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The Ghost of John Maynard Keynes

Posted By Mark W. Hendrickson On March 13, 2009 @ 6:00 am In The Path to Freedom | No Comments

The British economist John Maynard Keynes (1883-1946) turns out to have been something of a prophet. He once wrote that “practical men,” as opposed to theoreticians, “are usually the slaves of some defunct economist.” Ironically, the defunct economist who is influencing Barack Obama, his advisers, and his supporters in Washington is Keynes himself.

Like a ghostly presence, Keynes’ ideas are hovering over us. The very notion of a government “stimulus” for the economy originated in Keynes’ 1936 book The General Theory of Employment, Interest, and Money. In it, Keynes spelled out his theory that government could offset the economic ups and downs of the business cycle with “contracyclical” policies—that is, by running surpluses when economic activity is vibrant and deficits during slowdowns.

Keynes’ theories lost some of their luster in the 1970s when the United States experienced “stagflation”—the simultaneous occurrence of high unemployment and high inflation—which wasn’t supposed to happen according to Keynesian theory. Today, though, desperate to justify massive deficit spending, policymakers are resurrecting Keynesian ideas. This represents a triumph of hope over experience. Let’s look at some history.

After the stock market crash in 1929, President Herbert Hoover—a virulent foe of free-market economics, contrary to popular myth—ramped up federal spending and ran large deficits in the hope of counteracting the economic downturn. The economy did not recover, so voters elected Franklin Roosevelt in 1932. FDR then proceeded to out-Hoover Hoover, running even larger deficits and jacking up federal spending even more. The depression persisted. Then Keynes’ General Theory appeared in the winter of 1935-36, and FDR was delighted that the already-famous economist prescribed deficit spending as the correct anti-depression policy. FDR then continued running high deficits for another five or six years, but the economy still did not recover. As FDR’s Treasury Secretary, Henry Morgenthau, put it in congressional testimony in May 1939, “We are spending more money than we have ever spent before and it does not work. … [A]fter eight years … we have just as much unemployment as when we started … and an enormous debt to boot.”

A more recent example is the just-ended presidency of George W. Bush. If deficit spending truly stimulates and improves economic activity, then after an eight-year period during which federal spending increased by 50 percent and the national debt doubled, the economy should be booming now. Oops. Deficit spending clearly is not the cure for our economic woes.

A related Keynesian myth haunting us today is the theory of a government “multiplier.” This theory asserts that each dollar spent by Uncle Sam will be spent and re-spent numerous times, causing total GDP to grow by some multiple of that spending (a common estimate is 1.5 times). The absurdity of this theory is self-evident. First, does anyone believe that one becomes wealthier by going on a spending binge? Just as an individual can’t spend himself into prosperity, neither can a country. Second, if government indeed has the magical power to multiply and increase economic growth, then why bother having a private economy? Why not embrace socialism and let the government be in charge of the entire economy? Because socialistic Big Government devastates countries economically.

Here, some Keynesians might protest that the only reason they want increased government spending is to compensate for private citizens not spending enough, which they believe is the cause of depressions. This misdiagnoses the problem. What ails us today is not under-consumption, but oversupply. For example, housing prices are falling due to a glut of housing units. One estimate is that 10 percent of all houses built in the United States since the year 2000 are vacant, and this percentage may rise as foreclosures increase. Similarly, in the now-global automobile market, there appears to be manufacturing capacity of over 90 million units per year, which may be as much as 30 million units above actual demand.

Keynesians claim that this supposed under-consumption represents what they call “the paradox of thrift”—that while saving instead of spending may be good for individuals, it is bad for the overall economy. True, lower spending leads to business failures and job loss. As painful as this can be for the individuals involved, though, this is not something to be avoided. In fact, it is absolutely necessary. Unnecessary, wasteful production must end. For example, fewer houses and cars should be produced, because we don’t need all that have been and are being produced. It is not economically healthy for businesses to keep wasting scarce resources by producing things that people don’t need. On the contrary, it is far better for society to stop wasting resources and to redeploy them into businesses that produce more highly valued goods. (For an excellent explanation of how government intervention causes the destructive, painful boom/bust cycle, read the dialog between my colleagues Dr. Jeff Herbener and Dr. Paul Kengor—Part I, Part II, Part III.)

Let us hope that the ghost of Keynes with his fallacious theories does not linger long. If it does, our country will pay a frightful price in squandered wealth and delayed economic recovery.


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