CHAPTER VIII DISTURBANCES OF ECONOMIC EQUILIBRIUM 1. The Sources of Disturbance

The differences between rich and poor are a very understandable cause of dissatisfaction and criticism, and all of us have reason to give our serious attention to the demand for greater social justice. No less challenging is the fact that our civilization seems to be stricken with the curse of instability and recurrent mass unemployment. Here again we confront a problem to which a better solution must be found in the future than has been found in the past, if our civilization is not to be placed in the greatest jeopardy. Thus, we touch once more upon a theme to which we have had to give our attention over and over again in the course of this book. And although it is impossible to investigate the problem from all angles within the framework of the present discussion, it is nevertheless too important for us not to make the effort in this chapter to survey the basic issues involved.¹

We know already that our economic order rests upon an incalculable number of freely taken decisions in production, consumption, saving, and investment, and we are aware also of the forces which shape a definite order out of this seeming chaos. How enormously complicated this operation is was made clear in our discussion of the developments attributable to the modern division of labor. By the same token, we are now in a better position to appreciate how extremely unstable such an economic system must be and how easily disturbances can occur now in one sector, now in the other, their elimination requiring a process of continuous adaptation.

We can also understand how these disturbances may become so serious and so extensive as to impair the entire economic process and bring about extensive unemployment (depression.) The greater the degree of division of labor, the greater will be the growth of productivity but, at the same time, the more susceptible the economic system will become to equilibrium disturbances. This instability is still further increased due to the fact that the production of consumer goods does not follow a direct path, but rather takes a detour via the anterior production of producer goods. In other words, the modern process of production is not only a labor-dividing one but simultaneously an indirect, detour-making, and therefore time-consuming process. Just as the division of labor requires that producers mutually arrive at a correct estimate of their needs for goods, so too the greatly increased importance of capital goods production requires that the need for fore-products be rightly estimated, and that the extent of fore-production be kept in proper proportion to the extent of end-production. These relationships, moreover, must be preserved in spite of the difficulties which the characteristic time-consuming nature of our production process entails.

Again, all this takes place in a world in which politics, the caprices of consumers, the inventive spirit and a thousand other things daily create a new and unforseen situation. Keeping all these things in mind, there it seems more reason for astonishment over the high degree of order in the economy than over the fact that this order is continually disturbed.

Also, since a socialist state will have to reckon with the same sources of disturbance (the division of labor, advances in the technology of production, and instability of the outside world), it would be erroneous to assume that it would be spared the problem of equilibrium disturbances. So long as there is division of labor and a highly developed technology, so long as man, nature, and society have not become rigid machines, so long as there are new inventions, harvest fluctuations, changes in consumption habits, migrations, fluctuations in births and deaths, wars and revolutions, optimism and pessimism, trust and mistrust, every social order will be confronted with the problem of disturbances in economic equilibrium. Wherever these disturbances occur, one must adapt oneself to them in order to overcome them. The difference between the market economy and the collectivist economy in this respect lies fundamentally in the fact that the process of adaptation in the market economy is, in accordance with the essence of this economy, spontaneous; in the collectivist economy, however, adaptation is “commanded.”

If we now assume that our economic system is afflicted by that severe disturbance which we call depression, we will find ourselves faced with the melancholy picture of idle factories and unemployed workers—although just a short time before (in a boom) production may have reached record figures. Thus, the situation would appear to be due to a generalized condition of over-production. But we will not arrive at the underlying causes of this situation simply by saying that total production has exceeded consumption and that excessive quantities of all goods have been produced. Further reflection will show us, in fact, that there is no rational basis for this popular concept of generalized over-production. One awaits in vain an answer to the question: over-production in relation to what? The living standards of the masses are almost everywhere so low that not even a tenfold increase in present levels of production would serve to raise these standards noticeably. Until these standards are so raised, it is meaningless to even question the necessity of putting all the productive forces at our disposal into the fight against scarcity. In this light, we are faced not with a general oversupply of labor power but with a deficiency of it, not with too many machines but rather too few, not with too much rationalization of production but rather with too little. This constantly recurring fear of production is absurd.

But how does this square with the indisputable fact that in a depression factories are shut down and workers made idle? The question may best be answered by means of the following comparison. The battle against the scarcity of goods, which we are condemned to fight with chronically inadequate forces, is like the battle of an army against a superior opponent. Every soldier is used in such a battle and every technical advance in armaments is welcome. And yet because of the organizational disturbances which are inevitable in the enormously complicated apparatus of a modern army, it is a common occurrence for individual units to be withheld from action even though they may be bitterly needed on some other sector of the front. Temporary surpluses of soldiers in individual sectors does not mean that there is not a shortage of soldiers as a whole. Hence, no reasonable man will conclude that these momentarily unemployed troops should be sent home or that the army as a whole should adopt a “spread the fight” program by increasing the number of furloughs or by reverting to the use of halberds. The close connection between “too little” on the whole and “too much” in parts is so obvious here that even a person of the most limited capacities cannot fail to recognize it. But understanding of the fact that we are confronted with this very same problem in the economy appears to be extremely difficult for most people. A depression cannot be defined as generalized over-production of all goods simultaneously, nor as the overtaking of consumption possibilities by production possibilities. It is to be defined, rather, as a disproportion among the individual branches of production: an equilibrium disturbance within a productive system which—on the whole and over the long run—is as yet clearly unable to satisfy all the possible needs of consumers.

