From Keynes to Piketty

Peter de Haan

From Keynes to Piketty

The Century that Shook Up Economics

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Peter   de Haan

To Marisales

vii

Sometime ago I read an obituary about the American sociologist Daniel Bell. It said that two of his books were included in the Times Literary Supplement List of the 100 Most Infl uential Books since World War II. To satisfy my curiosity, I compared the Times Literary Supplement ( TLS ) list with my own list of books written by economists. To my delight I dis-covered that most of the books on my list were also included in the TLS list. However, there are also diff erences. Th is is partly explained by the fact that the TLS list ends in the 1990s, while my list ends in 2014. And, surely, the criteria applied by the ones who put together the TLS list were diff erent from mine. Th e fi rst criterion I applied was that the selected books should best refl ect the often turbulent political and economic developments since the early part of the twentieth century. Th e second criterion was that the selected works should be refl ective of the ups and downs of mainstream economic theories (in particular Keynesianism and neoclassical theory) and how these theories infl uenced public opinion and policymaking in the political domain. Th e third selection criterion was that the books should explain the factors behind these economic ups and downs.

To put a bit of historical order in my list, I cut it into seven distinct periods and brought the selected books that represented the political, eco-nomic, and intellectual ‘signs of the times’ under the period concerned. Two books written by John Maynard Keynes fi tted the fi rst period,

Pref ace

viii Preface

spanning the time between the start of the First World War and the end of the Great Depression. Th e Economic Consequences of Peace (1919) pretty much predicted what would happen after the ill-fated Treaty of Versailles, while Th e General Th eory of Employment, Interest, and Money (1936) ushered in the Keynesian revolution.

During the second period, encompassing the 1940s, economists like Joseph Schumpeter and Karl Polanyi struggled with the question whether socialism would not be a better option than capitalism. After all, capi-talism had not brought much improved economic life after the ‘Gilded Age’ had abruptly ended. In Capitalism, Socialism and Democracy (1942) Schumpeter investigated whether socialism could eclipse capitalism. He concluded that it very well could. Th e main theme of Karl Polanyi’s Th e Great Transformation (1944) is that self-regulating markets required sub-ordinating society to the market. It means no less than the running of society as an adjunct to the market, instead of the economy embedded in social relations. Unchecked, they lead to excesses as confi rmed by the endless—and sometimes extreme—ups and downs of entire economies.

After the end of the Second World War a third period—this time of affl uence—started which was enjoyed by the industrialised countries. Pent-up demand, reconstruction, and Keynesian policies resulted in robust growth, full employment, higher incomes for all and social secu-rity formed the constituent parts of affl uence. John Kenneth Galbraith epitomised the period in Th e Affl uent Society (1958). And so did Tibor Scitovsky, zooming in on affl uence’s troubling aspects in Th e Joyless Economy (1976). But the ‘Golden Age’, as this postwar period was called, didn’t last.

Th e fourth period began in the fi rst half of the 1970s when wages and prices in industrialised countries spun out of control. Growth sputtered, infl ation soared, and so did unemployment. Th is lethal mix became known as stagfl ation. Keynesians wrung their hands; they couldn’t explain, nor redress, what was happening. Neoclassical economists main-tained that they knew how to solve the problems. Milton Friedman and Friedrich Hayek were the intellectual leaders of the neoclassical counter- revolution, discarding Keynesianism. Hayek’s Th e Constitution of Liberty (1960) and Milton Friedman’s Capital and Freedom (1962) wielded enor-mous infl uence, not only in economics but also in terms of economic

Preface ix

policy. Nonetheless, there were economists who questioned the neoclas-sical assumptions. Albert Hirschman, for example, argued in Exit, Voice and Loyalty (1970) that when the market fails to achieve an optimal state, society will recognise the gap, and non-market social institutions will arise and attempt to bridge it.

