Addendum to SCIOD 4: Liar's Paradox

Gödel's Theorem illustrated with regard to Say's Law and the Theory of the Lump of Labour:

1. "...a fallacy long recognized by economists as being especially pernicious. It is based upon the old exploded 'lump of labor theory'—the theory that there is a limited amount of work to be done. The truth is, of course, that every worker turning out a salable product thereby automatically generates a demand for other products, and thus sets others to work."


2. "The theory of a wage-fund and that of a 'lump of labor' naturally cohere, and there seems to be as much truth in one as in the other."


3. "Mill's successors rejected his wages-fund theory but overlooked the fact that Mill's refutation of Malthus depended on it." -- Keynes


4. "Of all the opinions advanced by able and ingenious men, which I have ever met with, the opinion of M. Say, which states that, Un produit consommé ou detruit est un débouché fermé appears to me to be the most directly opposed to just theory, and the most uniformly contradicted by experience." -- Malthus

Daniel R. Fusfeld (1980) "The Conceptual Framework of Modern Economics."  Journal of Economic Issues, 14, 1, pp. 7-8:

Gödel's theorem offers a profound challenge to the theory of knowledge on which logical empiricism is based. Unprovable propositions compromise the completeness of theoretical models. The results depend on the assumptions made about the unprovable propositions, and since those assumptions cannot be proven to be correct (or incorrect), the results must also be unprovable. If investigators try to avoid assumptions by using casual empiricism as the foundation for their unprovable propositions, they will then find themselves testing their hypotheses with the empirical data from which their casual empiricism was drawn, and the argument becomes circular. The only alternative is to leave the entire system open and unprovable through pure assumption or faith. The knowledge derived from formal axiomatic models must be imperfect, subjective, problematic.  

Gödel's theorem has had little impact on economic method, however, and has not been discussed by economists [Sandwichman: prior to Mirowski]. They have always used the ceteris paribus assumption to close their models. The embarrassing presence of an undecidable proposition can be avoided by inserting at any convenient point in the chain of deductive reasoning the simple assumption that "everything else remains the same." This procedure closes the model at that point and allows the remaining axiomatic model to be logically complete -- qualified, of course, by the "as if" assumption made when "everything else remains the same." This procedure was traditional in economics long before the epistemological problems raised by Gödel's theorem were recognized. Economists have been able to proceed as if Gödel had never lived.

"Gödel's Theorem seems to me to prove that Mechanism is false, that is, that minds cannot be explained as machines." J. R. Lucas (1961) "Minds, Machines and Gödel." Philosophy, 36, 137.

SCIOD 4: Paradox Laws

The moral to this story, as to any tale, is not fully circumscribed by its plot. The story's composition, its reception and retelling, the motives of its narrators are all implicated. The customers crowding the cheap market are not all there to buy the products on display. Some show up simply to loiter and observe. "In the flaneur," Walter Benjamin wrote, "the intelligentsia sets foot in the marketplace — ostensibly to look around, but in truth to find a buyer."

The supply of explanations creates its own demands. At the plot level alone, the theoretical consequence of Say's supposed law is that overproduction – a general glut on the market – is impossible. Leaving the "true" meaning of Say's Law to the pedants, what concerns us here is precisely its indeterminateness. Dogma arises out of mystery and assertion. The anthropologist Peter Yu describes the reasons given for ritual acts as being linked to a "general system of thought. If the system changes, as frequently happen, without disturbing the ritual acts, they will be reinterpreted in terms of the new system." Whatever else they are, whatever other meanings and uses they have acquired, the exchange of commodities or services for money and of money for commodities or services are ritual acts. In this case, the explanation of those ritual acts, the law that supposedly governs them, has itself become a ritual act. A textbook from the mid-19th century asserts dogmatically:

The proposition, that all men desire wealth, is inconsistent with the occurrence of a general glut. Some have supposed such a thing possible; it is plainly impossible.

So what exactly does "the proposition, that all men desire wealth" mean? Why is this proposition, even if true, "inconsistent" with a general glut? What is so "plain" about an impossibility asserted on the grounds of an alleged inconsistency? And finally, when is an inconsistency not inconsistent? Answer to the last question: when it is a paradox. Say's Law (or Platitude) has also been referred to as Say's Paradox, particularly in light of its relationship to another paradox – proposed by William Stanley Jevons in 1865.

"It is wholly a confusion of ideas," wrote Jevons in The Coal Question, " to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is the truth." He went on to explain:

As a rule, new modes of economy will lead to an increase of consumption according to a principle recognised in many parallel instances. The economy of labour effected by the introduction of new machinery throws labourers out of employment for the moment. But such is the increased demand for the cheapened products, that eventually the sphere of employment is greatly widened. Often the very labourers whose labour is saved find their more efficient labour more demanded than before.

In other words, to recall Rasbotham's Rule: "A cheap market will always be full of customers." No sooner is a product created than it opens a market for other products. Supply creates its own demand, not least because more supply makes products cheaper... and we all know what happens in a cheap market.

