero capital, zero income, etc. Perpetual consumption is indeed the recipe for impoverishment, not just of an individual, but of the whole of an economy.

People like JG forget that one must have first produced in order to consume, and that the same is true of an economy of exchange. While the Crusoe Model deals mostly with autistic exchange, the mechanism is exactly the same as in interpersonal exchange. The Crusoe Model elaborates this point quite clearly.

Also, in case you're wondering why I am harping on the whole Crusoe Model thing, it is because I don't believe that JG has the intellectual capability to grasp what is being shown in Fig. 41 of MES. At least not at this time.

Anonymous said...

It seems that the concirn of Austrian Economists is that economic activity creates wealth, and that the concirn of Keynsians Economists is that it creates employment.

Dinro said...

It seems that the concirn of Austrian Economists is that economic activity creates wealth, and that the concirn of Keynsians Economists is that it creates employment.

Dinero said...

It seems that the concern of Austrian Economists is that economic activity creates wealth, and that the concern of Keynsians Economists is that it creates employment.

William L. Anderson said...

The creation of wealth actually creates employment. Don't forget that to Keynesians, WWII is a "good time" economically speaking.

Yes, a time when people were being shunted off to jobs where they were killed or maimed, and where there was little to consume at home was a "good time." Yeah, people had jobs and incomes, but they could not buy anything legally that was not rationed by the state.

Dinero said...

Yes wealth creation can produce jobs but the main aim of progress is to reduce toil.
Keynsianism aims to keep everyone in a constant state of activity. An individual's instinct towards efficiency aims to reduce the amount of daily toil required but the macro economy does not seem to bea able to accomodate this idea.

Pulverized Concepts said...

Yes, indeed, we're seeing the marriage of the Keynesians and the MMTers, who have been dating for a long time. According to both, money, the medium of exchange, is a creation of the state, ergo there can be no commerce as we know it without state-supplied money. Anything else is barter or gifts. Keynesian/MMT thought rejects the concept that taxes are needed for government spending and that someone in the government can determine the proper amount of money to inject into the system to balance employment and inflation, some Wizard of Oz-like figure. MMTers, and Krugman as well, believe that there has been insufficient money enpixelated to enable the consumption necessary for full employment, despite the procession of QEs adding up to many billions of fiat dollars.

In the Keynesian/Krugman/MMT world, companies that employ people can't be allowed to fail, there can be no consequences to bad decisions. Actually, we've gone through this before, with William Jennings Bryan and the progressive movement in the latter decades of the 19th century. All that was necessary to bail out struggling farmers was MORE MONEY in circulation. Fortunately, there was enough brains in the country to forestall that line of thinking for a short time.

Anonymous said...

Beating strawmen is fun!! here, let me try:

Austrians believe that economics as a field of study is actually just a branch of mathematics and all conclusions are theorems and must be derived purely from axioms and logic. So, any phenomena you observe in the "real world" that deviates from our conclusions is at best an illusion and is false by definition...

Pay no mind to the illusion of 1.5% on T-bills and negative TIPSs in the "real world" since, as we have clearly "demonstrated", we are actually living in Zimbabwe circa 2005.. Who are you going to believe, us or your lying eyes?

Mike said...

Citation of 1.5% Treasuries to support an argument fails to account for the Fed monetization and massive use of interest rate swap agreement to produce said 1.5% Treasuries.

Dennis said...

Keynesian economics ultimately results in the destruction of production through unbridled consumption. It's akin to a farmer eating his seed corn. He may feel full in the short term, but in the not-so-much-longer term he's going to starve.

Chris Barcelo said...

Pulverized wrote:

"In the Keynesian/Krugman/MMT world, companies that employ people can't be allowed to fail, there can be no consequences to bad decisions."

Don't confuse it by changing the name, it's called Fascism.

Zachriel said...

Chris Barcelo: Don't confuse it by changing the name, it's called Fascism.

Godwin was a genius.

Zachriel said...

Mike: Citation of 1.5% Treasuries to support an argument fails to account for the Fed monetization and massive use of interest rate swap agreement to produce said 1.5% Treasuries.

If there were no confidence in U.S. Treasuries, then no amount of manipulation will keep rates low on currency markets.

Tel said...

JG My consumption is your income, and vice versa. Without my consumption you cannot grow. Why is this such a difficult concept for you anti-Keynesians to grasp?

