Oddly, could the real beginning of the Keynesian counter-revolution begin here in Australia? It’s one thing to stop spending because you have run out of other people’s money. It’s quite another to understand the problem of valueless public spending which will lead to a very focused attack on public waste.

Adam Creighton has a wonderful article in today’s Australian, Nothing austere about Europe’s fiscal policies which truly goes to the heart of the problem. He begins:

IN 1946 George Orwell famously pointed out how politics degraded and abused the English language for the sake of political ends. The same is true in economics. The word austerity, used to describe European and even US fiscal policy, has been a clever ruse by opponents of measures that may cause any reduction in the size of government.

No objective, sane person could describe, in a relative or absolute sense, fiscal policy in Europe or the US as austere, a word stemming from the Greek meaning harsh or severe.

‘The word austerity entered into the conversation once it became clear what a disaster the debt-financed stimulus was going to be,’ says Steven Kates, an economics lecturer at RMIT University, referring to the failure of repeated and colossal budget deficits to resurrect economic growth across advanced countries, almost five years after the end of the global financial crisis.

‘Those who support public spending and deficits prefer to characterise those who oppose them as wearing a hair shirt, rather than wanting to reduce public waste and have governments live within their means,’ he adds.

Government budget deficits in Europe are still up to twice as large as they were before the GFC – when no one described them as austere – and are contributing to already vast public debt burdens. Far from the ‘savage cuts’ of Wayne Swan’s imagination, European governments have reduced only the rate of growth of public spending. Even in Greece, a country with little population or economic growth in recent years, spending is still greater than it was five years ago.

Yet ‘mindless austerity’ has become a favourite phrase of the Treasurer since he dumped his promise to restore the budget to surplus this financial year. With a tsunami of costly spending promises on the horizon across disability, health, the environment and parental leave, it appears unlikely the budget will return to surplus soon – and without a change in attitude, ever.

OK, obviously I was one of the people he spoke to when he put this article together. But I speak to lots of people who never seem to get it. This is different. He sees the point and explains it exactly right which I don’t think you can do unless you understand it. And while it has felt somewhat strange to discover what I have discovered ploughing this furrow since the 1980s, I would still make the statement that there is no other way to find our way out of the economic problems we are in without a return to pre-Keynesian economic theory. First let me get back to the article and then let me continue:

Adam Smith’s dictum that what is prudent for households is never folly for governments infuriates economists who remain deeply wedded to the theory of John Maynard Keynes, who said public borrowing and spending, however wasteful, could revive moribund economies.

The giants of economic history before then – Jean Baptiste Say, John Stuart Mill and Alfred Marshall, for instance – all railed against the idea, which for Mill was an absurdity: ‘The usual effects of the attempts of government to encourage consumption is merely to prevent saving; that is, to promote unproductive consumption at the expense of the reproductive (investment).’

You won’t find the problem explained in any modern text based on the idea that aggregate demand drives an economy forward, which as it happens constitutes virtually all modern texts at the macro level. You certainly cannot make sense of the economic problems we have in the absence of a focus on value adding activity (i.e. the supply side of the economy) as the actual driver of economic growth. These concepts were, however, the foundational principles of the economics of Smith, Mill and Marshall, and indeed for all economists of the classical school prior to Keynes. But with the publication of The General Theory, which argued that public spending on anything at all will prime the pump and get an economy moving again, the notion that spending to create growth and jobs had to be value adding evaporated from the curriculum.

For me, schooled in the classics as I am, it was as obvious as a cloudless day that the stimulus could never achieve its ends. For virtually the rest of the profession it was not. Why the difference? I base my understanding on the classical theory of the cycle; they base their understanding on Keynes. That’s it. Nothing else. Anyone can do it. So why don’t they? Because the grip of Keynesian demand management has since the 1930s had the profession locked into the most destructive form of economic analysis, a form of analysis every classical economist understood as fallacious to its very roots. So all I can do is direct you to the pre-Keynesians. Here is a primer on the classics.

After that read either the first edition of Haberler’s 1937 Prosperity and Depression or if that doesn’t appeal to you, you can try my own Free Market Economics. But unless we can get out of this Keynesian death grip, our economies may never fully recover. We’ll just get used to slow rates of growth and limited improvements in our standard of living, in just the same sort of way the Japanese have done since their own Keynesian stimulus of the 1990s wrecked the world’s fastest most vibrant economy of the time.