Keynes's radical policy views in The General Theory

At a quick first reading, The General Theory appears to be primarily about economic theory, not about concrete policy proposals. Indeed, the preface opens with the following statement:

This book is chiefly addressed to my fellow economists.

(CW 7, p. xxi) Nevertheless, the "second place" policy discussion turns out to be quite important. This is not surprising because the main purpose of the book was to help create a consensus in support of Keynes's new macro theory among economists in the academy, government, business, finance, and main political parties, plus economically literate non-economists. He was especially focused on younger economists who were not yet committed to the then-current orthodoxy. Keynes's hope was that this consensus would lead to support for his radical policies, which are stated repeatedly in the book. In my opinion, the purpose of the new macroeconomic theory unveiled in the book was to provide an impregnable defense of these long- held policy positions.

Keynes believed The General Theory to be a revolutionary book. As he wrote to George Bernard Shaw in 1935:

To understand my state of mind, however, you have to know that 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.

(CW 13, p. 492, emphasis in original)

This represented something of a shift in Keynes's political strategy. He had previously relied on tireless proselytizing through speeches, newspaper articles, radio broadcasts, work with various government bodies, efforts to gain more political power for the Liberal Party, attempts to create alliances between Liberals and the Labour Party, and so forth.

I think [the book] is excellently done and I am naturally in sympathy with nearly all of it. I recognize its origins in a good many cases in previous publications with which I was concerned. I think the prac­tical proposals nearly all excellent and a government or party which adopted this volume as its programme would have my enthusiastic support.

(CW 21, pp. 354-355)

But he refused to sign the document because "my own state of mind at this moment, whatever it may have been three or four years ago is materi­ally different from that of the compilers." At "this moment," Keynes was fully engaged in finishing The General Theory, which was published the following year.

My own belief today is that neither the real remedy nor the power of persuading people to adopt it will come except from a more fun­damental diagnosis of the underlying situations and a wide-spread understanding of this diagnosis and conviction of its correctness... [W]hilst I thought that the proposal and the sort of ideas which your book contains was my job two years ago, and I daresay it was, I now consider my job is rather different.

(CW 19, pp. 354-355)

Keynes's contemporary British audience was quite familiar with his writings, speeches, and newspaper articles on public investment and national planning. They knew he was a "Liberal Socialist" who had campaigned tirelessly for the adoption of democratic planning in Britain. For his British audience, Keynes did not have to endlessly repeat his radical policies in the book.

What follows is an examination of some of the main policy positions Keynes presented in The General Theory more or less in the order they appear in the book.

Keynes's radical policy views 293 state-guided rate of capital accumulation rise fast enough and for long enough to create a rapid growth of AD sufficient to achieve and sustain full employment.

What may be a surprise to the reader is the fact that while his radical policies appear all over The General Theory, only a handful of economists trained after WWII associate these policies with Keynes. The purpose of this chapter is to provide convincing evidence to support the claim that The General Theory repeatedly explains Keynes's radical policy views.

Chapter 10 on "The Marginal Propensity to Consume" is focused on the impact of increased public investment on unemployment; there is no ref­erence to the multiplier on private investment. All students of economics learn that there is a multiplied effect of all exogenous sources of spending, whether public or private, on equilibrium output. But chapter 10 is devoted almost in its entirety to a demonstration that an increment in "public investment" or in "public works" will have a magnified or multi­plied effect on equilibrium income and therefore on equilibrium employ­ment. The goal of the chapter is obviously to demonstrate that public investment is a powerful policy tool. As we have seen, Keynes used the concept of the multiplier on public investment repeatedly in his efforts in the 1930s to generate support for his policies. Chapter 10 contains his most detailed defense of this position. Relying on data collected by Simon Kuznets for the USA, which he considered to be the best data available, Keynes estimated the value of the multiplier in the USA to be about 2.5.

