Is Keynes still relevant? Solving the problems of Pakistan

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Following is the article published by our group coordinator in Pakistan's National Daily, Dawn.
The article discusses the importance of Keynes' view of increasing public expenditure for economic growth instead of following strict austerity measures to reduce fiscal deficit.

Keynes in Islamabad
by Aqdas Afzal

THE story of modern economic policies starts in 1929 during the Great Depression, an economic crisis like no other. Its most severe impact was in the US where the economy contracted by almost 30 per cent, leaving one in four Americans without employment.

This crisis created an existential challenge for the liberal order — capitalism and democracy — with people wondering what good was a system if they could not put food on the table. Some scholars even connect the rise of Nazism in Germany to the ravages of the Great Depression.

John Maynard Keynes was the first economist to identify that capitalist economies had a tendency to remain stuck in a recession, unless shocked by the infusion of more money. Keynes showed that once someone’s income went up after obtaining a job, they increased consumption, which, in turn, increased the income of firms that sold whatever these newly employed people were consuming, enabling the firms to create still more jobs. In other words, the final impact of an extra unit of money would be far greater than the initial amount injected into the economy.

This ‘multiplier effect’, argued Keynes, would increase the overall demand in the economy, thereby pulling it out of an economic recession. Keynes believed that monetary policy would fail to stimulate the economy. Thus, Keynes singled out fiscal policy — public or government expenditure — as the most effective policy tool for stimulating stagnant capitalist economies.

Had Keynes been our finance minister, he would have serious reservations.

Taking a cue from Keynes, President Franklin Roosevelt implemented a massive fiscal stimulus called the New Deal. Hundreds of public projects entailing huge government spending were set into motion with the government injecting money by employing almost eight million previously unemployed Americans, at times even employing out-of-work artists to paint elaborate murals. By the time the New Deal ended in 1938, massive government spending had brought an end to the Great Depression.

A recent World Bank report points out that Pakistan’s economic growth will average only around 3pc in the next two years. Given this anaemic growth, the economy cannot generate jobs to absorb millions of people entering the labour force each year. At the same time, the government’s austerity programme aimed at reducing the fiscal deficit through cutting expenditure is alarming. Evidence from Britain’s austerity experiment since 2010 (Big Society initiative) shows that curtailing expenditure has led to entrenching poverty.

Had Keynes been Pakistan’s finance minister today, he would have serious reservations about present economic policies and would have offered a different prescription for taking Pakistan out of the economic impasse.

Keynes would have made the case that this government has taken an incorrect approach by focusing on reducing fiscal deficit by cutting expenditure as the multiplier effect also works in reverse. When the government cuts spending on infrastructure projects, like new roads, construction firms do not hire labour. This not only leads to job losses but those without jobs cut back on consumption, thereby forcing other firms to reduce production, which leads to further job losses.

Instead of curtailing expenditure and trying to squeeze more revenue, Keynes would have the government provide a fiscal stimulus for increasing the size of Pakistan’s economy or GDP. This would involve putting more money in the pockets of people belonging to the lower socioeconomic groups since they end up re-spending a big portion of their income. Doubling the size of the Benazir Income Support Programme would thus be an ideal policy for the short term. A higher GDP not only creates more jobs, it also leads to still higher tax revenues, which can then be used towards reducing the fiscal deficit.

Keynesian policies have made a comeback in the shape of Job Guarantee programmes. Argentina introduced the JG programme after the economic crisis of 2001 in which heads of households were provided employment for at least four hours per day. India has the National Rural Employment Guarantee which gives guaranteed employment of 100 days per year to rural workers — it increased the incomes of low-income households by 13pc.

The severe economic crisis facing Pakistan demands out-of-the-box thinking and agile leadership. Keynes has shown how nations can come out of economic recession by injecting — not withdrawing — money from the economy. JG programmes have been tried successfully in a number of countries where they have created jobs, raised incomes and provided economic fillips. The best brains in the nation need to get together in order to conceive, design and implement effective JG programmes that will not only reduce poverty in Pakistan but will also take us out of these economic doldrums.

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