Your consumption is only useful for growth if you also have some productive capacity that you are offering in exchange. The economy is about trade you know.

Your consumption is never necessary for growth, there are always other options.

Calgacus said...

If there were no confidence in U.S. Treasuries, then no amount of manipulation will keep rates low on currency markets.

That isn't true, Zachriel. (Taking "currency markets" to mean "the bond market", as seems to be intended.) The Treasury + Central Bank can decide on what the rates are at any term. Exactly the same way that it is decided that 5 Washingtons = 1 Lincoln. Basically that is what the US explicitly did during WWII, until the 1951 Treasury-Fed accord, and to some degree thereafter.

What governments cannot do easily, automatically by fiat is decide on inflation, on the prices of goods and services in the private economy, on the value of its currency there. By taxing and spending, by interacting with the private sector, it can roughly control it, set boundaries for price variation, but fine-tuning is not possible unless it takes over the entire economy. That government have the same, limited control over the foreign exchange value of their currency on fx currency markets is a special case of this.

Tel said...

http://www.econlib.org/library/Enc1/Fascism.html

That's a pretty good historical article on how government can take over economies:

Mussolini also eliminated the ability of business to make independent decisions: the government controlled all prices and wages, and firms in any industry could be forced into a cartel when the majority voted for it. The well-connected heads of big business had a hand in making policy, but most smaller businessmen were effectively turned into state employees contending with corrupt bureaucracies. They acquiesced, hoping that the restrictions would be temporary. Land being fundamental to the nation, the fascist state regimented agriculture even more fully, dictating crops, breaking up farms, and threatening expropriation to enforce its commands.

Tel said...

http://www.forbes.com/2010/08/26/government-business-labor-opinions-columnists-warren-meyer.html

In effect this corporate system is just another age-old, historically time-worn effort to cement the power of a small group of elites. Entrepreneurship and innovation are often impossible, as incumbent businesses can call on tremendous state powers to stifle competitive threats. The unemployment rates of the young and unskilled can be astronomical, even in rich nations like Germany and France, as older unionized workers have worked to calcify labor markets to their own advantage. In the end, consumers and taxpayers pay for the whole system in the form of reduced growth and economic output, higher prices, higher taxes and less mobility for those not already in power.

Pulverized Concepts said...

The urbanization of the country has obscured a fact that's always been to rural agriculturalists, that some people just aren't as productive as others. Wandering down a rural road it's easy to see who the good farmers are and who the lay-abouts are. The serious farmers have well-tended grounds, maintained buildings, healthy animals. Their less enthusiastic neighbors have dilapidated fences, peeling barns and many cattle. Yet US ag policy treats these very different operations exactly the same. Of course in an urban environment we can't know how productive our neighbors are even if we have a somewhat intimate acquaintance with them. The idea that every worker can fill a job would be a surprise to any experienced human resources specialist. There's a pretty good chance that a large portion of the unemployed are simply not as good as those that still have jobs.

Anonymous said...

It's comical watching the Austrians squirm like fish out of water trying to critique MMT. Mosler and el have been correct for 20 years and going. Meanwhile, the Austrians struggle to have people accept there free advice, and suck from the government teet from there cushy state funded job. Ignorance and hypocrisy is a fools combination, Anderson

Pulverized Concepts said...

The MMT/chartalist program is composed of enpixelating money to spur aggregate demand that raises employment without destructive levels of inflation, exactly the goal of the federal reserve and pretty much the identical methodology. The only difference is that to the MMT mind, and Krugman's as well, there simply hasn't been sufficient enpixelation, trillions of phantom dollars aren't enough to rescue an economy already distorted by government intervention. Today, for instance, Government Motors has an inventory of 788,194 unsold Malibus, Silverados, Sierras and other models, far in excess of normal. Getting those cars off the dealer lots requires the deposit of billions of dollars in the bank accounts of would-be drivers. Time to get on it.

Economic Warfare said...

There are few problems in the world that economic prosperity cannot help solve. Yet the engines of that prosperity are under fierce attack. The forces that seek power over others have gained the upper hand against those that seek freedom. By harming wealth creation, they cause even more strain on society. Historically, this is nothing new. State domination over its subjects has roots that connect statism, totalitarianism, communism, and socialism to more modern-day variants of liberalism and progressivism. It is a constant fight and we must win.

Thanks,
Wealth Creation