Friday, June 25, 2010

By George, he hasn't got it: What would JM Keynes think of George Osborne's Budget?

Robert Skidelsky has an excellent article in today's Independent, which is well worth reading in full, in which he argues against Osborne's budget, not on moral grounds or in terms of whether it is progressive or regressive, but on the grounds that it is theoretically incoherent.

He first states the beliefs of Keynes and argues that this is what has so far been followed:

The message of John Maynard Keynes's General Theory of Employment, Interest and Money (1936) comes in three parts. First, the community's level of income and output is determined by the level of aggregate demand, or purchasing power. Second, consumer demand, especially investment demand, can fall short of the supply of goods, so that the community's available stock of labour and plant can exceed the demand for their services. Third, this situation can continue indefinitely, in the absence of an outside stimulus to replace the missing private sector demand.

Now compare what happened in 1929-1932 (the Great Depression) and what has happened since 2008 (the Great Recession). In both periods the world economy declined at the same rate for five quarters. But whereas the Great Depression economy went on declining for another seven quarters, the Great Recession economy's decline stopped after five quarters, and there has been a very modest recovery. Almost all analysts agree this was because this time, unlike in the earlier period, governments all over the world poured a huge amount of extra money into their shrinking economies. Many allowed their deficits to expand from about 2 per cent of GDP to 10 per cent; and their central banks flooded the banks with new money.

This was good old fashioned Keynesianism.
In a slump, Keynes said, governments should increase, not reduce, their deficits to make up for the fall in private spending. Any attempt by government to balance its budget in a slump would only worsen the slump.

Compare this to the key sentence on the first page of HM Treasury's Budget 2010:
"Reducing the deficit is a necessary precondition for sustained economic growth" – an almost exact reversal of Keynes's theory.
Now,of course, Osborne has never explicitly given us whatever theory he is employing, but his theory can be gleaned from statements which he has made.
It can be boiled down to three propositions of expanding generality: (1) in the absence of the fiscal stimulus, the economy would have rapidly recovered to full employment; (2) following a shock, economies quickly self-adjust back to full employment in the absence of counter-productive government efforts to revive them; (3) markets are optimally self-regulating in the absence of government interference. Osborne has never said any of this precisely, but his pronouncements make no sense unless he believes this.
Now, none of Osborne's theories have ever been proven, indeed, there are many of us who believe that we avoided recession only because the government pumped money into the system, exactly as Keynes demanded; but we should also never forget that Cameron and Osborne objected to this government intervention and even objected to the government bailing out Northern Rock and the banks.

Of course, there is a precedent for the situation we find ourselves in.

An important footnote is an exchange between President Roosevelt and Keynes in 1938. From 1933 to 1937, America had experienced four years of recovery since the Depression, with unemployment falling from 25 per cent to 14 per cent. Keynes attributed this recovery to the solution of the credit and insolvency problems and establishment of easy short term money; establishment of adequate relief for the unemployed; public works and other investment programmes helped by government funds or guarantees; the surge in private investment, and the momentum of the recovery. By the time of Keynes's letter to Roosevelt on 1 February 1938, however, the American economy was experiencing a "double dip" recession: unemployment had gone up from 14 per cent to 18 per cent, industrial production had fallen by 21 per cent and real GDP by 3.5 per cent. Keynes attributed this to the premature curtailment of the public works programme, as Roosevelt tried to "balance the budget" in 1936-37. Keynes's letter marks the start of the "Keynesian" phase of the New Deal which, by 1941 had reduced unemployment by 8 percentage points.

Whose judgement – or ideology – do we trust, Keynes's or Osborne's?

I am by no manner or means an economist, but I do struggle to work out how removing money from the economy is supposed to help the recovery. The problem at the moment is that people are not spending. Removing benefits from the poorer elements in society, whilst increasing unemployment, will only mean that there are even more people with even less to spend.

Osborne's theory appears to be the opposite of Keynes's. Which implies it's not only immoral, it's based upon an insane belief that the market will self correct, when most of us would conclude that the lesson to be learned from the recent economic upheaval is the very opposite of what Osborne is arguing.

Click here for full article.

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