Category: Uncategorized

Why Do G7 States Want Tax Cartel?

On June 6 my good friend and fellow libertarian economist, Dan Mitchell, took on the corporate tax cartel now being formed by the G7 industrialized nations:

Biden’s tax agenda – especially the proposed increase in the corporate rate – would be very bad for American competitiveness. We know this is true because the Administration wants to violate the sovereignty of other nations with a scheme that would require all nations to impose a minimum corporate tax rate of 15 percent.

Mitchell also notes that

the White House openly says it wants to export bad policy to other nations “so that foreign corporations aren’t advantaged and foreign countries can’t try to get a competitive edge”.

This is where the G7 countries come into the picture: Canada, France, Germany, Italy, the U.K. and the United States have indeed agreed to form a tax cartel. Its purpose is, simply, to set a floor for the taxation of corporate income; although it is unclear how they intend to enforce the cartel, the mere fact that it now exists is a significant change in tax policy – and it is not for the better.

But it doesn’t stop there. What we have just seen is only the beginning. The OECD, an international so-called think tank in Paris, has been trying to create a global tax cartel for at least 20 years. For just as long, Dan Mitchell has been leading the fight against this cartel; we all owe him a thank you for the fact that this cartel – the “OPEC for politicians” as Mitchell calls it – has taken this long for the first part of the tax cartel to form. But once we have placed gratitude where it belongs, we also need to keep in mind that the next step for this cartel is the personal income tax. In all likelihood, other taxes will follow: sales taxes, the Value Added Tax, excise taxes, property taxes, wealth taxes, death taxes… the possibilities for a global tax cartel are endless.

They are also much more likely than we would like to believe. The only thing more persistent than the tax-cartel efforts by government interests across the planet are the terrible economic consequences that the cartel will inflict upon us. With the G7 countries now taking the first step toward formalizing what the OECD and other interests have been fighting for over the past couple of decades, we better bring ourselves up to speed very quickly and line up behind a frontline fighter like Dan Mitchell.

One of the key aspects of this tax-cartel campaign is the reason why it exists in the first place. Prosaically, we can refer to it as political greed or a government power grab, but that would be to under-estimate the determination behind the cartel. The idea of a global tax cartel saw the light of day about the same time as the major industrialized welfare states in the world began to sink into permanent budget deficits. This happened during the 1990s but became more pronounced in the lead-up to the constitution of the European Union and the formation of the European currency union. Table 1 reports the fiscal balance of the consolidated government sector in 27 EU member states. The numbers indicate the percentage of spending that was funded by deficits; red, of course is a deficit. Countries whose names are marked in red did not see a single year with a budget surplus:

Table 1

Source of raw data: Eurostat

It is the persistence of budget deficits – which of course the United States government is all too familiar with – that drives the tax cartel. Those deficits, in turn, are caused by excessive government spending.

Now, if the story stopped here, it should not be too hard to convince democratically elected politicians that it is time to reduce the size of government until spending is aligned with revenue. However, the spending that drives the deficits is not just any type of spending: it is ideologically driven and manifests itself in the welfare state. This spending, which totally dominates government outlays in modern, western economies, aims to redistribute income, consumption and wealth between individual citizens.

Economic redistribution, plainly.

Figure 1 reports the share of consolidated government outlays that went to the welfare state in 13 European countries from 1995 through 2017. The selection of countries is based solely on the availability of relevant data: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Sweden. In the aggregate, the governments in these countries use more than 71 percent of their appropriations for the purposes of income redistribution:

Figure 1

Source of raw data: OECD

In other words, at the end of the day the tax cartel that is now emerging under the banner of the G7 countries, is in reality a welfare-state cartel. It exists to secure as much tax revenue as possible for governments that want to take from Pete and give to Paul.

In coming articles we will examine this political cartel in greater detail. Until then, make sure to subscribe to our Economic Newsletter and get our weekly Stagflation Updates in the bargain!

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Economic Newsletter 24 2021

In this week’s issue of The Liberty Bullhorn Economic Newsletter we report the Consumer Price Index figure for April and what it means for our economy. We also point to some good news in private workforce compensation.

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Say vs. Keynes: Part 2

In the first part of this article I explained how Say’s Law is illogical and cannot function unless we assume away time itself. In this part I am going to explain how the alternative, Keynes’s Law, works and how it, unlike Say’s Law, is the realistic basis for economic analysis.

Since the key problem with Say’s Law is its reliance on logical time, in other words a de-facto elimination of time itself, Keynes starts with replacing logical time with historical time. Also known as sequential or discrete time, this concept of time is far from as fancy as it sounds. It simply means that we start our economic analysis by recognizing reality as it is:

  • Economic decisions are made in sequences where one precedes the other; and
  • Every economic decision today is based on information asymmetry, where we know less about the future than we know about the past.

It is this asymmetry that Say’s Law is trying to ignore, but Keynes recognizes. He made valuable contributions toward our understanding of the implications of historical time, but the most pertinent one is captured in his concept of uncertainty. Since the future has not happened yet, we have not way of knowing what it will look like unless we establish predictable conditions for future economic activity.

