The Shortcomings of Keynesianism

Keynesianism’s premise is that the private sector does not allocate resources properly, and that government, through deficit spending and expansionary monetary policy, is the only vehicle to stimulate the economy. I wholly disagree with that premise. The opposite of Keynesianism would be neoliberalism – my economic philosophy: that the private sector can allocate resources much more efficiently through the influence of market forces, and it is the optimal role of government to take as little capital away from the market as reasonably possible.

As the Keynesian theory goes, recessions are caused when – for some reason or another – individuals stop buying goods (perhaps due to pessimistic views of the future). They begin to horde money. As consumptions decreases, as does employment. It is therefore the duty of the government to spend large sums of money to “prime the pump”, i.e., flood the market with money so as to increase consumption, and sustain employment.

This suffers from a variety of flaws in my opinion. First of all, people need to consume the basics to survive. Bread, milk, shoes, etc. If people must continue to spend, then they must continue to produce, which in turn leaves room for adjustment of the market. The fact that businesses and banks are unwilling to invest or lend, is due in part because they are still attempting to clean their books. By allowing businesses to adjust naturally (by lowering wages, reducing spending) it gives them time to rebuild savings, and return to productivity. Money pumped into the system prematurely by the government, only adds to uncertainty, increases the level of nonperforming assets held by banks, and prolongs the recovery.

But because fear of the future exists, people are more likely to be prudent with their money as opposed to spend it away. An increase in confidence is what’s needed in order for people to reignite the flow of capital. Stimulus packages, mounting debts, inevitable tax increases, bailing out of banks and car companies, and government involvement in Health Care, only adds to the uncertainty of the future.

Its important to look at the historically miserable record of Keynesianism, because it really tells of the story for us. The 1921-1923 economic recession, which began with a steeper decline than the Great Depression, got no help from the government, and saw a quick economic recovery for precisely that reason. The federal government actually reduced spending from $6.4 billion in fiscal year 1920 to roughly $3.3 billion in 1923. The pullback by the federal government left more capital in the private sector to fund real economic growth rather than government consumption.

However, in 1933, Roosevelt went on a spending binge, and while got industrial production to increase, by 1934, it took a U-turn back down, showing that a large jump in government stimulus can only temporarily improve the economy. Follow the logic here. Governments can only spend to the extent that they can borrow or tax from the private sector. In that sense, the economic growth that funded the spending had already occurred. To presume that productivity would multiply thanks to government stimulus is the equivalent of assuming that a thief could aid a convenience store by first stealing $20 from the store, then returning later in the day to spend it. Whether by increasing taxes, national debt, or printing the money (growing inflation), the government has to damage long-term wealth in order to provide short-term economic activity.

Tax cuts are far more superior in stimulating the economy than direct investment by the government. Allowing companies to keep more of their revenue is an incentive to create more wealth and thus promote economic growth. Allowing individuals to spend more of their own money as they see fit helps the market more accurately understand demand signals than when the government just spends trying to create demand out of nothing. For example, in the six months prior to the Bush tax cuts, GDP grew at an annual rate of just 1.7%, and lost 267,000 jobs. In the six quarters following the tax cuts, the growth rate was 4.1 percent and added 307,000 jobs, followed by 5 million more jobs in the next seven quarters. Tax revenues in 2006 were 18.4 percent of GDP, which was above the 20-year, 40-year, and 60-year historical aver­ages.

Keynesianism, with its kneeling so much on government, cannot possibly work to stimulate the economy in the long-run. Only the private market can fix itself, and if the government wants to help that natural process, it can refrain from taking away capital by spending less and lowering taxes.

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One thought on “The Shortcomings of Keynesianism

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