Among the unhappy consequences of the current financial meltdown is the apparent triumph of a set of moral imperatives that seem every bit as perverse as those recorded in Alice in Wonderland. Financial institutions that took extreme risks and collapsed have to be bailed out by taxpayers on the grounds that “they are too big to fail.” Improvident borrowers, who purchased homes they could not afford and then defaulted when they could not make the monthly mortgage payments, must be subsidized by taxpayers in order to halt the slide in all house prices. Bankers whose firms lost billions must be paid extravagant bonuses—in some cases courtesy of the taxpayers—lest they be lured away by competitors (who are similarly insolvent). In order to save the system, we must first save those most responsible for placing it at risk.
In addition to trying to save the banks and defaulting home-buyers, the U.S. government, meanwhile, is trying to buck up the spirits of debt-ridden consumers with a stimulus package of nearly one trillion dollars, paid for with still more borrowed money. Everyone agrees that the credit crisis was brought on by a decade-long spree of lavish borrowing and spending by governments, banks, and consumers; now many are effectively insolvent, except for the federal government which has the advantage of being able to borrow and to print money nearly to infinity (which it will do). All agree that it would be good if Americans saved and produced more, and so borrowed, consumed, and imported less. Yet that is not what is likely to happen. The American economy thrives on consumption, and, indeed, the American consumer has been the stimulant for investment and production throughout the world. Thus, to deal with a crisis brought on by too much borrowing and consuming, our national government will encourage us to borrow and consume still more.
All of these developments might qualify as stark examples of what Daniel Bell has called “the cultural contradictions of capitalism.” There is little doubt, as Bell reminded us three decades ago, that the matrix of beliefs now operational in the nation’s cultural and financial centers bears little resemblance to the manners and mores that were once associated with capitalist enterprise. The Protestant ethic of saving and self-denial which accompanied the rise of capitalism has long since given way (as Bell says) to a modernist culture based upon consumption, self-realization, and hostility to any ideals that smack of “Puritanism.” Up until a few months ago, however, the new ethic appeared to mesh nicely with an economic order built upon consumption, easy credit, and short-term accounting. The unprecedented wealth accumulated in recent decades was called forth for many purposes, among them to underwrite new and experimental lifestyles. This uneasy entente between the realms of culture and finance developed as a pronounced though somewhat surprising aspect of the modern capitalist order. Now, in the wake of the crash, one wonders how, and on what terms, it will be held together.
Bell may not have envisioned the degree to which even bankers and business leaders might be overtaken by what Susan Sontag, in praising the burgeoning counterculture of the 1960s, called “the New Sensibility.” Bell, like Joseph Schumpeter before him, diagnosed an emerging conflict between an anti-capitalist culture and the worlds of business and finance, not a shotgun marriage in which self-expression and profits might emerge as partners in a common enterprise. Nevertheless, he saw the two elements—a modernist culture and a dynamic capitalist economy—as making for a potentially explosive mixture, whether working in tandem or in opposition to one another. He wondered whether consumption and the acquisition of wealth alone, without a transcendent rationale for those activities, could sustain the legitimacy of the capitalist enterprise—or, indeed, whether the enterprise can be made to work at all on its modernist foundations.
His fears have not yet been borne out. The two revolutions—one in morals and the other in markets—appear to have triumphed nearly everywhere, at least up until now. Still, unfolding events may renew these old fears for—who knows?—that rough beast slouching towards Bethlehem to be born may be that young banker risking billions on the basis of equations that exclude the human element or the miffed shopper exiting the department store after learning that her line of credit has been cut off. It is too soon to know if the financial collapse represents mainly a crisis of markets or perhaps also something more extensive that calls into question the moral prescriptions by which we have lived.
