Keynesianism constrained

Jim Tomlinson

The current economic crisis has reignited a debate about Keynesianism that many had thought only of historical interest. This commentary suggests that the revival of Keynesianism undermines a key assumption of almost all accounts of postwar capitalism, namely that it can be fundamentally divided into a ‘Keynesian’ and a ‘post-Keynesian’ period.

Keynesianism is taken here to mean the use by national governments of their taxing and spending power to alter the overall level of economic activity. Across the developed world national governments are pursuing expansionary fiscal policies, and accumulating public deficits, as part of their attempts to limit the recessionary impact of the banking crisis. While there is much debate about the precise shape of such packages, almost all countries have some measures of this character planned or enacted. A few voices have raised concerns about the long-term impact of such packages, but they have been ineffective against the compelling need felt by most governments to be seen to be using all possible instruments to stave off economic collapse.

These events clearly contradict the narrative of economic policy developments which sees Keynesian policies as a product of the middle years of the twentieth century, ideologically challenged and then comprehensively defeated by monetarism and neoliberal economics from the 1970s onwards. For many commentators this ideological shift was in turn rooted in a transformation of the productive character of capitalist economies, so the ‘end of Keynesianism’ reflected not just ideological defeat for the centre-Left, but a profound transformation in the nature of capitalist economies. For this narrative, the revival of Keynesian policies in the early twenty-first century appears incomprehensible. There has been no sustained ideological challenge to the predominance of neoliberalism, nor an identified shift back to the economic structure that is purported to have been the material base for the earlier phase of Keynesianism. Clearly that narrative needs to be revised.

Perhaps the best place to start that revision is to ask the simple question, what are the conditions of existence of Keynesian policies?1

Big government

The most important of these conditions is the existence of big government. If manipulations of spending and taxation are to make a significant difference they must be a large part of national income. While Keynesianism did not cause the rise of big government in the twentieth century, its effectiveness was predicated on that rise. That connection is, of course, why conservatives have always been at best wary if not hostile to Keynesianism, notwithstanding that Keynes’s own political project was to save liberal capitalism.

Challenges to Keynesianism from the 1970s were very much associated with attacks on contemporary levels of public spending and taxation, with allegations of an over-mighty and inefficient state. The result of these attacks in most Western countries was an end to the rapid rise in the size of the public sector which characterized the 1960s and early 1970s. The ‘fiscal crisis of the state’ is undoubtedly central to the weakening of Keynesianism under the Thatcher and Reagan governments and later in other Western countries. But that ‘rolling back’ of the state had clear limits. Across the OECD world the story of the last three decades is not one of inexorable state retrenchment, but of a break in the expansionary trend in the 1970s, followed by stabilization, and latterly renewed expansion in some countries.

Here we need to distinguish between the ideological battle – where belief in the efficacy of government action has undoubtedly been on the defensive across the Western world for most of the last four decades – and government action, which has been driven by electorally powerful forces towards higher spending, notably ageing populations, and the ‘revolution of rising expectations’ in popular understanding about physical and mental health. Similar expectations about education, combined with governmental commitments to ‘upskill’ their workforces, have driven huge expansions in state spending on education. In sum, the ‘welfare state’, however compromised by ‘marketization’ and ‘partnerships’ with the private sector, has continued to expand.

In Britain this is strikingly evident in the huge expansions at the beginning of this century, the biggest ever sustained increase in a short period. In the USA welfarism has been particularly on the defensive ideologically (at least up to the election of Obama), but even there, in practice, spending has increased. This is in part disguised, as in veteran support, which provides a ‘hidden’ welfare state to so many Americans, and also in ‘penal Keynesianism’, with rising state spending on ‘fighting crime’, and especially on imprisonment, a well-aimed method of taking over 2 million of the least employable out of the labour market.

For effective Keynesianism government spending has to be not only big, but also subject to effective national control. In more federal systems, like the USA and Germany, this has always been an issue. American states are constitutionally bound to run balanced budgets, and in the 1930s this led to expanding federal programmes being offset by state-level retrenchment. This time, however, the Obama plan includes federal subsidies to states to help them sustain their spending as their tax revenues are hit by the recession. So far it has been taken for granted that what matters for Keynesianism is the size and capacity of national governments. This focus is, of course, wholly at odds with notions that globalization has rendered national states largely impotent in the face of global economic forces. What are we to make of such claims?

