Cainz X ESSA DEBATE: Is Keynesian economics dead?

September 1, 2020

The speakers in this article are competitive debaters, and therefore the views expressed may not necessarily represent their beliefs or the beliefs of the organisation they belong to.


Keynesian economics are various macroeconomic theories about how, in the short run economic output is influenced by aggregate demand.

ESSA is affirmative and Cainz is negative, we hope you enjoy!

First Affirmative (Jeremy Mann)

If the recent economic downturn has shown us anything, it’s that the myth of Keynesian economics is well and truly a thing of the past. Proponents of this long-disproven theory hold the belief that governments have the magical power to speed up economic recovery through a one-size-fits-all approach to stabilisation. With the unpredictable COVID-19 pandemic forcing Australia into record levels of public debt, supposed ‘easy-fix’ stimulus packages will not only be inadequate in boosting our economy out of a recession, but will be detrimental for future generations to come.

Demand-side economics brings with it an excessively high-degree of volatility, with levels of consumption within the national economy left entirely susceptible to relatively short-term fluctuations in the business cycle. Given that consumers and firms alike act entirely in their own self-interest, whether that involves taking advantage of cheaper credit or higher investment returns, the likelihood of the private sector obeying the political ‘whip’ of government policy remains substantially low. As we’ve seen, households in Australia have the tendency to pay down debt during consecutive periods of low interest rates and favourable conditions, despite having little overall effect on output as a whole. In turn, excessive borrowing inevitably leads to higher interest rates and financial crowding out.

The simple equation shows that more spending equals more borrowing, putting pressure from the government on the private sector to provide investment, leaving firm to scramble with the decreased availability of resources left for them. Given this, we know that resources would be better put to use by encouraging businesses to increase their efficiency and productive output, rather than providing wasteful subsidies and discretionary hand-outs to already struggling industries.

Instead, governments should be focusing on building up education and training, as well as incentivising research and development to expand business technologies in the long term. A further decrease in corporate tax for small and medium-sized enterprises will encourage greater levels of investment in capital and labour resources, creating more jobs and growth into the future. Putting earned income into hands of those that need it most rather than forcing a reliance on ineffective stimulus payments will lead to greater economic resilience, and a mutually beneficial situation for all sectors of the economy.

At a time when both Australian workers and businesses are struggling and desperate for financial assistance, we need a viable long-term that will not continue to harm our economy and place a significant burden on the next generation to pay off extraordinary amounts of debt. Keynesian economics is dead, and its return would mark a period of further widespread economic uncertainty and instability for Australia.

First Negative (Neharika Rastogi)

Keynesian economics has always been present but dormant. However, in recent times, COVID-19 has triggered Keynesian economics to actively come into play. With issues following COVID-19, such as unemployment, the fast spread of the virus, and slowing down of the economy, governments around the world become highly aware of the immense importance of Keynesian propositions. 

Following the theory formulated by Keynes, governments are complying with the suggestions to get the economy back in track. Undeniably it is the Modern era and there would be changes to the procedures, but the crux has not changed. 

Firstly, looking at the USA, let us consider the period between FDR’s second win and Donald Trump presidency as two halves–40 years to 1976, and 40 years since. As per the Keynesian economics basic understanding of deficits, the surpluses have to be run in good times, and deficits in bad times. However, instead of following this, they failed to draw a proper distinction between day-to-day spending and investment. During COVID-19 times, why is there not enough budget allocated for public health, international students, and jobs? Because of the ever use of taxpayers’ money and no saving. In Keynes’s words from the bubble burst of 1929–it is a continuous process and history is repeating itself–unemployment, lack of growth and public dismay. 

Secondly, Britain is another country that has accepted the Keynesian economics terms and propositions to come back on track after COVID-19. With the biggest fiscal boost after 30 years, Bank of England (keeping in mind Keynesian economics) has reduced interest rate and have accepted that it is the government who has to play the role in bringing up the productivity and drive the economy forward. Undoubtedly the colossal errors of past decades remain. But with the alien virus infecting people all around, it is all about the efforts and getting up from the low bottom, thus applying Keynesian propositions.

Lastly, what would the post-COVID world look like? We can draw comparisons with the post-war world where there were high levels of poverty, unemployment, health issues, and economic downturn. Keynes believed that governments (both developed and developing countries) have the power to change the ills of capitalism through the injection of money into the economy which would generate demands and solve the problem of massive unemployment. And this can be done with massive projects just as it was done after world war.

The fact that Keynesian economics came back to play a significant role means that it was never really gone. The USA shows how Keynesian economics is still adopted, although there were errors in application. Britain further indicates its presence by implementing Keynesian propositions to combat current issues. Lastly, it was identified that policies based on Keynesian economics are needed to support the current economy. We learn from economic policy failures as well as from successes, and just because Keynesian economics was kept in back pedestal does not mean it was absent. Theories have been in existence since centuries back and in practice for even longer.