After the ‘Lost Decade’ of the 1980s (and for many developing countries well into the 1990s), period number fi ve started. Th e study of economic growth again fl ourished, with a particular focus on devel-oping countries. Douglass North’s Institutions, Institutional Change and Economic Performance (1990) is a classic work in which he demonstrates the importance of institutions in explaining economic growth or stag-nation. His book greatly infl uenced development economics and devel-opment practitioners. Before North, Peter Berger had published Th e Capitalist Revolution at the right time, that is, in 1986 when capitalism was riding high. He presented 50 propositions about prosperity, equality, and liberty. He concluded that capitalism was to be preferred to a socialist order. After the dragon of stagfl ation had been slain, a fairly long period of stability followed. Neoclassical economists believed that ‘Th e Great Moderation’, as this period was coined, would last forever. Even Nobel Prize laureates made statements that the economic science had developed the instruments to fi ne tune the economy. But they should have known better. Surely there were economists who sent out warnings about insta-bilities in the system, but they were not heard.

And then, in 2007, the housing bubble burst, not only in America, but also in countries such as Ireland and Spain. Period number six, a dark period, began. Banks started to have trouble. A year later, credit dried up all of a sudden. Banks and insurance companies failed. Th e process was contagious; the entire fi nancial sector nearly collapsed. Governments intervened with unprecedented emergency rescue operations, but they could not prevent the Great Recession and the Euro-zone crisis from hap-pening. In taming the crisis, Keynes was re-appreciated by economists and policymakers alike. Neoclassical economics was blamed for what had gone wrong. Not all recession-ridden countries applied Keynesian anti- depression policies; some resorted to austerity. John Cassidy in his book How Markets Fail: Th e Logic of Economic Calamities (2009) describes what went wrong and what was done about it.

x Preface

After the Great Recession the seventh period started. Just like after the Great Depression, a host of critical books appeared. Some of them pas-sionately advocated Keynesian policies, others focused on the downside of unfettered capitalism. A favourite subject was inequality; an issue that is not new, but that regained relevance given the widening gap between the wealthy and the rest. In 2014 the English translation of Th omas Piketty’s Capital in the Twenty-First Century was published. Th e book was a bestseller. Piketty—like Keynes almost a century before him—gained world fame.

Th ese seven periods constitute seven chapters of this book. Each chapter contains a summary of the books I mentioned, which—to my mind—best represent the particular period at hand, preceded by a biog-raphy of the author concerned. Th e introductory chapter sketches the political and economic context in which the books were written, starting with the aftermath of the First World War up to the Great Recession, subsequent Euro-zone crisis and ending with serious concerns about the economic system at large.

I believe that this book gives the reader an insight into the main devel-opments of the economic science of the past and current century. It will also aid in understanding the debate on major economic challenges. After all, the authors and their works presented are the ones who provided the theoretical groundwork for the economic policies applied today.

Milton Friedman once said that Marx and Keynes may have been the best-known economists, but their works were the least read. I hope that the biographies and summaries presented in this book give the reader a handy guide to what the authors proposed.

Th e Hague Peter   de Haan May 2015

xi

Writing seems a lonely business, but it is not so. I received a great deal of help from other people. Th ey took a genuine interest in what I was trying to accomplish and—to my great delight—were indeed willing to help.

My good friend and former colleague Kees Beemsterboer thoroughly analysed my text and provided solid advice, which improved the text con-siderably. Th e same applies to retired banker Dr Th om van de Burgt. His critical eye spotted inconsistencies, which I quickly removed. My friend and retired publisher, Leo van Grunsven, consistently told me to keep the text brief. He was not very successful in getting his message through, I admit. Yet, he managed to have me limit the introductory chapter from the original 50 pages to some 20 pages.

Alfonso Garcia, my former Bolivian colleague, also helped me in sort-ing out the wheat from the chaff and putting order in the build-up of the argument. Peter Kardoes, a retired lawyer, went through all the ver-sions of the manuscript, and—again—helped me a great deal with his suggestions. He even confessed, after having read the manuscript, that he started to take an interest in economics, which is a rare compliment coming from a lawyer.

I also want to thank Professor Bert Helmsing who gave me help-ful comments, like he did with earlier manuscripts of mine. Professor Arie Kuyvenhoven analysed the text as well. I am particularly grateful for the critical, yet constructive, manner in which he provided me with

Acknowledgments

xii Acknowledgments

comments and suggestions, which I gladly took on board. Th e same applies to Dr Auke Leen, who has been a strong supporter, right from the start, of this book’s idea and purpose.

