Structure of intellectual production
1 Scholars-intellectuals: economist writing for economists
2. Intellectuals writing for laymen, historical and statistical data is provided
3. Journalists and economists: provide ideas to policy makers and the general public
The clash of economic ideas is one of what the role of government should be in the economy. It is a clash of markets owing and directing finance and production vs the government commanding or steering where investment funds go. Both theories (socialism and markets) propose more prosperity (“a blanket term from the abundance of means by which individuals can satisfy their preferences”).
Chapter 1: The Turn Away From Leissez-Faire
Keynes didn’t believe that the laizzes faire impersonal system would allocate resources and economize in the best way. More government intervention, “intelligent” intervention, is necessary to help people and boost the economy.
Keynes was not the first one to advocate for more government intervention. Before the 20th century in the US a period called the Progressive Era is one characterized by ideological changes towards a more “active government”
Leissez faire was never the most popular idea amongst economists or laymen. Marshall, Fisher and his student Pigou alleged that capitalism had certain fallacies, amongst them:
- Individuals acting separately are often too weak or too ignorant to do what is good for them. Therefore, society would be benefited with guidance from experts. E.g. restriction of sale and consumption of drugs. All of these for the betterment of society as a whole.
- Negative externalities: when the injury to society outweighs the benefits to the individual.
- A dollar matters less to an individual with higher income, than to one with a lower income. Therefore governments should use progressive taxation to help distribute wealth.
Before WWI, the economy was going great with new technologies such as the telephone and faster trains. During the war, governments like the US took a broader control of the fragile economy and after the war gave up a Little bit of the new power and size they had recently acquired. In 1917 the last tsar lived in Russia, followed by a socialist revolution led by Lenin with the Bolsheviks. Marx and Engels never explained how to direct production under a socialist regime but merely claimed that it would be scientifically inevitable to go from capitalism to socialism. They didn’t discuss how to allocate resources or how a socialist economy would work, they only mentioned that private property shall be abolished to eliminate the exploitation of man by man. Once in power, after the revolution, what will Lenin do?
Chapter 2: The Bolshevik Revolution and the Socialists Calculation Debate
In less than four years (from 1917 to 1920) the Bolsheviks reached starvation and decreased production to only one third of what it was in 1916. Lenin ended up restating some market policies in 1921.
Socialist ideals were the fashion not only in Russia but also in Hungary, Vienna and Budapest. Ludwig von Mises enters the debate against socialism with an allegation on the impossibility of economic calculation under socialism. Mises defined socialism as any system were all of the mediums of productions are communal, where a market does not exist. This makes impossible for someone to allocate resources or to choose from different ways to produce and from different things to produce. What should the communist produce? How should they produce it? To what extent should they produce it? All of these question still remain unanswered.
|Labor Theory of Value
||Marginal-utility theory of Value
|Adam Smith, Ricardo, Marx
||Carl Menger (father of the Austrian school of economics)
|The value (price) of any product comes out of the amount of labor that was put into creating it.
||Things have no intrinsic value by themselves. Individuals prefer certain things above other and this is how prices are created. We are the meaning makers.
|Flaws: How do you explain that the price of diamonds is higher than the price of water?
In response to Mises critique on socialism, Oskar Lange proposed that a socialist government could be able to set prices in order to make economic calculation. Lange proposed that the government should assign prices via a trial and error mode and experiment with them until they reached a point of general equilibrium. Lange’s theory is named market-socialism. Oskar also argued that we don’t have competition, we have oligarchy and monopoly and that technological progress is much slower in this system because no one wants their capital to be worth nothing or replaced tomorrow as a result of a new and better discovery. Mises responded to Lange in Human Action by saying that entrepreneurial action, bidding for inputs only works when entrepreneurs are seeking for profit. “Completely taxing profits away would completely suppress entrepreneurial activity.”
Hayek joined the debate against Lange’s theories in two articles: “Socialist Calculation: The competitive Solution” where he argued that in a market, prices are low because of constant competition and that prices adjust fast and easily without intervention. His second article “The Use of Knowledge in Society” he explains that competition is what brings about the least-cost production functions via the learning and discovery of profit seeking entrepreneurs. There is no best way of knowing how to produce, it is rather something that is constantly discovered because it is constantly changing and learning. Central planning eliminates this learning process. It is not a question of whether it shall be planning or not, but rather a question that who shall do the planning? Prices in a market economy allocate resources to its best and most urgent needs. The Walrasian theory of general equilibrium does not account for the process of discovery that Hayek accounted for with the market.
