KEYNESIANISM AS FULFILLMENT by Jesse Alec Gastelle A Dissertation Submitted to the Graduate Faculty of George Mason University in Partial Fulfillment of The Requirements for the Degree of Doctor of Philosophy Economics Committee: ___________________________________________ Director ___________________________________________ ___________________________________________ ___________________________________________ Department Chairperson ___________________________________________ Program Director ___________________________________________ Dean, College of Humanities and Social Sciences Date: _____________________________________ Summer Semester 2013 George Mason University Fairfax, VA Keynesianism as Fulfillment A Dissertation submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy at George Mason University by Jesse Gastelle Master of Arts George Mason University, 2012 Director: Peter J. Boettke, Professor Department of Economics Summer Semester 2013 George Mason University Fairfax, VA This work is licensed under a creative commons attribution-noderivs 3.0 unported license. ii DEDICATION This is dedicated to my love, Olivia Hart. iii TABLE OF CONTENTS Page KEYNESIANISM AS FULFILLMENT ............................................................................. i List of Figures ..................................................................................................................... v Abstract .............................................................................................................................. vi Introduction ......................................................................................................................... 1 Chapter One: The Decline of Laissez-Faire ........................................................................ 4 Constitutional Economics ............................................................................................... 4 The Decline of Classical Political Economy ................................................................. 10 Culmination ................................................................................................................... 22 Chapter 2: Becoming Doctors to the World ..................................................................... 34 The Perceived Failures of Capitalism ........................................................................... 38 The Government Solution ............................................................................................. 42 Efficient Management ................................................................................................... 46 The Active State and the Economic Expert ................................................................. 59 Chapter 3: The Failures of Keynesian Economics ............................................................ 77 The Failures of Keynesianism ....................................................................................... 77 The Public Problem ....................................................................................................... 81 The Role of Rules .......................................................................................................... 85 General Rules ................................................................................................................ 91 The Abuse of Expertise ................................................................................................. 98 Conclusions ..................................................................................................................... 100 References ....................................................................................................................... 106 iv LIST OF FIGURES Figure Page Figure 1: Federal, State, and Local Share of Total Expenditures ..................................... 45 Figure 2: Expenditures as a percent of GNP ..................................................................... 46 v ABSTRACT KEYNESIANISM AS FULFILLMENT Jesse Gastelle, Ph.D. George Mason University, 2013 Dissertation Director: Dr. Peter J. Boettke This essay is composed of three chapters that contextualize the Keynesian Revolution within trends in history of economic thought and trends in institutional transformations in American public administration. In the first chapter, I look at the transforming nature of economics between Adam Smith and the Keynesian revolution. It is argued that Smith and the classical economists were engaged in a constitutional analysis and that that perspective gradually faded throughout the nineteenth century and disappeared in Keynesianism. In the second chapter, I explain why the Keynesian Revolution was able to so quickly sweep the economics profession; Keynesianism represented the opportunity for economists to become experts to the state. The demand for economist experts was generated by the Progressive reforms of public administration that took place through the first half of the twentieth century. Keynesianism fulfilled these demands. Throughout the vi chapter I show the affinities between the Keynesian supply of expert economics and the demand that derived from the Progressive ideals. In the final essay I argue that the failures of Keynesian economics can be seen as a facet of the broader problems in the Progressive paradigm. Because public decision makers are not omniscient or benevolent, institutions must be arranged to cope with knowledge and incentive problems. Ostrom presents a theory of polycentric order as a means of coping with these problems. He also argues that a similar theory was the foundation of the American constitution that the Progressives rejected. The Progressives ignored these issues in their reforms of American public administration. The failures of Keynesian policies can thus be seen as a manifestation of the problems of the Progressive bureaucratic regime. vii INTRODUCTION Over 200 years ago, Adam Smith expressed concern for the juggling tricks that states inevitably perform. Spending financed through borrowing accumulates into debts that eventually have to be paid back or financed through additional debt and at some leveling of spending debt finally becomes unaffordable. The recent debt crises in the U.S. and the ongoing crisis in Europe suggest that many nations are currently feeling the pressure of those accumulating debts. According to Smith, nations then have two options. They can either disgracefully declare bankruptcy or inflate their way out of debt. Neither scenario leaves the nation with a positive looking future Over the past 50 years we have seen ongoing deficits. Only in a few instances did the U.S. balance its national budget. At the same time, the federal reserve has been steadily increasing the money supply and steadily raising prices. In response to the most recent recession, deficits were dramatically increased. When that failed to produce recovery, multiple rounds of quantitative easing were intended to further boost aggregate demand. Most recently, Ben Bernanke announced unlimited quantitative easing until more positive economic growth is seen. The Keynesians predicted that if governments followed their prescriptions, business cycles would smooth, unemployment would be eliminated, and inflation would be managed. Since then, Keynesian policies have been half followed. Repeatedly, 1 deficits have been used to boost aggregate demand during recessions. Unfortunately, business cycles and unemployment haven't been eliminated and are not clearly better than in the pre-Keynesian world (Romer, 1999). The Keynesians tell us that business cycles would have been much worse had the spending not taken place, but this kind of unfalsifiable reasoning is hardly helpful. Moreover, instead of following Keynesian prescriptions during the boom, politicians have continuously engaged in deficit spending and inflation, the kind of juggling trick that Smith was concerned about. Whether we deem this the fault of politicians or Keynesians is irrelevant, at some point we have to start questioning the applicability of Keynesian policy prescriptions. The intention of this essay is to shed light on these events. In the first chapter, I look at the transforming nature of economics between Adam Smith and the Keynesian Revolution. It is argued that Smith and the classical economists were engaged in a constitutional analysis. That is, economics was defined by a focus on rules and the incentive they produced. That perspective gradually faded away throughout the nineteenth century and gave way to a focus on the formal properties of optimality. This perspective towards economic sets the stage for the second chapter which focuses on the Keynesian Revolution. I argue that the Revolution was so massive and rapid because Keynesianism represented the opportunity for economists to become experts to the state. The demand for economist experts was generated by the Progressive reforms of public administration that took place throughout the first half of the twentieth century. Keynesianism fulfilled these demands. Throughout the chapter I show the 2 affinities between the Keynesian supply of expert economics and the demand that derived from the Progressive ideals. In the final essay I argue that the failures of Keynesian economics can be seen as a facet of the broader problems in the Progressive paradigm. Because public decision makers are not omniscient or benevolent, institutions must be arranged to cope with knowledge