An Analysis of the Paper "What is Post Keynesian Economics "

In my paper titled “What is Post Keynesian Economics” presented at the 4th International Post Keynesian Workshop at the University of Tennessee, I argued that Keynes’s Treatise and the General Theory provided the groundwork for an intellectual revolution in economics. By questioning some basic assumptions and bringing money and financial markets into the determination of real output and employment, Keynes posed a serious challenge to the classical model that is still relevant today. Unfortunately, this revolution was aborted and replaced by what has been called the “grand neoclassical synthesis” by such economists as Samuelson, Solow, Tobin, and Modigliani in the 1950s and 1960s.

I also argued that the “new” Keynesians are just the “old” synthesized Keynesians disguised in new clothing and many heterodox economists who claim some adherence to post Keynesian economics have through their “Babylonian tradition” dropped the “Keynes” out of the post-Keynesian. Finally, I discussed what I consider to be the four fundamental features of post-Keynesian economics. The first feature is that the primary goal of post-Keynesian economics is to understand the nature of the capitalist system and to develop a practical understanding of how to deal with economic problems in the present-day world.

The second is that the future is uncertain and the past is immutable.

From Chapter 12 of Keynes’s General Theory, situations of uncertainty cannot be adequately modeled in terms of probability distributions and because of this, a difference needs to be made between uncertainty and risk where uncertainty is the general case and risk the particular.

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The real-world economic system that entrepreneurs and consumers face is not a system that can be statistically controlled by probability theory or predicted by future outcomes of variables determined by some present value formula. Recognizing the importance of non-probabilistic uncertainty in economic decision-making also brings up the importance of looking at the economy as moving through historical time which is the third feature. Rather than looking at time as a symmetric variable where in the long run economic agents never make mistakes, Keynes argued that the economy moves through a real historical time where economic decisions are made in a world that has an unknowable future, influenced by one’s past. Because of uncertainty in the world, the fourth feature is looking at the role that institutions and public policy play in the economy. Given the precarious nature of the future, Keynes recognized that long-term development and stability in the economy required institutional arrangements and public policies. This has always been a very important part of post-Keynesian economics and is represented by such post-Keynesian policies like TIP, policies to control speculation on the dollar, and banking policies that guarantee the security of deposits. Also, post-Keynesianana economy where the future is unknown, contractual agreements through institutional arrangements are needed to incur the factor inputs necessary for efficient production through historical time. Such contractual agreements require money and liquidity so that entrepreneurs can meet their contractual liabilities before production takes place. This leads us to the importance of monetary and financial institutions or the role of money in an entrepreneurial money exchange economy. For Keynes, money is never neutral except under unusual circumstances.

These features can be found throughout Keynes’ writings and gave him insights and a vision in which lot the economic problem was not simply being the question of how to allocate scarce resources efficiently in a predictable and certain world. Keynes saw the economic problem more in the context of a social, institutional, and political setting in a world that is uncertain. This comes clear in such passages as this one from the End of Laissez-Faire:

Many of the greatest economic evils of our time are the

fruits of risk, uncertainty, and ignorance. It is because

particular individuals, fortunate in  a situation  or in

abilities can take advantage of uncertainty and

ignorance, and also because for the same reason big

business is often a lottery, the great inequalities of

wealth comes about, and these same factors are also the

cause of the Unemployment of Labour, or the

disappointment of reasonable business expectations, and

of the impairment of efficiency and production. Yet the

cureincurtain lies outside the operations of individuals; it may

even be to the interest of individuals to aggravate the

disease. I believe that the cure for these things is

partly to be sought in the deliberate control of the

currency and of credit by a central institution… These

measures would involve Society in exercising directive

intelligence through some appropriate organ of action

over many of the inner intricacies of private business,

yet it would leave private initiative and enterprise

unhindered. (Keynes, 1963, pp.317-318).

This passage is as relevant today as it was when Keynes wrote it in the 1920s. Also, this view provided Keynes with cautious optimism that allowed him to say “…the economic problem may be solved, or at least within sight of a solution… This means that the economic problem is not — if we look into the future — the permanent problem of the human race.” (Keynes, 1963, p. 366) Keynes could hold this cautious optimism because he believed that through social and political means and the dedication of individuals to high professional standards the economic problem could be dealt with. Such optimism could never be gotten from the neoclassical model because built into its assumptions is the view that the economic problem is a natural and inseparable law of nature. The features that Keynes believed gave such vivid insight into the nature of our real-world economic life is simply removed from orthodox economics.