Michiel Vergeer, former spokesman of the Netherlands Bureau of Statistics, was very helpful in sorting out unemployment and economic growth data for the Netherlands during the diffi cult time of stagfl ation and Dutch Disease. Dr Marein van Schaaijk, director of Micro-Macro Consultants, acted as sparring partner in understanding the mathemati-cal intricacies of Piketty’s formula: r > g , which we discussed aboard his ship. It was in various ways a dizzying experience.

All of them regularly sent me copies of articles they felt that might interest me, which they certainly did. As a positive side-eff ect (as econ-omists would say, an externality) I got to know Dorothy Parker, who characterised the Bloomsbury Group in a funny way (her quote is in the section on Keynes). I also got to know Dorothy’s two favourite words: ‘cheque’ and ‘enclosed’. Needless to say, Ms Parker was a professional writer.

My sister, Simone Whittemore, who took American citizenship some 60 years ago, did a sterling job in editing my English, assisted by her daughter-in-law, Genanne Walsh, who is a writer. Th ank you Simone and Genanne!

My wife, Marisales Ramón-Chordá, read the entire text, and—as always—made critical comments, which, at times, I found hard to swal-low. But, as always, I accepted them with deep gratitude, as she was right.

Finally, the unwavering support of Palgrave Macmillan’s Rachel Sangster and Gemma Leigh helped me through the stages of the publish-ing process. I thank them and all other Palgrave Macmillan staff for their solid and often charming assistance.

xiii

1 Political and Economic Developments, 1914–2014 1 A Bird’s-Eye View 1 Capitalism or Socialism? Th at’s the Question 9 Affl uence 13 Th e Return of Neoclassical Economics 14 Capitalism Riding High 18 Th e Great Recession 22 Challenges 34

2 Th e Great War and the Great Depression 37 Introduction 37 Biography: John Maynard Keynes (1883–1946) 38 Th e Economic Consequences of Peace 57 Th e General Th eory of Employment, Interest, and Money 69

3 Capitalism or Socialism? Th at’s the Question 109 Introduction 109 Biography: Joseph Alois Schumpeter (1883–1950) 110 Capitalism, Socialism and Democracy 120

Contents

xiv Contents

Biography: Karl Polanyi (1886–1964) 158 Th e Great Transformation: Th e Political

and Economic Origins of Our Time 164

4 Affl uence 173 Introduction 173 Biography: John Kenneth Galbraith (1908–2006) 174 Th e Affl uent Society 181 Biography: Tibor Scitovsky (1910–2002) 201 Th e Joyless Economy: Th e Psychology of Human Satisfaction 206

5 Th e Return of Neoclassical Economics 225 Introduction 225 Biography: Friedrich August Hayek (1899–1992) 226 Th e Constitution of Liberty 237 Biography: Milton Friedman (1912–2006) 277 Capitalism and Freedom 292 Biography: Albert Otto Hirschman (1915–2012) 308 Exit, Voice and Loyalty: Response to the Decline in Firms,

Organizations and States 317

6 Capitalism Riding High 351 Introduction 351 Biography: Peter Ludwig Berger (1929–) 352 Th e Capitalist Revolution: Fifty Propositions

About Prosperity, Equality, and Liberty 354 Biography: Douglass Cecil North (1920–2015) 386 Institutions, Institutional Change and Economic Performance 395

7 Th e Great Recession 425 Introduction 425 How Markets Fail: Th e Logic of Economic Calamities 426 Conclusion 469

Contents xv

8 Inequality Revisited 471 Introduction 471 Biography: Th omas Piketty (1971–) 473 Capital in the Twenty-First Century 479

Erratum to: From Keynes to Piketty E1

Epilogue 495

References 499

Index 507

xvii

List of Figures

Fig. 1.1 GDP levels, 1928–1942 6 Fig. 1.2 Unemployment development, 1928–1938 7

xix

Table 1.1 GDP levels, 1921–1927 3 Table 1.2 Per capita growth rates of stagnating

African economies, 1980–2002 21 Table 5.1 Organisational reactions to exit and voice 347 Table 5.2 Organisational decline in relation to exit and voice 347

List of Tables