The "War on Demand": Krugman and Rowe

Two great posts are up by Paul Krugman and Nick Rowe on the problem people have accepting that we have a demand problem.

Krugman starts, and marvels that the very idea that we could have an effective demand problem is so repugnant to people. The post is mostly just expressions of dismay, but he mentions a few interesting things. First, the baby-sitting co-op experience. This is a fascinating little episode and if you're not familiar with it you should click through the link. It's a microcosmic example of a monetary disequilibrium, demand side depression. George Mason University does lots of experimental tests of microeconomic phenomenon and the market process. I wish they'd do macroeconomic experiments like this one - perhaps with free bankers and a central banker? The other interesting point that Krugman raises is that the Monetarist advocates of a monetary disequilibrium theory are really - in the eyes of the intellectual vandals jettisoning demand-side thinking - just as bad as Keynes. I think this is basically right. One thing that he does not seem to be aware of is that by the same token there are monetary-disequilibrium Austrians out there too that offer an important in-road that simply isn't available in the RBC or New Classical side of the demand-skeptic camp.

Nick Rowe follows up by highlighting "short-side thinking". What position would you rather be in right now - in the market to buy a product, or in the market to sell a product? In the market to buy a product, clearly. Rowe points out that there's obviously a limit to this. At some point, the tables turn and you start to get pressure on prices. Nick points out that because of the obviousness of "short-side thinking", what's really amazing is that anyone doubts the primacy of the demand side.

But there are good reasons to doubt - and the doubt has to do with the distinction between the long run and the short run. In the long run, secular growth is determined by the supply side: by capital accumulation and technological progress. But in the short run demand is largely the concern. I'll also refer people to a post from November by Peter Dorman that does a great job laying the microfoundations for these demand-side problems. He also references a prominent critic of socialist calculation, Janos Kornai. That's right - the logic of one of the most famous critics of socialism also leads to the expectation that market economies will be plagued by effective demand problems.

Matt Yglesias's kinda-sorta-half-decent response

I started by titling this "Matt Yglesias is making things less clear, not more clear", but that didn't seem entirely fair.

Anyway - he writes a good post, ostensibly in opposition to Steve Horwitz , without really addressing Horwitz's point. That, unfortunately, reinforces Horwitz's implicit claim that Keynesians are consumption-mongers. The charge that Horwitz is "extremely foolish" was uncalled for, but then again I'm sure Horwitz has had worse thrown at him.

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Yglesias walks into precisely the same trap I outline here: assuming that "consumption" is the same as "demand". It's not. Firms "demand" labor and firms "demand" capital goods. None of this is "consumption". "Demand" in a monetary economy is simply "when somebody wants to give another person money in exchange for something else". Yglesias is right to trumpet loudly that what we face is a demand problem. But he jumbles that up with Horwitz's talk about consumption. I think this consumption line needs to be firmly put to rest. Nobody should mistake the babbling of a journalist or a politician for the Keynesian position. Consumption may or may not be depressed - it probably is a little depressed - but the real concern is investment demand.

Keynesianism and Consumption, "Keynesian Humanitarianism", and a few links

I think one of the hardest transitions from "vulgar Keynesianism" to real Keynesianism for people is the stumbling block that is consumption. Sometimes the mistake is a misuse of the national income equation. Sometimes the mistake is that they think "demand" and "consumption" or "spending" and "consumption" are synonyms. Sometimes people take the Keynesian worry about the paradox of thrift and assume they don't like saving, and therefore don't like investment and prefer that more income be consumed.

A very thrown-together and hopefully not misleading illustration

All of this is quite confused, and ironically gives you not just a non-Keynesian, but a quite anti-Keynesian view of the economy. I like to think of the Keynesian approach to investment and consumption in pretty basic Econ 101 terms - I like to say that Keynesians "want to move along the consumption demand curve, but they want to actually shift the investment demand curve". It doesn't exactly translate over from microeconomics, but here's an illustration of what I mean:

Let's start with the left panel. Here we just have simple loanable funds market. Supply of loanable funds is constant, but demand for loanable funds shifts to the left because firms increase their preference for liquidity and decrease their preference for new investments. The same loanable funds are available. So without getting into any assumptions about reduced consumer demand, we now have aggregate demand shifting down purely due to the reduction of investment demanded at market prices from I' to I''. Now - should we assume that consumption demand changes? Maybe a little - cautionary saving is certainly plausible on the part of households for the same reason that liquidity preference is in play for firms. But there are good reasons not to change consumption demand relationships that much. Keynes thought that the marginal propensity to consume out of income was a psychological law - certainly informed by time preferences, but not something that shifted around a lot. This is what we see in the data - consumption volatility does not play a very big role in the business cycle compared to investment volatility. Keynes certainly would have been aware of this.

