Tuesday, December 28, 2010

The Keynesian Economic Theory Is Out of Date With A Modern Global Society

            We all know how hard it is to admit you were wrong about something.  Right? 

Now, let’s say you spent a lot of time studying and researching a subject, perhaps for a
PhD thesis or even a book.  Here’s an example.  About 15 years ago a veterinary
graduate student wrote his PhD thesis on the premise that dogs and cats didn’t have
strokes (cerebrovascular accidents).  He believed only humans suffered from strokes,
and other animals had what he called “vestibular syndrome,” a problem with the middle
ear apparatus that created all the central nervous system signs normally attributed to a
stroke.  Now, hold that thought while I discuss John Maynard Keynes.
            The study of economics is relatively new, primarily developing in the late 19th and
20th centuries.  British economist John Maynard Keynes published his conclusions on
the subject in 1936, entitled, “The General Theory of Employment, Interest and Money.” 
It soon became one of the most controversial and variously interpreted theories of its
time, and has influenced governments’ attempts to control their economies ever since. 
In fact, the current administration is putting all its eggs in Keynes’ basket right now.  Or,
rather, our President is putting all OUR eggs into that basket.
            The Federal Reserve System was set up in 1913 to “maintain the stability of the
financial system and contain systemic risk that may arise in financial markets,” among
other things, yet is has never been able to do so.  It didn’t prevent or control the Great
Depression, and it hasn’t prevented or solved any of the subsequent recessions,
including the one we are in now.  Likewise, Mr. Keynes’ theory was used by President
Roosevelt to end the Great Depression, but it failed miserably.  The massive industrial
mobilization of World War II is what brought us out of the Depression, not any economic
            So now we have what we call a “global economy,” and a subsequent Modern
Global Society.”  I’ve argued that we have had a global economy ever since the first
wooden ship left shore with a cargo to trade; it’s just that this is done faster and on a
much bigger level today.  So why should Keynes’ economic theory work any better
today than it did before?  President Obama believes that President Roosevelt simply
didn’t spend enough money.
            Here’s Mr. Keynes’ theory in a nutshell.  First, he believed that we should spend
all the money we make, or total spending in the economy, termed “aggregate demand.” 
Now, that’s hard to take.  It reminds me of the fable about the grasshopper and the ant. 
Next, he thought that aggressive government action could stabilize the economy.  This
is based on his belief that large fluctuations in the economy significantly reduce well-
being, and that the government is wise and capable enough to improve on the free
market.  I guess that means we should trust in the knowledgeable judgment of our
elected officials, like House Financial Services Committee Chairman Barney Frank (D-
            Keynes’ solution to a recession or depression is to stimulate the economy by
reducing interest rates and having government invest in infrastructure.  This is
supposed to have a “domino effect” by funding income, which leads to more spending in
the general economy, thereby stimulating more production and investment.  This is
supposed to repeat over and over, so that the end result is a multiple of the initial
government investment.  Times have changed significantly, however, from the 1930s.
            I’ve had this copy of Fortune¹ in my office for many years.  I think I bought it
because it is from the war years, and I’m very interested in World War II.  Inside this
December 1942 issue was the third in a series of reports “on potential courses for
democratic action” after the war was over.  They were assuming at the time that it would
be over in another year or two.  Part III is “The Domestic Economy.”  Now, here are two
paragraphs from page 6 that I want to read to you.  It’s headed, “Fallacies of debt.”
            “The commonest objection to a policy of government spending arises from the
fear of public debt.  To some extent this fear is grounded in a theoretical
misapprehension: that public debt is like private debt, and that if the government
continually spends more than its income it will go broke or cause inflation.
            “This analogy is false so long as the productive capacity of the nation is
maintained, the debt is internally held, and the government retains its taxing power.  For
with production flowing, since the interest on the debt is paid to residents of the country,
the government can always recover an equivalent sum in taxes, no matter how huge.”
            Has the productive capacity of our nation been maintained?  No, it has mostly
gone to China.  Is our debt internally held?  No, thirty percent of our national debt is
foreign-held, with nearly half of that (48%) held by China, Hong Kong, and Japan.  Has
our government retained its taxing power?  Yes, but one out of three isn’t good enough.
            This report goes on to state on page 8 that some economists urged “a fairly
drastic redistribution of income from the saving to the consuming class.  The ‘propensity
to consume’ is highest in the lowest income groups; therefore, for the sake of stability,
let us tax the rich and subsidize the poor.”  Sound familiar?
            We see all around the country signs of our President’s stimulus plan at work. 
(Show photo of “Project Funded by the American Recovery and Reinvestment Act sign
by highway)  Each of these signs, by the way, costs us $900 to make and erect.  He
believes that Roosevelt’s application of Keynes’ theory didn’t work because he didn’t
spend enough money.  Obviously, he’s taken care of that.  Roosevelt thought in millions
and billions.  Mr. Obama is calling on trillions to do the job.  Do you think it will work
            The assumption of a static economy seems to underlie Keynes’ entire work.  I
don’t believe he ever ran a business himself, and had no experience with the “human
factor” of the economy.  He really didn’t take into account an important ingredient: public
trust and confidence.  The only people who truly believe that government  has all the
answers and should run everything are the liberal-socialists.  The rest of society, if they
know any history at all (by the way, for several decades our children have become
ignorant of the lessons of history), realize that socialism is horrible.  As Winston
Churchill said, “The vice of capitalism is that it stands for the unequal sharing of
blessings; whereas the virtue of socialism is that it stands for the equal sharing of
            So, yes, I believe that the Keynesian economic theory is out of date with a
modern global society.  It is out of date with any society outside the halls of academia,
and has proven so whenever it was used to solve a recession or depression.  Why do
some think it will work now?
            Remember the theory of “vestibular syndrome?”  Well, about ten years ago a
group of pathologists, after studying over a thousand post-mortem examinations of dog
and cat brains, discovered that animals other than man do, in fact, have strokes. 
Nevertheless, a whole generation of veterinarians is still telling pet owners that their pet
did not suffer a stroke, but instead has vestibular syndrome.  Many veterinary colleges
continue to promote the theory to this day.  And a funny thing – the treatment we’ve
always used for a stroke, anti-inflammatories, antihistamine, and time to heal, seems to
cure the problem no matter what you call it.
            Even though you’ve proven a theory to be wrong or ineffective, it inevitably
persists.  Nobody likes to admit they were wrong.


¹  “The United States In A New World – A series of reports on potential courses for democratic action.  Prepared under the auspices of the Editors of Fortune.  III: The Domestic Economy.”  Fortune 26, no. 6, December 1942

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