Where Modern Economics Went Wrong

0:00Dr. Mark Skausen is a professor of economics at Rollins College in beautiful Winter Park, Florida. Love it. Can't get enough of going to Winter Park. Mark Skausen worked for the CIA as an economic analysis analyst before starting his own company and becoming famous in the world of investment and financial privacy advising. He's written widely in this area, most notably his complete guide to financial privacy, Policy, The Price Control Game, How Some People Will Profit from the Coming Controls, Closing the Door, The End of Financial Privacy in America, Forecast and Strategies, 100% Gold Standard, The Economics of Pure Commodity Money, The Structure of Production, New York University Press, Economics on Trial, The Lies, Myths and Realities, and I think most recently The Descent on Keynes, a collection of critical appraisals of Keynesian economics.

1:10And you'll find his writings just about everyplace else, including publications of the Ludwig von Mises Institute, so I'm very pleased to welcome Mark Skausen to Auburn University and I look forward to his discussion of how the economics profession has gone wrong. Good question. So the floor is yours. Thank you. Well, it is a delight to be here at Auburn for the first time, and actually what I'd like to talk about is on a more positive side of it, given that I think the profession has gone down the wrong road in many directions, particularly in the way economics is taught at the college level. I'm working on a project right now called Economic Logic, which is a new textbook, an introductory textbook on the college level.

2:04And my approach is very different from the way economics is taught. And so I would like to get your reaction to this. I think in explaining what I'm trying to do in this textbook, Economic Logic, you will see why I have problems with the way economics is presented to students today. Let me first say that I worked a long time on the title to try to get the title right.

2:50I want to emphasize the logical approach that I'm trying to take in economics, and I don't think economics is taught in a logical fashion right now. I think students would have a difficult time predicting what the next chapter will be in in a textbook because they just are not predictable. You don't know whether it's micro first or macro. You don't know when government is going to be introduced. It really is, I think, in a lot of ways a hodgepodge of throwing a little out here, a little out there. What I've tried to do is develop a simple to complex, logical step-by-step introduction to economics that will be presented in a way that students can understand and say, yeah, that makes sense to me.

3:49It's common sense from the beginning to the end. Although the conclusions when you're finished with the course may often be surprising, which which is what happens a lot in economics. So my first part of the textbook, and I've done about six chapters in the book, is I basically rely on a lot of Austrian concepts that were developed from Menger and from Barber

4:52and In my Economics on Trial book and in my Structure Production book, you have four stages of production. You start with natural resources, then you have manufacturing and semi-manufacturing, then you have the wholesale trade marketing part of the business, and then finally you have consumer goods and services.

5:45You notice each stage gets larger as you add value. Now, to me, you see, this is one thing Hayek never did, even though he had the, what you would call a trial, but the steps, if you will, he never identified them, as I've done here, and I've identified these because they fit very nicely into government statistics on, like on prices, you can get commodity price index, you can get a producer price index, you can get a wholesale price index, and you can get a consumer price index. I would like to see government statistics in this area broken down even more, where we'd look at unemployment in the natural resource sector, unemployment in the manufacturing sector, unemployment in the wholesale sector, unemployment in the retail market.

6:38I think you'd learn a lot about the economy by looking at it in this fashion. My first chapter of the book talks about what are we trying to achieve in studying economics? What is economics? I basically focus on the idea of wealth creation and economic growth and improving and measuring standard of living. To me, that approach is much better than the traditional approach of choice and scarcity. I see choice and scarcity as kind of a subset of the whole concept of wealth creation. So my first chapter is focusing on how do we define wealth, what are we trying to achieve as economists in studying wealth creation or wealth destruction, because you can have both.

7:33And then I focus on how we measure wealth, and I measure basically using the criteria Quantity, Quality, and Variety of Goods and Services Standard of Living since 1975. However, when we talk about quantity, quality, and variety of goods and services, almost every student comes to the opposite conclusion that our standard of living has been rising since 1975. So it's a valuable exercise to go through to be talking about how we measure standard of living and wealth and so on. And we can introduce GDP at this This point is a major, not the only major, of wealth creation.

9:03After I've discussed this concept of the goal, we always keep in mind this goal of studying wealth creation, then we talk about how do we achieve this goal. That's the logic of my system. We talk about what the goal is and how do we achieve the goal. That's where I then introduce the four-stage model of the economy, which I've talked about here. I basically show that the four stages of production are necessary in order to achieve wealth. We talk about how natural resources in their natural state are basically unusable. No one can use iron ore or trees and what have you until they go through a whole series of stages of production to achieve that final consumer goods and services where we actually consume these things.

10:08So I introduce everything in terms of pointing down in this direction, in which here's our goal to increase, to achieve wealth creation. And we have these stages of production moving in a timely fashion toward that goal. And as a result, we can achieve our goal, which is the final rectangle. And then I talk about land, labor, and capital. And one of the things that I do which I think is very unique in this approach is I show that the economic system, the market system is actually, we often think of it as a competitive system, a dog-eat-dog world and so on.

10:56What I try to demonstrate with this stage of production model is that it's very much a cooperative system. The Capitalism is a cooperative system, not just a competitive system. It's actually both, but we often forget to develop the cooperative, the voluntary cooperative side of the market system. And so what I point out is that land, labor, and capital must work together at every stage of production in order to get to this final goal of wealth creation. And if they do not cooperate, you cannot achieve wealth creation. So that's very different than the standard neoclassical model of land, labor, capital and they're fighting over this economic pie, which I think is a very bad way to teach economics, but nevertheless is very much a part of standard modeling.

11:54When you don't develop this time sequential stage of production approach, which allows The Theory of Money and Credit

12:30of the Firm. At that point, I do something which I think is very simple but very powerful for students to grasp the relationship between micro and macro. Starting again with this four-stage model, I say, how does the individual company or

13:25The difference is the profit level, assuming this is a profitable firm. Now, to get there, I first introduce the student to a simple income statement. So you see, instead of supply and demand, I'm into chapter probably five here. I have not introduced the supply and demand curve yet. Supply and Demand Curve The basics of accounting and you can explain an income statement very pretty simply and I use a real example I use Microsoft Corporation 1992 to show their revenues, their expenditures including the cost of capital, cost of materials and total inputs and then we have net income or profit listed there.

14:45And on the next page, using a two-stage micro model of my macroeconomy, remember it was four stages, and now I've got it down to two stages, it's basically the same kind of model where I have expenses, revenues, and then you show the profit. And what's nice about this method is that you can then show what companies need to do. You can introduce the dynamics of a market economy. See, the problem with supply and demand curves is that you have a point of equilibrium and it's hard to show why a firm would ever move away from that point of equilibrium when you're at equilibrium.

15:32You know, it wants to just keep producing the wide switches. Why do you want to always cut your costs? Why are you always looking for new products? How can you explain the dynamics of the world economy when you go into any grocery store or any Walmart and you'll notice that they're constantly trying out new products and you're seeing an increase in variety? Why is it that Procter & Gamble produces 60,000 different products? I can show this with this diagram. It's hard to show that with the supply and demand curve. And the way I show it is, we'll say, suppose Microsoft wants to introduce Windows 95 or a new software package. What's the dynamics here?

16:18And the dynamics here is, well, we want to increase revenues and marginal revenues, and to what extent will the marginal cost increase as a result of that? And if marginal revenue exceeds marginal cost, then we have a profitable item and it's worth pursuing. I have arrows moving the expenses and revenues up and down showing the dynamics of the economy and why new products are constantly being introduced. I can also show downsizing very nicely with this graph. Why do corporations go through this downsizing process?

17:06and the whole idea is to cut expenditures more than you cut revenues because if you cut expenditure you're probably going to cut revenues but the question is you can introduce this marginality concept right away at the beginning level again without any discussion of supply and demand you can introduce marginal principles here so I like the dynamics of this very simple model and I go through a lot of different cases downsizing introducing new products and so forth, and why companies have to constantly be vigilant on both their revenue side and their expenditure side. Another thing that's nice about this is that a lot of companies as well as individuals make the mistake of just concentrating on their income side and not their expense side, and this shows why both, kind of like the scissors, you need The Theory of Money and Credit The Theory of Money and Credit

18:34break even and Sears was losing money and what's nice then is you can sit down with your students and talk about well what can each one do to improve their situation and we talk about Sears and how they could go through a variety of choices to get back on an income level. Again I relate the micro to the macro, I say the macro model you notice you have value added at each stage of production and that's what you're trying to do on a micro level Profitability is a reflection of value added.

