Keynes, Friedman and ‘the paradox of thrift’ – who is right?

“Some people spend their money freely and still grow richer. Others are cautious, and yet grow poorer.” (Proverbs 11:24)

What’s an atheist doing quoting from the Old Testament? Well, I’m just pointing out that the proposition that spending may help and saving may hurt an economy is not a new one.

In 1705, a poem by Bernard Mandeville entitled ‘The Fable Of The Bees’ was published. It was considered scandalous, as it implied that prosperity was increased by expenditure rather than by saving. This idea was later called ‘the paradox of thrift’ by the economist John Maynard Keynes; the principle is that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individual savings attempt to rise, and, broadly speaking, that increase in savings may be harmful to an economy. When people spend less, the government has to spend more.

Keynes was the intellectual architect of Roosevelt’s New Deal and the modern welfare state. The market crash of 1929 had created an overwhelming consensus that laissez-faire (unrestricted private enterprise) had failed and that governments needed to intervene in the economy to redistribute wealth and regulate corporations. The paradox of thrift is a central component of Keynesian economics, and formed part of mainstream economics until the 1980s.

Johann Hari has recently renewed the case for the paradox of thrift:-

“In a recession, private individuals like you and me, perfectly sensibly, cut back our spending. We go out less, we buy less, we save more. This causes a huge fall in private demand, and with it a huge fall in economic activity. If, at the very same time, the government cuts back, then overall demand collapses, and a recession becomes a depression. That’s why the government has to do something counter-intuitive. It has to borrow and spend more, to apply jump-leads to the economy. This prevents economic collapse. Instead of spending a fortune on dealing with mass unemployment and economic breakdown, with all the misery that causes, it spends the money on restoring growth.

Wherever it has been tried, it has worked. The Great Crash of 1929 was followed by a US President, Herbert Hoover, who did everything Cameron demands. He cut spending and paid off the debt. The recession grew and grew. Then Franklin Roosevelt was elected and listened to Keynes. He ramped up spending – and unemployment fell, and the economy swelled. It’s working now. Which countries have come out of this recession fastest? They are the ones like South Korea, which have had by far the biggest stimulus packages, paid for with (yes) higher debt. Which countries have fallen furthest and shattered most severely? The ones that tried to pay down their debts immediately with huge cuts.”

By contrast, Chicago University economist Milton Friedman believed history “got off on the wrong track” when politicians began listening to Keynes. Friedman believed that humans are governed by self-interest and, as Naomi Klein remarks, “patiently protected the flame of a pure version of capitalism, untarnished by Keynesian attempts to pool collective wealth to build more just societies". In the 1960s, few people listened to Friedman, with most insisting that governments could and should do good.

Friedman wrote to General Pinochet, the butcher of Chile, in 1975 saying: “The major error, in my opinion, is to believe that it is possible to do good with other people’s money". Finally, after he’d spent decades in the intellectual wilderness, came the eighties and the rule of Thatcher (who called Friedman “an intellectual freedom fighter”) and Reagan (who was seen carrying a copy of Friedman’s manifesto on the presidential campaign trail). There were now political leaders who were prepared to encourage unfettered free markets, which is where we are in the UK today with Cameron, Osborne and their sidekick Clegg. But shouldn’t they have learned from history?

Maybe they don’t want to learn. Naomi Klein has argued how disasters of any kind are used by the disciples of Friedman as an excuse for widespread privatisation, for transferring control from politicians who can be held to account to corporations which only answer to their shareholders. And if some generous donations to party coffers are obtained in the process, then all well and good. So the longer the economic downturn continues, the more time there is to complete the transfer and signal a return to the days of laissez-faire before 1929, which proved such a spectacular failure and a recipe for human misery.

