The Critics of Keynesian Economics

I. Introduction1

In the course of writing my book, The Failure of the “New Economics”: An Analysis of the Keynesian Fallacies, I naturally read a good deal not only of the works of Keynes and the Keynesians but of the writers who had criticized Keynes’s major theories, particularly the doctrines found in his General Theory of Employment, Interest and Money. In only one or two instances, such as Arthur Marget’s two formidable volumes on The Theory of Prices (1938 and 1942) and L. Albert Hahn’s The Economics of Illusion (1949), did I find critiques that attempted any full-length or systematic analysis. It was precisely the lack of any thorough chapter-by-chapter or theorem-by-theorem critique, in fact, to offset the immense laudatory literature, that led me to write my own book in an effort to fill this need.

But I did find a refreshing number of instructive and sometimes brilliant short discussions of the General Theory or of some of its leading tenets. These discussions were, however, either widely scattered in learned journals, the back numbers of which are available only with difficulty, or consisted of single chapters or a few pages in sometimes lengthy books. It seemed to me that it would not only be serviceable to make these available in permanent book form, but that if assembled within two covers they would complement and reinforce one another, and would have considerably more impact when collected than they had had or could have when published separately, for different audiences, over a wide range of years. This seems even more probable when one considers that the political or academic receptivity to any criticism of Keynes was extremely low in the first decade or more after the appearance of the General Theory, and that what then seemed to many readers a mere “lack of hospitality to new ideas” might now be recognized as an independence of mind that refused to be swept along by mere intellectual fashion.

The following selections are arranged chronologically, in the order of their appearance, or approximately so. It has seemed to me that this order not only does most justice to the individual contributions, giving credit to those who may have anticipated a particular observation or criticism later made by others, but is likely to be most helpful to the reader, curious to know which weaknesses in the General Theory were obvious to the first reviewers and which, if any, were not apparent until later analysis.

It is for this reason that I have included two selections—those from Jean Baptiste Say and John Stuart Mill—that long antedated the General Theory itself. The truth of the basic propositions of the General Theory rests (on the contention or admission of most Keynesians) on the truth of Keynes’s “refutation” of Say’s Law. But when we turn to the original statement of this law in the words of the economist after whom it is named, and to its elaboration by the classical economist who argued it most fully, we find that these statements in themselves, particularly the one by Mill, anticipated the objections of Keynes and constituted a refutation of them in advance. I have also included these two “classical” statements because they are today otherwise accessible only with great difficulty.

Each of the selections in the present volume is preceded by a note identifying the author or calling attention to some special aspect of his contribution.

Not the least important function which the present symposium is designed to serve is to make available to the reader a short summary of the theme of Keynes’s General Theory as well as a short summary of the chief objections to it. In fact, at least half a dozen of the articles included each do that individually. This of course involves some repetition, although each article or extract selects different doctrines for discussion or emphasis and emphasizes different criticisms. But any reader who has not time to read the whole volume will be able to make his own selection, as will the instructor to make his own recommendations or assignments to students.

Having been led, myself, by a desire for fullness and thoroughness, into writing an analysis that ran to 450 pages, I feel that it would be useful if I also offered here a short restatement of a few of my leading criticisms. The argument for each of them, of course, must either be violently condensed or omitted altogether.

I do not think we can point to any one “central” fallacy in Keynes upon which all the others depend, or of which they are all corollaries. The book is not that logical or consistent. It is a succession, rather, of a whole series of major fallacies that are intended to support each other.

But perhaps it is best to begin with a statement of what can not be found in the General Theory. In spite of the incredible reputation of the book, I could not find in it a single important doctrine that was both true and original. What is original in the book is not true; and what is true is not original. In fact, even most of the major errors in the book are not original, but can be found in a score of previous writers.

On the negative side, the book seems mainly designed to prove that excessive money wage rates are not the major cause (or even a cause) of unemployment, and that reductions of such money wage rates to marginal-productivity levels will not restore employment. In denying this proposition, it may be pointed out, Keynes is denying what is perhaps the most solidly established of all economic doctrines—to wit, that if any commodity or service is overpriced, some of that commodity will remain unused or unsold: supply will exceed demand; whereas if it is underpriced, a “shortage” will develop: demand will exceed supply.

Yet it is hard to find any place in the General Theory where the argument against this proposition is clearly and directly stated. Keynes seems to admit it freely enough when it is applied to commodities; but he makes “labor” an exception. (He even, on occasion, lefthandedly admits it about labor itself, as on pages 264 and 265.) But Keynes’s argument on this point is usually obscure and oblique, and seems constantly to shift.

One form of his argument is that the labor unions just won’t accept a cut in money wages, and therefore something else must be done. This something else is monetary inflation, which will raise prices. Keynes contends, in other words, that labor unions will not accept a cut in money wage rates but will accept a cut in “real” wage rates. This factual contention, even if it may once have contained a germ of truth, has long been outdated. The major American labor unions today all have their “economists” and “directors of research” who are keenly aware of index numbers of consumer prices and insist that wage rates must at least keep pace with these. But even if this were not so, Keynes’s contention would be irrelevant to the “orthodox” doctrine that wage rates in excess of the “equilibrium” point (i.e., of the marginal productivity of labor) will cause unemployment. In fact, Keynes’s argument tacitly admits that at least real wage rates must be at equilibrium levels if “full employment” is to be achieved.

