Saturday, March 21, 2009

A Fundamental Flaw in Keynesianism

In this opinion piece, economist Don Boudreaux explains one of the fundamental problems with Keynesianism. According to Keynes, when there's a recession, the government should spend more in order to make up for the reduced spending of private parties. The problem with this is that the reduced spending of private parties is a signal to investors and producers to look for opportunities in areas different from those where they've been investing and producing. Government spending dampens that signal and simply arrests or retards the readjustments that the recession is telling people should be made. As Prof. Boudreaux explains:

For example, suppose consumers’ taste for fish intensifies while their taste for beef weakens. Consumers will then spend more money buying fish and less buying beef. The resulting higher price of fish relative to the price of beef will signal to entrepreneurs, investors and resource owners to produce more fish and to produce less beef. This change in production patterns is precisely what should happen.

Specialized beef producers, though, aren’t so keen on this little piece of economic change. Some workers in the beef industry will lose their jobs. . . . Would it be sound economic policy for government to save those jobs by entering the beef market and buying more beef? Of course not, for to do so would divert scarce resources from other uses more valuable to consumers.

Now suppose that an unusual amount of such economic changes take place at one time. The result will be, and should be, that an unusual amount of economic displacement takes place in the short-run as an unusually large number of workers adjust to the new pattern of consumer demands.

Keynesians, however, misread such events as evidence that total demand is too low and prescribe higher government spending. Politicians, ever eager to justify meddling further into the economy, jump on this Keynesian bandwagon. The result is that the normal corrective adjustments in the market are thwarted and government’s power over the private economy grows dangerously.

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