19:34Introduction to the Concepts of Short-Term Versus Long-Term Profitability

20:04How do I introduce supply and demand using the simple micro-system? What I essentially do is take the bottom revenue side, which basically represents P times Q, to introduce the ordinances of the supply and demand curve, price and quantity. So this is my first dot on a demand curve that I'm going to develop basically showing this is the same thing as the revenue bar in my micro model.

20:58So I've got one dot here with price and quantity for a particular product at Microsoft, in this case Windows 95. And then I talk about the decision-making process of choosing different prices. What if Microsoft raised the price of Windows 95 from $24.95 to $34.95? What would be the results? And so what I basically do is start getting points and you can see how I develop my demand Supply and Demand Curve, then, right from the income statement, the revenue side of the income statement. And then I can do the same thing with the supply curve, that's the idea. So I get a supply and demand curve from the revenue portion of the income statement by using certain assumptions and that way developing an equilibrium point using supply and demand from the Revenue, and then the other thing that I do is, and I need to do that in the next chapter, the next chapter is I then have the cost, so you have supply and demand determining

22:15the price, but then you've got the cost revenue, the cost or the expenditure side which I also put on the supply and demand model, which is similar to what economists do with the the average cost curve and the marginal cost curve. But I think that's an important principle to add that cost figure into the supply and demand model so that you can show that there is this dynamic going on. There's a lot of examples in the real world, and I don't know how most of you teach, when you teach economics, how you explain this, but a lot of pricing is cost driven. and you see this all the time in the computer industry and in other dynamic industries where the cost is reduced and reduced and then they bring the price right down with it and then you can show the profitability increasing while that's happening so by emphasizing the cost aspect In fact, you can show how by cutting costs, it allows the firm to cut their prices and maintain market share.

23:36And you'd be surprised how many companies emphasize market share as a reflection of controlling the market. I've met with a number of firms that market share is more important to them than profitability. So, it's these kinds of practical things that I learn in the business world which I've tried to develop in my economic model. So, once I finish, let me go on to say that on the expenditure side, when I emphasize the expense side or the cost side, that's when I talk about factors of production. I have a chapter on wages and labor. I have a chapter on rent and land. I have a chapter on capital and interest. I have a chapter on entrepreneurship.

24:26So there's a logical step when I introduce the expense or cost side of the firm. That's when I introduce these ideas of land, labor and capital as the factors of production. I talk about GDP as a measure of economic activity, but I do make an important difference in discussing GDP, and that is, I make a big point that GDP is only one of the four stages of the economy. But I do make an important difference in discussing GDP, and that is I make a big point that GDP only reflects the output of final goods and services.

25:14So on my four-stage model, it's only the last stage that represents GDP, and the other stages earlier are very important and should not be ignored. So I've created a new economic statistic called GDO, Gross Domestic Output, which represents all spending in the economy. Is it double-counting? Yes, it is double-counting, but it's like you take all the sales of all corporations and you add it all together, and that's an important statistic because it indicates a Total amount of expenditure or spending that goes on in the economy. And when you do that, you find out that the total capital investment is substantially larger than consumption.

26:12And that's valuable because there's a lot of air, I think, in the thinking that we're The Final Consumption is the biggest part of the economy when in fact it is not. The stages of production leading up to final consumption is substantially larger if you include investment with that. So this first graph here, if you want to pass that around, you can see what I'm doing. This is from 1986. I haven't updated it, but at least you get an idea of what I would be showing in my textbook.

26:58You know, normally what happens is that everything starts here with gross national or gross domestic product, the middle graph. You've all seen those kind of charts or bar charts before. I start earlier if you'll notice in the first bar there I have my gross national output or gross domestic output and it includes this gross intermediate product which is the earlier stages of production. And I put that in there to demonstrate how big the economy is in terms of total spending. So I find that this is an easy way to explain my concept of GDO or GNO, and it is helpful to give a perspective of how big the economy is and where economic activity is taking place.

