Quotation of the Day…

by Don Boudreaux on September 8, 2011

in State of Macro

… is from page 249 of Vol. 9 of Hayek’s Collected Works; here – in an essay written in 1983 and originally published in The Economist – Hayek is discussing J.M. Keynes:

In these theoretical efforts he [Keynes] was guided by one central idea – which in conversation he once described to me as an “axiom which only half-wits could question” – namely, that general employment was always positively correlated with the aggregate demand for consumer goods.  This made him feel that there was more truth in that underconsumption theory preached by a long row of radicals and cranks for generations but by relatively few academic economists.  It was his revival of this underconsumption approach which made his theories so attractive to the Left.

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{ 62 comments }

SaulOhio September 8, 2011 at 1:36 pm

When I argue economics with people on the Left, that crack about half-wits is typical of their rhetoric. I think its psychological projection.

Kevin September 8, 2011 at 1:42 pm

In short, he boiled economics down to something that liberal arts majors could suddenly understand.

… Sorry, that wasn’t nice.

vikingvista September 8, 2011 at 1:42 pm

This is as much of a dig as you can expect from an LSE gentleman writing publicly about a colleague.

Daniel Kuehn September 8, 2011 at 1:47 pm

People interested in what Keynes said, and not what Hayek said he said, can refer to Chapter 23 on this point. When discussing underconsumption theories with limited praise, Keynes goes on to criticize them this way:

“Nevertheless, their theory failed of completeness, essentially on account of their having no independent theory of the rate of interest; with the result that Mr. Hobson laid too much emphasis (especially in his later books) on under-consumption leading to over-investment, in the sense of unprofitable investment, instead of explaining that a relatively weak propensity to consume helps to cause unemployment by requiring and not receiving the accompaniment of a compensating volume of new investment, which, even if it may sometimes occur temporarily through errors of optimism, is in general prevented from happening at all by the prospective profit falling below the standard set by the rate of interest.”

This is the alternative he offers himself back in chapter 16.

The point is this – underconsumptionists say C is low, so there’s lots of S, so there’s more I than is necessary, so we have a recession until the overproduction works itself out. This is what Don criticizes in the last post.

But this is exactly what Keynes criticizes in the underconsumptionists. Keynes notes that investments will be made in response to specific future demand (which can come in the form of future investment or future consumption – future investments being, of course, responding to consumption even futher in the future). Keynes points out that an act of saving does not require a specific commitment to future demand, so an act of saving does not automatically result in new investment.

Keynes acknowledges consumptionists as recognizing the beginning of the problem. He criticizes them, though, and was not himself an underconsumptionist.

Economic Freedom September 8, 2011 at 5:56 pm

Hobson laid too much emphasis (especially in his later books) on under-consumption leading to over-investment, in the sense of unprofitable investment, instead of explaining that a relatively weak propensity to consume

IOW, “Weak propensity to consume” = “underconsumption”. The former is just pseudo-scientific jargon for the latter.

helps to cause unemployment

IOW, Keynes believes that “underconsumption” causes unemployment.

by requiring and not receiving the accompaniment of a compensating volume of new investment,

IOW, Keynes believes that “underconsumption” causes unemployment because, as consumers opt to save their dollars rather than spend them, the banks that hold these increased consumer dollars, are not lending them out to new businesses OR existing businesses are not opting to borrow.

which, even if it may sometimes occur temporarily through errors of optimism,

IOW, even if a stray optimistic entrepreneur should opt to borrow in order to start or expand business projects,

is in general prevented from happening at all

he would be categorized as an outlier or a one-off; others would not follow his lead because,

by the prospective profit falling below the standard set by the rate of interest.”

Most potential borrowers — the majority not suffering from an “error of optimisim” — would speculate that their “prospective profit” from starting a new project by means of new borrowing would neither equal nor exceed the interest they’d be paying for the new loans.

And why would the majority of potential new borrowers speculate so pessimistically about prospective profits? Regime uncertainty. Lowering the rate of interest in order to fool businessmen into believing that their “prospective profits” — however slim — will exceed their low interest payments is NO incentive to borrow, invest, and hire, if businessmen also believe that those “prospective profits” might be taxed away, or evaporated away in complying with increasing regulations.

It’s not hard to understand. One simply has to take into account how people actually act in the real world, as opposed to memorizing pseudo-scientific jargon and calling it economics.

