Authors: David Smith
And now – I have been hinting at his arrival for some time – the moment has come. Given that Adam Smith was Scottish, our next guest must rank as the greatest English economist, although David Ricardo has his fair share of supporters. Anyway, there can be no doubt that John Maynard Keynes was the greatest modern British economist, and one of the towering figures of the twentieth century.
If the title of this chapter makes Keynes sound like a master chef, showy magician might be more appropriate. Keynes weaved his spell over economics at a time when the subject was growing into a mainstream area of study in universities.
Time
magazine named him the greatest economist of the twentieth century and, in truth, there were no other serious candidates to challenge him. For the past seventy to eighty years the economic debate has been dominated by Keynes, both by those who followed and developed his ideas and, as importantly, by those who sought to challenge them. When, after the 11 September 2001 terrorist attacks on America, the Bush administration pushed a pro-gramme of tax cuts and additional government spending to head off recession, it was, said commentators, because Washington had rediscovered Keynes. That was not quite right. Keynes had never really gone away.
Who was he? John Maynard Keynes, always known as Maynard to friends and colleagues, was born in 1883, the year of Marx’s lonely death. His father, John Neville Keynes, was a distinguished economics professor at Cambridge, although not as distinguished as Alfred Marshall, his contemporary. Marshall, who later taught the younger Keynes, is worth a brief digression. When we left English classical economics it was in a state of some disarray, Marx having emerged to challenge some of its cosy, and not-so-cosy, assumptions. Marshall’s great contribution was to put classical economics into a coherent framework, recognizable to economics students today. His
Principles of Economics
, published in 1890, not only provided the first clear signal that economics was to develop as a science, rather than as the art of political economy, but it demonstrated how the ‘marginals’ – marginal cost, marginal revenue and marginal utility – that we have already encountered, fitted in. If Smith, Ricardo, Mill et al. were classical economists, Marshall’s approach was ‘neo-classical’, adapting and setting their work in what was then a modern context. Keynes is sometimes said to have thrown his teacher’s work back in his face by overturning some of its assumptions, but that is not really fair. Marshall was concerned mainly with microeconomics, the working of individual markets, Keynes’s main area of influence was macroeconomics.
After studying at Eton Keynes returned to Cambridge to read not economics but mathematics, in which he took a degree. While there he became an Apostle, a member of the university’s elite secret society, and also – perhaps because of that society’s belief in the superiority of homosexual love, perhaps because of his time at Eton – a practising homosexual. He did, however, apparently renounce homosexuality on his unlikely marriage in 1925 to the Russian ballerina Lydia Lopokova, who was to prove a great source of support during his later life, particularly after his first heart attack in 1937. Keynes entered the India Office (part of what is now the Foreign Office) in 1909, staying only two years before returning to Cambridge as a teaching fellow in economics, his skills in the subject having been both noticed and encouraged by Marshall. Almost immediately he became editor of the prestigious
Economic Journal
.
The First World War and its aftermath were to be the making of Keynes, as we shall see, but even a brief account of his life could not leave out his extraordinary renaissance man qualities. He was a member of the Bloomsbury group, which included Virginia Woolf and Lytton Strachey, and Keynes’s own writing was much admired for its elegance. Indeed, some of his best sayings rival Oscar Wilde’s. ‘I would rather be vaguely right, than precisely wrong,’ he said, and: ‘I do not know which makes a man more conservative – to know nothing but the present, or nothing but the past.’ He could also be wonderfully cutting. Of one senior Treasury mandarin, he wrote that ‘he could stay silent in several languages’. Of another that ‘caught young’, he might have understood the elements of economics. He often attracted wit back. When, at the 1946 conference in Savannah, Georgia, that launched the International Monetary Fund, Keynes said he hoped no ‘malicious fairy’ would wreck the proceedings, Frederick Vinson, head of the US delegation, replied: ‘I don’t mind being called malicious, but I do mind being called a fairy.’