What does this mean? Suppose you wake up tomorrow on another planet. You know nothing about who you can trust, let alone how to interact with anyone. You don’t know how to get food, shelter or other necessities. Your future survival is genuinely uncertain; normally you could just extrapolate your past experiences, relying on the repetition of successful interaction from the past. But you can’t do that now.

This situation, while stylized and empirically unrealistic (I don’t think any of us will wake up on Hoth or the Klingon Homeworld any time soon), gives us a fair idea of Keynes’s concept of time and its inevitable companion: genuine uncertainty. But it can also be applied in a more realistic, everyday context. Here is how, and how this concept of uncertainty makes Say’s Law unworkable.

To reduce uncertainty about tomorrow, we build, so to speak, points of confidence in the future. We enter into agreements with people that hopefully will result in a gainful exchange of resources. I agree to do my neighbor’s taxes while he shovels snow off my driveway. If we are both happy with the exchange we decide to repeat it next year, or to agree on other gainful exchanges on a more frequent basis.

We have actually institutionalized the repetition of successful trade. Every retail store is an organization that reduces uncertainty and increases our confidence in the future. A mortgage payment is another example: we can set the terms we want for a regular expense for a considerable period of time into the future. An employment contract works the same way, setting terms on which a person can reasonably predict his future.

There are countless examples that in the same way make our future predictable: everything from street names to our Constitution serve the purpose of reducing uncertainty and improving the confidence with which we can go about our daily business. Taken together, all our economic, social and cultural conventions, habits, contracts and institutions create reference points in the future, thereby actually creating the future.

But how does all this relate to Say’s Law? It centers in on product prices. Under Say’s Law – and all mainstream microeconomics – prices are flexible, adjusting instantaneously to shifts in the market. When there is a slump in demand for a product, the price falls immediately until it brings supply and demand back in equilibrium, or vice versa for an increase in demand (with corresponding changes, obviously, in response to supply changes). The problem with this view is that it allows for a scenario where you wake up tomorrow morning and every single price that you encounter, from the gas pump on the way to work to the wage you earn, has changed radically overnight. Everything you thought you knew about how to plan your finances, be it as a household or as a business, is obsolete and irrelevant.

As mentioned, Say’s Law addresses this problem by simply assuming that you will know, the night before you go to bed, exactly what those prices will be. How you know it remains an enigma; it is just axiomatically stated that we all have perfect foresight of tomorrow.

This is, of course, a convenient way to protect a nice theory from a not-so-nice reality. It is, however, not a convenient way to start a foray into realistic economic analysis. For that, we have to rethink that market adjustment process in response to declining sales, where Say’s Law predicts a fall in the price. To do so, let us go back and remind ourselves of the single most important passage in Keynes’s General Theory of Employment, Interest and Money (1936, ch. 16):

An act of individual saving means – so to speak – a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any other specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, – it is a net diminution of such demand.

Say’s Law responds to this decline in demand by saying that restaurants and their patrons will agree on a price tomorrow, today. That price is known to everyone today, as they go about and plan their business today, for tomorrow. Say’s Law also prescribes that if there is a net decline in restaurant business, there will be an increase in the business of doing something else in the economy: the net reduction in dine-out spending comes with a direct promise by restaurant patrons to spend their money somewhere else in the economy.

At no point does the economy as a whole skip a full-employment beat.

Keynes, on the other hand, refutes the idea that the decline in spending in one market automatically means the increase in spending in another market. His refutation is based on his concept of time and of uncertainty, its inevitable companion. In the scenarion he lays out in the quote above, the decision not to have dinner today is motivated not by changing preferences where the consumer prefers to buy something else instead – as would necessarily be the case under Say’s Law – but by the consumer being less confident in his ability to manage his finances in the near future. He prefers to keep more cash on hand.

The reasons for his weakened confidence are important in a broader context, but not in order to understand the mechanics of Keynes’s Law and how it contrasts to Say’s Law. Given a weakening in consumer confidence, there is less money spent in the economy as a whole. Neither restaurant owners nor other businesses will respond by immediately cutting prices; their prices represent confidence in the sense that they can plan their finances from one day to the next, from one month to the next. A price cut upsets their short-term financial planning: their bills, from food supplies to wages, all come in fixed-price format.

A fixed price is also a reference point for those patrons that still frequent the restaurant. While they would certainly appreciate a price cut, they also appreciate a price that remains fixed in both directions: a price that changes frequently in response to changes in supply and demand eventually becomes unpredictable. Where fixed prices are a bulwark against uncertainty, flexible prices are a venom for confidence.

This is not to say prices rigidly remain unchanged. Marginal adjustments take place all the time, but they are minor exceptions to the major trend of price stability. However, it is also important to recognize that even if prices did fall in response to an uncertainty-driven decline in consumer spending, it is by no means a given that consumption would pick up again. As I demonstrated in my own study of consumer confidence and price stability, it is practically impossible to identify price adjustments that would accommodate a rise in uncertainty and still be palatable for price setters, i.e., businesses who have fixed-price bills to pay.

