Back from Davos
Maria Ramos, once Director General of the Finance Department, then CEO of Transnet and now of Absa and also incidentally newly married to long serving Minister of Finance Trevor Manuel, returned from Davos to tell us “We are all Keynesians now”
This is what Time magazine thought prematurely in 1965
This was in fact the heading of an iconic Time Magazine story written on 31 December 1965. Economists were then very confident that by fine tuning government spending and taxes, the Keynesian prescription, they could maintain full employment without inflation. Ramos might have been surprised that Time magazine in its “We are all Keynesians now” title was quoting none other than Milton Friedman. It was he more than any other economist who helped suppress the Keynesian revolution in economics.
What stagflation and Milton Friedman did for the Keynesian revolution
He was greatly assisted in his anti-Keynesian campaign by the stagflation (slow growth, high inflation) seventies that followed the high tide of the Keynesian economics so lauded by Time magazine and practised in Washington. The attempts to achieve full employment without igniting inflation clearly failed. President Lyndon Johnson’s attempts to fight the Vietnam war and fund the Great Society led first to more inflation and then slower growth.
Time Magazine calling
An extract from that Time Magazine article indicates the spirit of those naively optimistic times:
“……Because he was a creature of his times, Keynes was primarily interested in pulling a Depression-ridden world up to some form of prosperity and stability; today’s economists are more concerned about making an already prospering economy grow still further. As Keynes might have put it: Keynesianism + the theory of growth = The New Economics. Says Gardner Ackley, chairman of the Council of Economic Advisers: “The new economics is based on Keynes. The fiscal revolution stems from him.” Adds the University of Chicago’s Milton Friedman, the nation’s leading conservative economist, who was Presidential Candidate Barry Goldwater’s adviser on economics: “We are all Keynesians now.”
“………….Within the next two weeks, Ackley and his fellow council members will have to give President Johnson a firm economic forecast for the year ahead and advise him about what policies to follow. Their decisions will be particularly crucial because the U.S. economy is now moving into a new stage. Production is scraping up against the top levels of the nation’s capacity, and federal spending and demand are soaring because of the war in Viet Nam. The economists’ problem is to draw a fine line between promoting growth and preventing a debilitating inflation. As they search for new ways to accomplish this balance, they will be guided in large part by the Keynes legacy.
“……..Yet Keynes did not despair of capitalism as so many other economists did. Said he: “The right remedy for the trade cycle is not to be found in abolishing booms and keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”
“………The key to achieving that, Keynes perceived, is to maintain constantly a high level of what he called “aggregate demand.” To him, that meant the total of all demand in the economy—demand for consumption and for investment, for both private and public purposes. His inescapable conclusion was that, if private demand should flag and falter, then it had to be revived and stimulated by the only force strong enough to lift consumption: the government.
“———-The pre-Keynesian “classical” economists had thought of the government too. But almost all of them had contended that, in times of depression, the government should raise taxes and reduce spending in order to balance the budget. In the early 1930s, Keynes cried out that the only way to revive aggregate demand was for the government to cut taxes, reduce interest rates, spend heavily—and deficits be damned. Said Keynes: “The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rates of interest, and partly, perhaps, in other ways.”
Keynes and the epigone – Keynes addressed depression, not tradeoffs between inflation and employment
As the extracts reveal, the depression economics of Keynes was not about Keynesian fine tuning or hopeful tradeoffs of marginally higher inflation for marginally fuller employment. Keynes called for extreme measures to deal with extreme circumstances when private demands collapsed for want of confidence and credit. When depression and mass unemployment stalks the land, deficits are indeed to be damned and demand is to be stimulated without restraint. This is the depression economics of Keynes.
Keynes and Obama
The Obama stimulus package is truly Depression Economics in the tradition of Keynes. The government deficit to GDP ratio will rise to as much as 13% of GDP with the government debt to GDP ratio expected to soon rise to 100%.
The latest stimulus package passed by Congress is equivalent to about 7% of GDP and includes about $282bn of tax cuts divided between incentives for businesses and households. The other 65% of the package is spending on unemployment and health benefits as well as on construction projects.
Will it work and will it work too well – If so what next?
The big question is will the extra spending work to lift the US out of depression? And if it does will it work only too well to permanently raise the share of government spending in the US? At least a third of the spending is regarded by some commentators as irreversible.
And if it works well will the politicians be able to reverse direction and reduce spending or more likely raise tax rates sufficiently to reduce the deficits and the government borrowing requirements to a sustainable norm? If they prove unwilling to face up to the task the outcomes might well prove Keynesian in due course – permanently higher inflation rates with less growth.
SA got into trouble for much more prosaic reasons than global crisis – interest rates were too high for too long
SA does not face anything like the banking and credit crisis that portends depression. Indeed the sharp slowdown in household spending in SA in late 2008 has more to do with interest rates being pushed too high and held there far too long than any weakness in the global economy. The weakness in the SA economy was caused by a collapse in household spending that accelerated in late 2008 without any credit crisis. However the global weakness and what it has meant for export prices, demand, share prices and capital flows now compounds the difficulties the economy will face.
But very slow growth is a huge burden for South Africans
Yet while SA may escape the negative growth rates predicted for the US and UK, the mere one percent GDP growth predicted this year and well below potential growth in 2010 and the year after represents a tragic waste of employment output and income. Slow growth is not easily afforded by South Africans.
Deficits are to be damned at times like these
Budgeting for a deficit is the right way to stimulate demand and budgeting for an increase in government spending of 16% is surely as much as can usefully be spent by the public sector. Indeed Minister Manuel gave an impassioned appeal in Parliament for much better use of the money he has provided. Yet a Budget deficit of a mere 3.9% of GDP in current circumstances, given also the very strong state of the government balance sheet and low interest expense ratio, is not presumably what Keynes himself would have recommended.
Adding Eskom and other public sector spending makes a better impression
However we should perhaps add Eskom spending and borrowing in 2009/2010 to the deficit now that the Treasury has come to its senses and agreed to guarantee Eskom debt. Had they come to this inevitable decision sooner we would have been saved much hand wringing and more reasonable demands for tariff increases. The total public sector borrowing requirement that is over 7% of GDP gives a more favourable impression of government support for an economy under strain.
Keynes would surely have recommended less government revenue
Keynes might well have persuaded us to budget for a larger deficit. It seems to me that the 2009/2010 Budget could have offered more to stimulate private spending through significant income tax cuts for households and business. Lower effective business tax rates, also accelerated depreciation allowances, especially if accompanied by a sunset clause would have helped sustain business expenditure. To budget for a 6% increase in government revenues this fiscal year seems too conservative in current circumstances.
The spirit of Keynes
When lower tax rates work to keep the economy going they may well lead to higher tax revenues. This is not a Keynesian notion. And so we are not all the naïve Keynesians that Time magazine glorified in the sixties. Yet we are right to draw on the lessons of Keynes when facing recession or worse. South Africa after this Budget might well be regarded as among the more reluctant to embrace his spirit.
