By Richard Tomlinson
March 23 (Bloomberg) -- The spending that politicians uncorked as the financial meltdown crippled the global economy in late 2008 and early 2009 followed a script written during the Great Depression by British economist John Maynard Keynes: Use government money to fill the void until consumer spending and business investment revive.
Now it’s the red ink created by this largest-ever application of Keynesian stimulus that’s polarizing political and economic debate, Bloomberg Markets magazine reports in its May issue. One camp argues that deficits and public debt have become the biggest threats to sustained economic growth. The other side says cutting spending too soon will destroy a still- fragile recovery.
“The fact that the world hasn’t slid into another Great Depression, which the collapse of the banking system in 2008 made possible, is because governments followed Keynes,” says Robert Skidelsky, author of a three-volume biography of Keynes and an advocate of keeping public money flowing until robust growth returns. “Governments bailed out financial institutions and allowed their budget deficits to grow -- neither of which happened between 1929 and 1931.”
Six decades after his death, Keynes’s ideas are being put to the test as never before. While the economist wrote his greatest works in the 1930s, he was largely unsuccessful in efforts to persuade U.S. and British leaders to boost government spending during the Depression. Keynes sent a copy of his 1933 treatise, “The Means to Prosperity,” to President Franklin D. Roosevelt and met him in Washington in 1934. Still, in the mid- 1930s, the U.S. cut spending -- and the Depression dragged on.
Keynesian Again
Keynes’s influence rose after World War II and ebbed starting in the 1970s, as economists led by Milton Friedman argued that long-term state-funded stimulus created unemployment and inflation.
Now, almost everyone has become a Keynesian again, at least temporarily. Governments have spent more than $2 trillion to spur growth since the credit crunch began, according to data compiled by Bloomberg. Budget deficits will equal 5.6 percent of global gross domestic product this year, or about 10 times the level prior to the start of the crisis, the International Monetary Fund forecasts.
Reducing deficits is both a political and economic challenge. The Greek government has committed, even amid street protests, to cut spending and raise tax revenue to persuade skeptical investors that it’s safe to buy the country’s bonds. Portugal has passed a budget plan to reduce its deficit. The Irish government is negotiating pay cuts with public workers as it tries to limit its outlays.
Election Issue
In the U.K., where Prime Minister Gordon Brown must hold an election by June, the Treasury forecasts the deficit will almost double to about 170 billion pounds ($260 billion) for the fiscal year that ends this month. Chancellor of the Exchequer Alistair Darling said on March 21 on BBC television that he won’t offer pre-election “giveaways” that would widen the deficit when he presents the government’s budget this week.
Britain’s main opposition Conservative Party promises limited spending cuts in 2010 and bigger ones in 2011 if they win the election that must be held by June. “While private- sector debt was the cause of this crisis, public-sector debt is likely to be the cause of the next one,” George Osborne, the member of Parliament who speaks for the Conservatives on economic matters, said in a Feb. 24 speech.
Republican Rallying Point
The U.S. deficit -- forecast by the Obama administration to reach a record $1.6 trillion this year -- is a rallying point for Republicans. They are demanding lower spending and complaining that future generations will pay for today’s profligacy with higher taxes. While Keynes’s critics often complain that inflation comes with stimulus spending, prices have been steady so far in the U.S.
Nobel laureate Joseph Stiglitz says such talk is reminiscent of what politicians and bankers said in the 1930s. “Keynes would be amused by the fact that financiers, as in the 1930s, are saying that we have to focus on deficit reduction,” says Stiglitz, an economics professor at Columbia University.
While President Barack Obama says he too wants to tackle the deficit, he and his fellow Democrats don’t want to turn off the spending tap too soon. “We’re not going to make the mistakes that many other countries have made in the past, which is to, at the first signs of life and hope, step on the brakes,” U.S. Treasury Secretary Timothy F. Geithner said in a March 12 speech.
Obama has created a commission to come up with a plan for taming the budget. Former Federal Reserve Chairman Paul Volcker and former Republican Senator Alan Simpson of Wyoming are among the members.
AAA Rating
Moody’s Investors Service said in a March 15 report that the U.S. and U.K. have moved substantially closer to losing their Aaa rating. The two will spend more on debt service as a percentage of revenue than other countries that command the highest sovereign debt classification, the ratings company said. Neither is likely to lose the top rating anytime in the next three years, Moody’s said.
The next big battleground over Keynes’s theories may be in his native land. Stiglitz, Skidelsky and 65 other economists published a letter in the Financial Times on Feb. 19, warning that the U.K.’s weak growth would be threatened by overly hasty spending reductions.
They were responding to a letter that ran in the Sunday Times five days earlier from 20 academics, including Howard Davies, director of the London School of Economics and Political Science. This group demanded a credible plan to cut the deficit faster than Brown has promised.
Invoking Keynes
Even deficit hawks invoke Keynes in their arguments. “Keynes wouldn’t have been happy to see structural deficits persist for a very long time,” Davies says, referring to budget gaps that linger even when an economy is growing.
Jesper Fischer-Nielsen, a fixed-income analyst at Danske Bank A/S in Copenhagen, says Keynes’s prescription to revive growth is right. “You need a sustainable recovery in the big world economies, and then you get the chance to restore public finances,” he says. “I’m a Keynesian, and we should all be Keynesians once again.”
To contact the reporter on this story: Richard Tomlinson in London at
rtomlinson1@bloomberg.net
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