Monday, 24 July 2017

Economic myths: "Does supply create its own demand?"

Interesting article at The Daily Signal covers the main points.

It appears - as always - that people's political viewpoint colours their interpretation of economics. Instead of answering the actual question, it drifts off into "How should a government respond to a recession?"

The right-wingers are supply siders, they say that the best way to stimulate the economy is tax cuts; the left-wingers are Keynesians and say that the best way to stimulate the economy is deficit spending (quite on what is not clear). Really, those are two ends of a spectrum - tax cuts (if you're not already in the wrong side of the Laffer Curve) implies deficit spending just as much as, er, deficit spending. Unless core government spending is reduced during a recession, which most would agree is a bad idea. The Tories talk a good game on austerity, but they are actually running massive deficits in supposedly better times, which even Keynes said was a bad idea.

In normal times, of course supply creates demand. Not necessarily for the product itself but for other things. With electricity, there is a nice feed back loop. Electricity was just something scientists stumbled across in the lab; having discovered it, people worked out what it could be used for (electric lighting and radios). So we have demand for light bulbs and radios. The more light bulbs and radios people use, the more electricity is produced and the more the National Grid is extended etc. Meaning that more people can buy light bulbs and radios, etc.

As to the proposed government responses to recessions, both are wrong, as they don't address why we have recessions in the first place. The reason is that when the land-price/credit bubble pops after eighteen or so years, banks try and claw back as much of their loans as possible. They can't speed up the rate at which people can pay off mortgages on land, so they call in loans from - and reduce lending to - the productive economy instead (be that loans to businesses or consumer credit loans). That has knock-on effects which no amount of tax cuts or deficit spending can prevent.


Ben Jamin' said...

As the OP says, in the widest possible sense, supply only increases aggregate demand because it leads to a better allocation of resources ie productivity.

Other than that, it really depends on the variables in each case.

Government increased spending on infrastructure may well help a depressed economy in the short term, but does that only depress it in the long term? Probably.

Lola said...

Your last paragraph is most telling. It should come first in the argument. That is once the credit expansion / land price bubble pops what do we do? Well right wingers are quite keen on keep land prices up, so they advocate stuff that will do that and not tackle the core problem - banking and credit creation. Left wingers don't get it either. They think that they have the unique wisdom to plan the economy (which they don't) and set about spending which increases (false) demand which keeps the land bubble going. You'd think that they'd nationalise the banks and try and sort it out that way. Well they did, and they failed at that as well (see my constant banging on about the FSMA2000).

FWIW the supply siders are right - as long as the banking / land nexus is sorted.

Now just who is going to do that?

DBC Reed said...

Never got the argument that producing twice as many Rolls Royces would ,of itself, double their sales.Aren't we on the Keynes side of the Says Law argument? That LVT would increase (non-property) demand and sell more Rollses? The problem being that, faced with rampant land taxing and land nationalisation from his hero Silvio Gesell, Keynes plagiarised his stamp money which made it expensive not to spend like mad and did not plagiarise the vital land bit of Gesell's argument.

Graeme said...

DBCR... Did you watch a TV show where Harvey-Jones of IcI dispensed advice to companies? One such company was Morgan, still manufacturing cars by hand in a way you would probably approve - sheet metal workers cutting metal with snips. Their problem was their huge and growing waiting list. He proposed ways of improving throughput. All rejected because the management realised that the wait and the hand crafted element enabled a higher price. I think the same goes for RR. Just as for Persimmon Homes

paulc156 said...

Advocacy of supply side economics sounds to me another way of saying that more investment in productive capacity drives growth and profitability. However to the extent that's correct, neither the growth nor the profitability is self sustaining but rather it lays the ground for recession and crisis. Investment in labour saving machinery and software etc ultimately drives down profitability once all and sundry are doing the same thing. When profitability falls so does investment and the recession/crisis ensues. Profits are then the root of the cycle. Land prices the symptom.

paulc156 said...

Graeme. Re RR. Veblen goods.

Graeme said...

Paulc....agreed about Veblen goods and surprised that Harvey-Jones didn't see a Veblen good when he saw one. But are you advocating that investment should stop because it might encourage over consumption? As someone who experienced rationing, I prefer the risk of over consumption rather than the risk of not having enough. Ymmv. DBCR probably wants his ration books back

Mark Wadsworth said...

BJ, there's an element of that.

L, the likes of us will make it happen.

DBC, i they make more Rolls Royces then demand for PETROL would increase. That was my point.

G, good point re Morgan.

