Commentary on Political Economy

Tuesday 25 October 2011

Keynes's Discovery of Society: From Science to Uncertainty

The Great War of 1914 to 1918 shatters the illusions of the European Enlightenment: it is not simply the ability of human beings to behave “rationally”, according to the methods and laws of science, that is called into question; it is not merely the belief in a steady “progress” of humanity toward “peace and prosperity” (it is the motto of the Habsburg Austro-Hungarian Empire shortly before its collapse) again in the footsteps of science and technology that tragically confuted; it is above all the very content of “scientific rationality” that is called into question – nowhere more so than in the sphere of economics. Alfred Marshall may have exemplified the faith reposed in science before the War:

From Metaphysics I went to Ethics, and thought that the justification of the existing condition of society was not easy. A friend, who had read a great deal of what are now called the Moral Sciences, constantly said: "Ah! If you understood Political Economy you would not say that." So I read Mill's Political Economy and got much excited about it. I had doubts as to the propriety of inequalities of opportunity, rather than of material comfort. Then, in my vacations I visited the poorest quarters of several cities and walked through one street after another, looking at the faces of the poorest people. Next, I resolved to make as thorough a study as I could of Political Economy. (Marshall quoted in Keynes, ‘EinB’, p137)

Nothing epitomized the Panglossian “optimism” of pre-War Europe than the existence of the Gold Standard as a seemingly “automatic” regulation of global trade and industry. Here was sparkling proof of the harmonious convergence of scientific rigor and welfare maximization. Here was evidence of the “automatic” functioning of the self-regulating market mechanism that could reconcile in Say’s Law both the labour theory of value of Classical Political Economy and the marginal utility theory of the Neoclassics. The general equilibrium mathematically identified by Walras uniquely brought together for economic analysis the “form” of mathematical scientific precision with the “content” of utility maximization for each individual economic agent.

Keynes perceives from the end of the War that the peace and prosperity of the Golden Age had been built on very shaky foundations. Shakier still and ominously dangerous for him is the insensate credence of the victorious powers at the Paris Conference of 1919 in their ability to return to the old pre-War “equilibria” of the Gold Standard and the League of Nations. To be sure, the “elements” of his economic analysis – to poke irony at his derogatory critique of the “axiomatic” character of neoclassical theory – remain steadfastly neoclassical. But one “historical reality”, an imponent presence upsets all the “equilibria” of the marginalist revolution for Keynes: the extreme implausibility of the equilibrium of savings and investment as a “spontaneous self-regulation” of the market mechanism – the Invisible Hand that decrees that “supply creates its own demand”. Say’s Law would hold in the “special case” in which supply (investment) and demand (consumption) could adjust instantly and seamlessly to variations in their respective schedules. In such a case, there would be not so much an “equilibrium” of “quantities” as rather a “harmony” of “information” because the “equilibrium” would consist in the “perfect matching” of “demands” (the informational equivalent of “consumption”) and “expectations” (the mental equivalent of “investment”). In such an “economy” all “information” relevant to production and consumption schedules would be immediately and omnisciently available to all market participants in such a way that no “discrepancy” could arise between supply and demand: supply would adjust to known demand and demand would adjust to available supply.

For Keynes, here the neoclassical school has “illicitly” (ch.2, GT) allowed the “form” of the science to rationalize the “content” of capitalist “economic society”, to justify its conduct, to certify its legitimacy. The error of all previous theories is that they fail to distinguish between form and content: the form serves merely as a warranty of the optimality of capitalist activity, of the reality of bourgeois society! Just as did Hegel, for whom the philosophy of history is the history of philosophy because “whatever is real is rational and what is rational is real”, so has economic science illicitly become the scientific certification of present “economic conduct and practice”! It is not so much that the capitalist economy requires “different scientific categories” for its analysis! Keynes insists that the “tools” of analysis are the same as those that can be used for “any” economic society. But the “actual workings” of the capitalist society are different from those of other societies in the sense that “the basic factors of production and distribution” (“Value and Production”) work differently in this society. Keynes distinguishes between the “tools” of economic analysis and the fabric of society: the same scientific tools can be applied to different historical economic societies that are made “different” by their institutional frameworks. This is the challenge that Keynes throws against “the postulates of the Classical Economics”:

Most treatises on the theory of Value and Production are primarily concerned with the distribution of a given volume of employed resources between different uses and with the conditions which, assuming the employment of this quantity of resources, determine their relative rewards and the relative values of their products. (Ch.2)

The question, also, of the volume of the available resources, in the sense of the size of the employable population, the extent of natural wealth and the accumulated capital equipment, has often been treated descriptively. But the pure theory of what determines the actual employment of the available resources has seldom been examined in great detail…. I mean, not that the topic has been overlooked, but that the fundamental theory [p.5] underlying it has been deemed so simple and obvious that it has received, at the most, a bare mention.

