Keynes and Laissez-Faire

Keynes is back

Keynes's idea of economically active governments have made a dramatic comeback. Around the world banks in practice have been nationalized. In practice it has been recognized that laissez-faire with its uncontrolled quest for profit is not consistent with the best for society in economic core areas. Politicians themselves have not yet understand what happened. In words, the still praise privatization and laissez-faire, but in deed they give in to Keynes.

In the postwar period John Maynard Keynes was just supreme. His theories were simply identical to the scientific subject of national economy. He created the term macro economics. All universities taught in national economic models based on Keynesian works.

The economic activity of society is determined by the aggregated supply and demand of goods and services. The point where these two curves, representing supply and demand, intersect, represents the current activity of society. However, there is no reason to believe that this activity automatically will represent full employment, he wrote. Indeed, it would be a unique case, if society's supply and demand of themselves just met at a point, representing full employment. Therefore, it is necessary that governments actively manage the economy through fiscal policy, public projects, tax and monetary policy.

When the Great depression of the thirties developed in the U.S. with factory closures and rising unemployment, he outlined his solution in two "open letters" to Franklin D. Roosevelt in December 1933 and June 1934, as well as in some speeches he made in England in which he evaluated the results of the American New Deal policy.

Keynes considered Franklin D. Roosevelt as "guardian of the reformers in all countries seeking to address evils of society with rationel experiments within the framework of the existing social system." For Roosevelt, Keynes was "the most sympathetic of the World".

Also in 1933 the Nazis came to power in Germany. Very quickly the German financial genius, Schacht, wiped out the unemployment with a very similar monetary expansion policy, which characterized both the Keynesian ideas as well as Roosevelt's New Deal. As you will recall, Keynes had way back from the time of the peace negotiations in Versailles good connections in Germany. He gave his famous lecture "End of Laissez-faire" first in Germany already in 1926. He was a key figure in the international fight against the great crisis of the thirties.

In his writings of the twenties and early thirties, he argued for a "new liberalism". He demonstrated that governments "deficit-spending" was an effective mean to overcome the Great Depression. His early articles and speeches contained all the main components, which were later included in his principal work "The General Theory of Employment, Interest and Money", published in 1936 and which became the principal work for several generations of economists and politicians.

The philosopher Bertrand Russell said that Keynes was the most intelligent person, he ever knew. "Every time I argued with Keynes, I felt that I had my life in my hands, and I rarely escaped without feeling me a bit of a fool."

In 1944, Keynes participated in the Bretton Woods Conference as leader of the British delegation. The conference aimed to organize the international economic system after the war. The World Bank and the International Monetary Fund were formed. At this conference, Keynes proposed to establish an international reference currency, as a kind of global reserve currency. He did not get his proposal through. After the war, the U.S. dollars, in practice became the international reserve currency, greatly benefiting the U.S. economy.

Keynes ideas are often mentioned as the theory behind the deficit-national economic policy, which also nowadays is very popular with many governments. The critics of such policy point out that an increased money supply certainly will lead to inflation.

However, we must remember that he recommended the governments to stimulate the economy in times of crisis by expanding the money supply, but also he recommended to counteract economic overheating in other times by reducing the money supply.

The first part of the theory the democratic politicians have taken completely to their hearts; today huge amounts of money are created every day, just think of the government of president Obama in the United States. But the second part of the theory, which prescribes reducing the supply of money by collecting taxes and let the money disappear in a magical puf, has never been popular either among the politicians or among their voters.

In 1936, three years after Adolf Hitler's appointment to head of the German Government, Keynes masterpiece "The General Theory of Employment, Interest and Money" was published in Germany. Keynes hoped to be "met with less resistance on the part of German readers than from English", because the german economists had longe since rejected the clasical economists. He wrote in his preface: "If I can contribute a single morsel to the full meal prepared by German economists, particularly adjusted to German conditions, I will be satisfied."

At the end of the preface he wrote: "The theory of aggregate production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state, than - - under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries, where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced." (All cites above from "Monetary Central Planning and the State", Part 20)

It is likely such that almost any theory of economic management of society is associated with both carrots and sticks. In a democratic system with its faithless and unpredictable marginal voters, you can in general use only carrots.

The alternative to economic management of society is to leave the economy to the business men, the private initiative. In this way, the economy becomes a kind of natural disaster, nobody are really responsible, and the politicians can therefore not so easily be blamed that they have done something wrong.

Keynes' ideas seemed discredited after the inflation and unemployment of the seventies, which governments could not bring to an end with traditional Keynesian policies. Keynes's theoretical opponents, the monetarists, led by Milton Friedmann, triumphed.

