Economy,  History

The misunderstood Mr. Keynes

Guest post by Andrew Murphy

In the 20th century, two economists stand out: John Maynard Keynes and Frederich Von Hayek. As I have argued on Harry’s Place in the past, Hayek is still misunderstood by both critics and advocates alike. This misunderstanding applies equally to Mr. Keynes, perhaps even more so.

There are certain things everybody “knows” about Keynes and what he advocated. Critics, especially in America, are quick to say with certitude what that is. Conservative radio populist Rush Limbaugh told one of his listeners in 2010:

“You want more people to know who John Maynard Keynes was. Okay, attention, class. John Maynard Keynes. If you want to know what Keynesian economics is, you’re living it: Barack Obama, massive government spending, massive debt, massive redistribution of wealth, the lie that government spending, deficit spending can propel economic growth.”

According to libertarian historian Ralph Raico, Keynes is nothing more than a commie sympathizer (PDF).

So let’s start to separate Keynes the myth from Keynes the economist.

Myth # 1- Keynes believed in deficits extending out into perpetuity

Keynes in fact would scoff at politicians such as Dick Cheney who once quipped, “Deficits don’t matter.”

In 1937 Keynes wrote, “The boom, not the slump, is the right time for austerity.” Government deficits were only permissible for Keynes during economic bad times. He made it very clear that his book, General Theory of Employment, Interest and Money (PDF) was to address a specific economic condition of the time in the 1930s, not a blueprint for good times.

Of course Keynes’s disciples have not done him any favors. During the boom years, many of his devotees have said, “spend, spend, spend”. In the Clinton era, when President Clinton was making balancing the federal budget as a prime focus during an economic boom, many of his Keynesian advisers were pressuring him to “invest” the surplus. And it is because of this, now in the Great Recession of 2008-2012, when many countries in Europe should be running deficits to counter and make up for the lack of spending in the private sector, they are constrained because during the boom years, they spent money and ran massive deficits. Modern Keynesians have been their own worst enemy.

And on the other side, it has been the Chicago School of Economics, like Gary Becker and the late Milton Friedman who argued during the GOP years that deficits were tolerable if it would “starve the beast”(if you deny the state revenue and run major deficits, it will force it to cut spending).

Keynes, properly understood, was fiscally conservative. He certainly has less to answer for than the American supply-siders and the Chicago School, both of whom tolerated massive deficits during the Reagan and Bush years in hopes that it would force the government to stop spending. “Starving the Beast” has been responsible for far more of the deficit problem in the USA than even anything advocated by misguided Keynesians. The late Bill Niskanen of the libertarian Cato Institute lays out (PDF) the fiscal mischief caused by “Starving the Beast.”

Myth #2 – Keynes was a crude inflationist and for price controls

When it comes to price controls, people seem to conflate John Kenneth Galbraith with Keynes. It was the economist Galbraith who had a love affair with price controls, even after nearly every economist had abandoned such views, Galbraith continued up to the 1990s to nostalgically think about the benefits of controls on prices.

When President Nixon imposed wage and price controls in 1971 on the US economy, he joked, “We are all Keynesians now.”

Au contraire, Tricky Dick. One of the greatest books of the 20th century on the evils of price controls and inflation is The Economic Consequences of Peace by Keynes. When referring to price controls, Keynes wrote:

The preservation of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself … the seeds of final economic decay, and soon dries up the sources of ultimate supply.

Keynes opposed both the British and USA World War II price and wage controls.

The inflation charge is rather shocking, since Keynes’s entire life was devoted to exposing the evils of inflation. In fact, his arch-nemesis F.A. Hayek, years after Keynes death (1946), would concede in a book written in the 1970s, that Keynes would be“one of the most determined fighters against inflation,” if he were still alive.

In his book Tract on Monetary Reform, Keynes devotes most of his energy pointing out the evils of inflation and how governments love it, since it is basically a tax.

[The burden of inflation falls] on the holders of the original . . . notes, whose notes [after inflation] are worth . . . less than they were before. The inflation has amounted to a tax . . . on all holders of notes in proportion to their holdings. The burden of the tax is well spread, cannot be evaded, costs nothing to collect, and falls, in a rough sort of way, in proportion to the wealth of the victim. No wonder its superficial advantages have attracted Ministers of Finance.

In several letters to the (London) Times in 1937, Keynes, even at the height of the Great Depression, was concerned about inflation. He admonished the British government that stimulus may have run its course and the Treasury may need to scale back investment spending. Likewise, even with unemployment at 12 percent, Keynes was worried about inflationary potential in the government’s spending program.

This is important because when General Theory came out, he argued, that given a choice between a little inflation and a pure deflationary economy, the former was better than the latter. However at the first signs of inflation, Keynes abandoned those views, as those letters to the Times illustrate. Keynes would have been mortified in the postwar era with his name being connected in any way to the so-called Phillips Curve: the argument that there is a tradeoff between lower unemployment and higher inflation (which was the standard American Keynesian argument till the 1970s). Is it any wonder that management guru Peter Drucker, who attended Keynes seminars at Cambridge, always said that Keynes despised the American economists that invoked his name?

