Abstract
Using the detailed picture painted by the economist Keynes, Lorenzo Pecchi and Gustavo Piga illustrate the differences between what was imagined years ago and what is the reality of the financial world today. They note that although his forecast on growth was remarkable, Keynes failed to depict important developments in modern-day work and leisure. Furthermore, they note that in today's society, higher wages have led to higher consumption yet happiness levels remain unchanged. While this may sound like too harsh a reality, Pecchi and Piga stress the need to understand and learn from past mistakes.
The failure of economists to forecast the timing and depth of the recession we are currently experiencing should worry us deeply. This is especially true in view of our fundamental incapacity to divine the future and to establish, with a reasonable degree of confidence, the right economic policies to lead us out of these troubled waters and into the 21st century, full of hope and enthusiasm. A possible solution is to take a step backward from this recession and look at things from a broader perspective, both historical and global. Start by looking at our standards of living today; compare them with those of our grandfathers. Today's conditions are, with all their difficulties, objectively better. More than that, a large portion of the non-Western world, which cannot yet claim to have achieved a significant level of well-being, now lives in hope and happiness, as measured by the increased living standards, reduced poverty rates, greater opportunities and improved access to information of the last decade. The growth of these countries has sustained the wealth of the Western world through the expansion of export markets for our products. In the meantime, differences in knowledge are shrinking rapidly. This threatens our traditional competitive advantage and raises the temptation of protectionism.
From a long-term perspective, stepping back from this recession, there is no reason to believe that we are becoming poorer. Nevertheless, we feel vaguely near to experiencing that fear that comes with recessions and the renunciation of economic conquests which were taken for granted. We call for help.
For that, we need someone who has delved into the insecurities of our wealthy society, reduced them to a reasonable dimension, fortified our defences and, most importantly, worked out an appropriate strategy at a global level. A thaumaturge or, rather, a ‘Freud of economic sciences’: John Maynard Keynes.
Not the Keynes whose policies (but were those his policies or those of one of his less brilliant disciples?) met with theoretical and practical failure during the last crisis in the 1970s, powerless before the shock wave of the oil price surge. Not the Keynes who was exalted in the post-war period in order to support the ideology of Social Democracy, as Alain Minc claims somewhat correctly in his latest work. 1 Not the Keynes who is recalled from the past to sustain the need to manage the business cycle and the way out from temporary underemployment.
Alain Minc, Une sorte de diable: les vies de John Maynard Keynes (Grasset 2007).
We are talking, rather, about the ‘long-term’ Keynes, the one with a partially classical view (careful readers, please note the words in italics, to which we will soon return) of what it is that allows for, over decades and even over centuries, the accumulation of the wealth of nations. Keynes is well known to have said that in the long term we are all dead, but he was certainly thinking seriously about that post-mortem situation with a view to the welfare of future generations. Indeed, it is little known that he was perhaps the first economist of the modern age who identified the fundamental engines for the long-run growth of an economy. He was the only economist at the onset of the Great Depression who suggested there wasn't anything to be afraid of. With the incredible optimism of scientific enlightenment, enriched by the knowledge of history, he told everyone to look back 100 years, then look ahead another hundred. By drawing logical conclusions, Keynes reassured everyone about the prosperous future of our capitalistic systems.
He did this in a small article, ‘Economic Possibilities for Our Grandchildren’, published in his Essays in Persuasion. This article is a brave attempt to paint an impressive picture of the world and life conditions that the Londoners of 1930s could expect for their grandchildren 100 years later, in 2030. A superb piece of science fiction, it should be read like a book by Jules Verne, both for what it foresaw with an incredible precision and for what ended up being wrongly forecast. This is a piece of work that provides us with the tools to paint a picture for our grandchildren–-citizens of the 21st century–-for whom we are indeed so worried in these strange years of increasing instability.