*Entrepreneurs have the necessity to respond to the signals of prices.
What is the difference between a Rob Crusoe and an economy with more people? Why is it that in the former it is possible for Crusoe to calculate or to rationally choose between two options and in the latter it is not possible? Pg. 40. Why does one need more exact info while acting in a bigger scale? 41
What are the biggest problems with the theory of general equilibrium and with a computer owing all the answers to our questions?
Chapter 3: The Roaring Twenties and Austrian Business Cycle Theory
After the recession ended in 1921 until 1929, the economy of the US was roaring. The Fed had been experimenting with monetary policies since 1914 until finally they couldn’t hide their flaws and the economy crashed in 1929. Offering explanations to this crash came Keynes and Hayek: “Hayek’s account of what had gone wrong (in a nutshell: loose monetary policy had kept the interest rates too low and thereby distorted production into an unsustainably top-heavy structure) became the chief rival to Keynes’s account (in a nutshell: loss of nerve by investors meant that investment spending failed to make up for too little consumption spending).” According to Keynes, there should be more intervention to prevent a finish with a depression, easier monetary policy, increase in government spending financed by borrowing.
Mises, based on the earlier Austrian economists Bohm-Bawerk, created a theory of the boom-bust cycle. According to Mises, these cycles result in monetary malinvestment. The boom begins with a banking system arbitrarily expanding the supple of loans beyond the supply of monetary savings. As a consequence of this policy, interest rates reduce to a rate below the natural equilibrium. With low interest rates, there is a big incentive for economic activity; new businesses start that would not make profits and that wouldn’t have excited under a normal or natural interest rate. At one moment, the expansion policy needs to be stopped because if it is not stopped, the currency collapses. “The longer the boom, the bigger the bust”: Hayek argued further that low interest send the wrong signals to everyone. “It signals that borrowing to finance lengthy invest projects has become less costly relative to the projects’ anticipated future revenues” (pg.80). Money is used to invest in the longer triangle but that doesn’t match the demands of the present consumption. The Austrian business cycle can be compared to a hangover with recessions following “prosperous” times. On the other side, Keynes argued that a hangover never comes when the drinker never stops drinking. Keynes argued that the policies executed during the roaring twenties were right until the depression began caused by a lack of nerves, a lack of animal spirits to stimulate investment and consumption.
Even amongst Mises and Hayek were some disagreements. Mises was closer to the Free Banking School on the source on the monetary expansion: central banking that couldn’t resist to cheap money based on their political pressures. While Hayek accepted more the Currency School position that overexpansion could come from the central bank but also from commercial banks. There was another school led by Thomas Tooke and John Fullarton called the Banking School. They believed that no bank can over issue, neither a central nor a commercial bank, of course that they argued that their notes should be backed up with gold.
*Real bills doctrine (RBD): short-term transferable IOUs (I owe you’s) issued by business firms to finance goods in the process of production.
*nominal spending: money stock times its velocity of circulation.
What is the Hayek triangle? What does it explains or shows? How is it important to the Austrian business cycle theory?
Which policies of the Fed led to the crash?
How does the Fed play around and control the value of the currency?
What was the critique against Hayek? Pg. 90-91
Under which grounds the RBD was critiqued?
Chapter 4: The New Deal and Institutional Economics
Simon Patten: Wanted an economy of abundance, he thought that scarcity was obsolete. He wanted work place regulations, free education and to restrain business speculation.
Tugwell thought that WWII showed us that competition among nations leads to war and therefore competition amongst the market was the same evil. Instead of insecurity we should have planning. According to him only planning could eliminate the three greatest evils of capitalism: 1. Violent contrasts of well being; 2. Irrational allotments of individual liberty; 3. Unconstrained exploitation of human and natural resources. Tugwell claimed that under Taylorism in a great scale, we would have greater efficiency in production. By using only one third of the resources used today we would achieve the same amount of products, he didn’t offer any explanation or evidence as how this could be the case. Tugwell also disliked the fact that profits direct production and the entire economy of today.
