The Impact of Keynesianism on Macroeconomic Policies of a State - Essay Example

Keynesian revolution Introduction Some of Keynes contemporaries and seniors dislike the expression "the Keynesian Revolution." There was nothing, they say, so very new in the General Theory. 1Of course everything can be found in Marshall, even the General Theory. But we know what Marshalls pupils who had gone into the Treasury believed, from the famous White Paper of 19292 which was an example of neo-classical theory in action. In the General Election of that year Lloyd George was fighting his campaign on a promise to abolish unemployment which had long been above 10 per cent (it rose later to 20 per cent) by a programme of public works. The Treasury (very improperly from a constitutional point of view) was asked to show why this was impossible. Their argument is very simple. The total fund of saving is given, and if more is used for home investment, foreign lending, and consequently the export surplus, would be reduced correspondingly; there would be no advantage to the economy as a whole (Robinson, 1963). Nowadays this seems merely laughable. It is not necessary now to repeat the familiar tale of the hard-fought victory of the theory of effective demand; we are concerned rather to see the relevance of the new line to the themes that we have been discussing. First of all, Keynes brought back something of the hardheadedness of the Classics. He saw the capitalist system as a system, a going concern, a phase in historical development. Sometimes it filled him with rage and despair but on the whole he approved of it or at any rate he felt it worthwhile trying to patch it up and make it work tolerably well. Secondly, Keynes brought back the moral problem that laisser-faire theory had abolished. It is true that in Cambridge we had never been taught that economics should be wertfrei or that the positive and the normative can be sharply divided. We knew that the search was for fruit as well as light. But the anodyne of laisser faire had worked pretty thoroughly even in Cambridge. Marshall, certainly, was a great moralizer, but somehow the moral always came out that whatever is, is very nearly best. Pigou set out the argument of his Economics of Welfare in terms of exceptions to the rule that laisser faire ensures maximum satisfaction; he did not question the rule. Readjustments were needed here and there to make the distribution of resources between uses the most efficient possible. The inequality of the distribution of the product raised doubts, but they were easily deflected into Utopian daydreams. Even Keynes, as we have just seen, while he did not much like the profit motive, thought (in the Twenties) that it provided a better mechanism than any other "yet in sight" for operating the economic system, with the reservation that it did not necessarily make the best possible use of its resources. In the Thirties a large part of its resources were not being used for anything at all; Keynes diagnosed the cause as a deep-seated defect in the mechanism, and thereby added an exception to the comfortable rule that every man in bettering himself was doing good to the commonwealth, so large as completely to disrupt the reconciliation of the pursuit of private profit with public beneficence (Robinson, 1963). The whole elaborate structure of the metaphysical justification for profit was blown up when he pointed out that capital yields a return not because it is productive but because it is scarce.3 Still worse, the notion that saving is a cause of unemployment cut the root of the justification for unequal income as a source of accumulation. What made the General Theory so hard to accept was not its intellectual content, which in a calm mood can easily be mastered, but its shocking implications. Worse than private vices being public benefits, it seemed that the new doctrine was the still more disconcerting proposition that private virtues were public vices. By making it impossible to believe any longer in an automatic reconciliation of conflicting interests into a harmonious whole, the General Theory brought out into the open the problem of choice and judgment that the neo-classicals had managed to smother. The ideology to end ideologies broke down. Economics once more became Political Economy. Thirdly, Keynes brought back time into economic theory. He woke the Sleeping Princess from the long oblivion to which "equilibrium" and "perfect foresight" had condemned her and led her out into the world here and now (Robinson, 1963). This release took economics a great stride forward, away from theology towards science; now it is no longer necessary for hypotheses to be framed in such a form that we know in advance that they will be disproved. Hypotheses relating to a world where human beings actually live, where they cannot know the future or undo the past, have at least in principle the possibility of being set out in a testable form (Robinson, 1963). The view has been maintained, with some justification that, ever since it’s emergence in the late seventeenth and the early eighteenth century, orthodox modern economic theorizing has