Disaggregating Keynes Demonstrates Macro Delusions

First Published: 2020-09-20


The current economic crisis through which the United States and the world are passing is primarily the result of government responses to the Coronavirus crisis in the form of command and control lockdowns with the dictates to stop going to work, don’t go shopping, and stay at home with “distance” between you and anyone with whom you come into contact. Never was there a clearer and more glaring instance of a severe economic downturn traceable to the doorstep of those in political power and authority.

Matching it have been massive infusions of government deficit spending and mounting debt in the attempt to counteract the falling output and rising unemployment the government’s own policies have produced. Behind it all is the nearly, now, 85-year-old Keynesian medicine of “activist” monetary and fiscal policy. The policy proposals lingering behind what is called “Modern Monetary Theory” and the wider central planning agenda of a Green New Deal all rest on presumptions to be found in Keynes’s “New Economics” of the 1930s and 1940s.

So, this week I offer a “disaggregation” of the premises and policy proposals behind all that still may be found in Keynes’s famous 1936 book, “The General Theory of Employment, Interest, and Money,” to demonstrate their logical absurdities, factual fantasies, dangerous policy prescriptions, and political foundations in an underlying philosophy of elitism and nihilism about which Keynes was, actually, very explicit.

There is the old adage: “Know thy enemy.” Never was this truer today for friends of liberty and sound economics, and knowing Keynes is an important part of this.

Disaggregating Keynes Demonstrates Macro Delusions

by Richard Ebeling

The economic downturn that has accompanied the coronavirus crisis has seen huge increases in government deficit spending and mounting national debt in the United States and many other countries around the world. A revived version of Keynesian Economics has emerged rationalizing and justifying massive government expenditures as cures for falling production, rising unemployment, and widening income inequality. It seems worthwhile, therefore, to take a fresh look at Keynesian Economics and to “disaggregate” its originator, British economist John Maynard Keynes (1883-1946).

After dominating the economics profession for more than a quarter of a century following the Second World War, Keynesianism had been challenged by various “counter-revolutions” in macroeconomics beginning in the late 1960s and early 1970s. They had taken the forms of Monetarism, Supply-Side Economics, New Classical or Rational Expectations Theory, New Keynesianism, and even Austrian Economics, following the awarding of the Nobel Prize to F. A. Hayek in 1974.

The fact is, however, that neither Keynes nor his economics have ever been gone or replaced. Keynesian Economics has continued to dominate and hold sway over the way the vast majority of economists think about and analyze the nature of economy-wide fluctuations in employment and output.

Keynes’s Legacy of “Demand Management” Economics

It is the idea that government must manage and guide monetary and fiscal policy to assure full employment, a stable price level and to foster economic growth. Some of the terms of the debate may have changed over the last half-century or so, but the belief that it is the responsibility of government to control the supply of money and aggregate spending in the economy persists today just as much as it did in the 1940s.

The modern conception of “demand management” is a legacy of John Maynard Keynes’s 1936 book The General Theory of Employment, Interest and Money. The impact of Keynes’s book and its message should not be underestimated. Its two central tenets are the claim that the market economy is inherently unstable and likely to generate prolonged periods of unemployment and underutilized productive capacity, and the argument that governments should take responsibility to counteract these periods of economic depression with the various monetary and fiscal policy tools at their disposal. This was bolstered by Keynes’s belief that policy managers guided by the economic theory developed in his book could have the knowledge and ability to do so successfully.

No less important in propagating his idea of demand management economic policy was Keynes’s literary ability to persuade. As economist Leland Yeager (1924-2018), expressed it, “Keynes saw and provided what would gain attention – harsh polemics, sardonic passages, bits of esoteric and shocking doctrine.” Keynes possessed an arrogant amount of self-confidence and belief in his ability to influence public opinion and policy.

Austrian economist Friedrich A. Hayek (1899-1992), who knew Keynes fairly well, referred to his “supreme confidence . . . in his power to play on public opinion as a supreme master plays his instrument.” On the last occasion he saw Keynes in early 1946 (shortly before Keynes’s death from a heart attack), Hayek asked him if he wasn’t concerned that some of his followers were taking his ideas to extremes. Keynes replied that Hayek did not need to be worried. If it became necessary, Hayek could “rely upon him again quickly to swing round public opinion—and he indicated by a quick movement of his hand how rapidly that would be done. But three months later he was dead.”

Even today, respected economists argue that Keynesian-style macroeconomic intervention is needed as a balancing rod against instability in the market economy. One example is Robert Skidelsky, the author of a widely acclaimed multi-volume biography of Keynes and active supporter of the British Labor Party.

A few years ago, Professor Skidelsky argued that capitalism has at its heart an instability of financial institutions and, “This insight by Keynes into the causes and consequences of financial crises remains supremely valuable.” In any significant economic downturn, government should begin “pumping money into the economy, like pumping air into a deflating balloon.”

Keynes’s Road to The General Theory

Shortly before the First World War, Keynes published his first book on monetary policy, Indian Currency and Finance (1913). During the First World War, he had worked in the British Treasury. In 1919 he served as an advisor to the British delegation in Versailles. But frustrated with the attitude of the Allied powers toward Germany in setting the terms of the peace, Keynes returned to Britain and published The Economic Consequences of the Peace (1920) in which he severely criticized the peace settlement. In 1923, he published A Tract on Monetary Reform, in which he called for the end of the gold standard and suggested a national managed paper currency in its place. He strongly opposed Great Britain’s return to the gold standard in the mid-1920s at the prewar gold parity. He argued that governments should have discretionary power over the management of a nation’s monetary system to assure a desired target level of employment, output, and prices.

