Tag Archives: Great Recession

Fight of the Century: Keynes vs. Hayek – Round II

The debates raging over what policies will pull the economy out of its Great Recession is quite similar to those that occurred during the Great Depression. And like in the 1930 s it is the theories of John Maynard Keynes who gets most followers. But that does not mean his pay-as-you-go policy is best suited for todays integrated global economy.

“To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm.”

Friedrich A. Hayek

One might get the impression that J.M. Keynes Grand Theory is like a natural law of economics. Underlined by quotes like “We re all Keynesian now, by former US president Richard Nixon, or like former Norwegian politician Einar Forde rewrote – We re all social democrats now.

But during the last years of economic crisis, the once undisputable law of economics have come under questioning.

Ecos of voices of those who were critical of Keynes ideas have surfaced.

And the hottest theme amongst economic experts and science today is whether the whole argument behind governmental stimulation of the economy as a repair tool for recessions is false or not.


The British economist, Friedrich A. Hayek, was Keynes strongest opponent.

In media and in the blogosphere is this debate described as The Fight of the Century, or Keynes vs Hayek – Round 2, etc.

Recently Richard Ebeling, a professor of economics at Northwood University, have published articles, including letters from the two sides that have never been seen before.

The letters have never been seen before and shed a new light on the discussions that formed the ruling monetary policies of today.

The Wall Street Journal writes.

On Oct. 17, 1932, the Times published a lengthy letter from John Maynard Keynes and five other academic economists. Keynes, et al. (Keynes for short), made the case for spending—of any kind, private or public, whether on consumption or investment.

“Private economy” was the culprit that impeded a return to prosperity. If a person decides to save, there is no assurance that the funds “will find their way into investment in new capital construction by public or private concerns.” They cite a “lack of confidence” as the reason that savings is not intermediated into investment. Accordingly, “the public interest in present conditions does not point towards private economy; to spend less money than we should like to do is not patriotic.” They conclude by endorsing public spending to offset unwise private thrift.

The views in this letter came to be known as Keynesian economics. Depressions are caused by a spending deficit, which can be made up by government spending. Keynesian economics (which predates Keynes) is easily identifiable in speeches given by President Obama and his economic team.


Two days later, on Oct. 19, 1932, four professors at the University of London responded to the Keynes letter, and one of the signers was Friedrich A. Hayek who more than 50 years later would win the Nobel Prize in Economics.

Hayek, et al. (Hayek for short), identified three areas of contention. First, they correctly identified Keynes’s argument about the futility of savings as actually being an argument about what has classically been known as the dangers of hoarding, i.e., the potentially pernicious consequences of an economy-wide increase in the demand for money that is not met by a corresponding increase in the supply of money. “It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.”

“The great debate is still Keynes versus Hayek. All else is footnote.”

Second, the London professors disputed that it mattered not the form spending took, whether on consumption or investment. They saw a “revival of investment as peculiarly desirable,” as do today’s proponents of supply-side economics. They distinguish between hoarding of money and savings that flows into securities, and reaffirm the importance of the securities markets in transforming savings into investment.

Their third and greatest disagreement with Keynes was over the benefits of government spending financed by deficits. They demurred. “The existence of public debt on a large scale imposes frictions and obstacles to readjustment very much greater than the frictions and obstacles imposed by the existence of private debt.” This was not the time for “new municipal swimming baths, &c” (Keynes’s example). In our contemporary context, no stimulus.

Finally, and importantly, they offered a way forward. Governments world-wide, led by the U.S. with the destructive Smoot-Hawley Tariff of 1930, had turned to protectionism and restrictions on capital flows. Hayek argued it was time “to abolish those restrictions on trade and the free movement of capital.”

In short, they argued that the cure for the Great Depression was a reinvigorated international global trading system. The world economy has not turned to protectionism this time, but efforts at expanding global trade have flagged. As Allan Meltzer, a professor of economics at Carnegie Mellon University, recently reminded readers of this page (“Why Obamanomics Has Failed,” June 30), only expanded trade can enable us to pay off the public debt that burdens the economy.

Prof. Ebeling’s rediscovery of these letters has unleashed a torrent of comments on blog sites. As New York University economist Mario Rizzo put it, “The great debate is still Keynes versus Hayek. All else is footnote.” Economists have clothed the debate with ever greater mathematical complexity, but the underlying issues remain the same.

Was Keynes correct that savings become idle money and depress economic activity? Or was the Hayek view, first articulated by Adam Smith in the “Wealth of Nations” in 1776, correct? (Smith: “What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too.”)

Is all spending equally productive, or should government policies aim to stimulate private investment? If the latter, then Mr. Obama is following in FDR’s footsteps and impeding recovery. He does so by demonizing business and creating regime uncertainty through new regulations and costly programs. In this he follows neither Hayek nor Keynes, since creating a lack of confidence is considered destructive by both.

Finally, is creating new public debt in a weakened economy the path to recovery? Or is “economy” (austerity in today’s debate) and thrift the path to prosperity now, as it has usually been considered before?

By GERALD P. O’DRISCOLL JR.

Mr. O’Driscoll, a senior fellow at the Cato Institute.

He formerly served as vice president at the Federal Reserve Bank of Dallas. With Mario J. Rizzo, he is co-author of “The Economics of Time and Ignorance” (Routledge, 1996).

VIDEO BONUS

Well, some of you are probably familiar with last years smash hit eco-mucic video – Fear the Boom and Bust Rap.


So, there just had to be a follow-up.

And here it is, released just about a week ago,

Enjoy!

