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Arnold Kling on PSST

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In today’s European Wall Street Journal, Arnold Kling eloquently and concisely explains his idea of “PSST” – patterns of sustainable specialization and trade [2] – and highlights how an understanding of the economy based upon PSST differs fundamentally from an understanding based on Keynesianism.  I encourage you to read the entire essay: it is not long on words but it is impressively long on insight.

Arnold has more here [3], and (especially) here [4].

Once again, perhaps the greatest calamity unleashed by Keynesianism is the – what shall we call it? – pedestrianization of scientific economics.

Pedestrian economics has always been with us, and will always be with us.  This is ‘economics’ that prompts its practitioners to look only at the seen and to ignore the unseen; it is ‘economics’ that mistakes personal experience for economic wisdom; ‘economics’ that seldom inspires people to ask sensible-yet-nonobvious questions (such as “Is the nation-state really as fundamental an economic or social unit as popular discussion presents it as being?”); ‘economics’ that (because it encourages excessive obsession with what is seen) speaks of jobs as ends in themselves; ‘economics’ that – precisely because it is pedestrian – sees consumer demand to be the great determinant of economic activity and economic health.

Stated differently, pedestrian economics is ‘economics’ devoid of recognition of the dispersion of knowledge; destitute of appreciation of the indescribably large volume and frequency of mostly small economic adjustments made daily throughout the modern economy by individuals each of whom has unique “knowledge of the particular circumstances of time and place [5]“; empty of an understanding of the role of relative prices in coordinating these multitudes of individual plans and actions; and barren of any realization of the enormous creativity of entrepreneurs operating in economies that are at least reasonably free.

Keynesianism elevates this matrix of misunderstanding into an alleged science.  By focusing laser-like on the one feature of an economy (that is, demand) that fills the tunnel vision of pedestrians on the street – and then by focusing on demand as if its magnitude is largely determined independently, without being much (if at all) affected by supply – Keynesianism seems to these pedestrians to be smack-on correct.

Of course, Keynesianism is itself adorned in magnificent scientific costume and make-up, and its practitioners have built for themselves elaborate games to play that cause them to think that they’re engaged in something more than pedestrian economics.  They can shift IS-LM curves, as well as aggregate-demand curves; they can calculate multipliers (“balanced budget” and otherwise); they can impress hoi polli with mysterious terms such as “liquidity trap,” “marginal efficiency of capital,” and “marginal propensity to consume.”  But through it all, they – at least when doing Keynesian economics – ignore the very heart of the economy, namely, the goo-gob-gillions of daily adjustments that individuals make to changes in their knowledge, and the smaller – yet still large – number of creative acts that people do daily in hopes of improving their economic prospects.  Paying far too little attention to these micro-level matters (or – what is the same thing – assuming these micro-level matters to be fixed and given in ways that, by assumption, leave demand as the only available variable to affect the economy), Keynesians of course can build impressive models that show how exogenous changes in demand will do this or that to the economy.

But these models miss 99 percent of the relevant action – and they miss all of the action that pedestrian economists never become aware of.  No pattern of sustainable specialization and trade was ever created by aggregate demand.  And no such pattern can be explained or understood by using a method of analysis that focuses only on what, in the final analysis, are largely the consequences of people’s success or failure at establishing patterns of sustainable specialization and trade.