Whether Keyness Theory and Policy Is Still Relevant to Today's Post-Crisis Situation - Essay Example

KEYNES CRITIQUE ICAL THEORY By Location Keynes critique ical theory Introduction In his book “General Theory” Keynes severely made some criticism of the classical employment theory. His employment theory is based on criticism of Say’s classical theory. There are various points that Keynes emphasized in classical theory criticism. His main argument was that the classical theory had unrealistic assumptions and irrelevant. The aim of this essay is to analyse the Keynes critique on the classical theory. The analysis will conclude with suggestions on whether classical theory is important in today’s economy. Keynes challenge on classical theory Keynes criticized classical theory and proved that the law was quite invalid. The classical law stated that every production or supply creates its demand and thus unemployment and over-production problems do not arise (Ahiakpor 2007, P. 56). Of course, it is true that the demand of goods is created by supply because there are several factors that are depended upon during production activities and they earn income which is in turn used on goods. For instance, when production factors are employed in the production of clothes, then incomes such as profits, wages, interest, and rent accumulate to them which they use to buy other goods. However, from this point of view, there is no proof that supply of production creates its own demand. The income that various factors of production earn is equal to the produced output value, but there is no proof that all this income that the production factors accrue will be used for services and goods. It is obvious that the production factors will save a part of their income and therefore, the saved portion does not create demand for products. If business owners do not make equal savings, then cumulative demand that, without intervention of government, consists demand of capital goods and consumer goods, will not meet the need of purchasing available output supply. Hence, in case of aggregate demand being insufficient for purchase of the available supply, the manufacturers will not be able to sell all their out following a decrease in their profits. As a result, the level of production will also go down increasing the rate of unemployment in the market. In most cases, consumers use a portion of their money on goods and services and they save the rest. On the other hand, there is a time when entrepreneurs spend a lot on machines and factories (they mainly focus on investing). Aggregate demand refers to the amount of investment demand and consumption demand (Casarosa 2002, P. 45). However, in a free market, the people who save and those who make investments are often different. In addition to the aspects that determine investment and savings are also different. Discussed below are the main views of Keynes critique of classical theory. Unrealistic assumptions of the condition of full employment Keynes considered the assumptions that classical theory made on full employment condition as unrealistic. According to Keynes, there is a possibility of underemployment equilibrium condition being a normal phenomenon. Keynes termed this as a rare occurrence. In fact, Keyness considered the condition of underemployment equilibrium as being more realistic. Undue essentialness to the long duration Keynes disagreed with the insistence of classical theory about long-term equilibrium. He instead emphasized on the short-term equilibrium. According to Keynes, “everybody is dead in the long-term equilibrium”. Therefore, there is no need to assume that everything will be okay in the long run. Denial on the law of markets Many classical economists rely on the market law that blindly suggested that supply creates own demand. Keynes completely opposed this view and emphasized that there is possibility of supply being higher than demand resulting in disequilibrium in the market, and asserted that the economy has automatic self-adjustment (Chick & Dow 2001, P. 706). Keynes further noted the weakness in classical theory emphasizing that all income accrued by production agents during the production process can be necessary spent on producing goods thus, there is a possibility of aggregate demand deficiency. According to Keynes, unemployment results from deficiency in aggregate demand. He further affirmed that it is not necessarily that the income that is not spent on other needs to be spent on purchasing goods from the producers (Barro 2007, P. 308). Therefore, sometimes there can be a deficiency in aggregate demand. It is also evident that an increase in supply does mean that demand will also increase. Keynes also disagreed with the Say’s view that demand and supply are always in equilibrium and that the equilibrium process is self-balancing and automatic (Benassy 2005, P. 503). Keynes pointed that the structure of today’s society is based on two main classes, the poor and the rich and therefore there must be unequal distribution of income