In Chapter VI Keynes attempts to define income, saving and investment in order to further develop his general theory. Keynes' discussion of income involves the different costs which affect income, so I will break up my analysis of his writings according to each different cost.
User cost: Keynes defines user cost as the "sacrifice of value involved in the production of A" (finished output sold to consumers). This cost is made up of the value foregone by choosing to produce and sell A, as well as any output purchased from other entrepreneurs. He does not specify whether this "finished output" is higher order goods which the entrepreneur will use to produce lower order goods, or if these are consumption purchases by the entrepreneur. I do not see why Keynes includes a discussion of user cost, for it has little use to economic analysis. Whatever higher order goods an entrepreneur purchases he will combine with his labor and capital to create a lower order good. Also, the value forgone when producing output only matters to each individual entrepreneur when making a decision on what and how much to produce. Economists can say little if anything more on the matter.
Factor cost: Keynes defines the factor cost of A as "the amount paid out by the entrepreneur to the other factors of production in return for their services." These other factors of service not being specified, but assumed to be the owners of land and labor. Keynes goes on to say the difference between output and factor costs is equal to aggregate income. Keynes calls this difference the entrepreneur's profit, but he neglects to adjust for interest and the entrepreneur's own wage. Profits and losses are the markets way of informing people which businesses are best satisfying consumer desires, but only if profits are properly define. Keynes prefers to equate profit to income, when profits are really an excess over what the entrepreneur makes due to a wage and interest. Only under this Austrian definition of profits can they be useful in guiding firms to swiftly satisfy consumer desires.
Supplementary cost: Keynes writes that a change in market values, wastage due to time, or destruction due to a catastrophe are supplementary costs. I do not see the significance of these costs, changes in market values and wastage due to time should be anticipated by entrepreneurs, that is part of what makes them entrepreneurs. Catastrophes are insurable risks, and as such should not affect output - and employment because that is Keynes' focus - because the cost is covered by insurance.
Windfall loss: Keynes defines windfall loss as supplementary costs which are unforeseen. For example, a particularly exceptional catastrophe would be considered a windfall loss. The main point Keynes makes is that "although the windfall loss (or gain) enters into his decisions, it does enter into them on the same scale - a given windfall loss does not have the same effect as an equal supplementary cost." I found myself wondering why Keynes believed these similar costs affected someone differently, but he never explained it further. I do not think that this fact could be empirically or theoretically proven, but I may be wrong.
Keynes ends his discussion on income by stating this definition of income is different that his definition in his Treatise on Money. He then goes on to take a quick look at saving and investment, concluding that saving is equal to investment. From that he makes the argument that the propensity to consume is essentially the inverse of the propensity to save, and he will use the former in all further discussions. Since we already discussed propensity to consume, and its inherent flaws, I will end the discussion here.
This chapter was by far the most confusing yet, and it appears he is simply defining income, saving and investment in a manner that best fits his general theory. As opposed to Rothbard's Man, Economy, and State which starts from a simple axiom and proceeds to develop theory from there, it almost seems as if Keynes has his theory already in mind and uses these chapters to make it viable.
Friday, October 29, 2010
Monday, October 25, 2010
Weekly Column - 10/23/2010
This week's column:
"No, but you…you… you’re thinking of this place all wrong. As if I had the money back in a safe. The, the money’s not here. Well, your money’s in Joe’s house… that’s right next to yours. And in the Kennedy House, and Mrs. Macklin’s house, and, and a hundred others." – George Bailey, It’s A Wonderful Life
I do not wish to speak ill of one of my favorite films. But an appreciation for the fraudulent nature of fractional reserve banking has altered my perception of at least this one scene. In striving to stave off a bank run, George Bailey was forthright with his customers, but he mislead them nonetheless. For his customers did not run on the banks to retrieve their savings—or time deposits—but their demand deposits, what we call checking. George falsely assumed that these two disparate functions were one and the same.
To understand the proper role of banking, we have to set aside anything we think we might know about it. The first function of a bank is to securely store money; rather than lug it around at all times, a customer would pay a small storage fee to relieve himself of this burden. His money would sit idly in a vault; it would thus not collect interest, but it would be available to him on demand. This runs counter to our ideas of banking, but it makes practical sense: if I deposit money in a bank, I wish to be able to withdraw this money at any time. This can only be ensured if the money is actually in the bank, rather than being lent out to someone else.
"No, but you…you… you’re thinking of this place all wrong. As if I had the money back in a safe. The, the money’s not here. Well, your money’s in Joe’s house… that’s right next to yours. And in the Kennedy House, and Mrs. Macklin’s house, and, and a hundred others." – George Bailey, It’s A Wonderful Life
I do not wish to speak ill of one of my favorite films. But an appreciation for the fraudulent nature of fractional reserve banking has altered my perception of at least this one scene. In striving to stave off a bank run, George Bailey was forthright with his customers, but he mislead them nonetheless. For his customers did not run on the banks to retrieve their savings—or time deposits—but their demand deposits, what we call checking. George falsely assumed that these two disparate functions were one and the same.
To understand the proper role of banking, we have to set aside anything we think we might know about it. The first function of a bank is to securely store money; rather than lug it around at all times, a customer would pay a small storage fee to relieve himself of this burden. His money would sit idly in a vault; it would thus not collect interest, but it would be available to him on demand. This runs counter to our ideas of banking, but it makes practical sense: if I deposit money in a bank, I wish to be able to withdraw this money at any time. This can only be ensured if the money is actually in the bank, rather than being lent out to someone else.
Monday, October 18, 2010
Weekly Column - 10/16/2010
This week's column:
“For most people, anarchy is a disturbing word, suggesting chaos, violence, antinomianism — things they hope the state can control or prevent.” – Joe Sobran, The Reluctant Anarchist
The late Joe Sobran was correct about the shortcomings of using a misunderstood word. Hans-Hermann Hoppe, whom Sobran credits with finishing his conversion, prefers the term natural order, but this also requires a lengthy explanation. For now, it seems that anarchists will have to firmly elucidate their opposition to aggressive force.
