Tuesday, January 29, 2013

From 'The Economic Consequences of Mr. Churchill'

J.M. Keynes, "The Economic Consequences of Mr. Churchill" (1925):
The truth is that we stand mid-way between two theories of economic society.  The one theory maintains that wages should be fixed by reference to what is "fair" and "reasonable" as between classes.  The other theory - the theory of the economic Juggernaut - is that wages should be settled by economic pressure, otherwise called "hard facts," and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the chance consequences of the journey to individual groups.

The gold standard, with its dependence on pure chance, its faith in "automatic adjustments," and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine.  I think that they are immensely rash in their regardlessness, in their vague optimism and comfortable belief that nothing really serious ever happens.  Nine times out of ten, nothing really serious does happen - merely a little distress to individuals or to groups.  But we run a risk of the tenth time (and are stupid into the bargain) if we continue to apply the principles of an Economics which was worked out on the hypotheses of laissez-faire and free competition to a society which is rapidly abandoning these hypotheses.
Basic economic theory typically ignores the role of social norms in labor markets.  To some degree, that's ok - we can't have everything in every model, and the basic models (i.e., intermediate micro) give some useful insights.  The danger comes when economists - and the consumers of economics - forget that the models are (over) simplifications.

The context for Keynes's essay was Britain's return to the gold standard at an overvalued level - Winston Churchill was the Chancellor of the Exchequer at the time - but much of it holds up well 88 years later as an essay on the danger of "internal devaluation" such as we're seeing now in Spain.