The difference between Keynesian and classical economics, by Steve Kates. The two understandings of how the economy works are so incompatible that when Keynes started to propose his ideas in the 1930s he was regarded as a crank by nearly all economists of the time. But Keynes’ theories suited banks and governments, particularly in the 1930s, and they elevated his theory to orthodoxy. Classical economics was forgotten.

Classical economic theory begins from the existence of a market economy in which, on one side of the equation, there is a mass of people who would like to buy goods and services, and on the other side there are people who would like to earn their living by producing and selling things to others.

The producers continually try to work out what to produce that others will buy, and do it by trying to decide what buyers will pay enough for in total to cover their production costs. These producers hire employees and the combined incomes of producers and wage earners become the purchasing power of the community.

Classical economic theory is thus entirely supply-side driven. And what is particularly interesting about reading the classical literature is that government regulation was an important part of how the economic system worked. … The notion that classical economics was simply leave everything to the market is 100% wrong. …

Crucially, classical theory assumes the role of the independent entrepreneur as the linchpin in making an economy work. Try to find a modern economic text that starts from there. Other than my own – Free Market Economics, Third Edition – none of the major mainstream texts starts from the supply side and none – as in zero – feature the role of the entrepreneur.

Keynesian economics assumes economies are driven from the demand side. That is, it is buying goods and services that makes an economy grow and employ, not their production. It is based on the total confusion between the demand for a single product [and total demand] … Demand affects individual products; demand in aggregate does not affect the level of output in total.

The more that is produced, the higher the level of demand, for the obvious reason that the more that is produced, the more there is that buyers are able to demand. But if you are a Keynesian, you will go on believing that the cause of higher output is higher demand, whereas the reason more can be demanded is that more output is being produced.

Public spending may have many benefits, but increasing the level of income and speeding up the rate of economic growth is not one of them. If anything, higher levels of public spending slow things down and lower real incomes below levels that otherwise would have been reached.

Keynesian economics is based on the fallacious belief that buyers will not buy as much as an economy can produce, and therefore demand must be stimulated to ensure everything produced is bought and that everyone who wants to work is employed. A great theory if you are in government and need a justification for taking as much money as you can get away with from income-earning citizens and spending it yourself. But a pernicious theory if you are interested in raising living standards as rapidly as possible.

In Keynesian economics, the economy is driven by a big blob of simple-minded aggregate demand that responds to money printing and interest rates. Which has led to the world’s current economic predicament of way too much debt and near-zero interest rates, so when the next recession comes along…

The world will return to the mean level of money/debt, one day. Will it be because of an intense depression that dwarfs the 1930s (see graph), or will governments print away the debt? Pretty obvious, isn’t it?