As with any aphorism, there are a lot of underlying assumptions, qualifications and corollaries to Say's Law, Jevons's Paradox and Rasbotham's Rule that are "understood" (or perhaps they are not understood, misunderstood or understood differently in different circumstances by different people). This sea of ambiguity make it possible for the same authority to believe in Say's Law and simultaneously scoff at the Jevons Paradox even though they are simply two statements of the exact same principle. There is, indeed, such a thing as being "too profound."

Both positive and negative valences attach to the bird trapped inside the hollow paper figure, the man concealed in the chess-playing automaton, the enigma of steadfast doctrines that dissolve into a mare's nest of platitudes and paradoxes. The economists' economic laws and theoretical models are, in fact, no more autonomous in their moves than was von Kempelen's mechanical Turk.

Theory of the Lump of Labour: "not as simple as it has been supposed to be"

Eleventh Special Report of the Commissioner of Labour. Regulation and Restriction of Output, reviewed by David F. Schloss, The Economic Journal, Vol. 15, No. 60 (Dec., 1905), pp. 558-564.

In the concluding chapter it is stated, that "it will probably appear to one who has read the foregoing Report that a study of the question of restriction of output in Great Britain is not as simple as it has been supposed to be." This is a conclusion which the brief analysis of the Report contained in the preceding pages will, it is believed, explain and justify.  -- David F. Schloss

In his 1891 article, "Why Working Men Dislike Piece Work," David F. Schloss, reported a conversation with a laborer making washers on piece work. "I know I am doing wrong," Schloss quoted him. "I am taking away the work of another man. But I have permission from the Society." It was to those italicized passages that Schloss assigned the name, "the Theory of the Lump of Labour."

In accordance with this theory it is held that there is a certain fixed amount of work to be done, and that it is best in the interests of the workmen that each shall take care not to do too much work, in order that thus the Lump of Labour may be spread out thin over the whole body of work-people. As the result of this policy, it is believed that the supply of available labour being in this manner restricted, while the demand for this labour remains (as it is supposed) unchanged, the absorption into the ranks of the employed of those who are now out of work will follow as a necessary consequence. 

As I was saying...

A little over a year ago, Sandwichman posted Peer Review: Economists and the Rhetoric of Groveling. It may seem a bit unfair to single out economists for engaging in a behavior that is undoubtedly universal. Folks grovel. Indeed, the use of the word "folks" -- as in "we tortured some folks" -- is a prime example of groveling.

My point, though, was that much of what economists perceive as economics is no such beast. It's genuflection, plain and simple. Or, as Fitzmaurice observed regarding the rhetoric of late modern English letters, "the rhetorical structures adopted by the men seeking patronage indicate the extent to which epistolary mendicity is conventionalized in humiliative discourse..."

In fewer syllables: untruth abounds in the service of groveling. To be more specific, the form this groveling often takes relies on denigrating lower social orders: beggars, cranks, shirkers, free-loaders, featherbedders, manual laborers. It's a pathetic attempt to persuade one's social superior to identify with the supplicant by emphasizing their mutual distinction from the rabble.

ProGrowthLiberal asks if economists should be honest or civil. Isn't it a bit late for civility? The only question left is whether they should be honest or deceitful in their incivilities. And I don't mean any disrespect to economists when I suggest they are "pandering lackeys." I simply don't see any immanent grounds for exempting them from the consequences of their own rhetorical strategies.

The Natural Rate Does Not Equal NAIRU: A Reminder

I am not keen on poking at a post appearing on Angry Bear, a friendly blog that often links favorably to posts here by many of us and with which I generally agree.  But maybe it is precisely because of this usual agreement that I am posting here an extension I made of a comment there on an August 1 post by Edward Lambert arguing that not only is 6.2% the US natural rate of unemployment, but that it is also the NAIRU (Non-Accelerating Inflation Rate of Unemployment), because, hey, the two are equal to each other, period.

Much of the post is quite good and interesting.  Lambert has a model that focuses on such things as capital stock capacity utilization and such measures for land aalso, as well as the unemployment rate.  Based on his model, levels of capital stock capacity utilization are now in ranges that look like full employment of capital stock, at least.  This may reflect the low rate of capital stock formation in recent years, a supply-side damage coming from insufficient aggregate demand over an extended period of time, but Lambert may well be on to something. 

Let me also state that I am not necessarily opposed to the idea of a "natural rate of unemployment," although I think that one should not make too much of it, which Lambert does (along with many others).  I think it is more useful to think of a "natural rate of employment," more relevant to the current state of low labor force particpation.  Indeed, Lambert trumpets that he beat out the Brookings Institution in forecasting the most recent unemployment rate.  They (and "most economists") said the UR would go down while he said it would go up, and, whoop de doo!, he was right.  However, it turns out that this was not due to some failure of job growth, but due to a favorable response on the labor force participation side.  There are plenty of reasons for employment to continue rising without any inflationary presssure in the near term, something Lambert actually admits, but what happens to the unemployment rate per se may really mean nearly nothing.

