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John Maynard Keynes is Dead. Long Live Supply-Side!

This entry is an exception to what I said earlier about working through my backlog first.  It was written more recently than the other posts that will be going up and submitted to (if memory serves) two different magazines. They're taking too long to respond, which is one of the main reasons I now have a blog.  

I’m not an economist.  Oh, I’ve studied around the edges enough to have a passing, rather shallow familiarity with the Dismal Science, but start in on me with graphs and jargon and I’ll be lost in mere seconds.  Perhaps I’m not missing much.  Noted Richard Lehmann in a recent issue of Forbes, “I don’t think (the dismal science) is really a science at all, despite its grandiose mathematical modeling.  It’s dependent on human behavior, so it is an art and a rather dark one at that.  The absence of scientific principles allows economics to be used by politicians to advance almost any program they want to promote and find willing accomplices with respectable credentials to cheer them on.  Some of these experts have been known to completely change their views when in search of a new job.”

What I am is someone involved in running a business, and the son and grandson of small business entrepreneurs.  Virtually every adult I grew up around who was influential in the development of my worldview ran some sort of business, creating jobs, employing people, and methodically building (or, albeit less often, losing) wealth through a process of decision-making and calculated risk-taking peculiar to the small businessman.  That gives me a solid foundation of what used to be called good business sense or, if you like, common sense–there being little practical difference between the two.

Those credentialed economists Lehmann derided love to confound those of us who are simply trying to make our way in the world while keeping the books reasonably balanced.  Attempting to understand where they’re all coming from, particularly when their Big Ideas are inherently counterintuitive, can be both intimidating and exasperating.  That’s why I typically don’t bother.  The word “counterintuitive” sometimes describes a theory which is valid despite being ungraspable, such as General Relativity.
More often, ideas are counterintuitive because, once stripped bare, they are the utter nonsense they first appeared to be.  Thus if an academic economist, no matter how high he or she fallutes, makes claims that appear to run contrary to the commonest of sense, thinking people everywhere should scrutinize and, if necessary, challenge those claims without being put off by the smokescreen of jargon that typically accompanies them.  This is particularly true if that economist is in a position to make or influence public policy.  Of late, the dusted off and once again ballyhooed model du jour is demand-side Keynesian economics and the myth of  its so-called “multiplier,” which together have infected the current administration and a working majority of Congress.  My aim is to take the common sense, everyman approach to exposing the Keynesian multiplier for the ethereal hooey it clearly is, and to do so in a jargon-free manner.  This shouldn’t be too difficult, since I’m not competent to use the jargon myself and so generally avoid it.

When Keynesian economics reared its long-dormant head toward the end of the last presidential administration with the passage of TARP, then went into hyperdrive in the form of a series of federal “stimulus” packages engineered by Treasury Secretaries Paulson and Geitner, respectively of the Bush and Obama Administrations, something fundamental just wasn’t seeming to make sense.  We were told that if the federal government were to shore up a bunch of bad assets on the books of banks throughout the land and add wildly to the national debt by dumping loads of nonexistent federal dollars into targeted sectors of the economy, this would have a “stimulative” effect.  It would break the lending logjam and “multiply” throughout the economy, since recipients of stimulus dollars would need to hire people, engage with suppliers and vendors, and so forth.

A moment’s pondering of this proposition should expose its fundamental illogic.  Under the Keynesian “multiplier” scenario, government is placing a dollar into the economy for the purpose of stimulating, in particular, demand–Keynes was very specific about this.  In order to exist in the first place, that dollar turned loose by the federal government must have been either (1) printed, so it’s not attached to anything tangible, or (2) appropriated (through taxation), such that it originally came about by being created in the conventional manner, but was taken by government and simply re-routed to some other use ordained by the sausage-making process that is politics.  Under the ordinary, capitalistic scenario, when the economy grows by $1, a dollar that didn’t previously exist is created by the following process: Capital is either borrowed (debt financing–when the entrepreneur goes to the bank for startup capital) or invested (equity financing–when the entrepreneur convinces investors–venture capitalists–to put money into an endeavor that will serve as its startup capital).  In either scenario, capital is put to work toward an enterprise which has been willed into being for the purpose of combining things of lesser value into things of greater value, ideally taking profits as part of that process.  Capital needn't simply be money; very often a participant in a venture contributes labor, equipment or intellectual property to the enterprise, and money simply represents the value of both the capital inputs and the enterprise's outputs.  Capital is anything capable of either increasing the value of something, or of combining things of lesser value into something of greater value.  It is the only means of adding to the wealth of a society.
Using as an example something I’m most familiar with, imagine a top-down integrated forest products firm.  Capital is invested in the hundreds upon hundreds of individual assets–chainsaws, yarder, rolling stock, sawmilling machinery, training and employment of various personnel, etc.–required to sever a log from its stump, transport it to a sawmill and transform it into lumber.  The lumber always “existed” within the tree, but it took human, financial and mechanical capital to bring it into being.  Wealth was added to the economy by employing those resources toward successfully increasing the value of the tree for human use.  Dollars--and the value those dollars represent--exist after the lumber is sold that did not preexist the lumber, or the capital that extracted that lumber from the tree, because adding capital to the tree added value to it by turning it into lumber.

