It is ironic that Joseph Stiglitz waited until he gained the credibility of sharing the Nobel Prize in Economics to become an unabashed cheerleader for Keynesian economics, especially when it comes to suggesting policies for Japan. Receiving the universally recognized accolade allowed him to come out of the closet to support a body of economic thought that had recently been thoroughly discredited by notable failures.
Now he and other promoters of Keynesian economic theories are “outing” themselves to encourage governments to engage in active policies to manage levels of demand and consumption. Their selective memory blithely reveals a gap that overlooks stagflation of the 1970s, soaring public-sector deficits of the 1980s and 1990s and relentless growth in government control over private lives during most of the postwar period. It would be wise for the rest of us to resist their belief that governments can fine-tune an economy by making adjustments in taxes or government spending or manipulating interest rates.
This caution is offered since there is a dearth of evidence to support their views. As it is, Keynesian policies are based upon a widely accepted fallacy that economic growth is driven by demand, especially consumption spending. Perhaps unwittingly, those who support this view see savings as a nonessential and even counterproductive activity that undermines the health of the economy.
Such a negative view of savings is painfully familiar in Japan. However, the ruinous attempts at demand management by Tokyo over the past decade have not been enough to dissuade die-hard loyalists or unwitting cohorts. Now that interest rates are virtually at zero and fiscal spending has become constrained by high debt, Tokyo has exhausted conventional policy tools to offset its economic malaise. The truth is that these tools do not work.
Instead of the Keynesian presumption that demand drives economic growth, the reverse is true. Demand is the result of economic growth. Paraphrasing an economic law named after 19th-century French economist Jean-Baptiste Say, market economies work on the basis of the supply of one good creating the demand for other goods. In other words, you must first produce to be able to consume.
Reviving the neglected verities of Say’s Law requires debunking a subconscious belief system that is seldom subjected to introspection. One problem in exorcising Keynesian economic policy influences is that the demystification process requires understanding some basic economic theory that is hard to grasp. There are many implicit assumptions that make Keynesian analysis seem obscure in their effect or validity to lay persons.
Understanding Say’s Law begins with the common sense observations that purchasing power as the basis for consumption necessarily arises out of the act of production. In addition to this simple truth, just as goods cannot be purchased unless people earn income from producing, goods cannot be consumed if they are not produced. Hence, the driving force of a market economy is supply, not demand.
Following this logic then shows that economic growth depends on how much is saved (and how well it is invested) rather than on how much consumption there is. Economic growth and development requires increases in saving combined with prudent investment. This can lead to increases in the per capita quota of invested capital so that increases in productivity lead to higher wages and increased prosperity.
At the same time, spending on consumption means there will be fewer resources available for production. This is because production is derived from capital (the material means of production) and that depends upon savings. Increased savings are the basis for the accumulation of capital and increased production that provides the means and the ends of consumption.
Policies to force interest rates artificially lower to boost consumption are actually counterproductive since they discourage savings. Even if it could, there would be undesirable effects on the pattern of economic activity. This is because it causes a change in the pattern of production that encourages long-term investment in activities that will not be unsupported by long-term consumption trends.
If all goods were consumed and none were set aside to invest in time-consuming production, we would be in the situation faced in the fable of the grasshopper and the ant. While the ant toiled away, the grasshopper derided him for not playing in the sun. When winter came, the grasshopper faced starvation for not laboring in the present to prepare for the future. Keynes, being childless, perhaps saw no merit in the wisdom of nursery tales.
Attempting to increase aggregate demand by increasing government spending will not restore growth. There is little evidence to suggest that fiscal or monetary policies have a systematic effect on real economic variables. This is because a policymaker’s ability to identify and bring about improvements in these structures is no better than that exhibited by central planners. Government officials are unable to acquire the relevant knowledge to control markets regardless of whether they are policymakers or planners. Even though macroeconomic meddling to “correct” market conditions involves the same presumptions that (mis)guided central planners, supporters of Keynesian policy willfully ignore evidence from the failures of communism and socialism.
Although market economies experience fluctuations that include booms and busts, the sort of meddling that is supported by Keynesian prescriptions has caused most of the extremes. These same interventions also interfere with the innate self-adjustment mechanisms that would generate stability in capitalist economies.
Alas, Keynes’s teachings remain very much alive and just as wrong now as they were then. Apparently the discovery that centralized economic decision-making through political mechanisms is inferior to decentralized market mechanisms has already been lost on some. Perhaps Nobel laureates and highly paid professors are unable to admit that decentralized decision-makers participating directly in commercial and financial activities know more about markets better than they do.
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