Let’s assume for a moment that Keynes was correct in the 1930s that increases in aggregate demand by government do indeed increase GDP. This is actually not something most economists, including many from the Chicago and Austrian schools of thought challenge. It’s hard to deny that once a variable in the GDP equation is increase it would in turn increase GDP. Obviously GDP is measured as private consumption + gross investment + government spending + (exports – imports;) So of course if you increase the variable that is government spending then GDP increases. That’s not what I’m saying “let’s assume;” Let’s assume that government spending increases general welfare with employment (though I feel the assumption is factually incorrect) and can fill in the hole of slacking private investment. The premise of this relies on an increase in aggregate demand by government, which makes up for the lack of private investment; this does not require that the multiplier be more than 1 (meaning you’d spend more money than you’d receive back in general welfare.)

Assuming that, let’s also run with facts that we have; currently U.S. employment from manufacturing is ~7% vs ~30% during the Great Depression. Let’s also note that many economies in the Far East rest their economic strength solely on exports and thus artificially devalue their currencies, and give their domestic companies export subsidies to lower the cost of goods to the U.S. and other trading partners. Likewise, let’s concede that current U.S. trade balance for June 2010 was $-49.9 Billion, where exports decreased from $150 Billion from $152 Billion (May 2010); while Imports increased to $200.3 in June from 194.4 Billion in May. For goods, the deficit was $62.0 billion in June, up from $54.3 billion in May. For services, the surplus was $12.1 billion in June, down from $12.4 billion in May. Notice anything strange about these numbers? Though the services sector was in decline, the deficit for goods on the U.S. balance of trade increased. Similar diversions have occurred in spite of the economic stimulus package. How is that possible?

I hypothesize (though I can’t show any hard numbers) that the stimulus which relied on increases in aggregate demand for “goods” rather than “services” leaked out of the U.S. economy at a rate much higher than what was seen during The Great Depression, and we can see this in our trade deficit. If we review the equation for the GDP equation we note that the number also includes (exports-imports) which in a quarter at the rate of -49.9 Billion a month ends up around ~$250 Billion. At the rate of $8 Billion in deficit increases per month in a given quarter that is ~$32 Billion, or roughly 8%. Given this hypothesis, the multiplier would be impacted negatively, by ~1% (assuming it was a multiplier of 1). That’s not a big number, but if you consider that the average multiplier from government spending is from .50 to .80, it is actually a more substantial percentage of the multiplier itself; and more around 9%; So ~9% of the actual multiplier was diminished, as a result of it leaking from foreign outflows. This is all, non-technical, and a roundabout method mostly doing small calculations, but the multiplier could theoretically fall from .50 to .45. You have to consider that the stimulus package contained $200 Billion in tax cuts which according to Keynesians would be horded by consumers instead of spent, then you have an even bleaker picture of government spending’s impact on aggregate demand and domestic GDP.

So what caused the economy’s rebound if not government spending? I think Friedman’s pluck theory answers that question. Generally recoveries are proportional to their declines, the Federal Reserve inserted trillions into the financial sector through loans, and businesses had to replenish their inventories…I hardly see any room in the [brief?] recovery to point at government spending as a large player.

Basically what I’m saying is that the U.S. economy has so evolved away from manufacturing of goods, that it’s hard to justify trying to increase aggregate demand with government spending. Keynes could have been right (though I say he wasn’t) that spending could increase welfare, but I don’t think that the modern economy in the U.S. supports this notion, and I think the numbers agree with me. This is obviously what Krugman would call “wonkish,” but I believe that the numbers are highly suspect…and it’s interesting that the trade deficit numbers increased even though the heights of the U.S. dollar index….all of this to me screams, “this isn’t working.” Arnold Kling wrote a similar argument in November of 2009, and I even stole one of his graphs.

The most important function that markets serve is the allocation of resources, but it isn’t very often that we are taught that prices are a feedback of market demands which allow for this process to occur. The price system is an intrinsically important part of the market structure, in the same way that our nervous system is an essential part of the human body. If you share this view, then the market is in many ways a natural occurrence through the interaction of human beings, in the same way that there are relationships within nature which require the cooperation of smaller agents to form larger eco-systems. The problem that economists such as Friedman, Hayek, and Mises have pointed out is that the distortion of this system presents a problem of distorting the feedback process and thus gives producers the incorrect information hampering their ability to properly allocate resources.

