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«Tamara Lothian* Columbia University – Center for Law and Economic Studies Roberto Mangabeira Unger* Harvard University March 1, 2011 * © Tamara ...»

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The focus of policy fell first on the containment of economic insecurity and then on the popularization of opportunities to consume and the consolidation of a market in mass-consumption goods. The European social democracies advanced, through different paths and in different variations, toward a political economy and a social policy devoted to the maintenance of a high level of universal (and therefore redistributive) social entitlements, paradoxically funded through the regressive taxation of consumption. Humanity sought to drown its sorrows in consumption, and called solace justice.

It was not by these means, however, that the world overcame the slump of the 1930s. It was -- we have already recalled -- the war that did it. The war economy combined massive mobilization of physical, capital, and human resources with innovations in the institutional arrangements governing the relations among firms as well as between firms and governments. Such innovations, rather than serving as points of departure for post-War developments, remained quarantined: they were dismissed as pertinent only to the peculiar war circumstances.

Teachings, like those of Keynes and of his Swedish contemporary Wicksell that advocated a governmentally induced rise of “aggregate demand” through public spending, had only a modest effect on the economic conditions. The war did much better on account of both the magnitude of the resource and human mobilization it produced and the breakthrough effects of the attending institutional innovations.

54 Vulgar Keynesianism is the doctrine summarized in the IS-LM graphs of the standard economic textbooks written in the last decades of the twentieth century by the American followers of Keynes. They rendered him intellectually and politically palatable by leaving out the more dangerous and enigmatic parts of his ideas. They recast his doctrine as a theory of some of the tools needed to mitigate business cycles and to reconcile monetary stability with full employment in the established regulated market economy.

The practical concern and the strategy for addressing it were foremost in the evolution of Vulgar Keynesianism: sustaining aggregate demand, especially a mix of fiscal and monetary policies, the better to wring the most employment from the economy without arousing (too much) the demons of inflation.

Insofar as Vulgar Keynesianism was a theory, it was, and is, the theory of the use of these specific tools in this distinctive historical context. It required no break with general-equilibrium analysis, only recognition of multiple possible equilibriums in an economy, some of them compatible with massive underutilization of resources, especially labor. It took the whole of institutional structure of the state and of the economy for granted. Its intention was to normalize, not to subvert, reconstruct, or re-imagine.

The association of the practical toolbox of macroeconomic theory with the recognition of multiple equilibriums, some more desirable than others, accounted for almost the entirety of Vulgar Keynesianism, whether or not dressed up in pseudo-mathematical representations.

Vulgar Keynesianism found its principal intellectual adversary in a a range of connected theories that theorized what they took to be the futile and counterproductive character of the governmental initiatives in which the Vulgar Keynesians put their pride. Some of these theories 55 (e.g., the quantitative theory of money) emphasized the importance of money and of its management by government in determining the prospects for the combination of economic stability with economic growth. They prized constant and reliable rules about the money supply.

Other theories (e.g., real-business cycle theory) exposed the powerlessness of governmental initiative. It did so, in particular, by arguing for the powerlessness of fiscal policy to bring about economic recovery by raising aggregate demand above the level compatible with the economy’s supposedly predetermined potential to grow.

Yet other views (e.g., rational expectations theory) suggested that the policy instruments favored by the Vulgar Keynesians would be robbed of much of their efficacy by the protective measures taken by economic agents. If they expect higher taxes to lie in the wait in the future, the agents would, for example, spend less and save more now.

These allied and convergent theories had as their central idea the beliefs that the market order has a determinate logic and determinate implications, that attempts to tamper with it are likely to prove either ineffective or costly, and that impersonality, universality, and constancy in the applications of the same rules of that order are to be preferred to the fine-tuning of would-be know-it-alls.

These doctrines were able to claim the intellectual authority of the mainstream of economic theorizing as well as to profit from the indifferent and unconvincing record of Vulgar Keyesianism in power. If the original Keynesianism had (contrary to legend) never been a significant influence on the social-democratic compromise of the midtwentieth century, the intellectual attack on Vulgar Keynesianism and the reaffirmation of views that had not been regarded as orthodox since the 1920s contributed, from the right, to the many forces working to circumscribe or to undermine that compromise.

56 It is impossible to understand the structure of practical economic debate in much of the world today without appreciating that it has been very largely shaped by a contest between the believers in a determinate logic of the market economy and the Vulgar Keynesians, against the background of widespread consensus between the Vulgar Keynesians and their adversaries about both the fundamentals of economic theory and the established institutional arrangements of a market economy. At no moment, for example, was the part of those arrangements governing the relation of finance to production brought into question.

When the crisis of 2007-2009 broke out and later produced the sequel of a “jobless recovery,” the chief intellectual response by progressives and social democrats, especially in the United States and Europe, was to resort, once again, to the Vulgar Keynesian toolbox.

They allowed for only such adaptations of the toolbox as seemed required by the distinctive conditions of a balance-sheet recession, in which firms and households alike were concerned to rebuild their balance sheets and deflation often seemed a more immediate peril than inflation. Chief among these adaptations was the aggressive use of monetary policy (as in the form of “quantitative easing”) to combat the deflationary danger and reinforce the uncertain effects of a fiscal stimulus that never seemed large enough. In the ensuing debate, the progressives were reputed, or reputed themselves, to be those who demanded more stimulus, and called for a postponement of the inevitable fiscal reckoning. Such was the putatively progressive message propagated in the newspapers and recognized in the public conversation as the touchstone of opposition to the moneyed interests.

