State of Innovation

I received the following question:

So is Keynes right or wrong?

You can make up for lack of private sector spending after a panic, thus maintaining demand.

OR

You can’t make up for lack of private sector spending after a panic, because the money is just borrowed, which causes inflation, or is taken from the private sector and just redistributed, not increasing demand in the aggregate.

My answer is:

If you actual follow what Keynes states, which is run a budget surplus during good times and spend the surplus during bad times you can moderate the economic cycle.  Note the moderation will include dampening the upside.  In addition, this substitutes government decision making for private decision making, which always results in less growth over time.

The way Keynesian economics works in practice is that it is an excuse to spur demand by deficit spending, usually by programs like cash for clunkers or tax rebates to people who do not pay taxes.  In these cases they are stimulating consumption (mainly).  No one ever got rich by consumption or stimulating the economy by consumption.  Think of a farmer eating his seed corn, this stimulated demand but he is likely to starve to death.  The other common example is to suggest that we break everyone’s car window.  This increases demand and consumption, but are we any wealthier?  No, all we have done is transfer money from the rest of the country to the auto glass industry.  When Keynesian policies result in the country having to borrow money to spur demand, then it does lead to either inflation, higher borrowing costs, or higher taxes or a combination of all three.  This reduces future economic activity and usually the amount of economic activity is not conserved but subject to entropy.  I think you can sum up Keynesian economics in practice as consumption creates wealth, which is clearly nonsense, no matter how many PhD trained ivy-league economist professors repeat it.

I think of my chart on page 11(reproduced here) as showing the boundary layer condition for wealth.  In engineering and physics we look for boundary layer conditions to check and setup our answers to problems.  The income per capita chart clearly shows that the only way to grow income per capita is by changing our level of technology.  Look at the major suggestions on how to spur our economy.  Keynes: consumption equals wealth creation.  This is clearly complete nonsense.  Supply side economics: this normally focuses on reducing taxes and regulatory burdens.  When an economy is running at less than its optimum point this will cause economic growth, but without inventions we will eventually stagant.  Now regulations and taxes can reduce the incentive to invent, so there is overlap.  Monetarists: If we just manage the money supply appropriately we will create economic growth.  Money is just a medium of exchange and a medium of measurement.  While screwing with the money supply messes up the functioning of the economy, even if the money supply is stable it will not create anything that makes us wealthy.  Invention-side economics is the only way to increase our wealth over time – it is the boundary layer condition.  An interesting example from the book is Eli Whitney’s invention of the cotton gin.  The US was producing just 4000 bales of cotton per year before the Whitney’s invention.  Ten years later in 1801 we were producing over 100,000 bales of cotton per year, more than a 50x increase.  “But for” (as lawyers like to say) Whitney’s invention the output of cotton would have hardly changed.  Inventions are game changers in the economy.  The other approaches are just tinkering around the edges at best.