The debate over what John Maynard Keynes “really” meant by the theories he put forward in The General Theory of Employment, Interest, and Money has been going on almost since it was published in 1936. The release of the second Hayek-Keynes hip-hop video brought this debate back to a boil. For example, in a May 2 blog post at The New Republic, Jonathan Chait argues that Keynesian fiscal policy is not “an argument for larger government.”
Unfortunately Chait misses two important points. First, Keynes’s argument for why his view of fiscal policy need not mean a larger government ignores the incentives facing the politicians who must implement it. Those incentives would lead to a larger government. Second, Keynes called for the socialization of investment as part of a broader vision of how to prevent the crises that necessitate stimulus spending in the first place. The result of both arguments is larger government. Thus Chait’s claim about Keynes just ain’t so.
Chait rightly notes that while Keynes argued that deficit spending was necessary as a stimulus during recessions, he also argued that governments should run surpluses in good times to pay off the debt. Chait concludes: “This policy is perfectly compatible with any level of government and does not require higher aggregate levels of debt than maintaining a regular balanced budget.”
Indeed, in theory it is compatible, but the problem is that the theory does not comport with reality. Keynesian ideas have ruled fiscal policy for at least 50 years, fewer than five of which had budget surpluses. During this time the debt has gone up to more than $14 trillion and the size of government has expanded enormously. Surely the economy was not in recession all but those few years. Apparently Keynesian policy is not compatible with any level of government and does seem to necessitate higher levels of aggregate debt.
What Chait overlooks is that regardless of what Keynes believed government should do, what it in fact will do is another matter. As James Buchanan and Richard Wagner argued in their classic critique of Keynesian fiscal policy, Democracy in Deficit, by removing the preexisting moral and institutional constraints on deficit spending as a way to balance the economy, Keynes and the Keynesians unleashed the perverse incentives of the political process into policymaking. The problem with Keynes’s analysis is that he paid no attention to the real incentives facing politicians, who now had the green light to deficit-spend in the name of economic stability.
Buchanan and Wagner argued that vote-seeking politicians will always prefer spending to taxing because the former gets them votes and the latter does not. As long as there are no institutional or moral impediments to this (such as a balanced budget amendment or a deeply held norm against deficit spending, except during wartime), politicians will always take deficits over surpluses, especially when economists such as Keynes have given them theoretical support. The result is that rather than the offsetting surpluses Chait focuses on, politicians continue to deficit-spend even during periods of economic growth because none wish to raise taxes or cut the flow of government benefits to their prospective voters. The result is exactly what Buchanan and Wagner predicted in 1977: large and increasing deficits and debt, and a growing danger of higher levels of inflation to pay it off.
In addition it’s worth observing that government stimulus spending simply does not work. Part of the Keynesian story is that deficit-financed spending will end recessions and generate the growth that will lead to the later surpluses to pay off the deficits. But what if stimulus spending doesn’t generate growth, or even prolongs or deepens recessions? In that case deficits beget deficits, debt begets debt, and government grows out of control. When Chait wrote in May unemployment was about 9 percent three and a half years after the recession started and around two years after it officially ended. As I write this two months afterward unemployment is unchanged. Massive stimulus spending is not just the path to larger government but also to permanently low rates of growth, which will only worsen the deficit and debt.
What Not to Do
In his article Chait also claims that defenders of Hayek cannot tell us what should be done when an economy is stuck in a recession. That’s an unfair charge. First, Hayekians can tell us what not to do: engage in large-scale stimulus spending, for the reasons noted. Second, Hayekians do have positive advice: Government should get out of the way so entrepreneurs and others who have a better idea of what to do can try things and see if they work. Chait claims it’s a cop-out for Hayekians to criticize Keynesian solutions for relying on government without specifying what the alternative is. The Hayekian perspective is that neither Hayekians nor Keynesians know what to do. That’s why we have market competition, which in Hayek’s words is a “discovery procedure” that helps us figure out how to revive a moribund economy.
Finally, Chait overlooks the broader context of Keynes’s fiscal policy recommendations. These were really only stop-gap measures rather than a long-term solution to what Keynes saw as the chronic tendency of capitalist economies to fall into recession. In his view there would never be enough profitable investment opportunities to match the public’s saving. So he proposed a fix for this oversaving/underconsumption problem. That fix was the socialization of investment through the State.
In trying to argue that there’s nothing in Keynes to suggest larger government, Chait is correct, but only if he’s referring to “fiscal policy” in its narrowest sense and ignoring the political incentives discussed above. But Keynes’s fiscal policy analysis was part of a larger story of the instability of capitalism, which requires that government play a more prominent role in allocating money for investment to avoid future recessions. This element of fiscal policy clearly calls for a bigger government.
The claim that Keynesianism doesn’t necessarily imply bigger government and greater debt is shown to be mistaken when we consider the implications of Keynes’s argument for countercyclical fiscal policy, the record of Keynesian policy in the last 50 years, and the broader context of his views on fiscal policy in The General Theory.