Postscript to Keynesian Economics

The central focus of Keynes's pathbreaking work was on the determination of national income, with particular reference to the circumstances of deep depression. This preoccupation has prompted some commentators to challenge the accuracy of the title of the General Theory and to contend that Keynesian analysis is really the economics of a special case. Keynes himself lent support to this interpretation when, in the concluding pages of that work, he wrote:

Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards.*

For once Keynes claimed too little. In a formal sense it is correct that circumstances of full employment reinstate the postulates of neo-classical analysis and dissolve the unique feature of the Keynesian model, i.e. the possibility of a liquidity trap based on hoarding. Nevertheless, Keynesian analysis cannot accurately be described as exclusively the economics of unemployment. The problems of a full-employed system can also be instructively analysed with the macro-economic tools he forged.

In his post-General Theory writings, Keynes charted directions in which his aggregative concepts could be adapted to other situations. During the war years he applied them to the problems of managing a fully employed economy. Similarly, he stimulated a substantial revision in the theory of international trade. From a Keynesian point of view, the process of balance of payments adjustment could more usefully be traced through changes in aggregate income associated with surpluses or deficits in the international accounts than through gold movements and the ancillary monetary and price changes to which the neo-classical economists had directed attention.

In at least two respects, however, there is substance to the charge that the analytical structure of the General Theory is more partial than general. In the first place the scope of this work was deliberately restricted to a time span of six to nine months. For this reason it was appropriate for Keynes's purposes to consider only one aspect of investment expenditure - namely its income-generating properties via the multiplier process - and to ignore the longer-term effects of investment spending on the economy's stock of productive assets. Secondly, the General Theory, when viewed as an analytical system, can quite rightly be regarded as less comprehensive than the other master models because of its neglect of micro-economic analysis. Though Keynes ruptured the neo-classical symmetry between micro- and macro-economics, he provided no integrated analytical reconstruction to replace it. Around both of these issues a substantial debate has subsequently revolved.

The first of these analytical omissions has largely been taken care of by the growth models developed by Professor Evsey Domar in the United States and by Sir Roy Harrod in Britain. These schemes are built on Keynesian conceptual foundations but raise a further question: once a full employment level of economic activity has been achieved, what conditions must be satisfied if it is to be sustained? This problem is addressed by examining the dual properties of investment expenditure: on the demand side it generates income through the Keynesian multiplier; on the supply side it augments productive capacity. If full employment is to be maintained through time, equilibrium between aggregate demand and aggregate supply must be achieved. With a few simplifying assumptions and a bit of algebraic manipulation, it can be demonstrated that the equilibrium rate of growth in national income equals the ratio of saving to income divided by the ratio of capital to the value of output.

These formulations - which are clearly of Keynesian parentage - have been widely used in discussions of planning for economic growth in a number of countries. In the United States this apparatus has supplied the framework of ideas underlying projections for growth in gross national product prepared by the President's Council of Economic Advisers. Similar procedures have been used by the British National Economic Development Council. Much the same type of analytical framework has also been extended to long-term planning operations in parts of the underdeveloped world. Among the countries which have devised ambitious long-term development plans - India and Nigeria are pertinent cases in point - the mould within which the economy is cast for planning purposes has owed much to the apparatus provided by post-Keynesian growth models. Once a targeted rate of growth in national income and product has been established and estimates of the likely values of the capital-output ratio and of the saving-income ratio have been worked out, this type of model provides criteria against which the consistency of various components can be checked.

In a similar vein Keynes's kit of aggregative concepts has provided the point of departure for much of the discussion of inflationary tendencies exhibited by a number of advanced economies since the Second World War. While Keynesian notions of aggregate savings, investment, and consumption have been common to most of these analyses, many economists have sought to move beyond a simple explanation of inflation in terms of excessive aggregate demand. Several competing schools have emerged which attempt to link the behaviour of the aggregative variables to nodes of unchecked market power. One, for example, pins the main responsibility for upward pressures on prices to organized labour, arguing that trade union bargaining pushes up costs which are passed on to consumers through increased prices; another traces the trouble to the prevalence of monopolistic sellers who possess the ability to administer prices. On these points, Keynesian economics per se - by virtue of its neglect of micro-economic relationships - has nothing fresh to contribute.

Keynes's failure to provide a systematic link between macro- and micro-economics has left an opening for a neo-classical type of counter-attack. Much of the ensuing controversy has centred on the analysis of the rate of interest, the theoretical lynch-pin of Keynes's most revolutionary innovations. What is now labelled as the 'neoclassical synthesis' attempts to reinstate the rate of interest as a sensitive regulator of economic activity, though the argument is now more subtle than in the days before the General Theory challenged Say's Law. In the up-dated version the equilibrating tendencies of the rate of interest embrace the relationship between changes in capital values of paper assets and decisions to consume. A person who observes an appreciation in the value of his portfolio as interest rates fall, it is maintained, is likely to spend more freely than he would otherwise have done. This phenomenon, in turn, might more than offset tendencies for idle balances to accumulate (and for a liquidity trap to emerge). Keynes dealt with this line of criticism with the argument that the impact of interest rate variations on consumption was likely to be too limited and too delayed to forestall substantial fluctuations in economic activity. Moreover, when fluctuations occurred, the remedies of fiscal policy would be more effective than those of monetary policy. The neo-classical revivalists do not, of course, maintain that substantial underemployment can never exist. Instead it is asserted that the market system is sufficiently sensitive to assure full employment so long as wages and prices are perfectly flexible. In the world in which we live, this requirement would be extremely difficult to satisfy. Indeed the mere attempt to give it reality might have highly destabilizing consequences. However appealing the logical symmetry of the neo-classical system may be, its applicability to real problems is limited.

In most Western economies Keynesian theory has laid the intellectual foundations for a managed and welfare-oriented form of capitalism. Indeed, the widespread absorption of the Keynesian message has in large measure been responsible for the remarkable degree of economic stability in the Western world during the past two decades and for the significant re-orientation in attitudes toward the role of the state in economic life. It is not yet clear whether the extension of a Keynesian analytical framework to the underdeveloped economies will have consequences equally as fortunate. Keynes, of course, fixed his own sights on the problems of highly organized industrial economies and, even in this setting, his central concern was with short-period stabilization at full employment. Many of the special problems of the underdeveloped parts of the world can be brought into clearer focus with other types of models. In fact, some of the extensions of the Keynesian aggregative reasoning - such as those suggesting that all important economic problems in the underdeveloped countries will solve themselves if the ratio of net investment to national income is raised above a critical minimum percentage - have detracted attention from prevalent institutional rigidities and from the long-term consequences of unprecedented rates of population growth. After all, a Keynesian aggregative framework is not ideally suited for close contact with questions dealing with efficient resource allocation or with long-period dynamic growth.

Keynesian theory has accomplished a great deal - but it is by no means the last word on the subject of aggregative economics. In the three decades since the publication of the General Theory, its findings have been embellished, refined, and modified. The economists who have undertaken these tasks have paid to Keynes the highest tribute any theorist can ever expect: the questions they have attempted to answer are the ones he inspired.