Keynes straddled the worlds of academic life, government, the City and the arts. He chaired National Mutual Life Assurance and the Cambridge Arts Theatre and, as a highly successful investor, made money for both himself and his beloved King’s College, lost much of it in the 1929 crash, which he did not see coming, but made it back again, and some more, over the following few years. He was the first chairman of what became the Arts Council. Keynes was no ivory tower economist. He badgered and cajoled politicians and a Treasury that was generally resistant to his ideas. He often set out his views in the pages of
The Times
and publicly took on his critics. In one of Keynes’s most famous quotes he takes to task politicians, ‘madmen in authority’, for being ‘slaves of some defunct economist’. Keynes did his best to ensure his ideas were taken up before he was defunct. He lived until 1946, dying at the age of sixty-two, a comparatively short life, and he was in poor health for the last ten years of it. Arguably, his influence was far greater after his death. Now let us see why.
The economic consequences of peace and Churchill
Keynes returned to government service early in 1915, once it became clear that the optimistic view of the First World War, that it would all be over by Christmas 1914, had proved to be badly mistaken. As a Treasury adviser, initially a junior, he rose rapidly and was put in charge of the key task of co-ordinating the country’s foreign exchange expenditure on essential wartime imports. Keynes, as he was to demonstrate on many occasions, did not suffer fools gladly, however senior, on one occasion telling Lloyd George, the Prime Minister, that he was talking rubbish. Perhaps surprisingly, this brutal honesty did him little harm with political leaders. Despite being a young man of huge influence, he was evidently frustrated by his wartime service at the Treasury, writing to fellow Bloomsbury group member Duncan Grant in December 1917: ‘I work for a government I despise for ends I think criminal.’
This frustration spilled over at the end of the war when, having been assigned to the UK delegation to the Versailles peace conference, he resigned in June 1919 over what he considered to be the dangerous direction it was taking. The issue was the amount of war reparations the defeated Germany should pay to the victorious allies. Keynes argued for no more than £2 billion, still a huge sum at the time, while others were pressing, it appeared successfully, for £24 billion. Although no figure appeared in the Versailles treaty, the implication was that reparations would be very substantial. After his resignation Keynes wrote
The Economic Consequences of the Peace
, criticizing the approach of the allies at Versailles. ‘If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp,’ he wrote. Heavy reparations would result initially in a great inflation and eventually in a war ‘which will destroy, whoever is victor, the civilisation and progress of our generation’.
Historians have long debated whether Keynes was right. After all, while the Versailles treaty sounded tough, the amount of reparations actually paid by Germany was under £2 billion. However, there was a great inflation, the hyperinflation of the Weimar era. Inflation is when the general price level is rising. Hyperinflation is when it is rising very rapidly, by more than 50 percent a month on one definition. Germany in the early 1920s certainly qualified. Between August 1922 and November 1923 prices rose by an average of 322 percent a month. Thanks to the power of compound interest, this meant that prices at the end of the period were 10.2 billion times those at the start. To put that into perspective, a million marks at the start of the period would be worth less than a pfennig at the end of it. Versailles also established a climate in which the defeated German people felt angry and resentful because, it seemed, the victors were determined to extract full revenge. This was the perfect climate for the rise of Adolf Hitler.
The Economic Consequences of the Peace
became a bestseller and Keynes a public figure in Britain and abroad, albeit one often at odds with the political establishment. This was compounded in 1923 when he published
A Tract on Monetary Reform
, in which he argued strongly against a return to the pre-war gold standard. The gold standard, whose heyday was from about 1880 to 1914, was, as its name suggests, a system in which currencies were tied to gold, for both domestic and international purposes. It appealed to ‘sound money’ bankers and had a certain theoretical simplicity. A country running a balance of payments deficit would in theory have to ship gold out to creditor nations (in practice it was usually moved between different parts of central bank vaults). This loss of gold would, in turn, reduce the supply of money and cut spending at home, thereby correcting the deficit. Keynes, however, had little time for gold, a ‘barbarous relic’, or for the system. When, against his advice, Britain returned to the gold standard in 1925, the then Chancellor Winston Churchill having taken the decision, Keynes wrote
The Economic Consequences of Mr Churchill
, predicting that the result would be a damagingly overvalued exchange rate and chronic unemployment. Again, he was right. Britain left the gold standard six years later, in 1931, but only after the damage was done.
