Home > Uncategorized > Follies and fallacies of Chicago economics

Follies and fallacies of Chicago economics

from Lars Syll

Savings-and-InvestmentsEvery dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

John Cochrane

And the tiny little problem? It’s utterly and completely wrong!

What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments, and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity there is of course nothing to say about the law, but as such it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex ante and ex post adjustments. And as further stressed by a famous English economist about the same time, what happens when ex ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex ost. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

Government borrowing is supposed to “crowd out” private investment.

william-vickrey-1914-1996The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

In a lecture on the US recession, Robert Lucas gave an outline of what the new classical school of macroeconomics today thinks on the latest downturns in the US economy and its future prospects.

lucasLucas starts by showing that real US GDP has grown at an average yearly rate of 3 per cent since 1870, with one big dip during the Depression of the 1930s and a big – but smaller – dip in the recent recession.

After stating his view that the US recession that started in 2008 was basically caused by a run for liquidity, Lucas then goes on to discuss the prospect of recovery from where the US economy is today, maintaining that past experience would suggest an “automatic” recovery, if the free market system is left to repair itself to equilibrium unimpeded by social welfare activities of the government.

As could be expected there is no room for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply side policies.

Lucas is convinced that what might arrest the recovery are higher taxes on the rich, greater government involvement in the medical sector and tougher regulations of the financial sector. But – if left to run its course unimpeded by European type welfare state activities -the free market will fix it all.

In a rather cavalier manner – without a hint of argument or presentation of empirical facts – Lucas dismisses even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead – “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” – this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do over and over again in their attempts to explain away the fact that the latest economic crises shows how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be government.

Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich. Trying to explain business cycles in terms of rational expectations has failed blatantly. Maybe it would be asking to much of freshwater economists like Lucas and Cochrane to concede that, but it’s still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas or John Cochrane was. John Maynard Keynes, on the other hand, will still be known as one of the masters of economics.

  1. Michael Robinson
    November 23, 2016 at 9:28 am

    “Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich.”
    But the question is, if so, given the unquestionable political success of Chicago economics, then why?
    Consider (emphasis added):
    “International free trade involved no less an act of faith. Its implications were entirely extravagant. It meant that England would depend for her food supply upon overseas sources; would sacrifice her agriculture, if necessary, and enter on a new form of life under which she would be part and parcel of some vaguely conceived world unity of the future: that this planetary community would have to be a peaceful one, or, if not, would have to be made safe for Great Britain by the power of the Navy; and that the English nation would face the prospects of continuous industrial dislocations in the firm belief in its superior inventive and productive ability. However it was believed that if only the grain of all the world could flow freely to Britain, then her factories would be able to undersell all the world. Again, the measure of the determination needed was set by the magnitude of the proposition and the vastness of the risks involved in complete acceptance. Yet less than complete acceptance spelled certain ruin.
    “The utopian springs of the dogma of laissez-faire are but incompletely understood as long as they are viewed separately. The three tenets–competitive labor market, automatic gold standard, and international free trade–formed one whole. The sacrifices involved in achieving any one of them were useless, if not worse, unless the other two were equally secured. It was everything or nothing.
    “Anybody could see that the gold standard, for instance, meant danger of deadly deflation and, maybe, of fatal monetary stringency in a panic. The manufacturer could, therefore, hope to hold his own only if he was assured of an increasing scale of production at remunerative prices (in other words, only if wages fell at least in proportion to the general fall in prices, so as to allow the exploitation of an ever-expanding world market). Thus the Anti-Corn Law Bill of 1846 was the corollary of Peel’s Bank Act of 1844, AND BOTH ASSUMED A LABORING CLASS which, since the Poor Law Amendment Act of 1834, WAS FORCED TO GIVE ITS BEST UNDER THE THREAT OF HUNGER, so that wages were regulated by the price of grain. The three great measures formed a coherent whole.”
    Polanyi, Karl. (1944) The Great Transformation: The Political and Economic Origins of Our Time
    It’s as simple as this: if the poor do not pay for the mistakes of the rich, free-market economics does not work, and cannot be made to work. We can dress it up with euphemisms (e.g. “competitiveness”, “labor productivity gains”, etc.), but rebalancing of trade by adjustment of wage levels through the threat of hunger is, and has always been, an essential requirement for a functioning free-market economy.
    If the Chicago School promotes free-market economics, it implicitly promotes coercive adjustment of wage levels (“the poor having to pay for the mistakes of the rich”). One cannot exist without the other.
    It is the task of a school of economics which promotes free markets to provide political cover for policies which have the effect of punishing the poor for the mistakes of the rich, because without such political cover, the poor will resist such policies, which is, as Polanyi explains, the single greatest threat to the continuation of free markets (cf. Greece).
    The fact that such political cover may take the form of “a dangerous pseudo-scientific zombie ideology” is rather beside the point. The only measure of success is the degree to which it is able to support the implementation of policies which result in involuntary wage adjustment (i.e. “punish the poor”) (cf. Greece again).

  2. Billie Knighton
    November 23, 2016 at 12:19 pm

    Whatever happened to the “multiplier effect”?

  3. November 23, 2016 at 3:05 pm

    Some speculate that the reason humans have not found evidence of other sentient life transmissions in the cosmos is that global climate collapse has not yet been solved anywhere before life is extinguished. This is where economic growth leads to at this time in Earth history and it is reasonable to wonder if this has occurred on other planets in other galaxies.

    The longevity of Chicago economic school underpinnings of military empire illustrates the impotency of the rest of academic economics to supply a countervailing logic to austerity and economic class royalty.

    Over and over again we hear and read weak economic reasoning used in a false attempt to distance decent human economists from grotesque war mongers who will destroy the entire planet in a vain attempt to satisfy their gnawing want of insatiable greed. Each new conquest by individuals afflicted with insatiable want is like a temporary heroin fix for an addict. Humanity has no choice but to accept the obvious evidence that infinite capitalist growth be it 3% or 9% per year is a form of sociopathic mental illness.

    Deficit spending and subsidies are essential to Koch brothers style capital acquisition and their class has skillfully possessed the balanced budget position. Include all externalized chemical pollution and a growing cancer epidemic in the subsidy category and one begins to see the sickness of wealth seeking more wealth at any cost.

    There is another kind of economic reasoning that does not support university supported Chicago style piracy as a part of economics and instead sees it as a criminal propaganda enterprise. The granting of borrowing and subsidy authority to any government is the death knell of democracy. There is no elite educated bureaucracy capable of rationally deciding what to spend debt or subsidy on without destroying democracy and eventually all life on Earth[.

    The reason that democracy is central to economics twofold; it is a tool to facilitate information flow and it is the only known way to focus distributed human intelligence.

    Check November 20, http://www.zerowastenews.org for a short description and source revealing the 420 unique chemicals routinely found in the human body that are known or suspected carcinogens.

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