The Keynesian Moment Passes

The illusion that the global financial crisis opened a new era of social democratic possibilities, with state intervention to tame capitalism and promote fairness, is dissolving.

Nobel Prize winning economist Paul Krugman wrote about ‘The Keynesian moment’ in 2008. Keynes’s ideas had dominated the economics profession until the 1970s when it became clear they had failed to predict, prevent or solve the slump that ended the long post-war boom. Krugman now gloated that ‘in the long run, it turns out, Keynes is anything but dead’.

Keynesian fiscal policy was apparently vindicated as governments, especially in the United States and China, started to boost spending and expand their budget deficits to overcome the global financial crisis. Huge sums were spent on bail-outs for failing banks. In Iceland, Britain, Ireland this included nationalisations.

In an unguarded moment during his 2008 election campaign for the presidency of the United States, Barack Obama even said ‘think when you spread the wealth around, it’s good for everybody’.

In February 2009, then Australian Labor Prime Minister Kevin Rudd wrote that ‘it now falls to social democracy to prevent liberal capitalism from cannibalising itself’. In contrast to the neo-liberal policies that led to the economic crisis, he argued that a new era was opening, drawing on Keynesian economics and social democratic traditions, ‘a system of open markets, unambiguously regulated by an activist state, and one in which the state intervenes to reduce the greater inequalities that competitive markets will inevitably generate’.

The logic behind increases in public spending in rich countries was that the financial crisis had led to collapses in both individual expenditure and business investment.

The financial system was in a mess, no-one wanted to lend to anyone else because it was unclear who held how many assets, especially real estate derivatives, which might turn to vapour and bankrupt their owners. Market interest rates went up, businesses could not borrow to invest and, in any case were reluctant to expand or update their machinery, equipment and buildings for fear that they wouldn’t be able to sell their products. As unemployment rose, consumers were fearful about their future and cut back on their purchases too.

Many governments borrowed or expanded the money supply not only to prop up banks but also to boost effective demand. So they subsidised increased household consumption by giving away money, through direct payments, tax rebates, tax cuts and rebates, for example on purchases of home insulation in Australia and fuel-efficient cars ‘cash for clunkers’ in the USA. They funded construction of school buildings, roads and other infrastructure. An aspect of most stimulus packages was some redistribution of income from the rich to the less well off, who were more likely to spend rather than save the extra money.

But this was not their main purpose. By racking up large budget deficits to sustain demand, governments wanted to create a safety net for profits, plummeting because of chaos in the financial system.

In the short term, this approach had some success, in countries which could afford it.

The fundamental problem is not dealing with short-term movements in effective demand. It is declining profit rates.

As the value of machinery and equipment grows, compared to outlays on employing workers who create new wealth, there is a long term tendency for the rate of profit to fall. This tendency can be offset in various ways. Companies can squeeze more work out of employees or gain access to cheaper raw materials and other inputs. Businesses that have bought assets at a discount during an economic crisis can achieve a higher rate of profit than the previous, but now bankrupt, owners of the very same productive resources. Governments can reduce taxes on profits in the form of the revenue of corporations or wealthy individuals. An individual firm can boost its own profits by investing in new, more efficient technologies than its rivals use, although this also reduces profit rates across the industry.

Low profit rates in productive enterprises led to a spectacular rise in the financial gambling that creates no new value and simply redistributes wealth to those who are lucky or who have inside knowledge. This speculation gave rise to the Global Financial Crisis. It was intensified, but not caused, by the lax regulation of banks, hedge funds and other enterprises that have no interest in the creation of real, let alone useful, commodities. They traded and still trade in exotic securities, like credit default swaps and collateralised debt obligations, as well as, currencies and vital commodities, like oil, food and minerals, leading to wild fluctuations in prices.

Some neo-liberal policies ‘free up’ labour markets, by attacking trade unions and workers’ ability to organise, and seek to reduce the drain on private sector profits represented by taxes on corporations and the rich that help fund public health, education and welfare spending. To this extent, they help restore profit rates, redistributing income to the wealthy by reducing the living standards of the large majority of the world’s population who are workers.

