The Way of the World

Despite his “pox on both your houses” conclusion, something I endorse whole-heartedly, I found a lot to dislike in Dean Baker’s latest article at the Guardian. He of all people should realize that consumption is not a fixed, static thing. In 1905 there was very little demand for automobiles in the United States. Only 8,000 of them were sold nationwide. Despite initially low demand over the period of the next several decades there was an enormous amount of capital investment that resulted in more employment, more consumption, and the largest industrial sector the world had ever seen. And that happened without federal stimulus packages or bailouts.

Yes, we need more end user consumer demand. End user consumer demand is not the only kind of consumption or demand. The road to more end user consumer demand lies through capital investment and the reasons for doing that will be what they have always been: you have a better idea, you can do it better, you think you can make a buck doing it. Take away those incentives as we have done with our current system of intellectual property, bailing out floundering dinosaur industries, and taxes or the fear of taxes and you get less of what we need.

What really irked me was this:

The world doesn’t work that way. Firms create jobs when they have more demand, not because we are nice to their rich owners.

On what basis can he tell me how the world works? He’s never been there. He’s either been an elected official, a worker at a not-for-profit, or an academic. How does that prepare you for lecturing on how the world works?

I think there was a reasonable argument three years ago on Keynesian grounds for a WPA-type program in which people who were unemployed were given a government-created job. Instead of Keynesian “government as employer of last resort” we got neo-Keynesian “government as consumer of last resort” dragged through the filter of cronyism and politics. The result was pretty much what could be reasonably expected: not nearly as much as its proponents had hoped or claimed.

I thought we needed structural reform then. The need is even more intense now.

17 comments… add one
  • Brett

    Baker’s schtick has always been to re-iterate the same stuff we hear from Paul Krugman (more fiscal stimulus), except with extra-annoying snark* and jabs at the Washington Post. I tried following his blog on RSS for a while, but just couldn’t do it.

    * Snark has become really annoying as a form of humor.

    On what basis can he tell me how the world works? He’s never been there. He’s either been an elected official, a worker at a not-for-profit, or an academic. How does that prepare you for lecturing on how the world works?

    I’m dubious of these kinds of “personal experience” arguments. Baker has a solid economics background, so he’s fairly well qualified to talk about economics issues even if he’s never been a business owner.

  • Drew

    “I’m dubious of these kinds of “personal experience” arguments. Baker has a solid economics background, so he’s fairly well qualified to talk about economics issues even if he’s never been a business owner.”

    You are obviously entitled to your own opinion, Brett. But as a graduate of the best business school in the country, but also a business financier and owner for some 20 years now, I will tell you unequivocally I’ll take practical experience over the academic in a nanosecond. Those dudes are clueless.

  • He’s not talking about economics issues but about business—not how things are in theory but how they are in practice. He didn’t say “there’s no theoretical support for that” but “the world doesn’t work that way”. That’s what got my Irish up. It is not true that entrepeneurial activity depends on demand in any but the most indirect of ways. That is a lie. Risk-taking is not based on present consumption or on aggregate demand but on expectations of future consumption within the target market. I can present hundreds, maybe thousands of examples.

    There was no demand whatever for the iPad five years ago when Apple began investing tens or hundreds of millions of dollars into its development. They created the demand from nothing. Why did they do that in a period of declining aggregate demand? Because that is the nature of entrepeneurial activity. Aggregate demand is meaningless in that context.

    He knows better. He is lying. He is trading on his PhD in economics to make sweeping, incorrect generalizations outside of his own specialty that support his policy preferences. He knows there’s no such thing as a lump of consumption. For goodness sake his doctoral dissertation was on consumption theory.

  • I think there was a reasonable argument three years ago on Keynesian grounds for a WPA-type program in which people who were unemployed were given a government-created job.

    What is the fascination with this notion? It was a program enacted as part of Roosevelt’s New Deal after he nearly killed off the recovery that started around April of 1933. If he hadn’t done that he’d probably have never needed the WPA.

    Why all the praise for trying to fix completely blinkered thinking?

    There was no demand whatever for the iPad five years ago when Apple began investing tens or hundreds of millions of dollars into its development.

    Yes, at that time there was no demand for a product that did not exist. This is trivially true. However, if there continued to be no demand, then iPad would have been a flop and those millions wasted. Demand is essential, either current demand (as there is for the iPad now that it exists) or potential demand (as was the case with the iPad 5-10 years ago). Basically, you are taking a risk that people will demand what you produce. In some cases, there isn’t even speculation (e.g. a McDonalds, you can’t tell me there is currently no demand for burgers, or that it is something new).