This is important, because it is this opposition which constitutes the real difference between violent anarchists and those who wish to replace the State with a system of voluntary association. The anarchists of yesteryear were assassins, eliminating the heads of state under the naïve belief that the State itself would fade away without its figurehead. Modern anarchists, at least those influenced by Sobran and Hoppe, know full well that the State cannot be replaced so easily. Moreover, the State is force; to meet it on its own terms is to grant legitimacy to its coercive nature, something anarchists would never do. The State will fall, not in a paroxysm of violence, but by the withdrawal of citizens who refuse to accept the coercive apparatus and return to cooperative means to meet human needs.
“For most people, anarchy is a disturbing word, suggesting chaos, violence, antinomianism — things they hope the state can control or prevent.” – Joe Sobran, The Reluctant Anarchist
The late Joe Sobran was correct about the shortcomings of using a misunderstood word. Hans-Hermann Hoppe, whom Sobran credits with finishing his conversion, prefers the term natural order, but this also requires a lengthy explanation. For now, it seems that anarchists will have to firmly elucidate their opposition to aggressive force.
This is important, because it is this opposition which constitutes the real difference between violent anarchists and those who wish to replace the State with a system of voluntary association. The anarchists of yesteryear were assassins, eliminating the heads of state under the naïve belief that the State itself would fade away without its figurehead. Modern anarchists, at least those influenced by Sobran and Hoppe, know full well that the State cannot be replaced so easily. Moreover, the State is force; to meet it on its own terms is to grant legitimacy to its coercive nature, something anarchists would never do. The State will fall, not in a paroxysm of violence, but by the withdrawal of citizens who refuse to accept the coercive apparatus and return to cooperative means to meet human needs.
Thursday, October 14, 2010
Keynes - The General Theory - Chapter V
Section I: In this chapter, Keynes deals with the role expectation plays for the entrepreneur. He offers some sensible advice, but also puts things in such a way that they are liable to be misunderstood. He also introduces distinctions and terminology without necessity.
For instance:
“The first type [of expectation] is concerned with the price which a manufacturer can expect to get for his “finished” output at the time when he commits himself to starting the process which will produce it; output being “finished” (from the point of view of the manufacturer) when it is ready to be used or to be sold to a second party. The second type is concerned with what the entrepreneur can hope to earn in the shape of future returns if he purchases (or, perhaps, manufactures) “finished” output as an addition to his capital equipment. We may call the former short-term expectation and the latter long-term expectation.”
The concept is clear enough: a manufacturer expects to sell a certain good; he expects the addition of capital—for instance, a new machine for his shop—to increase production. The reason why these expectations merit distinctions as short-term or long-term escapes me.
Keynes writes: “The actually realised results of the production and sale of output will only be relevant to employment in so far as they cause a modification of subsequent expectations.” This is correct, but he gives too little attention to “actually realized results”. True, expectations are ever-changing, but what really alters employment are not fluctuations in expectation—which are far smaller than Keynes implies; it's not as if a manufacturer changes the goods he produces on a daily basis—but the disparity between expectations and reality. In other words, small changes in plans of production will alter employment little compared to the realization that produced goods cannot be sold profitably on the market. In his exuberance to emphasize expectation, he under-emphasizes the importance of actual results.
Section II: Little is added in this section, so I leave it without comment.
For instance:
“The first type [of expectation] is concerned with the price which a manufacturer can expect to get for his “finished” output at the time when he commits himself to starting the process which will produce it; output being “finished” (from the point of view of the manufacturer) when it is ready to be used or to be sold to a second party. The second type is concerned with what the entrepreneur can hope to earn in the shape of future returns if he purchases (or, perhaps, manufactures) “finished” output as an addition to his capital equipment. We may call the former short-term expectation and the latter long-term expectation.”
The concept is clear enough: a manufacturer expects to sell a certain good; he expects the addition of capital—for instance, a new machine for his shop—to increase production. The reason why these expectations merit distinctions as short-term or long-term escapes me.
Keynes writes: “The actually realised results of the production and sale of output will only be relevant to employment in so far as they cause a modification of subsequent expectations.” This is correct, but he gives too little attention to “actually realized results”. True, expectations are ever-changing, but what really alters employment are not fluctuations in expectation—which are far smaller than Keynes implies; it's not as if a manufacturer changes the goods he produces on a daily basis—but the disparity between expectations and reality. In other words, small changes in plans of production will alter employment little compared to the realization that produced goods cannot be sold profitably on the market. In his exuberance to emphasize expectation, he under-emphasizes the importance of actual results.
Section II: Little is added in this section, so I leave it without comment.
Saturday, October 09, 2010
Weekly Column - 10/09/2010
This week's column:
"We will fix the number of citizens at 5040, to which the number of houses and portions of land shall correspond." – Plato, Laws
We hear much of the benefits of democracy, but the most striking aspect of the representative system of the American republic may be its sheer size. One searches in vain through the annals of political philosophy for a recommendation of running a representative system with a large number of people—let alone with near universal suffrage. Indeed, until Thomas Hobbes’s decidedly anti-democratic Leviathan was published in 1651, the consensus was that the State should be, if not limited in power, at least restricted to lord it over a small number of citizens.
Thus Plato keeps his Republic small, while in the Laws, he sets an explicit limit to the number of citizens. Aristotle neither recommends democracy nor the totalitarianism of Plato; but while he deigns to give an exact number of citizens, the state is to be kept contained, so that the citizens will know each other, and that, should there be a democratic aspect to the state, those with suffrage may be gathered in a single place to deliberate its functions. Even Rousseau, who advocated government by the general will, probably had Geneva—a small state with limited suffrage—firmly in mind while writing his book On the Social Contract.
