The Keynesian Illusion

The Keynesian program can be described briefly as follows:

During recessions, the government should countercyclically borrow and spend to stimulate the economy. During boom times, the government should countercyclically cut spending and reduce its debt.

For example, the Keynesian wizard deluxe, Paul Krugman, wrote in a recent column:

"The boom, not the slump, is the right time for austerity." So declared John Maynard Keynes 75 years ago, and he was right. Even if you have a long-run deficit problem — and who doesn’t? — slashing spending while the economy is deeply depressed is a self-defeating strategy, because it just deepens the depression. ... When the private sector is frantically trying to pay down debt, the public sector should do the opposite, spending when the private sector can’t or won’t. By all means, let’s balance our budget once the economy has recovered — but not now. The boom, not the slump, is the right time for austerity.

Let's examine how this Keynesian program might be applied in the real world.

In his recent press conference, President Obama said that the federal government could stimulate the economy by sending money to state and local governments to hire more police officers, firefighters, and teachers:

[O]ne of the biggest weaknesses has been state and local governments, which have laid off 450,000 Americans. These are teachers and cops and firefighters. Congress should pass a bill putting them back to work right now, giving help to the states so that those layoffs are not occurring. ... The private sector is doing fine. Where we’re seeing weaknesses in our economy have [sic] to do with state and local government — oftentimes, cuts initiated by governors or mayors who are not getting the kind of help that they have in the past from the federal government and who don’t have the same kind of flexibility as the federal government in dealing with fewer revenues coming in.

One municipality that has cut the number of its police officers dramatically over the last several years is San Jose, California. A website sponsored by the San Jose Police Officers Association, the union for San Jose policemen, has a graphic that shows that the number of police officers in San Jose has been reduced from around 1420 in 2000 to around 1070 in 2012, a 25% reduction. So, presumably, President Obama would approve of sending federal money to San Jose so that San Jose can hire back the police officers who have been laid off.

But, let's ask ourselves why these police officers were laid off? According to Chuck Reed, the Democratic mayor of San Jose, it is because the cost of retirement pensions and benefits for these government workers has spiraled out of control. If San Jose is to make the payments it is obligated to make to retired police and firefighters, it has no choice but to make cuts elsewhere, including in the number of police and firefighters currently employed.

Now, suppose that the Federal government sends stimulus money to San Jose to hire back some of these laid off workers. According to the Keynesian program, this stimulus money will be withdrawn when the economy improves. After all, "the boom, not the slump, is the right time for austerity." But, then, San Jose will find itself back in the same situation it currently is in: the costs of pension and benefits for its retirees will still be sky high and it still won't have sufficient funds to cover them.

We conclude, then, that, absent any reform to police retirement pensions and benefits -- a reform that 70% of San Jose residents recently voted for, but that the San Jose police union is vigorously opposing in court -- either San Jose will again be forced to lay off massive numbers of city employees when the Keynesian stimulus is withdrawn, or the stimulus will not be withdrawn. The second alternative is the one that is usually chosen. After all, when "happy days are here again," what incentive is there to cut spending? This results in a new, permanently higher plateau of federal borrowing and spending.

In sum, the Keynesian program that economists like Krugman and politicians like President Obama peddle is a bait and switch. People are lured into spending by the promise that debt and deficit reduction will follow. But, only the first part of the program, the stimulus spending, is ever carried out. The "time for austerity" never, in fact, arrives and deficits and debt spiral ever upward.

The only permanent solution to San Jose's problem is to reduce its retirement pension and benefit costs. Keynesian stimulus won't work. It is nothing more than a payoff for Obama's cronies in public service employee unions, similar to the payoffs to the UAW that Obama orchestrated through the Chrysler and GM bailouts.