Limits to Keynesianism

Last week in the FT Martin Wolf sounded a Keynesian battle cry, passionately urging governments to redouble their efforts to use cheap funds to raise future wealth and so improve the fiscal position in the long run:

It is inconceivable that creditworthy governments would be unable to earn a return well above their negligible costs of borrowing, by investing in physical and human assets, on their own or together with the private sector. Equally, it is inconceivable that government borrowings designed to accelerate a reduction in the overhang of private debt, recapitalise banks and forestall an immediate collapse in spending cannot earn a return far above costs.

Mr Wolf is of course incorrect. It is absolutely conceivable that governments will not be able to earn a positive return on borrowing. Indeed, the United States has spent the entire previous decade borrowing money to invest in highway building and war. Mr Wolf also goes on to use the case of Japan, yet another country that spent 20 years investing in negative return public works projects. Or, as others have described it: paving the country over with cement.

What has the United States won for itself, after a decade of Keynesian largesse and cheap money policy? Mostly, a further increase in poverty. As the Census Bureau reported this week, poverty in America advanced for a third straight year to reach its highest levels since 1993. While Keynesianism appears to have a benevolent, humanistic intent it is greatly disappointing that so many of its advocates do not also recognize its destructive aspects. Yes,  free markets misallocate capital routinely. But Keynesianism as a policy also distributes capital unevenly, and unfairly. First receivers of government capital gain competitive advantages. First receivers of easy monetary policy also gain, and become predatory. The housing bubble was perhaps the most spectacular example of the destructive force of easy money, which resulted in a huge transfer of risk and wealth, recycled through society.

But the greatest flaw with Keynesianism now is that, like the economy itself, it has run squarely into the energy limit. As the most recently updated data shows, 2011 will be the 6th year that world production of crude oil was unable to increase beyond the ceiling established in 2005. Oil remains the primary energy input to OECD economies. OECD economies are of course where the Keynesian experiment has flourished longest, first in Japan, then the United States and now Europe. It is hardly, hardly the case that the current financial crisis in the OECD is “simply a matter of accounting.” Instead, the crisis is one of systemic, structural growth now permanently limited by energy costs as OECD economies try to service debt loads that have escaped their ability to manage. Change all the digits, and the energy limit remains.

While I continue to be an advocate of debt jubilee, and, of energy infrastructure Keynesianism (building out more efficient transport and non fossil fuel energy production), the energy-intensity problem of OECD economies is now the controlling factor in the West’s ongoing crisis. The redoubling of government efforts to distribute paper capital to society will not bring forth the cheap energy required to spur the growth Keynesians either assume, or have failed to even consider.

–Gregor

  • http://www.ericgarland.co ericgarland

    “Inconceivable that government borrowings…cannot earn a return far above costs.”

    Mr. Wolf, you keep using that word. I do not think it means what you think it means.

  • Anonymous

    As always, a sharp perspective that does not get a proper airing inside the Beltway. When the ne plus ultra of government is claiming you’ve created jobs, talking about a new model for the economy in which jobs *will not be created* is a non-starter.

  • http://biophilic.blogspot.com/ Burk

    This sounds like a great deal of confusion on both sides, really. One can only evaluate the government’s outlays on a very macro scale, and classic Keynes shows that, in the current environment, any investment, however poorly “returning” in the gimlet-eyed sense, (helicopters dropping money comes to mind), would help restore overall GDP and employment on a sustained basis, and thus pay back over the long run, reducing government deficits into the bargain.

    While I certainly appreciate your resource restriction focus, it simply is not relevant here. Krugman has pointed out in some detail that resource constraints have a relatively minor role in restricting growth, even now. We can hire people to build windmills, or do pedicures.. Replacing our highway infrastructure with rail or eco-pods or whatever would also do wonders for the economy, just like it did in WW2 and thereafter. There is also a huge reservoir of conservation yet to seriously tap. 

