Sunday, July 19, 2009

Say vs. Keynes

The real battle in politics and economics isn't between liberals and conservatives, it's between the theories of Jean-Baptiste Say and those of John Maynard Keynes.

Until Republicans understand this, they're going to keep losing political battles. And the American economy will keep tanking.

The fundamental idea of Say's ideas is that it is production (with its siblings investment and saving) that creates wealth.

Say's Law has been expressed various ways, including that "aggregate supply creates its own aggregate demand." He himself wrote, "... a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. ... (T)he mere circumstance of creation of one product immediately opens a vent for other products."
Consider the automobile. When various mechanics and tinkerers began making horseless carriages, they created first a demand for this revolutionary form of transportation. Then their factories hired workers and bought raw materials and other items — creating wealth.

Of course, as today's auto industry makes extremely clear, production and demand can get out of synch. But according to Say and the dominant stream of classical economics, prosperity is based on production. Indeed, a corollary is that consumption destroys wealth.

The Keynesian view, of course, takes the opposite tack: It claims that consumption and spending are the basis of prosperity.

The current recession could be a fine model to test these theories. It could be argued that an orgy of consumption in the United States eventually ate away at the nation's vast wealth. Meanwhile government policies encouraging loose money and housing undercut saving and fueled an oversupply of houses and autos. Right now, the Keynesian solution of pumping money into the economy looks like a flop.

But it remains irresistible to the media and politicians. Sadly, most Republicans buy into it too.

When the Obama administration opened the money spigot, Republican politicians dove right in. Only a few governors even hesitated. And they were unable to convincingly say why they should balk at accepting money from the government.

That's even true here in Utah, one of the most conservative states. Lt. Gov. Gary Herbert (who is virtually governor while Jon Huntsman Jr. awaits confirmation as ambassador to China) has eagerly accepted the money, and is even thinking of pumping more state money into housing.

But this way lies ruin. If it is spending and consumption that have gotten out of whack, only when the U.S. makes production (and savings and investment) primary will the recovery start.

And until then, Republicans will keep getting hammered politically. After all, If spending and consumption are the mainsprings of the economy, then the more spending the better. After all, if spending is good, voters draw the logical conclusion and back the party that spends most enthusiastically.

So Republicans have to fight back. Not to be irreverent, but they must recite Say's Law when they get up in the morning and when they go to bed all night; it should be on their lips and in their hearts: Supply creates demand.

If the liberal/Democratic mantra is "tax and spend," for Republicans it has to be "save, invest and produce."

That will take guts and political skill, however. Transitioning to a savings and production-based economy, and away from the consumption model, will be painful. Taxes on consumption might have to rise.

Other painful political steps await. They have to come out against government spending, but far more intensely than ever before. This doesn't mean fighting just "pork" or "waste," it means fighting all spending. If the feds want to spend money on a Home for Widowed Mothers of American War Heroes, Republicans in Congress have to vote "no."

Then, if Congress, in its current insanity, passes another bailout, the "red" states have to say "no."

Here in Utah, for instance, we're fighting to keep various kinds of nuclear waste out. If classical economics is right, Republicans ought to be fighting to keep federal cash out too, for it's just as toxic.

Transformation would include such touchy issues as free trade. If the U.S. is going to focus on making things, not just buying them, it will have to have places to sell them. Free trade right now can be a tough sell.

Yet there could be selling points too, if understood correctly. Yes, capital gains and corporate taxes would have to go down. But so should payroll taxes. The important thing, however, is that taxes wouldn't be cut to "put money in pockets." They would be cut to help productivity. From the viewpoint of classical economics, payroll taxes are insane. They penalize people for working, and companies for hiring workers.

Republicans could help ordinary Americans by lowering the tax burden on savings, once a backbone of the American economy, but which now seems as outmoded as typewriters and slide rules. That too can help all Americans -- but Republicans have to sell it: "You don't have to be a Wall Street insider to profit from saving money. Just go down to the bank and open an account. And we will make sure you get to keep the interest it earns."

So it can be done. All that's required is sustained intellectual effort, party discipline, imagination and courage. It should be heartening that Ronald Reagan and the GOP had those qualities once, so it's not impossible Republicans could get them again.

But until they do, the party and the economy are destined to flounder.

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