Among current proponents of activist government, few have greater name recognition than Paul Krugman. While most economists focus on communicating their ideas to their students and peers, professor Krugman has targeted the educated public with his work. This work now includes an introduction to The General Theory of Employment, Interest, and Money, by John Maynard Keynes. Brad Delong has posted an abridged version of this book on his website. Given the reputation of this book and its author a proper introduction should be of great interest to members of the educated public. Unfortunately professor Krugman’s introduction is seriously flawed.
One major problem with this introduction is that it perpetuates the mythology of Keynes’s influence. According to the mythology popular among Keynesians The General Theory reshaped professional opinion over night. Keynes published his book in 1936. By this time the idea that falling aggregate demand causes depressions was well known and widely accepted. In 1929 a German economist named Lautenbach published a book- Kredit zins Produktion- that was very similar to Keynes’s theory. In fact, some German economists accused Keynes of plagiarism . [1]
The “Keynesian Multiplier” was in fact developed by Richard Kahn in 1931. In the same year Herbert Hoover leaned on industrial employers to keep wages high so that workers could spend more. Hoover thought that high consumer demand, combined with government spending on public works, would restore prosperity. In 1932 several professors at the university of Chicago recommended “Keynesian” policies to deal with the Great Depression. The Polish economist Michal Kalecki also anticipated much of what Keynes later wrote, with articles that he published in 1932 and 1935. The Swedish economist Gunnar Myrdal also claims that Swedish economists were familiar with the ideas in Keynes’s General Theory before its publication. The proposition that Keynes transformed professional opinion single-handedly does not hold up to scrutiny. While professor Krugman claims that Keynes’s General Theory was revolutionary, it actually fit in with much of existing professional opinion.
Professor Krugman also claims that Keynes shaped public policy with his work. The fact of the matter is that Keynes did not go very far in working out the policy implications of “his” theory. Economist Abba Lerner was largely responsible for working out these details. Keynes initially criticized Lerner’s recommendations, but reversed his position a month later [2] . Lerner also had a key role in developing other parts of the ‘Keynesian’ paradigm, both on wages and interest and money demand [3]While Lerner sorted out many of the details of Keynesian theory, Economist John R Hicks developed the standard model for postwar Keynesian economics [4]. The Hicks model consisted of some equations concerning equilibrium of money demand and supply, and equilibrium of investment and saving. The Hicks model of Keynesian economics deviated from what Keynes wrote in his General Theory. The claim that the postwar keynesian paradigm betrayed Keynes’ own thinking was made not only by prominent associates of Keynes, like Joan Robinson, but also by Hicks himself-
“The “Keynesian Revolution” went off at half-cock…The equilibrists, therefore, did not know they were beaten; or rather…they did not know that they had been challenged. They thought that what Keynes had said could be absorbed into their equilibrium systems; all that was needed was that the scope of their equilibrium systems should be extended. As we know, there has been a lot of extension, a vast amount of extension; what I am saying is that it has never quite got to the point….I must say that that diagram [IS-LM] is now much less popular with me than I think it still is with many other people. It reduces the General Theory to equilibrium economics; it is not really in time. That, of course, is why it has done so well.” (JR Hicks, Time in Economics, in Evolution, Welfare and Time in Economics p. 289-90, 1976)
Hicks came to realize that his IS-LM model was static, while Keynes’ theory was dynamic. The postwar Keynesian paradigm also included the Philips curve- a statistical relation between employment and GDP. The fact of the matter is Keynes theory was not new at the time of its publication, and the postwar version that most economists accepted as Keynesian was a version that other economists revised significantly. This revised version extended Keynes’ ideas in some respects, but it also deviated from what Keynes wrote in important ways. Yet Professor Krugman defends the equilibrium reinterpretaton of Keynes’ General Theory as an accurate interpretation of this book.
