FREIDMAN VS. KEYENS: THE MULTI-TRILLION DOLLAR QUESTION

By Adhvith Dhuddu

 

The global economic crisis has rekindled the classic yet unsettled debate about government intervention, free markets and capitalism. Economists to this day are at loggerheads about this, and the most famous on either side of the debate are renowned economists Milton Freidman and John Maynard Keynes. Although the Economist magazine hailed Milton Freidman as the most influential economist of the 20^th century, Keynesian policies are being adopted all over the world by policymakers and legislators to pull the world economy out of an unprecedented crisis. It’s often said that the argument between Freidman and Keynes has long been settled and globalization, free markets and capitalism have vindicated Milton Freidman’s theories. But nothing less can be said of Keynesian economics as his deficit spending stimulus policies are rampantly being adopted in many industrialized nations as we speak.

Keynesian policy dictates that, “private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government, to stabilize output over the business cycle.” Clearly this crisis has unfolded just as Keynes envisioned: decisions by the private sector (like the over-leveraged investment banks and profit-thirsty mortgage originators) led to inefficient macroeconomic outcomes (declining GDP, rising unemployment, etc) to which governments all over the world are responding by fiscal and monetary stimulus trying their best to stabilize the business cycle.

This is also being echoed from the Obama administration who firmly believes that government is the only institution that can reverse the spiraling and reactionary crisis that is unfolding right now. Their argument is that non-government expenditure has slowed significantly and depleted close to $2 trillion in GDP leaving them no choice but plan billion’s in deficit spending to reverse a contracting business cycle. Although Keynesian policies have its drawbacks, they seem to be gaining momentum around the world as the right approach to alleviate some pain in the world’s economy now.

Keynes’s primary argument focused on utilizing government as a stimulant or a backstop during economic downturns. He claimed that aggregate demand for goods and services will decline drastically during economic downturns that will lead to high unemployment and significant losses in output. In this case only the government can step in to fill the vacuum to improve economic activity by increasing government spending and reducing interest rates. Keynes’s policies were widely adopted during the Great Depression in the 1930s-40s when the world was going through a deep contraction. To this day there are debates about whether or not massive government spending helped or prolonged the depression. Passionate cases can be made for and against the argument.

Freidman on the other hand was an extremely vocal cheerleader of a deregulated and free market economy and highlighted that government should have a progressively smaller role in the economy and the private sector. He vehemently opposed all types of government regulation saying it only contributes to lower productivity and adds costs to businesses. Many of his theories were questioned and challenged initially but in the second half of the 20^th century, the US and UK largely embraced his policies which materialized wholly during the Reagan administration (where Friedman was a top economic advisor to President Reagan) in the US and under Margret Thatcher in the United Kingdom.

His primary criticism of Keynesian policies was the threat of stagflation. He argued that too much government intervention and increased deficit spending will only spur inflation and keep productivity and growth levels very low.

So the trillion dollar question is whether the Keynesian policies adopted around the world will result in stagflation like Friedman predicts or just a slow growth period with little or no inflation. In the recent few decades, Friedman clearly had the upper hand as deregulation, opening of borders and globalization led to a flattened world, with consistent growth. Friedman, who passed away just over two years ago said as late as 2006 that the world economy is in great shape and many more years of sustained growth are foreseeable.

I only wish he lived to witness a rewinding of so many policies that were adopted over the past few decades. There are many disturbing trends that clearly show protectionist inclinations which are very worrying. The global economy is at a very critical point and the next few years might just see tectonic shifts in economic power.

Although we blame government time and again for their inefficiencies and red-tape, it is they who we turn to during times of crisis. But unfortunately, government intervention also means profits getting privatized and losses getting socialized. Friedman’s theories were celebrated, but one theory by another famous analyst, Nicholas Nassim Taleb (who predicted the economic disaster) says famously in his book, “The Black Swan,” that no math model can predict tsunami like economic events like the one we are experiencing now.

So only time will tell if the deficit spending policies being adopted will bear fruit and pull the world economy out of a recession. Personally, these policies are not the best given the current situation but we have no choice but to live with it. 

References: http://en.wikipedia.org/wiki/Keynesian_economics

http://en.wikipedia.org/wiki/Milton_Friedman

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