Sunday, January 29, 2006

Part 25 - Hyperwage Theory: The Reality of the Keynesian Multiplier

Hyperwage Theory Part 25

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Table of Contents

Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Part 8
Part 9
Part 10

Part 12
Part 13
Part 14
Part 15
Part 16
Part 17
Part 18
Part 19
Part 20

Part 22
Part 23
Part 24
Part 25
Part 26
Part 27
Part 28
Part 29
Part 30
Part 32
Part 33


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A PDF copy of the entire book on Hyperwage Theory is available currently for free.

Send an email to streetstrategist@gmail.com for the latest edition.

Want to order other books by Thads Bentulan?

The Misadventures of the Street Strategist Vol 1 to 13
..................................................................................................

Hyperwage Theory
Part 25

Chapter 25: The Reality of the Keynesian Multiplier

The beauty of Hyperwage Theory is that it builds on both Classical and Keynesian economics. From another perspective, it also builds on micro and macroeconomics. Paradoxically, these theories appear contrapuntal to Hyperwage at first glance but once we actually delve deeper into economic and non-economic analysis we realize that the collision of ideas are merely a mirage collage.

Keynesians vs. monetarists
At this stage, we are focusing on the Keynesian multiplier in particular and Keynesian economics in general. Let me warn you that when I was younger, I was more familiar with Milton Friedman and his monetary theory, and I heard of Keynes only as name but never had any inkling as to what is Keynesian economics.

In the aftermath of the 1997 Asian financial crisis, in “A Debate in Hong Kong” I wrote about directing a question at two famous economists whether Keynesian or monetarism is the solution to the crisis. One was Allan Meltzer of Carnegie-Mellon University and author of books on monetarism and a critic of the IMF and World Bank, and the other was Lawrence Summers former US Secretary of Treasury and now president of Harvard University and nephew of Nobel Laureates Paul Samuelson and Kenneth Arrow.

Their opposing answers to my question, which included personal snipes at each other, were quoted in the South China Morning Post the next day and was aired on TV and carried by Bloomberg.

Monetarism and Keynesian economics need not be exclusive of each other. In fact, Keynes achieved an extraordinary feat of including a monetary theory in his revolutionary book The General Theory of Employment, Interest and Money, a feat no other economist has done before.

Poverty
However, before we forget, these theories do not profess solve poverty. And that is why I find these theories very limiting.

In fact, books on economics are about the wealth of nations and individuals. The World Bank and the Asian Development Bank although tasked with eliminating poverty appears to me as being sidetracked by too much focus on microlending, microhousing, microenterprise which to me are lolippop solutions because they affect only a micro number of people.

In contrast, Hyperwage Theory is comprehensive and single-stroke: Give labor its true cost and value. Is this an extraordinary theory? I don’t think so.

Anyway, let’s proceed. I would like to share with you my insights into Keynesian economics which like many other economic theories I have discussed earlier has become a nesting place for Hyperwage. Who would have thought that the obscure theory of labor monopsony, the controversial study of Card and Kruger, the unknown features of asymptotic hyperinflation, and revolutionary thought of Keynesian economics are actually friendly theories and intellectual allies of the Hyperwage Theory? Not to mention the 6-year old Gauss.

Keynesian myth?
If you research about Keynesian economics you will come across economists who are anti-Keynesian. In fact, one respected journal published a paper on the mythology of the Keynesian multiplier.

Now, guys, listen very carefully because what I’m going to say is not found in textbooks but my own insight into this Keynesian multiplier debate.

Some people think the Keynesian multiplier is a myth, an error in concept. Now the Keynesians who used deficit spending to save their economies defend the value of Keynesian economics and impliedly the Keynesian multiplier.

Is the Keynesian multiplier a myth? I daresay no. And I further say that the PhDs who believe it is a myth do not really understand the underlying principle behind the multiplier. And again this reflects their shallow understanding on basic economic concepts such as the Keynesian multiplier.

Let me explain in a roundabout manner because I explain things best this way.

My former accounting teacher found me obstinate when I pressed for an explanation as to why assets = liabilities + capital. I recounted this incident in “The Accounting Wizard” and “Inventing the Street Strategist’s Accounting Codes.”

