===== PAGE 1 =====

The Development of Keynes’s
Economics: From Marshall
to Millennialism

Joseph T. Salerno*

has been growing in influence recently, emphasizes that
Keynes’s sociopolitical vision was formulated long before
and, in fact, inspired the heterodox economic analysis and policy
prescriptions that were served up in his most influential work. One
of the earliest proponents of this interpretation, Joseph Schumpeter
([1951] 1965, p. 268) writes that “In those pages of the Economic
Consequences of the Peace [published in 1919] we find nothing of the
theoretical apparatus of the General Theory. But we find the whole
of the vision of things social and economic of which that apparatus is
the technical complement. The General Theory is the final result of a
long struggle to make the vision of our age analytically operative.”
More recently this interpretive thread has been taken up by
scholars who can be classified mainly, though not exclusively, as
opponents of textbook Keynesian economics. For example, in a recent
article on “The Sociopolitical Vision of Keynes,” the late Karl Brunner
reaches a conclusion similar to Schumpeter’s. According to Brunner
(1987, p. 32), “The general direction of Keynes's sociopolitical
thoughts had . . . already emerged many years before he wrote the
General Theory. . . . [The latter work] provided the underlying vision
of the socioeconomic process in an extensive analytic context. The
sociopolitical program outlined over the prior decade naturally fitted
with the General Theory into a coherent story of modern Western
society.”
In another recent contribution, Allan Meltzer (1988, p. 5) declares
that “[i]t is nearer the truth to say that the General Theory provided

O ne long-standing interpretation of the General Theory, which

* Joesph T. Salerno is associate profeesor of economics at Pace University in New York
City.
The Review of Austrian Economics, Vol. 6, No. 1 (1992): 3-64
ISSN 0889-3047

3


===== PAGE 2 =====

4 The Review of Austrian Economics, Vol. 6, No. 1

the analytic framework for Keynes's long-standing policy views than
to conclude that the books’ [sic] policy recommendations are the
derived implications of his theory.” Finally the post-Keynesian
Hyman P. Minsky may be cited. Echoing Schumpeter, Minsky (1975,
p. 145) writes:

In an interpretation of Keynes's views on the implications of The
General Theory for broader social issues and on the appropriate
structure of policies designed to implement the new theory, his
writings on politics and social policy prior to The General Theory are
relevant. While The General Theory marks a sharp break in economic
theory, the “social philosophy” implications he drew from the work
are consistent with his earlier views. In fact, The General Theory can
be viewed as giving an economic theoretic rationalization for views
that Keynes’s ethics and intuition had led him to, even as he was a
practicing “classical” economist.

Textbook Keynesians, on the other hand, who generally are wont
to emphasize the Great Depression as the main intellectual stimulus
to the formulation of the “vision” underlying the General Theory,
strongly demur from the Schumpeterian interpretation. For instance,
in discussing Brunner’s contribution cited above, Lester Thurow
(Brunner 1987, p. 52) flatly states that “The General Theory would
not have been written without the Great Depression.” In his comment
on Brunner, James Tobin (Brunner 1987, p. 53) expresses agreement
with Thurow that the General Theory was presented as “a diagnosis
of the world economic crisis of the Great Depression.”

In this paper I shall argue that when the nature and evolution of
Keynes's “vision” is fully grasped, the Schumpeterian and neo-Key-
nesian views of the General Theory are complementary rather than
antithetical. It is indeed true that Keynes's ethical and sociopolitical
views were formulated long before the writing of the General Theory
and inspired and suffused the heterodox vision of the economic
system presented in the book. But it is also true that prior to the onset
of the Great Depression and up through 1931, in theorizing about the
capitalist economy, Keynes proved to be a rigidly orthodox and paro-
chial Marshallian economist, despite the idiosyncratic refinements
and contrivances he introduced into Cambridge monetary theory in
his Treatise on Money. It was not until 1932, at the earliest, that
Keynes set himself to the task of overturning the Marshallian ortho-
doxy by undertaking the construction of a deliberately heretical
economics explicitly based upon and embodying concepts and pre-
cepts derived from his ethical and social philosophy.

Keynes's social philosophy, the rudiments of which can already
be found in The Economic Consequences of the Peace and which was


===== PAGE 3 =====

Salerno: The Development of Keynes's Economics 5

expounded in widely scattered articles, book reviews, and speeches
throughout the 1920s and early 1930s, can be classified as
“millennialist.” Although there are numerous variants of social mil-
lennialism or chiliasm, including those based on Christian theology
and Hegelian philosophy (Rothbard 1990), what is common to all is
the view that social evolution is teleological and, from a specific
starting point, progresses along a necessary and definite course to a
pre-ordained end. All millennialist theories are therefore presented
as theories of historical stages in which human history is foretold as
coming to a close in a paradisiacal final stage or millennium.

The teleological aspect of social millennialism has been well-de-
scribed by Ludwig von Mises ([1936] 1951, p. 287):

The teleological view describes the course of [social] evolution in all
its windings and deviations. Thus it is typically a theory of stages. It
shows us the successive stages of civilization until one is reached
which must necessarily be the last, because no other follows it. When
this point has been reached it is impossible to foresee how history is
to proceed.

As a consequence of their teleological orientation, millennialist
theories are inherently esoteric, gnostic, and antirationalist, involving
the explicit or implicit assumption that the theorist or prophet alone
possesses gnosis or direct intuition of the truths of social evolution.

Before examining Keynes's specific theory of social evolution, it
is useful to broadly contrast this general characterization of
millennialist theories with the approach to social evolution that I
have elsewhere designated as “social rationalism” (Salerno 1990).
The rationalist approach is methodologically individualistic and
seeks for the ultimate explanation of social evolution in the per-
ceived benefits which accrue to individuals as a result of their
participation in the social division of labor. The rationalist ap-
proach is thus nonteleological and eschews any attempt to foretell
the exact course of human history. Social progress is identified
with the intensification and extension of the social division of labor,
which proceeds from the recognition by ever-increasing numbers of
individuals and groups that it is advantageous to endeavor to satisfy
a growing number of wants by consciously organizing their produc-
tive activities in accordance with the law of comparative advantage
(Salerno 1990, pp. 27-31). As Mises ([1936) 1951, p. 287) points out,
in the rationalist view, ‘[t]he end of social evolution can be no other
than that of society itself.” The law of comparative advantage which
is “the law of social evolution” yields “insight, not into man’s destiny,
but into man’s doings” (Mises [1936] 1951, pp. 287-88).


===== PAGE 4 =====

6 The Review of Austrian Economics, Vol. 6, No. 1

Because the rationalist theorist relies only on ratiocinative pro-
cesses in formulating his explanation of the evolution of society, his
theory is exoteric and subject to critical examination and refutation
by other reasoning beings. Indeed, in order for much progress to be
made toward the formation of a world-embracing division of labor and
market society, the law of comparative advantage requires conscious
affirmation by human reason. In history, this affirmation takes the
form of the deliberate development and popular acceptance of a
coherent ideology of social life which supports human liberty, private
property, and a market economy, while abhorring political omnipo-
tence, privilege, and warfare (Salerno 1990, pp. 46-53). The
millennialist approach, on the other hand, posits the existence of a
metaphysical and supra-rational force which, through “the cunning
of History,” drives human beings to those actions which are necessary
to the achievement of humanity’s final goal.

In the next section, I provide a brief overview of Keynes’s most
important intellectual influences. These influences are small in num-
ber and relatively parochial, involving two Cambridge dons and a
British political theorist. In creating his sociopolitical vision, Keynes
drew mainly upon the ethical philosophy of G. E. Moore, the political
philosophy of Edmund Burke, and the economics of Alfred Marshall.
From Marshall, Keynes also adopted the millennialist theoretical
framework which the former constructed as a prop for his “preaching
of mid-Victorian morality, seasoned by Benthamism” (Schumpeter
[1951) 1965, p. 104).

In section 3, I trace the development of Keynes's millennialist
theory of social evolution, upon which, I argue, his sociopolitical
vision is based. I also suggest that, during the decade of the 1920s,
in which this development mainly occurred, Keynes viewed Marshall-
ian economics as a tool for guiding a dynamic and useful but unsteady
and unethical capitalist economy toward the impending post-scarcity
millennium and that his Treatise on Money (Keynes [1930] 1958) was
intended as a handbook for just this purpose.

Section 4 contains an account of Keynes’s apostasy from
Marshallian economics in consequence of the Great Depression and
his endeavor, beginning in 1932, to formulate a heretical body of
economic analysis and policy, which was designed to effect a rapid
transition to the millennium. In the fifth and concluding section of
the paper, I present the case that the basic building blocks of the
General Theory, including the theories of effective demand and liq-

_uidity preference and the concept of the marginal efficiency of capital,
are fashioned out of the Moorite ethical precepts that Keynes pre-
sumed would guide action in his imagined millennial state.


===== PAGE 5 =====

Salerno: The Development of Keynes’s Economics 7

Keynes's Intellectual Influences

G. E. Moore served as Keynes's guide in his conception and pursuit
of the ethical good. In Keynes's interpretation of Moore, ethical
goodness or “the Good” is an attribute uniquely related to “states of
mind,” which are the only things valuable in and of themselves. In
elaborating upon his version of the Moorite “religion,” Keynes (quoted
in Skidelsky [1983] 1986, p. 141) writes:

Nothing mattered except states of mind. . . . These states of mind
were not associated with action or achievement or with consequences.
They consisted in timeless passionate states of contemplation and
communion, largely unattached to “before” and “after.” . . . The
appropriate subjects of passionate contemplation and communion
were a beloved person, beauty and truth, one’s prime objects in life
were love, the creation and enjoyment of aesthetic experience and the
pursuit of knowledge. . . . [The Moorite] religion was altogether
unworldly—with wealth, power, popularity or success it had no
concern whatever, they were thoroughly despised.

According to Keynes (quoted in Skidelsky [1983] 1986, p. 142), he
and the other early proselytes of Moore's religion:

lived entirely in present experience, since social action as an end
in itself and not merely as a lugubrious duty had dropped out of
our Ideal, and not only social action, but the life of action generally,
power, politics, success, wealth, ambition, with the economic mo-
tive and economic criterion less prominent in our philosophy than
with St. Francis of Assisi, who at least made a collection for the
birds.

Thus the Moorite contribution to Keynes’s thought is a concept of
the highest good as consisting in a succession of timeless states of
consciousness to be experienced in the present moment. There is
further a tendency in Moore to treat these internal states of goodness
as wholly independent of any external means for their achievement. As
Skidelsky ([1983] 1986, p. 146) points out, not only is economic welfare
not the same as ethical goodness, “there is nothing in Moore’s argument
to show that it is a necessary condition of it.” Thus Keynes absorbed a
radical present orientation from Moore’s thought and a related tendency
to denigrate “economizing” or purposeful behavior associated with scar-
city, since attainment of ethical goods did not directly depend upon—
indeed was inhibited by—the undertaking of time-consuming pro-
cesses of production employing scarce means.

On two crucial points, however, Keynes broke with Moore. First,
while he accepted the sharp distinction drawn by Moore between
economic welfare and ethical goodness, Keynes struggled mightily to


===== PAGE 6 =====

8 The Review of Austrian Economics, Vol. 6, No. 1

forge a logical link between economic, social, and political goods on
the one hand and the Moorite ethical good on the other. Keynes
supplies this link by conceiving the existence of society as an absolute
and necessary precondition for the realization of the individual's
“good states of mind.” The overall social good, including economic
welfare, while not intrinsically good, is therefore to be sought after
as a “useful” and “valuable” means to the ultimate end of the ethical
good (Skidelsky [1983] 1986, p. 154). For Keynes, however, because
the ethical quality of the end could never be imputed to or reflected
by the means, the Good is always to be valued absolutely above its
means of attainment, thereby precluding the logical development of
a universal principle on which resources are to be allocated between
the immediate attainment of good states of mind and the securing of
conditions that may be useful for their attainment in the future. Thus
the claim of the ethical good on behavior appears to be absolute,
indivisible, and beyond the pale of scarcity and economic science. Of
course, Keynes did believe that non-ethical ends had a claim on
behavior in certain circumstances, but, as Skidelsky ([1983] 1986, p.
154) states, “the connection [between economics and ethics] for
Keynes was never mechanical, always problematic.”

For guidance in identifying the social good and the proper method
for its achievement, Keynes turned to the political philosophy of
Edmund Burke. As Skidelsky ([1983] 1986, p. 154) states, “[i]f Moore
was Keynes's ethical hero, Burke may lay strong claim to be his
political hero.”

Keynes (quoted in Skidelsky [1983] 1986, p. 155) broadly charac-
terized Burke as a utilitarian, for whom politics and government were
the essential means to securing the “happiness of the people” in the
form of “physical calm, material comfort, and intellectual freedom.”
For Keynes these qualities are, in turn, the “great and essential
means” for the attainment of the ultimate Moorite “good things” in
life, which flow from the cultivation of the “tastes and emotions, good
feeling and right judgment.”

