Friday, January 31, 2020

Keynes and Us

In the last week I finished a remarkable book, Money and Government, by the British historian Robert Skidelsky.  Eight years older than I am, Skidelsky made his reputation writing a three-volume biography of John Maynard Keynes, which appeared between 1983 and 1992.   This exhaustive work--most of which I have not read--paid tribute to the man who provided the theory behind the enormous economic success of the middle third of the twentieth century.  I too had learned to revere him in my youth, and have been almost as astonished to find him become unfashionable in my middle and old age.

Keynes was the hero of by far my most important course as a Harvard freshman in 1965-6, Economics 1.  As I described in my autobiography (see above), the course spent the first term on microeconomics and the second, more important term on macroeconomics.  Microeconomics focused on the theory of competitive markets and the Pareto optimum, which, it was easy to see then, was an ideal type (a concept I learned later) with only very intermittent relation to reality.  Firms large and small were always looking for edges that would make markets less competitive, to prevent the market from driving profit down to the affordable minimum.  Macroeconomics, on the other hand, were in the midst of the climax of the Keynesian era, which had saved both capitalism and civilization.

Classical theory held that national economies naturally reached an equilibrium, and that disturbances came from non-economic factors like famine, war, or unwise government policy.  Classical economists and their allies in national banks and treasury ministries believed that economies would self-correct, provided the banking system maintained stable prices.  For much of the 19th century this seemed like a reasonable approximation of the truth, since all the advanced economies grew quite impressively and prices remained stable, even though serious panics occurred at least every 20 years or so.  Things changed, however, in the wake of the First World War, and especially, of course, during the Great Depression.  Keynes, a Cambridge academic who had also worked in the British Treasury during the war, had too much respect for reality to stick to the old theory in the midst of inflation and depression in the 1920s and 1930s.  He eventually argued in The General Theory of Employment, Interest and Money that national economies could reach a kind of equilibrium that involved high unemployment, without any natural countervailing force operating to reduce it.  He also realized that savings did not necessarily turn into investment, and argued that when private interests failed to invest enough of their wealth to stimulate the economy, the government had to use that money itself--obtained if necessary by borrowing--for investment in public goods that would stimulate the economy effectively.  That was, of course, also the theory, in a very raw form, of FDR's New Deal, although Roosevelt got the nation and the world economy back into serious trouble again in 1937 when he decided to try to balance the budget,  helping to trigger another serious recession.  In Keynes' own Britain, however, no government tried his prescription seriously until the Second World War came.  And indeed, Skidelsky's first book--probably his Ph.d thesis--entitled, Politicians  and the Slump, described how the Labour Government of 1929-31 failed to try to Keynesian remedy when the Depression hit, and split itself and formed a government with the Tories instead.

I used that book to write one of the presentations I gave in my first-year graduate school colloquium in the spring of 1972.  I had been brought up in a New Deal household, I had read Arthur Schlesinger's New Deal histories at a pretty early age, and I had also learned in Economics 1 how well the Keynesian theory had been working the Kennedy and Johnson Administrations.  Indeed, I recall how my section man, David Major, in our very last class, remarked that the economics profession had made remarkable strides in solving macroeconomic problems in recent years, but not in microeconomic ones.  I also remember that he spent about 20 minutes of one class talking about the bizarre ideas of a rogue economist named Milton Friedman, then regarded as an oddball. "I think it's good for you to be exposed to this," he said.

Skidelsky's new book is a survey of large-scale economic thought since th 18th century, focusing on the rise and fall of Keynesianism.  Clearly he, like me, never imagined that the man to whom he devoted several decades of his life, and who had done so much to create the benevolent world that he and I grew up in, could become so unfashionable.  But he has, and Skidelsky explains how.  The pretext for discarding him was the advent of stagflation--a combination of high unemployment and veyr high inflation--that hit the western world, and especially Britain, in the 1970s and 1980s.  Keynesians had not anticipated this and had no remedy for it.  Others, however, eagerly seized upon this to repudiate the whole Keynesian model, because they wanted to restore the economic sovereignty of private enterprise and eliminate the government as a competitor for the use of capital, and accumulator of revenue, and a serious regulator of private enterprise.  Margaret Thatcher, Ronald Reagan, and Paul Volcker of the Fed tossed the Keynesian idea out the window, and in the 1990s Bill Clinton and Tony Blair did not really pick it up again.  The idea of the economy as a benevolent self-regulating mechanism returned to favor, and from about 1990 to 2006,  the combination of steady growth and lower inflation seemed to favor it.