The total quantity of goods which we may profitably produce is not a cake of a certain fixed weight or size which those willing to work are required to divide up among themselves in a spirit of mutual jealousy; it is rather, superficially considered, something which is dependent on total demand. Now we know that total demand results, in the last analysis, from the successful disposal of goods on the market, so that the total amount of demand is determined by the total amount of production. Thus it follows that consumption is determined by production and not the other way around. This means that there are no limits to profitable production on the whole (assuming that the composition of total output is “right”) since the saturation point for human desires is not in sight; there is only one limit to consumption and that is set by the existing production technology. All else is nonsense: the fear of production, the belief that we must always be prepared to “spread the work,” the opposition offered to every attempt to improve production methods. It is inconceivable that all producers will produce surpluses which they are unable to exchange with one another, provided they have correctly adjusted their production to their mutual needs. As to the question of what will become of unemployed workers and idle factories in a period in which markets are choked with goods and every branch of production overstocked, we make the following answer. In a depression, productive facilities are lying fallow, so to speak; these facilities will come to life and a market for the resultant goods will be created when those who have been shut out of the productive process win back their former purchasing power by being reinstated in this process, a chain of events which will occur once economic equilibrium is reestablished. Unused production reserves correspond, then, to an equivalent amount of unused reserves of purchasing power. The reestablishment of economic equilibrium creates purchasing power.

To understand that total equilibrium disturbance which we describe as the alternation of prosperity and depression (the business cycle), we must begin with two fundamental ideas. One is that the real cause of depression is not to be found in the depression period itself but in the preceding boom. The other idea is that the boom mechanism, which finally leads to depression, produces a sharp rise in capital investments (conversion of money capital into real capital), which in our economic system are financed by an expansion of credit (credit inflation) and which set the whole economy in motion in a network of changes acting and reacting on one another. Expansion and contraction of investments, which go hand in hand with expansion and contraction of the supply of credit, constitute the real core of the cyclical movement.

If we wish to understand more fully why the “full employment” of a boom period—after it has exceeded a certain critical point-leads to ever greater tensions which ultimately induce a depression, we must take into account a number of circumstances which are described in the special works dealing with cyclical theory. Long before the entire labor force has found employment, scarcities will develop with respect to certain important types of skilled workers. These scarcities, in conjunction with other difficulties, will lead to production bottlenecks in industries which have a decisive bearing on total production. Wage increases and rising prices for raw materials, machines, or other goods will sooner or later paralyze entrepreneurs’ incentives, speculation will make the price and rate structure more and more unstable until, finally, it needs only one slight touch to cause it to topple. Above all, however, the sudden and abrupt increase in investment is itself a source of disturbance and one which would also give trouble to the collectivist state, involving as it does problems of a technical nature. The phenomenon in question may be designated as the “acceleration principle.” Thus, a rise in investments is itself the occasion of still greater investment activity since an increase in capital goods production presupposes, in its turn, an increase of capital goods. A boom in poultry farming, for example, is a self-reinforcing process which will continue so long as new farms are established, resulting in an increased demand for fowls for breeding purposes. However, a point is finally reached at which the need for basic equipment for new farms has been satisfied. Further poultry production will then be at a level in excess of normal requirements for fowls for consumption and breeding purposes. This situation will arise as soon as there is a decline in the previous rate of increase in the number of new farms. It is evident that once the poultry boom has gotten underway there will come a certain moment when a “bust” can no longer be avoided since one cannot go on forever producing fowls for the sake of producing fowls. There is equally little justification in the economic system at large for producing capital goods at an ever-increasing rate for the sake of the capital goods. One cannot keep on forever building and “rationalizing,” erecting new electrical plants, and installing new machinery. Above all, one cannot do this in a geometrical progression since the strength of the credit system needed to finance this flood of investments would in the end be enfeebled to the point of breakdown. So soon as it proves impossible to avoid a shrinkage of the capital goods industry, collapse of the boom is inevitable.

All of these reflections make it clear that a too abrupt and extensive rise in investment (over-investment), with its attendant disturbance of the economy’s equilibrium, is a possibility which must be reckoned with in any highly developed complex system. A rise in investment will remain within safe bounds, however, so long as investments are financed by the voluntary savings of the population, for movements of the latter are themselves generally even rather than erratic. Only when investments are pushed beyond the boundaries set by real savings can they constitute a threat to equilibrium (total investment > total savings). To produce this situation, some sort of compulsion will be required to loosen the bond which ties capital goods production to the voluntary savings of the population, and to raise the relative restriction of consumption above the point which the population itself is prepared to undergo via its savings. This compulsion can take the form of the openly brutal methods of the collectivist state which, on the model of the Russian many-year-plans, stimulates investment activity by keeping the consumption of the population at a low level through taxation, manipulation of prices, and the planned economy. In our non-collectivist economic system this compulsion is replaced by credit expansion of the kind we have already dealt with in a previous section. Credit expansion fulfills a double function: it provides the entrepreneur who is prepared to invest with the additional credits he needs and, by increasing the prospects for profit, it stimulates the desire to invest generally. Investment activity of this type, in contrast to that which prevails in a collectivist state, is dependent on the voluntary decisions of the entrepreneur. It is only such credit expansion which, constituting as it does the motive power behind every boom period, makes it possible for investments in our economic system to exceed regularly the total amount of real savings.

