Keynesianism

A Demand-Oriented School of Thought Within Economics

An Article in the Compendium of Market-Based Social-Ecological Economics

Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?

Click here for the list of all articles: Compendium
Click here for the German-language version: Keynesianismus

Table of Contents

  1. Overview
  2. Introduction
  3. Keynes’ Revolutionary Approach
  4. The Helplessness of Economic Schools of Thought
  5. Outlines of a Sustainable Globalization Paradigm/li>
  6. The Conclusion is Obvious:

1. Overview

The economic policy debate is still determined by economic theories, which have already proved to be only suitable to a limited extent under the earlier conditions of national autonomies. Keynesian and neoclassical theories are at the center of the current economic debate, which, with increasing »market liberalization«, only provoke fruitless continuous disputes. However, dealing with historical theories makes sense, because it can sharpen the view for a contemporary economic paradigm, a paradigm that reconciles economic globalization with social welfare.

2. Introduction

The English economist John Maynard Keynes (1883 to 1946) triggered a revolution in economic thought with his major work »The General Theory of Employment, Interest and Money«, published in 1936. Keeping the consequences of the world economic crisis in mind, Keynes rejected the then prevailing supply-oriented Neoclassical Doctrine, which assumes self-regulation and self-stabilization of the economy with full employment. He claimed against it the possibility of equilibrium with simultaneous underemployment, from which he derived the necessity and the possibility for state control (see also the supplementary article Classical and Neoclassical Economics.

In the academic as well as in the economic policy controversy, the Keynesian paradigm and the neoclassical doctrine are still irreconcilably opposed today. Under the conditions of continued national deregulation and the emergence of open global markets (the neoliberal Economic Globalization), however, this dispute is completely unproductive, because both historical schools of thought are based on the premise of economically autonomous nation-states under which they originated at the time. And moreover, even under this premise, they could not achieve permanent full employment. Nevertheless, it is helpful to absorb the basic features of Keynesianism as well as of neoclassicism, above all in order to show in comparison that the current development of the neoliberal globalization is historically unprecedented and that all attempts to steer it into equilibrium with the traditional instruments must be unsuccessful.

It should first be noted that the dogma of »market liberalization«, which dominates the current globalization, is not compatible with a meaningful economic governance and stabilization. Overcoming this dogma requires economic policies of autonomous, largely homogeneous economic areas (mostly nation-states)and international agreements based on a sustainable globalization paradigm that satisfies today’s requirements. This paradigm must detach itself from the erroneous notion of global centralist control and turn (back) to the design of foreign trade interfaces between the traditionally very different trading nations. The recourse to historical concepts is by no means excluded, as long as they do justice to the reality of the 21st century.

3. Keynes’ Revolutionary Approach

Keynes assumed systemic instability and a lack of self-healing powers in the market economy and essentially attacked the neoclassic with five theses of his General Theory:

  1. Overall economic demand is mainly determined by the income of households and enterprises – not by the interest rate.
  2. Even if the money, goods and labor markets are in equilibrium, there can be permanent underemployment if production capacity is not fully utilized. In contrast to the neoclassical theory, the employment level is not determined by the labor market equilibrium but by the effective total demand for capital and consumer goods. In the absence of total demand, even arbitrarily flexible real wages cannot generate additional demand on the labor market and thus cannot induce economic expansion (growth).
  3. In market economies, investment decisions are associated with uncertainties that can lead to instability and underemployment – the assumption of full foresight and constant equilibrium is unrealistic.
  4. Investors make their decisions largely autonomously and independently of the interest rate – there is basically no automatic compensation between saving and investing.
  5. Due to a lack of transparency and information, there is imperfect competition in market economies – including on the labor market. The assumption of perfect competition and full information is unrealistic.

