Thursday, April 17, 2014

A Plague on Both Your Houses, II: Democrats

Yesterday we told you what is wrong with the Republican emphasis on cost-cutting to balance the budget and restore fiscal sanity.  Today we are going to tell you what is wrong with the Democratic emphasis on increasing spending, both to meet people’s needs directly, and to stimulate the economy to create jobs that will, presumably, allow people to meet their own needs through their own efforts.

Consumer demand creates capital demand
Democrats, you’re right.  Everybody needs to spend more.  At the crudest level, spending stimulates the economy.  This is because, as Dr. Harold Moulton pointed out in 1935 in The Formation of Capital, demand for marketable goods and services creates the incentive for producers to supply those same marketable goods and services.

This includes both “consumer” and “capital” goods and services.  This is because, as far as the producer of the good or service is concerned, it’s all consumption.  Whether you’re buying a loaf of bread from a bakery, a primary dwelling from a builder, or a factory from . . . wherever it is you buy new factories, you are “consuming” that product, at least from the perspective of the producer of that product.

Capital good? or consumer good?
He, she, they, or it don’t care one bit what use you put your purchase to, as long as you pay for it.  It’s all consumption to them, because it generates the profits and the wages that owners and wage-workers can use for their consumption.  As Moulton explained when critiquing some of the past savings analyses of downturns in the business cycle,

“[T]hey apparently exclude the receivers of profits from the consuming class, and argue that a deficiency in consumptive demand exists to the precise extent that profits exist.  Thus they arrive at the conclusion that ‘presently there are more goods on hand than the people can buy and pay for out of income.’” (Harold G. Moulton, The Formation of Capital.  Washington, DC: The Brookings Institution, 1935, 178.)

Consistent with this and similar analyses, the solution to the under-consumption that causes and sustains depressions and recessions is to tax profits and redistribute the profits (fiscal policy).  The idea is that this will stimulate consumer demand and drive the demand for new capital goods, thereby creating jobs.

Inflation makes money worthless.
Within this framework, if taxing and spending is insufficient to stimulate enough consumer demand, then the government starts manipulating the currency to induce inflation (monetary policy).  Monetary policy is a more powerful economic “tool” than fiscal policy — and much more popular with taxpayers and politicians, at least in the short run.  Until the problems start popping up.

The idea with manipulating the currency is that pumping money into the economy drives up prices.  This causes consumers to have to pay more and get less, thereby meeting the Keynesian definition of “saving”: “[T]he excess of income over expenditure on consumption.” (John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1936, II.6.ii.)

The problem is that the reductions in consumption caused by induced inflation do not benefit those who are reducing their consumption.  This is because inflation results in Keynesian “forced saving” — “saving” being defined as decreases in consumption.

Induced inflation shifts purchasing power from consumers to producers.  Forced saving presumably provides producers with the necessary financing for new capital formation.  This in turn creates jobs, allegedly making for a net collective gain to workers and consumers in the aggregate, although it hurts workers and consumers individually when their income no longer buys what it once did.

The emphasis on the collective is one of the things that irritated Friedrich von Hayek about Keynes.  Von Hayek quite rightly noted that the collective is an abstract, while people are reality.  He didn’t do anything about it, and rejected humanity’s political nature, but he was at least a third right.

Jean-Baptiste Say
Anyway, the Democratic error is painfully obvious, at least from the perspective of binary economics.  As Jean-Baptiste Say explained, we don’t really purchase what others produce with this thing called “money.”  Rather, we purchase what others produce with their labor and capital, with what we produce with our labor and capital.

“Money” is just the medium by means of which we exchange what we produce for what others produce.  It is production that purchases production, thus (as Say’s Law is usually oversimplified), production equals income, therefore supply generates its own demand, and demand, its own supply.

Malthus, Author of the Economics of Despair
Consequently, as Say explained to the Reverend Thomas Malthus, if some goods remain unsold, it is because other goods are not produced.  The solution to a business downturn is not to “multiply barren consumptions,” i.e., manufacture additional claims in the form of debt-backed government money.  Instead, empower people by giving them the ability to produce something to exchange for what others produce.

Yes, it may be necessary to “prime the pump,” as Keynes put it, but even Keynes thought that this only needed to be done once, not as a usual thing to keep the economy running.  Moulton pointed that out Keynes never actually said that government stimulus was the usual way to run an economy.  As Moulton explained,

“It should be noted here that Keynes — so far as can be discovered from his published writings — has never contended that pump priming would have to be continued permanently or that an indefinite expansion of the public debt would carry no dangers.”  (Harold G. Moulton, The New Philosophy of Public Debt.  Washington, DC: The Brookings Institution, 1943, 15.)

So, if there is going to be an increase in spending, it must be for the right things: for things that will help people become productive, not merely “multiply barren consumptions.”

Tomorrow we’ll look at a proposal that would allow both the Republicans and the Democrats to be able to cut costs and increase spending, and everybody would be better off as a result.


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