Historical Perspectives on Macroeconomics: Sixty Years After the 'General Theory'

HISTORICAL PERSPECTIVES ON MACROECONOMICS

Since the publication of Keynes’ General Theory of Employment, Interest and Money in 1936, macroeconomic theory has altered considerably, often reflecting developments in the study of Keynes’ work such as the New- and Post-Keynesian school. More recently, scholars have emphasised the richness of nonKeynesian contributions to economics. Each chapter in this volume focuses on an issue which either preceded, accompanied or followed the ‘Keynesian Revolution’ and helped to shape economics in subsequent years. Part I reconsiders some of the major concepts in the General Theory: unemployment and the identity of income and output. Part II highlights some controversies in macroeconomic theory, while Part III reviews the macroeconomic policy implications and consequences. The essays in this volume represent the contemporary scholarly perspective on an important section of the history of macroeconomics. Philippe Fontaine is Professor of Economics at the École normale supérieure de Cachan. Albert Jolink is Assistant Professor of Philosophy of Economics at Erasmus University, Rotterdam, and Director of the Erasmus Institute for Philosophy and Economics.

ROUTLEDGE STUDIES IN THE HISTORY OF ECONOMICS 1 ECONOMICS AS LITERATURE Willie Henderson 2 SOCIALISM AND MARGINALISM IN ECONOMICS 1870–1930 Edited by Ian Steedman 3 HAYEK’S POLITICAL ECONOMY The socio-economics of order Steve Fleetwood 4 ON THE ORIGINS OF CLASSICAL ECONOMICS Distribution and value from William Petty to Adam Smith Tony Aspromourgos 5 THE ECONOMICS OF JOAN ROBINSON Edited by Maria Cristina Marcuzzo, Luigi Pasinetti and Alessandro Roncaglia 6 THE EVOLUTIONIST ECONOMICS OF LÉON WALRAS Albert Jolink 7 KEYNES AND THE ‘CLASSICS’ A study in language, epistemology and mistaken identities Michel Verdon 8 THE HISTORY OF GAME THEORY, VOL. 1 From the beginnings to 1945 Robert W.Dimand and Mary Ann Dimand 9 THE ECONOMICS OF W.S.JEVONS Sandra Peart 10 GANDHI’S ECONOMIC THOUGHT Ajit K.Dasgupta 11 EQUILIBRIUM AND ECONOMIC THEORY Edited by Giovanni Caravale 12 AUSTRIAN ECONOMICS IN DEBATE Edited by Willem Keizer, Bert Tieben and Rudy van Zijp 13 ANCIENT ECONOMIC THOUGHT B.B.Price 14 THE POLITICAL ECONOMY OF SOCIAL CREDIT AND GUILD SOCIALISM Frances Hutchinson and Brian Burkitt 15 ECONOMIC CAREERS Economics and economists in Britain 1930–1970 Edited by Keith Tribe 16 UNDERSTANDING ‘CLASSICAL’ ECONOMICS

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Studies in the long-period theory Heinz Kurz and Neri Salvadori 17 HISTORY OF ENVIRONMENTAL ECONOMIC THOUGHT E.Kula 18 ECONOMIC THOUGHT IN COMMUNIST AND POST-COMMUNIST EUROPE Hans-Jurgen Wagener 19 STUDIES IN THE HISTORY OF FRENCH POLITICAL ECONOMY: FROM BODIN TO WALRAS Edited by Gilbert Faccarello 20 THE ECONOMICS OF JOHN RAE Edited by O.F.Hamouda, C.Lee and D.Mair 21 KEYNES AND THE NEOCLASSICAL SYNTHESIS Einsteinian versus Newtonian macroeconomics Teodoro Dario Togati 22 HISTORICAL PERSPECTTVES ON MACROECONOMICS Sixty years after the General Theory Edited by Philippe Fontaine and Albert Jolink

HISTORICAL PERSPECTIVES ON MACROECONOMICS Sixty years after the General Theory Edited by

Philippe Fontaine and Albert Jolink

London and New York

First published 1998 by Routledge 11 New Fetter Lane, London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Introduction and editorial matter © 1998 Philippe Fontaine and Albert Jolink; individual chapters © the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalogue record for this book has been requested ISBN 0-203-97927-3 Master e-book ISBN

ISBN 0-415-16241-6 (Print Edition)

CONTENTS

List of contributors

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Preface

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Introduction: history of macroeconomics and the breakdown of the consensus PHILIPPE FONTAINE AND ALBERT JOLINK

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PART I Keynes reconsidered 1

Keynes, Keynesian programmes, and unemployment MICHEL DE VROEY

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2

The Keynesian identity of income and output CLAUDE GNOS

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PART II Controversies in macroeconomics 3

Pigou on unemployment HANSJÖRG KLAUSINGER

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Co-ordination failure: economic theory in the 1930s BRIAN J.LOASBY

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5

Lindahl on disequilibrium growth: price expectations, wage regimes and income distribution MAURO GALLEGATI AND DOMENICA TROPEANO

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PART III Macroeconomic theory and policy 6

Changes in Dutch economics in the 1930s ARNOLD WILTS

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Keynesianism and British labour market policy: from the 1930s to the 1980s WILLIAM R.GARSIDE

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Index

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CONTRIBUTORS

Michel De Vroey is Professor of Economics at the Université catholique de Louvain and holds the chair of History of Economic Theories. He has published in the European Economic Review, the Cambridge Journal of Economics, Economics and Philosophy and the European Journal of the History of Economic Thought. He is the managing editor of Recherches économiques de Louvain. Philippe Fontaine is Professor of Economics at the Ecole normale supérieure de Cachan. His current interest is in the relationship between economics and psychology. Mauro Gallegati is Professor of Economics at the University of Teramo. He has published several articles on macroeconomic theory, particularly on nonlinear models of business cycles. William R.Garside is Professor of Economic History at the University of Birmingham. He has written extensively on aspects of twentieth-century British macroeconomic policy, with special reference to industry and labour. He has completed, in collaboration with Professor C.Buchheim, a comparative study of industry and labour in Britain and Germany in the 1930s. He is currently engaged in a reappraisal of the political economy of British/Japanese industrial policy since 1945 and in a study of flexibility and adaptation in the West Midlands manufacturing district since 1900. Claude Gnos is Associate Professor of Economics at the Université de Dijon and Director of the Centre d’Etudes Monétaires et Financières at the LATEC (Centre National de la Recherche Scientifique, France). His main interests are in macroeconomics, monetary theory, European integration and history of economic thought. He is the author of Production, répartition et monnaie (1992) and contributor to Inflation and Unemployment, Contributions to a New Macroeconomic Approach (1996). Albert Jolink is Assistant Professor of Philosophy of Economics at Erasmus University, Rotterdam, and Director of the Erasmus Institute for Philosophy and Economics. He is the author of The Equilibrium Economics of Léon Walras (1993) (with J.Van Daal) and The Evolutionist Economics of Léon Walras (1996). His present interests include the history of economics (the works of Tinbergen and Koopmans) and conceptual issues of path dependence and causality. Hansjörg Klausinger is Associate Professor at the Institute of Economic Theory and Policy of the Vienna University of Economics and Business Administration. He has written extensively on Keynesian and monetary theory and its relation to policy issues. He is the author of Theorien der Geldwirtschaft: von Hayek und Keynes zu neueren Ansätzen (1991). Brian J.Loasby studied economics at Cambridge University and held appointments at the Universities of Aberdeen, Birmingham and Bristol. In 1967 he became Professor of Management Economics at Stirling University. Though retiring early in 1984, he has remained at Stirling as Honorary and Emeritus Professor. His primary interest is in the organisation of knowledge, both within the economics

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profession, evidenced by his writing on the history and methods of economics, and within the economy, evidenced by his writing on firms, markets, institutions and evolution. Domenica Tropeano is Lecturer in Economics at the University of Macerata. She has published several articles on the history of macroeconomics, particularly on Swedish thought. Arnold Wilts is post-doctoral fellow at the Max Planck Institute for the Study of Societies, Cologne. He wrote his dissertation on intellectual and institutional developments in Dutch economics between 1930 and 1960 while staying at the Department for Science and Technology Dynamics at the University of Amsterdam. His research interests include the sociology of science, institutional dynamics in national research systems and socioeconomics.

PREFACE

The history of macroeconomics has been described in several ways. Economists and historians of economics have been eager to inform the academic community that trends, business cycles, or at least a rise and fall, can be observed in the history of macroeconomics: now macroeconomics is hot, now it is not. Whatever the final verdict, it is certainly true that macroeconomics in the last sixty years has undergone rapid stages of development, some synthetic, some leading to diverging branches, but all as chain reactions to previous developments. In this respect it seems to be justified to speak of a history of macroeconomics. In this book we have opted for a different strategy. Not the history of macroeconomics but historical perspectives on macroeconomics are central. This makes a difference which mainly consists in a pluriform approach to historical developments. In our case, Keynes’ General Theory of Employment, Interest and Money, and the developments since its publication, has been taken as the thread joining the chapters of this book. Each chapter stretches around the theme offering insights from different perspectives. All chapters together shape the overall picture forming a remarkable unity. The chapters in the book were originally presented at the first European Conference on the History of Economics (ECHE) organised in Rotterdam. The articles, then, were not submitted jointly but seemed to fit together and were consequently adjusted to each other. The final product, we believe, has greatly benefited from the willingness of the authors to relate their work to the volume as a whole. In the process of compiling and editing this book we have been greatly assisted in making the book feasible. We thank José Luís Cardoso and Robert Leonard, who, together with the present editors of this volume, embarked on the adventure of establishing a platform for the history of economics in Europe by organising the first (and as it turned out, the second and third) ECHE annual meeting. We would also like to thank the participants to the conference who, directly or indirectly, contributed to the present collection of essays. We thank Manon Geluk and Loes van Dijk for administrative and supportive activities in the organisation and editing of this book. Philippe Fontaine and Albert Jolink

INTRODUCTION History of macroeconomics and the breakdown of the consensus Philippe Fontaine and Albert Jolink

[I]f people had been equipped with better theory would they have had better policy? You needed not only the better theory but also the better theory to be accepted, and that is very different. My hunch is that all theories of a Keynesian type, paradoxically, start to wilt a bit if things get very, very bad. They are most acceptable when they are least needed. (Skidelsky 1994:85) A BLESSING IN DISGUISE The last three decades have seen a significant disruption in macroeconomic theory. As Mankiw (1990:1645) has aptly pointed out, it was easier being a student of macroeconomics when a form of consensus prevailed. Likewise, it is fair to say that macroeconomics displays less visibility than it used to for policy-makers. The IS-LM framework is no longer regarded as the only model of the economy and the guiding principles provided by macroeconomists have lost some strength in the eyes of policy-makers confronted with several recessions since the 1970s. Clearly the consensus view has disappeared in modern macroeconomics, leaving the ground to a description of macroeconomics in terms of competing schools of thought (see Chrystal and Price 1994). Controversies have never been favoured by those theorists whose main objective is to arrive at broad groupings of macroeconomic theory or by decision-makers in need of ready-to-apply policies. This is not to say, however, that disarray has replaced harmony in modern macroeconomics. The existence of several competing schools of thought may also be viewed as a sign of the remarkable fertility and vitality of a field under reconstruction (Phelps 1990:x; Laidler 1992:459–60). More precisely, the very problems that caused the breakdown of the consensus have led to the development of new directions of research. Although much effort has been put into the search for microeconomic foundations for macroeconomics in recent years, it is not our intention here to report on the achievements of both ‘new classicals’ and ‘new Keynesians’ on this score (see, for instance, Hoover 1988; Mankiw and Romer 1991a, 1991b). Rather, we would like to show how the breakdown of the consensus has encouraged historians of economics to consider some Keynesian macroeconomic ideas in a different light, thereby providing new perspectives on modern macroeconomic thought. Here three distinct orientations are worth pointing out. In the first place, the breakdown of the Keynesian consensus in the 1970s appears to have put back in the foreground the remarkable variety of Keynes’ macroeconomics and of its interpretations.1 As the proliferation of labels, such as ‘ISLM-Keynesian’, ‘post-Keynesian’, ‘neo-Keynesian’, and ‘new-Keynesian’ clearly points out, the consensus view was only part of the story, albeit an effective one in guiding economists through the complexities of Keynes’ macroeconomic thought. With this marker gradually losing

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in importance, historians of economists have increasingly felt the need to reconsider Keynes’ macroeconomic work, hoping to identify its neglected or undeveloped directions of research. The contributions by De Vroey and by Gnos to this volume provide interesting illustrations of such an orientation. Drawing on Leijonhufvud’s view of the development of schools of thought as a sequence of crucial research decisions along a decision tree, De Vroey designs an ‘unemployment decision tree’ composed of ten nodes, each node representing the methodological choices faced by the Keynesians (and retrospectively by Keynes) in their elaboration of theories of unemployment. De Vroey’s retrospective approach provides two interesting conclusions. On the one hand, the emergence of Keynesian research programmes appears as the result of the unfeasibility of Keynes’ own research programme; on the other hand, their variety stems from the distinct options available along the unemployment decision tree (radical strategy versus reformist strategy, non-frictional unemployment versus frictional unemployment, partial equilibrium versus general equilibrium, etc.). For De Vroey, then, the breakdown of the consensus and the subsequent emergence of new schools of thought are instrumental in providing new theoretical frameworks for the assessment of Keynes’ General Theory. On a different level, Gnos revisits the Keynesian identity of income and output. He claims that the inconsistency that derives from a definition of the equality between investment and saving as both an equilibrium condition and an identity can be removed when one examines Keynes’ identity of income and output in the light of the distinction between factor cost and prices. In a sense, Gnos sits on the side of those who believe that the consensus view has misconstrued Keynes’ own ideas and who strive to ‘complete the aborted Keynesian revolution in economics’ (Arestis 1992:ix)—a perspective that De Vroey deliberately sets aside in his chapter. In the second place, the breakdown of the consensus and the subsequent resurgence of controversy are reminders of the diversity of approaches characteristic of the development of macroeconomic knowledge. However important the ‘Keynsian Revolution’ was, it should not indeed obscure other significant contributions to macroeconomic thought. Since there were controversies before the consensus, the latter should be interpreted not so much as the outcome of the; unification of schools of thought as the result of the desertion of areas of research. As the chapters by Klausinger, Loasby, and Gallegati and Tropeano in this volume clearly illustrate, Keynes’ authoritative figure may have, in retrospect, obscured some interesting lines of enquiry. For instance, Pigou’s Theory of Unemployment proves to have been underestimated, partly because of Keynes’ critique that Pigou’s theoretical framework was inconsistent with his practical policy recommendations. Likewise, when we turn to co-ordination failure, the Keynesian theme par excellence, we find out that Myrdal, not Keynes, was Shackle’s main source of inspiration. Accordingly, Myrdal’s distinction between ex ante and ex post views, with its emphasis on the comparison of unknown expectations and outcomes, provides the appropriate framework for the study of movement between equilibria. Finally, by using the General Theory as a reference point for the analysis of Lindahl’s cumulative process, one misses the gist of his argument as to how growth is affected by changes in prices, price expectations, the distribution of income and wage regimes. In the third place, the breakdown of the consensus invites reconsideration of the oft-discussed and still controversial view that the ‘Keynesian Revolution’ was not so much a revolution in practice as a revolution on paper (see Booth 1983; Tomlinson 1984; Rollings 1985). Hoover has rightly observed that ‘Keynes new macroeconomic theory was welcome because it seemed to fill the yawning gap between economic analysis and the real-world problem of the Great Depression’ (1988:9; italics ours). It seems, however, that the new theory diverted economists from investigating an important aspect of this gap, notably the actual relationships between macroeconomic theory and economic policy.

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There are, in fact, two aspects to this problem. First, it is unclear whether the low levels of unemployment and the prosperity observed in industrial market economies after the Second World War stemmed for the most part from Keynesian stabilisation policies. As Snowdon, Vane and Wynarczyk have reminded us, there is no consensus as to whether ‘the severity of business cycles in the period since 1945 has actually declined compared to previous periods’ (Snowdon et al. 1994:9–10). Accordingly, macroeconomists may aptly wonder whether post-war Keynesian policies have achieved as much as is usually acknowledged. Moreover, recent theoretical arguments, such as the policy irrelevance proposition, the Ricardian equivalence proposition or the distinction between optimal and consistent policy, have challenged the effectiveness of stabilisation policies. As a result, the breakdown of the consensus may be thought to have led macroeconomists to re-examine the relevance of a wide range of stylised facts about business cycles in relation to alternative macroeconomic theories (for a good example of this line of investigation, see Greenwald and Stiglitz 1988). Secondly, despite the developments observed in macroeconomics since the 1970s, there has been no significant change in the way applied macroeconomists analyse the economy (see Mankiw 1990: 1645). This would suggest that there is no particular reason for macroeconomists to reconsider the relationships between macroeconomic theory and economic policy. Historians of economics and economic historians may, however, promote the reconsideration of such a relationship as the chapters by Wilts and Garside in this volume demonstrate. Wilts’ detailed study of the changes in Dutch economics in the 1930s shows that the relationship between macroeconomic theory and economic policy can take different forms according to the actual involvement of economists in economic policy-making and the differences in their traditions and working environments. Likewise, Garside argues that the persistence of unemployment in Great Britain in the 1930s was due to the inability of economists to convince policy-makers to adopt a new macroeconomic policy centred on Keynes’ policy prescriptions, thus providing an interesting counterpoint to the idea that the persistence of full employment in Britain after the Second World War was the outcome of the ‘Keynesian Revolution’. The permeation of economic policy-making by Keynesian ideas cannot be fully understood otherwise than by minute investigation of the institutional environment surrounding economic policy, especially the relationships between macroeconomic theorists and policy-makers. More generally, as soon as it is acknowledged that economic policy is more than the simple reflection of macroeconomic theory in the practice of policy-makers, one may hope to shed a new light on the actual relationship between macroeconomic theory and economic policies. Colander has recently brought new insights into the discussion. Recalling J.M.Keynes’ tripartite division between positive science, normative science, and the art of economics, he shows that applied economy actually belongs in the latter and that ‘it relates the lessons learned in positive economics to the normative goals determined in normative economics’ (Colander 1992: 192). However, it is likewise important to know how the tripartite division relates to the distinction between theory and practice. The fact that the theory of art defines general economic precepts while the practice of art describes actual economic policy-making, does not say much about the policy relevance of the macroeconomic science. In any case, before attempting to bridge the gap between science and macroeconomic policy, macroeconomists need to define the exact nature of the relationship between theoretical applied macroeconomics and macroeconomic policies. This would make it easier, in turn, for academic macroeconomists to accept that it takes some time for applied macroeconomists, aware of the constraints of practitioners, to adopt new theoretical constructs, and that, once adopted, the latter remain always only one part of the information set of policy-makers.

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KEYNES RECONSIDERED Involuntary unemployment The notion of involuntary unemployment has always been considered central to Keynesian economics in general and to Keynes’ General Theory in particular. With the development of equilibrium business cycle theory, however, the notion has been heavily criticised by leading exponents of new classical macroeconomics. Lucas (1981 [1978]), for instance, has argued that Keynes’ concept of involuntary unemployment could be disposed of without major implications for macroeconomics. Part of the problem arises from the existence of two different interpretations of ‘involuntariness’. On the one hand, there is the idea that, due to severe recessions, workers can sometimes be forced out of work; on the other, there is the issue of the actual decisions that lead a worker to unemployment. A distinction has then to be made between the empirical claim that it is hard to believe that the ‘high’ levels of unemployment observed in real economies amount only to voluntary unemployment and the theoretical claim that it is difficult to account for the workings of the labour market without resorting to the notion of involuntary unemployment. The most customary definition of involuntary unemployment appears to be associated with the inequality of supply and demand at existing wages or with a situation where a worker who is willing to work at the same wage as similar workers is not hired.2 This definition is helpful, but, as Blinder observes, economists should not restrict themselves to defining involuntary unemployment; they also have ‘to explain it theoretically, to give the theory empirical content, and then to devise policies to reduce it’ (Blinder 1988:3). In his essay, De Vroey claims that sixty years after the General Theory, Keynes’ research programme, as reconstructed in the unemployment decision tree, has not yet been fully implemented. In view of Blinder’s recommendation above, this comes as no surprise. De Vroey argues, indeed, that the definition of involuntary unemployment in the General Theory is somewhat confusing. He goes on to suggest that while Keynes might well have demonstrated the lack of full employment, he did not provide a satisfactory theoretical explanation of involuntary unemployment, favouring instead observations on its empirical existence. Unfortunately, Keynes’ characterisation of the notion is associated with an observational problem, which clouds the empirical content of the theory: How to distinguish unemployed workers who have made the decision not to work from those who would work if they could? From a more general perspective, De Vroey contrasts Keynes’ own research programme with more sophisticated Keynesian models, arguing that for the most part the latter mark a significant departure from the former. In the process of developing Keynes’ programme, his followers were often led to take different paths along the unemployment decision tree. As the unemployment decision tree has no less than ten nodes, many bifurcations are possible. One of them, however, deserves special attention, as it relativises Keynes’ policy prescriptions—a central orientation of the General Theory. As De Vroey shows, there are Keynesian models, such as efficiency-wage models, which, although they use a similar definition of involuntary unemployment as Keynes’, favour supply-side over demand-management policies. With the emergence of new directions in research in recent years, it has become clear that although involuntary unemployment and deficient aggregate demand can co-exist, they do not necessarily do so. As a result, devising policies to reduce involuntary unemployment may well prove more intricate than Keynes initially believed. The principle of effective demand and the identity of income and output For many students of Keynes, the principle of effective demand is regarded as central to the General Theory.3 According to Amadeo,

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Keynes’ principle of effective demand can be enunciated as follows: given a change in investment demand (or any other autonomous component of aggregate demand), the level of income (that is, the levels of price and output) will change in such a way that, in equilibrium, the corresponding change in saving will be equal to the initial change in investment. (Amadeo 1989:1) Thus defined, the principle of effective demand identifies the equality between investment and saving to an equilibrium condition. However, as Gnos notes, Keynes also stated that income is ‘equal to the value of current output’, which amounts to defining the relation between investment and saving as an identity. The central question which needs to be answered, then, is how can the equality between the flow of investment and the flow of saving be considered both an equilibrium condition and an identity. It is well known that Shackle insisted on the ‘General Theory’s need for expression in ex ante terms’ and viewed the use of the Myrdalian approach as a solution to this problem. Gnos holds, however, that the latter is beyond the scope of ex ante and ex post analysis, as Keynes used the ‘Swedish device’ for expository purposes, but had serious reservations about its analytical power. As Loasby makes it clear in this volume, in the General Theory, ‘long-term expectations…are…not systematically adjusted in response to outcomes …, and short-term expectations are either assumed to be always realised or, in some passages, to converge on realisations during a short-period adjustment process.’ In explaining the persistence of unemployment, Keynes thus favoured the principle of effective demand and its associated equilibrium frame-work over Myrdal’s sequence analysis. Gnos takes Loasby’s argument a step further and reminds us that for Keynes entrepreneurs’ decisions refer to ex ante analysis whereas realised results belong to ex post analysis. Although entrepreneurs make ex ante decisions according to the proceeds they expect, nothing indicates that the point of effective demand—the point of intersection of the aggregate supply function and the aggregate demand function—and the associated level of output supplied coincide with the actual level of output demanded ex post.4 As a result, ex ante and ex post analysis is no answer to the question of how the relation between investment and saving can be an identity as well as a condition of equilibrium. To prove the consistency between the principle of effective demand and the identity of income and output, Gnos turns to the distinction between prices and factor cost. It appears that the principle of effective demand and the identity of income and output involve these two distinct units of measurement. Since the aggregate demand price does not necessarily recoup the factor cost, the equality between supply and demand appears as an equilibrium condition. Furthermore, since factor cost creates the money income which is necessary and sufficient to pay for output, supply and demand are identically equal. In sum, the contributions by De Vroey and Gnos show that Keynes’ General Theory is susceptible to varied interpretations. It is still debatable whether this demonstrates the strength or weakness of the book. What should be clear, however, is that the General Theory crystallised the thoughts of its day. Keeping that in mind may help commentators to remember that ‘Keynes did, after all, have important predecessors and contemporaries who made significant contributions of their own, which Keynes then often developed and synthesised, not always for the better’ (Laidler 1995:267). It may likewise account for the very special place Keynesian ideas hold in an age of controversy.

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CONTROVERSIES IN MACROECONOMICS Mr Keynes and the classical economist Taking Keynes as a benchmark in the development of economics has led to a rich literature to illustrate why Keynes’ economics, or better still, Keynesian economics, should be distinguished from ‘classical economics’; a neoclassical synthesis has in this respect only added to the distinct position of Keynes’ work. However, it was above all Keynes, who portrayed his General Theory as a break with traditions, described as classical economics; what followed was later described as the ‘Keynesian Revolution’ with a strong emphasis on the noun (and an apparent casualness with respect to the adjective). The ‘Revolution’ was partly motivated by Keynes’ attack on ‘classical’ economics in general and Pigovian economics in particular. According to Mark Blaug (1991), the attack was based on inconsistencies between theory and policy recommendations, rather than on the policies themselves; neither argument, as Terence Hutchinson (1978) has argued, had been well founded or explained. In the last decade or so, a quite extensive literature has developed on the issue of whether, and to what extent, Keynes misinterpreted Pigou’s economics, i.e. The Theory of Unemployment (1933). Pigou’s unemployment model was taken up by David Collard (1981) and Nahid Aslanbeigui (1992) to undermine Keynes’ critique. In particular Keynes’ misunderstanding, or misreading, of Pigou’s unemployment model leads, according to Collard and Aslanbeigui, to ill-founded conclusions. Others, such as Allin Cottrell (1994a, 1994b) and Michael Brady (1994) have argued that Keynes’ critique was sound on several grounds. Specifically, the dichotomy between a real and monetary economy is viewed as a serious obstruction in relating policy recommendations to theory. In this perspective, Hansjörg Klausinger addresses the alleged inconsistency in Pigou’s work, hence concentrating on Hutchinson’s critique of Keynes’ claim. Klausinger argues that much can be said in favour of ‘barter illusion’ in Pigou’s analysis as the link to a monetary economy is weak. This leads to an initial conclusion that some of Pigou’s policy recommendations cannot be deduced from his theory. Klausinger, however, argues that a more reconstructive reading of Pigou’s Theory of Unemployment gives ample arguments in support of the policy recommendations, hence putting the ‘inconsistency’ thesis into a more argumented perspective. Klausinger illustrates his arguments by drawing up some of the models implicit in Pigou’s work so as to demonstrate where the theoretical support for the policy recommendations can be found in The Theory of Unemployment. What could have been but never was… One might want to argue that ‘revolutions’ hardly ever take place in isolation (what would be the point?); one might even want to argue that revolutions presuppose their own context (whatever the perspective: political, historical, methodological). In the case of the ‘Keynesian Revolution’, the general context is one of bifurcating intellectual domains, of which economics is just one. The ‘Keynesian Revolution’ in the history of economics has attracted a fair (or perhaps unfair) amount of attention, undoubtedly in retrospect, at the expense of other, complementary and conflicting, economic ideas. As set out in Leijonhufvud’s (1981) account of some of the schools of macroeconomics, ‘new’ economic ideas may have taken the form of ‘variations on a theme’. In this respect, the Keynesian variety of macroeconomics is closely related to other varieties, which Leijonhufvud has labelled ‘The Wicksell Connection’, relating to the interest-rate-savings-investment theme.

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Brian Loasby’s chapter takes the Wicksell connection up again and explores it further: why do similar varieties of economic theory fail to co-ordinate? He explores the potential for co-ordination of Keynes’ economic theory and the economic theories of Hayek and of Swedish economists such as Myrdal and Ohlin. In particular, on the very subject of economic co-ordination (failure), he illustrates how individual authors grope in the shady area of money, equilibrium and expectations and how missing links in this intellectual triad fail to accomplish convergence of the ‘new’ economic ideas. In the interim, the chapter draws attention to the ‘arbitraging’ role of George Shackle in the coevolution of macroeconomic theories in the 1930s, implicitly underlining Shackle’s (1967:237) observation that ‘Keynes attained a right conclusion by a leap of argument which, for the step-by-step logician, involves a chasm in the path and a pit of fallacy.’ Taken still one step further, a ‘Keynocentric’ perspective, viewing the history through the General Theory, can distort our present-day understanding of nonKeynesian contributions to economic theory in the 1930s. There is much more than ‘variations on a theme’: there are many more themes. One of these themes concerns ‘economic growth’. When viewed from the perspective of the General Theory the issue of economic growth becomes muddled in ‘visions’, implicit assumptions, and, finally, sixty years of controversy (see Guthrie and Tarascio 1992). As argued by Gallegati and Tropeano, discussions on economic growth in the 1930s are best separated from the General Theory. They illustrate that Lindahl’s contributions of the 1930s on economic growth should be viewed from the perspective of disequilibrium processes in a monetary economy. In this perspective, Lindahl can be brought in line with the Wicksell connection but on the side of the Austrians (Hayek) rather than on Keynes’ side. Then again, Lindahl’s disequilibrium processes are very different to Hayek’s approach (or to the Wicksellian conditions for that matter): for Lindahl, changes in the economy will be highly unstable in terms of volatile (expected) prices and wages. Gallegati and Tropeano expand on Lindahl’s view of growth in two formalised models. They report on the case of ‘money illusion’, which in this model has serious consequences for (desired) capital stocks and investment: ‘the system becomes locally unstable and globally stable, giving rise to deterministic fluctuations of an apparently stochastic nature’. When confronted with Kevin Hoover’s reading of ‘money illusion’ in Keynes’ General Theory (‘money illusion in Keynes’ own view could not be theoretically fundamental, whatever its practical importance’ (Hoover 1995)), Gallegati’s and Tropeano’s insistence on reading Lindahl in non-Keynesian terms could not be more justified. MACROECONOMIC THEORY AND POLICY The ingredients that have led to the advancement of the ‘Keynesian Revolution’ have been considered over and over by historians of economics and economic historians. As summarised by Blaug (1991), these ingredients of success were above all to accentuate the theoretical novelty of the General Theory and its fecundity as a research programme, in line with the purpose of Keynes’ book: ‘its main purpose is to deal with difficult questions of theory and only in the second place with the applications of this theory to practice’ (Keynes 1936). Wilts and Garside address this second issue: the application of Keynes’ theory to practice. As has been observed, one of the consequences of the ‘Keynesian Revolution’ ‘was a rapid increase in the level of precision and explicitness with which aggregate economic theories were formulated’ which ‘benefited from decades of methodological improvement’ (Lucas 1981:216). Robert Lucas attributes this consequence more to Tinbergen than to Keynes, presumably due to Tinbergen’s macroeconomic modelling in the 1930s and its relevance for economic policy. It is Tinbergen’s work on the model of the Dutch

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economy that embedded demand management in a theory of economic policy. In this light one might even claim that Tinbergen’s work advanced the ‘Keynesian Revolution’ rather than follow it. Arnold Wilts sheds light on the necessary academic and social/cultural conditions for the application of economic theories to practice. His chapter reveals in a detailed case-study of the Netherlands in the 1930s how, and why, economists’ policy involvement was highly correlated with theoretical unease. Because the sociology of economic science is crucial to understanding the evolution of academic and policy interaction, Wilts specifies the conditions under which theoretical traditions map onto the role of the economist in debates on economic policy. In this line, Wilts argues that Tinbergen’s preoccupation with obtaining a leading role for economists in policy matters greatly advanced the professional boundaries of the discipline. Although Wilts does not make the claim, one may further the argument by stressing the relevance of Tinbergen’s economic policy modelling for the practical application of Keynes’ theory. In particular Tinbergen’s efforts to bridge the gap between theory and practice/policy may be considered as a necessary, though not a sufficient, condition for the realisation of a ‘Keynesian Revolution’. To this latter point, the application (or rather the lack of it) of Keynes’ prescriptions for the UK economy from the 1930s onwards is taken up by Garside. In the final chapter, Garside reviews the critical reactions of, primarily, Treasury officials to Keynes’ (emerging) suggestions for multiplier-linked government interventions. As argued by Garside, the end of the Second World War is now sufficiently distant to survey the perceptions of government officials regarding the economic situation, on the one hand, and regarding the solutions offered by economists, on the other. He supports the stance that contemporary officials held a clearer view than Keynes of the constraints facing government intervention in the 1930s. But also for the postwar period, Garside argues that the influence of Keynesian ideas on economic policy is weak, or at least difficult to assess, in any country, due to a different economic situation; hence, a real experience of Keynesian demand management is yet to come. This perspective, not often encountered among economists, creates an interesting puzzle for the history of economics. This may be exemplified by the following, contradicting observation by Lucas and Sargent: For the applied economist, the confident and apparently successful application of Keynesian principle to economic policy which occurred in the 1960s was an event of incomparable significance and satisfaction…We dwell on these halcyon days of Keynesian economics because without conscious effort they are difficult to recall today. In the present decade [1970s] the US economy has undergone its first major depression since the 1930s…accompanied by massive government budget deficits and high rates of monetary expansion, policies which…promised to modern Keynesian doctrine rapid real growth and low rates of unemployment. That these predictions were wildly incorrect and that the doctrine on which they were based is fundamentally flawed are now simple matters of fact, involving no novelties in economic theory. (Lucas and Sargent 1981:295–6) Given this ‘observation’ and given Garside’s account, either ‘matters of fact’ are not that simple, the British and US experiences have been very dissimilar or Keynesian ideas have not had such a widespread application as has been supposed. The puzzle remains: What has happened to macroeconomics over these last sixty years?

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NOTES 1 Besides macroeconomics, there are indeed other aspects of Keynes’ thought that deserve the attention of historians of economics (see Cottrell and Lawlor 1995). 2 On definitional problems, see Hoover (1995:677–81). 3 This is particularly true of post-Keynesians (see, for instance, Chick 1983 and Amadeo 1989). 4 Chick rightly emphasises that ‘effective demand is an unfortunate term, for it really refers to the output that will be supplied’ (1983:65).

REFERENCES Amadeo, EJ. (1989) Keynes’s Principle of Effective Demand, Aldershot: Elgar. Arestis, P. (1992) The Post-Keynesian Approach to Economics: An Alternative Analysis of Economic Theory and Policy, Aldershot: Elgar. Aslanbeigui, N. (1992) ‘Pigou’s Inconsistencies or Keynes’ Misconceptions?’, History of Political Economy 14: 413–33. Blaug, M. (1991) ‘Second Thoughts on the Keynesian Revolution’, History of Political Economy 23:171–92. Blinder, A.S. (1988) ‘The Challenge of High Unemployment’, American Economic Review 78:1–15. Booth, A. (1983) ‘The “Keynesian Revolution” in Economic Policy-making’, Economic History Review 36:103–23. Brady, M.E. (1994) ‘A Note on the Keynes-Pigou Controversy’, History of Political Economy 26:697–705. Chick, V. (1983) Macroeconomics after Keynes: A Reconsideration of the ‘General Theory’, Oxford: Allan. Chrystal, K.A. and S.Price (1994) Controversies in Macroeconomics, third edition, New York and London: Harvester. Colander, D.C. (1992) ‘The Lost Art of Economics’, Journal of Economic Perspectives 6: 191–8. Collard, D. (1981) ‘A.C.Pigou, 1877–1959’, in D.P.O’Brien and J.R.Presley (eds) Pioneers of Modern Economics in Britain, London: Macmillan, 105–39. Cottrell, A.F. (1994a) ‘Keynes’ Appendix to Chapter 19: A Readers Guide’, History of Political Economy 26:681–95. ——(1994b) ‘Brady on Pigou and Keynes: Comment’, History of Political Economy 26: 707–11. Cottrell, A.F. and M.S.Lawlor (eds) (1995) New Perspectives on Keynes, Durham and London: Duke University Press. Greenwald, B.C. and J.E.Stiglitz (1988) ‘Examining Alternative Macroeconomic Theories’, Brookings Papers on Economic Activity 1:207–70. Guthrie, W. and V.J.Tarascio (1992) ‘Keynes on Economic Growth, Stagnation, and Structural Change: New Light on a 55-Year Controversy’, History of Political Economy 24:381–412. Hoover, K.D. (1988) The New Classical Macroeconomics: A Sceptical Inquiry, Oxford and Cambridge, MA: Basil Blackwell. ——(1995) ‘Relative Wages, Rationality, and Involuntary Unemployment in Keynes’ Labor Market’, History of Political Economy 27:653–85. Hutchinson, T.W. (1978) On Revolutions and Progress in Economic Knowledge, Cambridge: Cambridge University Press. Keynes, J.M. (1936) The General Theory of Employment, Interest and Money, London: Macmillan. Laidler, D. (1992) ‘Issues in Contemporary Macroeconomics’, in A.Vercelli and N.Dimitri (eds) Macroeconomics: A Survey of Research Strategies, New York: Oxford University Press. ——(1995) ‘Comment’, in A.F.Cottrell and M.S.Lawlor (eds) New Perspectives on Kiynes, Durham and London: Duke University Press. Leijonhufvud, A. (1981) Information and Co-ordination: Essays in Macroeconomic Theory, Oxford: Oxford University Press. Lucas, R.E., Jr (1981) Studies in Business-Cycle Theory, Cambridge, MA: MIT Press. Lucas, R.E., Jr, and T.J.Sargent (eds) (1981) Rational Expectations and Economtric Practice, London: Allen & Unwin. Mankiw, N.G. (1990) ‘A Quick Refresher Course in Macroeconomics’, Journal of Economic Literature 28:1645–60.

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Mankiw, N.G. and D.Romer (eds) (1991a) New Keynesian Economics, Volume I, Imperfect Competition and Sticky Prices, Cambridge, MA and London: MIT Press. ——(1991b) New Keynesian Economics, Volume II, Co-ordination Failures and Real Rigidities, Cambridge, MA and London: MIT Press. Phelps, E.S. (1990) Seven Schools of Macroeconomic Thought, Oxford: Clarendon Press. Rollings, N. (1985) ‘The “Keynesian Revolution” and Economic Policy-making: A Comment’, Economic History Review 38:95–100. Shackle, G.L.S. (1967) The Years of High Theory: Invention and Tradition in Economic Thought, 1926–1939, Cambridge: Cambridge University Press. Skidelsky, R. (1994) ‘Interview with Robert Skidelsky’, in B.Snowdon, H.Vane and P.Wynarczyk (1994). Snowdon, B., H.Vane and P.Wynarczyk (1994) A Modern Guide to Macroeconomics: An Introduction to Competing Schools of Thought, Aldershot: Elgar. Tomlinson, J.D. (1984) ‘A “Keynesian Revolution” in Economic Policy-Making?’, Economic History Review 37: 258–67.

