Keynes's Theoretical Development

Toshiaki Hirai

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134230402
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Comprehensive and authoritative, this book, written by a recognized authority on the subject explores the contributions to modern economics by John Maynard Keynes and addresses neglected, yet crucial aspects of the genesis of Keynesian economics.

In this book, the author elucidates Keynes' development as an economic theoretician through an examination of his books, articles, various manuscripts, lecture notes and controversial correspondence. Departing from a narrative account and analyzing processes of theory-building and re-building which constitute Keynes's intellectual journey from the Tract to the General Theory, this volume shows Keynes' theoretical development as a theoretical hypothesis.

An excellent exposition of Keynes' contribution, this is a valuable addition to the bookshelves of all to students and researchers interested in Keynes and more widely the history of economic thought and macroeconomics.

1
The relative decline of the British economy

The purpose of this chapter is to outline how the British economy proceeded in relation to the world economy from the early 1800s to the Second World War. This will go a long way towards helping us grasp Keynes’s activities as a theoretical economist and an economic policy adviser and critic in the broad historical context.

The course of the world economy here can be divided into three periods: the early 1800s to the third quarter of the nineteenth century, when Britain was the workshop of the world and dominated the international economy; the last quarter of the nineteenth century to the First World War, which witnessed the relative decline of the British economy due to the rapid economic growth of the United States and Germany; and the interwar years, which saw the demise of the old international economic order, and during which Keynes was actively involved in the economic problems of the United Kingdom as well as the worldwide issues.

I The workshop of the world

The United Kingdom was the first country to experience an ‘Industrial Revolution’.¹ Starting in the 1760s, the process was completed by the 1830s. Propelled by technological innovations such as Watt’s steam and rotative engines, Crompton’s ‘mule’, and so forth,² Britain saw unprecedented advances in cotton, iron and steel, and civil engineering. These advances were transforming the British economy, and with the final stage of the Industrial Revolution the transformation was complete. It was then that the United Kingdom came to dominate the international economy as ‘the workshop of the world’, meeting with no serious challenge until the 1880s.

We now see, thanks to Harley (1982) and Crafts (1983), that two industrial revolutions are distinguishable: ‘the wave of gadgets which occurred in the last third of the eighteenth century, and the economy-wide changes accompanied by rapid growth of the industrial sector which became dominant after 1815’ (Mokyr, 1985, p. 4). Actually, just a few industries (above all, the cotton industry) grew at a truly amazing rate, but industry as a whole did not: ‘the macroeconomic effects of the Industrial Revolution are not overwhelming before 1820’ (p. 5).

After 1820 the British economy developed spectacularly. Up to 1870, British industrial production grew by 37.7 per cent with each passing decade.³ The dimensions of this expansion can be grasped by calculating indices for raw cotton consumption and pig iron production: the former had risen to 1,322 by the year 1870 (the base year: 1815);⁴ the latter to 1,836 by the year 1870 (the base year: 1818).⁵

This progress was considerably sustained by exports. In the cotton manufactures, the ratio of exports to total production had reached 63.8 per cent by the 1880s from 56.4 in the 1830s.⁶ In the steel industry, the ratio doubled from 16.5 per cent in the 1830s to 32.8 in the 1880s.⁷ This excessive dependence on foreign markets was to leave the British economy vulnerable to competition from other exporting nations as the international competitiveness of the British industries weakened.

The Industrial Revolution was also to bring far-reaching reforms in economic structures and policies, two of which in particular deserve mention.⁸

The first was the tariff and financial reforms introduced by the Peel (1840s) and Gladstone (1850s) governments, through which the United Kingdom established a free trade system. The second was a reform of the banking system. In 1825 and 1837 the British economy suffered severe depressions, in response to which two schools arose: the Currency School (Overstone and Torrens) ascribed the cause of the depressions to over-issue of notes by local banks, while the Banking School (Tooke and Fullarton) maintained that the issue of notes was automatically regulated by the needs of trade. The Currency School carried the day, as a result of which, through the Bank Charter Act of 1844, a monetary system was established under which the Bank of England became the nation’s de facto central bank, with sole authorisation to issue notes based on gold reserves. The Bank was also entrusted with the task of stabilising foreign exchange rates by means of the bank rate.

Thus the United Kingdom was to dominate the world economy over the ensuing decades.

II Relative decline

The period covering the last quarter of the nineteenth century⁹ to the First World War¹⁰ saw the beginnings of Britain’s relative decline as an industrial power.¹¹ Three factors were largely responsible for this state of affairs: the industrialisation of the United States and Germany; Britain’s failure to exploit technological innovation; and the weakening of the entrepreneurial spirit.

