Appendix 1: Did history demonstrate that Keynes's theory of secular stagnation was wrong?

Did the high growth and rapidly rising real incomes of the postwar Golden Age prove that Keynes's projection of secular stagnation was a mistake? Obviously, the world has not remained in depression since the 1930s, but in my view, the appropriate formulation of the question is this: were there good reasons for Keynes to expect secular stagnation in the absence of an improbable dramatic increase in the role of the state in the economy, in the absence of unforeseeable system-transforming technical change, in the absence of rapid population growth, and in the absence of war? Keynes thought there were, and he proposed a radical change in the economic role of the state precisely because this was the best way to end economic stagnation in Britain.

What actually ended stagnation was not stabilizing disequilibrium market processes as in classical theory, but rather the radical transform­ation of both the US and UK economies, starting in the 1930s (with the New Deal and the tight regulation of financial markets in the USA), accel­erating in WWII with both governments in control of all crucial economic decision-making in the planned economies of the period, and culminating with the era of big government and the welfare/ warfare state after the war.

However, even this radical transformation, along with the spread of the second industrial revolution across much of the developing world, did not permanently end the specter of secular stagnation. Rather, it led to the "Golden Age" of capitalism in the 1950s through the late 1970s, a period of about a single generation. Following economic turmoil in the 1970s, the institutions and processes of the Golden Age were replaced by those of the emerging global neoliberal order, which in its turn eventually brought about a "Leaden Age" of rising unemployment, rising inequality and slower growth in the West, and rising inequality within the faster­growing developing economies.

In recent decades, the "insane" financial markets of the 1920s and 1930s were reincarnated as the new superheated global financial casino of this era. This contributed to the onset of the global economic crisis in the mid- 2000s that caused much of the global economy, including the developed economies in the West, to fall into deep recessions with rapidly rising public debt, widespread economic policies of austerity, and, again, increasing income and wealth inequality. Several influential mainstream economists (including Paul Krugman, Robert Gordon, and Larry Summers) have recently expressed support for a theory of secular stagnation.

These developments again raise the fundamental question at the heart of Keynes's focus on secular stagnation theory: is prosperity that is occa­sionally interrupted by bouts of stagnation the normal state of modern or mature capitalism - or is it the other way around?⁵ Keynes believed it was the other way around, and for this reason argued for a change of economic systems from capitalism to liberal socialism.

In The General Theory, Keynes presented and defended his understanding of the long-term crisis of the American and British economies in the midst of the Great Depression. If these countries were to continue to operate under the relatively unregulated capitalist systems they had in the 1920s, he argued, they would continue to experience slow growth and perpetu­ally high unemployment. These problems could neither be eliminated by market disequilibrium processes nor by moderate policy change within existing political-economic regimes. If the government response to the turmoil of the 1930s remained constrained by classical maxims, Keynes expected to see continuing social, economic, and political unrest, with an ongoing increase in popularity of political movements of the extreme left and extreme right. Such movements had already taken power in Italy, Germany, and the Soviet Union. Keynes understood that the forces that created secular stagnation were strong enough to create the potential for political chaos, even in the USA - a threat so powerful that it had already induced major experimentation in many countries, with such dramatically increased government intervention in the operation of the economy as to be unprecedented outside of wartime.

By 1939, most of the continent's functioning democratic systems were in extreme ruins. Weimar Germany, the most modern constitutional polity of its day, gave way to the Third Reich. Across eastern and southern Europe, the interwar transition to democracy was thrown into reverse as no fewer than 16 countries shifted right.

(Financial Times, January 31/February 1, 2015, p. 7)⁶

To sum up: textbook Keynesian theory concludes that it is logically possible for a capitalist economy to be stuck in a high-employment equi­librium. Since the theory implicitly assumes that market economies are efficient long-term allocation mechanisms, most Keynesians, at least until very recently, argued that when the economy is in recession, all that is required is a temporary "kick-start" to AD through monetary and/ or fiscal policy that will cause the economy to return to its natural low- unemployment long-term growth path. This conclusion is an act of faith in the efficiency of modern capitalism rather than a deduction from a careful, open-minded historical and institutional analysis. Keynes, who conducted just such an analysis, did not share this faith.

So, it is not true, as many have argued, that The General Theory is solely about the short and intermediate runs with no theory of the long run. Indeed, in the 1930s, Keynes and Alvin Hansen, a Harvard economist strongly influenced by Keynes's work, were the non-Marxist economists most associated in the eyes of the economic profession with secular stag­nation theory.