Democracy in Deficit: The Political Legacy of Lord Keynes

James M. Buchanan.
Buchanan, James M. and Richard E. Wagner
(1919- )
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First Pub. Date
Indianapolis, IN: Liberty Fund, Inc.
Pub. Date
Foreword by Robert D. Tollison.

Part I. What Happened?

Chapter 1What Hath Keynes Wrought?


In the year (1776) of the American Declaration of Independence, Adam Smith observed that "What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom." Until the advent of the "Keynesian revolution" in the middle years of this century, the fiscal conduct of the American Republic was informed by this Smithian principle of fiscal responsibility: Government should not spend without imposing taxes; and government should not place future generations in bondage by deficit financing of public outlays designed to provide temporary and short-lived benefits.


With the completion of the Keynesian revolution, these time-tested principles of fiscal responsibility were consigned to the heap of superstitious nostrums that once stifled enlightened political-fiscal activism. Keynesianism stood the Smithian analogy on its head. The stress was placed on the differences rather than the similarities between a family and the state, and notably with respect to principles of prudent fiscal conduct. The state was no longer to be conceived in the image of the family, and the rules of prudent fiscal conduct differed dramatically as between the two institutions. The message of Keynesianism might be summarized as: What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation.


"We are all Keynesians now." This was a familiar statement in the 1960s, attributed even to the likes of Milton Friedman among the academicians and to Richard Nixon among the politicians. Yet it takes no scientific talent to observe that ours is not an economic paradise. During the post-Keynesian, post-1960 era, we have labored under continuing and increasing budget deficits, a rapidly growing governmental sector, high unemployment, apparently permanent and perhaps increasing inflation, and accompanying disenchantment with the American sociopolitical order.


This is not as it was supposed to be. After Walter Heller's finest hours in 1963, fiscal wisdom was to have finally triumphed over fiscal folly. The national economy was to have settled down on or near its steady growth potential, onward and upward toward better things, public and private. The spirit of optimism was indeed contagious, so much so that economic productivity and growth, the announced objectives for the post-Sputnik, post-Eisenhower years, were soon abandoned, to be replaced by the redistributionist zeal of Lyndon Johnson's "Great Society" and by the no-growth implications of Ralph Nader, the Sierra Club, Common Cause, and Edmund Muskie's Environmental Protection Agency. Having mastered the management of the national economy, the policy planners were to have moved on to quality-of-life issues. The "Great Society" was to become real.


What happened? Why does Camelot lie in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists.


The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians' ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax. "Democracy in deficit" is descriptive, both of our economic plight and of the subject matter for this book.

The Political Economy


This book is an essay in political economy rather than in economic theory. Our focus is upon the political institutions through which economic policy must be implemented, policy which is, itself, ultimately derived from theory, good or bad. And central to our argument is the principle that the criteria for good theory are necessarily related to the political institutions of the society. The ideal normative theory of economic management for an authoritarian regime may fail completely for a regime that embodies participation by those who are to be managed. This necessary linkage or interdependence between the basic political structure of society and the economic theory of policy has never been properly recognized by economists, despite its elementary logic and its overwhelming empirical apparency.


Our critique of Keynesianism is concentrated on its political presuppositions, not on its internal theoretical structure. It is as if someone tried to make a jet engine operate by using the theory of the piston-driven machine. Nothing need be wrong with the theory save that it is wholly misapplied. This allows us largely but not completely to circumvent the troublesome and sometimes complex analyses in modern macroeconomic and monetary theory. This does not imply, however, that the applicable theory, that which is fully appropriate to the political institutions of a functioning democratic society, is simple and straightforward or, indeed, that this theory has been fully developed. Our discussion provides the setting within which such a theory might be pursued, and our plea is for economists to begin to think in terms of the political structure that we observe. But before this step can be taken, we must somehow reach agreement on the elements of the political decision process, on the model for policy making, to which any theory of policy is to be applied.


At this point, values cannot be left aside. If the Keynesian policy precepts for national economic management have failed, there are two ways of reacting. We may place the blame squarely on the vagaries of democratic politics, and propose that democratic decision making be replaced by more authoritarian rule. Or, alternatively, we can reject the applicability of the policy precepts in democratic structure, and try to invent and apply policy principles that are consistent with such structure. We choose the latter.*2 Our values dictate the democratic decision-making institutions should be maintained and that, to this end, inapplicable economic theories should be discarded as is necessary. If we observe democracy in deficit, we wish to repair the "deficit" part of this description, not to discard the "democracy" element.

A Review of the Record


We challenge the Keynesian theory of economic policy in this book. Our challenge will stand or fall upon the ability of our argument to persuade. There are two strings to our bow. We must first review both the pre-Keynesian and the post-Keynesian record. Forty years of history offers us a basis for at least preliminary assessment. We shall look carefully at the fiscal activities of the United States government before the Great Depression of the 1930s, before the publication of Keynes' General Theory.*3 The simple facts of budget balance or imbalance are important here, and these will not be neglected in the discussion of Chapter 2. More importantly for our purposes, however, we must try to determine the "principles" for budget making that informed the political decision makers. What precepts for "fiscal responsibility" were implicit in their behavior? How influential was the simple analogy between the individual and the government financial account? How did the balanced-budget norm act to constrain spending proclivities of politicians and parties?


