I felt it necessary to publish this lengthy quote because it reveals the true extent of Guest's utter ignorance of economics. What is missing here is any understanding of the vitally important fact that the economy has both a capital structure and a relative price structure. Any government policy that promotes consumption must skew the price structure in favour of the lower stages of production. The effect of this process would be to retard the structure's expansion — keeping living standards lower than they would otherwise be — or even shorten it in absolute terms thereby actually cutting living standards. (Friedrich von Hayek, The Paradox of Savings in Profits, Interest and Investment, Augustus M. Kelley Publishers, 1975, pp. 255-263).

The view that one can separate budgets from the so-called "real economy" is pure hogwash. Budgets must always influence spending and therefore the pattern of production. It would be asinine to argue otherwise. It follows that if a budget raises consumption this must be at the expense of economic growth. This is because growth is in fact forgone consumption. To contest this fact is to argue that the economy is like a magic pudding.

If Guest were not completely clueless he would have argued that because of the existence of idle resources government handouts would do little or no damage. However, even this line of thinking does not hold up. First and foremost, it begs the question about the nature of idle resources (W. H. Hutt, The Theory of Idle Resources, Liberty Press, 1975 and The Keynesian Episode: A Reassessment, LibertyPress, 1979). Secondly, it tacitly assumes that capital is heterogeneous and timeless. In other words, the economy consists of two stages: production and consumption which are synchronised. This is the neo-classical error and one that Solow subscribes to. Hence his dangerously misguided view that

components of a fiscal stimulus package are costs to the federal budget; but to the extent that they put otherwise unemployed labor and idle industrial capacity to work, they do not impoverish the economy*.

Sound economics — as explained by the Austrians — stresses that any policy of recovery from recession that focuses on consumption will actually hold the economy back. This is what happened in the US during the Great Depression. Hoover implemented a policy of trying to maintain consumption in the belief that this would promote an economic recovery. The result was

that of a total of almost 14 million persons were without jobs at the peak of unemployment in March, 1933, 6½ million were from the durable goods industries, nearly 6 million were from the "service" industries, and only 1½ million were from the consumption goods industries. Investment activity, in a word, is the tail that wags the industrial dog. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 235).

Failure to grasp the fundamental fact that demand springs from production leads to the view the problem of widespread persistent unemployment is one of insufficient demand. From this it follows that just about any government spending that puts people to work rather than keeping them on the dole "will be beneficial tot he economy". And this is exactly what Guest argues, even though it is pure rubbish. One would expect a reasonably intelligent person to ask why an unemployment problem should last "for the next few years". Not our Mr Guest.

Although Roosevelt immplemented massive public works programs Australia recovered faster than the US despite the fact that Australia cut government spending while Hoover and Roosevelt increased it. The following chart was constructed by Sinclair Davidson, a Professor in the School of Economics, Finance and Marketing at RMIT. It clearly shows that after unemployment peaked in 1931 it then began to fall in the face of government spending cuts. This completely refutes Guest's mercantilist view that government spending is needed to put people to work.

What the likes of Guest cannot grasp is that the recession is the recovery process. This is when malinvestments created by a loose monetary policy are liquidated and the necessary price adjustments are made that restore "proportionality" — the balance between consumption and investment — to the economy.

So allow me to make this so simple that even a former Member of the Legislative House can understand it. As long as there is sufficient land and capital to employ people the problem of persistent mass unemployment should not emerge. However, if the cost of labour is raised above the value of its marginal product then unemployment will become a problem. Moreover, the larger the gap between the marginal value of the product and the gross wage (the total cost of hiring labour) the higher will be the level of unemployment. The next chart provides statistical evidence for this view.

Source: Recovery from the Depression: Australia and the World Economy in the 1930s, Cambridge University Press, edited by R. G. Gregory & N. G. Butlin, 2002,p. 268

We deduce from productivity theory that if wage rates (the gross wage) in excess of the value of the marginal product cause unemployment then a reduction in these rates relative to the product should cause unemployment to fall. This is precisely what the chart shows. The real wage in manufacturing for full-time labour in 1927-28 equalled 100. In 1930-31 it was still 100. For 1936-37 it was 99. During this period it never fell below 98. (C. B. Schedvin, Australia and the Great Depression, Sydney University Press, 1988, p. 350). But we can clearly see that once productivity began to rise thereby reducing the wage rate relative to the value of the product the demand for labour increased and the level of unemployment fell. There is nothing new here. In the 1920s Professor Benham produced similar results for Queensland.

Source: Frederic C. Benham, The Prosperity of Australia, O. S. King & Son LTD, 1928, p. 210-12, Table 1 Queensland: Wages, Production and Unemployment. *The ratio of the average wage to the total value of the product.

