John Maynard Keynes (Part II)

John Maynard Keynes The General Theory of Employment, Interest and Money, which I will refer here as the General Theory, revolutionized the way the world thinks about economics. It was published in 1936, seven years in to the Great Depression. He differs from the other economists because it is non-textual. He used the reality to guide his assumptions. The idea of the book is hard to understand unless you have a thorough background in economics but for the sake of discussion I will try to give my own analysis of his work.

I am a History major and the moment I knew that we have to do Adam Smith and Keynes as a project, I was a little hesitant. I have learned of Adam Smith as the father of modern economics and I was always puzzled by the "Keynesian" economics according to my readings. So I decided to give it a shot.

I
The General Theory written by Keynes was generally considered to be his magnum opus. It sought to bring about a revolution, commonly referred to as the "Keynesian Revolution", in the way economists thought - especially in relation a market economy and full employment. . During the 1920's, the U.S. experienced a stock market crash of enormous proportions which crippled the economy for years. Keynes knew that to recover as soon as possible, the government had to intervene and put a decrease on taxes along with an increase in spending. By putting more money into the economy and allowing more Americans to keep what they earned, the economy soon recovered and once again became prosperous.

In The General Theory, Keynes said that the classical economists had believed that "supply creates its own demand," and that therefore unemployment was impossible. This is because every product offered on the market was guaranteed a buyer. But since periods of depression and widespread unemployment had happened in the past (and one was the Great Depression), it clearly showed that the classical economists had been wrong. The "Great Depression" is so named because it is by far the largest sustained decline in industrial production and productivity from the century and a half where economic records have been kept with any regularity, and it reached virtually the entire industrialized world and their trading partners in peripheral nations. It led to massive bank failures, high unemployment, as well as dramatic drops in GDP, industrial production, share prices and virtually every other measure of economic growth.

The economists before Keynes emphasized that as long as men have unsatisfied wants, there is always more work and production to be done. Demand can never too small in comparison with the supply. But they were not able to point out that there can be mismatches between the individual supplies offered on the market and the individual demands for a particular good.
Keynes, or any other sensible theoretical economist, would agree that free-markets are a good idea in principle, which is seldom if ever realized.

II
The General Theory provides the theoretical framework within which temporary measures like the New Deal can be justified. Simply out, the public borrowing simply crowds out private investment. Here, government should always balance its annual budget. Keynes himself placed equal emphasis on taxation and a monetary policy of ‘cheap money. ’

Accordingly, he did not believe governments should run deficits for current consumption, as opposed to public investment. Another concept would be that depression and high unemployment result from insufficient private spending and that to cure these problems the government can always and must do something. And that is to increase its spending. It is the responsibility of the government to maintain full employment. The central theme of the book is that the level of employment is determined, not by the price of labor as what the other economists had in mind but rather by spending money or what we call as the aggregate demand.

Government protectionism (not always bad), monopolies (almost always bad), lack of sufficient incentives and transparency (almost always bad), are a few things that prevent markets from forming and operating efficiently "as if by invisible hand" to use one of the most beat up quotes in all economic literature. . The role of government in the Keynesian system was thus a double one: to improve the conditions of confidence--to give businessmen confidence that the system would last, that property rights would be maintained, and that the demands of workers would be restrained; and at the same time to make sure by fiscal and monetary policy that total spending in the economy would equal full employment output. In practical terms this meant that any increase in businessmen's pessimism about the future must be offset by increased government spending to compensate for an increased propensity to hoard. Keynes was quite aware of a possible conflict between the two roles of government.

III
Another point of discussion is the assumption that the market because it is competitive will deliver full employment. Of course, full employment will be the equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken. One implication of The General Theory is that a lack of competition is not the lproblem. Keynes does not set out a detailed policy program in The General Theory, but he went on in practice to place great emphasis on the reduction of long-term interest rates and the reform of the international monetary system.

Just as the reception of The General Theory was encouraged by the 1930s experience of mass unemployment, its fall from favour was associated with the ‘stagflation’ of the 1970s. Although Keynes addresses inflation, The General Theory does not treat it as an essentially monetary phenomenon nor suggest that control of the money supply or interest rates is the key remedy for inflation. However, many of the innovations introduced by The General Theory continue to be central to modern macroeconomics.

IV
Keynes does get blamed for failed economic policies of those Keynesians of the sixties and seventies who believed they could tinker the economy into perfection. Mistrust developed in Keynes General Theory. But when I read his book, I came to the conclusion that at some point he is right. Monetary policy can be used to get away with bad times. If I may say, the central conclusion of his work is that government in its involvement in the economy is always necessary. Although difficult to read, it has been essential to my understanding of modern economics.

The key here is the notion that at particular times in the business cycle, an economy can become over-productive and will begin a result in massive lay offs and even cut sin production to balance supply and demand. On the other hand, an economy can sometimes reach underemployment state, something is necessary to boost employment.

The main point of difference of Keynes and the classical economics is that the latter just assumes that a gap is always filled by planned investment (where the economy is at full employment, no less) without even making an argument for it.

V
His famous "in the long-run we are all dead" remark clearly reveals that he was more concerned with the long run in a historical rather than logical sense. Technically, the logical long period can emerge after a short or long amount of time. Indeed, one of the major appeals of Keynes's General Theory was precisely that it seemed to lend theoretical guidance to policy-makers in an era when the Great Depression still had its grip on the industrialized world.

Keynes's theory is simple and practical: firms will hire more labor only if they believe they can sell the extra output; consequently, if demand as a whole declines, they will cut back production and lay workers off. However, by laying workers off, the income of potential customers decreases and thus demand as a whole will be even lower. Thus, as firms do not see demand rise again, they have no incentive to rehire. The economy, in short, is caught in a vicious circle of high unemployment and low demand. This is where an exogenous agency, such as a government, can step in and, by increasing demand, push the economy into a virtuous cycle of high demand and high employment.
Briefly, the "General Theory" argued that the level of aggregate demand in a modern economy was determined by a range of factors including the propensity to consume (the percentage of any increase in their income that people chose to spend on goods and services), the propensity to save (the percentage of any increase in their incomes that they chose to save), the attractiveness of fixed capital investment (dependent on anticipated rates of return) and the level of interest rates. Keynes's key arguments included that in an economy bedevilled by weak demand (e.g. a depression), where in his terminology there was an ignition problem (a difficulty in getting the economy to move forward more vigorously), then the government (more broadly the public sector) could increase aggregate demand by increasing its expenditures, including by borrowing to finance the expenditures, and that the public-sector borrowing would not increase interest rates sufficiently to undermine the effectiveness of such a policy.

JOHN MAYNARD KEYNES (part I)

I. HIS LIFE
John Maynard Keynes is another influential name in economics, in the middle third of the twentieth century that an entire school of modern thought bears his name. Many of his ideas were revolutionary; almost all were controversial. His works were now called Keynesian Economics and is a yardstick that can define virtually all economists who came after him. Keynes’s ideas took a dramatic change. Keynes investigated causes of Britain’s economic woes, and The General Theory of Employment, Interest and Money was the result.

John Maynard Keynes was born in Cambridge and attended King’s College, Cambridge, where he earned his degree in mathematics in 1905. He remained there for another year to study. After leaving Cambridge, Keynes took a position with the civil service in Britain. While there, he collected the material for his first book in economics, Indian Currency and Finance, in which he described the workings of India’s monetary system. He returned to Cambridge in 1908 as a lecturer, then took a leave of absence to work for the British Treasury. He worked his way up quickly through the bureaucracy and by 1919 was the Treasury’s principal representative at the peace conference at Versailles. He resigned because he thought the Treaty of Versailles was overly burdensome for the Germans.

After resigning, he returned to Cambridge to resume teaching. A prominent journalist and speaker, Keynes was one of the famous Bloomsbury Group of literary greats, which also included Virginia Woolf and Bertrand Russell. At the 1944 Bretton Woods Conference, where the International Monetary Fund was established, Keynes was one of the architects of the postwar system of fixed exchange rates. In 1925, he married the Russian ballet dancer Lydia Lopokova. He was made a lord in 1942. Keynes died on April 21, 1946, survived by his father, John Neville Keynes, also a renowned economist in his day.

