I. “The Keynesian Revolution”

UNTIL THE end of World War II, the most widely used economics textbooks in America were still in the classical tradition. They taught that free enterprise was a workable system. It had its faults, they said, such as inequalities and monopolies, but at least it gave us a maximum of individual opportunity and economic progress.

What the “new economists” propose

Now the most widely used textbooks present a very different view, one which the authors call the “new economics,” or the “Keynesian revolution.” This new set of doctrines purports to prove that free enterprise, in addition to other alleged faults, is “without a steering wheel or governor,” inherently unstable and inefficient.

Because of this inherent and basic defect, the theory goes, a “mature” economy like that of the United States must suffer an intolerable degree of unemployment and unused capacity—unless government comes to the rescue.

Government is to effect this rescue by taking charge of all incomes, savings, investment and spending. It is to exercise its control through taxation, subsidies, government ownership and executive orders. The aim is to regulate spending, saving, investment, prices and wages so that the flow of spending always equals the flow of goods, thus bringing about full employment and capacity production without too much inflation.

This government “management” is labelled a “compensatory fiscal and monetary policy.”

A “managed economy” from now on

Of course, governments throughout the world are already following such a policy to a greater or less extent. But many persons, especially in the United States, hopefully believe that it is in some way connected with war or the threat of war. They are vaguely aware that some economists and politicians want to make it permanent and more complete. But they think that such “radicals” are in a minority. They expect more “conservative” leadership will eventually win out, put a stop to the present drift, and restore at least enough freedom of enterprise so that America may once again become a land of ever more abundant opportunity. Furthermore, they hope that this reversal of the trend will come about before any great disaster overtakes them.

What such optimists do not realize is that a revolution in economic thought now taking place in American colleges and universities is rapidly making any reversal of the present trends increasingly difficult and improbable. Still less do these optimists realize that disaster may even now be overtaking them and multitudes of other individuals as they fall victims to the supposedly new economic thought and policy.

“Keynes . . . had the revelation”

Typical of this “new economics” is the book which has held first place in college adoptions since 1949: Economics, An Introductory Analysis, by Paul A. Samuelson, professor of economics at the Massachusetts Institute of Technology. Other textbook writers of the same school of thought are Lorie Tarshis, Seymour Harris, Theodore Morgan, Richard Ruggles, Lawrence R. Klein, J. A. Nordin and Virgil Salera.¹

These authors and teachers, along with hundreds or thousands of their associates, are deliberately and systematically trying to bring about what they themselves call a revolution in the economics being taught to American college students.

According to a survey reported in the American Economic Review for December, 1950 (Supplement, Part 2), nearly 80 per cent of the college teachers questioned were then teaching economics from the point of view of the “new economics.”

Until recently, the authors of this revolution did not hesitate to call themselves “Keynesians.” Now, most of them call their view the “national income approach,” or “the national income determination-full employment approach.” But, as Professor Harris, one of their number, says, it was Lord Keynes who “had the revelation.” It was this English economist who revived and popularized the old pattern of thought which is the core of their system. “His disciples are now divided into groups,” continues Harris, “each taking sustenance from the Keynesian larder. The struggle for the Apostolic Succession is on.”²

“The reign of laissez faire has ended”

It was during the 1920s, in England, that “the revelation” came to this modern oracle, and perhaps one may better understand the message if he knows the circumstances which inspired it.

The problem which the economists of that country were debating was unemployment. From 1920 to 1937, except for one year, unemployment in England remained above 10 per cent of the labor force, a level equalled only twice before in the preceding 60 years.

Classical economists said that the causes of this chronic unemployment were interferences with free enterprise: heavy taxes and burdensome government restrictions; unemployment doles, which subsidized idleness; and trade union wage-kiting and restriction of output. The remedy, these economists argued, was to remove or reduce these burdens and restrictions.

The trade union leaders, of course, indignantly rejected this argument. So did the Fabian Socialists, who held many academic positions. However, the attack on the free-market theory of prosperity lacked academic prestige until John Maynard Keynes, a tutor at the University of Cambridge, joined in.

