By JACOB M.
SCHLESINGER
Staff Reporter of THE WALL STREET
JOURNAL
WASHINGTON -- Keynes is dead. Long live Keynes.
The most influential economist of this century, John Maynard Keynes armed policy makers with fiscal weapons to fight recession and depression. But as the century ends, many nations are laying those weapons aside.
The budget President Clinton issued Monday is another step toward global fiscal disarmament. Mr. Clinton began his presidency six years ago proposing Keynesian-style public-works spending to boost a lagging economy. Now, he proposes a counter-Keynesian plan to lock up the bulk of mounting federal surpluses for the next 15 years to pay down the national debt. A centerpiece of his desired legacy: cutting the federal government's borrowing to its lowest level since 1917.
Monday morning at the White House, Mr. Clinton stood in front of a big chart labeled "Cutting the debt by more than two-thirds" and explained how "fiscal discipline has transformed the vicious cycle of budget deficits and high interest rates into a virtuous cycle of budget surpluses and low interest rates."
Onetime welfare-state champions across the Atlantic have undergone an even bigger conversion. As of the beginning of this year, Germany, France and nine other countries adopting the euro as a common currency committed themselves to keeping public deficits at 3% of gross domestic product or less. Those who push their deficit beyond that ceiling can be fined up to 0.5% a year of their GDP.
Keynes Is Dead?
In emerging markets from Bangkok to Moscow to Brasilia, the International Monetary Fund has responded to financial turmoil by ordering a painful anti-Keynesian mixture of tax increases and spending cuts. In Thailand, where the Asian crisis began 18 months ago, the government was ordered to counter adversity by amassing a budget surplus equal to 1% of its economy. To do so, Thai officials raised the sales tax by roughly 50% and slashed spending on social services and public transport.
All around the globe, fiscal stimulus is out, and fiscal austerity is in. Keynes, it seems, is dead.
Or is he?
For even as officials lay to rest Keynesian orthodoxy, signs of a revival appear. The world financial system has been hit with its biggest scare since the Great Depression first inspired Lord Keynes to urge the use of public coffers to manage demand. Much of the world now suffers from the very woes he sought to cure. That puts the fiscal rectitude embraced through the 1990s to its greatest test yet.
Reversing Course
After criticism from outside and its own soul-searching, the IMF has reversed course in Asia and urged deficit spending to soften the depression aggravated by government cutbacks. In a report issued last month on its handling of the Asian crisis, the IMF acknowledged both "overselling . . . fiscal adjustment" -- translation: too much anti-Keynesian austerity -- and then taking too long to embrace Keynesian-style expansionism. The IMF is now telling Thailand, for one, to run a deficit of 5% of GDP.
Japan, the basket case of the developed world, put on hold its year-old fiscal-austerity law after a humiliating electoral defeat last summer. Two years ago, with its economy flailing, Tokyo took the supreme anti-Keynesian act of raising the national sales tax to 5% from 3% in order to achieve long-term budget balance. It's now pushing public-works spending, tax cuts, even special shopping coupons for every family, in a fiscal-stimulus package valued at nearly $200 billion, equal to 5% of the country's GDP.
And in Europe, with the euro barely a month old, new left-center governments facing an economic slowdown and struggling with double-digit unemployment have been hinting at bending the spending constraints that were imposed on the European system by their more conservative predecessors. While still embracing the philosophy of fiscal discipline, French Prime Minister Lionel Jospin has suggested a massive Continent-wide project to build new highways and other infrastructure. Italian Prime Minister Massimo D'Alema backed the idea, adding that such spending could somehow be excluded from the official deficit limits with a "looser interpretation" of the deficit limits.
"Those with the old views are coming out, like rats out of the wall," gripes Klaus Regling, a former German Finance Ministry official who helped draft the anti-deficit rules.
