Why America forgot about economic power

We adopted Keynesianism — which worked for a time.

Friends,

Several of you have asked me why America went so quietly from democratic capitalism — the economic organization that dominated American life from 1933 through the late 1970s — to the corporate capitalism that has dominated it since the Reagan administration and that Joe Biden is starting to reverse.

The answer has a lot to do with Keynesianism. It removed the issue of economic power from American politics, along with the struggle between capital and labor.

How? Let me start by telling you a bit about John Maynard Keynes himself.

A Cambridge University don with a flair for making money, a graduate of England’s exclusive Eton prep school, a collector of modern art, the darling of Virginia Woolf and her intellectually avant-garde Bloomsbury Group, the chairman of a life insurance company, later a director of the Bank of England, married to a ballerina, Keynes — tall, charming, and self-confident — nonetheless transformed the dismal science into an engine of social progress.

Born in 1883 to John Neville Keynes (a noted Cambridge economist) and Florence Ada Keynes (who became mayor of Cambridge), young John Maynard was a brilliant student but didn’t immediately aspire to either academic or public life. He wanted to run a railroad. “It is so easy … and fascinating to master the principles of these things,” he told a friend, with his typical immodesty. But no railway came along, and Keynes ended up taking the civil service exam. His lowest mark was in economics. “I evidently knew more about Economics than my examiners,” he later explained.

Keynes was posted to the India Office but the civil service proved deadly dull, and he soon left. He lectured at Cambridge, edited an influential journal, socialized with his Bloomsbury friends, surrounded himself with artists and writers, and led an altogether dilettantish life until Archduke Francis Ferdinand of Austria was assassinated in Sarajevo and Europe was plunged into World War I. Keynes was called to Britain’s Treasury to work on overseas finances, where he quickly shined. Even his artistic tastes came in handy. He figured a way to balance the French accounts by having Britain’s National Gallery buy paintings by Manet, Corot, and Delacroix at bargain prices.

His first brush with fame came soon after the war, when he was selected to be a delegate to the Paris Peace Conference of 1919-20. The young Keynes held his tongue as Woodrow Wilson, David Lloyd George, and Georges Clemenceau imposed vindictive war reparations on Germany. But he let out a roar when he returned to England, writing a short book, The Economic Consequences of the Peace. The Germans, he wrote acerbically, could not possibly pay what the victors were demanding. Calling Wilson a “blind, deaf Don Quixote” and Clemenceau a xenophobe with “one illusion — France, and one disillusion — mankind” (and only at the last moment scratching the purple prose he had reserved for Lloyd George: “this goat-footed bard, this half-human visitor to our age from the hag-ridden magic and enchanted woods of Celtic antiquity”), an outraged Keynes prophesied that the reparations would keep Germany impoverished and ultimately threaten all Europe with another war.

His little book sold 84,000 copies, caused a huge stir, and made Keynes an instant celebrity. But its real import was to be felt decades later, after the end of World War II. Instead of repeating the mistake made almost three decades before, the U.S. and Britain bore in mind Keynes’ earlier admonition. The surest pathway to a lasting peace, they then understood, was to help Germany and Japan rebuild. Public investing on a grand scale would create trading partners that could turn buy the victors’ exports and also build solid middle-class democracies.

Yet Keynes’ largest influence came from a convoluted, badly organized, and in places nearly incomprehensible tome published in 1936, during the depths of the Great Depression. It was called The General Theory of Employment, Interest and Money.

Keynes’ basic idea was simple. In order to keep people fully employed, governments needed to spend when the economy slows. The private sector won’t spend or invest enough. As economic activity declines, businesses naturally reduce spending and investing, setting in motion a vicious cycle: less investment, fewer jobs, less consumption, and then even less business spending and investing. Governments must pick up the slack through deficit spending.

Keynes had a hard sell, even in the depths of the Depression. Most economists of the era rejected his idea and favored balanced budgets. Most progressive politicians, meanwhile, focused their attention on the evils of concentrated economic power — and opted either to break up big corporations through antitrust laws or to regulate corporations. But neither neoclassical economics nor progressive politics seemed up to the task of pulling the nation and the world out of the deep economic hole. “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist,” Keynes wrote.

Keynes’ visit to the White House in 1934 to urge Franklin Roosevelt to do more deficit spending was not a blazing success. “He left a whole rigmarole of figures,” a bewildered FDR complained to Labor Secretary Frances Perkins. “He must be a mathematician rather than a political economist.” Keynes was equally underwhelmed, telling Perkins that he had “supposed the President was more literate, economically speaking.”

But by 1938, FDR embraced the only new idea he hadn’t yet tried, that of the bewildering British “mathematician.” As he explained in a fireside chat, “We suffer primarily from a failure of consumer demand because of a lack of buying power.” It was therefore up to the government to “create an economic upturn” by making “additions to the purchasing power of the nation.”

Not until the U.S. entered World War II did FDR try Keynes’ idea on a scale necessary to pull the nation out of the doldrums — and Roosevelt, of course, had little choice. The big surprise was just how productive America could be when given the chance. Between 1939 and 1944 (the peak of wartime production), the nation’s output almost doubled. And unemployment plummeted — from more than 17% to just over 1%.

Never before had an economic theory been so dramatically tested. Even granted the special circumstances of war mobilization, it seemed to work exactly as Keynes predicted. The grand experiment even won over many Republicans. America’s Employment Act of 1946 — the year Keynes died — codified the new wisdom, making it “the continuing policy and responsibility of the Federal Government … to promote maximum employment, production, and purchasing power.”

And so the federal government did. Within a few years it was accepted wisdom that government could “fine-tune” the economy, pushing the twin accelerators of fiscal and monetary policy (lowering taxes and interest rates) to avoid slowdowns, and applying the brakes (raising taxes and interest rates) to avoid overheating. All questions of power, and the appropriate balance between capital and labor, were smoothed over (and swept under the rug) by Keynesian demand management. In 1964, Lyndon Johnson cut taxes to expand purchasing power and boost employment. In 1971, Richard Nixon famously proclaimed, “we are all Keynesians now.”

With Keynesianism seemingly smoothing out the business cycle and bringing on an era of growth and widespread prosperity, Ronald Reagan’s shift from democratic capitalism to corporate capitalism did not seem nearly as jarring as it later proved to be.

Yet over the next four decades, the steadily increasing concentration of corporate power combined with widening inequalities of income and wealth — the central concerns of progressive reformers from Teddy Roosevelt to his fifth cousin, Franklin — finally overwhelmed the capacities of Keynesianism to balance the economy.

Fiscal and monetary policies have proven no match for corporate monopolies and oligopolies able to keep prices high while depriving workers (who are also consumers) of the incomes needed to buy what is produced.

Deficit spending on the scale necessary to avoid recession has caused the national debt to explode. Interest rate reductions necessary to avoid recession — essentially pushed down to zero — have proven unsustainable. Inflation has eroded wages, robbing workers of purchasing power. Interest rate hikes to counteract inflation are punishing workers by making it expensive to borrow and are risking another recession.

Keynesian “demand management” of the economy is still necessary, but inadequate. It is once again necessary to address economic power, as Teddy Roosevelt and Woodrow Wilson did at the start of the last century. Antitrust laws must be used to break up giant corporations and stop the wave of mergers and acquisitions. Labor laws must be utilized to strengthen labor unions. Other laws and regulations should encourage worker cooperatives, collectives, worker ownership, and other sources of countervailing power.

As FDR described the economic challenge during the presidential campaign of 1932, it is the task “of distributing wealth and production more equitably, of adapting existing economic organizations to the service of the people.”