The American Spectator

Understandable as this comment appears at the time—when Keynes was very alive to the fact that Hitler had been the first practicing Keynesian—this is actually an inadequate response to Hayek, for it ignores the fact that the enlargement of the state which Keynes wanted itself alters public and private morality. Not for the first time, Keynes attempted to cover up an inconsistency or ambiguity in his own position by means of what is little better than a clever debating point.

Keynes, therefore, must take some responsibility for legitimizing, through omission and a propensity to avoid pointed criticism, certain misapplications of his doctrine, although he is less responsible for its economic than for its political waywardness. These misapplications, however, would no doubt have occurred anyway, whatever the warnings he bequeathed. For as a political formula Keynesianism was too valuable to be restricted to the economic uses for which the founder intended it. Its limited legitimation of government deficit spending could well be adapted, by vulgarization, to the problem of governing a mature/senile capitalism under conditions of mass democracy and powerful trade unions; or to the problem of maintaining an international capitalist system which, at the end of the war, was faced with an inexorable need to expand in a world in which it had already permeated every corner. It is no coincidence that the first industrial nation (Britain) should have been the one to have carried Keynesian policy to its greatest degree of refinement over the longest period of time; or that the United States , as leader of the. capitalist world, should have made itself responsible, by sustaining a chronic balance of payments deficit, for keeping its major trading partners in a state of boom. The systemic inflation and creeping bureaucratization embedded in the political function of Keynesianism seemed a small price to pay for postponing the day of reckoning.

TO UNDERSTAND THE demand mismanagement which has led to the present impasse, one must understand how the restricted economics of Keynes became the panacea of Keynesian economists, and how the naive politics of Keynes became the diffidence of Keynesian politicians. The first generations of Keynesian economists must take some responsibility for this mismanagement, though senior Keynesians have been foremost in blaming it on the “stupidity” of politicians. Quite simply, a combination of technical overoptimism and political nervousness caused politicians to promise more than Keynes himself ever promised or than macroeconomic policy could ever deliver.

A classic instance of this technical overoptimism was the so-called Phillips Curve which, on the basis of a historical time series, assured governments of the existence of a stable, and politically very favorable,”trade-off” between unemployment and inflation. In effect, governments were assured that it lay within their power to fix the unemployment percentage at any politically acceptable level without running into significant inflationary problems. It all seems madness today; yet for ten years, until Milton Friedman’s demolition job, the Phillips Curve reigned virtually unchallenged.

Technical over-optimism was reinforced (and partially induced) by political pessimism. The first generation of Keynesians, as products of the Depression, had no faith in the “natural” resilience of the entrepreneur economy. It was held that a mature capitalist economy had a natural and increasing tendency towards depression or “stagnation” which could be offset only by increasingly higher levels of public spending. And in order for capitalism to be accepted by the non-entrepreneurial classes, there also had to be increasingly higher spending on the social services—something to which Keynes himself had never attached much importance. The first generation of Keynesians tended to be social democrats in politics; and Keynesianism entered politics as a social democratic formula, in which high levels of public spending performed the double function of maximizing output and employment and redistributing resources from rich to poor. The humanitarian impulse behind this strategy is unquestionable. The political analysis is more dubious. It was based on the assumption that the legitimacy of capitalism was so precarious, its wealth-producing potential so enfeebled, that it required continuous political reinforcement if it was not to collapse into either fascism or Communism. The notion that 5 percent unemployment spelt political death for any government which allowed it, and a “crisis of legitimacy” for the system as a whole, was for long an article of faith that united economists and politicians until disproved by events.

So much, then, for the contribution of the postwar Keynesians. But of course the blame was by no means theirs alone. The professional opinion of economists that maximum output could and must be continually maintained by political action coincided with other pressures on the political system working to the same end; it was the two in combination which drastically altered the fiscal stance of modern governments, giving rise to the familiar   of the “overloaded” state. Its chief symptom was the permanent budget deficit, now called the “public sector borrowing requirement.” In the nineteenth century governments borrowed from the public only for war emergencies. In the twentieth century Keynes made loan-financed public spending respectable if done for the purpose of restoring an economy to full employment. He also sanctioned a larger permanent role for the state in creating capital assets. This, of course, implied a continued though limited public sector borrowing requirement, since the government would have to borrow to invest, like any private businessman. Beyond this Keynes was very cautious.

