Explain the Rise and Fall of Keynesianism - Essay Example

?Rise and fall of Keynesianism Introduction Keynesianism is a macro economic theory proposed in 20th century by John Maynard Keynes who is consideredas the most famous economist of the twentieth century and probably one among the greatest economists of the whole history. Keynesianism is also termed as Keynesian economics or Keynesian theory. The theories regarding Keynesian economics were primarily published in his book ‘The general theory of employment, interest and money’ in 1936 but his theories initially did not get adequate acceptance as some ideas seemed contentious (Business and economics). When the Great Depression shook the global economy; many economists contributed their own part to the formulation of new strategies that would answer the economic downturn. Even though a large numbers of economic policies were suggested by different economists, none of them could function in an efficient manner. Keynes suggested his theory to then president Roosevelt but the president rejected his proposal. In contrast, years later, Keynesian economics was accepted in Britain on the strength of the initiatives taken by Federation of British Industries. Key elements of Keynesianism Keynesianism suggests that often private sector decisions cause inverse macroeconomic outcomes and hence it is suggestible for the public sector to deliver active policy responses which mainly include central bank’s monetary policy actions and government’s fiscal policy actions. Keynes argues that these activities would assist the economic sector to stabilise output over the business cycle. Although Keynesian theory can be stated thus in simple terms, it comprises larger ideas. To illustrate, Keynesianism has a close similarity with the concept of ‘General Glut’ proposed by classical economists. However, it is identified that classical economists had disagreement regarding the conditions of general glut as some of them believed in Say’s law “supply creates its own demand” (Best, n.d.). In contrast, Keynes argues that insufficiency in aggregate demand for goods can be featured as the direct cause of general glut which would lead to economic decline and subsequent unemployment difficulties. In this situation, Keynesianism recommends (as cited in Blinder) that thoughtful governmental policies can easily overcome such crises if these policies are effectively employed to increase the aggregate demand. This in turn would mitigate the adverse impacts of unemployment and deflation. Similarly, Keynesian economics brings some theoretical basis for a crucial distinction between involuntary unemployment and voluntary unemployment. From the Keynesian point of view (as cited in Knoop, 2010, p.40), the individuals who seek jobs at the existing wage rates can be grouped into involuntary unemployed. Corry (n.d.) reflects that Keynes’ innovative concepts produced some revolutionary changes in the economic sector since the traditional economists believed that unemployment was resulted from certain labour market rigidities such as ‘excessive wage claim, trade union activities, and unemployment pay’ (ibid). According to Keynesianism, the increasing unemployment rate can be directly attributed to the failure in total spending caused by the inefficient business decisions of private firms. Therefore, it is obvious that government has to play a crucial role in formulating efficient growth policies which would facilitate sustainable economic growth of the country. In short, Keynesian economics constitutes a demand based economy (Reference for Business). Limitations The Keynesian economics gave greater emphasis on employees’ wage rates without considering the profitability of the firm. Although, it had aided the nation to ensure employee welfare, the constancy of this system was always subject to change. For instance, sometimes, international competition adversely affected the capital requirements and public expenditure of the nation. In such difficult situations, the government failed to meet adequate funds for wage distribution. As a result, some economies, namely Britain was forced to find extra capital so as to confront with international competition. Therefore, the Britain began to stimulate investment practices which necessitated the restructuring of Keynesianism. As this practice would directly hurt the basic interests of the Keynesianism, an ideological conflict was inevitable between Keynesian Welfare State and government. In order to fund healthcare, education, and workers’ housing needs, the government was forced to spend further amount on public and private sectors. Although increased taxation was a better method to meet the extra public expenditure, it seemed impractical in the country because increased taxation would demand further wage rise. Ultimately, the government was driven to depend on increased borrowing so as to meet the needs of the economic sector. Similarly, the terms of the Keynesian economics caused rise in inflation which compelled the government to adopt deflationary measures. Consequently, this event changed the labour class system in favor of employers that in turn caused immense class struggle among organised and unorganised workers. Challenges to Keynesianism We have already seen that Keynesian theory could not secure the investment activities and thereby productivity which in turn led to increased public expenditure and insufficient accumulation of capital. Similarly, this theory caused a class struggle between two groups of working class people. The frequent wage claims largely affected inflationary pressure so that government could not properly concentrate on capital accumulation process. The immense pressure from trade unions led to further increase in public expenditure. According to Clarke (1988, p.304), the contradictions of Keynesian economics reflected in the form of economic, political and ideological crises. In addition, it was not useful to increase the profitability at the immediate expense of working class since there was no guarantee that the additional profit would be deposited for increasing domestic investment and thereby productivity (ibid). These difficulties questioned the flexibility of the Keynesianism and accountability of the capital accumulation strategies of the state. Consequently, it raised the need of social control on capital as it would facilitate the effective capital accumulation process that may in turn contribute to the aspirations of the working class. Since the state could not raise adequate capital in times of needs, this situation was