Keynes and Friedman on Laissez-Faire and Planning

Sylvie Rivot

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781135022105
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

The 2008 crisis has revived debates on the relevance of laissez-faire, and thus on the role of the State in a modern economy. This volume offers a new exploration of the writings of Keynes and Friedman on this topic, highlighting not only the clear points of opposition between them, but also the places in which their concerns where shared.

This volume argues that the parallel currently made with the 1929 financial crisis and the way the latter turned into the Great Depression sheds new light on the proper economic policy to be conducted in both the short- and the long-run in a monetary economy. In light of the recent revival in appreciation for Keynes' ideas, Rivot investigates what both Keynes and Friedman had to say on key issues, including their respective interpretations of both the 1929 crisis and the Great Depression, their advocacy of the proper employment policy, and the theoretical underpinnings of the latter. The book asks which lessons should be learnt from the Thirties? And what is the relevance of Keynes' and Friedman's respective pleas for today?

1 Introduction

Without denying what constitutes the specificities of their original findings about the functioning of economic macro-systems that led them at roughly 30 years of distance to launch the first two revolutions in macroeconomics of the twentieth century, our view is that significant similarities but also strong ties are at work in the logics that govern Keynes’ and Friedman’s respective approach to political economics. In particular, there is a problematic that is common to their two theoretical constructs, which is the issue of stability in a monetary economy. Truly, this shared concern for stabilisation is not founded upon identical theoretical principles and is not necessarily formulated in the same fashion (especially regarding the relevant time horizon to deal carefully with this fundamental issue). Strikingly, for both authors the main feature of the modern economies we live in is that they use monetary assets to facilitate exchanges. On this basis, through the lens of the stability issue a careful reading of their advocacies about the economic policy brings to light the convergent matters of concern at work in their political advices. In particular, for both of them the key task of policy guidelines they call for turns to anchor private agents’ expectations. Hence, over and above the received ideas that might remain about their pioneering works, and even despite the professions of faith (hardly reconcilable) that these two authors themselves might have wanted to give, there are similar preoccupations that should deserve our attention.

It is with this perspective that another look could be taken at the way we currently grasp the issue of crises. To take but a few examples, Keynes should have for his part a lot to teach us about the necessity to implement new policy devices to stabilise both the real and the financial sides of the economy, which basically means the management of long-term expectations. On his side, Friedman should have a lot to warn us about the adverse consequences of erratic policies for the dynamics of private agents’ expectations in the short run.

Let us first present the aims and scope of this book. We will then provide the reader with an outline of the following chapters.

1.1 Aims and scope

To which extent is State intervention able to stabilise a decentralised market economy and to improve its day-to-day functioning? Depending on the precise way one looks at the problem, on how one frames the terms of the debate at stake, the issue of the proper economic policy to be implemented is addressed in very different manners. But in any case, Keynes and Friedman are caricatured in the most stereotypical images as poles apart on almost everything.

The very first way one can address the issue is the way Hayek did, in particular in The Road to Serfdom (1944). Here, the alternative is set in terms of freedom versus planning. Worded this way, the issues that arise are the following. To what extent are freedom and efficiency deeply intertwined values to be pursued hand in hand? Once one allows the State to interfere with the daily functioning of markets, what should be the moral principles underlying its interventions? If the battlefield is formulated this way, the answer given by these caricatured figures would be for Keynes to give up to planning all that is necessary for the sake of efficiency and in the opposite a pure laissez-faire regime and not the smallest concession to freedom for Friedman.

The second basic way to address this basic problem is to gauge the self-adjusting capacity of a decentralised market economy, in the long run as well as in the short run. In case of a large and protracted shock, when the economy suffers a severe downturn, are discretionary actions of public authorities necessarily detrimental, so that the State should refrain from intervening and let the purge go on? On the contrary, if one considers that Say’s law proves utterly irrelevant in our modern monetary economies, how are State authorities supposed to intervene so as to forestall the potential problems inhering in decentralised market economies? Once State intervention is acknowledged in the public’s interest, how should these policy devices be designed and implemented? Besides, it can also be considered that a laissez-faire system is self-adjusting but only in a long-run perspective, so that it undergoes short-run departures from the growth path of the economy, which are costly in terms of collective welfare. If so, are State authorities supposed to intervene with the view to ensure the maintenance of full employment? And what is the best way to avoid those departures? Here again, Keynes and Friedman are said to be poles apart. Keynes would have made a radical case for big government, impotence of the monetary weapon, anti-cyclical discretionary policies, no care for public deficits and inflation and above all an insistence on short-term devices. As for Friedman, a dismissal of public spending and of short-term fine-tuning, anti-discretionary monetary policy and above all a strict kingly State, which means laissez-faire in every single area of State intervention.

