This paper has been written for the special issue of Revista Comercio Exterior on Economic Thought in the Twentieth Century.
Coordinators: Homerio Urias and Eugenio Correa.
Keynes at the Pantheon
Amid twentieth century economists, Keynes is the one who has attained perennial fame being ranked equal to Einstein and Freud in the century’s intellectual Pantheon. The public at large remembers Einstein for his theory of relativity and Freud for the theory of psychoanalysis while one will always remember Keynes for his theory of effective demand. Einstein brought a new vision of the universe, Freud a new understanding of the human mind, and Keynes changed forever the relationship between humankind and its material environment by unveiling the mystification of national scarcity inherited from classical economics. One is still convinced that together they invented a new world out of genuine cultural revolution.
The best proof of Keynes’ ubiquitous presence is given by the obsessive reference to his work by those who strive to restore the old world haunted by inhuman or natural constraints. Contemporary advocates of unfettered capitalism in the guise of globalization and its sibling, the “new economy”, are proud of their anti-Keynesianism and accuse their adversaries of being guilty of Keynesianism. Vintage after vintage of orthodox textbooks want to debunk Keynes’ legacy because their authors believe that it is the sine qua non of their ability to convince students and teachers of the soundness of their restored version of neo-classical economics. Contriving to scorn Keynes has been the ultimate test for a promising career as an economist praised by corporations, governments and international organizations like the International Monetary Fund and the World Bank. All those powers in charge of the economy are right to fear Keynes because, for ages, their supporting economics have been doubted by those who read Keynes and strive to understand him. The doubter or heterodox economists deem themselves post-Keynesians because Keynes has been the starting point of their own fight or revolution against the phoenix-like neo-classical economics, which is still the underlying justification of the ruling ideology. Being a genuine post-Keynesian does not require to be enthralled by the economics of Keynes or to endeavor to rewrite the General Theory by twisted interpretations. What is at stake is the discovery of Keynes’ message and answering this message by a new general theory encapsulating what must be kept of Keynes’ own economics. Post-Keynesians failed to grasp a large audience because too many of them used to be unable or unwilling to be beyond the literal content of the General Theory, both in terms of economic theory and economic policy (Parguez, 2001). Keynes’ work encompassed the whole twentieth century intellectual revolution. Freud’s critique of classical psychology lies underneath the Keynesian critique of economic rationalism (Dostaler and Marris, 2000), while Keynes’ vision of time is very close to Einstein’s relativity theory. Both reject the classical notion of an objective time independent from observer and space. Keynesian time is a subjective “lived” time, which explains why the future cannot be foreseen or even expected.
In this paper, I intend to unravel the success of the Keynesian revolution, which requires first to prove that there has been such a revolution against the whole establishment vision of the economy. A shrewd and stealthy way of debunking Keynes is to contrive to encapsulate him into neo-classical economics. Such a standardized Keynes is bereft of message, and he should be reduced to a chapter of text-book dealing with the IS-LM model, the micro-economic foundations of macroeconomics, the foundations of national accounts or with the then vintage of “Neo-Keynesians” (Rochon, 1999).
A first part must be devoted to the origins of the revolution. Contrary to writers of economic textbooks, Keynes did not exist in a virtual world bereft of anchor in the real world. The blatant failure of classical economics, the ruling orthodoxy, to grasp the crisis of the world capitalist economy led Keynes to doubt its fundamental propositions. In the second part, I explain Keynes’ answer to his Cartesian doubt in terms of his method and solution. A third part reveals Keynes’ true impact on the course of economic theory and economic policy.
1: At the Beginning: Doubting a Bankrupted Orthodoxy What Keynes deemed “orthodoxy” is the theory or set of propositions underlying prevailing interpretations of major failures of the economic system and policies intending to cure them. From his early writings to the General Theory, he became more and more aware of the existence of an orthodoxy to which economists, policy-makers and experts were enthralled. It is dubbed “classical economics” in the General Theory, and Keynes wants to overthrow the rule of the “Ricardian inquisition” by proving that its remedies are preposterous because either they are inefficient or they worsen the diseases afflicting society. One has sometimes reproached Keynes for his rather offhand critique of orthodoxy that would prove that he was not a pure economist, “purity” meaning being only concerned with internal logical consistency. Such an accusation cannot be substantiated because, on its own terms, orthodoxy embedded a practical vision of the world leading to inaction or policies that ought to be germane to the main characteristics of the economic system. Keynes is therefore right to emphasize efficiency as the benchmark of truth for the orthodoxy. To display its inefficiency is tantamount to reveal its intellectual bankruptcy.
The Historical Context of the Indictment of Orthodoxy:
The Collapse of the Liberal World Economic Order Keynes shared with his contemporaries, Hayek for instance, the vision of a benevolent economic order that would have existed between the mid-nineteenth century and the First World War. It was an idealized and even mythical vision which reveals the horror of the war and its aftermath that led a generation to dream of a better past. The difference between Keynes and Hayek is that Hayek believed that the past order could be restored, while Keynes became convinced that it could not be restored.
It was the time when orthodoxy was born as the mirror of a world ruled by a stable order generating harmony. According to Keynes, the nineteenth century order ignored mass and persistent unemployment while it allowed mild and sustainable cyclical crises because financial markets were so tamed that they could not hinder the accumulation of real wealth. National economies had been locked by trade and real investment flows into a global economy thriving on stable currencies. It was the golden era of the gold standard because, according to Keynes’ reappraisal of the gold standard in the Treatise, the constraints resulting from the gold anchor of the monetary system could not jeopardize the smooth functioning of the world economy. Being the offspring of an era of stability and relative harmony, orthodoxy was doomed to encapsulate stability and harmony as its underlying principles.
