An assessment of the impact of the ideas and activities of John Maynard Keynes on the development of the international economy

John Maynard Keynes was arguably the most influential economic thinker of the twentieth century. His ideas and theories have generated academic discussion and debate. As with all landmark scientific achievements in human history Keynesian economics too has had mixed fortunes in its journey so far. The following quote from Knut Wicksell succinctly expresses this condition, “…there is no single doctrine taken to be a scientific truth without the diametrically opposite view being similarly upheld by authors of high repute … in other fields of science these conflicts usually come to an end … It is only in the field of economics that the state of war seems to persist and remain permanent.” (Dillard, 1948) This observation by Knut Wicksell is perfectly applicable to the impact and interest Keynesian economics has generated in the last seventy years or so. The rest of this essay is an attempt to assess the impact made by the Keynesian school of thought in the context of international economy. John Maynard Keynes’ seminal work, the General Theory, has had a profound effect on the way macroeconomic thought had evolved ever since. It divided the fraternity of economists into two groups. On one side were those who believed that a capitalist market economy does not need governmental interference as it is intrinsically regulated by underlying price mechanisms. The other group questioned this supposed self-equilibrating economy’s ability to minimize unemployment rates. This was a widely debated topic during the 1950s and 1960s. Ironically, economists resorted to the neoclassical analysis for settling this argument. As it stands, some form of reconciliation seem to have been achieved between the two viewpoints, but not a convincing one. The economic mechanism behind unemployment rates is of interest to both politicians and businesses alike (Dillard, 1948). In this context, Keynes had made a significant contribution in deciphering and helping understand these key economic processes that concern public representatives and common citizens. To quote, “The theoretical debate relating to the consistency of macroeconomic equilibrium with an excess supply of labour appeared to have been won by supporters of the invisible hand view, but as a practical matter it was accepted that the self-righting properties of the market were too weak and needed the helping hand of fiscal and monetary policies in order to achieve and maintain the primary stated objective of full employment. Keynesians of all persuasions accepted the possibility of widespread and frequent 'effective' demand failures together with prolonged involuntary unemployment.” (Eichner, 1979) The General Theory suffered a temporary setback during the late 1960s and early 70s when the microeconomic underpinnings of the supply side of Keynesian models were proved inaccurate with the breaking down of the Phillips curve. Scepticism over the veracity of Keynesian thought grew in 1973 when the OPEC went through a turbulent economic phase. This was one of the low-points of Keynesianism when many academics denounced it and opted to adopt the new classical model proposed by Robert Lucas. But it is a testament to the robustness of the Keynesian thought that it survived these sporadic aberrations and continues to be studied and expanded even to this day. More than thirty years after the publication of The General Theory, the vibrancy and vitality of the Keynesian school had led to the development of New Keynesian Economics. This new avatar was founded on need to “search for rigorous and convincing models of wage and/or price stickiness based on maximizing behaviour and rational expectations” (Eichner, 1979). This meant that Keynesians started focusing on the following areas of economics that were not properly understood: 1. Nominal wage stickiness 2. Nominal price stickiness 3. Real rigidities 4. Co-ordination failures The relevance of new Keynesian models to contemporary business management cannot be overstated. In an era when globalization is on the ascendancy and most business corporations having an international presence, the reasons for worker layoffs, increasing labour costs, etc are difficult to grasp. The new Keynesian framework addresses these gray areas of international economy. For instance, new Keynesian models suggest that the rationale behind worker layoffs during economic downturn is not due to high labour costs. To the contrary, it points to the overall fall in sales for laying-off employees (Eichner, 1979). This new model is consistent with the original Keynesian economics, in that, it states that the very existence of the phenomena of business cycles is an evidence of economy-wide market failure. Further, “This also implies accepting the existence of involuntary unemployment, the non-neutrality of money, sticky prices and wages, and non-clearing markets. However, it is important not to assume that new Keynesians are protagonists in the monetarist-Keynesian debate because new Keynesians do not hold a unified view with respect to the relative potency of fiscal and monetary policy nor do they '. . . necessarily believe that active government policy is desirable'. The recent work of Edmund Phelps has also inspired the emergence of a 'structuralist' branch to the new Keynesian school where non-monetary models are given emphasis” (Klein, 2001) The fact that the General Theory outlasted controversies and disagreements pertaining to it at the time of its introduction says something about its value to modern commerce. The