Sources used:-

http://en.wikipedia.org/wiki/The_Fable_of_the_Bees

http://en.wikipedia.org/wiki/Paradox_of_thrift

http://johannhari.com/2011/03/29/the-biggest-lie-in-british-politics/

Naomi Klein, ‘The Shock Doctrine’, Penguin (2007), pp 17-18

Friedman's model of economics is inherently self-destructive. One cannot live within a society that fosters hyper-individualism, self-gratification, base greed and avarice, and cutthroat competition and expect that society to survive. Ultimately, it will turn upon itself like starving wolves in the darkest of winters. We are seeing that now in the US as our population divides itself between the haves and have-nots, the religious and the apostates, the gays and the straights, and even man vs. woman.

People fail to understand -- or they choose not to understand -- that America's free market capitalistic successes were largely built upon an extremely unique period in history, that being the post WWII era. America could not help but be prosperous when it sat untouched by the horrors of war yet was still instrumental in the war's end. After which time the US built everything, exported everything, and, well, damn near owned everything. America dictated the economic terms throughout the 50's and 60's and even into the 80's as America continued to ride the economic wave of prosperity that followed the war. Americans prospered because there were gaping holes in the world economy and we were more than willing to fill them.

But that economic wave has since crashed into the seawall of global competition, and to survive, it cannot be an "every man for himself" ideology. We will lose that fight. In order to compete internationally, we have to actually BE a nation, not just a collection of individuals with the happenstance of living in the same geopolitical region. That means paying our workers well, not hoarding profits for the good of the corporation and the top 1%. Societies with huge wealth disparities have never lasted, and certainly never achieved or maintained "economic superpower" status. Nations like France during the successive reigns of the various Louises managed to build opulent castles like Versailles for its top aristocrats, it managed to fund expensive wars across the globe, and it managed to keep the "haves" living in luxury. But sooner or later, the people decided enough was enough ... and that holds true now as it did then.

People need to be wealthy enough to buy the products and services they make and offer or else the economy will implode, a key facet of Keynesian economics. Conservatives in America often cite our very high per capita income as proof of our prosperity, but those numbers are extremely misleading. Our citizens spend a HUGE portion of that income on basic necessities including an average of $14,000 per year on health insurance alone, which is 25% of the nation's average income. Add to that figure historic levels of student loan debt, exorbitant rent prices, always increasing food prices, and an endless litany of fees, there's really not much left at the end of the month to go out and spend in the general economy. Major retailers are dropping like flies, and with them go the manufacturers that make the products they once sold. In addition, the infrastructure behind both industries are affected -- everyone from truck drivers and mechanics to marketers, advertising firms, and bankers feel the pinch.

The individualist doctrine invariably produces a citizenry that feels each person is entitled - yes, I said entitled - to more money than the next person. The end result is a population that has no sense of community or national cooperative spirit. Every person is viewed as a potential competitor for the scant wealth and resources that the top 1% have artificially made rare. The latent volatility in such a system can be seen in the French Revolution, the Russian Revolution, the Iranian Revolution, the collapse of the Soviet Union, and even the American Revolution.

‘An economy in crisis, a coalition in denial’

Extracts from an article by Robert Skidelsky:-

"What happens if all households and firms try to increase their saving at the same time? Then the total spending in the economy will fall because everyone’s spending is someone else’s income. There will be less demand for goods and services and therefore for labour. Our collective attempts to get back into balance will have made us all poorer, and, indeed, reduced the amount of saving as well, given that we will have smaller incomes out of which to save. So the economy will go on shrinking until the excess saving is eliminated by the growing poverty of the community.

New acts of saving, though virtuous for the individual, make us all poorer when the demand for new capital has declined. That is why Keynes rejected more saving as the remedy for a slump. The correct response was more spending. And if private agents lack the resources or incentive to increase their spending then the government needs to increase its own spending.

The important figure is not what I owe but the ratio of what I owe to my income. I can try to reduce this ratio either by saving my income to pay off the debt or trying to make my income larger. Reducing the national debt is more complicated. It can only be done by taxing more or spending less, and this drives down people’s incomes and creates unemployment. Furthermore, by reducing incomes, it also reduces people’s ability to pay taxes, and this can be self-defeating. Something like this has happened in Europe, where falling incomes due to austerity have driven debt ratios up, not down."

