A Critique of Keynes

It is my purpose this afternoon to urge upon you the virtues of socialism. I shall argue
that at the present time, the proper way to manage our economic life is through social
planning founded upon collective management of the means of production. I shall not
advance this proposition in the customary way, however, by telling you affecting tales of
human suffering or by thundering at the injustices of the capitalist system. Human suffering
we have aplenty in our society, and there is more than enough injustice to support a multitude
of tirades. But I have charted a quieter course for myself this afternoon. I shall review with
you something of the history and development of economic theory during the past two
centuries; in order to show you why even the most sophisticated elaborations of modern neoclassical econometric model-building no longer serve to keep us from disastrous economic
trouble. My argument will be quite simple and rather abstract, as benefits a philosopher, and
there will be very little in it to puzzle or put off those among you who have not yet
undertaken the study of economics. The heroes of my story are an Anglo-Jewish stock broker,
an migr from Soviet Russia, the son of an Italian jurist, and a left-Hegelian romantic
philosopher -- which is to say, David Ricardo, Wassily Leontief, Piero Sraffa, and Karl Marx.
I begin by voicing what is, I hope, our shared agreement that the American economy is
in a godawful mess. We will also agree, I hope, that the establishment of professional
economists is no longer able to speak with solid, collective scientific confidence about the
causes of our present disaster and the alternative possible cures. The present disarray of the
economics profession is manifest in the self-doubts expressed in technical journals and
presidential addresses to associations of economists, in the absence of consensus among those
middle-of-the-road economists who are routinely looked to by both major parties for
guidance and counsel, and in the bizarre emergence into respectability and even hegemony of
such pseudo-science -- Voodoo economics, our vice-president once called it -- as supply-side
theory.
The profession of economics or political economy, as it was once called has gone
through a succession of stages of confidence and self-doubt during the past two centuries.
The triumphant reception of the elegant and powerful theories of David Ricardo in the first
quarter of the nineteenth century gave way to increasing doubt and confusion as the century
wore on, both because of the internal theoretical inadequacies of Ricardos principles and
because of a succession of increasingly violent business cycles of boom and bust which
threatened both social peace and the continued growth of capitalist enterprise. The new
marginalist theories of the last third of the nineteenth century laid the theoretical foundations
for a moral justification of capitalism, as set forth most famously in the work of J.B.Clark,
and also for the scientific conclusion that in a properly functioning free market, there could
be no sizeable long-term involuntary unemployment. The great depression after the first
world war strained belief in this bit of economic science to the breaking point, for as the
depression grew deeper and unemployment in the United States, for example, exceeded a
quarter of the work force, it became more and more difficult to maintain that this violent
deviation from rational, efficient full-employment was simply a short term frictional
imperfection or a perverse consequence of sub-optional collective bargaining.
With the macro-economic theories of John Maynard Keynes, the economics profession
entered a new era. If Keynes was right, then it ought to be possible to salvage capitalism by
managing the swings from boom to bust with counter-cyclical actions by the central

government. The state, it seemed, was not to be confined under capitalism to the role of
night-watchman. Instead, it had a much more important task to perform, as the regulator of
effective demand in the service of full employment growth.
The great test of Keynesian theory came with the end of the second world war. In the
United States and Western Europe, the experiment was made of capitalism with the state as a
macro-economic governor. For a quarter of a century, the theory seemed to work with
brilliant success. Unemployment was low, growth was steady and rapid, inflation was kept to
an acceptable level and the inevitable business contractions were softened so as to be nothing
more than pauses on the way to ever greater growth. It was during this period the golden
age of the profession of economics that Nobel prizes began to be distributed to these
physicians of the body politic. Clearly, ideology and politics had given way to science.
Alas, the reputation of economics, like the housing and automobile markets, has soared
to ever greater heights, only to plunge to new depths. As unemployment creeps toward ten
percent and the United States, once proud leader in per capita gross national product, dips to
tenth place behind even Italy, once the weakest partner in the Atlantic Alliance, it is perhaps
time to stand back and reflect a bit on what has gone wrong.
My message today is scarcely original, but it is, I believe, true. I shall argue that it is
fundamentally irrational to permit the direction and shape of our economic life to emerge as
the unplanned consequence of a myriad of private decisions. For reasons which are simple
but theoretically quite fundamental, an industrial economy in which there is both population
growth and technological innovation cannot be relied upon to grow in a crisis-free manner.
What is more, efforts to shape or direct an essentially private economy by fiscal or monetary
policies of the central government are doomed to fail. The only rational solution, I shall
suggest at the end of my talk, is a thoroughly socialised economy in which the course of
capital accumulation and allocation, as well as the pattern of distribution of the social
product, is made the object of collective social choice.
Let me begin my story almost two centuries ago, with the classical vision of a capitalist
economy as a free market system in which the pattern of prices, of capital accumulation, of
distribution, and of growth emerges as the unintended consequence of the interactions of
rationally self-interested workers, consumers, and entrepreneurs. This vision, first
adumbrated by Adam Smith and brought to rigorous fulfillment in David Ricardos
PRINCIPLES OF POLITICAL ECONOMY AND TAXATION, rested upon a number of
simplifying assumptions, each of which in a different way made it possible for Ricardo and
his followers to draw powerful theoretical conclusions from the premises of perfect
competition, rational self-interested, and a free market.
The assumptions fall into three categories: behavioral assumptions about the criteria or
guidelines followed by the several classes of agents in their economic decisions; knowledge
assumptions about the kind, degree, and accuracy of the information available to economic
agents; and a rather special assumption about the nature of money.
The behavioral assumptions are these: capitalists were assumed to be motivated entirely
by a rationally self-interested pursuit of profit, which they measured in monetary terms.
Confronted by a choice among several alternatives, capitalists could by and large be counted
on to choose the most profitable. Furthermore, capitalists were conceived as perfect
accumulators, so to speak. Accumulate! Accumulate! That is Moses and the Prophets! said

