Thursday, January 10, 2013

Full Employment v Inflation

In Keynesian economics there is a presumed necessary trade-off between employment and inflation. The theory is that if you want full employment, you have to inflate the currency to increase demand. This increases the demand for new capital formation, and results in job creation.

There are a number of assumptions underlying this theory. For one thing, Keynes assumed as a given that, in order to finance new capital formation, it is essential to cut consumption in order to accumulate enough cash to finance the new capital.

Keynes also assumed that "money" consists solely of bills of credit emitted by the government, and represents a "general claim" that the government has on all the wealth of society. In effect, this understanding of money assumes that the State is the ultimate owner of everything.

For example, consistent with the thought of Thomas Hobbes in Leviathan, this means that taxation is not a grant from the citizens to the government. Taxation is, instead, an exercise of the ultimate right of property vested in the State.

Given this understanding of money, Keynesian economics is socialism in all but name. There are, of course, other reasons for classifying Keynesian economics as a form of socialism, such as State-controlled allocation of resources and permitted rates of return to business (General Theory, VI.24.iii), but we've covered those in previous blog postings.

Consistent with these theories, the trend of the economy must be inflationary. Prices have to increase in order to ensure that consumption will decrease. At the same time, there must be constant infusions of additional purchasing power to restore and maintain effective demand at adequate levels.

This is one of the many contradictions in Keynesian economics. The theory requires that consumption both increase and decrease at the same time. Similarly, the Keynesian "money multiplier" requires that checks both clear and remain on deposit at the same time.  There is also the claim that a rise in the price level both is and is not inflation, and so on.

The issue today, however, is something a commentator on our FaceBook page raised. He asked, "Does the minimum wage hurt workers?"

This is a reasonable question. The minimum wage is a cornerstone of Keynesian economic policy. Since wages and State benefits are the only form of income available to the non-owning workers, they must necessarily be at such a level as to 1) allow the wage earner/welfare recipient to meet needs adequately. 2) The level of wages and benefits — effective demand — must be such as to provide sufficient consumption power to clear goods and services at market prices.

One Keynesian solution is for workers to be paid to produce goods for which no market exists (Keynes used the example of cathedrals and pyramids as totally useless goods, logical choices for an atheist), or to produce goods destined for destruction, such as war material. Either produces goods that do not add to the supply of marketable goods and services. Instead, they generate effective demand that keeps prices up, transfers savings from consumers to producers, and doesn't require that goods be consumed in order to fulfill their purpose.

This gets around the "problem" in classical economics caused by the insistence that the purpose of production is consumption. No, in Keynesian economics, the purpose of production is to generate effective demand and provide adequate financing for new capital formation.

This is because Keynes did not consider "supply" a problem. He therefore focused on "demand." This renders the laws of supply and demand irrelevant — but only if you ignore reality.

It also laid the groundwork for the pointless conflict between "supply side" and "demand side" economics. "Supply siders" claim to accept "Say's Law of Markets." "Demand siders" say they reject Say's Law. Both supply siders and demand siders, however, distort and misstate the concept, basing their theories on the logical fallacy of a straw man argument.

Minimum wage legislation sidesteps these problems. Unlike the case in binary economics, which proposes that "future savings," i.e., future increases in production instead of past reductions in consumption be used to finance new capital formation, today's mainstream schools of economics presuppose that the only way to finance new capital formation is by cutting consumption.

Yes, new capital can be financed by cutting consumption, and often is. Reducing consumption to finance new capital, however, also means that the new capital will likely not be financially feasible, and new jobs will not be created. As Harold Moulton expressed this "economic dilemma,"

"The dilemma may be summarily stated as follows: In order to accumulate money savings, we must decrease our expenditures for consumption; but in order to expand capital goods profitably, we must increase our expenditures for consumption." (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 28.)

Moulton resolved this dilemma by pointing out that the definition of "saving" is not, despite Keynes's dogmatic and somewhat disingenuous assertion to the contrary, exclusively defined as "the excess of income over expenditures on consumption." (General Theory, II.6.ii.) (Keynes undermined his own claim by the fact that twenty or so pages after he declared that "everyone is agreed" on this definition of saving, he spent several more pages "proving" — by mere assertion — that the people who thought that new capital could be financed without first cutting consumption were wrong, implicitly acknowledging that "everyone" was not agreed.)

As Moulton demonstrated, new capital can be — and, during periods of rapid capital growth, frequently is — financed by increasing production in the future, not decreasing past consumption in the past. Reliance on past savings (labeled "slavery" by Louis O. Kelso and Mortimer J. Adler in the subtitle of their 1961 book, The New Capitalists) can and should be replaced with reliance on future savings.

Keynesian economics tries to circumvent this contradiction in its theory by setting minimum wage levels (thereby instituting "cost push" inflation), and by printing money, inducing "demand pull" inflation. Both types of inflation reduce consumption by raising the price level artificially.

Raising nominal wages by mandating minimum wage levels creates the illusion that wage workers are getting more when they are actually getting less. Nominal wages may be increased, but the goods and services that can be purchased with those wages decreases.

Producers — capitalists — benefit by making more profit from less production. The State benefits by being able to spend the present value of future tax collections now rather than in the future.

The drop in demand by wage earners is made up by consumer credit. It is no coincidence that widespread use of credit cards came in just as the wartime wave of prosperity that resulted from government spending in the Korean War was winding down, or that the "Great Society" began pumping effective demand into the economy to take up the slack left by insufficient use of consumer credit.

So, to answer the question, yes, minimum wage legislation hurts workers. At the same time (such are the contradictions inherent in Keynesian economics), legislating minimum wages gives the illusion that wage earners are somehow better off. Inflation and the rapid expansion of consumer credit pays for the illusion — at least until the bills come due.

There is a way out. One, finance new capital out of non-inflationary future savings, not past savings — especially the Keynesian "forced savings" that rob the poor to give to the rich through inflation. Two, vest wage workers with capital ownership so they can increase their income without raising the price level.

This can be done by implementing an aggressive program of expanded capital ownership — such as Capital Homesteading — at the earliest possible date.

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