According to Keynes (quoted in Skidelsky [1983] 1986, p. 155),
one of the most important corollary principles of Burkean utilitari-
anism is an “extreme timidity in introducing present evils for the sake
of future benefits.” In support of this principle, Keynes argued that:

Our power of prediction is so slight, it is seldom wise to sacrifice a
present evil for a doubtful advantage in the future. Burke ever held,
and held rightly, that it can seldom be right to sacrifice the
well-being of a nation for a generation, to plunge whole communi-
ties in distress, or to destroy a beneficent institution for the sake
of a supposed millennium in the comparatively remote future. ... It


===== PAGE 7 =====

Salerno: The Development of Keynes’s Economics 9

is the paramount duty of governments and of politicians to secure the
well-being of the community under the case in the present and not to
run risks overmuch for the future.

Keynes (quoted in Skidelsky [1983] 1986, p. 157) summed up
Burke's political philosophy in the following terms:

His goods are all in the present—peace and quiet, friendship and
affections, family life, and those small acts of charity whereby one
individual may sometimes help his fellows. He does not think of the
race as marching through blood and fire to some great and glorious
good in the distant future; there is, for him, no great political millen-
nium to be helped and forwarded by present effort and present
sacrifice.

Thus, Keynes derived two things from Burke: (1) the belief that
government and politicians are competent to directly secure the
material conditions that foster “general happiness” or “the wide
dissemination of comfort” and that are also the means for attaining
the spiritual or mental states that constitute the ultimate good; and
(2) a strong present orientation in policy matters which dovetails with
the severely foreshortened time horizon that is entailed by accep-
tance of Moore’s notion of the ethical good.

The second point on which Keynes disputed his mentor on ethics
involves probability theory. As a utilitarian, Moore contended that it
is rational to pursue one’s own immediate good only if this pursuit
will, on balance, increase or at least not decrease the good of the
Universe. However, in attempting to judge which course of action is
rational in this sense, the individual actor is confronted with the
daunting task of correctly forecasting and assessing the myriad
consequences of his action, which may ramify into every corner of the
remote future. The insuperable difficulty of this task leads Moore
(quoted in Skidelsky [1983] 1986, p. 152) to argue that “[oJur utter
ignorance of the far future gives us no justification for saying that it
is even probably right to choose the greater good within the region
over which a probable forecast may extend.” Moore concludes, there-
fore, that, in most cases, an individual rationally pursuing the ethical
good can do no better than to conform to general rules of conduct,
such as those embodied in the dictates of conventional morality.

Keynes reacted to this argument by challenging Moore’s under-
lying approach to probability, which Keynes identified as a frequency
theory of probability involving certain knowledge of the distribution
of outcomes. In Keynes's view, the concept of probability which is
relevant to action is one which refers to the available evidence
regarding alternative actions. A proposition about the outcome of a


===== PAGE 8 =====

10 The Review of Austrian Economics, Vol. 6, No. 1

contemplated action is more probable than a proposition regarding
an alternative outcome, if, however slight the presently existing
evidence, it indicates that the first outcome is more likely than the
second. As Keynes ([1921] 1962, pp. 307, 310) states:

Given as our basis what knowledge we actually have, the probable
. . . is that which it is rational for us to believe. . . . To believe one
thing in preference to another, as distinct from believing the first true
or more probable and the second false or less probable, must have
reference to action and must be a loose way of expressing the propri-
ety of acting on one hypothesis rather than another. . . . We might
put it, therefore, that the probable is the hypothesis on which it is
rational for us to act. . . . The results of our endeavors are very
uncertain, but we have a genuine probability, even when the evidence
upon which it is founded is slight. . . .

With this theory of probability, Keynes is able to free the Moorite
pursuer of good mental states from the shackles of conventional rules
of correct conduct that were clamped on by Moore himself as a
utilitarian concession to the uncertain future. According to Keynes
([1921] 1962, pp. 309-10): “If good is additive, if we have reason to
think that of two actions one produces more good than another in the
near future, and if we have no means of discriminating between their
results in the distant future, then by what seems a legitimate appli-
cation of the Principle of Indifference we may suppose that there isa
probability in favor of the former action.” Thus, the claims of the
immediate good upon action are even stronger for Keynes than for
Moore, because Keynes’s theory of probability permits him to ignore
the unforeseeable future ramifications of present action.

The final major influence on Keynes’s social philosophy is his
mentor in economics, Alfred Marshall. Marshall’s influence on the
early Keynes is difficult to overestimate. From all accounts, Keynes
the economist was steeped in Marshall. Dating from his academic
appointment to Cambridge in 1909, Keynes “taught straight
Marshallian doctrine . . . the doctrine he mastered as few people did
and with which he remained identified for twenty years to come”
(Schumpeter [1951] 1965, p. 263).

Revelations of Keynes's astonishing parochialism in economic
theory are provided by Harrod, his disciple and authorized biogra-
pher. In urging the young Harrod to attend Cambridge, Keynes
“brushed aside” the London School of Economics and rejected the
alternative of a foreign university because, according to Keynes, “they
knew nothing at all of Economics on the Continent” (Harrod 1951,
p. 319). Harrod (1951, p. 322) refers to “Keynes’s dictum that there
wasn’t any place but Cambridge where one could learn economics.”


===== PAGE 9 =====

Salerno: The Development of Keynes's Economics 11

After enrolling at Cambridge, Harrod was impressed by Keynes's
view that “the content of economic theory was extremely small” and
that “wide reading in economic theory” was not necessary. Keynes
believed, as Marshall had, that “there was not much further work to
be done” in the field of economic theory, and Keynes's “recipe for the
young economist was to know his Marshall thoroughly and read his
Times every day carefully, without bothering too much about the
large mass of contemporary publication in book form” (Harrod
1951, p. 324).

More recently, Moggridge (1976, p. 153) has affirmed that
“broadly Marshallian modes of analysis pervade all Keynes's work,
even when Marshall and his successors were the objects of attack, as
in the General Theory.”

In the judgment of his fellow Cantabrigian, A. C. Pigou (quoted
in Keynes 1973, p. 22), even after he discarded some of the technical
apparatus of Marshallian theory in the 1930s Keynes remained, in
terms of his philosophical approach to economics as a branch of
applied ethics, “a firm disciple of the ‘Master.”” As late as 1938, for
example, Keynes defended Marshall's view, as against Robbins’s, that
economics is “a moral science” which “employs introspection and
judgments of value” (Moggridge 1976, p. 22).

Writing in 1941, Keynes (quoted in Hession 1984, p. 326) de-
scribed the doctrinal filiation of his own intensely ethical approach
to economics in the following terms:

Along one line of origin, at least, economics more properly polit-
ico-economy is a side of ethics. Marshall used always to insist that
it was through ethics he arrived at political economy, and I would
claim myself in this, as in other respects, to be a pupil of his. I
should have thought that nearly all English economists in the
tradition, apart from Ricardo, reached economics that way. There
are practically no issues of policy as distinct from technique which
do not involve ethical considerations.

Accordingly, one of the main props for Keynes's social philosophy
is the value-laden theory of wants developed by Marshall. Marshall's
classification of wants is threefold. “Natural” human wants refer to
the biological needs for, e.g., food and shelter, which characterize both
the lower animals and uncivilized man. According to Marshall ([1920]
1949, p. 86), the wants in this class “are countless in number and very
various in kind: but they are generally limited and capable of being
satisfied.” As civilization progresses, however, there emerges a sec-
ond class of “artificial” wants, which are not capable of satiation.
Marshall ([1920] 1949, p. 88) includes in this class the craving for
distinction among one’s fellows which, for example, in the case of


===== PAGE 10 =====

12 The Review of Austrian Economics, Vol. 6, No. 1

women’s dress, gives rise to “the evil dominion of the wanton vagaries
of fashion.”

Marshall’s third category encompasses “wants adjusted to activ-
ities.” In the early stages of social evolution, wants are the prod to
human “activities,” which are aimed almost exclusively at satisfying
these wants. In the higher stages, in which natural wants have been
satisfied, “higher” activities begin to be undertaken for their own sake
leading to the creation of wants. Marshall’s example of this inverted
relationship between wants and activities is the pursuit of science,
literature, and art for their own sake, generating a demand for the
labor of those who pursue these activities professionally (Marshall
[1920] 1949, pp. 88-89). The rapid increase in the consumption of tea,
while the consumption of alcohol stagnates, affords another illustra-
tion, because, according to Marshall ([1920] 1949, p. 89 1n), tea is
desired to “stimulate the mental activities,” just as alcohol serves to
“merely gratify the senses.” As the pursuit of higher activities be-
comes increasingly widespread in society, there emerges a pervasive
“desire for excellence for its own sake” causing the processes of
production, heretofore seen as merely a means to want satisfaction,
to be transformed into higher activities pursued as ends in them-
selves. Thus the work of the fisherman begins to take on the character
of the “activities” of a Newton or a Stradivarius (Marshall [1920]
1949, p. 89). For Marshall (quoted in Parsons [1937] 1968, p. 141 1n),
then, “[w]ork in its best sense, the healthy energetic exercise of
faculties is the aim of life, is life itself.”

Marshall’s theory of wants and activities serves as the basis of
his theory of social evolution, which also deeply influenced Keynes.
Thus Marshall ({1920] 1949, p. 85) tells us that “it is to changes in
the forms of efforts and activities that we must turn when in search
for the keynotes of the history of mankind.” The reason is that “man’s
character has been molded by his every-day work, and the material
resources he thereby procures, more than any other influence unless
it be that of his religious ideals” (Marshall [1920] 1949, p. 1). Human
character is thus developed in the very process of economic and social
evolution in which, in the later stages, “each new step upwards is to
be regarded as the development of new activities giving rise to new
wants” (Marshall [1920] 1949, p. 89).

Most important for Marshall, economic and social progress is
expressed in a “rising standard of life,” a term which Marshall never
clearly defines but which can be understood as “some kind of index
of human quality: a scalar function of a vector of attributes or
‘activities,’ physical or mental, such as energy, dexterity, rationality,
foresight, honesty, unselfishness, striving for self-improvement and


===== PAGE 11 =====

Salerno: The Development of Keynes’s Economics 13

social improvement, and so on” (Whitaker 1977, p. 180). An increase
in the standard of life implies, e.g., a reduction of expenditure on
debilitating alcoholic beverages and an increase of expenditure on
healthful food and drink and children’s education, as well as an
increase in saving and therefore capital accumulation. The resulting
improvement in the laborer’s health, morale, and human capital as
well as in the material structure of complementary capital goods will
tend to increase labor efficiency and real wage rates. Increased wage
rates will, in turn, provide the wherewithal, including the greater
opportunity for the enjoyment of leisure, which is needed to satisfy
the wants induced by the pursuit of “higher activities” (Whitaker
1977, 179, pp. 184-85).

Marshall's almost obsessive emphasis on leisure—albeit leisure
to pursue ennobling or “higher” activities—as a prerequisite of char-
acter development and social progress should be noted. In his own
words, “Some free time from the fatigue of work that tires without
educating, is a necessary condition of a high standard of life.” For the
young, in particular, it is “an essential condition” for developing “their
higher nature” and making them “efficient producers” that they be
given “long-continued freedom from mechanical toil; together with
abundant leisure for school and for such kinds of play as strengthen
and develop the character” (Marshall [1920] 1949, p. 720).

The improvement of character that results from higher activities
pursued during leisure time will further heighten the standard of life
and lead to a further round of improvement in consumption habits
and of increased investment in material and human capital, with the
consequent increase in real wages starting the whole process over
again. Marshall ([1920] 1949, p. 690) implies, however, that this
development process may be short-circuited if an increase in real
wage rates is squandered on increasing the “standard of comfort,” by
which he means “a mere increase of artificial wants, among which
perhaps the grosser wants may predominate.”

And if the masses persist in wallowing in a degraded standard of
life, thereby obstructing social progress, Marshall ([1920] 1949, p.
714) suggests a two-pronged solution. The “residuum,” or those who
are “physically, mentally or morally incapable of doing a good day’s
work with which to earn a good day’s wage,” are to be prevented from
perpetuating themselves by rearing up children “in their own patten.”
To this end, those with young children are to “come under a paternal
discipline” and to incur “a more strict subordination of personal
freedom to public necessity.” As a last resort, Marshall ([1920] 1949,
pp. 714-15 1n) advocates that “the homes might be closed or regu-
lated with some limitation on the freedom of the parents.”


===== PAGE 12 =====

14 The Review of Austrian Economics, Vol. 6, No. 1

Marshall’s second method of “causing the residuum to cease from
the land” and hastening social progress involves “the application of
the principles of Eugenics to the replenishment of the race from its
higher rather than its lower strains. . ..” (Marshall [1920] 1949, pp.
714, 248). Theodore Levitt (1976, p. 429) perceptively refers to this
second method as “the ultimate solution,” because “ultimately what
Marshall preached was not so much economics as it was moral and
aesthetic development.”

Although Marshall advocated a political solution to the problem
of the residuum, “It was free enterprise, softened and modified by
altruism and chivalry, which was to be the main agent of human
evolution” (Whitaker 1977, p. 181). According to Marshall, as society
progressed, men in the realm of business would increasingly fore-
swear the single-minded pursuit of the coin of pecuniary gain and
substitute competition for the coin of chivalric achievement and the
social acclaim and approbation it purchased. In this way business
activities would come to resemble the arts and sciences. Such “chiv-
alrous competition,” to use Marshall’s term, would be undertaken
primarily as a “higher activity,” which, as Whitaker (1977, p. 173)
describes it, unites “public spirit and conscientiousness with a delight
in doing noble and difficult things and a desire for full exercise of
one’s own abilities.”

