In the third part of our series on Keynesianism, Dominic Alexander looks at cycles, crisis, and why Keynesianism always looks to fix capitalism 

The Limits of Keynesianism series:
Part One: John Maynard Keynes and Orthodox Economics
Part Two: The Assumptions Keynes Makes
Part Three: Marx, Keynes and the Analysis of the Trade Cycle
Part Four: The Keynesian Attack on the Labour Theory of Value
Part Five: can the working class advance within capitalism?

The assumption of orthodox economics in Keynes’ time was that the capitalist economy, despite perturbations, would always return to an equilibrium in which productive capacity is used to its fullest extent, and hence employment is at maximum levels. The worst thing a government could do would be to intervene, as this would only upset the natural recovery of markets to this ideal equilibrium. In the light of the numerous economic crises of the nineteenth century, it is difficult to see how this orthodoxy remained in any way credible. Nonetheless, this doctrine, known as Say’s Law, remained accepted within the field of orthodox economics until the Great Depression of the 1930s rendered it unsustainable, as it was shown that an underemployment equilibrium could last at least a decade.[1] This turned out to be only a temporary setback for the law: the long years of neoliberalism have made it, guardedly, acceptable again.

Say’s Law had it that supply creates its own demand. If one area of production is overproducing and another underproducing, market action will bring about equilibrium. It can be presented within an apparent common-sense logic of demand and supply to appear plausible, but it only does so in an abstract way, divorced from the real movements of the economy. Marx consistently ridiculed ‘the insipidities’ of Say, writing, for example:

In order to prove that capitalist production cannot lead to general crises, all its conditions and distinct forms, all its principles and specific features—in short capitalist production itself—are denied. In fact it is demonstrated that if the capitalist mode of production had not developed in a specific way and become a unique form of social production, but were a mode of production dating back to the most rudimentary stages, then its peculiar contradictions and conflicts and hence also their eruption in crises would not exist.[2]

Say argued that supply created its own demand, since if a producer made a commodity, then the workers would be paid, and would thus be able to buy the product. On a generalised scale, this would mean that if goods were produced there would be an available demand for them. If one producer was making too much of one commodity, and another too little of a second, then the laws of supply and demand would even that out sooner or later. Equilibrium would be achieved.

For Marx, this would not work, because it ignores the nature of production itself, both the need for capital accumulation and surplus value. At the most basic level, Say’s law assumes that all exchanges happen simultaneously, but in reality, this is not so. In fact, if there is too great a gap of time between actions of sale and purchase, then the result is crisis.[3] This is only the beginning of the difficulty. To take another aspect, because the worker does not receive the full value of the productive labour expended, the wages a worker earns are not equivalent to the value of the commodity produced. There is a shortfall, and crisis is therefore endemic to the system. The same dynamic also produces an overaccumulation of capital, with the potential for production being much higher than the capacity to consume. Marx’s arguments on this issue were, of course, ignored by orthodox economics.

The uncertainty of animal spirits

Keynes also discarded Say’s law, but his reasoning differed from that of Marx. He was not concerned with the inner nature of the production process, and did not consider exploitation as a factor in any way. He reasoned simply from the principle of supply and demand, and retained the basic assumption of Say’s Law that a certain quantity of production ought to be matched by equivalent demand. The problem lay, for Keynes, in the motivation for investment and therefore production:

the act of saving implies, not a substitution for present consumption of some specific additional consumption which requires for its preparation just as much immediate economic activity as would have been required by present consumption equal in value to the sum saved, but a desire for “wealth” as such, that is for a potentiality of consuming an unspecified article at an unspecified time.[4]

In one respect, Keynes comes close here to Marx’s formulation of the capitalist cycle as being M-C-M’(capital to commodity to capital plus profit), unlike in pre-capitalist exchange relations where the cycle went C-M-C, as use values rather than exchange values were dominant. The problem with Keynes’ conception here is that it does not make any class distinctions between capital and worker, or producer and consumer; the classical assumption that all are equal participants in the market remains unquestioned. This narrowed focus is made easier in Keynes by the absence of value analysis, which in Marx is key to revealing the hidden workings of capitalism.

