7 votes

I need help disproving Keynesian Theory

Everyone agrees with this:

  • Consumption is good
  • We cannot consume more than is produced, on net
  • To consume more requires us to produce more

The divide is on HOW to accomplish this. Two basic contradictory proposals:

  1. focus on increasing consumption which will "trigger" the needed production increase...or
  2. focus on increasing production to allow for the consumption increase

I think approach #1 is foolish. But I'm having a really hard time coming up with a simple, clear, concise, elegant explanation to show why it's foolish.

If you've heard such an explanation, or can come up with one, please let me know.

I think approach #1 is the single most dangerous and prominent misunderstanding of economics. Basically all future prosperity depends on debunking it...so no pressure.

EDIT: Thanks for all the feedback. Based on comments, I want to clarify something...

I'm not trying refute the fallacy that GOVERNMENT should decide for us what to consume. Yes, this is definitely a part of Keynesian Theory, but the broken window fallacy already does a nice job of refuting that part of the theory.

I'm saying that EVEN free people deciding on their own to increase their consumption on goods that really would make their lives better, does NOT stimulate the production increase required to meed those new demands.

In fact, those production increases come from the opposite of consumption: they require human work, innovation, technology, and under-consumption.

So whether or not the increased consumption is market driven or government driven, I don't think it causes production to increase, and I'm looking for a good way to show that.

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completely agree

In fact, that's the first line of my post: Consumption is good.

I've also been making the point throughout that increasing production in the future, which allows for us to consume more in the future, requires that we under-consume in the present so we can devote more resources to increasing our means of production (technology, capital, etc.).

He is referring to his book,

He is referring to his book, which is a revised edition of his father's book from the 1980s. Here is an online version:

http://imgur.com/a/zh1s9

Sorry, but consumption drives production

I'm not saying that consumption stimulus is a good thing. Because its not.

But, consumption is much more effective at creating production than production is at creating consumption.

Pick an industry... say computers.
People dont care much for desktop computers anymore. Because of various newer options like notebooks, netbooks, tablets, mobile phones, etc. The overall demand for desktops has diminished. As a result, the market for desktops has tanked. There is unbelievable surplus of new and refurbished desktops that no one is buying. Simple production of more desktop computers will not increase the number of desktop computers that get purchased. There is simply not a demand for them. No amount of overproduction will stimulate consumption of this particular "good".

Now, imagine if you will a sudden demand in desktop PCs (whether it is artificially created, or naturally occurring) if, all at once everyone decided they simply had to have another desktop computer, almost overnight, companies would ramp up production enough to meet that demand. And as soon as the consumption slowed, they would immediately stop producing.

Consumption drives production, not the other way around.

The error in the Keynesian economic theory is that consumption creates prosperity. As well as the idea that markets can somehow be guided more effectively by centralized intervention than by simply allowing people to choose to produce, consume, but, sell, and otherwise enter into contracts with one another in whatever way they feel is most beneficial to them.

In all reality, the government doesn't need to "focus" on either of your paths to prosperity. The government needs to focus on protecting the rule of law so that free people can interact with confidence.

Your talking about micro production shifts, not macro increase

Your confusing production "shifts" at the micro level with production "increase" at the macro level. If there is all of a sudden a huge desire for people to have tablets instead of desktops, of course producers will try to shift productive resources toward tablets and away from desktops. This happens in response to the price changes, which is the main signal to align people's desires with their productive efforts.

But the argument I'm trying to refute is a macro argument...that increasing consumption on the macro level, will increase production on the macro level.

The only thing that creates a macro increase in production is for people to get better at production. This takes time, work, innovation, and technology. More importantly, it takes UNDER-consumption in the present time, to invest in those long term productivity increases.

Still holds true tho

Even with all of that considered, society still only produces enough to fit the demand, which is measured using the current rate of consumption.

Sure, people invent new things, and try to create a demand for them, but if that demand doesn't show up, the new thing will not continue to be produced.

Consider a scenario where there are people on an island, and lets assume for a moment that having enough fish is all anyone really wants. At first, every fish that is caught is like gold. In this scenario, it feels like the only thing holding up the consumption of fish is the ability to produce (or catch) more fish. there are lots of starving people, so there is incredible demand for fish. people will spend every waking hour trying to get fish, just to make ends meet.

There comes a tipping point though when suddenly there are enough fish to feed everyone as much as they actually want. Would we continue fishing like mad-men catching every possible fish, "saving" them up... maybe some people will feel the need to do this, but by and large, people are lazy.

