"Keynesianism has been found fatally wanting in both theory and practice, so why is it back?"
Zombie Keynesianism, with its promise of 10,000-volt stimulus, continues to lurch around the political scene, while John Maynard Keynes’ acolytes struggle to gussy up his policy Frankenstein for another prime time appearance.
Chief among Lord Keynes’ public proponents are economist Joseph Stiglitz and his biographer, Robert (Lord) Skidelsky.
Prof. Stiglitz recently wrote in Vanity Fair of the importance of understanding the roots of the present crisis. “The battle for the past will determine the battle for the present,” he wrote, reflecting communications strategy from Nineteen Eighty-Four. “So it’s crucial to get the history straight.”
It is indeed crucial to understand the past, but rather than clarifying Keynesian history, both Messrs. Skidelsky and Stiglitz seem intent on shoving inconvenient truths down the memory hole, and engaging in rhetoric rather than objective analysis. There is an old economic joke: “Sure, it fails in practice but does it work in theory?” The approach of Messrs. Stiglitz and Skidelsky is to bury the evidence of practice, demonize straw-man opposition and not so much establish the theory as simply assert its moral credentials.
No comment has been more eagerly leapt upon by interventionists than Alan Greenspan’s mea culpa about his misplaced faith in markets. In a piece in last Sunday’s New York Times, Lord Skidelsky suggested that since the case for light regulation lies in the market “efficiency” that Mr. Greenspan found wanting, then the free-market capitalism jig is up.
In fact, the case for free markets since Adam Smith has not been that they are perfect, but that they represent an astonishing co-ordinating mechanism that government attempts to improve — beyond the protection of property, and the enforcement of contracts — at everybody’s peril.
If Mr. Skidelsky is interested in mea culpas, meanwhile, a more relevant one is that of former British prime minister James Callaghan, who said, in 1976, “We used to think that you could just spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you, in all candour, that that option no longer exists; and that insofar as it ever did exist, it only worked by injecting bigger doses of inflation into the economy followed by higher levels of unemployment as the next step. That is the history of the past 20 years.”
Lord Keynes was concerned about a very real problem in the 1930s: that economies might be “stuck” at a low level of output and a high level of unemployment, which he saw as a failure of classical economic theory. His analysis was contained in his book, The General Theory of Employment, Interest and Money, which was published in 1936. Keynes claimed that such a phenomenon — when individuals were, in their irrational fear, allegedly socking away cash in their mattresses — required government expenditure to keep up “aggregate demand.” It didn’t matter where the government spent — be it roads, pyramids or even wars — such expenditure was needed to jolt the economy back to full employment.
Adam Smith had observed that “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.” Keynes’ version, as economist James Buchanan pointed out, turned this wisdom on its head: “What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation.”
Spend yourself rich!
But how could government inject anything into an economy that it did not take out, either currently via taxes, or by taking on the burden of debt? In fact Keynes said that government deficits should be matched by corresponding surpluses in good times, but Keynesianism inevitably proved a one-way pendulum, as Prof. Buchanan had warned. Meanwhile Friedrich Hayek, who was both Keynes’ friend and rival, had pointed out that there was an even greater danger in any policy system that implied that governments knew best; it was called The Road to Serfdom.
Significantly, both Hayek and Buchanan were stigmatized for their apostasy, not least because Keynesianism — with its stratospheric worldview and its promotion of “macroeconomics” — proved wildly popular with both politicians and policy wonks.
As Milton Friedman, wrote: “Here was one of the most famous and respected economists in the world informing governments that the way to full employment was paved with higher spending and lower taxes. What more attractive advice could politicians wish for?”
Keynes was at least vaguely aware of the potential dangers of his policies, but chose to believe that the politicians to whom he gave advice shared his own sense of noblesse oblige.
In a famous letter congratulating him upon the publication of The Road to Serfdom, Keynes wrote to Hayek: “Dangerous acts can be done safely in a community which thinks and feels rightly, which would be the way to hell if they were executed by those who think and feel wrongly.”
As Prof. Friedman mischievously pointed out, Keynes’ agreement with “virtually the whole” of The Road to Serfdom obviously did not extend to the chapter titled “Why the Worst Get on Top”!
Meanwhile Keynes’ theories had other purely economic flaws, a major one of which was pointed out by Robert Lucas. Prof. Lucas’s theory of “rational expectations” pointed out that the success of Keynesian stimulus depended essentially on fooling all of the people all of the time. In fact, businessmen would tailor their decisions to government policies, thus neutralizing them.
Keynesianism has thus been found fatally wanting in both theory and practice, so why is it back? One reason is sheer political desperation, or as Professor Lucas put it, “I guess everyone is a Keynesian in a foxhole.”
However, the support of Messrs Stiglitz, Skidelsky and other modern liberals, such as Paul Krugman, is also based on a fundamental distaste for free-market capitalism as the rule of greed and materialism (not to mention a system that deprives them of their rightful role as society’s guardians).
Prof. Stiglitz looks at the doughnut and sees only a hole: the economy in his eyes is everywhere plagued by “market failure.” Lord Skidelsky’s moralistic approach is on flagrant display in an article in the current Prospect magazine. He fulminates against materialism and “the corruption of money.” He denigrates “off-shoring.” He bemoans globalization and the “rape of nature.” Above all, he projects a world in which a race of omniscient Keynesian geniuses make markets “well-behaved” and render globalization “efficient and acceptable.”
Lord Skidelsky stresses with approval that Keynes was “a moralist as well as an economist. He believed that material wellbeing is a necessary condition of the good life, but that beyond a certain standard of comfort, its pursuit can produce corruption, both for the individual and for society.”
So a guardian class must decide, presumably, what an acceptable dividing line between “comfort” and “corruption” will be. Otherwise, as Keynes hysterically suggested, “We are capable of shutting off the sun and the stars because they do not pay a dividend.”
Such is the thinking behind the “new” Keynsianism. High moralism. Desperate politics. Terrible economics.