From The General Theory until Britain entered WWII: 1936-1939

By 1936, the political situation in Europe had deteriorated badly. Hitler had occupied the Rhineland and the Spanish Civil War had broken out. The British economic upturn of the mid-1930s slowed, coming almost to a halt in 1936-1937.

In January 1937, Keynes published a series of articles in The Times on controlling the business cycle. Keynes acknowledged that the extreme instability of private investment, emphasized in The General Theory, might make adequate control of the business cycle challenging, even if given a relatively smooth path of public investment. He argued that acceleration or deceleration of public investment could be used as a countercyclical tool to balance fluctuations in private investment. He stressed that under no circumstances should monetary policy be used to raise interest rates to slow an overheated boom, an argument also found in chapter 22 of The General Theory.

We must avoid it, therefore, as we would hell-fire...

(CW 21, p. 389, emphasis in original)²

Rather, to slow an overexuberant boom, the authorities might temporarily raise taxes (an approach he would later reject), let in a greater volume of imports, and postpone the starting date of suitable public investment projects. Keynes also argued that the chief task at the moment is not to "avoid the perils of a somewhat hypothetical boom," but to ensure that the current moderate upturn does not fall back into a slump at some point in time. And he reiterated a theme from The General Theory: after invest­ment has contributed all it can to growth, the state should use its powers of taxation to progressively redistribute income and, in so doing, raise the propensity to consume.

The concluding section of the articles ("Planning Investment") is most interesting. Keynes stressed yet again the importance of creating an insti­tutional structure that can support the new role of investment planning.

The capital requirements of home industry and manufacture cannot possibly absorb more than a fraction of what this country, with its present social structure and distribution of wealth, chooses to save in years of general prosperity; while the amount of our net foreign investment is limited by our exports and our trade balance. Building and public transport and public utilities lie half-way between private and public control.³ They need, therefore, the combined stimulus of public policy and a low rate of interest. But a wise public policy to promote investment needs, as I have said, long preparation.

In special cases subsidies may be justified, but in general it is the long-term rate of interest which should come down to the figure which the

Britain's entry into WWII 315 marginal project can earn... If we know what rate of interest is required to make profitable a flow of new projects at the proper pace, we have the power to make that rate prevail [assuming strict capital controls]. A low rate of interest can only be harmful and liable to cause an inflation if it so low as to stimulate a flow of new projects more than enough to absorb our available resources... Is there the slightest chance of a constructive or a forethoughtful policy in contemporary England? Is it conceivable that the Government should do anything in time? Why shouldn't they?

(CW 21, pp. 394-395, emphasis added)

Keynes lays out here a sophisticated view of macro planning. It presumes capital controls and managed trade.

In March 1937, Keynes evaluated the likely economic impact of the government's plan to borrow £80 million a year to finance a military buildup. His comments stress the need for an improved set of institutions to facilitate state economic planning. He estimates that this spending increase might raise national income by perhaps 4.5 percent at a time when the insured unemployment rate was "as high as 12.5 per cent." He did not think this spending would cause inflation provided, consistent with his general support for industrial policy, that "measures to ensure that all possible orders are placed in the Special Areas [of high unemploy­ment] where surplus resources are available" are taken (CW 21, p. 407). However, for the short term, there might be "some congestion" because capital spending was still on the rise. Therefore:

It is essential to set up at the centre an organisation which has the duty to think about these things, to collect information and to advise as to policy.

process of arriving at decisions much more complicated and difficult. But, at this juncture, it is a sacrifice which in the public interest they ought to make. It is easy to employ 80 to 90 per cent of the national resources without taking much thought as to how to fit things in. For there is a margin to play with, almost all round. But to employ 95 to 100 per cent of the national resources is a different task altogether. It cannot be done without care and management.

(CW 21, p. 409)

In May 1937, Keynes suffered a severe heart attack that slowed down his work pace considerably in subsequent months and affected him on and off for the rest of his life (see Skidelsky, 2002, for the details). But, as we shall see, Keynes's slowed pace was still faster than almost anyone else on the planet.

By early 1938, the USA had sunk back into severe recession, largely as the result of more restrictive fiscal policy, and the British recovery had faltered. Keynes wrote a personal letter to President Roosevelt imploring him to undertake a more aggressive policy of public investment to restart the US economy and, in the process, help other nations with their own recoveries. The problem in the USA, according to Keynes, was that the policy required to restore prosperity - a persistent large-scale increase in public investment - had never before been implemented. The banking system had been repaired and credit was now cheap, but, as he stressed in The General Theory, this is a necessary but not sufficient condition for recovery. "An increased [credit] supply will not by itself generate an adequate demand [for capital goods]" (CW 21, p. 435).

