Over 70 years after The General Theory on Employment, Interest and Money was published, Keynesianism now holds sways over macroeconomic thinking. Neo-liberalism almost made Keynesianism as obsolete as communism but the tradition of The General Theory proved to be resilient. Resilient as it may be, there are dangers in following the track of Keynesianism and it is certainly not the only option available out there when it comes to facing economic downturns.
Keynesianism, despite its wide explanation of the economy, is best known as the idea which advocates the state taking an active role in managing the economy. In times of uncertainty, the idea that the government needs to spend to pick up the slack in the economy has again regained currency. The Abdullah administration recently introduced an economic stimulus plan worth RM7 billion, announced by the new Finance Minister Najib Razak, to do just that. The DAP proposed an even bolder move involving spending about 6 folds larger than the planned stimulus.
This happens at a time when the country is expected to experience its 12th consecutive fiscal deficit in year 2009.
During the first tabling of the 2009 Budget, the government projected a deficit of 3.6 per cent of the country’s gross domestic product. With lower energy prices as well as increased expenditure, the deficit can go only higher.
When Keynesians espouse deficit spending, they really mean a counter-cyclical fiscal policy in which the government increases its activities in the economy in times of crisis and cuts down the frictions it causes in the economy in good times. However, too many advocates of the policy, especially politicians, conveniently forget or even do not know what the Keynesian countercyclical fiscal policy is all about.
Not that I am advocating the true form of the Keynesian policy but clearly, many politicians subscribe to the narrative of countercyclical fiscal policy only in times of hardship. In better times, none of the action proposed by Keynesian economics is implemented. The continuous fiscal deficit is a proof to that. In all likelihood, the continuous deficit would merely impose a higher cost of borrowing on the country, forcing future generations to bear the burden of past mistakes.
It is true that fiscal deficit and debt in general is not necessarily bad. If borrowing today offers an opportunity for profits tomorrow, that borrowing might be a good idea. The problem with this country is that the government, instead of truly investing in public goods with more convincing multiplier effects like education, is more interested in investing in white elephants, or in the stock market, as evident in the RM5 billion injection into ValueCap through borrowing. It is things like this that make it imperative for us to be suspicious of politicians who seemingly adhere to the Keynesian school of thought.
It has to be noted that when Keynes wrote The General Theory, he was trying to save capitalism. On the contrary, politicians who inconsistently advocate for Keynesianism are not trying to save capitalism. In times of economic crisis, the political environment could be very dynamic and it is Keynesianism, out of several others, which has the potential of calming the electric atmosphere.
While I lament each time Keynesian economics takes centre stage, its effectiveness in smoothing the downside of capitalism is undeniable. There are side effects however.
The government is expected to finance the deficit and the fiscal stimulus through borrowings. The Finance Minister has indicated that the government will mostly obtain the funds from local sources. This effectively means that private enterprises will have to compete against the government in sourcing for precious capital. With the financial crisis well under way internationally, it is likely that the opportunity for local private entities, especially smaller ones, to borrow from abroad is small, leaving local sources as the only options.
This competition for capital only increases the lending rate as demand increases vis-Ã -vis supply of loanable funds. This has the potential of crowding out private investment. As a result, the private sector may miss out opportunities in times of a downturn and be unable to be as dynamic as it should during recovery times and during yet another era of exuberance.
Deficit spending may also defeat the purpose of the economic stimulus. With higher interest rates, it makes more sense for individuals to save rather than invest in various value-creation initiatives, with all else being equal.
This, in a way, makes countercyclical fiscal policy unhelpful. At least one paper — by Gordon and Leeper — highlights that. The paper states that “countercyclical policies may create a business cycle when there would be no cycle in the absence of countercyclical policies”.
Furthermore, if Keynesians are interested in fighting business cycles so selflessly, why do they not simply eliminate business cycles altogether?
Instead of trying to smooth out cycles after it happened, the Austrian school of economics seeks to inherently smooth business cycles by instilling discipline in monetary policy. While there is not much data to compare the effectiveness of the two schools, the Austrian theory, if business cycles are of concern, sounds far more superior to the Keynesian countercyclical action.
Finally, despite the level of comfort far too many people have when they confidently say that government spending is the only option available in facing an economic downturn, that statement is absolutely false.
One of them involves private rather than public spending. Malaysians — and East Asians in general — have a tremendous amount of private savings. A report states that the level of savings by Malaysians is well above 30 per cent of income. Policymakers could design a policy which takes advantage of that fact. Indeed, the reduction of worker’s contribution to EPF from 11 per cent to 8 per cent is one policy which takes this path.
Others include permanent tax cuts to encourage businesses and enhance disposable income or even simply let the market eliminate unprofitable ventures made unwisely to give other promising ventures a shot.
A version of this article was first published in The Malaysian Insider.
