Monday, May 16, 2011

Democracy in America - Alexis de Tocqueville

This post will contain all of the posts PJ and I put up in our discussion of Alexis de Tocqueville's Democracy in America.

Introductory Chapter
Democratic Social Condition of the Anglo-Americans
Unlimited Power of the Majority in the United States, and Its Consequences (Part I)
Unlimited Power of the Majority in the United States, and Its Consequences (Part II)

Tocqueville - Democracy in America - Author's Introduction

As part of our ongoing series of discussions, PJ and I will be covering selections from Alexis de Tocqueville's Democracy in America. The first of these comes courtesy of Princeton Readings in Political Thought. We hope to add further selections from the text at a later date.

Tocqueville was a French aristocrat, who journeyed to the United States to study its penal system. Enthralled with the young nation, he jettisoned his topic to pen his masterwork.

In his introduction, Tocqueville describes this enchantment: "Among the novel objects that attracted my attention during my stay in the United States, nothing struck me more forcibly than the general equality of condition among the people." No doubt this would have been surprising to someone from a country such as France, where, while the people were becoming daily more democratic, the political institutions lagged behind.

This equality was the key to understanding the American people: "The more I advanced in the study of American society, the more I perceived that this equality of condition is the fundamental fact from which all others seem to be derived and the central point at which all my observations constantly terminated."

That America would be an interesting topic for a book seems obvious, yet it was far from evident that this country, so very new to the old lands of Europe, could have much, if anything, to teach France. Tocqueville argues that "a great democratic revolution is going on among us"; later he will add that, whether it is desirable or not, it is "irresistible." The virtue of studying the American republic and her people is that it demonstrates "the most peaceful and the most complete" democratic development. France can thus be instructed, not only in ways in which such a transformation can be affected, but also in the advantages and disadvantages of such a transformation.

To this end, Tocqueville sketches a brief history of the decay of aristocracy. The essential points being that, first, it is upon us, whether we like it or not: "The noble has gone down the social ladder, and the commoner has gone up; the one descends as the other rises. Every half-century brings them nearer to each other, and they will soon meet." Even those who resist democracy's march ensure its success.

Second, the rise of democracy brings with it some tradeoffs as against aristocracy: "If there were less splendor than in an aristocracy, misery would also be less prevalent; the pleasures of enjoyment might be less excessive, but those of comfort would be more general; the sciences might be less perfectly cultivated, but ignorance would be less common; the ardor of the feelings would be constrained, and the habits of the nation softened; there would be more vices and fewer crimes."

This last point is important. Our country is still very fond of democracy, but we often mean by it, not the cultural forms which Tocqueville discusses, but the singular American system of government--or something akin to it. Yet Tocqueville teaches us that democracy, too, has its drawbacks. So we see that while most Americans can watch football on HDTV's, our culture is incapable of producing Molière.

It is important to realize that there are advantages and disadvantages to democracy, but not necessarily because we can seek to change our culture. Whereas Burke, gazing upon the demise of an English aristocracy, lamenting that which he is powerless to stop, Tocqueville frankly examines what he knows is upon him. As a fellow champion of seemingly lost causes, I have considerable sympathy with Burke; but one can admire Tocqueville's realism, which, for what it's worth, seems to possess more by way of practical value.

Keynes - The General Theory - Chapter XXI

Section I: Keynes proposes to give us his theory of prices. He points out the problem with economists who divorce their theory of money from the rest of their teachings, noting, quite correctly, that a theory must be able to make sense of money, an integral aspect of the modern economy. For "as soon as we pass to the problem of what determines output and employment as a whole, we require the complete theory of a Monetary Economy."

Moreover, this problem cannot be avoided: "We cannot get rid of money even by abolishing gold and silver and legal tender instruments. So long as there exists any durable asset, it is capable of possessing monetary attributes and, therefore, of giving rise to the characteristic problems of a monetary economy." This is well said.

In this section, he also notes, and in italics: "For the importance of money essentially flows from its being a link between the present and the future." Actually, the essential importance of money is that it serves as a medium of exchange. True, people expect money to be valued in the future, but this is true of a variety of other things, whereas non-monetary goods are seldom used as a medium of exchange.

Section II: This is comprised of a single paragraph, with little value.

Sections III-IV: Keynes wishes us to grant him two assumptions for him to illustrate what will happen to employment if the money supply is increased. To wit: "(1) that all unemployed resources are homogeneous and interchangeable in their efficiency to produce what is wanted, and (2) that the factors of production entering into marginal cost are content with the same money-wage so long as there is a surplus of them unemployed."

