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From Keynesianism to Socialism

Posted By William R. Hawkins On August 3, 2010 @ 12:06 am In FrontPage | 10 Comments

The Office of Management of Budget published its Mid-Session Review July 23, forecasting Federal outlays and tax revenue to 2020. The numbers presented showed that the Obama administration has transformed government finance far beyond the immediate need of stimulating the economy to pull the country out of a major recession. Obama has locked the country into dangerously high structural deficits that will persist even after the economy resumes normal growth.

The deficit in 2012 is estimated at $911 billion and the deficit in 2020 at $900 billion. These massive deficits are not the result of lingering effects from the recession. The OMB’s economic assumptions are:

“The growth rate is projected to rise to 4.3 percent in 2012 and 4.2 percent in 2013 as the economy returns closer to its potential output level. Beyond 2013, real GDP growth is projected to moderate, declining gradually to 2.5 percent per year in 2018-2020.”

This growth rate is within normal parameters for a mature economy like that of the United States.

The OMB sees a 5.2 percent unemployment rate in 2020. But the return to normalcy will not bring about the “fiscal responsibility” President Barack Obama talks about and which financial markets need. The deficit in 2020 will still be 3.8 percent of GDP, a level normally associated with recessions, not prosperity.

The OMB’s review takes a potshot at the George W. Bush budgets, noting: “The previous Administration’s decisions not to pay for three large domestic initiatives (the tax cuts of 2001 and 2003 and the Medicare prescription drug benefit of 2003).” Yet, the highest debt-to-GDP ratio of the Bush years prior to the economic downturn that exploded the 2009 budget was 3.5 percent in 2004. So the OMB considers it to be a triumph of fiscal responsibility to reduce the normal deficit to somewhat higher than the worst year of the previous administration.

The OMB also states,

“Because of the unsustainable nature of the Government’s medium-  and long-term fiscal outlook….The result of the [National Commission on Fiscal Responsibility and Reform] recommendations will be annual deficits that are approximately equal to 3 percent of GDP. Deficits of this size will stabilize the ratio of debt to GDP. Most economists consider this to be necessary for fiscal sustainability as debt and interest payments rise only as much as economic growth, rather than rising as a share of output and the budget over time.”

Yet, a deficit-to-GDP ratio of 3 percent is not reached by 2020 under current assumptions. And even if it does become the standard, it will still be higher than “normal” years in the past.

Tax revenues in 2020 are forecast to be $1.9 trillion higher than in 2012. Government spending will also be $1.9 trillion higher, so there is no effort to use rising revenues to cut the deficit. Every new dollar taken in will be spent. GDP in 2020 is supposed to be $7.7 trillion higher than in 2012, which means the government will be taking and spending 24.7 percent of the nation’s growth over those years, a much higher share than in the past. In 2020, Federal outlays will be 23.5 percent of GDP, compared to the average of 20.2 percent of GDP during the 20 years prior to the 2009 downturn.

The economic theories of British economist John Maynard Keynes have taken a beating from conservatives during the debate over fiscal policy. Keynesianism has long been synonymous with deficit spending. But Lord Keynes cannot take the rap for (or be used to justify) Obama’s policies. Keynes’s ideas about macroeconomics came to prominence during the Great Depression. His purpose was not to replace capitalism but to save it. As Herbert Stein summed the matter up in his classic The Fiscal Revolution in America “It was accepted policy that we should run deficits in depressions, that we would not raise taxes in depressions in an attempt to balance the budget, and that in severe depressions we would raise expenditures, at least for relief and probably for recovery.” Stein’s book came out in 1969 when he was a member of President Richard Nixon’s Council of Economic Advisors. Soon his boss would acknowledge “We are all Keynesians now.”

When President George H. W. Bush was perceived to have acted too slowly to counteract the 1992 recession, he lost re-election. His son learned the lesson and jumped aggressively to offset the 2000 downturn with tax cuts (invoking Ronald Reagan) and to adopt even more simulative measures in 2008 as the financial crisis erupted. But the measures adopted by President Obama using the same rhetoric and supposed logic have mot been effective because they have been used to perpetuate government programs, not stimulate the private sector. The result will be unprecedented structural deficits as far as the OMB can see.

True followers of Keynes should not be pleased by this. Alvin Hansen, known as “the American Keynes” argued against long term deficit financing. The budget should be brought into balance over the business cycle, with the increased revenue flowing in during booms used to pay down deficits run up during busts. And even though Milton Friedman is credited in conservative circles for advancing the “crowding out” hypothesis, it was actually Hansen who first raised the issue. He noted that borrowing to fund deficit-financed public works could raise interest rates, retarding private investment during growth periods. If private sector demand is high, then the government can and should step back to let capitalism thrive.

It should be noted that when the IMF warned about sovereign debt in Europe, it was not talking about counter-cyclical measures to fight recessions. It was warning about structural deficits stemming from ongoing government programs like health care and early pensions. Running deficits that strain financial markets during normal times leaves nothing in reserve for emergencies. And there is quite likely to be another recession by 2020 or soon thereafter. If there is already a $900 billion deficit when the next cyclical downturn hits, what will fiscal policy be able to do without triggering a sovereign debt crisis?

It was the political popularity of deficit spending that outstripped the responsible use of fiscal policy. Indeed, theories become popular mainly because interest groups find them useful as cover for advancing their own agendas. There quickly grew up a mutation of Keynesianism even while Lord Keynes was still alive, a mutation he denounced but could not quash.

When I was just starting my teaching career, I was stuck with Economics by Campbell R. McConnell, then the most widely used college textbook in the field. Its author was a follower of Abba Lerner, the founder of “functional finance” which is opposed to the “sound finance” of Hansen. The Lerner-McConnell view was that deficits never matter, and that the government should probably run them all the time because the private economy is inherently so unstable that it can not be trusted to provide full employment. Programs should not be funded based on the availability of tax revenue; they should be adopted on their own merits. And, of course, once the link between “buying” government services and paying for them is severed, there is no limit on what the politicians can do for their special interest supporters. Everything from Washington can be offered for free!

Here is the real root of the radical notion that government fiscal policy is not meant to merely save capitalism during a crisis but to replace capitalism as the engine of growth and social transformation. In accordance with the opportunity of “never letting a crisis go to waste,” Obama has moved decisively beyond Keynes towards what really can be called socialism.


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