2010 Election: Keynesianism vs. Deflation?

Many commentators have suggested that the recent recession is in the same league of the Depression of the 1930s which began to enter its direst phase in October 1929 with the collapse of the US stock market and came into full effect in 1931 with the folding of the Kreditanstalt bank in Austria and the subsequent weakening of the global banking sector.  The Depression affected different countries in different ways but generally led to mass unemployment, in some countries only peaking in 1936 and really only came to an end with rapid rearmament in many states in the period 1938-9.  The Second World War disrupted the global economy but also provided stimuli.  However, in 1945-7 it looked like many states would continue to suffer low production and consumption and so continue to face high unemployment.  The Marshall Plan in 1948 providing millions of dollars to states of western Europe helped to pick up demand which stimulated the US economy and in turn other economies across the world, not simply in Europe but late Japan and South Korea too.  Other factors such as the decline of colonial empires so freeing up markets to a wider range of states, organisations such as OECD and the EEC fostered trade, consumption and production.  This was aided by low oil prices sustained in part by neo-colonial relationships between the industrialised powers and the oil-producing states.

In the 1930s there was a clear lack of ideas about how to deal with the Depression.  For the dictatorships the drive for rearmament and related infrastructure, notably road building, did stimulate certain sectors of the economy but at the expense of light industry and consumption of domestic items.  Unemployment was ended by effectively drafting workers into state projects and in many cases throwing certain people out of jobs, for example, Jews, Socialists and Communists in Nazi Germany.  The Soviet Union underwent a massive programme of industrialisation combined with collectivisation of agriculture.  The country was starting from a lower industrial base and the consequences of the programme was the starvation of millions, though, by 1939 the USSR had become more industrialised than a decade before.  In the democracies the only real approach to combating the Depression was deflation and protectionism.  This involved particularly cutting back government expenditure, making more government employees unemployed and restricting welfare payments.  Currencies were freed from the gold standard and allowed to float but economies put up tariff barriers to protect their internal industries and those states with colonial empires developed trade with their colonies but firmly shut out other providers.  With the dictatorships also pursuing a policy of autarky, i.e. to make themselves self-sufficient for raw materials and markets whether through direct control or bilateral, often barter deals, trade was choked off.  This tendency was the one which Marshall Aid and initiatives such as the Bretton Woods process on currencies aimed to address after the Second World War.

There were some voices in the democratic states arguing for a different approach to the Depression.  Democratic forms of economic planning were advocated by centre, centre-left and centre-right groups, in the UK by the Liberal Party and people such as Harold Macmillan, later Conservative British prime minister.  Most notable was the work of economist John Maynard Keynes (1883-1946).  Keynes's principles developed following the First World War.  He opposed the harsh reparations imposed on Germany seeing a weak German economy as being damaging to the whole European economy and thus much of the global economy.  He opposed the rigidity of returning to the gold standard for setting currency exchange rates as happened in many capitalist countries in the 1920s.  With 'Treatise on Money' (1930), 'The Means to Prosperity' (1933) and 'The General Theory of Employment, Interest and Money' (1936) he outlined his policies for counter-cyclical economic approaches.  Basically he felt that depression could only be combated by stimulating consumption rather than reducing it through deflation.  He believed in the 'multiplier effect' that if the state pumped money into the economy to create work, often through major infrastructure project, then unemployment would not rise and with more people in work they would continue to consume products which, in turn would keep consumer good production going so keeping even more people in work.  In contrast to the balanced budgets, i.e. government receipts and expenditure were generally equal, Keynes was happy for the state to borrow in the short-term to fund the projects to keep employment levels higher, believing in the long-term that the maintenance of the tax revenues which would rise as the economy revived, would pay off the money borrowed.

Though there is some dispute about how directly Keynes's ideas influenced US policy, the New Deal, started 1933-4, introduced by President Franklin D. Roosevelt (1882-1945), president 1932-45, seems to be based on the kind of assumptions that Keynes's ideas used.  Roosevelt established a swathe of government agencies many of which produced public works projects to provide employment.  Examples include the Civilian Conservation Corps for agricultural workers, the Works Progress Administration, which included units for employing actors and writers and the vast Tennessee Valley Authority for public works building hydro-electric energy generation dams and facilities.

In Britain Keynes's approach was seen to be adopted in the 1941 budget, though of course, with the war in full force at the time, stimulus through arms spending and borrowing to fund the war, were likely steps anyway.  After the war the Labour Government initially pursued economic planning which was seen as a more Socialist approach to the economy compared to Keynes's Liberal (in the British sense of the word not the US meaning of it) economics.  However, by 1948 and certainly by 1950 they were moving more to Keynesian assumptions.  France pursued economic planning up to the 1980s but had things such as tax breaks to stimulate certain sectors of the economy and unlike British nationalised industries, large state-owned companies such as Electricite de France (now EDF Energy) strove to stimulate other sectors. Other states in Europe such as West Germany worked on Keynesian assumptions, keeping a predominantly capitalist economy but stimulating it with government regulations and funds, especially for regional development.  Partly Keynesianism, though forming the basis of economic assumptions after the Second World War was not really needed as there was an economic boom until the mid-1970s when the US economy became recessed in the early 1970s and then the sharp oil price rise in 1973-4 brought the boom to an end. Though there were some minor differences from 1950-1974 no-one in British politics really challenged Keynesian assumptions; they did not even challenge the mixed economy with a sizeable state-owned sector, which had been a Socialist rather than Keynesian policy.  Keynesianism was not used in a sophisticated way.  By the mid-1950s credit controls had generally been given up and the UK tax authorities eschewed tax breaks in the way they were used in many continental countries.  The basic tool was simply manipulating the base rate, the basis of the interest rates that banks charge.

