Wednesday, September 14, 2011

The Mysterious Ideas of Hard Keynsianism

I'm reading a lot these days about the ideas of this think called "hard" or "real" Keynsianism, the idea that we should run a surplus when the economy is in good shape. As well as finding a home on political websites like Labour list, it's also been mentioned by economists I incredible amounts of respect for like John Quiggin and Paul Krugman(1). I've also seen arguments from right wing types suggesting that Keynes said surpluses should be run during the good years. The problem I've got with this is that I can't find anything in the General Theory(2) that supports this.

It's obvious that Keynes thought that in time's of high unemployment, we can find plenty of passages to support this viewpoint in the general theory, the idea of running surpluses in good times I'm not so sure about. One fact that leaps out at me when reading the General Theory is the contempt he holds for the principle's of what he calls "sound" finance. We have this snippet from Chapter 8 where he laments excessive requirements for sinking funds (suppose you could call them reserves) for building maintenance and it's affect on employment.
Or again, in Great Britain at the present time (1935) the substantial amount of house-building and of other new investments since the war has led to an amount of sinking funds being set up much in excess of any present requirements for expenditure on repairs and renewals, a tendency which has been accentuated, where the investment has been made by local authorities and public boards, by the principles of "sound" finance which often require sinking funds sufficient to write off the initial cost some time before replacement will actually fall due; with the result that even if private individuals were ready to spend the whole of their net incomes it would be a severe task to restore full employment in the face of this heavy volume of statutory provision by public and semi-public authorities, entirely associated from any corresponding new investment.
Another good example of this is Chapter 10, one of the places where he talks about digging holes. The point he makes here is that in situations where there is unemployment you may as well pay people to dig holes, indeed he suggests that humankind had already unwittingly discovered this practice with the form of hole digging known as gold mining.
The analogy between this expedient and the goldmines of the real world is complete. At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available, our wealth suffers stagnation or decline. Thus gold-mines are of the greatest value and importance to civilisation. just as wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable, so gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance; and each of these activities has played its part in progress-failing something better. To mention a detail, the tendency in slumps for the price of gold to rise in terms of labour and materials aids eventual recovery, because it increases the depth at which gold-digging pays and lowers the minimum grade of ore which is payable.
He then proceeds to point out the absurdity of the principles of sound finance by suggesting that hole digging in the form of gold mining is a superior investment to building houses on this basis.
In addition to the probable effect of increased supplies of gold on the rate of interest, gold-mining is for two reasons a highly practical form of investment, if we are precluded from increasing employment by means which at the same time increase our stock of useful wealth. In the first place, owing to the gambling attractions which it offers it is carried on without too close a regard to the ruling rate of interest. In the second place the result, namely, the increased stock of gold, does not, as in other cases, have the effect of diminishing its marginal utility. Since the value of a house depends on its utility, every house which is built serves to diminish the prospective rents obtainable from further house-building and therefore lessens the attraction of further similar investment unless the rate of interest is falling part passu. But the fruits of gold-mining do not suffer from this disadvantage, and a check can only come through a rise of the wage-unit in terms of gold, which is not likely to occur unless and until employment is substantially better. Moreover, there is no subsequent reverse effect on account of provision for user and supplementary costs, as in the case of less durable forms of wealth.
Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. Thus we are so sensible, have schooled ourselves to so close a semblance of prudent financiers, taking careful thought before we add to the "financial" burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to "enrich" an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time
Now to me, the idea of saving in the good years to prepare for inevitable downturns seems to be me very similar to those ideas of "sound" finance. I have a hard time believing people who advocate a practice similar to that Keynes was so passionately critical of suggesting that their interpretation is "Hard" or "Real" Keynsianism.

Now, I will have to add a bit of a caveat here in that I don't think Keynes thought it was acceptable for governments to continually run deficits. I'm sure he recognised the obvious dangers of accumulating excessive levels of debt obligations, I'm also sure he recognised the role fiscal policy played in price stability. Given those two assertions I think it's fair to say that he advocated keeping national debt stable and budgets roughly balanced over the medium term. I don't object to this, what I object to is the fact that a lot of people seem to have read between the lines on the subject of balanced budgets and come up with a set of hard and fast rules and then had the cheek to call it "Real" Keynsianism.

