Keynes

1. Keynes History of economic thought 2 Bernard Chavance ABIK, June 2010

2. John Maynard Keynes (1883-1946) • The economic consequences of the peace, 1919 • Treatise on probability, 1921 • Treatise on money, 1930 • General theory of employment, interest and money, 1936 • How to pay for the war, 1940 • Collected Writings, 30 vol.

4. The historical background • The collapse of the world order in the first WW • A controversy on economic liberalism, and on the opposition of economic systems (capitalism/socialism) beginning in the 1920s • The Great depression of the 1930s, triggered by an American Stock exchange crash in 1929 • … manifested in a contraction of production, incomes, world trade, and an upswing of unemployment in most capitalist countries • Eventually, the problem of reconstructing a world economic order after the second WW (Bretton-Woods conference, 1944)

5. A revolution from within the mainstream • Fallacies of economic liberalism (« The end of laissez-faire », 1926) • A qualified defense of capitalism • A critique of the dominant theory from « within the citadel » • A « heretic » stance, compared to « the classics » (i.e. mainstream from Ricardo to contemporary economists) • Absence of self-regulation of markets, a need for economic intervention of the state

6. Macro-economic analysis • The error of generalizing economic relations from the individual level to the macro level • … linked to the phenomenon of emergence and the systems effects… • …justify analysing directly macro-economic relations at the global level, as opposed to the neoclassical macro analysis as a direct generalization of micro analysis • Macro aggregates: national production or income, global investment, global consumption (in the national sphere)

7. A criticism of « Say’s law » • A premise of « classical economics » • Supply creates its own demand, the value of production is equal to the revenues distributed • There may be local, temporary gluts, but a general overproduction is impossible • This alleged law is linked to a neutral and instrumental view of money, and implies a self-equilibrating character of the capitalist economy (with a tendency to full employment)

8. Insufficiency of effective demand • The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let it well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. (1936)

9. Y = C + I • Y = production, income • C = consumption, the more stable part of aggregate demand • I = investment, the more volatile part of aggregate demand

10. Taking institutions into account • The influence of John R. Commons (author of Institutional economics) • Importance of money, wage-labor • Significant changes in institutions of capitalism in the 20th century: the outdated character of « classical economics » • Trade unions and wage bargaining • Split between ownership and management of capital

11. Psychology of economic agents • Differs of the postulates of rationality of traditional economics, and of utilitarian views • Role of psychological variables: propensity to consume, marginal efficiency of capital, interest rate, liquidity preference • The mistaken idea that entrepreneurs are looking for products, not for money (reference to Marx’s formula M – C – M’) • The role of « animal spirits »

12. A monetary theory of production • As opposed to the « classical » real exchange economy • Exchange is immediate, while production takes time • The economic world is not a real economy with a veil of money, but a monetary economy where real and money dimensions are intertwined and interactive • Money is not neutral towards the real economy, there is no dichotomy between real and monetary economy • Money is related to time, to uncertain and changing anticipations of the time ahead, it is a « link between the present and the future »

13. Active, not neutral money • ‘the theory which I desiderate would deal...with an economy in which money plays a part of its own and affects motives and decisions, and is, in short, one of the operative factors in the situation’ • ‘Booms and depressions are peculiar to an economy in which... money is not neutral .... I believe that the next task is to work out in some detail a monetary theory of production...’(1935).

14. Uncertainty • Uncertainty : « The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. » (1937: 113) • Radical uncertainty: applying probability calculus is inadequate

15. Prominent flaws of capitalism • « The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes. » (1936) • The immanent instability of the capitalist system

16. Assessing the money motive • In the times of our grandchildren … ‘The love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.’ (1930)

17. Fallacies of economic liberalism • ‘ It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. • ‘ The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide.’ • ‘It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately. ’ • The end of laissez-faire (1926)

18. Financial markets and speculation • Organized financial markets aggravate the structural instability of capitalism • Speculation aims at a profit on the stock exchange by anticipating the psychology of the market • Enterprise aims at a profit by investing in physical capital and estimating future returns during its whole life • ‘Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’ (1936)

19. Different types of financial markets • The case of New York (Wall Street), where speculation prospers • The case of London, where access is more difficult • A proposal for the US: a heavy state tax on all transactions, to reduce the liquidity of the market

20. An ambivalent assessment of capitalism • « (A) time may be coming when we shall get clearer than at present as to when we are talking about capitalism as an efficient or inefficient technique, and when we are talking about it as desirable or objectionable in itself. » • «  For my part I think that capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that in itself it is in many ways extremely objectionable. Our problem is to work out a social organisation which shall be as efficient as possible without offending our notions of a satisfactory way of life. » The end of laissez-faire (1926)

21. A compromise between efficiency and morals • On the side of efficiency, capitalism • Has immanent defects: unemployment, income and wealth inequalities • But is less bad than other conceivable systems (eg socialism) • And may be made more efficient if wisely managed • On the side of morals, capitalism • Is highly objectionable • ➞ Search for acceptable compromise

22. The dominant role of ideas • “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”(1936)