Once the demand for consumption is met, people will start working fewer hours, doing non-productive things with most of their time. There will be people who choose not to fish at all. But if the supply of available fish goes below comfort level, then they kick in and start fishing again.

Society is made up of lazy people (practically everyone would prefer to be non-productive, given the opportunity). So, we only produce what we have to in order to get what we need for the near future, with a little bit of saving for a rainy day.

Society simply wont produce more than the rate of consumption before it stops. This is not simply on an item by item / market by market analysis. Dropping the price on items over-produced only creates "demand" for them until the potential purchasers feel like they have more than they really need.

If there was suddenly a huge overstock of socks in america and they went down to nearly free prices, I'd go by a few boxes full of socks. But once I had a few years worth of socks to replace my ugly old ones, I'd stop buying them. No amount of production of new socks is going to make me want more. If you brought me boxes of free socks, I'd tell you to take them elsewhere, I don't have room for them in my house, and I have enough socks.

Companies cant produce things above consumption demands because if they do they risk the likelihood that prices will have to drop below their cost of production in order to sell off inventory.

Sure, companies shift from one thing to the next hoping to find new markets to tap. But, if we honestly had surplus across the board, companies would fire everyone and stop making stuff. There is no incentive to produce unless there is first demand which manifests itself in the form of consumption.

Consumption drives production. Society will never overproduce, it has no incentive to do so.

But, to the heart of the real question. The answer to getting the economy running smoothly isn't a consumption/production question at all. The question that needs to be considered is this... what barriers exist that make it difficult for people to produce the things that are in demand? The answer to that question is almost always "government intervention". eliminating all of the government's attempts at fixing the economy would heal it almost overnight. The only thing the government need concern itself with is providing an environment where people can buy/sell/produce on equal grounds one with another (no favoritism, all laws applied equally, and contracts are upheld by the law)

Focusing on more or less than that causes problems.

Ehhh........

...People only demand things that they are aware of. Before computers were invented, there was NO demand, but a guy had an idea and followed it through because he believed that the demand for computers would be great, once people became aware of them.

Today's production/supply affects tomorrow's consumption/demand.

Meaning that SAVINGS drives production, not consumption.

"I do not add 'within the limits of the law,' because law is often but the tyrant's will, and always so when it violates the right of an individual."

That's partially true

Savings does not drive production, it simply enables it.

I have a savings account. It doesn't drive me to produce anything at all.

The thing that drives me to produce is the fact that my family and I need to buy stuff in order to survive and be comfortable. It is our need to consume that drives me to produce. There may be some people who have more noble reason to go to work, but most people are lazy enough to only work hard enough to make ends meet, with a little wiggle room.

Sure, the inventor of the computer used capital to make it a product and find ways to show people they wanted it. But late night shopping networks are full of things that someone produced hoping to find demand, but didn't. The existence of those goods doesn't drive me to pick up my phone and buy them, even when the prices are unbelievable and they throw in a free universal TV remote to sweeten the deal.

The existence of computers didn't create the demand, sure, they had to exist before they could be demanded, but people have to have an honest use for something before they will demand it. And the use for it has to be important enough that they are willing to produce something to make enough money to pay for the desired product.

In the end, consumption is the key factor. people produce so they can consume. companies produce only things that will be consumed. There is a little bit of wiggle room, but the exception that occurs in that wiggle room is not significant when compared with the underlying reality that consumption is the only lasting reason anyone produces anything. If consumption stopped tomorrow, production would immediately follow suit.

War debt

"Before computers were invented, there was NO demand, but a guy had an idea"...
There were governments with demand for computing power. First of all for making their wars more effective through more accurate ballistic devices , cryptography and other machines needed in warfare. So they issued war loans as always to develop for example computers.
The currency system of today is largely accumulated circulating war debt.

To say that consumption

To say that consumption drives production is the same as saying that stepping on a gas pedal drives a car forward. Yes, technically, the gas pedal tells the car to move forward. But what actually drives the car is the engine, not the gas pedal. Consumption and production work the same way. Consumption tells businesses what to produce in the form of demand signals, but the production is the engine. Without the engine, the demand signals, or gas pedal, are meaningless. We can all demand yachts and private jets and olympic-sized swimming pools, but it doesn't matter one bit unless someone actually builds them.

I respectfully disagree

If we all truly demand yachts and private jets and Olympic sized swimming pools, someone will actually build them, because if they don't, we will build them ourselves. In the end, if we truly demand something it will be created for us whether we build it ourselves or someone does it for us.

What I am saying is ... in a free market, if demand is high enough to justify the costs of production, production will ALWAYS follow to meet that demand. And it will continue until the demand changes enough that it no longer justifies a price high enough justify the cost of production. At which point, production will cease. The only thing that slows down production is when people aren't willing to pay the actual costs of production.

If the SHTF and suddenly there is no production in the whole world ... people would start producing their own food and making their own clothes, and cutting down their own trees to meet their consumption levels. Then, they would sell their surplus to others who wanted to consume it in exchange for other things they want but don't have the know-how or energy to produce themselves.

The need to consume goods would FORCE production to keep up, or people would die. Consumption is the driving force behind production.

If consumption was not the driving force, then in the SHTF scenario, everyone would sit around on their butts, waiting for production to kick back in because they just don't know how to consume without it.

The need to consume is not willing to sit around and wait for production. However the need to produce is perfectly happy to wait for demand.

Availability does not create demand, Demand creates availability.

The fallacy enters when you take that simple truth and use it to falsely conclude that artificially increasing consumption will somehow stimulate the economy. It wont. Neither will artificially stimulating production.

To break down that position,

To break down that position, explain it like this:

In order to to stimulate production through consumption, you must create false demand. This false demand misallocates resources because nobody is smart enough to figure out the best thing which should be subsidized. This creates bubbles which eventually pop, leaving people out of work. In addition, the excess resources which were used during the inflation of the bubble are wasted.

It's not possible to be an omnipotent, infallible economic planner. If instead you allow production to naturally follow the availability (or scarcity) of resources, we will get much closer to optimal production in relation to the real demand. The reason for this is mainly because entrepreneurs must maintain a profit margin. In order to do so, each company has to weigh demand, costs, labor, and production capacity, and do this weighing constantly.

The free market is a natural, organic delegation of what we all want: a vibrant, mostly stable, productive economy where everyone's standard of living rises with each new innovation and each increase in efficiency.

Relation between savings, production, and consumption

Video:

http://mises.org/media/4353/Austrian-Theory-of-the-Trade-Cycle

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

How an Economy grows and Why

How an Economy grows and Why it Doesn't (relevant to your link)

http://imgur.com/a/zh1s9

watching now

watching now

Phxarcher87's picture

i ust to be so pessimistic before the lord washed my soul.

Then now I sit here and read all these ideas, floating freely in beautiful order. I am so honored to be part in what we all know as right. Our ideas have consequences and i thank anyone and everyone who contributes to changing the ideas to one of freedom, prosperity, non aggression, and free market ideals. Thank you everyone who continues to strive and fight for what is right.

"Whenever you find yourself on the side of the majority, it is time to pause and reflect" - Mark Twain

Phxarcher87's picture

Basic common sense

To get out of debt you do not acquire more debt.

Prosperity and growth will never be possible by simply printing paper.

A group of Free people willing to make voluntary life decisions is always better than 1 individual making choices for hundreds.

Whatever the Federal Government touches it destroys.

You cannot get something from nothing.

"Whenever you find yourself on the side of the majority, it is time to pause and reflect" - Mark Twain

Austrian VS Keynesian Analogy...

I think you are laying out the argument wrong.

Keynesianism isn't about the role of money. It's about the role of the individual vs the role of some top-down authority structure.

And the way to annihilate that argument is this:

Austrian Theory distributes the weight of the economy across the entire economy itself - across all of the participants. And when each participant adds his preference to the pot, the result is balance.

Like our bodies. The maintenance of our bodies is distributed across trillions of individual cells each adding their needs to the whole.

Top-down theory is unnatural, results in INEQUALITY, INEFFICIENCY, and tends toward CORRUPTION. It's as simple as this: Would you rather have a KING or a DEMOCRACY ? (I know a democracy allows for the possibility of a majority to out-vote a minority. no analogy is perfect)

Have you ever heard of the WAZE App for iphone or android ? Each driver adds his Point of View to the entire map and the result is a well-functioning "organism" (program) (economy)

Wow, good comparison between

Wow, good comparison between the human body and "market" feedback of individuals/cells; I can't believe I've never thought of it that way (being in the medical field, myself).

Adding to this analogy, a top-down situation would be living in a cold environment--sure, you can survive in a cold environment, but it is not an ideal place for the human body to function. A human has the choice and authority to decide to live there, but the human body will have to work harder to make it survive; your body will divert important resources to maintain the production of heat at the expense of other bodily functions. You will expend more effort in keeping your feet and hands from being frost-bitten than if you lived in a temperate climate--that extra effort could have been used to acquire more food or build onto your house.

Phxarcher87's picture

homeostasis

Would you consider homeostasis a simple process?

And who invented homeostasis because whoever invented homeostasis is pretty much responsible for the creation of free market theory.

"Whenever you find yourself on the side of the majority, it is time to pause and reflect" - Mark Twain

Yes. By way of example...

Government may create a demand for something nobody but it wants or needs. Or it may expend resources on something totally useless to anyone. The Government orders thousands of armored vehicles and the material and labor and capital needed to produce those tanks are gathered and the armored vehicles are assembled. These then are parked in a desert in California north or Reno, Nevada. "Demand/Consumption" of the tanks stimulated the production and supply of tanks. The tanks themselves benefit nobody. They are sitting in the desert.
The materials and labor to produce the tanks could have been used elsewhere in the economy. How was the tank production financed? People who want other things are taxed. The tax money is transferred to the people who made the tanks. They might as well just been given the money for doing nothing because what they did for the money benefits nobody. In fact it would have been better because the resources now sitting in the desert could have been used to make cars or air conditioners or any of variety of things people can actually use. According to Keynes, the tank builders will now take their paychecks and buy ice cream thereby stimulating ice cream production. Well, what about the people who were taxed to pay for the tanks? Don't they like ice cream?
All Keynesian stimulus does it distort the economy. It creates economic bubbles. It transfers wealth and resources to areas where they are not needed. One can say "consumption" is stimulated, but the question that is not answered is "Consumption of what?" Creating demand for something that is otherwise not needed is counterproductive. Let's say the government orders 500 tanks and the labor and resources are recruit to build them. It stimulates the economy as a result. The tanks get built. Now what? The stimulus ended. There is no way out. If the economy is dependent on artificial stimulation the distortions and misallocation of resources has to be perpetual or the reorganization and reallocation of labor and material the government was hoping to avoid will now occur. The end is ultimately and unhappy one. Everyone will be busy making things nobody wants and are taxed to keep themselves employed. Then it all stops. The Soviet Union died making weapons that did not work and uncomfortable shoes nobody wanted to wear.

[F]orce can only settle questions of power, not of right. - Clyde N. Wilson

A very good point against Stimulus

Basically, that's the broken window fallacy...that artificially making people buy a good or service they don't need, in an effort to create growth or jobs, is worse than letting people buy the goods or services they DO need.

That's a very good argument against Keynesian style stimulus.

But I want to take it even further...

I'm saying that even if the buying activity (consumption) is done completely freely and the purchased goods ultimately ARE wanted by the consumers, I still maintain that the consumption of those goods does not stimulate the production of them.

Our ability to produce more does not come from increased consumption, but by getting better at production, which takes time, work, research, and technology...and under-consumption.

.

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"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Does this make sense:

If #1 is true, then the big obstacle standing in our way of prosperity is getting people to want more stuff (or better stuff). Once we accomplish that, production will "fall into line" and make the stuff.

If #2 is true, then the big obstacle standing in our way of prosperity is figuring out how to make more/better stuff. Once we accomplish that, we can then enjoy the more/better stuff.

It should be self-evident to anyone that understands human nature that #1 falls flat on its face, and doesn't describe why people have different levels of prosperity over time or in different parts of the world. We don't have more prosperity today than 100 years ago because we are better at wanting stuff, we're better at making stuff.

Does that make sense to anyone?

SteveMT's picture

Money has to be saved before consuming or producing anything.

In other words, you need a checkbook before making or consuming. Keep it real simple with Keynesian Theory. You cannot continually borrow money to get out of debt. It's impossible. If you are in debt, you can neither consumer or produce. Believe it.

For a Good Start, use the GDP formula

I'm no economist but I've heard about Keynesian Economic theory changing the gross domestic product (GDP) formula. The formula has "Government Spending" ADDED into this formula.

See the link here: http://en.wikipedia.org/wiki/Keynesian_formula

Obviously, Dr. Paul and Peter Schiff discredit this formula. Government Spending technically could add to GDP if we didn't have a shadow gov't, military industrial complex and corrupt politicians. Or rather, we actually had an honest gov't. But instead, it simply misallocates resources that could be used elsewhere.

The simpler GDP formula should be calculated by subtracting total imports from total exports. This is a quick way to break down a Keynesian. For example, imagine using the Keynesian GDP formula for and individual's finances, by assigning a "spender" to that individuals budget and then adding those expenses back into the budget. It simply doesn't make sense. Hope this helps!

Easy......

Production ADDS to the general wealth "pie". The fact that production makes us richer is self-evident, and easily understood by the human mind.

Consumption SUBTRACTS from the general wealth "pie". The fact that consumption makes us poorer is also self-evident, and easily understood by the human mind.

These are absolute positions, meaning that there are no exceptions. Any exception that a person "thinks" he may find is always a result of ignoring the "unseen", and usually involves an appeal to emotion.

Increasing demand doesn't directly increase supply. Increasing demand of a product( or all products)will push prices up, making production more profitable. The high profits entice new competition into the market. IT IS THIS COMPETITION that increases production, improves quality, and lowers price.

....And, of course, if these potential newcomers CONSUME all their wealth, they have nothing SAVED to invest in said COMPETITION, thus, they can't increase PRODUCTION, no matter how high DEMAND is.

Keynesianism can't happen in the real world. You can't "overproduce" things that people want and are willing to work for. You can "malinvest" and make things that people DON'T want to work for.

As far as I can tell, this proves that keynsianism is backasswards, and the Austrian school still holds the banner of "causal-realist economics".

"I do not add 'within the limits of the law,' because law is often but the tyrant's will, and always so when it violates the right of an individual."

Generally, I like it.

The whole claim I'm trying to refute is "consumption causes production". I'm not sure you refuted that claim.

Someone who believes that consumption causes production will simply agree with your argument and come back with: "consumption by itself subtracts wealth, but it also causes an increase in production which will re-add that wealth back."

Broken window fallacy...

Like others have said, you just point to Hazlitt's book.

In the part in quotations, you stated that the wealth will be added BACK.....

...it's only a small mental step to realize that putting consumption before production leaves us constantly trying to make up for the loss.

...Once again proving that consumption CANNOT be the driving force behind INCREASING wealth and prosperity. If wealth is consumed, where does the additional wealth needed to expand production come from?

...It doesn't come.

First, you must want,
then, you must have an idea that will satisfy it,
then, you must save something towards that idea,
then, you must invest in that idea,
then, you can produce something that satisfies that want,
and ONLY then can you consume that something, and you want is satisfied.

It can only happen this way. Trying to take the path backwards will, inevitably, produce backward results(economic decline).

Empirical support: With the internet and google, all technology is available to anyone with access, yet there are places in the world that have living standards that are DRAMATICALLY lower than the U.S. Why, when these places have the same access to technology as we do, are they still poor? Why can't they just build, buy, use the same equipment, and have access to the same stuff?

Well, these places have very little SAVINGS going towards increased PRODUCTION, because all wealth is CONSUMED.... and consumption drives them exactly where it logically goes.... keeping them poor.

"I do not add 'within the limits of the law,' because law is often but the tyrant's will, and always so when it violates the right of an individual."

If consumption is the same thing as demand.

The question is the demand for what and by whom?
If the government demands an aircraft carrier and it robs the economy of material that could have been used to make metal lathes, the consumption of the aircraft carrier caused the production of an aircraft carrier, but that pushed aside the consumption of machines that could be employed to make metal parts that go into things people really want.
The key to economics is the unseen. People see the ship, but the do not see what was sacrificed to produce it.
There is no lack of demand. The fundamental rule of economics is scarcity. A resource goes to the highest bidder. If resources are unemployed it is because they are too expensive. Teens remain unemployed because minimum wages are too high compared to the value of their labor. Gasoline stations had grease monkeys who would pump your gas and check the oil and tire pressure for you. They would clean your windshield. The minimum wage killed those jobs.
It was not because windshields no longer get dirty or tires don't leak now.

[F]orce can only settle questions of power, not of right. - Clyde N. Wilson

Non-Interventionism Lets The Market Send The Proper Signals

If you create artificial demand by, say, lining everyone's pockets with printed money; businesses get false signals and accordingly make poor decisions in production, hiring, investment, and every other facet of business.

That's why the bust will inevitably follow the boom.

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"Bipartisan: both parties acting in concert to put both of their hands in your pocket."-Rothbard