The above chart shows an inverse relationship between the ratio of the average wage and the total value of the product. The higher the ratio the lower the level of unemployment. In 1921 the RAWTVP fell to its lowest point at 3.5. At the same time unemployment rose to its highest level at 15.5 per cent. When in 1924 the RAWTVP rose to 4.5 unemployment fell to 6.4 per cent. (It should be noted that this inverse relationship emerges when the real wage exceeds the value of the product). Therefore the greater the difference between the wage and the value of the product the lower the rate of unemployment. Thus Benham declared: "It would be hard to find a clearer proof of our thesis [that excessive wage rates cause unemployment]." (Ibid. p. 210). The next chart is of equal interest

Source: This chart was designed so that a constant percentage increase would appear as a straight line. The values of product and wages are both expressed in dollars of constant buying power. The data for product are for the private sector, and are from the series by John W. Kendrick in his paper, National Productivity and Its Long-Term Projection (National Bureau of Economic Research, May 1951), brought up to date by the National Industrial Conference Board. For the data on wage rates, see Chapter 1, p. 11.

Despite Guest's assertion that Roosevelt-like spending on "school libraries" and increased grants "to first home owners" have worthwhile advantages the lesson of the 1930s clearly demonstrate otherwise. Although Guest can appeal to Solow all he likes the fact remains that the Keynesians have been proved completely wrong about the Great Depression. The Austrians and those sneered at as old fashioned economists warned that concentrating on consumption and government spending would have dire consequences. What was needed, they pointed out, was a revival in the capital goods industries as shown by the following table.

Comparative Producion of Producers' and Consumers' Goods in the United States (1925-1929 average=100)
	1925	1926	1927	1928	1929	1930	1931	1932
Producers' Goods	93	99	92	104	113	83	54	29
Consumers' Goods	97	97	102	100	104	88	89	82
Source: C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 127.

The consumer goods production index in 1929 stood at 100. By 1932 it had fallen to 70, rising to 77 in 1933 after which it continued to rise. Bad as these figures are they are dwarfed by what happened to the capital goods industries where production dived from 100 in 1929 to 32 in 1932, rising to 38 in 1933. (Frederick C. Mills, Prices in Recession and Recovery, The National Bureau of Economic Research, Inc., New York, 1936, p. 418). I should add that during this catastrophic contraction real hourly wage rates continued to rise even as prices fell.

Throughout the 1930s it was the higher stages of production that suffered the greatest, not the consumer stages of production, a process that was greatly aggravated by the sort of thinking the likes of Guest engage in. It wasn't consumption that needed to be encouraged but production. Mill was expressing the classical view when he stated:

What a country wants to make it richer, is never consumption, but production. Where there is the latter, we may be "sure that" there is no want of the former. (John Stuart Mill, Essays on Economics and Society 1824—1845, Liberty Fund, 2006, p. 263).

In 1935, when unemployment was about 20 per cent, Americans bought twice as many refrigerators as in 1929 when unemployment was 3.2 per cent. The problem was not lack of consumption but lack of production. Once you swallow the demand deficiency fallacy then there is no end of economic miracles that an accommodating state can conjure up. Hence Guest smugly tells us that by funding the insulation of houses this will reduce heating and cooling bills and "help offset some of the costs that result from Australia agreeing to reduce CO2 emissions".

Clearly it never occurred to Guest that if people felt that they would receive a net financial benefit from insulating their homes they would have done so without a government cheque. If the money comes out of the surplus the effect is basically no different from the Reserve Bank printing the equivalent amount of dollars and distributing them to the lucky few. This would be a one-off effect with no redeeming features. If it comes from taxes it ought to be clear — even to an economic illiterate like Guest — that the effect is to temporarily change the pattern of consumer spending while doing nothing to increase aggregate demand.

Guest's economic illiteracy also shines through with his opinion that taking money from Joe to help offset Bill's rising electricity bills that a stupid economic policy will drive up amounts to us all becoming better off by taking in each other's washing. In plain English, if Joe is going to subsidise Bill who the devil is going to subsidises Joe? Furthermore, what the hell does the government think it is doing in driving down living standards in order to please a bunch of lying green fanatics. And why doesn't this bother Guest? Is it because he is filthy rich and figures he doesn't have to worry about electricity bills?

The oh-so self-satisfied Mr Guest once said of Greg Barnes that he "writes rubbish about something concerning which he has more opinions than knowledge". May I humbly suggest that Guest take his own advice and just shut up about economics.

*What one might call the Solovian approach is completely rejected by the Austrian school. For Solow capital theories are either technocratic or descriptive. For Austrians capital is a heterogeneous structure with a time dimension. This approach allows the Austrians to explain the nature of the boom-bust-cycle and why the higher stages of production are always the first to go into recession and suffer the greatest falls in output.

The Austrian economist Mark Skousen has, in my opinion, been far too generous to Solow with respect to his treatment of capital. (Mark Skousen, The Structure of Production, New York University Press, 1990). On the other hand, Ludwig M. Lachman was not so forgiving. His treatment of the Solow approach was devastating. (L. M. Lachman, Macro-economic Thinking and the Market Economy: An essay on the neglect of the micro-foundations and its consequences, The Institute of Economic Affairs, 1973). Rather than mindlessly quote Solow, Guest would be better occupied in studying the facts of the Great Depression.

Gerard Jackson is Brookesnews' economics editor

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