    I would put the issue as one of distribution. If we continue to distribute wealth upwards, to people who save money and are currently shy of investing it, we will continue to spiral downwards on a macro basis. Even with all the resource constraints, if we distribute money more equitably, the economic (and cultural) system can be restored to a more prosperous equilibrium, and economic incentives can be used into the bargain to drive conservation and infrastructure transitions as well.

  • http://twitter.com/NormCycles Norman Michaels

    We are of kindred spirit…nice article. It’s what I have been preaching for more years than one can remember.

  • rich ruscio

    Another great piece. Thanks.

    Hope the new home is treating you well.

  • http://www.rossgreenspan.com rossgreenspan

    “While I certainly appreciate your resource restriction focus, it simply is not relevant here. Krugman…”

    You make a good point. But, the wealth distribution flow you’re citing has an energy factor, too. Physical capital is much more valuable than paper money. Corporate assets in the form of… whatever, is worth more in place defecating dividends as long as possible. If the energy exists to run it on a profitable cash margin for shareholders, run it into for-ev-er, and damn the whales!

    It is very difficult to achieve a high ROC today investing in physical construction of more “stuff.” The energy inputs are becoming an egregious cost. I get that people who live in boxes their whole lives think an infinite number can conceivably be constructed. The energy equation is fixed, finite. Fiat money seeks to subdue the equation, or abuse it.

    “I would put the issue as one of distribution.” You must’ve experience the recent blackout in Southern California. Or, maybe you’re in Vermont waiting for an airlift of supplies after having roads washed out by Irene.

  • Anonymous

    This piece would be more informative if you cited actual numbers.  For example, you say “Indeed, the United States has spent the entire previous decade borrowing money to invest in highway building and war.”
    What are the amounts, and what percentage of GDP were they over the course of the last decade?  

    Secondly, can you really compare investing in public infrastructure with spending on wars?

    Lastly, you have not developed your argument that “…systemic, structural growth (is) now permanently limited by energy costs…” The chart shows crude oil production, but not energy costs.

    Like-minded people will no doubt nod their heads at this post, but I’m not persuaded.

  • Paul Andrews

    “classic Keynes shows that, in the current environment, any investment,
    however poorly “returning” in the gimlet-eyed sense, (helicopters
    dropping money comes to mind), would help restore overall GDP and
    employment on a sustained basis, and thus pay back over the long run”

    This is incorrect.  Classic Keynes refers only to the short run, that being the period during which prices and wages stay sticky after an interest rate or money supply change.  Then you need a period of growth without stimulus before the next short run opportunity arises.  We have not had this since the last n rounds of stimulus, so these short run tactics are not applicable at the present time, even if you agree with the theory.

  • Anonymous

    I cannot say more than yes, I believe you are 100% correct in this: The problem is that economists live on a different planet to humble technologists such as myself. They think that everything is built out of money, we know things are built with intellectual effort, planning, bricks, concrete mortar cement metals..and, above all, they are built with energy.

    The emphasis on creating jobs is totally illusory. We actually need to create WEALTH. And to create WEALTH we need ENERGY.

    The myth of renewable energy is largely apparent to those who understand the technical detail of power generation, and its economics. There is nowhere else to go, but what gas we have left and coal and if you dont like carbon, nuclear power, (which if the world in its collective paranoid insanity doesnt oulaw, is probably a technology that has several hundred years left in it as a fuel source).

    That doesn’t solve the food or population pressure problems, but it buys us time.

    The only things really worth spending (public) money on are nuclear power stations and a better electricity and gas grid.

    And education of the brightest and best to a higher degree of competence, rather than indoctrinating the majority into a degree of utter incompetence.

    Sadly this won’t happen in the current political climate.

  • Anonymous

    Any Fule can create a job. Its creating one that pays for itself, in the sense that it benefits society overall,  that is the harder task.

    We actually shoudl be destroying all the jobs that cost the nation more than they benefit it, probably starting with the London School of Economics.

    The residual cash could pay to keep the incumbents on benefits at far less expense to the nation..than employing them.