One part of his doctrine, however, did lend itself to much more radical fiscal conclusions. This was the theory that it is investment which creates savings, not the other way round as the classical economists had taught. This led by easy steps to the debased doctrine that all government spending creates its own revenues. There opened up a wonderful vista wherein public spending up to any .level that was thought politically necessary would itself promote the growth to finance it. Keynes’s own insight that government spending may become a source of diminished business confidence, thereby diminishing the very investment it was meant to augment, tended to be replaced by a wholly mechanical link between public spending and the output of goods and services. If the growth failed to materialize, the consequences of such policies became inevitable: a bloated public sector in deficit to a private sector whose own resulting shortage of funds had to be made good by printing more money. This was the general experience in the 1970s; and explains the revival of the “crowding out” argument— the conservative thesis that government borrowing competes with private borrowing, driving up the rate of interest and impairing private investment—which Keynes was thought to have killed. It is true that in his political pamphlets for Lloyd George, Keynes made sport of “crowding out,” arguing that the same illogic which states that government crowds out business means that businesses ought also to crowd each other out, and that therefore aggregate investment could never be raised. It clearly can be, because businessmen have a variety of psychological impulsions to increase investment regardless of the rate of interest. But what modern Keynesians do not realize, and what Keynes did realize, is that these same nonrational impulsions are debilitated by the blow to confidence which results from large government deficits (and only secondarily from the borrowing required to finance them).

The gamble that loan-financed public spending would under virtually all circumstances produce the growth to finance it becomes understandable in the light of the political problems facing Western governments. These governments were committed to maintaining mature capitalist systems under conditions of genuine mass democracy. On the one side were the needs of capitalism which included not just an expensive array of public goods, but also the assurance that property rights would not be tampered with, the latter presupposing a definite limit to taxation. On the other side, governments were responsible to electorates the majority of which controlled a minority of wealth and looked to state action to compensate for this deficiency. It is this pull of incompatible requirements which explains the character of the “competition for votes” which developed after the Second World War, and the increasingly desperate faith that public spending could induce the growth which would provide the wherewithal to keep both parties happy. Once this double set of expectations had been developed, its self-sustaining character made it extremely difficult for governments to change course once adequate growth had failed to develop. They were trapped in the circle of their own pseudo-solutions. Large sections of business and the general population had become dependent on inherited and automatically expanding public programs. Even though the rationale and to some extent the political support for them had eroded, they could not be reduced without plunging the economy into a depression. The permanent budget deficit with its attendant inflationary consequences is a good illustration of how Keynes’s own limited solutions to quite precise problems were perverted by political necessities into pseudo-solutions for much more general and unrelated problems.

In the international sphere, “world Keynesianism” has been adapted to the political necessities of America’s role as leader and protector of a pluralist bloc of capitalist democracies. Here again, Keynes’s own proposals, over-ambitious as they seemed at the time, were models of financial caution compared to what followed. Keynes wanted to retain the advantages of the old gold-standard system (chiefly currency convertibility at fixed exchange rates) while eliminating the savage deflationary adjustments which the old system had prescribed as the only alternative to the Protection and competitive devaluations which broke up the world economy in the 1930s. To this end, he devised a set of institutions and rules, only partially embodied in the Bretton Woods Agreements of 1944, to ease the pain of adjustment. Initial responsibility for adaptation was to fall on creditor countries, debtors being given a “breathing space” in the shape of credit facilities and permission for moderate devaluations to put their houses in order. In practice, the postwar monetary system developed without any effective adjustment mechanism at all. No pressure was brought on either surplus or deficit countries to bring their current accounts into equilibrium. World demand was maintained at a high level through the structural deficit in the American balance of payments: the international equivalent of the pseudo-Keynesian budget deficits. The growth of this deficit proved the only way of combining the politically required level of free world prosperity with the maintenance of relationships of military dependence and political and economic independence in the American-led alliance structures. With the explosion of the American deficit due to the Vietnam war confidence in the dollar was eventually undermined, leading to the suspension of gold convertibility in August 1971. Even more than in the case of the permanent domestic budget deficit, the permanent U.SI balance of payments deficit is a striking example of the pseudo-solution with a built-in self-destructive momentum.