John Maynard Keynes is the economist of the hour, returned to favor in consequence of the financial collapse. This is a “Keynesian moment” after three decades in intellectual exile, as some have said, the occasion for a Keynesian revival in which popular faith will be restored in government’s capacity to engineer prosperity through tax and spending policies. As if to accelerate that revival, two publishers have recently gone into print with new editions of Keynes’s most influential works, The Economic Consequences of the Peace, originally published in 1920, and The General Theory of Employment, Interest, and Money, which appeared first in 1936. The reappearance of these two works, which express the different poles of his intellectual personality, provides a good occasion to review Keynes’s thought in relation to the current slump.
Keynes’s theories have gone in and out of fashion several times since he died in 1946. Each reversal has served as an occasion to revise or to adjust his legacy according to the perspective of the hour. The focus today is on “stimulus” or on what one columnist has called “depression economics,” with Keynesian prescriptions for an economy in crisis. These newly published works, as well as the authoritative three-volume biography of Keynes published by Robert Skidelsky between 1983 and 2000, also amply document the fact that Keynes had a far more ambitious agenda in mind than merely to propose deficit financing as a remedy for unemployment. Keynes, at a minimum, looked to redefine the relationship between the state and the market in capitalist societies in order to find a “middle way” between laissez faire and socialism. His new order required, in turn, a general reorientation in behavior and outlook such that the older culture of saving, self-denial, and minimalist government might be replaced by one more tolerant of consumption, debt, and government spending. From this standpoint, one can see that some of those “cultural contradictions of capitalism” were suggestively implied in Keynes’s writings.
The General Theory is by general agreement the more influential of the two works because in it Keynes laid out the theoretical case for countercyclical government spending policies to arrest recessions or depressions before they can become too deeply entrenched. The $800 billion stimulus package recently passed is thus the offspring of Keynes, though not a very attractive one as many of his contemporary followers will readily admit. The General Theory is notoriously difficult for the layman to read or understand, containing as it does a bewildering mix of abstract theory and seemingly unrelated excursions into subjects like stock market speculation and mercantilism. Even Paul Samuelson, one of Keynes’s American expositors, found it to be “a badly written book,” full of “mares’ nests of confusions,” where the reader encountered flashes of insight interspersed with tedious algebra. Keynes left it for others, like Samuelson, to work out fully the implications of his tour de force. The Economic Consequences of the Peace, by contrast, contained a powerful and lucid argument that no one could misunderstand or dismiss. Nevertheless, the two works, while vastly different in these respects, hammered at a common theme—namely, the obsolescence of the pre-war order in Europe, along with all of its associated ideas and assumptions.
In The General Theory, Keynes mounted a sustained attack on what he called the “classical” school of economics, the then-reigning doctrine of free and self-adjusting markets that developed out of the writings of earlier theorists, beginning with Adam Smith and running through David Ricardo, John Stuart Mill, and Alfred Marshall. The classical theory, he said, is not a general theory but rather a special theory applicable to certain circumstances which no longer obtain in modern economies. It seemed obvious to Keynes, as to others, that the Depression had cast doubt on the idea that free markets necessarily contained self-correcting features.
Keynes sought to prove, in opposition to the classical theorists, that there was no necessary process of adjustment in wages, prices, and interest rates that would correct the slide in employment and output. The market might reach equilibrium at levels well below full employment—and Keynes argued that this was, in fact, what had happened in the 1930s. There might even be times when negative interest rates would prove insufficient to induce people to spend and invest. Where there is no consumer demand, there will be no investment, and, thus, no growth or progress (the definition of progress being the accumulation of capital). Indeed, in the midst of slumps consumers will save and hold back on consumption, effectively accelerating the downward cycle of spending, investment, and employment. This is his well-known “paradox of thrift”: the situation in which a well-established virtue leads to economic ruin. Keynes was here directing a theoretical sally at Adam Smith, who said that the pursuit of self-interest (regarded as an individual vice) leads to the good of all, which for Smith and the classical school implied that government need not plan the outcomes that self-interest will produce on its own.
