[p2p-research] Post-Keynesian Solutions - A Reply to a Critic of the Blog

[Ryan]

High quality argument...one I disagree with strongly, but very high
quality.

Sent to you by Ryan via Google Reader: Post-Keynesian Solutions - A
Reply to a Critic of the Blog via CynicusEconomicus by
CynicusEconomicus on 6/19/10
I have recently been given a lesson in the correct terminology for the
various forms of Keynesian thought from a regular commentator on the
blog, who posts under the title of 'Lord Keynes' (hereafter LK). For a
long time now, he has posted comments critical of the perspective of
this blog, and demonstrated a strong grasp of the various forms of
Keynesian arguments. For a short while, I did engage with his
arguments, but found that I ended up doing nothing but engage with his
arguments, rather than writing the blog.

The reason for this is that, at whichever point, LK would provide reams
of 'evidence' in support of his assertions. In recent times, he has
even proposed that, for example, the Austrian economists provide no
evidence for their theory, which is clearly not true. What LK and other
Keynesians do is pick and mix from the available evidence, present
arguments for the defence of their arguments based upon the
policy/experience of country 'x' doing policy 'y' with the result 'z'.
Typically, what they do is identify an individual policy, and then
separate it from the broader context of the policy. In doing so, they
appear to provide a cast iron case in favour of their policy.

I do not think that the Keynesians are alone in this, but they seem to
be masters of the art. One example oft cited by LK is fairly typical,
in which LK suggests that the Scandanavians have managed to be
successful despite a large government sector (quoted from the comments
section):

Denmark, Sweden and Finland are successful economies that run current
account surpluses and that have substantially lower unemployment than
the US or the UK, yet nearly half of all GDP is taken as taxes and
spent by the government.

Germany, a manufacturing powerhouse and very wealthy country, takes
40.6% of GDP as tax revenue.

The UK is actually around the middle, not the higher end, of the
spectrum.

By contrast, Haiti only takes 9.4% of GDP as tax revenue (before the
earthquake, I might add), and what is it?? An economic basketcase!The
Haiti case simply makes my point. Apparently here is proof that low
government expenditure is bad for your economy. No context, just a
figure as 'proof'. We can also take the case of Sweden, which according
to the World Economic Forum, is ranked as 4th in the world for
competitiveness. The report uses the following pillars for the ranking:


- Institutions
- Infrastructure
- Macroeconomy
- Health and primary education
- Higher education and training
- Market efficiency
- Technological readiness
- Business sophistication
- InnovationNote that the ranking systems does not include tax against
GDP. In the Economic Freedom of the World 2009 report Sweden was ranked
4oth, despite the rankings scoring very negatively for large size of
government expenditure with Sweden ranked 127th on this measure.
According to a ranking of business regulation, Sweden comes in at
number 18 overall, but is also number 7 for trading across borders.
According to the IMD world competitiveness rankings, Sweden comes in at
the 6th most competitive country in the world.

I can go on. For the informal economy, where people work outside of the
official economy, Sweden is ranked = 82nd. According to the Economist
Intelligence Unit, Sweden ranks number 2 for 'e-readiness'. Sweden
holds 11th place for the number of patents in the US patent system, and
ranks 4th in the world overall. Sweden lies at the third best in the
world on rankings for perceptions of corruption. The country also rates
at number 3 for technological achievement. Sweden has the 6th highest
level per capita of spending on research and development, and the
second highest aggregated (curiously after Togo as number one). On the
technological achievement index, Sweden ranks 4th (creation of
technology; diffusion of recent innovations; diffusion of old
innovations; and human skills). On the global innovation index, Sweden
ranks as number 4 (though this does include government policy such as
patent law, and fiscal policy). Sweden is the world's most networked
economy.

Of course, what the Keynesians will say is that this is all an
achievement of government policy and the large proportion of GDP that
goes into the state. However, how can a generous benefits system
support, for example, the innovation that is shown here? Is the
innovation what allows spending of this size, or is it that the
spending causes the innovation. Cause and effect - how do you untangle
these? Is the ability for government to spend so much the effect or the
cause? I expect that LK will answer some of these rankings with
examples of how government action facillitated the ranking. The problem
is that this takes the particular context of one country as an exemplar
for another country.

