John Maynard Keynes, now more than ever
Posted in Uncategorized by demandside on October 20th, 2008 Monday’s Backcast, also with economic performance by president.
Today’s Monday backcast is a long and lingering look at John Maynard Keynes, the Godfather of Demand Side, through readings from noted Keynes biographer Robert Skidelsky and from a note by Ed Crooks of the Financial Times. Then we’ll mark the first anniversary of the Demand Side Podcast with a look at our initial week’s podcast, back before the market crash, the commodities bubble, and the mishandling of the financial sector meltdown.
Leading off, however, the promised statistics for economic performance by president. When Democrats have been in the White House, Democrats have been in the White House for 26 of the 61 years between 1946 and 2006. Real GDP growth has averaged 4.0 during that period. Republicans have been in power the other 35 years, during which time Real GDP growth has averaged 2.8 percent per year. Net GDP, taking into account the federal borrowing, drops Democratic performance to 3.5 percent. The same adjustment for Republicans drops their number to a meager 0.8 percent. More than two-thirds of Republican growth has been borrowed. Since 1980 there has been zero Net Real GDP growth under Republicans.
In the realm of employment the most cited statistic is the rate of unemployment. Unemployment has been lower on average under Democrats, 5.1 percent v. 6.2 percent. More striking than the actual rate is the progression of the measure over time.
Under Democrats unemployment has shown an unmistakable, persistent tendency to fall from year to year. After 1949 and the turbulence of transition from war to peace, only twice under Democrats has unemployment failed to fall. Under Republicans the rate of unemployment has been just as likely to rise as fall.
Regarding employment growth, a figure much less subject to official manipulation. During the postwar, employment growth under Democrats has been 2.8 percent per year, versus half that, 1.4 percent for Republicans. The past 12 years of Republican administration, Bush father and son, have been particularly bad, averaging 0.8 and 0.5 percent respectively.
This is only through 2007. The negative numbers from Bush II for 2008 are not included. It is quite possible W. willl be the only president in the postwar period to preside over a net job loss.
Our figures are from the 2008 Economic Report of the President.
Investment has again favored Democrats. Total private domestic investment grew at an average annual rate of 6.6 percent through the years of Democratic chief executives. Under Republicans, the figure was less than half that, 3.2 percent.
These numbers and the charts that go with them are available at Demandside one word dot net, look in the PDF of Demand Side the book beginning on page 53. Also there are numbers for corporate profits. These also favor Democrats, though less definitively. We expect separation with the 2009 report.
Everyone does better in a demand side economy.
Now to Keynes
Robert Skidelsky is author of the definitive biography of John Maynard Keynes. He wrote in the Washington Post yesterday. The treatment we are going to read was edited by Mark Thoma of the Economists’ View Blog, who also contributes this initial quote from Keynes. “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done”:
We Forgot Everything Keynes Taught Us, by Robert Skidelsky, Commentary, Washington Post: …The Great Financial Meltdown would not have surprised the British economist John Maynard Keynes,… for he thought that this was exactly how unregulated markets would behave. …Keynesian economics was … designed to prevent such turbulence. It held that governments should vary taxes and spending to offset any tendency for inflation to rise or output to fall. …
Keynes first became convinced of the instability of unregulated economies in the boom years of the “Roaring ’20s.” In many ways, the 1920s were like the last 15 years in their technological dynamism, the extravagant lifestyles of the very rich and in their “irrational exuberance.” But they were especially like the recent past in their belief that prosperity would continue without interruption.
The magical formula for success was supposed to be the new “science” of monetary management. From the fact that depressions were associated with falling prices and booms with rising prices, the economist Irving Fisher concluded that economic cycles could be eliminated by keeping prices stable. Under his influence, the Federal Reserve Board set itself the goal of price stability. And the price level did stay remarkably stable for most of the 1920s. Fisher’s views were discredited by the stock market crash of 1929, but his doctrines were revived by Milton Friedman in the 1970s. Plagued by inflation, governments around the world took up Friedman’s monetarism, which maintained that inflation was due to governments’ printing too much money. Central banks were … given the single task of keeping prices stable. Moreover, financial innovation in increasingly deregulated markets was said to make investment less and less risky. The formula seemed to work. Not only did inflation stay low … with very little price volatility from the 1990s onward, but the U.S. economy showed strong, though not particularly steady, growth… So what went wrong?