Now it is to be observed that the economy will enter the boom period with a reserve of unused labor power and productive means inherited from the previous depression. This reserve will for a while permit investments to be financed by means of credit expansion, without any of the above-mentioned consequences. Obviously, the investment of capital means that productive power is being used for the erection of factories, the installation of machinery, or the building of houses instead of for the production of consumption goods. The greater the amount of investment, the less the quantity of productive resources which remains for the production of consumption goods. Hence, a nation must save if it wishes to augment the number of its machines, factories, and roads. If it does not, its consumption will have to be restricted forcibly (via the authoritarian forced saving of a collectivist economy or the monetary forced saving of a noncollectivist economy). The greater the amount of investment, the less the quantity of goods that can be consumed. This mutual competitiveness of investment and consumption does not obtain, however, so long as resort can be had to unused production reserves for the additional amount of investment. In the latter case, investments, far from disturbing equilibrium, are the indispensable means needed to reestablish it and thus to put an end to the depression (investment in such case is complementary to, not competitive with consumption). If, during the depression, investments were less than savings, additional investments will result in the reestablishment of equality between total investment and total savings. Hence, until a state of equilibrium is attained, investments are not in competition with consumption for the economy’s factors of production; on the contrary, such investments have a salutary effect on the economy by their mobilization of unused productive resources. What in fact happens is that, thanks to the increase in total production brought about by investments, consumption is even greater than before. As long as the unused productive resources are not fully absorbed, total production may not be regarded as the usual cake which, as is well known, one cannot eat and have too; on the contrary, it is a cake which actually becomes bigger the more we eat of it. This seems paradoxical unless it is realized that it is precisely the claim on the factors of production resulting from an increase of investment which, by reestablishing equilibrium (quantity of investment = quantity of savings), sets the whole productive apparatus in motion.

As long as the upswing of economic activity can draw on the reserves of unused factors, credit expansion will not bring about a rise in prices since the increase in purchasing power is compensated for by a corresponding increase in goods. Credit expansion, then, serves the salutary purpose of compensating for the decline in purchasing power which had come about because of the fact that in the depression more was saved than was invested (deflation); in this case, credit expansion is compensatory, not inflationary. This idyllic phase will come to an end, however, as soon as the unused production reserves are exhausted and when there is no more unemployment worth mentioning (a condition imprecisely described as “full employment”). As a rule, however, the end of this phase of “safe” expansion is reached somewhat earlier than might be expected on account of the aforementioned “bottlenecks.” The more intensive the demand by labor for wage increases during the upward movement is, the sooner the critical point will be reached, since in this case, credit expansion is converted into an increase in prices instead of an increase in employment.

When this critical point in the upswing is reached, credit expansion becomes inflationary instead of compensatory. Investments once again enter into competition with the production of consumption goods, and the magic cake which simply grew bigger the more we ate of it, is changed back into a quite ordinary cake of which we cannot eat a single piece and still have it. Investments made after this point is attained are equivalent to a real subtraction from the means of production available for consumption uses. From this moment on, we are traveling in a danger zone: the factors originally responsible for the boom mutually reinforce each other in a cumulative process which must end, finally, in a new depression. The stronger one’s determination to prolong this process for the purpose of maintaining the “full employment” situation, the worse will be the final and inevitable collapse. We should not forget that the last great crisis of 1929-32, whose consequences were so enormous, was a collapse of this type. The crash of ‘29, however, was not only a consequence of the extraordinary piling up of investments which preceded it (notably in the United States); a whole constellation of other mishaps conspired together to intensify and extend the catastrophe.

In what light, then, are we to regard depression? We can understand why a depression must come, once free rein has been given to a cumulative process of over-investment via an inflationary expansion of credit during the boom period. After being built up to too high a level, the tower of investments crashes down, and makes necessary a painful and costly process of readjustment and rearrangement of the economy. Extravagance and unsound speculations come to an end; close reckoning becomes necessary once again and all economic structures which are interiorly unstable collapse. There is, however, the grave danger that this, in itself inevitable reaction, will far exceed the character of a mere cleansing operation and that henceforth, a cumulative process of decline will develop, representing the counterpart of the preceding cumulative process of expansion. The inevitable primary depression may be followed by a secondary depression which it should be the first object of policy to avoid. It is indeed quite possible that in the unfavorable psychological climate of a depression (to which many other more or less fortuitous circumstances, political and other, may contribute), entrepreneurs’ incentives may be weakened to such an extent that investments will sink below the level required to convert the continuing savings of the economy into investments and thereby into demand for goods (total investments < total savings).

To understand the above, two things have to be kept in mind. First, it is to be observed that the act of saving, or the putting aside of a part of one’s income, means nothing else than nonconsumption, i.e., the absence of demand, and thereby a minus in the sale of consumer goods. Savings are once again converted into demand when they are invested, i.e., used for the purchase and production of capital goods. Secondly, we must realize that these two actions-saving and investing—do not necessarily synchronize with one another; on the contrary, they are two distinct processes, each of which takes place independently of the other. Savings are not necessarily converted into investments; at the same time, such conversion is not necessarily excluded, a fact which deserves to be emphasized in opposition to certain excessively pessimistic theories of the present day.² The extent to which such conversion—with its decisive bearing upon economic equilibrium—takes place depends upon numerous and varying circumstances of a psychological, legal, institutional, or political nature. It is understandable, of course, that this process of conversion will run into severe difficulties following the collapse of the boom. Should investments, at this juncture, continue to lag behind savings (under-investment), a decline in demand will take place (deflation) which, should it assume large proportions, can bring about a secondary depression of that dangerous type which afflicted the world after the crisis of 1929. Then we are faced with a very severe disturbance attended by the well-known phenomena of mass unemployment and drastic price declines, effects which may be aggravated by the mutual reinforcement and multiplication of the effects of a fall in demand. The disturbance will be brought to an end only when total savings and total investments are again harmonized with one another, be this through an increase in investments or a decrease in savings.³

