THIS IS NO TIME TO THROW AWAY THE CRUTCHES / THE FINANCIAL TIMES COMMENTARY & ANALYSIS (RECOMMENDED READING )

This is no time to throw away the crutches

Peter Clarke

Published: August 30 2009 19:40

Recent news about the world economy has cheered many people after months of unremitting gloom. It is right that we should regain our confidence that the system can recover. Certainly, there will be no lasting recovery without such confidence.

But it is dangerous, as well as tempting, to forget how bad things looked only a short time ago. This premature amnesia is not only psychological, burying painful experiences; it also has an ideological dimension, as seen in the US debate over the efficacy of the stimulus package and the bail-out of Wall Street. We are being told simultaneously that these measures have not worked – and that they were not necessary anyway. We are supposed to forget the frightening precipice over which we peered only a few months ago; and we are also asked to believe that what has saved the situation is the spontaneous resilience of the free market. Thus the bogey is “big government”.

Like many alarmist narratives, this story feeds on real fears. It is not unreasonable to worry about the size of current budget deficits. The fact that these deficits are partly due to bailing out banks that took unwarranted risks will not strike sympathy among taxpayers. The truth is that the alternative scenario was even worse – a systemic collapse of credit. But this is the bit that is too easily forgotten, innocently or otherwise.

The stimulus strategy has an impact on the budget. Indeed, opponents like to blame Keynesian policies for incurring avoidable debts as a deadweight burden, if not on us then on our grandchildren. What lends credence to such criticisms is not only our memory loss about recent events but our failure to benefit from a longer historical perspective.

A key episode during the Great Depression provides a cautionary tale. Though the name of John Maynard Keynes was often invoked by opponents of the New Deal, the recovery measures under Franklin D. Roosevelt’s presidency can hardly be seen as textbook Keynesianism. Roosevelt was no ideologue. He had denounced the budget deficits of his Republican predecessor when running for president in 1932. FDR appointed a fellow member of the Hudson River squirearchy, Henry J. Morgenthau, as his Treasury secretary. If modest deficits appeared in the federal budgets in Roosevelt’s first term, it was mainly a cause for political embarrassment.

Convoluted, contradictory, controversial, the diverse expansionary measures of the New Deal nonetheless averted disaster and paved the way for a modest economic recovery by 1936. Whereupon, Morgenthau sensed his opportunity “to throw away the crutches and see if American private enterprise could stand on its own feet”, with plans to balance the budget within two years. FDR went along, hoping to wrong-foot his relentless Republican critics. The results were impressive but perverse. Hesitant economic recovery was halted in 1937-1938 and the Democrats’ natural constituency was hurt by job losses in “the Roosevelt recession”, as political opponents gleefully dubbed it.

“The present recession ought not to have taken us by surprise, though, in the case of most of us, in fact it has,” wrote Keynes to an American friend. He was correct to attribute the cause to the cut in government spending at a vulnerable moment. This message was not lost upon the economists advising the president. The Keynesian case for tolerating a budget deficit almost made itself.

It was certainly enough to turn Roosevelt in his tracks, with a compelling logic that was as much political as economic. With elections looming, he allowed himself to be corralled by those liberal Democrats who saw the writing on the wall. With characteristic adroitness, he abandoned Morgenthau. The administration accepted the principle that fiscal policy should promote recovery, not thwart it.

It remains true, however, that the New Deal did not cure unemployment, just as its critics maintain. But what the critics usually fail to add is that this was because the fiscal stimulus was too small. Only with the advent of the second world war was government spending set at a level that induced full economic recovery. “It is, it seems,” commented Keynes, “politically impossible for a capitalistic democracy to organise expenditure on the scale necessary to make the grand experiments which would prove my case – except in war conditions.”

At any rate, military expenditure appears to enjoy a continuing exemption from kneejerk abhorrence of big government in the US. Indeed, the present scale of US public debt is largely a result of the deficits generated by the previous administration to pay for wars in Iraq and Afghanistan. Had the inherited Bush deficit been smaller, the relatively small Obama deficit added by the stimulus package could have been financed more easily. But real-world conditions are seldom ideal or policy choices straightforward. Historical parallels are likewise seldom exact, though they are sometimes worth remembering.

The author’s new book Keynes: the Twentieth Century’s Most Influential Economist, will shortly be published by Bloomsbury in London and New York

Copyright The Financial Times Limited 2009