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Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics, Philosophy

The Real Story Behind US Corporate Record Profits

One of the major news stories yesterday was the figures released by the US Bureau of Economic Analysis that showed US corporate profits hitting a new record in third quarter this year. But that’s not quite accurate. According to Harvard Business Review, the US corporate profits has in fact been even higher once before – in 1929!

“The reason that corporate profits are near their all-time highs would appear to be that financial corporations – mainly big financial corporations – and multinationals are making lots of money and paying less of it out in taxes.”

Justin Fox


Editorial director at Harvard Business Review, Justin Fox, makes some interesting observations of the yesterday’s big news about US corporates making all-time-high profits in Q3 this year. As usual, statistics can be used to prove almost anything, Mr. Fox points out.


US Corporate profits hit a new record in the U.S. in the third quarter of this year.

Well, that was the headline after the data were released Tuesday.

Editorial director Justin Fox at Harvard Business Review hits the bullseye with the following comment:

“It was kind of a meaningless distinction: In a growing economy, even a fitfully growing one, corporate profits should hit new records on a pretty regular basis.”

Of course! That’s the whole point of economic growth, right?

But Mr. Fox makes several other – not so obvious – observations:

“Indications are that inflation-adjusted corporate profits are probably still slightly below the levels of before the Great Recession (the Bureau of Economic Analysis doesn’t adjust the main corporate profit number for inflation, because — given all the profits that flow in from overseas — it doesn’t know what inflation rate to use),” he writes in a new blog post.

According to Justin Fox, it’s easier and probably more meaningful to measure profits simply as a share of the economy.

(Sounds logical, too.)

“You can divide by either gross domestic product or national income — I do the latter below because it’s more of an apples-to-apples comparison, plus it involves downloading fewer tables from the BEA.”

“So here’s the chart, going back to 1947, of after-tax corporate profits as a share of national income :”

(click on the image to see a larger version)

 

“You might not be able to tell this from the chart, but the third-quarter 2010 profit share, at 9.46%, is slightly below the peak of 9.58% in the third-quarter of 2006.”

Anyway –  it’s still quite high by historical standards. And the chart only goes back to 1947, that’s as far back the quarterly data goes.

But there is annual data going back to 1929, and the only time besides 2006 and this year, when the profit share topped 9% was in 1929, when it hit 9.9%, Mr. Fox writes.

“Approaching a record set in 1929 doesn’t seem like an auspicious sign.”

According to Justin Fox and Harvard Business review, economists have surprisingly few answers to what exactly such a high profit share mean.

“There’s been lots of work done on the meaning of cyclical shifts in corporate profits — basically, a profit upswing usually precedes a broader economic boom. But I’ve been looking since the late 1990s for good explanations of secular shifts in profits, and found very little — and I’m not the only one.” he writes.

“When confronted with such apparent gaps in economic knowledge, my natural tendency is to fire up Excel and start playing with the numbers. I do this not as a trained economist or statistician, but just as a guy who sort of knows how to use Excel (although I find the latest Mac version awfully confusing).”

Here’s the main discovered:

  • Pre-tax domestic nonfinancial corporate profits — a mouthful, but also seemingly a fair measure of the underlying health of business in America — are nowhere near record levels as a share of national income.

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  • They exceeded 15% of national income once in the late 1940’s, and repeatedly topped 12% in the 1950’s and 1960’s; in the third quarter of this year, they were 7.03% of national income.

This might go some way toward explaining the seeming disconnect between booming corporate profits on the one hand and a very cranky business community on the other. For much of the business community, profits aren’t that high by historical standards.

“These people have every right to be cranky.”

So what is, in fact, doing better?

The answer comes as no surprise to this blogger:

“According to the BEA’s data, financial industry profits and “rest of world” profits — that is, the money US-based corporations make overseas – are relatively much higher now than they were in the 1950’s or 1960’s. And the taxes paid by corporations are much lower now than they were then, as a share of national income.”

“The reason that corporate profits are near their all-time highs would appear to be that financial corporations (mainly big financial corporations) and multinationals are making lots of money and paying less of it out in taxes.”

In other words: The money is increasingly going to a select group at the very top of the economic food chain, who are able to reap the rewards of global growth, play the financial system astutely, and avoid taxes.

“You can spin this in a moderately positive way: these are very dynamic economic times, and the rewards are going to those companies and individuals who position themselves to take advantage of this dynamism,” Justin Fox points out.

But concludes:

“There are an awful lot of negative ways you can spin it, too.”

(Original post here.)

 


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Filed under International Econnomic Politics, National Economic Politics

iRock: The Dollar And Its Diving (Great Recession Remix)

The talented folks at versusplus.com is out with another financial parody song – just in time for the Christmas holiday season – and the upcoming “Black Friday“…

The versusplus.com 2010 Holiday Songbook begins with “The Dollar And Its Diving (Great Recession Remix),” – an econoparody of “The Holly And The Ivy” (Traditional).

This new piece is an animated, Great Recession update of their original 2006 “Dollar” econoparody.

Here it is, “The Dollar And Its Diving” (Great Recession Remix) – Happy Holidays !

Download “THE DOLLAR AND ITS DIVING [Great Recession Remix]” song from iTunes (US): http://itunes.apple.com/us/album/the-dollar-and-its-diving/id405777954.

Watch “THE DOLLAR AND ITS DIVING [Great Recession Remix]” – and other hilarious econoparodies – on versusplus.com: http://versusplus.com or http://versusplus.com/dollar_2010.html (with parody lyrics).

More Financial Music Videos at iRock >>

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Filed under International Econnomic Politics, National Economic Politics