Friday, December 2, 2011
The Keynesian Conundrum: Chapter 24 Bankruptcy?
"Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."
John Maynard Keynes, The General Theory, Chapter 24, last paragraph
The madmen in authority today are distilling their frenzy from Keynes, just as he predicted. From my perspective, Keynes is the most misread, misinterpreted, misquoted and misunderstood economist of modern times. In The General Theory, Keynes proposes two primary techniques of using fiscal policy to stimulate the economy toward full employment:
1. Progressive income taxation. Here Keynes assumes that wealthy people do not spend all of their incomes but rather save a good portion of the income. This contrasts with the lower classes which tend to spend all of their income. This is the marginal propensity to consume. By taxing income away from the wealthy and redistributing this income to the working class, aggregate demand increases, thus increasing employment. Keynes also considered high rates of death and estate taxes on the wealthy to serve this same purpose. This is a policy he felt should be used continuously, not just in times of economic contraction.
2. Deficit spending. Keyne's second policy prescription is to be implemented in times of economic contraction. This is simply to have the government borrow large sums of money to spend on public works projects. These deficits can be slowly repaid over the long term during times of economic expansion. Their immediate expenditure will increase aggregate demand and therefore employment.
Of course, this is a greatly over-simplified interpretation of Keyne's complicated treatise. However, I feel it is instructive to reexamine his thoughts in relation to the economy of the United States today. Let's examine them in that light:
1. Progressive income taxation. Since the 1970's the progressivity of income taxes has decreased dramatically. Whether justified via theory (the Laffer curve, etc.) or imposed via tax avoidance schemes, Warren Buffett is correct. It is not good tax policy for Mr. Buffett to have a comparable effective income tax rate as the average working American. Not only have effective tax rates on the wealthy decreased, but the payment of these decreased tax rates is largely avoided by loopholes, shelters, etc. If the "madmen in authority" truly want to pursue Keynesian economics then they need to radically overhaul and simplify the tax codes.
2. Deficit spending. This is truly our Achilles heel in 2011. If we assume that World War II did indeed finally bring us out of the Depression and we look at the magnitude of the deficit spending implemented from 1939 to 1945, this would be roughly equivalent to about $10 trillion of deficit spending in today's dollars. A $10 trillion public spending campaign, I think, could jump start our economy quite well. However, if we announced deficit spending plans of that magnitude today, those in authority would definitely be derided as madmen. Because we have been irresponsible, profligate spenders, we do not have that magnitude of borrowing capacity. We are in a "Catch-22."
This brings us to Chapter 24 of The General Theory titled, "Concluding Notes on the Social Philosophy towards which the General Theory might lead." Reading this chapter, sometimes somewhat between the lines, Keynes warns us not to use his theories of deficit spending in order to justify long term, structural deficits which ultimately result in unmanageable debts. Unfortunately, that is exactly what we have allowed our politicians to do, and exactly where we are. The United States is bankrupt for exactly the reasons Keynes warned us about.
Our use of deficit spending to pay current expenses has generally grown over the last 50 years and today precludes the use of our most powerful fiscal tools. Politically, I'm afraid that these deficits were simply used by both Republicans and Democrats alike to buy votes of various interest groups. We cannot achieve vibrant economic growth again until we have radical political reforms.
"The American republic will endure until the day that Congress discovers that it can bribe the public with the public's money."
Alexis de Tocqueville