Institutional Economics | New Economic Perspectives

By Phil Klein

I know I’m a little behind, but I’m only just catching up with the debate (see here and here) over the importance of Paul Samuelson’s contribution to economics. I’ve found the discussion of the underconsumption controversy especially interesting because it took me back to a debate in the department of economics, not exactly yesterday, but germane to the discussion in AFEE in December. It also pertains to a reconsideration of the forecasting ability of Paul Samuelson.

I have always found it useful to acquire each edition of Samuelson’s book as it appears because it chronicles neatly each fad in economics, particularly economic theory, as it appears.

The underconsumption controversy and Paul Samuelson were both involved ultimately in the appraisal of Keynes’ General Theory and the work on which it was based.

In Samuelson’s first edition (1948), Keynes is mentioned exactly twice in the index (pages 253 and 303). (How long ago was 1948? For answer, my edition informs us that the book cost $3.25.) To be fair to Samuelson, he did recognize that Keynes might be different – he does call him, “a many-sided genius.” But he then refers to his non-economics interests – a large insurance company, the ballet, the drama, how to make money, etc. In the end, he tells us that the General Theory “created one of the greatest stirs in economic thinking of the century, and is likely to live longer than his other works as a classic.”

It is clear that Samuelson had reservations about Keynes from the beginning. For example, he says of Keynes’ work that “its broad fundamentals are increasingly accepted by economists of all schools of thought, including, it is important to notice, many writers that do not share Keynes’ particular policy viewpoints and who differ on technical details on analysis.”

At the University of Texas, there was considerable discussion concerning the General Theory when it came out in 1936. The Austin discussion of Keynes’ General Theory started from its publication. By the mid 40s, it had begun to focus on the relationship of Keynes’ work in contrast to the work of S. Gordon Hayes. In this early discussion of Keynes, it is interesting and important to note Ayres’ position. At this time, the “underconsumption controversy” was going hot and heavy. Keynes was discussed in connection with the book by H. Gordon Hayes, Spending, Saving, and Employment (1946):

“The principal difference between the position taken in this book and that taken by Keynes is, in part, a matter of emphasis. He stresses the importance of investing what is not consumed, and here the emphasis is on consuming what is not invested. The difference, however, is more than a matter of emphasis. Keynes holds that the real cause of unemployment is lack of investment, while I ascribe it to a lack of consumption. He sees a continuous increase in investment as the remedy for unemployment, while I regard that as impossible. I believe that the very condition that ‘makes investment necessary’ if we are to have employment – namely, lack of consumption – prevents additional investments from being profitable.” (Samuelson’s only comment is to include the underconsumption theory among what he refers to as “one of the five better known theories” of the business cycle.)

The dispute between the underconsumption theory and the overinvestment theory waxed hot and heavy in the department. Ayres sided with the underconsumptionists, and his colleague, Professor Everett Hale, led the overinvestment theorists. The dispute culminated with Ayres’ ultimately declaring, “I would gladly sell Gordon Hayes down the river if it would keep peace in the family.”

Upon reflection, I would think today the possible cause of unemployment, it could be argued, rather than being caused by underconsumption OR overinvestment, is caused by the disparity between the rate of consumption and the rate of investment.

The underconsumption controversy was by no means the last time that Samuelson’s position was murky at best and unhelpful in introducing the Americans to Keynes’ work. (That job was far better done by Dudley Dillard, whose book introduced the basic Keynesian theory in a simpler framework designed to make the introduction to Keynes easier to grasp.) As for the theory itself, Alvin Hansen applied the theory to the United States’ economy in a way that made the international relevance of the theory easier to understand.

Samuelson restricts his comments on Hansen mainly to his work on the “secular stagnation” view.

Work at the National Bureau of Economic Research did a good deal to study the implications of Keynesian theory for the study of business cycles. In this connection, the Bureau, particularly in the work of Ilse Mintz, focused the business cycle theory on growth cycles as well as level cycles. Not only did this work show that the level of economic activity fluctuated cyclically, but so did the rate of growth. The turning points in the rates of growth had the further advantage of leading the fluctuations in the level of activity.

Instead of recognizing the value of this insight for forecasting, Samuelson said that the National Bureau was in danger working itself out of a job. Therefore, it was clear in short order that Samuelson was dead wrong here. Much work has since been done showing that studies of growth rates was a valuable contribution to the efforts to make leading indicators lead cyclical activity as well as reflecting it.

In sum, Paul Samuelson’s reputation for making accurate contributions to our understanding of business cycles are at most very small indeed.