Cafe Hayek
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I recently wrote about Larry Summers’s statement about the economic impact of the tragic events in Japan. Here is what Larry Summers said:
"If you look, this is clearly going to add complexity to Japan's challenge of economic recovery," Summers said. "It may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”
The post generated 125 comments, a lively back and forth debating what Summers “really meant.” What did he mean by “temporary increments” in GDP. What did he mean by “economic strength?”
Let me try to help.
He meant it was a good thing for the economy. He wasn’t saying the tsunami was a good thing. He began his response to the interviewer by making it clear that this was first and foremost a human tragedy. But on the financial side, he was saying it had a silver lining, just like Paul Krugman concluded after 9/11 because there would now be some rebuilding and that would be good for the economy.
Read the Krugman piece. Tell me where the nuance is. There isn’t any. Read the Summers quote. It’s pretty straightforward. He does say “may lead to” not “will lead to.” He does talk about “adding complexity” but that presumably a reference to the human costs. He adds no caveats in his remarks, no qualifiers, about the Kobe earthquake or the increases to GDP.
Do you really need to look for subtlety or nuance? Summers and Krugman believe that spending creates prosperity. It’s called Keynesianism. As I said in my original post, I don’t understand the logic because it implies that destruction is a good thing for the economy. Nothing Summers said (or Krugman) shows anything other than that.
You want subtlety? You want nuance? You can argue that comes into play because there’s unemployment. There’s slack in the economy. In the Keynesian world view, when there’s slack, it’s because there isn’t enough spending. So anything that boosts spending (digging ditches and filling them back in, a really big war (see Krugman’s piece), or a natural disaster) is good for the economy. Not just good for the construction industry–we’d all agree on that–but good for the economy overall.
It’s a particularly peculiar argument when we’re talking about an increase in private spending on rebuilding rather than a debt-financed increase in public spending. My eleven year-old understands that spending on rebuilding means less spending on something else. That was his reaction when I asked the family at dinner last night what they thought of Summers’s claim. What does Larry Summers understand that my eleven year old is missing? I really don’t get it.
BTW, when I asked my eleven year-old and thirteen year-old what they thought Summers was thinking with his argument, they both started singing from Fear the Boom and Bust:
Even a broken window helps the glass man have some wealth
The whole verse goes:
The monetary and the fiscal, they're equally correct Public works, digging ditches, war has the same effect Even a broken window helps the glass man have some wealth The multiplier driving higher the economy's health
I think that’s how Larry Summers and Paul Krugman view the world. Can someone find me something they’ve said or written that suggests otherwise–that suggests there is something other than a free lunch or that suggests that destruction is bad for the economy?
Finally, I’d love to interview Larry Summers on EconTalk and let him give his side of the story. He’s a smart guy. He’s smarter than my eleven year-old and smarter than I am. But why he believes that spending on rebuilding destroyed buildings is good for the economy is a mystery to me.
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1 Tim Worstall March 14, 2011 at 1:31 pmOh, come on. It’s not that tough.
“My eleven year-old understands that spending on rebuilding means less spending on something else.”
Now introduce savings into your 11 year old’s model. Either that people will do less saving because they are rebuilding or that they will draw down their savings to rebuild.
We now have more economic activity *now* than we would have done without the rebuilding. Thus the rebuilding activity is stimulative. Because we have more economic activity now.
That this doesn’t help in the longer term is of course entirely true. We lose whatever else might have been financed with those savings (perhaps other buildings, perhaps other productive investment, perhaps just the higher human utility of a well funded retirement).
And of course everyone is less wealthy (we should be careful to distinguish here between wealth, a stock, and income, a flow) than they would have been without the destruction of already extant buildings and infrastructure.
My rejection of the stimulative effects of spending comes not from the first part, for I can see that drawing future consumption into the present by dis-saving (or less than would otherwise have been the case) will stimulate current economic activity. My rejection rather comes from my inability to see that more such activity now makes us better off in the long run. Most especially when the reason for more activity now is that we’ve got to rebuild what was previously built so as to make us better off in that long run.
Bastiat and Keynes can coexist, as long as each is allowed to work on different time scales.
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2 Seth March 14, 2011 at 2:03 pmRuss – I thought the nuance was that GDP does not count aggregate the value of the assets destroyed (not to mention the present value of the future production of the lives lost). Or does it?
Which, btw, I think is one reason why GDP is not a good measure for the health of the economy.
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3 Seth March 14, 2011 at 2:04 pmOops! Didn’t mean to reply to TW’s comment.
But now that I have, Tim, what time scale does the time value of money work on?
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4 wintercow20 March 14, 2011 at 8:43 pmTim,
I appreciate the addition of savings to this “model.” But can you help me understand where my thinking is going wrong here: suppose the spending on rebuilding did come out of saving, just as you indicate could result in moving consumption forward. But savings do not just sit around. They are invested. And the investment is nothing other than consumption of different lived goods than consumers generally consume. But I simply do not see how businesses building factories and relationships and the like is any less “economy activity” than a consumer rebuilding a home or office. This is an honest question.
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5 vikingvista March 15, 2011 at 2:22 amAnd a good question. Savings isn’t just future consumption, but is, as you say, investment.
