Marie Duggan

I tell my students a great paper requires you to leave some of your soul on the page. Well, I left some of my soul with these students, especially my seniors, who taught me to be a great teacher. They didn’t always appreciate my attempts to push them toward their personal best–it takes subtlety, and subtle may not be my best thing–but they delivered. It takes my breath away how much I’ll miss them.  These are my parting thoughts from our long conversations in ISECON 360 History of Economic Ideas.

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Market Forces and the Economist: Thoughts Inspired by The Scholastics, Smith, Marx, and Keynes

John Maynard Keynes argued that impersonal economic forces exist, but that humans don’t need to accept the outcomes that will result.  Humans can act as members of communities to change the economic outcomes. The job of the economist in this context is to identify the market forces, see where they are heading, and then to come up with institutions or rules that will divert the market force away from any disagreeable end, and toward something that benefits the community.  His blistering analysis of the failings in the leaders who created the Treaty of Versailles suggests that he does not have a rosy view of human nature in general, though his proposals for institutional reform suggest that he has faith that humans can do good.  Perhaps his faith is in economists, rather than in humanity. 

The economist is the one who has to check the greed of politicians or the fears of the masses by providing technical solutions, ways of channeling economic forces toward good.  Skidelsky (2003, p. xxiii) is correct when this role for the economist makes him a priest of a sect, since the explanation of how the economy works is part of the economists’ job.  But Keynes’ also gives to economists the role that Scholastic economists had reserved for priests (Langholm 2003): the economist has the ear of politicians who are motivated by greed for votes or revenge.  Like a father confessor, he reminds them to do what’s right, and like a scientist he offers possible solutions.  

The Scholastics gave the priest in the confessional the task of curbing the selfish impulses which can lead an ambitious merchant to destroy the community by taking advantage of his customers or destroying his competitors.  Keynes’ gives the task of curbing selfish impulses to the economist who works for the government—and it is often the selfish impulses of the politicians which they are to curb.  Just as Kings had confessors, then, so do modern politicians have economists.  For politicians to deceive the public may be a venial sin, but for the politician to deceive himself or his economist is a mortal transgression.  Such deceit is what Lloyd George committed at the Treaty of Versailles, betraying the European community and leading to the resignation of his economist.  

Yet Keynes’ economist is also a technician, who develops institutions that divert the outcome in some way.  This last makes economics a science, because either the institutions have the expected desired effect, or they do not.  If they do not, then presumably the faith of the economist in a certain interpretation was misplaced.  Keynes seems not to have got it wrong very often. 

Economic Forces. Adam Smith and Karl Marx identify economic forces that act without the conscious will of the people involved. For Smith, price competition forces firms to bring down prices when there is a shortage of customers relative to the supply.  This occurs even though individual ambitious men who own the firms all desire to raise prices above cost.  The deviations of market price about natural price serve to signal capital to flow into the industries where consumer demand is not yet met.  Superprofits motivate the movements of capital, labor, and land, but the superprofits will inevitably vanish as capital saturates the opportunities (Smith 1776, p. 55-63). 

Marx sees that the need to survive in a market economy coupled with the initial condition that most men own nothing does compel people to sell their labor power at a price below the value of what they produce (Marx 1867, pp. 270-280).  Human nature has little to do with the economic decisions men make, for either Smith or Marx. The outcomes are determined by the forces of supply and demand, or by the search for the higher wages, profit, and rent.  Whether or not a capitalist is the type of man who loves his workers or who loves to exploit them, any factory owner is going to be forced to adopt new technology, lay off many workers, and pressure the others to work long hours for low pay.  If Marx’s industrialist does not behave this way, he will become unprofitable and be forced out of business by the competitors (Marx 1867, pp. 435-436).  Competition is just as determining in Marx as in Smith, but for Marx the competition is between larger capitals, and in the battles, each attempts to wipe out the others completely. 