When the Keynesians propose country 'x' as an exemplar, they appear to
view all countries as having identical strengths and weaknesses, and
take no account of, for example, business culture. For those like me,
who have worked in US, UK, French and German companies, as well as
having worked with the Japanese, the Italians, Swiss, Chinese and so
forth, it is apparent that there are real differences in business
culture.

For example, hhilst I have worked with Swedish people, I have not done
so enough to have a clear perspective on their business and working
culture. However, I have had considerable experience of working with
another oft cited example from the Keynesians, and that is the Germans.
In particular, I have worked for a German multinational. My experience
of working with Germans was that I was deeply impressed. They have a
culture of thoroughness, of attention to every detail, and this is
ideal for a manufacturing base. When compared with a British company,
it was all very impressive. It is not just the experience of working
within a German company, but also my experience of working with Germans
in general. How does this kind of factor fit into explaining the
success of country 'x', 'y' or 'z' in the examples given by the
Keynesians. The answer is that, because it can not be measured, it does
not appear (comments from those who have worked with German business
welcomed).

The point I am trying to make here is that policy 'x', 'y' or 'z' does
not operate in a vacuum, but in the context of a long history of
economic policy, social policy, educational policy, particular
resources, particular stages of economic development, and the global
economic context of the particular time and so forth. As I have said,
the Keynesians are not alone in this, and this is why economics is a
matter of such debate. Cause and effect are actually very difficult to
identify when looking at any individual policy. It is why opposing
schools of economics are able to justify their positions in direct
opposition to one another. I will give another example of this
generalisation from country 'x' to country 'y' later.

One of the most interesting points that LK is making is that high
government expenditure can sit alongside economic success, and this is
why he cites the examples of Scandinavia etc. What he does not cite are
the counter examples such as the UK. The UK has seen a steady expansion
of the size of the state in the UK over the last ten or so years.
However, having expanded the state, the UK is now in deep economic
trouble. Is this not a counter example to those that he has given?
Could it be that there are factors specific to the cited examples that
allow them to support such a large state, but the UK lacks those
factors? LK will not doubt suggest that the UK state misused their
increasing control over the output of the country....

In a recent example, I mentioned the work of Carmen Reinhart and
Kenneth Rogoff 'This Time is Different', a book founded upon empirical
evidence, and LK immediately responded with a list of authors who have
criticised their work. No doubt, the critiques included counter
examples, and this is what we always find. For every example, in a
complex history of economics, and a complex world, there are always
ways to present a counter argument - as there is endless variability in
contexts. In the end, what we are always left with, is the underlying
theory, and which theory we choose to believe, and which interpretation
of the 'facts' is most credible.

For example, LK puts the explanation for post war economic growth as
follows (in the comments section):

The sources of post war growth can be found in effective financial
regulation (to prevent asset bubbles), discretionary fiscal and
monetary policies, and Keynesian demand management.
It is an explanation that has often been offered by LK. Note that the
economic growth during this period takes no account of increased
productivity of labour, or the many innovations that took place during
this period. If we want to see an explanation for why an economy gets
richer, would it not be useful to take into account the innovations and
technologies? Instead of this, LK looks at the monetary and fiscal
policies, and Keynesian demand management as explanations. I will ask a
simple question.

If a factory yesterday can make 1000 toasters per hour per unit of
labour, but in a years time can make 1200 toaster per hour per unit of
labour, does this not represent a real increase in material wealth?

What we have are two different explanations for the same thing; growth
in economies in countries like the US and Europe. In my version, we can
see real changes in output per worker as new and more efficient
production methods, systems and machines are introduced, creating real
increases in output per worker (and this includes services), and we can
see a real and measurable outcome of such innovation. On the other
hand, we can see abstract and indirect theoretical transmission
mechanisms that are represented by 'effective financial regulation (to
prevent asset bubbles), discretionary fiscal and monetary policies, and
Keynesian demand management.' The post world war growth, according to
LK is resultant from Keynesian policy....and there is no way to
comprehensively disprove his view.