As against this, Keynes argued that when thrifty individuals hold back on consumption, government must step in to borrow and spend as a means of maintaining employment and generating consumer spending, instead of waiting for the market to make adjustments that may never occur. As recovery takes place, budgets might be brought back into balance to prevent inflation or to keep interest rates from rising. Keynes, however, did not stop with this short-run prescription for dealing with the painful side of the business cycle. He further suggested that the state should take control of investment in order to rectify the shortage of capital that he identified as an endemic weakness of market capitalism. As he wrote, “a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.” The state, he said, unlike individual investors or businessmen, is in a position “to calculate the marginal efficiency of capital goods on long views and on general social advantage,” a proposition which provoked the retort from Hayek that while governments may be in a position to take the long view, they rarely do.
In Keynes’s theory, the moral assumptions regarding individual liberty and free choice that buttressed the classical school were subordinated to the interplay of abstract forces like aggregate demand and investment, and to a self-confident belief that the state could be relied upon to intervene efficiently in the interests of all. By these and other means, Keynes placed the study of economics on a new foundation which, not incidentally, carved out a special role for government in modern economies as the back-up for private spending and investment. It was partly to answer Keynes that Hayek wrote The Road to Serfdom as a defense of classical liberalism and the proposition that the market allocates resources more efficiently than the state, and also with the vital guarantee of personal freedom.
The legacy of Keynes’s doctrine was to rewrite the fiscal constitutions of Western democracies by providing a compelling rationale for government spending and deficit finance which dovetailed perfectly with demands for national welfare programs coming from other directions. Keynes’s theory arrived too late to inform in any important way the policy debates of the 1930s, and, thus, it is difficult to detect much of his influence in, for example, the policies of the New Deal. His theory only came into its own during the Cold War era, when it achieved wide influence in the academic discipline and guided the policies of various governments, most notably the Kennedy-Johnson administrations and British Labour governments of the 1960s and 1970s. Keynes’s continuing influence, even if somewhat less pronounced in recent decades, is evident in the continuing deficits in national accounts that have persisted in good times as well as bad in the post-war era. From the late-1960s to the present, for example, the U.S. government has achieved budget surpluses on just two occasions, notwithstanding the general prosperity of the period. During the heyday of the so-called classical school, balanced government budgets were the expected norm. In the United States, federal spending today takes up roughly 25 percent of GNP, compared to just 3 percent in the early 1930s before the Keynesian revolution took hold.
Regardless of the economic appeal of Keynes’s theory, there can be little doubt that it was politically naïve, as even some of his friends and allies have acknowledged. Keynes seemed to believe that government budgets can be freely manipulated into and out of balance by policymakers in much the same manner and with as much freedom as central bankers have when they set interest rates or expand the supply of money. Roy Harrod, Keynes’s friend and biographer, wrote that Keynes held a faith that important governmental decisions would always be made by public-spirited experts acting in the general interest, when, in actuality, public budgets are subject to intense political pressures and are formulated by elected politicians with scant regard for something as abstract and ill-defined as the public interest. Expenditures committed during slumps are not easily withdrawn in times of recovery—a political fact of life in democratic systems. Thus, the attempt to apply Keynesian fiscal policy has generally led to chronic public deficits and, in turn, to inflation. The difficulties in applying Keynes’s fiscal doctrine are multiplied when we move to the subject of public investment. One can only imagine what nightmares would ensue if, as Keynes recommended, political bodies like the U.S Congress ever took control of investment decisions for the entire American economy.
Yet Keynes was more than an economist and, indeed, was one of the more influential intellectual figures of his era. He wrote widely on historical and political subjects and counted among his friends various novelists and artists associated with the Bloomsbury group of the interwar period. In an essay on Alfred Marshall, his mentor at Cambridge, Keynes wrote that the “master economist” must possess a combination of gifts: “He must be mathematician, historian, statesman, and philosopher—in some degree. No part of man’s nature or his institutions can be outside his regard.” Keynes understood, perhaps as well as any thinker of his age, that economics as a field of study ought not to proceed in isolation from history, politics, psychology, and, even, culture. Thus he saw, for example, that great changes in economic practice must be accompanied by corresponding changes in those cultural assumptions which tell us what we should value, whether and how much we should save or invest, how we should think about politics and government, and on what terms we should calculate the future.
