I read an article in the Financial Times earlier this week (September 23, 2023) -…
As more people become aware of Modern Monetary Theory (MMT), extreme reactions emerge to basic concepts that, in any reasonable sense, should evade such reactions. For example, when the concept of the Job Guarantee (JG) is explained the reactions include hysterical comments such as “This is Socialism”; “MMT advocates the government employing everyone – they are stealth Communists”; “MMT is Communism in disguise”; and the rest. I get several E-mails along these lines per week – all which go into the trash immediately – so why bother sending them! I also get many (polite) E-mails suggesting that we (MMTers) should adopt a compromise line and embrace the ideas of those, who while clearly holding ideas that are inconsistent with MMT, do advocate government-led stimulus in the present context. Apparently we should also use terminology that is consistent with the mainstream to minimise the chasm that has to be be crossed to jettison that orthodoxy and accept MMT. These tactical suggestions have resonated once again in the current little dispute about whether various economists, who operate in the New Keynesian paradigm are channeling Minskian ideas. The suggestion is that, while they might not have foreseen the crisis and hold to various theoretical concepts that are inconsistent with MMT development, we should, as a matter of strategy, form alliances with these economists because they are now advocating policy more or less similar to that proposed by MMTers. So our common purpose should be prioritised over our theoretical differences. I disagree. History shows us that it is very dangerous to develop a new approach by minimising the differences between it and the dominant, but erroneous paradigm just to make it easier for adherents of the latter to embrace the former.
I should add that I generally think compromise is a good thing in life – in getting along with people. But in the development of ideas it is a dangerous strategy because it ignores the capacity of one’s opponents to render the essential ideas irrelevant.
One of the suggestions has been that MMTers should sign the A Manifesto for Economic Sense. I declined the invitation politely, even though I agree with much of the text, because in the Manifesto we read that:
There must of course be a medium-term plan for reducing the government deficit.
Why should there be any emphasis on that? There should be a plan to reduce unemployment and promote sustainable growth. Whatever the deficit that results once those goals are achieved is the appropriate outcome. By adding that qualification, the Manifesto organisers and signatories are really giving credence to false premises.
These are the same premises that are being used to justify austerity even though the signatories are clearly opposed to austerity.
Here is some history that might help explain my position.
Prior to the publication of Keynes’ General Theory, a colleague Roy Harrod wrote to him – Harrod to J. M. Keynes , 1 August 1935 (The letter was reprinted in Keynes, Collected Writings, vol. XIII, pp. 533-34):
as from Christ Church
1 August 1935
You may wonder why I lay such stress on a point that merely concerns formal proof rather than the conclusions reached. I am thinking of the effectiveness of your work. Its effectiveness is diminished if you try to eradicate very deep-rooted habits of thought, unnecessarily. One of these is the supply and demand analysis. I am not merely thinking of the aged and fossilized, but of the younger generation who have been thinking perhaps only for a few years but very hard about these topics. It is doing great violence to their fundamental groundwork of thought, if you tell them that two independent demand and supply functions wont jointly determine price and quantity . Tell them that there may be more than one solution. Tell them that we don’t know the supply function. Tell them that the ceteris paribus clause is inadmissible and that [b] we can discover more important functional relationships governing price & quantity in this case which render the s. and d. analysis nugatory. But dont impugn that analysis itself.
The fact that saving is only another aspect of investment makes it worse not better. If there were two separate things, saving & investment, then it is clear that the two equations will not determine both. But with one thing, then if you allowed the cet. par. clause which you rightly do not, it would be quite logical and sensible to approach it in the classical way.
The context of this letter was Keynes’ proposed attack on the Classical theory of the determination of wages and employment. I outlined the Classical labour market theory in this blog – Less income, less work, less income, more work! – and will assume the discussion is known.
The important Classical result is that the interaction between the labour demand and supply functions determines the real level of the economy at any point in time. Unemployment was thus a real wage problem – and could be easily cured by cutting real wages.
Interestingly, New Keynesians still hold on to the notion that involuntary unemployed occurs because of wage and price rigidities. But that is another story – definitely not unrelated.