My answer to the LK argument is that economic growth is created by the
kinds of innovations that make increases in outputs, and development of
new goods and services, possible. Those innovations are created in the
competition between suppliers of goods and services, each trying to
outdo each other in the market, in a battle for profits and survival.
Whilst monetary and fiscal policy might have an influence, along with
the regulatory regime, these are not the drivers of economic growth.
Instead, they are potential hindrance of economic growth, and the best
outcome that they might achieve is a neutral effect upon growth. None
of these lead to the innovations that mean that there can be more
output of good or service 'x' by worker 'y'.

In other words, government monetary policy, fiscal policy, and
regulation do not create the innovations that create real increases in
output. In the end, you can choose which is the better explanation of
the post war growth. Was it government policy, or a period in which
innovation created massive gains in output?

One argument might be that elements of government fiscal policy might
have some indirect impacts, such as the proportion of government
spending being used in effective and efficient education programs. Some
government funded research programs might also lead to innovations that
will impact upon output in the economy. However, how those research
programs might produce results in comparison to the actual investment
in research, in comparison with having the money being used in research
by private organisations/individuals, is a question for which there is
no neutral answer. For example, elements of the modern Internet flowed
from US government defence research, but the application benefits in
the civilian Internet were coincidental but huge.

But then again, the huge amount of money poured into defence programs
must surely eventually result in some kind of breakthrough...

In proportion to the total of government expenditure, how might we
measure such benefits, and how might they be compared to private R&D
expenditure? If the money were left in private hands, what kind of
economic growth might it achieve? We do not know the answers to such
questions, and there is no neutral way of making such an assessment.
There is no data that might objectively measure such a thing.

This brings me onto LK's favourite term, which is the idea
of 'industrial policy'. This is a bit problematic, as it is always
vague and undefined. I will quote some examples from LK:

That is why they need to nationalize banks, tightly regulate them,
control allocation of capital to productive investments, adopt
aggressive trade and industrial policies and rebuild manufacturing and
output of tradable goods and services. (here)

This can be done through social policies to help families as well as
immigration and vigorous industrial policy. (here)

It's [the US] main problem is that it allows it multinational
corporations to ship its jobs to East Asia.
This can be fixed quite easily through industrial and trade policy or
by taxing corporations according to the value added in the US. Yes,
that means higher prices for manufactured goods. But it also means
employment, investment, stronger industries and a healthy economy.
(here)

The rise of China was very little to do with comparative advantage. It
rose through aggressive industrial policy.
The UK and US can use aggressive industrial policy as well to rebuild
their manufacturing sectors. (here)
Only in one case have I found anything that might explain what
industrial policy might really mean, and that is a link provided by
Lord Keynes to a Google books page on Taiwan's emergence as a modern
economy. Other than suggesting a formula which might, or might not
have, contributed to Taiwan's growth, it is all rather vague. If we
look at LK's blog, we find a few indirect references:

The only region that showed an increase was East Asia, precisely the
region dominated by the protectionist state-led model of
industrialization, led by Japan, South Korea, Taiwan, and (from the
early 1990s) China. (here)
In another post, LK discusses the New Zealand experience of industrial
policy, but never makes clear exactly what that policy was, or how it
might have succeeded. Instead, he discusses external factors, and
claims that the big fall in GDP was a result of neo-liberalism. Once
again, we have a selection of factors that suit the argument being made
(if you read the post, it does not mention many of the factors
involved, such as what drove the eponymous instigator of the liberal
policies known as Rogernomics to declare that the country faced
economic ruin - and the instigator was a Labour MP).

What we have here is some very vague suggestions from LK, that are
never fully elaborated. I used Google to search my site for industrial
policy comments from LK, and could not find anything which might
explain how this industrial policy might really work. There are
certainly indications that the intent is to introduce capital controls,
impose tariffs (direct or indirect) and to control industrial sectors -
as well as hinting at mercantilist policy. However, I will not comment
on these here, as they are only speculation.