Politicians again hailed private enterprise and laissez-faire. Led by Ronald Reagan and Magaret Thatcher governments privatized public enterprises around the world. The British government sold British Steel and the coal mines, the German government sold its shares in Volks Wagen, the Danish government sold Tele Danmark, Girobank and Copenhagen Airport. Ferry service, housing, cleaning of schools and hospitals were left to private firms. Foreign exchange rates and short and long term interest rates were left to find their level guided by the market forces. Or, let's face it, the agents behind the market forces, the finacial industry.

Now a days unemployment is explained in terms of excessive real wages only, inflation is the result of oversupply with money, low growth is a result of unnecessary restrictions of the dynamic market forces. A Kenynesian economist would had refered to failing demand and pessimistic business expectations. It is not the government's job to operate companies, it was said. The market's "invisible hand", guided by the individual's selfish quest for wealth, would arrange everything to the best for the common good.

Keynes in the Soviet Union

In 1925 Keynes married the Russian dancer Lydia Lopokova. They traveled together to Leningrad to visit her family. They continued to Moscow, where he met with government members and academics and gave a few lectures.

When he returned to England, he wrote a short article "A Short View of Russia", in which he expressed strong criticism of the communist regime: "For me, brought up in a free air undarkened by the horrors of religion, with nothing to be afraid of, Red Russia holds too much which is detestable - - I am not ready for a creed, which does not care how much it destroys the liberty and security of daily life, which uses deliberately the weapons of persecution, destruction, and international strife. It is hard for an educated, decent, intelligent son of Western Europe to find his ideals here."

He continued: "How can I accept a doctrine, which sets up as its bible, above and beyond criticism, an obsolete text-book which I know to be not only scientifically erroneous but without interest or application for the modern world? How can I adopt a creed which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and the intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement? Even if we need a religion, how can we find it in the turbid rubbish of the red bookshop? It is hard for an educated, decent, intelligent son of Western Europe to find his ideals here, unless he has first suffered some strange and horrid process of conversion which has changed all his values. -- "

But where the Soviet Union had an advantage over the West, Keynes wrote, was in its fervent commitment to revolutionary action, in its romatizing of the ordinary worker and its condemnation of profit. The Soviet Union's attempts to move the "profit mentality" up by the roots, was really, according to Keynes, "a tremendous renewal".

Even capitalist society, said Keynes, had to find a moral base elevated over the selfish interest, "the love of money". Therefore, Keynes saw the Soviet Russia as being on a moral level higher than the capitalist West with its selfish individualism. He also argued that "every scrap of useful economic technique" developed in Soviet Russia, could be easily transplanted to the Western economy and thereby contribute to his model, "The New Liberalism" with "same or greater success" than it had in the Soviet Union."

The End of Laissez-Faire

Laisssez-faire is the idea that governments should not interfere in the market, and they should let the market forces and the business men take care of the economy.

In 1926 Keynes published an article entitled "The End of Laissez-Faire", in which he wrote: "It is not true that individuals possess a prescriptive "natural liberty" in their economic activities. There is no "contract" conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately."

In modern times the notion of laissez-faire everywhere are presented as a well established scientific truth, quite in line with Newton's laws as well as Darwin's evolutionary theory. However, Keynes pointed out that no great economists has ever supported general laissez-faire, and this idea is really not very scientific. The concept of laissez-faire comes basicly from some conversation subjects, which were popular in the Parisian cafe life in the beginning of the nineteenth century.

The industrialization and modern development progressed. The original near perfect competitive markets were gradually replaced by oligopolies. The Industrial organisations grew still larger and more powerful. They exercise today great power and influence also in the universities. A University who lectured John Maynard Keynes more than Milton Friedman and von Mises, would be labeled as "red". Their graduates would have difficulty finding work in today's powerful international business groups. That would mean failing influx of students, lack of funds and sinking academic status. Therefore, the laissez-faire principle over time has become increasingly well established, despite its weak theoretical foundations, and despite the fact that the markets of the real world in fact have evolved away from the near perfect competition, which laissez-faire implies.

Chinese television showed recently that the province of Liaoning had purchased a number of Danish piglets for further breeding. They arrived in good condition with some scratches, which they had got from the internal fighting during the journey. Full of energy and curiosity they put their snouts towards the camera. The viewers could clearly see their long snouts and blue eyes.

In a few years Chinese farmers will be able to enter the international markets and offer the same as the Danish farmers and slaughterhouses - only cheaper.

An information letter from the Agriculture Council says that more and more Danish pig breeders are specializing in breeding of piglets for export, it pays better off than traditional pig farming. The slaughterhouses will increase the settlement price per kg in order to motivate these farmers to return to normal pigbreading.

Nobody seems to mind that it is the result of centuries of Danish breeding effords, which individual farmers sell to our competitors for small money. It is laissez-faire and private enterprise in action and fully consistent with the traditionel liberal attitudes of the danish farmers associations.

