Society, Politics & Law

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Economics and the 2008 crisis: a Keynesian view

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# 6.2 Government expenditure (2)

Lloyd George’s £300 million programme had three main planks:

• Transport: To modernise the rail and transport system, including electrification of railways and particular emphasis on roads, since they were under the direct control of the government sector. A capital sum of £145 million for road replacement and extension over two years was proposed.
• Housing: To build 200 000 houses a year: a million houses over a ten-year period would provide for slum clearance and reduction of overcrowding. Unemployed building workers would be set to work on these road- and house-building programmes.
• Small projects: A host of other small developments, such as telephone development and land drainage. All this required was a Treasury green light for ‘innumerable schemes pigeonholed in government offices’ (Keynes, 1972, p. 99).

Similar public spending programmes were announced throughout the world in response to the economic crisis of 2008. In the USA, President Obama introduced the American Recovery and Reinvestment Act of 2009, which resulted in US$831 billion of government spending on items such as infrastructure, health and education. In the same year, Australia launched a ‘Nation Building and Jobs Plan’, costing AUS$42 billion, on items such as building local community infrastructure and refurbishing schools – estimated to create 90 000 jobs and to boost annual GDP by 1% after two years (Vu and Tanton, 2010, p. 129).

The official UK government position in 1929, however, as summarised by the Balfour Committee on Industry and Trade, was that a programme of this kind ‘could not provide employment in their own trades for any considerable number of unemployed persons’ (quoted in Keynes, 1972, p. 100). Against this pessimistic assessment, Keynes stated the Liberal position that ‘each million pounds spent annually on road improvements would employ, directly or indirectly, 5,000 workpeople’ (Keynes, 1972, p. 103). Keynes pointed out that this is four times higher than the assessment given by the Balfour Committee. The committee had failed to take into account the indirect employment effects of the road-building programme.

This error was eventually admitted, after questioning in the House of Commons, by the Conservative Minister of Transport, Colonel Ashley. After noting that for each £1 million of road-building expenditure employment ‘might be increased to as much as 2,500’, Colonel Ashley conceded that for each of these direct jobs ‘another man would be indirectly employed in producing and transporting materials in other ways, and this assumption may not be unreasonable’ (quoted in Keynes, 1972, p. 104). There would be additional indirect employment created in the production and transport of the tarmac and other materials that are required for road-building, leading to a further possible 2500 jobs.

## Activity 9

As reported above, the official estimate was that 5000 jobs were created by each £1 million of expenditure. Directly and indirectly, how many jobs could have been created by the £72.5 million earmarked for the first year of the Lloyd George road-building programme?

The total impact would have been 362 500 jobs (72.5 × 5000) in the first year – a substantial hole in the more than one million unemployed in 1929, created just by road-building. For Keynes, this was not a Lloyd George fantasy; it was confirmed by the government itself after intensive pressure and analysis.

In Keynes’s view the Balfour Committee had failed to take account of something much more significant than the indirect employment to which the Liberal Party’s pamphlet and statements had drawn attention. By putting unemployed people into work both directly and indirectly, an initiative such as the road-building programme would increase what he called ‘effective purchasing power’. Newly employed workers in the road-building industry would spend part of their wages on a wide range of goods and services, providing increased income and creating further new jobs in other parts of the economy. This in its turn would lead to further spending, more income and more new jobs. In this way there would develop a considerable ripple in the form of successive rounds of spending: ‘the forces of prosperity [would] work with a cumulative effect’ (Keynes, 1972, p. 106).

This notion of cumulative increases in demand and hence in income and output is so central to Keynes’s system that it is worth quoting at some length from the pamphlet that he wrote with Henderson:

It is not possible to measure effects of this character with any sort of precision, and little or no account of them is, therefore, taken in ‘We Can Conquer Unemployment’. But, in our opinion, these effects are of immense importance. For this reason we believe that the effects on employment of a given capital expenditure would be far larger than the Liberal pamphlet assumes.

(Keynes, 1972, p. 107)

By the time Keynes published The General Theory of Employment, Interest and Money in 1936, he had refined his thinking about these cumulative effects and showed how they might be estimated using the marginal propensity to consume.

The analysis that follows in the next section shows how the impact of government expenditure on output and employment can be modelled, using the aggregate demand framework.