Wednesday, July 13, 2011

The Cambridge Response

Peter Boettke shares a paper that reviews a mock trial held in 1933 at LSE. It's a trial of economists for "conspiracy to spread mental fog".

I'm reading through the paper and there's a lot of interesting stuff in here. One particularly interesting this is a letter to The Times in 1932 that was in response to the LSE letter that got a lot of coverage in the blogosphere when Mario Rizzo shared it several months back (see this if you're not sure what I'm referring to).

The Cambridge response is really fantastic, although until today I didn't know there was one (I've added some emphases for what I particularly like):



It is not possible for six people in their collective capacity to carry on a continuing correspondence. We wrote to you in reply to which given prominence was given in your columns categorically inviting the opinion of economists in the matter of private spending, and we had no intention of carrying the matter further. In certain comments, however, that have been made upon our letter there is revealed, as it seems to us, a fundamental confusion which, unless it can be dissipated, must render discussion futile and paralyse remedial action.

We are told that the vital thing to do at the present time is to ―concentrate such resources as we have upon works that are absolutely necessary, or which, when completed, will give the maximum of employment; while expenditure now upon libraries, museums, and so on ―must inevitably reduce the funds available when confidence returns. What are these ―resources and ―funds? It seems to be thought that there exists a stock of stored-up wealth the amount of which is fixed independently of our action and which we can only employ in setting people to work now, on pain of having less of it available to set them to work later on. This conception, though since its burial by Adam Smith it has enjoyed many resurrections, is an illusion. The resources out of which workpeople and all other persons are paid in any year consist almost entirely of what is produced – either directly or through purchase aboard – by the brains, hands and capital equipment of the country. In so far as this labour and capital are idle, the resources available for paying income to their owners are not conserved; they simply do not come into existence.

The purpose of our letter to you was to urge that, while in normal conditions money economy of individuals and groups of individuals means that labour and capital are set to producing capital goods instead of consumption goods, in present conditions it often means that they are reduced to idleness. A reply which, ignoring the conclusive evidence of unemployment statistics, tacitly assumes that this reduction to idleness is impossible, misses the whole point of our contention.

We are your obedient servants,

D. H. MACGREGOR (Professor of Political Economy in the University of Oxford)
A. C. PIGOU (Professor of Political Economy in the University of Cambridge)

Keynesian economics in a lot of ways is a rebirth of Smithian economics after a long classical dormancy. It's an economics that rejects the production possibilities frontier as anything like reality. Smith told contemporary protectionists that in fact the normal order of things is to transcend the production possibilities frontier - that we are not stuck in a zero-sum world. Keynes told contemporary goldbugs that we occasionally fall below the production possibilities frontier and a zero-sum mentality will produce poor assessments of how to get us out. Both men resisted the view of a zero-sum society and the simultaneously stagnant and Panglossian equilibrium of the classical economists.


  1. Daniel, I don't think you know anything about Classical economics. Read it and you may be surprised what it says.

    Start with J.E.Cairne's "Principles of Currency" for example.

  2. Well in the past couple weeks I've had my doubts you know anything about Keynesian economics.

    But then, recognizing the sincerity of what you write, I consider the possibility that you're emphasizing quite real strains of thought that you disagree with, but perhaps overemphasizing those and choosing to ignore other points that would provide a much richer and less caricatured picture.

    It's entirely possible I'm doing the same thing. But "don't know anything" is a little much, Current. If I were the first one to make critiques like this (broad-stroked and vague as they may be in this short post), you might have something of a point. But I'm not.

  3. Daniel,

    read your comments on Keynes vs. reality

    16,112,566 individuals were members of the United States armed forces during World War II.

    By the time the original G.I. Bill ended in July 1956, 7.8 million World War II veterans had participated in an education or training program and 2.4 million veterans had home loans backed by the (VA)

    There was a tremendous increase in the capacity of the US university system, especially at the lower end, after world war 2 in order to accomodate the veterans who were GI Bill beneficiaries. This involved not only paying for additional tuition, but also building campaigns at many schools.

    I'd like to hear your take on the role of the GI Bill in the postwar recovery. Remember, it was passed in 1944, prior to the end of the war.

  4. This is one of the most succinct summaries of Keynes' problem with "classical economics" I have seen. Yet another addition to my optional readings for the Keynes class...