There was no full-blown Keynesian "revolution" in the 1930s. The American acceptance of Keynesian ideas proceeded step by step from the Harvard economists, to economists in general, to the journalists, and, finally, to the politicians in power. This gradual spread of Keynesian notions, as well as the accompanying demise of the old-fashioned principles for financial responsibility, is documented in Chapters 3 and 4. The Keynesian brigades first had to storm the halls of ivy, for only then would they have a base from which to capture the minds of the public and the halls of Congress. Chapter 3 documents the triumph of Keynesianism throughout the groves of academe, while Chapter 4 describes the infusion of Keynesianism into the general consciousness of the body politic—its emergence as an element of our general cultural climate.


Even if our review of the historical record is convincing, no case is established for raising the alarm. What is of such great moment if elected politicians do respond to the Keynesian messages in somewhat biased manner? What is there about budget deficits to arouse concern? How can the burden of debt be passed along to our grandchildren? Is inflation the monster that it is sometimes claimed to be? Why not learn to live with it, especially if unemployment can be kept within bounds? If Keynesian economics has and can secure high-level employment, why not give it the highest marks, even when recognizing its by-product generation of inflation and relatively expanding government? These are the questions that require serious analysis and discussion, because these are the questions that most economists would ask of us; they are explored in Chapter 5.

The Theory of Public Choice


Our second instrument of persuasion is a theory for decision making in democracy, a theory of public choice, which was so long neglected by economists. This is developed in Chapters 6 through 9. Keynes was not a democrat, but, rather, looked upon himself as a potential member of an enlightened ruling elite. Political institutions were largely irrelevant for the formulation of his policy presumptions. The application of the Keynesian precepts within a working political democracy, however, would often require politicians to undertake actions that would reduce their prospects for survival. Should we then be surprised that the Keynesian democratic political institutions will produce policy responses contrary to those that would be forthcoming from some idealized application of the norms in the absence of political feedback?


In Chapter 7, it is shown that ordinary political representatives in positions of either legislative or executive authority will behave quite differently when confronted with taxing and spending alternatives than would their benevolently despotic counterparts, those whom Keynes viewed as making policy, whose behavior is examined in Chapter 6. In Chapter 8, the analysis of Chapter 7 is extended to the behavior of monetary authorities, and monetary decisions are considered as endogenous rather than as exogenous variables.


A crucial feature of our argument is the ability of political and fiscal institutions to influence the outcomes of political processes, a subject that we explore in Chapter 9. Institutions matter in our analysis. While this position is generally accepted by those who call themselves "Keynesians," it is disputed by many of those who consider themselves "anti-" or "non-Keynesians." These latter analysts argue that institutions are generally irrelevant. With respect to institutions, we are like the Keynesians, for we do not let an infatuation with abstract models destroy our sense of reality. Instead, we accept the proposition that institutions, like ideas, have consequences that are not at all obvious at the time of their inception, a point that Richard Weaver noted so memorably.*4 At the same time, however, our view of the nature of a free-enterprise economic order is distinctly non-Keynesian, although "Keynesianism" must to some extent be distinguished from the "economics of Keynes."*5


The theory of public choice discussed in Chapters 6-9 is not at all complex, and it offers satisfactory explanations of the post-Keynesian fiscal record. The Keynesian defense must be, however, that the theory is indeed too simplistic, that politicians can and will behave differently from the predictions of the theory. We do not, of course, rule out the ability of politicians, intelligent persons all, to learn the Keynesian lessons. But will the voters-citizens, who determine who their political representatives will be, accept the proffered wisdom? This is a tougher question, and the familiar call for more economic education of the public has long since become a tiresome relic. The Keynesian who relies on a more sophisticated electorate to reverse the accumulating record leans on a frail reed.

Fiscal and Monetary Reform


In the last three chapters of the book, we return to what may be considered the main theme. Even the ardent Keynesians recognized, quite early, that some replacement for the fiscal rule of balanced budgets might be required as guidance for even the enlightened politicians. In Chapter 10, we examine the alternative rules for fiscal responsibility that have been advanced and used in the discussion of fiscal and budgetary policy. These include the rule for budget balance over the business cycle, and, more importantly, the rule for budget balance at full employment which continues to inform the official economic pronouncements from Washington, even if it is largely disregarded in practice.


Chapter 11 represents our response to what will seem to many to be our most vulnerable point. What about unemployment? Our criticism of the implications of the Keynesian teachings may be widely accepted, up to a point. But how are we to respond to the argument that the maintenance of high-level employment is the overriding objective for national economic policy, and that only the Keynesian teachings offer resolution? These questions inform this chapter, in which we question the foundations of such prevalent attitudes.


Chapter 12 offers our own substantive proposals for fiscal and monetary reform. Our emphasis here is on the necessity that the reforms introduced be treated as genuine constitutional measures, rules that are designed to constrain the short-run expedient behavior of politicians. Our emphasis here is in the long-range nature of reform, rather than on the details of particular proposals. To avoid charges of incompleteness and omission, however, we advance explicit suggestions for constitutional change, and notably for the adoption of a constitutional amendment requiring budget balance.

Notes for this chapter

For a formulation of this choice alternative in a British context, see Robin Pringle, "Britain Hesitates before an Ineluctable Choice," Banker 125 (May 1975): 493-496.

John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace, 1936).

See Richard M. Weaver, Ideas Have Consequences (Chicago: University of Chicago Press, 1948).

See Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (London: Oxford University Press, 1968); and G. L. S. Shackle, "Keynes and Today's Establishment in Economic Theory: A View," Journal of Economic Literature 11 (June 1973): 516-519. A somewhat different perspective is presented in Leland B. Yeager, "The Keynesian Diversion," Western Economic Journal 11 (June 1973): 150-163.

End of Notes

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