It’s now clear that the federal government’s massive stimulus
spending has not achieved its objectives. Why hasn’t it? It’s
important that we have answers to that question.
The stimulus was premised on the economic model known as
Keynesianism: the intellectual legacy of the late English economist
John Maynard Keynes. Keynesianism doesn’t work, never has worked,
and never will work. Without a clear understanding of why
Keynesianism cannot work we will be forever doomed to pursuing the
impossible.
There’s no real mystery about why Keynesianism fails.
There are numerous reasons why and they’ve been known for decades.
Keynesians have an unrealistic and unsupportable view of how the
economy works and how people make decisions.
Short-Run Focus
Keynesian policy advocates focus primarily on the short
run — with no regard for the future implications of current events
— and they assume that all economic decision-makers do the same.
Consider the following quote by John Maynard Keynes: “But the long
run is a misleading guide to current affairs. In the long run we
are all dead. Economists set themselves too easy, too useless a
task if in tempestuous seasons they can only tell us that when the
storm is long past the ocean will be flat again.”
After passage of the stimulus package, Lawrence Summers,
Obama’s chief economic advisor at the time, often said that the
spending should be “timely, targeted, and temporary.” Although
those sound like desirable objectives, they illustrate the
Keynesian focus on the short term. Sure it would be convenient if
you could just spend a bunch of money and make the economy get
well, but it’s not that simple.
The implication of a Keynesian perspective is that you can
hit the economy a few times with a cattle prod and get society back
to full employment. Remember that so-called “cash-for-clunkers”
program? Maybe it accelerated some new car sales by a month or two,
but it had no lasting impact.
The “Chicago School” is the primary source of serious
research and analysis related to the Keynesian model. Two Chicago
School conclusions, in particular, make it clear where Keynesian
policies run aground. The two theories are the “permanent income
hypothesis” and the theory of “rational expectations.”
The “permanent income hypothesis” was how Milton Friedman
termed the findings of his research on the spending behavior of
consumers. The MIT Dictionary of Economics defines the
permanent income hypothesis as “The hypothesis that the consumption
of the individual (or household) depends on his (or its)
permanent income. Permanent income may be thought of as
the income an individual expects to derive from his work and
holdings of wealth during his lifetime.”
Whether consumers and investors focus mostly on the short
run or the long run is basically an “empirical question.” A
convincing theoretical case can be made either way. To find out
which focus actually conforms closer to reality, you have to gather
evidence.
Not Evidence-Based
Much of the difference between the two schools of thought
can be explained by differences in their methodologies. Keynes was
not known for his research or empirical efforts. Keynesianism is
definitely not an evidence-based model of how the economy works. So
far as I know, Keynes did no empirical studies. Friedman was a far
more diligent researcher and data collector than was Keynes.
Friedman fit the theory to the data, rather than vice
versa.
The Keynesian disregard for evidence is reflected in their
advocacy for more stimulus spending even in the face of the obvious
failure of the what’s already been spent. At a minimum, we are due
an explanation of why it hasn’t worked. (Don’t expect that to be
forthcoming, however).
Failure to Consider Incentives
Another of the Chicago School’s broadsides against
Keynesianism is the theory of “rational expectations.” It’s a
theory for which the 1995 Nobel Prize for Economics was awarded to
Robert Lucas of the University of Chicago. As economic theories go,
it is relatively straightforward. It essentially states that
“individuals use all the available and relevant information when
taking a view about the future.” (MIT Dictionary of Modern
Economics) The rational expectations hypothesis is the simple
assertion that individuals take into account their best guesses
about the future when they make decisions. That seemingly simple
concept has profound implications.
The Chicago School’s research led them to conclude that
individuals are relatively deliberate and sophisticated in how they
make economic choices. Keynesians and their liberal followers
apparently think individuals are short-sighted and
simple-minded.
An elemental but too often overlooked reality about our
economy is that it is based on voluntary exchange. Voluntary
exchange is an even more fundamental feature of our economy than is
the market. A market is any arrangement that brings buyers and
sellers together. In other words, the primary purpose of a market
is to make voluntary exchange possible.
Voluntary exchange leaves large amounts of control in the
hands of private individuals and businesses. The market relies on
carrots rather than sticks, rewards rather than punishment. The
actors, therefore, need to be induced to move in certain desired
directions rather than simply commanded to do so. This is the basic
reason why incentives are such an important part of economics. If
not for voluntary exchange, incentives wouldn’t much
matter.
In designing economic policy in the context of a market
economy it becomes important to take into account what actually
motivates people and how they make choices. If you want to change
behavior in a voluntary exchange economy, you have to change
incentives. Keynesian policies do not take that essential
step.
The federal government’s share of GDP has gone from 19
percent to 24 percent during Obama’s time in the White House. A
larger government share of GDP ultimately necessitates higher taxes
or more debt. In and of themselves, higher taxes retard economic
growth because of their impact on incentives. The disincentive
effect of higher taxes illustrates why big government is far
costlier than it first appears.
It’s no accident that Keynesianism is so popular with
liberals. It blends well with their unquenchable thirst for
expansive government. It doesn’t work for the economy but it works
for them. The obvious failure of Keynesianism is further evidence
of the bankruptcy of liberalism.
Keynesianism is essentially all the Democrats have. It’s a
one-trick pony. That one trick hasn’t worked and now Dems are
floundering with nothing more to offer.
All but one member of the president’s original economic
team has exited. According to liberal columnist Ezra Klein,
“Lawrence Summers and Christina Romer were two of the most
influential Keynesians in the country. Obama didn’t just have a
team of Keynesians. He had a Keynesian all-star team.”
Now the president has a Keynesian all-gone team. It will
be a brighter day for the country when Keynesianism itself is gone
for good.
