Why Not Keynes?
In the high crisis just two years back, the cult of John Maynard Keynes saw a dramatic revival. Deficits were acceptable, stimulus plans became law, books entitled Return of the Master and The Keynes Solution rushed into print. Enthusiasts spoke of a “new New Deal.” Today, although the economy has not recovered, and although unemployment remains near 9 percent, none of this remains.
Barack Obama declined to become a third Roosevelt. His Bernard Baruch proved to be Robert Rubin. There is no Wagner in the Senate, no Eccles or Currie at the Federal Reserve. The agencies that harbored Leon Henderson and the young John Kenneth Galbraith do not exist. If Keynes were alive today and came to visit, one wonders who in official Washington would see him.
The new dawn of the Keynesian idea has gone dark.
That it was a false dawn goes without saying. People who had actually read and understood Keynes never came close to power. Those who did come to power under Obama were False Keynesians. They would support a “stimulus,” but only if it were limited and temporary. To Lawrence Summers, a two-year program met the definition of “sustained.” $800 billion spread over two years—about 3 percent of a GDP in free-fall—qualified as “substantial.” Ben Bernanke and Christina Romer, both of whom had reputations as experts on the Great Depression, were closer to Milton Friedman’s view of that matter—that the Fed did it—than to Keynes.
The False Keynesians also relied on forecasting models that were conceptually anti-Keynesian because they incorporated the notion of a “natural rate of unemployment.” The models assumed that economic recovery would occur, returning us to an unemployment rate near 5 percent after five years. This would happen—so said the models—no matter what the policies were. The models thus defied the commonsense perception that we were in a deep and systemic crisis. In 1930 Keynes wrote, “The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” In 2009 we realized it. But our computers, and the technicians who ran them, overruled us.
As a result, policies were inadequate and the results fell short. In March 2009 I predicted in The Washington Monthly that a temporary program—rather than strategic effort coupled with forceful financial reform—would not foster business investment and sustainable renewed growth. As the stimulus package wore off, the economic recovery would be slow. This prediction came true with disastrous political effects for Obama. And so the False Keynesians went home—Romer back to Berkeley, Summers to Harvard. The reputation of Keynesianism is just part of their collateral damage.
After the midterm elections, all attention turned to the victors’ agenda: the federal budget deficit, the public debt, spending cuts, and the cause of “entitlement reform”—our Orwellian phrase for slashing Social Security and Medicare. How can we understand this march of budget-cutters and free-market fundamentalists? Where do their ideas come from? Unlike the Reagan revolutionaries of 30 years ago, they have no academic messiah, no newspaper apostles, and, so far as one can tell, no sacred text. “Monetarism” plays no role, nor does “supply-side economics.” They are not really “Austrians,” though some claim as much. If they are “slaves of some defunct economist”—then of whom?
The answers are not far to seek. Adam Smith and David Ricardo—and also their acolytes, the late 19th-century Social Darwinists Herbert Spencer and William Graham Sumner—can be heard murmuring in the vapors of our present discourse. And far more than Marx or Keynes, Thurman Arnold and Thorstein Veblen can help us grasp what their message actually is.
Adam Smith, the most humane and optimistic of all economists, adapted his theory of value from the Physiocrats he’d encountered in France, who held that economic value arose on the land. Smith was not comfortable with that, so instead he wrote that value was vested by labor in physical products, which could then be exchanged. Those who made things were “productive” and those who did not were not. Government (including soldiers), alongside the arts and domestic service, fell into the unproductive category. These activities were necessary, even desirable, but only up to a point. They had to be supported out of “revenue,” economic rent, and did not accumulate as wealth. A country that allowed too much of those sorts of things would become poor.
This idea contradicts the accounts of national income that give us our modern definitions of economic activity and growth. Government purchases are indeed part of the GDP. So are the labors of ballet dancers and college professors. The accounts make no distinction between public and private spending or between tangible and intangible wealth.
Yet Smith’s idea appeals powerfully to instinct—even to common sense. Surely there must be “good” and “bad” spending. Just as we approve of factories, just as we dislike “planned obsolescence” in the private sector, so we consider much of what government does to be “wasteful” and “fundamentally unproductive.” Waste, of course, is a burden by definition, and unproductive activity is to be kept to a minimum. The issue, once framed in this way, becomes one not of whether to cut, but of “how much” and “what” and “on whom.” We forget entirely (until the victims remind us) that, by accounting, budget cuts will reduce income, cost jobs, and cause economic activity—and business profits—to fall.