It is impossible to make sense of the specific arguments that Keynes puts forward to deny the “classical” doctrine. He contends that, if any adjustment were made of wage rates to prices, it would have to be a uniform, en bloc adjustment, “a simultaneous and equal reduction in all industries,” such as is possible only in a totalitarian economy, or it could not work; and even if it did it would be terribly “unjust.” This assumes, of course, that the previous interrelationship of wages and prices must have been precisely what it ought to have been! Keynes even puts forward the hysterical argument that if money wage rates were once lowered to adjust them to lower prices and demand, they might “fall without limit.”

One of the sources of Keynes’s errors on this subject is his failure to distinguish, most of the time, between (weekly, daily, or hourly) wage rates and total wage payments, (i.e., total payrolls or total wage income). This is because he habitually uses the ambiguous word “wages” to describe either or both. This in turn leads him tacitly to assume that a reduction in wage rates means a corresponding reduction in wage income, and hence “reduces purchasing power” and “effective demand” and leads to a descending spiral without limit. But the “classical” contention is simply that those wage rates that are above the equilibrium level should be reduced to that level in order to restore employment and to increase and maximize the aggregate of wages paid.

Another repeated fallacy of Keynes in his discussion of wages is his constant reference to something he calls “an equilibrium with unemployment.” But this is simply a misuse of the term “equilibrium.” What Keynes is really discussing is a frozen situation, a frozen disequilibrium with unemployment. An “equilibrium with less than full employment” is a contradiction in terms.

Keynes tries to refute Say’s Law. All Keynesians think that he did so; and many of them think that this was his “greatest achievement” and his chief “title to fame.” Say’s Law (originally put forward by Jean Baptiste Say, 1767-1832) may be most briefly described as the doctrine that supply creates its own demand. But as elaborated by the classical economists—Ricardo, James Mill, and John Stuart Mill—this was stated merely as an ultimate truth, true only under what today would be called conditions of equilibrium. It was designed to point out chiefly that a general overproduction of all commodities is not possible. It was never anything so foolish as a contention that money is never hoarded or that depressions are impossible. Keynes “refuted” Say’s Law only in a sense in which no serious economist ever maintained it.

Keynes is hailed by his admirers almost as if he alone had discovered the important role of “expectations” in economics. The truth is that he did not sufficiently recognize that role. He saw that expectations affected current output and employment, but seemed to forget that they are also embodied in every current price, interest rate, and wage rate. It is partly because he underrated the central importance of expectations that he denounced “liquidity preference” and “speculation.” He failed to see that speculative anticipations and risks are necessarily involved in all economic activity, and that somebody must bear these risks.

Keynes’s discussion of the relation of “savings” and “investment” is too confused to be summarized. He alternated constantly between two mutually contradictory contentions: (1) that saving and investment are “necessarily equal” and “merely different aspects of the same thing,” and (2) that saving and investment are “two essentially different activities” without even a “nexus,” so that saving not only can exceed investment but chronically tends to do so, and hence brings on deflation.

What we can accurately say about this relationship depends partly, of course, on the particular definitions we choose to give each of these terms. But, assuming the appropriate definitions, I should contend that, under the assumptions of a constant money supply, saving and investment are necessarily at all times equal. When investment exceeds prior genuine saving, it is because new money and bank credit have been created. When ordinary saving exceeds subsequent investment, it is because the money supply has meanwhile contracted. In other words, it is not, generally speaking, an excess of saving over subsequent investment that causes deflation, but deflation that causes the deficiency in subsequent investment. An excess of saving over (subsequent) investment is but another way of describing deflation, and an excess of investment over (prior) saving is but another way of describing inflation—or of saying that it has meanwhile occurred.

Keynes’s disparagement of saving in the General Theory was not new with him. He had deplored or ridiculed saving for the whole of his writing life, beginning with The Economic Consequences of the Peace in 1920. The disparagement came from his failure to understand the nature and function of saving. “Economic growth,” higher real wages and living standards, are possible only through new capital formation. And production and saving are both indispensable to the formation of capital.

This is what Keynes tended constantly to overlook. He persistently regarded saving as something merely negative, a mere non-spending, forgetting that it was the inescapable first half of the completed positive act of investment. He could have learned this if he had ever seriously studied Böhm-Bawerk, who had pointed out a generation earlier that: “To complete the act of forming capital it is of course necessary to complement the negative factor of saving with the positive factor of devoting the thing saved to a productive service. . . . [But] saving is an indispensable condition to the formation of capital.” And the rate of true “economic growth” is in effect the rate of capital formation.

What Keynes failed to recognize was that, normally, to save is to spend: but to spend on capital goods rather than on consumer goods. And even if, in abnormal conditions, saving takes merely the form of monetary hoarding, it does not lead to unemployment, as Keynes supposed, unless wages (or prices) are inflexible in the downward direction. Otherwise, the result would be merely the continuance of the same volume of output and employment at lower prices and wages.