Then there is the Keynesian perfectly circular arguments for government
borrowing. These are the arguments that government borrowing is
unconstrained, and that government borrowing might be a way to lead an
economy out of recession. According to LK, there is no limit to
government borrowing, and that government borrowing creates
economic 'growth'. This is a recent comment from LK, in which he
claims 'proof' that economic stimulus works:

Secondly, the Western countries have returned to mild growth and are
not contracting: this is proof of the success of fiscal policy (you are
mistaken to say that Keynesian stimulus can never be proved “wrong”: if
we got a major depression and negative growth in the face of large
fiscal stimulus, then this WOULD demonstrate that something is wrong
with the Keynesian theory).The most interesting thing here is that LK
actually thinks that the consumption of borrowed resource represents
economic growth. The simplest way to illustrate why this is such an odd
idea is to pull away any restraints on borrowing. For the sake of
illustration, let's imagine that the US had a credit line of an
additional $1 trillion this year, in addition to their current huge
borrowing, and that the US utilised that credit line. If they did so,
they could start any number of huge projects, all utilising that
borrowed money, and there would not just be GDP growth, there would be
a massive boom in the economy. GDP growth would sky rocket.

If this is the case, why not just borrow that additional $1 trillion.
The economy would boom, tax revenue would boom, and the economic growth
would mean that the debt to GDP ratio would fall, suggesting that the
debt is more serviceable. If this is the case, then it would seem that,
the more that is borrowed, the greater the economic growth, and the
more successful the economy. On this basis, every economy should add
ever more borrowing every year to ensure endless economic growth. After
all, the growth reduces the debt to GDP ratio, and increases the tax
revenues to ensure repayment of the debt. Here is a recent example of
this thinking from Krugman, offering a critique of German austerity
measures:

"But that doesn't make sense. Even if you manage to save 80 billion
euros – which you won't, because the budget cuts will hurt your economy
and reduce revenues – the interest payments on that much debt would be
less than a tenth of a per cent of your GDP. So the austerity you're
pursuing will threaten economic recovery while doing next to nothing to
improve your long-run budget position."So here you have it - cutting a
budget deficit hurts tax revenues. This is so circular, that I find it
beyond belief that any person might suggest this as a realistic
approach to economics. If government borrows money, and that borrowed
money enters the economy, then more activity will take place, which
will create more government tax revenue, meaning that the government
can claim that the economy is growing whilst improving their ability to
service the debt that they used to start the whole process.

It is a perfectly circular system. It is an economic perpetual motion
machine. So what is the problem with this economic perpetual motion
machine?

The trick to understanding this is not to think of government borrowing
money, but of borrowing of resources. When a government borrows money
from overseas, they are actually borrowing the output of that overseas
country. For example, if borrowing from the Gulf states, it is the
equivalent of borrowing oil. When that oil enters into the economy, it
allows for increased activity in the economy as the oil is consumed. At
each stage of activity in the economy, a percentage of that oil is
consumed and that oil is a contributor to the output within the
economy. It is a system in which real resources are being consumed. The
problem here is that the consumption is consumption of Saudi Arabian
output, not US output. In consuming the oil, the measurement is not of
US output, but is a measure of US output + Saudi Arabian output.

All the time this consumption is taking place, there is an accumulation
of an obligation to provide goods and services in the future to repay
the loan of oil in the future. Those goods and services will
necessarily require the consumption of resources (including oil) in the
future to repay the loan of oil. If this is the case, then a percentage
of the total resources of the US must be allocated to making this
repayment. If those resources are being utilised to repay the loan of
oil, then they will not be available for internal consumption.
Remember, the oil resources that were borrowed have been consumed.

What all of this tranlates into is that, if you borrow and consume huge
amounts of resource, it is possible to achieve growth in activity. I
can not argue with this. It is self-evidently true. It is very easy to
generate activity with borrowed resources. Just borrow more and more,
and you will generate ever more activity. That this is the case does
not in any way imply that this is a good long term strategy for an
economy. It is actually the easiest thing to do - borrow money to
create activity. It is so easy that we might think a monkey could do
it. It is not clever, it is not sophisticated, and you do not need to
have a PhD in economics to understand that if you throw enough borrowed
resources into an economy, it will create activity. But where does it
leave you, but with an obligation to repay that resource in the future.

