Keynes and The General Theory Revisited

Axel Kicillof, Elena Odriozola

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9780367884611
• eBook ISBN: 9781351601252
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Every time the economy goes through a period of crisis, Keynes' name is called upon by economists and politicians from diverse backgrounds. However, 70 years after the publication of The General Theory of Employment, Interest and Money, specialists are still far—maybe everyday further—from reaching agreement about the genuine contents of Keynes' most important work. This controversy has been marked by a paradoxical turn: it is above all the literature about Keynes which, in the last decades, has imposed the terms of the debate, while The General Theory lacks readers. Accused by both its detractors and admirers of being a confusing book that is inconsistent and even plagued with logical errors, the most important contribution of the most influential economist of the 20th century has been condemned to be forgotten or, at best, to live uncomfortably in the voices of those who have spoken on his behalf.

This book is the result of rigorous critical research which reconstructs the spectrum of discussion surrounding Keynes' main work. The book begins by describing the historical background and the state of the pre-Keynesian economic theory, subsequently immersing the reader in a concise but detailed—as well as innovative— interpretation of the original text. The revision of some of the main interpretative currents prepares the field for the book's ultimate contribution: the identification of the fundamentals that sustain the analytical structure of The General Theory. At the same time, this exploration of the theoretical fundamentals of The General Theory makes this book an original intervention on the genesis and relevance of the divide between micro and macroeconomics—a division that has been fully accepted by contemporary macro theorists.

1 Keynes and his understanding of early 20th century capitalism

Keynes and the historical moment

In 1914, John Maynard Keynes celebrated his 32nd birthday. On September 28, the assassination of Archduke Franz Ferdinand of Austria in Sarajevo became the pretext for the outbreak of First World War. Thus, what E. Hobsbawm called the twentieth-century’s Age of Catastrophe began, an age that would last for more than thirty years, until Keynes was more than 60 years old. The Great War put an end to an era of prosperity, ending an approximately century-long period when relative peace prevailed among the great European powers. Such peace was interrupted solely by isolated two-power confrontations, such as the Crimean War and the Russian-Japanese dispute, or by internal conflicts, such as the United States Civil War. According to Hobsbawm, the First World War

marked the breakdown of the (Western) civilization of the 19th century. This civilization was capitalist in its economy; liberal in its legal and constitutional structure; bourgeois in the image of its characteristic hegemonic class; glorying in the advance of science, knowledge and education, material and moral progress.

(Hobsbawm, 1998 [1987])

Keynes witnessed the end of nineteenth-century civilization. His place of observation was nothing less than London, the hub of world trade, finance, and industry. It could be said that the Great Depression of the 1930s broke out in England, ahead of time though less violently than elsewhere, by the end of First World War, in anticipation of what would become an unprecedented economic convulsion at a global level. While the 1920s brought remarkable prosperity – the so-called “Roaring Twenties – to the United States, in England production collapsed during the first postwar period, and remained halted for approximately two decades. It did not recover to its pre-1919 level until 1935. A long stretch of the most intellectually productive phase of Keynes’s life – from his thirties to his mid-forties –¹elapsed during a period that for England was marked by chronic economic stagnation. In the period 1921–38, the unemployment rate neared, in average, 14 percent (Temin, 1990). The decrease in output that begins in 1919 seems to reverse in 1922, but the expansive cycle appears to be feeble. This cycle is briefly interrupted by a light slump in 1926 – associated with the return to the prewar pound parity – and is finally reverted when the world collapse of the 1930s sweeps British economy. The real recovery of industrial production will begin together with Second World War.

In England, Keynes played a leading political role in economic events since his youth. When he was 35 years old, he publicly resigned his post in the British delegation gathered in Versailles to negotiate a Peace Treaty in the wake of the Armistice. At that moment, he published The Economic Consequences of the Peace, a work that denounced the unfair conditions that the victorious powers, mainly England and France, wanted to impose on a defeated Germany. The book would earn him fame throughout Europe and the United States. In the first chapters of The Economic Consequences, before devoting himself to a detailed discussion of the Treaty, Keynes warns his readers:

The power to become habituated to his surroundings is a marked characteristic of mankind. Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century.

(Keynes, 1919: 5)

Even though the book delves into the personalities of the great men who played a leading role in the Conference and offers a detailed literarily masterful depiction of them, the spirit of the text points to something else. It seeks to show that, behind their incidental appearance, social processes hide the slow but inescapable motion of deep economic processes. It is those deep movements that Keynes seeks to unveil.

The great events of history are often due to secular changes in the growth of population and other fundamental economic causes, which, escaping by their gradual character the notice of contemporary observers, are attributed to the follies of statesmen or the fanaticism of the atheists.

(Keynes, 1919: 10, emphasis added)

It is necessary, therefore, to probe below the surface and to consider the situation in a broader framework. Keynes’s hypothesis, crucial to understanding the historical process that was then developing, is that one of the great stages of the history of capitalism came to its end in 1914.