But Keynes had no adequate theory of either capital or interest. He seemed in this field to get everything upside down. He thought that interest was a purely monetary phenomenon, the “reward” that had to be offered to the holders of money to induce them to “part” with their “liquidity.” Years before Keynes announced this doctrine it was already very old, and Ludwig von Mises had rightly dismissed it (as early as 1912) as a view of “insurpassable naïveté.”

Keynes’s theory of interest was, indeed, what Irving Fisher, and before him Böhm-Bawerk, had labeled the Exploitation Theory—the theory that to take interest is, necessarily and always, to take advantage of the debtor; the theory that there ought not to be any interest at all. One form of this theory was developed by the socialists of the Nineteenth Century, notably Proudhon, Rodbertus, and Marx, but in its most naïve form it goes back to the Middle Ages, and, indeed, to Ancient Rome.

It is hardly necessary to add that, as a result of all these theoretical misconceptions, all Keynes’s recommendations for practical policy were unsound. He wanted government control and direction of investment—a proposal which, if taken seriously, would lead to full socialism and a totalitarian state. His ideas of creating employment by budget deficits and continuous cheap money policies—i.e., by continuous inflation—got a thorough tryout in both Great Britain and the United States. In Britain they were dramatically and successfully repudiated in 1957, when the Bank of England discount rate was raised to 7 per cent. In the United States they failed miserably, in the entire period from 1930 to 1940, to achieve the goal of eliminating mass unemployment.

But here the Keynesian philosophy remains dominant. Keynesian policies are still the policies of most of our politicians and bureaucrats. At the first sign of recession, they begin to demand increased “public works,” increased government spending—whatever will create deficits that in turn will lead to the creation of more paper money. If there is unemployment in any line, or in many, no politician is ever heard to suggest that it might be because wage rates have been forced up too high in those lines and ought to be reduced to levels that would encourage reemployment. The demand is solely that the government spend still more to create more jobs. This demand is, in effect, a demand for more inflation. At every emergence of unemployment, a functioning relationship is to be restored between wages and prices, not by readjusting downward the wage rates of relatively small groups of workers, but by pushing up still further the prices that must be paid by everybody. As Jacob Viner succinctly predicted in a review in 1936, when the General Theory appeared, Keynes’s prescription would lead to “a constant race between the printing press and the business agents of the trade unions.” That race has been going on for two decades. It is still going on. And in the foreseeable future it seems more likely to accelerate than to come to a stop.

Behind the triumph of the Keynesian philosophy and nostrums lies an intellectual mystery. How did it happen that a book so full of obscurities, contradictions, confusions, and misstatements was hailed as one of the great works of the Twentieth Century, and its author as a master economist? Perhaps no complete answer is possible; but it is not difficult to point to some of the elements in such an answer.

The Keynesian philosophy seemed to supply a new and more sophisticated rationale, not only for the traditional contention of labor leaders that money wage rates should constantly be raised and under no circumstances reduced, but for the immemorial political recourse of monetary inflation.

But other factors were no less important. Keynes’s reputation as a great economist rested from the beginning on his purely literary brilliance. Surely a man who could write (in 1919) that Lloyd George found to his horror that “it was harder to de-bamboozle this old Presbyterian [Wilson] than it had been to bamboozle him” must be a very clever dog. If he ridiculed the stodgy old orthodox economists it must be he who was right. Literary men judge specialists by their literary qualities; and among these grace and wit rank higher than rigorous reasoning or a thorough and accurate knowledge of subject matter.

Yet even this hardly seems to apply to the General Theory, which with the exception of a few passages is one of the most obscure, awkward, and circumlocutory economic books ever written. But here another element enters. Just as with some of the works of Hegel and Marx, the very mystification added to the book’s prestige. Unintelligibility was assumed to be a mark of profundity. One secret of the success of the General Theory was its technique of obscure arguments followed by clear and triumphant conclusions.

But there was probably an even more important factor. Keynes had announced in his preface that the composition of the General Theory had been “a long struggle of escape . . . from habitual modes of thought and expression.” He tauntingly predicted that “those who are strongly wedded to what I shall call ’the classical theory’ will fluctuate . . . between a belief that I am quite wrong and a belief that I am saying nothing new.” This undoubtedly intimidated many economists, whose greatest dread was to be regarded as “orthodox” and “wedded” to old ideas. As Frank H. Knight put it: “Our civilization today, being essentially romantic, loves and extols heretics quite as much as its direct antecedent a few centuries back hated and feared them. The demand for heresy is always in excess of the supply and its production is always a prosperous business.” And the irony was that this heresy in turn became the intellectual fashion, which academic economists could ignore only at the cost of being themselves ignored, or challenge only at the cost of losing status.

But whatever the full explanation of the Keynesian cult, its existence is one of the great intellectual scandals of our age.

HENRY HAZLITT

1 Part of this Introduction appeared in National Review, November 7, 1959, and is reproduced here with its permission.