"We will fix the number of citizens at 5040, to which the number of houses and portions of land shall correspond." – Plato, Laws
We hear much of the benefits of democracy, but the most striking aspect of the representative system of the American republic may be its sheer size. One searches in vain through the annals of political philosophy for a recommendation of running a representative system with a large number of people—let alone with near universal suffrage. Indeed, until Thomas Hobbes’s decidedly anti-democratic Leviathan was published in 1651, the consensus was that the State should be, if not limited in power, at least restricted to lord it over a small number of citizens.
Thus Plato keeps his Republic small, while in the Laws, he sets an explicit limit to the number of citizens. Aristotle neither recommends democracy nor the totalitarianism of Plato; but while he deigns to give an exact number of citizens, the state is to be kept contained, so that the citizens will know each other, and that, should there be a democratic aspect to the state, those with suffrage may be gathered in a single place to deliberate its functions. Even Rousseau, who advocated government by the general will, probably had Geneva—a small state with limited suffrage—firmly in mind while writing his book On the Social Contract.
Tuesday, October 05, 2010
Keynes - The General Theory - Chapter IV
Section I: Keynes uses the first section to outline the purpose of the next four chapters; which comprise Book II: Definitions and Ideas. It is "an attempt to clear up certain perplexities which have no peculiar or exclusive relevance to the problems which it is our special purpose to examine." I am not entirely sure why Keynes felt the need to devote four chapters to issues which are not integral to the General Theory, but hopefully they will not be completely void of use. The rest of Chapter four is devoted to the choice of units in economic analysis.
Section II: Keynes begins by claiming “the units, in terms of which economists commonly work, are unsatisfactory,” and this “can be illustrated by the concepts of National Dividend, the stock of real capital and the general price level.” Keynes breaks down his analysis of each of the three concepts, so I will do the same:
(1) The National Dividend, according to Marshall and Pigou, measures the volume of current output or real income and not the value of output or money income. Keynes argues that it would be fallacious to use the National Dividend to erect a quantitative science, “it is a grave objection to this definition for such a purpose that the community’s output of goods and services is a non-homogeneous complex which cannot be measured.” I have no quarrel with Keynes’ argument here, as I too believe the National Dividend is not quantifiable, and should not be used in economic analysis.
(2) Keynes continues that it is even more difficult to calculate the stock of capital equipment, “for we have to find some basis for a quantitative comparison between the new items of equipment produced during the period and the old items which have perished.” This is a reasonable disagreement, because not only does a firm change their stock of capital but as the equipment wears down it can become less productive. He continues to critique Pigou’s argument for using net addition to capital equipment to determine National Dividend, by claiming – correctly – that “since this deduction is not a deduction in terms of money, he is involved in assuming that there can be a change in physical quantity, although there has been no physical change; i.e. he is covertly introducing changes in value .” Keynes’ critique receives bonus points when he cites Hayek’s criticism of Pigou’s argument.
(3) The last concept is the general price level, which Keynes attacks in similar fashion to the previous two. Keynes, when describing the “conundrums” caused by these concepts, makes a particularly fine point when he writes, they “have no relevance to the casual sequence of economic events, which are clear-cut and determinate in spite of the quantitative indeterminacy of these concepts. It is natural, therefore, to conclude that they not only lack precision but are unnecessary.” He goes on to say that the proper place for such concepts as National Dividend or the price level is statistical and historical analysis.
Section III: In this section, Keynes attempts to justify the use of two units when developing his general theory: quantities of money-value and quantities of employment. Keynes argues that on every occasion, entrepreneurs are concerned with how much they should work their given stock of capital equipment. My qualm with this statement is that capital is not fixed for an entrepreneur; they have the choice of increasing their stock of capital equipment through saving and investment. Obviously in the immediate future capital will be fixed, but it is dangerous to assume this is the only decision entrepreneurs are concerned with. From this claim, Keynes continues that when there is an increase in aggregate output, this must be due to firms employing more labor to work their given stock of capital equipment. Thus, Keynes avoids using National Dividend to represent output by claiming, “for purposes of description or rough comparison, we wish to speak of an increase of output, we must rely on the general presumption that the amount of employment associated with a given capital equipment will be a satisfactory index if the amount of resultant output.” This is an interesting statement, for in critiques above Keynes would have taken Pigou to task for relying on “general presumptions” and a “satisfactory index.” Furthermore, we know that economics as a subdivision of praxeology derives economic analysis from certain axioms, not general presumptions.
Section IV: This section is a maze of mathematical equations and functions which Keynes attempts to use to rewrite his aggregate supply function in terms of employment and money, his fundamental units. He comes to the conclusion that:
The ordinary supply curve, p = (Zr + Ur(Nr))/Or = (φr(Nr) + Ur(Nr)) /ψr(Nr)
Where,
φr(Nr) = the expected proceeds (net of user cost), depending on some employment level, Nr
Ur(Nr) = the expected user cost, depending on some level of employment, Nr
ψr(Nr) = the level of output, depending on some level of employment, Nr
Keynes entire reasoning for this complex and confusing equation is so that, “we can aggregate the Nr’s in a way in which we cannot aggregate the Or’s, since ∑Or is not numerical quantity.” Essentially, Keynes used Section II to refute the argument that net output can be used in economic analysis, but then claims here that if you use a mathematical formula dependent on employment that represents net output, everything is fine. This is unfortunate because not only are the Greek symbols and equations confusing, they focus on the aggregate when all economic action is taken by individuals.
Weekly Column - 10/02/2010
Due to a mistake which was, for once, not my own, no column was published last week. We've returned to normal, so here's this week's column:
"As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever." – U.S. Social Security Administration
What economist Walter Williams rightly calls "The National Ponzi Scheme" is not doing well. The system is dependent, as he says, on "expanding the pool of suckers." That pool is drying up. He wrote his article in February of 2009, noting that Social Security was expected to pay out more than it took in sometime in 2016. He was much too optimistic. It is 2010, and that point has been reached.
