John Maynard Keynes

 

What in the heck is John Maynard Keynes doing in a self-described Republican blog?  Growing up in a fiercely Republican household, I learned quickly to equate Dr. Keynes’ name with socialism.  However, I have since learned that this is not exactly accurate.  The primary tenet of socialism is the public ownership of the “means of production,” which Keynes did not advocate.  In these times of big government and massive bailouts there are important distinctions to be drawn.  

Animal Spirits, published last year, coincidentally around the time of the financial system’s collapse, expounded on for nearly 200 pages, and I found myself disagreeing with a great deal of it.  However it did outline an important point that goes right to the heart of our capitalist system and to the role of governance.  

Keynes actually accepted Smith’s “classical theory” of the economy–private property, free markets, and the “invisible hand.” His goal was to find a way to minimize market corrections.  “Market correction” is a technical term that doesn’t really convey the depth of human misery that such disruptions can cause[1].  So he tried to find the flaw in the classical theory that would explain such disruptions.  What he found was the definition of humans as “rational actors” within the system. 

Now anyone who has ever watched daytime television should realize that human beings are not always rational.  They are highly neurotic, and can be self-destructive, self-aggrandizing, lazy, immoral, shortsighted etc.  All these things are arguably quite natural; so he labeled them “animal spirits” to point out that they come from the more base instincts within our nature[2]. 

Humans are rational most of the time, this is probably because of our need for socialization; we tend to act in ways that benefit others as well as ourselves.  The trick is to institute rules that maintain a free, open and democratic society, while protecting society from these base instincts.  When viewed as such, it is really not much different from our criminal justice system.  The authors sum up this particular part of Keynes theory: 

“Keynes’ claim about how animal spirits drive the economy brings us to the role of government.  His view of the government’s role in the economy was very much like what we are told in the parenting advice books.  On one hand, they warn us not to be too authoritarian.  The children will be superficially obedient, but when they become teenagers they will rebel.  On the other hand, these books tell us not to be too permissive.  In this case they have not been taught to set proper limits for themselves.  The advice books then tell us that appropriate child rearing involves a middle road between these extremes.  The proper role of the parent is to set limits so that the child does not overindulge her animal spirits.  But those limits should allow the child independence to learn and be creative.  The role of the parent is to create a happy home, which gives the child freedom but also protects him from his animal spirits[3].” 

Clearly Keynes was not afraid of using government proactively.  This is where I think Republicans should draw the line; as far as government is concerned, a little bit goes a long ways.  Democrats tend to look to the government for all the answers; Republicans believe in using  the government only as a last resort. 

When I studied Keynes at the University of Arizona in the late 70’s, what I was really taught was fiscal policy, the velocity of money and the multiplier effect.  These are the real meaty parts of the theory; the ones that academics like to chew on because they can be used to create elaborate mathematical models.  Those models tend to lend credibility to a theory. 

The Keynes’ multiplier effect, boiled down, amounts to financial leverage (debt), and has been used to varying degrees by every President since Herbert Hoover.  With Keynesian fiscal policy (AKA deficit spending), investment in the economy comes from the public sector.  This “investment” can take many forms.  In a perfect world, government would be extremely careful using this powerful tool, but our process tends to be rather messy.  A key difference between the 1930’s and now is that the governments of Britain and the United States were credit worthy back then.  Poor fiscal policies by prior administrations during economic booms have led us to the brink of insolvency, and here’s the kicker, the worse offending administrations between the Roosevelt and Obama were Republicans, quite frankly it was the conservative icons Ronald Reagan and George W. Bush.  Looking at the last 30-year boom cycle, it is nearly impossible to determine what affect such policies had on the booms themselves, but it could have been considerable.  Regardless, with public debt very quickly approaching yearly GDP, what is clear is that government is not as credit worthy today as it was back then[4]. 

The bubble within the housing industry should have been avoided.  Cleary there was a breakdown within the market, and blame enough to go around, but what if the government performed better in its role as regulator (i.e. parent)?  Wouldn’t that have been worth the cost of the regulatory agency and the resulting drag on economic activity?  The fact that the government didn’t act as a hedge against Wall Street is directly related to the fact that the protections that were in place by the late 1940’s were eroded starting in the early 1980’s.  Once the financial institutions failed, President Bush and Congress had no choice but to bail them out.  Furthermore, as parents, what message have we sent Wall Street by bailing them out?  Kids can tell when parents are all talk and no consequences. 

Now get ready for the real irony.  Thanks to unrestrained capitalism, we now have public ownership of several financial institutions and an insurance company (not to mention a run-up of the national debt).  This is something that Keynes never wanted but Marx and Engle predicted!  

[1] Economists agree that we have been in an extended boom cycle that began in the early eighties.  Politicians and economists are still trying to “negotiate a soft-landing” for the economy to avoid even further economic disruption.  

[2] Other economists have lists of causes for market dysfunction; however, they always seem to return, at their core, to human irrationality.  Consider such things as short-term profit taking (taking advantage of unequal information between buyer and seller), externalities (primarily environmental degradation and crime), and reflectivity (a sort of conventional wisdom that tends to cause things like irrational exuberance).  Even Smith was concerned with this part of human nature and published “The Theory of Moral Sentiments” prior to the “Wealth of Nations.” 

[3] Akerlof and Shiller, Animal Spirits, Princeton University Press, page ix (preface). 

[4] Private debt started growing around the same time.  Private debt is really a bigger part of the problem, and holds the recovery back.  The classical model assumes perfect information and  rationality so that lenders would not have allowed such precipitous debt accumulation.