[sheyboer]

How would Keynesians respond to the following Austrian (I believe their Austrian) arguments that government cannot stimulate the economy by spending:

1. Government cannot give unless it first takes; so every dollar spent by government has as its opportunity cost of being spent or saved in the free market (the jobs and wealth that would have been created).

2. When government spends dollars in particular areas to stimulate growth it is competing for resources with the private sector thus raising their price and reducing private sector demand for those resources and the potential growth that would have occurred.

3. Government spending in particular areas redirects resources away from their most efficient and desired uses creating an unsustainable bubble.

[gpm2313]

Sheyboer,

A Keynesian would respond to the points that you raise by saying the following:

1. When there is a situation of large-scale unemployment of resources, every dollar that the government appropriates would not have been spent by the private sector. In fact, it is precisely because the private sector does not spend enough that we have a situation of widespread and sustained unemployment. The government needs to step in and spend the money because the private sector is refusing or is unable to do so. There are psychological factors holding back the amount of expenditure in the private sector and so there is no way that private sector expenditure can increase without help from the outside. So the government has to step in.

2. This is precisely why the government is not really competing with the private sector for resources when it spends money. Given the lack of private sector expenditure, the unemployed resources would not have found any employment were it not for government expenditure.

3. In a scenario of high unemployment one should not care about how resources are allocated. The key is to ensure that the resources find a source of employment, which they will find only if there is more expenditure. And this expenditure is not forthcoming from the private sector due to certain psychological factors.

A criticism of Keynes must try and pick apart his theory of why unemployment arises in the first place. If one accepts his theory of unemployment as being caused by a lack of expenditure forthcoming from the private economy due to certain psychological factors, one essentially has already accepted defeat!

GP Manish

[sheyboer]

Would Say’s Law be an appropriate response to Keynes’ argument for why unemployment occurs in the first place? Or would the Austrian Business Cycle Theory be a more effective response?

[gpm2313]

Sheyboer,

That is an excellent question. The pre-Keynesian beleif that chronic and sustained unemployment is not a market phenomenon was based on Say’s Law. One of the primary goals of Keynes’ General Theory was, of course, to critique Say’s Law and therefore to prove that the free market could and does often generate periods of widespread unemployment.

In the process of critiquing Say’s Law, however, Keynes “straw-manned” it, i.e., he caricatured what economists before him believed was the content of the law and then proceeded to criticize this caricature. Unfortunately, many economists just adopted Keynes’ rendition of the Law as the correct and true one and completely forgot about what the pre-Keynesian economists actually said and believed.

Thus, the history of interpretation regarding Say’s Law is rather tortured. The best source to understand what the pre-Keynesians actually believed is found in the work of Steven Kates, especially his work titled “Say’s Law and the Keynesian Revolution.”

I urge you to read Kates’ book if you are interested in this topic as well as the book by William Hutt titled “Say’s Law: A Re-statement” that is available for free on mises.org. Hutt’s work re-states Say’s Law and improves on the formulations of the pre-Keynesians. While this book is a vital and important contribution to economics, it is rather difficult to understand at first, so you may have to persevere!

Austrian business cycle theory provides an understanding of why a boom turns into a bust. It does not, however, provide an explicit theory of why the bust turns into a recession, i.e., a period of chronic unemployment.

GP Manish

[patriciacolling]

http://mises.org/daily/1803

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