Where Gardiner Means went Wrong

It was in his interpretation of Keynes’ General Theory, and this is clear in Means’ brief article “Which was the True Keynesian Theory of Employment?” (Challenge 19.3 [1976]: 61–63).

When the General Theory of Employment, Interest and Money (1936) was published, Gardiner C. Means – the originator of the administered price thesis – was unclear about what Keynes’ fundamental arguments against the neoclassical system actually were, and whether the theory depended on inflexible wages and prices.

This is illustrated by a fascinating piece of forgotten history told by Means himself: his visit to John Maynard Keynes in July 1939:

“In the summer of 1939, on my way to a holiday in Norway, I made it a point to visit Keynes with the specific purpose of asking him to what extent his explanation of persistent unemployment rested on an assumption of wage-rate or price inflexibility. His answer was a categorical: ‘Not at all.’ I asked the question in several different ways in order to make sure there was no failure of minds to meet and the answer was always the same. I said, ‘Suppose that prices and wage-rates met the classical assumption of perfect flexibility so that, if there were excessive unemployment, the price-wage level would fall frictionlessly. Then with the nominal money stock remaining constant, wouldn’t the rise in the real value of the money stock create added demand which would tend to absorb unemployed workers?’ But still the answer was no. Once interest rates had fallen to their limit there would be no further corrective. We were in complete agreement that, in practice, neither prices nor wage-rates were as flexible as classical theory assumed, but he insisted that his theory of unemployment did not depend at all on this fact.” (Means 1976: 61–62).

Despite these emphatic statements by Keynes, Lee (2000: 403) notes that Means was dissatisfied with Keynes’ replies (see also Ware 1992 for another account of the meeting).

Later, Means (1976) defended the neoclassical synthesis interpretation of the General Theory contrary to the explicit answers Keynes had given to him in 1939, because Means continued to believe in the efficacy of the real balances effect (Means 1976: 63).

Had Means properly read and understood Chapter 19 of the General Theory, he would not have made this error.

What also emerges from this article is that Means himself sent a draft of his famous Senate document “Industrial Prices and their Relative Flexibility” (1935) to Keynes, and Keynes even asked him to publish a version of this in the Economic Journal (of which Keynes was the editor), though Means was unable to do this (Means 1976: 61).

Keynes, then, must have been aware of the empirical evidence on administered prices by the mid-1930s, and he was explicitly aware of them in his work on buffer stocks in 1938 (Keynes 1938: 452–453).

BIBLIOGRAPHY
Keynes, J. M. 1938. “The Policy of Government Storage of Foodstuffs and Raw Materials,” Economic Journal 48.191: 449–460.

Lee, F. 2000. “Gardiner C. Means (1896–1988),” in Philip Arestis and Malcolm Sawyer (eds.), A Biographical Dictionary of Dissenting Economists (2nd edn.), Edward Elgar, Cheltenham, UK and Northampton, MA. 399–405.

Means, Gardiner C. 1935. “Industrial Prices and their Relative Flexibility,” Senate Document no 13. 74th Congress, 1st Session, 17 January.

Means, Gardiner C. 1976. “Which was the True Keynesian Theory of Employment?,” Challenge 19.3 (July/August): 61–63.

Ware, C. 1992. “Academic Resistance to Administered Prices,” in Frederic S. Lee and Warren J. Samuels (eds.), The Heterodox Economics of Gardiner C. Means: A Collection. M.E. Sharpe, Armonk, N.Y. 337–348.

Keynes’s Mistakes in the General Theory

Matias Vernengo raises the issue of Keynes’s errors in the General Theory in this post.

The mistakes and oversights that Keynes made in the General Theory are arguably as follows:

(1) the assumption of an exogenous money supply;

(2) the marginal efficiency of capital (MEC) idea. Keynes, in developing the MEC, failed to free himself from the neoclassical marginal productivity of capital (King 2002: 209):

“[sc. Keynes] made a fatal mistake in offering a quasi-long-period definition of the inducement to invest as the ‘marginal efficiency of capital’, that is, the profit that will be realised on the increment to the stock of capital that results from current investment and, still worse, identified the profitability of capital with its social utility. This was an element in the old doctrine from which he failed to escape. He had an alternative concept of the inducement to invest as the expected future return on sums of finance to be devoted to investment. Minsky (1976) points out that he did not seem to recognise the difference between the two formulations. If he had stuck to his short-period brief, he would have used only the second.” (Robinson 1979: 179–180).