For the sake of analogy, let us suppose that we interfere with an internal eco-system. Suppose we take a pain killer, then we stick our hand on a stove. The pain killer may dull the pain just enough to prevent us from moving our hand in a timely manner and now we have significant nerve damage along with severe burns. Though the burn did not hurt as much as it would have, our body received faulty feedback and ended up having a significantly larger amount of damage despite the information that our brain was receiving that says otherwise. That is a small and perhaps poor analogy of price systems. Price systems are the “nerves” of the economy in many senses, and if we put in price ceilings which prevent pain of high prices, the allocation of resources cannot properly be achieved.

Under systems such as socialism or communism, we find that if prices are centrally planned, there are significant distortions in prices and thus we find large disparities between resources that are given and resources that are desired. Under an economy that is entirely centrally planned, how do we know which is more rare, gold or copper? Under the market system the prices serve as the function which communicate to market agents that gold is indeed more rare than copper. How do we know this is the case? Simply put, gold costs more. The system is still far more complex than that, because you also have to considering the wants and needs of market agents. Once you realize that this series of computations occur naturally through market forces it becomes easier to see the shortfalls of centrally planned systems.

A retort to this could be that the brain is a central planner, except it’s really not. The brain adjusts to information that it receives through its nervous system. You don’t consciously try to breathe or blink, it occurs naturally through information that stems from the nerves in your body. The information is fed to different parts of your brain which you have no idea even occur, the brain itself is very much spontaneous and runs off of a market-esque system. It’s this insight into nature that have led some economists such as the Physiocrats to treat the economy as a human body that can be cured with things such as bloodletting.

Friedman, who based this idea off of Hayek’s “The Use of Knowledge in Society”, proposed that prices serve 3 functions:

1. They transmit a very wide range of information. They transmit information about the availability of goods today versus tomorrow though futures markets, and so on.
2. They serve as an incentive for people to adopt the least costly methods of production and to use available resources for the most highly valued uses.
3. They serve their second function, so that they may perform their third function, which is to determine who gets what and how much – the distribution of income.

Friedman notes that the distribution of income is quite often a major source of dissatisfaction within an economy, and this occurs no matter what the system may be; be-it a command economy or a market economy. From Friedman’s essay “Market Mechanism and Central Planning:”

I am reminded of a remark made by Alvin Johnson many years ago when he was conducting a study of incomes in difference occupations. He found that physicians complained that lawyers were getting more than physicians, and lawyers complained that physicians were getting paid more than lawyers…[the same occurrence occurred between carpenters and plumbers]…Johnsons finally concluded that life was an underpaid occupation.

A legitimate argument isn’t that prices are an improper transmission of information, but that we also have social “costs,” which are not reflected in the price system. I believe this is generally where some free-market economists start to diverge from each other, into total laissez-faire and positive economics. The idea of positive economics is basically to say that we can have social programs so long as they are dictated by markets, while more laissez-faire economists believe that there is a delicate eco-system which should not be tampered with because even small “static” in the information could cause improper resource allocation.

Some people in government have seen the price system as so powerful that they believe that they can raise “dirty” energy prices with legislation such as “cap and trade,” to give the market the signal that it needs to develop alternatives. Likewise the Federal Reserve lowers interest rates in order to find a delicate balance between inflation and unemployment. The problem with both of these is that in the case of cap and trade it leads us away from Friedman’s 2^nd function of prices. In the case of the Federal Reserve the rate of interest can affect the nominal rates of prices and distort entire eco-systems such as the housing market. It is for this reason that while there is a strong disagreement between The Chicago School and Austrian Schools of economics both acknowledge the distortion of prices by the Federal Reserve. They both have difference solutions, in the Friedman case the K% rule allows the money supply to expand with the rate of population and GDP in order to maintain a price stability that allows information to be transmitted since prices are stable in real terms. The Austrian view is that the market sets the supply of money and that too is an important market function. To which is right? I’m not sure, but I would put the argument that much like the body needs blood you don’t want your blood level to decline or rise too rapidly…or to become too thin (velocity?)

This problem of information through prices is unfortunately missed by many modern “conservatives” in the mainstream, and thus they start to lose the moral argument for free markets. Hayek stated that this problem of information and distortion of price systems was the ultimate debunk of socialism, period. I can’t help agree with his observation, but unfortunately I believe that the “static” in the economic arguments often prevent this argument from being a forefront of the moral argument for free markets. Perhaps the problem of information extends into the political world…which is all the better to keep its hands off of more important information eco-systems.

Example of price distortion:

This is a poem first published in 1705 from “The Fable of the Bees or Public Vices, Publick Benefits,” by Bernard Mandeville; it connects well with the the latter (in time frame) two of the past three posts about what makes the world go ’round.

