The long run is a misleading guide to current affairs.  In the long run, we are all dead.

                                                                                       John Maynard Keynes

Indeed.  But what if, in the short run, we are also dead?  What happens to the economic systems of stagnant and dying human populations?  If examining current affairs yields the inescapable conclusion that markets have been oversupplied relative to demand; that demand can not sustainably grow because the population is not growing; that demand can not expand through ever-increasing living standards because living standards are already as high as animal spirits will propel them, what then? 

Thus is the problem faced by today’s economic architects–how to manage economic systems whose populations are stagnant or declining to achieve the best possible outcomes, even in decline.  It is not a situation ever openly contemplated by either Keynes or Friedman, the dead economists adopted as intellectual fathers by liberal and conservative economists (respectively), the two main competing views over which, inter alia, offers the best formula for achieving the greatest wealth creation in economic systems.  Keynes well understood that economic growth is closely tied to population dynamics:

The great events of history are often due to secular changes in the growth of population and other fundamental economic causes, which, escaping by their gradual character the notice of contemporary observers, are attributed to the follies of statesmen or the fanaticism of atheists.

In other words, Keynes acknowledged that one fundamental cause of changing economic performance is a change in the population growth rate.  And a changing population growth rate is precisely what all of the developed countries, and some lesser-developed countries, have experienced over the last half-century.  Birth rates have plummeted, and are lower than replacement (roughly 2.1 per female) in the following countries or areas, according to the CIA World Factbook, 2008:  The European Union (1.5);  Germany (1.4); Italy (1.3); the United Kingdom (1.66); Russia (1.4); Japan (1.22); China (1.77); South Korea (1.29), among others.  Declining birth rates take time to manifest as declining population growth rates (as the old must die off first).  But anything less than replacement portends negative population growth, i.e., an aging and declining population.

Positive population growth rates are implicitly assumed in both Keynes and Friedman’s economic theories; it is in fact a foundational assumption of all of neo-classical economics.  But it turns out to be false.  At some level of economic development and well-being, birth rates level off and begin declining, until they force population growth rates negative, such we see today, e.g., in Japan (-0.14%) and Russia (-0.4%).   Negative population growth rates in the three centuries before, during and after the Industrial (and agricultural) Revolution were unimaginable.   About the same time as Adam Smith was laying the foundations of modern economic theory, Robert Malthus was dismally predicting that population growth would always equal or exceed growth in the food supply, keeping humanity in a constant state of subsistence living.   Things didn’t turn out that way.  Population growth rates and economic growth rates developed a negative correlation.  The richer a country got, the lower went its birthrate.  Hong Kong, Milton Friedman’s favorite example during the nineties of a purely capitalist society, has a birth rate of exactly one child per female, less than half that required for replacement.  

During the Great Depression, Keynes recognized that production efficiencies caused excessive supply which eventually overshot demand to a scale that even a growing population hungry to raise its living standards could not absorb, and recommended government borrow and spending to carry the slack until demand (population) could grow to meet the expanded capability to supply it.   Excessive capacity was endemic during the Great Depression–in the production of everything from consumer goods to agricultural and industrial commodities.  Keynes felt that government spending could sop up some of the excess supply while creating (if falsely) an expansion in demand.  The government, in some cases, took his theories too far, e.g., borrowing money to buy and then destroy crops and livestock as a hackneyed means of expanding demand while reducing supply.   Juicing demand through government borrowing might have been the prescription then, as the country had plenty enough build-out into the modern, industrial era yet to go.  Now it seems more like gladly paying Tuesday for a hamburger you eat today.

Friedman believed the Depression was, if not directly caused, then at least hugely exacerbated by the government’s policies regarding the currency.  At the start of the Depression, the currency was backed by gold.  As the contraction took hold, gold fled the treasury, making dollars more scarce and thereby more valuable.   The Federal Reserve refused to do anything to ameliorate the declining supply of money.   There was a true deflation to exacerbate price declines that would have happened anyway due to demand contraction.  Deflation has its own depressive impact on economic activity, incentivizing people to put off purchases so long as they can, so long as prices keep falling.  But the depressive effect of deflation is not permanent.  Eventually expectations adjust to account for it, and anyway, the situation quickly resolved in 1933, when Roosevelt abandoned the gold standard.   It didn’t stop prices from falling–there still was the contraction in demand to contend with–but it did remove the multiplier effect of having a currency that is steadily increasing in value.  From there, modest growth in output accrued until the “depression within the depression” of 1937, which itself might have been the result of anti-Keynesian budget balancing, or, more likely, the passage of the  Robinson-Patman Act in 1936 that effectively made lowering prices illegal for merchants.    But it’s all very difficult to tease out the true effects of programs initiated during the Great Depression.  There were so many of them until the economic landscape was in a constant state of flux, which itself might have contributed to the contraction.