What about if the borrowed resource is used for investment? It may be
that some of those oil resources were borrowed and used to create new
output, for example, building a factory. If this is the case, it might
be that the factory will later produce goods and services that might
help pay for the borrowed oil. The question here is to ask whether this
is actually what is taking place? Are the gargantuan sums of borrowed
money being directed into investment or consumption?

If it were the case that the huge sums of money were being wisely
invested in new and productive investments, we would see a massive
growth in the US economy as a result of the investments. However, we
can not see any such resultant growth, but instead see the US limping
along, with no real signs of recovery.

The answer of LK to this problem is to suggest that the massive
stimulus spending is not being correctly utilised, and should be used
for infrastructure projects/ other projects specified by the wise sages
of post-Keynesianism. What I always find interesting about such
proposals is that, if these projects were of genuine economic benefit,
why were they not undertaken before? After all, all governments want
economic growth, and there is no reason why such projects might produce
such a return in the good times as in the bad times. What has changed?
By curious coincidence, these projects move from being unconvincing in
the good times, to convincing in the bad times. In other words, the
value of the projects is being subjectively reassessed in the bad
times. What was a poor investment becomes a good investment.

As an interesting example, LK cites the case of the success of the
stimulus in China as follows:

First: the tremendous success of Keynesian stimulus in China and
Australia.
To repeat a previous post:

In the face of a massive collapse in their export-led growth economy,
what did China do?

They implemented a massive $586 billion dollar Keynesian stimulus – and
then got a very impressive recovery, so impressive in fact that with
growth in the first quarter of 2010 at 11.9%, there is talk that they
may need to cool down the economy.

Does that sound like a “failure”?

Australia also implemented a large Keynesian fiscal stimulus, which
worked very well, and it benefited from China's stimulus as well.

Conclusion? Countries that are close trade partners benefit
tremendously from Keynesian stimulus in both countries.

Your failure to even address this point severely undermines your whole
argument.
I am not sure whether LK has been to China, but there are large swathes
of China that genuinely lack infrastructure. As one example of the
government spending on infrastructure, the last time I was in China, I
went along a pot-holed track and could see a massive new highway being
built alongside it. The road was opening up a large area of Sichuan
province to the rest of China, and would thereby pull that region into
the Chinese economic system. There was little potential for economic
development of the area prior to the road being built, as the
communications were simply too poor to allow any growth. When I viewed
the road being built, there could be little doubt that it was a genuine
investment which would allow the people of the region to contribute to
economic growth in the future.

You may note the difference here. In an emerging economy such as China,
there are many projects that are not only attractive, but actually
essential. This is not to say that all investments in infrastructure in
China will repay the investment (it is a very corrupt country), but
that it is easy to find good investment projects. Even before the
crisis, China was investing heavily in such projects (as there were so
many that were necessary) and they have just accelerated this process.
Unlike a developed economy, these projects were self-evidently a good
investment before the 'bad' times. Furthermore, China is a current
account surplus country, meaning that it can pay for these projects
without the risks in having to borrow the resources of other countries
to fund the projects.

What we will see from the Keynesians is that they will suddenly find
hundreds, if not thousands, of projects that have been crying out for
investment. They appear as if by magic, as soon as there is a downturn.
In the case of an emerging economy like China, many of the projects
will be of great value, but in a developed economy, they are unlikely
to be anything but of marginal benefit at best. In using China as an
example, LK does exactly what I discussed earlier. He takes a case out
of context to 'prove' his point, but in reality, proves nothing. I
believe that I have answered LK completely here, and his use of this
example just illustrates my point about context. Any comparison of the
situation of China and a country like the US is pointless.

What of all those unemployed? According to the Keynesian arguments, all
of these people are sitting around as unproductive resource. Would it
not be better to employ this idle resource?

