Most bad practices and policies have their roots in good theories and recommendations. That’s why the world is grappling with a virtually unsolvable problem today.

To understand how or why, we have to go back to an old saying: a sure sign of madness is when someone keeps trying the same solution despite having failed each time. This has now become true of governments as well.

That’s why, since 2009, after the Atlantic financial crisis of 2008, not a single country in the world, big, mid-sized or small, has been able to fix its economy. Governments have come and gone but not one of them has been able to prevent high unemployment and high inflation for very long.

The only policy they have all adopted is flooding the economy with money. Print it and distribute it. But it hasn’t worked.

The 1955-2008 era of steadily growing employment and reducing, but volatile, inflation, with some hiccups, seems definitely over. So why this persistence with a failed policy?

The answer may well lie in macroeconomic theory which is still drawing sustenance from the classic work of John Maynard Keynes published in 1936. He said it’s the duty of governments to revive flailing economies by spending more than they earn by way of tax revenue.

That is, they should borrow the amount they think they need but don’t have. That’s how modern deficit budgeting was born. It’s turned both countries and citizens into debtors.

Keynes was actually referring to a very specific problem: unutilised industrial capacity. It was unutilised, he said, because people weren’t earning any money to spend. No spending meant no sales. No sales meant less production. Less production meant unutilised capacity.

Ergo, he told governments, put money in peoples’ pockets and convert their private deficit into a surplus by going into a deficit yourself. Initially, there were no takers for this idea because the Second World War had the same effect. Capital destruction and deficit financing.

Macroeconomics legitimised

It took a long time for economists to build the Keynesian solution into a major body of acceptable economic theory. But by the end of the 1950s a new economic bible had been written. Its core message was that it was okay for governments to run deficit budgets.

But it wasn’t until 1968 that the then US president, Lyndon Baines Johnson, adopted this ‘spend more by borrowing more’ as a major policy. He called it the Great Society initiative. But all he wanted was to win the November 1968 election.

That’s why governments since the 1970s have been doing exactly this. They all want to get re-elected and economics has handed them the perfect instrument. It’s called welfarism now. But it is just a way of bribing the voters.

The main casualty has been productivity. People have rightly asked “why work hard if you don’t have to?” That’s one reason why savings rates are down globally.

This perversion of Keynes was the exact opposite of East Asian policies where the focus had been on productivity. But that was before they got democracy in the late 1980s and the financial crises of the late 1990s.

By the mid-2000s the politicians there also had bought into this seductive idea. It’s no wonder, then, that for the last two decades, productivity has been falling there also. Until recently this decline was made up by China. Now even that’s going.

What’s to be done

So this is where we are now at the end of the first quarter of the 21st century: to misquote a Dire Straits song, it’s now “money for nothing and life for free”.

One of the most perverse outcomes of these policies has been that there’s no real need to work hard anymore. The growing inequality is, therefore, because those who have worked hard have earned more. It’s wrong to blame them.

This is obvious but the politicians don’t recognise it. They want to blame everything except laziness. Indeed the more inequality there is, the higher is the pressure for this form of perverted Keynesianism that benefits mainly politicians. Where does the world go from here? The most promising answer is to bring back the pre-1970 explicit link between budgets and capital. The current link between budgets and labour can’t be eliminated but it can be diluted.

That is, budgets must focus on enhancing the competitiveness and productivity of capital rather than sustaining labour alone. Long term economic sustainability won’t be achieved if budgets are mainly devoted to winning votes.

Can the next Indian government lead the way? This one is already doing so by upping capex. So are several States. You can check the numbers. We could indeed become the Vishwa Gurus of economics.

Related Topics
comment COMMENT NOW