It takes a recession to set price changes in motion at any macroeconomically meaningful level. However, when those price changes occur the factor determining the rise in economic activity is whether or not employers have experienced a decline in the real wage. If their labor costs have fallen enough to raise revenue per hour worked, they will summon the confidence needed to again expand business activity and payroll.

In practice, a decline in the real wage does not have to appear as a strict adjustment of prices, i.e., per-unit sales revenue vs per-unit labor. All it takes is a rise in revenue from either higher prices or increased productivity. Contrary to what Say’s Law predicts, a rise in the real wage at the bottom of the recession would increase costs for businesses and thereby delay the recovery, or even aggravate the recession.

We discovered the flaw in Say’s Law when we sequenced it, finding quickly that it does not work under historical, or discrete time. By the same token, Keynes’s Law shows its prowess under sequencing:

  • A decline in consumer spending depressed business sales;
  • Businesses largely maintain prices in order to maintain, short term, the predictability of their own finances;
  • All other things equal, any price adjustments made have to result in a decline in the real wage before businesses are motivated to increase activity and expand payroll.

It is not possible to predict with any precision how long a recession will last when it begins. Generally, it is a good rule of thumb that an organic recession – not one caused by an artificial government-imposed economic shutdown – lasts for 18-24 months. However, they can last longer, driven exclusively by an adverse shock to confidence in the economy. The reason is to be found at the microeconomic level; contrary to what some of Keynes’s critics suggest, he was very well aware of microeconomics.

The problem for many of Keynes’s critics is that they adhere ot the fallacy that microeconomic behavior, i.e., decisions made by individual economic agents, is driven by a rationality that will always result in full employment general equilibrium at the macroeconomic level. This is not at all the case: as Keynes explains on at least three occasions in the General Theory, actions that are perfectly rational for the individual in pursuit of goal X, may very well result in non-X happening. If it is rational for all consumers to decide to cut spending today so they will be better off tomorrow, they may all find themselves worse off tomorrow.

Say’s Law proponents would suggest that if only they all had perfect foresight, they would know that it is better not to act in pursuit of X, or to anticipate non-X as the inevitable result of X. However, that assumption is premised on the existence of logical time as opposed to historical time. Tomorrow does not exist today; when our knowledge of tomorrow turns out to be wrong, we already have proof that we do not have, nor can we achieve, perfect foresight. But even more so: to realize that the pursuit of X will result in non-X, we all need to beat the cat-and-tail game I discussed in my book on prices and uncertainty. To get the knowledge that everyone else is going to pursue X, we need to gather information about what everyone else is doing; once we have done that, we adjust our economic plans accordingly. But since everyone else has done the same surveys, they now change their decisions as well. Our knowledge of their behavior is now obsolete and we have to do the same round of information gathering again.

The cat tries to catch its own tail, but every time he tries the tail moves.

In other words, some rational behavior leads to an irrational outcome, precisely because time is historical and not logical.

Keynes’s Law explains recessions, even depressions. At no point in his scholarly work – and certainly not in the General Theory – does Keynes say that government should play a regular role in the economy. The only role he assigns to government is to play an active role in moving the economy out of a depression – not a regular recession.

I wish that Keynes’s critics would be as interested in reading Keynes as they are in reading Hayek or Murray Rothbard. Maybe then we could actually summon some forces among conservatives and libertarians to get decent, workable economic reforms done to reduce the size of government, phase out the welfare state and restore the full force of economic freedom to our economy.

Click here for Part 1.

Stagflation Update

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Say vs. Keynes: Part 1

When I was an undergraduate in economics I had a professor – to use the term generously – whose ignorance of even basic economics was overshadowed only by his arrogance in what he claimed to know. We students lost faith in him so fast that after three classes about 80 percent of us spent the time in the library instead, studying economics.

In honor of this professor we invented a term: perbertility. It is a spoof on his name and means, plainly, that the person in question has a job where he is supposed to be an expert, is completely ignorant of what he is supposed to be an expert on, and couples that ignorance with an equal or larger portion of arrogance.

It was comparatively easy to find fine examples of perbertility in Sweden, where I grew up and went to college. It is more difficult to find such instances here in America, primarily because our academic system is semi private and the schools need to operate on a market in order to secure their own future existence. That, however, does not insulate us against perbertility: on rare occasions (though they seem to be growing in number) I run across a perbertile academic.

Today, my Facebook newsfeed offered me a storefront example, courtesy of the American Institute for Economic Research. Now, before we get down to today’s exercise in perbertility I should note, for full disclosure, that I on two occasions have done some work for the AIER, most recently a couple of years ago when I did some blog writing for them. I quit when I was told that the AIER was not pursuing solutions to societal problems – they just wanted to keep a conversation going. I don’t know if this is the case today, but it was certainly an insightful experience in terms of where the American libertarian movement is heading.

