Keynesian economics lie at the center of the political debate over government spending, deficit reduction and economic recovery. Image: CC Ivy Dawned/Flickr

Keynesian economics advocates using government spending in hard times to stimulate consumption and economic growth. A wave of austerity measures sweeping through Britain signals that Keynesian economics are being abandoned in the birthplace of John Maynard Keynes. American conservatives are using the example of Britain and the struggling U.S. economy to declare Keynesian economics dead.

Keynesian economics 101

Keynesian economics is based on the cycle of money. Spending by one person creates earnings for another in a healthy economy. During the Great Depression people stopped spending, the cycle of money stopped, and the economy tanked. Keynes argued that the government must spend to revive the cycle of money. He was ridiculed by proponents of laissez-faire capitalism, the most popular economic theory of the time. Keynes’ ideas were taken to heart by the Roosevelt administration, which spent to build roads, dams and other public works projects. Then World War II came along with massive government defense spending and the U.S. economy boomed for 50 years.

Europe rejects Keynesian economics

The global financial crisis exposed massive government deficits in Europe as the continent’s economy crashed. U.S. Treasury Secretary Timothy Geithner recommended Keynesian economics to European governments. Instead, Europe is heading the other way with austerity measures. Britain is cutting $130 billion in spending that will erase 500,000 jobs and affect the military, pensioners, the middle class and the poor. Nobel Prize winner Joseph E. Stigliz told The Guardian that the British government’s plan will result in less growth, less tax revenue and higher national debt.

Keynesian economics and the midterm election

A U.S. economy that remains sluggish despite billions in government stimulus has conservatives arguing that the Obama administration should follow Britain’s example. Right wing pundits eagerly anticipating Republican gains in Congress are trumpeting the 2010 midterm election as the official declaration that Keynesian economics have failed. The White House cautions that an abrupt end to government economic stimulus will extend the downturn. Conservatives argue that the economy has stabilized, and it’s time to wean the country from deficit spending.

Sources

Wisegeek.com

New York Times

National Review

More than likely, someone in this line would have accepted less if they would be assured of coming out on top. (Photo Credit: CC BY/Tony/Flickr)

Setting aside the idealism of the Declaration of Independence, we know it to be true that not all men, women and children are created equal. According to a recent piece in Slate, America is in the middle of a “Great Divergence,” a time when the income gap between the haves and the have-nots is as large as it has been in 80 years. Not surprisingly, the last time it was this wide was during the Great Depression.

Income gap and the economics of inequality

According to emeritus Professor Finis Welch of Texas A&M in his lecture “In Defense of Inequality,” the very nature of economics and the income gap in America springs from inequality. Without it, Welch argues, there would be “no trade, no specialization, and no surpluses produced by cooperation.” If skill, effort and even sheer chance played no role in establishing incomes, he argues that life would be that much more deadening, emotionally. It’s hard to argue that this isn’t already the case for many who spend their working lives in manual labor, for instance.

Eating up what we don’t have

Being undereducated is not the only problem the have-nots of the American workforce face today, suggests Slate. Once upon a time (for most of the 20^th century), the rewards of going to college had an immediate impact on money earned. However, the demand for highly skilled labor isn’t being met sufficiently, and the working middle class is feeling the most profound effects of America’s latest Great Divergence. As wages remain in a state of stagflation, consumption remains high, according to the Cato Institute. It’s high to the point that it continues to outpace income.

Social and income inequality are intertwined

Slate writes that “Among industrialized nations, those that have achieved the greatest social equality are the same ones that have achieved the greatest income equality.” Nations like France – which happens to enjoy what the World Trade Organization calls the world’s finest health care system – have displayed a drop in income inequality while other nations have gone in the opposite direction. Jonathan Rowe argues in his essay “The Vanishing Commons” that among nations where the income gap has grown unchecked, there are more institutional borders placed between the upper class and the rest of humanity, rather than public institutions aimed at equalization. In other words, countries like the United States are very much the opposite of what an “ownership” society could be.

