Why the Keynesian Economic Theory is So Wrong
It is leading the world into disaster
I was wondering why the world was in such a huge economic mess. That led me into the rabbit hole of studying economic theory. And then I realized that the world follows the Keynes economic theory. This made everything clear. That economic theory is leading to an economic disaster. Let me explain.
First, the Major 3 Economic Theories
There are three main economic theories - Classical, Austrian, and Keynesian. While this won't be a deep dive into each, I'll analyze the important bits and key differences.
The classical economic theory was introduced by Adam Smith in his book, Wealth of Nations. If you studied economics in school to any length, you would be familiar with his name.
Essentially, Adam Smith argued for work and specialization. He basically said people must be involved in productive work for wealth to grow. Also, he emphasized specialized work. This means that instead of one person making something they need from scratch, people should focus on different areas.
For example, if you want to make a t-shirt alone, you have to plant the cotton. Take care of the plantation. Harvest when ready. Then you have to process it all by yourself. And then sow it into a design, just to make a t-shirt for yourself.
Adam Smith argued against this lifestyle as it is anti-wealth. He said everyone should specialize in something. The cotton farmer should only specialize in planting and harvesting cotton. There should be people working on cotton processing separately. Then, the people who sow are different too. And so on.
With this, production can be at scale and productivity can grow rapidly. That's basically the core of Adam Smith's idea. The whole theory goes into so many other things and details.
The Austrian school of economics was a development on the classical idea. Austrian economics focused on people determining the value of things by what they are willing to pay for it - which meant that all work is not valued the same way even though they might entail the same labor.
They agreed with the classical idea to a large part but introduced more concepts into the mix. Concepts such as marginal utility value.
It goes like this. If you have 1 pot, the difference it makes in your life going from 0 pot to 1 pot is pretty significant and valuable. But as you increase your number of pots, it becomes a less valuable addition. 2 pots sounds great, but not as profound as getting that first pot. And by the time you have 20 pots, the value of the 21st pot is almost zero. (You get the point).
So, the production of value (as argued in the classical theory) becomes subjective with time. Individual consumers over time get to determine the value of what is produced. This means that if people won't buy (or use), even though work has been done to produce it, the thing doesn't have value.
Unlike classical theory that argues that the value is imputed by work. Austrian argues along the lines that the value is imputed by the consumer's willingness to buy.
But this has some drawbacks because we know that the consumer can be very irrational. However, the Austrian school takes economic theory to the realm of philosophy and free markets. The consumer must be allowed to decide and economic policy is built around how people live.
Keynesian economic theory looks like what someone came up with when they asked the question - how can we make governments rich while the people stay poor? I know that sounds like a direct attack, but it got me really mad. Keynesian economics is always at odds with the Austrian school.
While the Austrian school tends towards economics as a philosophy, Keynesian economists argued for it as being a science. A science like physics. This means an economic theory driven by data and statistics. The theory basically states that government intervention (can and) should stabilize the economy. This, in my opinion, has been the reason the world has been in a debt mess, especially since 2008. Let me explain.
The Keynesian theory argued for fiscal stimulus. Now, because the consumers were irrational, the Austrian school of economics found the boom-bust cycle inevitable. Every couple of years, there is a recession or depression. This is the reason for the Keynesian theory (named after the economist, John Maynard Keynes).
First of all, think of how stupid this is, has recession or depression ended because of that? No, it hasn't. Do we have price stability? Nope. So, the very problem it solves still continues. Just a side note. (Yes, I'm mad)
Keynesian theory proposes that the government minimize spending during the boom times and tax the people. Then during the bust, the government creates fiscal stimulus for the economy and essentially devalues the currency. This is to cushion out the boom-bust swings. This is so that there won't be depressions and recessions.
This fiscal stimulus theory is why the world is caught in a debt trap today. And yes, things look like they were going well at first. But eventually, the reality sets in. Just like you can't predict the consumer, the government is just as unreliable.
Yes, there are taxes and there is an inflation target for central banks. But government spending never goes down. During the boom, the government overspends. During the bust, they still overspend. And it has gotten so bad that there is no incentive to reduce fiscal deficit in any country.
