“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.
...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.
Copyright The Financial Times Limited 2008