Permanent Keynesian Unemployment
by Gary North: Government
the West, unemployment remains stubbornly high. Unemployment
in these European nations ranges from 8.5% in Italy to over 20%
as a whole, the figure is 10.3%. What is revealing is this: ever
since 1995, it has been above 9% most of the time. Only
in February 2008 did it fall to 7.3%. For workers under age
25, the figures are much worse. A generation of educated college
graduates has become a lost generation.
Yet as the
chart reveals, a few countries are doing far better. Netherlands,
Austria, and Germany have rates from about 4.5% to 6.5%. These are
nations noted for their comparative frugality.
as a whole, it has been 40 years of unemployment. It the 1960s,
European employment was high.
This changed in the 1970s. Keynesian economists seem baffled
by this. Keynesian policies of government deficits were supposed
to end unemployment. They haven't in Europe.
The chart for
the United States since 1965 is revealing. The unemployment rate
climbs in recessions, then falls into the 4% to 6% range. Not this
time. Since 2008, the rate has soared and has refused to come down.
the interactive chart to select a base year.
All this is
to say that the Keynesian system is unable to explain why unemployment
should persist. The Keynesian tool kit has been available to national
governments. The political leaders are disciples of Keynesianism.
Their advisors are Keynesians. Yet the prescription is no longer
working. The U.S. government has run three consecutive years of
trillion-dollar-plus deficits. They have not worked to bring down
the unemployment rate.
a pair of questions. First, with respect to economic theory, why
isn't the policy prescription working? Second, historical: When
a theory ceases to explain events, why won't it be abandoned by
a younger generation of theorists?
These two questions
faced neo-classical economists in 1936. They could not answer either
of them. They lost the war for the minds of the next generations.
In 1936, Macmillan
published John Maynard Keynes' book, The
General Theory of Employment, Interest, and Money. The book
was an attack on the free market's ability to clear itself of unsold
goods, including "labor goods," by means of downward price adjustments.
to this issue had been provided two years earlier in a book also
published by Macmillan and written by the rising economic star,
Lionel Robbins. Its title: The
Great Depression. It was written from an Austrian School
approach. Robbins had studied informally with Ludwig von Mises in
Vienna. Keynes' question was answered again in 1937 by another book
published by Macmillan, Banking
and the Business Cycle, by three economists. It also was
written from an Austrian outlook. So, the big winner in all this
became dominant. Younger economists adopted it. The other two books
were forgotten by 1940. Within two decades, the modified Keynesianism
of Paul Samuelson was dominant in Anglo-American academia. It remains
The heart of
Keynes' thesis is this: downward price flexibility does not clear
markets, including the capital goods markets. Classical economics
had taught that the competitive pressures of the free market will
lead to falling prices and decreased unemployment. The rule was
this: "At a lower price, more is demanded." This includes labor.
The Great Depression
by 1936 seemed to refute the classical economists' theory. Because
this theory of causation was central to economics from Adam Smith
to the Great Depression, the persisting unemployment seemed to refute
this fundamental tenet of free market economic theory. Thus, the
profession was waiting for a new theory of free market pricing.
Keynes supplied this. The theory was wrong, but it had a ready market.
what every Western government had been doing since 1930: run deficits.
His solution was more of the same: larger deficits and more government
facing the West was what classical economists had argued against:
tariffs that restricted trade and government-mandated domestic price
floors that encouraged the production of goods that could not be
sold at the legal prices. The U.S. government under Herbert Hoover
ran unprecedented peacetime deficits. It restricted trade, both
domestic and foreign. The story of this came late: Murray Rothbard's
Great Depression (1963). It was ignored. The only major
academic to pick it up was Paul Johnson, in his 1983 book, Modern
Times. This section of his book has also been widely ignored.
guilds in history, economics, and political science are committed
to the ideal of fiat money. With the lone exception of Austrian
School economists, fractional reserve banking is not merely accepted,
it is actively promoted. So is central banking.
is easy to explain. First, in a world dominated by government spending
on education, he who pays the piper calls the tune. Tax money is
the basis of formal education in the West. Formal education is compulsory
through the teenage years. The teachers are required to be certified
by government-policed accrediting institutions. The lure of money
buys compliance. Those who go through the subsidized educational
system generally believe in the legitimacy of the system.
reason for the widespread acceptance of Keynesianism is that Keynesian
theory supports rule by certified economists. The economists dream
of power and money, as do so many other graduates of tax-funded
schools. This dream of getting in control over all that spending
is irresistible to members of a class of guild-certified specialists
to whom the supreme tool of power money creation is
handed by the politicians.
Money is the
central economic institution. It came as a result of market developments.
The civil government took over the certification process. Then it
demanded a monopoly of control. It has asserted this sovereignty
over money creation for over two millennia.
In the field
of money, there is no level playing field. It is tilted in favor
of government. Thus, in the field of economic theory, the same tilting
was tied more to fiscal policy deficits than to monetary
policy. But from the beginning of modern central banking in 1694,
with the Bank of England, there was a quid pro quo between the politicians
and the private owners of central banks. In exchange for the monopoly
over the money supply, the central bankers promise to provide sufficient
money newly created to buy new issues of the national
debt at below-market rates. In a world in which fractional reserve
banking and central banking are universally accepted, the Keynesian
policy of federal deficits inevitably leads to a defense of central
banking money expansion. Keynesianism and central bank inflation
are a package deal.
WAR II: WHY KEYNES WON
had begun half a decade before Keynes' book appeared. They had not
worked by 1936. They did not work in 1937, 1938, and most of 1939.
