Michael Roberts: Is Keynesianism dead?

Is Keynesianism dead?

by Michael Roberts

“Is Keynesianism dead?” says Andy Haldane, former chief economist at the Bank of England, writing in the Financial Times.  Haldane’s answer is “Keynesianism, if not dead, is potentially defunct.”

What does he mean and why raise the question in the first place?  The gist of it is that Haldane reckons Keynesian theory, namely that economic slumps or stagnation can be overcome by increased public spending, which “could revive the animal spirits of the private sector and, with them, growth,” no longer works. The reason is that “when debt is the disease, fiscal medicine may be as likely to harm as heal” by driving up bond yields and so raising the cost of borrowing for the capitalist sector.

So what’s the answer?  Haldane says, instead of spending more, governments need to save more ie by cutting spending and/or raising taxes so that the private sector can expand. In essence, Haldane is delivering a new (or old) argument for austerity ie cut public services (except defence of course – assuming you consider defence as a ‘public service’) and raise taxes so that majority of us pay down the rising debt.

There are so many things wrong with this so-called “expansionary consolidation“, as Haldane calls it, (the idea that trimming state debt can actually encourage private spending and confidence), it is difficult to know where to start.

First, why are public debt levels so high in the major capitalist economies?  Is it because of profligate spending by governments on public services, welfare benefits, infrastructure and pensions?  This is just manifestly untrue. 

In the OECD, public social expenditure amounted to less than 10% of GDP in 1960, but has more than doubled to just over 20% on average across the OECD since.  But two-thirds of this spending goes towards pensions and health services as populations in the major economies get older. ‘Other social spending’ is a mixture of income support to the working-age population and social services other than health. It is no more than an average 6.5% of GDP. Income support worth 1.6% of GDP is on sickness and disability cash payments, 1.1% on family cash benefits and 0.6% on unemployment benefits.  This spending is tiny compared to government subsidies to industry (1.5%, now at the highest level the global financial crash of 2008) and defence (now averaging 2.0-2.5% and targeted to rise to 3.0-5.0% of GDP by the end of this decade).

Take the UK. The Resolution Foundation think-tank estimates that total social security or welfare spending in Britain in 2025-26 will be 10.8 per cent of GDP. This is 0.8 per cent of GDP higher than it stood on the eve of the global financial crisis in 2007-08. But compared to 2012-13 (the peak in the post-GFC recession), total welfare spending has fallen by 1.2 per cent of GDP. Added to this, welfare spending is expected to rise by only 0.1 per cent of GDP until 2029-30.

So when Haldane talks about needing to end ‘fiscal stimulus’ Keynesian style because of excessive public debt, this cannot be blamed on welfare spending. 

Moreover, Haldane does not say why public debt levels have risen so much in the major economies. But if you look at the time series for public debt to GDP, you can clearly see that the sharpest and ‘step change’ rises took place in conjunction with financial crashes and recessions in the capitalist economy. It was these that forced governments to bail out the banks and other financial institutions in 2008-9 and to fund employers and businesses in the COVID pandemic slump.  Both before and between these two events, public debt levels hardly rose. 

As for annual budget deficits, again the biggest deficits were in the period of the two economic crises as governments paid out more on unemployment and other benefits while receving less tax revenues.

In the relatively faster growth periods (1991-2007), annual budget deficits averaged 3% of GDP, as they did between 2014-19.  Annual deficits have been higher since the end of the pandemic slump and this is due to the rise in interest costs as debt levels built up and interest rates rose, along with very poor economic growth in most major economies. Throughout the periods of austerity, while the majority of people faced higher taxes, others got cuts in income tax (particularly for higher income groups) and in corporate profits tax. That meant that government tax revenues as share of GDP remained flat at around 36% of GDP, ensuring a rise in annual budget deficits. 

Haldane argues that Keynesian policies of macro-management ie increased government spending and lower taxes to boost economic growth are ‘defunct’ in the current world of high public debt, because Keynesian measures will drive up debt not growth.  Haldane reckons that this means the famous Keynesian ‘multiplier’ no longer works.  The Keynesier multiplier argues that increased government spending boosts consumption and investment and so will lead to increased real GDP growth. That growth in real GDP will outstrip the extra spending and public debt and so pay for itself.

