Keynes VS Schumpeter

The two greatest economists of this century, Jospeh A. Shumpeter and John Maynard Keynes, were born, only a few months apart, a hundred years ago: Schumpeter on February 8, 1883, in a provincial Austrian town; Keynes on June 5, 1883, in Cambridge, England. (And they died only four years apart - Schumpeter in Connecticut on January 8, 1950, Keynes in southern England on April 21, 1946.) The centenary of Keynes's birth is being celebrated with a host of books, articles, conferences, adn speeches. If the centenary of Schumpeter's birth were noticed at all, it would be in a small doctoral seminar. And yet it is becoming increasingly clear that it is Schumpeter who will shape the thinking and inform the questions on economic policy for the rest of this century, if not for the next thirty or fifty years.

The two men were not antagonists. Both challenged longstanding assumptions. The

opponents of Keynes were the very "Austrians" Schumpeter himself had broken away from as a student, the neoclassical economists of the Austrian School. And although Schumpeter considered all of Keynes's answers wrong, or at least misleading, he was a sympathetic critic. Indeed, it was Schumpeter who established Keynes in America. When Keynes's masterpiece, The General Theory of Employment, Interest and Money, came out in 1936, Schumpeter, by then the senior member of Harvard economics faculty, told his students to read the book and told them also that Keynes's work had totally superseded his own earlier writings on money.

Keynes, in turn, considered Schumpeter one of the few contemporary economists worthy of his respect. In his lectures he again and again referred to the works Schumpeter had published during World War I, and especially to Schumpeter's essay on Rechenpfennige (that is, money of account) s the initial stimulus for his on thoughts on money. Keynes's most successful policy initiative, the proposal that Britain and the United States finance World War II by taxes rather than by borrowing, came directly out of Schumpeter's 1918 warning of the disastrous consequences of the debt financing of World War I.

Schumpeter and Keynes are often contrasted politically, with Schumpeter being portrayed as the "conservative" and Keynes the "radical." The opposite is more nearly right.

Politically Keynes's views were quite similar to what we now call "neoconservatice." His theory had its origins in his passionate attachment to the free market and in his desire to keep politicians and governments out of it. Schumpeter, by contrast, had serious doubts about the free market. He thought that an "intelligent monopoly" - the American Bell Telephone system, for instance - had a great deal to recommend itself. It could afford to take the long view instead of being driven from transaction to transaction by short-term expediency. His closest friend for many years was the most radical and most doctrinaire of Europe's left-wing socialists, the Austrian Otto Bauer, who, though staunchly anticommunist, was even more anticapitalist. And Schumpeter, although never even close to being a socialist himself, served during 1919 as minister of finance in Austria's only socialist government between the wars. Schumpeter always maintained that Marx had been dead wrong in every one of his answers. But he still considered himself a son of Marx and held him in greater esteem than any other economist. At least, so he argued, Marx asked the right questions, and to Schumpeter questions were always more important than answers.

The differences between Schumpeter and Keynes go much deeper than economic theorems or political views. The two saw a different economic reality, were concerned with different problems, and defined economics quite differently. These differences are highly important to an understanding of today's economic world.

Keyned, for all that he broke with classical economics, operated entirely within its framework. He was an heretic rather than an infidel. Economics, for Keynes, was the equilibrium economics of Ricardo's 1810 theories, which dominated the nineteenth century. This economics deals with a closed system and a static one. Keynes's key question was the same question the nineteenth-century economists had asked: "How can one maintain an economy in balance and stasis?"

For Keynes, the main problems of economics are the relationship between the "real economy" of goods and services and the "symbol economy" of money and credit; the relationship between individuals and businesses and the "macroeconomy" of the nation state; and finally, whether production (that is, supply) or consumption (that is, demand) provides the driving force of the economy. In this sense Keynes was in a direct line with Ricardo, John Stuart Mill, the "Austrians," and Alfred Marshall. However much they differed otherwise, most of these nineteenth-century economists, and that includes Marx, had given the same answers to these questions: The "real economy" controls, and money is only the "wil of things," the microeconomy of individuals and businesses determines, and government can, at best, correct minor discrepancies and, at worst, create dislocations; and supply controls, with demand a function of it.

Keynes asked the same questions that Ricardo, Mill, Marx, the "Austrians," and Marshall had asked but, with unprecedented audacity, turned every one of the answers upside down. In the Keynesian system, the "symbol economy" of money and credit are "real," and goods and services dependent on it and its shadows. The macroeconomy – the economy of the nation-state - is everything, with individuals and firms having neither power to influence, let alone to direct, the economy nor the ability to make effective decisions counter to the forces of the macroeconomy. And economic phenomena, capital formation, productivity, and employment are functions of demand.

By now we know, as Schumpeter knew fifty years ago, that every one of these Keynesian answers is the wrong answer. At least they are valid only for special cases and within fairly narrow ranges. Take, for instance, Keynes's key theorem: that monetary events - government deficits, interest rates, credit volume, and volume of money in circulation - determine demand and with it economic conditions. This assumes, as Keynes himself stressed, that the turnover velocity of money is constant and not capable of being changed over the short term by individuals or firms. Schumpeter pointed out fifty years ago that all evidence negates this assumption. And indeed, whenever tried, Keynesian economic policies, whether in the original Keynesian or in the modified Friedman version, have been defeated by the microeconomy of business and individuals, unpredictably and without warning, changing the turnover velocity of money almost overnight.

When the Keynesian prescriptions were initially tried - in the United States in the early New Deal days - they seemed at first to work. But then, around 1935 or so, consumers and businesses suddenly sharply reduced the turnover velocity of money within a few short months, which aborted a recovery based on government deficit spending and brought about a second collapse of the stock market in 1937. The best example, however, is what happened in this country in 1981 and 1982. The Federal Reserve's purposeful attempt to control the economy by controlling the money supply was largely defeated by consumers and businesses who suddenly and most violently shifted deposits from thrifts into money-market funds and from long-term investments into liquid assets - that is, from low-velocity into high-velocity money - to the point where no one could really tell anymore what the money supply is or even what the term means. Individuals and businesses seeking to optimize their self-interest and guided by their perception of economic reality will always find a way to beat the "system" - whether, as in the Soviet bloc, through converting the entire economy into one gigantic black market or, as in the United States in 1981 and 1982, through transforming the financial system overnight despite laws, regulations, or economists.