Monday, December 1, 2008

Resorting to Keynes and other crutches

Dan Ryan is a director of the Lion Rock Institute

The world's governments are about to embark on a massive spending spree. China is busy spending US$586 billion. Others in the region have committed to large government spending packages. US president-elect Barack Obama has just announced he plans to save or create 2.5 million new jobs through spending on government projects.

Now, our chief executive has suggested that there needs to be large-scale government-funded infrastructure spending here. Before we go ahead, it is worth asking whether such government spending will actually bring our economy out of recession earlier than would otherwise be the case.

The rationale for such action is that a "stimulus" is needed, through "deficit financing" if necessary, as a "countercyclical measure" to "kick-start" the economy by injecting money into the system.

We have grown used to this language and thinking but, before the era of economist John Maynard Keynes, for government to assume such a role would have been considered very foreign to the average citizen. While deficits certainly occurred, they were generally seen as something to be avoided. Instead, the rather quaint view prevailed that a government should balance its budget and live within its means.

Keynes' influence was created during the Great Depression when he found a receptive ear in governments eager for new solutions. Yet there is meagre evidence that his policy prescriptions did anything to reduce the length of that downturn.

Spending on make-work projects and infrastructure simply failed to pull the economies of the world out of recession as Keynes claimed they would - real growth only occurred after the second world war because of the peace dividend and a more liberal global economy.

Keynesian-style public spending and borrowing were further discredited during the stagflation of the 1970s when governments reluctantly came to accept the view that you can't spend your way out of a recession.

The fact that Keynesianism seems to be once again the default policy setting for most of the world's governments is not because the theory isn't false. It is because it allows governments to expand their role, to "do something", and to gain popularity by dispensing largesse to key interest groups.

Certain private companies may benefit from government-directed projects, but it does not contribute to growth of the private sector as a whole - it just gives bureaucrats a role to decide which firms or industries do and don't get funding.

But, they say, we're spending money on "infrastructure". The problem is that it matters a great deal what is being built, not simply that you're building something. Either a project provides a net benefit to the economy as a whole or it doesn't. If it doesn't, then it is an overall drag on growth. If it is worthwhile, then it should be justifiable in good economic times or bad - and it is preferable that the private sector should finance and take the risks associated with it.

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