The article highlighted in my Facebook feed was a piece called “Say’s Law versus Keynesian Economics” and was penned by Richard M Salsman. It was published in February 2020, and at first I wondered why the AIER suddenly chose to highlight it again. Presumably, the reason is that the AIER is trying to drum up opposition to President Biden’s gigantic budget for fiscal year 2022, and that their approach angle is to tag the budget as “Keynesian”. By their conventional logic, that would allow them to attack Keynesian economics and thereby somehow undermine the economic reasoning behind the Biden budget.

Again, I don’t know for a fact whether or not the AIER has taken this angle, but be that as it may. Their recent interest in telling the world how poor of an economist John Maynard Keynes was is actually amusing in its feebleness – and, again, offers us a good example of perbertility at work.

The current proprietor of this dubitable character trait is the aforementioned, venerable Richard M Salsman. At the time of his article’s publication with the AIER, he was listed as visiting assistant professor of political economy at Duke University. Hence, his reasoning in the article about Say’s Law can be assumed to reflect his scholarship as dispensed in the classroom.

Salsman’s thesis is to educate his reader on what he refers to as the first principle of political economy. This first principle, he explains, is Say’s Law. Formulated about two centuries ago, this law prescribes that supply of goods and services in the economy always create their own demand. Wherever someone adds new supply of something – be it sneakers or college lectures – there will always be demand for that product.

According to Say’s Law, the economy is always going to be in full-employment equilibrium, without any recessions and without any unemployment, so long as government keeps its hands off the economy. The magic that perpetuates this full employment is known as the “price mechanism” and it works as follows:

  • If there is new supply on a market but no new demand, the price falls instantaneously until people buy so much more goods that the market reaches a new equilibrium;
  • The lower price raises real wages and people spend more money across the economy, causing demand for labor to rise;
  • When demand for labor rises and the economy is already in full employment (as it always is under Say’s Law) money wages rise until the increase in real wages has been eliminated;
  • Once real wages are back to where they were before this process started, the economy once again operates at full employment general equilibrium; the only lasting result is a re-allocation of resources from the rest of the economy to the market where supply initially increased.

When explained this succinctly, Say’s Law seems to make a lot of sense. It is easy to fall for its clean simplicity and obvious logic.

The only problem is that it rests on an absurd implicit axiom, one that none of its proponents has ever been able to explain. To get to it, let us walk through Salsman’s AIER article and its attempt to make a passionate case for Say’s Law.

Salsman starts off boldly:

Say’s Law is the most important first principle in economics, with innumerable important corollaires and implications; its logic is irrefutable, its empirics undeniable.

And now for the punch line:

Any economist who denies the Law is akin to a physicist who denies the Law of Gravity; an economist opposed to Say’s Law isn’t really an economist, any more than a gravity denier is a true physicist.

With this bombastic opening, Salsman obviously needs to deliver a substantial case for Say’s Law. Ideally, it should be both empirical and theoretical, but since we are talking fundamental economic theory here, a solid theoretical case should suffice.

Specifically, that case must address the absurd implicit axiom. Before we reveal what it is, let us see if Salsman actually brings it up.

His first explicatory foray into Say’s Law brings up its decidedly supply-side nature:

Among the many important implications of Say’s Law is that prosperity and economic expansions are supply-side phenomena, a consequence of entrepreneurs, the profit motive, saving, investment and capital accumulation. Put negatively, “consumers” per se don’t drive economies

It is curious to see an economist put quotation marks around the term “consumer”. But even more so, Salsman owes us an explanation to what would happen to the economy if consumers tomorrow decided to cut their spending in half. A lot of people lose their jobs and the economy is now in a recession. If capital formation drives economic growth, then surely at this point businesses will immediately bring the economy back to full employment by doubling investments – right?

Salsman has an answer to that. It runs along the four points above, which when taken out of their axiomatic context again seem to make perfect sense. The problem, though, is that there is some sort of time sequence needed in order to set in motion and complete this return to full employment. If no such return happens immediately (and by “immediately” we really mean “in an instant”) it is the government’s fault.

Needless to say, you don’t put out a theory as simplistic as Say’s Law without attracting criticism. The first major blow to it came from John Maynard Keynes, whose analysis of Say’s Law centers in on the interaction between prices and wages. His analysis of how wages and prices change, especially in response to a recession, is essential to anyone’s understanding of both Say’s Law and his alternative, sometimes called Keynes’s law: in order for the economy to restore full employment in a recession, Keynes explains, the money wage must fall faster than prices. In short: workers must in the aggregate take a real pay cut. The problem with this, Keynes notes, is that it means there is less spending in the economy, whereupon businesses have less revenue and therefore are less inclined to hire back workers who los their jobs due to the recession.

For Say’s Law to work, the real wage has to move in the exact opposite direction: prices must fall faster than money wages. But if they do, then in the aggregate businesses will lose money if they hire more workers. This loss comes on top of the losses they have already suffered as a result of the recession.

