Alternative Insight

Was Keynes More than a Little Wrong?
An opinion, only an opinion



John Maynard Keynes is the most well known economist of the Twentieth century. His contributions to political economy and his prolific output merit highest recognition. Nevertheless, claims of his having solved the economic crises of the Capitalist system have not been substantiated. John Maynard Keynes was a brilliant economist and deserving of praise. However, an analysis of the British economist's principal theories of resolving an economic crisis, which proceeds from a different approach than those of his normal detractors, concludes that Keynes was more than a little wrong

Demand
Start with Keynes' most discussed assertion, seconded by his ardent followers, such as Paul Krugman, which argues that lack of demand is the main cause of a failing economy and promotes deficit spending to increase the demand and rescue the economy.

By citing "leakages" in demand, Keynes countered arguments by economists Jean-Baptiste Say and David Ricardo that supply always has demand and production of goods are always cleared. These leakages occur from unspent funds in the money supply. Although the latter might be correct, is lack of demand a result rather than the principal problem of a falling economy?

Supply, which is production of goods, has a guaranteed built-in demand, the wages of the workers for established goods. In a well-functioning and balanced system, purchasing power equals the production of goods. This does not mean that supply will always clear the market at an original price - a negative current account, financial speculation and other transactions divert internal purchasing power, and lead to available funds becoming less than total production costs. Decreased purchasing power predicts faltering supply. Artificial stimulation of demand by private debt and government deficit spending temporarily replace the aggravated diversion of purchasing power into imports, speculation and inability to use profits for investment, all of which are the real causes of the economic downfall.

From where does the Great Recession's lack of increasing production arise? A system that has recurring problems must have structural deficiencies. The present decline in the U.S. economy exhibits an inhibition to reinvest profit internally, and this problem causes inadequate internal demand. Increasing demand by deficit spending is only a temporary expedient, also subjected to "leakage," and not a permanent solution. Although deficit spending has a significant role in relieving unemployment and stimulating production, its effects are not guaranteed. In present history, budget deficits have only slightly budged the GDP.

Banks have money to lend and interest rates are low, but no demand. Why? Because banks sense the lending will not stimulate production and supply. Further increases in the money supply from the vault of reserves might only unleash a huge inflation - at least that seems to be the consensus.

Adding to the dubious concept that increasing demand by increasing the money supply automatically increases employment, Keynes also asserted that the increased demand has a multiplier factor that generates more income. However, has the theory worked practically?

income Multiplier
Keynes theorized that an increment of aggregate investment will increase national income (GDP) by an amount that is k times the increment of investment. He called k the investment multiplier.Using the equation dYw = dCw + dIw, where dYw is national income (expressed in wage units) and Cw and Iw are the increments of consumption and investment, and defining dCw/dYw as the marginal propensity to consume, and equal to 1 - 1/k, Keynes determined that dYw = k x dIw.

The greater the marginal propensity to consume, the greater is k, and greater the multiple of national income. In practical terms, as workers spent the wages resulting from a new investment, new production will hire workers, who will then spend the wages for new produced goods, who will hire new workers, and so forth. National income will multiply until "leakage" sheds the system of more increases in purchasing power. The theory seems to fall apart at an extreme; if all increase in investment is spent for consumption, the multiplier becomes infinite and a perpetual expanding economic system occurs.

Actually, the theory does not fall apart, but demonstrates the real message of the "multiplier" - if all of a production cycle is purchased, the production cycle can be indefinitely repeated - no multiplier; just the same investment being constantly reinvested. A cycle of investment folllowed by a cycle of total consumption propels a new cycle of investment and consumption. Similar to a machine that continues to run when lubricated from friction, the capitalist system continues to run when there is no friction (leakage) to prevent investment from being totally consumed. Keynes only redefined a theoretical capitalist system.

A simple example demonstrates that the concept of an income multiplier is a misinterpreted concept.
Toss $1 billion into an economy that has no leakage. Those receiving the $1 billion largesse can purchase production from B workers, who purchase production from C workers, and so forth. After all goods are purchased, the added $1 billion remains. What happens to it? The remaining funds either increase the prices of the limited goods or are invested into new production. Ignoring the service economy, where money, independent of a new investment, can continually circulate, provide temporary employment and add to GDP, the real product GDP grows by only $1 billion, the same amount as the additional investment, and employment grows only to accommodate the new production. Time constraints limit the investment and no practical multiplying factor exists. If the original investment is never totally consumed, then over a long period of time, the GDP will eventually decrease to the GDP before introduction of the added investment.

Viewed as an investment being added to the GDP by a value of more than unity, the income multiplier formula also contradicts the equation of exchange,

MV = PT = GDP

where

M = Money Supply,
V= velocity of money,
P = price.,
T = number of transactions

Because the money supply has increased by only the investment, and the income multiplier formula does not include an increase in the velocity of money, the GDP cannot increase more than the investment.