What you see on the Keynesian cross panel on the right is the shift in income resulting from this reduction in investment demand from C+I' to C+I''. Because the diagram assumes some autonomous consumption (i.e. - there is some consumption out of savings even when income is zero), the share of income that is consumed is increased somewhat as income is reduced (this stands to reason if investment is more volatile than consumption). I've added a horizontal line that I think may be useful for understanding how consumption shifts in a Keynesian framework - it's the dashed line I call the "fully depressed investment level of consumption" (FDILC). This is the level of consumption when investment is so depressed that there is zero investment. The first vertical line extending up from the FDILC notes the additional consumption above FDILC for the C+I'' equilibrium, while the second vertical like notes the additional consumption above FDILC for the C+I' equilibrium. What you'll note is that investment demand recovers, we will see a recovery in consumption too. You will observe improvement in consumption data, without any changes in underlying consumer preferences or confidence. Unlike the investment level I never moved that consumption curve. The change is due entirely to an increase in income - in other words, the existing consumer demand became more "effective" as more income came online to spend.

Implications for consumption, a few links, and humanitarianism

So, what does this say about consumption boosting policies like unemployment insurance? Well to be clear, first and foremost it says they might do something. If you actually can boost the consumption curve you are going to shift out to a higher income level. The problem is, you are remedying a symptom and not the underlying disease. As the FDILC line illustrated, the fluctuations in the consumption level are a result of the changes in the income level. You can bolster that consumption short-fall, to be sure - but you're not doing anything about the underlying cause. If investment demand is still depressed, then as soon as you turn off the unemployment insurance spigot you'll go right back to where you started. Maybe consumer confidence plays a big role in the reason for depressed investment demand. If that's the case, then investment may recover somewhat. But Keynesians usually point to more than just consumer confidence - particularly if there are concerns about a liquidity trap.

This all means that consumption-driven policies are not entirely useless, but in the end they're symptom-treating policies from a Keynesian position. As I've pointed out in the past, you can see this in the General Theory, where Keynes himself ridicules the very idea of unemployment insurance. A real Keynesian perspective is pretty agnostic and skeptical when it comes to unemployment insurance, which I think is illustrated by recent thoughts from Greg Mankiw on the UI extension that you can read here. One of the posts that actually got me thinking about this problem was one by Russ Roberts where he ties concerns about consumption to Keynesianism. The post is simply titled "Keynesian sentence of the day" - and the sentence from the Washington Post that he's refering to is "After two years on the sidelines, American consumers are spending again and raising hopes that they are ready to shoulder the burden of the nation’s economic recovery." What frustrates me about Roberts and many other commenters on his blog is that it seems like they think "anything a liberal ever says about the economy is Keynesianism". The blog is rife with suggestions that Keynesians want to see people consume more and invest and save less. Another example is this video featuring Hiwa Alaghebandian which was recently shared by Don Boudreaux as a video that demonstrates "some of the flaws of Keynesian economics":

The video is riddled with problems (a major one being the unsupported assumption of perfect crowding out), but one of the most obvious problem was the consumption-centric interpretation of Keynesianism. It's a little embarassing, because Hiwa is a senior at my alma mater, the College of William and Mary. Maybe there has been staff turnover, but I know that none of the macro professors that were there when I was there would have taught her this. She has, however, had internships at Cato and AEI. I imagine she picked up this understanding of Keynes there.

