Shattered Consensus. James Piereson
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this kind of politics also creates inflexibilities in public budgets that make it difficult to adjust fiscal policy to movements in the business cycle. Politicians have found it all too easy to increase spending and to approve stimulus programs during slumps; but those expenditures, once made, are difficult to scale back during subsequent recoveries. Every item of expenditure on the public budget develops an interest group whose main purpose is to keep it going. Under those circumstances, it is not hard to understand how and why political leaders can gradually lose control of public budgets.
Nearly eighty years after the publication of The General Theory, the problems that Keynes diagnosed of too much saving and obsessive thrift have given way to the opposite problems of exploding debt and uncontrolled spending. With the United States and the developed world facing new challenges of public debt and insolvent governments, the question arises as to how and on what terms the system of political economy that Keynes helped to design can be maintained in political and economic circumstances that superficially resemble those of the 1930s but in fact are far different.
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There have not been all that many clear-cut cases in which efforts to apply Keynesian fiscal policies have rescued modern economies from recession or depression. FDR’s spending policies during the 1930s are sometimes cited in this connection, but those policies were too inconsistent, quixotic, and uncertain in their effects to be judged as Keynesian successes. The Kennedy tax cut of 1964 is more plausibly cited as a triumph of Keynesian policy, since it was explicitly crafted by Kennedy’s advisers as a demand-side stimulus and it did produce a boom, at least for a short time. It is of special interest that this effect was achieved by cutting taxes rather than by increasing expenditures. There is also the argument that our modern political economy incorporates built-in stabilizers such that recessions create automatic and self-correcting deficits; in other words, we have constructed a Keynesian system that automatically prevents or corrects for slumps. From this point of view, Keynes no longer stands for a set of policy prescriptions but rather for a fiscal system that is built into the structure of governance.
On the other hand, there are several contrary cases that must be considered, such as the British experience in the 1960s, when Keynesian policies led to a major devaluation, and the American experience in the 1970s, when similar policies resulted in “stagflation.” For the past twenty-five years, since the collapse of its real estate and stock markets, Japan has tried various Keynesian-type policies, including major stimulus packages and public works programs, with little success in producing sustained growth but leaving a public debt roughly twice the size of the annual gross domestic product. The United States also enacted a Keynesian stimulus package in 2009 to deal with a major recession, but the results were disappointing. Once the funds were spent, the expansion slowed and unemployment rates began to creep up again, provoking calls for further stimulus spending. Meanwhile, government debt levels in the United States now exceed annual GDP, a condition that is manageable only so long as the nation’s central bank can maintain interest rates at low levels. In the United States, Japan, and several European countries, governments have come close to expending whatever Keynesian ammunition they once had.
For a theory of such longstanding influence, this one has had decidedly mixed results when applied to real-world economies.13 Of course, there are many economists who claim that his approach does not work at all or that the market economy adjusts much more smoothly to shocks than Keynes or his followers contend. There are others who suggest that recent experiences in Japan and the United States show the growth effects of Keynesian policies to be getting weaker with the passage of time.
One possible reason for this weakening may be that political processes in Western democracies lead gradually to an allocation of public resources that does not contribute to economic expansion but may instead hinder it. In such a situation, Keynesian spending policies might actually interfere with necessary adjustments in the economy, thereby slowing down rather than speeding up economic growth. If this is so, then the problem lies more with the political economy of Keynes than with the economics of Keynes.
This case was first advanced in 1982 by Mancur Olson in The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities.14 In this insightful book, Olson tried to account for the “stagflation” of the 1970s and the failure of Keynesian theories to explain it. He argued that democratic nations over time develop political rigidities that permit strategically placed interest groups to block breakthroughs in policy and to exploit political influence in order to seize shares of national income that they have neither earned nor produced. These “distributional coalitions,” in Olson’s terminology, are organized around struggles over “the distribution of income and wealth rather than over the production of additional output.”15 Often called “rent-seeking” coalitions, they include cartels or special-interest groups like trade or industrial unions, public employee unions, trade associations, advocacy organizations, or corporations that try to increase the incomes of their members by lobbying for legislation “to raise some price or wage or to tax some types of income at lower rates than other types of income.”16
As rent-seeking groups accumulate and multiply their influence, they win more advantages for themselves but impose ever-greater burdens on the private economy, by blocking change or disinvestment in old industries and by diverting resources from wealth-creating to wealth-consuming uses. When an economy reaches a point where distributional coalitions are pervasive, it loses the flexibility to respond to shocks, recessions, or unanticipated changes in price levels. “The economy that has a dense network of narrow special-interest organizations will be susceptible during periods of deflation or disinflation to depression or stagflation,” Olson writes.17 The reason for this is that an unexpected deflation will expose above-market incomes and prices in the “fixed-price” sector, forcing movement out of that sector and into the “flexprice” sector where incomes, wages, and prices are set by market competition. Many will resist such moves, or not know how to accomplish them; queuing and searching costs will be high; the adjustments will force prices to fall further in the flexprice sector, reducing overall demand in the economy. An extended period of stagnation will follow as the marketplace adjusts to the distortions caused by distributional coalitions.
One might suggest that the government should then step in with the standard Keynesian remedy, borrowing money and incurring debt to arrest the deflation and to allocate funds to maintain the above-market prices and incomes in the fixed-price sector. This in fact looks very much like what the U.S. government tried to accomplish with its $800 billion stimulus package in 2009, which was allocated disproportionately to public employee unions, university research programs, energy companies that could not get loans from banks, and bankrupt auto companies and their labor unions.c Olson’s reply might be that such remedies will have only a temporary effect because they empower distributional coalitions that do not produce wealth and growth but seek to maintain their advantages at the expense of the economy as a whole. Keynesian spending policies run up debt that everyone is obliged to repay in order to underwrite above-market incomes and prices for groups whose activities impede economic growth.
This is the reason, Olson suggests, that new states grow more rapidly than long-established ones: because new states have yet to develop rent-seeking coalitions. Thus, the United States economy grew rapidly during the nineteenth century, and the economies of Japan and West Germany similarly expanded in the two or three decades after World War II. These economies all had extended periods in which markets were free to operate and interest groups had not organized to obstruct change or to claim rents; they were open to investment and entrepreneurship, and as a consequence they enjoyed historically high rates of growth. Olson emphasizes that all three countries had gone through traumatic wars and revolutions that had the salutary effect of cleaning out existing rent-seeking groups. In the United States, such groups were wiped out by revolution and then restrained by constitutional rules that limited the power of the central government; in Germany and Japan, they were eliminated by war, so that these countries started over with clean political slates. But growth and affluence led over time to the formation of rent-seeking groups that created obstacles to further expansion.
Olson has been criticized for suggesting that such rigidities are usually cleaned out by wars and revolutions—upheavals that are far worse than the problem they would solve.