As David Schepp from Daily Finance reports: "The nation’s Social Security system will pay out more than it takes in this year and next, as aging baby boomers begin entering retirement." The economic recession—which has officially ended, but which unofficially remains very much in force—has reduced the base from which the government can seize funds. Proponents of the scheme point out that once the recovery gains momentum, tax receipts will increase, allowing Social Security to bounce back into the black. After all, the fund dipped into the red during the Carter administration, so we can’t argue that a spell of economic woes demonstrates the untenability of Social Security.
"As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever." – U.S. Social Security Administration
What economist Walter Williams rightly calls "The National Ponzi Scheme" is not doing well. The system is dependent, as he says, on "expanding the pool of suckers." That pool is drying up. He wrote his article in February of 2009, noting that Social Security was expected to pay out more than it took in sometime in 2016. He was much too optimistic. It is 2010, and that point has been reached.
As David Schepp from Daily Finance reports: "The nation’s Social Security system will pay out more than it takes in this year and next, as aging baby boomers begin entering retirement." The economic recession—which has officially ended, but which unofficially remains very much in force—has reduced the base from which the government can seize funds. Proponents of the scheme point out that once the recovery gains momentum, tax receipts will increase, allowing Social Security to bounce back into the black. After all, the fund dipped into the red during the Carter administration, so we can’t argue that a spell of economic woes demonstrates the untenability of Social Security.
Thursday, September 30, 2010
Keynes - The General Theory - Chapter III
Section I: After two introductory paragraphs in which a fairly clear concept is muddled by ill-defined terms, Keynes offers us a number of equations. Here are the first two: "Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z = φ(N), which can be called the Aggregate Supply Function. Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D = f(N), which can be called the Aggregate Demand Function."
There are a number of problems with these equations. First, while there is a general relationship between the number of people employed and the "aggregate supply price", this is not a mathematical function, such that any increase in N would lead to an increase in Z. Hiring a certain individual would cost more than hiring another individual; again, different individuals do different amounts of work. By giving equations, Keynes leads the reader to believe that a certainty exists where there isn't one. It follows that any attempt to combine an equation which is nothing more than a vague relationship will lead to problems.
In addition to the problem with treating N as an aggregate, there is a larger problem with the second equation. D represents "the proceeds which entrepreneurs expect to receive"; but the expectations of entrepreneurs are of less importance than what actually occurs. If the expectations are high, but these expectations are unwarranted--say, if contractors were employing a large number of men to build real estate in 2007--the economy may nonetheless be in very serious trouble. In fact, a large variance between expectation and reality is a reasonable definition for a recession. Unless Keynes has another equation to track reality, I don't see how this second equation will help him.
In what is becoming routine for him, Keynes lays into "the classical theory" in this section: "The classical theory assumes, in other words, that the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N. " Now, you'll have to correct me if I'm wrong on this, but the assumption of the classical theory is full employment in equilibrium. In other words, there is only one value for N. This is not to say that full employment always exists; the economy is a series of moving parts, so equilibrium is always changing. Hence, even the smoothest running economy will have frictional unemployment. Keynes seems to think that none of his predecessors were aware of this.
Another general point: Keynes often speaks in such a way as to confuse the reader about the real relationship between two things. For instance, he writes: "For entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost." But no entrepreneur actually thinks this way. Instead, he asks himself if he can afford to hire an individual at a certain cost,; if he expects that the prospective employee will offer him more value than this salary, he hires the man. He doesn't concern himself with the amount of employment in the economy.
Section II: Here we come to the heart of the general theory, though it is presented sketchily as most terms have not yet been defined--which Keynes readily admits. We'll take a look at his list of points one by one:
1) In a given situation of technique, resources and costs, income (both money-income and real income) depends on the volume of employment N.
So long as we remember that N is made up individuals, and therefore, aggregation is of limited utility, I see nothing wrong here.
(2) The relationship between the community’s income and what it can be expected to spend on consumption, designated by D1, will depend on the psychological characteristic of the community, which we shall call its propensity to consume. That is to say, consumption will depend on the level of aggregate income and, therefore, on the level of employment N, except when there is some change in the propensity to consume.
Again, Keynes is aggregating. The propensity to consume--which could just as easily have been called the propensity to save, as the relationship is precisely inverse--is a characteristic of an individual. Hence, despite the fact that Americans are up to their eyeballs in debt, our father is a notorious cheapskate. Also, the propensity to consume varies widely, even among individuals. There is nothing to prevent Scrooge from collecting his horde of gold coins to buy a Christmas goose for Bob Crachit.
(3) The amount of labour N which the entrepreneurs decide to employ depends on the sum (D) of two quantities, namely D1, the amount which the community is expected to spend on consumption, and D2, the amount which it is expected to devote to new investment. D is what we have called above the effective demand.
This one is a bit strange. I guess Keynes is saying that entrepreneurs depend on a certain amount of investment--so as to borrow funds to produce capital goods--and a certain amount of consumption--so as to purchase consumer goods. But the individual entrepreneur is less concerned with this ratio than is with whether or not he can sell his product. Apple isn't worried that Americans are tightening their belts; they're confident that the various iThings will sell.
(4) Since D1 + D2 = D = φ(N), where φ is the aggregate supply function, and since, as we have seen in (2) above, D1 is a function of N, which we may write χ(N), depending on the propensity to consume, it follows that φ(N) - χ(N) = D2.
Substitutions don't work if you're not dealing with actual equalities. Since these are relationships, but not explicit function, they cannot be combined mathematically. The Greek letters he uses, seemingly at random, only adds the confusion.
(5) Hence the volume of employment in equilibrium depends on (i) the aggregate supply function, φ, (ii) the propensity to consume, χ, and (iii) the volume of investment, D2. This is the essence of the General Theory of Employment.
