Thursday, September 22, 2011

The Keynesian Circular Flow Model vs. The Austrian ERE

The Evenly Rotating Economy is an important tool used in Misesian economics. Rothbard demonstrated to us in Chapter 5 of his magnum opus MES, that the ERE was definitely a tool superior to the circular flow model of the ballyhooed Keynesian School. The Keyensian Circular Flow Model is blatantly collectivist and coercive in nature, attempting to delineate the flow of goods and services within a system of predicted certainty. It assumes unrealistic and ineffective equations such as Y=C+I+G+NX move in tandem and if properly applied can avoid downturns, or thus save economies from them. The ERE is a basic model that sticks to the fundamentals, while making an assumption of certainty, yet it always holds intact the importance of praxeology. Through this unique Austrian axiom capital theory is illuminated, and capitalism becomes more pronounced and vital within a truly free society. This serves to further derive an explanation of the importance of uncertainty and the entrepreneur. Not only does the ERE trounce the circular flow model, it also allows us to see the unimportance of collectivism in our lives as well as the utter validity of the truly free-market.

The Circular Flow Model is found in every economics textbook taught by statist economists subscribing to orthodox economics. It is a shame they even teach this gobbledygook since it is run amok with coercion and collectivist idiocy. Sadly the first most absurd mistake is to think that Firms and Households are themselves actors. Humans are actors, Firms and Households are entities filled with various actors. Secondly, to homogenize capital indeed leads them to think economies should be planned (refer to figure 41 below to better understand capital theory). To think that GDP properly takes into account the effects of certain distortions to the economy by the government, overlooks the importance of money. Money is central to an economy, not the government and its distortion of it (this distortion I speak of is what they find pertinent when calculating GDP). Sadly the circular flow boasts the ineffectiveness of closed economies as some sort of interesting movement of money from the hands of consumers toward consumption. It is not the interest rate that does equilibrating in this model, but income. The complete lack of respect for the fact that fiat money distorts income and creates the booms and busts in an economy through inflation, allows them the excuse to insert a third party into the mix, their central planner, the government. This entity tyrannically waves a wand and allocates “scarce” resources magically, somehow increasing one coefficient like C and decreasing another like G. Naively G and C can increase together, yet in dire consequence to the long run. The calculation of such coefficients is so broad, numbers get distorted and the booms and busts are never seen. The ineffective system continues to be relied on, because income is more important than the interest rate. The robbery (taxation and borrowing) and coercion, continue without any understanding of the complexity of an economy and the various stages of the capital structure.

Superior to this fallacious model, is the ERE, evidently designed to demonstrate to the Keynesian that even with the assumption of certainty of the future the government creates in their model, the free market still allocates resources better and avoids booms and busts. The ERE is primarily used to distinguish profit from interest. Entrepreneurs earn pure profits when they judge future conditions better than their rivals, while they suffer losses if they exercise poor foresight. In an uncertain world, a man may anticipate that consumer demand for a new product will be higher than others expect, and he will buy the factors necessary to produce the good and reap a much higher payment when he sells the finished product to consumers. This phenomenon is impossible in the ERE, because everyone knows exactly how much each good will fetch from consumers in the future. However, because capitalists advance present money to the owners of factors in order to sell goods to consumers in the future, the capitalists still earn more money from consumers than they had to pay to all of the factor owners who contributed to the production of the good. This excess would appear as a “profit” to an accountant, but not to an economist. It merely represents the interest earned by the capitalists on their invested funds. In the ERE the rate of return (per unit time) will be equal in all lines of production. The most significant fact to remember is that every person is a capitalist, insofar as their bank makes loans with the consent of the storer of money and his savings. Furthermore, to render profit from an economist's point of view, the entrepreneur must use artifice to calculate the market in a manner which renders them not just interest, but further profit outside of the ERE.

Now all this said, Austrians are aware that humans act due to the uncertainty of the future. Man does not know enough about natural phenomena to predict all their future developments, and he cannot know the content of future human choices. All human choices are continually changing as a result of changing valuations and changing ideas about the most appropriate means of arriving at ends. This does not mean, of course, that people do not try their best to estimate future developments. Indeed, any actor, when employing means, estimates that he will thus arrive at his desired goal. But he never has certain knowledge of the future. All his actions are of necessity speculations based on his judgment of the course of future events. The entrepreneur is the driving force of a market economy, and he takes center stage in the ERE. It is the entrepreneur who judges that something is missing in the market, and decides to start a new business or develop a new product. The entrepreneur uses savings (either personal or borrowed from capitalists) to hire workers, rent land and equipment, and purchase raw materials, electricity, semi-finished goods, and other inputs. Thus this uncertainty so dear to the free market, diminished and practically cancelled out by government in the circular flow model, affords us this ordered liberty and plethora of choice in the real world.

Sources Used:

LinkLessons for the Young Economist, Robert P Murphy

Man, Economy and State with Power and Market by Murray N Rothbard

Macroeconomics by Gregory Mankiw (statist economist)Link