It is a tempting argument, if only for the dignity of the unemployed
workers (which is a concern I share). However, in employing these
people, for example in infrastructure projects, they are not a resource
that is being used productively, but rather a resource which costs more
resource to appear to be productive. If the infratructure project is
not viable as an investment, then the additional resources needed to
emply these workers mean that they are just consuming additional
resources in their employment. Compared with having the unemployed
worker sitting at home (for example on benefits) this represents a net
increase in resource consumption per person who is employed on the
project compared with being unemployed at home.

'Yes', in the short term, a person can appear to be gainfully employed,
but at what cost for the future?

To illustrate the point, prior to the crisis exploding, there was high
employment in many developed economies as a result of the credit boom.
All of those people appeared to be engaged in productive and useful
employment. However, the apparently productive employment was resultant
from the borrowing of resources from other countries, and the
consumption of these resources. Each of these people employed as a
result of the credit boom looked every bit like they were making a net
contribution to the economy, but many of them were just facilitators of
consumption of the output of other countries. Their net contribution to
the economy was actually negative, as they were part of a system in
which consumption exceeded output. The result is the massive debt
overhang in many developed countries. The Keynesian stimuli just offers
more of the same. Just as the private debt overhang led to unemployment
now, the government debt overhang will create unemployment in the
future. It is just a delay, not a solution.

The private debt accumulation led to lots of employment in
unsustainable sectors, such that resources were directed into an
unsustainable economic structure. When the structure collapsed,
unemployment went up. However, the stimuli measures have sought to turn
this back, but by doing the same thing as the original problem. By
trying to support an economy based upon borrowing, which entrenches an
unsustainable structure.

This is the other problem with the Keynesian solution; it evades the
underlying problems in an economy. If we think of the net
over-consumption in the economy, it must be the case that, at some
point, the balance must be reversed to pay back the previous
over-consumption. By borrowing more money, the structure of the economy
is left in a form in which large sectors of the economy are structured
towards the over-consumption. If people are employed on infrastructure
projects that represent a consumption of resource (not an investment),
then the sectors of the economy that are supported by over-consumption
are left in place. These sectors continue to have resources directed at
them. Replacing private borrowing with government borrowing just leaves
the same structure in place, completely unreformed.

This kind of problem, however, is not apparent at the time of the
stimulus spending. In fact, none of these problems are apparent at the
time of spending the stimulus money. This is why LK can claim success,
as he has done, for recent bouts of stimulus spending. LK points to
country 'x' and says look how they have returned to growth having
spent 'x' amount of money on a major stimulus. As I have said earlier,
it is no wonder that pouring masses of borrowed resource into an
economy will stimulate activity. It really does not take much to see
the cause and effect, but it is a different matter to see the long term
consequences.

So why does LK think this will work long term? I will quote from one of
his recent comments:

That the effect of a stimulus is “transient” is an utterly trivial
point. Of course it is.
The whole point is to temporarily stimulate the economy back into
growth, so that demand for private goods will be restored and private
business confidence and output will rise - which creates a
self-sustaining economic expansion. Output of what will rise? If you
are stimulating with borrowed resources, yes, output will rise, but it
will rise in the sectors of the economy which otherwise can not support
themselves. You are simply entrenching the structural problems, as I
discussed earlier. It is not self-sustaining, as the parts of the
economy that are supported by overconsumption remain in place. They can
only be supported by ongoing borrowing for consumption.

I have noted in previous posts that, as economies such as the US and UK
returned to so-called growth, we could see a commensurate deterioration
in the trade balance. No doubt, all of the consumption fuelled by the
borrowing will support the economy for a little longer, but the
underlying structural problems are kept in place at the cost of
accumulation of debt. It is a transient effect, and this in not
an 'utterly trivial point' as LK claims. It is exactly the point. As
soon as the stimulus is withdrawn, the economy will return to the
problems that have not been addressed. This brings me to another point.

LK criticised me recently as follows (my words quoted in italics):

If the fiscal stimulus runs out of steam, have another one, and another
one, and another one. If it is not working, a larger one will do the
trick. If the larger one does not do the trick, then there is an even
larger one that might be do the trick. In nobody will lend, print
money. If that does not work, just print more.