The existence of impersonal economic forces of this type leads most people to see the economy as something similar to a natural force.  Just as a hurricane can wipe out your crop, so can a surplus of product caused by uncoordinated individual farmers planting more of one crop than anyone expected lead to a disastrous fall in prices.  The market economy can make your product worth less than it cost to make it.   Keynes is unique in that on the one hand he acknowledges the existence of market forces, but on the other gives the economist the role of protecting the community by channeling them.  Because I find this a guide to what I might be as an economist, I’m going to take the time to explore three institutional diversions of market forces that he proposed.

Keynes at Versailles. With the reparations issue, Keynes the technician identified the economic forces at work, and then proposed an institutional mechanism to prevent reparations payments from having the negative effect on all of Europe that the economic logic enabled him to foresee.  The balance of payments equation was the tool he used to identify the pressure that payments of tribute in foreign exchange would put on Germany’s balance of trade.  Germany would have to export more than it imported, if it was to have the wherewithal to pay the reparations (see Skidelsky 2003, p. 241). 

Prior to the war Germany had imported more than it exported.  This would mean that the total drop in German imports from France and Britain (relative to what Germany had imported prior to the war) would necessarily be severe if Germany was to make the reparations.  Given further that Germany had lost some of its manufacturing base by loss of territory to France, Germany would have to generate this export surplus by decreasing imports to the point of privation on the locals.  The Germans would resent the reparations, and the British and French would see their manufacturing bases eroded by imposing them. 

To escape from the catastrophe foretold by the economist and his tools, Keynes suggested not only that reparations be reduced, but also that Germany’s balance of trade not be used to finance reparations.  Instead, he advocated that German float government bonds internationally, and that these be used to pay the reparations.  The sales of bonds to foreigners would generate a financial inflow of foreign exchange to pay reparations, meaning that trade could remain balanced, or even in deficit.   

Keynes used the insights of economic theory, coupled with an innovative institutional solution.  If left unchecked, the reparations by their nature as payments of tribute in foreign currency would require Germany to run an export surplus.  Human institutions could, however, mitigate the damage by raising the foreign exchange through some other method—floating the bonds. 

Forced Saving: Keynes would agree with Smith that when there is a shortage of supply relative to customers, prices will rise.  But he does not think people are powerless in such a situation.  This comes up for example in his proposal for forced saving during WWII.  The massive government spending on war and the increased wages of the workers who were suddenly in short supply created a shortage of consumer goods, and the result would be inflation.  He would say, if we do nothing else, then when there is a shortage of customers, prices will rise.  But he does not think people are powerless in such a situation.  The way out, he suggested, was for the government to force working people to save more through social security.  Thus, his solution acknowledged that market forces exist, and yet at the same time, he saw that human institutions could channel the market forces (here, channel more money toward savings) in such a way that the market forces would lead to different outcomes.

Keynes at Bretton Woods. Keynes was more successful in affecting policy as an older man in 1945 at Bretton Woods.  His goal was not only to carve out financial space for Britain to rebuild, but also to set the global community onto a path of economic growth that would benefit all—and hence bring out the best in human nature.   This is what Keynes seems to have had in mind when calling the Bretton Woods conference into being.  There would be an opportunity for high-minded technocrats to work out of the limelight to craft rules that the politicians could be manipulated into accepting.  These rules would then channel the greed of the business community and the desire for national gain of individual nations into something that would benefit the community.

Britain had come out of the war with $14 billion owed to the empire –the “Sterling balances.”  It was expected to run a trade deficit in the years immediately after the war simply in order to rebuild the factories that had been damaged.  In addition, the threat hung over Britain that the empire elite would pull out the Sterling balances and transfer them to banks in NY.  The bad condition of the industrial base made it unlikely that Britain would run a trade surplus.  The threat of liquidated sterling balances threatened a negative financial account.  The reserves had been depleted by the Battle of Britain. 