As it is, the original definition of the natural rate of unemployment by Milton Friedman back in 1968 was simply a rate that the economy would tend to go to if left to itself with "neutral" policy (if that can be defined) at any point in time.  Such may well exist. The issue is whether this natural rate has any signfiicance for policy, and for that things are not at all convincing.  Indeed, from the very beginning, others who were pushing similar ideas, notably Edmund Phelps, were heavily caveating the concept with the fact this natural rate is highly endogenous to the recent rate, particularly for labor force participation reasons, many of those related to how labor market skills (if not labor skills themselves) can deterioriate during lengthy periods of unemployment, an issue most relevant to the current situation.

My big complaint here has to do with identifying this natural rate with NAIRU, a highly problematic concept.  Friedman vaguely suggested such a link in his original talk, but he never really made a case for why inflation would not only increase, but that the rise would accelerate.  Indeed, aside from some handwaving about expectations, the case for why such an acceleration should occur at URs below the natural rate has never ever been made anywhere in any rigorous or coherent way by anybody.  That said, the subsequent inflation of the 70s was blamed by many on the supposedly excessively stimulative policies of the 60s, even as the acceleration of that inflation coincided with rising unemployment (and unemployment rates) in the notorious staglation.  But this somehow came to be identified with Friedman being right, and the identification of the natural rate with NAIRU entered macro textbooks at nearly all levels despite the lack of clear or rigorous or even empirically validated arguments supporting it.  It became something "everybody knows," (or should know) with even progressive economists who should know better such as Lambert falling for this empty nonsense.

Quite aside from the warnings from Day One about endogeneity of the natural rate to the recent actual rate, the famous episode of the 90s when Greenspan, urged on by Janet Yellen btw, allowed continued stimulative monetary policy even as the UR went below its then widely advertised natural rate and we saw falling inflation rather than rising, much less accelerating.  Many considered this to be the death knell of this identity, with some such as James Galbraith declaring it publicly in print in the Journal of Economic Perspectives in 1997 in "Time to Ditch the NAIRU" (although Jamie made it clear then that he had never thought much of the concept, and I don't think he has ever thought much of the natural rate concept either).

Now Lambert does recognize the Greenspan episode, but elides the issue  by saying that it set up the economy for the next recession, which took a good half a decade to show up.  What caused that recession in most peoples' books was the collapse of the dot.com bubble.  Now, maybe it was the stimulative monetary policy that goosed that bubble to ridiculous levels, but it had been going on for some time and was associated with real capital investment in that leading sector that did generate a lot of non-inflationary growth with lowered unemployment and reduced inequality.  Not too bad.  And the end of it was not associated with any increase in inflation.

Lambert's position is given in his final remarks:

"...when unemployment pushes below its natural level, the economy tends to overheat and become unstable.  At which point, the economy would like to return to its natural level.  The paths of that process can involve inflation, reduced output, falling capacity utilization and even tighter monetary policy."

Well, just two final comments on this.  One is that he leaves out what happened last month and also what happened during the three year period in the mid-80s when employment and output grew but the UR remained stuck at 7.0%, namely that labor force participation can increase, particularly if it has been "unnaturally" suppressed for an extended period.  The"natural rate of unemployment" may not even be tied to any particular level of the economy, much less its "natural" level.

The other comment is that in fact those declines in output and capacity utilization that have occurred in the past when "overheating" has occurred have usually been triggered by the tighter monetary policy, which has usually been a result of either actual inflation picking up or in many cases the Fed (or foreign central banks such as the ECB in recent years) getting nervous that inflation might pick up, in some cases spooked into doing so by taking too seriously all these fantasy stories so embedded in so much literature about the natural rate equaling the NAIRU.

This is a fantasy that needs to be exposed once and for all and banished from the textbooks once and for all, and indeed from publich discourse more generally, particularly by economists.

Barkley Rosser

Should Economists Be Honest or Civil?

The question of course is directed towards Laurence Kotlikoff. I guess this was an attempt to be honest:

The fiscal gap — the difference between our government’s projected financial obligations and the present value of all projected future tax and other receipts — is, effectively, our nation’s credit card bill. Eliminating it, would require an immediate, permanent 59 percent increase in federal tax revenue. An immediate, permanent 38 percent cut in federal spending would also suffice. The longer we wait, the worse the pain. If, for example, we do nothing for 20 years, the requisite federal tax increase would be 70 percent, or the requisite spending cut, 43 percent. Even if we do nothing — which, given Washington, is the likeliest outcome these days — we should at least be transparent about our insolvency. A bill introduced last year by the Democratic senators Tim Kaine of Virginia and Chris Coons of Delaware and the Republican senators Rob Portman of Ohio and John Thune of South Dakota would require the Congressional Budget Office, the Government Accountability Office and the Office of Management and Budget to conduct such “generational accounting.”

I have no problem with a well informed version of generational accounting but I do share the concern expressed by Dean Baker that Kotlikoff’s habit of ginning up very big numbers tends to scare more than it informs. Paul Krugman echoes Dean’s wisdom here. The day after this exchange over long-term budget forecasting, Kotlikoff offers Krugman this advice:

I think public intellectuals, like Paul Krugman, have a responsibility to act like grownups in speaking with the public. If they start calling people with different views “stupid,” they demean themselves and convey the message that name calling rather than respectful debate is appropriate conduct. It certainly is not … But what I’m writing about is not Paul Ryan. I’m writing about the level of national discourse. No one, and I mean no one, deserves to be called stupid.