Nonetheless, the upshot for Keynes is that the cycles of capitalism are affected by the problem of uncertainty, which makes investors prefer to hoard or save capital in certain market circumstances. Rather than reaching equilibrium, the fear that an acceptable return on capital will not be made inhibits investment. There is a direct relationship between employment and investment in this argument:

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.[5]

Investment depends upon an estimation of likely consumption, but this is inevitably guesswork, and so depends ultimately on the sheer mood of the economic actors. Hence the often quoted concept of the ‘animal spirits’ of investors, which Keynes invoked to explain the problem:

Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; – though fears of loss may have a basis no more reasonable than hopes of profit had before.[6]

If capitalists are not confident that they will receive an acceptable return on the capital they advance, then they will not invest the capital, but prefer to keep it as cash or savings. This problem is known as the liquidity trap. The result is that workers are not employed, and do not earn wages. Effective demand then is reduced, and commodities are not bought. An economic downturn is then the result, but it is not the result of a real crises of profits; it is not rooted in exploitation, or the cycle of value, but in the confidence of capitalists. It is a psychological problem, rather than one rooted in the value cycles of production and circulation.

Investment does not rest purely on confidence, of course. In discussing the marginal efficiency of capital, Keynes outlines how inducement to invest depends partly on the investment demand schedule and partly on the rate of interest.[7] The demand schedule involves the cost involved in producing ‘an additional unit of such assets’, that is to say output, which can vary greatly depending upon the nature of the commodity in question. And yet, Keynes warns, the marginal efficiency of capital ‘is here defined in terms of the expectation of yield and of the current [original emphases] supply price of the capital-asset.’[8] Once again, the subjective view of the capitalist becomes centre-stage. The other side of the equation, the disincentive to invest, depends upon the rate of interest, but that is no more objective a factor: ‘It is evident, then, that the rate of interest is a highly psychological phenomenon.’[9]

State investment, wages and inflation

Keynes worked out his General Theory as an answer to the obviously defunct classical theory that capitalism will always return to full employment in a state of equilibrium. He reduced the problem to one of investment; only if investment is high enough will production be at a level which can produce full employment. Yet, investment depends upon the interest rate, which ‘in convention is thought to be rooted in objective grounds’, but which Keynes showed was subjective. There was hope, he thought, in the fact that ‘precisely because the convention [about long-term rates of interest] is not rooted in secure knowledge, it will not be always resistant to a modest measure of persistence and consistency by the monetary authority.’[10]

This is Keynes’ justification of government interference in the market to stimulate demand; if interest rates are subjective rather than objective by nature, then there can be no technical objection by economists to the adjustment of the stimulus to investment by an actor ‘outside’ the market. Indeed, as Skidelsky comments, the upshot of the analysis of the marginal efficiency of capital and its relation to interest rates is that ‘only an exogenous injection of demand can get the economy moving again’ once it has sunk into low confidence and therefore depression.[11]

This hopeful conclusion is undermined as the analysis goes on, as even with a stimulus to investment confidence, there are many factors which will kick in to reduce the marginal efficiency of capital, and confidence in further rounds of investment. The monetary authority will be limited by its wariness of incurring debts, and low interest rates can themselves induce people to hold cash instead: ‘In this event the monetary authority would have lost effective control over the rate of interest.[12]

Even where intervention is successful in reflating the economy, ‘as soon as output has increased sufficiently to begin to reach “bottle-necks”, there is likely to be a sharp rise in the price of certain commodities.’ This then reduces effective demand, or puts pressure on wages to rise in response to rising prices. The result is that ‘the wage-unit may tend to rise before full employment has been reached.’[13] In one respect, this appears to be critical of capitalism, in that Keynes is positing that full employment is unlikely in normal circumstances.

However, there is a sting in the tail for labour here. The analysis produces a justification for the classic ploy to divide workers against each other; the employed are being selfish in asking for higher wages, because that will prevent the unemployed from finding jobs. Labour is caught out both ways, and a healthy economy depends upon workers restraining their wage demands. Otherwise that delicate flower, the confidence of the capitalist in his profits, will be damaged, to the detriment of all. Indeed, Keynes’ close ally, Joan Robinson, identified trade unions’ level of ability to bargain for higher wages as a key element in what leads to a crash during a period of high employment.[14] In this respect, Keynes, far from being the economist for society, even less for the cause of labour, cleaves strongly to the interest of capital. It could not be otherwise, when his analysis always starts from the perspective of capital in regard to the whole economic process.

Keynes is led in this direction as there is, in fact, a lacuna at the heart of his whole analysis. The theory provides no material analysis for why confidence, and therefore investment, should rise and fall, short of the tautology that during a boom, confidence leads to overinvestment, which then turns into the flight to liquidity when confidence declines. What is missing is, of course, the analysis of profitability in terms of the production process that Marx provided.

