October 19, 2001, Review
& Outlook, Wall
Street Journal
Keynes Really Is Dead
Anybody watching the debate in Congress over "stimulating" the economy might wonder: What are they thinking? How to explain that politicians have so much faith that a burst of government spending will restore economic growth when economists long ago gave up on the idea?
Well, if John Maynard Keynes were suddenly to materialize in Washington, he would feel right at home. Lord Keynes was Time Magazine's Economist of the Century. Too bad it was the last century.
Keynes believed that government policy could manage the economy by smoothing out normal fluctuations in the business cycle. The notion required an active role for government, and it became fabulously popular after World War II. If the economy was looking limp, then government had to inject a little "fiscal stimulus."
The most effective way to stimulate, according to Keynes, was to have the government spend money. How much money? The more, the better. How the government spent that money didn't really matter. Keynes even thought it would be okay for the government to pay people to dig ditches and then pay them to fill the ditches back up. (Sound familiar?)
The only problem with this Keynesian spending injunction is that it has never worked. First, there is a question of timing. Inevitably, there is a big, long lag between the time spending is ordered by Congress and the time spending actually shows up in the economy.
Second, fiscal fine-tuning tends to consist of temporary, rather than permanent, fixes. And people don't fully or predictably respond to one-shot policies.
Third, government spending is less efficient, and thus less productive, than private spending. The government tends to spend on items (welfare, subsidies) that produce less economic growth than private investment does. The profound point about government spending is that the money has to come from somewhere, which means the private sector. The government must take it either through taxation or borrowing. "But either way," says University of Chicago Professor of Finance John Cochrane, "no new wealth is created."
By now, it's pretty much impossible to find an introductory macroeconomics textbook that recommends this type of fiscal stimulus. If Keynes appeared in any of the heavy-duty academic centers around the world, he would find his idea referred to as a "classic fallacy." Most economists have moved on to other models.
(Not that the Keynesian faith in government economic fine-tuning has faded away entirely. Calling themselves Neo-Keynesians, a younger group of economists has invoked monetary policy. They argue that if the economy is drooping, then easier money will stimulate it. This idea isn't working either; witness Japan, where even essentially zero interest-rates haven't revived the economy. But we digress.)
Nowadays most serious people favor government policies that are permanent and create incentives for the private sector to work, invest and take risk. Except in one place -- Washington, D.C., and especially Congress. There they still believe in Keynes, or claim to. We suspect that what the Members really want to do is spend money on subsidies and tax favors for an assortment of special interests. But for political cover they need to invoke someone, so why not a long dead economist?
Thus the House Ways and Means Committee has delivered a "stimulus" bill full of temporary tax credits and faster business expensing. There is also a reprise of last summer's one-time-only tax "rebate," this time going to 30 million workers whose income was too low for the previous round. Recall that our neo-Keynesian politicians told us that the last rebate was going to fire up the economy, but in the end only 18% of the money was spent.
One mystery is what spell has come over White House economic adviser Larry Lindsey. He once wrote a good book on the benefits of Ronald Reagan's reduction in marginal tax rates, a repeat of which would help the economy just now.
But now that he's in the White House, Mr. Lindsey calls himself a "Keynesian and a supply-sider," which is the economic equivalent of Saudi Arabia saying it wants to fight terrorism while financing Osama bin Laden. This White House policy confusion is one reason the "stimulus" bill has become such a mess on Capitol Hill. And that's before the bill even gets to the Senate Finance Committee and its chief economic masseur, Montana's Max Baucus.
If this is the best the politicians can do, it's probably time to call off the whole "stimulus" charade. The economy deserves better, and so does Keynes's ghost.
