Alternatives to the Cuts: Keynesian stimulus

This post forms part of the alternatives to cuts series, an exploration into why cuts won’t work, and what we could be doing instead.

As I wrote in the Will Austerity Solve the Deficit Problem? post, there is a clear relationship between the size of the deficit, and periods of growth/recession.  During periods of growth the deficit shrinks, and if the problem you are seeking to solve is the size of the deficit, then one thing you want to do is ensure that there is growth in the economy.  In that post I showed that austerity is not producing growth now, rather the economy has flatlined., and that this will fundamentally undermine the spending cuts in their effect on the deficit.

In this post I am not going to explore deeply the theory behind why governments borrowing and spending money produces growth, if people want it, I will try to write a post on that.

The basic idea is that recessions happen because of a lack of demand.  People stop spending money, and so the level of production/trade in the country decreases to match this new level of spending.  Unfortunately, there is a vicious circle effect, because as people lose their jobs, their spending (demand) decreases, causing further reduction in the level of aggregate demand, which in turn causes reduction in the level of production/trade and so on.

Governments have the ability to step in and produce demand during these periods, and to turn the vicious circle into a virtuous circle of rising demand and employment.  There are a number of ways they can do this, and Quantitative Easing was one of them.  But this produced jobless growth, as it reduced the level of debt (or at least the level of risk associated with the debt) of the private sector, allowing some growth in value of the economy, without a commensurate increase in employment.

Now is the time where a government should be spending money to invest in the economy, in order to stimulate demand and in turn stimulate the private sector back into growth.  There are many proposals as to how this money should be spent, and I will outline some of them here.

The best way to spend money for a Keynesian stimulus is by investing in infrastructure, or in areas which are either too risky, or have a rate of return that is too long for private companies to invest in.  If these investments can also help to forward other policy aims, then so much the better.

Please note that the inclusion of a possible policy here does not constitute a statement of support for that policy by Birmingham Against the Cuts.  There are other discussions to be had about the merits of each of them, which I am not going to enter here.

■Investment in Green Manufacturing / Green New Deal / Green Jobs for Growth

Variously called by different titles, this set of investment would see government funds invested in the manufacturing sector surrounding “green” industries.  The most likely place for much of this money to go would be into the design and manufacture of wind turbines – particularly offshore wind turbines- tidal and wave generators.  The UK has some of the best resources for renewable energy in each of these areas, and could be world leaders in these technologies.  Investing in these could replace some of the industries that have been largely lost, such as shipbuilding or steel production.

Additionally, it would make sense that the UK would start as the major customer of the industry in this country, and doing so would help us to reduce our reliance on fossil fuels and combat climate change.  Along with this, we need to reduce our dependency on oil and gas, and become (more) self-sustained in terms of energy usage.

I will do a lengthier post on this at some point.

■HS2 railway

This is particularly controversial at the moment, and I must emphasise that its inclusion here does not imply support or dislike for the project.  I am including it here because it is a good example of an investment whose returns will take too long for a private company to invest.  There is never likely to be the profit in a short enough space of time for a company to invest in such a project, which will take many years to construct, and many more before a return on investment is possible (if ever, given the amount of subsidies that are paid to railways already).

■Social Housing

The great council house sell-off, and the ban on councils investing in new housing is part of the reason why house prices are so high today (there are other factors, but the lack of a widescale, reasonably priced, rental market has allowed rent and house prices to rise).  We hear often of issues with affordable housing, particularly in London, or with a lack of housing.  These houses could be built to the highest environmental standards, and would be very cheap to heat during the winter.  With ever rising gas prices, this could be especially helpful for elderly people.

Additionally, the construction industry is always hit hard by a recession, and this would help that sector in particular.

■Buildings projects

Schools, Hospitals and many other public buildings could use renovating or replacing.  Such projects should not be done using PFI, which has been shown to be expensive, but would improve public services, through a one-off payment.

There are many other ways to produce a Keynesian stimulus.  The key is that increased government spending produces demand, and that it is easy for that spending to be removed once the need for the stimulus is over.  The unemployment benefit system is an example of an existing keynesian stimulus, which works almost naturally – as we enter recession, more people become unemployed, and government spending on unemployment benefits increases.  As the private sector moves back to growth, people get jobs and spending on unemployment benefits decreases.  But this is not enough – it is already existing in the system, it limits the depth of a recession but will not take us out of one.

Join us in calling for an alternative to austerity, on Sunday 18th September, outside the Liberal Democrat Conference in Birmingham.
For more information about alternatives, you can also see False Economy


Filed under Alternatives to Cuts

9 responses to “Alternatives to the Cuts: Keynesian stimulus

  1. Mike Tucker

    By accepting a Keynesian analysis of how the crisis occurred and of Keynesian solution to it you may well be presenting a more optimistic view than the situation warrants. I personally as someone who grew up during the era when Keynes dominated public discussion of the economy and public policy in many areas such as health and education and benefited from these changes I would wish that they could return and I am prepared to accept that a Keynesian stimulus would on the short term lessen the impact but we are in a bigger hole than that.