General Theory was a compendium of several ideas. The problems arose when people picked a particular set of ideas for analysis while neglecting the rest. Those economists who tried to pinpoint the essence of Keynes’ ideas inevitably attained an incomplete and incomprehensive understanding of the General Theory. Hence, an acknowledgement of the expansiveness of Keynesian economics is key to its proper interpretation and application (Klein, 2001). Other eminent economists such as Milton Friedman and Gregory Mankiw are strong advocates of certain aspects of Keynesian economics. For instance, both Mankiw and Friedman agree to Keynes’ assertion that the business cycle represents a kind of large-scale market imperfection. Mankiw even goes on to state that the breakdown of the Phillips curve does not discredit orthodox Keynesianism. Rather, a more robust Phillips curve, one that addresses deficiencies on the supply side, was the answer. This goes to show that where Keynesian economics fails, it is not due to fundamental flaws, but due to oversight or approximation. Gregory Mankiw further illustrates how the new Keynesian macroeconomic principles are gaining wider acceptance today. In a world economy dominated by powerful multi-national corporations, the theory of imperfect competition requires special attention. In Mankiw’s own words, “A large part of new Keynesian economics is trying to explain why firms set and adjust prices over time in the way they do. Firms in a perfectly competitive environment don't have any choice over what their prices are going to be. Competitive firms are price takers. If you want to even talk about firms setting prices you have to talk about firms that have some ability to do so, and those are firms that have some market power: they are imperfectly competitive. So I think imperfect competition is central to thinking about price setting and therefore central to new Keynesian economics.” (Mcdermott, 1993) A little recognized aspect of Keynesian economics is its congruence with Marxism. The failure of the Soviet Union cannot be a statement on Marxism; it is anything but. In a recent poll conducted by BBC Radio, Marx was voted as the most important intellectual of the modern era. This is an astounding fact given the anti-communist propaganda in Western European nations and the participants were primarily from bourgeoisie British demography. This makes results are thus very convincing and decisive. The aspect of Marx in Keynes’ work is discussed below (Aoki, 2001). The General Theory of Employment, Interest and Money was published in 1936. But Keynes’ initial draft of 1933 contained a feature which was omitted in printed version. In the draft, Keynes employs a taxonomic framework to distinguish the classical theory of capitalism from his general theory. The taxonomy showed that depending on the manner in which capital and motivation of production are incorporated, an economic enterprise’ “market-clearing results will be either ensured or merely possible”. When compared to the co-operative economy of the classical theory, the entrepreneur economy illustrated by Keynes can succeed in bringing about the following outcomes – market clearing, stagnation and instability. Keynes also agreed with the distinction Marx made between C-M-C and M-C-M. In other words, between a) selling commodities (C) to obtain money (M) with which to buy other commodities and b) purchasing commodities with money so as to generate more money. These two models also seem to distinguish the modes of operation of the proletariat and bourgeoisie respectively. The fact that Marx and Keynes agreed on many fronts is a sign of authenticity for Keynes’ theory. It also holds relevance for policy makers of today, for the early years of the twenty first century has seen renewed interest in socialism and community-based economic systems as is evident from the success of the World Social Forum in Porto Allegre (Maclachlan, 1993). Another crucial point that Keynes makes is the distinction between consumption and investment, the understanding of which is key to grasping his larger synthesis. To quote, “His theory states that employment depends upon the amount of investment, or that unemployment is caused by an insufficiency of investment. This, of course, is a great simplification. Nevertheless, it indicates the emphasis on investment. Not only do some workers receive employment directly in building new factories, houses, railroads, et cetera, but the workers so employed spend their money for the products of factories already built, pay rent on houses already built, ride railroads already built, et cetera. In brief, employment in investment activity helps to maintain demand for the consumption output of existing facilities. In order to make full use of the factories already in existence, we must always be building new factories…” ( Maclachlan, 1993) Continuing on the theme of Keynes and the modern social justice movement, the questions raised by Keynes’ work pertaining to the effect of the wealth owning class of society on the rest of the populace deserves mention here. According to Keynes, when wealth-holding class chooses to hoard the money rather than channelling it toward development projects that includes investing and lending, then the whole of the society is adversely affected. If this practice of preferring to own rather than invest was pervasive among the wealth-owners is a sure indicator of future economic uncertainty, which would not augur well for all sections of demography. In other words, in an atmosphere of predictable economic future, there would be no point in storing money in currency