India: An Economic Reform Case Study

A look at the work of Indian economist and student of Hayek, B R Shenoy...

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Is Europe Repeating China’s 1911 Error?

A century after bailing it out, Europe is asking China for money...

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Default, Devalue or Despair

The likely consequences of Eurozone bankruptcies...

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Default, Devalue or Despair

The likely consequences of Eurozone bankruptcies...

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The Tragedy of the Euro

Unseen economic effects from the single Euro currency...

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Being, Acting & Entrepreneurs

Entrepreneurship is the foundation of society...

HUMANS ACT and they act purposefully: this is the axiom of action proposed by Ludwig von Mises, teacher of Hayek, writes Toby Baxendale at the Cobden Centre.

From this, Hayek claimed, the whole of economics could be deduced. Because as Mises shows, in order to be, we act purposefully. Not being, we would not act, indeed we would not exist. We act upon satisfying our most urgent needs first, then our second most urgent needs, and so on a so forth, ranking our preferences, with the most urgent needs/demands being satisfied first, the least urgent, and the furthest away in time.

From this hierarchy we derive the law of demand, the downward sloping demand curve, the law of diminishing marginal utility, and on and on it goes. Lord Lionel Robbins in his masterful 1932 book, The Nature and Significance of Economic Science shows in very clear terms how all the laws of economics are derived from the a-priori thought process.

To try to refute it, you cannot, as you act purposefully to do so. Just as Pythagoras's Theorem is implied in the concept of a right angle triangle – and we knew about the concept of the right angle triangle before Pythagoras "discovered" his Theorem – so, too, do the laws of economics flow from the one irrefutable axiom that humans act purposefully. It is a bit like saying Darwin "discovered" the Theory of Evolution, when what he actually did was articulate it and find very plausible data sets to help explain it to the sceptical mind. Evolution was always there.

So what can this Axiom tell us about entrepreneurship?

When we act, we choose to satisfy our most urgent needs first, and we forego other opportunities which form our subjective costs. Action implies a sacrifice: what opportunity you forgo is your cost, and what you hope to gain is more than your cost: this is your entrepreneurial profit. This entrepreneurial profit does not have to be measured in money; it can be the choice between going to the theatre or staying at home and watching a TV program.

The entrepreneur is someone who is good at generating entrepreneurial profit, not only for himself but in the way he/she can help many more others in achieving and consuming the results of entrepreneurial profit. He is more alert at spotting opportunities that will satisfy peoples most urgent needs in quicker and in better formats, and for this he is rewarded usually with more money for his efforts.

According to Jesus Huerta De Soto in his book called Socialismo Calculo Economico Y Funcion Empresarial (1992) – soon to be published in English by Edward Elgar in Association with the IEA, and called Socialism, Economic Calculation and Entrepreneurship – there are six characteristic of the information and knowledge that the entrepreneur captures to use to provide better goods and services to all in society.

#1. Knowledge is Subjective, not Objective & Scientific
I have just watched my local farmer bring in a grass crop frantically in 3 days as he assessed a window of opportunity for him to do so, since rain was coming. He could not send this up to a state planner to make a decision for him – only his local knowledge about this particular time and circumstance, and his informed intuition re the weather could lead to this decision. He has crop that he can sell now. A planner in Whitehall (or Washington, Brussels or wherever) would neither have all the information necessary nor respond quickly enough to make this all happen.

#2. Knowledge is Exclusive & Dispersed
In my farmer example, this knowledge about when to bring the crop in is exclusively his and resides in him alone.  In the same way, knowledge across the whole economy is broken up into little pockets of subjective knowledge held by millions of different people.

