A survey of orthodox economics – monetarism and Keynesianism

The scourge of monetarism

So capitalism survives. But all the optimism about its ability to generate improvements in living standards for as far ahead as the eye can see has gone. And the ideology of economists has changed along with the nature of capitalism.

Monetarism is ‘a school of economic thought which argues that disturbances within the monetary sector are the principal cause of instability in the economy.’ The quote is from a standard economics dictionary (Macmillan dictionary of modern economics p 278 ). From it we might assume that monetarism is utterly harmless, if a dry academic matter which must be incomprehensible to ordinary folk. In fact monetarist policies have blighted the lives of millions of working class people.

There are two levers economists can use to influence the behaviour of a capitalist economy. They are fiscal policy and monetary policy. Keynesians tend to believe that fiscal policy is a more effective instrument. They may use cuts in tax or increase government spending to put money in people’s pockets and increase effective demand in order to reflate the economy. If they believe the economy is running too fast, they may increase taxes or cut government spending. In both cases they are using fiscal policy to affect aggregate demand and thus the level of economic activity.

Monetarists believe monetary policy, targeting the money supply, is more effective than fiscal policy. But they also believe that the capitalist economy, left to itself, tends to stability. Monetarists frown sternly at attempts to manipulate the economy through expansionary fiscal policy or by ‘printing money’ to make people better off. They emphasise the need for balancing the books and monetary discipline.

Economists, with outstanding exceptions such as Marx, have usually set out to glorify capitalism, and a particular idealised laissez faire version of the system at that. Mesmerised by the laws of capitalism, they tend to conclude that it will automatically produce full employment and increasing prosperity – so long as nobody messes about with its workings. That is the outlook of monetarism in spades.

The expression ‘monetarism’ is associated with the writings of Milton Friedman and his ‘school’. Friedman saw himself as a rebel against the post-War Keynesian consensus that we discuss in the next section. It can be argued that monetarism represents a return to traditional economic principles and policies of the pre-Keynesian era. ‘Forward to the nineteenth century’ is their rallying call! The period after the Second World War was characterised by relatively full employment in the advanced capitalist countries and an unprecedented increase in prosperity. The working class in this region shared in this increased prosperity. In retrospect it was a golden age for capitalism. Since most economists had been won over to the ideas of Keynes, the golden age was put down to Keynesian economic policies. Marxists dispute this, as we see later.

After 1973 the golden age fell apart. Together with the economic slowdown came a resurgence of strikes and class struggle. For the first time mass unemployment and recession, actual falls in production, emerged in the advanced capitalist countries. Even more puzzling for Keynesian economists, this economic slowdown was associated with an increase in the rate of inflation. For Keynesians inflation is a sign that the economy is running too fast. Unemployment is a sign that the economy is growing too slowly. Their theoretical apparatus was incapable of grappling with the phenomenon of stagflation.

The monetarists stormed into the vacuum of ideas. Instead of the irresponsible printing of money which, they alleged, was at the root of the problem, they demanded strict rules. Inflation was to be squeezed out of the system. Some admitted this might cause a little transient pain. Other more optimistic souls declared the ‘real economy’ would be entirely unaffected by this adjustment to the money supply. In either case the economy would soon resume its stately progress. As we know, this didn’t happen. We’ve had the pain, but not the gain. The golden age is gone for good and no-one can bring it back.

Monetarism screws up

One of the monetarists’ key propositions was that the government should target the money supply. In 1979 the Tories under Thatcher enthusiastically embraced the new religion. But, in office, they had a problem. Which money supply should they target? There were several different measure of the money supply, and quite often they moved in different directions. The Tories were reluctant to admit that this was because monetarism is pure economic quackery. But we can now see that not a single government in the world attempts to target the money supply. It is generally admitted to be impossible. The central tenet of monetarism has been universally abandoned. Britain’s Monetary Policy Committee deals exclusively with the control of interest rates. This is an alternative approach. At least the government, within limits, has the power to affect the rate of interest. But manipulating interest rates influences the demand, not the supply, of money. After all, you are more likely to borrow when the rate of interest is low.

