Democrats Are About to Spend, Spend, Spend - But It Won't Help Much

A certain amount of Keynesian pump-priming, of the right sort, won't do any harm - but it probably won't do much good either.

A certain amount of Keynesian pump-priming, of the right sort, won't do any harm—but it probably won-t do much good either.

Welcome back, John.

"We are all Keynesians now," said President Nixon in the early 1970s, as he came to terms with deficit financing and a prices and incomes policy inspired by the economic doctrines of the great Cambridge economist John Maynard Keynes.

In fact, he couldn't have been more wrong: Keynesianism was past its intellectual high watermark and was ceasing to be a guide for economic policy makers all over the world. Its death knell was sounded by the double whammy of the election of Margaret Thatcher in Britain (1979) and Ronald Reagan in America (1980).

The American economy is almost certainly further down the recession road than Britain (or continental Europe).

That was then, this is now – and British newspapers, in full "capitalism-in-crisis" mode, are carrying little potted biographies of Keynes and his economic doctrine. The British government is now talking openly about resorting to some old-fashioned Keynesian pump-priming by talking about bringing forward some major multi-billion dollar capital spending projects, from Crossrail (a massive new underground railway spanning London from east to west) to modernizing Trident, Britain’s nuclear deterrent to speeding up the construction of two new Queen Elizabeth class aircraft carriers.

"We are all Kenyesians now," to coin a phrase. Expect similar demands from a Democratic-controlled Congress post-November 4th as the depth of America’s looming recession panics the politicians on Capitol Hill. A little history will be made here in Britain on Friday when officials announce a downturn in economic growth between July and September, for the first time in 16 years. Hence the revival of Keynes (dismayed free marketers should console themselves: it could be worse – in Germany, Karl Marx’s unreadable Das Capital is soaring up the best-seller list!).

The American economy is almost certainly further down the recession road than Britain (or continental Europe). So many Democrats will soon be dusting off their own copies of Keynes and calling for more federal spending programs.

However, expectations of just what Keynesian economic policy can achieve should be limited.

Its original exponent (other than Adolf Hitler) was Franklin D Roosevelt who, though elected in 1932 on a promise to balance the budget, quickly saw the nonsense of that and started to try to lift America out of the Great Depression with a public works program financed by federal borrowing.

Though this did wonders for America's morale (and helped get FDR re-elected three times!) its effect on the economy and unemployment was marginal. U.S. dole queues only started to plummet when Roosevelt went on to a war economy footing as Hitler's War raged in Europe and he knew America could not forever avoid engagement in it.

The most recent exponents of a Keynesian boost to the economy are the Japanese: they embarked on pump-priming on a massive scale undreamt of by FDR or Keynes in the aftermath of their banking crisis in the 1990s, which pushed the economy into a severe deflation. But no matter how much the Japanese government borrowed and spent – current net debt is still an incredible 195% of Japan's annual national wealth (American borrowing is around 60%) – the economy stayed mired between deflation and sluggish growth for years (it still is).

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The lessons of history are clear: a certain amount of Keynesian pump-priming, of the right sort, won’t do any harm – but it probably won’t do much good either.

In the end, recovery will only come when banks start to lend to businesses – especially small business – and the fall in house prices bottoms out, so that consumers feel inclined to spend again. None of that is going to happen very quickly, which is why this recession is likely to be shaped, not like a V but like a bath tub.