Keynes also stressed that the value of the mpc is cyclically variable and therefore so is the value of the multiplier. When the economy is depressed, the multiplier will be much higher than it is when unemployment is low because families will try to sustain their traditional or normal living standards as best they can. This will cause the mpc to be well above its average value in slumps. "The marginal propensity to consume is not con­stant for all levels of employment, and it is probable that there will be, as a rule, a tendency for it to diminish as employment increases" (CW 7, p. 120). He said that 2.5 is "a figure quite plausible for the boom, but... improbably low for the slump" (CW 7, p. 128). Public investment will thus have the largest multiplier just when the most powerful demand stimulus is needed. On the other hand, changes in public investment will not sub­ject the economy to excessive instability once full employment is achieved because the mpc and the multiplier will be at their lowest values in this situation.

In chapter 12, Keynes argued that "insane" casino financial markets were a major cause of investment volatility, which logically implies that they reinforce the tendency toward secularly stagnant investment because they make investment risker at all values of the mec. Excessive liquidity in financial markets in combination with fundamental uncertainty

contributed to high-amplitude business cycles and were a major cause of the Great Depression. In this chapter, Keynes discussed three possible pol­icies to reduce or eliminate the deleterious impact of excessive financial market volatility on the capital investment decision and thus on income and employment.

First, Keynes argued that the threat posed by financial market instability was so serious that he considered supporting policies designed to elim­inate the connection between private financial markets and capital investment altogether.

The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave causes, might be a useful remedy for contemporary evils... For this would force the investor to direct his mind to the long-term prospects and to these only.

(CW 7, p. 160)

The fact that this proposal would entail serious costs as long as capital investment spending depended on stock and bond prices would have to be weighed against its substantial benefits. This constituted a "dilemma."

The liquidity of investment markets often facilitates, though it some­times impedes the course of new investments. For the fact that each individual investor flatters himself that his commitment is "liquid" (though this cannot be true of all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of [financial] investments were rendered illiquid, this might seriously impede new [capital] investment, so long as alternative ways in which to hold his savings are available to the individual. This is the dilemma.

(CW 7, p. 160, emphasis in original)

He argued that as long as investors have the option of holding their wealth in the form of safe financial assets like cash, Treasury bills, or short-term savings accounts - "money" for short - that are immune from substantial nominal loss of capital value. "[T]he alternative of purchasing risky cap­ital assets cannot be rendered sufficiently attractive. except by organ­izing markets wherein these assets can be easily realised for money" (CW 7, pp.161-162).

Thus:

the only radical cure for the crises of confidence which afflict the eco­nomic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital asset which, even though it be on precarious

Keynes's radical policy views 295 evidence, impressed him as the most promising investment available to him.

(CW 7, p. 161)

This would at least "avoid the disastrous, cumulative and far-reaching repercussions of its being open to him, when thus assailed by doubts, to spend his income on neither one nor the other" by hoarding his income in the form of money (CW 7, p. 161). When investors are "assailed by doubts," the price of stocks will collapse and the long-term interest rate will spike, causing a fall in AD, income, and employment. The fact that Keynes even considered such a radical policy prescription reflected the depth of his concern with casino capitalism in the USA and elsewhere.

Second, Keynes proposed the imposition of a substantial financial transactions tax - now often called a Keynes tax, a Tobin tax, or a Robin Hood tax - that would respond to the dilemma described above by sub­stantially reducing but not totally eliminating the liquidity of financial markets. Keynes observed that the instability of prices on the London Stock Exchange was of a lesser magnitude than it was on Wall Street. In his view, British financial markets were not dominated by speculative gam­bling. Speculation in London was, in comparison with speculation on Wall Street, "inaccessible and very expensive" due to the:

high brokerage charges and the heavy transfer tax... The introduc­tion of a substantial Government transfer tax on all transactions might prove the most serviceable reform available with a view to mitigating the present predominance of speculation over enterprise in the United States.

(CW 7, p. 160)

Since Keynes believed that, given fundamental uncertainty, excessive liquidity made modern capitalist economies dangerously unstable, the transfer tax would have to be very large indeed to eliminate most of the volatility in financial markets.

Third, in the last paragraph of chapter 12, Keynes presented his pre­ferred policy solution to both excessive instability and secular stagnation problems. It is a radical solution that reflected his long-held belief that this problem was so deeply rooted in modern capitalism that no normal set of market regulations would be capable of resolving it. In the last section of the chapter, Keynes repeated a statement he had made in his address to the Liberal Party Summer School in 1927, in BIF, and elsewhere: the stock of capital already under public control or guidance was already exceeding large.

