Presumptuous Economists

In this post on her blog, Econgirl nails on the head what I attempted to say in my recent post, keyenesian econmists misjudge the economy.

In her post, Econgirl has an imagined debate between philosopher Michael Sandel and a group of economists. Here’s the pertinent exchange:

Sandel: The second limitation to market reasoning is about how to value the good things in life. A deal is economically efficient if both parties consider themselves better off as a result. But this overlooks the possibility that one (or both) of the parties may value the things they exchange in the wrong way.

Every Economist Ever: The “wrong way?????” Who in the hell are you to tell people what they “should” be valuing? Some economists may try to account for tastes, but none of us are presumptuous enough to tell anyone what their tastes should be.

I disagree with Econgirl that ‘Every Economist Ever’ would have that response.

The point I tried to make in my post is that keynesian economists are presumptuous enough to tell people what they “should” be valuing when they see what they call ‘aggregate demand’ fall.

Rather than considering why aggregate demand fell (i.e. the reasons folks are spending and investing less), they simply assume it is bad (a presumptuous subjective value judgement) and the government must override the will of all of those people.

Rather than considering that aggregate demand fell because people are being more careful with their money (because they no longer have banks willing to loan them money on their bad credit), or foresee more uncertainty in the future (because government has taken an active role in arbitrarily changing the rules), or are changing what they value (since they longer get easy loans, they stop buying things like singing fish), they just assume that they are right and everybody else is wrong.

Getting cause and effect backwards

This post at The Pretense of Knowledge about the cognitive dissonance anti-consumerist supporters of Keynesian stimulus (i.e. college hippies), reminds me of an often misunderstood cause and effect in our economy.

The underlying belief of government stimulus spending is that spending itself is wealth.

But, the cause and effect go the other way. Spending does not cause wealth, wealth causes spending. 

Before my early ancestor, Unk, initiated the first trade with your early ancestor Puhg, Unk had to first create something that Puhg wanted. Likewise for Pugh.

So, while Unk got really good at gathering apples (investing), enough so that he had more than he needed at the moment (savings), Pugh was honing his skills catching fish (investing again), more than he needed. Unk trade a few of his extra apples, that he valued less, with Pugh for some fish, which he valued a bit more.  Likewise for Pugh.

In the trade value was created for both Unk and Pugh.

Now supporters of Keynesian stimulus will tell me that government stimulus “spending” is really “investment”, just like the investment Unk made in improving his apple gathering productivity. The government “investment” improves “our” productivity.

And, in some cases, that may be true. However, I noticed on a recent trip through several states that many of the shiniest and most architecturally adventurous new buildings, many adorned with art, happened to be government buildings.

I noticed some new private buildings, too. They were more conventional, less flashy. Maybe government knows something the private building owners don’t. Perhaps they know that groundbreaking architecture and public art adds to productivity. Certainly there are some private buildings like that as well.  But, I wondered how “we’ve” become more productive with such an elaborate edifice for a public works building, in one case.

Do you need another can of green beans in your pantry?

English: Cut Green Beans Español: Habichuelas ...

"Creating" Demand

I enjoyed Arnold Kling’s column (econblogger at EconLog), Government Cannot Create Sustainable Jobs, published in the European edition of The Wall Street Journal.

I think the following two paragraphs contain the most concise and understandable contrast of two competing visions on how the economy works (emphasis mine):

For Keynesians, job creation is simple. Entrepreneurs have knowledge of how and what to produce. All that is required is more demand, in order to induce them to undertake more hiring.

n contrast, in our [Adam] Smith-Ricardo story, the knowledge of how and what to produce has to be discovered. Entrepreneurs have to figure out ways to utilize resources that satisfy wants in an efficient way. The market mechanism first must undertake trial and error to create production processes that exploit comparative advantage. Until these new patterns of sustainable specialization and trade are discovered, there are no job slots.

I bolded the key phrases.  Do you believe that progress comes from stimulating evermore demand or from trial and error experimentation?

I believe the latter.  Progress, wealth, improvements in the standard of living, GDP per capita growth — whatever you call it — comes from experimentation and trial and error and a process that allows the valued to survive and multiply and the least valued to die off (i.e. evolution).  This trial-and-error market process is driven by the ultimate democracy of individuals voting with their own value store on the the things they value and vote against those things they don’t value.

The problem for me with the former explanation, creating more demand, is where this new demand comes from.

The theory says that more government spending will put more money into some folks pockets, which they then spend.  So, then the businesses that benefit from that extra spending will spend more too.  And so on.  This is a chained spending effect.  By the time the that extra dollar of government spending has worked its way through the economy, it’s spawned more than a dollar of economic activity.

This seems reasonable on the surface.  But pry deeper.  Where did that extra dollar of government spending come in from in the first place?  It either came from current or future spending.

If it came from current spending, then all we’ve done is take a dollar from someone to get the spending chain started.  That someone may have started their own chain by spending it themselves.

Defenders of this theory will say, yes, but that someone wasn’t going to spend it any time soon so it’s best for everyone that the government took it and spent it.

I believe the miss in this line of thinking is that someone was waiting to discover something of value to spend it on, while spending it now does not help him find that value.

What’s really happened is that demand was pulled forward from the future and we’ve spent it on something that doesn’t add value.

Companies see this when they run ineffective limited time promotion.  The sale will produce a sales spike during the offer period and a lull afterwards.  The sale encouraged people who were going to buy the product anyway to buy it sooner, and buy less later.

But, in the case of the government pulling forward demand, it makes things worse.

That someone with the original dollar was waiting to spend that dollar on something he valued — maybe a new pill that will reduce his sick days and make him more productive.

Instead, the government takes it and spends it on another can of green beans.  So, instead of having four cans of green beans in the pantry (that he’s never going to eat), he has five now — something that doesn’t bring as much value as that new pill.  But, hey, the green bean growers and canners are better off.  Except, we find that since there’s a glut of canned green beans now, green bean makers will sell fewer cans in the coming months.

So, creating demand through government spending is a myth.  There is no creation.  Just moving demand from one place to another or from the future to now — and in either case, we replace careful spending with careless.

Related articles

Keynesian stimulus in one sentence

Milton Friedman, Nobel Prize in economics and ...

Image via Wikipedia

We’re not sure why you’re not spending your money, but we don’t like it, so we’re going to spend it for you.

No?  What am I missing?

Unfortunately, when this happens it moves spending from Types 1 through 3 spending, per Milton Friedman, to Type 4 spending.

In Type 1, you spend your money on yourself.  That’s the most carefully spent money.

Type 2 is you spending your money on someone else (e.g. gifts you give).  Type 3 is you spending someone else’s money on you (e.g. you on business travel).  Type 2 and 3 spending isn’t quite as carefully spent as Type 1, but they’re still much better than Type 4.

Type 4 is spending someone elses’ money on someone else (e.g. government spending).  The result of Type 4 spending creates value in the same way receiving a gift of 100 cans of green beans for your pantry creates value, even though you don’t much care for green beans. To be clear it doesn’t.  That destroys value — even if you donate them to a charity (but I won’t get into that now because I might be wrong about that).

And that’s why stimulus doesn’t stimulate.  It ignores why people aren’t spending money (because they’re being careful for some reason) and overrides that with spending that’s not likely to create net value because it’s not carefully spent.

UPDATE: Be sure to read W.E. Heasley’s excellent elaboration on this post at his blog, The Last Embassy, where he also coins Type 5 spending.