The first assumption is preposterous. Workers cannot be treated homogeneously so long as they differ drastically--in training, ability, physical or metal prowess, etc. As written, the second is tautological, though if what he means is that workers do not demand raises while others are unemployed, he is making an erroneous assumption.

Nevertheless: "So long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money." (Italics his.)

At the moment, the first half of this supposition is faring rather badly. Inflation, even according to the deliberately under-stated government criteria, is far outpacing employment, which is stagnant. The second half of his statement is not correct, either, though it is less obviously flawed. As we have discusses previously, inflated money does not enter the economy all at once, but through those who have access to the money first. So when Bernanke gives money to his pals at Goldman-Sachs, they can spend that money on fine cigars; the cigar store owner and the manufacturer of the cigar then spend this money, which is in turn spent, and so on. Overall, prices do increase, but they increase more for some goods than for others.

Keynes then mentions five possible complications. He enumerates them here, and then offers a defense of his earlier supposition in the following section of this chapter. I shall list each reason, followed by brief commentary.

(1) Effective demand will not change in exact proportion to the quantity of money.

We have discussed this above. Inflation redistributes wealth, taking from the poor and giving to richer, more well-connected people. But also, and more fundamentally, it distorts the price structure.

(2) Since resources are not homogeneous, there will be diminishing, and not constant, returns as employment gradually increases.

An excellent point. Actually, entrepreneurs are well aware of this fact. The unemployed are those who cannot be expected to produce enough to make hiring them worthwhile; they can only be hired at a lower rate Of course, judgments of entrepreneurs are not infallible; nonetheless, this holds for every good in the economy.

(3) Since resources are not interchangeable, some commodities will reach a condition of inelastic supply whilst there are still unemployed resources available for the production of other commodities.

Again, well said Keynes. During a bust, employment decreases, but it does so unevenly. Realtors are probably still hurting, but other professions are doing comparatively better. Similarly, just because housing prices in Miami, FL continue to fall, does not mean International Falls, MN experienced much of a housing bubble.

(4) The wage-unit will tend to rise, before full employment has been reached.

This strikes me as plausible. When unemployment begins to fall--and I mean substantially, more so than the insignificant changes we've experienced during the last few years--people who were happy enough to be employed, may start to look for better jobs elsewhere. Employers are not required to hire only those who are unemployed; just because a person changes jobs does not mean that an unemployed person will necessarily be able to fill the vacated position.

(5) The remunerations of the factors entering into marginal cost will not all change in the same proportion.

This is true, and I have said as much above.

Keynes also introduces the term "cost-unit," which he calls "the essential standard of value." I am not terribly sure what he means by this.

Section V: With all the increases in the supply of money, we come to inflation: "When a further increase in the quantity of effective demand produces no further increase in output and entirely spends itself on an increase in the cost-unit fully proportionate to the increase in effective demand, we have reached a condition which might be appropriately designated as one of true inflation."

This is a curious way of putting it. Keynes speaks as if the money which is used to increase employment is somehow exhausted. Yet the whole point of printing money was to increase employment, thereby increasing the propensity to consume, which would redound to the benefit of everyone in the economy.

Inflation is a monetary phenomenon. When the supply of money is increased, more dollars--or whatever the unit of currency may be--are available to compete with the same supply of goods. The effect of this is to drive up prices. Generally rising prices, then, are an effect of inflation; but prices may rise for other reasons--an increase in demand or a decrease in the supply of a particular good. The effects of inflation may be obscured by improvements in the productive process; so while computers are still falling in price, they are falling less than they would be if helicopter Ben had kept his fingers off the printing press.

Sensible thinking about inflation would have led Keynes to be more cautious about the supposedly salutary connection between an increase in the money supply and unemployment.

Section VI: Again, we have some more algebra which does not merit our time. Lest the reader think I glance over a subject which I do not possess the training to understand, I merely note that, as an engineer, and one who took courses in mathematics as electives, I am sufficiently qualified to simplify equations.

Section VII: Our economist notes that in "the very long-run course of prices has almost always been upward. For when money is relatively abundant, the wage-unit rises; and when money is relatively scarce, some means is found to increase the effective quantity of money."

Yet this is only true because the authorities are so often trying to debase the currency. Absent that, prices tend to fall, as we see, not only in certain sectors, such as the aforementioned computer industry, but more ubiquitously in those infrequent periods of history in which the money supply was kept stable, such as after the American Civil War. Keynes would have been better served trying to determine why governments are so intent on impoverishing the citizenry through debasement of the currency rather than rationalizing that such theft is actually good for those being robbed.