For the full article:-
http://www.newstatesman.com/politics/politics/2012/09/economy-crisis-coalition-denial

Expert opinions can't seem to decide whether personal Savings are a "Good Thing" or represent a failure to invest in the national economy. The voices which lament low investment in personal pensions are the same voices that exhort Consumers to support the retail economy.

Traditionally the Government has always had a branch of The Treasury that taps into personal savings, but the investments offered have dwindled recently to little beyond Premium Bonds, which suggests that Government doesn't actually need to borrow any more money. Whilst producing figures demonstrating recession.

There used to be a joke that said if you wanted twelve variations on the best economic advice you need to ask twelve economists.

Expert opinions can't seem to decide whether personal Savings are a "Good Thing" or represent a failure to invest in the national economy. The voices which lament low investment in personal pensions are the same voices that exhort Consumers to support the retail economy.

There used to be a joke that said if you wanted twelve variations on the best economic advice you need to ask twelve economists.

OW. At the risk of stating the obvious, poor people are more likely to spend all of their money than the rich. So if you cut taxes for the poor, it will help stimulate demand in the economy. If you cut taxes for the rich – as with our absurd reduction in the top rate of income tax from 50% to 45% - the stimulating effect will be quite small. Some of that money may be saved in offshore tax havens, and some might go into the kind of financial and real estate speculation that precipitated the last crash.

I accept that economics is not an exact science, but I suspect that most economists fall roughly into two camps these days – those who support Keynes and those who support Friedman. Interestingly, Ramesh Patel describes himself as a Conservative yet he clearly supports Keynes:-

“Economic history shows that austerity at a time of recession has never worked and it always shrinks the economy via job losses, which means fewer people spending, which results in further job losses and even less spending. This cause and effect of job losses leads to a downward spiral of the economy - hence it is self defeating. Ask yourself this question: have you ever heard of an unemployed man paying off his debts?”

http://www.huffingtonpost.co.uk/ramesh-patel/david-cameron-ed-balls_b_1920913.html?utm_hp_ref=tw

Richard J. Murphy touches on another point which is disturbing. I mentioned in the opening posting how undemocratic it is to “transfer control from politicians who can be held to account to corporations which only answer to their shareholders”, as happens when right-wing governments privatise everything in sight under the cover of an austerity programme. Murphy says:

“It’s often presumed that the target of austerity is government deficits. I’m not at all sure I agree. The Spanish government has announced its fifth round of budget cuts and tax increases in just nine months, as part of a reform package that could pave the way for an EU bailout and sovereign debt purchases by the European Central Bank. Alongside the spending cuts, the government said it would pass 43 new laws over the next six months and establish a new independent budgetary authority to monitor government spending. The sting is in that tail: a new unelected body is going to preside over these cuts, and presumably be accountable to the EU.

Greece and Italy have lost governments to austerity and democracy with it as the EU has moved in. Now Spain is going that way. How the right-wing must love this: they say they’re the enemies of the state, actually they’re the enemies of democracy. It is for governments to be accountable: passing the job to the great and good is neo-feudalism.”

http://ht.ly/e5jHX

....“transfer control from politicians who can be held to account to corporations which only answer to their shareholders”.

Yes indeed. The Credit Crunch of 2008 was a wake-up call to all elected governments. Mighty international companies operating globally are already beyond effective control, and adjust their accounts to maximise profits at the expense of any national treasury.

In the USA, California and Washington States are finding it difficult to meet their public financial obligations, despite having within their boundaries Silicon Valley, Boeing and Microsoft - which SHOULD be generating squillions of Dollars in taxes - but aren't!

The Multinationals establish a worldwide network of linked Companies in places like Cayman Islands, Republic of Ireland, Luxembourg, Channel Islands etc., which RECEIVE the sales income from more heavily-taxed locations. Google, Facebook, Boots, Vodafone and many other familiar names pay little or no tax on their profits generated in the UK.

Time for some International co-operation, perhaps.