Then the war
broke out. From that point on in the West, governments inflated.
They all imposed price and wage controls. They all adopted rationing.
Then they drafted tens of millions of working-age men to serve in
the armed forces. This was repressed inflation on a scale never
dreamed of in the West. Nothing like this had been seen since the
Roman emperor Diocletian's reform in the early fourth century.
creates demand. "When the price of anything is reduced, more is
demanded." The legal prices of most new goods were reduced by government
decree. Then the money supply was increased by government decree.
So, there was an enormous demand for basic consumer goods. This
demand could not legally be supplied by the controlled markets.
So, the governments imposed rationing. The market principle of "high
bid wins" could not be abolished, but it could be modified. The
high legal bids were placed in the hands of those who had ration
stamps. The high illegal bids often thwarted the central planners.
statement is true. "World War II solved the Great Depression." The
problem is, this statement is not challenged by the economist's
question: "At what price?" Government officials with guns told people
where they could work and for how much. When people with badges
are pointing guns at citizens, the government is capable of putting
people back to work.
did not overturn classical economics' theory of pricing. Keynesianism
was the historical outcome of a government-decreed system of price
floors. Monetary deflation coupled with wage and price rigidities
did produce unemployment on a massive scale. It did not go away,
because the policies did not go away. "Too many goods chasing too
little money at government-mandated prices."
also did not overturn classical economics' theory of pricing during
World War II. The governments inflated massively and imposed price
ceilings. Demand rose. Supplies fell. Goods could not easily be
obtained. "Too much money chasing too few goods at government-mandated
The Great Depression
was the product of bankrupt fractional reserve banks, which shrank
the money supply when they failed. To this was added government-imposed
price floors. People were offered goods to buy, but there was not
enough money to buy them at the above-market mandated prices. Result:
The Great War
was funded by fractional reserve banks, which increased the money
supply when central banks bought government debt. To this was added
government-imposed price ceilings. People had money to spend, but
not enough consumer goods to buy them. Ration coupons eliminated
legal market demand, but this led to black market prices, which
siphoned goods away from law-abiding people. Result: not enough
goods to meet market demand. Result: reduced wealth.
intervention, 1930-39, reduced wealth. Government intervention,
1939-45, also reduced wealth for those who were not killed. Worldwide,
about 60 million were killed. This reduced production even further.
Why did Keynes
win the intellectual battle? Because the masses did not want to
believe that the Great Depression and World War II had been avoidable.
A privately created gold coin standard plus the enforcement of contracts
would have presented both of these events. People did not want to
believe that government policies brought such misery. They had been
taught that government heals. They had been taught a messianic view
of the state. They were not ready to break with the supposed source
of safety in an economic downturn.
have been unwilling to abandon the chief premise of Keynes, namely,
that government deficits can mitigate and then overcome recessions.
This premise rests on an assumption: there is a class of specially
trained experts who can successfully oversee the process of deficit
spending, so as to avoid either crowding out of capital in the private
sector or the pop-gun effect of insufficiently large deficits.
The tools in
the Keynesians' tool kit have failed to overcome unemployment in
the U.S. since 2008. Massive deficits have not worked. Central bank
inflation has not worked. These are the twin pillars of Samuelson's
call for patience. That was what neo-classical economists called
for in the 1930s. At some point, everyone lost patience. Some Keynesians
call for larger deficits. But more of the same hastens the day of
reckoning when private investors refuse to lend more money at today's
low rates. Then what?
is dependent on government spending. People receive their checks.
They need those checks to maintain their present lifestyle. They
greatly fear losing these checks.
Today, we are
told by Keynesians and their fellow travelers that the government
should not reduce spending. Why not? Because this would supposedly
exacerbate the recession.
It would not
exacerbate the recession. It would increase unemployment. The two
outcomes are different.
Spending by the government crowds out spending by those who were
either taxed or who lent the government money. When taxpayers are
allowed to keep their money, their pattern of expenditures will
change. They will re-budget. It will take time for this new demand
to register in the thinking of entrepreneurs. In the meantime, those
no longer receiving checks will have to readjust. There will be
added unemployment until these now highly motivated people adjust.
"You can't spend it if you ain't got it."
This is not
part of the recession. It is part of the overcoming of recession.
This rising unemployment will be added to the existing figures but
this will not last. Without the welfare checks, people will find
employment. It may take them time. They will have to lower their
wage demands. But, at some low price, the markets will clear. They
clear on the stock exchanges. They clear on the bond exchanges.
They will clear in the labor exchanges.
No one in Washington
wants the political effects of reduced government spending. Yes,
unemployment will rise. It will take time for those who received
government money to find new sources of revenue. But this does not
mean that the money will not be spent. Others will retain the money
that Washington did not spend.
rests on a grand deception. It argues that government spending can
get the market rolling, whereas spending by private citizens cannot.
This makes no sense. Spending is spending.
deficits will not end, because the politicians do not want to cut
spending. The Keynesians have built their careers and their self-confidence
on the assumption that any reduction of government spending in a
recession will make the recession worse. Yes, reduced spending by
the government will make unemployment worse until people who lose
their bailouts reduce spending. This will not make the recession
worse. It will reduce the bottlenecks on production.
are permanent. High unemployment is also permanent. The Keynesian
prescription will not make the patient well. It will make him sicker.
come a day when Keynesians will no longer be able to sell their
patent medicine to opinion leaders. There will be a Great Reversal
of opinion. I think this will come in the aftermath of the Great
Default by national governments. That default is coming.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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