Brad DeLong has already pointed out that Krugman did not call Congressman Ryan stupid. What Paul was really saying is that the Republican fiscal policy wonk was a con artist:

all the alleged fiscal responsibility lay not in the much-hyped changes to Medicare, but in magic asterisks claiming huge but unspecified savings from discretionary spending and huge but unspecified revenue gains from closing loopholes he refused to name.

Ryan has often called for large reductions in taxes on the well to do. Kotlikoff on the other hand frets that we are not raising enough in taxes to pay for all the things that the government has promised. And yet Kotlikoff wants us to be nice to politicians like Paul Ryan who are not being honest with us. I’m speechless.

Economist's Squares

Mark Thoma's daily links has jumped the shark, recycling mostly the same old same old 'celebrity' economic bloggers gossiping about each other. Case in point: "Simon Wren-Lewis and Nick Rowe Annoy Each Other... - Brad DeLong"

Plot summary: Simon and Nick disagree about something Paul said, so Brad steps in to settle the dispute (probably a rerun or at least a rehash of a sequel to a remake). Most Lucky-like ("...the skull the skull the skull the skull in Connemara in spite of the tennis...") sentence -- what Brad wrote:

Conventional monetary policy that swaps liquid cash for short-term safe nominal assets cannot help unless and until it summons the Inflation Expectations Imp and so makes interest rates at the zero interest rate lower bound consistent with the configuration of real interest rates across the risk spectrum that corresponds to the current Wicksellian natural rate.

What the reader sees:

Blah, blah, blah, blah, Nick Rowe, blah, blah, blah, Simon Wren-Lewis, blah, blah, Brad DeLong, blah, blah, blah, blah, Paul Krugman, blah, blah, blah, blah, blah.

Storyline for Economist's Squares (adapted from the storyline for Hollywood Squares):

Nine celebrity economist bloggers, seated in a three-by-three tier as in a tic-tac-toe board, joined two contestants, one of them a champion, in a game known best for the celebrities' wonkish answers to questions. The object was to win an otherwise standard game of tic-tac-toe by determining whether a celebrity economist was giving a correct answer to a general knowledge question or bluffing ("agree" or "disagree"). Contestants selected a celebrity, for which host Mark Thoma reads a question; a correct decision to agree or disagree by the player allowed him/her to place their mark in that box, while the opponent's mark was placed there if said decision was incorrect (unless it led to tic-tac-toe, in which case the contestant had to earn the box). During the first complete game of a show, a "Secret Square" game offered the contestants a bonus prize package for a correct answer. The contestant winning the best-of-three match was champion and returned to face a new challenger.

Jobless Future or Futureless Jobs?

In a Washington Post Innovations blog op-ed published July 21, Vivek Wadhwa wrote:

In an op-ed in The Wall Street Journal, former Treasury Secretary Lawrence Summers revived a debate I’d had with futurist Ray Kurzweil in 2012 about the jobless future. 

He echoed the words of Peter Diamandis, who says that we are moving from a history of scarcity to an era of abundance. Then he noted that the technologies that make such abundance possible are allowing production of far more output using far fewer people.

Asking the wrong question again. There will not be a "jobless future." There may not even be a future. And that's the good news!

The bad news is that if machines replace enough people (and everything else remains the same) then wages will fall to a low enough level that it will be cheaper to use people to do the work that machines could otherwise do. Of course, everything else won't remain the same.

When writing about jobless futures, "futurists" seem to forget that using more and more machines requires burning more and more fuel. Burning fuel emits carbon dioxide and requires more and more work to find and get and refine the fuel. Reductio ad absurdum implies that all the fuel and all the work will be expended going after the fuel to enable the process of going after the fuel -- a sort of perpetual inertia machine.

We won't ever get there. But we might travel too far in that direction to allow us to turn back.

Wadhwa makes a suggestion the Sandwichman has long advocated: "The only solution that I see is a shrinking work week. We may perhaps be working for 10 to 20 hours a week instead of the 40 for which we do today." I don't suppose Wadhwa realizes how deeply embedded the antagonism towards this "only solution" is among the high priests of fookerism.

Addendum to SCIOD 3: Petty Foggery and Political Arithmetick

"The meaning of fooker might be 'capitalist.'" -- Anatoly Liberman

In Chariots of the Luddites, I cited Dorning Rasbotham's allegation, "There is, say they, a certain quantity of labour to be performed..." as a precursor of Say's law of markets and the locus classicus of what eventually came to be known as the lump-of-labor fallacy claim. But who are "they"?