27:56It's a mistake to focus only on final output of goods and services. And so this would be a considerable change in the National Income Accounting section of my textbook with the addition of this additional concept of GDO or GNO. The other thing that I try to do is introduce the concept of economic growth very early The Theory of Money and Credit This is an excellent way to contrast my approach versus the, let me have an extra one if there's one too, thank you.

29:10You'll see the first model is the standard Keynesian model that was in Samuelson's textbook for many years and it really does form, you've all seen the circular flow diagram, that's essentially what you have, there's the circular flow diagram, which is in all the textbooks The Circular Flow Diagram is the way our economy works. In this case, Samuelson has savings leaking out and hopefully coming back in the form of investment, but the connection is questionable.

30:00Well, the second model, which I discovered in Paul Eakins' book, Professor Paul Eakins at University of London, he's a very pro-environmentalist economist who would shudder to think that a free market Austrian economist was using his model. But I thank God the day I discovered this graph here because, and I think one of the reasons to, I always make the case that it's valuable to read people you don't agree with. And this is an example of it where this guy had this brilliant flow diagram here, which to me is far more eloquently presenting how the economy really The Theory of Money and Credit of the Economy, which is what the above chart does and which is what the normal circular flow diagram does.

31:33It's very much spending is what really matters. And here down below it demonstrates very clearly that it's capital formation investment that drives the economy and drives economic growth. So I like the dynamics of this lower model and this is what I use in my textbook with The Diamond Economic Process is basically my four-stage production model that I would insert right in that point.

32:19I like that in demonstrating the dynamics and then the final section of my textbook deals with government policy, monetary policy, fiscal policy, tax policy, and how it affects this model and so that completes the concept, the basic structure of my textbook. I believe it does qualify with the objectives I originally had in mind of starting in a logical fashion and moving in a way that students will walk away saying, yes, I now understand how the economy works using these kind of methods.

33:06There is a lot of interest in my textbook, primarily among smaller schools. I have over 50 professors of economics who have reviewed my first six chapters and sent me all kinds of notes on how to improve it. My objective is to get a mainstream publisher. I have Erwin, which is quite interested in the textbook project, and also Harper Collins. Roger Leroy Miller, who is not an Austrian, really likes my textbook, and what I've tried to do in this textbook is not ever call it Austrian per se, I present it as a logical way to explain economics.

33:58But people will wonder when the first chapter, well I highlight a different economist in The Fundamentals of Economic Behavior

34:36and but I do plan to have a full biography when I have the the section on labor I'll probably have Karl Marx as the economist and talk about him and stuff but my intention is to have have a textbook that can be acceptable as a as a textbook that will give the basics of supply and demand and and everything that economists currently teach, but in a much broader way so that these Austrian principles can develop it. And I also think, I'm having a lot of business students read the textbook to make sure it fits in nicely with accounting majors. And so far the accountants really like it, although when I use the term working capital, One of my accountant friends, he said, Skousen, I don't know what economists mean by working capital, but this is not it.

35:34Because working capital has quite a different meaning in accounting than it does for economists. So that's valuable information for me to make sure I don't make those kinds of mistakes. Working capital is not actually used that much anymore by economists, but I used it in my textbook and used it very much differently than the accountants. So that sort of thing is valuable. I've been told that the textbook publishers spend a million dollars of their own capital in developing a market for a new textbook. So they're pretty difficult to deal with. They want to make sure they can get a lot of sales. So one of the reasons I'm speaking to a number of colleges and universities about this idea is to try to engender support, trying to get professors to say, this is a textbook I could adopt, and that's going to be helpful to have a series of letters like that to give to the publishers to say, I think there's going to be demand here.

36:43They frankly said that you've got to be able to guarantee at least $15,000 to start $15,000 in sales, in adoptions, before they will really consider it. So that's a pretty uphill battle and I'll probably end up self-publishing or getting Phillips Publishing, my newsletter publisher, to publish it. They published my investments lectures and I may start off that way and I just think it's going to take some time because the textbook approach is very different and it's going to require a different way of presenting the material. So I recognize that it's an uphill battle for me to get this published by a mainstream publisher, but that's my goal anyway.