What was wrong was the theory. … Asset bubbles can coexist with a stable price level, even while the rest of the economy is starting to slide into depression. And this, in essence, is what Keynes believed was happening in the late 1920s. Money, he argued, was being switched from production to speculation. The rich were getting very much richer, while the incomes of the rest were stagnating. .. Share prices were being driven up to dizzying heights even as farmers were finding it harder to service agricultural mortgages. …
No one has bettered Keynes in his understanding of the psychology of financial markets. … “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done”…
“The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made,” Keynes wrote in … “The General Theory…” in 1936. We disguise this uncertainty from ourselves by assuming that the future will be like the past, that existing opinion correctly sums up future prospects, and by copying what everyone else is doing. But any view of the future based on “so flimsy a foundation” is liable to “sudden and violent changes…” …
One must bear in mind that Keynes’s aphorisms, which seem so apposite today, were for years dismissed with a pitying smile as the product of a primitive state of economic thinking that had been rendered obsolete by powerful desktop computers and Ph.D. math unavailable to economists of Keynes’s generation. The second strand of Keynes’s economics was formed by the depressed 1930s, rather than the booming ’20s. His main insight was that a wounded economy would not simply bounce back but might take years to recover. In his language, it might remain a long time in a state of “underemployment equilibrium,” from which it could be rescued only by a massive external shock. … It was not the New Deal that brought the U.S. economy back to full employment, but the huge increase in government spending caused by World War II. …
We all hope that the new Nobel laureate Paul Krugman is right that the rescue operations taken in the past couple of weeks may be enough to stem the financial crisis. But the wreckage may be with us for a long time to come. …
Keynesians want to create financial corridors to limit “the flight of the butterfly,” in Paul Davidson’s graphic phrase. Free-marketers argue that the cost of periodic crashes and massive rescue operations is worth paying to preserve freedom of capital movements and technological dynamism. Today, as the costs of the bailout mount up, this argument is heard much less. We know now that we know very little. But Keynes’s insights should not be tossed away…
Now to Ed Crooks in the Financial Times. We note the carricature of Keynes accompanying the article displays a mustache of a size never gracing the economist’s face. We suspect Keynes’ appearance was far too modern for attempt to place him in the distant past.
Financial Time
“We have reached a critical point,” John Maynard Keynes wrote in March 1933. “We can … see clearly the gulf to which our present path is leading.” If governments did not take action, “we must expect the progressive breakdown of the existing structure of contract and instruments of indebtedness, accompanied by the utter discredit of orthodox leadership in finance and government, with what ultimate outcome we cannot predict.”
As the world reels from a 1929-style stock market plunge and a 1931-style banking crisis, his words are a fair assessment of the dangers we face once again. Keynes, whose life’s mission was to save capitalism from itself, is more relevant than at any time since his death in 1946.
His renewed influence can be seen everywhere: in Barack Obama’s planned stimulus package, for example. When George W. Bush said his administration’s plan to take equity in banks was “not intended to take over the free market, but to preserve it”, he could have been quoting Keynes directly.
The key to Keynes was his commitment to preserving the market economy by making it work. He was dismissive of Marxism but believed the market economy could survive only if it earned the support of the public by raising living standards.
The role of the economist, he believed, was to be the guardian of “the possibility of civilisation”, and no economist has ever been more suited for that role.
Lionel Robbins, later head of the London School of Economics, described Keynes as “one of the most remarkable men that have ever lived,” surpassed in his time only by Winston Churchill. Even Friedrich Hayek, Keynes’ staunchest adversary, described him as “the one really great man I ever knew, and for whom I had unbounded admiration”.