After the war, stability and harmony are over. That ominous observation initiated Keynes’ revolt against established orthodoxy. Mass permanent unemployment is now the rule, cyclical crises are gone forever at a time when untamed financial markets have unleashed forces of disequilibrium suppressing any anchor for the world economy. The world crisis of the new era is a spiral of deflation, which is not followed by an automatic compensating boom. The economy is still global, but globalization generates a world accumulative deflation instead of bringing growth and stability. Chaos has replaced order, and Keynes is aware that economic chaos must destroy the very fabric of society. A strong feeling of emergency explains Keynes’ increasing will to face the forces of chaos. He is a staunch advocate of political liberalism in the Montesquieu-Burke tradition, and he knows that, since liberalism thrives on stability and harmony, it cannot survive chaos. Orthodoxy is ultimately to be doubted, not for the sake of a pure logic without anchor in the real world, but because it does not fit the last resort benchmark – the survival of the liberal political order.
The Classical Synthesis Keynes has been lectured for his bold synthesis which, on the one side, integrates Smith, Ricardo and the rather infamous Say, and, on the other side, dares to integrate the classical school and the whole neo-classical school. Neo-Ricardians are obviously infuriated and stalwart neo-classical economists as well, while cautious historians of economic thought are stunned by Keynes’ contention that neo-classical economics is just an offspring of the classics.
In retrospect, I think that Keynes was right to undertake such a synthesis, which is a decisive contribution to the advancement of economic thought. The Keynesian synthesis is rooted in two propositions:
1. Say’s law is a logical consequence of the economics of Smith and Ricardo since demand does not exist as a constraint on the system. Smith and Ricardo are more radical than Say because, in their system, there is a permanent identity of output and demand, which excludes any notion of causality. It is therefore sensible to integrate Smith, Ricardo and Say.
2. The so-called “marginalist revolution” leaves unscathed the core of classical economics. Classical economics survives in the disguise of neo-classical economics, which is nothing but the methodological veil of erstwhile postulates. Their integration is therefore substantiated, and the outcome must be dubbed “classical economics” or “Ricardian economics” in its ultimate aspect.
The survival of the Smith-Ricardo real saving postulate is the benchmark of the second proposition. References to the classical saving postulate are ubiquitous in the General Theory, but Keynes would have been more convincing had he explained that the classical theory of labour was a consequence of the saving postulate. According to Keynes, the first classics postulated that, in any period, society is constrained by the amount of the ex-ante real saving fund, which is equal to the excess of real or physical output over consumption. The saving fund is the real surplus society recycles in real investment allowing the reproduction or the growth of the stock of real wealth. The saving postulate enshrines the objective or real scarcity law: scarcity rules since the sine qua non condition of just the constant stock of wealth is the squeeze imposed on the share of the given output devoted to consumption. The neo-classical offspring of the first classics never doubted the saving postulate, which is the cornerstone of its capital theory. Ex-ante real saving (the supply of capital) is adjusted to ex-ante real investment (the demand for capital) in the real capital market by the interest rate mechanism, which equates the rate of interest with the marginal productivity of real capital. The real saving postulate explains why the rate of interest is always converging on its natural level reflecting the equilibrium rate of profit.
The loanable funds theory relies on the real saving postulate because the supply of loanable funds is the monetary disguise of the ex-ante real surplus. As long as the rate of interest mechanism channels monetary ex-ante savings into desired or ex-ante investment spending, money is neutral, since society invests in accumulation the share of real or physical output it has saved before. From Smith to Robertson and the whole Cambridge School, it is therefore obvious that thriftness has been the ultimate source of investment and wealth.
The inexistence of a demand constraint is the logical consequence of the saving postulate. As shown by the first proposition for Smith and Ricardo, Say’s law is an identity. Since physical output is absorbed either by consumption or accumulation, it is independent of demand, which does not exist as an independent force. According to the later neo-classical school, the interest rate mechanism generates a demand for capital equal to ex-ante saving, which is Say’s law, since supply by the virtue of the market for capital always creates its own demand.
Herein is the proof that full employment is a corollary of the savings postulate. In the Ricardian system Keynes has in mind, the whole real saving fund is the outcome of the capitalist class thriftness because the real wage is just equal to its subsistence level. In any period, aggregate real wage is the share of previous output invested into the real consumption of the workers used in the production process. The real wage fund (real investment) is equal to ex-ante real saving (the saved part of former surplus). According to the postulate, society escapes from the iron law of scarcity by thriftness. The real saving fund is therefore high enough to grant society the highest possible level of output, which requires the employment of the available labour force at the exogenous subsistence wage rate. Permanent full employment is the characteristic of the initial classical theory, and it is the natural reward for sustained abstinence. The subsistence wage did not fit into the neo-classical postulates of ubiquitous rationality and objective time, the last one ensconcing the notion of perfect certainty leading to long-term planning. Since it was not an existence condition of the saving postulate, it could easily be discarded without softening the scarcity constant. It was therefore replaced by the labour supply function, which is the second classical postulate of labour theory according to Keynes. There are now two interlocked markets, the market for real capital and the labour market adjusting firms’ demand for labour to the supply of labour originating from holders of production factors. They must comply with two apparently interdependent choices, the first is between consumption of real income and saving, the second is between working to get a wage or not working to get leisure. Both choices are reflected by the intertwined supply of saving (or supply of capital) curve and supply of labour curve, which depend upon the real prices factor, the rate of interest (the rate of profit), and the wage rate. The rationality postulate imposes the equality between factor prices and the respective marginally utility of consumption and leisure. The rate of interest is equal to the marginal utility of consumption at any point on the supply of saving curve, while at any point in the supply of labour curve, the wage rate is equal to the marginal utility of leisure (or the marginal disutility of work, in Keynes’ words). Since marginal utilities are a decreasing function of both consumption and leisure by virtue of the axiom of decreasing returns, the supply curves are increasing functions of the factors prices. Any rise of the wage rate (or the rate of interest) reflects a higher marginal utility of consumption (or leisure) and therefore requires a greater supply of saving (or work).
