Today's date:
Spring 2009

The Resurrection of Keynes

Paul Samuelson, 93, was awarded the Nobel Prize in Economics in 1970 and is professor emeritus at the Massachusetts Institute of Technology (MIT). He was a student of Joseph Schumpeter at Harvard, and his nephew is former Harvard president Larry Summers, now President Barack Obama's top economic adviser. Samuelson's 1948 classic, Economics: An Introductory Analysis, is one of the best-selling economic textbooks of all time. He spoke with NPQ editor Nathan Gardels.

NPQ | You have outlived Milton Friedman, who died in 2006. And now your Keynesian ideas have also outlived his radical free-market ideology. Is economics back to where you started?

Paul Samuelson | You are right. I am old enough to have seen the cycle come full circle. My experience is more valuable now than it was even a year ago, since I first became actively engaged in economic policy on Jan. 2, 1932, at the rock bottom of the Great Depression, when I was an adviser to the Federal Reserve Bank in Washington. In subsequent years, I was principal economic adviser to President-elect John F. Kennedy in 1960 and recruited the team for his Council of Economic Advisers.

I became a centrist early on. Of course, the central planning system of the socialist states we still contested with ideologically in those days was idiotic, but that didn't mean government doesn't play a critical role.

And today we see how utterly mistaken was the Milton Friedman notion that a market system can regulate itself. We see how silly the Ronald Reagan slogan was that government is the problem, not the solution. This prevailing ideology of the last few decades has now been reversed.

Everyone understands now, on the contrary, that there can be no solution without government. The Keynesian idea is once again accepted that fiscal policy and deficit spending has a major role to play in guiding a market economy. I wish Friedman were still alive so he could witness how his extremism led to the defeat of his own ideas.

NPQ | How does the current economic crisis compare to the Great Depression?

Samuelson | The current situation is very similar and certainly the worst experience America or the world has faced since the end of World War II. In some cases—the housing market—it is even worse.

Clearly there is going to be an extraordinarily long recovery period, even with very large deficit spending by the government. Obama has a good team—including my nephew Larry Summers. But as an old veteran of battles over economic policy in Washington, I am sure Obama will run into a lot of overt and covert resistance. His honeymoon will be short.

Current projections that we might see some recovery by the second half of 2009 are highly implausible. I suspect we won't see a recovery before 2012 and possibly even 2014. That more closely resembles the time frame it took Roosevelt from his inauguration in March, 1933, to the eve of World War II.

I'm afraid that young people listening to Obama's reassuring remarks lack historical perspective on this score. Obama has a fighting chance, but it is going to be very, very difficult.

There have been ups and downs and economic bubbles since the cavemen. What makes this meltdown different is that we have built such an elaborate house of cards on the fiendish financial schemes of "brilliant" MIT and Wharton School graduates that it will take a great deal of time to unwind the mess and rebuild confidence in the financial system. They created instruments so complex that no CEO understood them. They so lacked transparency that the meltdown came as a surprise.

NPQ | The Obama approach includes tax cuts as well as infrastructure spending. Some argue that tax cuts are less bang for the buck in terms of creating new jobs more quickly than infrastructure, which has more bang for each buck. Back in the Kennedy days, you proposed tax cuts as a way to stimulate the economy. What is your view now?

Samuelson | In the Kennedy days, we worked hard to get a tax reduction, which we finally got. It did help then. But the legacy that George W. Bush leaves us with is terrible because people today confuse his giveaways to the rich with tax reductions that can have a meaningful effect on economic growth. Obama's plan should give tax breaks to the lower middle class; that will work. But giving tax cuts to the Fortune 500 companies and their shamelessly overpaid executives is not going to make them suddenly dynamic.

The system of corporate governance that has allowed CEOs to earn 400 times the median wage of their employees—two decades ago it used to be 40 times—has undermined any case for tax cuts to the upper brackets. Corporate pay based on quarterly earnings instead of long-term growth, combined with golden parachutes even if executives fail, undermines productivity. Tax cuts for this group, then, is literally counterproductive. Bush's policies failed miserably on this score.

On infrastructure, you have to distinguish between the short run and the long run. If there are "shovel-ready projects"—for example, a mass-transit project in some major American city which already has zoning and environmental approvals and only awaits federal funding—we should just pitch ahead. But terms like "jump-starting" the economy or "priming the pump" are wrong. That is like tossing dollar bills out of an airplane across the country, letting them fall where they may and hoping they do some good. Shots in the arms don't produce much.

Any effort must be sustained, not one off. Bridges to nowhere won't lead to recovery; they have to be bridges that connect economic activity between two places so net growth is produced over the long run.

NPQ | Obama is proposing a stimulus of between $800 billion to $1 trillion. Is that enough to do the job?

Samuelson | It is in the right ballpark. In the end, it may take more.

NPQ | With all that deficit spending, shouldn't we worry about inflation?

Samuelson | If, optimistically, we are back at 4 percent unemployment by 2012, the price level will be higher than it is today, probably rising at 2 percent a year, culminating in 8 percent. I think that is worth it because deflation is the greater worry. Given the circumstances, we should err on the side of over-stimulus. Nobody in his right mind would try to roll back that level of inflation if it avoids deflation and leaves us with an intact, self-sustaining economy again.

NPQ | The United States has been able to fund its overspending habits by borrowing from the Chinese and others who have reserves from their trade surplus. That has kept borrowing costs down. With the global financial crisis, capital is still "fleeing to safety" in the US, propping up the value of the dollar. Will that last?

Samuelson | I do not share the conviction of some that the American dollar will remain strong because we are the last refuge of safety. That won't endure. This crisis will quickly teach Asian nations, in particular China, that they need to shift from an export orientation to building domestic consumption if they want sustainable growth. When the immediate panic is over, they will need all that capital at home, not parked in US Treasuries.