His optimistic, positive thought reflected his comfortable and happy upbringing and career. An academic’s son, he won scholarships to Eton and Cambridge and fell in with the Bloomsbury Group, the circle of writers and artists such as Virginia Woolf and Lytton Strachey who embodied an ideal of cultured living.
He was an imposing figure, six feet, six inches tall and full of jokes, gossip and sharp observations. Alongside economics, he had an array of other interests as mathematician, administrator, academic, investor, journalist, art collector, politician, impresario and diplomat. He was even an exemplary husband, devoted to his wife, Lydia Lopokova, a ballerina. In his language he could be carelessly provocative. But, as he said: “Words ought to be a little wild, for they are the assaults of thoughts on the unthinking.”
When bad policies were making economic problems worse, he felt a moral obligation to change them. He worked with distinction at the Treasury during the first world war and at the war’s end argued presciently against the imposition of excessively harsh conditions on Germany. When his advice was ignored, he left and published his views in his first great polemic, The Economic Consequences of the Peace .
Returning to Cambridge, Keynes kept up a flow of books and articles, including The Economic Consequences of Mr Churchill, savaging Britain’s return to the gold standard in 1925. It was not until the Great Depression, however, that his ideas reached their full flowering, published as The General Theory of Employment, Interest and Money in 1936.
The heart of the book is the idea that economic downturns are not necessarily self-correcting. Classical economics held that business cycles were unavoidable and that peaks and troughs would pass. Keynes contended that in certain circumstances economies could get stuck. If individuals and businesses try to save more, they will cut the incomes of other individuals and businesses, which will in turn cut their spending. The result can be a downward spiral that will not turn up again without outside intervention.
That is where government comes in: to pump money back into the economy by some means, such as spending on public works, to persuade individuals and businesses to save less and spend more themselves.
Keynes wrote to George Bernard Shaw that he expected the General Theory to “largely revolutionise … the way the world thinks about economic problems”, and so it proved.
Economists such as Paul Samuelson and James Tobin systematised Keynes’ ideas, using them as the foundations of what became orthodox thought and economic policy for more than two decades after the second world war.
The cover of Time magazine in December 1965 quoted Milton Friedman saying: “We are all Keynesians now.” Friedman later said he had been misrepresented by selective quotation, but the point held good. Charles L. Schultze, then US budget director, felt able to tell Time: “We can’t prevent every little wiggle in the economic cycle, but we now can prevent a major slide.”
By the time Richard Nixon borrowed Friedman’s line in 1971, however, the tide was already beginning to turn. Like a share tip from a lift boy, Nixon’s endorsement was a sign that Keynes’ intellectual stock was about to fall. Keynesian economics seemed as inadequate in the 1970s stagflation as classical economics had been for the 1930s depression, and Friedman’s monetarism eclipsed it among policy-makers in the US and Britain.
After crude applications of monetarism also foundered in the 1980s, modern macroeconomic orthodoxy blended ideas from both, reflecting a belief in the ability of monetary and fiscal policy to affect employment and growth, but also concern for inflation and budget deficits.
As the financial crisis has deepened, that orthodoxy has been shaken. The problems Keynes faced in the 1930s, such as the ineffectiveness of monetary policy and banking failures triggered by falling asset prices, again seem the most pressing. Keynes’ solutions, including greater public spending funded by borrowing, are becoming popular. The criticisms that this will fuel inflation and raise budget deficits are still heard but are increasingly seen as irrelevant.
Robert Skidelsky writes at the end of his definitive three-volume biography that Keynes’ ideas “will live so long as the world has need of them”. It certainly seems to need them now. Keynes was scathing about the view that the Great Depression was a return to normality, a necessary correction after the unsustainable excesses of the 1920s. On the contrary, he argued, the economic expansion should be seen as the normal state of affairs and the downturn was an “extraordinary imbecility”.
With the right policies, he said, the good times could be brought back. He was right then; we must hope he will be right again.
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