I am forever being told that Keynesian economics has disappeared and has been well and truly transcended. But I am told this by people who have no idea what makes a Keynesian model Keynesian. So let me make clear what the essential feature of a Keynesian model is. It is the argument that economic growth and employment are determined by the level of aggregate demand. The more demand, the more production. Supply will follow along if demand can set the pace. The aim of a Keynesian policy is to raise the level of aggregate demand.
What comes with Keynesian economics is a concern with the level of saving. According to Keynesians, over-saving is the greatest single problem an economy can face, since it means that those with money choose not to spend as much as they could. Policy everywhere is designed to encourage more spending and less saving. Buried as I am for most of my time in the pre-Keynesian classical literature, it always comes as the greatest imaginable surprise to come across modern macroeconomic thought and its aim to increase the level of spending. There have been many such examples of late, such as the CSIRO having recently bought into the superannuation debate. From the AFR: Researchers at the CSIRO believe we have a problem:
Because most super earnings are tax free and most retirees receive the age pension, policymakers would prefer super savings to be spent rather than saved to pass on to children.
This report was followed by an editorial, When savings are for spending too, where again the preference was for spending rather than saving. The notion that saving are spent – common ground among economists from Adam Smith right through to 1936 – is now a concept as dead as it is possible to be. Yet as foreign to modern economic thought as it is, the crucial importance of saving remains as paramount for economic success as ever.
But the worst example of this spending mania I have come across was found just the other day in an article in the Financial Times by its Economic Correspondent, Martin Wolf, an article which was also reprinted by the AFR. Its headline title ran, Japan’s weak private demand is the dominant challenge for Abenomics but its sub-head was beyond the pale: “The country saves too much, but higher wages and taxes could help eliminate the surplus.”
This is not merely economic illiteracy but falls into deep incoherence. Savour this if you will:
Shifting Japan’s excess corporate retained earnings into wages and taxes would go a long way towards eliminating the structural savings surplus. One could slash depreciation allowances, for example. Reform of corporate governance might also increase the distribution of corporate earnings. Yet another possibility would be to force up wages.
It is, in brief, “not the supply, but the demand, stupid”. The structural savings surpluses of the private and, in particular, of the corporate sectors have driven the government into its deficits and growing debts. Abenomics does not recognise this underlying reality. Japan must offset the private surpluses, export them or eliminate them. This is the dominant challenge.
Did you follow that? The refusal of the private sector to spend has driven the government of Japan into that painful necessity of having to blow away those accumulating savings even before any wealth has been produced. That industry has gone into a shell in the face of reckless government spending is no surprise. But the real problem goes well beyond mere business confidence. The core of the problem is that you cannot use the same resources in two places at once. Either the government chooses what to produce, or industry does it. Either the government uses the economy’s productive resources to fulfil its own agenda or business uses those resources. But no matter how you try to manage an economy, a brick can only be laid in one place, and once it is in one wall, it cannot be placed in another.
If that’s too metaphorical for you, then try this. Households, he argues, have been running a financial surplus year after year which has driven the government to increase its spending since the private sector has not borrowed the funds. A “counterpart borrower” to do the necessary spending has therefore been required.
The counterpart borrower has been the government. The ratio of gross public debt to GDP jumped from 67 per cent in 1990 to 246 per cent in 2015, while the ratio of net debt increased from 13 to 126 per cent. Yet, despite sustained fiscal deficits and near-zero short-term interest rates, the mild deflation has not been durably eliminated.
This is madness, insanity, economic vandalism. That such an outcome would with certainly slow your economy would have been as obvious as the noonday sun a generation or two back. That the advice is not to immediately slow the rate of public spending and go through the necessary readjustment, as painful as it will surely be, only shows how lost in modern theory Martin Wolf now is. But he is hardly alone since the whole of the profession is filled with just this kind of advice. Economists know no better. Here is the final sentence of the article that tries to focus on what Martin Wolf sees is the problem to be solved. It is a sentence that would be hard to beat for its dangerous inanity.
The first step is to recognise the core problem — one of insufficient private demand. Only then can it be solved.
Any policy maker who starts with insufficient private demand as the central problem will only ever do harm to any economy it is trying to fix.
Law of Markets 