Naturally, Krugman’s introduction indicates that Keynes’s contribution were positive in nature. This is a highly contentious issue. The early Keynesians predicted a return of depression conditions in 1946. They predicted this because the end of the Second World War meant an end to wartime government spending. According to Keynes’s theory such a drastic reduction in government spending should cause a depression. This did not happen. This is not the only empirical problem with Keynesian economics. Most politicians have not followed the Keynesian policy of counter-cyclical deficit spending. Before Bill Clinton entered office in 1992, he held a conference at Little Rock Arkansas. The economists there recommended Keynesian deficit spending. He pursued the opposite policy. First he increased taxes (Keynesians recommend tax cuts to stimulate the economy). Later the Republican Congress pressured him to control spending (Keynesians recommend spending increases to stimulate the economy). Of course, some politicians attempt to implement Keynesian policies. During the 1992 election President Bush proposed a increase in the deficit to end the 1992 recession. The Democratic Congress refused to consider this proposal- for obvious political reasons. The Democrats did not want to take a chance on the recession ending soon enough to help George Bush in his reelection bid. Keynes and Lerner were politically naïve. They did not appreciate the potential for politicians to use “Keynesian” policy to help their own political careers [5]. This Naiveté seems to have rubbed off onto professor Krugman. Also, Milton Friedman pointed out years ago that Keynesian policy suffers from long and variable political lags.
Another part of the myth of Keynes’s General Theory concerns Keynes’s opponents. Professor Krugman claims that the alternative to Keynes’s theory was the ‘classical’ theory concerned with a barter economy, one without money. In reality, Keynes debated FA Hayek during the 1930′s. Hayek proposed a monetary theory of the trade cycle, originally developed by Ludwig von Mises. Hayek critiqued Keynes’s early work on trade cycles, and prompted Keynes to incorporate capital into his later work (the General Theory). The fact of the matter is that Keynes and Hayek responded directly to each other in discussing both of their ideas on money and the trade cycle. The classical theory of a barter economy that professor Krugman refers to is a straw man. Professor Krugman should know this because he penned an attack on a straw-man version of the Mises-Hayek theory of trade cycles [6].
Professor Krugman correctly points out that Keynes believed that a market economies’ automatic tendency to eliminate unemployment works slowly, if at all. The belief is not well founded. Recent work by Harold Cole and Lee Ohanian at UCLA demonstrate that the policies of the Roosevelt administration interfered with recovery from the depression [7]. Richard Vedder and Lowell Galloway did similar work years earlier [8]. Professor Krugman believes that Keynes hit the nail on the head with his analysis, and that we are all Keynesians now. However, the truth of the matter is that professional opinion has been slowly moving against Keynes for decades. Modern Keynesians, or ‘New Keynesians’ sometimes say that they have more in common with Milton Friedman than John Maynard Keynes [9].
Professor Krugman also claims that no other book has been both as brilliant and as timely. The General Theory had immediate practical relevance! Actually, there have been many such books. Adam Smith’s Wealth of Nations was a towering intellectual achievement with immediate practical relevance. Smith critiqued the mercantilist policy of Europe. David Ricardo carried this argument further in his Principles of Political Economy and Taxation. Smith and Ricardo made some mistakes, but they also demolished their opponents, the Mercantilists, on major policy issues of their time. Ludwig von Mises published his brilliant Socialism, an economic and sociological analysis shortly after the Bolshevik takeover in Russia. FA Hayek published his Road to Serfdom during the reign of Stalin and Hitler. Milton Friedman and Anna Schwartz published their Monetary History of the United States just before inflation and stagflation emerged to cast doubt on the Keynesian paradigm. Keynes was neither right about the problem of his day, nor the only one to address policy problems in a timely fashion. Many have done this, and done so better than Keynes.
