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Part I showed that on Keynes Island (and in other Keynesian paradises) all is initially harmony, goodwill, peaches and cream. When politicians use good intentions, emotive rhetoric and compulsion to promise Paul a brighter economic lifetime from the future production of Peter, Paul tends to feel richer. For his part, Peter does not immediately feel poorer (because, as often as not, he has not even been born). As Mr Buffett describes it, PNP (Psychic National Product) increases whilst RNP (Real National Product) remains unchanged. Illusions regarding wealth produce euphoria. Ecstasy, in turn, produces majority votes for the politicians who campaign on a platform of bliss. But neither an illusion nor euphoria can produce rice and wine. As one of the foremost authorities on the British constitution (and one of the most astute political commentators of his day), A.V. Dicey, put in 1867: “the beneficial effect of state intervention, especially in the form of legislation, is direct, immediate, and so to speak, visible, while its evil effects are gradual and indirect and lay out of sight. Hence the majority of mankind must almost of necessity look with undue favour upon governmental intervention.”
Given demographic trends such as a falling birth rate and lower death rate, if the predicament on Keynes Island is to be avoided then one or more of several things must happen. One saviour is dramatically and permanently higher productivity. But given that the culture and practice of savings has been banished from Keynes Island, it is foreigners who will have to save, invest and ride to the Keynesians’ rescue. Residents, in other words, must to a significant extent put their fate in the hands of foreign savers to beget the capital which generates increases of productivity. Another possible saviour is a rising population in the form of mass immigration of working-age people whose labour can (for a time) finance the privileges of retirees. Absent these developments, either producers must lose even more economic ground (which is unlikely, since they remain a majority of the population and also vote); or once-sacrosanct promises to retirees must be greatly reduced and the retirees bear the brunt of the changed reality. A much better and just way (in the sense that nobody benefits at the expense of another, and indeed in the sense that everybody wins) is that the inhabitants of Keynes Island abandon Keynesianism and adopt the ways of the residents of Mises Island.
Welcome to Mises Island
What does this latter possibility entail? Let us, borrowing from Sean Corrigan’s excellent article Destroying an Economy to Save It, set out premises and reasoning that lead to some discomfiting (for contemporary Americans, Australians and Britons) conclusions - namely that, at the very least, spending does not have to create jobs and thrift does not have to destroy them. Imagine an island where a small group of people co-operate in order to produce just enough to satisfy all of their daily wants. Mises Island is a capitalist island, and to keep things simple (and thereby to reason towards these unsettling conclusions as clearly as possible) let us say that its population comprises 10 workers (and their dependents) and 1 capitalist (and his dependents). The capitalist, known affectionately by some and less affectionately by others as “Boss,” owns one company (call it Company A) that employs all of the islanders’ workers and produces everything that the islanders consume.
Assume further that each day Boss and each of his employees earns $10 (Boss pays himself a dividend from his company, and each worker receives a salary) and produces $10 worth of goods. “Gross Island Product” is therefore $110 per day, and income equals consumption. No goods, in other words, rot on the shelves, full employment prevails and nothing is saved. Now suppose that one of the workers has a son (let us call him Junior) who no longer wants to depend upon his father and therefore seeks employment. At first glance, this is a problem: Junior’s father, the other workers and the capitalist are fully employed and their production satisfies everyone’s daily wants. It seems, in other words, that Junior is superfluous and there is no prospect (until one of the ten workers retires or dies) that he can obtain gainful employment.
One of the workers agrees and suggests that some or all of the others volunteer to share the existing work (and an accompanying share of their salary) with Junior. A few others are inclined to agree. At the same time, however, they note that Junior is a newcomer who will require training and supervision - and that the other workers will not be particularly willing to provide it. This second subgroup therefore suggests that Junior be given a fictitious “job” that produces little or no output but nonetheless has an equal claim on the day’s produce. They also propose that additional money, equal to 1/12 of that on issue, be printed for him to spend. Yet another subgroup of workers goes further: they predict that no worker will voluntarily cede part of his work (and therefore income) in order to “make work” for Junior; accordingly, this third subgroup demands that all workers and the capitalist be forced to restrict their work so that there is “room” for Junior. A final subgroup goes furthest: a portion from every man’s income should be confiscated and transferred to Junior (who, under this scenario, need not work for his daily bread).
Much debate, some of it heated and acrimonious, ensues. Most (including Junior) agree that Junior should receive an honest day’s pay only in exchange for an honest day’s labour. But none of the workers can find a means of doing so without cost to themselves, i.e., without reducing their own income. The implication is ominous: as others’ children reach maturity, then more and more “room” will have to be made for these new workers, and each existing worker’s income will have to fall further. If so, then the islanders’ future is surely sombre.
At this point, when the workers have argued themselves into exhaustion and depression, the capitalist rises and calmly begins to speak. His suggestion astounds everyone. Boss proposes that henceforth, each day for one month, every worker and the capitalist save one-twelfth of his income, combine these eleven lots of $0.83 into a single lump of $9.17, and, every day for thirty days, lend this sum to Junior. But a condition attaches to the capitalist’s proposal: Junior must spend the next month trying to find or make something different (i.e., not currently produced or consumed on the island) that is nonetheless valued (i.e., that the others will want to consume). Alternatively, Junior might try to fashion new and better versions of the tools or processes that Company A’s workers presently use to produce the island’s daily output.
Using the jargon of Austrian economics, Boss proposes that the islanders save and invest in either a horizontal (Junior produces a new consumer good), or a vertical (Junior devises better means to produce more of the currently-produced goods using the same amount of labour) extension of the island’s structure of production. Either way, says the capitalist, the output wrested from the island’s existing human and natural resources can, either by specialisation of labour or through technological advance, be increased. Either way, in other words (assuming that Junior’s entrepreneurial effort succeeds), everybody - the capitalist, the workers and Junior - will be able to consume more than he could before Junior entered the island’s workforce.
A couple of the workers who have long disliked Boss oppose his proposal. But most, who admire his intelligence and trust his ethics but do not understand the details of his proposal, support him. So too does Junior. It is therefore decided that Boss’s proposal be tried.
...continued in Part III
 
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