Tag Archives: Aggregate demand

Conscious Design, the Collective Mind and Social Decline

20 Wednesday May 2015

Posted by in Big Government, Human Welfare, Spontaneous Order

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All those in favor

The great gains in human welfare over the past few hundred years are not the result of some conscious design by a central authority. They are due instead to the emergence of conditions under which a “spontaneous social order” could bear fruit. Yet most people toil under the illusion that the progress of humanity and civilization are impossible without the imposition of some conscious design and intervention by human planners. In “The Counter-Revolution of Science“, F.A. Hayek noted that conscious direction was unnecessary to the development of such fundamental institutions as language, markets, money, the legal system and morals:

“We flatter ourselves undeservedly if we represent human civilization as entirely the product of conscious reason or as the product of human design, or when we assume that it is necessarily in our power deliberately to re-create or to maintain what we have built without knowing what we were doing.“

A liberal, spontaneous social order arose against a backdrop of secure rights that encouraged voluntary exchange. Individuals, free to act on their preferences, capabilities and personal resources forged their own trade relationships and contractual arrangements. In this sort of environment, the prices established by free exchange not only direct goods and resources in the present, but also direct their availability over time by balancing the time preferences of savers and investors. Again, it was this set of unplanned but voluntary private arrangements that brought such dramatic material progress to humanity. The chief contributions of central authority were the provision of a reasonably stable legal environment and, ironically, the constitutional framework in the U.S. that imposed limits on government power.

On the other hand, there is a long history of attempts to impose “conscious” designs by edict. They have met with consistent failure, and for good reason: human authorities cannot possess the dispersed knowledge needed to balance the diverse needs and preferences of millions of economic agents with the abilities of others to produce and provide for those demands. Nor would human authorities have the correct incentives to properly direct resources to their most valued uses, even if they possessed the requisite knowledge. In fact, the imposition of a “collective” plan implies a degree of coercion. The plan, no matter how well meaning, will necessarily conflict with the objectives of some individuals. Efforts to work around the plan will lead to additional coercive steps to bring all parties into compliance.

Still, there seems to be a deeply ingrained belief that advances can only be a product of conscious design and central direction. The idea dovetails with the tendency to view policies and objectives as things that must be achieved by “society” as a collective. But the details of deliberate social policies must be promulgated by relatively few policymakers and then executed by technocrats, even if the policies themselves are the product of representative democracy.

The elites who administer central plans must rely on aggregate measures of economic activity and broad categories or class groupings, which grossly over-simplify and misrepresent the complexities of human activity. This aggregation problem afflicts a wide variety of measurements and attempts to analyze behavior. Gary Galles discusses various aggregation problems in “How Economic Aggregation Hides The Problems of Interventionism“.

By analyzing things at aggregate levels, we may deceive ourselves by thinking that the aggregates can represent meaningful outcomes, or even worse, policy levers. The aggregates become constructs to which theories of “behavior” are applied, often rationalized by so-called “micro-foundations” of “representative agent behavior”. This effectively elides the fundamental reasons for engaging in voluntary market exchanges in the first place: differences in preferences, abilities, knowledge, and endowments of resources create opportunities for gain through trade. David Kreps is quoted at a link above on a prominent example of this phenomenon, the weak foundations of “aggregate demand”:

“… total demand will shift about as a function of how individual incomes are distributed even holding total (societal) income fixed. So it makes no sense to speak of aggregate demand as a function of price and societal income ….“

In short, the theoretical relationships between aggregates do not describe real economic behavior. Hayek noted that relying on aggregates fosters the all-too common but mistaken view among policymakers, pundits and the public that the economy can be shaped and managed much as an engineer designs a machine, or as a manager runs his factory. That is an incorrect but insidious viewpoint. Hayek explains that engineers or factory managers are able to perform their functions with relative precision because they are able to take so much for granted: prices or the availability of certain materials and resource flows, and reliable, technical relationships between inputs and outputs. Again, the economy and society encompass too many complex relationships and details that are unknowable to any central authority to manage effectively from the top down.

