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G20 and its Keynesian critics

The G20 consensus that public spending should be reigned in has been criticised by, among others, Paul Krugman, who are resurrecting the ideas put forward by Keynes. What are we to make of this?

The “slash public spending” argument rests ultimately on the assumption that by squeezing public spending and getting rid of some of the waste that is inevitably entailed in that, the markets will eventually sort themselves out, with wages falling to market-clearing levels and economic activity returning to something like full employment.

That this had almost never happened in the years running up to the Great Depression of the 1930s was the driving force behind Keynes’s studies. Now I do not claim to be an expert on Keynes or even to have read him at first hand, but, and I stand to be corrected, I understand that one of the main points of his theory is that economies tend to suffer from a shortage of aggregate demand that governments must stimulate by running budget deficits.

Keynesianism applied

The policy was widely applied after World War 2 and appeared to work well. Inflation ran at a rate of about 2% and there was reconstruction to be done. But gradually, the rate of inflation rose and the UK suffered from a financial crisis in the mid-1960s. Inflation started to rise, in particular after the “dash for growth” under the Heath government in the early 1970s. At the same time, the UK suffered the first of the post-war booms and busts. The bust has normally been attributed to the sharp rise in oil prices in 1973 but it was preceded by a property (land) price bubble and the rise in oil prices is in itself no reason why a bust should have occurred. It is more likely that the oil price rise triggered something that had already been primed by the land price rise.

From this, however, it is reasonable to conclude that the Keynesian recipe was not and is not sustainable. In the later 1970s came very high rates of inflation in the UK, intervention by the IMF, the election of a Conservative government and the Thatcher squeeze. That led to a period of mass unemployment, the collapsing of British industry, the growth of the largely parasitic financial services “industry” and two more boom-busts. There are substantial areas of the country where unemployment is chronic, where there families with three generations out of work. A new underclass has emerged. Thus the famous “lost demand” has returned. Yet Keynesian theory never explains how it arises.

A circular argument

A Keynesian apologist will explain the thing roughly so…

There may be unlimited demand in terms of what people desire, but in terms of actual demand, that is determined by what people are able and willing to pay or exchange etc., and that’s determined by what they can earn, produce, what assets they have, which is not unlimited. A child of five could see that if, for example, you can earn more, in effect you can give yourself more time to do those things. And if you sustain demand a la Keynes, then you can maintain the economy and wages.

This is a circular argument. A snake trying to feed on its tail. What determines what people can earn? If they have access to all the factors of production, they can earn as much as they are capable of producing. If they do not, then they can produce nothing and then have nothing to bring to the market to exchange for what they want for themselves. Keynes never even comes near to addressing this.

Of course there is no point in anyone producing things for which the demand has been satisfied, but demand comes from desire ie people want stuff. That is what advertising is largely about, to make people want stuff they would not have otherwise have wanted, or had never even thought of wanting. “Lack of demand” cannot be a reason why people should periodically be thrown out of work in large numbers for extended periods, creating a situation which can only be remedied by the accounting fiddle of permanent deficit budgeting ie depreciating the currency.

Neo-liberalism takes over

The ruling economic theory can be described as neo-liberalism. Arguably, it is dangerous nonsense peddled by privileged groups who lack a sense of sound economics or even basic humanity. Anyone who is willing to support policies that will lead to long-term mass poverty is either stupid, wicked or both. And given that social unrest is likely to develop from the situation they are incubating, things could misfire badly.

However, Keynes is discredited by events. One does not have to be right wing or libertarian to recognise that. Keynesian theory, as a whole, is dead. However, he threw up some useful insights into the economic process and these need to be taken notice of, but where can we go from here? What is the real origin of the mysterious “missing demand”?

What caused the crash?

Human demand is unlimited. There is not a shortage of labour. There is not a shortage of physical capital, since it can always be produced. There is apparently a shortage of credit, due to the problems that the banks created for themselves, but how did they do that? It is said that they caused an asset price bubble which subsequently collapsed, but that provides no satisfactory explanation. Why were the banks taking on bad debt?

  • What was the motivation?
  • What was the mechanism?
  • What was the borrowing for?
  • What was being used as collateral?
  • Why did the bank managements fail to see that what they were doing was risky behaviour?

Too many simple and obvious questions are still not being asked. Too many “facts” are still being taken for granted. But should governments return to the Keynesian principles of deficit budgeting?

One can reasonably argue that it is good practice to borrow in order to create new infrastructure. One can, with less justification, argue that it is sound practice to borrow to repair existing infrastructure. But borrowing is normally done with the intention that the borrower will enjoy an increased return as a result of the investment.

A deficient theory

If, say, a government borrows to construct a new, and needed (that qualification is important) item of infrastructure, how does that bring increased revenue to the government later on? There is no mechanism for collecting the addition stream of wealth created by the infrastructure. Who, in fact, reaps the benefit? Keynes never explains. The theory is not entirely wrong, it is, quite simply, deficient.

The theory we in the Campaign are working to can provide a plausible explanation for both the “lost demand” and a practical means of recovering the wealth created by investment through deficit budgeting. Lost demand is due, essentially, to land being under-used or out of use, thereby throttling the economic process. The wealth created by deficit budgeting for infrastructure investment can be captured by collection of the rental value of land, since it is land values that are supported and enhanced by infrastructure. If the right sort of land value taxation is in place and deficit budgeting is used only to pay for necessary infrastructure, governments can indeed spend their way out of a recession without inflationary consequences.