Marx of the capitalist class. In effect, what this meant was that the total private consumption
of the capitalist class was so small, in comparison with the aggregate output of the economy
as a whole, that it could, for purposes of economic calculation, be treated as effectively zero.
In part, of course, this assumption was justified by the relative smallness of the capitalist
class as a group. Even a high standard of living per capitalist does not add up to much in the
way of aggregate consumption. But more important was the behavioral assumption that
capitalists, for whatever reasons, were driven by a desire to accumulate capital as rapidly as
possible. To this end, they reinvested almost their entire profits in an expanded scale of
operations. The classicals and Marx viewed this process of reinvestment as the primary
engine of economic growth.
The landlords who loom larger in the writings of Smith and Ricardo than in those of
Marx are by contrast conceived as grasshoppers, as perfect consumers. They save nothing,
and support a large population of unproductive servants. As a consequence, of course, the
portion of profits diverted to them as rentals drops out of the economy and plays no role in
the process of growth.
Finally, the workers are presumed to live at or near the subsistence level, with the
consequences that as a class they do not save. In the short run, to be sure, individual workers
may succeed in saving enough to rise into the class of small entrepreneurs, and during the
transitional periods of labour shortage wages may rise significantly above subsistence for
large numbers of workers; but both Ricardo and Marx thought that over the long run, external
pressures of population or unemployment would hold wages at a level at which worker
saving could not regularly take place.
The effect of these behavioral assumptions, you will immediately realize, is to make
certain theoretical calculations extremely simple. The quantity of capital directed toward
investment will be exactly equal to aggregate profits. Effective final demand for consumer
goods will simply equal rents plus wages. And so forth. To an extent that is not always
recognized, particularly by those outside the profession of economics, the distinctive a priori
character of the reasoning of classical economic theory derives directly from these behavioral
assumptions.
In addition to the behavioral assumption, classical theory makes a number of powerful
simplifying knowledge assumptions. Consumers and sellers are presumed to have effectively
a perfect knowledge of the market what is being sold, where, and at what price.
Entrepreneurs have perfect knowledge of the available production techniques, of the prices in
factor markets, of the risks and constraints of different modes of production. Entrepreneurs
know also how other entrepreneurs are doing, so that superprofits anywhere in the economy
will fairly quickly draw interested investors to the favored sector. The result of these
assumptions is to consign to the margins of the theory any consideration of market
imperfections.
The familiar model of a self-correcting economy in dynamic equilibrium, efficiently
allocating available resources in response to consumer demand, rests upon these twin pillars
of simplifying behavioral assumptions and the assumption of perfect knowledge. The
theorems of the classical model, and also those of the neo-classical model as well, can be
proved only because the knowledge and behavior of economic actors is conceived in this
manner.

