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Not even Paul Krugman is a real Keynesian

Two economists argue that John Maynard Keynes’s insights have yet to go mainstream

doug chayka for the boston globe

Economists’ ideas are far more powerful than is immediately obvious. As the economist John Maynard Keynes once wrote: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”

Keynes was surely thinking of his influential predecessor, Knut Wicksell, who had died a decade before. This remark is from his “General Theory,” published in 1936, Keynes’s famous account of capitalism and depression, in which he broke free from Wicksell’s thinking.

Wicksell argued that if interest rates rise above some “natural rate,” they weaken investment demand and growth, while if they fall below it, they spur excessive demand and inflation. But markets inherently correct imbalances, restoring optimal equilibrium.


Keynes disagreed. “The economic system . . . seems capable of remaining in a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse,” he wrote. “The evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence.”

Keynes’s insights have enormous practical importance, according to Lance Taylor and Duncan Foley of the New School. Temperamentally opposite — Foley a brilliant theorist, Taylor a pragmatist influential in developing nations — they jointly received the Leontief Prize for Advancing the Frontiers of Economic Thought at Tufts University’s Global Development and Environment Institute on Monday.

But isn’t Keynes now mainstream? No, say Foley and Taylor. The mainstream still sees economies as inherently moving to an optimal equilibrium, as Wicksell did. It still says demand causes short-run fluctuations, but only supply factors, such as the capital stock and technology, can affect long-run growth.

John Maynard Keynes. Unknown

EVEN PAUL KRUGMAN, a self-described Keynesian, Nobel laureate, and New York Times columnist, writes in the 2012 edition of his textbook: “In the long run the economy is self-correcting: shocks to aggregate demand affect aggregate output in the short run but not in the long run.” He says Keynes and Wicksell are in key respects “essentially equivalent.”


Krugman does point to one exception: If interest rates are nearly zero, as during the financial crisis, markets lose restorative force. But, Taylor asks, what’s the logic?

Keynes saw capitalism’s general state as allowing almost arbitrary unemployment: hence his “General Theory.” Full employment was a lucky exception.

To Taylor, calling full employment the general state and allowing one unlucky exception turns Keynes upside down. And look where this confusion has brought us, he adds. Take the current eurozone disaster. For two decades, the European Union bureaucracy in Brussels, the German Council of Economic Experts, and a chorus of others, branded Germany, the “sick man of Europe,” as suffering from a sclerotic supply side: rigid labor unions, impediments to layoffs, a burdensome welfare state. But German labor costs to produce output sank steadily, and Germany generated huge trade surpluses — hardly signs of a sclerotic supply side. Yet growth has barely averaged 1 percent a year since 2000.

The problem? Weak demand, according to Taylor. The chorus ignored demand because the mainstream says it cannot affect long-run growth and employment. But it does. Now the same chorus is telling southern Europe to institute “reforms” like Germany. But if the German model doesn’t work well in Germany, how can it work in Greece, Italy, or Spain? A misguided idea is undermining the European Union itself.


TWO ECONOMISTS COULD hardly have arrived at broadly similar views by more different paths. A lifelong Quaker, Duncan Foley planned to go into the Foreign Service but had to postpone training until his partner at the time could become a citizen. He’d liked economics as an undergraduate, so he entered the Yale PhD program in 1964.

Herbert Scarf’s “Mathematical Economics” lit his thinking on fire. Scarf mapped out “the whole development of high economic theory” for the next quarter century, Foley recalls in an essay. A sad reflection on economic theory, he adds. Theorists would fritter away those years working out “increasingly esoteric implications of well-established concepts.”

Scarf’s teaching awoke in him a lifelong obsession with uncovering what would later be dubbed the “microfoundations of macroeconomics”: How might interactions among individuals and firms conspire to generate the workings of an entire economy?

On the one hand, the canonical “general equilibrium” model, published a decade earlier, had come as close to capturing Adam Smith’s ideal of the “invisible hand” as anything economists have ever invented. It depicts an economy in which numerous distinct individuals, making decisions according to their personal preferences, and trucking and bartering in competitive markets, create a best of all possible economic worlds. There is neither recession nor overheating. There is no unemployment.

On the other hand, Keynes’s world sees “dark forces of time and ignorance” enveloping the future. Speculators chase after what they think other speculators think, sometimes wreaking disaster. Firms may fail to sell goods or workers to find jobs. But this world is rather metaphorical. Instead of being inhabited by individual persons, it is comprised of homogenized “capital” and “labor,” “consumption” and “investment.”


How could Foley reconcile the general equilibrium model, more realistically based on diverse individuals but depicting an unbelievable utopia, with the Keynesian model, depicting a more realistic world but based on disembodied labor and capital?

When Foley thought of quitting Yale after a year, his sympathetic adviser James Tobin, later a Nobel laureate, persuaded him to take general exams that summer and write his thesis next year. He finished his PhD in an astonishing two years. He laments that Yale failed to socialize him into “the extremely narrow and ideological constraints” of the profession, though conceding he might have been uneducable in that respect.

Foley pursued these explorations after landing “in the club” as a faculty member at MIT, then widely regarded as the top economics department anywhere. There was great team spirit, says Taylor, who also taught there: Arrayed around “Paul Samuelson as the king and Robert Solow as the prince,” MIT spread its influence far and wide.

Ironically, it was none other than Foley who brought general-equilibrium theory, often considered the crown of mainstream economics, to MIT. Money, central to Keynes, is absent from the barter general-equilibrium model. Foley hoped that by weaving money into general equilibrium he could show how economies really work.