Many accounting professors simply state that A = L + C without deriving it or without any intuitive insight into it. It was only many years later that I found a better way to derive the accounting equation and now, I think it is the best way to explain it.

Why did I ask how A = L + C was derived? Because I was brainwashed into thinking that all formulas are either postulates which we have to accept; or theorems which we have to derive from postulates or from the laws of nature.

For example, Force = mass x acceleration, Newton’s second law of motion, is based on the laws of nature.

Another example Voltage = Current x Resistance, which is Ohm’s Law (E=IR), is based on the law of nature. Einstein’s E=mc2 is a law of nature.

Thus, if a formula or equation is based on a law of nature it cannot be a myth.

Physical reality
We go back to the question: Is the Keynesian multiplier a myth? In effect, the underlying question is: Is the Keynesian multiplier based on a physical law of nature?

This is probably the first time you’ve heard of this question: Is the Keynesian multiplier based on a law of nature thereby making it a real physical process?

If the answer is yes, it is based on a physical process, then the conclusion is that, no, it is not a myth.

Now that we know what question to ask, how do we answer that question?

Listen very carefully because even the Keynesians themselves are not used to this line of thinking.
Ara earns $100. Her marginal propensity to consume (MPC) is 80%. Thus, Ara spends 80% of $100 on a product sold by Bobby. Ara’s expense is Bobby’s income which is $80. Assuming a constant MPC of 80%, Bobby buys the product of Charlie at 80% of $80. Charlies’ income therefore is 80% of $80 which is $64. Charlie spends 80% to buy the product of Dylan. Dylan’s income therefore is 80% of $64 which is $51.2, and so on and so forth until infinity.

Thus, the total income for the community is Ara + Bobby + Charlie + Dylan + … + until infinity. In amounts, this is: 100 + 80 + 64 + 51.2 + …

Total income
Let’s pause. One man’s expense is another man’s income is another man’s expense is another man’s income and so on and so forth. Is this spending and earning a real physical process? Yes. Is this a myth? No?

Therefore, if we can obtain a formula out this physical process, then the formula is not a myth but a physical reality.

Now, if you have noticed, the sum above is actually a geometric progression with common ratio r = 0.80.

Thus, we have seen right before our very eyes that the spending and earning process follows a geometric progression. And what did we say about a geometric progression with r less than 1? That progression can be simplified as the formula we discussed in the previous chapter.

The sum is S = a (1/1-r). In the above example, a=100, r=0.8, therefore S = 100 x 5 or $500. The multiplier is 5.

What has happened? Think of the economy as a Keynesian magic box. You give $100 to a single solitary person, and out comes $500 for the entire economy. Expense becomes income and individual corresponds to the entire economy.

In fact, it doesn’t have to be called Keynesian, or Kahnian because the process is actually a physical buying and selling process.

Multiplier vs. gravity
What does this mean? The Keynesian multiplier is as physical as gravity; if we refuse to recognize the reality of the multiplier it is just the same as refusing the reality of gravity.
In other words, the discovery of the multiplier by Kahn and Keynes is equivalent to the discovery of gravitation by Newton. Gravity and the multiplier were there physically but only these discoverers formulated the equation for it.

PhDs vs man in the street
Let’s pause for moment. We have PhDs claiming the Keynesian multiplier is a myth and that it is getting something out of nothing. After the explanation above by the Street Strategist, do you think it is a myth?
Well, I don’t think so. In fact, if you call it a myth, for me, it means that you have a shallow understanding of the physical process behind the multiplier concept.

As I have mentioned before, I confess that I didn’t know whether the multiplier is a myth or not. I did not have enough education to decide for myself so I believed the experts, the PhDs.

But when I integrated the concept of Gauss into the imbroglio, I had an epiphany. Eureka! I found it!

Remember I told you that the best way to teach the multiplier is via the geometric progression? Having heard of my explanation, would you explain it another way? That is my challenge to the teachers of economics.

Paradigm shift
If we learn of the multiplier via the physical process of buying and selling and formalized it as a geometric progression then we are assured of certain benefits.

