Larry Elliott Monday July 22, 2002 The Guardian larry.elliott at guardian.co.uk
Cometh the moment, cometh the man. Crashing share prices, global financial instability, deflation lurking in the background: this is a world made for Keynes. For all those who kept the sacred flame flickering during the long, dark night of laissez-faire, this is their moment. The old devil is back.
Keynes is a helmsman for stormy seas. When a witches' brew of speculation, banking failures and falling prices led to mass unemployment and a collapse in living standards in the 1930s, Keynes rejected the notion that in the long run market forces would operate to leave the sea flat calm again. Now that the global economy is again gripped by systemic failure, it is inevitable that thoughts turn to the man who revolutionised economic thinking 70 years ago.
Keynesian policies never entirely disappeared from the arsenal of policymakers, even those of a neo-liberal stamp. Keynes argued, for example, that attempts by governments to balance their budgets during recessions by raising taxes or cutting spending simply made matters worse. When John Major's government allowed the budget deficit to balloon in the early 90s, they were acting in textbook Keynesian fashion.
Big package
But 10 years ago Keynes was still something of a secret vice; now he can be brought out of the closet and made respectable again. Gordon Brown has his own secret little debating club - Keynes in the 21st Century - to which he invites the great and good of the economics establishment. For the chancellor, Keynes has been the love that dare not speak its name. Until recently. Last week, Brown not only noted that deflation was as big a threat to the economy as inflation (not something many chancellors have found the need to mention these past 50 years) but he also did something to prevent deflation from becoming a reality with his big package of public spending.
Keynes would have seen the injection of investment by the state as a wise precaution against an ebbing of private-sector demand during troubled times. Moreover, he would have seen Brown's overall approach to fiscal policy - building up surpluses in the good times to provide leeway for deficits in the bad times - as entirely correct.
Like many so-called new Keynesians, however, the chancellor believes that Keynes was writing about special circumstances, and that it is only when there are clear signs of market failure that his ideas are applicable to a modern economy.
Keynes believed that markets were imperfect, and that market failure was a chronic condition of capitalism. His view was that neo-classical economics was the special case, because it was dependent on a series of assumptions that did not apply in the real world. With patrician disdain, he said individuals acting separately to promote their own interests were usually "too ignorant or too weak even to achieve these. Experience does not show that individuals when they make up a social unit are always less clear sighted than when they act separately."
Despite turning economics on its head, Keynes was no revolutionary, nor even a member of the Labour party. He was a liberal toff - educated at Eton and King's - who wanted to reform capitalism and save it from itself. Keynes was a big player of the markets, sometimes suffering heavy losses.
The crowning glory of his life's work was the General Theory of Employment, Interest and Money (usually known as the General Theory), which explained at length why classical economic theory was wrong and he, Keynes, was right. Like Joyce's Ulysses, the General Theory is a book more admired than read. Those who argue (rightly) that Keynes was much tougher on inflation than his post-war followers say the General Theory is not even his best book, giving that accolade to the Treatise on Money.
Today, he would not cavil with those who argue that capitalism has been the driving force behind the unprecedented improvements in living standards in the West over the past 250 years. Nor would he dispute that the new wave of technological progress holds out the prospect of a golden age. What he would argue is that there are three crucial areas where policy needs to be re-thought before this can happen.
The first is where the private sector is unwilling to spend but the normal remedy - lower interest rates - proves ineffective, either because individuals and companies are psychologically scarred by recent experience or because falling prices mean that interest rates cannot be reduced to a low enough level. Keynes called this a liquidity trap, and it is what policymakers in Japan have been grappling with for the past 10 years. The low and falling level of inflation across the rest of the developed world is a warning that other countries may soon be faced with the same problem. As Japan has found, it is easier to fall into a liquidity trap than escape from one.
Secondly, falling prices are a symptom of an imbalance in global demand and supply. One of the basic tenets of classical economics is Say's law, which states that there can never be slumps because supply creates its own demand. But, as Robert Kuttner says in his book (Everything for Sale), the reality of globalisation is that low-wage workers in poor countries are adding vastly to the world's supply of goods but lack the purchasing power to buy the products they make. There is, in other words, a global deficiency in aggregate demand that is leading inexorably to lower prices, thus intensifying deflationary forces. The Keynes blueprint for the post-war system was for a floor to be put under commodity prices, for trade imbalances to be remedied by expansionary policies on the part of creditors rather than deflationary action by debtors, and controls on capital to allow nations to pursue full employment. Instead, we have the dead hand of the IMF, foisting deflation and depression on a country such as Argentina.
Finally, the deregulation of financial markets has made capitalism less stable. As the American Keynesian Paul Davidson has argued, markets are now more liquid, but that is not the same as being more effective. Keynes was adamant that capital markets were there to provide investment for entrepreneurs, not gambling chips. "Speculators may do no harm as bubbles on a steady stream of enterprise", he said. "But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill done."