In 1930 Keynes published A Treatise on Money, a two-volume work that he hoped would establish his reputation as a leading monetary theorist of his time instead of only an influential economic policy analyst. However, over the next two years a series of critical reviews appeared, written by some of the most respected economists of the day. The majority of them demonstrated serious problems with either the premises or the reasoning with which Keynes attempted to build his theory on the relationships between savings, investment, the interest rate, and the aggregate levels of output and prices. But the most devastating criticisms were made by a young Friedrich A. Hayek in a lengthy two-part review essay published in Economica in 1931-1932 (reprinted in Bruce Caldwell, ed., The Collected Works of F. A. Hayek, Vol. 9 [1995], pp. 121-146 & 174-197),

Hayek argued that Keynes seemed to understand neither the nature of a market economy in general nor the significance and role of the rate of interest in maintaining a proper balance between savings and investment for economic stability. At the most fundamental level Hayek argued that Keynes’s method of aggregating the individual supplies and demands for a multitude of goods into a small number of macroeconomic “totals” distorted any real appreciation and analysis of the relative price and production relationships in and between actual markets. “Mr. Keynes’s aggregates conceal the most fundamental mechanisms of change,” Hayek said. (p. 128)

Implicitly accepting the criticisms, Keynes devoted the next five years to reconstructing his argument, the result being his most famous and influential work, The General Theory of Employment, Interest and Money, published in February 1936.

Keynes argued that the Great Depression of the 1930s was caused by inescapable irrationalities in the market economy that not only created the conditions for the severity of the economic downturn but necessitated activist monetary and fiscal policies by government to restore and maintain full employment and maximum utilization of resource and output capabilities. For the next half-century Keynes’s ideas, as presented in The General Theory, became the cornerstone of macroeconomic theorizing and policymaking throughout the Western world, and continue to dominate public policy thinking today.

John Maynard Keynes and an Interventionist “Liberalism”

What were the wider philosophical principles and ideas behind Keynes’s views about a market society? In 1925, Keynes delivered a lecture at Cambridge titled “Am I a Liberal?” (reprinted in his Essays in Persuasion, pp. 323-338)) He rejected any thought of considering himself a conservative because conservatism “leads nowhere; it satisfies no ideal; it conforms to no intellectual standard; it is not even safe, or calculated to preserve from spoilers that degree of civilization which we have already attained.” Keynes then asked whether he should consider joining the Labor Party. He admitted, “Superficially that is more attractive,” but rejected it as well. “To begin with, it is a class party, and the class is not my class,” Keynes argued. Furthermore, he doubted the intellectual ability of those controlling the Labor Party, believing that it was dominated by “those who do not know at all what they are talking about.”

This led Keynes to conclude that all things considered, “the Liberal Party is still the best instrument of future progress—if only it has strong leadership and the right program.” But the Liberal Party of Great Britain could serve a positive role in society only if it gave up “old-fashioned individualism and laissez-faire,” which he considered “the dead-wood of the past.” Instead, what was needed was a “New Liberalism” that would involve “new wisdom for a new age.” What this entailed, in Keynes’s view, was “the transition from economic anarchy to a regime which deliberately aims at controlling and directing economic forces in the interests of social justice and social stability.”

A year later, in 1926, Keynes delivered a lecture in Berlin, Germany on, “The End of Laissez-Faire,” (reprinted in Essays in Persuasion, pp. 312-323) in which he argued, “It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. There is no compact conferring perpetual rights on those who Have or on those who Acquire.” Nor could it be presumed that private individuals pursuing their enlightened self-interest would always serve the common good.

In a world of “uncertainty and ignorance” that sometimes resulted in periods of unemployment, Keynes suggested “the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution.” And he believed that “some coordinated act of intelligent judgment” by the government was required to determine the amount of savings in the society and how much of the nation’s savings should be permitted to be invested in foreign markets as well as the relative distribution of that domestic savings among “the most nationally productive channels.”

Eugenic Planning and Economic Planning

Finally, Keynes argued that government had to undertake a “national policy” concerning the most appropriate size of the country’s population, “and having settled this policy, we must take steps to carry it into operation.” Furthermore, Keynes proposed serious consideration of adopting a policy of eugenics: “The time may arrive a little later when the community as a whole must pay attention to the innate quality as well as to the mere numbers of its future members.”

This agenda for an activist and planning government did not make Keynes a socialist or a communist in any strict sense of these words. Indeed, after a visit to Soviet Russia he published an essay in 1925 strongly critical of the Bolshevik regime (“A Short View of Russia,” reprinted in Essays in Persuasion, pp. 297-312). “For me, brought up in a free air undarkened by the horrors of religion, with nothing to be afraid of, Red Russia holds too much which is detestable . . . I am not ready for a creed which does not care how much it destroys the liberty and security of daily life, which uses deliberately the weapons of persecution, destruction, and international strife . . . It is hard for an educated, decent, intelligent son of Western Europe to find his ideals here.”

