We can’t count on redistribution to help

By James McCusker

If you listened to the news of the financial bailout agreement with Greece you could hear the unmistakable sound of a can being kicked as high as the force of 86 billion borrowed Euros would take it. No doubt students the world over will be asked to calculate the trajectory of the can this time and determine precisely when the Greek economy will again crash on impact with reality.

The more resourceful of these students will discover that a lot of the preliminary work has already been done on this sort of problem … almost 100 years ago.

In 1919, John Maynard Keynes wrote a book entitled, “The Economic Consequences of the Peace,” which concluded that the German economy was not sustainable under the punishing level of reparations demanded in the agreement that ended World War I. Instead of peace and prosperity, he predicted, Europe would get rampant inflation, economic stagnation and political chaos. He was correct.

More recently, a report from the International Monetary Fund — one of Greece’s creditors — contained echoes of Keynes when it concluded that neither the Greek economy nor the bailout agreement were sustainable without some sort of debt relief. The can will return to earth sooner than was hoped.

There are echoes of Keynes also in one of the ideas floating around Washington, D.C. these days: fixing income inequality by taxing the rich to benefit the poor. Of course, there are echoes of Robin Hood in that idea, too, but frankly most of the politicians and lobbyists don’t look so good in the costumes.

The idea’s roots are in one of the basic elements of Keynesian theory — the consumption function and its implication that as their income grows people spend a smaller proportion of it. Those with low incomes tend to spend all of their income on necessities like food, clothing, and housing. Those with higher incomes tend to spend a smaller percentage of it on these things and are able to save part of their income as well.

During the 1930s when Keynes was developing his theory, he believed that inadequate aggregate demand — consumption and investment, basically — was the reason behind economic downturns like the Depression. His conclusion was that recessions and depressions could be cured by transferring money from the people who were saving too much and putting it into the hands of those who would spend it.

Keynes believed that this could best be achieved by “deficit financing,” in which the central government borrows money to launch public projects like roads, dams, and buildings. The income received as paychecks by those who worked on these projects would be spent immediately, raising aggregate consumption and putting the economy back on track.

The theory combines economics with the widely shared belief in “pump priming” when the economy stalls. Moreover, since the funding is obtained in the bond market, it does not disturb market capitalism as the driving and balancing force in the economy.

Deficit financing turned out to be a lot different in practice than in theory. And in recent times politicians began to like it too much, and used capital markets to fund deficits that are now a permanent feature of government finance. This allowed them to avoid the politically painful budget cuts that would otherwise be necessary.

“Income redistribution” is also likely to be different in practice. It is being proposed as a cure for income inequality and long-term economic stagnation.

In its simplest form, the idea is to tax those with higher incomes and give the money to those with lower incomes. And the beauty of it, in the eyes of its supporters, is that it will increase aggregate demand without damaging the budget. It’s magic: deficit financing without the deficit.

Unfortunately, it retains a Keynesian vagueness about how the money collected, just like the money borrowed, would be redistributed. The existing methods all involve programs that are chronically susceptible to leakage from both fraud and general inefficiency. And it is difficult to imagine that the government will be able to keep its hands off any new tax revenue, which will further dilute the idea’s practical effectiveness.

The imbalance and stagnation in our economy today probably isn’t due to the tax code. It more likely is rooted in how we fixed the problem caused by the Wall Street financial crash. Our efforts had to be focused on capital markets but brought the unintended consequences of reducing access to these markets by ordinary mortals, encouraging speculation, and devaluing thrift.

We are only slowly recovering from that recession and are grasping at income redistribution to speed up the process. What are the odds, though, that another fix on top of the first one will solve the problem?

James McCusker is a Bothell economist, educator and consultant. He also writes a column for the monthly Herald Business Journal.