Happy B-day to 2 Misunderstood Men: Adam Smith & J.M. Keynes

It is a fun fact that both the "founder" of economics, Adam Smith, and "founder" of macro economics, John Maynard Keynes, share the same birthday.  It is a not so fun fact that both men and their theories are so misunderstood by, not just the general public, but by other economists as well.  I realize I'm a day late on wishing them a happy birthday, but I'd like to give them both a belated present:  Clearing up some common misconceptions of their work.

Adam Smith was a compassionate person who cared greatly about morality, the well-being of humanity, and the poor.  Before publishing his famous economic Treatise, The Wealth of Nations, he published The Theory of Moral Sentiments.  A book that starts out with (bold emphasis mine)

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it... a matter of fact too obvious to require any instances to prove it

Smith was certainly no "let the poor fend for themselves or die" Ayn Rand disciple.  Despite this, the right wing in this country attempts to portray Smith as their mascot.  Even to the point of naming right-wing institutes after him.  So let's take a look at some of his views that would get him drummed right out of the republican party, tea party, and the general conservative movement.

Adam Smith recognized "the rich" taking advantage of the poor.  This excerpt is from From Book I, chapter 11 of the Wealth of Nations. (bold emphasis mine)

Rent, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land. In adjusting the terms of the lease, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself, without being a loser, and the landlord seldom means to leave him any more.

In his day, Smith didn't use the term 'the rich' or the '1%' to describe wealthy people living off of the working class.  In his day they were called land lords and he didn't particularly care for them.  In this day and age he'd be accused of "envy" and "class warfare".  The excerpt above is just one of many that paints a negative view of landlords.

One last thing on Adam Smith.  If you were to claim Adam Smith's principles of taxation as your own, your right-wing friends and relatives would label you a socialist. It's really that first principle that would get smith labeled a socialist and thrown out of the tea party. From Book 5, Chapter 2, part 2. (bold emphasis mine)

1. The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state...
2. The tax which each individual is bound to pay, ought to be certain and not arbitrary...
3.  Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it...
4. Every tax ought to be so contrived, as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state...

I'm not saying Smith would be a liberal or a democrat if he were alive today.  But I am saying he'd be a lot closer to one than he would be to modern conservatives.

Now let's move on to Keynes.  John Maynard Keynes was a pro-capitalist, anti-communist British economist.  His biggest contribution to economics was a coherent theory showing that when it comes to analyzing a modern economy, money matters.  Up to that point, many thought that one could apply the principles of a barter economy to a monetary economy.

The common perception is that Keynes's big contribution to economics was that "demand creates its own supply" as opposed to "Say's law" which stated "supply creates its own demand".  If that was the only thrust of his argument, people wouldn't still be talking about him.  Economists had been making that argument since the time Say made his law.  It was the underlying theory behind his conclusion that made him famous.  Keynes arrived at his  "demand creates its own supply" conclusion based on his analysis of money and it's effect.  There was a reason his major book was called "The General Theory of Employment, Interest, and Money" not "The General Theory of Employment, Interest, and demand".  There was a reason that the prequel to "The General Theory" was called "A treatise on Money" and not "A Treatise on aggregate demand".  If you still don't believe me, read this excerpt from the Preface to "The General Theory".

When I began to write my Treatise on Money I was still moving along the traditional lines of regarding the influence of money as something so to speak separate from the general theory of supply and demand. When I finished it, I had made some progress towards pushing monetary theory back to becoming a theory of output as a whole.
[snip]
This book, on the other hand, has evolved into what is primarily a study of the forces which determine changes in the scale of output and employment as a whole; and, whilst it is found that money enters into the economic scheme in an essential and peculiar manner, technical monetary detail falls into the background. A monetary economy, we shall find, is essentially one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction.

There is something else about Keynes.  He shows that, because of money, the state must play a role in the economy to maintain full employment.  This has spawned two common misconceptions:  One is that conservatives demonize Keynes as the second-coming of Karl Marx.  The other is that in a recession, the government should spend money all willy-nilly until the recession is over.

