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Thoughts from the Frontline

Time to Put a New Economic Tool in the Box

July 26, 2014

[E]conomists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the “scientistic” attitude – an attitude which, as I defined it some thirty years ago, “is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.

– Friedrich Hayek, from the introduction to his Nobel Prize acceptance speech in 1974

Last week we took a deep dive into how the concept of GDP (gross domestic product) came about. We looked at some of the controversies surrounding GDP statistics that we use to measure the growth of the economy, and we noted that the GDP tool seems designed to reflect and serve an economic theory (Keynesianism) that prefers to focus on the demand side of economic activity. If your measurement of the growth of…

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Yesterday, 1:12 p.m.

Although useful for analysis of economy internals the aggregate C + I + G in GDP already subsumed what is called intermediary investments (II) in Gross Output (GO). As Mauldlin correctly observed there’s double count, thus the qualification “Gross”, there’s no netting here, no elimination of what was already counted and accounted for.

It must be noted (in the Steve Hanke’s text, linked, quoted and sanctioned by Maudlin) nonetheless the fallacious nature of contrasting the result of division from different bases (fallacy of division) and the comparison of properties of things supposed to represent the same reality but that are of fundamental different nature (fallacy of equivocation if I remember well).

Fallacies expressed boldly in paragraphs like this:

“Contrary to what the standard textbooks have taught us and what the pundits repeat ad nauseam, consumption is not the big elephant in the room.The elephant is business expenditures.”

To be clear, to say that, measured by Gross Product, now consumption it’s only about half the of economy as measured by GDP, and presumedly that gives a new knowledge of relative importance of consumption, is the same thing as to compare C/(Y + 1.4x) and C/Y saying that since C/(Y + 1.4x) is less than C/Y, an obvious fact, it gives you a new insight of the real participation of C in the Economy.

No, it doesn’t. With GDP as base you are comparing consumption with total production, with GO as base you are comparing consumption with a measure of total transaction that recursively includes a multiple of what is included in consumption. There’s for sure new insights to be gained in GO measure in many details of economy internals and in many useful facts for description, but no new insights in the role of C. The magnitude of C as a drive of the Economy is not altered whatsoever and so the assessment of the importance of C (and G and I) to guide economy policy is not bettered in any way.

Ironically the advocacy of a new measure of economy as something that will better the policy (“Time to Put a New Economic Tool in the Box”) is antithetical with everything that Hayek defended all his life. Just imagine what new distortion in the complex economy structure that a fundamentally flawed reason of uncritically transfer the procedures of the nature sciences to social sciences, that Hayek regarded sarcastically as “scientistic”, with yet new measures, and so illusions of new controls and dials,  will entice by intervention of fiscal and monetary authorities. Just Imagine! New Taxes, new suppression of market signals, new macro prudence policies, etc ad nauseam. Beware the dials!

One cannot fight the marxist inspired left embedding in one’s own thinkings and frame one’s own reasons, like it was an imperative
categorical, the very methods,terms and frames they use. If you do that you already concede the most and you only dispute the least.
A conservative policy have to be assertive in his own terms. 

So is appropriate to close with a yet another quote from the classic F. A. Hayek “Pretence of Knowledge” Nobel address.

“The conflict between what in its present mood the public expects science to achieve in satisfaction of popular hopes and what is really in its power is a serious matter because, even if the true scientists should all recognize the limitations of what they can do in the field of human affairs, so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power. It is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science…

If we are to safeguard the reputation of science, and to prevent the arrogation of knowledge based on a superficial similarity of procedure with that of the physical sciences, much effort will have to be directed toward debunking such arrogations, some of which have by now become the vested interests of established university departments. “

Randall Zindler

Yesterday, 5:30 a.m.

I believe it was 2001 when the province of British Columbia cut taxes and mandated a 1/3 cut in all government regulations over the following few years. Don’t know if there has been a study on the effects, but given Mauldin’s comments on regulations it could be interesting.

July 27, 11:19 p.m.