Hence the debates over the balance of economic policy among rival defenders of the capitalist order, from the outset of the global financial crisis. Some gave greater weight to short-term measures to prop up effective demand and failing banks. Others emphasised attacks on wages and public spending.

At least initially, social democratic politicians prime ministers Rudd, Gordon Brown in Brown and, initially José Luis Rodríguez Zapatero in Spain and George Papandreou in Greece generally favoured ‘Keynesian measures’.

Some conservatives Chancellor Angela Merkel in Germany, the French President Nicolas Sarkozy, and Australian opposition leader Tony Abbott were early, stronger advocates of austerity. Merkel, presiding over the relatively strong German economy and concerned to maintain its competitive edge put together a tough ‘savings package’ in 2010. She opposed stimulus spending by weaker countries in the European Union, which would be underwritten by Germany.

On the other hand, it was the conservative Bush, confronted with the sharp downturn but in charge of the largest economy in the world, who initiated stimulus spending in the United States, coupled with tax cuts for the rich. Similarly, China’s conservative rulers, despite their ‘communist’ label, dramatically increased public spending. They could draw on revenues accumulated during many years of rapid growth and were fearful that if growth slowed much and unemployment rose they might face popular revolt, as economic prosperity was their main source of legitimacy.

Despite continuing high levels of unemployment in many countries, particularly since 2010, there has been a shift towards more austere economic policies across the world.

In some countries, continuing economic stagnation prompted the turn back to neo-liberal policies. Out of favour with public and private international financial institutions, Greece, Ireland, Portugal and Spain simply could no longer afford to prop up economic activity through public spending.

In Britain the victory of the Tory-Liberal Coalition of David Cameron and Nick Clegg signalled the shift.

Elsewhere Australia, China, Germany and to some extent the USA improvements in growth rates opened the way to neo-liberal policies.

Rudd’s successor, Prime Minister Julia Gillard has made deficit reduction a matter of honour and electoral credibility. While promising to cut the corporate tax rate, she proposes an income tax levy which will affect large numbers of workers, on the pretext of disaster relief. She is cutting government spending and imposing new penalties on the unemployed.

Obama’s recent ‘State of the Union’ address was a further step in his migration to neo-liberal policies, designed to raise profits at workers’ expense. He had already extended George Bush the Lesser’s tax cuts for the rich and announced a two year freeze on federal public servants’ salaries. In a bid for partnership with the Republicans who have won control of Congress, Obama now wants to ‘lower the corporate tax rate for the first time in 25 years without adding to our deficit’, while committing to hold discretionary spending steady for five years, that is to reduce it in real terms, and foreshadowing cuts in health and welfare outlays too.

The social democrat Gillard and the ‘liberal’ Obama are intoning the same dirge about budget deficits as the conservative Merkel, Sarkozy and Abbott, and the gnomes of the European Central Bank and International Monetary Fund.

Underpinning the reversion to neo-liberal policies is the reality that capitalism depends on profits extracted from workers and that squeezing more out of workers is crucial to restoring the profit rates upon which capitalist growth depends.

Across the developed world, governments are cutting public spending, raising the age at which people are eligible for pensions and targeting wages. The Keynesian vision is evaporating.

Keynes is literally and metaphorically dead. And neo-liberal ideas are zombies, still walking and spreading misery, like the system they justify.

On the other hand, the Arab revolution spreading out from Tunisia raises demands that are not only democratic but also economic and social. These and the capacity of ordinary people for mass organisation and initiative demonstrated by the upsurges, suggest the possibility of a world that is not geared to profit-making or based on national or workplace dictatorships.

Rick Kuhn is the author of the Deutscher Prize winning Henryk Grossman and the Recovery of Marxism and the co-author with Tom Bramble of Labor’s Conflict: Big Business, Workers and the Politics of Class. He is a member of Socialist Alternative and a Reader in Politics at the Australian National University. He can be reached at