Sunday, October 03, 2010

Obama and Keynes - Government Must Do what the Private Sector Can't

As I wrote in my last post, Republican congressmen love to slander President Obama's economic policy as "Keynesian." Considering how few people know who Keynes is, they might get the impression that he is Obama's budget director or something. Actually, John Maynard Keynes was a British economist who died 64 years ago. (Note: The President's budget director is Peter R. Orszag. No one really knows who he is either.)

Keynes was writing about the problems of the Great Depression and how government should address them in the early 1930s, and his work came to the attention of the Roosevelt administration. Keynes met and corresponded with President Roosevelt, and his ideas helped shape New Deal economics and have been influential in American economic policy ever since.

Keynes favored interventionist policies for tackling a recession. His theories challenged the earlier neo-classical economic paradigm, which had held that provided it was unfettered by government interference, the market would naturally establish full employment equilibrium. He believed that demand, not supply, is the key variable governing the overall level of economic activity. In a state of unemployment and unused production capacity, one can only enhance employment and total income by first increasing expenditures for either consumption or investment. Without government intervention to increase expenditure, an economy can remain trapped in a low employment equilibrium. Thus Keynes called for government to stimulate demand in times of high unemployment, for example by spending on public works.

The New Deal of the 1930s demonstrated that Keynes was correct. The Roosevelt administration raised taxes and spent lavishly on hiring the unemployed to rebuild the country's infrastructure, something that the Hoover administration had refused to do earlier in the Depression. The contrast in results could not be starker. Under the conservative policies of Hoover, GDP fell 28% in the first three years of the Depression. Under Roosevelt, in just three years GDP grew by more than 10% per year so that by 1936 American productivity had surpassed 1929 pre-crash levels.

In 1978, Keynes' demand-side ideas were at the heart of the Humphrey–Hawkins Full Employment Act, which specified that unemployment rates should be not more than 3%, and that the government should create a reservoir of public employment if the private sector fails to meet employment goals. (Hey, this law is still in effect, so where's the reservoir of public employment?)

Belief in demand theory has also long been something that has crossed partisan political lines. Even President Nixon said, "I am now a Keynesian in economics." More recently, Greg Mankiw, a former chairman of George W. Bush's Council of Economic Advisors, has said he used "Keynesian logic" in designing his tax cuts. "The idea that demand is an important driver of the economic cycle" -- that's Keynesian -- "is uncontroversial."

Pulitzer Prize winner Paul Krugman has recently discussed America's economic problems as having strong parallels to the crises of the 1930s, and recommended Keynesian solutions similar to those used to fight the Great Depression. This past July, Krugman called for more federal stimulus, saying, "The most effective things you can do, in terms of actual bang for the buck, is actually having the federal government go out and hire people," he said. "We are deep in the hole here, and you need to be unconventional to get out of it."

More recently, Krugman has noted that the chief problem with President Obama's economic stimulus is that it hasn't been large enough in scope:

"President Obama’s economists promised not to repeat the mistakes of 1937, when F.D.R. pulled back fiscal stimulus too soon. But by making his program too small and too short-lived, Mr. Obama did just that: the stimulus raised growth while it lasted, but it made only a small dent in unemployment — and now it’s fading out."

"And just as some of us feared, the inadequacy of the administration’s initial economic plan has landed it — and the nation — in a political trap. More stimulus is desperately needed, but in the public’s eyes the failure of the initial program to deliver a convincing recovery has discredited government action to create jobs."

So what, exactly, is it that the government needs to do to get the economy moving? I thought Michael Moore summarized it neatly in a call to action last week:

Announce a New 21st Century WPA.
"Who's hiring? THE GOVERNMENT IS HIRING!" Put together a simple plan to hire enough people to repair our roads, fix up our aging schools, and rebuild our infrastructure. Fund this by taxing the richest 1 percent who have more financial wealth than 95 percent of Americans combined! Unemployment will drop to 5 percent. Can you pass it? Well, you sure can't unless you try! And as you're trying, announce that you will force the Republican senators (who until now simply have had to say they "intended" to filibuster in order to kill a bill) to have to actually filibuster! Make them stand on the floor of the Senate and read from the phone book 24/7. They won't last a day. And America will see them for who they really are.

The WPA was of course the Works Progress Administration, which employed millions of Americans in the late 1930s. It included construction of public buildings and roads, and operated large arts, drama, media, and literacy projects. It fed children and redistributed food, clothing, and housing.

Or we can always go with the Republican plan to fix our economic problems: do nothing.

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