But where Soviet Russia had an advantage over the West, Keynes argued, was in its almost religious revolutionary fervor, in its romanticism of the common working man, and its condemnation of money-making. Indeed, the Soviet attempt to stamp out the “money-making mentality” was, in Keynes’s mind, “a tremendous innovation.” Capitalist society, too, in Keynes’s view, had to find a moral foundation above self-interested “love of money.” What Keynes considered Soviet Russia’s superiority over capitalist society, therefore, was its moral high ground in opposition to capitalist individualism. And he also believed that “any piece of useful economic technique” developed in Soviet Russia could easily be grafted onto a Western economy following his model of a New Liberalism “with equal or greater success” than in the Soviet Union.

That Keynes had great confidence in a state-managed system of “useful economic technique” was clearly seen in the following comparison he made, also in the mid-1920s, between a regulated wage system in the name of “fairness” between social classes and market-determined wages, which he condemned as “the economic juggernaut.”

“The truth is that we stand mid-way between two theories of economic society. The one theory maintains that wages should be fixed by reference to what is ‘fair’ and ‘reasonable’ as between classes. The other theory – the theory of the economic juggernaut – is that wages should be settled by economic pressure, otherwise called ‘hard facts,’ and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the change in consequences of the journey to individual groups.” (Quoted in D. E. Moggridge, Maynard Keynes: An Economist’s Biography [1992], p. 433)

Keynes: Markets Fail and Unemployment Rises

With the coming of the Great Depression, not surprisingly, Keynes once again rejected the idea of a free market solution to the rising unemployment and idled industry that intensified following the crash of 1929. In his writings of the 1920s and early 1930s, advocating a “New Liberalism” and a deficit-spending government to “solve” the Great Depression were the premises for the Keynesian Revolution that would be officially inaugurated with the publication of The General Theory of Employment, Interest and Money. With those ideas, Keynes produced one of the greatest challenges to the free market economy in the 20th century.

The General Theory was published on February 4, 1936. The essence of Keynes’s theory was to show that a market economy, when left to its own devices, possessed no inherent self-correcting mechanism to return to “full employment” once the economic system had fallen into a depression. At the heart of his approach was the belief that he had demonstrated an error in Say’s Law. Named after the 19th century French economist Jean-Baptiste Say (1767-1832), the fundamental idea is that individuals produce so they can consume. An individual produces either to consume what he has manufactured himself or to sell it on the market to acquire the means to purchase what others have for sale. Or as the classical economist David Ricardo (1772-1823) expressed it in his Principles of Political Economy and Taxation (1817), “By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person . . . Productions are always bought by productions, or by services; money is only the medium by which the exchange is affected.” (p. 280)

Keynes argued that there was no certainty that those who had sold goods or their labor services on the market would necessarily turn around and spend the full amount that they had earned on the goods and services offered by others. Hence, total expenditures on goods could be less than total income previously earned in the manufacture of those goods. This, in turn, meant that the total receipts received by firms selling goods in the market could be less than the expenses they incurred in bringing those goods to market. With total sales receipts being less than total business expenses, businessmen would have no recourse other than to cut back on both output and the number of workers employed to minimize losses during this period of “bad business.”

But, Keynes argued, this would merely intensify the problem of unemployment and falling output. As workers were laid off, their incomes would necessarily go down. With less income to spend, the unemployed would cut back on their consumption expenditures. This would result in an additional falling off of demand for goods and services offered on the market, widening the circle of businesses that find their sales receipts declining relative to their costs of production. And this would set off a new round of cuts in output and employment, setting in motion a cumulative contraction in production and jobs.

Rigid Wages, Money Illusion, and Investment Uncertainties

Why wouldn’t workers accept lower money wages to make themselves more attractive to rehire when market demand falls? Because, Keynes said, workers suffer from “money illusion.” If prices for goods and services decrease because consumer demand is falling off, then workers could accept a lower money wage and be no worse off in real buying terms (that is, if the cut in wages was on average no greater than the decrease in the average level of prices). But workers, Keynes argued, generally think only in terms of money wages, not real wages (that is, what their money income represents in real purchasing power on the market). Thus, workers often would rather accept unemployment than a cut in their money wage.

If consumers demand fewer final goods and services on the market, this necessarily means that they are saving more. Why wouldn’t this unconsumed income merely be spent hiring labor and purchasing resources in a different way, in the form of greater investment, as savers have more to lend to potential borrowers at a lower rate of interest? Keynes’s response was to insist that the motives of savers and investors were not the same. Income-earners might very well desire to consume a smaller fraction of their income, save more, and offer it out to borrowers at interest. But there was no certainty, he insisted, that businessmen would be willing to borrow that greater savings and use it to hire labor to make goods for sale in the future.

Since the future is uncertain and tomorrow can be radically different from today, Keynes stated, businessmen easily fall under the spell of unpredictable waves of optimism and pessimism that raise and lower their interest and willingness to borrow and invest. A decrease in the demand to consume today by income-earners may be motivated by a desire to increase their consumption in the future out of their savings. But businessmen cannot know when in the future those income-earners will want to increase their consumption, nor what particular goods will be in greater demand when that day comes. As a result, the decrease in consumer demand for present production merely serves to decrease the businessman’s current incentives for investment activity today as well.

Keynes’s Peculiar Assumptions About Consumption

If for some reason there were to be a wave of business pessimism resulting in a decrease in the demand for investment borrowing, this should result in a decrease in the rate of interest. Such a decrease because of a fall in investment demand should make savings less attractive, since less interest income is now to be earned by lending a part of one’s income. As a result, consumer spending should rise as savings goes down. Thus, while investment spending may be slackening off, greater consumer spending should make up the difference to assure a “full employment” demand for society’s labor and resources.

