Posts Tagged ‘john maynard keynes’

Creative Destruction, Say’s Law and the Pseudo Science of Economics

Monday, October 20th, 2014

Dear Friends,

It seems to me, supply really does drive demand in the creative phase of the creative destruction cycle, and arguments to the contrary are most often based on observation bias. The theory that supply drives demand is Say’s law, but I am changing it a bit. Keynesian economic theory is that demand drives supply which is the opposite of Say’s law. These two theories have been at odds since John Maynard Keynes developed his theory. Keynes theory falls short of the mark, as does Say’s law, but if we combine Schumpeter’s theory with that of Say, the amalgam provides us with a better snapshot of the workings of a healthy economy. This is because an economy is a complex system, and complex systems are by their nature messy, making it impossible to quantify and measure the inputs to any real degree of reliability, therefore economics are a pseudo science or in other words, an art. This is important because our lives are better when we live in an expanding economy with a rising standard of living.

Economics is not a real science in the strictest of terms. The theories cannot be independently verified because the fundamentals cannot be effectively measured. Moreover economics, like any of the humanist “sciences,” are subject to the personal bigotries of the “scientist.” These pseudo sciences have built in traps for those who would promote their theories over those of another. One of those traps is observation bias. In the hard sciences like physics the parameters can be set, measured and quantified. The bias of the observer is irrelevant, a stone dropped accelerates at nine point eight meters per second squared, no matter who is observing it, but since humanistic sciences, economics and climate “science” are not hard sciences based on directly observable phenomenon, but are instead complex systems that have far too many inputs and interactions, so observing and measuring any number of inputs and interactions, many of which are not directly observable at all let alone measurable, gives very little insight into the emergent phenomenon that is different in kind than the sum of the inputs… a key distinction of a complex system.

Since economics is the science/art of a complex system, theories cannot be measured by looking at any of the inputs, but instead must be measured from the emergent phenomenon that rises from the complex system itself. In other words, we cannot reason from the bottom up, like the hard sciences, we have to reason from the top down, and even then, we find observation bias creeping in. In the aggregate demand aggregate supply model, the assumption is that if there is no demand for products and services, any supply is over supply, and therefore demand drives supply. In Say’s law, that supply drives demand, the foundation is that if there is a supply of something there will be demand, even if the demand is at a price point that is lower than the manufacturing cost. In Schumpeter’s theory of creative destruction, the theory rests on the concept that new ideas draw in the means of production until the idea is fully implemented, then the outmoded ideas are destroyed.

All those theories start at some sub function of the complex system, demand, supply, new ideas, etc… then reason from the sub function or input, to the emergent phenomenon. As I have explained this is not an efficient way to reason about complex systems. If we instead look at the desired results, the emergent phenomenon we seek in an economic system, IE. a “healthy economy,” and then reason down, we are more likely to find workable theories that are less subject to observation bias… as long as the term “Healthy economy” is agreed to at the outset. Let’s set the parameters for a “healthy economy,” to be full employment, an expanding economy and a rising standard of living. Notice I didn’t make one of the parameters no recessions. This is because recession’s are clearly a facet of a healthy economy as we have described. We can deduce this by the fact that all complex systems grow in fits and starts, animals and plants grow rapidly, slow, then grow rapidly again, until they have reached maturity. Weather patterns change constantly from rain to clear and back to rain, all complex systems wax and wane and therefore reasoning from the top down, we can reasonably conclude recession is a function of a healthy economy, just as sleep is a function of a healthy body.

The emergent phenomenon of a healthy economy, requires a high utilization of workers, increasing demand for products and services, innovations that improve the standard of living and rising wages relative to the cost of living. From this we can see that driving demand by whatever means has no effect on innovation, it has no direct correlation to wages and only a tangential correlation to demand for labor. Creative destruction correlates well with innovation and tangentially with demand for labor but falls short of the mark when it comes to wages and demand. Say’s law that supply drives demand also falls short. If we combine them however we can get closer to describing conditions required for the emergent phenomenon we are calling a healthy economy.

Justus Moser lamented the fact that the market system invents new products then creates a demand for them. Before there were home computers there was no demand for them, in fact many of the economic brianiacs of the day argued there would never be a need for a home computer, because who needs all that number crunching power? Once the PC came out however, many new uses, from word processing and spreadsheets to computer games followed, giving the home computer uses that exceeded anyone’s initial concept of what a home computer would do. These innovations drove demand for the products they created and for their ancillary products as well. The same holds true for new innovations that have not even been thought of yet.

