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John Maynard Keynes: A Brilliant Man, But With Just Another Outdated Solution?

Wednesday, March 11, 2009

Over the course of my four years studying as a Global Economics major, I have been told a number of times that there are essentially two broad perspectives to economic theory, with a number of specific variations or the two filling in the gap in between the theoretical divide.

The first and more traditional school of thought is the classical interpretation developed and supported by thinkers such as Adam Smith, David Ricardo, and Thomas Malthus, in which theories on value (or price) and distribution attempt to explain market tendencies. As it relates to prices, three inputs are said to impact the value of goods or services: 1. the level of outputs or "effectual demand," 2. technology and 3. wages. From these assumptions, economists are able to derive the general equilibrium model. This free-market philosophy also supports the idea of the "invisible hand" that guides economics in a natural cycle. The highs of these undulations are periods of growth and expansion, while recessions and depressions are responsible for the troublesome times.

The other economic philosophy that is taught as the prevailing "alternative" to this classic view is the "Keynesian" thinking, which was derived from the more neoclassical school of thought and is based on three essential assumptions: 1. People have rational preferences among outcomes that can be identified and associated with a value, 2. Individuals maximize their own utility while firms look to maximize profits, and 3. People act independently on the basis of full and relevant information.

At core of John Maynard Keynes' economic theory is that markets, whether local, national or global, cannot be viewed as natural systems in which intervention is not only not necessary, but discouraged. He saw markets as inefficient, subject to slowdowns and crisis in which the government should step in to boost demand in the marketplace. A balanced government budget is irrelevant when the private sector is unable to invest sufficiently enough to generate demand, in which case it is the responsibility of the government to increase spending as a method of creating jobs for citizens. More jobs obviously create higher incomes, which then increases the demand for goods and services.

It was back on October 24th, 1929 that the United States stock market crashed, marking the start of the Great Depression, the worst economic crisis the U.S., or the world for that matter, had ever seen or experienced (well, modern period that is). President Roosevelt turned to the policy recommendations of Keynesian thinking and used these theories as the framework for his "New Deal." Public works projects were created in a variety of industries through massive government spending, which temporarily provided jobs to millions of Americans and immigrants. As a result, unemployment began to slow throughout the 1930's, but it wasn't until increased spending as a result of World War II that the economic slowdown was able to rebound. This "success" story influenced most mainstream economists to accept the Keynesian views.

It wasn't until the 1970's that Keynesian thinking began to fall by the wayside amongst theorists. Keynes' models project that inflation and unemployment have an inverse relationship and that the government can control either through monetary policy such as adjustments to interest rates and the money supply or by the way of fiscal policy such as taxation and spending. This theory was essentially disregarded with the existence of 8% unemployment and 16% inflation in the U.S. during the 70's, with countries such as Japan and the United Kingdom experiencing similar conditions. Along came the conservative thinking of Milton Friedman and his view that interest rate and money supply adjustments should always be the primary tools for economic policy. Lower taxes and lower interest rates while letting the pursuit of wealth act as the driver for economic recovery. This philosophy has seen its share of "success" stories as well.

Strangely enough, Keynesian thinking is making a "comeback" due to the current economic crisis and the ineffective nature of monetary policy. Interest rates are essentially zero and can go no lower, while lending remains minimal, economic activity has ceased, and employment figures continue to dive. This is why the White House and their $787 billion dollar stimulus package became the prevailing solution to boost aggregate demand. An unprecedented amount of spending on public-works projects, health care, education, law enforcement, greener and more advanced technology, and a number programs for various industries look to create jobs, boost incomes, and generate demand. Obviously during these tough times, consumers are forced to save money to handle their mortgages, debt obligations, and other basic needs rather than exhibit "normal" consumer spending tendencies.

The issue with I take with the polarized nature of economic thinking, especially as it relates to my educational upbringing in becoming an economist is that I am constantly reminded that even the experts, the analysts, the professionals, the politicians, the professors...nobody seems to know what's really happening or how to fix "it." There are a lot of ideas, opinions, interests, and even opportunities amongst those with and without a voice, but in terms of an effective solution that a broad majority can truly understand and believe it, that "idealism" appears to be absent. Confidence levels continue to fall. Daily waves of economic reports, statistics, and business conditions flood the media outlets and tend to provide little or no inspiration to individuals around the world. In a recent poll (Zogby Interactive), only 27% of likely voters believe the new economic stimulus package will personally benefit them or their families. This can then be broken down by political party, in which 48% of Democrats expect it will help, while only 19% of independents and 7% of Republicans feels the same way. And the poll itself doesn't effectively portray the gravity of voter confidence because how do you define "help" or "benefit." Is it the individual, the family, the community, the nation, the continent, or the planet that will be aided by such a policy, and to what degree?

I find it odd that, at least at my university, economics students are exposed to a fixed number of concepts, models, schools of thought, philosophies...all that were deemed "effective" or "successful" during time periods that are not even remotely comparable or relevant to today's situation. I cannot even begin to count the number of times I have read or heard the phrase, "This is the worst economic situation we have faced since the Great Depression." Anything that we may have "learned" from that time period, or any period for that matter, is not truly comparable to the grave situation we are faced with today. We need new ideas, fresh concepts, and original models (even though I don't even like the idea of models because they often are too general. Generalities tend not to be incredibly useful in solving complex, global situations.) How are up-and-coming students, the world's future leaders, potentially bright minds, or influential professionals supposed to solve a situation that 1. was inherited from a previous generation(s), 2. have not been directly active in the planning or brainstorming of potential solutions, and 3. have only been "taught" or exposed to the archaic theories of the 20th, 19th, and even as late as the 18th centuries. This is a 21st century problem in need of a 21st century solution.

That is not to say that we cannot draw or learn from our previous experiences. Of course we can. History is a repetitive cycle of ups and downs, periods of growth and downturns, peace and war. It is not possible to stumble upon modern, unique, and effective solution without considering the strategies of the past. And it is not going to be a silver bullet solution, but rather a series of well thought out policies, reforms, and ideas that are implemented after the consideration of all beliefs and philosophies. But at the very least we can provide young theorists with the tools, motivation, and experience to re-invent economic theory. This is what has been motivating me as an economist for the past couple years, especially recently because of the increased intensity of the global economic crisis. When studying economics, there are truths, facts, and assumptions. But on a grander scale, there is no truth, no solution; it has yet to be discovered.

During the last economic crisis of this scale and magnitude (but once again, very different in many ways), a British professional argued "We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand." This was over 70 years ago, and I think that declaration is still applicable and appropriate today. But then again, this same individual did also famously declare, "In the long run, we are all dead." This man was John Maynard Keynes.

Hopefully the average person in this globalized world is waking up to what is going on and as a cooperative and open-minded society, we are able to create the appropriate solution not only for the short term, but for generations to come.


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