Shattered Consensus. James Piereson
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by far the greatest influence in the post-Depression and postwar era. More than Hayek, Schumpeter, or any other economist of the time, Keynes went beyond diagnosis to offer practical remedies for the economic crisis of the 1930s. His General Theory did not arrive in time to be of much use during the Depression, but his insights revolutionized economic policymaking and the study of economics in the postwar era.
The evolution of “managed economies” in the postwar era owed a great deal to the writings of Keynes in which he assigned responsibility to governments for stabilizing economies. For Keynes, achieving full employment was the principal goal of economic policy, and he provided policymakers with a set of fiscal tools for smoothing out the booms and busts of the business cycle. This was the “middle way” that he tried to steer between the extremes of communism and fascism, and between state planning and free-market capitalism. From a political point of view, Keynes was among the liberal reformers of that time who sought to “tame” capitalism by giving new managerial duties to national governments.
Many attributed the rapid growth in America’s postwar economy to the application of Keynes’s theories. One economist called the postwar era “the age of Keynes.”1 Time magazine took note of his vast influence by publishing a cover story in 1965 under the title “We Are All Keynesians Now.” As the magazine acknowledged, “Keynes and his ideas, though they still make some people nervous, have been so widely accepted that they constitute both the new orthodoxy in the universities and the touchstone of economic management in Washington.” Though Keynes’s theories were temporarily in retreat in Washington and London during the 1980s and 1990s, they never really lost currency among academic economists, and the recent financial crisis provided a new occasion for their application. We have not yet evolved beyond “the age of Keynes.”
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In The General Theory, Keynes worked out the premises for a conclusion he had already reached. This is evident in a series of essays that he wrote during the 1920s and into 1930, which are collected into a single volume under the title Essays in Persuasion (1931). Here he reflected on the evolution of the capitalist order from its origins in the eighteenth century and on the significant changes in the international system brought on by the war. He maintained that rapid changes in the economic order required parallel changes in political and economic institutions, and corresponding adjustments in political and economic theory.
“The End of Laissez-Faire” (1926) is an essay in which Keynes rejected the principles of natural liberty and enlightened self-interest that lay at the heart of Adam Smith’s economics of free markets. “The world is not so governed from above that private and social interest always coincide,” he wrote. “It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened.”2 This was rather a caricature of the foundational assumptions of market economics, which did not insist that enlightened self-interest always operates in the general interest, but that it will do so more reliably than other forms of economic organization. Nevertheless, Keynes rejected these principles for two reasons: first, he considered them to be far too abstract to offer solutions to practical problems; second, he judged them to be increasingly obsolete in the modern world of institutional capitalism shaped by large corporations, labor unions, and not-for-profit institutions. At this time he began to consider (as he wrote) “possible improvements in the technique of modern capitalism by means of collective action.”
In that essay, Keynes focused on the organizational evolution of capitalist economies as a factor that altered or undermined the operation of free and competitive markets. An important phenomenon of modern life, he wrote, is the tendency for large enterprises to socialize themselves—or, in other words, to pursue social as opposed to purely private objectives. He suggested that “A point arrives in the growth of a big institution—a big railway or public utility enterprise but also a bank or insurance company—at which the owners of capital are almost entirely dissociated from the management, with the result that the direct personal interest of the owners (the shareholders) becomes quite secondary.”3 As organizations reach a certain size, managers become interested in other goals besides profit, such as stability, security of employment, reputation, and independence. Keynes also welcomed the development of semiautonomous not-for-profit institutions such as universities and scientific societies that promote the general interest in different spheres of activity.
Keynes envisioned an emerging system of capitalism in which large business enterprises and not-for profit institutions operated alongside government in common efforts to promote the public interest. The friction between the public and private spheres, so much an aspect of the old order of liberalism, was giving way to a new order of cooperation among large institutions. Keynes’s corporatist vision of the capitalist order represented an evolution of liberalism beyond its nineteenth-century emphasis on individuals, competition, and suspicion of the state.
The separation of ownership and control in large organizations implied that expert managers might assume new powers in the direction of political institutions and of private corporations, a concept that Keynes first broached in The Economic Consequences of the Peace. While this seems like a modern technocratic concept, it also had a traditional aristocratic pedigree, at least for Keynes. Roy Harrod, his friend and biographer, suggested that Keynes assumed that important economic decisions would always be in the hands of experts operating in the public interest, much in the way that central bankers are allowed to control interest rates and the supply of money without close political supervision. As a member of his country’s intellectual aristocracy, Keynes “tended to think of the really important decisions being reached by a small group of intelligent people, like the group that [later] fashioned the Bretton Woods plan.”4 Keynes, according to Harrod, approved of this as a normative matter; he also thought it to be an element in the evolution of modern capitalism as experts inherited control of the system from entrepreneurs.
Keynes pointed out two areas where the state could and should intervene to improve the operation of the capitalist order. The first was in the area of money and credit, where he called for deliberate control and planning by a central institution—that is, by a central bank with powers sufficient to regulate the supply of currency and credit toward the goal of full employment and stable prices. This was an implicit attack on the gold standard, which Keynes regarded as an archaic inheritance from the nineteenth century, and as an ineffective instrument for regulating money and credit in the wake of the war.
He had several longstanding objections to the gold standard. The main problem was that it required nations to expand or contract money and credit in order to maintain the exchange value of their currencies, while Keynes believed that monetary policy should assign priority to domestic employment and stable internal prices. His second objection was that the United States now held the lion’s share of the world’s gold reserves, mainly due to wartime loans, and this circumstance allowed the U.S. central bank to dictate interest-rate policy to the rest of the world. Keynes vehemently opposed Britain’s return to the gold standard in 1926, predicting that it would lead to deflation, rising real interest rates, added burdens to debtors, and domestic unemployment. He cheered when Britain abandoned the gold standard in 1931, after his forecasts were borne out, in favor of central bank management of monetary policy. On this subject, Keynes proved to be farsighted. After many fits and starts during the 1930s and in the postwar era, the world abandoned the gold standard for good in the 1970s in favor of a system of fiat currencies managed by central banks.
Keynes’s second innovation was to call for public control over investment such that the state would replace banks, investment houses, and wealthy individuals as the major supplier of investment capital. In the modern world, he pointed out, “savers” and “investors” were now different people and institutions; their decisions had to be coordinated by private intermediaries that took in savings and directed them toward new and hopefully profitable enterprises. Keynes had little faith that this process could be carried out seamlessly in the public interest, and so he looked to the state as the institution where the investment function could be carried out rationally in the interests of society as a whole. He returned to this theme again and again in the 1930s, and in The General Theory he argued in great detail for public investment as a means of rescuing