Paul Davisdon - TheKeynesSolution[Welcome Paul Davidson, and Host Stirling Newberry - bev]

The Keynes Solution: The Path to Global Economic Prosperity

Some books are written for their moment. When John Maynard Keynes published his General Theory the world was, in fact, more than ready. Key ideas had already been put forward in papers and letters, and political figures were already looking for a means to implement truths the felt to be correct. Keynes advised, prophesized, synthesized, and proselytized. But to some extent he was a victim of the breath of his ideas and the range of his converts. As with many other epoch making ideas, it was in redaction and reduction that Keynes came to the world.

At the same time economics began to suffer from a kind of physics envy, taking equations and a search for mathematical complexity as well as a formality, which translated into equations of the economy with dizzying numbers of variables and parameters. Keynes, whose mathematical formulation was elegantly open, became known through more complex ideas meant to join the classical “economic” formalism of the marginal revolution, filled with a sometimes illusory clarity. The result was often like sorting grains of sand with a pair of tweezers. The result is that many of Keynes most radical ideas were implemented in bastardized form. It was a result that he saw coming, in that policy, he knew, was not made by great intellects.

Other books are written before their time. Paul Davidson‘s compact book on Keynesian solutions is such a book. It should be clear by now that the present generation in power is looking to save Friedman, Barro and Lucas. Keynes is the shadow that hangs over present policy makers, more because they understand that if they fail to deal with this crisis, a true Keynesian moment will arrive, and with it a radical restructuring of power.

Which is precisely why people should be reading, and reading carefully, what Prof. Davidson has to say. Reviews so far have been inordinately condescending, talking about Davidson’s place as an interpreter of Keynes, or the place of theories in the village discourse. Davidson, however, is not writing about film or fashion, or television, or any other subject which is about divining the zeitgeist. Instead, he goes back to the roots of Keynes’ theory, and looks carefully at what he finds. It is the ideas, and their applicability, that matter.

First he finds the market mechanism wanting as a sole arbiter of human fate, because it is, as even it’s defenders admit, filled with metaphysical entities that have no real existence, and run by people who are anything but rational, but instead infected with fear and greed. Instead, Davidson argues that Keynes has a better grip on reality, and that economics is about real things. From there he launches an almost point by point assault on the various symptoms of unreality in economic thinking: views on deficits as being about numbers, views on toxic assets, global trade, and income distribution.

Davidson’s early books patiently elaborated on how the total supply, and total demand, in an economy only tend to balance at the point of what Keynes called “effective demand.” Too little demand sets off a spiral of stagnation, and leads to the “paradox of thrift.” The neo-classical solutions of the last 30 years have been on the assumption that demand was robust, and that prices could be raised, and wages lowered, virtually indefinitely, if done slowly enough. In fact, in the UK right now, Labor and the Tories are arguing over exactly how fast they can boil the public’s frog.

This crucial idea inverts the importance of supply and demand in policy.

The last generation has seen a focus on the suppliers as being the special class, and the public being a kind of infantile gob, that sucks in, but produces only a lump of labor. Supplier policies have a very clear boom and bust pattern. Let the boom run, and then, when the bust occurs, find a way to spread the pain out over a large enough number of smaller people, that there is no place for the electorate to run to. In the United States, this has lead to Japanification. It is also not a market theory, in the end, since it is about small groups of elites making large decisions based on large concentrations of power and capital. Instead, the demand side view is that people know what they want, and, on aggregate, they will make better decisions than 8, now 20, finance ministers who all have Goldman Sach’s upper executive suit on speed dial. Hence instead of a constant spiral down of real wages, a wage policy that undercuts attempt to externalize cost, and profit from it.

From here he goes on to financial regulation. Because in Keynes’ theory, future required investment is too uncertain to always match future savings, and therefore, it is not assured that production will be here when it is needed. This creates a built in instability in a market economy: investment and savings are not always equal, because it is planned, not present savings, that finances planned, not present, investing, but any project requires planned investment. The swings above and below this point of equality, are enough to create permanent instability. Government then steps in, and makes sure that savings is stable enough, by, for example, having a public pension system, and that planned investment will be relatively constant, by, for example, borrowing when investors are panicking and banks are not lending. The last decade, again, attempted to end run this, by creating investments which were safer than safe, out of loans that were too risky to make.

Think on this the next time a radical libertarian pretends to have some deep connection to reality that liberals lack.

Prof. Davidson is not expansive in his explanations, he neither he spares  complication, nor does he shy away from making proposals which will shock the conscience of a freshwater economic thinker. The average reader is going to have to pick up the book, read, set it down, and think. Because Davidson is thinking more like an economist than most economists. Instead of arguing that because we have not had a great depression, all is well, he argues that we have to compare what we have, to what we could have. Yes, the Great Recession is not the Great Depression, but it is far less than a path to global prosperity and development. This, in the jargon of the field, is known as the opportunity cost, and the opportunity cost of current policies figures prominently in Davidson’s description of how deficit spending works.

Can these ideas work? They have more actual rigor than those being proposed, a longer track record of success, and empirically better results. They also mean a radical reduction in the demand for private jets, and governments that no longer act as if their job is to sell financial policies to the public in return for campaign contributions. Can these ideas be implemented? They are in fact simpler and more streamlined than the ones being pursued. One could drop the entire book in the current version of the health care bill, and only raise a medium sized ripple. Can these ideas be understood? We clearly didn’t understand Guassian copulas and structured finance. Are these ideas good politics? Better politics than high unemployment, flagging industrial production, and a world unable to raise capital for vital projects.

While policy makers present are busy ignoring the contents of this book, policy makers future would be wise to read every word of it, and agree or disagree, understand the thrust of the argument: that ultimately that demand drives policy and politics.  This lesson was forgotten in the 1930′s, to the world’s peril. Once the system could not supply the aspirations of a wide swathe of people, they turned to totalitarian states. As Keynes argued then, there was a precedent for what was happening in his day and age, it was called “The Dark Ages.”