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Keynes and the Treasury Samuel Brittan: Contribution to British Academy Panel 14/05/04. Introduction Let me start by saying that I might be here on false pretences. I am not part of the Keynes industry. There is in some circles an excessive preoccupation with the minutiae of what Keynes said, what he really meant and what he should have meant. (Similar remarks might apply to Wittgenstein in philosophy). The reason I accept this and similar invitations is that an investigation into Keynes's thoughts and activities can lead us into problems still interesting today. Investment A question that has long puzzled me is why Keynes attached such importance to public investment as a way of raising expenditure both in relation to deep-seated stagnation and to more conventional business cycle recessions. After all if a recession or slump is due to attempted savings exceeding attempted investment, why not then tackle the savings side by stimulating consumption? (Chapters 10 and 11 of the Peden volume are most relevant to this range of issues.) It is interesting to see how near and yet how far the official Treasury came to something like Gordon Brown's Golden Rule. Treasury officials eventually accepted that budget balance should be sought over a whole economic cycle and not every year. They accepted moreover -- as they said they had always done -- that certain capital projects, e.g. Post Office investment, which brought a financial return should be financed "below the line" out of borrowing. (The last remnants of the "line" disappeared in the 1960s.) Keynes himself, however, wanted a capital budget covering a much wider range of expenditure -- including, I imagine, schools and hospitals -- which might not bring a financial return but which had a long-term benefit. It is this interpretation that now prevails in Gordon Brown's Golden Rule doctrine. But the warnings of the wartime Treasury, that a tendency to classify more and more items as capital could lead to a long-term weakening in the public finances, may still come home to roost. In the wartime debates about postwar employment policy officials mainly concentrated on the practical snags in plans to turn public investment on and off as a counter-cyclical weapon. Variations in public investment or in inducements to private investment have in fact formed a decreasing part of government macro-economic policy. Attempts to turn investment on and off disturbed the sectors affected and came into effect too late to do anything other than aggravate the business cycle. In fact official stabilisation policy has mainly taken the form of interest rate policy and automatic variations in the budget balance ("built in stabilisers"). Even in earlier post-war decades, when fiscal policy played a more active part, it normally took the form of discretionary tax changes augmented by variations in credit restrictions. What is surprising to the present day observer is how small a part that both Keynes and his Treasury critics assigned to monetary policy, which is surely the first line of defence against economic fluctuations and which does not involve any direct judgment by the authorities of which sectors of the economy need to be stimulated. All sides to the wartime discussion seemed to regard half a per cent short-term interest rates and two or, at most, three per cent long-term interest rates as a near-permanent norm. If they had foreseen how high average real equilibrium rates would be they might have allowed monetary policy a more active role. One underlying theme in the war time discussions was terror -- I do not exaggerate -- about the future balance of payments. The greatest exponent of balance of payments pessimism was Sir Hubert Henderson, who had been an ally of Keynes during the Lloyd George campaign for public works in the 1920s but had since become an in intellectual reactionary. (Milton Friedman once said of him that he began his career by writing a very good book on supply and demand and spent the rest of his life finding one area after another where he alleged they did not apply.) The official Treasury was nearer to his pessimism than to the Keynesians. The fear was that an economic downturn might be triggered by a fall in exports. The Export Obsession The Treasury's export obsession is perhaps explained by the fact that, according to Christopher Dow's pioneering analysis, over 40 per cent of the shortfall in total final expenditure below trend in the 1929-32 depression reflected a fall in exports. This was by far the largest component. In the three major post war recessions, on the other hand, consumer spending was the biggest culprit, accounting for between 34 and 50 per cent of the shortfall. Fixed investment came next with 17 to 35 per cent, with exports a long way third. (Christopher Dow, Major Recessions, OUP 1998, table 5.9 Page 114). Keynes himself doubted whether home demand could fill the gap resulting from an export shortfall; and unlike James Meade, who was much more of a Keynesian than the master himself, he did not see exchange depreciation as part of the solution. He was all too inclined to talk in terms of temporary import restrictions and other direct controls. It is