Keynes and Pyramid-Building: What He Really Meant

Here is a passage in Keynes’s The General Theory of Employment, Interest, and Money that his opponents repeatedly misrepresent:

“When involuntary unemployment exists, the marginal disutility of labour is necessarily less than the utility of the marginal product. Indeed it may be much less. For a man who has been long unemployed some measure of labour, instead of involving disutility, may have a positive utility. If this is accepted, the above reasoning shows how ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.

It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly ‘wasteful’ forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions.

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.” (Keynes 2008 [1936]: 1936: 115–116).

What is notable is that the hordes of commentators on this passage supress the important qualifications:

Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.

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.”

The assumption behind these comments is an economy suffering from

(1) severe depression or
(2) high involuntary unemployment and idle resources.

It is not an economy at full employment. In other words, we are talking about the terrible conditions of the 1930s when there were armies of unemployed and idle plant in many capitalist nations. Keynes’s solution of deficit-financed public works spending faced opposition from the neoclassicals of his day who held the so-called “Treasury” view.

Keynes’s assertion that even wasteful public loan expenditure might “serve to increase wealth” in such times was his way of shocking contemporaries into seeing that effective demand drives output and employment, and that even wasteful spending would tend to raise production and employment in conditions of idle resources, insufficient demand and low private investment. In fact, Keynes could have added that even wasteful private investment or spending would have done the same thing. In such an economy with high involuntary unemployment and idle resources, any failed or wasteful private investment is essentially in the same category as the government having people dig holes in the ground, but no one doubts that this private activity raises output and employment while it is in progress.

But the whole point of the passage is precisely that that we do not want wasteful public loan expenditure, and that it is the incompetence and stupidity of neoclassical theory held by many economists and policy makers that prevents the necessary public investment in useful spending programs.

Keynes did not seriously advocate pyramid-building, wars or digging holes in the ground as a method of stimulus. His preferred method was the equally misunderstood solution of the “socialisation of investment”:

“By ‘socialisation of investment’ Keynes did not mean nationalisation. Socialisation of investment need not exclude ‘all manner of compromise and devices by which public authority will co-operate with private initiative’ ... This single throw-away line in the General Theory reflects Keynes’s thinking on ‘public-private partnerships’, which came out of his involvement in Liberal politics in the 1920s (Skidelsky, 1992, chs 7 and 8). In essence, he sought to expand the public-utility component of investment to give greater stability to the investment function. Today, he would have seen the big institutional investors like pension funds as a major support for stability. A guaranteed stream of investment would reduce fluctuations to modest dimensions, which could be readily controlled, if so wished, by speeding up or slowing down elements in the investment programme. Such investment would not necessarily be profit-maximising. But provided it yielded positive returns, there would be a gain. If markets had perfect information, public investment would be inefficient. But with uncertainty, there is a gain as against having no state investment at all, because of the losses due to uncertainty.” (Robert Skidelsky, “The Relevance of Keynes,” January 17, 2011).

BIBLIOGRAPHY

Keynes, J. M. 2008 [1936]. The General Theory of Employment, Interest, and Money, Atlantic Publishers, New Delhi.

Skidelsky, R. J. A. 1992. John Maynard Keynes: The Economist as Saviour 1920–1937, Macmillan, London