The existing condition of the labour supply curve is the income provided by accumulated wealth out of saving. The true meaning of the curve is that rational agents prefer to live on their capital income when the marginal utility of consumption out of labour falls. The labour supply curves displays the transmogrification of workers into pure rentiers. That fits the objective time postulate since the choice now between consumption and saving controls future choices between work and leisure.
The labour supply curve is the necessary and sufficient condition of full employment in the neo-classical system. Keynes has been right to emphasize the paramount role of the second postulate, which is forgotten in many textbooks. The labour supply curve itself is the logical corollary of the saving supply curve reflecting the saving postulate. Were the saving postulate rejected, there would not be a labour market at all, since no supply curve would exist. It is therefore true that the saving postulate is the existence condition of full employment in the neo-classical system.
The Keynesian synthesis is a remarkable achievement proving that it is vain to strive to restore Ricardian economics to debunk neo-classical economics. What is still missing is a systematic demonstration, because Keynes has not explicitly derived the second neo-classical postulate (the labour supply curve) from the saving postulate. He deals with the second postulate in a rather sloppy and offhand way while, when he addresses the saving postulate, he does not mention the second postulate. Since Keynes emphasizes that the saving postulate is tantamount to full employment in classical economics, I am not sinning against historical truth by striving to expose what he could have easily written had he wished to substantiate this proposition.
The Classical Synthesis Is an Orthodoxy An economic theory evolves into an orthodoxy when it interprets all situations that apparently contradict it as the outcome of exogenous forces leading rational agents out of equilibrium. It becomes henceforth impervious to any denial, which explains why dissenters are indicted for ignoring the laws of pure reason and therefore are deprived of their quality of economist. According to Keynes, at least since the Treatise, such is the nature of the classical synthesis, which became a totalitarian orthodoxy, an inquisition3 obsessed by its survival in the wake of the wreck of its supporting order.
The last resort equilibrium condition is that investment never exceeds the ex-ante saving fund, which requires the perfect neutrality of money. Within the classical universe, money either does not exist or it is insignificant, a mere disguise for the real or physical flows that are the essence of circulation. Keynes’ interpretation of the classical notion of neutral money is much more complex than the naïve version of textbooks. Money is intrinsically neutral, it must be, or more accurately, it ought to be neutralized to ensure the rule of the saving postulate. The classics used to analyze all anormal situations as states of disequilibrium resulting from non-neutral money circulation. As soon as the saving anchor is removed, holders of production factors are bereft of guidelines and their choices are no more constrained by the rationality axiom - they suffer from the nefarious monetary illusion that move them out of the supply curves. It is only the state which can inject excess money into the economy, and it is used to use this power because it is the existence condition of its supremacy. Keynes could therefore explain why the classical orthodoxy has always been prone to think of all anormal situations, relative to the ideal equilibrium state, as the outcome of state interventions using the weapon of money to overthrow the saving constraint. Too few historians of economic thought have emphasized the true nature of classical liberalism in Keynes’ reappraisal of classical economics: It is nothing but the logical corollary of the saving postulate of which the state must be the stern steward.
Classical orthodoxy dealt with three major anomalies - the high unemployment of the British economy during the twenties, which has resisted all stabilizing forces, the unbridled financial speculation in the late twenties, and the spiraling process of deflation afflicting the world economy in the aftermath of the financial crisis.
Since the early twenties, Keynes had been worried by the dogmatic explanation of orthodox economists: all anomalies reflect the dramatic lack of saving, which is the logical outcome of the state’s excessive outlays financed by money creation. England’s real capital fund has been squeezed by inflation that had been caused, first by war spending, and next by state bounties, for instance unemployment compensation financed by non-neutral valueless money. Inflation induces a flight from saving, thriftness is vanishing. England has been permanently impoverished as its capital fund is depleted quite below its prewar level. Real investment collapsed because it is led by ex-ante saving which imposed the fall of real output, production being led by the embodied stock of real capital. Had there been a strong compensating fall in the real wage level, full employment could have been maintained, but it could not happen because of the workers’ stubborn monetary illusion. They craved for higher monetary wages to enjoy a greater consumption, which is the benchmark of the lethal monetary illusion. Workers were lured into the denial of rationality by those strike bounties generating inflation, the worse being unemployment compensation, which breaks the supply curve.
The speculation frenzy is likewise explained by state profligacy. Through its bounties, the state provided banks with so much money that they could grant credits to speculators, which caused financial inflation attracting more demand for credit, which banks could meet because they were more and more awash with state money. The rise in stocks prices accounts therefore for the lack of real saving artificially clouded by monetary inflation.
All egregious supporters of the classical orthodoxy praised the 1929 – 1931 crisis as the necessary liquidation crisis displaying the restoration of the scarcity law. Unemployment increased because, like in the twenties in England, of the rigidity of real wages imposed by workers wishing to maintain the money wage rate. Everywhere since the crisis, workers moved out of their supply curve, and labour market curves were shut off. A normal state (full employment) would be restored when society could regenerate its stock of real capital by an increased thriftness, which requires an economic policy of deflation.