Aggregate supply aggregate demand, being easy to quantify is therefore scientific appearing, it is an oversimplification however that leads to many negative policies that hinder an economy from being healthy. Moreover it is especially subject to observation bias. This model is easy to understand. The most pernicious effect of this theory is that it’s inherent observation bias gives rise to bad policies. Policies that encourage politicians to deficit spend and redistribute other people’s money. It argues all demand is equal. If that was so then full aggregate demand of anything would give rise to a healthy economy. This is reasoning from the bottom up however. For example, if the only demand in an economy was for cocaine and all the productive resources was put to that end, would that lead to a healthy economy? Of course not, a truly sick economy would arise from such demand, even though aggregate demand exceeds aggregate supply, proving the weakness of the aggregate demand aggregate supply model.

If however, we combine Say’s law with Schumpeter’s creative destruction, reasoning from the top down, we find we have a better description of what is needed to have a healthy economy, ergo… sufficient demand for supply, innovation that betters people’s lives, increasing demand for labor and a rise in real wages driven by the demand for more complex labor. Put simply the theory simply works. Reasoning further down, we can observe the conditions that give rise to creation and the supply produced driving demand. The lower we descend however the more observation bias is likely to come into play. Creation requires as a prerequisite, ease of starting a business, else there can be no creation. This presupposes access to the capital necessary to start a business along with the tax and regulatory environment conducive of it. If these conditions are not met, lacking the supply that creation provides, demand falls short, and an economy fails to meet our definition of healthy. That is why I say, creative destruction must be wedded with Say’s law, to better explain the factors that give rise to the emergent phenomenon of a healthy or sick economy, which then points us to policy directives that will result in a healthy economy.

Sincerely,

John Pepin

Deflation and Deficit Spending

Monday, May 26th, 2014

 

Dear Friends,

 

It seems to me, the real reason economists, politicians and Central Bank Presidents are so terrified about deflation, has nothing to do with any pernicious incentives deflation would introduce into the economy, but actually because it would hamper the ability of governments the world over, to deficit spend. Deficit spending has become so entrenched in our political systems that most people don’t give it a thought, and when they do, they grumble but consider it a necessary evil. The ability to deficit spend gives politicians extraordinary power, over the economy, our lives and political evolution. The political elite exploit their ability to spend huge sums of money, to reward their political cronies aka crony capitalism, they “stimulate” the economy with deficit spending and they get and hold office, by promising this or that constituency a hand out if they get elected. All of which are pernicious and destructive of our economies, our Rights and our personal standard of living.

 

John Maynard Keynes aggregate supply aggregate demand model of economics gives politicians an imperative to deficit spend. In the aggregate demand aggregate supply model, if aggregate demand exceeds aggregate supply the economy grows, but if aggregate demand falls below aggregate supply then the economy shrinks, resulting in recession. Keynes made no distinction between consumer demand, business demand or government demand. In fact, he is famously known for saying, if the government buried money in the bottom of a mine, and let firms use the market system to get it out, that would stimulate the economy. This shows he made no distinction between productive uses of money, and schemes that use money to draw people into non productive actions, actions they otherwise wouldn’t engage in.

 

One of the fundamental reasons the aggregate supply aggregate demand model is deficient, is that it doesn’t make distinctions between productive spending, where productivity is increased by upgrading plant and equipment or where someone’s needs or wants are being met, and schemes where money is wasted to draw in other money, which is then also wasted, to increase aggregate demand. When government spends money to stimulate the economy, it takes money that otherwise would be used for productive purposes, and wastes it.

 

The more money that is wasted the lower real economic output will be. Every government today counts government spending as a part of Gross Domestic Product. Therefore, as they deficit spend to draw in other money to gin up the economy, using aggregate demand aggregate supply, the money that is wasted feeds a system where government must have more deficit spending, to offset the loss of market efficiency that is the inevitable result of government “stimulus.” In other words, government spending is increased, to increase GDP, where the market has been so damaged by deficit spending and stimulus, it cannot increase GDP itself. Where government doesn’t deficit spend sufficiently to raise GDP, outside of actual economic growth, economists call it fiscal headwinds.

 

Crony capitalism around the world is fueled by deficit spending. The political elite use it to reward their half witted brother in laws and political backers. In many countries it is impossible to get a permit to do business unless you have political backing. No one can get licensed in those countries to compete with the political hacks. If the power to deficit spend were limited, that would also limit the ability of the politically favored, to reward their backers and half wit relations, for their own illegitimate purposes.

 

The first goal of any political party is to get and hold power. Deficit spending allows the faction in power at any time to hold that power. Further, it allows that faction that is willing to damage the interests of society as a whole, by deficit spending, to get that power they so covet. This is a pernicious incentive for political factions each trying to out promise the other. The party offering the most rewards to the people will be the one to get and hold office. This has the tendency to ratchet up deficit spending to ever higher extremes while lowering outcomes. Simply because, that party which has the least scruples to protect the public purse is rewarded, while the party that practices the most fiduciary responsibility, is punished.