As this book aims to show, the reality is a far cry from this oversimplified image. First and foremost, this book is an exercise of text reading. Through a careful analysis of what these two authors wrote concerning the functioning of a monetary economy, its ability to stabilise by itself at around full employment and also what they viewed as State duties regarding this fundamental goal, our aim is not merely to bring to light similarities and dissimilarities in their theoretical constructs. By the same token, we do not aim only to establish some parallels in their policy advice.

At the theoretical level, our ambition in this book is to investigate the logics that underlie these proximities in the way Keynes and Friedman respectively address the stability issue. An avenue of research will be to question their respective understanding of the ‘individual versus collective’ issue through the lens of institutions. By the latter we mean the ability of a collective body to behave more efficiently than an individual one, what is nowadays called the ‘collective rationality’ issue. Friedman’s profound confidence in the individual leads him to advocate the return to the old principles of laissez-faire, i.e. the ‘classical liberalism’. Hence Friedman’s absolute distrust vis-à-vis centralised authority to behave according to collective welfare. By contrast, Keynes’ confidence towards State authorities but also the opportunities he sees in the rise of the ‘big company’ for the collective interest is to be explained with regard to his mistrust towards the individual to behave rationally and, much more fundamentally, his claim that a collective body does much better than individuals, in particular on financial markets when decisions on long-term views are susceptible to be stifled by conventional judgements. Hence the ‘new liberalism’ Keynes calls for. Another line of approach will be to investigate the way our two authors envision the monetary character of a decentralised market economy and, from this, how they grasp the issue of uncertainty and expectations. We will see that, because of their dissimilar treatment of uncertainty and money, Keynes turns out to be concerned with the long-term real expectations (in particular the expectations held by investors and entrepreneurs), while Friedman focuses his attention on the short-term nominal expectations of every kind of agent.

At the policy level, we aim to show that a fresh look can be taken at Keynes’ and Friedman’s policy advice regarding State duties in a monetary economy once the perspective set above is adopted. This is the second dimension of our inquiry. Strikingly, both of them are true liberals in the political sense of the word, highly preoccupied by the preservation of our basic freedom. Both of them agree that untimely actions of public authorities might be detrimental for efficiency and both of them develop long-term views on the best way to stabilise the economy. In short, both of them agree that some degree of freedom has to be conceded for the ultimate purpose of preserving a laissez-faire system. It is on the extent of this concession towards planning and also on the practical definition of what has to be conceded that they part company. On the one hand, the need to achieve a compromise between a pure laissez-faire regime and planning (understood as collectivism and fully centralised activity) through the design and the careful implementation of a ‘Middle Way’ doctrine proves to be, so to speak, the cornerstone of Keynes’ political writings. On the other, despite Friedman’s own claims to be a true defender of a pure laissez-faire system and despite the inclination towards libertarianism he acknowledges, the implementation of a policy regime à la Friedman inevitably implies that some dose of State intervention has to be conceded to enforce the rules of the game, especially regarding monetary affairs. To put it differently, Friedman is definitively not a true anarchist, or a true libertarian. He could barely share the “libertarian goal of the shrinkage of the state” (De Long 2000a, p. 90) that is ascribed to him. So what appears for Keynes a crucial issue to be explicitly dealt with turns to be almost a blind spot for Friedman. Ultimately, it is on the issue of how to achieve this great compromise between freedom and efficiency rather than on the relevant compromise to be made (and in particular on the proper way to stabilise the economy) that they are poles apart.

Likewise, the specific logics that underlie their respective pleas can also provide the fundamental rationales of their advocacies regarding the way fiscal and monetary policies should be conducted. We will see that the contemporary perspective, which formulates the debate in terms of rules versus discretion, appears much too narrow to encompass the whole of the stakes of the debate between our two authors. On the one hand, what one now calls rules is much too discretionary to fit into a Friedma-nian policy advice setting. On the other, what we now call discretion is merely alien to Keynes’ overall policy principles. Keynes too advocates ‘policy guidelines’ although he parts company with Friedman about the ultimate goal of the rules and differs in the dose of leeway to be given to the authorities. Yet, we hasten to add that discretion is highly needed for Keynes when the system endures unforeseeable shocks despite the stabilising effect of the rules implemented. However, the fact remains that Keynes is quite alien to fine-tuning and to deficit spending.