For the first misconception, Keynes seemed ready for the attack.  In the last chapter of "The General Theory" he states several times he is no socialist and does not advocate it.

But beyond this, no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.
[snip]
To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use.  There are, of course, errors of foresight; but these would not be avoided by centralizing decisions.
[snip]
But there will still remain a wide field of the exercise of private initiative and responsibility.  Within this field the traditional advantages of individualism will still hold good.

Finally, if your only understanding of Keynes is, "use government stimulus to get out of recessions", you haven't fully understood him.  Keynes made clear that in a monetary economy, there is chronic under-consumption and under-utilization of resources.  Even during expansions there is a need for "social investment" (though not necessarily as much).  If the government can always guarantee full employment levels of spending, the private sector will respond by making their own investments and thereby cut the amount government needs to make.  There's much more to Keynes than just his conclusion of demand management.  But they'll have to wait as this post is too long already.  They'll have to wait until next year.

How much will it cost to fence up the border?

Last Wednesday, Felona asked "How much will it cost to fence up the border?"  That's a great question.  First of all, there aren't any perfect answers.  Until it is actually "fenced up" we can only estimate, but I will give you the best estimates I can find.  Before diving into the numbers, I must say I was shocked at the price tag.  I guess when I hear the word "fence" I think of the chain link fence in my backyard, or the wood picket fence my grandparents had.  But the "Border fence" is actually more like a prison wall, or even multiple prison walls like the walls in the designs below.

A concept design of a Border wall(s)

Actual Image of a Border Wall(s)

So, the question remains, how much will these walls cost?  Let's try one part.  Boeing was payed 67 million dollars to create a 28 mile "virtual fence".  Based on the fact that the U.S. Mexico border is 1993.4 miles(pdf), it comes down to a math problem.  67 million/28 miles * 1993.4 miles = nearly 4.8 billion dollars to build.  Unfortunately, it doesn't end there.  Due to delays, glitches, and other cost overruns, The fence actually ended up costing  almost a billion dollars to span just 53 miles.  Plug that into your calculator and you get 37.6 billion dollars.  A lot higher than earlier reports of only 6 or 7 billion.

Of course, other, less costly style border walls have gone up.  But even those will be upgraded with additional fencing and equipment.  The problem is that a single fence is not good enough.  A single fence can be scaled, dug under, etc...  It requires something elaborate to actually stop people.  So I think it's fair to estimate the cost of a Boeing style wall:  Double walls, specially built with barbed wire or slants at the top to make it difficult to climb over, separated by cameras and other sensors to alert border agents.

To check my numbers, I found this congressional research service report from a couple of years ago about the status of the border wall.  It threw out a lot of estimates on per mile costs of the fence:

The Congressional Budget Office (CBO) has estimated that border fencing would cost $3 million a mile to construct and that maintenance would total roughly 15% of the overall project costs per year.103 However, the CBO does not elaborate on what is included in those estimates. DHS predicts that the San Diego fence will have a total cost of $127 million for its 14-mile length when it is completed—roughly $9 million a mile. Construction of the first 9.5 miles of fencing cost $31 million, or roughly $3 million a mile, while construction of the last 4.5 miles of fencing is projected to cost $96 million, or roughly $21 million a mile.104 However these costs may be somewhat misleading due to the following factors: construction of the fence was delayed for an extended period of time; the remaining construction involves filling a relatively large gulch which may be more complex than the average stretch of border; and DHS is proposing to use private contractors to expedite the construction process which may increase the labor costs and thus may increase the overall project costs. According to the Government Accountability Office (GAO), the border fencing constructed by the end of FY2007 (using mostly the Corps of Engineers and the National Guard to construct the fencing) cost about $2.8 million a mile.  The fencing constructed
in FY2008, using mostly private constructors, cost about $5.1 million a mile.105

All those estimates are between 3 and 9 million dollars per mile(I left out the 21 million dollar per mile estimate since, as the report described was an unusual geography).  That's between 6 and 18 billion dollars to complete.