Note in the quote to follow Keynes's habitually pragmatic approach to the question of nationalization. The traditional view that Keynes was ideo­logically opposed to the nationalization of industry is not true.

Now one had hoped that the needed... factors would be organised in time. It was obvious what these were - namely increased invest­ment in durable goods such as housing, public utilities and transport. Can your Administration escape criticism for the failure of these

Britain's entry into WWII 317 factors to mature?.. Housing is by far the best aid to recovery.. In this country we partly depended for years on direct subsidies. There are few more proper objects for such than working-class houses. If a direct subsidy is required to get a move on,... it should be given without delay or hesitation. Next utilities. Is it not for you to decide either to make real peace [with the privately-owned utilities] or to be much more drastic the other way? Personally, I think there is a great deal to be said for the ownership of all utilities by publicly owned boards. But if opinion is not yet ripe for this, what is the object of chasing the utilities round the lot every other week? If I was in your place, I should buy out the utilities at fair prices. But elsewhere I would make peace on liberal terms, guaranteeing fair earnings on new investments and a fair basis of evaluation in the event of the public taking them over. Finally, the railroads. Whether hereafter they are publicly owned or remain in private hands, it is a matter of national importance that they be made solvent. Nationalise them if the time is ripe. If not, take pity on the overwhelming problems of current managements. I am afraid I am going beyond my province. But the upshot is this. A convincing policy, whatever its details may be, for promoting large-scale investment under the above heads is an urgent necessity. Those things take time. Far too much precious time has passed. Forgive the candor of these remarks. They come from an enthusiastic well-wisher of you and your policies. I accept the view that durable investment must come increasingly under state direction... I regard the growth of collective bargaining as essential. I approve minimum wage and hours regulation. But I am terrified lest progressive causes in all the democratic countries should suffer injury, because you have taken too lightly the risk to their prestige which would result from a failure measured in terms of immediate prosperity.

(CW 21, pp. 436-438, emphasis added)

He repeated the core of this message in his response to Roosevelt's reply.

[F]urther experience since I wrote you seems to show that you are treading a very dangerous middle path. You must either give more encouragement to business or take over more of their functions your­self. If public opinion is not ready for the latter, then it is necessary to wait until public opinion is educated. Your present policies seem to presume that you possess more power than you actually have.

(CW 21, p. 440)

At about the same time, in an address to life insurance executives, Keynes stressed that effective government planning was not a threat to economic and political "freedom," but rather the only way to preserve it. As he argued in the final chapter of The General Theory, the effective

choices facing the UK were depression, war, and totalitarianism or demo­cratic socialism with state economic planning.

For the difficulty of avoiding disastrous depression in the modern world can scarcely be exaggerated... A great deal is at stake. We are engaged in defending the freedom of economic life in circumstances which are far from favourable. We have to show that a free system can be made to work. To favour what is known as planning and man­agement does not mean a falling away from the principles of liberty which could formerly be embodied in a simpler system. On the con­trary, we have learnt that freedom of economic life is more bound up that we previously knew with deeper freedoms - freedom of person, of thought, and of faith.

(CW 21, p. 446)⁴

In September 1938, Keynes wrote an article reviewing a report evalu­ating technical change and the rapid rise in labor productivity over the past ten years. He was quite impressed with the data, but worried that the maldistribution of productivity growth across industries contributed to structural unemployment. He also concluded that there was a greater margin for growth in the economy than was generally assumed, even with the rise in military spending. And he worried again about whether Britain could hope to successfully compete with the planned German economy unless she adopted her own democratic variant of planning.

This helps to explain what may otherwise perplex us in the German economy. If British industry could be fully occupied at modern standards of efficiency, the additional output beyond what was suf­ficing for our needs a few years ago would be enough to provide a prodigious volume of resources available for purposes of peace - or defence. We are still allowing a great volume of potential wealth to evaporate. How can we hope to keep pace with a form of gov­ernment [in Germany] which has devised a means of producing and maintaining full employment? This is the critical task before us, if we are to maintain the supremacy of our own notions of what civilization should mean.

