Monday, March 7, 2011

The Wrath of Keynes, or, The Fall of the House of Hayek, Part III

We’ve received a few comments on this series, the point of which is that, while presented as completely different from one another, Keynesian and Austrian economics share a common principle.  This is that the supply of loanable funds is a commodity, and that it is therefore impossible to finance new capital formation without cutting consumption and accumulating money savings.  Further, the supply of loanable funds determines the "production possibilities curve," beyond which it is impossible to finance new capital except to a limited extent in the short run by eliminating waste and increasing efficiency, i.e., by measures that do not require the reinvestment of accumulated savings.

Unfortunately, the commentators seemed to believe that we are trying to reconcile Keynesian and Austrian economics, and thereby achieve a synthesis that will provide a solid foundation on which to implement a sustainable economic recovery. On the contrary, we’re trying to show that, despite the apparent differences between the two systems, they agree just where it does the most harm.

That is, Keynesian economics focuses on demand, evidently assuming that supply will take care of itself, while the Austrian school focuses on supply, taking the opposite position that demand is not something to worry about. Both assume as a given that the only way to have the wherewithal to finance new capital formation is to cut consumption and accumulate money savings.

Consequently our commentator was incorrect in trying to characterize binary economics as “supply side” (or demand side, for that matter), and somehow “post-Keynesian.” On the contrary, by working to restore the functionality of Say’s Law of Markets — which Keynesians reject and the Austrians redefine — binary economics focuses on both supply and demand.

This is consistent with the observation by Dr. Harold G. Moulton, president of the Brookings Institution from 1916 to 1952, in The Recovery Problem in the United States (1936), that the two most important factors in an economic recovery are employment (demand) and production (supply). Everything else is secondary.

As Dr. Moulton explained in The Formation of Capital (1935), consumer demand is critical because it provides the justification for new capital investment, that is, production. Financing new capital through the application of pure credit principles is equally critical, because if we cut consumption in order to finance the new capital, we take away the incentive to finance new capital in the first place by lowering demand.

In The New Capitalists (1961), Kelso and Adler refined Dr. Moulton’s thought by pointing out that we cannot rely on a system in which ownership of the means of production in concentrated in few hands, whether those hands are those of the State, as in socialism, or private investors, as in capitalism to ensure the restoration of Say’s Law of Markets and an economy in equilibrium. Neither is the wage system adequate to ensure that there is sufficient demand in the system to clear production at market prices.

Rather, to ensure that the income generated by capital is spent on consumption rather than diverted to reinvestment and where production equals income, ownership of the means of production must be widespread. This emphasizes the importance of the subtitle of The New Capitalists: “A Proposal to Free Economic Growth from the Slavery of [Past] Savings.”

Applied consistently and in conformity with the four pillars of an economically just society, as in the proposed “Capital Homestead Act,” widespread capital ownership will 1) provide adequate funding for all financially feasible capital projects without requiring reductions in consumption, 2) supplement and, in some cases, replace wage income as the source of effective demand (consumption income) for most people, 3) rebuild the tax base and reduce the demands on government so that government can live within its means, and 4) restore political democracy by reestablishing it on a foundation of economic democracy.

None of this is probable, or even possible until and unless we can get away from the slavery of past savings, and restructure the financial system to serve humanity, rather than the other way around.

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