Happy just being on top

For the most part, the haves of America don’t appear to see the need to take ownership for the nation’s economic inequality. However, the have-nots of society seem to have trouble with arithmetic. Slate cites a 1998 study by economists Sara Solnick and David Hemenway. Subjects of the study were middle class or lower. The question posed was whether it would be preferable to earn $50,000 per year while everyone else earned $25,000, or to earn $100,000 per year while everyone else earned $200,000. All other factors being equal, 56 percent of respondents chose $50,000. If more people could abandon the idea of being on top at all costs and focus more on the income gap’s downward pull on consumer demand, America would be getting somewhere.

Sources:

“In Defense of Inequality“

Slate

“Thinking Clearly About Economic Inequality“

Alyona Minkovski reports for the Russia Times America

Production is on the rise

If you need easy loans just to make it from paycheck to paycheck, and even then you could still use some extra cash, take heart. Recently there have been hopeful signs that the current recession is coming to an end.

At the end of July, the government reported that the real gross domestic product (GDP) fell at an annual rate of only 1% in the second quarter. Manufacturing activity rose to its highest level in the last year. Car sales jumped 15% and manufacturers are ramping up production. Based on the data now available for July, experts are predicting that the GDP will increase by as much as 3% in the second quarter.

Home sales are on the rise

Another encouraging trend is that existing home sales are on the rise. Between April and May, the S&P/Case-Shiller 20-city index of house prices fell just 0.2%, the smallest decline in the past two years. Stabilizing house prices are expected to reduce mortgage-loan defaults, shore up bank balance-sheets and improve the flow of credit.

Oddly, unemployment is also on the rise

Employment, however, is the single most important economic benchmark, and the outlook on that front remains grim. Unemployment rates are still on the rise, which is surprising given that economists generally predict that an increase in the GDP will be accompanied by a decrease in the unemployment rate.

The accuracy of this rule of economics, called Okun’s law, has been disputed, however; and according to Michael Feroli, an economist at JPMorgan Chase, Okun’s law would have predicted a national unemployment rate of only 8.6% during the second quarter of this year, whereas the actual rate averaged 9.3%.

Many factors influence the rising unemployment rate

Several factors may be at work in the discrepancy between the improving GDP and the worsening unemployment rate. Last week, the government revised earlier data to show that the GDP has declined a cumulative 3.7% (rather than 2.5%) since the end of 2007, tying with 1957-58 as the deepest recession since the Great Depression.

Also, expanded unemployment-insurance benefits are encouraging some workers to keep looking for jobs rather than drop out of the workforce altogether, which according to the government, could add as much as a half percentage point to the unemployment rate. Similarly, dissipation of wealth is driving people to look for employment rather than retire or stay at home with the children.

Another factor may be that employers have been quick to slash payrolls. Businesses are budgeting more conservatively because of the credit crunch, and many are pessimistic about an eventual economic recovery.

Whatever the explanation, productivity is rising and so is unemployment. According to a recent article in The Economist, Robert Hall of Stanford University, head of the academic committee that identifies and assigns time frames to recessions, says Okun devised his law in an era when productivity usually fell during recessions: “When productivity rises, the law fails.” Okun’s law, he says, is “obsolete.”

The rise in production may be a false reading

Employers are not likely to do much hiring until it seems reasonably certain that the new growth in production will continue. And some economists are doubtful that what we are seeing is real growth. These experts attribute the recent increase in production to the replenishment of inventory after an extended period of filling new orders from existing inventory in idle factories. They point out that inventory replenishment gives production a temporary boost without a corresponding increase in consumer demand.

The federal cash-for-clunkers program may also have given production an artificial boost. Recent car sales have been strong, in large part because of the program, which offers subsidies of as much as $4,500 to people trading in older, higher-emissions vehicles for newer, more fuel-efficient cars. But the $1 billion set aside for the program, which was supposed to run for several months, was depleted within the first week. The House of Representatives has now voted to spend an additional $2 billion and the Senate is expected to do likewise. But cars bought now will mean fewer cars bought later.

Numbers have a way of changing

And one more qualification: Government figures are notoriously subject to revision. Even the Great Depression is getting worse. According to the latest revisions, the GDP fell 26.7% (rather than 26.6%) between 1929 and 1933. In another 50 or 60 years, or as soon as next week – who can say? — today’s fresh new growth in production may never have happened.