The Grumbling Hive: or, Knaves turn’d Honest.
A Spacious Hive well stockt with Bees,
That liv’d in Luxury and Ease;
And yet as fam’d for Laws and Arms,
As yielding large and early Swarms;
Was counted the great Nursery
Of Sciences and Industry.
No Bees had better Government,
More Fickleness, or less Content:
They were not Slaves to Tyranny,
Nor rul’d by wild Democracy;
But Kings, that could not wrong, because
Their Power was circumscrib’d by Laws.
T h e s e Insects liv’d like Men, and all
Our Actions they perform’d in small:
They did whatever’s done in Town,
And what belongs to Sword or Gown:
Tho’ th’ Artful Works, by nimble Slight
Of minute Limbs, ’scap’d Human Sight;
Yet we’ve no Engines, Labourers,
Ships, Castles, Arms, Artificers,
Craft, Science, Shop, or Instrument,
But they had an Equivalent:
Which, since their Language is unknown,
Must be call’d, as we do our own.
As grant, that among other Things,
They wanted Dice, yet they had Kings;
And those had Guards; from whence we may
Justly conclude, they had some Play;
Unless a Regiment be shewn
Of Soldiers, that make use of none.
Va s t Numbers throng’d the fruitful Hive;
Yet those vast Numbers made ’em thrive;
Millions endeavouring to supply
Each other’s Lust and Vanity;
While other Millions were employ’d,
To see their Handy-works destroy’d;
They furnish’d half the Universe;
Yet had more Work than Labourers.
Some with vast Stocks, and little Pains,
Jump’d into Business of great Gains;
And some were damn’d to Sythes and Spades,
And all those hard laborious Trades;
Where willing Wretches daily sweat,
And wear out Strength and Limbs to eat: Read more…

As I posted here the propensity of the economic dialogue generally consists of the poor becoming poorer, and the rich becoming richer. However as western societies have advanced at a tremendous pace many of the life essentials have slipped and many of the luxuries have climbed the charts to near necessity. I would attribute this to the need for individuals to establish a “status.” Many of the poorest people in the U.S. still have items which are considered quite luxurious in many countries; people give up paying for their health insurance, healthy food, etc…and trade it for cable access, large televisions, etc. This isn’t to say that many of the poor aren’t left behind, which results largely from sprawl and the lack of education….however the fact remains that while some people do remain poor, they still waste a lot of food, clothing, land, etc. As many have experienced, even in my own personal experience, children in schools would get discounts for being underprivileged, but at the same time would be driving a pretty nice car, have the latest phone, etc. This chart helps to illustrate what many people consider to be the necessities of life, some people have now even considered internet access a “human right.” I don’t know if this is a bigger sign of a social agenda or the strong upward progress of human living conditions over just the past two decades (most likely the latter). You can see the rest of the study which these charts were derived at Pew Research Center:

When it comes to income levels, the story is different. Here, the pattern tends to play out in one direction only: the more income a person has, the more likely he or she is to view goods and gadgets as necessities rather than luxuries.

However, the degree of variance varies. For some items, it is fairly significant and for others it is minor or non-existent.

Income makes a big difference when it comes to three information era items – home computers, high-speed internet access and cell phones. It also has an effect on attitudes toward one old warhorse of a home appliance – the dishwasher; and on one creature comfort – the car air conditioner.

It makes a smaller difference for cars and for clothes washers and dryers.

And it makes virtually no difference for a mixed bag of items, including home air conditioning, a microwave, and a battery of entertainment products, including a television, high definition television, satellite and cable TV services, and an iPod.

Overall, some 45% of adults with family incomes of $100,000 and above rate at least 10 of these 14 items as necessities, while just 15% of adults with incomes below $30,000 do the same. In short, the more money you have, the more things you need.

This quotes from Pew indicates that income has a heavy effect, however the percentage growth in the “needs” far exceeds the income growth between 1996 and 2006.

I just read an article about how self proclaimed environmentalists buy goods labeled “green” strictly for their social status. According to the study:

“…a series of experiments showed that activating status motives led people to choose prosocial green products over more luxurious, equally priced non-green products. In line with the predicted reputational benefits of self-sacrifice, status motives increased desire for less-luxurious green products when shopping in public, but not in private. Indeed, when people considered shopping in private, status motives produced a tendency toward self-indulgence rather than self-sacrifice.”

This reminds me of an idea I’ve had meddling in my head for a while, which may seem either obvious or crazy…that all of life involves trying to impress someone. I believe we all do it, and it’s because we want to find people like ourselves or people interested in us. Whether it’s turning up your favorite song secretly hoping someone will notice your musical tastes, wearing a t-shirt “expressing” yourself, going to church or giving a nod to someone with the same model of car as you…we always have a tendency to want to reach out. Even people who are loners are looking for people like themselves, or at least secretly hoping to find someone who “understands them.” They aren’t alone though, at least I don’t think they are, I believe everyone has a longing for recognition.