What is the salvageable theoretical core of Keynes’s theory, beyond the limits of Vulgar Keynesianism as well as beyond the boundaries of the kind of slump that aroused his imagination and directed his will? It may seem strange to ask such a question, so late in 57 the day, given the immense influence of Keynes’s ideas. It is nevertheless useful to ask it, and to attempt to answer it: the answer suggests both the value and the inadequacy of the approach we find in Keynes’s work. Something vital to insight into a crisis and a slump such as those the world has recently faced are missing there. The missing element must be produced, and then combined with the indispensable insights that we can find in Keynes and in some of his intellectual allies.

The whole of Keynes’s theoretical system, as expounded in The General Theory and in the writings of his that preceded and prepared it, can be reduced in a few propositions, stated in a language in many respects alien to Keynes’s own.

In stating these propositions, it is useful to represent the view laid out in Keynes’s General Theory as the account of a special case of depressed economic activity. It not a special case merely in the sense that it takes as its inspiration a crisis and a slump in which, differently from what happens in balance-sheet recessions, a dynamic of exorbitant indebtedness plays no major part in the unfolding of events. It is also a special case in the sense that it offers the theoretical elaboration of grounds for a particular response to the slump: one in which a governmentally induced raising of aggregate demand performs a central role. The primacy accorded to this special case gives the Vulgar Keynesians reason to claim for their views and proposals the authority of the master.

Keynes’s own occasional and popular writings of the 1920s and 1930s explore a much broader range of possible responses to the depression, including responses that would use governmental power to shape the course of the investment (as the large emerging economies have done today). Keynes, however, feared that such proposals would place him in the company of the socialists and compromise his influence. He wanted to shine and to influence in his own time, not just 58 to bet on posterity. He was unwilling to embrace truth at the cost of marginality, truth for which the world, his world, was unprepared. For this reason, his occasional and popular writings are often more philosophical than the theoretical proto-system worked out in the General Theory. Insofar as Keynes has something more than a theory of the special case to offer, it is to be found in them more than in it.

The view that emerges from a comparison of his General Theory with these richer and shadowier antecedents can be summarized by the following nine propositions.

1. A money economy is different from a barter economy. Money matters. It is not a transparent veil. The relative and changing desire to hold liquid balances, rather than to invest or to spend, may be a powerful influence on the level of economic activity.

2. Quantifiable risk differs from unquantifiable uncertainty. Both are at issue in economic life. The unknowability of the future and its power to defy our attempts to predict and to contain it are fundamental features of our circumstance. One of the special and important forms of this unknowability has to do with how other people will respond to the unexpected. At any given time, our attitude to money carries the imprint of our apprehensions or hopes about the uncertain future. More specifically, finance, although indispensable to the economy, is by its very nature a hotbed of trouble and of illusion, embroidered by greed and shadowed by fear.

3. Economic life cannot be adequately understood on the model of instrumental rationality: the selective and comparative marshalling of limited means toward the fulfillment of predetermined ends. It is a field of aspirations -- fear, hope, and greed -- and of illusions, especially illusions about what the future holds in store for us.


4. Say’s law is false. Supply does not ensure its own demand. It is true that the price for the unwanted good or service may fall until it is wanted, but only until an advantage has turned into a disaster for someone who took a risk.

5. More generally, supply and demand may adjust in any given economy at different levels of economic activity and employment. Among the multiple possible equilibriums, some may support high or full employment of resources; others may be compatible with large-scale idling of labor.

6. Not only are there multiple equilibriums, consistent with different levels of employment but there is also a persistent tendency to disequilibrium. Equilibrium, in the sense described by the marginalist economics of the late nineteenth century and developed by the general equilibrium theories of the twentieth century, is the limiting case rather than the normal state of affairs. Disequilibrium typically takes the form of descending to a lower-level equilibrium or ascending to a higher-level one, when lower and higher are defined with respect to the level of employment. A localized event in an economy, whether it is the result of decisions taken by firms or households or of exogenous shocks, can produce, through a chain of cumulative effects, results that seem disproportionately greater than their triggers.

7. The danger of falling into lower-level equilibriums increases because of the rigidity of many prices in a modern economy. The most important instance of such rigidity is rigidity in the price of labor: it can rise more easily than it can fall. (The significance of this thesis in Keynes’s protosystem is often exaggerated. It is, in any event, an insight to be found in Marshall and in Marshall’s disciple, Pigou.)

8. The state can and should act to wrench an economy out of a lowerlevel equilibrium. It can do so by making up for the dearth of private 60 spending and investment.

9. The beneficial effect of such a governmental intervention may be greatly enhanced by the reverse and positive side of the vicious downward cycle of economic depression: one inducement to invest and to spend leads to another, in a virtuous circle of confidence and enterprise.

A great virtue of the way of thinking summarized in these nine propositions is to be relatively free of the analytic emptiness into which, on the pretext of rigor, the “Marginalist Revolution” tempted economics.

Ever since then, the purest forms of economic analysis, the ones that set the most exacting standards for the discipline have been the ones that make no causal-empirical or normative claims. They provide a pure apparatus of analysis, which operates to explain the world or to guide policy on the basis of empirical or normative stipulations provided to it from the outside. It is a strategy of invulnerability through immunity to controversy. It imposes, as such a strategy always does, the denial of the opportunity for self-subversion and progression in thought. It turns the mathematical representation of economic ideas into an expression of hypothetical reasoning rather than an instrument of contestable causal inquiry.

It is a merit of Keynes’s proto-system that it is relatively free of this defect. It makes a host of causal claims about how economies work.

Moreover, it shows no embarrassment in avowing its devotions and repulsions.

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