Hopefully he states this more explicitly later, because I can't get myself to remember what the the Greek letters are supposed to represent.
(6) For every value of N there is a corresponding marginal productivity of labour in the wage-goods industries; and it is this which determines the real wage. (5) is, therefore, subject to the condition that N cannot exceed the value which reduces the real wage to equality with the marginal disutility of labour. This means that not all changes in D are compatible with our temporary assumption that money-wages are constant. Thus it will be essential to a full statement of our theory to dispense with this assumption.
Again, each individual decides if a change in D requires him to alter his employment status. We'll see what happens when he gets into the changes in money-wages.
(7) On the classical theory, according to which D = φ(N) for all values of N, the volume of employment is in neutral equilibrium for all values of N less than its maximum value; so that the forces of competition between entrepreneurs may be expected to push it to this maximum value. Only at this point, on the classical theory, can there be stable equilibrium.
I'm not sure what Keynes means by "neutral equilibrium". If N does not square with full employment--setting aside those voluntarily unemployed, for n less than N--we are not in a state of equilibrium at all.
(8) When employment increases, D1 will increase, but not by so much as D; since when our income increases our consumption increases also, but not by so much. The key to our practical problem is to be found in this psychological law. For it follows from this that the greater the volume of employment the greater will be the gap between the aggregate supply price (Z) of the corresponding output and the sum (D1) which the entrepreneurs can expect to get back out of the expenditure of consumers. Hence, if there is no change in the propensity to consume, employment cannot increase, unless at the same time D2 is increasing so as to fill the increasing gap between Z and D1. Thus — except on the special assumptions of the classical theory according to which there is some force in operation which, when employment increases, always causes D2 to increase sufficiently to fill the widening gap between Z and D1 — the economic system may find itself in stable equilibrium with N at a level below full employment, namely at the level given by the intersection of the aggregate demand function with the aggregate supply function.
The psychological law which Keynes observes sounds right, but it is not binding, and it is therefore not a law. It might seem reasonable that if I get a raise, I won't go out and spend all of it, but there is nothing to prevent me from doing so. I can, in fact, take the raise and spend that amount plus some of my savings--though if I was a good Keynesian, I'm not sure how much savings I would have. Hence anything which depends on this "law" holding true at all times will go awry should individuals not conform their behavior with the so-called law.
Regarding Keynes conclusion, it would be useful to attack the problem from a different direction. I'm not certain this could be done praxeologically, but at least theoretically, one could demonstrate that, despite a variance of savings rate--i.e. the propensity to consume--different rates of employment are possible. This seems to be the big take away here: if the propensity to consume isn't high enough--or low enough?--unemployment will result. I can't seem to find what that rate should be, so if you could point that out, I'd be grateful.
Section III: The rhetoric in this section is scurrilous. I've commented before on how poorly written the General Theory has been, but here, Keynes shines. He doesn't so much offer an argument, however, so I'll end my summary here.
This is arguably the most important chapter in the book, so please point out anything you think I may have missed or glossed over.
There are a number of problems with these equations. First, while there is a general relationship between the number of people employed and the "aggregate supply price", this is not a mathematical function, such that any increase in N would lead to an increase in Z. Hiring a certain individual would cost more than hiring another individual; again, different individuals do different amounts of work. By giving equations, Keynes leads the reader to believe that a certainty exists where there isn't one. It follows that any attempt to combine an equation which is nothing more than a vague relationship will lead to problems.
In addition to the problem with treating N as an aggregate, there is a larger problem with the second equation. D represents "the proceeds which entrepreneurs expect to receive"; but the expectations of entrepreneurs are of less importance than what actually occurs. If the expectations are high, but these expectations are unwarranted--say, if contractors were employing a large number of men to build real estate in 2007--the economy may nonetheless be in very serious trouble. In fact, a large variance between expectation and reality is a reasonable definition for a recession. Unless Keynes has another equation to track reality, I don't see how this second equation will help him.
In what is becoming routine for him, Keynes lays into "the classical theory" in this section: "The classical theory assumes, in other words, that the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N. " Now, you'll have to correct me if I'm wrong on this, but the assumption of the classical theory is full employment in equilibrium. In other words, there is only one value for N. This is not to say that full employment always exists; the economy is a series of moving parts, so equilibrium is always changing. Hence, even the smoothest running economy will have frictional unemployment. Keynes seems to think that none of his predecessors were aware of this.
Another general point: Keynes often speaks in such a way as to confuse the reader about the real relationship between two things. For instance, he writes: "For entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost." But no entrepreneur actually thinks this way. Instead, he asks himself if he can afford to hire an individual at a certain cost,; if he expects that the prospective employee will offer him more value than this salary, he hires the man. He doesn't concern himself with the amount of employment in the economy.
Section II: Here we come to the heart of the general theory, though it is presented sketchily as most terms have not yet been defined--which Keynes readily admits. We'll take a look at his list of points one by one:
1) In a given situation of technique, resources and costs, income (both money-income and real income) depends on the volume of employment N.
So long as we remember that N is made up individuals, and therefore, aggregation is of limited utility, I see nothing wrong here.
(2) The relationship between the community’s income and what it can be expected to spend on consumption, designated by D1, will depend on the psychological characteristic of the community, which we shall call its propensity to consume. That is to say, consumption will depend on the level of aggregate income and, therefore, on the level of employment N, except when there is some change in the propensity to consume.
Again, Keynes is aggregating. The propensity to consume--which could just as easily have been called the propensity to save, as the relationship is precisely inverse--is a characteristic of an individual. Hence, despite the fact that Americans are up to their eyeballs in debt, our father is a notorious cheapskate. Also, the propensity to consume varies widely, even among individuals. There is nothing to prevent Scrooge from collecting his horde of gold coins to buy a Christmas goose for Bob Crachit.