One final theoretical assumption underpins the classical theories, an assumption

concerning the nature of money. It is an odd fact odd, I might say, to the point of absurdity
that there is no place for real money as we know it either in the economic theories of the
classicals or in the marginalist theories of modern economics. Ricardo conceived of money as
simply one commodity among others gold, of course, in the world he was looking at
whose value was determined, as was the value of every commodity, by the conditions of its
production. An ounce of gold exchanged for so much linen, coal, or corn, he thought, because
the conditions under which it was mined and refined bore a certain relation to the conditions
under which linen was woven, coal dug, and corn grown. Just as a change in the techniques
for growing corn would affect its value relative to other commodities, although in ways more
complex than Ricardo had originally thought, so too a change in the techniques for mining
and refining gold would alter the rate at which gold exchanged with other goods.
The assumption of commodity-money, as it was called, an assumption which Marx
shared, makes even modern capitalist economic transactions essentially sophisticated acts of
barter. The grounding of the economic system in a physical base of commodity production is
thereby rendered transparent, with the consequence that such phenomena is inflation, credit
squeezes, the so-called money-illusion, and so forth can play no theoretical role in the
analysis of the economy.
The classicals concluded from their simplified model that in the absence of distorting
interventions from the central government, a capitalist economy would function efficiently in
long-run equilibrium. Marx sought to demonstrate that capitalism, even in this extremely
simple conception of it, is internally unstable and prone to operational breakdowns. But Marx
shared with the classicals all of the behavioral and knowledge assumptions I have just
sketched.
One of the first major departures from this simple model appears in John Stuart Mills
PRINCIPLES OF POLITICAL ECONOMY, a book which, in many editions, was the leading
economics textbook of the nineteenth century. In a little chapter entitled Of Competition and
Custom, Mill introduces a new element into political economy which, I shall argue, destroys
classical theory and eventually leads to an entirely different understanding of capitalism. It is
completely typical of Mill that at one and the same time he understands the theoretical
significance of what he is doing, and yet treats it as a mere adjustment to a theory which he is
otherwise prepared to continue supporting. This paragraph, from the opening page of Mill's
little chapter "Of Competition and Custom," is worth quoting:
"So far as rents, profits, wages, prices, are determined by competition, laws may be
assigned for them. Assume competition to be their exclusive regulator, and principles of
broad generality and scientific precision may be laid down, according to which they will be
regulated. The political economist justly deems this his proper business: and as an abstract
or hypothetical science, political economy cannot be required to do, and indeed cannot do,
anything more. But it would be a great misconception of the actual course of human affairs,
to suppose that competition exercises in fact this unlimited sway. I am not speaking of
monopolies, either natural or artificial, or of any interferences of authority with the liberty of
production or exchange. Such disturbing causes have always been allowed for by political
economists. I speak of cases in which there is nothing to restrain competition; no hindrance
to it either in the nature of the case or in artificial obstacles; yet in which the result is not
determined by competition, but by custom or usage; competition either not taking place at

all, or producing its effect in quite a different manner from that which is ordinarily assumed
to be natural to it."
In his development of this idea, Mill emphasizes the customary character of groundrent,
and also to a lesser degree of market prices for consumer goods. Now, I wish to suggest that
once custom has been acknowledged as a determinant of any of the central economic
variables, the entire edifice of classical economic theory must surely crumble. Before turning
to the way in which Mills little point about custom has been expanded into a full-scale
theoretical transformation of the classical theory, let me explore for a bit the significance of
the elementary example Mill offers.
Originally, as we have just seen, economists presumed that all indices, including rents,
were determined by the interplay of objective factors (facility of production, fertility of land,
and so forth) as these are taken up into the rational calculations of profit-maximizing agents.
The calculability of economic magnitudes -- the possibility, that is, of deducing the
magnitude of changes in prices, rents, wages, or profits that would result from a change in a
technique of production, say, -- depends completely on this assumption of rational selfinterest. In order to determine the effect of an improvement in the technique for producing
corn, for example, we must assume that corn producers will adopt the new technique
unhesitatingly once they calculate that it is more profitable; that consumers will bid down the
price of corn as soon as there is excess supply in the market; that producers in less profitable
lines will shift their capital as soon as possible to the corn sector, where higher profits are
being made; and that landlords will readily rent out their land for as much as or as little as
they can get.
With these assumptions, some very nice theoretical deductions can be made. For
example, with the aid of modern mathematical techniques, it can be shown that any
technological innovation that it is profitable for the individual firm to introduce at current
prices will, once the total system of prices has adjusted itself to the innovation, have the
effect of raising the system-wide rate of profit. Or, to take a very much more elegant and
powerful result due to the great mathematician John von Neumann, any economy engaged
solely in the production of capital goods and wage goods has available to it a balanced
growth path along which the growth rate of the economy exactly equals the profit rate. And
so on and on.
Once we introduce Mills factor of custom, however, all such deductions become in
principle impossible. If the rental for land depends in part upon custom and habit, what will
be the effect on rents of an improvement in the techniques for producing corn? If custom is
not a factor, the answer is simple: rents will rise. With a little modern algebra, one can even
calculate exactly how much they will rise. But if custom is a factor, there is really no telling.
The most we can possibly say is that if custom holds sway, rents may change not at all. If
competition is the sole determinant, the full effect will be felt. Somewhere between the two
lies the answer.
Now, growth depends on the disposition of the annual surplus, and according to the
behavioral assumptions of the classical model, capitalists invest and landlords consume. So
clearly the secondary effect of custom will be to alter the growth rate of the economy. The
more custom operates to hold rents at the traditional levels in the face of technical advances
in corn production, the more will the additional output resulting from those advances turn up
as profit in the pockets of the capitalists, there to serve as additional capital for growth. The