Then there is the question of whether the fall in spending, profits, and jobs will be made up quickly and easily by some other sector. Leaving aside exports, here there are two possibilities: private consumption and business investment.
On this issue David Ricardo championed another Frenchman, Jean-Baptiste Say, whose Law held that savings creates investment or, equivalently, that supply creates demand. If there was ever an excess of production, then prices would fall, demand would increase, and that would take care of it. Thus it was impossible for there to be a general glut, meaning sustained mass unemployment. The system was self-correcting; crises did not happen. This powerful confidence now sustains the Tea Party; they have blotted the collapse of the private banking sector from their minds.
The rabbit in Ricardo’s hat was the nature of money in his time—mainly coins and paper backed by gold or silver. The quantity of money thus didn’t fall in a glut, and its purchasing power would rise as prices fell. Consumption and investment would take up the slack.
But we no longer live in that world. In our credit-money economy, purchasing power goes away when banks stop lending, and the money stock falls. This is why Milton Friedman and Anna Schwartz could blame the Depression on the Federal Reserve, and why Ron Paul favors abolishing the Fed and a return to the gold standard.
With gold-money unavailable, the Republican staff of the Joint Economic Committee has a new paper on how big budget cuts might support economic growth. They offer no theory, just citations to empirical papers that turn out to be highly implausible or else unsupportive. But this work, alongside the balanced-budget amendment cosponsored by all the Republican senators, presumes that some force will drive up business investment to a more-than-offsetting degree, creating a larger and more private economy than we have now. The Keynesian “multiplier” is negative in this view.
This argument dovetails with the line of the business lobbies, who whine on about regulations and “uncertainty,” as if we hadn’t spent the past 30 years deregulating everything in sight. In their version of the story, interference by government is a choke-leash on the animal forces of free-market dynamism. Lift regulation, they say, and business investment will rise to the challenge of replacing the demand and incomes lost to budget cuts. While the public-spending multiplier is negative, the private-investment multiplier is anything but.
How can this be? It’s an old theme, redolent of the Social Darwinists’ view of the divine right of the rich to rule. Thurman Arnold in The Folklore of Capitalism captured the spirit in this description of a 1936 meeting with bankers, businessmen, lawyers, and others up in arms because the Interstate Commerce Commission was proposing a cut in fares on the New Haven Railroad:
[One] gentleman present had the statistical data on why the railroad would suffer. In order to take care of the increased traffic, new trains would have to be added, new brakemen and conductors hired, more money put into permanent equipment. All such expenditures would, of course … remove persons from relief rolls, stimulate the heavy goods industries, and so on. This, however, was argued to be unsound. Since it was done in violation of sound principle it would damage business confidence, and actually result in less capital goods expenditures, in spite of the fact that it appeared to the superficial observer to be creating more…
And Thorstein Veblen, in The Theory of Business Enterprise, in 1904, explained what the sound principle underlying it all was. The bottom of the matter was emotional: “Depression is primarily a malady of the affections of the business men. … Any proposed remedy, therefore, must be of such a nature as to reach this emotional seat of the trouble. … What is required is a business coalition … loosely called a ‘trust’.”
There you have it: business people need to be in charge. And more than that: they need to feel in charge. Anything else is fundamentally unsound.
That is what made Keynes insufferable. It wasn’t that as a young man he liked boys. It wasn’t that he taught that that thrift is a vice, or that savings are pathological, that deficits are helpful, that debt is necessary, that interest rates should be kept low, that the economy should be run at full employment for the good of all. It wasn’t even his reference at the end of The General Theory to the “euthanasia of the rentier.”
No, it was the fact that Keynesian policy required Keynes. And if Keynes were in charge, then the captains of industry could not be. Larry Summers is not Keynes. But he did give the impression, for a while, of running the show. This was a fatal error. It was the impression of making policy that business and the Tea Party could not stand. A better policy would not have been better liked.
With Jeffrey Immelt, we now have a business face and no economic policy at all. The president has learned. Whether it will save him be remains to be seen. A full government of business people would be much more authentic.
Meanwhile, in the halls of Congress, as well as at Westminster and in Frankfurt and Brussels and Berlin, the ghosts of Smith and Ricardo mutter on about unproductive government and how savings create investment. So they cut and cut, and when that doesn’t work they call for more cuts. And the penetrating voices of Arnold and Veblen can be heard too, explaining what is really behind it.
Madmen in authority, distilling their frenzies indeed. Keynes got that right.
James K. Galbraith is the author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. He teaches Keynes at the University of Texas at Austin.