Econ101 – Keynes

Summary

  • Keynes microeconomics was brilliant, his macroeconomics have never worked in the real world
  • Examples where it failed include: Japan, Venezuela, China, Russia, North Korea, U.S. in every administration since WWII
  • Keynes idea that government can borrow and spend to stimulate growth relies on the ignorance of the people to recognize that increased spending will cost them in taxes/inflation, that government will trim back as the economy gets better (which never happens), and assumes that jobs are highly mutable (they’re not any more). 
  • Not all government spending is bad, it’s just usually worse than the alternatives: and the few successes are the broken window fallacy (looking at seen benefits, while ignoring larger unseen consequences)

Keynes: old and new

Keynes had micro and macro theories, and while his micro theories/models were quite good and still work, his macro-theory (the model of models) is what most people who say they’re Keynesians tend to be talking about. Those not only never worked (Hayek won the nobel prize for showing why in the 1940’s), but they broke completely in the 1970’s with Stagflation (which couldn’t exist according to Keynes’s models).

Rather than admitting their prophet was wrong, Keynesians reworked the models and called that New Keynesianism — they fixed the models so that stagflation could exist, and kept their religious theory in tact. So pre-1970’s and post 1980’s Keynesianism is based on different models, but the same flawed beliefs.. But we know that the new models have also never been accurate in any major prediction of trajectory in a recession or a recovery. So while they’re not as glaringly wrong, it still doesn’t actually work.

Treasury View

The treasury view (pre-dates Keynes) is that government spending displaces private spending (and private spending is more efficient): the bigger the government, the smaller the private sector. Economists (even Keynes) agreed on this, mostly (this is called economics). But Keynes did disagree in the absoluteness of the statement (there was more nuance). Prior to him the models were a fixed pie and 1:1 displacement. Keynes revised that that the pie can grow or shrink as well, it’s more elastic.

Thus, since the model was more dynamic, you could inject artificial borrowing/spending to stimulate things in down-turns. To Keynes, the problem in a down economy was fear. Sometimes private sector would over-react and over-cut (e.g. markets weren’t perfectly efficient). In those cases (depression/recession) unemployment would spike, the cost of labor would crash, and while things would eventually recover, there was more harm in that down-spike than there needed to be. So, his theory was that if in those down markets, government could spend up to where the economy should have been (the balance point), assuming we know what that was, and we could take up some of the slack (soften the fall from unemployment and create artificial consumption). While government still wasn’t as efficient as private sector, it was NOT a macro-win (efficient jobs were replaced by less efficient ones), but it was less of a loss than doing nothing (and those jobs just not getting done). So in the short term (and micro-view), that’s better than nothing. And when the economy went back up, you could CUT those government programs/jobs, the private sector would replace them with more efficient versions private sector jobs as things got better, and you changed a big dip into a smaller dip, which let you grow more overall.

Nice theory. FDR tried it in the great depression (believing in his "brain trust"), and the results were extending the depression by a decade, and we have many more examples of its failure. So it’s never actually worked in the real world. Keynes was a brilliant micro-economist, with delusions of being a macroeconomist, but his religion of collectivism got in the way of understand human nature (how people and thus economies would react) or the nature of governments.

Why doesn’t Keynesianism work?

The problems are:

(1) for it to work, you have to exist in an information vacuum

If people SEE government spending (and borrowing), they’re generally smart enough to react to it. Since they realize government spending means the government must either tax, print money or borrow (to fund that spending), thus they KNOW they’re going to get hit by either taxes or inflation: which hurts their purchasing power. So they react (sometimes in advance of the policies even kicking in), by saving more, spending less, or sheltering investements. That negative economic reaction swamps any of the theoretical benefits in Keynes algorithms, sometimes before the policies have a chance to be implemented. His magical positive multipliers turn it into negative multipliers. Hayek believed that consumers were smart enough to see this and react. Keynes didn’t factor it into the models. Guess which maps better in the real world?

(2) For it to work, you have to CUT government spending/programs when the economy gets better

If you don’t cut when you have the opportunity, all you succeeded in doing is replacing the more efficient private sector with the less efficient public sector, over time. But as Milton Friedman said, "nothing is as permanent as a temporary tax/program". Once you create a program it becomes a special interest and thus has impetus that not only keeps it around forever, but tries to make it grow. And in good times, everyone is more tolerant of that wasteful program, so there’s no leverage to implement a cutback. Which means that whole sector suffocates under the weight of a subsidized government competitor. (They reinvest, innovate and grow, less). Thus you did soften the dip, a little, but you also soften the recovery by even more — and you’ll never climb back to where the economy would have gotten without that less efficient replacement holding it back. Since a gain in efficiency of output translates, loosely, to higher salaries — you lost a lot of earning/economic potential, it’s just a missed opportunity cost (hidden). 