less custom operates, the more additional output will end up as increased rents, to be
consumed unproductively by the profligate landlords.
How can we adjust our theory to take account of custom? The obvious maneuver, and
the one which is essentially at the heart of modern econometrics, is to introduce into our
equations a dummy variable standing for the influence of custom on rents. We can, for
example, stipulate that when techniques of corn production change, the rents will change by a
factor of k times the amount that would change if competition along were operative.
The value of k, obviously, cannot be calculated by the sort of a priori reasoning on
which classical theory rests. In order to put a value to k, it would be necessary for us to
collect large amounts of data from actual land-rentals over long periods of time. We would
then have to make a number of simplifying assumptions, such as that all renters are affected
by custom to the same degree, that the effect of custom is reasonably constant over time, and
so on.
Now, it is very important to understand that this something called custom which is
thereby introduced into our model has an ontological status if you will permit me some heavy
philosophical artillery, fundamentally different from that of the rational self-interest
underlying competition. Custom is not that name of a principle of rational choice, nor is it
even the name of a stable, identifiable non-rational psychological element. Custom is
simply a catch-all title for the sum-total of all the deviations from rational self-interest that
might cause ground-rents to be something other than what the pure theory of competition
dictates. Some landlords may fail to adjust rents because of laziness, others because of
stubbornness, others for religious or family reasons, and others still because of bonds of
baronial loyalty to the peasantry. Obviously, a wide variety of historical, social, economic,
and cultural forces may manifest themselves under the heading of custom, with economic
consequences of quite varied sorts.
With the marginalist revolution of the 1870s, based on the substitution of subjective
utility for objective technology as the fundamental determinant of price, all hope is given up
of a theoretically a priori determination of economic magnitudes. Individual consumers are
assumed to have consistent preferences among alternative bundles of commodities, but these
preferences -- summarized under the heading utility functions -- are asvaried, as
idiosyncratic, and as unfathomable as any subjective psychological phenomena can be.
Economists have sought to overcome the anarchy of subjective preference by a number of
heroic assumptions about the general mathematical shape of individual indices of satisfaction
-- assumptions that bear no particular relation to reality. The result is an elegant structure of
microeconomic theory -- what is now called the theory of consumer behavior -- whose
principal virtue is its ability to support the ideological claim that capitalism is both efficient
and fair. What has been lost, however, is the ability to relate the objective facts of technology
and production in some direct way to the structure of prices, wages, profits, and rents through
which the social product is distributed among the major classes of the society. It is in fact
quite striking that the original theoretical model of equilibrium put forward by Leon Walras is
actually a model of pure barter or exchange, in which production does not figure at all. Only
after he has established his major theoretical propositions for the case of an exchange
economy in which the goods being exchanged are simply posited, or given, at the outset, can
Walras move on to extend his theory to the case of production.