Finally, full employment policies have had to be applied in a world of public and private monopoly. Giant private corporations, nationalized industries, municipalities, and trade unions have all functioned, to a greater or lesser extent, as monopolistic suppliers of goods and services. The unhesitating and unreflective extension of full employment policy to the needs of this world can be seen, first, in the dropping of Keynes’s own distinction between voluntary and involuntary unemployment which proved unacceptable to the trade union leaders, and second, in the failure to demand any quid pro quo—a wage-price policy, restriction on strike action, labor market reforms—for the full employment service being provided. It is easy to show how, in the absence of incomes policies, trade unions and business oligopolies can between them push up prices even when labor and goods are in excess supply. How important this “cost-push” has been as a cause of inflation is doubtful. It applies mainly to the monopoly sectors of such highly unionized countries as Britain . And it stretches credibility to maintain that in Europe as a whole (including Britain) there was excess labor supply in the 1950s and 1960s, when unemployment was at one or two percent and when there was a massive influx of foreign labor.

The cost-push theorists maintain that trade unions cause inflation. But this is unlikely in the case of the United States which is less unionized than most European countries. In America, the inflationary pressures which built up in the 1960s are more plausibly ascribed to the lack of external discipline on public and private spending—the result of the privileged position of the dollar in the international monetary s);stem. But even where trade unions are more important, one can still maintain that governments cause inflation by making political commitments to overfull employment which give unions the power to force them to expand the money supply to “save jobs.” I would prefer to say that governments cause inflation, and cause themselves to grow, and cause themselves to lose authority; but only on the understanding that throughout this process politicians are acting in the way which seems to them the easiest to overcome their immediate political problems.

ALL GOVERNING FORMULAS which break down tend to discredit the kernel of scientific truth or plain wisdom which they contain. Just as neoclassical economics was blamed quite wrongly for the failures of laissez-faire (despite the fact that it was used to support egalitarian welfare policies), so Keynesian economics has been blamed for the growing decay of political authority despite the fact that it contributed to three decades of unparalleled prosperity. What I have tried to show is how the Keynesian remedy for a specific disease of capitalism (involuntary unemployment) was turned into a pseudo- Keynesian pseudo-solution to the much more fundamental problems of governing divided societies, thereby bringing the inevitable crisis and reaction.

Whether this deterioration of Keynesian policy into an all-purpose governing formula was inevitable is difficult to say. Marxists would no doubt say it was. Vulgarized Keynesianism, they would argue, was the only way to salvage a decaying capitalism perceived to be on the brink of imminent collapse, at the cost of intensifying its contradictions in the future. I would prefer to lay more stress on the failings of political systems which trap politicians in short-term calculations. Harold Wilson’s dictum that “a week is a long time in politics” explains much of what has gone wrong in the application of Keynes’s ideas.

But perhaps a more fundamental problem arises from the inherent limitation of any economic technique, however soundly reasoned, as an instrument of governing. Governors and governed must in the end speak a common language, and it cannot be the language of Keynesian economics. Common to Keynesians and the politicians who used their ideas was the belief that somehow one could “model” the whole economy, pull certain levers, and expect certain results to follow more or less mechanically. Politicians, of course, were expected to communicate what they were trying to do. But they did not adequately understand the techniques they were using (except in an immediate political sense) and no one understood their explanations. So when, as was inevitable, Keynesian results fell short of expectations, Keynesian politicians were left with nothing to communicate to the public. From this point of view, the increasing reversion by politicians to the simpler language of nineteenth-century economics reflects not just disillusionment with the results of pseudo-Keynesianism, but also the need of politicians to regain an audience as a preliminary to the revival of the art of government. After all, it is much easier to understand homilies on the virtues of individual self- reliance—which can be derived from extremely sophisticated moral and economic argument— than it is to understand any comparable simplifications of Keynesian economics. From another side, protective communitarian approaches to economic life can be much more readily communicated in the language of socialism or nationalism than in the language of Keynes. The reaction against the Keynesian sophistication of economic discourse has already started (Margaret Thatcher and Wedgwood Benn in England, Ronald Reagan in the United States) and there is no knowing where it will end. This clear indication of the decline in the ability of Keynesian economics to do “political work,” however, should not blind us to the genuine “economic work” which Keynesianism accomplished, even in its bowdlerized form; or lead us to belittle the genius of the man who set out to “create the possibility of civilization for all.”

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