So what do we do about consumption-related policies like unemployment insurance extension? Different people are going to split different ways on this, but I'm personally cautiously sympathetic to UI extension. One thing you won't hear me arguing quite as often is that we should think of it as a depression-fighting policy. Because I take the Keynesian view that most of our problems have to do with investment demand, I primarily support UI extension as a humanitarian policy and a structural unemployment policy. The humanitarian justification should be obvious - workers are unemployed through no fault of their own in the midst of a tough job market. They have obligations and they have fulfilling lives to lead. It's simply a humanitarian imperative, apart from any macroeconomic concerns, to provide a cushion for them. But there are other more calculated economic reasons for doing it. Unemployment insurance supports active job search, and that will help keep "the unemployed" from becoming "the unemployable". Long-term unemployment poses serious risks of higher structural unemployment in the future, and UI can help fight that. Ideally, to do this UI would be paired with options for training, job search assistance, and new hire incentives for businesses who hire unemployed workers, or even public employment options. Again, though, there's no argument here about the cyclical benefits of UI.

So are there any cyclical benefits? There are a few. First, as I noted above, shifting the C curve up will improve output, and this may improve investor outlook. UI is also paid out of unemployment insurance trust funds - which are exactly what they sound like: pools of saved payroll tax funds that are invested, but kept relatively liquid to be paid out in the form of unemployment checks. Drawing down on these trust funds can be thought of as making use of relatively idle capital. In other words, we're not just shifting money earned today from the employed to the unemployed: we're shifting money from an idle fund to the unemployed.

Mostly, though, I think of UI and many other consumption-oriented policies as being humanitarian and perhaps structural policies, rather than primarily cyclical or "Keynesian".

This message leaps off the page of the General Theory, too. The General Theory is all about investment, and much less about consumption. As I like to point out, Keynes has (if I remember correctly) about twice as many chapters dedicated to investment as he has dedicated to consumption, and he's famous for advocating the "socialization of investment", not the "socialization of consumption". And when consumption is addressed, it's usually addressed as a stable relationship that investment oscillates around.

This will be an awesome event...

...and I strongly encourage readers to listen to the audio webcast or show up if you're in the D.C. area on December 10th.

The discussion will be held at the Urban Institute and is called "New Unemployment and What to Do About It: Jumpstarting the Job Market". There will be a series of interesting guests. First, Tim Bartik of the W.E. Upjohn Institute for Employment Research will be there. The Upjohn Institute does some really incredible labor economics research that I've been following for a long time. Bartik is especially good - he's long been an advocate of job creation tax credits (corporate tax cuts for newly hired employees), a policy favorite of mine. I like to think of these policies as the labor-demand equivalent of the EITC. Bartik actually has a history of debating the merits of these tax credits with some of my colleagues here at the Urban Institute in the Tax Policy Center who are more skeptical.

Next there is Robert Graboyes of the National Federation of Independent Business (NFIB). I don't know Graboyes, but I know the NFIB. They're the ones that produce the data that says loudly and clearly that we have aggregate demand issues, but for some reason always lobby against regulation and taxes as the biggest problem for business.

There will also be Cliff Johnson of the National League of Cities. I don't know him. Finally, Bob Lerman of the Urban Institute - long time advocate of community colleges and apprenticeship programs - will round out the list of panelists. Lerman is a professor of economics at American University, a celebrated labor economist, and one of my graduate school references. I'll actually be with him on a site visit investigating the operation of an apprenticeship program in Indiana for the two days prior to this event.

Margaret Simms, a really wonderful economist here at the Institute and all around nice and insightful person will be moderating the panel.

I am really going to think hard about the questions I want to ask (I always ask questions at these things). I kinda want to make sure the NFIB guy knows what his data actually say, and challenge him if he side-steps that - but I also would like to hear more about the job creation tax credits. This should be a very interesting talk.

John Taylor on Keynesianism

John Taylor has a post up on Keynesian economics that's a little interesting and a little odd. I'll just quote in full:

"This past weekend Columbia University hosted a conference on the occasion of the 40th anniversary of the famous Phelps volume on the micro foundations of macroeconomics. In addition to the technical papers, which will eventually be published in a conference volume, important lunch and dinner talks were given by two of the most recent Nobel Prize winners in economics--Dale Mortenson and Chris Pissaredes--as well as by Fool’s Gold author Gillian Tett of the FT and Ned Phelps.

