Tuesday, May 26, 2009

John Maynard Keynes and his other book

The Cultural Contradictions of J.M.Keynes is an excellent review of Keynes' influence through his two most influential works - "The Economic Consequences of the Peace", originally published in 1920, and "The General Theory of Employment, Interest, and Money", which appeared first in 1936. The reviewer James Piereson summarizes these two key works of Keynes' work and places them both in the context of his search for a way forward for post-World-War-I Europe that broke from the pre-War European mold:

... here was someone who, beginning in 1918, wrestled with Europe’s civilizational crisis, searching for ways to reverse the damage done by the war. The economic approach that he formalized in The General Theory is only the most widely recognized of his proposed avenues of escape. Like many, Keynes believed that the Great War had shattered European civilization beyond any hope of repair. The shibboleths of the old regime—laissez faire, nationalism, the gold standard, empire, Victorian ideals—could not survive in a new era of sovereign debt, despair, debauched currencies, and a permanently changed balance of world power.

Keynes in his first book widely criticized the Peace Treaty of Versailles signed after World War I as too harsh. As Keynes wrote:
"... the Carthaginian Peace is not practically right or possible. The clock cannot be set back. You cannot restore Central Europe to 1870 without setting up such strains in the European structure and letting loose such human and spiritual forces as will overwhelm not only you and your “guarantees,” but your institutions and the existing order of your society.

Keynes foresaw that the treaty would cause economic dislocation and harm, and in time his contrary views were considered prophetic:
Keynes had been right to predict that the twin burdens of German reparations and inter-ally war debts would weigh heavily upon the international system and return to bedevil statesmen and central bankers for years to come. The German hyperinflation of the early 1920s, the Great Depression as it spread around the world, even Hitler’s rise to power and the war that followed—all were linked in one way or another to those causes of mischief that Keynes identified in The Economic Consequences of the Peace.

Keynes blamed American President Wilson for much of this failure, because the United States was the economic 'winner' who could have forced England and France not to pursue a punitive peace. However:
Wilson was so thoroughly “bamboozled” by these masters of European intrigue—so judged by Keynes—that he headed back to America comfortable in the illusion that the Treaty established the foundations for true peace.

The economic crises of the 1920s and 1930s that grew out of the failed Treaty of Versailles led Keynes to a critique of traditional economic assumptions. The book "The General Theory ..." captured this critique,a view that Government could unfreeze a system stuck in underconsumption and underemployment through macro-economic demand-side stimulus - or in layman's terms, deficit spending:
In Keynes’s theory, the moral assumptions regarding individual liberty and free choice that buttressed the classical school were subordinated to the interplay of abstract forces like aggregate demand and investment, and to a self-confident belief that the state could be relied upon to intervene efficiently in the interests of all.

A common error of the liberal or socialist mind-set is that they will posit the superiority of the Government-run schemes by assuming an unrealistic idealism about how they will automatically work. The over-investment errors, market bubbles or lack of 'animal spirits' are viewed as market failures that are fundamental, but Government waste, corruption and the inherent short-sightedness of democraticly-elected political actors is ignored in the Keynesian world-view:
The state, he said, unlike individual investors or businessmen, is in a position “to calculate the marginal efficiency of capital goods on long views and on general social advantage,” a proposition which provoked the retort from Hayek that while governments may be in a position to take the long view, they rarely do. ...
Keynes seemed to believe that government budgets can be freely manipulated into and out of balance by policymakers in much the same manner and with as much freedom as central bankers have when they set interest rates or expand the supply of money. Roy Harrod, Keynes’s friend and biographer, wrote that Keynes held a faith that important governmental decisions would always be made by public-spirited experts acting in the general interest, when, in actuality, public budgets are subject to intense political pressures and are formulated by elected politicians with scant regard for something as abstract and ill-defined as the public interest.

It is curious that Keynes would be so naive about Governmental action, when in fact he was witness to the greatest Governmental follies in European history: The failure of diplomacy to stop World War I; the failure of generalship during World War I, leading to years of bloody yet inconsequential fights; the failure of peace-making after World War I to create lasting peace. All these failures were the failures of Government, of leaders who lacked imagination and foresight.

Keynes' second book is well-known and is so important it is the foundation for the economic strain of thought called "Keynesianism". However, the limits of this train of thought have been exposed in previous Keynesian experiments such as Japan in 1990s, European stagflation of the 1970s, structural deficits, etc. Keynes had not really overthrown the truisms of classical economics, and subsequent reformulations ("rational expectations", monetarianism, behavioral economics) reconciled classical economics to a broader understanding of wider forces that drive economic behavior. So in the end, it is Keynes' other book, his first book, that endures as a reliable and prophetic work, a testament to the common folly and unintended consequences of Governments that pursue short-term goals.

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