After 1870, there was developed on a large scale an unprecedented situation, and the economic condition of Europe became during the next fifty years unstable and peculiar […] What an extraordinary episode in the economic progress of man that age was which came to an end in August 1914!

(Keynes, 1919: 8)

Remarkably, this very same characterization of a transition to a new economic stage in the history of humankind persists and is even reinforced over time; it is part of the hidden backdrop against which The General Theory, which will be published twenty years later, is written.

It is for this reason that the hypothesis that a “new economic period or age” was commencing is crucial to understanding the theoretical and practical stances Keynes will adopt from then on. Even more, these deep economic transformations are also key to understand the evolution of scientific theories: in Keynes’s view, history plays a central role in the explanation of scientific revolutions and the victory of orthodoxies. Indeed, it is also the historical factor that gives account of why certain ideas, although involving scientific truths, fail to succeed and are, instead, rejected by public opinion, statesmen, and scholars. Society’s evolving needs explain the success and failure of the economic ideas prevailing in each period. According to Keynes, his own teachers had become prominent, first and foremost, because their work reflected “the environment” where it was developed. For example, on Marshall’s Industry and Trade he said,

Thus such unity as the book possesses derives from its being an account of the forms of individualistic capitalism as this had established itself in Western Europe at about the year 1900, of how they came to pass, and of how far they served the public interest.

(Keynes, 1924: 37; emphasis added)

There is a direct relationship between each historical period and the prevailing economic theory: individualistic capitalism is the term Keynes chooses to refer to the stage whose fundamental traits Marshall’s doctrine articulates. The same kind of link is stressed in The General Theory to account for the success of Ricardo’s ideas:

The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected […] That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.

(Keynes, 1939 [1936]: 32–33); I.3.III)

Something similar occurs regarding the causes that, according to Keynes, limited the acceptance gained by his pre-1931 works. In the preface to his book Essays in Persuasion, a collection of articles written since 1919, he states that

The volume might have been entitled “Essays in Prophesy and Persuasion”, for the Prophesy, unfortunately, has been more successful than the Persuasion. But it was in a spirit of persuasion that most of these essays were written, in an attempt to influence opinion. They were regarded at the time, many of them, as extreme and reckless utterances. But I think that the reader, looking through them today, will admit that this was because they often ran directly counter to the overwhelming weight of contemporary sentiment and opinion, and not because of their character themselves.

(Keynes, 1931: 1; emphasis added)

In short, for Keynes, nineteenth-century individualistic capitalism was already exhausted by the 1920s. More than a decade and a half would still have to pass until the publication of The General Theory; however, the work plan to which Keynes would devote his research efforts was already outlined. Economic theory must always be an accurate reflection of the social processes of its time. If a stage of capitalism had come to its end, economic theory had to be worked out anew, adapting it to the new era. In a lecture delivered in 1925, collected in Essays in Persuasion, Keynes publicly challenged mainstream thinking,

Half the copybook wisdom of our statesmen is based on assumptions which were at one time true, or partly true, but are now less and less true day by day. We have to invent new wisdom for a new age. And in the meantime we must, if we are to do any good, appear unorthodox, troublesome, dangerous, disobedient to them that begat us.

(Keynes, 1925: 338)

Keynes’s diagnosis runs along these same lines of reasoning: the orthodox theory had turned the traits that characterized nineteenth-century society into its own doctrinary assumptions, its premises. Among the properties of the economic system that had become undisputed axioms, there is one that bears terrible consequences.

The assumption that the economy will always be moving towards a position of full employment may have been suitable to describe a social form that, according to Keynes, ceased to exist by the end of the nineteenth century. It is evident that the endemic stagnation of world economy cannot be understood from the point of view of a doctrine that categorically denies the possibility that resources may remain unemployed.

All our ideas about economics, instilled into us by education and atmosphere and tradition are, whether we are conscious of it or not, soaked with theoretical pre-suppositions which are only applicable to a society that is in equilibrium, with all its productive resources already employed. Many people are trying to solve the problem of unemployment with a theory which is based on the assumption that there is no unemployment.

(Keynes, 1933)

A theoretical project begins to take definite shape: whereas the classical theory believed that full employment was the only equilibrium possible, Keynes will seek to show that the system can also be in equilibrium when there is unemployment. Neither could the monetary or global exchange forms that had plainly disappeared be taken for granted, as the orthodoxy did. The postulates of the gold standard and of free universal trade did not correspond to this new reality as”

The various currencies, which were all maintained on a stable basis in relation to gold and to one another, facilitated the easy flow of capital and of trade to an extent the full value of which we only realize now, when we are deprived of its advantages.

