September 8th – A new direction or more of the same?
By Chris Clancy
On September 8th President Obama is going to make a speech. The content of that speech is going to have a profound effect on all of us, one way or the other.
If it's a new direction then we have some hope. If it's "more of the same" we pass the tipping point. This essay tries to explain why "more of the same" should not be an option.
This means writing about the dreaded 'K' word – Keynesianism.
But please! Don't stop reading at this point. I promise I won't launch into economic-speak. I'll keep it descriptive and only use one simple formula. OK?
Right - here goes.
Keynesian economics has been with us for a long time. A question comes to mind immediately. How could something so fundamentally flawed have lasted for so long? It's an interesting question.
It's not as if it didn't have its critics. It did. But up until a few years ago they were few and far between. Now it's rampant.
Its popularity was probably due to the fact that it was, on an intuitive level anyway, so accessable. The circular flow of income, with its injections and leakages etc. all seemed so straight-forward, so simple and so obvious.
You can even sum it up in a formula.
Y = C + I + G + (X–M)
For the purposes of this essay let's dispense with the pesky (X – M).
Which leaves us with this little minx:
Y = C + I + G
It's just a tease really - it shows a bit of leg but that's all – it flatters to deceive.
So what does it say?
Well, in plain English: Y represents total spending in the economy. The higher this figure the more people who should be employed. It's value is determined by adding three other totals together: consumer spending (C), investment spending (I) and government spending (G).
So how does the thing work?
Well, let's use an example. Assume the economy is in a position where everyone who wants a job, and is able to get a job, has got a job. Economically speaking everything is hunky dory.
Now assume that, for whatever reason, spending by the great unwashed, C, falls. This means less demand for goods and services, which means less people are needed to provide them, which in turn means jobs are lost. If C falls then Y must also fall.
Things are no longer hunky dory.
So what can be done to remedy the situation as quickly as possible?
Step forward the government. According to the formula they have to increase G by enough to compensate for the fall in C. So all the government has to do is replace the money which has leaked out by shoveling an equivalent amount back in!
Once this is done Y is restored to where it was before, jobs are restored and everyone is happy.
No. Not quite … in fact, not at all.
This kind of economic thinking is not just naive and ignorant in the extreme – it is absurd! Yet this, in essence, is what is meant by "stimulus spending".
Which brings us to the first major flaw in Keynesian economics. It ignores the incredible and unbelievable complexity that makes up an economy. No one person, group or organization can ever effectively plan an economy – it is an impossibility.
In his classic essay, I Pencil, Leonard Read takes the simplest object he can think of to illustrate this point. And he does so brilliantly.
Keynesian economists treat an economy as if it were a machine of some kind. All you have to do is "fix" the bit that's broken. There's no time dimension. Their analysis is static, like pieces in a jigsaw – sunk in concrete.
They think everything can be reduced to Y = C + I + G !
By contrast, Austrian economists regard it as being more like an ecosystem.. It is dynamic – left alone it evolves over time – it finds its own balance. Interfere with it and a series of chain-reactions are set off. How long, how far, how wide and how deep they go is simply unknowable.
In other words, there's no "quick fix".
Which brings us to the second major flaw in Keynesian economics. It focuses its attention on consumer spending, C. Why?
Because they tell us that C is the largest component of total spending – about 70 % - and as such this is what drives an economy.
To return to the machine analogy, it's like trtying to fix the thing by repairing the wrong part!
He puts it very well.
Instead of "more of the same" the government needs to get out of the way and let the private sector do what the government cannot do – create real jobs.
We await with trepidation the words of the President on September 8th.
Chris Clancy lived in China for seven years. Most of this time was spent as associate professor of financial accounting at Zhongnan University of Economics and Law in Wuhan City, Hubei Province. He now lives in Thailand where he spends his time reading, writing, lecturing and, whenever he gets the chance, doing his level best to spread Austrian economics.