As members of the middle and upper classes come to exert
themselves more and more for chivalric motives, the supply prices of
the various kinds of managerial and professional effort, especially of
what Marshall ([1920] 1949, p. 618) calls “business ability in com-
mand of capital,” decline absolutely and relative to the wage rates of
the more common grades of labor, and this effects a spontaneous
redistribution of income toward the working class. As Marshall
(quoted in Whitaker 1977, p. 174) puts it, “if society could award . ..
honor, position, and influence by methods less blind and wasteful;
and if it could at the same time maintain all that stimulus which the
free enterprise of the strongest business men derives from present
conditions, then the resources thus set free would open out to the
mass of the people new possibilities of a higher life.” Thus does
chivalrous competition promote social evolution, permitting mem-
bers of the working class to attain to the “society of gentlemen”
wherein “no one is to do in the day so much manual work as will leave
him little time or little aptitude for intellectual and artistic enjoy-
ment in the evening” (Marshall quoted in McWilliams-Tullberg 1975,
p. 102).

As noted above, all millennialist social theories are essentially
teleological, typically attempting to describe the precise course of


===== PAGE 13 =====

Salerno: The Development of Keynes’s Economics 15

evolution by positing a series of well-defined historical stages through
which society must evolve before reaching its final goal in the culmi-
nant stage of human history. Now this is certainly typified by
Marshall's theory of social evolution. This theory is centered upon
what Talcott Parsons ([1937] 1968, p. 158) has identified as
“Marshall's belief in an absolute goal of evolution, the development
of character in his peculiar sense.” Marshall (quoted in Whitaker
1977, p. 183) himself describes the final stage of social evolution as a
state with “no rights but only duties; where everyone shall work for
the public weal with all his might expecting no further reward than
that he in common with his neighbors shall have whatever is neces-
sary to enable him to work well, and to lead a refined and intellectual
life.” In a more mature work, Marshall (quoted in Levitt 1976, p. 439)
posits a “distant goal where the opportunities of the noble life may be
accessible to all.”

In the Principles, Marshall ([1920] 1949, p. 752) gives a decidedly
Hegelian cast to his desiderated millennium, referring to “an order
of social life, in which the common good overrules individual caprice,
even more than it did in the early ages before the sway of individu-
alism had begun. But unselfishness then will be the offspring of
deliberate will; and, though aided by instinct, individual freedom will
develop itself in collective freedom. . . .” Thus, for Marshall, human
history is to culminate in what we may call the Era of the Noble Life,
in which all human activities, from sipping tea to mining coal, are
completely transformed into “higher activities” not driven by wants
but undertaken as an aid to or an exercise of the higher human
faculties.

Before society can enter into this paradisiacal state, however,
humanity and the human character must be prepared by passing
through two earlier stages. In the first stage, let us call it the “Era of
Scarcity,” almost all human activities are directed toward solving the
problem of scarcity, conceived of in Marshall’s peculiar and narrow
sense of satisfying basic human wants. The transitional stage or the
“Era of Chivalry” dawns with the arrival of the Victorian gentleman
upon the scene: the solution of the economic problem for at least some
segments of the population yields the leisure and material resources
necessary to an enhanced “standard of life” marked by the pursuit of
character-developing and productivity-improving higher activi-
ties. The resulting character development effects a progressive
transformation of the motive, from pecuniary to chivalric, for
which capital is invested and business activities are undertaken,
thereby lowering the supply price at which “business ability in
command of capital” is forthcoming and raising the real wages of


===== PAGE 14 =====

16 The Review of Austrian Economics, Vol. 6, No. 1

the working class. In this way, free enterprise conducting itself in
accord with chivalrous competition will insure that the resources and
opportunities for character development and a rising standard of life
trickle down to the working classes.

To the extent that members of the working class invest the newly
won additions to their incomes in the acquisition of higher skills for
themselves and for their offspring, the supply of unskilled labor will
eventually diminish, augmenting the rise in the real wages of the
unskilled and offering increased access to a higher standard of life.
The residuum who, due to defect of will or ability, do not avail
themselves and their children of this opportunity for character im-
provement will be eventually suppressed by compulsory State educa-
tion and supervision of child rearing and, in the last resort, of
reproductive activities. Thus will the chivalrous and duty-bound
Victorian businessman, abetted by a bracing dose of State paternal-
ism and eugenics administered to the physically and morally unfit,
usher humanity into the Era of the Noble Life.

Marshall's theory of social evolution leads to a peculiar conception
of the economic problem confronting humanity. Construed conven-
tionally as the confrontation between virtually limitless human
wants and limited resources, scarcity is not the permanent problem
burdening humanity. For Marshall, the central problem of economic
science and of social evolution is the devising of a framework for
society's business and productive activities which promotes the un-
impeded development of human character. To put it another way, once
the Era of Scarcity has been transcended, consumption is no longer
the end of production but the means which permits men to “work well”
and improve their standard of life. Thus Marshall ([1920] 1949, pp.
530, 193) proclaims that the “end of all production” is to “raise the
tone of human life” and that “the chief importance of material wealth
lies in the fact that, when wisely used, it increases the health and
strength, physical, mental and moral of the human race.”

What Marshall ([1920] 1949, p. 85) calls the “keynote of the
history of mankind,” therefore, is not the struggle against scarcity,
which is an ephemeral condition capable of resolution, but the proper
development of human character. Marshall (quoted in McWilliams-
Tullberg 1975, p. 93) is emphatic on this point, declaring that “I have
always held that poverty and pain, disease and death are evils of
greatly less importance than they appear, except in so far as they lead
to weakness of life and character. . . .” The raison d’étre of economic
science is therefore to study the evolutionary process of human
character formation in order to guide it to its fruition in the millen-
nium of the Noble Life. In Marshall's words (quoted in Whitaker 1977,


===== PAGE 15 =====

Salerno: The Development of Keynes’s Economics 17

p. 179): “[The] progress of man’s nature . . . is I conceive, the center
of the ultimate aim of economic studies. . . . human will, guided by
careful thought, can so modify circumstances as largely to modify
character; and thus to bring about new conditions of life still more
favorable to character; and therefore to the economic, as well as moral
well-being of the masses of the people.”

In arevealing comment, Keynes (quoted in Whitaker 1977, p. 185)
observes that “[t]he solution of economic problems was for Marshall,
not an application of the hedonistic calculus, but a prior condition of
the exercise of man’s higher faculties.” In fact, as we shall now see,
Keynes adopted Marshall's view of the economic problem as well as
the latter’s millennialist vision of social evolution.

The Development of Keynes’s Sociopolitical Vision

Keynes's social philosophy and particularly his theory of social evo-
lution are not coherently stated in any one of his works but must be
pieced together from scattered discussions in articles and books
written over the span of more than a decade. Nevertheless, this
endeavor does lead us to view Keynes as a consistent and thorough-
going millennialist in his approach to social evolution.

We get an early and brief glimpse of Keynesian themes in this
area in The Economic Consequences of the Peace, first published in
1919 (Keynes [1920] 1971). In a chapter on “Europe before the War,”
there appears a section blandly entitled “The Psychology of Society.”
In little more than four pages, Keynes suggests the fundamental
irrationality of abstaining from present consumption, emphasizes the
importance of capital accumulation and compound interest to social
evolution, delineates a teleological approach to human history whose
goal is inexplicably known to him, and speculates on an evolutionary
solution to the problem of scarcity. All of these themes were absorbed
from his mentors and were to become hallmarks of Keynes's later
works.

To begin with, Keynes ([1920] 1971, p. 19) points to the “immense
accumulations of fixed capital” which occurred, “to the great benefit
of mankind,” in the fifty years leading up to the World War I and
attributes these to the inequality of the distribution of wealth in favor
of that class least likely to consume it. Thus the maintenance and
accumulation of capital depends on what Keynes ([1920] 1971, p. 19)
calls “a double bluff or deception.” On the one hand, the laboring
classes were deceived into accepting “a situation in which they could
call their own very little of the cake that they and Nature and the
capitalists were cooperating to produce” (Keynes [1920] 1971, p. 20). The
capitalists, on the other hand, were equally deceived because, although


===== PAGE 16 =====

18 The Review of Austrian Economics, Vol. 6, No. 1

the greatest part of the national income “cake” accrued to them, it
could remain in their possession only “on the tacit underlying condi-
tion that they consumed very little of it in practice” (Keynes [1920]
1971, p. 20). Any attempt by the capitalists to exercise their de jure
right to expend their vast accumulation of wealth on present con-
sumption would provoke the wrath of the much more numerous
laboring class and result in the capitalists’ expropriation.

But how was this elaborate deception maintained, by whom, and
to what end? According to Keynes, the deception was maintained by
ordaining saving as a virtue and the consequent growth of the capital
structure and national income as “the object of true religion.” Says
Keynes ([1920] 1971, p. 20), “There grew round the non-consumption
of the cake all those instincts of puritanism which in other ages has
withdrawn itself from the world and has neglected the arts of production
as well as those of enjoyment.” But, clearly, saving or “the non-consump-
tion of the cake” is, from the individual's point of view, without reason
or purpose. The conventional motives of saving for one’s dotage or for
one’s offspring, Keynes ([1920] 1971, p. 20) suggests, were based on a
self-delusion, for “the virtue of the cake was that it was never to be
consumed, neither by you nor by your children after you.”

Who is the perpetrator of this grand deception and the founder of
the false religion of saving? Keynes’s answer is a hypostatized Society,
which is wisely propelling humanity forward to the millennium
through the actions of the deluded savers and investors. Writes
Keynes ({1920] 1971, pp. 20-21):

In the unconscious recesses of its being Society knew what it was
about. The cake was really very small in proportion to the appetites
for consumption, and no one, if it were shared all round, would be
much the better off by the cutting of it. Society was working not for
the small pleasures of today, but for the future security and improve-
ment of the race. . ..

The progressive accumulation of capital insures that, eventually,
Society reaches its pre-ordained goal, the problem of scarcity is resolved
and the millennium is at hand. As Keynes ([1920] 1971, p. 21) prophe-
sies, “[iln that day overwork, overcrowding, and underfeeding would
have come to an end, and men, secure of the comforts and necessities
of the body, could proceed to the nobler exercises of their faculties.”
Note that Keynes's brief description of the millennial state reflects
the narrov- Marshallian conception of scarcity as the inability to
provide for the basic human wants of food, shelter, and clothing. Once
such biological needs are adequately met, humanity is freed from the
shackles of scarcity to pursue, if it only will, ennobling activities.


===== PAGE 17 =====

Salerno: The Development of Keynes's Economics 19

Note also that, for Keynes, the primary force propelling humanity
toward its destiny is not Marshallian free enterprise rendered pure
and chivalrous but capital accumulation pure and simple. This is why,
as Brunner (1987, p. 37) has recognized, “Keynes was very much
concerned with the accumulation of real capital in modern econo-
mies.” As we will see, Keynes never wavered in his belief that capital
is the foremost agent of social transformation.

Also noteworthy is Keynes’s view that the accumulation of capital
and, hence, the progress of society toward the millennium depends
on a thoroughly irrational propensity of human beings to save. This
poses a conundrum of great moment which Keynes, at this early
stage, attempts to resolve by reference to mysterious social forces
that perpetrate a “double bluff.” The bluff misleads two classes of
individuals, capitalists and laborers, whose interests are irrevocably
opposed, into undertaking activities and entering into social arrange-
ments that are in the interests of neither class. But Keynes was
understandably uneasy with this resolution and, as I shall argue
below, the evolution of Keynes's technical economics can be viewed as
a long struggle to unravel the conundrum.

In a series of articles written in the 1920s, Keynes further trans-
formed Marshall's millennialist vision by incorporating additional
elements of Moore’s philosophy into it. In particular, Keynes called
into question what was firmly averred by Marshall: the intrinsic
value of the activities and mental states inspired by competitive
capitalism. Keynes also emphatically rejected Marshall’s belief that
humanity’s millennium lay in the distant future and that progress
toward this desideratum still demanded stiff present sacrifices. For
Keynes, the millennium was close at hand, and humanity would be
wise to sample its fruits in the present.

In “A Short View of Russia,” first published in 1925, Keynes
([1931] 1963, pp. 297-311) favorably contrasts the religious spirit at
the core of Russian communism to the spiritual poverty that attends
the pursuit of money-making under modern capitalism. According to
Keynes ([1931] 1963, pp. 302-03),

[the] emotional and ethical essence [of Leninism] centers about the
individual's and the community's attitude toward the Love of Money.
... [IIn the Russia of the future it is intended that the career of
money-making, as such, will simply not occur to a respectable young
man as a possible opening, any more than the career of a gentleman
burglar or acquiring skill in forgery and embezzlement. Even the
most admirable aspects of the love of money in our existing society,
such as thrift and saving, and the attainment of financial security
and independence for one’s self and one’s family, whilst not deemed


===== PAGE 18 =====

20 The Review of Austrian Economics, Vol. 6, No. 1

morally wrong, will be rendered so difficult and impracticable as to
be not worth while.

Even in the contemporary Russia he was observing, Keynes
([1931] 1963, p. 304) detected evidence of the denigration of money-
making, remarking that “[t]he private trader is a sort of permitted
outlaw, without privileges or protection, like the Jew in the Middle
Ages—an outlet for those who have overwhelming instincts in this
direction, but not a natural or agreeable job for the normal man.”
Keynes ([1931] 1963, p. 304) deems a society which treats money-
making in this manner “a tremendous innovation.”

