Keynes’s General Theory Contains Oddly Few Mentions of “Fiscal Policy”

File WhiteandKeynes jpg Wikipedia

Something that has puzzled me for quite a while: Keynes’s General Theory contains remarkably few references to fiscal policy in any form:

  • “Government spending”: no matches…

  • “Government purchases”: no matches…

  • “Fiscal policy”: 6 matches:

    • Four in one paragraph about how fiscal policy is the fifth in an enumerated list of factors affecting the marginal propensity to consume…
    • One about how an estate tax changes the marginal propensity to consume…
    • One about how fiscal policy in ordinary times is “not likely to be important”…
  • “Public works”: 10 matches:
    • Three in a paragraph about how the multiplier amplifies the employment effect from public works…
    • Two in a paragraph warning that multiplier calculations are overoptimistic because of import, interest rate, and confidence crowding-out…
    • Four on how public works have a much bigger effect when unemployment is high and “public works even of doubtful utility may pay for themselves…”
    • One a criticism of Pigou’s logic…

And yet it also contains this one paragraph:

In some other respects the foregoing theory is moderately conservative in its implications. For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected. The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative…

Chasing back this “banking policy” that is the alternative to the “somewhat comprehensive socialization of investment”, there are three cites to “banking policy”: this paragraph is one, and the others are:

  • “to every banking policy there corresponds a different long-period level of employment…”
  • and the “it is, I think, arguable that a more advantageous average state of expectation might result from a banking policy which always nipped in the bud an incipient boom by a rate of interest high enough to deter even the most misguided optimists. The disappointment of expectation, characteristic of the slump, may lead to so much loss and waste that the average level of useful investment might be higher if a deterrent is applied…. [But] the austere view, which would employ a high rate of interest to check at once any tendency in the level of employment to rise appreciably above the average of; say, the previous decade, is, however, more usually supported by arguments which have no foundation at all apart from confusion of mind…”

The question of why “it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself… a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment…” is left hanging. And how “a somewhat comprehensive socialisation of investment” is to be implemented are left hanging as well.

So will somebody please explain to me why “fiscal policy” plays such a small part in the General Theory and yet such a large part in mindshare perceptions of “Keynesianism”?

Brad DeLong and Charlie Deist on Austrian Economics

Bob Zadek

Charlie Deist: Brad DeLong on Austrian Economics:

Charlie Deist: Good morning everyone, and welcome to the Bob Zadek Show.

I’m Charlie Deist, Bob’s producer, once again filling in for Bob, who will be back next week to discuss the topic of morality and capitalism. Are the two compatible? Is a moral citizenry required for a capitalist system, or is it the inverse? Is capitalism the only system that does not require a moral citizenry?

I also want to wish our listeners a “seasonally-adjusted greetings.” The adjustment is both my filling in, and my special series here on the business cycle. When we talk about economics, we often refer to seasonally-adjusted statistics—business cycles fluctuate up and down, not only in these longer boom and bust cycles, but also throughout the year. Around Christmas time, consumers are running off to the store to buy the latest gadgets and gizmos, so we see a temporary spike in spending.

Last week I was joined by Robert Wenzel, who is a self-described Austrian economist. That does not mean that he is of Austrian nationality—it means he follows the ideas of libertarian economists such as Friedrich Hayek, and Ludwig von Mises. These were 20th-century economists who built a foundation for economics on a philosophical concept that is both simple and profound—that is, that humans are purposeful actors; we act with an intention to achieve certain aims, and use economic means as well as other means to achieve our desired ends.

The Austrian school is important today because everyday we see stories on the front pages of the newspapers about booms and busts, bubbles bursting, Bitcoin, etc. Is Bitcoin a bubble? We might wonder whether humans are actually rational. Are they pursuing their ends in a way that will actually best achieve them, or are they, perhaps, less than perfectly rational?

These are the kinds of questions that economists debate, and today I’m privileged to have an economist with me. I’m joined this morning by UC Berkeley economics professor, Brad DeLong. Every so often, I need to ask a favor of Brad DeLong. He’s my old teacher and undergraduate advisor, from when I was something of an aspiring libertarian economist.

While preparing for last Sunday’s show, on the hardcore libertarian Austrian theory of the business cycle, it occurred to me that I don’t actually know what I’m talking about. I don’t have a PhD, or even a Master’s degree in economics, although thanks to Brad I was able to complete an undergraduate thesis on monetary policy. But it occurred to me, if I were in almost any other field, trying to diagnose a problem—something as complex and serious as the booms and busts in the economy, my musings here would be something akin to malpractice.

Brad DeLong is the chair of the political economy major at UC Berkeley. He was deputy assistant secretary at the U.S. Treasury, and is a visiting scholar at the San Francisco Federal Reserve Bank. He joins me by phone from Berkeley, where he also writes the popular blog, “Grasping Reality with Both Hands.” Now, that’s a metaphor, so if you’re driving keep both hands on the wheel.

I’m going to try to cram in close to a whole semester of economics with Professor DeLong, and hopefully he can help to explain in layman’s terms, his academic perspective on what’s really going on in the economy when we read about the Federal Reserve and interest rates, money supply, quantitative easing, and so on. Thanks for taking the time to talk with me.

Brad DeLong: It’s a great pleasure on my part to be virtually here. Thank you for asking me.

Charlie Deist: I want to start with a quote from a blog post that you wrote all the way back in 2004. This was when Alan Greenspan was still Federal Reserve Chairman, and it echos the message of my last guest, which was that the Federal Reserve negatively influence the economy—I don’t think there’s any question about that among economists. This was the end of a post from April 2004, where you were trying to figure out what was going on with monetary policy at the time.

You said:

Alan Greenspan frightened away the evil depression fairy in 2000 to 2002, by promising—not that he would let the evil fairy marry his daughter—but by promising high asset prices, unsustainably high asset prices for a while. Whether this was a good trade or not depends on the relative values of the risks avoided and the risks accepted. And to evaluate this requires a model of some sort…

So back in 2007, you were worried, just like our last guest, about the Federal Reserve inflating a bubble. What would you say is the Keynesian perspective, if you will, on the potential for the Federal Reserve to engage in this kind of pro-cyclical monetary policy—i.e., monetary policy that, rather than smoothing out the business cycles like it’s supposed to, actually can exacerbate them and make them worse?

Brad DeLong: Well, I would say that it’s not so much a Keynesian perspective as a Keynesian–Monetarist perspective. Or rather, since Keynesianism, Monetarism, and Austrianism are all very large and vague, unsettled creatures with very fuzzy borders, such that it’s not clear where the core is, let’s say John Maynard Keynes himself rather than the Keynesians, Milton Friedman himself rather than the monetarists, and Friedrich Von Hayek himself rather than the Austrians.

Here Keynes and Friedman would have been on the same side, approving of Greenspan’s policies. That is, Keynes thought the most important thing for monetary policy was to manipulate the economy so that the level of spending in the economy—the level at which the government plus private actors wanted to spend—was large enough to be able to put everyone to work, who wanted to work, at the prevailing wage level, without creating an excess of demand, over the amount that could be produced that would produce inflation. That, as he said, inflation is unjust in that it robs the saver of the returns that they’re expecting, and deflation is inexpedient. Perhaps deflation is worse in an impoverished world, but these are both evils to be shunned.

Milton Friedman was very much the same. That is, Milton Friedman thought that the right policy for the Federal Reserve to follow was for it to be constantly intervening in asset markets in order to keep the money supply from falling—even if private actors wanted to shrink their holdings of money—or keep the money supply from rising if private investors and private actors wanted to increase the supply of money. Also, Friedman thought that if there were to ever be sharp shifts in the velocity of money—sharp changes in how much people wanted to hold in terms of dollars in their bank account for every dollar they spent—the Federal Reserve should offset those too.

So in both Friedman and Keynes’ view, the right strategy for the Federal Reserve was the Greenspan strategy of “act to try to keep inflation and unemployment as stable as possible, by doing whatever is necessary in terms of buying and selling assets, and pushing asset prices up and down.” It’s just that Friedman called it a neutral monetary policy, and Keynes feared that the Federal Reserve would not be able to do enough, and that you’d have to bring in other tools as well.

I think Keynes has won this one after 2007 to 2009, when the Federal Reserve did everything and it didn’t work. But they’re on one side agreeing with Greenspan.

Hayek, and I suppose also Hyman Minsky—who are on the other side—were saying back in the 1930s, the 1950s, the 1960s, that no, this is a very dangerous policy to pursue.

Charlie Deist: So there’s a lot to unpack here. We have four names: Keynes, Friedman, Hayek and now Minsky, who we’ll try to get to later. And each of them is telling a different story, and proposing a different remedy for this problem of the business cycle.

You used the word “manipulation”, and that seems to be where the Austrians would have the biggest disagreement with even the monetarists like Milton Friedman, who was one of the most famous libertarians—maybe the most famous libertarian. Yet, in this one area, Friedman did favor a role for government manipulation: of the money supply. This gets to the core of the technical debate in monetary policy, which is, what is the Fed actually doing on a day to day basis? How do they adjust, both through direct action and through the influence of expectations of the actors in the economy? Let’s summarize for listeners in layman’s terms how they influence the economy. Economists talk about a transmission mechanism. This is just the direction of causality from one action to the results that we see. Could you break down how the Federal Reserve actually achieves the smoothing of the business cycle, in either the Keynesian model, the Monetarist model, or whichever hybrid of the two you think makes the most sense?

Brad DeLong: Well, as early liberal John Stuart Mill put it back in 1829—and I think he got it right and Keynes and Friedman would agree—that the economy is in balance, in a business cycle sense, if the supply and demand for money are equal. That is, if demand for money is greater than supply, then people are cutting back on their purchases because they want to hold more money than they can find. Then you have what they used to call in the colorful language of the early 19th century call a “general glut of commodities”: high unemployment, idle factories, cotton goods going begging as far as Kamchatka, in Thomas Malthus’ phrase. That’s a bad thing. And if the supply of money is greater than the demand, well that’s inflation, which is also a bad thing.

To keep the economy in balance, you need to match the supply and demand for money. But since the demand for money is somewhat erratic, the Federal Reserve or the Bank of England always have to be in there, buying and selling, pushing and shoving, increasing and decreasing the supply of money in order to keep there from being either unwanted inflation or unwanted deflation. That is just the way things are, if you are going to keep the economy stable.

Now this is a somewhat awkward position for Milton Friedman to be in because when you ask Uncle Milton about practically any other market, his response is, “The market will sort it out optimally. And even if the market wouldn’t sort it out optimally, building up any government bureaucracy to try to do better is doomed to failure.” Yet somehow, with respect to monetary policy, Uncle Milton goes very far towards saying that there are major institutional or cognitive human deficits in how the market for money works. So, we have to have this form of extremely soft, light-fingered central planning for the money supply—which he hoped could be done by a rule. That the Federal Reserve is going to say, “We’re going to let the money supply increase by one percent every quarter.” But it turned out that such rules don’t work very well. We need much more complicated rules—we need feedback rules, and even with the feedback rules, we have to deviate from them substantially on occasion.

So that is very much what Friedman and Keynes think is going on there. Minsky thinks that’s going on too, but Minsky also thinks that the same current of thought and institutions that lead to episodes of deflation and inflation in the private market—to financial over-speculation and so forth—that those are also going to affect the minds of policy makers. So, it’s just when asset prices are rising and people are enthusiastic and getting over-leveraged, then you’re going to find large political calls for deregulation of finance and for a reduction in regulatory requirements for collateral and down payments. And, conversely, just when the economy is in serious trouble and people are depressed, that’s when you’re going to have the Dodd-Frank bills imposed. That’s when you’re going to have governments demanding lot higher down payments. That’s when you’re going to have collateral requirements required by the Bank of International Settlements go through the roof.

Charlie Deist: So Minsky tells another story of the pro-cyclical policy where government, rather than smoothing out the business cycles, is tracking with either the people’s confidence of lack of confidence in the financial system. It’s a case where human irrationality and the lack of a sound technician at the board, so to speak, is leading to these wild fluctuations.

Brad DeLong: Well in Minsky’s view it’s a logical impossibility. Right? That, as William McChesney Martin—Fed Chair in the 1960s—said, “The purpose of the Federal Reserve is to take the punchbowl away just when the party gets going.” But just as the party gets going, that’s when absolutely nobody wants to take away the punch bowl.

Basically, Minsky had all kinds of hopes about how—because we would understand this cycle—we could transcend it, and moderate it, and deal with it. But those are basically unconvincing. If you take a Minsky point of view, we’re pretty much hosed, and all we can do is remember the historical parallels and analogies, and whimper and complain whenever this cycle gets going.

Charlie Deist: Tell us Hayek’s story—how Hayek relates to Minsky, and how it might echo it in some ways, or vice versa.

Brad DeLong: With Hayek, it’s in some sense very apocalyptic. It’s that everything would be fine if the market were just working well. It’s that you do not have a sudden large increase in the demand for money—the kind of thing that produces a depression—unless you had a large previous episode in which too much money has been created; in which the economy has somehow found itself with lots of liquid assets, which do not correspond to any fundamental values, either because the government has previously been printing a lot of money and generates an episode of inflation, or because the banking system has gone absolutely haywire, and private agents are facing bad incentives. Banks have extended many, many, too many loans thinking that they’ll reap fortunes if there are no bankruptcies for as long as they’re president of Bank of X. And if there should be bankruptcies, well, they’ll probably have moved on to another job by now.

So it’s a combination of fecklessness on the part of politicians who print extra money to spend or to lower taxes and so produce inflation, plus a principle–agent failure in the banking system, in which bankers make loans that are really lousy business in the long run because, hey—the long run might not come until they’ve moved on to another job.

That creates the inflation, and only after the inflationary boom comes is there ever a chance of being a large recessionary crash. So, for Hayek it becomes somewhat of a moral answer: that you have to keep the government a kind of moral, budget-balancing government, and you have to keep the bankers from grabbing us by the plums. And if we can have moral bankers and a moral government, somehow, then everything will be fine.

Charlie Deist: That’s an interesting interpretation—I want to pause on this question of market failure versus government failure. It’s a mixed story that you’re telling, where on the one hand there are the politicians and their short-sightedness—their money printing. On the other hand, there’s what economists call a “market failure,” which is where private actors supposedly acting in their own best interest, either short-term or long-term, make loans that will not bear the fruit necessary to pay back those loans.

So we end up with people, not only borrowing, but leveraging or borrowing with the money that they’re making initially off asset price increases.

They inflate this bubble, and get overly optimistic about the proceeds from this investment initially, so they’re doubling up, until we reach what’s called the “Minsky moment,” where everyone suddenly looks around and realizes that the punch bowl has been taken away, or that these investments are clearly not sound. And then we get a sudden crash.
Hayek said that this would not happen if government was not inflating a bubble, but Minsky considered himself a Keynesian, I believe, and argued that this would happen in the absence of that fecklessness on the part of the politicians. There is something inherent in human nature about being overly optimistic in these boom times.

And how do the Austrians solve that? They might say, “Well, we should go to a gold standard so that banks have to back up their deposits with some sort of hard money, precious metals and the like, and that will limit the loans.” Or they argue that in a free market banking system, agents would, on the whole, make more rational decisions. But this is an open question. Maybe it’s an empirical question. Maybe it’s a philosophical question. But you think that the preponderance of evidence is, empirically, on the side of people like Keynes and Minsky, who would still give some role for a wise and benevolent leader at the helm of the Federal Reserve, who could make corrections.

I think I remember a Keynes quote, and I don’t remember the exact quote—this might have been your email signature for a time—but it stuck in my mind, and it was something to the effect of, “We should hope that one day, economists will be as useful as dentists.” It’s “economists as technicians” rather than economists as “worldly philosophers.” People like John Stuart Mill seem to be more in the model of philosophers, but they also had economic theories, and these two things do seem to dovetail. What do you think is the proper role for economists, and are they more like dentists or they more like philosophers?

Brad DeLong: Well, we’re not terribly good as philosophers. As far as philosophers are concerned, we’re either third-rank libertarians or third-rank utilitarians. Or we used to have—I don’t know what you want to call it—third-rank Hegelians, talking about the necessity of freedom and the nurturing of humanity’s species-being, or identity as a species in one way or another. We’re not terribly good at any of those, and I think we’re better when we try to be technicians. Unfortunately, we’re lousy technicians.

Now let’s take this kind of question for example: Keynes, Friedman, Hayek and Minsky are all extremely smart and are all trying extremely hard, and indeed their positions bleed into each other. When Hayek stops talking about government engaging in deficit spending as the [sole] source of the boom that produces the bubble, and then slides over into banks that are improperly regulated for individuals who really do not understand that, say, the fact that Bitcoin has gone from 1,000 to 16,000 this year, does not mean that Bitcoin is likely to rise in the future—then, all of a sudden, Hayek starts moving over into Minsky. And when Keynes talks about how a boom leads to an increase in capital investments, that then reduces the rate of profit that can be earned on new investments, he starts sliding in the direction of Hayek.

Friedman’s hopes that you could make good Federal Reserve policy not automatic, but close to automatic, has pretty much been dashed, and that’s a big victory for Keynes. Keynes’ belief that you could have wise technocrats running the government does not look so hot, and that’s a victory for Minsky. And Hayek’s belief that, in some sense, the bubble is the cause of the depression and that if you avoid the boom in the bubble, you manage to avoid the depression, that really doesn’t look so good these days. Largely, because the two biggest depressions we’ve had in the past century—the 1930s and then the past decade—are far, far greater in magnitude than the previous bubble to which Hayek wants to blame them on. But I was much more of a monetarist 15 years ago than I am now. I thought Friedman looked much better than Keynes, and Minsky worse. Reality has a way of teaching you lessons.

Charlie Deist: Yes, and this is a nuanced perspective. We’re not calling names, or it’s not those bad guy Austrians or those good guy Keynesians. It’s a much more complicated picture with a lot of different shades and overlap between the theories. That’s what I’ve always appreciated about your blog and your writing is that it does seem like an earnest attempt—and even if we might disagree on some philosophical issues, there does seem to be this good faith effort to actually get to the truth. We have a caller on the line, so I want to hear from them and see if we can maybe bring this conversation back to some fundamentals.
Michael, let’s hear your question.

Michael: Hi Charlie. Thanks for a fascinating show. I was going to bring up some fundamentals. When you talk about the Austrian school, a fundamental aspect of it is praxiology, and I was wondering how praxeology fits into the discussion?

