On Re-reading The General Theory

I read Keynes' GENERAL THEORY for the history of economic thought I am now teaching. This was the first time I read the book since graduate school. Given the resurgence in interest in Keynes and his work, it was interesting to read it with fresh eyes. I think that some of what he emphasized is important and should be emphasized, but have to disagree with much else.

First, the good: Keynes emphasized strongly the importance of uncertainty when business people are deciding on investment projects. This emphasis was not the result of the Great Depression, but was part of his dissertation on probability. (His doctorate was in mathematics). His discussion of uncertainty is similar to that of Frank Knight, who distinguished between risk and uncertainty, where risk can be calculated such as with actuarial tables but uncertainty cannot be calculated. The future is inherently uncertain. Keynes goes so far to suggest that based on pure calculation, no one would make the investments that business people make. It is the fact that we humans like to be doing something that brings investment about--his notion of animal spirits. He then notes that when business people get pessimistic, they will not invest. It is the lack of investment that causes aggregate demand to be ineffective in bringing about full employment.

The rest of his arguments fall short, in my view. He denies the equilibrating of investment and saving via changes in the interest rate, putting much more focus on propensity to consume, and therefore the propensity to save, than on responses to interest rates. He saw the economy as inherently unstable and called for a socialization of investment. We could not leave investment in the hands of the private sector and public investment would have to ready and willing to make up for inadequate private investment to bring about full employment. Further, he argued, we have seldom had full employment. Hence the government needs to consistently spend on infrastructure to provide full employment. It is unclear what the government would do once the entire country is paved over.

Reading the book again made me appreciate Axel Leijonhufvud's interpretation of Keynes and the Keynesians. It is clear that what came to be Keynesianism after World War II differed substantially from Keynes own writings. For example, Keynes did not aggregate output; he aggregated either labor or things measured in money prices. I tend to think Axel's interpretation of Keynes' contributions are incorrect as Keynes' views, but make sense anyway. In particular, the idea that the economy is normally self-regulating, but if buffers are eliminated, the self-regulating mechanisms can break down. To me, it explains the depth and severity of the Great Depression and helps explain the Great Recession as well.

Visit to China

I visited China with a group of Hope College students during spring break. We visited a number of businesses while there, learning a lot about business in China. In Beijing, we visited Amway Asia, Super8, Motorola, and Sinochem, a state-owned enterprise. In Shanghai, we visited Dow Chemical, GM Asia, Gentex, TRW, and JCI. Some lessons learned:

China's perspective on their history over the last 150 years is that they experienced several "humiliations" at the hands of western powers, including two Opium Wars, the Boxer Rebellion, and the Japanese invasion during World War II. China can use a "nationalistic card" at almost any time. China wants to be treated with respect and not as one subjhgated to the West. Face matters.

China is trying to develop faster than any country has ever done. This involves several strategies. The process began thirty years ago when China opened up to trade. They had about one billon people, but 900 million were farmers. Today they have about 1.3 billion with about 600 million farmers. Urbanization has taken place by cities expanding geographically some amout each year.

According to a historian we met, many service workers in Beijing are "illegals", i.e. they are from rural areas and do not have the documentation needed to live in Beijing. There is a huge disparity between rural and urban areas in terms of income and education.

China sets goals, involving a series of five-year plans. The want to achieve urbanization of 70% of the population by 2020 and are trying to achieve this at the rate of 1 percent a year. They set goals for economic growth, extending development to the western provinces, industrialization, and so on. They acknowledge that pollution is a problem but have the strategy of grow first and then clean up.

Many American businesses there are part of joint ventures. In some industries, a foreign firm cannot operate in China except as part of a joint venture. An important example is automobile production. An American firm has to be in a joint venture and the Chinese firm has majority control. Joint ventures are not required in auto parts so Gentex is not a joint venture, although TRW and JCI are involved in joint ventures.

I suspect much of the data coming from China is inaccuate. They set growth rates and always make them or surpass them slightly. On the train from Beijing to Shanghai we passed some cities that appeared to be largely empty of people. A lot of construction has been done that appears to be unnecessary. Still, great economic gains are clearly evident, especially in the number of autos on the roads. We were informed that about 2000 new cars are on the roads in Beijing every day. The scary thing is that most of the drivers are new drivers and don't have much experience. Rules of the road seem to be suggestions at best.

I lived in Los Angeles for four years, and the pollutoin in Beijing is much worse than any I experineced in LA. Shanghai was a breath of fresh air--literally and figuratively. It would have been intersting to get into a more rural part of the country, but we didn't have time. It was a fascinating trip, and one that impacted our students greatly.

An Inside View of the Mortgage Crisis

Important op-ed piece in today's WSJ by economist Charles Calomiris. I agree that Wall Street was at fault a lot in bringing about the financial crisis, but so was the government, especially through Freddie Mac and Fannie Mae. Calomiris helps doucment this.

Nobel Prize Announcement

The new Nobel prize winners in economics are Thomas Sargent and Christopher Sims for work in macroeconomics. An article from the WSJ is here. Sims' work is primarily econometric as he helped develop and popularize Vector Auto Regression. Sargent's work links monetary policy and fiscal policy. He helped build the reputation of the University of Minnesota's economics department. The Nobel site will have further explanations of the work of both men that should be of interest.

Is Small Business the Engine of Growth?

It is common for politicians and others to say that small businesses account for most job creation. This is somewhat misleading though. Many small businesses go out of business after a year or two, so that they are also responsible for a lost of job loss. A new working paper by Erik Hurst and Benjamin Wild Pugsley suggests that small businesses are small and do not account for a lot of new employment. They note that most small business owners are not the entrepreneurs that provide the "creative destruction" Schumpeter wrote about. Instead, most small business owners do not bring a new idea to the market and do not have a desire to grow large. Instead, many are starting small construction firms, a legal practice or small retail store or restaurant. The motive is often being one's own boss rather than starting the next Apple Corporation.

Most small businesses have no paid employees. For the state of Michigan, over half of all business establishments have fewer than five employees. The Small Business Administration provides regulations that determine the size limits for "small" businesses. A table of these limits for industries can be found here. The limits are given in revenues for some industries and in number of employees for some. For example, establishments in mining have employee limits of 500, while those in transportation manufacturing have limits of 1,000 employees.

Simple explanations of the economy or job growth generally miss the mark. But politicians often look for simple explanations and simple solutions. Promoting small business will not solve the employment problem. A better solution is to provide an environment that supports business activity regardless of the size of the firm.

Tyler Cowen on Taxes

In his Sunday New York Times column, Tyler Cowen challenges the "no new taxes" pledge many of the Republican candidates are stressing. It is a worthwhile column to read as he notes that no new taxes today, without spending cuts that are not going to happen, means a pledge to higher taxes in the future--at least if one is "fiscally conservative."

Back when the Reagan tax cuts were being discussed, I favored the cuts for two reasons. The first is that I thought the marginal tax rates were too high and discouraged investment while encouraging tax avoidance behavior. Second, lowering federal income would be the only way to lower government spending. I still think I was correct on the first point but not on the second point. Government tends to borrow when its income is reduced. Now, one of the points Cowen is making, is that eventually taxes will have to be raised. But we are still able to delay that because of the position of the US in the world economy. We are not Greece. But postponing deficit reduction is not a sustainable position. Fiscal conservatism consists of two major points--over time we must balance the [operating] budget, and the size of the federal government should be limited.

Debt Ceiling Comment by a Colleague

Here is a column about the debt ceiling by my colleague, Todd Steen.