Home > economics, political-economy, shorter work time > Billy Mitchell and the Austerians: The Case of the False Dilemma

Billy Mitchell and the Austerians: The Case of the False Dilemma

Ever get the feeling you were being offered a choice between two bad alternatives (we mean, of course, other than every election day)? Well, we looked at the menu of choices offered in the debate between the proponents of austerity and the proponents of stimulus and came away with the queasy feeling that we are being set up no matter which option we choose.

From Billy Blog, July 6, 2010:

The origins of macroeconomics trace back to the recognition that the mainstream economics approach to aggregation was rendered bereft by the concept of the Fallacy of Composition which refers to errors in logic that arise “when one infers that something is true of the whole from the fact that it is true of some part of the whole (or even of every proper part)” (Source). So the fallacy of composition refers to situations where individually logical actions are collectively irrational. These fallacies are rife in the way mainstream macroeconomists reason and serve to undermine their policy responses. The current push for austerity across the globe is another glaring example of this type of flawed reasoning. The very fact that austerity is being widely advocated will generate the conditions that will see it fail as a growth strategy. We never really learn.

The origins of this logical error lie in the way in which mainstream economics developed. It was largely concerned with microeconomic and started its a priori reasoning from the perspective of an atomistic individual. The single consumer or single firm. I won’t go into detail here but this body of theory soon got into trouble via the so-called Aggregation Problem.

This is one of the more interesting recent entries by Billy Mitchell on the failings of economics in this crisis. According to Billy, the field has failed to take account of the microeconomic roots of its origins in such a way as to avoid generalizing false assumptions.

Stated simply, the Fallacy of Composition is a mistaken assumption that what is true for each of us is true for all of us.

For instance, each of us may try to save by limiting how much of our income we spend. However, if we collectively were to actually reduce our purchases at the same time to achieve this goal, the critics of mainstream economics point out, this leads not to increased savings but reduced income. Based on this reasoning, Billy concludes that the current demand for austerity in Europe and the United States will end badly. If every nation is tightening its belt at the same time, it is likely to make matters worse for all of us.

If the private sector desires to save, for example, $10 in every $100 it receives then that $10 is lost from the expenditure stream. If nothing else happens, unsold inventories will appear and firms will start to lay off workers because the production level is too high relative to demand. Firms project demand expectations and make their production decisions based on what they think they can sell in the forthcoming periods.

The decline in economic growth then reduces national income which in turn reduces saving, given that the latter is a positive function of total national income.

This conclusion by the critics of austerity seems rather sound, but, be warned: when things seem sound in a perfectly irrational system, you can be sure there is something amiss. It usually indicates that some intermediate step has been lost in the reasoning process.

The fallacy of composition does not tell us why a particular individual action leads to the opposite effect when applied to the whole. It is not all that clear, for instance, why individual saving necessarily results in reduced economic activity when we all try to save – we just know it does because economists tell us it does, and we take their word for it.

Billy Mitchell warns us that austerity will lead to dire consequences, because, unless national governments are prepared to accumulate debt, the desire of individuals to save will result in massive economic dislocation.

Another way to put this: our economy works in such a way that it automatically limits savings to what can be absorbed in the form of productive investment. When some given level of savings is achieved forces kick in which reduce overall economic activity to a level consistent with productive investment. Billy doesn’t explain why this is a bad thing. He not only doesn’t say why we would not want the economy to operate this way, he doesn’t even bother to restate his scenario in a way that throws light on what is actually taking place: The economy can only absorb so much saving before it responds by depressing economic activity!

Savings are not, by any measure, an unqualified social good. Despite our particular prejudice toward savings and investment – a phrase that at least ranks up there with Mom, The Flag, and Apple Pie in our political discourse – saving is not identical with productive investment; and whenever saving exceeds productive investment the society is heading for a big time hurting.

Indeed, even investment is not an unqualified social good: every depression results in massive write-offs of productive capacity simply because the period preceding the depression saw unsustainable investment in new capacity beyond what society needed. We only have to look at the auto industry to see how true this is.