The central theoretical claim of marginalism, of course, was that a capitalist economy,
unfettered by state restrictions or legal distortions, would achieve and maintain an
equilibrium position in which all markets, including the market for labour, would clear and in
which no further improvement in subjective satisfaction could be achieved by mutually
acceptable exchanges. To say that the labour market clears is to say that there is no long-term
involuntary unemployment. Those who are out of work are either between jobs, as it were, or
else prefer leisure to employment on the terms being offered.
The equilibrium thesis of marginalism was mortally wounded by the experience of the
great depression. The presence of millions of unemployment workers, unable to find work
year after year, constituted as much refutation as any scientist could want of the theses of the
established economic theories. It was clear that the microeconomic foundations of economic
theory were incapable of yielding plausible macroeconomic conclusions. There were two
options open to the economist: the first was the reject the microeconomic foundations, and
begin a search for a theoretical perspective capable of yielding conclusions more in keeping
with reality. The second was to formulate a theory of the economy as a whole, and leave to
one side, at least for the time, the relation of the large scale theory to the theory of individual
economic units. As you all know, John Maynard Keynes GENERAL THEORY took the
second tack.
I do not propose today to review Keynes theory. Rather, I wish to call attention to
certain of its foundations which tend to be lost sight of in the complications and elaborations
of macroeconomic model-building. Essentially what Keynes does is to extend and generalize
Mills notion of custom by introducing into his analysis of the behavior of capitalists and
workers the idea of subjective preference and subjective estimates of probability.
The most dramatic break with previous economic theory was the substitution of
subjective expectation for objective probabilities or perfect knowledge. It is, on reflection,
obvious that what actually determines a capitalists decisions is his subjective estimate of
future prices, future sales, future costs, not the actual prices, sales, and costs that ensue.
Keynes, who was methodologically quite sophisticated about matters of rational choice and
probability, therefore constructs his entire model of investment and employment on the basis
of such subjective estimates of probability, or, as he calls them, expectations.
At the same time, Keynes loosens up the classical behavioral assumptions by
recognizing that capitalists are not perfect accumulators and workers are not perfect
consumers. Instead, each individual is thought of as having a certain innate psychological
inclination or propensity to consume some proportion of his or her available income. When it
comes to disposing of the remainder of the income, the individual is conceived as having a
second propensity or subjective preference, namely a preference for holding a certain
proportion of the non-consumed income in the form of money, the remainder to be invested.
This positing of psychological propensities and preferences is in keeping with a long
tradition of British empiricist thinking, which goes all the way back to the writings of David
Hume, Lord Shaftesbury, and Frances Hutcheson. Like his distinguished predecessors,
Keynes is essentially an armchair psychologist, offering quasi a priori reasoning rather than
experimental evidence in support of his claims about human motivation.
Here, for example, is Keynes introducing one of the building-blocks of his theory:

The fundamental psychological law, upon which we are entitled to

depend with great confidence both a priori from our knowledge of
human nature and from the detailed facts of experience, is that men
are disposed, as a rule and on average, to increase their consumption
as their income increases, but not by as much as the increase in their
income. (Keynes, p.96)
Keynes then offers a mathematical expression of this so-called law which makes it
look quite impressive and objective, but obviously we have here nothing more than an ad hoc
stipulation.
The central concept of Keynes analytical model is what he calls the marginal
efficiency of capital. He defines this, in a manner familiar to those who have studied some
economics as follows:
the relation between the prospective yield of one more unit (of a
certain type of capital) and the cost of producing that unit.
The key word in this definition, though it may not seem so, is prospective. The cost
of producing one more unit of machinery, is objectively determined by the current state of
technology in the machinery-producing industry taken together with the current costs for
steel, coal, labour, and so forth. In short, the cost of producing one more unit of machinery, or
of any other sort of capital, is the sort of objective fact that classical economics dealt in. But
the prospective yield of that additional unit is quite another matter. Prospective yield
simply means yield expected by the capitalist making the investment. If his hopes are high,
his animal spirits frisky, then he will evaluate the prospects for future yield quite favorably,
and as a consequence the marginal efficiency of the capital will be high. If, with exactly the
same technology available and the same current prices ruling in the market, he takes a
gloomy view of the future, anticipating a downturn, dreading the turn of international affairs,
fearing a resurgence of the Labour Party and a decline of the Tories, then the marginal
efficiency of capital will decline.
These remarks are in no sense an expos of the hidden and unacknowledged
implications of Keynes theories. Quite to the contrary, he is insistant to the point of repetition
on the subjective sources of economic indices. It is evident, he says at one point in his
discussion of the incentives to liquidity, that the rate of interest is a highly psychological
phenomenon. (p. 202). And when he comes to restate his general theory, he lists among his
ultimate variables the three fundamental psychological factors, namely, the psychological
propensity to consume, the psychological attitude to liquidity and the psychological
expectation of future yield from capital-assets, which is to say, the propensity to consume,
liquidity preference, and the marginal efficiency of capital.
All of the modern efforts to manipulate, manage, shape, control, and direct an
essentially private capitalist economy rest on this Keynesian theory, with its subjective
psychological foundations. In the tradition of British philosophy and political economy from
which he derives, Keynes takes subjective propensities as given data impenetrable,
inexplicable, beyond argument or appeal. They are, to use the term of which economists are
fond, exogenous variables, which is to say they come from outside the system. They are
given in exactly the same way that the laws of nature and the resources of the earth are given.