The unemployment “tool” needs sharpening.  The reason unemployment is down is because so many have given up trying to find a decent paying job.  The American middle class trajectory is down.  I’ve moved from engineering to tutoring math at a local university.  I now make 1/8 of what I used to.  I train young people and middle-aged unemployed to be productive in fields for which there is declining demand.  My 66 years on the planet have taught me that production increase isn’t worth much if no one’s buying.  I’d drown my sorrows, but I can’t afford to drink. 
The effect of business regulations is radically less than the effect of Chinese labor cost being about 1/5 of American labor cost. 
The GOOD NEWS is that the county property assessor’s office downgraded the value of my house from $181,414 to $135,205.  This should reduce my property tax by about $570 per year. 
In addition to calculus I also tutor business math and economics.  One of my economics students had his mom move in with him because she lost her job.  His daughter never did leave home, because she can’t get a job.  He is unemployed and living off student loans. 
Stop in on your way to the unemployment student aid office, I can help you compute the slope of the American Middle Class GDP curve.  Do you know what the sign is for this slope?  Very good!  Now if we take the second derivative of that curve it will give us the rate of change of the slope?  Can you tell me what sign it is?  Excellent!  That’s enough math for now, let us move to economics and learn various theories for why that “light of the end of the tunnel” may actually be a freight train headed straight at you.

Tom Brennan

July 27, 4:39 p.m.

If your business was inefficient, wouldn’t that increase II and thus GO?
Is it sufficient to assume that market forces _must_ drive out inefficiencies?

Dallas Kennedy

July 27, 4:09 p.m.

This is a terrific article, and everyone who’s read it should go on to read Diane Coyle’s new book on GDP. As John wrote in another piece, her book provides the deeper background to where GO came from.

An aggregate can measure any number of things, including total final demand, total output, or total expenditure. And none of these aggregates are direct measures of individual welfare or productivity.

Contrary to a common misconception, the choice of GDP doesn’t lead anyone to being a Keynesian. The GDP is simply a *definition*. What Keynes postulated was more, a *theory*, that there were stable and simple relationships among various macroeconomic aggregates. By the 1970s and 80s, it was clear that there was something fatally wrong with this theory. The *definition* remains.

Similarly, the money equation (MV = PT) is simply a *definition* of money velocity (V). The simplest version of monetarism is a *theory* about V, namely, that it’s constant. It isn’t. The simplest version of monetarism is wrong. The definition stands.

Perhaps people can postulate and prove or disprove some simple and stable macroeconomic relationships with such alternative aggregates other than GDP.

Craig Cheatum

July 27, 1:21 p.m.

It seems like there are two other tools needed to understand how we compare with other countries.  First is Net Domestic Product (GDP minus New Debt), since all the primary factors can be misleading otherwise.  Second is the Current Account (Exports minus Imports), which is the only way to measure the quality of economic activity on the world stage.

Craig Cheatum

July 27, 11:28 a.m.

Just a few reasons why Keynes “won” vs the supply siders in the 20th and 21st century.

Customer demand generates sales.

When sales decrease or remain flat and productivity can’t make up the difference gross margins, operating income and net income correspondingly decrease or remain flat.

To make up the difference employers cut back on nonessentials, may invest less, purchase less inventory and at minimum postpone hiring or begin laying off.

If conditions persist, employers layoff personnel.

Conclusion: Demand either capital investment, exports, or consumer spending is king. Supply reacts to increases in demand.

If you disagree with this syllogism and narrative, then why does China have more auto plants than the the US.

I will accept the argument that innovations and mutation of the innovations will create its own demand if successfully implemented, e.g., cotton gin, railroad, telephone, automobile, airplane, radio, TV, internet, iPhone, etc. These however, are rare game changers.

Kenneth Harlan

July 27, 9:59 a.m.

