forbes.com
We're All Keynesians — Still?
By Steve H. Hanke
YOU WOULD THINK that the
economic booms brought on by Margaret
Thatcher and Ronald Reagan would have killed
Keynesianism. They abandoned fiscal fine-tuning
in favor of smaller government, less regulation
and flatter taxes, and for their efforts they got
economic booms.
And yet Keynesianism is not dead. It lives on in
the moribund economy of Japan and the
bankrupt policies our Treasury Department is
foisting on Japan.
Like it or not, John Maynard Keynes will go
down as one of the 20th century's most powerful
economists. His 1936 classic, The General
Theory of Employment, Interest and Money,
popularized fiscal fine-tuning—the notion that
more government spending, less taxing or some
combination of the two will cause an economy to
accelerate by a multiple of the stimulus. And that
a fiscal contraction will slow things down. A
touch on the fiscal tiller is supposedly all that is
needed to adjust demand so that it just matches
an economy's capacity to produce.
It was a neat theory, and it captivated two
generations of economists, especially those who
rather liked the idea of a strong central
government. Even Richard Nixon, who claimed
not to be a fan of big government, was moved to
say, "We are all Keynesians now."
And then Margaret Thatcher came along. In
1981, when she was prime minister, Britain's
fiscal deficit was relatively large, 5.6% of gross
domestic product, and the economy was in the
middle of a nasty slump. To restart the economy,
Thatcher instituted a fierce fiscal squeeze,
coupled with an expansionary monetary policy.
This was immediately condemned by 364
dyed-in-the-wool Keynesian economists. In a
letter to the Times of London, they wrote,
"Present policies will deepen the depression,
erode the industrial base of our economy and
threaten its social and political stability."
Thatcher was quickly vindicated. No sooner had
the 364 affixed their signatures than the economy
turned around and boomed for the next five
years. That result provoked disbelief among the
Keynesians. After all, according to their dogma,
the relationship between the direction of a fiscal
impulse and economic activity is supposed to be
positive, not negative.
As it turns out, the correlation between a fiscal
impulse and economic activity can be either
positive or negative, depending on the state of
confidence in a government's policies. There is a
world of difference between increasing a deficit
from 8% to 12% of GDP and going from a surplus
of 2% to a deficit of 2%.
In the first instance, pump-priming would destroy
confidence and be judged foolhardy, a precursor
of financial crises and of increases in taxes,
inflation and interest rates. Consequently, the
stimulus would cause the economy to slump. On
the other hand, the latter scenario would be
regarded as quite consistent with a stable
long-run financial policy. Confidence would
remain upbeat, and a fiscal expansion would
cause the economy to accelerate.
This brings us to Japan and the current state of
the world economy. According to the
International Monetary Fund, world growth will
be 2.2% in 1999, half the 1999 rate the IMF
projected a year ago. The IMF also cautions, in
its World Economic Outlook of December 1998,
that if Japan, the world's second-largest
economy, doesn't arrest its economic slide, more
downward revisions in world growth will be
forthcoming.
Just what are the prospects for Japan? Led by
Treasury Secretary Robert Rubin and his deputy,
Lawrence Summers, the Keynesians have
escaped from their cages. And, unfortunately, the
Japanese authorities have listened to them. This
year, Japan's yawning fiscal deficit will increase
from 7% of GDP to over 10%.
Not surprisingly, the Japanese people fail to
perceive this as a credible policy, and confidence
is taking a nosedive. Since October 1998, prices
of Japanese government bonds have plunged and
yields on ten-year bonds have almost tripled,
pushing real interest rates to punishingly high
levels. Contrary to the Keynesians' claims, this
fiscal stimulus package will meet the same fate as
other recent packages. It will further exacerbate
Japan's economic problems.
Ready yourselves for more downward revisions
in world economic growth. |
