Where Keynes and Kalecki Went Wrong

By George P. Brockway, originally published April 8, 1991

1991-4-8 Where Keynes and Kalecki Went Wrong Title

1983-12-26 John Maynard Keynes

EVERY NOW AND THEN a learned journal carries an article, or a think tank issues a report, that effects a significant change in academic theory. Once in a blue moon, such an article or report results in a revision of public policy.

Given the volume of material produced every year by the dozens of think tanks and scores of learned journals devoted to economics, it is no wonder that even many of their best offerings bloom to blush unseen. Neither is it surprising that the most open of professions is slow to embrace challenges to established doctrine (and hence, if you want to be mean-minded about it, to established reputations). It is doubtful that learning could proceed in the midst of incessant turmoil.

That said, the fact is that groundbreaking work does appear; moreover, its appearance must be widely discussed if learning is indeed to proceed-and if public policy is to benefit. Accordingly, I rise to salute a recent article and a recent report. The article, by Fred Block, professor of sociology (not economics) at the University of Pennsylvania and the University of California, Davis, is entitled “Bad Data Drive Out Good: the Decline of Personal Savings Revisited. It leads off the Fall 1990 issue of the Journal of Post Keynesian Economics. The report, by Robert A. Blecker, assistant professor of economics at American University, is entitled Are Americans on a Consumption Binge? The Evidence Reconsidered. It is available from the Economic Policy Institute, 1730 Rhode Island Avenue, NW, Washington’ DC 20036.

These two papers are careful empirical examinations of two claims or assumptions that have ruled American economic policy for the past 30 or 40 years, and especially for the past 10. Blecker looks at the claim that Americans are irresponsible wastrels who have starved American industry and the American government. Block looks at the related claim that personal savings in this country have fallen so low we can no longer finance our own deficits or maintain a civilized standard of public services.

Together the Blecker and Block papers destroy both claims at their roots and thus cut off the theoretical sustenance that has nourished Reaganomics and Bush Voodoo. If it is not, as a matter of empirical fact, true that Americans have been consuming at an extraordinary rate, or that they have failed to save at some expected rate, then there must be other reasons to explain the misfortunes the American economy has suffered over the past decade.

A couple of months ago I remarked on the irony that the noisy supply-siders of recent years are now noisily complaining that the current recession has been caused by the failure of the demand side to consume (“Our Austerity Recession,” NL, January 14). They can’t have it both ways – the more fools we if we let them. Nor should we continue to hang our heads in shame whenever our saving is compared with that of the Japanese and Germans. As Block shows, we’re saving more today than we did in the early postwar years when our unemployment rate was lower, our inflation rate was also lower, and our after-tax profits were higher. On the record, it is not improbable that we have been saving too much rather than too little.

Besides the empirical facts about saving, there are a couple of theories. The one you hear in urban bars, on commuter trains and within the Washington Beltway argues that if you want to make anything (the supply side), you have to have proper raw materials and tools, and you have to have enough food, clothing and shelter to keep you and your colleagues going while you’re making it. Saving all these things, in short, is necessary to production. After all, you can’t grow corn unless you’ve saved seed.

But no so fast. You can’t save seed unless you’ve already harvested it. Your ancestors had to gather seed before they could plant their first crop. That’s not a quibble, but since it sounds like one lets turn to high theory.

In college classrooms, saving equals investment, or S = I. This neat little equation, arrived at independently about 60 years ago by John Maynard Keynes and MichaI Kalecki, is fatally flawed yet has been fatefully influential. Kalecki published his work three or four years before Keynes; but because he wrote in Polish, only his countrymen and only a handful of them-knew about it until much later (minority-language advocates, please note).

Kalecki s proof, though not difficult, is too complicated to retail in this space. Approaching the problem more directly, Keynes constructed and solved a pair of simultaneous equations that go as follows: (1) National output equals consumption plus investment; (2) national output equals consumption plus saving; therefore (3) saving equals investment.