Although other factor totals must be considered for the years shown, such as household disinvestment (~$500 billion) and current account deficits ( ~$1000 billion), which counter spending, if an income multiplier has a practical existence, why has the GDP increased by only 600 billion from 2010-mid 2012, during which time the government ran deficits that totalled almost $3000 billion. Where has the stimulus been multiplied?

BILLIONS OF CHAINED 2006 DOLLARS
2010 2011 2012
    SEASON   ADJUST  AT  ANNUAL  RATES        
I II III IV I II III IV I II
GDP 12,947.00 13,019.60 13,103.50 13,181.20 13,183.80 13,264.70 13,306.90 13,441.00 13,506.40 13,558.00
Personal consumption 9,100.00 9,159.40 9,216.00 9,308.50 9,380.90 9,403.20 9,441.90 9,489.30 9,546.80 9,582.00
Goods 3,159.00 3,185.40 3,215.10 3,276.50 3,320.30 3,312.20 3,323.50 3,367.90 3,406.60 3,412.80
Services 5,940.00 5,973.60 6,001.40 6,034.90 6,064.80 6,094.00 6,121.10 6,126.00 6,145.90 6,174.50
Gross pvt dom invest 1,591.00 1,646.40 1,710.10 1,684.30 1,661.60 1,711.30 1,735.80 1,867.30 1,895.10 1,934.00
Government
Total receipts 3,846.00 3,877.90 3,965.80 4,017.00 4,078.90 4,106.30 4,090.70 4,126.50 4,281.00 ---
Total expenditures 5,535.00 5,603.40 5,578.30 5,593.80 5,596.40 5,699.70 5,635.60 5,639.90 5,622.80 5,645.50
net borrowing (-) -1,689.00 -1,725.60 -1,612.50 -1,576.70 -1,517.50 -1,593.40 -1,544.80 -1,513.40 -1,341.80 ---

Using artificial stimulation of demand by deficit spending, Keynes envisioned a solution to the economic cycle. Deficit spending is the natural response to augment a money supply that is stagnant due to diminishing private debt and is being reduced by bankruptcies. Nevertheless, its practical implementation is not simple.

Misdirected Stimulus
Interpretations of Keynes consider that any deficit spending will stimulate the economy. Public work projects, especially attention to improving infrastructure, are most mentioned as the desirable recipients of government largesse. Not considered is that a temporary stimulus must result in additional manufacturing of goods or the newly circulated money will only result in either temporary employment or eventually provoke an eventual increase in prices. Deficit spending must be targeted to permanently increase production and permanently increase employment.

The Obama administration successfully accomplished permanent increases by providing funds to the automobile industry and unfortunately failed by subsidizing the eventually bankrupt Solyandra. Nevertheless, without employment of workers for increased production, preferably of either export industries or those that compete with imports, the increase in money supply will either augment the service economy, provoke inflation, or eventually "leak" from the system to import purchases and outsourcing.

Keynes focused on "leakage" and its damage to the economy - incompletely. He failed to realize the overriding position of profits, or, to use Karl Marx's wider description - surplus value.

Leakage
Marx showed, although Keynes did not agree, that profit (surplus value ) is the engine of the capitalist system. Quoting Marx, "Capitalist production is not merely the production of commodities, it is essentially the production of surplus-value. The labourer produces, not for himself, but for capital. It no longer suffices, therefore, that he should simply produce. He must produce surplus-value. That labourer alone is productive, who produces surplus-value for the capitalist, and thus works for the self-expansion of capital."
(ref.1) Reinvestment of profits in capital goods or new production is the multiplier that creates more goods and more labor. To Marx, the function of the capitalist system is to generate new capital - when that slows and halts, as it often does, so does the capitalist system.

Insufficient attention as to how profits are made, and what happens if they are not distributed or reinvested degraded Keynes'analyses. According to Keynes, "the only reason capital yields a surplus value is because it is scarce. If capital weren't scarce, there would be no surplus value. Indeed, the value of capital would be zero, or what comes to exactly the same thing, there would be no capital at all."

Purchasing goods involves redeeming costs and providing profit. Aggregate wages in the system accommodate costs, but from where do the profits arise? A positive current account (money enters the nation's economy), government and private debt and immediate re-circulation of the profit enable profits to continue and investment to grow. A negative current account, diminishing private debt (overcome by deficit spending), and failure to distribute and.or reinvest profits perform the opposite - profits are reduced and the economy grinds to a halt.

Keynes wanted to increase supply by creating demand, but neglected to realize that the supplier will only meet the demand if assured of continual profits. Without assured profit, the increased demand will not result in increased investment, which leads to the principal problem - unless there is a positive current account and minimal financial speculation, maintaining profit will depend on growing credit and credit will eventually reach a maximum level.

