Friday, 12 September 2014
Keynesian economics still works.
Leading Liberal Democrats, including Vince Cable, have patronisingly claimed that Keynesian economics is "old hat" - no longer a viable option in the open economies of today's world.
Whilst it is true that "Keynesianism in one country" is more difficult to implement in world of open economies, figures quoted in a letter from Labour MP Michael Meacher in Wednesday's Guardian demonstrate that Keynesian policies still produce the desired effects.
First, some elementary theory.
When an economy goes into recession government revenues fall because of reduced taxation income, and government expenditure rises because of increased social security payments. Hence the budget is likely to fall into deficit. The pre-Keynesian solution, implemented in the 1930s, was the intuitive one of trying to restore balance to the budget by cutting government expenditure, including social security payments, and increasing taxes.
The result was to make the recession or depression worse because the resulting decline in demand forced businesses into bankruptcy and put even more people out of work. This is indeed what happened in the UK and much of the developed world in the 1930s. Economies eventually recovered largely as a result of the increased government expenditure mad e necessary to fight the Second World War.
Keynes's counter-intuitive solutions is to combat a recession by increasing government expenditure and cutting taxes. The resulting increase in demand will eventually generate further economic activity, increase taxation income,reduce social security expenditure, and thus reduce or eliminate the budget deficit.
Meacher's figures demonstrate that this reasoning is still valid, even in our modern open-economy world.
In 2009 and 2010 the Labour Chancellor, Alistair Darling, introduced two Keynesian stimulatory budgets (increased government expenditure with a cut in taxes; VAT from 17.5% to 15%). Bingo. Instead of an increase in public borrowing the annual public deficit fell from £157bn in 2009 to £118bn in 2011, a reduction of almost £40bn in two years.
Although Meacher doesn't mention it, the economy actually grew during this period and was growing when the Tory-led coalition came to power..
In 2010 George Osborne took over with his austerity budgets, based on the pre-Keynesian intuitive position: social security payments savagely cut, other public expenditure reduced and taxation in the form of VAT increased from 15% to 20%. The economy promptly flat-lined and the budget deficit, in the following three years, was reduced by a mere £10bn. compared with £40bn in the previous two years.
It must surely logically follow that the Tory cuts are introduced not from economic necessity but from an ideological drive to reduce the size of the state. It is shameful that the Liberal Democrats in government have gone along with this damaging and counter-productive programme. We need now to have the courage to campaign on a bold programme of Keynesian public works to restore our economy to health, and the lives of those most blighted by this unnecessarily prolonged recession to the level of decency they should expect in what is still a very rich economy.
As Meacher also points out, following this blog and countless much more highly qualified economists, it is absolutely stupid, whilst interest rates are close to zero, for the government to miss the opportunity to borrow at historically low cost in order to to repair our dilapidated infrastructure, generate millions of jobs and return us to full-employment prosperity.