Despite his assurance that his theory is a general one, Keynes finds himself commenting on particular problems that plagued those of his time: "The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money."

Hence the authorities will have to step in and massage the rate of interest. Yet the rate of interest, like everything else, is determined by market forces; it is coordinated between borrowers and lenders. I can see no reason to offer judgment as to whatever agreements are reached between said groups.

Keynes - The General Theory - Chapter XX

Note: Chapter XIX includes an Appendix, which concerns Professor Pigou’s "Theory of Unemployment." Since I'm unfamiliar with Pigou's work, and since the material adds little to what Keynes has stated in the chapter, we shall avoid discussing it.

Section I: Keynes seeks to define an employment function. This chapter, and this section in particular, thus becomes a confused collection of variables and algebraic simplifications. Keynes tells us that: "Those who (rightly) dislike algebra will lose little by omitting the first section of this chapter."

Although we would do well to take him at his word, at least in this instance, there is one point I wish to make regarding his "function." The term has a precise definition: "an ordered triple of sets, which may be written as (X, Y, F). X is the domain of the function, Y is the codomain, and F is a set of ordered pairs. In each of these ordered pairs (a, b), the first element a is from the domain, the second element b is from the codomain, and every element in the domain is the first element in exactly one ordered pair."

Thus, for the employment function, the domain would be wage-units, or whatever other variable Keynes believes he can track to give us: employment, the codomain, measured in men--or man hours, perhaps. If the employment function exists, a change in wage-units would necessitate a change in employment; moreover, we could determine beforehand what this change will be. That this is plainly not so should be obvious; no matter how sophisticated the functional models of the econometricians, they come no nearer to being able to predict the future. Empirical reality diverges wildly from what their algebra would suggest.

Now, this is not to say that there is no relationship between, say, wage rates and employment. It is only to say that the relationship is not a precise mathematical one. By using mathematical terminology, Keynes leads us to believe that a relationship possesses a precision which it can not have. I believe I have made this point earlier, but it bears repeating as the pseudo-precision is hitting us rather hard at this point in the book.

The remaining sections held little that caught my eye, so I'll pass them over to summarize the next chapter.

Monday, May 09, 2011

Reflections on Osama

In and of itself, the announcement of the death of Osama is far less interesting than the media's reaction to it. The conspiracy set is convinced, not unreasonably, that the terrorist leader has probably been dead for years. It is likelier that the Obama administration, not exactly renowned for its competence, blithely assumed that everyone would be so jubilant over the demise of the figurehead that no one would be concerned about the missing body or the lack of photos.

One problem with constantly lying to the citizenry--say, over the spurious reasons for invading countries or the insistence that the economy is recovering--is that the citizenry begins to doubt every pronouncement of the government. This is a sound impulse, even when it is ultimately incorrect.

Returning to the matter of spin, this afternoon I listened to Hannity on my way home from work. Today, he was interviewing Peter King, a Republican Congressman from New York. King was explaining the importance of torturing terrorists, though he used the Orwellian term "enhanced interrogation techniques" in alluding to water-boarding. For, you see, we are being told that torture was used to extract the information which was then utilized to hunt down Bin Laden.

Now, no one denies that torture can be propitious. The problem--from a practical point of view, and setting aside the moral trepidation we should feel toward the procedure--is that there is no way to distinguish between good and bad information when it is extracted via torture. Certainly, we can attempt to verify the information, but we are told that water-boarding might be necessary for a "ticking time bomb" scenario, in which we will not have time to validate the truth contained in a confession. The choice is not between letting innocent people be blown to smithereens by a terrorist and extracting information via torture. If torture is used, the government may very well give the order to kill a group of innocents. This rather dims the supposed stark contrast between good guy Americans and the evil terrorists. But as blowing up civilians is routine for our military, the line is rather blurred already.

Had we not lapsed into using torture, it is true that Osama may never have been caught. Yet, being mortal, he would have died; his Maker would have judged him. In the almost ten years since Osama bin Laden wandered into the American consciousness, we have poured trillions of dollars into two losing, and, evidently unending, wars; we have seen thousands of our own soldiers return in coffins--though this pales in comparison to the larger number of dead they have left scattered behind them. We have not taken the eminently sensible approach of policing our border so as to provide a modicum of national security. Instead, we must be groped by brown shirts each time we wish to board a plane.

