By PRIME economists: Victoria Chick, Douglas Coe, Ann Pettifor
Today, Wednesday 3 August 2011 at 08.00pm BST (GMT +1), BBC Radio 4 will broadcasta debate which took place at the London School of Economics (LSE) on 26 July. This broadcast will be repeated on Saturday, 6 August, at 10.15 p.m BST (GMT +1).
Debaters considered whether Keynes or Hayek had the solution to the present financial crisis. The economist George Selgin and philosopher Jamie Whyte spoke for Hayek; Keynes’s biographer Robert Skidelsky and the economist Duncan Weldon spoke for Keynes.
On the one hand we are pleased that the BBC and the LSE now acknowledge rival positions to the present austerity policies of Western governments. On the other we are concerned that the debate might have served mainly to reinforce existing prejudices, rather than to clarify the substance of the matters under discussion, matters which – there can be no doubt – are of the most profound importance.
Lord Skidelsky provocatively but justly reminded the audience that in the early 1930s, the same orthodoxy driving western austerity policies directed the actions of Germany’s 1931 Bruning government and paved the way for the rise of Nazism. These actions – vigorously opposed by Keynes – were the final straw for a Germany crushed by defeat and the disastrous boom-bust cycle that followed their return to the gold standard. Reparations were easily circumvented by wildly excessive borrowing from financial interests around the world, in a manner that even Keynes did not anticipate. It was these financial and fiscal policies that brought Hitler to power.
With financial interests still firmly in the ascendency and reactionary right-wing forces increasing their grip in the United States and much of the Western world, we must not forget these lessons from history, which formed the background to the original debate between Keynes and Hayek themselves. The stakes are high indeed.
Keynes shared with Hayek a preference for the economy to be primarily the province of the private sector. However, he recognised that ‘the market’ did not always best serve the common good and therefore that state intervention was necessary – and not just during a slump. In this he was diametrically opposed to Hayek.
For Keynes, the market’s major flaws were rooted in monetary arrangements that favoured speculation and excess consumption rather than productive activity. In addition, in a slump, the pessimistic outlook of producers and investors allowed the slump to persist and needed the stimulus of public works expenditure.
The LSE debate neglected the subtleties of the respective positions of Hayek and Keynes and reinforced many of the most common and most dangerous fallacies about Keynes’s contribution – and even established some new ones. While both economists were misrepresented to some extent, our main concern must be to rectify distortions about Keynes. There are eight misrepresentations that we want to bring out.
1. Hayek as “an opponent of financial excess”
From 1971 through the early 1980s, restraints on the financial sector were steadily unwound. These actions were prompted by Hayekian ideals of liberalism, as is well known. The Hayek supporters at the LSE debate dissociated themselves from this liberalisation, the cause as we now know, of the rapid expansion of the money supply before the crash. Hayek might not have predicted this consequence of liberalisation, but its disastrous consequences are now plain to one and all. Perhaps this is why the debaters dissociated themselves from this aspect of Hayek’s position. Instead they castigated the conduct of the liberalisation policy rather than the policy itself. Indeed the ideal of liberalisation was scarcely mentioned, for to do so would be to acknowledge the existence of an alternative: Keynes’s managed financial system.
2. Keynesian policy as “promoting the big state”
Keynes’s most substantial legacy was a financial system managed by the state. This system prevailed from the end of the gold standard until the 1970s. This management ensured that on the one hand low long-term interest rates facilitated both private and public sector investment; on the other, restraints on
banks and capital mobility kept speculation and excessive consumption at bay. Keynes had devised and helped implement a financial system that was conducive to production and investment rather than speculation and consumption. A larger state rightly prevailed than in the 1920s or 1930s, but ironically Keynes’s state was still smaller than the state that prevailed after the counter-revolution of financial liberalisation
The post-war world was one in which the state and the private sector operated powerfully in tandem, supported by a greatly revised monetary architecture.
As we have stressed, Keynes was concerned mainly with the effective operation of the private economy.
3. The inflation of the 1970s as “the fault of Keynesian policies”
The inflation of the 1970s began just after the Keynesian post-war mechanisms for the regulation of finance started to be dismantled. In Britain, controls on banking and capital mobility were relaxed, and liberalised arrangements were restored, beginning with Competition and Credit Control (1971) (evaluated as “all competition, no control” by most economists). The root cause of the inflation of the 1970s was the massive expansion of the money supply that followed the deregulation of credit control, as both Friedman’s monetarism and Keynes’s General Theory, Ch. 21, predict.
The inflation of the 1970s was not the consequence of Keynes’s policies but of the dismantling of his policies for restraining the finance sector. In the past, the inflationary 1970s would have been understood as a ‘bankers’ ramp’.
4. Keynes as “advocate of deficit spending”
While the importance of Keynes’s monetary policies is scarcely recognised, even his fiscal policies are severely misrepresented. Most prominent and pernicious of all is the idea that he advocated deficit spending. From his earliest contributions to the debate on fiscal policy, Keynes was concerned to establish how public works expenditure would pay for itself and would constitute a relief rather than a burden to the public finances. As we have shown in ‘The economic consequences of Mr Osborne’,[i] the outcomes of public expenditure policies over the last century vindicate his analysis. It remains a puzzle why even Keynes’s most ardent champions neglect the evidence.
5. Keynes as “a supporter of wasteful expenditures”
Even after being corrected by Lord Skidelsky in an earlier exchange during the LSE debate, George Selgin repeated the false charge that Keynes supported “indiscriminate spending.”
As Lord Skidelsky emphasised during the debate, Keynes was concerned to revive private investment. He argued that government spending was the only possible means of doing so when businesses were in deep recession (elsewhere Keynes had also recognised the burden of heavy indebtedness on business). Given that the state had to spend to revive the private sector, it was more sensible for government to spend on socially useful activities. But failing that, even spending on socially useless ventures for reviving the private sector was better than nothing.
What Keynes actually said was this:
… ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.” [ii]
(Keynes’s attack on the principles that ‘stand in the way of anything better’ continues for a further two pages.)
The sort of misrepresentation that Selgin engaged in serves him and public debate very badly.
Equally fallacious is the Hayekian charge that public expenditure diverts resources from the private activities that should be the basis of any free society. Keynes showed that in a recession no private activity would emerge of its own volition: resources would simply be left idle. To wait for some pre-ordained and virtuous private expansion would be to wait forever while unemployment grew and society crumbled.
6. Roosevelt’s New Deal as “trivial in scale and impact”
The economics profession has recently been willing accessory to the idea that the New Deal was economically without meaning. Sadly – as Selgin trumpeted with some glee during the LSE debate – this idea is associated with Christina Romer, the Chair of the US Council of Economic Advisors in the early years of Obama’s Presidency. Under Romer, the EAC championed fiscal expansion to counter the effects of the ‘great recession’. But Romer appears to have been compromised by her earlier claims that fiscal policy was unimportant in the Great Depression. In 2009 she attempted to set the record straight:
One crucial lesson from the 1930s is that a small fiscal expansion has only small effects. I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression. From this, some have concluded that I do not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be farther from the truth. My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression, fiscal policy failed to generate recovery ‘not because it does not work, but because it was not tried’.[iii]
But this is to demean Roosevelt’s courage and achievements as well as to misrepresent the facts. Romer’s earlier conclusion follows from a failure to understand that the public sector deficit or surplus does not measure the policy stance, but reflects the outcome of policy. If spending is successful in raising income, higher tax revenues and lower benefit expenditures automatically reduce the deficit.
Instead of relying on abstract analysis in evaluating government expenditure during the great depression, let us look at the figures that are readily available on the Bureau of Economic Analysis website.
Table 1: US Government consumption and investment expenditures
The increases in state spending in the mid-1930s have no precedent in peacetime.[iv]
The Hayekians at the LSE debate also argued that World War Two did not bring the Great Depression to an end. The idea is ludicrous from any but the most perverse of perspectives. Note that the end of the Great Depression began as Roosevelt’s spending began in earnest, as this chart of unemployment shows:
US Unemployment rate