Subscribe to BrookesNews’ Bulletin
Government spending and jobs — another Keynesian fallacy
Gerard Jackson
A student wrote in asking for advice on how to deal with Professor Quiggin’s fallacies on jobs, savings and investment. (Her lecturer is using one of Quiggin’s articles to justify raising taxes). This lecturer’s collectivist ideology surely reveals what is wrong with a great deal of what passes for economics in our universities.
In Quiggin’s view pressure on governments retarded the growth in the amount of resources that the state can allocate to health and education, “even though there is substantial unmet demand for these and other publicly provided services” which, in his opinion, is capable of creating considerable employment (Australian Financial Review 12 May 1997) .
He followed this with the assertion that the drive against government spending is ideologically motivated, clearly, and dishonestly, implying that it had nothing to do with economic theory. In another article (Australian Financial Review, 20 March 1995) he even argued that if we added foregone earnings of students and reclassified health and educational spending as investment the measured decline in Australia's savings would be wiped out.
Sneering at his market opponents as “fundamentalists”, our unrepentant collectivist dismissed their objections on the grounds that they are merely ideological. (This is the usual leftist approach to tax cuts). Now let us do what Quiggin refused to do and that is strictly adhere to economic logic.
Quiggin rightly pointed out that there is some confusion on the issue. Unfortunately, he too is confused, especially on the nature of savings and investment. It is only the sloppiest of thinking that has an economist call the consumption of hospital services or education investment activities. They are no more acts of investment than eating out at McDonald’s. Investment takes only one form and that, as the Austrian School has pointed out, is the material means of production. (See Professor Lachman’s Capital and its Structure and Böhm Bawerk’s monumental Capital and Interest).
The Austrians stress that production takes place in stages. The more roundabout the stages of production the higher will be the productivity of labour and hence living standards. Only savings, forgone consumption, makes investment possible. There is no other way. Because capital takes the form of a structure consisting of stages of production (we owe production structure analysis to Böhm Bawerk), it takes little imagination to realise that the more stages are added to the structure the further away they move from the final stage which is consumption.
This insight allows us to immediately demolish Quiggin’s fallacies and clear away the debris.
He asserted that the unmet demand for government subsidies would create a considerable number of jobs. There are two very old fallacies here, fallacies that the classical economists had demolished more than 200 years ago, and the logical destruction of both can be found in John Stuart Mill’s works. The first fallacy is the assertion that taxes expand the demand for labour. John Stuart Mill put the pre-Keynesian case beautifully when he wrote:
The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be ‘like the dews of heaven, which return in prolific showers’. It is no longer supposed that you benefit the producer by taking his money, provided that you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasoning of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided that he expends it all again at the same shop, is a public benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman a fortune.
In other words, taking money from some to spend on others changes the pattern of demand, it does not add to it any more than it adds to the demand for labour. Mill would be shocked to find that the doctrine he despatched with such clarity and eloquence has now become the received wisdom at some universities.
The second of Quiggin’s fallacies is his belief that the demand for goods is the demand for labour. (In fairness to Quiggin this appalling fallacy is rife in all our universities, which explains why it tends to dominate economic commentary). As Mill pointed out the demand for consumer goods is not the demand for labour, explaining that if we mean by demand for labour that which raises the value of labour services then demanding consumption goods directly does not perform this function (Principles of Political Economy, 1848).
Demanding consumption goods directly, whether they be in the form of education, medicine, TVs or hamburgers, does nothing to raise real wages.
All of which brings us back to capital as a structure and Austrian analysis. This demonstrates how directing spending to consumption does not raise productivity and thus the real demand for labour. Directing spending to consumption means that more productive methods (stages) would have to be eventually abandoned in favour of more labour intensive and less productive processes thus exerting a downward pressure on real wages. (see Hayek’s Prices and Production and Profits, Interest and Investment.
It follows that when Quiggin’s critics argue that spending on hospitals is not investment they are perfectly correct in the sense that hospitals and schools, like cafes, theatres and cinemas, are at the final stage of the production structure, the point of consumption. Hence spending at this level does not raise the marginal productivity of labour. It is because they lack Austrian capital theory that the critics are unable to effectively deal with Quiggin’s fallacies and statist solutions for unemployment.
As for Quiggin — he is wrong, wrong and wrong. And no amount of snide comments by him about market “fundamentalists” can alter that fact. But there is no way the likes of Quiggin will abandon their collectivist ideology, even in the face of inexorable logic.
Even our rightwing has fallen into the trap of sneering at so-call
fundamentalist economics
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 6 March 2006