been built around, or has mainly consisted of, one central model of maximization and self equilibration. It has been claimed regarding modern political economy and economics that though there have been unsuccessful rebellions . . . its basic maximizing model have never been replaced,4 that is, neither its maximizing statics nor its self-adjusting dynamics (Hutchison, 1978). The self-adjusting, self-equilibrating model, or system, was generalized and consummated in The Wealth of Nations. But by Adam Smith the model was not carried to extremes of unrealistic abstraction, and was based on historical and psychological evidence and analysis, including a view of man. Essentially interconnected with the fundamental assumption of full or adequate knowledge and correct expectations have been the two central concepts of competition and equilibrium. Competition, with heightened rigor, became perfect competition, while market equilibrium requiring correct, and therefore compatible, expectations, introduced the dynamic element. The competitive concept with its essential characteristic of large numbers of decision-makers, each too small to impinge on one anothers decisions, is logically interlocked with the perfect knowledge concept so as to secure the compatible and correct expectations required for equilibrium (Hutchison, 1978). With regard to the equilibrium concept; the position of equilibrium has always been the very central concept of economic analysis. The only justification for the special concern with this position and the treatment of disequilibrium as simply a temporary aberration from the normal, can be that, in fact, the economic conditions under which we live in some sense tend towards it (Hutchison, 1937, p. 646). Since Ricardo first inserted this decisive element into the central model of so much of orthodox economic theorizing, it is remarkable how far economists have managed to avert their gaze from the extreme unrealities of the abstractions involved in the adequate knowledge assumption. Until very recently, those who have paid any significant attention to this decisive assumption have been very few and far between. In fact, excluding living writers, perhaps only four names need mentioning in this connection: Cliffe Leslie (1879), Carl Menger ( 1883), F. H. Knight (1921), and Keynes (1910 and 1936-7), to which might be added the Swedish contribution, notably from Myrdal, regarding anticipations and the ex-ante and ex-post distinction (Hutchison, 1978). More than a quarter of a century later, in his General Theory, Keynes returned to this theme of expectations and uncertainty with regard to investment decisions. In doing so he undoubtedly suggested a fundamental methodological criticism of Ricardian orthodoxy, such as Cliffe Leslie had pressed home. But Keynes was not prepared to take on board the methodological implications for his own mode of theorizing. In The General Theory Keynes emphasized, that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist (1936, p. 162). These criticisms were indeed fundamental and revolutionary. But in fact they played very little part in the process, or episode, known as the Keynesian revolution. Few of the early--or subsequent-expositors of the revolution gave to this argument regarding uncertainty and expectations an important role, and most of them hardly even mentioned it. 5For over three decades Keyness treatment of expectations and uncertainty, and especially its significance as a fundamental criticism of much orthodox theorizing, received--with only one or two notable exceptions--almost no attention from economists. 6 The reason for the thoroughgoing neglect of this absolutely fundamental criticism, so plainly and bluntly developed by Keynes himself, is perfectly obvious. For Keyness description of a pretty, polite technique was, and is, applicable not simply to the orthodox classical, or neoclassical theory of investment; it is equally applicable and destructive across most of the whole range of orthodox economic model-building since Ricardo. Not only the targets which the revolutionaries wished to attack, but other intellectual investments were exposed, which they were by no means willing to abandon. In fact, a full recognition of the attack Keynes was making on what we have called the fundamental assumption of adequate knowledge would have called in question the whole method of theorizing of orthodox and revolutionaries (Hutchison, 1978). Three points may be noted in relation to this conclusion. In the first place, Keynes did not go to extremes in generalizing the argument, or at any rate in drawing general conclusions about the nonself-adjusting nature of the economy, or parts of it, implied by a full recognition of ignorance and uncertainty. For Keynes, self-adjusting forces, though they might need supplementing by government action, played quite an important part in various sectors of the economy, in allocating resources and internationally in the balance of payments. Secondly, neither in his macroeconomic theory of employment, nor in his criticism of classical orthodoxy, did Keynes put his main thrust behind the criticism of the assumption