These Three Dead Guys Can Fix Our Broken Economy

(Top photo: a trader on the floor of the New York Stock Exchange. Photo: Richard Drew/AP/Press Association Images)

We seem to be reliving the 1930s – first time as tragedy, second time as farce. For the financial crisis, read the stock market crash; for austerity, the gold standard; for right-wing authoritarian populism, well: right-wing authoritarian populism. In both eras a financial shock rippled through the economy, engendering a lost decade. Th

ey had high unemployment. We have stagnant wages. Both have political turmoil and a growing revulsion towards globalisation. The 30s ended badly. We should probably try to get off this train.

The sad bit is, all this pain has been unnecessary. Eighty years ago, three economists showed us the way out. Alvin Hansen described what is wrong with the economy, John Maynard Keynes told us how to fix it and Michal Kalecki recognised the political obstacles to the cure.

Alvin Hansen explained the mass unemployment of the 1930s with the expression "secular stagnation". The phrase unfortunately might evoke the image of an atheist sitting on a park bench, guzzling beer in the middle of the day, but all it means is: too much saving and not enough investment. The reason the Great Depression lasted so long, according to Hansen, was that the private sector refused to invest its savings in new technology or productive capacity. This savings glut drained the economy of needed demand. Lack of investment created the Great Depression.

Consumption is relatively constant; we always need to feed and house and clothe ourselves. But investment is variable, and it is changes in investment that determine the health of the economy. If investment exceeds savings, the economy grows fast but interest rates and inflation go up. When it's the other way around, as in the 1930s and today, demand is insufficient, wages stagnate, unemployment is high and recessions much more likely.

The reason investment was lax – both during the Great Depression and today – is that the cost of capital goods (the machines companies need to make other products) keeps falling. The technology of the 19th and early 20th century was capital intensive. Today, not so much. It cost billions to start US Steel. It cost hardly anything to start Facebook, Snapchat or Twitter. The digital economy requires little investment, and even steel mills cost much less than they used to. Cheap capital goods lower the need for investment. Meanwhile, growing inequality increases our collective propensity to save. Neither trend is likely to change. We could be stuck in secular stagnation for a long time.

Fortunately, John Maynard Keynes figured out the solution. Back in the 1930s, a third of the country was ill housed, ill clothed and ill fed, not because we couldn't manufacture enough homes, shirts or vegetables, but because consumers could not afford to buy them. And as long as consumers were unwilling to purchase products, firms had no reason to hire anyone to make them.

At the time, orthodox economists had a simple solution for unemployment: cut wages. If wages fell far enough, they figured employers would start to hire and the economy could finally take off. Keynes saw the flaw in their logic. Workers are also consumers. Lower their wages, they will have less money to spend and entrepreneurs will sell less. Firms will fire workers rather than hire more. Keynes had the answer. If the private sector is loath to invest, then the public sector must take its place and become the investor of last resort.

Half-jokingly, he suggested government pay some men to dig ditches and others to fill them. Even that useless labour would put money into workers' pockets, which they would spend, which would stimulate manufacturers, which would give impetus for the private sector to once again hire and invest. Government deficit spending, for Keynes, was the magneto – or starter motor – that sparks the mighty engine of the private sector economy.

World War II proved Keynes right. Everybody knows it was WWII that ended the Great Depression, but it is important to remember it wasn't the slaughter of soldiers or the destruction of cities that restored economic growth, but rather government deficit spending. Killing people and blowing up factories is even less productive than digging ditches and filling them. Had we spent the same amount of money fixing roads or improving schools as we did defeating the Nazis the economic effect would have been even greater.

This isn't news. Keynesian counter cyclical deficit spending is taught in every Introduction to Economics class. And yet policymakers habitually ignore this simple solution. It seems bizarre. Government spending on infrastructure improvements creates jobs, hikes wages, increases sales, raises corporate profits. It stimulates the economy today and creates better schools, roads and hospitals for tomorrow.

And yet, even in the midst of recession, men in expensive suits told us we need to tighten our belts, cut budgets, raise taxes. Austerity is the exact opposite of what the economy requires. Why do pundits, politicians and businessmen fulminate against the very policies that could make everyone's life better?

Michal Kalecki began his "Political Aspects of Full Employment" by noting that most economists recognised fiscal stimulus can cure unemployment. Spending on infrastructure improvements (or subsidising mass consumption) is good for workers, giving them jobs and higher salaries, but   Kalecki added it is also good for business. Extra demand creates sales and so boosts corporate profits. Everybody wins – workers and entrepreneurs alike. Kalecki asked, "The entrepreneurs in the slump are longing for a boom; why do they not gladly accept the synthetic boom which the government is able to offer them?"

His perceptive answer: full employment reduces the boss' power. When jobs are easy to get, getting fired is no big deal. If your boss is a pain in the ass you can tell him to "take this job and shove it", wander across the street and get a job with his competitor. Good luck trying that today. Right now, all the power in the workplace is with the employer. No matter how unreasonable your boss, you had better obey his whims. A "reserve army of the unemployed" keeps workers in line, and for management that is more important than higher profits.

For Kalecki, writing in 1943, this explained the appeal of fascism. By militarising government spending, fascism keeps workers subservient while still stimulating employment and profits. Like most Tories and Republicans today, German big business vehemently opposed increased   government spending. That is, until Hitler showed up. Once he crushed the unions and left-wing parties, firms were happy to make huge profits rearming the German military.

The 1930s ended with Hitler and war. If policymakers in our current decade had employed Keynesian fiscal policy, rather than austerity, we would have more jobs, higher wages, a stronger economy. Most likely, Brexit and Donald Trump both would have been avoided. We could have afforded to build schools and hospitals and public housing and free WiFi for all. Minuscule interest rates tell us we have all the capital we need. Fiscal stimulus creates jobs today and builds infrastructure for the future. If the private sector wants to save but doesn't want to invest, the public sector can invest for it.

The only thing standing in our way is elite fear that plentiful jobs and a growing economy will make workers too cocky and hard to control. It is worth the risk. The downside is too steep. If   the powers that be continue to oppose fiscal stimulus, their intransigence might end up as badly this time as the last.

@tomstreithorst