37:35So that's basically what I wanted to present. And if you have some questions or comments or criticisms, I would be glad to hear them. Yes? What happened to the Cain-Hill cross and the idea of demand, idea of supply analysis? Yeah, that's a good point. In my macro section I probably will not, I considered at one time to introduce the aggregate supply and aggregate demand curves that come out of Keynesian economics, but I felt that that would confuse the student. I am going to have an appendix on the Keynesian cross and a little bit on Keynesian economics. I think aggregate supply and aggregate demand is so far wrong that it's best to just drop it and not have it in there in the first place.

38:31That's another reason it probably won't be adopted. I do have my own form of aggregate supply and aggregate demand, which I introduce in my structure production book. And I don't know how many of you have seen that, but it actually, it's a little bit difficult to explain to students. I don't know if any of you have tried to explain my vectors, kind of a vector analysis. So it's a little bit advanced, but I think that it's best to just, I've decided to be pretty hardcore on my textbook. While still trying to get the mainstream to adopt it, I'm not going to put things in there. I just don't believe. I'm just not going to do it.

39:16So given that kind of situation, that does lessen my chance of being published. But Paul Hayne did a pretty good job of publishing his textbook. He did introduce aggregate supply and demand in one of his editions. Then he dropped it in the next one. His latest edition doesn't have it. So, I think you can publish a textbook without compromising your principles, but most professors do compromise their principles. I mean, I talked to Roger Leroy Miller, and he says, oh, I put in the Agri-Spina Man, but this is BS, and I don't really believe it, and I don't know anyone who does. And I said, well, Roger, why do you put it in there? And he said, well, because I'm selling textbooks. Well, you know, as you know, the textbook market changes so slowly because people change their classroom tactics or antics so slowly.

40:12And you know, people want to teach. Aggregates imply an aggregate demand, and so that's what people are given. There's no doubt it's fulfilling the customer's desire. And the customer is the professor, not necessarily the student, but indirectly the student because The Profession is Gradually Shifting on Aggregate Supply and Aggregate Demand

42:30The beginning part, which I think students are going to more easily grasp, and with unemployment as low as it is in the United States, the emphasis is going to be on long-term equilibrium. So I like what he's doing there. It's quite different than what I'm doing here, but still it's a movement away from the Keynesian episode, as Leland called it. What do you call it? Keynesian Diversion. That was your phrase. It seemed to me, listening to you talking, you're trying to talk about the practical business aspects and using the income statement. There's sort of a lot of what I think mainstream would consider managerial economics in a lot of ways.

43:19How do we use economics principles in businesses? How do we see them being applied to businesses? I do have a lot of management. My approach in economics is to include a lot of management, marketing, as well as pure economics, business, corporate structure, and I also have a chapter on finance, which I think is very important. on Stocks and Bonds and Corporate Finance, which economics, in large measure, does a very poor job in developing. While you talk to Friedman and so on, he still argues it's kind of a casino aspect of the markets.

44:11They don't think he really understands the role of capital. And the Chicago schools has always been, their emphasis on capital has been low. It's kind of funny, though, because Friedman considers the best chapter in his price theory book his chapter on capital. And it's so standard, neoclassical capital and interest rate kind of stuff. One of the things going through this discussion in the layout of the book that I noted is there's two basic types of students that you're going to get in an economics class, the very few who actually understand it and get something out of the material, and then the vast majority who don't.

44:57Who are there just to get into the tree part? Well, they really don't get the essence of economics and really understand what's really generating the economic process and all that kind of stuff. The people who get it tend to be the people who have experience in the market, they already have felt the competitive pressures in the balance sheet and supply, or not supply and demand, but revenues and expenses and all that stuff. People who have that kind of experience tend to latch on to the economic principles much quicker when you take the standard approach of starting out with supply and demand and then going on from there. I think that may be a big benefit if you're dealing with a standard student who really doesn't have any economic experience, who really doesn't know much more than the names of these companies, to work them through some of the real business aspects before they actually get to supply and demand because I think that's the real, the fact that most classes, most

46:04The first approach in textbooks really don't get to the students because they don't have the experience necessary to understand the underlying forces of supply and demand. Well, I have a whole appendix, even though I introduce an income statement, a very basic income statement, and then I have an appendix on accounting. But most textbooks do that as well, but I integrate it more and I put it up near the beginning of the course. And so a number of my colleagues have said you really are writing a business economics textbook or a managerial economics textbook and I think that's because they haven't seen the entire book where I do start off that way but I have a lot of pure economics that comes in, especially in the macro section at the end.