It is quite remarkable that by 1930 Keynes was already aware that the whole world was going to witness a slump which would take ‘its place in history amongst the most acute ever experienced’, to use his words. From the very beginning he thought that an active and determined government policy was necessary, and not one limited only to changing interest rates. Today, experts are debating whether the American and European economies may be entering a V-shaped (short and sharp) or U-shaped (long and mild) downturn. Yet all the economic indicators seem to point towards a downturn that is best described as L-shaped, that is, sharp and lasting, of the type envisaged by Keynes. In this case traditional policy options, to curb the downturn by managing interest rates, are likely to be the wrong answers.
The few pages of ‘Economic Possibilities’ foresee a wealthy life for the grandchildren of Keynes in 2030. They will be satisfied and able to dedicate themselves to the arts, leisure and poetry, given that they will be finally free from painful economic activities such as saving, accumulating capital and working. They will live in a steady state, in which the satisfaction of primary needs will be assured by a mechanised society, with a very large amount of capital available, thanks to the persistent energy of entrepreneurs, who are partly honoured by Keynes.
More specifically, Keynes forecast that by 2030, the standard of living in ‘progressive’ countries, as he referred to them, will have increased between four and eight times, implying an upwardly limited growth rate of about 2.1%. He also conjectured that as people became increasingly wealthy, they would achieve a state of satiation and consequently would lose the incentive to work and accumulate for the future. He predicted that hours worked could be around 15 per week, which is about one-third of the weekly hours worked in 1929. As a result, people would have to deal with the problem of occupying an enormous amount of leisure time. The most gifted would solve this problem by dedicating themselves to higher callings such as poetry, the arts and altruistic pursuits.
We need to return to that Keynes in order to recover our confidence, to get back to work, with the right recipe, more convinced than ever of the prosperous destiny for Western capitalism; convinced that our ‘Great Depression’–-still nothing compared to the one our grandparents experienced–-can be contained, halted and finally overcome. Going back to Keynes is the appropriate destiny for us, since we contributed to blocking his thought, forgetting it and defeating it through adopting policies which became more and more automatic, bureaucratic and decoupled from the unpredictable, which is the charm of historical and social mechanisms.
Keynes s article now makes for impressive re-reading. We asked 16 leading economists to do so and respond with their comments, which have recently been published as a book. 2 It is noteworthy how accurate Keynes was in 1930 in forecasting the level of individual wealth that we–-his grandchildren–-have reached and his ability to foresee the determinants of this growth: the power of the capitalistic engine of accumulation, savings, investments and technical progress.
Revisiting Keynes–-Economic Possibilities for Our Grandchildren, edited by Lorenzo Pecchi and Gustavo Piga (MIT Press, 2008). The 16 economists who contributed to this book are William Baumol, Leonardo Becchetti, Gary Becker, Michele Boldrin, Jean Paul Fitoussi, Robert Frank, Richard Freeman, Benjamin Friedman, Axel Leijonhufvud, David Levine, Lee Ohanian, Edmund Phelps, Luis Rayo, Robert Solow, Joseph Stiglitz and Fabrizio Zilibotti. Four of these are past recipients of the Nobel Prize.
However, it is also important to emphasise that the forecasting errors of this great artist of economic thought are equally noteworthy. First is the unforgivable omission of the destiny of the poorest countries and the poorest people inside each country. Keynes only had the advanced economies in mind; Africans, Asians and Latin Americans were left out of his speculations. While most of the advanced countries have achieved a standard of living comparable to Keynes s predictions, some 50% of the world still lives on less than two dollars a day. Indeed, world growth rates have varied greatly over different periods and among different geographical areas.
Keynes s prediction on growth remains, however, the most robust aspect of his essay. At the same time, he completely missed the mark in trying to capture future developments in work and leisure. The forecast of an economic system in 2030, where individuals would not work more than 15 h a week, would give up consumer behaviour and fully dedicate themselves to free time and culture could not be more inaccurate! Today, the United States is the most striking counter-example to the prediction that increased wealth would bring with it more leisure. In the United States, GDP per capita is 30^0% higher than in Europe, but Americans work 30% more hours than Europeans.