Deflation Has Shamefully Failed:
Classical Orthodoxy Is Inefficient and Therefore False Modern readers of the General Theory may miss the explanation of the dire warning of Keynes against the intellectual dictatorship of past economists (Ricardo and his offspring) to whom practical men (corporate leaders, speculators and, above all, politicians) are enthralled. For the first time in the history of capitalism, professional economists had access to power during the post-war years because of the desire for rational management of the economy. Economic policy was born to implement modernization and its twin, “competitiveness”. Politicians and bureaucrats used to rely on the advice of economists who became experts in the art of technocratic rule. Classical orthodoxy had been enforced since the end of the war as the only sensible economic policy nobody dared to discuss because it was the byproduct of science. The agenda of the new technocratic regime was therefore the restoration of the saving constraint by a shock therapy of deflation from the early twenties onwards. Everywhere, fiscal policy targeted surpluses through rising taxes and dramatic cuts in expenditures. Politicians were obsessed by the search for expiation of their former sins against the scarcity dogma. Central bankers ruled over the state bureaucracy, and they used their new powers to increase interest rates because they hoped to accelerate deflation by imposing a fall in consumption leading to an increase in real saving. England restored the gold standard to suppress the monetary powers of the state and thus substitute a neutral money for the debased money, which had been the initial cause of the lack of saving.
Orthodoxy exports were not amazed by the mass unemployment following the financial crisis. They asked for more fiscal deflation, higher interest rates, the repealing of all kinds of help to unemployed workers. They preached far more deflation to force society to save more. Keynes wrote the Treatise when England had already been submitted to ten years of shock therapy. He wrote the General Theory when the administration of American President Franklin D. Roosevelt was still targeting a balanced budget, notwithstanding unabated unemployment and a stagnant real investment. In 1930, it was obvious that the shock therapy had failed to curb unemployment in England. In 1935, the failure was even more ominous because the new deal of shock therapy had not stopped the rise in unemployment while orthodox experts had enjoyed quasi-dictatorial powers to impose their agenda. Keynes scorned their call for more deflation to get full employment in the long run, which was always postponed to a farther future.
2: Keynes’ Solution:
The Foundation of an Economics Without Saving Constraint Keynes has always thought that critical doubt was useful if it led to the discovery of the founding principles of the positive science of economics free of ideology. Being now convinced of the falseness of classical economics, we still ignore those principles, we need first a method.
Keynes’ Method: The Logical Realism Reality exists, unemployment cannot be doubted, but it is a reality void of sense because it cannot teach the observer an explanation of its components or an interpretation. An observer that would strive to be free of theory could never know why unemployment exists, however sophisticated his technical tools of observation are. In the Descartes-Kant tradition, Keynes had since the start rejected empiricism, which substantiates his later rebuff of Tinbergen’s econometrics. All tests embody a pre-existing model, which is used to test another model derived from an axiomatic theory. Their answer is first that the tested axiom does not fit into the testing model. They cannot grasp a reality independent of the intertwined models – the testing one and the tested one, the “pure being” in Heidegger’s sense. I deem a “logical realism” the systematic search for the founding abstract principle(s) of reality, which cannot be doubted without accepting as true a logical impossibility.
Logical realism is the search for the economic cogito unveiling the sense of reality. Keynes has proven that the saving postulate is the logical core of classical economics. If it (they) exist(s), the searched principle(s) is (are) the ultimate negation of the saving postulate. If the economist denies it (them), the saving postulate is true, and the classical orthodoxy is efficient, which is false since it is inefficient. This (those) principle(s) is (are) therefore the anchor of the genuine general theory. Keynes never doubted the existence of cogito because he was a dedicated humanist for whom reality must be adjusted to the fundamental needs and aspirations of mankind. His humanism explains his staunch horror of any kind of determinism, which denies the ability and right of humankind to shape the material world. It is the clue of Keynes’ contempt for Marxism, which enshrines a crude historical determinism rooted in the iron law of changes of technology.4 Since man exists for action, reality has a hidden sense. The cogito must and can be discovered. Keynes never indulged into the fatalist mood of many dissenters who doubted the possibility of discovering the alternative to the ruling orthodoxy.
Logical realism deters any attempt to rely on the so-called “national accounts” to find the cogito. It is preposterous to think of Keynesian economics as the naïve economics of national accounts5 (Parguez, 1998). National accounts are the artefacts built by technocrats relying on classical orthodoxy that wanted to transform the saving postulate into operational tools of control. Their data are ciphers, and only technocrats have the codes allowing others to read them. They are the veil of ideology luring people into believing that they are the hard reality. Those who dally with notions like GDP, rate of growth and the likes, should remember Keynes’ critique of the conventional measures of production. The logical realism commandment is to doubt all which is declared true because it would be revealed by official data.
The Founding Principles: The Causal Identity of Saving and Investment What is saving but the excess of income over consumption. Since the saving postulate no more holds, income is not earned in nature as physical goods but in money. Saving is therefore the discrepancy between monetary income and the share of this income spent to acquire consumer goods. In the General Theory, Keynes endeavours to get an objective concept of income bereft of the ideological illusions aroused by the conventional measures of “production” used in national accounts. Income is the objective value of the net increase in real wealth provided by production. Income reflects the discrepancy between the value of the stock of available commodities after production and the value of stock before production, minus what Keynes deems the “user cost of production”. The user cost is the value of that part of the initial stock which has been destroyed to get production; it is the value inherited from the past which is embodied in newly produced goods. Income, being the contribution of the present real wealth, is net of user cost. Keynes rejects official measures of production because they cannot account for the contribution of the past, which leads to grossly inflated estimations of the net increase in real wealth.