Life is full of incentives and I’d say the biggest incentive is recognition; and I believe this is why some children feel detached from their parents, they feel the need for rebellion because they didn’t get the recognition they feel they deserved. This idea could explain why there is strong correlation with single parent homes and higher rate of crime. I read a paper trying to disprove this fact of single parent homes and violence saying that step-parents entering the family did not lower the crime rate. I think this ignores a lot of data, such as when did the step-parent enter the family? That’s an important question, because based on my hypothesis the family is innately tribal and thus any instability in that tribe is going to rub off on all members. Once the child passes a certain age, the child is going to be drawn to a tribe that will recognize them…such as a gang or just a group of friends with bad influences.

Apart from the connection with crime, it also has a connection with wealth. How do you prove that you’re wealthy? You waste things. Think about it, a bigger house with bigger rooms, high ceilings; bigger cars, eating at expensive restaurants, buying more expensive goods. It’s apart of life, waste is a status symbol; It may not seem like waste, but anything in excess (waste) of standard living conditions is considered wealth. When a good that once was beloved by the wealthy becomes available to the masses, the wealthy generally abandon it or improve upon it. That’s what drives societies, it’s why capitalism works. Various studies have shown that the wealthy steer toward goods that the masses can’t afford, and the poor try to obtain the goods that the wealthy can afford. In the progression of society, the poor has benefited much more from this chase, even though the rich generally do become richer in the most advanced societies…the progession of material wealth (non-monetary) generally works toward the poor. Since 1980 the rich have been a fast growing base of capital, however can we really just measure wealth in money in stocks or bonds? Since that time, the number of televisions per household has increased drastically, as graphed below:

Not only has TV ownership improved, so has home ownership, computer ownership, mobile phone ownership. While the rich have gained, so have the poor, possibly even more so. There are very few things in the U.S. which can be obtained by the rich but not the poor thanks to market forces. In the U.S. being poor currently consists of being obese, only having 2 televisions, basic cable, and one family car; in other countries it consists of one serving of rice a day, and malaria. As Milton Friedman noted in Free to Choose:

Industrial progress, mechanical improvement, all of the great wonders of the modern era have meant little to the wealthy. The rich in ancient Greece would have benefited hardly at all from modern plumbing — running servants replaced running water. Television and radio — the patricians of Rome could enjoy the leading musicians and actors in their home, could have the leading artists as domestic retainers. Ready-to-wear clothing, supermarkets — all these and many other modern developments would have added little to their life. They would have welcomed the improvements in transportation and in medicine, but for the rest, the great achievements of western capitalism have rebounded primarily to the benefit of the ordinary person. These achievements have made available to the masses conveniences and amenities that were previously the exclusive prerogative of the rich and powerful.

All of these advancements were in the name of trying to impress someone…raising your social status. Studies also show that productivity among men in the work place rises when women are around. How does this fit into my hypothesis? Well, men naturally try to impress women…it’s an incentive of recognition. I think my hypothesis (which I’m not sure I’ve made all-too-clear) can help explain why people are currently experiencing a faster growing need for recognition. I think this is largely an evolutionary thing, and has a lot to do with just living in a wealthy society as well. In the past 20 years the world has become much smaller, but at the same time things have drifted apart. The family is now smaller, more liberal, and much less tribal. So now people are looking for recognition outside of the family, because they can. This probably leads to a sense of dissatisfaction and it takes more and more attention to relieve the need for it…and people are less impressed, less impacted by things because our society is wealthy. So now people are finding new ways to renew their statuses, such as going “green,” people are shifting away from waste and trying to establish a political identity. People are less concerned with living the lifestyle associated with it, but instead are looking for recognition…in a very tribal manner. Then sometimes we give up the essential things for the nonessential…not because it adds real value to our lives, but because it adds the perceived value of our lives, at least in a spiritual sense. Though at the same time, perhaps it does add real value. The spirit can be killed by the lack of luxuries (see socialism.) It’s a theory, I could be wrong. I had more to say, but now it’s 2am.

“Give me the luxuries of life and I will willingly do without the necessities.” – Frank Lloyd Wright

Friedrich von Hayek’s classic book “Road to Serfdom” has jumped to #1 on Amazon’s best sellers list, this is no doubt due to TV personality Glenn Beck’s endorsement of the book…however most people are probably going into the book with little knowledge of Hayek, so let’s fix that. Here is a brief run-down of Hayek’s life and his work which was conjured up for a class on Economic Thought.

