6 August 2019

Have the Tories really ‘discovered Keynes’?


It’s become trendy to claim that the Conservatives have rediscovered Keynes. Some have even concluded that ‘everyone is a Keynesian these days’, just because the government is planning to spend a bit more money. This is desperately thin stuff.

Let’s first deal briefly with the report which appears to have triggered some of these claims. When asked this Sunday on Sky how additional spending on the NHS would be financed, Conservative party chairman James Cleverly replied that ‘the money’s coming from economic growth’. But there is nothing particularly ‘Keynesian’ about this statement, despite bold assertions from commentators like George Eaton and Lewis Goodall.

It might be different if Mr Cleverly had said that the additional spending would itself boost growth and thus be self-financing. But he didn’t. Instead, he argued that the economy has recovered from the global financial crisis and that it is this improved performance, along with stronger public finances, that allows more spending. He even talked up the potential boost from further supply-side liberalisation, including tax cuts and ‘free ports’. (You can view the full interview here.)

So, what does it actually mean to be ‘Keynesian’? Obviously, you’re never going to get every economist to agree. But The New Palgrave Dictionary of Economics defines Keynesianism as the ‘use of macroeconomic policy to stabilise the economy and maintain low levels of unemployment’, noting that ‘Keynesianism is associated with the fine-tuning the level of government spending and taxation so as to use the variations in the budget deficit to counter-act shocks’. Similarly, Investopedia defines Keynesian Economics in terms of ‘using active government policy to manage aggregate demand in order to address or prevent economic recessions’.

The sort of temporary stimulus that Keynes and his followers might support during a recession is therefore very different from the permanent increase in day-to-day spending being discussed today. Indeed, Keynes himself was wary of running persistent budget deficits, except in economic downturns, and placed at least as much emphasis on fine-tuning via monetary policy as fiscal policy.

What’s more, it’s far from obvious that the Conservatives have ever ‘undiscovered’ these ideas. The current government’s ‘fiscal mandate’, for example, of keeping borrowing below 2% of GDP in 2020-21 is expressed in terms of the ‘structural’ deficit, i.e. adjusted for the stage of the economic cycle. In other words, it allows for the possibility of running a larger deficit during a downturn. This sounds pretty Keynesian to me.

By this stage, some readers are doubtless screaming ‘what about the years of austerity?’. How could the budget cuts of the early 2010s be squared with a Keynesian approach to demand management?

Here, I’d argue that it was always accepted that fiscal tightening would delay the recovery from the global recession. Nonetheless, at the time this was considered ‘a price worth paying’ to bring the public finances back under control. Put differently, Keynes hadn’t been forgotten, but the dire fiscal position was assumed to leave no room for temporary fiscal stimulus.

We can, of course, debate whether this judgement was correct. With hindsight, it probably wasn’t, for at least two reasons. First, officials, both in the UK and elsewhere, under-estimated the negative impact of fiscal tightening on the economy, especially when austerity was being implemented in many countries at the same time. The IMF in particular had initially supported fiscal consolidation, but subsequently revised its estimates of the impact of tax increases and spending cuts on GDP (the so-called ‘fiscal multipliers’) sharply higher.

Second, fears that the UK faced a Greek-style debt crisis were overdone. In part this was because, outside the euro, the Bank of England maintained control of monetary policy and could support increased borrowing (indirectly) via quantitative easing. Interest rates have also remained lower for longer than many anticipated, and sterling was free to find its own level.

Taken together, these two points mean that the costs of austerity were larger than expected, and it probably would have been better to allow fiscal policy to continue to support the economy. Next time there is a similar crisis, the authorities would surely respond differently. But with the economy now close to full employment, we are not in that position today.

So, where else is the evidence that the Conservatives have rediscovered Keynes? Perhaps it can be found in the renewed emphasis on spending on infrastructure, including transport and hospitals, or housing. Keynes himself frequently argued that capital spending should be regarded differently from day-to-day spending. Investment projects typically have a higher fiscal multiplier, meaning that they are more likely to help pay for themselves via stronger economic growth, or at least generate revenue streams that can be used to finance increased debt.

But this isn’t a uniquely ‘Keynesian’ perspective. Indeed, many of the economic benefits of increased investment spending come from enhancing potential supply, rather than any boost to aggregate demand. Examples here might include the extension of broadband, or improvements in the housing stock that help labour market mobility. And in the case of healthcare, the main benefits are not necessarily economic at all.

In short, if Keynesianism is about using fiscal and monetary policy to fine-tune demand over the business cycle, that idea has never gone out of fashion. Rather than being rediscovered, it wasn’t lost in the first place. But the great man would not have supported increased public spending just for the sake of it, regardless of the economic weather.

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Julian Jessop is a freelance economist