Second Affirmative (Jeremy Mann)

Recognition of the intrinsic flaws characterised by Keynesian economic thought has never been so crucial towards developing an effective and thorough response to the devastating economic impact of COVID-19 the economy is facing today.

The propositions put forth by those arguing in favour of this antediluvian theory suggest that government spending should be held to the whim of volatile demand-side factors. Instead, the solution to their problems lies with the adoption of conservative free-market policies aimed at increasing competitiveness and boosting efficiency in production.

Firstly, the undeniably basic Keynesian understanding of peaks and troughs along the business cycle ignores the premise of ‘stagflation’, marked by periods of higher rates of inflation coinciding with increased unemployment. In the 1970s, the American economy was facing this very issue, baffling the historically-orthodox view that these two economic indicators were inversely related. Milton Friedman, the famous critic of this belief of the time, argued that the introduction of supply-side reforms was pivotal in increasing market efficiency and reducing labour market imperfections in the long run. To address these key issues, U.S. President Ronald Reagan introduced policies aimed at reducing income and capital gains tax, as well as tightening the level of government spending to rein in demand-pull inflation. As such, the USA was able to escape the 1981-1982 recession with lower rates of unemployment and stable inflation after a previous tightening of the money supply as pushed for by Keynesian economists.

Secondly, there is a large amount of uncertainty in being able to accurately predict the output gap in an economy facing an unexpected fall in productivity. As we’ve witnessed recently, drastic changes to the operation of firms and the labour market as a result of the global pandemic have had various effects on national economics across the globe. In the UK, the introduction of government policies such as the ‘Future Fund’ is aimed at ensuring that high-growth companies receive the investment they need to continue to grow. The benefits of this incentive allow companies to build upon their existing business structures to create more jobs and bounce back from a recession. Whilst Keynesian economics assumes perfect knowledge on how much demand needs to increase by to manage an output gap, a strategy utilising supply-side policies will be better suited towards a lasting and more permanent path towards sustainable economic growth.

Lastly, the Australian Government’s response to COVID-19 involving the $70 billion JobKeeper wage subsidy program would have contributed to a much greater amount of public debt had it not been for the rationalist economic policies introduced over the past eight years. Efforts directed towards fiscal consolidation involving a reduction in government outlays matched by a decrease in tax rates has allowed for a greater propensity for spending when it’s needed. In saying this, had the government taken the wrong turn by following the misguided Keynesian theories of ages past, the situation we find ourselves in at present may have been turned out to be a lot worse than it already is.

Second Negative (Sarah Tu)

Countries around the globe have their differences, but when it comes to relieving its citizens and economy as victims of COVID-19, we see the consensus in governments deep diving into creating stimulus in innovative ways, which fully aligns with the Keynesian economic theory.

Over the course of economic history, the growths and troughs resemble a deadly roller coaster ride, accentuated by Black Swan events and its aftermath. However, it certainly does not imply that one example of a theory that lent influence into the making of fiscal policy, as the affirmative side claims, rejects all other theories’ feasibility and vitality. One economic state calls upon a strategic policy, right now the global economy is facing a record low recession, stemming from an unprecedented virus gone viral. Our current situation demands government actions to be advised on the Keynesian economic theory. That means government measures have to support large parts of the economy in a very short time to maintain financial stability, maintain household economic welfare, and help companies survive the crisis.

Some are concerned that the heavy investment in relief packages may pile up debt. In full agreement with the Economy Professor at the University of New South Wales, “[Covid-19] is a huge shock and we need to go into debt to fix it — there’s nothing wrong with that at all.” As the cycle of life turns from winter to spring, economic upturn will again regain its revenue-generating abilities. The calling for JobKeeper extended to wider eligible groups exemplifies the need for immediate government support to make ends meet and survive through the winter. 

The success of stimulated demand is the first step to close the recessionary gap. As a result of lockdown measures, demands came practically to a halt. As the free market gives out, the government is relied upon to push back the damage done. Let’s imagine if the economy were to free fall in this economic turmoil. In a state of income uncertainty, consumers are disincentivized to spend their discretionary income, commercial businesses, in turn, finish with losses, thus limiting its ability to pay the landlord. Landlords who contracted loans may be forced to declare insolvent, leaving the bank to write off bad loans. As loan portfolios typically compose a bank’s primary assets, when the liability of bad debt outweighs assets, we foresee bankruptcy. The government’s injection of relief measures essentially prevents cyclical financial disaster in its infant stage. The crisis has prompted governments to develop aggressive stimulus packages to avoid a catastrophic and historic global economic collapse. For example, Australia announced the extensive JobKeeper payment that aims to subsidize the wages of up to six million workers through payments made every two weeks.

The global economy is sick with unemployment, stagnation, and reduced profits and our leaders globally are to prescribe the plan of recovery. As per the Keynesian economic theory, governments around the world are intervening to protect its economy, its people, and businesses, setting up for the spring back.

Third Affirmative (Jeremy Mann)

In claiming that Keynesian stimulus is in some way innovative, those espousing such antiquated economic theories clearly ignore the greater economic benefit of market-based supply policies.  As aforementioned, government outlays should be directed towards bolstering supply and business investment over the long-term, rather than encouraging throwaway stimulus spending based on spontaneous occurrences in the business cycle.