Ned spoke about what he called the “recrudescence of Keynesian economics.” He explained why, as he put it in his New York Times column of last August, “The steps being taken by government officials to help the economy are based on a faulty premise. The diagnosis is that the economy is ‘constrained’ by a deficiency of aggregate demand. The officials’ prescription is to stimulate that demand, for as long as it takes, to facilitate the recovery of an otherwise undamaged economy — as if the task were to help an uninjured skater get up after a bad fall. The prescription will fail because the diagnosis is wrong.”

The problem with these Keynesian policies is that at best they give short term boosts to the economy, but then fizzle out as we are seeing now. Sustaining growth in employment requires sustaining investment, which requires government policy that encourages investment and innovation, not short-run stimulus packages that try to boost consumption and government purchases, which crowd out investment.

Will there be an end of this recrudescence? Politics as well as economics will be an important determining factor, at least that’s what the historical analysis in the paper I presented at the conference shows. The good news then is that more people are beginning to see the problems with these stimulus packages and the political process is responding."

I find his position quite reasonable, but what's strange to me is that he's describing sort of an odd version of Keynesian economics. He's playing fast and loose with terms like "demand" and "consumption", acting like the point of stimulus is to boost the latter. The point of a Keynesian stimulus isn't (primarily) to boost consumption, and the fact that the fiscal stimuli we've seen largely do is a valid critique of the focus of the stimulus package. But it's not really a valid critique of Keynesianism, whose primary emphasis is to boost investment demand through (1.) reducing interest rates, and (2.) the enigmatic "socialization of investment". The General Theory is not really a consumption story at all. Consumption is that psychologically stable-sloped slide that a depressed economy drifts down. To use classic econ 101 phrasing - "we move down the consumption schedule in this case, the consumption schedule doesn't move". Other points, like the idea that stimulus packages crowd out private investment, are of course absurd - but if you don't think it is true then you are forced to accept some important Keynesian premises, which I don't think John Taylor wants to do.

I do think there's an extent to which what we traditionally think of as "innovation policies" can be put to good use as "stimulus policies". We categorically separate them because of how we think of innovation as a determinant of secular growth, but it's not clear why that's necessary.

The Equation of Exchange and the Metaphysics of Commerce

"The Balance of trade is the metaphysics of commerce, which few understand and which serves no other purpose than to disturb the imagination" - Thomas Fitzsimmons, 1785

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What would you all think if I wrote "By definition Y=C+I+G, so if you increase G you increase Y". You probably wouldn't take me very seriously. Even when I make a case for fiscal policy, it's never that case. Freshmen learn what's wrong with that argument. Would it improve things at all if instead I said "By definition Y=C+I+G, so if you increase G holding everything else constant you increase Y"? This version is at least logically coherent, but would your opinion of me change all that much? Probably not. Let me put it this way - I should hope you would still think I was talking nonsense. It's true that Y=C+I+G; that is trivially true. But when you change government spending, you can't expect other things in the equation to stay the same. So the first, unqualified statement that I made is logically wrong because nothing constrains C and I to stay the same, allowing me to conclude that we can increase G ad infinitum to achieve permanent growth. The second version of my statement was logically sound, but meaningless and demonstrative of a very poor understanding of economics. The lack of understanding is evident not in my manipulation of the equation itself, but in my understanding of the meaning and use of the equation.

Unfortunately, Don Boudreaux recently made precisely the same mistake with another famous economic law, the equation of exchange, MV=PQ. Don writes:

"In today’s Wall Street Journal, U.S Treasury Secretary Timothy Geithner, Singapore Finance Minister Tharman Shanmugaratnam, and Australia Treasurer Wayne Swan worry aloud that, in emerging economies, “rapid growth” increases “the risk of domestic inflation.” Baloney. Inflation is the result of too much money chasing too few goods. So by increasing the flow of goods (and services) produced in an economy, rapid growth decreases the risk of domestic inflation. That the finance ministers of three major world governments do not understand this fundamental fact is appalling." (emphasis is mine)

Don is quite wrong here, and the various finance ministers he cites are correct*. The key to understanding how to think about the quantity theory is that it's simply a balancing of the books. Alone, it tells you nothing about the causal relationship between any of these variables. I want to emphasize that because a lot of people from all sides of the aisle treat it like it's a causal law (Exhibit A being the regular testimony in the banking committee of the politician that every libertarian wants to pretend isn't just another politician).