It has been said that Keynes did for economics what Nietzsche had done earlier for morals—that is, he stripped away the illusions and pretenses that shielded traditional beliefs about economics and politics. This is partly true, though Keynes was far from being a nihilist. After all, here was someone who, beginning in 1918, wrestled with Europe’s civilizational crisis, searching for ways to reverse the damage done by the war. The economic approach that he formalized in The General Theory is only the most widely recognized of his proposed avenues of escape. Like many, Keynes believed that the Great War had shattered European civilization beyond any hope of repair. The shibboleths of the old regime—laissez faire, nationalism, the gold standard, empire, Victorian ideals—could not survive in a new era of sovereign debt, despair, debauched currencies, and a permanently changed balance of world power.
Keynes’s ideas about the war and the damage it had done to the social order were first displayed in The Economic Consequences of the Peace, the sensational exposé of the Paris Peace Conference that he wrote in a few months near the end of 1919 after serving as a member of the British delegation to the Conference. The book turned Keynes into a celebrity because, in it, he foretold, quite correctly, that the Treaty negotiated in Paris, unless revised, would lead to financial ruin across Europe and, eventually, to another war. The book was wildly popular: it ran through five editions and was translated into eleven languages within just a few years. It was not so widely acclaimed a book, to say the least, in diplomatic and political circles in London, Paris, and Washington, where it was condemned as too negative about the future course of world affairs, too favorable to Germany, too hostile to President Wilson, and too heavily focused on the economic aspects of the Treaty at the expense of political factors. A reviewer for the New York Times called it “an angry book”—a reference to the fact that Keynes had resigned in protest from his position at the Peace Conference in order to begin work on it. Keynes was in wide demand afterwards as a public speaker and pamphleteer, and he wrote frequently on public affairs throughout the 1920s and 1930s, even as he maintained a rapid pace of academic publication and taught his courses in economics at Cambridge. The book turned Keynes into an academic celebrity, a social type all too familiar today but less so at that time.
Most people expected that the French, British, and American leaders who controlled the conference would craft a treaty that incorporated, in some way, the principles President Wilson had earlier outlined in his Fourteen Points. The Germans certainly thought so, and the armistice that they negotiated in 1918 had been predicated upon this expectation. Keynes, like many others, was stunned when in the end, after six months of deliberation, the victors agreed to a punitive regime of reparations against the Germans that (Keynes wrote) they could not and would not pay. It was, as he called it, “a Carthaginian Peace”—something of an exaggeration since Germany was never even occupied by its foes at the end of the war, let alone destroyed by them.
The Treaty, nevertheless, contained some harsh provisions involving reparations and territorial concessions that were designed both to punish Germany and to turn the country back into the semi-agricultural society that it had been fifty years before. The purpose was somehow to reduce Germany to an economic and military parity with France which, due to rapid growth in the German population over the previous half century, could not be accomplished absent Procrustean measures designed to shrink Germany or stretch France. This, however, is what the conferees set out to accomplish, much to the disgust of Keynes:
My purpose in this book is to show that the Carthaginian Peace is not practically right or possible. The clock cannot be set back. You cannot restore Central Europe to 1870 without setting up such strains in the European structure and letting loose such human and spiritual forces as will overwhelm not only you and your “guarantees,” but your institutions and the existing order of your society.
Here was one of the chief errors against which Keynes persistently inveighed until the end of his life—the misbegotten crusade to restore a pre-war order in Europe.
Among the most insightful chapters in the book was one carrying the title “Europe before the War,” a melancholic rumination on a golden age blasted to smithereens on the battlefields of France and Belgium. “What an extraordinary episode in the economic progress of man that age was that came to an end in August, 1914,” he wrote. He marveled at the economic progress made across the continent beginning around 1870. Before that time, most states, except for Great Britain, were largely agricultural and self-sufficient. After that time, industry and population grew steadily as trade across the continent accelerated, widening the sphere of prosperity and the reach of modern comforts. Germany was at the center of this remarkable evolution, and by 1914 she was a key trading partner for every other European nation, including Great Britain. At the time the war began, Keynes wrote, “the inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep.” The generation that grew to maturity before the war had seen the world remade by the explosion of capitalist enterprise.
