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Thursday, May 26, 2011

Economics 101A - Keynes got it wrong, Me and Adam Smith got it right

     Keynes said that the way out of recession was spending money, even in such apparently foolish ways as burying bottles full of £ notes and letting the free market employ people by digging them up. Actually a lot of the Roosevelt new deal was of this nature (eg paying farmers to produce milk and then throwing it away). This worked, but only in the short term. As soon as it was stopped the US economy went back into recession in 1937 when this pump priming was cut.
File:US Unemployment 1910-1960.gif
What is usually thought to have ended the Great Depression was World War II where governments around the world mutually engaged in stocking up productivity by spending on a scale that would make burying millions of bottles full of money look restrained by comparison. They also killed a lot of people but we will leave that aside. So if wartime spending was all that was happening then, as soon as the war was over, there should have been the grandaddy of all Depressions. After all by then not only was the pump-priming gone but there was an enormous national debt to drag the economy down.

 There wasn't. The returning soldiers got jobs and the factories built to manufacture tanks turned over to manufacturing cars and washing machines.

My suspicion is that what really caused the post war boom was not the government money spent in digging holes but the government money spent in pushing the technological envelope (bigger aircraft, jet aircraft, thousands of air[ports, mass production of vehicles, & ships, netter electronics, radar, even the beginning of computers). Unfortunately it seems to be only during wartime that government has an incentive to spend money on real promotion of progress rather than the more bureaucratic policy of digging holes, or nowadays the more bureaucratic & comfortable policy of spending money on environmental impact studies of building holes.

Keynes example was wrong, (though only in the long term) because he had picked the least useful government "investment" he could - deliberately so because he was trying to make a point, that deficit spending can have a real effect in smoothing out a recession.
"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez faire to dig the notes up again . . . there need be no more unemployment. . . . It would indeed be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing." .........John Maynard Keynes, The General Theory, p. 129.
Friedman has since proven that the extreme cut-back in the money supply whenn the Depression stated did worsen it. So Keynes wasn't nearly as Keynsian as most of his followers think, nor Friedman quite as market orientated. He was correct that building houses would be netter but not totally so. Houses may trun out to be built in the wrong places or in a more old fashioned and thus expensive way than could be done. Though with our institutionally backward building industry who would notice? What is needed is for the money to be spent on pushing the technological envelope. Good research always pays off socially but, partly because its results are unforseable, it is difficult to get the investment. Keynes never thought of X-Prizes though Adam Smith did.

The lesson for today being -  if we want deficit spending, to create jobs in a recession and clearly every government does, the best way to do it is to reward entrepreneurs not by simple makework projects but by rewarding them for pushing the technological envelope.
If Obama's next $ trillion stimulus or our "quantative easing"were to be put into guaranteeing X-Prizes to produce real promotion of progress it would have all the advantages of WW2 without the bad stuff. (If Japan had done this in response to their banking crash in the 1990s they would be selling Mars by now. China take note)

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