[T]here is a growing class of investments entered upon, or at the risk of, public authorities, which are frankly influenced in making the

investment by a general presumption of there being prospective social advantages from the investment, whatever its commercial yield may prove to be within a wide range, and without seeking to be satisfied that the mathematical expectation of the yield is at least equal to the current interest rate, - though the rate of interest which the public authority has to pay may still play a decisive part in determining the scale of investment it can afford.

(CW 7, pp. 164-165)

What was needed was a long-term plan by the state to increase this stock at a rate adequate to attain and sustain full employment - a goal that could not be achieved unless the interest rate could be forced to decline by enough to allow accelerated investment spending to cause the mec to fall toward zero. Though the stock of publicly controlled capital was already quite large, Keynes argued that it needed to grow even larger to achieve full employ­ment. In the final paragraph of the chapter, he proposed that the government take "an ever greater responsibility for directly organising investment."

I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the gen­eral social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the marginal efficiency of different types of capital... will be too great to be offset by any practicable changes in the rate of interest.

(CW 7, p. 164, emphasis added)

This is the exit message for one of the most famous chapters in The General Theory. It is hard to understand how the profession missed it.

As we have seen, chapter 16 was a defense of Keynes's thesis that, in the absence of strong counter-tendencies, the profit rate on new invest­ment and the expected profit rate will fall as the capital stock increases over time. He argued that the mec had in fact fallen substantially in the boom of the late 1920s. In chapter 17, Keynes explained that there are institutional as well as behavioral and psychological reasons (related to "liquidity preference") as to why the interest rate has a high lower bound under the current regime and argued that the mec had been too low rela­tive to the long-term interest rate in the UK in the interwar years and in the USA after 1929 to permit a level of capital investment spending high enough to sustain full employment. Under then-current policy regimes, Keynes said in chapter 16, both the USA and the UK would continue to suffer from chronically high unemployment. However: "This disturbing conclusion depends, of course, on the assumption that the propensity to consume and the rate of investment are not deliberately controlled in the social interest but are mainly left to the influence of laissez-faire" (CW 7, p. 219). His proposed policy regime would solve the problem.

Keynes was optimistic that if the state could sustain investment at a level that achieved full employment, the rate of profit on capital invest­ment would approach zero "within a single generation." Of course, this would require that monetary policy and strict capital controls would "ensure that the rate of interest is consistent with the rate of investment which corresponds to full employment" (CW 7, p. 220). Forcing the cap­ital stock to grow rapidly over time through public investment while forcing the interest rate to decline as rapidly as the mec could only be accomplished by a government with unprecedented peacetime power to control economic activity.

Let us assume... that State action enters in as a balancing factor to pro­vide that the growth of capital equipment shall be such as to approach saturation point at a rate which does not put a disproportionate burden on the standard of life of the present generation. On such assumptions I should guess that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation.

(CW 7, p. 220, emphasis added)

Keynes continued this line of argument, stressing the necessity of a very low interest rate eventually approaching zero in order for his policies to achieve their goals. This would require, he said, the nationalization of the Bank of England. The Board of National Investment was to have control over the majority of long-lived, large-scale capital investments concentrated in areas such as infrastructure, transportation, and public utilities, and it was to have strong influence over spending on residential and business construction. These capital investments are highly interest­elastic. As the interest rate falls, the potential volume of public investments and private investments such as housing that can be undertaken by the Board becomes much larger.

Since, under Keynes's plan, the interest rate would be at or near zero within a generation or so, this would signal the death of the ren­tier class - "the rentier would disappear" (CW 7, p. 221). This comment foreshadowed his support in chapter 24 for "the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist" (CW 7, p. 376).

Keynes fully understood that his policy regime constituted a direct attack on the existence of the economic and politically powerful rentier class. The rentier class and the institutions that supported it knew this as well.

If I am right in supposing it be comparatively easy to make capital­goods so abundant that the marginal efficiency of capital is zero, this may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism. For a little reflection will show what enormous social changes would result from a gradual dis­appearance of a rate of return on accumulated wealth.

