The priority of secular stagnation in The General Theory

For Keynes, stagnation was not a chronic or universal condition of cap­italist economies, but rather a chronic tendency of mature capitalist econ­omies. There are periods in which the underlying forces pulling a mature capitalist economy into sluggish growth can be overwhelmed by what Marx called "counter-tendencies" in his own version of secular stagna­tion theory, usually referred to as the theory of "the falling rate of profit." Marx did not title the section of volume III of Capital on the propensity of mature capitalist economies to stagnate "The Law of the Falling Rate of Profit," but rather "The Law of the Tendency of the Rate of Profit to Fall." In chapter 14 ("Counter-Acting Factors"), he discussed a list of poten­tial developments that could, for an extended period of time, prevent the profit rate from falling.

[T]hen the difficulty which has hitherto troubled the economist, namely to explain the falling rate of profit, [has been superseded by] its opposite, namely to explain why this fall is not greater and more rapid. There must be some counteracting influences as work, which cross and annul the effect of the general law, and which give it merely the characteristic of a tendency, for which reason we have referred to the fall of the general rate of profit as a tendency to fall.

(Marx 1967, p. 232)

For example, Marx argued that when labor markets are tight, workers' bargaining power is at its peak, which enables labor to claim an increasing share of firm revenues, causing the profit rate to fall and the rate of capital accumulation to decline. Capitalists typically respond to the rising power of labor through the use of labor-saving technical change embedded in new machinery (as well as by "the widespread introduction of female and child labour"; Marx 1967, p.

However, these developments create their own problems for prof­itability in the long run. The falling wage share and resulting rising inequality can lead to inadequate consumption demand and thus inad­equate AD - what Marx called problems in the "realization" of "surplus value" (profit plus interest plus rent). Under Marx's theory of value, a rising capital-labor ratio, or rising "organic composition of capital," will lower the rate of profit on capital over time.³ The "law of the tendency" embodies Marx's belief that, in unregulated capitalism and in the long run, the forces pushing the profit rate down would ultimately prevail over the counter-tendencies that raise the profit rate from time to time. Keynes held a generally similar view.

This book has listed a large number of factors Keynes believed contributed to the secular stagnation of the period. In The General Theory, he mentioned an important subset of these factors. The larger the number of factors that constitute impediments to long-term growth that are pre­sent in any particular historical era and the stronger their negative impact on output and employment, the more likely the existence of stagnation - and vice versa.

The basic structure of the argument in support of secular stagnation in The General Theory rests on three main propositions. First, in the absence of powerful countervailing tendencies, the larger the capital stock, ceteris paribus, the lower the actual profit rate on capital investment and therefore the lower the expected profit rate or mec.

Some of the "facts" Keynes mentions in the book in support of his stag­nation thesis are: that high income and wealth inequality in mature capit­alist economies such as in interwar Britain and the USA did cause the mpc to be low; that "institutional and psychological factors" in mature econ­omies placed a high lower bound on the value of the long-term interest rate; and that while the mec was kept at an exceptionally high level in the nineteenth century by "the growth of population," the "growth of inven­tion" (or the existence of system-transforming, capital-augmenting tech­nical change), the "opening up of new lands," the "state of confidence," and "the frequency of war." All of these factors had weakened qualita­tively in the interwar period. In the absence of these counter-tendencies, Keynes argued, the inherent tendency of the mec to fall in a mature economy as the capital stock rises over time will prevail. Moreover, the creation of "insane" casino financial markets in the era facilitated rising financial fragility in real-sector and financial firms, building a potential crisis trigger mechanism. The generation of extreme financial instability in the late 1920s and early 1930s in turn increased the perceived riskiness of capital investment, which lowered what we might call the risk-adjusted mec.

The first mention of stagnation in The General Theory occurs in chapter 3, where Keynes explained his "principle of effective demand" - the idea that it is the expected sales of a company's products when they eventually got to market that primarily determines its decision about how much to produce and how many people to employ today. Here, he laid out for the first time in the book the outline of his basic argument in support of the secular stagnation hypothesis.

He presented the stagnation thesis in this chapter in an attempt to explain the "paradox of poverty in the midst of plenty," in which mass unemployment and poverty haunted the richest countries in the world. His explanation contains the assertions that the mpc falls as the economy matures due to rising inequality and that the mec has a tendency to decline as the stock of capital increases. Together, these assertions imply a ten­dency toward stagnation unless the interest rate falls rapidly.

