The American Spectator

(From the August 1981 issue of The American Spectator.)

Keynes has become a dirty word to many people. The easiest way for any economist to make a name for himself is to attack the fallacies of the Keynesians. The decline in Keynes’s reputation has done wonders for the reputations of long-standing critics of Keynesian economics like Milton Friedman and Friedrich von Hayek. The name of Keynes has become something of a liability to governments which for years worshipped at the shrine, thus confirming that in politics there are only marriages of convenience. The decline in the political utility of Keynesian economics has in turn weakened the cause of political moderation, giving fresh life to the two traditional, and in political terms, antagonistic anti-Keynesian ideologies: Marxism and laissez-faire capitalism. The old conflict between authoritarian central planning and market economics which Keynes seemed to have transcended has returned. Statist and socialist economics on the Left; attacks on the Welfare State from the Right: These are the twin political fruits of the Keynesian era.

What has brought about the great disillusion? Chiefly, I think, the realization that after thirty years or so of Keynesian economic management we are back to where we started, but with a seriously constricted range of attractive options. That is to say, we are experiencing once more the levels of unemployment which the Keynesian Revolution had abolished— 13 percent in Belgium, 10 percent in Italy, 10 percent in Britain, 7 percent in the United States —only this time round, unemployment is accompanied by high rates of inflation. This inhibits Western governments from acting to expand demand on the old Keynesian lines in an effort to increase employment, for to do so might just as easily increase inflation. Modern Keynesians say the only solution to this dilemma is incomes policy—wage and price controls. But this implies either legal coercion, which is highly unattractive, or centralized agreements between governments, trade unions, and business leaderships which have not only been unattainable, except for short periods, but which also carry disagreeable implications of corporatism.

We have also, since the 1930s, lost a certain amount of innocence about the workings of government. In the nineteenth century, enlightened opinion was virtually united in its mistrust of the state. The ills of economies were ascribed to political interference. For much of the twentieth century, the reverse was true: The maladies of economies—poverty, injustice, high unemployment—were ascribed to laissez-faire or insufficiency of government. Government was viewed as an unexplored, or at least unexploited, political resource, available to correct the “flaws” of capitalism. Keynes believed this; so did the welfare economists; so did the social democrats. Since the 1930s the potentialities of government have been much more fully exploited, and the results have been found wanting. As early as 1960, the British economist J.R.C. Dow found that fiscal policy as pursued by British governments was actively destabilizing. The old view that the state was always available to compensate, in a relatively costless way, for “market failure” is now seen as having been much too simple. Often we do not solve problems by making the state responsible for them. We simply transfer the problem from the private to the public sector; in the course of doing so, we saddle governments with what Professor Anthony King has called “growing reach and declining grasp.”

That the name of Keynes should have come to be associated with inflation and the spawning of bureaucracy is an ironic verdict on someone who loathed both. It was Keynes who wrote “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency”—and whatever Keynes had in mind, it was not to overturn the existing basis of society. It was also Keynes who insisted that his proposals were the only alternative to authoritarian central planning. “Those who do not realize this,” he wrote in 1940, “have not grasped what the Americans call ‘the big idea.’” How then has his revolution come to be associated with results which, in many respects, were contrary to his intentions? Was it his fault? Was he perhaps naive about the economic and political consequences of Mr. Keynes? Or was his revolution absorbed by other developments which deflected it from its original purposes ? Would we have had growing inflation and bloated government even had there been no Keynesian revolution?

LET US START WITH the question of Keynes’s own responsibility, which involves, first of all, asking what he set out to achieve. We must be clear about one thing. Keynes did not come to praise capitalism; but he did not come to bury it either. His aim was to make a decentralized system— what he called an “entrepreneur economy”— work with less damaging fluctuations and at a higher level of continuous employment than was the case between the wars. “It is certain,” he wrote, “that the world will not much longer tolerate the unemployment which.., is associated … with present day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease while preserving efficiency and freedom.” His object was to abolish slumps by stabilizing booms.

In his General Theory of Employment, Interest and Money, published in 1936, Keynes argued that in an entrepreneur economy there was no presumption that investment would be sufficient to maintain continuous full employment. That it had succeeded in maintaining a “reasonably satisfactory average level of employment” in the nineteenth century was due to a conjuncture of special circumstances which had passed away. Given the inescapable uncertainty surrounding future events, the likelihood was that a par.t of what was produced would not be spent, but would be hoarded, or kept liquid, for the purpose of speculation or as a precaution against future loss. The role of government in the Keynesian system was thus a double one: to improve the conditions of confidence—to give businessmen confidence that the system would last, that property rights would be maintained, and that the demands of workers would be restrained; and at the same time to make sure by fiscal and monetary policy that total spending in the economy would equal full employment output. In practical terms this meant that any increase in businessmen’s pessimism about the future must be offset by increased government spending to compensate for an increased propensity to hoard. Keynes was quite aware of a possible conflict between the two roles of government. Increased government spending, he warned Roosevelt, might depress private investment by an equal amount even in conditions of high unemployment if businessmen were worried by the objects of the expenditure or the methods by which it was financed, in short, he recognized the possibility that government policy may i itself be the cause of the pessimism for which government spending then had to compensate. This line of thought has been developed by monetarist economists who argue that it is discretionary variations in the money supply which play the major role in destabilizing the entrepreneur economy.

In retrospect, nothing is more striking, given Keynes’s emphasis on uncertainty, than his own confidence in the future. As the Great Depression gathered force in 1930 he wrote an essay entitled “The Economic Possibilities for our Grandchildren.” In it he argued that by keeping employment and investment continually high for a couple of generations, governments would be able to solve the poverty problem once and for all, freeing Western man to tackle his “permanent problem— how to use his freedom from pressing economic cares, how to occupy his leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.” Of the poverty and looming political revolt of the Third World, there is not a hint in Keynes’s writings.