"They" turn out to be either John Graunt, William Petty or both. The following passage appears in Graunt's Natural and Political Observations made upon the Bills of Mortality:

We have said, 'Twere better the Publick should keep the Beggars, though they earned nothing, &c. But most men will laugh to hear us suppose, That any able to work (as indeed most Beggars are, in one kind of measure, or another) should be kept without earning any thing. But we Answer, That if there be but a certain proportion of work to be done; and that the same be already done by the not-Beggars; then to employ the Beggars about it, will but transfer the want from one hand to another…

There was some dispute about the authorship of the work which appeared under Graunt's name with probably the most credible explanation being that Graunt was indeed the author of the pathbreaking statistical analysis (and thus the "Columbus" of vital statistics) but that his intimate friend Petty may have contributed literary embellishments. Since the cited passage is more in the nature of an embellishment, it is quite possible, then, that Petty wrote it.

Just What the World Needs: Two More Introductory Economics Textbooks

Well, just maybe.  My offerings, Microeconomics: A Fresh Start and Macroeconomics: A Fresh Start are now available in print and as e-books.  The elevator version goes like this: the books embody substantial changes designed to close the gap between the way economics has been taught to undergraduates and the way it is practiced by professionals.  Their approach is empirical and open-minded.  They aren't my own personal take on the subject, since I hope some instructors will adopt it who aren't me.

They are published by Springer, so they don’t have the snazzy production values of the Big Boys.  But on the other hand you can buy them new for about $75 apiece.  (Hardbound, 450 pp.)

If you want the backstory, which will no doubt persuade you that these texts are what's been missing from your life all these years, click here.  And here are the links for ordering exam copies of the micro text and its macro companion.

Nike’s Bermuda Affiliates Are Named After Its Shoes

Forbes is also a fan of the good work of the Citizens for Tax Justice (CTJ) and note something a little odd:

What does Nike have to do with taxes? It turns out that Nike is very aggressive when it comes to sheltering profits overseas … Twelve of those subsidiaries are in Bermuda alone! The CTJ says that Nike has about $7 billion of profits parked offshore that are not being taxed by the United States or any other country … What is fun about this is that Nike apparently named its tax shelters after its shoes. According to the CTJ, 10 of the Bermuda subsidiaries are actually named after Nike shoes: Air Max Limited, Nike Cortez, Nike Flight, Nike Force, Nike Huarache, Nike Jump Ltd., Nike Lavadome, Nike Pegasus, Nike Tailwind, and Nike Waffle.

I guess you can say that the Nike tax planners have some fun with their jobs. But I do have a couple of issues with how CTJ is spinning this. Counting the number of affiliates in tax havens is not a great way of measuring profit shifting. If they parked $7 billion in one Bermuda affiliate, it would have the same financial impact. Also – this $7 billion figure must be an accumulation over time. Nike generates around $3 billion in profits each year on $25 billion in sales. I checked their 10-K which shows a 25% effective tax rate in part because 52% of their income over the past three years stays in the U.S. And some of the rest goes to distribution affiliates in other high tax nations. Of Nike’s sales, 55% are to foreign customers. But given the profits attributable to Nike’s trademarks, I guess one could expect more of the income coming back to the U.S.

SCIOD 3: Chariots of the Luddites

Edmund Cartwright was checkmated in his endeavor to turn a commercial profit from his mechanical loom. In 1790, Cartwright licensed Robert Grimshaw of Manchester, a manufacturer of cotton check cloth, to install 500 of his power looms in a large weaving factory at Knott Mills. The proposed factory was to be on a larger scale than any mill in existence at that time. Only twenty-four of the looms were in operation by February of 1792 when the Grimshaws received an anonymous threatening letter, presumably from hand-loom weavers (or competitors?) who were alarmed by the scale of the undertaking and its potential impact on the market:

Sirs—We have sworn together to destroy your factory, if we die for it, and to have your life for ruining our trade; and if you go on, you know the certainty, which comes unknown to my companions.

About a month later, the mill was burnt to the ground. The fast combustion of the building indicated arson. Although the factory had been well insured, Grimshaw declined to rebuild and forfeited his license from Cartwright, perhaps because he took seriously the threat of further violence.

The destruction of the factory at Knott Mills foreshadowed the Luddite uprising that was to come two decades later and also followed in a tradition that had led to several incidents at cotton spinning factories in Lancashire a decade earlier, just five years before Cartwright had his auspicious conversation about spinning, weaving and chess-playing automatons:

A mob rose and scoured the country for many miles round Blackburn, destroying all the jennies, carding engines, and every machine driven by water or horses…. Even the upper and middle classes in those days entertained a great dread of machinery, and they connived at, and even actually joined in, the opposition of the working classes to its extension.

In response to those outbursts, Dorning Rasbotham, a magistrate near Bolton, wrote a pamphlet, "Thoughts on the Use of Machines in the Cotton Manufacture," that was to make an enduring impression on political economists. Although there has been some question raised regarding Rasbotham's authorship of the pamphlet, a memorial plaque in the church where his remains were buried described him as having "the characters of the poor man's friend." The pamphlet was signed "a Friend to the Poor." Squire Rasbotham strove to leave no doubt about where his sympathies laid:

I am, from the bottom of my heart, a Friend to the Poor. I wish to plead their cause, and to speak in their favour. I feel tenderly for the poor man and his family. And, if my heart does not deceive me, I would do, I would suffer any thing for their welfare. Led by no other principle, but regard to the Poor, I now wish to enter into free and friendly conversation with you, my poor but esteemed friends, on the subject of our machines.

Rasbotham's repertoire consisted of a series of assertions, several of which express notions that are repeated perennially as commonplaces in economic thought:

1. The interests of the poor should have the highest priority (after all, what would become of the rich if there were no poor people to till their grounds, and pay their rent?);
2. There is not so great a difference between the real interests of the rich and of the poor;
3. Trade is a large and difficult subject that requires deep thought, long study, extensive reading and large experience to form a true judgment;
4. Machines distinguish men in society from men in a savage state. There are many examples showing how machines invariably benefit people;
5. All improvements at first produce some difficulty but many receive the benefit while only a few suffer (probably not much and hopefully not for too long), Those who are inconvenienced should be grateful for the opportunity to make a sacrifice for their fellow man;
6. Trade will find its own level. Those thrown out of their old employments will find or learn new ones. Those who get a disproportionate gain will soon find many rivals and lose their temporary advantage;
7. There is a disposition among people to be unduly alarmed by new discoveries;
8. Even if machines are evils they are necessary evils. We might as well make the best of them;
9. This would be a prosperous time for the poor, if only they would show some initiative and weren't so inclined to carry their money to the alehouse;
10. Anyone who disagrees with the above truths is an irreligious, conscienceless scoundrel and nincompoop; and, last but not least,
11. The belief that "there is only a certain quantity of labour to be performed" is a false principle.

John Ramsey McCulloch, one of the more prominent political economists of the second-rank in the early 19th century was effusive in his praise for the sensibility and soundness of Mr. Rasbotham's opinion, emphasizing the observation that "There is, in fact, no idea so groundless and absurd, as that which supposes that an increased facility of production can under any circumstances be injurious to the labourers." Rasbotham's final point merits quotation in full if only because future economists echoed it incessantly for two centuries hence, presumably without the faintest clue as to its origin:

There is, say they, a certain quantity of labour to be performed. This used to be performed by hands, without machines, or with very little help from them. But if now machines perform a larger share than before, suppose one fourth part, so many hands as are necessary to work that fourth part, will be thrown out of work, or suffer in their wages. The principle itself is false. There is not a precise limited quantity of labour, beyond which there is no demand. Trade is not hemmed in by great walls, beyond which it cannot go. By bringing our goods cheaper and better to market, we open new markets, we get new customers, we encrease the quantity of labour necessary to supply these, and thus we are encouraged to push on, in hope of still new advantages. A cheap market will always be full of customers. [emphasis in original]

Banal as Mr. Rasbotham's paragraph may seem, it anticipates by around 20 years a principle expressed by Jean-Baptiste Say that eventually would come to be baptized "Say's Law" and preside over centuries of dogmatism, controversy and confusion. Here is how Joseph Schumpeter described in 1954 the variegated reception of Say's Law down through the years:

He hardly understood his discovery himself and not only expressed it faultily but also misused it for the things that really mattered to him. …Ricardo understood it because it tallied with considerations that had occurred to him in his analysis of international trade, but he also put it to illegitimate use. Most people misunderstood it, some of them liking, others disliking what it was they made of it. And a discussion that reflects little credit on all parties concerned dragged on to this day when people, armed with superior technique still keep chewing the same old cud, each of them opposing his own misunderstanding of the 'law' to the misunderstanding of the other fellow, all of them contributing to make a bogey of it. (624-5).

A half century later, Robert Clower subtitled his article on Say and his law, "the story of a mare's nest." So just what does this so-called law say? In the 1821 English edition, C. R. Prinsep renders the following translation of the key paragraph:

It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products.

"The creation of one product… opens a vent for other products." Although not identical, this version is reminiscent of Rasbotham's "By bringing our goods cheaper and better to market, we open new markets." Book I, Chapter VII of J. B. Say's Treatise on Political Economy, "Of the Labour of Mankind, of Nature, and of Machinery Respectively," reiterates many of the same points that Rasbotham made, down to using the same examples to illustrate the arguments. I don't know if Say read Rasbotham's pamphlet but it was well known, Edward Baines and John Ramsey McCulloch praised it highly, and Say attended school in England in the mid-1780s.

Although criticized by defenders of the sanctity of Say's Law, Keynes's version, "demand creates its own supply," captures the essence of the argument, albeit ambiguously and incompletely. There may well be, though, as Poe's Dupin remarked, "such a thing as being too profound." From the start, Say's Law incorporated a vast amount of ambiguity and evasion. Clower suggested it could have been better labeled Say's Platitude. Keynes's reductive summary of the claim legitimately represented the reductivism that prevailed in typical textbook dogma. Keynes didn't exactly capture all the nuance of Say's Law. Neither did the textbooks that revered it. Nor did Say.

Figuring out the Inflation Vigilantes

Brad DeLong provides the raw material, and Paul Krugman adds some speculation to an account of unrelenting and unapologetic error on the part of those who would scare us about inflation, always just around the corner.  Here are two further thoughts to chew on.