Part I KEYNES RECONSIDERED

1 KEYNES, KEYNESIAN PROGRAMMES, AND UNEMPLOYMENT Michel De Vroey

This chapter is part of a broader project, centred on the acceptability of the notion of involuntary unemployment in macroeconomics, from Keynes to the present. Such a project raises two difficulties. First, the notion of involuntary unemployment poses definitional problems. When defined in a very general way, as synonymous to underemployment, it can rather easily be integrated within the neoclassical framework. However, as soon as it is given a strict definition—as Keynes himself intended it—problems are piling up and its integration becomes highly problematic (see De Vroey 1997a). The second difficulty relates to the identification of Keynesian theory. As observed by Gerrard, ‘a number of alternative interpretations [of the General Theory] have been proposed but no single interpretation has achieved universal acceptance’ (1995: 445). It is the purpose of this chapter to cast new light on this problem by using an ‘unemployment decision tree’. This construct is adapted from Leijonhufvud’s original definition of the development of economics: It is useful to think the history of our subject as forming a decision tree. Major economists force their contemporaries to face choices— choice of what to ask, what to assume, what to regard as evidence and what methods and models to employ—and persuade the profession or some fraction of it to follow the choice they make. The path that any particular school has followed traces a sequence of such decisions. Many of the choices faced in such a sequence were not anticipated by the founder to which we trace the development in question but were created by subsequent contributors; some of the decisions made we may judge to have been wrong in hindsight. (Leijonhufvud 1994:148) This chapter puts Leijonhufvud’s definition to the test by applying his notion of a decision tree to Keynes and the Keynesians. The task set forth is to reconstruct the different methodological choices faced by Keynes when writing the General Theory (1936). When complemented with the supplementary choices brought to the forefront by subsequent economists, an ‘unemployment decision tree’ emerges, which includes no less than ten nodes. The Lakatosian concept of research programme, understood in a rather loose sense, will serve to designate any sequence of specific choices made along the branches of the tree. Thereby, it will be possible to identify Keynes’ programme, to gauge Keynesian programmes against it and, finally, to account for the state of aifairs described by Gerrard. Most students of Keynesian economics define the explanation of persistent underemployment as one of Keynes’ most important theoretical goals (see Gerrard, 1995:449). Although this account is quite fair, it implies too broad a characterisation. By contrast, the unemployment decision tree enables us to reach a much thinner and more precise (yet more controversial) definition of Keynes’ programme. It will then

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become easier to perceive the obstacles its implementation faces. The longer a programme remains nonimplemented the higher the probability that this failure results from the presence of some basic difficulties, such as inconsistencies or lack of analytical tools. This consideration fully applies to Keynes’ programme. To date, fifty years after the publication of the General Theory, it has not yet been implemented—at least, I am claiming so. This explains, in turn, why alternative Keynesian programmes have emerged. More or less unwittingly, their authors have realised that to have an implementable programme, they needed to depart from Keynes’ own agenda in some way. The first section defines the unemployment decision tree. In the following section, the reconstruction of Keynes’ research programme as a specific sequence of choices on the unemployment decision tree is justified. The claim that Keynes’ programme is difficult, if not impossible, to implement is also briefly discussed (for details, see De Vroey 1997a, 1997b). Next to be considered is a sample of seminal Keynesian models recast in terms of the unemployment decision tree and contrasted to Keynes’ own programme. The last section provides concluding remarks. THE UNEMPLOYMENT DECISION TREE The decision tree under consideration (see Figure 1.1) is geared towards providing a theory of unemployment. At the beginning of the tree, unemployment is considered a highly general category, the very aim of the whole enterprise being to narrow it down until it becomes a well-specified object for analysis. The existence of involuntary unemployment is one of them, yet not the only possible one. Before delving into the presentation of the tree, several remarks are in order. 1 The unemployment decision tree shown has no claim of completeness. First, some ramifications are not introduced. In particular, the radical strategy and the search approach could have been further explored. Second, some supplementary nodes could have been introduced, e.g. a divide between joblessness versus equal allocation of underemployment across all workers. Third, the unfolding of theory may (and will certainly) point to further nodes. Four, the fact that the decision tree comprises only dichotomic choices is certainly a drawback. 2 A distinction should be drawn between the definition of a programme and its successful implementation. Some outwardly plausible programme can prove non-implementable. 3 As far as coherence or plausibility is concerned, not all combinations should be put on the same footing. To wit, any combination associating Walrasian general equilibrium with involuntary unemployment choice has little chance to prove an implementable programme. 4 The tree is described in general terms and, as such, it has nothing Keynesian to it. In other words, it can be used to characterise non-Keynesian as well as Keynesian theories. The first methodological choice arises only when the claim to be vindicated is involuntary unemployment. It then bears on the question of whether this claim can be made within the boundaries of the neoclassical paradigm. According to the diagnosis made, two distinct strategies will emerge, which can be labelled the ‘radical’ or the ‘reformist’ strategy.2 Underlying the radical strategy is the conviction that, without the consideration of a series of factors, such as radical uncertainty, money, real time, asymmetry between firms and workers, the involuntary unemployment claim cannot win the day. Given that the existing theory is impervious to them, a thorough change in paradigm is deemed necessary. On the contrary, the reformist strategy rests on the opinion that the integration of the hitherto excluded concept can be achieved with only minimal changes in economic theory as it exists. The issue to be addressed can then be described as

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follows: granting that, at a certain stage of theoretical development, a given concept or proposition is absent from the theory, what are the smallest possible changes in assumptions required in order to allow its integration in a ‘methodologically correct way’? In what follows, only those ramifications that pertain to the reformist strategy are discussed. The second node bears on a first delimitation of what is to be understood by unemployment, stemming from separating non-frictional from frictional unemployment. When this distinction is understood in a common-sense way, frictional unemployment refers to some incompressible proportion of unemployment. In turn, non-frictional designates any unemployment beyond that threshold. In other words, frictional (nonfrictional) unemployment amounts to normal (excessive) unemployment. Whenever this line is taken, it is implicitly assumed that no qualitative difference exists between the two types of unemployment. However, a less intuitive interpretation can also be taken, where the contrast between the two categories is seen as starker. Here, frictional unemployment is made synonymous to search unemployment. This conception, the argument then runs, makes sense only when set against a rather decentralised vision of the working of markets. By contrast, non-frictional unemployment is understood as any type of unemployment occurring in the context of a well-organised market structure, where none or little role is left for search. In this chapter, the search line of investigation will not be investigated. ‘Unemployment’ therefore refers to non-frictional unemployment. Node 3 bears on the question of whether unemployment should be analysed in either a partial or a general equilibrium framework, or, in other words, whether what is to be adduced is a labour-market or an interdependency explanation. Whenever the first option is taken, unemployment is seen as a phenomenon liable to be analysed by considering the labour market as a separated set-up. In which case, one can attribute unemployment to a too high real wage, which, in turn, can hint at several possible factors (the existence of unions, collusive behaviour, a wage-floor, or whatever other reason for wage stickiness). The second choice rests on the view that unemployment should be traced back to problems of interdependency across markets or co-ordination across agents. In this case, any reference to wages being too high or rigid may prove inapposite. Whenever, at node 3, the interdepency solution is chosen, a further question arises, the subject matter of node 4: should the unemployment claim be made within the framework of Walrasian general equilibrium theory or within some general equilibrium approach different from the Walrasian one, for which the most plausible candidate is what could be called a ‘Marshallian general equilibrium’ approach?3 At this juncture, we may overlook the fact that the two options thus opened cannot be put on the same footing, for only the first one really exists as an elaborated theoretical construct. Whereas this difference matters for the implementation of these two programmes, it does not affect their definition. Node 5 arises because the unemployment claim can be made either under the assumption of perfect competition (atomicity, price-taking behaviour) or imperfect competition, where some agents have the power to fix prices or quantities and capture a rent.4 The claim made about unemployment may pertain to its existence as an end-state, that is, as arising after the adjustment process towards it has come to an end. Existence can then be analysed whilst shelving the issue of how the end-result is formed. Alternatively, the unemployment claim can pertain only to its existence during the adjustment process. Hence node 6. Should the unemployment claim relate to a static or a dynamic outcome? This is the choice taken up at node 7. The divide I have in mind here is that the analysis can aim at demonstrating the existence of unemployment either at one point in time, isolated from the previous and subsequent ones, or its existence (and fluctuation) over time. Thus, the divide is between either a ‘one-shot’ or a multi-period analysis. Note that this choice arises only if the existence choice has been made at node 6.

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Figure 1.1 The unemployment decision tree

The analysis may be geared at explaining either involuntary unemployment or any distinct forms of underemployment. This is the subject matter of node 8. By involuntary unemployment, we mean situations characterised by a breaching of the ‘reservation wage principle’ (see De Vroey 1997a). According to this principle, whenever economic agents are observed as non-participating in the labour market, it must be true that the market wage rate is lower or at the least equal to their reservation wage. The involuntarily

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unemployed are then agents who are observed as non-participating in the labour market in spite of the fact that market wage rate is higher than their reservation wage. The point is that other forms of underemployment, where the reservation wage principle is respected, are also conceivable theoretical targets. In De Vroey (1997a), this alternative is dubbed as ‘underemployment equilibrium’, with a further distinction between the ‘efficient market clearing underemployment equilibrium’ and ‘dominated market clearing underemployment equilibrium’. The analysis may strive at explaining either the cause of unemployment or its persistence (node 9). Whenever the first choice is made, the issue of its persistence can be added to it. By contrast, a study which is limited to persistence takes the arising of unemployment as exogenous. Finally, node 10 concerns policy recommendation. A distinction is drawn between demand management, on the one hand, and supply-side measures, including reforms to the labour market and to the tax or benefit system, on the other.5 KEYNES’ PROGRAMME Had Keynes been asked to put down his research agenda, he would certainly have mentioned some of the choices indicated in the tree, such as involuntary unemployment, interdependency and demand-deficiency, but that would probably be all. Given that he was pioneering new territories, Keynes could not have a full awareness of the complexity of the choices his enterprise involved. The decision tree, as presented in Figure 1.1, is an ex post reconstruction, the result of theoretical developments some of which have arisen decades after the publication of the General Theory. If new branches have come to the surface, it is partly because of the impasse faced by the implementation of Keynes’ initial goal, partly because of the gradual realisation that the matters were more complicated than had been thought before. This being stated, the research alternatives were nonetheless already there, which suggests that Keynes made implicit choices in addition to well-acknowledged choices. What I label Keynes’ programme is thus my personal reconstruction of the sequence of choices which I find plausible to attribute to him. Assessing Keynes’ programme Before presenting my account of how Keynes’ programme could be spelled out in terms of the unemployment decision tree, let me briefly comment on his overall goal. As is well known, Keynes wrote the General Theory with both a political and a theoretical motivation. Whereas the policy dimension remains somewhat implicit, it nevertheless stands to reason that Keynes wanted his book to be more than just a theoretical work. To him, it had to serve a policy purpose, positively, as a justification for government intervention in the economy and, negatively, as a dismissal of wage deflation policy. His targeted readership, however, was academic, which resulted from his perception that these policy recommendations faced a theoretical hurdle. Economists, he recognised, were torn between their ‘flair and instinct’ (Keynes 1934; reprinted in Keynes 1973:486) and their analytical tools. The former prompted them to believe that mass unemployment resulted from a system failure and was to be corrected accordingly, whereas their theoretical reasoning compelled them to trace it back to wage-earners’ unwillingness to accept a fall in wages.6 Something had thus to be done in the field of theory in order to unravel the existing deadlock and give the new policy its missing intellectual credentials. Let me now turn to the unemployment decision tree. As concerns node 1, Keynes would probably have refused to choose between the two strategies, for his discourse was either radical or reformist, depending on the occasion.7 Using literary criticism, both orientations can partly be disentangled by reference to the ‘text’

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or ‘sub-text’ of Keynes’ writings. Let us consider as the ‘text’ of the General Theory the bare model it contains. Its most popular rendition is Hicks’ IS-LM model.8 Its ‘sub-text’ would then comprise Keynes’ commentaries on his central model, statements of purpose, polemical passages, earlier and posterior expositions of his main insights, etc. Here, we touch on an interesting methodological point, namely the possibility of a gap between an author’s intention and the effective outcome of his work, between the way in which the designer of a new theory interprets his work and its interpretation by subsequent protagonists in the discussion. If such a distinction is accepted, the impression prevails that, as far as ‘text’ is concerned, Keynes’ work ought to be put under the mantle of the reformist strategy. Keynes’ claim to offer a generalisation of classical theory implies that its premises are basically maintained. His desire to change only one postulate, whilst keeping the other ones, also testifies to such a strategy. By contrast, when looking at the ‘sub-text’, Keynes’ discourse would bend towards the radical strategy. However, taken alone, this argument cannot win the day, for it is an exaggeration to argue that all radical elements of Keynes’ work belong to its ‘sub-text’. For example, the drafts of the first chapters should be regarded as more than commentaries (see, for instance, Tarshis 1989). However, the very fact that they were dropped is indicative of a shift from the radical towards the reformist strategy (see Favereau 1985:49–59), Assuming that, at an initial stage of his writing, Keynes found the radical programme intellectually more appealing, it might have dawned on him that the pragmatic programme has the advantage of being easier to ‘sell’ to fellow economists. In view of the urgency of the policy issues underlying the debate, this could not but be a crucial argument. Yet, he did not want to fully renounce to the radical viewpoint, as indicated by his 1937 article in the Quarterly Journal of Economics. Despite mixed evidence, a clear-cut choice has to be made. Once this is accepted, the elements pertaining to the reformist strategy do prevail. To all intents and purposes, this is also the viewpoint adopted by most Keynesian economists with the exception of those who have taken up the post-Keynesian or Kaleckian banners. Whereas the exploration of the ramification of Keynes’ radical project is certainly an interesting topic for research, it will not be pursued here. Hence the remainder of my analysis will be exclusively concerned with further decisional nodes belonging to the reformist strategy. Turning to node 2, it is indisputable that Keynes wanted to discard frictional unemployment. Yet, he was unaware that the frictional and non-frictional unemployment categories should be considered as underpinned by radically different representations of the working of the labour market. At node 3, it is unlikely that Keynes would have drawn an explicit distinction between a partial and a general equilibrium approach since, at the time, this distinction was hardly widespread. Imagine, however, that Keynes had been interviewed in a ‘conversation’ about his work. He would then, one may presume, have insisted on the need to go beyond a strict labour-market analysis of unemployment in order to bring to the fore some ‘system failure’. The labour-market explanation of unemployment was the sort of diagnosis and policy prescription which reigned before the General Theory and which Keynes strove to dismiss. Involuntary unemployment, he believed, cannot be understood by reasoning only in labour-market terms. Nor could it be solved by acting directly upon this market. Its clue, he believed, lay elsewhere, in the financial sector or the money market. Hence, we can safely attribute to him the interdependency or general equilibrium choice. When discussing node 3, Keynes has been considered as having opted for the interdependency choice. Today, interdependency is almost immediately identified with Walrasian general equilibrium theory. Yet this is not how things were in Keynes’ time. Walras’ views were hardly appreciated in Cambridge and, for better or worse, Keynes did not think that Walras’ theory could be of any help for his own project.9 So, the idea that his unemployment agenda might involve a choice between the Marshallian and Walrasian

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approaches, as encapsulated in node 4, was entirely alien to him. To him, the route to be taken was to generalise Marshallian analysis, by taking into account the interdependency across markets.10 As far as node 5 is concerned, Keynes did not want to join the imperfect competition line of argument which was emerging at the time in Cambridge. He wanted to put his argument in terms of perfect competition, possibly because he associated imperfect competition with collusion, unions, etc. The fact that Keynes saw no connection between unemployment and imperfect competition has puzzled many commentators. As noted by Tobin: By assuming that firms are price takers in auction markets rather than price setters in monopolistic competition or oligopoly, he [Keynes] made it harder to sustain his vision of persistent disequilibrium, with failures of co-ordination, communication, and adjustment. Imperfect competition was the other revolution in economics in the 1930s; one of its sites was Keynes’ Cambridge, and two of its agents, Joan Robinson and Sraffa, were in his group. Yet for some mysterious reason the two revolutions were never meshed. (1981:207)11 Nodes 6 and 7 are also easily settled. As concerns the choice between end-state or adjustment existence of unemployment, it is usually admitted that Keynes opted for the former.12 As concerns statics versus dynamics, he emphasised the former, that is, the ‘one-shot’ line of research, though some elements of a theory of dynamics were present in Chapters 5, 12 and 22 of the General Theory. Concerning node 8, the involuntary unemployment/underemployment divide, Keynes took a firm and clear-cut stance, claiming that his theory was specifically geared towards demonstrating the first of these two concepts.13 Above, it has been argued that Keynes aimed at generalising the Marshallian partial equilibrium approach in order to come to grips with the functioning of the economy as a whole. Here we touch on his second purported major breach from Marshallian orthodoxy, namely his intention to remove its incapacity to generate an involuntary unemployment result. Marshallian value theory is able to produce cases of market-day equilibrium, featuring market-clearing, which prove to be a disequilibrium when gauged against the criterion of normal value. Yet it is unable to generate non-market clearance.14 To refer specifically to the labour market, in a Marshallian set-up, only market-clearing underemployment or overemployment can be conceived of. Keynes’ aim can then be described as consisting in reversing this outcome, by getting a result featuring jointly labour-market disequilibrium (or non-market clearance) and normal equilibrium, that is a lack of incentives to change behaviour. Node 9 (cause or persistence of unemployment) is again a choice about which Keynes’ position is ambiguous. On the one hand, it seems that Keynes wanted to give a causal explanation of involuntary unemployment, i.e. elucidate the reasons for its emergence. Yet, on the other hand, the fact that he considered it a postulate, allegedly replacing the so-called second classical postulate —which in fact, as argued by Leontief (1947:233–4), was a result drawn from more basic premises, rather than a postulate— may be interpreted as meaning that he was interested only in the less ambitious issue of persistence. Though the general thrust of Keynes’ view on policy was that the government had to intervene actively in the functioning of the economy, this insight received no precise content in the General Theory. However, I suggest to endorse the traditional interpretation, according to which the remedial policy involved by Keynes’ model was demand activation.15 Hence, the choice ascribed to Keynes about node 10 is ‘demand policy’. To summarise, Keynes’ programme is seen as aiming at providing an analysis

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1 2 3 4 5 6 7 8 9 10

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which can be characterised as adopting a ‘reformist strategy’; having non-frictional unemployment as its subject-matter; taking the interdependency line of research; set against the background of the Marshallian approach; based on the perfect competition assumption; bearing on the existence of unemployment as the end-state of some adjustment process; interested in its static rather than dynamic existence; focusing on involuntary unemployment rather than underemployment equilibrium; concerned with the origin of unemployment; requiring demand activation as its specific remedial policy. Has Keynes’ programme been fulfilled?

Having characterised Keynes’ programme, the question may now be raised as to whether it has been fruitfully implemented. Immediately after the publication of the General Theory and for many years afterwards, the prevailing answer was positive; however, this view gradually subsided under the blows of the anti-Keynesian offensive led by Friedman and Lucas (see De Vroey 1997a). This early positive impression was made possible because of the confusion between involuntary unemployment and lack of full employment in general, as encompassing other forms of underemployment distinct from involuntary unemployment (see De Vroey 1997b). In Chapter 2 of the General Theory, Keynes starts by defining involuntary unemployment according to the reservation wage criterion. Then, in Chapter 3, he shifts to the lack of full employment concept. At one point, full employment is defined as the opposite of involuntary unemployment, whereas, at another point, it is defined as maximum employment, i.e. the employment level which cannot be augmented through an increase in aggregate demand. It is taken for granted that the two ensuing lack of full employment concepts are selfsame. Yet, this is untrue. It then turns out that Keynes may well have succeeded in making a point about the existence of a lack of full employment in general without having been able to demonstrate involuntary unemployment, narrowly defined. The General Theory was sufficiently opaque to allow readers to be unaware of the flaw. Amongst the factors which may be adduced to explain the lack of realisation of Keynes’ programme, two stand out. First, the elaboration of a Marshallian general equilibrium theory has proven to be a much harder nut to crack than Keynes believed. In spite of several attempts, such a construct is still lacking (see De Vroey 1997e). Second, Keynes hardly perceived how daunting a task it was to make a concept such as involuntary unemployment acceptable within neoclassical theory.16 On the one hand, the outward obviousness of the involuntarity of real-world unemployment helped to hide the difficulty of its theoretical acceptability. On the other hand, at the time, neoclassical theory was not yet sufficiently developed for making this incompatibility manifest. KEYNESIAN RESEARCH PROGRAMMES Introduction When realising the difficulty of fulfilling Keynes’ programme, two strategies are conceivable: one is to ‘keep punching’, i.e. still trying to devise some resolution without foregoing any of Keynes’ choices; the other amounts to changing Keynes’ own agenda in at least one respect. When looking at the works which may be put under the mantle of Keynesian theory, it appears that most authors have opted for the second

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strategy. This implies betraying Keynes’ programme, yet for a good cause, in so far as thereby an outwardly unimplementable programme becomes transformed into an implementable one. As several distinct paths for departing from Keynes’ programme prove possible, the plurality of Keynesian theories should come as no surprise. To recount the development of Keynesian theories, from the aftermath of the General Theory up to the present, is obviously beyond the scope of this chapter. Hence, I will content myself with selecting some seminal Keynesian models, classifying them in terms of the unemployment decision tree and seeing how the programmes they comprise can be contrasted with Keynes’ programme. The following models will be considered: 1 Hicks’ (1937) inaugural formulation of the IS-LM model in ‘Mr Keynes and the “Classics”’; 2 standard IS-LM models; 3 Chapter 13 of Patinkin’s (1965), Money, Interest and Prices; 4 Barro and Grossman’s (1971) disequilibrium model; 5 Clower and Leijonhufvud’s (1975) programme of co-ordination of economic activities; 6 Shapiro and Stiglitz’s (1984) efficiency wage model; and, finally, 7 Roberts’ (1987) co-ordination failure model.

BOX 1.1 BELOW SUMMARISES THE DIFFERENCES BETWEEN THE ABOVE MODELS AND KEYNES’ PROGRAMME. THE TYPE IN BOLDFACE INDICATES A DEPARTURE FROM KEYNES’ PROGRAMME. Keynes’ programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a neo-Marshallian approach; node 5: perfect competition; node 6: end-state analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: cause and persistence analysis; node 10: demand policy}. Hicks’s IS-LM programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a combination of a neo-Marshallian and a neo-Walrasian approach; node 5: perfect competition; node 6: end-state analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: persistence analysis; node 10: demand policy}. The standard IS-LM programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a combination of a neo-Marshallian and a neo-Walrasian approach; node 5: perfect competition; node 6: end-state analysis; node 7: static analysis; node 8: underemployment equilibrium; node 9: cause and persistence analysis; node 10: demand policy}. Patinkin’s programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a combination of a neo-Marshallian and a neo-Walrasian approach; node 5: perfect competition; node 6: adjustment analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: cause and persistence analysis; node 10: demand policy}. Barro and Grossman’s programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a neo-Walrasian approach; node 5: perfect competition; node 6: endstate analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: cause and persistence analysis; node 10: demand policy}. Clower and Leijonhufvud’s programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4:

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a neo-Marshallian approach; node 5: perfect competition; node 6: end-state and adjustment analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: cause and persistence analysis; node 10: demand policy}. The efficiency wage programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: partial equilibrium; node 4: a neo-Marshallian approach; node 5: imperfect competition; node 6: end-state analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: cause and persistence analysis; node 10: supply policy}. Roberts’ programme: {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: a neo-Walrasian approach; node 5: perfect competition; node 6: end-state analysis; node 7: static analysis; node 8: involuntary unemployment; node 9: persistence analysis; node 10: supply policy}.

A snapshot account of Keynesian programmes The above claim that Keynesian models can be seen as attempts to modify Keynes’ own programme does not apply to Hicks’ (1937) seminal paper ‘Mr. Keynes and the “Classics”’, whose purpose was rather to make sense of Keynes’ General Theory. In other words, Hicks aimed at identifying more precisely Keynes’ programme, an essential task, in view of the General Theory readers’ perplexity as to the exact nature of its contribution. The result is a different rendition of Keynes’ programme from what has been expounded above. To Hicks, Keynes’ real target was the neutrality of money view, coming down all the way from Ricardo. The gist of the classical viewpoint, as he sees it, is that ‘the level of activity will be solely determined by the real factors in the system, and that the quantity of money will solely act upon the level of prices’ (Hicks, 1967:159). The purpose of his IS-LM model is then to assess to what extent the Keynesian model departs from the classical neutrality of money model. In confronting Hicks’ rendition of Keynes’ theory with my above account, two differences emerge. They relate to node 4 (a Marshallian or a Walrasian approach), on the one hand, and node 9 (explaining the origin or the persistence of involuntary unemployment), on the other. Hicks has often been hailed for having brought Walrasian theory (back) to the forefront, thanks to his celebrated Value and Capital (1946). Authors, such as Patinkin (1987:27, 35) and Weintraub (1979:39), have expressed the view that the IS-LM model, being a simplified general equilibrium model, has a strong Walrasian lineage. This seems to suggest, in turn, that Hicks chose the Walrasian approach solution at node 4. However, the matter is more complicated; more precisely, it seems that Hicks took a middle-of-the-road approach, attempting to combine elements of both Walras and Marshall. Such a judgement is predicated on the premise, defended in De Vroey (1997d), that the tâtonnement hypothesis is an essential ingredient of Walrasian theory, because without it the issue of the institutional set-up underlying the price formation process would remain disregarded. When looking at the organisation of trade underpinning the IS-LM model, it is clear that it does not function according to the tâtonnement pattern.17 This is not an accident, for tâtonnement was one component of Walrasian theory which Hicks strongly disliked. Right or wrong, he believed that it was possible to do general equilibrium analysis in a Walrasian way, without having to adopt this hypothesis. Accordingly, he regarded the Walrasian system as composed of Marshallian markets, that is, separated loci for the obtaining of separated equilibria, each of them being identified with a specific good traded for money.18 As far as node 9 is concerned, Hicks’ reasoning starts from the premise that the money wage is rigid at a level such that employment remains increasable. This is true both for his classical and his Keynesian systems. Their difference rather bears on another point, namely persistence and policy effectiveness. In the classical

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system a monetary expansion will necessarily increase employment (at least, in the short term), whereas, in the Keynesian system, this result may fail to arise, as soon as, over a certain domain, preference for liquidity exhibits perfect interest elasticity. In Hicks’ paper, no attempt is made at explaining the cause of wrong nominal wage and hence of unemployment.19 Subsequent IS-LM models should not be mixed up with Hicks’ own model (see Dr Vroey 1997f). First of all, in these models, the classical system is depicted differently, with money shocks having no real effects. Second, subsequent authors have been more explicit than Hicks in their account of the labour market. Following Modigliani (1944), they have usually assumed an inverse-L supply of labour curve, this shape supposedly capturing the sociological factors affecting the labour market. These models’ programme differ from Keynes on two scores. First, like Hicks’ model, they shift away from the Marshallian approach yet without belonging fully to the Walrasian one. Hence their A-B classification (a combination of the two approaches) concerning node 4. However, they differ from Hicks’ model in that they are concerned with the cause of unemployment. Nonetheless, the type of unemployment they put forward is not involuntary unemployment (De Vroey 1997b). Hence, their second departure from Keynes’ programme concerning node 8. Chapter 13 of Patinkin (1965) provides a well-known reformulation of Keynes’ insight, centred around the idea of spill-overs across markets. Patinkin wanted to place his analysis within the framework of Walrasian general equilibrium, although my above remark, made apropos Hicks, applies to him as well. Thus, as far as node 4 is concerned, he should be considered as taking the combination stance. On the other hand, Patinkin is keen to stick to a strict definition of involuntary unemployment. Hence, on node 9, he departs from the standard IS-LM model to return to Keynes’ own stance. Yet, Patinkin is perfectly aware that, within the Walrasian framework, equilibrium and involuntary unemployment are incompatible bedfellows, as soon as it is accepted that the latter is concerned with end-states. This leads him to take the only escape route he can think of to give involuntary unemployment some credentials, namely to consider its existence as limited to the adjustment process. Involuntary unemployment, his argument runs, can exist only as a disequilibrium phenomenon, arising in-between positions of equilibria. Any existence it may have is transitory, since market forces will progressively eliminate it. Hence, his departure from Keynes at node 6. Barro and Grossman present their disequilibrium model as an attempt at synthesising Patinkin’s (1965) and Clower’s (1965) models (only the former being considered here). Yet their model differs from both of them. Barro and Grossman give up Patinkin’s governing-idea that involuntary unemployment can exist only during the process of price formation. Instead, they turn back to Keynes’ choice in favour of unemployment as an end-state quaesitum. The only, yet significant, difference between Barro and Grossman’s model and Keynes’ programme concerns node 4. In a sense, these authors go further than Hicks and Patinkin, who wavered between a Marshallian and a Walrasian account of the working of the economy. Their model is fully Walrasian, with prices being determined through the tâtonnement process. However, the very fact of having pushed the process of ‘Walrasisation’ of Keynes, initiated by Hicks, to its logical conclusion quickly brought to the fore a basic inconsistency. Within the Walrasian general equilibrium framework, there is no room for false trading in general and therefore for involuntary unemployment. As stated by Negishi: Walrasian economics cannot explain Keynesian equilibrium with involuntary unemployment since tâtonnement always results in a general equilibrium with full employment in the labour market. As a result of its assumptions, Walrasian economics fails to explain involuntary unemployment, which is more than a temporary disequilibrium phenomenon and cannot be quickly solved by the automatic forces of the price mechanism.

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(1979:17)20 Clower and Leijonhufvud are the first authors within the Keynesian camp who have criticised the Keynesian models of the IS-LM sort (see Leijonhufvud 1968; Clower 1975; Clower and Leijonhufvud 1975). Their indictment is that Hicks has ‘Walrasised’ Keynes. In Clower’s words: [To Hicks], everything of significant economic interest was—or seemed to be—suitable grist for the neo-Walrasian mill. So it is not surprising that Hicks in his 1936 review of the General Theory for the Economic Journal should have interpreted Keynes’ work not as a generalisation of Marshallian partial process analysis but rather as a special case of the neo-Walrasian theory that he was himself engaged in writing out. (1975, reprinted in Walker 1984:192)21 Clower and Leijonhufvud’s strategy can easily be grasped in terms of the unemployment decision tree. Starting from the realisation that the ‘Walrasisation’ of Keynes cannot but lead to an impasse, they decide to climb back up the decision tree, to what they feel is the wrong bifurcation,22 the dilemma between a Marshallian and a Walrasian general equilibrium approach. One should shift, they claim, from the latter to the former. As Clower writes: Keynes must rather have intended to offer the world an analytically manageable aggregative version of the kind of general process analysis that Marshall himself might have formulated had he ever felt a need explicitly to model the working of the economic system as a whole. (1975:198–90) Thereby, Clower and Leijonhufvud are falling back on Keynes’ own programme, as described above. The only difference manifests itself at node 6. They seem to think that the analysis should be geared to the process as well as to the end-result aspect. It is no wonder, then, that their programme stumbles on the implementation when discussing Keynes’ programme. To date, more than twenty years later, their views have not gone beyond the blueprint stage. Their scenario of a decentralised economy with money as a social link, in which the auctioneer is substituted by private merchants and in which multiple disequilibria could be the norm, may well be appealing, yet it has hardly been transformed into a fully-fledged theory. It is just as if there was an inverse correlation between the appeal of a programme and its implementability. The programme underlying Shapiro and Stiglitz’s shirking model (1984) differs from Keynes on two scores. First, they abandon the interdependency perspective to turn back to a labour market explanation. Second, as far as remedial policy is concerned, their model does not vindicate demand activitation.23 On the other hand, this model succeeds in yielding a micro-founded involuntary unemployment result, in accord with Keynes’ definition—quite a feat, it must be acknowledged.24 Finally, Roberts’ (1987) model belongs to the emerging co-ordination failure approach. It is one of the rare pieces putting forward a perfectly competitive involuntary unemployment result in a general equilibrium setting. Set against the unemployment decision tree, it differs from Keynes’ programme on two scores. First, at node 4, it takes a Walrasian rather than Marshallian approach. Second, at node 10, no demand-activation policy is vindicated.25 Although the authors examined above would hardly formulate it this way, I believe that their departing from Keynes’ programme stems from their more or less unwitting realisation of its non-implementability and of the need to replace it by a more easily implementable programme.26 However, not all of these new

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programmes have proven implementable. Without having the possibility of delving into this matter here,27 I would rank the IS-LM, the efficiency wage and Roberts’ co-ordination models amongst the implemented programmes, whilst considering the other models as non-implemented. This judgement, I hasten to add, should not be taken out of proportion, for, as the dictum runs, ‘A vanquished Greek may well be worth a triumphant Roman.’ NON-KEYNESIAN PROGRAMMES It has been stated above that the unemployment decision tree should not be exclusively associated with ‘Keynesian’ programmes. To give but one example, let me mention that Lucas’ analysis of unemployment can easily be recast in terms of the decision tree. In his Models of Business Cycles, Lucas (1987) contemplates two distinct programmes, aiming either at explaining variations of employment over the business cycle or unemployment seen as joblessness. In terms of the unemployment decision tree, the latter line amounts to opting for frictional instead of non-frictional employment at node 2. The former line of research, which has his preference and which constitutes his main contribution, amounts to the following set of choices shown in Box 1.2 (as above, boldface type indicates a departure from Keynes’ programme): {node 1: the reformist strategy; node 2: non-frictional unemployment; node 3: general equilibrium; node 4: Walrasian approach; node 5: perfect competition; node 6: end-state analysis; node 7: dynamic analysis; node 8: other forms of underemployment; node 9: cause analysis; node 10: supply policy}.

The boundaries of Keynesian theory The above sketch may help understanding why, with the passing of years, the meaning of the Keynesian label has become blurred. A first basic divide is, of course, between those who argue that only those economists who have taken up Keynes’ radical project truly deserve this label and those who have followed his reformist strategy. The emergence of the new classical school has marked a further watershed within the latter group, between ‘old’ and ‘new’ Keynesians. As a result, the label is increasingly nebulous. Previously, delineating the frontiers of Keynesian theory (or for that matter drawing the typical Keynesian economist’s profile) was rather easy. Two criteria were combined. The first was methodological, i.e. whether given models were using the concepts which Keynes, in person, or his patented interpreters, such as Hicks and Hansen, had introduced. IS-LM models were thus emblematically ‘Keynesian’. The second criterion pertained to policy motivations. Keynesian models were to uphold Keynesian policy results, i.e. demand activation. The link between these two criteria stamped the Keynesian brand. Leaving aside the adepts of a more radical reading of Keynes, a Keynesian economist was somebody who strived to introduce involuntary unemployment into the neoclassical framework, requiring demand policy as its appropriate remedy. After the all-out new classical attack against Keynesian economics, the intellectual landscape changed drastically. New Keynesian economists have dropped most references to Keynes’ own concepts as well as to the IS-LM methodological apparatus.28 Instead, they have accepted the playing field imposed by new classicists. Whereas some ‘Keynesian motivation’ may still persist, its content is vaguer, the Keynesian banner serving mainly to muster economists nurturing some scepticism towards fully-fledged laisser-faire.29

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CONCLUDING REMARKS The purpose of this chapter was to take up the old and much discussed issue of identifying the aim pursued by Keynes in the General Theory—his research programme—and of confronting the latter with subsequent Keynesian programmes. To this end, the unemployment decision tree has been devised. It allows a more complete account of Keynes’ programme which, in turn, has enabled us to see better the difficulties impeding its implementation. My analysis resolves two standard enigmas in the history of Keynesian economics. The first one is the question of why Keynesian theories, departing from Keynes’ own way of putting issues, have emerged. They have arisen, it has been claimed, because Keynes’ programme has proved to be unfeasible. The second conundrum is why, if Keynes’ programme had to be amended, it has not been replaced by one unique alternative programme, rallying the view of all Keynesian economists. Why, in other words, are there competing Keynesian theories? Here again, the answer is quite simple. Once it is admitted that some departure from Keynes’ programme is necessary, several alternatives present themselves. In principle, every node composing the unemployment decision tree could serve as a starting point for amending Keynes’ original programme. Small surprise, then, that very different Keynesian theories co-exist. They all have a lineage in Keynes’ programme and there is no reason to argue that one particular departure is superior to the others. Therefore, my chapter runs on a collision course with Patinkin (1990), who argues that the only possible reason for differences in interpretation of the General Theory resides in political motivations. Finally, my analysis suggests a broader methodological lesson. In a brilliant and often quoted passage of the General Theory, Keynes wrote: Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment—if there is such a thing (and who would deny it?). The classical theorists resemble Euclidian geometers in a non-Euclidian world who, discovering that in experiences straight lines apparently parallel often meet, rebuke the line for not keeping straight—as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidian geometry. (1936:16) Assume, for the sake of argument, that Keynes is right in his diagnosis. Still, this does not bring us very far. The fact that a non-Euclidian geometry may be something one might pray for hardly suffices for bringing it about. And if it proves so difficult to construct, what should be done in the meantime? With the exception of Clower and Leijonhufvud, on the one hand, and of advocates of the radical interpretation of Keynes, on the other, Keynesian economists can be seen as geometricians who, however sick at heart, have opted for continuing to use traditional Euclidian geometry, simply for want of an alternative. NOTES 1 This research has been supported by a grant, ‘Action de recherches concertées’ n° 93/98–162, from The Ministry of Scientific Research of the Belgian French-speaking community. Comments by Franco Donzelli and Philippe Fontaine are gratefully acknowledged. 2 The temptation to grasp these strategies in Kuhnian terms should be resisted. To give but one example, the ‘Keynesian Revolution’ expression usually covers a move belonging to the reformist strategy.

