John Maynard Keynes (1883 – 1946) was a British economist who had a lot to say about what governments should do in times of recession. His influence is still at the forefront of political debate today, perhaps more than ever. But were his ideas simply wrong?
Keynes was one of the great economists of the 20th century. I, by contrast, have no formal economics education, although I do have a background in mathematical physics, and yet even I can see what’s wrong with Keynes’ big idea. And so, I think, can anyone with an ounce of common sense.
In a recession, Keynes said, consumer spending will fall, causing the economy to contract further and a vicious cycle to set in. True enough, but Keynes’ answer was this: when individuals cut their spending, it is the role of government to step in and start spending to boost the economy.
But think what this means. Individuals see clearly that, because their income is falling or their job is at risk or because the cost of living has increased, they need to cut their spending. Keynes argued that the government must over-ride their individual choices and spend public money on their behalf. But public money comes from individuals through taxation. And so, instead of allowing individuals to control their spending, Keynes says the government must spend their money for them, and on things it considers important, not the individuals themselves.
Apart from the moral issue and the denial of free choice, it’s easy to see why this whole concept is just wrong.
Suppose for the sake of argument, Keynes was right. If the government spends an extra billion, the economy increases by a billion. That would be beneficial. Then logically, if the government spent 2 billion, the effect would be even better. Have you spotted the problem yet?
According to this argument, the more the government spends, the greater the economic benefit. Therefore there is no limit to the amount the government should spend on our behalf. This applies regardless of whether the economy is growing or in decline. Spend, spend, spend is always the solution.
This is clearly an absurdity. By pushing the argument to its logical conclusion, it’s easy to see why it’s wrong. And if it’s wrong in this case, it’s wrong in every case.
The problem is that in order to spend more, the government must either borrow more or raise taxes. Both have a negative impact on the economy. If the government raises taxes in order to increase its spending, then the increase in its spending is exactly equal to the amount that individuals must cut their spending to pay the increased taxes. And if the government borrows in order to spend, it’s just pushing the problem into the future and making it even worse, as interest payments pile debt on top of debt.
The logical conclusion is that government spending is not an answer to an economic downturn. The “correct” amount for the government to spend is the minimum it needs in order to meet its obligations. Any more than this is simply waste.
The free-market economist Milton Friedman (hero of Margaret Thatcher) argued that Keynes was wrong and that the appropriate response of a government to a recession is to reduce the burden of taxation (after all, the less money people have, the less tax they can afford to pay). This takes the pressure off ordinary working families and allows for a private-sector-led recovery to take place.
That sounds like common sense to me.