    Basically, the notion goes all the way back to Jean Baptiste Say,

    It is worthwhile to remark that 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. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products. (J.B. Say, 1803: p.138-9)

    Basically, supply creates its own demand, a.k.a. Say’s Law.

  • steve

    “There was no demand whatever for the iPad five years ago when Apple began investing tens or hundreds of millions of dollars into its development. They created the demand from nothing. Why did they do that in a period of declining aggregate demand?”

    I understand this for a new, innovative product. It is not like demand is zero. There are still millions of people left with discretionary income. For something new, people will spend. Or, instead of buying laptops, they will buy IPADs (I dont know the predominant buying pattern). However, most businesses are not like that. Most business is finding cheaper, better ways to provide the stuff we already use, or responding to population growth by providing what is needed to the increased number of people.

    “The world doesn’t work that way. Firms create jobs when they have more demand, not because we are nice to their rich owners.”

    This is actually true for lots of larger corporations. Go through the Dow 30. How many of those are actually making new, innovative stuff? Wouldnt increased demand lead to them hiring more workers?

    Steve

  • Icepick

    Wouldnt increased demand lead to them hiring more workers?

    yes … in China.

  • This is actually true for lots of larger corporations. Go through the Dow 30.

    I’ve had some of them as clients. They’ve been downsizing for the last 30 years. Don’t expect them to be job-generators. They’re irrelevant in that respect and it’s why IMO we shouldn’t be propping them up.

  • It is not like demand is zero.

    My very point is that for new, innovative products or even new, innovative ways of making old products capital investment anticipates, i.e. precedes, demand. Claiming otherwise, as Dr. Baker is doing, is to deny risk-bearing entirely.

    Our problem right now is that businesses are extraordinarily risk-averse. That explains the inadequate level of capital investment we’ve had for years and the slower rate of new business formation.

  • michael reynolds

    Despite initially low demand over the period of the next several decades there was an enormous amount of capital investment that resulted in more employment, more consumption, and the largest industrial sector the world had ever seen. And that happened without federal stimulus packages or bailouts.

    There was a whole big pile of government money spent that helped the car — county roads and state highways followed by the interstates. No roads = no cars. No tax money = no roads.

  • There was a whole big pile of government money spent that helped the car

    The sequence was the other way around—once the industries had established themselves. In 1905 there were less than 200 miles of paved roads in the United States. Capital investment, then buying cars, then building roads to drive them on.

    I agree that the interstates have been a subsidy to the automobile manufacturers. They’re a poor subsidy, IMO. Most of the interstates have been built since 1970. Look at how the auto companies have done since 1970. At the very least interstates have been an ineffective subsidy for domestic auto companies because they’re so poorly targeted.

    Similarly, the light bulb preceded state-subsidized power generation and distribution companies not the other way around.

  • steve

    “Our problem right now is that businesses are extraordinarily risk-averse. That explains the inadequate level of capital investment we’ve had for years and the slower rate of new business formation.”

    Well, yes, but this has been going on for, IIRC, 10-12 years. This has ben going on when the economy is good or bad.

    “Similarly, the light bulb preceded state-subsidized power generation and distribution companies not the other way around.”

    And it made no money until that was provided. Or, as Manzi noted.

    “Many entrepreneurs hold the opinion that “I did it all on my own,” which may be well adapted to leadership success in certain situations, but it is objectively myopic. The entrepreneur relies on an ecosystem of venture capitalists, risk-taking purchasers, and so on. This ecosystem itself rests on a deeper foundation of collective, government-led enterprise. The delivery of our software, for example, depended on the existence of the Internet, which is the product of a series of government-sponsored R&D efforts, in combination with subsequent massive private commercial development. Government funding has been essential to much of the university science that entrepreneurs have exploited. Honest courts and police are required for functioning capital markets and protection of assets; physical infrastructure is required for the roads and running water without which we would not spend much time thinking about artificial intelligence software. At the absolute foundation, national armed forces protect the whole system against external aggression. All of our exciting technical and economic innovations ultimately require men to stand watch all night looking through Starlight scopes mounted on assault rifles—and die if necessary—to protect our commercial, law-bound society. Would you do this to protect a billionaire hedge-fund manager who sees his country as nothing more than lines on a map?”