Keynes identified the cause of this rapid growth in a psychological disposition among all classes to save and invest newly created wealth rather than to exhaust it in consumption. The wealthy, in particular, were greatly responsible for the rapid accumulation of capital because “they were not brought up to large expenditures, and preferred the power which investment gave to them to the pleasures of immediate consumption.” They had “the cake,” so to speak, but on the condition that they did not eat it. The laboring classes accepted this arrangement because, while they lacked the resources to consume, the wealthy lacked the temperament to do so—and thus the proceeds from labor were continuously plowed back into the building of more factories and railroads. Much of this surplus was invested in America, which in turn sent back surplus foodstuffs to support Europe’s growing population. The duty of saving, he noted, became a widely prescribed and observed virtue, and the growth in wealth “the object of true religion.”
The tragedy was that, in time, all this wealth would be expended, not in consumption, but rather in war—and expended in a way that turned it into a conflict of unprecedented destructiveness. The war permanently disrupted the delicate balance among the various factors of trade, psychology, population, and investment upon which the pre-war order was constructed, leaving millions on the continent starving and destitute. The suffering was magnified by the comparison to the comfortable lives Europeans enjoyed before 1914 and the hopes for the future that everyone had entertained just a few years before.
The Peace Conference failed, Keynes said, because instead of seeking to re-establish the life of Europe, to heal wounds, and to relieve immediate suffering, the leaders of the great powers preoccupied themselves with political boundaries, balance of power calculations, revenge and reparations, and (in the case of Wilson) abstract principles that could not be shaped into practical remedies and so instead were deployed as camouflage for a “Carthaginian Peace.” Instead of re-integrating Germany (and Austria-Hungary) back into the life of Europe, so that trade could commence once again to permit the vanquished to earn the credits with which to repay the victors, the Treaty imposed harsh penalties designed to isolate and dismember them. On this general point, Keynes reserved his sharpest words for Wilson, who he said would do nothing that was not “just and right,” except that Clemenceau and Lloyd George, taking the measure of the American president, found it all too easy to cloak their national designs in terms and phrases that seemed to meet the requirements of fairness, self-determination, and collective security. Wilson was thus misled into the belief that securing the League of Nations outweighed the many imperfections in the Treaty, which was far from being the case. Wilson was so thoroughly “bamboozled” by these masters of European intrigue—so judged by Keynes—that he headed back to America comfortable in the illusion that the Treaty established the foundations for true peace.
In thus pointing the finger of blame at Wilson, Keynes implicitly recognized that a solution to the European situation would have to come about through the intervention of a United States that had come out of the war with reserves of wealth Europe would not be able to match for some time to come. Great Britain and France sought heavy reparations from Germany partly to pay for the war, partly to punish the Germans, but also partly to repay American banks for wartime loans. The amount of these loans, some $10 billion payable at 5 percent annual interest, represented a burden on European economies that proved difficult to bear under conditions of post-war austerity. If, in an act of generosity and statesmanship, the United States (along with Great Britain, which was owed sums by France and Italy) would agree to cancel the inter-ally war debts, reparations imposed upon Germany might likewise be scaled back to a level that the Germans could afford to pay without bankrupting themselves.
This proposal went nowhere, however, particularly after the American Senate spiked the Treaty and the United States withdrew from European affairs. The proposal to cancel debts came in for especially heavy criticism because it seemed to strike at established conventions regarding the sanctity of contracts and the obligation to pay debts. Here again Keynes broke with pre-war conventions and in doing so anticipated the future. Only after the next war did the cancellation, restructuring, or rolling-over of sovereign debt become a routine aspect of international finance. Keynes, as things developed, played a further role in that evolution when he was invited to participate in the Bretton Woods meetings of 1944 that established the International Monetary Fund and hammered out the monetary rules for the international financial system.