Brad DeLong: Praxeology, at least as I understand it, at one level it is sheer and total genius. I was reading a piece last night by three left-wing economists at—Sam Bowles, Rajiv Sethi, and I’m blanking on the name of the third author. [It] said that Hayek’s decisive and positive contribution to economics was in fact his rejection of Walrasian static, and also general equilibrium theory, as developed by Arrow and Debreu, [along] with the idea that the justification for the market is that it produces the best equilibrium. Because there’s never an equilibrium. Because all human action is a discovery and interaction process, in which people have different plans that are extraordinarily often inconsistent. And it’s the right way to analyze economics, and indeed all social life, is to look at how agents behaving in a disequilibrium situation, learn and react and adapt to each other.

Michael: I think the first step in criticizing praxeology is defining it. So why not just tell the listeners what it consists of.

Charlie Deist: Sure. Thanks, Michael.

Brad DeLong: As I’m saying, that’s my view of what praxiology is.

Charlie Deist: Praxeology being, most simply, the study of human action. Mises, in his book “Human Action” defines—I don’t know if he originated the word—but basically it’s “how do humans act?” It’s not necessarily what should they desire, but given that humans have certain ends, and that they use certain means, what can we say?

Whereas the typical classical economic approach to studying markets doesn’t necessarily begin with these assumptions about human action—these axioms that can be laid out just by going inward and thinking about the structure of the mind. It starts more with what [DeLong] is talking about: this Walrasian idea of an equilibrium (Leon Walras, not to be confused with the marine mammal, was the guy who basically invented supply and demand curves).

You have supply, where people will be induced to produce more of a good if there’s a higher price, and then demand, people will demand more if it’s a lower price. That gives you an upward-sloping supply curve and a downward-sloping demand curve, and where those meet, you have an equilibrium price and quantity. That’s what the market will produce. But, in praxeology, can we use supply and demand curves or do we need a completely different model?

Brad DeLong: Well, we can use supply and demand gingerly, because they do have very stringent underlying assumptions that most of the discovery that is the core of the market process have already been accomplished. I think that view, that rejection of Walrasian general equilibrium as a road that may well mislead us—that’s going to miss most of what is going on—is the very good part of praxeology.

The bad part of praxeology is simply when one tries to reduce what is, after all, an empirical study of how markets behave, to a set of logical consequences of looking inward and trying to assess one’s own motives. Even what I see as the Hayekian side of praxeology moves us towards creating a reified theoretical superstructure that then has little to do with how markets actually operate in the world. So I think the internal, psychological side of praxeology kind of leads away from the world, into another, different, abstract theoretical structure.

That’s why I would prefer to say Hayek rather than the Austrians, because I think Hayek has by far the better of the arguments here. I find Hayek’s viewpoint, which is focused on the market as discovery process, much more congenial to how I think than saying that we will take another step back from empirical reality, and try to derive laws of thought and human action from introspection.

If the psychologists tell us anything, it’s that we’re pretty bad at introspection. We vastly overestimate how smart we are—even how much of the world we see around us—and that can lead us wrong.

Charlie Deist: We should be more humble with regard to what we can know, and I think that the Austrian school tends to emphasize this in one area—mainly with respect to what government can know about the economy and thus what it can manipulate, so it’s very skeptical of the sort of technocratic economist-as-dentist paradigm. But you’re offering, with the same logic, a counterpoint which is that when we try to build our foundations for economics on this logical deduction, based on the logical structure of the human mind, that can also take us in a direction where we might have the overconfident in our models.

Brad DeLong: Did you receive the gorilla basketball video?

Charlie Deist: I believe so, but describe it for our listeners.

Brad DeLong: It was a psychologist’s experiment. They take the students to the professor to be experimented on and they set them in front of a TV screen and they say, “A basketball team is going to come out, and they’re going to practice, and they’re gonna pass the ball to each other, and your job is to count how many times they pass the ball to each other. And we’re trying to assess how smart people are, and how well they can deal with rapid information, so you’re trying to count accurately. And of course, we’ll judge you as if you get it wrong, et cetera, et cetera.”
And so then the basketball team comes out and they begin passing. And after about a minute, a person in a gorilla suit walks into the field of view from the left, slowly, and in the middle of the field of view, he beats his chest, and then walks off to the right, and then the video ends and people report how many times the ball was passed.

And then the experimenter asks, “Was there anything else about the video that struck you as remarkable?” And recorders of the people, they know, and then they say, “Did you notice the gorilla? The person in the gorilla suit?” And two-thirds of the people say no. That always struck me as a statement, not just about how focused humans are on whatever they’re focused on, but also how much we overestimate how aware of what’s going on in the world around us we can possibly be.

You can get the same experience by going to magic shows, by the way, in terms of just how unaware the people they are conducting their tricks on are—how unable to follow everything that’s going on. Especially, if you’re Penn and Teller and you have three different levels of misdirection there.

Charlie Deist: It’s a fascinating example of how we can have these huge blind spots, and it’s another good lesson about the humility that we should bring to any academic or philosophical enterprise. So thank you, Michael ,for your question, and I believe we have another caller on the line. Let’s hear from John.

John: I have a question for the professor. I assume that housing values and stock values represent much of the wealth in America and those values have fluctuated widely in the last ten years from high to low, now to very high. Has our society gotten wealthier or is this purely a monetary phenomenon? I’ll take the answer off the air.

Brad DeLong: Has our society gotten wealthier? Well, I would say yes and no. I would say the best way to look at it right now is that high stock and housing prices more reflect a low expected private rate of return on investment so that companies that have earnings right now, plus some that don’t like Amazon, plus houses that are built and are providing satisfaction to human beings, have a relatively high price relative to currently produced goods and services because there’s little opportunity to build new buildings and take new machines and use them to create enterprises that will be equally profitable. So that in one sense, it reflects not that we’re rich now, so much as though we’re not expected to become that much richer, faster in the future.

And you can go down to Silicon Valley and find Google’s Chief Economist Hal Varian, and he’ll say that what’s really going on is we’re becoming more prosperous at an amazing rate. Look at how much people like their cell phones, look at access to information and communication. It’s just that these particular sources of human well-being are not ones that are really being created and transferred by the market process. That is, that rather than selling what it produces, which is information, Google is running off of the fumes created by selling your eyeballs to advertisers, and the value it earns by selling your eyeballs to advertisers is much, much less than the value you receive from the access to information that Google gives you.

So, the fact that it isn’t expected that future investments will be very profitable doesn’t mean that they won’t be very productive or very welfare-enhancing, but Hal is a minority point. The majority point is that we seem to have entered a world in which people are less optimistic about the future of economic growth than they were. That’s the thing that’s pushing up housing prices, and currently installed housing prices and current stock prices, because those companies have made their investment.

And what it’s really saying is investments in the past were more valuable than the investments you make today, and that’s why they’re so high.

There’s a second sense in which high housing prices in greater San Francisco are a sign of our poverty. That is, in a better functioning world—in a world without my crazy NIMBY neighbors, there’d be no way that a house like mine—a mile south of the University, a mile north of the Rockridge BART—there’s no way that the neighborhood of Elmwood now would still be composed overwhelmingly of houses like mine rather than of triple-deckers like the small apartment buildings surrounding Harvard, or like the ten-story apartment buildings surrounding Columbia, or like the 25-story stuff surrounding NYU. But [given] the population of greater San Francisco, if San Francisco development in the land of Silicon Valley had followed the standard American pattern, we’d have seen its population grow from five million to ten million over the past 25 years.

Instead, it’s only grown from five to 6.5 million due to NIMBY development restraints.

And that means that the houses that exist are extremely valuable. But the reason they’re so valuable is because they’re so scarce. It’s a monopoly rent. And we’re poorer by the fact that we ought to have 3.5 million dwelling units in greater San Francisco that we do not have because we have seriously screwed up our land-use governance over the past 25 years. So.. all of this is a standard economist’s answer: on the one hand, on the other hand; yes and no.

Charlie Deist: Right. Another axiom that economists are fond of is that there are always trade-offs. One of the points that the Austrians maybe internalized, but maybe still have a ways to go in incorporating into their thinking is the idea that planning has to take place at some level. There’s no such thing as a purely neutral zoning policy, for example, and if we want to come up with the ideal regulations, well, maybe there is no such thing as an ideal regulation, because there will always be trade-offs. So economists have to be the wet blankets to inform people that they can’t have everything that they want.

Sadly we’re coming close to the end of the hour.I’m speaking with professor Brad DeLong. He is at UC Berkeley, where he is the chair of the political economy department. He’s also a visiting scholar at the Federal Reserve Bank in San Francisco and served as deputy assistant secretary at the U.S. Treasury, so he’s an expert in the matters of monetary policy as well as economic history and a variety of other things.

I wish I could pick his brain all morning, but in these last ten minutes, I want to come back to what you were saying about Hal Varian and this world that we’re entering, where more of the value is coming from our smartphone technology, from information technology. On the one hand, this can give us an incredible amount of satisfaction. I’ve found blogs and Twitter and all these things to be a source of incredible education. But at the same time, they can also be… it’s a mixed bag. And in this new economic system, maybe there’s less emphasis on physical stuff and things.

But the Austrian business cycle theory places a big emphasis on these long-term capital malinvestments—these are the areas where we tend to see inflation having the greatest effect. We get inflation from the long-term areas because cheap credit encourages a sort of … Hayek talks about the structure about production, meaning certain investments take longer to materialize … and if we’re injecting money into credit markets first, then you will tend to incentivize people to develop longer-term things.

Is there any kind of application for that model in your mind to the current world that we live in?

Most of these Austrians were writing well before the 1960s. Hayek and Mises were early 20th-century economists. Is there anyone doing work in your mind that brings these ideas into the 21st century? Or, what areas do you think would be most fruitful for someone who is interested in an Austrian approach to focus on, without getting to thick into the weeds?

Brad DeLong: Well, with respect to that of over-investment in the structure production, I think the Minskyist current is winning and is the most productive one to pursue now. That is, if you’ve made investments and if you did make them assuming long-term interest rates will be lower than they in fact are now, and if they are now unprofitable, that doesn’t mean we should shut them down. To say we should shut them down is the sunk cost fallacy, to which I think Hayek and Von Mises fell subject to, to a large degree. What it does mean is that our future investments should be focused on things that have short-term payoff.

Then the question is, “Well, if we shouldn’t shut down long-term investments that are now unprofitable because we’ve already made them (and we might as well get something out of them), why is the reaction to a period of prolonged sub-normal interest rates a depression?”

And the Minskyite answer is that it’s the financial system that messes up. That there’s no good way to quickly allocate the losses. The core of it is the fact that losses have not been allocated, and people wanting to commit new money are scared their new money will go to pay for old losses.
And that, I think, is a very fruitful line of investigation—that it’s not so much a hangover of excess buildings and excess machines, because we can always find uses for buildings and machines. It’s a hangover of bad assets—of bad debt that somebody is going to have to pay, or swallow and eat—and social disagreement over who has to eat them.

So, I would say investigating the structure of bankruptcy and principal–agency finance, and how to quickly resolve situations in which debts go bad is the most fruitful thing to pursue.

If I can also give a commercial?

Charlie Deist: Absolutely.

Brad DeLong: I had dinner last week in San Francisco with a guy named Jerry Taylor, who used to be a vice president at the Cato Institute, and he now has split off and has his own libertarian think tank called the Niskanen Center in Washington D.C., which has a lot of smart people doing a lot of interesting thinking. If you’re looking for a set of people thinking and arguing about libertarian ideas in the 21st Century, and want to put them on your Christmas list, I think the Niskanen Center ought to be first among your choices.

Charlie Deist: Those who listen to this show know that we often host guests from the Cato Institute—sometimes we’ll have a month where half our guests or more will come from Cato. Jerry Taylor, as Brad DeLong is mentioning, is someone who fits that mold, but he has come up with a new intellectual venture. This is the Niskanen Center, and they are producing ideas—would you characterize them as a moderate, centrist, technocratic Libertarian perspective or … what is their byline or subtitle?

Brad DeLong: Their byline is to explode the center and to kind of ask, “What does libertarian mean, not in the 19th, not in the 20th, but in the 21st century?”

Charlie Deist: I had also hoped to ask you—this is one of those questions that I could talk about for hours, and we’ll just have to keep it to a few minutes—but to your mind, what is the different between a liberal and a classical liberal, and do you identify as one or the other, or both?

Brad DeLong: The shortest way I’d put it is:

Suppose you’re locked in a cage and suppose there’s a key that someone outside the cage is holding. The classical liberal would say, “You’re free as long as there’s a key and there’s somebody you could buy it from.” A New Deal liberal would say, “Wait a minute, you’re only free if you have the money to buy the key from the person holding it.”

I would say I’d identify myself as a modern liberal—a New Deal liberal—for that reason, but I’d also say that New Deal liberals, traditionally, have an appalling disregard for the magnitude of government failure and for the damage caused to the economy by rent seeking.

If I find myself in a group of too many social democrats, I’ll actually start calling myself a neoliberal. And if I find myself in a group of too many liberals, I’ll start calling myself a social democrat.

Charlie Deist: So kind of a natural contrarian—I like that.

We’re gonna have to cut off my conversation here. If you are interested in following Brad DeLong’s work, you can find him at He’s also on Twitter at @delong. And once again, I’m Charlie Deist, filling in for Bob, who will be back next week.

We’ve just spent the hour discussing the Austrian theory of the business cycle, in contrast with the Keynesian perspective, as well as the Friedmanite, the Minskyist, and there’s probably many other perspectives that we didn’t get to. This is an area that anyone who’s interested can get online and do their own homework, and form their own conclusions. We’ve been fortunate to have someone who has a nuanced perspective, and can treat this issue with the full intellectual weight it deserves. So stay tuned next week, Bob will be back. And you can always catch this episode and any others at Once again, thanks Brad for taking the time to talk with me.

Brad DeLong: You’re welcome. It’s been a great pleasure.

Charlie Deist: Alright, well have a great rest of your day and to all the listeners out there, enjoy the weekend. We’ll talk to you soon.

What Thinkers Will Define Our Future?: No Longer Fresh at Project Syndicate

Preview of Untitled 3

Over at Project Syndicate: Which Thinkers Will Define Our Future?: BERKELEY – Several years ago, it occurred to me that social scientists today are all standing on the shoulders of giants like Niccolo Machiavelli, John Locke, Adam Smith, Alexis de Tocqueville, Max Weber, and Émile Durkheim.

One thing they all have in common is that their primary focus was on the social, political, and economic makeup of the Western European world between 1450 and 1900. Which is to say, they provide an intellectual toolkit for looking at, say, the Western world of 1840, but not necessarily the Western world of 2016. What will be taught in the social theory courses of, say, 2070? What canon – written today or still forthcoming – will those who end their careers in the 2070s wish that they had used when they started them in the late 2010s? Read MOAR at Project Syndicate

Several years ago I had a thought: it seemed to me that the social sciences we’re still standing on the shoulders of giants—thinkers like Niccolo Machiavelli, John Locke, Adam Smith, Alexis de Tocqueville, Max Weber, Emile Durkheim, and company. You can indeed see far when you stand on the shoulders of a giant. But, unless you adopt a twisty and undignified posture , you see best only in the direction that the giant is looking. And the giants of social science were all looking at the Western European world from 1450 to 1900–looking at its orders and disorders, its structures and changes, and its problems and proposed solutions.

We will very shortly be trying to understand the world of the second fifth of the 21st century. Attempting to do so using an intellectual toolkit that is really focused on 1840 or so seems hazardous. So I asked myself: what will be taught in the social theory courses of, say, 2070? What authors and what toolkits–written today or still unwritten—will those who will end their careers in the 2070s wish that they had focused on when they started their careers in the late 2010s? I started a file folder: “The Social Theory of the Late 21st Century”. I filled it with things when I found something I thought had purchase on something likely to be an important problem over the next couple of generations. I put things in. I took things out. I looked at the folder again last week. The bulk of it consisted of the writings of three people: Alexis to Tocqueville, who wrote in the 1830s and 1840s; John Maynard Keynes, who wrote in the 1920s and 1930s; and Karl Polanyi, who wrote in the 1930s and 1940s.

Now the fact that I appear to think that the cutting-edge social theory of the 2070s will then be composed of books between 125 (Polanyi’s The Great Transformation) and 235 (Tocqueville’s Democracy in America) may simply be a consequence of my own stupidities and biases. But maybe, just maybe, there is something more here.

John Maynard Keynes’s central concerns as he wrote in the 1920s and 1930s were five:

  1. The fragility of our collective prosperity.
  2. The grave tensions between the demons of nationalism and the rootless cosmopolite attitudes needed to support a peaceful and prosperous global society.
  3. The need to figure out how to organize our lives and utilize our prosperity to create a world fit for humans to live good lives in.
  4. The bankruptcy of the ideological nostrums—laissez-faire, spontaneous order, collective cooperation, socialist command-and-control—with which his world was faced.
  5. The delicate and technocratic problems of running a prosperous economy—and the economic, moral, and political disasters that would follow from failing to do so.

But after World War II the problems that had spurred Keynes’s concerns faded into the background. The Thirty Glorious Years after World War II allowed some to believe that they were permanently—rather than temporarily—solved. The subsequent inflation of the 1970s could be blamed on social democratic overreach, and the claim that the Thatcher-Reagan correction had been salutary and effective was highly credible to the moneyed classes that prospered thereafter, and to their tame ideologists who dominated the 1980-2010 public sphere.

But today the problems that had spurred Keynes’s concerns are back.

Karl Polanyi’s central concerns writing in the 1930s and 1940s was that a market society could indeed produce a great deal of material prosperity, but it did so by making people and the fabric of their lives puppets and playthings of mindless market forces, and that people really did not like that. The task was to grasp the prosperity that came with a market economy without suffering the risks of poverty, the destructions of enterprise, and the erosion of community and expectations that came with a market society. If the modern bourgeois order failed at this task, Polanyi warned, fascist and communist authoritarian or totalitarian forces would benefit.

Like Keynes’s problems, Polanyi’s closely-related problems faded into the background for the Thirty Glorious Years immediately after World War II. And in the subsequent Neoliberal Age the argument that the prosperity of a market society was great and worth the price paid was, again, highly credible to the moneyed class and to their tame ideologists.

But today the problems that had spurred Polanyi’s concerns are back.

Alexis de Tocqueville’s central concerns writing in the 1930s and 1940s were about the consequences of the destruction of caste—the big castes of supposedly Frankish nobles of the sword and supposedly Gallo-Roman villeins, bourgeois, and nobles of the robe; and all the little castes with all their little privileges and liberties that gave them autonomy and a measure of control over their lives—and that came, of course, with obligations attached that grew as social status declined. Tocqueville saw this ordered world of societal orders being replaced by societal democracy and formal social equality—in which everyone would be equally free, but would also be at the mercy of society. No privileges or liberties would protect you if you failed to find a counterparty in the market, or ran afoul of the tyranny of the majority, or simply sought some form of direction as you tried to decide who you were supposed to be.

