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Common Myths About Keynesian Economics

My inbox is filled with emails calling me a socialist following the Friedman post. This is not surprising because the word “Keynesian” has become synonymous with “socialist” in the last few decades. This is strange because Keynes identified himself as a capitalist and regularly criticized socialism (I too identify as a capitalist and reject socialism). It seems that the term “socialism” has become a rallying cry for politicians and the general public has come to view Keynesian economics as a form of “big government” economics. The reality is that the only people who could possibly think Keynesian economics is synonymous with socialism are people who really don’t understand Keynes at all and who have read none of his work.

There are lots of myths out there about Keynesian Economics so here are some facts:

1.  Keynes was a capitalist. He even stated, in plain English that he was on the side of the capitalists:

“I can be influenced by what seems to me to be justice and good sense; but the class war will find me on the side of the educated bourgeoisie.”

Keynes was even insulting of the working class in his critiques on Marxism:

“How can I adopt a creed which, preferring the mud to the fish, exalts the boorish proletariat above bourgeois and the intelligentsia who, whatever their faults, are the quality in life and surely carry the seeds of all human advancement?”

But he also understood that unfettered capitalism could actually undermine its own existence and lead to socialism.  Yes, Keynes did not favor socialism, but was worried that an extreme case of capitalism could actually lead to a socialist takeover. This makes complete sense because capitalism is inherently monopolistic. A good capitalist wants to own all of the means of production so they can maximize profits. That’s fine except that it has a tendency to result in a world of haves and have nots. A democracy filled with a few capitalists who own everything and a working class that feels like it has been screwed could turn to the government to overturn what looks like an injustice. This is precisely what Keynes feared. Keynes thought some use of government could actually keep capitalism healthier in the long-run.

2. Keynes would be considered a modern day moderate conservative. Many honest conservatives like Peter Drucker and Bruce Bartlett have pronounced Keynes to be a conservative and even a neoconservative. As Drucker noted:

“[Keynes] had two basic motivations…one was to destroy the labor unions and the other was to maintain the free market. Keynes despised the American Keynesians. His whole idea was to have an impotent government that would do nothing but, through tax and spending policies, maintain the equilibrium of the free market. Keynes was the real father of neoconservatism, far more than [economist F.A.] Hayek!”

3. Keynes disliked socialists and communists.  He once said this about socialism:

“Marxian Socialism must always remain a portent to the historians of Opinion – how a doctrine so illogical and so dull can have exercised so powerful and enduring an influence over the minds of men, and through them, the events of history.”

He added:

“if you tell me that [Marxists] discovered a clue to the economic riddle, still I am beaten – I can discover nothing but out-of-date controversialising.” 

4. The foundation of Keynesian economics is built around driving business investment. Keynes understood that entrepreneurs and businesses were the key to maximizing prosperity. He said:

“Economic prosperity is … dependent on a political and social atmosphere which is congenial to the average businessman.”

The whole basis of the General Theory was around entrepreneurs and investment:

“The outline of our theory can be expressed as follows. When employment increases aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment. It follows, therefore, that, given what we shall call the community’s propensity to consume, the equilibrium level of employment, i.e. the level at which there is no inducement to employers as a whole either to expand or to contract employment, will depend on the amount of current investment. The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and risks.”

The crux of Keynesian economics is to maximize business investment so that capitalists will hire workers which will increase output. Anyone who has read Keynes, and I mean really read him, knows that Keynes was not anti-capitalism. His whole theory is centered around boosting aggregate demand so that capitalists will maximize investment. The only people who focus on the “demand” component as if it’s some “dig holes and fill them up” sort of economic theory, are the ones who don’t understand that the demand component was really all about maximizing business investment by maximizing profits for capitalists. As a businessman Keynes understood that capitalism runs on sales. And sales boom when demand is strong.

5. Keynes was not in favor of “big government”. He was in favor of using government as a tool to help smooth the business cycle. He thought that we should buffer the bust with government intervention and reduce government intervention during the boom. He was in favor of budget deficits during the contraction and surpluses during the expansion.  As noted in “What Keynes Really Said about Deficits“:

“In economic downturns the automatic variation in the collection of social security contributions might result in a deficit in that fund. However, in prosperous times, the fund should automatically run a surplus. No other type of deficit should be incurred in the current budget. It is possible, however, to reduce contributions to the sinking fund for repayment of outstanding nonproductive debt in periods of economic downturn”

Not only was Keynes against “nonproductive” forms of government spending, but he was against running a budget deficit during boom periods. Unfortunately, some people have taken the idea of using some government to mean total authoritarian control via government.

There’s no doubt that Keynesian economics can be associated with liberals and even extremist liberals. But understanding and appreciating Keynesian economics does not make you a socialist or even a supporter of “big government”. I am politically centrist and I am not sure I’d call myself a “Keynesian”, but I appreciate the nuances in his work and I think his view of the world was balanced in a manner that made a good deal of sense. Unfortunately, the people who misuse the term Keynesian as being synonymous with “socialism” are merely using scary rhetoric to promote a political agenda that is inherently unbalanced. And since economics tends to be pretty complex stuff lots of people seem to have fallen into this trap.

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