The world after Keynes

Keynes is back in fashion, but his policies did not give to the state - at all levels - the leading role in investment that is now necessary, argues Stuart Holland. What is required is a radical rebalancing of relations between economic and social power, led by democratised state institutions

January 10, 2009
12 min read

The global financial crisis has vindicated those who have fought for 30 years against the delusion of Milton Friedman that state intervention was the principal economic problem and deregulation the solution. Former French prime minister Michel Rocard has written that he regrets that Friedman is dead since, were he alive, he should be tried for crimes against humanity. Yet what can or should be done now is not simply a matter of trampling on the grave of Friedman and resurrecting Keynes.

For one thing, the world has changed since Keynes wrote his General Theory of Employment, Interest and Money and was a driving force at the Bretton Woods conference whose outcome was the IMF, the World Bank and the General Agreement on Trade and Tariffs, the forerunner of the World Trade Organisation.

He was right in stressing that comparative advantage in trade would depend on full employment obtained by the action by national governments that an international monetary system should support. But he assumed economies in which capital was mainly national. Now capital is multinational and can relocate investment and jobs to other countries at will. He assumed trade to be between different firms in different countries. Now most of it is driven by foreign investment by multinational companies, which excludes the least developed countries – especially sub-Saharan Africa, which has only 0.1 per cent of this investment. A new international monetary system, which is now on the agenda, needs both mechanisms to offset such inequalities from economic globalisation and to promote global socialisation, including social investments, which can maximise welfare rather than relying only on trade to do so.

Where key Keynesian principles are still relevant is in the need for the state to assure a sufficient level of demand to sustain full employment, and in the mechanism of the multiplier by which investment and spending generate jobs and incomes – a mechanism that Friedman had denied. But this mechanism is best triggered by long-term investments. And in Scandinavia it was such long-term investment through public infrastructure programmes, public enterprise, and welfare states introducing new public services in health care and education, and state pensions, rather than demand management, that generated rising long-term demand after the second world war, rather than short-term Keynesian demand management.

Social democracy succeeded in Scandinavia not only because it managed the level of demand, but because under the pressure of strong and highly political social and trade union movements, it redistributed it through progressive taxation and could fund high-class education, health and welfare services. In Sweden it gained trade union participation in ‘loan funds’ committed to long-term investment that generated high levels of public income and expenditure. The role of public investment in the post-war economic ‘miracles’ of Germany, Italy and France was well covered by former journalist Andrew Shonfield in his Modern Capitalism of 1965. Keynes himself had stressed the case for public works in his journalism. But he neglected this in his General Theory, as did most Keynesians after him.

The dominance of demand management

Despite its title, General Theory is primarily concerned with very specific rather than general issues. It focuses on solving short-term cyclical unemployment rather than assuring long-term investment. What Keynes rightly addressed was how to get people back into employment from either a recession or slump. But although he criticised stock markets as a less than rational means of shifting savings into investment, his own theory of the state did not include that it should have a direct rather than indirect role in doing so: ‘There is no more reason to socialise economic life than there was before … 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,’ Keynes wrote in the book’s final chapter, ‘Concluding Notes on the Social Philosophy to which the General Theory might lead’.

Notably, in this final chapter, Keynes claimed that fiscal and monetary policy in the sense of short-term changes in taxes and interest rates should be enough to stimulate demand growth and encourage confidence in business to keep investment high, otherwise only allowing that it might, perhaps, also need to influence demand in other ways.

The term ‘fiscal policy’ also implied several sets of meanings. It included taxation and public expenditure, and within the latter allowed in principle for expenditure on public investment. But its main message was demand management, as in the right enough association of Keynes and Keynesianism with this. There was no recognition that the state itself might need to become an entrepreneur and drive long term innovating investment through public ownership.

Taking the demand message as gospel, as Anthony Crosland did in his Future of Socialism, first generation Keynesians focused on how to manage it, with debate being about what might be the appropriate level of interest rates or taxes to increase it or slow down it down to avoid inflation. One result of this was the ‘stop-go policies’ of the the UK in the 1950s, which never convinced leading firms to increase long-term investment.

The National Plan of 1965 was supposed to remedy this, but was based on a misreading of French planning – and gave the government no negotiating power with the private sector or real leverage over investment. It failed to appreciate that by the 1960s the French already were planning by negotiating public money in exchange for a commitment by leading firms to invest in long-term high technology projects, rather than just discussing the need for it with them in the industrial sector workshops that were the National Plan’s main mechanisms for involving the private sector. These proved simply to be talking shops. The French were also were very tough in making the public money conditional on revealing transfer pricing, requiring detailed information on this from such firms. This process influenced the proposal for planning agreements in Labour’s programmes from 1972 through to 1983. But, in government from 1974, Harold Wilson, under pressure from the City and the CBI, made planning agreements voluntary, which gelded them.

Keynes, Schumpeter and Marx

Keynes also assumed in his concluding notes to the General Theory that provided the state assured sufficient demand through fiscal and monetary policies, the supply side of the economy could be left to ‘perfect and imperfect competition respectively’. But both these were in what economists call a partial equilibrium framework. While imperfect competition could mean that a firm could increase price by a margin through brand attachment, as in buying Gucci and paying more for an item of clothing to do so, there was no analysis of the unequal dynamics of competition such as in Marx, or the admission that they could come to dominate both markets and macro outcomes such as employment or prices.

By assuming perfect or imperfect competition, Keynesianism lacked a realistic supply side economics, leaving the monetarists to capture the term for their own devices. That a handful of big firms, or oligopoly, could come to dominate markets, extend this globally, and cause a fiscal crisis for the state by transferring profits through tax havens was not recognised till later, and not embodied in mainstream Keynesian thinking.