The inflation cure for unemployment

At first Keynes argued that cutting wages was the wrong remedy for unemployment in depressions because of “wage rigidities” arising from trade unionism and social security. In other words, at lower wages more jobs might be open but the unions and the doles would keep workers from taking them. Keynes said it would take years of mass unemployment to induce workers to accept lower wage rates, and that was too high a price to pay for free markets. The reign of laissez faire in England had ended, he said, and economists might as well stop pleading for it.

The only feasible remedy for the unemployment, in Keynes’s opinion, was to raise the price level so that employers could pay the wages demanded by the unions. To this end, he urged that the government and the Bank of England reduce interest rates and encourage an expansion of bank credit, even if this meant devaluing the currency in terms of gold.

The classicists, or free-enterprise economists, replied that the easy-money policy advocated by Keynes would be dishonest and dangerous. It would mean cutting the purchasing power of wages, and it would work only if the workers did not find out what was going on. If or when they learned the truth, they would demand wage increases to match the rise in living costs. This would nullify any possible benefits of inflation in reducing unemployment. They charged further that the devaluation of the pound or continued inconvertibility which Keynes advocated would violate a trust and endanger the business of England’s bankers, who financed most of the world’s international trade.

Why Keynes attacked thrift

In short, Keynes’s critics accused him of using the argument of political expediency to justify a bad economic policy.

In reply, Keynes tried to show that wage-maintenance and currency inflation are good economics as well as good politics, as long as there is less than “full employment.” For this purpose, he had to find some cause for chronic, large-scale unemployment other than high wage rates, high taxes, and the dole. He professed to find it in hoarded (uninvested) savings. Consequently, as Harris says, he began an “all-out attack on thriftiness.”³

Economists used to teach that individuals save mainly in order to invest or to spend later. They pointed out that most of the savings are deposited in banks, which lend them to businessmen and other producers. These borrowers spend (“invest”) the money for goods and services used in production. This keeps the money circulating and maintains the demand for labor. A rise in the supply of savings leads to a fall in the rate of interest, and this decline in interest rates stimulates borrowing and investment. An increase in investment opportunities leads to a rise in interest rates, which in turn encourages saving. Thus the supply of savings in free markets tends to equal the demand for loans to be used in financing production.

“. . . the system is in the lap of the gods”

Keynes and his disciples repudiate this line of reasoning. They deny that individuals, if left free to choose, adjust the flow of savings to the rate of investment or the rate of investment to the flow of savings. Says Samuelson, author of the best seller among college textbooks in economics: “Whatever the individual’s motivation to save, it has little directly to do with investment or investment opportunities . . . saving and investing are done by different individuals and for largely independent reasons.”⁴

It is only an accident, he asserts, if investments at any time equal the sums which individuals want to put aside as savings. Consequently, if individuals are left free to save as much as they wish, the result may be chronic depression and large-scale unemployment. Investors, explorers, and promoters may fail to open up sufficient new investment opportunities to induce businessmen to borrow the savings and put them to work, or population may not grow fast enough to provide markets for the products of the new machines in which businessmen invest. Or, the opposite may happen. Investment opportunities may increase faster than savings. If free to do so, banks may manufacture credit currency to finance these opportunities, and the result may be an inflationary boom with an unfortunate aftermath of financial stringency, crisis, panic, and depression. Nordin and Salera put it this way:

Hence, we say that the acceleration principle interacts with the multiplier to produce instability in the economy. Such instability is inherent in the system, as opposed to being the product of poor business judgment . . . We shall see that the government, which means all of us in the community, can do much to smooth out the fluctuations.⁵ (Italics supplied.)

In the words of Samuelson, “As far as total investment or money-spending power is concerned, the system is without any thermostat,” “. . . it is in the lap of the gods.”⁶

The Menace of the “Mature Economy”

In an economy with an open frontier, a high rate of invention, and a growing population, say the Keynesians, the opportunities may be sufficient to cause entrepreneurs to bid for and borrow all of the funds which consumers want to save.