As mathematical proofs both the Keynes and the Kalecki equations are perfectly valid. The conclusion S = I, however, is flawed in a way that is particularly characteristic of mathematical reasoning.

My great teacher, John William Miller (author of The Paradox of Cause and four other books I recommend to you), was fond of quoting Touchstone: “Much virtue in if.” Keynes’ first and second propositions would be clearer reading: (1) If national output equals consumption plus investment, and (2) if national output equals consumption plus saving….

Keynes was well aware of the virtue in if and devoted many pages of his great book to defining his terms so that his propositions made sense. But no more than Homer was he exempt from nodding, and here he did nod, with dire consequences. In these instances he is correct only in “real” terms, that is, only if he is talking about goods and services and is specifically excluding money and any of the legal instruments possible in a money economy. But we do live in a money economy (as Keynes knew more profoundly than his predecessors and most of his successors), and our society would collapse if we tried to live without money.

In another passage Keynes gives “investment” a portmanteau definition that is misleading in a different respect. He writes, “In popular usage it is common to mean by [investment] the purchase of an asset, old or new, by an individual or a corporation. Occasionally, the term might be restricted to the purchase of an asset on the Stock Exchange ….” Again Keynes nods. A share of stock or a bond is not an investment in the same way that a machine purchased with the proceeds of that share or bond is an investment. The machine is a producer’s good; it makes other goods. The share or bond makes nothing; it is not an economic good at all, it is a legal asset.

Keynes had some fun writing about stock speculators who made (or lost) money guessing what other speculators were going to do, and he implied that the New York Stock Exchange is a casino (which it isn’t). Still, he had little trouble believing that the exchanges were reasonably efficient ways of evaluating business enterprises. Although he was pre-eminently the analyst of a money economy, he did not quite see that a bull market continues to rise only with continuing infusions of money that is thereby denied to the producing economy (or what he called the industrial circulation).

In short, the conclusion of his (and Kalecki’s) exercise should have been: Saving equals investment plus speculation.

THE CORRECTION is clearly necessary if the elements of the equation are to be quantified in terms of money. Once one has money, it is obvious that one can hide it under one’s mattress. Hidden money is certainly saved, and just as certainly it is not invested. Hoarding (which Keynes called liquidity preference) may be done for a great variety of reasons, but all of them amount to speculating that the future will be more propitious for investing or consuming than is the present.

More important than hoarding is the money that flows into a bull market. While that influx of money may be said to be “invested” in the market, it has only tangential effects on the enterprises whose shares are traded. Practically all the activity on every exchange is speculation, and most of it is in search of capital gains (see “Why Speculation Will Undo Reaganomics,” NL, September 7, 1981). Similarly, investing in land is frequently speculation. The saving for which the Japanese are famous is sunk in real estate to such an extent that you could buy all the land in the 50 United States for less than you would have to pay for the land of Japan (even though it is smaller than Montana).

The high price of real estate does not make Japan a better place to live, of course, or even a richer country. But it needs to be said that speculating doesn’t make any country a better place to live. And it is crucial to insist that saving equals investment plus speculation. Policies that are supposed to encourage saving, such as many advanced in the U.S. this past half century, are worse than useless when what is encouraged is speculation rather than investment.

The Block and Blecker papers underscore this point. They prove that we have not been on a consumption binge, and that we have not imprudently failed to save. Since our interest rate has unquestionably been too high for our industries, since we have unquestionably used money borrowed abroad to finance a large part of our deficits, since those deficits are unquestionably used to excuse our failures in education and medical care and the general welfare, we must now look beyond the false answers of high consumption and low saving to find the explanation not only for the current recession but for the shameful general performance of our economy.

I’ll give you a couple of hints. Try looking at (1) the increasing share of our income that is diverted to speculation, and (2) at the increasing polarization of our society.

 The New Leader


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