In other words, if we actually try to make a logical sequence of Say’s Law, it becomes a contradiction in terms. The very mechanisms that are there to guarantee that the Law works – the free-market prices for products and labor – and return the economy to full employment, actually guarantee that the Law does not work. Instead, the economy is trapped in a recession.

Keynes goes to great length already in the beginning of his General Theory. By reference, Salsman recognizes this book as Keynes’s cardinal attempt at disproving Say’s Law, yet not with one word does he mention Keynes’s analysis of the price-wage sequence. This is stunning and gives the reader of Salsman’s article the impression that he has never even opened the General Theory.

Instead of trying to disseminate the sequence that will unfold Say’s Law, Salsman resorts to conceptual masturbation. Let us listen to him in steps. First:

Say’s Law holds that supply constitutes demand (not “supply creates its own demand”), with the crucial corollary that aggregate supply always equals aggregate demand. There can never be a deficiency (or excess) of aggregate demand relative to aggregate supply; the two phenomena are the same thing (or “two sides of the same coin”) viewed from different sides.

In other words, the outlays a car manufacturer has while producing a passenger car are equal to the revenue he receives. Not upon selling the car – upon producing it. The instant the car rolls off the assembly line, its accrued costs turn into revenue. Nobody has to buy the car for this to happen. All that is required is that the car is produced.

Sounds absurd? There’s more. Secondly, Salsman states:

It’s misleading to define Say’s Law as “supply creates its own demand” (or, so goes a typical ridicule, that supplying bikinis will create a demand for bikinis, even in Alaska). In truth, newly created bikinis entail a demand for things other than bikinis. There can be a “glut” (surplus) of goods (or money) in some markets (microeconomic), but no “general glut” in all markets (macroeconomic), and to deny this is to commit the fallacy of composition (“what’s true of the parts is true of the whole”).

If the car does not turn into instant revenue for the manufacturer, then everyone who is laid off at the assembly line can immediately – in a split second because there is no time factor in Salsman’s analysis – go sew and sell bikinis instead. Everyone is always employed. And since everyone is always employed, every resource is always utilized. The unsold car is presumably, and instantaneously, dissolved and transformed into a bikini warehouse.

Every worker laid off at the car manufacturer knows immediately, without delay, where there is work to be found and at what wages. They immediately show up there, are hired in a split second and put on payroll.



Production is the creation of wealth (utility) and spending is the exchange of wealth while questions about who earns wealth (and how much – and why) pertain to the distribution of wealth; the consumption of wealth is not equivalent to demand but to the destruction of wealth (utility), the opposite of creating it (production). Demand is not equivalent to consumption; it’s a desire to purchase plus purchasing power (and the latter comes only from the creation of supply, or from the income one is paid for doing so). One cannot demand unless one first supplies (produces) something of value for offer to others in exchange for their goods. Markets are made by producers, not by consumers qua consumers (because consumption is the destruction of wealth, or utility). 

This paragraph is so riddled with illogical cul-de-sacs that it is difficult to capture them all without taking a considerable toll on the reader’s time. Therefore, let us focus on the most essential delusion, namely that spending – by consumers – is “exchange of wealth” but that consumption is “the destruction of wealth (utility)”.

Here, Salsman claims that the consumer acquires wealth – which for some inexplicable reason he equates to utility – by buying a new car. Then, if the consumer consumes the car, he destroys utility. In fact, by Salsman’s standard the economy is better off if manufacturers just produce cars and pile them up in some parking lot somewhere.

I do not know why Salsman would buy a car. I don’t know if he owns one or not. But under the not too audacious assumption that he does, presumably he derives some sort of positive experience from using that car. This experience is referred to in economics as “utility”. In other words, the consumption of the car is a positive experience according to the very same microeconomics that Salsman claims Keynesians are disconnected from. Yet Salsman claims that using a car somehow generates a negative utility experience, i.e., a negative value experience for the car owner/consumer.

It should be noted that Salsman uses the term “consumption” in a way that does not comply with standard terminology in economics. An act of consumption is an act of spending money in exchange for a good or a service; the purchase of a car is an act of consumption. Salsman chooses to call this act “spending”, which is pointless when there is a perfectly established term – consumption – in both macroeconomics and microeconomics. But his terminological confusion pales next to the absurd notion that consumers have negative experiences, disutility, from using the services and goods they purchase.

Why else would they spend money?

Let us also note that Salsman’s tirade about wealth/utility is eerily similar to how a Marxist would apply Marxian labor-value theory. The consumer is irrelevant; the accumulation of labor value in products and productive capital is the only path to prosperity.

If consumption has nothing to do with value creation, then should not the Marxian system work? If free markets operate just like Marxian theory says, then should not the central planners in the Soviet Union have been closer to endless prosperity than the pesky, consumption-based capitalist economies?

With Say’s Law being lost in some crypto-Marxist labyrinth, it is almost pointless to bring up the implicit axiom we mentioned earlier. This is the axiom that holds Say’s Law together. This is the axiom of logical time.