(CW 7, p. 221)

In chapter 22, Keynes returned to his chapter 12 attack on casino capit­alism, arguing that modern financial markets were a major cause of cyc­lical instability and had the potential to generate severe depressions when major economic downturns occurred in conditions of high financial fra­gility. As in chapter 12, Keynes insisted that capital investment was too important to the economy and society to be left in the hands of volatile, destructive and excessively liquid financial markets. He also argued that central bank manipulation of interest rates alone cannot solve the problem. There are two reasons for this, he said. One is that while the mec can fall to very low levels in a serious cyclical downturn (in part because excess capacity is very high) and in the long run due to secular stagnation, the long-term interest "never falls below a conventional level" (CW 7, p. 325).¹ Keynes believed that under then-present institutional arrangements, the long-term interest rate could not fall below 2.5-3.0 percent. Of course, when Britain was on the gold standard, the rate of interest could not be allowed to fall below rates available to investors in other countries (CW 7, p. 339).

The other reason is that a monetary policy strategy of changing interest rates frequently in an attempt to offset volatile market fluctuations cannot work; such economic volatility "cannot be sufficiently offset by corresponding fluctuations in the rate of interest" (CW 7, p. 320).² Indeed, a strategy of changing the interest rate in response to every shift in the mec would make central bank policy itself a major creator of uncertainty and would therefore lower the average value of the risk-adjusted or confidence-adjustedmec.

Thus, with markets organized and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest... In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current value of investment cannot safely be left in private hands.

(CW 7, p. 320, emphasis added)

He used the late 1920s boom in the USA to demonstrate his point. By 1929, "New investment during the previous five years had been, indeed,

Keynes's radical policy views 299 on so enormous a scale in the aggregate that the prospective yield of further additions was, coolly considered, falling rapidly." Therefore, to generate enough investment to sustain full employment, the Fed would have had to lower interest rates to "an unprecedentedly low level" (CW 7, p. 323). But such low interest rates would have pushed the financial-market boom into an even greater frenzy and caused leverage and financial fragility in the system to rise even higher than the great heights actually achieved in late 1929, worsening the subsequent crisis. "A rate of interest high enough to overcome the speculative excitement [in financial markets] would have checked, at the same time, every kind of reasonable new [capital] investment" (CW 7, p. 323). To resolve this problem would require "a socially controlled rate of investment" (CW 7, p. 325).

Keynes also repeated here his standard argument that the policy of increasing public investment should be accompanied "by redistributing incomes or otherwise, to stimulate the propensity to consume." This could be accomplished not only by much more progressive income tax rates, but also, as we will see in chapter 24 of The General Theory, much higher estate or "death" taxes (CW 7, p. 372).

His ideal strategy was to give priority to increasing public investment for a generation or so while moderately increasing the mpc through the progressive redistribution of income and wealth. When investment was no longer scarce, a fall in AD below full-employment AS should be met by a rising mpc.

Keynes strongly believed that there was a great unmet need for public and private investment that could not be satisfied in less than a generation.³

I am myself impressed by the great social advantages of increasing the stock of capital until it ceases to be scarce. But this is a practical judgment, not a theoretical imperative. However, I should readily concede that the wisest course is to advance on both fronts at once. Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital, I should support at the same time all sorts of policies for increasing the propen­sity to consume. There is room, therefore, for both policies to operate together.

(CW 7, p. 325)

In chapter 23, when discussing state economic policy under nineteenth­century laissez-faire, Keynes noted that, unlike modern capitalism, this was "a society where there is no question of direct investment under the aegis of public authority" (CW 7, p. 335). Further along in the chapter, while lamenting the fact that under current conditions policies of free trade and free capital mobility policy were likely to promote war rather than peace, he stated his own belief in public control of investment and

in the capital controls required to be able to set the "autonomous" interest rate at a very low level.

It is the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment programme directed to an optimum level of domestic employment which is twice blessed in the sense that it helps ourselves and our neighbors at the same time.

(CW 7, p. 349, emphasis added)

Capital controls are obviously a necessary condition for the achievement of an "autonomous interest rate, unimpeded by international preoccupa­tions." Earlier in the book, Keynes explained why capital controls were necessary to get the interest rate to near zero.