Company profits depend on the 'welfare payments' they get from society

Extracts from an article by Ha-Joon Chang:-

"The free market is a myth. From drug patents to quantitative easing, businesses make money because of state help. The pharmaceutical industry most starkly reveals how profits are ‘social’ creations – it makes its profit because it is granted artificial monopolies in the form of patents. Another obvious case is the banking industry. Today, many banks all over the world would not have existed but for the huge public money poured into them in the aftermath of the 2008 crisis.

The horsemeat scandal has revealed that British supermarkets and the European meat industry have made higher profits from the relaxation of regulations regarding food standards, introduced by the coalition government in 2010 in the name of cutting government spending and, more important, ‘red tape’. The Poundland scandal has revealed that British retail stores would make lower profits if they were not allowed to use the claimants of unemployment benefits as unpaid workers. Businesses make what profits they make only because the government, and the electorate as the ultimate sovereign (at least in theory), helps them in all sorts of ways.

Once we accept that the amounts of profit companies make are ultimately determined by these ‘welfare payments’ society decides to confer upon them, we begin to see the problem with the free-market view that has dominated the world for the last few decades. Poor people receiving government benefits have been told far too often that they are spongers, when the rich get even more government benefits."

For the full article:-
http://www.guardian.co.uk/commentisfree/2013/apr/05/company-profits-welfare-payments-society

The Multinationals establish a worldwide network of linked Companies in places like Cayman Islands, Republic of Ireland, Luxembourg, Channel Islands etc., which RECEIVE the sales income from more heavily-taxed locations. Google, Facebook, Boots, Vodafone and many other familiar names pay little or no tax on their profits generated in the UK.

As I am at the coal face when it comes offshore tax havens, I should just let you know that all of the above locations are sharply in decline, with the USA coming down heavily on Cayman, BVI ect and the EU and UK on the other locations. Most of these companies and the offshore finance companies have now moved east, with Singapore, Qatar, Hong Kong, Bahrian and Mauritus now taking over the mantle. I would estimate that around 50% have already moved with many more looking to do so. Heaven knows what will happen with regulation over there as their compliance is far inferior to the strict rules we abide to

Individual Americans living abroad are still liable to complete an Annual Tax Return for the IRS.

http://www.taxesforexpats.com/uk/us-tax-preparation-in-uk.html

You might ask how American Corporate Bodies manage to make so much global profit without incurring a corresponding tax liability in the US.

Starbucks doesn't even have a tax liability in the UK. It has a monopoly on student fast food outlets, and makes mega-bucks.

Anyone care to explain??

Write and ask your MP what Gideon Osborne is doing about it.

‘Living within our means’ makes no economic sense

From an article by Ha-Joon Chang:-

If you borrow money to do a degree or get a technical qualification, you will be spending beyond your means today. But your new qualification will increase your future earning power. Your future means will be greater than they would have been if you hadn’t taken out the loan. In this case, living beyond your means is the right thing to do.

Like individuals, of course, a government can increase its means in the long run by borrowing to invest in things that will make the economy more productive, and thus increase the tax revenue. If a government invests in improving the transport system, it will make the country’s logistics industry more efficient. Or if it invests in healthcare and education, that will make the workers more productive.

More importantly, unlike individuals, a government has the ability to spend “money it does not have”, only to find later that it had the money after all. The point is that deficit spending in a stagnant economy will increase demand in the economy, stimulating business and making consumers more optimistic.

If enough businesses and consumers form positive expectations as a result, they will invest and spend more. Increased investment and consumption then generate higher incomes and higher tax revenues. If the tax take increases sufficiently, the government deficit may be eliminated, which means that the government had the money that it spent after all.

http://www.theguardian.com/commentisfree/2015/oct/13/living-within-means-economic-labour-john-mcdonnell

Although you may not immediately recognise the name of Navinder Singh Sarao, you will recall the story about his carrying out investment raids on the US stock exchange from his parents house in Hounslow, from where he was charged with making squillions of Dollars from cancelled trading orders. He has been ordered to make substantial repayment, but it now appears that his own personal investments are worthless.

http://www.msn.com/en-gb/money/news/how-flash-crash-trader-navinder-singh-sarao-went-from-genius-to-dupe/ar-AAmVBAs?li=BBx1bGE&ocid=iehp