    Steve

  • I am not arguing that every entrepeneur pulls himself up completely by his bootlaces. I am arguing the very narrow and historically obvious point that entrepeneurial activity, i.e. risk-taking, exists.

    Well, yes, but this has been going on for, IIRC, 10-12 years. This has ben going on when the economy is good or bad.

    And we have lurched like a drunk from lamppost to lamppost, from bubble to bubble, for, what, 15 years.

    As I see it we can take steps to encourage entrepeneurial activity and increased economic activity, the only real prospect we have for more growth and jobs, or we can just just accept the present new normal with permanently higher unemployment.

  • Dave is correct, the national highway system didn’t come until Eisenhower and even then it wasn’t for commerce or ease of transportation for the average person, but for national defense. The idea was to build a series of roads our military could use to quickly move men and material around as needed in the event of an invasion of the U.S.

    And while demand is effectively zero for innovations, the risk is that there is significant potential demand. That is, if the product is brought to market people will buy it. In some cases it works, people want the new product (iPad, home computers, etc.), in others it does not (Apple Newton, Betamax, Segway, etc.).

    I think steve has it right. People have discretionary income, and entrepreneurs want it, so they try to come up with ways to get it. Some rely on old tried and true products just done better or slightly differently (e.g. all the “fusion” food trucks), or new products. But in both cases demand is essential…and so is supply. As Alfred Marshall noted years ago, prices are determined by both supply and demand. You need both.

    Baker’s focus on demand is problematic in that it ignores supply. That is folly. Of course, if you focus on just supply you might not be getting as much bang for your policy buck as you could. Was some stimulus to demand warranted back in 2008 and 2009? Probably. Problem is we did it, as government often does, badly.

    As I indicated, people love this WPA bullshit, but in reality the WPA was an attempt to make up for failed prior policies (NIRA). A simpler solution, at that time, would have been to not implement NIRA and let the economy recovery that was taking place due to inflationary policies (going of the Gold Standard) continue.

    Study history, and realize that some of the claptrap you have been taught in your high school and second year college history courses is just that, claptrap.

  • As I see it we can take steps to encourage entrepeneurial activity and increased economic activity, the only real prospect we have for more growth and jobs, or we can just just accept the present new normal with permanently higher unemployment.

    This. And we can’t do it by having the government gobbling up ever greater shares of GDP. It might work in the short run to prevent total system collapse, but as a long term solution it sucks. Sucks balls. If for no other reason than the deadweight loss.

    So, we need policies that promote business activities. Nobody knows what the great next new hope for employment will be. So fostering a positive atmosphere for business is probably the best strategy going forward.

  • Dave is correct, the national highway system didn’t come until Eisenhower and even then it wasn’t for commerce or ease of transportation for the average person, but for national defense.

    I was going back a bit farther than that. Between 1905 and 1925 tens of millions of autos were licensed in the U. S. with fewer than 50,000 miles of additional roads paved in toto in the whole country. That’s tens or even hundreds of millions of private capital investment (with Henry Ford well on his way to becoming the first billionaire) and relatively little public investment of any kind at any level.

    In 1925 Congress passed the first federal appropriations bill for roads for automobiles. That’s the bill that spawned U. S. Highway 1 (that ran down the east coast from Maine to Florida) and, in the 1930s, Route 66 from Chicago to Los Angeles. It wasn’t a Field of Dreams kind of thing. That’s claptrap. It was to accommodate the cars that were already there. The notion that all we need to do is pump up consumption and growth will necessarily follow is hooey. So is the idea that the main source of growth is government’s prudent stewardship of the economy. All the nice little central planners are in love with the idea but it’s one that’s failed everywhere it’s been tried.

    Despite the downturn there’s plenty of consumption. Just look at the retail sales figures. What there isn’t is a lot of capital investment and there hasn’t been nearly enough for decades.

  • Drew

    “Our problem right now is that businesses are extraordinarily risk-averse. That explains the inadequate level of capital investment we’ve had for years and the slower rate of new business formation.””

    I’m not sure I’m interpreting this comment correctly. My first reaction was”balls,” animal spirits are what they ever were. People are just rationally reacting to the current political/tax/regulatory environment, which is not positive right now. Is there some notion that people have fundamentally changed?

  • steve

    “current political/tax/regulatory environment”

    The latest Philly Fed report shows that these are not the primary concerns among businesses.

    Steve

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