Friedman is the intellectual priest of our present Federal Reserve System’s catechism.  It is Friedman that propounded the idea of monetary expansion at a slow and steady rate in order to keep output growing, which the Greenspan, and then Bernanke Fed, seemed to think meant a steady increase in consumer prices of one to two percent annually.   Friedman believed a little inflation was good, but feared deflation above all else.  So too did Greenspan, and now does Bernanke.   The anti-deflation bias–believing at all times and all places that declining prices are bad–is probably most to blame for the financial crisis that struck beginning in 2007.

Today, even in the US (which has a meagerly growing population–all due to immigration–as the birthrate is almost exactly at replacement), and more so elsewhere, there is no growing population hungry to raise its living standards.  Living standards well above subsistence such as the US enjoys makes for few hungry citizens (metaphorically, and otherwise, as obesity statistics attest), and are negatively correlated with population growth.   Deficits today won’t likely become a vanishing share of growing economic output tomorrow.  Some economic systems are coming around to understanding the problems that ordinary Keynesian analysis presents for an aging and declining population.   Against the advice of Paul Krugman, today’s most vocal and vociferous Keynes acolyte, Great Britain, France, Greece, Ireland, Iceland and others are traveling a different road, tightening their budgets in the face of declining tax revenues resulting from the recession.  Call it counter-Keynesian, which seems pro-cyclical, but perhaps isn’t.  As Britain’s new Prime Minister, David Cameron claims, it might just give their economic systems the confidence boost they need in order to structurally reform to face the realities of their underlying demographics.  The increase in the retirement age that France is attempting to institute, in the process spurring widespread strikes and unrest, is perhaps just a glimpse at the West’s anti-Keynesian future. 

About ten years ago, Japan, went hyper-Keynes and hyper-Friedman, running fiscal deficits and printing money, to no avail.  Friedman was still around to advise that Japan do exactly what she did monetarily, i.e., to print, print, print until the dark cloud of deflation lifted.  It didn’t work.  Still she languishes in the economic doldrums, as she has for the last two decades.  Deflationary expectations are more firmly entrenched than ever.  Her population decline is accelerating, yet her government borrows more and more in hopes of stimulating demand.  Fortunately for the rest of the world, almost all of Japan’s debt is owed to her own citizens, so when default comes, Japan itself will suffer the brunt of decreased living standards.  Japan’s experience with demographic implosion should be instructive to others facing the same quandary, and since Japan is on the leading edge of dealing with the effects of an aging and declining population, it should be a bellweather for what similarly-situated economic systems might expect.  Closely watching Japan could answer the question really no one knows the answer to:  Does demographic implosion reverse itself when the survival of the economic system or nation is finally and genuinely imperiled?  Within fifty years, Japan’s very survival as a distinct nation and culture will be at risk if trends continue.  What will happen then?

A great many commentators, and especially the political economists among them, falsely see a dichotomy with Keynes’ and Friedman’s varying approaches to maximizing economic performance.   The two lions of industrial-age economics aren’t so different.  Both believed in the efficacy of government intervention to affect real economic outcomes.  Keynes believed governmental borrowing the proper prescription for a contraction in demand.  Friedman believed that properly managing the money supply would prevent wild fluctuations in demand.  Both believed in allowing markets to set prices, which is sort of ironic in Friedman’s case.  While he was a stout proponent that market regulation was best done through the price-setting mechanisms of the markets, he didn’t see any logical inconsistency with that view and his view that government should control the supply and therefore price of the money with which all the rest of goods and services would be priced.   Keynes didn’t necessarily disagree with Friedman’s monetarism, but did not have the same confidence that money supply manipulations alone could affect real outcomes.  Both men understood the destruction wrought by the gold standard during the early stages of the Depression.  Keynes was not as anti-regulation as Friedman, and that is their major difference, which is a relatively minor, along the margins, sort of difference.  To which of Keynes or Friedman should these quotes be attributed?

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Inflation is everywhere and always a monetary phenomenon.

Of course, every first-year economics student should know that Keynes made the first observation, in his book, The Economic Consequences of the Peace.  Friedman made the second statement in numerous publications and speeches during his lifetime.  The point is, the two men weren’t nearly so far apart as academia and popular discourse would today have you believe. 

Even so, neither they, nor Adam Smith, nor Robert Malthus, nor any number of economic scientists of the last three centuries, would recognize an economic system in which the participants are aging and dying out, with no replacements on the way.   Yet that is today’s reality.  The best strategy for managing an economic system whose population is in decline is the political, economic and social question for our era.  Which must be why no one is asking it.