“Look after the unemployment, and the budget will look after itself ” (Keynes 1933). Is he still right?

Keynes was undeniably a genius of his time, but he wasn’t infallible. We should not just assume that he was always correct. As with all prolific writers we can cherry-pick quotations to suit our own political purposes. If we want to argue for more government spending, we can use this:

For the proposition that supply creates its own demand, I shall substitute the proposition that expenditure creates its own income.

(Collected Writings of John Maynard Keynes, Volume XXIX, pp 80-81)

Keynes meant that the mere supply of a commodity is not enough to ensure the sale of that commodity, but money from all government spending inevitably ends up in someone’s pocket. This is a statement of the obvious, maybe, but he evidently felt it needed making anyway. On the other hand, if we are suspicious of what sounds like “magic money tree” economics, as many scathingly describe any deviation from their understanding of ‘sound money’, we can find this quotation:

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

(Economic Consequences of the Peace, Chapter VI, pp. 235-236)

Rather than play these games we might look at how economics has progressed since his time and interpret his comments in the light of the now available evidence. This Huffington post article makes a good a case, in support of Keynes’s opinion, that a healthy economy will help minimise the government’s budget deficit.

One possible counter argument, from those of a more right wing disposition, would be that it is unclear which is cause and which is effect. Does a healthy economy with low levels of unemployment, and underemployment, naturally produce a small budget deficit or is it the other way around? If we force the budget to balance, by draconian measures, will unemployment fall too?  A quick glance at the figures for Greece is enough to eliminate that possibility. It has a relatively modest budget deficit of 3.5% but an unemployment rate of over 25% with no tangible sign that any fall is imminent.

To give an answer to the question posed in the title, we can say “usually yes”, but we must acknowledge there are several, sometimes conflicting, factors involved. It is possible to conceive of a healthy economy with low levels of unemployment at the same time as the government’s budget deficit possibly being a little on what some may consider to be the high side.

To understand why, we need to look at the sectoral balances. To start with, imagine that everyone who issued or used the pound sterling as a currency was separated into either the government or the non-government sector. The assets of the non-government sector have to equal the liabilities, or debts, of the government sector. If money is paid as tax to government the assets of the non-government sector fall exactly as the government debts fall too. We can then divide up the non government sector into domestic and international. So in one year, and using the terminology of internal deficit for the Government’s deficit:
Internal Deficit = Savings of Domestic Sector + External Deficit.

For Keynes to be right on the question of unemployment and the internal deficit it should follow that everyone will save less when unemployment is low. This is a reasonable assumption but there could be exceptions. Everyone is more likely to borrow too, essentially the same as de-saving, when the economy is buoyant and there is confidence that money doesn’t have to be stored for those rainy days ahead. The effect on the external deficit is harder to predict. If the UK reflated its economy, when everyone else was in recession, we could well see that, even as unemployment fell, the external deficit, and so the internal deficit, could increase due to a local upturn sucking in more imports. Exporters could also switch their production to local markets. In that sense, and if we interpret “look after itself” to mean “fall”, Keynes could possibly be wrong! The important thing is that governments should understand these relatively simple relationships to make informed policy choices. The internal and external deficits may not be such a problem as we might be led to believe, if international investors see the UK as a safe place to park their surplus cash. The number one priority for any government, at least in peacetime, should be to ensure the health of the economy, both to offer jobs and business opportunities for all citizens and at the same time maintain the confidence of our external investors.

Ironically, if the UK lost that confidence, no-one would want to lend us any money. The pound would fall. Imports and exports would have to balance. We’d all end up somewhat poorer and we couldn’t then afford to save so much. The internal deficit would have to fall too and maybe even turn into a surplus. But, we have to ask ourselves: “Is this what we really want?”

* Peter Martin is not a LibDem party member but has voted LibDem in previous elections.

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  • Surely, some of the problems are with inflexibilities? For instance – our rigid division into the “public sector” and the private sector” seems paralysing to sensible actions. Our fear of “investors” should also be changed. For instance overtly sensible answers to the Greek long-term situation seem to have been blocked by refusing to overrule investors and go for partial debt write-off, without which things will drag on with no end in sight for those who have been pushed into poverty and hunger, and unfairly deprived of a living.

  • Katerina Porter 20th Dec '15 - 12:39pm

    What still seems to be missing in economic discussion is what was described about two years ago in a Demos report as the mismeasured economies – that is that the return on public investment is not included in GDP calculation. The report uses figures taken from the US . A couple of these are that public bodies there spend $180 per annum on surface transport. The return is $800 billion but that is not shown in GDP as a public gain. And in the first 20 years after the passing of their Clean Air Act $500 billion was spent on compliance but the benefit has been 20 trillion. This does question the present neo-liberal approach that reduction in public spending is a good in itself.

  • I’d say broadly speaking yes. The higher the proportion of the workforce who are employed in the private sector, the lower the burden on the state, and the larger the tax base.

    Maintaining that workforce and enhancing productivity through education/training, healthcare, functioning state – pension system etc. is an essential function of the state in my view (and an essential investment).

  • Steve Coltman 21st Dec '15 - 12:07pm

    Interesting note that unemployment was 1.8 million in the dark days of the great depression and 1.7 million now. OK, the population and labour force are larger now but its still a lot, plus apparently 3 million under-employed plus I would guess a lot of people living on disability benefit who could possibly work if something suitable could be found for them. But too few of them have the skills the job market needs.

  • Katerina Porter 21st Dec '15 - 2:56pm

    Clean Air Act is not niceness but the saving of the cost of for instance bad health. The Demos report, not me, says that
    these benefits are not included in calculating GDP.

  • Katerina Porter 22nd Dec '15 - 11:56am

    The other example I took from Demos was public money spent on surface transport in the US -$180 billion p.a.for benefit of $800 billion .

  • Katerina Porter 22nd Dec '15 - 3:55pm

    The Demos point is that the GDP calculation leaves out the return on much public spending and presumably they are working with the knowledge of what you refer to.

  • Katerina Porter 27th Dec '15 - 7:08pm

    Quote from Demos ” the way we measure government’s role in the economy is limited, inaccurate and unrealistic……..most government services are provided free.. do not have market prices..much of what GDP measures as personal, private spending… two thirds to 70% of economy is ….socialized consumption…..not financed from..private household earnings but from public sources or from publicly subsidized private sources……….etc

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