of certainty and adequate knowledge. In spite of its quite fundamental character, Keyness introduction of ignorance and uncertainty was almost something of an obiter dictum (Hutchison, 1978). Thirdly, Keynes himself adopted no clearly stated or satisfactory procedure for meeting the fundamental methodological problem to which he had called attention. As Professor Patinkin has observed: In neither The General Theory nor the 1937 article in The Quarterly journal of Economics. . . does Keynes develop a theory of economic behavior under uncertainty (1976, p. 142 ). But it must be added that a theory of economic behavior under uncertainty, if it were to be useful, would have to be founded and constructed by a quite different method from that which Keynes called the pretty, polite technique of deducing conclusions about maximization under certainty from a fundamental assumption of adequate knowledge. Of course, Keynes could not continue with the fundamental assumption of adequate knowledge; so he proceeded to reach the conclusions he wanted by thinking up ad hoc, or plucking from the air, 7the suitable assumptions about expectations and ignorance. To serve the purpose--as Keynes explicitly acknowledged--of reducing to a minimum the necessary degree of adaptation of the orthodox theory (1936, p. 146) he, at some points, assumed that expectations remained constant in the long run, though they nevertheless might meanwhile have been disappointed. As Mr. Kregel has agreed: Unfortunately, Keynes often changed what he was assuming about expectations to suit a particular purpose’8. For example, the dogmatic Keynesian conclusion about the impossibility of bringing about a general cut in real wages by means of a general cut in money wages was obtained by assuming a particular kind of expectations, which may well have represented an important possibility, unjustifiably excluded by orthodoxy, but one which it was arbitrarily dogmatic to insist upon in general terms as the only possibility. Keyness cavalier, casual empiricism with regard to expectations, or his plucking of assumptions about them out of the air, may have been partially justifiable for a major pioneer, on the frontiers of the subject, gifted with Keyness own outstanding flair and genius. It is hardly justifiable as a normal’ or routine method (Hutchison, 1978). The Impact of Keynesianism It is abundantly clear that to try and characterize a Keynesian policy regime is to enter a thicket of complex and competing definitions that is almost as dense as that surrounding Keynesian theory. Nevertheless, most authors concur in seeing the policies pursued in early postwar Britain as deserving that name, with however much qualification. Perhaps the best term is simple or hydraulic Keynesianism (Cottrell, & Lawlor, 1995). Simple Keynesianism is a term employed by Alan Booth to describe how the very broad agenda of 1930s Keynesianism was narrowed by going through the Whitehall machine in the later years of the war, so that by the late 1940s the Keynesian program focused much more on the simple manipulation of aggregate demand than was likely to have occurred if that program had not had to bend to the demands of administrative acceptance (Booth 1986; 1989, chaps. 8-11). As Booth argues, this program did not have much impact on policy in the early postwar years (1945-47) because of the Labour governments emphasis on controls and planning, but after 1947 it became more important as, to a growing extent, fiscal policy displaced physical controls. After 1951 and the end of the Korean War it came much more into its own as the Conservatives continued the "bonfire of controls" begun by Labour in 1948 and reactivated monetary policy (Rollings 1988). There was no straightforward transition to simple Keynesianism, however. Howson (1993), for example, has shown how a combination of Keynesian advice and desire to redistribute income led to the policy of cheaper money in 1945 and 1946, and how this was only slowly reversed in the late 1940s. This reemergence of monetary policy was also accompanied by complex arguments about its role, which remained matters of dispute up to the 1959 Radcliffe Report and beyond (Fforde 1992, chaps. 4-10). The simple Keynesianism that emerged in the 1950s focused attention on aggregate demand and its manipulation via fiscal and monetary policy. In his standard survey of the management of the economy from 1945 to 1960, Dow emphasized that "the chief instruments used by the government have been fiscal policy, which in practice has meant the adjustment of tax rates, and monetary policy.... The policies in question are concerned essentially with large-scale effects on the main economic magnitudes: employment, the general price level, and the aggregates which figure in national income accounts" (1965, 1-2). This regime quickly became characterized (and attacked) as one of "stop-go," in which government’s generated excessive fluctuations in activity by their Pavlovian responses to either rising unemployment figures or falling foreign exchange reserves. How far policy did act countercyclically as was intended has long been a matter of