Under the Keynesian scenario, the government would have simply printed or appropriated money and handed it over to the sawmill.  This may have allowed the sawmill to produce more lumber for a time, or possibly to even hire more people, expand, buy more from suppliers, or what have you. However, everything resulting from that handover of money would have been “stimulated” not by market demand, as is ordinarily the case, but by the influx of capital that had either been created out of thin air or taken from someone else who might have put it to a different use.  Almost invariably, that would have been a higher and better use, since investors make carefully calculated decisions about where to put money that’s theirs to lose.  Money thrown about as a result of politics needn’t have any ties to good economic sense.  In any event, if there is no actual demand for the lumber thus produced, the entire transaction is a sham.  The sawmill got the money not because there was an underlying need for lumber in the stream of commerce that wasn’t being fulfilled, but because their member of Congress had more pull than someone else’s.

Demand is stimulated by people having money they wish to spend on certain goods, not by simply throwing money at something in hopes of–to use a metaphor that’s as inaccurate as it is overused–“priming the economic pump.”  The economy is not a pump, which simply moves water from one place to another.  If moving water is the metaphor of choice, it’s more like a hydroelectric dam, which converts the power of moving water to something of higher value by employing labor and capital in a calculated manner.  No wealth or value has been created under the hypothetical Keynesian scenario detailed above, or under any actual such experiment historically attempted.  Only a government mentality would torture sense into Keynesian doctrine, government being generally in the business of producing edicts, rules, and processes that are of little use to anyone other than government types interested primarily in broadening their power and justifying their existence.  In that light, it’s hardly surprising that bureaucrats should see the world through Keynesian goggles.  It gives them the ultimate, God-like power to take from some and give to others, choosing winners and losers based entirely on politics.

Another fundamental flaw of the Keynesian view of the universe is that it mislabels division as multiplication.  Money multiplies only when value is added to something.  If I turn a profit in my sawmilling operation by the time my employees, all of my vendors and suppliers, the bank, the tax man and so forth have all been paid off, I’ve multiplied money by adding value to something (a tree) and increasing the overall wealth of the world around me by releasing this value-added product back into it in response to an extant market demand for it.  If I’ve simply received money taken from somewhere else and spread it around (something else government types are generally disposed to do), I haven’t grown anything or produced any wealth.  I’ve divided money, not multiplied it, and would require another, similar infusion of cash from elsewhere in order to repeat the process.  The first example is self-sustaining, as some of the profit I turned can be put back into the enterprise to grow or maintain it.  The second example is a one-shot deal.
It should, of course, come as no surprise that lefties are innumerate.  There's a reason they gravitate toward law, the humanities and political "science," and shy away from business, economics, medicine and the hard sciences.  Nor should it surprise us that people capable of so basic an error as mistaking division for multiplication would be the source of other numerically implausible mythologies, such as the notion that the "rich" who, depending on how these straw men are defined, pay anywhere from 80 to 95% of the taxes in this country, are failing to pay their "fair share."  We're also told by the left that failure to maintain confiscatory rates of estate taxation results in "concentrations of wealth."  How this could be credibly alleged when there was once only Joe Kennedy, yet today lamentable scores of his wretched descendents, is yet another failure to recognize division as it occurs in plain view.

As another example, imagine that you determined to take it upon yourself to “stimulate” your local economy by maxing out all of your credit cards at local retailers.  Once again, you’ve executed a one-shot deal.  The money ripples through the economy, temporarily enriching all who touch it.  In the end, however, what is left is a bankrupt consumer with no further purchasing power.  The local businesses have one less customer.  When that customer seeks bankruptcy protection, everyone who lent him money is forced to eat a loss.  That means there is less capital available in the economy for those who might borrow it for productive ventures, either because the bank has less to lend, or has made its lending standards more stringent in light of its losses resulting from the bankruptcy.
To illustrate the patent absurdity of Keynesian economic "stimulus" with a patently absurd example, imagine the government were to dissolve all agencies and fire all personnel responsible for implementing its various entitlement programs for the poor and aged, then print $300,000 to hand to every man, woman and child in the nation.  Would this be "stimulative"? Hardly.  Millions would simply cease all productive work.  The currency would be largely meaningless, because a fiat currency (which all world currencies have been ever since the gold standard was abandoned) must be tied, at least in some attenuated manner, to units of wealth produced in the manner previously described. This is what economists refer to as the "money supply."  What good is it to have $300,000 if there are no goods and services to buy because none are being produced?  As absurd as this example appears, there is a reason I picked $300,000 for my example:  It represents the amount, per man, woman and child currently living in America, of the combined, long-term unfunded liabilities of the three major entitlement programs: Social Security, Medicare and Medicaid.

The flaw of Keynesianism is also the flaw of demand-side economics more generally.  Demand-side economics assumes that demand is the key to simulating and growing the economy.  Supply-side economics recognizes that someone must put up the capital (machines, intellectual property, a trained workforce, office buildings, etc.) in order to provide consumers with the jobs and income that lead to demand in the first place.  Demand cannot be conjured from thin air.  People need to be making money in order to consume and invest.

Accordingly, nobody who subscribes to Keynesian or demand-side economics should be considered qualified to occupy an elected office higher than that of Dog Catcher.  This would disqualify the last two presidents of these United States.

For more on the problems with Keynesian theory, check out a recent article by Professor Jeffrey Miron at Harvard:

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Reader Comments (2)

How can I be reading something at 12:56 pm that was posted at 2:26 pm the same day? Are you in New York?

October 28, 2010 | Unregistered CommenterDad


October 28, 2010 | Unregistered CommenterDJ

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