Britain had agreed to open the empire to free trade after the war as the quid pro quo for getting grants from the US to purchase US military equipment with which to fight Hitler in 1941. Free trade sounds harmless, but Keynes knew that Britain would have low output of products of lower quality than those produced by the many brand new factories installed in the US during World War II.  Opening the empire to free trade would be certain to give Britain a trade deficit. 

A trade deficit can be balanced by a financial account surplus.  However, making the dollar the key currency of the world was likely to cause the Sterling Balances to depart from London for NYC, which would tend to put the financial account into large deficit also.  Britain would be forced to seek loans, probably from the US, no matter what political conditions or interest rate the US would place on her.  Britain would fall from the political perch she had held, and her economy would struggle to rebuild.

This was the economic logic of the situation.  Keynes’ skill as a technician comes through in his Bretton Woods proposals designed to accept free trade, and yet nonetheless create a system where Britain would be able to balance payments without losing political sovereignty or paying high interest.   This is what the International Clearing Union he proposed at Bretton Woods would have accomplished.    Nations keep trade surpluses at an international bank, so deficit nations go to the bank to borrow, rather than into any humiliating political negotiations.  Furthermore, hoarding is automatically eliminated—a growing surplus at the bank will be lent to others automatically.  A generous automatic overdraft facility keeps the money flowing to deficit nations.  The threat to confiscate unused surpluses over a specific amount, coupled with capital controls, means that most surpluses will be “voluntarily” spent on imports from or FDI into deficit nations.  Making Bancor the global reserve currency would prevent any one nation’s central bank from running global monetary policy.       

Human nature. Human nature is central to the Scholastics and to Keynes.  For the Scholastics, humans have an innate propensity to greed.  Furthermore, one man’s gain is another man’s loss, so such greed has a tendency to destroy the community.  Ambition is not to be trusted or unleashed.  Private property is their concession to the known fact that people work harder when the proceeds belong to them (Langholm 1992, pp. 172).  But even here: in the face of true need, the needy have the right to take what is by God’s law theirs, even if human law says it belongs to another. 

Keynes is a conundrum.  His insights into the human weaknesses of Wilson, Clemenceau and Lloyd George reveal his ability to see the failures of people.  Wilson wants to think he’s doing good, even when he is not.  Clemenceau wants revenge.  Lloyd George will sacrifice the good of Europe for reelection (Keynes 1920, pp. 27-55).  It seems odd then to conclude that Keynes has faith in human nature.  Skidelsky suggests that Keynes has faith in technocrats.  He has faith that some well educated people will put the good of society before the good of their own careers or profits.  It’s up to these people to manipulate for good behind the scenes the desire for reelection, or revenge, or reputation that motivates those directly in the public eye.  

Harry Dexter White’s deceit in itself would not have scandalized Keynes.  He was all for high-minded people pulling off deceptions of the public, if that were in the public’s best interest.  Franklin Delano Roosevelt had done it with Lend-Lease, and won Keynes’ admiration.  Keynes was himself attempting to do it at the Mount Washington Hotel.  What would have shocked him is that a technocrat like himself could think that the demise of the British Empire (with its educated aristocracy) and the rise of the Soviet Union (with its faith in the working class) were in the interests of humanity.  

References:

John Maynard Keynes, The Economic Consequences of the Peace.  Harcourt, Brace, and Howe, 1920.

Odd Langholm, Economics in the Medieval Schools: Wealth, Exchange, Value, Money and Usury according to the Paris Theological Tradition, 1200-1350.  Leiden: E.J. Brill, 1992.

Odd Langholm, The Merchant in the Confessional: Trade and Price in the Pre-Reformation Penitential Handbooks.  Leiden: E.J. Brill, 2003.  

Karl Marx, Capital: A Critique of Political Economy, Vol. I.  New York: Penguin, 1976 [1867].

Robert Skidelsky, John Maynard Keynes 1883-1946: Economist, Philosopher, Statesman.  New York: Penguin, 2003.

Adam Smith, The Wealth of Nations. New York: Random House Modern Library, 1937 [1776].