  5. "If I were the first one to make critiques like this (broad-stroked and vague as they may be in this short post), you might have something of a point. But I'm not."

    No you're not, but those old critiques weren't any better than yours. Legends are old lies that have become hallowed by time.

  6. "The Cambridge Response" would be a great title for a spy novel; I'd set it in either the 1930s or the 1970s. I'd either make it about British espionage in Germany (1930s) or about a Soviet mole in British intelligence (1970s).

  7. argosyjones -
    I was thinking about posting this here but I really didn't want to give Russ a platform. Some thoughts, though:

    1. I don't know much about the post-war period and it's entirely likely that government spending like this that was targeted to the potentially unemployed played a big role. I just don't know. You have to remember that whatever the GI Bill did was in the context of much, much bigger demobilization cuts.

    2. Regardless of its cyclical impact, the GI Bill clearly had a major positive structural impact on the US economy by upgrading the nation's human capital.

    3. My point with Russ was more that simply pointing to a decline in government spending has little to do with Keynesianism. Keynesianism is about the impact of demand on employment, and the prospect of stable underemployment levels of demand. Pointing to a period of strong demand and low unemployment - like the immediate postwar period - is just about the most bizarre way of refuting Keynesianism I can think of. All you've demonstrated is that Samuelson doesn't have perfect foresight. I think we all knew that, given that Samuelson is a human being.

    This is another very strange instance of Russ (1.) correctly noting that science isn't fortune telling, and then (2.) trashing science when it proves in practice that it's not fortune telling. I really don't know what goes on inside that man's head sometimes.

    For a variety of fairly uncontroversial reasons investment demand was strong after the war. Interest rates and prices began to rise again as resources were fully utilized and crowding out kicked in, and unemployment was low.

    That sounds like Keynes to me.

  8. All you've demonstrated is that Samuelson doesn't have perfect foresight.

    No at all. It demonstrates that Samuelson was blinded by Keynesian glasses he was wearing.

  9. Can you please explain what you mean by that, Subhi?

    I'm getting somewhat tired of sloppy claims on this point which was why I didn't dedicate a post to this.

    Exactly what Keynesian insight necessitated this forecase by Samuelson.

    If you've followed this blog, you know how poorly reasoned I think claims like "Y=C+I+G so if we increase G we increase Y" are, so if all you've got is "Y=C+I+G so if we decrease G we decrease Y", then I'm going to request you go back to the drawing board.

  10. Daniel,

    Do you have any links to key blog posts where you discuss Y=C+I+G type of reasoning? I'd like to understand the topic better.

  11. Josh -
    I looked and I really can't seem to find a particularly detailed treatment of it, because there's not all that much to it, really.

    Y=C+I+G is just an accounting identity. It has to be true. That's how we define these variables. And intuitively it has to be true too.

    Well, what happens when you shift any one of these? That depends on how the others respond. We don't know what an increase in G does to Y unless we know how C and I respond to an increase in G. So anyone that goes around acting as if increasing G increases Y by definition doesn't understand the difference between a definition (or "identity") and a scientific law.

    We could imagine lots of scenarios where Y would respond differently. Let's say all the factors of production were being fully utilized. The cost of capital is high, wages are increasing because firms are competing for labor, unemployment is low, etc. If you just exogenously increase G the production that has to be directed toward that G is likely to crowd out production of I and C. Y isn't going to increase that much, if at all. We also know that since fiat allocation is less efficient than price mechanism allocation under most circumstances, the impact could actually be negative.

    Without getting into the details of how such a situation could come up, let's say the factors of production are going to be heavily underutilized. Here, increasing G has a chance at increasing Y because for one thing it doesn't have to prevent other productive activities in order to implement its own productive activity. It doesn't have to work out well. Let's say you increased G by financing it through heavy taxes on the lowest tax bracket. Those people spend most of their income and often have major barriers to accessing credit. You'd probably reduce C by the same amount that you're financing G.

    So a basic principle of fiscal stimulus is don't tax poor people to do it. Borrow from rich people and increase G by giving jobs to poor people. That sort of strategy has a lot more potential to increase Y if resources are underutilized.

    The origin of my complaint is essentially this: the identity Y=C+I+G tells us nothing about how one variable will respond to a change in another. We have one equation in four unknowns. You can't determine anything from that. People who think you can don't know what they're talking about.

  12. Thanks for the reply; that makes sense.


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