But Keynes doesn’t allow this to happen because of what he calls the “fundamental psychological law” of the “propensity to consume.” As income rises, he says, consumption spending out of income also tends to rise, but less than the increase in income. Over time, therefore, as incomes rise a larger and larger percentage is saved.

In The General Theory, Keynes listed a variety of what he called the “objective” and “subjective” factors that he thought influenced people’s decisions to consume out of income. On the “objective” side: a windfall profit; a change in the rate of interest; a change in expectations about future income. On the “subjective” side, he listed “Enjoyment, Shortsightedness, Generosity, Miscalculation, Ostentation and Extravagance.” He merely asserts that the “objective” factors have little influence on how much to consume out of a given amount of income – including a change in the rate of interest. And the “subjective” factors are basically invariant, being “habits formed by race, education, convention, religion and current morals . . . and the established standards of life.” (pp. 89-112)

Indeed, Keynes reaches the peculiar conclusion that because men’s wants are basically determined and fixed by their social and cultural environment and only change very slowly, “The greater . . . the consumption for which we have provided in advance, the more difficult it is to find something further to provide for in advance.” (p. 105) That is, men run out of wants for which they would wish investment to be undertaken; the resources in the society—including labor—are threatening to become greater than the demand for their employment.

Keynes’s Upside-down World: Limited Ends and Increasing Means

Keynes, in other words, turns the most fundamental concept in economics on its head. Instead of our wants and desires always tending to exceed the means at our disposal to satisfy them, man is confronting a “post-scarcity” world in which the means at our disposal are becoming greater than the ends for which they could be applied. The crisis of society is a crisis of abundance! The richer we become, the less work we have for people to do because, in Keynes’s vision, man’s capacity and desire for imagining new and different ways to improve his life is finite. The economic problem is that we are too well-off, and therefore we suffer from it with rising and persistent unemployment.

As a consequence, unspent income can pile up as unused and uninvested savings; and what investment is undertaken can erratically fluctuate due to what Keynes called the “animal spirits” of businessmen’s irrational psychology concerning an uncertain future. The free market economy, therefore, is plagued with the constant danger of waves of booms and busts, with prolonged periods of high unemployment and idle factories. The society’s problem stems from the fact that people consume too little and save too much to assure jobs for all who desire to work at the money wages that have come to prevail in the market, and which workers refuse to adjust downward in the face of any decline in the demand for their services.

Pyramids, War, and Socialization of Capital for Full Employment

Only one institution can step in and serve as the stabilizing mechanism to maintain full employment and steady production: the government, through various activist monetary and fiscal policies.

In Keynes’s mind the only remedy was for government to step in and put those unused savings to work through deficit spending to stimulate investment activity. How the government spent those borrowed funds did not matter. Even “public works of doubtful utility,” Keynes said, were useful: “Pyramid-building, earthquakes, even wars may serve to increase wealth,” as long as they create employment. “It would, indeed, be more sensible to build houses and the like,” said Keynes, “but if there are political or practical difficulties in the way of this, the above would be better than nothing.” (p. 129)

Nor could the private sector be trusted to maintain any reasonable level of investment activity to provide employment. The uncertainties of the future, as we saw, created “animal spirits” among businessmen that produced unpredictable waves of optimism and pessimism that generated fluctuations in the level of production and employment. Luckily, government could fill the gap. Furthermore, while businessmen were emotional and shortsighted, the State had the ability to calmly calculate the long run, true value and worth of investment opportunities “on the basis of the general social advantage.” (p. 164)

Indeed, Keynes expected the government would “take on ever greater responsibility for directly organizing investment.” In the future, said Keynes, “I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.” As the profitability of private investment dried up over time, society would see “the euthanasia of the rentier” and “the euthanasia of the cumulative oppressive power of the capitalist” to exploit for his own benefit the scarcity of capital. This “assisted suicide” of the interest-earning and capitalist groups would not require any revolutionary upheaval. No, “the necessary measures of socialization can be introduced gradually and without a break in the general traditions of the society.” (pp. 376-379)

This is the essence of Keynes’s economics. A world with arbitrary assumptions about workers and wages, income and consumption, and investors and animal spirits; all of which “rig the game” so that no matter what, markets cannot rebalance themselves and coordinate productions and employments. Only the wise and enlightened in government – who are somehow free from the foibles and failures of character possessed by everyone else – can set society on a stable and even course of full employment.

Keynes’s Worldview: Social Elites and Enlightened Planning

In a famous lecture, “National Self-Sufficiency,” delivered in Dublin, Ireland, in April 1933, John Maynard Keynes renounced his previous belief in the benefits of free trade. He declared, “I sympathize . . . with those who would minimize rather than those who would maximize economic entanglement between nations . . . Let goods be homespun whenever it is reasonably and conveniently possible; and above all, let finance be primarily national.” (Yale Review, June 1933, p. 758) He remained loyal to economic protectionism in The General Theory. In one of the concluding chapters he discovered new value in the 17th- and 18th-century writings of the Mercantilists and their rationales for government control over and manipulation of international trade and domestic investment. (pp. 333-351)

But Keynes expressed another sentiment in that 1933 lecture:

“We each have our own fancy. Not believing we are saved already, we each would like to have a try at working out our salvation. We do not wish, therefore, to be at the mercy of world forces working out, or trying to work out, some uniform equilibrium according to the ideal principles of laissez-faire capitalism . . . We wish    . . . to be our own masters, and to be free as we can make ourselves from the interference of the outside world.” (pp. 761-762)

