to economic expansion but may instead hinder it. In such a situation, Keynesian spending policies might actually interfere with necessary adjustments in the economy, thereby slowing down rather than speeding up economic growth. If this is so, then the problem lies more with the political economy of Keynes than with the economics of Keynes.
This case was first advanced in 1982 by Mancur Olson in The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities.14 In this insightful book, Olson tried to account for the “stagflation” of the 1970s and the failure of Keynesian theories to explain it. He argued that democratic nations over time develop political rigidities that permit strategically placed interest groups to block breakthroughs in policy and to exploit political influence in order to seize shares of national income that they have neither earned nor produced. These “distributional coalitions,” in Olson’s terminology, are organized around struggles over “the distribution of income and wealth rather than over the production of additional output.”15 Often called “rent-seeking” coalitions, they include cartels or special-interest groups like trade or industrial unions, public employee unions, trade associations, advocacy organizations, or corporations that try to increase the incomes of their members by lobbying for legislation “to raise some price or wage or to tax some types of income at lower rates than other types of income.”16
As rent-seeking groups accumulate and multiply their influence, they win more advantages for themselves but impose ever-greater burdens on the private economy, by blocking change or disinvestment in old industries and by diverting resources from wealth-creating to wealth-consuming uses. When an economy reaches a point where distributional coalitions are pervasive, it loses the flexibility to respond to shocks, recessions, or unanticipated changes in price levels. “The economy that has a dense network of narrow special-interest organizations will be susceptible during periods of deflation or disinflation to depression or stagflation,” Olson writes.17 The reason for this is that an unexpected deflation will expose above-market incomes and prices in the “fixed-price” sector, forcing movement out of that sector and into the “flexprice” sector where incomes, wages, and prices are set by market competition. Many will resist such moves, or not know how to accomplish them; queuing and searching costs will be high; the adjustments will force prices to fall further in the flexprice sector, reducing overall demand in the economy. An extended period of stagnation will follow as the marketplace adjusts to the distortions caused by distributional coalitions.
One might suggest that the government should then step in with the standard Keynesian remedy, borrowing money and incurring debt to arrest the deflation and to allocate funds to maintain the above-market prices and incomes in the fixed-price sector. This in fact looks very much like what the U.S. government tried to accomplish with its $800 billion stimulus package in 2009, which was allocated disproportionately to public employee unions, university research programs, energy companies that could not get loans from banks, and bankrupt auto companies and their labor unions.c Olson’s reply might be that such remedies will have only a temporary effect because they empower distributional coalitions that do not produce wealth and growth but seek to maintain their advantages at the expense of the economy as a whole. Keynesian spending policies run up debt that everyone is obliged to repay in order to underwrite above-market incomes and prices for groups whose activities impede economic growth.
This is the reason, Olson suggests, that new states grow more rapidly than long-established ones: because new states have yet to develop rent-seeking coalitions. Thus, the United States economy grew rapidly during the nineteenth century, and the economies of Japan and West Germany similarly expanded in the two or three decades after World War II. These economies all had extended periods in which markets were free to operate and interest groups had not organized to obstruct change or to claim rents; they were open to investment and entrepreneurship, and as a consequence they enjoyed historically high rates of growth. Olson emphasizes that all three countries had gone through traumatic wars and revolutions that had the salutary effect of cleaning out existing rent-seeking groups. In the United States, such groups were wiped out by revolution and then restrained by constitutional rules that limited the power of the central government; in Germany and Japan, they were eliminated by war, so that these countries started over with clean political slates. But growth and affluence led over time to the formation of rent-seeking groups that created obstacles to further expansion.
Olson has been criticized for suggesting that such rigidities are usually cleaned out by wars and revolutions—upheavals that are far worse than the problem they would solve. In the modern age, these are obviously off the table as solutions to this economic problem. Of course, the business cycle might operate in market economies to disperse at least some distributional coalitions by making above-market prices and wages more expensive for others to bear. Yet the objective of Keynes’s approach was to “smooth out” the business cycle, which allows distributional coalitions to persist over the long run, even as new ones are forming. The fact that some governments (like that of the United States) can incur debt almost without limit means that this process of underwriting distributional coalitions by government spending can be extended well into the future, or at least until that borrowing capacity is called into question. But the distributional coalitions and the debt are both burdens on future growth.
Thus, in an economy where distributional coalitions are numerous and powerful, the Keynesian remedies (or at least spending remedies) may be ineffectual in restoring consumer demand, private sector investment, and economic growth. Keynesian spending policies may in fact encourage the formation of distributional coalitions that eventually render those policies less effective. In the process, political friction builds between influential rent-seeking groups and those who are compelled to fund their benefits. This is the political flaw hidden within Keynes’s theory.d
* * *
The “age of Keynes” has now lasted about seventy-five years, or roughly as long as the “age of laissez-faire” that preceded it. Is this era approaching an end under the pressures of the long recession, the financial crisis, accumulating public debt, the demands of distributional coalitions and the political tensions they generate? Keynes himself argued that the capitalist system evolves through stages by the development of new organizational forms and by its dynamic process of invention and destruction. There is thus no reason to assume that the “age of Keynes” represents a permanent or final stage in the evolution of capitalism. One prospect is likely: the United States, and advanced economies in general, are in the early stages of an upheaval that will test the Keynesian system to its limits.
a As things turned out, Keynes was not far off in this prediction. In the United States, per capita income increased about sevenfold from 1945 to the present time. Yet there is no thought today that the “economic problem” has been solved.
b In an addendum to The General Theory (chap. 23), Keynes approvingly cited Mandeville’s Fable of the Bees, which suggested that frugality and virtue carried to excess lead to general impoverishment. Keynes’s point was that his theory about consumer spending and consumer demand was not novel but had an ancient pedigree in the history of economic thought.
c The General Motors (and United Auto Workers) bailout was paid for out of the Troubled Asset Relief Program, the $750 billion program adopted to allow the federal government to recapitalize banks and insurance companies by purchasing “troubled” assets.
d The consequences for party politics are further discussed in Chapter 5 below.
Much as generals