Foley’s colleagues were intrigued by his projects — even such forays as studying anthills — but feared they were too quixotic to net many journal articles. He recalls that he would chew the fat with Joseph Stiglitz in the next office, who liked “small models” addressing contained questions. Small models netted many journal articles, and if they contradicted each other somewhat, depending on the assumed situation, the MIT ethos accepted that they should only be applied with that specific scenario in mind. Stiglitz later was awarded the Nobel Prize. Foley wanted a more unified understanding. He did publish articles in top journals but finally concluded that you cannot weave money into general equilibrium because it is already there, operating so efficiently as to be invisible. When his wife was hired to teach classics at Stanford, he moved there.


The same questions still obsess Foley. In a paper he will give in April, he argues that economies assume dark Keynesian aspects because people interact socially outside markets. If we didn’t care how others value stocks, we would each value them at what we consider companies’ fundamental value. But we do care how others value stocks. “Technical traders” care about nothing else, buying and selling according to market “sentiment.” The result, Foley’s paper shows, is to drive a moderate equilibrium to extremes, limited only by traders’ perhaps scant “common sense” and bankers’ rather flexible “patience.” Likewise, social interactions drive aggregate demand and unemployment.

doug chayka for the boston globe

LANCE TAYLOR HAD a less tempestuous career. Majoring in math at Caltech, he was fascinated by Keynes’s “General Theory.” Even in the 1960s, reading Keynes was unusual. Gregory Mankiw, who teaches macroeconomics at Harvard, has written, “One might suppose that reading Keynes is an important part of Keynesian theorizing. In fact, quite the opposite is the case.” Taylor could hardly disagree more.

In the economics PhD program at Harvard, he focused on developing nations: “It might do some good,” he says. He found his way down Massachusetts Avenue to MIT’s Center for International Studies, then financed partly by the CIA. He thinks Paul Rosenstein-Rodan, a principal founder of development economics who ran the center, may have been a CIA agent: “There was this amiable old guard who let you in, but he had a gun under his desk.” Rosenstein-Rodan helped Taylor get a job in Chile, where he learned about how developing economies worked “or didn’t work,” he cautions.

The fierce class divisions impressed him. His wife, a doctor, attended to the poor, contracted typhoid, and spent a month reading “A Hundred Years of Solitude” as she recovered. Next, off to Brasilia, bleak modernist architecture plunked into the jungle, he learned about the Texas of Latin America. Offered a job teaching at MIT, he published a stream of articles and sailed through tenure.

In 1978 Taylor wrote an article with Krugman, then an MIT graduate student. Unlike some professors who take credit for their brightest students’ work, he left Krugman’s name first. It became Krugman’s “job paper,” the one he sent to schools to get a job. Despite intellectual disagreements since then, Krugman gave a warm remembrance of Taylor when Taylor retired from full-time teaching last year.

Reminded how the pursuit of “small models” bothered Foley, Taylor shrugs, “I do it all the time.” Of course, his “small models” follow different lines from the mainstream. As for deriving models of economies from the microeconomics of interacting individuals, he responds, “I always thought standard microeconomics was silly.” In the mid-1990s, Taylor moved to the more collegial environment of the New School, where his collaboration with Foley and others deepened.

He argues that the structure of an economy cannot be derived from individuals; social institutions inherently shape it. He starts from national accounts — a tally of purchase and sales, investment and savings, among households, firms, the government, and banks that Keynes helped develop and saw as critical to understanding economies. Today, they are published by statistical agencies, principally the Bureau of Economic Analysis in the United States. On this accounting framework, Taylor imposes assumptions intended to capture the structure of key social institutions. He labels his approach, “structuralist,” a term borrowed from Latin American economists.

Two key economic facts, Taylor argues, are largely determined outside of — or even in spite of — markets. He follows Keynes in insisting that the first is demand. He treats demand as generally driving long-run growth, not just the ups and downs of business cycles. For example, all advanced nations employed industrial policies when they were developing, in part to sustain demand. Most economics texts tell how England, better at manufacturing, traded with Portugal, better at winemaking. Taylor notes that, in fact, the British navy sailed into Lisbon harbor, lowered its guns, and forced Portugal to sign the famous 1703 trade treaty to expand its market for manufactured goods. Britain required its colonies to buy its goods for the same reason. And it imposed some of the highest tariffs ever to block manufactured imports. The United States did likewise when we industrialized after the Civil War. The second fact — again determined largely by societies, not markets — is the distribution of income between profits and wages, and between high-earners and low-earners. In his “General Theory,” arguably as a concession to the mainstream, Keynes treated wages as determined by markets. But in response to friendly critics, according to Taylor, Keynes revised that idea and allowed that social bargaining determines wages. Taylor considers this approach both more consistent with Keynes’s central thinking and more realistic.

Taylor concedes that societies cannot ignore markets. According to work by Taylor and colleagues that extends Keynes’s approach, although demand drives all economies, some turn out to be “wage-led”: Consumer demand spurred by higher wages drives growth. Others turn out to be “profit-led”: Investment demand spurred by higher profits drives growth.

Modeling the US economy has convinced Taylor it is profit-led. A higher profit share boosts growth. Asked if he gets pushback from friends on the left, he hesitates. “Yes,” interjects Foley. “It’s constant.” His friends want the economy to be wage-led, Taylor agrees. “It’s their political preference. And it’s mine.” But he sees his models as tools to understand how economies work, not how he wants them to work. Not a bad lesson for all economists, Keynesian or not.

Jonathan Schlefer, a researcher at the Harvard Business School, is the author of “The Assumptions Economists Make.” Schlefer also studied with Lance Taylor as a PhD candidate at MIT.


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