Don is discussing the role that rapid growth (and increase in Q) plays in inflation. Taking the naive view of the equation of exchange, he reasons that since P = MV/Q, when Q increases P (the general price level) must decrease. He doesn't even say "holding everything else constant", and so his claim is logically wrong. But even if he had said "holding everything else constant", that just begs the question - why would you ever claim to hold everything else constant? Don certainly wouldn't let me get away with "holding everything else constant" in the national income identity. So how does Q grow in Don's example? Well for the answer to that question we have to turn to some method of determining output - Q. For this, of course, economists traditionally turn to supply and demand. Profit maximizers and utility maximizers come together in a market and set their respective marginal benefits and marginal costs equal to each other and come to agreement on a Q and a P**. So that gives us two of the four variables in the quantity theory - not bad. How does Q and P change in a supply and demand model? Well, the supply schedule can shift, the demand schedule can shift, or both can shift simultaneously. These supply and demand curves, unlike the equation of exchange, are actual behavioral claims made by economists. If you have a given set of preferences, and you have certain rational and informational prerequisites, and you face a particular suite of prices you will purchase Q goods for P dollars each in the market. This is claimed to be causal and it does describe behavioral relationships. It is not an accounting identity like MV=PQ or Y=C+I+G. So what happens if demand for goods and services increases? We would expect to see Q and P both increase. What happens if the supply schedule shifts to the right? We would expect to see Q increase and P decrease.

Now, to make another trivially true statement, we can say that if M and V are held fixed, these supply and demand dynamics will be reflected in observed values. On this point alone - even at this "trivially true"/"ceteris paribus" stage in the game, and after adding one supply curve and one demand curve to give some actual behavioral traction to our equation of exchange, Don is clearly wrong. Output growth can occur for at least two reasons - a supply shift (i.e. - increased productivity) or a demand shift, and a shift in demand will cause prices to increase at the same time that quantity increases***.

But presumably we aren't satisfied with a "trivially true" refuation of Don's point. When supply or demand shift, things happen to M and V too. When demand for goods and services increases, more transactions occur and people increase the rate at which they spend a given stock of money. In other words, the velocity of money, V, increases. Another way of saying this is that the desire to hold on to cash decreases if your demand for goods and services increases and your income stays the same. That cash did not circulate before, and now it is put into circulation. This is a standard impact of an increase in demand, and its inverse is why Keynesians associate low demand with an increase in the desire to hold cash or other liquid, idle assets. So if we have demand-lead growth, we would expect V to go up as well (which is another reason why when Q goes up in the equation of exchange you can't simply assume P goes down - that increase in Q may be a part of a process that simultaneously increases V).

What happens with the money stock? Well, of course that depends on how you define money. If you're thinking in terms of a very narrow definition of money, you can safely assume that that stays fixed and the explanation provided above of P, Q, and V gives you what you need. I don't know too much about this end of the theory, but clearly there are definitions of M with varying breadth. Nominal credit creation in response to an increase in demand can also be said to increase the money supply, and would also create inflationary pressure. Would you have nominal credit creation in response to a productivity (i.e. - supply schedule) increase? I don't really see why you would expect that. People need less exchange media to conduct the same amount of commerce, so it's probably less sensitive to supply-lead growth. Then again, if the aggregate demand schedule is highly elastic, maybe you would need more. These are the kinds of issues you have to think through - the equation of exchange doesn't provide you the answer to any of these relationships.

So be careful when you use these. Don't get caught saying "when we print more money it creates inflation" or "when output grows, it lowers prices". These are abuses of the quantity theory.

*George Selgin has some comments in the comment section of this post that are worth reviewing. I think Selgin is basically right and understands precisely what I'm saying here. Unfortunately he was clearly indulging Don's misunderstanding of the issue when he was taking issue with my comments, and trying to paper over a pretty egregious Cafe Hayek post.

**You could of course raise some market process objections to this story, but the basic supply and demand relationship has been experimentally verified (by other George Mason professors, in fact), so whatever non-auctioneer market process is going on is clearly giving us about the same results, which should not be surprising to anyone.

***In the article that Don discusses, the authors mainly point to demand-lead growth in emerging economies as the inflation risk for emerging economies only. They specifically cite demand for exports, growing domestic demand, and rising commodity prices (which have been demand-driven, not supply-driven).

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Quantity theory links:

- I started a thread on this issue in Jonathan's forum here.

