Gerard
Jackson
Some
readers, still swayed by the current orthodoxy, are a little puzzled by the
argument that government policies that bring about increased consumption come
at the expense of economic growth (capital accumulation). The classical
economists fully understood that economic growth was forgone consumption,
meaning that investment, spending on capital goods, can only take place by
directing resources away from consumption. It follows that the reverse must
be true. Promoting consumption at the expense of savings results in resources
being redirected from investment.
Unfortunately,
policy-makers, not to mention a huge number of economists, genuinely believe
that increasing the demand for consumer goods, by whatever means, will raise
profits and thereby raise the demand for more capital goods which in turn
would lead to an increased demand for labour. This Alice-in-Wonderland
thinking (meaning the Keynesian multiplier) leads to the absurd conclusion
that massively raising the spending power of the unemployed would generate
enormous growth.
Moody’s
Mark Zandi actually argued this when he stated that “the bang for the buck is
very high” from extended jobless benefits and would yield $1.64 of GDP. It
didn’t take long for fellow Democrats to jump on his magic wagon, with Pelosi
claiming that $1 spent on food stamps yielded $1.79 of GDP. But this is not
how derived demand works, as any Austrian economist would immediately point
out. The problem here is a complete failure to grasp the real nature of
demand, including derived demand. Like the classical economists the Austrians
argue that demand springs from production: that production, meaning supplies,
is what really constitutes demand.
This
brings us back to investment. The Austrian school of economics stresses that
increased investment lengthens1 the capital structure which
increases the future flow of goods hence raising real wages and consumption.
Within this insight lies the concept of the balance between savings
(investment) and consumption. This concept should never be lost sight of. So
long as the real savings-consumption ratio is maintained living standards
will continue to rise.
I think
that any discussion of the savings-consumption ratio must be accompanied by
an explanation, no matter how brief, of the Austrian theory of the trade
cycle. After all, it was the experience of the Great Depression that led to
the present economic orthodoxy. The Austrians argue that credit expansion
disturbs the balance and generates the business cycle2. The
problem starts when monetary policy throws the savings-consumption ratio out
of kilter by generating a boom. If the boom is allowed to continue
consumption eventually begins to rise relative to investment spending. The
effect will be to create a profits squeeze in the higher stages of production
causing manufacturing to contract. As Hayek put it, the higher stages become
unprofitable
not
because the demand for consumption goods is too small, but on the contrary
because it is too large and too urgent to render the execution of lengthy roundabout
processes profitable3.
In
fact, even if savings were increased their beneficial effects could be more
than cancelled out by an increased demand for consumer goods [ibid, pp.
228-33]. Raising the demand for consumption goods relative to producer goods
causes non-specific factors to shift to the lower stages of production, those
close to the consumption stage. Now these factors, like all factors, are
complementary, meaning that they have to be used in cooperation with other
factors. Shifting non-specific factors from one line of production to another
therefore sees the abandonment of specific factors, factors that only have
one function.
This
causes excess capacity to emerge as the shift towards consumption increases.
Even though employment would fall in manufacturing the employment level could
still be kept comparatively steady by the increased demand for labour in the
lower stages of production. As this process gets underway labour costs in the
economy rise even as manufacturing employment falls. This is the final stage
of the boom. Now the final stage was so well documented in the nineteenth
century that Marx was able to attack Rodbertus’s underconsumption theory of
the trade cycle by stressing that
crises
are precisely always preceded by a period in which wages-rise generally and
the working class actually get a larger share of the annual product intended
for consumption4.
Unfortunately
economic thinking has now deteriorated to the point that one of the major
economic fallacies the classical economists refuted is now presented on a
daily basis in universities, colleges and the media as an irrefutable fact.
The result is that governments the world over are implementing policies that
direct economic activity to increased consumption at the expense of gross
investment. As the Austrians are forever pointing out, it is gross
investment, expenditure on all future-goods factors, that maintain the
capital structure: not net investment or consumer spending
We are
thus left with the conclusion that fighting a recession by encouraging
consumption will prolong and perhaps even deepen it5. One thing is
certain from an Austrian perspective: if the critical point is reached where
increased consumption spending continues to drive down gross investment then
real wages must eventually fall if the phenomenon of permanent widespread
unemployment is to be avoided.
1When
Austrians speak of lengthening the capital structure they are not suggesting
that stages of production will be continuously added to the structure ad
infinitum, as some critics seem to think. The lengthening of investment
periods does not always require more stages of production. In some cases a
lengthening simply involves the replacement of existing stages with more advanced
but more time consuming stages. I stressed the addition of more stages to
emphasise the importance of the stages of production analysis. Failure to
grasp this importance and the vital role of Austrian capital theory is why R.
G. Hawtrey and Keynes were completely surprised by the arrival of the Great
Depression.
2If
the savings-consumption ratio is driven out of balance then what the
classical economists called disproportionalities will be created. The
classical economists linked the emergence of disproportionalities directly to
the idea of circulating capital being converted into fixed capital. James
Wilson, founder of the Economist,
discussed this issue in his magazine. The article in question was later
published in his book Capital, Currency
and Banking as Article XI, The
Crisis, The Money Market. Wilson’s opinion that “railway
mania” caused excess investment by converting circulating capital into fixed
capital was supported by John Stuart Mill (Principles
of Political Economy, Vol. II, University of Toronto Press,
Routledge & Kegan Paul, 1965, p. 543.) Colonel Torrens was also in full
agreement, stating that “[t]he railways were rapidly absorbing the
circulating capital of the country, and outbidding commerce in the discount
market”. (The Principles and Practical
Operation of Peel’s Act of 1844 Explained and Defended,
London: Longman, Brown, Green, Longmans, and Roberts, 1857, p. 74.) The
stress on real factors means that these discussions came tantalisingly close
to anticipating the Austrian theory of the trade cycle.
3Friedrich
von Hayek, Profits, Interest and
Investment, Augustus M. Kelley Publishers, 1975, pp.
255-263).
4Karl
Marx, Capital: A Critique of Political
Economy, London: Swan Sonnenchein & Co., 1910, p. 476
5I
have had numerous exchanges with Keynesians over the years on this particular
point. They argued that post-WWII recoveries from recessions refuted the
Austrians. This only proves that Keynesians have never read the Austrians
because what they cite as evidence against the Austrian view actually
supports it. The Austrians stand with the classical economists when they say
that driving down the rate of interest encourages business spending. This is
exactly what Keynesians argue, except they refuse to recognise that the
policy ends badly. That there are circumstances where lower rates do not
trigger business spending is a fact that Austrians are also aware of. The
point remains that this criticism of the Austrians does not even dent their
trade cycle theory.
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