In a more “mature” economy, however, like the United States since 1929, these economists say, investments are not so likely to keep pace with the amount individuals try to save. First, the field for investment shrinks, at least compared to what people try to save. Second, what they try to save (their “propensity to save”) increases as average incomes rise and as more of the income goes to the well-to-do, who have a high “propensity to save.”

Eventually, therefore, a time comes in “mature” capitalism, when the opportunities for investment fail to keep pace with the amounts individuals put aside as savings. When this happens, uninvested savings pile up in the banks. Some of the currency, then, no longer circulates; and total spending declines. Meanwhile, entrepreneurs have paid out money as income to producers. Now only a part of this money comes back to them in purchase of goods. In other words, entrepreneurs’ receipts fall below their expenses. The difference (equal to the uninvested savings) constitutes a business loss. Entrepreneurs must then reduce their future expenditures by that amount. They lay off workers, cut dividends, and otherwise reduce their outlays for production. This reduces the incomes of wage earners, stockholders, and others. Out of these lower incomes, presumably, individuals will not try to save so much as formerly, and the decline in incomes continues until savings are once more brought down into line with investments.

At this new point of equilibrium, however, a large part of the labor force may be unemployed. This unemployment will persist until something happens to increase total spending again. This “something” might be a series of revolutionary inventions to create new opportunities for investment. But this, says Samuelson, leaves the system “in the lap of the gods.” How much more sensible it would be for government to come to the rescue with a “compensatory fiscal and monetary policy”!

Government to the rescue!

Says Theodore Morgan in his readable Income and Employment, “To set the responsibility for attaining and maintaining full employment on the shoulders of individual consumers or individual businessmen is absurd.”⁷ According to Samuelson, “The private economy is often like a machine without an effective steering wheel or governor. Compensatory fiscal policy tries to introduce such a governor or thermostatic control device.”⁸

This “compensatory fiscal policy” includes two sorts of measures: (1) measures to reduce “the propensity to save,” and (2) measures to increase private and government spending.

(1) In order to reduce the propensity to save, Keynesians urge that “we” increase “social-consumption expenditures.” By this they mean that government should extend the “social security” program. Lawrence Klein, in The Keynesian Revolution, writes:

We need a non-profit institution like the government which can provide a comprehensive, minimum program of social security in order to reduce the propensity to save. This program must cover the entire population, and it must cover all those contingencies which cause people to save on a large scale for the future.⁹ (Italics supplied.)

Samuelson, discussing social security payments by government, asks, “Are such expenditures really capitalistic?” Here is his answer:

We shall later see that “on the first round,” these expenditures do not directly consume goods and services; but by swelling the purchasing power of their recipients, they do, “on the second round,” create orders and jobs for free private enterprise. However, the thing to note is that the production induced by this process is both privately produced and privately consumed.¹⁰

According to Samuelson, therefore, we still have capitalism as long as the title to the means of production remains with private persons even though government takes and redistributes the income and fruits of the property on the basis of need or political pressure. This reasoning enables Keynesian economists to profess ardent loyalty to private enterprise and private property while they call for various government measures (e.g., heavily progressive taxes on incomes) for confiscating the fruits of both.

(2) In order to raise the rate of private investment and spending, Keynesian economists propose that government aid “small business,” subsidize home building, compel licensing of patents, and reduce interest rates.

However, it is by government spending, rather than by private investment, that these economists hope to put back into circulation the “enormously high” savings that Americans try to accumulate. Lorie Tarshis, for example, in his textbook, The Elements of Economics, contends that the United States “cannot long maintain full employment through high private investment, because its stock of capital equipment will rise rapidly toward the danger point. . . .” This Stanford University professor goes on to say:

It seems to be an almost impossible task to raise private investment to the astronomical figure that is now needed; and an even harder problem to keep it there.¹¹

Therefore, more and more government spending is necessary to keep private enterprise going.

“Public investment medicine . . . can cure”

“If we take enough of this public investment medicine,” Tarshis writes, “it appears that we can cure any depression, so long as we are willing to keep on taking it.” And Tarshis explains that by government “investment” he means all government purchases of goods and services, from hiring tax collectors to building monuments.¹²

These authors propose that government try to spend for useful objects, like power plants and public housing, roads and schools.

Nevertheless, they agree with Keynes who said, “if the education of our statesmen in the principles of classical economics stands in the way of anything better” even a war or an earthquake may serve to enrich a nation. Samuelson says that there should never be any need for government to spend for boondoggling purposes in view of the many useful projects available. As compared with building pyramids or digging holes and filling them up, “Properly planned useful public works have just as favorable secondary effects, and in addition they fill important human needs.” But he stresses the idea that unemployment is a worse evil than government waste. “The one way that the American people should not want to spend their income is upon involuntary [sic] unemployment.”¹³

The Keynesian view of investment

Theodore Morgan puts the same idea more plainly:

. . . even from the point of view of output, it is better to employ men in digging holes and filling them up than not to employ them at all; it is better to employ men to make products which we thereupon dump in the middle of the ocean than to leave them idle.

He agrees with Keynes: “Pyramid-building, earthquakes, even wars may serve to increase wealth.”¹⁴

Giving money to foreigners, says Tarshis, is a form of “investment,” even though we get nothing in return. To make the point so plain that not even the most bored sophomore should miss it, he writes:

If we could only export one of the printing presses used for the manufacture of Federal Reserve Notes to, let us say, China, our foreign investment would be enormously higher.¹⁵

This makes even war an “investment” and a means of enrichment, insofar as it gives employment to workers who would “otherwise” be idle.

Among useful government “investments,” these economists propose public housing, rural electrification, airfields, more TVAs, Federal aid to education, and government grants or loans to foreign countries. The student will find in Keynesian textbooks little objection to any government “investment” except the possibilty that it may temporarily reduce employment by discouraging timid investors in competing private industries.

Keynesians want fiat money

Government spending stimulates private employment and production, according to “the new economics,” even if it is financed by new taxes. But to be fully effective in expanding employment, government should finance its “investments” in some way that does not at the same time take funds from private hands.

Therefore, Keynesians prefer that government finance its compensatory spending by manufacturing currency, especially deposit currency (bank credit). “The manufacture of money by banks,” says Morgan, “is a cheap and simple process,” and this is the process these authors recommend.¹⁶

However, if banks are to lend funds and create deposits whenever government gives the word, they must forget about their gold reserves and their responsibility for paying out gold on demand. In other words, the Keynesian proposal for “compensatory’” deficit spending by government implies abandonment of the gold standard in favor of a “managed currency,” that is, inconvertible paper money, or fiat currency.

Keynesian economists know this to be true. Therefore, they belittle and berate the gold standard in terms that remind one of William Jennings Bryan and his “cross of gold.” Samuelson says that the gold standard “made each country a slave rather than the master of its own economic destiny.”¹⁷ Tarshis ridicules it by comparing it unfavorably with a limburger cheese standard.¹⁸

And more controls to check inflation

These economists admit that their “loan-expenditure” policy may cause rising prices and currency depreciation under a fiat (“managed”) currency. Some of them say that a little inflation is a good thing, but all of them agree that a people may easily get too much of it. To prevent this, they propose increased government authority over credit, interest rates, wages, and prices. As Klein says, “There is no reason why intelligent economic planning cannot be of just the correct amount, that amount which gives permanent full employment and stable prices.”

There are several administrative methods of gaining full employment without inducing inflation. If the economic planners are given complete control over the government fiscal policy so that they can spend when and where spending is needed to stimulate employment and tax when and where taxation is needed to halt upward price movements, there will be no problem of associated inflationary dangers.¹⁹ (Italics supplied.)

This means that “the planners” would control every individual’s income and expenditures.

