The Keynesian past is past: Nostalgia is not the future

By Pete Dolack

Human beings tend to divide on political questions into various camps; there is no surprise when so many theories contend in the debates over the causes of economic collapse and what should be done. Finance is a poorly understood subject shrouded in mystery, compounding the tendency toward multiple theories.

One common line of thought frequently heard in the United States — and among the most coherent, as it is based on reality unlike many competing theories — is that the two decades or so following World War II represent a “golden era,” and point toward high taxation on the rich, high taxation on corporations and the far higher level of unionization as enabling a relatively more egalitarian distribution of income that fueled consumption and therefore production. That was an era of high government spending on investment, helping start entire industries.

The logical conclusion of this Center-Left viewpoint is that what is necessary is a return to the conditions of the 1950s, the height of the so-called “golden age.” (Of course it was not so golden if you were a woman confined by limited options or an African-American facing officially sanctioned discrimination.) Concomitant to this viewpoint is that government has a role to play in stabilizing the capitalist system; the economists most known for advocating this are “Keynesians,” a school named for the famed British economist John Maynard Keynes.

The period from the end of World War II to the 1970s is sometimes referred to as the “Keynesian consensus,” so accepted was the Keynesian model. Keynesianism, simply put, is the belief that capitalism is unstable and requires government intervention in the economy when private enterprise is unable or unwilling to spend enough to lift it out of a slump. Keynes developed his theories during the 1930s, when the Great Depression had discredited the “laissez-faire” economics that had plunged the world into crisis. (Laissez-faire is an older name for “neoliberalism”; there is little new under the sun.)

The arguments summarized just above boil down to this: Government spending, not austerity, is the route out of economic slump. To be sure, Keynesian spending would be much better than the neoliberal austerity on offer around the world, but it also true that we’re no longer in the mid-20th century. Government spending — the New Deal, the immense effort to win World War II, the Marshall Plan and a significant state sector in European economies — did indeed lift living standards in the advanced capitalist countries of the North. Putting money in the pockets of working people by employing them does stimulate the economy.

But those more than two decades of economic boom was an anomaly that won’t be repeated, and this time Keynesian spending can’t save the day — the world capitalist system is undergoing a structural crisis in a time much different than the 1930s.

Mid-20th century Keynesianism depended on an industrial base and market expansion. A repeat of history isn’t possible because the industrial base of the advanced capitalist countries has been hollowed out, transferred to low-wage developing countries, and there is almost no place remaining to which to expand. Moreover, capitalists who are saved by Keynesian spending programs amass enough power to later impose their preferred neoliberal policies. A vicious circle arises: Persistent unemployment and depressed wages in developed countries and inadequate ability to consume on the part of underpaid workers in developing countries leads to continuing under-consumption, creating pressure for still lower wages by capitalists who can’t sell what they produce and seek to cut costs further because there is no incentive for them to invest in new production.

The economic collapse that began in 2008 is not the latest in a series of downturns that are regular features of the “business cycle” of boom and bust endemic to capitalism. This structural crisis is a culmination of a long sequence of events, and has its roots in the 1970s, when mounting contradictions within Keynesianism and sharpened global competition created the openings for capitalists and the governments that capitalists have decisive influence over to begin to reverse the previous decades’ gains by working people and begin to impose neoliberal policies.

Sustained organized unrest during the 1930s had caused governments such as the Roosevelt administration to fear the possibility of revolution and, in response, massively increase social spending to dampen that unrest. Unions were emboldened, strikes disrupted production, and socialist and communist parties were acquiring mass followings — this was, so far, the only time the capitalist system has been threatened with replacement in the United States.

As significant as New Deal spending was, it was the unprecedented government spending required to win World War II that pulled the West out of the Great Depression, and the United States government continued spending to rebuild Europe and Japan through the Marshall Plan, successfully expanding markets for U.S. products, which was the intent of it.

The Keynesian compromise was not necessarily what capitalists would have wanted; it was a pragmatic decision — profits could be maintained through expansion of markets and social peace bought. This equilibrium, however, could only be temporary because the new financial center of capitalism, the U.S., possessed a towering economic dominance following World War II that could not last. When markets can’t be expanded at a rate sufficiently robust to maintain or increase profit margins, capitalists cease tolerating paying increased wages.

Ironically, just at the time when the conservative Richard Nixon declared “We are all Keynesians now” is when the tide turned against that school of economic thought. The rebound of Western Europe and Japan eroded U.S. manufacturing dominance, squeezing corporate profits and intensifying competition, and U.S. manufacturers responded by moving production overseas. A steady loss of well-paying jobs became a hammer held above the heads of working people — industrialists found it easier to squeeze their employees. Neoliberal ideology, particularly in the forms of the Austrian and Chicago schools of economics, supplied the intellectual justification.

By the early 1970s, the Nixon administration believed that the Bretton Woods monetary system put in place during World War II no longer sufficiently advantaged the United States despite its currency’s centrality within the system cementing U.S. economic suzerainty. Under Bretton Woods, the value of a U.S. dollar was fixed to the price of gold, and the value of all other currencies were pegged to the dollar. Any government could exchange the dollars it held in reserve for U.S. Treasury Department gold on demand.

Rising world supplies of dollars and domestic inflation depressed the value of the dollar, causing the Treasury price of gold to be artificially low and thereby making the exchange of dollars for gold at the fixed price an excellent deal for other governments. The Nixon administration refused to adjust the value of the dollar, instead in 1971 pulling the dollar from the gold standard by refusing to continue to exchange foreign-held dollars for gold on demand. Currencies would now float on markets against each other, their values set by speculators rather than by governments, making all but the strongest countries highly vulnerable to economic pressure.