The MEC seems to suggest that there exists a rate of interest which is low enough to induce full utilization of capital goods. But this is just smuggling in the Wicksellian natural rate of interest, when Keynes had wanted to abandon the natural rate.

A number of Post Keynesians reject the MEC, because it is based on the neoclassical or marginalist theory of distribution.

(3) Keynes did not sufficiently stress the role of uncertainty and expectations in undermining the coordinating role of interest rates (King 2002: 14). In Chapter 18 of the General Theory, Keynes played down the role of uncertainty (which he had stressed in Chapter 12) and, if he had really maintained the crucial role of uncertainty (as he did later in Keynes 1937), this would have “ruled out any stable functional relationship between investment and the interest rate” (King 2002: 14). The door was thereby left open for neoclassical synthesis Keynesians to reformulate the General Theory as a general equilibrium model where the interest rate has a pivotal role (King 2002: 14).

(4) In Chapter 2 of the General Theory, Keynes used the marginal productivity of labour concept. Later he was criticised by Lorie Tarshis and Dunlop, who invoked empirical evidence on pro-cyclical wages, and in Keynes (1939) he came to reject this marginalist idea, apparently giving some endorsement of Kalecki’s theories.

Other possible problems include:

(1) Did Keynes properly understand the heterogeneous nature of capital goods? Possibly he did (see Hayes 2007), though the Cambridge capital debates were long after he died;

(2) Did Keynes understand the extent and significance of fixprice markets? One charge against Keynes is that the General Theory does not consider fixprice markets properly. By contrast, Michał Kalecki did understand fixprices, in his ideas on cost-determined pricing. Kalecki and later Post Keynesians understood that as long as excess capacity exists in fixprice market firms, then government stimulus produces direct increases in output and employment in the latter markets, not just inflation.

LINKS
“Keynes’s Marginal Efficiency of Capital: A Mistake?,” January 1, 2012.

“Post Keynesian Policy on Interest Rates,” March 12, 2013.

“Interview with Bob Rowthorn,” March 4, 2012.


BIBLIOGRAPHY
Hayes, M. 2007. “Keynes’s Z-Function, Heterogeneous Output and Marginal Productivity,” Cambridge Journal of Economics 31.5: 741–753.

Keynes, J. M. 1937. “The General Theory of Employment,” Quarterly Journal of Economics 51: 209–223.

Keynes, J. M. 1939. “Relative Movements of Real Wages and Output,” Economic Journal 49: 34–51.

King, J. E. 2002. A History of Post Keynesian Economics since 1936. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Robinson, J. 1979. “Garegnani on Effective Demand,” Cambridge Journal of Economics 3: 179–180.

The Personal Relationship of Hayek and Keynes

Hayek and Keynes undoubtedly had deeply conflicting, and at times mutually hostile, views on economics. Their personal relationship, however, was not so bad, as Skidelsky has noted:

“[Keynes] had no personal animus against ... [Hayek], ‘Hayek has been here for the weekend,’ Keynes wrote to Lydia on 5 March 1933. ‘I sat by him in hall last night and lunched with him at Piero’s to-day. We get on very well in private life. But what rubbish his theory is – I felt to-day that even he was beginning to disbelieve it himself.’ This seems to have been the last occasion when they discussed economic theory. Thereafter they corresponded amiably enough about their various antiquarian discoveries. Keynes befriended Hayek during the war, and it was he who proposed him for a fellowship of the British Academy in 1944. He made an unforgettable personal impression on Hayek – ‘the magnetism of the brilliant conversationalist with his wide range of interests and bewitching voice.’ But Hayek never ceased to believe that Keynes’s influence on economics was ‘both miraculous and tragic.’ Hayek remained a bystander as the Keynesian Revolution unfolded; and only started to organise a resistance after Keynes’s death.” (Skidelsky 1992: 459).

Hayek’s harsh judgement on Keynes’s economics is reflected in the videos below.



From 1.00 onwards, Hayek dishonestly states that he accurately “predicted” the inflation of the 1970s (or strongly implies so). In fact, he did no such thing: Hayek himself stated elsewhere that his “prediction” of what would happen in the post-war period was wrong in important respects:

“While on the one hand, immediately after the war I never believed, as most of my friends did, in an impending depression, because I anticipated an inflationary boom. My expectation would be that the inflationary boom would last five or six years, as the historical ones had done, forgetting that then the termination was due to the gold standard. If you had no gold standard—if you could continue inflating for much longer—it was very difficult to predict how long it would last. Of course, it has lasted very much longer than I expected.” (Nobel Prize-Winning Economist: Friedrich A. von Hayek, p. 184).

