Jamie Whyte is the Head of Research and Publications at Oliver Wyman, a strategy consulting firm specialising in the financial services industry. This is his opening statement from the Keynes vs Hayek debate at the LSE on 26 July 2011.
(1) The power of prayer is something people are normally inclined to doubt. But in moments of peril, credulity increases and the idea of a magical benefactor becomes irresistible. As the saying goes, there are no atheists in trenches.
Or, to adapt it to economics, there are no Hayekians in recessions. No one wants to suffer the pain of liquidating bad investments, including the bad investment of working for the wrong company. During a recession, the Keynesian idea that government spending can save us becomes irresistible.
(2) Hence “The return of the Master”, as Lord Skidelsky puts it in the title of his recent book. Since Keynesian policies were last popular and unsuccessful, in the 1970s, the growing consensus had been that paying people to dig holes in the ground and dropping freshly printed dollar bills from helicopters are not paths to prosperity.
But it does not take long for the desperate to forget a thousand unanswered prayers. When the Federal Reserve’s interest rate price-fixing finally led to a financial crisis in 2008, politicians around the Western world recommitted their lives to Keynes.
(3) Sorry, that is not quite right. Politicians around the Western world committed the lives of citizens to government officials. The central Keynesian idea is that, because ordinary people are subject to irrational mood swings, politicians and their appointed bureaucrats, who are cleverer and less animal in their spirits, should force us to make the correct investment decisions.
In your irrational fear, you might be unwilling to invest in a recently failed bank or in a company that builds green cars or that makes tunnels allowing turtles in Florida to cross roads safely. You may be unwilling to invest in a firm that buys cars for thousands of dollars and then destroys them.
Well then, the government will force you to, by borrowing money, investing in these enterprises and, on threat of imprisonment, making you service the loan with your taxes. Submit to these superior beings and you will be saved.
(4) You may think my talk of prayer, submission and salvation is unfair. Keynesian economics is not a religion but a science. When Christina Romer, President Obama’s economic advisor, designed his stimulus programme, she did so with mathematical precision. Borrowing hundreds of billions to spend on turtle tunnels and such like, she told us, would have a multiplier effect of 1.57. For every dollar of such government spending, GDP would increase by $1.57. Not $1.56 or $1.58: $1.57. This is science!
Unfortunately, in the same report, we learned that Ms Romer’s Keynesian model predicted US unemployment peaking at 9% without her stimulus and at 8% with it. Well, they got the stimulus and unemployment peaked at 10%. The Keynesian model didn’t just get the magnitude of the effect wrong; it got the direction wrong. As it also did in the great depression. The Keynesian policies of deficit spending adopted by both the Hoover and Roosevelt administrations, which were supposed to reduce the length of the downturn, made it the longest in modern history.
The problem with Keynesian economics is not that it is unscientific – like any good scientific theory, it issues testable predictions. The problem is that it is false.
(5) Macro-economics is a difficult and relatively new subject. Even theories that have not yet suffered repeated empirical refutation should inspire scepticism. To discard voluntary exchange and the normal consequences of business failure in return for the promised benefits of some miraculous macro-economic theory is intellectually adolescent. Someone who does it is like a teenager who, having read a new-age self-help book, tells his parents that all their inherited wisdom is bunkum.
Alas, unlike teenagers, the wishful politicians who adopt Keynesian economic policy are not just hormones and big talk. They are hormones and big government. Keynesian economics encourages politicians to wield the power of the state in ways that do enormous harm.
You can listen to the debate here.