There also was no consideration by Keynes in his General Theory of long-term cycles, and associated booms and slumps, through waves of innovation, as in Schumpeter. Nor was there allowance, as in Marx, that business cycles might be due not only to under-consumption but also what he called a ‘rising technical composition’ of capital. Marx’s rising technical composition is similar to Schumpeter’s concept of creative destruction, or how technical progress can destroy jobs, but without this necessarily creating others. It is structural rather than Keynes’ or Schumpeter’s main concern with business cycles. It cannot be redressed only by Keynesian fiscal and monetary policy to manage the level of demand.

Short-term Keynesianism failed in France, with a recovery from 1981 stopped in 1983, because the incoming government of the left expanded demand faster than other OECD countries, resulting in a forced devaluation, and then high interest rates to defend a ‘strong franc’. The first PASOK socialist government in Greece was forced into a devaluation of the drachma, at considerable cost. Also, the individual economies were too exposed to speculation against their currencies to be able to sustain Keynesian growth on their own if others did not come with them. The incoming Spanish socialists did not even try Keynesian policies, gave priority to the fight against inflation, and allowed unemployment to approach 20 per cent.

Also, while there is reason nonetheless to call the post-war era Keynesian and to recognise that leading economists in most advanced countries were convinced at the time that full employment was feasible, none of this was sufficient to countervail the failure of Keynesian demand management in Europe when governments did not manage a coordinated reaction to the oil shock of 1973 and ensure that short-term demand adjustment was not at the cost of longer term investment. Their Keynesianism was so shallow and lacking in conviction that within months it was hard to find an avowed Keynesian in any Chancellery or Treasury. Coming from backstage, Milton Friedman stepped forward with answers that were worthy of Voltaire’s Pangloss in Candide after the Lisbon earthquake. Just control government money supply and rational markets will ensure the best of all possible worlds. Michel Rocard has reason to claim that he was the godfather of the financial earthquake now.

Efficient economies and efficient societies

So where does this leave us now, other than in its ruins? First, it is clear that borrowing to invest, as in the US New Deal, is the answer to countering a recession in both in the UK and Europe, but led by governments rather than relying on private sector institutions. European governments have begun to grasp this by increasing the capital base and lending of the European Investment Bank. Second, it is vital that the investments should not only be in advanced technology and aimed at competitiveness, but also social, in health, education, urban renewal and the environment, and aiming to rebalance the asymmetry between markets and societies. Third, we need to recognise that an aggregate increase in productivity from technical progress and innovation will not offset the tendency of Marx’s rising technical composition of capital to displace jobs except in entirely new sectors, such as environmental technology. A recovery programme must be green.

But more than this, we need to rethink growth and distribution in a globalised economy. The best way to secure economic recovery is by public investments shifted through the pockets of the poor, in both the developed and less developed economies. Redistribution should not depend on growth, but be its driver, as it was in the Scandinavian welfare states. We also need to rethink the relation between economic and social efficiency and therefore replace the assumption that only economic productivity should be the criterion of any success.

An efficient market concerns economic criteria, competitive advantage and private gain. An efficient society concerns social criteria, mutual advantage and social gain. An efficient economy is concerned with market innovation. An efficient society is concerned with social innovation.

For example, within a market cost-focused economic paradigm, efficient production in competitive markets reduces labour per unit of output rather than being labour intensive. In line with the recent rhetoric on downsizing, delayering, outsourcing and business re-engineering, it takes jobs out. But social efficiency does not.

An efficient society increases employment to assure social inclusion. It assures sufficient teachers and health workers to provide universal high quality and customised health and education, sufficient social workers to care well for the elderly when they do not have family support, or to relieve pressures on families from the entire burden of such support, as well as providing finance for investment and revenue to fund other high quality public services and to assure environmental protection.

High-quality teaching and health are labour intensive. No one judges a school or university to be better because it has more pupils or students per teacher, but the reverse. This means reducing ‘output’ per teacher and therefore reducing economic productivity, but increasing social productivity. Smaller class size is at a premium within private education, as is more personalised care in health, each with lower economic productivity in terms of pupils taught per teacher, or the longer time and higher cost allocated to a patient by a doctor or health worker. Parents and patients able to do so readily pay for this at a higher price, which compensates the institution, whether school, university, hospital or health centre for what in economic terms is lower productivity. But it is society itself that should invest in this, with both economic and social gains.

First, an efficient society should invert the standard economic assumption that more output per worker should be the sole criterion of efficiency in public services. Second, at a macroeconomic level, an efficient society will draw on gains in economic productivity and efficiency to employ more people rather than less, reducing unemployment and promoting social inclusion. Third, it thereby will generate and sustain demand within an economy through income, employment and taxes paid by more people in jobs rather than drawing benefits because they do not have them. Fourth, it will be more concerned than Keynes in his General Theory with both full and useful employment, with use value and fulfilment for people themselves, rather than the exchange value of doing a job only for the money

This means less concern with human capital than with human value in terms of creativity and innovation in both the market and social domains, such as was the innovation of the welfare state itself. It means less presumption that markets will maximise welfare than a realisation that welfare can generate markets. It means realising both that public spending does not drain, but sustains, the private sector, and investing in new and more plural forms of social ownership closer to people themselves, at regional and local level. It also means recovering the claim of Adam Smith that, in any competition, the welfare of society should cast the balance against all other motives.

Stuart Holland was a leading architect of Labour economic programmes from 1972 to 1983. He is now a visiting professor at the University of Coimbra in Portugal

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