Keynes complemented the theses of his General Theory with three concrete economic policy measures of anticyclical monetary and fiscal policy:

  1. In a recession, the state increases the money supply (expansive monetary policy) in order to lower the real wage level through inflation. On the one hand, this stimulates companies’ demand for labor and, on the other, employees are encouraged to offer more work to compensate for their declining purchasing power. As soon as the recession turns into an upswing, the money supply is reduced again.
  2. Because monetary policy loses its effect once it has generated excessive liquidity, the state also pursues an expansive fiscal policy during a recession. In other words, the state increases its debt-financed spending (deficit spending) so that companies can better utilize their production capacities and demand more labor following additional government demand – until finally, full employment prevails with stabilized wages. As soon as the recession turns into an upswing, taxes are raised and spending reduced to repay public debt.
  3. In order to avoid instability due to entrepreneurial investment decisions, government investment planning is pursued in addition to private initiative.

Overall, the Keynesian proposals aim to combine indirect demand control at the macroeconomic level with the efficiency advantages of market-based control at the microeconomic level (the level of private households and enterprises). From today’s perspective, it should be noted that deficit spending only significantly increases employment if predominantly labor-intensive sectors of the economy benefit from government spending. Moreover, it is doubtful that the government investment planning envisaged by Keynes would bring efficiency benefits to companies.

In the mid-seventies, Keynesian theory was shaken because it could not explain the simultaneous occurrence of stagnation and inflation (stagflation). The novel phenomenon of stagflation triggered the »monetarist counterrevolution« and helped the theory of monetarism, developed by Nobel Prize winner Milton Friedman (1912 – 2006) and others in the 1950s and 1960s, to achieve a breakthrough and at the same time a renaissance of the neoclassical theory. Both theories are based on the assumption of self-regulation and self-stabilization of the economy with equilibrium-oriented full employment. Monetarism also advocates the reprivatization of all areas of life and rejects Keynesian fiscal policy because it assumes that credit-financed public measures lead to a crowding out of private investment. Instead, it argues for a long-term monetary policy with possible financing of economic stimulus programmes through central bank money creation. And it interprets unemployment as largely voluntary and assumes that it is based on false real wage expectations and lack of information as well as on market failure due to unemployment insurance and social assistance!

KeynesianismusJPG01Since the 1990s, the influence of the Keynesian paradigm on economic policy has been reduced to the deficit spending described above, partly as a result of the monetarist counterrevolution, but above all because of the continuous neoliberal depression with its high unemployment. This depression is forcing countries affected to take on ongoing new debt without ever giving them the opportunity to repay their debt by raising taxes and reducing spending. At the same time, companies are anxious to compensate for stagnating domestic demand by expanding their export markets. In the open global markets, they come under increased competitive and cost pressure and are forced to cut more and more jobs or relocate jobs to low-wage countries – which in turn increases the volume of cheap imports and leads to further job losses. With the consequence that – despite the continuing deficit spending – the domestic economies are moving further and further away from an equilibrium with full employment.

4. The Helplessness of Economic Schools of Thought

Since both the neoclassical doctrine and monetarism have failed to prove that the economy is self-regulating and self-stabilizing, new life is now brought into Keynesianism under the term post-Keynesianism. This modern Keynesian doctrine is increasingly dedicated to the interactions between social distribution, employment, investment and growth and tries to take into account the real imbalances caused by general uncertainties, social conflicts and capital concentrations. Similar to Keynes himself, post-Keynesianism does not view the labor market as a market in the usual sense, where full employment could be achieved only through real wage levels, but calls for economic policy measures to stimulate labor demand.

Supporters of monetarism and post-Keynesianism ensure that the controversy between supply- and demand-oriented theory still continues today – with some new facets. This controversy can be most impressively observed among the members of the Council of Economic Experts of the German Federal Government, the so-called Five Wise Men. However, since the exogenous influences of the neoliberal globalization on national economies are historically without example and have no theoretical foundation, none of the traditional schools of thought can logically come any closer to solving the problems caused by this globalization.

The economic confusion is understandable because the depressive state with high unemployment that has prevailed since the turn of the millennium is similar to a conventional depression that, according to textbook opinion, should actually be replaced by an upswing with high employment in the economic cycle. But the current phenomenon, as said before, eludes economic classification and resists economic control. Since the economic textbooks cannot give an up-to-date answer, they indirectly provide the advocates of the neoliberal free trade doctrine with a fair »scientific« justification to trivialize the fluctuations of economic parameters as »classical« economic cycles despite the continued increase in underemployment and poverty. See also the article Business Cycle / Economic Cycle.