between these two classes. The rich cannot spend all that they have on produced goods while the poor have little to a point that they are even unable to meet their consumption. Therefore, Keynes pointed the error in classical theory in denying unemployment and general overproduction (Gordon 2004, P. 433). He also added that the system of economy in reality cannot be self-balancing. Therefore, according to him, the intervention of the state is important to make adjustments between demand and supply in our economy. Critique of the policy of Money Wage Cut Keynes disagreed with the classical employment theory, which stated that unemployment can end if employees accept low payment rates. He particularly disagreed with Pigou’s notion of flexibility in payments as a means of reducing unemployment in times of depression. Pigou claimed that unemployment in the society can be reduced through money wage cuts since it can lead to increase in demand and production therefore increasing employment and investments (Ambrosi 2006, P. 67). Keynes refuted the notion that flexible wages can reduce unemployment using two counts; theoretical and practical. On the theoretical side, he pointed that reducing wages will reduce purchasing power thus reducing demand of industry’s products. Reduction of products’ demand will negatively affect industries, thus reducing the employment level. On the practical ground, he pointed that in the modern world, industries are under control of trade unions and there would definitely reject a wage cut policy (Keynes 2006, P. 78). Labour unrest and strikes can also arise from implementation of such policy. Attack on strategic variable interest rates Keynes criticized the classical theory in regard to its investment and saving view. He objected to the classical view of investment and saving equilibrium through flexible interest rates. To Keynes, investment and saving equilibrium are achieved through changes in income but not in interest rates. Lastly, Keynes strongly objected the classicists’ unrealistic approach towards the problems of the contemporary economic system. Their view that free perfect competition can reduce unemployment problems seemed invalid in the current world. According to classical theory, intervention of the state with the free employment, economic system leads to unemployment. Classical theory also condemned involvement of trade union activities, claiming that they prevent reduction of wages and therefore, this increases the rate of unemployment (Hawtrey 2004, P. 56). Keynes argued that trade unions are very vital for the current societal and asserted that they will keep on growing since they fight for the rights of employees. Besides, a growing welfare nation will not stop adopting or agreeing the principle of setting minimum wage policies and protect the rights of workers. Keynes supported the involvement of government to make adjustments and bring change in the workplace (Bateman & Davis 2011, P. 78). He argued that the modern economic condition is not automatic and self-adjusting as it was assumed in the classical-theory. Conclusion In conclusion, according to Keynes’s point of view, classical theory is irrelevant, unrealistic, and out of date to the current modern conditions. Therefore, classical theory can be relied upon to solve the problems affecting the modern economy. Therefore, there is need of economists coming up with a more realistic and relevant theory that will help in finding a solution to the current economic issues. The new theory should be worth to be used a guide for finding solution to current issues such as business cycles, inflation, and unemployment, and many other economic ills affecting the life of people. Following the Keynes’s economic theory revolution is currently being believed by a large group of economists. They agree that the government should play important and active role in promoting economic status and especially in the employment condition. The government should take appropriate monetary and fiscal measures. The governments of the modern world should, therefore, stop following the classical theory since according to Keynes’s critique it has irrelevant and unrealistic assumptions that instead of healing the modern economic problems will make things worse. Bibliography Ahiakpor, JC 2007, Full Employment: A Classical Assumption or Keyness Rhetorical Device?,Southern Economic Journal, 56-74. Ambrosi, GM 2006, The Keynesian reception of classical analysis: Pigous theory of unemployment and its critique in Keynes general theory, FreieUniversität Berlin; FachbereichWirtschaftswissenschaft; Institutfür Quantitative Oekonomik und Statistik. Barro, RJ 2007, Long-term contracting, sticky prices, and monetary policy, Journal of Monetary Economics, 3(3), 305-316. Bateman, BW, & Davis, J 2011, Keynes and Philosophy: Essays on the Origins of Keyness Thought. Benassy, JP 2005, Neo-Keynesian disequilibrium theory in a monetary economy. The Review of Economic Studies, 503-523. 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