It is important to analyse the circulation of value, but this must be rooted in an understanding of the structure of production.[15] Keynes’ implicit argument against concerning oneself with the dynamics of production, is the principle of uncertainty, and that therefore there are no ‘scientific’ processes going on beneath the realm of the circulation of commodities. However, it is not necessary to assume the neoclassical myth of total market knowledge on the part of every actor, to posit that capitalists are aware of the likely rate of profit for any investment, and that decisions are made accordingly. The analysis can assume a social average, where the vicissitudes of individual decision making are ironed out, in order to assess the objective processes governing production. Thus, if there is a problem with investment, leading to a systemic crisis, this, in the Marxist view, will be due to material problems in the economy, rather than purely psychological ones.

It is important to bear in mind these differences in approach, so as not to be misled by the superficial similarity between Keynes’ theory and one aspect of Marx’s analysis. Keynes posits that there is a permanent tendency for capitalism to develop the problem of a lack of effective demand. This can be compared to the underconsumptionist reading of Marx, where productive capacity is not matched by the workers’ ability to consume the products of their labour.

The gap between the two theories is the absence of an analysis of class and exploitation in Keynes. Where in Marx, the problem is inescapable, and is one of the drivers of the tendency to crisis, in Keynes the problem is contingent on the balance of investment confidence. It can, provisionally, be fixed so that capitalism could achieve a long-term, even permanent, stability. The problem then becomes one of attempting to encourage investment by various inducements. Uncertainty and speculation became the central determinant of the analysis of trade cycles, rather than any material problems with the nature of capitalist production.

The financialisation of theory

In the absence of a theory of value with which to analyse the circuits of capital, and the relations between production, distribution and exchange, Keynesianism tends to be driven to explain phenomena through a psychologising subjectivism. Hence Keynes himself could only analyse the realm of finance and credit in these terms:

Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market … Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done … These tendencies are a scarcely avoidable outcome of our having successfully organised “liquid” investment markets.[16]

It is notable here that there is no explanation of the circumstances in which ‘speculation’ dominates ‘entrepreneurs’, or when the latter are able to hold the former in check. The issue is, of course, very complex and difficult within Marx’s analysis, but value theory offers a way of understanding the dynamics involved with credit and speculation. The tendency within Keynesianism is to ignore the ways in which different circuits are connected, as for example the ‘rootedness of credit in commodity money’ which has ‘been informally bypassed by Keynesian policies after the 1930s’.[17]

After Keynes, this tendency to deflect analysis towards the psychological was only increased. This is so even among left-leaning Keynesians, whose attention is increasingly drawn away from what is sometimes called the ‘real economy’, towards the sphere of finance, taken as essentially separate, but determining the former. It is true that there is a long-term tendency for capitalism to develop an ever-greater financial sector as opposed to the directly productive sphere, and that this tendency is especially marked in the decades after the 1960s.

Unlike Keynes, Marx’s analysis of value is able to open several windows on tendencies of the credit system and its relation to the production and circulation of commodities. Credit, not merely ‘speculation’ in Keynes’ terms, is both necessary to the circulation of capital, but also produces unstable forms of fictitious capital.[18] The increasing ‘financialisation’ of economics is also partly explained through the rising organic composition of capital. Where the increase in the use of technology reduces the share of labour in production, it therefore reduces the relative quantities of surplus value being produced. Since labour is the only source of value, as the technological input into production increases, the rate of profit will therefore decline.

This is to say, there is an increasing mass of capital seeking areas in which to invest, but, irrationally from the point of view of the system as a whole, it does not necessarily invest itself in surplus-value producing activity. The result is that capital will turn away from production towards speculative activity in the hope of capturing a greater rate of surplus value. This result is a parallel to Keynes’ ‘liquidity trap’ theory, but explains the reasons for the process, where Keynesianism merely suggests the ebb and flow of confidence.

The financialisation of Keynesian theory reached its peak with Hyman Minsky, for whom economics could concentrate entirely on the financial sphere. Indeed, Minsky drew out the theme in Keynes’ theory that depressions were caused by speculative bubbles themselves; the 2008 crash is sometimes referred to as a ‘Minsky moment’. This makes the capitalist market flawed in the sense that it is driven by irrational dynamics, but, equally, it means that capitalism does not have the internal contradictions that Marx saw, by which it would tend towards self-destruction. Rather, it would respond to the regulation of speculation alone.