See Joseph Salerno’s lecture: “The Financial Crisis and the Death of Macroeconomics”

http://youtu.be/9GlZFiCqIGo

SheetWise September 8, 2011 at 11:30 pm

I think I’ve got Keynes criticism of under-consumption simplified …

The theories ignored interest rates and focused on under-consumption leading to unprofitable investment — instead of recognizing consumer malaise contributes to unemployment unless balanced by new investment (investment which won’t happen if you do acknowledge interest rates).

Economic Freedom September 9, 2011 at 1:56 am

instead of recognizing consumer malaise contributes to unemployment unless balanced by new investment

In other words, the volatility of the investment side of things is caused by inexplicable, unaccountable “animal spirits”; the volatility of the consumption side of things is caused by an inexplicable, unaccountable “malaise.” Thus, the two basic causal principles that govern a modern economy are “animal spirits” (or lack thereof) and “malaise” (or lack thereof).

Impressive. Keynes certainly did his part in nudging economics a bit more toward rigorous scientific analysis.

SheetWise September 9, 2011 at 3:15 am

“Keynes certainly did his part …”

Everything I’ve read about the guy I get the impression he was a real charmer — he certainly was a great BSer. He almost comes off the page. Keynes could write some seriously hypnotic nonsense. You usually have to read a Private Placement Memorandum to get anything even close to as good.

SheetWise September 8, 2011 at 10:01 pm

Noting that the quote you’ve supplied is all one sentence, I wonder if it wouldn’t be asking too much if you could diagram it for me.

Daniel Kuehn September 9, 2011 at 6:50 am

Holy crap – that is one sentence! Wow.

No – I will not diagram it.

Roger McKinney September 9, 2011 at 1:06 pm

Referring to Keynes’ books tells us nothing about what Keynes thought. He changed his mind frequently. As he said, when the facts change, I change my mind. Keynes may have held to the things he wrote in GT no longer than the time it took the ink to dry.

Hayek knew Keynes for many years and lived with him during the war. I doubt even Skidelsky knows Keynes as well as Hayek did.

Daniel Kuehn September 8, 2011 at 1:52 pm

So… why does Hayek say he’s an underconsumptionist?

First – Hayek may just have remembered the whole thing wrong. It’s not unprecedented. Bruce Caldwell recounts Hayek changing his story a couple times about why he didn’t respond to the General Theory, for example. Hayek often adopted new memories that were more convenient to have at different points in time. It’s nothing special about Hayek – we all do that. Brains are funny things.

What seems clear here is that Keynes has said consistently in the General Theory and elsewhere that consumption and prospective consumption determines employment (because investments will not be made without prospective consumption). “Consumption and prospective consumption drives employment” can be synonymously read “consumption and investment drive employment”.

Hayek seems to misunderstand this, but it’s all pretty clear in the General Theory. The ratio of chapters on investment to chapters on consumption are about two to one.

Don Boudreaux September 8, 2011 at 2:17 pm

Hayek is far from being the only person who classified Keynes as an underconsumptionist.

Daniel Kuehn September 8, 2011 at 2:28 pm

Certainly.

I know a lot of people who say Hayek didn’t care about the unemployed. When I read Hayek I conclude the accusations don’t hold up well.

Economic Freedom September 8, 2011 at 6:01 pm

I know a lot of people who say Hayek didn’t care about the unemployed.

Some say Hayek didn’t care about the unemployed because they confuse moral sentiments with economic arguments. On the other hand, many say that Keynes was a “weak propensity to consume”-ist (i.e., an “underconsumptionist”), which is a perfectly reasonable interpretion of his arguments. You’re comparing two completely different things.

I’m utterly fascinated by the way your mind works.

Daniel Kuehn September 9, 2011 at 6:54 am

It’s still either true or false that Hayek felt that way and it’s either true or false that Keynes thought that. So you’re wrong, but perhaps you’d be more comfortable with this:

I’ve heard people say that Hayek thought deflation helped the economy under all circumstances, but when I read Hayek I conclude that the accusations don’t hold up well.

I mean really EF – how is it that you’re criticizing my thought process here and not Don’s. Don is the one commiting the argumentum ad populum. You’re a very transparent yes-man, you know that?

Methinks1776 September 9, 2011 at 7:02 am

You’re a very transparent yes-man, you know that?

Irony drips from every syllable.

Don Boudreaux September 9, 2011 at 7:40 am

Do you believe also that “the American Keynes” – Alvin Hansen – also was not an underconsumptionist?