Biographical Summary

Friedrich August von Hayek was born on May 8^th 1899, the son of a doctor in the municipal health service, and was the grandson of two prominent academics in the field of biology ad statistics. His father’s family had been raised to the ranks of Austrian nobility for its services to the state, with his mother’s family belonged to the wealthy bourgeoisie (owners of capital.) In 1917 he joined the regiment in the Austro-Hungarian Army and fought on the Italian front of World War I. Shortly after the war Hayek began to pursue his academic career and vowed to work for a better world and avoid the mistakes that led to World War I. In 1921 and 1923 after attending the University of Vienna, he earned his doctorates in law and political science, as well as studying in the fields of philosophy, psychology and economics.

During his time at the University of Vienna, Carl Menger and Friedrich von Weiser both left a lasting influence on Hayek’s economic and political views. On the recommendation of Weiser, Hayek began working under Ludwig von Mises, though Mises later shifted Hayek’s views away from those of Weiser with his book, Socialism. Later in the 1920’s, with the help of von Mises, Hayek founded and served as the director of the Austrian Institute for Business Cycle Research and joined the faculty at the London School of Economics. After the reign of Hitler pushed its way upon Austria, he refused to return to Austria and continued his work at the London School of Economics until 1950 when he became a professor at the University of Chicago, teaching in the Committee on Social Thought. Hayek went on to win the Nobel Prize in economics in 1974 and later received the U.S. Presidential Medal of Freedom in 1991; Hayek is regarded to a number fellow Nobel winner as the greatest economist of the modern period, though often times in surveys he is beaten out by Friedman and Keynes. Despite his own criticism of the status-quo and other’s criticisms of his own held beliefs, the importance of Hayek’s cannot be downplayed or ignored in the discussion of modern economic and political thought.

Works and Contributions

Monetary Theory and the Trade Cycle

• Hayek recognized that expectations about future movements in the rate of interest and entrepreneurial interpretations of intertemporal price movements can have an important effect on the course of the trade cycle.
• Hayekian theory shows how a monetary disturbance can induce an intertemporal discoordination of economic activities (the artificial boom), how the discoordination eventually comes to be recognized (the bust), and what adjustments are made necessary by the money-induced discoordination (the recovery).

The Road to Serfdom

• In the book, Hayek’s central thesis is that all forms of collectivism tend towards tyranny, and he used the Soviet Union and Nazi Germany as examples of countries which had gone down “the road to serfdom” and reached tyranny.
• He explained that once you lose your economic freedom you will quickly give up all other freedoms. The first thing you do is give up property rights to a central planning board, and the next thing you know you are goose-stepping down the street screaming heil Hitler.
• He doesn’t like central planning because it is too inefficient. There are way too many economic decisions going on all the time for a central planning board to decide. At the time he wrote this, it was very controversial, and it was a minority argument. At the time, people thought some degree of government planning was necessary to advance an industrial society. His solution was laissez-faire capitalism.

The Constitution of Liberty

• The book was first published in 1960 and it is an interpretation of civilization as being made possible by the fundamental principles of liberty, which the author presents as prerequisites for wealth and growth, rather than the other way around.
• The Constitution of Liberty has notably been held up at a British Conservative Party policy meeting and banged on the table by Margaret Thatcher, who reportedly interrupted a presentation to indicate, in reference to the book, that “This is what we believe”.

Why I Am Not a Conservative

• In this writing, Hayek lays out his belief that his thought is the embodiment of true liberalism.
• He argues that conservatives are anti-intellectual. He explains that the ideology is static and that it is a lot like socialism because it relies on the paternalistic government to tell you what social norms to accept, while socialism uses the same system to order the economic sphere.

The Fatal Conceit: The Errors of Socialism

• This was a book, published when Hayek was over 90 years old, which examined the origin and nature of ethics.
• Hayek believes that ethics lie somewhere between instinct and reason. Ethics — like language, the marketplace, and the common law — are a spontaneous order that, in the words of Adam Ferguson, is the product of “human action, but not human design.”
• In the book, he lays out the contradiction between “small group” ethics and “extended order” ethics. It is the conflict between people pursuing collective ends and people pursuing individual interests.