2. Stabilization Policy

In order to discover the right methods for the attainment of the vitally important goal of economic stabilization and to distinguish these from the wrong methods, we must make a scrupulously conscientious effort to picture—in this instance in outline form only—the extraordinarily involved nature of the economic process and the conditions necessary for the maintenance of equilibrium. Competence in evaluating a given economic situation requires a fairly clear understanding of what really goes on in the economy in terms of production, saving, investment, and consumption, of the way in which the flows of money and goods are related to one another, of the significance of prices, wages, interest and profits, of how and where credit enters the picture, of how banks and stock exchanges work together to keep the economic process functioning, etc. If we are all agreed that the real issue at stake is to attain and maintain as high a level of employment as possible, such a study of the dynamics of economic life should put us in a better position to recognize the dangers of a policy of forcible stabilization which, under the label of “full employment,” has become popular in all countries. It is a policy which is shaped exclusively by reference to the question of how total demand, by means of the continual creation of new money (and with complete disregard for the deeper causes of equilibrium disturbances), can be maintained at a level sufficient to ensure the sort of “full employment” which existed in peacetime in National Socialist Germany, and in all countries during and after World War II. In reality, of course, full employment of this type would be more accurately defined as abnormal “over-employment.” For those eager to establish such a policy of “constant inflationary pressure,” the problems arising from disturbances of economic equilibrium with which we have concerned ourselves seem hardly to exist. The only circumstance that interests them is that these disturbances lead to a fall in demand which they hasten to push up again through the creation of money, without inquiring into the deeper causes of disturbance and the means of overcoming them. It is this radical simplification which gives rise to all of the grave dangers of such a policy of constant “full employment.”⁴

We have been dealing here with a wrong policy whose dangers, as seen in the National Socialist full employment experiment and in contemporary economic tensions, have received far too little attention. We should take note of the fact, however, that there are other ways of attaining the goal of a stable economy with a high level of employment; these ways may be more unpleasant, but on that account can be recommended with a clearer conscience by the economist. In this connection, there are four principal points to keep in mind:⁵

1. Given the inevitable fluctuations in economic conditions and associated fluctuations in employment, the necessity of continual adaptation and adjustment is of the first importance. This is only possible, however, if the economic apparatus is, in all its parts, as flexible as possible. The more rigid this apparatus becomes—a trend which has increased noticeably over the past decades, and which will become even more pronounced in the future if certain politico-economic tendencies of our time are perpetuated—the more difficult will adaptation and stabilization become, and the more severe the fluctuations of the economy will be. Simultaneously, the greater will become the temptation to keep employment high by resort to the mechanical method of increasing the money supply—recommended by the “full employment” school, cost what it will. Then only will it become clear how apt is the apparently paradoxical statement: the more stabilization, the less stability. We can make this very clear to ourselves if we compare the economic apparatus to a bicycle. A bicycle can be ridden securely only if the handlebars are movable, thus allowing us to adjust the vehicle to every small disturbance of equilibrium. Were the handlebars to be “stabilized,” the bicycle rider would fall. So also is it in economic life, where the handlebars steering the economy is the free market. Every price and cost rigidity, every official restriction of market freedom, every arbitrary collective contract, every monopoly, every immobility of the factors of production, every quantitative limitation of output—all are additional accessories screwed onto the handlebars of our economic apparatus, encumbering it so that it can no longer remain upright and gives us one spill after another unless the state provides ever increasing support.⁶

2. If it is true that the changing ratio between total savings and total investment is a principal cause of disturbance, then the proper course of action is to forestall both the over-investment of a boom period and the underinvestment of a depression. As soon as the boom enters the danger zone of inflation, investment must be braked by taking appropriate measures with respect to money, credit, and budget policy. In a depression, on the other hand, investment should be stimulated (when absolutely necessary, but only then!) by resort to those radical methods advocated by the “full employment” school as suitable at all times.

3. Such stimulants, however, as are given to investment in a depression period may prove to be of little avail. Indeed, the outdistancing of investments by savings can become a permanent tendency if entrepreneurs are dissuaded from investing by a combination of exaggerated wage and social demands, a government policy of increasing arbitrariness and restrictiveness in respect to economic life, and monopolistic rigidities. In this situation, investment, which even in normal times requires a great deal of daring on account of the uncertainty of all calculations regarding the future, will become an increasingly risky business in which one can lose a great deal but win only a little. Heavy taxation, forcible reduction of dividends, ruthless exploitation on the part of labor-union monopolies (the consequences of which have to be borne by the less ruthless and less tightly organized workers), abandonment by governments of fixed principles in the making of their economic and social policies, the routine granting of subventions, threats of further socialization as the result of which one can no longer be sure whether one will reap tomorrow what one sows today, disregard of individual rights and freedoms, complete arbitrariness in the matter of international trade policy and monetary policy—all of this can be regarded as very progressive and the opposite branded as ‘‘reactionary.” But then there should be no surprise if in such a climate investments fail to come up to expectations, with the consequences for employment opportunities with which we are familiar. From these remarks may be inferred what the ingredients of a positive policy of stabilization should be.