One final point concerns the importance of ideas. JM Keynes often gets cited for noting that it is the influence of ideas for good or evil, not the power of vested interests, that matters. Keynes did write this, but Lionel Robbins, at the London School of Economics, made the same basic point earlier-
“The policies which at present prevail have been adopted, not because they have been forced on politicians by the masses, but because the masses have been taught to believe them …The ideas which, for good or bad, have come to dominate policy are the ideas which have been put forward by detached and isolated thinkers … In the short run, it is true, ideas are unimportant and ineffective, but in the long run they can rule the world.” Lionel Robbins, The Great Depression 1934, pp199-200
In short, Keynes’s General Theory was a relatively unoriginal book, whose author received undue credit for founding a defective intellectual movement. The ideas attributed to Keynes served to diminish the fiscal discipline of politicians without addressing the real causes of trade cycles. While JM Keynes is an iconic figure to those who embrace activist government, there is no real basis for this honor. Perhaps the most important reason for the perpetuation of the myths concerning Keynes and Keynesian economics is the lack of attention that economists pay to history. Most graduate programs in economics do not offer, let alone require, history of economic thought. Unfortunately, most economists simply ignore the history of their own subject. Fortunately, Economists like Ohanian, Cole, Vedder, and Galloway pay attention to the history of actual economic events. In any case, Professor Krugman’s introduction to Keynes’ General Theory of Employment, Interest, and Money suffers from a serious lack of historical accuracy.
NOTES
[1] See Barkain, Avram- Nazi Economics: Ideology, Theory, and Policy, Yale U Press and George Garvey, “Keynes and the Economic Activists of Pre-Hitler Germany,” The Journal of Political Economy 1975
[2] See Abba P. Lerner, “Functional Finance and the Federal Debt,” Social Research 10 (February 1943): 38-51;
[3] Lerner wrote numerous articles in developing the Keynesian paradigm. See Mr Keynes’s General Theory”, 1936, International Labor Review, Saving Equals Investment”, 1938, QJE, Saving and Investment: Definitions, assumptions and objectives, 1939, QJE, Interest Theory: Supply and demand for loans or supply and demand for cash?”, 1944, RES, The Burden of the National Debt, 1948, in Income, Employment and Public Policy, The Inflationary Process: Some theoretical aspects, 1949, REStat, On the Marginal Product of Capital and the Marginal Efficieny of Investment”, 1953, JPE, On Generalizing the General Theory”, 1960, AER
[4] See Mr Keynes and the Classics: A suggested interpretation 1937, Econometrica
[5] See Nordhaus, William D. “The Political Business Cycle.” Review of Economic Studies 42, (1975) 169-190 and Political Cycles and the Macroeconomy, by Alberto Alesina
[6] See web.mit.edu/krugman/www/hangover.html
[7] See http://mises.org/freemarket_detail.aspx?control=515&sortorder=title
[8] See Out of Work, by Vedder and Galloway
[9] See ‘New Keynesian Economics’ 1991, Mankiw and Roemer eds.
{ 19 comments }
Great analysis of Keynes! Thanks! However, I wish more Libertarians would address the public as Krugman does. After all, they’re ones who vote.
Krugman’s introduction demonstrates the tremendous influence of the early interpreters, especially Abba Lerner and Alvin Hansen. The key claim that Krugman makes is that “Keynes was no socialist–he came to save capitalism, not bury it.”
Wrong. Keynes came to prop up capitalism long enough for more meaningful social reforms to be implemented. Most of the book (roughly Chapters 1 through 23) are about proping up the unstable capitalist system. The last chapter (Ch. 24) is about replacing capitalism with something better. It is here that Keynes declares that “interest rewards no genuine sacrifice” and calls for a “comprehensive socialization of investment.”
How could Krugman miss Keynes’s final chapter? I suspect that he–like so many others–take it from Lerner and Hansen that Chapter 24 can be ignored. In his own writings, Lerner turned Keynes book into an exercise in “functional finance.” That is, The Gerneral Theory is all about how we can guide capitalism with fiscal and monetary policy to keep it performing at its best. Hansen’s 1949 book on the Keynesian system is wholly dismissive of the social reform Keynes recommended–saying that in Chapter 24, Maynard was just “flying his kite.”
Now we see that Lerner + Hansen = Krugman.
We can only hope that people who read Krugman’s introduction will go on to read Keynes’s book—with special attention to Chapter 24.
People should stop listening to Krugman when he talks about Macroeconomics or Business Cycle Theory. They should also start listening to him when he talks about the great benefits of Free trade, outsourcing and globalisation.
Speaking about Business Cycle Theory, should I read America’s Great Depression By Murray Rothbard ?
