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.