I have now received Louis-Philippe Rochon’s reply to my critique of Keynesian economics which was the lead comment in an exchange we are having on Keynesian economics. His reply comes under the heading, How to Promote a Global Economic Recovery? “The worst infliction we can impose on our economies is to leave them to the tyranny of the markets”.
Thus, from the very heading I can see how far apart we are. There are an astonishing number of techniques and approaches that can be used to manage an economy with public spending to get an economy out of recession only one amongst this vast array of possibilities. If you are going to start with the assumption that not trying to spend your wasteful way to recovery is the same as laissez-faire then there is no possibility of ever understanding how badly our economies are now being mismanaged. But perhaps that is just the title. What more does his letter say? Let me pick up his argument point by point, starting with this misbegotten piece of theory.
The driving force behind economic growth both in the short run and the long run is aggregate demand, pure and simple. . . . Yes, that’s right: more government spending leads to more investment. It’s a crowding-in effect!
Nothing to lift an economy like public investment! Every business like the post office. Every investment another Solyndra. All subsidised with nothing self-sustaining through the revenues it earns. Dig a hole and get fill it in again. Don’t worry about earning a greater return than the funds outlayed. Just close your eyes and spend. Don’t worry, it will all work out once that magic multiplier cuts in. If this is all there is to the theory, there is nothing there but wishes and wind. But there is also your recollection of those magic Keynesian moments at the end of World War II.
My recollection of Keynesian policies is quite different: they contributed to 3 wonderful decades of growth following WWII – what we fondly call the Golden Years of capitalism. Keynes is quite evidently the greatest economist of the 20th century who saved capitalism from self-destruction. For that, he is remembered as one of the greatest thinkers.
First, the General Theory was published in 1936, three years after the Depression had come to an end in every economy but the United States, where it dragged on until the coming of the war to the US in 1941. And, of course, those three wonderful post-war decades were preceded by the decision of the United States in 1945-46 to balance its budget immediately. The massive wartimes deficits were instantaneously brought to an end and a balanced budget put in its place even with millions returning to the workforce after being mustered out of their wartime military service or from their jobs in wartime industries. The Keynesians of 1945 all wanted a continuing deficit but Truman turned them down.
How does a Keynesian explain that, I wonder? We are instead reminded of the supposedly woeful economic outcomes of the 1980s, which I must confess not to remember in quite the same way as this:
By contrast, starting from the 1980s, with the monetarist debacle and the real business cycle shenanigans, we ended up with less average growth and higher average unemployment rates.
It is a contrast, of course, but the contrast of importance is with the 1970s, the greatest period of Keynesian disaster until the one we are in the midst of now. The catastrophic stagflation of the 1970s, where deficits and spending only led to high unemployment and a blowout in inflation that could only ultimately be controlled by a fierce monetary policy that finally did regenerate a period of prosperity that continued for another two decades. But what about the period after the GFC when governments were spending hand over fist on one stimulus after another.
While governments did put into place Keynesian aggregate demand policies in 2009, they quickly abandoned these policies in 2010 in favour of austerity measures.
A one-year stimulus, was it? The US is the paradigm example. Despite Congressional attempts to slow the growth in the deficit, the attempt to contain public spending in the US only seriously began with the sequester in 2013!
And indeed, the White House specifically dates the commencement of the sequestration from the first of March that year. If ever a stimulus was given time to work itself out, that was then. The disastrous response of the American economy to the stimulus is perfectly in line with my own argument. The very belief that conditions were improving up until the sequestration began can only mean we are living in a parallel universe.
But how much we differ on the timing when restraint finally began, we can certainly agree on the current disaster. He may think it’s because the stimulus was brought to an end too soon. I think of it as the inevitable consequence of a Keynesian policy.
When you look at aggregate demand today, it is at best anemic. Consumers are saddled with debt, and private investment has flatlined; austerity measures are being imposed everywhere. There is no room for growth. That leaves only exports to ensure a recovery. But with Europe on the verge of deflation, the BRIC countries slowing down, the prospects for exports are dimming. So where will growth come from? I am afraid that without aggressive fiscal deficit spending, we are dooming future generations and ourselves to another decade or more of weak economic growth.
On this much we can agree, that the world’s economies are in a mess. Consumers deep in debt, savings eaten away by low productivity government spending, and private investment going nowhere. And I didn’t just say the stimulus would not work; I said the stimulus would make things much much worse. You describe what I see, but I expected things to end like this from the start. You could only start to recognise a problem more than a year later, and only because by then it was obvious to all and sundry that in every place the stimulus had been introduced economic conditions had become much worse. You nevertheless continue to believe that the problem is not enough government spending.
This secular stagnation is the direct result of a lack of fiscal spending advocated by austerity voodoo doctors and charlatans.
I understand that the principle of cause and effect never applies to Keynesian theory. The plain fact is that there has never been a single instance in the whole of the period since the General Theory was written that a public sector stimulus has been able to bring a recession to an end. There is not one single solitary example, with the coming of World War II the only supposed example when unemployment ended mostly because half the male population under 30 was put into the military.
It is not aggregate demand that matters, but value adding aggregate supply. You must do more than build brick walls, you must build where what is built actually contributes to future prosperity. To think more holes dug up and then refilled can generate recovery because it constitutes “fiscal spending” is the essence of economic illiteracy. And for true economic illiteracy, it’s hard to go past your program for recovery:
First, we must replace private debt with public debt.
Second, we must put job creation above all other goals.
Third, we must deal head on with the problem of income inequality, which is at the very core of the crisis in aggregate demand.
Fourth, with respect to Europe . . . they must either adopt the proper federal institutions to deal with the problems facing the Southern countries, or get rid of the Euro all together.
That is to say: we must socialise our economies.
Private debt is incurred by private sector firms. To replace this debt with public debt would so obviously drive us into us deep recession that it is almost impossible to understand how this is not perfectly obvious to you.
If such a program appeals to you merely because of this aggregate demand incantation of yours, I’m afraid, your program would be part of the problem and in no way part of any solution. I fear, however, that three quarters of a century after the publication of The General Theory, economics is now at such a low ebb that what you have written will look like perfect good sense, even as every attempt to do what you have suggested would make things worse than they already are.
In times gone by, before Keynes, economists talked about “effective demand”, that is, what had to happen to turn desire for products into an ability to buy those products. Now it is aggregate demand – the total level of demand – which has leached the original concept of any understanding that for everyone to buy from each other, they first have to produce what each other wish to buy. If that is not obvious, then common sense has gone from the world.
But I say again. A short post cannot state everything that needs to be said. For a more complete explanation of these issues and what needs to be done, you must turn to the second edition of my Free Market Economics. It’s still not too late, but it is getting later all the time.
Law of Markets 