Shattered Consensus. James Piereson
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is an area in which (fortunately) the Keynesian revolution never fully took hold, despite Keynes’s great influence and the growth of state spending in the postwar era. Banks and investment houses are still in private hands and our stock markets still allocate capital through private channels. Today we understand something that Keynes did not—namely, that modern governments, because they respond to constituent pressures, lobbyists, and campaign donors, are incapable of allocating capital on a rational or disinterested basis; they allocate funds on the basis of political rather than economic signals. Private investors, whatever their flaws, do a far better job of allocating capital than modern governments could ever do. Yet Keynes, writing in the midst of the Depression, focused far more on the failures of private markets than on the possible defects of democratic governments.
In 1930 he was still optimistic that the economic slump was but a temporary lapse in the onward march of capitalist development; he dismissed claims that it marked the end of prosperity or the collapse of capitalism. The system had “magneto trouble,” he wrote in “The Great Slump of 1930,” suggesting thereby that something had gone wrong with the starting mechanism of the capitalist machine. The system was not corrupt or fundamentally broken, as socialists and communists claimed; the machine only required a fix to make it run more smoothly and reliably. Keynes went on in that essay to identify the problem, writing, “If I am right, the fundamental cause of the trouble is the lack of new enterprise due to an unsatisfactory market for capital investment.”5 Investors and entrepreneurs were not putting capital to work because, in the midst of the slump, they saw no market for machines, factories, new employees, and the like. At that moment, Keynes thought the slump could be reversed if the central banks in Britain, France, and the United States could coordinate monetary policy to increase the flow of credit internationally. Such a play might have worked, but it was never seriously attempted.
The tone is even more optimistic in “Economic Possibilities for Our Grandchildren” (1930), an essay in which Keynes characterized the current economic difficulties as a transitional period from the age of laissez-faire to the age of institutional capitalism. “We are suffering, not from the rheumatics of old age,” he wrote, “but from the growing pains of over-rapid changes, from the painfulness of readjustment between one economic period and another.”6 Keynes calculated that over the previous one hundred years the standard of living of the average European and American had grown at least fourfold, and predicted that over the next one hundred years it would improve between fourfold and eightfold again.a Within two or three generations, he suggested, the necessities of a comfortable life would be available to all, and mankind’s long struggle for survival in the face of scarcity would be near an end.
Keynes thought that the values of work, thrift, and moneymaking were erroneously associated with capitalism; he believed they are instead called forth by scarcity, poverty, and need. He speculated that these values would be rendered obsolete when, through capitalist enterprise, scarcity was eventually overcome, at which point mankind would be able to turn its attention to activities that make life worthwhile: art, music, literature, and philosophy. This, according to Keynes, would establish the final stage of capitalism—an end of history—when advanced societies would be able to live off their accumulated capital. Capitalism, with its moneymaking preoccupations, would then “wither away,” much as Karl Marx had predicted, but through a peaceful and evolutionary process.
Like many other thinkers of his time, Keynes regarded the political and moral principles associated with market capitalism as degrading and in need of replacement by a more humane set of ideals. There was an evolutionary or historical element in his thought: he claimed that capitalism developed in historical stages and also in a morally favorable direction. Institutional capitalism was an improvement over the “classical” system of the nineteenth century, but still a stepping-stone on a path to the final phase of capitalist development, when the “economic problem” would be solved once and for all.
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Keynes published his collected Essays in Persuasion during an economic slump that he thought would soon end. Like everyone else, he expected the world’s economies to bounce back quickly from the crash in the United States, just as it had done on many occasions in the past, most recently in 1920 and 1921. Keynes was as surprised as anyone by the severity of the slump, and in fact he lost a fair amount of money in the crash of the world’s stock markets.
The industrial economies had gone through recessions and even depressions in the past, but none as deep and prolonged as the collapse in the 1930s. In the United States, where the slump began, industrial production declined by a third between 1929 and 1933 and unemployment exploded from 3 percent to 25 percent of the workforce. More than a third of the country’s banks failed between 1931 and 1933, leaving depositors broke and the credit system badly damaged. In Great Britain the decline was not as steep, in part because the country’s economy had never fully recovered from the war. Nevertheless, economic output declined by a third there as well, exports declined by more than half, and unemployment rose to about 20 percent of the workforce in 1932. It was a global catastrophe that bottomed out only when the world’s economic machinery ground to a halt in 1933.
Disasters of this magnitude were not supposed to happen in market economies, which were thought to possess self-correcting features. When the slump dragged on, Keynes concluded that there was something wrong with the adjustment mechanisms of the market that was not accounted for in the standard economic theories. Much like the Great War, for Keynes the Great Depression called into question the received wisdom of the time.
This was the background for his General Theory, where he laid out the theoretical case for countercyclical government spending policies that proved to be so influential in the postwar era. Like The Economic Consequences of the Peace, this book too was widely discussed and reviewed when it first appeared, frequently in newspapers and magazines that catered to policymakers and intelligent laymen. But whereas the former set out a lucid argument that no one could misunderstand, The General Theory contained a bewildering mix of new concepts and arguments, critiques of old theories, and loosely related excursions into subjects like stock market speculation and mercantilist theories, all of which led to confusion among readers as to what the central point actually was. Paul Samuelson, one of Keynes’s American expositors, found it to be “a badly written book,” full of “mares’ nests of confusions,” where flashes of insight were interspersed with arguments that seemed to lead nowhere.7 Keynes developed a meandering argument in his tour de force and left it to others to work out the implications.
In The General Theory, Keynes mounted an attack on what he called the “classical” school of economics, the doctrine of free and self-adjusting markets developed by the political economists of the previous century. The classical theory, he suggested, is not a general theory but rather a special theory applicable to a condition of full employment and to an economy of small producers, independent workers, and competitive markets—circumstances that no longer obtained in modern economies, increasingly dominated by large institutions and by labor unions. A central theme of Keynes’s theory, and of Keynesian economics in general, is that market economies do not automatically adjust to systemic shocks like stock market crashes, widespread bank failures, famines, and wars. A second is that the market system, left on its own, will operate most of the time at levels below full employment and potential output.
In an early chapter, he set down and rejected three postulates of “classical” political economy that (he claimed) were central to the theory of self-correcting markets. The first was Say’s Law, named for Jean-Baptiste Say, a nineteenth-century economist who held that aggregate supply creates its own aggregate demand, or as Say put it, “The general demand for products is brisk in proportion to the activity of production.” Thus, a general glut across the entire economy ought never to occur because demand should always be sufficient to soak up the goods produced. The second principle, and one related to Say’s Law, was that widespread unemployment should never occur because workers, even during slumps, should find employment by adjusting their wage demands downward to levels where employers will hire them. A third was that savings are a form of deferred consumption that are put to work in the form of investment for the production of future goods, with the interest rate regulating the general volume of savings and investment at any particular moment.