Saturday, June 29, 2013

Poor Analogies Can Be Misleading

Stephen Kinsella writes in the Irish Independent HERE 
Austerity is like 'bleeding' the patient – and may be as deadly
In the late 18th Century in the court of Louis XIV, the Sun King of France, a doctor named Francois Quesnay met Adam Smith. Adam Smith wrote the founding text of economics in 1776 and influenced Quesnay as much as Quesnay influenced Smith. Quesnay was a scientist, one of the first of the medical profession who learned from scientific experiment as much as from direct, clinical experience.
Quesnay wanted to bring Smith's ideas and the new scientific mode of inquiry together. The circulation of blood around the organs of the body had just been discovered, and Quesnay wanted to apply this thinking to the economy. He produced the first national accounts for France, then the largest economy in the world, based on the idea that all wealth comes from surpluses generated by agriculture. Money was the blood that flowed around this system and the "pulse"' of the nation, in a sense, was how much output it was producing, or how much people were spending, or how much income people had. Because the economy was a closed system– much like an unpunctured human body – these three things, output, income, and expenditure, would amount to the same thing. Statisticians and economists use these national accounts to measure the value of the economy's output over some time. Things are pretty grim. Retail sales, which were looking up only a few months ago, are falling, no doubt as a result of sustained austerity, which reduces disposable income, and uncertainty surrounding the property tax. …
Three things explain the decline. First, austerity is working: personal expenditure fell by 3pc. This is down to austerity, pure and simple.
Second, credit constraints are biting: Capital investment dropped 7.4pc.
Third, the international economy is weakening somewhat, people are buying less of our stuff, and Ireland's pharmaceutical sector is falling slowly off a patent cliff, so the value of net exports also fell. Amazingly, government expenditure was about the same – no real drop at all.
The story of the Irish economy is one of sustained stagnation in key areas. The pulse is weakening. Doctors in Quesnay's time let their patients bleed to let out harmful "humours."
This weakened and sometimes killed the patient. This was later recognised as barbarism and abandoned. Ireland's policy of austerity is exactly like bloodletting, and history will recognise it is just as barbaric.”
Stephen Kinsalla writes for a general readership, explaining complex ideas developed by economists in language the general public can follow. I have no beefs with that approach at all.  The ability to communicate is too a rare skill and is commendable.
However, without denigrating Stephen Kinsalla’s exposition, I feel I must say something about the relevance and accuracy of his version of from the history of economic ideas. 
Economists rightly esteem Francois Quesnay for his pioneering work.  Adam Smith was much taken with Quesnay and his circle (the Physiocrats) during his visit to France in 1764-66 with the young Duke of Buccleugh (who later played a crucial role in Smith's life). 
Quesnay authored the first “Tableau Economique”, in an attempt to make economics an exact science, which received many adulatory responses from those in his circle and elsewhere, and since.  However, Quesnay did not “produce the first national accounts for France”; his Tableau was purely illustrative of the effects of the arithmetic flow of wealth (nominally illustrated by 2,000 Livres) in the forms of ‘advances’, ‘receipts’,  ‘net products’, ’receipts to the productive classes’ and to the ‘sterile classes’, and the subsequent potential equilibrium, unless too much was diverted from ‘productive activity’ to ‘sterile activity’ (from Alexander Gray’s “The Development of Economic Doctrine”, 1st ed. 1931 – still used as a textbook in Edinburgh University’s Political Economy Classes in the early 1960s).  Quesnay’s Tableau was more about the possibilities of notional accounting for an economy rather than the actualities of today’s national accounts, which measure everything, whereas Physiocratic theory only considered agriculture to be “productive”, while all else, including industry and commerce, were “sterile”, that is, they did not produce anything or add to “net product” because they only consumed “productive” output.
Kinsalla in his article sees Quesnay's early idea of the Tableau as a prelude to 20th-century National Income Accounting practice, which today is a major background theme to much modern political argument over the state of an economy.
Kinsalla’s account of the current Irish economy is used as a criticism of what he calls “austerity and also draws on Quesnay’s work for an analogy between the necessity of the circular flow of blood in the human body and the flow of economic transactions, particularlyvia an analogy between the “barbaric” practice of “bloodletting” supposedly to rid the human body of bad “humours”, which weakened, possibly killing, patients rather then  curring them.
Stephen Kinsalla compares 18th-century bloodletting to “Ireland's policy of austerity” and claims that “history will recognise it is just as barbaric.”   It’s a good debating point for a students’ debating club or an ill informed parliamentary or conference speechwriter. 
Except for one significant fallacy.  Extending, for the moment, Kinsalla’s bloodletting analogy, by considerong the modern practice of blood transfusion from human to human, a practice that saves millions of lives across the world, and without which many patients would surely die if their blood flows out, or it is not generated from within a healthy body for some reason.
That is analogous to the problem with debt when the donors no longer believe that the patient is taking measures to generate the necessary flows between its sectors to earn sufficient to pay back their debts in the original lending agreement as expected, and therefore lenders become reluctant, at first, to continue lending at the original relatively low rates of interest, or worse, lend at all.  Lenders charge penal rates of interest before ceasing to lend at all. In so far as Stephen Kinsalla’s analogy has any relevance to Ireland’s debts, it is surely not “barbaric” for existing commercial lenders to refrain from lending, which surely is prudence – its their money. 
In today’s world, friendly governments or international bodies may step in on a debt crisis on a temporary basis but surely cannot be expected to lend/donate continuous bailouts, especially if the borrower shows no signs of altering its economic behaviour.  
Kinsalla calls this similar to the ancient mistaken medical policy of “bloodletting”. 
I call his expectation that an Irish government should increase its already risky debt-based spending to avert the consequences of the years (decades even) by borrowing yet more money (assuming willing creditors) to spend more borrowed money rather alter its behaviour and earn it from within its national economy and its foreign trade.  In current circumstances, more borrowing is an unreasonable expectation, suggesting reckless prodigals who have learnt nothing from the mess it is already in from living with substantial amounts of borrowed money.  Creditors read Ireland’s national accounts and Irish company accounts too.
Smith reserved his most strident passages in Wealth Of Nations (WN II.iii.1-40: 330-49) for his condemnation of “spendthrifts” and  “prodigals” in an economy, and he praises “parsimony” and “frugality” as safer policies.  I suggest a reading of his strictures is a helpful guide (even if his language seems a trite old-school today in our debt ridden world) and they are a corrective to policies of the ‘when in debt borrow more’ school of politics prevalent on this side of the Irish Sea too.
I think Stephen Kinsalla is too ready to rely on a Francois Quesnay’s analogy, much as I appreciate him introducing the grand-old economist to readers of The Irish Independent, though ‘tis a pity he developed a false analogy.


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