The specific problem I have with this kind of policy is that it seems to assume certain properties of economic cycles that don't really exist. People act as if recessions are regular and inevitable events rather than occasional freak events with vastly different causes. The List of Recessions in the UK notes recessions in 1919, 1930, 1973, 1980, 1990 and 2008 and each one has a unique cause(3) (. If we were to run surpluses in the "good" (non bad?) years we have to ask ourselves just how long we would have to maintain this surplus, we have to ask ourselves why we are withdrawing demand from the economy and why we are putting off the building of houses, schools and hospitals for no other reason than to prepare for an imaginary downturn that may or may not happen.

Overall then, I'm not really sold on this whole Hard/Real Keynsianism idea. I think that unfortunately it's an idea that's cropped up because of the current obsession with fiscal policy in political debate rather than as a product of solid economic reasoning. I think it's important to remember that Keyne's main concern was always that of unempoyment.

1. Krugman is quite nuanced in what he advocates, so I'm not sure whether my accusations s
2. I should admit that I may be missing something here, I've not really read much of Keynes' other work.
3. Finance seems to crop up an awful lot in recession causes, funny that? You might think that a better way of dealing with the problem of downturns and the deficits they produce might be to regulate this activity more strongly.


John Quiggin said...

As you say, "Given those two assertions I think it's fair to say that he advocated keeping national debt stable and budgets roughly balanced over the medium term. I don't object to this, what I object to is the fact that a lot of people seem to have read between the lines on the subject of balanced budgets and come up with a set of hard and fast rules and then had the cheek to call it "Real" Keynsianism."

Apart from the words "hard and fast rules", it doesn't seem as if there is any disagreement here.

But, if you're going to keep national debt stable, you need some target at which you would like to stabilise it (expressed as per cent of GDP say)

There are two obvious candidates

(a) a level which is sustainable, if nothing goes wrong, but doesn't leave you very much room for Keynesian stimulus if there is a severe recession

(b) A level which allows for a substantial stimulus, in the event of a recession, without needing a rapid swing back to austerity.

Hard Keynesianism is (a). Given your reference to "an imaginary downturn that may or may not happen", I interpret you as supporting (b). But that's not really a Keynesian position since either there aren't going to be any more downturns, which makes Keynesianism irrelevant, or there won't be enough capacity to respond to them when they do happen.

A key misunderstanding is your reference to "putting off building of houses, schools and hospitals". If you are at or near full employment, then any resources that go to building houses must be at the expense of something else. If you want more public and less private expenditure in these circumstances, you need to raise taxes.

Finally, I agree entirely with point 3.

John Quiggin said...

Sorry, got (a) and (b) transposed

Andreas Paterson said...

Hi John, and thanks for your comment. From your explanation it seems that your views on Hard Keynsianism are not that far from my own views more generally on how things should be done. I suspected as much, and suspect that it is more the way I've seen hard Keynsian ideas used politically that I'm objecting to.

A minor point, I understand what you say on spending in times of full employment but I wonder how often we've seen a genuine full employment situation in recent times (roughly around the pre crisis decade). In the UK we certainly had realtively low unemployment, I'm not sure an unemployment rate of 5% can really be considered full employment.

Also, I'd be interested in your views on the UK situation leading up to the crisis. Our national debt had risen from around 31% to around 37% of GDP as a result of the government running a deficit leading up to the crisis. It's suggesting that we should have been running a surplus at this point and that this would have been the proper Keynsian response, but the only way I see this happening would be if we ran surpluses as a matter of course. While I believe that debt should be kept low I'm not a fan of running a perpetual surplus and view the fact that we had a deficit at the time unfortunate but not an absolutely terrible decision given that there was an intention to balance the budget of the medium term.