Social Welfare

Economic growth in the late nineteenth and early twentieth centuries lifted many boats but sank others. Its stormy wake contributed to the success of socialist and reform movements that challenged the primacy of laissez-faire.

Alfred Marshall had carefully noted that individual transactions often had positive or negative effects, ‘‘external economies’’ that spilled over onto others.² His prize student Arthur Pigou further developed the concept of ‘‘externalities’’, explaining how taxes and subsidies could be used to bring private and social costs closer together and advocating, among other policies, family allowances.³ Many of Pigou’s contemporaries warned that govern­ment policymakers might lack both the motivation and the information necessary to maximize social welfare. But as previous chapters have shown, many were persuaded that individual decisions would not necessarily yield the optimal rate of population growth. The concept of externalities would later come to play a titanic role in debates over environmental degradation and global warning.

In the early twentieth century, however, issues of instability trumped issues of sustainability. After the stock market crash of 1929, the U.S. economy spiraled into a downturn characterized by persistently high unemployment rates. The British economy, dislocated by World War I, had been faltering since 1918; the French economy, growing very slowly, was less integrated into world trade. By the mid-1930s, however, the Great Depression had become a global phenomenon. Most economists believed it would be self-correcting: unemployment would cause wages to fall, which would in turn increase the demand for labor.

By 1932, U.S. voters, if not economists, had lost patience with this view, and Franklin D. Roosevelt won a landslide victory with his promises of a New Deal. Neither his philosophy nor his policies were well-formed at that time, but he moved quickly to establish government relief efforts and win passage of the Social Security Act of 1935. This legislation (discussed briefly in Chapter 18) built on earlier state legislation to provide public assistance to the elderly, indigent mothers and children, and the unemployed. Re-elected in 1936, Roosevelt used his second Inaugural Address to establish his new philosophical touchstone: ‘‘We have always known that heedless self-interest was bad morals; we know now that it is bad economics.”⁵

In Great Britain, economic events seemed to validate the views of econo­mists like John Maynard Keynes, who had long expressed skepticism regarding the magic of self-interest. Keynes described economics as a moral science.⁶ In a small but elegant book entitled The End of Laissez Faire published in 1926, he offered a concise reprise of economic doctrines that challenged prevailing views, emphasizing that private and social inter­ests did not always coincide (see epigraph to this chapter).⁷ In Economic Possibilities for our Grandchildren he wavered a bit, suggesting that avarice should rule until prosperity was more widespread.⁸

But in his enormously influential General Theory of Employment, Interest and Money, published in 1936, Keynes rejected the argument that greed could regulate itself. He pictured an economy driven by aggregate demand and government spending rather than individual decisions. The analytical tools that grew out of the General Theory explained how competitive econ­omies could get stuck in low-level equilibrium traps. The cumulative implications seemed eerily consistent with Roosevelt’s philosophy.