[T]he long-term interest rate may [hit a lower bound] when once it has fallen to a level which, on the basis of past experience and present expectations of future monetary policy is considered "unsafe" by repre­sentative opinion. For example, in a country linked to an international gold standard, a rate of interest lower than prevails elsewhere will be viewed with a justifiable lack of confidence; yet a domestic rate of interest dragged up to a parity with the highest rate (highest after allowing for risk) prevailing in any country belonging to the international system may be much higher than is consistent with full employment.

(CW 7, p. 203, emphasis in original)

Now consider the problem faced by Britain in 1936 after it had moved off the gold standard and its fixed exchange rate system. Under Keynes's proposed policy revolution, most large-scale investment would be con­trolled by the state and used to accumulate capital so rapidly the mec would approach zero. For this policy to be successful, a nationalized cen­tral bank would have to be willing to push the interest toward zero. This would lead, as Keynes stressed in chapter 24, to the elimination of the ren­tier class. The inequality of wealth and income would also decline dramat­ically under Liberal Socialism. If such a program were perceived as likely to be enacted, a massive and prolonged flight of capital would take place that might be large enough to cause a collapse of financial markets and private investment along with a serious deflation. Keynes's policy revolu­tion therefore could not possibly succeed without capital controls.

The most important discussion of the new role of the state took place in chapter 24, the final chapter in the book, titled "Concluding Notes on the Social Philosophy towards Which the General Theory Might Lead." Here, he argued for a "comprehensive socialisation of investment" (CW 7, p. 378). There is a widespread belief that Keynes's support in chapter 24 for the socialization of investment was just an isolated, last-minute whim unconnected to and unsupported by the core of the book or, for that matter, Keynes's other writings. For example, a macro textbook written by two distinguished progressive American economists, Sandy Darity and Jamie Galbraith, states: "There is no evidence to suggest that Keynes promoted his proposal for socializing investment, and it only surfaces briefly in the latter pages of The General Theory” (Darity and Galbraith 1994, p. 53). As we have seen, this interpretation is profoundly mistaken. Indeed, in a 1932 draft of the final chapter of the book, Keynes titled this chapter “Socialism" (O'Donnell 1999, p. 161).

The chapter begins with a reminder that the theory constructed in the book disarms the traditional argument that a very unequal distribution of income and wealth is necessary to generate the high savings rate required for high rates of investment and economic growth. Since, in general - except at full employment - increases in inequality lower the propensity to consume, they also lower AD, equilibrium income, employment, and the total amount saved and invested. Thus, significantly less inequality of income and wealth than at present is needed to generate sustained full employment and is preferable on grounds of social justice as well.

"The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and income” (CW 7, p. 372). Keynes applauded the significant increase in the taxes paid by the wealthy "through income tax and surtax and death duties - especially in Great Britain” since the turn of the century. But additional efforts in these directions have been limited by a combination of secular stagnation and the mistaken classical belief, based on the discredited Say's Law, that high savings cause high investment, or:

by the belief that the growth of capital depends upon the strength of the motive towards individual savings and that for a large propor­tion of this growth we are dependent on the savings of the rich out of their superfluity... But it may considerably modify [this belief to understand that] up to the point where full employment prevails, the growth of capital depends not at all on a low propensity to con­sume, but is, on the contrary, held back by it; and only in conditions of full employment is a low propensity to consume conducive to the growth of capital. [M]easures for the redistribution of incomes in a way likely to raise the propensity to consume may prove positively favourable to the growth of capital. In contemporary conditions the growth of wealth, so far from being dependent on the abstinence of the rich, as is commonly supposed, is more likely to be impeded by it. One of the chief social justifications of great inequality of wealth is therefore removed.

(CW 7, p. 373)

There is justification for a modest degree of income inequality, Keynes argued, but this "does not apply equally to inequality of inheritances”: very high inheritance taxes are justified on both economic and social justice grounds (CW 7, p. 374). He went on to explain that the distribution of income could be much more progressive without impeding necessary risk­taking or entrepreneurial activities. These would be forthcoming even if their potential rewards were reduced significantly from their current level once everyone adjusted to them. "Much lower stakes [income incentives] will serve the purpose equally well, as soon as the players get used to them" (CW 7, p. 374).

