The Keynesian years 1981-2007

A modern fairy tale is that Ronald Reagan in 1981 started a supply side and neoliberal revolution, with lower taxes and deregulation of markets, such that the economic growth since then derived not from Keynes but from Hayek. Alan Greenspan believed that fairy tale and supported the Reagan revolution with his low interest policy. 

It is a fairy tale because hard economic analysis causes these qualifications: (1) lower taxes also provide a stimulus, (2) lower rates of interest provide a stimulus, (3) deregulation releases funds that then scramble for investment opportunities (and investment is demand too).

Thus we actually had Keynesian years. It is rather amazing how much the financial sector has been bloated to create that relatively meagre economic growth. Funds were sprayed around like water from a fire hose, in ict,, housing and the financial sector itself. Most investments failed but some were productive enough to count as economic growth.

The main thrust of the Reagan revolution lies not on the supply/demand distinction but on fundamental goals, such as on more income inequality and less parliamentary control of social-economic processes. To evaluate its success, it is necessary to correct for the “Keynesian” demand-side stimulus, otherwise we could exaggerate.

Of course there were supply side effects. Disentangling these effects is not easy. Policy measures have effects along different channels, and only partial effects might be classified as purely supply or demand. But these subtle issues get lost in the fairy tales that are being told.

This analysis is crucially important for understanding what we should do now in this phase of the economic crisis. The Reagan stimulus has fallen away and there is actually a contraction since we start re-regulate again. World investments have been paltry. Firms redirect funds towards consolidation rather than towards expansion and innovation. We now are in the anti-Keynesian years 2007-2012. Governments face a huge challenge to turn the scales and jump-start their economies again.

The best policy for governments is to set up National Investment Banks (NIBs) and redesign the tax mechanism, see DRGTPE. Value added tax (VAT) can be 1% and some countries may consider a 20% reduction in the working week, since such NIBs may take some time to get started.

PM. Piketty et al. (2011) consider the tax rate of the top 1% of the pre- and post-Reagan situations, and try to determine the impact. On income inequality they conclude: “the evolution of top tax rates is a good predictor of changes in pre-tax income concentration.” On wealth creation itself: “there is no correlation between cuts in top tax rates and average annual real GDP-per-capita growth since the 1970s.” I am a bit afraid that the discussion will be about their elasticities while the real clarification rather lies in the logic of the analysis. In my impression it is possible to already resolve current unemployment, see DRGTPE.


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