That is the “destiny” of mathesis: to be its own fulfillment. If one defines, as did Robbins and Hayek with their “Science of Choice”, the “available resources” as “given” and therefore “fully employed”, then it follows that economic analysis boils down to the mere mathematical selection of the method of allocation and distribution of these resources consistent with the maximization of human welfare. But the problem, as Keynes points out, is that the “actual employment” may well not be “full” – that there may be “involuntary unemployment” of the available resources not because of some interference or disturbance or shock “external” to a historical economic society, but rather because of its very modus operandi, of the real institutional “content” of its behaviour!

The task of economic analysis then cannot be to devise a mathematical description of an ideal reality, a perfect state, a “general equilibrium”, and then to attribute all the evident flaws of this reality to some “disturbance” or “exogenous shock”! The task of scientific analysis is to register these “shocks” as part and parcel of the economic system under consideration and then to suggest changes to the current institutional asset to prevent these “shocks” from destroying the “peace and prosperity”, the “equilibrium” of the economic society in question. As Keynes puts it with a half-derisive tilt at “economic science”:

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the [p.34] manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

The ultimate goal for Keynes is to preserve society – “economic society”, bourgeois society. And it is clear from the very first lines of the General Theory that the major, most imminent threat to the existence of bourgeois society is the “involuntary unemployment” of human resources – of “labour”. It is this “discrepancy” between the “available resources” for employment and the “actual employment” of those “resources” that threatens the stability and the very survival of capitalism and of bourgeois society: the question then is to establish why such a discrepancy exists. Existing economics assures us that any “unemployment” of available resources is either “voluntary” or “frictional”, if it is not due to “political interference” with the “self-regulating market mechanism”. But provided this mechanism is allowed to operate “freely”, then full employment will return “in the long run”.

Two concepts immediately demand Keynes’s attention here: one is the notion of “long run”, which requires a certainty verging on faith in the ability of “the market” to steer a society to “peace and prosperity”, and the other is the assumption of the “freedom” of economic agents – of “individuals”. And once again it is the experience of the Great War that confutes both these credos of economic “science”. For the War has destroyed all “certainties”, scientific and moral, all faith in “values” and replaced them with one frightening “certainty”: - the certainty of death. Death with its finality is the only “certainty” and “value” that the War has brutally confirmed. Not only is the future of “the long run” not assured; not only is it “uncertain” – and here “uncertainty” comes to occupy a central role in Keynes’s economic analysis. But also the “freedom of choice” on the part of the “individual” that neoclassical theory and its marginal utility postulate implies a “rationality” on the part of the “individual” in exercising his “choice” or his economic “conduct” – a rational “freedom of choice” that the very absurdity and irrationality of the “European civil war” and its near annihilation of societies and civilization have quite simply demolished! Individuals act neither independently of one another, nor rationally according to the scientific dictates: economic analysis itself, in seeking to describe “rigorously” their behaviour and to prescribe their conduct along “scientific-rational” lines, shows conclusively that there is no obvious “objective” definition of “freedom” or indeed of “rationality”!

Nowhere is this more evident than in the determination of the “wage”. Here Keynes notices a crucial defect in all prior economic theories in the fact that they confuse “money wages” with “real wages”. If indeed “the real wage” could be defined strictly as “the marginal product of labour”, then this “marginal product” could be “quantified” so that the quantity of employment could be exactly equal to the quantity of employment required for the utility of the real wage to equal the marginal disutility of labour given a physical and cultural requirement. But the problem is that “the wage” is not paid “in natura”, in terms of physical product: it is paid “in money”. Even if it were paid in “wage-goods”, it would be impossible to determine what amount of wage-goods represented and “equaled the marginal product of labour” given that such a “marginal product” would have to be defined in terms of “market prices” which, in turn, would have to stand for “physical quantities” of the “wage-goods” concerned! The circuitousness of these definitions is evident. Keynes summarises it as follows:

At different points in this chapter we have made the classical theory to depend in succession on the assumptions: (1) that the real wage is equal to the marginal disutility of the existing employment; (2) that there is no such thing as involuntary unemployment in the strict sense; (3) that supply creates its own demand in the sense [p.22] that the aggregate demand price is equal to the aggregate supply price for all levels of output and employment. These three assumptions, however, all amount to the same thing in the sense that they all stand and fall together, any one of them logically involving the other two.

