Keynesian Revolution

The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the orthodox classical economic framework, which based on Say's Law argued that unless special conditions prevailed the free market would naturally establish full employment equilibrium with no need for government intervention. Employers will be able to make a profit by employing all available workers as long as workers drop their wages below the value of the total output they are able to produce – and classical economics assumed that in a free market workers would be willing to lower their wage demands accordingly, because they are rational agents who would rather work for less than face unemployment.

Keynes argued that both Say's Law and the assumption that economic actors always behave rationally are misleading simplifications , and that the classical economics was only reliable at describing a special case. The Keynesian Revolution replaced the classical understanding of employment with Keynes view that employment is a function of demand, not supply. ^[1]

Revolutions in Economic thought prior to Keynes

Professor Harry Johson has written that Economics in its modern form can been seen as dawning with the Smithian Revolution against mercantilism. Prior to Keynes there were five other major developments in economic thought rapid enough in pace to be characterised as revolutions, most notability the Ricardian . ^{[2] [3]} Collectively these fashioned the classical economic orthodoxy that Keynes attacked.

The course of the revolution

John Maynard Keynes.

Keynes revolutionary theory was set out in his book, General Theory of Employment, Interest and Money , commonly referred to by the abbreviated title General Theory. While working on the book, Keynes wrote to George Bernard Shaw saying "I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once but in the course of the next ten years – the way the world thinks about economic problems … I don't merely hope what I say, in my own mind I'm quite sure" ^[4] Professor Keith Shaw wrote that this degree of self confidence was quite amazing especially considering it took more than fifty years for the Newtonian revolution to gain universal recognition; but also that Keynes's confidence was fully justified. ^[5] John Kenneth Galbraith, has wrote that Say's Law dominated economic thought prior to Keynes for over a century, and the shift to Keynesianism was difficult. Economists who contradicted the law, which inferred that underemployment and underinvestment (coupled with over-saving) were virtually impossible, risked losing their careers.^[6]

Keyne's General Theory was published in 1936 and provoked considerable controversy, yet according to professor Gordon Fletcher it rapidly conquered professional opinion. ^[7]

For biographer Lord Skidelsky, the General Theory triggered a massive reaction immediately after its release, with extensive reviews in journals and popular news papers all around the world. While many academics were critical, even the harshest critics recognised there was a case to be answered. As with other theoretical revolutions the young were most receptive with some older economists never fully accepting Keynes work, but by 1939 Keynes view had broadly gained ascendancy both in Great Britain and the US. ^[8]

According to Murray Rothbard , an Austrian School economist strongly opposed to Keynes:

Rothbard goes on to describe that by the end of the 1930s every single one of Friedrich Hayek's followers at the LSE were convinced by Keynes ideas - all economists who had previously opposed Keynes advocacy of state intervention in the economy. ^[9]

Despite Keynes's early success, the revolutionary effect on theoretical economics was soon diminished. From the late 1930s, a process began to reconcile the General Theory with the classical ways of viewing the economy - developments which included Neo-Keynesian and later New Keynesian economics.

An alternative take was advocated at the dawning of the revolution by Dennis Robertson , who Fletcher has described as the most intellectually formidable of Keynes's contemporary critics. This view held that the great excitement triggered by the General Theory was unjustified - that genuinely new ideas presented were over stated and not supported by evidence, while the verifiable ideas were merely well established principles dressed up in new ways. According to Hyman Minsky this position eventually became dominant in mainstream academia, though it is by no means unchallenged. ^[10]