- This recent post by Brad DeLong doesn't explicitly mention the quantity theory, but he does bring up the problems with a Monetarist approach to the crisis. His critique is based on the interpretation of Monetarism as a misuse of the quantity theory... or at least a misuse given the very special circumstances we're going through now.

- Stephen Williamson replies to Mark Thoma and writes: "This is why I'm not an old-fashioned quantity theorist. What has to be going on here is a large increase in the world demand for US currency during the financial crisis. All the more reason to be worried about inflation, as the crisis-driven demand [for US currency] goes away." I'm not sure if Williamson is saying that "old-fashioned quantity theorists" misuse the equation of exchange, but this doesn't seem quite right as a critique of the quantity theory itself. If there is an increase in world demand for US currency that you expect to be temporary, then that's the same as saying there is a decrease in V that you expect to be temporary. If you expect it to be temporary, then you'd expect an increase in V in the future. If, following the processes I outlined above, you think that increase in V is going to be paired with an increase in demand and thus P and Q, then Williamson's worry about inflation in the future is perfectly justified and perfectly consistent with the quantity theory. It's simply not on the top of my list of things to worry about right now. When we actually see that inflation, it means we're probably out of the slump.

- Bill Mitchell, of the Modern Monetary Theory school, has a weekly quiz. The second question of a recent quiz is on the quantity theory. Mitchell sets up a straw man of what quantity theorists believe (essentially attributing Don Boudreaux-type views to them), and then credits Keynes with fixing all that. This is a little much - many users of the quantity theory long before Keynes used the quantity theory without making these mistakes, and Keynes certainly embraced the quantity theory - and he used it correctly and to great effect. So Mitchell's analysis here is correct - but his history is a little self-serving.

- Jonathan reposts some thoughts by Richard Ebeling on Hayek and the quantity theory here.

- And of course, a lot of this emerges from our discussion of Hayek's Prices and Production. You'll find my post on the first lecture, in which I deal with some of these questions, here. I think Hayek does much the same thing that Mitchell does with his treatment - he provides a reasonably accurate analysis of the quantity theory, but a fairly self-serving history of the idea. He also has a weird "this isn't important and in fact it's misleading" reaction to it by the end.

- Keynes has a suberb discussion of the use and misuse of the quantity theory in the Tract on Monetary Reform (it actually is the same discussion where he says "in the long run we're all dead"). I'll hopefully get a chance to quote it at length this weekend, but if I don't please look it up yourselves

Keynes, Krugman, Technological Unemployment, and Overproductionism

Today Tyler Cowen brings up Keynes's famous essay "Economic Possibilities for Our Grandchildren", where he presents an overproductionist story that clashes a little with his usual underconsumptionist approach. It talked a little about this essay here.

When I was thinking about Don Boudreaux's post that brushed up against overproductionism the other day, I looked through some old Krugman posts and found this on technological unemployment and the Great Depression. While I'm sharing Cowen's post, that seems reasonable to share.

One of the encyclopedia entries I'm writing for the Encyclopedia of Populism is going to be on just this topic - technological unemployment. It's an interesting idea. The grand predictions were all proven wrong, but the predictions themselves are fascinating.

Krugman and Boudreaux on Overproductionism

Don Boudreaux manages to take a swipe at Krugman in the midst of a post praising an old Slate article of his that takes the logic of overproductionism and the crisis of capitalism to task. This is, of course, related to the overproductionism post I had the other day.

Of course, Krugman is right here. So why do I post semi-favorably on overproductionists and treat them with kid-gloves when Boudreaux and Krugman are more harsh? There are several reasons:

1. Overproductionism as a permanent crisis of capitalism is different from overproductionism as a reason for temporary dips in the economy. The latter is fairly respectable - the inventory cycle is nothing if not an overproductionist theory, and everybody believe the inventory cycle exists. We also live in a world where Diamond, Pissarides, and Mortensen all have Nobel prizes so we have no excuse to not take search and matching frictions seriously. When technological development increases manufacturing productivity it can seriously screw up mid-Western factory towns. Dislocation matters, particularly if you're the one being dislocated. This is all fine. What's not fine is the sort of "crisis of capitalism" overproductionism that says we're going to invent ourselves out of jobs and the owners of capital are going to become plutocrats and workers will starve. Economies do adjust - but that doesn't mean frictions, dips, and cycles don't happen along the way.