Osama bin Laden is almost certainly dead, but his spirit lives on. The fundamental transformation of our system of government is troubling, but less so than the fact that their is no political will to rollback the horrid changes. For the conservatives, the supposed defenders of limited constitutional government, are not demanding an end to our futile war on terror and the TSA's harassment of citizens. They are occupied with the far more important matter of ensuring that we do not cease to torture terrorists.

It is hard to escape the conclusion that Osama bin Laden has won.

Tuesday, May 03, 2011

Keynes - The General Theory - Chapter XIX

Section I: Keynes undertakes to examine the relationship between money wages and employment. The relationship between the two ought to be very obvious, but as is his wont, Keynes denies the validity of what he calls the Classical Theory: "The argument simply is that a reduction in money-wages will cet. par. stimulate demand by diminishing the price of the finished product, and will therefore increase output and employment..."

In other words, if unemployment is too high at present wage rates, wages must fall until the marginally unemployed become employable. This is economics 101: if the price of a good is too high to meet demand, the price must fall or the good will remain unsold. It matters not at all whether we are discussing labor or apples, the principle holds.

Naturally, Keynes denies this: "For, whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money-wages will or will not be accompanied by the same aggregate effective demand as before measured in money, or, at any rate, by an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages (i.e. which is somewhat greater measured in wage-units)."

But aggregate demand has nothing to do with whether or not a man can be employed. True, if the industry in which he is hired begins to slump, he may have to find alternative employment. This frictional employment, though not unimportant, is not germane to this discussion.

Section II: Keynes begins this next section by asking two questions:
(1) Does a reduction in money-wages have a direct tendency, cet. par., to increase employment, “cet. par.” being taken to mean that the propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest are the same as before for the community as a whole? And (2) does a reduction in money-wages have a certain or probable tendency to affect employment in a particular direction through its certain or probable repercussions on these three factors?

It might appear at first glance that a reduction in wages will reduce the propensity to consume, thereby endangering the economy. But this analysis only makes sense if we also assume that the prices of things a man is trying to buy aren't falling at a similar rate. Yet it is exceedingly probable that the reason the man's wages were reduced was due to a decrease in the price of the goods he was making. A fall in the price of widgets necessitates a cut to the wages of the widget maker--not the other way around.

Keynes devotes some of this section to incorrect expectations of entrepreneurs. This has nothing to do with the systemic unemployment which transpires during a recession. Those employees of failed entrepreneurs can find work with successful bosses.

He goes on to list seven of the most important repercussions due to a reduction of money-wages, most of which he deems bad for employment. Most of his reasoning is specious, relying on some of his assumptions from earlier. Basically if wages fall, than consumption falls, which decimates the economy.

He continues: "We can, therefore, theoretically at least, produce precisely the same effects on the rate of interest by reducing wages, whilst leaving the quantity of money unchanged, that we can produce by increasing the quantity of money whilst leaving the level of wages unchanged."

Here the central planners smile. Finally, something is found for Paul Krugman to do.

Yet the attempt to solve unemployment through debasement of the currency is curious, for at least two reasons. First, inflation enriches those who have first access to the new money, that is, the bankers. My copy of The General Theory features a quote from Time calling the author a "workingman's revolutionary." Yet these policies would enrich the bankers at the expense of the workingman.

Second, unemployment is seldom evident across all industries. Our real estate bubble allocated too much labor into industries connected to real estate. This labor needed to be reallocated throughout the economy. But while inflation could conceivably prop up housing prices, thereby offsetting unemployment in that sector, we need recall that other sectors needed no such readjustment. Rather than allowing prices to fall so as to clear the supply--of workers and unsold houses--the solution is to inflate until those prices are realistic. And when the inflation causes another bubble in a different industry, we need only inflate once again.

Strikingly, Keynes recognizes this: "There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment; — any more than for the belief than an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines."

The key word here is "unaided". But it's still a pretty telling admission by Keynes. Someone ought to tell Bernanke.

Still, on the whole, Keynes sides with the bankers: "Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable."

Of course, allowing wages to fall is trivially easy. It takes no intervention from central planners and happens, by mutual consent, between the employer and the employee. The alternative, as we see clearly, is not an economic boost due to the benevolent bankers, but unemployment due to wage rigidity.

Again, Keynes puts things backwards, in assuming that wage flexibility creates debt, whereas increasing the money supply does not. On the contrary, an inflationary system punishes savers and rewards debtors, thereby encouraging the latter. Hence it is no surprise that the Western world, enthrall to inflationary policies, is drowning in a sea of debt.

