“That [traditional economic theory] reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparently cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.”
– J M Keynes
In the previous two posts, I described the general rightward drift in economic policy and its resultant effect on political and social values. In this post, I would like to sum up just how things ended up the way they did.
The above quote summarizes the overwhelming power that traditional economic theories hold on policy makers, economists and society at large. These theories afford a certain convenience and Candidian optimism to those concerned with these issues. To doubt these conclusions was not only to be unscientific, but also to be a depressive doubting Thomas in the face of general optimism. In fact, it was partly a result of a generally depressive attitude toward mainstream economic theory during the Great Depression that allowed Keynesian ideas of public expenditure, progressive taxation, research spending, social safety nets and moderate regulation to take hold to the extent they did. In addition, a persistent sense of competition between the Allies and the Axis, and later the West and the Soviet bloc, lent a sense of urgency to equitable, socially and democratically acceptable economic policies. Some economists would argue that Keynesianism helped save capitalism. I would agree, with the added conjecture that it did so by making capitalism resemble socialism.
So, if these policies were so vital in maintaining stability and growth across the Western world, how did they come to be unseated with such force? The traditional story, often repeated in economics textbooks, claims that it was the combined economic stagnation and inflation of the 1970s (often termed stagflation) that caused these policies to be overthrown. Critics of Keynesianism such as James Buchanan and Robert Lucas claimed that Keynesian theory, which deals with economic variables in aggregate, “lacked microfoundations,” i.e., were inconsistent with the principle of rational, individual self-interest on which mainstream microeconomic theory is based.
This story would be more credible if there were not strong evidence that certain economists and policy makers were beating against the door of Keynesian theory, basically from the day the post-war Keynesian consensus was established. In 1947, a group of free market economists and policy makers founded the Mont Pelerin Society– a society dedicated to the maintenance of “freedom,” and resistance against the creep of “totalitarianism.” The cast list of the Mont Pelerin Society is an interesting one, it has included members such as Friedrich Hayek (Keynes’ chief intellectual rival), Ludwig von Mises, Milton Friedman, Chicago School economists Ronald Coase, James Buchanan and Gary Becker (the founders of rational choice theory– the idea that not only are economic actors all rationally self-interested, but also that this assumption on the human psyche can be applied to decision making in all spheres of human endeavor.) The society included a Chancellor of West Germany, a President of Italy, several Pulitzer Prize-winning journalists, and 22 of Ronald Reagan’s 67 economic advisors.
The stated purpose of the society being what it was, combined with the not insignificant wealth and influence of its members certainly raises some questions as to whether it was a simple set of concurrent economic problems which brought the greatest period of stability, growth and development the Western world had yet seen to an end. The development of neat, internally consistent theories like rational choice held the same scientific appeal that Keynes attributed to mainstream economic theory. Not surprising, as it consisted of little more than applying these ideas to a broader sphere. The ease with which these ideas can be spread when its pioneers play the role of educators and policy advisors can greatly speed up their acceptance. The sheer amount of social power that the Mont Pelerin Society and its political allies held ensured that these ideas could be enforced. All they needed was a convenient excuse, and, with stagflation, they got it. (Never mind that the stagnation was little more than a typical, if somewhat prolonged recession, and the inflation was largely caused by fiscal pressure from the Vietnam War and oil price hikes.)
The most devious trick of the Mont Pelerin Gang was convincing several generations of budding economists that their obvious putsch was not a putsch at all, simply by throwing a few graphs and a couple of sentences of text into the textbook. Keynes had rightly noted the role of power and wealth in maintaining theories. In a sense, he had made one of the few accurate predictions any economist has ever made, and with it, signed his own death warrant.
In the next and final post, I will discuss what, if anything, can be done to get us out of this hole.