indeed remarkable how little faith anyone in the Treasury discussions had in market or price mechanism approaches. The slump of the 1930s, followed by immersion in the war economy, had promoted a dirigiste turn of mind. Controls were not seen as the route to a socialist paradise, but a defensive and pessimistic reaction to a world they feared. There is just one sentence in the Peden volume of "Treasury responses" which does pinpoint my problem with Keynes. (Keynes and his critics: Treasury responses, edited by G.C. Peden, 2005. Section 10.6; page 293). In a Treasury note on The Maintenance of Employment there comes the following remark. "The essential task in a depression, resulting from a decline in investment, is to turn over part of productive power from the output of capital goods to the output of consumer goods." But having almost hit the nail on the head the Treasury authors ran away by talking, as officials are inclined to do, of complex problems requiring "a many sided and concrete approach.� It seems pretty clear to me that if consumer goods and services are to be boosted at a time of recession the most important requirement is to put sufficient purchasing power into the hands of the consumer. But I am afraid I do not find these newly collected Treasury papers very helpful about my fundamental question. Keynes believed that deficient demand and slump were normal conditions for capitalist economies. The succeeding half century showed him to be wrong then. But who is to say that the problems of deficient demand might not occur again?. If so would an investment boost be a sufficient solution? The question was put to Keynes several times in correspondence during World War II (Keynes, Macmillan edition Vol XXVII). He did offer various answer, even though the question seemed to irritate him. Like others, he started off from the view that past business cycles had been touched off by fluctuations in investment. Therefore stimulating capital expenditure artificially to make up for private investment downturns seemed a natural route and involved less structural dislocation. He believed it was much easier to win over public opinion to investment promotion than it was to stimulate consumption through budget deficits. He also feared that tax remissions and the like would be saved whereas extra investment would go straight into the economy. Some of Keynes' wartime correspondents did probe him about what would happen when investment was pushed as far as practical. Even then he did not turn to budget deficits, post-war credits, Milton Friedman's helicopter money, or anything similar. Indeed he once said in reply to a letter from the poet T.S. Eliot (Vol XXVII) that the remedy would then lie in shorter hours. He did not make it clear whether he was thinking of compulsion or a natural drift. The Saturation Bogey and the Work Ethic It seems to me that he was skating very near what I call the saturation fallacy. This was exemplified by all the people who used to ask: "What will we spend our money on when every family has two cars, a refrigerator, television and other consumer durables?� Needless to say I regard such a possibility as unlikely in the extreme and mainly raised by people sitting in club armchairs who do not know what they are talking about. But now consider another possibility, which looks similar, but is basically very different. This is that people will voluntarily and without state compulsion move towards shorter working hours or a more congenial working environment, or longer holidays or more sabbaticals or some mixture of all these things. This will mean, not that saturation has been reached, but that above certain levels of income the demand is for leisure and a better environment rather than for more take-home pay and tangible goods. (Income elasticity of demand for "leisure" would then well exceed 1). Then we really would have the world of "economic possibilities for our grandchildren" described in an earlier essay of Keynes. The economic problem would not really have been solved, but we would enjoy a less puritanical and work-obsessed culture. This would be a utopia rather than a nightmare. The danger is that policy-makers and opinion-formers will mix up those two kinds of reaction and plague us, as has already happened in the European Social model, with compulsory reductions of working hours, artificially early retirement and all the rest of the ridiculous battery of make work measures, instead of just encouraging flexible personal choices in all these matters. To conclude. The chronic deficiency of demand, which Keynes feared was endemic to capitalism as a result of the experiences of the 1930s, has not been a feature of the post-World War II world, but who can be dogmatic that it will not recur? It is indeed important to maintain effective demand at a sufficient but non-inflationary level. If stimulus is required, consumer demand is just as worthy of being stimulated as investment, so long as consumption is broadly defined to include leisure environmental improvements and amenities in the workplace. We can indeed have market capitalism without the Puritan work ethic if only we have sufficient imagination.
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