Remember the price-wage sequence we tried to unfold in order to make Say’s Law work? The only way to successfully bring that sequence to the conclusion needed to validate Say’s Law, is to allow each and every economic decision maker to be in possession of perfect foresight: to guarantee full employment at every turn, at every point in time, each worker must always possess perfect information about where there are jobs, and what is needed to get them. He must then be able to skill himself exactly as needed for the job, and to adapt his private finances to that he can smoothly adjust his life to whatever job is available.

This can only happen if people can move back and forth in time, to “trial and error” into the future to eventually acquire all the knowledge about tomorrow that they need in order to make the perfect decision today. The future can in no way be uncertain, or even probabilistic; each decision maker must have perfect foresight, or else Says’ Law cannot generate full employment in the aggregate.

Perfect foresight means that you know everything there is to know for you to make the perfect economic decisions. That, in turn, is equivalent to logical time. Or time travel, if you will.

The opposite of logical time is historical time, which is what our reality is equipped with. Salsman has chosen to completely ignore historical time, which is like a physicist ignoring the Law of Gravity.

In the second part of this essay we will explore how we can make Say’s Law work under historical time. Except, when we do, it becomes Keynes’s Law.

Economic Newsletter 23 2021

In this week’s issue of The Liberty Bullhorn Economic Newsletter we examine the analysis of President Biden’s budget by conservative think tanks. Given that they are thought leaders on the right side of the political aisle, our conclusion is not encouraging for America.

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Biden’s Big-Cost Preschool Plan

As if Biden’s plan for paid family leave was not bad enough, he is also proposing a two-year universal preschool “reform” that will require big, new tax hikes at the state level.

The Biden budget for fiscal year 2022 proposes “universal access to high-quality preschool to all three- and four-year-olds, led by a well-trained and well-compensated workforce”. It is essential to take this proposed entitlement program for what it is spelled out to be, with the key term being “universal”.

Americans in general are not familiar with European welfare-state terminology, but since the Biden administration is working hard to complete the European-style welfare state we have, we must also understand their intentions in exactly that context. Therefore, “universal” means that:

  • it will cover every child in the targeted age group; and
  • it will become mandatory.

At this stage, there is no mention from the Biden administration of making preschool mandatory. This would formally look like an expansion of the program, and it would require them to come forth with the true cost of the program. However, the fact that the term “universal” is not spelled out to mean “mandatory for all” is in itself no reason to assume that it won’t happen. There is this conventional wisdom among conservatives that the welfare state is somehow a static project, not driven to expand over time. It is only when one looks at the ideological architecture – and the international history of similarly socialist welfare states – that one sees the underlying trajectory of structural growth.

What this means, plain and simple, is that once the preschool program is established, it will grow and expand – just like Medicaid has. And just like Medicaid back in the day, the now-proposed preschool program starts off as a limited offering with only a minor fiscal footprint. This is a tried-and-true tactic from the left: it is always easier to lure Republicans into accepting a new entitlement program if it looks small to begin with. People on the right side of the aisle are, namely, prone to believing that every new entitlement program will always be small, that government never expands, and that when it does all you need to do is cut taxes.

In the real world, where taxpayers live and where the left builds its socialist welfare state one entitlement program at a time, we have to assess the cost for every entitlement program based on the promises it makes. The goal of the left is, namely, always to expand their spending programs up to the point where they deliver on every single one of their promises. Therefore, when we want to see the likely cost of this program, we have to assume that all children aged 3-4 will be enrolled in the Biden administration’s proposed “universal” preschool.

The total amount of kids affected by this program depends, of course, on annual birthrates. Recently, births have dipped below four million, but assuming that they will climb again as memories of the 2020 economic shutdown fade into history, it is reasonable to assume that over time a total of eight million children will enroll in this preschool program.

What would the cost be to provide preschool to eight million kids? There is a great deal of variety in different assessments (none of which is included in the president’s budget) but a conservative estimate would place the cost at 50 percent of the cost of putting one child through public K-12 education. Based on Department of Education data we can expect the average K-12 student to cost taxpayers $14,784 in 2022.

If eight million children enrolled in preschool that year, and if we divide the K-12 per-student number by half, we get a total cost of $59.1 billion for this preschool program.

For 2022 the Biden administration has proposed $302 million in appropriations toward universal preschooling. In other words, one half of one percent of the maximum entitlement value that their reform comes with. This is, of course, due to the fact that the administration envisions a gradual phase-in of the preschool program, with full capacity being reached only several years into the future. At the same time, the Biden budget’s own ten-year outlook does not even come close to providing the full cost of a truly universal preschool program: by 2031 the Biden administration’s own proposed appropriations would only cover 38.4 percent of the expected annual cost of universal preschool.

In short: unless the administration expects only marginal enrollment in universal preschool, there is a major gap in the budget. Since the preschool appropriations are supposed to be paid out as federal aid to states, the burden for filling this gap will fall on state legislators.

