When were we Keynesian?

The government has announced a big  investment in infrastructure - to start in 2014. If you believe the OBR's forecast for economic recovery, this means the investment will come just after the economy most needs a boost.So much for Keynesianism.

This set me pondering. Just how counter-cyclical has public investment in infrastructure been in the past?

My chart suggests: not much. If spending were counter-cyclical, you'd expect to see a negative correlation between gross public investment as a share of GDP and the output gap, with recessions causing high spending and booms lower spending. But in fact, there's no such relationship. According to Treasury/OBR data, the correlation was zero between 1963 and 2010*.

You might find this surprising, because you don't need to be a Keynesian to believe that infrastructure spending should be countercyclical. If real interest rates fall in recessions, you only have to think it's a good idea to borrow more when interest rates are low to want a negative correlation between the output gap and infrastructure spending.

So, why haven't we had one? Anti-Keynesians could argue that it's just impossible for governments to behave in a Keynesian way.The time lags involved in finding and planning big investments mean they cannot be started when the economy is weak. Alternatively, perhaps investment decision have been driven more by politicians'vanity - a desire for grand projects such as Concorde - than by economic logic.

Good points. But they run into a problem. If we split our data sample into three periods, we find different, and negative,  correlations: -0.1 for 1963-79;-0.56 1979-97;and -0.85 for 1997-2010.

What we have here is an example of Simpson's paradox.

In other words, both the Thatcher/Major governments and New Labour behaved Keynesianly, having higher investment in booms and slumps. For example, Thatcher cut infrastructure spending as the economy moved from recession in 1981-82 to boom in 1988-89.

If anything, it was the pre-1979 governments that were not so Keynesian, having only a weak correlation between the output gap and investment. The golden age of Keynesianism was no such thing.

In this sense, Cameron's announcement of rail investment represents a return to pre-Thatcherism. 

* In theory, this could be because governments have seen recessions coming and increased investment in anticipation of them with the result that recessions haven't materialized, and so there's been no correlation between spending and the output gap. But I don't think anyone thinks this has been the case in practice.

Comments

[Alex]

Wouldn't that be explained by the output gap not moving about as much before 1979? If public investment was determined by a mixture of the output gap and a gaggle of other factors independent of it*, and the output gap starts to move about more, ceteris paribus, the degree to which public investment is determined by the output gap must go up.

*which is evidently true of any real Keynesian government, as governments don't only have macro stabilisation as a goal.

[chris]

@ Alex. It's a nice theory, but it runs into the problem that the output gap was more volatile in 1963-79 than in 1997-2008 (SD of 1.1pp vs 0.6pp), and yet there was a stronger "Keynesian" relationship in the latter period.

[Edward Harkins]

An aside - but let's beware joining the general confusion and conflation between 'Kenysian' stimulus and additional public infrastructure capital spend.

There is a rising chorus in the UK demanding additional spend on infrastructure - a self-interested chorus with a self-serving song to sing. Many of the chorus members are, of course, the same corporate interests that pillaged the public coffers through PFI (and now that that has been rumbled, are maybe looking for alternative public-funded cash cows).

There is virtually no generally accepted evidence from modern economic history that proves that infrastructure spend is a means of escape from recession. Such spend does enhance longer-term economic performance and maybe growth in an economy (as OECD data has demonstrated). But that's only if the domestic economy has the means and capacity to make optimum or near-optimum use of the enhanced infrastructure commensurate with the investment.

There are for more effective, short-term, public expenditure measures to be taken if we are seeking an early escape from recession. Keynes himself had little to say about capital infrastructure investment in this context - he did, famously, suggest that for stimulus you'd do well to pay the poor to dig up holes and then fill them in... and if that failed, then just chuck currency out of flying helicopters. The aim is getting cash circulating in the economy - not enahancing long-term growth.

[Keith]

I may be wrong but my impression is that Keynes himself never explicitly proposed a counter cyclical infrastructure programme. By the 1940s he had made peace with the idea of a social democratic state which would spend much more as a proportion of GDP then before the two world wars. But when demand is adequate all spending would be financed by taxes and fees. In a recession part of spending would be financed by borrowing as a automatic result of falls in revenue. The job of the Government being to avoid cuts during recessions which would worsen the demand shortfall. Most Governments seem to have followed this policy. The idea that the state should increase spending substantially to boost demand has been discussed at length for decades but with little result. Some forward planning might allow the timing of capital spending to be varied but no one at the treasury has ever pulled it off on a big scale. Attempts to do so fall foul of the fact that the Government machine moves slowly with lots of barriers to quick action. Local Government has to be on board and has its own veto; even when there were large Nationalised firms they resisted attempts to vary their spending on a Treasury time line. Sudden revisions to capital spending is likely to weaken effective evaluation of its utility and value for money.

[Sachiko]

Tom,I remember when I first cdionsered joining a T.A.B. board (The Alternative Board). It's a great system of having other business owners in a monthly environment of encouraging and digesting issues together that only those in ownership can appreciate. I was surprised however when my request (later demand) for all of us to bring our balance sheets and P&L's was a somewhat unique concept. My point is your financials are the picture of everything you've ever done as a business owner (the balance sheet) and what you are currently achieving (the profit and loss statement). If a business owner is not looking at his/her business through the lens of the financials, my humble opinion is they are flying blind. This is not a new revelation, but should be cdionsered a most fundamental truth for success. Too often however, I've found the financials don't translate well for some owners. They are passionate about their product or service but their financials are only for the banker or the accountant to do those lousy tax returns. I hope to change this attitude one business owner at a time. Your On Target CFO friend Scott.

[Tineke]

1.You need to review Keynesian ecicnmoos. It has been alive and well since the New Deal.2. F.A. Hayek did win the Nobel Prize and was belittled by the co-winner that year for being a reactionary and not a real economist. Same thing happened to Milton Friedman. A group of economists even publicly came out against Hayek and threatened to give back their prizes because he won.3. Take off your tinfoil hat. My comment specifically stated government funding.