Faceoff: Keynes versus Hayek

Ron Kneebone, PROFESSOR, DEPARTMENT OF ECONOMICS AND THE SCHOOL OF PUBLIC POLICY, UNIVERSITY OF CALGARY

STANCE: GOVERNMENTS CAN HELP DURING SHOCKS

Butting heads

People like to paint a picture of excessive disagreement among economists. I don’t think we’re really at loggerheads. We all believe the market economy in Canada is resilient, and if left to its own devices will absorb the effects of shocks and eventually recover.

If you brought John Maynard Keynes and Friedrich Hayek into a room, they’d agree most of the time. But an important source of contention would be how quickly the economy responds to market shocks. Hayek thought it responded pretty quickly without the need for government intervention. Keynes had his doubts.

Easing equilibrium

Government spending may have done little for Bay Street. But the Bank of Canada’s efforts to ease liquidity, minimize the domino effect of troubled financial firms, and provide confidence in Canadian financial markets had a huge impact on equity markets.

Pay attention to what the Bank of Canada and OSFI will do to regulate financial markets, and to what Mark Carney is doing in his new role as chair of the Financial Stability Board for the G20. These actions will weigh far more on the future of Canadian financial markets than any other form of stimulus spending.

Shock treatment

Rigidities can prevent the economy from adjusting quickly, [so I] sometimes support trying to speed up adjustment. No economist disagrees with what Hayek said: eventually the economy will adjust to full equilibrium. But when Keynes wrote his 1936 treatise on stimulus spending, it was almost seven years into the Great Depression. He wondered how long it would take to get back to long-run equilibrium. “After all,” he said, “in the long run, we’re all dead.”

At the start of the 2008 recession, the prevailing fear was that if something dramatic wasn’t done quickly to buttress crumbling markets, there would be prolonged and deep recession. Most economists supported a strong stimulus package; many cited Japan. It was hit with a similar crisis in the early 1990s, was slow to inject stimulus, and suffered a long recession and slow economic growth for 20 years.

Key lessons

The Canadian government need not have applied its stimulus package nationwide. The recession was more serious in certain regions; in particular, Ontario and Alberta. Yet the Canada Action Plan was applied nationwide with the result that too little stimulus was applied where it was needed most, and some stimulus was applied where it wasn’t needed at all.

Extra government spending or tax cuts tend to have a hangover effect in the form of debt. The full economic impact of a stimulus package is not known until the debt incurred to finance the stimulus is paid off. To be more proactive, policymakers should make these stabilizers more sensitive to the state of the economy. Pay more in EI; cut taxes more deeply for people out of jobs.

The great debate

Keynes	Hayek
Recovery entails reducing the propensity to save and increasing consumption in order to sustain companies’ profit expectations.	Recovery requires the liquidation of excessive investments and an increase in consumer saving.
More spending	More austerity
Government oversight	Free markets
Fight unemployment with inflation	Fight inflation with unemployment

Niels Veldhuis, VP OF CANADIAN POLICY RESEARCH, FRASER INSTITUTE

STANCE: STIMULUS SPENDING DAMPENS ECONOMIC GROWTH

Evading evidence

There’s enough empirical and academic evidence to suggest a Keynesian model of stimulus doesn’t help economies transition from recession to growth.

There’s enough empirical and academic evidence to suggest a Keynesian model of stimulus doesn’t help economies transition from recession to growth.

Numbers don’t lie

As a result of stimulus spending, countries have been left with large annual deficits and significantly more government debt — all of which are a significant drag on the economy. When governments directly compete with and supplant borrowers in the private sector, private investment projects — which are crucial to a sustained economic recovery — are displaced.

The Fraser Institute analyzed what caused the economy to stir between the second and fourth quarters of 2009, and found the government’s contribution to growth remained unchanged, while the growth rate of business investments and exports increased dramatically.

And, between the second and third quarters of 2009, GDP growth improved by 1.1 percentage points, of which government consumption contributed 0.1 percentage points, while private-sector investments contributed 0.8 percentage points.

Key lessons

In 1995, the Wall Street Journal dubbed Canada an honorary member of the third world because of the unmanageability of our government debt.

In the 90s, federal and provincial governments got their budgets in order and began reducing business and personal taxes to make this country a better place to invest. That’s why we didn’t feel the pinch as much as other G7 nations, and rebounded much more quickly.

Also, governments usually can’t get the timing of a stimulus right. Even professional economists can’t anticipate recessions correctly. By the time governments are galvanized into action, the economy naturally starts pushing itself out of recession.

The best course of action is for a government to make the country a better place to invest and take entrepreneurial risks. It doesn’t mean meddling in certain industries, or regions.

It’s the same role regardless of recession or boom. But taking money from businesses that have been successful and transferring it to businesses that haven’t is not a model for economic growth.

Kanupriya Vashisht is a freelance journalist and writer based in Toronto.