Making a profit system work continually without recourse to excessive credit is the challenge for economists. Keynes did not meet that challenge. He only recommended replacing diminished private debt with increased public debt, a temporary expedient until debt again hits a wall and the crash causes the next "bust." The British economist had it backwards - demand does not stimulate production and profits. Profits, continually obtained and properly reinvested, stimulate demand. "Leakage" of money supply does not lower a national income multiplier; it lowers the investment of profit and stagnates the system. Nevertheless, no matter the palliative, a profit system is eventually doomed, and a capitalist system will be compelled to make adjustments. Profits fire the capitalist system and falling profits forecast the dying embers.

Supply and Demand
Keynes held that overproduction arises when consumption lacks behind income; needs have been met and consumers' savings are not adequately invested.
Three contradictions - (1) By Keynes' own admission, SAVINGS = INVESTMENT; either the income is spent or its savings become investment. (2) When material goods have been satisfied, services are purchased. The service economy then purchases the goods. As industrial growth has slowed, the service industry has grown, and (3) Overproduction has occurred when savings have been nil. Low savings has been a feature of the American economy for a decade, while high savings has been prominent in the Chinese economy. Which economy has grown faster, and which economy has declining production? Reason - The Chinese complemented high savings with high exports. External demand replaced internal demand.

Keynes correctly focused on lack of investment as a reason for declining production. However, he, again, only redefined the Capitalist system - if capital does not regenerate capital, the system collapses.

Historical Keynes
Modern history portrays Lord Maynard Keynes as the man who lifted the United States out of the Great Depression and successfully promoted government deficit spending as a cure for ailing economies. History does not validate these descriptions. Keynes wrote valuable treatises on economics, and his concepts and presence complemented state intervention into the economy. United Kingdom governments during the 1950's and 1960's used Keynes' proposals of full employment and income re-distribution to succesfully guide their economies to moderate prosperity and stability. Nevertheless, his theories on rescuing falling U.S. economies never translated into official U.S. policies. State intervention in the economy (remember Teddy Roosevelt and the monopolies) preceded Keynes and did not rely on Keynes. Welfare capitalism arose from an obvious need and not from a doctrine.

President Franklin D. Roosevelt's intervention policies commenced before he knew or met (one time) with Keynes in 1934, and they occurred several years before publication of Keynes' 1936 treatise "The General Theory of Employment and Economics." Correspondence between the British economist and the U.S. president were a one-way street. Keynes sent a nine-page letter to the American president in 1938 and received a one-page form letter prepared by the Secretary of the Treasury,
(ref. 2) which had no comments on Keynes' detailed proposals. Roosevelt acted independently of John Maynard Keynes. Any policy relationships were purely coincidental. John Kenneth Gailbrath verifies this thesis.

The following year he visited FDR, but the letter had been a better means of communication. Each man was puzzled by the face-to-face encounter. The President thought Keynes some kind of 'a mathematician rather than a political economist.' Keynes was depressed; he had 'supposed the President was more literate, economically speaking.' (ref. 3)

M.S. Eccles, one of Roosevelt's closest advisors also commented that with the exception of two advisors, none of those who developed the New Deal had ever heard of Keynes. (4)

Deficit spending has been a tool for increasing national income in good times, bad times and no times. President Ronald Reagan, no Keynesian, exploited the use of deficit spending to invigorate an economy during an era of high interest rates - a recession soon succeeded rapid growth. President Bill Clinton used government surpluses to tone down excessive private debt and, according to some, provoked the 2001 recession. President George W. Bush went all out to increase the money supply and prosperity by encouraging low interest rates and deficit spending - the result was the Great Recession. President Barack Obama has used huge deficits to maintain employment, especially to prevent states from discharging teachers and other public personnel. Efforts have prevented a declining economy from going into a more severe downturn, but have failed to sufficiently stimulate the economy. Results have been only a small decline in unemployment and a slight rise in GDP.

Keynes was more than a little correct in many of his ideas, and more than a little wrong in the direct application of some of his economic theories. Economists were greatly wrong in their conclusions that Keynes had an impact and influence in resolving the constant crises of capitalism, which Karl Marx had predicted before their happenings. By contradicting the classical economists, Adam Smith, David Ricardo and Karl Marx, and attempting to supplant them with his own theories, Keynes slightly diverted the progress of economic theory to a side road rather than enlarging upon a substantial knowledge and maintaining economic theory along a smooth road.

1. Karl Marx. Capital Volume One

2. Exchange of letters between FDR and J.M. Keynes, 1938. http://www.fdrlibrary.marist.edu/aboutfdr/budget.html

3. John Kenneth Galbraith, The Age of Uncertainty

4. The Crisis of Keynesian Economics. Geoffery Pilling

alternativeinsight
july, 2012

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