    There are alternative explanations and solutions that can be based on Marx rather than Keynes. This article presents the main Marxist alternatives, namely variations on the theme of the explosion of financial sector in the world economy and variations on the theme of the falling rate of profit. Or David Harvey here can give you a much broader survey of possible analyses of what has occurred in an easily digestible form.

    My narrative of what has occurred would be the following on which I hope we could agree.

    The crisis was triggered by the inability of the holders of sub-prime mortgages in the USA to be able to pay the interest of their loans in 2006-7. This exposed the structural weaknesses of the world economy. It was shown that the loans were not worth their declared value. Ratings agencies like Moody’s that declared the bonds that contained the loans to be very secure financial instruments. The holdings of these bonds were held by most of the worlds financial firms. The new and very large financial sector that grew was based on the betting on the value of financial instruments for both good and bad reasons. When it became apparent that value of the holdings of financial companies did not match the declared value of financial assets, panic set in on the worlds
    financial markets, to take a couple of examples, Bear Stearns and Lehman Brothers. And the rest of the world was not immune to what happened in the USA because we live in a world of global finance.

    The financial bubble of asset values was evident in Iceland and affecting banks in the UK and the equivalent of the sub prime US crisis was evident here as shown by the example of Northern Rock. The property bubble was an international issue, as shown in the Baltic republics, Ireland and in Spain and Portugal. And the property bubble was financed by funds flowing in ultimately from those countries buying bonds from their earnings in the export markets, from Germany, China and the Middle East sovereign wealth funds. Chinese exports to the West were enabled by the Chinese purchase of US Treasury bonds which helped to keep interest rates low to finance the property bubble. German machine tool exports to East Asia were enabled by Chinese and East Asian boom. The financial crisis exposed the fragility of these linkages outside of the financial sector.

    When financial companies realized that the assets of other financial companies were not worth their declared value, they stopped lending to each other and to people and companies outside the financial sector, we saw a credit freeze. So what was a financial crisis spread to the rest of the economy shown by at minimum the reduction in growth and in many countries like ourselves by the shrinkage of the economy. The associated thing to remember is how the financial sector has ballooned since the last major capitalist crisis in the 1970’s and Britain like the USA is now dependent on a large financial sector.

    Governments and Central banks are responsible for the overall stability of the financial sector and they decided to salvage the financial companies many of whom were effectively insolvent with devalued assets by providing loans at very low interest rates and guarantees for the value of devalued assets. Hence the provision of massive loans to RBOS and to the merged Lloyds and HBOS in 2009. The financial crisis of the so efficient and so productive free market economy has been transformed into the current sovereign debt crisis of governments and of austerity for us or what used to be called the working class before we lived in the wonderful middle class world of Blair and Thatcher. Since the 2nd World War the debt of governments has been rising during each of the busts in the economic cycle to boost the economy but in most cases these governments did not pay the debt down in the boom times. The last Labour government was a rare exception to this as it did reduce the
    debt in the boom times. Post war growth has become weaker and weaker and thus the burden of government debt has become higher and higher and left governments with less room to manoeuvre. We are not in the situation of the immediate post 1945 era of the possibility of an era of growth to pay down a rising level of debt. Moreover anyone advocating a Keynesian solution must recognise the scale of worldwide government action that has already taken place to salvage the private sector – a stimulus has already occurred in the form of government loans and guarantees

    We are caught of the scissors of a dilemma. If we are to follow a government stimulus to the economy the level of debt and the interest to pay for it will rise and we will be at the mercy of the bond markets as with Greece, Portugal and Ireland and a default on our debt becomes a real possibility, all 3 of those countries are effectively insolvent or we accept austerity with the risk of either the shrinking or stagnation of the economy.

    An alternative approach would be to take into public ownership the financial sector, impose capital controls and direct investment to public purposes whether that is the TUC project of a million green jobs or a program of building social housing. Full employment must become a priority with the enforced reduction of working hours to achieve this.

    Paul Mattick in these articles also presents a much bleaker view of our current prospects:

    Endnotes present this piece on the limitations of the Keynesian approach:

    For a more lengthy explanation you may wish to read Guglielmo Carchedi:

    Or Carchedi in simplified form:

  2. Mike Tucker

    The 2 links I referred to in the article that are missing on my reply are:



  3. Hi Mike,

    Thanks very much for your comment – I have edited it to add the missing links into the article. I would encourage everyone to watch the David Harvey video (as well as others in the RSA animate series, truly beautiful productions).

    As you correctly say, I do not have any disagreements with your analysis of the cause of the crisis. I shall take the time over the next week to read the articles that you have linked to before responding properly to your argument, but my initial thought is that the proposal you make in the last paragraph is not too far away from my thoughts about what a Keynesian stimulus would look like – though I have not mentioned nationalisation or capital controls. It is the direct investment in the economy for public purposes that marks the distinction between the stimulus of quantitative easing and the Keynesian stimulus that is proposed.

    I think you raise a very serious issue though, which is that if the crisis is by nature something which Keynesian economics cannot explain, then a Keynesian solution cannot solve it.

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