dispute. Another criticism, much heard from the late 1950s, alleged that such short-term fluctuations impeded investment and hence growth (Shanks 1961; Shonfield 1958). In turn, this view has been criticized by those who note that fluctuations in economic activity in Britain were no greater than those in faster-growing western European economies (Cottrell, & Lawlor, 1995). In broader perspective, the impact of this regime in creating the concurrent period of full employment has been much debated. An early postwar generation tended to see a direct line from Keynesian theory to Keynesian policy to full employment. Few would now accept this strong version of the Keynesian revolution and its impact on policy. In 1968 Matthews showed how postwar fiscal policy at best played only a minor role in the strength of demand in comparison with the 1930s, most of the change coming from private investment and trade. His later more extended work came to a broadly similar conclusion (Matthews et al. 1982, 309-13). A one-sentence summary of the existing literature on the Keynesian revolution in economic policy with regard to Britain in the 1951-64 period would suggest that "much ado about nothing" would be a considerable exaggeration; nevertheless, the positive benefits to the economy of this regime have to be set clearly in the context of the international boom that characterized this period, a boom in which countries with highly variant policy regimes participated (Marglin and Schor 1991). The concurrence of the postwar boom has led to the view that the real importance of Keynes was felt not in domestic policy but in shaping the international policy regime after 1945. There can obviously be no dispute that Keynes himself gave the creation of a stable, expansionist international regime the highest priority in the later years of his life, and indeed killed himself working to ensure that the regime was superior to the mess apparent after 1918 (Cottrell, & Lawlor, 1995). First, much recent work on Western Europe has highlighted the rapidity with which much of the continent recovered in the late 1940s, in a period when the international regime had not been liberalized to any serious extent. Milward in particular has emphasized the extent to which even by 1947 the forces of revival were apparent, and it was precisely the strength of that revival that exacerbated the "dollar shortage" and balance of payments problems of western European countries (1984, chap. 1). Second, this revival of Western Europe was sustained via dollar injections, first by Marshall Aid and then aid under the Mutual Security Act, rather than by liberalization of the international economy. It was not until well into the 1950s that the American liberal grand design can be said to have been realized, by which time the boom had been preceding for a decade (Milward 1992). This is not to say liberalization played no role in the postwar expansion; the concurrence of booms in Western Europe is itself evidence against that view. And while the "grand design" was slow to be achieved, liberalization within Western Europe, albeit with tough discrimination against the dollar, was evident from the late 1940s. The point is that liberalization was only one element in the boom. Another element was that the structural conditions for fast growth and full employment in Europe in this period were particularly favorable, for two reasons in particular. On the one hand, the significant lag between European and American techniques of production (in the broadest sense) provided a scope for the large-scale "catch-up" that was facilitated by the political desire of the United States to export its model of a high productivity society to its allies. This lag predated the war, of course, but both political conditions and the absence of unemployment meant that efforts to reduce it were greater and more successful than in the interwar period (Maier 1987). On the other hand, the large agricultural sectors in most western European countries except the United Kingdom meant that rapid growth could be aided by a once-and for-all transfer of labor from low- to high-productivity tasks. While it of course expanded the labor supply, this productivity-raising shift also meant a surge in demand so that full employment could be sustained (Cottrell, & Lawlor, 1995). These points are made to suggest that the basis of the "long boom" did not lie primarily in liberalization of the international economy. This factor undoubtedly played its part, but it came too late to be decisive and it is probably outweighed in importance by the upward shift in investment responding to changes in demand and new technologies (Marglin and Schor 1991). Conclusion Was the fashionable idea of economic planning in the 1930s the political seed-bed of the Keynesian revolution in Britain, whose espousal by economic radicals of all colors signaled the birth of a new economic consensus amidst the conflicts and divisions of the pre-war years? This is the implication of the prevailing account of the planning movement, which has long dominated the historical interpretation of the background to the Keynesian victory. The account