2. Overproductionism is a path to underconsumptionism for the layman. Non-economists have tendency to view self-interest with embarrassment or disgust, so they have a hard time either seeing a lack of demand as even possible, much less a problem if it occurs. They have an easier time understanding "the boss has no work for me", so in the lay literature you see a lot more overproductionism than underconsumptionism. But the thoughtful ones find their way to underconsumptionism, money demand, liquidity preference, and all that - and that's very good. A layman expressing overproductionism has an inherent sense that general gluts are real. That insight alone goes a long way in separating the good economists from the bad, so when I see it in people I'm a little more forgiving - and if I see it without the apocalyptic doom and gloom, I'm even more encouraged that they're putting real thought into this.

3. Who knows - maybe one day we will invent ourselves out of work! Honestly, my faith in what Boudreaux and Krugman are saying here is largely an empirical faith rather than a theoretical faith. It's entirely plausible that one day we'll say "I'm sated now - I'm going to just kick back and read on the beach, be happy with my current state of wealth, and increase my leisure". Demand may not keep up with production. It's possible - why not? But history tells us that it's highly improbable. Every time someone has suggested this outcome their hopes/fears have been dashed. But there's nothing inherent in the economy or in human nature that I know of that says it can't happen, and if it ever were to happen, maybe it would be nice! Who knows. I don't think I ever will because I don't expect it to happen in my lifetime, if it ever does.

Underworld Economics, Cleaned up and Formalized

Peter Dorman has a great post up explaining why market economies have tendency towards underconsumptionism, a position which Keynes called "underworld" economics, but which he identified as being closely related to his own thinking.

Dorman talks specifically about the problems with Walrasian price setting, and suggests that in the real world firms set quantities and compete for customers on price. He loosense utility maximization assumptions about consumers as well and suggests that if consumers have loyalty to firms that satisfy their quality requirements, firms will invest in more production as way to maintain customers. Dorman writes "This fits with the literature in marketing, which stresses that a sale should always be seen as the opening to future sales and therefore worth a much greater investment than it would justify from a myopic perspective."

One of the most interesting points that Dorman makes is connecting this argument to the work of Janos Kornai. I first encountered Kornai in the way that I think most people did - as a critic of planned economies in a discussion of comparative economic systems. What a lot of people forget is exactly what Kornai's criticism of planned economies was - the idea was actually not that central planners regularly make disastrous "market process" calculation mistakes (to borrow an Austrian phrase) - it was that planners deliberately underpriced their goods. Central planners, Kornai argued, are price-setters whereas market economy firms are almost always quantity setters and price takers. The result was the socialist "shortage economy" - and the flip side is that the market economy is a "surplus economy". That's not that bad of a problem to have, of course! In all my concerns about demand deficiency, you never see me saying "man - we'd all just be better off under central planning", after all. But it does shed light on the economic problems we do face, which is overproductionism/underconsumptionism to put it crudely - and employment as a function of effective demand to put it a little more respectably.

And it is an interesting point that Kornai makes about central planners, isn't it? I don't even know if I would have been that radical before reading this post. If, as Hayek or Mises contends, the primary problem is a socialist calculation problem, then wouldn't we expect to see chronic oversupply - full warehouses and overflowing shelves - as often as chronic shortages in socialist economies? If it's just a miscalculation issue, why the observed bias towards shortages? The traditional SCD logic (in which I side with Mises and Hayek, don't get me wrong) doesn't seem to be able to explain this feature. Kornai can explain that, and can also explain the struggles of market economies.

A little while back, Jonathan Catalan blogged on overproductionism here.

Also, I suppose worth noting, H.P. Lovecraft and Bertrand Russell were fervent adherents to the idea of overproductionism - and I've found at least one letter of Lovecraft's and an essay of Russell's that specifically identifies underconsumptionism as a problem (usually you find that the overproductionist variant dominates in the lay literature - underconsumptionism is largely restricted to economists, I've found). I've gotten the impression that overproductionist concerns were very, very common in the early part of the twentieth century (Albert Einstein made the point at one time as well) - which is interesting because you really don't hear the idea voiced among non-economists these days at all.