Myth # 3- Keynes was for big government

Contrary to popular belief, Keynes was no advocate of a huge government. In correspondence with economist Colin Clark after the war, Keynes wrote that a 25 percent tax/GDP ratio “is about the limit of what is easily borne.”

Currently the USA tax/GDP ratio is 26.9 percent, for the UK it is 39 percent and in other parts of Western Europe like Sweden and France, the ratio is in more than 40 percent. Keynes would be considered a right wing economist in Sweden if he rose from the dead today.

Now from a pure libertarian perspective, a 25 percent tax/GDP ratio is monstrous; however, in the real world, a 25 percent rate is fairly realistic and obtainable. There is no way countries are going to give up their safety nets or national defense. One of the biggest misunderstandings in the USA perpetuated by Tea Party advocates is that government spending is full of easy cuts. Just get rid of X,Y, Z and problem solved.

If you look at the pie chart here, you will see that nearly 60 percent of the entire Federal budget of the USA goes to four items: Social Security, Medicare and Medicaid, national defense and interest on the debt. Now there are certainly arguments to be made that taxes and means testing reforms needed to be put in place, but none of these middle class entitlement programs are going to go away tomorrow, if ever.

Considering that Keynes’s 25 percent ratio is lower than any European country or the rugged individualist USA, one would have to classify Keynes as a bit of a conservative when it comes to government. So put that in your cigar and smoke it, Rush Limbaugh.

Myth #4- Keynes was a social democrat or socialist

This one is an amazing myth. One that Keynes would no doubt offend Keynes. In his famous speech “Am I a Liberal?” from 1925, Keynes comes out swinging with a rhetorical baseball bat as to why he could never side with the British Labour Party.

To begin with, it is a class party, and the class is not my class. If I am going to pursue sectional interests at all, I shall pursue my own. When it comes to the class struggle as such, my local and personal patriotisms, like those of every one else, except certain unpleasant zealous ones, are attached to my own surroundings. I can be influenced by what seems to me to be justice ad good sense; but the class war will find me on the side of the educated bourgeoisie.

Later he describes the Labour Party as made up of mostly an “immense destructive force” peddling “anti-capitalist rubbish.”

In a speech before the Manchester Reform Club in 1926, Keynes told the audience,

The political problem of mankind is to combine three things: Economic Efficiency, Social Justice, and Individual Liberty. …….The second ingredient is the best possession of the great party of the Proletariat. But the first and third require the qualities of the party which, by its traditions and ancient sympathies, has been the home of Economic Individualism and Social Liberty.

Keynes’ biographer, Lord Skidelsky, points out that one of Keynes’s first essays as a young man was on Edmund Burke, the quintessential philosophical conservative. “Statesmen must learn the wisdom in the school of Burke,” Keynes wrote.

Likewise, in his essay, The End of Lassiez-Faire, Keynes shows he is a man of the centre, not of the extreme. He was an opponent of not only socialism but Manchester Liberalism (today better known as libertarianism). They are philosophically two peas from the same pod.

Nineteenth-century State Socialism sprang from Bentham, free competition, etc., and is in some respects a clearer, in some respects a more muddled, version of just the same philosophy as underlies nineteenth-century individualism. Both equally laid all their stress on freedom, the one negatively to avoid limitations on existing freedom, the other positively to destroy natural or acquired monopolies. They are different reactions to the same intellectual atmosphere.

Keynes would write in Chapter 12 of his magnum opus, General Theory, “Economic prosperity is dependent on a political and social atmosphere which is congenial to the average businessmen.” Strip away all the veneer and all the wordy manifestos and party platforms and that one sentence encapsulates the governing principle of every centre-right political party in Europe and the Republican Party in the USA.

Myth # 5- Keynes praised National Socialist economic policy

It is common on the part of many critics of Keynes to try and smear him as a Nazi sympathizer because of his German Introduction to the General Theory in 1936.

Here is the alleged nasty endorsement:

The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Since it is based on fewer hypotheses than the orthodox theory, it can accommodate itself all the easier to a wider field of varying conditions. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced.

There is of course no endorsement of any kind of fascist economic policy. As author Harold Wattel writes, “Keynes is comparing the usefulness of micro and macro theory in a totalitarian state. He is not comparing the usefulness of his macro theory in a totalitarian state with its usefulness in a democratic state.”

As to flirting with fascism, conservative and libertarian critics seem to forget, that both FA Hayek and Ludwig Von Mises came much closer to putting their foot in their mouth when it comes to fascism.

Von Mises, the great Austrian economist and defender of Manchester Liberalism in its purest form, wrote in his book Liberalism:

It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history.

Hayek in the 1970s, in an interview with a Chilean newspaper, gave a backhanded endorsement to the Pinochet regime, saying, “My personal preference leans toward a liberal dictatorship rather than toward a democratic government devoid of liberalism.”

It is safe to say, Keynes is a very misunderstood man. It is time for the centre-right to embrace their inner Keynes. He is a man of the middle.

President Dwight Eisenhower once said, “People talk about the middle of the road as though it were unacceptable. Actually, all human problems, excepting morals, come into the gray areas. Things are not all black and white. There have to be compromises. The middle of the road is all of the usable surface. The extremes, right and left, are in the gutters.”

John Maynard Keynes would second that, for sure.

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