The recent rise and demise of Keynes

One of the several consequences of the global economic crisis was a rehabilitation of the economics of John Maynard Keynes among policymakers and the mainstream economics profession.
As the extent of the mess caused by deregulated finance and its international ramifications became clear, Keynes’ prescient warnings of the dangers of allowing finance too much freedom were recalled.
At the height of the crisis late last year, his characterisation of the liquidity trap was recognised as being applicable to the core capitalist economies.
And most of all, his insistence on the need for public spending to bring an economy out of its unemployment equilibrium was not just accepted but also put into practice through fiscal stimulus plans across the developed world.
But it turns out that this rehabilitation was short-lived. In fact, the backlash against the revival of Keynesian economics has already begun.
As soon as some “green shoots of recovery” began to be observed — even if they were only baby weeds — commentators started emphasising the need for caution on the fiscal front, pointing to the dangers of the growth of public debt and generally calling for more fiscal discipline.
As a result, there is a real danger that the recovery may be extinguished even before it can fully display itself.
If this does happen, a major reason will be the continued power of financial lobbies to influence economic policy across the world, despite all their recent crimes.
It is now well known that the dethroning and discrediting of Keynesian economics, especially in the last two decades of the 20th century, was closely related to the rise of the dominance of finance, both nationally and internationally.
This is a complex process calling for explanation in its own right. But there is no doubt that the growing political and economic power of finance played a role in three major ways: first, by rendering Keynesian policies far more difficult to engage in on a purely national level; second, by creating domestic conditions allowing for greater social tolerance of high levels of unemployment and greater intolerance of inflation; and finally, by constraining even the possibility of concerted expansion across the world.
Keynesian economics was originally developed for closed economies. The possibility of external trade did not alter the basic results or insights, although it did bring in the option of using external markets to compensate for insufficient domestic demand.
It also forced recognition of the fact that expansionary domestic policies designed to bring about full employment could cause external deficits which would have to be met somehow.
However, international capital mobility created an entirely new set of problems for such policies. Any attempt at domestic expansion could now bring about not only a trade deficit, but also a flight of capital and consequent pressure on the currency, forcing a retreat from such policies.
The experience of the Mitterand Government in France in the 1980s was the first glaring example of this in industrial countries; for developing countries, of course, it had long been a well-known fact of life.
But having tasted blood in this way, it was not to be expected that financial markets would give up the possibility of being able to control and influence economic policy-making through such movements. Indeed, the experience of the past two decades bears ample testimony to the power of finance in determining economic policies in both developed and developing countries.
This may be the single most important reason for the downfall of the Keynesian strategy, at least in its neo-classical synthesis form.
As long as financial markets remain open and capital can move across borders in response to policy changes or expectations, there are clear limitations to the use of Keynesian policies to attain full or near-full employment.
However, even Global Keynesianism, or the idea of co-ordinated economic expansion which will not cause punitive capital flight in any single country, faces constraints.
These also became evident in the 1970s, in the form of the inflationary barrier posed by the effects of such capitalist expansion on wages and commodity prices.
Thus, concerted expansion will increase demand for labour and for goods produced by primary product exporters (such as oil and other important raw materials and food) leading to a rise in their bargaining power.
If any attempt by these groups to raise their income share is then resisted by other groups, the result will be inflation. Not only can this be destabilising, it is complete anathema to finance.
It is this feature, which essentially amounts to a fight over distributive shares of income both across regions and between economic classes within regions, which is so critical in the present juncture.
Not only is it difficult for a single country — even the largest and most important one in the world — to embark on a sustained fiscal expansion with completely disregard for the response of financial markets.
It is even hard to think of a concerted expansion by major countries together, because of the fear of the consequent inflation.
So a growth process will be sustainable only if it forces some redistribution at the global level (through capitalist and/or rentiers accepting a decline in their income shares).
Otherwise the current unemployment equilibrium in the world economy as a whole will continue.
So the reason why Keynesianism is still not being accepted today goes beyond that fact that the basic insights are sought to be obscured by the miasma of half-truths forced upon us by financial institutions and market analysts.
It stems from a basic contradiction in the global capitalist system, which is the continued power of finance.
It is not enough, in this context, to regulate finance to make it behave better and more in accordance with society’s real economic requirements.
The power of finance itself must be broken, which is a much more difficult task. And so far there is little evidence that it is even being attempted.