Deep breath…
I started writing this becauese at work we got in trouble for talking about sensitive political and religious topics. One of my ‘comrades’ cleverly figured out that we could tilt the discussion onto a slightly more academic axis. He asked me what I knew about John Maynard Keynes.
I know a little. I dealt with Keynes a little bit here by way of discussing Peter Drucker’s economic views; I still hold the sentiments I shared in that post. Before that, Keynes really only registered on my radar when Krugman won the Nobel. Until then I knew Keynes mainly as a kind of ideological villain in the Greenspan-era, as well as coincidentally a friend and supporter of the young Ludwig Wittgenstein.
By luck I happened to find a copy of The General Theory of Employment, Interest, and Money in a used bookstore a few weeks ago. I was going to read it along with the Marginal Revolution book club (see also the frumpier Brad DeLong book non-club), I picked it up for a few minutes the other day, but it didn’t resonate with me and I wasn’t compelled to push myself – nor let myself get distracted from all the other stuff I’m trying to read. But scanning blogs and columns for material to work into a big post, yes, I do have time and energy for.
If you’re new to all this, start with the Time profile by Robert Reich. Or there’s the EconLib profile, or this one that has more links to resources.
The turnaround is almost incredible. In the past month alone, talk of stimulus, the “rebirth of Keynes,” and the “Keynesian moment” have drowned out the Friedman, Reagan, Greenspan crowd that dominated the discussion right up until the sub-prime collapse in 2007.
The Keynesian story – from what I understand — is that before Keynes it was inconceivable for governments to ever run a deficit (or at least it was inconceivable to do so intentionally), but in the Great Depression he argued successfully that it made sense for governments to go into debt in order to inject capital into the economy. Here’s the nut of his famous “open letter” to FDR:
The object of recovery is to increase the national output and put more men to work… Individuals must be induced to spend more out of their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes in the hands of their employees, which is what happens when either the working or the fixed capital of the country is being increased; or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. In bad times the first factor cannot be expected to work on a sufficient scale. The second factor will come in as the second wave of attack on the slump after the tide has been turned by the expenditures of public authority. It is, therefore, only from the third factor that we can expect the initial major impulse. [my emphasis]
An excellent explanation of this argument was provided by Bruce Bartlett the other day on Forbes. You need to read it, I can’t cut and paste enough of it here to do it justice. If you read nothing else though…
What Keynes figured out is that when conditions such as these exist, the federal government must step in to raise spending in the economy and thereby increase velocity. This means running a budget deficit, but that is only part of the solution. As noted earlier, spending just to buy financial assets does very little good.
We also know from the experience with tax rebates in 1974, 2001 and 2008 that this doesn’t do any good, either. People mostly save the money or pay down debts. Thus, rebates just become another form of exchanging assets that add little to spending (and hence velocity).
Keynes argued that the only thing that will really work is if the federal government uses its resources to purchase goods and services. It must buy “stuff”–concrete, computers, paper, glass, steel–anything as long as it is tangible. In other words, the government must spend the way households do, by buying things.
It must also employ labor, because much of what people spend money on today is in the form of services. This doesn’t necessarily mean putting workers on the federal payroll, it just means that, to the extent that the government purchases services, this will also help raise spending in the economy.
But Bartlett goes on, it isn’t so easy…
For what it’s worth, Keynes didn’t know what to do in this situation, either. He suggested building pyramids and burying bank notes in deep mine shafts that had been filled in. As people tried to dig up the money, they would be forced to employ labor and purchase equipment that would raise spending and thereby growth. In the end, it took the greatest war in history to make Keynes’ theory work.
Yglesias takes the opportunity to make a case for one of his hobby horses:
I think that mine idea is pretty clever. But obviously the better answer is SUPERTRAINS. In particular, whenever I start prattling on about high-speed rail, people point out that it would cost an ongodly sum of money. But in our current crisis, one of our main problems is a lack of non-ridiculous ideas about things to spend money on.
Hey, if people listened to me in July we might not be in this mess:
Just saw this interesting piece in The Onion: “Recession-Plagued Nation Demands New Bubble to Invest In” (via aldaily). It seems to have a double irony: the last laugh is on people who read (or wrote) it as straightforward satire. “The U.S. economy cannot survive on sound investments alone,” is a texbook truth. The U.S. economy has always been driven by people taking risks, many of which are unsound. A few of these succeed (if only by accident), and eventually create new industries, generating opportunities and resources for more sensible investments… The Onion’s suggestion that “perhaps the new bubble could have something to do with watching movies on cell phones” reminded me of Bruce Nussbaum’s suggestion in March that the way to pull the U.S. out of recession, “very clearly, is innovation” — citing the iPhone especially. I initially thought that was ludicrous until I realized that much of the surge in food and energy prices is largely because money has nowhere else to go. Making rules is a lazy, near-sighted solution to the problems caused by commodity speculation. What we need is a new innovation bubble-with-benefits to attract investors — one that will actually build something.
