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"...public opinion deserves to be respected as well as despised" G.W.F. Hegel, 'Philosophy of Right'

Costa on economics « Previous | |Next »
November 14, 2008

We can see one of the reasons why NSW is in the doldrums. Michael Costa, the former Treasurer, doesn't like Keynes. He says in The Australian that traditional Keynesian macro-economics is the theoretical refuge of economists who continue to believe economic magic can occur by the government waving its fiscal wand. The reality is that the market is best left to do its adjustment thing. Costa says that we need to put Keynes aside for a while and pick up Joseph Schumpeter and read about creative destruction.

Costa mentions Paul Krugman, as an example, and questions Krugman's argument that monetary policy by itself won't solve the financial and economic crisis and that a fiscal stimulus for the US economy is also needed.

What is wrong with this Keynesian argument? According to Costa:

How Krugman can equate this situation with the circumstances of the '30s described by John Maynard Keynes in his General Theory is difficult to understand.Even if you accept Keynes's analysis that lack of effective demand was responsible for the mass unemployment of the '30s, you would be hard pressed to credibly argue, coming off the recent speculative asset bubble, that lack of effective demand has caused the present problems....what is absolutely clear is that attempting to maintain aggregate demand at the levels seen during the asset bubble is a recipe for further financial dislocation.

Krugman is not saying that we need to return to the levels of demand of the asset bubble. What Krugman says is that:
what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.

As Martin Wolfe asks on Lateline: what are the engines of demand to pull the world out of this? He adds that historically the final engine of demand for the last 10-15 years has been the US consumer; and to a lesser extent the consumer in the United Kingdom, Australia, Spain etc. However, the big spending consumer is no more. So, where is the demand going to come from that will really pull the world out of this tailspin?

Costa opposes this form of fiscal intervention in favour of letting the market do its automatic adjustment thing coupled with a bit of welfare for the deserving poor:

As the recession bites, households' ability to consume at the levels of the recent past will certainly be curtailed. But remember, this household expenditure was based on excessive leverage and clearly unsustainable. A period of economic contraction and financial deleveraging is the natural, albeit unpleasant, antidote to the excesses of the period. Certainly the Government should provide support to those caught up in the inevitable adjustment process. In many ways the automatic stabilisers built into the system already provide that support through the social security system.

On Costa's account the present financial crisis is caused by the failure of government institutions, principally central banks, that were reluctant to burst the asset price bubble and are unwilling to accept the inevitable readjustment by the market. The inference is that government intervention should be minimal, because the market will inevitably produce the most efficient outcomes. So we should work to restore faith in markets.

His free market ideology Tiss that free markets are always best. This belief holds that that markets ultimately work themselves out, and therefore only need small nudges in the right direction by governments. If free markets are always the solution, then there is little need to flex the muscles of government when markets fail.

That still leaves us with the problem of where the demand going to come from that will really pull the world out of the recession tailspin? Costa's argument is that there are plenty of investment opportunities in the global economy that would return more than the risk-adjusted cost of capital. Markets are sufficient to generate investment, and people aren't hoarding scarce capital because of lack of profitable opportunities; rather, they are confused.

The immediate objection is that this overlooks the fact that without effective demand there is no point in firms investing in capital equipment. Costa's response, however, would be that investment drives growth not consumption---investment creates jobs that create the demand they keep the rest of the economy going.

However, if consumption is falling, and private investment is unable to compensate, then the federal and state governments should--have to---fill the gap. Secondly, Costa's defence of the free market is strange given that the market has failed, free market financial capitalism is broken, and the core of the lending system has been nationalized. This happened because something had gone terribly wrong, the financial world has been mismanaged, and people are now living in a world of hurt.

Where Costa is right is that we are entering a period of structural adjustment, and it will be painful for many.

| Posted by Gary Sauer-Thompson at 3:55 AM | | Comments (11)


The idea that the until-recently NSW Treasurer deserves serious attention on any economic issue is laughable. Like all good political thugs he chooses to assert that something is 'absolutely clear' in lieu of developing a coherent argument, which might require inconvenient stuff like evidence and logic.

