Steve Kates summarises lucidly:
Recessions occur because goods and services are produced that cannot be sold for prices that cover their costs. There are reams of possible reasons why and how such mistaken production decisions occur. But when all is said and done, the causes of recession are structural. They are the consequence of structural imbalances that result from errors in production decisions, not the fall in output and demand that necessarily follows.
This cannot be emphasised enough. Modern macroeconomics is built around the notion of the level of demand, while prior to Keynes recessions were understood in terms of the structure of demand. The difference could not be more profound. To policy-makers today, the basic issue in analysing recessions is whether there is enough demand in total. To economists prior to Keynes, the central issue was to explain why markets had become unbalanced.
In modern economic theory, rising and falling levels of spending are for all practical purposes what matters. That is why increasing public spending and adding to deficits are seen as an intrinsic part of the solution, not as the additional problem such spending actually is.
Missing in modern economic debates is an understanding of the importance of structure, that the parts of the economy must fit together. What’s missing is an understanding that if the entire economic apparatus goes out of alignment, recession is the result and recession will persist until all of the parts once again begin to mesh.
In 2009, Steve Kates warned:
We are on the precipice of adopting economic policies that will drag us into a deep and ongoing recession and which will diminish our economic prospects possibly for years to come. We may, just as Keynes said, drift on from expedient to expedient and never get really fit again.
These are issues of immense importance. To get them wrong may well leave our market economies in the wilderness for a generation. The question before us really is whether markets should be allowed to find their way with only minimal government direction, or whether the economic system should be directed from above by elected governments and the public service.
This is not a mere matter of regulation but of actual direction and expenditure. No one disputes the importance of regulating the operation of markets. There is also a minor role that increased public sector spending might play in allowing some additional infrastructure projects to go forward while economic conditions are slack.
But to believe it is possible for governments to spend our way to prosperity would be a major error in policy. There is no previous occasion in which such spending has been shown to work, while there are plenty of instances in which it has not. On every occasion that such spending has been used, the result has been a worsening of economic conditions, not an improvement.
The only lasting solution also consistent with restoring prosperity, growth and full employment is to rely on markets. The repeated attack on the market economy, and the role of the private sector, is a mindset begging for trouble.
Certainly there are actions that governments can take to relieve some of the problems of recession, but they are limited. Sure, this is a better time than most to build infrastructure. Absolutely, there need to be measures taken to assist the unemployed. Yes, the central bank should be lowering interest rates and ensuring the viability of the banking sector. All such steps are mandatory and largely non-controversial.
But what must be explicitly understood is that recovery means recovery of the private sector. It is business and business investment that must once again take up the load of moving our economy forward. It is the banking system that must be allowed to allocate funds. To expect and depend on anything else will take this economy down deflationary pathways that will require years to reverse.
The Keynesian model makes the engine of growth appear to be expenditure, irrespective of what that spending is on. And the most important element in the recovery process, according to these same models, is an increase in the government’s own level of expenditure, and again it appears to matter not much at all on what that money is actually spent.