I agree that Keynes can be seen as leaving the door open to socialism. He did advocate the socialization of investment. Yet, his remarks on the future were not very clear, and Keynes seemed to change his mind from time to time. One of the reasons that Hayek gave for not reviewng the GT was that he thought that Keynes would just change his mind again. There are two books on ABCT you might read. One is the orignal- The Theory of Money and Credit by LE von Mises. The other is the most recent major work- Roger Garrison’s Time and Money. As for the idea of Krugman’s intro demonstrating the influence of Hansen and Lerner- where? I just took another look at it on PKarchive.org, and I saw little other than praise for Keynes as an original and insightful thinker. Krugman mentions Hicks and Samuelson, but I saw no mention of functional finance, Lautenbach, or the fact that Kahn developed the multiplier.
To quote Krugman-
“Keynes’s appreciation of the power of the reigning orthodoxy also explains the measured pace of his writing. “The composition of this book,” wrote Keynes in the preface, “has been for the author a long struggle of escape, and so must the reading of it be.” Step by step, Keynes set out to liberate economists from the intellectual confines that left them unable to deal with the Great Depression, confines created for the most part by what Keynes dubbed “classical economics … The real classical model, as Keynes described it, was something much harder to fix. It was, essentially, a model of a barter economy, in which money and nominal prices don’t matter”
This is nonsense. The “reigning orthodoxy” at this time consisted of many views. Hayek and Mises were major contenders during the early thirties. Others blamed the depression on monopoly capitalism. There were also many demand side economists before Keynes- a few leaders like Lautenback and Kalecki, and many followers. The idea that economists were all or mostly locked into thinking about a barter economy where Say’s law is true in the strictest sense is pure mythology.
Kristian,
Definitely.
How do Keynes, Krugman, and the rest of the mainstream explain the fact that the economic downturn of 1920-1921, while quite sharp, was over in roughly one year? I am confident that they would not reference the facts that the federal government did close to nothing to “help” the economy emerge from the downturn, that prices were generally extremely flexible downward, and that the Federal Reserve was relatively speaking not overtly interventionist during this period.
And regarding the assertion that economists were locked into the barter economy model pre-Keynes, one of the major achievements of Mises in his “Theory of Money and Credit” was precisely integrating money into a supply and demand, subjective marginal utility analysis framework. Maybe Keynes would have not gone down the erroneous path he did if he was able to understand new concepts that were written in German. But given Keynes’s intellectual background and arrogance, and his millennialist ideology, he likely still would have produced that terrible retrogression in economic thought called “The General Theory”.
Professor MacKenzie, thank you for the excellent article.
Kristian- I also recommend “The Failure of the “New Economics”; an Analysis of the Keynesian
Fallacies” by Henry Hazlitt.A great book.
Yes, but AGD is available for free is “New Economics” also availble for free ?
I mean it is virtually impossible for me to order books like that considering that I don’t live in the states.
Dennis,
I have not heard much mention of the 1920 depression from Keynesian economists or historians in general. As I recall Temin got into this episode. He argued something along the lines that monetary policy was similar in both the 1920 depression and the early part of the GD. He concludes that the GD was more severe because in this case there was a drop in aggregate demand- as I recall, not having read his book on monetary cases of the Great Depression lately. I do not recall any analysis of the 1920 depression in the US by Keynes himself. Keynes did write about Germany at that time- his analysis of the Treaty of Versailles in The Economic Consequences of the Peace.
I am not sure if reading the Theory of Money and Credit would have helped Keynes. Keynes knew Haykek’s work, and that did not help. It is also worth noting that Hayek demolished Keynes’ earlier Treatise on Money. Keynes thought that his Treatise on Money would be his magnus opus. Had Hayek not reviewed Keynes’ earlier book Keynes might not have been so quick to write another book. Keynes had another reason to write the GT- to build upon Kahn’s multiplier. But Hayek did put pressure on Keynes. Since Keynes’ health deteriorated after the GT actually came out, any delay in writing it could have prevented its completion. For Krugman to ignore the Keynes-Hayek debate completely in his introduction is an unforgivable error. His intro is bad history, plain and simple.
Prof. MacKenzie,
Bad history on Krugman’s part indeed. But, what else would you expect from Krugman?