II. HIS WORKS
Keynes became a celebrity before becoming one of the most respected economists of the century when his eloquent book The Economic Consequences of the Peace was published in 1919. Keynes wrote it to object to the punitive reparations payments imposed on Germany by the Allied countries after World War I. The amounts demanded by the Allies were so large, he wrote, that a Germany that tried to pay them would stay perpetually poor and, therefore, politically unstable. We now know that Keynes was right. Besides its excellent economic analysis of reparations, Keynes’s book contains an insightful analysis of the Council of Four (Georges Clemenceau of France, Prime Minister David Lloyd George of Britain, President Woodrow Wilson of the United States, and Vittorio Orlando of Italy).

Keynes wrote: “The Council of Four paid no attention to these issues [which included making Germany and Austro-Hungary into good neighbors], being preoccupied with others—Clemenceau to crush the economic life of his enemy, Lloyd George to do a deal and bring home something which would pass muster for a week, the President to do nothing that was not just and right”

In the 1920s Keynes was a believer in the quantity theory of money (which is now coined as monetarism). His writings on the topic were essentially built on the principles he had learned from his mentors, Marshall and Pigou. In 1923 he wrote Tract on Monetary Reform, and later he published Treatise on Money, both on monetary policy. His major policy view was that the way to stabilize the economy is to stabilize the price level, and that to do that the government’s central bank must lower the so-called interest rates when prices tend to rise and raise them when prices tend to fall.

Having left the public service, Keynes returned to Cambridge as second bursar of King's College. In 1921 he assumed the first of a number of important company directorships. Also that year, he published A Treatise on Probability and, a year later, A Revision of the Treaty, a sequel to The Economic Consequences. In 1923 his Tract on Monetary Reform appeared. From 1924 until his death he was first bursar of King's College and through his expert management made King's what a contemporary has described as "indecently rich.”

Finally, in 1936, came Keynes's General Theory of Employment, Interest and Money, a book that not only revolutionized economic theory but also had a direct impact on the lives of a large proportion of the world's population. Here Keynes took issue with the classical theory which found in a competitive capitalist economy a set of mechanisms that automatically move the economy toward a state of full employment. These mechanisms functioned in the labor market and in the market for goods and services.

III. HIS LEGACY.
Keynes’s General Theory revolutionized the way economists think about economics. It was ground breaking because it introduced investment and government spending and because it showed (or purported to show) that full employment could be maintained only with the help of government spending. Economists still argue about what Keynes thought caused high unemployment.

Keynes’s conclusion initially met with opposition. At the time, balanced budgets were standard practice with the government. But the idea soon took hold and the U.S. government put people back to work on public works projects.

Contrary to some of his critics, Keynes was also an advocate of free markets. He believed that once full employment had been achieved by fiscal policy measures, the market mechanism could then operate freely.

Little of Keynes’s original work survives in modern economic theory. His ideas have been endlessly revised, expanded, and critiqued. Keynesian economics today, while having its roots in The General Theory, is chiefly the product of work by subsequent economists after him. But still, Keynes as the wellspring for so many outstanding economists is testament to the magnitude and influence of his ideas. In 1999, Time Magazine named Keynes one of the 100 Most Important People of the 20th Century and reported that, "His radical idea that governments should spend money they don't have may have saved capitalism". Keynes is widely considered the father of modern macroeconomics and is regarded as one of the most influential economist of the 20th century

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Sources:

Keynes. http://www.econlib.org/library/Enc/bios/Keynes.
Retrieved September 29, 2009.

John Maynard Keynes. www.wikipedia.org/ Keynes. Retrieved September 30, 2009.

Keynes. www. Britannica.com. Retrieved September 30, 2009.

The LEGACY OF ADAM SMITH (PART II)

The world came to know Adam Smith because of his work “An Inquiry into the Nature and Causes of the Wealth of Nations.” When we speak of Economics, Adam Smith is one of the key figures of the time. It is a great work. During those times, the book is a revolutionary one. It caused an upheaval to the upper class because it is mindful of the poor.

The book is about the wealth of nations and wealth, to Adam Smith, consists of the goods that all people of the society consume. (Heilbroner, 1986) But before Smith came with his ideas, there was first the concept of Physiocracy. He saw it as the nearest approximation to the truth that has yet been published upon the subject of political economy. The physiocrats believed that wealth came from production and not from the attainment of precious metals, which was adverse to mercantilist thought. They also believed that agriculture tended to produce wealth and that merchant and manufacturers did not. He did not embrace the idea of Physiocracy but Smith respected the ideas.