does have a beguiling sense of plausibility. Planning did represent a widespread demand for radical economic reform in response to the apparent breakdown of market capitalism in the early years of the decade. Its many proponents all met in a shared conviction of the impossibility of restoring the old order, in deploring the National governments unimaginative response to the crisis, and in calling for a fundamental refashioning of the national economy into a planned system. Ultimately, of course, the most powerful argument in flavour of the idea of planning as the forefather of the Keynesian revolution is the undeniable fact that a definite agreement on Keynesian economics did indeed emerge towards the end of the decade among many of the earlier planners: an agreement which both anticipated and shaped the eventual economic accord which arose in Britain during and after the Second World War. Yet, whatever the seductive plausibility of this thesis -- and the many truths it contains -- the conclusion of this study is that it distorts the meaning and significance of both the planning debate and the eventual turn to Keynes. First of all, planning was neither Keynesian nor even pre-Keynesian. Indeed, rejection of Keynes and all similarly indirect forms of monetary or fiscal management which fell short of the fundamentals of micro-economic planning was about the only point of serious agreement among the planners. Even more important, this common emphasis on physical planning was far from an indication of an accord on economic policy. On the contrary, beneath the shared language of planning, the radical economic policy-debate of the 1930s was riven by fundamental ideological contradictions which assured that instead of serving as a unifying cry for reform, planning remained a heterogeneous trend, diffused amongst reformers of all parties and none, but fragmented by the same divisions which dominated the more conventional political scene. Far from proving an early signpost towards the post-war consensus, the planning debate was in many ways the most vivid example of the ideological fragmentation which characterized British politics in this turbulent decade (Ritschel, 1997). Notes They are in a very weak position to say that to the present writer, who learned the pre-Keynesian orthodoxy at their feet. Memorandum on Certain Proposals Relating to Unemployment, Cmd. 3331. General Theory, p. 213. D. F. Gordon, 1965, p. 124. It is, for example, hardly ever mentioned in Professor Joan Robinson Introduction to the Theory of Employment, 1937, or her Essays in the Theory of Employment, 1936 and 1947; or in L. R. Klein the Keynesian Revolution, 1947. Professor E. Roy Weintraub in his article on "Uncertainty and the Keynesian Revolution, very rightly refers to Keyness treatment of uncertainty as an innovation of sublime importance ignored for almost thirty years by most economists and still ignored by many. The phrase is Sir Henry Phelps Browns. See his condemnation of arbitrary abstraction in his presidential address "The Under-development of Economics", 1972, p. 3. As Professor A. Leijonhufvud writes: "Keyness theory of expectations was sketchy at best" (1968, p. 178). References Daniel Ritschel, 1997. The Politics of Planning: The Debate on Economic Planning in Britain in the 1930s. Oxford University. Booth A. 1986. "Simple Keynesianism and Whitehall". Economy and Society 15.1: 72 87. Rollings N. 1988, "British Budgetary Policy 1945-54: A Keynesian Revolution?" Economic History Review 41, 2:283-98. Howson S. 1993. British Monetary Policy 1945-51. Oxford: Oxford University Press. Fforde J. 1992. The Bank of England and Public Policy 1941-1958. Cambridge: Cambridge University Press. Dow J. C. R. 1965. The Management of the British Economy 1945-60. Cambridge: Cambridge University Press. Shanks M. 1961. The Stagnant Society. Harmondsworth: Penguin. Shonfield A. 1958. British Economic Policy since the War. Harmondsworth: Penguin. Matthews R. C. O., C. H. Feinstein, and J. C. Odling-Smee. 1982. British Economic Growth 1856-1973. Cambridge: Cambridge University Press. Marglin S., and J. B. Schor, eds. 1991. The Golden Age of Capitalism. Oxford: Oxford University Press. Milward A. 1984. The Reconstruction of Western Europe 1945-51. London: Methuen Milward A. 1992. "Economic Aspects of British Perceptions of Power". In Power in Europe II. Edited by E. D. Nolfo. Berlin and New York: de Gruyter. Maier C. 1987. In Search of Stability: Explorations in Historical Political Economy. Cambridge: Cambridge University Press. T. W. Hutchison, 1978. On Revolutions and Progress in Economic Knowledge. Cambridge University Press, 1978 Hutchison, T. W., 1937: "Expectation and Rational Conduct", Zeitschrift für Nationalökonomie, Band VIII, Heft 5, pp. 636ff. Keynes, J. M., 1936: The General Theory of Employment, Interest and Money. Patinkin, D., 1976: "Keynes Monetary Thought: a study of its development", History of Political Economy, vol. 8, pp. 1ff. Joan Robinson, 1963. Economic Philosophy. Aldine Publishing Company/Chicago. Allin F. Cottrell, Michael S. Lawlor, 1995. New Perspectives on Keynes. Duke University Press. Read More