Where’s the wealth fund?

KvH

John Maynard Keynes was an English economist and academic who lived from 1883 to 1946. He was hugely influential in the foundation of modern macroeconomics. This is the study of economics on a national and international level, as opposed to microeconomics which is the study of interactions between individuals or companies. His theories have given rise to the ‘Keynesian school’, one of the main schools of economics, though there are other competing ones such as the Chicago school and the Austrian school.

It is important to understand that, despite the fact that economists use highly intricate mathematical models and theories, theirs is not really a mechanistic science in the way that physics or chemistry is. People are not like machines where a given input equates to a predictable output. If there is one thing that we all know is that people are capricious. At times we move like great shoals of fish, seamlessly and in unison, and at other times it’s like trying to herd cats. We are given to extremes of emotion. We sometimes fall into a mania of overconfidence and greed and at other times we are paralyzed by fear and disillusion. Economics is really a social science, in that it describes both the initial actions of human beings and their reactions to economic incentives. At least, it tries to describe it and given the difficulty in doing so, a number of different theories have grown up around the study of these unpredictable creatures.

The Keynesian school is one of these theories. It follows Keynes’ theory of how to best understand it. His principal idea was that aggregate demand should be moderated by government action. Aggregate demand is an economist’s way of describing the economic cycle. When the economy is booming, it has high demand and when it is in recession it has low demand. Keynesian theory says that it’s a duty of government to act as a counter-cyclical agent to the economic cycle, so when the economy is booming, the government should draw down liquidity from the economy, meaning it should spend less than it receives in taxes and put the surplus aside into a rainy day fund. In practical terms this means that it should use the tax surplus to pay down national debt and once a reasonably small debt is left to facilitate the national pension fund market, say 20% of GDP, it should begin to create a sovereign wealth fund to put aside the surplus to invest abroad. At the same time, this drawing down of liquidity should moderate the boom.

The economic cycle will of course inevitably turn to recession. Then the government can make use of the surpluses it put aside during the good times. It can now draw down the money it had previously saved in order to stimulate the economy during the bad times. Given that the debt to GDP is at an ultralow level, there is plenty of room to maneuver, by raising debt, if required. It can now use this cash to, for instance, support the construction industry through a program of investment in infrastructure. It can build roads, bridges, hospitals and schools which provide direct and immediate employment to an under-utilized construction sector, while at the same time producing assets that have a positive value to the nation. This also has the positive effect of injecting much needed liquidity into the economy.

The problem is that the economy tends to run on a six to ten year cycle, but politics runs on a four or five year cycle. They are misaligned. A politician’s principle incentive is to get re-elected. So if during his tenure, the economy is booming, he damages his chances of re-election by ignoring calls to use the current surplus to spend on new social programs and new entitlements. It is very difficult politically to ignore calls for more spending on this or that new initiative while the national coffers are overflowing. ”It’s only fair”, his constituency and his opponent in the next election will say. A brave and principled politician would explain that the surplus needs to be set aside for the inevitable future downturn and should not be frittered away.

When was the last time you encountered a brave and principled politician?

So we now find ourselves where we are. No politician dared to put money aside during the good times because he was constantly watching his back, watching for his re-election chances. And thus no surplus was created. So now we hear the current crop of politicians saying, “Well, Keynes said we should be stimulating the economy during the downturn”.

True, but where’s the money you should have put aside in the good times to pay for this?

Keynesian economics is a two way proposition. You only have the right to call for deficit spending in the bad times if you had the balls to resist the call to overspend during the good times.

Wheres the wealth fund you should have created?

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Update: Click on the image above to view a cool video on the difference between the Keynsian School and the Austrian School of economics.

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