Of course the current downturn wasn't caused by insufficient demand, but a drastic drop in consumer demand will be one of the consequences. Government deficit spending to help sustain levels of economic activity is therefore highly desirable.

Reading Costa's ill-informed economic 'analysis' helps us understand why NSW is such a basket case. His columns serve no other useful purpose apart from illustrating the urgent need to get rid of the Labor government in this state.

we have been sold a pipedream by those free market economists who promised us a rosy future due to globalization, free trade and deregulation.

Costa strikes me as a fox guarding the henhouse.

I try to understand these debates about economics, I really do. But somewhere between my eyes and brain there's on of those big, red, Wrong Way, Go Back signs.

unfortunately economics is the de facto language of public policy.

Costa's position is simple---Gillard puts it well---let the market rip. So your body is giving the right clues---don't go there. It's a dangerous place for those committed to social jusitce.

Costa says the market can do its own thing. He means this kind of process.

As business stagnates and profits fall, money will seek higher profits and finance, which will become riskier and riskier. Eventually, the house of cards falls, irrational and outdated investment becomes scrapped. After a painful recession or depression, bankruptcies will wipe out a good deal of debt. New investment opportunities present themselves. Eventually, the economy will be reinvigorated for a while until the cycle begins again.

So the reis no need for big government intervention ----just providing temporary support to those caught up in the inevitable adjustment process.

I wasn't very clear in my exposition.I've had a go at cleaning it up. Schumpeter's idea of creative destruction is that when the economy becomes sluggish, new innovations would be so profitable that investors would rush in and build up whole new industries.(PC computing) In doing so, they would destroy existing industry, but the net effect was to enliven the entire economy.

For Schumpeter, this process of creative destruction was the lifeblood of capitalism.

Thanks Gary. Creative destruction I understand.

"So your body is giving the right clues---don't go there"

Got it. It would be nice, however, if my body could manage this magnificent feat without making me feel stupid.

"unfortunately economics is the de facto language of public policy."

I don't generally consider myself to be a stupid person, though I'm willing to be corrected on that. It seems to me that either this de facto language should be outlawed immediately or someboy honest should be prepared to say that the public has no business concerning itself with public policy.

Oh. Costa. Got that.

or we--bloggers--- try and learn enough of the language to understand what is being argued. Paul Keating was able to do it.

But you are right. The talking head economists don't want you to understand. They want the public to see them as the expert/oracle.

Lyn as a piece of assessment, Costa's tripe would get a P-. It's 100% descriptive, with no argument at all. It offers no guidance for future action; it is solely concerned with making first year undergraduate points about the past. He adopts the time-honoured ruse of making himself seem learned by using technical jargon and referencing eminent scholars but there is no evidence at all that he comprehends the theory that he refers to.

Costa = wasted space. The only thing he and Iemma should be paid for is dressing up in clown suits at school fetes. If 'The Australian' is prepared to present him as a serious columnist, I confidently expect Kevin Andrews to start writing a weekly op-ed soon about ethics.

What Costa seems to want to take out of the equation is the role of intelligence, adaptability "normailty" and ingenuity, precisely the sort of thing that say, a Soros, is aware of and understands Schumpeter to be saying.
This possibility that human behaviour can get beyond herd level applies to human "products"
involving culture as well as material transformations.
Growth is measured by consumption and consumption of what compared to what else, based of cornucopia or shortage.
Like Lyn, am always wary when when the rich decide what's right for the rest, because their restless self seeking always betrays a lack rather than an adequacy of humanity.
Murdoch and Costa, both of whom would look totally at home in black uniforms, are people who can't be happy even to the level of many poor people. Yet they cannot abide the idea that the rest of us can do without them and the the things they value.
The one thing modern mechanistic neo economics doesn't take into account that Keynes anticipated, is "pathology".
There is a Politics of Envy, but few realise it is this terrible animosity the impotently wealthy and powerful bear toward normal people.
These, inexplicably, are happy on the "norm" because they can enjoy more fulfilling compensations at the personal level, that seem innacessible to the Gordon Geckos.