It is worth pausing for a moment to reflect on how far economics has moved from its
classical assumptions by the time we come to Keynes. Originally, all agents are assumed to
maximize gain in an environment of perfect certainty and complete knowledge. Prices,
wages, profits, rents, and the rate of economic growth are, under these conditions, functions
of two factors: the objective technology of production, which determines what combinations
of inputs are required for specified outputs; and the relative strength of the several classes of
the society, which determines how the annual net social product will be divided up among the
workers, the capitalists, and the landlords.
As the world becomes, and is recognized to have become, more complex, the
simplifying knowledge assumptions of the classical model must give way to the
acknowledgement of risk, uncertainty, and finally subjective expectation. At the same time, as
it becomes clear that workers do not live permanently at the level of subsistence, that
landlords are not mere idle consumers, and that capitalists, for a variety of reasons, are not
perfect accumulators, the elegant theorems derived from the simple behavioral assumptions
of classical political economy must be given up.
Faced with the intrusion of subjective non-rational elements into the process of
economic choice and decision, post-Keynesian economists are forced to alter fundamentally
the way in which they seek to understand a capitalist economy. Instead of a priori analysis
built on elementary assumptions of profit-maximization, they offer econometric models in
which dummy variables and functions stand for the several elements of the decision-making
process. A variable for liquidity preference; a variable for the propensity to consume; a
function separating a workers leisure/labour trade off, which is to say the proportion of total
available labour-time that the worker prefers to devote to leisure, expressed as a function of
income. And so on and on. Any of you who have taken even an elementary course in
macroeconomics will be aware of the extent to which the subject, as now taught, rests on this
sort of model-building.
The result is that economics has become an extremely elegant, complex,
mathematically sophisticated way of guessing at the shadows on the wall of the cave. In
Platos REPUBLIC, you will recall, Socrates relates an allegory of the human condition. We
are to imagine, he says, that a group of men are chained to the floor of a dark cave, so that
they can only look to their front at a blank wall. Behind them, fires are lit, and unseen
attendants walk before the fires, carrying small scale models of physical objects and people.
The light casts shadows of these objects on the wall, where they flicker in fantastic distortion.
At first, the captives are simply mystified by the succession of shadows, but after a while,
some of them, those best adapted to a troglodytic existence, begin to discern repetitions and
patters in the images. They formulate theories about what shadows will appear next, and the
most skillful among them acquire considerable reputations for their ability to anticipate by a
few moments the next images. Some, we may even imagine, extending the story a bit beyond
Plato, become tenured professors of shadow-guessing, and a few whose theories of the
shadow world have risen to heights of mathematical elegance even win Nobel prizes for
shadow-guessing.
One of the captives, Socrates tells us, driven by some obscure instinct that the world
holds more than shadows, works himself free of his bonds and crawls painfully to the mouth
of the cave. Dazzled by the bright sunlight, he slowly acclimates himself to the brilliant light,
and sees for the first time the real physical objects whose twisted and distorted shadows he
has all these years observed. At last he realizes that these are the reality of which the shadows

