Thus, in an economy where distributional coalitions are numerous and powerful, the Keynesian remedies (or at least spending remedies) may be ineffectual in restoring consumer demand, private sector investment, and economic growth. Keynesian spending policies may in fact encourage the formation of distributional coalitions that eventually render those policies less effective. In the process, political friction builds between influential rent-seeking groups and those who are compelled to fund their benefits. This is the political flaw hidden within Keynes’s theory.d
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The “age of Keynes” has now lasted about seventy-five years, or roughly as long as the “age of laissez-faire” that preceded it. Is this era approaching an end under the pressures of the long recession, the financial crisis, accumulating public debt, the demands of distributional coalitions and the political tensions they generate? Keynes himself argued that the capitalist system evolves through stages by the development of new organizational forms and by its dynamic process of invention and destruction. There is thus no reason to assume that the “age of Keynes” represents a permanent or final stage in the evolution of capitalism. One prospect is likely: the United States, and advanced economies in general, are in the early stages of an upheaval that will test the Keynesian system to its limits.
a As things turned out, Keynes was not far off in this prediction. In the United States, per capita income increased about sevenfold from 1945 to the present time. Yet there is no thought today that the “economic problem” has been solved.
b In an addendum to The General Theory (chap. 23), Keynes approvingly cited Mandeville’s Fable of the Bees, which suggested that frugality and virtue carried to excess lead to general impoverishment. Keynes’s point was that his theory about consumer spending and consumer demand was not novel but had an ancient pedigree in the history of economic thought.
c The General Motors (and United Auto Workers) bailout was paid for out of the Troubled Asset Relief Program, the $750 billion program adopted to allow the federal government to recapitalize banks and insurance companies by purchasing “troubled” assets.
d The consequences for party politics are further discussed in Chapter 5 below.
Much as generals make the mistake of fighting the last war, politicians are prone to recycle old nostrums that were previously successful in getting us (and them) out of one crisis or another. The financial meltdown of 2008 thus led to a revival of Keynesian public-spending remedies and the dream of replaying FDR’s New Deal. So strong is the hold of the New Deal over the liberal imagination that few people stop to consider how different the world is today from the one that Franklin Roosevelt faced when he took office in 1933 at the very bottom of the Great Depression.
It was not surprising, following Barack Obama’s election in 2008, to hear liberal pundits and Democrats in Congress calling for another New Deal and a rerun of Roosevelt’s “first hundred days,” but even more ambitious this time. One influential columnist called our new president “Franklin Delano Obama,” while lamenting that the original New Deal was far too modest and lacking in vision to achieve reform on the required scale. Shortly after the election, an issue of Time magazine carried on its cover an image of the president-elect’s face merged into a famous photo of FDR in a convertible, wearing a fedora and a wide smile. Accompanying the image was an article titled “The New New Deal,” drawing parallels between Roosevelt’s leadership during the Depression and the opportunities now arrayed before Obama. Many said (with much relief) that the financial collapse combined with Democratic electoral sweeps marked the end of the Reagan–Thatcher era with its focus on free markets, open trade, and low taxes.
President Obama and his advisers have been of two minds about these associations with FDR, at times embracing them to burnish his image as a reformer and at others rebuffing them out of concern that he may not be able to fulfill the hopes thereby ignited. They did, however, adopt the concept of a New Deal–type stimulus package including funds for public works programs, “clean” sources of energy, and other projects designed to stimulate consumer demand and create new jobs. The Wall Street Journal reported, “President-elect Obama is promising to intervene in the economy in ways that Washington hasn’t tried since the 1970s, favoring some industries and products while hobbling others.” It is sobering to recall that the policy experiments of the 1970s, which gave us a decade of alternating recession and inflation, were modeled on the New Deal. There was little reason to expect that they would work any better today.
The New Deal metaphor in wide circulation today is based on a misconception: the belief that the kind of interventions that were effective during the Great Depression are the right medicine for dealing with a financial crisis and a stagnant economy today. This misconception rests in turn on a faulty analysis of the recent past: the notion that the market-oriented policies of the past quarter century were a great mistake and should be replaced by a more coordinated set of policies that (it is argued) will yield more stable growth and a fairer distribution of income. Thus the New Deal metaphor is now invoked as a call to overturn the free-market revolution of the 1980s, just as the New Deal threw overboard the Wall Street–favored policies of the 1920s. Such hopes are based on a fairytale version of the New Deal and a highly ideological interpretation of recent history.
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The New Deal was erected in an unprecedented calamity, with the American economy at a near standstill. Between 1929 and 1933, unemployment rose from 3 to 25 percent of the workforce, national output fell by more than 30 percent, the dollar value of U.S. exports fell by more than two-thirds, the stock market dropped close to 90 percent, and more than a third of the nation’s banks failed. The Great Depression, as it came to be called to distinguish it from the mini-depressions of the 1870s and 1890s, was a catastrophe on a scale far beyond what anyone previously thought was possible. No one knew what to do about it, certainly not Franklin Roosevelt, who had campaigned on a platform calling for a balanced budget.
When FDR took office, things were about as bad as they could possibly get, and there was little reason to worry about what we would today call “downside risk.” Thus, Roosevelt took an experimental approach to the crisis, adopting various contradictory policies in the hope that some of them might work to reverse the slide. He also had more room to maneuver than is the case with policymakers now, operating as he did in an environment in which the federal government spent (in 1932) only about 3 percent of GDP, by contrast with today’s 20-plus percent. There were no social programs to speak of. The economic collapse removed the traditional political restraints on federal spending, while international factors of trade and exchange rates did not significantly restrict Roosevelt’s options after he took the United States off the gold standard. Thus there was much room to increase federal spending, and, by blaming the rich for the catastrophe, FDR had a justification for raising their taxes.
At that time, however, the federal government did not command a large enough share of the economy to “prime the pump” with Keynesian-style deficits. (That would come later.) Since most workers were employed on farms or in factories, they could be diverted in a time of high unemployment to public works programs, building roads, bridges, and schools. FDR did not have to worry about putting