Daniel Kuehn September 9, 2011 at 8:43 am

I don’t know him well enough. I seem to remember reading that in the mid-1930s he was a big-time underconsumptionist, but (1.) that’s second-hand, like this Hayek quote – but not implausible, and (2.) a lot of people were sorting out their ideas in the 1930s. There’s a reason why we call Hansen “the American Keynes” and why we don’t call Keynes “the British Hansen” – presumably Hansen learned something from Keynes. But I honestly don’t know him that well.

Underconsumptionism was very common in America at the time. I personally think that’s a big part of why Keynesianism caught on here in a way it didn’t on the Continent. But that doesn’t change the fact that the claim that Keynesianism points to consumption rather than investment as the primary problem is wrong.

I’m not just making this up on the fly to criticize you. I’ve pushed against this “Keynesianism as consumptionism” idea for a while – you can see some of what I’ve written here: http://factsandotherstubbornthings.blogspot.com/search?q=consumptionism

If you scroll down a little ways, you’ll notice I’ve even criticized Krugman for talking like a consumptionist (usually he’s pretty good about that… but he slips into it more easily than DeLong, who in a lot of ways is a more careful thinker than Krugman).

Daniel Kuehn September 9, 2011 at 8:44 am

btw – my Dad heard you on the radio yesterday talking about this stuff. I happened to be over for dinner and he asked if I had ever heard of you.

Daniel Kuehn September 9, 2011 at 8:54 am

Let me put out this evidence for a change of opinion on Hansen’s part – Hansen is responsible for providing one of the early versions of the IS-LM model after Hicks introduced his, and the IS-LM model is clearly a model about recessions caused by problems with investment, not problems with consumption.

Chris O'Leary September 8, 2011 at 2:18 pm

“(G)eneral employment was always positively correlated with the aggregate demand for consumer goods.”

So how then is government spending on infrastructure stimulative?

At best, there’s going to be a massive time lag until that new infrastructure comes on line and then indirectly benefits consumers.

Don Boudreaux September 8, 2011 at 2:27 pm

Keynesians would respond by saying that, by increasing employment (e.g., hiring currently unemployed workers to repave highways), household incomes will rise and, therefore, consumer spending will increase as soon as these workers start to receive their paychecks (and perhaps even sooner, as these workers – anticipating their coming paychecks – might start immediately to spend more).

muirgeo September 8, 2011 at 2:45 pm

Well stated… and that doesn’t make sense to you. The evidence doesn’t support it??? How many times do we need to repeat the concentrated wealth experiment before we can stop repeating history to the detriment of millions of lives and theadvancement of civilized society?

vikingvista September 8, 2011 at 3:00 pm

Of course it’s well stated. Understanding keynesiacs is easy. It’s the keynesiacs such as yourself who have the mental block.

Methinks1776 September 8, 2011 at 4:35 pm

Please refrain from insulting the Keynesiacs by counting Muirdiot as one of them.

vikingvista September 8, 2011 at 7:12 pm

I never thought I’d be saying this, but…

My sincerest apologies to keynesiacs everywhere.

SheetWise September 8, 2011 at 10:13 pm

“My sincerest apologies to keynesiacs everywhere.”

Now that’s class. It has the brand of sincerity its intended audience will appreciate.

Chris O'Leary September 8, 2011 at 3:01 pm

So how can we currently have both ginormous deficits and serious economic problems? Why isn’t all of that military spending stimulative?

It seems like our current economic straights disprove the theory.

muirgeo September 8, 2011 at 10:03 pm

Because the deficits are mostly a result of decreased revenues and not increased spending.

tkwelge September 9, 2011 at 2:21 am

Well, all levels of government are taking in 3,000 dollars less per person in 2005 adjusted dollars while spending an extra 2,000 dollars per person in 2005 adjusted dollars. Most of that decreased revenue is due to the fact that businesses and property owners aren’t paying the same taxes that they were when they were making more money. However, GDP didn’t really decline significantly, and it is now above what it was pre recession, so that money must exist elsewhere in the economy. Whether or not the deficit spending is the result of revenue decreases or spending increases means little when the money remains in the economy elsewhere.

Ameet September 8, 2011 at 3:48 pm

Mr. muirgeo,

Feeling lazy as I am today, perhaps you can help me by just looking at this link. Please put aside your confirmation bias when you see the Cato Institute portion of the link, and view.

http://www.cato-at-liberty.org/government-and-job-creation-help-or-hindrance/

If you are able to put aside your confirmation bias and view this video, then perhaps you would be more willing to see that the evidence indeed does not support the Keynesian case.