Ultimately, with the help of Keynes and Friedman we should be able to rethink the critical issue of crises, which is at the centre of the debates today. Indeed, for both of them the basic tenets of the economic policy they call for are strongly embedded in their interpretation of the 1929 crisis and the way the latter turned into the Great Depression. Keynes and Friedman were both struck by the Great Depression. It is usually considered that the 1929 crisis and the way it turned into the most severe recession of the twentieth century fixed the whole of their respective intellectual background – as a contemporary for Keynes and much more as a historian for Friedman. As during the time of the Great Depression, one can now find again at the core of debates issues such as the self-regulating forces that a decentralised market system might possess (or not), the ability of financial markets to coordinate the inter-temporal plans of investors and savers, but also and strikingly the role played by public authorities in the sudden occurrence of economic crises.

First, what are the critical elements at the origin of the crisis? In particular, is it possible for State authorities and in particular for monetary authorities, to have created the crisis through misguided policies, as Friedman claims regarding the 1929 episode and as Taylor argues today in his Getting off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis (2009)? Or are the very causes of the current recession to be found in the financial side as well as in the real side of the economy, through financial markets’ malfunctions and global imbalances, as Keynesians would argue?

On this basis, coming back to the policy devices Keynes and Friedman originally advocate should help us to reframe the terms of the debate surrounding the economic policy to be followed to escape the recession. What should be State priorities: the then-and-now diseases of a severely out of equilibrium economy? Or in a more long-run perspective the restoration of the self-stabilising forces that the system inherently possesses, having as its corollary a close attention paid to the growth-path tendency of the economy? Bearing in mind the overall advocacies of our two authors, no doubt policy-makers would argue that something has to be done, and that it does not make sense to simply and purely let the purge go on. As a reminder of Keynes’ most important lesson, one should keep in mind that the State is the central player in the economy able precisely to influence the course of things. To this extent, the State authorities’ duty is first and foremost to formulate a way ahead, to help private agents chart a course regarding the future ‘states of the world’. In this perspective, one might seriously wonder whether a great recession is the right time for austerity in public finances. If the very duty of the State is to drive the investors’ and the entrepreneurs’ long-term real expectations, no doubt pessimistic expectations on behalf of centralised authorities can only be harmful for the already depressed private agents’ expectations. By contrast, it might be the perfect time to design and to implement new institutional settings with the view to launch public-private partnerships, with the double goal of ‘pump priming’ in a short-term and demand-side perspective and the combined aim to make the economy more competitive in a long-term and supply-side perspective. And as a reminder of Friedman’s deepest matter of concern, one should consider seriously the stickiness of private agents’ nominal expectations. That is, people do take time to revise their inflationary expectations, and uncertainty regarding the discretionary policies carried out in the future is very likely to destabilise the real side of the economy. Consequently, confidence both in the economic climate and in the ongoing policy regime is critical to stabilise the economy around full employment. Erratic policies are very likely to make matters worse. Friedman’s claim appears to be a deep warning directed towards those who concentrate on the short-run diseases and urge for devices which are immediately visible at the expense of long-term stabilisation concerns, especially when this sort of short-termism means a significant reversal of priorities in a very short space of time.

Keynes published his first academic paper in 1909 in the Economic Journal (Keynes 1909, “Recent Economic Events in India”, CW 11, pp. 1–22). And he had always been committed to public life: he began as a civil servant for the Indian Office, then worked for the Treasury during World War I and ended his career as a political adviser – Keynes’ last plea dates from 1945. As for Friedman, he started what would become his ‘counter-revolution’ precisely at that time, until the last edition of Capitalism and Freedom (1962a) in 2002 as well as in his posthumous “Tradeoffs in Monetary Policy” (2010). Friedman, too, was fully engaged in the political and intellectual debate until his death in 2006. In between there was a lot of water under the bridge. One saw the rise of the ‘Keynesian revolution’, progressively superseded by the monetarist ‘counter-revolution’. The worlds respectively faced by our two authors were in many extents radically different. Regarding the way Keynes and Friedman respectively deal with the ‘real’ world, suffice it to mention the place allowed to the State in the economy or the role played by the ‘big company’. As far as theory is concerned we have learnt a lot: new tools are at our disposal, such as econometrics; new disciplines emerged, such as public economics. Undoubtedly, such a long time span might render any inquiry such as ours quite perilous. Accordingly, the first stumbling block to be avoided all along this study is anachronism. Moreover, Friedman did not battle with Keynes himself, but with his heirs. Here, our investigation runs the risk of being distorted by the presence of the Keynesians, or at least by the proponents of the income-expenditure Keynesian sub-current. Accordingly, the second rock on which an undertaking such as ours might come to grief is ventriloquism.