Latest Hot Spot
The complicated ebb and flow of Keynesian ideas is especially evident in Brazil, the latest hot spot in the global crisis. A few years ago as a sociology professor, Fernando Henrique Cardoso was a leader of Brazil's political left. Since becoming president, he has sounded like a latter-day version of balanced-budget champion Herbert Hoover. In the face of recession, he said last month, "we will need to put in place as rapidly as possible a fiscal austerity plan so interest rates can fall and Brazil can begin to grow again." Mr. Cardoso remains committed to cutting Brazil's public sector by more than 3% of GDP over the next year, a time when the economy is expected to contract by 4% and the unemployment rate to soar into double digits.
But Mr. Cardoso faces a tough sell imposing that anti-Keynesian line on his beleaguered constituents. A popular backlash has repeatedly slowed attempts to cut public pensions and tax automatic-teller-machine withdrawals. Antiausterity protests spurred the Congress to dig a moat around its chambers. The country's currency plunge last month was sparked by a rogue state declaring a moratorium on debt repayments to the central government. Minas Gerais Gov. Itamar Franco said the national government would get money from his region only if "we have money left after paying salaries to public servants and to pay for the food of inmates."
Even in the U.S., which has weathered the global economic storms better than Europe, Asia or Latin America, the anti-Keynesian line is fraying. Now that Washington has succeeded in balancing the budget, the bipartisan consensus for keeping big surpluses is dissolving. "Alan Greenspan cut interest rates to stave off a recession," new House Speaker Dennis Hastert said in response to Mr. Clinton's surplus plans last month. "We can afford to cut taxes to do the same thing."
Fiscal Discipline
The case against Lord Keynes has its origins in the 1970s and 1980s, when nation after nation was plagued by massive budget deficits and rampant inflation. Stimulating the economy with government spending seemed a good idea, but reining in spending once it got under way proved unexpectedly tough. The new advocates of fiscal discipline insist they aren't necessarily swearing off Keynesian stimuli. Runaway deficits during good times and bad blunted the impact of that tool, they say, and the current period of belt-tightening is designed to restore the value of fiscal policy in the future.
But the 1990s boom has also had a distinctly reverse-Keynesian flavor. Countries that made the tough decisions to reduce their deficits have thrived, as supportive financial markets rallied, further discrediting the old Keynesian thinking. For a 1996 report on fiscal policy around the world, IMF economists conducted a detailed study of 62 attempts by industrial countries over the prior quarter-century to get their finances in order. The study concluded that the 14 cases where governments had been the most draconian -- notably Denmark and Ireland in the mid-1980s -- resulted in the fastest growth. "The simple 'Keynesian' view of fiscal consolidation is that lower government purchases or higher taxes reduce aggregate demand," the report said. Instead, it concluded, "there may be a virtuous circle between economic growth and debt-ratio reduction."
The U.S. enjoyed just such a boost from sharp tax increases pushed through by Mr. Clinton in 1993. Bondholders cheered and interest rates fell. "The deficit was cut, and that proved to be an impetus to substantial economic progress," says Deputy Treasury Secretary Lawrence Summers. "That is fundamentally different from what four million readers of Samuelson came away with," he adds, alluding to the standard Keynesian economics textbook, written by Mr. Summers's uncle, Paul Samuelson.
Fiscal policy has also been undercut over the past two decades by the rising clout of monetary policy and the accompanying cult of central bankers, who steer the economy not with taxes and spending but with interest rates. Then-Fed Chairman Paul Volcker jacked up rates through the 1980s directly in response to Ronald Reagan's deficits, neutering much of the fiscal kick that would have resulted. Mr. Greenspan has taken a similar tack, making clear in public statements that he would reward lower deficits with lower rates and punish higher deficits with higher rates -- a major factor in keeping the Clinton administration's spending desires in check.