form. In Keynes’ own words, “the desire to store wealth in the form of money is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. . . . The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude." (Rousseas, 1986) And this observation has a lot of relevance today as the world economy is headed toward a period of recession at the time of writing this essay. The common cause between Marx and Keynes is succinctly captured in the following words, “…an aspect of common cause between Keynes and Marx. Specifically, the rhetorical task of persuading political economists to rethink capitalism's inherent stability requires a refutation of classical theory's thin concepts of money and the monetized nature of capitalist production. The antithesis is provided, of course, by the opposed political agendas: Keynes sought to theorize capitalism's instability in order to find effective policy controls, while Marx aimed at showing that this instability is fundamentally beyond control.” (Rousseas, 1986) When we scrutinize the objections raised by Marx and Keynes to the classical theory, we find many similarities in the way both of them treat “money, the motivation of production, and the conditions of crisis potential” (Mcdermott, 1993). It is also true that the taxonomic framework and its theoretical undercurrents to Marxist theory were eschewed in Keynes’ theories as well. In this sense Keynes’ contribution to modern economics is essentially an extension of Marx’s critique of capitalism. In the neo-liberal capitalist international economy of the twenty first century, Keynes’ concern regarding the crisis potential of capitalist systems is highly relevant. Keynes believed that a monetary theory of production, one in which capital has “operational importance regarding motives to produce, is necessary in order to theorize the possibility of crisis”. Keynes was also right in pointing out how the classical economists’ theorization was devoid of the basic characteristics of a monetary production economy, “in which production is motivated by the desire for money-profit and not for use-values”. Keynes was also correct when he pointed out the central role of production, namely, “its organization, the motivation for embarking upon it, the conditions which must prevail if its object is to be realized, and the determination of the aggregate level of production” (Sardoni & Kriesler, 1999). Such is the impact of Keynesian economics in the industrialized world that its ideas have helped shape the nature of the American economy. For instance, the success of the tax-cut program under Lyndon Johnson was seen by experts as a vindication of Keynesian thought. Of course, this has to be viewed alongside the recession and period of economic uncertainty that followed. Dissenting voices were heard in the 1970s when the Keynesian system apparently could not provide a solution to growing rate of inflation. But Nobel Laureate Lawrence Klein offers a different rationale for the inflation thus, “In the 1970s, Keynesian stimulus was made the scapegoat for the rising prices. But we should remember that balancing fiscal and monetary policies is a problem. If you do just one thing, it is not necessarily enough--neither monetary policy alone nor fiscal policy alone, and neither tax cuts nor expenditure increases alone. You need to mix policy. By having the right balance, you can get high employment and stable prices” (Kellner, 1997). Keynes’ emphasis on the importance of monetary policy was treated with scepticism as economists focused on fiscal policy. But as the events of the 1970s unfolded, it increasingly became clear that monetary aggregates such as M1 and M2 which were given un-due focus before, are not the key indicators. Ever since its first publication in 1936, the General Theory has had an influence in the agenda and direction that modern macroeconomics would take. Its impact is so significant that many new economic terms were spawned by the interaction between Keynesian system and older systems based on business cycles and the quantity theory of money. Keynes’ rise to prominence was a significant achievement, for his theory had to find acceptance among his peers, who included Irving Fisher, R.G.Hawtrey, Robertson and Hayek. Before Keynes published Treatise on Money in 1930, Irving Fisher was the most prominent economist. Alongside A Tract on Monetary Reform, Keynes had written an impressive set of books that would challenge conventional assumptions of classical economic thought and would change forever the way in which fiscal and monetary policies are constructed (Kellner, 1997). The rise in popularity of Keynes as an economist coincided with greater application of his theory to international economics. This shift in approach to international economics is evident from the following statistic, “John Cunningham Wood reprinted 110 journal articles written on Keynes between 1946 and 1981 in the four volumes of John Maynard Keynes: Critical Assessments, while Mark Blaug included another 73 published from 1981 to 1989 in the Keynes volumes of Pioneers of Economics. By contrast, one volume of Pioneers of Economics comprising nine articles suffices for Irving Fisher, Arthur Hadley, Ragnar Frisch, Friedrich Hayek, Allyn Young, and Ugo Mazzola.” (Snowdon & Vane, 1995) Joseph Stiglitz and Bruce Greenwald are two contemporary economists affiliated to the Keynesian school. They support the old Keynesian position that increasing wage and price flexibility may worsen a recession. On the other hand, the new Keynesians would suggest that natural economic processes can exaggerate economic shocks that are in reality quite small and