Hi Guys,
This is a frustrating period for everyone, rich and poor alike. The United States and the world’s other nations have been in an economic malaise for several years. What economic persuasion should be adopted to reverse this sorry state and to energize a vibrant, healthy recovery?
Common economic theory offers two disparate approaches. Are you a Keynesian or an Austrian or both? Here is a hint. You can not be both because they are incompatible disciplines. If you answered both you are a clueless politician.
The Keynesians promote the demand side of economic tradeoffs and the Austrians emphasize the supply side of this debate. The former advocates social solutions to economic maladjustments; the latter rejects social solutions in favor of private initiatives.
Personally, to address this challenging controversy, I like analogies because they are easily understood and useful to distinguish critical distinctions between competing solutions.
I propose to examine the two competing economic theories using a storytelling method to illustrate the principle features of both approaches. This storyline technique was used by French economist Frederic Bastiat in his 1840s “What is Seen, and What is Not Seen” essay, and popularized in Henry Hazlitt’s groundbreaking 1946 book “Economics in One Lesson”. Bastiat and Hazlitt inspired and informed this submittal.
The hypothetical scenario goes like this. The general population is suffering because crop failures have created food shortages; starvation is a real threat; bread is worth its weight in gold. A small segment of the population has escaped this dire threat due to their wealth status; these fortunate few hold sufficient resources to purchase bread at any price level.
The Keynesian solution to this dilemma is a redistribution of wealth enforced by government intervention. It is the “prime-the-pump” illustration that appeared in all high school textbooks after World War II. The government intervention typically takes the form of a progressive income-based tax structure, or even a supplemental, temporary tax program.
Under the Keynesian plan, the successful rich are incrementally taxed and the accrued monies are given by the government to the general population to buy bread. The immediate outcome is instant relief. Starvation among the needy poor is avoided while the society’s wealthy cohort retain sufficient resources to eat comfortably. Problem solved! No, not really.
The immediate benefits (and they are real) are “seen” as Bastiat observed. But there are impacts that are “not seen” according to Bastiat both in space and in time. Even in the short run, the redistribution process will have an impact. Bread prices will climb since demand will increase, whereas production (supply) will not. In the intermediate timeframe, farmers will be motivated to plant more wheat acreage and bakeries will add more shifts to increase supply. These groups will benefit from this preferential government support. In this instance the government picks winners and losers.
But these effects act on what economists term the margins. There is a limited multiplier effect that quickly smacks into a resource-constrained wall. Recovery stalls. There are both time-lag and production constraint phenomena that are activated. There is a limit to the expansion capability of cash constrained bakeries. If increasing taxes are extracted from the wealthy, less investment capital will be available for bakery expansion regardless of profit incentives.
There are frictional losses that are accumulated with added government employees who only manage the redistribution task; this cohort merely consumes bread without increasing the actual supply. This frictional drag lowers efficiency. In the end, it is overall efficiency that matters most.
The Austrian school offers an alternative plan. That plan might best be accurately characterized as a non-plan. The Austrians would most likely recommend to do nothing specifically, but to lower taxes and reduce regulations as a general target. The Austrian school distrusts government in favor of almost boundless entrepreneurialship. They would preferentially defer action to capitalists and entrepreneurs.
How would that prescription work in our imaginary scenario? The bread shortage would remain in the immediate term; some folks would indeed perish while others would survive on short rations.
However, the rich folks would not allow their excess resources to stagnate. The rich became rich because of their innovative and investment prowess. They would recognize the need for increased bakery facilities and would seize this profit opportunity. Rich people would finance new bakery construction mostly animated by profit incentives. All economists recognize the dominance of profit incentives as a decisive factor that stimulates economic progress.