#3. Knowledge is Tacit; It Cannot be Articulated
My farmer's knowledge is tacit and in him, yet he probably cannot objectively articulate why he is doing it. Michael Oakeshott in Rationalism in Politics (1962) gave us a very good example of a chef who is after all only following a formulaic procedure of putting together a recipe, so we should all be able to add X of this to Y of that and cook at 200 degrees for 10 mins, but the latent talent and know-how of an uber-chef, such as Gordon Ramsey, will allow him to be a great chef – just as it will enable me, following those exact same instructions, to be a very average cook.

#4. Entrepreneurship is Creative
There is no cost to an entrepreneurial idea, it is created ex novo. Bill Gates, when he created his first operating system, had his vision and his thought process, the idea, and then he got creating.  Profits are thus created new and from nothing.

#5. The Creation of New Information
Each creative new act of entrepreneurship creates new information which is used by others to profit them as well. A new software solution created by the creative minds of Apple alerts all their users to new ways of doing things that benefit them in a quicker, faster and better way.

I recently had a conversation with a potential entrepreneur who has identified an abundant source of farm waste product that could be excellent for fish feed. If his business is developed, farmers will suddenly be made aware that what was once a cost to get rid of this waste product cannot be a source of revenue for him. Thus he will adapt his farming processes to now harvest this waste and costly product for profit. The fish farmers will eagerly await this new source of protein and adapt their newer and better buying accordingly.

#6. The Transmission of Information
Although the price system is objective and allows the allocation of resources, the fish farmer does not need to know all the subjective information of the entrepreneur who has developed the new feed out of the farms' waste, just that he can buy it.  Likewise, the farmer does not need to know the detail of how it is going to be made useful to the fish farmer. All this knowledge is subjective and the briefest communication of it happens to facilitate trade.

Entrepreneurship is the foundation of society in that it insures the co-ordination of individuals' behaviors. Without it, society would not exist. There is always a competitive and on-going process of rivalry and discovery as this society-wide coordination process happens. It is limitless and produces progress if left uninterrupted. It is the single most important process which units society and permits its harmonious advancement.

The division of labor – as suggested by Adam Smith – shows us how, in a pin factory, if people concentrate on certain tasks and specialize, more production happens. This is an objective measure. Underneath this, and prior to it, is the subjective division of knowledge. In-depth knowledge is held in widely dispersed formats, often tacitly, precluding its articulation across society; thus it is impossible for any one person body or machine or government department to know all of this information.

Also, only tiny amounts need to be communicated to make coordination in society possible. So Huerta De Soto introduces a new concept into the body of knowledge concerning economics: the universal division of knowledge that exists as a deduction from the axiom that humans act and takes the subjectivist revolution started by Menger into our very understanding of the division of labor. He also moves man on from being the Robbinsian homo oeconomicus to the homo empresario. Acting man is entrepreneurship.

Once again, Huerta De Soto has given some great new insights into economics in the field of economics. He has built on the shoulders of Adam Smith , Mises, Hayek and Kirzner to great effect to knock the objective division of labor off its pedestal and put in its place the division of knowledge. This is what Einstein did to Newton in physics. Both still have their place, but the latter being of more fundamental importance.

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Gold Bullion or the Pound?

Can the Pound stand up to the reliability and safety of Gold Bullion...

NOWADAYS, DUE to the unstable financial market and meddling politicians, people want to have a regular source of money, but also a stable currency, Says Antonio Pancorbo of The Cobden Centre.

Where can we find good quality money? For centuries, and civilization after civilization, Gold Bullion and Gold Coins have consistently won out in the long-running contest against livestock, grain, cowrie shells, feathers, etc., to find an economic good that people can use as “money” for their trades. Something valuable and stable in its value to organise complex divisions of labour in societies. So if the Pound and the other fiat currencies want to replace gold as money for the next 3,000 years, they had better listen to what this “barbarous relic”, in Keynes’ words, has to teach them.

First of all, no rulers or brilliant minds ever had the great idea that Gold Bullion could play the role of money in society. Instead, they had to accept what people used and agreed to in their trades. In fact, rulers have always hated gold as money because of the power it has taken from them. They tried to bypass the laws of physics and chemistry and create gold from nothing, but the most they achieved was to debase their currencies, a blatant trick that has been condemned since time immemorial.

