Time to cast Keynes adrift

It is refreshing to see some quality comment beginning to emerge from the smoke (and mirrors) of the global financial crisis that does not come from the side of the argument that holds you must throw good money after bad, or that open-ended deficit budgeting is in any way a good idea.

Some sound common sense is coming from Australia. Not from the government, which gives the distinct impression that it views events with fixed horror, as one would a snake emerging under foot, and that it has no idea what to do other than politically. The Rudd Government is good at politics. It identifies a problem - that is, a political problem - and throws dollars at it while hurling abuse at anyone who presumes to quibble with its actions. Such is the vacuity and essential meaningless of modern social democracy.

Alan Kohler in the Australian online business newspaper Business Spectator (along with his colleagues Robert Gottliebsen and Steven Bartholomeusz) is a consistent critic of print-money economic management. Probably there are sound thinkers at the Reserve Bank who, if free to make a private point, would utter advice that is not for the moment politically acceptable.

There is certainly one well connected economist in Australia, Steven Kates of the Royal Melbourne Institute of Technology in Australia, who has called it as he sees it. (He is a part-time commissioner of the Australian Productivity Commission, to which he was appointed by the former Howard government, and who - sensible fellow - has clearly worked out that he is not going to be reappointed.)

Kates is not a Keynesian. He does not believe that recessions or depressions are caused by slack demand for products and services, or that they can be corrected by governments making decisions to spend money they don’t have to provide an artificial stimulus. He is an economic classicist, the sort of person for whom the nostrums of John Maynard Keynes, guru-in-chief to most post-World War II economists, are fundamentally foolish.

He says so eloquently in an analysis published in the latest edition of the Australian journal Quadrant (see it online). It’s worth reading, particularly by political leaders who are faced with public demand that they do something to head off catastrophe. This is not just a democratic problem. It is one that faces all governments. Unfortunately it is not a problem most political leaders are equipped to deal with, since their currency is votes (or the equivalent) and money the lure with which they fish for them.

In his Quadrant analysis, Kates makes this key point:

The missing ingredient in classical economic theory, Keynes wrote, had been the absence of any discussion of aggregate demand. It was this missing ingredient that Keynes made it his mission to put in place.

And how successful he was. Aggregate demand has since 1936 played the central role in the theory of recession. Recessions are attributed to an absence of demand, and even where they are not, overcoming recessions is seen as dependent on the restoration of demand which is the active responsibility of governments.

...

[But] no one explains the present economic downturn, the global meltdown we are in the midst of, in terms of deficient aggregate demand. It would be an absurdity to suggest the problems now being experienced have been caused by consumers no longer wishing to buy more than they have or savings going to waste because investors have run out of new forms of capital into which to invest their funds.

That the world is in uncharted territory in the new circumstances of the global crisis is a fact of life. But those who seek to suggest that in advanced economies the way to deal with this is to roll out massive public spending projects are fundamentally wrong.

They may even know this. After all - as Kates and others point out - history shows that the advanced economies which recovered first and most strongly from the Great Depression of the 1930s were Britain and Australia, where their governments kept to balanced budgets. There was pain but it was over more quickly. In America, home of the Roosevelt New Deal to which panicked politicians now look for inspiration, the Depression continued into the war years (and ominously was only solved by that conflict).

Politicians out of power are the only ones currently proclaiming a “don’t spend” policy. Most in fact are not even doing that: they’re simply saying spend less, or spend it here instead of there. They are the apprentice Neros fiddling while Rome burns around them. In Australia, former merchant banker Malcolm Turnbull, leader of the opposition, is in this class. In Britain, Conservative leader David Cameron - who on opinion polling looks a dead cert for prime minister after the next election - is too.

The sad and central fact of the world’s present predicament is that bankers and money market men and politicians got us into the mess and are now proposing that they meddle some more, in exactly the same way, to get us out of it.