That time thousand years ago, when the Chinese were the only ones, who knew about silk production, they kept the secret, as long as they could. They had not yet gotten their sound logic clouded by the notion of laissez-faire.

In a period in which industry and commerce also became concentrated in ever fewer hands, Keynes suggested: "I propose a return, it must be said to the medieval organization of separate autonomy."

"I believe that in many cases the ideal size for the unit of control and organisation lies somewhere between the individual and the modern state." He wrote in "End of Laissez-Faire". "I suggest, therefore, that progress lies in the growth and the recognition of semi-autonomous bodies within the State-bodies whose criterion of action within their own field is solely the public good as they understand it, and from whose deliberate motives of private advantage are excluded, though in some place it may still be necessary to leave, until the ambit of men's altruism grows wider, to the separate advantage of particular groups, classes, or faculties - bodies which in the ordinary course of affairs are mainly autonomous within their prescribed limitations, but are subject in the last resort to the sovereignty of the democracy expressed through Parliament."

Further, he wrote: "But more interesting than these is the trend of joint stock institutions, when they have reached a certain age and size, to approximate to the status of public corporations rather than that of individualistic private enterprise. One of the most interesting and unnoticed developments of recent decades has been the tendency of big enterprise to socialise itself. A point arrives in the growth of a big institution - particularly a big railway or big public utility enterprise, but also a big bank or a big insurance company - at which the owners of the capital, i.e. its shareholders, are almost entirely dissociated from the management, with the result that the direct personal interest of the latter in the making of great profit becomes quite secondary. When this stage is reached, the general stability and reputation of the institution are the more considered by the management than the maximum of profit for the shareholders. The shareholders must be satisfied by conventionally adequate dividends."

He used the "Bank of England" as an example: "It is almost true to say that there is no class of persons in the kingdom of whom the Governor of the Bank of England thinks less, when he decides on his policy than of his shareholders. Their rights, in excess of their conventional dividend, have already sunk to the neighbourhood of zero. But the same thing is partly true of many other big institutions. They are, as time goes on, socialising themselves.

The big companies, the stock companies, have received the savers' money - and learned to use them. Today, many of them are in reality already publicly owned, in the sense that they are owned by countless savers scattered throughout the whole society. The companies are in really only a few steps away from a real socialization, as Keynes put it.

In the West, the big stock companies are often controlled by a a self-complementary group of "managers", more than they are controlled by the owners, which are the shareowners. The share capital is typically owned by a multitude of small shareholders, who have no real possibility to control the operations of the company. The individual small shareholders have no knowledge of the business areas, in which the companies operate, they have no cooperation or joint concert with the other small shareholders, and therefore they cannot exercise authority against the "managers". The small shareholders have bought the shares in the hope that they can sell them again at a higher price within a relatively short period of time. They have only vague ideas of the companies' business. The real power in these share companies rests in the hands of the professional "managers".

Some may think that such semi-autonomous units, as he suggested, is a typical utopian and unworldly idea, which represents a period in history, which long since have passed. But in modern times such a socio-economic system actually has been tested in a huge scale and with great financial success.

Under Deng Xiao money leadership China's economy changed from a traditional socialist command economy to a "socialist market economic system", which was approved by the Fourteenth Party Congress in 1993. The foundation for this decision had already been laid in 1988 with the "Enterprise Law", which made large business organizations to legal entities.

To promote competition, the large state enterprises in every industry have been divided into several smaller organizations. In the mobile telephony business, China Mobile and China Unicom were formed. The White goods giant the Haier Group and the Qindao Beer brewery participates in the international market economy.

These big organizations were encouraged to operate on the market, as they were independent capitalist enterprises. However, they are still ultimately controlled by the state, which maintains ownership. But the government seems to exercise its power only rarely, in connection with very general conditions or in very exceptional situations. These rather large state firms are the big trees in the forrest. They are surrounded by a fertile vegetation of bushes in form of thousands of totally private companies, which operate under entirely normal market conditions characterized by supply and demand.

This whole set up reminds one strikingly of Keynes' semi-autonomous bodies. It also recalls the whole medieval organization, as he also said. Master artisans, who were organized into guilds, which regulated their own affairs, but ultimately had sworn loyality to the king. Monasteries and village communities were also separate units, which took care of their own affairs, but also ultimately accepted the king's sovereignty.

Thus, as was the case in Deng Xiao Ping's China, Keynes argued in 1926 that governments should have a line of communication directly into the heart of the major business organizations.

"Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance." Keynes wrote. "I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know. These measures would involve society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered."

Keynes cites Cairnes from a lecture in 1870 on "Political Economy and Laissez-faire".