Keynes showed that the aggregate employment level was in fact determined by the level of effective demand – which was determined by the conjunction of aggregate demand for goods and services and aggregate supply. In other words, the labour market alone did not determine the level of employment in the economy and so a simple red
The Classical approach – which was the mainstream reasoning in the 1930s used the so-called “Say’s law” to assume away aggregate demand failure. The “Law” is simplified as “supply creates its own demand” and refers to the denial by classical economists that there could ever be over-production and unemployment. If consumers decide to save more then the firms react to this and produce more investment goods to absorb the saving. They assume a total fluidity of resources between sectors and workers are simply shifted from making iPads to making investment goods.
Keynes showed that when people save – they do not spend. They give no signal to firms about when they will spend in the future and what they will buy then. So there is a market failure. Firms react to the rising inventories and cut back output – unable to deal with the uncertainty.
The break with neoclassical thinking came with the failure of markets to resolve the persistently high unemployment during the 1930s. The 1930s experience suggested that Say’s Law did not hold and that a failure of aggregate demand placed constraints on the labour market which created unemployment.
In terms of orthodox demand and supply analysis, the effective demand constraint pushed workers “off their supply curve” and firms “off their demand curves” which meant that the labour demand and supply relations in the labour market did not determine price or quantity. In other words, a total failure of the Classical paradigm.
The problem is that Keynes did make important compromises – notably in Chapter 2 when he assumed a simple Classical marginal productivity theory to explain labour demand. In adopting this assumption, which he later realised was unnecessary and empirically unjustified, Keynes opened the door for subsequent developments which perverted his message. Ultimately, we could argue that the neo-liberal dominance now is, in part, due to that strategic error made by Keynes.
As a matter of strategy, Keynes chose to differentiate his labour market analysis on the labour supply side. His analysis of labour supply was brilliant and broke the Classical view that workers would never supply more labour if real wages fell.
In the – Appendix to Chapter 19. Professor Pigou’s “Theory of Unemployment” – of the General Theory, Keynes wrote:
It is important to emphasise that the whole of Professor Pigou’s book is written on the assumption that any rise in the cost of living, however moderate, relatively to the money-wage will cause the withdrawal from the labour market of a number of workers greater than that of all the existing unemployed.
He also said that workers would resist real wage cuts driven by money wage cuts because they cared about wage relativities – which reflected social norms. So why would a worker voluntarily agree to a downgrading of their status when the problem was a lack of jobs rather than an excessive wage claim.
Keynes showed that an unemployed worker was involuntarily unemployed if they were willing to work at the current money wage if offered a job, even if the real wage was lower at the higher level of employment.
He believed the real wage would be lower because he had adopted the first classical postulate. In Chapter 2 – The Postulates of the Classical Economics – Keynes wrote:
The wage is equal to the marginal product of labour
In Section 5 of Chapter 2 he wrote:
In emphasising our point of departure from the classical system, we must not overlook an important point of agreement. For we shall maintain the first postulate as heretofore … and we must pause, for a moment, to consider what this involves.
It means that, with a given organisation, equipment and technique, real wages and the volume of output (and hence of employment) are uniquely correlated, so that, in general, an increase in employment can only occur to the accompaniment of a decline in the rate of real wages. Thus I am not disputing this vital fact which the classical economists have (rightly) asserted as indefeasible. In a given state of organisation, equipment and technique, the real wage earned by a unit of labour has a unique (inverse) correlation with the volume of employment. Thus if employment increases, then, in the short period, the reward per unit of labour in terms of wage-goods must, in general, decline and profits increase. This is simply the obverse of the familiar proposition that industry is normally working subject to decreasing returns in the short period during which equipment etc. is assumed to be constant; so that the marginal product in the wage-good industries (which governs real wages) necessarily diminishes as employment is increased. So long, indeed, as this proposition holds, any means of increasing employment must lead at the same time to a diminution of the marginal product and hence of the rate of wages measured in terms of this product.
So Keynes accepted the so-called law of diminishing returns (diminishing marginal productivity) which meant he also considered marginal costs to be increasing. As a result competition would force prices up as output (and employment) increased and real wages would decline.
Increased employment was thus associated with lower marginal productivity and lower real wages. As I will note later it was this assumption – a major compromise to make his departure from Classical thinking more palatable – that led to later developments which are now held out to be Keynesian, which in fact, bear no similarity with Keynes’ vision. The New Keynesian paradigm which is dominant now is part of these later developments.