It can forcefully be argued that there is no such thing as the money supply. When you go to the bank manager for an overdraft, you will be offered a facility. You don’t necessarily spend up to the limit right away. More generally, the supply of money can be demand determined – a favourite theme of post-Keynesian economists. The Labour economist Kaldor wittily pointed out in opposition to Thatcher that the government usually printed more money in late November to facilitate the pre-Christmas sales rush. Did this mean (as monetarists would presumably be forced to argue) that the increase in the money supply caused Christmas?

There were other unintended consequences of Thatcher’s attempt to strangle the money supply. It forced up borrowing costs in a crisis, thus pushing hard pressed firms over the edge. Interest rates were at one point above 20%. On top of that, high interest rates attracted speculators to buy the pound. The pound went from a low of $1.50 to a high of $2.45. Sterling became ludicrously uncompetitive on world markets, and so did the price of British exports. Those businesses which hadn’t gone under because of the recession and sky high interest rates were in danger of being bankrupted because they couldn’t sell their goods abroad. Unemployment soared from 1.2 million to over three million in Britain, and manufacturing output fell 17% in two years, in large part because of monetarist policy.

So wasn’t it all a disastrous failure? In part the Tories were using unemployment as a whip against the employed population. Militant trade unionism found it difficult to survive with so many desperate people out there prepared to work for almost any wage. Sure, monetarism was rubbish as a theory, but it was an ideology that faithfully served the interests of the ruling class.

Does Keynesianism work?

Meghnad Desai explains how he began his thinking life and political involvement as a Keynesian economist. “Keynesianism was my credo in academic economics and I had written a critique of monetarism.” (p vii) He has since rejected the philosophy, claiming it doesn’t work. He doesn’t explain why in Marx’s Revenge – he just takes it for granted. He links the failure of Keynesianism as he sees it with the ruling class onslaught since the 1980s. Now this just doesn’t make much sense. How does the electoral victory of the Tories (mainly owing to the Social Democratic Party splitting away from Labour and dividing the anti-Thatcher vote) throw any doubt on the correctness of Keynesian as an economic viewpoint? It’s not as if The Tories implemented Keynesian policies and found them wanting. They were carrying out monetarist policies – policies which are now completely discredited. In any case, what is the connection between Keynesianism, the reform strand of bourgeois economics, and ‘democratic socialism’, however defined?

What Desai seems to be doing is associating the success of reformism with the efficacy or otherwise of Keynesian anti-crisis measures. If Keynesianism works, then reformism can deliver.

The Tories provided a paradoxical confirmation of Keynes’ critique of the economic orthodoxy of his day, the interwar years. In addition to reining in the money supply, they were anxious to cut government spending. Yet after eighteen years of cuts they left office with government spending at about the same proportion of national income as when they were elected – roughly 43%. They were cutting, but their cuts had no effect. How? When the economy is booming, most people are in a job and the tax revenues roll in. When recession bites, the Treasury loses tax takings and has to spend more on unemployment benefit and social security. Rather than the government deciding the level of government spending, it is the economic cycle that determines whether the government is in surplus or in the red.

In exactly the same way workers are in a better position to pursue wage claims when the bosses’ order books are full. So wages move with the cycle. But as Marx said, ‘they are the dependent, not the independent variable’. Wages and the fiscal position of the government are both cyclical phenomena.

So, does Keynesianism work? There are still those in the labour movement arguing the Keynesian case. They believe the state can spend its way out of crisis. Does this offer an alternative to the brutal orthodoxies of bourgeois economics?

Keynes, writing in the 1930s, stated that capitalism suffered crises because of inadequate demand in the economy. What was needed was for somebody to go out and spend money in order to mop up the unsold stocks and get the factories working.