Minsky added an analysis of the role of debt in the capitalist economy to Keynes’ understanding of investment confidence and speculation. As Steve Keen describes it, the business cycle begins with the economy in a state where growth is enough to reduce unemployment, but where firms and banks are both conservative in their willingness to invest or lend. However, this results in a situation where ‘most projects succeed’, and therefore:

Investment projects are evaluated using less conservative estimates of prospective cash flows, so that with these rising expectations go rising investment and asset prices.[19]

The result is that caution is abandoned and both firms and banks take on more debt, credit increases, the economy moves into a ‘euphoric’ stage, and ‘Ponzi’ financiers come into the equation. Thus, a bubble is soon created, which will necessarily burst due to the pressures generated within the system, leading to a collapse of investment and a depression.[20]

In this view, recession and depression are generated by the internal cycles of finance itself, not for any other contradictions within capitalism. The implication here is that crises can be controlled or even largely prevented by the actions of monetary authorities; in short, capitalism can be saved from itself, and has no long-term tendencies towards an increasing magnitude of crisis.

Keynes himself argued that booms ‘are almost always due to tardy or inadequate action by the banking system’.[21] Slumps, in this argument ‘may sometimes get out of hand and defy all normal methods of control’, but that would require therefore more extensive government intervention than the ‘normal’ policies. The upshot is that crisis is amenable to moderation, at least. For Minsky the role of crises is in fact to strengthen capitalism.[22] Nonetheless, the reason mainstream economists tend to ignore or dismiss Minsky is made clear by his judgment about capitalism; ‘Not only is stability an unattainable goal; whenever something approaching stability is achieved, destabilizing processes are set off.’[23]

Euthanasia of the rentier

Keynes’ solution to the tendency of capitalism towards instability was the idea of socialising investment; or the ‘euthanasia of the rentier’.[24] This was a response to his concern that ‘the richer the community, the wider the gap between its actual and its potential production’, as capital will find it difficult to find sufficient investment opportunities. As a result, ‘the more obvious and outrageous [will be] the defect of the economic system.’ Superficially, Keynes appears to approach Marx’s analysis of the falling rate of profit here, but the mechanism is wholly different:

For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members.[25]

This is the operation of the liquidity trap, and suggests to Keynes that society would demand an end to the system as a result of the widening gap between potential and actual prosperity.

Keynes thought this was realistic on the grounds that as the economy developed, accumulation would mean that capital would become more abundant, and according to the laws of supply and demand, this would mean that it would become cheaper. And yet, despite the massive quantities of capital accumulated since Keynes’ time, we do not live in a world where the ‘rentier’ faces extinction. Part of the reason for this is that the system does not actually operate according to simple laws of supply and demand, but through the value cycle of capital, where profit is the overriding driver of all processes. There are also problems with Keynes’ simple concepts of interest and money, and indeed ‘rentiers’, but these also relate to his rejection of value theory.

The problem with explanations based on laws of supply and demand, according to Marx, is that at the point of equilibrium, supply and demand cease to explain anything.[26] That is to say that ‘fluctuations in the reciprocal relation between demand and supply can merely explain deviations of price from value, not value itself.’[27] Instead, the value circuits of capital need to be explored. One aspect of the problem is that the overaccumulation of capital leads to crises of profitability. Capital does not become abundantly cheap, but rather demands returns which are increasingly difficult for the social capacity for consumption to provide.

David Harvey analyses the consequences of this, showing that the financialisation of capitalism in recent decades is exactly a function of capital seeking areas where it can command a higher return than from the production of commodities themselves. This means it flows into areas like property speculation, which are parasitic on the productive economy, but where individual capital can find spectacular rewards. This lasts until the house of cards collapses, as in 2008. Minsky was therefore right to see the tendencies of capitalism to produce Ponzi-scheme moments. However, he was not able to root it in the deeper processes of capital value-circulation, precisely because the Keynesian school rejects value analysis, resting on an abstract supply and demand analysis.

Without an understanding of the processes of value, and the way that value is embedded in precise, historical social relations, Keynesian theory can see flaws in capitalism, but not explain why crises change in nature and impact over time. As a result, capitalism appears fixable in a Keynesian analysis; since the dynamics are conceived in abstract rather than historical terms, they should be amenable to technical adjustments which should balance the system.

There are a range of policies which can be applied to make adjustments to the system. At the conservative end, there is tinkering with interest rates, or capital-friendly quantitative easing, designed to boost the ‘confidence’ of capital. At the most radical end, there are solutions such as the socialisation of investment, which can have a progressive impact, at least in the short term. Yet, none of these measures take into account capital’s uncompromising drive to profit, and the way in which capital will resist any efforts to reduce its share of the return on investment.

Thus, some quasi-Keynesian solutions, such as quantitative easing coupled with government austerity policies, actually become a means by which capital attempts to solve a crisis by increasing its share of value at the expense of the rest of society. Such policies make people, that is to say the proletariat, most broadly understood, pay for the crisis, while protecting profitability as much as possible. The socialisation of finance, for example, which appeared to be a possibility during 2008 as many major banks faced collapse, was not allowed to become a reality. Instead, governments in most of the developed world socialised the costs of bailing out the banks, while ensuring that these institutions could return to profitability.