are more imperfect reflections or appearances. Rushing back into the cave to bring this
momentous news to his fellows, he is temporarily blinded by the darkness, and staggers about
as though mad. Naturally, the remaining captives simply laugh at his insistence that their
shadows are inferior appearances, behind which lies a truer reality. Puffed up by their skill at
shadow-guessing, they consider merely comic the claims by their former comrade that they
are enmired in unreality.
Marx had a name for the masters of shadow-guessing. He called them Vulgar
economists and contrasted them with the classical economists -- Petty, Quesney, Smith,
Ricardo -- whom he considered serious students of economic reality. Paul Samuelson, the
greatest of the shadow-guessers, has returned the compliment by characterizing Marx, in a
famous essay, as a minor post-Ricardian, and, worst of all, an auto-didact. (To be selftaught, I suppose, is from Samuelsons standpoint even worse than to be a minor follower of
the wrong economist, for if it should turn out that one can teach oneself to understand
economics, that will put an end to the hegemony of the profession.)
The dummy variables and functions of econometric model-building refer to nothing at
all that can be directly studied. There is no way that we can get at an individuals propensity
to consume, for the purpose of constructing a more adequate theory of consumer behavior.
Nor can anything useful be said about the inner determination of the capitalists expectations
for future gain, so as to lay the foundations for a scientific theory of investment and growth.
Instead, economists are forced to amass countless time-series of date, on which, in a manner
that would have made David Hume proud, they can perform simplistic extrapolations.
There are two central problems with this mode of theoretical operation, and together
they have brought economics to its present sad condition. The first problem is that there is no
stable set of psychological propensities or motives about which reliable knowledge can be
accumulated. As I pointed out when discussing Mills introduction of the factor of habit or
custom, these labels or placeholders -- habit, custom, propensity to consume, liquidity
preference, leisure/labour trade-off, and the rest -- are merely summary names given to whole
congeries of heterogeneous and shifting motivations. Some consumers may be guided in their
decisions about savings versus consumption by a consideration of present versus future
pleasures; others may be influenced by the uncertainty of unemployment; still others may be
reacting to the experience of seeing savings shrink in value under high rates of inflation. And
some consumers may even have been influenced by the sorts of public service advertising
that first surfaced during the Eisenhower years, when Americans were exhorted to buy on
credit as a way of showing their faith in the American system
Economists extrapolate from past behavior, only to find that the present deviates from
the past. As they make mid-course corrections in their econometric estimates, reality
continues to shift beneath them. The problem is not that modern economic reality is complex.
Their formal models are more than adequate to handle a high level of complexity. The
problem is that their theories are theories of appearances, surface manifestations, and hence
give no genuine insight into the causes of the shifting shadows.
The second problem, more serious even than the first, is that economics is a study of
human choice and decision, not of inanimate nature or animal behavior. The consumers,
investors, and entrepreneurs whose preferences and propensities are modeled by the
econometricians are themselves self-conscious agents increasingly aware of and influenced

by the descriptions, predictions, hopes, and anxieties of economists, public figures, and social
commentators.
All of you are familiar from todays newspapers with the ways in which the interplay of
economic prediction and private investment or consumption decision wreaks havoc with the
efforts of the central government to manage the national economy. Businessmen postpone the
expansion of productive capacity in the expectation that high interest rates will slow recovery,
balloon the federal deficit, send the government into the money market for even greater
borrowing, and thereby maintain the high rates. The government enacts a tax designed to
draw a larger share of income into savings, but the stock market discounts the effects of the
act six months before it goes into operation, condemning it to failure.
Under these circumstances, madcap schemes acquire respectability, and establishment
politicians and economists react by labeling them voodoo economics. But in fact, this is
merely the effort by licensed witch doctors to drive their upstart competition back into the
bush.
What is the heart of the problem? I should like to suggest to you that Marxs style of
diagnosis still retains considerable merit. The underlying problem, as he would have argued,
is that the forms of capitalist development have become fetters. In the early stages of
capitalism, the pressures of a permanent excess supply of workers, together with the almost
total lack of collective or legal protections, held wages at or near subsistence. Severe
competition among large numbers of small businesses forced firms to strive for maximum
growth if they were to survive at all. The effect was rapid, although uneven, expansion of the
productive capacity of the economy.
With the rise in worker standard of living and the unrelenting amalgamation of small
capitals into large, with the advance of collective bargaining and the development of a system
of money and banking sophisticated enough to support the new capitalist order, growth and
prosperity increasingly came to depend on the appropriate rate of savings and investment and
the proper management of the expansion of effective demand for the consumer goods and
capital goods being produced.
The new economics of Keynes and his followers sought to preserve an essentially
private economic order, in which not only mere legal ownership, but more importantly the
effective control and management of the means of production, remained lodged in countless
uncoordinated private firms. What this meant -- and means still today -- is that the ultimate
determination of the allocation of the collective social product rests with the irrational and
impenetrable subjective preferences, propensities, and expectations of private individuals. It
is scarcely surprising that even the most agile shadow-watchers are unable to either predict or
to control the flow of images on the wall of our cave. What is to be done? There are three
possibilities, each corresponding to a different conception of the relationship between the
economic theory and the practical management of the economy. The first possibility is to
press forward as we have been doing, with more elaborate and refined macroeconomic
models, more complex fiscal and monetary programs, all imposed on a private economy
organized on the pursuit of profit. This course we may call the persistence of the actual, and
as metaphysicians have often observed, the actual occupies a privileged place in our
experience and beliefs. I am absolutely convinced that this course of action is doomed to
failure, but I rather imagine it will take another decade or two of the economic disaster before