Keynes was convinced that left to itself, the market economy could not be trusted to assure either stable or full employment. Instead, an activist government program of monetary and fiscal intervention was needed for continuing economic prosperity. If this also required a degree of state planning, Keynes was open to that kind of direct social engineering as well. In an often-quoted 1944 letter to F. A. Hayek, Keynes said that he found himself “in a deeply moved agreement” with Hayek’s arguments in The Road to Serfdom. But less frequently mentioned is what Keynes went on to say in that same letter:

I should say that what we want is not no planning, or even less planning, indeed I should say that what we almost certainly want is more . . . Moderate planning will be safe if those carrying it out are rightly oriented in their own minds and hearts to the moral issue . . . Dangerous acts can be done safely in a community that thinks and feels rightly, which would be the way to hell if they were executed by those who think and feel wrongly. (Quoted in Roy Harrod, The Life of John Maynard Keynes [1951], pp. 436-437)

Of course, the question is: who determines which members of society think and feel “rightly” enough to qualify for the power and authority to plan for the rest of us? And how is it to be assured that such power does not fall into the hands of “those who think and feel wrongly”? Furthermore, on what basis can it be presumed that even those who claim to be “rightly oriented in their own minds and hearts” could ever possess the knowledge and ability to plan some desirable economic outcome for society?

Yet, as a number of commentators have pointed out, Keynes had no doubts about either his “rightness” or competency in claiming such authority or ability. He belonged to a British elite that viewed itself as being superior to the other members of the society in practically every way. As Keynes’s sympathetic biographer Roy Harrod (1900-1978) explained, “he was strongly imbued with . . . the idea that the government of Britain was and could continue to be in the hands of an intellectual aristocracy using the method of persuasion.” (pp.192-193) And as the American Keynesian, Arthur Smithies (1907-1981), also pointed out, “Keynes hoped for a world where monetary and fiscal policy, carried out by wise men in authority, could ensure conditions of prosperity, equity, freedom, and possibly peace.” (Quarterly Journal of Economics [November 1951, pp. 493-494)

Keynes and the Hubris of the Social Engineer

In September 1936, John Maynard Keynes prepared a preface for the German translation of The General Theory of Employment, Interest and Money. Addressing himself to German economists, Keynes hoped that his theory would “meet with less resistance on the part of German readers than from English, when I submit to them a theory of employment and production as a whole,” because the German economists had long before rejected the teachings of both the classical economists and the more recent Austrian School of Economics. And, said Keynes, “if I can contribute a single morsel to a full meal prepared by German economists, particularly adjusted to German conditions, I will be satisfied.”

What were those particular “German conditions?” For more than three years, Germany had been under the rule of Hitler’s National Socialist regime; in 1936, the Nazis had instituted their own version of four-year central planning.

Toward the end of this preface Keynes pointed out to his Nazi economist readers:

“The theory of aggregate production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state, than . . . under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory . . . Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced.” (German and English translated in full in James J. Martin, Revisionist Viewpoints [1971], pp. 203-205)

It would be historically inaccurate to accuse Keynes of explicitly being either a Nazi sympathizer (in spite of his support for eugenics) or an advocate of Soviet or fascist-type totalitarianism (though he clearly was open to a form of “democratic” planning). But Keynes clearly understood that the greater the degree of state control over any economy, the easier it would be for the government to manage the levers of monetary and fiscal policy to manipulate macroeconomic aggregates of “total output,” “total employment,” and “the general price and wage levels” for purposes of moving the overall economy into directions more to the economic policy analyst’s liking.

Keynes’s Elite: Self-Appointed and Answerable to No One

On what moral or philosophical basis did Keynes believe that policy advocates such as himself had either the right or the ability to manage or direct the economic interactions of multitudes of peoples in the marketplace? Keynes explained his own moral foundations in Two Memoirs, published posthumously in 1949, three years after his death. One memoir, written in 1938, examined the formation of his “early beliefs” as a young man in his twenties at Cambridge University in the first decade of the 20th century.

He, and many other young intellectuals at Cambridge, had been influenced by the writings of philosopher G. E. Moore. Separate from Moore’s argument, what is of interest are the conclusions reached by Keynes from reading Moore’s work. Keynes said:

“Indeed, in our opinion, one of the greatest advantages of his [Moore’s] religion was that it made morals unnecessary . . . Nothing mattered except states of mind, our own and other peoples’ of course, but chiefly our own. These states of mind were not associated with action or achievement or consequences. They consisted of timeless, passionate states of contemplation and communion, largely unattached to ‘before’ and ‘after’.” (pp. 82-83)

In this setting, traditional or established ethical or moral codes of conduct meant nothing. Said Keynes:

“We entirely repudiated a personal liability on us to obey general rules. We claimed the right to judge every individual case on its own merits, and the wisdom, experience and self-control to do so successfully. This was a very important part of our faith, violently and aggressively held. . . We repudiated entirely customary morals, conventions and traditional wisdoms. We were, that is to say, in the strict sense of the term immoralists    . . . [W]e recognized no moral obligation upon us, no inner sanction to conform or obey. Before heaven we claimed to be our own judge in our own case.” (pp. 97-98)