I cannot take the time to summarize Skidelsy's academic arguments. Suffice it to say that the neo-classical model of economics that once again dominates the profession relies on an absurd view of human nature, as he realizes.  Economic men and woman ruthlessly maximize their well-being, always buying at the lowest available price, investing eagerly at equilibrium interest rates, and willingly working for the prevailing wage.  Unemployment, this view holds, occurs when prevailing wages are too high, period.  Markets, such as the housing market (!!) regulate themselves far better than any government bureaucrat could.  Economics, I think, attracts a lot of scholars attracted to the beauty of mathematical theory--but not to the study of actual reality.  Such is the hegemony of a certain set of ideas, however, that one can spot only a few dissenters such as my old friend Jamie Galbraith here and there on the horizon, and they do not exert significant influence in either Republican or Democratic administrations, or Labour or Tory governments in Britain.

The great financial crash of 2008 grew out of the absurd new faith in unregulated markets, which, combined with cheap money, had allowed the big banks to create an enormous subprime mortgage bubble, one that would have destroyed the world economy when it burst without the massive intervention of the government.  This time however Ben Bernanke and Tim Geithner showed no interest in Keynesian intervention as the primary solution (although the Obama stimulus was a significant Keynesian move.)  Indeed, Bernanke in particular wanted to show that Hoover and FDR had chosen the wrong remedy by spending more government money instead of just restoring liquidity in the banking system--a term which meant, in practice, buying up all the worthless trillions of assets on the balance sheets of the banking system with money created by the federal reserve.  That, and the stimulus, did lead to a fairly successful recovery in the US, although inequality continued to increase.  But it has not done so in Europe, where economies have grown very slowly now for well over a decade, while central bankers, just like their counterparts in the 1920s and 1930s, continue to insist on austerity.  And as a result, the established parties in nearly every European country are losing ground, particularly to right-wing populists.

Skidelsky's last chapters are chilling.  He was trained as an historian, not an economist, and he knew at an early age that bad, traditional economic policy had done a lot to destroy democracy in parts of Europe--most notably in Germany--in the 1920s and early 1930s.  Now, he argues, the insistence on neoclassical economic principles and on depriving national governments of a major economic role has crippled politics in much of the West.  Private interests and national banks, not elected officials, are the most important actors in our economic system, which they have organized for their own benefit.  The financial community in particular has taken advantage of deregulation to find many new ways to create, and hoard, enormous sums of money that benefit no one but themselves.   The most advanced western nations face critical shortages of many public goods such as infrastructure.  Millions of voters in the west now understand this and are repudiating the established politicians who have gone along with it.  Free trade and globalization are two other shibboleths of modern economic thought, and Skidelsky feels they need to be held back as well because of their disastrous economic impact in older industrial areas and their political consequences.  Many nations in past eras such as the late 19th century, he points out, prospered under protectionist regimes.  We need, he argues, new policies, and new economic thinking to go with them.  He does refer at one point to Thomas Piketty's 2014 work Capital in the Twenty-First Century and to its principle finding--borrowed, actually, from Karl Marx--that capital naturally grows more quickly under capitalism than the economy.  This still seems to me to be the biggest single reason that a Keynesian approach involving high taxes (including taxes on capital) and high spending on public goods is necessary to get us off the path that we are on now.

I completely agree with Skidelsky that the hegemony of the idea of self-regulating economies has crippled political power in the West.  The problem continually gets worse, of course, because our unregulated economies channel more and more of our wealth into a very few hands, increasing both their political and economic influence.  Our generations--Skidelsky's and mine--are victims of our parents' success.  They had to focus on public goods, broadly defined, to defeat the Depression, win the Second World War, and set up the western alliance for the Cold War.  Now that those threats have faded, the government seems to lack a compelling reason to mobilize private resources.  Worst of all, deeply flawed classical theories of economics remain hegemonic because they benefit the wealthy--whose largesse universities now need more than ever.  Like me, Skidelsky has remained faithful to what he learned in his youth--but he is now 80, and few replacements seem to be emerging either from our politics or from academia, and his remarkable book has gotten very little attention.  I learned about it from a very favorable review in The New York Review of Books, but even that review, I know think, didn't do justice to its scope.  It was panned, not surprisingly, in the Wall Street Journal, and it has not been reviewed at all in the daily or Sunday New York Times or in the Washington Post. 