Reich's Fantasy
In his memoirs, "Locked in the Cabinet," former Labor Secretary Robert Reich gives a fantasized version of an early Clinton-administration budget debate. In it, Mr. Reich advocates tens of billions of dollars for education, job training and other causes. Mr. Clinton struggles, unsuccessfully, to accept trimming subsidies for salmon hatcheries and advertising American breakfast cereals abroad. The discussion is suddenly halted by lightning, a loud thunderclap and the appearance of a cackling Mr. Greenspan, clad in a black cape. "If you take an ax to the deficit, I will cut short-term interest rates!" the Fed chairman says. "But!" -- more lightning and thunder -- "If you don't . . . I will wreck the economy."
In real life, Mr. Greenspan did reward Mr. Clinton's 1993 balanced-budget plan with rate cuts, and the 1990s boom has been largely defined by a shrinking White House role in addressing short-term economic fluctuations and an increasingly activist Fed. That's one reason for the current financial-market calm amid Mr. Clinton's impeachment ordeal. As long as Mr. Greenspan is around, many wags opine, the economy is OK.
The successful 1990s American formula has won disciples in Europe. In a speech given last November and now invoked widely around the region, France's Socialist finance minister, Dominique Strauss-Kahn, urged his Continental colleagues to reject the "Ronald Reagan-Paul Volcker lax budget-tight money policy" and embrace the "Bill Clinton-Alan Greenspan mix" of smaller budgets and lower rates.
Consider the tortuous path of Germany's Heiner Flassbeck. Until last fall, Mr. Flassbeck was the head of the Deutsches Institut fuer Wirtschaftsforschung Deutsches Institut fuer Wirtschaftsforschung (German Institute for Economic Research), an influential left-leaning think tank in Berlin. He was called Germany's leading Keynesian by the European press. In a 1997 essay, his institute wrote that the rigid budget limits required for Europe's economic and monetary union "make no sense" because they could force budget cuts in a downturn and heighten "the danger of destabilization." Today, Mr. Flassbeck regularly assures investors of his commitment to the pact. "If you're in a Japanese situation, you should use fiscal policy, but not under normal circumstances," he said during a recent visit to Washington, deriding an overreliance on budgets for economic stimulus as "the main error of the naive Keynesianism of the 1970s."
Europe's Constraints
The Europeans have practically chiseled the informal American arrangement in stone. In addition to accepting the straitjacket on deficits, monetary union has also created a new transnational European Central Bank with powers that, in many ways, exceed those of any of the governments that created it. In the U.S., Congress could, if it chose, alter the Fed's independence and its mission. In Europe, it would take unanimous approval of 15 separate governments to amend the 1992 Maastricht Treaty, which declares inflation-fighting the ECB's primary goal and says the bank must not "take or seek instructions" from member states. Wim Duisenberg, the former Dutch central banker who now runs the ECB, famously declared late last year that while it is "normal" for politicians to voice opinions on monetary policy, "it would be abnormal if these suggestions were listened to."
In much of the world, the refrain is the same: stronger central banks, finance ministries forsaking short-term economic concerns in favor of pursuing longer-term goals. Implicit in that is a global victory for Mr. Greenspan and his German counterparts at the old Bundesbank in the belief that inflation-fighting is the primary means to long-term prosperity. The old argument that governments should tolerate higher inflation in order to lower unemployment is rarely heard these days. As one of its first acts, Britain's Labor government freed the Bank of England from the control of the Chancellor of the Exchequer. Japan and Mexico have moved in the same direction, as has South Korea, under IMF pressure. Countries as disparate as South Africa, Turkey, Hungary, Peru and Ecuador espouse the mantra of "fiscal discipline" as a chief mission.
But with inflation receding as a threat, the specter of deflation looming, and high unemployment and recessions plaguing many parts of the globe, the new stirrings of Keynesianism should hardly be a surprise. And if the U.S. economy turns south, some analysts predict active fiscal policy will return with a vengeance.
"If we had 8% unemployment, Keynes would be back," says Harvard economist John Kenneth Galbraith, who proudly keeps over the fireplace in his study a framed cartoon of himself meeting with the British economist during the war. "We must remember that economists are not necessarily the creatures of great thought but of circumstance," Mr. Galbraith says. "Keynes would not have written 'The General Theory' except in the Great Depression."