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The Keynesian Diversion II

When Jim DeLong e-mailed to me this link to this ungated edition of Henry Hazlitt’s The Critics of Keynesian Economics (my own hard copy of which I lost long ago), he said that he especially likes the essay by David McCord Wright.  I just re-read Wright’s essay and concur with Jim’s favorable assessment of it (save for Wright’s attributing high British unemployment in the 1920s to that country’s inadequate technology without mentioning Churchill’s calamitous 1925 decision to return the British pound to the gold standard at pre-WWI prices).

These paragraphs from Wright’s essay are key:

Characteristically, Keynes deferred a statement of the basic assumptions of of his fundamental model until the eighteenth chapter of his book, where they are often overlooked.  Yet everything in his model depends upon these assumptions, and I am sure that if their limited nature were more widely recognized, Keynes’ conclusion would have far less prestige.  The crucial passage runs as follows:

“We take as given the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer . . . the social structure including the forces. . . which determine the distribution of the national income.  This does not mean that we assume these factors to be constant; but merely that, in this place and context, we are not considering or taking into account the effects and consequences of changes in them” (italics supplied [by Wright]).

This passage (some of the more technical sentences are omitted) assumes in effect that (i) there is no technical change or invention, (ii) there is no change in taste, (iii) there is no change in population or resources, and (iv) there are no changes in the preferences of the population between work and goods, on the one hand, and leisure, on the other.  These assumptions, it will be seen, in effect “freeze” the system, and practically every dynamic element of capitalist civilization is removed.  Of course, as he explains, Keynes did not mean that these forces were always lacking in reality.  But what he did mean, and the point cannot be too often stressed, is that in the basic model on which his system rests, virtually all the dynamic social forces are omitted.

Such assumptions assume away much (most?) of the very things that drive economies – drive them not only to grow (or shrink) over the long-run, but to escape (or not) recessions.

Consider especially the first three assumptions mentioned by Keynes:

We take as given the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique….

To take as given especially the existing “quality and quantity of available equipment [and] the existing technique” is to ignore possible changes in the capital structure.  Keynes assumed away any possibility for unexpectedly rising inventories and other signs of consumers’ change in demand (including changes in their demand to hold money) to prompt entrepreneurs and investors to respond with actions that lengthen the time-structure of production.  Keynes assumed away the possibility that machines and other capital goods can be redeployed, through changes in technique, to produce familiar goods and services differently, or to produce entirely new goods and services.

In short, as Leland Yeager suggests in the passage highlighted here, Keynes’s assumed away most of the adjustments to economic discoordination that actually take place in economies – most of the stuff that are the objects of ‘microeconomic’ analyses.  Keynes was then left – not surprisingly – with deficient aggregate demand as the overwhelming culprit that must be solved.

Tim Worstall says it best: “In the long run, it’s all microeconomics.”