If you are not able to put aside your confirmation bias, then I admit some sympathy to your plight.

N.B. I admit I find it ironic that you deplore repeating history. And yet, to a libertarian, it feels very much like we have been in a repeat of the Great Depression, policy-wise. Somehow it doesn’t to you.

vikingvista September 8, 2011 at 4:01 pm

Repeating again and again and again…

Economic Freedom September 8, 2011 at 6:18 pm

Good video. Thanks for posting.

SheetWise September 8, 2011 at 10:32 pm

I think the video moves a little too fast. Is there a pop-up book version?

muirgeo September 9, 2011 at 10:38 am

I watched your video and sotted the fallacy which you consumed with out question because of your own confirmation bias. It’s at about 1:52 on the slide board. Do you see it? The video should ITSELF be used as a lesson on confirmation bias.

Kirby September 8, 2011 at 4:20 pm

Muirego: The US highest marginal tax rate is higher than the Scandinavian countries. So quit talking about taxes and start talking about inventors creating wealth.

Chris O'Leary September 8, 2011 at 3:06 pm

But highways aren’t consumer goods.

P.S. I’m not arguing with you, Don, just pointing out a disconnect in the theory. The quote states consumer goods and not infrastructure. At a first glance, a broad-based consumer stimulus (e.g. $500 check to every household) seems like a very different thing than pouring all of that money into just one industry. I could see that stimulate the heck out of that industry but not have the same broader effect.

P.P.S. That could also explain why all of our current military spending isn’t as stimulative.

ccresci September 8, 2011 at 3:12 pm

The irony of infrastructure projects is that the Government could have the work done by people in exchange for the ability to collect future revenues in the form of tolls or fees without spending any money at all.

Ameet September 8, 2011 at 4:16 pm

Indeed! And it would be much more likely to be useful infrastructure because if it could only work with tolls and fees, the market system discipline of building where revenue would cover costs (because of demand) would likely kick in, even if the government was running it.

Not as well as if the government just issued a statement saying that private companies could build whatever roads they wanted and collect the tolls, and that the government would not help them at all via eminent domain (meaning they’d have to negotiate with each property holder for right of way use). But it’d still be better than today’s system.

Methinks1776 September 8, 2011 at 4:33 pm

Yes, ccresci, but then that robs politicians of the power to pay back cronies and defeats the whole point of infrastructure projects.

Economic Freedom September 8, 2011 at 6:09 pm

Keynesians would respond by saying that, by increasing employment (e.g., hiring currently unemployed workers to repave highways), household incomes will rise and, therefore, consumer spending will increase as soon as these workers start to receive their paychecks

And by Keynesian lights, since the product of this labor — the infrastructure itself — is of secondary consequence, and of primary consequence is the paycheck these workers receive, it follows (per Nancy Pelosi) that simply handing out paychecks would be stimulative, even without any new bridges or highways.

muirgeo September 8, 2011 at 2:40 pm

Hayek had the last word in life while real world evidence and data and facts consistently give Keynes the last word in reality.

Ameet September 8, 2011 at 4:00 pm

muirgeo,

If that was so, then why were Keynesians wrong about the recovery at the end of WWII with the cutting off of government military spending? Surely you recall that the federal government cut expenditures by at least 30%, despite leading economists saying that would lead to another recession? And yet it didn’t.

Last I checked, that would mean “consistently” is a false description of the empirical support for Keynes.

Or are you going to chalk that up to humans just being bad forecasters? Though if that’s the case, should we give credence to Keynesian forecasts, since they come from humans? Perhaps not.

-Ameet

John Galt September 8, 2011 at 6:03 pm

It might be too late for him. He’s caught in the stupidity trap. He believes the breaking wind fallacy where dreams become real with no real world effort if they are noble and pure enough.

http://mises.org/daily/4489

Look what the underconsumptionists did for France. France is now the leading world producer of silk thanks to Laffemas.

SaulOhio September 9, 2011 at 5:52 am

Real world evidence? Like:

70′s stagflation
Japan’s lost decade
Recovery only after WWII ended and government spending was cut
No new recession after war spending was cut and soldiers returned looking for work.
1920 depression, economy recovered almost right away with no stimulus because government cut spending
Trillions of dollars of stimulus spending, and we haven’t yet recovered from the Great Recession, unemployment is still high after 3 years

That’s the short list.