Chapter 5: The Great Depression and Keynes’s General Theory
According to Keynes the GD was caused by the flaws inherent in any capitalist system. In the 1930s people were cough in a vicious cycle where the general public was not buying or investing but were just saving. This led to a lack of capital investment and enterprise.
Keynes thought that savings didn’t turn out in investments. The only thing that turns out into more investment is anticipated consumption. This leads him to say that government should incentivize full employment in order for investment to happen. If everyone has a job, everyone will be able to consume, there will be anticipated demand and therefore capital will be invested.
Income expenditure equilibrium: E + C + I + G = Y
E = current expenditure
C = sum of household purchases
I = business investment purchases
G = government purchases
Y = equilibrium current output of goods and services
“Paradox of Thrift”: an increased propensity to save (leaving all other things in the circular flow constant) results in a contract of incomes and outputs.
How are prices determined according to Keynes? *
What is the function of interest rates according to Keynes? *
Differences between Hayek and Keynes’s theories:
- Keynesians think of consumption and investment as moving in the same direction. Hayek acknowledge “opportunity costs” along with scarcity and so he says that we either use our resources on one thing or on other things. If we have a 100$ we can either save them in order to use them later, while someone else will invest them (loaning our money from the bank) or spend them. We can’t do both at the same time, there is always a trade off.
- According to Hayek, the interest rates coordinate the quantity available of loanable funds with the quantity demanded for investment. It is the same process as the automatic mechanism that adapts production to shifts in demand. Keynes said something about a liquidity preference and neglected automatic mechanisms in economics. Keynes wants to remove the price of interest rates and he is replacing them with the government controlling them.
- I am not that clear on the third major difference, but I think it is that Hayek takes into account the time needed to produce the goods, while Keynes treats production as instantaneous. What does this has to do with changes in the business cycle and labor markets? Pg 139 last paragraph before new subtitle. *
Keynes thought that the economy was below its potential because of too little aggregate demand. Not because there was too little consumption or because people were being underpaid.
Underconsumption: Malthus and Sismondi thought that more goods were being produced than what was demanded and therefore there was a surplus on certain goods and some people had a lot of goods without having the money to buy what they wanted. Ricardo and San answered by saying that whoever has commodities has the power to consume and that people produce with a view to purchase another thing.
Say’s law of markets claim that …
Back to Keynes: involuntary unemployment: when people are willing to work at less than the existing real wage.
Sticky wages: workers oppose to any lowering of their wages but they don’t do so when consumer prices go up. This equally lowers their real wage. Wages don’t change as fast as other prices in the economy.
Keynes’s theory didn’t offer an explanation for the boom, it didn’t offer an entire or complete explanation of the markets and of economics. He didn’t look at the causes of a depression but just at “solutions” for it. But how can you find a solution to a problem if you don’t understand the complexity of its cause? Still, Keynes’s theory caught on because it offered optimism by saying that something could be done to cure the economy. Unlike Hayek approach that said that a depression was the period of recovery of bad economic policies before the depression started.
IS (Investment-saving equilibrium) – LM (liquidity preference – money supply equilibrium) model.
Phillips Curve: you can either have high inflation or high unemployment, e.i. you can remove inflation and have a lot of unemployment or you can remove unemployment with lots of inflation. The problem with this theory was shown in the 1970s when rising inflation occurred with rising unemployment.
Chapter 6: WWII and Hayek’s Road to Serfdom
Why the worst get on top? The people that get un top of totalitarian regimes are the ones to love to plan, who dislike freedom and who left away their values in order to get where they are. That is why it isn’t by luck that the worst get on top.
How do you measure wealth?
What is the alternative of talking about nations?
How can we answer: are you wealthier? By referring to the macro
How is wealth measured? Can it be measured?
High interest rates: people are saving and not spending
How can we create institutions that substitute the government as in helping poor people.
Hayek’s Road to Serfdom was followed by Orwell’s Animal Farm and 1984. It was the right timing.