Globalization and national economics

First, it is vital to get a sensible historical perspective on ‘globalization’. Ever since the rise of modern capitalism national economies have been interconnected with each other. In the late nineteenth century these interconnections were immensely strengthened with the enormous expansion of international trade based on steam shipping, railways and national policies favouring trade expansion, even if few counties went the whole hog with free trade. After 1870 these trade flows were accompanied by unparalleled flows of capital and labour, creating what economic historians stress was the first great age of globalization.2 While much of this ‘globalization’ was a one-off creation of European expansion into North America and Australasia, it was by no means restricted to those areas, with much of Asia, especially, drawn, willingly or unwillingly, into large-scale economic interaction with the rest of the world.

While the interwar period saw a retreat from the heights of globalization reached by 1914, few countries even attempted to retreat to full economic isolation. The transmission of the slump of the 1930s around the world well demonstrated how strong international economic links still were. Paradoxically, it was in the country which continued to have the most internationally integrated economy (even if below the ‘hyper-globalized’ levels of 1914), Britain, where Keynesianism was born. While Keynesian textbook models occasionally assumed a closed economy for the purposes of exposition, Keynes’s own life work was largely concentrated on making national economic management compatible with continuing high levels of international economic integration. While seemingly sometimes despairing of this dual project in the depths of the 1930s slump, Keynes’s work in the 1940s in attempting to create new international economic institutions was clearly predicated on the belief that Britain’s interest lay in combining national policies of full employment with maximization of trade and long-term capital flows between countries.

Keynesianism, then, has nearly always operated in countries with substantial openness to international economic forces. The ‘national economy’ may always have been a ‘myth’, but it is not a myth that Keynesians have historically had to subscribe to.3 But what about now, after the recent period of renewed globalization in the late twentieth century? Is there still a significantly autonomous national economy to be the object of Keynesian (or indeed any other kind of) management?

The trends here are mixed. The above emphasis on the continuing existence of a high-spending state for national policy could be offset if state expenditures were largely spent on imports, either by the state itself, or by the recipients of transfer payments, such as pensions and social security. However, taking the British case, most direct state spending on services like the NHS and education is on staff salaries, so the impact, like that of transfer payments, depends on what consumers spend their money on. The long-term trends have been for consumers, as well as paying more in taxes to pay for public services, to spend a smaller proportion of their incomes on food and, more recently, less on manufactured goods, and more on services. As regards food, there has been a definite trend to ‘deglobalization’. Britain is far less dependent on imported food than before 1914, when two-thirds of all British food consumption relied on imports.

Manufactured goods are the quintessential internationally traded items. The long-term trends are twofold. On the one hand, a world of freer trade and the rise of new industrial nations has sharply raised the proportion of consumption of manufactures sourced from abroad. On the other hand, the significance of manufactured goods to total consumption (and production) has declined. As regards the portmanteau category of ‘services’ the story is also mixed. Some of these (tourism and travel, for example), and some financial services, are highly internationally tradable. But many services are defined by being ‘personal’ – requiring the personal presence of the supplier at the place of consumption (restaurants, live entertainment, hairdressers and other ‘beauty’ providers, shops). Also notable is the expansion of personal-care services such as childcare, and care for the elderly and infirm. Thus many private services are akin to the major public services of health and education in requiring the ‘human touch’ as a large component of what is purchased, and so lacking international tradability. From all these trends has emerged an aggregate trade picture which suggests that openness to trade today is only fractionally above where it was in 1913.

For migration the picture is more straightforward. Compared with the pre-1913 period, the scale of movement of people in and out of the major Western countries is significantly lower relative to their total populations. While migration may well have effects on wage levels in both sending and recipient countries, these are likely to be relatively small in aggregate, though may have serious implications for particular categories of workers.

The area where the effects of globalization on national economies is focused is international capital flows. Again, it is worth stressing that pre-1913 such flows were enormous, and certainly in the British case are smaller today than they were then. For most OECD countries they are only at similar levels. It is also worth noting that ‘globalization’ is in many respects a misnomer here, as many of these flows are confined to limited geographical areas, though there have been some recent shifts as a result of the rapid industrialization of India and China.4 The crucial question is: how far do these flows undermine the conditions for national economic management?

Cred

One term often deployed here is the ‘race to the bottom’, which suggests that faced with internationally mobile capital, countries will slash tax (and hence spending) to retain their attractiveness to international investors. But there is no good evidence of this occurring – tax rates on corporations have fallen a little in many OECD countries, but this has been offset by parallel cuts in corporate tax allowances. The evidence on spending certainly doesn’t suggest national governments are finding it impossible to finance that spending because of capital flight.