Saving capitalism from itself
Keynes’s criticisms of the conventional wisdom had given him fame, wealth and notoriety but his most constructive contribution was yet to come. The context was the high unemployment of the inter-war years, due to a series of events, including the mistaken desire of countries to return to the gold standard, the Wall Street crash of 1929, and the attempt by countries to protect themselves against global economic woes by putting up trade barriers (so-called ‘beggar-my-neighbour’ tariffs, such as America’s Smoot–Hawley Act of 1930, which pushed tarriffs on US imports to more than 50 percent). Staple industries such as coal, iron, steel and shipbuilding suffered from chronic overcapacity, hitting parts of Britain particularly hard. As Eric Hobs-bawm put it in
Industry and Empire
:
In 1913–14 about three percent of the workers in Wales had been unemployed – rather less than the national average. In 1934 – after recovery had begun – thirty-seven percent of the labour force in Glamorgan, thirty-six percent of that in Monmouth, were out of work. Two thirds of the men in Ferndale, three quarters of those in Brynmawr, Dowlais and Blaina; seventy percent of those in Merthyr, had nothing to do except stand at street corners and curse the system which put them there. The people of Jarrow, in Durham, lived by the Palmer’s shipyard. When it closed in 1933 Jarrow was derelict, with eight out of ten of its workers jobless, and having like as not lost all their savings in the crash of the yard, which had so long been their harsh and noisy universe.
In truth, however, nowhere was immune. In America, without even Europe’s limited pre-war welfare provision, the consequences of mass unemployment were even more severe. The Great Depression, the mass movement of desperate people in search of work and food chronicled in John Steinbeck’s
The Grapes of Wrath
, and the failure of thousands of banks and therefore of the supply of credit – on some explanations the cause of most of the trouble – spoke of a global crisis for capitalism.
It is not true to say that the economists before Keynes had failed to envisage mass unemployment. In general, though, they believed that such episodes would be self-correcting. Temporary spells of unemployment would result in falling wages, which would increase the demand among employers for workers. The depression and mass unemployment of the inter-war years appeared to mark capitalism’s nadir. Arguably it was in its death throes. Many of the intelligentsia in western capitalist societies saw the crisis as proof that Marx was right, and many saw Marxism as the only solution to it. Smith’s ‘invisible hand’, it seemed, either was very shaky or no longer worked at all.
Keynes did not. When he wrote
The Economic Consequences of Mr Churchill
he advocated, as an alternative to returning to the gold standard, a programme of government spending, of deliberately running a budget deficit in order to restore economic growth and reduce unemployment. He did so again when appointed to the Macmillan Committee on Finance and Industry in 1929, and whenever he was given the opportunity in his many writings for newspapers and magazines. He was, however, up against a powerful force, the so-called ‘Treasury view’. For the guardians of Britain’s public finances, Keynes’s ideas were dangerously radical. The country, they believed, should run a balanced budget and, where possible, seek to repay debt, not deliberately allow it to build up. Gordon Brown, Chancellor of the Exchequer at the time of writing, tells of finding a pamphlet by Keynes in the Treasury archive. Scrawled across it, by a senior official of the day, was the single word ‘inflation’.
The General Theory
Keynes was not deterred. In 1935 he wrote thus to George Bernard Shaw, the playwright: ‘I believe myself to be writing a book on economic theory, which will largely revolutionise – not, I suppose, at once but in the course of the next ten years – the way the world thinks about economic problems.’ The book, published in 1936, was
The General Theory of Employment, Interest and Money
. Keynes persuaded Macmillan, his publisher, to put it on sale at five shillings (25 pence), believing that, like his earlier works, it would be a bestseller. That was optimistic. Although tens of thousands of copies have been bought by economists and students over the years, the book was never one for the general reader. Even economists find it difficult and, in some respects, confused and contradictory. The great communicator, able to turn out highly readable op-ed articles for
The Times
, had produced a rather inaccessible book. That, however, was less important than its message which, as he predicted, did indeed make people think differently about economic problems and made it one of the three most important economics books ever written, along with Smith’s
Wealth of Nations
and Marx’s
Capital
. We have yet to see a fourth to rank alongside these three, although this is not for want of trying on the part of publishers. When, at the end of the 1990s, the financier George Soros brought out a book on the ‘crisis in global capitalism’ (this was after Asia had hit economic and financial problems), his publishers claimed, ridiculously, that he had produced the fourth in a quartet of greats.