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3 The adjectives ‘Walrasian’ and ‘Marshallian’ are understood in a broad sense, as encompassing what is often qualified as ‘neo-Walrasian’ or ‘neo-Marshallian’ models. The contrast between a ‘Walrasian economy’, based on tâtonnement, and a’Marshallian economy’ is vividly drawn in Clower (1975). See also De Vroey (1997e). 4 The reader may find it odd that I consider the possibility of Walrasian imperfect competition models. But this may be explained by my special use of the term ‘Walrasian’, which also includes neo-Walrasian models. Gabszewicz and Vial’s (1972) Cournot—Walras model is an example of a Walrasian imperfect competition general equilibrium model. 5 Given that supply measures are understood as covering all alternatives to demand activation, they also include the ‘nothing to be done’ policy conclusion. 6 Keynes writes: ‘A classical economist may sympathise with labour in refusing to accept a cut in its money-wage, and he will admit that it may not be wise to make it meet conditions which are temporary; but scientific integrity forces him to declare that this refusal is, nevertheless, at the bottom of the trouble’ (1936:16). 7 For an alternative interpretation, see Gerrard (1995). 8 Meade (1937) and Harrod’s (1937) earlier accounts were very similar to Hicks’ piece. Cf. Young (1987). 9 Clower (1975) quotes an extract of a letter from Keynes to Georgescu-Roegen dated December 1934, running as follows: ‘All the same, I shall hope to convince you some day that Walras’ theory and all the others along those lines are little better than nonsense!’ (reprinted in Walker 1984:190). 10 On Keynes’ Marshallian roots, see Clower (1975, reprinted in Walker 1984) and Clower (1989, reprinted in Clower 1995). 11 On this point see, for instance, Feiwel (1989:32 ff.), where this passage is quoted, Marris (1991) and Keppler (1994). 12 On this point, Patinkin has recurrently defended a minority viewpoint, according to which the main thrust of the General Theory is the dynamics perspective. See, for example, Patinkin (1987). 13 Yet, his understanding of the alternative concept would have been different from mine, which refers to results which surfaced only recently. Cf. De Vroey (1997a). 14 Cf. De Vroey (1997c). 15 For an opposite view, see Meltzer (1988) and Darity and Horn (1983). 16 Recall that neoclassical theory is predicated on depicting economic agents as free-choosers. How can an involuntary outcome arise from such a premise? Recent theories which have succeeded in demonstrating involuntary unemployment have been compelled to drop the lack of freedom connotation of this concept (see De Vroey 1997a). 17 Tâtonnement is characterised by the fact that trade functions under the aegis of the centralised figure of the auctioneer. The economy is seen as one grand market, where every trade occurs simultaneously. The equilibrium value for all goods is obtained in one stroke, no trading taking place before its realisation. 18 Whereas most economists have no qualm with such a viewpoint, I have criticised it on the grounds that it shelves some basic differences between the Marshallian and the Walrasian perspectives (in De Vroey 1997e). 19 Such attempts are, however, to be found in Hicks’ later works. 20 I disagree with Negishi’s suggestion that involuntary unemployment can exist as a temporary disequilibrium phenomenon. 21 In my view, the IS-LM model is only half-baked Walrasian theory. As argued above, Hicks was in fact sitting on the fence between Marshall and Walras. Ironically enough, the full ‘Walrasisation’ of Keynes is to be found in the works of Barro and Grossman whose aim was to elaborate on Clower’s insight. 22 In Leijonhufvud’s terms: ‘when the workable vein [of an accepted research programme] rans out, [one] way to go is backtrap. Back there, in the past, there were forks in the road and it is possible…that some roads were more passable than the one that looked most promising at the time’ (quoted in Clower 1989, reprinted in Clower 1995: 295). 23 According to Stiglitz and Shapiro, the policy required is subsidy and taxation, whereas, according to their critics, the posting of bonds or the formulation of more complete contracts could dispense with the problem (see, for example, Carmichael 1985).

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24 Yet the common-sense meaning of the concept, in particular of the adjective ‘involuntary’, namely the idea that involuntary unemployment amounts to an infringement on freedom, ought to be dropped (see De Vroey 1997a). 25 However, when going beyond what we can learn from the decision tree, more important methodological differences surface, as a game theoretical approach, the use of a distinct equilibrium concept and a multiple equilibria framework. 26 Clearly, this observation does not hold for Clower and Leijonhufvud. 27 The issue is addressed, though in an incomplete way, in De Vroey (1997a). 28 Mankiw (1992) gives an enlightening illustration. 29 As stated by Mankiw: ‘The rubric “Keynesian” is so broad and so vague that many researchers have applied the term to their theory. If there is a single theme that unites Keynesian economics, it is the belief that economic fluctuations reflect not the Pareto-efficient response of the economy to changes in tastes and technology, but rather some sort of market failure on a grand scale’ (1990:1654).

REFERENCES Barro, R. and H.Grossman (1971) ‘A General Disequilibrium Model of Income and Employment’, American Economic Review 61:82–93. Carmichael, L. (1985) ‘Can Unemployment be Involuntary? A Comment’, American Economic Review 75:1213–14. Clower, R. (1965) ‘The Keynesian Counterrevolution: A Theoretical Appraisal’, in F.Hahn and F.Brechling (eds) The Theory of Interest Rates, London: Macmillan. Reprinted in D.Walker (ed.) (1984), 34–58. ——(1975) ‘Reflections on the Keynesian Perplex’, Zeitschrift für Nationalökonomie. Reprinted in D.Walker (ed.) (1984), 187–208. ——(1989) ‘Keynes’ General Theory: The Marshall Connection’. Reprinted in R.Clower (1995), 284–98. ——(1995) Economic Doctrine and Method. Selected Papers of R.W.Clower, London: Elgar. Clower, R. and A.Leijonhufvud (1975) ‘The Co-ordination of Economic Activities: A Keynesian Perspective’, American Economic Review 65:182–8. Darity, W. and B.L.Horn (1983) ‘Unemployment reconsidered’, Southern Economic Journal 49:717–33. De Vrooy, M. (1997a) ‘Accounting for Involuntary Unemployment in Neoclassical Theory. Some Lessons from Sixty Years of Uphill Struggle’, in R.Backhouse, D.Hausman, U.Mäki and A.Salanti (eds) Economics and Methodology: Crossing Boundaries, London: Macmillan, 177–224. ——(1997b) ‘Involuntary Unemployment. The Missing Piece in Keynes’ General Theory’, The European Journal of the History of Economic Thought, 4:258–83. ——(1997c) ‘Marshall on equilibrium and time. A reinterpretation’, mimeo. ——(1997d) ‘Is the tâtonnement hypothesis a good caricature of market forces?’, mimeo. ——(1997e) ‘The Marshallian market and the Walrasian market economy. Two incompatible bedfellows?’, mimeo. ——(1997f) ‘IS-LM “a la Hicks” versus IS-LM “à la Modigliani”’, mimeo. Favereau, O. (1985) ‘L’incertain dans la revolution keynésienne: l’hypothèse Wittgenstein’, Economies et Sociétés, série Œconomia 3:29–72. Feiwel, G.R. (1989) ‘Towards an Integration of Imperfect Competition and Macrodynamics: Kalecki, Keynes, Joan Robinson’, in G.R.Feiwel (ed.) The Economics of Imperfect Campetition and Employment. Joan Robinson and Beyond, London: Macmillan, 3–145. Gabszewicz, J.J. and J.Ph.Vial (1972) ‘Oligopoly “a la Cournot” in General Equilibrium Analysis’, Journal of Economic Theory 4:381–400. Gerrard, B. (1995) ‘Keynes, the Keynesian and the Classics: A Suggested Interpretation’, Economic Journal 105: 445–58. Harris, S. (ed.) (1947) The New Economics. Keynes’ Influence on Theory and Public Policy, New York: A.A.Knopf. Harrod, R.F. (1937) ‘Mr Keynes and Traditional Theory’, Econometrica. Reprinted in S.Harris (ed.) (1947), 591–605. Hicks, J. (1937) ‘Mr Keynes and the “Classics”’, Econometrica 5. Reprinted in J.Hicks (1967), 126–42.

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——(1946) Value and Capital, second edition, Oxford: Clarendon Press. ——(1967) Critical Essays in Monetary Theory, Oxford: Clarendon Press. Keppler, J. (1994) Monopolistic Competition Theory: Origins, Results and Implications, Baltimore and London: Johns Hopkins University Press. Keynes, J.M. (1934) ‘Poverty in Plenty. Is the Economic System Self-adjusting?’ From The Listener, 21 November, reprinted in Keynes (1973), 485–92. ——(1936) The General Theory of Employment, Interest, and Money, London: Macmillan. ——(1973) ‘The General Theory and After. Part I: Preparation’, vol. 13, in D.Moggridge (ed.) The Collected Writings of John Maynard Keynes, London: Macmillan for the Royal Economic Society. Leijonhufvud, A. (1968) On Keynesian Economics and the Economics of Keynes, Oxford: Oxford University Press. ——(1994) ‘Hicks, Keynes and Marshall’, in H.Hagemann and O.Hamouda (eds) The Legacy of Hicks. His Contributions to Economic Analysis, London: Routledge, 147–62. Leontief, W. (1947) ‘Postulates: Keynes’ General Theory and the Classicist’, in S.Harris (ed.) (1947), 232–42. Lucas, R.E., Jr (1987) Models of Business Cycles, Oxford: Basil Blackwell. Mankiw, G. (1990) ‘A Quick Refresher Course in Macroeconomics’, Journal of Economic Literature 28:1645–60. ——(1992) ‘The Reincarnation of Keynesian Economics’, European Economic Review 36:559–65. Marris, R. (1991) Reconstructing Keynesian Economics with Imperfect Competition. A Desk-top Simulation, London: Elgar. Meade, J. (1937) ‘A Simplified Model of Keynes’s System’, Review of Economic Studies. Reprinted in S.Harris (ed.) (1947), 606–18. Meltzer, A. (1988) Keynes’ Monetary Theory. A Different Interpretation, Cambridge: Cambridge University Press. Modigliani, F. (1944) ‘liquidity Preference and the Theory of Interest and Money’, Econometrica 12:45–88. Negishi, T. (1979) Microeconomic Foundations of Keynesian Macroeconomics, Amsterdam: North-Holland. Patinkin, D. (1965) Money, Interest and Prices, second edition, New York: Harper and Row. (1987) ‘Keynes, John Maynard’, The New Palgrave. A Dictionary of Economics, vol. 3, London: Macmillan, 19–41. ——(1990) ‘On Different Interpretations of the General Theory’, Journal of Monetary Economics 26:205–45. Roberts, J. (1987) ‘An Equilibrium Model with Involuntary Unemployment at Flexible, Competitive Prices and Wages’, American Economic Review 77:856–74. Shapiro, C. and J.Stiglitz (1984) ‘Equilibrium Unemployment as a Worker Discipline Device’, American Economic Review 74:433–44. Tarshis, L. (1989) ‘Keynes’ Co-operative Economy and the Aggregate Supply Function’, in J.Pheby (ed.) New Directions in Post-Keynesian Economics, Aldershot: Elgar, 35–58. Tobin, J. (1981) ‘Review of Patinkin’s Keynes’ Monetary Thought’, Journal of Political Economy 89:204–7. Walker, D. (ed.) (1984) Money and Markets. Essays by Robert Clower, Cambridge: Cambridge University Press. Weintraub, E.R. (1979) Microfoundations. The Compatibility of Microeconomics and Macroeconomics, Cambridge: Cambridge University Press. Young, W. (1987) Interpreting Mr Keynes. The IS-LM Enigma, London: Polity Press.

2 THE KEYNESIAN IDENTITY OF INCOME AND OUTPUT Claude Gnos

In the General Theory, Keynes defined income as being ‘equal to the value of current output’. Equating investment to the value of the output which is not consumed, and saving to the excess of income over consumption, he thus concluded that saving necessarily equals investment. He wrote the famous set of equations: Income=value of output=consumption+investment. Saving=income—consumption. Therefore saving=investment. (Keynes 1973a:63) These equations, which posit the identity of income and output and hence the necessary equality between saving and investment, are puzzling. They seem to be in contradiction with the principle of effective demand, which is at the core of the General Theory. The identity of income and output—known as Say’s Law—is a hallmark of the classical doctrine according to which ‘Supply creates its own Demand’: as Keynes wrote, the classics supposed that the aggregate demand price of output (D) is equal to its supply price (Z) ‘for all volume of output’, so that ‘there is no obstacle to full employment’ (ibid.: 26). In contrast, setting out the principle of effective demand Keynes argued that the equality between supply and demand is conditional and that achieving equilibrium between supply and demand does not necessarily command full employment. To lay out more of the puzzle, let us briefly recall Keynes’ line of reasoning which is based on entrepreneurs’ expectations. On the one hand, the aggregate supply price (Z) of the output of a given amount of employment (N) is defined as ‘the expectation of proceeds which will just make it worth the while of the entrepreneurs to give that employment’ (ibid.: 24). On the other hand, the aggregate demand price (D) represents ‘the proceeds which entrepreneurs expect to receive from the employment of N men’ (ibid.: 25). The volume of employment is determined at the point of intersection between the aggregate demand function and the aggregate supply function, which Keynes calls the effective demand. If D were necessarily equal to Z, Keynes argued, full employment would occur: competing entrepreneurs would be encouraged to increase employment until there were no more idle workers available on the labour market. Involuntary unemployment is conceivable only if D can be deficient, i.e. inferior to Z (for a discussion of this point, see De Vroey, this volume). According to Keynes’ above definitions, the relation between supply and demand or, what amounts to the same thing, the relation between saving and investment, is an identity, whereas according to the principle of effective demand, the equality between supply and demand is an equilibrium condition. Hence the inconsistency.

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It has been suggested that such inconsistency can be removed by using the ex ante and ex post analysis advocated by the Swedish economist Myrdal: Myrdalian ex ante language would have saved the General Theory from describing the flow of investment and the flow of saving as identically, tautologically equal, and within the same discourse, treating their equality as a condition which may, or not, be fulfilled. (Shackle 1989:51) In what follows, it is argued that the inconsistency under consideration is beyond the scope of the ex ante and ex post analysis, for Keynes’ macroeconomics is to be distinguished from ex ante and ex post analysis. Accordingly, we show that the principle of effective demand is linked to a theory of income distribution, where profits are a redistributed share of factor income, which is transferred to firms when prices exceed factor cost. So, the identity and the equilibrium condition may rightly live under the same roof: they relate to separate measurements of income and output, factor cost and prices. Factor cost constitutes an exhaustive measure of both income and output: the payment of factor cost creates the money income which is necessary and sufficient to pay for output. Nevertheless, the equality of supply and demand prices is conditional: the aggregate demand price does not necessarily recoup the factor cost and simultaneously pay entrepreneurs the profits they claim. Finally, we shall corroborate our interpretation of the identity of income and output with reference to Keynes’ analysis of the role of money in a production economy. KEYNES’ MACROECONOMICS AS DISTINCT FROM EX ANTE AND EX POST ANALYSIS We are concerned here with a question of logical consistency in Keynes’ macroeconomics: how can the equality between income and output or between investment and saving be both necessary and conditional? Can the distinction between ex ante and ex post, as Shackle puts it, be used to clear up this question? In macroeconomics, the ex ante and ex post analysis is usually referred to by analogy with the standard price theory. On this view, ex ante supply and demand generally differ; they have to adjust to each other. Their equality is an equilibrium condition. When the latter is fulfilled, transactions can take place. Thereafter, ex post, supply and demand are identical: they are two sides of the same coin and their measures are tautologically equal. Namely, every transaction is such that the purchaser’s outlay is the seller’s proceeds. It is worth noting that Keynes was well aware of the ex ante and ex post analysis. In a letter to Bertil Ohlin, written in January 1937, Keynes (1973b: 184–5) acknowledged that he had been thinking and lecturing almost along those lines in 1931 and 1932. He explained that he had finally decided it would be better to give up such reasoning: So, after writing out many chapters along what were evidently the Swedish lines, I scrapped the lot and felt that my new treatment was much safer and sounder from the logical point of view. (ibid.: 184) At the very most, Keynes conceded to Ohlin that he should use the Swedish method for exposition: So, as I say, I should be rather inclined to use it for exposition. But, when one comes to prove something truly logical and properly water-tight, then I believe there are advantages in my method. (ibid.: 185)

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Naturally, using the Swedish method for exposition does not mean agreeing with the proposed analogy between income and price theories by which supply and demand may be unequal ex ante while they are necessarily equal ex post.1 In rough notes surviving from his 1937 lectures, Keynes stressed the meaning of the distinction from his own point of view. Ex ante is the domain of entre-preneurs’ decisions, which may be taken ‘by trial and error or by judicious foresight, or (as in fact) by both’ (ibid.: 183). Ex post is the domain of realised results. Keynes’ point of view is naturally in accordance with the principle of effective demand: entrepreneurs have to make ex ante decisions according to the proceeds they expect. But in no way does this mean that ex post (realised) demand and supply prices are necessarily equal: this is what the classical doctrine maintained and what Keynes rejected. For Keynes, the crucial point is that ex post demand and supply prices may be unequal. Otherwise, entre-preneurs would not need to make forecasts and full employment would occur. So, the equality of supply and demand prices is clearly a condition of equilibrium, these variables being expected or realised. Paraphrasing a witty remark from Keynes, we may state that this condition holds ex ante, ex post and ‘ex anything else’. Keynes himself confirmed in as many words that his theory does not depend on the distinction of ex post and ex ante. ‘Let us suppose identity of ex post and ex ante, my theory remains’ (ibid.: 183). In addition, as Keynes emphasised, entrepreneurs’ decisions are reached by trial and error (ibid.) This is a method which clearly relates to realised results. Indeed, the principle of effective demand involves ex ante expectations and decisions, but these are partly based on past results which may or may not have satisfied conditions of equilibrium. Errors on which entrepreneurs base their decisions at any given moment in fact arose previously. As a matter of fact, a tautological identity between income and output—or between saving and investment—may well be obtained by ex post reckoning of actual transactions and prices. The value of both variables is thus made up from the same amounts of money paid by purchasers and received by sellers. National accountants make use of this empirical method. But such a tautology is not a determining matter for macroeconomic analysis: when he criticised Say’s Law and propounded the principle of effective demand Keynes was not up against a tautology. As we have just seen, the principle of effective demand is distinct from price theory. Unlike the latter, it commands a conditional equality between supply and demand both ex ante and ex post. So, the question is still open: how could Keynes maintain the identity of income and output while the principle of effective demand supposed a conditional equality between supply and demand? THE IDENTITY OF INCOME AND OUTPUT IN THE LIGHT OF THE DISTINCTION BETWEEN FACTOR COST AND PRICES In order to solve the problem under consideration, we propose to consider one of the premises on which Keynes based the principle of effective demand, namely: the distinction between factor cost and prices. At the beginning of Chapter 3 of the General Theory, Keynes defined factor cost as follows: the employment of a given volume of labour by an entrepreneur involves him in two kinds of expense: first of all, the amounts which he pays out to the factors of production (exclusive of other entre-preneurs) for their current services, which we call the factor cost of the employment in question. (Keynes 1973a:23) The second kind of expense which is referred to here is what Keynes called user cost; it relates to the cost of raw material and equipment. We may disregard it as it is not part of income. Factor cost constitutes the

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income of the factors of production. As for entrepreneurs, their income is profit, which they endeavour to maximise through their sales. Keynes emphasised that the total income made up by factor cost and profit may be looked at, from the entrepreneurs’ point of view, as the proceeds of the employment they offer. And, as we know, these proceeds are at work in the principle of effective demand. But, although factor cost and profit may be added, he underlined that they are created in different ways. Factor cost is an expense met by entrepreneurs who buy the current services of the factors of production. The proceeds of sales have to offset this expense. Profit is ‘the excess of the value of the resulting output over the sum of its factor cost and its user cost…’ (ibid.: 23): it stems from sales. This distinction is explicit; we shall argue that it removes the inconsistency we are examining. Let us consider—ex ante—the level of employment, N1, such that the aggregate supply price, Z1, is greater than the (expected) aggregate demand price, D1. Let us suppose that Z1 equals £120 while D1 is £90, the factor cost amounting to £100. Of course, employment N1 will not be chosen: the entre-preneurs would not only fail to make a profit, they would actually make a loss. The very possibility of such a loss logically results from the distinctive feature of factor cost. In our example, entrepreneurs would spend £100 in paying factor cost which the sale of the output would be unable to recoup in full. This possibility is highly significant: although the proceeds of sales amount to £90 only, the total expenditure of the economy as a whole is £100. The loss is not a mere loss of profit or opportunity cost: it is a charge on firms, which has to be financed. In A Treatise on Money, Keynes analysed precisely such a case. In one instance, he explained that the fall of the selling price of goods below their factor cost means entrepreneurs suffer a loss (Keynes 1971:159) and concluded that the public save the corresponding part of their income, which the entrepreneurs borrow either directly or through the intermediary of banks to make good their losses: Thus the increased saving has not increased in the least the aggregate wealth of the community; it has simply caused a transfer of wealth from the pockets of the entrepreneurs into the pockets of the general public. The savings of the consumers will be required, either directly or through the intermediary of the banking system, to make good the losses of the entrepreneurs. (ibid.) The concept of transfer may be applied to profits (cf.Schmitt 1972:148–56). Profits are not factor costs, they are derived from sales. That is to say that they are earned at the expense of buyers: they are transferred from the pockets of the general public into the pockets of the entrepreneurs. These considerations lead us to a very helpful distinction. It is undeniable that the principle of effective demand runs counter to the identity between aggregate supply price and aggregate demand price. The relation between Z and D is a conditional equality, not an identity. Nevertheless, demand and supply are identical: the identity concerns factor cost. Every difference between prices and factor cost, loss or profit, diverts a fraction of the income created in the payment of factor cost. It induces a transfer from firms to the public or from the public to firms. In this respect we are entitled to consider that factor cost is an adequate yardstick of the community’s income and output. Moreover, as stated in A Treatise on Money, this income is necessarily spent, either by consumers or by firms. This is a confirmation that the Keynesian identity of income and output is not merely an accounting equation tautologically describing the actual aggregate price of output and its constituent parts. Finally, we have to agree with the statement that ‘Supply creates its own Demand’, but only in so far as the income created in paying factor cost is concerned. The principle of effective demand is linked to a theory of income distribution where profits are earned at the expense of purchasers: they are a redistributed

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share of the money income earned by the factors of production, So, their existence does not invalidate the identity of money income earned by the production of goods and spent on purchases (whether on consumption goods or on investment goods). But they may be high or low, positive or negative (negative profits are losses), determining via expectations the amount of employment entrepreneurs are ready to provide. THE FUNDAMENTAL ROLE OF MONEY IN A PRODUCTION ECONOMY One of Keynes’ main objectives was to set out ‘the complete theory of a Monetary Economy’. In order to corroborate the analysis proposed here, we may consider this feature of Keynesian economics. We shall refer to three complementary points. Our first point relates to Keynes’ ‘finance motive’, which accounts for the way entrepreneurs pay for their costs of production and the consequent generation of money income. The second point is concerned with the fact that bank money is involved in bilateral transactions: we shall be able to confirm that the money income is necessarily lent to entre-preneurs if not spent by its holders. The third point deals with the definition of factors of production and Keynes’ choice of units of measurement. Keynes introduced what he termed ‘the finance motive’ in two articles published in the Economic Journal in June and December 1937, where he indicated that starting production requires the banks to undertake to finance firms. This ‘finance’ or ‘commitment to finance’, which takes the form of credit lines (overdraft facilities), is unusual in that it does not involve raising funds from pre-existent savings: ‘But “finance” has nothing to do with saving…It does not absorb or exhaust any resources’ (Keynes 1973b:209). On the contrary, it is a flow, as Keynes pointed out in opposition to Ohlin’s view (ibid.), which results in the building up of a stock, of both savings and investments: ‘there will always be exactly enough ex post saving to take up the ex post investment and to release the finance…’ (ibid.: 222). At first sight, the use of the term ‘finance’ may seem rather confusing as finance is usually considered as the use of saving. The ambiguity is minor, though. Keynes’ aim is to explain why firms ask for money. Moreover, although the creation of money is not actually a source of financing it does provide finance for firms, which comes from the very deposits created in this way. The monetary payment of factor cost is precisely a matter for commitment to finance: it does not absorb pre-existent resources but generates the income—the resources—which are necessary and sufficient to pay for output, whether consumption goods or investment goods (including involuntary inventories). In the General Theory, especially in Chapter 7, Keynes linked the identity between saving and investment to an outstanding feature of bank money: The prevalence of the idea that saving and investment, taken in their straightforward sense, can differ from one another, is to be explained, I think, by an optical illusion due to regarding an individual depositor’s relation to his bank as being a one-sided transaction, instead of seeing it as the two-sided transaction which it actually is. (Keynes 1973a:81) Money is involved in bilateral transactions: it is both a liability and an asset on the banks’ balance-sheets. Thus, for every deposit made with a bank an equivalent loan is granted by the bank. As Keynes pointed out, this reconciles ‘the identity between saving and investment with the apparent “free will” of the individual to save what he chooses irrespective of what he or others may be investing’ (ibid.: 84). This reference is consistent with the analysis of the way entrepreneurs’ losses are financed (cf. supra) and with the analysis

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of the financing of inventories (voluntary or not). Once created, the income allotted to the factors of production is available and necessarily lent to firms if it is not spent by its holders. Banks are intermediaries in financial transactions that the depositors are not necessarily aware of. Last but not least, we must look at the definition of factors of production. Emphasising the requirements of analysis, in Chapter 4 of the General Theory, Keynes criticised the reference to the general price-level: this term is ‘very unsatisfactory for the purposes of a causal analysis, which ought to be exact’ (1973a:39). He proposed instead to measure output and its variations ‘by reference to the number of hours of labour paid for…on the existing capital equipment, hours of skilled labour being weighted in proportion to their remuneration’ (ibid.: 44). So the total wages—the quantity of employment multiplied by the wage-units— constitute the proposed measure of output. Further on, Keynes confirmed his suggestion: It is preferable to regard labour, including, of course, the personal services of the entrepreneur and his assistants, as the sole factor of production, operating in a given environment of technique, natural resources, capital equipment and effective demand. (ibid.: 213–14) We know that this suggestion was received with great circumspection. Contemporary economists, as Hicks (1975) reports, were puzzled and eventually Keynes’ suggestion was disregarded. In analysing the Keynesian identity of income and output, we rediscover its virtue. However, is it necessary to confine the definition of factors of production to labour? Keynes’ analysis of the role of money in a production economy allows us to clarify this point. We notice that investment uses pre-existent resources, i.e. savings. This implies that firms when buying capital goods perform a financial transaction: they exchange current income against future income they will make over to lenders and to shareholders. How is firms’ income (profits) created? We cannot assume that they pay themselves as this would contradict the principle of effective demand, their dependence vis-à-vis the proceeds of sales. Moreover it would contradict the fact that firms have to borrow saving in order to invest: they could by the same argument pay for capital goods without raising pre-existent resources. The sole solution is to recognise that the income of firms proceeds from sales, where it is earned at the expense of buyers. With labour, the situation is completely different: labour is not a product which has to be paid for out of previous resources. On the contrary, and in keeping with the analysis of the finance motive, income is in this case created by payments. All things considered, wages actually constitute an exhaustive measure of income and output. The General Theory is known as a badly written and confusing book. On this count, Samuelson argued that it should not have been published (Samuelson 1972:1520). Others believe that the work provides scope for an indefinite series of (mis)interpretations (Weintraub 1979). But one has to make due allowance. A lot of confusion could certainly be avoided if Keynes’ interpreters examined the difficulties they meet in the light of Keynes’ work as a whole. We hope to have convinced readers that the inconsistency between the identity of income and output and the principle of effective demand is the result of a partial view. In particular, we have to take seriously the considerations Keynes developed about the choice of units and the definition of factors of production. By measuring income and output in wage-units (factor cost), we are able to corroborate the Keynesian identity of income and output despite the coexistence of a conditional equality between supply and demand prices which is at work in the principle of effective demand.

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NOTES I am grateful to Evert Schoorl and to an anonymous referee for helpful comments. All errors of course remain mine. 1 According to Myrdal (1939), income determination is not merely analogous to price determination, it is actually part of it. Income is determined as part of a whole price system resulting from individual behaviour.

REFERENCES Hicks, J. (1975) The Crisis in Keynesian Economics, Oxford: Basil Blackwell Keynes, J.M. (1971) A Treatise on Money, vol. 5, in D.E.Moggridge (ed.) The Collected Writings of John Maynard Keynes, London: Macmillan. ——(1973a) The General Theory of Employment, Interest and Money, vol. 7, in D.E.Moggridge (ed.) The Collected Writings of John Maynard Keynes, London: Macmillan. ——(1973b) The General Theory and After: Part II Defence and Development, vol. 14, in D.E.Moggridge (ed.) The Collected Writings of John Maynard Keynes, London: Macmillan. Myrdal, G. (1939) Monetary Equilibrium, London: W.Hodge. Samuelson, P.A. (1972) The Collected Scientific Papers of Paul A.Samuelson, vol. 2, Cambridge, MA: MIT Press. Schmitt, B. (1972) Macroeconomic Theory: A Fundamental Revision, Albeuve (Switzerland): Castella. Shackle, G.L.S. (1989) ‘What did the General Theory do?’, in J.Pheby (ed.) New Directions in Post-Keynesian Economics, Aldershot: Elgar. Weintraub, E.R. (1979) Microfoundations: The Compatibility of Microeconomics and Macroeconomics, New York: Cambridge University Press.

Part II CONTROVERSIES IN MACROECONOMICS

3 PIGOU ON UNEMPLOYMENT Hansjörg Klausinger

Recently there has been a renaissance of interest in the macroeconomics of Pigou. Once considered, thanks to Keynes’ classification, as ‘the classical economist’, the first impulse for rediscovering Pigou came from Hutchison (1978, Ch. 6) who destroyed the myth of Pigou as an advocate of a policy of wage-cutting during the Great Depression. To the contrary Pigou was shown to have favoured moderately expansionist policies in the early 1930s rather similar to those advocated by Keynes himself.1 Yet Keynes’ critique was foremost directed against Pigou’s theoretical framework as being inconsistent with his practical policy recommendations. Keynes (especially in the appendix to Chapter 19 of the General Theory) maintained that Pigou’s analysis on the one hand neglected monetary factors and on the other hand was based on the assumption of labour market equilibrium, i.e. full employment—so that it was ill-suited to explain unemployment in a monetary economy. The main object of this so-called ‘inconsistency thesis’ was the theoretical account which Pigou (1933) gave in the Theory of Unemployment (TU). Following the lead given by Hutchison, historians of economic thought have started to re-examine Pigou’s TU and to reevaluate Keynes’ critique. The lively debate thus generated—to which the following is meant to contribute —gave another boost to reconsidering Pigovian macroeconomics.2 At last, in the light of modern developments in business cycle theory and labour economics Pigou’s work is interpreted as an approach which although microeconomic in character did not fall prey to the danger of neglecting relevant factors as a result of an undue aversion to empirically-based (ad hoc) hypotheses.3 With regard to the TU, Pigou’s mode of presentation is mathematical only inasmuch as some elements and relations between them are stated in formal terms, yet there is neither a consistent representation of the model as a whole nor are the results formally derived. Nevertheless the analysis is of that neoclassical kind, which even when stated in verbal terms lends itself easily to a formal description, and indeed in his contributions to the debate of Keynes’ General Theory, Pigou (e.g. 1937, 1943) provided a formal model of his macroeconomics. Therefore the attempt is legitimate to capture the relevant relations of Pigou’s macroeconomic analysis in a simplified model. Yet, to my knowledge, up to now there does not exist a formal model of Pigovian macroeconomics, despite the excellent work initiated by ÖAslanbeigui (1992). In the following section, such a model is set up as an exercise in rational reconstruction of Pigou’s verbal results. Thereby special emphasis is laid on the evaluation of the employment effects of ‘public works’ or similar policies towards unemployment.4 The lessons to be drawn therefrom on the consistency of Pigou’s thought are summarised in the concluding section.

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PIGOU’S (1933) MACROECONOMIC MODEL OF UNEMPLOYMENT The structure of the macroeconomic part of TU is characterised by the fact that it takes a model of a purely real economy as its point of departure. According to Pigou, it is irrelevant whether to start the analysis ‘either from the money end or…from the real end’, as the ‘two studies, if made complete and carried through correctly, must necessarily come to the same thing’ (TU, v). However the structure of TU is illsuited to make the reader realise that it is finally meant to apply to a monetary economy, too. The first 185 (of 320) pages are devoted to the real economy; then different monetary regimes are introduced, but are analysed for the most part on the assumption of rigid real wages; and there are just 10 pages left for the analysis of rigid money wages. The structure of the simplified model will follow that of Pigou’s book. At first the real economy model (i.e. the real subsystem of the monetary model) is examined. Then the monetary subsystem is introduced by distinguishing two kinds of monetary regimes. For each of these the monetary economy is analysed, first under the assumption of rigid real wages and then—thus bringing some of Pigou’s unfinished business to an end—under the assumption of rigid money wages. The real economy model The real economy model is composed of three markets, for wage-goods, for non-wage-goods, and for labour, respectively, represented by the following equations. The first two equations refer to the market for wage-goods, indicated by the subscript w: (1) (2) where cw is demand for wage-goods, v real wage (in terms of wage-goods), z x+y total employment, a nonwage-earners’ demand for wage-goods, f the production function for wage-goods and x employment in the wage-goods sector. Equation (1) is the market clearing condition. In particular, as specified in (1), the demand for wage-goods conforms to a ‘classical’ consumption function so ‘that wage-earners take out the whole of their income in the personal consumption of wage-goods’ (TU, 155)—a hypothesis which is entertained by Pigou throughout the book.5 Furthermore the demand for wage-goods by non-wage-earners is exogenous, a=a0. This corresponds to one of two special cases examined by Pigou (TU, 92f.), namely that of an absolutely inelastic demand of non-wage-earners; later on Pigou confirms the relevance of this case by describing non-wage-earners’ demand as ‘only a small proportion’, ‘presumably inelastic’ and ‘highly stable’ (TU, 146f.). Equation (2) is the profit maximising condition for employment as explicitly stated by Pigou: ‘the quantity of labour demanded…is such that the value in terms of wage-goods of its marginal net product…approximates to that rate of wage’ (TU, 41). The next two equations are the market clearing and profit maximising conditions of the market for nonwage-goods, indicated by the subscript n: (3) (4) where cn is demand for non-wage-goods, g the production function for non-wage-goods, y employment in the non-wage-goods sector and r the relative price of wage-goods in terms of non-wage-goods. Following Pigou, non-wage-goods are either devoted to luxury consumption or investment (cf. TU, 145f.) —when for simplicity the former is disregarded then the demand for non-wage-goods will depend in a familiar way on the rate of return on investment and the rate of interest, respectively. Accordingly in (3) the demand for investment h is determined by its expected yield q. The exogenous component b=b0 represents government

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demand as well as the effects on private demand by waves of optimism (or pessimism). As above, (4) describes profit maximising employment. The next equation (5) stipulates the condition that rates of return for investment in real and financial capital must be equal: (5) where i is the rate of interest. The yield of investment is taken to be ‘real’ in terms of a composite good where is the share of non-wage-goods and 1− that of wage-goods. So the yield will be positively affected by an increase of the relative price of wage-goods r.6 These characteristics of the investment goods market are only implicit in Pigou’s analysis but typical for contemporary (monetary) business cycle theory, and it is well established that they are also part of Pigou’s overall approach.7 There remains the labour market. Here again recent research has demonstrated that Pigou did not assume full employment (as Keynes maintains in his critique) but examined a case of fixed real wages: (6) Employment is then determined by labour demand from (2) and (4).8 The real (part of the) model is made up of the five equations (1)—(5) which determine the five endogenous variables x, y, r, i and q. The real wage v and the two demand variables a and b are exogenous. Besides the labour market and the markets for wage-goods and for non-wage-goods there is a capital market (or market for loanable funds) implicit in the model. Therefore because of Walras’ law, variations in the exogenous demands, a or b, imply equal variations in the (excess) supply of loanable funds, i.e. an increase in a means a decrease in planned saving by non-wage-earners and similarly for b. Now the ‘reduced forms’ for the real economy model can be derived.9 An equilibrium where for the sake of simplicity: ã==0, is the point of departure. The model has a recursive structure, so that x, y, r and i can be determined in this order. First, totally differentiating (2): f"dx=dv, which implies: (R1) where for the sake of brevity reduced form partial derivatives are denoted by subscripts, e.g. Then totally differentiating (1): dcw=v (dx+dy) +zdv+da=f'dx=vdx, and substituting from (2) leads to: vdy=−zdv−da and therefore: (R2) Again totally differentiating (4) and substituting from (R2) leads to: (R3) After some manipulation a sensible condition for determining the sign of can be found. Note that the elasticity of labour demand in the non-wage-goods sector y with regard to the product wage rv is given by

substituted into (R3) this renders the condition: (A1) In the following the qualitative results will always be given for the general case first, and then (in parentheses) for the case when condition (A1) holds.10 Next the solution for i. First solving (5) for q leads to: dq=di−(1− )qr, where for simplicity now and in the following: 1;then substituting into (3) and again making use of (R2) gives:

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(R4) At last the results for total employment, z=x+y, follow trivially from (R1) and (R2): (R5) For convenience the qualitative results of the real economy model are summarised in Table 3.1.11 Table 3.1 The real economy (R)

x y r z i

V

a

b

_ − (+) − (+)

0 − + − +

0 0 0 0 +

These results shall now be interpreted and confronted with textual evidence from TU. The question of the ‘elasticity of demand in terms of wage-goods for labour as a whole’ (TU, 73ff., 88ff.) is central to Pigou’s analysis. In the wage-goods sector a lower real wage directly increases employment and output. While the increase in demand induced by additional employment in the wagegoods sector just equals the increased output of wage-goods: vdx−f'dx=0, the demand for wage-goods per hour employed must fall as a result of the lower real wage: zdv0, so that =−z/v, as above. Combining the above results for x and y and defining the real wage elasticities of employment accordingly gives for ez,v: where

This is exactly the value of the elasticity that Pigou derives for the special case where, as in the model above, ‘non-wage-earners have an absolutely rigid desire for wage-goods’ (TU, 92). This value is the upper limit (numerically) for this elasticity. If non-wage-earners’ demand for wage-goods were more elastic, e.g. by making it depend on profits, then the elasticity would be (numerically) lower (cf. TU, 92f.). Another question which Pigou attempts to answer is that of the inter-dependence between employment in the two sectors. The above model implies that, firstly, an exogenous increase in the demand for wage-goods (da>0) will decrease total employment, and secondly, that an exogenous increase in the demand for nonwage-goods (db>0), for instance ‘road-making’ as part of a ‘public works’ programme, will leave total employment unchanged. Pigou’s statements fully comply with these results. First, for the sake of argument taking an employment effect from such ‘road making’ in the non-wage-goods sector for granted, Pigou denies (for the real economy model) the possibility of ‘secondary employment’ in the wage-goods sector (i.e. a multiplier effect of the Kahn-Keynes-type): ‘This argument, in the present connection, is invalid. When the real—not the money—rate of wages ruling in the wage-good industries is given, the quantity of labour demanded in these industries is determined …’ (TU, 75, emphasis in original; cf. also 143f.). Secondly, even the primary employment effect in the non-wage-goods sector from public works is

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questionable.12 Since, for a given real wage, employment in the wage-goods sector is fixed, such effect presupposes that wage-goods can be transferred to the non-wage-goods sector from other uses (TU, 144ff.). Pigou mentions ‘the personal consumption of wage-goods by non-wage-earners,…the storage of wagegoods,…the purchase by non-wage-earners of non-wage-goods… from abroad’ (TU, 146) as possible sources, none of which he considers as important (cf. TU, 147f.). In the simplified model none of these sources is available, so that the primary effect on employment is nil. Thirdly, the real economy model implies that an exogenous shift of demand from wage-goods to non-wage-goods (da=−db1>0.27 The sign of the effect of shifts in the demand for wage-goods is again indeterminate. However, when assuming symmetry (A2) as above, the result becomes definite:

Therefore, in the non-standard system the effect is plausibly positive. Furthermore, the effect of shifts in the demand for non-wage-goods is positive, too, so that there are definitely primary (and secondary) employment effects of, e.g., deficit-financed public works.28 Again it must be noted that Pigou (at least) did not emphasise that the transition from the real economy model to one of rigid money wages in the end may reverse the sign of those effects, so that the policy prescriptions valid for the real economy cannot be maintained. Moreover, comparing the respective results proves that generally the effects of the demand disturbances, a and b, are smaller in the standard than in the non-standard system—which on the other hand means that in the latter case demand management (e.g. public works) is more effective. Again assuming

