Video: 3 Reasons why Keynesian Economics

Transcript Below:

Hi. Welcome to another edition of Strategic Business Insights. Today, we're going to talk about Keynesian economics and whether or not it's a good thing or whether it's a bad thing. Straight up, I'm going to tell you right now that I am not a believer of Keynesian economics. But we all need to understand basically what it is and what the reality is today.

So Keynesian economics basically says when we have a recession - in other words when the psychology of a population thinks, "Oh my gosh. We're going into rough times," they restrict their spending, and so we actually end up in rough times. People spend less money, so the economy contracts. And when that happens, the government needs to jump in and spend more money to offset that. So the population spends less. The government spends more to offset it and help the economy get back on track.

Now, the theory is that in bad times, government spends more to get the economy back on track, but in good times government's supposed to pay that money back and start, in other words, accumulating a surplus to pay back the debt that they accumulated in the rough times. We'll get back to that in a second.

Secondly, the reality today is that basically all the policy-makers in the western world, including the United States, Europe, certainly Japan. But even countries like Canada and Australia and New Zealand, basically all developed nations, the policy-makers in these countries are pretty much unanimously Keynesian economists. In other words, they believe in this hypothesis that we just mentioned so that when spending goes down, they need to do a stimulus. They need to do some sort of extra fiscal spending to offset that reduction in consumer spending to keep the economy back on track.

Now, I've got three problems with Keynesian economics. I don't believe Keynesian economics actually helps our economy and I have three reasons for that. Number one, is what I just mentioned a second ago. The government does indeed spend more when we're in the rough times. When consumer spending goes down, they spend more. So we have these big stimulus packages and construction and projects, and they're throwing money into the economy. But when the economy's doing well, they don't reverse the policy. They don't pay back any of the money they borrowed. So the debt goes higher and higher and higher.

We now know what that leads to. This has been going on for over 30 years in the western economies, is that they've been borrowing money, deficit spending year after year after year after year - almost no surpluses at all. So the debt level just keeps getting higher and higher and higher.

For many years, we thought this could go on forever. There's no problem. And there were even politicians along the way who said, "We can borrow money forever." We now know that that is not true. Just look at Europe. Look at Greece and Ireland and Spain and Portugal and all these countries. As I said, Spain is kind of getting close to the line of whether or not the bond market is going to start charging higher interest rates for them to borrow, because they view it as a higher risk.

If Spain falls, then France is next. Mathematically, they are going to hit that line eventually. And Japan has borrowed enormous amounts of money. And just wait. They're going to hit that line as well. But we've already seen it in countries like Ireland, Portugal, and Greece. You cannot do this forever. You have to start paying back some of these debts.

Number one, if the Keynesians reverse their policy in good years and did some deficit spending in bad years, and then in good years, they actually paid the debt back, I would have a different opinion. But the fact is, that that never happens. So the first is, we never reverse the policy.

Number two is that Keynesian economics breeds kind of an entitlement culture within the economy. There's tax cuts and incentives, and they're going to get stimulus money. Whenever things go bad, there's going to be this magic bank that shows up that throws money your way.

Now, I understand that people need help, especially people who are living below the poverty line or people who are unemployed. Again, I believe in a progressive tax system. I believe in a social safety net. But we have to limit the extent to which we offer those incentives, because what happens-- just take someone who's unemployed as an example. If they receive unemployment insurance, then they've got a lifeline to keep their life going. And as a result of that, their incentive to try something new or something different is less than what it would be otherwise.

Now, I'm not suggesting we have to push the economy into desperation. But what happens when someone does get to desperation? And by the way, I have been one of those people. I was making no money for years, really struggling. And what did it do? It forced me-- I used to rack my brain. I used to think, "What can I do? What can I do to get my life back on track? What can I do to make some money?" One question I used to ask myself all the time, I used to say, "What can I do to make $500 this weekend? There's got to be something I can do - some sort of a stunt or something. Maybe sell some sort of a program or do something to generate $500 this weekend." Of course, I didn't find many of those things.

But it spurred innovation. Again, there's a balance here between the humanitarian interest of taking care of people who need help, but also realizing that innovation comes out of that. When people are really desperate and they don't have any other lifelines, that's when they start really tapping into the creativity and saying, "What could I do?"

That's innovation, and that is good for the economy. Long term, it is good for the economy. That's the second reason.

The third reason is that when government borrows money, it crowds out private investment. Hear me out on this, because people don't really understand these mechanisms, but GDP as a figure - Gross Domestic Product - GDP equals consumer spending plus investment plus government plus exports minus imports. That's the equation. So it's C plus I plus G plus X minus M, is the equation of what GDP equals. But when government borrows money, then what ends up happening, they're borrowing money from people or institutions. In other words, someone is lending the money.

Well, if they couldn't lend the money to the U.S. government in the form of treasury notes, what would they do instead? Would they just leave the money sitting in a bank somewhere? No. They would take the money and find somewhere else to invest it. Think about the investor perspective. Let's say it's me, and I've got money that I want to lend out. I want to invest it somewhere. I could invest it in U.S. treasury notes, but if those aren't for sale, if the government isn't selling U.S. treasury notes, then I've got to look elsewhere and say, "Where else can I invest the money?"

In other words, when government borrowing is super high, which it is right now. We've got annual deficits like $500 billion. A few years ago, it was $1 trillion, even higher than that. Huge amounts of government deficit spending. That's the government borrowing money.

When they borrow money, there's all kinds of people who end up lending it to the government, because it's a safe haven. They feel like it's a safe investment. But if that wasn't there, that same money would go elsewhere. Where would it go? It would go to businesses. They would look for investment opportunities in business, and that is good.

So when government has a lot of borrowing, it crowds out this investment, and it sets it up so there's less money available for business. And that's for the economy. So I believe that Keynesian economics has three huge flaws. The first is, they don't pay back the debts that they spend in the bad years, in the surplus years. When you've got a good year, you've got to pay back the debt.

Number two, all these entitlement programs and excessive social safety net programs like long-term unemployment insurance-- I've got a friend of mine. He's been on unemployment insurance for two years. It's crazy. That diminishes innovation in the economy. If he didn't have that, he would look harder for something else or maybe even start his own business. But he's not doing that, because he's getting money every single month or every two weeks or whatever it is.

Number three, government borrowing crowds out private investment. And we need private investment. That is the growth, that is the primary driver of growth in the economy. Innovation and investment are the two things.

So I am not a fan of Keynesian economics. You can have an opinion either way, but hopefully this helps you shed some light on what the discussion and what the debate is actually all about. And I encourage you to share your thoughts in the comments below for people who watch this video after you.

Thanks for watching. I do appreciate it. My name is Patrick, reminding you as always to think bigger about your business. Think bigger about your life.