46:58Your gross domestic output statistic, the Investors Business Daily reviewed that very favorably and I think it really does tell you a lot more about the economy because you're looking at all the sectors of the economy rather than just final output, but in terms of the Austrian theory of the business cycle, do you think it improves or doesn't really Do you do anything in terms of telling us where we are in the cycle and that sort of thing? Does it give you any better information? Yeah, I think it does because what I try to do is, when I come to, I have a chapter on the business cycle, and what I do is try to disaggregate the economy according to these time, these stages of production.

47:47So in looking at, instead of just looking at the unemployment rate, what we try to look at, or the employment, total employment, that also, we try to look at each sector, like the natural resource sector, the manufacturing sector, what kind of statistics we have on those, and to see where is the boom actually taking place, where is the bust actually taking in Place, and so we don't look at just the consumer price index, we will look at commodity price index, and if the commodity price index is just skyrocketing, that's an indication of a boom, the early stages of the boom. So I do try to look at these sectors of the economy to determine where we are in the business and to what extent government is encouraging or causing the boom to take place and how far along is it.

48:48So it has a lot of predictive power as well in my opinion and that's what I try to do there on the business cycle. Of course now these statistics aren't very good and I wanted to ask you how you come down on the CPI debate I think the statistics on a relative basis are pretty good. In other words, if they're all using the same methodology, the error rate is fairly equalized is what I would estimate. Friedman and others, I've gone the rounds with them on this. I think that they do have a good point about quality changes and things like that as far as the CPI, and in that sense maybe it does overestimate prices. But on the other hand, the CPI is a poor indicator of cost of living. I would like to see a cost of living index Rather than a CPI. That's harder to judge, but for example it leaves out, generally leaves out taxation. The only time taxes play a role in the CPI is if you have an increase in the

50:10sales tax, then that can be reflected in the CPI. But like a change in real estate, especially income taxes is not included and that can be 30% of your cost of living, could be taxes. So, cost of living, if we had a cost of living index, I think it would be substantially higher than the CPI. I have a section in my textbook that I plan to write on this, and that would be my main point there. Well, we only have about one minute left for the seminar time, so I wanted to get you an opportunity to do some predicting about where we are in the cycle and where we're going. Money Supply is Loosening, Money Supply is Loosening,

51:53What you watch, what you watch is financial assets, particularly stocks. Stocks are where the new money, the extra money is going into. And I'm very bullish on all those markets, but it's headed for, it'll be a major correction here at some point. I think it'll be sharp, treacherous, and it'll be very hard to predict when it will happen. So I don't know, I'm not into market timing like I used to. And the reason is, is because even though government is playing its business cycle game and tight money, easy money and all that sort of thing, this worldwide global free market expansion that I've been seeing over the last, well, since the collapse of the Berlin Wall, I mean, I travel a lot and I was over in Europe, was down in Latin America, been to a number The demand for U.S. goods is really remarkable. I went into a mall in Santiago, Chile, and I thought I was stateside.

53:01They had The Gap and Rockford Shoes and McDonald's, and everybody spoke English. It was just mind-boggling. in the United States or outside the United States by U.S. companies. So that's why all these, there's no such thing as a U.S. stock market anymore. All markets are global. So I'm 100% invested in global stocks at the present time. Not bonds because the bond market, that's, that game is over to make money on bonds. I would not recommend anybody playing the bond market. 7%. Interest rates will probably be rising in this mini and the inflationary boom. Stocks can continue to rise also though. My prediction is that when the 1990s are over, this decade of the 1990s will statistically probably be the best return on stocks ever of the 20th century. So I'm not into market timing, 100% invested, but in stocks, not bonds.

54:17Well, as in bonds, as in the seminar time, we are all up with time and we've got some from students and instructors who have to get to their next class. I want to thank you, Mark, for coming.