Freeman

THOUGHTS ON FREEDOM

Naive Keynesianism: A Failure of Imagination

APRIL 21, 2011 by DONALD BOUDREAUX

Each of us has a set of peeves—things that disproportionately irritate us.

By their nature, most peeves are small. For example, I bristle at the failure to use hyphens correctly. As my late, great teacher Fritz Machlup pointed out, a foreign exchange student is typically not a foreign-exchange student. The first is a student studying temporarily in a foreign country, while the second is a student of international currency transactions. (I can’t resist recalling a classified ad whose author offered for sale a “black-man’s bowling ball.” I’m quite sure that this hyphen was misused.)

Some peeves, however, are large. These are ones that spark over-the-top irritation. One of my largest peeves is the frequently heard assertion that because personal consumption expenditures are currently (say) 70 percent of GDP, our standard of living will fall if personal consumption expenditures fall below that level.

This notion is Keynesianism at its most naive—Keynesianism that, though rejected or slathered with conditions by most or all Keynesians in the academy, motivates the (mis)understanding of too many reporters, pundits, and politicians who speak on economic issues.

I avoid here any discussion of the many conceptual problems involved in measuring economic output and in classifying expenditures. (Okay; I’ll mention just one such problem: A large chunk of “personal consumption expenditures” in the United States is on medical care, which is financed massively by government. As Michael Mandel points out, “[I]t’s misleading to say that ‘consumer spending is 70 percent of GDP’, when what we really mean is that ‘consumer spending plus government health care spending is 70 percent of GDP.’”)

The fundamental error woven throughout such naive Keynesian arguments about the importance of a particular level of consumer spending to the economy is that there is no “correct” or “optimal” level of consumer spending apart from whatever is the level that results from individuals freely choosing to spend and to save.

The Precious Aggregate

Suppose Americans for the past several years spent 70 percent of their incomes on consumer electronics, Las Vegas vacations, and massage therapy, while saving the remaining 30 percent for retirement. There is in this pattern of spending and saving nothing inherently natural or precious. It’s simply the measured aggregate result of how hundreds of millions of Americans chose to allocate their resources over the past several years.

What happens if this year Americans’ preference for saving changes so that they now spend only 60 percent of their incomes on consumer electronics, Vegas vacations, and massage therapy, while saving 40 percent for retirement?

One effect is that producers and importers of consumer electronics will earn less money than before, as will masseuses and owners of Vegas hotels and casinos. Another effect is that some workers in these industries will lose their jobs.

Naive Keynesians focus like lasers on this effect. They worry that workers—some of whom are laid off and all of whom now (the naive Keynesians tell us) are more anxious about their economic futures—will reduce their spending even further. And because workers reduce their spending, investors (it is alleged) will reduce their investing.

It’s a spiral downward. The economic rot spreads.

And because before consumers changed their behavior, personal consumption expenditures were 70 percent of GDP, naive Keynesians—after intoning that “consumption is 70 percent” of the economy—will demand government action to restore that level of consumption.

But the fact is that, in this example, personal consumption expenditures are not any longer 70 percent of GDP. They are lower. And there’s nothing wrong or undesirable about this fact.

When income earners change the amounts they spend relative to the amounts they save, they of course change the pattern of economic activity. One trouble with naive Keynesians is that they assume the earlier pattern of economic activity—the one that prevailed before the “disruptions” when the level of employment was high—is somehow special. They take that earlier pattern as defining some sort of standard that ought not be disrupted—and if disrupted, ought to be restored.

With people now spending only 60 percent of their incomes on consumption goods and services, while saving 40 percent, naive Keynesians assume that—in the absence of government intervention—the economy will shrink, jobs will disappear, and people will become poorer. The reason is that some chunk of necessary consumer expenditure is now going into savings.

“How can the economy recover,” ask naive Keynesians, “if the 70 percent of it that is personal consumption expenditures is not all used for that purpose?”

Naive Keynesians commit too many errors even to list in the space allotted to me in this column. Perhaps foremost among these errors is their mistaken presumption that the practical imagination and initiative of entrepreneurs is as narrow and as anemic as their own in fact is.

If it were true that entrepreneurs were so dull that none of them could ever figure out how to employ a greater supply of saved resources in ways that improve the operational efficiency of a factory, increase the quality of a consumer good, and enhance worker training so that more will be produced in the future when those higher retirement savings are drawn down, then perhaps increased savings would always spell economic trouble.

Precluding Economic Change

But that would be a world in which any economic change spelled trouble. It would be a world in which, even if people merely changed the kinds of consumer goods they purchased (rather than changed the total amount they purchase), entrepreneurs would be unable to figure out how to adjust to such changes in consumer preferences.

Any change would spell damnation, releasing spooky animal spirits that scare everyone into withdrawing as much as possible from the economy.

Open-eyed observation of the commercial world in which we live should be sufficient to dispel these naive-Keynesian presumptions and fears. Entrepreneurs are forever on the lookout for ways to improve efficiency, to make their products more attractive to consumers, and to introduce totally new products.

Change is a natural and ever-present part of the competitive market process. So just because naive Keynesians can’t imagine how increased savings might be productively employed to make the economy stronger—just because they can’t imagine what capital goods the economy would produce if consumers changed their preferences and started saving more—does not mean that pattern of spending and saving which existed in the recent past is better than any one that will emerge in the future.

ASSOCIATED ISSUE

May 2011

ABOUT

DONALD BOUDREAUX

Donald Boudreaux is a professor of economics at George Mason University, a former FEE president, and the author of Hypocrites and Half-Wits.

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