In 1938 and 1939, two empirical papers were published by those sympathetic to Keynes challenged his adoption of the marginal productivity assumption. The papers were:
1. Dunlop, J. (1938) ‘The Movement of Real and Money Wage Rates’, Economic Journal, 48, 413-434.
2. Tarshis, L. (1939) ‘Changes in Real and Money Wages’, Economic Journal, 49, 150-54.
The American John Dunlop and the Canadian Lorie Tarshis used US data to show that real wages and employment moved together directly, rather than inversely. They established that money wages and real wages moved together rather than in opposite directions.
Keynes replied (he was the editor of the Economic Journal at the time) by saying (p.38):
… it seems we have been living all these years on a generalisation which held good, by exception in the years 1880-1886, which was the formative period in Marshall’s thought on this matter, but has never once held good in the fifty years since he crytalilised it … it had the tendency to offset the influence of the main forces which I was discussing and made it necessary for me to introduce qualifications which I need not have trobled with if I could have adopted the contrary generalisation (i.e. of a positive relation between employment and the real wage … the practical case for a planned employment policy is considerably reinforced – because not reduction in the real wage is implied.
The full reference is – Keynes, J.M. (1939) ‘Relative Movements of Real Wages and Output’, Economic Journal, 49, 34-51.
Alfred Marshall for those non-economists (and perhaps even some of the more modern economists) was the professor at Cambridge who wrote the Principles of Economics, which was the English statement of the neo-classical approach to markets and such.
This brings to mind the book – God and Man at Yale – which was written by William F. Buckley, Jnr in 1951, who later was the doyen of the American conservatives and started the rag – National Review – to further spread his irrationality. Buckley was a supporter of Joseph McCarthy in his attempted purge against Communism, a white supremacist (in the context of the US Civil Rights movement), and later, a supporter of Augusto Pinochet and his ruthless, murderous attack on civil rights in Chile.
So not exactly my kind of guy.
The 1951 book recounted Buckley’s life as an undergraduate at Yale and he claimed that academics had forced liberal ideology onto their classes. He also claimed that academics had tried to undermine the religious beliefs held by students by introducing “liberal” ideas.
He demanded that Yale teach courses that did not challenge the “beliefs of the students”. He seemed to have a curious view of what education is.
The book “named names” as the expression goes – in the true McCarthyist mould. So why would I want to read such a book?
My reason for reading his 1951 book was related to one chapter in it on Canadian economist Lorie Tarshis. But first some background.
On October 9, 1993, one of my early mentors, Australian economist Geoff Harcourt wrote an article in the British Independent – Obituary: Professor Lorie Tarshis – which recalls some of these events.
Also interesting is this obituary from Stanford University where Lorie Tarshis taught for many years – Memorial Resolution Lorie Tarshis (1911 – 1993).
Tarshis was a Canadian who studied under Keynes at Cambridge in the early 1930s (pre General Theory). As Geoff Harcourt notes, Tarshis attended a series of lectures given by Keynes “which became Keynes’s General Theory in 1936” and later completed his PhD in Cambridge.
His PhD was very interesting but that is another story again.
Geoff Harcourt recounts that in:
… 1936 Tarshis went back to North America to teach economics at Tufts University in Boston. There he met at Harvard seminars other ardent ‘youngsters’ – Paul Samuelson, James Tobin, for example – who were propagating Keynes’s message.
I will come back to his work with John Dunlop (published in 1938) later.
But in the early 1940s, Tarshis published an introductory textbook for the US market which was the first to expound Keynesian economics and one of the few that would emerge which was in Geoff Harcourt’s words:
… deeply and intelligently true to Keynes’s vision.
It was a very interesting evolution of “Keynes’ vision” because it provided a much more elaborate version of the supply-side of the aggregate economy as being “as important as aggregate demand in determining the point of effective demand”.
You can access the textbook HERE.
