The great economist John Maynard Keynes is a much-misunderstood man. More than that, Keynes himself didn’t understand how international economies work, and he took far too optimistic a view about the ambitions of those in government. The result? Highly indebted countries are pursuing to their detriment what they mistakenly believe to be Keynesian policies.
That’s the argument recently put forward by Guy Fraser-Sampson, a former investment manager at the largest sovereign wealth fund in the world, the Abu Dhabi Investment Authority, and now an investment and economics consultant who teaches at Cass Business School in London.
Speaking at the recent Finance Directors’ Forum, Fraser-Sampson told an audience of CFOs and other senior business executives that “there is a deep and instinctive view that something has gone horribly wrong. A lot of people are very frustrated that they know something has gone wrong but are not really sure how or why or when.”
Fraser-Sampson said that since the Second World War, politicians have been adopting what he called a “bastard Keynesian” model. Keynes himself took the view that, in times of recession, governments should, indeed, intervene in the economy by running budget deficits: “They should boost public spending and that public spending will lift the economy out of recession,” Fraser-Sampson explained.
But what most people apparently don’t know is that Keynes called such deficits “abnormal spending.”
Such spending isn’t something “he envisaged governments doing all the time. It was something he envisaged them doing occasionally. As soon as good times returned, they would make good that money by running a surplus in the good years,” said Fraser-Sampson.
But what nation can actually do that? In the United Kingdom, he said, a structural surplus has been recorded only five times since 1945, “and if you talk about a real surplus — a surplus that actually reduces the amount of public debt outstanding — that’s only happened once: right at the very end of the [1979–1990] Thatcher era.”
Keynes, said Fraser-Sampson, “was a warm, wonderful generous human being and he made the classic mistake of believing that everyone else was the same as he was. He thought politicians were essentially fine, good, upstanding public-spirited people who went into public office for the good that they could do for the country, and that it was perfectly OK to trust them with running a budget deficit. As we’ve seen, he was tragically misguided.”
The world Keynes inhabited was quite different in other ways, too. It was a world of fixed exchange rates, and where most currencies were linked at least indirectly to gold. It was also a world in which there just wasn’t anywhere near as much reliance on international trade as there is today. “Keynes, himself, in [his major work] The General Theory, quite candidly admits that he doesn’t know how to model the effect of international trade — and therefore he’s left it out.”
Where all of this leads to is that a fundamental plank of Keynes’s theory starts to fall apart. He developed the idea of the income multiplier: money spent becomes income in someone else’s hands; he then spends some of that income, which in turn becomes income for others, and so on. But, said Fraser-Sampson, research suggests that in open, international economies where there are floating exchange rates and the burden of net debt is greater than 60% of GDP, the income multiplier is actually negative over the medium term.
What does this mean? “If you are a heavily indebted government in a modern environment and you try to spend your way out of recession, you will actually make things worse rather than better,” Fraser-Sampson said.
That doesn’t prevent many from trying. Look at the euro zone, he said: “We see lots of phony growth that’s been pumped in, and now the day of reckoning is at hand. You have to have very dramatic economic contraction such as you’re seeing in Greece and soon in Spain to try to squeeze all that out [of] the system.”
While acknowledging the terrible cost in terms of human misery, Fraser-Sampson argued that what was happening was, “in cold, calculating economic terms, definitely healthy rather than unhealthy. It is the Greek economy trying to find a natural level at which it can operate.”
That thought may have been depressing enough for an audience of CFOs. But there was more: “The really depressing news is, sooner or later, that is what is going to have to happen in the UK,” he warned.
Fraser-Sampson argued that, while net debt is around 70% of GDP in the United Kingdom, that figure doesn’t include the government’s enormous contingent liabilities under public-sector pension schemes, which guarantee retirement benefits tied strictly to civil servants’ salaries. Add to that the cost of financial intervention — bailing out the banks — and the ongoing liabilities associated with long-term public-private partnership infrastructure funding schemes.
The net result, Fraser-Sampson argued, is that net debt in the United Kingdom could easily be 300% of GDP, “and some people are estimating it might be 350%,” he said. “Greece at the moment is about 150%.”
So if Britain is in worse financial shape than Greece, “the natural level of economic activity for the United Kingdom might be somewhere like 70% or 75% of the present level of GDP,” he said. “You could be talking about economic contraction of up to 5% [a year] — which is roughly what’s happening in Greece — for 10 years.”
Andrew Sawers is editor of CFO European Briefing, a CFO online publication.