Keynes' grandchildren

In 1930, Keynes wrote a graceful essay on 'Economic Possibilities for Our Grandchildren', in which he envisioned more gentle and soften human hearts free from problems of economic necessity.

Four things in Keynes' eyes are necessary to be governed in order to reach such a economic bliss, namely, 'our power to control population, our determination to avoid wars and civil dissensions, our willingness to entrust to science the direction of those matters which are properly the concern of science, and the rate of accumulation as fixed by the margin between our production and our consumption'.

For all those four factors, Keynes optimistically thought that 'the last will easily look after itself, given the first three'; however, none of the first three have achieved good track records globally since then. Alas, Keynes must have been appalled by the financial turmoil and the prospect of unprecedented recession we, as grandchildren of his generation, are facing now.

In retrospect, Keynes' advice to President Roosevelt is to invest on public projects, although it will increase the budget deficit. However, Keynes's idea is that balanced budgets are stupid during recessions. Since incomes fall, government collects less in taxes. If the government is conservative to maintain the balanced budget, it must either cut spending or raise taxes, which will squeeze the economy further by the multiplier process.

What kind of solutions Keynes would give to current problems that President-elect Obama is facing? It's not so hard to guess as we have a Keynesian economist Paul Krugman. While advocating aggressive measures that Obama team should take on the fiscal expansion, Krugman highlights some misreadings of FDR's New Deal to clarify confusions that might have scaled down the scope of the stimulus plan that is likely to be adopted by Obama.

One potential hazardous measure is increasing tax while proceeding the public spending in an effort to balance the budget. Krugman points out that this is what FDR did after his winning of the election in 1936, which nearly destroyed his legacy. The poor economic performance directly led to a defeat in the 1938 midterm election, and the real stimulus for the American economy is WWII, which provides enormous public projects adequate to the economy's need.

More specifically, the problem of the American economy in 1930s was the so-called under-utilization (Paul Kennedy), a phenomenon of high productivity with high jobless rate. Because of the depressed demand, the New Deal were insufficient to stimulate the economy. Only when the huge rearmament programs started, the problem of under-utilization was corrected.

The historical lesson of FDR for the Obama's administration, as Krugman argues, is that if Democrats won't deliver economic recovery, they might be defeated in the 2010 midterm election as what FDR encountered in 1938. Krugman suggests that the new administration should not be prudent on the public spending scheme; too much stimulus is better than too little in the time of recessions.

This advice, interestingly, fits well with Chinese economic stimulus package, totalling 4 trillion yuan ($586 billion) over two years, announced this week. Characteristically, it'll be implemented fast, without being scrutinized by the congress like what US did. So the timing effect might be positive. Although there are some suspicions about how much of the total is actually the new investment, the action swiftly taken by the state council of China in fact has enhanced the government purchasing power, which opens window for more import and has significant global implication.

Krugman's view is more or less from the domestic standpoint, but Jeffrey Sach's point has global perspective. Based on the fact that US has huge foreign deficit, roughly 700 billion annually, Sach argues that it can't sustain. The suggestion he gives is to stimulate American export and increase domestic investment. His advice is more from the perspective of global economy, as both China and Japan are in the position to expand domestic demand, which has potential to increase the import from US if the mutually benevolent political will could be established.

In the end of his essay, Keynes wrote: 'do not let us overestimate the importance of the economic problem, or sacrifice to its supposed necessities other matters of greater and more permanent significance'.

After nearly eight decades, it's still resounding.