(CW 21, pp. 481-482)

In a supplementary note to this piece, Keynes argued that the combin­ation of rapidly rising labor productivity and sluggish final demand was creating a situation in which the depreciation reserves of industry were more than enough to finance their new investment needs. In The General Theory, he had warned about the disastrous consequences of this condition for long-term growth. Under these conditions:

Britain's entry into WWII 319 it becomes increasingly improbable that anything approaching full employment can be maintained without normal loan expenditure by the Government on one ticket or another. At any rate, it is certain that in the last quarter century such a state of affairs has never existed, apart from very brief periods in abnormal conditions, in any indus­trial country in the world, except perhaps in the United States in 1928. The problem thus presented is the outstanding problem of today, and cannot be solved by turning a blind eye to it.

(CW 21, p. 483)

Its solution, he adds, will require managed trade - the creation of "new and necessary machinery for linking up exports with imports, so as to make sure that those from whom we buy spend a reasonable proportion of the proceeds in corresponding purchases from us" (CW 21, p. 483).

In terms of the evolution of Keynes's thinking about policy and planning, early 1939 marks the end of an era. From here on, war spending and the war itself will substantially alter the economic and political con­text within which Keynes must struggle. In April 1939, he wrote:

The Chancellor of the Exchequer should frame his Budget on the assumption that the problem of abnormal unemployment will cease to exist during the financial year 1939-40, and that all plans and spe­cial provisions for dealing with this problem should be dropped forth­with as being a waste of time and money.

(CW 21, p. 509)

Keynes estimated that loan expenditure for the coming year would be on the order of £200 million greater than the previous year. With a multi­plier of about two, this would raise national income by 8 percent and increase employment by well over 1 million. And there were immediate plans to add 200,000 young men to the military (CW 21, p. 532).

Government priorities, an acute shortage of skilled labour, trade union restrictions, the task of shifting workers to the districts where demand is greatest, the curtailment of unessential services - all the problems of the last War - are round the corner.

(CW 21, p. 511)⁵

But the restoration of full (and even overfull) employment due to war did not change his belief that the era of laissez-faire ended with WWI and that Britain would have to move, once the current war crisis ended, to an entirely new economic role for the state as the fulcrum of a democratically planned economy.

The war effort and postwar economic planning would now occupy all of Keynes's work time. He was largely responsible for creating Britain's

system of war finance, for preparing Britain's proposals for a new postwar international system and defending them against increasingly devastating attacks by the bullying Americans, and for negotiating with the Americans over the terms of the reconstruction loan - a Herculean undertaking for anyone, much less someone with a serious heart condition. At the same time, he was also the person most responsible for planning Britain's postwar economy. He did so in a way that was completely consistent with the tra­jectory of his thinking through the 1920s and 1930s. As the war unfolded, he became increasingly convinced that postwar state planning for full employment as well as a more comprehensive social welfare system in Britain were inevitable; political reality would demand it. The relevant questions for Keynes, then, became not whether state planning would be created, but what its form and content should be and how to get the state to adopt his preferred policies.

The inevitability of postwar full-employment planning, which the war period cemented in his mind, seemed clear to Keynes before the war effort was even underway. He believed it would be politically impossible for any party to try to take Britain back to its nineteenth-century economic model.

[T]he grand experiment has begun. If it works, if expenditure on armaments really does cure unemployment, I predict that we shall never go all the way to the old state of affairs. If we can cure unemploy­ment for the wasted purposes of armaments, we can cure it for the productive purposes of peace. Good may come out of evil. We may learn a trick or two which will come in useful when the day of peace comes, as in the fullness of time it must.

(CW 21, p. 532)

He continued in this vein.

The armament programme will bring abnormal unemployment to an end. Some day, and the sooner the better, we hope to stop the existing abomination and return to the ways of peace. Is that to mean a return to abnormal unemployment? It will go hard with the fabric of society if it does. To avoid this outcome, it will be necessary for productive investment, public and private, out of borrowed money to continue at a rate at least as high as this year's programme.

(CW 21, p. 546)

This theme is also reflected in his correspondence with his sister Margaret in June 1939. She was on a Royal Commission studying the feasi­bility of a public board responsible for the location of industry. Keynes reminded her that he had not written anything recently on the subject of a National Investment Board, that his "first proposals on this were not published in my own name," but included in the report of the Liberal Industrial Enquiry (1928), and that he had "got something similar some­where into the report of the Macmillan Committee" (CW 21, p. 590). He then suggested that at war's end, whichever party was in power would be likely to create some form of National Investment Board.