Keynes declared that he and those like him were “left, from now onwards, to their own sensible devices, pure motives and reliable intuitions of the good.” Then in his mid-fifties, Keynes declared in 1938, “Yet so far as I am concerned, it is too late to change. I remain, and always will remain, an immoralist.” As for the social order in which he still claimed the right to act in such unrestrained ways, Keynes said that “civilization was a thin and precarious crust erected by the personality and the will of a very few, and only maintained by rules and conventions skillfully put across and guilely preserved.” (pp. 98-99)

On matters of social and economic policy two assumptions guided Keynes, and they also dated from his Cambridge years as a student near the beginning of the century; they are stated clearly in a 1904 paper, “The Political Doctrines of Edmund Burke.” First, “Our power of prediction is so slight, our knowledge of remote consequences so uncertain that it is seldom wise to sacrifice a present benefit for a doubtful advantage in the future . . . We can never know enough to make the chance worth taking.” And second, “What we ought to do is a matter of circumstances . . . [W]hile the good is changeless and apart, the ought shifts and fades and grows new shapes and forms.” (Quoted in D. E. Moggridge, Maynard Keynes: An Economist’s Biography [1992], p. 125)

Contra-Keynes: Self-Interest for Social Harmony and Long-Run Policy

Classical liberalism and the economics of the classical economists had been founded on two insights about man and society. First, there is an invariant quality to man’s nature that makes him what he is; and if society is to be harmonious, peaceful, and prosperous, men must reform their social institutions in a way that directs the inevitable self-interests of individual men into those avenues of action that benefit not only themselves but others in society as well. They therefore advocated the institutions of private property, voluntary exchange, and peaceful, open competition. Then, as Adam Smith (1723-1790) had concisely expressed, men would live in a system of natural liberty in which each individual would be free to pursue his own ends, but would be guided as if by an invisible hand to serve the interests of others in society as the means to his own self-improvement. (Adam Smith, The Wealth of Nations [1776; 1937], p.651)

Second, it is insufficient in any judgment concerning the desirability of a social or economic policy to focus only upon its seemingly short-run benefits. The laws of the market always bring about certain effects in the long run from any shift in supply and demand or from any government intervention in the market order. Thus, as French economist Frederic Bastiat (1801-1850) emphasized, it behooves us always to try to determine not merely “what is seen” from a government policy in the short run, but also to discern as best we can “what is unseen,” that is, the longer-run consequences of our actions and policies.(Frederic Bastiat, Selected Essays on Political Economy, pp. 1-50)

The reason it is desirable to take the less immediate consequences into consideration is that longer-run effects may not only not improve the ill the policy was meant to cure but can make the social situation even worse than if it had been left alone. Even though the specific details of the future always remain beyond our ability to predict fully, one use of economics is to assist us to at least qualitatively anticipate the likely contours and shape of that future aided by an understanding of the laws of the market.

Short-Run Policies and an Ideology of Nihilism

Keynes’s assumptions deny the wisdom and the insights of the classical liberals and the classical economists. The biased emphasis is toward the benefits and pleasures of the moment, the short run, with an almost total disregard of the longer-run consequences. It led F. A. Hayek to lament in The Pure Theory of Capital (1941):

“I cannot help regarding the increasing concentration on short-run effects . . . not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilization . . . It used, however, to be regarded as the duty and the privilege of the economist to study and to stress the long run effects which are apt to be hidden to the untrained eye, and to leave the concern about the more immediate effects to the practical man, who in any event would see only the latter and nothing else. . . . It is not surprising that Mr. Keynes finds his views anticipated by the mercantilist writers and gifted amateurs; concern with the surface phenomena has always marked the first stage of the scientific approach to our subject . . . Are we not even told that, ‘since in the long run we all are dead,’ policy should be guided entirely by short-run considerations? I fear that these believers in the principle of après nous le deluge [after us, the flood] may get what they have bargained for sooner than they wish.” (pp. 409-410)

But if every action and policy decision is to be decided in the context of shifting circumstances, as Keynes insisted, on what basis shall such decisions be made, and by whom? Such decisions are to be made on the basis of the self-centered “state of mind” of the policymakers, with total disregard of traditions, customs, moral codes, rules, or the long-run laws of the market. Their rightness or wrongness was not bound by any independent standard of “achievement and consequence.” Instead it was to be guided by “timeless, passionate states of contemplation and communion, largely unattached to ‘before’ and ‘after.’” The decision-maker’s own “intuitions of the good,” for himself and for others, were to serve as his compass. And let no ordinary man claim to criticize such actions or their results. “Before heaven,” said Keynes, “we claimed to be our own judge in our own case.”

Here was Keynes’s elitist ideology of nihilism. The members of this elite were self-appointed and shown to belong to this elect precisely through mutual self-congratulations of having broken out of the straitjacket of conformity, custom, and law. For Keynes in his fifties, civilization was this thin, precarious crust overlaying the animal spirits and irrationality of ordinary men. Its existence, for whatever it was worth, was the product of “the personality and the will of a very few,” like himself, naturally, and maintained through “rules and conventions skillfully put across and guilely preserved.”

Society’s shape and changing form were to be left in the hands of “the chosen” few who stood above the passive conventions of the masses. Here was the hubris of the social engineer, the self-selected philosopher-king, who through manipulative skill and guile directed and experimented on society and its multitudes of individuals. It is what made Keynes feel comfortable in recommending his “general theory” to a Nazi readership. His conception of a society maintained by “the personality and the will of a very few,” after all, had its family resemblance in the Fuhrer’s principle of the unrestrained “one” who would command the Volk.

