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Forget about Keynes

June 25,2018
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Kim Hyoung-tae
*The author, former president of the Korea Capital Market Institute, is a guest professor at the Seoul National University Business School.

While the United States’ rapprochement with North Korea and trade scuffle with China are dominating headlines, think tanks in Washington have been tending to a more sober and imminent concern: snowballing national debt.

Their worries are valid. To finance President Donald Trump’s ambitious tax cuts and infrastructure spending, the U.S. Federal Reserve is out to nearly double government borrowing through bond issues this year ahead of the midterm elections in November.

Economic perspectives on debt differ greatly by school of thought. Neoclassical economics regards government debt in the same light as private debt. But Keynesian economics differentiates between public and private debt. It advocates increased government spending — and debt — to stimulate growth. Today, mainstream economists advise a certain cap on public finances since the risks from debt can overwhelm the merits of stimulus.

Therefore, approaches to debt can differ among economists. Carmen Reinhart and Kenneth Rogoff of Harvard University advise austerity, arguing that excess debt against a certain threshold in gross domestic product can cut growth rather than aid it. Meanwhile, Keynesians argue for debt-financed growth, because austerity can slow down the economy.

But the ideas of John Maynard Keynes from a century ago cannot apply to today’s world. Debt was a lesser problem then. Debt could be tamed by monetary policy. Few would anticipate the policy’s effects. Today’s economy and markets have become too complicated for the government to control. Debt levels have become colossal because debt has been refinanced with debt. Authorities cannot rely on inflation to contain rising debt. People have become more savvy and responsive to the market’s cycle and development than even the government.

Keynesian economics works better in developed economies like the United States, Japan, European Union and United Kingdom — markets where their currencies have reserve status. A state with reserve currency has the same credit rating as top-grade investment enterprises that can borrow as much as they want from banks. Korea does not have such a currency status and therefore lacks credit. It must improve its credit to borrow.

A company lacking good credit cannot afford debt profligacy. It must have a completely different debt plan. Korea must be extra sensitive to excess debt. We must forget about Keynes. Even he would be stupefied by the contemporary infatuation with his theory.

His concept remains tempting. The idea of stretching government debt without any worries about the limit is surely alluring. But recent studies show that if government debt reaches a certain level, debt-financed spending does little to aid economic growth. Excess debt can hinder growth and stoke a financial crisis.

As the Bank of Korea leans toward tightening, some pundits say it would be easier to achieve growth beyond the interest rates since they still remain subdued (1.5 percent as of May). The argument could be used to justify increased spending backed by bond issues. But that theory is dangerously misleading. Low interest rates — especially in the long term — are the result, not the cause, of slow economic growth.

If interest rates have fallen due to slow growth, the economy cannot run at a faster rate as long as interest rates stay low. Birds fly off at the sight and movement of a train approaching. The train’s movement should not be affected by birds on the rail. Low interest rates, therefore, cannot be a primary factor for growth. Economic policies often flop when authorities get the causes and results mixed up.

Alexander Hamilton made the rare case of being the best and the first. He was not only the first U.S. Treasury secretary, but he is also still regarded as the best that the United States ever had. His life was even turned into a Broadway musical. He regarded federal government debt in the same light as private debt and stressed discretion in use and timely repayment. His economic focus was to raise the integrity of U.S. sovereign debt. As a result, the government was able to borrow at lower rates than the United Kingdom to achieve economic hegemony.

The Korean economy is in serious need of a statesman like Hamilton.

Translation by the Korea JoongAng Daily staff.

JoongAng Sunday, June 23-24, Page 35