6 comments:

JRW said...

So is Bernie Sanders the best hope? There surely don’t seem to be many younger politicians in the Democratic Party that care about much other than identity politics.

Bozon said...

Professor

Too much here to comment on in any detail.

I would just refer, for those interested, to Keynes' The Economic Consequences of The Peace, squibbed briefly in Wikipedia.

I am not on the Keynesian left, nor in Ferguson's camp as such, but it summarizes key points rather well. I would just note that France was mainly blamed, and here we have Anglophone commentators, whereas in my view Britain was only slibhtly less at fault at Versailles.

Americans, including yourself among others, now are accustomed to blaming Germany for all that went wrong with the 20th Century, similarly to the manner in which the South was blamed for the Civil War. That is hardly my view of either, and thinkers like Keynes were fully aware of that.

All the best

Energyflow said...

https://www.goldmoney.com/research/goldmoney-insights/estimating-the-shape-of-the-coming-crisis

Here is a typical article that is anti keynesian. In the last part of it he compares our curret system over 100 years to John Law's system in France that led to ruin there but at a much faster rate of time. At any rate I never recall you discussing economic policies specifically and presumed that historians were lacking in this area. Apparently it is not so. I am thankful. OTOH discussions of such theory often become opaque like going onto a buddhism forum for general advice and the long timers are swapping jargon of theravidism vs god knows what. Real life experiences often get left behind.

If the above article is correct then Keynes and similar though well intentioned ae stepping off the staigght and narrow to lead us astray in the end. Of course as he famously asserted, 'in the long run we are all dead' so a saeculum of economic stability experimenting with currency debasement and controlled government economc stimulus is worth a try. Industrialism and massive economic and population growth were certainly one time historical developments which necessitated special measures. However we see the end game here as described above in dirdct comparidsn with Law's scheme. Equity values are being central bank supported. As they fall so will confidence in the currency itself and therefore in the governmental institutions and the gig is up. Perhaps this is due to debt oversaturation as the maturation of the industrial system, based on progress(waves of ever new technologies constantly replacing one another as speculative vehicles) and endless demographic growth to feed the pension ponzi scheme and consumption/debt engine on which banking profits rely. IOW in a normalized zero to minimal growth world likein middle ages with stable technology and population hard currency is neccessary. Roman currency was famously debased by diluting silver content of coins as the empire had increasing problems finding new colonies to plunder and pay for their upkeep, troop enforcements, like USA in Middle East today.

Of course I am not a hard hearted dickensian 'reduce the surplus population, are the no work houses'scrooge type of guy but voluntary support associations like oddfellows existed where benefits such as medical, unemployment were paid and people knew who was a slacker. True community support must in the end, when excess massive production of all consumer products ends, as it must. You must remember how pre cheap Cinese imports local production of goods was common and toys clothing TV sets were more exensive and one took care to repair and mend instead of discard. As the Chinese demographic bulge hits its downside and coal reserves there are used up, global inflation and relocalisation and renormalization of economies will return. This partiular 20 year bubble was based on that 'China extension' and Moore's Law, which, being dead, ensures the end of the pipe dream of Easy Street here on earth, much as the colonization of space hit its brick wall in the 70s due to oh so practical realities of everyday survival in small space exposed permanetly to radiation without a basic ecosystem.

Energyflow said...

https://econimica.blogspot.com/2020/01/what-does-lowest-population-growth-in_31.html
Another good article explaining demographics relative to stalling of growth and desperate government/Fed measures.

Steve Clark said...

Perhaps you should investigate Modern Monetary Theory (MMT), which starts precisely from reality to explain how money and credit actually operate in modern economies. From its start in the 90s, its post-keynesian grasp of the financial system is now leaping into the mainstream of economic debate. A leading proponent, Stephanie Kelton, is a top economics advisor to Sanders. It is Keynesian thinking updated by another 80 years of financial experience.

Unknown said...

Milton Friedman and the Chicago School just resurrected Austrian economics to suit their purposes. The Laffer Curve was just these right-wingers "laughing" all the way to the bank. There are still economists out there who understand that money doesn't "trickle down", or in the words of Jim Hightower, "tinkle down". I believe Sen. Elizabeth Warren understands this better than any other Democratic candidate. She knows that unregulated capitalism is just greed. What's sad is that so few people have any real understanding of economic principles and seem to blame the wrong party for economic downturns, when we know the opposite is true. Republicans, the supposed party of conservatism, is anything but that.