Keynesianism: what it is and why it still matters

For the last three decades laissez-faire conservatives have sought to systematically discredit the ideas known as “Keynesianism.” This assault has had deleterious consequences for economic policy and public economic understandings. It is time for Keynesians to fight back.

Keynesianism refers to the set of ideas associated with the great British economist John Maynard Keynes, who published his magnum opus, The General Theory of Employment, Interest and Money, in 1936. The General Theory provided a framework for understanding the Great Depression. But far more than that, it provided a framework for understanding the “big picture” operation of modern capitalist economies. In a sense, it was to economics what Einstein’s general theory of relativity was to physics.

Keynesianism rests on the simple compelling insight that, subject to capacity limits, the level of economic activity is determined by demand for output. This principle explains a wide range of phenomena in capitalist economies. If demand is insufficient, firms will reduce production and employment and the economy will fall into recession. That is why we worry about consumer and business spending.

Most importantly, Keynes explained why market economies do not automatically generate sufficient demand to ensure full employment. In fact, demand is usually slightly less than that needed for full employment, which means market economies spend most of the time with unnecessary unemployment that is economically wasteful, socially destructive and the cause of great individual suffering. Moreover, on occasion the employment shortfall can be large, as during the Great Depression. However, though recognizing that market economies usually fail to produce full employment, Keynes was not anti-market. Markets work well for those that are employed; the problem is they tend to create insufficient employment.

This failing means that there is a role for government in ensuring full employment. Thus, government can affect demand through taxes, social security and unemployment insurance, and through spending on infrastructure and government services. Government can also affect demand through labor and minimum wage laws that impact wages and income distribution. Finally, central banks affect demand through their control over interest rates.

The period 1945 – 1975 is widely regarded as having been a golden age of mass prosperity, and it was a time when Keynesian ideas dominated policymaking. In 1971 President Nixon famously declared “We are all Keynesians now.” Since then Keynesianism has been in retreat, though owing to its outstanding earlier success policymaking still remains subject to Keynesian influences. This influence is evidenced by Federal Reserve interest rate policy and by the acceptance of larger budget deficits in recessions. However, there has been a retreat in politics and academic teaching, with important consequences.

This retreat is the result of both attack by the right and over-selling by the left. With regard to the right, it always opposed Keynesianism’s identification of an important policy role for government and it disliked progressive taxation. The right also opposed labor market institutions and financial regulations that promoted robust stable demand at the expense of their economic and political power. With regard to the left, it tended to overstate the extent of Keynesian market failure, to understate the effectiveness of market prices and incentives in driving economic action, and to stretch the case for government replacing market production. Finally, Keynesian success in achieving full employment aggravated the perennial problem of conflict over income shares, thereby causing higher inflation. This problem needed a political solution that was never forthcoming, and the right skillfully used the inflationary OPEC oil shocks of the 1970s to blame Keynesianism for the resulting economic disruption.

The political, intellectual and rhetorical retreat from Keynesianism has had enormous consequences. First, there has been a retreat from true full employment, which means that we live today with unwarranted unemployment. Second, the pre-Keynesian ideology of self-adjusting economies has reasserted itself and been used to rollback financial regulation, labor market protections, trade unions and the minimum wage. This has worsened income distribution and created a proclivity to boom-bust cycles. Third, the case for progressive taxes and a more equal income distribution have been rolled back as this is no longer viewed as part of the demand management policy agenda. Fourth and finally, the relevance of Keynesianism for globalization has been suppressed. Keynes was always cautious about free trade and skeptical about international mobility of financial capital because of the impacts on employment and the ability to conduct national economic policy. These concerns speak to the 21st century relevance of Keynesianism and the need for a Keynesian counter-revolution.

P.S. If you would like to read more about these matters please feel free to buy my book Plenty of Nothing, Princeton University Press, 1998 or download my article “From Keynesianism to Neo-liberalism: Shifting Paradigms in Economics,” in Neo-liberalism: A Critical Reader, Johnston & Saad Filho (eds.), Pluto Press: London, 2004.

4 Responses to “Keynesianism: what it is and why it still matters”

  1. Jim Stodder Says:

    A good read. I would put the case of the Right’s miss-appropriation a bit more strongly:

    * The Right has hijacked half of Keynesian deficit spending it always liked: the cutting of taxes (not an increase in spending, or not unless it’s on armaments or construction contracts to Bush’s campaign donors). It deliberatley obscures its tax-cutting rationale — a supply-side wolf in Keynesian sheep’s clothing. James Tobin said it in 1983 — Regan’s defict spending made ‘Keynes look like a piker.’ And of course Bush II is far worse. For the Right it’s ALWAYS the right time to cut taxes. In recession it’s for Keynesian reasons, in boom it’s to incentivize the poor belaguered risk-taking investor.

    * The Left for its part has always pushed just the other half of Keynes (government deficit spending), and also minimized the role of monetary policy. Here Tom gets it about right. The Left hardly ever sees a government expansion policy it doesn’t like. No wonder Keynes was so courted by both Left and Right, and why both were so dissapointed. He refused to think, as Rush L. now brags, with half his brain tied behind his back.

  2. Susanne Shaw Says:

    Taxes help redistribute the collective wealth. The wealth was there long before hte first humanoid dropped out of the trees: mineral, water, air, forests, soild, edible stuff, etc. Capitalism (all rightwing bullies)only exploits that wealth out of the environment–with often exploited human help and abuse of animals. It does not share. Taxes provide roads, hospitals, UNIVERSAL healthcare (not seen in the USA for sheer stupidity on the part of the voters), schools, food inspection, medicines, research, restaurant and housing inspections, policing, ambulances, unemployment insurance, environmental care, parks, water quality, GOOD car insurance (in BC, it’s still owned by hte people) and welfare, etc. I’ve never been reluctant to pay my taxes. What makes me mad is the rich and corporate don’t pay theirs!

  3. Markus Marterbauer Says:

    The sentence “It is time for Keynesians to fight back.” is even more appopriate for the European Union than for the US. In the EU weak economic development combined with rising unemployment and rising inequality is holding on for more than five years now. Economic policy is concetrated on improving supply side conditions, this can be positive (better education, more spending on R&D) and is improving potential growth rates. But this potential growth is never realised due to a lack of effective demand. Demand stimulating measures are needed: Higher public investment, redistribution in favour of low income households and so on - the (Keynesian) instruments are available, but economic policy so far is not interested in implementing them.

  4. José Pérez Oya (BA.-MA. Oxon) Says:

    Dear Sir; The hate of a long-lasting reactionnary “american” right to Keynes is an old, old phenomenon. I call your attention to a publication I have in Spanish, but obviously translated from English: it is signed “Liberal Fund” entitled “Keynes en Harvard” written by the so called (in Spanish) “Centro de estudios sobre la libertad” . It was promoted in Argentina by the “Veritas Foundation Staff” and dated 1981. According to these people Keynes was a fabian,social-communist agent. ETC:ETC.
    Yours very sincerely José.