that prevailing price rigidities might decrease the intensity of the fluctuations as stated by Keynes. New Keynesian economics have crucial policy implications, especially when every presumption regarding non-interventionist theories come under heavy scrutiny. Nation-states drawing up fiscal policies can take heart from the fact that empirical evidence shows how their timely interventions have stabilized the economy more often than not. Discretionary ad hoc measures on part of the government are highly relevant today, for “changing economic circumstances require changes in economic policy, and it is impossible to prescribe ahead of time what policies would be appropriate” (Snowdon & Vane, 1995). Also, it would be impractical for any government to adhere to a set of predetermined rules for if the rate of unemployment soars, the government will have to intervene irrespective of what was planned before. However, it has to be kept in mind that moderation is the key to good governance. In the context of interference in the national economy, ambition should be pursued with caution and restraint. Since international economy is dominated by large business corporations, their decisions can have cascading economic effects. Usually, most firms are cautious during an economic downturn as they are attuned to risk minimization. This implies that “a negative aggregate demand shock could translate itself into a leftward shift of the aggregate supply schedule” (Mcdermott, 1993). Other factors such as generic volatility associated with all imperfect markets, asymmetric information equity and limited risk diversification options, etc, make business corporations susceptible to bankruptcy, especially when the level of output is high. Further, “Risk-averse firms will be less willing to supply at every price when the environment becomes less favourable and increasingly uncertain. When in an economic downturn firms observe a shift in their demand curve they must either reduce their output or their price. Risk-averse firms prefer to adjust their output because the uncertainties associated with changing prices may be much greater…The important implication is that the resultant risk-based aggregate supply curve will shift leftwards following an economic downturn initiated by an aggregate demand shock. This results in the non neutrality of money even if prices are perfectly flexible” (Hazlitt, 1984). A fitting conclusion to this essay would require us to compare the importance of Keynes’ work with that of other legendary economists of the past. As early as within the first decade subsequent to the publication of John Maynard Keynes' The General Theory of Employment, Interest and Money it had become a corner stone of modern economic thought and “has had more influence upon the thinking of professional economists and public policy makers than any other book in the whole history of economic thought in a comparable number of years”. Similar to Adam Smith’s Wealth of Nations, which was the most significant work on economics to be published during the eighteenth century and Karl Marx’s Das Capital the following century, Keynes' General Theory has aroused admiration and disagreement alike. While Smith's work was a critique of mercantilism, Marx's book was an analytical discourse on the deficiencies of capitalism. Even those economists who were initially quite critical of Keynes’s theories have come to accept the validity of the Keynesian position. References Aoki, M. (2001). To the Rescue or to the Abyss: Notes on the Marx in Keynes. Journal of Economic Issues, 35(4), 931+. Baddeley, M. (1999). 10 Keynes on Rationality, Expectations and Investment. In Keynes, Post-Keynesianism and Political Economy, Sardoni, C. & Kriesler, P. (Eds.) (pp. 196-213). London: Routledge. Besomi, D. (2003). A History of Post Keynesian Economics since 1936. Economic Record, 79(246), 380+. Casares, M. (2007). Monetary Policy Rules in a New Keynesian Euro Area Model. Journal of Money, Credit & Banking, 39(4), 875+. Cottrell, A. F. & Lawlor, M. S. (Eds.). (1995). New Perspectives on Keynes. Durham, NC: Duke University Press. Defina, R. H. (1991). International Evidence on a New Keynesian Theory of the Output-Inflation Trade-Off. Journal of Money, Credit & Banking, 23(3(1-2), 410+. Dillard, D. (1948). The Economics of John Maynard Keynes: The Theory of a Monetary Economy. New York: Prentice-Hall. Eichner, A. S. (Ed.). (1979). A Guide to Post-Keynesian Economics. White Plains, NY: M. E. Sharpe. Fitzgibbons, A. (1988). Keynes's Vision: A New Political Economy. Oxford, England: Clarendon. Hazlitt, H. (1984, November 16). Keynes's Lifelong Confusions. National Review, 36, 44+. Kellner, P. (1997, February 28). Keynesianism Is Dead; So Long Live Keynesianism. Because the Past 18 Years Have Proved That It Can Work, in Doses. New Statesman, 126, 27. Sardoni, C. & Kriesler, P. (Eds.). (1999). Keynes, Post-Keynesianism and Political Economy. London: Routledge. Klein, L. (2001). Keynesianism Again. Challenge, 44(3), 6. Lawson, T. (1993). Keynes and Conventions. Review of Social Economy, 51(2), 174+. Maclachlan, F. C. (1993). Keynes' General Theory of Interest: A Reconsideration. New York: Routledge. Mcdermott, K. A. (1993). The Evolution of the "Investment System": Keynes' Theory of Employment and Money Revisited. Review of Social Economy, 51(1), 62+. Rousseas, S. (1986). Post Keynesian Monetary Economics. Armonk, NY: M.E. Sharpe. Snowdon, B., & Vane, H. (1995). New-Keynesian Economics Today: The Empire Strikes Back. American Economist, 39(1), 48+. Wray, L. R. (2000). A New Economic Reality: Penal Keynesianism. Challenge, 43(5), 31.

Related Posts: