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Thursday, March 7, 2013

Another Keynesian Error

Keynesians are nothing if not consistent: there is just not enough spending to uphold the economy, or so they claim. Therefore, the government needs to ramp up its own spending in the absence of more private spending, gaining the new revenues either by borrowing or by creating new money. As The New York Times recently lamented:

The federal government helped bring the economic recovery to a virtual halt late last year as cuts in military spending and other factors overwhelmed the Federal Reserve’s expanded campaign to stimulate growth.

In this article, I won’t deal with how the government obtains new money to spend, nor will I analyze the effectiveness (or harm) of such actions. Instead, I’ll identify a simple, yet vital, point that’s often overlooked: the Keynesian paradigm violates the means-end framework upon which all economic analysis depends. In violating this framework, Keynesians—and “mainstream” economists in general—wrongly assume that consumption itself is a factor of production.

Next Top Model

Modern economists often create mathematical models that few people can comprehend. The “top” economics journals are full of the stuff, and it does not matter whether what is written squares with the basic laws of economics. As long as papers seem “rigorous,” and as long as the math seems to work, these publications are trumpeted as a contribution to economic science.

While the models look impressive, they ignore things like the law of opportunity cost and the law of scarcity. Even more important, too many academic economists ignore the truism that economist Murray N. Rothbard pointed out in Man, Economy, and State 50 years ago: all individuals act, and they act purposefully through a means-end framework. Individuals have desired ends, and they work through means to obtain those ends.

This insight hardly seems profound, and no doubt many economists would dismiss it as trivial: “Of course people act through a means-end framework. Everybody knows that! So what does that have to do with Keynesian thinking?”

In economics, the desired end is consumption, and the means is production. We produce in order to consume. And we consume in a purposeful manner, hopefully in ways that meet our various needs at given times. That may sound trivial, but when we examine Keynesian thinking we find that Keynesians have turned this paradigm upside down, promoting consumption as the means to produce.

Spending Sprees and Seed Corn

Take a recent editorial page article by Nobel Prize-winning economist Joseph Stiglitz, a Keynesian, on why he believes income inequality is damaging the current economic recovery:

The most immediate [reason] is that our middle class is too weak to support the consumer spending that has historically driven our economic growth. While the top 1 percent of income earners took home 93 percent of the growth in incomes in 2010, the households in the middle—who are most likely to spend their incomes rather than save them and who are, in a sense, the true job creators—have lower household incomes, adjusted for inflation, than they did in 1996.

Proponents of this viewpoint claim that the mass of Americans cannot consume enough to clear the shelves—as though consumption were a necessary means for production. The main purpose of consumption, it seems to Stiglitz, is to enable more production. Instead of the means-end framework, in which purposeful individuals produce in order to consume, Keynesians have created a circular model in which the economy is little more than a perpetual motion machine.

I am not engaged in any semantic exercise. Individuals consume in order to meet their needs; consumption that artificially clears store shelves so that people can work to put more goods on the shelves is not consumption at all, and certainly not a meaningful economic paradigm.

The Keynesian paradigm violates what economists call Say’s Law. Now, this is not the straw man Say’s Law allegedly discredited by Keynes. In the straw man version, Say is supposed to have argued there were no impediments to full employment. And Straw Say is supposed to have pointed out the simple fact that our “demand” for goods comes from the very supply of goods that we create—or “supply creates its own demand”—which means that an economic downturn cannot come from alleged general “overproduction” or general “underconsumption.” 

Yet, curiously this is the image of overproduction/underconsumption that modern economists are selling to everyone else. In their view, the economy is a delicate machine that grinds to a halt if people don’t “spend” enough, requiring constant injections of government spending to keep the wheels spinning. Left to their own devices, free markets, they argue, always will result in “underconsumption.” Say’s Law says quite the opposite: in free markets, production drives demand.

It is important to get this point right, because when governments drop money into an economy in the name of “stimulus,” they further damage the economic relationships in which people produce something that other people wish to consume and are willing to give up something in their possession in order to be able to consume. Instead, governments are urged to throw money at anything, be it useful or not, in order to “stimulate” spending and keep the cycle moving.

As I stated before, the means-end framework is not trivial. Economic analysis depends upon it, and ignoring this framework is tantamount to ignoring the basic laws of economics.

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.