The Stanford Memorial Resolution (cited above) said this of the textbook:
Tarshis was highly critical of big business (“monopolies”), looked more approvingly on labor unions, put much emphasis on the economic harm caused by the maldistribution of income and wealth in this country, expressed skepticism about the usefulness of the gold standard, approved of government deficits and of an increase in the national debt under certain circumstances, and in general called for greater government involvement in the economy on the ground that a general policy of laissez faire was not sufficient to ensure the health of the economy. These views all flowed from the theory and discussion presented in the text, and all were meant by Tarshis to strengthen and preserve the capitalist system (an aim of Keynes himself), reduce poverty, and contribute to world peace.
Had his exposition remained in vogue and been built upon, then as Geoff Harcourt notes:
… his version of Keynes’s analysis would have provided the basis both for understanding the ‘stagflation’ episode and providing appropriate policies to overcome it. It would also have limited the damage … that has been done because of the different way in which Keynesian thinking came through the textbooks into the profession, especially in the United States.
This is crucial in terms of the upsurge of Monetarism and its associated thought and, later, the New Keynesians (such as Greg Mankiw, Paul Krugman, J. Bradford De Long etc), who have dominated the profession since the mid-1970s.
As I will argue soon – these aberrant macroeconomic developments – were given oxygen because of the way in which Keynesian economics developed in the US under the watchful hand of Paul Samuelson. The latter coined the phrase – the Neoclassical Synthesis – which purported to meld the theory of effective demand (Keynes’ macro) with the classical microeconomic theory (free markets, rational agents, etc).
The Synthesis was not “deeply and intelligently true to Keynes’s vision”. It was the anathema of that vision.
But it’s poorly developed supply-side opened the “Keynesians” (that is, the synthesis Keynesians) to criticism that their “demand-side” analysis failed to account for the stagflation that accompanied the OPEC oil price hikes in the 1970s and the contractionary policy reaction. Up until the 1970s, the Synthesis version of the world considered two broad states: (a) full employment with a demand-pull inflation threat; (b) unemployment with low inflation.
If inflation was becoming an issue then it was interpreted as being excessive aggregate demand growth and thus “over-full employment” and the policy response was to engage in contractionary fiscal and/or monetary policy.
Conversely, if there was unemployment, then it was assumed that inflation was not an issue (because demand was weak and not pulling up prices) and the policy response was clear – engage in expansionary fiscal and/or monetary policy.
The dichotomy was often expressed in terms of a reverse-L shaped aggregate supply curve (describing a relationship between prices on the vertical axis and output on the horizontal axis) where the economy was defined as having these two states. Up until full employment, policy could push quantity of output up (the real economy) at constant prices because firms were assumed to have excess capacity and would not experience any cost pressures. This is the horizontal section of the aggregate supply curve – where demand expansion is assumed to stimulate only a real response from the firms (that is, prices are constant in the face of the expansion).
After full employment was reached, the aggregate supply curve became vertical so that firms only responded to increased nominal aggregate demand with price increases, having exhausted their capacity to expand real output.
So when prices started to inflate after the cost hikes (OPEC) in the 1970s and these were accompanied by increasing unemployment such a dichotomised framework appeared to be short of an explanation.
The paradigm shift away from “Keynesian” thinking and policy development occurred in this period and led to what we have now – a neo-liberalism that largely ignores mass unemployment and progressives being defined by New Keynesians who bear no relation to Keynes’ original message.
It was more complicated than that because a major part of the Monetarist attack on the Synthesis Keynesians focused on the way in which Samuelson and his followers had constructed the so-called “microfoundations” of the story. That is the topic for another blog.
But the interesting point is – why did this version of Keynes dominate in the US and the earlier, much richer treatment developed by Lori Tarshis disappear?
In the Obituary to Lorie Tarshis, Geoff Harcourt provides some credible ideas:
Why this should have happened is related to the second disgraceful treatment of Tarshis during his academic life. When he was teaching at Williams in the summer of 1947 he began to get disquieting news about his book. An anti-New Dealer, Merwin K. Hart, led the attack through a pamphlet, written by Rose Wilder Lane, which was sent to the trustees of every university in the country. (William Buckley Jnr joined in later, devoting a chapter to Tarshis’s book in God and Man at Yale.) As a result many departments reneged on their initial decision to prescribe the book so that sales were only respectable, not all-embracing.
