Hard to Believe

Brad DeLong quotes a 1939 John M. Keynes piece on the Second World War and the power of fiscal stimulus. The post’s title provides the context (hard to believe some people still doubt the ability for fiscal stimulus to boost production in a liquidity trap). The final sentence of the excerpt is the one I’m most interested in,

If we can cure unemployment for the wasted purpose of armaments, we can cure it for the productive purposes of peace.

What I find hard to believe is that the lessons of the socialist calculation debate are still not being applied to broader economic theory.

Few people doubt that the Second World War brought the U.S. economy to “full employment.” Indeed, whoever wasn’t conscripted into the military had ample opportunity work in a factory geared towards wartime production. But, targeting full employment for full employment’s sake doesn’t imply a productive a economy, and Keynes acknowledges this (when comparing the “productive purposes of peace” to the “wasted purpose of armaments”).

What Keynes — and, much worse, those reading Keynes today who should know better — doesn’t acknowledge is the debate revolving around the allocation of resources, which culminated during the 1920s and the 1930s. There’s two ways to pose the challenge. First, an institution not subject to profit and loss is likely to invest towards “second-best” (or third-, fourth-, …, best) projects. Second, non-localized investment is not as privy to the relevant knowledge that should command spending. The conclusion reached through these two arguments is that even peacetime public spending is likely to be “unproductive” in relation to the investments that could have been (opportunity cost).

The case against fiscal stimulus is not that it can’t bring an economy to full employment. It’s that that full employment market will be less productive than that which would have manifested through the market process.

I don’t mean to downplay the more complicated arguments in favor of fiscal stimulus (the liquidity trap implies market failure, et cetera), but Keynes, in that excerpt, isn’t just considering the liquidity trap. In fact, Keynes was unsure if the Great Depression even represented such a liquidity trap! He timidly suggests that the United States may have experienced such an event in 1932 — I’m citing from memory, so let me know if I’m wrong —, but clearly the case for fiscal stimulus doesn’t rely on the liquidity trap. My only point is that we can reach full employment through fiscal stimulus, and we can conceivably change the level of “productivity” (which really means the degree to which production actually engages consumers’ preferences), but that this level of full employment will not be as “productive” as that which would result from only private spending.

If you don’t buy the auxiliary Keynesian arguments that suggest markets under-invest during depressionary episodes (without obstacles created by interventionism), then there’s a good reason to not support fiscal stimulus. As implied above, the debate can be more sophisticated, but simple arguments deserve simple responses.

  • http://bubblesandbusts.com/ Woj

    Good observations here. The goal of full employment is an important topic where I differ from MMT. Cullen Roche at Pragmatic Capitalism and Monetary Realism has often made this point that full employment says nothing about the productivity or living standards of our society. The points you make clearly need to be repeated many times so that these simple mistakes are eliminated.

  • Roman P.

    SCD is hardly relevant, Jonathan. I really dunno why Austrians and you specifically like to bring it up, because even if we consider Mises and his followers winning the debate, their point was about the possibility of a centrally planned economy, or, if you want, an economy described by a GE model with an auctioner. Yeah, alright, maybe it’s impossible. How that is linked with the desirability of the public spending?
    You correctly note the flawed nature of governments which could not know everything and might be choosing sub-optimal investments. Not many people will argue with you on this. I also won’t. My government as of now might only be helped by the sudden defenestrations. But you implicitly hold, for some reason, that the real entrepreneurs are infallibly good at making choices and have a perfect foresight (=make all reasonable investments and their investments are more effective than those of governments). Take, for example, the history of the early 19th century. As per Hobsbawm, private firms readily invested into the manufacturing of textiles, where the rate of profits was very high, but there was little to no private investment into the hightec of that time: railroads and steel. Steel-mills mostly survived on the government demand for cannons and rails. Yet, who will deny that building railroads was something that needed to be done at the time?
    There is no denying the ability of the entrepreneurs to effectively collect the ‘low-hanging fruits’: investments with high ROE and low payback periods. But some investments have limitations:
    1) They require a lot of resources;
    2) They have payback periods measured in decades;
    3) They require non-trivial coordination between multiple agents or are very risky.
    This results in the fact that not all important investments are likely to be made. My friend manages with some success a b2b advertising agency, but he and the owner are unlikely to move into the building of highways or providing an education for the working-class children (even if they had the necessary capital). Even if there theoretically *is* some profit to be made some (or maybe all) entrepreneurs *will not* be willing to try.
    In the world where everyone has the perfect foresight the question on how to organize the investing activity will not even arise… Alas, we don’t live in such a world.

