Monday, May 02, 2011

Keynes - The General Theory - Chapter XVIII

It is at this point that Keynes is ready to re-state his general theory, bringing together the many different topics he has touched on throughout the book.

Section I: Keynes describes the different variables that make up his economic model. Elements such as, "the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer" are all taken as given and unchanging. The variables that are affected by these givens as well as other uncomputable factors are, "he propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest" which Keynes dubs the independent variables. This leaves employment and national income as the dependent variables, or what he is trying to affect.

One might be led to ask why some factors are assumed as given while others are not, Keynes reasons:

The division of the determinants of the economic system into the two groups of given factors and independent variables is, of course, quite arbitrary from any absolute standpoint. The division must be made entirely on the basis of experience, so as to correspond on the one hand to the factors in which the changes seem to be so slow or so little relevant as to have only a small and comparatively negligible short-term influence on our quaesitum; and on the other hand to those factors in which the changes are found in practice to exercise a dominant influence on our quaesitum.

Thus, Keynes reveals his motive for establishing his general theory: determining the aspects of the economy which can be most easily manipulated by the government to increase employment and/or national income (GDP). As Keynes himself writes, "Our final task might be to select those variables which can be deliberately controlled or managed by central authority in the kind of system in which we actually live."

Section II: Here Keynes attempts to summarize the arguments made in the preceding chapters. Essentially he deduces from changes in one factor changes in subsequent factors until employment is affected. The numerous problems with some of his logic have already been noted, so I will move on.

Section III: Here Keynes notes that our economic system is relatively stable, rarely at full employment or high unemployment, but somewhere in the middle. From this observation, he describes his conditions of stability:

(i) When output increases because employment is increasing, the multiplier between them is slightly greater than one.

According to Keynes this is due to marginal propensity to consume, when employment expands consumption increases, but by less than the increase in income. This is not true when you introduce debt into the discussion, and the neglect of debt remains a large criticism of Keynes' theory.

(ii) "moderate changes in the prospective yield of capital or in the rate of interest will not be associated with very great changes in the rate of investment."

Keynes notes that this is not the case if their is a large surplus of capital-assets, but I think we can neglect this case as an outlier. Given that capital and the factors of production are scarce resources, small changes in the interest rate will result in small changes in investment. This is not a game changer, so we will continue on.

(iii) Changes in employment and money-wages tend to be in the same direction.

Keynes correctly notes that, "as employment increases, [the struggle for higher wages is] to be intensified in each individual case both because the bargaining position of the worker is improved and because the diminished marginal utility of his wage and his improved financial margin make him readier to run risks." Keynes continues that this leads to a stable price-level.

(iv) His last condition of stability is that when investment increases (or decreases) for a prolonged period of time, it has a tendency to reverse direction.

Keynes explains that if investment is declining for some period of time, it is likely that capital -assets will wear out over time. This will force an increase in investment. Furthermore, if investment rises too high, it will be forced in the opposite direction through a recession. This is only partially true; the recession only happens if the increased investment is not accompanied by increased savings. Conversely, but less likely, an economy can increase its time preference and decrease investment. The problem is not in whether or not investment is moving in one direction for an extended period of time, but when that change in investment is not accompanied by a change in savings.

1 comment:

A Wiser Man Than I said...

Thus, Keynes reveals his motive for establishing his general theory: determining the aspects of the economy which can be most easily manipulated by the government to increase employment and/or national income (GDP).

This principle no doubt guided Keynes. But his arbitrary division marks him as an exceptionally confused economist.

In order to illustrate a relationship, we keep certain factors constant; we can then alter our independent variable to see how this influences other factors. We do this so as to grasp an insight into how the economy works. Of course, in the real world, we have a multitude of moving factors.

Keynes insists that the "classical theory" confused their models for the real world, yet this very charge could be leveled at Keynes.

You missed this: "Our present object is to discover what determines at any time the national income of a given economic system and (which is almost the same thing) the amount of its employment..."

This is patently false. The heavily industrialized United States has a greater national income than China, which is less heavily industrialized, despite the fact that is possesses more employment. There are all sorts of factors which influence national income; we cannot simply choose one that we like for convenience.