Economics as Medicine

It is interesting the way people react to various economic proposals on what should be done about the current economic malaise. The two most divergent proposals are those of the Keynesians and the Austrians, with most other proposals being somewhere on a spectrum between the two.

It is interesting because of the disaster that Keynesian economists predict were Austrian proposals to be implemented. If an analogy were to be made between economics and medicine, with the economy being a sick patient, it highlights the absurdity of some of the Keynesian predictions of doom.

Imagine a patient is brought to a hospital with a broken leg. The patient is in pain and unable to walk. Doctor Keynes wishes to give large doses of pain killers, while Doctor Hayek wishes to set the bone before applying a cast. Hearing what Dr. Hayek plans, Dr. Keynes interjects with "There will be a lot of pain while you set the bone. I am interested in treating the patient's pain, your proposals only cause more pain."

Or if a patient is brought in with operable cancer, Dr. Hayek would suggest surgery and a few weeks of recovery. Dr. Keynes would point out that there will be harm caused by the scalpel going in, harm caused to the skin and muscle covering the tumor, and great difficulty for the patient in recovering from the tumor.

These comparisons are absurd, because if the subject were medicine there would be no argument about setting a bone or operating to remove a tumor. But the comparison is also valid.

The Austrian method of ending a recession or a depression is to allow malinvestments to liquidate and to remove barriers to growth. The Keynesian method of ending a recession is to stimulate aggregate demand through fiscal policy, as well as by any other interventionist method since no Keynesian in practice is confined to fiscal policy. Therefore failing industries would be subsidized until theoretically they are no longer failing, and prices that need to fall would be propped up through loose fiscal and monetary policy to prevent the specter of deflation.

Every Keynesian proposal treats a symptom. But what of the actual cause of the ailment? It is the well known "animal spirits", which are not a rational explanation of the cause. Austrian economics, on the other hand, tries to do a diagnosis.

Yes, transition to sound currency and balanced budgets would cause economic turmoil during the transition, and yes some people - especially those who depend on unbalanced budgets and fiat currency - would be hurt. In the long term the short term pain would lead to long term health, like setting a bone.

The Omniscience Fallacy

Austrian economics views people as rational actors when making decisions in the market, which is one of the many reasons government intervention is frowned upon. If a person wants to make one decision, and the government forces a different decision, then by definition that person is doing something they would normally consider irrational if not for the threat of government force.

Ayn Rand calls man the "rational animal" saying that reason is the tool of survival for man. She decried the use of government to intervene on the basis that since reason is the tool of survival, forcing a person to act differently is to force the person to act against their own survival.

Both of them would have that a person acting within the confines of their knowledge and desires will attempt to make the decisions that are best for themselves.

This runs into an interesting claim sometimes made by Progressives and Keynesians, that there is no way to consider a person to be a rational decision maker based on not having enough facts with which to make a decision. Supposing a person wants to buy a computer, and he compares several brands at several stores before coming to a conclusion based on cost, capability, and his needs. Well, the progressive will claim, if there is another model out there that still even more closely fits his needs then he didn't make the most rational decision.

By their unfairly high standard, it is impossible for anyone to make a rational decision. This clearly calls for the decision maker to know everything in order to make a decision. It is an attempt to deny that decisions are made rationally in the first place.

Accusing the progressive of demanding omniscience will only result in denials of that charge and a clarification that the person only need to know all the relevant information. But the problem is, that is omniscience. Suppose that same computer goes on sale the next day? Buying it that day will result in what is, from the progressive point of view, an irrational decision.

The irony here is that while creating a strawman in order to "prove" that an individual lacks sufficient facts, the progressive is undermining their own belief system. It is progressivism that believes that central planners can indeed have enough information to make plans, not only for themselves, but for others as well and for the economy as a whole.

The "rational" definition used by both Austrians and Objectivists clearly states that people are rational within the confines of their knowledge. Claims to the contrary are fallacies.

Why Monetarism?

Although Monetarism, as an interventionist economic policy, clearly isn’t libertarian, people continue to consider it as such. The basic difference between Keynesian Economics and Monetarist Economics is that one favors fiscal policy while the other favors monetary policy as a way for the government to manage the economy through the manipulation of aggregate demand.

And yet many people do consider Monetarism to be more libertarian, to the point where if a spectrum is arranged Monetarism is listed as basically a midpoint between Keynesian and Capitalism.

Considering Keynesian Economics, a reason to consider it as such is because all Keynesians are both Monetarists and Progressives, they believe in both monetary policy and in regulation as ways to manage the economy. A textbook Keynesian is no closer and no farther from libertarian than any Monetarist.

So there is reason to make a spectrum. But why go so far as to insist that instead of being a midpoint between real Keynesian and libertarian Capitalism, Monetarism is so often wrongly lumped with Monetarism?

It would best be described by Rothbard’s Law. "people tend to specialize in what they are worst at. Henry George, for example, is great on everything but land, so therefore he writes about land 90% of the time. Friedman is great except on money, so he concentrates on money." Rothbard went farther to describe Friedman in even harsher terms, saying "And so, as we examine Milton Friedman’s credentials to be the leader of free-market economics, we arrive at the chilling conclusion that it is difficult to consider him a free-market economist at all."

Then perhaps there is one reason left why people would consider Monetarism to be libertarian in any respect. It is because the current center of United States politics is so far devolved towards the regulatory state, with the government enmeshed in so many aspects of the American economy that to embrace textbook Monetarism is to embrace a reduction in the government's role in the economy.

Unfortunately there is a lot of room between slightly decreasing the role of government and actual libertarianism. Being in favor of slightly less regulation, slightly less control, slightly less taxing and spending, does not make one a libertarian.

