We're not Keynesians yet

15 April 2009

The global economic crisis seems to have given way to a view in some quarters that we are all Keynesians now. After all, governments worldwide are implementing fiscal stimulus packages to stimulate demand and hence production and labour employment to cushion their economies against the effect of the crisis.

But do these policies really add up to a conversion to Keynesian ideas?

Given that John Maynard Keynes's key insights have always struggled for air within the economics profession, what we are witnessing is probably more a casual flirtation than it is a blinding revelation.

As put soberly by American economist Thomas Palley, "We are all Keynesians in a recession."

This is not just an esoteric point about schools of thought in economics.

There is a danger here of assuming that because the world economy is in distress this will inevitably bring about a sea change in ideas about how market or capitalist economies work and how the problems they have can be fixed. It hasn't in the past and it is unlikely this time will be different, and therefore the possibility of future downturns may not be reduced.

The really novel insight of Keynes's work is that in the long run, no less than the short run, the growth of capitalist economies and the plight of their workforces are governed by demand for goods and services, not by their capacity to supply.

Keynes was unable in his time to effectively dismantle the supply-side vision of the long run and its accompanying proposition that unfettered markets could generate a long-run tendency towards full employment.

This vision dominated the economics profession before Keynes and since Keynes. But 73 years later we have the theoretical capability to see that this supply-side vision is not a correct deduction from any rigorous economics.

Capitalist economies are not and never have been governed by a long-term tendency towards full employment of the available labour force, despite periods where it may have approached this point.

We seem incapable of grasping this long-term reality just as we have become paralysed by the rhetoric of small government and an almost paranoid fear of budget deficits, inflation and any level of public debt greater than zero.

We comfort ourselves with sound finance in government policy, while public infrastructure decays and the concept of a social wage disappears into oblivion.

To correct all of this requires a fundamental revision in the views of the economics profession that infiltrate and inform so much policy opinion and public opinion. But there are other aspects to Keynes's insights that seem pertinent in the present climate and that relate to the international arena.

First was the notion of an international monetary system where no one currency would serve as a reserve or default currency and which would confer on that country the advantage of allowing it to settle its debts to the rest of the world in its own currency.

This was about avoiding a scenario where the growth of the world economy was driven by the policy of the reserve currency economy.

This idea was also about sharing growth in the world economy, so the countries with current account surpluses would be required to expand their economies and suck in the imports of the deficit countries.

Second, this kind of co-ordination between countries would mean jettisoning the belief in the ability of exchange rates fluctuations to correct balance of payments problems and impart a degree of autonomy to policy makers.

The experience of floating exchange rates since the early 1970s would give one little confidence in this idea. Neither is the confidence enhanced by the inability of conventional economic theory to adequately explain the dynamics of exchange rates.

Third, co-ordination of macro-economic policies to deal with global imbalances and greater policy control of exchange rates also would mean junking the belief in the efficiencies to be gained by the free movement of capital flows across foreign exchanges.

Such faith in free capital movements is often defended in the name of providing finance for developing countries. But, as a number of more progressive economists have noted, the finance in recent years has not been going from developed to developing countries but in the other direction.

The insight of Keynes and others in this regard, as early as the '40s, was to recognise a more insidious side to the free flow of capital funds. Under the nonsense rubric of market discipline, policy makers are required to factor in the response of foreign exchange markets to macro-economic policy in particular.

For Keynes, on the other hand, restricting the freedom of short-term capital movements was about imparting additional autonomy to policy makers to focus on what they are meant to focus on: domestic growth and employment, among other things.

So, are we all Keynesians now?

I seriously doubt it.

Graham White is a senior lecturer in the Faculty of Economics and Business. This piece was first published in The Australian newspaper on 15 April 2009.

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