If we divide capital flows into direct (much of which is long-term and carried out by multinational companies) and portfolio (which is predominantly short-term buying and selling of financial assets) we can get a handle on what is happening. On the direct side, the mobility of such capital is constrained by the ‘embeddedness’ of much of multinationals’ activity in local supply chains, based on specific transport and communication networks – in local (national) systems of commercial and patent law; in local labour markets, welfare systems and patterns of workplace regulation. All this means that the footloose nature of such capital is often exaggerated. It does move, but not readily, and not in response to every national policy change.

For short-term national economic management it is portfolio investment, where the costs of moving are usually vanishingly small, that is the constraint on national Keynesian policies. But how much of a constraint?

This issue is an old one. Ever since national governments sought to manage their economies they have been subject to the constraint of a potential adverse response by international financial markets, leading to a ‘loss of confidence’, capital flight, and enormous pressures to change direction. Such scenarios were enacted under the British Labour government of 1929–31, and later in the 1930s under the Blum government in France. Both countries endured similar problems, in Britain in the mid-1970s and under the Mitterrand presidency in France in the early 1980s. These episodes make it clear that in order to pursue national economic management governments have to pursue policies acceptable to international financial markets. In modern terminology, they have to sustain policy ‘credibility’ if they are not to be forced to change direction.5

But sustaining such credibility does not rule out Keynesian policies. The key issues for participants in international capital markets are inflation (actual and anticipated) and the scale of public borrowing.6 If inflation is deemed out of control, and borrowing is expanding at a rapid rate, then the markets are likely to see such policies as unacceptable and force a change of course – and such conclusions are more likely to be drawn if the government in power is on the left, and therefore seen as more likely to take risks with inflation and public borrowing levels.

The 1970s in Britain are instructive on this point. In 1974/5 inflation and public borrowing appeared to be getting out of control, the Labour government was forced by a loss of confidence to tighten policy from 1975, and after much excitement in 1976 this restrictive policy was given a ‘seal of approval’ by the IMF. By 1978 the government was able once again to pursue mildly expansionary fiscal policies, as by then inflation and public borrowing were clearly under control. This episode suggests that Keynesian policies are compatible with sustaining credibility as long as they are measured and not too ambitious, though plainly what is deemed ‘reasonable’ by financial markets is likely to shift over time rather than being a fixed entity.

‘Constrained Keynesianism’ is the only type that ever existed in the Western countries. In the light of the above, the revival of so-called Keynesianism may be seen as unsurprising. Governments possess the calculating machinery necessary to gauge the effects of manipulating the very high levels of spending and taxation they control. There is a separable economic domain within which their actions are (subject to ‘leakages’) effective – call it, for the sake of argument, a national economy. If they calculate carefully they can finance their policies without suffering a loss of confidence, especially as fears of inflation are absent. Of course, the satisfaction of these conditions of existence does not necessarily bring such policies into being – that also requires the necessary political calculation. But in a self-reinforcing way, if such policies do not threaten a loss of confidence then the political calculus shifts towards Keynesianism by greatly reducing the potential downside of expansionary policies. The possibility of mitigating a recession otherwise likely to bring all sorts of difficult policy dilemmas, as well as electoral unpopularity, is likely to prove extremely attractive.

Notes

1.  See Jim Tomlinson, ‘Why Was There Never a Keynesian Revolution in Economic Policy?’, Economy and Society 10, 1981, pp. 72–87.
2. Martin Daunton, ‘Britain and Globalization since 1850: I. Creating a Global Order, 1850–1914’, Transactions of the Royal Historical Society 16, 2006, pp. 1–38.
3. Hugo Radice, ‘The National Economy – A Keynesian Myth?’, Capital and Class 22, 1984, pp. 111–40.
4. Paul Hirst and Grahame Thompson, Globalization in Question, Polity Press, Cambridge, 1999.
5. Gordon Brown, ‘The Conditions for High and Stable Growth and Employment’, Economic Journal 111, 2001, pp. 30–44; Ben Clift and Jim Tomlinson, ‘Credible Keynesianism? New Labour Macroeconomic Policy and the Political Economy of Coarse Tuning’, British Journal of Political Science 37, 2006, pp. 47–69.
6. Layna Mosley, Global Capital and National Governments, Cambridge University Press, Cambridge, 2003.

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