Debating Keynesian economics with a Keynesian

We are slowly but ever so surely finding our standard of living slipping away. In spite of all that public spending and the deficits and mounting debt – well actually because of all these things – we are slowing going under. Most of us find we are doing without some things we took for granted not that long ago. Whether you look to the US, the UK, Europe, Japan or Australia, a return to rising real incomes and full employment continues to look ever more remote.

And it’s not for lack of public sector “stimulus”. Those deficits continue and even so the money market geniuses keep worrying about deflation. What are we to do? More QE? More debt? More government subsidies for projects that cannot be funded through the revenues they are expected to earn? These are the textbook answers from the textbooks provided to every economic student in the world.

It is all the same Keynesian rot that has not only never worked on any occasion that it has been tried, it has always with no exception made economic conditions worse. If you know of some example where public spending led to recovery, please let me know. For myself, I can give you chapter and verse on all of the failures, and yet nothing seems to be more everlasting than a textbook theory that is simple, plausible and wrong.

I am now in the midst of an online debate with Louis-Philippe Rochon, an Associate Professor of economics, founding co-editor of the Review of Keynesian Economics and co-editor of New Directions in Post-Keynesian Economics. It has been organised by Edward Elgar between two of its authors, and I have just had my first go in an exchange of letters. I have also discussed this debate at Quadrant Online.

The problem remains for me remains as it always was:

What I can tell you from personal experience is that the notion of aggregate demand as a driver of economic activity is now so universally believed that it is nearly impossible to get anyone even to see that it might possibly be wrong, that there is another way of thinking about things. But before Keynes came on the scene, no economist, other than a handful of cranks, ever thought that economies were driven from the demand side.

To deny the independent existence of aggregate demand is so conceptually disorienting to an economist educated any time over the past half century that it is near impossible to get them even to see what you mean. But I have had my go and I expect Louis-Phillipe to answer in the next day or so. I am pleased that he has taken this on, but I remain curious how he will respond. I can only say that no one has ever been brave enough to take this on before. I have had plenty of slanging and ignorant comment. But if it is possible to show that aggregate demand for anything however wasteful can ever promote economic growth and higher employment – NBN, mothballed desal plants, bridges to nowhere – I hope to hear it now.

Debating Keynes

The single most timely piece of economic writing I ever managed to put together was for Quadrant which was published online in February 2009 just as the various stimulus packages were being rolled out across the world. The title it was given, much more aggressive than I might have chosen myself, was The Dangerous Return to Keynesian Economics. And while the whole thing could have been written today without the need for a single change to bring it up to date, the passage I have quoted time and again is this:

What is potentially catastrophic would be to try to spend our way to recovery. The recession that will follow will be deep, prolonged and potentially take years to overcome.

Keynesian economics is, was and always will be a disaster wherever it is applied. That virtually no one understands why that is after three generations of economists have gone through their economics education with standard Keynesian macro at its core is to be expected. What is far less expected is that there has been no serious effort to examine more closely what went wrong after the failures of the stimulus.

As it happens I am at the start of an online debate with Louis-Philippe Rochon, Associate Professor of economics at Laurentian University, the founding co-editor of Review of Keynesian Economics and co-editor of New Directions in Post-Keynesian Economics which is an Edward Elgar book series. One presumes that if anyone can defend Keynesian economics he is the one to do it.

I, however, have been the one to open the batting. Keynesian economics has so many different disguises that unless I could narrow the lines of the debate to within some kind of practical dimensions there would have been no hope of limiting the range of where such a conversation might end up. Elgar has now published the first of these exchanges, How to Promote a Global Economic Recovery? The Keynesian vs. Free Market Approach. Crucially, the delimiting of the debate was the first essential. I therefore began with this:

There are about as many versions of Keynesian theory as there are Keynesians but all versions have two things in common. The first is that economies are driven by aggregate demand. The second is that an economy’s rate of growth and level of employment can be increased by increasing aggregate demand, either through higher public spending or lowering rates of interest. Both are wrong and the destructive consequences of these beliefs are everywhere to be seen.

What I can tell you from personal experience is that the notion of aggregate demand as a driver of economic activity is now so universally believed that it is nearly impossible to get anyone even to see that it might possibly be wrong, that there is another way of thinking about things. But before Keynes came on the scene, no economist, other than a handful of cranks, ever thought that economies were driven from the demand side. What they believed instead was this:

Certainly a government can itself employ, or can buy from others causing those others to employ. And those additional employees can use their incomes to buy things from others still. And so, for a brief period of time, we can say there has been an increase in employment relative to how many might otherwise have been employed.

But unless whatever has been produced is value adding, as time goes by these additional employees merely drain away the productive capacity of the economy. Savings are indeed absorbed but the value left behind is lower than the value used up during production. The economy not only remains stagnant, it winds even further down as its resource base is diverted into wasteful forms of expenditure.

This is the classical pre-Keynesian view of how an economy works and why a stimulus never will. That the classical theory so perfectly captures the economics world we see around us should at least make someone stop and think about the macroeconomics we teach. There should therefore have been at least some consideration that giving politicians and public servants the power to direct such large proportions of our economic resources could not possibly have improved economic outcomes but would only make conditions worse. These are people who, except in the rarest of circumstances, have absolutely no ability to direct a productive enterprise in a value adding way, as they have shown at every turn. It has therefore been astonishing to see that thus far there has been virtually no re-consideration of Keynesian theory and the policies it underwrites, given the evident failures of the stimulus everywhere it has been introduced.

In a week’s time, Louis-Philippe will provide his reply to what I have written. I will naturally post what he writes since I am extremely curious to find out whether there is something I have missed, some bone-crunching reply to the issues I have raised. Although I have looked everywhere for some such reply, thus far I have found nothing, but we shall see.

Obviously, my arguments cannot be properly explained in a brief note of a thousand words. If you are interested in understanding not only why Keynesian economics provides no solutions to our economic problems, but also what should be done instead, read the second edition of my Free Market Economics: an Introduction for the General Reader. There is literally nothing else like it anywhere, which is itself a large part of the problem we have.