In comparison to communism, Keynes ([1931] 1963, pp. 306-07)
portrays capitalism as “absolutely irreligious, without internal
union, without much public spirit, often, though not always, a mere
congeries of possessors and pursuers.” In order to survive in the face
of its profound spiritual poverty and in the teeth of “religious Com-
munism,” capitalism must prove itself to be not merely more efficient
than communism but many times more efficient. In Keynes's estima-
tion, however, capitalism at the beginning of the twentieth century
had proven itself to be only “moderately successful.” In fact, in breach
of another tenet of the Marshallian faith, Keynes wonders whether
capitalism is losing its efficacy, and therefore its limited value, as a
means of economic progress and social transformation.

Keynes ({1931] 1963, p. 307) confesses his doubts in the following
terms:

We used to believe that modern capitalism was capable, not merely
of maintaining the existing standards of life, but of leading us
gradually into an economic paradise where we should be compara-
tively free from economic cares. Now we doubt whether the business
man is leading us to a destination far better than our present place.
Regarded as a means he is tolerable; regarded as an end he is not so
satisfactory.

If capitalism is not leading toward the millennium, then Keynes
([1931] 1963, p. 307) questions “whether the material advantages of
keeping business and religion in different compartments are suffi-
cient to balance the moral disadvantages.” He explicitly rejects the
“Protestant and Puritan” view that business and religion naturally
belong to different domains, as well as the view of the Marshallian
“believer in progress,” who affirms capitalism “as the means to the
establishment of heaven upon earth hereafter.” In their place, Keynes
counsels a radically present-oriented, Moorite “third state of mind,”
which exalts the pursuit and enjoyment of the ethical good in the here
and now.


===== PAGE 19 =====

Salerno: The Development of Keynes's Economics 21

According to Keynes ([1931] 1963, pp. 307-08), those who have
attained to this third state of mind:

do not fully believe either in a heaven which is elsewhere or in
progress as a sure means towards a heaven upon earth hereafter; and
if heaven is not elsewhere and not hereafter, it must be here and now
or not at all. If there is no moral objective in economic progress, then
it follows that we must not sacrifice, even for a day, moral to material
advantage—in other words, that we may no longer keep business and
religion in separate compartments of the soul.

Whether or not capitalism remains a useful means for further
amelioration of the economic problem, Keynes affects no doubt as to
its degraded moral quality, because it distracts men from the imme-
diate enjoyment of exalted mental states, while absorbing their
minds and lives in the love and pursuit of money and in its accumu-
lation for an ever-receding future. Thus Keynes ([1931] 1963, p. 308)
concludes that “it seems clearer every day that the moral problem of
our age is concerned with the love of money, with the habitual appeal
to the money motive in nine-tenths of the activities of life, with the
universal striving after individual economic security as the prime
object of endeavor, with the social approbation of money as the
measure of constructive success, and with the social appeal to the
hoarding instinct as the foundation of the necessary provision for the
family and for the future.”

In “Am I a Liberal?” also first published in 1925, Keynes ([1931]
1963, pp. 323-38) embraces the theory of stages of economic develop-
ment outlined by the American institutionalist, Joseph R. Commons.
Commons’s first epoch, the Era of Scarcity, is marked by very little
individual liberty and a great deal of coercive control exercised by
governmental and other institutions. This, Keynes (1925, p. 334) tells
us, was “the normal state of the world up to (say) the fifteenth or
sixteenth century.” The transition to Commons’s Era of Abundance
occurred in the seventeenth and eighteenth centuries and culminated
“gloriously in the victories of laissez-faire and historic Liberalism” in
the nineteenth century (Keynes [1931] 1963, pp. 334-35). In this
epoch, individual liberty is given its full head and coercive political
control is minimized.

The contemporary world, according to Keynes and to Commons,
was in transition to the third stage, characterized by Keynes as the
Era of Stabilization. Keynes ([1931] 1963, p. 335) argues that prog-
ress into this stage requires “[t]he transition from economic anar-
chy to a regime which deliberately aims at controlling and direct-
ing economic forces in the interests of social justice and social
stability. . . .” No longer can “the economic Juggernaut [be] allowed


===== PAGE 20 =====

22 The Review of Austrian Economics, Vol. 6, No. 1

to crash along the highway of Progress without obstruction and even
with applause,” as it was allowed to do in the nineteenth cen
(Keynes [1931] 1963, p. 337). For Keynes ([1931] 1963, p. 335), “laissez-
faire individualism and the free play of economic forces” have outlived
their usefulness while socialism offers no better alternative because
both are “Sprung from the presuppositions of the Era of Abundance.”

Like Moses, capitalism had gotten society within sight of the
promised land but was morally unfit to enter. Now, Keynes believed,
an alternative system must be devised and readied to secure human-
ity in its impending enjoyment of millennial bliss. Yet a more imme-
diate source of concern for Keynes involved certain defects which he
perceived in the technical operation of laissez-faire capitalism, particu-
larly in the area of money, and which needed to be remedied to assure
a smooth transition to the millennium. It was the task and destiny of
what Keynes ([1931] 1963, pp. 335, 337) referred to as the “New Liberal-
ism” to prepare the solutions to the immediate technical problems of the
transition as well as to “invent new wisdom for a new age.”

Unlike Marshall, Keynes did not foresee a spontaneous remedy
for capitalism’s technical shortcomings and moral failings in the
replacement of the profit motive by Victorian chivalry. It was on this
issue that Keynes abandoned Marshall for Burke.

Keynes's Burkean tract “The End of Laissez Faire,” which first
appeared in print in 1926, proposes an “Agenda of State,” which is
aimed at effecting “improvements in the technique of modern Capi-
talism by the agency of collective action” (Keynes [1931] 1963, p. 319).
The criterion governing these agenda, according to Keynes ([1931]
1963, p. 317), is not to replace private decisionmaking with State
decisionmaking but relates “to those decisions which are made by no
one if the State does not make them.” Three examples of the applica-
bility of State agenda are given by Keynes.

First there are the “economic evils” associated with risk, uncer-
tainty, and ignorance, including inequality of wealth, unemployment
of labor, and reduction of efficiency and production. The State agen-
dum in this matter lies in “deliberate control of the currency and of
credit by a central institution” and “the collection and dissemination
on a great scale of data relating to the business situation,” including
the legally coerced publication of all useful business facts (Keynes
[1931] 1963, pp. 317-18). (Regarding the latter, business secrecy had
been an especial bugbear of Marshall’s.)

The second example Keynes ([1931] 1963, pp. 318-19) offers
refers to saving and investment. In this area, the State agendum is
to provide “a co-ordinated act of intelligent judgment” regarding how
much the nation should save, what proportion of aggregate savings


===== PAGE 21 =====

Salerno: The Development of Keynes’s Economics 23

should be invested abroad, and whether the private capital market
is channeling domestic investment to the most productive uses.

The third agendum of State mentioned by Keynes ([1931] 1963,
p. 319) is control of the quantity and quality of the national popula-
tion. Keynes still has enough of the classical economist in him to fear
that the Malthusian devil may forever bar the door to the millennium
by wasting the fruits of capital accumulation on sustenance for an
ever-expanding population. Keynes's reference to the Marshallian
devil of a genetically incorrigible residuum is veiled and tentative:
“The time may arrive . . . when the community as a whole must pay
attention to the innate quality as well as to the mere numbers of its
future members” (Keynes [1931] 1963, p. 319).

Having contrived Burkean expedients for overcoming problems in
its technique, Keynes once again expresses satisfaction, if only half-
heartedly, that capitalism is capable of producing steady progress to-
ward the millennium. Nevertheless, he is even more firmly convinced
that a new system, which is consistent with Moorite ethical precepts,
must be excogitated as a final replacement for the spiritually desolate
capitalism. Donning the mantle of the millennialist prophet, Keynes
boldly proposes to undertake this task by consulting his internal gnosis.
Thus, he (Keynes [1931] 1963, pp. 321-22) concludes that:

capitalism, wisely managed, can probably be made more efficient
than any alternative system yet in sight, but that in itself it is in
many ways extremely objectionable. Our problem is to work out a
social organization which shall be as efficient as possible without
offending our notions of a satisfactory way of life.

The next step forward must come, not from political agitation or
premature experiments, but from thought. We need by an effort of
the mind to elucidate our own feelings. . . . We need a new set of
convictions which spring naturally from a candid examination of our
own inner feelings in relation to the outside facts.

Apparently, Keynes took seriously the task he set himself in 1926
and he pondered long and hard on the problems of social evolution in
the next few years. In 1930 he published “Economic Possibilities for
Our Grandchildren,” which is based on ideas expressed in a speech
in early 1928 and wherein is presented a fully developed theory of
humanity’s path to “our destination of economic bliss” (Keynes [1931]
1963, p. 373). In particular, Keynes provides answers to some of the
questions he raised in previous articles. Most importantly, he fore-
tells the process by which human nature will be spontaneously
purged of the pecuniary motive without the necessity of institutional
transformation.


===== PAGE 22 =====

24 The Review of Austrian Economics, Vol. 6, No. 1

While some of Keynes's disciples, including Harrod (1951, p. 399),
discount its significance as a serious expression of Keynes's ideology,
Hession (1984, p. 242) has insightfully characterized this article as
“an important statement of his personal philosophy or Weltanschau-
ung. . . . Indeed, this essay may be regarded as analogous to
Marshall’s ‘Possibilities of Economic Chivalry’ or to John Stuart Mill’s
speculations on the ‘Stationary State,” both well-known examina-
tions of the future of Western Society.”

Significantly, in 1930, Keynes ([1930] 1958) also published his
Treatise on Money, which he had been working on during the previous
five years and which can be seen as a technical guide for carrying out
the State’s agenda with respect to the “gaps” in modern capitalism
caused by uncertainty, foreign investment, and the lack of a mecha-
nism for equating saving and investment. As I shall argue below, the
Treatise was intended by Keynes to be a handbook to guide Burkean
policymakers in their charge of keeping society on course and on time
in the last leg of its journey to the millennium.

Keynes begins “Economic Possibilities” by emphatically reaffirm-
ing his faith in the continuation of economic progress in the face of
widespread and growing doubt attributable to the slowdown of eco-
nomic activity that was beginning to take hold in the world economy
in 1930. In fact, Keynes regards the downturn, quite sanguinely, as
evidence of the transition to the next stage of history. Opines Keynes
([1931] 1963, p. 358): “We are suffering, not from the rheumatics of
old age, but from the growing-pains of over-rapid changes, from the
painfulness of readjustment between one economic period and an-
other. The increase of technical efficiency has been taking place faster
than we can deal with the problem of labor absorption; the improve-
ment in the standard of life has been a little too quick. ...”

As merely a problem of the transition, the downturn can be
remedied by the implementation of the appropriate State agendum.
However, Keynes's express purpose in this essay is not to treat
short-term problems of economic management but “to take wings into
the future” and to reveal his new intuitions regarding the course of
the long-term evolution of British economy and society (Keynes
[1931] 1963, p. 360). He begins by presenting a more detailed stage
theory of history, which focuses almost exclusively on capital accu-
mulation as the agent of social transformation. The first stage of
history spans the period from 2,000 B.C. to 1,700 A.D. and is charac-
terized by a stagnant standard of life for the average man dwelling
in the centers of civilization due “to the remarkable absence of
important technical improvements and to the failure of capital to
accumulate” (Keynes [1931] 1963, p. 360). Keynes's intuition leads


===== PAGE 23 =====

Salerno: The Development of Keynes’s Economics 25

him to speculate that, during some epoch before the dawn of recorded
history, “there must have been an era of progress and invention
comparable to that in which we live today” (Keynes [1930] 1963, p.
361).

Following, then, what we might call the pre-historical and pre-
modern eras is the third stage or “modern age.” Keynes ([1930] 1963,
p. 361) holds that the transition to the modern age was precipitated
by “the accumulation of capital which began in the sixteenth century”
with the influx of gold and silver from the Americas into Spain. Once
begun, the process of capital accumulation begets its own continuous
growth through the wondrous power of compound interest. Gone is
Keynes's belief, expressed in the Economic Consequences of the Peace,
that capital accumulation depends on psychologically unstable and
irrational motives to save. The link between saving and investment
is explicitly severed in the Treatise and Keynes is already halfway to
the views of the General Theory that saving actually impedes the
process of capital investment and destroys its fruits. Thus, in the
latter work, saving is considered the enemy of social evolution and of
the ethical good, to be shown no quarter and hounded unto death
polemically.

For now, Keynes ((1931] 1963, p. 361) writes: “From that time [of
the influx of the precious metals into Spain] until today the power of
accumulation by compound interest, which seems to have been sleep-
ing for many generations, was re-born and renewed its strength. And
the power of compound interest over two hundred years is such as to
stagger the imagination.”