So, in the short term, the bread shortage is unaffected and belt tightening is the order of the day. But remember how the US reacted to the dire reality of WW II. Our war production machinery responded almost instantaneously. Tanks rapidly replaced automobiles on Detroit assembly lines. In our scenario, bakeries would proliferate, the bread shortfall would be resolved in the intermediate term, and production capabilities would likely exceed our needs. We Americans always overreact in a manner that requires a retrenchment.
Yes the rich would profit handsomely. But so would the entire population as bread became abundant to satisfy all hunger. Prices would adjust downward as production ramped upward. Such are the merits of a capitalistic society and system.
Certainly the rich would prosper disproportionately, but the starving would survive to perhaps become rich in a society that emboldens financial ladder climbing. Also, more farmers would plant wheat crops, bakery construction would be encouraged, more bakers would be employed, more trucking would be on the road to transport wheat and bread, more fuel would be burned, and more machine tool manufacturing would be designed to fabricate up-scaled bakery equipment. This interconnected web of impacts is endless. The multiplier effects are huge and unfathomable to predict.
Most assuredly, some groups would suffer if the Austrian school prescriptions were adopted. In a free capitalistic society there are always winners and losers. The government’s size would not expand, and might even shrink. That’s not so good for politicians and government employees, but that would be a superb outcome for the silent majority - like 80 % of the general population.
That’s not a bad compromise tradeoff. When entering battle, every general knows he will suffer casualties. The goal is to minimize those losses, to construct and implement a plan that is most efficient at achieving the goal.
In my judgment, the Austrian School initiatives are more likely to succeed than the competing Keynesian School. In the end, it comes down to efficiency and scope. I trust the time-tested capitalistic concept more than I trust the social-democrat redistribution policies. These policies largely failed during our Great Depression, they failed in Russia for decades, and they are currently failing yet again in the European social-democratic Nations. Its poor historical record is undeniable.
The fundamental disparity between the Keynesian and Austrian Schools is that the Keynesians think more immediate, more short term. The Austrians think in terms of less intervention and more long term in their doctrines. A centralist Keynesian wants to expand all highways; an Austrian wants to build a concrete plant and allow local leaders to decide if a highway expansion is responsible.
The fundamental distinction between the competing schools is that the Keynesians treat the symptoms of an illness; the Austrians attack the root cause of it. The Austrians want to reward individual merit; the Keynesians want to spread the rewards according to need.
In Henry Hazlitt’s eminently readable book, he really does summarize economics in a single sentence lesson. That lesson is: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups”. Impact inclusiveness, time horizon, and properly aligned incentives are the essential elements of good economics policy.
Economic tradeoffs are often painful and unfair for some. That’s the nature of our complex and interconnected economy. As gym instructors frequently admonish, there is no gain without pain.
Recall Milton Freidman’s famous quote: “There’s no such thing as a free lunch”. Less famously, he also noted that “We have a system that increasingly taxes work and subsidizes nonwork.” Now that’s truly an upside down incentive system.
Well, that’s my story. I hope it gave you some insights, and maybe even raised your ire just a little. If it did, please comment. I always welcome your thoughts.
Best Regards.
Comments
Hi Bee,
Thanks for the Link. I had seen it several years ago and had forgotten its existence. Thank you for the nudge. I watched it again. It’s a winner; great stuff.
I always marvel at the inventiveness and imagination of these videos. Not only are they factually correct for the most part, but they are entertaining. They’re often funny too. It is small wonder that they have been viewed millions of times.
Your reference directed me to chapter two of these Hayek-Keynes debate videos. It was issued earlier this year and has already attracted over one million viewers. That offers the prospects of some serious learning. That can’t be too bad.
Here is the address for Round 2 of the Keynesian-Austrian controversy:
I like it better then the first video. Enjoy.
First it is interesting that you chose Austrian economics which favors verbal arguments over mathematical basis as you advocate math in many other articles of yours. There is no basis for quantifiable measurement and predictions in Austrian economics. It is too much eloquent words.