The Keynesian revolution in policy making

While much attention is given to the impact on academic economics, the revolution also had a practical dimension. It influenced decision makers in governments, central banks and global institutions like the IMF. According to Lord Skidelsky, the revolution began in policy making terms as early as December 1930, with Keynes's participation in the Macmillan Committee on Finance and Industry.^[8] The Committee had been formed to make policy recommendations for Britain's economic recovery - while Keynes plans for an interventionist response were rejected, he did succeed in convincing the government that the classical conception that wages would drop along with prices and thus help to restore employment after a recession was wrong. ^[8] The first government to adopt Keynesian demand management policies was Sweden in the 1930s. ^{[11] [12]} Keynes has some influence on President Roosevelt's 1933-1936 New Deal ,though this package was not as radical or as sustained as Keynes had wished. ^[8] After 1939 Keynes's ideas were adopted more whole heartedly by policy makers in the developed world, especially the Anglo-Saxon countries. Keynesian thinking was generally the decisive influence throughout the 1940s, 50s, and most of the 60s. From the late sixties Keynes's influence was displaced following the success of "counter revolutionary" efforts by economists like Milton Friedman and others sympathetic to the free market. Following the financial crises in 2008, there has been a revival in Keynesian thinking among policy makers in favour of robust government intervention, which the Financial Times has described as a "stunning reversal of the orthodoxy of the past several decades". ^[13]

Origins

Lord Skidelsky has wrote that Keynes's motivation for the revolution arose from the failure of the British economy to recover from its post World War I recession in the manner predicted by classical economics -through out the 1920s British unemployment remained at historically high levels not previously seen since a brief period in the aftermath of the Napoleonic Wars. ^[8] Skidelsky notes a December 1922 lecture to the British Institute of Bankers where Keynes noted that wages no longer fell with prices in the classical fashion, due in part to the power of unions and wage "stickiness". ^[8] Keynes's recommended government intervention as the cure for unemployment in this circumstance, a position he never deviated from though he was to refine his thinking on what sort of intervention would work best. For Dr Peter the revolution can be seen as dawning in 1924 which was when Keynes first started advocating public works as a means by which the government could stimulate the economy and tackle unemployment.^[14]

The revolution that never was

According to some post Keynesian economists, in the accademic sphere the so called revolution failed to properly get of the ground, as Keynes thinking was misunderstood or misrepresented by the revolutions leading popularisers, the founders of neo Keynesian economics such as John Hicks and Paul Samuelson. ^[1] The post Keynesians felt neo Keynesianism excessively compromised with the classical view. For Paul Davidson the revolution was "aborted"^[15] in its early years ; for Hyman Minsky it was "still born";^[10] while for Joan Robinson the revolution led to a "bastard Keynesianism".^[10]

A suggested reason for the distortion is the central role John Hicks's IS/LM model played in helping other economists understand Keynes's theory – for post Keynesians, and by the 1970s even Hicks himself, the model distorted Keynes vision. ^[15]

A second reason offered is the attacks on the more progressive expressions of Keynes views that occurred due to McCarthyism. For example, while initially popular, Lorie Tarshis's 1947 text book introducing Keynes ideas, The elements of economics was soon under heavily attacked by those influenced by McCarthy. ^[15] The books place as a leading text book for Keynes ideas in America was taken by Paul Samuelsons Principles of Economics . According to Davidson, Samuelson failed to understand one of the key pillars of the revolution, the refutation egodic axiom (i.e. saying that economic decision makers are always confronted by uncertainty - the past isnt a reliable predictor of the future).^[15]

Economists Robert Shiller and George Akerlof re-asserted the importance of recognising uncertainty in their 2009 book Animal Spirits.

Another reason for the distortion of Keynes views was his low level of participation in the intellectual debates that followed the publication of his General Theory, first due to his heart-attack in 1937 and then due to his busyness with the war. ^[10] Its been suggested by Lord Skidelsky that apart aside from his busyness and incapacity, Keynes didn't challenge models like IS/LM as he perceived that from a pragmatic point of view they would be a useful compromise. ^[8]

Significance

Professor Gordon Fletcher stated that Keynes' General Theory provided a conceptual justification for policies of government intervention in economic affairs which was lacking in the established economics of the day - immensely significant as in the absence of a proper theoretical underpinning there was a danger that ad hoc policies of moderate intervention would be overtaken by extremist solutions, as had already happened in much of Europe back in the 1930s before the revolution was launched. ^[16]. Almost 80 years later in 2009, Keynes ideas are once again a central inspiration for the global response to the Financial crisis of 2007–2009. ^{[17] [18]}

See also

Notes and references