Today, for post-Keynesians, the message is the same and the task at hand is similar to the one Keynes stated in chapter 1 of the General Theory:

I have called this book the General Theory of Employment,

Interest and Money, emphasizing the prefix

general. The object of such a title is to contrast the

character the of my arguments and conclusions with those of

the classical theory of the subject, upon which I was

brought up and which dominates the economic thought,

both practical and theoretical, of the governing and

academic classes of this generation, as it has for a

hundred years past. I shall argue that the postulates of

the general theory sand a special case only

and not to the general case, the situation in which it

assumes being a limiting point of the possible positions

of equilibrium. Moreover, the characteristics of the

spathe cial case assumed by the classical theory happens not

to be those of the economic society in which we actually

live, with the result that its teaching is misleading and

disastrous if we attempt to apply it to the facts of

experience. (Keynes, 1936, p.3)

The classical theory that Keynesthat refers to is still the foundation of orthodox economic thought represented in monetarism, the neoclassical synth,eisandsandthe in, lot the can meet at and, the counter-revolution of the new classical critique of Keynesian economics. Looking ahead we can see two fronts that post-Keynesians must deal with which is reflected in the two primary goals Keynes set out for the General Theory: The first is to get the theory right and extend the logic of that theory to explain how we might deal with economic problems like uncertainty and unemployment in the real world that we live in today. Paul Davidson for years, and many messages over pkt, has argued that to truly understand and extend Keynes’s insights and logic you must first understand why Keynes rejected three significant assumptions of the classical model. They are 1) The rejection of the neutrality of money; 2) the rejection of the “gross substitution” assumption that everything is a substitute for everything else; and 3) the rejection of the assumption that the economy moves through an ergodic system that is reliable and predictable (Davidison, 1994, p. 17). My reading of Keynes supports Davidson’s message, and I believe will provide post-Keynesians a guiding hand in developing new models and establishing a new research agenda for dealing with the new economic and social challenges that we will be facing in the next century. This takes us to the second primary goal Keynes had in the General Theory which was more political. It also represents Keynes’s criticism of classical economists who relied on economic prediction instead of economic policy in guiding the future of the economy. The second primary goal for Keynes was to establish public policies that would increase the performance of Britain’s economy. Relying simply on the predictable forces of the market might not lead a nation’s economy to a level of full employment with stable prices. What might be needed, Keynes believed, are particular public policies to help sustain long-term economic growth.

These goals of getting the theory right and establishing public policies are still relevant today but differently. The theory and policy implications we should be concerned about are not with a closed economy as Keynes focused on but an open economy in the new information and technological age. One of the major contributions that Marx provided to the history of ideas was his ability to break through what seemed to be the impenetrable logic of Hegel’s system. Keynes did the same thing by breaking through the logic of Say’s law which questioned the foundation of the classical model in a closed economy. Post Keynesians today need to take that insight and extend it now to an open economy by challenging the gospel truth of comparative advantage. Similar to Say’s law, comparative advantage holds only under limited cases. These limited cases are not represented in the world we live in today with flexible exchange rates and high levels of worldworldwideployment. Similar to applying and carrying out public policies based on the assumptions of Say’s law in the 1930s, we can find ourselves in the next century with a theory that can lead to a worldwide economic disaster.

From World War II to the late 1960s the world saw considerable economic growth with low rates of unemployment and acceptable levels of inflation. Starting in the early 1970s, we saw the sequence of events that gave way to high rates of unemployment and fear of inflation. The fear of inflation led governments in the 1970s to focus on restrictive aggregate demand policies that had some impact in reducing inflation but created higher rates of unemployment in industrialized countries as compared to a decade earlier. Finally, with the oil shock of 1979-1980, policies were set into place that guaranteed an inflationary bias in government policies which is still true today. With the comfortable collusion of economists and politicians, strongly influenced by the views of the financial sector, we see an inflationary bias where price stability is a more laudable goal than full employment. Inflation’s most corrosive impact is caused by uncertainty about price changes. The adverse effects of anticipated inflation can be compensated, Keynes believed, by creative institutional changes Unemployment o, on the other hand,s an unambiguous loss to society, and can contribute to poverty, disease, homelessness, and racial antagonism, and crime. Social ills that we have seen increased over the last decades in the United States.

With the inflation bias that started in the early 1970s, we also saw the breakdown of the Bretton Woods agreement which had a significant impact on the global economy. With the end of the Bretton Woods agreement, we saw the introduction of flexible exchange rates and efforts to deregulate international capital markets. The consequence of these policies became evident in the 1980s with the debt crisis that plagued Mexico and other Latin American countries and in the 1990s with the Asian crisis where we saw significant currency devaluations and international capital flows guided by fears of exchange and interest rate speculation and not by long term real investment. As long as the current international trade policies stay in place we can expect to see this type of economic instability facing different world regions in the decades ahead.