You have equated Keynesianism as socialism. It is far from truth. Keynes prefers government to step in where demand side is severely damaged. It is not a day to day affair as you put it. Basically, Keynes advocates government intervention where there is a market failure. The Austrian theorists are known to have a leaning towards anarcho-capitalist solutions under those conditions. It is easier said on paper than implemented in real life as you have to be rather insensitive to the suffering around you to continue implementing it.
I should note that before Keynes came up with his ideas Austrian economics was already present. It was pretty much the orthodoxy and it could not solve the problems of the great depression. It did not work in practice like it was put in textbooks. It causes so much suffering and enhanced crisis and I will even say contributed to the rise of Hitler to power because suffering masses were more willing to follow radicals as a solution to their problems.
Naturally, Austrian economics is favored by the rich as somehow sold to clueless masses as the solution, because they are not the one that will be suffering by the lack of bread. It is recession when my neighbor goes hungry and depression when I go hungry. Who cares if the poor classes of the society has short term food shortage and having survival difficulties!
Breakdown of society and social order is not a problem for Austrian economics. I am sure Austrian economics will see this an opportunity to setup more prisons and protective security forces to protect their wealth against increasingly agitated society where wealth is more and more concentrated in the hands of few. Now you said that that Keynesian economics about fixing the symptoms (bandaid). How how is that as a bandaid for Austrian economics?
What is the recommendation of Austrian Economics to economic crisis. Since Austrian economics does not favor any government action, the recommended course happens to be austerity and more austerity as more and more economy is destroyed (until it hits the bottom, after many many businesses are destroyed) By austerity the meaning is the less fortunate masses suffer more during the time the rich takes their time to setup mechanisms to enhance their wealth. entrepreneurship will not work under these conditions because demand is not present as people are unemployed and increasingly unemployed. As the potential customer basis is decreasing, the rich will not setup business when there is lack of demand.
As you can say, I am a Keynesian in that I see Government having a function is ensuring markets are functioning orderly and fairly. I reject laissez-faire as requested by Austrian economics and we have seen numerous examples of how laissez-faire ideology has failed and cost us as a society big. When markets fail, government may need to interfere until normal market functioning is restored. I also reject as your submission equates Keynesianism as socialism. I see socialism is inserted as a fear factor.
Paul says it better than I can.
http://krugman.blogs.nytimes.com/2011/09/26/lucas-in-context-wonkish/
When I look at the situation the most frightening thing is the lack of immediate opportunity for the young. Optimism, once blown out, is hard to reignite. I wouldn't blink if the various governments employed them all temporarily. What's wrong with putting the best young minds to dreaming? What's wrong with putting the strongest young arms to building? People speak as if we cannot contribute to the future by capturing the present and making it the best investment for the future. And that is government spending and it is contributions from captures of current affluence wherever it is found. (Making sure the young start a life in the workplace is no different than making sure they are fed and educated to go in the workplace.) We have a situation where, even though the "job makers" have funds they aren't building bakeries fast enough to feed the crowd and aren't sharing one iota of a future plan to meet the needs of the population. It is a scam. Bunk. I have a new meaning for "just-in-time". Namely, just-in-time to use the only tool the average American's have to fill in where private sectors have left a growing gap - it's called government!.
People need to defocus from dead (and live) poets and focus on meeting the current needs of the people no matter which dead poet's feelings are hurt.
I do think that my formally under-educated mind will have to have "dogma" as my word of the day.
MJG noted early in his write that one is either a K or an A type....but can not be both.
This leads me to conclude that I must be either a republican or democrat, or a Catholic or Protestant or whatever else may be indicated as a black or white scenario.
I must state that I am a rainbow person, apparently; as I pull pieces from whatever area is needed to accomplish my mission, whatever that mission may be at the time.
I regard being flexible and adaptable taking me to the middle of the road to attempt to view the road ahead to find the exit I may need to access to allow me to continue the journey.
Investor noted, "I see Government having a function in ensuring markets are functioning orderly and fairly."