Kristian:
You bet!
Sorry, try this:
http://mises.org/rothbard/agd.pdf
Sweeden’s doing pretty well with a strong social safety net, aren’t they? What is wrong with helping poor people? Aren’t we morally obligated to do so? Of course we are!
Am I morally obligated to help poor people by taking your money and giving it away? I think charity is great, but that’s not what you’re suggesting.
As Lew Goldberg said, “If you feel driven to feed the poor, get your checkbook out and keep your tyrannical mouth shut about it.”
If I’m morally obligated to help the poor where does it stop? Is there some minimum standard that everyone has to live under? Is the ultimate goal the elimination of all economic inequality? Poverty is a relative condition, the poorest man in Appalachia is wealthy relative to his predecessors of centuries past. Furthermore, to whom do I owe this obligation? Am I only bound to help poor people in the USA? What about the starving billions in the “developing world”? Certainly their plight is worse than that of the poor of the USA, so they should get first dibs on the product of my labor, hell they should get first dibs on the product of my poor countrymen’s labor. Poor Americans are rich by the standards of most of the world, so they should fork over their money to the poor of Guatemala or Chad or Bulgaria. If the idea of moral obligation is taken to its logical extreme, it is immoral for anyone to have anything more than anyone else. I think that charity is great, but fo redistribute wealth at gunpoint is terrible. First, it is a violation of property rights, and if property rights are not absolute then no rights are absolute and the state can do whatever it wants and no one can complain. Second the purpose of the welfare state is not to help the poor, but to institute a level of control over the population. If everyone is somehow tied to the state (public education, medicare, welfare, financial aid) then everyone has a vested interest in the status quo, the only argument will be over how much of the pie each group gets. While oceans of ink have been spilled over the negative effects of welfare statism (the subsidization of irresponsibility, the inefficiency, the fraud) the two points listed above are more than enough to brand it as wholly wretched. As for Keynes, it is a testament to how far general economic understanding has to go that anyone cares about his ideas anymore.
Justin,
Sweden is not doing as well as you think. Sweden was quite poor in the early 19th century. Then Sweden adopted free market reforms in the mid 19th century. Sweden developed into a prosperous place in the late 19th century because it went free market. Sweden began going for a social welfare state in the 1930s and since then its LR rate of growth has slowed. After ww2 Sweden was, as I recall, 2nd only to the US in per cap GDP. Sweden is still doing OK compared to much of the rest of the workd, but there is considerable evidence that their welfare-regulatory state has slowed development down, so they could have done better. They owe what they have to 19th century free market reforms, not to their 20th century welfare state. See these links-
http://www.cato.org/pubs/pas/pa-160.html
http://mises.org/daily/955
Keynes’s objective in the General Theory was to show that the standard, neoclassical ,aggregate labor market condition for full employment(market clearing),w/p=mpl,where w is the money wage,p is the price level where the expected price level equals the actual,current,or realized price level,w/p is the real wage,and mpl is the aggregated marginal product of labor derived from the standard,aggregate,neoclassical production function(see p.283 and p.285 of the GT).
Keynes demonstrated that the above condition is a special case of his general result that w/p=mpl/(mpc+mpi),where the mpc is the marginal propensity to spend on consumption goods,and mpi is the marginal propensity to spend on investment goods.The mpi is just the inverse of the Keynesian investment multiplier,k.
Unless the mpc=1 or the mpc+mpi =1(see pp.261-262 for the literary development and exposition;the mathematical development and technical exposition takes place in chapter 20(and 21)on pp.282-286 of the GT and requires that the reader be able to simplify elasticities and then integrate the derivatives),the above condition for market clearing can’t take place.If the mpc+mpi<1,you will obtain involuntary unemployment.A set of stable,multiple equilibria exist,only one of which is full employment.Keynes thus argued that neoclassical theory is a special case of his general theory.
Any mention of J.M. Keynes that doesn’t include: “Fabian Socialism”, is to cut one adrift from the shores of the land that domeciles accurate insight into that individual.
Keynes’ GT is little, if any, more than State-/Educrat bolstering agitprop posing as an “Economics” text.
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