The modern age is also “the great age of science and technical
inventions,” the beginning of which Keynes ([1931] 1963, p. 363) dates
from the sixteenth century and which has been “in full flood” since
the start of the nineteenth century. Keynes estimates that a one-
hundredfold increase of the capital stock combined with rapid tech-
nological advance have worked to raise the contemporary standard
of life in Europe and the United States fourfold since the end of the
pre-modern era. So rapid has been the advance of labor-saving tech-
nology in the decade of the 1920s in Europe, and especially in the
United States, that it has unleashed a new economic affliction which
Keynes ([1931] 1963, p. 364) labels “technological unemployment.”
Thus, for the Keynes ([1931] 1963, p. 364) of 1930, the contemporary
employment situation is only “a temporary phase of maladjustment”
and is, in fact, a welcome harbinger of the impending dawn of the
millennium. According to Keynes ([1931] 1963, pp. 364-65), “All this
means in the long run [is] that mankind is solving its economic

problem. 1 would predict that the standard of life in progressive


===== PAGE 24 =====

26 The Review of Austrian Economics, Vol. 6, No. 1

countries one hundred years hence will be between four and eight
times as high as it is today.”

For support of his assertion that scarcity is a transitory historical
stage, rather than a fundamental and categorial precondition of
human life and action, Keynes draws on the Marshallian classifica-
tion of wants. He distinguishes between two classes of wants, which
he designates as “absolute” and “relative” respectively. Wants of the
second class, which are based on a desire to attain superiority over
one’s fellows, very well may be insatiable “for the higher the general
level, the higher still are they” (Keynes [1931] 1963, p. 365). However,
in the case of absolute wants, “a point may soon be reached, much
sooner perhaps than we are all of us aware, when these needs are
satisfied in the sense that we prefer to devote our further energies to
non-economic purposes” (Keynes [1931] 1963, p. 365). With his typical
gnosticism, Keynes ([1931] 1963, p. 366) then reveals to his readers
that, assuming no significant wars or growth in population, the
economic problem will be solved or “in sight of solution” within one
hundred years and that, therefore, the economic problem is not “the
permanent problem of the human race.”

Echoing Marshall, Keynes ({1931] 1963, p. 367) characterizes the
“real” and “permanent” problem confronting man as “how to use his
freedom from pressing economic cares, how to occupy the leisure,
which science and compound interest will have won for him, to live
wisely and agreeably and well.” In other words, the problem is one of
adjusting human nature to the millennium, and, not surprisingly, it
is a problem to which Moore’s philosophy is the ready-made solution.

The problem stems from the fact that, from its very creation,
humanity has been in a death match with scarcity and, thus, has been
“expressly evolved by nature” to solve the economic problem. The
impending solution of the latter problem therefore deprives human-
kind “of its traditional purpose.” The consequence is that the “ordi-
nary man” will be required to cast aside, within the space of a few
decades, inbred habits and instincts that have served him for centu-
ries (Keynes [1931] 1963, p. 366).

Failure to come to grips with this problem will result, according
to Keynes ([1931] 1963, p. 366), in a “general ‘nervous breakdown,’”
quite like the condition afflicting the wives of the well-to-do in the
United States and England of Keynes's time. In fact, it is these women
who are humanity’s vanguard in the millennium. It is they “who
have been deprived by their wealth of their traditional tasks and
occupations—who cannot find it sufficiently amusing, when de-
prived of the spur of economic necessity, to cook and clean and mend,
yet are quite unable to find anything more amusing” (Keynes [1931]


===== PAGE 25 =====

Salerno: The Development of Keynes's Economics 27

1963,p. 367). In general, the wealthy are humanity’s “advance guard”
in the millennium, “who are spying out the promised land for the rest
of us and pitching their camp there,” and, for the most part, they have
“failed disastrously . . . to solve the problem which has been set them”
(Keynes [1931] 1963, p. 368).

Despite the failures of the vanguard, Keynes is confident that
right thinking can serve as a guide in the millennial “age of leisure
and of abundance,” and he maps out the steps that must be taken in
this direction. In general, his plan involves abandoning the long-ac-
cepted attitudes toward activities and morals that evolved in re-
sponse to the economic problem and inculcating Moorite attitudes in
their stead. In particular, attitudes toward work, money, purposeful-
ness, and futurity must undergo radical transformation.

In the case of work, it is to be recognized as an activity which, in
small doses, is necessary to human contentment or will be for ages to
come. Keynes ([1931] 1963, p. 369) recommends that the work still to
be performed in the millennium be spread very thinly so that every-
one might content himself with a fifteen-hour work week carried out
in three-hour shifts.

There must also be great changes in the code of morals. This is to
be purged of the “pseudo-moral principles” which “ have exalted some
of the most distasteful of human qualities into the position of the
highest virtues” but which were nonetheless necessary to foster the
accumulation of capital (Keynes [1931] 1963, p. 269). For example,
the desire to possess money, valueless and irrational in itself and
finally rendered useless as a means, will be seen for what it is:
according to Keynes ([1931] 1963, p. 369), “a somewhat disgusting
morbidity, one of those semi-criminal, semi-pathological propensities
which one hands over with a shudder to the specialists in mental
disease.” The same reappraisal will take place with regard to customs
and practices involving the distribution of wealth and income, which
while “distasteful and unjust in themselves,” are “tremendously use-
ful in promoting the accumulation of capital” (Keynes [1931] 1963,
pp. 369-70).

Moreover, for Keynes, the individual’s pursuit and accumulation
of wealth is only a subspecies of purposive behavior. Such behavior,
as Keynes recognizes, implies the logical and temporal separation of
means and ends: all action employs means in the present and is aimed
at achieving an end in the more or less remote future (Mises 1966,
pp. 100-01). The elements of futurity and teleology inherent in
purposive action, however, offend Keynes’s Moorite notion of the
good, involving as they do the sacrifice of immediate and direct
experience of timeless, self-contained, and intrinsically valuable


===== PAGE 26 =====

28 The Review of Austrian Economics, Vol. 6, No. 1

mental states. As Mises (1966, p. 100) points out, “[flor contemplative
meditation, time is only duration,” with no distinction between pres-
ent and future; it is purposeful action “that provides man with the
notion of time and makes him aware of the flux of time. . . . [I]t is not
recollection that conveys to man the categories of change and of time,
but the will to improve the conditions of his life.”

Thus, as Keynes also recognizes, the very notion of present and
future is ineluctably bound up with purposiveness. From the insight
that action is necessarily aimed at the future, however, Keynes
([1931] 1963, p. 370) incorrectly deduces a non-marginal or absolute
preference to postpone present consumption forever into the future
or, in the terminology of the later General Theory, a “propensity to
save.” This leads him to lash out at the seeming irrationality of
purposeful activity:

For purposiveness means that we are more concerned with the
remote future results of our actions than with their own quality or
their immediate effects on our own environment. The “purposive”
man is always trying to secure a spurious and delusive immortality
for his acts by pushing his interest in them forward into time. He does
not love his cat but his cat’s kittens; nor, in truth, the kittens, but
only the kittens’ kittens, and so on forward for ever to the end of
cat-dom (Keynes ([1931] 1963, p. 370).

If Keynes had fully grasped the time preference theory of interest,
he would have been aware that acting man does not demonstrate an
absolute preference for future satisfactions (which, of course, implies
forever postponing consumption in the present) but discounts future
vis-a-vis present satisfactions. All other things equal, human beings,
acting in isolation or on the market, will only save and invest re-
sources in provision for the future, if such investment promises a level
of future consumption that exceeds the sacrificed present consump-
tion by an amount that overcomes their subjective time preferences.
The rate of interest, then, is the catallactic reflection of the universal
phenomenon of time preference.

At this point in time, however, Keynes construes capital as an
independently productive factor, coordinate with land and labor and
automatically generating an interest return (a view which he was to
renounce in the General Theory). Keynes thus sees the phenomenon
of compound interest, not as a categorial implication of action, but as
simply another rationalization for the delusive future orientation of
purposive action. For Keynes, interest serves to reinforce and reward
an innate or evolved propensity to wealth accumulation present in
human beings of the “modern age.” This explains Keynes's strange
and oblique reference to the Jews in the following terms: “Perhaps it


===== PAGE 27 =====

Salerno: The Development of Keynes's Economics 29

is not an accident that the race which did the most to bring the
promise of immortality into the heart and essence of our religions has
also done the most for the principle of compound interest and partic-
ularly loves this most purposive of human institutions” (Keynes
[1931] 1963, p. 371).

Once the burden of scarcity and the need for capital accumulation
have been eliminated, the human race will at long last be free to
return to what Keynes ((1931] 1963, p. 371) calls “some of the most
sure and certain principles of religion and traditional virtue” as its
guide in the millennium. Keynes ([1931] 1963, pp. 371-72) recites and
extols these Moorite virtues, while condemning the vices associated
with purposiveness, in terms worthy of the Sermon on the Mount:

avarice is a vice, . . . the exaction of usury is a misdemeanor, and the
love of money is detestable, . . . those walk most truly in the paths of
virtue and sane wisdom who take least thought for the morrow. We
shall once more value ends above means and prefer the good to the
useful. We shall honor those who can teach us how to pluck the hour
and the day virtuously and well, the delightful people who are
capable of taking direct enjoyment in things, the lilies of the field who
toil not, neither do they spin.

But, counsels Keynes ([1931] 1963, p. 372), a century yet must
pass before such values can be embraced and, so, “[a]varice and usury
and precaution must be our gods a little while longer.” Even so,
Keynes ([1931] 1963, p. 373) encourages “mild preparations for our
destiny” in the form of experiments in “the arts of life” as well as in
“the activities of purpose.”

The Renunciation of Marshallian Orthodoxy

As the 1930s wore on and the world economic crisis deepened, how-
ever, Keynes began to doubt that capitalism as constituted could ever
bring about the ripening of the modern age into the millennial. Beset
by this growing doubt, Keynes was inspired to rethink the economics
of capitalism and the implied State agenda as these were presented
in the Treatise on Money in 1930. His exhortation—as expressed in
his popular writings—to experiment in the “activities of purpose,”
i.e., in the institutions and organization of the economy, became more
insistent.

As his thought evolved during this period, Keynes came increas-
ingly to believe that the sins of “avarice, usury, and precaution”
(which, in the language of the General Theory, became “liquidity
preference, interest payments to the rentier, and saving”), not only
were evil and had no use in the paradisiacal age of leisure and
abundance, but were at the root of the economic instability and


===== PAGE 28 =====

30 The Review of Austrian Economics, Vol. 6, No. 1

stagnation of the present age of economic scarcity and therefore must
be expunged by the State. It was at this point that Keynes’s intuition
suggested the extension of the Moorite perspective from personal
ethics and social philosophy to technical economics.

In fact, we already see this beginning to occur in the Treatise.
Here, Keynes breaks the link between saving and investment, theo-
rizing that investment and capital growth can occur without necessi-
tating saving to an equal extent and, conversely, that saving can occur
without generating equal investment, an insight which Keynes,
under the influence of Dennis Robertson, incorporated into his
thought as early as 1926 (Patinkin 1976, pp. 36, 46, 50, 124). How-
ever, while Robertson and the early Keynes argued that excess
investment and excess saving were the consequences of and equal to
bank credit expansion and contraction, respectively, the later Keynes
explicitly and emphatically repudiates this view in controversy with
Robertson and Hayek (Patinkin 1976, pp. 28, 30-31). From the later
perspective of the Treatise, Keynes (1973, p. 251) argues that
“[slaving and investment can get out of gear without any change on
the part of the banking system from ‘neutrality’ as defined by Dr.
Hayek, merely as a result of the public changing their rate of saving
or the entrepreneurs changing their rate of investment, there being
no automatic mechanism in the economic system to keep the two rates
equal” [Emphasis added].

Thus Keynes in the Treatise identifies saving-investment disequi-
libria as arising from within the capitalist economy itself, and there-
fore necessitating a Burkean State agendum to match decentralized
decisions to save and to invest. Moreover, these disequilibria create
instabilities in prices and output, causing what Keynes calls “credit
cycles.” Taking direct aim at the sinful “love of money as a posses-
sion,” Keynes ([1930] 1958, pp. 2, 347) attributes such disequilibria
to the increased “bearishness” of a public, which, in the grip of
heightened uncertainty about the future, is suddenly possessed of an
increased “propensity to hoard” savings deposits and forego owner-
ship of securities. This irrational behavior drives the long-term rate
of interest above its equilibrium level thereby driving down “the value
and volume of new investment.”

In fact, the Treatise was written with the primary purpose of
setting out detailed State agenda for “the control of the rate of
investment,” and, therefore, of capital accumulation and the pace of
the approach to the millennium. This is consistent with Keynes's
statement at the end of “Economic Possibilities for Our Grandchil-
dren” (Keynes [1931] 1963, p. 373) that “[t]he pace at which we can
reach our destination of economic bliss will be governed” by, among


===== PAGE 29 =====

Salerno: The Development of Keynes’s Economics 31

other things, “the rate of accumulation as fixed by the margin be-
tween our production and our consumption.”

Not surprisingly, as Patinkin (1976, pp. 125-26 6n) has pointed
out, the Treatise is infected with a “magic-formula mentality.” Surely
someone who is blessed with knowledge of history’s final goal can be
presumed to have the formula for reaching that state. Thus, Keynes
(1973, p. 354) himself refers to the Treatise’s “fundamental equations”
of price-level determination as “my secret” to the explanation and,
presumably, to the remedy of booms and slumps. The remedy Keynes
advocates in the Treatise for disequilibrium between saving and
investment is bank rate and Treasury bill policy. Especially during a
slump, Keynes believed that central bank action designed to lower
interest rates and spur investment must be complemented by inter-
national central bank cooperation or, if cooperation is either not
forthcoming or not successful, supplemented by government borrow-
ing for expenditures on public works (Patinkin 1982, pp. 205-07).