Finally, since, except in conditions of full employment, higher saving is caused or created by higher investment and not, as in classical theory, the other way around, there is no justification for the traditional support by economists of high-interest rate policies because they believed they would maximize total savings. This "has a bearing on the future inequal­ities of wealth" because rentier income accrued primarily to the richest families in the Britain of his time (CW 7, p. 375). Since high investment is facilitated by a secularly low "autonomous" interest rate (made pos­sible through capital controls), in the world Keynes envisions, interest rates will be cut to a minimum. "Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment" (CW 7, p. 375).

But since the profit rate will approach zero as full employment is sustained over time, the interest rate required to maintain full employment will also have to fall toward zero. The rate of public investment required to achieve and sustain full employment over the long run could only be financed if the rate of interest could be reduced to a "very low figure" (CW 7, p. 375). When the interest rate nears zero at the capital saturation point, the income flow to rentiers would be reduced to a trickle.

Keynes tells us that the policies required to sustain full employment:

would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital... I see, therefore, the rentier aspect of capit­alism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advan­tage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor,. will need no revolution. Thus we might aim in practice. at an increase in the volume of cap­ital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the entrepreneur. to be harnessed to service of the community on rea­sonable terms of reward.

(CW 7, p. 376, emphasis added)⁴

Thus, a fall in the interest rate toward zero would not only reduce inequality and facilitate full employment - it would also eliminate an "oppressive" and economically and politically powerful rentier class whose interests were championed not only by their representatives in Parliament, but also by the largest financial institutions and the Bank of England itself. Since the key demand of the rentier class was high interest rates, the economic power of rentiers would have to be eliminated if Keynes's policy agenda was to have any hope of success.

Keynes understood that sustained full employment brought about by a high level of public investment would permanently eliminate Marx's "reserve army" of unemployed and thereby permanently empower workers in their economic and political conflicts with capital. It would simultaneously eliminate the pressure on governments that builds up during depressions and serious recessions to adopt capital-friendly pol­icies in the hope that these policies would tease out more investment and more jobs in the midst of high unemployment. Finally, strict capital controls would be needed to achieve the low interest rates required to eliminate the scarcity of real capital. In the absence of capital controls, the rentier class could force interest rates up to the higher levels avail­able in other countries through capital flight. Without capital controls, capital flight would also be triggered whenever rentiers became dissat­isfied with or nervous about the general tenor of government economic policy. It is not an exaggeration to suggest that sustained full employ­ment achieved through high rates of public investment accompanied by the euthanasia of the rentier, radically progressive tax reform, and capital controls would constitute a revolution of sorts in Britain's class relations.

The conventional wisdom is that Keynes wrote The General Theory to "save capitalism." Clearly, this is either false or "capitalism" must be redefined to apply to any economic system in which markets, monetary incentives, and freedom of consumer choice are allowed to exist in some form, even if most important economic decisions are determined collect­ively via democratic political processes before people get to choose in the marketplace. If we use the traditional definition of capitalism, it was clearly Keynes's goal in writing The General Theory to replace capitalism with a form of democratic socialism.

A central impediment to the achievement of Keynes's policy objectives was that almost all conservatives and many liberal readers were likely to be very nervous about the program because the powers to be removed from the control of capitalist firms and rentiers and vested in the state were, by the standards of 1930s Britain or, for that matter, current-day America, enormous. He listed some key state responsibilities.

The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative... If the State is able to deter­mine the aggregate amount of resources devoted to augmenting the instruments and the basic rewards of those who own them, it will have accomplished all that is necessary. Moreover, the necessary measure of socialisation can be introduced gradually and without a break in the general traditions of society.

(CW 7, p. 378, emphasis added)

We have seen that Keynes thought that the state should use a combin­ation of progressive income taxes, very high inheritance taxes, and his­torically low interest rates to substantially reduce inequality and, after a time, actually eliminate the powerful rentier class. Keynes's contemporary readers in Britain also knew he was on the public record in favor of the idea that it is the responsibility of the state to manage trade and to control the flow of financial capital across its borders. Here, he added control of the propensity to consume (and, therefore, of the national savings rate), the rate of profit on capital ("the basic rewards" to the owners of real capital), and the "somewhat comprehensive socialisation of investment" - which we know was the centerpiece of AD management. The socialization of investment would also allow the state to strongly influence the allocation of capital investment among competing public and private demands. The capital class understood that the combination of all of these policies would constitute a radical transformation of Britain's political economy. This is why most of its members vigorously opposed his policies.

