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I recently debated Karl Smith, a
New Keynesian professor at
UNC, on the possible merits of government spending (video here). Smith brought up
what I consider to be the strongest argument against the Austrian position,
namely that during a recession there appear to be "idle resources."
According to the Keynesian view, if government spending could mobilize those
resources (including unemployed workers), then it
carries little opportunity cost from a society-wide perspective.
My answer to Karl (starting at the
44:00 mark) involved the Austrians' sophisticated
view of the economy's capital structure. A cruder Keynesian model, which
involves aggregates such as K and L, can't grasp the Austrian
diagnosis of the typical boom-bust cycle, and consequently yields disastrous
policy advice — such as massive deficit spending to prop up
"aggregate demand."
"Idle"
Resources and the Alleged Output Gap
Today's leading Keynesians tell us
that the US economy is currently sitting on a host of idle resources —
unemployed workers and businesses running at less than full capacity. Relying
on estimates of output from the peak of the boom, they extrapolate forward
and wonder why current output is so depressed. The following diagram (from Menzie Chinn) is typical:
Back in 2010, it was ironically Karl Smith
himself who most succinctly made the (New) Keynesian point about
the tragedy and uselessness of recessions:
We have very low capacity utilization (75%) and very high unemployment
(10%).
That is, we have factories sitting idle for lack of workers — low
capacity utilization. At the same time we have workers sitting idle for lack
of factories — high unemployment.
There are machines waiting to be worked and people waiting to work them
but they are not getting together. The labor market is failing to
clear.…
This is a failure of our basic institutions of production. The job of the market is to bring
together willing buyers with willing sellers in order to produce value. This
is not happening and as a result literally trillions of dollars in value are
not being produced.
Let me say that again because I think it fails to sink in —
literally trillions of dollars in value are not being produced. Not
misallocated. Not spent on programs you don't approve of or distributed in
tax cuts you don't like. Trillions of dollars in value are not produced at
all. Gone from the world entirely. Never to be had, by anyone, anywhere, at
any time. Pure unadulterated loss.
Time and time again I see people speak about recessions as if they are a
bad harvest — an unfortunate event wherein we have to figure out how to
go with less. Some say we should all sacrifice — some say the sacrifice
should be based on X or Y. Some say each family should take their lumps as
they come.
However, they are all getting the basic idea wrong. This is not a bad
harvest. The problem isn't that there is less to go around. The problem is
that we are creating less, building less, making less.
We have people who would be working but are instead watching Judge Judy.
We have machines that could be spinning but are literally rusting for lack of
use. This is a coordination disaster.
The question is how do we end this thing as
quickly as possible. How do we stop wasting our basic resources (men and
machines), day-after-day, month-after-month, year-after-year.
Now to be fair to Karl, he is not
suggesting in the above excerpt that the government go spend billions of
dollars having people dig holes and then fill them up. His chief
recommendation during the recession has been to cut payroll
taxes on both employers and employees, preferably to zero. That's
a proposal any libertarian Austrian would get behind, though perhaps for
different reasons.
Even so, I excerpted Karl's remarks
above because they epitomize what I think is wrong with the aggregative,
Keynesian view of the economy. Working with such a framework, the Austrian
theory of boom and bust is almost impossible to even conceive.
Attack of the Mischievous Gnomes
To illustrate what's wrong with the
typical Keynesian view of the economy, in the debate I told the spectators to
imagine that one night, mischievous gnomes decided to rearrange all of the
capital goods and skilled laborers in the country. The next morning, brain
surgeons who were supposed to report to a hospital in Albuquerque would wake
up in Miami. Factory owners in Trenton would open their doors and see that
their assembly lines were gone, replaced by defecating cows. Farmers in Iowa,
for their part, would be baffled to see drill presses and computer servers
sitting in their empty fields.
Suppose the Keynesian statisticians
in this absurd thought experiment could make perfectly accurate measurements
of their standard variables. What would they say? In the first place, they
would be horrified to report that "real GDP" — the flow of
newly created goods and services — suffered the worst collapse in world
history. The annualized rate of real output in one day would have fallen
perhaps 99 percent. Factories would be idle, and workers would be wandering
the streets in a daze. Official unemployment statistics would be 90 percent
or higher in the days immediately following the gnomes' evil prank.
The government and the public would
demand that the elite economists explain this calamity. The Keynesians would
check the various aggregates and consult their models. Was it a
"supply-side" disturbance? It wouldn't appear to be so: the total
stock of capital goods was the same as it had been the week before, and the
same would be true of the supplies of various types of labor. It wasn't as if
the economy had been struck by an earthquake or a plague; the same
"productive capacity" was still there. Furthermore, there wasn't
any negative "technology shock," as far as the Keynesians could
ascertain. The recipes for turning inputs into outputs would all still work, just
as they did the week before.[1]
Depending on the specifics, the
Keynesians might conclude that the tremendous fall in output was the result of
flight to safety combined with "sticky prices" and nominal debt
contracts. After all, when people awoke to find themselves plunged into near
autarky overnight, they panicked and began to hoard their cash balances. Even
though the output of goods and services plunged, it's conceivable that their
unit prices quoted in dollars would fall too.
