- Is the recession's
great irony that government
spending killed Keynesianism?
With economists, bankers and
investors perplexed over the
economy's continued funk, we
cannot be blamed for looking in
odd places for answers. Could it
possibly be that continuously
increasing spending over eight
decades has left little ability
for government spending to
affect the economy?
How could
increased overall government spending have
priced stimulative spending out of the
market? To understand what has happened,
we must look back to the 1930s. The New
Deal was a concerted effort for government
to take up the economy's slack.
In 1930, federal
government spending (a 6 percent nominal
increase from 1929) amounted to 3.4
percent of gross domestic product (GDP). Under
President Franklin D. Roosevelt's
New Deal, federal spending would top out
at 10.7 percent of GDP in 1934
- only breaking the 10 percent threshold
twice more in the 1930s. The increase of
government relative to the economy was
roughly threefold.
In contrast, the
federal government
consumed 24.7 percent of America's GDP last
year. As large as the economic stimulus
nominally was, it was just a fraction of
the nation's $14 trillion economy.
While arguments
still rage as to the New Deal's efficacy,
at least government intervention was
fiscally plausible then. Because of the government's
previously minor economic impact, it could
grow so much larger because it
historically had been so much smaller.
In that regard,
it was in line with John Maynard Keynes'
own theorizing. He had envisioned
government performing a countercyclical
economic function. Government intervention
would increase during an economic downturn
but, just as important, it would decrease
once the economy recovered. It would
dampen the cycle he believed to be
inherent in the economy: eliminating
innate volatility by filling in the
troughs and pulling down the peaks.
Washington was
happy to embrace Keynes'
theory to advance government growth,
thereby putting more resources into its
own hands. It welcomed increasing
government intervention during economic
downturns but resisted decreasing it in
recovery. While Keynes'
goal was economic, theirs was political.
Keynesianism was
taken only semiseriously in Washington -
the spending half of the theory. Today,
the federal government's
share of the economy is roughly 2 1/2
times its New Deal peak. Even absent the
current downturn, the Congressional Budget
Office only projects its further increase
as entitlement spending swells.
As a result, it
is no longer possible for the government
to administer the economic jolt it
attempted in the 1930s. At a quarter of
the economy now, government could hardly
triple economically as in the 1930s.
Today's large nominal increases in
spending amount to little relative
economic impact.
Indeed, these
increases actually could have a perversely
opposite effect. When government was
historically small, the reasonable
expectation was it would return to
historical levels with economic recovery.
Eight decades and a much larger government
later, this is hardly today's expectation.
Increased economic intervention now may be
tapping into underlying concerns of
deficit, debt and taxes - offsetting any
stimulative effect.
The assumption government
will not retrench could be a rational
expectation at this juncture. In 1934, the
federal budget deficit was 5.9 percent of
GDP. Last
year, it was 9.9 percent of GDP - only
slightly less than 1934'stotal
federal spending percentage.
Increased
government spending could then be having
an expectation effect similar to
inflation. Inflation, in a historically
stable money supply, can temporarily
stimulate, as its effects are not readily
recognized.
Over a prolonged
period however, inflation is recognized,
and the reaction is quite different. The
market builds in premiums to offset
inflation's effects. The negative effect
is factored in immediately, eventually
more than offsetting any stimulative
effect an inflated money supply might
have.
Is such the
case, over a much more prolonged period of
time, with government spending today? The
current expectation is that government
spending is high and will only increase.
An attempt, therefore, to use a spending
increase temporarily to jolt the economy
is not only more difficult, but may not
work as it might have 80 years ago.
It could be
adding yet further uncertainty to the
economic uncertainty already prevailing.
Financial markets brace themselves not
only for the current downturn but for the
aftereffect of having raised the spending
base line still higher.
With economic
tools running low and economic results
running even less, we must search harder
for an explanation. The government
is dramatically larger than anything that
could have been imagined when Keynes'
theory prevailed. Government spending may
be such a large part of the economy that
it can no longer serve as an exogenous
stimulant.