[T]he richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor com­munity will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the savings propensities of its wealthier members are to be compatible with the employment of its weaker members. If in a potentially wealthy com­munity the inducement to invest is weak, then in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has to become so poor that its surplus over consumption is suffi­ciently diminished to correspond to the weakness of the inducement to invest.

But worse still. Not only is the propensity to consume weaker in a wealthy community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the interest rate falls at a sufficiently rapid rate.

(CW 7, p. 31)

Keynes also said here that he would explain later why the interest rate "does not automatically fall to the appropriate level" at which invest­ment is large enough (given the value of the multiplier) to sustain full employment.

Chapter 8 of The General Theory discusses the determinants of the mpc and marginal propensity to save (mps). One important point stressed in this chapter is that saving by business and government is a very large share of total national saving and that this form of saving had grown by enough to become a major drag on AD growth in the UK and the USA in the interwar years. Excessive depreciation reserves by business and large government reserves to pay back the huge debt accumulated during WWI - which Keynes refers to here as "sinking funds" - had substantially raised the proportion of national income saved. This lowered the expected profit rate on additional investment because the mec is a positive function of expected consumption spending. These sinking funds "diminish the current effective demand" (CW 7, p. 100).

[I]n Great Britain at the present time (1935) the substantial amount of house-building and of other new investments since the war has led to an amount of sinking funds being set up much in excess of present requirements for expenditures on repairs and renewals, a tendency which has been accentuated, where the investment has been made by local authorities and public boards, by the principle of "sound" finance which often requires sinking funds sufficient to write off the initial cost some time before the replacement will actually fall due; with the result that even if private individuals were ready to spend the whole of their net incomes it would be a severe task to restore full employment in the face of this heavy volume of statutory pro­vision by public and semi-public authorities, entirely disassociated from any corresponding new investment.

(CW 7, p. 101)

The same problem existed in the USA.

In the United States, for example, by 1929 the rapid capital expan­sion of the previous five years had led cumulatively to the setting up of sinking funds and depreciation allowances, in respect of plant which did not need replacement, on so huge a scale that an enormous volume of entirely new investment was required merely to absorb these financial provisions; and it became hopeless to find still more new investments on a sufficient scale to provide for such new saving as a wealthy community in full employment would be disposed to set aside. This factor alone was probably enough to cause a slump.

(CW 7, p. 100)

The result was that financial accounting practices exacerbated the existing problem of savings at full employment being far in excess of investment levels that were already shrunken by a collapsing expected profit rate. This was an institutional problem that Keynes believed placed a severe constraint on AD.

We cannot, as a community, provide for future consumption by finan­cial expedients but only by current physical provision for the future [in the form of capital investment]. In so far as our social and business organization separates financial provision for the future from phys­ical provision for the future so that efforts to secure the former do not carry the latter with them, financial prudence will be liable to diminish aggregate demand [by increasing savings] and thus impair well­being, as there are many examples to testify. The greater, moreover, the consumption for which we have provided in advance [through capital investment], the more difficult it is to find something further to provide for in advance, and the greater our dependence on current consumption as a source of demand. Yet the larger our incomes, the greater, unfortunately, is the margin between our incomes and con­sumption... [T]here is no answer to this riddle, except that there must be sufficient unemployment to keep us so poor that our consumption falls short of our income by no more than the [current capital goods] which it pays to produce today.

(CW 7, pp. 104-105)

He summed up this argument as follows: since the demand for capital goods is ultimately derived from the expected demand for consumption goods in the future, a falling propensity to spend either income or wealth on consumption goods is one reason why the profit rate on new invest­ment would fall as the capital stock grew.

Thus the problem of providing that new capital-investment shall always outrun capital disinvestment [i.e. the current level of depre­ciation provision] sufficiently to fill the gap between net investment and consumption, presents a problem which is increasingly difficult as capital increases. Each time we secure to-day's equilibrium by increased investment we are aggravating the difficulty of securing [full-employment] equilibrium tomorrow.

(CW 7, p. 105)

Keynes finished the chapter by pointing out that while the belief that the economically productive opportunities for public investment are quite limited was the conventional wisdom, the opportunities for prof­itable private-sector investment were widely considered to be virtually unlimited. He found this belief to be "curious." Note his assertion that the UK had entered an era with a stationary population: this was a core assumption of his theory of secular stagnation. In fact, population data in England show that the rate of population growth in the interwar period was dramatically lower than it had been in the nineteenth century.