4. We would be very much mistaken were we to regard the problem of stabilization as solved by the measures to which we have thus far alluded. Even in the most favorable case, we shall have to reckon with considerable fluctuations in economic conditions. The task which confronts us in consequence can best be made clear by an illustration. Smooth driving depends on two conditions: the smoothness of the road and the quality of the springs with which our car is equipped. A road can never be so smooth that we can dispense with springs; the bumpier the road, however, the better must the springs be. Applying this illustration to our problem of economic stabilization, we find that up to now we have concerned ourselves with the smoothness of the road and with the means needed to make it still smoother. But just as we cannot expect to find roads which will render springs unnecessary, neither can we hope to attain complete economic stability. Indeed, it is to be expected that the economic highway of the future will be spotted with a number of bad holes. Hence, with respect to economic life, we must take care to provide ourselves with a better set of springs and in this way ensure that individuals will be better able to resist the shocks that will be inevitably encountered. And herewith we glimpse the outlines of a policy—going beyond cyclical policy—which seeks to mitigate the sensitivity and instability of our proletarianized, centralized, mass-type society through decentralization, de-proletarianization, the anchoring of men in their own resources, encouragement to small farmers and small business, increased property ownership, and the strengthening of the middle classes. In this way, it would be possible to equip society, internally, with a set of springs with whose help it could withstand even the strongest economic shocks without panic, pauperization, and demoralization.

3. The Impact of Keynesianism

John Maynard Keynes, who died in 1946 at the age of 62, is not only the best known economist of our times but also a man who by any standards must be reckoned as one of the leading personages of the first half of the twentieth century. The history of the era which followed World War I can no more dispense with the name of this singular individual than it can with the names of Einstein, Churchill, Roosevelt, or Hitler. It is only in this broad perspective that Keynes’ full importance becomes visible. How ought we to judge the influence of this man? Is he the Copernicus of economics, as so many claim, the man who banished the ghosts of economics grown rigid in the chains of tradition, who opened the door to prosperity and stability? Or did he destroy more than he created and has he summoned into being spirits that today he possibly would be gladly rid of?

It is difficult to make a simple answer to these questions. A fair judgment would have to take into account not only the manifold talents and personal charm of the man, but would require also the dissection of issues which have nourished most of the economic controversies of our time and which have given even the experts pause. We may begin by noting a characteristic trait of this animated, impulsive, and artistically sensitive man: his virtuoso-like ability to change positions on important questions, positions which he had only shortly before defended with intelligence and vigor. It is difficult to recognize in the author of The Economic Consequences of the Peace (1919) and of the famous series of articles on reconstruction in the Manchester Guardian—works which at the beginning of the ‘20’s stood for a program of free trade and Malthusian liberalism—the same man who later announced the “end of laissez-faire,” who, using extremely weak arguments, took it upon himself to champion economic autarky and so prepared the ground intellectually for the transition to economic and monetary nationalism on the part of his own and other countries. Indeed, it was his fate—one in which, initially, he even appeared to find some visible satisfaction and which at any rate he did not explicitly disavow—to become the intellectual authority for economic policy in National Socialist Germany. A fund of nervous energy, great productivity, temperament, virtuosity in debate, a cavalier nonchalance in changing positions—these were the chief notes of Keynes’ personality.

In two fundamental respects, nevertheless, Keynes was more consistent than he appeared to be. In spite of all his criticisms of “capitalism,” he never became a socialist. He remained a liberal, professing devotion to democratic freedoms and convinced that in his singular way, he was promoting them. Another constant in his career was his belief, derived from his expanding researches in monetary theory, that the real defect of our economic system must be sought in the organization of its finances and its monetary institutions. To improve this organization, he made proposals ranging from the moderate ones of his Tract on Monetary Reform (1923) to the radical ones of his last great work, The General Theory of Employment, Interest and Money (1936).

This is not the place to evaluate in detail the services which Keynes, in these works, rendered to the advancement of theory. Unquestionably, they are considerable. At the same time, it is precisely because he so deeply influenced his time that it is necessary to ask whether the practical results of his theories and proposals, which were intended to improve the working of the existing economic system, did not ultimately have the effect of weakening its foundations—so that Keynes, in tragic opposition to his own intention, must be numbered among the grave-diggers of that very order of liberal democracy to which his innermost allegiance belonged.

One may believe that there are times in which vigorous measures to increase the money supply will prevent disaster; but not with impunity can a leading scientific figure like Keynes bestow the mantle of his authority on the chronic propensity of all governments to inflate. One may believe that under certain circumstances an increase in government debt is the lesser evil; but not with impunity is such a temporary measure transformed into a maxim. It can happen—as in the Great Depression of 1931-32—that all efforts to put a quick end to unemployment prove useless, so that recourse must be had to an increase of “effective demand” by the expansion of the money supply; but not with impunity can one treat, with hardly concealed contempt, the established rules and institutions upon which, in the long run, the ordered conduct of economic life de-pends if it is not to be held under constant inflationary pressure. One can uncover in the mechanism of saving many a problem requiring special attention, overlooked by earlier and more fortunate generations; but not with impunity can one take away from men the feeling that it is right to save, to put aside a reserve for themselves and their families, instead of spending everything and then calling upon the help of the state—the greatest spender of all—in time of need. Just as a storm on the high seas may require that masts be cut down and freight thrown overboard, so too in economic life there will be hurricanes which will require us temporarily to suspend the principles of free international trade; but not with impunity can one declare these principles to be “out of date” so soon as they get in the way of a policy of “full employment,” a doctrine which, following the shock of the Great Depression, has become as inflexible as any of the views ever held by the despised “old economics.” To be sure, competition, freedom of markets, wage flexibility, and a prudent fiscal policy do not necessarily guarantee prosperity and stability; indeed, there are extraordinary situations in which exceptions to these excellent principles must be made; but not with impunity can one announce to the crowd that henceforth they may in good conscience be trampled upon.