Cultural/Economic Influence and Criticisms

Hayek’s book The Road to Serfdom became a true classic, and is still widely read and well regarded in modern Conservative and Libertarian circles. In the 50^th Anniversary Edition of the book the foreword was written by Milton Friedman who said the book was “in some ways…even more relevant to the United States today than it was when it created a sensation…half a century ago.[1]” Despite this high praise from fellow Nobel Laureate, friend and colleague Milton Friedman, other economists have not been so generous. Paul Krugman (Neo-Keynesian) whom is also a Nobel Laureate said, “If one asks what substantive contributions [F. A. Hayek] made to our understanding of how the world works, one is left at something of a loss. Were it not for his politics, he would be virtually forgotten.[2]“ Much to Krugman’s discredit, Barron’s writer Gene Epstein suggested that Krugman’s writings appeared to suggest that he knew little or nothing about Hayek’s theory of the business cycle, a theory build upon the cumulative efforts of Menger, Böhm-Bawerk, and Mises. In reaction, Krugman later conceded that he“, wasn’t familiar with Austrian theory,” but then added “I regard [their theory] as being about as worthy of serious study as the phlogiston theory of fire.” This is in the same light as the leader of Krugman’s field of thought, John Maynard Keynes, who said of Hayek’s Prices and Production:

The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it, beginning with page 45 [Hayek provided historical background up to page 45; after that came his theoretical model], and yet it remains a book of some interest, which is likely to leave its mark on the mind of the reader. It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in bedlam.

Friedman is often credited as Keynes’s first true advocacy, and for this Hayek expressed regret in his own challenging of Keynes, stating that, “I have … defaults in my activities which I frequently regret… When Keynes, after I had devoted so much time to criticism of his Treatise on Money, thought out his general theory and told me no one believed in what I spent so much time to criticize, I did not return to the charge and never systematically attacked the General Theory.[3]”

Despite his earlier disagreements with Milton Friedman in his early tenure at the University of Chicago, Friedman’s views converged with Hayek’s on many levels; Hayek’s paper “The Use of Knowledge in Society” was used as one of the underlying themes of Friedman’s massively influential work Free to Choose, on top of being taught in Friedman’s graduate seminars. Friedman and Hayek both regarded each other as close friends, Hayek once said in an interview, “I don’t like criticizing Milton Friedman not only because he is an old friend but because, outside of monetary theory, we are in complete agreement.[4]” Friedman, late in his life (2003), expressed that “the use of quantity of money as a target has not been a success. I’m not sure that I would, as of today, push it as hard as I once did,” which reflects a regret in the disagreement between Friedman and Hayek over Hayek’s championing of a “free banking system,[5]” thus putting then at a near complete agreement.

Other more laissez-faire economists, such as Walter Block, have both criticized Hayek for merely popularizing Ludwig Von Mises, and not making a strong enough case in support of laissez-faire capitalism. Hayek expressed his distaste saying that, “probably nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rules of thumb, above all of the principle of laissez-faire capitalism.”

[2] “The Hangover Theory,” Slate, Paul Krugman

[3] “An Interview with F.A. Hayek,” Cato Policy Report, vol. V, no. 2, Feb. 1983.

[4] “Hayek on Money, Keynes, Friedman & Gold,” Taking Hayek Seriously, http://hayekcenter.org/?p=354

[5] Financial Times [UK] (7 June 2003)

Neo-Keynesian Paul Krugman recently had a blog asking “where’s the crowding out effect?” I commented on it here. Now there is a study from Harvard that confirms that the crowding out effect is indeed real, and that the stimulus dwarfed private spending. From Harvard’s website:

Recent research at Harvard Business School began with the premise that as a state’s congressional delegation grew in stature and power in Washington, D.C., local businesses would benefit from the increased federal spending sure to come their way.

It turned out quite the opposite. In fact, professors Lauren Cohen, Joshua Coval, and Christopher Malloy discovered to their surprise that companies experienced lower sales and retrenched by cutting payroll, R&D, and other expenses. Indeed, in the years that followed a congressman’s ascendancy to the chairmanship of a powerful committee, the average firm in his state cut back capital expenditures by roughly 15 percent, according to their working paper, “Do Powerful Politicians Cause Corporate Downsizing?”

“It was an enormous surprise, at least to us, to learn that the average firm in the chairman’s state did not benefit at all from the unanticipated increase in spending,” Coval reports.

Over a 40-year period, the study looked at increases in local earmarks and other federal spending that flowed to states after the senator or representative rose to the chairmanship of a powerful congressional committee.

We asked Coval about the relationship between the government and the private sector, and how policymakers should critically evaluate federal stimulus plans to help local companies.