On “THE INVISIBLE HAND”

The Wealth of Nations explains that the free market, although it may appear that it is unrestrained, is actually guided to produce the right amount and a variety of goods by a so-called "invisible hand". Smith introduced the invisible hand doctrine, which held that as individuals pursued their own interest, they would be lead as if by an invisible hand to promote the good of the society. (Rollf 1989)

If we are to analyze the so called Invisible hand, we may notice that it is actually a guide for an individual to pursue self-interest. We may say that the invisible hand is in a way indirectly promoting the good of the society. A person would regard self interest as a factor in creating a good or in doing a service. In a free market when that person would try to keep prices low, would work hard to make a service good, and work hard because of a self interest while at the same time making an effort to create an array of goods and services.

According to Smith “‘it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest’” this is a clear statement of self interest. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity. Each person serving his own ends is led, in Smith's famous phrase, "by an invisible hand" simultaneously to serve everyone else's ends as well. But it is self interest and that is the invisible hand that guides the workforce. And I quote “he intends only on his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” (Smith 1776)

On the “DIVISION OF LABOR”

Smith also believed that a division of labor would affect a great increase in production. He cited as an example are the pin workers. In his famous opening example,
“a workman in the ‘trifling’ manufacture of pins might at best make twenty pins a day if he had to do all the operations himself, whereas even an ‘indifferent’ factory where ten men worked, each on a different task, could produce 48,000 pins a day. Therefore the process in which labourers hire themselves to capitalists, who organize industry on the basis of the division of labour, makes everybody in a capitalist society richer than even the richest members of a non-capitalist traditional society.” (Smith 1776)

Considering the idea, we may say that his theory on the division of labor was quite vague during the time. But in the modern sense, he is correct. Division of labor would cause an increase in production. From there, competition would start. The proposition is to divide the labor to increase economic prosperity. From this Smith argues towards his general prescription in favor of capitalism, laissez-faire, and free trade. In economics, Smith gives the pioneering analysis of the structure of a functioning economy, and the benefits of the division of labor.
Division of labor is one important concept in Smith’s work. It is just how people can best apply their own labor, their own resource to earn the highest possible return. That it should always yield an equal rate of return. I would have to agree with Smith on his theory that the division of labor can increase the value of production and that there is a value arising from labor in the process of production. Specialization of labor yields total output because labor can become more skilled at a particular task. From this came the idea of differences in wage. That difference in work would mean difference in pay. But a statement in his book would definitely make us feel that it is not division of labor per se but helping each other. And I quote: “Man has almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only.” (Smith 1776)

On “LAISSEZ FAIRE” and “FREE Trade”

Smith did not coin the term laissez-faire but he did identify a general set of principles that brought clarity to what we call market transactions. But in his writing, he expounded on the idea of a limited government intervening with market. He opposed government intervention in the market. The wealth of a nation can be measured by the number and variety of consumable goods it can command. Free trade is essential for the maximum development of any nation. According to Smith, variety of goods can become possible when the government is not intervening with production. It is always the impulse of self-interest would bring about the public welfare. One of the main points of The Wealth of Nations is that the free market, while appearing chaotic and unrestrained, is actually guided to produce the right amount and variety of goods by what Smith refers to as the "invisible hand"—which is more of an economic law than a mysterious force.

Adam Smith expressed disbelief over the government intervening with production. But he mentioned in some parts that the government had a role to play. That is to enforce contracts and encourage new ideas. He even thought that government restrictions had always hindered industrial expansion. He attacked most forms of government interference in the economic process, including tariffs. This theory, referred to as laissez-faire, (A popular French phrase that means ‘let the people do as they choose), influenced government legislation later, especially during the nineteenth century. Smith criticized a number of practices that later became associated with laissez-faire capitalism, and as such are often wrongly associated with him. What he did was just to explain the causes of the slow production and of some government restrictions but these became the basis for some of our modern concepts of economics. What Smith is against is the meddling of the government with the market. Against restraints on imports and bounties on exports and against government law that shelter industry from free competition. (Heilbroner 1986)