My own feeling is that, when we are ready for reforms again, opinion will be found to have hardened a good deal in this direction. Any gov­ernment except an ultra-Conservative one might be expected to make a begin­ning towards introducing it. I am interested that you are meeting with the argument that it is not possible to find work of a useful and public character to employ any very large number of men. This used to be the argument of Neville Chamberlain and the Government in the last slump. But most people, I had thought, had quite given it up. It is a wholly untenable position. It is some time since anyone had the face to use it in public... Anyhow, I should say that practically all reforming minds are in favour of making some move in the direction of the establish­ment of a National Investment Board. If a National Investment Board were to be set up, it would be most advisable that it should work in close collaboration with a Board for the location of industry. But the functions of the former body would go. very far beyond those of the latter.

(CW 21, pp. 590-591, emphasis added)

In January 1939, The New Statesman published an important "conver­sation" between Keynes and the editor Kingsley Martin. The topic was "Democracy and Efficiency." The main points stressed by Keynes were the urgent need for ambitious central planning in the new era and the com­patibility of such planning with democracy and liberal values. He again called his preferred new system "Liberal Socialism."

Martin opens with this statement: "You have held that private capit­alism is an out-of-date institution incapable of meeting the requirements of the twentieth century." Keynes responds: "I agree entirely" (CW 21, p. 492). He continued:

In contemporary conditions we need, if we are to enjoy prosperity and profits, so much more central planning than we have at present that the reform of the economic system needs as much urgent attention if we have war as if we avoid it. The intensification of the trade cycle and the increasingly chronic character of unemployment have shown that pri­vate capitalism was already in its decline as a means of solving the economic problem. But the breakdown of international good faith and the con­stant threats to peace are making it still more obvious that, quite apart from war, we have to move a long distance along that very road which actual war would make it imperative for us to take. But it is not the threat which the necessary [planning] measures might offer to personal liberty and democratic institutions which stands in the way of what wants doing to make us prosperous within and safe without. Any such threat is so remote from the first and the next and the next things that want doing, that it is not now, and is a long way from being, a practical issue.

(CW 21, p. 492, emphasis added)⁶

Since Keynes was quite familiar with the extreme degree of planning that war entails from his experience in government during WWI, his view that we had to go "a long way along that very road" even if war did not occur is quite telling.

Martin then asks: what is preventing the country from satisfying the "desperately obvious" need for planning? Keynes responds that, first, the public is lukewarm "towards the particular amalgam of private capit­alism and state socialism which is the only practicable recipe for present conditions" (CW 21, p. 492). Second, the needed reforms are "not in tune with the inherited slogans" of any of the major political parties.

Keynes next stresses the importance of maintaining a significant role for private property and private enterprise in a new system of planning because of their "profound connection" to personal and political liberty. But he immediately adds the caveat that he does not defend the "fact that the lawyers of the eighteenth century perniciously twisted this into the sanctity of vested interests and large fortunes" Martin agrees.

I know of no more extraordinary confusion than that which identi­fies the right to own the fruits of one's own labour in pre-industrial society with the right of Mr Rockefeller or the Duke of Westminster to own the labour and control the conditions of life of thousands of other people. Surely the monopoly ownership of our day is one of the great enemies of liberty. But I agree that the right of personal prop­erty is inseparable from the conception of liberty, and that this confu­sion between personal property, which no intelligent Socialist has ever wished to take away from anyone, and property in the sense of the right to play the money market, and employ, sack or pay what wages one likes, has had very serious results.

(CW 21, pp. 493-494)

Keynes then takes up the question of the lack of sympathy for his views in the parties. The problem is not that there are no sympathizers within each party; there are in fact many liberals (with a lower-case "l") in all three. But their views lack "organised expression." "There is no one in pol­itics today worth sixpence outside the ranks of liberals except the post-war generation of intellectual Communists under thirty five. Them, too, I like and respect" (CW 21, pp. 494-495).⁷

Martin suggests that the political situation is hopeless unless liberals and "amateur" Communists can work together, which is why he finds

Britain's entry into WWII 323 the anti-communism of the Labour Party so disturbing: "they seem intent rather on fighting their own left than on providing an alternative to the capitalist governments they are supposed to be opposing" (CW 21, p. 496). Keynes agrees.

