The Mixed Economy Manifesto – Part 3

By Michael Hoexter, Ph.D.

Mr. Smith’s Unattainable Ideal

Another cause for this polarized view (of capitalism) has been the separation of the study of the functions of the state from the study of the economy, with the eclipse of the older discipline “political economy” of the 18^th and 19^th Centuries by a supposedly value-free “economics”.  Economists, thinking they were isolating the essence of a politics-independent economy, gravitated throughout the 20^th Century towards greater mathematization and abstraction.  Markets, a copious supplier of often indecipherable numbers, became the raw material for formal models that had little to do with the actual economy.  Non-mathematical methods to study politics and social institutions and economically-relevant cultural practices became uninteresting to economists.  As a general tendency, economists also became more and more ignorant of the real world around them and almost completely unconscious of the effects of their theorizing on that world, making them ideal candidates to become “useful idiots” for powerful economic interests.

Readings, but more often glosses, of Adam Smith, by prominent, largely conservative, economists are also in part responsible for the urgent need now to discover the outlines of our already-existing mixed economy, a combination and interaction of a state and public sector and a private sector.  Most economists and students of economics seem to forget that Adam Smith wrote Wealth of Nations as a polemic, a document to persuade government officials and the public that they should abandon mercantilism as a guiding economic policy and instead allow trade and domestic markets to manage themselves.  As a polemic, Wealth of Nations employs more colorful and elegiac language, (i.e. “the invisible hand”) in pushing for lesser government involvement and “freer” trade and this is what most casual readers of Smith take away from reading his work.  More careful or progressive readers of Smith point out his support of government provided public goods, including ports, roads and education but these are not illustrated with colorful metaphors.  Furthermore, Smith’s earlier work, Theory of the Moral Sentiments, is cited by these more progressive readers as an indication that Smith believed that people were motivated by morality in addition to self-interest, i.e. unlike the “invisible hand”.  Unfortunately the division of labor between these two works has helped reinforce a framework whereby economists and those influenced by various schools of economics and economic philosophy have tended to shuttle back and forth between defending and castigating self-interest.  Misread or carefully read, the impulse towards allowing long-dead social philosophers/scientists to determine the boundaries of present day social theory is itself a problematic enterprise.

Students of economics or business who would like to hold little else in their minds except a few passages of Wealth of Nations, will have to look long and hard in economic history to find anything resembling the autonomous market of the “invisible hand”.  Most of what is recognizable as a modern economy has benefited from collaboration between government actors and private actors that violate the more polemical aspects of Smith’s magnum opus.  The early American government helped build an industrial base via the “American System” of protective tariffs against European competition.  The early development of infrastructure was often financed by government, such as the Erie Canal built by the State of New York.    The economic “miracles” of almost all current industrial powers, including the rapidly developing nations of East Asian and Latin America, have been engineered by for the most part adequately-designed industrial policies that violate the shibboleths of free trade ideology.  Almost all developed nations have substantial infrastructure that was built with public funds, without which the rapid growth of private enterprises would be unthinkable.  The belief in “free markets” from a selective reading of Smith acts in reality as a virtuous-seeming straitjacket used to limit rational thought and observation about how economies actually work.

In practice, the economic policy of governments has for the most part recognized the limitations of the airy abstraction of an autonomous, self-organizing, self-righting market.  From early on, government actors sympathetic to the development of capitalism have recognized that market actors do not automatically provide for and often endanger public welfare.  Efforts from the side of government to ameliorate some of the worst conditions created by capitalism without overturning capitalism itself can be traced to the 1870’s when German Chancellor Otto von Bismarck created the first welfare state in response to increased German immigration to America as well as a growing socialist and workers’ movement in Germany. Bismarck also instituted protective tariffs, which had long been an instrument of governments to protect domestic industries.  The terms from the Bismarck era Sozialstaat (social state) and Sozialpolitik (social policy) were forerunners of the notion of the “welfare state” in English.  Later on, reform and “good government” movements in the United States in the early 20^th Century were reactions to the growth of capitalist oligopolies and monopolies as well as populist, and workers’ movements in the United States.   Using the lens of Smith’s classical or, the now current neoclassical economics, a study of economic history would appear to be simply the story of series of lapses from an unrealistic economic ideal.  Instead, the only way to write a meaningful narrative of economic history and to chart its near future development is to use the concept of a mixed economy as an overarching framework.