1. The paranoia about inflation is a widespread, longstanding phenomenon, with immense influence over public discourse and economic policy, and out of all proportion to the actual—and very history-specific—threat.  It deserves to be studied by the normal tools of social science, the ones we devote to other significant political, religious and social ideologies.  Obviously, political economy has a key role to play, insofar as net creditors, as a rule of thumb, benefit from less-than-expected inflation.  (I give this a short treatment in my introductory macro text, due to be released in about a week.*)  But I’d like to see the full range of analysis: social psychology, networks of influence, case studies, and any other tools that can replace speculation with solid understanding.  The disinflation lobby is an important part of the political landscape and deserves careful study.

2. One aspect of the IV impact on our discourse that has particularly rankled me as an economics instructor is the deliberate propagation of what I call Type II money illusion.  (Does anyone else use this terminology?)  Type I is carefully explained in every introductory textbook: if you look only at your money income and ignore changes in the price level for the goods you buy, you will overestimate your true spending power.  Governments are said to rely on this confusion when they engage in expansionary monetary policy, and one of the functions of Econ 101 is to innoculate the masses against it.

But there is also the reverse error, to observe changes in the price level of consumption goods but not the (roughly) corresponding increase in money income.  This is circular flow stuff, as fundamental as it gets.  It is an error for the public to think that a rise in inflation makes them, considered together, poorer—as if, with lower inflation, everyone would continue to get the same wage hikes and enjoy the extra consumption.  Seeing the spending side of inflation and not the income side is Type II money illusion.

The interesting thing is not simply that lots of people (in my experience even a large majority) harbor this, but that it is actively purveyed by the media and even, on occasion, prominent members of the economics profession in their popular writings.  “Good news for consumers!  The latest report shows that inflation has come in below market forecasts.”  “Inflation is the cruelest tax of all.”  You know the drill.  And that is exactly the way it works: it is drilled in, over and over, until money illusion becomes the shared reality and the few of us who recognize it as an error find ourselves reduced to shouting at passers-by (or at least our students), like incomprehensible fanatics.

I mention this partly to vent, but also because I think this massive, systematic disinformation really deserves to be studied.  Why does it persist?  Why do the economics textbooks not bear down on it like they do against Type I, even though far more people today are in the grip of this second kind of illusion?  Political economy surely plays a role, but only indirectly, since most of the confusion is purveyed by people, like journalists and your Republican cousin at this summer’s family reunion, who have no direct interest one way or the other.

Note: I’m sure some people will read the above and immediately try to argue that inflation really does eat into spending power through a wealth effect.  That’s a separate discussion (it could be true, but it doesn’t get rid of Type II money illusion, which is quite specific and impossible to defend), but note that wealth channels get complicated: you have to consider net and gross debtor and creditor positions, financial versus real assets, nominal versus real exchange rate movements for internationally diversified portfolios (and the degree to which these are baked into asset prices), and so on and on.  Trust me: that’s not what most people are thinking about when they burble that of course inflation is bad because it reduces your real income.

*Don’t worry about the announced release date; I’m told it is imminent.  And, no, it's not 109 pp.  Closer to 4x.

SCIOD 2: A Left-Handed Mechanical Loom

In the summer of 1784, Edmund Cartwright, a clergyman, was on holiday in Matlock, Derbyshire, not far from Cromford, where Richard Arkwright had a cotton-spinning mill. Cartwright fell into conversation with some gentlemen from Manchester about what would happen when Arkwright's patent expired. "One of the company observed," Cartwright later wrote, "that... so many mills would be erected, and so much cotton spun, that hands never could be found to weave it."

Cartwright suggested that Arkwright ought to get busy inventing a mechanical loom. His companions scoffed at the impracticality of the idea. Knowing nothing about either weaving or machines, Cartwright called attention to the chess-playing automaton built by Baron Ludwig von Kempelen, which had recently been exhibited in London:

Now you will not assert, gentlemen, said I, that it is more difficult to construct a machine that shall weave, than one which shall make all the variety of moves which are required in that complicated game. 

Later on, recalling this conversation, Cartwright gave the matter more thought and came to the conclusion that such a machine was indeed possible. He hired a carpenter and proceeded to build a prototype, having "never before turned my thoughts to any thing mechanical, either in theory or practice, nor had ever seen a loom at work, or knew any thing of its construction." Needless to say, the first loom was rather crude but Cartwright persevered and in August of 1787 patented a loom, "nearly as they are now made," he wrote in a letter to Dugald Bannatyne, author of the Encyclopaedia Britannica article on "Cotton Manufacture," published in 1818.

In his communication to Bannatyne, Cartwright didn't say if he ever found out that the chess-playing automaton that inspired his invention was an elaborate hoax – a puppet operated by a man concealed in the device's cabinet. In an essay about the chess-player, published in 1836, Edgar Allan Poe observed, "we find every where men of mechanical genius, of great general acuteness, and discriminative understanding, who make no scruple in pronouncing the Automaton a pure machine." If these assumption had been correct, the chess-player would undoubtedly be "beyond all comparison, the most astonishing of the inventions of mankind." According to Poe, though:

The first attempt at a written explanation of the secret, at least the first attempt of which we ourselves have any knowledge, was made in a large pamphlet printed at Paris in 1785. The author’s hypothesis amounted to this — that a dwarf actuated the machine.… This whole hypothesis was too obviously absurd to require comment, or refutation, and accordingly we find that it attracted very little attention.