3) For it to work, you really need to be replacing the same jobs you’re losing.

That was fine when job training in the early 1900’s was hours: whether working a hoe, hammer, or welder, a worker was a worker was a worker. There was lots of grunt work, and much less skilled labor. Assembling a car, digging a ditch, a monkey could do it. So creating productivity required a body. But in the modern economy, it doesn’t work that way. Unions have made job mobility difficult in low-skill jobs. And most jobs aren’t low-skilled union ones any more. More of our economy is built around high skill jobs (that have far less worker mobility). Replacing a computer programmer with a ditch digger doesn’t work, nor does replacing a SEO Optimization person with an accountant work. So a government temporary bridge projects doesn’t help out of work IT folks, or autoworkers, accountants and so on. Retraining programs can’t solve recessions since, the training lasts longer than the recession itself does — thus it takes potential workers out of the economic pool of contributor (even fractional contributor, if they’re doing something below their skill level), and moves them to the pool of taker/burden for the duration of the recession (while they’re in training). This magnifies the depth and length of the recession. (Called Obamanomics).

4) For it to work, government has to be as efficient (or close to it) as the job it is displacing

If you replace 100 workers with 200, you lose 100 workers worth of money for the same output. That negative multiplier means the economy lost 100 workers worth of potential output. And it’s the output (what we produce) that is real net value to the economy. That’s where the famous Milton Freedman anecdote (that predates him) about replacing workers shovels with spoons comes from [1], it’s not how many workers are working, it’s how much they’re producing that matters. And in the end, rarely, government programs start out as efficient, and they entropy quicker in a productivity sapping bureaucracy (there’s no profit incentive for continual improvement in efficiency).

This is why Keynesian magic positive multipliers never actually worked in the real world.

We’ve had 80 years of examples of Keynesian failures:

  • Japan’s lost decade alone should prove it – in the 70’s and 80’s they borrowed to stimulate their economy, and it worked, for a while. Then that debt-load helped push their economy into a recession, as new capitalist countries in the region (South Korean, Chinese and South Asian) came into market and made it harder to compete. Japan kept trying to spend their way out of recession in the late 80’s, 90’s, 00’s, and now half way through the 10’s, and their economy has been flat or declining. All attempts to “stimulate" their way out have failed or made things worse. 
  • Most countries that converted from Communism/Socialism to Capitalism saw their economies get explosive growth (Russia, China, India, Vietnam).
  • Most countries that went the other way, saw them collapse (Cuba, Venezuela, Vietnam).
  • Pre and post cold war Russia and China show the contrast between big government spending (before), and letting the private sectors exist and take off (after), and how dramatic the differences are
  • North Korea vs. South Korea is another perfect contrast of Keynesian command economy stimulating growth in the North, versus free markets letting income inequality and social injustice destroy the South
  • The rare exceptions to the rule, often had mitigating or local factors like Denmark, Norway, Finland. All saw their growth rates slow with large social programs (they were growing much faster before enacted). But they often offset their high social spending with high personal or single sector taxes (Oil in Norway, timber Sweden, etc), while having extremely LOW business taxes/regulations (far lower and more competitive than us). This pro-business / anti-individual economic model more resembles economic fascism than traditional socialism: and you see it in low personal liberties and purchasing power, but high employment and returns for businesses — they have high theoretical incomes per capita, and all live in tiny homes and have to ride bikes in the snow and eat rotten fish
  • After WWII we cut government spending faster than any time in human history. Keynesians predicted utter ruin, and we got… the post war economic boom (dramatic increases in GDP, economic output, employment, and quality of life). 
  • Every administration that cut government & taxes (JFK, Reagan, Bush, Truman) was predicted doom and gloom by Keynesians, and we got economic upturns
  • Every administration that increased governments spending and reach got economic cooling (Johnson/Nixon, Carter, Obama)
  • Clinton got great economic upturns, but not in the first term (when raising taxes), only in the second term — after Republicans took congress/senate and blocked further spending (which was predicted by Keynesians to be a coming disaster, but turned out extremely positive).
  • The opposite of Clinton happened with Obama’s multi-trillion dollar spending spree. It was supposed to pull us out of a minor recession, and it gave us a much bigger one and the slowest recovery we’ve had in 80 years, until Republicans got control of the purse, and slowed further spending, and then the economy recovered. Of course Keynesians just say how much worse it would have been if they hadn’t of spent. And then they ignore countries like Greece (which tried spending), versus successes like Iceland or Ireland which used austerity to pull out. But you can’t reason with religious zealots or Keynesians, but I repeat myself. 