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(A1) so that > , it turns out that the employment effect of money wage variations is greater in the standard than in the non-standard system. With regard to monetary variables the non-standard system by holding the quantity of money constant necessitates adjustments of the price level in the face of disturbances whereas in the standard system the price level was kept stable. Similarly the behaviour of the rate of interest in the standard and in the nonstandard system can be examined. In the non-standard system the interest rate diverges from the reaction as prescribed by the management of the standard system, i.e. that of the ‘proper rate’ (TU, 2.11). Because of these divergences the interest rate does not fully adjust to demand disturbances (such as variations in a or b) in the non-standard system, so that these disturbances are intensified and monetary ones are introduced (cf. TU, 210). These divergences can be calculated as follows:

Therefore when (A1) holds, then , and Pigou’s conjectures are confirmed. As can be seen from the above results, rigid money wages in the face of disturbances to aggregate demand may represent a cause of unemployment as well as a justification for expansionist policy. Although Pigou only implicitly (if at all) analyses such employment effects, he comments on the interrelation between money wage rigidity, unemployment and public works. In principle, Pigou considers neither the wage rate nor the state of demand as the sole cause of unemployment so that consequently neither wage reduction nor expansion of demand is the only possible remedy (cf. TU, 253). Rather, the relevant factor is whether current wage rates form part of a ‘wage policy’ conceived as a ‘permanent plan’ that typically aims at some desired level of the real wage (ibid.). From this perspective, the case of rigid money wages can be interpreted as applying to the short run (relevant for the business cycle) and that of rigid real wages determined by wage policy as applying to the long run.29 Whereas with ‘perfectly free competition…and labour perfectly mobile…there will always be a strong tendency for wage-rates to be so related to demand that everybody is employed’ (TU, 252), ‘the goal at which wage policy aims is…a wage-rate substantially higher than the rate which…would yield nil unemployment’ (TU, 253). Therefore with wage policy given, long-run government policies can have no effect on unemployment (cf. TU, 248). Nevertheless, this longrun ineffectiveness thesis does not restrict activist government policy to the depression phase of the business cycle; in Pigou’s view even the heavy unemployment in Great Britain during the 1920s would have constituted an example of ‘a short-period malady, needing treatment only for a few difficult years’ (TU, 250)—besides, a useful hint at the duration (‘years’) of the short period. With regard to the distinction between the short and long run this means that rigid money wages might constitute a justification for activist policy in two respects. First, policy can be used as a remedy against the effects of temporary disturbances and against the danger that these effects might generate cumulative processes. And second, as can be concluded from Pigou’s statement concerning the 1920s, policy could be used as a substitute for money wage reductions if the adjustments brought about by expansionist policy were not in conflict with wage policy—a qualification which, as many ‘classical economists’ criticised, is

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crucially absent from Keynesian analysis. Anyway, it must be noticed that for Pigou money wage rigidity, due to some meta-economic reasons,30 did constitute a possible justification for activist policy. SOME LESSONS FROM THE MODEL Drawing on insights from the formal model, Pigou’s approach is now critically evaluated with a view to its relation to what was later on described as classical and Keynesian macroeconomics. The first question to ask is whether by conducting almost the whole analysis in real terms Pigou did not fall prey to a kind of ‘barter illusion’31 when applying it to a monetary economy. And in fact the model reconstructed above points to some crucial differences which Pigou neglected. First, a change in the demand for non-wagegoods has no effect on employment if either real wages are rigid or the monetary system is a standard one, whereas the effect is positive with rigid money wages and a non-standard system. Second, the sign of the effect of a demand shift towards wage-goods is negative in the case of rigid real wages; it is (under conditions of symmetry) zero with rigid money wages and a standard system, and positive with a nonstandard system. In such a case, when the sign of the effect is reversed, it does not make good sense to start the analysis from the real end and give policy prescriptions predicated on that model, without ever hinting at the fact that these will change drastically when applied to a monetary economy. Therefore it is evident that the policy conclusions valid for the real economy model cannot be applied to an economy with rigid money wages even if the monetary system is a standard one. For though money wage variations in the latter model have the same comparative-static effects as real wage variations in the former, such similarity no longer holds when the effects of demand shifts (e.g. of public works) are concerned. The results of the real economy are equivalent to those of a monetary economy only when real wages are fixed, but qualitatively different when money wages are fixed irrespective of the monetary system. So the criticism that Pigou’s analysis suffers from ‘barter illusion’ is more justified than conceded by those rejecting Keynes’ inconsistency thesis. Indeed, Pigou did not completely carry through his analysis to a monetary economy as promised. This leads back to the question of the consistency of Pigou’s policy recommendations. It should be noted that, strange as this might have been in 1933, the TU is primarily theoretical and statements about policy are just scattered throughout the text. Nevertheless it is legitimate to ask about the context of such prescriptions and whether they follow from the analysis. As the discussion of the above versions of the model has shown, recommendations of public works cannot be deduced from the real economy model. Insofar as Keynes exclusively refers to this part of TU his critique is, of course, correct. However, Pigou’s proposals might be founded on his more cursory treatment of the monetary economy. A justification for expansionist policy may then arise in two contexts. The first is a kind of disequilibrium (or, as one might put it in modern terms: instability) argument. Accordingly fiscal policy might be necessary either to maintain the standard monetary system and a stable price level when monetary policy alone cannot fulfil this task, or —if the standard system fails—the ensuing price deflation might degenerate into a cumulative downward process that again only fiscal policy is able to stop.32 Evidently the drawback of this justification is that it is not fully integrated with the core of Pigou’s analysis, rather appearing to be a kind of afterthought. The alternative context for justifying public works is that of rigid money wages, as although not explicitly derived in the TU it should not be doubted that Pigou was aware of the possibility of positive employment effects of public works in this case. Summarising, the first (instability) argument for fiscal policy cannot be reconstructed consistently within a comparative static framework of Pigou’s analysis although it might be appended to it as a description of an economy out of equilibrium, whereas the second argument—referring to an economy with rigid money

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wages—can be thus reconstructed, yet only as what Pigou should have said, not what he really did say in TU. However, even if Pigou’s macroeconomics of unemployment is judged as providing a logically coherent framework of analysis not inconsistent with his practical policy recommendations of the 1930s, this does not mean that Pigou’s diagnosis or therapy was—in a theoretical sense—truly ‘Keynesian’. For in his attempt at synthesising short-run, i.e. business cycle, and long-run analysis by his thesis of the long-run stability of full employment equilibrium Pigou’s analysis seems to anticipate just that kind of ‘Keynesian’ macroeconomics as reconstructed by the so-called neoclassical synthesis. Perhaps one should also keep in mind Keynes’ statement (Keynes 1936:257) that it is ‘the classical theory [which] has been accustomed…to lay on rigidity [of money wages] the blame of maladjustment’, i.e. of unemployment. NOTES A preliminary version of this paper was published as no. 31 of the Working Papers of the Vienna University of Economics and Business Administration (Department of Economics). Helpful comments by the discussant, Tony Aspromourgos, by my colleagues, Ferry Stocker and Gert Wehinger and by an anonymous referee are thankfully appreciated. The remaining errors and omissions are mine. 1 From a more Keynesian perspective, this is confirmed by Clarke (1988, Ch. 8) and Dimand (1988, Ch. 3); cf. also Garside (1990, pt V). 2 On this debate, cf. Aslanbeigui (1992), Cottrell (1994a, 1994b) and Brady (1994). An early contribution is Collard (1981). 3 For a re-evaluation of Pigou from a modern perspective, cf. for example Solow (1980), Barber (1993) and Collard (1996). 4 For simplicity in the following ‘public works’ is synonymously used for ‘expansionist fiscal policy’. 5 The assumption of different saving behaviour of workers and capitalists was not uncommon in the contemporary business cycle literature, cf. Keynes’ ‘widow’s cruse’ (Keynes 1930a:125) or Robertson (1934). 6 Some calculation proves that the qualitative results do not change much when the expected yield is specified otherwise, e.g. weighed by a different price index. 7 Pigou dealt with monetary aspects more thoroughly in Pigou (1929); cf. also Aslanbeigui (1992:423ff.) and Collard (1996). 8 Keynes’ critique of Pigou’s labour market analysis has been refuted by Collard (1981) and Aslanbeigui (1992: 418ff.). Cf. also recently Cottrell (1994a, 1994b) and Brady (1994). 9 The solutions of the different versions of the model are distinguished by super-scripts, e.g. ‘R’ denotes solutions of the real economy model. 10 The economic intuition behind (A1) is as follows: starting from equation (4), if v increases, it is known from (R2) that y will fall and therefore rise. The reaction of r depends on which of these effects dominates. If the demand for labour in the non-wage-goods sector is not ‘too elastic’ with regard to its product wage, then (A1) will be fulfilled and r will rise. 11 In the following tables dependent variables are arranged in rows and independent variables in columns so that the respective fields show the signs of the comparative-static effects. These signs are valid for the general case; only when they are indeterminate in the general case, will the signs be given (in parentheses) for the case of condition (A1). 12 Thus it is not true, as Keynes believed, that ‘Professor Pigou accepts…appar-Z ently the possibility of increased primary employment’ (Keynes 1936:277). 13 ‘All gratuitous payments to poor people and all social services, in so far as they are financed at the expense of the richer non-wage-earning classes…of necessity reduce pro tanto the quantity of labour demanded at a given real

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14

15 16

17

18

19 20 21 22 23

24 25

26 27 28 29 30

wage-rate’ (TU, 155f.). Conversely, total labour demanded will be increased by ‘contracting pensions and unemployment pay and remitting equivalent taxation on the well-to-do’ (TU, 156). It should be noticed that the simplified model has another thoroughly classical property inasmuch as employment is increased by higher saving (and decreased by higher consumption) of non-wage-earners. Furthermore, due to the absolutely inelastic demand for wage-goods of non-wage-earners fluctuations in investment demand are fully compensated for by corresponding movements of the rate of interest, without affecting other variables. Of course, these results could be modified, e.g. by making the demand for wage-goods depend on the interest rate. It might be conjectured that it is a positive relative-price effect which would be consistent with Pigou’s analysis as his estimate (in TU, 92) for the ratio x/z=3/4, so that the upper limit for the crucial elasticity z/y=4. Monetary factors are analysed in TU in Part II, Ch. X (100–106) dealing with the elasticity of labour demand with regard to the money wage; in Part IV (185–243) under the assumption of rigid real wages, and in Part V, Ch. IX (293–7) where at last rigid money wages are introduced. The relation between Cambridge and Keynesian monetary thought is discussed by Patinkin (1982, Ch. 6) and Laidler (1991:60ff. and 86n.9), who do not find evidence for a systematic analysis of the interest rate as a determinant of velocity in e.g. Marshall and Pigou before 1930. However, an interest sensitive velocity is explicitly formulated in Pigou (1937:409f.) when commenting on Keynes’ General Theory. Similar rules of a secularly falling price level were favoured, as Robbins (1934: 20) puts it, by ‘the majority of economists of repute…[i.e.] Marshall, Edgeworth, Taussig, Hawtrey, Robertson, Pigou’. The history of such rules is discussed by Selgin (1995). The model is an example of what Patinkin called ‘the invalid dichotomy’. On Pigou, cf. Patinkin (1965:609f.). In the following only the qualitative results are reported in the text. The calculation of full results is available upon request from the author. Similar mechanisms of forced saving were common in the writings of contemporary business cycle theorists, cf. for example Wicksell, Schumpeter, Hayek or Robertson. Patinkin (1976:132n.; 1982:168) has repeatedly pointed to this passage of Pigou’s TU. Pigou’s argument, looked at with hindsight, seems to come close to stating the problem of aggregate demand deficiency as in consequence of a decrease in consumption (da0 is : (A3) eV,i0, and therefore: 1 + However, these employment effects vanish with a constant income velocity of money, eV,i=0. Of course, this presupposes that workers—presumably by changing the money wage—can also control the real wage, an assumption that Keynes (1936, Ch. 2) vehemently contested. Cf. Clarke (1988:179) for Pigou’s evidence to the Macmillan committee. Keynes’ policy prescriptions drawn from the Treatise on Money were also based on the argu ment of money wage rigidity due to meta-economic (social or political) forces, cf. Clarke (1988:166f.).

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31 Aslanbeigui (1992:424) attributes this term to Dillard (1988). 32 This argument resembles that of ‘secondary deflation’ as a justification for ‘pump priming’, cf. Röpke (1933) and Robertson (1931:61).

REFERENCES Aslanbeigui, N. (1992) ‘Pigou’s Inconsistencies or Keynes’ Misconceptions’, History of Political Economy 24:413–33. Barber, W.J.(1993) ‘Keynes vs. Pigou on the Economics of War: Isolating the Properties of Competing Analytic Perspectives’, in R.F.Hébert (ed.) Perspectives on the History of Economic Thought, vol. 9, Aldershot: Elgar: 155–67. Brady, M.E. (1994) ‘A Note on the Keynes-Pigou Controversy’, History of Political Economy 26:697–705. Clarke, P. (1988) The Keynesian Revolution in the Making 1924–1936, Oxford: Clarendon. Collard, D. (1981) ‘A.C.Pigou, 1877–1959’, in D.P.O’Brien and J.R.Presley (eds) Pioneers of Modern Economics in Britain, London: Macmillan: 105–39. ——(1996) ‘Pigou and Modern Business Cycle Theory’, Economic Journal 106:912–24. Cottrell, A. (1994a) ‘Keynes’s Appendix to Chapter 19. A Reader’s Guide’, History of Political Economy 26:681–95. ——(1994b) ‘Brady on Pigou and Keynes: Comment’, History of Political Economy 26: 707–11. Dillard, D. (1988) ‘The Barter Illusion in Classical and Neoclassical Economics’, Eastern Economic Journal 14: 299–318. Dimand, R.W. (1988) The Origins of the Keynesian Revolution. The Development of Keynes’ Theory of Employment and Output, Aldershot: Elgar. Garside, W.R. (1990) British Unemployment, 1919–1939. A Study in Public Policy, Cambridge: Cambridge University Press. Hutchison, T.W. (1978) On Revolutions and Progress in Economic Knowledge, Cambridge: Cambridge University Press. Keynes, J.M. (1930a) A Treatise on Money. The Pure Theory of Money, vol. 5 in D.E.Moggridge (ed.) (1971) The Collected Writings of John Maynard Keynes, London: Macmillan. ——(1930b) A Treatise on Money. The Applied Theory of Money, vol. 6 in D.E.Moggridge (ed.) (1971) The Collected Writings of John Maynard Keynes, London: Macmillan. ——(1936) The General Theory of Employment, Interest and Money, vol. 7 in D.E.Moggridge (ed.) (1973) The Collected Writings of John Maynard Keynes, London: Macmillan. Laidler, D. (1991) The Gol.den Age of the Quantity Theory, Princeton, NJ: Princeton University Press. Patinkin, D. (1965) Money, Interest and Prices. An Integration of Monetary and Value Theory, second edition, New York: Harper and Row. ——(1976) Keynes’ Monetary Theory, Durham: Duke University Press. ——(1982) Anticipations of the General Theory? And Other Essays on Keynes, Chicago: University of Chicago Press. Pigou, A.C. (1929) Industrial Fluctuations, London: Macmillan. ——(1933) The Theory of Unemployment, London (reprint London: Frank Cass, 1968). ——(1937) ‘Real and Money Wage Rates in Relation to Unemployment’, Economic Journal 47:405–22. ——(1943) ‘The Classical Stationary State’, Economic Journal 53:343–51. Robbins, L. (1934) The Great Depression, London: Macmillan. Robertson, D.H. (1931) The 1931 Crisis, reprinted in Robertson (1940), 60–4. ——(1934) ‘Industrial Fluctuation and the Natural Rate of Interest’, Economic Journal 44, reprinted in Robertson (1940), 83–91. ——(1940) Essays in Monetary Theory, London and New York: Staples Press. Röpke, W. (1933) ‘Trends in German Business Cycle Policy’, Economic Journal 43: 427–41. Selgin, G. (1995) ‘The “Productivity Norm” versus Zero Inflation in the History of Economic Thought’, History of Political Economy 27:705–35.

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Solow, R.M. (1980) ‘On Theories of Unemployment’, American Economic Review 70: 1–11.

4 CO-ORDINATION FAILURE Economic theory in the 1930s Brian J.Loasby

The title of this chapter has a double meaning. It refers not only to the theories by which economists in the 1930s attempted to explain co-ordination failure within economic systems, but also to the failure of these economists to co-ordinate their various attempts at explanation. Both meanings can be illuminated by focusing on a crucial episode in the academic career of George Shackle. In January 1935, Shackle arrived at the London School of Economics (LSE) to work as a research student with Hayek. As he has explained (Shackle 1990: 193–4), he was enthused during that year by accounts of Keynes’ forthcoming book, and wished to change the direction of his research accordingly. This cannot have been welcome to Hayek, because of his theoretical disagreements with Keynes, but Hayek, in Shackle’s words, ‘proved himself the most magnanimous man I ever met’. Now although Keynes is the leading figure in Shackle’s (1967) account of the theoretical development of The Years of High Theory the hero of that book is Gunnar Myrdal. The reason is clear: Myrdal’s analysis is based on the distinction between ex ante and ex post views, in which a sequence of decisions is triggered by a comparison of expectations and outcomes, and each decision rests on anticipations of a future which cannot be known, and must therefore be imagined. But it is not only the demand for investment which is an expectational (and underdetermined) variable; so too is the demand for consumption, which, Mydral states, can change without any change in ‘so-called objective circumstances’ (Shackle 1967:125). In Keynes’ General Theory, by contrast, long-term expectations, although without any secure basis, are for that very reason not systematically adjusted in response to outcomes, or any other source of information, and short-term expectations are either assumed to be always realised or, in some passages, to converge on realisations during a short-period adjustment process. Keynes wished to explain the persistence of unemployment, and sought an appropriate instrument not in sequence analysis, which might have evolved out of the Treatise on Money, but in a model of equilibrium which was determined by the level of effective demand (Kregel 1976: 211–15). Movement between equilibria was not analysed; in Shackle’s (1967:182) vivid metaphor, Keynes offers a series of tableaux, and only when the curtains are closed do ‘we hear the clatter of violent sceneshifting’. In 1935 none of Myrdal’s work on macroeconomic themes had been published in English, nor had that of his Swedish colleagues. But Shackle knew of them from Brinley Thomas, who had been sent to Sweden for a year to find out what was going on, and had given five lectures—the most that Robbins would permit—on Swedish theories immediately after Shackle’s arrival at LSE. Thomas recalled that Shackle sat immediately under the lectern; and Shackle thought Thomas the most wonderful lecturer that he had ever heard. It was the prospect of applying Swedish analysis to Keynes’ General Theory that prompted Shackle’s change of direction. Now Hayek already knew of Myrdal’s work through an article published in a German-language collection which he had edited (Hayek 1933a), and had responded to it in a lecture given in Copenhagen (Hayek 1933c), which will be considered later. They shared an intellectual tradition which was scarcely

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represented in Britain outside the LSE; so one might ask why Shackle did not attempt to work on Swedish analysis in an Hayekian context. Shackle’s own explanation is that he had been unable to make progress within that context, and therefore wished to combine Swedish ideas with those of Keynes. But that explanation invites two further questions: why did neither Keynes nor the Swedes show any interest in such a combination and why did Hayek himself not welcome this Swedish analysis? These questions turn out to be well worth investigating. THE WICKSELL CONNECTION The title of this section is borrowed from Leijonhufvud’s (1981) analysis of confusions in macroeconomics; being differently focused, it may be regarded as a supplement to his discussion. Hayek and Myrdal had both started their analyses of co-ordination problems with Wicksell’s work. Wicksell had begun by seeking to combine Walras’ theory of general equilibrium, in which money is not explicitly modelled, with BohmBawerk’s theory of interest, which depended on the productivity of time and the superiority of roundabout methods of production. Wicksell then sought to establish the conditions of monetary equilibrium both for a cash economy and for a pure credit economy, and to show, using price-theoretic reasoning, how a monetary disruption in either economy could initiate a cumulative movement away from that equilibrium. An increase of cash, because of governmental mismanagement, or of credit, as a consequence of inappropriate incentives in the banking sector, would cause an increase in monetary demand which naturally led to higher prices; these higher prices provided higher money incomes for sellers, which led to a further increase in demand, and this cumulative process continued until a price level was reached at which a new monetary equilibrium would be established. Hayek’s (1928) pioneering exposition of intertemporal general equilibrium was linked with a concern for the possible implications of money for such an equilibrium, and in a series of lectures at the London School of Economics in February 1931 he presented the results of his investigation into these implications (Hayek 1931). He observed that there were two definitions of monetary equilibrium in use: one required voluntary savings to be equal to voluntary investment, the other required stability of the price level. Now anyone who believes that capital is productive, and especially anyone who accepts BohmBawerk’s emphasis on the central role of increasingly roundabout production in economic development, must see that these two definitions are consistent only when savings and investment are zero. Positive investment drives down costs, and in an intertemporal competitive equilibrium with positive investment prices are therefore lower at later dates; when investment is greater than zero, price stability thus requires, not constancy but some expansion of monetary demand. (This difficulty, of course, does not appear in a model of a stationary economy.) Hayek chose to define monetary stability in terms of the equality of voluntary savings and voluntary investment, with its concomitant of falling price levels in a regime of neutral money. This he judged to be consistent both with consumer sovereignty and with the predominant experience of the nineteenth century, and also perhaps with the spirit of Walrasian intertemporal general equilibrium. (That the benefits of economic progress were best distributed through lower prices was the predominant view among those economists who expressed an opinion.) But in Prices and Production what Hayek offered was a modification of Wicksell’s cumulative process which transformed the outcome. Hayek began, like Wicksell, with a monetary expansion which was motivated by inappropriate incentives, impinging on a perfectly co-ordinated economy; but in Hayek’s theory this expansion affected not just the level of demand but its composition, and it was this differential effect which caused the trouble. The fall in interest rates which resulted from excess credit changed a crucial price in the economy—the price of time; and this change in relative prices led, not just to investment which was greater than voluntary savings, but to

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investment in more roundabout methods of production which were appropriate to this reduced price of time but incompatible with the restoration of monetary equilibrium unless voluntary saving rose to match. However, since the reduction in interest rates reflected, not a change in consumer preferences from present to future consumption, but nothing more than excessive credit, there was no reason to expect voluntary saving to increase. On the contrary, the diversion of resources to investment in order to install the new capital, which had apparently become profitable, entailed a reduction in the current supply of consumer goods that was not matched by a reduction in current consumer demand. This excess demand for consumer goods therefore produced a rise in their prices, and this allowed the suppliers of such goods to start bidding resources back again from the creation of new roundabout methods of production, thus invalidating the assumptions on which the additional investment had been based. The new intertemporal equilibrium to which the economy appeared to be moving was an illusion, which could be sustained only by a perpetual growth of credit. The change in the composition of output would not permit a new Wicksellian equilibrium at a higher price level; that required the restoration of the previous composition of output, since the fundamental data of the economy had not changed. However, the more roundabout methods which had falsely seemed profitable entailed the creation of complex structures of complementary and sometimes highly specific capital goods; these structures were therefore not easily adaptable to less roundabout methods. Thus the removal of the monetary distortion, and of the false signals which it had generated, did not lead smoothly to the re-establishment of the old equilibrium, but to a recession until the new and inappropriate pattern of capital structures could be replaced. Monetary disorder had real effects, and not the least of these was the reduction of effective productive capacity through misdirected investment. The similarities and differences with Keynes (1936) are both worth noting: the similarities suggest the possibility of co-ordinating the theories, but the differences present formidable obstacles to such an enterprise. For both authors, co-ordination failure results from complementarities, but they are opposite complementarities. In Keynes’ analysis investment and consumption are complements: given the propensity to consume, then a change in investment is both necessary and sufficient to move consumption in the same direction. It is this complementarity which underpins Keynes’ principle of effective demand. But Hayek, in accordance with the mainstream tradition of economics as the study of resource allocation, treats investment and consumption as substitutes; when one rises, the other necessarily falls. What causes the persistent trouble in his model is the complementarity within the capital structures which impede the reallocation of misdirected resources. Within the theoretical framework of the General Theory, however, the composition of either investment or consumption doesn’t matter: no doubt new factories are better than holes in the ground, but they have the same effect, pound for pound, on levels of employment and consumption. Misdirected investment does not depress income, but merely changes its distribution, in ways which Keynes (1936:321) finds quite acceptable. Keynes assumes complementarity between the categories of investment and consumption, and substitution within each category; Hayek does the opposite. Thus Keynes’ scheme has no room for Hayek’s conclusions: investment facilitates consumption instead of frustrating it, and even if investment were excessive, it would always be put to some use. Keynes’ assumptions are necessary for an analysis in terms of the now conventional macroeconomic aggregates, but Hayek, like other Austrian economists, never accepted such aggregates. His theory of monetary disorder is pure microeconomics: resources are misallocated because of an externally-generated market failure. On policy, Keynes was, as usual, pragmatic; in his Times articles of 1937, when British unemployment was still 10 per cent, he observed that ‘the economic structure is unfortunately rigid…We are in more need today of a rightly distributed demand than of a greater aggregate demand’ (Keynes 1982:385). That this structural rigidity fitted Hayek’s theory

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much better than his own appears not to have been noticed. However, Hayek was not ready to admit—still less to emphasise, like the maverick Austrian, Schumpeter—that the falsified expectations embodied in these structures need not have a monetary origin. Neither Keynes nor Hayek apparently considered the possibility of invoking the incompatibility of closely complementary specific capitals—human and organisational as well as physical—with current patterns of demand as a source, via the multiplier, of involuntary unemployment. Both Keynes’ and Hayek’s models are driven by fallible expectations, and, specifically, by fallible expectations about the profitability of investment. For Keynes, this fallibility is ineradicable, because the future cannot be known; but for Hayek it is a strictly limited kind of fallibility, which is induced by monetary disorder, and (at this stage in the evolution of his thinking) by monetary disorder alone: in all other respects the price system works perfectly. Indeed, without monetary mismanagement we would have something rather like a rational expectations equilibrium, as can be seen in Hayek’s (1937) ‘Economics and Knowledge’. In the General Theory, however, ‘the behavior of the banking system…is out of the picture altogether’ (Leijonhufvud 1981: 163); its role as a cause of trouble is filled by the fallibility of expectations. Because expectations are always fallible, there is no possibility of a rational expectations equilibrium: Keynes therefore does not need a theory of the trade cycle for his theory of unemployment, but can give primacy to the principle of effective demand. The state of long-term expectations at each point of time determines the level of investment, and therefore income and employment, at that time. The question whether those long-run expectations eventually turn out to have been correct is irrelevant, for by then it is the new state of expectations over the next long-period which matters, and that is connected only in the loosest fashion with the fate of previous expectations, as Shackle reminds us with his metaphors of tableaux and kaleidoscopes. The comparison of outcomes with expectations has no leverage in Keynes’ model. Hayek, however, like Wicksell, is trying to analyse a process; but, unlike Wicksell’s cumulative sequence, it is a process which is self-reversing, and the falsification of expectations is what triggers the reversal. The comparison between the ex ante and the ex post view is therefore crucial for Hayek’s theory of co-ordination failure. Underlying these differences was a fundamental divergence in vision and method. In the 1930s Hayek accepted intertemporal general equilibrium both as the only proper framework for economic theory and as an acceptable representation of actual economies; and he believed that actual economies could be relied on to converge rapidly on the appropriate equilibrium if supplied with the correct prices. Therefore, as he declared in his Copenhagen lecture, ‘Every explanation of economic crises must include the assumption that entrepreneurs have committed errors’ (Hayek 1933c:141). In order to generate a crisis these must be systematic errors, and since the real economy worked so well, money was the prime candidate as a source of systematic error. De Vroey’s (this volume) argument that Keynes made a methodological mistake by introducing involuntary unemployment as a postulate, and should have tried to derive it within the general equilibrium research programme, is an updated equivalent of Hayek’s view. Both versions of this methodological imperative assume that there is only one correct research programme. That assumption Keynes clearly denied, for example, in his comparison between ‘classical theorists’ and ‘Euclidean geometers in a non-Euclidean world’ (Keynes 1936:16). Classical analysis deals satisfactorily with the allocation of the resources which are employed, but not with the level of employment (ibid.: 378–9). Keynes’ alternative may be traced back to Marshall’s well-known lack of enthusiasm for general equilibrium models as a practical method of analysis. The attempt to close such models was almost certain to lead either to the definition of a stationary state or the assumption that future knowledge could be anticipated, and neither expedient was obviously relevant to a progressive economy. Keynes’ (1921) own work on probability, the shock of war in 1914, and the experience of the interwar years, built on this

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Marshallian foundation the conviction that to assume even the possibility of correct expectations about investment was to found analysis on a false premise. When this falsity is incorporated in a theory of the natural rate of interest, then ‘the wild duck has dived down to the bottom…and bitten fast hold of the weed and tangle and all the rubbish’ (Keynes 1936:183). If there is no credible basis for intertemporal general equilibrium, then it does not seem unreasonable to postulate involuntary unemployment, and to define the economist’s task as the development of a theoretical apparatus that will explain the level of involuntary unemployment at any particular time. This might be regarded as a partial equilibrium analysis of a quasi-Marshallian kind, since the neglected relationships are not inter-industry but intertemporal; and it is not surprising that such neglect was denounced by Hayek (1941: 409) as ‘a serious and dangerous intellectual error’. That must surely have also been Sraffa’s view, for a believer in long-run equilibrium based on costs of production could not possibly approve of Keynes’ method (Lachmann 1986b); but, no doubt wisely, Sraffa made no attempt to destroy Keynes’ theory as he had attempted to destroy Hayek’s (Sraffa 1932). If we now compare Hayek’s theory with that of the Swedes, as that was expounded by Ohlin (1937a, 1937b), we find that both were concerned with the consequences of monetary disorder; both attempted to analyse sequences; both sought to explain sequences by a series of plans which are based on fallible expectations, and by the revision of those expectations consequent upon the comparison of outcome with forecast. The Swedes, however, were much more radical subjectivists. The future was uncertain, therefore, even in the absence of monetary disorder investment was not based on the known physical productivity of available technologies, as Hayek followed BohmBawerk and Wicksell in believing, but on the prospective investor’s subjective assessment of possibilities (Ohlin 1937b:223); and consumption decisions were based on individual expectations of future income, future prices, and future needs, none of which could have any secure anchor in reality. No wonder Shackle was enthusiastic. In extending the realm of fallible expectations from investment decisions to consumption, the Swedes were significantly more radical than Keynes. Thus there was no justification for assuming a constant multiplier (Ohlin, 1937b: 239), as Robertson also argued; instead we have a succession of changes as people revise their expectations in the light of experience, and their plans as a consequence of their changing expectations—but without access to any correct forecasting model or optimal choice algorithm, for there are none. Thus recorded outcomes are not a reliable indicator of past intentions but a jumble of realised and frustrated plans. By contrast, Keynes relied on what Ohlin regarded as the ‘old-fashioned’ method of equilibrium theorising, with no reason, from the Swedish perspective, for believing that his equilibria were stable (ibid.: 235–8). Whether the Swedes realised how far they had departed from their orthodox origins is a question not examined here; but it does seem likely that these departures, together with the difficulties, which Keynes noted, of identifying a general-purpose length of period (D.H.Robertson’s sustained attempt to develop period analysis encountered similar difficulties) were major reasons for the decline of a onceexciting programme. Keynes’ distinctive use of equilibrium was intimately linked with his emphasis on the principle of effective demand: it was this principle that produced the equilibrium, and the characteristics of that equilibrium that demonstrated the principle’s power. To maintain this linkage, it was essential both that longrun expectations could never be derived from a ‘correct model’ of the economy, and that they could be assumed to remain constant within the analytical structure. As Lachmann (1986a:98) has pointed out, Keynes’ treatment of expectations allows just enough subjectivity as will support the principle of effective demand, and no element of subjectivity which might threaten it. As has since been demonstrated, it is a treatment that leaves his analysis vulnerable to a relentless application of rational choice theory; but so is any analysis in which unemployment is involuntary.

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We should also note that Hayek, although explaining why substantial amounts of capital equipment might be left unused, gave no explicit attention to unemployed people, whereas the Swedes were concerned with the effects of the sequences which they were analysing on levels of unemployment (even though their models did not always adequately reflect this) and were advising their government on unemployment policy. There was thus a sharp difference over policy, which was an obvious impediment to an alliance with Keynes, and an obvious incentive for Shackle to develop a Swedish version of Keynes’ theory rather than Hayek’s. Much later Shackle (1966:55) observed that there was really no conflict between the two theories, because Keynes was discussing unemployment and Hayek inflation. Shackle’s (1949) own theory, not surprisingly, turned out to be rather Austrian in its subjectivism, which was too comprehensive to be entirely acceptable to some post-Keynesians and many Austrians, but was highly compatible with Lachmann’s vision of continuous markets prone to serious error—a vision which may yet provide a basis for co-ordinating Austrian and Keynesian ideas. The policy difference between Hayek and the Swedes was symptomatic of a wider political disagreement. Hayek had lived in Vienna, and had seen the consequences of a socialist administration; the Swedish economists were socialists, and as Brinley Thomas conjectured in a conversation, might not have been acceptable to Hayek as intellectual allies. THE MISSING LINK However, although it is reasonable to believe that Hayek would not wish to align himself with a theoretical apparatus that was associated with policies with which he profoundly disagreed, there was also a methodological objection. Hayek’s work, it has been suggested by Hutchison (1981) and Caldwell (1988), falls into two distinct research programmes, which rest on contradictory assumptions: the perfect (if probabilistic) information basis of general equilibrium, and the limited knowledge basis of spontaneous order. Though Hayek’s later emphasis on the subjectivity as well as the diversity of knowledge, and on the importance of institutions in providing a framework of order, offers a clear contrast to his early views on the power of prices to guide everyone rapidly to equilibrium if monetary mismanagement is avoided, the transition started earlier and took longer than Hutchison and Caldwell suggest (Foss 1995). By the time Shackle changed direction in 1935 Hayek had already begun his move from the first programme to the second, but he had not moved far enough to forego the anchor of intertemporal equilibrium based on justified expectations; it is therefore likely that the Swedish apparatus was not methodologically congenial. Hicks (1982:6) reports that he was asked by Robbins to ‘turn the Hayek model [of Prices and Production] into mathematics’. He started with Wicksell’s and Pareto’s Walrasian models of a perfectly coordinated economy—what Leijonhufvud (1981:136) helpfully calls a full information economy; but in order to proceed from there to a Hayekian model of monetary disequilibrium it seemed that an intermediate model was necessary: that of a perfectly co-ordinated monetary economy. No such model had been produced. Since Hayek had argued that in order to explain co-ordination failure we must first explain how co-ordination can be successful, we might think that he would have agreed with Hicks; but what we have surely learned by now, after the failure of so many attempts, is that it is impossible to produce a monetary version of Walras’ model, for the rather fundamental reason that there is no role for money in such a model. It is precisely because co-ordination is problematic, because full information is not available, that money comes into use. If equilibrium is defined as a situation in which everyone has already chosen the best available option set —in Hayek’s language, everyone has an optimal set of plans, or in more widely accepted terms an optimal set of contracts— why should anyone require money? One can always invent rules such as a ‘money in advance’ constraint, but these rules, being neither natural givens nor the products of rational choice,

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represent crucial departures from the principles of axiomatic theorising—for those people who still believe in what was once thought to be the hard core of scientific economics. As Keynes recognised, we hold money only because we know that our plans and contracts are not complete, either because we have deliberately refrained from completing them, or because we are afraid—with good cause—that despite our best efforts there are contingencies which we have not identified. It is because the knowledge, and not merely the markets, required to support an intertemporal general equilibrium cannot be supplied that money gains its importance as ‘a link between the present and the future’ (Keynes 1936:293). Hicks (1982:7) had already realised by 1933 that ‘one must introduce uncertainty, before one can introduce money’ and (ibid.: 41) that the form taken by economic fluctuations ‘is to be explained largely by the close connection between imperfect foresight and the use of a Means of Payment’. But when considering anyone within the Austrian tradition—and that certainly includes Hayek—what is significant is not Keynes’ recognition of the link between money and uncertainty, but that of Menger (1871), who, as Hicks (1982: 287–8) later argued, had a broader conception than Keynes of the ways in which people tried to make provision against uncertainty. Now Hayek’s theory of the trade cycle did not allow for uncertainty, though it did depend on a very specific source of error. On the contrary, it was, as Witt (1997) has observed, an exercise in applied price theory in the Wicksellian tradition, and accepted all the conventions of that theory: Markets respond instantaneously and perfectly flexibly to changing demand and supply conditions… and the system of relative prices has an undisputed capacity to bring about adjustments on the part of the agents. It does not need to be emphasised that such a view presupposes complete, frictionless markets, perfect price information on the part of all agents, and prices that contain all relevant information. (Witt 1997:47; see also Foss 1995:350) This was the basis of Hayek’s model of a perfectly co-ordinated economy, and in the opening sentence of his Copenhagen lecture it was the unquestioned basis for good theory. ‘The most characteristic feature of the work of our generation of economists is probably the general endeavour to apply the methods and results of the pure theory of equilibrium to the elucidation of more complicated “dynamic” phenomena’ (Hayek: 1933c). This is long way from Menger’s conception of economics. To produce a model of the trade cycle from a theory of perfect co-ordination the obvious—perhaps the only —expedient is to introduce an endogenous source of false information. This Hayek attempts to do through the introduction of money, together with a market for money. However, the reason why this does the trick is that the rate of interest, which in the model of perfect co-ordination is determined in the market for real capital, and is therefore, like all other prices, a true index of the real forces in the economy, is now determined in this new market— which necessarily lies outside the real economy, since the real economy has no use for money. Despite Hayek’s intentions, the source of false information lies outside the model with which he is trying to work. That the rate of interest may fail to balance savings and investment because it is determined in the wrong market is, of course, a central feature in Keynes’ General Theory, and had already been a theme of Robertson’s Banking Polity and the Price Level (1926); but neither Keynes nor Robertson were committed to the general equilibrium programme within which Hayek was still working. Instead they were heirs to, and developers of, a long British tradition of concern for the effects, both good and ill, of money in the real economy, summarised by Shackle (1967:137) in the proposition: ‘Money enormously enlarges the hurtful power of uncertainty at the same time as it enormously facilitates the beneficent power of specialisation.’ Since the Walrasian general equilibrium model on which Hayek based his perfectly co-ordinated economy allowed no function for money, as Hicks discovered, there is no telling what price might emerge from the

