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20140914 Clash of Economic Ideas

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MAIN IDEA:

This book is detailed depiction of development of economic ideas over last 2.5 centuries, implementation of these ideas in real life, and results of such implementations. This description and analysis pretty convincingly demonstrates that ideas of state control over economy failed everywhere where it was tried. The result was always misery, but extent of it was different from relatively benign misery of American implementation to outright murderous result of Russian implementation.

DETAILS:

Introduction

This book is focused on policy related parts of economic theory and empirical work. In this introduction author gives a very nice preview of each chapter. An important part of author’s view is the statement that economic ideas do have real life consequences, even if they are not direct. Authors describe the process of influence as following: on early stage academic economists come up with idea which them picked up by journalists and popular writers who disseminate it to general population which internalizes them and pushes politicians to implement it in legislative and executive actions.

As to content of opposing economic ideas they mainly relate to two choices:

  • Governments versus Markets
  • Socialism versus Capitalism

The second choice is pretty much made by whole world selecting Capitalism after disintegration of Soviet Union and China’s move to mainly market economy. The first one is still pretty much in play mainly at the level of gradation of how much economy and how much government should be used.

  1. The Turn Away from Laissez-Faire

This chapter sets the stage, describing economic thought on the verge of the First World War. It introduces two figures that will reappear throughout the book, the English economist John Maynard Keynes and the Austrian economist Friedrich A. Hayek. Each subsequent chapter begins with a major economic problem that triggered or revived debate among economists, or a policy experiment to which economists contributed.

The main idea expressed by Keynes is need to end of absolutely free market as result of its failure to avoid depressions and necessity of government intervention to fix various “market failures”. Correspondingly the main idea expressed by Hayek was necessity of free market not only for economic prosperity, but also to maintain human freedom with any government intervention into market being harmful for economy and push of humanity to serfdom.

 2. The Bolshevik Revolution and the Socialist Calculation Debate

Chapter 2 examines the issue of central economic planning versus the market price system, starkly posed by the Bolshevik Revolution of 1917 which then developed into the crucial “socialist calculation debate.”

At the beginning it reviews nearly perfect experiment of implementing pure socialism in a big country: Bolsheviks taking over Russian empire and creating Soviet Union. The results were perfectly disastrous providing tremendous amount of data and absolute prove of Mises theory of impossibility of planning and valid economic calculations in socialist economy. Here also reviewed case of Oskar Lange who came up with proposal of socialist economy that would emulate market pricing and performance. This idea just plainly did not work and he did not even try to implement it when he becomes high-level communist economic functionary in Poland.

 3. The Roaring Twenties and Austrian Business Cycle Theory

Chapter 3 examines pre-Keynesian business cycle theory, in particular the theory developed by Hayek and other Austrian economists, in light of the boom of the Roaring Twenties that ended in the crash of 1929. The New Deal policy experiment of the early 1930s followed in the United States.

Mises/Hayek cycle theory is based on credit expansion caused by low interest rates and government push for cheap money. This causes misallocation of resources to projects that could not be profitable. Eventually this overinvestment creates lots of capital goods without corresponding amount of consumer goods. Excess of money paid for creation of capital goods over availability of consumer goods causes inflation, but more important, at some point investors realize that expected returns on the project will not occur. The cancellation of projects initiates run away from investment and bust. The graphic representation is diagram of value added process that is becoming longer during boom, but contracts when it exceeds public’s savings term. In short, it is cycle caused by variance between savings and investment beyond public’s tolerance. 

  1. The New Deal and Institutionalist Economics

Chapter 4 traces origins of New Deal to the Institutionalist school of economics, especially as represented by the economist Rexford G. Tugwell.

It is notable and important to what extent New Dealers including Roosevelt where in awe before fascist regime in Italy and Mussolini because economically this regime and later German Nazis were very close to their ideas of Government control over cartelized economy. Tugwell was a student of Simon Patten who brought in America German economic ideas of controlling Government as developed and implemented in practice by Bismarck. On demand side Thorstein Veblen author of “The Theory of Leisure Class” introduced notion of “Conspicuous consumption” and believed that Economic Engineers should define reasonable level of consumption and managed economic machine to efficiently satisfy it. The economic institutionalism was lead through second half of XX century by John Galbraith. 

5 The Great Depression and Keynes’s General Theory

Chapter 5 relates how Keynes’s 1936 book The General Theory of Employment, Interest, and Money fomented a revolution in economic thinking about the causes of ups and downs in the economy as a whole.

Keynes really did not cared what caused recessions or depressions. His believe was that market just failed from time to time to maintain equilibrium and fall into “vicious cycle” when low demand led to decrease in production pushing labor out of work and thus decreasing demand even more. The obvious way out was for government to create artificial demand by pumping money into economy to increase earnings and decrease unemployment. Instead of Hayek’s intertemporal triangle Keynes proposed diagram of circular flows of resources between businesses, households, and government insisting that the levels of flow could be changed by government actions within productive capacity of the system. The main difference Keynes model is summarization of current consumption and investment, while Hayek’s is trade off between today’s consumption and investment as future consumption. Another big difference is interest rates. For Hayek it is driven by market mechanism to clear preference between loanable savings (supply) and investment (demand). Keynes denied validity of such mechanism.