"The maxim of laissez-faire", he declared, "has no scientific basis whatever, but is at best a mere handy rule of practice." (Cairnes well described the' prevailing notion' in the following passage from the same lecture: "The prevailing notion is that P.E. undertakes to show that wealth may be most rapidly accumulated and most fairly distributed; that is to say, that human well-being may be most effectually promoted by the simple process of leaving people to themselves; leaving individuals, that is to say, to follow the promptings of self-interest, unrestrained either by State or by the public opinion, so long as they abstain from force and fraud. This is the doctrine commonly known as laissez-faire; and accordingly political economy is, I think, very generally regarded as a sort of scientific rendering of this maxim - a vindication of freedom of individual enterprise and of contract as the one and sufficient solution of all industrial problems.")

In modern times the European steel mills and shipyards have been more or less pushed out of business by the Japanese and Korean competitors. One can wonder, what are the real causes for this. Now a days, Japanese and Korean workers have a relatively high salary, which can be compared with their European colleagues, and steel prices are similar all over the world. What is the reason for this difference in competitiveness?

There is no doubt that one very important difference lies in the employees and management's basic attitudes towards their organization and thus the labor productivity.

In the West, we have for several hundred years been brain washed that every single individual are the masters of their own fortune and happiness - only. There is no sacred purpose of society, which can override the individuals quest for happiness and fortune. The workers as well as the capitalists should care about their own wealth only, then some natural market forces will arrange everything to the best for society in a perfect balance. There is nothing that is sacred except for the rights of the individuals to pursue their own interests. If someone is talking about idealism and patriotism, they are probably some unnatural hypocrites. Everyone should just follow the impulses, he gets to pursue "the promptings of their self-intereste". It is completely natural and the invisible market forces will make sure to arrange everything to the best for the common good.

Typical Western business men are not expected to feel any special responsibility for their employees. They will be sacked without mercy, when there is no need for them anymore. Also Workers with strong unions will not hesitate to squeeze the company as much as possible. In spite of all it is just a contract between free individuals, nothing personal. That is the meaning of the whole system, it is said; everybody should just pursue their own happiness, and the laissez-faire market will sort out the rest in perfect balance.

A traditional Western worker does not have any trouble having long breaks or working inefficiently, as long as he gets his salary. After all he is only responsible for himself, he feels.

Keynes writes: "One can sympathize with Coleridges view, as summarized by Leslie Stephen, that "the utility philophers destroyed every element of unity and made Society a struggle between selfish interests, and hit the very root of all order, patriotism, poetry and religion."

Koreans and Japanese employers and workers have national feelings and have a strong sense of belonging to the same people and culture. There have an attitude of shared social responsibility and common identity among the firms and their employees. Korean workers and employers work not only for Hyundai and Daewo; they also work for Korea.

Keynes is the Greatest

In two hundred years from now, when the dust has settled, John Maynard Keynes will be mentioned in line with Plato, Kant, Newton and Einstein. His theoretical opponents, Milton Friedman and Ludwig von Mises will only be some sophists, who threw the dust up, which people got in their eyes, so they could not see clearly. Only experts will then know their names.

William of Occam was a very clever man. His "razor" prescribes that out of several possible theories, the simplest is the most likely to be true.

Let us imagine a "Keynesian" conversation on the Great Depression:

- What was the real cause of the Great Depression of the thirties, when factories closed and millions were unemployed?
- Hm - jaah. Maybe too few bought the factories' products.
- Wonder why they did not buy?
- Nja - they probably had no money.
- And why did they have no money?
- Well - maybe much of the money had slipped through the fingers of ordinary people and passed to the business men. At least there was a bonanza for shares at the time for the start of the big depression.
- And what could we do about it?
- Jo-eh - if you do not want to make revolution, you probably have to print some more money, perhaps borrow some, and them send them into circulation in such a way, that the unemployed get them in their hands, they will certainly buy something.

Such is the foundation of the Keynesian theory of the great crisis, simple and straightforward, and very likely true.

The Monetarists' and the Austrians' theories are much more complicated and contains several assumptions that are difficult to prove.

Milton Friedman and the monetarists explain that the incompetent central bank kept a too small aggregate money supply for too long time and thus caused a minor crisis. With his New Deal policy Roosevelt and the government interfered in the free market and thereby violated the laissez-faire principle. In this way the government became responsible for prolonging the crisis. Moreover, the government ignored the international financial market forces and established a fixed exchange rate between dollars and gold, thus creating some "bank runs", which also prolonged the crisis.

Ludwig von Mises' Austrian Economic School imagines that the government and the central bank increased the money supply, this led the price of money, the interest rate to fall and thereby tempted some developers to invest in unsustainable projects, which collapsed soon after and thus began a vicious cycle of unemployment and failing demand .