In 1789 a book was published at Dresden by M. I. F. Freyhere in which another endeavor was made to unravel the mystery…. His supposition was that “a well-taught boy very thin and tall of his age (sufficiently so that he could be concealed in a drawer almost immediately under the chess-board”) played the game of chess and effected all the evolutions of the Automaton. This idea, although even more silly than that of the Parisian author, met with a better reception, and was in some measure believed to be the true solution of the wonder, until the inventor put an end to the discussion by suffering a close examination of the top of the box. 

These bizarre attempts at explanation were followed by others equally bizarre. Of late years however, an anonymous writer, by a course of reasoning exceedingly unphilosophical, has contrived to blunder upon a plausible solution — although we cannot consider it altogether the true one.

After reviewing these previous attempts at explaining the secret of the Automaton, Poe endeavored "to show how its operations are effected, and afterwards describe, as briefly as possible, the nature of the observations from which we have deduced our result." After enumerating 17 observations, Poe concluded that the decisive clue is that the Automaton plays with his left arm – "for the Chess-Player plays precisely as a man would not":

Let us, for example, imagine the Automaton to play with his right arm. To reach the machinery which moves the arm, and which we have before explained to lie just beneath the shoulder, it would be necessary for the man within either to use his right arm in an exceedingly painful and awkward position, (viz. brought up close to his body and tightly compressed between his body and the side of the Automaton,) or else to use his left arm brought across his breast. In neither case could he act with the requisite ease or precision.

Although a plausible conjecture, Poe's conclusion seems at first hardly conclusive. A right-handed Automaton could be operated easily enough by a left-handed person. As it turns out, lefties tend to be more heavily represented among chess players than in the general population. But they are still outnumbered by roughly five to one. As Poe's character, Dupin, was later to remark in "The Murder in the Rue Morgue," "there is such a thing as being too profound. Truth is not always in a well." Superficial as it may seem, odds of 5 to 1 in hiring an operator for the puppet are probably sufficient cause for constructing a left-handed automaton.

Transocean Transfer Pricing and Corporate Inversions

Martin Sullivan had the perfect line four years ago for this corporate inversion debate:

By inverting, a multinational is no longer subject to U.S. tax from its foreign operations. In addition, the transactions often are accompanied by planning techniques that strip income out of the United States.

His paper documented the drop in the effective tax rate for certain oil drilling rigs that did corporate inversions between 1999 and 2002. Ensco complained about this back then but they have joined the club since. About the same time, Senator Baucus used the Senate Finance Committee to blast Transocean:

Transocean, still largely physically located in the U.S., moved its headquarters to the Cayman Islands in 1999, thus avoiding U.S. taxes, and has since relocated the headquarters to Switzerland. Baucus led the fight in the Senate to shut down this practice, known as corporate inversion, and successfully passed the American Jobs Creation Act of 2004, which closed loopholes in the tax code that made corporate inversion possible. Baucus sent a letter today calling on Transocean to provide detailed documents and explanations relating to the company’s tax practices. This information will help the Finance Committee discern the tax benefits Transocean received by exploiting the loopholes closed by the American Jobs Creation Act of 2004 and determine whether further legislative action is necessary to prevent erosion of the U.S. tax base through corporate inversions.

I read the questions for the CEO of Transocean and I hate to say but the Senator completely missed the boat – as in Bareboat Charter arrangements, which I’ll explain in a moment. His notion that Transocean is largely physically located in the U.S. is simply not true. Yes about 25 percent of their activity is here but they have oil drilling rigs all over the world. Oil drilling rig multinationals are an incredibly simply issue as all they do is to combine very expensive equipment with workers so the only issue is who gets the profits from their equipment, which is predominantly these rigs which often cost $500 million a piece. The trick is that formal ownership of the rigs is transferred to tax havens, which lease the use of the rigs to the operating affiliates in places like the US and the UK. Now if this planning technique does not offend you – the intercompany lease rates should. The UK government certainly is according to Reuters:

"Currently, some companies making significant operating profits in the UK are able to move up to 90 percent of these profits overseas and out of the UK tax net," a spokeswoman for the UK Treasury said … Osborne's change, which will limit the amount companies can deduct from profit for such lease payments to 7.5 percent of the historical cost of the rig, will replace generous deductions calculated on the market value of rigs, which has been soaring. Andrew Cox, Tax partner at Deloitte, said HMRC had most recently agreed in 2008 that drillers could take tax deductions of up to 15 percent of the market value of a rig each year.

Finance Minister George Osborne is very frustrated with his national income tax authority for not challenging clearly excessive intercompany lease deductions. I would submit to Senator Baucus that we should be equally upset with the IRS for their failure to challenge overly aggressive transfer pricing. Rather than get lost in endless and ineffective tax rules, why not simply look at the real economics of these multinationals transfer pricing?