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market for money. Like the appendix in a modern human body, money in a general equilibrium model can only be a source of trouble. Why should all those perfectly informed agents put up with it? As Witt (1997:48) has pointed out, it is not surprising that Lucas (1987) should be so impressed with Hayek’s construction: in basing his own theories on perfectly functioning markets which are subjected to a systematic distortion that is—often for no very good reason—not recognised by the market participants, it is easy to understand that Lucas may believe himself to be a neo-Austrian (vintage 1931). Not only does the new classical focus on economic agents’ problems of distinguishing changes in relative prices from changes in the price level appear to carry ‘a remarkably Austrian flavour’ (Hoover 1988: 235); the claim that new classical models incorporate cyclical theory into general equilibrium theory is a claim to have resolved what Hayek (1933b: 33) called ‘the crucial problem of trade cycle theory’. But Austrians, at least, have moved on; and some of them, at least (O’Driscoll and Rizzo 1985; Lachmann 1986a), do not believe that general equilibrium theory provides an appropriate framework (though it might provide an appropriate foil) for theories of co-ordination failure. As Garretsen (1994:99) points out, ‘the rational expectations hypothesis is not solely based on individual behaviour …but also on the fact that the economy is always in a state of expectational equilibrium’; thus, as Hayek (1937:36–7) observed of the assumption of perfect foresight, it is not a condition of equilibrium but part of the definition. Hayek’s increasing concern with the subjectivity as well as the dispersion of knowledge led to an emphasis on processes and institutions which is quite outside the scope of new classical macroeconomics. Nevertheless, one can wish that Hayek had moved faster. In his Copenhagen lecture he raised ‘the question of the significance of the concept of equilibrium and its relevance to the explanation of a process which takes place in time’ (Hayek 1933c:138), and even hinted (ibid.: 155) that the process of forming expectations might be problematic; but if this was a response to Myrdal’s criticism of Prices and Production (Foss 1995:354) it did not lead him very far in the direction of Swedish analysis. One begins to understand why Shackle felt he had to switch to a Keynesian basis. What Hayek had failed to learn from Menger by 1931, and had only begun to learn by 1937, goes beyond the importance of money as a means of coping with uncertainty, thereby allowing money a role, and providing a basis for mistakes as well as inappropriate incentives, to much broader questions of the limitations of knowledge and their implications for the working of economic systems. Menger (1871) explicitly rejected the ideas of perfect knowledge and of perfect markets; he declared that what is a good depends on our knowledge of how it might be used, and insisted that transactions are costly, pointing to the obvious difficulty in selling anything we have just purchased back to the original vendor for as much as we have paid for it. The emergence of money is explained by Menger as a means of reducing what we now call transaction costs; but there are no transaction costs in perfect competition—by definition. It is from its convenience in reducing transaction costs and increasing transaction capabilities that money, in Menger’s analysis, derives its value as a form of reserve against uncertainty; and the same is true of other institutions which reduce transaction costs, such as firms, and continuing relationships between firms. In retrospect—though perhaps only in retrospect—it is very odd that in Hayek’s (1931) theory a model of co-ordination failure that depends on complex structures of complementary assets which are designed to permit roundabout methods of production is combined with the agent anonymity of perfectly competitive theory. Closely complementary activities are not usually co-ordinated by anonymous agents, even when these activities are distributed among several organisations (Richardson 1972). It is only in retrospect that we can see how transaction costs and the switching costs that are necessarily entailed in the commitment to any kind of transaction technology increase the penalties for decisions that turn out to be misguided, and lengthen the time needed to make whatever partial recovery is possible from those errors. But what is clear is that the incorporation of these further elements of complementarity, with their linked potential for both

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benefits and dangers, could increase the attraction of a model of fallible co-ordination which rests on the combination of complementarity and fallible expectations in a path-dependent model. From this perspective, Hayek’s (1937) famous paper on ‘Economics and Knowledge’ must be seen as a missed opportunity. By insisting, first, on the dispersion of knowledge, and second, on the argument that perfect foresight (of contingencies, one should nowadays add) is a defining characteristic of equilibrium, and can therefore not help in explaining how equilibrium might be brought about, he opens the way to a theory of the economic process in which agents construct plans on the basis of fallible expectations and revise those expectations ex post—a theory with the same epistemic, but not necessarily political, foundations as that of Myrdal. But despite including what is probably the first reference by an economist writing in English to Popper’s falsificationist theory of science, in which science is taken as the most clearly-defined example of the universal human search for knowledge, Hayek (1937: 33) fails to construe all plans—or even expectations—as conjectures. Such an interpretation would have led him to the natural implications first, that most plans and expectations are at least partially falsified, second, that the ways in which people respond to falsification are crucial elements in under-standing whether particular failures are likely to lead towards or away from better co-ordination, and third, that a perfect foresight equilibrium is not a credible condition for a real economy, but at best a clue to what is missing from any theory which relies on it. Had he done so, he could hardly have failed to make the connection with Swedish theories, and their incorporation of individual interpretations of an uncertain world. At least so one might think; but human beings sometimes fail to make connections that in retrospect seem obvious. Therefore, despite Hayek’s (1937:45) assertion that ‘hypotheses or assumptions that people do learn from experience, and about how they acquire knowledge…constitute the empirical content of our propositions about what happens in the real world’—an assertion which might be mistaken for a paraphrase of Popper— he turns away from the questions of how, and in what circumstances, people learn from their experiences, towards the problem of ‘how much knowledge and what sort of knowledge the different individuals must possess in order that we may be able to speak of equilibrium’ (ibid.: 48)—which could certainly not be a paraphrase of Popper, who is concerned not with any equilibrium of knowledge but of its never-ending growth. Although Hayek is fully justified in pointing out that the conventional definition of the economic problem in terms of efficient allocation within an economic system which is based on the division of labour presupposes the solution of a deeper problem of the ‘Division of Knowledge’ (ibid.: 49), he nevertheless poses this deeper problem in terms of equilibrium, not of the movement towards it—still less of a never-ending process, as Popper and (implicitly) the Swedish economists had done. He is still attracted to an Austrian variant of general equilibrium. By the time that he wrote his second famous article on knowledge (Hayek 1945), and after his participation in the planning debate, he had moved to the new programme. But he never provided a theory of co-ordination failure which drew on the characteristics of that programme, a theory of spontaneous disorder to be constructed from the same materials as the theory of spontaneous order, such as Lachmann (1986a) has suggested. Monetary disorder can certainly disrupt a Walrasian equilibrium; but so, in a theoretical sense, as Hellwig (1993:232) has recognised, can any attempt to introduce money into it; for the presence of money demonstrates that the conditions for Walrasian equilibrium—indeed for Walrasian analysis—are not satisfied. As Hayek showed, any change in the quantity of money is likely to change relative prices. Hayek was right to argue that we need to understand how co-ordination can be achieved before we can explain how it can fail. He tried to do this in Prices and Production, but on the basis of an inadequate conception of a monetary economy—which is unfortunately still too common. Though he later came to emphasise the role of institutions (including money) in the co-ordination of knowledge which is dispersed, incomplete and

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subjectively held, he never attempted an institutional explanation of co-ordination failure in a market economy. That the institutions of planning would fail he did of course argue. So we are not guided towards the study of the co-ordination of knowledge as a never-ending process, in which no general hypothesis can ever be proved correct—the Popperian perspective which both fits comfortably with the Austrian tradition and undermines the theory of optimal planning against which Hayek was in part reacting in his 1937 article. Had Hayek guided us towards the co-ordination process, then we might in due course have recognised, as Marshall (1920:138) had done, that capital embodies knowledge, that complementary structures of capital—including human capital—embody complementary structures of knowledge, and that co-ordination failures can arise from erroneous hypotheses about what are regarded in conventional economics (but not, significantly, by Menger) as the data of the system— goods, resources, and technologies, as well as—and perhaps more often than —from erroneous expectations resulting from monetary disorder. It is in my view a very great pity that Hayek, having erected the right signpost, then pointed it firmly in the wrong direction. CONCLUSION Economists failed to co-ordinate their theories of co-ordination failure in the 1930s because these theories were not partitions of potentially common knowl edge but rival structures of complementary conjectures, each based upon a particular set of categories which was imposed—with some difficulty—on a continuum of economic activities. The theories are incommensurable, in the straightforward sense of not being reducible to a common set of dimensions. But we have shown that what is incommensurable need not be undiscussable, and even that such discussions can improve understanding. The double meaning of coordination failure in this chapter is not coincidental, but encompasses two aspects of a common problem of imperfect knowledge. Economic agents, like economists, base their decisions, consciously or unconsciously, on their own complementary conjectures developed within their particular categories which they impose on phenomena; and the co-ordination of these differently-based decisions is necessarily problematic. Co-ordination failure is a matter of degree; but it is entirely reasonable to pay special attention to widespread failure, and to look for systematic causes of such failure—both in the economy and in economic theory. The history of macroeconomics suggests very strongly that systematic causes of failure in the economy have something to do with imperfect knowledge, and a systematic cause of failure in economic theory is a refusal to accept imperfect knowledge as a basis for theorising. Despite hints to be found in the work of Hayek, Keynes and the Swedes, and rather more than hints to be found in the work of Lachmann, Leijonhufvud and Shackle, we have no macroeconomic theory which is firmly based on incompatibilities between the theories of economic agents. What might be possible is suggested by the most important trade cycle theory of the 1930s which has not been discussed in this paper. The primary cause of depression in Schumpeter’s model (1934) is the incompatibility between the innovators’ new combinations and the routines of established businesses; when these routines no longer work, these people, businessmen and workers alike, do not know what to do; so they do nothing. Is that not an appropriate description of the situation of those whom some economists would call involuntarily unemployed? NOTE This paper has benefited from comments on an earlier version at the European Conference on the History of Economics at Rotterdam and the reports of referees.

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REFERENCES Caldwell, B.J. (1988) ‘Hayek’s Transformation’, History of Political Economy 20:513–41. De Vroey, M. (1998) ‘Keynes, Keynesian Programmes and Unemployment’ (this volume). Foss, N.J. (1995) ‘More on Hayek’s Transformation’, History of Political Economy 27: 345–64. Garretsen, H. (1994) ‘The Relevance of Hayek for Mainstream Economics’, in J.Birner and R.Van Zijp (eds) Hayek, Co-ordination and Evolution: His Legacy in Philosophy, Politics, Economics and the History of Ideas, London and New York: Routledge. Hayek, F.A. (1928) ‘Intertemporal Price Equilibrium and Movements in the Value of Money’, in Money, Capital and Fluctuations: Early Essays, London: Routledge and Kegan Paul, 1984. ——(1931) Prices and Production, London: Routledge. ——(ed.) (1933a) Beiträge zur Geldtheorie, Vienna: Julius Springer. ——(1933b) Monetary Theory and the Trade Cycle, translated by N.Kaldor and H.M.Croome, London: Jonathan Cape. ——(1933c) ‘Price Expectations, Monetary Disturbances and Malinvestments’, in Profit, Interest and Investment, London: Routledge, 1939, 135–56. ——(1937) ‘Economics and Knowledge’, Economica, N.S. 4:33–56. ——(1941) The Pure Theory of Capital, Chicago: University of Chicago Press. ——(1945) ‘The Use of Knowledge in Society’, American Economic Review 35:519–30. Hellwig, M. (1993) ‘The Challenge of Monetary Theory’, European Economic Review 37: 215–42. Hicks, J.R. (1982) Collected Essays on Economic Theory, vol. II: Money, Interest and Wages, Oxford: Basil Blackwell. Hoover, K.D. (1988) The New Classical Macroeconomics: A Sceptical Inquiry, Oxford: Basil Blackwell. Hutchison, T.W. (1981) The Politics and Philosophy of Economics: Marxians, Keynesians and Austrians, Oxford: Oxford University Press. Keynes, J.M. (1921) Treatise on Probability, London: Macmillan. ——(1936) The General Theory of Employment, Interest and Money, London: Macmillan. ——(1982) Collected Writings, vol. 21, London: Macmillan. Kregel, J.A. (1976) ‘Economic Methodology in the Face of Uncertainty’, Economic Journal 86:209–25. Lachmann, L.M. (1986a) The Market as an Economic Process, Oxford: Basil Blackwell. ——(1986b) ‘Austrian Economics Under Fire: The Hayek—Sraffa Duel in Retrospect’, in W.Grassl and B.Smith (eds) Austrian Economics: Historical and Philosophical Background, Beckenham: Croom Helm. Leijonhufvud, A. (1981) Information and Co-ordination, New York and Oxford: Oxford University Press. Lucas, R.E. (1987) Models of Business Cycles, New York: Basil Blackwell. Marshall, A. (1920) Principles of Economics, eighth edition, London: Macmillan. Menger, C. (1871) Principles of Economics, translated by J.Dingwall and B.F.Hoselitz, Glencoe, Ill.: Free Press, 1950. O’Driscoll, G.P., Jr and M.J.Rizzo (1985) The Economics of Time and Ignorance, Oxford: Basil Blackwell. Ohlin, B. (1937a and 1937b) ‘Some Notes on the Stockholm Theory of Savings and Investment’, Economic Journal 47, Part I: 53–69; Part II: 221–40. Richardson, G.B. (1972) ‘The Organisation of Industry’, Economic Journal 82:883–96. Robertson, D.H. (1926) Banking Policy and the Price Level: An Essay in the Theory of the Trade Cycle, London: King and Son. Schumpeter, J.A. (1934) The Theory of Economic Development, Cambridge, MA: Harvard University Press. Shackle, G.L.S. (1949) Expectations in Economics, Cambridge: Cambridge University Press. ——(1966) The Nature of Economic Thought. Selected Papers, 1955–64, Cambridge: Cambridge University Press. ——(1967) The Years of High Theory: Invention and Tradition in Economic Thought 1926–39, Cambridge: Cambridge University Press. ——(1990) Speech at Conference. In S.F.Frowen (ed.) Unknowledge and Choice in Economics, Basingstoke and London: Macmillan. Sraffa, P. (1932) ‘Dr Hayek on Money and Capital’, Economic Journal 42:42–53.

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Witt, U. (1997) ‘The Hayekian Puzzle: Spontaneous Order and the Business Cycle’, Scottish Journal of Political Economy 44:44–58.

5 LINDAHL ON DISEQUILIBRIUM GROWTH Price expectations, wage regimes and income distribution Mauro Gallegati and Domenica Tropeano

The aim of this chapter is to review Lindahl’s passages on the cumulative process, particularly the sequences that start when changes on the real or on the monetary side occur. These sequences have been carefully examined in the debate on the anticipations of the General Theory.1 The participants in this debate were concerned with the end of these sequences since Keynes’ multiplier theory seemed to suggest that the process of output or price increase should converge under certain assumptions. The opinion on the convergence of the process became the discriminating device between the two opposite parts in the doctrinal controversy. We think that using the General Theory or, still worse, the textbook model of income determination denominated as ‘Keynesian’ as a reference point may be misleading. This model is a simplified static model. The Swedes and the Austrians in the 1920s and early 1930s were instead dealing with the issue of a growing monetary economy (see Tropeano 1994). These sequences will therefore be interpreted by looking both at the theory of growth and cycles prevailing at that time and at the theories developed in the period after the Second World War. In the debate before the publication of the General Theory, Keynes and the Austrians were on opposite sides. Some attempts in this direction have already been made (see, for instance, Seccareccia 1990). However, we disagree with the main conclusions of this work, particularly the statement that the cumulative process always ends when a new equilibrium position is reached characterised by the equality of the money rate of interest and the marginal rate of return on capital.2 The idea of marginal decreasing returns to capital, based on the technical properties of an aggregate production function, cannot be found in Lindahl’s work.3 Instead it is clearly stated that in the absence of technical progress, the change in output is limited upwards by the available supply of labour, and can continue forever in the opposite direction. This would not happen if the economy was supposed to grow under decreasing marginal returns to capital. Moreover, Lindahl did not deal with changes in the real rate of interest since he did not make any effort to define this concept, which in Wicksell partly overlapped with the ambiguous notion of marginal productivity of capital. On the real side the changes concern the autonomous consumption (changes in the propensity to save), technology4 and the expenditure by the State (changes in the propensity to save by the State).5 The case with the cumulative process started by a change in the monetary rate of interest is considered first and the other cases are dealt with referring to the conclusions of the first. Since no change in the capital structure motivated by cost considerations appeared in these other cases, the reference was to different considerations, the expectations, the wage regime and the changes in income and wealth distribution. In these other cases the reason behind the expansion process is a change in planned investment provided that the initial disturbances are expected to continue in the future. If a cumulative process starts, following a change in the money rate of interest, and expectations on the general price level are constant, the expansion in output is the result of input-output linkages among sectors while long-term expectations on demand are not changed. Therefore we get a new equilibrium position with a higher capital stock and incidentally a higher output. It is a comparative statics

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exercise. But this is just a small part of the story. Using this example as a benchmark case the author develops other truly dynamic situations.6 When long-term expectations change, the issue considered is whether planned investment will grow at a constant rate. Under realistic assumptions the belief that a constant rate of investment, a sort of balanced growth, can be spontaneously reached by the economic system proves wrong. It is more likely that cumulative processes with expansions and contractions in output will occur.7 Given that the expansion process is limited by the available labour supply, the main reference in this work will be to the contraction process, since in this case, given that no boundaries exist, the forces at work are clearly elucidated by the author. For this reason most quotations are related to this case. Like other Swedish economists of the time, Lindahl rejected the hypothesis of equilibrium growth warranted through the fulfilment of the Wicksellian conditions: stable price level, equality between saving and investment, interest rate set at the ‘natural’ level (see Wicksell 1935, 1936). He argued that the most likely outcome of a cumulative process, started by a change in profitability for whatsoever reason, is a process of disequilibrium growth. During this process, relative prices, absolute prices and income distribution change. According to Lindhal, the prices of the factors of production are flexible and saving depends only on incomes. Both mechanisms that allow some type of balanced growth process to happen in neoclassical and neo-Ricardian models were available but this outcome was considered, as we shall argue in the following pages, an unlikely event. In fact, both approaches assume that the rate of growth of capital is exogenous. Lindahl instead tried to explain how growth is affected by changes in prices, price expectations, the distribution of income and the wage regime. Changes in relative prices can cause changes in the mix of factors used in production, as in neoclassical models, with total production constant or growing at the exogenous balanced growth rate. The most likely effect can be a change in the structure of production, a change in the composition of sectors leading to a different weight of capital intensive sectors, according to the Austrian capital theory. This factor alone cannot explain growth. The most important force behind the process of expansion or contraction in output and employment is the revision of the desired capital stock by entrepreneurs and the availability of funds due to the shift in income distribution.8 Income distribution plays a key role in the process although in a different way than in neo-Ricardian models. In the latter the exogenous rate of growth and the propensity to save of capitalists determines the rate of profit, whereas in Lindahl price changes and the distribution of income affect the rate of growth of capital. This chapter is organised as follows. In the first section we report on Lindahl’s analysis of the cumulative process starting with a doctrinal-historical paragraph on the Austrian capital theory, drawing from this reading some key elements for our interpretation of his thought. In the second section we give a simple model that is based on the previous reading but entails a drastic selection of some aspects of Lindahl’s detailed but quite complicated exposition. To simplify things, we use an aggregate model instead of a twosector model, as would be required by close fidelity to the text, and we suppose a constant relation between capital and labour used in production. These passages are explained piece by piece and are not relevant to the interpretation. LINDAHL AND THE AUSTRIAN THEORY OF GROWTH AND CYCLES Lindahl used the Austrian theory of capital but he did not reach the same conclusions as Hayek on the question of whether long run growth is possible without voluntary saving. Hayek (1931, 1933) denied this with a complex reasoning centred on the Ricardo effect. The relative prices of capital and consumer goods would change in different directions during the period necessary to produce new capital goods. At the time these goods would be completed and ready for use, the demand for them would have declined. There would be an excess supply of capital goods. On the other hand, the reorientation of production towards less capital-

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intensive products would be difficult because of the scarcity of adequate capital and of losses of entrepreneurs who had previously invested in capital goods (see Moss and Vaughn 1986). The pattern of movement in relative prices that causes the crisis is explained by von Mises (1934), as shown by Moss and Vaughn (1986). After a fall in the loan rate of interest, the price of capital goods and the price of consumer goods rise, the latter to a lesser extent. While capital goods are being produced the reverse movement in prices occurs. Since the price of consumer goods is supposed to rise more than wages, real wages fall and it then becomes more convenient to switch to labour intensive methods of production. Thus the demand for capital goods falls and the capital goods already produced or almost ready are not demanded. On the other hand, it becomes difficult to find circulating capital to produce with a different method and credit presumably becomes tighter. This is the famous crisis scenario. To Lindahl, changes in the prices of consumer goods raise capital values and, if this increase is believed to last in the future, changes in investment plans follow. With constant nominal wages or with a rate of wage increase lagging behind prices, the shift in income distribution in favour of entrepreneurs allows new investment to be financed through internal funds. The same can happen even under flexible nominal wages since the profit margin is raised by the fall in the real value of interest payments. Thus the relative price changes are outweighed by the movement of both prices in the same direction in the sequence. In particular, the reverse movement that is essential for the Austrian theory will not happen if profitability expectations are revised. If entrepreneurs decide to enlarge the scale of production, both prices rise. In this context, a rise in real wages will not mean a fall in the demand for labour or a switch to capital intensive methods of production and a fall in real wages will not imply the reverse process. Only if the scale of production is unchanged does the expansion in one sector imply a contraction in the other sector. On the contrary, if investment increases the expansion can occur in both sectors. The prices of capital and consumer goods are linked by expectations. An increase in the prices of consumer goods will make capital values rise. The price of capital goods is not determined by the demand and supply for those goods. Growth is not accompanied by falling real wages. In the Austrian scheme, the pattern of real wages during the expansion is exactly opposite to Lindahl’s scheme. In the first phase, they are constant or rising; in the second phase, they fall. To Lindahl, they may fall in the first phase but they are constant or rise in the second phase. Thus the reverse movement does not take place. The credit problem does not arise, either, because of the availability of internal funds. If one wished to get a cycle from these sequences, the turning point would have a different origin; it might be caused by the reduction in the profit margin at the end of the boom due to higher nominal wages and perhaps to higher interest rates. The rise in the interest rate could be due to the higher discount rate set by the Central Bank to control inflation or to the rise in market interest rates because of the increase in the risk premium. The dynamics of capital goods prices and the source of investment finance are the points that make Lindahl’s story different from Hayek’s. Under these circumstances no credit crisis will occur. GROWTH, PRICE EXPECTATIONS, WAGE REGIMES AND INCOME DISTRIBUTION Like other economists belonging to the so-called Wicksell connection, Lindahl examined the consequences of a change in profitability in the fashion of a cumulative process. Wicksell had done the same but had focused on price movements, only allowing for changes in quantities in a situation of unemployment. According to Wicksell, a cumulative process can be set in motion by a change in the money rate of interest or by a change in the real rate of interest. In the interpretation of Swedish followers of Wicksell, the real rate of interest could more simply be thought of as a rate of profitability. Other causes could be a shock to

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demand, such as a change in the propensity to save, or a technological shock to production. Lindahl discussed in detail all these cases and particularly the change in the money rate of interest. Beyond the differences due to various starting points, all these cases show none the less a similar pattern or scheme: if a change in the money rate of interest occurs, the sequence of events is a rise in the prices of consumer goods and a rise in capital values and investment. A cumulative process in prices and quantities may develop with changes in wages, price expectations and income distribution. Otherwise, after some oscillations in relative prices, a new stationary equilibrium will be reached although at a different output and price level. In the first case, price expectations are destabilising, monetary wages are flexible, and income distribution is strongly affected by the huge price movements with a strong revaluation of debt effect. In the second case, the picture is simpler: price expectations are inelastic, monetary wages are rigid, the only factor that matters for income distribution is the moderate change in the real value of wages due to the moderate inflation or deflation. These are two extreme possibilities of a wide spectrum produced either by different combinations on these elements or by the same elements in different proportions. Static price expectations, rigid monetary wages and the real wages effect This case is easily described by referring to the discussion of what happens after a rise in the money rate of interest. Lindahl first assumes that expectations on prices may be elastic, that people observing prices fall believe they will continue to fall. In this case, when monetary wages are rigid, unemployment will develop and will be stronger in the sector of capital goods. In fact the fall in the rate of interest may make it more convenient to produce consumer goods rather than capital goods. But since prices are expected to fall further, entrepreneurs decide to cut production both in the capital goods sector and consumer goods sector. Therefore output in the last sector may fall, thus moderating the fall in prices of consumer goods. This will not stop the downward run of total production and of the price level (see Lindahl 1939:185). If entrepreneurs anticipate that ruling prices will be maintained, the picture changes. The substitution effect will be the major force at work and a new stationary equilibrium will soon be reached. The fall in the interest rate will cause a shift of the production from capital goods to consumer goods as before but this will be the only consequence. As in the neoclassical train of thought, the sectoral shift will make the price of capital goods rise and, on the other hand, given rigid monetary wages, the real wage effect will make the demand for consumer goods increase. Thus supply and demand in this sector may match again. The initial shift in the rate of profit between sectors will cause a reallocation of resources, but this will affect the other sector’s output, given that both factors are jointly used in production. The decrease in the planned supply of capital goods will make the demand for labour fall and thus the demand for consumer goods, the prices of the latter and so on. This can be avoided only if entrepreneurs expect that the fall in prices will be reversed. As Lindahl (1939: 185–6) writes: Retaining the assumption that the entrepreneurs in each period anticipate that ruling prices will be maintained, the decrease in capital production will not continue indefinitely. Even in this case there are two circumstances influencing the profitability of long investments in the direction opposite to the immediate effect of the changed rate of interest, namely the relative price rise of products that require more waiting, and rising real wages. It may thus occur that the nominal income of the community gradually becomes adjusted to the supply of consumption goods. In this case the price fall will come to an end, and the community will become stationary, if other conditions do not prevent this.

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The other conditions referred to by Lindahl are the unemployment that mitigates or cancels out the effect of rising real wages on the demand for consumption goods and the worsening in financial conditions of firms due to the revaluation of debt or more simply to the increase in the value of interest payments. If these factors are not considered, monetary wages are rigid and expectations are static, the repeated movement of prices and quantities can be prevented by rising real wages, which stops the fall in consumer goods prices, and by the rise in the price of capital goods. Elastic price expectations, flexible monetary wages and the Fisher effect When monetary wages are flexible and expectations are not static, income distribution plays a major role in processes of positive or negative growth. In the case of a rise in the rate of interest with flexible monetary wages, the sequence of events is the following: rise in the rate of interest; decrease in stocks and increase in the supply of consumer goods; fall in their prices; decline in capital values and losses to entrepreneurs, who will be forced to reduce labour costs and other services still further (cut in nominal wages); reduction in consumption and in the price of consumer goods; fall in capital values and in the price of capital goods, the latter being reduced more than the former. In this case, a downward run of prices and quantities will occur, the contrary would happen with a fall in the rate of interest. This process of positive or negative growth is brought about by changes in the income distribution as Lindahl (1939:184–5) himself indicates: In this case the result is again brought about by the redistribution of income. Receivers of fixed income and workers, whose wages do not fall in the same degree as the cost of living, find their position improved. On the other hand entrepreneurs will be making losses, and must use up their capital resources (reduction in savings or sales of capital goods) for interest payments on their loans and to keep up their standard of living. Thus, for the community as a whole, consumption will exceed total income in each period, and real capital resources will consequently diminish gradually, while prices will continue to fall. The savings behaviour of entrepreneurs is the key factor in this process of disequilibrium growth. During the contraction phase, their propensity to save decreases; whereas it increases during the expansion phase. At the same time, during the expansion phase, the incentive to invest is stronger provided that expectations are elastic and the availability of internal funds greater because of the devaluation of debt. During the expansion phase, workers and capital lenders find their income decreased, not only because the real value of their income has decreased following the price rise, but also because the interest paid by entre-preneurs on debt has decreased in real terms. Entrepreneurs find the value of their capital increased, the value of their debts decreased as well as the interest they pay on it (see Lindahl 1939:162, 174). The shift in income distribution will increase the wealth of entrepreneurs who are already considered as the group with the higher propensity to save and invest. Moreover, as in the contraction phase, they may be prompted to increase their propensity to save and apply it to the purchase of labour and capital goods to enlarge production. This appears to be the main force that can justify processes of positive or negative growth beyond the change in the composition of sectors derived from the Austrian capital theory. These processes are likely to happen after a shock to profitability only under some circumstances, the most important ones concerning the elasticity of expectations and the wage regime. Another circumstance to be mentioned is the implicit assumption that the money supply is endogenous. The Central Bank sets the interest rate and the commercial banks decide the quantity of credit to grant on the basis of profitability and liquidity considerations.

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Real wages effect versus revaluation of debt effect During the expansion or contraction process, profitability and the demand for labour are not negatively related to real wages. When monetary wages are rigid, a stationary equilibrium may be reached because the rise in real wages contrasts or completely offsets the reduction in profitability caused by the rise in the interest rate. In reality, this effect may be cancelled by the fall in demand caused by the increase in unemployment so that the stationary equilibrium is never reached. In the symmetrical case of a fall in interest rates, falling real wages with constant monetary wages may in a similar way help to reach the stationary point through their negative rather than positive effect on profitability. The fall in demand that they cause may dampen the rise in the prices of consumer goods and thus reduce the rise in capital values and the speed of investment. The reasoning that real wage changes should lead to more employment is linked to the view of investment profitability as determined by the ratio of capital values to reproduction costs. If capital values rise but reproduction costs do the same, nothing would happen unless a time lag is introduced. In the case considered by Lindahl, the profit margin is affected by several contrasting factors: the interest rate effect, the wage effect, the anticipated gains due to higher prices, the effect of a falling real value of debts. Even if the rise in costs, due to a wage increase, perfectly balanced the rise in capital values due to the anticipated gains, the decrease in interest payments and the decline in the real value of debts would drive up the profit margin. Nominal wage rigidity under unit-elastic expectations ensures convergence to a stationary equilibrium in both cases, although the reasons are different from current aggregate supply models. Real wages, which are supposed to rise or fall when nominal wages are fixed and prices change, do not directly affect aggregate supply and demand for labour as in current models. In the expansion process, the fall in real wages means that the tendency towards rising prices and therefore improvements in capital values will be dampened; the opposite happens in depression. There are good reasons to believe that the working of this mechanism during the expansion process is uncertain; it is, however, certain that it would not work during a depression, given the asymmetry examined above. The result of the cumulative process then depends on elasticity of interest expectations, real wage effects, real value of debt effects and perhaps also wealth effects. The effect of real wages in contrasting an expansion or a depression phase is indeed considered quite weak whereas the effect resulting from financial conditions such as the weight of interest payments and the real value of debt is considered more powerful. The combination of wrong elasticity of price expectations, very weak real wage effect and very strong revaluation of debt effect is really perverse during the depression. A renewed interest in this topic appears in the economic profession nowadays in connection with the debate on the microfoundations of underemployment equilibrium. In particular, the issue of the relation between price and wage flexibility and full employment equilibrium has been reexamined by many scholars. Tobin (1993), for instance, discusses the relative strength of the real balance or Patinkin effect, the so-called Keynes effect, the real wage or Pigou effect, and the Fisher effect or, as he calls it, the reverse PigouPatinkin effect. This discussion is necessary to provide an answer to the question of whether or not proportionate deflation of nominal prices increases aggregate effective demand. The Keynes effect is described as the effect of rising or falling prices on the fixed money supply. Since the real value of money increases, demand for money decreases, interest rates fall and the real aggregate demand should increase. Using a liquidity trap argument, Keynes showed that this is unlikely to happen. Pigou and Patinkin argued instead that a change in the real value of wealth can directly affect aggregate demand without the intermediation of the money market. Tobin (1965) argued that those effects are not very strong and that their direction is unclear since most assets are inside assets; accordingly, he claimed that, under certain

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conditions, the Fisher effect is likely to be stronger than the previous ones. Lindahl is concerned with all those effects with the exception of the Patinkin effect. In fact, the Swedes had no money balances and they thought that the latter did not matter very much for the economy. They were close to Wicksell’s notion of a pure credit economy.9 Since money supply was not considered fixed, it was impossible to discuss the real balance effect. Therefore it was not necessary to think of the liquidity trap as a device showing that price flexibility does not lead to full employment. The Swedes especially considered the Pigou effect and the Fisher effect, arguing that the latter is more powerful than the former, particularly in depression. Moreover, they examined wealth effects arising from the changes in the value of capital goods for their owners. This would be equivalent to what in recent macroeconomic models would be a change in the price of shares for holders of these assets. A SIMPLE DYNAMIC MODEL To elucidate Lindahl’s view on growth, we formalise a model that agrees with the most important conclusions arising from the author’s verbal discussion. Some elements of his discussion will be excluded from the model for the sake of clarity in the following. Thus, the model is an aggregate model, instead of a two sector model, and the relation between capital and labour is constant. Apart from this, the structure of Lindhal’s discussion is maintained on the nexus between growth, price expectations, the wage regime, and firms’ financial conditions. In the following we describe two modelling strategies: model I is devoted to a setting with workers (i.e. households) and entrepreneurs (the aggregate sectors firms-banks), where credit takes the form of an infrasector connection, so that as regards the ‘entrepreneurial’ sector, no debt relation ship is taken into account; then, in model II, we add to the households, financial and non-financial corporations as separate agents. In this setting finance matters and we leave that classical assumption. It will be shown that, since external finance is less cheap than internal finance, stability conditions are tighter, while the growth path is unaffected. The model mark I We model the change in the capital stock, i.e. investment I, as a function of the difference between the desired capital stock Kt*, and the past one, Kt−1, plus autonomous investment: (1) Capital stock accumulation is given by (2) where is the physical depreciation rate. The desired capital stock depends in turn on the expected change in the price level, P: (3) e The expected price level, P , is a positive function of the past price level, Pt−1, according to a simple adaptive expectational rule: (4) We simply assume that price expectations depend positively on the past price level. The rate of inflation,

depends on the difference between lagged aggregate demand, D, and lagged aggregate supply, S,

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(5) The demand for output is equal to the expenditure out of total wages, wL, where w is the nominal wage bill and L is the number of workers (for the sake of simplicity we put the marginal propensity to consume out of wages equal to 1), profits PR (with 00, which requires K>1− . A very interesting case has been detected for values of slightly smaller than 1 ( =0.954). In such a case, the system becomes locally unstable, but globally stable, giving rise to deterministic fluctuations of an apparent stochastic nature. A representation of that case is shown in figure 5.1. It is quite evident that endogenous fluctuations develop around the growth path. We pursued further simulation with flexible nominal wage, i.e. w=p, and the system has shown a considerable increase of instability: in fact, on the one hand, when prices go down, desired capital and investment decrease, lowering profits and aggregate demand, which further pushes prices down; on the other hand, deflation pushes real wages down, so that aggregate demand decreases still lowering the price level. We have already discussed the Fisher-effect on pp. 93–4. To formalise it, we have to modify the model by introducing debt accumulation and the banking sector. The model mark II When finance matters, nominal investment has to be equal to internal finance (retained profits) plus external finance, F, (12) A debt deflation effect can be detected whenever P rises, since financial funds in real terms decrease, thus lowering investment expenditure. Equation (9) has to be modified to take into account financial commitments, rX, (9') where X is the total debt, and r is the exogenous rate of interest. Firms’ demand for finance, F, at a given interest rate equals the financial gap. Debt accumulation is (13) and its growth, gx is

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(14) Substituting equations (9 ) and (12) into equation (14), yields (14′) which says that debt grows at a rate equal to the rate of interest. The no Ponzi game condition requires that gk>gx, i.e. the rate of change of output has to be greater than the rate of interest. This further assumption restricts the stability conditions while at the same time it does not affect the growth path. Further, if gpgx), real debt commitments rise (decrease), thus pushing down (up) profits and restoring financial fragility (robustness). CONCLUSION Stable growth characterised by full employment, a stable price level, and equality between saving and investment seems a strange idea if compared with the picture given above. If growth occurs, the actual pattern of capital accumulation will depend on price expectations, the wage regime and the distribution of income. A path that leads to a stationary point may be found under rigid monetary wages and inelastic price expectations. To Lindahl, both assumptions seem very far from reality. In reality, growth will be accompanied by big changes in expected prices and therefore presumably in monetary wages. To mitigate the unstable character of such a growth, monetary authorities have to act upon price expectations. Even if they succeed, Lindahl does not believe they will put the economy on any stable path but they will just avoid unnecessary detours. NOTES 1 The main theme in this debate was the anticipation of the Keynesian multiplier theory and the saving-investment theory by the Stockholm School (see Steiger 1972; Patinkin 1982, 1987). The Swedish economists directly involved in the doctrinal controversy did not show much interest in this issue with the exception of Bertil Ohlin who strongly asserted that the Stockholm School anticipated Keynes’ main message. Myrdal was no more interested in his earlier works and he had turned instead to development theory. Lindahl and Lundberg took different routes, the first researching on planning theory under uncertainty and the latter working on empirical business cycle research. Hammarskjold became the UNO general secretary. Consequently the whole debate was centred on Ohlin’s personal contribution. 2 The quotation of a sentence from Lindahl (1939:181) by Seccareccia (1990:145) is misleading since it applies only to the case where entrepreneurs expect changes in relative prices but do not foresee any continuous change in the general price level. The English translation, however, is not very clear. The expression price level in one important sentence is simply translated by ‘price’ thus hindering a correct understanding of Lindahl’s point (see Lindahl 1939:180; 1929:45). This idea is clearly stated in the Swedish version (Lindahl 1929:473b), whereas the whole sentence has been deleted in the English translation (Lindahl 1939:182b). 3 Lindahl never used the marginalist theory of distribution preferring instead the classical theory. In this regard he disagreed with Wicksell. 4 The aim of the Swedish book Penningpolitikens Medel (The Means of Monetary Policy) partly translated in Lindahl 1939 was, following the debate between Wicksell and Davidson, to show which monetary policy norm was optimal in a growing economy with technical progress. Lindahl agreed with Davidson that the rule should be a price level moving in the opposite direction to productivity rather than Wicksell’s constant price level norm. On the debate between Wicksell and Davidson, see Uhr (1960).

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5 The pages referring to the economic activity of the State do not appear in the English translation (see Lindahl 1929:63–8). 6 This is in accordance with Lindahl’s considerations on method. Statics, although very far from reality, can be used as an approximation before dealing with more complex and dynamic situations. However, the stationary equilibrium cannot be considered as a gravitation point for dynamic phenomena (see Lindahl 1939:33–4). 7 Therefore economic policy by the State is needed. Monetary policy should not be used to eliminate the cycles but to smooth them. In this respect the Swedes were not Keynesian but closer to the Austrian economists Mises and Schumpeter. The latter were against Keynes’ price stabilisation proposal since it would have implied cancelling physiological phenomena like business cycles. 8 Income distribution has been discussed in a static framework by Velupillai and Chiodi (1982). 9 Following Wicksell, the Swedes advocated an extreme antiquantity theory position close to the Banking School doctrines. In particular, they denied that the quantity of money can determine nominal income and argued that, in a developed credit system, the causal link goes the other way around, from the level of income to the quantity of money and credit. A very good exposition of Wicksell’s theory, whose implications hold for his followers as well, can be found in Laidler (1993). 10 Simulations have been performed by Dr Eliana Perucci Guidi. Figure 5.1 has been depicted using the following values: gk0=0.05; pt−1=1; =0.05; =0.15; =0.95; kt−1=5; =0.01.