1. We will never question the reality of the multiplier, and we will be amused at PhDs who think so.

2. We see the importance of buying and selling or the process of consumption. Even Keynes considers consumption as the most important factor in the economy. He devoted Chapter 10 of his book to this.

3. We see the paradox of thrift, that the more we spend, the better for the entire economy; and that excessive savings is bad for the economy.

4. We see the benefit of transferring wealth from the rich who simply hide them to the poor who will spend all of them.

5. We see that increasing wages by transferring from the rich to the poor is actually good for the economy as a whole.

6. We see that government can afford to pay hyperwage because the GNI or GNP is bound to increase to an amount determined by the Keynesian multiplier. Which government does not benefit from a greater GNI? And will all the precipitating taxable transactions which government does not earn more?

7. We see that taxation discourages spending therefore it dampens the effect of the multiplier.

8. We see that purchasing power does not operate on a “conservation of money” principle but on a multiplier.

9. We see the Keynesian magic box that transforms $100 of expense into $500 of income and yet, this is not magic but a mathematical and physical process.

10. Hyperwage will exploit the Keynesian magic box. This is a win-win for capital labor and government. Can you offer a more suitable alternative?

Imperfections
I would like to remind you that I have not yet touched on the macroeconomic equation itself under the Keynesian theory. I have only touched on the Keynesian multiplier. I deliberately focused on the geometric process of the multiplier because I realized that even PhDs do not understand the multiplier.
Is the buying and selling a perfect geometric process? No, but such imperfection does not eliminate the geometric nature of the process.

I hope I have justified my circuitous way of explaining a simple concept as the multiplier. Even Keynes in his book did not use the geometric process, which I think was a poor choice of weapons because his own method of explaining allowed his detractors to consider it a myth.

Brown, Wiener, etc
But had he gone by the geometric physical process, who can argue against a process as real as gravity?
In finance, there are many instances where a physical process or a process of nature (natural process) is the basis of an economic or financial formula. Option theory uses the geometric Brownian process. Remember Robert Brown in 1827 and his discovery of particles in motion?

Then there is the stochastic Wiener process in finance theory. There’s the Poisson process and the Bessel process.

At any rate, what I’m saying is that the mind process of the 6-year old Gauss gave me an insight into the Keynesian multiplier which I have never seen before. As such my appreciation of the Keynesian economics has been deeply enhanced.

Insights of a child
But if you didn’t know the link between Gauss and Keynes, don’t worry. I only learned of the linkage last year, although for several years I had this hunch that the multiplier would support rather destroy Hyperwage Theory.

Where do we go from here? Hyperwage will use the Keynesian multiplier as a lever. And since we have already proved it is not a myth, we can proceed to an overview of Keynesian economics. Now, I must warn you that Keynesian economics is not necessary to understand Hyperwage but since most of us do not know classical from Keynesian, I will give an overview of the theory for the same of completeness of our presentation.

I will discuss the minor concept called accelerator effect, the investment multiplier , and the employment multiplier.

That should seal the macroeconomic aspect of Hyperwage. We have already tackled the microeconomics before.

After that, I will summarize the non-economic benefits of Hyperwage, then after than I will provide a Q&A.
Isn’t it great that we are now seeing the end of this series?

(Thads Bentulan, Oct. 27, 2005)
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Table of Contents

Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Part 8
Part 9
Part 10

Part 12
Part 13
Part 14
Part 15
Part 16
Part 17
Part 18
Part 19
Part 20

Part 22
Part 23
Part 24
Part 25
Part 26
Part 27
Part 28
Part 29
Part 30
Part 32
Part 33


To join the mailing list send an email to streetstrategist-subscribe@googlegroups.com

A PDF copy of the entire book on Hyperwage Theory is available currently for free.

Send an email to streetstrategist@gmail.com for the latest edition.

Want to order other books by Thads Bentulan?

The Misadventures of the Street Strategist Vol 1 to 13
..................................................................................................

3 comments:

Anonymous said...

You use HK and Singapore as comparisons. They started out poor, but eventually became rich. Do you really think they got that way by engaging in MLM-style mumbo-jumbo economics (what "Hyperwage" sounds like to me) ?

