Wednesday, December 3, 2008

The Irrelevance of Keynes

Before Keynes, we didn't know that the slump was caused first by the bank collapse and then the inadequacy of aggregate demand. Now we know, thanks to Keynes and his disciple, Milton Friedman (yes, of course, after all, he uttered "We're all Keynesians now!"). So what went wrong today, and how can Keynes be relevant today if despite his advice, we are still in the same type of slump?

I think the problem is bigger than managing aggregate demand and the money supply. We may have all been taught wrongly by our economic professors - who after all are like "nasi lemak" sellers in a row, selling homogeneous products except for the power of the sambal.

Keynes was a liberal in as much as Churchill was, and his great concern was that the prevailing model of democracy of the Western World may be lost to the new Russian order. Can the free economy be discarded for the command economy? As the free world fell into a slump, he was concerned that it would lead to a political change and he responded with the General Theory which argued that the government must add demand to the economy to keep it up, at a time when the UK Treasury was quite happy to let the economy adjust itself properly despite the huge unemployment.

The Classical economist, Keynes argued, has got the economic story wrong. While it is true that the market is an integral component of a modern economy, the market does not operate according to theory initially envisaged - where if the price goes up, demand is reduced, when the price falls, demand increases; and all is well. All has not been well, as we can see today by the effect of the fuel price in recent months and the catastrophic effect that it has caused the economy, despite the current decline in the oil price. I think the point about the market being not symmetrical has been well understood, though not necessarily by policymakers. It would therefore appear that counter-cyclical policy is the way to go - and with the revivial of Bretton Woods (another Keyensian creature) - if Keynes is still relevant. But Keynes is not relevant anymore.

The rise of China economy has shown the world that the market mechanism is not the monopoly of democracy. This puts Adam Smith more at risk than Keynes.

Aggregate demand cannot be the issue today, as the very loose monetary policy of Greenspan has shown. The collapse of the world economy today is not that there is not sufficient money stock in the system or that there is not enough aggregate demand but the contrary - there is too much money printed and incredible amount of aggregate demand as evidenced by the huge budgetary deficit of governments around the world. The ordinary person is simply exhausted from too much consumption and investment. This Keynesian proposition is therefore wrong.

If we observe where the economic failure is, in 1930s or even today, it is the collapse of asset prices - of stocks and real estate.

So the real problem could be that the sustained asset inflation due to prolonged printing of money has created a false sense of security for many people who thought they have been set up for a comfortable retirement. The bursting of the asset bubble has made naught their dream and now they do not know what to do with having practicised a proper profession for some time - apart from punting in the stock and property markets.

The reason for stock market earnings not being taxed is that it is considered by economists not to represent earnings in the proper sense - merely the transfer of payment from the loser in the punt to the winner in the punt. Now, I think that, since the government is invariably caught with having to rescue the stock market with it collapse, we should tax stock market earnings and put that tax in a sinking fund (in cash, please, not stocks). Governments should not use taxpayers' money to prop up share prices.

The tendency for the monetary economy to keep collapsing comes from the tendency of the banking system to lend to create collateral assets such as shares and real estate. This gives rise to a virtuous cycle (which gives huge payouts to bank CEOs) which then collapses into a vicious cycle once banks exhausted their avenues for lending. The pay of bank CEOs should not be tied to bank share prices - because it rewards the building of the foundation for future economic disaster.

I disagree that Keynesian countercyclical policy should be for stabilisation purposes -because it assumes that the economic structure is still good and therefore runs the risk of propping up the inefficient and problem sectors. The economy could have collapsed, as of now, because of a change in the structure of the economy.

The collapse of the Japan economy in the 1980s was due to rise of IT in the US, likewise, the collapse of the US economy is the result of the rise of China.

The problem of the Malaysia economy today is the result of the temporary rise of FDIs (as a result of the collapse of the Japan economy in the 1980s) which led the government to embark on infrastructure expansion (which is now in a glut) and accentuated by the rise of China (investment outflows). To continue to build mega projects would be to prop up construction firms at the expense of the knowledge-building industries. Industrial investment should drive infrastructure development.

The focus on stabilisation policy may have been done in the past at the expense of the need for a long term strategy for national economic supremacy. Has Keynes done more harm than good in Malaysia?

National economic supremacy should be based on education and knowledge, the application of skills and the practice of diligence - founded on a national economic system with a strong social safety net especially for old age.

1 comment:

de minimis said...


This is a seminal post. Malaysia should be honoured that your analysis concludes in the Malaysian context although your insight applies to the global phenomenon.

Perhaps you can consider enlightening us with some more insights on how the banking system appears to have become a careening runaway train, something that Keynes may not have addressed at the time.

Was it the departure from Bretton Woods, which led to free printing of money in the US, that has led to this turmoil? Greenspan has pleaded culpability, for all that is worth.

Has the modern financial behemoth become unviable? Or, was it a case of lax regulation that was too doctrinally bound by the idea of free market and self-regulation?

What kind of virtuous influence can the Chinese approach to market capitalism lend to the rest of us?

So many questions.