These bitter-sweet reflections come to mind as one attempts to fill in the impressive outlines of Keynes’ full and immensely influential life. Because he was possessed of such an acute intelligence and such an attractive personality the damage he inflicted was all the greater, for his teachings were rendered all the more seductive thereby. Thus, he accustomed a new generation to a kind of economic logic which revolves solely about the question of how “effective demand” can be most securely maintained at the highest possible level, whereas the real problem of the postwar era was how an inflationary boom can be braked in time. Other things he did were of still graver import in their ultimate consequences. He not only demolished that which was decayed, but by his preaching of economic pragmatism and his attack on deeply rooted principles in the moral-political sphere, he became one of the principal agents in that general decay of standards, of norms, and of principles which constitutes the real core of the social crisis of our time. At bottom, his economic policy program consisted in saying: pecca fortiter; that is, do with a light heart what you have hitherto regarded as a sin! Whether and to what extent Keynes’ accomplishments on the level of economic theory and economic technique are right, will be a subject of debate for a long time to come; but that on the higher level of social philosophy and political ethics he was very wrong, is already sufficiently clear.

That Keynes not only preached these things but preached them apparently in good conscience, indeed with the same messianic fervor which has become so characteristic of his numerous disciples, is something which has a deeper explanation, an explanation which must be sought in the type of man and the type of philosophy which he represented. How is it that such an extraordinary man (in the best sense), whose intellect was so wide-ranging and who was just as much artist and organizer as he was scholar, could at the same time be so blind to moral-political postulates (which even in the narrower domain of economics are more important in the long run than clever monetary formulae) without which human society cannot exist?

To fully appreciate the kind of man and the kind of philosophy we are here concerned with, it is useful to compare Keynes with Adam Smith. In the depth and extent of their influence at least, the two men were strikingly similar. Moreover, both Smith and Keynes had interests which extended far beyond the confines of economics. But whereas Smith left us, in addition to his magnum opus on the Wealth of Nations (1776) a book on the Theory of Moral Sentiments (1759) which exposes the full moral-philosophical foundations of his much-misconstrued economic doctrines, Keynes has left us, in addition to his economic works, a monograph on the theory of probability (A Treatise on Probability, 1921). For Smith, whose book on the Wealth of Nations was planned as a segment of a giant opus on the cultural history of mankind, economics was viewed as an organic part of the larger whole of the intellectual, moral, and historical life of society; for Keynes, economics was part of a mathematical-mechanical universe. The one man was a representative of the humanist spirit of the 18th century; the other a representative of the geometric spirit of the 20th century; a deistic moralist was the one, an exponent of positivistic scientism the other. For the one, the cosmos of human society and the human economy was the result of the working of an “invisible hand,” a living order with an immanent logic of its own which the human mind could comprehend and even destroy but could not duplicate; for the other, economy and society were the result of mechanical quanta subject to precise measurement and direction by an omnicompetent technical human intelligence. The teachings of the one were a promising beginning; those of the other the end product of a process of disintegration in which the crisis of an exclusively rationalistic society finds its ultimate expression. On the lesser level of economics, the road from Adam Smith to Keynes has doubtless been one of progress in many respects; on the higher level of total intellectual and spiritual development, it is equally certain that the road has been one of reaction and regression.

There is little consolation in the fact that Keynes at the close of his life worriedly endeavored to dampen the overzealousness of his followers. And it is tiresome, after a while, to have to listen to the repeated affirmation that Keynes himself, had he lived, would have contributed the necessary correction of “Keynesianism.” This may well have been the case. On the other hand, the real tragedy of the Keynesian legacy is that what Keynes regarded as intellectual “working capital,” i.e., ideas easily shifted from the service of one ideal to that of another, became for his less flexible disciples intellectual “fixed capital,” the profits of which were protected by every means available, including that of monopolistic exclusion. Keynes cannot be spared the reproach of having failed to take this fateful result of his writings and teachings into account.

A fact of the postwar era, which is as singular as it is compromising for Keynesianism, is that the more determinedly the Keynesians have sought to enthrone the teachings of the master as the only legitimate economics, the more decisively have actual economic events moved away from the Keynesian postulates. Most governments, if not most economists, have become painfully aware of the inadequacy of Keynes’ teachings in dealing with the chronic inflation of the postwar years; nor was this teaching able to shed any light on the fact that it was precisely the noninflationary economies of this period, least influenced by Keynesianism, which achieved the most remarkable rates of growth, employment, and stability, whereas it was the inflationary (in particular, the Anglo-American) economies which, by comparison, stagnated. Indeed, so compromising for Keynesianism were these postwar developments that the efforts to transform the ideology into a mere logical apparatus, capable of being shifted with cool detachment from the fight against deflation to the fight against inflation, are quite understandable. Of course, when this is done with the claim that it is still the pure light of Keynesian teaching which informs the new approach, we scientific legitimists will be excused for showing some astonishment at so much flexibility. After having for years pointed out to the representatives of the “new economics” the threat (inflation) which finally became reality, we find it difficult to accustom ourselves to seeing our analysis and prescriptions tricked out in the language of this same “new economics.” This being the case, it may at least be permitted to make a few comments thereon.

