A Keynesian Error

      A Keynesian Error, (and Why Unions are Still Needed. )           
When most people think of Keynesian economics, they think of deliberate deficit spending used to stimulate a sluggish economy and prevent the country from sliding into a recession.  That was indeed a part of the theory of John Maynard Keynes. Another part was deliberately running a surplus to slow down an overheated economy and prevent runaway inflation.  When a country runs a surplus, it removes money from the economy through taxation faster than it injects money into the economy through government spending.  Running a fiscal deficit does the opposite.

            According to Keynes, at any point in time, there should be exactly enough money circulating in the economy to purchase all of the goods which is produced.  If this situation does not occur naturally, then Keynes believed that it is the obligation of government to create such a situation, because if government does not do this—then no one will do it.  And any deficiency in circulating cash will result in some of the goods being unsold.  As unsold goods accumulates, this leads to layoffs and eventually a depression.  But if there is too much cash, that is, too many dollars chasing too few goods, the result will be increasing prices, and eventually runaway inflation.  Yet, at some point in between, there must exist a fiscal policy which would be neutral.  To most people, It seems natural to assume that this point would occur when the budget is balanced.  Originally, even Keynes assumed this.  But this would be a serious error.  The stable, neutral point does not seem to occur with the budget in balance--it occurs with a slight deficit.  But why?  For years, I have struggled to find an answer. I think I now have one.
           The first answer I saw was related to population increase.  A neutral economy might keep everyone working if the number of workers remained constant. But if the number of young people entering the workforce were to exceed the number of old workers retiring, then some expansion of the economy would be required so that the increase in the total number of workers did not radically exceed the number of jobs. So an expansionary fiscal policy, at least a slight one, might always be required.

            You may point out that our population is not expanding much anymore, so this argument has little to say about today, even though it may explain the need for expansion in the 50s and 60s.   But there are ways that an economy can be swamped with new workers without any population expansion at all.  During the 50s, most married women were “stay at home” housewives.  But between 1965 and 1980, millions sought work outside the home.  The increase in female workforce participation in the U.S. in this time period amounted to about 19 million women.   This deluge of excess labor in itself could have caused a severe depression, but since the Johnson administration tried to fight the Viet Nam War without raising taxes to pay for it, we had a wildly expansionary fiscal policy, and so we had runaway inflation instead.

            But today, the number of women working outside the home is probably as high as it’s likely to get, so why is the expansion still needed?   Well, it’s like this:  Just when the supply of labor and the demand for labor is in perfect balance, some no good bastard, (like me) will install a piece of labor saving machinery, which will cause layoffs in that industry.

             Mind you, the specific company where the layoffs will occur will probably not be the firm where the labor saving equipment was installed.  More likely, the firm with the new equipment will lower its labor cost enough to expand its share of the market, and layoffs or plant closings will occur at the firm of a competitor who could not afford to buy such equipment.  But for the industry as a whole, more labor saving equipment equals fewer workers, unless total demand increases.   And what increases total demand?  An expansionary fiscal policy, of course!

            So what is the exact relationship between increased labor productivity, and the deficit required to keep the country out of severe depression?  It depends.  What it depends on is the strength of labor unions.   During the 40s, 50s, and 60s, we had rapid increases in productivity, but we also had tough, effective unions.  So whenever a firm installed equipment which decreased the hours required for a unit of production, the unions demanded, and usually got, a raise in hourly wage.  They were simply demanding that some of the benefit of the increased productivity per worker be shared with the workers who made it possible.  Because the average wage per hour increased as the hours per unit of production decreased, there was little or no net depressive effect on aggregate demand.  Put another way, if the workers in the firm with the new equipment were paid a high enough increase in wages, this would help compensate for the reductions in national buying power caused by the layoffs from the firm which closed its doors. In fact, this increase in spending power given to workers as a group could cause the economy as a whole to expand enough to provide jobs for all of the workers who were squeezed out.  So only a very modest deficit was required to keep the economy humming along. 

            But today, industrial unions do not usually have the power to force corporations to share the benefits of productivity increases with workers.  So those workers who are squeezed out will not be rescued by the boom caused by the increased buying power of other workers.  Either the boom to provide the required jobs will be produced by substantial deficit spending, or else we will have a depression.  I know there are many conservatives who do not much care for big unions--or for big deficits either.  And they will not be happy to learn that, over the long run, they may have to choose one or the other. But remember, when you have a real depression, it isn’t just workers who go broke.