Wednesday, April 1, 2015

Shooting Fish in a Barrell

OK, since this article came out attempting to refute Keynesian (or rather, demand-side) macroeconomics, there have been enough takedowns from real economists that for a non-economist to join in the game may seem like piling on.  The argument rests on so many bizarre, unreal assumptions that showing them up may seem like shooting fish in a barrel.  Just for fun, I will add the comments of a few real economists as well.  All right, here goes.  The author is trying to understand how an economy can come to ruin from insufficient demand.
I want to think here of a complete economy peopled by real people who produce and consume things. Let's say four of them: a phone guy who makes phones, a burger flipper, a hairdresser and a tattoo artist. 
Hm.  I preferred Plato's imaginary four-man economy consisting of a farmer, a builder, a weaver and a shoemaker.  It seemed more likely to meet people's actual needs that a phone guy, a burger flipper, a hairdresser and a tattoo artist.  But maybe that's just me.  To continue.
Let's say that the burger flipper only wants a phone, the hairdresser only wants a burger, the tattoo artist only wants a haircut and the phone guy only wants a tattoo - around the circle in effect. 
That's a strange economy.  Apparently only one person in this odd little economy eats!  (At least burgers are the only food we hear about it producing).
We'll suppose that each can produce one phone, burger, haircut or tattoo and that each values the unit of what they want to buy more than the unit of what they can sell. That is, the hairdresser happily cuts hair if he can get a burger and so forth. 
Wait, WHAT??? Not only does this economy have only four people, but each produces only one item??  They'll all starve!  More seriously, I have never heard of an economic model that assumes each participant engages in only one transaction.  The whole point of economic models is to model a steady equilibrium.  Equilibrium can be achieved only with many transactions.
What happens is clear enough: the phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger. All are employed, all get what they want - everyone is happy.
Again, "manage to sell exactly one of their product" is not most people's definition of being "employed."  To most people, being "employed" means having regular, ongoing business.  And, of course, if you tried to even imagine an economy in which these four individuals did ongoing business, you would realize that the idea of an economy consuming tattoos and burgers at an equal rate (especially if burgers are the only food it produces!) is simply absurd.
Now suppose that the phone guy suddenly decides he doesn't like tattoos enough to be bothered building a phone. Now the circle is broken and this is a complete catastrophe. Everyone is unemployed. Demand is insufficient. There isn't enough consumption - none at all in fact. And notice how this works: one person - the stupid phone guy who is causing the problem by not wanting to buy a tattoo - is "voluntarily unemployed" - he is lazy and doesn't want to work. The other three are "involuntarily unemployed" each one is willing to work in exchange for pay. The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed.
OK, give the guy some credit for acknowledging that there can be involuntary unemployment when your customer base dries up.  But why is your customer base drying up?  According to Levine, because one customer just got lazy and decided not to contribute.  Time to defer to some professional economists. Brad DeLong: "But does anybody — save DKL — believe that an extraordinary and contagious outbreak of worker laziness is what caused the downturn that began in 2008?"  He goes on to point out that what actually happened was that assets (particularly assets securing debts) plunged in value.  Budgets took a huge hit as a result.  He further argues, as does Paul Krugman that when one member of the economy arbitrarily decides to quit working, that is actually a supply shock, rather like a crop failure, rather than a demand shock.  But then again, that is probably the whole point.  People like Levine don't actually believe in deficient demand, only in supply shocks.  But that honestly is not my main concern here.

