During the Great Depression and war period, Keynesian economic theories failed to provide a viable solution.
During the Great Depression and war period, Keynesian economic theories failed to provide a viable solution.
When financial systems crumble and "capitalism" falters, the government, at its finest, steps in to spend money, restoring the economic order and abundance that the free market could never accomplish alone. This succinctly sums up Keynesianism, a theory first introduced by JM Keynes in his 1936 publication, the "General Theory." Another straightforward explanation: Keynesian economic healing comes from the "multiplier," which enables individuals receiving government funds to generate new recipients as they invest a significant portion of their earnings, creating a chain reaction until the final recipients opt to save the additional income gained through this process. Government spending ignites economic activity amongst all recipients of the funds.
Glance at the macro data from the 1930s. During the New Deal era, when the multiplier should have been negative, the recovery was dismal. The New Deal only marginally improved the economy towards its 1920s norms. From 1929 to 1940, the private economy (excluding government spending) grew at a meager 0.7% annually. Prior to this, the economy habitually expanded by 4, 5, or 6% annually. In terms of "GDP," a statistic developed during the Depression, the overall growth rate for the eleven-year period was nil, with the latter seven-eight years primarily focused on New Deal policies.
However, the government did produce goods, you might say. But it doesn't matter if they did or not. If the private economy stagnated, and government spending escalated, we have evidence to suggest that the multiplier was absent. The private economy saw no growth from 1929-1940, coinciding with an increase in government spending from 11 to 20% of GDP. As a consequence, there was no multiplier effect from government spending. How did Keynesianism survive the 1930s, given this record?
The Keynesian conviction is that the multiplier generates new demand for government goods, which everyone acknowledges and appreciates (despite Keynes' assertion that government production can be fruitless and stimulating). Government production during the New Deal, however, consisted mainly of items with minimal interest in the market. Murals in post offices. Cabins in remote forests. Overlooks made of stone. Dams in isolated locations. The government absorbed idle labor and allowed them to “work” on producing items that an increasingly desperate population (in the 1930s) did not exactly yearn for, while paying them a meager wage and escalating tax rates up to 79%. This is supposed to amplify economic activity in the private sector? According to statistics, it did not.
Another argument: However, growth was rapid from 1933 to 1937 (and then sort of from 1938 to 1940); the multiplier worked when starting at the lowest point, aiming to bring the country back to reasonable levels. No, that's not it either. If you select the lowest point in American economic history (1933), the chances of a sharp rebound are statistically high. Is Keynesianism then just randomness?
The primary challenge, once again, is that the fabled 1933-1937 rebound never even came close to recapturing the preceding period of prosperity's trend line. If, after all the multiplication is complete, the starting point of the whole process remains elusive, how can the multiplier truly exist? And to be completely fair, the New Deal had several years of effective operation (allegations about the Supreme Court opposing reforms and other excuses aside). The primary objective of such a fundamental economic theory – and if there ever was one, it was Keynesianism – is not only to maintain the standard of living but to exceed it. It is to excel.
Population growth dropped in the 1930s. This is another letdown for Keynesianism. The New Deal becomes slightly more acceptable when analyzing growth on a per capita basis. However, the achievement disappears once we make the necessary adjustments.
An escalation in defense spending in the late 1930s and 1940s? This is the epitome of wasteful expenditure from a lifestyle perspective. As we discussed in Taxes Have Consequences, GDP ex-defense (representing the standard of living) declined after 1940, and significantly so. Where oh where is the multiplier???
Postwar prosperity – this was the ultimate validation of Keynesianism and the multiplier. The economy surged after 1945. It sure did – and in doing so, government spending declined from 43 to 11% of GDP. The largest economic surge in modern American history occurred, ironically, when government spending decreased significantly. How once again did Keynesianism survive the 1940s, given this record?
Harvard economics endowed chair holder Stephen Marglin pens early in his recent 800-page vindication of Keynes, Raising Keynes: A Twenty-First Century General Theory, that this book is not an easy read. Directness and conciseness will get you nowhere when defending Keynes. Perhaps that is why they label them as simpletons.
Despite the lackluster results during the Great Depression, Keynesian policies were argued to be effective when the economy was at its lowest point, aiming to bring it back to reasonable levels. However, the economic rebound in the 1930s never approached the previous period of prosperity's trend line.
During the New Deal era, the government produced goods such as murals and cabins, absorbing idle labor and providing meager wages, but these projects did not stimulate significant economic activity in the private sector.
Postwar prosperity, marked by a surge in economic growth after 1945, is often cited as the ultimate validation of Keynesianism and the multiplier. Interestingly, government spending as a proportion of GDP decreased significantly during this period of rapid economic growth.
Eventually, after the Great Depression, Keynesian economic theories came under question due to the seemingly contradictory results of government spending and economic growth. Critics argued that the multiplier effect was not evident, as government spending increased without stimulating private sector growth.