An Analysis of the Unintended Consequences of Keynesian Economics

The U.S. is finally experiencing the repercussions of the past 55 years of economic policy.

The political consequences are seismic.

Nick Eberstadt, in his book Men Without Work tells us that the percentage of working-aged men outside the workforce rose to 22% last year from 10% in 1965.

In addition, Eberstadt reported that there are millions more who are underemployed.

Furthermore, the employment-to-population ratio for men in the ages from 25 to 54 is lower today, 6.8% lower than even in 1930 during the Great Depression.

These figures point to the fact that there is a structural problem in the United States economy, one that fully raised its head in the recent election.

This structural problem has arisen because of the government's reliance upon an economic philosophy that is out of date. It has resulted in unintended consequences that are hurting the people the policies are supposed to be helping.

The philosophy is that of early 20th century economist John Maynard Keynes and stems from his theories about macroeconomics and the use of fiscal policies to reduce unemployment in an economy.

Keynes' economic philosophy became more widely known during the presidency of John F. Kennedy. Kennedy had campaigned "to get America moving again."

The head of the President's Council of Economic Advisers was Walter Heller, a prominent Keynesian economist.

The initial thrust of this program was a tax cut, ultimately signed into law in 1964 by President Lyndon B. Johnson.

The original idea of Keynesian fiscal stimulus was to combat recessions and return people to work in the jobs in which they had been employed before the recession hit.

By the mid-1960s, this approach was extended beyond the recession and was aimed at enhancing economic growth and lowering unemployment rates in both good times and bad.

The underlying empirical relationship that justified having fiscal deficits in both recessions as well as in non-recessionary periods was the Phillips Curve that showed a trade-off between inflation and unemployment. That is, lower levels of unemployment could be achieved at the price of a little more inflation.

President Richard Nixon accepted this approach to economic policymaking, and this philosophy of government fiscal stimulus ha been generally adopted by presidential administrations. Politicians liked this approach because proposing short-term programs of fiscal stimulus to combat unemployment helped them to continually get re-elected.

This was one of the first efforts in financial engineering that occurred in the last half of the twentieth century. This practice was refined with increasingly complex and sophisticated econometric models that used increasing volumes of data, with the idea that government economists could help fine-tune the U.S. economy.

The practice of financial engineering spread throughout the U.S. economy in the 1960s and beyond, affecting financial and non-financial institutions.

This process became known as the "financialization." Financialization took advantage of the situations created by the government's policies to stimulate and inflate the economy.

Financial innovation came to dominant the economy and this was accomplished by greater amounts of financial innovation and financial risk taking. Advancements in information technology helped to accelerate this process.

Unfortunately, these trends changed the job composition of the labor market. The same old skills weren't needed in manufacturing, and heavy industry and the new areas creating jobs in the economy required more and different skills than before.

Using economic policies to put people back to work in their old jobs just did not work as the century moved along.

Furthermore, the new jobs created in information technology and in the financialization going on required different training and different skills. Information technology as well as evolving financial firms required more people with college degrees, and even with Ph.D.'s in mathematics and physics.

Bulky economic policies aimed at promoting increases in aggregate demand ceased to do the jobs, and the credit being created by these programs led to more financialization.

These structural problems could not be corrected by the economic fine-tuning of Keynesian fiscal policies. That is where we are now: The structurally unemployed or unemployable are in revolt.

It should be noted that Keynes was from the highest intellectual community of his time. His economic models and the economic policies derived from them, according to his many biographies, represented an effort to ease the societal and cultural tensions of the 1920s and 1930s and protect his own little band of artistic and intellectual elites, the Bloomsbury group, from the threat of the proletariat uprising ravaging Russia and spreading to central Europe.

Keynes studied mathematics and conceived of the original macroeconomic model that became the foundation of future governmental financial engineering used to manage economies. Furthermore, Keynes was a successful financial investor (speculator) who benefited from bets with or against the economic policies of governments, much as the wealthy have done over the past 50 years.

So now the government programs aimed at keeping people in their jobs created an environment where workers thought that they would have their jobs forever. Many young people entering the labor force believed that these manufacturing jobs and other low-paying service jobs would be available to them as the older workers retired. 

Just creating more aggregate demand is not going to turn this situation around. The policies that will work to lessen the structural problem won't be an overnight success.

Furthermore, the policies that are constructed must consider the potential unintended consequences of the programs.

This is the revolution that the new president and those who study and influence economies face. 

This article is commentary by an independent contributor. 

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