Which brings us to another fallacy: namely, the Fallacy of Division.

This fallacy is encountered when we ascribe to each individual in a society an assumption that may only apply to the society as a whole. In this instance, Billy appears to assume that all individuals save, and that, therefore, it is the responsibility of government to accommodate this effort by incurring debt. We all want to save, and government can help all of us save by running deficits.

On the surface, such a demand for increased national debt may seem altogether plausible until we begin to ask who is actually saving, and why. And, since Billy will deny he is assuming that all individuals are saving, we will save him the effort of a response and explicitly assume only that some portion of society is saving. This way, even if Billy is not making this assumption, we can make sure you don’t either.

Now, we have a problem: Why should the rest of us essentially subsidize the desire of some of us to save in such excess that government must run into debt to accommodate their saving? (Actually, since these excess savings do not result in any investment – even failed investment – we should call it hoarding, not saving.) If the economy works in such a way that excess saving and investment are being periodically flushed from the economy, why should government accommodate the saving decision of some members of society when that accommodation leads directly to an accumulation of public debt payable by all of us?

Fortunately, Billy has a reasonable answer:

“… if the economy is to remain at full employment all the output produced has to be sold. Enter the national government. It is the one sector that can step in and net spend the $10 in every $100 to fill the ‘spending gap’ left by the saving. All the output is sold and firms are happy to retain the employment levels that created the output. The system is in what economists call a ‘full employment equilibrium’.”

According to Billy then, we should accept government subsidies of the private saving decisions of some individuals, because, in so doing, government keeps us all happily slaving our lives away, eating watermelon, and dancing. If some individuals want to save in aggregate more than can be productively invested into the economy, or the level of investment of the preceding period should turn out to be excessive, public debt must be used to stabilize the employment level.

The net spending by the government (the deficit) ratifies the savings decisions of the private sector. The budget deficit maintains full employment aggregate demand and the resulting national income produced generates the desired private saving level. So the budget deficit finances the private saving on a daily basis.

Billy is so enamored of his silliness, he even tries to implicate Karl Marx in his delusion:

Marx had already worked this out and you might like to read Theories of Surplus value where he discusses the problem of realisation when there is unemployment. In my view, Marx was the first to really understand the notion of effective demand – in his distinction between a notional demand for a good (a desire) and an effective demand (one that is backed with cash).

There is a certain fallacy of composition being committed by Billy, of course. He wants us to believe that, because he might agree with Marx on one issue – effective demand – a general reading of Marx is consistent with his government debt-financed employment scheme. In fact, Marx held no such view – not even vaguely or implicitly. That Billy does not explicitly admit to a fundamental divergence of his views with Marx is, we think, a deliberate attempt to fool his audience – an attempt to dress his views up in the radical critique of society offered by Marx.

Marx did not imagine a society of savers who should be subsidized by government debt. Rather, he disclosed two distinct categories of individuals in society: those who worked, and those who saved, or more accurately, accumulated. The former might have some modest savings with an eye to large purchases or toward retirement, but, by and large, they live on what they earn and have little more. For the latter group, however, the situation is the reverse: although they might convert some of their income into purchases, the great bulk of it is meant to circulate as capital – constantly enlarging itself.

Essentially, Billy Mitchell is arguing that government subsidize Bill Gates’ accumulation in the form of public debt payable by taxes on the wages of Gates’ receptionist. Billy won’t admit this, but this is precisely what he is proposing: the public should be burdened with providing a liquid medium for the excess savings of a tiny minority of individuals. He won’t admit it because it is an embarrassing exposure of his absolute self-abasement to capital. The very wealthiest need some safe place to hide their money and he wants to use your taxes to provide it for them.

However, he does have a point: As things now stand, unless government is willing to perform this untidy chore you will be out of work at a minimum – and, more likely, you will suffer quite unimaginable economic pain. The kind of economic pain the austerians believe you must suffer for the sake of the economy.