  • http://www.investingwithoptions.com/ steveplace

    Dwight has a more efficient solution than a debt jubilee:

    http://www.quickmeme.com/meme/353jkd/

  • gregor.us

    My weakness is that I often try to take on very large subjects in short blog posts. The offset is that if you read this blog over a period of time, I do provide quite alot of data. I assume that US govt expenditures of the Keynesian kind are familiar to most readers: the subsidies to Fannie and Freddie, the wars, the massive highway bills, and various stimulus packages–all encompassing the past decade. The Bush Administration in particular was quite Keynesian, and so was the Federal Reserves. Indeed, I no longer think there’s any meaningful distinction between FED operations in total, and the fiscal efforts.

  • gregor.us

    Cheers. I am just now getting settled in to PDX. Best, G

  • http://claimid.com/blissex Blissex

    «The only things really worth spending (public) money on are nuclear power stations and a better electricity and gas grid.»

    And the Internet and public transport. Because the Internet (better telecommunications) is the new fantastic extension that all previous generations of humanity lacked, and has the potential to save on a lot of transport and energy costs.

    As to nuclear power stations (which are safe only if managed and maintained very competently and without short term cost cutting), some scary news. The first found by Ritholtz in a budgeting document from the Marine Corps:

    http://www.ritholtz.com/blog/2009/01/us-military-force-structure/
    «Slide 2.  Competing demands in the federal budget FY-09  and beyond are
    in the range of $7.5 Trillion per year.  The price tag  alone for
    recoring the 283  nuclear plants (built in the 70s &  80′s that
    depend on federal assistance to recore) is $2.5b per plant…comes to over
    $7 Trillion
    »

    That money instead has gone towards recoring banker bonus pools, a much more productive use of public money, as all value is produced by highly paid people.

    http://theenergycollective.com/ansorg/63481/saudi-arabia-s-nuclear-energy-ambitions
    «The Kingdom of Saudi Arabia (KSA) plans to build 16 nuclear reactors over the next 20 years spending an estimated $7 billion on each plant.
    The $112 billion investment, which includes capacity to become a regional exporter of electricity, will provide one-fifth of the Kingdom’s electricity for industrial and residential use and, critically, for desalinization of sea water.
    »

    That’s a major oil exporter massively investing in nuclear power (1 large nuclear plant every 1-2 years for twenty years is not trivial) because they are obviously running out of the black stuff, and want to keep exporting it to pay for food imports, as they don’t need to import water if they can use electricity to power the desalinisation plants, as they have plenty of sea around them, but no cropland for growing food.

  • gregor.us

    The End of Growth is now impolite, and it doesn’t sell. What continues to sell is the idea that the limits we face are self-imposed, and all that’s required is a different political direction. I note for example that even among the carbon-warriors, the notion that we can and must return to growth is foregrounded in most presentations.

    The case that I make here imo has already come true. We can tweak our way around the limits, and of course I do think that marginally we can indeed make very different discretionary choices, in the area of transport and powergen. But the notion that any new industrial growth will outpace industrial decline is now off the table, imo. We can experience that in many ways, but the least painful is a chronic decline. Hence, the start of a new long-term trend: a rise in poverty.

    My strategy: moving to Portland, cutting down the household oil useage by a large amount, and getting myself like-minded neighbors. The beltway will never move until is has to. Accordingly, I have made my own. :-)

    G

  • Anonymous

    “OECD economies are of course where the Keynesian experiment has flourished longest, first in Japan, then the United States and now Europe.”

    You have your timeline a little historically wrong here.  Japan and Europe began they Keynesian-like experiment long before the book was even written.  All fueled by nations that were under the protective “umbrella” of the US after WW-II, allowing those governments to begin social contracts (entitlements) that were unsustainable.

    Japan’s break happened sooner.   Why?  Simple, Europe entered into an economic contract with the formation of the Euro, which allowed these policies to go on long after they would have normally bankrupt the nation individually.

    The US can have an honest debate to fix entitlement.  Will we?  I doubt it, history shows that we turn a blind eye to the truth, even when it kicks us in the teeth.