Patinkin (1976, p. 55) characterizes the development of Keynes's
technical economic thought between the publication of the Treatise
and the publication of the General Theory as progressing through
three stages. These stages can be related to the progressive shatter-
ing of Keynes's Marshallian faith, under the impact of the Great
Depression, in the efficacy of contemporary capitalism to maintain a
rate of capital accumulation sufficiently high to see society through
the transition to the millennium within a reasonable period of time,
i.e., Keynes's prophesied one hundred years. In the face of his lapsing
faith in the Marshallian orthodoxy, Keynes began to formulate a
deliberately “heretical” economics which emphasized the Moorite
value of radical present orientation in private and governmental
spending decisions as the key to restarting and maintaining the
engine of capital accumulation on the road to the age of leisure and
abundance. Conversely, the new faith sought to “criminalize” saving,
particularly the piling up of idle and barren money balances, and the
taking of interest as the main impediments to capital accumulation.

In 1930, although he declared that the desire to possess money
as an end in itself would be recognized as a “semi-pathological,
semi-criminal propensity” in the coming age of abundance and lei-
sure, Keynes did not dissent in the slightest from the orthodox
Marshallian economic doctrine that such a propensity was necessary
to the achievement of permanent victory over economic scarcity.
However, by the time the General Theory was published in 1936, the
moral crimes of “liquidity preference” and “the propensity to save” stood
indicted by Keynes, the Moorite heretic, as the main obstructions on the
road to the solution of the economic problem. In explicit opposition to


===== PAGE 30 =====

32 The Review of Austrian Economics, Vol. 6, No, 1

Marshall’s belief that the constraint on capital accumulation is to be
explained by “the preference which the great mass of humanity have
for present over deferred gratifications,” Keynes ([(1936] 1964, p. 242),
writing in the General Theory, propounded the doctrine that the
paucity of accumulated capital “after several millennia of steady
individual saving... is to be explained. . . neither by the improvident
propensities of mankind, nor even by the destruction of war, but by
the high liquidity-premiums formerly attaching to the ownership of
land and now attaching to money.”

Let us now examine the process by which, during the crucial
period of 1930-36, Keynes transformed his technical economics by the
infusion of Moorite insights. In the first stage of this transformation,
(which by Patinkin’s account lasted through 1931), Keynes was en-
gaged in what Patinkin (1976, p. 55), borrowing Moggridge’s termi-
nology, calls the “arguing out of the Treatise.” During this time
Keynes continued to adhere to the technical economics and policy
prescriptions of the Treatise and, on the broadly philosophical side,
to his earlier belief that current institutional arrangements would
continue to produce steady progress to the millennium. Nonetheless,
toward the end of this period, Keynes waxed increasingly critical of
the role of saving in perpetuating Britain's slump and was perfervid
in his advocacy of a massive increase in public and private spending
as the cure for the depression.

In an article published in January 1931, Keynes ([1931] 1963, pp.
152-54) declaimed against increased thrift and in favor of unleashing
“the improvident propensities” of both consumers and government as
a remedy for depression:

The best guess I can make is whenever you save five shillings, you
put a man out of work for a day. Your saving that five shillings adds
to unemployment to the extent of one man for one day—and so on in
proportion. On the other hand, whenever you buy goods you increase
employment—though they must be British, home-produced goods if
you are to increase employment in this country... .

Therefore, oh patriotic housewives, sally out tomorrow early into
the streets and go to the wonderful sales which are everywhere
advertised. . . . Lay in a stock of household linen, of sheets and
blankets to satisfy all your needs. And have the added joy that you
are increasing employment, adding to the wealth of the country
because you are setting on foot useful activities. . . .

For what we need now is not to button up our waistcoats tight,
but to be in a mood of expansion, of activity—to do things, to buy
things, to make things. .. . Now is the time for municipalities to be
busy and active with all kinds of sensible improvements. . . .

Nationally, too, I should like to see schemes of greatness and


===== PAGE 31 =====

Salerno: The Development of Keynes's Economics 33

magnificence designed and carried through. . . . For example, why
not pull down the whole of South London from Westminster to
Greenwich, and make a good job of it—housing on that convenient
area near to their work a much greater population than at present,
in far better buildings with all the conveniences of modern life, yet
at the same time providing hundreds of acres of squares and avenues,
parks and public spaces. . . . Would that employ men? Why, of course
it would.

The great weight placed on current spending in the foregoing
passage and the lack of reference to techniques of monetary policy in
the balance of the article from which it is extracted represents a
departure, at least in emphasis, from the agenda Keynes elaborated
in the Treatise for righting a capitalist economy in a slump. Also, in
this passage the view is clearly expressed—which is at the core of the
technical economics of the General Theory and is not to be found in
the Treatise—that, in depression conditions, spending per se is pro-
ductive of income.

Despite all this, however, Keynes ([1931] 1963, pp. 155-56), at
the end of the article, is at pains to demonstrate that labor produc-
tivity and national income are continuing to grow at a healthy clip.
He concludes with a stirring reaffirmation of his Marshallian belief
that the slump is evidence of an ongoing transition to the millennium:

Be confident, therefore, that we are suffering from the growing pains
of youth, not from the rheumatics of old age. We are failing to make
full use of our opportunities, failing to find an outlet for the great
increase in our productive powers and our productive energy. There-
fore we must not draw in our horns; we must push them out. Activity
and boldness and enterprise, both individually and nationally, must
be the cure. (Keynes [1931] 1963, p. 156)

In a series of lectures presented in June 1931 and published the
same year, it is evident that Keynes (1973, pp. 343-67) is still
analyzing the depression from the philosophical perspective and
using the theoretical apparatus of the Treatise. Thus, he draws
attention to the worldwide investment boom which occurred in the
lustrum 1925 to 1929, speculating that “[a] very few more
quinquennia of equal activity might, indeed, have brought us near to
the economic Eldorado where all our reasonable economic needs
would be satisfied” (Keynes 1973, p. 348).

In a polemical swipe at supporters of the Mises-Hayek theory of
the business cycle, represented in Great Britain by Lionel Robbins
and other economists associated with the London School of Econom-
ics, Keynes (1973, p. 349) chastises those “austere and puritanical
souls” who hold that the investment boom was inflationary and


===== PAGE 32 =====

34 The Review of Austrian Economics, Vol. 6, No. 1

unsound and, therefore, requires a period of liquidation. For Keynes,
any acquiescence in a period of “prolonged liquidation” of previous
capital investments postpones or even reverses progress toward the
millennium. The thing is to get the aborted investment boom re-
started as quickly as possible. What is required, according to the
“magic formula” of the Treatise, is to restore business confidence and
profits via “a drastic fall in the long-term rate of interest” (Keynes
1973, p. 359).

Striking a Burkean note, Keynes (1973, p. 365) emphasizes that
it is “the prime object of financial statesmanship” to insure that the
long-term rate of interest is properly adjusted to “the technical
possibilities of [the] age,” so as to produce equality between the
volume of savings and the demand for new capital. Failure to achieve
such equality will not only produce cyclical fluctuations but runs the
risk of throwing society off its long-run course to economic bliss.

Keynes (1973, p. 369) concludes:

Thus we need to pay constant attention to the long-term rate of
interest for fear that our vast resources may be running to waste
through a failure to direct our savings into constructive uses and
that this running to waste may interfere with that beneficent
operation of compound interest which should, if everything was
proceeding smoothly in a well-governed society, lead us within a
few generations to the complete abolition of economic want.

It is thus clear that Keynes's vision of capitalism during the
period of “arguing out the Treatise” was still a fundamentally
Marshallian one of a self-steering vehicle carrying humanity forward
along the road to the millennium. Although this vehicle proceeded
unsteadily in fits and starts, Keynes did not doubt that its direction
on balance was forward and that it would eventually reach its desti-
nation. Extending the metaphor, what the vehicle lacked, according
to Keynes, was not so much a pilot as a governor to steady and
maximize its rate of speed in order to expedite its journey. In partic-
ular, saving and investment rates needed to be governed and equili-
brated at the margin by means of continual political manipulations
of the long-term interest rate.

As the world and Britain’s economic crisis deepened, however,
Keynes began to doubt the accuracy of this vision. The vehicle had
stopped dead in its tracks and was even threatening to reverse its
course. Capitalism had ceased to deliver the goods, now or in the
future, as both consumption and investment shrank to drastically low
levels. By 1932, Keynes entered into what Patinkin (1976, pp. 55, 61)
calls “the formative stage of the General Theory.” It was during this
period that Keynes consciously set out to overturn the Marshallian


===== PAGE 33 =====

Salerno: The Development of Keynes’s Economics 35

orthodoxy and found a self-proclaimed heretical religion based on
Moorite ethics. .

In an unpublished two-page note, probably written in 1932,
Keynes (1973, pp. 406-07) confesses his apostasy, at the same time
revealing the central tenets of his new faith. First, he denies that the
capitalist economy embodies “natural forces” which operate to restore
output to its “optimum level” whenever it is disturbed. Second,
Keynes) singles out “the strength of the forces in the community
which tend toward saving” as the factor which causes real output to
achieve an equilibrium at a level below the optimum. Contrary to the
“orthodox theory,” which emphasized “the importance of saving as the
means of making a community wealthy,” Keynes stresses the primacy
of investment. He also denounces orthodox policy prescriptions, re-
vealing that “it now seems to me that the economists, in their
devotion to a theory of self-adjusting equilibrium, have been, on the
whole, wrong in their practical advice and that the instincts of
practical men have been, on the whole, sounder.”

Keynes (1973, p. 407) also upholds certain policies favored by
“uninstructed public opinion and the common sense of the business
world” as “tending towards optimum output.” These include: “Mer-
cantilist and protectionist policies,” which tend to foster foreign
investment by improving the balance of trade; “Anti-usury laws
and principles and cheap money policies,” which reduce the rate of
interest thereby spurring domestic investment; and “Expenditure
as a thing in itself ‘good for trade’” since it decreases saving in
excess of investment. These “popular policies” are economically
justified, declares, because, under modern capitalism, “it is a normal
thing . . . for output to be below the optimum level.”

Keynes concludes with the suggestion, which was to become a
central insight of the General Theory, that an increment in invest-
ment will generate the saving necessary to finance itself. Writes
Keynes (1973, p. 407): “Thus so far from its being true that, if we look
after saving, output and investment will look after themselves, the
opposite is more nearly true, namely that, if we look after investment,
output and saving will look after themselves. For it is frequently the
case in practice that a deliberate increase in saving will diminish
investment and hence output . . . while a deliberate increase in
investment will increase output and hence saving.”

Now, it is true that in 1932, Keynes had not yet elaborated the
theoretical structure to properly house these insights. As Patinkin
(1973, p. 72) says of this among, other fragments of Keynes's writings
in 1932, “[t]he voice is that of the General Theory: but the analytical
framework is still largely that of the Treatise.” And, it might be added,


===== PAGE 34 =====

36 The Review of Austrian Economics, Vol. 6, No. 1

the voice is clearly calling for economic salvation through renuncia-
tion of the sin of saving. For Keynes, at long last, the precepts of
economic rationality have become one with those of virtuous behav-
ior. Virtue receives its reward in this age as well as in the next, after
all; and one can have one’s economic pie in the millennium and still
consume it in the here and now.

In 1933, Keynes published an article entitled “National Self-Suf-
ficiency,” whose significance has been downplayed by his followers.
Generally, if it is alluded to at all, it is treated ‘as a temporary
deviation by Keynes from his internationalist principles in a desper-
ate and ill-advised search for an expedient to alleviate domestic
unemployment (Harrod 1951, p. 446; Harris 1955, pp. 186-87; Harris
([1947] 1973, pp. 319-22). One of the few to grasp its true import was
the neglected international monetary economist Michael A. Heilperin
(1962, pp. 111, 116), who referred to the article “for all its brevity, as
one of Keynes’s most significant writings” and as representing “far
more than a passing mood.”

Indeed, the article represents much more than Keynes’s profes-
sion of disbelief—spewed forth in desperation and soon to be re-
tracted—in the classical arguments in favor of free trade and the
international division of labor. When considered in the context of
the development of his Weltanschauung, it is nothing short of
Keynes’s public declaration of a loss of faith in the ability of
capitalism ever to solve the problem of scarcity and deliver society
to the promised land. Accordingly, the article also sends forth a
clarion call for experimentation with alternative economic institu-
tions and arrangements.

Until this point, Keynes had been unwavering in his view that,
despite its intrinsic viciousness, capitalism was tolerable and even
indispensable as the means to a future age of abundance in which
virtue could be cultivated in comfort and leisure. In this article,
Keynes signals a radical departure from this view, arguing now that
capitalism is intolerable because it is unable to deliver humanity from
scarcity and that it is precisely its lapses from virtue that prevent it
from doing so.

Thus Keynes (1933, pp. 760-61) declares that “[t]he decadent
international but individualistic capitalism . . . is not a success. It is
not intelligent, it is not beautiful, it is not just, it is not virtuous—and
it doesn’t deliver the goods. In short, we dislike it, and we are
beginning to despise it.” However, Keynes does confess to perplexity
about what to put in its place, while noting that “the world is
embarking on a variety of politico-economic experiments.” Russia,
Germany, Italy and other countries are or will be seeking “after new


===== PAGE 35 =====

Salerno: The Development of Keynes’s Economics 37

economic gods.” Keynes (1933, p. 761) expects “many mistakes” to be
made in these bold experiments in Bolshevism, Nazism, and Fascism,
but “[n]o one can tell which of the new systems will prove itself best.”