criticised as the real indication of the state’s subordination to political rules influenced by capitalism. At the same time, there was a growing demand emerging toward state’s subordination to civil society. In 1970s, the operational weaknesses of Keynesian theory caused the decline of political and ideological framework of Keynesian Welfare State. Idea of new market According to Yergin and Stanislaw (1998), the conservative government elected in 1970 took the initial steps to eliminate the elements of Keynesianism from the country. Similarly, government designed some efficient strategic tools including monetary policies so as to defend the crises arose from inflation. As part of strengthening monetary controls, the new conservative government reorganised the financial sector to encourage competition. As discussed above, capital accumulation was one of the major difficulties raised by Keynesianism; therefore, the new government emphasised on developing more active monetary policies in order to ensure uninterrupted capital acquisition. The government set considerate money supply as the central point of the economic policy. At the same time, decisions regarding fund allocation were completely left to the choice of competitive market forces. Although the formed monetary policies did not have a direct impact on the inflation rates, it was beneficial to maintain the demand-management. Since the real value of interest rates is fluctuated from its nominal values during the periods of inflation, it was not suggestible to set interest rates as an indicator of the efficiency of the applied monetary policy. Hence, Clarke (1988, p. 308) says that domestic credit expansion and money supply became the most suitable indicators of monetary stance than interest rates. The existed balance between fiscal and monetary policy was also changed because fiscal measures were inefficient to deal with the inflationary pressures. Soon after the rejection of income policy, the government reformed industrial relation policies and formulated some best fitted programs in order for ensuring an effective balance between trade unions and employers. Fall of Keynesianism The new government’s policies altered the working class groups to a large extent. Trade unions had protested against this change and it led the workers into direct confrontation with the state. The Labour Party responded to the strike in a way that it tried to demobilise the framework of the Keynesian Welfare State by introducing a radical Keynesian programme. At the same time, trade unions reconciled with the state and proposed an industrial policy; but it also seemed impractical as the state did not have adequate expertise or technical supports for implementing the proposed strategy. Moreover, the government had to rapidly address the economic crisis since it needed to build supportive political atmosphere to win the second election. Instead of implementing industrial strategy or investment-led reflation, the government emphasised on the introduction of an expansionary budget that promised an increase in the public sector payment. When the government extensively applied the tools of deflationary policies as an attempt to eradicate inflation, it adversely affected the competitiveness of domestic production which in turn impeded investment and profits. The 1975 budget duly refused the idea of Keynesianism on account of rising unemployment rate. Similarly, the success of monetary policies in reducing public expenditure had also contributed to the repudiation of Keynesian expansionism. Similarly, Conservative’s government failed to control the growth of the money and credit that forced the Bank of England to strengthen the debt management and monetary control. Subsequent to 1975 budget, wide ranges of economic reforms were introduced in order to facilitate stabilized economic growth. The period of 1974-1976 is regarded as the decline stage of Keynesianism even though it was later restructured in the modern era. Though the1974-75 reflation was the outcome of political pressure, it brought a new concept that level of investment is clearly computed on the basis of level of demand. Therefore, effective demand management strategies became essential to meet the growing requirements of increased investments. The economists of this period also identified the fact that profit is the driving factor that stimulates accumulation, but not demand. This finding led to a new concept i.e. rising wages and increased public expenditure must be confined to the limits of the capital. These structural changes in concepts necessitated the restructuring of institutional frames of Keynesianism. The outcomes of 1976 crisis and new economic realism led to the fall of Keynesianism and subsequent rise of monetarism. Conclusion The Keynesian theory is of the concept that the public sector must emphasise on the active policy responses including monetary policy and fiscal policy actions in order to eliminate the flaws of inefficient macroeconomic outcomes. The Keynesianism was introduced in Britain with intent to overcome the adverse impacts of the Great Depression. Although, this policy could benefit the Britain in meeting some of their objectives, it could neither enhance capital accumulation nor reduce public expenditure. By the 1976 crisis, the Keynesian economics lost it significance and it gave way to a new concept called Monetarism. References Best, B n.d., Say’s law and economic growth, viewed 3 March 2011 http://www.benbest.com/polecon/sayslaw.html Blinder, AS n.d., ‘Keynesian economics, The concise encyclopedia of economics’, Library economics liberty, viewed 3 March 2011 http://www.econlib.org/library/Enc/KeynesianEconomics.html Business and Economics, n.d., Fundamentals of economics for business, World Scientific publishing Co. Pte. Ltd, viewed 3 March 2011 http://www.worldscibooks.com/etextbook/6794/6794_chap01.pdf Clarke, S 1988, Keynesianism, monetarism, and the crisis of the state, Edward Elgar Publishing Company, England. Corry, B n.d., ‘Keynesianism’, New Perspective Journal, Vol 5, No 1, viewed 3 March 2011 http://www.history-ontheweb.co.uk/concepts/keynesianism51.htm Knoop, TA 2010, Recessions and depressions: understanding business cycles, Edition -2, ABC-CLIO, LLC, California. ‘Reference for business’, n.d., Encyclopedia of Business, viewed 3 March 2011 http://www.referenceforbusiness.com/management/De-Ele/Economics.html Yergin, D and Stanislaw, J 1998, The commanding heights, pp.105-113, viewed 3 March 2011 http://www.pbs.org/wgbh/commandingheights/shared/pdf/prof_margaretthatcher.pdf Read More