Of course, that is just the cost to complete the fence.  That doesn't cover maintenance of the border fence.  There is a very real possibility of people knocking down portions of the wall or nature just washing away 40 feet of it at a time.  In the same report at the one above, the army corp of engineers estimated the maintenance costs to be between 16.4 and 70 million dollars per mile over a 25 year period.  That comes out to 650 thousand and 14 million per year per mile.  Or put another way, between 1.3 billion and 5.6 billion per year just to maintain and repair the wall after it is completed.

Not a direct cost, but the Sierra Club and others have noted the damage to wildlife that a border fence would pose.  It is unclear to me how much that would cost business or government to either solve or to endure it.

In conclusion, I have to say while building and maintaining a border wall along the U.S.-Mexico border is very expensive, it is not completely impractical.  Even taken the highest estimates to build and maintain, we are talking about between 1 and 2% of the average Federal Budget to build the fence and less than 1% per year to keep up.  I'm happy to offer some the real, concrete numbers. I'll let others argue about whether it is worth the costs.  I think my position has been made clear in the past.  Thanks for the great question, Felona!

Types of Unemployment

Modern, mainstream economics universally recognizes three types of unemployment:  frictional, structural, and cyclical.  Some people add in seasonal unemployment to give us four types of unemployment.  These types of unemployment are pretty universal.  Not only on the net(see here, here, here, and here), but in N. Gregory Mankiw's Intro text book, Principles of Economics, as well.  Let's take a brief look at each kind.

Frictional Unemployment are workers who are literally "between jobs".  It is only the time lag it takes for a worker to leave one job and go to another(or become self-employed).  There might be some delay while a worker works on her resume` and goes through the interview process and possible wage negotiations.  Frictional unemployment is normal and healthy in any economy.  In fact, not having any, I speculate, would be inefficient and have a lot more unhappy workers who are stuck in their jobs.

Structural unemployment is the type of unemployment that comes up when the jobs employers are offering do match the skill or desire of those who are looking for work.  In a way, this could be considered long-term frictional while employees get new skills or employers adjust their requirements.  But I think that it is right to separate this kind of unemployment from frictional.  It's causes are different and therefore solutions would be different.

Combating structural unemployment seems to be the one issue that unites liberals and conservatives in the United States.  Reducing structural unemployment seems relatively simple.  If workers don't have the skills they need, then they need training or education.  Job training appears to be the only "jobs" program conservatives are willing to fund.

Cyclical unemployment is of course unemployment related to downturns in the economy.  Classic Keynesian economists will say it's from a lack of demand in the economy.  Monetarists or neoliberals like Mankiw will call it a downturn out of sync with the "natural rate of unemployment".  Austrians will deny that such a thing exists(claiming it's a type of structural unemployment created by bad policy) .  Unlike structural unemployment, conservatives are usually less willing to do anything about this.  Although not always, since the Bush tax prebates in 2001 that sent money to people is a Keynesian solution to driving up demand.  It might not be considered an orthodox approach, but it accepts the Keynesian precepts of driving up demand via government.

Finally, we come to seasonal unemployment.  There are some jobs that are only demand for part of the year.  For instance, retail stores hire extra people before Christmas.  Another example are farm workers who are only needed during the planting season and harvest time.  These are jobs that naturally don't exist year round.  When the demand for those jobs end, workers are left unemployed.  I understand why some people don't consider this a type of unemployment.  Some might just call this frictional since, presumably the workers will find other seasonal jobs once laid off.  I can understand that reasoning of both sides.  Seasonal employees will likely have more than 1 job, but seasonal unemployment poses unique problems from the other types so it makes sense to track them separately.

So that's the three (or four) different types of unemployment.  Not a lot of controversy for the most part.  The only part up for debate between the different economic schools is the existence of cyclical unemployment, and how best to understand it.

General Theory Study Guide, Preface and Book 1, Chapter 1

After reading of the Preface and Introduction(Book 1, Chapter 1) of The General Theory I find four things worth mentioning.  The first is why he wrote the book and the urgency with which he writes it.  The second is who he wrote the book for and why.  The thrd is the books relationship to his earlier writing, "A Treatise on Money".  The last thing I'll discuss is Keynes preview of the book and the significance of his title.