I assume this is mainly meant to be rhetoric?
If not, which countries have tried 6 stimulus packages that failed?
Answer: none.
Have any countries tried 5, 4, or 3 stimulus packages that failed?
Answer: none.
In fact, have any countries even tried 2 stimulus packages yet??Yes,
Japan. It has long been using all of the tools advocated by LK. And
when these did not work, the cry is that they should have done more
of 'x' and 'y', they stopped the stimuli at the wrong time etc. No
doubt LK will claim that Japan did not apply their various stimuli
correctly...or they should have pushed on through with more of the
same. More bridges to nowhere....

And this leads me on to the next problem, which is the idea that
government borrowing is different from private borrowing:

In the real world, the government controls monetary policy. Its debt
isn’t even remotely like private debt. An entity that has the power to
create money cannot go bankrupt.
It can certainly use too many real resources, cause inflation in boom
times, increase the external deficit unsustainably, or stupidly borrow
money from private markets when it has no need to.Within this argument,
we see that LK is a supporter of printing money (or he will no doubt
use the weasal term quantitative (QE) easing). I agree that borrowing
money on private markets is foolish, but that is because I do not agree
with the borrowing of money in the first place. However, the proposal
of LK appears to be that the best route is to simply print money, and
utilise this rather than money borrowed from private markets. As we
know, this is what the UK was doing until recently. For those of us who
pointed out this was inflationary, we are now being vindicated. The UK
is indeed now subject to growing inflation, despite the 'output gap',
despite the fall off in private credit. In fact, the UK is importing
inflation due to the decline in the value of the pound, and this
despite the Bank of England's continuous predictions of deflation. The
only question remaining is how far the inflation might climb (although
the austerity measures being proposed may put a halt to the inflation).

The problem is this. If you start down the road of printing money to
finance deficits, you eventually create inflation. The transmission
method of the inflation may be through currency depreciation, may be
through a boom in credit, asset price appreciation or a host of
different conduits. It may be that the effects are delayed, for example
where the UK banks used the process of QE to rebuild reserves. However,
eventually, the new money appears in the economy. When it does so, it
must be sterilised, or it will lead to inflation, and here is the
problem. In order to sterilise the money, the Bank of England must sell
assets to destroy the newly created money, which means selling gilts.
In doing so, the process of QE just becomes a delaying mechanism, as
those gilts must be sold in private markets. Either that of the Bank of
England must print money to sell the gilts to itself, thereby defeating
the purpose of the sale (though I would not be surprised at such a
lunatic policy).

It is an incoherent idea to suggest that a government does not
eventually need to turn to private markets to finance their deficits.
And if the private markets do not want to buy? What happens then? The
money created remains in the system....and the inflation will follow...

And this is why government debt is like any other debt. Sure, a
government can not go bankrupt in that they have no money, but a
country can end up with a worthless currency that can not be used to
exchange for goods and services. In order for a government to borrow,
the potential lenders have to, in the end, believe that they will have
the borrowing repaid in a value that exceeds their lending. So a
government can print money, and default on its debts indirectly.
However, a default is a default is a default, regardless of the
specific form of the default. The more a government borrows, the
greater the call of the creditors on the future output of the borrowing
country. If the output does not increase faster than the borrowing (not
including the output that is itself resultant from the borrowing),
then, at some point in the future, there will be a loss of output for
internal use in the borrowing country. Either that, or the country
defaults on debt (for example paying with printed money).

And when a country defaults, with outright or indirect default, the
credit will stop, or will be offered at high interest rates to reflect
the risk. Whichever the case, the private debt markets will impose a
fiscal discipline on the government. It is not that the private markets
are evil and anti-democratic. They have a reasonable expectation of
repayment when they lend money. If there is any evil (though I do not
like this word) it is governments seeking to bribe their voters with
borrowed money today which will have to be repaid by others in the
future. It is the lie that this is sustainable and can be continued
with no future consequence. I keep coming back to the point - it is
easy, if not lazy, to just keep borrowing more money, in order to
support a failing economy. Pouring borrowed money into an economy is
the easiest thing in the world, but it is the repayment of the
borrowing in the future that is the challenge.