The world’s oil-producing states dramatically raised oil prices in 1973. The Nixon administration eliminated U.S. capital controls a year later, encouraged oil producers to park their new glut of dollars in U.S. banks and adopted policies to encourage the banks to lend those deposited dollars to the South. Restrictions limiting cross-border movements of capital were opposed by multi-national corporations that had moved production overseas, by speculators in the new currency-exchange markets that blossomed with the breakdown of Bretton Woods and by neoliberal ideologues, creating decisive momentum within the U.S. for the elimination of capital controls. Private banks quickly became the center of international finance in place of central banks, leading to international dominance of the U.S. and British financial systems and U.S. financial institutions.*

Margaret Thatcher in Britain and Ronald Reagan in the U.S. ascended to office determined to tighten this domination, a project that would require both deregulation and lower standards of living for working people. It is no accident that the first move of the Thatcher administration, upon taking office in 1979, was to eliminate British capital controls (further stimulating financial speculation) and later maneuvering to break the miners’ union (striking a decisive blow against working peoples’ ability to defend themselves). Similarly, when Reagan took office at the start of 1981, he deregulated U.S. banking and broke the air traffic controllers’ national strike. (The ability of Thatcher and Reagan to break such strikes was strongly augmented by the lack of solidarity from workers in other industries — their reward for their silence would be to come under attack themselves, further eroding living standards.)

Although Thatcherites provided ideological ballast for Reaganites, it would be the far larger U.S., and Reagan administration policy, that would be decisive. In the U.S., it should be noted that austerity began to be imposed near the end of the Carter administration when the then chairman of the Federal Reserve, Paul Volcker, unilaterally began to raise interest rates sky high, inducing the deep recession of the early 1980s. The Reagan administration severely tightened monetary policy to squeeze out inflation; gave huge tax cuts to the rich, thereby providing a correspondingly large boost to the financial industry (because the windfalls of the rich would inevitably be put to use in speculation); and pursued a policy of a highly valued dollar.

The extraordinarily high interest rates offered by U.S. banks attracted foreign capital, financing the Reagan administration’s deficit spending and military buildup; in turn the U.S. applied pressure on other countries to loosen their capital controls to enable this flow of funds into the U.S. At the same time, oil was paid for in dollars internationally; a combination of high oil prices and a highly valued dollar triggered the debt crisis of the 1980s. Latin American payments to service debt increased from less than a third of the value of the region’s exports in 1977 to almost two-thirds in 1982, a graphic illustration of the grip of finance capital.**

That grip strengthened to the point that the Clinton administration seemingly further deregulated financial markets on the demand of a large U.S. bank, Citigroup, that acquired an insurance company in defiance of then existing law, while a few small countries (such as Iceland) based their entire economies on financial speculation.

The economic turnaround of the 1990s rested on a stock-market bubble, particularly in technology stocks. When that bubble burst in 2000, a bubble in real estate began to inflate, expanding the numbers of people engaged in speculation as the middle class was encouraged to buy houses for short-term investment and banks pocketed windfall profits by knowingly making housing loans on unfavorable terms to lower- and middle-income people who could not afford their mortgages. When a bubble bursts — in this case, when real estate prices had gone far beyond reasonable or sustainable — corporate profits will have already been pocketed, leaving others to pay the bills.

No more bubbles to inflate, decades of Reaganite neoliberalism in the U.S. reached its logical conclusion with 2008’s freefall, taking down the global economy with it.

Having ridden a tiger they can’t control, ideologically dependent on financiers, ensnared in the global web of financial markets and lacking any fresh ideas on how to combat ongoing stagnation, the governments of the world’s advanced capitalist countries have had no answer other than to prop up the financialization that led to the collapse. Or additionally, in the case of the Obama administration, to semi-desperately give subsidies to solar energy companies in an effort to kickstart a new “green energy” industry.

The problem here is that China is already a low-cost manufacturer of such equipment because the preceding four decades has seen a steady exodus of manufacturing from high-wage countries to low-wage countries — a process that is the logical outcome of capitalist competition. The only way to bring manufacturing back to a country such as the U.S. on a large scale would be through massive reductions in wages. Indeed, the “revival” of the U.S. automobile industry is based on new autoworkers earning wages half that of workers who had been there before the industry bankruptcies.

Here’s another example. Caterpillar Inc. locked out its unionized workers at its locomotive assembly plant in Ontario when they refused to accept a 50 percent wage cut, then closed the plant in February. Caterpillar then expanded production in Indiana, at a plant it had bought shortly before the lockout. The company last year placed an online job advertisement seeking human-resources managers having “experience with providing union-free culture and union avoidance,” according to a Feb. 3 report in The Wall Street Journal.

The race to the bottom is accelerating. Government spending can no longer provide anything other a tap to the brakes, and so much debt has been accumulated because governments borrow from the rich and corporations instead of taxing them that deficit spending in the amounts of the past aren’t possible. Corporations are sitting on unprecedented piles of cash, the rich have so much they can’t even speculate with all of it, working people are being immiserated — and the only solution on offer is to give more to those at the top.

Such a state of affairs can’t last forever — nobody has yet invented a perpetual-motion machine.

* This and the preceding paragraph based in part on Michael Loriaux, Capital Ungoverned: Liberalizing Finance in Interventionist States, pages 219-222 [Cornell University Press, 1997]; Peter Gowan, The Global Gamble: Washington’s Faustian Bid for World Dominance, pages 19-26 [Verso, 1999]; and Eric Helleiner, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, pages 112-121 [Cornell University Press,1994]

** This and the preceding paragraph based in part on The Global Gamble, page 40; Capital Ungoverned, page 222; and Giovanni Arrighi, The Long Twentieth Century: Money, Power, and the Origins of Our Times, page 323 [Verso, 2002]