John Maynard Keynes founded the dominant school of economic policy in the Western world from the 1930s to the 1970s, and argued that an expansionary fiscal policy through deficit spending was essential to stimulate the economy in a recession or depression. During this period, social welfare spending, strong labor unions and regulation of capitalism were part of the social democratic consensus, but all of this came unraveled in the stagflation and oil shocks of the 1970s. Stagnation and decline in Eastern Europe and the Soviet Union of the planned economies were evident and began to crumble under the pressures of inflation, low productivity, servicing foreign debts and the high costs of imported consumer goods. Another important change in the 1970s involved the shifting of Fordist mass production industries to developing countries and the creation of Rust Belts in Britain, the U.S., Germany and France. All of these factors led to the revival of free market capitalism of the type that Milton Friedman had called for in Capitalism and Freedom in 1962, which had been embraced by conservative political leaders like Margaret Thatcher and Ronald Reagan and “a fundamental rethinking of economic and political axioms that had been taken for granted since the Second World War” (Maier 26). The decades ahead the new international capitalism imposed strict limits on the Keynesian welfare state, at least up until the great crash of 2008-09 and the Great Recession that ensued.
Keynesianism was the dominant economic policy in the Western world from the 1940s to the 1970s, and in retrospect this appears to be a Golden Age compared to what came before or afterwards. To that extent, Keynesianism was more successful than the laissez faire capitalism of the Calvin Coolidge or Margaret Thatcher variety. Keynes thought that expansionary fiscal policy through deficit spending was essential to stimulate the economy in a recession or depression because capitalism did not produce full employment in the absence of fiscal and monetary stimulus, which would increase aggregate demand. He developed his theories for the explicit purpose of countering them. His General Theory (1936) was a product of the Great Depression “in which inefficiency of aggregate demand was identified as the main economic problem” (Skidelsky 152). Governments had to ensure full employment to maintain maximum aggregate demand, while on the supply side taking action to ensure that monopolies and oligopolies did not keep prices artificially high. In the present recession, the parallels with the situation in the 1930s are all too obvious, and had Keynesian measures not been undertaken promptly the entire economic system would have collapsed.
Keynes regarded laissez faire economics as a mechanistic, Newtonian philosophy of the 18th Century that may have fitted the small-scale, decentralized economy that existed at that time but no longer applied to a system of giant corporations. Moreover, when capitalism collapses, as it did in 1929 or in 2008-09, this leads to well justified doubts about its efficiency “for increasing material wealth” (Skidelsky 132). Keynes agreed with Karl Marx that eventually it would outlive its historical usefulness and evolve into some form of socialism, although he was emphatically opposed to the totalitarian type of economic system that existed in the Soviet Union. He even agreed with free market economists like Friedrich Hayek that “the stock of government knowledge was inevitably inferior to that of dispersed knowledge”, but insisted that a society with mass poverty and unemployment would lead to the destruction of the liberal values that he and Hayek shared (Skidelsky 160).
No depression or financial crash occurred in the period from 1945-73, and even though Keynesianism did not abolish the business cycle, it bottom phases were not so low and its recessions not as long as in the 1930s, the 1980s or the present. During this era “full employment was maintained, real wages rose constantly, economies were relatively stable, and wealth and income inequalities were reduced”, which was definitely not the case in the 1920s and 1930s or in the last thirty years (Skidelsky 164). In the 1960s, Keynesian welfare state policies expanded further in most Western nations, although in the mass protests of the decade, “liberals were unprepared for the mobilization of society that had taken place and all the new demands for rights from women, young people, workers and minority groups (Maier 39). Leaders of the large corporate interests and establishment elites of the Trilateral Commission openly worried about an excess of democracy (Samuel Huntington) or a democratic overload. Over the next two decades, the global capitalist interests they represented “demonstrated that there could be no successful Keynesianism in any single country”, and even British Labour and the French and Swedish socialists were forced to accommodate to the revived free market economics of the following two decades (Maier 42).
The seeming decline of the socialist economies and the unraveling of the Keynesian consensus in the West led to the revival of free market capitalism of the type that Milton Friedman advocated. Monetarists and conservative economists and politicians blamed welfare spending, government regulation and labor unions for the stagflation of the 1970s. Milton Friedman and other free market-monetarist economists argued that Keynesian stimulus policies simply did not work, and argued for central bank manipulation of money supplies and interest rates as a way of eliminating boom and bust cycles. His most influential book was Capitalism and Freedom (1962), in which he called for free markets, reduced taxes, floating exchange rates, vouchers (or school choice) in public education, and an all-volunteer army. He argued that the social democratic state was anti-liberal and that its catchwords “became welfare and equality rather than freedom” (Friedman 319). For the supporters of revived laissez faire economics, even Social Security, tariffs and agricultural subsidies were violations of individual liberty. Yet even Friedman had to concede that even capitalist countries could be authoritarian or fascist, which was certainly the case for Germany, Italy, Spain and Japan in the 1930s and 1940s (Friedman 321). In his 1963 book, Monetary History of the United States, 1867–1960, he blamed the polices of the Federal Reserve Board for the Great Depression, first of all for not raising interest rates and contracting the money supply during the overheating and speculative boom of the 1920s, and then not lowering them quickly enough during the 1930s Depression. To maintain stability, Friedman insisted that the Federal Reserve should increase the money supply at the same rate as the increase in real GNP, which would eliminate inflation. Friedman disagreed with the Keynesians that economy policy-makers always faced a tradeoff between inflation and unemployment that was known as the Phillips Curve, and maintained that correct monetary policy could maintain full employment without inflation. (Milton Friedman, Concise Library of Economics).
During the current recession, which is the most severe since the Great Depression of the 1930s, the fiscal and monetary policies of John Maynard Keynes have been revived after being largely discredited and ignored for the past thirty years. In the present recession, the parallels with the situation in the 1930s are all too obvious, and had Keynesian measures of deficit spending, stabilization and fiscal stimulus not been undertaken promptly the entire economic system would have collapsed. These included a Troubled Assets Relief Program (TARP) designed to aid banks and other corporations facing bankruptcy, an $800 billion stimulus passed in 2009, extensions of unemployment and health care benefits, and new regulations on bank holding companies through the Federal Reserve. If they are withdrawn too quickly, a collapse may still occur, along with radical deflation, mass unemployment and extreme political unrest. For these reason, it seems now that policies and politics have come full circle from the neoconservative revolt against Keynesianism and the welfare state during the 1970s and 1980s.
WORKS CITED
Friedman, Milton. Excerpts from Capitalism and Freedom (1962). Niall Ferguson et al. The Shock of the Global: The 1970s in Perspective. Harvard University Press, 2010: 318-23.
Kotkin, Stephen. “The Kiss of Debt”. Ferguson et al: 80-93.
Maier, Charles S. “’Malaise’: The Crisis of Capitalism in the 1970s” Ferguson et al: 25-48..
Milton Friedman, Concise Library of Economics
http://www.econlib.org/library/Enc/bios/Friedman.html
Skidelsky, R. Keynes: The Return of the Master. Perseus Books Group, 2010.