Section III: We come across more nonsense: "The chief result of [a] policy [of flexible wage rates] would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live."

Here, as so often, Keynes paints a dark picture when, by simple recourse to economic history, he would see things in a better light. Wages were kept rigid during the Great Depression, yet unemployment persisted; prior to Hoover's intervention, wages were allowed to fall, and, instead of the violence Keynes postulates, we saw short recessions, followed by a return to normalcy.

And we have a bold-faced lie: "It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage-policy could function with success." Again, recourse to economic history would have served Keynes well. The comparatively freer America of the post-Civil War years demonstrated wage flexibility. True, the changes were not "sudden, substantial, all-round", but only Keynes is silly enough to think they need to be.

"In the long period, on the other hand, we are still left with the choice between a policy of allowing prices to fall slowly with the progress of technique and equipment whilst keeping wages stable, or of allowing wages to rise slowly whilst keeping prices stable."

The first alternative sounds fine to me, but the choice is a false one as Keynes can only keep prices stable by becoming a dictator of a closed economy. In any event, it's telling that he thinks it would be terrible if one's cost of living is falling with respect to one's wages. This strikes me as sound economic policy.

Monday, May 02, 2011

Keynes - The General Theory - Chapter XVIII

It is at this point that Keynes is ready to re-state his general theory, bringing together the many different topics he has touched on throughout the book.

Section I: Keynes describes the different variables that make up his economic model. Elements such as, "the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer" are all taken as given and unchanging. The variables that are affected by these givens as well as other uncomputable factors are, "he propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest" which Keynes dubs the independent variables. This leaves employment and national income as the dependent variables, or what he is trying to affect.

One might be led to ask why some factors are assumed as given while others are not, Keynes reasons:

The division of the determinants of the economic system into the two groups of given factors and independent variables is, of course, quite arbitrary from any absolute standpoint. The division must be made entirely on the basis of experience, so as to correspond on the one hand to the factors in which the changes seem to be so slow or so little relevant as to have only a small and comparatively negligible short-term influence on our quaesitum; and on the other hand to those factors in which the changes are found in practice to exercise a dominant influence on our quaesitum.

Thus, Keynes reveals his motive for establishing his general theory: determining the aspects of the economy which can be most easily manipulated by the government to increase employment and/or national income (GDP). As Keynes himself writes, "Our final task might be to select those variables which can be deliberately controlled or managed by central authority in the kind of system in which we actually live."

Section II: Here Keynes attempts to summarize the arguments made in the preceding chapters. Essentially he deduces from changes in one factor changes in subsequent factors until employment is affected. The numerous problems with some of his logic have already been noted, so I will move on.

Section III: Here Keynes notes that our economic system is relatively stable, rarely at full employment or high unemployment, but somewhere in the middle. From this observation, he describes his conditions of stability:

(i) When output increases because employment is increasing, the multiplier between them is slightly greater than one.

According to Keynes this is due to marginal propensity to consume, when employment expands consumption increases, but by less than the increase in income. This is not true when you introduce debt into the discussion, and the neglect of debt remains a large criticism of Keynes' theory.

(ii) "moderate changes in the prospective yield of capital or in the rate of interest will not be associated with very great changes in the rate of investment."

Keynes notes that this is not the case if their is a large surplus of capital-assets, but I think we can neglect this case as an outlier. Given that capital and the factors of production are scarce resources, small changes in the interest rate will result in small changes in investment. This is not a game changer, so we will continue on.

(iii) Changes in employment and money-wages tend to be in the same direction.

Keynes correctly notes that, "as employment increases, [the struggle for higher wages is] to be intensified in each individual case both because the bargaining position of the worker is improved and because the diminished marginal utility of his wage and his improved financial margin make him readier to run risks." Keynes continues that this leads to a stable price-level.

(iv) His last condition of stability is that when investment increases (or decreases) for a prolonged period of time, it has a tendency to reverse direction.

Keynes explains that if investment is declining for some period of time, it is likely that capital -assets will wear out over time. This will force an increase in investment. Furthermore, if investment rises too high, it will be forced in the opposite direction through a recession. This is only partially true; the recession only happens if the increased investment is not accompanied by increased savings. Conversely, but less likely, an economy can increase its time preference and decrease investment. The problem is not in whether or not investment is moving in one direction for an extended period of time, but when that change in investment is not accompanied by a change in savings.