REFERENCES Fitoussi, J.P. and K.Velupillai (1993) ‘Macroeconomic Perspectives’, in H.Barkai et al. (eds) Monetary Theory and Thought, London: Macmillan, 210–39. Hahn, F. (1988) ‘Hicksian Themes on Stability’, Working Paper, University of Cambridge. Hayek, F.A. (1931) Prices and Production, London: Routledge. ——(1933) Monetary Theory and the Trade Cycle, London: Jonathan Cape. Hicks, J.R. (1946) Value and Capital, second edition, Oxford: Oxford University Press (first published in 1939). Laidler, D. (1993) ‘Was Wicksell a Quantity Theorist?’, in H.Barkai et al. (eds) Monetary Theory and Thought, 146–77. Lindahl, E. (1924) Penningpolitikens Mal och Medel (The Aims and Means of Monetary Policy), Malmo, Sweden: Förlagsaktiebolagets i Malmö Boktryckeri. ——(1930) Penningpolitikens Medel (The Means of Monetary Policy), Förlagsaktiebolagets i Malmö Bokttryckeri (published for private circulation in 1929), Lund, Sweden: Gleerup. ——(1939) Studies in the Theory of Money and Capital, London: Allen and Unwin. Mises, L.von (1934) Theory of Money and Credit, London: Jonathan Cape. (Translated from the 1912 German edition.) Moss, L. and K.Vaughn (1986) ‘Hayek’s Ricardo Effect: A Second Look’, History of Political Economy 18:545–65. Patinkin, D. (1982) Anticipations of the General Theory, Chicago: University of Chicago Press. ——(1987) ‘On the Relation Between Keynesian Economics and the Stockholm School’, Scandinàvian Journal of Economics 80:135–43. Steiger, O. (1972) Studien zur Entstehung der neuen Wirtschaftslehre in Schweden, Berlin: Duncker and Humblot. Seccareccia, M. (1990) ‘The Two Faces of Neo-Wicksellianism during the 1930s: the Austrians and the Swedes’, in D.E.Moggridge (ed.) Perspectives in the History of Econonic Thought, vol. 4, Aldershot: Elgar, 137–54. Tobin, J. (1965) ‘Keynesian Models of Recession and Depression’, American Economic Review. Papers and Proceedings 55:195–202. ——(1993) ‘Price Flexibility and Full Employment Equilibrium’, in H.Barkai et al. (eds) Monetary Theory and Thought, 55–71. Tropeano, D. (1994) ‘Equilibrium, Disequilibrium or Cyclical Growth: Interpretations of the Cumulative Process by the Swedes’, mimeo, University of Macerata.

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Uhr, C.G. (1960) Economic Doctrines of Knut Wicksell, Berkeley: University of California Press. Velupillai, K. and G.Chiodi (1982) ‘On Lindahl’s Theory of Distribution’, Working Paper, no. 12, European University Institute, Florence. Wicksell, K. (1898) Geldzins und Güterpreise, Jena. ——(1935) Lectures on Political Economy, translated from the original Swedish (1906) by E.Classen, edited by L.Robbins, London: Routledge. ——(1936) Interest and Prices, translated from the original German by R.F.Kahn, London: Macmillan.

Part III MACROECONOMIC THEORY AND POLICY

6 CHANGES IN DUTCH ECONOMICS IN THE 1930s Arnold Wilts

Debates between Dutch economists in the 1930s on the foundations of new approaches in economic thinking concerning market failure and imperfect competition had a profound political aspect. During the economic crisis of the period, the question of economic ordering was one of the most vividly debated topics in both science and politics. Faced by the very severe social and economic problems of the Depression the Dutch government saw itself forced to adopt new, interventionist policies. Yet, growing government intervention in economic life was at odds with the traditional liberal ideology of free competition, which still held wide support in the Netherlands at the time. The liberal view on the working of the economic process had found its theoretical expression in early neoclassical economic thinking, which held that free and unlimited competition, ideally, would guarantee the spontaneous and most efficient co-ordination of economic life. This viewpoint, however, was discredited by the persistence of the crisis and by the apparent inability of the economic process to restore full employment in the leading industrialised countries. Partly in reaction to the perceived shortcomings of contemporary theory in accounting for actual developments in the economy, new approaches in economic thinking emerged, the most notable of these approaches being the new field of econometrics and the array of insights that generally is referred to as Keynesian economics. During this period in which major changes were taking place in economic thinking more generally, Dutch economists became increasingly involved in economic policy decision-making. Reorganisations of the government apparatus and the instalment of new advisory bodies in the 1930s provided economists with increasing opportunities to set themselves up as experts on matters of economic policy. Yet, in Dutch economic thinking unanimity was lacking concerning the theoretical issues associated with policy questions. In the 1930s, Dutch economic thinking was characterised by a plurality of approaches and theoretical styles on which economists could draw for their policy work. The different viewpoints in Dutch economic thinking, concerning the theoretical and methodological underpinnings of policy questions, are here referred to as economic policy designs. These designs entailed notions about the structure of the economy and about the ways and possibilities to learn to know the structure scientifically. By consequence, economic policy designs also entailed ideas, often implicitly, about the expertise and the skills that were required for doing policy work. The differences between three such designs are analysed here in more detail. In doing so, an answer is sought to the question: under what conditions could different approaches in Dutch economic thinking in the 1930s be developed and sustained, considering the growing involvement of Dutch economists in economic policy decision-making. The answer to this question seems obvious. Since economics is a social science, its theories will reflect broader trends in social and political thought. Consequently, different approaches in economic thinking can be sustained as long as their premises are in accord with beliefs that hold wider support in the public arena.

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Such an answer, however, would ignore that economic policy-making since the 1930s seems to have become an almost exclusive concern of trained economists.1 Nowadays, the professional expertise that is required for doing policy work must be obtained largely through formal academic training, preferably in economics. Thus it seems that economists have been quite successful in establishing a professional identity as experts on matters concerning the implementation and evaluation of government policy. Apparently, also, economic science has been particularly suited for generating the knowledge and the intellectual tools that are applicable in the policy decision-making process. It seems, then, that by engaging in policy work economists have been quite successful in establishing both a professional and an intellectual identity of their discipline, thereby making economic thinking something different from social thought more generally.2 There are a number of strategies that scholars can deploy to ensure for their theories and insights a scientific status and the associated prerogatives. These strategies include using various forms of rhetoric, demonstrating the usefulness of research results and discrediting the sincerity of those who adhere to acclaimed ‘non-scientific’ beliefs.3 At least to some extent, therefore, scientific developments seem to be susceptible to factors traditionally portrayed as exogenous to cognitive change. The contingencies of the development of a particular scientific field, however, are structured to the extent to which that field becomes institutionally organised in the professional work of its practitioners.4 As a scientific field emerges as a distinct intellectual project, changes take place in the organisation of the work within it. These changes include organisational features such as the increase of publication outlets and the founding of professional associations, but can also include cognitive changes such as the articulation of research agendas and the development of advanced methodologies. Apart from the means with which scientific work is done, the location of this work, then, is of importance when studying the history of a particular scientific field. This holds especially true for policy related science, because work in these fields often is located outside the traditional academic structures. The question of the sustainability of approaches in Dutch economic thinking in the 1930s points to the maintenance of the disciplinary boundaries of Dutch economics, of which the stability and change can be observed in the practices and vocabularies of economists. Moreover, the relative merits of such approaches must be seen in conjunction with changes in the character and organisation of economic policy-making at the time. It is argued here that the nature and organisation of Dutch economists’ involvements in the policy decision-making process changed rather funda-mentally in the course of the 1930s. Subsequently, the work of three Dutch economists in this period is discussed, to see how economists used different vocabularies to set themselves up as experts on matters of economic policy. Then, the academic working environments of these economists are considered more closely, to learn more about the circumstances that allowed for the formulation of various economic policy designs. Finally, an answer is formulated to the question of the sustainability of the different approaches in Dutch economic thinking in the 1930s. THE POLICY CONTEXT Political and scientific debates on economic issues in the Netherlands in the 1930s were above all dominated by one theme: economic order. Ideas on demand management were introduced in economic policy debates in the Netherlands as early as 1935, when the Social Democratic Workers Party published its much debated Labour Plan, which was meant to provide a blue-print for a new socio-economic order in the Netherlands. ‘The lack of order’, said the socialists’ Plan, ‘is one of the prime causes of the present misery’ (S.D.A.P. 1935:122).5 Industrial organisation and, if necessary, the curtailment of individual economic freedom were therefore presented as inevitable steps in the solving of the enormous social and economic

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problems of the times. The ideas, however, that were defended in the Labour Plan generally were considered too radical to be put into practice, because they entailed a plea for direct and lasting state intervention in the economy that many feared would lead to statism and further economic stagnation. The plea by the social democrats for a determined co-ordination of economic life, however, fitted in a broader development in this period that also found its expression in Dutch economic thinking. The economic difficulties of the crisis of the 1930s and especially the persistence of massive unemployment confronted most economists with severe problems, that could not be dealt with by contemporary theory. The trust in the idea of free and unlimited competition as the driving force of economic and social progress was shaken by the occurrence of evident forms of imperfect competition and by the apparent failure of market forces to restore full employment. In reaction the idea gained ground that determined efforts at mastering the ambiguities of economic developments had become both practically necessary and theoretically tenable. The business cycle, with its characteristic ups and downs, was thought to be an inevitable phenomenon. Yet economists increasingly believed that through policy and organisation extremely unbalanced economic developments could in the future be timely curbed. At the time that these insights developed, the organisation of economic policy-making in the Netherlands underwent fundamental changes. Under the pressure of the social and economic problems of the times the Dutch government saw itself forced to implement legislation to battle the worst effects of the crisis. Until then the attitude of successive governments towards economic policy had explicitly been one of nonintervention and the so-called ‘crisis measures’ that were now devised to battle the worst and most persistent problems of the day were thought to be only temporary deviations from other wise sound policy. The crisis measures that were enacted had a predominantly protectionist character. This, however, changed over the decade. One of the early crisis measures that was taken was the implementation of the Crisis Import Act, passed in 1931. This Act allowed for the introduction of import quotas for designated goods. As a result of this law, and similar ones, trade policy measures could serve as important instruments in the government’s striving for economic recovery.6 At the same time this meant a move away from the traditional policy of free trade. Several other new laws that were devised in response to the problems of the economic crisis concerned Dutch agriculture. In 1931, also, legislation was passed that aimed at restructuring this important sector of the Dutch economy, culminating in the 1933 Agricultural Crisis Act. The Dutch government thereby explicitly embarked on an interventionist policy, since the new laws made it possible to enforce a reorganisation of the agricultural sector of the economy. A point of fierce debate in the 1930s was Dutch monetary policy, another traditional policy area. In 1925 the Netherlands had got back to the gold standard, which was supposed to promote trust in the Dutch economy and prevent inflation of the currency. Under the system of the gold standard, given stable exchange rates, monetary policy can be an effective instrument in maintaining a desired price level. It also inhibits a devaluation of the currency, since the value of that currency is linked to a fixed quantity of gold. This last point, in particular, was subject to fierce controversy in the 1930s. Proponents of a devaluation argued that a cheaper currency would benefit the Dutch export position, thereby preventing further loss of jobs.7 The government strongly opposed the idea of devaluation, which was said to be a breach of contract that would scare off foreign capital. In 1936, however, Dutch economic development hit a low point that forced the Netherlands off the gold standard. This generally is considered to be a breaking point in Dutch economic policy, because it made a more flexible monetary policy possible that could be integrated in a general system of policy measures. At the beginning of the 1930s relief from the economic difficulties was sought in traditional policy areas such as trade, monetary and fiscal policy. But in the course of the decade these separate policy areas became more and more tied into an overall view on economic policy, in which potentially conflicting priorities

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could be geared to solving the most urgent problems of the crisis. Generally the idea gained ground that the government had to fulfil a task to solve economic problems and to guarantee social welfare. Consequently, the institutional organisation of economic policy-making changed. During this period the preparation and implementation of policy measures was centralised. This made it necessary to obtain overall information on the status of the economy.8 Also, the centralisation of economic policy decision-making required the availability of instruments with which measures could be taken and their effectiveness and efficiency evaluated. The changing attitude towards economic policy, therefore, is exemplified by various reorganisations of the government bureaucracy in the 1930s. Changes in the government apparatus Several reorganisations were carried through in this period in the Ministry of Economic Affairs with the objective of centralising the documentation and publication of economic information that was deemed relevant to Dutch business and industry.9 By 1936, a central economic information service had become, in the words of the Minister of Economic Affairs, an ‘indispensable aid’ for policy.10 This service had been established in 1932. During its reorganisation four years later an economic research bureau, comprising ‘trained economists’ was added to the economic information service.11 The task of the research bureau was to study economic developments and more specifically to investigate questions concerning the development and dynamics of business cycles. The work of the economic information service and its research bureau thus provide an early example of the explicit use of economic science in supporting economic policy decision-making. The gathering and processing of information could serve a function in the co-ordination of economic policy in more than one way. After all, the more active role of the government in economic life was far from being uncontroversial and there still existed wide-spread fears for statism and too much state control of economic life. Therefore, economic information clearly could serve a function in building consensus on the urgency of the new policies on social and economic terrain, as well as in evaluating their effectiveness and efficiency. The more active role of the government in economic life necessitated a differently organised policymaking process, which required new forms of expertise. This is exemplified by another organisational change of the government apparatus when, in 1932, the Act on the Economic Council was passed.12 With the establishment of this council as an advisory body to the government, economists got involved in the policy-making process in a new way. Early organised forms of policy involvements of economists, for instance, dated from 1919 when a number of advisory councils had been established. These councils, however, mainly served particular interests of trade or industry and were not specifically concerned with general economic policy. The Economic Council, on the other hand, was devised to have a function in the general co-ordination of policy by advising the government on matters of ‘national economic’ importance.13 The Council concerned itself both with the organisation of economic policy-making as well as the content of specific policy measures. In answer to a request for advice by the Minister of Economic Affairs in 1935, the Council claimed a role for itself as the ‘centre of the system of advisory bodies on the terrain of economic policy’. And, in 1936, the Economic Council recommended the reorganisation of the economic information service, thereby emphasising that this service should be managed by someone with ‘sufficient economic theoretical knowledge’. Other reports that were formulated by the Economic Council concerned requests for, often detailed, advice on the content of policy measures, such as questions of whether or not import quotas would have to be introduced for designated goods. The Economic Council could only achieve its objectives if it had sufficient political and social support. The issues with which it would concern itself, after all, often were highly controversial. The members of the

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Council however were not representatives of employers or labour unions and the like. It was believed that this would prevent conflicts of interests and hence inertia in formulating advice. The members of the Council were independent experts from business and academia, that were appointed because of their ‘personal knowledge and capacities’.14 These experts would have to make their knowledge and experience subservient to an effective public administration, at a time when the central government saw itself faced with a host of difficult problems that bordered on deep-seated ideological opposition and political conflicts. To ensure support for its functioning, therefore, various approaches to economic policy were represented by members of the Council. Its member Heldring, for instance, was a strong supporter of traditional free trade policies, whereas De Vries, professor of economics in Rotterdam, was one of the proponents of a more active and interventionist economic policy. Despite recurrent differences of opinion between the members of the Economic Council, its instalment marked an important change in both the content and the organisation of economists’ policy work, since economists institutionally became involved in centralised economic policy decision-making. Crisis policy measures in the beginning of the decade were a first crystallisation point of policy changes in the 1930s. But, as the founding of the Economic Council and the reorganisation of the economic information service indicate, government involvement with economic life gradually lost its temporary and ad hoc character. Economists’ policy involvements began to institutionalise and the boundaries of new professional practices of economists outside the traditional academic structures started to emerge. But, what were the vocabularies that economists made use of to secure the acknowledgement of their expertise on matters of economic policy? ECONOMIC POLICY DESIGNS The economic problems of the times and the unprecedented level of unemployment in particular had led Dutch economists to reflect on the causes and dynamics of the economic crisis. A wide variety of standpoints with regard to the services that economic theory could render economic policy decisionmaking consequently was articulated in the course of the decade, ranging from strong defences of economic liberalism to as vehemently propagated ideas about direct state control of economic life. The critique on accepted economic theory was however growing, particularly concerning the idea that individual initiative and perfect competition in a free market would guarantee an optimum outcome of the economic process and a spontaneous co-ordination of economic life. This basic axiom of contemporary theory was increasingly rejected as a theoretical abstraction, too far removed from the reality of economic life to be successfully employed in solving the very urgent economic problems of the day. The critique on the actual usefulness of some of the fundamental axioms of economic thinking at the time did however give rise to theoretical difficulties. If the uninhibited functioning of the market could no longer guarantee an efficiently coordinated economy, alternative, determined forms of economic co-ordination needed to be developed and the question, of course, was how these new ideas could be theoretically justified. Early neoclassical thinking and especially the approach of the so called Austrian School had found broad adherence in the Netherlands, starting with N.G.Pierson at the end of the nineteenth century and carried on after the First World War by influential economists such as C.A.Verrijn Stuart—who had been appointed as the first director of the Central Bureau for Statistics back in 1899. The latter was very critical about changes in governmental policy on economic terrain.15 The problems of the Dutch economy, according to Verrijn Stuart in 1934, were not symptoms of a crisis of some sort of the capitalist order in the Netherlands, but, rather, were the result of ‘interventionism, which is precariously growing, day by day’.16 Because of such interventionism, Verrijn Stuart wrote, the innate tendency of the economic process to restore its optimal

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equilibrium was disturbed time and again, resulting in ever more complicated economic problems. According to this eminent Dutch scholar it was unacceptable that well-established theoretical insights into market functioning and the working of the price mechanism were increasingly dismissed as mere theoretical abstractions without much direct practical merit. Ideas like these, however, were more and more losing their intellectual appeal, as is particularly exemplified by the work of another leading scholar in the Austrian tradition, namely F.De Vries, professor at the Netherlands Trade School in Rotterdam and member of the Economic Council. In the course of the 1930s, his thinking on questions of economic order underwent some important changes that are illustrative of a turn towards new forms of economic thinking in Dutch economics in this period. The work of De Vries is compared here with the work of another key figure in prewar economic thinking in the Netherlands, namely the catholic economist M.J.H. Cobbenhagen, professor at the Catholic Trade School in Tilburg, in order to learn more about the different vocabularies in which economists could set themselves up as experts on matters of economic policy. Determined co-ordination of the economy At first, De Vries had rejected any form of market regulation as a disturbance per definition of the optimal functioning of the market economy. Partly under the pressure of the economic and social problems of the economic crisis of the 1930s De Vries however felt himself forced to modify this liberal standpoint considerably. According to De Vries, the actual conditions for perfect competition were increasingly undermined by structural changes in the economy, such as the development of forms of monopolistic competition, the formation of trusts and cartels, and the occurrence of concentration and co-operation among producers.17 Even this leading representative of liberal economic thinking in the Netherlands, therefore, lost his faith in the actual working of the market. The idea no longer could be upheld, according to De Vries, that the uninhibited interaction of market forces inevitably would lead to the most efficient coordination—in terms of the allocation of goods, money and people—of economic life. Economic regulation as such had become inevitable, the question now was to know the ‘matter of degree’ that was required.18 In consequence, De Vries was forced to put more emphasis than he had done before on the importance of empirical research.19 For, empirical and not theoretical research is necessary if one wants to learn under what circumstances free competition or regulated competition should be preferred. This put practical aspects of questions of economic order on the agenda and it was particularly these aspects on which opinions in public debates differed profoundly. Cobbenhagen’s thinking on questions of economic order was rooted in a different tradition from the one in which De Vries developed his ideas.20 De Vries was educated as a lawyer and belonged to the first generation of economists occupying chairs outside the traditional university structure at the beginning of this century. In 1913 he was appointed to the Netherlands Trade School in Rotterdam, the first institute for higher education in economics in the country, that was founded at the initiative of the Rotterdam business community. Cobbenhagen belonged to the next generation of Dutch economists being a student of De Vries, who supervised his dissertation in 1927. Cobbenhagen, an ordained priest, stemmed from a genuine Roman Catholic background. After he had got his Ph.D. awarded in Rotterdam, Cobbenhagen was appointed professor at the newly founded Roman Catholic Trade School in Tilburg. There Cobbenhagen became the leading voice of catholic economic thinking in the Netherlands. According to Cobbenhagen, as for De Vries, the contemporary economic crisis had important consequences for economic theorising, since structural economic changes in the 1920s and 1930s forced economic theory to address questions on economic order more explicitly than before. For Cobbenhagen, however, such questions should be on the agenda regardless of actual economic developments, because the ‘question of

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order’ to him exemplified that the full meaning of economic problems ultimately lay in the relation between ‘economics and ethics’.21 Not the practical aspects of questions of economic order, but the philosophical underpinnings of those questions and their sociological ramifications, therefore, were particularly addressed by Cobbenhagen. Both Cobbenhagen and De Vries thus emphasised the need for determined economic ordering, as supplemental to the spontaneous co-ordination of economic life by free market forces. The concept of order, however, in many respects had a different meaning to both, as is exemplified by their work on the theory of prices. Prices and markets In the approach of De Vries the economic act ultimately came down to individual choices between competing ends. Because the means with which such choices are made are scarce per definition, individual choices together form a‘coherent system’ which forms the ‘fundamental structure of economic action’.22 According to De Vries, every evaluation of the alternative uses of scarce means to satisfy a multitude of ends was necessarily subjective and unpredictable. However, to him this did not exclude the occurrence of regularities in economic action.23 After all, if there were no such regularities it would make no sense to think of the economic process as continuously moving towards equilibrium. This is of particular importance, because in the approach of De Vries the positive formulation of the laws of economic equilibrium was a constitutive element of the science of economics. Therefore, knowledge of price formation was essential for De Vries to understand the functioning of the economic process. In his approach prices were the result of the continuous interaction between all the subjective evaluations of alternative uses of economic resources, hence De Vries’s original emphasis on competition and rivalry as warrants for the spontaneous and efficient co-ordination of economic life. In contrast to De Vries’s way of thinking, Cobbenhagen did not understand prices as indicators of strictly economic phenomena that could be described in equilibrium laws. He did, however, see price formation as a fundamental theoretical problem, because it referred to the ‘typical economic aspect of social problems’.24 Cobbenhagen tried to develop an understanding of the price system as embedded in a broader, cultural framework. In his view prices not only had the function of realising economic possibilities that were potentially available in existing markets, but also served a function in the cultural and social integration of modern society. Goals and preferences of action could be mutually adjusted through the price system that, hence, had a distinct social, or rather sociological, dimension. This link between economy and culture expressed itself in Cobbenhagen’s attempts at developing a modern notion of the ‘just price’. With his ideas on the just price Cobbenhagen referred back to the classical economists of the nineteenth century as well as to scholastic philosophy, which was an important source of inspiration for his approach to economics. Not every price that was set by market forces was a just price according to Cobbenhagen. A price could only be called such when it expressed the essential connection between economic equilibrium and cultural or social equilibrium.25 That is, economic strivings, in Cobbenhagen’s view, were encompassed within a specific social and cultural order. Thus, ‘price’ and ‘order’ explicitly and per definition were complementary notions in the thinking of Cobbenhagen.26 This was the background to Cobbenhagen’s critique of contemporary Austrian economics, that according to him did not pay sufficient attention to ethical and normative aspects of economic actions and had thus put ‘questions of the nature and the function of prices outside consideration’.27 Cobbenhagen’s critical attitude towards early neoclassical economic thinking illustrates an important difference between his approach towards economics and that of De Vries. In the thinking of the latter the

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individual, or rather the individual choice, ultimately was the unit of analysis. This stemmed from De Vries’s subjective or Austrian approach. In Cobbenhagen’s view the individual always was considered as a member of some group and the unit of analysis therefore was not the individual as such, but the group or rather the organic units that together form a social structure. More generally speaking, these different theoretical stances were based on different understandings of the structure of the economy and the functioning of the economic process. In consequence, De Vries and Cobbenhagen also had different methodological preferences, that is different ideas about how to learn to know the structure and functioning of the economy scientifically. A notion of the economy as the sum total of a number of sets of individual economic agents presupposes another answer to the question of how scientific knowledge about the functioning of the economy can be obtained, than does a notion of the economy as built up by organically structured, purposeful collectivities. Methodological preferences De Vries took the standpoint that the typical economic aspects of individual choices were expressed in economic regularities that were similar to natural laws, that is he held the standpoint that ‘given specific conditions a certain effect necessarily follows’.28 According to De Vries economic laws were always logically valid, that is valid regardless of historical and social circumstances. Discovering these laws was the object of economic science. Yet, this did not mean for De Vries that economic laws or regularities could be empirically observed in their pure form. It was rather so that the very object of scientific economic knowledge only emerged as the result of economic theory abstracting from empirical reality. Through economic concepts, according to De Vries, ‘we can only start to see reality as an economic phenomenon as such’.29 In the approach of De Vries the hypothetical specification of economic laws, derived at by deductive theorising, thus was the basis of the scientific nature of economic knowledge.30 This methodological preference of De Vries fitted his ideas on the function of prices. Following De Vries, price formation in a free market would ideally lead to an optimal and spontaneous co-ordination of economic life, that is to a continuous movement towards economic equilibrium. The working of the free market, however, was increasingly disturbed by structural economic changes that influenced the actual manifestations of economic laws as formulated by economic theory. It follows that two kinds of knowledge are necessary to gain insight into the functioning of the economy, namely universally valid knowledge about economic regularities and, secondly, specific empirical knowledge about market types and structures in which such regularities become manifest. Unlike De Vries, Cobbenhagen stressed that every economic action always and under all circumstances had an ethical or moral aspect.31 Understanding and analysing economic developments thus needed more than strictly economic theory and methods. Economic science per se could, in Cobbenhagen’s approach, only produce knowledge of an aspect of the problems under study. For understanding the full significance of those problems, economic-theoretical insights needed to be complemented with insights from other disciplines, more particularly with insights from sociology and philosophy. Only then could the essential characteristic of economic action, that consisted of the fundamental connection between economic equilibrium and social equilibrium, the synthesis between economic and social life, be grasped. Standing firmly in the catholic tradition, Cobbenhagen forged an unbreakable link between action and responsibility. Economic actions, according to him, always evolved in a web of mutual dependencies that were constitutive of society. Cobbenhagen depicted the structure of modern society as an organic stratification, in which individual interests, group interests, and the common good should be harmonically

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integrated. Therefore, the essential aspect of economic action could in Cobbenhagen’s view not be known with the help of a method that only took the economic aspect into account, and left out the ethical and moral aspects of economic action. This was a reason for Cobbenhagen to be critical of the growing use of quantitative methods in economics, which, although he thought these could be helpful, could never replace what he called ‘the realistic approach in economics’.32 The nature of strictly quantitative methods thus, according to Cobbenhagen, was such that they could not surpass the superficial level of economic problems. The restricted use of such methods, on the other hand, fitted reasonably well in the approach of De Vries, in which regularities in sets of individual actions were an important focus of attention. Thus, different methodologies fitted the different approaches of De Vries and Cobbenhagen. Implied by these differences are different opinions about the social or political role of economists and about the practical use of economic insights. De Vries, more than Cobbenhagen, upheld a strict separation between theoretical and practical economics. The task or role of economists in solving actual economic problems, then, can consist in learning about—and possibly influence—the circumstances under which economic laws are operative. In Cobbenhagen’s view economics had to be connected with sociology, ethics and philosophy, especially when it came down to applying economic insights to actual economic problems. In that case, the economist can only point out the limits of individual and group interests and thereby contribute to a better integration of economic and cultural goals. This implies a less instrumental use of economic knowledge and, hence, another social role for the professional economist. De Vries and Cobbenhagen had different views on the structure of the economy and different opinions on the question of how this structure could be known by economic theory. In consequence, both had different ideas about the required expertise for doing policy work, as well as about questions of what constituted applicable theory. De Vries and Cobbenhagen thus drew up different economic policy designs, in which they implicitly anticipated differently to theoretical and methodological innovations in economic thinking in the 1930s, more specifically to the emergence of typical macroeconomic and econometric approaches. Economic models As far as Dutch economics is concerned, the emergence of new approaches in economic thinking at the time is associated above all with the name of the eminent Dutch economist Tinbergen.33 Tinbergen’s main research interest in the course of the 1930s was business cycle research. He was able to devote much of his time to this topic in his work for the Central Bureau for Statistics and, later, in his well-known work for the League of Nations in Geneva. Tinbergen combined these activities with his teaching in Rotterdam, where he had been appointed as an extra-ordinary professor of statistics and mathematics in 1933.34 This dual position arguably proved to be advantageous in two respects. Firstly, at the Central Bureau for Statistics Tinbergen had access to the statistical material that was needed for his pioneering work on economic modelling and, secondly, his work in Rotterdam allowed him to keep up with relevant developments in the field of economics at the time. In 1936, Tinbergen was one of the discussants at the annual meeting of the Dutch economists’ association. The topic of the meeting was the question of how to improve the performance of the Dutch domestic economy in relation to the country’s export position. According to Tinbergen, several policy measures could be used to improve the performance of the Dutch economy and the question consequently was which of these measures was to be preferred. Tinbergen proposed to evaluate the economic merits of the various possibilities with the help of an economic model. This model, which Tinbergen presented in his discussion paper, is considered to be one of the first genuine, statistically tested, economic models ever published.35 It was developed by Tinbergen, aided by some of his collaborators at the division for business

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cycle research and mathematical statistics at the Central Bureau for Statistics. In this model Tinbergen understood the economy as a system that was composed of mutually dependent entities, such as unemployment, wage level, prices and so on.36 These entities were represented in the model as variables, that were partly lagged. The dynamic relations between these variables were written as mathematical equations. To survey the complex dependencies between economic entities Tinbergen argued that numbers were necessary and ‘quantitative formalising’ inevitable.37 Therefore, the economic model promised to be the best tool for economic analysis. After all, it comprised both the use of numbers and the use of formalising techniques. For economic policy it was necessary, according to Tinbergen, to distinguish between systematic and cyclical movements in the economy or, what amounted to the same thing, in the data. Systematic movements represented the long term developments in the economy, cyclical ones the short term deviations from those developments. This made mathematics a particularly useful tool for surveying the economy. In equations and model relations both the systematic and the cyclical movements could be described and explained and, by implication, predicted, provided of course that all the necessary data were available. The economic model was, in the words of Tinbergen, ‘the mathematical machine that at once produces results’. At one and the same time, therefore, Tinbergen proposed a change in economic theoretical thinking and a change in economic policy thinking. He did so by proposing a new way of integrating theoretical problems and policy questions, namely in the economic model. Tinbergen’s approach differed in this from traditional economic thinking. In the approach of De Vries, for instance, the economic and the policy problem areas had still been clearly separated. In fact, according to De Vries, this separation was the very basis of the scientific character of economic knowledge. He therefore developed a view on economic theory as auxiliary to political decision-making, whereas Tinbergen clearly adopted a more instrumentalistic view of the use of economic insights. Tinbergen’s approach therefore also differed in an important respect from that of Cobbenhagen. He, too, integrated economic and policy problems. Cobbenhagen did so, however, in a cultural framework, in which the economist consequently had a relatively modest role. Tinbergen’s view on the relations between economics and policy, however, went further and was expansionistic in the sense that the economist in principle was awarded a leading role in debates on economic policy, at least as far as the technical aspects of economic policy decision-making were concerned. Yet, Tinbergen stressed in his 1936 paper that, although formalised, his model was not essentially different from traditional economic reasoning. The advantage of the quantitative method over traditional approaches however lay in the ability of numbers to give a criterion for evaluating policy options. These options, after all, could a priori be evaluated by ‘just making small changes in the formulae’. A side effect was that different positions in the debate on the relative merits of the policy options in question could be pinned down to certain values of designated variables. Thereby, at least according to Tinbergen, the use of economic models could lead to more fruitful discussion. It is important to note that this standpoint implies the exclusion of those who are neither able nor willing to appreciate the quantitative argument. Tinbergen therefore circumscribed the number and background of participants in the policy debate differently than for instance De Vries and Cobbenhagen did. Tinbergen concluded on the basis of his calculations that a devaluation of the Dutch currency would be the best way to enhance the level of employment. He concluded his paper by stating that his method might be crude, but promised to be the only way out of a political stalemate by the force of the quantitative argument. All that had to be done now was to ‘further develop the engineering science of econometrics’. This was a remarkably instrumentalistic view of the use of economic analysis, that at the time however carried the promise of wide applicability. Thus, Tinbergen redefined the boundary between economics and politics by proposing a new way of integrating theoretical and policy problems. This redefinition was especially

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persuasive, because the introduction of mathematics and quantitative techniques as new elements in economic thinking allowed for the use of economic insights as tools or instruments, instead of theoretical reflections or informed opinion. Here it becomes particularly clear how, in the vocabularies of Dutch economists in the 1930s, different perceptions of the structure of the economy were combined with specific methodological preferences and ideas about the social role of economists. These vocabularies, or economic policy designs, referred explicitly to the use of economic knowledge in the policy-making process. At the same time these designs served a function in preserving and extending the domain over which economists could claim to possess professional knowledge and skills. Yet, as the differences between the various approaches that were discussed here indicate, not every economic policy design was equally suited to claim professional expertise on matters of economic policy. This seems to be at odds with the assumption that economists made every effort to strengthen the boundaries of their discipline. After all, considering the increasing opportunities for claiming expertise on matters of economic policy, why was it that some economists maintained ideas that apparently were less supportive of such claims? THE ACADEMIC SETTING The academic organisation of the discipline of Dutch economics in the 1930s permitted the existence of important dissimilarities between the working environments of economists, to which the existence of diverging emphases in Dutch economic thinking can be traced back. The existing institutes for higher education in economics at the time were differently organised and were financed from different sources. The dissimilarities between these academic organisations unmistakably found their expression in the several curricula in which the formal training in economics was organised at the time. In March 1929, for instance, the position of the subject of sociology in the curriculum of the Roman Catholic Trade School in Tilburg stood on the agenda of the regular senatorial meeting. In that meeting Cobbenhagen said: The subject sociology is part of the curriculum to give our school its distinguished character. If we drop sociology as a compulsory subject, the students might as well leave Tilburg after two or three years and continue their studies in Rotterdam or Amsterdam.38 Nowadays it is quite remarkable that an economist puts so much emphasis on the value of sociology for the study of economics. Cobbenhagen’s plea for sociology, however, fitted well into his broad approach to economic theo-rising, which clearly had its institutional basis in Tilburg. The idea that economic science needed to be more than strictly conventional economic theories and methods even lay at the very basis of the foundation of the Catholic Trade School. Elsewhere, less value was attached to the broad design of the study of economics that was so typical for Tilburg. The economists at the Netherlands Trade School in Rotterdam for instance—among them F.De Vries and Tinbergen—generally held other ideas about the place of the subject of sociology in the curriculum. In a senatorial meeting in March 1938, almost ten years after the quoted discussion in Tilburg, it was said: The senate is still doubtful about this subject [sociology], which isn’t clearly demarcated from other disciplines and that tries to combine elements, that are already under study in various other fields and, consequently, already have their place in higher education. For the moment the senate will adopt an unfavourable disposition.39

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The different ideas on the place of a subject like sociology in the curriculum reflected the different attitudes towards the nature and function of the science of economics, that were, in general, adhered to in the schools in Tilburg and Rotterdam. Those different attitudes were also reflected in discussions in the two schools on the question of the place of econometrics and mathematical economics in the respective curricula. Tilburg kept some distance from these quantitatively oriented approaches.40 Rotterdam, on the other hand, adopted a relatively positive attitude towards the growing use of quantitative and mathematical techniques in economic research and education. Organisation and education Two years before the senatorial meeting in which Cobbenhagen made his plea for sociology the Roman Catholic Trade School had been founded in Tilburg (1927). It was the third institute for higher education in economics in the Netherlands. The first institute for the study of economics was the Netherlands Trade School, founded in Rotterdam in 1913. Nine years later this initiative had been followed by the establishment of the first university faculty of economics—although still called the science of trade—at the Municipal University in Amsterdam. The trade school in Tilburg was the only catholic institute for the study of economics in the country and its denominational character clearly distinguished the school from the other institutes for higher education in economics. The first initiatives towards the founding of a separate institute for higher education in economics, which had led up to the formation of the Netherlands Trade School in 1913, had been taken by representatives from the Rotterdam business community that also financed the new school during the first years of its existence. According to the founders, the new trade school had to prepare ‘young lads’ for the practice of business and commerce. Those young lads then would no longer be forced to seek their education abroad, but could find a trade school close to home, that offered them an education specifically suited to Dutch business life. The origin of the Netherlands Trade School in Rotterdam, therefore, was closely linked to the interests and preferences of the business community, that could exert its influence on the organisation of the school via the board of trustees. Typical, therefore, of the curriculum of the school in Rotterdam, especially in the first years of its existence, was an orientation towards the requirements of business life, exemplified by the place in the curriculum of subjects such as chemistry and commercial correspondence.41 The background to the initiative that led to the founding of the trade school in Tilburg was quite different from that in Rotterdam. Here the initiative towards the founding of a trade school came from representatives of the Roman Catholic church. It was also the church that furnished the necessary financial resources for the founding of the school in 1927. The motivation for founding a trade school, almost by consequence, was different from the motivation of the founders of the school in Rotterdam, fourteen years before. In Tilburg the emphasis lay in the perceived lack of catholic education in the new and rapidly expanding field of the science of trade, or as it soon came to be called, the science of economics.42 The catholic view of the functioning of the economy found its expression in a curriculum in which approaches that put economic phenomena in a broader, philosophical framework had their place, hence Cobbenhagen’s plea for sociology.43 The catholic background of the trade school in Tilburg was further exemplified by its formal subjection to the authority of the church. The different backgrounds of the schools in Tilburg and Rotterdam also were expressed in the different ways in which they were financed. Being private institutes the schools were not financed by the Ministry of Education, although both schools were officially recognised by the Dutch government as institutes for higher education in economics. The school in Rotterdam, however, had been allowed a subsidy ever since 1913. A similar subsidy was continuously denied to the school in Tilburg, the main argument being that its

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denominational character prevented government backing. Needless to say, this was felt in Tilburg as a grave injustice, provoking recurrent debates about the orientation of the school’s educational programme. The differences between the schools in Rotterdam and Tilburg, in terms of their local traditions and organisational peculiarities, represented different working environments of the economists that were affiliated to these institutes. The field of Dutch economics in the 1930s had not yet fully established itself as an academic discipline and the orientation and the content of the respective teaching programmes still reflected much of the circumstances under which the various institutes for higher education in economics had been established. The local distinctiveness of the trade schools in Rotterdam and Tilburg was however not only expressed in different teaching programmes, but also in differences in the styles and vocabularies that were used by the economists that were affiliated to these institutes. Cobbenhagen’s broad approach to economic theorising expressed some of the basic characteristics of the principles on which the Catholic Trade School was founded. The connection, for instance, that Cobbenhagen tried to establish between economic and social equilibrium seems very much to be in accord with corporatist ideas and the notion of subsidiarity which had a central position in catholic social thought at the time.44 The catholic identity of the trade school in Tilburg on the other hand did not easily permit the development of ideas in which the central government was allotted the initiative in the determined ordering of the economy. And, given the polarised political relations in the Netherlands at the time, socialist inspired ideas were literally unthinkable in the catholic atmosphere of Tilburg. Cobbenhagen’s approach, on the other hand, seems to have been at odds with some basic characteristics of the organisation of the Netherlands Trade School in Rotterdam. The overall pragmatic attitude in Rotterdam was not so supportive of a philosophically inclined approach to economic questions. Yet, it apparently did offer a favourable environment for the introduction of practically oriented approaches to economic theorising such as the work of De Vries in the 1930s. It also proved to be a favourable environment for the new, quantitatively oriented approaches that were emerging at the time, as is exemplified by Tinbergen’s work in Rotterdam, in which management problems now were discussed at the level of the national state. Apart from many similarities between the two schools, then, there existed important differences in terms of organisation and financial support, as well as in terms of the content of teaching programmes and in terms of styles of theorising of economists that were affiliated to these institutes. Already in the 1930s, however, a development started to become visible, that was to gain considerable momentum after the war. The emphasis in the curricula of the institutes for higher education in economics started to develop from occupational training, geared to the demands of business and commerce, towards professional academic study. This change is illustrated by the change of name that both the school in Rotterdam and in Tilburg underwent after 1937. Instead of schools of trade the names now spoke of schools of economic science. These and similar changes were formalised in the new Higher Education Act of 1937 and in the new Academic Charter of 1938. In these documents the competence associated with a degree in economics, such as teaching qualifications, were explicated. Also, the required content of the curriculum for the study of economics was formalised, in consequence of which teaching was more or less standardised across the country. After the middle of the 1930s, then, the local working environments of De Vries, Tinbergen and Cobbenhagen—and, by implication, of Dutch economists in general—gradually started to resemble one another. This initial process of the academisation of the discipline meant that the differences between the local circumstances that allowed these economists to develop and sustain their distinct approaches to economic theorising began to fade. In consequence, the range of vocabularies that economists could make use of to set themselves up as experts on economic policy gradually began to narrow.