And investment isn’t just planning for people’s future consumption, although it is that. It is also a complex network integrated into the economy to produce the higher order goods that we associate with a developed economy, and productivity advances that are the essence of economic growth. Diverting funds from investment into current consumption, disrupts and wastes complex long term capital structures, and actually POSTPONES economic growth, rather than promoting it, as keynesiacs believe.
Keynesiacs do not understand capital. They do not understand growth. To the keynesiac, more “economic activity” is the goal. But economic activity is NOT desirable. We strive for, and want, to accomplish the same goals using LESS economic activity. That is wealth. That is what savings and investment gives us. And that is what keynesiacs deprive us of every time they force us to squander our capital to stimulate economic activity.
And that is why it is a TRAGEDY, not an irony, that the Japanese will be increasing their spending on rebuilding.
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6 Tim Worstall March 15, 2011 at 5:18 amWell, in Keynes’ model (which we do have to assume in order to see what Summers is getting at) savings do not equal investment, do they? It is possible to have dead cash sitting around in bank acounts, sitting on the balance sheets of companies.
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7 John Papola March 14, 2011 at 1:41 pmThe only missing "subtlety" from this post is that less-crude (sounding) Keynesians argue that this kind of spending "increases velocity". So that if MV = PT and PT (Aggregate Demand/NGDP) = C+I+G"¦ then, assuming everything else is fixed including the money supply, an increase in AD will drive up velocity. This is, from what I can tell, a misunderstanding of what these "equations" are able to tell as and what they are not. It is, much like Mark Zandi's "it would have been worse" calculus, a mathematical model which assumes that keynesianism is true and thus tautologically arrives at Keynesian answers.
MV = PT is not pure truth or a short-run rule of causality. I thought that was a point Keynes had understood. Hume surely did.
But beyond all of this macro model nonsense, is a simple idea being posited. Rebuilding will "increase confidence". When "people" become more confident, they demand less cash balances. So destruction, in the keynesian framework, can elevate monetary disequilibrium by allowing the demand for money to fall back to the level of the supply of money.
Of course, if we assume that this monetary equilibrium theory approach is valid"¦ there's an easier way to deal with increased demand for money than national tragedy: increase the money supply to meet demand.
The true flaw in all of this is the aggregate view which keynesians take. There is no group called "people" with some aggregate level of "confidence". Some people are more confident and others are less and there is no reason to believe that Keynesian spending of any sort can target the people who are hoarding money rather than those who are not. During the rebuilding, the construction workers may feel better about their situation. Were they hoarding money before? How could we possibly know? And what about the people who lost everything? Are they more confident? Probably not. But lets say they're covered by government spending and private insurance? The resources must come from somewhere. The people losing out are surely less confident after the devastation.
Keynesianism sees none of these issues and has no means to answer the questions. Instead, they're hand-waved away.
Destruction makes us poorer. The set of assumptions needed to make it such that the rebuilding will bring an end to monetary disequilibrium is preposterous"¦ and that assumes that monetary equilibrium theory is true. In a world with central banks, I'm unconvinced of MET.
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8 Daniel Kuehn March 14, 2011 at 3:13 pmre: “The true flaw in all of this is the aggregate view which keynesians take. There is no group called "people" with some aggregate level of "confidence". Some people are more confident and others are less and there is no reason to believe that Keynesian spending of any sort can target the people who are hoarding money rather than those who are not.”
Ever heard of the price mechanism?
So fiscal and monetary policy expands the money supply. Individuals do demand money at different rates – and not only that, the same individual will demand different amounts of money at different prices. That’s why we have a demand schedule or curve rather than a single thing called “the demand for money”. Increasing the supply of money shifts the market equilibrium down the demand curve, lowering the interest rate and allowing more investment at lower and lower levels of marginal return to capital. The price mechanism efficiently allocates the created money – you don’t have Ben Bernanke saying “so who wants this the most!”.
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9 DG Lesvic March 14, 2011 at 3:39 pmAgain, I must give the Devil his due, and thank the Devilish Daniel for the best explanation of a demand curve that I have ever seen. That has been a big help to me. So, thanx, Devil, old boy.
The key to understanding Keynesian economics is to understand that it isn't economics at all but anti-economics, "economics" against economization.
Don’s 11 year old understands that, in his own affairs, he cannot spend his way to prosperity. But, according to the Keynesians, the economy of a nation was different from that of an individual, and thrift, a private virtue, was a public vice. Hence, the two different kinds of economics, Micro and Macro, the economics of the individual, and of the nation.
So Keynesian "economics" is characterized not just by the notion that the market economy is inherently unstable and in need of government action to stabilize it, but by the division between micro and macro, and, most especially, anti-economics.
For Macro Schmacro, and, following it, The Cause and Cure of the Depression, see
http://econotrashtalk.org/#Macro_Schmacro_
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10 DG Lesvic March 14, 2011 at 3:44 pmPardon me. I should have said Russ’s 11 year old, not Don’s.
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11 John Papola March 14, 2011 at 4:22 pmWhat is the price of money, Daniel? The answer is not “interest rates”. Money has no market of its own or price of its own in the way you are describing.
Where is the market process for this “price mechanism” you are referencing?
The closest thing you get to the “price” of money is “purchasing power”, which is what people seek to preserve when then hold cash balances.
Am I missing something?
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