It is a curious thing, worthy of mention that the popular mind seems only to be aware of this ultimate perplexity where public investment is concerned, as in the case of road-building and house-building and the like... "What will you do," it is asked, "when you have built all the houses and roads and town halls and electric grids and water supplies and so forth, which the stationary population of the future can be expected to require?" But it is not so easily understood that the same difficulty applies to private investment and to industrial expansion; particularly to the latter, since it is much easier to see an early satiation of the demand for new factories and plant which absorb individually but little money, than of the demand for dwelling-houses.

The obstacle to a clear understanding is. an adequate appreciation of the fact that capital is not a self-subsistent entity existing apart from consumption. On the contrary, every weakening in the propensity to consume regarded as a permanent habit must weaken the demand for capital as well as the demand for consumption.

(CW 7, p. 106)

This quote provides a simple statement of the general problem: "what will you do" with respect to private investment demand if you can imagine the private sector building all the investment projects that it makes sense to build on the assumption of a falling interest rate? What Keynes envisages here is a massive increase in the stock of public and private capital over one or two generations, during which he expects no system-transforming or substantially capital-augmenting technical change, little if any population growth after a century of rapid population growth, no wars, and no large export surplus. Under such assumed conditions, it is perfectly sensible to assume that the rate of profit on capital and the mec will fall substantially. Indeed, with physical capital growing exponentially and the labor force hardly growing at all, the resultant rise in capital per worker would lower the marginal product of capital in a classical/neoclassical model.

The proposition that there is a tendency of the rate of profit on invest­ment to fall is addressed most directly in chapter 16, titled "Sundry Observations on the Nature of Capital." Here, Keynes argues that profit on capital is a form of rent paid to the owner of capital goods because capital goods are scarce; the scarcer they are, the higher the rent, and vice versa. If the capital stock was to grow very rapidly for a long period of time under state control as Keynes intended, its scarcity value and the profit rate would decline, eventually approaching zero. If the zero profit rate was achieved, the economy would, temporarily at least, be in a stationary state. Keynes argued that it is the inability of the interest rate to fall along with the rate of profit in a regime of free capital movements across borders and adherence to a gold standard that preserved the scarcity value of cap­ital and thereby prevented the level of investment from being high enough to sustain full employment.

It is much preferable to speak of capital as having a yield over its life­time in excess of its original cost, than as being productive. For the only reason why an asset offers a prospect of yielding during its life ser­vices having an aggregate value greater than its initial supply price is because it is scarce; and it is kept scarce because of the competition of the rate of interest on money. If capital becomes less scarce, the excess yield will diminish, without its having become less productive - at least in the physical sense.

I sympathise, therefore, with the pre-classical doctrine that every­thing is produced by labour, aided by what used to be called art and is now called technique, by natural resources which are free or cost a rent according to their scarcity or abundance, and by the results of past labour, embodied in assets, which also command a price according to their scarcity or abundance.

(CW 7, p. 213, emphasis in original)

Keynes went on to say that capital goods could conceivably become so abundant that the profit rate could even be negative - the present value of its expected future cash flows could be less than its cost. "A correct theory, therefore, must be reversible so as to be able to cover the cases of the mar­ginal efficiency of capital corresponding either to a positive or negative rate of interest" (CW 7, pp. 214-215).

In wealthy economies with large stocks of capital goods, a sustained high rate of investment will, in the absence of substantial change in long­term "facts" that condition the profit rate, cause the mec to fall below the prevailing interest rate at output levels associated with high unemploy­ment. This process, which leads to stagnation, he said, currently existed in Britain and the USA.

The post-war experiences of Great Britain and the United States are, indeed, actual examples of how an accumulation of wealth [capital goods], so large that its marginal efficiency has fallen more rapidly than the rate of interest can fall in the face of the prevailing institu­tional and psychological factors, can interfere, in conditions mainly

High-unemployment long-run equilibrium 181 of laissez-faire, with a reasonable level of employment and with the standard of life which the technical conditions of production are cap­able of furnishing.

(CW 7, p. 219)

Keynes reinforced his argument with a hypothetical example that compared two nations with the same level of technology but different­sized capital stocks.

It follows that of two equal communities, having the same technique but different stocks of capital, the community with the smaller stocks of capital may be able for the time being to enjoy a higher standard of life than the community with the larger stock; though when the poor community has caught up with the rich - as, presumably, it will - then both alike will suffer the fate of Midas.