They also tried to replace gold with something of low value they could control. Something that they could give to people (or force them to accept) in exchange for their properties and labour so they could continue with their grandiose schemes, wars and white elephants. Rulers had to wait until they invented fiat money (backed only by governments’ promises to maintain its purchasing power) for their dreams to come true.

We accept fiat money and the rationale behind it. It is true to say that if central banks print paper money, an economic good devoid of any other utility (except for collectors), this fiat money releases gold from its social function as money, and becomes more available for other purposes. Jewellery, ornaments, medallions and many other beautiful things you can make with gold are, thus, more affordable. However, we accept this rationale with a serious note of caution. Behind fiat monies there are governments historically eager to indulge in public spending and irresistibly tempted to create money by simply running the central bank’s printing press.
If we compare fiat money with Gold Bullion, there are a few lessons that fiat money has already learnt from gold –namely, its physical characteristics. Fiat monies, like gold, tend to be scarce, valuable, divisible, transportable and incorruptible, which makes them as efficient means of exchange as gold.

However, physical characteristics alone were not all that made gold the most efficient means of exchange. Gold production is also limited and not manipulable. To produce this scarce, valuable, divisible, transportable and incorruptible substance it must be mined from the ground, which is a slow, expensive and risky business. In stark contrast, producing fiat money is not a slow, expensive and risky process. It is simply a political decision that only requires an accounting entry in the central bank’s books. This makes fiat currencies political creatures more than anything else, which gives them a nasty taste (except for those in with the political power). And here is where the serious lessons from gold start kicking in.

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The Keynesian Malaise

Can we really borrow our way to recovery...?

ACCORDING to Keynesian Theory, a recession is caused when there is not enough demand "aggregate demand" to soak up all the goods and services in the economy, writes Toby Baxendale of the Cobden Centre.

The way around this, apparently, is to force more consumption.

"Consumption – to (state) the obvious – is the sole...object of all economic activity...The more virtuous we are, the more determinedly thrifty...the more obstinately orthodox...the more our incomes will have to fall...Obstinacy can bring only penalty and no reward. For the result is inevitable."

So wrote John Maynard Keynes in his General Theory of 1936. And this increase in consumption can be done by the government extracting your money and spending it for you by way of a fiscal stimulus. Governments dedicated to the principles of laissez-faire would be better off to "fill old bottles with bank notes, bury them at suitable depths in disused coal mines which are then filled...with town rubbish, and leave it to private enterprise... to (invest in) dig(ing) the notes up again."

"Can American Spend Its Way to Recovery?" was the title to an article written by Keynes in 1934 for a magazine called Redbook.

"Why, obviously!" came his answer. "A man poor can make a nation wealthy."

Once the poor man is penniless, he should borrow so as to continue spending. And if some projects are uneconomical at current interest rates, the rates must be lowered so that businesses pursue them, thus driving up aggregate demand.

The ultimate target rate should be zero.

"I should guess that a properly run community...ought to be able to bring down the....(general rate of business profit and interest) approximately to zero within a whole generation. You should also create money out of thin air and place it in the banks so it can act just as savings would do, then require the banks to lend it out."

In the crazy Keynesian world, there is no appreciation that if you want to purchase something more costly than your monthly income, you should save. Where immediate means are insufficient, debt is always the answer.

The first gigantic bailout, fiscal stimulus, and massive printing money session (aka Quantitative Easing) has all come to pass and the effects are wearing off. The liquid share indexes such as FTSE are falling, as we predicted many months ago. Long ago on the Cobden Centre's site we explained why QE would not work.

Yet the mantra of Keynes and his modern-day followers is that one man's spending is another man's income. Therefore, if we all consume, there will be no recession. The problem with Keynes is he did not have a theory of capital.