Keynes pretty much denied Say’s law that “ Supply creates its own demand”. It is important to note often used misunderstanding of this law when supply and demand are considered as of the same type. In reality supply of one thing create demand for another. Economy grow if shoemaker’s production grew because taxes decreased and more productive people have money to buy shoes so he can make more shoes because he expects higher marginal profit which would allow him to increase demand for whatever he wants to consume let’s say meat. The same reasoning would apply to butcher. As result it will be more shoes and more meat produced and cleared at the market. However if it is demand side and government instead of decreasing taxes just give a pooper money to buy some shoes overall supply of shoes or meat is not going to increase because neither shoemaker nor butcher will expect to get more and therefore will not increase their effort. The only outcome would be increase in pooper’s consumption at the expense of shoemaker and butcher because of inflation.

There is a very interesting point on reasons why Keynes became so popular despite intellectual deficiency of his theory. It is its optimism and insistence on human ability to control economic events that turn people in mass to support it. Too bad it did not really worked out.

  1. The Second World War and Hayek’s Road to Serfdom

Chapter 6 focuses on a very different book, Hayek’s Road to Serfdom of 1944, which grew out of his concern about the dangers of continuing the central planning policies pursued during the Second World War. In the immediate postwar period, very different economic policy paths were taken by different nations.

This chapter also includes an interesting review of Nazi economic policies: Strict currency exchange control; Centralized agricultural policy with import quotes; large public works to provide full employment. As always these policies caused shortages of goods and rationing.

Western intelligentsia also was completely smitten by ideas of economic planning and state control. In Hayek’s view these measures would directly lead to totalitarism. Hayek dedicated his book to socialists of all parties to warn them that their economic push could lead to political result they would hate. The reality of after WWII mass movement to economic socialism in Britain and other countries of the West do not support Hayek’s assertion, but just barely. Rather then stay on the way to totalitarism these countries’ democracies were strong enough at the moment to prevent it. 

  1. Postwar British Socialism and the Fabian Society

Chapter 7 chronicles the nationalizations undertaken by the Labor Party in Great Britain and traces those policies to the socialist ideas that the Fabian Society had tirelessly developed and advocated in the previous six decades.

Implementation of Fabian socialism in Britain plentifully demonstrated that it does not work as economic model, but it succeeded in putting quite a few shackles on British economy so people are still suffering from it.   

  1. The Mont Pelerin Society and the Rebirth of Smithian Economics

Chapter 8 tells the story of a society with a strongly contrasting policy outlook, the Mont Pelerin Society, which Hayek founded after the war to rally the intellectual opponents of socialism. It is mostly intellectual history of rebirth of Adam Smith’s free market ideas that created foundation for next step when economic socialism failed in the West. 

  1. The Postwar German “Wonder Economy” and Ordoliberalism

Chapters 9 and l0 offer case studies of two countries that headed in very different directions and had very different results over the next thirty years. With important input from some Mont Pelerin Society economists, Germany moved in a market-friendly direction and prospered. 

  1. Indian Planning and Development Economics

With important input from Fabian thinkers, India adopted nationalization and quasi-Soviet Five-Year Plans and did not prosper. 

  1. Breton Woods and International Monetary

Chapter 11 tells the story of the 1944 Bretton Woods conference, how and why Keynes and other economists there hashed out an international monetary system that reduced the role of gold and allowed greater scope for discretionary national monetary policies. The Bretton Woods system collapsed in 1971, for reasons that economists have debated. Its collapse coincided with the onset of a period of high inflation. 

  1. The Great Inflation and Monetarism

This chapter recounts collapse of monetary system served as the seedbed for the revival and development of “monetarist” ideas by Milton Friedman and others, who challenged the dominance of Keynesian thinking. 

  1. The Growth of Government: Public Goods and Public Choice

Chapter 13 notes the growth of government in the postwar era and contrasts two leading economic theories that see the growth of government through very different lenses: the optimistic-about-government theory of public goods and the cynical-about-government theory of public choice. 

  1. Free Trade

Chapter 14 is discussion of the long-running debate between free traders and protectionists. 

  1. From Pleasant Deficits to Unpleasant Sovereign Debt Crisis

Chapter 15 examines the clash between Keynesian and “new classical “economists over the benefits and costs of government budget deficits and debt.

MY TAKE ON IT:

In my opinion, based on history of last century there is no intellectual justification for support for big government control over economy. However struggle is far from over, because lots of individuals are highly dependent on government for their wellbeing. These include rich crony capitalists who obtained their wealth through connection with politicians and bureaucrats of government; pseudo intellectuals in education, science, and culture who are highly dependent on grants from government bureaucrats, masses of poor who live in misery of welfare, but afraid of freedom of the market because they have no idea how they would survive it. Last, but far from least it is bureaucracy members themself, mainly at the higher level who know in their hearts, that they would not be able to achieve the same level of control over resources and ability to use them outside of government.

The losers in this system are always individuals who provide real goods and services because huge share of these goods and services going to individuals who do not produce anything of value at all and, more often then not, actually impede production of anything of value. The way out in my opinion is not easy but possible by:

  • Pushing through equal, unalienable, and marketable rights on natural resources so everybody would have something to sell on the market regardless of inheritance, abilities, and luck; therefore providing better access to resources then welfare state does
  • Educating young people and convincing them that they would be by far much better off not only materially, but even, more important, in life satisfaction in environment of free market then in environment of rigid government hierarchy
  • Convincing productive individuals that it is worthwhile to allocate some of their time to support fight against crony capitalism, corruption, and other forms of government intervention because it would bring better return on investment especially initially, than their regular productive activities.

If these measures succeed the political resistance to free market would become extremely week because only well established bureaucrats, politicians, and crony capitalists are really benefit from socialism in all its forms.


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