  • gregor.us

    Could you address the destructive aspects of Keynesianism, and how it enhances inequality, by stratifying first receivers from late receivers of government largessse–and also by magnifying the differences in skill levels, among society’s participants? I really think Keynesians (and I am not as hostile to Keynesianism as one might think) are obligated to address the destructive aspects of dispensed capital.

    Also, could you clarify your view that energy inputs are not relevant here?

    Best,

    G

  • gregor.us

    Fair enough.

  • http://biophilic.blogspot.com/ Burk

    Thanks, Gregor-

    You seem to take a rather broad approach to Keynes. Keynes was mostly about recognizing that slumps of private demand/investment can be self-perpetuating (showing up as unemployment and deflation) and need to be fixed by the investor/spender of last resort, which is the modern government. Not all deficit spending is Keynes. The Bush era was not Keynesian to any great extent. Rather, deficit spending is an ongoing condition of our macro-economic situation, with strong international and saving demand for dollars that need to be printed to keep the monetary value stable. 

    The question is who those dollars get spent to, whether under normal conditions of deficit, or under the extraordinary extra-spending needs of today. The government can advance the public purpose by making forward-looking investments, especially in education and infrastructure, or it can give tax cuts to the wealthy (“job creators”, in the current parlance!) and hope that their investment practices yield long-term growth (not, since they are currently saving). Or it can redress inequality by giving money to the poor, employing the unemployed, etc. The spending can be used to increase inequality or to reduce it… it is our choice, and that is what the fierce politics in Washington are all about.

    So, I don’t think Keynesian policy is destructive in the least. Its point is to restore economic activity to its potential, thereby raising employment, raising wealth, and raising ultimate government capacity to continue providing public services. To the government, money is free- its only cost is inflation if it spends too much, deflation if it spends too little. The role of taxation is to garner a portion of private demand/capacity so that it can buy things without causing inflation.

    *** cont…

  • http://biophilic.blogspot.com/ Burk

    *** cont…

    Resource limitations are a separate issue, not to say they are unimportant. The issue is whether the political economy translates resource limitations into joblessness. Remember that, say, two hundred years ago, we had far fewer resources than now, but still employed everyone more or less. The issue is not finding work for people to do, but having the will to put everyone to work. Which means raising demand for workers by monetary & public means, even if that means some degree of redistribution viz-a-viz the laissez-faire system. My take on laissez-faire is that it does not necessarily care about or fix unemployment. 

    Additionally, resource limitations are exactly the place where one wants to apply economic incentives most rigorously, raising gas prices/taxes, raising coal costs, etc., so as to guide the economy in a forward direction. The US economy is roughly half as energy-efficient as similar economies. There is simply enormous, vast scope for conservation and re-engineering, were we to actually take resource limitations seriously, rather than invading Iraq, in the vain hope that we could take their oil. China certainly faces more difficult tradeoffs, but in my book, the ultimate point is to keep our planet a healthy place to live, and that means using economic incentives to get ahead of the curve of resource (carbon) depletion, not lagging behind. 

    This is a place where the invisible hand can work wonders. If it turns out that our living standards (conventionally computed) take a hit from rising energy costs and a cleaner planet, in the absence of magical technological solutions, then so be it.. it remains the political system’s job to redistribute the pain as equitably and rationally as possible.

  • http://www.facebook.com/profile.php?id=796435084 Michael Costigan

    My sense is that very little deficit spending in the last decade went to the highway bill. In fact the last reauthorization was paid for by borrowing from the future returns of the federal gas tax. Hence the failing grade that America’s infrastructure gets annually from the American Society of Engineers. Wouldn’t borrowing to buildout key elements of America’s creaking infrastructure – highways and more energy efficient alternatives – have a positive return in such a context? 

  • W Clay

    I’m trying to deconstruct “Fule”. It reminds me of the wag who said in regard to coal back during the 1970s energy crisis, “There’s fuel like an old fuel.”

  • Anonymous
  • Anonymous

    rise in poverty, fall in population, or, probably, both..

    “History started badly and hav been geting steadily worse.”

