What Would Keynes Do?

     John Maynard Keynes, the British economist who lived from 1883 - 1946, was by far the most influential economist of the 20th century. His ideas were adopted by Franklin D. Roosevelt to battle the Great Depression, as the President expanded government spending, created federal works projects and ran up a big federal deficit.

     Critics argued that these Keynesian economics were flawed -- that the Depression really didn't end until World War II -- but everyone, even Republicans, credited Roosevelt with making great strides in overtaking the Depression, sending aid to drought-stricken farmers, feeding millions of people, giving them work, and setting the stage for an economic boom for the rest of the century. Historians credit FDR with saving capitalism and democracy. By the early 1970s Republican President Richard Nixon had to admit, "We're all Keynesians now."

     Keynes theorized that during recessions, the public gets frightened and holds back on spending. This causes the economy to decline further, as less spending leads to poorer business conditions which is turn leads to more layoffs in a vicious circle of economic decline. The way to break the cycle, said Keynes, is to pump government spending into the economy.

     FDR did this by building roads and bridges and parks and dams, even hiring people for pointless, make-work projects, just to get them into a job and a paycheck. Roosevelt went so far as to hire unemployed writers for a Federal Writers' Project. They traveled around the country and produced guide books on the states and various cities and regions.

     In a nutshell, Keynes challenged classical economic theory which posited that free markets are self regulating and by themselves produce full employment. Clearly that theory is not correct -- or at least it's not correct all the time. Keynes argued instead that aggregate demand is what determines overall economic activity. If demand falls short, it leads to recessions. And then the public gets frightened, holds back on spending, and the economy goes into that vicious decline which produces persistent high levels of unemployment.

     Keynes's economic approach fell out of favor in the 1980s under President Reagan and his supply-side economists. But President Bush brought back Keynes in response to the 2000-2001 recession. Bush lowered taxes, ramped up spending and ballooned the budget deficit in order to pump up aggregate demand.

     So what would Keynes do now, in 2011? Let's speculate.

     1)  Clearly, he would engage the federal government to rebuild America's infrastructure -- building roads, reconstructing bridges, laying down rail lines, updating the electric grid, developing alternative energy sources, maybe even reinvigorating the space program. Remember, it was FDR who created the alternative energy projects of the 1930s, from the Hoover Dam to the Tennessee Valley Authority.

     2) Keynes proposed the concept of price stickiness -- the idea that labor quite understandably, but not practicably, refuses to lower wages in response to falling demand for workers. He might very well support budget-strapped governors from California to New York, and a lot of places in between, who are resisting wage and benefit demands from state and local workers. Higher wages for a few means fewer jobs for everyone else. And unlike the federal government, states cannot create money and run a deficit to boost economic activity.

     3) Keynes said that if money being saved exceeds the amount being invested, then unemployment will rise. Think of all the money currently being hoarded on American corporate balance sheets (Exxon has $10 billion, Apple has $28 billion, Google has $39 billion!). He very likely would be in favor of lowering corporate taxes on funds that corporations hold abroad, encouraging them to bring the money back home and invest it here in capital improvements and in more jobs. He might also try to unlock the savings of wealthy individuals, and get that money into the hands of people who would spend it. One way to do this would be to abolish the ceiling on the payroll tax, then lower the overall payroll tax rate -- transferring money from high earners who tend to save it, to lower earners who will spend it.

     4)  Keynes felt that countries should not run large trade deficits or surpluses. He would likely favor lowering the value of the dollar even more, to boost American exports and improve the balance of trade. And that's another reason he would support the development of alternative energy sources (and perhaps more drilling as well), since oil imports contribute mightily to our trade deficit.

     5)  Finally, Keynes believed in deficit spending not as a good in itself, but only as a strategy to improve economic conditions. He argued that World War II should be paid for not by issuing more debt, but largely out of higher taxation. Today, he would likely push for more federal debt in the short term, but also for a more balanced budget in the long term. He might very well support Medicare and Social Security reforms that would "bend the cost curve down" on these programs. But he was also not opposed to higher taxes. To the extent that higher taxes would not reduce demand, he would be in favor of increasing taxes on the super-rich, the near rich, and the plain old rich.

     {A slightly different version of this article appeared on Technorati.}