As for the first reef, as time obviously elapsed between Keynes’ first advocacy to Friedman’s last plea, we need to be particularly cautious in taking into account the specific historical circumstances of such or such a plea. As far as Keynes is concerned, we will concentrate our investigation each time it will be possible to the time of and after the General Theory. As for Friedman, our way to solve this difficulty will be to put as far as possible his critique of Keynesianism aside, and to concentrate on his own original analyses. Finally, we will adopt for both authors consistency as a working hypothesis. Indeed, as for all great authors we will consider that Keynes and Friedman meant exactly what they wrote when scrutinising their texts and that, despite local amendments, their thoughts should be considered as consistent bulks.

1.2 Synopsis

If one plans to compare Keynes and Friedman on the issue of the proper way to enforce stability of macroeconomic systems, there is a prerequisite to be fulfilled, that is to put the Keynesians of the neoclassical synthesis off-stage. Chapter 2 deals with these preliminaries. Indeed, Friedman was definitely not a contemporary of Keynes. He did not battle with Keynes himself, but with his heirs, especially with those of the (Walrasian) neo-classical synthesis. The scope, scale and intensity of the quarrel varied as time elapsed. He is even said to have shown more flexibility towards Keynes in comparison to the Keynesians. This chapter aims to clarify the issues of the debate at stake, on both the theoretical and the methodological level, by specifying the context and especially by attempting to disentangle Friedman’s critique towards the Keynesians from his own original arguments. We will see that Friedman’s critiques of functional finance, of inflationary gap analysis as well as the Keynesian consumption function hardly apply to Keynes. Besides, since our main concern refers to political economy, the so-called ‘Keynesian’ Phillips curve will be at the core of our investigation in this chapter. The main issue of this chapter is to assess the relevance of Friedman’s assault on the Phillips curve for the economics of Keynes himself. Again, we will see that Keynes’ construct stands quite immune to Friedman’s critique, whether in respect to the call for short-term devices, inflationary remedies to unemployment or the employment-wages dynamics underlying the ‘Phillips curve exercises’.

Chapter 3 probes into Keynes and Friedman’s respective views on institutions, either private, ‘semi-public’ or public. We know well that neither Keynes nor Friedman were directly and explicitly interested in institutions as such. Yet, both of them developed original thinking regarding the individualistic competitive body, the ‘big company’ or the ‘State’ understood as centralised authorities. Through this particular lens, we aim to bring to light some of the rationales behind their respective views on the self-adjusting capacity of a laissez-faire economy – which are hardly reconcilable. Here, we focus on the salient features of a modern economy with regard to the old type of laissez-faire: Keynes’ ambitions to take advantage of the natural tendency of the system towards concentration while Friedman calls for the return to a purely competitive system. We also show that Keynes’ and Friedman’s appraisal of the ‘State’ as an institution ensues from their respective confidence towards the ‘collective’, a deep confidence in collective bodies regarding Keynes and a basic distrust towards anything which is not individualistic regarding Friedman. Finally, these findings are applied to their respective interpretation of the 1929 financial collapse. Their analyses of the main features of the US economy during the 1920s as well as their severe assessment of the Fed’s inept monetary policy at the end of the period are not so distant. But a careful reading of their positions regarding the way the 1929 crash turned into the Great Depression brings to light the type of mechanisms at work in a monetary economy on which they respectively insist to sustain their opposite appraisals of the ability of collective institutions to behave efficiently: Keynes insists on the second-round real effects of a financial collapse while Friedman focuses solely on monetary disturbances. This comparison allows us to learn lessons regarding Keynes’ and Friedman’s policy philosophies: Keynes’ new liberalism basically consists in the set-up of new institutions to cope with the inability of a laissez-faire regime to absorb by itself large and protracted shocks while Friedman calls for the return to the principles of the ‘old liberalism’, which means power as dispersed as possible in both the...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Acknowledgements
• 1. Introduction
• 2. Keeping the Keynesians off-stage
• 3. Private, public and semi-public institutions
• 4. Keynes and Friedman on the employment policy: structure and conduct
• 5. The functioning of a monetary economy
• 6. Conclusion: where to draw the line between laissez-faire and planning?
• Notes
• Bibliography
• Index