To the mathematician Keynes, capital is summed up as the blob called K, a homogeneous blob that can mysteriously change form one thing to another to suit the needs and requirements of the people automatically. He did not consider that during the 1920s, as money was made artificially cheap, borrowers invested in longer methods of production – more capital-intensive methods – to produce goods for which there was no real demand for once the printing presses had stopped producing cheap money. This led to excess build up of capital producing goods no one really wanted. The bust was inevitable

In the current recession, we have postponed the inevitable correction. Our policy makers can take what I call the "Ireland route" or the "Keynesian Malaise route". In case you did not read Liam Halligan's article is this week's Sunday Telegraph, I will quote directly from his wise words:

"Last week, it emerged that the Irish economy has climbed out of recession. New data showed GDP grew by a buoyant 2.7% during the first three months of 2010, reversing a contraction of the same size during the previous quarter. This is highly significant – and not only if you're Irish.

"A year and a half ago, Ireland endured nothing less than an economic implosion. After a decade of rampant borrowing and spending, the Celtic Tiger was shot between the eyes. The country's runaway housing market and related construction boom turned to bust...

"Ireland's recovery is troublesome for a hard-core of neo-Keynesian economists, those still banging the drum for yet more government borrowing and spending. Such loose thinking is legion – hard-wired into the minds of many. The UK's tough new fiscal measures have been greeted with howls of protests by numerous economists who should know better. Less government spending will make things worse, they say, not better. Yet Ireland shows that if you knuckle down, take the medicine and reassure your creditors, then recovery can be relatively swift."

Earlier in the article, Liam mentions the Bank of International Settlements report, which gives a truer picture of our debt. Even if we accept the UK government's figures of a £900 billion national debt at the end of this year, with GDP projected at around £1.4 trillion and the state accounting for one half of it, this implies a private sector GDP of around £750bn. With interest service alone at £45bn this year, this implies that 6% of all private sector activity is paying our national debt interest service.

In addition to the redemption and ongoing tax extractions, it is mad to go down the Keynesian Malaise path of more fiscal spending and money printing. I vote we go down the Irish route as quickly as possible. But the great snake oil salesman himself said:

"The duty of ordering the current volume of investment cannot safely be left in private hands."

This is from Keynes' General Theory of Employment, Interest & Money. Now, with over half of the banking sector in the ownership of the state, and lending targets set and politicians in government embarking upon initiatives to "get lending going again", it is no big step to see that soon the state will become the allocator of capital in the economy.

So watch out for this next step in the tragic mess we are in.

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Gold as Money: Exchange & Value

Whether Gold or not, money's role as a medium of exchange relies on its longer-term value...

SUBJECTIVE decisions about how useful different goods are – made by each and every individual – determine the value of those items, writes Toby Baxendale, founder and chairman of the Cobden Centre.

The utility of money is determined by its prospective use as a medium of exchange. This is interesting as the subjective utility is determined by its objective exchange value – the only product whose price is determined in such a way.

If a good such as tea did not have an objective exchange value, it would have no price and would thus be free. Money without an objective price would be worthless as no one could use it for exchange. If it cannot command any purchasing power over others goods and services, there is no point to it.

Increases in the supply of goods and services are generally seen as social progress, as people have more of the things they value. Production and consumption happen and more satisfaction for more people happens in this capitalistic process. Increases in money however, whose only purpose is to exchange for more things, does not bring about more production or more consumption, as it is solely used for the purposes of exchange.

This would imply that there is always an optimal amount of money to perform the function of exchange in an economy. Adding more of it does not confer an increase in social benefit, unlike more goods and services.

When a government prints money and places it in the economy, it weakens the ability of the purchasing power of money to command what it previously did in terms of goods and services. It does not in itself produce more goods and services.