If government spending (and centralized command economies) could create utopia, our world would look quite different. They can create cities like East Berlin was, but not cities like New York or Beijing. 

Avoid the strawman

Now I’m not arguing government spending never produces anything good. It does. In theory, you can do things like invest billions in infrastructure, and that will benefit the economy in the long term. Hoover dam meant cheap power, and helped enable Vegas and L.A. So a few public works programs, do help, eventually. However, for each Hoover dam, there are a dozen Solyndra’s, or government spending disasters. When you average them all in, you get far more weighing down your economy than helps it up, because: politics. Obama’s stimulus spent ≈6% on infrastructure. And the individual spending by government is less efficient than spending by private sector (as far as output per dollar, and so on).

Mostly, it’s about time. Spending doesn’t usually happen fast enough to be useful for what it’s advocated for. Helping a recession requires immediate spending, not stuff that’s going to happen over 5, 10 or 40 years. This is why if you want to "stimulate", a tax cut has been MUCH faster and more effectively than government spending — as history has played out. Which choice will have the more immediate impact over the next 1-3 years?:

  • (a) government is going to stimulate by building roads & brides, so they start the studies on which need it the most, and 3 years later they’re ready to break ground on something that will take 4 years to complete
  • (b) all companies that invest in communications infrastructure or facilities improvement will get a tax credit for that amount for the next 3 years.

It’s not malice or partisan, it’s just logic and math.

You may hate the military industrial complex, and that’s fine. And war machinery isn’t horribly good at adding value to an economy (it has some abstract value in security/stability/confidence). But even there, accidentally creating a fuckton of information workers (computer programmers, engineers, etc), helped empower the dot-com boom, and other innovations. Of course if you look at the other side, imagine if you’d spent that trillions on information infrastructure that we can all use, instead of just weapons system that have less value to society? So it was a net loss compared to what the private sector would have done with the money. But it was a net win compared to just social spending or Obama type spending.

I just sum up government spending with the real world example of New Jersey: For each $1.00 New Jersey gets back from the fed, they have to give the fed $1.64, they have to pay $.18 in compliance costs, and the government borrows about $.81 of that buck, and leaves New Jersey with the debt obligation. Progressives see the $1.00 as a net win. The taxpayers see that they paid about $2.63 to get <$1.00 in value, to build something they may or may not need — and even then they only got that $1.00 back with all sorts of stipulations (politics) on how it would be spent (whether it made sense for their state or not). Yes, the $1.00 is better than nothing and occasionally does some good, and progressives love to crow about the occasional good things. But the point is that it never does nearly as much as much good as if the state/community had kept the $2.63 they had in the first place.

So government does good. Just historically it tends to produce less, for more money, than the alternative.

Conclusion

I believe that after another 60 years of examples, pounding home why he was wrong, Keynes would have eventually realized that while his micro-theories were valid, but his macro-theories never worked in practice (and broke in the 1970’s). Keynes was a reasonable man that admitted Hayek was brilliant. So it is likely he would have revised his views, and would no longer be a Keynesian (at least not as Keynesians today think of it).

Or in other words:

in theory, theory and practice are the same thing
in practice, they are not

Keynes created theories. Hayek observed the real world, and human nature, and said that Keynes (and others models) couldn’t work, unless you could model human behavior. Which you can’t very well.

What is left of Keynes theories has become a mockery of what Keynes had ever believed or advocated: that spending results in magic multipliers (for each dollar you spend, you get many in return), and does so by ignoring that the dollar comes out of the economy (and that this has any de-stimulating effects by people/companies smart enough to see through the charade), or that companies have become more mobile than employees (they can offshore, and job training makes make-work job programs and stimulus way too specialized to have broad economic returns). 

Thus simplest argument against Keynesianism is if Keynesianism worked, we wouldn’t have recessions in the first place. Governments could manipulate money and spending to just make them disappear — and of course, while governments can be credited with causing many recessions (or depressions), they can’t be credited with stopping any of them.

So Keynes and Hayek would have eventually grown to have more similar views over time. And it probably would have looked more Hayekian than Keynesian.


References

2012.09.01


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One frequently sees liberal criticism of "trickle-down" economics based on the idea that the "down" part never happens. Why, then, should we believe that Keynesian stimulus works any better? Isn’t that really just trickle-down, with the government making politically-motivated decisions at the top?

2014.12.22

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