To begin with, we will readily concede that the use of Keynesian-ism as a logical apparatus, as a simple technique in the struggle against inflation in the full employment countries is (and was) thoroughly legitimate in one respect at least. Non-Keynesians themselves make use of the apparatus when they say that such countries were “living beyond their means,” i.e., that their aggregate expenditures for consumption and investment generated more purchasing power for the output of the economy than could be supplied at current prices, with the consequent emergence of inflationary gaps and balance of payments deficits. Such insights could have been derived from the “old economics” as well, although it is conceded that macroeconomic concepts have been improved and refined by the “new economics.”

But having made these concessions and with them a step toward conciliation, it would be reasonable to expect that the representatives of the “new economics,” in turn, would frankly admit: first, that their passionately-held ideology has turned out to be, in truth, a mere logical technique; and secondly, that if in the postwar period it became necessary to apply the technique to a situation diametrically opposed to the one Keynes had in mind, this in itself was largely due to the ideological influence of Keynesianism with its emphasis on fear of deflation, full employment at any cost, and unrestrained government spending.

It is the latter circumstance which points to the great difficulty of applying the logical apparatus of the “new economics,” in admirable nonpartisanship, to either inflation or deflation, depending on the situation. Keynesianism, even in the most favorable case, tends to be latent inflationism.\This inflationism becomes virulent so soon as disturbances occur, especially those accompanied by unemployment and business contraction, which appear to constitute “deflation.” In fact, the disturbances may be due not to disproportions between the gross magnitudes of the economy (as the “new economics” would have it) but (in terms of the “old economics”) to false values—prices or wages—and to a false allocation of the factors of production. What then? What of the case in which wage increases cause unemployment? Above all: how is it planned to cope with the fact that the reduction of inflationary over-employment is usually accompanied by pseudo-deflationary phenomena?

We see that even where the new economics is reduced to a mere neutral logical technique, and even where it happens to find itself in agreement with the prescriptions of the “old economics,” the desired synthesis is considerably more difficult to achieve than at first appears. Such a synthesis will at all events not take place unless the representatives of the “new economics” determine to give up their claims that their theories and methods are the only valid ones, and until they abandon still more positions than they have already done.

The idea that by a continuous manipulation of macroeconomic variables it is possible to offset now a deflationary, now an inflationary tendency is extremely attractive. The “new economics,” however, has by no means an exclusive patent on it; from the beginning it has been the signpost of a reasonable economic policy. But it will remain a misleading and a dangerous idea so long as it is not purged, far more completely than hitherto, of all traces of “Keynesianism.” For inevitably the Keynesians will be found looking at inflation through the wrong end of the telescope and deflation through a magnifying glass. Hence, this otherwise useful idea—so long as it remains in the grip of the “new economics,” with its exclusive concern with macroeconomics—will be the captive of an intellectual outlook which distorts the nature of both deflation and inflation. The very circumstance that in the postwar period so much time and argument and so much inflation were required before even the more observant of the representatives of the “new economics” were persuaded to change course from anti-deflation to anti-inflation, shows the inner tendency of this whole school of thought. In the logical machine so cleverly devised by Keynes and his followers we find, to be sure, an inflation brake. But the machine is so constructed that the brake is depressed only when a breakneck rate of speed has been attained; and the brake has the further fatal tendency of being released as soon as the braking action is the least bit effective.

In summary, we find in the teachings of Keynes the social philosophy of a man who, proud of his alleged modernity and progressiveness, believes himself capable of “making over” society and the economy. We find a man who has forgotten those mysterious powers of the human soul and of human society which cannot be expressed in mathematical equations, nor confined within an assemblage of statistics or the rubrics of economic planning. It is in no small degree this character of Keynesian teachings which explain their large success in those countries and with those political parties in which a preference for social planning and active suspicion of individual freedom is especially marked. The greater the extent to which a person’s milieu, habits, way of life, and social environment prevent him from seeing that the real evil of our civilization lies in the profoundly unnatural character of our lives, our society, and our way of thinking—not in any still imperfect ability to increase government budget deficits, keep interest rates down, pump up “effective demand,” make rates of exchange flexible, and manipulate balances of payments—the greater is the likelihood of his susceptibility to the doctrines which Keynes made fashionable. Conversely, the success of these doctrines shows us how many people there are who find them appealing, and how sick is an age which could spawn them in such numbers. For all these reasons, we may expect to be able to measure the progress of the recovery of society (the first signs of which we believe to be already visible), in part, by the number of men who succeed in freeing themselves from the spell of Keynesianism and in recognizing not only its economic weaknesses, but the errors of its social philosophy as well.⁷ Then it will be possible to evaluate, objectively and unemotionally, the real contributions of Keynes, infused as they are with the elements of both grandeur and tragedy. On this note we may proceed to the last chapter of this book.

