until 1979 alongside monetary targeting, as part of the inflation-reduction strategy. The reluctance to put the whole burden of the fight against inflation on monetary policy reflects both a vestigial political commitment to full employment and an analytic commitment to the cost-push theory of inflation. It was the collapse of incomes policy in the ‘winter of discontent’ in 1978–9, leading to the election of the much more ideologically intransigent Conservative Party under Mrs Thatcher, which finally put policy Keynesianism to sleep. But not too much should be ascribed to parochial British ideology, since the demise of policy Keynesianism proved to be worldwide.
IV
A number of conclusions emerge from this, admittedly opinionated, survey. The most important is that Keynesian economics failed to renew itself intellectually during the golden age. It was therefore assaulted from outside and was severely damaged in the process. Friedman’s quantity theory of money approach fitted the emerging ‘stagflationary’ data better than the standard Keynesian models that predicted a stable ‘trade-off’ between inflation and unemployment. Specifically, his theory of ‘adaptive expectations’ explained why successive attempts to stimulate the economy had decreasing effects on output and increasing effects on prices, even with quite high unemployment.
Friedmanism was not formally inconsistent with the General Theory. Keynes agreed that the quantity theory of money is valid at full employment. Friedman’s ‘natural rate of unemployment’ was an analytically more precise analogue of Keynes’s ‘voluntary’ unemployment. Keynes did not highlight these aspects of his ‘general’ theory because he did not require them to explain the depression of the 1930s. Friedman’s monetarism is thus not the logical opposite of Keynes’s General Theory, but of his ‘special theory’, developed to explain the Great Depression of the 1930s, in which interest rates are ruled by liquidity-preference and investment demand is interest-inelastic. Hicks’s ‘generalised’ statement of the General Theory retains its value as providing a logical way of thinking about a variety of macroeconomic situations. Had it been interpreted in this way from the start, the Keynesian-Monetarist controversy might have produced less heat and more light.
Though both the Keynes and Friedman ‘special cases’ can be subsumed in a more ‘general theory’, there is a different feel to them, which reflects differing political and social values, and different assumptions about the political process. Keynes’s ‘special case’ implied the perversity of markets and the benevolence of governments; Friedman’s, the benevolence of markets, and the perversity of governments. Keynes’s quantity adjustment mechanism was designed to establish the case for discretionary government interventions to maintain full employment; Friedman’s assumption of self-adjustment at full employment was designed to get the government out of economic life. Friedman attributes this difference of approach to the fact that Keynes grew up in an aristocratic society with a strong tradition of public service, whereas he grew up in America where it was assumed that the political process would be dominated by political and bureaucratic self-interest.38 But other characteristics of the situation in which the two economists found themselves were very different. Keynes was diagnosing, and prescribing for, the ills of a laissez-faire economy; Friedman for the ills of a state-managed economy. The behavioural patterns – the virtues and vices – of the two kinds of system are likely to be very different; it was only natural that the two economists should overemphasise the vices of the system they knew, and exaggerate the virtues of the system they proposed. There are evidently long swings between collectivism and individualism, into which both the Keynesian revolution and the monetarist counter-revolution can be slotted.
The second major conclusion, which follows from the above discussion, is that Keynesian economics cannot be absolved from responsibility for the failures of government policy. The crude monetarist view that Keynesianism ‘caused’ inflation cannot be sustained. But it failed to develop an adequate theory of inflation, which might have helped governments combat it at an earlier stage, and with far less cost. The view prevailed in the 1960s that anything could be managed or fixed with the existing tools. The hubristic mood of the Keynesian economics profession is captured in Paul Samuelson’s testimony before a Congressional Committee in 1961: a community could have ‘full employment and absence of demand inflation, at a rate of capital formation it wants … with the degree of income distribution it desires’.39 A starker invitation to activist politicians to mismanage the economy can scarcely be imagined. It may be said that politicians choose the advisers to give them the advice they want to hear. But choice requires competition: if all the advisers are saying the same thing, it requires extraordinarily strong political nerves to go against it. A breakdown in the conventional wisdom in economics was thus a necessary condition for a shift in economic policy.
At the same time, certain features of policy, decided on non-technical grounds, made Keynesianism more difficult to operate and undermined support for it among the business and financial community. As a social philosophy, Keynesianism represented a delicate balance between capital and labour. Maintaining demand at a high level would give businessmen the confidence to invest, and guarantee labour against the heavy unemployment of the inter-war years. Moderate collectivism was traded off against greater collectivism. (A similar implicit social contract underpinned the welfare state: the wealthier classes would pay for most of it but would be entitled to its benefits.) The shift to a more collectivist politics in the 1960s and 1970s made Keynesianism increasingly controversial. It started to be associated with a growing share of national income spent by the state, growing public sector deficits, an increasing tax burden, and attempts to control supply through planning of production and incomes. Such policies, arguably, also made the market system work less well, thus creating reasons for ever more extensive interventions. At some point Keynesianism lost its political function of preserving freedom, and came to be widely seen as an agent of creeping socialism. It stopped being able to do political work.40
The relationship between these political/theoretical swings and changes in the structure of economies remains obscure. To what extent were the changes in cost structures which undermined the profitability of large sections of manufacturing industry in the early 1970s caused by excess demand? It is difficult to say. What is probable is that they precipitated the microelectronic revolution which brought to an end the ‘Fordist’ era of mass production and undermined the autonomy of national economic policy. These developments enormously strengthened the power of international capital. In the 1980s, governments lost their ability to ‘choose’ their national technologies and national rates of inflation, growth, employment, taxation. In short-run perspective, the shift to monetarism is best seen as the adaptation of theory and policy to the new facts. In the long run, these facts were, at least in part, brought about by the ideas and policies which dominated the Keynesian age.
Thus it is much too simple to see the fall of Keynesianism simply as a triumph of a reactionary rhetoric. The rhetoric was the result of real failures in policy and ideas, and real changes in economic structures. If ‘new Keynesian’ ideas are to play a part in shaping the policies of the future they will do so in a very different world and intellectual climate from those which gave birth to the Keynesian revolution.
CHAPTER 4
The Keynesian Consensus and its Enemies
The Argument over Macroeconomic Policy in Britain since the Second World War.
Peter Clarke
UNTIL THE Second World War, no government professed to have a macroeconomic policy. The concept simply did not exist. To be sure, governments had long been held responsible, in a general way, for the health of the economy and it is obvious that ‘hard times’ hurt the party in power. This helped to bring the heavens down on the Conservative Government in the General Election of 1880, serving as the electoral meteorology behind the rain-dance performed with such ostentation by Gladstone in his Midlothian campaign. Conversely, an uncovenanted upturn in the export trade apparently vindicated the Free Trade case in the 1906 General Election and made Joseph Chamberlain’s prescient warnings about manufacturing decline look like empty scaremongering. The arguments over the Gold Standard in the 1920s were, to our eyes, unmistakably about macroeconomic issues; in this