I’m glad that Paul Krugman is so observing that he sees that U.S. bond rates have dropped in a recent blog. As any right minded individual would think that probably has to do with a “flight to quality”…which basically just means everyone else is horrible compared to the U.S.’s current debt situation. Not Krugman though, uses it as proof that there is no “crowding out effect” which, ignoring that international capital flows largely negate crowding out, there is still evidence of it. Krugman uses the the 10 year t-note as such proof with the following chart:

I’m convinced, aren’t you? Well you shouldn’t be, because the crowding out effect is the “crowding out” of private capital from…private investments because of large public spending. Meaning Krugman is only showing one side of the equation, in that he left out the corporate bond rates…ooops. It’s hard to push a political agenda when you have to present all the facts. The following table would be a more accurate picture if you wanted to talk about the “crowding out effect,” even though it has been highly distorted by recent crisis. Either way the flattening of the yield curve is undeniable, which is generally a bad sign economically. I’m sure Krugman will say that this means that the government should spend more…but I guess he’s been missing the debt crisis…which have spread to governments. Granted Greece is very different from the U.S. for many reasons, mainly because the U.S. has it’s own central bank, but this table doesn’t exactly support anyone’s agenda, especially not Krugman’s.

Of course there is always these facts that don’t agree with Krugman’s assessment either:

Libor Shows Strains, Sales Evaporate, Yield Premiums Soar: Credit Markets

Corporate Bond Market Cracks, Treasuries Rally

Debt Level, Spending Pose Risk to U.S.’s Aaa Credit Rating, Moody’s Says

Truth be told, Paul Krugman is wrong.

Krugman posted a new article (it’s more of a random thought) on his blog which he calls “Why Libertarianism Doesn’t Work, Part N”

He offers an argument which I have heard from many liberal minds, and he falls into the same trap of disproving himself by trying to prove his views correction, let’s dissect:

Krugman says:

Thinking about BP and the Gulf: in this old interview, Milton Friedman says that there’s no need for product safety regulation, because corporations know that if they do harm they’ll be sued.

Interviewer: So tort law takes care of a lot of this ..

Friedman: Absolutely, absolutely.

Meanwhile, in the real world:

In the wake of last month’s catastrophic Gulf Coast oil spill, Sen. Lisa Murkowski blocked a bill that would have raised the maximum liability for oil companies after a spill from a paltry $75 million to $10 billion. The Republican lawmaker said the bill, introduced by Sen. Robert Menendez (D-NJ), would have unfairly hurt smaller oil companies by raising the costs of oil production. The legislation is “not where we need to be right now” she said.

And don’t say that we just need better politicians. If libertarianism requires incorruptible politicians to work, it’s not serious.

Ah, but Paul, you missed an important part of your argument. That $75 Million existed before the oil spill, thus when doing a cost/benefit analysis of safety measures, BP undoubtedly put the $75 Million into an equation and weighed the (relatively low) risk of such a large oil spill. So the company said something such as: “well, we could spend a few million on these safety measures on all of our rigs…but the government has us covered if we exceed $75 Million, so really it’s not even worth the money since our risk is already limited.” It’s kind of like “too big to fail,” when your risk is limited by a third party, you take more risk . It happens in insurance all the time; for example, you already hit your deductible, so you go ahead and start spending money almost without limit. Or you have a low deductible and take more risks, we’ve all seen episodes where people with no insurance are extremely careful. The bottom line is when you know you aren’t going to see the costs you’re going to take more risks, the same can be applied to health insurance…which is one of the reason why “insurance” itself is the problem with high costs.

Anyhow, by making this statement on how “corruption” has led to the price ceiling, he misses starts to diminish his own argument. Isn’t such a price ceiling against libertarianism? (Yes) Likewise, isn’t the lack of a fast clean up not an unintended consequence of these rather “progressive” measures? The idea of libertarianism is to limit the power of government, and if the government has limited power then its corruption (which is inevitable) has a limited impact. The oil spill was a private sector failure, but it was led by a government failure.

Milton Friedman is my favorite economist of all time, and I wrote this paper about him. He has an interesting story and mind, unlike most economists today he encouraged debate.

"A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both." - Milton Friedman

Before all the static and political fostering of the recent economic crisis, a great man passed away on November 16, 2006 at the age of 94. Milton Friedman was that man, and he insightfully clung to the belief that free market economics is not merely a series of insignificant accidents or coincidences, but rather a tapestry of measures that have culminated from an exquisite side of the human psyche. That is to say, that if policy makers are to choose wisely we must recognize the fundamental principles of our system; how a complex organized, and smoothly running system can develop and flourish without central direction, and how coordination can be achieved without coercion (Friedman and Friedman, Free to Choose).

Prior to divulging into the economic and political views of Milton Friedman, we must recognize that much like the free market, a man’s measure is also no mere coincidence. On July 31, 1912, Jeno Saul Friedman and Sarah Ethel Landau bore their fourth child, and only son for which they named Milton. Having immigrated from Berehovo, Ukraine -formerly part of Hungary and Czechoslovakia- to the United States in 1890 and 1895 respectively, Milton’s parents knew the value of a dollar; and just 13 months into Milton’s life they moved to Rahway, New Jersey where his father ran a dry goods store.  Although their financial position was precarious, and no member of the family had been to college before, it was decided early that Milton would attend college (Champion of Economic Freedom).

