Cometh the moment, cometh the man. Crashing share prices, global financial instability, deflation lurking in the background: this is a world made for John Maynard Keynes. For those who kept the flame flickering during the long night of laissez-faire, this is their moment. The old devil is back.
Keynes is a helmsman for stormy seas. When a witch’s brew of speculation, banking failures and falling prices led to mass unemployment and a collapse in living standards in the 1930s, Keynes rejected the notion that, in the long run, market forces would operate to leave the sea calm again. Now that the global economy is again gripped by system failure, thoughts turn to the man who revolutionised economic thinking 70 years ago.
Keynesian policies never disappeared from the arsenal of policymakers, even those of a neo-liberal stamp. Keynes, for example, argued that attempts by governments to balance their budgets during recessions by raising taxes or cutting spending would simply make matters worse. When governments have, in the face of recession, allowed their budget deficit to balloon, they have been acting in Keynesian fashion.
But a decade ago Keynes was still a secret vice; now he can be made respectable again. Some economists, such as Britain’s Chancellor of the Exchequer, Gordon Brown, have noted recently that deflation is as big a threat to an economy as inflation. Brown has just acted to prevent deflation from becoming a reality with a huge package of public spending. Keynes would also have seen the injection of investment by the state as a wise precaution against an ebbing of private-sector demand in troubled times. Moreover, he would have seen Brown’s overall approach to fiscal policy — building up surpluses in good times to provide leeway for deficits in bad times — as correct.
Like many so-called ”new Keynesians”, Brown believes Keynes was writing about special circumstances, and that it is only when there are clear signs of market failure that his ideas apply. Keynes believed that markets were imperfect, and that market failure was a chronic condition of capitalism. His view was that neo-classical economics (which stresses the optimal allocation of resources to wants) depended on assumptions that did not apply in the real world.
Despite turning economics on its head, Keynes was no revolutionary. He was a liberal toff — educated at Eton and King’s College, Cambridge — who wanted to reform capitalism and save it from itself. Today Keynes would not cavil with those who argue that capitalism has been the driving force behind the improvements in living standards in the West over the past 250 years. Nor would he dispute that the new wave of technological progress holds out the prospect of a golden age. What he would argue, however, is that there are three areas where policy needs to be re-thought before this can happen.
The first is where the private sector is unwilling to spend, but the normal remedy — lower interest rates — proves ineffective, either because individuals and companies are psychologically scarred from recent experience or because interest rates cannot be reduced to a low enough level. Keynes called this a liquidity trap, and it is what policymakers in Japan have been grappling with for 10 years. The low level and falling level of inflation across the rest of the developed world is a warning that other countries could shortly face the same problem.
As Japan has found, it is easier to fall into a liquidity trap than escape from one.
Secondly, falling prices are a symptom of an imbalance in global demand and supply. One of the basic tenets of classical economics is Say’s Law, which states that there can never be slumps because supply creates its own demand. But the reality of globalisation is that low-wage workers in poor countries are adding vastly to the world’s supply of goods, but lack the purchasing power to buy the products they make. There is, in other words, a global deficiency in aggregate demand that is leading to lower prices, so intensifying deflationary forces.
The Keynes blueprint for the post-war system was for a floor to be put under commodity prices; for trade imbalances to be remedied by expansionary policies on the part of creditors rather than deflationary action by debtors; and controls on capital to allow nations to pursue full employment. Instead, we have the dead hand of the International Monetary Fund, foisting deflation and depression on a country such as Argentina.
Finally, the deregulation of financial markets has made capitalism less stable. Markets are now more liquid, but that is not the same as being more effective. Keynes was adamant that capital markets were there to provide investment for entrepreneurs, not to provide gambling chips. ”Speculators may do no harm as bubbles on a steady stream of enterprise,” he said.
”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.” — (c) Guardian Newspapers