On the rapid change of Keynes’ ideas

Keynes’s ideas underwent a rapid change in a very short time. In 1919, he wrote The Economic Consequences of the Peace. He understood the world as a non-equilibrium system. In 1928, he gave talks on Economic Possibilities for Our Grandchildren and later he published it as an essay in 1930. By that time, he had already committed to general equilibrium theory. Why had he undergone such a rapid change over such a short time?

We will briefly discuss these two writings of Keynes. We will present his 1930 writing first. This article represents the standard economic theory. In that article, he asked such questions.

What can we reasonably expect the level of our economic life to be a hundred years hence? What are the economic possibilities for our grandchildren? (P 1)

His answer is that the economic problem will be permanently solved. People may work for three hours a shift or fifteen hours a week merely to satisfy their instinctive urge to work. Why was he so confident about future? He attributed to the power of compound interest.

The modern age opened; I think, with the accumulation of capital which began in the sixteenth century. I believe-for reasons with which I must not encumber the present argument-that this was initially due to the rise of prices, and the profits to which that led, which resulted from the treasure of gold and silver which Spain brought from the New World into the Old. From that time until to-day the power of accumulation by compound interest, which seems to have been sleeping for many generations, was re-born and renewed its strength. And the power of compound interest over two hundred years is such as to stagger the imagination. (P 2)

He also discussed the British situation specifically.

For I trace the beginnings of British foreign investment to the treasure which Drake stole from Spain in 1580. In that year he returned to England bringing with him the prodigious spoils of the Golden Hind. Queen Elizabeth was a considerable shareholder in the syndicate which had financed the expedition. Out of her share she paid off the whole of England’s foreign debt, balanced her Budget, and found herself with about £40,000 in hand. This she invested in the Levant Company --which prospered. Out of the profits of the Levant Company, the East India Company was founded; and the profits of this great enterprise were the foundation of England’s subsequent foreign investment. Now it happens that £40,ooo accumulating at 3f per cent compound interest approximately corresponds to the actual volume of England’s foreign investments at various dates, and would actually amount to-day to the total of £4,000,000,000 which I have already quoted as being what our foreign investments now are. Thus, every £1 which Drake brought home in 1580 has now become £100,000. Such is the power of compound interest! (P 3)

Then he concluded.

I draw the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not-if we look into the future-the permanent problem of the human race. (P. 4)

How accurate were his predictions? His most famous prediction was that the economic problem would have been permanently solved. People would work for fifteen hours a week, merely to satisfy the urge to work. For the elite, this prediction has been realized. This is the main reason why this article is so popular today. This article has been cited again and again by the well to do. But for elites, they never have to work, from ancient time to today.

For the majority of the population, they have to work hard, very hard to make a living.

Why were Keynes’ predictions in 1930 so wrong? Keynes himself provided a great answer in The Economic Consequence of the Peace, written in 1919. This is ten years earlier than Economic possibilities for our Grandchildren. This book is in many ways a response to the standard theory. This is how the book began.

Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century. We assume some of the most peculiar and temporary of our late advantages as natural, permanent, and to be depended on, and we lay our plans accordingly. On this sandy and false foundation we scheme for social improvement and dress our political platforms, pursue our animosities and particular ambitions, and feel ourselves with enough margin in hand to foster, not assuage, civil conflict in the European family. (P. 3)

Clearly, Keynes understood the world as a non-equilibrium system and sharply criticized the equilibrium view of the world. Then he discussed the importance of population dynamics.

The great events of history are often due to secular changes in the growth of population and other fundamental economic causes, which, escaping by their gradual character the notice of contemporary observers, are attributed to the follies of statesmen or the fanaticism of atheists. Thus the extraordinary occurrences of the past two years in Russia, that vast upheaval of Society, which has overturned what seemed most stable—religion, the basis of property, the ownership of land, as well as forms of government and the hierarchy of classes—may owe more to the deep influences of expanding numbers than to Lenin or to Nicholas; and the disruptive powers of excessive national fecundity may have played a greater part in bursting the bonds of convention than either the power of ideas or the errors of autocracy. (Keynes, 1919, p 8)

The above paragraph shows that Keynes thinks that population dynamics is the fundamental force in human society. This is a sharp contrast to his understanding about population ten years later. Keynes also discussed in great detail how French wanted to take over German coal, to empower France and to deprive Germany of power. Keynes keenly understood the importance of resources. However, ten years later, compound interest became the main drive to economic prosperity to Keynes.