  • http://claimid.com/blissex Blissex

    «economists live on a different planet to humble technologists such as
    myself. They think that everything is built out of money, we know things
    are built with intellectual effort, planning, bricks, concrete mortar
    cement metals..and, above all, they are built with energy.»

    Ahhhhhh you are talking about “Economists”, I mean Serious Economists.

    Historically political economists (a term justly fallen into disuse) knew that capital accumulation, resources, distribution of income are the core of the discipline of political economy, but hey, they are taboo topics in Economics.

    As to the «everything is built out of money» I read in another blog that money is not the same as wealth, while speculation crazed voters in the USA think otherwise.

    That’s well true at the aggregate level, but “money” represents purchasing power for individuals. Things like asset price bubbles create no new wealth, but they create a lot of new “money” in the form of capital gains for property owners, and this new money results in vast income transfer policy from those who don’t own property to those who own property, and from those who own less property to those to own more property.

    Because if your 100k property doubles in price you get an extra income of 100k as “money” you can spend, and your coworker who does not own property pays for that by getting less stuff for his “money” (necessarily, because output has not changed, and after tax it is even worse, because the 100k capital gain is not taxed or taxed way less than income), and also if someone has a 1m property and that doubles in price they get an extra income of 1m as capital gains, and they can use that purchasing power and outbid both the guy that has less property and the guy who has no property.

  • jonathan

    I think this essay is brilliant, Mr. Macdonald.  I have featured it in today’s post over at Real Economics.  I introduced it by writing:

    I was educated by Keynesians in the early 1970s.  So even though I rarely identify myself with the various manifestations of the Keynesians, I still have a bit of sympathy for them because I have warm and fuzzy memories of the great ones like John Kenneth Galbraith.  Then there is the little matter that something that requires massive investments like going green would seem a natural fit for Keynesian stimulus.Unfortunately, the Keynesians lost their nerve / imagination when USA Peak Oil and the Arab oil embargoes trashed the USA economy.  Yes there are still folks who claim to be Keynesians but they aren’t very imaginative and there aren’t many of them.  This is how I remember it going down:Yet by 1973, things had started going seriously wrong for the Keynesians. They had figured out how to balance consumption with industrial potential, but they never got around to dealing with the problems of how to value energy, waste, or other contributions of the natural order. For the first time in history, energy costs were set beyond the reach of their regulation. Cheap energy was at the very foundation of the prosperity the Keynesians liked to take credit for. The monetary prescriptions of Keynesians in response to the massive run-up in energy prices triggered a global outbreak of inflation. more
    This little gem recalls the reason why Keynesians no longer dominate the economic debates.  If this guy is younger than 40 so could not have been around when the Keynesian impulse ran out of gas (literally), then he is a freaking genius.http://real-economics.blogspot.com/2011/09/its-way-harder-than-it-looks.html

  • jonathan

    I think this essay is brilliant, Mr. Macdonald.  I have featured it in today’s post over at Real Economics.  I introduced it by writing:

    I was educated by Keynesians in the early 1970s.  So even though I rarely identify myself with the various manifestations of the Keynesians, I still have a bit of sympathy for them because I have warm and fuzzy memories of the great ones like John Kenneth Galbraith.  Then there is the little matter that something that requires massive investments like going green would seem a natural fit for Keynesian stimulus.

    Unfortunately, the Keynesians lost their nerve / imagination when USA Peak Oil and the Arab oil embargoes trashed the USA economy.  Yes there are still folks who claim to be Keynesians but they aren’t very imaginative and there aren’t many of them.  This is how I remember it going down:

    Yet by 1973, things had started going seriously wrong for the Keynesians. They had figured out how to balance consumption with industrial potential, but they never got around to dealing with the problems of how to value energy, waste, or other contributions of the natural order. For the first time in history, energy costs were set beyond the reach of their regulation. Cheap energy was at the very foundation of the prosperity the Keynesians liked to take credit for. The monetary prescriptions of Keynesians in response to the massive run-up in energy prices triggered a global outbreak of inflation. more