Now the question that we have to ask is why people have chosen to enjoy so little leisure. Answering this question bears critically on our 21st-century challenges. There may be some very plausible explanations. First, some of our expenditures are directed towards improving our leisure activities. Vacations and trips can be very expensive. People need to work more if they want to enjoy their leisure time in an expensive way. Moreover, a clear distinction between work and leisure, seen respectively as bad and good, is fundamentally flawed. People in many cases enjoy their work, whether in the market or at home, and even those jobs that are not very fulfilling can give considerable pleasure as a social setting where people meet and interact.
There is another explanation as to why leisure did not increase as Keynes expected. In the last 25 years real wages for most workers, at least in the United States, have not increased. Median wages were lower in 2004 than they were in 1974. Higher wages might lead to more leisure, but if for most workers wages did not really increase, average leisure time might also not increase.
However, something remains to be explained. Increases in wages may or may not lead to working fewer hours, but it is difficult to believe that increased wages will induce people to work more to the point of having a miserable life. Yet in the United States a ‘hurried working class’ is growing in which both parents work so hard, supposedly for their children, that they do not have any time left to share with them. Data on ‘happiness’ show that increases in productivity in the American economy have not resulted in higher levels of happiness.
Another puzzle that remains to be explained is why, over the last 40 years, Europeans have reacted to increased wages by substantially increasing their leisure time, while Americans have reacted with a reduction in their leisure. Critics of the European model argue that higher labour taxes in Europe discourage work. But the puzzle is that people at similar after-tax wages are working less in Europe than in the United States.
Stiglitz, in the book cited above, provides some relevant insights. First, we should consider a model wherein individual satisfaction depends not only on one's actual level of consumption, but on one's consumption relative to others. If there is satisfaction in having a car more luxurious than that of one's neighbours, there is no limit to the car that one desires. In this world, higher wages lead to higher consumption and happiness remains unchanged. However, this does not necessarily imply less leisure or lower savings for the economy. Growing inequality might instead induce consumerism and less leisure if the poor want to reduce the gap with their rich neighbours. The rich define the aspirations of society. As the poor strive to reduce the gap, the rich will react by consuming more to distinguish themselves. This becomes a race between affluent and less affluent people to consume more and more, with no winner.
Second, to explain why some societies have taken different directions one should consider that in some economic systems there are stronger incentives to distort preferences via advertising or education than in others. In the United States, these market forces have played a more important role than in Europe, pushing the American system towards an excess of consumerism.
It is an undisputable fact that American personal savings rates began to decline steadily in the mid-1980s, reaching negative levels in 2005. Keynes's prediction that people one day would become so rich that they would stop accumulating capital seems to be realised in the US. He thought that as people achieved a high standard of living, they would not have any motivation to care about tomorrow. Indeed, today people are not saving anymore, not for the reasons suggested by Keynes, but possibly because they are victims of excess consumerism. They are consuming too much, more than they can afford, and they are scared about the future.
No doubt the excess consumerism combined with the record level of indebtedness and bankruptcy in the US economy is part of an equation that has led to the financial mess we are in today. A heavy measure of responsibility must be borne by those financial institutions that failed to offer financial products that would have enabled ordinary families to face the risks they confront and not to lose their homes.
Going back to our initial considerations on the remedies to curb the actual economic downturn, it is clear that to stimulate our spendthrift ways only with traditional policy options such as tax cuts will not work. Tax cuts did not help the economy in 2001 and 2003, nor will they do so today. America's problem today is not that families consume too little: on the contrary, they are consuming too much. If anything, private savings need to be restored. Nevertheless, to re-establish the right kind of confidence in the marketplace, an expansion of aggregate demand is urgently needed. Thus, government has to step in and spend money on those investments that are needed the most. Investment in infrastructure, education and technology will boost the economy today and create the foundation for future economic growth. Investment in energy efficiency will also bring environmental benefits and long-term growth.