Keynes had been right to predict that the twin burdens of German reparations and inter-ally war debts would weigh heavily upon the international system and return to bedevil statesmen and central bankers for years to come. The German hyperinflation of the early 1920s, the Great Depression as it spread around the world, even Hitler’s rise to power and the war that followed—all were linked in one way or another to those causes of mischief that Keynes identified in The Economic Consequences of the Peace. His book, which was so strongly condemned and criticized in 1920, was, by 1940, judged to have been prophetic. By 1944, as Allied leaders began to look to the postwar world, Keynes’s diagnosis of the errors of 1919 had been incorporated into the conventional wisdom. Thus it was that many of the remedies he proposed in 1919—relief, reconstruction, renewal of trade, cancellation of debts, renouncement of reparations, and integration of the vanquished into the postwar order—stood as established guideposts for Allied planners.
As Robert Skidelsky has observed, The Economic Consequences of the Peace marked a turning point for Keynes insofar as he concluded that the ideals and institutions that were the foundations of pre-war prosperity could no longer serve as the bases for progress in the post-Versailles era. Although he had not yet developed the comprehensive critique of classical economics that evolved into the premise for The General Theory, he saw in 1919 that the moral and cultural assumptions of Europe’s liberal civilization had been badly shaken. Faith in automatic progress through saving and self-discipline had been shattered. Keynes’s experience at the Paris conference demonstrated that political leaders did not know how to repair it. If the old order of civilization could not be repaired, a new one would have to be created. The Economic Consequences of the Peace started Keynes on a search for a new order that eventually led to The General Theory.
Next to Winston Churchill, Keynes was (for good and ill) the most influential Briton of the last century. His influence is not only pervasive in the field of economics, but also in the worlds of politics and culture as well. He mounted an attack not simply upon classical economics, but on the broader political and cultural assumptions of nineteenth-century civilization. In doing so, he laid down the foundations for the mixed system of welfare capitalism under which we live today. We judge Keynes far too narrowly if we view him mainly as a theorist of stimulus packages and counter-cyclical government spending.
The present financial slump represents both a crisis of free markets and of the mixed system that Keynes envisioned and did so much to bring into being. It is a system in which government plays a large role in the economy, but in many areas on the basis of decisions that are highly political in nature. This is certainly true of interventions into the real estate, insurance, agricultural, and financial markets—and of several other markets as well. This is also true of many questions which have only recently arisen, such as: What industries or institutions should be bailed out or saved from themselves? Where are the lines to be drawn between those who should be saved and those allowed to fail? How far we should go in assisting mortgage holders or in propping up housing values? Should we compensate individuals who lost money in their retirement accounts? How far should governments go in borrowing against the future to promote recovery or to smooth out the business cycle? The resources governments can command are great but not unlimited. Governments also owe obligations to the future which, for obvious reasons, frequently go unrepresented. All of the questions are complicated by the fact that every bailout creates incentive for future episodes of recklessness or laxity. We have few political rules by which to make such decisions or moral standards by which to limit claims against society.
Unlike the classical theorists whom he criticized, Keynes gave little thought to the challenge of limiting government’s role, or of defining its relationship to the market, or of devising institutions that might serve such purposes. His economic theory is thus of little use in answering the kinds of questions posed above. His economic theory presupposed a revised relationship between the state and the market, but he paid little attention to the damage this might do to political institutions established in the preceding era. He cast aside the moral assumptions of the liberal order but failed to suggest workable ones to replace them. Consequently, the Keynesian order operates in a moral and political sea with few markers to direct it.
- The Economic Consequences of the Peace, by John Maynard Keynes; BN Publishing, 300 pages, $7.99. Go back to the text.
- The General Theory of Employment, Interest, and Money, by John Maynard Keynes; BN Publishing, 434 pages, $19.99. Go back to the text.
This article originally appeared in The New Criterion, Volume 27 Number 9 , on page 4
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