The Great Recession: whatever happened to Keynes?


Immediately after the outbreak of the financial-economic crisis in 2008, there was a flurry of speculation in the media (and even in the ALP) that governments (that is, the ruling class) were going to junk neoliberalism and revert to some form of the Keynesian economics that was fairly standard from the end of World War II until the early 1970s. This speculation was well summarised last October by Truthout journalist Michael Corcoran:

“After the 2008 bailout of Bear Stearns, Martin Wolf, an economics writer for the Financial Times and normally a staunch supporter of free-market globalization, wrote: ‘Remember March 14 2008: it was the day the dream of global free market capitalism died.’ In the same article, he quoted Joseph Ackerman, the chief executive of Deutsche Bank, saying: ‘I no longer believe in the market’s self-healing power.’ In an October 10 article, The Washington Post – in all seriousness – suggested that the current economic crises meant ‘The End Of American Capitalism’ as we know it. The cover of Time magazine in February 2009, said, ‘We are all Socialists Now,’ referencing the need for government intervention to save us from the ills of capitalism. ‘Whether we want to admit it or not,’ the article observed, ‘the America of 2009 is moving toward a modern European state.’”

But the revival of Keynesianism didn’t happen. Governments around the world quickly returned to neoliberal orthodoxy, trying to reduce deficits by reducing public spending on social welfare. Why was Keynes once again embraced and then discarded so quickly?

What was Keynes on about?

Before Keynes, traditional capitalist economics (usually called “neo-classical economics”) portrayed capitalism as a largely self-regulating system that might occasionally experience disruptions but which tended to return automatically to “normal”, this “normal” including full employment. The Great Depression was a rather rude blow to such optimism, and Keynes set out to discover how to preserve capitalist optimism, without doing any more violence to the underlying false theory than was absolutely necessary.

Neo-classical economics assumed that supply and demand determined prices, production, employment etc. Keynes, without violating these assumptions, argued that it was possible for supply and demand to determine two or more quite different situations: in some circumstances, supply and demand might balance at general prosperity, but in others, they might balance at prolonged depression (like the 1930s). A committed (and wealthy) defender of the existing order, Keynes sought to devise recipes for moving an undesirable equilibrium (like permanent recession) to a more desirable one.

At the start of a downturn in the capitalist business cycle, Keynes noted, there is usually an imbalance between supply and demand: more is produced than there is effective demand (demand backed by money) for. Capitalists therefore cut production, but this only worsens the problem, because it reduces employment and thereby further reduces effective demand.

Keynes argued that governments could prevent the downward spiral if, at the right time, they countered the supply-demand imbalance by creating an artificial demand. It didn’t really matter how the government did this; it could even pay people to dig holes and fill them up again, he said. The key thing was to put money in the hands of people who would spend it more or less immediately, so that effective demand would rise and capitalists would not need to cut production.


Critics said that creating additional purchasing power without increasing production would tend to drive up prices, i.e. it would be inflationary. Keynesians acknowledged that this would happen, but argued that inflation could be neutralised over the full business cycle. If the government prevented the “bust” of the business cycle by increasing effective demand, it could counter inflation by decreasing effective demand during the “boom”. For example, it could run a budget deficit to prevent a recession but then run a budget surplus when demand started to exceed supply. The strategy was “counter-cyclical”: the government should spend when workers and capitalists couldn’t or didn’t want to, and cut its spending when consumer and investment spending created an upturn.

Furthermore, Keynes said, a little inflation was certainly better than a return to the Great Depression of the 1930s, and in itself it wasn’t necessarily a bad thing. A reasonable degree of inflation would boost profits by eroding real wages, he argued; workers found it harder to counter this kind of attack than to resist direct wage cuts.

Did it work?

From roughly the end of World War II to the early 1970s, Keynesianism was the dominant economic ideology of governments in developed capitalist countries. And it appeared to be successful: overall, the period was one of capitalist expansion, and recessions were generally short and mild compared to the early 20th century, let alone the 1930s. However, this appearance of Keynesian success is simplistic and tends to confuse cause and effect.

The destruction of working-class living standards and organisation during the 1930s and the tremendous destruction of World War II had created ideal conditions for capitalism: an almost limitless market and virtually guaranteed profits. This situation, not anyone’s economic theory, was the fundamental cause of the postwar capitalist boom.

Periods of capitalist boom, as Marx pointed out, are generally more favourable for the conditions of the working class than recessions, even though capitalist expansion in the long run increases workers’ exploitation and oppression. The postwar boom period is now identified in the public mind with Keynesianism and the “welfare state”.