    • wrothbard

      “But you implicitly hold, for some reason, that the real entrepreneurs are infallibly good at making choices and have a perfect foresight ”

      He doesn’t hold that view in this blog-post and in no way needs to hold such a view in order to make the point that private investments are more productive than government investments. (Ie, entrepeneurs do not need to be infallible and perfect in order to outperform government.)

    • http://economicthought.net/blog JCatalan

      Roman,

      1. The socialist calculation debate isn’t just about the impossibility of socialism, but also about the superiority of monetary calculation. It applies whether we’re talking about monetary calc. versus partial socialization or full socialization. It applies whenever we’re replacing or distorting the pricing process.

      2. I am not assuming the entrepreneur is infallible. That’s exactly why I emphasize the market process and profit and loss. The market punishes those who fail and rewards those who do well; it’s a form of redistribution of capital. Not only do I stress the role of profit and loss, but I have consistently argued that a more heterogeneous market is better than a homogenous market, because then decision making is more dynamic and diverse.

      (Btw, there was a boom in railroad construction after the Civil War; one could describe it, in a sense, as a bubble.)

      3) They require non-trivial coordination between multiple agents or are very risky.

      This is a reason to prefer the market over central planning.

      …but he and the owner are unlikely to move into the building of highways or providing an education for the working-class children

      So? That a steel manufacturer is not going to move to the manufacturing of toys doesn’t mean that nobody else will invest in toys.

      In the world where everyone has the perfect foresight the question on how to organize the investing activity will not even arise… Alas, we don’t live in such a world.

      Ironically, you start the comment by questioning the relevance of the socialist calculation debate, but the very last sentence explains why monetary calculation is preferable over other forms of resource allocation.

      • Roman P.

        1. I think that the very concept of ‘monetary calculation’ is too vague.

        I doubt that it is, at any rate, useful to think that the monetary calculation, however defined, is not compatible with the socialization. Suppose that USA federal government buys all shares of Toys”R”US. There, now this corporation is socialized (its owners = public = country). Will that make the market of toys impossible to function (leaving aside the possible panic of financial markets)? No, little has changed in its functioning, and the managers of the company still sit and look into their ROE figures and price-lists.

        I also do not think that ‘distortions’ of monetary calculation are a viable concept because the price system is not a still and flawless lake surface into which the government could throw stones. Everything and everyone distorts monetary prices. In flexprice markets: I buy some platinum and ‘distort’ the markets. You sell an equity and ‘distort’ the markets. Everyone trades based on the mathematical formulas, their gut feelings, technical analysis, programming of trading programs or the astrology prognoses and ‘distorts’ those markets like hell. In fixprice markets: some manager notes the rising prices of platinum and sets a new price on the RAM chips. Another ‘distortion’! And that’s without getting into creation of the new money. Yet markets exist and prosper.

        The blogger ‘Lord Keynes’ made the same argument in much more eloquent English a month ago: http://socialdemocracy21stcentury.blogspot.ru/2012/10/mises-on-rational-economic-planning.html

        2a. Or, in other words, even if the distinct firms are not ideal by themselves, than after the process of weeding out through the profit and loss the market as whole a priori works better than anything else? How then thin or non-existent markets could be justified? Profit and loss is a powerful mechanism, but not a magic bullet either (to which status you seemingly heighten it).

        2b. That’s why I wrote ‘Hobsbawm, early 19th century’.