Some kinds of differences between individuals are recognized by planners and collectivists. Policies divide the population into groups subject to disparate treatments in an effort to meet social goals deemed worthwhile by the collective conscience. As my friend John Crawford said in a recent email: “… to have public policy the individual must be subjugated to the group simply for ease of understanding.” These disparate treatments imply that:

“… the simple act of generating public policy requires racism, ageism, sexism, classism, whatever-ism. Some ‘-ism’ must be conceived of simply so individuals can be grouped into bins, measured so a public policy action can be justified.“

These sorts of policies do not encourage a productive society. Instead, they promote political competition rather than economic competition, division rather than unity, and rent seeking and cronyism instead of productive effort, saving and economic growth. Norman Barry discusses the negative consequences of this shift in orientation in his essay “The Tradition of Spontaneous Order“:

“Hayek is no doubt correct in identifying the main disruptive threat to the preservation of a spontaneous order as the inevitable formation, under present democratic rules, of coalitions of interests which divert the stream of income in a catallaxy to politically-favored groups—to the ultimate harm of all.“

Dismal Implications of Aggregate Analysis

12 Thursday Feb 2015

Posted by in Macroeconomics

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keynesian cartoon

Economic aggregation is basic to traditional macroeconomic analysis, but it distorts and drastically oversimplifies the enormous number of transactions and the vast network of decision-makers that comprise almost any economic system, especially a market economy. There are some basic problems with aggregating across individuals and markets, but these are typically glossed over in macro-policy analyses. Instead, the focus is on a few key outcomes, such as aggregate spending by sector and saving, masquerading as collective “decisions” amenable to behavioral analysis. In this kind of framework, the government sector occupies an equal place to consumers and business investors. It is usually depicted as a great exogenous demander of goods and services, capable of “stabilizing” demand in the event of underconsumption, for example.

An insightful post by Gary Galles at the Mises blog drives home the inherent distortion involved in the analysis of macro-aggregates: “How Economic Aggregation Hides the Problems of Interventionism“.  The problems start with a nearly complete misapplication (if not neglect) of the basic problem of scarcity, as if that problem can be solved via manipulation of aggregate constructs. Galles offers a simple example of the macro distortion of “net taxes,” or aggregate taxes minus government transfer payments. Both taxes and transfers are complicated subjects, and both are subject to negative incentive effects. The net-tax aggregation is of little use, even if some rudimentary supply function is given treatment in a macro model.

By its very nature, aggregate government activity is distorted by the prices at which it is valued relative to market activity, and intervention in markets by government makes market aggregates less useful:

“For example, if government gives a person a 40 percent subsidy for purchasing a good, all we know is that the value of each unit to the buyer exceeded 60 percent of its price. There is no implication that such purchases are worth what was paid, including the subsidy. And in areas in which government produces or utilizes goods directly, as with defense spending, we know almost nothing about what it is worth. Citizens cannot refuse to finance whatever the government chooses to buy, on pain of prison, so no willing transaction reveals what such spending is worth to citizens. And centuries of evidence suggest government provided goods and services are often worth far less than they cost. But such spending is simply counted as worth what it cost in GDP accounts.”

Galles article emphasizes the unintended (and often unpleasant) consequences that are bound to flow from policies rationalized on the basis of aggregate macro variables, since they can tell us little about the impact on individual incentives and repercussions on the ability of markets to solve the problem of scarcity. In fact, the typical Keynesian macro perspective lends itself to slow and steady achievement of the goals of collectivists, but the process is destined to be perverse: more G stabilizes weak aggregate demand, or so the story goes, but as G expands, government entwines itself into the fabric of the economy, and it seldom shrinks. Taxes creep up, dependencies arise, regulation grows and non-productive cronies capture resources bestowed by their public sector enablers. At the same time, the politics of taxes almost ensures tat they grow more slowly that government spending, so that the government must borrow. This absorbs saving that would otherwise be available for productive, private investment. As investment languishes, so does growth in productivity. When economic malaise ultimately appears, we hear the same policy refrain: more G to stabilize aggregate demand! All the way down! Perhaps unemployed dependents are simpler to aggregate.

Aggregation masks the most basic issues in economics. A classic lesson in the complexity of creating even a simple product is told in “I, Pencil“, by Leonard Read. In it, he allows the pencil itself to tell the story of it’s own creation:

“Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items.

There is a fact still more astounding: The absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred. “

How many individual decisions and transactions are involved, throughout all intermediate and final stages of the process? How many calculations of marginal value and marginal cost are involved, and ultimately how many prices? While the consumer may think only of the simple pencil, it would be a mistake for a would-be “pencil czar” to confine their planning to final pencil transactions. But macro-analysts and policymakers go a giant leap further: they lump all final transactions together, from pencils to pineapples (to say nothing of the heroics involved in calculating “real values”, an issue mentioned by Galles). They essentially ignore the much larger set of decisions and activities that are precedents to the final transactions they aggregate.