Paul Samuelson’s introductory textbook with its less satisfactory way of expositing Keynes’s theory thus became the dominant textbook when it was published the next year. (He received the tail-end of these pre-McCarthyite attacks, but not enough to damage his sales.)
There was a reflection written by Paul Samuelson himself on textbook writing in 1997 (Full Reference: Paul A. Samuelson (1997) ‘Credo of a Lucky Textbook Author’, Journal of Economic Perspectives, 11(2), 153-160) which touches on these events.
Paul Samuelson wrote the most popular “Synthesis Keynesian” textbook, which dominated the market for years (up until the demise of this way of thinking).
In the section of the paper sub-titled “Tale of Two Texts”, he wrote on the Lorie Tarshis scandal:
I did cash in on bringing simple Keynes to the elementary classroom … One guy’s luck may be augmented by another’s bad luck. The tale I shall tell has its primary interest as an important chapter in the attempts by noneconomists to censor what is taught in the university. Censors seek suppression both from the right and from the left.
The 1948 Samuelson text was not the first to add a Keynesian analysis … The late Lorie Tarshis … finished The Elements of Economics at Stanford, and Houghton-Mifflin published it a full year before 1948. Lorie was a neighbor and good personal friend … It was a good book; a very good book … For one year the Tarshis opus had a good sale. Under normal circumstances, my book would have inevitably become a competitor … What almost killed the Tarshis book in its tracks were vicious political and personal attacks on him as a “Keynesian-Marxist.” (Earlier, Herbert Hoover popularized that one-word combination.) I knew well the diversities of ideologies in 1930-1950 America, but never could I understand the variety and virulence of the attackers on Tarshis from the right.
Tarshis was not notorious as a leftist; before then and until his death in 1994 at a ripe, ripe age, Lorie Tarshis was a low-keyed teacher and researcher … The attackers, I recall, included names then considered extremely on the right: a Colonel Namm, who owned a Brooklyn department store; also someone named ZoU, from a small fascist-leaning group on the right. There was, too, a Philip Cortney, who headed the Cody cosmetic company and lectured at Harvard that Sumner Slichter (who was actually the academic most beloved by business-group audiences) … [said] … was “the most dangerous man in America. Worse than an avowed Keynesian is this closet-Keynesian poisoning America’s policy formation.” Running with that pack was Rose Wilder Lane … [who] … Somewhere along the line … became possessed of economic truth and proclaimed that it was not to be found in the dangerous Tarshis canon …
God and Man at Yale by the young Bill Buckley (1951) quoted from some of them. The joke is that Buckley’s Yale was notorious in those days for its conservative old guard economists … I cannot judge Yale’s religious orthodoxies and heresies, but its economics at that time was devoutly orthodox.
All this may now seem bizarre and comical, but it was not a joke to earnest professors at scores of colleges who came under attack by regents and alumni visiting committees who had been alerted to the heresies being imposed on innocent college youth.
I thought it was worth quoting that section in its near entirety because I know the article will be hard to come by for those without access to library subscriptions.
Wilder Lane accused Lorie Tarshis of promoting “economic socialist heresy” and Buckley claimed the macroeconomics text was inspired by Communism.
The Stanford Memorial Resolution recounted the scandalous treatment of Lorie Tarshis in this way:
… the textbook immediately shattered the academic peace, both at Stanford and elsewhere. It was quickly attacked by some of its conservative readers – and by many others who never read it – beginning as early as August, 1947 in a long, hostile review by Rose Wilder Lane, a conservative publicist and editor of the Economic Council Review of Books. Her review was distributed widely by the President of the National Economic Council, Merwin K. Hart, to trustees, administrators, and others associated with colleges and universities, as well as to congressmen and other political leaders, in an overt attempt to prevent the use of the book.
