The Theories of John Maynard Keynes

©1996 by Chuck Braman

Introduction

John Maynard Keynes (b June 5, 1883, Cambridge, Cambridgeshire, eng.—d. April 21, 1946, Firle, Sussex), was an English economist, journalist, and financier. Although prominent in politics, he achieved his greatest fame as a the author of “The General Theory of Employment, Interest and Money” (1935-36), and as a result of the influence of this work became the most influential economist of the twentieth century.

Perhaps a large part of the impact of the General Theory had to do with the timeliness of its message. Written during the height of the depression, it offered a new explanation of the depression and the unemployment that plagued it. In addition to its timing, however, Keynes’ new theory probably also appealed to economists because it provided an alternative to the traditionally held view that unemployment can and should be eliminated by a drop in wage rates. Keynes alternative was politically and socially much more palatable to the intelligentsia, because the majority of the intelligentsia held the conclusion, claimed by the Marxist exploitation theory, that wages tend toward the minimum level required to maintain the subsistence of the workers. Thus, for economists to advocate that wages fall yet lower placed them in a seemingly morally indefensible position. Keynes new theory, on the other hand, conveyed a politically much more palatable solution to unemployment: according to Keynes, the solution to unemployment was a growth in government spending. The particular form of government spending advocated by Keynes was for the government to purposely adopt a policy of budget deficits; this he called “fiscal policy.”

Keynes' Theories

To arrive at this seemingly simple conclusion, however, Keynes developed a highly complex argumentation brimming with new economic terms and concepts of his own devising, such as “multipliers,” “consumption and saving functions,” “the marginal efficiency of capital,” “liquidity preference,” “I-S curve,” and many others.

The essence of Keynes’ theory, however, involves a shift from classical economics' concern with the production of wealth to a concern with the consumption of wealth. According to Keynes, Say’s Law is not true; that is, supply does not create its own demand. Rather, according to Keynes, supply is capable of outstripping demand, with the result that goods remain unsold, and production and employment are correspondingly cut back. As a result, the solution to unemployment, according to Keynes, is not to reduce wages and prices, as the Classicals advocated, but to increase consumption through the spending of money by the government. The question remains, however, as to why Keynes believed that supply does not create its own demand.

A major reason, Keynes claimed, is that, under modern conditions, savings and investment take place separately from one another, and therefore can be and often are dis-coordinated. For in modern conditions, those who save included the lower and middle classes, while those who invest are the businessmen—as Keynes saw it, primarily the upper classes. And whether or not the upper classes invest—and thus increase output, which, to produce, in turn, requires a larger number of workers and thus greater employment—depends, according to Keynes, on a constellation of subjective and irrational psychological factors, rather than merely depending on the availability of savings at a low rate of interest. In addition, investment depends on profitable opportunities to invest, which, according to Keynes, follow business cycles which are dependent on the creation of new technologies, and which, therefore, do not always exist. And conversely, the decision of the lower, middle and upper classes to save is not automatically coordinated with the amount of investment needed by the businessmen, according to Keynes, because there is what Keynes calls “liquidity preference”—meaning an allegedly frequent preference of potential savers to hoard their money in the form of cash rather than to save it.

When, for any of these reasons, saving is withheld from investment, unemployment results, which in turn results in “overproduction”—that is, the previous output of products cannot be sold, because those who would buy them are now unemployed and penniless. This, in turn, results in a general depression which, given the nature of a free market, Keynes believes is capable of lasting indefinitely. The reason for this, Keynes maintained, is that in a depression there is not a surplus of savings available at a correspondingly low interest rate, but rather, an absence of savings as the general population withdraws money in the struggle to survive. Without saving, again, there is no investment; without investment, no employment; without employment, no spending; without spending, an overproduction of goods that can’t be sold. When all of this is added up, there is a depression without end: unemployed men and women amid underutilized plant and equipment and unsold goods.

Thus, Keynes believed, in order to "get the economy moving again," the government must itself begin spending money, since the general population is unable to do so sufficiently. How, and where the government spends its money, and whether such spending fulfills any desirable public or private purpose beyond its economic function, Keynes held, is irrelevant. For the sole purpose of such spending is to buy goods that would otherwise remain unsold, so that the sellers of those goods can in turn “buy,” i.e., employ, currently unemployed workers. Government spending, for Keynes, fills the gap that necessarily must exist in a free economy between savings and investment, a gap which, if not filled by the government's spending, would be filled with unemployed people and unsold goods.

For Keynes, wealth is not conceived of as a static amount of physical goods produced within an economy, but as the amount for money that flows throughout it. It is not cars, TVs, houses, etc. but the passing of such goods from person to person by means of the spending of money. Thus, Keynes’ view of the importance of consumption: without a continuous consumption, stimulated by the government, goods are produced, but not bought; but with government-stimulated spending, people are able to consume, and as a corollary, they are given work to do. For Keynes, to be wealthy is to consume—and to consume is to make possible the work of the producer.

Likewise, it is not the “Thrift” of Adam Smith that benefits and economy, according to Keynes, but the subjectively-motivated “Enterprise” of the businessman. Expressing this, Keynes wrote:

“It has been usual to think of the accumulated wealth of the world as having been painfully built up out of that voluntary abstinence of individuals from the immediate enjoyment of consumption, which we call Thrift. But it should be obvious that mere abstinence is not enough by itself to build cities or drain fens.

…It is Enterprise which builds and improves the world's possessions… If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing.”

Again, spending, not saving, benefits an economy, according to Keynes—in fact, Keynes went so far as to denigrate savings itself as a destructive “leakage” of spending from the economy. And this spending itself, according to Keynes, creates an additionally stimulating “multiplier effect”—that is, a fraction of each dollar that is spent is in turn re-spent, so that each act of spending creates waves of benefits throughout the economic system.

Influence

The influence of Keynes on subsequent economists has been enormous, largely because one of his top students, Paul Samuelson, wrote what has become the standard college text on economics in the United States for the past several generations. Equally great, though, was the direct influence of his ideas on the policies of various governments. For example, in 1944 the British White Paper on Employment Policy stated that “the government accept as one of their primary aims and responsibilities the maintenance of a high and stable level of employment after the war.” In the United States, the Employment Act of 1946 stated: “The Congress hereby declares that it is the continuing policy and responsibility of the Federal Government to… promote maximum employment, production and purchasing power.” The Employment Act also created a council of economic advisers to report to the president at each regular session of congress on the state of the economy, and required the president to present a program showing “ways and means of promoting a high level of employment and production.” Similar programs were adopted in Sweden in 1944 by the Social Democrats, and in Canada and Australia.

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