Keynesianism is a Disease, Not an Economic Theory

Whether they know it or not, many Americans today advocate the theory of Keynesian economics which was popularized in the early 20th Century by John Maynard Keynes.  This should not be surprising considering the Keynesian theory has been taught in our schools for much of the past fifty years.

The belief is that in the short run productive activity is determined by total spending and that the government is needed to help manage the economy to avoid inefficient macro outcomes, they believe, is caused by the private sector.  When there is a downturn in the economy, Keynesianism focuses on “stimulating” a specific sector with tax dollars as a solution.  The result is always the same.  The specific sector that was stimulated may see a benefit, but their benefit was at the expense of another sector, or multiple sectors.

This intervention comes in three forms: subsidies, regulation, and inflation.

The famous 20th century economist Murray Rothbard accurately described the Keynesian theory as being

not truly revolutionary at all but merely old and oft-refuted mercantilist and inflationist fallacies dressed up in shiny new garb, replete with newly constructed and largely incomprehensible jargon.

The theory focuses on spending regardless of productive value and input. In other words, it matters not if the jobs being created are productive or satisfy consumer demand, as long as they are being created and money is being spent. When tax dollars are allocated for economic purposes, it defers economic activity from productive sectors of the economy to a perceived desire of where economic activity should occur.  But, this does not satisfy consumer demand, only distorts it.

For a simple analogy, if people are paid to dig holes and refill them with dirt, it is considered beneficial to this theory. Businesses expand in purchasing shovels for these hole digging and refilling projects. Shovel manufactures leverage debt in more interest rate sensitive, long term capital projects to increase the amount of shovels they can produce to meet this new demand. Employees leverage debt to purchase homes or remodel existing homes.  Two years later, the central planners decide breaking windows and replacing them is more beneficial. The shovel manufacturer cannot pay their loans and close down. Employees are laid off and can’t meet their debt obligations. Nothing is being produced of value except for an overabundant supply of shovels is now on the market while resources are squandered resulting in our society becoming poorer. Because of the new intervention subsidizing windows, more capital is deterred from productive sectors.  Destroying wealth and capital does not create prosperity, neither does spending for the sake of spending, yet we see the results of this theory all around our society, from bridges to nowhere to vacant buildings.

In the unraveling of the markets in 2008, we saw an overabundant supply of homes and foreclosures.  This distortion was led by money being allocated to the housing sector by various programs such as the CRA, Fannie & Freddie, and the Federal Reserve’s cheap cash injections.  These programs were well intended to get people into home ownership.  But, we should always remember that the road to serfdom is paved with good intentions.

Value is determined subjectively, as only the individual consuming the good or service can determine value. For example, if two people had 5 dollars for each of them left, one may purchase two hamburgers while the other may purchase gasoline to get to work the next day, earn more income, and eat for a week. The same relationship is true in all economic activity.  A group of central planners cannot accurately determine value priority for others.

This prevalent theory focuses on spending in the short term on specific groups.  It ignores the long term effects, often unintended consequences, amongst all groups.  So, while a decision to subsidize a corporation or industry may benefit that specific group immediately, what is the cost for all groups?  Or more specifically, what is the net benefit for all groups?  This figure goes ignored, yet it is elementary thinking.  When a family contemplates investing in a business, stock, bond, house, car, boat, commodity, or currency, they ask this basic question.

When the government spends a dollar, it takes that dollar from someone through taxation at some point.  Or, in the sense of market distortion, it defers that dollar from being spent somewhere else.  So, when that dollar is spent subsidizing shovels in our earlier analogy, it prevents it from being spent at building supply companies, contractors, farmers, retail stores, tourist destinations, or leisure enterprises through free voluntary exchanges.  Voluntary exchange is where wealth and prosperity is created.  It is highly productive to society, mutually beneficial, and satisfies consumer demand.

So, when we speak of subsidies or incentives provided to a firm such as General Motors, where would the money have been spent through voluntary exchange?  Should GM’s competitors, such as Ford, and their employees be responsible for subsidizing their competition?  Why did GM need the assistance and not their competition?  Was their need created as a result of bad business decisions or a market readjustment away from their goods or services?  If the former, why reward those that make bad decisions?  If the latter, did we just help inflate another bubble by distorting the markets further?  Again, this relationship is the same with each economic intervention, whether applied to the banking industry several years ago or to the railroads nearly two centuries ago.

Economics is not the study of spending and quantifying economic activity; it is the study of human action inclusive of the former. This should be our theory.  Businesses do it everyday to determine what avenues are best to invest their capital for a return.  Low taxes keeps the money invested in a free market of voluntary exchange that promotes stable, efficient, productive, and long term natural growth.  The government has a productive role in society whether through police, fire, education, etc, but attempting to steer an economy is not amongst them.

Prosperity cannot be created by a group of central planners deciding what is of economic value with the use of tax dollars. This is an impossible task, which only creates more economic hardships.  It creates market distortions that lead to mal-investments and wasted resources. It creates largesse, waste, & corruption. The problem becomes cyclical and compounding as intervention begets more intervention.

If you have caught Keynesian disease, do not worry.  There is a remedy for you.  You now have taken the first step to admit there is a problem.  The second step is administering a healthy dose of Austrian Economics.  I would suggest you begin by reading Henry Hazlitt’s “Economics in One Lesson.”  This is a short book that can help unlearn the fallacy of the Keynesian theory broken down in simplistic terms and examples so easy to understand a caveman can do it.  There is also videos of Hazlitt’s classic here.  You will then be on the road to recovery, both economically and philosophically.  Then, you can move on to reading the work of brilliant Austrian economists such as Ludwig von Mises, Murray Rothbard, Friedrich Hayek, and others.

There are also more resources compiled under the “Learn” tab at the top of the page.

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