PART FOUR

KEYNESIAN ECONOMICS

Introduction

Between the two World Wars, the economic environment of most industrial countries was shaken by a crisis of unprecedented dimensions. Unemployment mounted to record levels and was stubbornly persistent. With it came a wave of social discontent. In England, the crisis began in 1921 and continued with little interruption through the 1930s. Severe depression conditions were later in reaching the United States, but when they arrived with the 1929 crash, their force was greater. Clearly, it was not `normalcy' to which the Western world had returned.

The fabric of Western industrial communities was deeply rent by these events. In Britain, the general strike of 1926, which was bred in social hostility, generated still more. Later, when the bread lines and queues for the dole lengthened in the United States, unemployed veterans of the First World War marched on the national capital protesting that they were `forgotten men'. Amid these symptoms of distress many reflective persons were led to ask whether or not the Marxian prognosis about the future of capitalism - which had been largely written off as falsified by history in the heyday of late nineteenth-century capitalism - might not have been so far wrong after all.

The orthodox tradition in economic thinking was unprepared to deal with this situation. The framework of the neo-classical mentality had been organized around the assumption that full employment was an economy's normal operating level that departures from it would be minor, and that - when lapses did occur - the economic system itself would generate the necessary remedies. In the 1930s, this image of the functioning of an economic system seemed to be far out of touch with the realities. Not only had idleness in the labour force and in plant capacity reached unusual proportions but there was little to indicate that this distressing situation was correcting itself.

Despite the chasm separating the assumptions of neoclassical aggregative analysis from the world of events, economists schooled in the neo-classical tradition were not at a loss to offer an explanation for these abnormalities. The persistence of unemployment could be accounted for by rigidities within the economic system that stalled the mechanism for adjustment to full employment equilibrium. Two types of rigidities figured prominently in the discussion of the times. Perhaps the most important was the inflexibility of wages arising from the influence of trade unions. From this perspective the insistence of organized labour on strict adherence to negotiated minimum wage scales was held to be socially irresponsible. The system's normal response to unemployment, it was maintained, called for wage reductions which would, in turn, encourage employers to hire more workers. Were it not for the obstructionism of trade unions, the economy would begin to climb the path back to full employment.

A rigidity of a second type was also viewed as thwarting the self-adjusting properties of the economic system. In this case, the responsibility was placed at the door of the business community, or at least that portion of it which departed from the standards required by perfect competition. Many businesses - particularly large-scale industrial enterprises - had achieved a position in which they could exercise a substantial degree of control over prices. In the conditions of industrial organization of the inter-war period, fewer and fewer enterprises were price-takers accepting passively the prices established by unregulated markets, and more and more had the power to be price-makers. Elements of monopoly in the system reduced the flexibility of prices and augmented the ability of sellers to resist pressures to reduce prices when demand slackened. This line of explanation gained status in the early 1930s with the publication of the theories of imperfect and monopolistic competition worked out by Joan Robinson in England and E. H. Chamberlin in the United States.

If economists were not well equipped to deal with massive unemployment, statesmen were even less adequately prepared. Officially most of them appealed for business confidence and invoked the familiar canons of orthodox economic policy: the balanced budget and monetary soundness. In their conduct of affairs governments often departed from tradition, though not without a sense of sin. The leaders of most Western states in this period sought desperately to remedy their own country's ills by restricting international transactions. By various protective devices - from increased tariff rates to currency devaluation - home industries were sheltered in the hope that employment would be stimulated. In fact, however, these beggar-thy-neighbour policies bred retaliation by other countries that curtailed the volume of international trade but neutralized most of the hoped-for gains in employment.

Behind the scenes, most Western governments were groping for fresh approaches and new solutions. The distress around them was too obvious and too urgent to be ignored. But a carefully worked out strategy for attacking the economic malaise was lacking. Some halting steps in the right direction were taken. Britain experimented with public works programmes, though on a modest scale, as job-creating devices. In the United States the Roosevelt administration, which had come into office pledged to balance the budget at a reduced level of public expenditure, took bold initiatives in using public works programmes to stimulate the economy. These daring experiments were refreshing departures from the conventional wisdom, but they had no analytical foundations. In the absence of a solid theoretical diagnosis of the economics of unemployment no rational means were available to distinguish promising policy remedies from the panaceas offered by cranks and crackpots.

Much of the historical significance of Keynes's General Theory of Employment, Interest and Money stems from the fact that it offered a fresh insight into the aggregative behaviour of the economic system and provided a theoretical underpinning for a programme of government action to promote full employment. Many of the specific policies Keynes prescribed had been recommended on intuitive grounds by others. But a new theoretical scheme was required before these remedies could be communicated with conviction. Without a Keynes, the course of recent history would have been vastly different.