I take a fair number of jabs on Twitter at President Obama’s economic policies because, well, frankly, I think he is terribly misguided. As a result, I’ve had to watch numerous liberals jump to his defense and try to explain Keynesian economics to me. Now, I’m not a professional economist, but I have taken several undergraduate and graduate economics courses, I read about a dozen books on economics each year (even some advanced textbooks) and I attend seminars in the Cambridge/Boston area from time to time about economic issues that interest me. I’ve spent the last two years particularly fascinated by the resurgence in Keynesian economics.
So, I do believe I have a better understanding of economics than most people, even most educated people, and what follows is my explanation of Keynes’ key ideas. I also want to point out that, this isn’t a right/left debate like most people think. Bush was a huge Keynesian, and I believe Obama’s economic ideas are closer to Bush’s than they are to Clinton’s, which is why it seems so philosophically inconsistent to me to hear Clinton fans praising Obama. Clinton’s ideas were closer in alignment to Reagan’s ideas, both of who were influenced by Milton Friendman.
Anyway, I’ll explain my understanding of Keynes, and will wrap up by explaining why I think his ideas are destructive in our current economic climate.
First of all, let me address a key point: modern liberals and modern conservatives are both Keynesians. The primary economic innovation that Keynes brought was this idea that the in the short run, aggregate demand and aggregate supply may not match up, and that aggregate demand is the part of the equation you want to influence. There are two ways to do this. One is to have the government spend more to increase demand. The other is to cut taxes so that individuals have more to spend to increase demand. The former is the Keynesian path preferred by the Democratic party. The latter is the Keynesian path chosen by the Republican party. The point though, is that both are Keynesian.
Secondly, when Keynes advocated increased government spending, he was not referring to the stuff we do today. His logic at the time, when Britain faced high unemployment, was that the government was paying a lot of money to the unemployed, and that it would be better to just hire them and put them to work, instead of paying them to do nothing. Putting people to work would stimulate the economy and give everyone a psychological boost (let’s face it, most people like having a job) and the rest would take care of itself.
What I constantly hear is “hey, don’t we want to spend to make investments to grow the economy and get out of this slump?” But, the Obama administration is not doing that. This administration has decreased the federal workforce and has cut non-defense discretionary spending. In other words, the services the government provides and should provide are the areas being cut. Why? Because politicians are cowards who are more concerned with re-election than anything else, so rather than touch entitlements, the real problem, they nip and tuck here and there and say they are doing something about the problem.
So our problem is that, even if we were trying to be Keynesian, we aren’t. The “investments” we are making are actually very little. We are cutting things we shouldn’t be cutting, and are making the government primarily an entitlement machine mostly concerned with the transfer of wealth. Not all government spending is Keynesian, and based on what I have read about the man, I don’t believe he would have supported a massive entitlement state. Why are we doing this? I don’t know, but if I had to guess, I would give three reasons.
1. Obama believes that by shifting the burden of healthcare to government, he can fix the system. I believe this will turn out the same way it did when the government tried to fix education and tried to fix home ownership… they will make it worse, or have no impact except to waste a bunch of money. I know liberals disagree and believe that smart people working through government can solve big problems. But there are very few examples of government success at this scale, particularly when they meddle in economics.
2. No one will touch social security because old people vote in larger numbers than other people.
3. The Democrats and Republicans both want to prop up the economy artificially, even if it leads to inflation, because that helps the rich and protects their investment portfolios and leads to more campaign donations. Inflation will slam the poor’s standard of living, but they don’t donate big money to campaigns so who cares.
I don’t think Bill Clinton was a Keynesian. Why? Because he passed NAFTA, he cut unemployment benefits and reformed welfare, and he was concerned with balancing the budget because he believe a government deficit sapped money out of the private economy that could be used to fund growth and innovation. Reagan, despite cutting taxes, didn’t do it because he was a Keynesian, he did it because he philosophically opposed government and wanted to minimize government’s impact.
Now, some Republicans will claim that Republicans don’t believe in tax cuts for Keynesian reasons, but rather, because cutting taxes can lead to more revenue. Why do they think that? Because in the past, tax cuts at certain times actually have led to more tax revenue (but most times they haven’t). But, this happened when tax rates were very high, and were significantly slashed, so they actually changed behavior. I don’t honestly believe that most Americans change many of their decisions for a tax increase or decrease of a few percentage points. But when you are taking a massive ax to marginal rates like Reagan did, yeah, that can matter. But the truth is, Bush’s tax cuts were intended to be Keynesian.
I don’t believe what Obama is doing would actually be considered Keynesian by Keynes himself. But that said, I am not a fan of Keynesian stimulus in general. Why? Well first of all, Japan has tried it for two decades and it hasn’t worked.
But even beyond that, it just doesn’t make sense for the current situation. The economy that existed when Keynes proposed his ideas was not the economy we have today. In his day, he was trying to smooth out the business cycle and what he believed were inefficiencies in the free market that occurred because of over investment, or sometimes over saving. I believe that Japan’s boom, and the boom in the U.S., were created by playing with the money supply, and Keynesian economics can’t cure that type of hangover. Let me give you an example. There is a big difference between when your body is naturally tired, so you take some caffeine, and when your body is tired because you have been oscillating between caffeine and some downer drug for months, and you try to take some caffeine. If your body is tired for the first reason, caffeine will have an impact. If your body is tired because you are trying to modify it constantly with all kinds of drugs to control your energy level, the caffeine may have a very different impact. It may even fall flat, or cause more problems. All you can do at that point is suck it up and go through withdrawal.
The U.S. economy is the same way. Keynesian ideas worked back when the economy was otherwise left to its own devices. Then we could go in and guide it a bit. But we started trying to guide it more and more, and now we are trying to use the same medicine to solve our problems that got us into these problems in the first place.
I don’t think there is any way out of this mess except a few painful years of austerity to get back on track, or at least feigned long term austerity by major entitlement reform that may provide some confidence to the economy. My guess is that our politicians don’t have the guts to do that, so they will continue trying to stimulate the economy for another decade, we will see many false starts where we believe it is working, only to be disappointed again, and then finally, a new generation of leaders will take us in a new direction.
To end, I want to point out something very very important. Economic ideas are actually very difficult to test in a controlled environment, so we have to rely on real data which is messy and has a zillion variables influencing it, some of which we may not understand yet. I believe that the economic ideas en vogue at any given moment have more to do with which economists are popular, not the validity or accuracy of their ideas. In the 80s and early 90s, Milton Friendman was king. He was witty, smart, and usually won debates with his great aphorisms. (My favorite may be “if you put the federal government in charge of the Sahara desert, in 5 years there would be a shortage of sand.”) As he aged and his influence waned, Greenspan was the go to guy for a brief while, but then Paul Krugman rose to the top.
Krugman is the most prolific and popular economic writer of the past few years, so his ideas therefore permeate the consciousness of the American thinking class, who of course all believe they are open minded and independent thinkers but really just repeat the things they hear on NPR, read in the NY Times, or watch on the Daily Show. Why pick up a book that might challenge your thinking when you can listen to pseudo-intellectual babble and pretend it’s gospel?
The Republicans put their faith in Rush and Fox News. The Democrats have their gods too, those I mentioned above. Those brave enough to think for themselves usually find that it isn’t worth the time, and no one cares anyway. A vote is a vote. How much time you devote to understanding the issues doesn’t factor in.