Can Keynes, therefore, be indicted for famous optimism spilling indiscriminately into a panoptic sanguinity about the future? It is important to bear in mind the very restricted nature of the problem to which he saw his technique as an answer, as well as the very provisional character of the answer he gave. The General Theory was directed to explaining and remedying one segment of unemployment only—what Keynes called “involuntary unemployment.” This excluded both frictional, seasonal, and regional unemployment, and, much more importantly, all unemployment caused by “a refusal…, of a unit of labour…, to accept a reward corresponding to its marginal productivity.” These two types of unemployment could not be reduced by the macroeconomic policy of expanding demand in the product markets, but only by microeconomic measures to increase the efficiency of labor markets. Labor was involuntarily unemployed only when it wished to work for a reduced real wage but was unable to do so, because it could not reduce its real wage by accepting a lower money wage; any reduction in the money wage causing the general price level to fall leaving real wages unchanged.

Now there is little doubt that involuntary unemployment—the unemployment of those willing to accept but unable to get a lower real wage—has greatly declined since Keynes’s day. Yet, as Professor Meade has pointed out, Keynesian policy since the Second World War has ignored Keynes’s own distinction between voluntary and involuntary unemployment and has treated virtually all unemployment as susceptible to reduction by expanding demand; the end result of which is a static or declining level of employment maintained by increasing doses of inflation. The discriminate reasoning of Keynes—not the indiscriminate reasoning of Keynesians — underlies Professor Friedman’s notion of a “natural” rate of unemployment. Unpalatable though the conclusion may be, the constant reiteration by the British Prime Minister that workers are “pricing themselves out of jobs” is, under modern conditions of trade union organization, strictly in accord with the letter of Chapter 2 of Keynes’s General Theory, though not perhaps with the spirit of the book as a whole.

SECONDLY, KEYNES WAS MUCH more modest than many postwar Keynesians about what his technique could achieve in reducing even “involuntary unemployment.” In reply to a critic, he wrote in 1936:

(“Technical full employment” in the strict Keynesian sense included, we must remember, an allowance for a lesser or greater volume of “voluntary unemployment.”) These considerations allow us to infer that Keynes himself would have regarded the project of running the economy at a one to two percent level of unemployment by demand management alone as quite unrealistic. Whether he would have drawn the conclusion that full employment policies in the new era of trade union bargaining power, job protection legislation, generous unemployment benefits, and a public ethos of government responsibility for economic welfare, required statutory control of incomes is impossible to say. Keynes was torn between his hatred of wasted resources (postponing the moment of liberation from “pressing economic cares”) and his hatred of bureaucratic interference with liberty. He would at any rate have exerted his great authority to forestall our present hopeless impasse in which governments are increasingly reduced to governing through the level of mass unemployment as a consequence of their failure to tackle earlier the growth of trade union power.

If Keynes can be faulted for failing to spell out more clearly the political and industrial consequences of the attempt to maintain permanent boom conditions, he was also guilty of considerable naivete about the modus operandi of the political system which he supposed capable of bringing about these conditions. He had an excessively elitist or oligarchic view of the political process, one which he bequeathed to his disciples. Believing that public life was and should be managed by an intellectual and moral elite, his only concern was that the existing elite had the wrong ideas and was in need of conversion. Once converted, it would then act rightly. This view made him unduly dismissive of certain “fixed rules” of finance of bygone eras which were meant to curb a perceived inherent tendency of rulers towards extravagance and dishonesty. One thinks particularly of the balanced-budget rule and the gold-standard rule. This was not just a matter of Keynes failing to take on board the political consequences of democracy, well known at the time; for the rules devised to restrict the scope of government action by restricting its access to funds were devised, and therefore thought to be of more universal importance, long before the rise of Western democracy. Rather it was that in his eagerness for government action on unemployment Keynes was willing to jettison the wisdom of the nineteenth century, drawn from the experience of earlier times. The problem in the nineteenth century was to prevent rulers from robbing the wealth-creating sector for the purpose of military conquest or extravagant display. By rejecting the full employment assumption of the classical economists, Keynes saw that state spending, even on “useless” projects, could maintain output and investment at levels higher than they would otherwise have been. But his theory lent itself all too readily to the following vulgarizations: a) that state spending for any purpose was good since it kept up demand; b) that public spending was better, since in some sense more “rational,” than private spending; c) that budget deficits were the only way a capitalist economy could be kept going; d) that people who insisted on strict rules of finance were killjoys who believed in progress only through pain. The possibility that governments, armed with democratic mandates, might use pseudo-Keynesian legitimations for purposes quite other than Keynes intended, and in fact destructive of the values Keynes believed in, seems not to have occurred to him.

Given that Keynes had found a rationale, albeit austere in comparison with that of modern Keynesians, for governmental activity to ameliorate unemployment, he then had to justify and develop a governmental response to the edginess of capitalists which results when government sustains high levels of employment. In other words, having dealt with consumption, Keynes now had to deal with investment. His obiter dicta concerning the pathological propensities of bankers and other apostles of “sound money” gave much pleasure to generations of Cambridge students. But a serious flaw in political thinking is revealed by Keynes’s comment that the state “is in a position to calculate the marginal efficiency of capital goods on long views and on the basis of the general social advantage.” Keynes was rightly critical of the capitalistic process by which investment decisions emerged as the “byproduct of the operations of a casino.” That investment decisions taken by the state might emerge as a byproduct of a political roulette seems also not to have occurred to him.

Another example is equally instructive. In 1944 Keynes read von Hayek’s Road to Serfdom. It was, he told Hayek, “a grand book… Morally and philosophically I found myself in agreement with virtually the whole of it.” He went on: