Listener: 23 May, 1981.

Keywords: History of Ideas, Methodology & Philosophy;Macroeconomics & Money;

I once asked Dr W.B. Sutch how much Keynes had influenced the thinking of the first Labour Government. John Maynard Keynes’s book The General Theory of Employment and Money has been the most influential piece or economics writing this century in terms or its impact on both economic theory and economic policy. It explained how a government could practice deficit financing to increase employment.

Sutch, who was a government adviser in the 1930s, replied that Keynes had little influence. Rather, the government observed that housing materials were not being used, house builders were unemployed, and families desired houses, so that the Government ensured there was the finance to bring the builders and materials together to construct the houses that were needed.

This is undoubtedly an over simplification – Sutch had studied Keynes’s work in his doctoral programme* – but it is appropriate to emphasise the pragmatic response or the Government in the years immediately after 1936. Later economists used Keynes’s General Theory to justify and improve the management of the economy adopted at the time.

As a result, an entire school or Keynesian economists arose, and also politicians, businesswomen and others adopted the Keynesian framework of the time. For many of the practical men this adoption was uncritical without an awareness of some of the limitations or the framework, limitations that were known to Keynes.

For instance in a Keynesian-managed economy with powerful firms and powerful unions it is very difficult to prevent inflation, except by direct controls of wages arid prices.

A second obvious weakness is that the simple Keynesian models have no exports and imports. Keynes was aware or this and in the early 1930s had advocated the use of import controls as a means or limiting the impact of foreign trade on the domestic economy. In 1938, racing a shortage of foreign exchange the Labour Government introduced import controls, again as a pragmatic response rather than with a knowledge of Keynes’s position.

A third major limitation was that in order to simplify his theory Keynes assumed that the prices for goods and services in the economy were fixed relative to one another. This assumption was unnecessary, except for simplification. Unfortunately it was picked up and misinterpreted by the practical.

For them what the theory seemed to be saying was that prices may be ignored when we are concerned about the overall behaviour of the economy, in terms of its output, employment and balance of payments. Such a view was reinforced by a couple of antipathies from the 1930s.

First there was an antipathy against the market as an economic mechanism. Markets were seen to be a cause or the Depression or the 1930s and also an integral facet or capitalism.

It seemed to these people it was better to regulate the economy by direct government controls super-imposing over the market where necessary.

Second. changes in prices modify income distribution, sometimes against the interests of a particular social group such as businessmen, farmers or workers. If it is thought that these price changes have no effect on output, employment or the balance or payments, it followed that prices could be set for any desired distributional or political purpose.

The result was a plethora or arbitrary subsidies and indirect taxes, curious government price arrangements and the establishment of high cost industries.

It was these. sorts or considerations which gave rise to the simple Keynesian approach which was popular a quarter or century ago. Briefly it may be summarised as. that ‘it is right for a government to use its taxation. spending and monetary powers to pursue objectives or output, employment, the balance of payments and price stability’. However, the price structure has little influence on these objectives and so may be manipulated for other purposes. Today there is a significant and influential group or practical people who still hold this view; a group to be found in most pressure groups and all political parties.

Over the period there has grown up a succeeding group or Keynesians who, while agreeing with the first half or the proposition, disagree that the price system is irrelevant. To the contrary they would argue that our ignoring the price mechanism has been a major factor in a poor growth performance, unemployment, and our slowness of adjusting to new world economic circumstances.

Some of the personality disputes which erupted in our political parties last year were also disputes over economic policy. It is a pity that coverage tends to be about personalities with so little attention to the policy issues.

Concluding his General Theory Keynes remarked: ‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men. who believe themselves to be quite exempt from intellectual influences. are usually the slave of some defunct economist.’ Forty-five years later that defunct economist is often a simple minded version of Keynes.

* Sutch probably studied, or would certainly been aware of, Keynes’ Treatise on Money. He reviewed The General Theory in Tomorrow in early 1936, only months after it had been published. (Added in 2003)