Income is embodied into available consumer goods and the net increase in the stock of real capital or investment, which explains the first fundamental equation:
(1) Y = C + I. This equation tells that society uses income, Y, for consumption and investment, C being the value embodied into consumer goods, and I is the value embodied into investment. Since society earns a monetary income, which is the value embodied into net production, Keynes gets his second equation:
(2) Y = C’ + S.
This equation shows that earned income is split between expenditures, C’, and non-expenditures or saving, which is the sole definition of saving germane to a non-neutral monetary economy. Within this economy, there is no distinction between the embodied value of net production and its realized or effective value. Value or income is realized through sales or expenditures. C and C’ are therefore identical because they are the same thing, from which Keynes gets his famous identity:
(3) S = I.
This is an identity because it is always true, and it is logically independent of any kind of adjustment. It is therefore the negation of an equality meaning an equilibrium condition. S is not a source of value, it is a loss of value that must be compensated by an equal source of value, which is investment. This means that the identity is that “investment is the existence condition of saving”. Investment always generates an equal saving, which explains why Keynes deems saving a mere residual. Income is defined by the identity. No income could exist, were saving not equal to investment. It is therefore preposterous to believe that saving is adjusted to investment through changes in the level of income. Since investment is the objective value of the surplus, Keynes gets his first founding proposition:
Society gets a surplus out of a decision to invest which is not constrained by thriftness since available saving is created by the investment decision. Saving itself is therefore absolutely independent of thriftness.
The proposition is true because, if it is denied, the classical saving postulate holds. It is the searched cornerstone of the General Theory, the ultimate negation of classical economics. Its corollary is the inexistence of the saving supply curve, which abolishes the market for capital and its twin, the “loanable funds market”. The rate of interest, being without anchor in thriftness, is not the Wicksellian natural rate granting full employment. It must be explained and determined by the existence of a non-neutral money.
The Level of Employment Is Imposed
on Job-Seekers Who Hold the Labour Force The labour supply curve does not exist, which invalidates the labour market. In an economy free form the saving postulate, full employment is no more granted. The level or quantity of employment is denominated in terms of an objective homogenous unit of labour. For Keynes, there is a unique relationship between income and labour because to any income corresponds to a unique quantity of labour, which has been used to get the net output of which this income is the value. An income value of labour is this substituted for the classical theory of labour value of output. Labour has value because it has been embedded into output having a value which is income, defined by the fundamental identity.
In the General Theory, Keynes thought that it would be shrewd to interpret this relationship as a function, N being the quantity of labour, of income, so that
(4) N = F ( Y ) meeting the erstwhile condition of a continuously decreasing marginal productivity of labour,
(5) F’n = f (Y)
f’ < 0, which is part of what he deems the first postulate of the orthodox theory of labour. Keynes thought that this condition was innocuous since the labour supply curve does not depend on it. He also believed that the proof could be more convincing if involuntary unemployment exists even though the conventional first postulate still holds.
The level of income is given by the famous but often misunderstood “effective demand principle”. It means that income is determined by firms or entrepreneurs as a whole. Keynes never dallied with the impossible aggregation of individual unit behaviours or functions because they do not exist but in the eery universe of neo-classical economics. Economy is the rule of collective minds or entities which are substantiated for the psychological atoms of orthodoxy. When Keynes introduces The Entrepreneur, he thinks of an collective entity acting on its own will, which undertakes the production process. Characters in the Keynesian theatre are the emblematic figures of the society-wide chess-game, which is the economy. As soon as some individual enters the game, he (or she) does not exist any more as an individual person. He (she) become part of a super collective mind, The Entrepreneur, The Consumer, The Speculator, The Banker, etc. It is therefore preposterous to seek the micro-economic foundations of Keynes’ economics. It would likewise be weird to seek the micro-psychological foundations of Freud’s psychoanalysis or Jung’s theory of archetypes.6 Employment is the outcome of a game with three figures or collective minds, The Entrepreneur, The Income-Earner, and The Capitalist or Speculator. The game is led by the Entrepreneur according to the rule which is enshrined in the fundamental identity. (We must always remember that the Keynesian Entrepreneur is not the neo-classical representative entrepreneur. He is a genuine collective mind, within which one loses its individuality.) The Entrepreneur knows that to each potential output corresponds an income value reflecting the equality of earned or distributed income and aggregate demand. Say’s law does not hold since the saving postulate has been denied. Aggregate demand has been turned into a constraint, which must be foreseen or expected by the Entrepreneur. There is only one level of output for which earned income is equal to the level of aggregate demand, which defines the effective level of income and therefore effective output, the value of which is effective income.
Aggregate demand has two sources. Investment is under the power of The Capitalist, whose move is already known by the Entrepreneur, while consumption is determined by the Income-Earner. His move is ruled by the consumption function which is also known by the Entrepreneur. Keynes’ consumption function has not in the least any micro-economic foundations. I have tried to emphasize this proposition which explains the vanity of the erstwhile so-called “Disequilibrium school”. The Income-Earner is not free of thriftiness, he spends only a share of his income, the famous propensity to spend being some decreasing function of the level of income, so that
(6) C = a Y
a = 1 - s (7) a = a (Y) (8) a’ = A (Y)
A’ < 0.
