Diary

Not All Of Us Are Keynesians Yet

The President-elect has come out with a massive stimulus proposal aimed at revving up the economy anew:

President-elect Barack Obama added sweep and meat to his economic agenda on Saturday, pledging the largest new investment in roads and bridges since President Dwight D. Eisenhower built the Interstate system in the late 1950s, and tying his key initiatives – education, energy, health care -back to jobs in a package that has the makings of a smaller and modern version of FDR’s New Deal marriage of job creation with infrastructure upgrades.The president-elect also said for the first time that he will “launch the most sweeping effort to modernize and upgrade school buildings that this country has ever seen.”

“We will repair broken schools, make them energy-efficient, and put new computers in our classrooms,” he said in the address.

The president-elect is bringing new elements of his domestic agenda into his economic recovery plan, committing to a path toward giving every American access to an electronic medical record as part of an “economic recovery plan … that won’t just save jobs, it will save lives.”

Sounds great! Unfortunately, it falls on Dan Mitchell to be the fly in the ointment and present some reality-based economics to the self-styled “reality-based community.” Here is something from a few weeks back showing that Keynesian theory is all wet:

. . . Keynesian theory sounds good, and it would be nice if it made sense, but it has a rather glaring logical fallacy. It overlooks the fact that, in the real world, government can’t inject money into the economy without first taking money out of the economy. Put more bluntly, Keynesianism only looks at one-half of the equation. It conveniently ignores the fact that any money that the government puts in the economy’s right pocket is money that is first removed from the economy’s left pocket. As such, there is no increase in what Keynesians refer to as aggregate demand. The bottom line is that Keynesianism doesn’t boost national income, it merely redistributes it.The people who lend the money to government generally are not the same people who get money in their pockets because of the new spending or tax rebates, but that’s not important. The Keynesian theory is based on the notion that there will be an increase in overall spending power, yet that clearly is not the case. Some advocates of this theory get a bit more creative and say that Keynesianism works because it increases consumer spending rather than the money sitting idle. But money that is unspent by consumers does not sit idle. It winds up in the banking system someplace and is used to finance investment spending. So-called stimulus programs, at best, shift how national income is used so that more gets consumed rather than invested, but at noted earlier, there is no increase in overall economic output.

[. . .]

The real-world evidence also confirms that Keynesianism is a failure. Indeed, it was a failure even before Keynes published The General Theory in the mid-1930s. In his four years, Herbert Hoover was a poster-boy for big government. He increased taxes dramatically, including a boost in the top tax rate from 25 percent to 63 percent. He imposed harsh protectionist policies. He significantly increased intervention in private markets. Most important, at least from a Keynesian perspective, he boosted government spending by 47 percent in just four years. And he certainly had no problem financing that spending with debt. He entered office in 1929 when there was a surplus and he left office in 1933 with a deficit equaling 4.5 percent of GDP. Needless to say, Hoover’s big-government Keynesian experiment was not very successful since growth went down and unemployment went up.

Unfortunately, other than being a bit more reasonable on trade, Roosevelt followed the same approach. The top tax rate was boosted to 79 percent and government intervention became more pervasive. Government spending, of course, skyrocketed — rising by 106 percent between 1933 and 1940. This big-government approach didn’t work for Roosevelt any better than it did for Hoover. Unemployment remained very high throughout the 1930s and overall output did not get back to the 1929 level until World War II.

As Mitchell goes on to show, both 1990s Japan and the Bush Administration learned that Keynesian stimulus spending did and does nothing to get the economy humming again. Mitchell specifically takes on the Obamaian Keynesian project here.

Be sure to check out both articles in full for many valuable, embedded links in their texts (in addition to checking them out because I have excerpted rather little from the first one and nothing whatsoever from the second one). And the next time that someone tells you “we’re all Keynesians now,” you will have the evidence you need to include yourself out of the Keynesian fan club.