In the same interview quoted here, Hayek also noted that his trade cycle theory had become less and less relevant (see “Hayek on the Flaws and Irrelevance of his Trade Cycle Theory,” June 29, 2011). As I have shown elsewhere, Hayek’s trade cycle theory as a serious explanation of 1970s stagflation is nonsensical.

In the second video, Hayek states that he never replied to the General Theory because Keynes was always changing his mind. In fact, Skidelsky responds to this:

“… Hayek later repeatedly claimed that he did not review Keynes’ General Theory because he feared ‘before I had completed my analysis he would have changed his mind.’ More likely, Hayek did not want to expose himself to another mauling from the Keynesians. But the decisive reason, as he himself later suggested, was that ‘my disagreement with that book did not refer so much to any detail of the analysis as to the general approach followed in the whole work. The real issue was the validity of what we now call macroeconomics.” Skidelsky (1992: 459).

BIBLIOGRAPHY

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Skidelsky, R. J. A. 1992. John Maynard Keynes: The Economist as Saviour, 1920–1937 (vol. 2), Macmillan, London.

Keynes’ General Theory: A 75 Year Anniversary

This month – February, 2011 – marks the 75th anniversary of the publication of Keynes’ classic The General Theory of Employment, Interest and Money (1936), which Keynes published when he was 52.

While others have celebrated the anniversary of his work more eloquently than I ever could (see Jesper Jespersen’s lecture on the 75th anniversary of the General Theory, Ann Pettifor and Victoria Chick, “Happy Anniversary, Mr. Keynes,” Bloomberg.com, February 4, 2011 and Robert Skidelsky, “The relevance of Keynes,” January 17, 2011), I cannot resist making a few comments.

Keynes once wrote a letter in reply to George Bernard Shaw. This letter concerned Keynes’ view of Marxism and the writing of the General Theory:

“Thank you for your letter. I will try to take your words to heart. There must be something in what you say, because there generally is. But I’ve made another shot at old K.[arl] M.[arx] last week, reading the Marx-Engels correspondence just published, without making much progress. I prefer Engels of the two. I can see that they invented a certain method of carrying on and a vile manner of writing, both of which their successors have maintained with fidelity. But if you tell me that they discovered a clue to the economic riddle, still I am beaten – I can discover nothing but out-of-date controversialising.

To understand my state of mind, however, you have to know that I believe myself to be writing a book on economic theory which will largely revolutionalise – not, I suppose, at once but in the course of the next ten years – the way the world thinks about economic problems. When my new theory has been duly assimilated and mixed with politics and feelings and passions, I can’t predict what the final upshot will be in its effect on action and affairs. But there will be a great change, and, in particular, the Ricardian foundations of Marxism will be knocked away.

I can’t expect you, or anyone else, to believe this at the present stage. But for myself I don’t merely hope what I say, – in my own mind I’m quite sure.”
(Keynes to Shaw, 1 January, 1935, quoted in Skidelsky 1992: 520–521).

Here is the key to one of the greatest achievements of Keynes. He overthrew the foundations of both Classical and neoclassical economics, and avoided the errors and flaws of Marxism. Keynes in fact despised both communism and fascism (Skidelsky 1992: 485–489), and saw himself firmly in the British liberal tradition.

While detractors of Keynes – whether Marxists, Austrians, and other neoclassicals – accuse of him of being a defender of capitalism, fascism, or communism (take your pick!), in reality his destruction of neoclassical economics and the subsequent development of his ideas in Post Keynesian economics are the starting point for a democratic socialist/social democratic system that is independent of Marxism.

In some ways, the full promise of Keynes’ revolution was aborted by neoclassical synthesis Keynesianism (see “Neoclassical Synthesis Keynesianism, New Keynesianism and Post Keynesianism: A Review,” July 7, 2010), but that “revolution” has been kept alive by the Cambridge Keynesians, their successors the Post Keynesians, and now by Modern Monetary Theory (which, in many ways, also owes a fundamental debt to Keynes’ thought, as well as to the work of Abba Lerner).

I also suspect that a good deal of the insights of Post Keynesian economics would apply even to libertarian socialist economies where production would be conducted by worker-run enterprises.

BIBLIOGRAPHY

Minsky, H. P. 2008. John Maynard Keynes, McGraw-Hill, New York and London.

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