[Viewpoint]A Keynesian comeback?

Keynes is back on earth.

The Financial Times, a leading business daily published in London, declared that John Maynard Keynes has returned to the financial stage to save capitalism.

In 1933, right after the Great Depression in the United States, Keynes said, “We are now at an important juncture. If the government does not take action now, all existing contract structures and loan methods will fall apart one by one, which will lead to absolute distrust of the financial world and government leadership, and nobody can predict the ultimate consequences that will follow.”

It was a very ominous prediction.

Surprisingly, his prediction holds true also in the context of the recent stock market fall and financial crisis.

The governments of all countries in the world took special action in accordance with the prescription presented by Keynes 70 years ago.

They have taken extensive measures to revive the economy by injecting large amounts of public funds to financial companies, nationalizing weak ones, lowering interest rates, and expanding tax reduction and financial spending.

Keynesianism, which was pushed aside from the center of economic studies after the 1970s, has reappeared at the forefront with the U.S. financial crisis as the background.

In addition, with Paul Krugman, a self-described neo-Keynesian, winning the Nobel Prize for economics, Keynesian economics is being treated like the mainstream of this age.

The key point of Keynes’ prescription is that the government should actively intervene in the market through expansion of financial spending in an economic depression or crisis.

If consumption declines due to the shock of falling stocks or a financial crisis, this will lead to decreased production, which will in turn lead to decreased incomes again and then to further decreased consumption - a vicious cycle of deflation.

According to Keynes, under his “principle of effective demand” this vicious cycle cannot be solved by the market on its own, if the government does not intervene.

It means that as water has to be poured into a pump first in order to prime it to pump water, the government has to pour money into the economy first to get it going when the economy cannot stand up on its own.

During the Great Depression, the United States suffered from the worst kind of economic depression in history.

In 1934, Keynes met with President Franklin Roosevelt, who won election against Herbert Hoover, and presented his economic prescription.

He said the government should substantially increase financial spending and accept the risk of deficit.

However, Roosevelt did not accept Keynes’ proposal because he placed importance on a balanced budget.

When the depression was prolonged, Roosevelt tried to revive the economy through financial spending on public projects and farm subsidies, but he could not give up the obsession to keep a balanced budget.

Then at last, Keynes’ principle of effective demand started to work in full with the rising demand for military supplies due to the country’s entry into the Second World War.

Actually, it is not possible to confirm whether the Keynesian prescription held true, because his theory had never been executed properly.

The reason why I have made this long introduction of Keynes’ theory in relation to the financial situation we are now facing is because the rapid rise of Keynesianism recently is causing confusion in the counteraction against the crisis.

One reaction that has surfaced after the financial crisis broke out is the notion that U.S.-style neo-liberalism has fallen and Keynesianism has revived.

The view is that since neo-liberalism, which advocates reduced government intervention and puts emphasis on the autonomous market, has caused the financial crisis, it should be abandoned, and that the expansion of government intervention is unavoidable as a crisis solution.

Some even go one step further and claim that “big government” should be pursued instead of “small government.”

However, a grave error of understanding lies here.

First of all, the government stepping forward to relieve a financial crisis is not in the Keynesian prescription.

Pouring rescue funds to financial companies and nationalizing some of them temporarily are unavoidable to prevent the collapse of the financial system, but they are not the expansion of financial spending to nurture the economy as Keynes had proposed.

In addition, tax reduction and expansion of financial expenditures to prevent the collapse of the economy are also an emergency treatment to overcome the crisis situation.

They cannot be grounds for an argument that routine government functions should be expanded.

The financial crisis should serve as a turning point for strengthening government supervision on the financial market.

However, this does not mean that the government should increase its size or expand regulations.

In the United Kingdom, Keynes’ home country, people have come to the conclusion that a Keynesian prescription is not a long-term solution.

Keynes himself would probably not want people to expand regulations and seek bigger government because of the financial crisis.

*The writer is an editorial writer of the JoongAng Ilbo.

by Kim Jong-soo