Monetary Central Planning and the State, Part 21: The Keynesian Revolution and the Early Critics of Keynes

American economist Dudley Dillard began his 1948 book, The Economics of John Maynard Keynes, by pointing out, “Within the first dozen years following its publication, John Maynard Keynes’s The General Theory of Employment, Interest and Money (1936) has had more influence upon the thinking of professional economists and public policy makers than any other book in the whole history of economic thought in a comparable number of years.”

Indeed, by the mid 1940s, especially in England and the United States, Keynes’s General Theory had become practically a “New Testament” for the economics profession. Soon after the Second World War, textbooks began incorporating its teachings for purposes of instructing the young, and nontechnical, readable expositions of Keynes’s ideas were published for purposes of indoctrinating the general public about the wisdom of its policy proposals.

One of the most clearly written of these was The Keynesian Revolution by Lawrence R. Klein (who was awarded the Nobel Prize in economics in 1980). Published in 1947, it represents the views of the growing consensus of the time among economists and government policy advocates.

The final chapter of Klein’s book outlines what would be expected from government if the Keynesian “insights” were to be fully applied for the “social good.” In the brave new world guided by the ideas of Keynes, Americans would have to accept a greater degree of government regimentation than they had been used to in the past. Should they be afraid of this? No, Klein assured his readers. After all, “the regimentation of unemployment and poverty is infinitely more severe than the regimentation of economic planning.” He was sure that the American people would “quickly come forth with support” for the regimentation of economic planning.

The government economic planners would have to have “complete control over the government fiscal policy so that they can spend when and where spending is needed to stimulate employment and tax when and where taxation is needed to halt upward price movements.” The slow and cumbersome congressional budgetary process would have to be put aside. In its place,

“We must have a planning agency always ready with a backlog of socially useful public works to fill any deflationary gap that may arise [through discretionary government deficit-spending powers]; similarly, we must have a price-control board always ready with directives and enforcement officers to wipe out any inflationary gap that may arise…. Government spending should be very flexible and subject to immediate release or curtailment, in just the precise amount which will maintain full employment, no more and no less. This is the road to the kind of full employment that we need.”

At the same time, government would have to see to it that the members of society were kept from saving too much and spending too little, since excessive savings would diminish the “aggregate demand” upon which “full employment” was dependent. This would require, Klein argued, an active and conscious policy of redistribution of income:

“If we redistribute income from the rich, who have a relatively high marginal propensity to save, to the poor [whose marginal propensity to save is generally lower], we will decrease the community’s marginal propensity to save. Such policies of income redistribution can be carried out by taxing the rich and paying a dole or other types of contributions to the poor.”

Also, the motives for people privately desiring to save would have to be undermined by government’s taking over greater responsibility for such things as retirement planning. Klein argued:

“Most children are raised on the virtues of thrift, and high spenders are usually considered to be unworthy citizens. It is difficult to change these fundamental habits…. The people acting on individualistic principles do not know their own best interests. They must be taught to look at the system as a whole [in which consumption rather than savings is the ‘socially’ desirable conduct]…. We must resort to indirect methods such as social-security programs which wipe out the need for savings.”

For a book that created such a rapid and mass following among so many economists and public policymakers in such a short period of time, it is worth recalling that when Keynes’s General Theory first appeared, it was greeted by a wide variety of critical reviews in the leading publications of the day. For example, Alvin Hansen, who in the period after the Second World War would become one of the leading proponents of Keynesian economics in the United States, concluded a review in The Journal of Political Economy in October 1936 by pointing out that Keynes’s book “is not a landmark in the sense that it lays a foundation for a ‘new economics’…. The book is more a symptom of economic trends than a foundation upon which a science can be built.”

Especially critical of The General Theory were many of the leading members of the Chicago school of economics. Henry Simons, for instance, writing in The Christian Century (July 22, 1936) argued that Keynes “gives us a theory of unemployment, interest and money which attains generality by being about nothing at all.” His solutions to the problem of economic depressions ran “in terms of a great and curious variety of expedients … intended to demonstrate that wise governmental policy must deal directly with many particular [market] relationships,” with little thought as to whether government has the ability to actually master all the problems involved. He concluded that Keynes “may only succeed in becoming the academic idol of our worst cranks and charlatans — not to mention the possibilities of the book as the economic bible of a fascist movement.”

Jacob Viner, another leading economist at the University of Chicago, in a review in the Quarterly Journal of Economics, vol. 51 (1936), feared that The General Theory’s “display of dialectical skill is so overwhelming that it will have probably more persuasive power than it deserves.” Viner was especially critical of Keynes’s opposition to downward adjustments in money-wages as a method for restoring profit margins to firms as part of a market-based return to full employment and balanced investment and production. Viner warned that Keynes’s preference for government-induced increases in aggregate demand, as a method for increasing prices relative to rigid money-wage costs to stimulate full employment, carried the danger of creating the institutional conditions for an inflationary spiral, as labor unions came to demand higher wages to compensate for lost purchasing power due to rising prices:

“Keynes’s reasoning points obviously to the superiority of inflationary remedies for unemployment over money-wage reductions. In a world organized in accordance with Keynes’s specifications there would be a constant race between the printing press and the business agents of the trade unions, with the problem of unemployment largely solved if the printing press could maintain a constant lead and if only the volume of employment, irrespective of quality, is considered important.”

Frank H. Knight, also at the University of Chicago, reviewed The General Theory in The Canadian Journal of Economics and Political Science (February 1937). Professor Knight stated that he found the work “quite unsubstantiated.” He believed that this was partly the case because of Keynes’s caricature of the ideas of the classical economists, who were “set up as straw men for purposes of attack in controversial writing.” And he concluded, “It seems to me reasonable to interpret the entire work as a new system of political economy, built around, and built to support, Mr. Keynes’s conception of inflation as the cure for depression and unemployment.”

At Harvard University, Joseph A. Schumpeter reviewed Keynes’s book for the Journal of the American Statistical Association (December 1936). He criticized Keynes’s reliance on asserted “psychological propensities,” such as the “propensity to consume,” as a device for claiming to understand the causes of economic depressions. Rather than being a useful tool for understanding the logic behind human decision-making, “such a ‘propensity’ is again nothing but a deus ex machina, valueless if we do not understand the mechanism of the changing situations, in which consumers’ expenditure alternatively increases or contracts, and redundant if we do.”

As for Keynes’s inflationary remedies for unemployment, Schumpeter suggested,

“Let him who accepts the message [in Keynes’s book] rewrite the history of the French ancien regime in some such terms as these: Louis XV was a most enlightened monarch. Feeling the necessity of stimulating expenditure he secured the services of such expert spenders as Madame de Pompadour and Madame du Barry. They went to work with unsurpassable efficiency. Full employment, a maximum of resulting output, and general well-being ought to have been the consequence. It is true that instead we find misery, shame and, at the end of it all, a stream of blood. But that was a chance coincidence.”

Schumpeter, therefore, suggested: “The less said about the last book [The General Theory] the better.”

Categories: Freedom Daily Archive, Monetary Policy