    This little gem recalls the reason why Keynesians no longer dominate the economic debates.  If this guy is younger than 40 so could not have been around when the Keynesian impulse ran out of gas (literally), then he is a freaking genius.

    http://real-economics.blogspot.com/2011/09/its-way-harder-than-it-looks.html

  • http://pulse.yahoo.com/_KNAGABHPYZKHV6VA5DNM2WIT4Q RussellB

    For a good framework on how the economy should be engineered for employment maximisation, I strongly recommend the MMT work of UMKC, in particular:
     
    http://neweconomicperspectives.blogspot.com/p/modern-money-primer.html
     
    It uses real Keynesianism – a.k.a. the Post-Keynesian school building on the work of Hyman Minsky.
     
    The common perception of Keynesianism (i.e. deficit spending) was just a political cover of those ennacting the Predator State:
     
    http://www.tomhull.com/ocston/books/galbraith-predator.php
     
    Probably in full knowledge of the Energy Limits to Growth. But who is now holding the bag for all the debts built up? Yes the average taxpayer and citizen. Keynes has been used and abused, just like others before him (e.g. Adam Smith).
     
    A debt jubilee is needed to clear the slate and to start afresh with something akin to MMT.

  • http://pulse.yahoo.com/_KNAGABHPYZKHV6VA5DNM2WIT4Q RussellB

    For a good framework on how the economy should be engineered for employment maximisation, I strongly recommend the MMT work of UMKC, in particular:
     
    http://neweconomicperspectives.blogspot.com/p/modern-money-primer.html
     
    It uses real Keynesianism – a.k.a. the Post-Keynesian school building on the work of Hyman Minsky.
     
    The common perception of Keynesianism (i.e. deficit spending) was just a political cover of those ennacting the Predator State:
     
    http://www.tomhull.com/ocston/books/galbraith-predator.php
     
    Probably in full knowledge of the Energy Limits to Growth. But who is now holding the bag for all the debts built up? Yes the average taxpayer and citizen. Keynes has been used and abused, just like others before him (e.g. Adam Smith).
     
    A debt jubilee is needed to clear the slate and to start afresh with something akin to MMT.

  • http://pulse.yahoo.com/_KNAGABHPYZKHV6VA5DNM2WIT4Q RussellB

    For a good framework on how the economy should be engineered for employment maximisation, I strongly recommend the MMT work of UMKC, in particular:
     
    http://neweconomicperspectives.blogspot.com/p/modern-money-primer.html
     
    It uses real Keynesianism – a.k.a. the Post-Keynesian school building on the work of Hyman Minsky.
     
    The common perception of Keynesianism (i.e. deficit spending) was just a political cover of those ennacting the Predator State:
     
    http://www.tomhull.com/ocston/books/galbraith-predator.php
     
    Probably in full knowledge of the Energy Limits to Growth. But who is now holding the bag for all the debts built up? Yes the average taxpayer and citizen. Keynes has been used and abused, just like others before him (e.g. Adam Smith).
     
    A debt jubilee is needed to clear the slate and to start afresh with something akin to MMT.

  • http://pulse.yahoo.com/_KNAGABHPYZKHV6VA5DNM2WIT4Q RussellB

    For a good framework on how the economy should be engineered for employment maximisation, I strongly recommend the MMT work of UMKC, in particular:
     
    http://neweconomicperspectives.blogspot.com/p/modern-money-primer.html
     
    It uses real Keynesianism – a.k.a. the Post-Keynesian school building on the work of Hyman Minsky.
     
    The common perception of Keynesianism (i.e. deficit spending) was just a political cover of those ennacting the Predator State:
     
    http://www.tomhull.com/ocston/books/galbraith-predator.php
     
    Probably in full knowledge of the Energy Limits to Growth. But who is now holding the bag for all the debts built up? Yes the average taxpayer and citizen. Keynes has been used and abused, just like others before him (e.g. Adam Smith).
     
    A debt jubilee is needed to clear the slate and to start afresh with something akin to MMT.

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