The function unveils Keynes’ deep pessimism relative to human nature with its unsound quench for accumulation of wealth out of parsimony, which is the mark of its irrationality. Effective income is meeting the valorization condition:
(9) Y = (1 - a) Y + I
Y = 1/s I. It spells out the “Principle of Effective Demand”: I and the consumption function allow The Entrepreneur to know what level of aggregate demand will exist, and therefore be effective since it is the value of the ongoing production - the effective level of income. The principle determines the unique level of income for which the loss of value induced by saving is compensated by the value accruing from investment. It is therefore determining employment as a function of both investment and the propensity to save, which is a rising function of income.
The employment function is the climax of Keynes’ revolution because it unveils the absolute subordination of Job-Seekers. The Entrepreneur fixes employment at the level that allows him to exact the maximum profit out of income created by effective demand. He allocates the profit in his capacity of the Capitalist, “he who owns real wealth”. The maximum profit is reached when the rate of profit is equal to the given level of the rate of interest - an equality, which is handled by the Capitalist through the determination of investment. Neither the Entrepreneur nor the Capitalist are concerned by the collective Job-Seeker’s desire for work. The function emphasizes the paramount negative impact of thriftness: the higher is s, the lower is income and therefore employment, for a given rate of profit. For Keynes, amid those who are the recipients of income (the Capitalist and the Worker or Job-Seeker), the Capitalist is the one who suffers form the psychic disease of “thriftness”7 because his own income is incommensurable relative to the Workers’ income. This is the ultimate mark of the Worker’s subordination: Employment shrinks when the whimsical Capitalist decides to save more. There cannot be a compensating increase in investment because the Capitalist revels in thriftness because he does not want to invest. That will be the next step of the Keynesian revolution.
The employment function proves that all unemployment is involuntary and that involuntary unemployment is always possible.
Money Is Non-Neutral:
The Preference For Liquidity Explains Why Investment Does Not Generate Full Employment It is not enough to prove the possibility of unemployment. Keynes has now to prove that unemployment is the normal situation or that the true anomaly is full employment. The root of unemployment is the level of investment which is always too low to generate enough effective demand to hire all Job-Seekers and which cannot therefore compensate for the existing propensity to thriftness. The lack of investment is the outcome of the non-neutrality of money. Here is the core of the famous “liquidity preference theory” which, according to Keynes, was his most remarkable achievement that closed his General Theory of the capitalist economy. The identity has shown that saving is generated by investment, that the liquidity preference theory determines the level of investment, and proves that the employment function is the theory of unemployment.
For the Capitalist, investment is just a part of the allocation of his fund of wealth in various components. Wealth can be held in real asset, in financial assets, and in money. What Keynes deems “investment” is the desired increase in the stock of real assets, which is the outcome of a substitution effect shifting funds from money and financial claims to real capital. Each form of wealth has its specific yield, the rate of profit for real capital, the rate of interest for financial assets, and the liquidity preferences’ non-pecuniary yield for money. By shifting wealth from one form to another, the Capitalist is always targeting the equality of those yields, which explains why there is always an equality of the rate of profit to the rate of interest and to the liquidity preference. Herein is the cornerstone of the non-neutrality of money, the benchmark of the monetary production economy.
Money is the unit of account into which all assets value are denominated. The Capitalist is certain that the money value of real assets and financial assets falls when there is an interest rate hike or a lower rate of profit than the expected one in the case of capital assets. It is certain that the money value of wealth held in money is constant. Money provides him with the perfect insurance against losses of wealth. In an economic universe ruled by absolute uncertainty, the Capitalist cannot hinge on conventional probability computation to control the risk of loss. He is desperately searching for a safe form of holding his wealth and, by its intrinsic nature, money is the sole safe haven. Keynes’ theory of money relies upon a Freudian psychoanalysis of the Capitalist collective mind (Dostaler and Marris, 2000). Beyond the veil of apologetic rhetoric, Keynes discovers the sudden and indomitable lust for protection against a hostile universe. Were money be non-scarce because the Capitalist could get it either by resorting to some other force or by producing it in his capacity of Entrepreneur, it would be a free commodity without of intrinsic value. By its very nature, money is scarce; it embodies scarcity, which means that the Capitalist cannot get it at will since the available quantity of money is independent of his desire. To quench his desire, the Capitalist has to sacrifice other forms of wealth. Here is the foundation of the specific value of money. The scarcity of money provides its holder with a specific yield - the liquidity preference -, which is the translation in money units of the Capitalist’s lust of protection or liquidity. Were money a free commodity, its yields would be nil, and it would be neutral since it could not have an impact on investment.
Arbitration between money and financial assets leads to the equality of the rate of interest to liquidity preference. The latter being exogenously given, it determines both the level of the rate of interest and its very existence. When some exogenous power - the state - decreases a higher stock of money, money becomes less scarce relative to the Capitalist’s desire. It provides a lower yield allowing the fall of the rate of interest. In Keynes’ world, the rate of interest reflects the permanent equality of the exogenous stock of money to its desired amount as a component of wealth.
Arbitration between financial assets and real assets imposes the equality of the rate of profit to the rate of interest. The rate of profit is therefore ultimately determined by the Capitalist’s liquidity preference. It reflects the relative scarcity of capital, and capital is scarce because money itself is made scarce. Keynes’ capital theory relies on an inverse relationship between the stock of real assets and the rate of profit that could be mistaken as a classical curve.8 It means that an increase in the stock of real assets automatically leads to a fall of the expected rate of profit because the Capitalist is frightened by the lack of future aggregate demand (the Keynesian Capitalist has some entropic “vision” of the future). The Capitalist would never accept to increase his stock of real assets in the absence of a fall of the equilibrium rate of profit, which is the rate of interest. The Keynesian capital curve is tantamount to the proposition that investment is determined by the rate of interest, which is itself the mirror image of the capitalist thirst for money.
