THIS year marks the 80th anniversary of the Keynesian Revolution, spearheaded by the British economist John Maynard Keynes – regarded as the founder of macroeconomics. The groundbreaking and momentous year in history was 1936 when he published his magnum opus, “The General Theory of Employment, Interest and Money” – a book whose theorem and postulates still populate economic textbooks, dominate fiscal discussions and shape macroeconomic policy.
A year before publishing his seminal work, this clairvoyant of the dismal science had written a letter to Irish playwright and controversialist Bernard Shaw, expressing the following sentiments: “I believe myself to be writing a book on economic theory which will largely revolutionize – not, I suppose, at once but in the course of the next ten years – the way the world thinks about its economic problems.” Lo and behold, it turns out that he was indeed right about the transformative impact of his theories – and his forecasting wasn’t by any measure an act of sheer hubris.
For as long as macroeconomics has been around, there have been few more hotly debated topics than what role the STATE should play in the economy, notwithstanding the fact that prominent economists the world over have provided plenty of examples of market failure (climate change, health care and housing, for instance) that seemed to have justified direct government intervention through fiscal and monetary policy, as well as through regulations and conditionalities.
Citing the need to moderate booms and busts, the main plank of Keynes’ economic theory is that government intervention through active fiscal policy can stabilize an economy – and that spending by households, businesses and the government is the most important economic driving force – effectively countering the idea that free markets would automatically provide full employment and price stability, as the monetarists and neo-liberals believe.
Considered to be the intellectual founding father of the IMF and the World Bank, Keynes was insistent that the market is a kind of wild animal that needs to be tamed and governments can and should prevent recessions and depressions through demand management – arguing that demand creates its own supply – in direct opposition to Jean Baptiste Say’s Law which posits that supply creates its own demand. Further, Keynes maintained that inadequate overall demand could lead to prolonged periods of high unemployment and that state intervention is necessary to moderate the vicissitudes of the business cycle.
Keynesianism, whose proponents include Nobel Prize-winning economists Paul Samuelson, Joseph Stiglitz and Paul Krugman, came to life in the 1930s in response to the debilitating depression which ravaged the American economy and subjected many to a life of misery and destitution. By historical account, President Franklin D. Roosevelt’s New Deal (a relief, recovery and reform plan to rescue the United States from the Great Depression) was flavoured by Keynesian ideas, although the true extent of its impact is still being debated today. The Great Recession of 2007-2009, triggered by the financial dysfunctions and infelicities of American capitalism, saw the return of Keynesian policies by way of large stimulus packages (increased government spending and subsidies, and reduced taxes) which brought some of the world’s traumatized economies back to life.
The Columbia University Professor Joseph Stiglitz, who has consistently called for fiscal expansion during hard economic times especially when monetary policy is constrained, argues in a trenchant piece for the British Guardian entitled, “After The Financial Crisis We Were All Keynesians”: “A bloated and dysfunctional financial system had misallocated capital and, rather than managing risk, had actually created it. Financial deregulation – together with easy money – had contributed to excessive risk-taking. Monetary policy would be relatively ineffective in reviving the economy, even if still-easier money might prevent the financial system’s total collapse. Thus, greater reliance on fiscal policy – increased government spending – would be necessary. Five years later, while some are congratulating themselves on avoiding another depression, no one in Europe or the United States can claim that prosperity has returned…Yes, we were all Keynesians – but all too briefly. Fiscal stimulus was replaced by austerity, with predictable – and predicted – adverse effects on economic performance.”
John Cassidy, economist and author of the book, “How Markets Fail: The Logic of Economic Calamities”, shared a similar view when he wrote in The New Yorker: “In the real world that rarely intrudes upon conservative economists and voters, both parties (and all Presidents) are Keynesians. Whenever the economy falters and private-sector spending declines, they use the tax-and-spending system to inject more demand into the economy. In 1981, Ronald Reagan did precisely this, slashing taxes and increasing defence spending. Between 2001 and 2003, George W. Bush followed the same script, introducing three sets of tax cuts and starting two wars. In February, 2009, Barack Obama introduced his stimulus. The real policy debate isn’t about Keynesianism versus the free market, it is about magnitudes and techniques: How much stimulus is necessary? And how should it be divided between government spending and tax cuts?”
Of course, Keynesian economics is not without its fierce critics and some of its ideas haven’t found resonance everywhere. The view that governments can “manage” demand has been categorically rejected by a school of thought called Monetarism, led by the late Nobel laureate Milton Friedman and the Neo-Liberals headed by the late Friedrich Hayek (another Nobel laureate and student colleague of our own Sir Arthur Lewis) – which contends that government should “keep its hands off the economy, cutting back on regulations, and instead allow the free market – supply and demand – to determine prices and wages.” Perturbed by the fact that governments were often unable or unwilling to provide short-term relief to their people in times of recession, Keynes was exasperated by the view that, “provided the government doesn’t interfere, in the long run the economy is an equilibrium which will eventually return to a point of balance”, – to which he once replied: “Long run is a misleading guide to current affairs. In the long run we are all dead.”
Not surprisingly, some of Keynes’ policies have been labelled “left wing” and there are even suggestions that his main work be rewritten, as some mainstream economists and policymakers have cited theories that have been discredited, and ideas that have allegedly strangulated the free market. But, I ask in earnest, have we ever truly lived in a free market economy?
Writing in Forbes Business Magazine, Peter Ferrara bemoans what he sees as the failure of Keynesian economic policies to spur growth: “By the 1970s, Keynesian policies had produced double digit unemployment, double digit inflation, and double digit interest rates, all at the same time, along with four successive worsening recessions from 1969 to 1982. Keynesian monetary policy involves running up the money supply to increase demand, with artificially lowered interest rates promoting more spending. That is where the inflation came from. Ronald Reagan explicitly scrapped Keynesian economics for the more modern supply-side economics, which holds that economic growth results from incentives meant to boost production.”
Be that as it may, some of the economic ideas of Keynes have survived the test of time and have become immortalized in the lecture halls of universities as well as in the finance ministries of governments around the world. Paul Samuelson is quoted to have said, “Funeral by funeral, theory advances” – and so have the works of Keynes. Although he never won the Nobel Prize in Economics (the prize was first awarded in 1969, long after his death), his theories are an established fixture in economics education and his ideas have shaped the course of history. By any metric that mattered, John Maynard Keynes was the greatest economist of the 20th century. If indeed he had an Achilles heel, it was his “State” theory. That is, the assumption that the “State” always cares about its people.
For comments, write to [email protected] – Clement Wulf-Soulage is a Management Economist, Published Author and Former University Lecturer.
Someone may have forgotten to give the Republicans in congress and many European governments a copy of Keynes playbook. Also, one can reasonable argue, as Paul Krugman often does, that the Obama administration’s stimulus package, which was under a trillion dollars, was insufficient given the size of the American economy to change the trajectory of the great recession. Historically, during down turns in the economy, the transportation bill, used for allocating monies for the fixing and building the country’s infrastructure, was used to flood the economy with money and generate demand – but not this time. Given the interagency of the republican in congress, determined to see the Obama administration fail even at the expense of further damaging the economy, refused to even allow the transportation bill to come to the floor. Instead the Obama Administration relied on the Federal Reserve Quantity Easing (QE2) or bond buying program to flood the economy with cheap money. In the end, there is absolutely no doubt that the Keynesian’s model have stood the test of time, unlike the Republican’s Supply side, Tax Slashing, Trickle Down economic models, based more on ideology than any supportive empirical data.