(CW 7, p. 219)

This example was chosen to reflect Britain's economic history. Britain was the global "first mover" in creating the innovations and capital investments that constituted the first industrial revolution, and it became the world's largest exporter of many of the goods that dominated world trade at the time. It thus became the "rich" community in the quote above that was now suffering the "fate of Midas." Other European countries and the USA were the initially "poor" communities; they were the second movers in the first industrial revolution who could copy and even improve on the technologies first created and/or implemented in Britain and could create and/or efficiently implement some of the technologies of the second indus­trial revolution. Thus, these other countries industrialized quickly and grew rapidly, while Britain's industrial advantages evaporated. But now that they have caught up with and even surpassed Britain and have large capital stocks that embody the technologies of both the first and second industrial revolutions, in the absence of an unexpected third industrial revolution, they must face the same fate as Britain.

At this point in the chapter, Keynes returned to a point he made in chapter 10 about public investment and the multiplier. If the mec is low and the long-term interest rate is relatively high, so that capital invest­ment is far too small to generate full employment, and if the state will not or cannot undertake enough productive economic investments to quali­tatively alter this situation, it would be a second-best policy if the state and the private sector invested even in projects with little direct economic return, because such projects "will increase economic well-being" through their multiplied impact on jobs and income. And since these are not pro­ductive investments themselves, they will postpone the date on which a zero profit rate on productive investment is reached. If the relation of the mec to the long-term interest rate is such that the economy cannot

generate full employment and the government refuses to undertake the required level of economically efficient public investments:

then even a diversion of the desire to hold wealth towards assets, which in fact yield no economic fruits whatever, will increase eco­nomic well-being. In so far as millionaires find their satisfaction in building mighty mansions to contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions, the day when capital abundance will interfere with abundance of output may be postponed. "To dig holes in the ground," paid out of savings, will increase, not only employment, but the real national dividend of useful goods and services [via the multiplier].

(CW 7, pp. 219-220, emphasis added)

He had made the same point in chapterlO:

Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the clas­sical economics stands in the way of anything better... Ancient Egypt was doubly fortunate, and doubtlessly owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. Thus, we are so sensible, have schooled ourselves to so close a resemblance to prudent financiers, taking careful thought before we add to the "financial" burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment.

(CW 7, pp. 129, 131)

Keynes then returned to an exposition of his preferred economic policy centered on public investment.

Let us assume that steps are taken to ensure that the rate of interest is consistent with the rate of investment which corresponds to full employment. Let us assume, further, 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 [the point at which the average rate of profit on capital is zero]. 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 to zero within a

High-unemployment long-run equilibrium 183 single generation, so that we should attain the conditions of a quasi- stationary community where change and progress would result only from changes in technique, taste, population and institutions, with the products of capital selling at a price proportional to the labour, etc., embodied in them on just the same principles as govern the prices of consumption-goods into which capital-charges enter in an insignifi­cant degree.

(CW 7, pp. 220-221, emphasis added)

Here, again, Keynes suggests that the profit rate will decline as the stock of capital increases only if there are no powerful "counter-tendencies": if the population "is not increasing rapidly," there are no systemically powerful and employment-creating "changes in technique," no large changes in consumer "tastes," and no important changes in the "institutions" on which the economy is based.

It is clear from his discussion of stagnation that Keynes had great con­fidence in the empirical validity or historical truth content of the tendency of the rate of profit on capital to fall in this era and in the assumption that no system-shaking innovations had taken place in Britain for some time and that none were visible on the horizon. Of course, he could not yet (in 1935) clearly foresee the profound effects that WWII and its political and economic aftermath would have on his conditioning assumptions.

Thus, in the absence of the implementation of Keynes's preferred radical policy regime, he assumes that: the mec will remain low in mature and wealthy communities such as Britain and the USA, in which much of the income and wealth of the country are in the hands of a small percentage of the population; this will cause the investment multiplier to be low; and the interest rate will remain high relative to the rate of profit on capital. With both capital investment and household spending low, secular stagnation is likely to continue to plague mature capitalist countries.

