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Thursday, 8 October 2009

Keynesian bio-engineering

I am not an economist, but .. I have it in my genes as the offspring of two LSE graduates, and many years in the City, so I will have my say on cuts and Keynes. Actually I am more of an engineer by training so I will start here by copying a comment from a real engineer on one of the FT blogs last weekend:

“Economics reminds me of aerodynamics. There you are gaily flying the plane. Open the throttle (increase money supply) and the thing goes up. Reduce money supply and it starts to descend. You think you have it sorted. Then you try the stick. Wow Pull that back, and it goes up, but slowly, push it forward and it goes down. Call that taxation if you like.

So you reason, if you open the throttles wide and keep pulling the stick back, its never ending growth innit? Low taxes, cheap money supply..

Until an engine splutters because you are burning fuel at such a prodigious rate that the system cant keep up..oops you pull the stick back..and the thing stalls and spins and you lose half the altitude.

Why? because your aerodynamics has moved from a zone dominated by smooth laminar flow, to a chaotic one dominated by turbulence and the old rules don’t apply.

What is so hard for economists to understand about the proposition that depending on circumstances, one model or another may at any given time provide the best approximation to economic behaviour? Any engineer is utterly used to dealing with this. Things works smoothly up to a point, and then suddenly, they don’t. Limits are exceeded and the old rules no longer apply. So don’t exceed the limits.”

Now there seems to be a general outcry by pro-big state commentators to the effect that Keynes has demonstrated to everybody's satisfaction that government spending during a recession can mop up unemployment and stimulate growth through "multiplier" effects. I contend that in the UK and the current situation, the Keynes solution may not apply.

Keynes developed his theories at a time where the government played a much smaller part in the economy than today. Government borrowing may have been comparable as a proportion of GDP, but that borrowing was funding assets across the British Empire. Before the first world war government spending (current spending, investment and welfare payments) constituted 10% of the economy. Between the wars it was around 30%. Now it is over 50%. Rather than being an standby engine that can be switched on from time to time to boost the economy with multiplier effects, it is the greater part of the economy. The nature of any multiplier will be very different. That doesn’t invalidate Keynes entirely today, but equally it means that it may not be the most effective model for today.

A second observation is that Keynes did not assume permanent deficit spending, merely the use of deficit spending during recessionary periods to smooth the economy. In the UK we have had deficit spending in the boom times and more deficit spending in the recession. Meanwhile the rest of the economy has effectively been in decline for the last 6 years.

But probably more importantly, it seems to me that Keynes' models assume a more balanced economy that can be stimulated by a combination of lower interest rates and government investment in infrastructure. The theory is broadly that investment by government creates income, which results in more spending in the general economy, which in turn stimulates more production and investment and spending. The initial stimulus starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

The trouble is that this seems to imply a closed economy where everything is produced here, but spending government money does us little good if most of that money goes offshore. 80% of cash for the car scrappage scheme has been applied to cars that were manufactured overseas. UK car manufacturers may have made more money from the €5bn German car scrappage scheme than the UK scheme. Running a £175bn deficit does little good if a large part of that goes on civil servants buying German cars, Chinese wide screen TV's and Taiwanese iPhones.

Sure enough they might buy some life insurance but very little of the government spending may get through to British industry. If we have industry that is based on oil, petrochemicals, pharmaceuticals and aircraft parts, how is that impacted by the deficit spending? Very little, I would posit. If the problem is that (a) there is no credit capacity in the banks, because although they are flush with cash they don't have any spare risk capital, and (b) there has been underinvestment in British industry because it has become a less attractive place to invest, those are the problems to address.

But using another elegant biological metaphor, Sean Corrigan of Diapason Commodities, an avowed member of the Austrian School of Economics, applies at Keynesian economics to the biology of cells and the role of adenosine tri-phosphate (ATP) in the body:

… consider now the exquisitely complex machinery of the mitochondrion, that tiny organelle nestling inside the larger cell, wherein the process of respiration takes place, by which is meant the oxidative extraction and storage of food energy in those little re-chargeable battery molecules known as Adenosine Tri-Phosphate, or ATP.

Taking as our ‘intermediate good’ a molecule of pyruvic acid (broken down elsewhere from the rather more familiar glucose) and by successively transforming it with the aid of a battery of enzymes and co-enzymes (the ‘machine tools’ of the cell, if you will), while transporting in and out the likes of CO2, oxygen, hydrogen ions, and water (the ‘complementary’ raw materials and their resultant waste products), we end up with a store of useful and transportable energy on which depends nothing less than the very essence of life itself.

In essence the intricate balance of natural processes — which more widely also relate to the finding, ingesting, digesting, transport and sometimes storage of foods in the first place — is essential for us not to get sick. This, in a sense, can be compared to the workings and cycles of the global economy.

So what happens when you take a Keynesian approach to resolving health problems:

… to a Keynesian, the foregoing is merely superfluous detail for, should anything at all happen to go wrong with the system - should a disease pathogen, a toxin, a lack of some essential input, or an error of construction or repair, disrupt the metabolism — he believes that all that is needed is to increase the ‘effective demand’ made upon it by ’stimulating’ end-consumption, regardless of that latter’s composition. In other words, as long as the Krugmanite quacksalvers can get our gravely-ill patient running around the hopsital ward, burning up energy by discharging those little ATP batteries at a sufficiently rapid pace, they have done all that anyone can ever hope to do to secure his recovery, for the relevant capital structure and the requisite passage of ‘goods’ along his subcutaneous pathways will spontaneously coalesce out of what our Hermetic leech faciley presupposes to be homogenous cytoplasmic ‘gloop’ or readily-availhable, self-assembly constituents.

To go back to a mechanical analogy, there is no point in filling the fuel tank if the battery is dead.


engineer said...

I find the analogies are a bit questionable, but the point about the sheer scale of Government and the declining effect of debt is spot on

In the US, throughout the '70s, $1 of debt generated 75cents of GDP. This has declined progressively since 1980, such that last year $1 of debt generated only 25cents of GDP, dropping fast and likely near zero in the current circumstances.

Alex said...

I think it is very telling that the French and German economies which have more balanced economies than the UK and probably than the US have emerged faster from the recession. The reason seems obvious. More of the government pump priming flows into their own manufacturing industries, which in our case we have not got.