        3a. …For SOME projects. For the others maybe the global knowledge will be needed (as an antipode to the local knowledge in your example), or the market agents won’t be able to organize the production on their own, etc. I’m thinking of the very big and complicated projects like the creation of nuclear weapons (cheers to L. Groves and L. Beria) or the project Apollo.
        AFAIK, the creation of the USA interstate highways network was a federal program, to come with a less militarized example.
        3b. You treat entrepreneurship talent as if it is not scarce. And it is. That there is a theoretical possibility to coordinate the activity of thousands of teachers, managers and workers to create a corporation that will rival USA public school system and (I will be generous) be profitable and efficient does not mean that there are lines of businessmen under the doors of banks with proposals for starting such a business. That fruit just hangs too high, if you want.

        Sorry for the quality of the answer. I’d have polished it some more (I like discussions with you), but I need to sleep.

        • http://economicthought.net/blog JCatalan

          Roman,

          Yours is a long comment, so I can’t offer a comprehensive response. But, here a few comments on some key parts.

          You write,

          I also do not think that ‘distortions’ of monetary calculation are a viable concept because the price system is not a still and flawless lake surface into which the government could throw stones.

          There’s more to the pricing process than just prices. That’s why I mentioned concepts like “profit and loss.” You’re right that prices are imperfect; but monetary calculation doesn’t rely on “perfect” prices. I’ve already responded to that, or a similar, post by “Lord Keynes.” There’s more to the theory of monetary calculation than just relatively static price formation, and I’m not sure we can have a fruitful conversation without the concept of the pricing process (or the market process, if you prefer) being fully understood.

          Or, in other words, even if the distinct firms are not ideal by themselves, than after the process of weeding out through the profit and loss the market as whole a priori works better than anything else? How then thin or non-existent markets could be justified?

          I don’t understand your argument. You keep coming to the point of “imperfection.” Nobody is assuming that anything is a “magic bullet,” so there’s no need to attack the theory of the market process for relying on these kinds of ideas… because they don’t.

          I’m thinking of the very big and complicated projects like the creation of nuclear weapons (cheers to L. Groves and L. Beria) or the project Apollo.

          I can think of much more complicated products that were developed through the market process (and through localized knowledge). The entire theory of spontaneous order is built around explaining how complex outcomes come from decentralized action.

          You treat entrepreneurship talent as if it is not scarce. And it is.

          I do no such thing. There are also varying degrees of entrepreneurial talent.

          That there is a theoretical possibility to coordinate the activity of thousands of teachers, managers and workers to create a corporation that will rival USA public school system and (I will be generous) be profitable and efficient does not mean that there are lines of businessmen under the doors of banks with proposals for starting such a business.

          I’m not sure what your intention is behind these examples, but you realize that there’s a huge market in private education, right?

      • Stadius

        On your first numbered assertion:

        1. ‘Replacing or distorting the pricing process’ is not necessarily a corollary of public spending, and neither is laissez-faire sufficient or even necessary to prevent this from happening. Robinson made this latter point years ago, referring to the ‘administered prices’ set by ‘quasi-monopolies’ where there is significant managerial discretion.

        Generally, I agree with ‘Roman’ in that the economic calculation problem can’t be applied here. It’s application is in fact extremely narrow; it’s often presented as ruling out socialism in any form, but in fact it concerns only the case of a single planner owning absolutely all means of production (internationally, no less, which would imply the slavery of the global population minus one), hardly the aim of revolution! That people think of socialism as operating this way is probably due to confusion around the term ‘dicatorship of the proletariat’, which refers not to dicatorship in the usual sense, but to a proletarian (class) domination of political, economic and social power; by analogy, you could refer to the current status quo, with these spheres dominated by the middle classes, as the ‘dictatorship of the bourgeoisie’.

        So more realistic forms of the socialisation of capital, such as worker controlled firms, and of piecemeal intervention, are perfectly acceptable.