Stanford’s President, Donald Tresidder, was caught up in the controversy and suddenly found himself in lengthy correspondence with disturbed and irate alumni and others … A congressman wrote that left-wingers like Tarshis were silencing the more gentle right-wing professors. Even Herbert Hoover wrote a “Dear Don” note about the complaints he had heard about the book, but he offered no advice. The Dean of the Graduate School of Business at Stanford called Tresidder’s attention to the book’s “prosocialist propaganda.” One Stanford trustee wrote Tresidder: “If Tarshis’ theory is correct it won’t be long before Stanford’s endowment income won’t have enough purchasing power to buy a package of cigarettes.” Tarshis was accused by others of being a Marxist, having un-American views, and favoring Soviet communism over American freedom. To another letter writer, he was a “foxy minded… Russian- Communist Jew.” A Santa Ana publisher wrote to Tresidder that much of the textbook was “absolutely incompatible with the spirit of the Declaration of Independence and the Ten Commandments.” The entire episode now appears as a notable anticipation of the McCarthy period that soon followed.
Before all of this had time to erupt fully, Tarshis’s book was adopted by at least 100 colleges and universities, including almost all the Ivy League schools. However, the mounting campaign against the book, joined vigorously a few years later by William F. Buckley, Jr., in his God and Man at Yale (1951), and the appearance in 1948 of the first edition of Paul Samuelson’s textbook – soon to sweep much of the market for many years – greatly reduced the demand for Tarshis’s own book.
So what happened?
The upshot of these virulent attacks on Tarshis was that Paul Samuelson wrote a book that he admitted later was written “carefully and lawyer like” (see Colander, D.C. and Landreth, H. (1996) The coming of Keynesianism to America, Edward Elgar, p. 172).
That book became the dominant text of the time and so the Neo-classical-Keynesian Synthesis was born but the fundamental and revolutionary message contained in Keynes was lost and rendered relatively barren.
Earlier, within a year of the General Theory being released J.R. Hicks proposed the so-called IS-LM model of joint product and money market equilibrium, which became one of the centrepieces of the Neo-classical-Keynesian Synthesis. The model was not consistent with Keynes’ vision at all and eliminated, among other things, the importance of expectations and investment behaviour – a key idea in the theory of effective demand and the tendency of monetary economies operating under conditions of endemic uncertainty to generate mass (involuntary) unemployment.
Robert Skidelsky’s biography of Keynes suggests that the acolytes of Keynes at the time were not vehement enough in opposition when the IS-LM model was floated in September 1936, at the Sixth European meeting of the Econometric Society (held at Oxford University).
Skidelsky wrote (page 538) that in the context of the “desperate urgency” to cure the mass unemployment arising from the Great Depression:
… it was not surprising that the earliest “Keynesians” saw his book as a machine for policy, and interpreted it primarily as providing a rationale for public spending … [But] …. Hicks, Harrod, Meade and Hansen in America, the leading constructors of the ‘IS-LM’ Keynesianism, had a clear motive: to reconcile Keynesians and non-Keynesians, so that the ground for policy could be quickly cleared. These early theoretical models incorporated features which were not at all evident in the magnum opus, but which conformed more closely to orthodox theory. The constructors of these models also thought they were improving the original building. Joan Robinson, no slouch with insults, would later label the result ‘bastard Keynesianism’. But Keynes was the bastard’s father.
The full reference is Skidelsky, R. (1992) John Maynard Keynes – The Economist as a Saviour, 1920-1937, Macmillan. Emphasis in original.
So when the likes of Robert Lucas, Jnr wrote in 1980 that:
… one cannot find good under-forty economists who identify themselves or their work as – Keynesian?. Indeed, people often take offence if referred to as Keynesians. At research seminars, people don;t take Keynesian theorising seriously any more; the audience starts to whisper and giggle at one another.
– he was not talking about Keynes’ vision, but, rather, the bastardised version that followed the publication of the General Theory.
The full reference is Lucas, R. (1980) ‘The Death of Keynesian Economics’, Issues and Ideas, University of Chicago, Chicago, 18-19.
Both the Samuelson development and Hick’s IS-LM approach morphed and allowed the “Keynesian” approach to be discredited during the 1970s. What has followed in macroeconomic theory is deeply objectionable and largely erroneous. I include the New Keynesians in that description.
Please read my blog – Mainstream macroeconomic fads – just a waste of time – for more discussion on this point.
This discussion forms part of one of the book projects I am working on. This section is about compromise and strategy.
I think it matters the way a rival paradigm frames its language and concepts. I see no advantage in forming strategic alliances with schools of thought that are basically – when distilled down – part of the problem rather than the solution.
More on this theme another day.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.