All in all, it would not be
surprising in this fanciful thought experiment if most of the Keynesian
economists concluded that the problem originated on the demand side. There
was no physical reason for a bottleneck in production. For some inexplicable
reason, workers and capital goods weren't getting together to crank out
consumer goods and services desired by the public. This was clearly a
gigantic market failure, demanding a massive burst of monetary inflation and
large deficit spending to rescue the economy.
Unemployed Workers Not Necessarily
"Idle"
Of course, the real problem
in my thought experiment is that the production structure is a complex,
interlocking collection of heterogeneous capital goods. It's not enough to
say that the economy has the same number of workers and machines now as it
did in 2007. That alone doesn't prove that the measured "real GDP"
of 2007 was sustainable. (For those who prefer an illustration of this point
with actual numbers, try my "sushi
article.")
Steven Horwitz
recently
emphasized the centrality of capital theory to the Austrian
paradigm:
Normally Austrians talk about the
two big debates of the interwar period — the socialist calculation
debate and the Hayek-Keynes debate. And those were big, particularly if
"big" here means something like "had major, direct
consequences on policy." It's a fun conversation to try to argue which
one was more important.
But the more I think about it, and
the more that the reaction to the events of the last few years plays out,
especially the revival of Keynesian-style thinking, the more I think they
come in second and third place.
The most important economics debate
of the interwar period was the Hayek-Knight debate over capital
theory.… [I]t is disagreements over the nature of capital and how
decisions about its allocation are made that are at the root of the other two
debates!
[L]ook at
the debate we've been having here this week, as well as a bunch of earlier
posts on the stimulus and Keynes. The centrality of capital to the
calculation debate should be equally clear (after all, Ol'
Karl knew what was at the center of matters when he titled his magnum opus).
Austrians have often treated
capital theory as being an "advanced" topic that's "so
hard," and one that we steer graduate students away from. I think that's
been a mistake. I think it needs to be front and center in our vision of how
social coordination and cooperation takes place, and it should be one of the
first things, and not one of the last, we teach in Austrian courses.
The vision of a capital-using
economy that starts with Menger and goes through Mises, Hayek, and Lachmann, and
now our good friend Peter Lewin, is what marks the
distinctiveness of the Austrian approach.
Once we understand the Austrian
diagnosis of the cause of a recession — namely, that the
preceding boom period allowed the economy to reach an unsustainable
configuration — then we can also understand the "function" of
so-called idle resources.
After the collapse of a boom, it
takes time and
genuine search for displaced workers and owners of capital goods to
discover their best niches in light of the new information. In an unhampered
market, the bulk of this readjustment would probably be over within six
months. But with the government and central bank doing everything in their
power to prevent this dreaded "liquidation" process, the
alleged recovery churns along at an agonizing pace.
Go back to the silly gnome story
for a moment. If the government and Fed sat back and let nature take its
course, what would happen? It's true, the poor people
in our story would suffer a dramatic collapse in their standard of living.
Entrepreneurs would rush into the chaos, and try to salvage the situation by
finding suitable matches between idle capital goods and unemployed workers.
The reader might at first think
that it would simply take a month or so for all of the workers and capital
goods to undo the damage of the gnomes, by moving back to their starting
points. Yet this isn't correct. Remember that some very heavy pieces of
equipment would have been moved thousands of miles; it might not make sense
to ship everything back to where it started.
What's more, the transportation
system itself would be paralyzed because of the gnomes' prank. Even if all
the workers tried to make their way back home, for some of them it might take
as much as half a year. After all, the airports, buses, and trains would all
be inoperable at first, because the required spare parts, gasoline supplies,
and trained personnel would have been dispersed across the country as well.
As Mises
pointed out, the existence of malinvestments
requires the entrepreneurs to do their best, letting bygones be bygones. In
our hypothetical gnome scenario, it would be tragically incorrect for people
to try to resume the pattern of production reigning on the eve of the
collapse. If they did so, most people would starve to death before food
output could be restored.
Instead, people would need to
improvise. Brain surgeons might temporarily become manual laborers,
and backhoes originally from Houston might be used to plow snow in Detroit.
The crucial point is that even the
owners of "idle" capital goods and "unemployed" workers
would be actively seeking out their new roles
in the horrible adjustment period. Any attempt to short-circuit this process
with a wave of fiat inflation or deficit spending would simply screw up price
signals and make the adjustment process that much longer.
Conclusion
The Keynesian focus on aggregates
such as the "stock" of capital and "supply of labor"
leads to faulty policy recommendations. The Austrian School has always had a
rich conception of the structure of production. Of the major schools of
thought, only the Austrians can appreciate what happens to the economy in the
wake of a gnome attack — or the collapse of an unsustainable
inflationary boom.
Robert P. Murphy
Article originally published on
Mises.org here
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