My issue here is that the problem with the multiplier is not that it does not work in a world of high public debt, but that it does not work in a capitalist economy if the profitabilty of capital does not rise from government spendng.  As Guglielmo Carchedi and I explained way back in 2013, the difference between the Keynesian multiplier (the ratio of change in publc spending to growth) and the Marxist multiplier (i.e. the ratio of the change in profits to growth) is that “in the Keynesian multiplier, …..Profitability plays a subordinate role and the effects (of public spending) on the economy are always apparently positive.  In the Marxist multiplier, profitability is central…. The question is whether rounds of subsequent investments generate a rate of profit higher than, lower than, or equal to the original average rate of profit”.  As we explained in our paper, what matters in a capitalist economy is not the movement of ‘aggregate demand’, but the movement of the profitability of capital. The Keynesian multiplier is a feeble driver of growth compared to the Marxist multiplier of profitability (see World in Crisis, p26 Figure 1.10).

After the Great Recession ended, there is little evidence that those countries that ran higher budget deficits and thus increased public sector debt recovered quicker and increased GDP more than those that did not.  Several studies show the so-called Keynesian multiplier (the ratio of real GDP growth to an increase in government spending or budget deficit) is poorly correlated with the economic recovery after 2009.The EU Commission found that the Keynesian multiplier was well below 1 in the post-Great Recession period.  The average output cost of a fiscal adjustment equal to 1% of GDP was no more than 0.5% of GDP for the EU as a whole.

Haldane’s argument against the Keynesian multiplier is different.  Increased government spending, even if directed towards public investment rather than ‘welfare’ or public services, will actually depress growth, he claims. “In a study of 44 countries, Ilzetzki, Mendoza and Végh find evidence of fiscal stimulus depressing growth — a negative fiscal multiplier — when countries’ public debt exceeds 60 per cent of GDP. With all of the G7 having debt ratios above this threshold, might we now be entering the twilight zone for Keynesian policies?”

Here Haldane falls back on the discredited theory of Rogoff and Reinhart who argued in their (in)famous book, This Time is Different, that economies with high public debt ratios (they argued a threshold of 90% of GDP) would have lower growth and eventually a financial crisis. The empirical study behind this claim was subsquently exposed as riddled with coding and statistical errors. It’s true that other studies like the one Haldane cites show a correlation between high public debt and lower growth. But does that imply that it is high public debt that depresses growth or is it the other way round: slowing growth or outright recessions cause higher public debt?  It is clearly the latter as the evidence above shows.

And if we look for rising debt as a cause of slower growth and financial crises, private sector debt, in particular excessive corporate debt and financial debt ie what Marx called fictitious capital, is a much more iikely culprit than public debt.  Rising private debt started to outstrip public debt to GDP in the so-called neoliberal period and remained larger than public debt right up to the global financial crash of 2008-9.

And as the OECD put it recently: “Since 2008, corporate bond issuance has grown significantly above trend, while corporate investment has not. Cumulative bond issuance by non-financial companies in 2009-23 was USD 12.9 trillion higher than the pre-2008 trend, while corporate investment was USD 8.4 trillion lower. Rather than productive investment, a lot of debt in recent years has been used to fund financial operations like refinancings and shareholder payouts. This suggests existing debt is unlikely to pay itself off through returns on productive investment.” 

For Haldane, ‘fiscal consolidation’ (ie austerity) will help boost growth. For the Keynesians, ‘fiscal stimulus’ (government spending) will boost growth.  In my view, both are wrong.  What boosts growth is investment in the productive (value-creating) sectors of the economy, and what boosts productive investment is increased profitability for the capitalist sector, which contributes between 15-18% of GDP in investment compared to public investment at less than 3% of GDP.  While that ratio remains, it will be the voices of the capitalists that will dominate. And they will claim that high public debt causes recessions, and so the only way to restore growth is to cut debt through austerity. And yet it is clear that it is excessive debt and the subsequent busts in the capitalist sector that leads to high public debt.

There are several ways to reduce the debt ratio burden: higher inflation, which reduces the real value of the debt and raises nominal GDP. This solution shifts the losses to the holders of debt, which is why the financial sector opposes inflation so vehemently. But it also shifts the burden onto the majority of working people through a rising cost of living.  

The other way to lower the debt ratio is to increase growth in real GDP through higher investment.  But that won’t happen as long as investment depends on the profitability expectations (‘animal spirits’) of the capitalist sector.  And no existing government is prepared to bring the strategic sectors of the capitalist economy: banks and corporates, into public ownership to enable an expansion of public sector investment. Thus ‘expansionary fisal consolidation’ (Haldane) or what used to be called fiscal austerity will remain the policy of pro-capitalist governments.