Why keynesianism doesnt work

Sign up to have blog posts delivered straight to your inbox! Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Why is the economic response to increased government spending so different from the response predicted by Keynesian models?

Meltzer gives four reasons, beginning with the threat of higher taxes. First, big increases in spending and government deficits raise the prospect of future tax increases.

Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing. I also would have added the European fiscal crisis , which has made more people aware of the negative long-run consequences of excessive government.

He then lists the negative impact of having the government distort the allocation of resources, a point that is music to my ears. Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession.

What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment. Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy. Who can guess the size of the cost increases required by these programs?

ObamaCare is not the only source of this uncertainty, though it makes a large contribution. Fourth, U. How can that appeal to the taxpayers who will pay those costs? Once the subsidies end, the jobs disappear—but the bonds that financed them remain and must be serviced.

And how did the Great Depression end? With World War II - just as Keynes seemed to recommend the government engaged in massive spending financed by borrowing and printing money - and voila - the Great Depression turned into the great prosperity.

The thing is that the Keynesian prescription - spend more and don't worry about the bills coming due - sounds a bit too good to be true, almost like a perpetual motion machine. At which point I want to refer you to a drawing by M. It illustrates a canal with water flowing downhill and around several corners until it reaches a waterfall which runs a waterwheel, then flows around the canal downhill back to the top.

This is an illustration of a perpetual motion machine - which of course we know is impossible. How do we know this? If we measure the angles carefully and do the calculations we will discover - of course - that the water is flowing uphill.

And we might wonder if the reason that Keynes is so popular with those that do not do math is because they cannot measure the angles carefully. We might want to subject Keynes rather vague stories to some careful measurement. Another thing we might do with the Escher diagram is to try to build the machine - in which case we will discover it is impossible. As far as Keynes goes, we will come to that as well. I want to subject Keynes story to some scrutiny - to measure the angles carefully.

I could do this using complicated math - and if I wanted to be at all realistic I would do just that, but it is his reasoning I am after and I can measure that with a simple example that is precise but avoids any math - it is the precision that matters.

I want to think here of a complete economy peopled by real people who produce and consume things. Let's say four of them: a phone guy who makes phones, a burger flipper, a hairdresser and a tattoo artist. Let's say that the burger flipper only wants a phone, the hairdresser only wants a burger, the tattoo artist only wants a haircut and the phone guy only wants a tattoo - around the circle in effect.

We'll suppose that each can produce one phone, burger, haircut or tattoo and that each values the unit of what they want to buy more than the unit of what they can sell. That is, the hairdresser happily cuts hair if he can get a burger and so forth. What happens is clear enough: the phone guy produces a phone, trades it to the tattoo artist in exchange for a tattoo, who trades the phone to the hairdresser in exchange for a haircut, who trades it to burger flipper in exchange for a burger.

All are employed, all get what they want - everyone is happy. Now suppose that the phone guy suddenly decides he doesn't like tattoos enough to be bothered building a phone.

Now the circle is broken and this is a complete catastrophe. Everyone is unemployed. Demand is insufficient. There isn't enough consumption - none at all in fact. And notice how this works: one person - the stupid phone guy who is causing the problem by not wanting to buy a tattoo - is "voluntarily unemployed" - he is lazy and doesn't want to work.

The other three are "involuntarily unemployed" each one is willing to work in exchange for pay. The burger flipper would like to work making burgers if he can get a phone, the hairdresser would like cut hair if he could get a burger and the tattoo artist would like to work if he could get a haircut and yet all are unemployed.

Now to the multiplier. Suppose - instead of building a sports stadium - the government gives a phone to the phone guy. Why then he'll sell it for a tattoo he doesn't have any use for a phone himself the tattoo artist will use the proceeds to buy a haircut, and so around the circle.

Full employment. Just put in one phone and you also get a haircut, a tattoo and a burger! That is the multiplier, and just what we see when the city government builds a sports stadium. Nothing mysterious here. One is reminded of the old economics joke:.

A physicist, a chemist and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, "Let's smash the can open with a rock. Is the basis of Keynesianism that we should assume that the government has a phone to give away?

Well maybe not. Maybe the government should follow Keynes advice and print some money or bury it and give it to the phone guy.

Then the phone guy can buy a tattoo, and the tattoo guy can buy a haircut and the haircutter can buy a burger, and the burger flipper - ooops There are two possibilities. It is now clear that Keynesian politics has failed. But don't take my word for it. Here's Paul Krugman on the great abdication What's extraordinary about all this is that stimulus can't have failed, because it never happened.

Once you take state and local cutbacks into account, there was no surge of government spending. If that sounds familiar let's remember that by their own admission Keynesian's believe that Keynesian politics also failed during the Great Depression. Again, Paul Krugman on the New Deal Except that the New Deal didn't pursue Keynesian policies.