In the preface, Keynes lists his reasons for writing the book.  His goal was to deconstruct current economic theory, refute it, and reconstruct a new theory. He wrote the book during the Great Depression.  A time when unemployment was persistently high and didn't seem to be going down.  Most mainstream economists of the time were offering either conflicting or ineffective advice. Keynes noted that the longer the recession went on, the less the public was listening because the traditional advice(let the markets clear!) wasn't working.  Therefore there was an urgency to get things figured to end the Great Depression.

Keynes also made clear that he was writing this book for his fellow economists.  Apparently, he felt that they needed to be convinced before he had any hope of convincing the general public of his new ideas.  Since Keynes work was directed towards his fellow economists, Keynes really lays down the gauntlet.  He declares his book is going to attack current economic theory by refuting some of it's most basic assumptions.  He also warns that his disagreement isn't because he doesn't understand the mainstream economics of the time, but because he believes that mainstream economics is wrong.  As evidence he offers that he once "held with conviction for many years the theories which I now attack, and I am not , I think, ignorant of their strong points".

In the preface, Keynes mentioned something I found interesting about his earlier work, "A Treatise on Money".  His treatise was not only critiqued by his most-famous-rival Hayek, but his contemporaries piled on.  Keynes makes a bold claim in his preface.  He states that any legitimate criticism of his Treatise wasn't the result of him getting too far away from mainstream economics, but because he hadn't gotten far away enough.  If you don't think that's bold, imagine this:  You have an argument with someone.  The other person clearly loses.  The next day that person comes back and states, "I figured out why I lost our debate,  it was because I underestimated how wrong you are".

The last thing that I learned was from the introduction.  In the introduction, Keynes explains why the book is called "The General Theory".  Having never read the introduction before, I assumed that it was called "The General Theory" because he was laying a high level theory explaining the  economy.  Instead, Keynes had a subtler, more important meaning in mind for the title.

The title of the book, according to Keyne's introduction is that most of economics is based on a certain condition:  That the economy is in perfect equilibrium(everyone and thing is employed at what it is most efficient at).  Keynes says his book is an economic theory for when the economy isn't in equilibrium.  And, based on his intro, I believe that he believes the economy is almost never in that state.  From Keynes:

The characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live.

I specifically call this out because I've read economists that have claimed that Keynes was only writing for the Great Depression and his theory, conclusions, and recommendations didn't apply otherwise(see here, and here).  But his introduction leads me to believe that he was writing for almost every occasion.  He doesn't say 'currently' aren't living in.  He says flat-out, we don't "actually live" in the world assumed by classical economists.  I think this is the most significant thing I read as it refutes many people who suggest that Keynes didn't mean for his analysis to apply to non-depressions.

I didn't mention this in the intro, but be sure to read the footnote in Book 1, Chapter 1.  Keynes defines what he means by "The Classical School".  Apparently, he means any economist who can trace their work and theories back to David Ricardo.

For just a Preface and an Introduction, this was some pretty intense reading.  I have a feeling the rest of the book is going to be like this so I'd better settle in for a long ride.

How to define poor and poverty?

How do you define poverty and whether someone is "impoverished"? Someone asked me this question and i had a surprisingly hard time doing it. My problem is that i reject the numbers-based definition of poverty.

The U.S. government defines poverty based on someone's income and (to a lesser extent) how much stuff they have.  Being that governments need concrete rules for their bureaucracy, this makes sense.  If you make less than 'X' then you are poor.  No thinking or judgement required.  The problem i have with this approach is that it lumps people together without thinking.

A college student might not be making a lot of money, but I wouldn't necessarily call them impoverished.  Quite the contrary, I would call them privileged for the opportunity even if their income is low during their study.  We might also capture someone who has temporarily lost their job.  They might lose much of their income for a year, but with a little hard work and a little luck, they'll find a job and start rebuilding their nest egg.  They may temporarily need government assistance to get them through, but again, I wouldn't call that impoverished(Granted, I might call it stressful, awful, and wouldn't wish the situation on anyone).  Finally, even wealthy businessmen can declare bankruptcy and lose most of their fortune.  For a brief period they may technically qualify for government assistance, but with the help of a vast network of business contacts and established relationships, they can quickly rebuild their fortune.  So, again, I wouldn't call that person "impoverished".  It's because of these exceptions that I think "poverty" needs a better definition.  Something that can better explain the picture most of us have when we hear the word poverty.

Another class of definitions for poverty describes how well someone's basic needs are being met.  For instance, poverty is a lack of  shelter, food, etc...  This is better, but runs into some problems. First, how does one decide what items one should lack to be thought of as impoverished?  We can start with food, but what if someone has food, but no shelter.  A man living under a bridge might have all the food he needs from a nearby church, but that won't keep him warm at night.  So we add in shelter.  Well, what about health care?  Food and shelter is nice, but you're still suffering if you have tuberculosis and can't get the medicine you need.  Then, what about transportation?  What good are all those things if you can't get to wherever they are?  Now you can see the problem with this.  To get a full definition would require an exhaustive list and there would still probably be a form of poverty left out.

Here's another problem with this second definition.  Where the first definition might describe people as impoverished who really aren't, this has the opposite problem.  I think it doesn't necessarily capture everyone who is impoverished.  I think trying to define poverty by listing the things that poor people lacks is that your list is actually describing the manifestations of poverty, not necessarily the condition.  That brings me to the U.N. definition of poverty from 1998.

Fundamentally, poverty is a denial of choices and opportunities, a violation of human dignity. It means lack of basic capacity to participate effectively in society...

I think this was one of the best definitions of poverty I've ever found.  Lacking some income is not the problem for the impoverished, it is a denial of opportunities and choices that everyone else has.

Using this definition of poverty, one can easily explain why things like poverty and social justice matters.  Denying someone the opportunity or ability to participate in society and advance themselves is violence.  Just because nobody is holding a gun or knife to someone doesn't mean that a person cannot be harmed.

Reading The General Theory

As much as I've talked about economics on this blog, I've never actually read Keynes's entire Magnum Opus, "The General Theory of Employment, Interest, and Money".  Sure, I've read parts of it here and there, but never all the way through as written.  Normally, I'd feel ridiculous about talking about a subject without reading one of the most famous books on the subject.  But apparently, most "real" economists haven't done so either and some even actively advocate against reading it.

So, I started reading "The General Theory" and very quickly learned new things and other things that I wanted to find more information about.  That's when I discovered there are no free, online study guides for The General Theory that are pro-
Keyensreality (the one I found was written by a very hostile austrian enthusiast).  So, I've decided to start one.  What qualifies me to do this?  Absolutely nothing but a curious intellect and a blog.  But, the way I figure it, until a more qualified person offers the same thing , I've got a monopoly on this niche.

So, what I'm going to do is read a selection.  Then I'll blog about what I read.  In the title, I'll put what section I'm talking about.  I'll point out things that I think are correct, things that I think are wrong, things I found insightful or interesting, and things that I found difficult to understand.  I'll then try to justify why and put in the correct information or summary.  I expect that I may occasionally change my mind or find new information and will have to update a post.  If it's a small change I'll edit the post.  If it's a big change I might just rewrite it and note that the older section is deprecated.

I'll also be creating a new page, The General Theory Study Guide, that puts the readings in order so that future readers can easily find the different sections.  I have no idea how long this will take, but it won't be finished unless I start it.  Hopefully, somebody will eventually find this helpful.  For those who are curious, this is the edition I'll be reading on the eBook reader device of my choosing.

Economic History Debunked: Economics Before Adam Smith

There was a rich history of economists long before there was an Adam Smith.  They didn't necessarily call themselves "economists" or use even the older term "political economy", but what they were studying was the "dismal" science known as economics.  Despite this, "Smith is widely cited as the father of modern economics and capitalism and is still among the most influential thinkers in the field of economics today" according to many.