The only big spender in town that could possibly do that was the state. Where would the money come from? There wouldn’t be much point taxing people. That just transfers spending power from private pockets to the government. So Keynes proposed the government should spend money it hadn’t got. This sounds impossible, but we’ve all done this at one time or another – it’s called borrowing. Keynes and his disciples made the point that in a crisis people and material resources are both lying around unused and yet people complain that ‘we’re too poor’ to have the things we want and need. This is indeed the paradox of poverty in the midst of plenty that is a feature of capitalism often pointed out by socialists. There are obvious points of similarity between the Keynesian approach and the socialist analysis of crisis as manifested in overproduction.

Keynes suggested that this ‘deficit financing’ could eventually pay for itself. Here’s how. Government spending will boost economic activity. There will be a ‘multiplier effect’ as workers on public works projects go out and spend their wages on consumer goods, giving a shot in the arm to those markets. Workers in consumer goods industries will now have more money jingling in their pockets, and so on. Increased output and employment would raise tax takings and the government would be able to pay off the initial debt and balance the budget.

So Keynes opposed what was the orthodoxy of his day, as it is of our time as well.  Economic orthodoxy says that in a crisis the government should cut its coat according to its cloth. It should cut wages and social spending. This orthodoxy is accepted by the establishment not because it is right, but because it represents the interests of the ruling class.

On wages, Keynes first denied that they could fall fast and far enough for recovery to happen. But secondly he argued that the effect of wage cuts would be to cut aggregate demand. He was right. The National government was formed in 1931 when MacDonald and other Labour traitors went over to the Tories. The right wing coalition celebrated its victory by cutting teachers’ and other public sector workers’ pay and by cutting the benefits of the three million unemployed. But this did not stimulate the economy and lead to a recovery. There was still mass unemployment at the end of the decade as Britain went into War. The main reason jobs had picked up in the meantime was arms spending towards the end of the 1930s. And arms spending had this effect by stimulating aggregate demand.

But Keynesians don’t just stop at pointing out the inadequacies of capitalism. They suggest that under correct management (by the Keynesians) capitalism can be manipulated to deliver the goods. As a result of ‘pump priming’ we would move into a win-win situation with both capitalists and workers better off!

Keynesianism doesn’t work either

Marxists believe that Keynesianism doesn’t work. It doesn’t work because capitalism can’t be made to work. The problem of capitalism in crisis is not just a matter of inadequate demand - of markets - it’s a problem of profitable markets. Putting money in workers’ pockets may create a market for capitalists but it doesn’t give them any incentive to put their money into production. On the other side, boosting profits must necessarily be at the expense of workers’ living standards somewhere along the line. There are no free lunches to be had, as the capitalist world has discovered in the era of mass unemployment since 1974. Deficit financing doesn’t do away with the class struggle.

The dilemma of any individual capitalist is that they want to pay their own workforce as little as possible to maximise profits; but they want every other capitalist to pay their workers as much as possible so they will act as a market for the goods. The problem of capitalism in crisis is that any attempt to boost profits hits the workers as a market for capitalist commodities; any attempt at boosting markets by upping wages or the social wage is seen as a threat to profits.

Keynesianism was enthusiastically adopted as an ideology by right wing reformism after the Second World War during the period of the post-War boom. It was the perfect excuse not to bother with the hard slog of organising and preparing for the socialist transformation of society. In fact any serious attempt to implement a serious policy of public works, increased government social spending and redistribution will meet the resistance of the capitalist class - as we saw in the capital flight that greeted the election of the Mitterand government elected on just such a programme in France in 1981. The lesson for us is this - if you are going to wound a dangerous beast, best to be ready to fight and kill it.

The long post-War boom was for many years seen as a vindication of Keynes’ ideas. The reality is very different. This is the British experience. Here is R.C.O. Matthews in an article in the Economic Journal in 1968. “Throughout the post-war period the government, so far from injecting demand into the system, has persistently had a large current account surplus.”(Why has Britain had full employment since the War? p 556) In other words they were desperately trying to pay back the huge state debt they had built up during the War. He goes on, “the explanation of the rise in investment must lie at the heart of the explanation of the rise in the level of economic activity.”(ibid p 560) This, of course, is the point we made earlier. The brutal fact is that Keynesianism was never applied because it doesn’t work.

(to be continued...)