In the controversial chapter 17, titled "Properties of Interest and Money," Keynes defended the secular stagnation thesis by attempting to show that there is a high lower bound to the interest rate over the long run that prevents trend investment spending from being large enough to achieve full employment in the context of a falling mec. He makes several effective arguments in support of this hypothesis in the chapter. Unfortunately, their impact on the reader is blurred by the fact that he utilizes a long- run stock-equilibrium model to build his case, yet he relies on a number of supporting short-run arguments whose relation to the long-term static equilibrium model is unclear, at least to me. I review chapter 17 in some detail in Appendix 2.

Why did Keynes take on the daunting task of trying to fit potentially volatile short-run expectations into a long-term asset equilibrium model in chapter 17? I suspect it was because he believed that there was a very long-term dimension to the problem of constrained investment demand

associated with a long-term version of a variant of liquidity preference for stores of wealth other than the capital stock. He argued that, throughout much of history, capital investment was restrained by the propensity of wealth-holders to hold alternative assets whose exchange value was believed to be more secure or less risky than capital goods over very long periods of time. Moreover, a propensity to hold wealth in the form of land over many generations created a cultural imperative in which land­owning became a "way of life" for the hereditary land-owning class, as it did in Britain.

The exit argument in the chapter reflects this historical perspective. It points out that land ownership used to play the role that money own­ership now plays as an insurance policy against possible future capital loss. "The high rates of interest on mortgages on land, often exceeding the net yield from cultivating the land, have been a feature of many agricul­tural economies," which inhibited "current investment in produced cap­ital assets."

And rightly so. For in earlier social organization where long-term bonds in the modern sense were non-existent, the competition of a high interest-rate on mortgages may well have had the same effect in retarding the growth of wealth from current investment in produced capital assets, as high interest rates on long-term debts have had in more recent times.

(CW 7, p. 241)

He summed up his perspective on the powerful long-term negative influence of liquidity preference on economic development as follows:

That the world after several millennia of steady individual saving, is so poor as it is in accumulated capital-assets, is to be explained, in my opinion, neither by the improvident propensities of mankind, not even by the destruction of war, but by the high liquidity-premiums formerly attaching to the ownership of land and now attaching to money.

(CW 7, p. 242)

Keynes repeated this claim later in the book: liquidity preference, he said, was the major cause of inadequate capital investment over millennia. "The destruction of the inducement to invest by an excessive liquidity prefer­ence was the outstanding evil, the prime impediment to the growth of wealth, in the ancient and medieval world" (CW 7, p. 351). This is the long- run perspective that he tried to embed in the long-run stock-equilibrium model of the chapter with at best partial success.

Chapter 19 contains an important theoretical-historical discussion of the topic of secular stagnation. Near the chapter's end, Keynes said that

High-unemployment long-run equilibrium 185 the unique economic conditions prevailing from the late eighteenth cen­tury through the nineteenth century led to exceptional long-term growth in income and employment. This list of conditions incorporates many of the elements of his own explanation of why this century was so pros­perous and why the interwar years brought stagnation followed by global depression. The list therefore constitutes a guide to his theoretical perspec­tive on secular stagnation theory.

During the nineteenth century, the growth of population and of inven­tion, the opening up of new lands, the state of confidence and the fre­quency of war over the average of (say) each decade seem to have been sufficient, taken in conjunction with the propensity to consume, to establish a level of the marginal efficiency of capital which allowed a reasonably satisfactory average level of employment to be compat­ible with a rate of interest high enough to be psychologically accept­able to wealth owners. There is evidence that for a period of almost one hundred and fifty years the long run typical rate of interest in the leading financial centres was about 5 per cent, and the guilt-edged rate [on government bonds] between 3 and 3.5 per cent; and that these rates of interest were modest enough to encourage a rate of invest­ment consistent with an average rate of employment which was not intolerably low.

(CW 7, pp. 307-308)

So, the nineteenth century was exceptionally buoyant because of: the population growing rapidly (creating rising demand for consumer goods, especially housing); system-transforming innovations and technical pro­gress (such as the creation of the railroad system and the key inventions and innovations of the first and early second industrial revolutions); the opening up of new lands around the globe (which created profit­able trading opportunities for Britain, who dominated trade in cotton textiles, the most important commodity in world trade, and controlled global commerce and finance); frequent wars (which stimulated AD); and a high state of business "confidence" in an attractive profit rate on investment that became so deeply embedded in the British business and financial elites that it could not be shaken by short-term economic difficul­ties - "prosperity is cumulative." These factors led to an average value of the mec that was high enough that it sustained rapid capital investment and employment for over a century, even though the propensity to save was also high (and the investment multiplier therefore low) because of the extreme inequality of wealth and income in the era. The high rate of savings kept the long-term interest rate low enough to sustain rapid cap­ital accumulation and yet high enough to be "psychologically acceptable to wealth holders." This line of reasoning is reminiscent of his arguments in The Economic Consequences of the Peace, discussed in Chapter 2 of this book.