As ‘trendy’ as it may seem to some to follow fluctuations, the only way to ensure Australia truly returns to a period of uninterrupted economic growth post-pandemic is to bolster business productivity, increase potential output and get more people back to work. Much like today’s economic crisis brought about by the COVID-19 pandemic, the early 1980s recession came as an unexpected shock to households and businesses alike. Yet unlike Roosevelt’s ‘New Deal’ in the 1930s which encouraged intensely high borrowing at about $211 billion, Reagan’s ‘trickle-down’ recovery program utilised the structural taxation system to decrease both inflation and unemployment.

In this case, ‘Reaganomics’ was able to decrease marginal tax rates whilst simultaneously increasing tax revenue; a phenomenon illustrated by the famous supply-side economist Arthur Laffer. This situation clearly demonstrates that Keynesian economics is not a universal solution to every economic downturn as one would suggest; instead it attempts to fix a leaking pipe with sticky tape by wrapping the economy in stimulus packages that lack any substantiated benefit.

Indeed, here in lies the problem. Keynesian economics heavily relies on targeting those with a marginal propensity to spend. This target demographic, albeit a minority, uses this money for basic household purchases which is ineffective at stimulating the economy to any noticeable degree. Whilst many are facing hardship in the wake of massive job losses, many have argued that the current JobSeeker coronavirus supplement at $550 a fortnight (to be reduced to $250 a fortnight from late September) is not an accurate estimate of potential loss of income.

Of course, there is also the effect of tax cuts enable through extensive government borrowing having little impact on consumption due to the belief that governments will then raise the taxes to cover their debt in the future. This cyclical presumption, known as the Ricardian equivalence, shows that expansionary fiscal policy has little to not effect. Instead, the inflationary impacts of Keynesian demand-side economics often outweigh any minimal increase in growth witnessed as a result of increased government spending.

Keynesian theory applies a short-term umbrella resolution where long-term opportunities need to develop instead; focusing on infrastructure contributions, job creation, innovation and better overall living standards. Often, fiscal expansion comes too late, with its effects taking place at a period when the economy is already recovering and experiencing strong and sustainable growth. With an inability to accurately measure output gaps, a tendency to record high inflation and a lack of long-term structural impact, Keynesian economics is well and truly dead.

Third Negative (Matthew William)

There has been a paradigm shift in the economy’s mainstream thinking as Keynesian theory is being put to use once again. The cause of depression may be different, but medicinal treatment, which is to stimulate the main driver of the economy—consumption expenditure—remains. Furthermore, the idea of Reaganomics—based on supply-side policies—that was raised, had serious costs that left the economy indebted and posed no effect on economic growth. Moreover, there is strong empirical evidence indicating the failure of Reaganomics impact on the labour market. 

The illustrious aspect of Reaganomics is the ‘trickle-down’ effects of the cut in top tax rate. However, according to the data from 1945-2015, there exists no correlation between the top tax rate and GDP growth rate. Moreover, the lowering of corporate income-tax rate also did not induce economic growth. The supply-side economy also had an ambiguous effect on the labour market. Empirical evidence shows that there is a lack of connection between top tax rates and wage growth. Hourly wages decreased following the late 1980s tax cuts and spiked upwards after the 1993 tax increase. Moreover, while the top tax rate trends downward over the period, the annual change in unemployment is constant. 

In continuation, the direct effect of the Reagan policy is the enormous increase in the budget deficit and national debt. Between the beginning and the end of the Reagan presidency, the annual deficit almost tripled and gross national debt increased from $995 billion to $2.9 trillion. Another downside effect of the supply-side economy is the negative growth rate and yield curve, the unemployment rate and government share were over their 1988 values, while investment share was under its 1988 value.

Relating to the importance of demand-side policy, the US acted on Quantitative Easing to counter the Great Recession of 2007-2009. Quantitative Easing (QE), on the ground of prioritizing aggregate demand, is motivated by Keynesian economics. The Federal Reserve bought bonds from the market and applied zero interest rate policy. The end result of QE stimulated borrowing, investing, and spending activity, to kickstart economic growth. More specifically, Federal Reserve Chairman, Ben Bernanke, stated that QE was responsible for increasing economic activity by 3%, and adding close to 2 million jobs in the private sector, in comparison to a world without QE. Additionally, there were many who warned about coming hyperinflation, however their theories have been proven to be false. Overall, the success of QE relied heavily on the demand-side logic of Keynesian Policy. 

The strength of Keynesian convictions is and will be tested during major depressions, as we are in it now. There might be issues raised by prior mainstream economists pertaining to no more means left to deal with the downturn, but the economy does not stop, and it is all about evolving. There are still ways to stimulate demand through conventional and unconventional means such as helicopter money and monetizing a significant part of the government deficit to pursue policies of economic revival. Therefore, Keynesian Economics is not dead.

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