As Heilperin (1962, p. 114 30n) has pertinently remarked on
this passage, “[t]he fact that the ‘new economic gods’ of Russia,
Italy and Germany were totalitarian despotic gods, destructive of
human dignity and human rights did not, it seems, appear worthy
of note. They were experimenting—that was the wonderful thing
about it!” Heilperin’s judgment on the implications of Keynes’s
unbounded zeal for politico-economic experimentation is certainly
borne out by Keynes’s own revelation in the article that he is “one .
whose heart is friendly and sympathetic to the desperate experi-
ments of the contemporary world, who wishes them well and would
like them to succeed, who has his own experiments in view, and who
in the last resort prefers anything on earth to what the financial
reports are wont to call ‘the best opinion in Wall Street’” (Keynes
1933, p. 766).

Keynes’s almost exclusive concern at this point is that capitalism
be gotten rid of, so that the world will be free to experiment. What
replaces it depends on one’s “own fancy.” In Keynes's millennialist
terminology, ‘Inlot believing that we are saved already, we each
should like to have a try at working out our own salvation. We do not
wish, therefore, to be at the mercy of world forces working out, or
trying to work out, some uniform equilibrium according to the ideal
principles, if they can be called such, of laissez-faire capitalism.”
Accordingly, Keynes proclaims the dawning of a “transitional, exper-
imental phase” during which “we all need to be as free as possible of
interference from economic changes elsewhere, in order to make our
own favorite experiments toward the ideal social republic of the
future.”

While Keynes's “favorite experiment,” at least in its economic
aspect, must await full elaboration in the General Theory, he does
offer suggestive hints in this article. In particular, although he favors
“retaining as much private judgment and initiative and enterprise as
possible,” Keynes (1933, p. 762) reveals that he has “become con-
vinced that the retention of the structure of private enterprise is
incompatible with that degree of material well-being to which our
technical advancement entitles us, unless the rate of interest falls to
a much lower figure than is likely to come about by natural forces
operating on the old lines. Indeed, the transformation of society,
which I preferably envision, may require a reduction in the rate of
interest towards vanishing point within the next thirty years.” Eco-
nomic internationalism, by which Keynes means not only the free


===== PAGE 36 =====

38 The Review of Austrian Economics, Vol. 6, No. 1

movement of goods but especially a structure of interest rates deter-
mined on a globally integrated capital market, is thus emphatically
rejected by Keynes (1933, p. 763), because it “may condemn my own
country for a generation to come to a much lower degree of material
prosperity than could be attained under a different system.”

The conventional view, therefore, is doubly wrong in contending
that, for Keynes, economic autarky represented a temporary expedi-
ent for palliating a desperate employment situation in Great Britain.
To the contrary, Keynes's overriding concern, as expressed in the last
paragraph, is not with “full employment” per se, but with what he
. later refers to as “full investment”; and “greater national self-suffi-
ciency and a planned domestic economy” (Keynes 1933, p. 767) is
proposed as a necessary and permanent framework for an economic
experiment—here only alluded to but fully developed in the General
Theory (Keynes [1936] 1964, especially chapters 16 and 24)—in which
the interest rate is reduced to zero and underinvestment and artifi-
cial capital scarcity forever banished from the British Isles.

The long-accepted belief that, in writing the General Theory,
Keynes was seeking to provide a blueprint for “saving capitalism”
from its own instability is thus anachronistic at best. In fact, while
this was indeed Keynes's objective in contriving the “magic formulas”
of the Treatise, he abandoned it after 1931 and certainly by the time
he came to plump for indiscriminate politico-economic experimenta-
tion and national self-sufficiency in 1933. With respect to capitalism,
then, the Keynes of the General Theory is not a savior in any sense
but a vengeful angel come at last to destroy what is immoral and
unaesthetic because it has finally proven useless.

Near the end of his article on “National Self-Sufficiency,” as if to
accentuate the radical and irreversible nature of the “reorientation”
of his mind, Keynes (1933, pp. 763-65) undertakes what can only be
characterized as a diatribe against capitalist society and culture
which is as remarkable for its candor as it is for its unrestrained
vituperativeness. In this, Keynes recognizes and seizes upon eco-
nomic calculation in the form of financial accounting as the intellec-
tual foundation of market economy and the calculating mind as the
consummate product of social evolution under capitalism. Thus, he
contends that consistently judging action by the criterion of “the
financial results” transformed the conduct of life in the nineteenth
century “into a sort of parody of an accountant’s nightmare” (Keynes
1933, p. 763).

Keynes rails against economic calculation because it represents
an artificial constraint on the current use of resources, which is
imposed by the illusory notion of futurity inherent in purposive action


===== PAGE 37 =====

Salerno: The Development of Keynes's Economics 39

and, thereby, obstructs the living of a bountiful and cultured life in
the present. Thus Keynes (1933, pp. 763-64) declares that:

Instead of using their vastly increased material and technical re-
sources to build a wonder city, the men of the nineteenth century built
slums; and they thought it right and advisable to build slums because
slums, on the test of private enterprise, “paid,” whereas the wonder
city would, they thought, have been an act of foolish extravagance,
which would, in the imbecile idiom of the financial fashion, have
“mortgaged the future” —though how the construction today of great
and glorious works can impoverish the future, no man can see until
his mind is beset by false analogies from an irrelevant accoun-
tancy. . . . For the minds of this generation are still so beclouded by
bogus calculations that they distrust conclusions which should be
obvious. . . . We have to remain poor because it does not “pay” to be
rich. We have to live in “hovels,” not because we cannot build palaces
but because we cannot “afford” them.

But once one has “reoriented” his mind to an economics imbued
by the ethical verities, as Keynes has already done by this time, he
is enabled to pierce through the intellectual fog created by economic
calculation and perceive clearly that the active pursuit of virtues and
values in the present calls forth and multiplies the bounty of re-
sources necessary to their attainment. In the technical language of
the General Theory, financing considerations are never a constraint
on private (or public) investment, because investment creates the
saving needed to finance it and raises present income and consump-
tion into the bargain. As Keynes (1933, p. 764) expresses it here: “If
I had the power to-day, I should most deliberately set out to endow
our capital cities with all the appurtenances of art and civilization on
the highest standards of which the citizens of each were individually
capable, convinced of what I could create, I could afford. . ..”

Keynes is especially averse to the “rule of self-destructive finan-
cial calculation,” when it justifies, for example, through the promo-
tion of free trade, the eradication of activities whose unquantifi-
able intrinsic value can find no entry into such calculation. Writes
Keynes (1933, p. 764): “we have until recently conceived it a moral
duty to ruin the tillers of the soil and to destroy the age-long human
traditions attendant on husbandry, if we could get a loaf of bread
thereby a tenth of a penny cheaper.” Such present sacrifices in the
name of economic calculation, “this Moloch and Mammon in one,”
according to Keynes (1933, pp. 764-65), have been carried out with
equanimity because of a delusive concern for the future, “for we
faithfully believed that the worship of these monsters would
overcome the evil of poverty and lead the next generation safely


===== PAGE 38 =====

40 The Review of Austrian Economics, Vol. 6, No. 1

and comfortably, on the back of compound interest, into economic
peace.”

For Keynes (1933, p. 765), the tragedy of adherence to the old
doctrines does not lie in the absolute reduction of the British “standard
of life,” which, even in 1933, is at a higher level than ever before. It
lies mainly in the fact that sacrifices of ethical values and modes of
living have been made and made wholly in vain, because capitalism
has been unable “to exploit to the utmost the possibilities for eco-
nomic wealth afforded by the progress of . . . technique.” The impli-
cation, of course, is the principle of the multiplier by which it is held
that, under the normal operation of capitalism, the present “standard
of life” need never be diminished and is indeed enhanced by an act of
investment, which is aimed at fructifying the future and advancing
society closer to the millennium.

Keynes (1933, p. 765) is thus able to conclude that “once we allow
ourselves to be disobedient to the test of an accountant’s profit, we
have begun to change our civilization.” This, of course, is tantamount
to the call for the progressive socialization of investment, since the
State is the only organization, with its almost unlimited power to
appropriate scarce resources via taxation and monetary inflation,
that is unconstrained by the criterion of economic calculation. This
is realized by Keynes (1933, p. 765), who writes that “[i]t is the state,
rather than the individual, which needs to change its criterion. . . .
Now if the functions and purposes of the state are to be thus enlarged,
the decisions as to what, broadly speaking, shall be produced within
the nation and what shall be exchanged with abroad, must stand high
among the objects of policy.”

Keynes's article on “National Self-Sufficiency” thus presents the
core of what Patinkin (1976, p. 95) labels the “antivision” of the
General Theory. This is the “rejection of the traditional view that
there existed in the capitalist world an automatic, self-adjusting
mechanism that could be relied upon to maintain an acceptable state
of employment” and, I would add, investment. In fact, for Keynes, the
attainment of full-employment levels of income and consumption is
the consequence of and the present reward for expediting progress to
the future state of bliss by deliberately optimizing the rate of invest-
ment.

In a radio address on “Poverty in Plenty: Is the Economic System
Self-Adjusting?” delivered in 1934, Keynes (1973, p. 488) explicitly
ranges himself with “the heretics” who would “demolish the forces of
nineteenth-century orthodoxy.” Bringing his antivision to bear,
Keynes argues that the orthodox or “self-adjusting” school assumes
that “the rate of interest adjusts itself more or less automatically, so


===== PAGE 39 =====

Salerno: The Development of Keynes's Economics 41

as to encourage just the right amount of production of capital goods
to keep our incomes at the maximum level which our energies and
our organization and our knowledge of how to produce efficiently are
capable of providing. This is, however, pure assumption.”

Thus it is the failure of capitalism to provide the optimum level
of investment spending, or, what is the same thing for Keynes, the
maximum rate of progress toward the millennium (given prevailing
consumption habits) which is the root cause of its technical inade-
quacy. For Keynes (1973, p. 491) the solution is straightforward and
closed to all doubt: “The right course is to get rid of the scarcity of
capital goods—which will rid us at the same time of most of the evils
of capitalism—whilst also moving in the direction of increasing the
share of income falling to those whose economic welfare will gain
most by their having the chance to consume more.” Of course, the
solution will not emerge spontaneously from the operation of the
capitalist system and must be imposed from without by the State,
because “[t]he system is not self-adjusting, and, without purposive
direction, it is incapable of translating our actual poverty into our
potential plenty.”

The positive vision of the General Theory, then, emerges out of
Keynes's deliberate use of Moorite philosophical insights and doc-
trines to revolutionize the analytical apparatus of Marshallian eco-
nomic theory in order to provide an explanation of the capitalist
economic process that elucidates the causes and consequences of its
failure to achieve adjustment at an employment- and investment-
maximizing level of output. According to research by Patinkin (1976,
pp. 55, 73), the analytical structure of the General Theory was
completed by mid-1934, and, in the third and final stage of its
preparation lasting through 1935, Keynes was engaged in eliciting
detailed criticisms of the galley proofs of the book.

As identified by Keynes himself (Patinkin 1976, p. 66), the ana-
lytical components the development of which mark entry into the
third stage of transition to the General Theory consist in the theory
of effective demand, the theory of liquidity preference, and the con-
cept of the marginal efficiency of capital. To these three, I would add
the generally overlooked scarcity theory of capital, which Keynes
adumbrated in the General Theory only partly in response to
Hayek’s stinging criticism of the Treatise on Money for lacking
reference to a “clear and definite theory of capital” (Hayek 1931, p.
278). Taken together, these four components form a powerful analyt-
ical apparatus that permits Keynes to weave a vision in which the
sins of futurity and calculation—which characterize purposive action


===== PAGE 40 =====

49 The Review of Austrian Economics, Vol. 6, No, 1

under capitalism—prove also to be irrational, self-defeating, and
socially retrogressive. In particular, according to Keynes, attempts
by individuals to make monetary and financial provision for the
future cause humanity to be less well-provided for in the present and
the future.

The General Theory as Millennialist Economics

Let me broadly indicate the millennialist ethical orientation of the
technical economic analysis of the General Theory.

The theory of effective demand transmutes Keynes's Moorite
emphasis on present activities and states of being from a recipe for
individual salvation into the true path to the social millennium. Thus,
according to Keynes, present employment and income is determined
strictly by effective demand which, with the technical conditions of
production assumed constant, depends solely upon aggregate spend-
ing for consumption and investment activities. While it is evident
that consumption is a present activity, investment, as defined by
Keynes ([1936] 1964, pp. 62, 104), denotes “the current addition to
the value of the capital equipment which has resulted from the
productive activity of the period” and therefore involves “present
provision for future consumption.”

Saving, on the other hand, is defined not in terms of activity but
as the passive “residual or margin” between aggregate income and
consumption (Keynes [1936] 1964, p. 64). As such, saving in the
aggregate cannot be determined independently of the set of decisions
relating to consumption and investment (Keynes [1936] 1964, p. 65).
In the words of Abba Lerner (1983, p. 394): “With S thus almost
completely sterilized (as nothing but the conceptual arithmetic dif-
ference between actual income and actual consumption) it became
easier to concentrate on analyzing only the actual constituents of
income and sources of employment, C and 1.”

