Part 1 of a Discussion of Peter Foster’s Why We Bite the Invisible Hand Chapter 10 “The Rise and Fall and Rise of John Maynard Keynes”
Foster next turns his attention to John Maynard Keynes, a highly influential economist of the 20th century, because he sees the Keynesian theories that took hold as “contributing mightily to the corruption of economics.” (p. 201)
He notes in this chapter the rise and widespread adoption of these theories since the Great Depression were followed by a neoclassical turn from them in the 1980s, however, they later rose again as New Keynesianism. Even during the time when neoclassical economics pushed back, the Keynesian grip did not disappear. The theories were still taught in textbooks and followed by policymakers.
What does Foster mean by “the corruption of economics”?
In the Wealth of Nations, Adam Smith argued against the government interventions of the mercantilist system in order to allow the Invisible Hand of the free market to operate.
In contrast, the rise of Keynesianism questioned the ability of the Invisible Hand to operate well without sufficient help from the government.
Smith was misrepresented, castigated and ultimately turned upside down. He had pointed out what was potentially beneficial about free markets and counterproductive about government intervention. Economics increasingly became about what governments should do to counter alleged market imperfections and inequities. (p. 202)
“People respond to incentives” is a fundamental economic concept. Foster seems to suggest that a cynic could observe Smith was offering a world where there was not much need for policymakers and expert economists; however, Keynes’ world enshrined them in power.
Voices that clung to Smith’s view lost influence with governments navigating the bad economy of the Great Depression who “weren’t interested in hearing from people who told them that their initiatives were likely to be counterproductive.” (p. 202)
Foster quotes economist Milton Friedman, not a Keynesian, capturing this idea of government officials’ preference for economists who recommended “doing something” when there were downturns.
“Here was one of the most famous and respected economists in the world informing governments that the way to full employment was paved with higher spending and lower taxes. What more attractive advice could politicians wish for? Long regarded public vices turned into public virtues.” (p. 200)
And that is how we have ended up in the technocracy we have today — rule by experts. I discussed this idea in a previous blog.
Keynesian thinking also plays into the inborn biases Foster explored in a previous chapter such as the economy needs to be planned or else it would run amok.
Keynes’ theories, although many heirs of Adam Smith considered them fatally flawed, came to dominate public policy in the decades after the Second World War. The most obvious reason was their appeal to Smith’s “men of system”: those who reflexively believed that markets were immoral and unstable, and thus had to be regulated and “stimulated.” They also appealed more generally to most people’s unreflecting centralist assumptions that somebody should be “in charge.” (p. 201)
Smith’s Defenders
In the years just before Keynes’ theories caught on, economist Alfred Marshall was a leading voice in the vein of Adam Smith. Marshall is where we get our supply and demand graphs, so you can thank him for that for your Econ 101 experience.
On a trip to America, Marshall toured some factories and happily observed that Smith’s feared “mental mutilation” from the division of labor had not materialized. (p. 203)
His 1890 book, Principles of Economics, rejected socialism, embraced private property and competition, and was optimistic. But Marshall was leaning against the tenor of the times. (p. 203)
For the reasons given above, plus the impact of the Great Depression, Keynesianism gained traction in the 1930s and beyond.
Still, there were voices holding fast to the power of the Invisible Hand in the Austrian School of Economics, most notably Ludwig von Mises and F. A. Hayek, his student. Their work was contemporaneous with Keynes.
Mises and Hayek wound up fighting socialism on two fronts: in its extreme form as Communism, and in its more moderate forms such as fascism and social democracy, both of which permitted “fettered” enterprise under government regulation and control. On one front of their intellectual struggle, they refuted the theoretical possibility of full-scale central planning; on the other, they countered the promotion of mixed economies, which combine macroeconomic management with the extensive regulation and public ownership…(p. 204)
However, it was Keynesianism that became dominant leaving them as voices in the wilderness.
The Great Depression offers a good prism to see these two sides. The Keynesians saw that economic crisis as a failure of capitalism, refusing to acknowledge the government policies that had contributed to it such as: (p. 205)
- Contraction of the money supply
- Massive regulatory changes causing uncertainty, which hampers people’s ability to spend, save, and invest
- Increasing tariffs to protect domestic industry that then led to retaliation from other nations
These failures of government policies caused problems that they then blamed on capitalism, which allowed them to say they needed to be solved by more government policies.
The Austrians would point out the failure was caused by the policies and thus called for non-interventionist solutions.
However, like Marshall before them, both Mises and Hayek were leaning against the intellectual conceits — and career self-interests — of the time. (p. 204)
In the next blog, I will go deeper into the workings of Keynesian theory in the 20th century and how it lost out to neoclassical economics. After that, we can look into its return.
Reference: Foster, Peter, 2014. “The Rise and Fall and Rise of John Maynard Keynes” Chapter 10 of Why We Bite the Invisible Hand, Pleasaunce Press.