1 Industrialisation of the United States and Germany

The US economy took off in the period 1843–1860¹² with the spearheading growth of the cotton industry,¹³ the major thrust arriving in the 1865–1914 period.

The rise of Germany as an economic power took place in the period 1851–1873.¹⁴ Industrialisation gained impetus with formation of the Zollverein (the Customs Union) in 1834, and the rapid development of the railways backed by the coal and steel industries, and Germany’s industrial revolution was accomplished in the period 1873–1914.

Germany was also in the ascendant politically. Having won the Austro-Prussian War of 1866, Prussia embarked on war with France which was crowned with victory, culminating in proclamation of the German Empire in 1871. Germany was also rewarded with 5,000 million francs in reparations and the iron-rich region of Alsace-Lorraine.

Both similarities and dissimilarities are discernible in the economic advances of the United States and Germany. The two countries were alike in seeking to promote their domestic industries through protectionist policies to counteract the British industrial superiority, but differed in that the US economy developed through private enterprise, while the German economy developed thanks to the initiatives of the bureaucracy’s top echelon.

Some statistics will suffice to give an idea of the extent to which the economic fortunes of both the United States and Germany surpassed those of the United Kingdom over the period 1870–1913. Industrial production in the United States increased at the rate of 4.7 per cent per annum, and in Germany at the rate of 4.1. The corresponding rate for the United Kingdom was 2.1 per cent.¹⁵ The United States’ share of world pig iron production increased from 15.6 per cent in the period 1875–1879 to 40.2 in the period 1910–1913; Germany’s share rose from 12.7 to 21 per cent. By contrast, Britain’s share decreased from 46 per cent to 13.9.¹⁶ As for the share of manufactured goods in world trade, the figure for the United States increased from 2.8 per cent to 12.6 between 1880 and 1913; Germany’s figure from 19.3 per cent to 26.5. Meanwhile, the United Kingdom’s share declined from 41.4 per cent to 29.9 over the same period.¹⁷ By 1914 the national income of the United States had reached three times that of Britain, while Germany’s came to almost 96 per cent of Britain’s.¹⁸

The new industrial prowess of Germany and the United States enabled their firms to enter the United Kingdom, bringing further dismay and anxiety for the British in their wake. The ‘Fair Trade’ movement of the early 1880s and the ‘Tariff Reform’ campaign in the early 1900s symptomised the apprehensions engendered with British industry’s relative decline.

2 The failure to exploit technological innovation

The second factor was Britain’s failure to exploit technological innovation. The American and German entrepreneurs’ active pursuit of technological innovation resulted in new industries, while the traditional industries also benefited from the adoption of new methods. In the steel industry, for example, not only were large-scale mills constructed, but new processes, such as the Bessemer and Thomas methods, were introduced.

In Germany, industry was committed to intra-firm research and development, based on which the ‘New Industries’ – such as the chemical and electrical industries – made such outstanding headway¹⁹ that they soon held dominant positions in these fields.

Economic development in the United States²⁰ was equally remarkable. Mineral resources were exploited on a large scale: the coal mining industry, for instance, doubled production every decade during the period 1850–1910, while capital stock increased 14-fold between 1860 and 1920. Furthermore, the population trebled between 1860 and 1910, thanks mainly to the massive inflow of European immigrants, which was accompanied by an acceleration of westward migration. Stimulated by the establishment of new cities and the geographical spread of the population, American entrepreneurs developed new methods of marketing, including department stores, chain stores and mail order houses, and improved production methods applying the ‘scientific management’ techniques devised by F.W. Taylor.

In the United Kingdom, on the other hand, entrepreneurs were slow to adopt new technologies and new managerial methods.²¹ There was no attempt to introduce innovations into the traditional industries, nor were new ones being created. In the steel industry British industrialists continued to content themselves with the old small-scale mills. In the cotton industry innovation was similarly spurned. To put it another way, British industry became ‘overcommitted’ to the established industries and tried-and-tested technologies.²² Britain also failed to create a chemical industry, although the basic research which provided the foundations for this industry abroad was being done there.

3 The decline of entrepreneurial spirit

The third factor is the decline in that entrepreneurial spirit which had been the powerhouse of the Industrial Revolution. This was due to several influences, two of which were particularly significant.

First, ‘gentlemanship’ was established as the guiding ethos of the British society in the mid-nineteenth century.²³ In the light of this ethos, originating in the aristocracy, business was looked down upon as crude money making, while the aristocratic lifestyle and gentlemanly pursuits represented the true values. Not only the business class but also the middle class came to embrace this ideal. The top of the business class was continually being creamed off into the gentry and land-owning classes, acquiring estates, titles and the associated mode of life. Thus active involvement in business had a tendency to be abandoned the instant a man had garnered sufficient wealth to emulate the ways of his social superiors. The successful business class and ...