It is entirely unclear what this would mean over time. The Biden budget offers no formula whatsoever for how the preschool cost be split between the federal government and the states. Since there is also no estimate of a program phase-in, our only reasonable approach to estimating the cost for the states is to run a simple simulation based on full enrollment of eight million three- and four-year-olds. Assuming that:

  • The number of kids enrolled increases by one half of one percent per year;
  • The per capita cost is half of that for K-12;
  • Costs increase by 3.88 percent per year (equal to average annual K-12 cost increases over the past several years); and
  • The increases in preschool funding happen as proposed in the Biden budget;

we get the following state share of costs over the past ten years (with blue representing total costs and green the state share):

Figure 1

Sources of raw data:
White House Budget for FY2022 (Appropriations proposal); Census Bureau (Population); U.S. Dept of Education (K-12 costs)

It is, again, relevant to point out that this entitlement program would start in a fractional format and gradually expand until it is truly universal. As a result, initially the cost for the states would come in a lot lower. However, it is unlikely that the Biden budget paints an accurate picture of the phase-in they have in mind. To see why, suppose the program will split the cost 50/50 between the federal government and the states. Suppose, furthermore, that this formula holds over time and that the per-kid cost trajectory is the same as in Figure 1. By 2031, the “universal” program would still only cover a bit over 38 percent of all kids in the targeted age groups.

In other words, while the cost trajectory in Figure 1 is exaggerated, the Biden budget clearly under-estimates the true cost of its preschool program. The total cost will probably not reach the proportions in Figure 1 in the first few years – though that is likely to happen in the later half of this decade – but it is also likely that Figure 1 is closer to the actual cost trajectory for the whole ten-year period than anything we can derive from the Biden budget.

So far, we have examined two entitlement programs in the Biden budget and we have ended up with annual costs that are hundred of billions of dollars over what the president himself admits to. What else is hidden in there?

CBO: U.S. Debt Default Possible

Back in March the Congressional Budget Office published a bombshell report that got virtually no attention in media. Titled The 2021 Long-Term Budget Outlook, the report actually discusses the possibility of a U.S. debt default.

Their approach to the default scenario is not as blatant as it could be, but runs instead through the somewhat less dramatic term “fiscal crisis”. The choice of focus on “crisis” instead of “default” is intentional, of course, as the default term is basically an economic hand grenade with the pin taken out. However, the term “fiscal crisis” is only marginally less explosive, at least from an international viewpoint.

Americans generally do not understand either term, in particular when discussed in the context of sovereign debt. It is high time to change that, and the CBO report was a valiant but crude attempt at doing that. Having researched and published on fiscal crises for years, I find the CBO approach to the topic surprisingly shallow, given the wealth of literature and experience offered by both the academic and the public-policy community. Hopefully, though, this was only a very first take on the issue, with more to follow.

To the CBO’s credit, the very fact that they dare bring up the possibility of a debt default is a welcome change for the better. Despite scant interest in the matter from media, politics and think tanks, the fact that the question of a debt default is now out in the open as far as government is concerned, makes it possible for us independent analysts to make a broader outreach about it.

The report approaches the debt-default issue with care and caution. The term “default” is not mentioned at all; “fiscal crisis” gets its own section, called “Greater Risk of a Fiscal Crisis”. In this section the CBO attempts to define this term in such a way that it is comprehensible to the lay reader yet precise enough to inspire policy action. They succeed on the former but fail on the latter, one reason being – again – their lack of attention to existing literature.

Here is the CBO definition of a fiscal crisis:

High and rising federal debt increases the likelihood of a fiscal crisis. Such a crisis can occur as investors’ confidence in the U.S. government’s fiscal position erodes, undermining the value of Treasury securities and driving up interest rates on federal debt because investors would demand higher yields to purchase those securities. Concerns about the government’s fiscal position could lead to a sudden and potentially spiraling increase in people’s expectations of inflation, a large drop in the value of the dollar, or a loss of confidence in the government’s ability or commitment to repay its debt in full.

The starting point of the definition, namely the erosion of sovereign-debt investor confidence in the U.S. Treasury, is correct. The effect of confidence erosion is three-fold: first they shift demand from long-term debt to short-term debt; secondly they cease to buy more debt altogether; third, they start selling off Treasurys from their portfolios. For this reason, the signs of a looming fiscal crisis are detectible in the form of a slump in investor demand for U.S. debt, first and foremost for longer debt.

In my Tuesday updates I have tracked the rise in long-term Treasury interest rates and the simultaneous decline in rates on short-term debt. This is a classic first step toward a fiscal crisis. It does not necessarily lead to the other two steps, but it signals the distinct possibility thereof. So far, this first step appears to be the only one the market has taken, but the reason is by no means that investors have regained confidence in the market. On the contrary, it is more than likely caused by a rise in Federal Reserve purchases of U.S. debt, hinted at by the surge in money supply back in March. In other words, the central bank has concealed the first sign of a fiscal crisis, and in doing so postponed the second step.