To respond to the social and economic needs of the world, as mentioned earlier, post-Keynesians need to take the initiative both at the theoretical and political levels. First, it is important to point out in our theoretical discussions with our mainstream colleagues that comparative advantage as a theory for international trade is not applicable in a money-using, entrepreneurial world economy where there is not full employment in the economies where trade is taking place. Also, comparative advantage works under the assumption that there is restricted capital and labor mobility. If either capital or labor can move easily and quickly, as we see in today’s international economy, then the country with the lowest unit labor costs can find itself with full employment while its trading partner is struggling with unacceptable rates of unemployment. If countries are fearful of stimulating their economies to achieve full employment through domestic spending and tax policies because of currency speculation and capital flight, then the only recourse they have is export-led growth policies for expanding domestic employment. This has been the acceptable policy for the last two decades, but such policies have not led to worldwide full employment or international economic stability. What we have is an international game of who can lower their nominal labor costs or devalue their currency the most. Unfortunately, as we have seen in Latin America and recently in Asia su, ch a game has huge costs and risks associated with it. As Keynes pointed out that “the mercantilists were aware of the fallacy of cheapness and the danger that excessive competition may turn the terms of trade against a country”( Keynes, 1936, p. 345) forcing a nation’s living standards down.

The other initiative is political. We need to be able to recommend international public policies to help create worldwide economic stability and full employment. We should focus specifically on the problem of international capital flight, along with creating a new international payment mechanism that abandons the flexible exchange rate regime we have today. Keynes recognized the power and fear of capital flight and currency speculation on a nation’s ability to carry out domestic fiscal and monetary policies. To rid ourselves of the threat of currency speculation was an important requirement for Keynes in achieving a strong and healthy world economy. “Nothing is more certain than that the movement of capital funds must be regulated” (Keynes, C.W. V. 25). This will require us to develop international anti-speculation policies. With the right type of capital controls, we could see the elimination of speculative pressures that have contributed to the economic disruption experienced in Asia recently. Secondly, there needs to be a new international payments system. As Keynes pointed out:

It is characteristic of a freely convertible international

standard that it throws the main burden of adjustment on the

country  a which is the debtor position in the international

balance of payments — that is, on the country which is

(in the context) by hypothesis the weaker and above all the

smaller in comparison with the other side of the scales 

which (for this purpose) is the rest of the world. (Keynes,

C.W. XXV: 27)

What the existing system does is simply force the debtor nation to “tighten their belts” by carrying out contractionary economic policies. If we are to see global full employment in the next century as Davidson has pointed out “a fixed, but adjustable, rate system with a mechanism for requiring the surplus trading nation(s) to initiate most of the effort necessary to adjust a payments imbalance, without removing all discipline from the deficit trading partner” is needed (Davidson, 1997, p. 117). It is only when surplus countries take on the responsibility for payment adjustments by expansionary policies that we can hope for sustainable economic growth and full employment in the world.

Post Keynesians must always remember it is high levels of economic activity that lead to high levels of aggregate demand along with specific institutional and policy arrangements that will allow for full employment and worldwide economic growth. Yet we are reminded by our orthodox brothers and sisters that these are unattainable goals because of the economic problems of NAIRU, the evils of deficit expenditures, and the laissez-faire virtues of flexible exchange rates and international capital mobility. And they are right if you accept the assumptions app applied to toKeynesiane to the classical economists. If you accept the economic problem as defined by classical and neoclassical economists, then we will always find ourselves with a trade-off between inflation and unemployment, economic instability,y and unjust inequalities of income and wealth in the world. But by following a more general theory that assumes uncertainty, that money is not neutral and the importance that institutions and public policy play in creating economic stability in the world we might be lucky enough to break away from the old economic problem “of want and poverty and the economic struggle between classes and nations” (Keynes, 1963, vii) and find ourselves in a civilized world of full employment. Keynes in the thirties foresaw a time when attitudes surrounding the economic problem would be based on the good, not issues of scarcity and efficiency, and the money motive would be assessed at its true value, as distasteful and unjust. The policy recommendations by post-Keynesians could precipitate this change much sooner than Keynes expected if we stay the course and remember the hope that Keynes brought us:

The author … for all his croakings, still hopes and believes

that the day is not far off when the Economic Problem will take

the back seat where it belongs, and that the arena of the heart

and head will be occupied, or re-occupied, by our real problems —

the problems of life and human relations, of creation and

behavior and religion. And it happens that there is a subtle e

reason is drawn from economic analysis why, in this case, faith

may work. For if we consistently act on the optimistic

hypothesis, this hypothesis will tend to be realized; whilst

by acting on the pessimistic hypothesis we can keep ourselves

forever in the pit of want.” (Keynes, 1963, vii-viii)

Time for a change?

Bibliography

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