But there might be more to gain from Keynes's approach than simply reiterating his old-style aggregate demand policies. At the onset of the Great Depression, during a period of deep economic pessimism, Keynes looked 100 years into the future and clearly saw the capitalistic model of economic growth based on technological innovation, capital accumulation and low population growth as the way to bring about prosperity for future generations. In today's discussion about the current crisis, many participants are advocating strong state intervention and the nationalisation of private companies and banks without thinking about the consequences of similar actions for future economic growth. It seems that we forget that there are still millions in the world who are now just beginning to benefit from economic growth based on a capitalistic approach. Certainly there are issues such as climate change and environmental preservation that will impose some revisions to the economic growth model followed until now; however, we should avoid throwing the baby out with the bathwater. To abandon this model today would mean to condemn those people who are far from having solved their economic problems to permanent poverty.
Keynes's predictions also show that great thinkers can make mistakes. Yet their mistakes can sometimes be more instructive than their truths. These latter become part of common knowledge, whereas mistakes remain and demand solutions. Thus it seems to us, who admire his courage to imagine daringly, that it is not important to underscore Key-nes's mistakes but rather to understand and learn from them.
Maybe the vision of Keynes has only been postponed for another century. Or maybe it will never come true. Because in reality, the vision of Keynes was the one of ‘elitarian communism’ (quoting the term coined by Fitoussi in our book), in which the figure of the entrepreneur–-key to increasing income levels during a phase considered as transitory for wealthy societies–-must make way for a ‘better man’ who stops struggling for money and individual success. No, after almost 100 years this ‘better man’ has not materialised yet. All the wealth that we keep accumulating is due to that ideal figure, the entrepreneur, who, like a modern Sisyphus, never stops trying in the face of the most challenging adversity; or better, like an Odysseus, eager for knowledge, an explorer of new lands and inventor of new technologies, who wants to leave a virtuous sign of his presence on earth. It is that figure of the entrepreneur that Keynes was unable to recognise, and this has always differentiated him from the great classical economists such as Adam Smith or Alfred Marshall.
Several authors in our book insist that Keynes failed to recognise the constant aspiration of humans to improve their condition as well as the satisfaction they may derive from exercising their minds in facing new challenges. People are striving for more knowledge, to explore new things and set new goals; they are not aiming for a stagnant workless society. As Freeman eloquently put it: ‘Evolution presumably imbued us with a work ethic for our survival and not for a Garden of Eden existence.’ Similarly, Phelps argues: ‘But if Keynes had recognized that people need a system that throws out problems to challenge the mind and engage the spirit, he would still have gone wrong. He never saw that with the technical progress and capital deepening that he aptly postulates, an ever-increasing share of people can afford jobs that are stimulating and engaging. So unless the economic system is prevented from doing so, more and more jobs will be supplied that offer stimulation and engagement.’ Marshall developed the doctrine that it is new activities that give rise to new want rather than the other way around. As people improve their conditions–-moved both by the desire of excellence and distinction–-they demand new and better things in an endless fashion.
However, if Keynes were reborn today, we are certain that he would not make the same mistake: he would be the first one to put the entrepreneur and his or her strong willingness to leave a signature at the centre of the painting for the next century. The lesson of this ‘freed Keynes’–-for those of us who aspire to release the Western system from a stagnant economy–-is just one: the Western world must reply to the impressive dynamism of countries such as China and India. These countries have discovered the market and the virtue of a mechanism which feeds the new generation and is fed by it–-that is, the willingness to leave a mark, after many years of rough dictatorship and foolish central planning–-through the granting of opportunities and meritocracy. In order to help and defend entrepreneurs in an effective way, it is important to support European firms by eliminating useless bonds and constraints which harness their activities. There is a need for protection (not protectionism), especially for smaller firms and for those young entrepreneurs who have innovative ideas. In order to leave their mark, we need to allow them to carry out their ideas, expand them and assert them in a world without frontiers.
Footnotes