Now my concern is that people are getting so excited about the Keynesian renaissance that we’ll be too dogmatic about it — as if the spending doesn’t really count unless it comes from a government-works project.
Remember in Keynes’s time a government deficit was somewhat inconceivable. In our time we’re expect deficits and most of us can’t remember a time when the government wasn’t already in debt. Part of the problem now is the question of “how much deeper can we go in debt?” Another part of problem is that we, in our society, have a different relationship with money than people in the Great Depression: we not only expect our government to be in debt, we expect ourselves to be in debt too. We have wildly different spending habits compared to past generations – almost indifference in many cases – not to mention expectations about work, retirement, quality of life, etc.
Paul Krugman himself argued we have to be mindful of how we handle old ideas:
As readers may have gathered, I believe not only that we’re living in a new era of depression economics, but also that John Maynard Keynes—the economist who made sense of the Great Depression—is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: “Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”
We can argue about whether that’s always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes’s world—and ours—was therefore not of resources, or even of virtue, but of understanding.
We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead. Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the mind.
(First I’ve got to get my plug in and remind everyone I’ve been saying “the true scarcity is understanding” since my very first post in August 2007, and I’ll probably be trying to say it right up to my very last post before I die.)
When I read those last paragraphs from Krugman’s NYBooks article quoted above, I feel like I missed something. I’m wondering, “Which doctrines are obsolete? Keynes’s too (not to mention the underlying, virtually invisible assumptions shared by both Keynes and Friedman and every other economist in the last century)? When do we stop praising the man’s ideas and hammer out our own ideas that are better suited for our circumstances?”
Here in Canada we just witnessed an attempt by a coalition premised on the need to ram through a stimulus package faster than you can say “general theory of employment, interest, and money.” As I argued here, that could have been disastrous, considering they were talking about aiming funds specifically at some of the industries (or companies) that probably should and would shrink or fail anyways, regardless of the recession.
And remember we’re coming off of a massive boom. I don’t have a lot of faith in the ability of economists or anyone to judge whether the size of the economy is at, below, or even still above the level where it hypothetically ought to have been at if there wasn’t a boom, bubble, whatever. Might we end up going very deeply into dept in order to perpetuate a boom that will crash even harder in another four or five years? How do we know? What are the worst case consequences either way? Do we need to classify a different kind of recession — a “massive correction”???
That’s just speculative. I’ll try to refrain from taking that further until I have at least a slightly better understanding of what I’m talking about. But there are some other valid points to be made, mainly concerning different kinds of employment and skills compared to the those dominant in (everyone’s favourite decade) the 1930′s. I’ll hand it over to Arnold Kling:
We have created the expectation that government can ensure high rates of labor utilization. In an industrial economy, where there is a lot of low-skilled labor and economic activity is heavily concentrated in a few key sectors, inflationary policies may in fact have some effect in terms of bringing real wages into better balance, either across sectors or in the economy as a whole.
My guess, however, is that in a post-industrial economy, the necessary adjustments are too subtle and complex to be helped much by inflation-producing macroeconomic stimulus. The problem is not to bring about a general reduction in real wages, or even a reduction in real wages in a key sector. In today’s economy, an enormous variety of career changes, business start-ups, and business failures will be needed in order to bring labor markets into balance.
In theory, wise technocrats could help guide workers in declining industries to appropriate re-training and career development. In practice, technocrats are not that wise. But it is much worse than that. Instead of giving the technocrats the mission of making the adjustment process more efficient, politicians will give them the mission of delaying the adjustment process and resisting the signals coming from the market. Thus, the expectation that government should help could have an ironic effect: the more that the public asks government to relieve the distress in labor markets, the longer it may take for labor markets to adjust.
To be continued….
P.S. Though first I should add, my feeling right now is that the best solution would be a kind of “green bubble” that uses government funds to challenge researchers and entrepreneurs, and ultimatly generate new enthusiasm for private investment, rather than just conceiving old-fashioned infrastructure programs in terms of old-economy notions like handing out projects to companies and hiring masses of labourers. I have a feeling this is where Obama is going — he’s pretty well implied as much with his energy-independence moonshot, and his appointment of Steven Chu as energy secretary seems to confirm this direction – and I’ve already quoted GE’s Jeffrey Immelt advocating the same thing:
I think what would be important for the next president is to let us have the confidence of solving one problem together — and let’s pick energy…
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