Friedman attended Washington Public School, where he skipped the sixth grade and transferred to Columbus School in the seventh grade, both public schools in Rahway; and although he attended Hebrew school in the afternoon after public school and was “bar-mitzvahed,” Friedman became an agnostic at an early age of twelve (Champion of Economic Freedom).  From 1924-1928, Friedman attended Rahway High School where his favorite subjects were political science and geometry. Outside of his academic studies, he participated in sports, won an oratory competition, and almost read out the local public library (Ramrattan and Szenberg). He won a scholarship to attend Rutgers University in New Brunswick, NJ, which at the time was a private school.

Having a fascination with mathematics out of high school, Friedman majored in mathematics at Rutgers. Despite his fascination, Milton referred to himself as an “ignorant boy in a small town,” and that he “didn’t know what you used mathematics for…only…that it was used in the insurance industry somehow” (Friedman, Milton Friedman Interview). He took the actuarial exams, but since he failed some of them, he switched to economics. The economics department at Rutgers had two stalwart economists, Arthur F. Burns, who was writing his Ph.D. at Columbia, and Homer Jones who had been a student of Frank Knight, and completed graduate work at the University of Chicago. Friedman offered his abundant praise to them, for their teaching, influence and friendship. Friedman studied insurance and statistics with Homer Jones and it was Jones who introduced Friedman to the “Chicago view” of individual freedom and the right reform policy. Friedman wrote that “Had Homer not chosen to spend a couple of years teaching at Rutgers, I would almost certainly not have gone to Chicago.” He also remarked that besides being at the bottom of the Great Depression, “… becoming an economist seemed more relevant to the burning issues of the day than becoming an applied mathematician or an actuary” (Friedman, Milton Friedman Interview).

After finishing up his undergraduate degree at Rutgers, Friedman accepted a scholarship at the University of Chicago in 1932. At Chicago, Milton made one of the most important discoveries of his life upon taking Jacob Viner’s class on “Price and Distribution Theory.” Mr. Viner’s policy was to seat students alphabetically which landed Milton a seat beside a lovely woman named Rose Director. After courting each other for a few years Rose and Milton contemplated marriage, but decided that it would have to wait until they could maintain economic footing (Champion of Economic Freedom).

Aside from Milton’s new found love, he studied History of Economic Thought with Frank Knight, Monetary Theory with Lloyd Mints, and Correlation and Curve Fitting with Henry Schultz. Friedman noted: “I took courses enough to have the equivalent of a master’s degree in mathematics–which stood me in very good stead in my later career (Friedman and Friedman, Two Lucky People).“ Friedman received his M.A. from the University of Chicago in 1933, and with the encouragement of Schultz, was awarded a year’s fellowship to continue postgraduate studies at Columbia University. Friedman asserted that “the ideal combination for a budding economist was a year of study of Chicago, which emphasized theory, followed by a year of study at Columbia which emphasized institutional influences and empirical work–but only in that order, not the reverse” (Friedman and Friedman, Two Lucky People).

(Left to Right above: George Stigler, Milton Friedman, John Kenneth Galbraith)

Friedman took a job with the National Resources Committee shortly after his graduation, making an annual income of $2600. Milton wrote of this period in his life that “… ironically, the New Deal was a lifesaver for us personally. The new government programs created a boom market for economists, especially in Washington; Absent the New Deal, it is far from clear that we could have gotten jobs as economists” (Friedman and Friedman, Two Lucky People). In 1937, Friedman left the NRC and joined the research staff of the National Bureau of Economic Research in New York City. With this steady flow of income from his economic work, Milton Friedman and Rose Director finally tied the knot in 1938 under full Jewish religious tradition. Rose would play a large part in Friedman’s work as they collaborated on many books and projects over their lives including their joint memoirs, “Two Lucky People.”

In 1940, Friedman accepted a job at the University of Wisconsin but was forced to resign within a year. Friedman had fallen into conflict with other members of the faculty over America’s entry into World War II, which Friedman favored and others opposed (Champion of Economic Freedom). During World War II, he worked in the Treasury Department, where he helped create the federal withholding tax system, a system in which we take for granted today; prior to that, Americans had paid their taxes in a single lump sum each year. During the last years of the war, he suspended economic research and was employed as a mathematical statistician by a special projects group at Columbia University, concentrating on problems of weapons design, military tactics and metallurgical experiments (Champion of Economic Freedom).

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