Broken Paradise: A Critical Assessment of the Keynesian 'Full Employment' Era

THE IDEALIST VIEW: KEYNESIANISM AS THE VICTORY OF ONE IDEOLOGY OVER ANOTHER

Looking back on the 30-year-long economic expansion that followed World War II, Adam Przeworski and Michael Wallerstein concluded that 'by most criteria of economic progress the Keynesian era was a success'. It is hard to disagree: throughout the West, from the mid-1940s until the early 1970s, countries enjoyed lower levels of unemployment, greater economic stability and higher levels of economic growth than ever before. That stability, particularly in the US, also rested on a strong financial regulatory framework: on the widespread provision of deposit insurance to stop bank runs; strict regulation of the financial system, including the separation of commercial banking from investment banking; and extensive capital controls to reduce currency volatility. These domestic and international restrictions 'kept financial excesses and bubbles under control for over a quarter of a century'. Wages and living standards rose, and – especially in Europe – a variety of policies and institutions for welfare and social protection (also known as the 'welfare state') were created, including sustained investment in universally available social services such as education and health. Few people would deny that this was, indeed, a 'golden age' for capitalism.

However, when it comes to explaining what made this exceptional period possible and why it came to an end, theories abound. Most contemporary Keynesians subscribe to a quasi-idealist view of history – that is, one that stresses the central role of ideas and ideals in human history. This is perhaps unsurprising, considering that Keynes himself famously noted: 'Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.'

According to this view, the social and economic achievements of the post-war period are largely attributable to the revolution in economic thinking spearheaded by the British economist John Maynard Keynes. Throughout the 1920s and 1930s, Keynes overturned the old classical (neoclassical) paradigm, rooted in the doctrine of laissez-faire ('let it be') free-market capitalism, which held that markets are fundamentally self-regulating. The understanding was that the economy, if left to its own devices – that is, with the government intervening as little as possible – would automatically generate stability and full employment, as long as workers were flexible in their wage demands. The Great Depression of the 1930s that followed the stock market crash of 1929 – where minimal financial regulation, little-understood financial products and overindebted households and banks all conspired to create a huge speculative bubble which, when it burst, brought the US financial system crashing down, and with it the entire global economy – clearly challenged traditional laissez-faire economic theories.

This bolstered Keynes' argument – spelled out at length in his masterpiece, The General Theory of Employment, Interest, and Money, published in 1936 – that aggregate spending determined the overall level of economic activity, and that inadequate aggregate spending could lead to prolonged periods of high unemployment (what he called 'underemployment equilibrium'). Thus, he advocated the use of debt-based expansionary fiscal and monetary measures and a strict regulatory framework to counter capitalism's tendency towards financial crises and disequilibrium, and to mitigate the adverse effects of economic recessions and depressions, first and foremost by creating jobs that the private sector was unable or unwilling to provide. The bottom line of Keynes' argument was that the government always has the ability to determine the overall level of spending and employment in the economy. In other words, full employment was a realistic goal that could be pursued at all times.

Yet politicians were slow to catch on. When the speculative bubbles in both Europe and the United States burst in the aftermath of the Wall Street crash of 1929, various countries (to varying degrees, and more or less willingly) turned to austerity as a perceived 'cure' for the excesses of the previous decade. In the United States, president Herbert Hoover, a year after the crash, declared that 'economic depression cannot be cured by legislative action or executive pronouncements' and that 'economic wounds must be healed by the action of the cells of the economic body – the producers and consumers themselves'. At first Hoover and his officials downplayed the stock market crash, claiming that the economic slump would be only temporary. When the situation did not improve, Hoover advocated a strict laissez-faire policy, dictating that the federal government should not interfere with the economy but rather let the economy right itself. He counselled that 'every individual should sustain faith and courage' and 'each should maintain self-reliance'. Even though Hoover supported a doubling of government expenditure on public works projects, he also firmly believed in the need for a balanced budget. As Nouriel Roubini and Stephen Mihm observe, Hoover 'wanted to reconcile contradictory aims: to cultivate self-reliance, to provide government help in a time of crisis, and to maintain fiscal discipline. This was impossible.' In fact, it is widely agreed that Hoover's inaction was responsible for the worsening of the Great Depression.

If the United States' reaction under Hoover can be described as 'too little, too late', Europe's reaction in the late 1920s and early 1930s actively contributed to the downward spiral of the Great Depression, setting the stage for World War II. Austerity was the dominant response of European governments during the early years of the Great Depression. The political consequences are well known. Anti-systemic parties gained...