(3) The amount of labour N which the entrepreneurs decide to employ depends on the sum (D) of two quantities, namely D1, the amount which the community is expected to spend on consumption, and D2, the amount which it is expected to devote to new investment. D is what we have called above the effective demand.
This one is a bit strange. I guess Keynes is saying that entrepreneurs depend on a certain amount of investment--so as to borrow funds to produce capital goods--and a certain amount of consumption--so as to purchase consumer goods. But the individual entrepreneur is less concerned with this ratio than is with whether or not he can sell his product. Apple isn't worried that Americans are tightening their belts; they're confident that the various iThings will sell.
(4) Since D1 + D2 = D = φ(N), where φ is the aggregate supply function, and since, as we have seen in (2) above, D1 is a function of N, which we may write χ(N), depending on the propensity to consume, it follows that φ(N) - χ(N) = D2.
Substitutions don't work if you're not dealing with actual equalities. Since these are relationships, but not explicit function, they cannot be combined mathematically. The Greek letters he uses, seemingly at random, only adds the confusion.
(5) Hence the volume of employment in equilibrium depends on (i) the aggregate supply function, φ, (ii) the propensity to consume, χ, and (iii) the volume of investment, D2. This is the essence of the General Theory of Employment.
Hopefully he states this more explicitly later, because I can't get myself to remember what the the Greek letters are supposed to represent.
(6) For every value of N there is a corresponding marginal productivity of labour in the wage-goods industries; and it is this which determines the real wage. (5) is, therefore, subject to the condition that N cannot exceed the value which reduces the real wage to equality with the marginal disutility of labour. This means that not all changes in D are compatible with our temporary assumption that money-wages are constant. Thus it will be essential to a full statement of our theory to dispense with this assumption.
Again, each individual decides if a change in D requires him to alter his employment status. We'll see what happens when he gets into the changes in money-wages.
(7) On the classical theory, according to which D = φ(N) for all values of N, the volume of employment is in neutral equilibrium for all values of N less than its maximum value; so that the forces of competition between entrepreneurs may be expected to push it to this maximum value. Only at this point, on the classical theory, can there be stable equilibrium.
I'm not sure what Keynes means by "neutral equilibrium". If N does not square with full employment--setting aside those voluntarily unemployed, for n less than N--we are not in a state of equilibrium at all.
(8) When employment increases, D1 will increase, but not by so much as D; since when our income increases our consumption increases also, but not by so much. The key to our practical problem is to be found in this psychological law. For it follows from this that the greater the volume of employment the greater will be the gap between the aggregate supply price (Z) of the corresponding output and the sum (D1) which the entrepreneurs can expect to get back out of the expenditure of consumers. Hence, if there is no change in the propensity to consume, employment cannot increase, unless at the same time D2 is increasing so as to fill the increasing gap between Z and D1. Thus — except on the special assumptions of the classical theory according to which there is some force in operation which, when employment increases, always causes D2 to increase sufficiently to fill the widening gap between Z and D1 — the economic system may find itself in stable equilibrium with N at a level below full employment, namely at the level given by the intersection of the aggregate demand function with the aggregate supply function.
The psychological law which Keynes observes sounds right, but it is not binding, and it is therefore not a law. It might seem reasonable that if I get a raise, I won't go out and spend all of it, but there is nothing to prevent me from doing so. I can, in fact, take the raise and spend that amount plus some of my savings--though if I was a good Keynesian, I'm not sure how much savings I would have. Hence anything which depends on this "law" holding true at all times will go awry should individuals not conform their behavior with the so-called law.
Regarding Keynes conclusion, it would be useful to attack the problem from a different direction. I'm not certain this could be done praxeologically, but at least theoretically, one could demonstrate that, despite a variance of savings rate--i.e. the propensity to consume--different rates of employment are possible. This seems to be the big take away here: if the propensity to consume isn't high enough--or low enough?--unemployment will result. I can't seem to find what that rate should be, so if you could point that out, I'd be grateful.
Section III: The rhetoric in this section is scurrilous. I've commented before on how poorly written the General Theory has been, but here, Keynes shines. He doesn't so much offer an argument, however, so I'll end my summary here.
This is arguably the most important chapter in the book, so please point out anything you think I may have missed or glossed over.
Monday, September 27, 2010
Keynes - The General Theory - Chapter II - Sections III - VII
Section III: Keynes begins this section with a discussion surrounding the differences between a reduction of money-wages, and a reduction of real wages, "due to a change in the purchasing power of money which affects all workers alike." Keynes claims that although every other element in economics - such as prices - are set in real terms, people only care about money wages. It is quite a stretch for him to claim that unions and workers will accept falling real wages in the form of rising prices, as long as money wages remain the same. If this were the case, why do unions ask for raises to keep pace with inflation, and why does government grant its own employees a raise to compensate rising prices?
Section IV: Keynes uses this chapter to define involuntary unemployment. He writes, "Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relative to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment." At best, this describes frictional unemployment. If, as Keynes claims, the aggregate supply and the aggregate demand would be greater than the current condition the excess demand will employ the extra supply. Keynes' "problem" of involuntary unemployment is at worst a short-run case.
He goes on to argue that if the classical theory only applies to full unemployment, "it is fallacious to apply it to the problems of involuntary unemployment - if there be such a thing (and who will deny it?)" Considering Keynes wrote this during the Great Depression I doubt many of the thousands of unemployed would deny it, but that does not make it correct. Rather than making a case for involuntary unemployment, and arguing it against the classical theory, Keynes would rather appeal to people's emotions.