At this point in the chapter, one can begin to detect a hint of political sugarcoating by Keynes to make his policies seem less threatening to the status quo then they in fact were. He states: "In some other respects the foregoing theory is moderately conservative in its implications" because some economic decisions will still be made through decentralized markets. "For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected" (CW 7, pp. 377-378).

But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practic­able, the classical theory comes into its own again from this point onward. If we suppose the volume of output to be given. by forces outside the classical scheme of thought, then there is no objection to be

Keynes's radical policy views 305 raised against the classical manner in which private self-interest will determine what is to be produced, in what proportions the factors of production will be combined to produce it, and how the value of the product will be distributed between them.

(CW 7, pp. 378-379)

This statement either assumes that a much more progressive distribution of income and wealth has already been achieved or it is inconsistent with other sections of the chapter. If markets are allowed to determine "how the value of the product will be distributed between" the factors of produc­tion, then it cannot also be true that the state will determine "the basic rate of reward those who own" the means of production (CW 7, p. 378). He had also previously stressed the existence of serious problems associated with the nature of competition in industries with large economies of scale and with the process of downsizing industries with chronic excess capacity that are not mentioned here.

Keynes acknowledged that the existing system suffers from "errors of foresight; but these would not be avoided by centralizing decisions" (CW 7, p. 379). While literally true, the statement is misleading because he believed that the existing system was subject to huge instability and, in that sense, to huge "errors of foresight." Since Keynes also believed that reliance on state-guided public investment was capable of achieving a rea­sonably close approximation to sustained full employment with relatively moderate cyclical movements, he clearly believed that his preferred eco­nomic model would involve much smaller "errors of foresight."

Having presented a long list of the powerful economic functions to be undertaken by the state, he tried to calm his readers' nerves with the following assurance:

But beyond this no obvious case is made out for a system of [Soviet­style] State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of pro­duction which is important for the State to assume.

(CW 7, p. 378)

Keynes was, of course, correct to insist that his "middle way" represented a less radical departure from the status quo than the detailed physical planning of production and distribution under state ownership of all important means of production, which was the stated ultimate objective of the Labour Party. And he insisted, as he had done in "National Self­Sufficiency," that his radical policy proposals had to be achieved through democratic processes.

Keynes ended the substantive part of the chapter with a three-pronged appeal for his readers' sympathy and support reminiscent of the closing arguments in his 1933 essay "National Self-Sufficiency." First, he repeated

the argument that his system incorporates some of the most important advantages of individualism. His wording reflects both his own values and his understanding of the brutality involved in some of the more extreme contemporary experiments in national planning.

Let us stop for a moment to remind ourselves what these advantages are. They are partly advantages of efficiency - the advantages of decen­tralisation and of the play of self-interest. The advantage to efficiency of the decentralisation of decisions and of individual responsibility is even greater, perhaps, that the nineteenth century supposed; and the reaction against the appeal to self-interest has perhaps gone too far. But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life... the loss of which is the greatest of all the losses of the homo­geneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaiden of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future.

(CW 7, p. 380)

Second, Keynes expressed his belief that a hoped-for international system of planned economies would greatly reduce the likelihood of future wars. As he so forcefully argued in "National Self-Sufficiency," con­tinuance of the status quo promised only stagnation and war.

But if nations can learn to provide themselves with full employment by their domestic policy (and, we must add, if they can also attain equilib­rium in the trend of their population), there need be no important eco­nomic forces calculated to set the interest of one country against that of its neighbours. There would still be room for the international division of labour and for international lending in appropriate conditions. But. [i]nternational trade would cease to be what it is [in the 1930s], namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbour which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage.

(CW 7, p. 382)

His last argument is certainly the most powerful. It is an old standard for Keynes. Either Keynes's middle-way planning - radical though it is - will be accepted by Britain's economic and political elite or Britain will ultimately

Keynes's radical policy views 307 end up with a working-class revolution, totalitarian planning, or both. When he says "the world will not much longer tolerate" present-day capitalism, he clearly means that the working class will not much longer tolerate it. As has been stressed, the interwar years were an era of political and armed revolutions. Referring to his policy program as a whole, Keynes argues:

I defend it... both as the only practicable means of avoiding the destruc­tion of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative. The authoritarian state systems of to-day seem to solve the problem of unemployment at the expense of efficiency and freedom. It is certain that the world [i.e. the working class] will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated - and, in my opinion, inevitably associated - with present-day capitalistic indi­vidualism. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom.