Rational Economics: Choice, Trade, and Division of Labor

In the preface to The General Theory of Employment, Interest and Money, John Maynard Keynes stated, “the composition of this book has been for the author a long struggle of escape . . . a struggle of escape from habitual modes of thought and expression.” (p. xxiii) What Keynes struggled to escape from was the common-sense foundations of economics.

From Adam Smith in the 18th century to the Austrian economists of the 20th century, economics has developed and been refined into the study of human action and the logic of human choice. After more than two hundred years economists came to understand more clearly that nothing happens in “society” or “the market” that does not first begin with the actions and decisions of individuals. Indeed, “the market” is nothing more than a summarizing term to express the arena in which multitudes of individuals meet and interact as suppliers and demanders for the purpose of mutual gains through trade.

Each individual has various goals he would like to achieve. To attain them he must apply various means to bring those desired ends into existence through production. But man finds that, unfortunately, the means at his disposal are often insufficient to satisfy all the uses he has for them. He faces the reality of scarcity. He is confronted with the necessity to choose; he must decide which desired ends he prefers more. And then he must apply the means to achieve the more highly valued ends, while leaving the other, less valued, ends unfulfilled.

In his state of disappointment, man looks to see if there are ways to improve his situation. He discovers that others face the same frustration of unsatisfied ends. Sometimes he finds that those others have things that he values more highly than some of his own possessions, and they in turn value his possessions more highly than their own. A potential gain from trade arises, in which each party can be better off if they trade away what they respectively have for what the other has. But how much of one thing will be exchanged for another? This will be determined through their bargaining in the market. Finally, they may agree upon terms of trade, and will establish a price at which they exchange one thing for another: so many apples for so many pears; so many bushels of wheat for so many pounds of meat; so many pairs of shoes for a suit of clothes.

Trade becomes a regular event by which men improve their circumstances through the process of buying and selling. Appreciating the value of these trading opportunities, men begin to specialize their productive activities and create a system of division of labor, with each trying to find that niche in the growing arena of exchange in which they have a comparative production advantage over their trading partners. As the market expands, a growing competition arises between buyers and sellers, with each trying to get the best deal possible as a producer and a consumer. The prices at which goods are traded come more and more to reflect the contributing and competing bids and offers of many buyers and sellers on both sides of the market.

Trade, Money and Say’s Law of Markets

The more complex the network of exchange, the more difficult is the direct barter of goods one for another. Rather than be frustrated and disappointed in not being able to directly find trading partners who want the goods they have for sale, individuals start using some commodity as a medium of exchange. They first trade what they have produced for a particular commodity and then use that commodity to buy from others the things they desire. When that commodity becomes widely accepted and generally used by most, if not all, transactors in the market, it becomes the money good.

It should be clear that even though all transactions are carried out through the medium of money, it is still, ultimately, goods that trade for goods. The cobbler makes shoes and sells them for money to those who desire footwear. The cobbler then uses the money he has earned from selling shoes to buy the food he wants to eat. But he cannot buy that food unless he has first earned a certain sum of money by selling a particular quantity of shoes on the market. In the end, his supply of shoes has been the means for him to demand a certain amount of food.

This, in essence, is the meaning of Say’s Law. Jean-Baptiste Say called it “the law of markets:” that is, unless we first produce, we cannot consume; unless we first supply, we cannot demand. But how much others are willing to take of our supply is dependent on the price at which we offer it to them. The higher we price our commodity, other things held equal, the less of it others will be willing to buy. The less we sell, the smaller the money income we earn; and the smaller the money income we earn, the smaller our financial means to demand and purchase what others offer for sale. Thus, if we want to sell all that we choose to produce we must price it correctly; that is, at a price sufficiently low that all we offer is cleared off the market by demanders. Pricing our goods or labor services too high, given other people’s demands for them, will leave part of the supply of the good unsold and part of the labor services offered unhired.

On the other hand, lowering the price at which we are willing to sell our commodity or services will, other things held equal, create a greater willingness on the part of others to buy more of our commodity or hire more of our labor services. By selling more, our money income can increase; and by increasing our money income, through correctly pricing our commodity or labor services, we increase our ability to demand what others have for sale.

Sometimes, admittedly, even lowering our price may not generate a large enough increase in the quantity demanded by others for our income to go up. Lowering the price may, in fact, result in our revenue or income going down. But this, too, is a law of the market: what we choose to supply is worth no more than what consumers are willing to pay for it. This is the market’s way of telling us that the commodity or particular labor skills we are offering are not in very great demand. It is the market’s way of telling us that consumers value other things more highly. It is the market’s way of telling us that the particular niche we have chosen in the division of labor is one in which our productive abilities or labor services are not worth as much as we had hoped. It is the market’s way of telling us that we need to move our productive activities into other directions, where consumer demand is greater and our productive abilities may be valued more highly.

Market-Guided Money Prices and Wages Assure Full Employment

Can it happen that consumers may not spend all they have earned? Can it be the case that some of the money earned will be “hoarded,” so there will be no greater demand for other goods, and hence no alternative line of production in which we might find remunerative employment? Would this be a case in which “aggregate demand” for goods in general would not be sufficient to buy all of the “aggregate supply” of goods and labor services offered?

