Why I’m not a Keynesian

After world war II, the decline in government spending was enormous. Government spending as a percent of GDP went from over 45% to around 15%, which threw the US into a terrible recession, where GDP fell by over 12% in 8 short months. To put this in perspective, the “Great Recession” which lasted from 2007 to 2009, and which was the second worse recessions in the drop of GDP since WWII, only saw GDP decline by 4.3%.

This recession saw unemployment skyrocket to 5.2%. The average person was hurt by this, in 1946, while the GDP in 1946 fell by 11.6%, personal consumption grew by a paltry 12.4%, to put that in perspective it was the 85th worse year since 1930 (source: http://www.bea.gov//national/nipaweb/DownSS2.asp).

So what actually happened? We see that the decline in government defense spending after World War II caused the measured GDP to fall a lot, but what this meant is that the government stopped building tanks, aircraft carriers, rifles and ammunition. This meant that the US “produced” a lot less in 1946 than it did in 1945 or 1944, but that production was for military purposes only. While this created a recession, it was a recession on paper only. If you haven’t noticed, that 85th worse year for personal consumption growth? Out of a period of 85 years, (ie, the best).

The decline in one sector of GDP (government spending) was great enough to cause GDP to significantly retract (worse year for GDP since the great depression), but it did not make other sectors of GDP fall. In fact, not only did personal consumption have its best year eve (or since 1930 when the BEA statistics start), so did Gross Private Domestic Investment (same source as above). Unemployment did increase, but not to a very high level (we’ve seen a steady fall in unemployment for 6 years, but we’re still above the 5.2% immediate post war peak). Basically, the idea that the end of the war would throw the US back into depression was wrong, the only fall in GDP was only a reduction in anti-Nazi spending. Its a bit like saying that the best measure of a person’s economic well being is his consumption spending. And that in year 2, when he was healthy, he spent significantly less than in year 1, when he was fighting cancer. It was good that he was able to spend money fighting cancer in year 1 no doubt, but it was better that he didn’t have cancer in year 2.

If we’re to tell the story more, the drop in government defense spending allowed resources to be dedicated to other areas, such as business investment, new home construction, and creation of consumer goods. But this this the opposite of what is supposed to happen according to Keynesian economics. The fall in government spending is supposed to depress incomes in general, as all the soldiers return home and the tank builders are laid off, the total demand for goods and services wil fall, causing GDP to fall, not just in terms of fewer tanks and rifles, but everything else as well. This didn’t happen.

Now, this may not be the best case. You can argue that the proper Keynesian government level was still much lower in the war than actual government spending, or that the special circumstances dominate in immediate aftermath of the war.

More recently, we saw two major changes in government spending in the past 8 years. The first was the stimulus bill of 2009, which was supposed to jolt us to recovery and keep unemployment below 8%. The second was the sequestration, which, due to the Republican preference for lower government spending and political fighting about the debt limit, caused government spending to be reduced (and taxes to raise, both of which are considered anti-stimulative effects by Keynesians). Let’s look at how this effected the economy:

GDP Growth 2009 to present

Unemployment 2009 to present

It looks to me like government spending had little to no effect on GDP growth, and unemployment looks totally unaffected. It went up during the recession and a little bit afterwards, and has fallen consistently since, regardless of what the government tries to do.

This is my biggest complaint against Keynesian economics, or I guess fiscal stimulus to be specific. We had an $831 billion government program, and nothing to show for it. The Keynesian economist can make the case that things would have been worse without the stimulus or better without the sequester, that’s certainly a possibility and I don’t want to dismiss it. But I do think that the burden of proof should be on the people proposing trillion dollar expenditures. And I don’t think that the burden of proof was at all met. This is the strongest case I have against fiscal stimuli, they have enormous costs and very unclear benefits.

None of this is a counter to the idea that we shouldn’t have government spending.  There are many great things that government has provided, including roads, schools, police.  To return to the World War II example, we basically prevented a madman from conquering the world, which is a worthy a goal as there can be.  But what I am arguing against is the idea that government spending by itself typically stimulates the economy; the idea that we’re better off having the government hire people to do useless things.

There may be instances when this is true, that simply borrowing and spending money by the government can counteract a bad economic environment.  But as of right now, I’m convinced that it’s probably not true generally (ie, that any bad economic environment can be improved by the government spending more money), and that we can’t distinguish the instances where government spending helps from when it hurts or has minimal effect.

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