However, Keynes said, the special circumstances that generated high growth and acceptable employment levels had now evaporated and showed no signs of returning. Thus, Britain faced long-term stagnation unless it radically changed the structure of its political economy. "To-day and presumably for the future the schedule of the marginal efficiency of capital is, for a variety of reasons, much lower than it was in the nineteenth century" (CW 7, p. 308).

This is a clear statement of Keynes's belief in the truth content of the stagnation thesis. Given the current low secular trend of the mec and the low value of the mpc and the multiplier, the only hope for substantially stimulating the rate of private investment spending would be a large and permanent reduction of the long-term interest rate. Thus, sustained full employment could not be achieved until the central bank was nationalized and committed to a falling rate of interest - a point he made a number of times.

The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money... But the most stable, and the least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in the future, the minimum rate of interest acceptable to the generality of wealth-owners. If a tol­erable level of employment requires a rate of interest much below the average rates which ruled in the nineteenth century, it is most doubtful whether it can be achieved merely by manipulating the quantity of money.

(CW 7, pp. 308-309)⁴

Keynes noted in this chapter that there are several deductions to be made from the nominal long-term interest rate to arrive at the actual return to the bond holder: "the cost of bringing the borrower and lender together"; "income and surtaxes"; and "the allowance which the lender requires to cover his risk and uncertainty." It is this net yield that must "tempt the wealth-owner to sacrifice his liquidity" in spite of the potential for the cap­ital loss and possible default inevitably associated with long-term bonds (CW 7, p. 309). Liquidity or capital-safety preference may remain strong enough to keep the long-term interest rate too high to permit acceptable rates of unemployment in the face of a weak expected rate of profit. "If, in conditions of tolerable average employment, this net yield turns out to be infinitesimal, time-honored methods [of sustaining high employment] may prove unavailing," and therefore radical economic intervention by the state will be required to achieve sustained full employment (CW 7, p. 309). Keynes even quoted the nineteenth-century financial-market

High-unemployment long-run equilibrium 187 savant Bagehot on this issue: "John Bull can stand many things, but he cannot stand [a long-term interest rate of] 2 per cent" (CW 7, p. 309).

In chapter 22 on the business cycle, Keynes argued that the latter part of the vigorous capital investment boom in the late 1920s in the USA even­tually drove the actual profit rate but not yet the expected profit rate or mec down to a level that was below the long-term interest rate by the forces associated with his secular stagnation reasoning. This led to the end of the US boom in 1929 as the mec eventually reflected the decline in the actual rate of profit. However, even at the peak of the boom (with the measured unemployment rate near 4 percent), the profit rate remained well above zero, according to Keynes. It would take rapid investment for "twenty- five years or less" to drive the profit rate to zero.

It is, indeed, very possible that the prolongation of approximately full employment over a period of years would be associated in countries so wealthy as Great Britain or the United States with a volume of new investment, assuming the existing propensity to consume, so great that it would eventually lead to a state of full investment in the sense that an aggregate gross yield in excess of replacement cost could no longer be expected on a reasonable calculation from a further incre­ment of durable goods of any type whatever. Moreover, this situation might be achieved comparatively soon - say within twenty-five years or less. I must not be taken to deny this, because I assert that a state of full investment in the strict sense has never yet occurred, not even momentarily.

(CW 7, pp. 323-324)

Chapter 23, aptly titled "Notes on Mercantilism, Etc.," is a smorgasbord of observations by Keynes about both the errors and the important insights associated with mercantilism, an economic doctrine that dominated British thinking for 200 years prior to the nineteenth century, when it became displaced by the classical school. Mercantilists supported: managed trade; industrial policy designed to create conditions supportive of the growth of British industry through the pursuit of what is sometimes referred to as dynamic comparative advantage; and government-guided low interest rates. Keynes applauded the mercantilists for rejecting what became classical dogma: that free trade and the free movement of capital across borders would automatically set the interest rate at a level consistent with domestic full employment. Keynes vigorously opposed the free movement of money capital flows across Britain's borders because this increased domestic interest rates and lowered domestic employment.