But it has not eliminated it. The confidence-eroding circumstances on the debt market are still present.

Once the CBO has placed its finger on the starting point of a fiscal crisis, it moves on to explaining its immediate consequences. The mention of inflation is unfortunate: there is no immediate causality between fiscal crises and inflation. The only causal relationship between them is indirect and requires deficit monetization by the central bank. That can lead to an upward adjustment of inflation expectations, but it does not necessarily cause higher inflation in itself.

The real casualty for a fiscal crisis is the interest rate. It surges, often rapidly, as sovereign-debt investors turn their worries about debt default into portfolio action. This rapid and violent rise in interest rates is always disruptive for the economy, causing consumer spending and – even more so – business investments to plummet. In the Greek fiscal crisis surging interest rates and adverse fiscal policy measures caused a wipe-out of two thirds of all capital formation in the private sector.

Which brings us to the crisis response in the CBO report. Here, it becomes clear that the CBO report authors have not done their homework. They claim that policy makers – Congress and the President – “would have several options to respond to a fiscal crisis”. This is patently false: a fiscal crisis deprives policy makers of virtually all policy options, leaving them with only two: harsh fiscal austerity or debt default.

In fairness, the report does mention austerity as one “option”. They don’t use the term “austerity”, the reason being ostensibly that they are unfamiliar with it (again due to laziness on the homework front). They also mention deficit monetization as a so-called policy option, not realizing that austerity is only possible if combined with monetization. In other words, these two measures are in reality one, as evidenced by how the European Union, the European Central Bank and the International Monetary Fund responded to the fiscal crisis in several euro-zone countries a decade ago.

After having mentioned contractionary fiscal and expansionary monetary policies, they point to the the elephant in the room:

A third option would be to restructure the debt (that is, modify the contractual terms of existing obligations) so that repayment was feasible. (Restructuring the debt is generally viewed as less likely because it would undermine investors’ confidence in the government’s commitment to repay its debt in full.) Coordinating fiscal and monetary policies in times of crisis could also present significant challenges.

Again using the Greek crisis as an example – which I have written about primarily in this book from 2014 and this two-part white paper from 2018 – a debt default means that government goes to its creditors and unilaterally tells them that it will only repay a portion of what it owes them. In the Greek case the default amounted to 25 percent of the total debt.

In practice, you cannot do that without risking a complete meltdown of the market for your debt. The Greek government was able to “convince” commercial banks to take a debt haircut because the European Central Bank had made a pledge to buy up any sovereign debt that was denominated in euros, regardless of its credit status, for a prime-rate price that would protect investors from losing money. This, of course, led to a huge expansion of the euro-zone money supply and a complete elimination of the ECB’s last pretenses of monetary conservatism.

A similar default scenario in the United States would have to come with a very close coordination of Treasury and Federal Reserve policies, where the former absolves itself of part of its own debt and the latter promising to cushion the market when the market wants to dispose itself of all U.S. debt. While good in theory, this scenario is almost unimaginable from a practical viewpoint, as it could require a monetary expansion far beyond what we have seen to date.

It is unfortunate that the CBO report only scratches the surface of the debt-default issue, and that in doing so it lacks foundation in existing literature (needless to say, I am far from the only one who has written about this). That said, it is good that they have now allowed the subject out in the open. It is, in a sense, the economic equivalent of what UFO disclosure is to national defense.

As a further point to their credit, the CBO also tries to explain the difficulties in predicting when a fiscal crisis will start. They center in on the ratio of national debt to GDP as the metric that investors will use when deciding whether or not to trust the Treasury with their money:

In CBO’s assessment, the debt-to-GDP ratio has no set tipping point at which a crisis becomes likely or imminent; nor is there an identifiable set point at which interest costs as a percentage of GDP become unsustainable. Indeed, the agency cannot reliably quantify the probability that a fiscal crisis might occur. Thus, the distribution of possible outcomes that CBO considered in preparing its baseline projections does not include the potential budgetary and economic outcomes of a fiscal crisis.

They don’t need to. My book Industrial Poverty accounts in detail for those budgetary and economic outcomes, from Sweden in the 1990s through a number of countries in Europe during the Great Recession a decade ago.

It is good that the CBO recognizes the major difficulties in pinpointing the crisis trigger point. There are simply too few crises to make for a statistically relevant analysis of such trigger points. In addition, the institutional differences between the crisis-ridden countries are prohibitively large. However, experience gives us two important indicators to look out for:

  1. The aforementioned behavioral change among sovereign-debt investors, where they prefer short-term debt to long-term debt and then begin scaling down purchase altogether.
  2. The macroeconomic performance of a country: when there is no outlook predicting any meaningful growth in GDP and therefor in the tax base, while demand for tax-paid entitlements continues to grow, there is a significant risk for the crisis-triggering change in investor portfolios.

This last crisis trigger point is to some degree quantifiable, more so than the debt-to-GDP ratio. We will return to it in a separate article.

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