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For a long time, I've thought that economic thought took a turn for the
worse beginning around 1870, with Karl Menger and Alfred Marshall.
Before then, economics was a subset of politics and government, with
"politics" here not to mean winning elections so you can steal a lot of
money, but with its historical meaning of:
1a :
the art or science of government.
Today, we usually use the word "government" for this purpose. The study
of "political economy" thus meant: the study of government economic
policy, as opposed, for example, to "household
economy," which is where the word "economics" originally comes.
This was, like other studies of politics and government, a somewhat
broad, literary, and philosophical topic, which had been discussed
since ancient times.
Read Politics, by Aristotle,
circa 350 B.C. Confucius (sixth century B.C.) and Mencius (third
century B.C.) also discussed "political economy" (government economic
policy) in great detail. Mencius was a tireless advocate of the
"well-field system" of taxes, which was an effective 11% tax rate (very
low at the time) on farmers.
This is the discussion of "political economy" that has come down
through the millennium.
Before the 1870s, the defining work of "political economy" was Principles of Political Economy,
by John Stuart Mill. Mill, and others of his day and earlier such as
Ricardo and Smith, took a wide-ranging, if often episodic and
disorganized, view of economic topics. Prices, interest and money of
course engaged their interest, but so did taxes (read On the
Principles of Political Economy and Taxation, by David Ricardo),
regulation of all kinds, warfare, plague, famine, legal foundations,
welfare programs, and any other practical matter of statecraft.
However, after 1870 or so, economics gained a sense of physics-envy.
Economists wanted to make their study more scientific. Math makes a big
appearance. This tended to exclude all those aspects of public policy
that are hard to quantify -- try to quantify the economic advantage of
the introduction of the LLC structure, as opposed to the prior S-Corp,
for example -- and to reduce the focus to prices, interest, and money.
The focus of the time, and which has continued largely unchanged to the
present, was on "equilibrium theories" vaguely inspired by ideal gas
laws and other discoveries of physics. Leon Walras
is known today for his "general equilibrium
theory,"described in his 1874 book Elements of Pure Economics. ("Pure"
economics? Without the messy unquantifiable bits?)
Separately but almost simultaneously
with William Stanley Jevons and Carl Menger, French economist Leon
Walras developed the idea of marginal utility and is thus considered
one of the founders of the “marginal revolution.” But Walras’s biggest
contribution was in what is now called general equilibrium theory.
Before Walras, economists had made little attempt to show how a whole
economy with many goods fits together and reaches an equilibrium.
Walras’s goal was to do this. He did not succeed, but he took some
major first steps. First, he built a system of simultaneous equations
to describe his hypothetical economy, a tremendous task, and then
showed that because the number of equations equaled the number of
unknowns, the system could be solved to give the equilibrium prices and
quantities of commodities. The demonstration that price and quantity
were uniquely determined for each commodity is considered one of
Walras’s greatest contributions to economic science.
Their conclusions were something like this:
1) Prices:
Prices change so that supply meets demand and the market clears. If the
market-clearing price is below the cost of production, investment and
production is reduced; if the price is very profitable for producers,
investment and production increases. Wages get a lot of focus here: the
solution to unemployment is inevitably lower wages, to clear the labor
market.
2) Interest: Interest on loans
and bonds are ultimately a price of capital. Much the same principles
apply: the market interest rate leads to a clearing of the market
between the supply and demand for capital. Lower interest rates
increase demand for capital (more investment), and reduce supply
(incentive for less saving and greater consumption). High interest
rates discourage investment, but increase the returns on capital
creation (savings).
3) Money: Money is basically
neutral, in the Classical pre-1914 conception. Monetary distortion of
various sorts can upset the equilibrium of prices and interest.
Now, look at what we have here. Prices and interest are basically
self-regulating "equilibrium-seeking" mechanisms that can be left to
the "free market." Money is to remain neutral, basically on a gold
standard system.
Recessions have basically become impossible, or at least, minor or
unlikely. If there is a problem, then prices (especially wages) can
adjust, and the system finds a new equilibrium.
We have just scrubbed economics of all kinds of real-world things that
can certainly cause recessions and also long periods of stagnation and
decline. Taxes and regulation -- two giant areas of government economic
policy -- have disappeared from our model, either on the positive or
negative side. Economists no longer recommend good taxation or
regulation policy, or criticize bad taxation or regulation policy. It
has disappeared. Also, government spending has disappeared. Welfare
programs, public works, public education, or any other program that
could conceivably have positive or negative economic effects, have
disappeared. There is nothing to say whether a government spending
program creates great benefits, or is a total waste, or in fact creates
terrible consequences. It is all gone.
Education, the rule of law, judicial structure, ease of starting a
business, the insane regulatory burdens of business today or a
dozen other things that people discuss today in great earnest, have all
disappeared from the study of economics.
The U.S. Federal goverment: 4000 new rules per year.
Of course, any economist will agree, in casual conversation, that all
of these things could have a meaningful effect. But, when push comes to
shove, they stick to their mathematical models where all of this has
been scrubbed.
Let's look at some of the consequences of this, particuarly as it
relates to the Great Depression, when it became important.
