Despite its decline in academia, Keynesian economics is still alive and well in the American mainstream and business press. Recent developments in Estonia, however, should undermine that standing but probably won’t.
The reason empirical evidence hasn’t driven a stake through the heart of the Keynesian vampire is because Keynes created this house-of-cards theory to justify big government in practice (not the other way around). And because vested interests have incentives to continue big government, Keynesianism continues to haunt economics.
On the world stage, the debate over Keynesianism played out between the big powers during the world financial crisis and recession. The conservative British and German governments have been significantly reducing their government budgets. In the German case, the memory of hyperinflation during the interwar period drives the current fiscal prudence. In contrast, President Barack Obama has been priming the Keynesian pump by advocating and enacting a pork-larded package of government “stimulus” spending. Obama’s predecessor, George W. Bush, also spent federal cash like a drunken sailor in an attempt to revive the economy.
The nation’s media (and many Republicans) have supported Bush’s and/or Obama’s fiscal profligacy in the name of fighting a deep recession. For example, on March 7, 2011, the New York Times‘s editors commented on modest House Republican efforts to cut $61 billion out of the budget for the remaining seven months of the federal government’s fiscal year 2011: “If the Democrats try to compromise on even half that amount, they will still be doing enormous damage to many programs and threatening a recovery that is starting to show signs of real life.”
Yet the same day, buried in its back pages, the Times ran an article that undermined its own editorial position. The article spoke about Estonian voters rewarding in recent parliamentary elections a government that instituted a draconian government fiscal austerity program, which has spurred the economy out of the doldrums. Such thinking is contrary to Keynes’s advocacy of using greater government spending to stimulate private sectors of the economy. In fact, hiking government spending requires stealing resources from the more efficient private sectors through higher taxes or greater government borrowing (which crowds out private borrowing needed for business expansion) and using the proceeds to try to indirectly stimulate those now overtaxed and loan-starved sectors to expand activities. Instead, restoring the private sector’s confidence by reducing spending, taxes, and “crowding out” in the credit markets (thus lowering interest rates for business loans) will grow the economy without relying on wasteful government pork—and what has happened in the tiny country of Estonia demonstrates it.
According to the New York Times article, Estonia continued to embrace a laissez-faire policy in the months after the global economic meltdown. Even after the Estonian economy shrunk a whopping 15 percent because of the recession, the government drastically reduced its spending by the equivalent of 9 percent of GDP. Initially, demand fell steeply, and unemployment climbed to almost 20 percent in early 2010.
Yet now the Estonian economy is growing at a projected rate of 4 percent this year, and unemployment has been cut in half to around 10 percent. In January of this year, the Estonian economy was deemed healthy enough to be allowed to join the euro zone. In sum, short-term pain has produced a strong recovery.
Yet with Bush and Obama’s Keynesianism, the United States has struggled in recovery. The only bright spot is that the 2010 mid-term elections and House Republican attempts to reduce the budget have spurred the Obama administration to at least begin proposing modest budget cuts (instead of increases). In response to the House, the Obama White House and the Democratic Senate have proposed trimming $6.5 billion from current spending, including $2 billion in Pentagon cuts not in the House’s proposal.
Of course, even the $61 billion House proposal is a mere pittance compared to the yawning record federal budget deficits of more than $1 trillion per year. But I guess you have to start somewhere—however belatedly—and the meager Democratic proposal at least puts a much-needed reduction in defense spending on the table. Both Democratic and Republican politicians, however, need to go further in making tough fiscal choices—and the Estonian experiment shows that doing the right thing can reap economic rewards for the country and political rewards for the lawmakers.