the American people are prepared to scuttle the conventional wisdom and adopt some better
means of social decision.
The second possibility is to turn the clock back two centuries and try, by an act of faith
and will, to re-instantiate a world in which the classical economic theories work. This I shall
call the yearning for the impossible, and it is now, with the advent of the theory of rational
expectations and so-called supply-side economics, reaching the height of its brief resurgence.
The impossible has always exerted a powerful attraction on credulous souls, sometimes even
eclipsing the actual by its beauty and simplicity. In earlier days, when society was less
thoroughly interconnected, it was possible to embrace the impossible for quite some time
before being brought up short against reality. Now, unfortunately for Mr. Reagan, the
impossible succumbs to the actual in about as long as it takes to get from a presidential to a
mid-term election. I think we can with confidence conclude that rational expectations,
supply-side economics, and the revival of the theory of the free market have already peaked
and are on the decline.
[Alas, when I wrote this, I was in the grip of an optimism that Keynes would have
considered a very great effusion of animal spirits. A quarter of a century later, things have
only gotten worse, which I suppose some people would conclude means that are closer to
revolution!]
We are left with the third alternative, which is to confront directly the underlying cause
of the failure of modern economics, and respond by changing both our theory and our
practice.
As we saw, the problem is this: an economy guided by the uncoordinated decisions of
private individuals must necessarily rest upon subjective, variable, and self-referentially
influenceable motivations. So long as the theories of the behavior of producers and
consumers become factors influencing that behavior, no stable theory can be developed by
means of which the economy can be guided.
There is, however, a solution. What are now predictions by external observers of the
way in which economic agents will probably behave can be transformed into collective
decisions about how economic agents choose to act. Instead of attempting to shape and guide
an economy on the basis of predictions about what proportion of income consumers will
save, or what level of profit will draw new capital into investment, we can as a society choose
a level of savings that fits our collective goals and desires. We can decided to invest at a level
and in a pattern calculated to achieve whatever regeneration or expansion or transformation
of our industrial plant it is that serves our collective social ends. We need not rest our hopes
for full employment on the armchair psychological maxim that consumers will save a larger
fraction of each additional dollar of income, nor need we count for new capital investment on
the fragile, variable, semi-informed subjective expectations of individual capitalists.
The economic theory suited to the rational management of a modern industrial
economy is not the elaborate shadow guessing of modern econometrics. Rather, it is the
physical-quantities linear analysis developed by Wassily Leontief as input-output analysis,
together with the theory of linear programming, and the modern mathematical
reinterpretation of Marx carried out by Piero Sraffa and a host of economists around the
world. This theory has its roots in the Tableau conomique of Quesney and the physiocrats,
and builds on the analysis of Ricardo and Marx. Theories of this sort are already being

employed as tools of rational economic planning in Eastern Europe, and would have a far
more powerful and effective application to an economy as advanced as that of the United
States.
The foundation of economic planning is a set of objective data specifying the available
technologies, on the basis of which one can calculate the direct and indirect physical
requirements for whatever final output is collectively chosen by the society as the goal of its
economic activities. The level of output and rate of growth of an economy have natural limits,
imposed by the state of technology, the size and skills of the labour force, and the stock of
available tools, raw materials, and machinery. Neither ideology nor economic theory can
change these constraints, although over time, rational social planning can alter them in major
ways. With the modern methods of analysis to which I have referred, it is now becoming
possible to undertake complex society-wide planning based on objective facts and collective
choices, rather than on shadow appearances and subjective preferences and expectations. The
anarchy of the marketplace can finally give way to rational social management founded on a
politics of public deliberation and determination of collective economic goals.
There is, of course, an obstacle to the triumph of the rational, as we may call this third
course of action. The obstacle is not primarily theoretical, nor is it technological. Rather, it is
political. Those who are systematically benefitted by the present economic order will fight to
maintain their advantage. Hence the struggle for socialism, which is of course what I am
talking about, must be carried on in every political arena, as well as in the literature of
economic theory.
Nevertheless, there is a great deal to be gained by confronting established dogma and
exposing its true nature as the scholasticism of shadows. The economics of the neo-classical
synthesis, as it has been called, is in retreat. The master shadow-guessers of Samuelsons
generation are giving way to epigoni who struggle helplessly to reassert their authority in the
face of economic disaster. Theories of collectivel rational economic choice will not substitute
for political action, but they have an indispensable role to place in the social transformation
that must be undertaken. Perhaps my observations this afternoon will encourage some of you
to revisit the dismal science -- or to make its acquaintance for the first time -- and to explore
the new theories which are arising to challenge the old.