The obvious contradiction is that “the aggregate demand and supply prices” to which Keynes refers must evidently refer to “monetary entities” and that the existence of full employment depends on their “equality at all levels of output and employment”. But for this to happen “the real wage must also be equal to the marginal disutility of existing employment” – and here we have “illicitly” switched from “monetary” magnitudes that can be aggregated, to “real” ones that simply cannot be “aggregated” unless they are “converted” into “monetary” terms!

Keynes, however, does not “directly” confront this contradiction and vicious circle (it is in order to avoid contra-diction that the definitions are “circuitous”). Instead, he seeks to show that these “postulates of the Classical Economics” do not correctly describe the “reality” of what in fact “happens to be the economy in which we live”. First of all, these “classical postulates” do not describe at all properly the reality of the institutional behaviour of the workers, acting as a class:

Now ordinary experience tells us, beyond doubt, that a situation where labour stipulates (within limits) for a money-wage rather than a real wage, so far from being a mere possibility, is the normal case. Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods. It is sometimes said that it would be illogical for labour to resist a reduction of money-wages but not to resist a reduction of real wages. For reasons given below (p. 14), this might not be so illogical as it appears at first; and, as we shall see later, fortunately so. But, whether logical or illogical, experience shows that this is how labour in fact behaves.

But even leaving this to one side, the most crucial objection to the “classical postulates” is that the very presence of “money” and of “monetary aggregates” determines a fundamental “hiatus” between the “present” level of output and employment in the capitalist economy and the “expectations” of what the aggregate levels of consumption and investment will be in the future! A chasm appears therefore in the “predictability and regularity” (the phrase used by Keynes to describe the statistical endeavours of Jevons) of the functioning of the capitalist economy in terms of what the “agencies” involved in the economy “expect” to happen in future. These “expectations” are predominantly affected by “uncertainty” about the income streams that may be derived in future from the investment made in the present. And these income streams are determined by “the propensity to consume”. It is the fact that this “propensity to consume” may fall below the “expectations” of investors that causes the swings in the investment cycle that can lead to downward spirals of disinvestment and deflation and turn into outright depression.

Ultimately, Keynes attributes “uncertainty” to the fact that social life is “unpredictable and irregular”, irrational and “unfree”, as the cataclysms of war and economic depression demonstrate all too clearly. “Money” is the institutional link in capitalist economic society utilized to provide “a bridge between the present and the future”. Yet it is the existence of money itself that provides the institutional hiatus between present and future levels of output and employment. Never and nowhere does Keynes seek to explain why money exists and how it can exist in capitalism. The need for an explanation he simply and mysteriously conjures away between the lack of realism of “the Classical economics” and the descriptive realism of his own corrections of their theoretical framework. Far from being a “General Theory”, Keynes’s magnum opus is a very “generic” theory full of brilliant institutional insights but lacking any intellectual and theoretical coherence. Unlike his opponents in the Austrian School, Keynes’s intellectual ken and grasp of social theory and philosophical analysis was far too narrow to allow him to tackle the most fundamental theoretical “elements” of economic theory.

In the next intervention we will examine how Keynes “mystified” the political reality of the wage relation that is at the centre of capitalism by camouflaging it – though unwittingly – with his various categories of “marginal efficiency of capital”, “propensity to consume”, “animal spirits”, “the liquidity trap” and his account of the rate of interest.

[Just a personal note to commemorate Dr. Iain Macpherson, economic historian, of Gonville and Caius College, Cambridge, who I learned today passed away this year. I can testify that over the years I was the recipient of Dr. Macpherson’s endless and spontaneous Scottish generosity, not less than of his sincere and warm Scottish wit. I will miss him upon my return to Cambridge in a few weeks, and I shall never forget him. Requiescat in pace.]

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