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The Keynesian Debate

Since he published his most famous work, The General Theory of Employment, Interest and Money in 1936, John Maynard Keynes has been either celebrated or reviled by economists and fiscal policy enthusiasts. Even though Time magazine named Keynes one of the 20th century’s most important and influential people and he is widely known as a founder of modern macroeconomics, his theories are the source of relentless debate.

As often cited in current literature, Keynes suggested that, to fuel economic activity when private enterprise is reluctant to invest, hire and expand, governments should spend, even if deficits result. In fact, the 1999 Time article that celebrated Keynes’ influence, actually noted that, “His radical idea that governments should spend money they don’t have may have saved capitalism.” For those readers interested in political science, there were parallel developments during the 20th century relative to government’s role in economic stimulation, social evolution, and global affairs. Earlier economic theorists believed that capitalism was the sole and best engine of prosperity and that government should remain a peripheral player. Classical economists during that period were disciples of Say’s Law, which held that supply creates its own demand, and that free market workers would refrain from wage demands that would inhibit their employers from generating a reasonable profit. In other words, the premise was that workers would never demand wages or benefits that would negatively impact or jeopardize their employers’ ability to prosper. Whether this was a rational theory at the time remains questionable, but it has since proven to be highly inaccurate.

Keynes’ General Theory opus provided justification for interventionist policies, boldly countering the neo-classic economic belief that, without government interference, the market would naturally generate growth, demand, opportunity and full employment. Working with government and business through the 1929 stock market crash, Keynes forged a theory that the critical element of stability and growth is demand and not supply. Within this context, and what has led to a resurgence in Keynesian economics since 2008, is Keynes’ belief that aggregate demand must be defined as the sum of all investment and consumption, and that demand is comprised of all un-hoarded income. In other words, this approach simply embraces the belief that, when consumption declines, investment must be increased by any means possible.

Without taking a polarizing position here, it is clear that the debate centers on a larger discussion about the role of government. Frankly, much of this is philosophical and driven by personal opinion. For the more practical minded, government is seen as a tool. Certainly, a tool that must be forged, honed and maintained by and for the people, but a tool nonetheless. So, how is that tool to be used? Keynes argued that, when there is unused production capacity and high unemployment, society can best enhance employment and total income by first increasing expenditures for either consumption or investment. And, assuming that government is an elemental factor in this equation, it is the perfect vehicle to stimulate demand during high unemployment through various projects and initiatives (WPA in the 1930s and multiple infrastructure projects since 2008).

As noted in virtually every business and financial journal, enormous wealth is currently being hoarded, expansion is tentative, unemployment is high and the system is in a state of imbalance. Classical theorists have been proven incorrect in their assertion that workers would automatically reduce wage demands to preserve their employer’s ability to maintain a profit margin or to add additional jobs. Only through rampant brinksmanship and litigation are employee demands acquiescing to private and public workplace realities. If you don’t believe that, remain vigilant for emerging reports detailing pension, benefit and wage reductions that will sweep this nation for the next five or more years. As always, the plot is turning.

Keynes was not a proponent of big government. He saw it as part of a larger cultural equation that contained multiple facets and accountabilities. He provided an early warning that a shift to private power and the growing influence of financial speculators could bring about the same loss of control that was rampant after World War I. Unfortunately, Keynes’ lack of financial modeling and the surge in powerful financial interests began to reduce his influence after 1979 and detractors such as Milton Friedman and Hyman Minsky began to gain greater support. The irony here is that many of his admonitions are proving accurate, as financial speculators have undermined and seriously damaged the reputation of the U.S. financial community and banks have grown more omnipotent (for context, see economist Ed Lotterman’s recent column, Big Banks Pose Threat to U.S. Economy, Idaho Statesman, June 8).

More recently, in 2008, Martin Wolf, chief economics commentator or the Financial Times (13 November 2008), announced the death of free-market capitalism and James Galbraith provided a powerful, supportive commentary on the value of Keynesian economics rather than continuing the more monetarist approach advocated by Keynes’ detractors. Ironically, Galbraith’s comments were made in a speech at the 25th Annual Milton Friedman Distinguished Lecture, University of Texas, 2008. Has there been another turning point? Are we returning to a more rational theoretical approach to economics and fiscal policy? It is difficult to say.

However you view economics and various theoretical approaches, the message here is that the days of trusting the system and self-serving decision-makers are over. Whether you view government as a tool in the financial and economic took kit or are a steadfast non-interventionist, there is wisdom in understanding Keynes’ practical approach. Believing that every facet of business, government, and the financial community takes the Nation’s and each individual’s best interests to heart when making decisions is naïve. Since 2007, there has been a renewed interest in Keynesian economic theory in China, Europe, South America and the U.S. as stimulus has helped several economies weather economic storms. The exact formula remains elusive, but trust that Keynes’ theories and remedies will factor into the equation. Whatever your view, one of Keynes’ strongest critics, Friedrich Hayek, may have said it best…

He was the one really great man I ever knew, and for whom I have unbounded admiration. The world will be a much poorer place without him.

With over three decades working in and with federal, state and local government, John Luthy understands public agencies.  Known for his real world, straight talking style, he is a leading futurist specializing in city, county, state, and federal government long-range thinking and planning. John is the author of Operations Planning: A Guide for Public Officials and Managers in Troubled Times, and The Strategic Planning Guide, both published by the International City/ County Management Association (ICMA). His 2010 book, Planning the Future – A Guide to Strategic Thinking and Planning for Elected Officials, Public Administrators and Community Leaders, is being hailed as the best book for public managers and community leaders who are committed to building a sustainable future.  An innovative and dynamic presenter, John is frequently asked to speak and consult on how to prepare public organizations and communities for emerging challenges (public futures at http://www.futurescorp.com).

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