Randy September 8, 2011 at 2:43 pm

Keynes fails for the same reason that Marx fails. They prescribe political solutions to economic problems.

muirgeo September 8, 2011 at 2:52 pm

And libertarianism fails for the same reason all religions fail… the is no invisible hand god.

Shorter muir September 8, 2011 at 3:23 pm

I’m the one with the FDR avatar, but you guys are the cultists.

Randy September 8, 2011 at 4:50 pm

Libertarianism is not a religion. It is a resistance.

vikingvista September 8, 2011 at 7:13 pm

Vive la résistance!

muirgeo September 8, 2011 at 10:01 pm

Yeah a resistance to reality, pragmatism and real worldism…

Randy September 9, 2011 at 4:58 am

Yes, resistance to the real world reality of fascist political organization. And throughout human history the pragmatic thing to do has always been to join the fascists, or at the very least to pretend to respect them.

vikingvista September 8, 2011 at 3:01 pm

Keynes fails even as a purely analytical, rather than interventional, discipline.

Dan J September 8, 2011 at 2:58 pm

Underconsumption theory leads to foolish Econ policies like that of FDR’s, the crooked, and consequences, seen and unseen, which costs more in losses than gains.

SweetLiberty September 8, 2011 at 4:05 pm

Keynesians would respond by saying that, by increasing employment (e.g., hiring currently unemployed workers to repave highways), household incomes will rise and, therefore, consumer spending will increase as soon as these workers start to receive their paychecks (and perhaps even sooner, as these workers – anticipating their coming paychecks – might start immediately to spend more).

This makes TOTAL sense to me. Let’s say government hires 100 guys to build a bridge to nowhere. It takes 6 months and costs taxpayers 10 million dollars – 10 million those taxpayers would have saved or invested elsewhere but is now redistributed to the 100 unemployed workers. Fair enough. Now these guys build one hell of a bridge and cash their paychecks, buying stuff. Not a lot of stuff, mind you, because they know this is a temporary gig and they had better save for when they get laid off again. However, the places where these guys do spend their money aren’t complete idiots – the business owners know that, at the end of the 6 months, these guys are right back to being unemployed. So the local factories don’t invest in more machines and hire a bunch of new workers because they know the “boom” is very temporary. Instead, they may raise prices on the inventory they have, make money while they can, and then sit on any profits, waiting for these guys to get real jobs that are sustainable. That is why many companies aren’t hiring or falling for these short-term Keynesian stimulus measures – they know it’s artificial.

Yes, taxing money from some (or the future if borrowed or printed) may temporarily seem beneficial, but it doesn’t address the underlying disease.

Smart investors diversify their portfolios, because they know the likelihood of picking one or two winners based on anticipating future demand is very slim. So they spread their investments widely and, as real demand emerges, they invest more heavily in some industries while dropping others. However, government throws all their resources into a very few areas – most of which are wasteful or, at best, maintenance efforts. They can no more anticipate real future demand than the average investor. The difference is, government doesn’t care – they think any investment they make with other people’s money is prudent. It’s not.

Maybe the Keynesian solution doesn’t make sense to me after all.

Greg Webb September 8, 2011 at 5:46 pm

And by endorsing the under-consumption theory, Lord John Maynard Keynes won the “applause” that he sought. To Keynes, it did not matter that this applause came from radicals, cranks, and corrupt politicians. All that mattered was Keynes’s ego.

SweetLiberty September 8, 2011 at 6:20 pm

Sadly, now anti-Keynesians are the radicals and cranks. They still own the corrupt politicians.

Josh S September 8, 2011 at 6:22 pm

Has anyone noticed that liberals become radical anti-consumptionists whenever the economy is doing well? Then they’re fuming about how much gasoline we consume, how many trees we cut down, how much beef we eat, how much iron we mine, etc…there really is no pleasing liberals.

Methinks1776 September 8, 2011 at 6:43 pm

OMG! You’re right. I hadn’t thought of that.

How many times have I been lectured “Live simply so others can simply live”? When I asked how that worked I never got an answer.

Don Boudreaux September 8, 2011 at 6:52 pm

Yep – that “live simply” slogan has got to be one of the stupidest pieces of nonsense ever spit out by the economically ignorant amongst us.

Roger McKinney September 9, 2011 at 1:01 pm

“Precocious, supremely self-confident and abominably rude, Keynes was certain that he knew what must be done.”

http://www.bloomberg.com/news/2011-09-09/keynes-schumpeter-and-the-great-post-war-mistake-sylvia-nasar.html

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