Do we need another Keynes?

The August 30 edition of this newspaper contained an article by Dr Asad Zaman, in which he sheds light on the ideas of Adam Smith, Keynes and the financial crisis. This article is aimed as a follow up and addition to the same themes, although with a slightly different point of view.

Adam Smith is widely regarded as the father of modern economics. The principles he gave in The Wealth of Nations have been the cornerstone of the economies of the developed nations. One of these is the notion of the ‘invisible hand’. But it is unfortunate when his ideas are linked to present-day economic troubles since that reflects a poor understanding and interpretation of Adam Smith and his work. It is equally tragic that not many economists (and none outside the subject) seem to be aware of another of Smith’s equally remarkable book, The Theory of Moral Sentiments.

This book was published before The Wealth of Nations, and covers topics that form the moral and ethical basis of a society. That Adam Smith shed light upon topics related to morals should not be surprising since he was professor of moral philosophy. What can be surprising is how successfully he extended the insights from the book into developing clear principles of the working of a capitalist economy in The Wealth of Nations. The principle of the invisible hand is an example of that, first stated in The Theory of Moral Sentiments, but commonly understood to be from The Wealth of Nations.

The Theory of Moral Sentiments is a narrative of the powerful role of non-profit motives that form the basis of a harmonious and just society, upon whom the successful operation of a laissez-faire economy is based. Things like trust, honesty, compassion, prudence, public spirit, humanity, etc, are discussed at length. Smith implied that the peoples’ trust in a financial institution or individual is more valuable than the gold and money they possess.

To an extent, those lessons of ethics seemed to have been lost over time – until now. In the wake of the financial and economic crisis that has engulfed the economies of the industrialised world since 2008, Smith’s work in The Theory of Moral Sentiments seems to have undergone a revival of sorts. One shouldn’t be surprised at this development. Just look at the financial crisis from the point of view of ethics, and it would not be difficult to understand the spirit behind movements like ‘Occupy Wall Street’.

It was, after all, the financial intermediaries of Wall Street who pocketed the public’s hard-earned money, promised prodigious returns, and invested them in risky assets that turned out to be a disaster.

The public’s hard earned savings were washed away by the crisis, but those who perpetrated these ponzi schemes got bonuses and paycheques. Following Adam Smith’s opinion on bankers, it is not difficult to come to the conclusion that the ‘trust’ between society and its financial institutions has been severely dented (if not completely lost) in the aftermath of the crisis. Arguably, the saddest aspect of this whole affair is that estimates have been made regarding monetary losses, but not many seem to bother about the loss of trust and the ensuing pain to individuals.

Just as Smith is known as the father of modern economics, John Maynard Keynes is widely regarded as the man whose writings gave rise to ‘macroeconomics’, a branch of economics that deals with aggregate phenomena like GDP, employment, etc. In the wake of the Great Depression, he assumed a larger-than-life role with the publication of The General Theory of Employment, Interest and Money.

Much of the credit for government policies that helped the world dig out of the depression is given to his ideas. But like Smith, Keynes’s ideas have also been the subject of fierce debates among economists, and he also has been misinterpreted.

Take the idea of government’s increased investment or spending in the wake of such recessions. It is true that Keynes indeed advocated increased expenditure on the part of the government in the wake of recessions, but never did he imply this to mean a bigger government. Unfortunately, this is what people like Robert Lucas and libertarians would have others believe.

Similarly, textbook macroeconomic models like IS-LM have been credited to Keynes. Yet Keynes never stated the IS-LM model. It was John Hicks, another economist, who tried to present Keynes’s ideas in a graphical form in many of his articles and writings. Keynes’s own book contains few or no graphs.

As Dr Zaman pointed out in his article, modern economics (especially macro) has been reduced to sophisticated mathematical models. I would also like to add that the same is true for what econometrics (application of statistical techniques to economics) has done to economics. None of the mathematical or econometrics models could give a clue to the coming of the 2008 recession.

There is a lack of understanding (and reading) of economic history and understanding of the psychological aspects of a society’s economic decision making. For some top economists like Robert Lucas, economic history holds no value. That is precisely why he, in his exuberance, went on to remark that recessions are a thing of the past. Moreover, he once commented that discussion of Keynesian ideas elicits ‘giggles’! Well guess who’s ‘giggling’ now?

Had he studied economic history, he would not have made the mistake of uttering those words that were to prove an embarrassment in the wake of the financial crisis.

Do we need another Keynes? No. The underpinnings of recessions like the present one have been laid out in detail by many lesser-known economists, like Walter Bagehot in the late 19th century and Hyman Minsky in the late 20th century. A cursory reading of their ideas would make it easier for anyone to understand how the present recession came to be. So the tools for understanding these phenomena are already there; it’s just that nobody bothers to read them – ‘models’ do not incorporate their insights.

Regarding capitalism, it should be worth remembering that without economies based on capitalist principles, humanity would never have realised the gains that we’ve made, specifically after the industrial revolution. Capitalism, like other systems, has its weaknesses, the biggest probably being the failure to check runaway greed. However, critics would do well to recognise that these inherent weaknesses have been recognised by many industrialised societies, and they have implemented measures against them (for example, unemployment insurance, social security transfers, Medicare, free education, etc).

Even as ardent a critic of capitalism as Lenin, who is credited with the birth of Soviet Union and Communism, remarked in the wake of the 1919 economic crisis in Russia that “to believe that there is no way out of the present crisis for capitalism is an error”.

The same can be said about today. It is a mistake to call for abolishing capitalism altogether. Its alternatives have not fared better, with communism dying its own death. What is needed is an understanding (and education) regarding the moral basis of a society upon which various economic institutions rest, and a balance between individual pursuits and the common good of the society. That was Adam Smith’s message, a message that we tend to forget at our own peril.

The writer is a researcher and has taught at Bahria University and Iqra University.  Email: shahid.mohmand@gmail.com