Friday, August 05, 2011

The Left's Favorite Economist (and it's not Paul Krugman)

Would you buy a car designed by Henry Ford? Or fly in a plane that Lindbergh might have flown? Was your doctor trained by someone born in the 19th century? The answer to these is probably 'no'. So why do economists swear by John Meynard Keynes?

After yesterday's stock market crash the left is calling for more stimulus spending. They justify this using Keynesian economics.

Keynes believes that markets were imperfect and that government can improve on them in maximizing employment and minimizing economic downturns. He saw a recession as being caused by people saving too much of their money. His prescription was for the government to take up the slack by spending more, particularly on infrastructure projects.

This is a seductive idea for politicians in general and even more so for the ones who are convinced in the powers of government to do good. It lets them be seen doing something during an economic downturn and, to politicians, being seen working on problems is more important than solving them, even if they are actually making things worse.

While the left uses Keynes as justification, they don't actually believe in him. He not only suggested government spending, he also felt that the government should cut taxes during downturns. Try selling that to today's Progressives.

Keynes saw government as a moderating force. It should spend more during hard times but during the good times, it should slow the economy by cutting back on spending and raising taxes. This would help to balance the spending and tax cuts from the bad times. No one ever followed through on that part so Keynes became an excuse for ever-expanding government.

There were always problems with Keynes. It was long assumed that there was a direct inverse relationship between inflation and unemployment. Raising one causes the other to drop. Government's job was to find the optimal balance point. The stagflation of the 1970s discredited this theory and threw Keynes into disrepute until the Great Recession.

In the meantime, the problems with Keynes's policies have multiplied over the decades. In the 1930s most labor was unskilled or semi-skilled. If there was widespread unemployment in one sector of the economy it was fairly easy for workers to move to another sector. Today's workforce is much more skilled. An unemployed web designer is unlikely to take a job running a bulldozer. Moreover, with up to two years unemployment benefits, office workers do not have an incentive to take a construction job. This means that infrastructure jobs will not help the economy as a whole.

Then there is the lag in starting infrastructure work. President Obama already found out that there are no "shovel ready" jobs. He's even joked about it. In the 1930s, if the government wanted a bridge, it bought the land, hired an engineer, and started work. These days, before work can start the government has to do a traffic study and an environmental impact study. There may be legal challenges to eminent domain. The contracts for designing and building the bridge have to be bid out. All of this adds years to a project and makes immediate economic relief impossible.

There is also the problem that the government does not actually create jobs because it does not have any income of its own. What it spends comes from others as taxes and loans. Taxes take money from one part of the economy and put it into another. Economists sometimes claim that there is a multiplier effect where the money the government spends generates additional economic activity, offsetting the taxes. This is controversial and almost impossible to prove one way or the other. This can be offset somewhat by financing the projects with bonds as long as the deficit is eventually addressed and as long as the downturn does not go on too long. This is where we are now. We have spent three years trying to offset a downturn with high deficits and our debt is rapidly getting out of control.

Which is where we are now - two years into a flat recovery with our quiver of Keynesian tools exhausted.

The modern Keynesians have an answer for this, of course - more of the same. Much more. Keynes didn't fail, it was the scope of the stimulus that failed. We need to spend trillions more in order to get the economy to take off. It doesn't matter if we can afford it. It has to be done.

But what if we continue to spend and nothing happens? That's what happened in the Great Depression (Yes, I know that FDR tried to cut the deficit in 1937 and brought on a new downturn. He also raised taxes and implemented Social Security early.) The sad truth is that the Keynesian's first instinct will probably make things worse.

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