The Classical-leaning economists could see that the formation of prices
and interest rates, in the 1920s for example, were relatively free and
unmolested. This was not some kind of Venezuela-like statist failure.
The money was soundly linked to gold. Thus, they concluded that there
was no problem, and that "do nothing" was the best course of action.
The Keynesian economists argued that wages had become "sticky" due to
unions refusing to allow wage rates to fall. Unemployment was caused by
a "market that doesn't clear" due to wage "stickiness." The solution
was a devaluation of the currency to reduce real wages, even if nominal
wages were unchanged or rising.
The Keynesian economists also argued that economies could get
themselves into extended slumps, and the solution was to depress
interest rates. This would lead to more investment (and thus hiring of
the unemployed), and also less savings/more consumption. This reduction
in interest rates was basically to be accomplished via the printing
press, and would thus be a roundabout method of currency devaluation,
although the Keynesians didn't talk about that much. Thus, via one
justification or another, the Keynesians landed upon Money as their
solution for the problems of Prices (wages) and Interest. The title of
Keynes' influential 1936 book was The
General Theory of Employment, Interest and Money. Keynes, and
all his followers to the present day, are direct descendants of this
"general equilibirum" stuff from the 1870s.
The Classical-leaning economists, after it had been shown that "do
nothing" wasn't working, then went looking for reasons why "do nothing"
was a flop. Interest rates weren't very convincing, because they were
already very low in the Great Depression. (Today, the Keynesians talk
about the "zero bound" for interest rates, which supposedly keeps the
"market from clearing" during bad recessions.) If they didn't
particularly buy the "sticky wages" argument, and there weren't obvious
price controls and other such things preventing "equilibrium" in
prices, then they were naturally led to believe that there was some kind of problem with the money.
The Classical-leaning economists were probably a little hesitant to
embrace the "we need lower wages" argument, even if they agreed that
unions caused some "wage stickiness." (I personally think the "wage
stickiness" problem is grossly exaggerated today, basically due to
economists' need to blame something
within their very limited frame of reference.) Are you really going to
say that "everything is fine, we just need people to be paid less"?
Economic health had always meant higher productivity and higher wages.
It was a loser on both an intellectual level and a political one. You
could say much the same thing about interest rates, which collapsed
during the Great Depression. Interest rates are not low enough? When
they are at their lowest in history? There must be some other problem.
Thus we get a parade of Classical (anti-Keynesian) economists claiming
one or another problem with the money,
even though currencies around
the world were on a gold standard system without any great problems or
difficulties.
From this we get the "Austrian explanation of the business cycle,"
which blames anything and everything on some kind of money/credit
problem. It's the natural conclusion if you don't see a problem with
the prices or the interest rates. Now, I agree that sometimes there is
some kind of money/credit problem, especially in a floating fiat
currency evironment like today. But, you can also have problems (or
successes) from a great many other sources too. Also, any claim that
there was some kind of vast money/credit problem runs into the question
of: how did this come about under a gold standard system, which is
supposed to disallow and prevent these kinds of problems? After all,
the Keynesians (and other like them in the decades before Keynes)
always complained that the gold standard system prevented them from
engaging in the kind of activities that would create exactly the kind
of money/credit consequences that the Austrians describe.
Rothbard, and many like him, claimed that there was some kind of great
money/credit bubble, of Great-Depression-causing proportions, in the
mid-1920s when currencies were soundly on a gold standard system.
Milton Friedman claimed some kind of vast money/credit contraction, of
Great-Depression-causing proportion, again while currencies were
soundly on a gold standard system.
A few economists, notably Gustav Cassel, claimed that there was some
kind of gigantic change in gold's value (a rise), thus causing money
problems for all currencies linked to gold. But, gold had never shown
any such behavior in the previous five centuries. Even the 1880s and
1890s, though difficult for commodity producers, were a time of great
economic productivity and expansion.
Jacques Rueff, and some others, claimed some kind of vast disaster
caused by the "gold exchange standard," supposedly very different from
the pre-1914 "gold standard." But, we saw recently that they were
actually rather similar.
June
26, 2016: Foreign Exchange Transactions and the "Gold Exchange
Standard."
October
14, 2012: Book Notes: The Age of Inflation, by Jacques Rueff
Besides, it was the rinkydink countries that had "gold exchange
standards." Britain and the U.S. didn't. France began with one, in
1926, and then essentially went back to its pre-1914 policy.
July
27, 2014: The Bank of France, 1914-1941
Are we really going to blame the Great Depression on the fact that
Poland and Yugoslavia had a "gold exchange standard"? Nobody blames
Poland for causing the Great Depression.
Then there is the Blame France contingent, which Blames France because
... well, they haven't really figured it out yet. France accumulated a
lot of gold ... or "sterilized" something ... or there was an
"asymmetry" ... or France had more gold than some other people, so
there was a "disproportion," which sounds like an "imbalance," which
sounds like it might be a problem ... or maybe if we throw enough
spaghetti at the wall, something will stick.
Read
"The French Gold Sink and the Great Deflation of 1929-1932" (2012), by
David Irving.
