Inequality and Keynesian Economics

Paul Krugman and Robin Wells have an interesting article in the Occupy Handbook edited by Janet Byrne that has just come out that has just been reprinted at (Actually, it turns out we also have a paper in the volume, see this post).

Krugman and Wells articulate and expand on a thesis that they have suggested previously. They start by arguing that the huge increase in income inequality has also had major political consequences. So far so good. This is in line with our perspective in Why Nations Fail, and it’s something we have argued elsewhere, for example here. Next comes the original part of Krugman and Wells’s argument: the main corrosive effect of this inequality is in preventing Keynesian policies to combat the recession 2007-2008 and the sharp increase in unemployment that resulted. The idea here is that the “right” (the GOP) opposes any government intervention, and Keynesian fiscal policies and work programs that would have increased employment and combatted the recession are opposed by the right because, with increased inequality, they have become more beholden to the very wealthy.

Though intriguing, this idea is not backed up with direct evidence by Krugman and Wells. It may well be true, but it is also a curious thesis. Here are some of the things we find less than fully clear about this thesis.

First, the distinction between “right” and “left” (or perhaps pro-elite and anti-elite) is not a natural one when it comes to Keynesian economics and policies. Many conservative politicians, and not just Nixon and Reagan, have embraced Keynesian economics. Both Fascist Italy and Nazi Germany were big-time Keynesians. Work creation via government programs was a cornerstone of Nazi economic policy, so much so that an economic history of Nazi Germany by Dan P. Silverman is entitled Hitler’s Economy: Nazi Work Creation Program, 1933-1936 — though Adam Tooze, The Wages of Destruction: The Making and Breaking of the Nazi Economy, argues that work creation was only a secondary objective. (See also Peter Gourevitch’s Politics in Hard Times: Comparative Responses to International Economic Crises for a comparative and nuanced picture of how political attitudes and coalitions influenced macroeconomic policies during the crisis of 1873-96, in the aftermath of the Great Depression, and in the 1970s).

Second, the argument that elites are generally opposed to government involvement in the economy reveals the very US-centric focus of Krugman and Wells. Even a perfunctory look at recent or distant history (or at our book!) should have been enough to convince one that in most societies, even in the supposedly laissez-faire 19th century Britain, elites work very hard to make the government intervene in the economy — of course, in a very specific way, to support them. It should thus be no surprise that extractive institutions are rarely built on the foundations of laissez-faire economics — think of slavery, labor draft systems such as the mita, government monopolies, institutions such as the “colour bar” in South Africa designed to keep blacks disadvantaged and forced to supply cheap labor, and government corruption. This is not to argue that laissez-faire is inherently pro-poor or anti-elite, but to emphasize that the opposite perspective is also plainly false.

Third, even in the current US context it is not clear why the wealthiest Americans should be opposed to Keynesian policies. After all, wealthy Americans are the owners of the major corporations or at the very least are strongly vested in the US corporate sector, which would also be one of the main beneficiaries of expanded aggregate demand.

Fourth, even if Krugman and Wells’s emphasis is right, we find it hard to place lack of sufficient Keynesian stimulus as one of the most corrosive effects of soaring political inequality and political polarization in the US. What about the failure of our educational institutions; the huge incarceration rate, particularly for African-Americans; erosion of civil liberties; increasingly inefficient subsidies and tax breaks to select corporations and sectors; distortions created by implicit and explicit subsidies to the financial industry? Lack of sufficient Keynesian zeal seems a little less important.

Having said all of that, Krugman and Wells are probably right to some degree. Republicans prevented more aggressive Keynesian measures, and this has likely contributed to the persistence of very high unemployment (though there is no conclusive evidence showing a very large multiplier from government spending, which is something that needs to be factored in). All the same, the reasons for this hostility to Keynesian economics are still mysterious. Perhaps it was just politicking, with small p — a way of frustrating Obama’s economic policies. Perhaps it was based on a “slippery slope argument” — if the government starts being active now, what is there to stop it from becoming even more active in the future? Perhaps and just perhaps, it was for the same reason that some economists had a blanket opposition to Keynesian policies — on “ideological” grounds not clearly based on pure economic interest. Not as big a story, but a possibility.

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