In a world ruled by an objective scarcity of money and the Capitalist’s unbridled loathe for entrepreneurial adventure that would force him to leave the protective cocoon of money, the rate of interest is always too high to sustain full employment. The Keynesian revolution justifies the absolute pessimism of Keynes relative to the future of capitalism. It has turned the economy into a pure rentier economy of self-imposed scarcity. Entrepreneurs are pretending to behave as the Entrepreneur but they are disguised components of the rentier meta-mind whose income is a rent exacted on society. Involuntary unemployment is the price society has to pay for the rule of the rentier.9 Keynes has proven that deflation now and forever is not the shock therapy of unemployment because it cannot exercise the evil rentier spirit which is the force animating investment.
3: The Aftermath of the Keynesian Revolution: From the Rentier Paradigm to the
Theory of the Monetary Circuit Keynes’ hopes have been disappointed. In the early twenty-first century, classical orthodoxy still rules supreme over economic theory and policy. The same people who celebrate the “new economy” are enthralled to the saving postulate and push for shock therapies of deflation. Keynes has been never forgotten, but his remembrance is not enough to challenge the orthodoxy. It is not amazing if those who remember Keynes are neo-classical economists whose makeshift theories aim at reconciling Keynes with the classical orthodoxy. The transmogrification of Keynes began in the late thirties with Hicks and his IS-LM model. It was tried again by the disequilibrium theory of Clower in the late sixties and again by the new Keynesians in the nineties, who restored the saving postulate in its most explicit form (Rochon, 1999). It could be astounding if Keynes is remembered by those who deem themselves post-Keynesians, because, on one side, they share Keynes’ critique of the classical orthodoxy, and, on the other side, they explicitly want to elucidate those aspects of Keynes’ economics Keynes himself had not unveiled (or fully unveiled). Sixty years of post-Keynesian economics have not shaken the ruling orthodoxy because the Keynesian legacy includes a false theory of money leading to an over-simplified vision of modern capitalism.
A Dangerous Legacy:
The False Keynesian Theory of Money, But Forever Keynes Ultimately, Keynes substituted the scarce money postulate for the ancient saving postulate. He never doubted it because that would have undone his theory of employment. The famous finance motive is just increasing the relative scarcity of money since there is a rise in the desired stock of money relative to a scarce available stock. The postulate implies that money matters as long as it is desired as a form of wealth. As a means of payment, money is neutral, which explains why Keynes never bothered with the sources of finance for effective demand (Parguez, 2001). No circuit process can be discovered in Keynes’ economics from the Treatise onwards, even in the income equations, which are instantaneous relationships, which do not display a temporal causal link between firms’ outlays in one period and their receipts or proceeds in the same period.
The Keynesian postulate contradicts Keynes’ method because it does not fit into the General Theory of money, which has been spelled out by the theory of the monetary circuit (TMC). Using Keynes’ logical realism, the TMC proves that it is impossible to deny the saving postulate while asserting the scarce money postulate. Money cannot be scarce because it exists to provide firms, the state and income-earners with the finance they need to undertake their desired expenditures. The nature of money is therefore the debt titles issued by banks and the state central bank on themselves as the counterpart of credits granted to firms, income-earners and the state (Parguez, 2001). Being perfectly endogenous relative to effective demand, money is not scarce, and the liquidity preference vanishes. Keynes’ initial mistake was to maintain the neo-classical notion of the demand or desire for money, hoping that he could prove the non-neutrality of money by bringing about the proof that the demand for money is inconsistent with full employment. Likewise in neo-classical economics, the Keynesian money is a commodity endowed with an intrinsic value originating from its scarcity. Liquidity preference is a disguise of marginal utility. Positive and true money has no intrinsic value, its value is extrinsic originating from the ability of borrowers to generate real wealth out of their expenditures. Logically, money is created to be destroyed in the reflux phase of the monetary circuit when loans are recouped and when taxes are collected. The Keynesian demand for money does not exist as an irresistible alternative to the creation of real wealth.
Keynes’ false theory of money was rather infelicitous relative to his vision of capitalism and the role he gave to economic policy. Capitalism is not ruled by financial capitalism which is not the sole lust for hoarding. Keynes’ vision of a capitalist system motivated by the thirst for money as gold or quasi-gold is identifying capitalism with some feudal or pure mercantilist economy. It is a very romantic vision, which has always reminded me of Wagner’s Rheingold and the early nineteenth century British romantics. Believing that the Entrepreneur was nothing but the Capitalist himself, Keynes ignored modern firms and did not pay attention to their specific profits. His romantic vision led him to a very offhand theory of economic policy. We know what must not be done - deflation -, but we do not know what must be done. Sometimes, Keynes advocated public works but he could not explain how they could fit with his scarce money postulate. Whence would arise the funds is a mystery. Another mystery is the response of the always afraid Capitalist who could be frightened by some reinforced scarcity or money and increase accordingly his desired hoarding - some Keynesian version of the crowding-out play. No economic policy can be tried without having to first soften or suppress the yoke of the law of money scarcity. It would require some “socialization of investment”, another name for the romantic “euthanasia of the rentier”. Keynes never advocated some collectivization of capital that would bestow dictatorial power on the bureaucratic state he loathed. He had just in mind a world where investment would be freed from the yoke of desired hoarding by some moral reform of the Capitalist. Ultimately relative to economic policy, Keynes shared Hayek’s pessimism. When Hayek emphasized the inefficiency of state intervention, he was motivated by his faith in spontaneous market laws. For Keynes, emphasizing the same inefficiency is revealing his absolute pessimism since he knew that Hayekian market laws do not exist.