I am not picking on either of you, but these statements stuck in my mind. One is written to the black and white; and the other causes me to ponder who decides what is or is not "orderly or fairly"; and is this not a form of socialism?
My second word of the day would have to be; perverted.
While there are apparent base models for math, science, politics, religion, economics and others; mankind through beliefs and in some cases playing with the meanings of words has been able to pervert many of these areas and shape them to their own wants and needs.
Ethanol fuel...........geez, talk about perverted thinking for a less efficient fuel and driving up corn prices for the consumer and grain feed industry.
"If you don't believe as I do, you will go to hell." I've heard that enough times from those I have known over my 6+ decades on this planet. More perverted thinking.
Some economists: I'm not sure if these folks get out of the ivy covered towers very often; based upon comments they put forth. They have data sheets and computers running to the max; but they need to go do a "walk about" for a real sense of the sights, sounds and real smells of the real world.
Between dogma and perversion; let alone whatever else chooses to throw into the pot of human thought; it is a wonder that anything functions.
Mr. Flexible and Adaptable signing off.....just a plain, middle of the road guy.
Catch
Yes, indeed; the all knowing bunch. The rain outside has caused a work stoppage for me.
A short note: Many years ago when I was about 28 years; I was chosed to be supervisor of about 25 people (all mechanical/electronic/computer techs, and 2 ladies in the office). The manager was first in line, then myself. He was a very bright and generally fair minded person and would back up anyone in a dispute with a customer, if the evidence indicated this to be appropriate. He would go to the point of protecting a workers position, even if it meant educating and/or pissing off the customer; who he knew had no clue as to how we did our work.
But,.......he was the king of how things were to be done. Many times I suggested changes that I knew would be positive for all. The most important thing I discovered for making a change in his mind was to present the info in such a way and over a period of time, that he eventually "may" consider the idea to be his own, with small modifications. I would never mention that such and such a plan was put forth 4 months prior. Presto........changes would happen.
An office area was very inefficient for two ladies who handled (pre-computer era) a lot of paperwork. Both had to cross the room too many times to access files that they needed for their own work. This was discussed, but the manager would not move anything around; as he liked the way things set. Six months passed without any changes. I had worked with him for 1 year and we had a mutual respect for one another's thinking. He left for a two week vacation, and the very next day I asked the ladies in the front office (never any customer visits in this area) what might be the best arrangement for them to perform their work more effectively. They provided they answers and before the day's end, several of us arranged the desks and file cabinets to their best positions and of most benefit to getting things done. Upon the manager's return from vacation; he walked through the front door and did an "oh", smiled and never said another word about the change, except that it seemed to be "okay".
This is not totally related to the initial post here; but is an example of the tiny wars of mankind that are taking place at this very moment somewhere; with a "small" person trying to re-educate a "big" person......as in, who has the perceived position of "all knowning". The "they don't know, that they don't know."
Got to get back to the work thing..............
Catch
Your comments were truly encouraged and welcomed. While I didn’t agree with some of your postings, I fully recognize their value at expanding and balancing the debate on this raging economic theory battlefield. I appreciate and commend your fine contributions.
It is certainly true that I organized and documented my posting to support the position that I advocate. To do otherwise would be foolish and even disingenuous. There are surely shortcomings in the theory that I support. Not to acknowledge that would put me in the category of an inflexible ideologue; something I reject. I learn very day.
Sometimes that learning is painful like in the equity marketplace. As Otto von Bismarck remarked: “Laws (substitute economic theories) are like sausages, it is better not to see them made.”
In the US, the only economics taught in most schools when I attended classes was basic Keynesian; there was hardly an acknowledgement that other legitimate theories existed, beyond those assigned to the lunatic economic fringe underground.
So I was a Keynesian before I was an Austrian type. My transformation began in the late 1960s with the failures of the Lynden Johnson administration Great Society programs, and was completed in the late 1980s with the mostly successful Ronald Reagan policies.