The austerians – the proponents of austerity, balanced budgets, and a greatly reduced social safety net (for instance, the blogger Mish Shedlock) – usually admit that their alternative prescriptions will lead to large scale economic “adjustments” – a polite way of saying mass unemployment, misery, and unprecedented loss of existing productive investment. They rightly warn, however, that such trial by fire is inevitable for the economy; and, that putting off this “adjustment” for so long with the schemes of mainstream economics only increases the ferocity of the eventual calamity.

Speaking of the years of economic mismanagement by post-war economic policy, Mish recently wrote:

Greenspan and Bernanke combined to stave off paying what was due in 2001-2002. The result was a massive housing bubble that ultimately collapsed.

Congress and the Fed added to the misery by wasting trillions of taxpayer dollars bailing out banks and Wall Street while leaving the private sector in shambles, and millions of homeowners debt slaves to their houses.

Each time the day of reckoning is put off, the bigger the price down the road. Thus, we should all be fearing more Keynesian and Monetarist attempts to forestall the inevitable collapse.

Attempting to stave off further debt writedowns and another recession is like attempting to stave off a hangover by drinking more whiskey.

Yes there will be short term pain and lots of it to do the right thing now, but there will be greater pain down the road if we don’t.

Which brings us to another fallacy, namely, that of the False Dilemma.

A false dilemma often presents itself as two extreme, unpalatable, options. In this particular false dilemma, of course,  we are offered a choice between massive unemployment or massive public debt. As is typical of false dilemmas, other choices are left unexplored, unspoken, and unavailable.

Politicians like these false dilemmas because it allows them to muddle through crises instead of confronting the underlying issue head on. For instance, in place of a stark choice between massive unemployment and massive debt, the Messiah’s administration can show its “moderation” by not attaching itself to either of these ideological extremes – preferring to acknowledge the “valid” points of each view and pursuing some “balanced” combination of the two strategies.

The true significance of the false dilemma is that it usually presents the choices as mutually exclusive: we can have massive unemployment OR we can have massive public debt. There is, in fact, nothing about the choices presented which excludes the occurrence of both extremes together – we can have both massive unemployment AND massive budget deficits at the same time. If you think it is not possible, just ask any politician in California or Spain. Indeed, right now Washington is accumulating huge and unsustainable public debt side by side with massive unemployment.

We saw a similar problem during the Great Stagflation of the 1970s, when the economy was hit by both very high inflation and very high unemployment. Economists thought stagflation was impossible, but, as we are now fond of repeating endlessly: economists are simpletons who think the world is as silly and simple as they themselves are. There is, in fact, nothing that prevents continuing massive public debts from occurring side by side with unprecedented levels of unemployment anymore than it was impossible for high unemployment and high inflation to occur together in the 1970s.

We know that high and persistent unemployment can be associated with a balanced government budget,  a surplus budget, or even a budget deficit. And, we know that a balanced government budget can be associated with high unemployment, low unemployment, or even zero unemployment – the Soviet Union enjoyed both zero unemployment and a balanced budget. There is, in fact, nothing to suggest that we cannot continue to suffer both massive unemployment and massive government budget deficits at the same time. Even if the imposition of an austerity regime must result in massive and intolerable unemployment, it is far from settled that even massive government deficits can hold unemployment at bay.

The fact is government budget deficits and unemployment have absolutely nothing to do with each other – any attempt by economists and ideologues to link them together should be judged with suspicion. As Billy is fond of telling us, Washington does not have to run a deficit to spend money to hire the unemployed. Since, it can create money at will, nothing prevents Washington from simply creating sufficient quantities of worthless dollars to pay people to do nothing -  or something. Or nothing while they go through the motions of doing something.

The US dollar, last time I knew, is issued by one institution only. That institution is the US government. It issues the US dollar under monopoly conditions. The issuance of US dollars is accomplished, in the main, by electronic transactions between the US Government and the commercial banking system.

A keyboard operators within the US Government could type 1,000,000 billion or 1,000,000,000 billion into their computer when making one of these electronic transactions and the funds would show up as increased reserves in the banking system. It might be undesirable that the higher amount actually was injected into the spending stream (depending on the available real capacity of the economy) but that is a separate issue – not unimportant but separate.