Section V: Keynes continues his discussion of wages and employment in this section. He argues that with a given organization, equipment, and technique, real wages and the volume of output are correlated. From this correlation he claims, "an increase in employment can only occur to the accompaniment of a decline on the rate of real wages." He continues, "if employment increases, then, in the short period, the reward per unit of labour in terms of wage-goods must, in general, decline and profits increase." This is not necessarily true, for if an entrepreneur increases employment he will pay the new workers according to the output he expects them to contribute. If he is wrong, and the worker contributes less than he believed, the entrepreneur will experience losses. One must not forget that employment is a voluntary agreement among two parties, and the only law governing their wage is each parties individual value scale.
Keynes ends this section with a claim that is essential to his theory, "a willingness on the part of labour to accept lower money-wages is not necessarily a remedy for unemployment." This is the basis for the Keynesian belief that the government must intervene via inflation to stop involuntary unemployment. Yet, inflation affects the entire economy, including prices, while allowing flexible wage rates only affects certain sectors of the economy. Surely, it is more efficient and less distortive to allow wages to fall and clear the market for a particular labor factor than to inflate prices throughout the economy.
Section VI: In this section Keynes tackles the classical theorists belief that supply creates its own demand. He quotes from both J.S. Mill and Marshall, but one point from Marshall is of particular importance, "He is said to spend when he seeks to obtain present enjoyment from the services and commodities of his which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future." This is consistent with the Austrian view that all economic activity revolves around satisfying the desires of the consumer; either now or in the future. Keynes disagrees with this belief, and claims that there is no link between decisions to abstain from present consumption and decisions to provide for future consumption. Unfortunately for Keynes, time preference clearly provides the link between present and future consumption decisions.
Section VII: In the final section of this chapter, Keynes outlines the three assumptions of the classical theory that he has purportedly refuted.
Section IV: Keynes uses this chapter to define involuntary unemployment. He writes, "Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relative to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment." At best, this describes frictional unemployment. If, as Keynes claims, the aggregate supply and the aggregate demand would be greater than the current condition the excess demand will employ the extra supply. Keynes' "problem" of involuntary unemployment is at worst a short-run case.
He goes on to argue that if the classical theory only applies to full unemployment, "it is fallacious to apply it to the problems of involuntary unemployment - if there be such a thing (and who will deny it?)" Considering Keynes wrote this during the Great Depression I doubt many of the thousands of unemployed would deny it, but that does not make it correct. Rather than making a case for involuntary unemployment, and arguing it against the classical theory, Keynes would rather appeal to people's emotions.
Section V: Keynes continues his discussion of wages and employment in this section. He argues that with a given organization, equipment, and technique, real wages and the volume of output are correlated. From this correlation he claims, "an increase in employment can only occur to the accompaniment of a decline on the rate of real wages." He continues, "if employment increases, then, in the short period, the reward per unit of labour in terms of wage-goods must, in general, decline and profits increase." This is not necessarily true, for if an entrepreneur increases employment he will pay the new workers according to the output he expects them to contribute. If he is wrong, and the worker contributes less than he believed, the entrepreneur will experience losses. One must not forget that employment is a voluntary agreement among two parties, and the only law governing their wage is each parties individual value scale.
Keynes ends this section with a claim that is essential to his theory, "a willingness on the part of labour to accept lower money-wages is not necessarily a remedy for unemployment." This is the basis for the Keynesian belief that the government must intervene via inflation to stop involuntary unemployment. Yet, inflation affects the entire economy, including prices, while allowing flexible wage rates only affects certain sectors of the economy. Surely, it is more efficient and less distortive to allow wages to fall and clear the market for a particular labor factor than to inflate prices throughout the economy.
Section VI: In this section Keynes tackles the classical theorists belief that supply creates its own demand. He quotes from both J.S. Mill and Marshall, but one point from Marshall is of particular importance, "He is said to spend when he seeks to obtain present enjoyment from the services and commodities of his which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future." This is consistent with the Austrian view that all economic activity revolves around satisfying the desires of the consumer; either now or in the future. Keynes disagrees with this belief, and claims that there is no link between decisions to abstain from present consumption and decisions to provide for future consumption. Unfortunately for Keynes, time preference clearly provides the link between present and future consumption decisions.
Section VII: In the final section of this chapter, Keynes outlines the three assumptions of the classical theory that he has purportedly refuted.
Wednesday, September 22, 2010
Keynes - The General Theory - Chapter II - Sections I and II
Section I: Keynes starts the second chapter thus: "Most treatises on the theory of value and production are primarily concerned with the distribution of a given volume of employed resources between different uses and with the conditions which, assuming the employment of this quantity of resources, determine their relative rewards and the relative values of their products."
I'm not terribly familiar with the literature, but there are reasons to believe that this statement is not true. Whatever Keynes's ability as an economist, he often speaks as if he has a deep familiarity with divergent economic thought even when it is not the case. The problem is a real one, which is why Keynes was not the first to address it.
Continuing, Keynes gives two postulates upon which is based the "classical theory of employment." To wit:
1) The wage is equal to the marginal product of labour
My research tells me that this first postulate is an accurate summary of the classical position. However, this is not consistent with Austrian teaching, under which the wage is that which is agreed upon by the employer and the employee. There is no real equality; instead, the employee works for a wage which he prefers--both to other wage offers as well as the prospect of remaining idle--while the employer pays this wage because he prefers dispensing with this money in exchange for which he expects certain work from his employee.
The explanation offered by Keynes serves only to muddy the waters.
Onto the second postulate:
2) The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment
I'm honestly not sure what this means or why Keynes thought it was necessary. If you've defined your equality above, I'm not sure what this second postulate gives you. I may be missing something here.
Keynes uses a trichotomy to classify unemployment: frictional, voluntary, and involuntary. Yet frictional unemployment can be either, so I don't think it's a very helpful distinction. Nonetheless, Keynes proposes to look into involuntary employment and how it may come about.
He uses some more unhelpful terminology in this section by dividing goods into wage-goods and non-wage-goods. I can't think of any non-wage-goods. Further research suggests that by wage-goods, Keynes means consumer goods. I'm not sure why he felt need to introduce strange terminology--though in fairness these terms come from Pigou.
