Imagining a Keynesian revival

SALZBURG — In 2009, while the world economy was still reeling from the global financial crisis, Nobel laureate economist Robert Lucas observed that “everyone is a Keynesian in the foxhole”. The implication was that, when an economy is faced with a severe economic shock, conventional fiscal policy norms must take a backseat to stabilization.

Imagine a scenario where the global economy plunges into an economic crisis akin to the Great Depression of 1929-32, with unemployment skyrocketing to 20 per cent. Even the most fervent anti-Keynesian would agree that for the government to try to balance its budget in this situation would only make matters worse, by removing yet more purchasing power from the collapsing economy. Thus, current orthodoxy maintains that following a shock, fiscal “austerity” should be applied only gradually, though policymakers’ commitment to balanced budgets remains essential to recovery, because only this will give business the “confidence” to invest.

The orthodox hostility to large public debt-to-GDP ratios derives from the hoary doctrine of “crowding out,” which presupposes that a well-governed private-enterprise economy will use all available resources. Moreover, it assumes that public investment, being determined by arbitrary choices rather than market indicators, will generally be less efficient than private investment, yielding lower or even negative returns. On such logic, reducing the public debt from its “foxhole” level should always be a priority of fiscal policy.

The Keynesian revolution, however, called into question the rigid separation between public and private expenditure. Growth and employment, Keynes argued, hinge on mitigating two types of waste: the inefficient use of some resources and the failure to deploy others. While capitalism surpassed socialism in terms of allocative efficiency, its reliance on uncertain profit expectations left potential resources untapped. Consequently, the capitalist economy’s normal state was one of underutilised productive capacity. To overcome this conundrum, Keynes proposed a compromise: retain a free-market system for its efficiency benefits but rely on autonomous public investment to secure full employment.

The resurgence of neoclassical economics since the 1970s bulldozed the Keynesian compromise, leaving today’s economic policymakers in a bind. As governments seek to initiate costly projects to address global challenges such as climate change, they are constrained by an economic dogma that suggests that such actions inevitably divert resources to less efficient avenues or stoke inflation. When an economy is already operating at full employment, the thinking goes, it cannot simultaneously produce more guns and more butter.

Hence US President Joe Biden’s (misnamed) Inflation Reduction Act (IRA). Its centrepiece is an investment of $369 billion towards fighting climate change and bolstering energy security. However, over ten years the budget will be balanced with an extra $739 billion in revenue from increasing taxes on corporations and reforming prescription-drug pricing.

The strategic political manoeuvreing behind the IRA is evident. Its spending commitments align with essential environmental goals, while its projected tax increases are designed to appease fiscal hawks. Essentially, it is an expansionary budget in austerity camouflage.

This package contains the germ of a good idea known as the balanced budget multiplier: an increase in government spending will inject more demand into the economy than will be withdrawn by an equal increase in taxation, since some of the money taken by the tax would have been saved, not spent. This is a decisive answer to the simple “crowding out” thesis. But the balanced budget multiplier is a piece of Keynesian magic that dare not speak its name.

Europeans are even further from such dangerous thoughts. The European Union’s Temporary Crisis and Transition Framework, established in 2022 to help the bloc’s economies deal with the effects of the COVID-19 pandemic and the war in Ukraine, effectively functions as a debt-financing scheme, with the burden of repayment falling on future taxpayers.

Unveiling the Labour Party’s new plan to borrow an additional £28 billion ($35.6 billion) annually for green investments, the United Kingdom’s Shadow Chancellor, Rachel Reeves, emphasised its adherence to “fiscal rules”. The plan, Reeves claimed, would pay for “day-to-day spending through tax receipts” and reduce the country’s debt-to-GDP ratio. But she did not elaborate on how the increased spending would help achieve these goals.

With the decline of Keynesian interventionism, contemporary policy discussions have reverted to the age-old standoff between market-based supply-side economics and a supply-side approach rooted in industrial policy. This echoes the capitalist-socialist divide of the early twentieth century. Then as now, the economic debate centers on whether private or public spending is more effective at generating wealth and ensuring its equitable distribution.

The Keynesian revolution circumvented this microeconomic dilemma by introducing a novel concept, macroeconomics, which stressed the insufficiency of demand rather than the inefficiency of supply. This is the missing ingredient from the economic-policy debate today. Consequen1tly, commitments to public investment are framed by fiscal rules which assume they do harm. Policymakers must convincingly show that their proposed industrial policies would bolster growth and employment, lest they violate their own budgetary principles.

The most troubling aspect of what Reeves labels “securonomics” is its overt wartime framing, suggesting that the UK and other countries trade only with allies and reshore all other production activities. The inherently protectionist nature of today’s industrial policies should give the left pause for thought.

The ongoing debate about the future of capitalism is undeniably crucial. The economic shocks of the past two decades were not freak occurrences but rather the product of a profoundly flawed and corrupt system. But narrowing the policy discussion to a binary choice between market fundamentalism and protectionism overlooks the potential for constructive leadership. Before we resign ourselves to the inevitability of the capitalist-socialist conflict, we would be wise to give Keynesianism another chance.

Robert Skidelsky, a member of the British House of Lords, is professor emeritus of Political Economy at Warwick University. Copyright: Project Syndicate, 2023. www.project-syndicate.org