<blockquote>"
The resignation of Japanese prime minister Yasuo Fukuda on the grounds that his “fiscal stimulus” of $18 billion was inadequate throws into sharp relief a troubling reality: That most economically counterproductive of activities, the Keynesian boost in government spending, is making a horrid comeback. Like some eldritch creature from a 1950s Saturday morning horror serial, the old charlatan John Maynard Keynes never stays dead.
...
The inflation and slow growth of the 1970s at last caused policymakers to question the Keynesian synthesis, and in particular its recommendation of indulging in bursts of public spending every time the economy slowed. Far from there being a neat tradeoff between unemployment and inflation, it had become clear that as Keynesian public spending was increased, economies were very likely to get both, while growth rates became ever more sluggish.
To a classically-trained economist this was not surprising. Government spending, as Nobelist James Buchanan was to point out at length through public choice theory, involves bureaucrats disposing of resources in ways that suit the bureaucrats, not the owners of the resources. Consequently, it is much less efficient than private sector spending, automatically optimized by the resources’ owners. Hence diverting resources to the public sector has a substantial cost in productivity and growth, worsening the tradeoff between unemployment and inflation.
...
Alarmingly, the return of Keynesian deficit spending is not confined to Japan. In both Britain and the United States, governments of opposite political persuasions have found it convenient to spend public money, while excessively low interest rates have kept the apparent cost of financing their deficits artificially low. In both countries, the bursting of housing bubbles produced by over-expansionary monetary policies have caused governments to invent various housing bailout schemes, all of which increase public spending without providing a means to finance it. The resulting recessions, possibly accompanied in the US by the advent of a leftist government, will cause demands for additional spending to spiral. The politicians will accommodate these demands, since memories of the 1970s are now dim, while the more recent memories of the (temporarily non-inflationary because of innovations in global communications) something-for-nothing possibilities of 1995-2006 will prove only too alluring."</blockquote>
Resurrection of the charlatanBy Martin Hutchinson
September 08, 2008
SourceMartin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site www.greatconservatives.comThe resignation of Japanese prime minister Yasuo Fukuda on the grounds that his “fiscal stimulus” of $18 billion was inadequate throws into sharp relief a troubling reality: That most economically counterproductive of activities, the Keynesian boost in government spending, is making a horrid comeback. Like some eldritch creature from a 1950s Saturday morning horror serial, the old charlatan John Maynard Keynes never stays dead.
Even before the Great Depression, Keynes had been seeking some way to make his mark on economics that involved overturning some part or other of the classical economic paradigm. Since the world was still primarily on a gold standard, he couldn’t usefully invent monetarism – in any case, he never seems to have got the hang of interest rates. Denouncing Britain’s 1925 return to the Gold Standard was enjoyable, giving rise to numerous witty epigrams that went down very well with his Bloomsbury friends, but it was not sufficiently original – too many other economists were doing the same thing.
Since the most enjoyable part of Keynes’ career had been his period as a senior civil servant, it was natural that he should see economic life as best directed by a team of highly intelligent civil servants like himself. It’s a well-known conceit; sitting in a comfortable armchair one can always see how the world should be better organized, the only difficulty being how to get oneself appointed dictator with the power to organize it. Keynes faced only two problems. First, the existing economic theories postulated a government that was small in terms of the economy as a whole and pursued balanced budget policies – so could have little effect on major economic trends. Second, the political party he supported, the Liberals, was undergoing a series of traumatic election defeats, well on its way to utter irrelevance.
Keynes’ work advising Lloyd George in the run-up to the 1929 election was seminal. He discovered that politicians, particularly activist ones with little grasp of economic reality like Lloyd George, were delighted to be given a rationale for spending more of the taxpayers’ money on social programs, which could be used to bribe voters. While the immediate result of Keynes’ work in the May 1929 election was failure, it left the Liberals and Keynes as their chief economic adviser in a position of balance of power. For two years, he could use his powers of persuasion to advance his theories, while disparaging efforts by the Conservatives and by the cautious Labour Chancellor of the Exchequer Philip Snowden.
Keynes’ dreams of power came to a sharp end in 1931, with the collapse of the Labour government. The new Chancellor of the Exchequer Neville Chamberlain thoroughly distrusted Keynes and cut him off not only from the advisory top table but from his sources of insider information which had proved so lucrative – causing Keynes’ net worth to decline by two thirds between 1931 and 1936, even as the market was recovering.
Keynes despised the highly successful Chamberlain economic policies of public sector pay cuts and a modest tariff, which produced almost immediate economic recovery and made Britain’s 1930s experience far more benign than America’s. To get his revenge, he flirted with Communism and wrote the “General Theory of Employment Interest and Money” – two out of the three of which he knew very little about. The book was immediately influential among left-leaning civil servants, and resulted in Keynes’ readmission to the corridors of power when war broke out in 1939.
From then until the 1970s, Keynes was never out of power, in the flesh until 1946 and then in spirit. Much of Britain’s postwar poverty and lack of economic growth were due to his pernicious influence, whether domestically, in ensuring that government always overspent, or internationally, in setting up the statist postwar financial system, that destroyed the British Empire (by ending Imperial Preference) gave Britain thirty years of economic stagnation punctuated by balance of payments crises and left us with the World Bank and IMF, still blighting the world economy today.
The inflation and slow growth of the 1970s at last caused policymakers to question the Keynesian synthesis, and in particular its recommendation of indulging in bursts of public spending every time the economy slowed. Far from there being a neat tradeoff between unemployment and inflation, it had become clear that as Keynesian public spending was increased, economies were very likely to get both, while growth rates became ever more sluggish.