Debt to GDP

Government debt as a percentage of GDP is a popular measurement to determine if a government is spending too much, with various "thresholds" given for when the debt gets too excessive. Unfortunately it is not a good measure in itself.

The first problem is with the items being measured. GDP is measured with the formula "Y = C + I + G + ( X - M )", or GDP is equal to consumption plus investment plus government spending plus exports minus imports. Although there are many criticisms of GDP the worst is that it includes government spending as a positive component.

Government spending is, at best, a transfer instead of an actual investment or consumption. A measure of the GDP that leaves that out would be "Y = C + I + X - M". But given that there’s inefficiency in the process, every government dollar spent is actually a drain on the economy. They Keynesian "multiplier effect" is a myth unsubstantiated by actual results. To measure the full effect of GDP would be to subtract government spending, giving "Y = C + I + X - M - G".

The other part of the ratio, the debt, is also a problem. The government debt is not a stationary target, but is moving, which means to get an effective measurement includes the deficits. That means government spending is on both sides of the ratio. Increasing government spending will increase both GDP and Debt, making all ratio measurements unreliable.

The second problem is that debt to GDP is used to measure a government's ability to repay the government debt. That implies that the government has a claim on the GDP of a country, which implies that the government has a claim on the whole of the wealth of a country. Any attempt to claim that wealth in an effort to pay off the debt would destroy the economy and deplete the wealth of the country.

Third, given that both parts are moving targets, an 'improving' ratio doesn't necessarily show any greater or lesser responsibility on the part of politicians. If the debt increases slower than the GDP climbs, or if the debt decreases but the GDP decreases by a smaller amount, the result is the appearance of improvement. Reverse the ratios and it gives the appearance of economic degradation. In the first half of each example, debt increased. In the second half of each example, the GDP declined. None of those are good, but two of them give the appearance of a better economy.

Fourth, the measures can be manipulated. Take a country with a debt to GDP ratio far in excess of 100%, such as 130% or higher. That country's government can use the central bank to monetize the debt and borrow money a thousand times more than owed before, such as a country that owes trillions can create quadrillions. The government can then spend the money. That would surely alter the GDP equation, with G increasing by an exponential amount while C, I, X, and M trend towards zero, leaving Y increasing while basically equaling G. Debt would also be basically equal to the newly created money, leading to a debt to GDP ratio of approximately 100%. By those who favor debt to GDP as a measure, that leads to the conclusion that the economy of that country has improved, while any objective measure would show hyperinflation and the collapse of the economy.

There really is little use in debt as a percentage of GDP. It doesn't measure what it is supposed to measure, it is very prone to manipulation, and its components aren't very as reliable as one would desire in an economic measure.

Fallacy of the Broken Window

Anyone who has studied economics is familiar with the parable of the broken window. One day in a peaceful small town some kid throws a rock through the Baker’s window. Understandably the baker is upset about this because now he has to buy a new window. A Keynesian economist comes along and declares this to be a good thing because this stimulates economic activity, as the Baker will buy a new window enabling the Glazer to make purchases he would not have otherwise been able to, creating a ripple effect throughout the economy. He calls it "The Parable of the Broken Window."

But a Misean economist comes along and calls it "The Fallacy of the Broken Window” instead of "The Parable of the Broken Window" because the Keynesian assumes the Baker's money was doing nothing and is now being put to use. The Misean says that we do not know what the Baker might have done with the money, what he would have spent it on instead. The Baker might have purchased, for example, a newer and better oven, increasing his productivity. Instead of everyone being better off, because bread is now cheaper and more plentiful, the town is really only poorer by the amount of one window. This is commonly referred to as the problem of the unseen.

Socialists and Keynesians hate the fallacy of the broken window. It undermines their entire view. Creative destruction and central planning do not create wealth if the story of the broken window is considered a fallacy instead of a parable. But for a long time the only response was to say that calling it a fallacy is wrong. But now it seems there is circulating in the discussions of central planners a new counter to "The Fallacy of the Broken Window." Some central planners are starting to call it "The Fallacy of the Fallacy of the Broken Window."

Their argument is that we do not know that he would have spent the money in a productive manner. Since we do not know that the money would have been used productively if the Baker's window were not broken, and we do know that the money was used productively since the Baker’s window was broken, the certainty of productive use in the latter situation means that the problem of the unseen is a fallacy and therefore advocating for the former situation is uninformed.

There is a major problem with that counter argument.

While it is true we do not know exactly what the Baker might have spent the money on otherwise, we do know it in a few broad categories. He would either have saved it, spent it, or given it away.

If he gives it away then the three options pass on to another person, who either spends it or saves it or give it away. Eventually the wealth will get spent or saved, so this option can be ignored as simply regression.

If he spent it, then it is a given it would have been spent in a productive manner given that people do act in their own rational self interest within the confines of their knowledge. To say it was spent in an unproductive manner is a subjective value judgment that Keynesians are not actually capable of making. This is also true if the recipient of giving the money away spends it.

Finally if he saves it, it is a use. This is the biggest Keynesian stumbling block, but as all Miseans know saving is not detrimental to the economy. Saving is how a person is able to consume in the future. The Baker might be saving up for that new oven, and in another month would have been able to purchase it, but now cannot because his savings must be spent unproductively on a new window. If the money is saved in a bank, the bank lends it out for economically productive purposes. But even if the money is saved in a box buried in the back yard it is still being put to the economically useful activity of saving for the purpose of future consumption.

The central planner's response to "The Fallacy of the Broken Window" by calling it “The Fallacy of the Fallacy of the Broken Window" is actually "The Fallacy of the Fallacy of the Fallacy of the Broken Window."