        • http://economicthought.net/blog JCatalan

          It’s application is in fact extremely narrow…

          It actually isn’t. Like I wrote to Roman, the socialist calculation debate is about resource allocation through the pricing process versus resource allocation outside of the pricing process. Complete public ownership of the means of production is an extreme (as would be private ownership of the means of production by a single person), but the arguments of the debate apply as well to less extreme forms of resource allocation outside of the pricing process. This includes redistribution by the State. I made my case to a fuller extent here, but I’m not the first person to make these or similar points:L.v. Mises and W.H. Hutt have made similar arguments.

          What monetary calculation really refers to is to a disciplining process. I agree with you, believe it or not, that this doesn’t imply that private ownership of the means of production, in the sense of a world without some form of “collectivization” (worker controlled firms are an example), is the only form of firm organization (I’d argue that these are alternative forms of private ownership). But, these firms would be subject to the same disciplining forces as others. The point made in this post is that the State isn’t subject to these disciplining forces, which is why State allocation of resources tends to be inferior to private allocation of resources. This honestly shouldn’t be so controversial of a point; superficially, most of the profession agrees (just not necessarily in the framing I’m providing).

          • Stadius

            The point I was trying to make is that these ‘disciplining forces’ of the market only appear under the infamous assumptions of perfect information, perfect competition/contestability, etc. If you believe that these assumptions are not a description of reality, then you must recognise that the managerial hierarchy (what Galbraith termed the ‘technostructure’) enjoys significant discretion, and the calculation argument doesn’t apply. That’s why the economic calculation debate can’t be rolled out as an all-purpose trump card by laissez-faire (or fairly lazy?) economists.

          • http://economicthought.net/blog JCatalan

            Then your point is erroneous. The theory of the market process doesn’t rely on “perfect competition” nor “perfect information.” In fact, some of the main developers of the theory of the market process assume the exact opposite.

          • person

            do explain.

          • Stadius

            I didn’t get it either.

          • Stadius

            It’s not good enough to make vague, obfuscatory references to some transcendental ‘market process’; you actually have to give good reasons why the market would reach optimal equilibria without those conditions.

          • http://economicthought.net/blog JCatalan

            Stadius,

            I’m not trying to be rude; that’s definitely not my intention behind these short comments. So, please don’t take this the wrong way (I’m not saying you are, this is just a disclaimer).

            The problem is that the “market process” is something that I’ve discussed a lot on this blog, and some of the responses to this post show that you guys haven’t assimilated what I’ve written before. Some of the “red flags” include comments about “perfect competition,” “perfect information,” and now “optimal equilibria” (when we know that the Austrian tradition is one of disequilibrium, and I’ve defended that position quite a few times on this blog). The blog post that’s currently on top (I’m not sure for how long), but written yesterday, should shed some more light. But, I’ve referenced a few other blog posts that maybe you’d be interested in looking at. I’ve also linked to my Mises Daily “Government Spending is Bad Economics.” It’s not as if the information isn’t out there, or I haven’t written on the topic before. I’m not just too keen on continuing to argue about the basics, and it’s not fair to accuse me of being ambiguous.

            I really didn’t know this was such a controversial point. I thought most economists had already accepted the essential points, which is why I suggested that there are more complicated arguments to be used against the fact that the market is the best allocator of resources (e.g. market failures; i.e. markets can’t always allocate well).

          • Stadius

            No offence taken. I think you hit on the source of the disagreements that we have when you said you are ‘not too keen on continuing arguing about the basics’, since neither am I. The problem, I think, is that our respective traditions have diverged further than most realise, and that the divergence is continuing.

            This makes ‘assimilating’ unfamiliar Austrian concepts, such as the ‘market process’ or ‘monetary calculation’ into my own understanding increasingly difficult, and as a time-constrained PhD student already facing the daunting task of mastering with my own (very specific) area, it’s unlikely that I’ll dedicate much time to branching out into Austrian economics.

            On a completely unrelated note, I was recently discovered, to my surprise, that Lachmann used to lecture at my university decades ago. Presumably back then, the divergence was much less pronounced.

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