The Mainstream Keynesian policy regime and Keynes's Liberal Socialism

Sustained high unemployment in the 1930s and inadequate or nonexistent government unemployment compensation and family income-support programs were important reasons for the growth of the mass movements against capitalism that arose in this period.

After the war, Modern Keynesian theory eventually replaced clas­sical theory as the dominant mode of understanding the strengths and weaknesses of capitalism, and the Modern Keynesian activist approach of countercyclical macroeconomic policy eventually replaced laissez-faire. Keynes's main conclusion about the flaws in laissez-faire capitalism as interpreted by Mainstream Keynesians is that stable high-unemployment equilibriums are possible. Therefore, some agent outside the private cap­italist economy must be empowered to regulate AD. The government is the only agent that can do this job. Mainstream Keynesian growth models conclude that capitalist market economies will perform well over the long run and that the long-term growth path is not affected by short-term business cycles.

The dramatic changes in the government's role in the economy that took place in the early decades of the postwar political economy of the USA do bear a resemblance of sorts to Keynes's Liberal Socialism, which included support for a generous social welfare state.¹³ The post- WWII era saw an enormous increase in the peacetime economic role of the state. Net federal government spending as a proportion of GDP was 3 percent in 1929 and 17-20 percent from 1952 through the present. The "insane" US gambling casinos of the late 1920s and early 1930s were ini­tially replaced by tightly regulated financial markets that were relatively stable, though political pressure to deregulate financial markets began to gather steam rather quickly after the war. Moreover, most countries used capital controls for several decades after the war and international trade was initially modest.

However, the early postwar economic structure and policy regime was neither Keynes's Liberal Socialism nor the preferred Mainstream Keynesian political-economic structure. It was not Liberal Socialism for several reasons. There was no commitment to sustained full employ­ment. That was made clear when Congress refused to pass a 1945 bill mandating the pursuit of full employment as the main policy objective.

But the early postwar US economy did not reflect the preferred Mainstream Keynesian political economic structure either. Mainstream Keynesians opposed capital controls and managed trade in principle and argued that unrestricted global economic and financial integration is the best of all possible economic worlds. They promoted the radical deregu­lation of US financial markets, which accelerated after the 1970s because they taught that lightly regulated financial markets were "efficient" and thus could neither initiate instability nor magnify instability initiated in the real sector. In other words, Mainstream Keynesians supported the neo­liberal regime that eventuated in the global economic and financial crisis that began in 2007.

Keynes, as we have seen, vehemently opposed almost all elements of the global neoliberal regime. This does not mean Keynes was right and Mainstream Keynesians wrong about the character of the financialized global neoliberal capitalism within which we currently live, though my personal opinion was that he was right about most of this. But it does mean that Mainstream Keynesians badly misunderstood Keynes's eco­nomic theory and the policy regime associated with it, and therefore mis­lead several generations of students about Keynes's views on these crucial issues.

It might be fitting to end this introductory chapter by asking whether the post-WWII conventional wisdom that capitalism was permanently rescued from the threat of socialism, fascism, or communism by embed­ding it within a Modern Keynesian regime and an adequate social wel­fare system is still valid. The new postwar Mainstream Keynesian policy regime did help create the "Golden Age" of modern capitalism from WWII through the mid-1970s, an era in which confidence in the belief that modern capitalism had permanently resolved all of the problems that bedeviled capitalism in the interwar years became ever stronger. However, the belief that the Golden Age of modern capitalism was eternal has been weakening since then, an almost four-decade period during which growth has slowed in the USA and in many other developed countries, and within-country inequality has risen substantially in most countries. Confidence that capitalism guided by a Modern Keynesian policy regime will permanently sustain a widely shared prosperity hit rock bottom after the recent global financial crisis, a crisis that was not foreseen by main­stream economists and cannot be explained within their theoretical para­digm. The global financial crisis was met in most developed countries either by austerity macro policies or by macro policy stimulus too weak to eliminate high unemployment and by cuts in social services and attacks on organized labor - the kinds of policies Keynes opposed in the 1930s and during WWII. This further eroded public faith in the belief that cap­italism plus Mainstream Keynesian policies can deliver sustained wide­spread prosperity. There has even been a revival of interest in theories of secular stagnation by respected economists such as Robert Gordon, Paul Krugman, and Lawrence Summers.¹⁴

Meanwhile, seemingly incurable economic crises amidst high inequality have ignited a firestorm of political attacks on the economic status quo, most of which are reactionary, authoritarian, and nationalistic, though some seek a socialist remedy. The election of Donald Trump as President of the USA in 2016 is but one example of this process. In response to the question of what the eventual outcome of these political and economic struggles are likely to be, we might echo Keynes and say: "About such matters we simply do not know."

The next chapter will defend the proposition that the true Keynesian "revolution" in policy and theory began not with the publication of The

General Theory and other writings in the 1930s, but rather with the publica­tion of his 1919 book, The Economic Consequences of the Peace.¹⁵ In this book, Keynes explained why Europe faced a future of long-term stagnation and possibly a new world war unless it radically restructured its economic institutions and policies.