According to John Maynard Keynes,
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.
The power of Keynesian ideas is on display in the present world. Whenever there are signs that the economy is likely to fall into an economic slump most experts advise that the central bank and the government should embark on loose monetary and fiscal policies to counter the possible economic recession. In this sense, most experts are following the ideas of John Maynard Keynes.
Briefly, John Maynard Keynes held that one could not have complete trust in a market economy, which is inherently unstable. If left free, the market economy could self-destruct. Hence, there is the need for governments and central banks to manage the economy.
Successful management in the Keynesian framework is done by influencing the overall spending in an economy. It is spending that generates income. Spending by one individual becomes income for another individual according to Keynes. Hence, the more that is spent, the better things are going to be. What drives the economy, then, is spending.
Consumption and Production
In the Keynesian framework the largest part of spending is consumer outlays. Hence, consumer outlays are regarded as the motor of the economy—consumption sets in motion real economic growth.
But one must make a distinction between productive and nonproductive consumption. While productive consumption is an agent of economic growth, nonproductive consumption leads to economic impoverishment.
For instance, a baker exchanges his ten saved loaves of bread for ten potatoes. The potatoes are now sustaining the baker while he is engaged in the baking of bread. Likewise, the bread sustains the potato farmer while he is engaged in the production of potatoes. What we have here is that the respective production of the baker and the potato farmer enables them to secure goods for consumption.
What makes the consumption productive here is the fact that both the baker and the potato farmer consume in order to be able to produce consumer goods. The consumption of both the baker and the potato farmer maintains their lives and well-being, which is the only reason for production.
The introduction of money does not change what has been said so far. Thus, the baker can exchange his ten loaves of bread for ten dollars—he then uses money to secure ten potatoes. Likewise, the potato farmer can now exchange his ten dollars for ten loaves of bread. Although it fulfills the role of the medium of exchange, money has contributed absolutely nothing to the production of bread and potatoes.
Nonproductive Consumption
Now, to secure potatoes the baker had to exchange bread for money and then employ the money to secure potatoes. Something was exchanged for money, which in turn was exchanged for something else, or something for something is exchanged with the help of money.
Trouble erupts when money is created out of “thin air.” Such money gives rise to consumption which is not backed by any production. It leads to an exchange of “nothing” for “something.”
For instance, a counterfeiter has printed twenty dollars. Since he secured this money not through the production of some useful goods, the counterfeiter has obtained the twenty dollars by exchanging nothing for it.
The counterfeiter uses the newly generated money to buy ten loaves of bread. What we have here is the diversion of real wealth—ten loaves of bread—from a baker toward the counterfeiter. Note that the diversion takes place when the counterfeiter paying a higher price for bread—he pays two dollars per loaf. (Previously the price stood at one dollar per loaf). Also, note that since the counterfeiter does not produce anything useful, he is engaged in nonproductive consumption.
The potato farmer is now denied the bread that he must have to sustain him while he is producing potatoes. Obviously, this will impair the production of potatoes. As a result, less potatoes will become available, which in turn will undermine the consumption of the baker and in turn impair his own ability to produce.
We can thus see that while productive consumption sustains wealth generators and promotes the expansion of real wealth, nonproductive consumption only leads to economic impoverishment.
Money printed by the central bank and created through fractional reserve banking produces exactly the same damaging effect as the counterfeited money does. The expansion of money sets the platform for nonproductive consumption—an agent of economic destruction.
In the Keynesian framework, during a recession, when consumers tend to lower their outlays, it is the duty of the government to step in and boost its expenditure.
For instance, the government could employ various unemployed individuals to dig holes in the ground. The Keynesian framework holds that the money that the government is going to pay the workers is likely to boost their consumption, and this in turn is expected to lift the overall income in the economy.
In the Keynesian framework, it does not really matter whether holes in the ground contribute to individuals’ well-being. What matters is that people are being paid and then using the money to boost their consumption.
However, the government does not earn money as such—it is not a wealth generator. So how, then, does it pay the various individuals who are employed in various non-wealth-generating projects?
It secures the money either through taxation, by asking the central bank to print money, or by borrowing. This amounts to a diversion of wealth from wealth generators to government activities. Note that this generates the same outcome that money printing does—it sets in motion nonproductive consumption.
According to Mises,
[T]here is need to emphasize the truism that the government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.
From this, we can conclude that since government is not a wealth generator, it cannot grow the economy.
Contrary to popular belief then, the more the government spends, the worse it is for the health of the economy and thus for economic growth. Experts who advocate for very strong government stimulus measures during an economic slump never bother to ask how those measures are going to be supported.
Furthermore, it is the ongoing implementation of loose fiscal and monetary policies over the past several decades that has given rise to nonproductive consumption. The outcome of all this is the vast number of bubble activities.
What is required is not more Keynesian policies, but rather to allow wealth producers to start generating real wealth. This of course means that what is required is plenty of productive consumption. More government spending and the massive pushing of money by central banks will only strengthen nonproductive consumption.