NOTES

1. (p. 208) Economic Fluctuations

The reader is referred to the following additional publications of the author: W. Röpke, Crises and Cycles (London, 1936); W. Röpke, Civitas Humana (London, 1948). See also: G. Haberler, Prosperity and Depression (3rd ed.; Geneva, 1941); Hans Gestrich, Kredit und Sparen (2nd ed.; Godesberg, 1948); J. Schumpeter, Business Cycles (New York, 1939); League of Nations (report), Economic Stability in the Post-War World (Geneva, 1945); G. Haberler (ed.), Readings in Business Cycle Theory (Philadelphia, 1944); W.A. Jöhr, Die Konjunkturschwankungen (Tübingen-Zürich, 1952); G. Schmölders, “Konjunkturen und Krisen,” Rowohlts Deutsche Enzyklopädie, Vol. 3.

2. (p. 217) Inadequate Investment—A Matter of Fate?

Under the influence of Keynes (The General Theory of Employment, Interest and Money [London, 1936]) and of the American economist Alvin H. Hansen (Full Recovery or Stagnation? [New York, 1938]), widespread currency was given to the notion that the rich industrial countries have entered the phase of relative investment saturation (“mature economy”) and that consequently a permanent tendency for savings to outstrip investment will develop unless appropriate measures are taken to forestall this. This theory of latent chronic stagnation must, however, be abandoned as unproven. See W. Röpke, Civitas Humana (op. cit., pp. 218-220); Howard S. Ellis, “Monetary Policy and Investment,” American Economic Review, Supplement, March 1940; Henry C. Simons, “Hansen on Fiscal Policy” in Economy Policy for a Free Society (Chicago, 1948); Willford I. King, “Are We Suffering from Economic Maturity?” Journal of Political Economy, October 1939; George Terborgh, The Bogey of Economic Maturity (Chicago, 1945). The above-mentioned League of Nations report also rejects the mature economy thesis; in the interim it has long since been disproved by events, and its place taken by the concern as to how rapid rates of growth can be achieved without inflation.

3. (p. 217) Secondary Depression

See W. Röpke, Crises and Cycles, op. cit.; W. Röpke, “Die sekundäre Krise und ihre Ueberwindung,” Economic Essays in Honour of Gustav Cassel (London, 1933).

4. (p. 218) “Full Employment”

For criticism of the “full employment” school see: G. Haberler, op. cit.; Howard S. Ellis, op. cit.; Hans Gestrich, op. cit.; W. Röpke, The Social Crisis of Our Time (Chicago, 1950); W. Röpke, Civitas Humana, op. cit.; Allan G.B. Fisher, Economic Progress and Social Security (London, 1945); Henry C. Simons, op. cit., especially Chapter XIII, “The Beveridge Program: An Unsympathetic Interpretation”; L.A. Hahn, The Economics of Illusion (New York, 1949); W. Röpke, “ ‘Vollbeschäftigung’—eine trügerische Lösung,” Zeitschrift für das gesamte Kreditwesen, 1950, No. 6 (discussion on the same in No. 11). For the practical application of these thoughts to the case of German economic policy since 1948 see W. Röpke, Ist die deutsche Wirtschaftspolitik richtig? (Stuttgart, 1950), a monograph prepared at the behest of the German government, the essentials of which have been reprinted in Wilhelm Röpke, Gegen die Brandung (Erlenbach-Zurich, 1959). An extreme example of the “full employment” ideology and one in which its principal errors may be particularly well studied is the United Nations report by five economic experts entitled National and International Measures for Full Employment (Lake Success, New York, 1949). For criticism of this document see: Jacob Viner, “Full Employment at Whatever Cost,” The Quarterly Journal of Economics, August, 1950; W. Röpke, The Economics of Full Employment (New York, 1952).

5. (p. 218) Cyclical Policy

In addition to the above-mentioned League of Nations study, Economic Stability in the Post-War World, see my own book Crises and Cycles and also: Charles La Roche, Beschäftigungspolitik in der Demokratie (Zurich, 1947); B. Ohlin, The Problem of Employment Stabilisation (London, 1950); Paul Binder, Die Stabilisierung der Wirtschaftskonjunktur (1956).

6. (p. 219) Flexibility of the Economic System

This extremely important theme has been the subject of investigation by: H.L. Keus, De ondernemer en zijn social-economische Problemen (Haarlem, 1942); Allan G.B. Fisher, op. cit.; League of Nations, Economic Stability in the Post-War World, op. cit.; Madeleine Jaccard, La mobilité de la main d’oeuvre et Ics problèmes du chômage et de la pénurie de travailleurs (Lausanne, 1945); W.H. Hutt, Plan for Reconstruction (London, 1943). For discussion of current problems in this area see also my book A Humane Economy, op. cit.

7. (p. 228) “Keynesianism”

The theories of Keynes (“Keynesianism”) which long dominated economic debate and policy with respect to economic fluctuations, and which produced many uncritical analyses of the problem of “full employment,” have been subjected to increasingly sharp, even devastating criticism. See L.A. Hahn, Common Sense Economics (New York, 1956); L.A. Hahn, Geld und Kredit (Frankfurt am Main, 1960); Henry Hazlitt, The Failure of the “New Economics,” An Analysis of the Keynesian Fallacies (New York, 1959); Henry Hazlitt (ed.), The Critics of Keynesian Economics (New York, 1960); W. Röpke, A Humane Economy (Chicago, 1960); W. Röpke, “Was lehrt Keynes?” in Gegen die Brandung, op. cit.; David McCord Wright, The Keynesian System (New York, 1962).