The limits of economic stimuli

When George Osbourne first announced his austerity programme, the time for budgetary prudence was not the best. The US was trying to kick start its economy with the biggest stimulus programme in its history. Last week, President Obama told Congress to ‘pass the jobs act right away’, another enormous stimulus for the languishing us economy, or face the consequences of a long drawn out double dip recession. In other words, while Obama and the Democratic party believe that spending more money will fix the economy, in the UK George Osbourne holds fast to a programme of austerity. 

I am no economist so I wont judge either of the governments nor their hopes which may border on desperation in the face of an unprecedented economic downturn. However, I do know something about John Maynard Keynes and so it puzzles me what again and again Ed Balls, the Shadow Chancellor of the Labour Party, peddles as Keynesianism in action. 

Balls regularly tours the TV studios to say that Keynes advocated governments need to put on significant economic stimuli in times of economic downturns. Hence, Balls argues, Osbourne’s austerity drive is ill-thought out and runs counter to Keynes’ message to spend more in times of need. 

Yet, this is only half the story. Keynes did advocate an increase in governmental spending when the private sector suffered a downturn. However, the foundation of his theory, and the economic debate between Keynes’ supporters and opponents, centred on the issue of anti-cyclical spending. Keynes was keen to stress that the expansion of governmental spending at times of an economic downturn had to be followed by a significant cut in the government budget. 

This for two reasons. First, Keynes clearly understood the danger that economic activity subsidised by governments would crowd out private enterprise. Second, he also saw that in order to increase spending in hard times, government had to be thrifty in good times, so that they retain some room for manouvre when things get tough again. Economist argue about where the threshold lies where ‘activist’ governments turn into monopolist economic providers stifling the recovery of private initiative. 

Yet, there is general agreement that three of our four home nations have skidded fairly closely at this threshold with more than 60% of GDP in Scotland, Wales and Northern Ireland originating with state investment. In comparison, in the 1990s, post-communist Romania and Bulgaria had rates of 66 and 65% respectively. The rate for Germany under Helmut Kohl was believed to be 48% and generally seen as far too high. 

So, Balls’ argument suffers from two errors. First, even Keynes advocated sharp and significant cuts in governmental expenditure once the private sector showed signs of recovery. And second, in order to have space for another stimulus, governments need to roll back their investment in good times so they can act the next time around. 

For Keynes, economic stimuli were part of anti-cyclical governmental investment, rising in difficult times, while shrinking in good times. I have not heard Balls speaking of cutting expenditure once things come back to normal. In fact, the history of his involvement in the treasury indicates that cutting government spending is not his priority. So when it comes to unbounded profligacy, Balls needs to look elsewhere: Keynes wont help him with it.