On MERCANTILISM AND CAPITALISM

During his time, mercantilism was the prevailing economic system. (Although, I would say that it wasn’t a system by then). Smith was opposed to monopolies and the concepts of mercantilism in general. He opposed Mercantilism and that is maintaining a trade surplus to increase wealth. Mercantilism emphasized the maximizing of exports and the minimizing of imports. Smith believed that mercantilism benefits the wealthy and the politically powerful while it deprives the common people of the better quality and less expensive goods that would for them. There should be free trade. Adam Smith made mention of the flow of goods and services. I quote:

"Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society. (Smith 1776)

Smith also addressed some of the more important issues of his days. It is not just to explain he process of production or the division of labor and the wage difference, but also to point some of the pressing issues of British governance. The times were characterized by an increase in economic activity. Feudalism, with its economically, socially and politically self-sufficient manor was giving way to increasing trade. The mercantilist proceeded on the assumption that the total wealth of the world was fixed. During those times, the British crown was spending too much on its colonies even those that are not worth for keeping. He did at some point accepted government intervention in the economy that reduced poverty and government regulation in support of workers. He argued that the government should allow policies that will allow progress. In The Wealth of Nations Smith argues against the mercantilists that wealth is not mere pieces of metal: it is rather the ability to satisfy one's needs and desires.



III THE WEALTH OF NATIONS and some views.

Adam Smith wrote the book in many years. But he was writing about his age and his time. When he left the university in 1764 and became a tutor, his travels to France would have influenced him. England and France had just finished the Seven Years war. Paris, during those times, was torn between the great philosophies of the past and the new theories getting into the mainstream. France, by then was a great producer and exporter of corn and wine – an agricultural country – but the government had been trying to make the country an exporter of manufactured goods.

During the writing of the book, there was a strong sentiment for free trade in both Britain and America. This new feeling had been born out of the economic hardships and poverty caused by the war. However, at the time of publication in 1776, not everybody was immediately convinced of the advantages of free trade: The British public and Parliament still clung to mercantilism for many years to come. In 1776, the very year the American Declaration of Independence indicated the political failure of the old colonial system, the policy of mercantilism came under fire from the side of economic theory. A systematic rebuttal of the workings of mercantilism was put forward by Adam Smith. It is important to note that during those times, the English and the Dutch were able to take powers. Those nations became wealthy because of production. From this, the government of France believed that it is high time for France to move forward and forget its agricultural phase and move on to becoming a manufacturing power. From these, the government imposed laws on foreign manufacturers and gave bounty to the domestic manufacturers.

Adam Smith made mention in his book of government restrain. He might have observed this in France where there are restraints upon commerce. This made him comment on the issue of taxation that made the people’s lives miserable and that would later usher in the French Revolution.

Adam Smith is indeed a genius for writing a book that his predecessors failed to do so. How he was able to predict some of the more important issues of our time is indeed marvelous. Smith was able to identify several characteristics of growing economies. One of which is the division of labor. The revolution in labor in the seventeenth and eighteenth centuries, in which tasks were divided among workers each doing a single task, produced a revolution in production and it indeed increased a hundredfold. It is the with this, I can say that human life is productive and that the increase of production will not only result in more wealth but greater meaning and value for human life. We can also made mention of government intervention in labor may sometimes caused its stifling. Human beings work for their own profit but regulations and monopolies discouraged production. Each individual in a society is free to choose how to expend their productive labor and their capital. This selfishness, though, would not result in social injustice because there will always be the "invisible hand" which will guide people into right action.

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Sources:

Rowen, H. (1964). From absolutism to revolution: 1648 – 1848.New York: Macmillan Company.

Adam smith. www.lucidcafe.com/lucidcafe/library/96jun/smith.html.

Retrieved September 20, 2009.

Smith. www.blupete.com/Literature/Biographies/Philosophy/Smith.

Retrieved September 20, 2009.

Adam Smith. www. Wikipedia.Retrieved October 1, 2009
Heilbroner, R. (1953) The worldly philosophers. USA

Smith, A. (1776) An inquiry in to the nature and causes of the wealth of nations. London