Asia Times Online :: Asian news and current affairs

Oct 1, 2009

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Off with their blinkered heads
By Julian Delasantellis

The employment bust that followed World War I's employment boom also exacerbated this tendency; if governments and their armies were not going to buy any more of these factories' guns and tanks, the private sector probably wasn't going to do so, either.

Back in those days, in the economics profession, when crises or downturns in the general economy occurred, the policy response was slow to non-existent due to the profession having voluntarily encased itself in a straitjacket called "Say's Law", which stated that supply created its own demand. Thus, if things were going unsold and factories were closing as a result, all that had to

happen was that prices had to be slashed on the unsold goods; then, they'd get sold, and workers would get hired.

But Keynes saw this not happening, not after the job losses of the postwar period, especially not after the much larger job losses of the Great Depression of 1929. Instead, when companies tried to reduce prices to better meet demand, it just made things worse, since, at the lower prices, the companies weren't clearing enough profit to stay in business.

There was a missing, new factor that Keynes would add to the equation-demand.

Here in America, where you can own a candy store and be called a communist by your competitor if you lower prices on Snickers bars by a nickel, it's common to call Keynes a communist, perhaps along the lines of the Stalinist apparatchiks then brutally taking over the economy of the Soviet Union. Nothing could be further from the truth; Keynes was no proletarian Bolshevik; he was a confirmed upper class bourgeois bohemian, firmly committed to saving the system that had born and bred him into this lap of luxury.

If jobs were deficient and supply nominal, then it had to be demand that was the problem; there just wasn't enough general demand in the economy to keep the workers in the factories of the products demanded. In Keynes 1936 signature work, The General Theory of Employment, Interest and Money, Keynes expounds on, for the time, (and probably for this time, if last winter's debate on the Barack Obama stimulus proposals can be taken as a guide) some very revolutionary proposals.

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing."

Many of US president Franklin Delano Roosevelt's New Deal architects were confirmed Keynesians, and when the economy improved, or at least stabilized, sufficiently, to earn Roosevelt re-elections in 1936 and 1940, the theory gained more respect, as it did with the full employment arising from World War II's war orders and rebuilding of the industrial base, a sort of world Keynesian experimental laboratory by itself.

Keynes was an important adviser at the Bretton Woods conference that restructured the postwar international financial architecture from the gold-anchored failures of the 1920s and 1930s to the US dollar-centered system that survived up until 1973. When the new social democratic economies that emerged from out of the Nazi tyranny in Western Europe proved themselves firm devotees of Keynes for their rebuilding, the age of Keynesianism, of mixed government/private sector economies, could be said to have been truly at hand.

But as the postwar period progressed towards the 1970s, questions were raised about how relevant the master was to these new periods. Sure, most Western economies were operating at or near full employment, but that raised the specter of a phenomenon that Keynes had seemingly poorly, or not at all, planned for - inflation.

It was time for the second giant to arise, from Brooklyn via the University of Chicago. Although standing at only about 160 centimeters tall, Milton Friedman was the giant who ruled the financial world for the rest of the century.

It's not as if the Keynesians (Keynes himself died in 1946) had nothing to say about inflation, no matter how little a threat it posed to the economies of the world during the formative years of Keynes' theories.

Keynesians came to believe that there was a natural see-saw type relationship between inflation and unemployment. This tradeoff was measured on something called the Phillips curve, which had inflation falling/rising as unemployment rose/fell. In the case of too high inflation, the policy prescription was to bump up unemployment a bit, so that the newly unemployed were not so aggressively bidding with other consumers to bid up prices. This was done by having the government increase unemployment by either raising taxes or cutting back on the stimulus spending approved back when unemployment was high.

But what if what was happening was something that the Keynesians said was impossible - simultaneously high and rising inflation and unemployment? This was the situation that many industrial economies seemed to be in following the oil price shocks of the 1970s, one clearly not responsive to Keynesian policy prescriptions. The example of Britain, in particular, where the Mineworkers Union brought down the Conservative government of Edward Heath in 1974 by threatening to let the nation freeze and starve, convinced many that another economic alternative besides just letting unions run rampant in order to stimulate demand had to be found.

The new risen hero, Friedman, had as his core professional specialization monetarism, the study of how changes in the availability and supply of money to the general economy affected the general level of prices and output. This was a subject that Keynes basically ignored. But over and above monetarism, Friedman's economics, sometimes called neo-classicism, or random walk, or the rational expectations or Chicago School (due to the fact that so many of its practitioners found sinecures at the graduate economics department of the University of Chicago) had one, fairly simple common and enduring point.

Where Keynes seemed to believe that more government intervention in the economy was always better than less, Friedman and the Chicago School affirmed just the opposite, that private actors seeking the maximization of individual profit would always make better decisions than faceless bureaucrats deciding issues on the basis of some amorphous "public interest".

Monetarism's first working field test, in Chile in 1973, following the Augusto Pinochet junta's overthrow of the democratically elected government of Salvador Allende. Prior to the Pinochet coup, Allende's support of the trade unions and expansionary monetary policy led to inflation rates topping 140%. Pinochet, operating under the guidance of the Chicago School, and after personally meeting Friedman in 1975, slashed government spending and subsidies, and controlled the trade unions, frequently by the execution of their leaders.

Friedman never denied the brutality of the junta; he just said that, in lifting the prospect of economic uncertainty imposed by Allende, he was just respecting the Chilean people's right to make free economic decisions, a human right he placed equal to or above standard political rights.

By the late 1970s, it was clearly becoming the age of Friedman. It was self-evident that the Keynesian consensus was ineffective in fighting inflation. Friedman won the Nobel Prize in Economics in 1976. That, and the obvious failures of Keynesian governance in America, with Jimmy Carter, and Britain, with James Callaghan, meant that Friedman et al were the voices to listen to in all matters economic.

With the second oil shock of 1979-1980, inflation became the scourge of the capitalist world, and the capitalist world remembered the quick success Friedman's policies had had in suppressing inflation in Chile. Friedman took a place on newly elected US president Ronald Reagan's Economic Policy Advisory board. Other Chicago School confidants were also close advisors to Margaret Thatcher.

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