Tocqueville’s concerns never went away. But in Tocqueville’s world the destruction of caste was partial only: Tocqueville wrote for white men who knew their nationality, knew what those caste memberships meant, and knew what privileges they brought. Now, however, the destruction of caste and caste privilege is taking another step forward. Who, we all now ask, are the inhabitants of Birmingham? And we are trying to deal with it and grasp the opportunities for human betterment thereby created.

So my answer is: No, we have not resolved the concerns that spurred Tocqueville, Keynes, and Polanyi to think and write. We and our successors face their problems and opportunities in a transformed and reshaped form. Mark Twain said that history rhymes. And right now it looks as though the rhyme scheme is very strict.

Populist Backlash and Political Economy

Live from High Above the Former Iron Curtain: The very sharp Dani Rodrik:

Dani Rodrik: The Politics of Anger: “Perhaps the only surprising thing about the populist backlash that has overwhelmed the politics of many advanced democracies…

…is that it has taken so long…. Politicians’ unwillingness to offer remedies for the insecurities and inequalities of our hyper-globalized age… create[s] political space for demagogues with easy solutions… Ross Perot… Patrick Buchanan… Donald Trump, Marine Le Pen, and sundry others…. [In] the first era of globalization… mainstream political actors had to downplay social reform and national identity because they gave priority to international economic ties. The response… [was] fatal…. Socialists and communists chose social reform, while fascists chose national assertion. Both paths led away from globalization to economic closure (and far worse). Today’s backlash most likely will not go quite so far….

Still, the conflicts between a hyper-globalized economy and social cohesion are real, and mainstream political elites ignore them at their peril…. The internationalization of markets for goods, services, and capital drives a wedge between the cosmopolitan, professional, skilled groups that are able to take advantage of it and the rest of society… an identity cleavage, revolving around nationhood, ethnicity, or religion, and an income cleavage, revolving around social class. Populists derive their appeal from one or the other…. You can barely make ends meet? It is the Chinese who have been stealing your jobs. Upset by crime? It is the Mexicans…. Terrorism? Why, Muslims…. Political corruption? What do you expect… [from] big banks?… Establishment politicians are compromised… by their central narrative… [of] helplessness… [which] puts the blame… on technological forces… and globalization… as inexorable…. Mainstream politicians… [must] offer serious solutions…. The New Deal, the welfare state, and controlled globalization (under the Bretton Woods regime)… gave market-oriented societies a new lease on life… not tinkering and minor modification of existing policies that produced these achievements, but radical institutional engineering…

I find it alarming that here we are, more than one a half decades into the twenty-first century, and the wisdom and true knowledge that is state-of-the-art as far as political economy is concerned is still to be found in the writings of John Maynard Keynes and Karl Polanyi…

(1) Keynes taught that rich, free, capitalist societies could not survive without full employment–without giving everyone a useful, dignified, and prosperous economic role in society:

Inflation is unjust and Deflation is inexpedient…. It is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualist Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual entrepreneur, presumes a stable measuring-rod of value, and cannot be efficient—perhaps cannot survive—without one. For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision. We can no longer afford to leave it in the category of… matters… settled by natural causes… the resultant of the separate action of many individuals acting independently, or require a Revolution to change them…

(2) Keynes taught that rich, free, capitalist societies could not survive without promising stability in the rules-of-the-game–that the wealth and income you earned by following the rules would be yours, and not taken away by sinister economic processes you could not understand that did things like, for example, debauch the currency:

The problem of the re-inauguration of the perpetual circle of production and exchange in foreign trade leads me to a necessary digression on the currency situation of Europe. Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens… not only confiscate, but… confiscate arbitrarily…. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution…. The real value of the currency fluctuates wildly from month to month, [and] all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery. Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. In the latter stages of [World War I] all the belligerent governments practised, from necessity or incompetence, what a Bolshevist might have done from design…

(3) Keynes taught that proper government policy could attain those two ends–full employment and price stability–with only minor tinkering and adjustment to make sure that the automobile that was the economy actually would start when you turned the key: all that was required was proper monetary policy, with (probably) a somewhat comprehensive socialization of public and private investment:

The foregoing theory is moderately conservative in its implications…. The State will have to exercise a guiding influence on the propensity to consume… through… taxation… fixing the rate of interest, and… other ways…. It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. But beyond this no obvious case is made out for a system of State Socialism…

(4) Keynes taught that if those conditions were satisfied, the task of guiding economic destinies could be confidently and safely left to a sober bourgeoisie interested in accumulation:

If we have dealt otherwise with the problem of thrift, there is no objection to be raised against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition respectively… no more reason to socialise economic life than there was before… no reason to suppose that the existing system seriously misemploys the factors of production which are in use…. Thus I agree with Gesell that the result of filling in the gaps in the classical theory is not to dispose of the ‘Manchester System’, but to indicate the nature of the environment which the free play of economic forces requires…. There will still remain a wide field for the exercise of private initiative and responsibility. Within this field the traditional advantages of individualism will still hold good.

Let us stop for a moment to remind ourselves what these advantages are. They are partly advantages of efficiency–the advantages of decentralisation and of the play of self-interest… even greater, perhaps, than the nineteenth century supposed…. Above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future.

Whilst, therefore, the enlargement of… government… in… adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it… as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…

(5) whose efforts would redound to the benefit of all:


(6) and that there was little need to fear an extravagant plutocracy of aristocratic parasites:

There is, however, a second, much more fundamental inference from our argument which has a bearing on the future of inequalities of wealth; namely, our theory of the rate of interest. The justification for a moderately high rate of interest has been found hitherto in the necessity of providing a sufficient inducement to save. But we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest, provided that we do not attempt to stimulate it in this way beyond the point which corresponds to full employment. Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment.

There can be no doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto; and, so far as one can guess at the schedules of the marginal efficiency of capital corresponding to increasing amounts of capital, the rate of interest is likely to fall steadily, if it should be practicable to maintain conditions of more or less continuous full employment unless, indeed, there is an excessive change in the aggregate propensity to consume (including the State).

I feel sure that the demand for capital is strictly limited in the sense that it would not be difficult to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure. This would not mean that the use of capital instruments would cost almost nothing, but only that the return from them would have to cover little more than their exhaustion by wastage and obsolescence together with some margin to cover risk and the exercise of skill and judgment. In short, the aggregate return from durable goods in the course of their life would, as in the case of short-lived goods, just cover their labour costs of production plus an allowance for risk and the costs of skill and supervision.

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.

Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward…

(7) Rather, instead, in a century or so, the economic problem would be largely solved:

I draw the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not-if we look into the future-the permanent problem of the human race.

Why, you may ask, is this so startling? It is startling because-if, instead of looking into the future, we look into the past-we find that the economic problem, the struggle for subsistence, always has been hitherto the primary, most pressing problem of the human race-not only of the human race, but of the whole of the biological kingdom from the beginnings of life in its most primitive forms. Thus we have been expressly evolved by nature-with all our impulses and deepest instincts-for the purpose of solving the economic problem. If the economic problem is solved, mankind will be deprived of its traditional purpose. Will this be a benefit? If one believes at all in the real values of life, the prospect at least opens up the possibility of benefit. Yet I think with dread of the readjustment of the habits and instincts of the ordinary man, bred into him for countless generations, which he may be asked to discard within a few decades…. Thus for the first time since his creation man will be faced with his real, his permanent problem-how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well…. I feel sure that with a little more experience we shall use the new-found bounty of nature quite differently from the way in which the rich use it to-day, and will map out for ourselves a plan of life quite otherwise than theirs….

When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession -as distinguished from the love of money as a means to the enjoyments and realities of life -will be recognised for what it is, a somewhat disgusting morbidity, one of those semicriminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard….

We shall once more value ends above means and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day virtuously and well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin.

But beware! The time for all this is not yet. For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into daylight…

Polanyi’s teaching was less hopeful, less practical, and less visionary–and not quite parallel to Keynes’s. It was that there were three things, land, labor, and finance, that should not be turned into “commodities” and thus subjected to allocation by the laws of the self-regulating market economy. And, Polanyi argued, if they were turned into “commodities” and thus subjected to allocation by the laws of the self-regulating market economy, the result would be disastrous:

Labor is only another name for a human activity which goes with life itself, which in its turn is not produced for sale but for entirely different reasons, nor can that activity be detached from the rest of life, be stored or mobilized; land is only another name for nature, which is not produced by man; actual money, finally, is merely a token of purchasing power which, as a rule, is not produced at all, but comes into being through the mechanism of banking or state finance…

(1) Finance could not, in Polanyi’s view, be allowed to be the plaything of the self-regulating market for what were essentially Keynesian reasons–the system could not be stable:

The market administration of purchasing power would periodically liquidate business enterprise, for shortages and surfeits of money would prove as disastrous to business as floods and droughts were in primitive society…


Even capitalist business itself had to be sheltered from the unrestricted working of the market mechanism. This should dispose of the suspicion which the very term “man” and “nature” sometimes awaken in sophisticated minds, who tend to denounce all talk about protecting labor and land as the product of antiquated ideas if not as a mere camouflaging of vested interests. Actually, in the case of productive enterprise as in that of man and nature the peril was real and objective.

The need for protection arose on account of the manner in which the supply of money was organized under a market system. Modern central banking, in effect, was essentially a device developed for the purpose of offering protection without which the market would have destroyed its own children, the business enterprises of all kinds…. If profits depend upon prices, then the monetary arrangements upon which prices depend must be vital to the functioning of any system motivated by profits…. If the price level was falling for monetary reasons over a considerable time, business would be in danger of liquidation accompanied by the dissolution of productive organization and massive destruction of capital. Not low prices, but falling prices were the trouble. Hume became the founder of the quantity theory of money with his discovery that business remains unaffected if the amount of money is halved since prices will simply adjust to half their former level. He forgot that business might be destroyed in the process….

(2) Land could not, in Polanyi’s view, be allowed to be the plaything of the self-regulating market for essentially sociological reasons: where people lived determined who they were, and a self-regulating market that told people they could no longer afford to live in the community where they thought they belonged would trigger such a strong sense of communal injustice to spark the chaos of revolution:

Commercialization of the soil was only another name for the liquidation of feudalism which started in Western urban centers as well as in England in the fourteenth century and was concluded some five hundred years later in the course of the European revolutions, when the remnants of villeinage were abolished. To detach man from the soil meant the dissolution of the body economic into its elements so that each element could fit into that part of the system where it was most useful….

Some of this was achieved by individual force and violence, some by revolution from above or below, some by war and conquest, some by legislative action, some by administrative pressure, some by spontaneous small-scale action of private persons over long stretches of time. Whether the dislocation was swiftly healed or whether it caused an open wound in the body social depended primarily on the measures taken to regulate the process….

The inertia of the common law was now deliberately enhanced by statutes expressly passed in order to protect the habitations and occupations of the rural classes against the effects of freedom of contract. A comprehensive effort was launched to ensure some degree of health and salubrity in the housing of the poor, providing them with allotments, giving them a chance to escape from the slums and to breathe the fresh air of nature, the “gentleman’s park.” Wretched Irish tenants and London slum-dwellers were rescued from the grip of the laws of the market by legislative acts designed to protect their habitation against the juggernaut, improvement. On the Continent it was mainly statute law and administrative action that saved the tenant, the peasant, the agricultural laborer from the most violent effects of urbanization. Prussian conservatives such as Rodbertus, whose Junker socialism influenced Marx, were blood brothers to the Tory-Democrats of England…

(3) Labor could not, in Polanyi’s view, be allowed to be the plaything of the self-regulating market for the same essentially psychological reasons for which Keynes condemned inflation: a self-regulating market that told people they could no longer afford to practice the occupations they thought were theirs belonged would trigger such a strong sense of personal injustice–the same injustice Keynes saw as produced by wealth-confiscation-via-inflation–that it, too, would spark the chaos of revolution:

To allow the market mechanism to be the sole director of the fate of human beings… would result in the demolition of society. For the alleged commodity “labor power” cannot be shoved about, used indiscriminately, or even left unused without affecting the human being who happens to be [its] bearer…. In disposing of a man’s labor power the system would, incidentally, dispose of the physical, psychological, and moral entity “man” attached to the tag. Robbed of the protective covering of cultural institutions, human beings would perish from the effects of social exposure [and] social dislocation…

Polanyi calls the fixing of these problems generated by utopian and impractical attempts to turn over all authority to a self-regulating market by the name “socialism”:

Socialism is, essentially, the tendency inherent in an industrial civilization to transcend the self-regulating market by consciously subordinating it to a democratic society. It is the solution natural to industrial workers who see no reason why production should not be regulated directly and why markets should be more than a useful but subordinate trait in a free society. From the point of view of the community as a whole, socialism is merely the continuation of that endeavor to make society a distinctively human relationship of persons…

For both Keynes and Polanyi, social insurance in the form of progressive taxes, a universal basic income, and government provision of public goods plus private necessities would help, but that would not be enough to do the job. Also essential are: first, useful employment and the resulting honorable and dignified role in society; second, justice in the sense that playing by the rules of the economic game calls forth the expected rewards; and, third, communal stability in the sense that should people’s lives be transformed in place, community, and occupation it is by being pulled out of old ruts by brilliant opportunities locating in other places, living in other communities, and practicing other occupations–not being pushed out by regional or sectoral economic collapse, or perhaps by having one’s community transformed too rapidly around one.

There is a pronounced particularistic-cosmopolitan tension here. We economists do not like it at all when the opportunities for upward mobility for those who chose to be born in the wrong country or to the wrong parents are hobbled by restrictions on migration and trade. We economists do not like those who try to mobilize particularistic and nationalistic energies to the service of what look like negative-sum policies. This has been true for a long time. We economists, after all, looked at American labor’s early-1990s opposition to NAFTA’s hoped-for expansion of economic opportunity in NAFTA–the opposition that arose not because people thought NAFTA would be bad but because they thought it would be good for the working class of Mexico–and felt the same disgust then as Dani Rodrik does now when he looks at today’s “Donald Trump, Marine Le Pen, and sundry others…” But Dani Rodrik wisely warns us Rootless Cosmopolites that we dare not come down entirely on the cosmopolitan side. Let me repeat him:

Establishment politicians are compromised… by their central narrative… [of] helplessness… [which] puts the blame… on technological forces… and globalization… as inexorable…. Mainstream politicians… [must] offer serious solutions… not tinkering and minor modification… but radical institutional engineering…

But what engineering? To create what institutions?

  • Patrick Iber and Mike Konczal: Karl Polanyi for President
  • John Maynard Keynes (1919): The Economic Consequences of the Peace
  • John Maynard Keynes (1924): A Tract on Monetary Reform
  • Karl Polanyi: [The Great Transformation
  • Dani Rodrik: The Politics of Anger](

Today’s Economic History: John Maynard Keynes (1931): Unemployment as a World Problem

Unemployment as a World Problem


I. We are today in the middle of the greatest economic catastrophe—the greatest catastrophe due almost entirely to economic causes—of the modern world. I am told that the view is held in Moscow that this is the last, the culminating crisis of capitalism and that our existing order of society will not survive it. Wishes are fathers to thoughts. But there is, I think, a possibility—I will not put it higher than that—that when this crisis is looked back upon by the economic historian of the future it will be seen to mark one of the major turning-points. For it is a possibility that the duration of the slump may be much more prolonged than most people are expecting and that much will be changed, both in our ideas and in our methods, before we emerge. Not, of course, the duration of the acute phase of the slump, but that of the long, dragging conditions of semislump, or at least sub-normal prosperity which may be expected to succeed the acute phase. Not more than a possibility, however. For I believe that our destiny is in our own hands and that we can emerge from it if only we choose—or rather if those choose who are in authority in the world.

My main theme is to be an attempt to analyze the originating causes of the slump. For unless we understand these—unless our diagnosis is correct—I do not see how we can hope to find the cure. I shall make use of my own theories of monetary causation and therefore I may, perhaps, assume implicitly some measure of familiarity with them; but I shall try not to assume so much as to embarrass those who are not acquainted with them.

I see no reason to be in the slightest degree doubtful about the initiating causes of the slump. Let us consider a brief history of events beginning about 1924 or 1925. By that time or shortly afterward the perturbations which had, perhaps inevitably, ensued on the war and the treaty of peace and the readjustments of economic relations between different countries seemed to have about run their course. Confidence was more or less restored; the mechanism of international lending was functioning freely; and while several European countries still had serious difficulties to overcome, for the world as a whole conditions seemed to be set fair.

It was widely believed that the general restoration of the gold standard would complete the edifice of prosperity and that an indefinitely long period of ever increasing economic well-being was in front of the progressive industrial nations of the world. So, apart from certain local domestic troubles in Great Britain (and I am not dealing except incidentallv with the British problem), was indeed the case for some four or five years. Now what was the leading characteristic of this period? Where and how were the seeds of subsequent trouble being sown?

The leading characteristic was an extraordinary willingness to borrow money for the purposes of new real investment at very high rates of interest—rates of interest which were extravagantly high on pre-war standards, rates of interest which have never in the history of the world been earned, I should say, over a period of years over the average of enterprise as a whole. This was a phenomenon which was apparent not, indeed, over the whole world but over a very large part of it.

Let us consider the United States first, because the United States has held throughout the key position. The investment activity in this country was something prodigious and incredible. In the four years 1925-28 the total value of new construction in the United States amounted to some $38,000,000,000. This was—if you can credit it—at an average rate of $800,000,000 a month for forty-eight months consecutively. It was more than double the amount of construction in the four years 1919-22, and, I may add, much more than double the amount that is going on now.

Nor was this the whole of the American story. The growth of the instalment system, which represents a sort of semi-investment, was going on pari passu. And, more important still, the United States was a free purchaser of all kinds of foreign bonds, good, bad, and indifferent—a free lender for investment purposes,that is to say, to the rest of the world. To an important extent the United States was acting, in this generous foreign-loan policy, as a conduit pipe for the savings of the more cautious Europeans, who had less confidence in their own prosperity than America had; so that the foreign-bond issues were often largely financed out of short- term funds which the rest of the world was, for considerations of safety or liquidity, depositing in New York.

But Great Britain was also lending on a substantial scale. Altogether it is estimated that in 1925 the net foreign lending of capital-exporting countries amounted to about $2,300,000,000. Naturally the result was to facilitate investment schemes over a wide area, especially in South America. All the countries of South America found themselves in a position to finance every kind of scheme, good or bad.