Chapter 7: Postwar British Socialism and the Fabian Society
General 1945 elections: Atlee won over Churchill and he wanted to solve “poverty” by taking ownership of the commanding heights. He didn’t want to have powerful business people therefore he wanted to replace them with government. Their argument for planning was that if they could plan during war time, they could also plan during peace. Price controls and rationing of consumer goods continued after the war.
The Labor Party nationalization of most of the commanding heights was inspired by the Fabian Socialist movement who proposed a slower step by step revolution towards socialization. The term Fabian, taken from a Roman general is reference to incremental rather than revolutionary.
Labor Party Manifesto’s 4 part plan:
- Minimum Wage, maximum 48 hour workweek. Fight of unemployment: public work and employment insurance.
- Common ownership of the means of production, managed by a scientific plan and not by profit seekers.
- Progressive taxation
- The state was to expropriate surplus wealth.
The Webb Spouses (Sidney and Beatriz)
George Bernard Shaw
Harold J. Laski
Differences between Marxism and Fabians
Since the Fabians observed the century after the French Revolution, they noticed and thought that the economic position of workers had improved and that it would keep on improving. The Fabians believe in legislation as a means to get to socialism, without the need to go through a revolution. Another difference is that they envisioned these changes being implemented by intellectuals or scientists and not by the proletariat. The Fabians didn’t advocate for an immediate abolition of private property, but for a gradual transformation into state ownership of the means of production.
What they got from David Ricardo’s rent theory (Ricardo + Fabians):
- You only get your rents by the position of the land that you inherited = undeserved luck
- The rent receiving landowner contributes nothing to production.
George Bernard inspired by Henry George (influenced by Malthus): the price we pay for land rises as the population grows, the more people there are the more demand of land would be and the supple obviously stays the same.
Fun fact! HENRY GEORGE: “Georgist theory was even the inspiration for the board game Monopoly. The game’s original creator called it ‘The Landlord Game’ and intended it to illustrate the unfairness of receiving rent based on the lucky ownership of advantageous plots.”
- The greatest happiness for the greatest number. Everything should be judge under the stick of aggregate happiness.
- Critiques: how are we to measure happiness? How are we to calculate based on happiness, e.g. subtracting happiness here, adding happiness there.
Dreamt of a socialist system with individual liberties
Wanted the state to redistribute wealth via education, control of the banks, taxation, etc.
Chapter 8: The Mont Pelerin Society and the Rebirth of Smithian Economics
The Mont Pelerin Society was founded in Switzerland by Hayek and was funded by Americans and Swiss who were impacted by his Road to Serfdom. 37 economist, historians, journalist and philosophers were invited. The main idea was to discuss how to spread the ideas of liberty. The main goal was not to get to a consensus or agreement, it was to discuss about ideas of freedom, to debate and to think.
It amazes me the power and influence ONE person can have on a lot of other things. Hayek surely was one of these people, and it surprises me how coherent what he did is with what he wrote in his “Kids of order in Society”, especially with the broad and simple grounds under which the MPS was built: affirming the principles of human dignity and freedom, freedom of thought and expression, rule of law, private property and the competitive market, diffused power, peace and liberty and harmonious international relations. It is amazing the complexity that emerges from simple rules and very few grounds. Surely the MPS is a Society in Hayek’s term and not an organization. It didn’t look for consensus; it looked for advancement of certain simple principles and from there on complexity emerges.
“The group does not aspire to conduct propaganda. It seeks to establish no meticulous and hampering orthodoxy. It aligns itself with no particular party (dynamists in Virginia Postrel’s terms). Its object is solely, by facilitating the exchange of views among minds inspired by certain ideals and broad conceptions held in common, to contribute to the preservation and improvement of the free society.”
- Wealth of Nations, Theory of Moral Sentiments
- We can create wealth, what matters is a nations annual output of goods and services
- Prosperity: division of labor, specialization, free trade
- People trade and specialize out of self-interest
- Invisible hand: the spontaneous ordering process of a competitive market. The investor is led by market signals and incentives to coordinate his behavior with other market participants.
o Francis Hutcheson
o Mandeville: “beneficial overall results may emerge unintentionally from individual self seeking.”
o Scottish Influences: David Hume: saw trade as the source of economic development, and economic development as the source of civilization, peace, and happiness.
o Physiocracy: French economist against merchantilism. According to them not industry but land and agriculture is what creates wealth.