So if money were rooted in Gold – as it historically was – this would imply that an increase in gold supply would be of no benefit to society whatsoever. However, we should be aware that gold has other use values, in industry and in jewelry. So social benefit is gained by Gold Mining.

A gold miner may produce his product and sell it to industry, jewelry shops or central banks. The first two have use value. The latter has exchange value only. However if there is more demand to facilitate greater exchange, people will willingly swap real goods and services to buy more of the commodity of money to facilitate more exchange. Something that the person or institution values less is exchanged for gold, which the gold miner values less than that which is exchanged. An exchange of something for something happens.

Therefore we can conclude that with the supply of gold, we only see a gold mine providing a very useful set of services to facilitate peaceful indirect exchange between consenting adults, metal for industry and metal for jewelry.

Contrast this with a fiat currency, and you have money produced at a whim.

In a simple economy, with two people bartering their goods and services, no money is needed. When the economy is more complex and there are three people, they cannot facilitate barter. So they invent money and happily exchange gold lumps with each other. Enter the bandit into the economy, whom I am going to call "Gordon Brown", who says to the three people:

"From hence forth, you will accept, by pain of imprisonment, my new money paper notes."

With this new money, he offers me paper in exchange for my saved goods and services. He has achieved an exchange whereby he gets my real goods and services and I get his bits of paper. There has been a one-off wealth transfer from me to him.

Granted, I now have this new purchasing power and can spend on other things. But Gordon has got goods, for which he had done no prior production. This banditry is called "monetising" the debt and is the way we (or rather our governments) do things in most of the world. Contrast this with Gold Mining, when something is produced and exchanged for something else produced. One is honest and one is dishonest.

Besides being a medium of exchange, money is also used as a unit of account. Gold can be kept in bullion and paper claims to it can be granted for ease of use. It can be melted and made into many smaller units, for ease of use. As a store of value, gold cannot be rapidly printed like fiat paper money, and it has a cost to dig out of the ground. So the supply cannot be increased on a whim, and thus it is a good store of value.

I strongly suspect that if the free market were allowed to choose its own commodity to facilitate exchange, it would choose gold.

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Free Trade vs. Insanity

Europe's agricultural policy was dismissed 150 years ago...

FOOD IS on the whole cheap to us as an advanced or even a post-industrial nation, writes Toby Baxendale at the Cobden Centre.

Richard Cobden, with a small group of fellow manufacturers, took on the whole might of the aristocracy in putting forward the case to abolish the Corn Laws and have unilateral free trade.

For those interested in free trade, I have dug out possibly one of Cobden's finest orations delivered in the House of Commons, on March 13, 1845, and described by John Morley as:

Probably the most powerful speech he ever made. Men on the Tory benches whispered to one another, "Peel must answer this." But Peel crushed in his hand the notes he had made and remarked, "Those may answer him who can..."

For economic history buffs, you will love it. For its relevance today, we must remember we have one of the most economically insane policies that covers agricultural production in the United Kingdom and through the whole of Europe: the Common Agricultural Policy.

The Tax Payers Alliance has shown us the utter madness of the policy. Here is part of their executive summary:

With the onset of a recession, family budgets are tight. Despite agricultural commodity prices falling from their recent exceptional high, there are still global concerns at a food crisis. Saving £400 a year, over one per cent of average household, post-tax income, would be a welcome boost for many families struggling in a these tough economic times.

The Common Agricultural Policy (CAP) imposes a significant burden on families both by costing significant amounts of taxpayers' money and by pushing up food prices: The CAP costs the UK £10.3 billion a year, £398 per household. That is equivalent to adding around £7.65 per week to family food bills.

Abolish CAP; it serves no purpose for the public of this nation. Let farmers use cheap food and make cheaper products for the people of our nation. Let farmers invest long term in things that people want to consume.

Cobden's speech, made one full century and a half ago, could be made today by one of our politicians. Sadly, we seldom see such oratory in the House of Commons nowadays.

To enjoy it, read here...