In 1919, Keynes understood the world as a non-equilibrium system. Keynes understood the importance of population dynamics and physical resources in human societies. He knew that he was in a small minority. For the majority,

We assume some of the most peculiar and temporary of our late advantages as natural, permanent, and to be depended on, and we lay our plans accordingly. (P 3)

After ten years, Keynes himself joined the majority by converting to the standard theory of equilibrium theory. His equilibrium theory might be “dynamic”. The prices might be “sticky”. His opponents might denounce him for not having complete faith in the magic of market. The economic profession, as well as himself, might call the Keynesian Theory “revolutionary”. But at the core, Keynes gave up his idea on non-equilibrium system and embrace the standard equilibrium framework, which he modified to suit his needs.

There are several points to note. First, Keynes didn’t seem to emphasize the abundance of resource in his 1930 article. Most of his followers didn’t pay much attention to the issue of resources. After 1973, most economists call the rise of oil price as an “exogeneous” shock. If people regard human society as part of the physical world, they won’t make such a simple mistake.

Second, in his 1930 article, Keynes seemed to think growth by compound interest as a natural result. It isn’t. When Spain was defeated by Britain, Spain’s growth was retarded. It didn’t enjoy the “natural” compound interest of the Great Britain. After 1973, the economic growth of the “developed” countries can only be maintained temporarily by sacrificing biological return. From 1973, fertility rates in most “developed” countries dropped below two. After 2008, monetary policies become magic. Biological and physical constraints seem to mean little to policymakers and “Keynesian” economists. But fertility rates in US dropped below two after 2008, rendering biological return negative.

Third, animals, including human beings, vie for social status. It is certainly true that our society is abundantly supplied with material wealth, due to abundant cheap energy. High energy density of petroleum means material abundance can be supplied with few labors. But the fighting for social status is no less intense. That is the main reason why elites spend long hours displaying their moral superiority. Most social activities and virtue signalling by the population don’t do any good for the society. But they are essential for the advance for their own status.

Why did he change his mind in such a short period of time? We may find answers in his General Theory, published in 1936. This book describes his ideas in great detail. In the preface of General Theory, he pointed out.

(T)he deep divergences of opinion between fellow economists … have for the time being almost destroyed the practical influence of economic theory, and will, until they are resolved, continue to do so. (vi)

To restore the influence of economic theory, he needed to present a unified front. To achieve this goal, he aligned himself to the orthodox economic theory.

For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premisses. (Keynes, 1936, v)

For a theory to be correct, it has to be consistent with logic. But more importantly, it has to be consistent with reality. Orthodox economics is rarely consistent with reality. Instead, reality is imperfect when orthodox theory is inconsistent with reality. From the lens of the orthodox economics, reality is full of “imperfection”. But Keynes conveniently ignored that orthodox economics was rarely consistent with reality.

To further align himself with the orthodox economic theory, he reiterated that ideas, not vested interests, are driving economic policies.

I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. (Keynes, 1936, P 340)

However, earlier in 1919, Keynes already observed that other factors are more important than ideas.

(T)he disruptive powers of excessive national fecundity may have played a greater part in bursting the bonds of convention than … the power of ideas ... (Keynes, 1919, p 8)

Keynes aligned his ideas actively toward the orthodox economics. Soon his ideas became the standard version of the orthodox economics.  Keynes’s ideas and reputation soared spectacularly. His description and prediction of this world, on the other hand, failed spectacularly. 

References

Keynes, J.M., 1919(2019). The Economic Consequences of the Peace: With a New Introduction by Michael Cox. Springer International Publishing.

Keynes, J.M., 1930(2016). Essays in persuasion. Springer.

Keynes, J. M., 1936 (2018). The General Theory of Money, Interest and Employment. London: Macmillan.