The point is that the US Government can spend as much as it likes as long as there are goods and services available for sale.

So, if Washington wished, it could do exactly what Moscow did for years: employ people to do nothing by creating the money to pay them out of thin air. There would be no debt, and no unemployment.

Billy also tells us that when Washington does incur debt, it is not doing so because it needs the money, but simply because it needs to sop up the excess liquidity in the economy in order to hit some predetermined interest rate.

So why does the government issue debt if it is not to finance spending? Well it is rather to maintain … bank reserves such that a particular overnight [interest] rate can be defended by the central bank.

The entire purpose of corporations is to accumulate surplus capital and invest it. This activity presents society with a persistent and unsustainable tendency toward excess savings and investment – the root cause of crises, both financial and material. If the goal of government debt creation is to soak up excess liquidity in the economy, why can’t this be done by increasing taxes on corporations rather than incurring debt to these same corporations that must be repaid by taxes from the rest of us?

Neither the stimularians nor the austerians offer an answer to this question.

So where is option C: Fewer Hours of Work?

It is this latter point, however, that highlights the main error in the false dilemma created by austerians, like Mish Shedlock, and stimularians, like Billy Mitchell. If the root cause of economic crises is the accumulation of excess savings and excess productive capacity, why not simply restrict this accumulation in the first place? Instead of having Washington step in and add $10 of public debt to support demand for superfluous output, as in Billy’s hypothetical example above, why can’t it just step in and reduce hours of work, and keep reducing it until there is no more unemployment?

The argument certainly can’t be made that this will induce a shortage of labor power – with the depths and duration of unemployment and underemployment at post-war high levels, the percentage of labor force employed now at levels seen only in 1982, 6.8 million out of work for more than 27 weeks, and average hours worked falling for four years now, there is a vast pool of underutilized labor power to draw from.

And, no one can reasonably argue that reducing hours will lead to shortages of output, since we are looking at a huge global glut of idle capacity from the American auto industry to Chinese factories pumping out good destined for Wal-Mart. This excess capacity is now of such magnitude that the United States is currently experiencing only its second period of industrial capacity contraction in 234 years of history – the first occurring in 2002-2004 just before this most recent economic calamity.

Nor, can anyone reasonably argue that shorter hours of work will lead to a lower standard of living or individual bankruptcies.

In the first case, it is well know by economists that money wages are completely unrelated to our material standard of living. Your actual living standard can decline while your wages are unchanged; or, it can rise while your wages are unchanged. Moreover, your wages can fall without a change in your material standard of living; and, your wages can rise and still reflect no improvement in your material standard of living.

This is how you have been silently defrauded for years – they let your wages rise even as your material standard of living fell and you sank deeper into debt!

Moreover, your real wages (inflation adjusted) are completely unrelated to hours of work. Prices must reflect the average wage of working people. If those dollar wages contract along with hours of work, so must price levels. It is the value of labor power – wages – that always and everywhere determines prices of the goods we consume. Let the prices of the goods we consume rise while our wages remain constant and it will result in a glut of unsold goods. The economy can no more tolerate wages below the value of labor power than it can tolerate savings above what can be productively invested. In fact, these two – wages and investment – are merely two sides of the same coin. Let either diverge from their proper proportion for too long and a crisis will erupt.

This is precisely what happened in our current crisis.

In the second case, bankruptcies and the inability to service existing debts should not be considered a reason to tolerate massive unemployment for some with long hours of labor for the rest. Remember, when a bank loans you money it creates that money out of thin air. The money did not exist until you signed an agreement to repay it. It is not the banks money, it belongs to the United States government. Only national governments have the exclusive right to issue currency. For decades banks have been creating U.S. currency out of thin air and handing it out to people as if it belonged to them. People have been driven to bankruptcy and impoverishment trying to service debts that never should have been created in the first place. Now is the time to wipe this ugly chapter in our history clean.

The terms of this debate must change!

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