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The Democrats and the US Economy: Facts and Fallacies

Politics / US Politics Feb 18, 2008 - 06:49 AM GMT

By: Gerard_Jackson

Politics Democrats are doing what they do best: promising what they cannot possibly deliver, particularly when it comes to the economy. Listening to Dems pronounce on the economy is tantamount to "cruel and unusual punishment". What these clowns don't understand is that economics is a highly theoretical discipline with particular characteristics of its own, the main one being that economic problems tend to require long chains of complex reasoning. It is this inherent difficulty that gives rise to an abundance of fallacies and explains why people, seeing only the immediate effects of a particular policy or investment decision, tend to fall into the fallacy of composition and assume the same must hold for the economy as a whole.

Hence you get a sot like Teddy Kennedy screaming for ever higher minimum wages, totally indifferent to the destructive consequence of his proposal. That there is an insoluble link between productivity and real wages is something his decomposing brain is utterly incapable of grasping. This beings me to Clinton's boom and two dangerous myths ' one a crude derivation of the other ' that emerged as an explanation for its apparent success. One was that a new economy based on information had developed in which 'gain sharing' replaced rent, wages and profits.

With information as a new and vital factor of production productivity and living standards would surge even as manufacturing disappeared, which amounts to saying the US economy doesn't need agriculture because it has supermarkets. This sloppy thinking is the result of being unable to exercise even elementary economic reasoning. The other and more advanced fallacy stated that technology resulted in less capital and labour per unit of output. In other words, not only is capital a substitute for labour but capital saving machinery reduced the need for additional investment, which created even more advanced products.

And this is why America was able to grow with very little savings. Like all economic fallacies, there is nothing new in this one. The idea of capital-saving investments is an old one. B'Bawerk used a production-structure approach to explain how production must always take place in stages. As an economy progresses these stages multiply and become more complex and productive. Naturally, increasing savings is what makes an expanding capital structure possible.

Curiously enough, the capital economising argument was also used as a criticism of B'Bawerk's analysis. Now this is not a piece of esoteric economic thought. It is, in my opinion, a very important contribution to our understanding of what happened during the 1990s and what is happening now.

Horace White produced the example of oil extracted from bores as a capital saving innovation. Before this development oil was produced by whalers which involved a very lengthy and complex production process. (One only had to think of what was involved in just designing and building whaling ships let alone the increasing amount of time spent at sea). It was obvious to White that simply boring a hole in the ground to extract vastly more quantities of oil at ludicrously low prices was a huge capital saving innovation that greatly shortened the production process. Or did it?

Drilling for oil resulted in huge new investments being made not to mention developments in engineering and refining. Oil rigs became more complex as did refineries and huge oil tankers, shipyards and docks had to built. All of these tasks required production processes that dwarfed anything that went into whaling, while all the time dramatically driving down the price of kerosene.

In other words, White's 'capital saving' innovation was only able to yield its greater total output through investing in longer production processes. The very opposite of what he claimed. But B'Bawerk pointed out that White's criticism rested on the implicit assumption that the capital saving invention was progressively capital-saving. ( The Positive Theory of Capital and Its Critics, Part III , Libertarian Press, 1959, pp. 28-33) White failed to see the flaw in his argument because he could not take it beyond one stage. Because he could see that drilling for oil was a shorter though more productive process he failed to see that incorporating the process into lengthier production processes would yield even great output. And this brings us to the present.

What may have happened in some cases is that inventions have rendered some shorter processes more productive than the older but lengthier processes. But this would conceal the fact that had these inventions been used in lengthier processes the yield would have been even greater .In addition, those who deal with only one stage of a product tend not to see how complex the complete chain of production is. Hence those who argued, putting it rather crudely, that all the US economy needed was the Net never thought about what it really takes just to supply it with cables and electricity let alone those little things called chips.

In short, it takes a lot of investment in manufacturing. This should help make it clear why more advanced products always require lengthier production processes, not shorter ones. The fundamental point is that rising productivity comes from investment. That US investment is more productive than Japanese and European investment is due entirely to having freer markets. This is the basic reason why it produces more for less. This dynamism caused more productive techniques to be developed. Nevertheless, they were not capital saving nor were they substitutes for labour.

The conclusion of some that the US economy was becoming some never-never land where the average annual real income would soon be $200,000 and the need for savings would have disappeared was pure fantasy. No country can continue to prosper in the absence of savings, no matter where they come from. While entrepreneurship does drive an economy only savings can fuel it. Yet this lesson is still not being learnt. Republicans, the so-called party of fiscal restraint, have voted, with the support of Democrats, for a feeble fiscal package that assumes that it is consumption that fuels the economy and not business spending.

The classical economists understood that the "demand for commodities [consumer goods] is not the demand for labour". By this they meant that it is investment ' not consumption ' that raises real wages. This is a fact that Republicans desperately need to absorb. Should the Democrats win both Houses and the White House and then proceed to implement their fiscal and regulatory policies the consequences for the US economy would be extremely serious. Republicans should never forget that it was Roosevelt's tax and regulatory schemes* that kept the economy depressed and that it took WWII to bring about a recovery.

*In fairness it should be pointed out that Hoover's own destructive tax and regulatory policies laid the foundations of Roosevelt's disastrous administration.

How the Laffer curve really works

By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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