17 May 2017

Keynes would scoff at the logic of today’s anti-austerity brigade

By Kristian Niemietz

I’m not a fan of Keynesian economics. Given that I work for the free-market think tank Institute of Economic Affairs, that will not surprise many of you. But for the purposes of this article, let’s assume, just for ten minutes, that it could be proven beyond the shadow of a doubt that Keynesian economic policy recipes would have dragged the UK economy out of the Great Recession quickly and painlessly.

Let’s suppose we found a window into a parallel dimension where everything is exactly the same as here, except the UK government did not opt for a policy of fiscal consolidation in 2010.

Instead, let’s say they went for an all-guns-blazing, Paul-Krugman-on-steroids fiscal stimulus, and borrowed and spent such vast sums that even Syriza politicians could be heard saying “We reject austerity, but nobody is suggesting that we should be as spend as recklessly as the Brits”.

And now, let’s assume that in this parallel dimension, the British economy bounced back quickly, and then grew at phenomenal rates. Within a few years, the deficit has eliminated itself, and there is a budget surplus.

By 2017, this parallel-universe Britain has a lower debt-to-GDP ratio than the Britain we live in, a higher employment rate, higher wages, and higher tax receipts. It is superior to our version in every way.

What would be the implication? Would this mean that we should now give up on fiscal restraint, and open the public spending floodgates?

Absolutely not. It would only show that in retrospect it would have been better to do so during the recession. But even then, that would be water under the bridge.

Let’s go back to the basics for a moment. Traditional Keynesians do not believe that a country can borrow itself rich. They do not belief that permanently spending money you do not have is the path to prosperity.

They believe that a government can spend its way out of a recession. They believe that during a recession the economy is in a state of shell-shock. Some event has thrown the economy off course, and although things could now go back to normal, everybody is waiting for somebody else to make the first move. Consumers do not want to spend until employers start to hire, and employers do not want to hire until consumers start to spend. And so, the economy remains in this trap.

If this accurately describes the situation the economy is in, then yes, theoretically, government spending can provide an initial shove to get things moving again. In this specific situation, we can imagine an increase in government spending that does not come at the expense of private spending.

Since the economy is not running at full capacity, there are productive resources lying idle, and if the government doesn’t bring them back into use, nobody will. Under those assumptions, it is not just possible to have your cake and eat it, but rather, eating the cake becomes the very precondition for having it.

Traditional Keynesians would concede that such a situation does not occur very often. It requires a specific type of recession. Their theory is not applicable to “normal” economic times.

In fact, when the economy is growing, traditional Keynesians would argue that the government should aim for a budget surplus, and use it to pay back some of the debt it incurred during the recession.

In “normal” times, the Keynesian multiplier cannot work its magic, because government spending just crowds out private spending. I could steal £100 from you, spend it on dining out, and then argue that I have done this for altruistic reasons, namely to stimulate the economy. My spending becomes the income of the restaurant owners and their staff. They will spend the bulk of it. Their spending then becomes somebody else’s income. And so on.

But this is obviously nonsense. If I had not stolen that £100 from you, you would not have buried it in your garden. You would also have spent it. Or you would have saved it, in which case the bank would have lent it out, turning it into investment spending.

So yes, I may have started a little “stimulus package”, but by the same token, I have also prevented one, namely the one that you would have initiated had not robbed you.

On “austerity”, we will just have to agree to disagree. Some will always remember the period from 2010 onwards as a time of wilful social cruelty, in which the poorest in society were punished for the mistakes of the bankers and the fat cats. Others will remember it as a painful but necessary correction, which prevented the UK from becoming the Greece of the North Sea. But it is history now. We are back in normal economic times. This means that even under Keynesian assumptions, we cannot spend our way to prosperity.

Yet our debate on public spending continues as if we were still in 2009. For example, last year, Professor David Spencer from the University of Leeds wrote: “The focus on reducing the deficit by cutting public spending is adding to downward pressure on aggregate demand, thwarting economic recovery. […] there is a strong case for maintaining a budget deficit. […] [T]he government risks jeopardising recovery […] by taking demand out of the economy”.

Or last month, on a Sky TV debate on the subject of NHS staff pay, Faiza Shaheen of the think tank Class argued that a pay raise for nurses would pay for itself. These nurses, after all, would spend that extra income, pay taxes, and so on.

The anti-austerity narrative has taken on a life of its own. For large sections of the Left, “anti-austeritarianism” is no longer about a response to a recession. It has become a mindset in its own right. Its central tenet is that there is no such thing as economic constraints – there are only political choices. It is never “necessary” to cut spending on anything. It is always a deliberate choice. In this way, the anti-austerity mindset has really become an anti-economics mindset.

Indeed, for some, attending anti-austerity marches has become a way of life. It has turned into a hip, trendy subculture, and a marker of a tribal identity. A plea for fiscal responsibility will never do that. It seems staid and boring in contrast.

But that does not change the fact that, even if there ever was, there is no longer an economic case – even from a Keynesian perspective – for adopting the fiscal habits of pre-eurozone-crisis Greece.

Kristian Niemietz is Head of Health and Welfare at the Insitute of Economic Affairs