Official Gross Output data as an additional or alternative optic for viewing economic activity could not have come at a better time as the weaknesses in Keynesian Economics (or more correctly, neo-Keynesian economics) become more apparent.  The mere argument that consumption leads and production follows has always baffled me as a serious economic argument stretching beyond the theoretical discussion.  Now, however, it is so commonly accepted as fact that it presented daily by journalist, commentators and politicians to support their urgent case for new/larger/additional Keynesian measures.  This week I even heard debate where it was being argued that this country only exists because the government was formed first which then allowed businesses to form and begin production.  For me, more evidence to support my personal belief that the relatively rapid adoption of Keynesianism was in a large part due to the fact that it supported the rising political narrative of the period that was based on government centric philosophy.
It seems obvious (at least to me) that production always leads consumption.  Individually we are each a micro-production mechanism which must first produce in order to consume.  That consumption is in the long-run limited to what we can produce.  Through borrowing we can bring forward production (much like the period from birth to productive individual in most species) at the expense of future production, but as individuals not exceed that production on a sustainable basis.  Only government is exempt from this constraint for a longer but still finite period, because a government is a multi-generational collection of individual producers and can borrow future production from all individuals over several to many generations.  History clearly illustrates, however, that this to has absolute limits.  Whether those limits are reached in a host of subject countries before the pendulum reverses swing in the prevailing government centric a philosophy is a most fascinating study.  It also keeps me looking forward to the work fine thinkers and writers like John.

July 27, 8:10 a.m.

I don’t always don’t have the time to read all of Mauldin’s letters but this one touched a nerve by only going halfway to what I view as the meat of the issue - capital creation.

He and Skousen are not wrong.  Both of them are correct, Gross Output (GO) is better than GNP at giving us in the very short term a clearer picture of how fast the economy is moving, but it falls very short is telling us where it’s going.

“[Skousen] believes that the GDP should not be used as the sole measure of economic activity,” but his vision only goes so far.  He goes on to say that that while “...GNP is a useful measure of .. standard of living…” and that “... it has led to the misguided Keynesian notion that consumer and government spending drive the economy rather than saving, business investment, technology and entrepreneurship.”

Mauldin takes up this ‘savings vs consumption’ theme as a driver of “private production and business spending” the “real driver of the economy”.

Both he and Skousen touch on the idea of ‘wealth creation’ but skirt around the issue of the macro capital base as wealth, without dealing with it directly.  They both fail to make the point that consumption is the diametric opposite of wealth and therefore capital accumulation.  I like to use the example of ‘the fork’, the most simple piece of capital yet an amazing and useful tool, and in my economic lexicon a iconic example of capital.

Once a fork is manufactured, it can be used virtually an unlimited number of times by an unlimited number of people, enriching the lives of all who use it, (a well as those around them not having to watch them use their hands to eat their meat balls and spaghetti like a monkey, or lap up oatmeal like a dog.)  The quantity of knives, printing presses, and aircraft carriers in existence have similar lasting civilizing effects which neither GNP or GO measure.

Of course GO is a better example of wealth creation than GNP, but it only tells us how many forks were sold.  What is ultimately more important is not how many were sold but how many knives, forks, spoons, printing presses, drop forges and nuclear aircraft carriers exist.  Capital is the real driver of the economy.  Savings are important not because they drive investment and thus GO, but because and to the extent that they add to the capital base of society and thus the growing wealth of humanity.

Only a fraction of investment creates capital - ask any angel or VC investor - a lot of it ends up as consumption, spent for labor and resources.  The ‘real’ standard of living measured by the choices of consumers is determined by the amount of capital available to create consumables, freeing up their time for increasingly productive or leisure activities.

The use of GNP is pernicious as a misleading measure of the economic health of the nation not only because it doesn’t accurately measure output let alone the ‘wealth’ of the nation, but because consumption beyond savings erodes the capital base, depleting productivity, making innovation more difficult, and so impoverishing society as a whole.

Skousen should be commended for trying to change the debate.  Both he and Mauldin are bring to our attention the newly issued GO index but the real debate needs to be taken to the enemy at every opportunity.  The Marxist Left continue to use Keynes to controlled the economy by controlling semantics and statistics, a la 1984, bowdlerizing the story of the economy.  Capitalism has been made a dirty word and even its strongest proponents, like Mauldin and Skousen, dance around the the idea of ‘capital accumulation’ by tangentially referring to it as ‘standard of living’ or ‘wealth’.


Alan Shaver

July 27, 7:31 a.m.

If a White House staffer reads this we will start hearing again about the need for a value-added tax in the US.  Imagine how much more economic activity there is to tax!

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