In contrast to Veblen, John Maynard Keynes' life was characterized by good fortune. Born into an old traditional English family, he attended the best schools. Reminiscent of John Stuart Mill's intellectual powers, Keynes studied the meaning of interest at age four. He won a scholarship to Eton, where he earned superior grades and won numerous prizes.
At King's College in Cambridge, his grasp of economics was such that Marshall urged him to follow an academic career—which he declined in favor of something more lucrative. He placed second in civil service examinations for a position in the India Office but despised the work.
Resigning his position, Keynes returned to Cambridge, where he began a thirty-three-year stint as editor of the Economic Journal, England's most influential economic periodical. Keynes' diverse interests made him the exception to the saying "jack-of-all-trades and master of none." Indeed, he mastered debate, bridge, mountain climbing, modern and classical art, currency and finance, and economics. In later life, he became Lord Keynes, Baron of Tilton, and while serving as a director of the Bank of England, he also operated a profitable theater.
His greatest opportunity came with World War I when he undertook key roles in the Treasury and the Paris Peace Conference of 1919. Shortly afterward, he made a fortune of over $2 million by spending half an hour in bed each day studying and speculating in the international markets.
Keynes attained national fame with the publication of his book The Economic Consequences of the Peace (1919). He stated that peace treaties are unjust and unworkable, with their apparent solutions ending in fiasco. While he was not the sole possessor of this observation, his view was the first written version which encouraged a complete revision of the treaties. The book succeeded, and international developments confirmed his thesis.
Keynes' A Treatise on Money (1930) attempts to explain how the economy operates and to examine in particular the problem of unexplained bursts of prosperity followed by lows. Earlier writers accounted for this phenomenon by such theories as mental disorders of the economy or the effect of sunspots. Keynes returned to Malthus' warning—saving can result in depression.
To understand Keynes' thesis, it is necessary to grasp the meaning of prosperity in market economy. The true measure of a nation's prosperity is not gold and silver nor physical assets, but its national income, which is the total of all individual incomes in a country. The chief characteristic of income is its flow from pocket to pocket via daily purchases and sales. Thus, this movement is largely natural and arises from the use and consumption of goods.
On the other hand, one part of income which does not flow in daily transactions is savings, which represent the portion that is removed from the even flow of income. If that portion is hoarded, it serves no useful purpose. Significantly, no harm comes from the act of saving in modern nations because savings are usually put into banks and invested in stocks and bonds, becoming available when business wishes to expand production. In this event, savings flow into the economy. The increased capacity for production of more goods assures jobs and greater prosperity. Depression arises when savings are not invested into capitalistic expansion but are allowed to lie idle.
Keynes' line of reasoning, which he did not invent, but only helped to explain, is known as the see-saw theory of savings and investment. As a see-saw go up and down, savings goes up when investment goes down. The reverse is also true. In his polished examination of the see-saw theory, Keynes concluded that depression arises from a decline of investment on one side and an increased accumulation of savings on the other. However, depression is only temporary, for an abundant supply of savings reduces interest rates, leading to a higher rate of return to be gained from investment. Thus, prosperity returns.
Unfortunately, the see-saw theory has one shortcoming—its failure to explain a prolonged depression, such as the Great Depression of the 1930s. While interest rates declined during that period, no upswing of investment occurred. Recognizing this shortcoming, Keynes pondered the problem and published a revolutionary solution: The General Theory of Employment, Interest, and Money (1936). In it, he made the following pessimistic diagnosis of capitalism:
1. There is nothing automatic in economic developments which will relieve a depression. An economy in depression can remain so indefinitely.
2. Prosperity depends on savings being put to use. Otherwise, a descending spiral will result in depression.
3. Investment cannot be counted on, as it depends on the expansion of production. The entrepreneur cannot be expected to increase production beyond demand for goods, so the capitalistic economy continuously lives in the shadow of collapse.
Keynes described how savings, in a time of depression, cannot continue to accumulate. Savings actually dry up, reduced to a trickle rather than a flow. When funds are needed for investment to stimulate the economy, there is no savings accumulation available. So the seesaw theory is invalid—replaced by the elevator theory.
The elevator concept maintains that the economy, like an elevator car, can stall at any level. Even worse, a depression is a natural development, with every surge followed by a low. This phenomenon occurs because the economy, to avoid depression, must continually expand. However, capital expansion of any business is restricted by that business' market. So capital expansion does not move at an increasing rise, but in spurts. Understandably, Keynes' book proved as revolutionary as those of Adam Smith and Karl Marx. Keynes turned the classical view that depression is only temporary into the bleak conclusion that depression is inherent in the system itself and can be permanent.
Of course, Keynes' vigorous mind did not halt on a dismal outlook for the future. He provided a cure—government needs to "prime the pump" by deliberately undertaking heavy government investment to stimulate the economy. By absorbing capital goods and spending whenever private enterprise is unable to expand, government can insure a high level of economic movement. Therefore, governments should incorporate judicious spending programs into their permanent plans.
Keynes visited Washington in 1934 and observed President Franklin Roosevelt's New Deal methods to combat depression. This practical demonstration of Keynes' thesis became a defense for such policies. The WPA (Works Progress Administration) and a host of other New Deal projects existed specifically to "prime the pump." Such measures increased the national income by fifty percent and made a large dent in unemployment rolls.
Unfortunately, New Deal projects failed in the long run. The number of unemployed still amounted to around 9 million. What finally ended the Great Depression was World War II. Yet, the failure of pump-priming measures did not invalidate Keynes' thesis because government did not have enough funds to stem the tide and because opposition from the private sector feared government intervention in the economy.
Keynes next attacked one of the chief problems of World War II with his simple, original book, How to Pay for the War. He proposed a compulsory savings plan for wage-earners for the purchase of government bonds during wartime, to be reduced at the war's end. In this way, inflation would be defeated by putting into savings the extra war income. Prosperity at the end of the war would be stimulated by the flow of money available for the purchase of consumer goods from the cashing in of bonds. Ironically, this cure was just the opposite of Keynes' cure for depression because a wartime situation is just the reverse of an economic low. Nothing came of the plan, however, for political leaders preferred to use the old method of taxation and rationing, along with the purchase of bonds on a voluntary basis.
While labeled a radical by conservative economists, John Maynard Keynes had nothing but scorn for socialism and communism. Opposed to Marx's view that capitalism was doomed, Keynes believed in a policy of managed capitalism, one which would invigorate and save capitalism. Basically, he was a conservative with one major aim—the creation of a capitalistic economy in which its greatest threat, unemployment, would be forever eliminated. Consequently, he engineered a plan to foster a living and growing capitalism.
