Stagnation seeps into the US economy

Keynes's overall assessment of economic conditions and prospects in the early 1930s was bleak. "[I]t would not surprise me to see a closing of stock exchanges in almost all countries and an almost universal moratorium in the repayment of existing debts" (CW 21, p.

Prior to the "Great Crash" in US financial markets, Keynes believed that the US economy was not infected by the secular stagnation that had set in in Britain. By the early 1930s, he had become disabused of this belief. In February 1931, in a lecture to the Royal Institution, Keynes reminded his audience that innovations had played a large role in creating the boom of the late 1920s in the USA, but that this source of the demand for capital investment had, at least temporarily, dried up.

Until recently, new inventions such as the motor car and the motor lorry and the new roads which they require, new cinema developments, and wireless instruments, have played a big part in maintaining pros­perity, but there seems at the moment a lull in new inventions,

(CW 20, p. 480)

On the way home from his visit to the USA, Keynes prepared a memo­randum for the British government on economic conditions in the USA in mid-1931. For our purposes, the most interesting conclusion of the report was his belief that the USA had apparently entered a state of economic stagnation. He offered numerous reasons, in addition to the disasters in the financial system, as to why the US economy was now "stuck in a rut" just like the British economy.

The "population is no longer increasing rapidly" (CW 20, p. 573). The USA had joined Britain in the list of countries with rapidly slowing rates of population growth; for Keynes, this was one of the key conditioning factors for long-term stagnation.

Just as was the case in Britain, there appeared to be no system­transforming innovations on the horizon in the USA. There "is a marked absence of new invention, and it may be necessary, again, for a very great fall in the rate of interest before enough new techniques based on existing knowledge will be brought within the payable zone" (CW 20, p. 574).

Excess capacity in industry is so high it constitutes a powerful impedi­ment to increased capital investment. "In the leading manufacturing industries, such as steel, motors and many others, it is certain that no new plant will be required for a long time to come" (CW 20, p. 573).

"There is a good deal of renewal and reconstruction which the railways might do. But the great falling off in their revenues, more severe than in Great Britain, has broken their spirit and destroyed their credit" (CW 20, p. 573).

There is a great need to construct adequate housing for "the common man." Unfortunately, "with his present reduced earning power he cannot pay a higher rent" (CW 20, p. 574).

The "slump is primarily a slump in construction... It is difficult to see how there can be a real recovery without renewed construction enterprise on a large scale" (CW 20, p. 572). But "the opportunities to buy existing properties at bargain prices must stand in the way of new building" (CW 20, pp. 572-573). The large excess supply of buildings on the market played a role similar to that of excess capacity in manufacturing, stifling new investment.

An index of building activity was about 40 percent higher in 1928 than it had been in 1923-1925, but it experienced a severe collapse after 1928, falling to a level more than 20 percent below 1923-1925 by the end of 1930. In a comment that prefigured his theory of business cycles in The General Theory, Keynes observed that builders who continued to borrow in the 1927-1929 boom were ready "to neglect the rate of interest and to agree to pay [interest] rates which, cautious calculation should have shown, could not be earned by the enterprise" because housing was overbuilt, the popu­lation was no longer growing rapidly, and "the cream had been taken by now off most of the new construction business." He said that the "rate of interest may have to fall a tremendous way before it will pay on a cool calculation to repeat the enterprise of 1927-29" (CW 20, p.

"There are severe limitations on the possibilities of new construction expenditures by public authorities, though very large expenditures on roads are still proceeding" (CW 20, p. 574). Keynes said that the Roosevelt administration was committed to large expenditures on new construc­tion in principle, but "the President told me that he had just gone over the figures again, that they had already shot their bolt, and there was not above $150m worth of projects still to be done" (CW 20, p. 575). Keynes concluded that "an adequate recovery is really out of the question pending the elapse of time and a great fall in the long-term rate of interest" (CW 20, p. 575).

Keynes also observed that US labor markets had lost some of the flexi­bility he had previously attributed to them. US nominal wages in industry were not falling rapidly in the face of shockingly high unemployment as assumed in classical theory, but rather had become relatively stable. In "large-scale industry... my conclusion is that [nominal] hourly wage rates have not been affected very much more than in [rigid] England," falling from 1929 to mid-1931 by some 3-4 percent (CW 20, p. 576). (Wages in farming and small business had declined much further.) Keynes believed that this was a good thing because high wages help sustain AD in the face of rising unemployment, but they blocked a major disequilibrium process - falling real wages - portrayed in the orthodoxy of the time as a cure for high unemployment. What he failed to note here, but would emphasize in The General Theory, was that since prices were falling by as much as or more than nominal wages, real industrial wages in the USA were not falling at all. He used this "fact" in chapters 2 and 19 of The General Theory to attack the classical argument that when unemployment was temporarily high, falling nominal wages would automatically lead to falling real wages, which in turn would restore full employment. If prices fall by as much as or more than nominal wages, the classical theory of the labor market falls apart, but Keynes's theory of wage determination is supported.

He also argued, against his previous assumption, that high unemploy­ment would indeed cause social unrest in the USA, just as in Britain. The difference was that in the USA "it is not so much a question of strikes and lockouts as of direct social disorder, looting and other forms of lawlessness in that lawless country," a reaction strengthened by the fact that "there is no organized relief to the unemployed" (CW 20, p. 579).