Keynes and the Great Depression

As capitalism showed renewed signs of fragility and instability in the early mid-20^th Century, the outlines of how governments and non-government economic actors interact was made for a time the focus of public policy and economic thought.  The social and political ferment that followed the financial crisis of the 1920’s and the worldwide Great Depression of the 1930’s, provided an impetus for inserting government, heretofore largely untheorized in Anglo-American economics, as an important force in the economy.  The work of John Maynard Keynes provided a bridge into neoclassical economics of the idea that government was a part of a functioning economy.  Keynesians whether self-identified or, like Franklin Delano Roosevelt, Keynesians in deed, believed among other things that Communism could be thwarted by diminishing the crisis-prone nature of capitalism and its tendency towards inequality.  Out of the Great Depression and the experience of a world torn apart by armed conflict came the notion that both economies and political conflicts should be managed by national governments and by an association of national governments via the UN.

Despite its reputation on the Right as the entering wedge for state control of the economy, Keynes’ work and Keynesianism deliver a somewhat diffuse picture of the work and role of the state in the economy.  While some advocate a reading of Keynes’ work as sufficient, a “return to Keynes”, Keynes represents a moving target throughout his professional life, sometimes adopting and later rejecting neoclassical economic principles.  Keynes’s early death and changes in his views throughout his career, as well as a preference for elegant but elliptical self-expression did not produce a systematized view of what a real mixed economy, with a government and a private sector might look like.

Uncertainties about the direction of Keynes’ work after his passing also led to a fragmentation among Keynes’s students with the formation of neo-Keynesian, New Keynesian, and Post-Keynesian schools among others.  Students of Keynes and other economists who have grappled seriously with mixed economy dynamics have objected to the interpretations of Keynes that became popularized after WWII, finding the work of John Hicks and Paul Samuelson, the most prominent proponents of what was supposedly Keynes’ work, to have tailored Keynes to the prejudices of neoclassical economists rather than grappled with the real dynamics of the capitalist mixed economy.  Keynesianism became viewed as primarily a policy instrument as well as a political tendency within economics but fundamental tenets inspired by Keynes were not worked out into a consensus view of how either government or markets actually function in the economy.

Despite these drawbacks, Keynes and Keynesianism highlighted the value of the functions of government especially in a great economic crisis like the Great Depression.  Keynes was the founder of the discipline of macroeconomics, the economics of statecraft and of management of a globally linked economy by national governments singly and in concert.  Keynes’s opposition to hard-money ideology, i.e. the “Treasury View” that to him favored the rentier class led to his advocacy of governments spending on deficit to encourage growth in economies caught in what might be characterized as a “debt deflation” (not Keynes’ term for it), where investors and banks hoard money rather than invest it.  Instead of seeing government’s economic role as protecting passive investors (i.e. rentiers), Keynes defined the purpose of economics and government economic policy as promoting overall social welfare and in particular committed to generating and maintaining full employment. Keynes’s re-discovery of the “paradox of thrift” and its placement within the center of economic doctrine called attention to the limitations of economic doctrines that held out saving as the sole economic virtue. Assumed but not stated in bold terms in Keynes’ work was the value of the instrument of government, a bit of Oxbridge subtlety which turned out to be a major error in the tactical war with Keynesianism’s economic opponents.

Formalizing and systematizing the insights of Keynesianism was postponed, paradoxically, by Keynesianism’s early success in influencing government policy during the Great Depression, WWII, and the post-War era.  So dire was the situation of economies during the Great Depression and so unrealistic were the ideologically-charged policy prescriptions of its opponents, that victories for this approach were won by the success of activist policies by governments in Europe and North America.  This government activism also was spurred on by the building and management of war machines on both sides of the Allied-Axis conflict during the late 1930’s and 40’s, a conscious and unconscious “War Keynesianism”.

The pragmatic approach of Keynesians and actual policy success may have led over time to theoretical eclecticism, which stealthily re-installed existing dogmas from earlier economics, including laissez-faire notions about the functioning of markets.  These openings in the vaguely Keynesian consensus facilitated its fall from grace, when real-world success in steering government policy eluded Keynesian economists during the stagflation of the 1970’s.  If “government” as defined by the self-described Keynesians of the period couldn’t deliver results, it seemed reasonable to some that maybe one could dispose of “government” as defined in the political-economic discourse, and campaign against its role and even its existence inside economic theory.  To some pragmatism is the hallmark of solidity in any approach to the world but in this case, a commitment to pragmatism left little room for ongoing refinement of an accurate portrayal of the world that may or may not respond directly to actions informed by a still-evolving theory.  Rushed into practice, Keynesianism did not convince its most hard-bitten critics that they were as wrong as they actually were.