(CW 7, p. 381, emphasis added)

When Keynes argued that there would be terrible consequences unless his model of Liberal Socialism was adopted in Britain and elsewhere, he was deadly serious.

Toward the end of chapter 24, Keynes raised an important question concerning the ultimate determinant of government economic policy in a capitalist society. He asked whether "vested interests," by which he means capitalist class interests, or "ideas," theories about the how the economy works, posed the greatest impediment to the implementation of his proposed new policy regime. In the often-cited exit lines of the book, Keynes argued that, in the long run, ideas are more powerful that class interests.

[The] ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is com­monly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellec­tual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. But, soon or late, it is ideas, not vested interests, which are dangerous, for good or evil.

(CW 7, pp. 383-384)

He made a similar argument in a November 1934 radio lecture.

The strength of the self-adjusting [classical] school depends on its having behind it almost the whole body of organized economic

thinking and doctrine of the last hundred years. This is a formid­able power. It is the product of acute minds and has persuaded and convinced the great majority of the intelligent and disinterested per­sons who have studied it. It has vast prestige and a more far-reaching influence than is obvious. For it lies behind the education and habitual modes of thought, not only of economists, but of bankers and busi­nessmen and civil servants and politicians or all parties.

(CW 12, p. 488)

It seems to me that in these comments Keynes incorrectly assumed that there is no relation between dominant ideas and material or class interests. Marx would appear to be far more persuasive on this issue. He too believed that ideas could be a powerful political force, but he also argued that there was an important, though not a mechanistic, relation between dominant ideas and class interests in every stable historical era. In The German Ideology, he wrote:

The ideas of the ruling class are in every epoch the ruling ideas, i.e. the class which is the ruling material force of society, is at the same time its ruling intellectual force. The class which has the means of material production at its disposal, has control at the same time over the means of mental production, so that thereby, generally speaking, the ideas of those who lack the means of mental production are subject to it. The ruling ideas are nothing more than the ideal expression of the dominant material relationships, the dominant material relationships grasped as ideas.

(Marx 1932, p. 64)

But Keynes's position here is also at odds with arguments he made else­where in The General Theory. We repeat his comments so the reader can compare them with the previous quotations. Individualism and laissez- faire "could not... have secured their lasting hold over the conduct of public affairs, if it had not been for their conformity with the needs and wishes of the business world of the day" (CW 7, p. 286). In chapter 3 of The General Theory, in explaining how Ricardian economics "conquered England as completely as the Holy Inquisition conquered Spain," Keynes wrote that the fact that it "afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dom­inant social force behind authority" (CW 7, pp. 32-33). This would appear to be compatible with Marx's answer to the question of whether ideas or class interests are more influential in the determination of the economic role of the state in capitalism.

The consistency and clarity with which Keynes presented and defended his radical, pro-democratic socialist theory and policies in The General Theory once again raises a question I posed earlier. How is it possible that

Keynes's radical policy views 309 one of the most important and influential books in the history of economic thought, written by one of the most important and influential economists who ever lived, came to be so profoundly misunderstood by the eco­nomics profession?

Notes

1 "During the downward phase, when both fixed capital and stocks of material are for the time being redundant... the schedule of the marginal efficiency of capital may be so low that it can scarcely be corrected, so as to secure a satisfac­tory rate of new investment, by any practicable reduction in the rate of interest" (CW 7, p. 319-320).

2 See also page 164, where Keynes said that fluctuations in the market estimation of the mec "will be too great to be offset by any practicable changes in the rate of interest."

3 BIF (Liberal Industrial Inquiry 1928) contained an extensive catalog of important large-scale capital investment projects.

4 Note that Keynes foresees the euthanasia of the "functionless" investor and not of everyone who works in financial services. Some financial "entrepreneurs" provide "intelligence and determination and executive skill," but their services "could be obtained much cheaper than at present" (CW 7, p. 376-377).