(Keynes, 1919: 10)

The evidence put forward is enough to show that Keynes did believe to be witnessing the end of a phase of capitalism but also, more importantly, the chaotic beginning of a new one. Such transformation of society is what, in his view, makes a reframing of economic theory imperative. So what are the more relevant characteristics of this new stage of capitalism?

At the dawn of the twentieth century, there were many thinkers who, with different and sometimes even opposite approaches, announced that a deep economic change was imminent. Authors such as J. A. Hobson (1902), R. Hilferdin (1985 [1910]) or V. I. Lenin in his well-known Imperialism: the Highest Stage of Capitalism (1917), but also, among others, J. A. Schumpeter (1939) support the thesis of the beginning of a new historical stage.

The following paragraphs, however, do not intend to review, compare or critically assess the different theories purporting to explain such global transformations that are contained in this voluminous literature. It will neither be discussed whether a transformation of such magnitude and relevance as to be considered a hinge in world history was, in fact, emerging then. What in our view is relevant here is that Keynes held the hypothesis that a change of proportion was underway; reflecting such change in the economic theory was his aim.

This book will try to show that The General Theory is a genuine product of such need. What is relevant here is not to identify the nature of this process in itself but of Keynes’s perception of it, finding the references to that historical change in The General Theory and Keynes’s previous works. Some authors pertaining to the schools known as regulationist, institutionalist, post-Keynesian, and Marxist have researched, albeit from different perspectives, links between economic changes and Keynes’s theories.² How can it be shown that the transformations of differing importance and nature highlighted by Keynes are effectively reflected by the innovative theoretical system he will later build and make public in 1936? With the purpose of confirming such correspondence we will adopt a strict criterion. The theoretical system, inasmuch as it can be mathematically represented, has, simply put, two elements, each of a different nature. Some variables are considered to be endogenous because their determination may be expressed by means of a cause-effect relationship or a mechanism of economic nature. Other variables, instead, are treated as exogenous or given, since their explanation falls outside the economic system.

We will therefore collect references to the transformations of capitalism by differentiating those variables that, according to Keynes, are determined by economic processes apt to be represented by means of laws (endogenous) from those that are, instead, the exogenous variables of the system. If we are right, both sets of variables will differ from the ones derived from the classical system constructed in the nineteenth century. It will then remain to be discussed what the laws determining these endogenous variables are, that is, both the variables that were already considered to be such and the newly-listed ones. We will devote Chapter 3 of this study to that task – expounding Keynes’s system. By the time we reach that point, we will have already made some progress, since the aspects of economic reality whose changes the new economic theory has to reflect will have already been identified. In this sense, Keynes’s idea of economic transformations is part of the relevant background of The General Theory.

In the following section, we will summarize the general characteristics of the new stage of capitalism that began during the first decades of the twentieth century, as described in some writings before 1936. Then, in subsequent sections, three crucial aspects that concentrated the most important changes will be discussed: the fragmentation of the capitalist class, the organization of labor, and the transformations that took place in the monetary regime and the banking system.

II The stages of capitalism

Three stages of capitalism – scarcity, abundance and stabilization

At first sight, Keynes’s views on world history seem to be loaded with pessimism, the same pessimism attributed to Malthus. Humankind was crossing the threshold of an era burdened with tensions, and even though state intervention might to some extent relieve the situation, the tragic core of the “economic problem”³ would remain untouched. The years during which Keynes developed and introduced his theories to the academy and the public seemed to nurture this bleak view of the future. Moreover, the 1930 crisis could have worked as irrefutable evidence of his most pessimistic premonitions. However, Keynes predicted a future of redoubled prosperity for humankind. Hence, his attitude of concern towards the present mixed with optimism regarding future possibilities.

Next, we will summarize a glossed selection of Keynes’s historical arguments that will allow us to support our contention regarding their relevance to his entire argumentation. Even though we agree with the procedure applied by Keynes, we do not consider his periodization of the “economic” history of man adequate, as we will explicitly state later. However, we believe that the approach he chose – linking theory and history – is correct, and sets him apart from most of his followers.

In August 1925, Keynes delivered an address to the Liberal Summer School at Cambridge, which would later be published, with slight changes, as an article titled “Am I a Liberal?” In this text, he makes the conclusions of a work by Professor Commons his own; according to Keynes, Commons “has been one of the first to recognize the nature of the economic transition amidst the early stages of which we are now living, distinguishes three epochs, three economic orders, upon the third of which we are entering” (Keynes, 1925: 335).

The first stage, which Commons – and Keynes accordingly – calls the “Era of Scarcity”, runs from the eme...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Foreword
• Prologue to the English edition
• Previous publications
• Introduction
• 1 Keynes and his understanding of early 20th century capitalism
• 2 What did Keynes call classical theory?
• 3 Keynes’s critique of the classical theory
• 4 The General Theory by Keynes
• 5 Keynes’s system: Fundamental concepts
• Bibliography
• Index