A comparatively small country like the republic of Colombia, to give an example, found itself able to borrow—I forget the exact figure—something approaching $200,000,000 in New York within a brief space of time. Rates of interest were high indeed. But the lender was willing and so was the borrower. Germany, as we all know, was another country that was both able and willing to borrow on a gigantic scale; indeed, in 1925 she alone borrowed sums approaching $1,000,000,000.

This free borrowing was duly accompanied by capital expansion programs. In France there was long-continued building activity; in Germany industry was reconstructed and municipal enterprise was conducted on an extravagant scale; in Spain the dictatorship embarked on enormous public works; indeed, in almost every European country a large force of labor and plant was being employed on construction, thus consuming, but not producing, consumption goods. The same was true over the whole of South America and in Australia. Even in China the prolonged civil war involved great expenditures otherwise than on producing consumption goods—which, so long as it is going on, is analytically identical with investment, even though its future fruits are less than nothing. In Russia, at the same time, immense efforts were being made to direct an unusually large proportion of the national forces to works of capital construction.

There was really only one important partial exception, namely, Great Britain. In that country investment continued throughout on a somewhat moderate scale. Road development and housing programs did something to keep up investment. But the return to the gold standard and the relative decline of the British staple export trades seriously cut down her ability to carry on foreign investment up to anything like the same proportion of her savings as had been the case from 1900 to 1914; and for various reasons home investment was not on a sufficient scale to absorb the whole of the balance. This, I am sure, is the fundamental reason why we in Great Britain were feeling depression before the rest of the world. We were not participating in the enormous investment boom which the rest of the world was enjoying. Our savings were almost certainly in excess of our investment. In short, we were suffering a deflation.

While some part of the investment which was going on in the world at large was doubtless ill-judged and unfruitful, there can, I think, be no doubt that the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history. The expansion centered round building, the electrification of the world, and the associated enterprises of roads and motor cars. In those five years an appreciable change was effected in the housing, the power plant, and the transport system of a large part of the world.

But it was not unduly specialized. Almost every department of capital development took its share. The capacity of the world to produce most of the staple food-stuffs and raw materials was greatly expanded; machinery and new techniques directed by science greatly increased the output of all the metals, rubber, sugar, the chief cereals, etc. The economic section of the League of Nations has published the figures. In the three years 1925-28 the output of foodstuffs and raw materials in the world as a whole increased by no less than 8 per cent and the output of manufactured goods rose by 9 per cent, that is to say, at least as fast as that of raw materials. Progress was especially rapid in Europe where the increase in output was probably greater than even in North America.

Doubtless, as was inevitable in a period of such rapid change, the rate of growth of some individual commodities could not always be in just the appropriate relation to that of others. But, Onthe whole, I see little sign of any serious want of balance such as is alleged by some authorities. The rates of growth of construction capital such as houses, of capital for manufacturing production, and of capital for raw material production; or again those of foodstuffs, of raw materials, of manufactures, of activities demanding personal services seem to me, looking back, to have been in as good a balance as one could have expected them to be. A very few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado where all our reasonable economic needs would be satisfied.

It is not necessary for my present purpose to decide exactly how far this investment boom was inflationary in the special sense which I have given to that term—whether, in other words, it was balanced by saving or whether it was financed by surplus profits obtained by selling output at a price which was inflated above the normal costs of production. I am inclined to the view that the part played by inflation was surprisingly small, and that savings kept pace with investment to a remarkable degree. In fact, there was very little rise in the price of the commodities covered by index numbers.

This does not prove that there was no inflation: first, because we have no proper consumption index numbers, so that these might, if we had them, show a different result; second, because the period was one of rapidly increasing efficiency, and it may be that while the price of many commodities was unchanged, too small a proportion of the increasing product was accruing to the factors of production and too much to the entrepreneurs, which would, according to my definition, be inflationary. Probably in some places and at some dates inflation was definitely present. But I think that the evidence suggests that savings were in fact abundantly available and were adequate to finance a very large part of the investment which was going on. This conclusion, if it is correct, will be important in the sequel.

What was it, then, that brought all this fruitful activity to a sudden termination? This brings me to the second part of my discourse.

II. It seems an extraordinary imbecility that this wonderful outburst of productive energy should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man’s speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a “prolonged liquidation” to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanation of the current business losses, of the reduction of output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity, except in so far as it may, by some lucky chance, clear the boards for the recovery of investment.

I suggest to you, therefore, that the questions to which we have to bend our intelligences are the causes of the collapse of investment and the means of reviving investment. We cannot hope either to prophesy or to limit the duration of the slump except as the result of our understanding of these phenomena.

Looking back, it is now clear that the decline of investment began early in 1929, that it preceded (and, according to my theory, was the cause of) the decline in business profits, and that it had gathered considerable momentum prior to the Wall Street slump in the autumn of 1929.

Why did investment fall away? Probably it was due to a complex of causes:

1.Too high a rate of interest was being paid. Experience was beginning to show that borrowers could not really hope to earn on new investment the rates which they had been paying.

  1. Even if some new investment could earn these high rates, in the course of time all the best propositions had got taken up, and the cream was off the business. In other words, as one would expect, the increased supply of capital goods meant that the rate of interest was due for a fall if further expansion was to be possible.
  2. But just at this moment, so far from falling, the rate of interest was rising. The efforts of the Federal Reserve banks to check the boom on Wall Street was making borrowing exceedingly dear to all kinds of borrowers.
  3. A further consequence of the very dear money in the United States was to exercise a drag on the gold of the rest of the world and hence to cause a credit contraction everywhere.
  4. And a third consequence was the unwillingness of American investors to buy foreign bonds since they found speculation in their own common stocks much more exciting. In 1929 net purchases of this character by the United States fell to about a quarter of what they had been in the previous year, and in 1930 they fell so low as to be negligible.

I need hardly remind you how much fixed investment fell away in the United States. If we take the familiar Dodge figures for 1925 as our index of 100, we find a fall to 88 in 1929 and to 64 in 1930, while at the present time the figures are still lower. But this falling-away of fixed investment, while most marked, perhaps, in the United States, was not confined to that country. The complex of circumstances which I have outlined combined to cause a very marked diminution in the rate of investment all over the world.

Once this decline was started on a significant scale, it is exceedingly easy to see (on my way of looking at the matter) how the mere fact of a decline precipitated a further decline, for the high level of profits began to fall away, the prices of commodities inevitably declined, and these things brought with them a series of further consequences:

  1. The decline in output brought a disinvestment in working capital. In the United States this was on a huge scale.
  2. The decline in profit diminished the attractions of all kinds of investment.
  3. The fall in prices and the cessation of lending destroyed the credit of overseas borrowers, and made borrowing dearer for them just at the moment when they needed cheaper loans if they were to continue.

This decline has continued down to the present time, and so far as fixed investment is concerned, the volume of new investment must be today, taking the world as a whole, at the lowest figure for very many years.

Here I find—and I find without any doubts or reserves whatsoever—the whole of the explanation of the present state of affairs. But there is, I am afraid you may say, one very serious gap in my argument. I have been making all through a tacit assumption. And for those who do not accept this assumption, the conclusions must be unconvincing.

My assumption is this: I have taken it for granted so far that if investment falls off, then of necessity the level of business profits falls away also. Grant me this and the rest, I think, follows. Now I believe this to be true, and I have set forth in detail the reasons for my belief in the first volume of my recently published Treatise on Money. But the argument is not easy, and I cannot claim that it is yet part of the accepted body of economic thought.

It will be my duty, therefore, to endeavor in my next lecture to give you an outline of this reasoning in terms as well adapted as I can find for the medium of oral exposition. I shall then, in the light of this, pass on to what I have to say of a constructive character.


I have said that it is easy on my theory of the causation of these things to see why a severe decline in the volume of investment should have produced the results that we see around us in the world today. This theory, however, will not be familiar to many of you; and I must, if my argument is to be complete and intelligible, endeavor to set forth for you at least an outline of it. You must, therefore, forgive me a somewhat abstract discussion. Those who may wish to pursue the matter further I must refer to my Treatise on Money. But I will try, though it be at the risk of straining your attention, to put the gist of the matter very briefly as follows.

Entrepreneurs pay out in salaries, wages, rents, and interest certain sums to the factors of production which I shall call their “costs of production.” Some of these entrepreneurs are producing capital goods, some of them are producing consumption goods. These sums, these costs of production, represent in the aggregate the incomes of the individuals who own or are the factors of production.

These individuals in their capacity of consumers expend part of these incomes on buying consumption goods from the entrepreneurs; and another part of their incomes, which part we shall call their savings, they put back, as we may express it, into the financial machine—that is to say, they deposit it with their banks or buy stock-exchange securities or real estate or repay instalments in respect of purchases previously made or the like.

At the same time the financial machine will be enabling a different set of people to order and pay for various kinds of currently produced capital goods from the entrepreneurs who produce this class of goods, such as buildings, factories, machines, equipment for transport, and public-utility enterprises and the like; and the aggregate of expenditures of this kind I find it convenient to call the “value of current investment.”

Thus there are two streams of money flowing back to the entrepreneurs, namely, that part of their incomes which the public spend on consumption and those expenditures on the purchases of capital goods which I have called the value of current investment. These two amounts added together make up the receipts or sale proceeds of the entreprqneurs.

Now the profitableness of business as a whole depends, and can depend, on nothing but the difference between the sale proceeds of the entrepreneurs and their costs of production. If more comes back to them as sale proceeds than they have expended in costs of production, it follows that they must be making a profit. And, equally, if less comes back to them than they have paid out, they must be making a loss. I am speaking all the time, remember, of entrepreneurs as a whole. As between individual entrepreneurs, some will at all times be doing better than the average and some worse.

Now for my equation, a very simple one, which gives, to my thinking, the clue to the whole business:

The costs of production of the entrepreneurs are equal to the incomes of the public. Now the incomes of the public are, obviously, equal to the sum of what they spend and of what they save. On the other hand, the sale proceeds of the entrepreneurs are equal to the sum of what the public spend on current consumption and what the financial machine is causing to be spent on current investment.

Thus the costs of the entrepreneurs are equal to what the public spend plus what they save; while the receipts of the entrepreneurs are equal to what the public spend plus the value of current investment. It follows, if you have been able to catch what I am saying, that when the value of current investment is greater than the savings of the public, the receipts of the entrepreneurs are greater than their costs, so that they make a profit; and when, on the other hand, the value of current investment is less than the savings of the public, the receipts of the entrepreneurs will be less than their costs, so that they make a loss.

That is my secret, the clue to the scientific explanation of booms and slumps (and of much else, as I should claim) which I offer you. For you will perceive that when the rate of current investment increases (without a corresponding change in the rate of savings) business profits increase. Moreover,the affair is cumulative. For when business profits are high, the financial machine facilitates increased orders for and purchases of capital goods, that is, it stimulates investment still further; which means that business profits are still greater; and soon. In short, a boom is in full progress. And contrariwise when investment falls off. For unless savings fall equally, which is not likely to be the case, the necessary result is that the profits of the business world fall away. This in turn reacts unfavorably on the volume of new investment; which causes a further decline in business profits. In short, a slump is upon us.

The whole matter may be summed up by saying that a boom is generated when investment exceeds saving and a slump is generated when saving exceeds investment. But behind this simplicity there lie, I am only too well aware, many complexities, many pitfalls, many opportunities for misunderstanding. You must excuse me if I slide over these, for it would take me weeks to expound them fully.

Indeed, let me simplify further, for I should like for a moment to leave the variations in saving out of my argument. I shall assume that saving either varies in the wrong direction (which may, in fact, occur, especially in the early stages of the slump, since the fall in stock-exchange values as compared with the boom may by depreciating the value of people’s past savings increase their desire to add to them) or is substantially unchanged, or if it varies in the right direction, so as partly to compensate changes in investment, varies insufficiently (which is likely to be the case except perhaps when the community is, toward the end of a slump, very greatly impoverished indeed). That is to say, I shall concentrate on the variability of the rate of investment. For that is, in fact, the element in the economic situation which is capable of sudden and violent change. In the actual circumstances of the present hour that is the element which, according to common observation, has indeed suffered a sudden and violent change. And nothing, obviously, can restore employment which does not first restore business profits. Yet nothing, in my judgment, can restore business profits which does not first restore the volume of investment, that is to say (in other words), the volume of orders for new capital goods. (For the only theoretical alternative would be a large increase of expenditures by the public at the expense of their savings, an extravagance campaign, which at a time when everyone is nervous and uncertain and sees the value of his stocks and shares depreciating is most unlikely to occur, whether it is desirable or not.)

In the past it has been usual to believe that there was some preordained harmony by which saving and investment were necessarily equal. If we intrusted our savings to a bank, it used to be said, the bank will of course make use of them, and they will duly find their way into industry and investment. But unfortunately this is not so. I venture to say with certainty that it is not so. And it is out of the disequilibriums of savings and investment, and out of nothing else, that the fluctuations of profits, of output, and of employment are generated.

What sorts of circumstances are capable of occurring which would be of a tendency to bring the slump to an end?

It is important to notice that so long as output is declining, the effect of any decline of fixed investment is aggravated by disinvestment in working capital. Rut this continues only so long as output continues to decline. It ceases as soon as output ceases to decline further even though the level at which output is steady is a very low one. And as soon as output begins to recover, even though it still remains at a very low level, the tide is turned and the decline in fixed investment is partly offset by increased investment in working capital.

Now there is a reason for expecting an equilibrium point of decline to be reached. A given deficiency of investment causes a given decline of profit. A given decline of profit causes a given decline of output. Unless there is a constantly increasing deficiency of investment, there is eventually reached, therefore, a sufficiently low level of output which represents a kind of spurious equilibrium.

There is also another reason for expecting the decline to reach a stopping-point. For I must now qualify my simplifying assumption that only the rate of investment changes and that the rate of saving remains constant. At first, as I have said, the nervousness engendered by the slump may actually tend to increase saving. For saving is often effected as a guide against insecurity. Thus savings may decrease when stock markets are soaring and increase when they are slumping. Moreover, for the salaried and fixed-income class of the community the fall of prices will increase their margin available for saving. But as soon as output has declined heavily, strong forces will be brought into play in the direction of reducing the net volume of saving.

For one thing the unemployed will, in their effort not to allow too great a decline in their established standard of life, not only cease to save but will probably be responsible for much negative saving by living on their own previous savings and those of their friends and relations. Much more important, however, than this is likely to be the emergence of negative saving on the part of the government, whether by diminished payments to sinking funds or by actual borrowing, as is now the case in the United States. In Great Britain, for example, the dole to the unemployed, largely financed by borrowing, is now at the rate of $500,000,000 a year—equal to about a quarter of the country’s estimated rate of saving in good times.

In the United States the Treasury deficit to be financed by borrowing is put at $1,000,000,000. These expenditures are just as good in their immediate effects on the situation as would be an equal expenditure on capital works; the only difference—and an important one enough—is that in the former cases we have nothing to show for it afterwards.

Let me illustrate this by figures for the United States which are intended to be purely illustrative, though I have chosen them so as to be, perhaps, not too remote from the facts. Let us suppose that at the end of 1928 American investment was at the rate of $10,000,000,000 a year, while the national savings were $9,000,000,000. This meant, as my fundamental analysis shows, abnormal profits to American business at the rate of $1,000,000,000. Now let us suppose a decline in investment to $9,000,000,000. The exceptional profits are now obliterated. Next a further fall to$5,000,000,000. This means that the exceptional profits are not only obliterated, but that their place is taken by very large abnormal losses, namely, $4,000,000,000, so long as savings continue at $9,000,000,000. These developments naturally cause a steady decline in output, which aggravates the loss by bringing with it a disinvestment in working capital.

Let us suppose that the disinvestment in working capital is at the rate of $1,500,000,000 a year. As long as this is going on, the rate of net investment may fall as low as $3,500,000,000. This means (or would mean if other factors remained unchanged) business receipts (including agriculture, of course) of $5,500,000,000 below normal, and output will settle down to the level which just shows a margin over prime cost even when aggregate receipts are this much short of normal profits. But by this time the situation itself will have bred up some remedial factors. Let us suppose that a government deficit of $1,000,000,000 has developed and that saving by the public has fallen off by $1,000,000,000.

Moreover, as soon as output ceases to fall further, disinvestment in working capital will cease. Thus the falling-off in business receipts below normal will no longer be $5,500,000,000 but only $2,000,000,000 ($1,000,000,000 relief from government deficit, $1,000,000,000 from diminished saving, and $1,500,000,000 from the cessation of disinvestment in working capital). This means that output is below what is justified by the new level of business receipts. Consequently it rises again. This rise means reinvestment in working capital, and business receipts may, for a time and so long as this reinvestment is going on, recover almost to normal.

Nevertheless, if the nation’s savings stand at $9,000,000,000, granted a normal level of output and employment, then, so long as the rate of long-term interest in conjunction with other factors is too high to allow of more than $5,000,000,000 expenditure on fixed investment, a recovery staged along the foregoing lines is bound to be an illusion and a disappointment. For after it has proceeded a certain length, there is bound to be reaction and a renewed slump. Indeed, the figures accurately appropriate to the illustration may be such that the extent of the recovery will be comparatively slight.

There can, therefore, I argue, be no secure basis for a return to an equilibrium of prosperity except a recovery of fixed investment to a level commensurate with that of the national savings in prosperous times.


I. Whether or not my confidence is justified, I feel, then, no serious doubt or hesitation whatever as to the causes of the world-slump. I trace it wholly to the breakdown of investment throughout the world. After being held by a variety of factors at a fairly high level during most of the post-war period, the volume of this investment has during the past two and a half years suffered an enormous decline—a decline not fully compensated as yet by diminished savings or by government deficits.

The problem of recovery is, therefore, a problem of re-establishing the volume of investment. The solution of this problem has two sides to it: on the one hand, a fall in the l long-term rate of interest so as to bring a new range of propositions within the practical sphere; and, on the other hand, a return of confidence to the business world so as to incline them to borrow on the basis of normal expectations of the future. But the two aspects are by no means disconnected. For business confidence will not revive except with the experience of improving business profits. And, if I am right, business profits will not recovery except with an increase of investment. Nevertheless the mere reaction from the bottom and the feeling that it may be no longer prudent to wait for a further fall will be likely, perhaps in the near future, to bring about some modest recovery of confidence. We need, therefore, to work meanwhile for a drastic fall in the long-term rate of interest so that full advantage may be taken of any recovery of confidence.

The problem of recovery is also, in my judgment, indissolubly bound up with the restoration of prices to a higher level, although if my theory is correct this is merely another aspect of the same phenomenon. The same events which lead to a recovery in the volume of investment will inevitably tend at the same time toward a revival of the price level. But inasmuch as the raising of prices is an essential ingredient in my policy I had better pause perhaps to offer some justification of this before I proceed
to consider the ways and means by which the volume of investment and at the same time the level of prices can be raised.

Unfortunately there is not complete unanimity among the economic doctors as to the desirability of raising the general price level at this phase of the cycle. Dr. Sprague, for example, in an address made recently in London which attracted much attention, declared it to be preferable that:

manufactured costs and prices should come down to equilibrium level with agricultural prices rather than that we should try to get agricultural prices up to an equilibrium level with the higher prices of manufactured goods.

For my own part, however, I dissent very strongly from this view and I should like, if I could, to provoke vehement controversy—a real discussion of the problem—in the hope’ that out of the clash of minds something useful might emerge. Until we have definitely decided whether or not we should wish prices to rise we are drifting without clear intentions in a rudderless vessel.

Do we, then, want prices to rise back to a parity with what, a few months ago, we considered to be the established levels of our salaries, wages, andincome generally? Or do we want to reduce our incomes to a parity with the existing level of the wholesale prices of raw commodities? Please notice that I emphasize the word “want,” for we shall confuse the argument unless we keep distinct what we want from what we think we can get. My own conclusion is that there are certain fundamental reasons of overwhelming force, quite distinct from the technical considerations tending in the same direction, which I have already indicated and to which I shall return later, for wishing prices to rise.

The first reason is on grounds of social stability and concord. Will not the social resistance to a drastic downward readjustment of salaries and wages be an ugly and a dangerous thing? I am told sometimes that these changes present comparatively little difficulty in a country such as the United States where economic rigidity has not yet set in. I find it difficult to believe this. But it is for you, not me, to say. I know that in my own country a really large cut of many wages, a cut at all of the same order of magnitude as the fall in wholesale prices, is simply an impossibility. To attempt it would be to shake the social order to its foundation. There is scarcely one responsible person in Great Britain prepared to recommend it openly. And if, for the world as a whole, such a thing could be accomplished, we should be no farther forward than if we had sought a return to equilibrium by the path of raising prices. If, under the pressure of compelling reason, we are to launch all our efforts on a crusade of unpopular public duty, let it be for larger results than this.

I have said that we should be no farther forward. But in fact even when we had accomplished the reduction of salaries and wages, we should be far worse off, for the second reason for wishing prices to rise is on grounds of social justice and expediency which have regard to the burden of indebtedness fixed in terms of money. If we reach a new equilibrium by lowering the level of salaries and wages, we increase proportionately the burden of monetary indebtedness. In doing this we should be striking at the sanctity of contract. For the burden of monetary indebtedness in the world is already so heavy that any material addition would render it intolerable. This burden takes different forms in different countries. In my own country it is the national debt raised for the purposes of the war which bulks largest. In Germany it is the weight of reparation payments fixed in terms of money. For creditor and debtor countries there is the risk of rendering the charges on the debtor countries so insupportable that they abandon a hopeless task and walk the pathway of general default. In the United States the main problem would be, I suppose, the mortgages of the farmer and loans on real estate generally. There is, in fact what, in an instructive essay, Professor Alvin Johnson has called the “farmers’ indemnity.” The notion that you solve the farmers’ problem by bringing down manufacturing costs so that their own produce will exchange for the same quantity of manufactured goods as formerly is to mistake the situation altogether, for you would at the same time have increased the farmers’ burden of mortgages which was already too high. Or take another case—loans against buildings. If the cost of new building were to fall to a parity with the price of raw materials, what would become of the security for existing loans?

Thus national debts, war debts, obligations between the creditor and debtor nations, farm mortgages, real estate mortgages—all this financial structure would be deranged by the adoption of Dr. Sprague’s proposal. A widespread bankruptcy, default, and repudiation of bonds would necessarily ensue. Banks would be in jeopardy. I need not continue the catalogue. And what would be the advantage of having caused so much ruin? I do not know. Dr. Sprague did not tell us that.

Moreover, over and above these compelling reasons there is also the technical reason, the validity of which is not so generally recognized, which I have endeavored to elucidate in my previous lecture. If our object is to remedy unemployment it is obvious that we must first of all make business more profitable. In other words, the problem is to cause business receipts to rise relatively to business costs. But I have already endeavored to show that the same train of events which will lead to this desired result is also part and parcel of the causation of higher prices, and that any Policy which at this stage of the credit cycle is not directed to raising prices also fails in the object of improving business profits.

The cumulative argument for wishing prices to rise appears to me, therefore, to be overwhelming, as I hope it does to you. Fortunately many if not most people agree with this view. You may feel that I have been wasting time in emphasizing it. But I do not think that I have been wasting time, for while most people probably accept this view, I doubt if they feel it with sufficient intensity. I wish to take precautions beforehand against anyone asking—when I come to the second and constructive part of my argument—whether, after all, it is so essential that prices should rise. Is it not better that liquidation should take its course? Should we not be, then, all the healthier for liquidation, which is their polite phrase for general bankruptcy, when it is complete?

II. Let us now return to our main theme. The cure of unemployment involves improving business profits. The improvement of business profits can come about only by an improvement in new investment relative to saving. An increase of investment relative to saving must also, as an inevitable by-product, bring about a rise of prices, thus ameliorating the burdens arising out of monetary indebtedness. The problem resolves itself, therefore, into the question as to what means we can adopt to increase the volume of investment, which you will remember means in my terminology the expenditure of money on the output of new capital goods of whatever kind.

When I have said this, I have, strictly speaking, said all that an economist as such is entitled to say. What remains is essentially a technical banking problem. The practical means by which investment can be increased is, or ought to be, the bankers’ business, and pre-eminently the business of the central banker. But you will not consider that I have completed my task unless I give some indication of the methods which are open to the banker.

There are, in short, three lines of approach:

The first line of approach is the restoration of confidence both to the lender and to the borrower. The lender must have sufficient confidence in the credit and solvency of the borrower so as not to wish to charge him a crushing addition to the pure interest charge in order to cover risk. The borrower, on the other hand, must have sufficient confidence in the business prospects to believe that he has a reasonable prospect of earning sufficient return from a new investment proposition to recover with a margin the interest which he has to bind himself to pay to the lender. Failing the restoration of confidence, we may easily have a vicious circle set up in which the rate of interest which the lender requires to cover what he considers the risks of the situation represents a higher rate than the borrower believes he can earn.

Nevertheless, there is perhaps not a great deal that can be done deliberately to restore confidence. The turning-point may come in part from some chance and unpredictable event. But it is capable, of course, of being greatly affected by favorable international developments, as for example, an alleviation of the war debts such as Mr. Hoover has lately proposed; though if he goes no farther than he has promised to go at present, the shock to confidence, long before his year of grace is out, may come perhaps just at the moment when it will interfere most with an incipient revival. In the main, however, restoration of confidence must be based, not on the vague expectations or hopes of the business world, but on a real improvement in fundamentals; in other words, on a breaking of the vicious circle. Thus if results can be achieved along the two remaining lines of approach which I have yet to mention, these favorable effects may be magnified bv their reaction on the state of confidence.

The second line of approach consists in new construction programs under the direct auspices of the government or other public authorities. Theoretically, it seems to me, there is everything to be said for action along these lines. For the government can borrow cheaply and need not be deterred by overnice calculations as to the prospective return. I have been a strong advocate of such measures in Great Britain, and I believe that they can play an extremely valuable part in breaking the vicious circle everywhere. For a government program is calculated to improve the level of business profits and hence to increase the likelihood of private enterprise again lifting up its head. The difficulty about government programs seems to me to be essentially a practical one. It is not easy to devise at short notice schemes which are wisely and efficiently conceived and which can be put rapidly into operation on a really large scale. Thus I applaud the idea and only hesitate to depend too much in practice on this method alone unaided by others. I am not sure that as time goes by we may not have to attempt to organize methods of direct government action along these lines more deliberately than hitherto, and that such action may play an increasingly important part in the economic life of the community.

The third line of approach consists in a reduction in the long-term rate of interest. It may be that when confidence is at its lowest ebb the rate of interest plays a comparatively small part. It may also be true that, in so far as manufacturing plants are concerned, the rate of interest is never the dominating factor. But, after all, the main volume of investment always takes the forms of housing, of public utilities and of transportation. Within these spheres the rate of interest plays, I am convinced, a predominant part. 1 am ready to believe that a small change in the rate of interest may not be sufficient. That, indeed, is why I am pessimistic as to an early return to normal prosperity. I am ready enough to admit that it may be extremely difficult both to restore confidence adequately and to reduce interest rates adequately. There will be no need to be surprised, therefore, if a long time elapses before we have a recovery all the way back to normal.

Nevertheless, a sufficient change in the rate of interest must surely bring within the horizon all kinds of projects which are out of the question at the present rate of interest. Let me quote an example from my own country. No one believes that it will pay to electrify the railway system of Great Britain on the basis of borrowing at 5 per cent. At 4 1/2 per cent the enthusiasts believe that it will be worth while; at 4 per cent everyone agrees it is an open question; at 3 per cent it is impossible to dispute that it will be worth while. So it must be with endless other technical projects. Every fall in the rate of interest will bring a new range of projects within a practical sphere. Moreover, if it be true—as it probably is—that the demand for house room is elastic, every significant fall in the rate of interest, by reducing the rent which has to be charged, brings with it an additional demand for house room.

As I look at it, indeed, the task of adjusting the long-term rate of interest to the technical possibilities of our age so that the demand for new capital is as nearly as possible equal to the community’s current volume of savings must be the prime object of financial statesmanship. It may not be easy and a large change may be needed, but there is no other way out.

Finally, how is the banking system to affect the long-term rate of interest? For prima facie the banking system is concerned with the short-term rate of interest rather than with the long.

In course of time I see no insuperable difficultv. There is a normal relation between the short-term rate of interest and the long-term, and in the long run the banking system can affect the long-term rate by obstinately adhering to the correct policy in regard to the short-term rate. But there may also be devices for hastening the effect of the short-term rate on the long-term rate. A reduction of the long-term rate of interest amounts to the same thing as raising the price of bonds. The price of bonds amounts to the same thing as the price of non-liquid assets in terms of liquid assets. I suggest to you that there are three ways in which it is reasonable to hope to exercise an influence in this direction.

The first method is to increase the quantity of liquid assets—in other words, to increase the basis of credit by means of open-market operations, as they are usually called, on the part of the central bank. I know that this involves technical questions of some difficulty with which I must not burden this lecture. I should, however, rely confidently in due course on influencing the price of bonds by steadily supplying the market with a greater quantity of liquid assets than the market felt itself to require so that there would be a constant pressure to transform liquid assets into the more profitable non-liquid assets.

The second course is to diminish the attractions of liquid assets by lowering the rate of deposit interest. In such circumstances as the present it seems to me that the rate of interest allowed on liquid assets should be reduced as nearly as possible to the vanishing-point.

The third method is to increase the attractions of non-liquid assets, which, however, brings us back again in effect to our first remedy, namely, methods of increasing confidence.

For my own part, I should have thought it desirable to advance along all three fronts simultaneously. But the central idea that I wish to leave with you is the vital necessity for a society living in the phase in which we are living today, to bring down the long-term rate of interest at a pace appropriate to the underlying facts. As houses and equipment of every kind increase in quantity we ought to be growing richer on the principle of compound interest. As technological changes make possible a given output of goods of every description with a diminishing quantity of human effort, again we ought to be forever increasing our level of economic well-being. But the worst of these developments is that they bring us to what may be called the dilemma of a rich country, namely, that they make it more and more difficult to find an outlet for our savings. Thus we need to pay constant conscious attention to the long-term rate of interest for fear that our vast resources may be running to waste through a failure to direct our savings into constructive uses and that this running to waste may interfere with that beneficent operation of compound interest which should, if everything was proceeding smoothly in a well-governed society, lead us within a few generations to the complete abolition of oppressive economic want.

Hoisted from the Archives: Me Reviewing Robert Skidelsky on John Maynard Keynes

J. Bradford DeLong(2001): Review of Robert Skidelsky, John Maynard Keynes: Hopes Betrayed and The Economist as Saviour: Robert Skidelsky (1983), John Maynard Keynes: Hopes Betrayed (London: Macmillan: 033357379x). Robert Skidelsky (1992), John Maynard Keynes: The Economist as Saviour (London: Macmillan: 0333584996). And my review of volume 3: Fighting for Britain.

A couple of months ago I wrote a less-than-totally-enthusiastic review of the third volume of Robert Skidelsky’s Keynes biography–Robert Skidelsky (2000), John Maynard Keynes: Fighting for Britain (London: Macmillan: 0333604563). I wrote that I was disappointed: that:

I was expecting this to be a great book: as stunning as the first two volumes…. But it was not. Do not get me wrong: it is still a good book, well worth reading. Anyone who loved Skidelsky’s first two volumes will like this one…

Now let me repair the damage by writing a totally enthusiastic, totally adulatory review of Skidelsky’s first two volumes. He gives us John Maynard Keynes’s life, entire. And he does so with wit, charm, control, scope, and enthusiasm. You read these books and you know Keynes–who he was, what he did, and why it was so important.

The place to start is with the observation that John Maynard Keynes appeared to live more lives than any of the rest of us are granted.

Keynes was an academic, but also a popular author. His books were read much more widely outside of academia than within it. Keynes was a politician–trying to advance the chances of Britain’s Liberal Party between the wars–but also a bureaucrat: at times a key civil servant in the British Treasury. He was a speculator, trying to make his fortune on the stock market, but also at the core of the ‘Bloomsbury Group’ of artists and intellectuals that did so much to shape interwar culture.

For the litterati it is Keynes of Bloomsbury–his loves, enthusiasms, acts of patronage, and wit–who is the most interesting. For economists like myself, it is Keynes the academic who is the real Keynes: he was the founder of the half-science half-witchcraft discipline of macroeconomics. For those interested in the political and economic history of the twentieth century, it is Keynes the author and politician who is primary. In either case, John Maynard Keynes is the man who has the best claim to be the architect of our modern world–whether it is how our central banks think about economic policy, what our governments believe that they must try to do, the institutions through which they work, or the habit of thought that views the economy not as Adam Smith’s ‘system of natural liberty’ but as a complicated machine that needs adjustment and governance, all of these trace large parts of their roots to the words and deeds of John Maynard Keynes.

How did this man come to be?

That is the question answered by the first volume of Skidelsky’s biography: it is a bildungsroman, a story of growth and development. Skidelsky writes the best narrative interpretation of growing up as a smart and privileged children of academics in late Victorian Britain than I can ever conceive of being written. He writes of how Keynes was one of a relatively small number of brilliant students thrust as a leaven into the mass of Britain’s upper class at Eton, and thus became part of ‘an intellectual elite thrust into the heart of a social elite’ (HB, page 77). An entire cohort of Britain’s upper class thus learned before they were twenty that Keynes could be very smart, very witty, very entertaining–and very helpful if there was a hard problem to be thought through or something to be done.

Skidelsky then writes of Keynes at Cambridge, his joining the secret society of the Apostles, and his eager grasping with both hands of the philosophy of the aesthete common among the students of the philosopher G.E. Moore. As Keynes put it in 1938, he believed that one should arrange one’s life to achieve the most good, where ‘good’ was nothing more or less than:

states of mind… states of mind… not associated with action or achievement or with consequences [but]… timeless, passionate states of contemplation and communion…. a beloved person, beauty, and truth.

Thus Keynes left Cambridge convinced that:

one’s prime objects in life were love, the creation and enjoyment of aesthetic experience, and the pursuit of knowledge. Of these love came a long way first… (HB, page 141).

This embrace of aestheticism was and remained the key to the ‘Bloomsbury’ avatar of John Maynard Keynes, for whom the lodestars were to ‘be in love with one’s friends, with beauty, with knowledge’ and who was and remained an enthusiastic member of the Bloomsbury group, sharing ‘its intellectual values and its artistic enthusiasms,’ and participating ‘in its wild fancy dress parties’ (HB, page 234). Keynes was a man who could celebrate this appointment to the British Treasury with:

…a party for seventeen… at the Café Royale…. Afterwards they went back to 46 Gordon Square for Clive [Bell]’s and Vanessa [Bell, the sister of Virgina Woolf]’s party. There they listened to a Mozart trio… and went upstairs for the last scene of a Racine play performed by three puppets made by Duncan [Grant], with words spoken by the weird-voiced Stracheys. ‘The evening ended with Gerald Shove enthroned in the center of the room, crowned with roses…’ (HB, page 300).

But at the same time Keynes’s pursuit of knowledge was shading over into politics and policy as well. For Keynes it was never enough to pursue knowledge in order to achieve a good state of mind, one had also to be sure to cause the knowledge to be applied to make the world a better place. And how one could act in politics and policy was greatly constrained by the limits of our knowledge. One argument from Edmund Burke, especially resonated with Keynes. As he wrote:

Burke ever held, and held rightly, that it can seldom be right… to sacrifice a present benefit for a doubtful advantage in the future…. It is not wise to look too far ahead; our powers of prediction are slight, our command over results infinitesimal. It is therefore the happiness of our own contemporaries that is our main concern; we should be very chary of sacrificing large numbers of people for the sake of a contingent end, however advantageous that may appear… We can never know enough to make the chance worth taking… (ES, page 62).

Keynes’s industry and intelligence thus made him a trusted and effective member of Britain’s intellectual and administrative elite well before the eve of World War I. Sir Edwin Montagu, especially, pushed him forward both before and during the war. Before the war Keynes decided that he wanted the life of an academic rather than of an administrator: Cambridge rather than the India Office or the Treasury. Yet he kept a strong presence in both worlds, writing his practical and policy-oriented book Indian Currency and Finance in spare moments as he worked on the deeper and philosophical project that was his Treatise on Probability.

Thus it was no surprise that Keynes found an important and powerful job at the Treasury during the national emergency that was World War I. How do you mobilize the financial resources of Britain to support the war effort? How large a war effort could the British economy stand? How could an international trade system geared to consumer satisfaction be harnessed as an instrument of national power? These are all deep and complicated questions. These are what Keynes worked on. But as the death toll from World War I mounted up toward ten million, Keynes became angrier and angrier at this monstrous botch of human lives and social energy that was World War I–and angrier and angrier at the politicians who could see no way forward other than mixing more blood with mud at Paaschendale.

Keynes’s friend David Garnett wrote him a letter condemning his work for the government, calling Keynes:

an intelligence they need in their extremity…. A genie taken incautiously out… by savages to serve them faithfully for their savage ends, and then–back you go into the bottle…. Oh… our savages are better than other savages…. But don’t believe in the profane abomination.

The interesting thing was that Keynes ‘agreed that there was a great deal of truth in what I had said…’ (HB, page 321). And then the whole project of post-World War I reconstruction went wrong at Versailles–when the new German government was treated as a foe rather than a democratic ally, when the object seemed to be to extract as much in plunder and reparations from Germany as possible (‘until the pips squeak’).

Skidelsky quotes South African politician Jan Christian Smuts on the atmosphere at Versailles:

Poor Keynes often sits with me at night after a good dinner and we rail against the world and the coming flood. And I tell him that this is the time for Grigua’s prayer (the Lord to come himself and not to send his Son, as this is not a time for children). And then we laugh, and behind the laughter is [Herbert] Hoover’s horrible picture of thirty million people who must die unless there is some great intervention. But then again we think that things are never really as bad as that; and something will turn up, and the worst will never be. And somehow all these phases of feeling are true and right in some sense… (HB, page 373).

Keynes exploded with a book called The Economic Consequences of the Peace. It condemned the political maneuvering of Versailles and the treaty that resulted in the strongest possible terms. He excoriated short-sighted politicians who were interested in victory rather than peace. He outlined his alternative proposals for peace:

German damages limited to £2000m; cancellation of inter-Ally debts; creation of a European free trade area… an international loan to stabilize the exchanges…

And he prophesied doom–if the treaty were carried out and Germany kept poor for a generation:

If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for long that final civil war between the forces of reaction and the despairing convulsions of revolution, before which the horrors of the late German war will fade into nothing, and which will destroy… the civilization and progress of our generation… (HB, page 391).

The Economic Consequences of the Peace made Keynes famous. His horror at the terms of the peace treaty won him friends like Felix Frankfurter, a powerful molder of opinion in the United States. In his book, propelled by ‘passion and despair,’ Keynes ‘spoke like an angel with the knowledge of an expert’ and showed an extraordinary mastery not just of economics but also of the words that were needed to make economics persuasive. Before The Economic Consequences of the Peace Keynes was primarily an academic (with some government experience) with a lot of influential literary friends. Afterwards he was a celebrity. He was not only the private Keynes: ‘the Cambridge don selling economics by the hour, the lover of clever, attractive, unworldly young men, the intimate of Bloomsbury.’ He was also–because of what he had done with his pen after Versailles–‘the monetary reformer, the adviser of governments, the City magnate, the feared journalist whose pronouncements caused bankers and currencies to tremble… conferences jostled with holidays, intimacy merged into patronage. In 1925 the world-famous economist would marry a world-famous ballerina in a blaze of publicity…’ (HB, page 400).

So after World War I Keynes used what power he had to–don’t laugh–try to restore civilization. In Skidelsky’s–powerful and I believe correct–interpretation, Keynes before 1914:

believed (against much evidence, to be sure) that a new age of reason had dawned. The brutality of the closure applied in 1914 helps explain Keynes’s reading of the interwar years, and the nature of his mature efforts… to restore the expectation of stability and progress in a world cut adrift from its nineteenth-century moorings… (ES, page xv).

Skidelsky’s narrative of the mature Keynes–Keynes in the 1920s–is far from being a one-note recounting of the brave but losing struggle against the approaching Great Depression, against political insanity, and against the Nazi Party’s attempted revenge for the German defeat in World War I. Bloomsbury takes up a good chunk of the narrative. Skidelsky’s book includes love letters from Keynes to his future wife Lydia Lopokova:

In my bath today I considered your virtues—how great they are. As usual I wondered how you could be so wise. You must have spent much time eating apples and talking to the serpent! But I also thought that you combined all ages—a very old woman, matron, a debutante, a girl, a child, an infant; so that you are universal. What defence can you make against such praises? (page 181).

But when he tries to paint a picture of what it was like to be a member of the Bloomsbury culture group in the 1920s, Skidelsky’s words fail him. Instead, he resorts to the imaginings of one of the characters of novelist Anthony Powell, who thinks that Bloomsbury must have been:

…every house stuffed with Moderns from cellar to garret. High-pitched voices adumbrating absolute values, rational statse of mind, intellectual integrity, civilized personal relationships, significant form…. The Fitzroy Street Barbera is uncorked. Le Sacre du Printemps turned on, a hand slides up a leg…. All are at one now, values and lovers (page 11).

Virginia Woolf had a different, less happy and romantic view. She wrote of her:

vivid sight of Maynard by lamplight—like a gorged seal, double chin, ledge of red lip, little eyes, sensual, brutal, unimaginate. One of those visions that come from a chance attitude, lost as soon as he turned his head. I suppose though it illustrates something I feel about him. He’s read neither of my books… (page 15)

There is a clear lesson: if your circle includes novelists with wicked pens, read their books and praise them as often as possible.

The bulk of this second volume–The Economist as Saviour–is however devoted to Keynes’s political and intellectual struggle for stable money and full employment, and against deflation, overvalued exchange rates, and the sacrifice of the happiness of today’s populations in the hopes of regaining the imagined benefits of the classical gold standard at some time in the distant future. Keynes spent more than a decade arguing against central bankers who ‘think it more important to raise the dollar exchange a few points than to encourage flagging trade.’ He tried to prevent Britain’s return to the gold standard in 1925 at an overvalued exchange rate, for by overvaluing the exchange rate Britain’s Treasury Minister, Winston Churchill, was willing:

… the deliberate intensification of unemployment. The object of credit restriction, in such a case, is to withdraw from employers the financial means to employ labor at the existing level of prices and wages. This policy can only attain its end by intensifying unemployment without limit, until the workers are ready to accept the necessary reduction in money wages under the pressure of hard facts…. Deflation does not reduce wages ‘automatically.’ It reduces them by causing unemployment. The proper object of dear money is to check an incipient boom. Woe to those whose faith leads them to use it to aggravate a Depression! (page 203).

But in the end Keynes failed.

He was unable to persuade British governments that economic policy should be decided upon by rational thought rather than by obedience to old poorly-understood verities. He failed to achieve any material easing of the terms of the Versailles treaty. He failed to prevent deflation and high unemployment in Britain. He failed to convince people that the Great Depression was a man-made catastrophe that could be cured relatively easily. His pen–though strong–was not strong enough. His allies were too few. And among central bankers and cabinet ministers understanding of the situation in which they were embedded was rare.

So the 1930s saw a change of emphasis. Fewer short polemical articles were written. Instead, Keynes concentrated his attention on writing a book, a book which he thought:

…will largely revolutionize–not, I suppose, at once but in the course of the next ten years–the way the world thinks about economic problems. When my new theory has been duly assimilated and mixed with politics and feelings and passions, I can’t predict what the upshot will be in its effects on actions and affairs. But there will be a great change…’ (pages 520-521). And he was right.

His General Theory of Employment, Interest, and Money did change the world.

It ends with a bold claim for the importance of ideas rather than interests that, in context, has to be read not as a considered judgment but as his desperate hope:

Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas…. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil… (page 570).

The extraordinary thing is that Keynes was right.

The other extraordinary thing is that Skidelsky has told the story so well.

So buy these books. Read these books. These are great books. Time spent with them is time well-spent. Robert Skidelsky deserves great honors for having devoted so much of his life to writing down the story of John Maynard Keynes, and writing it down so well.

Are there any problems with the books? A very few–usually caused by the fact that Skidelsky is not a technically-trained economist.

For example, Skidelsky seems frustrated at the apparent appearance and disappearance of the quantity theory of money from Keynes’s thought (and from economic thought in general). He writes that:

In his youthful exuberance Keynes claimed that adherence to [the quantity theory] was a test of scientific competence…. A few years later he cheerfully jettisoned it; in the 1970s back it popped…. If economics were really like physics, it would be impossible for ideas fundamental to the subject to disappear one moment and reappear the next… (HB, page xviii).

To an economist this sounds simply silly. In the Marshallian tradition in which Keynes was trained, it was always clear that the constant-velocity quantity theory of money was just a first approximation–and indeed Keynes’s General Theory is very clear about just how he intends to get a better, second approximation that reduces to the constant-velocity quantity theory when velocity is indeed constant. The quantity theory may have ‘popped back’ into the sights of economic journalists like Skidelsky in the 1970s; but it had always been present in economists’ models under the guise of the LM curve.

And Skidelsky does not seem to be able to clearly set out what Keynes was trying to achieve in his Treatise on Probability. This is no crime: Keynes was not able to set it out clearly either. We today can because we have the mathematical tools–information sets and expected values taken with respect to them–that make Keynes’s objections to what he took to be ’empirical’ theories of probability both cogent and obvious.

Strangest of all–and this I really do not understand–is Skidelsky’s apparent belief that Keynes’s despair in the immediate aftermath of World War I was an echo of ‘the Victorian fear of a godless society.’ Skidelsky thinks that the rise of atheism ‘severely depleted’ the ‘moral capital which sustained the accumulation of economic capital…’ (HB, pages 401-2). As if everyone would have been optimistic after the Versailles peace conference if only everyone had still gone to church on Sundays! The existential crisis of people seeking meaning for their lives when they can no longer find it in transcendental sanction is one thing. The slaughter of Verdun, the panic of hyperinflation, the social waste of high unemployment, and the (temporary) end of economic progress in Europe is quite another.

No one needed the Death of God to cause despair when they looked around them after World War I, and contrasted the world they saw with the world as they had seen it only six years earlier.

Today’s Economic History: John Maynard Keynes (1919): “I personally despair of results from anything except violent and ruthless truth-telling…”

Today’s Economic History: John Maynard Keynes (1919): To Jan Smuts: “Ruthless Truth-Telling”: “My book [The Economic Consequences of the Peace] is completed and will be issued in a fortnight’s time…

…I am now so saturated with it that I am quite unable to make any judgement on its contents. But the general condition of Europe at this moment seems to demand some attempt at an éclairecissement of the situation created by the Treaty [of Versailles ending World War I], even more than when I first sat down to write. We are faced not only by the isolation policy of the U.S., but also by a very similar tendency in this country. There is a growing an intelligible disposition to withdraw (like America), so far as we can, from the complexity, the expense, and the unintelligibility of the European problems: and particularly as regards financial assistance, the Treasury is inclined, partly as a result of our own financial difficulties and partly because of the hopelessness of doing anything effective in the absence of American help, to let Europe stew. Also anti-German feeling here is, still, stronger than I should have expected.  But perhaps most alarming is the lethargy of the European people themselves. They seem to have no plan; they take hardly any steps to help themselves; and even their appeals appear half-hearted. It looks as though we were in for a slow steady deterioration of the general conditions of human life, rather than for any sudden upheaval or catastrophe. But one can’t tell.

Anyhow, attempts to humour or placate Americans or anyone else seem quite futile, and I personally despair of results from anything except violent and ruthless truth-telling–that will work in the end, even if slowly…

Must-read: John Maynard Keynes (1923): “A Tract on Monetary Reform”

Must-Read: John Maynard Keynes (1923): A Tract on Monetary Reform: “One is often warned that a scientific treatment of currency questions…

…is possible because the banking world is intellectually incapable of understanding its own problems…. I do not believe it…. If the new ideas… are sound and right, I do not doubt that sooner or later they will prevail. I dedicate this book, humbly and without permission, to the Governors and Court of the Bank of England, who now and for there future has a much more difficult and anxious task entrusted to them than in former days…


It is not safe or fair to combine the social organization developed during the nineteenth century (and still retained) with a laisser-faire policy towards the value of money…. we must make it a prime object of deliberate State policy that the standard of value… be kept stale… adjusting in other ways the redistribution of the national wealth if… inheritance and… accumulation have drained too great a proportion… into the spending control of the inactive….

We see… rising prices and falling prices each have their characteristic disadvantage…. Inflation… means Injustice to individuals… particularly to investors: and is therefore unfavorable to saving [and investment in capital]…. Deflation… is… disastrous to employment…. Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier.

But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient–perhaps cannot survive–without one.

?For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision

The economist as…?: The public square and economists

My paper for the Notre Dame conference on “public intellectualism” is finally making its way through the publication process…

I. The Salience Today of the Economic

Sit down some evening and watch the news on the TV, or scan the magazine covers in the supermarket, or simply immerse yourself in modern America…


A. Elements of Public-Square Gossip

If you are like me, you will be struck by the extent to which our collective public conversation focuses on seven topic areas:

  1. The personal doings of the beautiful, the powerful, and the rich – and how to become more like them.
  2. The weather.
  3. Local threats and dangers, especially to children.
  4. Amusements – usually gossip about the past or about our imaginary friends, frenemies, etc. (it is amazing how many people I know who have strong opinions about Daenerys Stormborn of House Targaryen1 – many more than have any opinions at all about her creator George R.R. Martin, author of the Song of Ice and Fire novels on which “Game of Thrones”2 is based).
  5. How to best procure necessities and conveniences.
  6. Large scale dangers (and, rarely, opportunities): plagues, wars and rumors of wars, the fall and rise of dynasties, etc.
  7. “The economy”: unemployment, spending, inflation, construction, stock market values, and bond market interest rates.

Now out of these seven topic areas, the first six are found not just in our but in other societies as far back as we have records. They are common in human history as far back as we have been writing things down, or singing long story-songs to one another around the campfire.

What, after all, is the story of Akhilleus, Hektor, and Agamemnon in Homer’s Iliad but a combination of (1), (4), and (6)?3

In April 2014, by a strange chance, the internet led me to a passage from the lost Biographies of third-century B.C.E. philosopher Hermippos of Smyrna. The passage was about a fourth-century B.C.E. Athenian, Phryne, who may or may not have been a model for the sculptor Praxiteles of Athens’s lost Aphrodite Knidia and the painter Apelles of Kos’s lost Aphrodite Anadyomene. Hermippos of Smyrna wrote of “the dazzling Phryne, who:

at the great festival of the Eleusina and that of the Posidonia in full sight of a crowd that had gathered from all over Greece, she removed her cloak and let loose her hair before stepping into the sea.

This provided the Athenians and the tourists with a rare opportunity to see her nude. Otherwise you had to be satisfied with art: “it was from her that Apelles painted his likeness of Aphrodite coming out of the sea.”4

That made me think: was the occupation “philosopher” in the third-century B.C.E. some weird mixture of what we would call a “philosopher” and what we would call a “writer for People magazine”? It appears so. Surely Hermippos of Smyrna’s agent would have welcomed a booking on “Oprah”.5

Six of these seven topics of public-square conversation are recognizably common across societies and across history. But we have a seventh. It is somewhat different. And it is what I want to focus on: that our collective public-sphere concern about the economy is unusual in historical perspective. Past society’s public squares have dealt with issues we would call economic: the local price of food is always of general interest as is the supply and demand of traded goods of interest to merchants. The wealth or lack thereof of individuals and cities of interest is always of interest to money-lenders.


B. The Rise of the Economy

But the economy?

There really wasn’t such a thing before 1700. We only begin to even see the word in the eighteenth century, as the phrase “home economics” – teaching how to cook, how to sew, how to clean, and how to budget – finds its first word replaced by “political”.6 Then “political economy” becomes a study of how the government managers should do for the state the things that a household manager does for a household. And then, in the late nineteenth and early twentieth century, the “political” gets dropped, and the “-y” gets replaced by an “-ics”. Why? As part of a movement to make the subject less, well, political – less partisan. It was a semi-deliberate move by those who were political economists and seek to become economists to claim a mantle for their discipline as more than an objective branch of knowledge that can at least aspire to the prestige of a true natural science and the respect given to its advice possessed by a technocratic what-works discipline like engineering.

So why does “the economy” and its study – “economics” – become a concept that needs a label in the eighteenth century? Why do we today watch it on the TV and read about it in the newspaper instead of learning more normal things – like Phryne’s fashion secrets, or Odysseus’s most-tricky battle strategems, or Akhilleus’s favorite strength-building recipes?

I believe that there is a simple answer. When we look into the deep past, the evidence – especially the skeletal evidence that finds adult humans around the year 1 little more than five feet tall7 – strongly suggests that, save for a small upper class, and save for lucky generations born into times of temporary land abundance (from technological changes like the invention of the wet-rice paddy or the horse collar, or from previous plague) the bulk of human populations saw very little economic change. Most people lived for the most part close to subsistence in the years between the invention of agriculture and 1500 or so. We can guess at what their material standard of living was like, and we can guess that their income level would strike us in today’s dollars as something less than $1000 per person per year.8 We do see substantial population growth: we guess that there were about 5 million humans in 8000 B.C.E., and 500 million in 1500, for we had much better agricultural and herding “technology” in 1500 than we did in 8000 B.C.E. But all or nearly all of better technologies between 8000 B.C.E. and 1500 showed up in Malthusian fashion as increasing population rather than increasing living standards.9 Crunch these guesstimates, and find a worldwide economic growth rate of 0.05%/year. That is not five percent per year – that is five percent every hundred years.

Thus what might have been called “the economy” was pretty much an unchanging backdrop back before 1500 from the standpoint of any individual year, or, indeed, from the standpoint of any individual’s lifetime – plagues, war and rumors of war, and their economic consequences aside. Substantial transformations of what might have been called the economic would have been visible only if one stepped back and looked across multiple centuries at what Fernand Braudel called the Longue Durée10 – the analytical perspective from which the long and gradual four-century long spread of the Merino-breed sheep across Mediterranean and then northwest Europe truly was a really big deal. Thus in any previous era the idea that one should pay attention to somebody called “an economist” – that there would even be a subject called economics that could be thought of as significant – would have been a strange one indeed.


C. The Centrality Today of the Economic

Compare that to the years since 1900 in which worldwide average real GDP growth was 3.5% per year. Compare that to the years from 1990-2007: worldwide average real GDP growth of 4.5%/year.11 And compare that to what happened in 2008-9: an eight-percent fall in total economic production in the United States and a six percent fall in employment driven purely by the monetary-financial derangement of our economy as a system, and not by any change in our knowledge or our technological capabilities or in the rest of the natural world.12

The fact is that we today see roughly 100 times as much economic growth and change in any given period – for good and for ill – than our pre-1500 ancestors did. Today economic change is a very big deal that determines what kind of job you will have, and if you will have a job, and how you will live ten or twenty years from now – if not tomorrow. Is it any wonder, given this ramping up of the pace of change, that the economy is salient today? Ours is an era in which, in our consciousness, issues like the filioque clause and the vicissitudes of the Bush or Habsburg dynasties appear to us to be in relative terms less salient, and the economy much more so. In such an age it is natural that the public square has a desire to listen to economists – for they claim to have knowledge about what is an important, newsworthy, and changing aspect of our civilization. And it is natural that economists will seek to speak today in the public square as public intellectuals.

II. Analyzing Emergent Properties of Systems of Decentralized Exchange

So what do economists have to say when they speak as public intellectuals in the public square? As I see it, economists have six things to teach:

  1. the deep roots of markets in human psychology and society,
  2. the extraordinary power of markets as decentralized mechanisms for getting large groups of humans to work broadly together rather than at cross-purposes,
  3. the ways in which markets can powerfully reinforce and amplify the harm done by domination and oppression,
  4. the manifold other ways in which the market can go wrong because it is somewhat paradoxically so effective, and
  5. how the market needs the state to underpin and manage it on the “micro” level.


A. The Five “Micro” Things Economists Have to Say

At the level of the “micro” – of how individuals act, and of their well-being as they try to make their way in the world – economists really have five things to say when they enter the public square as public intellectuals:

First, the Deep Roots of Markets: Probably most importantly, at some deep level human sociability is built on gift-exchange – I give you this, you give me that, and rough balance is achieved, but in some sense we both still owe each other and still are under some kind of mutual obligation to do things to further repay each other. Wherever we look in human societies across space or across time we find such overlapping networks of gift-exchange and resulting reciprocal obligation to be an important share of the social glue that holds us humans together.13 On top of this deep gift-exchange sociability, we economists say, we humans have built an economic system of decentralized market exchange. Today a great many of our gift-exchange relationships are not long-term relationships over time with people we come to know well, but rather one-shot exchanges with people we do not necessarily expect to ever see again. These exchanges are mediated by tokens called “money” that are acceptable to each of us as payment or repayment because they are acceptable to all of us. And this great enhancement of our potential network of those with whom we can exchange is what allows us to have a wide and productive rather than a cramped and penurious social distribution of labor.

This part of what economists have to say has been very clear since Adam Smith in 1776 published the first edition of his Inquiry into the Nature and Causes of the Wealth of Nations.14 Because humans have a “natural propensity to truck, barter, and exchange,” we can build markets of wide extent. Because “the division of labor depends on the extent of the market,” our extensive markets allow a detailed and sophisticated division of labor. And Adam Smith saw the detailed and sophisticated division of labor of eighteenth-century Britain as the principal cause of its relative productivity and prosperity. It is, perhaps, the most important thing that economists have to say as public intellectuals in the public square.

Second, the Extraordinary Power of Markets: Perhaps next in importance, organizing a great deal of our societal distribution of labor around market exchange mediated by tokens called “money” is more than something that works with the grain of the crooked timber of humanity. It is also something that turns out to be extraordinarily powerful and effective. The market system works amazingly, remarkably well as a decentralized societal calculating mechanism for determining what is to be collectively produced, how it is to be produced, and for whom it is to be produced. Take market exchange, add private property in things, and the proviso that people can get together and form smaller hierarchical or cooperative forms of economic organization within the matrix of the market economy when they think best, add the proviso that there is a government to enforce its conventions about property rights and contract obligations, and you find that you have a system that as a whole has marvelous advantages.

First of all, it happens that the great bulk of commodities in this world are what economists call rival in use – if I am making use of it, you cannot be. Thus one person’s enjoyment and use of a particular item reduces the available options of others. It thus makes sense for a rational and efficient social system to make a person who decides to feel the effect of their actions on the opportunities and choices of others. It turns out that if you (a) assign exclusive property rights to use to someone, and (b) require a person to pay a market price for the privilege of transferring those rights, then you have (c) a marvelously effective way of making each feel the effect of their decisions on the well-being of all. This is quite a coincidence. Nineteenth-century economist Richard Whately – the only person ever to have been in rapid succession Professor of Political Economy at Oxford and Archbishop of Dublin – detected the hand of Providence in this truly divine coincidence.15

Second of all, it just turns out to be the great bulk of decisions about what is the best economic use of resources in the world are best made at the local level, by individuals who actually know what is going on. It is not good to make them in some centralized Kremlin or GOSPLAN office.16 And, again by coincidence, it turns out that exclusive and transferable private property is a good way of making decisions take place where the information is at the periphery, rather than at the center where the information is not. And, as Ronald Coase pointed out, one of the geniuses of our market system is that it allows for islands of centralized hierarchy wherever and whenever people decide that there is stuff to be gained by centralized hierarchical planning and coordination, or by some other mode of coordination and collective decision-making other than decentralized market exchange.

That extraordinary power of markets that just happens to fit our world of largely rival commodities in which decision-making is largely better decentralized is, perhaps, the second most important thing that economists have to say as public intellectuals in the public square – along with noting that what has been true in the agrarian age in which Adam Smith lived that ended with the eighteenth century and in the industrial age of the nineteenth and twentieth centuries may not be true in whatever kind of age the twenty-first century turns out to be.

Third, Market Systems Reinforce and Amplify the Harms of Domination: Next, however, comes the serpent in the garden: that market systems can and do amplify the harm done by power imbalances: slavery in the context of the American South’s cotton plantations was a much worse thing than slavery in the context of West African households precisely because the first were embedded in a market economy and so there was a great deal of money to be made by whipping slaves to work until they dropped. Market systems are at the bottom very good ways of getting people to respond to incentives. Power imbalances create situations in which we would rather that people not have more reason to use their power.

Such power imbalances can cause enormous misery in the context of a market economy even in the absence of incentives to behave with affirmative cruelty, for power imbalances turn into wealth imbalances, and a market economy’s underlying calculus is a calculus of doing what wealth wants rather than what people need. Wealth imbalances alone produce a situation in which we do not like the pattern of incentives that the market system provides to individuals, and in which market systems go horribly, dreadfully, diabolically wrong.

Consider the Bengal famine of of the middle of the last century.17 In Bengal, in 1942, because of the interruption of world trade, those whose sole wealth was their labor in the jute plantations found their wealth valued at zero – nobody wanted to hire rural workers then because nobody thought it worthwhile to grow jute that would then have to be shipped out through the Indian Ocean as long as there was a chance that the aircraft carriers of Japanese Admiral Nagumo’s Kido Butai might be prowling the ocean. Moreover, the large logistical demands of supporting the armies of the United Nations in Burma pushed up urban food prices, and rural food prices as well. Without wages to earn, the ex-jute workers of Bengal had no wealth and no money to pay. With no money to pay, the market provided those in other parts of India who had food with no incentive to move the food to Bengal and sell it to the ex-jute workers. Two million people died, even though there was ample food in India for the population as a whole.

And the British state that ruled India, and was responsible for checking to see whether the incentives the market system was providing really were the incentives that people were responding to. Prime Minister Winston Churchill sent a telegram, asking: if it were really true that there was famine in India, why was Mohandas Gandhi still alive?18

Such behavior by the British Empire was not exceptional. My Gallagher ancestors knew well the earlier failure of the British state to take appropriate action to rebalance the distribution of wealth and prevent mass starvation in 1846-8, similarly in the midst of ample food nearby and plenty of resources to transport it.

Fourth, Other Ways in Which the Market Can Go Wrong: Moreover, even when the distribution of wealth is right, modes of “market failure” are many. The market system can and does wrong and provide the wrong incentives for behavior in myriad ways. The brilliant Ronald Coase of the University of Chicago – who remained productively at work as an economist a decade into the twenty-first century, even though his age had reached three figures – was interpreted to have argued that pretty much any arrangement of property rights will do about as well as any other and the government should simply step back.19 The canonical case adduced was the locomotive that occasionally throws off sparks that burn the nearby farmer’s crops. If the railroad has a duty of care not to burn the crops, Coase said, the railroad will attach spark-catchers if it is cheap and makes sense to do so – and the railroad will pay damages and settle in order to avoid being hauled into court on a tort claim if it is expensive and doesn’t make sense to do so. If the railroad has no duty of care, Coase said, then the farmer will offer to pay the railroad to install spark-catchers – and spark-catchers will be installed if the potential damage to the crops is greater than the cost of the spark-catcher and it makes sense to do so, and spark-catchers will not be installed if the damage to the crops is less than the cost.

Thus the same decisions will be made whatever the property rights – as long as there are settled property rights. If there are not settled property rights, then the crops burn and lawyers grow fat. But as long as there are property rights, the market will work fine. Maybe the widows and orphans who own railroad shares will be wealthier under one setup and maybe the farmers will be wealthier under the other, but that is rarely a matter of great public concern.

Now this argument has always seemed to me to be wrong. If there is no duty of care on the part of the railroad, it has an incentive not just to threaten not to install a spark-catcher, but to design and build the most spark-throwing engine imaginable – to make sure that the firebox is also a veritable flamethrower – and then to demand that the farmer bribe it not to set the fields on fire. What economists call “externalities” are rife, and call for the government to levy taxes and pay bounties over wide shares of the economy in order to make the incentives offered by the tax-and-bounty-augmented market the incentives that it is good for society that decision-making individuals have. Cutting property rights “at the joints” to reduce externalities is important. But it will never be efficient: what economists call Pigovian taxes and bounties make up a major and essential part of the business of government.

Fifth, the Market Needs the State: Last, the market needs the state. For the market system to work well and produce a good outcome, outcomes need to be dictated not by inequalities of wealth or power but by genuine win-win exchanges. This means that the government has to set out and maintain its laws of property and contract, so that what is yours stays yours and what is promised is delivered at good weight. In the absence of a properly-regulating government, what is yours is not yours, what is promised will not be delivered, and weight will not be good: instead, either roving bandits, local notables with bully boys functioning as barely-better stationary bandits, or the government’s own functionaries abusing its powers will decide that what was yours is now theirs. And having a government powerful enough to set out and enforce laws of property and contract that does not then turn around and become the largest and most destructive stationary bandit of all is perhaps the most difficult of all problems of political economy, for a government is, as the philosopher Ibn Khaldun wrote,20 at its foundation an organization that prevents all injustices save for those it commits itself.

Those five points and their application to the issues of today are what economists have to say about “micro” topics when they don the mantles of public intellectuals and speak in the public square. Moreover, it is economists’ task to speak about how much the technical details matter, and the technical details do matter – would you have thought ex ante that it would be important whether the property rights of the farmer were boosted by a requirement that anybody running machinery nearby have a duty of care? Economists are worth listening to – and hopefully paying – to the extent that they can combine their knowledge of the basic principles with sufficient institutional knowledge to understand just what small differences in regulatory institutions and organizations will mean for the distribution of wealth, and for the on-the-ground incentives provided to humans.

Economics in the public sphere is thus a difficult, important, and subtle discipline. It is concerned with what are the emergent properties of basing a great deal of the construction of our collective social division of labor on a decentralized system of money-mediated market exchange. Many of these emergent properties are not obvious and not well understood. And the devil is often in the details. That is why I looked forward in my twenties to making a comfortable living as an economist – as a speaker in the public square, as someone pushing forward we economists’ collective understanding of these emergent properties, and as someone teaching non-economists how to listen when we do speak in the public square. So far I have not been disappointed.


B. Macroeconomics in the Public Square

But: I lied back when I said that economists really have five things to say when they enter the public square. They actually have six:

(6) How the market needs the state to underpin and manage it on the “macro” level.

Sometimes the entire market system appears to go awry in some puzzling way. Sometimes when you go to the market, you find the money prices that you have to pay higher than you expected – perhaps 10% higher than you expected last year when you made your plans. It seems that, somehow, there is too much spending money chasing too few goods. How is it that this happens? And what should the government do to make sure that it does not happen?

Conversely, we can have the opposite problem – not a glut of money relative to goods, but what early-nineteenth century economists used to call a “general glut” of unsold commodities, idle factories and workshops, and idle workers all across the economy. Economists have important things to say about how to try to prevent these episodes and what to do when they happen to cure them.

And this sixth role of economists as public intellectuals in the public square is worth going into in more depth.

Back in the 1820s, the question of whether the circular flow of economic activity as mediated by the market system could break down and the economy become afflicted by a “general glut” of commodities was a live theoretical question. Everybody agreed that there could be particular gluts. Consider what happens should households decide that they want to spend less on electricity to power large-screen video- and audio- entertainment systems, and more on yoga lessons to seek inner peace. The immediate consequence – within the “market day,” as late-nineteenth century British economist Alfred Marshall would have put it21 – of this shift in preferences is excess demand for yoga instructors and excess supply of electric power. Prices of electricity (and of large-screen TVs, and of audio systems) fall as unsold inventories pile up in stores and as generators spin down and stand idle. Yoga instructors, by contrast, find themselves overscheduled, working ten-hour days, and stressed out – and find the prices they can charge for their lessons going through the roof. Workers in electric power distribution and in video and audio production and sales find that they must either accept lower wages or find themselves out on the street without jobs.

Over time the market system provides individuals with changing incentives that resolve the excess-supply excess-demand disequilibrium. Seeing the fortunes to be earned by teaching yoga, more young people learn to properly regulate their svadisthana chakra and teach others to do so. Seeing unemployment and stagnant wages in electrical engineering, fewer people major in Electrical Engineering/computer Sciences (EECS). The supply of yoga instructors grows. The supply of electrical engineers shrinks. Wages of yoga instructors fall back towards normal. Wages of electrical engineers rise. And balanced equilibrium is restored. Thus we understand how there can be a glut of a particular commodity – in this case, electric power. And we understand that it is matched by an excess demand for another commodity – in this case, yoga instructor services to properly align your svadisthana chakra.

But can there be a general glut, a glut of everything?

Some economists early in the nineteenth century said yes. Others said that the idea of a “general glut” was logically incoherent. Jean Baptiste Say, for example:

Letters to Mr. Malthus: I shall not attempt, Sir, to add… in pointing out the just and ingenious observations in your book; the undertaking would be too laborious…. [And] I should be sorry to annoy either you or the public with dull and unprofitable disputes. But, I regret to say, that I find in your doctrines some fundamental principles which… would occasion a retrograde movement in a science of which your extensive information and great talents are so well calculated to assist the progress….

What is the cause of the general glut of all the markets in the world, to which merchandize is incessantly carried to be sold at a loss?… Since the time of Adam Smith, political economists have agreed that we do not in reality buy the objects we consume, with the money or circulating coin which we pay for them. We must in the first place have bought this money itself by the sale of productions of our own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases such commodities as he may have occasion for…. From these premises I had drawn a conclusion… “that if certain goods remain unsold, it is because other goods are not produced; and that it is production alone which opens markets to produce.”…

[W]henever there is a glut, a superabundance, [an excess supply] of several sorts of merchandize, it is because other articles [in excess demand] are not produced in sufficient quantities… if those who produce the latter could provide more… the former would then find the vent which they required…22

Yet Say changed his mind. By 1829, in his analysis of the British financial panic and recession of 1825-6, Jean-Baptiste Say was writing that there could indeed be such a thing as a general glut of commodities after all: “every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared…” The general glut, Say wrote in 1829, had been triggered by a panicked financial flight to quality in financial markets. What was going on? The answer was nailed by John Stuart Mill:

Those who have… affirmed that there was an excess of all commodities, never pretended that money was one of these commodities…. What it amounted to was, that persons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute….

The result is, that all commodities fall in price, or become unsaleable…. [A]s there may be a temporary excess of any one article considered separately, so may there of commodities generally, not in consequence of over-production, but of a want of commercial confidence…23

Note that these financial-market excess demands can have any of a wide variety of causes: episodes of irrational panic, the restoration of realistic expectations after a period of irrational exuberance, bad news about future profits and technology, bad news about the solvency of government or of private corporations, bad government policy that inappropriately shrinks asset stocks, et cetera.

When the government does not create “enough” money and safe savings vehicles you have an excess demand for them, an excess supply of everything else, and high unemployment and idle factories.

It seems as if there is always or almost always something that the government can do to affect asset supplies and demands that promises a welfare improvement over, say, waiting for prolonged nominal deflation to raise the real stock of liquid money, of bonds, or of high-quality AAA assets. Monetary policy open market operations swap AAA bonds for money. Quantitative easing that raises expected inflation diminishes demand for money and for AAA assets by taxing them. Non-standard monetary policy interventions swap risky bonds for AAA bonds or money. Fiscal policy affects both demand for goods and labor and the supply of AAA assets – as long as fiscal policy does not crack the status of government debt as AAA and diminish rather than increasing the supply of AAA assets. Government guarantees transform risky bonds into AAA assets. Et cetera.

And the government’s proper task is made much more difficult by the fact that what is “enough” jumps around as the set of savers and investors do their behavioral-economics thing: the Kindlebergian cycles of displacement, profit, transformation, boom, speculation, enthusiasm, mania, crisis, panic, revulsion, and discredit.24

When the government creates “too much” money and safe savings vehicles, you have an excess supply of them and an excess demand for everything else–which means inflation. And what if there is a glut not of commodities but inflation? Simply apply the same policy tools in reverse.

Right now our economy is going badly wrong in this “macro” dimension, with a prime-age 25-54 adult employment-to-population ratio of barely 78% even as late as the spring of 2016, when in a healthy and well-functioning macroeconomy that number should north of 80%.25 The only excuse my friends in the Obama administration offer is that Europe is doing much worse.26

That is the last of the six things economists have to say in the public square: that the economy does not consistently balance itself at high employment with stable prices. The principle that it does economists have called Say’s Law – even though Say himself had abandoned it by 1829.27 And it is important for economists to say, loudly, that Say’s Law is not true in theory, and it takes delicate and proper technocratic management to make it work in practice.

So economists’ τεχνε (“art, skill, qualities of craftsmanship”) does have many powerful lessons for the public square. They are: (i) a bias toward freedom, choice, decentralization, and individual responsibility; (ii) knowledge that systems of decentralized market exchange have important emergent properties that depend on close knowledge of and careful reasoning from institutional details; (iii) a recognition that markets can amplify oppression as well as opportunity; (iv) a fear that getting those institutional details wrong produces horrible outcomes; (v) a recognition of the importance of government to get details right; and (vi) to act as a balance wheel when the set of savers and investors do their behavioral-economics thing.

III. Economics as a Vocation

That is how we economists try to sell ourselves, and also how we see ourselves. We as a species have made a choice to organize our very large – now seven-billion human wide – social division of labor largely through decentralized arms-length market exchange. Such a system has powerful advantages. Such a system also has lots of emergent properties, good and bad, that are non-obvious consequences of institutional and regulatory details. Economists are here to tell you what’s what, and how to do it.


A. John Maynard Keynes

The aim is, as John Maynard Keynes said at the start of the 1930s at the end of his talk about “Economic Possibilities for Our Grandchildren,” to be a profession that performs a very useful but not overwhelmingly important role in understanding the economy and how to treat it in a way analogous to the way that dentists perform a useful but not overwhelmingly important role in understanding teeth and how to treat them. People should not:

overestimate the importance of the economic problem, or sacrifice to its supposed necessities other matters of greater and more permanent significance. It should be a matter for specialists – like dentistry. If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid28

Yet was there ever a dentist who attempted to reshape, in the interest of dental hygiene, not just a single human mouth but rather the shape of human destiny in the way that Keynes in the interest of economic hygiene tried to do pretty much every day? Here is Keynes reviewing Leon Trotsky’s Where Is Britain Going:

A CONTEMPORARY reviewing this book says: “He stammers out platitudes in the voice of a phonograph with a scratched record.”… In its English dress it emerges in a turbid stream with a hectoring gurgle which is characteristic of modern revolutionary literature translated from the Russian. Its dogmatic tone about our affairs, where even the author’s flashes of insight are clouded by his inevitable ignorance of what he is talking about, cannot commend it to an English reader…. The book is, first of all, an attack on the official leaders of the British Labour Party because of their “religiosity”, and because they believe that it is useful to prepare for Socialism without preparing for Revolution…. “Together with theological literature, Fabianism is perhaps the most useless, and in any case the most boring form of verbal creation…. “ [T]hat is how the gentlemen who so much alarm Mr. Winston Churchill strike the real article….If only it was so easy! If only one could accomplish by roaring, whether roaring like a lion or like any sucking dove!…

[Trotsky] assumes that the moral and intellectual problems of the transformation of Society have been already solved – that a plan exists, and that nothing remains except to put it into operation…. [But] force would settle nothing…. We lack more than usual a coherent scheme of progress, a tangible ideal. All the political parties alike have their origins in past ideas and not in new ideas – and none more conspicuously so than the Marxists. It is not necessary to debate the subtleties of what justifies a man in promoting his gospel by force; for no one has a gospel. The next move is with the head, and fists must wait.29

Did ever, would ever any humble dentist ever write so?

On the one hand, Keynes claims to be asserting only a very minor kind of authority – that based on his expert knowledge of the emergent properties of systems of decentralized market exchange – and to be giving merely technical advice about adjustments needed to achieve self-evidence and obvious goals like full employment, price stability, and healthy increases in productivity. He claims to be performing the economic equivalent of the dentist saying: “you should brush your molars much longer in the morning” and “that tooth has to come out now or you will be in real trouble”.

On the other hand, Keynes then leverages his professedly limited technical and technocratic expertise to attempt to banish from participation in high politics entire schools of political and moral thought, entire mass movements with their utopian aspirations, and to silence via their exclusion from valid technocratic debate the prophets of those schools of thought and mass movements. Trotsky is indeed a prophet – as Edmund Wilson wrote in his To the Finland Station:

Here are some references [from Trotsky]…. “If the prince was not succeeding in peacefully regenerating the country, he was accomplishing with remarkable effectiveness the task of a more general order for which history had placed him at the head of the government: the destruction of the political illusions and the prejudices of the middle class.” “History used the fantastic plan of Gapon for the purpose of arriving at its ends.”… History, then, with its dialectical Trinity, had chosen Prince Svyatopolk-Mirsky to disillusion the middle class, had propounded revolutionary conclusions which it had compelled Father Gapon to bless…. These statements make no sense whatever, unless one substitutes for the words “history” and “dialectic of history” the words “Providence” and “God”…30

And it is not just Trotsky and his followers whom Keynes wishes to banish. He would apply the same to the stewards of Europe today, and to that part of President Barack Obama who speaks of how because the current Lesser Depression has compelled households to tighten their belts that the government needs to tighten its. As Keynes said back in 1931:

It seems an extraordinary imbecility that this wonderful outburst of productive energy [in the boom] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man’s speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a ‘prolonged liquidation’ to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again. I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding [during the boom]… but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity…31

There is more than a little inconsistency and tension here…


B. Alasdair Macintyre

You can resolve this inconsistency and tension in one of several ways.

It is impossible to think about issues of history and moral philosophy, especially here at Notre Dame, without thinking of Alasdair Macintyre and his brilliant After Virtue32, surely one of the best and most important books in history and moral philosophy of the second half of the twentieth century. We economists seek to leverage a narrow claim to limited technical and technocratic expertise to banish and dispel the Trotskys and all his peers and all their works – for, in our view, they contain many false works and empty promises. Alasdair Macintyre, by contrast, seeks to banish and dispel all of us economists – for we are the archetypes of what he regards as one of the most unhealthy and poisonous diseases of modernity, the disease of “managerialism.” What MacIntyre sees as the vice of the manager – that he or she doesn’t tell you that you ought to do X or not to do X, only how to do X if you decide you should – we see as respect for autonomy, as granting people equal significance to us, and as the virtue of the economist: we are just supposed to tell you what is likely to happen if you do X.

Of course to provide someone with knowledge of the consequences may be simply to give them the kind of freedom that is necessity: the freedom to do what is the right thing. The old Cold War joke was of the strategist who would offer the president three possible options: immediate surrender to the Russians, total thermonuclear war, and his preferred policy.33 To the extent that there is no grave disagreement about what the good is and what the ends are, control is exercised not by the one who chooses the ends but rather the one who chooses how the means are evaluated.

It is still not completely clear to me what Macintyre’s root objection to economics in particular and “managerialism” more generally is. The possibilities are:

  • We economists say “our technical expertise tells you that if you do X the effects will be Y” when we should say “you need to do X”.

  • We economists say “our technical expertise tells you that if you do X the effects will be Y”, but we do so because we hold to moral values Z that we do not express, and are in fact harmful.

  • When we say “our technical expertise tells you that if you do X the effects will be Y” we refuse to stake an explicit claim as to what the moral order inscribed in the firmament is, and so we encourage nihilism by teaching not how to reach the good but how to reach whatever you take to be your good.

It is clear to me that John Maynard Keynes believed in second of these objections: that economics was good for the body but taught moral values that were bad for the soul, yet in a world as poor as the world Keynes saw the needs of the body took precedence. When the world becomes rich, Keynes wrote:

We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession – as distinguished from the love of money as a means to the enjoyments and realities of life – will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard…34

Briefly detouring into anti-semitism:

Perhaps it is not an accident that the race which did most to bring the promise of immortality into the heart and essence of our religions has also done most for the principle of compound interest and particularly loves this most purposive of human institutions.

And then calling for, someday, Kingdom Come: a rejection of “managerialism” and of economics as thorough as Macintyre could wish for:

I see us free, therefore, to return to some of the most sure and certain principles of religion and traditional virtue – that avarice is a vice, that the exaction of usury is a misdemeanour, and the love of money is detestable, that those walk most truly in the paths of virtue and sane wisdom who take least thought for the morrow. We shall once more value ends above means and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day virtuously and well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin. But beware! The time for all this is not yet. For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into daylight.35

From this viewpoint, the fundamental difference between Keynes, at least in his “Economic Possibilities for Our Grandchildren”, and Macintyre is that Keynes believes that the Kingdom is still a century off, while Macintyre believes that the Kingdom is at hand.

But Keynes’s century is now almost over. And there is no Kingdom at hand, or even within sight, here in this world.


C. Leon Trotsky and St. Benedict

But I believe that we can go further. Macintyre, at least in his After Virtue mode, believes that good civilizations are ones with moral consensus led by prophets, rather than ones with moral confusion managed by managers. It is Macintyre’s belief that we should hope for a civilization led by Trotskys (less preferred) or St. Benedicts (more preferred), but in either event it is to be preferred to managerial Keyneses.

If you step back, however, and inquire into the content of the this-world secular ideologies of the Trotskys, it then becomes very difficult to prefer the prophetic Trotskys to the managerial Keyneses. Trotsky’s gospel, it turns out, is in reality little more than a managerialist gospel. Trotsky says that History speaking through Marx and him knows how to build a Communist utopia. What is a Communist utopia? It is a society in which humans pull together and coordinate their activities. It is a society in which people are free to do what they want, within reason of what is not destructive for the community. It is a society in which people are prosperous: well-fed, well-clothed, well-housed, and well-entertained. Trotsky’s gospel is that Keynes’s market economy is incapable of even approaching such a utopia, while Marx and History have together told him how to accomplish it.

And here we have to bring in history: the regimes that accepted versions of Trotsky’s gospel in the twentieth century and tried to implement it range from Pol Pot’s to Fidel Castro’s, with Stalin’s and Mao’s regimes at the worst, and something like Erich Honeker’s Stasi-spies-on-everyone East Germany close to the best.

The whole point of saying that you would prefer Trotsky to Keynes is that Trotsky has a gospel which, if not true, is true enough to hold society together in moral consensus and produce a modicum of prosperity. But what if Keynes’s managerialism does better at fulfilling what Trotsky claims will be the accomplishments of Trotsky’s gospel more effectively than Trotsky does? It does. We can see that Keynes was totally correct in wanting to reduce the influence of a Trotsky in the public square, because a Trotsky’s ideas about good organization of the economy were seen immediately by Keynes as, and turned out to be a horrible disaster, even from the perspective of Trotsky’s values–especially from the perspective of Trotsky’s values.

In a similar fashion, many of the same conclusions follow if you step back and inquire into the content of the other-worldly gospels of the St. Benedicts. Their lodestones swing from following the ethical teachings of Rabbi Yeshua of Nazareth to worshipping the Anointed Λόγος that is of a higher order of reality than we, with a certain tension between them. But when Rabbi Yeshua spoke of what the Anointed Λόγος commanded his followers to do in this world, his followers were commanded to successfully attain managerial ends:

Then shall the king say to them that shall be on his right hand: “Come, ye blessed of my Father, possess you the kingdom prepared for you from the foundation of the world. For I was hungry, and you gave me to eat; I was thirsty, and you gave me to drink; I was a stranger, and you took me in: Naked, and you covered me: sick, and you visited me: I was in prison, and you came to me.”

Then shall the just answer him, saying: “Lord, when did we see thee hungry, and fed thee; thirsty, and gave thee drink? And when did we see thee a stranger, and took thee in? or naked, and covered thee? Or when did we see thee sick or in prison, and came to thee?” And the king answering, shall say to them: “Amen I say to you, as long as you did it to one of these my least brethren, you did it to me.”36

That is a very powerful statement that what is sought after is successful managerialism – a successful managerialism with a preferential option for the poor: one that feeds the hungry, clothes the naked, heals the sick, welcomes the immigrant, and visits the imprisoned. Right ritual, right moral orientation, right faith seem to be nowhere – at least in this part of Matthew.37

IV. We Dwell Not in the Republic of Plato But in the Sewer of Romulus

In the last days before the coming of the Roman Empire, Marcus Tullius Cicero in Rome wrote to his best correspondent Titus Pomponius Atticus in Athens:

You cannot love our dear [Marcus Porcius] Cato any more than I do; but the man – although employing the finest mind and possessing the greatest trustworthiness – sometimes harms the Republic. He speaks as if we were in the Republic of Plato, and not in the sewer of Romulus…38

Whatever you may think about economists’ desires to use their technical and technocratic expertise to reduce the influence of both the Trotskys and the St. Benedicts in the public square, there is the prior question of whether here and now – in this fallen sublunary sphere, among the filth of Romulus – they have and deploy any proper technical and technocratic expertise at all. And we seem to gain a new example of this every week.

The most salient relatively-recent example was provided by Carmen Reinhart and Kenneth Rogoff39 – brilliant, hard-working economists both, from whom I have learned immense amounts. Rogoff’s depth of thought and breadth of knowledge about how countries act and how economies respond in the arena of the international monetary system is a global treasure. Reinhart’s breadth and depth of knowledge about how governments have issued, financed, amortized, paid off, or not paid off their debts over the past two centuries is the greatest in the world.

Debt to GDP Ratio and Future Economic Growth pdf page 5 of 6

However, they believed that the best path forward for the developed economies – the U.S., Germany, Britain, and Japan – was for them to shrink their government deficits quickly and quickly halt the accumulation of and begin to pay down government debt. My faction, by contrast, believed that the best path forward for these economies was for them to expand their government deficits now and let the debt grow until either economies recover to normal levels of employment or until interest rates begin to rise significantly.

Why does my faction disagree with them? Let me, first, rely on the graph above that is the product of work by Berkeley graduate student Owen Zidar,40 plotting how economic growth in different industrialized countries in different eras has varied along with the amount of government debt that they had previously accumulated. And let me give the explanation of why I disagree with Reinhart and Rogoff that I was giving at seminars around the country in the early 2010s:

The argument [for fiscal contraction and against fiscal expansion in the short run] is now: never mind why, the costs of debt accumulation are very high. This is the argument made by Reinhart and Rogoff: when your debt to annual GDP ratio rises above 90%, your growth tends to be slow.
This is the most live argument today. So let me nibble away at it. And let me start by presenting the RRR case in the form of Owen Zidar’s graph.

First: note well: no cliff at 90%.

Second, RRR present a correlation – not a causal mechanism, and not a properly-instrumented regression. Their argument is a claim that high debt-to-GDP and slow subsequent growth go together, without answering the question of which way causation runs. Let us answer that question.

The third thing to note is how small the correlation is. Suppose that we consider two cases: a multiplier of 1.5 and a multiplier of 2.5, both with a marginal tax share of 1/3. Suppose the growth-depressing effect lasts for 10 years. Suppose that all of the correlation is causation running from high debt to slower future growth. And suppose that we boost government spending by 2% of GDP this year in the first case. Output this year then goes up by 3% of GDP. Debt goes up by 1% of GDP taking account of higher tax collections. This higher debt then reduces growth by… wait for it… 0.006% points per year. After 10 years GDP is lower than it would otherwise have been by 0.06%. 3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?

The 2.5 multiplier case is more so. Spend 2% of GDP over each of the next three years. Collect 15% of a year’s extra output in the short run. Taking account of higher tax revenues, debt goes up by 1% of GDP and we have the same ten-year depressing effect of 0.06% of GDP. 15% now. -0.06% in a decade. The first would be temporary, the second is permanent, but even so the costs are much less than the benefits as long as the economy is still at the zero lower bound.

And this isn’t the graph that you were looking for. You want the causal graph. That, worldwide, growth is slow for other reasons when debt is high for other reasons or where debt is high for other reasons is in this graph, and should not be. Control for country and era effects and Owen reports that the -0.06% becomes -0.03%. As Larry Summers never tires of pointing out, (a) debt-to-annual-GDP ratio has a numerator and a denominator, and (b) sometimes high-debt comes with high interest rates and we expect that to slow growth but that is not relevant to the North Atlantic right now. If the ratio is high because of the denominator, causation is already running the other way. We want to focus on cases of high debt and low interest rates. Do those two things and we are down to a -0.01% coefficient.

We are supposed to be scared of a government-spending program of between 2% and 6% of a year’s GDP because we see a causal mechanism at work that would also lower GDP in a decade by 0.01% of GDP? That does not seem to me to compute.

Now I have been nibbling the RRR result down. Presumably they are trying to see if it can legitimately be pushed up. This will be interesting to watch over the next several years, because RRR is the heart of the pro-austerity case right now.41

That ends what I would typically try to say.

And that is as concise and simple an explanation of why I disagree with Reinhart and Rogoff as I can give.

If you are not a professional economist and have managed to understand that, I salute you.

They disagree with me, first, they started with different prior beliefs – different assumptions about the relative weight to be given to different scenarios and the relative risks of different courses of action that lead them to read the evidence differently. Second, they made some data processing errors – although those are a relatively minor component of our differences – and are now dug in, anchored to the positions they originally took, and rationalizing that the data processing errors do not change the qualitative shape of the picture. Third, they have made different weighting decisions as to how to handle the data. Is Owen Zidar putting his thumb on the scales, and weighting the data because he knows that the effects of high debt in reducing growth are small? I don’t think so: his weighting scheme is simple, and he is too young to be dug in and have a dog in this fight. But I am, perhaps, not the best judge.

But when we venture out of data collection and statistics and the academy into policy advocacy in the public square the differences become very large indeed. Matthew O’Brien quotes Senator Tom Coburn’s report on Reinhart and Rogoff’s briefing of the Republican Congressional Caucus in April 2011:

Johnny Isakson, a Republican from Georgia and always a gentleman, stood up to ask his question: “Do we need to act this year? Is it better to act quickly?”

“Absolutely,” Rogoff said. “Not acting moves the risk closer,” he explained, because every year of not acting adds another year of debt accumulation. “You have very few levers at this point,” he warned us.

Reinhart echoed Conrad’s point and explained that countries rarely pass the 90 percent debt-to-GDP tipping point precisely because it is dangerous to let that much debt accumulate. She said, “If it is not risky to hit the 90 percent threshold, we would expect a higher incidence.”42

I think we have by far the better of the argument. Yet it is very clear that even today Reinhart and Rogoff – and allied points by economists like Alberto Alesina, Francesco Giavazzi, et al.,43 where I also think we have the better of the argument by far – have had a much greater impact on the public debate than my side has.

Thus, the key problem of knowledge: Since technical details matter, conclusions must be taken by non-economists on faith in economists’ expertise, by watching the development of a near-consensus of economists, and by consonance with observers’ overall world-view. But because political and moral commitments shape how we economists view the evidence, we economists will never reach conclusions with a near-consensus – even putting to one side those economists who trim their sails out of an unwarranted and excessive lust for high federal office. And note that neither Carmen Reinhart nor Kenneth Rogoff have such a lust.

We do not live in the Republic of Plato. We live in the Sewer of Romulus. In this fallen sublunary sphere, the gap between what economists should do and be and what they actually are and do is distressingly large, and uncloseable.

And this leaves you – those of you who must listen to we economists when we speak as public intellectuals in the public square – with a substantial problem.

V. Should You Pay Attention to Economists as Public Intellectuals in the Public Square?

You have to.

You have no choice.

You all have to listen.

But you have nearly no ability to evaluate what you hear. When we don’t reach a near-consensus, then Heaven help you. Unless you are willing make me intellectual dictator and philosopher-king, I cannot.44

Must-read: Benjamin Mitra-Kahn: “Keynes passed away 70 years ago today–his copyright follows”

Must-Read: Benjamin Mitra-Kahn: Keynes passed away 70 years ago today–his copyright follows: “The most frustrating (or magical) thing about doing archival research…

…is the need to first identify and then physically inspect every box of unknown letters. But what if… we could… move the history of economics scholarship from dusty rooms around the world to the web…. The Carnegie Mellon University digitisation of Herbert Simon’s papers shows it can be done though. Building an on-line Keynes archive would be a sizeable task, but not impossible. Including Keynes’ published, unpublished (possible through Rod O’Donnell’s INET project) and uncategorised work could be a real boon to scholars and people interested in Keynes…. I think there are a number of institutions out there with a real interest in Keynes’s work, meaning this could be done…