To continue:
Now to the multiplier. Suppose . . . the government gives a phone to the phone guy. 
Wait?  Where did this "government" come from?  I thought we were in a four-man economy.  There is no government, at least not if you believe that government is not a mysterious thing, but made up out of actual flesh-and-blood human beings.
Why then he'll sell it for a tattoo (he doesn't have any use for a phone himself) the tattoo artist will use the proceeds to buy a haircut, and so around the circle. Full employment. Just put in one phone and you also get a haircut, a tattoo and a burger! That is the multiplier. . . Nothing mysterious here. 
But...this what an economist would call standard competitive equilibrium theory - meaning there isn't a free lunch, and indeed we better ask - how did the government get a phone to give to the phone guy?
Um, maybe it made the phone.  Government does make things, after all.  If phone guy can make phones, why can't government?
One is reminded of the old economics joke:
A physicist, a chemist and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, "Let's smash the can open with a rock." The chemist says, "Let’s build a fire and heat the can first." The economist says, "Let's assume that we have a can-opener..." 
Is the basis of Keynesianism that we should assume that the government has a phone to give away? 
**Deep sigh!**  Let's get this straight.  To assume a four-person economy is perfectly reasonable.  (Plato did it, after all!)  To assume that those four are a phone maker, a burger flipper, a hair dresser an a tattoo artist is reasonable.  (Plato would probably disagree on that!)  To assume that all four products are consumed at an equal rate is reasonable.  To assume that each of them can only make one product is reasonable.  To assume that that each of them making one product and engaging in one transaction chain constitutes full employment is reasonable.  To assume that recessions are caused by someone just getting lazy is reasonable.  And finally, to assume that this system has a government that has no phones and is incapable of making them is reasonable.  But to assume that the government can make a phone -- now that's just nuts!  After making such a far-fetched string of assumptions, we are far enough away from anything even remotely resembling reality that you might as well just flip a coin on whether to assume that government can or cannot make phones.  One seems just as good (or bad) as the other.
Well maybe not. Maybe the government should follow Keynes advice and print some money (or bury it) and give it to the phone guy. Then the phone guy can buy a tattoo, and the tattoo guy can buy a haircut and the haircutter can buy a burger, and the burger flipper - ooops...he can't buy a phone because there are no phones. There are two possibilities. One is that the burger flipper realizes he shouldn't sell the burger because he can't buy anything he wants with the proceeds, and we are right back where we started with everyone unemployed. Or maybe he doesn't realize that and gets left holding the bag. There is a word for that kind of scheme - it is called a Ponzi scheme and sometimes they work - people do make mistakes - and sometimes they don't - and it seems like a poor excuse for economic policy that our plan is that we hope the burger flipper will be a fool and be willing to be left holding the bag.
At this point I am fairly sure one of DeLong's columns pointed out that it is actually Milton Friedman who recommended printing money, not Keynes.  OK, so we are adding a new element into our little economy besides government -- money.  But he still doesn't explain why the assumption that governments are incapable of making phones.  He then goes off explaining that the government can only get a phone by taking it from someone else who already has one.  He gives as an example Greece an Germany -- the Greek phone guy is on strike and has collapsed the economy.  For the Germans to give him a phone would collapse the German economy.  But the series of far-fetched assumptions is so great here as not to be even worth refuting.  Next:
Now there is something else we can try: we could force the phone guy to make the phone - then he might as well sell it and get the tattoo, and the world is good - for everyone except the phone guy who is forced to build a phone he'd rather not build. Now there is a sense in which that might be worth it - after all, we helped three people - the tattoo artist, the hairdresser, and the burger flipper at the expense of one - the phone guy. But then let's at least not pretend that there is a free lunch - let's be honest and say that we are screwing the phone guy to help everyone else. It doesn't seem that this is what Keynes or the Keynesians are talking about - and forcing people to work against their will probably seems pretty fantastic as an economic policy...but let's go back to the example of World War II because that is exactly what the government did - not only did they spend a lot of money that they borrowed or printed, but they also drafted soldiers into the military and forced a lot of businesses to produce and do things they would really rather not have done. And certainly while economic activity may have picked up a great deal during and after the war - it is doubtful that the draftees who died in the war benefited much from this.
Look, I don't think anyone favors a return to the sort of command economy we had during WWII, let alone all the bloodshed involved.  But then again, considering that the alternative was letting Hitler win, I think most of us would agree that the war was the lesser evil.  Levine's overall message appears to be, if phone guy goes on strike, the whole economy collapses and there is nothing that can be done about it.

Nick Rowe offers his own startling refutation -- in this economy, phones are the medium of exchange.  Unlike anything else in this model, that actually makes sense.  Half of this economy consists of services.  Services just aren't as portable as goods.  If the tattoo artist wants to buy your product but you don't want a tattoo, it seems most unlikely that you will agree to let the artist tattoo you anyhow, so you can peal it off and hand it to someone else who wants a tattoo.  Burgers are a good, but (hockey puck jokes aside) they are perishable.  If an economy had no currency and only one portable, durable product, it does seem likely that people would use that product as a medium of exchange.  (Or, in Plato's four-man economy, the builder would do well to build up a large store of grain, cloth and shoes to use as exchange if no one wants a house built right now).  Hence, Rowe says, the government can make phones; making phones is its whole job.

Since then I see that Levine has come back with a rejoinder.  He knows that phones are the medium of exchange in his economy.  They represent the gold standard, or commodity money in general.  I suppose that does explain why the government can't make phones.  Gold supply is entirely dependent on how much gold is mined out of the ground, a matter the government has no control over.  Levine seems to see this as an argument for the gold standard (or at least some kind of commodity money). Fiat money is a Ponzi scheme, leaving people with worthless pieces of paper.  Commodity money will always keep flowing because it has intrinsic worth.

Funny thing, but it doesn't seem like a very good argument for the gold standard to me.  We would have to imagine, then, that phone guy, instead of making phones, mines them out of the ground. Sometimes, through nobody's fault whatever, and purely as a result of poor geological conditions, he may run into a snag and be unable to mine any more "phones."  As a result of technical difficulties beyond anyone's control, the whole economy can suddenly collapse.  (NOTE:  That actually did happen under the gold standard.  Quite a lot).  I don't know about you, but that seems like a lousy way to run an economy to me!

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