The Keynesian myth By John Manfreda | Reflections Magazine November 2010

The Keynesian myth

By John Manfreda

The Obama administration has been attempting to revive the economy through government stimulus spending. Washington plans to spend this stimulus money on roads, bridges and jobless benefits as a way to “put Americans back to work.” But historical examples provide ample evidence that public work programs are much less effective to revive an economy than private sector growth.

The last time a major economic powerhouse used this stimulus economic model was Japan in the earlier 1990s. In 1992, Japan faced declining property values, as well as a falling stock market. In April of 1993, Japan passed a stimulus-like bill that cost 13.2 trillion yen, which consisted mainly of public works. The result was the economy went sideways, and no signs of economic growth. In the same year, Japan passed another stimulus bill of 6.2 trillion yen. This consisted of infrastructure projects, low interest home financing and business contracts. In February 1994, Japan spent another 15.3 billion yen to stimulate their economy. At the end of the year Japan’s debt to GDP ratio was around 80 percent.

Once again in 1998, Japan spent around 40 trillion yen to stimulate their economy, and as a result, add comma its debt to GDP ratio was 114.3 percent. Over the course of the decade, Japan’s economy grew at an anemic rate, while its debt increased drastically. When banks were forced to deal with their bad assets and there was increased privatization, the Japanese economy gradually recovered. This example shows that Washington is practicing a failed policy. When an administration does not learn from past mistakes, it is doomed to repeat them.

The greatest myth that persists today is that President Franklin Delano Roosevelt’s New Deal implemented from 1933 to 1938 led America out of the great depression. Yet contrary to popular belief, the New Deal actually prolonged the depression. In fact, Americans were working less during the New Deal, than they were before Mr. Roosevelt took office. During the New Deal, the average worker was working 23 percent less hours, than he was before the president took office. Per capita consumption level was 25 percent less than pre-New Deal policy. In fact, the New Deal destroyed a viable recovery because it suppressed competition which is the life blood of capitalism, and it set prices and wages that were above normal market value in many sectors of the economy. It also restricted output and productivity by placing quotas on industrial plants and equipment.

For generations, many economists have claimed that the New Deal is proof that capitalism cannot through its own mechanisms recover from a recession, and that therefore government intervention is needed. Yet the opposite is true: intervention prolongs economic hardhsip. With the New Deal’s protectionist policies, big labor increased its bargaining power, which drove up wages around 25 percent more than they should have been. These above-market value wage expenses were passed on to consumers, and products became too expensive for consumers to purchase which in turn led to an economic contraction. Thus, in 1939, the unemployment rate was about 17.2 percent.

During the Great Depression, from 1933-39, the monetary money supply increased over 100 percent. What the Fed should have done was liquidate the bad investments so that a real recovery could begin. Today, we are repeating the exact same mistakes of Mr. Roosevelt. The president tripled the tax rate imposed on businesses, as well as the amount of regulations that were imposed on American businesses.

Some economists and historians maintain that it was not the New Deal that led America out of the Great Depression, but World War II. To a degree this is true because families were forced to save their money because of the war. During the war, American citizens began to save 25 cents for every dollar they earned. As a result, the personal savings rate was around 25 percent of their gross income. This savings rate set up an explosive boom period that followed World War II, which resulted in the United States becoming the economic superpower of the world. Thus it was capitalism, not interventionism, that ultimately ended the depression.

The good news is that currently the American consumers are paying down their personal debts. The bad news is that the consumer still has a large debt to pay off before he/she can start acquiring savings. This is needed for a true economic recovery.

Since Washington is trying to end this current recession by emulating Keynesian policies in Japan, as well as President Roosevelt’s New Deal, it is safe to bet that history will repeat itself and no real economic growth will take place in America anytime soon.

-John Manfreda is a writer living in Bethesda, Maryland.