The alternative to such planning, says Klein, is government wage and price control. He appears not to realize that abolishing the free market restricts individual liberty fully as much as the “complete control” over fiscal policy, which he admits is inconsistent with present political institutions in the United States. Instead, he writes that:

The OPA served us beyond all best hopes and wishes during the war, and it did not infringe upon any fundamental liberties, only upon the liberty of greedy profiteering. This organization can serve us also in peace.²⁰

In order to avoid the two extremes of mass unemployment or destructive inflation, therefore, Klein offers us either an authority with “complete control” over government spending and taxes, or general price control.

Samuelson says that “when everything is ‘short’ relative to demand and full-employment capacity, reliance on the price mechanism is inequitable and gives rise to an endless inflationary spiral with grave economic consequences.” At such times, he says, the price mechanism must be “supplemented” by direct controls and rationing.²¹

Keynes proposed to prevent inflation by forced savings, in addition to tax increases, subsidies, price control and rationing.

Following the master, then, these economists urge that government manage the currency and credit, control saving and investment, fix prices and incomes, ration commodities, constantly expand government industries and “investments,” and provide for every individual in sickness, accident, unemployment, immaturity, old age, and death. And this is to be the program in time of peace as in time of war.

“We owe it to ourselves”

One of the chief road-blocks which Keynesians see in the loan-expenditure route to prosperity is the businessman’s fear of mounting government debt. This fear, they assure us, is not well founded. Rapidly increasing debt is merely a price we pay for prosperity, says Tarshis.

If we do not want high debt, high interest rates, high wages, and high prices, then in effect we do not want high employment and prosperity.²²

“The only question, then,” Tarshis continues, “is whether the government can always find a lender or someone who will accept government bonds.”

In the final analysis this is no problem for the simple reason that the government controls the Federal Reserve Banks and can always compel them to buy government bonds. Anyone who controls a bank and is free to make the rules under which it operates will have no trouble in borrowing money. The government is in precisely this position, and therefore can always secure funds.

There is no sign that a high debt exhausts the credit of the government of the United States. And since as a last resource “it can borrow from itself,” there need be no fear on this account.²³

Klein agrees: “An internally held public debt can never be a burden, because we owe it to ourselves.”²⁴

On this point, however, Samuelson dissents. He notes that a large public debt may be a burden even though “we owe it to ourselves.” Even if the people that paid the taxes were the same ones who received the interest payments on the government bonds, yet the taxes might reduce incentive to work and produce. But he goes on to say:

In dispassionately analyzing the growth of the debt, one error we must avoid: we must not forget that the real national product of the United States is an ever-growing thing.

For this reason, he says, “the public debt might increase by 250 billion dollars in 25 years without its relative percentage burden growing.” This would, he claims, permit an average deficit of 10 billion dollars per year before it would be necessary to turn to printing money or selling interest-free bonds to the Federal Reserve Banks.²⁵

The debt burden and inflation

A skeptic might ask whether the real national product will continue to increase, as Samuelson so confidently expects it will, under the policies of the “mixed economy” which he and other Keynesians endorse and advocate. He might also ask why Samueleson believes a 10-billion dollar deficit in future will not lead to printing money or selling interest-free bonds to the Federal Reserve Banks, whereas much smaller deficits in the past led to large issues of paper money in this country and necessitated large purchases of government securities at nominal interest rates.

Theodore Morgan, like Samuelson, admits that a government debt might be burdensome, even though “we owe it to ourselves,” but he suggests that the government ease the burden by permitting a little price inflation. He suggests that a rise of 1 or 2 per cent per year in the general price level would be beneficially stimulating to the economy, and at the same time it would ease the burden of the debt on taxpayers.²⁶

This proposed rise in prices would correspondingly reduce the buying power for owners of many kinds of property and for persons with fixed incomes. In effect, therefore, Morgan proposes a discriminatory capital levy of 1 or 2 per cent every year on the owners of bank deposits, bonds, and other fixed-income properties, together with a special income tax increasing each year by the same per cent on persons living on pensions, insurance benefits, and salaries.

Any “easing” of the debt burden and any “stimulus” to the economy would result from this expropriation of salaried persons, pensioners, bond holders, and beneficiaries of life insurance policies and endowments.

This indifference to property rights shown by Theodore Morgan is typical of Keynesian economists.