The True Legacy or Beyond Keynes Post-Keynesians failed because they wanted to be obedient to the whole legacy. Their dedication to the scriptures lured them into preserving liquidity preference and what lies underneath the scarcity of money postulate. They could henceforth never be more convincing in asserting that Keynes himself is the positive reconstruction of economics either in terms of economic theory or in terms of economic policy.
As a humanist, Keynes had bequeathed to us the vision of the true role and mission of economics. It is the science of liberty allowing humankind to break up the artificial constraints imposed by the ruling class(es) out of fear of losing their preserve of control. Keynes teaches us that arbitrary power thrives on scarcity or fear of scarcity. This explains why deflation is the perennial temptation of policy, whether it is undertaken by domestic states or supranational organizations is irrelevant. The starting proposition of the theory of the monetary circuit is indeed that, but in exceptional situations, scarcity does not exist as an objective constraint. Keynes has also bequeathed to us his method of logical realism, which must be applied to the discovery of the true founding principles of the monetary production economy. The cornerstone is the principle of essentiality of money, which means that money is the existence condition of the monetary production economy that is the capitalist economy. Essentiality of money contradicts the scarcity of money postulate. Keynes had been unfaithful to his method. Keynes has at least bequeathed us the principle of effective demand. Global demand is always an autonomous constraint firms have to bet on. Nobody should therefore doubt the existence of a resilient involuntary unemployment, which cannot be suppressed by automatic adjustments when employment is imposed by firms on job-seekers. The theory of the monetary circuit allows us to generalize the Keynesian propositions by getting rid of the hoarding-addicted Capitalist-led economy postulate.
I hope that the reader is now convinced that Keynes belongs to the twentieth century intellectual Pantheon instead of being a mere chapter in a dull and dusty textbook on the history of economic thought. Without Keynes, we would still be in a quandary suffering from an orthodoxy we do not dare to doubt.
References Dostaler, Gilles and Marris, B. 2000. “Dr. Freud and Mr. Keynes on Capitalism” in John Smithin (ed.), What Is Money?, London and New York: Routledge.
Keynes, John Maynard. 1930. “A Treatise on Money” in The Collected Writings of John Maynard Keynes. Edited by Donald E. Moggridge et al. 30 vols. London: MacMillan and New York: St. Martin’s Press. Vol. VI.
Keynes, John Maynard. 1936. “The General Theory of Employment, Interest and Money” in The Collected Writings of John Maynard Keynes. Edited by Donald E. Moggridge et al. 30 vols. London: MacMillan and New York: St. Martin’s Press. Vol. VII.
Keynes, John Maynard. 1937. 1939. “The General Theory and After” in The Collected Writings of John Maynard Keynes. Edited by Donald E. Moggridge et al. 30 vols. London: MacMillan and New York: St. Martin’s Press. Vol. XIV.
Parguez, Alain. 1998. “The Roots of Austerity in France” in Joseph Halevi and Jean-Marc Fontaine (eds.), Restoring Demand in the World Economy. Trade, Finance and Technology, Cheltenham, UK and Northampton, MA, Edward Elgar. 209 pages.
Parguez, Alain. 2001. “Victoria Chick and the Theory of the Monetary Circuit: An Enlightening Debate” in Philip Arestis, Sheila Dow, and Meghdad Desai (eds.), Festschrift Victoria Chick. London and New York: Routledge.
Parguez, Alain, and Seccareccia, Mario. 2000. “The Credit Theory of Money: The Monetary Circuit Approach” in John Smithin (ed.), What is Money?, London and New York: Routledge.
Rochon, Louis Philippe 1999. Credit, Money and Production: An Alternative Post-Keynesian Approach, Cheltenham, UK and Northampton, MA: Edward Elgar. 341 pages.
1 The author is Professor of Economics at the University of Besançon in France.
2 While, as usual, I do not want to implicate them, I have been greatly stimulated by years of discussion with Thomas Ferguson, Joseph Halevi, Marc Lavoie, Louis-Philippe Rochon, and Mario Seccareccia.
3 In the General Theory, Keynes refers to the Ricardian holy inquisition and not to a neo-classical inquisition. The dogma lies in the ancient classics; their neo-classical followers have changed the ritual - that is obviously what Keynes had in mind.
4 Keynes’ rebuff of Marxism has nothing to do with efforts to save capitalism from itself. Keynes had just contempt for the social democrats of his time.
5 I never understood the national accounting Keynesianism because national accounts embody the classical orthodoxy when, for instance, it emphasizes the distribution of a given value-added or net product. It is impossible to derive the Keynesian causal identity from national accounts (Parguez, 1998).
6 It would be more logical to substitute global demand for aggregate demand because there are no true aggregates in the economics of Keynes. Reality only exists as global. There is no atomistic data that could be aggregated. A corollary is that micro-economics is a logical impossibility.
7 The national accounting notion of households is a spurious one which does not fit into Keynesian economics.
8 The Keynesian capital curve does not hinge on the decreasing marginal productivity of capital. The rate of profit is not equal to the neo-classical marginal productivity of capital. Like Joan Robinson later, Keynes explicitly rejects the neo-classical production function.
9 Keynes’ impassioned denunciation of rentier capitalism stirs echoes that are not social democrat third-way like. “It 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 (Keynes, 1936, p. 376)”. By imposing scarcity, the capitalist generates the rate of profit!