This was a period during which average wages rose gradually but fairly regularly, if only because they started from a very low level. “Social welfare” measures, which are generally the part of workers’ wages paid collectively instead of individually, were better than at present because of a combination of factors: unemployment benefits were less of a cost for capital because many fewer people were unemployed; technological changes required a more educated workforce, so education had to be made cheaper; imperialist governments needed to convince sections of their workers that the system was fair and reasonable in order to win support for wars against the colonial revolution; the super-profits of imperialism were still enormous, making it easier for capital to throw money around when necessary to calm social tensions.

Keynesianism is contrasted with neoliberal economics, which became increasingly dominant from the 1973-74 international recession, and which has been the more or less official government ideology in a period of setbacks for working-class conditions and organisation. Under the guise of concern about debt, neoliberalism seeks to reduce as much as possible all the elements of the social wage: education, health care, unemployment insurance, pensions, public transport, parks and other public amenities, clean air – everything that makes workers’ lives easier or more enjoyable for which they do not have to pay a specific charge.

The difference in economic theory really exists, but it is less significant than the altered conditions of world capitalism, which are the reason behind the shift from Keynesianism to neoliberalism. Keynesianism and neoliberalism do not serve different class interests, but are different ways of protecting capitalist interests in different objective conditions.

What changed?

What changed in the objective conditions that caused capitalist ruling classes to switch from Keynesianism to neoliberalism?

Even during the Keynesian heyday, counter-cyclical policies were never able to be followed consistently. Rising prices are one of the prime motive forces of a boom. Consequently, governments weren’t able to reduce spending power during booms by the same amount they had increased it in the downturn; trying to do that almost always threatened to turn the upturn into a new recession.

Partly, this inability to follow Keynes’ advice – that governments should take out of the economy at the up stage of the cycle as much effective demand as they had put in at the down stage – was due to overlooking a psychological factor. (This was ironic, since much of Keynes’ theory relied on observed or presumed psychological attitudes of capitalists, workers and consumers.) If you are thinking of buying a new refrigerator or washing machine, and you have enough money and prices generally are rising, then the reasonable thing to do is to buy the appliance now. But if prices are falling (because the government is reducing spending power in order to make price changes sum to zero over the entire business cycle), then the logical thing to do is wait to see if they might fall a bit further. When large numbers of people started acting on this reasoning, budget surpluses had a greater depressing effect than was expected by Keynes or the governments that followed his ideas.

As a result, inflation became built into postwar capitalist economies. Unions began to seek “cost of living” adjustments in their contracts with employers; to help the employers, governments increased their lying about the rate of inflation. But lying doesn’t stop reality from continuing on its way. By the late 1960s, governments’ “normal” injection of effective demand was no longer sufficient to block a recession. Inflation and recession (“stagnation”) now occurred at the same time and were described by a new term: “stagflation”.

Like every other long (and short) boom, the postwar boom gradually undermined the conditions that made its existence possible. Under the more favourable economic conditions of the 1950s and ’60s, workers gradually improved their wages. As production boomed, markets began to be filled and then overfilled. The more capitalists accumulated profits, the more they exerted downward pressure on the rate of profit. An international recession in 1973-74 signalled that the postwar boom was over.

Keynesianism had not really been responsible for the boom, and even less was it able to counter the forces that were bringing the boom to an end. To better defend their interests in the new conditions, the majority of capitalists began shifting to the more aggressive strategy of neoliberalism, involving much more open and direct attacks on working people, their living standards and their ability to organise.

Keynes and politics

The “Keynesian resurgence” of 2008 may have aroused hopes in a few social democratic politicians, but it was never meant seriously by any significant part of the ruling class. The talk of Keynesianism appears to have been intended only to provide a cover for handing out vast sums to banks that appeared to be close to failing. This was not really a Keynesian measure, since Keynes wanted spending power to be distributed to people who would spend it, and do so quickly. The bailed-out banks have mostly been sitting on the money they were given. (In the United States, some of them have been borrowing money from the government at near-zero interest rates and then lending it back to the government at higher rates.)

The reason for capitalists’ disinterest in Keynesianism is simple. Both economic and political conditions of capitalism today are completely different from those of the 1950s and 1960s, when Keynesian policies seemed the most suited to protecting capitalists’ interests. We are still in the period that persuaded capitalists of the need for neoliberalism.

Better “social wage” (or “social welfare”) policies would be favourable for working people, and fighting to defend or improve them is an important part of any fight back against the capitalists and their governments. But there should be no illusions that the fight will be won by appeals to reason, by convincing politicians that such policies are more rational than those of the neoliberals. As in disputes over the direct wage, the capitalists will give up only what they are forced to give up.

Direct Action – March 14, 2012

Views, Discussion & Debate
The World