Great Britain in the pre-war years of the twentieth century provides an example of a country in which the excessive facilities for foreign lending and the purchase of properties abroad frequently stood in the

way of the decline in the domestic rate of interest which was required to ensure full employment at home.

(CW 7, p. 337)

The mercantilists turned out to be more insightful about this problem than the classicists that succeeded them, Keynes said, and for this reason they supported state intervention to keep the interest rate low.

Mercantilists' thought never supposed that there was a self-adjusting tendency by which the rate of interest would be established at the level consistent with sustained full employment. On the contrary, they were emphatic that an unduly high interest rate was the main obstacle to the growth of wealth.

(CW 7, p. 341)

They also rejected the core classical belief that disequilibrium processes could be trusted to quickly restore full employment when the economy suffered from underemployment. In the middle of the eighteenth century, David Hume helped solidify the shift of focus from potentially unstable disequilibrium processes to stable equilibriums.

[He] began the practice amongst economists of stressing the equilib­rium position as compared with the ever-shifting movement towards it, though he was still enough of a mercantilist not to overlook the fact that it is in the transition that we actually have our being.

(CW 7, p. 343, emphasis added)

Keynes emphasized that the crucial insight embedded in mercantilist thought was that the core problem of laissez-faire capitalism is the com­bination of a tendency of the profit rate to fall over time and of the rate of interest to remain high. Indeed, he argued that this has been the core economic problem throughout history. What he said here is a good short statement of his strong belief in the long-run stagnation thesis.

It is impossible to study the notions to which the mercantilists were led by their actual experiences, without perceiving that there has been a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest. The weakness of the induce­ment to invest has been at all times the key to the economic problem. To-day the explanation of the weakness of this inducement may chiefly lie in the extent of existing accumulations; whereas, formerly, risks and hazards of all kinds may have played a larger part. But the result is the same. The desire of the individual to augment his personal wealth by abstaining from consumption has usually been stronger than the inducement of

High-unemployment long-run equilibrium 189 the entrepreneur to augment the national wealth by labor on the con­struction of durable assets.

(CW 7, pp. 347-348, emphasis added)

Keynes then commented again on how the classical school was able to rule out of serious discussion self-evident truths that had been established across "several millenniums" - including the belief that, left only to pri­vate financial markets, interest rates will usually be too high to achieve full employment.

There remains an allied, but distinct, matter where for centuries, indeed for several millenniums, enlightened public opinion held for certain and obvious a doctrine which the classical school has repudiated as childish, but which deserves rehabilitation and honour, I mean the doctrine that the rate of interest is not self-adjusting at a level best suited to the social advantage but constantly tends to rise too high, so that a wise government is concerned to curb it by statute and custom and even by evoking the sanctions of moral law... The destruction of the inducement to invest by an excessive liquidity preference was the outstanding evil, the prime impediment to the growth of wealth, in the ancient and medieval world.

(CW 7, p. 351)

How, then, did classical theory become the conventional wisdom in spite of the fact that it was inconsistent with most of world history? Keynes notes here "the analogy between the sway of the classical school of economic theory and certain religions" (CW 7, p. 351). His main answer to this question was consistent throughout the interwar years: the era from the mid-eighteenth century through the end of the nineteenth century in Britain was in fact a relatively unique period in the history of capitalism, but it was pictured in classical theory as if it were the perpetual state of laissez-faire capitalism in all eras and all places. The growth of capital investment in Britain remained high throughout this era because Britain was the main beneficiary of: the rise of capitalism; the construction of a globally integrated economy; the creation of Britain's empire; the domin­ation of the world's cotton industry, the most important global industry during this era; Britain's role at the center of global commerce and finance; and the industrial revolutions that took place in this period. These events created enormous opportunities for highly profitable investment projects. "For nothing short of the exuberance of the greatest age of the inducement to invest could have made it possible to lose sight of the theoretical possi­bility of its insufficiency" (CW 7, p. 353).

Keynes acknowledged that during the long nineteenth century, the policy positions derived from classical theory worked reasonably well, even though classical theory was a deficient general theory of long-run

capitalist dynamics. But when the unique conditions that led to rapid growth in the long nineteenth century ended, the laissez-faire policies supported by classical theory proved to be disastrous for Britain and the global economy because the assumptions of classical theory conflicted sharply with actual conditions in mature capitalism.