How Generosity damages your pocket
Recently I heard an interesting story about John Maynard Keynes. The story takes place inNew Yorkafter the Great Depression. Keynes was enjoying a walk with a friend of his in the streets of the city. While walking, they passed by a homeless person who was begging for money.Keynes’ friend turned back and gave to the poor man a dollar. Then Keynes, surprised and frustrated, turned to his friend and said: “Do you realise that you are the reason of depreciating our currency? You shouldn’t have helped him!”
Keynes reaction sounds cruel, especially for most people with no knowledge on economics. So what exactlyKeynesmeant by his saying?
In an equilibrated economy (only in theory) individuals usually can spent what they can produce. Every individual, based on the level of its salary, will rationally (in a utopian world) allocate it between spending and investing (usually by depositing the money in a bank account).
To illustrate the abovementioned, let’s consider the case ofKeynes’ friend (probably namedBob, since the story takes place in theUS). To keep it simple, we will assume thatBob’s monthly salary is 10$ and that he spends as much as he saves in his bank account. Thus the month that they met the homeless person,Bobwas about to deposit 5$. Considering thatBobneeds 5$ to cover his monthly needs, he will deposit only 4$ this time. On the other hand, the homeless earned 1$ by producing nothing and I will rationally assume that his marginal propensity to consume is 1 (meaning that he is going to spent all his money instead of investing them).
If these two have never been met (and imagining that the rest population of NY luck of generosity), the total value of their aggregate demand for goods and services would be 5$, since onlyBobgenerated income. But in our case,Bobinstead of investing the rest of his salary (and thus creating growth), he gave to the homeless person the capacity to consume as well.
Since the latter did not produced anything, the aggregate supply of goods and services remained the same, while the economy’s aggregate demand increased by 1$. The result here is inflation (and in our case without a decrease in unemployment asPhilip’s curve suggests). Ultimately, what Keynes was implying, is that by taking money from someone who produces (e.g. taxation) and giving them to someone who doesn’t (e.g. unemployment benefits), you simply decrease your purchasing power by devaluating your money.
I don’t know if the story continues withBobaskingKeynes’: “And what do you suggest? Leave these people die on the street?”, but I am sure that at this point we all have the same question. The answer is not simply since economy is a highly complex ‘organic’ structure which cannot be analysed only from a mathematical point of view.
One thing for sure is that generosity (either public or private) is NOT the solution to the problem. What those people need is help, to help themselves, to enhance their skills and competences, become more competitive, build up their lost confidence and re-educate themselves so as to become capable of re-joining the working force. In the short term, policies such as unemployment benefits are necessary in many cases so as to help people who just lost their jobs, to stand up on their feet, cover their current liabilities and boost their attempt to make a new start. In the long term these policies can seriously damage the economy (e.g. in UK and Germany many people have learnt to live from these benefits for years, thus ending up totally de-motivated to look for a job and in many cases, they simply become lazy).
I believe now its obvious that the well known quote: “Tax the rich and feed the poor”, could only be the beginning of the end of an economy. The right policy would be: tax them all and feed government spending. Thus, economic growth will be generated, resulting to job creation for people entering the labour market for the first time as well as for people currently unemployed.
The chart above shows the level of real national output (GDP) and total employment inUK’s economy since1980. Inboth of the last two recessions (1980-81 and 1990-92), the number of people in work has fallen sharply. But a period of sustained economic growth (as experienced by theUKfrom 1993-2001) has led to a major increase in employment rates.
Unemployment has always been the cancer of every economy and the cure is right in front of us. Why hasn’t been ‘’treated’’? I assume, most probably because humans are not as altruistic as they want to think they are, and on the top of everything we place our own interest. Nowadays the world has reached at a socioeconomic critical point where collapse can easily be seen with naked eye in the horizon. We have been turning our back to the real problems for decades, but now the “long run” is here and action needs to be taken.
P.s. I had the intention to integrate the Greek case in this topic, but then I realised that I would probably end up writing a whole book and unfortunately I don’t have the time.