I’m a slow learner. It took me decades to unlearn that which I learned in my formal schooling, including both Samuelson economic and econometric studies.
Today, I learn from new experiences and new data. In that sense, I reach my conclusions from an inductive reasoning, data assembling methodology. I search for results. The controversy between Keynesian and Austrian economic policy is an unsettled issue. If it were, we would not be presently having this somewhat heated interchange.
I gently chide you folks who strongly endorse pure Keynesian economics that you are members of a vanishing cohort. I do like your loyalty and your sensitive and emotional commitment to the poor, those at or below the poverty level. But to assume that Austrian economics supporters do no not share this same empathy is a misguided belief that is not factually based. We care in a way that promotes upward mobility out of these dreadful circumstances. Surprise, some Austrians do have a heart.
One of Austrian economics primary goals is an enlargement of the pie, not simply a redistribution of the existing pie. The pragmatic political reason to redistribute the economic pie is that when you tax Peter to pay Paul, it assures voting support from Paul. That’s not progress; that’s corrupt politics.
Forum member Investor vigorously defended the Keynesian program. I admire his dedication, courage, and tenacity. But he made some assertions that were misguided and incomplete. Here is my rendering on some of the activities that he highlighted.
The Nazis party apparatus had both socialistic and an nationalistic agenda aspects. They were social democrats who never received a majority vote in any fair election, but used deception and propaganda to momentary enlist the aid of other minorities (like the Commies), and then tossed them under the bus to achieve their sole leadership status.
Frederic Hayek and Ludwig von Mises, grandfathers of the Austrian School, hated the Nazi movement and published numerous papers to warn England and the US of its dangers to freedom. These political-economic scholars identified the socialist roots in various forms of these movements.
On this matter see Hayek’s book “The Road to Serfdom”. He clearly outlines the matter in “The Socialist Roots of Naziism”, chapter 12, and “The Totalitarians in Our Midst”, chapter 13. He published papers in the Spring of 1933 titled “Nazi-Socialism” that cautioned about the unholy policy of pitting the bourgeois against the proletarian sects; that’s class warfare in authentic communist tradition. Austrians were never fooled by these socialistic-nationalist movements.
The Brain-Trust that FDR assembled in the 1930s was challenged by our economic crisis and was enamored by progress reported in Italy. Three prominent members of Roosevelt’s Brain-Trust (Hopkins, Ickes, and Morgenthau) debated the issue extensively with the social-democrat side the eventual winner. The New Dealers originally admired Benito Mussolini who finally “made the trains run on time” in Italy. But Mussolini’s policies were both contradictory and confused; so were the US government’s interpretation of them.
The Italian boom was orchestrated under the direction of finance minister Vicenza De Stefani who reduced both strangling tariffs and an investment depressing progressive income tax structure. Hitler and Roosevelt’s Brain-Trust missed these points entirely.
One critique of my submittal charged that I presented no data, no documentation. Wrong. I referenced large scale economic experimental results (like our Great Depression, like the Russian experiment, and like current European test cases) and deployed an up or down assessment criterion. That’s hard data.
I eliminated some examples because of space limits. For example, England was unsuccessfully applying Keynesian methods before Roosevelt decided to try them in the US. On a local level, the Tragedy of The Commons, local Utopian, and socialized town experiments in England and the US also folded unsuccessfully.
You wanted some supportive numbers. I initially did not incorporate any because of the complexity of gauging theories with a few controversial statistics. But you asked, so here are a few. The US has been more or less pivoting towards a Keynesian ideology since the Great Depression of the 1930s. Over the ensuing decades, the percentage of Poverty Liners have essentially remained a constant that hovers around 15 % despite massive spending in that arena. The good news is that that 15 % keeps changing as entrepreneurial spirit drives folks up the financial ladder.