 

All of these things rely on deficit spending and deficit spending needs inflation. Inflation is a hidden tax on the accounts of savers. As a government’s deficit gets ever larger, if the value of the money that the deficit is counted in gets smaller, that deficit also shrinks. If however, the value of the money a deficit is counted in goes up, savers and consumers are rewarded, but government deficits become more problematical. Therefore, governments, central banks and their dependent economists cannot allow any deflation. Deflation would explode the huge deficits governments have built up over the years… to reward their cronies, buy power and “stimulate” the economy. Deflation would show in stark contrast the fiction that deficit spending can go on indefinitely and the system of political favor would come crashing down. Make no mistake, they couldn’t care less about the good to society, in fact the ability to deficit spend rewards those who care the least for the public good, so next time you see a central banker weep at the possibility of deflation remember, those are crocodile tears.

 

 

Sincerely,

 

John Pepin

 

Bureaucracy vs Complexity

Thursday, June 21st, 2012

Dear Friends,

It seems to me, the main difference between bureaucratic and complex systems, is that bureaucracies are inefficient and primarily benefit those in charge, while complex systems are extremely efficient and the benefits are more widely distributed. This is a well known truth yet is overlooked by most people. This fact can be applied to many areas of life but is most appropriate in the sphere of economics. Overlooking or disregarding this reality leads to all sorts of negative outcomes, like huge trade deficits, lowered economic outcomes, low or even negative GDP growth, and even outright tyranny.

Bureaucracies are hierarchical in structure. This type of system is characterized by a top down decision making structure. The commanders in such a system can be a single person or a group of people. All governmental structures are built this way. The decisions are made at the top, the middle men enforce them and the people dutifully carry them out. Unfortunately, the natural evolution of this type of system, is for those in charge to become more and more selfish. Feeding both their greed and egos until all the efficiency is wrung out of the system and only the people at the top get any benefits.

This is only one avenue of inefficiency in the bureaucratic system. Perhaps the primary source of inefficiency in a bureaucracy, is that so many decisions need to be made every second of every day in a modern economy, it becomes impossible for any group of people, no matter how smart or benevolent, to keep up. The task is simply too herculean. Just think about how many decisions need to be made when you build a house. The floor plan must be thought out, the type of heating system must be determined, the electrical feed must be decided, the exterior siding and trim must be considered, the color of the home is important to it’s blending into its surroundings, the interior color scheme and trim must also be considered, the roof system and treatment must be thought out, the list goes on and on. This doesn’t even take into account the millions of smaller decisions that need to be made, like figuring the rise and run of the cellar stairs, how long to cut each stud, the rafters must be measured and bird’s mouths cut… etc. Now, magnify this a hundred million times, and we have the decisions that are made in a simple economy in a single second.

Command and control economies, like socialist and communist, are forms of bureaucracies. If we look at the historical examples, of governments that have been socialistic or communistic, we see that this paradigm holds true. Those at the top get the goods while the people get the orders.

Complex systems are distributive in their structure. Decisions are made at the lowest level possible by the people who have the most information regarding them. This distributed decision making structure of the complex system, is the fundamental reason complex systems are so much more efficient… than bureaucratic ones. As the decisions themselves, are made by those most able to amass the necessary information to make them, in the most efficient way possible, the benefits are also distributed to the people… not the bureaucrat. Another reason complex systems are more efficient is that they build in competition. Competition forces efficiency, because those that are less efficient, are surpassed by those who are more efficient. This makes the limited money available more wisely spent and thus achieves the most bang for the buck.

Demand side economics is a form of bureaucratic decision making process, while supply side economics is a form of complex system. Demand side, as expressed by John Maynard Keynes, empowers the bureaucrat to take money from the earners and spend it to drive up demand. Supply side encourages those people who earn money to make their own decisions what to do with it. The one presupposes the individual will make the most of their own money while the other presupposes the government will make the most of someone else’s money.

The upshot is that demand side’s inefficiency’s create incentives to corruption, huge government deficits, general poverty and outright oppression, the other, supply side, leads to economic growth, personal freedom and general prosperity. But demand side has one thing going for it, it empowers those in charge, to misspend money earned by others, to massage their egos, enhance economic outcomes for the rulers and create a perpetual ruling class. As Thrasymachus said, most people just want to be left alone but those great men want power…

So I ask, is it more important that “great” men have power, or that there be general prosperity?

Sincerely,

John Pepin