France was on a gold standard system. So was the U.S. and Britain, and
everyone else. Basically, they had the same currency, just like the
eurozone today, or countries which peg their currencies to the euro
with a currency board.
Anyway, the point is that, the blinkered logic of Prices, Interest and
Money led the Classical economists to Blame Money as a cause, and the
Keynesians to Embrace Money as the solution. Some people were a little
in both camps, notably Milton Friedman, who couldn't really decide
whether he was a Classicalist or a Keynesian (he was basically a
Keynesian).
June
12, 2016: Milton Friedman Blames the Federal Reserve
August
12, 2012: The Dying Gasp of Monetarism
Keynesians have a little to say about nonmonetary goverment policy, but
they are mostly interested in Spending. What the money is spent on is
largely irrelevant. "Public works" sounds nice, and justifiable,
although it does not take much probing to find that they Keynesians are
completely disinterested in the question of which public works. The fact of the
matter is, that any "public works" engaged in with the primary purpose
of simply increasing overall spending is probably total waste. This is
in part due to the fact that real public works projects of real value
-- I once used Hoover Dam as an example -- typically have a
multi-year planning process, while "stimulus" spending is generally
aimed to create its effects within 6-12 months, and stretching over
12-18 months. Real things of real value don't work like that.
February
22, 2009: Public Works Done Right
The focus on spending again comes from "general equilibrum" notions,
basically the idea that "overall prices" are reflective of "aggregate
supply" and "aggregate demand." If "overall prices" are going down, as
is common in an economic downturn with a stable currency, and if a big
increase in supply is not obvious ("supply" is typcally shrinking in a
recession), then "more aggregate demand" is the natural solution,
following this line of logic. "Aggregate demand" basically means
spending money, and since the government is about the only thing around
capable of spending money in sufficient size, that's where the focus
goes.
Now think of that. All of government policy -- taxes, regulation,
tariffs, law and justice, welfare programs, public works and other
public spending -- just got turned into a single number of "spending."
There is really no place in this construct for any discussion of the
actual details of taxes, or welfare programs, or anything. Even if you
discussed it in depth for a month, and came to many great conclusions,
there would be nowhere in economists' equations of equilibrum to plug
them in.
Economics today, among academics, hasn't really advanced much, and is
still stuck in the Prices Interest Money prison. One reason for this is
that mathematics is still a big part of economists' career track, even
though they will have to abandon
mathematics to incorporate all of the other important factors of
economic policy. Maybe "abandon" is too strong a word, and
"de-emphasize" would be better. But, I think you could actually
"abandon" it, because I don't think that any of the math, going back to
Walras, has really led to any new insight. It has just caused problems.
That's why the economists who do focus on all of these factors that
fall outside of Prices Interest and Money tend to be outside of the
"macroeconomics" circle, and are interested in developmental/regional
economics, which tends to be more a matter of history and geography.
When we start to talk about the economics of a real place and time,
like China in the 1980s or India in the 1960s, then all of a sudden we
are again talking about things like education or taxes or whether
public investment to created real benefits or just crony payoffs, or
whether tiny sole proprietorships have access to capital, or whether
property is protected in court or confiscated wantonly by corrupt
officials, or whether a country invites foreign direct investment or
perhaps insists on domestic ownership of corporations, or how easy it
is to set up a corporation, or a dozen other things.
Now, I know that every economist is going to claim that I am wrong, and
that they are actually oh so very very concerned about all those
things. Of course they are. They could not claim otherwise. Then, these
very same people might turn around and suggest "nominal GDP targeting,"
which is basically the claim that steady economic progress can be
produced from monetary manipulation alone, and that all other factors
are irrelevant.
March
24, 2016: The Simple Simplistic Simplicity of "Nominal GDP Targeting"
"Nominal GDP targeting" is really just a sort of automaticized version
of Keynesian monetary manipulation. Keynesianism boils down to little
more than money manipulation and government spending; and if, as a
conservative, you don't get very excited about deficit spending for no
clear purpose except jiggering "aggregate demand," then you are left
with money alone.
The great advance of "supply side economics" in the 1970s was to
finally bring back in all those things that got scrubbed from economics
in the 1870s. Tax policy is a problem. Tariff policy is a problem.
Regulation is problem. Existing welfare programs might be a problem.
Maybe education is a problem. We don't have to blame money for
everything, for lack of a better solution within the Prices Interest
Money box. The solution is: Tax reform. Tariff reform. Regulatory
reform. Welfare reform. Education reform. Or, whatever else might be
the problem, you just fix it.
Oddly enough, despite quite a lot of excellent work done on all of
these topics over the past forty years or so, it still hasn't
penetrated the hermit kingdom of academia. They are still stuck in the
Price Interest Money box.
But, even the Classical tradition, best expressed in the 1950s and
1960s by the "Austrians," especially Mises and Hayek, was stuck in a
similar Prices Interest Money box, and needed a major upgrade.
When you read the writing of any economist, from 1800 to the present, I
invite you to ask: is this person stuck in the Prices, Interest and
Money box? Just by asking the question, I think you will know the
answer.
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