In 1976 the pound was put under so much pressure that the British government went to the IMF (International Monetary Fund) for money to strengthen the currency (in those days the exchange rate with the dollar was reported on a daily basis and any move was seen as a source of concern, probably equivalent to falling house prices in the UK nowadays.  It is interesting how the British makes a fetish of particular economic indicators rather than looking at the broader economic picture; before the currency, the balance of payments had been the key focus).  The IMF demanded a deflationary approach to the economy, which had about 20% of industry under state control at the time.  From 1976 onwards there was consequently a move from Keynesian stimulus approaches in times of recession back to deflationary processes.  In the US there was the rise of monetarist economic approaches, which after 1974 gained ground in the British Conservative Party, though even after 1972 under Conservative prime minister Edward Heath there had been some minor steps in this direction until he fell in 1974.  Monetarism sought a strong control of the availability of money as a way to combat inflation, which was a key problem once oil prices had jumped, something they would do again following the Iranian Revolution of 1979.  Monetarism was wedded to 'free market' economics perceiving the end of state involvement in the economy through privatising state-run industry and reducing regulations on companies so allowing them to impose the pay rates and conditions that they wished.

Margaret Thatcher embraced monetarism and her regime 1979-90 saw it pursued increasingly vigorously with privatisation of the state sector, removal of regulations and reduction of the state, including dismissing a third of the civil service.  Private business was lauded and allowed to make as big profits as it liked and to move capital from the UK whenever it wanted.  The impact for the average person, however, was mass unemployment and an abrupt ending of established British industries.  In the move to a post-industrial economy after 1973 in the USA and 1974 in the UK, this was going to have happened anyway but monetarism made it more brutal and sudden.  Workers were encouraged to make themselves employable by taking lower pay and working longer hours, so reducing their ability to consume.  This seems to run counter to Keynesian approaches.  By the end of the Thatcher period, as I have noted on previous postings, the assumptions had shifted towards continued acceptance of monetarism.  In 1995 the Labour Party abandoned its objective of nationalising any industry.  When it came to power in 1997 it granted independence to the Bank of England to set the base rate so giving up the remaining Keynesian tool.  The Labour governments, bar in minor cases, before 2008, did not take back into state control industries that have been privatised.  This is apparently now called the Washington Consensus.

The financial crisis from 2007 onwards has led to what some have termed a Keynesian 'resurgence'.  It is fascinating how the faith in monetarist approaches dropped away so quickly.   In Germany and India both of which had retained a strong state role in the economy, but also the USA and the UK which had been at the forefront of monetarism, leading economists, bankers and politicians began talking about stimulus.  The President of the World Bank advocated developed countries pledging 0.7% of their GDPs to stimulus.  In January 2009 President Obama passed a US$787 billion (£512. billion: €589 billion) stimulus bill.  In November 2008, the British government launched a £20 billion (US$30.6 billion; €23 billion) package equivalent to 1% of the UK's GDP.  Much of this has gone into supporting banks rather than stimulating the economy through public works and there has been a challenge in that the supposed 'easing' of lending has not risen to the extent that the governments hoped.  This reflects that during the Thatcherite/Washington period financial institutions were given so much freedom that it is now impossible really to get them to do anything governments want, for example, even reducing bonuses.  Inadvertently the British have effectively nationalised two banks, but as was typical with British nationalisation of the past, they have not asserted much control over their behaviour and kept an 'arms length' approach.  In addition, in the face of claims of 'unfair competition' from other banks the government has not used its banks to drive certain behaviour by example or provide freer lending to stimulate business.  The state is not as strong as it was in Keynes's day and mulit-national companies and banks are often more powerful than governments as we have seen in resistance to various 'windfall' taxes and attempts to restrain bankers' behaviour.  However, stimulating (parts of) the economy through borrowing, now at £152 billion (US$232.6 billion; €175.1 billion).

Thus, it seems for the first time ever that Keynesianism is being implemented to combat what it was designed for, i.e. a depression.  In British politics because in the 1950s up to the mid-1970s there was consensus of the need for Keynesian economics and it was just over the details rather than the economic approach.  By 1979 even the Labour Party had stepped away from Keynesianism and whilst it did not embrace monetarism in the way the Conservatives did, it was no longer a strong advocate of an alternative economic path, partly because the economics then were focused on wage and price inflation which had not been a characteristic of the 1930s depression when there had often been over-supply depressing prices rather than excess demand or at least excess demand for income whether from sales or pay as was the case in the 1970s and overall was stimulated by the artificially raised oil price, oil being vital for freight of all kinds at that time and things like plastics at a time when plastic packaging was growing massively.

In 2010 we do have a difference between the continuation of Keynesian policies under Gordon Brown and with David Cameron, the revival of not even really monetarist but in fact deflationary policies as pursued by Conservative leaders such as Stanley Baldwin in the 1930s and overseen by the cross-party National Government set up in 1931.  Cameron's emphasis on the need to reduce public borrowing so reducing the available stimulus to the economy (though no-one would envisage a balanced budget these days) and swingeing cuts to public services is text-book deflation; it will cause unemployment not least amng public sector employees and raise unemployment, increasing social welfare payments and suppressing domestic consumption and through fear of job losses, domestic demand even from those still in work.  Keynesianism is not simply about stimulating consumption but with it the confidence to consume. Cameron is pretty old fashioned in his approach to the economy even in Conservative terms.  Perhaps this is because the Thatcherite approach of the free market now seems so debased with constant reports of vast profits for those in big business at the expense of jobs and homes for ordinary people.  This is the first time in British history that the two key economic approaches of the 20th century are being brought face-to-face and as a consequence Britain stands at more of a crossroads that this lacklustre campaign suggests.