The flawed logic of Keynesian economics: Part II

Keynes believed that saving was bad, which is why he, and other Keynesians are in favour of penalizing savers through taxation and other measures in order to force people to spend more. The Keynesian model, which separated private savings and investment into two separate functions, demonstrated that savings were a drain on the economy. As a result his work portrays private investment as being inferior to deficit spending.

As Joseph Salerno noted in his speech at the 30th anniversary of the Mises Institute, Keynes wasn’t the only one that believed this flawed logic. Abba Lerner, another British economist, formalised these doctrines of wasteful spending, describing Keynesian economics as ‘topsy turvy’ economics because, as Salerno describes, “it stood on its head all the truths of classical and Austrian economics.”

Lerner’s view was that an economy in which there was high unemployment was an upside down economy which needed the remedies of topsy turvy economics to stand it the right way up.

One of his four principles stated that where there is unemployment, “efficiency is uneconomic”. He went on, “in every socially significant sense, the increase in efficiency brings not greater happiness but greater misery.” Lerner praised “monopolistic restrictions, wasteful union rules, tariffs that interfere with the international division of labour”, and anything else that reduces productive efficiency because that leads to an increase in employment. In other words, wastefulness enriches society.

Spending creates GDP, not necessarily wealth

Keynesian economists lack a fundamental appreciation for what it is that creates wealth. Spending for the sake of spending creates GDP growth because GDP measures spending, but rising GDP and a wealthy, prosperous society are not the same thing. Not if the spending is of no lasting benefit to society.

Many Keynesians believe for example that war is good for an economy, because if you replenish your stock of cruise missiles and tanks you will provide a boost to GDP, but no activity that destroys savings and capital (not to mention human lives), will, on balance, create wealth.

Incredibly, even though Keynesian economics failed to predict or explain the housing bubble, the financial crisis or the stagnant recovery, its ideas are still being pursued today, in the form of New Keynesianism – which is why we have the current policy of QE to infinity.

In 2008 Martin Feldstein, a Harvard Economist and presidential advisor, wrote an op-ed article in the Wall Street Journal advocating, “a large temporary increase in spending” by the department of defence, homeland security, FBI and other national intelligence agencies. Feldstein was advising Obama to ramp up military spending and increase the annual military recruitment goal by 15%.

This form of Military Keynesianism has also been endorsed by Nobel Prize-winning economist Paul Krugman. In an article in The New York Times in 2011, he writes, “Military spending does create jobs when the economy is depressed. Indeed, much of the evidence that Keynesian economics works comes from tracking the effects of past military build-ups. Some liberals dislike this conclusion, but economics isn’t a morality play: spending on things you don’t like is still spending, and more spending would create more jobs… So I welcome the sudden upsurge in weaponized Keynesianism, which is revealing the reality behind our political debates.”

That same year Krugman came up with the idea of the threat of an alien invasion to end the current economic slump. “It’s very hard to get inflation in a depressed economy, but if you have a programme of government spending, plus an expansionary policy by the Fed you could get that. If we discovered that space aliens were planning to attack and we needed a massive build up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months.”

Government is the problem not the solution

Rather than accepting economic downturns as a natural part of the business cycle, Keynesians believe that recessions must be treated like the symptoms of a cold. This is why they emphasise the role of demand-side factors, as opposed to supply-side factors, in determining overall economic output.

They also ignore the role that government intervention played in creating the boom which led to the bust. When governments interfere with monetary and fiscal policy, for example keeping the cost of borrowing artificially low for many years, they send false signals to businesses causing them to misallocate capital and generally triggering imbalances within the economy. This meddling leads to a bigger boom, but also a bigger subsequent bust.

By focusing purely on short-term measures to prop up a failing economy, Keynesian methods prevent the process of creative destruction, and prevent the system from being cleansed. Thus they actually prolong the recessionary process.

The bottom line is that Keynesians have it backwards. Demand is not the cause of economic growth, it is the consequence of economic growth. Wealth is created by saving and investment, the result of which is goods and services that people desire to have and use. You cannot continue to stimulate consumption without increasing the production of goods and services. It was this mentality that caused the current Great Recession in the first place.

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