5. Outlines of a Sustainable Globalization Paradigm/

A predatory competition with absolute price advantages (in dollars or euros) on open global or European markets, including the tendency towards complete territorial specialization and the greatest possible concentration of capital, has never existed in economic history before. Because of the inherent contradiction between the doctrine of deregulation of national markets on the one hand and the demand for measures to achieve an economic equilibrium with full employment on the other, the chances for equilibrium and full employment are inevitably poor. Added to this is the sobering experience that only during the extraordinary economic growth following the destruction of the Second World War was it feasible to secure full employment for several decades. Only one thing seems certain: In the environment of academic economics, an economic theory that could promise full employment even with low growth or stagnation is not yet in sight – which for me is the motivation for this compendium.

Anyone observing what is really going on will note that the doctrinal contradiction creates a constant wrangling in the day-to-day political business between proponents and opponents of »market liberalisation«. As long as the proponents pursue their self-serving economic goals and the opponents can think of nothing better than to resort to historically outdated economic theories, there will be no breakthrough on the road to sustainable economic globalization.

6. The Conclusion is Obvious:

The doctrine of national deregulation with the aim of a global liberalization of all economic activities has obviously failed in view of the social and ecological devastations caused. In particular, the consequences of the financial market and economic crisis which began in 2008 can only lead to the reverse conclusion, namely that a sustainable globalization must be based on economic policies of autonomous, largely homogeneous economic areas. In concrete terms, this means that economic areas must first align their domestic economic activities towards sustainable welfare, and only subsequently regulate their international trade in such a way that their cross-border transactions are constructively integrated into their domestic economy and domestic competition (see also the article Sustainable Social Welfare).

A decisive lesson to be learned from historical experience is that neither monetary or fiscal policy stimulation of the supply side (production) nor that of the demand side (investment and consumption) can guarantee lasting full employment. For measures on either side serve merely – directly or indirectly – to increase production without counteracting the natural entrepeneurial tendency to concentrate production capital. Since capital concentration is responsible for widespread desertification of economic structures, an increase in production volume without adjustment of production structure cannot create employment and equal distribution of income and wealth. However, both are prerequisites for sustainable social welfare.

That means in plain language:

The key to full employment, prosperity and welfare lies solely in the production structure!

The priorities must therefore be reversed: Instead of uncontrolled concentration of economic power and capital, the focus must be on regulated decentralization, or rather on regulated subsidiarization of economic structures. This is also a prerequisite for decentralized democratic responsibility and for the broad participation of all citizens in economic life and their fair share of the economic outturn, i.e. for full employment and livelihoods, but also for ecological sustainability.

Increases in productivity and production volume, including the associated realization of economies of scale and economies of scope, are then achieved strictly within the framework of the predefined decentralized (subsidiary) structures. This ensures that the desirable progress in productivity produces social yields as well as the lowest possible ecological costs or even ecological yields instead of external costs, such as in the neoliberal system.
See also the supplementary article Scale Economies and Productivity.

Only on the foundation of autonomously designed subsidiary structures within each and every enonomic area can a future-oriented economic globalization be realized. The quality of the interfaces that determine the benefits of foreign trade between autonomous economic areas is measured by the extent to which trade is conducive to the development of participating domestic economies. The prerequisite for this is an uncompromising return to bilateral trade agreements, possibly with subsequent multilateral agreements as a useful supplement. Bilateral exchange rates that neutralize the respective price and productivity gaps between trading partners are central to cross-border interfaces, accompanied by mutually granted autonomy to set tariffs and trade quotas. Only then can international trade and competition be based on relative instead of absolute price advantages and be mutually profitable by stimulating domestic economies through foreign trade for progress and welfare.

As a supplement I recommend the articles Economic Subsidiarity, Market and Market Economy, Principles of Global Economic Order, Full Employment, Economic Competition, Economic Pricing, Future-Proof Foreign Trade, Comparative Advantage – Upgraded and Full Employment.

Click here for the German-language version: Keynesianismus.

Advertisements
%d bloggers like this: