Immortal Keynes?

Anyone who has been watching President Obama's response to the Great Recession will realize that policymakers have learned little since the 1930s.



Whatever you may think of Keynesian economics, you have to give it credit for one thing: its staying power. You can't watch a news program without hearing pundits analyze economic conditions in orthodox Keynesian terms, even if they don't realize that's what they're doing. One TV personality says that the rejection of Keynes indicates a disbelief in all science! What accounts for this staying power?

I'd have said it's because Keynesianism gives intellectual cover for what politicians would want to do anyway: borrow, spend, and create money. They did these things before Lord Keynes published his The General Theory of Employment, Interest, and Money in 1936, and they wanted to continue doing those things even when trouble came of it. So it was convenient that an eminent Briton furnished them a—I almost said "clear," but the General Theory was never called that—theoretical justification.

One of my favorite economists, Lawrence H. White of George Mason University, offers a different reason for this staying power in his instructive 2012 book The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Yearsnamely, that Keynes's alleged solution to the Great Depression offered hope, apparently unlike its alternatives.

Many observers have credited the professional success of the new Keynesian doctrine to the optimism it offered, the promise that something could be done to speed recovery from the Great Depression. [Keynes biographer Robert] Skidelsky has commented that Keynes "gave people hope that unemployment could be cured" without abandoning a free society (in contrast to the path taken by Russia, Italy, or Germany), "and that was the great appeal of The General Theory for many people, including many of the young economists." John Kenneth Galbraith reminisced that, returning to Harvard after studying under Keynes in England, "There was this breath of hope and optimism, and I came back from Cambridge to find a whole group of people here who had also readThe General Theory."

One may point out that the Keynesian "cure" did entail some serious abandonment of freedom—Keynes even called for the "socialization of investment," which means that politicians and their court economists would make the crucial decisions about what is produced.

White also notes that "Milton Friedman, looking back in a 1996 interview, essentially agreed [that the alternatives to Keynesianism promised only a better distant future]. Academic economists had flocked to Keynes because he offered a faster way out of the depression, as contrasted to the 'gloomy' prescription of [F.A.] Hayek and [Lionel] Robbins that we must wait for the economy to self-correct."

What did Hayek and Robbins (and Ludwig von Mises) call for? White writes:

Hayek's and Robbins's contrasting policy recommendation, to let output and employment recover on their own as bankruptcies and layoffs released workers and machines to find more sustainable employments, was regarded by many as a counsel of despair.

Of course, Keynes made his name by rejecting the established understanding, which began with the classical economists (if not earlier) and was further developed by the Austrians, that—when governments give them the chance—ailing economies fix themselves and resume their beneficial equilibrating processes. That is, left to their own devices, people adjust their behavior and restore the market's coordinating powers, overcoming the previous disruption.

Note that the concern was not with what would put the economy on a long-term sustainable path, but rather with what would give the short-term appearance of improvement. It was regarded as obstructionist to warn that the measures intended to produce that appearance would themselves bring trouble in the future. Anyone who has been watching President Obama's response to the Great Recession will realize that policymakers have learned little since the 1930s. But they are not very good at producing even the appearance of good times, are they?

A related aspect of the Keynesian response to the Great Depression—this also carries on to the current day—is the stunning lack of interest in what causes hard times. Modern Keynesians such as Paul Krugman praise Keynes for not concerning himself with why the economy fell into depression in the first place. All that mattered was ending it. Krugman took the same position with respect to the 2008 recession. White quotes Krugman, who faulted economists who "believed that the crucial thing was to explain the economy's dynamics, to explain why booms are followed by busts."


Krugman went on:

Instead, Keynes saw it as his job to explain why the economy sometimes operates far below full employment.… Rather than getting bogged down in an attempt to explain the dynamics of the business cycle—a subject that remains contentious to this day—Keynes focused on a question that could be answered. And that was also the question that most needed an answer: given that overall demand is depressed—never mind why—how can we create more employment?

Indeed, if you're trying to end mass unemployment, why would you want to get bogged down trying to understand what actually caused the mass unemployment? It's not as though the cause could be expected to shed light on the remedy.

"Hayek, by contrast objected exactly to the 'never mind why' approach," White continues in The Clash of Economic Ideas

He considered it an irresponsible search for a superficial fix: "I cannot help regarding the increasing concentration on short-run effects … not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilisation."

Hayek, Robbins, and Mises, in contrast to Keynes, could explain the initial downturn in terms of the malinvestment induced by the central bank's creation of money and its low-interest-rate policies during the 1920s. If you believe that explanation is correct, you'd want to see the mistaken investments liquidated so that ever-scarce resources could be realigned according to consumer demand and time preferences (the intensity of preferences for goods sooner rather than later). And you'd want the harmful government policies that set the boom-bust cycle in motion to end.

But Keynes did not see production as a multistage process through time (although he did in earlier writing) and did not believe that interest rates balance saving and investment. In fact, according to Keynes, saving is bad because it reduces the demand for goods and thus creates unemployment.

Much of White's chapter shows that Keynes casually cast aside the long-established understanding of self-generating market processes. Among the highlights is a clear explanation of Jean-Baptiste Say's law of markets, which Keynes had to misstate (as "supply creates its own demand") in order to refute. White shows that Keynes was not the first economist to reject the idea that when people are left free, their activities create orderly processes that serve individual and social well-being. White also shows that the body of knowledge discovered by early 19th-century economists, particularly in England and France, refuted Keynes long before he came on the scene.

This article originally appeared at the Future of Freedom Foundation.