While January 2009 marked the inauguration of a new President of the United States, it was also a virtual coronation of John Maynard Keynes as the king of modern economics.
For decades, the economics profession attacked Keynesianism, first for lacking a theory of inflation and then for an insufficient appreciation of individual rationality in decisions by investors and employers. Robert Lucas, Thomas Sargent, and other radical conservatives ruled the roost, arguing that markets work best when fully deregulated, that labor market protections reduce employment, and that economic growth is driven by a series of exogenous shocks. Milton Friedman’s influence was felt more than that of Keynes.
But for the past two years Keynesianism has served as the scientific foundation for the ideas of today’s most celebrated economists, both conservative and liberal. From Martin Feldstein to Joseph Stiglitz, from Glen Hubbard to Paul Krugman, all major economists have supported Keynesian demand management in the form of large fiscal stimulus to reverse our economic decline. Even today, it is only the far right of the economics profession that has backed away from this view in preference to the politically popular notion that deficits should be eliminated in the short run.
The embrace of Keynes is a welcome development. He brought deep insight about the nature of capitalism and especially the need for adequate demand (as opposed simply to downwardly flexible wages) to generate fully employment.
The Keynesian concern is the short-run stabilization of employment and income. The current situation poses a longer-term set of challenges, rooted in the structural changes that have plagued the economy both during and prior to the crisis in 2008: stagnant wages and a huge buildup of household debt, the disappearance of manufacturing jobs and a persistent trade deficit, a bloated and destabilizing role for finance, a reduced rate of private sector innovation, and heightened economic insecurity. A progressive response to these problems is likely to be more informed by another great social thinker of the 20th century, Karl Polanyi, than by Keynesianism.
In Polanyi’s 1942 book The Great Transformation: The Political and Economic Origins of Our Time he found that when free markets create unacceptable social conditions–massive unemployment, poverty or dangerous working conditions, for example–governments have often responded with a “countermovement” like the one we’re witnessing today: they expand regulation of markets, strengthen social protections like anti-poverty programs and work safety regulations, and bail out failing businesses and households. Whether it was wage subsidies to avert mass poverty in England at the end of the 18th century, or the late 19th century British laws on coal mine safety, workers’ compensation, or even the expansion of public access to vaccinations, legislators supported government intervention because, Polanyi argued, the effect of free markets was so devastating for the disenfranchised that it threatened social cohesion.
Polanyi insisted that markets function because they are embedded in social and political institutions, which create trust and provide norms and limits. Market systems work best when market freedoms are balanced by attention to other freedoms, including the provision of such basic needs as adequate food, housing, healthcare, education, income security, and retirement support.
America’s failure to adequately address many of these social freedoms contributed to our economic collapse: For example, households borrowed excessively to enhance economic security and even to pay for healthcare.
Polanyi also found that while the move to laissez-faire occurs as a result of careful deregulation and political change (for example the adoption of the gold standard in 1870), the re-regulation of capitalism often occurs under emergency conditions and in an ad hoc manner. The passage of a $700 billion TARP in 2008 without clear guidelines or sufficient oversight is a perfect example of the chaotic nature of the countermove.
Keynesianism is the easy part. Economists can faithfully rely on his 1936 General Theory for scientific justification and politicians can readily support more spending and lower taxes. The harder part involves the Polanyian pendulum swing, since it signals the need for a new social contract and a new way of thinking about the economy. The passage of a universal health insurance plan, and a new regime of financial regulation are indications of the countermove. But they do not appear adequate to respond to the structural challenges of our day. In particular the slow pace of job creation and the rebound in income inequality and the trade deficit all signal the need for a new way of organizing American capitalism, with more attention to innovation policy, financial regulation, raising the quality and pay for services jobs and the environment.
Thus while it is the economic principles of Keynes that inform economists and politicians today, it is Polanyi’s pendulum swing that constitutes the longer-term challenge for economic policy and social change.
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