Like so many other western sciences, economics has roots in the Greek philosophers of ancient times.  Plato stumbled onto a variation of the advantages of the division of labor.  One of Plato's greatest students, Aristotle, also touched on the subject of economics.  Just read book I of "Politics" Chapters 8(VIII) through 11(XI).  It is available online.  In it he discusses the "art of acquisition".  He touches on subjects that modern economists would refer to as "the nature of money", the concept of a monopoly, and markets.

Skipping ahead a few centuries... we come to Spanish Scholasticism at the University of Salamanca.  Scholasticism is a term usually used to describe a type of learning by medieval monks and scholars.   The University of Salamanca in Spain was founded by a group of scholastic scholars.  Austrian economist Joseph Schumpter did a lot of research to uncover much of the work done on economic thought at the University.

Similarly the Spanish Scholastic Diego de Covarrubias y Leiva (1512–1577) a distinguished expert on Roman law and a theologian at the University of Salamanca, wrote that the "value of an article" depends "on the estimation of men, even if that estimation be foolish." Wheat is more expensive in the Indies than in Spain "because men esteem it more highly, though the nature of the wheat is the same in both places." The just price should be considered not at all with reference to its original or labor cost but only with reference to the common market value where the good is sold, a value, Covarrubias pointed out, that will fall when buyers are few and goods are abundant and that will rise under opposite conditions

Schumpter gives a lot of credit to the late medievalearly Renaissance scholars at the school for making advances in economics that were later credited to Austrian economists that came 300+ years later.  Pretty good head start if you ask me.

To read more about these religious scholars struggle with "Just Price" you can read an excerpts from the book, "Modern Catholic Social Documents and Political Economy".  This link to Google Books should allow you read the whole excerpt "Scholastic Just Price" that starts on the bottom of page 63.  To sum up the excerpt, there was a great debate of whether the "Just Price" of a product was the market price, or the "cost to produce" price.    It is an interesting discussion because what they were discovering without realizing it, I think, was what came to be known as "economic rent".

The next group to talk about is probably the mercantilists.  For those who do talk about mercantilism, I think the conventional wisdom gets it right.  Mercantilism isn't so much a complete economic theory as much as it's a collection of disparate ideas of how to make the ruler of a nation state rich and rival rulers poor.  I won't rehash what others have said better:

Mercantilism was a reaction against the economic problems of earlier times when states were too weak to guide their economies and when every town or principality levied its own tariffs on goods passing through its borders.
The modern age brought the rise of powerful nation states (Holland, France, Spain and England) and was marked by almost constant warfare. Money (bullion) was needed to support ever-expanding armies and navies. Mercantilist concepts developed from this need.
Underlying this theory was the belief that wealth was finite. If one nation hoped to grow richer, it had to do so at the expense of some other nation.

Mercantilism drove economic and foreign policy during Renaissance Europe.  The reason I mention it is because it's existence was what our next group was rejecting:  The Physiocrats.  This group came on the scene in the mid 1700s - just a couple decades before Adam Smith published his Treatise.  They started and were based entirely within France.  There physical location is important.  The french economy was under severe distress at the time.  It makes sense that a group would be formed to understand why and come up with ideas of how to fix it.  While this group didn't come up with supply & demand concepts, they are sometimes still cited for things that they did come up with.  Some things that Smith also discovered and some things that he missed.  There is too much to put in this post, but they were a significant school of economic thought before Adam Smith(It is unclear to me how much Smith was affected by the french physiocrats). After the Physiocrats, finally came Adam Smith's treatise on the Wealth of Nations.

Here is one more worthy historical note.  My above analysis is extremely Anglo/European centric.  I've completely left out of my above are any non-western thinker.  There were several non-western thinkers that touched on economics that are worth exploring from the middle east, India, China, and probably others that I haven't found yet.  It's a shame our natural bias seems to leave out non-European thinkers from the official history.

As you can see he was most certainly not the first economics writer.  I'm not sure why he, historically, gets the credit for being the first.  Maybe because his book was the most complete and accurate tome written at the time.  A worthwhile accomplish no doubt, but not sure why he seems to get credit for "founding" economics.