By Adam Kaiser
There has been much buzz about our northern neighbor’s new government under Justin Trudeau. Between his shiny aesthetically diverse cabinet, charming good looks, and embrace of “Millennial Politics” he’s all the rage nowadays. However it also marks something else of equal importance that’s snuck in relatively unnoticed; John Maynard Keynes’s worn policies have returned once again to Canada. While not in extremely bad shape Canada’s economy is technically in a recession right now. After running a balanced budget for several years Trudeau’s promise of sweeping deficit spending to jumpstart the economy has gained in popularity. There is a problem with this- Keynesian deficit spending has never been proven successful. It has been tried again and again with no concrete result except for a large debt to show for it.
Keynes’s ideas exploded onto the economics field during the Great Depression where the prolonged downturn with an excruciating slow recovery left people desperate for a quick fix. With one simple problem and one simple solution, boosting aggregate demand, Keynes’s magnum opus, The General Theory of Employment, Interest and Money, captivated policy makers. The New Deal was partially inspired by some of Keynes earlier works. This is where reality starts to hit though; as two UCLA economists pointed the New Deal added seven years onto the Great Depression. I find it personally amazing how fondly an abject public policy failure is remembered in the American conscious but that’s a matter for another time. Its unfair to discredit Keynes based on one data point though especially considering that the New Deal was a total hodge-podge of bad ideas and that WWII, which involved mega-spending, is generally considered what finally ended the depression. However another challenge comes up at the end of WWII when it was time to shut the war machine down. Government spending was about to tank and Keynes disciples were predicting a slide back into the Great Depression. Instead as we know the economy took off. This misstep was simply forgotten and the boom was chalked up to an increase in aggregate demand from returning soldiers. Everything kept chugging along fine until the 1970’s when a combination of factors led to stagflation where a high rate of inflation occurred alongside a deep recession. The Keynesian orthodoxy had no explanation for this as tradition Keynesian theory had regarded high unemployment and high inflation as mutually exclusive expressed by the Phillips curve. They also had no solution as their traditional prescription, fiscal policy would do nothing but send the economy spiraling into hyperinflation. Finally public opinion had seemed to turn against Keynes. Paul Volker, a monetarist, was appointed chairman of the Federal Reserve and quickly spiked interest rates to reign in inflation (albeit at the cost of a quick, sharp recession) and combined with a wave of deregulation and tax cuts, led to the strong steady growth seen through the rest of the 80’s and up until 2008 with a few minor interruptions.
Finally out of fashion in America for the time Keynesian failures moved overseas. Around 1990 Japan fell into a significant recession, fortunately for them their government promptly responded with a series of major stimulus packages ready to boost aggregate demand and spend their way straight out of the recession. Unfortunately the next 20 years would be known as the Lost Two Decades as they struggled and fail to jump out of the recession. From 1995-2007 nominal GDP fell nearly a trillion dollars and real wages fell 5%. It wasn’t for lack of trying though. Every Keynesian tool in the book was promptly put too work. Interest rates were slashed to zero, and during the 90’s the government passed ten stimulus packages totaling more than 100 million yen. All this was done with nothing but further stagnation to show for it. However on the other side of the world Germany fell into a recession in 2001 and instead of reactionary governmental spending they engaged in free market solutions cutting taxes, slowing government spending, privatizing pensions, etc. By the end of 2002 their GDP and employment rate had swung right back up.
Keynes hadn’t left America indefinitely though, after the 2008 financial crisis he emerged back into popularity with bailouts being swiftly provided to large banks and a $900 billion stimulus package being passed by congress with the expressly stated goal and projection of bringing unemployment under 8% and swiftly bringing it down to 6%. The result, unemployment rose to 8% and stayed there for three years. So after all this failure why do people still cling to worn Keynesian dogma? The answer may lay with what Frederic Bastiat termed “that which is unseen” now known better as opportunity costs. First off everyone loves an activist government and it is easy to see the jobs created on highways, or other infrastructure by federal spending but what you don’t see is the jobs and projects that could have been created had the money stayed in the private market. The core fallacy of Keynesianism is that the government can’t create value it can only redistribute it. All government spending has to be printed (which is just inflation) or pulled from private industry by either taxation or borrowing. Taxing government spending actually has a slight negative effect on aggregate demand due to inherent governmental inefficiencies that go with the bureaucracy of collecting it. Borrowing is just as bad since when you save your money at a bank, the bank lends it out where it’s spent on capital investments. When the government borrows money to increase spending, there is less available for private investment spending to do so leading to an insignificant change in overall aggregate spending (plus it has to be paid back with taxes later). It is taking a bucket of water out of the deep end of a pool and pouring it back into the shallow end. The Keynesian response to this and the cornerstone of their entire philosophy is that in the short term prices especially wages can be sticky leading to a brief period where there are stagnant resources available that the government could step in and put to work. The issue with this is that resources are typically stagnant due to government intervention. At the onset of the Great Depression Herbert Hoover asked business leaders to adjust prices but spare workers wages. This gesture while noble resulted in the sticky wages that kept the market from reaching equilibrium. Also unemployment benefits make it a lot more comfortable for unemployed workers to wait for a job of equivalent salary rather than take a wage cut in a new job. This might sound a little suspect to many here at Olaf but before the Great Depression there was a very large depression in 1920-1921 during which there was no effort on behalf of the legislature or the Federal Reserve to fight it with fiscal or monetary policy. Wages were not sticking, actually falling 20%, and by the end of 1921 the economy had recovered being well on its way into the Roaring 20’s.
It’s tempting to fall into the Keynesian trap. Everyone wants there to be an easy fix during times of economic trouble. However recessions are the result of market corrections to economic bubbles caused by malinvestment and thus are inevitable. It’s only when we in our arrogance try manipulating market forces that the true disasters happen. The idea that just spending money makes us richer is preposterous. By that logic congress could spend $50 billion in a recession buying themselves diamond studded gold thrones and that would be acceptable as a “stimulus”. Real economic growth is an increase in productivity driven by entrepreneurial innovation. That is funded by investment spending which derives from your savings. So my warning to Trudeau would be don’t use a mild recession as an excuse to blow away a balanced budget. You would merely join a long list of Keynesian failures. Be fiscally responsible, take your medicine and the end will soon be in sight.