The obstacles to Keynesian budgeting

Keynesianism pertains to the group of economic doctrines and programmes of the English economist, John Maynard Keynes (1883-1946) and his followers, the advocates of governmental programmes and policy of maintaining high employment, controlling inflation by varying the interest rates, tax rates and public expenditure. Keynesian economists support the issuance of extra currency and budgeting for full employment.

Indeed, Keynes’s greatest book: The General Theory of Employment, Interest and Money was published in 1936. The book transformed economics and policymaking for the past 80 years. However, two elements of Keynes’s legacy remain secure. First, Keynes’ invented macroeconomics – the theory of output as a whole. He called his theory ‘‘general” to distinguish it from the pre-Keynesian theory which assumed a unique level of output – full employment. In showing how economics could remain stuck in underemployment equilibrium, Keynes challenged the central idea of the orthodox economics of his day: that markets for all commodities, including labour are simultaneously cleared by prices. This Keynesian challenge implied a new dimension to policymaking: Government may need to run deficits to maintain full employment.

The aggregate equations that underpin Keynes’s theory still populate economics and shape macroeconomic policy. Even those who insist that market economies gravitate toward full employment are forced to argue their case within the framework that Keynes created. Central bankers adjust interest rates to secure a balance between total demand and supply, because, thanks to Keynes, equilibrium might not occur automatically.

Keynes’s second major legacy is the notion that governments can and should prevent depressions. The widespread acceptance of this view can be seen in the difference between the strong policy response to the depression of 2008-2009 and the passive reaction to the Great Depression of 1929-1932. As the Nobel laureate Robert Lucas, an opponent of Keynes, admitted in 2008,” I guess everyone is a Keynesian in a foxhole.”

On the other hand, Keynes’s theory of under-employment equilibrium is no longer accepted by most economists and policymakers. The global financial crisis of 2008 bears this out. The collapse discredited the more extreme version of the optimally self-adjusting economy. But it did not restore the prestige of the Keynesian approach. Certainly, Keynesian measures halted the downward slide of the world economy. But they also saddled governments with large deficits, which ultimately came to be viewed as an obstacle to recovery – the opposite of what Keynes taught.

With unemployment still high, governments returned to pre-Keynesian orthodoxy, cutting spending to reduce their deficits and undercutting economic recovery in the process. There are three main reasons for this regression. First, the belief in the labour market clearing power of prices in a capitalist economy was never wholly overturned. So, most economists came to view persistent unemployment as an extraordinary circumstance that arises only when things go terribly wrong, certainly not the normal state of market economies. The rejection of Keynes notion of radical uncertainty lay at the heart of this reversion to pre-Keynesian thinking.

Secondly, the post-war Keynesian demand management policies, credited with having produced the long post-1945 boom, ran into inflationary trouble at the end of the sixties. Alert a worsening tradeoff between inflation and unemployment, Keynesian policymakers tried to sustain the boom through income policy-controlling wage costs by concluding national agreements with trade unions.

Income policy was tried from the sixties to the end of the 1970s. At best, there were temporary successes, but the policies always broke down. Milton Friedman provided a reason that jibed with growing disenchantment with wage and price controls, and that reasserted the pre-Keynesian view of how market economies work. Inflation, Friedman said, resulted from attempts by Keynesian governments to force down unemployment below its natural rate. The key to regaining stable prices was to abandon the full employment commitment, emasculate the trade unions and deregulate the financial system.

And so the old orthodoxy returned. The full employment target was replaced by an inflation target and employment was left to find its natural rate whatever that was. It was with this defective navigational equipment that politicians sailed full steam ahead into icebergs of the 2008 depression. The final reason for the fall of Keynesianism was the rightward ideological shift that began with the British premier Margaret Thatcher and the US President Ronald Reagan. The shift was due less to the rejection of Keynesian policy than to hostility toward the enlarged nation state that emerged after World War II. Keynesian fiscal policy was caught in the crossfire, with many on the right condemning it as a manifestation of excessive government intervention in the economy.

One final reflection of the failure of Keynesianism suggests a renewed role for Keynesian economics. An even bigger shock to the 2008 orthodoxy than the collapse itself was the revelation of the corrupt power of the financial system and the extent to which post-crash governments had allowed their policies to be scripted by the bankers. To control the financial markets in the interest of full employment and social justice lies squarely in the Keynesian tradition.

Second final reflection on the eclipse of Keynesianism, for new generations of students, Keynes’s relevance may lie less in his specific remedies for unemployment than in his criticism of his profession for modeling on the basis of unreal assumptions. Students of economics eager to escape from the world of optimizing agents into one of fully-rounded humans, set in their histories, cultures and institutions will find Keynes’s economics very sympathetic. Which is why Keynes is expected to be a living presence decades from now on the centenary of the General Theory in 2036. Thus, the Keynesian based 2016 Buhari Budget may be heading for the rocks for being based on obsolete principles.