All Commentary
Friday, February 1, 1991

Book Review: Economics On Trial: Lies, Myths, And Realities by Mark Skousen

Business One Irwin, Homewood, IL 60430 • 1991 • 314 pages $21.95 cloth

“No comment,” says Paul Samuelson.

What he’s declining comment on is Mark Skousen’s Economics on Trial, a trenchant analysis of the concepts, theories, and delinquencies of the “top 10″ economics texts used in college classrooms today. But it’s a work that Samuelson would do well to study carefully.

Samuelson’s Economics, which has been through 13 editions since its original publication in 1948, is the leader of the pack, the neo-Keynesian template for the modern textbook approach. Samuelson was among the first of the “armchair economists” to sic such Keynesian notions as “the paradox of thrift” and the wonders of deficit spending on the unsuspecting college students of the postwar world.

John Maynard Keynes’ mammoth—and mammothly misleading—General Theory saw print in 1936, at a time of growing intellectual hostility toward capitalism. Economists and other professional thinkers of the day were vastly susceptible to plausible-seeming rationalizations of government intervention in the economy. Although only the Austrian school of economic thought, as represented by Ludwig von Mises and Friedrich Hayek, had successfully predicted the scourge of the Great Depression and could now prescribe the needed policy antidote, the anti-interventionist analysis of the Austrians was washed aside in the • wake of the Keynesian theoretical tsunami. And so, even though many of the Keynes-inspired “models” of economic activity blatantly contradict observable reality and common sense, they have nonetheless emerged as standard textbook fare.

Mark Skousen is an emissary from the real world. Far from being a mere subsidized armchair theorist, he has actually engaged in extensive entrepreneurial activity in what we call the economy, the realm of goods and exchange and profit-seeking. He has built his reputation as a financial analyst and is intimately acquainted with market conditions and the consequences of government controls. He has also traveled quite a bit and done some savvy comparison-shopping of the world’s economies. And as far as theories go, Skousen is most sympathetic to the Austrian school, which defines economic value as “subjective” (i.e., dependent upon personal valuation and action rather than being intrinsic in any good or service), spurns mathematical formulae in favor of verbal deductive reasoning, and emphasizes the crucial role of production and the entrepreneur in a healthy market economy.

Economics on Trial should be required reading in all Econ 101 courses. Skousen has supplied a need that lie himself felt as an economics student-the need for “a book that would simply but thoroughly dissect the large number of dubious theories and questionable doctrines taught in the classroom.” He takes on about 20 concepts or perspectives of modern economics and devotes a chapter to each, first giving the textbook version of things, then stripping away the rationalistic veneer of official doctrine to expose its logical and factual deficiencies.

Take, for example, the Keynesian notion of the “paradox of thrift.” This is a conceptual glass house that has been popularized by Samuelson. The contention is that, while savings may well be beneficial on an individual level, the effects can be deleterious for “society as a whole,” at least during economic downturns. Instead of thrift and savings, therefore, during slow times we should stress and encourage the demand side of the economy (buying). Elsewise, businesses will be deprived of the funds that have been tucked away in savings. Says Samuelson, “If people try to increase their saving and lower their consumption for a given level of business investment, sales . . . will fall. Businesses will cut back on production. How far will production fall? GNP will fall until people stop trying to save more than businesses are investing.”

Skousen has no trouble disposing of this strange claim. First, he notes, Samuelson ignores the probability that an individual’s savings, rather than merely moldering in a bank vault, will be lent out to business enterprises and thus contribute to production. “Second, investment under Keynesian theory is primarily a function of business expectations of consumer demand. An increase in consumption Will stimulate investment, and vice versa. This is contrary to classical economic theory, which contends that investment decisions are determined by the profit margin of business opportunities. Demand is just one side of the equation. Businesses also consider such factors as the level of interest rates and the costs of production—not just final demand—to determine their profit margins.” But the most central objection that can be raised against the Keynesian approach is that it imposes its own blindered short-term outlook on economic actors in the market:

The Keynesian model assumes that the only thing that matters is current demand for final consumer goods—and the higher the consumer demand the better. But this view fails to recognize another force that is just as strong as current demand—the demand for future consumption . . . . [I]f every attempt to curtail consumption results in a proportional decline in production, as the Keynesian theory contends, then no addition to a nation’s wealth could ever occur from increased savings. By the same token, if everyone went on a buying spree at the local department store or grocery store, investment would not necessarily expand. Certainly, investment in consumer goods would expand, but increased expenditures for consumer goods will do little or nothing to construct a bridge, build a hospital, pay for a research program to cure cancer, or provide funds for a new invention or a new production process.

What the Keynesians have overlooked is that the decision to save is an act of time preference, the choice between current spending and future spending. Savings do not disappear from the economy; they are merely channeled into a different avenue. Savings are spent on investment capital now and then spent on consumer goods later.

How do the textbook writers manage to get away with such sophistries as the view that planning for the future is an economic ill? One reason is that policy-makers are looking for ways to rationalize their indulgence in short-term expediency. Another is that students come to class with little or no real-world economic experience, and usually without the intellectual wherewithal to challenge the conventional wisdom. This wisdom is wrapped up in arcane terminology and then formally represented in forbidding-looking graphs, with the relevant fallacy neatly plotted along the x and y axes; it’s easier to memorize the graph than to argue with the professor and risk a bad grade.

There’s a huge question as to the intellectual utility or propriety of graphic representations in economies—even when they represent economic truths—inasmuch as these models tend to hint at or presuppose constant relationships that simply do not exist in the realm of human action. Mises eschewed such visual tools completely, although, as Skousen notes, many of his followers have not been so finicky. Perhaps graphs do have some kind of heuristic role if not taken literally, but to avoid misconception the stress has to be on verbal ratiocination. Students must be able to spell out causal connections m step-by-step fashion if they are to attain and demonstrate real economic understanding. Skousen thus makes the pro-Misesian reader a little uneasy when he occasionally overturns a rico-classical model only to offer a new and improved version of his own; the lines are still too neat.

A few other objections could be raised about Skousen’s own theoretical approach, but thankfully these add up to a very minor and peripheral flaw in the book. Overall, Economics on Trial achieves its goal of providing simply and clearly argued objections to the textbook orthodoxy, and it does so with eminent fairness. Skousen gives credit where credit is due, and when he critiques an idea he often mentions which texts feature it and which ones (if any) adopt a more sensible perspective. He also provides much that is just plain missing from the official version of things, such as discussions on the history of money, the workings of the world’s healthier economies, and the relevance of the Austrian school of economics. No economics student—or, for that matter, textbook author—should be without a copy of Economics on Trial.

David M. Brown is the managing editor of the Laissez Faire Books catalog and a free-lance writer