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Keynesians, Austrians, and the Continuing Economic Depression, Part 3


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Shortly after Barack Obama took office in 2009, he requested new spending of $800 billion to help “stimulate” the economy, and given that the Democrats controlled the White House and Congress, he faced little opposition. Soon construction workers were making highway repairs and digging ditches, and new signs declared that the workers were funded by the newly passed “stimulus.

(Near where I live, stimulus-funded workers rolled sod onto the narrow median in a stretch of I-68 on the Allegheny Plateau. The place where they were putting the new grass receives heavy snowfall during the winter, and a number of us predicted that much of that grass would be killed by the next spring because of leaching from road salt. In fact, by the next summer, most of the “stimulus grass” was dead.)

Before long, the money was spent, but the jobless rate went up to about 10 percent by 2010, well above where it had been when Obama took office. And while the official rate of unemployment has fallen about a point since then, no one except a few White House flacks is claiming that the country is in anything approaching a meaningful recovery.

By all accounts, the U.S. government has ramped up its borrowing and spending for the past five years, yet the economy has not improved. When faced with these hard facts, the Keynesians usually reply in one of two ways (or say both things). The first is that the spending has kept the economy from getting worse, as though if there had not been the huge amount of spending, then the economy would have fallen into a depression with unemployment rates in the double digits.

The second excuse has been that the Obama administration has been too timid in its approach, and that it should have demanded and spent considerably more money than it has. Paul Krugman has claimed that had the stimulus been the $1.2 trillion that he demanded, versus the $800 billion that was spent, then the economy would have gained what Krugman calls “traction” and then would have moved back into prosperity.

There are serious logical problems with both explanations. The former is true only if the economy is directed by government spending and private investment carries little weight. If it matters little what kind of capital investments would have been created in a free market and if it matters little in what direction consumer spending and preferences lead investment, then the “we prevented a bigger downturn” might be accurate.

However, if capital investment matters, and if an economy can be sustained only if the mix of capital and consumer goods reflects both the rate of savings in a society (which provides funding for capital) and consumer preferences, then one can argue — as the Austrians do — that the influx of government spending has prevented the economy from making the necessary adjustments that must be made in the wake of a crisis. While it is true that the massive injections of new money might have resulted in some people’s being able to be temporarily employed, in the long run, if the capital investment adjustments are not made, then there will be no real recovery and no new and meaningful employment opportunities.

Economies are complex things, and capital and other factors of production are heterogeneous, not homogeneous, as Keynesians assume. Massive new government spending treats only the symptoms of the downturn, and in the end it prevents a real cure from happening.

Second, Krugman’s contention is based on the fallacy that new stimulus spending would result in an economic recovery, and would not simply have put the economy into a holding pattern. To put it another way, he takes it as a given that new spending will bring about recovery, so the more spending government achieves, the better and stronger the recovery. Thus, he can always claim that the reason there has not been a real recovery is that the amount of new spending is too low. (That view is an example of the logical fallacy of begging the question, in which a conclusion is embedded in the assumptions of an argument. Krugman assumes that new spending will bring recovery, so the more spending, the better for the economy.)

Austrians rightly believe that the Keynesian view is terribly flawed for a number of reasons. First, as already has been mentioned, it makes wrong-headed assumptions about the homogeneity of factors of production and then claims that the newly unemployed factors will always respond positively to new bouts of spending.

For example, when the housing boom collapsed, the first response of the government was to throw more money into the system, as well as to essentially nationalize the mortgage industry so that lenders would have more confidence when making questionable loans. (We should not forget that for all of the claims that the problem was a lack of government regulation of the home lending market, it was the government that was pushing lenders to make loans to borrowers who had dubious qualifications. Those two points are mutually exclusive, despite what those who blame the free market might say.)

When the housing market dried up (because it meant continuing to insist that people making $50K-a- year incomes should be purchasing $500K homes), government then tried a number of programs to prevent foreclosures, but foreclosures continued apace. And even when the government ramped up its spending, the housing market continued to collapse.

All of that should give us pause in accepting Keynesian theory, for if the problem were simply “idle resources” that needed only to be “stimulated,” then why did people continue to move away from the housing market? In fact, as Austrians predicted, when people received new money, they did not point it in the direction of continued capital investment in housing and related industries but, instead, spent the money on consumer goods.

“Green energy”

We see the same patterns in Obama’s “investment” centerpiece, “green energy.” The Solyndra failure made the headlines, but the bigger story is that this administration (like administrations before it) has diverted hundreds of billions of dollars into alternative fuels and “green” production of electricity, yet that industry continues to flounder, kept alive only with new injections of government money.

Furthermore, because of federal and state mandates for electric utilities to purchase “green electricity,” consumers are forced to pay more for less electricity, but even those mandates have not made “green energy” economically viable. Now, if the Keynesian theories were true and the only things the factors of production in “green energy” needed were injections of new money, then by all rights, those factors should be profitable. After all, if factors of production are homogeneous, then it does not matter where the spending is directed, just as long as it goes somewhere.

Yet that is not the case. Taxpayers are forced to contribute billions to “green energy” companies, yet they cannot turn a profit on their own by selling their products in the marketplace. And even though the “green energy” advocates claim that solvency is “just around the corner,” it is quite doubtful that the firms can ever be profitable in something that even approaches a free market.

There is something else that Austrians point out, and that is the simple fact that when government uses coercion to direct money into lines of production that are not profitable, on the whole, it makes everyone poorer. Yes, those on the receiving end of the subsidies benefit, but it is at the expense of the greater public.

Austrians are the only economists actively to point out that profits in a free market mean that producers and entrepreneurs are moving resources from lower-valued to higher-valued uses, as ultimately determined by consumers. It is not a trivial point; people on the Left, along with Keynesians, believe that profits in a free market actually amount to an extraction of wealth from everyone else.

Yet free-market profits are not an extraction but instead are a signal to producers that consumers believe that the actions of those producers have made consumers better off. When Mises wrote that socialism lacked a method of economic calculation that would enable producers to move resources from lower-valued to higher-valued uses, he pointedly referred to profits (and losses) as the ultimate signaling devices.

Because Keynesian spending has been directed in ways that subsidize losses or prop up government projects, they ultimately are moving resources from higher-valued uses to lower-valued uses. They are making us poorer in real terms, and when such policies are applied on a massive scale, they succeed in destroying wealth and, thus, destroying economic opportunities.


For the past several years, we have seen government engaged in an “experiment” of massive new spending. At the same time, government regulators have imposed new costs and burdens on private producers, ostensibly in the name of “protecting consumers.”

Unfortunately, what the government has done has been to ensure that malinvested resources are not liquidated or transferred to profitable uses. Instead, government has created huge new costs, imposed economic losses, and then laid the burden on taxpayers and consumers. Out of that, Washington argues, will come an economic recovery.

Ideas matter and in regard to boom and bust, they matter greatly. The U.S. economy at present is under the grip of people who are diverting resources to politically connected producers who continue to destroy wealth, with those in charge appealing to Keynesian theory as well as a “people before profits” mantra that hides the hard fact that when government continues to subsidize losses, it is people who suffer.

The Austrians really do have the answers even if the government and academic elites don’t want to hear them. Because Washington continues to ignore the Austrians, the economy will founder and economic opportunities will disappear. The American economy is a wonderfully productive and resilient thing, but even the strongest economies can be brought to their knees when governments continue to assault them, and especially assault them in the name of creating a false prosperity.

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    William L. Anderson teaches economics at Frostburg State University in Maryland.