Time to Cast Keynes Adrift

By Richard Laidlaw

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 Bartholomeuz) 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 at www.quadrant.org.au/blogs/qed/2009/02/the-dangerous-return-to-keynesian-economics). 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.

In a consumer society it is naturally very difficult to tell people they cannot spend wildly, should not get too deeply into debt, and need to look at relative values before deciding they really do live in a gold mine. But someone must find the courage to do so. This is not only a Western problem, but it is in the West – because those economies are the most directly consumer oriented – that the worst and most intractable problems lie. The way out for these countries is to live within their means and save money. That is not the message consumer societies want to hear; nor is it one political leaders are keen to give.

Keynes was not a consumerist. But his essential message – that when you’re losing money you can just print more and throw it around – was tailor-made for the consumer society that emerged in the early 20th century and which came of age in the post-World War II boom. Governments grabbed the idea with glee. Using Keynesian theory, they could be seen to be doing something – the imperative of democratic politics – and, moreover, to be supporting creation of private wealth.

Deregulation – of virtually everything – followed in the days of so-called Reaganomics and Thatcherism. That was no bad thing (if governments cannot even run politics, why should anyone think that they can run things that actually produce saleable goods). But they forgot one essential: that legislation and the law still need to guard against malfeasance and stupidity. Australian bank regulation has proved stronger than in most advanced economies. The mess in America would be unbelievable if it were not true. The mess in Britain, similarly, is a nightmare. The answer when the crunch came essentially ran to renationalizing the banks throughout Europe and taking that step – previously anathema – in the heartland of capitalism, the US

In our region, outside of Australia, New Zealand and (maybe) Singapore, everything depends on China. It used to be Japan that was the linchpin, but no more. Its post-war copy-and-improve economy long ago stalled; it will not recover without radical surgery and probably not even with that outside of a much more closely knit economic partnership with China. There are some very difficult politics in pursuing that course of action.

Southeast Asian resource economies – such as Indonesia’s – fare reasonably well when consumer economies are buying in bulk. When these markets recede, things get dicey. There is nothing Indonesia can do about that, beyond fiddling at the margins, taking price cuts, and managing on even less money. Fortunately, outside the big cities most Indonesians are effectively self-sufficient within their communal living arrangements. It’s not comfortable, but no one will starve. The elective-spending elements of Indonesia’s economy (a prime example: Bali with its dependence on international tourism) may yet suffer significant contraction.

It is by no means clear yet what the ultimate depth of the coming recession really is, how long it will take to get out of the trough, or what shape the new world that eventually emerges will take. There is a lot of sensible advice around – consigning the fundamental stupidity of Keynesian fire-and-forget pump priming to history is part of this – but it is profoundly unclear whether anyone with a hand on the priming pump is actually listening, far less that they even understand the question.

Until the world as a whole really gets to grips with the fact that it cannot live on what it does not have, until political leaders everywhere – and the people whose lives they govern – understand this point and are prepared to accept it and swap profligacy for caution, there is no answer.

Richard Laidlaw is a former Australian journalist now living in Bali.

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