The SAT school scores serves as another example to illustrate the point that central decision making is a dangerous tool. Although funding has dramatically increased since Lyndon Johnson’s administration, these scores have remained stubbornly constant. The invariant scores are another measure of failed social engineering programs on a national scale.
It is self-serving, but I have concluded that sociologists have not improved our lot, engineers and scientists have done it. And engineers and scientists require funding to further their disciplines. Those monies come from the wealthy who continually strive to increase their wealth, and not from the poor. Has a poor man ever hired you?
The centralization of decision making enhances the likelihood of bad choices. A classic illustration is when Ming Dynasty officials in China burned most of their navigation charts. By 1500, the Emperor ordered the destruction of all oceangoing ships. At that time China was a superpower. Its engineering accomplishments and scientific discoveries permitted them to design and construct ships (9-massted titans) that enabled sailing huge distances, exploration, and commerce well beyond the capability of European States.
For reasons that still remain a mystery, the Emperor unilaterally decided against foreign involvement and ordered the destruction of his ocean fleets. China suffered for centuries from that single irrational decision by a single, omnipotent ruler. Austrian economists fear central government control for that very reason.
The Solyndra debacle is a current example of the dangers of a central government selecting winning and losing technologies. Neither the Keynesians nor the Austrians possess a crystal ball. The Austrians simply want capitalists to bear the risk burden and allow the marketplace to choose a winner from whatever solution appeals to the global population for a multiplicity of unpredictable reasons.
It is not true that Austrians recommend sitting on ones hands during an economic downdraft. They consistently recommend less government intervention, lower taxes in general, a flatter income tax schedule overall, and reduced regulations. Financiers will invest if they see stability up along the way. Some government oversight will be needed to protect against charlatans and outright fraud. Austrians favor reduction, not the elimination of government.
What part of my storyline does NOT represent a plausible scenario? I have taken time to fact check much of what I am currently reporting. If I made errors or misrepresented facts please identify them. I do listen.
Best Wishes.
You raised a provocative question, but one which is based on a false dichotomy: that the Keynesian and the Austrian approaches are in opposition. While there certainly is some degree of truth to that, your question is based on misrepresenting Keynesian theory.
I second Investor’s comments on this matter. You state that Keynes favored “social solutions to economic maladjustments”, “redistribution of wealth” by the government and that only Austrians are capitalist whereas Keynesians are socialist. These contentions are simply unfounded.
Keynes was fundamentally a capitalist; he was not a socialist and did not favor state ownership and control of production, indeed, both socialists and fascists condemned him for being the “savior of capitalism”; he favored high levels of government deficit spending ONLY during times of recession; and the principle of income redistribution plays no explicit role in his theory.
The principle that a national system of taxation should be progressive is not Keynesian, by the way; it was endorsed by the father of capitalism himself, Adam Smith, in the 18th century as being the only equitable and sustainable basis for tax collection in a market-based economy.
Catch22 argues that one does not have to be in either one camp or the other. I fully agree. Keynes himself believed that the free market normally worked quite well; he only favored government deficit spending as a last resort if an economy was being sucked down in a recessionary whirlpool. Keynes and the Austrians are far more kindred than they are at odds.
An interesting discussion!
I am sorry MJG. We are on different frequencies. You still equate Keynesian intervention as socialism. I do not see it that way. The stuff you have described in your second post is really more about Socialism. There are similarities but they are not the same.
Keynes was invited to US and after his visit he concluded that he was not as Keynesian as the rest of the economists at the time. I guess, the issue is also because he refined his ideas over time.
As for Hitler, I gave it as a direct consequence of what suffering in the population can lead to. Germans were under very heavy austerity to pay-off their debt (in gold) to France etc. and it caused so much social suffering that they were willing to follow a racist lunatic that promised the world with deception. All I am saying that, policies of Austrian economics leads to severe suffering an unintended consequences. What Hitler did after he came to power was not my focus. It was what was before. Actually, having seen the terms of first world war, Keynes predicted that another war was inevitable. He was dead right.