Meanwhile, the government chooses who to save during the bust cycle - they end up helping the rich get richer with the fiscal stimulus. Fiscal stimulus keeps increasing the distance between the super-rich and others.
Fiscal stimulus has become a tool of the government to help their business friends.
The Austrian school makes a lot of sense to me and yes it does need a bit of improvement. However, the Keynesian theory is leading to a disaster. Almost all countries in the world use Keynesian economics - the USA definitely does.
There are two ways the Keynesian economic theory ends - hyperinflation (and the brutal devaluation of currency) or government collapse (fueled by lack of trust).
Inflation is already a problem in most parts of the world. And political stability is at an all-time low because fewer people trust the government. It is just a matter of time before people start thinking they can do without governance. And that will get ugly. Or maybe it is already in some places.
The Three Assumptions of Keynesian Economics
How can you be so sure Keynesian will fail? The economic theory makes three basic assumptions. And I doubt if John Keynes himself was aware of these assumptions. But over time, it is becoming clearer that those assumptions are not true. Here they are:
1. People are stupid. People are economically stupid. They cannot see, anticipate, or solve economic problems. They always need saving. This includes individual businesses too.
2. Governments are responsible and completely rational. Government will make data-driven decisions that are completely logical and smart every time
3. Economic growth is not possible without inflation
Fiscal stimulus is why businesses aligned with governments are rich and others struggle for so little.
It turns out people are not so stupid. When push comes to shove, people aren't so stupid. They may be economically stupid during the boom, but the bust drives some logic into them again. And yes, while many still stay economically stupid, those who aren't stupid don't want to share in the fate of those who are.
Governments gradually grow irresponsible. It doesn't happen overnight. But with each fiscal stimulus, the government grows more irresponsible. And with the financial market getting a jolt of excitement when there is a fiscal stimulus, the economy gradually depends on stimulus that everybody just wants to eat a piece. It becomes less about creating value people need. And it becomes more about creating what there is a stimulus for. And governments start to chase bigger and bigger pipe dreams.
This is why central banks have a 2% inflation target. That tells you everything you need to know. With an inflation target, they are forcing businesses to chase growth. But the problem is what happens when you don't have tangible things to grow into? This is when you have problems such as Facebook (now Meta) getting into the metaverse. I'm still unsure of the fundamental problem that solves.
It is just as explained in the Austrian school. The metaverse is like the 21st pot you bought. Almost unnecessary. Almost doesn't improve the quality of life in any way. But those companies have to keep coming up with "growth", otherwise their valuations start to drop. And the worst of it all is that such stupid growth is encouraged by fiscal stimulus.
Think about the mass production of EVs where the demand is not close to that. But governments keep providing stimulus so people can buy them. It doesn't make sense. Government-driven consumption through fiscal stimulus is not sustainable. It only creates more wealth inequality.
The biggest disadvantage of Keynesian economics in my opinion is the emphasis that economics is a science that must be data-driven. I find that utterly stupid. First, data is always backward-looking. How can you use data from the past to formulate economic policy for the future?
Second, data can be manipulated. And it is manipulated. You can make data say what you want it to say. People will always find a way to keep fiscal stimulus coming their way.
Economics is only a science in retrospect. Economic policy should be led by philosophy, not data. The question should always be - what kind of economic environment do we want to create? Are the incentives in the right places to create such an environment?
I agree more with the Austrian school as far as national economics is concerned. However, it needs some improvements too. But there is hope along those lines.
Where there is no honest money, trust will keep going down. Trust in governments (all over the world) has been consistently dipping since 2008. Maybe even longer than that.
I asked a friend what fundamental developmental product or service has the world produced since 2008. I'm struggling to come up with one. Everything made has been consumption-led goods and services. It's kind of like the 21st pot - people replacing their 20th pot with another pot. I don't think we've had a zero-to-one moment since then. And the money supply has skyrocketed.
Every business is chasing fiscal stimulus, thanks to Keynesian economics. Well, I highly recommend you chase the fiscal stimulus too. That's because when the bad times come, it will come on everybody - whether you enjoyed the fiscal stimulus or not. Maybe the bad times have already started, who knows?
I rest my case
P.S. Learn about how banks operate in today’s world. If you haven’t never studied this, your initial guess will be wrong