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CONCLUDING REMARKS The working environments of Dutch economists were rapidly changing in the 1930s. The principle of free trade that had long dominated debates on economic policy was gradually abandoned and various interventionist measures were introduced over the decade. Traditional policy areas became increasingly integrated in an overall economic policy outline. Policy-making consequently was centralised and explicit use was made of the methods and insights from economic science. This provided Dutch economists with new and unprecedented opportunities to set themselves up as experts on matters of economic policy. Dutch economists’ growing involvements in the policy decision-making process, however, were associated with theoretical uncertainties regarding the underpinnings of fundamental policy questions. In Dutch economic thinking at the time various perspectives were developed on the desirability and the actual possibilities of forms of determined market co-ordination. Three such perspectives have been analysed here in more detail. It was argued that these approaches expressed different views of the structure of the economy and different understandings of what comprised the appropriate methodology of economic science. Consequently, these approaches entailed different views of the social role of economists and the practical use of economic knowledge. The approaches that were discussed represented different economic policy designs. It was argued that these designs expressed basic characteristics of the circumstances under which they were drawn up. Thus, the theoretical vocabularies and methodological repertoires of Dutch economists in the 1930s varied with the institutional location of their work, In consequence, these economists were faced with different opportunities and possibilities to maintain contacts with the government bureaucracy at a time when the character of the policy-making process underwent fundamental changes. This crude conclusion conveys the answer to the question that was set earlier. Economic policy designs comprised different intellectual and professional strategies and provided economists with various opportunities and rationales for striking up alliances with non-economists. Therefore, different approaches in Dutch economic thinking were not equally well equipped to fence off a new identity of economic science as indispensable to political decision-making. Under these conditions the various approaches in Dutch economic thinking did not equally affect the emergence of new disciplinary boundaries. In consequence, some of these approaches, most notably those that could not easily be reconciled with quantitative techniques, were not likely to be sustained in the future. NOTES I wish to thank Rob Hagendijk, Adrienne van den Bogaard and Mary Morgan for their comments on an early draft of this chapter. 1 The organisation of the discipline and the body of accepted theories and methods today differ fundamentally from the situation in the 1930s. The characteristics of what is now known as the field of modern economics started to emerge in the 1930s, but this development gained momentum only after the war (cf. Galbraith 1987). These characteristics of modern economics include the extensive use of quantitative and mathematical techniques, internationally standardised, anglosaxon oriented, research procedures and agendas and, at times, a scientific self image (cf. McCloskey 1983). Economics in the 1930s was a field in transition, which can clearly be observed in the work of Dutch economists in this period. See also Whitley (1986) who describes the field of modern economics as having developed into a specific form of work organisation, in which only certain kinds of research can fruitfully be taken up. Developments in Dutch economics and changes in the professional practices of economists outside academia between 1930 and 1960 are extensively discussed in Wilts (1997).

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2 The professionalisation of economists’ policy work generally is analysed as the result of a process of a division of labour, in which economists have been successful in establishing their owm professional identity in competition with other interest groups within the government apparatus. The division of expert labour, then, is understood as a guarantee for optimal administrative efficiency and economic thought, consequently, is seen as a vehicle for professional strategies (cf. Abbott, 1988). See Coats (1981, 1993) for an international comparison of the position of economists in government bureaucracies. For the place and function of economists in the government bureaucracy in the Netherlands since 1945 particularly, see Bemelmans-Videc (1984). 3 See Gieryn (1995), who uses the concept of ‘boundary work’ to describe the ways in which scientists rhetorically demarcate their work from non-science. See also Jasanoff (1987), who describes the relations between scientists and policy-makers as instances of overt struggle for cognitive authority and access to material resources, and Yonay (1994) about strategies for realising conceptual dominance in the field that were deployed by American economists in the 1920s. This theme is also explicitly addressed by Wagner and Wittrock (1991), who describe the relations between social scientists and policy-makers as ‘discourse coalitions’ or discursive alliances, that maintain and alter the boundaries between science based policy and policy related science and thereby serve a function in the reproduction of the disciplinary boundaries of policy relevant sciences such as, for instance, economics. 4 Following Granovetter (1985), the scientific work of economists can be seen as embedded in configurations of intellectual and institutional structures, that are maintained in patterned networks of social relations. The working environments of economists, for instance, are made up of patterned relations with such groups as academics, university administrators and policy-makers, who themselves may be trained economists. Each of these groups is likely to control a relevant aspect of the research process in economics, either in the sphere of the choice of research problems, the necessary access to financial and material means, or the criteria for the application of the resulting knowledge. Part of the communication between these groups, then, consists of negotiation about the relevance of research problems and the acceptability of problem solutions. About questions concerning the analysis of the relations between the content of intellectual work and structural features of scientists’ practices see Hagendijk (1990). 5 Earlier, the Social Democratic Workers party had published reports that argued for socialisation and drastic reorganisations of major parts of the Dutch economy. These reports defended radical socialist policies and met with devastating criticism. The political borderlines in the Netherlands at the time ran along sharp ideological fissures and political ideas were deeply entrenched in different ideological and religious belief systems, the gaps between which proved extremely difficult to bridge (cf. Lijphart 1968). In the course of the 1930s, however, less radical policy measures were proposed by the socialist party, as a result of which it became more acceptable to the other political parties as a coalition partner. The two pillars on which the 1935 Labour Plan was drawn up were the ordering of the existing economic structure and control of the economy’s future expansion (see S.D.A.P. 1935:10). In the Plan extra government expenditure and a policy of demand management were promoted as a means to get the economy out of its slump. Among the authors of the Plan were a number of economists, including Tinbergen. 6 Trade policy was of central importance in the political reaction to the economic difficulties. At first, the Dutch government actively strove for international co- ordination of trade policy measures. Traditionally, the Dutch economy is very dependent on international trade and therefore sensitive to international economic developments. After the international trade conference in London in 1933 had failed, the Dutch government started to use trade policy measures more explicitly as a means of furthering the interests of the Dutch economy (see Hirschfeld 1936: 177–8, 1946). In 1933 the policy of free trade was introduced as a reinforcement of the 1931 Crisis Import Act. In 1934 legislation was passed that allowed for the introduction of tariffs on the import of designated goods. 7 Tinbergen, for instance, argued this in his 1936 discussion paper for the annual meeting of the Dutch economists’ association. At the trade school in Rotterdam the devaluation standpoint found broad adherence, which led to critical remarks by prime minister Colijn himself. In a speech for Amsterdam industrialists in 1935 Colijn stressed that devaluation would be beneficial only to certain groups in society. These benefits would be only temporary at that. To most people, Colijn argued, devaluation would not be beneficial at all. This held especially

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for those who had put ‘their trust, their unwavering trust’ in the government by subscribing to the latest national loan (speech Colijn, Dutch National Archives, archives of the Ministry of Trade, Industry and Shipping, no. 8683). Not wanting to betray trust of course is an ethical and not an economic-theoretical argument. See also Magnus and Morgan (1987:123). The Central Bureau for Statistics (C.B.S.), for instance, became formally part of the Ministry of Economic Affairs and Labour in 1932. Until then the C.B.S. came under the Ministry of the Interior. The Bureau for Statistics had an important function in providing information on economic trends and developments necessary for the preparation of economic policy measures. See Bemelmans-Videc (1984: 93ff.). Branches of the C.B.S. also were engaged in business cycle research and in the construction of an economic barometer. This barometer and its development into a mathematical model of the Dutch economy is discussed in van den Bogaard (1996). The name of the Ministry of Economic Affairs was changed several times during the 1930s, itself an illustration of the lack of political consensus concerning the nature and organisation of economic policy. In 1932 the Ministry was called ‘Economic Affairs and Labour’, in 1933 just ‘Economic Affairs’. The Ministry was then split in 1935 into the Ministry of ‘Trade, Industry and Shipping’ and that of ‘Agriculture and Fishery’. During the war the exiled government in London established a Ministry of ‘Agriculture, Trade and Industry’, thereby recombining the two policy terrains that had been separated in 1935. In 1945, after the liberation from German occupation, the two separate ministries were reestablished as the Ministry of ‘Trade and Industry’ and that of ‘Agriculture, Fishery and Food Supply’. In 1947 the name of the first was changed again, this time into the Ministry of ‘Economic Affairs’. In 1952 a temporary Ministry of ‘Industrial Organisation’ was established, that did not have its own staff, but made use of the staff of the Ministry of Economic Affairs. Since the name of the Ministry has changed so often, the phrase ‘Ministry of Economic Affairs’ is used as a short-hand description. ‘Industrial policy aimed at improving the domestic economy as well as the level of employment and economic information for foreign markets go hand in hand. A well equipped and well managed economic information service, co-ordinated by solid study of the trade cycle, are an indispensable aid for such policy’ (speech of the Minister of Trade, Industry and Shipping on 19 June 1936, reflecting upon the reorganisation of the economic information service. Published in Handelsberichten, publication of the Ministry, 23 July 1936). The economists that were working at the economic information service were not so much employed because of their personal experience, but rather because they had had a formal training in economics. That is, these economists were above all hired because they were professional economists. See Handelsberichten, publication by the Ministry of Trade, Industry and Shipping, 13 July 1936: ‘In this bureau trained economists are employed, who study general economic questions to contribute to the available supply of economic information. The bureau maintains contacts with the Central Bureau for Statistics and with other organisations that are engaged in economic research’ (emphasis mine). Act on the Economic Council, 8 July 1932, Nthl. Statute Book, 1932: no.346. A number of eminent Dutch economists have been members of the council, among them De Vries, Lieftinck (secr.) and, after the war, Tinbergen. The Economic Council originally was devised as a temporary organisation that would serve the government as long as economic developments made such service necessary. The Council met once a month as of June 1933. After the German occupation in May 1940 the meetings were postponed. After the war the Council resumed its work for another five years until it was replaced in 1950 by the Social Economic Council, one of the most important advisory councils to the Dutch government until this day. The work of the Economic Council was partly done in several permanent and ad hoc committees that consisted of members of the Council as well as noncouncil members. The reports and advice of the Council were not published. The central position of the Economic Council in decision-making on important matters of economic policy was formalised in 1934 (Nthl. Statute Book, 1934: no.113). Minister of Economic Affairs Verschuur, Proceedings of the Dutch Parliament (Handelingen, II, 1931–1932: 2368). ‘Indeed, the Economic Council gives general economic advice to the government. If the advice of the Industrial Council and the Trade Council would have been sufficient for the government, it would have sufficed to create only an Agricultural Council. However, we want to avoid all partiality and want to have an arrangement

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in which all advice will be considered in a council that looks at the problems in question from a nationaleconomic viewpoint.’ Minister of Economic Affairs Van den Brink said for instance on occasion of the renewed installation of the Council in April 1948: ‘The government intends to appeal for necessary advice to the Economic Council, of old a board of experts, whose members have been approached because of their personal knowledge and capacities’ (Dutch National Archives, archive of the E.C., no.19, Report of the Economic Council 1948–1950:4). Even Böhm-Bawerk (1891:229), one of the leading Austrians, recognised the influence of Austrian ideas on Dutch economic thinking at the time: ‘…und teils durch Jevons und teils durch die Österreicher angeregt, hat sich in jüngster Zeit eine überraschend große Zahl von Forschern aller Nationen der neuen Ideen zugewendet. Die große holländische Literatur ist ihnen fast völlig ergeben…’. See also Verrijn Stuart (1934:607), who wrote that it was the ‘lasting achievement’ of Menger c.s. to have given the science of economics a ‘totally new foundation’. For a history of nineteenth century Dutch economics see Hasenberg-Butter (1969). See also Behrens (1969:435–46) and Duyverman (1978: esp. 12 ff.) and, for developments in Dutch economic thinking in the interwar period, in particular Dullaart (1984, 1992). ‘If there would have been general awareness of the fact that freedom—in the sense of a free price mechanism in all markets and free transactions—is a necessary condition for the realisation of maximum prosperity, and if governments would have acted accordingly, the inevitable impoverishment as a result of the war would certainly have already been checked and been replaced by a renewed increase in the standard of living. The crisis of today is not a crisis of capitalism, but a crisis of interventionism, which is precariously growing, day by day’ (Verijn Stuart 1934:615). ‘…individual activity and personal initiative in many respects are being superseded by the control and initiative of organised groups’ (De Vries 1935:12, 1933: 302). ‘Based on conclusions drawn from the theory of free price formation, the conclusion cannot be upheld, that a society in which everything is determined by individual initiative and individual competition will function appropriately…It is a matter of degree. Depending on the circumstances, in the one case free competition and in the other case regulated price making and production might be beneficial to the functioning of the economic mechanism’ (De Vries 1935:31). Earlier De Vries had above all emphasised the need for pure theorising. Cf. De Vries (1928:758): ‘The task of theory is to show how, given a certain organisation of economic life, the economic process and its specific manifestations can be explained. The actual situation at a given moment is the result of an endless chain of causes, as much of climate and race as of social institutions; but none of these causes alone determines the economic consequences they have. Specifying these is the very task of economic theory’ (emphasis mine). Dullaart (1984:187) likewise notes: ‘This comprises a program for the next years: gathering facts and the classification of market forms become the center of attention.’ See also Dullaart (1992). See Dullaart (1984:88, 91) and Behrens (1969, especially Ch. 12). De Vries was born in 1884 and came from a protestant background. He studied law at the Free University in Amsterdam and at the Municipal University, also in Amsterdam. In 1910 he obtained his doctorate at the University of Groningen. He taught economic theory in Rotterdam from 1913 till 1944. From 1945 until 1954 De Vries was professor at the Municipal University in Amsterdam. In 1930 he was appointed member of the Royal Academy of Science in the Netherlands. He served on several advisory committees and councils, but is mostly remembered for his chairmanship (1950–1958) of the Social Economic Council. De Vries died in 1958. Cobbenhagen was born in 1893 and started his studies in economics in Rotterdam in 1917. After he had graduated in 1921 he taught economics at the seminary in Rolduc, where he himself had studied earlier on. In 1927 he obtained his doctorate at the trade school in Rotterdam, supervised by De Vries. Cobbenhagen was the unchallenged leader of the catholic school in Tilburg until his untimely death in 1954. ‘Because the question of order…is not just a practical economic issue, but first and foremost a fundamental and principal question, the coincidence of theoretical research into questions of regulated price making with the principal quest for order must be seen as an unintended, but actually present illustration of the relation between economics and ethics’ (Cobbenhagen, 1937a:293; emphasis mine).

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22 ‘…that the multitude of ends (the wants), towards which human action is oriented, are given…and at the other hand that the means for satisfying those wants are too limited to satisfy all ends, while the realisations of those ends are dependent upon the same means and thus form a coherent system. The typical economic aspect of all actions ultimately depends on this fundamental structure of economic action’ (De Vries 1928:756). 23 ‘What is relevant to economics is first of all this, that certain groups of people under similar circumstances react in the same way, and so regularity in their actions can be observed’ (De Vries 1928:766; emphasis mine). 24 ‘If one is searching for the typical economic aspect of social problems, one is bound to end up with questions concerning the price and price formation’ (Cobbenhagen 1935:23). 25 ‘The principle of equivalence of the scholastic justium-pretium doctrine therefore is the basis of a broad notion of societal equilibrium: not only of an economic equilibrium, but, considering the subservient character of the economic, also of a social and a cultural structure of society’ (Cobbenhagen 1938:288). 26 ‘…as just in the full meaning of the word can be seen that system of prices, which, if employed with professional guidance, is capable of realising the economic possibilities that are represented in it in such a way, that maximum economic prosperity will be achieved without violating the necessary place of the economic goal in the order of cultural goals. A just price, then, is a price that fits in such a system of prices’ (Cobbenhagen 1936b:622). 27 ‘With the abandonment of the notion of “natural price” or the reinterpretation of this concept with socialeconomic meaning into an “equilibrium-price” with a very limited and economically faded content, the adherents of the subjective value-and price-theory have put questions of the nature and the function of prices outside consideration’ (Cobbenhagen 1935:28). See also Cobbenhagen (1935:23–4) and Cobbenhagen (1936a:341). 28 ‘With the notion of economic laws nothing else is meant in economics than short formulas in which the observed dependencies…between phenomena are expressed. Given specific conditions a certain effect necessarily follows. There is, therefore, no difference between natural laws and economic laws, as their logical nature is concerned’ (De Vries 1946:5; emphasis mine). 29 ‘From the perspective of the typical problematics that form the content of economic science and that determine its domain, and in and through working on these problematics, we have to mould the concepts through which we can only learn to see an economic phenomenon as such, which consequently enables us to determine and define what really is relevant to economic research’ (De Vries 1946:5). 30 For De Vries deductive theorising was the only way in which scientific economic knowledge could be formulated. The essential aspect of economic phenomena was reflected in regularities, in the constants of economic action, as De Vries wrote in one of his early publications: ‘Often we have to abstract considerably from reality; when learning about the economic categories and fundamental economic laws we ignore every contingency in economic developments and the changing organisation of our economy through time, and concentrate on that which independently of time and place constitutes the essence of economic action’ (1926:592). 31 ‘And because our economic strivings have to be contained by our moral strivings, every economic objective and every economic action is both of an economic and of a moral nature, which are not separated, but do have to be distinguished from one another’ (Cobbenhagen 1936b:614). 32 ‘Therefore, the economic studies that are built up from mathematical thought constructions, although they can be of help to the realistic approach in economics, can never replace that approach, because neither economic reality, nor its individual manifestations, can be captured in mathematical formulas’ (Cobbenhagen 1940:92). See also Cobbenhagen (1937b:583). 33 After the war Tinbergen became very actively involved in the policy process in his capacity as director of the Central Planning Bureau, in all respects the most influential policy supporting organisation in the Netherlands up till this day. In 1969 Tinbergen, together with the Norwegian economist Ragnar Frisch, was awarded the first Nobel Memorial Prize in economics for his innovative work in the 1930s, a clear illustration of the discipline’s assessment of the quantitative approach. See Magnus and Morgan (1987) for an overview of Tinbergen’s career, Kol and De Wolff (1993) for a survey of Tinbergen’s scientific work, Morgan (1990) for a study of Tinbergen’s pioneering work in econometrics, and Boumans (1992) for a study of the cognitive sources of Tinbergen’s work before the war, and van den Bogaard (1996) on the influence of Tinbergen’s scientific work on economic policy decision-making.

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34 When Tinbergen’s appointment as an extra-ordinary professor was discussed in the meeting of the Board of Trustees of the Netherlands Trade School in June 1933 strong objections were made (Archive Nthl. Trade School, at the Municipal Archives in Rotterdam, minutes Board of Trustees, 28 June 1933). Tinbergen, a committed member of the Social Democratic Workers Party was to teach on statistics, but, according to trustee Suermondt, this could ‘not be reconciled with the membership of a political party that does not accept the present social order’. In this meeting it was also suggested that earlier an appointment of Tinbergen at the Municipal University of Amsterdam had foundered because of his socialist sympathies. In Rotterdam, however, the senate had not put a second candidate’s name on its list of recommendation. Eventually Tinbergen was appointed. One of the things that eased the opponents’ fears was the fact that the appointment of extra-ordinary professors each year had to be reconfirmed, whereas a full time appointment of university professors was for life and normally could not easily be done away with. As a footnote to this might be added that in 1942 the German authorities refused to reconfirm Tinbergen’s appointment, apparently because of his socialist sympathies. After intervention by the Dean of the school in Rotterdam reconfirmation was secured. 35 Magnus and Morgan (1987) refer to Tinbergen’s 1936 model as the ‘first macroeconometric model’. See also Barten (1988:83). 36 See Boumans (1990), who concludes that Tinbergen conceived of the economy as a closed system, which enabled him to introduce into economic thinking notions and ideas from physics, the science in which he had been trained. This implies a technocratic and hence elitist programme according to Boumans, since it limits the number of participants in the policy debate considerably. 37 See Tinbergen (1936). The quotations in the text are all taken from the original Dutch version of Tinbergen’s 1936 discussion paper, as it was published in the proceedings of the Dutch economists association, references to page numbers have been omitted. An English translation of Tinbergen’s discussion paper was published as Tinbergen, J., ‘An Economic Policy for 1936’, in L.H.Klaassen et al. (eds), Jan Tinbergen, Selected Papers, Amsterdam: North-Holland. 38 Archives of the Roman Catholic Trade School at the Catholic University of Brabant in Tilburg, minutes senatorial meeting, 20 March 1929. 39 Archives of the Netherlands Trade School at the Municipal Archives in Rotterdam, minutes senatorial meeting, 24 March 1938. 40 The Tilburg economist Dalmulder in 1936 wrote the first Ph.D on econometrics in the Netherlands, supervised by Tinbergen in Rotterdam. It is interesting to see how Dalmulder motivated his econometric exercise. In his thesis Dalmulder stressed the potential use of econometrics, but he did so in a specific way. He wrote for instance ‘From all this it follows, therefore, that theoretic economics, more specifically econometrics,…have a fecundating influence upon the world of practical knowledge, and as such do not only help to shed light on God as the first cause but also, though indirectly, helps us to lead us to our honorable good, eternal happiness, which consists in the contemplation of God’ (Dalmulder 1937:17). 41 At first Rotterdam offered a two year course. In the curriculum the attention to matters of practical affairs was expressed by the position of technical subjects such as chemistry and knowledge of commodities, as well as subjects like commercial correspondence and foreign languages, alongside education in economics and statistics. See van Stuijvenberg (1963) and van Rossum (1979:188, 190). For a brief history of the Faculty of Trade Sciences, later Faculty of Economics, at the Municipal University in Amsterdam see Vanthoor (1992). 42 The Episcopacy had explicitly instructed the founding committee in Tilburg to develop the organisation of a trade school ‘in the direction of the Netherlands Trade School in Rotterdam’ (Letter to the committee 22 March 1924, Archives of the Roman Catholic Trade School at the Catholic University of Brabant in Tilburg, no.c179). See also Bornewasser (1978, especially Ch. 1), who describes the foundation of the trade school in Tilburg as an important step in the emancipation of Dutch catholics. For a characterisation of the typical, antagonistic organisation of Dutch political life at the time see Lijphart (1968). 43 See Bornewasser (1978:37–45). The perceived lack of a visible catholic vision of economic life also played a role in the establishment of the monthly journal Maandschrift Economie that was published in Tilburg as of September 1935 and which was an important publication outlet for Cobbenhagen.

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44 Catholic social thought had found its authoritative expression in the Papal encyclic ‘Quadragesimo Anno’, published in 1931, where the principle of subsidiarity was extensively discussed and where modern capitalist society was described as a widely ramified organism, that—by its nature—could not be controlled from one central point without seriously disturbing economic equilibrium and damaging social integration.

REFERENCES Abbott, A. (1988) The System of Professions: An Essay on the Division of Expert Labour, Chicago: University of Chicago Press. Barten, A.P. (1988) ‘The History of Dutch Macro Economic Modelling, 1936–1986’, in W.Driehuis et al. (eds) Challenges for Macro Economic Modelling, Amsterdam: Elsevier Science Publishers, 39–88. Behrens, H.H. (1969) De Ontwikkeling in het Economisch Denken, Utrecht-Antwerpen: Het Spectrum. Bemelmans-Videc, M.L. (1984) Economen in Overheidsdienst, Bijdragen van Nederlandse Economen aan de Vorming van het Sociaal-Economisch Beleid, 1945–1975, unpublished Ph.D. thesis, Erasmus University, Rotterdam. Bogaard, A.A.van den (1996) ‘Past measurement and future prediction’, Discussion paper, Dept of Science & Technology Dynamics, University of Amsterdam. Böhm-Bawerk, E.von (1891) ‘Macht Oder Ökonomisches Gesetz?’, in F.X.Weiss (hrsg.), Gesammelte Schriften von Eugen von Böhm-Bawerk, Wien: 1924, 230–300. Bornewasser, H. (1978) Katholieke Hogeschool Tilburg, Economie, Ethiek en Maatschappij, Deel 1, 1927–1954, Baarn: Ambo. Boumans, M. (1990) Tinbergen’s Early Program, Research Memorandum 9023, Faculty of Economics, University of Amsterdam. ——(1992) A Case of Limited Physics Transfer: Jan Tinbergen’s Resources for Reshaping Economics, Amsterdam: Thesis Publishers (Tinbergen Institute research series, no. 38). Coats, A.W. (1981) Economists in Government: An Intenational Comparative Study, Durham: Duke University Press. ——(1993) The Sociology and Professionalization of Economics, London: Routledge. Cobbenhagen, M.J.H. (1935) ‘Beschouwingen over den Prijs I’, Maandschrift Economie 1:23–30. ——(1936a) ‘Beschouwingen over den Prijs III’, Maandschrift Economie 1:338–46. ——(1936b) ‘Beschouwingen over den Prijs V’, Maandschrift Economie 1:613–22. ——(1937a) ‘De Economische Mengvorm of Tussenvorm’, Maandschrift Economie 2: 288–301. ——(1937b) ‘Productie en Verdeling’, Maandschrift Economie 2:577–84. ——(1938) ‘Enkele Beschouwingen over Samenhang en Evenwicht in het Economisch Leven’, Maandschrift Economie 3:270–95. ——(1940) ‘Over Nieuwe Opvattingen in de Theoretische Economie’, Annalen van de Vereniging tot Bevordering der Wetenschap onder de Katholieken in Nederland 32: n.n. Dalmulder, J.J.J. (1937) On Econometrics: Some Suggestions Concerning the Method of Econometrics and its Application to Studies Regarding the Influence of Rationalisation of Employment in the U.S.A., Haarlem: Bohn. Dullaart, M.H.J. (1984) Regeling of Vrijheid, Nederlands Economisch Denken Tussen de Wereldoorlogen, unpublished Ph.D. thesis, Erasmus University: Rotterdam. ——(1992) ‘The Embarrassment of Freedom’, in J.van Daal and A.Heertje (eds) Economic Thought in the Netherlands: 1650–1950, Aldershot: Avebury. Duyverman, M.H.J. (1978) ‘Feiten en Feitjes Betreffende de Groei van de Economische Wetenschap in Nederland’, De Economist 126:1–36. Galbraith, J.K. (1987) A History of Economics. The Past as the Present, Harmondsworth: Penguin. Gieryn, T.F. (1995) ‘Boundaries of Science’, in S.Jasanoff et al. (eds) Handbook of Science and Technology Studies, Thousand Oaks: Sage. Granovetter, M. (1985) ‘Economic Action and Social Structure: The Problem of Embeddedness’, American Journal of Sociology 91:481–510.

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Hagendijk, R.P. (1990) ‘Structuration Theory, Constructivism, and Scientific Change’, in S.Cozzens and T.Gieryn, Theories of Science in Society, Bloomington: Indiana University Press. Hasenberg-Butter, I. (1969) Academic Economics in Holland, 1800–1870, The Hague: Martinus Nijhoff. Hirschfeld, H.M. (1936) ‘De Taak der Economische Voorlichting’, Handelsberichten: n.n. ——(1946) Actieve Economische Politiek in Nederland in de Jaren 1929–1934, Amsterdam: Elsevier. Jasanoff, S. (1987) ‘Contested Boundaries in Policy-relevant Science’, Social Studies of Science 17:195–230. Kol, J. and P.De Wolff (1993) ‘Tinbergen’s Work: Change and Continuity’, De Economist 141:1–28. Lijphart, A. (1968) The Politics of Accommodation: Pluralism and Democracy in the Netherlands, Berkeley: University of California Press. Magnus, J.R. and Morgan, M.S. (1987) ‘The E.T. Interview: Professor J.Tinbergen’, Econometric Theory 3:117–42. McCloskey, D.N. (1983) ‘The Rhetoric of Economics’, Journal of Economic Literature 31: 481–517. Morgan, M. (1990) The History of Econometric Ideas, Cambridge: Cambridge University Press. Rossum, W.van (1979) Wetenschappelijke Ontwikkeling als een Sociologisch Probleem, met Speciale Aandacht voor Ontwikkelingen in de Nederlandse Bedrijfseconomie, unpublished Ph.D. thesis, University of Amsterdam. S.D.A.P. (1935) Plan van de Arbeid, Amsterdam: Arbeiderspers. Stuijvenberg, J.H.van (1963) De Nederlandsche Economische Hoogeschool 1913–1963, van Handelshoogeschool naar Hogeschool voor Maatschappijwetenschappen, Rotterdam: Nijgh and Van Ditmar. Tinbergen, J. (1936) Kan hier te lande…?, Prae-adviezen van de Vereeniging voor de Staathuishoudkunde en de Statistiek, The Hague: Martinus Nijhoff, 62–108. Vanthoor, W.F.V. (1992) ‘Zeventig Jaar Economische Faculteit binnen de Universiteit van Amsterdam, 1922–1992’, in M.M.G.Fase and I.van der Zijpp (eds) Samenleving en Economie in de Twintigste Eeuw, Leiden-Antwerpen: Stenfert Kroese. Verrijn Stuart, C.A. (1934) ‘Theorie en Praktijk’, De Economist 83:605–23. Vries, F.De (1926) ‘Economie en Ethiek’, De Economist 75:579–600. ——(1928) ‘Institutionalisme’, De Economist 77:737–71. ——(1933) ‘Coördinatie van het Verkeerswezen’, De Economist 82:275–313. ——(1935) Regeling of Vrijheid, rede uitgesproken ter gelegenheid van de 22ste herdenking van de stichting der Nederlandsche Handels-Hoogeschool op 15 Nov. 1935, Rotterdam. ——(1946) ‘De Taak der Theoretische Economie’, De Economist 94:1–23. Wagner, P. and B.Wittrock (1991) ‘Institutions and Discourses: A Comparative Perspective on the Structuration of the Social Sciences’, in P.Wagner et al. (eds) Discourses on Society, the Shaping of the Social Science Disciplines, Dordrecht: Kluwer Academic Publishers, 331–57. Whitley, R. (1986) ‘The Structure and Context of Economics as a Scientific Field’, Research in the History of Economic Thought and Methodology 4:179–209. Wilts, A.S. (1997) Economie als Maatschappijwetenschap, een sociologische geschiedenis van de economische wetenschap in Nederland (ca. 1930–1960), unpublished Ph.D. thesis, University of Amsterdam. Yonay, Y.P. (1994) ‘When Black Boxes Clash: Competing Ideas of What Science is in Economics’, Social Studies of Science 24:39–80.

7 KEYNESIANISM AND BRITISH LABOUR MARKET POLICY From the 1930s to the 1980s William R.Garside

Over the past two decades or so there has been a substantial volume of research into the links between Keynes’ thinking and policy advice and the prevailing economic conditions of interwar Britain. Two distinct views have emerged. Because the General Theory appeared in the wake of depression and recovery, attention has focused on the extent to which Britain missed an opportunity to apply a more effective remedy to mass unemployment than was evident in the policies actually pursued. The alternative perspective is that Keynes’ radical message had little direct relevance to the particular national and international economic difficulties facing Britain in the 1930s. The latter view has encouraged among historians growing support for the traditional policies implemented by British governments on the grounds that contemporary officials, unlike Keynes, understood clearly the constraints facing any programme of national reflation and increased government intervention in economic affairs.1 In parallel with this research we now feel sufficiently distanced from the end of the Second World War to produce broad surveys of economic policy and performance down to recent times. The post-1945 period falls into three distinct phases, first the reconstruction period from 1945–51, second the period of the long boom from 1951 until the early 1970s, and third the inflationary and high unemployment experience of the late 1970s and 1980s. These periods provide a useful contrast with the 1920s and 1930s and pose interesting questions about any supposed link between economic theory and economic policy (see Crafts and Woodward 1991; Cairncross 1986). To what extent, for example, was the reluctance of British officials in the interwar period to adopt the policy advice of Keynes the result of economic ignorance and an ideological commitment to economic priorities incompatible with a substantial reduction in unemployment? Given the extent of state intervention in the post-1945 economy and the co-existence of near full employment down to the mid-1970s, can we presume that Britain benefited from the application of those Keynesian ideas ignored between the wars or was the link between Keynesianism and economic management after the Second World War more tenuous than is customarily presumed? And why, in addition, did the Keynesian call for state intervention and increased public expenditure go unheeded when recession struck Britain so deeply in the 1980s? This chapter poses these questions in an effort to examine the extent to which British labour market policy since the First World War and down to modern times has been influenced less by the logic and application of economic science than by a distinct form of political economy, itself a reflection of the political, social and cultural environment in which economic policy is formulated. KEYNES AND HIS CRITICS BEFORE 1939 Despite the emergence of persistent unemployment after 1920, following the collapse of the post-war inflationary boom, the development of an active employment policy during the subsequent decade was extremely limited.2 Those public works that were undertaken were developed purely as emergency

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measures necessary to allay social unrest and called forth meagre government expenditure. For much of the 1920s governments, whether Conservative or Labour, strove purposely to reduce their commitment to such activity to the shortest period compatible with efficiency and economy, preferring instead to await a substantial reduction in industrial costs and the revival of normal trade. Demands for increased public works expenditure violated the contemporary dictates of sound finance. It was generally believed that government should aim for a small budget and an ex post surplus sufficient to permit redemption of the National Debt on a regular basis, whatever the state of the economy. When revenues fell, as they inevitably did during periods of depression, it was accepted that public expenditure should be reduced in accordance with balanced budget orthodoxy. The Treasury set its face against unbalanced budgets on the grounds that they would adversely affect business confidence by withdrawing funds from productive use, be inflationary, and increase the dead-weight of National Debt. Appeals for increased spending on public works, on behalf of the unemployed rankled not only Treasury officials but also the majority of businessmen, who feared consequential rises in taxation beyond levels already felt to be both excessive and a detriment to productive enterprise. Whether the preoccupation of Chancellors of the Exchequer to generate budget surpluses for the reduction of the National Debt damaged the prospects of the unemployed did not worry the Treasury; its responsibilities lay in the fields of budgetary control and debt management, not in the determination of the level of employment. Despite these contemporary constraints, Keynes argued as early as 1924 for a drastic remedy for unemployment complaining that the prevailing volume of savings, largely untapped because of the lack of domestic investment, was drifting abroad under the stimulus and bias of British financial institutions, There was, in his view, no established means beyond free market forces of allocating aggregate savings between home and foreign investment. With new capital expenditure already severely curtailed by industrial depression, there was little hope of boosting jobs within the strict confines of sound finance. What was needed, he maintained, was ‘an impulse, a jolt, an acceleration’. The Treasury, he urged, should raid the Sinking Fund to the extent of £100 million for the purpose of constructing capital works at home (Keynes 1924). Advocacy of government-sponsored schemes of national reconstruction grew particularly strong during the 1929 election. The Liberal Party, heavily influenced by Keynes’ ideas, proposed a bold emergency twoyear programme of road and bridge construction, housing development, land drainage and telephone and electricity services. These were destined to stimulate cumulative increases in employment beyond levels hitherto experienced. The Party’s plans incorporated what might now be regarded as a crude formulation of the multiplier mechanism. Not surprisingly, the enormity of the Liberal Party’s pledge, namely that it could by a deliberate policy of national development ‘abolish’ abnormal unemployment in the course of a single year without undue financial repercussions, was curtly dismissed in Whitehall. The Treasury lost no time in condemning large-scale, state-sponsored public works as diversionary and unproductive. Post-war governments had encouraged small-scale public works by local authorities, if the projects could satisfy strict criteria of usefulness and if they were able to be financed predominantly from local finances. Nor was the state averse to becoming involved in substantial investment expenditure, as witnessed by the capital spending undertaken during the slump years under the aegis of the Central Electricity Board, the prototype public corporation behind the establishment of the National Grid. Moreover, the second Labour administration won approval in 1930 for increased investment in trunk roads, an initiative which the National Government supported in principle thereafter. Such examples of public works and other forms of national expenditure reflect the fact that there was never any wholesale opposition to planned expenditure if financial support was limited and strictly controlled (the road development programmes in the 1920s, for example, were financed by the Road Fund,

