Monday, January 14, 2013

Keynesian Theory: Benefits and Detractors

Keynesian economic theory has been under increased scrutiny as the U.S. national debt load increases and the economy suffers from a long period of recession. The theoretical standpoint of the Keynesian model is one of a mixed bag where those elements that would have a positive impact are often drowned out by inefficient governmental waste, political favoritism, and the cost of servicing the debt. Under certain circumstances the policies can help stave off economic collapse but fail to bring about positive benefits the longer it is used.

According to the U.S. Census Bureau an era between 1790's to 1930's only saw deficits in government spending in approximately 38 years. Most of this debt was short-term and a direct result of increased costs of war or economic downturns (Lee, 2012). Total federal budgets ran at approximately 3.2% of GNP when compared to nearly 70% of GNP today (The 2012 Long-Term, 2012). At such a high debt-to-earnings scenario the Keynesian approach loses its power to encourage future economic benefits.

To Dr. Dwight Lee, from the University of Georgia, most recessions were relatively small before the Great Depression of the 1930's (2012). They were small because market forces moved in to clear up slack in the economic system and create more productivity. He further makes the argument that Keynesian economics work best when running a surplus for many years and then used to spur economic growth in a quick paced fashion. However, running a long-term deficit and then applying additional debt on top of old debt creates higher levels of inefficiencies and costs. It dilutes the potential positive power of each dollar spent and increases its costs. 

One problem with Keynesian economics result from the political process that filters effective action through multiple competing interests and short-term results that create fiscal irresponsibility (Lee, 2012). What could have been considered effective government spending is often wasted in unrelated expenditures that do little to solve economic problems. This often occurs as decisions are filtered through the political process and sifted to those who support that process. It is always easier to spend then it is to save or ask for a tax increase.

It can be beneficial to see how poorly designed spending matched with political favoritism can impact the effectiveness of taxpayer liabilities. Accordingly, natural disaster legislation has shown that in the past nearly half of the funds were allocated based upon political interests versus that which actually aligns with the needs of victims (Garrett and Sobel, 2003). Such wasteful activities dilute much of the potential benefits of a stimulus that encourages recovery and growth by inappropriately allocating resources to the least effective entities and pinning them to taxpayer debt. 

It is this political favoritism that has made economic policy more dangerous. For example, the multiplier effect is based upon the concept of Keynes statements, “to dig holes in the ground" can benefit society (Keynes, 1936). In this concept, as money is paid for employment purposes it impacts secondary services through the economic chain passing resources to small businesses, companies, and other entities. However, if only a percentage of that money makes it through to these secondary entities its overall impact is diminished.

The end result of misguided economic applications of Keynes theory will result in higher taxes and greater expenses on debt (Barro, 1974). Someone will need to pay back the money. In most cases it will be the next generation and the one thereafter. The costs associated with debt servicing rises above the original costs creating ever increasing problems for the future. It is this future that is short changed for current needs.

The concepts of Keynesian economics works well under certain circumstances but can be disastrous if inappropriately applied in the long term. Positive applications of Keynesian economics occurs when the nation has been running a surplus for a number of years and uses this surplus to spur economic growth through liquidity that fosters cash flow and lending. Such monies will need to be effectively and efficiently allocated only to those areas where it is likely to have the most beneficial and long-term impact. As political favoritism, debt servicing costs, and inefficiencies rise the effectiveness of the financial economic injection diminishes.When used appropriately with assurances of proper expenditures in strategic entities it has the ability to increase economic activity in the short run.

Key Points:
-Keynesian Economics comes with benefits and risks.
-Money spent should have an immediate impact with long-term potential.
-The economic chain and spending decisions should avoid all waste.
-The cost of debt rises over time.

-Keynesian policies work in the short-run to counter quick shocks to the market.
-Political favoritism diminishes its impact.

-Economic activity would need to pick up much more than the costs associated with debt and misspending when compared to low debt and efficient spending in order to justify such policies. 
-The risks and benefits of using such policies should be carefully analyzed and calculated. 

Garrett, T., and Sobel, R. (2003) The Political Economy of FEMA Disaster Payments. Economic Inquiry 41 (3): 496–509.

Lee, G. (2012).  The Keynesian Path to Fiscal Irresponsibility. Kato Journal, 32 (3).

Keynes, J. M. (1936) The General Theory of Employment, Interest and Money. New York: Harcourt, Brace and Co.

The 2012 Long-Term Budget Outlook. (June 5th, 2012). Congressional Budget Office. Retrieved January 14th, 2013 from

No comments:

Post a Comment