Section II: Keynes postulates: "that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage." This is interesting, but not surprising. I'm certain a fair number of employees would accept a pay cut if they could find no other work; this number would be more substantial without generous unemployment benefits. When this wage reduction occurs clandestinely through inflation--for this is the primary cause of a reduction in real wages--it makes sense that people would tolerate this as well. There is a point at which people will seek employment elsewhere or cease working entirely; but it is not one penny less per hour as Keynes seems to think classical economists thought.
Keynes tells us: "It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing." Unfortunately, he does not tell us why it is implausible. Murray Rothbard makes a good case in his book, America's Great Depression, that the refusal of the partnership of big business and government to let wages fall exacerbated the depression. It would certainly seem reasonable to argue that allowing wages to fall would have created more employment.
He also writes: "It would be interesting to see the results of a statistical enquiry into the actual relationship between changes in money-wages and changes in real wages." His argument is empirical, so it would behoove him to take the time to accumulate some data, so as to see if his theory is reasonable. Keynes fails to do the necessary research here.
Continuing: "The traditional theory maintains, in short, that the wage bargains between the entrepreneurs and the workers determine the real wage ; so that, assuming free competition amongst employers and no restrictive combination amongst workers, the latter can, if they wish, bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage." Note the italics. Barring interference from the State--as for instance, raising the minimum wage would disallow laborers from working for less than the minimum--this is sound.
Then Keynes starts to get muddled by looking at the forest and forgetting that it is comprised of trees: "The classical conclusions are intended, it must be remembered, to apply to the whole body of labour and do not mean merely that a single individual can get employment by accepting a cut in money-wages which his fellows refuse." There is no such law which applies to the body of labor. All action occurs with individuals, and, to be more specific, at the margins. Employers do not say, "we shall raise employment by some quantity today" but rather ask, "shall we hire this person?" It is foolish to speak otherwise.
More: "To sum up: there are two objections to the second postulate of the classical theory." We have explained the problems with the first, so we'll move to the second: "There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs. This will be our contention." Again, labor does not act as a whole. Individual laborers may seek alternative employment should a change in conditions prove undesirable to them. I don't see how this can be disputed.
I'm not terribly familiar with the literature, but there are reasons to believe that this statement is not true. Whatever Keynes's ability as an economist, he often speaks as if he has a deep familiarity with divergent economic thought even when it is not the case. The problem is a real one, which is why Keynes was not the first to address it.
Continuing, Keynes gives two postulates upon which is based the "classical theory of employment." To wit:
1) The wage is equal to the marginal product of labour
My research tells me that this first postulate is an accurate summary of the classical position. However, this is not consistent with Austrian teaching, under which the wage is that which is agreed upon by the employer and the employee. There is no real equality; instead, the employee works for a wage which he prefers--both to other wage offers as well as the prospect of remaining idle--while the employer pays this wage because he prefers dispensing with this money in exchange for which he expects certain work from his employee.
The explanation offered by Keynes serves only to muddy the waters.
Onto the second postulate:
2) The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment
I'm honestly not sure what this means or why Keynes thought it was necessary. If you've defined your equality above, I'm not sure what this second postulate gives you. I may be missing something here.
Keynes uses a trichotomy to classify unemployment: frictional, voluntary, and involuntary. Yet frictional unemployment can be either, so I don't think it's a very helpful distinction. Nonetheless, Keynes proposes to look into involuntary employment and how it may come about.
He uses some more unhelpful terminology in this section by dividing goods into wage-goods and non-wage-goods. I can't think of any non-wage-goods. Further research suggests that by wage-goods, Keynes means consumer goods. I'm not sure why he felt need to introduce strange terminology--though in fairness these terms come from Pigou.
Section II: Keynes postulates: "that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage." This is interesting, but not surprising. I'm certain a fair number of employees would accept a pay cut if they could find no other work; this number would be more substantial without generous unemployment benefits. When this wage reduction occurs clandestinely through inflation--for this is the primary cause of a reduction in real wages--it makes sense that people would tolerate this as well. There is a point at which people will seek employment elsewhere or cease working entirely; but it is not one penny less per hour as Keynes seems to think classical economists thought.
Keynes tells us: "It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing." Unfortunately, he does not tell us why it is implausible. Murray Rothbard makes a good case in his book, America's Great Depression, that the refusal of the partnership of big business and government to let wages fall exacerbated the depression. It would certainly seem reasonable to argue that allowing wages to fall would have created more employment.
He also writes: "It would be interesting to see the results of a statistical enquiry into the actual relationship between changes in money-wages and changes in real wages." His argument is empirical, so it would behoove him to take the time to accumulate some data, so as to see if his theory is reasonable. Keynes fails to do the necessary research here.
Continuing: "The traditional theory maintains, in short, that the wage bargains between the entrepreneurs and the workers determine the real wage ; so that, assuming free competition amongst employers and no restrictive combination amongst workers, the latter can, if they wish, bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage." Note the italics. Barring interference from the State--as for instance, raising the minimum wage would disallow laborers from working for less than the minimum--this is sound.
Then Keynes starts to get muddled by looking at the forest and forgetting that it is comprised of trees: "The classical conclusions are intended, it must be remembered, to apply to the whole body of labour and do not mean merely that a single individual can get employment by accepting a cut in money-wages which his fellows refuse." There is no such law which applies to the body of labor. All action occurs with individuals, and, to be more specific, at the margins. Employers do not say, "we shall raise employment by some quantity today" but rather ask, "shall we hire this person?" It is foolish to speak otherwise.
More: "To sum up: there are two objections to the second postulate of the classical theory." We have explained the problems with the first, so we'll move to the second: "There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs. This will be our contention." Again, labor does not act as a whole. Individual laborers may seek alternative employment should a change in conditions prove undesirable to them. I don't see how this can be disputed.
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