No, they became wealthy by figuring out how to stimulate production and other forms of wealth creation within their economies. That is the underlying *reality* of it all. All the fancy economic theories will not help if a society does not figure out how to increase production, and "Hyperwage"'s prescriptions and notions on how it will supposedly stimulate productivity do not necessarily follow. They are mainly based on pretty loose assumptions.

Meng Hu said...

That theory is actually flawed.

Hazlitt :

“Let us try to look at one probable origin of the concept. If a community’s income, by definition, is equal to what it consumes plus what it invests, and if that community spends nine-tenths of its income on consumption and invests one-tenth, then its income must be ten times as great as its investment. If it spends nineteen-twentieths on consumption and invests one-twentieth, then its income must be twenty times as great as its investment. If it spends ninety-nine-hundredths of its income on consumption and invests the remaining one-hundredth, then its income must be a hundred times its investment. And so ad infinitum.
These things are true simply because they are different ways of saying the same thing. The ordinary man in the street would understand this. But suppose you have a subtle man, trained in mathematics. He will then see that, given the fraction of the community’s income that goes into investment, the income itself can mathematically be called a “function” of that fraction. If investment is one-tenth of income, income will be ten times investment, etc. Then, by some wild leap, this “functional” and purely formal or terminological relationship is confused with a causal relationship. Next, the causal relationship is stood on its head and the amazing conclusion emerges that the greater the proportion of income spent, and the smaller the fraction that represents investment, the more this investment must “multiply” itself to create the total income!”

“The final criticism of the multiplier that must be made is so basic that it almost makes all the others unnecessary. This is that the multiplier, and the whole unemployment that it is supposed to cure, is based on the tacit assumption of inflexible prices and inflexible wages. Once we assume flexibility in prices and wages, and full responsiveness to the forces of the market, the whole Keynesian system dissolves into thin air.”

Meng Hu said...

Huerta de Soto :

"Indeed the multiplier indicates that any increase in credit expansion will cause a rise in real national income equal to the reciprocal of the marginal propensity to save (one minus the marginal propensity to consume). Hence according to Keynesian logic, the less people save, the more real income will grow. ... Credit expansion will stimulate investment that will drive up the price of the factors of production and bring about a subsequent, more-than-proportional increase in the price of consumer goods and services. Even if gross income in money terms rises as a result of the injection of new money created by the banking system, the multiplier, owing to its mechanical and macroeconomic nature, is inadequate to depict the disruptive microeconomic effects credit expansion always exerts on the productive structure. Consequently the multiplier masks the widespread malinvestment of resources which in the long run impoverishes society as a whole (rather than enriching it, as Keynes alleges). We agree with Gottfried Haberler when he concludes that the multiplier ...

"turns out to be not an empirical statement which tells us something about the real world, but a purely analytical statement about the consistent use of an arbitrarily chosen terminology — a statement which does not explain anything about reality. . . . Mr. Keynes’ central theoretical idea about the relationships between the propensity to consume and the multiplier, which is destined to give shape and strength to those observations, turns out to be not an empirical statement which tells us something interesting about the real world, but a barren algebraic relation which no appeal to facts can either confirm or disprove."

Short-term unemployment can only be eliminated through “active” policies if workers and unions let themselves be deceived by the money illusion, and thus maintain nominal salaries constant in an inflationary atmosphere of soaring consumer prices. Experience has shown that the Keynesian remedy for unemployment (the reduction of real wages through increases in the general price level) has failed: workers have learned to demand raises which at least compensate them for decreases in the purchasing power of their money. Therefore the expansion of credit and effective demand, an action Keynesians supported, has gradually ceased to be a useful tool for generating employment. It has also entailed a cost: increasingly grave distortions of the productive structure. In fact a stage of deep depression combined with high inflation (stagflation) followed the crisis of the late seventies and was the empirical episode which most contributed to the invalidation of all Keynesian theory."

Etienne Mantoux :

"It is altogether reasonable to use a term such as the “multiplier” to express a fact patent to everyone; one may go on to regard the proportion of income devoted to consumption as an independent function; lastly, it is quite permissible to make a certain function, called the “multiplier,” depend by definition on a certain variable called the “propensity to consume.” It is another matter to turn this formal relationship into a causal relationship. The entire demonstration, it would seem, nevertheless rests on this function."