The reason why the apparently radical proposal of the ‘euthanasia of the rentier’, fails to gain purchase, is because of Keynesianism’s failure to address social relations of production, and the way in which capital is embedded in a social and political system geared towards the protection of capital’s ability to reproduce itself; the process of M-C-M’, or profitability. Yet, even so, the proposal is not nearly as radical as it sounds, depending as it does, upon an undialectical separation of production and finance capitalism. The aim, firstly, is not to abolish capitalism, but to preserve it. Secondly, the problem with this procedure is that it is not possible to separate ‘good’ producer capitalists from ‘bad’ financial capitalists, as the two functions are, in practice, wholly bound up with each other.[28] It is not possible to abolish the problematic parts of capitalism by reigning in or transforming the nature of finance alone; the whole system from production to investment needs to be socialised.

Resuscitation of the rentier

These issues are related to another area in which Keynesian theory departs crucially from the Marxist explanation of crisis. Keynesians seek to blame crisis on policy failures, in the regulation of banks and lending, for example, and therefore see the financial system itself to be the direct cause of crises. Marx allowed that this sector could contribute to crisis (in 1847-8 and 1857 for example), but held that finance was not constitutive of crisis in itself.[29] If the 2008 crisis had been merely an issue of policy and regulation of finance, then by now there would have been a genuine recovery. The failure of that to appear points to a much graver malaise in contemporary capitalism.

Keynes’ theory is two sided; on the one hand it has a radical aspect, but on the other it is wholly geared towards the encouragement of capital. It takes as a given, rather than as an historically determined phenomenon, that capital is the only social actor which is capable of driving economic activity. This results in at least one argument which carries noxious social implications. Keynes noted the disutility of gold mines, as they add ‘nothing whatever to the real wealth of the world’, but imagined the government filling ‘old bottles with banknotes’ then burying them ‘at suitable depths in disused coal-mines which are then filled up to the surface with town rubbish’.[30] The government would then lease these mines to private enterprise, which, to get at the money, would employ labour. This would reduce unemployment, and because people are being paid, due to the ‘multiplier effect’ of their consequent spending, the economy would grow at a greater rate than the government expenditure entailed.

This scenario is reproduced in real life by quantitative easing, where the government buys its own bonds, thus cheapening credit, and supposedly thereby encouraging investment. The difference is that quantitative easing does not directly create any employment, whereas Keynes’ notion of ‘digging holes in the ground’ would do. Keynes said that it ‘would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.’[31]

The ‘political and practical difficulties’ will always set in, however, because of the social power of capital. We have ended up in an even worse situation than Keynes envisaged, where quantitative easing flows to the benefit of capital, and financial speculation makes housing unaffordable. Minsky admits that when ‘conservatives are Keynesians, then tax and spending policies may well be used to give life to rentiers rather than to abet their euthanasia.’[32] Far from the euthanasia of the rentier, the ‘political and practical difficulties’ ensure that only capital’s interest is really considered in economic policies.

While left-leaning Keynesian economists would object that the implementation of policies such as quantitative easing are not the right sort of government interventionism, there is the bias in the whole theory that whatever stimulates capital is better than nothing. The obverse is that anything which discommodes capital ought necessarily to be restrained or eliminated. This is a political weakness in the logic of the theory as it leads directly to the free-market position that all restraints on capital necessarily harm wealth production, and make everyone poorer.

This problem clearly lies behind the ambivalence among Keynesians about trade unions. Minsky, with apparent approval, quotes Keynes from an essay written in the 1920s, saying that trade unions were ‘once the oppressed, now the tyrants, whose selfish and sectional interests need to be bravely opposed.’[33] Keynes thought he had done away with what he saw as the ‘muddle’ of Marxist economics, and rejected the ‘statism and homogeneity’ which followed from socialist ideas.[34] The demands that social-democratic governments have constantly made, even before the crises of the 1970s, that workers and trade unions show restraint in their wage demands, flows, in one respect, from the main tendency of Keynesian thinking.

The notorious Labour government white paper, ‘In Place of Strife’ (1969), which proposed restrictions on trade-union rights, was no accident, nor the simple result of weakness in the face of right-wing forces. The Keynesianism which generally guides social-democracy policy has an internal logic which tends towards the restraint of labour, at least as much as capital. This is even before the institutional power of capital over government is considered as a pressure upon social-democratic governments to ‘moderate’ their demands on capital.