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the Exchequer and the local authorities) or if there were specific and tangible benefits, such as the opportunity to encourage new industrial development by influencing the operational control of cheaper electricity. But pleas for the Treasury to be involved in substantial borrowing to finance major improvements in the national infrastructure were of a different order. With a limited stock of genuine savings available to finance new investment, the Treasury argued, the use of such funds for large-scale public works would merely reduce the supply of capital available to finance private investment, thereby lowering efficiency and raising costs within the economy. Public works would not increase aggregate employment unless they were financed by credit creation, which ran the danger of encouraging inflation. Borrowing to finance such schemes, the criticism ran, would merely drive up interest rates and pose a direct threat to debt redemption and the stability of the budget. Since a very large proportion of any extra government borrowing could only be obtained without inflation by diverting money, which otherwise would be used by private industry, the net addition to employment resulting from any large public works scheme would not be large. The Treasury did not doubt that loan-financed public works expenditure could raise aggregate demand and employment in the short run, but it rejected the idea that a works programme could be successfully financed on a scale sufficient to provide a permanent solution to chronic unemployment. The Treasury’s criticisms were based on more than a crude supply of capital thesis; they drew upon issues of practical politics, administration and psychology. How, it argued, could the government market a substantial debt without creating a crisis of confidence? Any deficit financed by bond sales would raise doubts about the government’s overall economic strategy and promote an increased demand for cash. This in turn would prevent idle balances from taking up the additional bonds unless interest rates rose. The business community in consequence was likely to curtail investment, thereby exacerbating deflation. And to the extent that foreigners viewed the government’s financial policy as unsound, stability of interest rates would be threatened by an unwelcome outflow of sterling. The Treasury argued further that an extensive programme of national reflation via public works would produce a very lopsided form of prosperity unlikely to be of much assistance to the depressed basic trades most in need of help. Few Treasury officials believed that demand impulses created by large-scale investment projects would successfully work their way through to industry as a whole. Nor were these the only objections to ‘nascent Keynesianism’. Large-scale public works projects, Treasury officials maintained, would need careful planning and sufficient time to allow for the acquisition of suitable land, labour and materials. Such activity was unlikely to synchronise with the vagaries of the trade cycle. Moreover, public works were likely to come to an abrupt end without any guarantee that attached labour would be reabsorbed into normal industrial activity (see Middleton 1987; Garside 1990, Chs 12, 13). The authorities’ narrow views as to what constituted acceptable public works virtually ensured that any development programme would have limited impact. They insisted that state aid for public works had to come from current revenue, that the execution of any programme had to remain the initiative of local authorities, and that the works themselves had to be directly useful, remunerative and likely to improve industrial efficiency. The small scale upon which they could be mounted inevitably made them of limited use and incapable of effecting a substantial reduction in unemployment. Nonetheless, the pleas of more radical economists and politicians for an interventionist and publiclyfunded stimulus to national demand fuelled fears within official circles of domestic instability and budgetary chaos. Such misgivings grew stronger and gained wider currency as the world depression deepened in 1930. At the same time Keynes became convinced that private investment alone could prove insufficiently buoyant to reduce unemployment to any appreciable extent. He argued for domestic reflation, emphasising both the political and the social difficulties of attempting to enforce wage cuts as a means of

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creating jobs. If the need to protect gold reserves prevented the rate of interest from equating saving and investment, he argued in 1930, it was the government’s responsibility to look to public works as a useful reserve weapon to promote internal stability by fiscal means, leaving monetary policy to safeguard the existing gold standard regime. Once Britain was forced off gold in 1931, interest rate movements were no longer dictated by international considerations. Keynes’ initial reaction to the break with gold was to advocate cheaper money to promote domestic recovery. But by 1932 he had grown increasingly sceptical of the view that the capitalist system possessed an inherent tendency towards self adjustment sufficient to maintain full employment. Keynes recognised that lower interest rates would not necessarily induce sufficient investment to absorb all current saving; in a situation of excess saving over investment, interest rates could settle at a level dictated by the public’s desire to hold non-interest bearing money rather than investment-financing bonds. It could not be assumed, however, that at this level investment would prove sufficiently attractive to employ all unused resources; the economic system, in other words, could be in equilibrium at less than full employment. The interaction of a relatively high interest rate elasticity of demand for money with a relatively low interest elasticity of demand for investment, both of which were influenced by expectations, suggested that any adjustment mechanism based on monetary policy alone would work only very slowly to improve employment (see Moggridge and Howson 1974). At this juncture Keynes supported public works not because of the international complications that would be generated by continued reductions in the rate of interest but because he believed such reductions would not be adequate to the task. In the short run, Keynes was to argue, monetary policy should become subordinate to a progressive policy of government-induced investment the effect of which, by raising expectations, would be to encourage further investment, output and employment without serious inflation, given the existence of substantial surplus capacity. However, with the pursuit of economy and stability to the fore the view that unorthodox reflationary finance could prove an effective remedy for large-scale unemployment was almost doomed. Indeed government fiscal policy during 1931 to 1932 was inherently deflationary. The Treasury was in no mood to relax its fiscal grip. The co-existence of low interest rates, a boom in private house building, and a rise in real per capita income of those in work initiated a domestic market recovery which the National Government was loath to compromise, least of all by indulging in unsound investment. The Chancellor of the Exchequer refused to countenance deliberately unbalanced budgets. Real prosperity lay in promoting trade recovery not in following the whims of the ‘new economics’. This view was shared by the majority of contemporary politicians, civil servants and City financiers who regarded a policy of deliberately unbalancing the budget in the hope of expanding employment as a fearful prospect, not least in its potential for encouraging demands for yet further increases in public expenditure (see Skidelsky 1979). Keynes remained the economic heretic and spearheaded the attack on conventional wisdom in 1933. Convinced by this time of the fundamental importance of investment expenditure to economic prosperity, he was particularly sensitive to the evil of thrift in times of economic sluggishness and more willing to concede the importance of the aggregate demand for output as a whole. If an increase in saving because of greater thriftiness was not translated via the capital market into increased investment, he argued, the result could be a depression of the overall level of income, demand and employment. The rate of interest, as a purely monetary phenomenon, could not be relied upon to reconcile savings and investment decisions. Although interest rates fell following the demise of the gold standard, Keynes came to believe that they would not, for a variety of reasons, work quickly enough or positively enough to stimulate sufficient investment to generate full employment. If investment was deficient then the level of national income upon which saving depended would be below that required to produce full employment. The state’s responsibility,

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he argued, was to create more optimistic conditions for the expansion of business enterprise by undertaking new loan expenditure on a scale sufficient to raise the level of aggregate demand. None of this cut much ice with the Treasury. Officials continued to worry about the practicality of largescale works programmes, given the length of time they took to bring into operation, and about whether recourse to substantial borrowing would raise the long-term rate of interest, perhaps to the point where public confidence would be so diminished that the authorities would be forced to monative the debt, threatening inflation and the stability of the pound. The decision of Treasury officials in 1937 to encourage local authorities to prepare additional public works schemes on a counter-cyclical basis might suggest that the influence Keynes and other economists exerted on economic thinking in the later 1930s was greater than is generally supposed. However there is little evidence to support this view. The action in 1937 was modest in scope and was motivated more by a desire to prevent unemployment worsening during an anticipated slump than to drive it to substantially lower levels by the deliberate timing of expenditure over the course of the trade cycle. In truth, Treasury thinking has not moved significantly from its 1930 position. Officials remained alert to the prospective state of the national finances, to the need to sustain the primacy of monetary policy, and to the acknowledged difficulty of ever abandoning public works once they had been implemented. Moreover, the shift in Treasury policy after 1936 towards substantial loan-financed expenditure did not represent a conversion to Keynesianism, at least in the now familiar terms of savings, investment and aggregate demand. Rather a combination of political, economic and psychological factors associated with the finance and management of rearmament put the Treasury on the defensive. We have already noted that Treasury orthodoxy, aimed at limiting the rise in public expenditure and the role of the state, was firm but not inflexible. In the early 1930s Treasury officials worked steadfastly to strengthen their resistance to the emerging radical economics, not by resolutely defending the somewhat rigid ‘Treasury view’ of the 1920s as espoused by Churchill as Chancellor of the Exchequer, but by making concessions around the principles of financial orthodoxy when forced by the pressure of prevailing circumstances. The Treasury’s practice of fiscal ‘window dressing’ designed to conceal the deficits imposed upon its annual accounts by the cost of financing long-term unemployment is a case in point (see Middleton 1984). Its initial resistance to increased expenditure on armaments also reflected for a time how temporary such concessions to fiscal rectitude were meant to be. From early 1937, when defence spending began increasingly to be met from borrowing rather than from taxation, to mid1939 the Treasury kept appropriations under close scrutiny. Their scale was never allowed to threaten government credit, industrial performance or the balance of trade; economic prosperity after all was regarded as the ‘fourth arm of defence’. Deficit spending on rearmament, therefore, was limited almost down to the outbreak of war to what was thought to be required in light of the international situation, and with regard to its anticipated effects upon costs, the balance of payments and the exchange rate. It was only when national survival seemed threatened under the weight of German militarism that the greater financial resources were made available (see Shay 1977; Peden 1984). In truth opposition to ‘nascent Keynesianism’ was as strong as ever. Apart from the considerations already outlined, government officials had profound fears over the likely effect of deficit-financed expenditure on the political and administrative role of the state, particularly in relation to local authorities. Behind the Treasury’s notorious rejection of large-scale public works expenditure lay the powerful conviction that it would undermine the democratic structure of local government and threaten private property rights. Keynes’ political assumption that the management of the economy could be controlled by a mandarin of elite civil servants largely protected from the pressures of demagogic politics was naive, to say the least. Furthermore, when Keynes remarked in the 1930s that the solution to economic recession in the short term might require a comprehensive ‘socialisation of investment’, he implied only that the state should be prepared when necessary to augment private investment sufficiently to help restore full employment. He

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was concerned less with planning the economy than with seeking ways of managing it better, encouraging the minimum amount of state intervention consistent with the fullest use of the country’s resources (see Skidelsky 1977). There was no presumption here that the state would control the economy through budgetary policy, merely that budget deficits would be resorted to as a means of pulling the economy out of a slump. However, what worried contemporary politicians about the development programmes of Lloyd George, Oswald Mosley, Keynes and others was their implicit assumption of a powerful central executive, their rejection of the inherent efficacy of market forces in favour of some form of managed capitalism, and a suggested timetable of action which smacked of bureaucratic dictatorship (see Middleton 1983; Peden 1984). It is hardly surprising therefore that there is scant evidence of a conversion to Keynesianism by 1939, despite the fact that the foundation of Keynes’ arguments in favour of a more deliberate use of monetary and fiscal policy had found sophisticated expression in the General Theory. Indeed there are good reasons for not dwelling unduly on the absence of a coherent body of economic analysis in support of deficitfinanced public works as an excuse for the shortcomings of government policy. It is unlikely that such a policy of national reflation would have gained earlier acceptance even had there been a more progressive elucidation of the concept of the multiplier or of the idea of pumppriming. The influences determining the official response to interventionist remedies on behalf of the unemployed have to be sought outside of the imperfections of economic knowledge. After all, Keynes had an instinctive grasp of policy priorities long before the General Theory provided the theoretical foundations to support many of his proposals. It was the imperfections and injustices of the laisser-faire system and not the blatant inadequacies of economic theory that spurred Keynes to action. What was distinctive about inter-war Britain, however, was the predisposition of those directly influencing economic policy (principally within the Treasury) and those bearers of economic orthodoxy elsewhere, especially in the City, to eschew any attacks upon conventional economic management which threatened their immediate interests or their sense of intellectual or moral superiority. Moreover, there was never much pressure from the unemployed themselves for a more radical approach. If anything, the depression blunted rather than sharpened the edge of social discontent. The Trades Union Congress proved reluctant to mobilise working class support for a reflationary economic policy. The unemployed came to regard their position less as an injustice to be remedied than as a misfortune to be stoically endured (see Garside 1985). KEYNES AND ‘KEYNESIANISM’ IN THE MODERN PERIOD The experience of the planned war economy of 1939–45 and the demands of reconstruction in the postSecond World War period are generally believed to have diminished substantially previous misgivings over interventionist economic policy. The persistence of full employment in wartime, and the desire to learn from the mistakes of the 1930s, encouraged a belief that a new era of economic management had come to dominate public policy. We now know from the public record that the so-called conversion of government officials to ‘Keynesianism’ in the post-1940 period was a far more drawn-out affair than we have previously supposed, the Treasury resisting the idea of deliberate use of the budget for management purposes down to the late 1940s and beyond (see Booth 1989). Contemporary observers of the 1950s and 1960s, however, were content to view those decades as the high periods of demand management in the UK. From the standpoint of the recession of the 1980s, those years had the appealing characteristics of high employment, moderate growth and reasonably stable prices, assisted by the absence of external economic shocks and by the restrained financial policy of the USA. The Keynesian approach to demand management adopted in Britain after the war was certainly couched in terms

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of budgetary action. Regard was paid to monetary conditions but care was taken to make monetary and fiscal policy pull in the same direction. Shortterm interest rates moved in sympathy with the government’s fiscal stance. Governments did not deliberately limit the money supply as a prime object of policy. The principal preoccupation was to use the budget to ensure that the pressure of demand was neither too great nor too deficient. The universality of full employment in the post-war period, however, makes it difficult to attribute it to successful economic management or to the influence of Keynesian ideas in any particular country. The problems of the post-war world were different from those of the world in which Keynes had lived; a world of obstinate unemployment and stable or falling prices. Mass unemployment disappeared after 1945 and worries over deflation were replaced by a watchful eye on the prevailing level of inflation. The post-war boom, the buoyant levels of private investment, and the rapid expansion in trade meant that the regulation of employment could be undertaken within very narrow limits. These were not, therefore, years of budget deficits. Indeed over the period of the 1950s and 1960s the British government’s general stance towards the economy was somewhat deflationary. The level of world demand, the buoyancy of the American market, and expanding trade supported a prolonged investment boom and the persistence of full employment had only the slimmest connection with the strict application of Keynesian ideas (see Matthews 1968). Except in one important respect. To the extent that the ‘Keynesian Revolution’ had convinced businessmen that the government would intervene to stem any major recession there was a sufficient underpinning of confidence to sustain investment. Cyclical fluctuations continued, of course, but they generally implied only temporary unemployment, many of those laid off finding it relatively easy to obtain work again when the upturn came. The low levels of unemployment were assisted, moreover, by the implicit agreement between government, employers and the trade unions that the latter would exercise informal wage restraint in return for full employment, thereby enabling periods of high aggregate demand to exist without the inflationary consequences of a money-wage explosion. Nonetheless, it is clear in retrospect that government commitment to full employment, stable prices and a healthy balance of payments after 1945 actually began to erode confidence in the Keynesian prescription. Post-war Britain was now more fully bound up with the international economy and the rise of new competition. It had to contend with a series of balance of payments crises and pressures on sterling, which demanded swift action by government when the pressure of demand threatened international competitiveness. The Keynesian obligation for most of the post-1945 period was to manage a high pressure of demand rather than to intervene regularly to stimulate economic activity. British governments had to remain constantly alert to the balance of payments consequences of rising imports. When, therefore, the economy threatened to overheat the budget was used to restrain demand up to the point where that restraint in itself threatened a slump. This gave rise to the infamous ‘stop-go’ cycle of demand management which subsequently evoked intense criticism. The complaint heard in the early 1960s was that demand management was producing fluctuations in economic activity rather than preventing them. Governments seemed to intervene just as the economy had started to build momentum, taking measures to withdraw purchasing power in order to bring the expansion under control. Thus British production in the 1950s tended to grow in short bursts punctuated by intermittent spells of stagnation of output. A presumption grew that if the government refrained from interventionist activity, stability and growth might improve (see Hatton and Chrystal 1992). And not, it seemed, before time. Countries whose economies had been more devastated by war than had Britain’s were making more rapid economic progress in relative terms. These concerns over the nature and consequences of demand management became more pronounced during the troubled decade of the 1970s. With output falling and unemployment rising, the Conservative

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government made a dash for growth. Fiscal policy became steadily reflationary from 1971 and credit was made extremely attractive by the abolition of direct controls on bank lending. The effect of such monetary laxity was to increase the rate of inflation. When further inflationary twists were added by the world-wide commodity price boom, the oil price shocks of 1973–4, and by the depreciation of sterling after it had been floated in 1972, the authorities were forced on the defensive. Suddenly the government faced the unenviable prospect of failing to achieve any of the four principal policy objectives of the post-war economic consensus, namely adequate economic growth, full employment, a satisfactory balance of payments and stability of prices. Attempts were made to hold back wage pressure by the use of statutory prices and incomes policy whilst demand was kept at a level sufficient to reduce unemployment. Interest rates were raised towards the end of 1973 and new forms of direct control on bank lending were introduced but inflation accelerated to over 24 per cent in 1975. It was in these strained circumstances that serious doubts began to be expressed about the efficacy of Keynesian demand management. Officials were reluctant to expand aggregate demand to reduce unemployment when faced with accelerating inflation. In the early post-war period, economists and politicians had been optimistic about their ability to achieve simultaneously the objectives they had set themselves. During the economic recession of the 1970s, however, the question frequently posed was not how could governments achieve their economic objectives but was it possible for them to do so? Could governments manage an economy along a path of stable growth, with low levels of unemployment, low inflation and an acceptable balance of payments position? The eclipse of fiscal policy came not because of its proven failure to influence aggregate demand but because of its apparent impotency in the face of severe supply shocks (see Cairncross 1986). Keynes himself had not been unmindful of the problems that an overreliance on demand management alone might bring. Although he had always insisted on control over the level of effective demand as a precondition of full employment he was fully aware that this was not a sufficient condition. Throughout the 1930s, he drew attention to perversities in the behaviour of markets that could thwart the efforts of government to expand demand. Deficit expansion, for example, might fail in its effects if the City and businessmen believed governments to be involved in unsustainable extravagance. Ever increasing demands on the money supply could also generate alarm and lead to an outflow of funds and pressure on foreign exchanges. Any success government intervention might have in curing unemployment, Keynes noted in 1943, would weaken the economy’s resistance to the inflationary problem. Conditions of full employment would make it extremely difficult to prevent a progressive increase in wages. ‘The task of keeping efficiency wages reasonably stable’, he wrote, ‘is a political rather than an economic problem’ (quoted in Lord Kahn 1974). The change in official attitudes towards the management of the economy as a consequence of the searing experience of inflation in the 1970s combined with high and persistent unemployment was remarkable. Conventional methods of demand management seemed wholly inadequate to deal with rising public expenditure, a balance of payments in heavy deficit, a drain in foreign exchange reserves, a fall in the exchange rate and unemployment at a level unprecedented since the Second World War. The words spoken by Prime Minister Callaghan at the 1976 Labour Party Conference proved symptomatic of the change in attitude to Keynesian-like intervention: ‘We used to think’, he declared, ‘that you could just spend your way out of a recession, and increase employment, by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and that in so far as it ever did exist, it worked by injecting inflation into the economy.’3 The Labour Party, reflecting this new sentiment, introduced monetary targets from 1976, beginning in effect the process of downgrading employment policy, a move taken up with a vengeance by the Thatcher administration a few years later.

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By the end of the 1970s, Keynesianism had become increasingly discredited. Criticism of the theory of demand management was levelled by key economists, notable Milton Friedman. Government itself gave less prominence to full employment as a goal of economic policy. The fundamental problem lay in the difficulties associated with sustaining full employment in conditions very different from those of the 1930s. The General Theory may have produced a sophisticated theoretical paradigm against which to pitch the ‘Keynesian Revolution’, but it had very little to say as such on the application of policy. The ‘stop-go’ policies of the 1950s and 1960s had demonstrated the difficulties of adapting an economic philosophy forged in years of severe depression to a world of buoyant economic conditions and tight labour markets. And there were attendant problems. Employers had conceded large-scale wage demands, partly because full employment enabled them to pass such wage increases on to consumers as price increases. The overriding belief in full employment led firstly to cost inflation and then to employers substituting capital for labour when worries over prices became more explicit. Although Keynes had recognised the inflationary threat posed by full employment policies, this was not a threat sufficiently recognised by governments, trade unionists, or employers. Britain conspicuously failed to develop any effective system of income restraint and had a poor history of encouraging tripartite discussions to determine the relative shares of wages and profits in a competitive economy. It is clear in retrospect that the kind of Keynesian demand management exercised in the years after 1945 relied too heavily upon crude instruments of economic policy. In reality, governments were far less able to ‘fine tune’ the economy than they cared to believe. Indeed, the actual influence of government on economic events from 1945 was small in comparison with the effort that it put into policy-making. The aims of policy were themselves influenced by events and government attempts to manage the domestic economy seemed, in reality, little more than a reaction to circumstances.4 By the time Thatcher gained power in 1979 the stage was set for a fundamental reappraisal of the means and objectives of macroeconomic policy. Her administration, reflecting on the experience of the 1970s, put the defeat of inflation everywhere and the maintenance of full employment nowhere. It perpetuated the policy initiated by the previous Labour administration of setting a target for the money supply around which other economic variables would be made to settle. The post-war consensus was turned on its head. Keynesianism seemed to have had its day. However, such was the deflationary impact of relying upon the rate of growth of the money supply as the predominant instrument of economic policy, that the Thatcher administration soon had to abandon its strict reliance upon monetary targets. What emerged from the mid-1980s, in effect, was a disguised form of demand management as the government found itself obliged to sustain those thrown out of work as a consequence of its strict monetary regime. CONCLUSION Two things are clear from the British experience outlined above. First, the resistance during the interwar period to Keynes’ ideas for interventionist government policies to prevent an economy becoming locked in underemployment equilibrium were much stronger and more powerful than is commonly supposed. There was no ‘Keynesian Revolution’ in the 1930s. The Treasury’s opposition to unsound finance was based on a sophisticated appraisal of what it believed to be the most appropriate response to contemporary economic circumstances. It would be foolish, in other words, to presume that governments failed to understand the message of Keynes and missed a golden opportunity. The Treasury understood very clearly what Keynes was saying both in the 1920s and the 1930s, at least in terms of a clamour for a fundamental redirection of economic priorities. However, it refused to acccpt that Keynes’ policy advice would actually improve the contemporary situation. To the official mind, maintaining the status-quo ante was the most effective way of

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promoting stability, growth and ‘real’ jobs. It would be unwise to presume that Keynes’ challenge to economic theory, even had it become available earlier, would in itself have proved sufficient to persuade Whitehall officials to abandon policies they fervently believed to be in the national interest. The second lesson it that ‘Keynesianism’ played only a supportive role in the economic performance of Britain down to the 1970s. There is no doubt that the commitment to full employment and interventionist economic policy helped to sustain confidence and private investment. But economic management remained crude and untested during the 1950s and 1960s. Ironically, when the need for robust government intervention came in the downturn of the 1970s, it occurred at a time when Keynesianism, cast in the post-war mould of containing high levels of demand, seemed singularly inappropriate. What brought about the subsequent reorientation of macroeconomic policy? Four features of British economic life in the 1970s provide an answer. First, the rapid inflation that occurred in the 1970s; second, the growing success of economic theorists strongly critical of post-war Keynesian orthodoxy of demand management; third, appreciation of the practical difficulties of ‘fine tuning’ economic activity; and fourth, a discernible move away from the idea of state intervention and public expenditure towards private sector activity and the market economy. These factors proved powerful because they were mutually reinforcing. As economic conditions declined so the belief in the effectiveness of demand management diminished. Critics of Keynesianism gained credibility as official economic policy conspicuously failed to achieve its promised goals of price stability and job security. Faced with the persistence of ‘stagflation’ it was clear that demand management as a single instrument could not cope with both problems. The situation was made worse by the deterioration in economic circumstances internationally. In the early post-war years external economic conditions were favourable for Britain with world trade booming, currencies relatively stable, and the international monetary system unified by the leadership of the United States. Subsequent years were marked by a lack of a coherent international financial system and by fluctuating currencies. When these trends were combined with an escalation in oil prices and a decline in the growth of world trade in the 1970s domestic expansion became increasingly difficult to achieve. Criticism of Keynesian policies was swift to emerge. Why did the call for more state intervention along Keynesian lines not appeal to the British government when deepening recession in the 1980s seemed to provide its clearest rationale? Ironically, although the power of economic theory to influence the course of events proved limited in the interwar period, it was the development of a set of theoretical propositions counter to the ‘Keynesian Revolution’ that enabled monetarist economists in the early 1980s to advance two principal arguments of significance. The first was that the main determinant of the level of aggregate demand was not investment or government spending or other Keynesian autonomous items of expenditure but rather the supply of money. Fiscal policy, in other words, could make only a very marginal contribution to the management of detmand. The second proposition was that in a world where workers, expecting price rises, had begun to bargain for real rather than money wages, the authorities could no longer reduce unemployment below its natural rate without generating a higher rate of inflation (see Smith 1977:44–55). These two propositions sustained the doctrine that government intervention should be limited to the control of the growth of the money supply. By implication, fiscal policy and discretionary intervention to manage the level of demand had to be downgraded as objectives of policy with attention increasingly focused instead upon microeconomic policies (including taxation and reform of the trade unions) designed to increase incentives and improve the supply side of the economy (see Minford 1991). These changes in economic thinking were reinforced by growing doubts about the record of demand management in previous decades. The problems of fine tuning the economy in the 1950s and 1960s, so graphically illustrated by the ‘stop-go’ cycle of economic activity, indicated how difficult it had been to

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manage the economy in ways Keynesians assumed were available to them. Those who sought to manage the economy had often been unable to forecast with much confidence the effect of changes in taxation or other budgetary instruments. Time lags and the uncertain reaction of economic agents had raised fundamental questions about the feasibility of demand management. To this weakening influence was added a backlash against the growth of the state in favour of individual freedom, and support for the curative and energising effect of competitive market forces.5 Does this mean that employment policy or, more broadly speaking, Keynesian demand management as we customarily view it are things of the past? Not necessarily. If Britain can learn from the record of traditional demand management and from her experiment with monetarism then the lessons preached by Keynes in the interwar period might still prove useful. A deliberate attempt to stimulate demand to protect incomes and jobs could operate in conditions of underused capacity without higher public expenditure crowding out private spending. The reaction against Keynesianism in the 1970s arose from a growing awareness of the difficulties of applying his theory to shifting national and international circumstances. We now recognise better than in the past that demand management, conventionally defined, is not sufficient in itself. It has to be accompanied by, among other things, appropriate policies to deal with the balance of payments, the variable economic position of the regions, the elasticity of manufacturing output, the need for adequate investment in human capital in terms of training and education, and the determination of the level of money wages. This will call in the latter case for radical changes in the relationship between the state, employers and the trade unions. Britain has never successfully forged a workable dialogue among these parties and has suffered as a consequence. This should not be blamed on John Maynard Keynes. The ‘Keynesian Revolution’ may yet have its day. NOTES 1 2 3 4 5

For details of the conflicting views see Garside (1990). For detailed treatment of interwar unemployment policy see Garside (1990). Labour Party (1976). For a powerful condemnation of official policy see Pollard (1982). These are the themes of my current research on the rise and fall of Keynesianism in Britain, 1939–90.

REFERENCES Booth, A. (1989) British Economic Policy 1931–49. Was There a Keynesian Revolution?, London: Wheatsheaf. Cairncross, A. (1986) Economics and Economic Policy, Oxford: Basil Blackwell. ——(1992) The British Economy since 1945, Oxford: Basil Blackwell. Crafts, N. and N.Woodward (eds) (1991) The British Economy since 1945, Oxford: Oxford University Press. Garside, W.R. (1985) ‘The Failure of the “Radical Alternative”: Public Works, Deficit Finance and British Interwar Unemployment’, Journal of European Economic History 14:537–55. ——(1990) British Unemployment, 1919–1939. A Study in Public Policy, Cambridge: Cambridge University Press. Glynn, S. and A.Booth (eds) (1987) The Road to Full Employment, London: Allen and Unwin. Hatton, T. and K.Chrystal (1992) ‘The Budget and Fiscal Policy’, in N.Crafts and N.Woodward (eds) The British Economy since 1945, Oxford: Oxford University Press. Keynes, J.M. (1924) ‘Does Unemployment Need a Drastic Remedy?’, Nation and Athenaeum 24 May: 235–6. Labour Party (1976) Report of the Annual Conference of the Labour Party, 1976. Lord Kahn (1974) ‘On re-reading Keynes’, Proceedings of the British Academy 60:361–91. Matthews, R.C.O. (1968) ‘Why Has Britain Had Full Employment since the War?’, Economic Journal 78:555–69.

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Middleton, R. (1983) ‘Treasury and Public Investment: A Perspective on Interwar Economic Management’, Public Administration 61:351–70. ——(1984) ‘The Measurement of Fiscal Influence in Britain in the 1930s’, Economic History Review 37:103–6. ——(1987) ‘Treasury Policy on Unemployment’, in S.Glynn and A.Booth (eds) The Road to Full Employment, London: Allen and Unwin, 109–24. Minford, P. (1991) The Supply Side Revolution in Britain, Aldershot: Elgar. Moggridge, D. and S.Howson (1974) ‘Keynes on Monetary Policy 1910–1946’, Oxford Economic Papers 26:226–47. Peden, G. (1979) British Rearmament and the Treasury, 1932–1939, Edinburgh: Scottish Academic Press. ——(1984) ‘The “Treasury View” on Public Works and Employment in the Interwar Period’, Economic History Review, 2nd ser. 37:167–81. Pollard, S. (1982) The Wasting of the British Economy. British Economic Policy 1945 to the Present, London: Croom Helm. Shay, R. (1977) British Rearmament in the Thirties, Princeton: Princeton University Press. Skidelsky, R. (1977) ‘The Political Meaning of the Keynesian Revolution’, in R.Skidelsky, The End of the Keynesian Era, London: Macmillan, 33–40. ——(1979) ‘The Reception of the Keynesian Revolution’, in M.Keynes (ed.) Essays on John Maynard Keynes, Cambridge: Cambridge University Press, 89–107. Smith, D. (1977) The Rise and Fall of Monetarism. The Theory and Politics of an Economic Experiment, London: Penguin, 45–55.

INDEX

Academic Charter (Netherlands, 1938) 122 Agricultural Crisis Act (Netherlands, 1933) 108 Amadeo, E.J. 6 Amsterdam Municipal University 120 Arestis, P. 2 Aslanbeigui, N. 8, 52 Austrian capital theory 90–1, 94 autonomous consumption 89

Colander, D.C. 4 Collard, David 8 competition see imperfect competition, perfect competition co-ordination failure 28, 32, 72–85 Cottrell, A. 8 Crafts, N. and Woodward, N. 133 credit economy 96 Crisis Import Act (Netherlands, 1931) 108 cultural framework for economics 114, 117

balance of payments crises 142–3 banks 46 Barro, R. and Grossman, H. 28, 31 barter illusion 8, 66 Blaug, M. 7, 10 Blinder, A.S. 5 Böhm-Bawerk, E.von 73–4, 78 Booth, A. 3, 141 Brady, M. 8 Britain 4, 10–11, 65, 133–47 bureaucracy 109 business cycles 3, 5, 33, 80–1, 85, 108–9, 116, 136, 138, 141 business studies 120

De Vries, F. 110–19, 122 De Vroey, M. 2, 5–7, 17–18, 22, 26, 30, 41, 77 defence spending 139 deficit financing 136–40, 143 demand: deficiency of 6 demand management 10, 26, 34, 141–7 devaluation of currency 118 disequilibrium processes and models 9, 28, 94 division of labour 83 dynamic analysis 21, 25 econometrics 105, 120 Economic Council (Netherlands) 109–10 economic growth see growth economic laws 115–16 Economic Journal 45 economic policy designs 106–7, 116, 118, 123 economists: professional identity and standing of 106, 122 effective demand: principle of 6–7, 40–7, 73–8 efficiency wage model 6, 28–9, 33 employment policy 134–6; see also demand management equilibrium 6–7;

Cairncross, A. 133, 143 Caldwell, B.J. 79 Callaghan, J. 144 capital, return on 88–90 Central Bureau of Statistics (Netherlands) 116–17 Central Electricity Board (UK) 135 Chrystal, K. 1, 142 Churchill, Sir Winston 139 classical economics 7, 29, 114; see also new classical school Clower, R. 31–2; and Leijonhufvud, A. 28–9 31–2 35 Cobbenhagen, M.J.H. 112–21 111

112

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economic and social 121; partial and general 21, 24–7; see also intertemporal general equilibrium economics and ethics 113 ex ante and ex post analysis 3, 6–7, 41–3, 72, 76 expectations 6, 40, 61, 72, 78, 92–3, 100, 137; long-run 78; see also fallible expectations factor cost 7, 41, 43–7 factors of production 46–7; prices of 89 fallible expectations 76, 78, 83 false trading 31 Favereau, O. 24 ‘finance motive’ 45 fiscal policy 61, 67, 137–43, 146 Fisher effect 96, 99 Foss, N.J. 79–80 free trade 108, 122 frictional unemployment 19–21, 24 Friedman, M. 26, 144 full employment 26–7, 35, 40–1, 51, 54, 96, 105, 107, 133, 137–8, 140–1, 144–5 Gallegati, M. 3, 9 Garretsen, H. 82 Garside, W.R. 4, 10–11, 136, 140 General Theory 144; sub-text of 23–4 George, D.L. 140 Gerrard, B. 17–18 Gnos, C. 2, 6–7 gold standard 108, 137–8 government officials, economic understanding and views of 10, 133, 138–40, 143, 145 Greenwald, B.C. and Stiglitz, J. 4 Grossman, H. 28, 31 growth 9, 94, 96 Guthrie, W. and Tarascio, V.J. 9 Hatton, T. and Chrystal, K. 142 Hayek, F. 8–9, 72–85, 90–1 Hellwig, M. 84 Hicks, J.R. 23, 27–32, 34, 47, 79–82 Hoover, K. 2–3, 9, 81 Howson, S. 137 Hutchinson, T. 8, 51, 79

imperfect competition 21, 25, 105, 107 implementability of policies 33 import quotas 108, 110 income: distribution of 90–1, 93–4 income and output: equality of 40–7 passim inflation 142–6 interest rate 81, 88–93, 96, 137–8, 141–2; natural 77; negative 60; proper 60–1, 64; real 61 intertemporal general equilibrium 74, 77, 79–80 investment: misdirected 75–6 investment and saving: equality between 2, 6–7, 40, 43, 74 involuntary unemployment 5–6, 17–27, 31–2, 34–5, 41, 76–8, 85 IS-LM model 1, 23, 27–31, 33–4 ‘just price’ 114 Kahn, L. 143 Kaleckian analysis 24, 98 Keynesian research programmes 22–6, 28, 34–5 Keynesian Revolution 3, 7–10, 141, 145–7 Keynesian theory, boundaries of 33–4 Klausinger, H. 3, 8 Kregel, J.A. 73 labour market explanation of unemployment 24, 32 labour as sole factor of production 46–7 labour supply and demand 30, 88–9, 95 Lachmann, L.M. 77–9, 82, 84–5 Laidler, D. 1, 7 League of Nations 116 Leijonhufvud, A. 2, 8, 17–18, 28–32, 35, 73, 76, 79, 85 Leontief, W. 26 Liberal Party 135 Lindahl, E. 3, 9, 88–100 liquidity trap 61, 96 Loasby, B. 3, 6, 8 London School of Economics 73–4 Lucas, R.E., Jr 5, 10, 26, 33, 81; and Sargent, T.J. 11 macroeconomics:

INDEX

breakdown of consensus in 1–4 macroeconomic principles: application of 10–11, 18, 133–4, 141 Mankiw, N.G. 1, 4; and Romer, D. 2 market clearing 22, 25, 53 market failure 76, 105 Marshall, A. 21, 24–5, 27, 30–2, 77, 84 Matthews, R.C.O. 141 Menger, C. 80–2 Middleton, R. 136, 139–40 Minford, P. 146 Mises, L.von 90 Modigliani, F. 30 Moggridge, D. and Howson, S. 137 monetary disorder 75–8, 84 monetary equilibrium 74 monetary policy 108–9, 137–8, 140–5 monetary systems: standard and non-standard 57–67 money: neutrality of 29; role of 41, 45–7, 80–2, 84 ‘money illusion’ 9 money supply and monetarism 96, 144, 146–7 Mosley, O. 140 Moss, L. and Vaughn, K. 90 Myrdal, G. 3, 6, 8, 41, 72–3, 82–3 National Debt 134 Negishi, T. 31 Netherlands 4, 10, 105–11, 116–23 new classical school of economists 34 O’Driscoll, G.P., Jr and Rizzo, M.J. 81 Ohlin, B. 9, 42, 46, 77–8 ‘optimal’ as distinct from ‘consistent’ policy 3 optimal planning, theory of 84 overemployment 25 Patinkin, D. 27–31, 34–5, 96 Peden, G. 139–40 perfect competition 21, 25, 111–12 Phelps, E.S. 1 Pierson, N.G. 111 Pigou, A.C. 3, 7–8, 51–67, 96 policy decision-making: involvement of economists in 3–4, 105–9, 118, 123 policy irrelevance proposition 3

Ponzi game 100 Popper, K. 83–4 Price, S. 1 price system 113–15 prices and incomes policy 142 profits 44–5, 92, 95, 98; maximization of 53 protectionism 108 public expenditure 134 public works 52, 56, 60–1, 64–7, 134–40 quantitative methods in economics 115–18, 122–3 ‘radical’ strategy on unemployment 19, 23–4 rational choice theory 78 rational expectations 76, 82 ‘reformist’ strategy on unemployment 19, 23 relative prices 90–1 reservation wage principle 22, 26 reverse Pigou-Patinkin effect 96 Ricardian equivalence proposition 3 Ricardo, D. 29, 90 Richardson, G.B. 82 Rizzo, M.J. 81 roadbuilding 135 Robbins, L. 73, 79 Roberts, J. 28–9, 32–3 Robertson, D.H. 78, 81 Robinson, J. 25 Rollings, N. 3 Romer, D. 2 Rotterdam: Netherlands Trade School in 119–22 roundabout methods of production 73–5, 82 Samuelson, P.A. 47 Sargent, T.J. 11 Say’s Law 40, 43 Schmitt, B. 44 Schumpeter, J.A. 76, 85 search unemployment 21 Seccareccia, M. 88 Second World War 140 sequence analysis 72 Shackle, G. 3, 6, 9, 41–2, 72–3, 76, 78–9, 81–2, 85 Shapiro, C. and Stiglitz, J. 28, 32 Shay, R. 139 shirking model 29, 32 Skidelsky, R. 1, 138–40

113

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INDEX

Smith, D. 146 Snowdon, B., Vane, H. and Wynarczyk, P. 3 social role of economics 118 socialism 79 sociology 10, 114, 119–21 sound finance 134–5, 145 spill-overs across markets 30 spontaneous order and disorder, theory of 84 Sraffa, P. 25, 77 stabilisation policies 3 static analysis 21, 25 Stiglitz, J. 4, 28, 32 ‘stop-go’ cycle 142, 144, 146 subsidiarity 121 supply side measures 146 Tarascio, V.J. 9 Tarshis, L. 24 tâtonnement 30–1 Thatcher, M. 144 Thomas, B. 73, 79 Tilburg Roman Catholic Trade School 119–22 Tinbergen, J. 10, 116–18 Tobin, J. 25, 96 Tomlinson, J.D. 3 trade cycles see business cycles trade unions 140–1, 146–7 transactions cost 82 Treasury orthodoxy 134–41, 145 Tropeano, D. 3, 9, 88 underemployment 17–19, 22, 25–6, 95–6, 145 unemployment 4, 92–3, 107, 134–6, 139, 141–5; labour market explanation of 24, 32; natural rate of 146; Pigovian theory of 3, 8, 51–67; see also frictional unemployment, involuntary unemployment, search unemployment unemployment decision tree 2, 5, 17–23, 27, 32–4 United States 11, 141, 146 user cost 43 Vane, H. 3 Vaughn, K. 90 Verrijn Stuart, C.A. 111 wage cuts 137 wage policy 65–6 wages, monetary and real 21, 59–67, 91–3, 95;

see also reservation wage Walker, D. 32 Walrasian analysis 19, 21, 24, 29–32, 54, 73–4, 79–81, 84 Weintraub, E.R. 29, 47 Wicksell, K. 8–9, 73–6, 78–80, 89, 92, 96 Wilts, A. 4, 10 Witt, U. 80–1 Woodward, N. 133 Wynarczyk, P. 3