To a classically-trained economist this was not surprising. Government spending, as Nobelist James Buchanan was to point out at length through public choice theory, involves bureaucrats disposing of resources in ways that suit the bureaucrats, not the owners of the resources. Consequently, it is much less efficient than private sector spending, automatically optimized by the resources’ owners. Hence diverting resources to the public sector has a substantial cost in productivity and growth, worsening the tradeoff between unemployment and inflation.
Using OECD figures for public sector size and economic growth you can run a regression for the period since 1960. You will find that more than half the differences between countries and eras in growth rates can be explained by two factors: the size of the public sector and its rate of growth. Very large public sectors lead to very sluggish economic growth rates, while the fastest growth rates among OECD members are in countries such as Korea and Japan before 1990 that have the smallest public sectors. Further, periods of rapid public sector growth, as in Britain in 1964-79, West Germany in 1969-76 and France in 1974-82, produce sluggish or non-existent economic growth, even if the public sector early in the period is relatively modest.
The revival of free-marketism in the 1980s and its successes, first in Britain and the United States, and then with extraordinary results in East Asia, China and India, appeared to have doomed Keynesianism to a well-deserved irrelevance. To the extent that “stimulus” was thought necessary, it was carried out by tax cuts rather than spending increases. These proved equally politically popular and less damaging to long term growth. Unless, as in the case of the Reagan tax package of 1981 and the US dividend tax cut of 2003, the tax cuts had a substantial supply-side effect, this “Republican Keynesianism” however produced ever-larger budget deficits, which could only be financed through ever-looser monetary policy.
The “Washington Consensus” of the 1990s, supported even by the naturally statist World Bank and IMF, notably did not include support for Keynesian reflation. Indeed, it was largely deflationary, although in deference to its origins it generally took the existing level of public spending as a given and balanced budgets through tax increases, rather than the other way around, thus producing a ratcheting up over time in the size of governments.
In the 1990s, the last bastion of Keynesian public spending was Japan, where the collapse of the 1980s bubble produced a lengthy recession, worsened by the refusal of the Japanese banks and their regulators to recognize that most of their real estate loans were of little or no value. Stimulus package after stimulus package was introduced, largely taking the form of infrastructure projects in rural areas (popular with backbench LDP parliamentarians.) The most notorious of these, in 1998, was for no less than $400 billion, 10% of Japan’s Gross Domestic Product. Needless to say, these packages had no positive effect – the 1998 effort indeed produced a renewed lurch into deeper recession, as free marketers would have expected. They merely increased the size of Japan’s public sector, depressing the economy’s efficiency and long term growth and caused its public debt to spiral to over 180% of GDP.
The futility of Keynesian public spending stimuli was demonstrated exhaustively in Japan in 1990-2001; the success of the opposite policy, cutting back the size of the public sector and allowing the private economy to expand into the economic space opened up, was shown by the government of Junichiro Koizumi after 2001. From the early months of 2003, when the new policies began to take effect, Japan resumed healthy growth. As of Koizumi’s politically forced retirement in 2006, all that was needed was an increase in short term interest rates, to prevent inflation and give adequate returns to Japan’s legion of savers, and continuing budgetary restraint, to reduce the deficit, start paying down the monstrous public debt and return Japan to the small-government position that had produced such remarkable economic growth before 1990.
Regrettably Koizumi’s retirement produced opportunities for backsliding. His two successors, Shinzo Abe and Fukuda, tried to maintain his policies but were less skilful than Koizumi in facing down the public spending barons. At the central bank Toshihiko Fukui, the sound-money governor chosen by Koizumi in 2003, stopped increasing interest rates in early 2007 because of an upper-house election campaign, then wimped out at a crucial meeting in August 2007, as the cheap-money faction was able to claim that the beginnings of the US subprime crisis required Japan to maintain low interest rates. When Fukui’s term ended in March 2008 he was replaced by an inflationist, and Japan’s short term rates are now substantially negative in real terms.
With Fukuda’s resignation, and the likely succession of pro-spending Taro Aso, the path is now clear for Japan to return to primitive Keynesian public spending, combining it with negative real interest rates in a poisonous combination reminiscent of 1970s Britain. This will produce one of two outcomes. If the Bank of Japan is more inflationary than the Ministry of Finance is profligate, inflation will soar, reducing the real value of Japan’s government debt, but impoverishing the middle classes and producing long term stagflation. Alternatively, if Ministry of Finance profligacy wins out, inflation will not destroy the value of Japan’s public debt quickly enough, and its size will spiral upwards until the country is forced into default. Not a happy future either way.
Alarmingly, the return of Keynesian deficit spending is not confined to Japan. In both Britain and the United States, governments of opposite political persuasions have found it convenient to spend public money, while excessively low interest rates have kept the apparent cost of financing their deficits artificially low. In both countries, the bursting of housing bubbles produced by over-expansionary monetary policies have caused governments to invent various housing bailout schemes, all of which increase public spending without providing a means to finance it. The resulting recessions, possibly accompanied in the US by the advent of a leftist government, will cause demands for additional spending to spiral. The politicians will accommodate these demands, since memories of the 1970s are now dim, while the more recent memories of the (temporarily non-inflationary because of innovations in global communications) something-for-nothing possibilities of 1995-2006 will prove only too alluring.
Eventually deep recession and spiraling inflation will cause even politicians to realize they have got it wrong. By that stage however government will be taking an even larger portion of the economy than it is currently and long term growth prospects will be correspondingly depressed.
“Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back,” said Keynes. One of the very few times he got it right.