Keynes and the myth of the Reagan administration’s neoliberalism

Robert Skildelsky, biographer of John Keynes, has written an essay written an essay on the 80 year legacy of the General Theory in which he credits Keynes with inventing macroeconomic policy and for showing how government could employ means at its disposal to offset economic depressions.

For all the genius of Keynes’ General Theory, its importance has not always been acknowledged by mainstream economics. By the 1980s, according to Skidelsky, most of mainstream economics came to reject many of the ideas first proposed by Keynes, particularly his argument capitalist economies were inherently prone to chronic underutilization of both capital and labor.

Skildelsky attributes the rejection of Keynes policies to three causes: First, Keynesian policies produced a hyperinflationary spiral, which the fascists tried and failed to control by wage and price controls. Second, according to Skidelsky, most economists never really discarded their pre-Keynesian ideas of a self-regulating capitalist market. Third, when Keynesian economic policies ran into hyperinflation, economists like Milton Friedman argued capitalism requires some minimal level of unemployment to control it — an argument that soon won broad following among economists.

“And so the old orthodoxy was reborn. The full-employment target was replaced by an inflation target, and unemployment was left to find its “natural” rate, whatever that was.”

Now, Skidelsky is an acknowledged expert on Keynes, and my opinion isn’t worth crap, but I do want to note two things about this argument that seem wrong to me.

Why is underutilization of capital and labor now chronic?

First, based on Skidelsky’s accounting of Keynes’ General Theory, it is never clear why capitalist economies experienced underutilization of capital and labor during the Great Depression, nor does Skidelsky explain why economies still tend toward underutilization today, eighty years after the depression.

Before the Great Depression economists thought persistent mass unemployment was impossible, yet Skidelsky never actually explains why this changed during and after that depression. Keynes indeed showed why a capitalist economy might have a chronic stubbornly high rate of unemployment, but he did not first do this in the General Theory; rather, in his famous 1930 essay, Economic Possibilities for our Grandchildren, Keynes argued unemployment was persistent because capitalism was doing away with the need for labor. According to Keynes, assuming a constant, steady increase in the productivity of labor over the following century or so, society would eventually be forced to shorten hours of labor.

Thus, behind his General Theory, Keynes made the argument that the emergence of mass unemployment during the Great Depression was a permanent fixture of capitalist economies. Underutilization of capital and labor would increasingly become a widespread problem as the productivity of labor increased.

Now, what no one has ever done is explain why, in 1930, Keynes argued hours of labor would have to be shortened, yet by 1936 he argued government intervention was necessary to prevent depressions not by shortening hours of labor, but by running deficits and maintaining low interest rates. If, as Keynes wrote in 1930, capitalism was reducing the need for labor faster than it could find new uses for labor, by 1936 he was arguing for fascist state economic intervention to find new uses for the labor set free by capital.

The flaw in Keynes General Theory

It is likely, therefore, that the General Theory embodies a serious theoretical flaw: namely, the idea the diminishing need for labor, and the resultant chronic underutilization of both capital and labor, could be overcome by state deficit spending and low interest rates. This flaw might just explain why, by the 1960s, the state attempt to find new uses for labor exploded into borderline hyperinflation: finding new uses for the labor and capital that capitalism no longer needed turned out to be inflationary.

And it might just explain why the solution adopted by capitalist countries to control hyperinflation was sensible. As Skidelsky explains, that solution was simple: just stop trying to maintain so-called “full employment”. In other words, capitalist countries soon discovered that trying to prevent underutilization of capital and labor, even as capitals were shedding labor, was inflationary. So they simply stopped trying to maintain artificially full employment. Not surprising, once government stopped trying to create jobs for workers displaced by rising productivity inflation began to drop.

Skidelsky only gives us half of the story in his essay. In fact Keynes’ General Theory failed because it made no sense in the first place. If the problem was capital’s progressive reduction in the need for labor, it turns out there is nothing state policy can do to counteract this.

This conclusion might have been open to question during the golden age of the 50s and 60s in the middle of the post-war boom, but it hardly needs additional proof today.

Did Reagan bury Keynesianism or praise it

Second, Skidelsky has terribly overstated the extent to which the fascists have moved away from Keynesian policies. To give one example: after the 1970s, which was supposed to have been a period of rejection of Keynesian policies, the fascist state, far from rejecting Keynesian deficit spending and artificially low interest rates, has run a toxic combination of an unbroken string of fiscal deficits and loose monetary policy just as General Theory recommended.

Here is a chart of the debt accumulated by Washington since 1980:

Total Federal Debt 1980-2016 (SOURCE: Federal Reserve)

And this how the Federal Reserve have maintained loose monetary policy since 1980:

Effective federal funds rate 1980-2016 (SOURCE: Federal Reserve)

In fact, the deficits and loose monetary policy did not really begin until the Reagan administration, when Keynes’ theory was supposed to be unpopular. Skidelsky never explains how is happens that Keynesian deficit spending and loose monetary policy becomes routine conditions of the economy only after Keynesian theory has allegedly already fallen into disrepute?

Skidelsky speaks of Reagan as the start of a new neoliberal era, but the plain fact is that continuous deficit and low interest rate stimulus of the sort we have witnessed in the past 35 years was never thought possible before the era of  so-called “Reagan neoliberalism”.

Pardon me for saying this, but something about Skidelsky’s argument is very muddled. Rather than neoliberalism signaling the end of Keynesian policies, neoliberalism made Keynesian-style stimulus a permanent and continuous feature of fascist state economic policy. The two most important policy measures prescribed by Keynes to fight depressions — deficit spending and maintenance of low interest rates —  are now routine under so-called neoliberalism.

The Reagan administration did not kill Keynesian stimulus policies — it made them permanent.