Yes; the attitude of the official Labour Party towards all this strikes me as one of the silliest things in the history of British politics.. I sympathise with Mr Bevin in fighting shy of contact with the pro­fessional Communists, regarding their body as a Trojan horse and their overtures in doubtful faith. But I should risk contact all the same, so as not to lose touch with the splendid material of the young amateur Communists. For with them in their ultimate maturity lies the future.

(CW 21, pp. 495-496)⁸

Keynes then moves on to another major obstacle to the radical changes needed in the economic role of government - the Civil Service. This is extremely important to Keynes because of his belief that the details of planning must be conducted primarily by "expert" civil servants, not politicians.

[T]he present heads of our Civil Service were brought up in, and for their part still adhere to, the laissez-faire tradition. For constructive planning the civil servants are, of course, much more important than Ministers; little that is worth doing can be done without their assistance and good will. There has been nothing finer in its way than our nineteenth-century school of Treasury officials. Nothing better has ever been devised, if our object is to limit the functions of govern­ment to the least possible and to make sure that expenditure, whether on social or economic or military or general administrative purposes, is the smallest and most economical that public opinion will put up with. But if that is not our object, then nothing can be worse. The Civil Service is ruled today by the Treasury school, trained by tradition and experience and native skill to every form of intelligent obstruc­tion. And there is another reason for the heads of the services being what they are. We have experienced in the... years since the War two occasions of terrific retrenchment and axing of constructive themes. This has. inevitably led to the survival and promotion of those to whom negative measures are natural and sympathetic. I am afraid that they are becoming a heavy handicap in our struggle with the totalitarian states and in making us safe from them.

(CW 21, pp. 496-497)

Finally, Martin observes that totalitarian states have been able to use central planning to fully utilize their national economic capacity, but

unfortunately this success is directed toward war and "has wiped out lib­erty, decency and indeed almost everything that makes life worth living." As a result, "we in Britain are doomed unless we can make the essential changes quickly and without these unnecessary and appalling sacrifices" (CW 21, pp. 499-500). "Yes. That is the truth," Keynes replies. But he adds that there is no need to be concerned about such losses in Britain, at least not for a long time to come. "I say that we are so far from such a situ­ation that the risk does not now exist" (CW 21, p. 500). He concludes his remarks with a call for "liberal socialism" in Britain.

The question is whether we are prepared to move out of the nine- teen-century laissez-faire state into an era of liberal socialism, by which I mean a system where we can act as an organised community for common purposes and to promote economic and social justice, whilst respecting and protecting the individual - his freedom of choice, his faith, his mind and its expression, his enterprise and his property.

(CW 21, p. 500, emphasis added)

Notes

1 In February 1937, the Government announced it would borrow £500 million over five years for military purposes.

2 See also CW 21 (pp. 549, 565).

3 Keynes frequently referred to the importance of "semi-public" investment projects. Here, he refers to investment in buildings (both residential and non- residential), public transport, and public utilities as examples of semi-public investment. Some of this is semi-public because it is under the control of public corporations.

4 In an article in The Economic Journal in September 1938 (calling for state control of the storage of important commodities in order to minimize the fluctuations in their prices and supplies), Keynes observed, not for the last time, that the state will spend its way to full employment in war but not in peace. "If only we could tackle the problems of peace with the same energy and whole-heartedness as we tackle those of war! Defence is old - established as a proper object for the state, whereas economic well-being is still a parvenu... Nevertheless, we are at this moment allowing war expenditure for defence to help solve our problem of unemployment as a by-product of such spending, whereas if disarmament had prevailed we might have allowed a serious recession to have developed by now before introducing loan expenditure on a comparable scale for the productive works of peace" (CW 21, p. 463).

5 Still, in June 1939, Keynes believed that "there is room for a very substantial increase of the national income, say, by something between 5 and 10 per cent" (CW 21, p. 548).

6 Keynes's reference to "the increasingly chronic character of unemployment" implies that he continued to be concerned about secular stagnation even as the war buildup was underway.

7 He continued: "Perhaps in their feelings and instincts they are the nearest thing we now have to the typical nervous nonconformist English gentlemen who went to the Crusades, made the Reformation, fought the Great Rebellion, won us our civil and religious liberties and humanised the working classes last cen­tury" (CW 21, p. 495).

8 See Durbin (1985) for a detailed discussion of the relation between Keynes and important elements of the Labour Party and "young amateur Communists," who he strongly influenced in this period.

22