The Need for Keynes. Repeated.

It’s not everyday that one finds economic opinion piece like this in Reuters. Anatole Kaletsky, an economic writer and author of Capitalism 4.0 penned an article with the same thesis that under-girded every one of my previous policy articles: that government spending in the Western world is both necessary and too low to revive economic growth. I welcome this piece, but there are a few things to comment on. But first some context.

The Context

Both the United States and Europe are still “recovering” from the effects of the Great Recession. In terms of GDP figures, the United States has generally performed better than Europe since it was willing to run extremely high deficits in the first three years following the recession. Europe took a different track. The periphery countries (think Greece, Ireland, Portugal, Spain which will henceforth be known as PIGS) undertook incredibly harsh austerity measures. Public spending was slashed, public employees were sacked, and state assets were liquidated,all of this in the context of tax increases and wage cuts.

In a recession, when most private entities are cutting back spending, the only way to maintain or increase unemployment is if somebody steps in and spends enough to revive sales which in turn revives hiring. In the absence of private spending, Keynesian thought turns to the government as the “spender of last resort.” If the government tap is shut off as well, then economies can take ages to recover; or they can enter into multiple and repetitive recessions (look up Triple Dip Recession). What’s worse is that not only did Europe cut off the tap of spending, but its tax increases and wage cuts further reduced the capacity of individuals to spend. It’s a cycle that’s producing political instability across the continent and is allowing our generation to witness, for the first time since World War II, a major revival of far-right parties in major European countries.

Obviously, none of this discussion takes government debt into account, the obvious justification for the aforementioned austerity policies. I’ve written in the past on the West’s ability to run deficits, but for now I’ll leave you with two possible assumptions to put your collective minds at ease. With near zero interest rates, governments can run deficits without serious fiscal risk for the time being. For the economically risque, let’s also assume that governments like America’s (with control of their own currencies), can run deficits ad infinitum provided that their present monetary structures continue unchanged.

The Commentary

With all that in mind, it’s worth noting that the article isn’t entirely correct about the United States’ fiscal policy. Before the sequester, the Budget Control Act of 2011, or the Fiscal Cliff, we had it at the state level. Public spending cuts, wage and pension cuts, mass public sector layoffs, and restrictions on unionization all started before the Federal Government lifted a finger to cut spending. And by nearly every indication, they’ve hamstrung Federal efforts to revive hiring. Nearly every state has some sort of balanced budget provision which means that they can’t even consider spending extra without taxing more; and with anti-tax sentiment pervading the political right even that becomes a nonstarter. The result is an orgy of decimation for what’s left of our government services and an economy that continually lacks the necessary orders to force businesses to hire.

Then there’s a different problem. Kaletsky ends by remarking that we have arrived in another era of Keynesian dominance. Have we really? You could have fooled me. Europe may have slowed down on cuts but nobody, here or there, is about to start ramping up spending in any significant way. All incoming governments, left or right, are busy convincing voters they can be fiscally prudent. Germany, the bulwark of current European economic policy, is still as intransigence as ever to any paradigm shifts. Japanese Prime Minister, Shinzo Abe’s fiscal stimulus is running aground against a coming sales tax hike. And the American public is likely about to return a reactionary, economically illiterate set of politicians to control the Senate. To top it off, any “Keynesian” policy now will just be governments running higher deficits in and of themselves.

That’s not enough. Remember that many Western nations run foreign deficits of some sort (trade, balance of payment, or current account deficits) which all involve local currency leaving the economy to purchase foreign products. At minimum, government deficits need to be at least high enough to fill in the gap and that’s if we want the private sector to be in the black. We do by the way.

But even then, that wouldn’t be enough. The United States ran effective deficits for a few years after the recession. But recall that unemployment never fell fast enough before we started cutting spending. Yes, GDP rebounded.. But GDP, while it’s the most common valuation method for economic activity, isn’t directly linked with our most important social indicators. POLICY matters as well. For example. The Obama stimulus was divided between tax cuts, social safety net measures, and lack luster infrastructure building projects. Economists at the time noted that the monetary value was likely insufficient and once the spending petered out, the positive effects on the economy began vanishing. Something permanent and renewable is needed. It has to be something that permanently reforms our economy away from a pure reliance on monetary policy or sole private sector investment as a source of growth. More on that next time. If there’s a takeaway from Kaletsky’s blog article and my own, it’s the following. It is the height of foolishness to disregard the largest entity in any economy, an entity with the largest amount of funds, an entity that makes the rules in an economy, and the entity that has stepped in to save it countless times before.

Chirag

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