Keynesianism isn’t the answer
From their vantage point in the celestial senior common room, John Maynard Keynes and John Kenneth Galbraith must be observing current events, if not with pleasure, then at least with the satisfaction of those whose ideas have unexpectedly been retrieved from history’s wastepaper basket.
Having watched financial markets repeat the spiral of recklessness, delusion and collateral damage that he first observed in 1929, Galbraith will no doubt have recalled his condemnation of ‘the euphoria of self-conceit’ and his view that free-market economics were never more than a rationalisation of vested interests by a greedy elite. Keynes will have been particularly pleased by Gordon Brown’s nationalisation of Royal Bank of Scotland and controlling investment in the proposed merger of Lloyds TSB and HBOS — together with his declaration that banks in which the state invests must stop paying bonuses to senior executives and dividends to ordinary shareholders, and must carry on lending to firsttime buyers and small businesses through the coming recession. The Cambridge economist will no doubt remind his Harvard companion why the alternative of allowing rescued banks to carry on as before was unacceptable: ‘When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’ He might also raise his sherry glass of ambrosial liquor to the award of the Nobel economics prize this week to the neo-Keynesian New York Times columnist Paul Krugman.
At last the uncontrolled experiment that was the free-market era has been judged an utter failure, the two great men will conclude, and the world must now regret that it dismissed the wisdom of those whose views were formed by the economic earthquakes of the first half of the 20th century, rather than by the surging prosperity of its final decades. Yet too quickly they and we may forget that the position suddenly arrived at, in which all the levers of financial power are in the hands of an autocratic socialist prime minister, is not one which ever carried ideological support in Britain outside the extreme Left, even in the postwar heyday of the centrally planned ‘mixed economy’. On the contrary, it is a position that has been arrived at not by planning but by accident. It has happened because confidence between banks had collapsed so completely — and the confidence of customers in banks was so close to collapse — that only a blanket state guarantee could save the day. Not wishing to give that guarantee explicitly, the government made it implicit by taking equity stakes in vulnerable banks, guaranteeing interbank lending, and pumping unlimited liquidity into the market. The rest of the world swiftly followed, so that the Brown formula became, instantaneously, the new orthodoxy.
But Brown must not allow this renaissance in his own standing — more dramatic even than that of Keynes — cloud his view of economic reality. This was and still is an emergency, in which all that matters in the short term is whether panic and paralysis are averted. But the situation thus created is very far from some neo-Keynesian utopia; it may just be a less urgent disaster than the last one.
The intention is that banks in which the government has taken shares should be returned wholly to the private sector, perhaps within five years; meanwhile, those banks which have not taken the Prime Minister’s shilling will be under pressure to toe his line, lest they should need state help at a later date. But if our commercial banks are obliged to pursue uncommercial, politically directed lending policies through a bitter recession, they are highly unlikely to have stronger balance sheets by the end of it. In that case, the state’s shareholdings will be unsaleable for many years to come, while the loss of shareholder value and dividend income to pension funds that have traditionally invested heavily in bank shares can only exacerbate future hardships.
Far better that the government should appoint experienced non-executive directors to represent the taxpayers’ interest, move rapidly to strengthen regulatory oversight and capital adequacy rules — and leave chastened banks to make their way in the world again. That way, the taxpayer might indeed earn the return that ministers claim is in prospect. Existing shareholders will suffer less pain and be more inclined to provide additional capital when asked. And when recovery comes, the finance it needs will not be held back by stultifying state quotas and targets.
Brown needs to remember that the halfcentury of Keynesian orthodoxy expired at the end of the 1970s because it too was judged, after exhaustive experience, an utter failure. Businesses which governments controlled were inefficient, unresponsive and often heavily loss-making. ‘Pump-priming’ by higher public spending during recessions merely imposed high taxes and inflation risks in return for short-term job creation. Central planning did little to encourage the kind of investment and innovation that might have kept Britain competitive.
‘When the facts change, I change my mind,’ said Keynes — who, we should remember, was also an enthusiastic player of stock markets. Minds have been changed by the terrifying fact of imminent financial collapse. But the intervention required to halt the collapse is no panacea: it carries huge longer-term risks for the public finances and for economic resurgence. It must be a strictly temporary measure. The facts will change again, and when they do even Keynes himself might favour a return to business as usual, despite its occasional perils.
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