The answers had already been suggested in the middle of the 19th century by the English classical economist John Stuart Mill (1806-1873) in a restatement and refinement of Say’s law of markets. In an essay titled “Of the Influence of Consumption on Production” (1844), Mill argued that as long as there are ends or wants that have not yet been satisfied, there is more work to be done. As long as producers adjust their supplies to reflect the actual demand for the particular goods that consumers wish to purchase, and as long as they price their supplies at prices consumers are willing to pay, there need be no unemployment of resources or labor. Thus, there can never be an excess supply of all things relative to the total demand for all things. (Reprinted in, Henry Hazlitt, ed., The Critics of Keynesian Economics [1960], pp. 24-45)

But Mill admits that there may be times when individuals, for various reasons, may choose to “hoard,” or leave unspent in their cash holding, a greater proportion of their money income than is their usual practice. In this case, Mill argued, what is “called a general superabundance” of all goods is in reality “a superabundance of all commodities relative to money.” In other words, if we accept that money, too, is a commodity like all other goods on the market for which there is a supply and demand, then there can appear a situation in which the demand to hold money increases relative to the demand for all the other things that money could buy. This means that all other goods are now in relative oversupply in comparison to that greater demand to hold money.

To bring those other goods offered on the market into balance with the lower demands for them (i.e., given that increased demand to hold money and the decreased demand for other things), the prices of many of those other goods may have to decrease. Prices in general, in other words, must go down, until that point at which all the supplies of goods and labor services people wish to sell find buyers willing to purchase them. Sufficient flexibility and adjustability in prices to the actual demands for things on the market always assure that all those willing to sell and desiring to be employed can find work. And this, also, is a law of the market.

Free market economists, both before and after Keynes, have never denied that the market economy can face a situation in which mass unemployment could exist and a sizable portion of the society’s productive capacity could be left idle. But if such a situation were to arise, they argued that its cause was to be found in a failure of suppliers to price their goods and labor services to reflect what consumers considered them to be worth, given the demand for various other things, including money. Correct prices always assure full employment; correct prices always assure that supplies create a demand for them; correct prices always assure the harmony of the market.

This was the reality of the law of markets from which Keynes struggled so hard to escape. Instead, he constructed an imaginary world of “aggregate demand” and “aggregate supply” in which all the relative prices and wages, relative demands and supplies, relative profits and losses, and relative resource and labor uses and allocations that really guide and coordinate a market economy in the sustainable direction of “full employment” production are submerged in statistical magnitudes of output and employment “as a whole.” (See my articles, “The Myth of Aggregate Demand and Supply” and “Macro Aggregates Hide the Real Market Processes at Work”.)

Which Conception of Man, Markets, and Morality Shall We Choose?

A dynamic, growing and adaptable market economy requires a number of institutions. Private property is paramount, along with money prices generated through the competitive processes of buying and selling both finished goods and the factors of production. Market prices enable the intellectual exercise of economic calculation, through which the relative value and cost of all market-traded goods and services can be established so as to assure their rational and efficient use.

The competitive interaction of market supplies and demands, the structure of relative prices for goods and resources, the presence of entrepreneurial creativity and alertness induced through the potential for market-based profits, and a relative flexibility in the mobility and adaptability of the factors of production to changing circumstances are what assure the effective functioning of a free society.

But fundamentally, none of these elements of a market economy can survive in the long run without the necessary philosophical and moral principles. These principles lay outside of supply and demand. They are based, and must be based, on a conception of man, the human condition, and a good society.

Does man have a right to his own life, liberty, and honestly acquired property? Do we presume that man is a reasoning and rational being who is capable of directing and guiding his own life? Should human relationships be based on voluntary choice and mutual agreement among men? Shall we allow each individual to design the plans for his own life, and coordinate his actions with those of others through the peaceful and competitive interactions of the open marketplace? Shall we limit the role and responsibilities of government to securing each individual’s rights against any use of force and plunder?

Or do we accept Keynes’s view of man? An irrational creature guided by “animal spirits,” who cannot be trusted to make intelligent decisions concerning either the present or the future; who needs an intellectual and political elite of managers and manipulators who use “rules and conventions skillfully put across and agilely preserved” to control those who are presumed too untrustworthy to be left free of a paternalistic overseer.

The current economic crisis has been made by the very types of elites about whom Keynes had so much confidence. Misreading the medical and scientific evidence about the coronavirus, they sent the U.S. and the world into a terrible economic tailspin by commanding and compelling social and economy-wide lockdowns and work stoppages that have ruined the workings of the market and the livelihoods of tens of millions. Now, in the face of their own disastrous handiwork, they can only dream new dreams of even more political paternalism and planning. (See my articles, “There will be No Recovery Without Production” and “How Lockdowns Shattered the Structure of Production” and “Will There be Tyranny in the Post-Coronavirus World?”)

Which view of man prevails – man seen as a reasonable but imperfect person who can guide and direct his own life, or man seen as an irrational being constantly needing someone else to direct and dictate how and what he does – will determine the future for mankind, not only out of the current economic crisis, but also for the many years and decades to come. 

Dr. Richard Ebeling is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel, in Charleston, South Carolina.

Dr. Ebeling is the author of Austrian Economics and Public Policy: Restoring Freedom and Prosperity  (2016); Monetary Central Planning and the State (2015) as well as the author of Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (2010) and Austrian Economics and the Political Economy of Freedom (2003). And the editor of the three-volume, Selected Writing of Ludwig von Mises, published by Liberty Fund.

He is also the co-editor of When We Are Free (Northwood University Press, 2014), an anthology of essays devoted to the moral, political and economic principles of the free society, and co-author of the seven-volume, In Defense of Capitalism (Northwood University Press, 2010-2016).

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