PC, nope. Land prices/lending are the underlying cycle. You have absolutely no evidence to support your theory that all business investment decisions naturally move in step, it's just your usual anti-free market rant.

James Higham said...

"Quite on what is not clear" is the operative expression.

Shiney said...


"Investment in labour saving machinery and software etc ultimately drives down profitability once all and sundry are doing the same thing. "

Huh? Really? Wow... so every investment in technology since, oh I don't know, the flint arrowhead (!!!) has been a waste of time then. Who knew?

Mark Wadsworth said...

JH, exactly.

Sh, nice one, i couldn't be bothered pointing that out.

Lola said...

JH. An expensive railway vanity project. Seemingly.
And, altogether now, who will actually benefit from said benefits, aka deficit, spending on said expensive railway...?

paulc156 said...

G. "But are you advocating that investment should stop because it might encourage over consumption?"
Not at all and it wasn't so much a 'fear' of 'over' consumption ('under' consumption actually) as much as a simple truism. Increased investment made in order to increase productive capacity whilst good for the pioneering firm[s] that gets a head start will be replicated in a competitive market by others and profitability will inevitably be driven down in time for all. And that 'profits' drive investment rather than the other way round.

SH. No point in being silly. Of course it hasn't been 'a waste of time'. I merely suggest that it's mostly (not only) profits that drive the investment 'and' the business cycle.

MW. I'm not anti free market, so why would I engage in an anti free market rant? As for evidence that all business investment moves 'in step', that's rather vague and I'm not sure what you would consider evidence. I clearly don't claim that all business investment decisions are made simultaneously with the same results nor would I need to to establish a causal link between profits and investment in that direction/order. There's plenty of empirical data to support such a position.

“both business confidence and profit growth are highly statistically significant in explaining capital spending.” JP Morgan reckons that business spending “is less a function of borrowing costs than of an assessment of the outlook and profitability. On balance, this model explains 70-85% of the variation in business equipment spending growth”. JP Morgan. 2016.

Mark Wadsworth said...

PC, land price bubble -> credit bubble -> more lending to business for (mal) investment.

In the era of Georgism Lite, the 18 year land credit cycle was suppressed and recessions were shorter and less severe, bank crises were localised and minimal.

paulc156 said...

MW. Localised bank crises and shorter recessions when exactly?
The US spent more time in recession in the latter 19th C (post 1871) than at any time since. The NIEBR has the data on that. As for banks, well bank crashes would more likely be localised in the pre globalisation era regardless of which taxation methods were employed so not sure what exactly it is you are claiming there...just saying :)

DBC Reed said...

They manufacture more Rolls Royces but don't sell them and this increases demand for petrol?

Mark Wadsworth said...

PC, the Georgism Lite period was approx from 1945 to 1970. The Golden Era of capitalism.

DBC, if they make them they will sell them, might have to drop the price is all. Do you not understand the basic concept that additional supply of one thing increases demand for complementary products? Is my electricity example too obscure?

DBC Reed said...

Right so they manufacture more Rollers and sell them at a loss (why should they do this in a free market economy?) and these losses increase petrol sales? Hm very interesting.
I notice there is no comment about the really relevant issue: how did Keynes get away with plagiarising Gesell's ideas for increasing velocity of money without taxing land which made Gesell's scheme viable?

Mark Wadsworth said...

DBC, why do keep mentioning Rolls Royces, and why would you expect them to make so many that they are sold at a loss?

As far as petrol suppliers are concerned, they are not fussed about the make of car, or whether it is a new car or whether the supply of cars is maintained by simply looking after old ones properly.

Most car manufacturers try to maximise profits. Some try to maximise selling prices by restricting output (Porsche, Morgan). But for every Morgan or Porsche which is not sold, people by a cheaper mass manufactured one or repair their old one.

And as far as car manufacturers are concerned, they are not fussed who produces the petrol. Supply of one increases demand for the other.

Which is where electric car makers have missed a right old trick - they will only take off if they have standardised, easily replaceable batteries, so you stop at the 'petrol' station and swap your flat one for a fully charged one and drive on your merry way.

So supply of charged batteries will increase demand for electric cars and vice versa.

See also all the other things that only took off because of industry standards on the replaceable bit - like cassette players or CD players.

DBC Reed said...

Was hoping to get out of the Say's Law debate and onto the question of why Keynes misconstrued Gesell's theories of boosting demand.
I raised Gesell at the Labour Land Campaign in the 1980's and got the brush off then.Meanwhile a Gesellian experiment with demurrage money is going on in the Tyrol with the Chiemgauer.Seems to be working alright .But nobody is the slightest bit interested.

Mark Wadsworth said...

Gesell was making it all too complicated, just like the Positive Money people.

Mike W said...

DBC Reed,

Thanks for raising the issue. My reading of the Natural Economic Order was that the Henry George LVT/ his version, 'Land Nationalization' was crucial to Gessel. I recall he states, without the Georgist element money will simply flood into land to avoid the stamp charge.Which seems to be a good, 100 year old prediction, of what our central bankers have not grasped about Gessel and their 'zero bound' today.

In case anyone but DBC is interested, Gessel means by 'Natural' the world of the Manchester School, free market view, rather than Marx and his view of what human nature might be under communisim. Hence Keynes comment on him in the GT. 'The future belongs to Gessel...

Keynes, I think DBC, was just ducking the Henry George element of the theory for political reasons. I find it hard to believe he had not understood Gessel?

I still think Wadsworth is correct though in previous posts.Henry George is the 'general theory' not a nice add on. As argued here, Georgism/LVT isn't for just pulling an economy out of a slump, given enough time it will strangle out foolish property lending anyway.

I wish some PM/MMT folks would post here again :)

DBC Reed said...

That was my initial question: why Keynes "adopted" Gesell's principles of increasing the velocity of money,albeit with a pale imitation of Gesell's stamp money, and did not get what he called the Henry George part ie.that money had to be kept out of land investment via land tax or land nationalisation.The latter HG stuff is the easy bit which is where you would think he would have started.
The Chiemsee scheme is holding on and is successful in increasing velocity of money by five times and in collecting demurrage money for public purposes.
However as I grow older I am forced to reconcile myself to the fact that these useful ideas are going to stay repressed. Whatever happened to Social Credit? A popular idea that fixed everybody up with unearned income so you could have robot production.Total wipe-out.Yet "1984" was based on it.

Mike W said...


Yes, Orwell had been reading around the papers and magazines that published 'Social Credit' ideas.

I find this quite moving.Chapter Six, Road to Wigan Pier:

'That scene stays in my mind as one of my pictures of Lancashire: the
dumpy, shawled women, with their sacking aprons and their heavy black
clogs, kneeling in the cindery mud and the bitter wind, searching eagerly
for tiny chips of coal. They are glad enough to do it. In winter they are
desperate for fuel; it is more important almost than food. Meanwhile all
round, as far as the eye can see, are the slag-heaps and hoisting gear of
collieries, and not one of those collieries can sell all the coal it is
capable of producing. This ought to appeal to Major Douglas.'

Mark Wadsworth said...

Mike, fuck me, Orwell was very condescending though, wasn't he?

Mike W said...


Ok, Ok, Enough of the Orwell stuff! Just one final comment, notice in the quote, despite seeing the grinding poverty he doesn't jump in and say, 'come the revolution comrade, we will string the bastards who did this up'. He is still forced to think, what could be done? There are some Orwell quotes where he is virtually paraphrasing Henry George, as it happens, but I can find nothing explaining why he had decided that Douglas not HG was the future.

Anyway, yes Orwell comes over as an arse sometimes, even in the best biography by Crick. All my childhood heroes it turns out,would not be ideal company either: Wells, Russell,Koestler. Even Popper, who I once had a chance of meeting,turns out to not have tolerated much criticism, despite building his entire philosophy on the idea! The old golden rule: never meet your heroes :)

DBC Reed said...

Returning to Gesell (and avoiding Orwell whose world economy in "1984" depends on destroying as much production as possible by warfare lest people get hold of it, cease work and become ungovernable- straight Social Credit), I am astounded by MW's remark that Gesell's money theory is too complicated. What? It is chugging along in the form of the chiemgauer in the Tyrol which is voluntary, superintended by a local school teacher and administered by schoolchildren.What was so difficult about Gesell's demurrage money when first circulated in the 30's (with great success) at Worgl and Swannenkirchen (sp from memory)? You got issued a bank note which lost money over time so people spent it; to keep it current you had to stick stamps on it.Thats about it.No temptation to try and buy land with it.Gesell thought that horrific land value tax would lead to a flight from landed investment so the State could buy it all up in a compensated land nationalisation. With MW's language skills he should be the Brit representative of Chiemgauer propaganda.
Also why is MW trying to fund a Citizens Income from LVT? Too complicated. What is wrong with the original Major Douglas social Credit scheme of nationalising the creation of credit and doling it out equally to all?
That way you could provide the demand money for robot production while the populus sat around doing nothing. Douglas thought they should be encouraged to play golf.God no!