A good example of this lazy and dishonest approach to economic
management are the state pension schemes. As every year goes by, the
liabilities steadily accumulate. As they do so, governments pretend
they are not there, as confronting the problems of the accumulating
debt would not be popular. The pensions will, one day, need to be paid,
and that liability is going to become the liability of the following
generation. It is no different from borrowing to build a hospital, or a
new road. In both cases, the benefits accrue to one group now, at the
cost of future tax payers. In the case of pensions, the provision of
savings to support the pension schemes would come at a cost of less
activity in the economy now. Less 'growth'. In the case of the hospital
built with borrowed money, the same thing. In all cases, someone is
going to have to pay for these benefits, just not the people who are
enjoying the benefits.

This is the Keynesian policy writ large. The avoidance of only
consuming what you can produce. Beneath all of the sophisticated
arguments, it all comes to this central point. If you borrow, you must
repay. I do not believe in government borrowing at all, but borrowing
more than your underlying growth of wealth creating capacity means that
someone in the future must pay for your consumption now. This is
morally bankrupt and irresponsible.

And then I come to the question of why governments borrow in the first
place. If there is unemployment, why borrow the money to alleviate the
problem. Why not just tax more and use the taxes to pay for the
unemployed? The reason is that the high tax would be unpopular. Why
borrow to build a new hospital. Because paying for the hospital
directly would be reflected in higher taxes for the users of the
hospital. How much better to spend borrowed money and call
it 'investment' or other euphimisms for passing on cost to those in the
future. And for people like LK, they offer sophisticated arguments,
endless cherry-picked evidence to hide the fact that if you consume
more than you produce, unless your output increases above the rate of
your borrowing, someone is going to pay in the future.

Someone in the future is going to have less, so that you can have more
now.

There are many other arguments made by LK, and many other Keynesians.
Within all of their arguments, we always come back to the same themes.
Government borrowing is the solution to all ills, and if governments
can not borrow now, they can always print money. It is the endless
pushing of today's problems into the future. It is exactly like the
pensions problem. Do not confront difficulties now, just leave them to
the future. But this is the great attraction of Keynesian economics. It
is why defenders of Keynesian policy gain so much support.

However, as one commentator put it in the Telegraph, the days of spend
now pay later are over. Later is now. Many governments are now facing
the point where the markets are asking how governments plan to pay back
the money they have borrowed. In the world of LK, he proposes that the
answer is to ignore the markets, and print money instead, ignoring that
one day, like it or not, the markets must buy the debt. No doubt,
printing money might delay the problem a little longer, avoid the
absolute need for economic restructuring, but only at ever greater cost
later. This is the problem with the soltuions offered - they delay
confronting the problems to create a greater later cost.

I fully expect reams of counter argument from LK. He will, insist that
his case is right, will contest the Swedish point, and so forth.
However, for the readers of this blog, just think about the perpetual
motion machine of government borrowing creating economic growth.
Borrowing to consume now creates wealth in the future.
Wise 'investments' appear from thin air. Think of the way in which
China offers 'proof', entirely free of context. Think about the pension
deficit, of how easy it is to pass the buck. Think of the arguments
about how governments do not need the private markets for borrowing as
they can just print money. Think how easy it is to pour money into an
economy, but how difficult it is to pay back.

It is a lazy economics dressed up with sophistication and misdirection.
It is easy to have a party on borrowed money, but less easy to deal
with payment in the future. It is very easy to spend the money of
future generations and have good times now. Any idiot can do this. The
true genius of Keynesian economics is that they can dress this up so
well with theory. In the end, my argument rests on one key point. If
you consume more than you can produce through borrowing on an ongoing
basis, you have a problem, and you can only delay facing that problem
for so long.

Note: LK has written extensively on mnay subjects and, even with such a
long post, I have not covered them all. In fact, to give a full
response to LK would take a lifetime, so I leave this reply partly
unfinished. I also note that LK has added some substance in his recent
comments on industrial policy. Unfortunately, added after this post was
written, and I really do not want to revise the section. This was time
consuming enough.
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