With consumption rigidly determined by the propensity to con-
sume—according to Keynes ([1936] 1964, pp. 96-97), a “fairly stable
function” and one of the “ more permanent psychological propensities” —
investment spending becomes the sole factor determining levels of
present as well as of future income and consumption. Hence “employ-
ment can only increase pari passu with an increase in investment;
unless, indeed there is a change in the propensity to consume” (Keynes
[1936] 1964, p. 98). Nor does an increase in investment require an
antecedent increase in saving because, according to “the fundamental
psychological law” governing the marginal propensity to consume, an
increment to social income always calls forth a positive but less than


===== PAGE 41 =====

Salerno: The Development of Keynes's Economics 43

equal increment to consumption. Thus, as income increase, it induces
an automatic increase in saving in the form of an expansion of the
absolute size of the gap between income and consumption. The mul-
tiplier sums up the process by which, with a given marginal propen-
sity to consume, an increase of investment results in a rise in the level
of income sufficient to generate the additional saving necessary to
finance itself.

From Keynes's ethical standpoint, the multiplier apparatus is a
masterstroke because it permits him to argue that investment pro-
motes higher standards of income and consumption in the present as
well as in the future. The all-important growth in society’s capital
stock is no longer dependent on the semi-pathological, semi-criminal,
and, in any event, unethical propensity to abstain from present
enjoyments in order to provide for a chimerical and ever-receding
future. The ethical maxim of the Sermon on the Mount is thus
transformed into the eminently practicable policy prescription of
rational economics: those who would be well cared for, in the present
and in the future, are those who do not trouble themselves overmuch
about provision for the future.

But Keynes is not satisfied merely with demonstrating that
individual efforts to provide for the future by financial accumulation
are superfluous to the process by which social income and capital are
created; he seeks to portray private saving as self-defeating and
socially destructive. Here, again, the concepts of effective demand
and the multiplier are ready at hand. Any attempt by an individual
to increase saving by accelerating the rate at which he “pile[s] up
claims to enjoyment which he does not intend to exercise at any
definite time” (Keynes [1936] 1964, p. 131), ipso facto, lowers the
propensity to consume and causes a slackening of effective demand.
The result is a destruction of social income whose size is a determi-
nate multiple of the original reduction in consumption.

However, the social ravages of vicious and irrational precau-
tion do not end with reductions in the current income level; the
greater enormity lies in its retardation of the growth of the capital
stock, resulting from the circumstance that estimates of the pro-
spective yield rate or marginal efficiency of capital partly depend
on “the strength of the existing consumers’ demand for goods that
require for their efficient production a relatively larger assistance
from capital” (Keynes [1936] 1964, p. 147). For Keynes ([1936] 1964,
p. 106), therefore, “every weakening in the propensity to consume
regarded as a permanent habit must weaken the demand for
capital as well as the demand for consumption.” Thus, a decline in
investment due to a weakening propensity to consume reduces


===== PAGE 42 =====

44 The Review of Austrian Economics, Vol. 6, No. 1

potential future income and living standards at the same time that
it aggravates the declines in current levels of effective demand,
income, and consumption.

The ultimate and cruel irony, of course, is that the individual's
attempt to increase saving is incapable of generating a realized
increase of saving in the aggregate and, in fact, serves to reduce
aggregate realized saving, since the margin between income and
consumption, as determined by the marginal propensity to consume,
necessarily narrows as the level of income decreases. As Keynes
([1936] 1964, p. 65) puts it, “A decision to consume or not to
consume truly lies within the power of the individual; so does a
decision to invest or not to invest.” But aggregate saving is merely
one of the “results of the free choices of individuals whether or not to
consume and whether or not to invest. . . .”

Based on his economic analysis of saving as a self-frustrating and
socially deleterious activity, Keynes ([1936] 1964, p. 161) contemplates,
as “the only radical cure” for economic crises, that saving be outlawed,
that is, that the individual be allowed “no choice” between spending his
income on consumption or investment in a “specific capital asset” and
saving it in the form of cash hoards or debt purchases. As we shall see,
however, Keynes ultimately opts for an alternative set of policies involv-
ing the socialization of investment and the euthanasia of the rentier via
the reduction of the rate of interest to zero.

This brings us to the marginal efficiency of capital (MEC), which
Keynes defines as the prospective rate of return on an increment of
monetary investment in the current production of capital goods. For
Keynes ([1936] 1964, p. 145), the MEC schedule “is of fundamental
importance because it is mainly through this factor (much more than
through the rate of interest) that the expectation of the future influ-
ences the present.” In this passage, the parenthetical remark about
the rate of interest underscores Keynes’s determination to maintain
a rigid analytical distinction between the concepts of the MEC and
the rate of interest. Indeed, Keynes ([1936] 1964, pp. 192-93) devotes
a special excursus to refuting those Austrian-Wicksellian interest
theorists, such as Mises, Hayek, and the early Alvin Hansen, who
identify the basic rate of interest with the rate of price differentials
between the products of successive stages of the structure of produc-
tion. These writers, as well as Keynes of the Treatise (Keynes [1936]
1964, pp. 173-74), stand accused of “confusing the marginal efficiency
of capital with the rate of interest.”

The apparent eagerness with which Keynes seeks to disentangle
the two concepts can be explained by their different standings in
terms of his ethical thought. The MEC represents a return to a


===== PAGE 43 =====

Salerno: The Development of Keynes's Economics 45

current and productive activity, investment, which is legitimately,
even nobly, future-oriented. In Keynes’s words, “[t]he social object of
skilled investment should be to defeat the dark forces of time and
ignorance which envelope our future” (Keynes [1936] 1964, p. 155).
The rate of interest, in contrast, is a sop to avarice, a “bribe” paid to
the nonproductive saver to induce him to part with liquidity, an
irrational and nugatory provision for the future.

For Keynes, the all-important task of estimating the prospective
rate of return on newly-produced capital equipment is apt to be badly
done under capitalism, because open markets and monetary calcula-
tion tend to promote irrational expectations of the more remote
future. Keynes's argument runs briefly as follows: The knowledge
which governs our expectations of the outcome of a long-term invest-
ment rests on an extremely precarious basis at best and “is usually
very slight and often negligible” (Keynes [1936] 1964, p. 149). Thus,
were it not for the fact that human beings take direct pleasure in the
riskiness and activity of constructing factories and farms, not much
investment would be undertaken “merely as a result of cold calculation”
(Keynes [1936] 1964, p. 150). However, under modern capitalism, it is
precisely considerations of cold calculation which predominate in invest-
ment decisions, because the irrational striving for liquidity has led to
the emergence of the stock exchange, an organized market on which
investments may be resold and revalued on a daily or even hourly basis.

The result is that most investments come to be “governed by the
average expectation of those who deal on the stock exchange as
revealed in the price of shares, rather than by the genuine expecta-
tions of the professional entrepreneur.” Hence, for example, if an
existing investment can be had on the stock market at a purchase
price below the cost of constructing a new investment of a similar
type, this class of investment will be discouraged regardless of its
prospective yield. Moreover, the average investor, because his knowl-
edge of the factors governing the prospective yield of the various
investment opportunities is virtually nil, bases his decisions on an
“arbitrary convention,” according to which it is assumed that the
existing market valuation of the investment reflects the existing
knowledge of the facts which determine its yield and is therefore
“uniquely correct” (Keynes [1936] 1964, pp. 152-53). A change in the
investment’s market value will only occur, therefore, as a result of
the (presumably slow and orderly) revision of knowledge as new and
relevant facts come to light.

However, such “conventional valuation,” in actuality, is not based
on genuine, if incomplete, knowledge of the future laboriously accu-
mulated by the experts, but on the “state of confidence” of the mass


===== PAGE 44 =====

46 The Review of Austrian Economics, Vol. 6, No. 1

of ignorant investors, which reflects their vague, uninformed, and
mercurial doubts, fears, and hopes. Any change in the state of confi-
dence, whether or not in reaction to events reasonably expected to
effect long-term investment prospects, brings about a dissolution of
the existing conventional valuation and the emergence of a new one.
As a consequence, investment markets are inherently volatile and,
therefore, divert “the energies and skill of the professional investor
and speculator” from attempting to forecast the long-term prospec-
tive yield of an investment to contriving to beat the mass of investors
in foreseeing and profiting from short-term changes in the conven-
tional basis of valuing stocks (Keynes [1936] 1964, p. 154).

For Keynes ([1936] 1964, p. 153), then, it is ultimately perfidious
calculation and irrational convention that account for the “problem
of securing sufficient investment.” As noted above, both calculation
and convention represent serious departures from the ethical code
Keynes supposes will prevail in the millennium. The absorption of
one’s skill and energy in the service of monetary calculation is the
very negation of the Moorite notion of the ideal life as the enjoyment
of a sequence of good states of mind. The reason is that money, as
Keynes ([1931] 1963, p. 356) characterized it, is “the grand substitute
motive, the perfect Ersatz, the anodyne for those who, in fact, want
nothing at all.”

Regarding the ethics of relying upon convention as a guide to
action in the face of an uncertain future, which was a position
espoused by Moore himself, the theory of probability propounded by
Keynes in the Treatise on Probability implies that such a reliance is
irrational, and therefore counterproductive, as a means to attaining
the good. As pointed out above, in Keynes’s approach to probability,
a probability exists in favor of an action as long as the balance of
existing evidence, however slight or precarious such evidence is,
suggests that it is the most productive of desirable results. Applied
to the case of a long-term investment, therefore, although knowledge
of the factors affecting the success of its outcome is bound to be
precarious, the probability of its success can always be rationally
determined as an ordinal ranking in a hierarchy of alternative invest-
ment projects.' Even where evidence concerning the long-term re-
sults of alternative actions or investments is completely absent, as is

The reference to ordinal ranking of probabilities in this case illustrates Keynes's
skepticism toward cardinal estimates of probability which is based on his general
reluctance to conceive the theory of probability as synonymous with the theory of
statistical frequency (Keynes [1921] 1962, esp. chap. 8). I am indebted to an anony-
mous referee for raising this point.


===== PAGE 45 =====

Salerno: The Development of Keynes’s Economics 47

sometimes bound to be the case, if there is evidence that one will yield
greater advantages in the near future than the others, then, accord-
ing to Keynes ([1921] 1962, p. 310), “by what seems a legitimate
application of the Principle of Indifference we may suppose that there
is a probability in favor of the former action.”

Keynes's opposition to the conventional valuation of investments
alleged to occur in the stock market therefore derives ultimately from
a deep-seated ethical belief that, in its recourse to convention,
humanity abandons rationality and succumbs to “the dark forces
of time and ignorance.” In organized investment markets, the
abandonment of rationality is reflected in the fact that, since
conventional valuation is unrelated to long-term yield considerations
and rests on no objective foundation at all, continual and wholesale
fluctuations in the state of confidence of investors result from random
events. These fluctuations provide lucrative opportunities for “spec-
ulation,” which divert the professional investors away from the activ-
ity of “enterprise” or the task of reasonable estimation of long-term
yield prospects. The consequence of such recurrent bouts of over-
optimism followed by crises of confidence is the collapse in the MEC,
which precipitates the dreaded trade cycle (Keynes [1936] 1964, pp.
315-16).

The existence of the trade cycle thus bespeaks a moral as well as
an economic failing of financial capitalism, since it is attributable to
“the uncontrollable and disobedient psychology of the business world”
(Keynes [1936] 1964, p. 317). Regarding the activity of speculation,
which feeds on and profits from such “disobedience”—presumably, to
the conclusions of his laboriously elaborated probability theory—
Keynes ([1936] 1964, p. 359) draws an explicit connection between its
degraded moral quality and its pernicious social consequences:
“When the capital development of a country becomes a byproduct of
the activities of a casino, the job is likely to be ill-done.”

By extending the nexus of monetary calculation to include sec-
ond-hand investments, organized financial markets thus promote the
sins of convention and speculation and suppress capital accumula-
tion. These markets further dampen the rate of investment by in-
creasing its risk. By facilitating the differentiation of the saver-lender
from the entrepreneur-borrower, the existence of financial markets
requires that, before it may be undertaken, a risky investment prom-
ise a return that is sufficient to yield, in addition to the pure rate of
interest plus a premium for the borrower’s or entrepreneur’s risk,
compensation for “lender’s risk.” Unlike the entrepreneurial risk
premium, the premium accounting for lender’s risk is not “a real
social cost” which may be diminished by increased skill in forecasting,


===== PAGE 46 =====

48 The Review of Austrian Economics, Vol. 6, No, 1

but “is a pure addition to the cost of investment which would not exist
if the borrower and lender were the same person” (Keynes [1936]
1964, p. 144). Moreover, the lender’s risk component includes and
duplicates a part of the entrepreneur’s risk component, because the
lender as well as the borrower require a greater premium before
committing funds to riskier investments (Keynes [1936] 1964, p. 145).

Keynes ([1936] 1964, p. 164) sees only two remedies for the
distorted and volatile MEC schedule and the continually fluctuating
and, on average, chronically insufficient level of investment which
result from convention, speculation, and the unnecessary and waste-
ful duplication of risk. The first involves the implementation of a
monetary policy designed to manage interest rates in such a way as
to elicit continuously the “appropriate volume of investment.” But
Keynes confesses skepticism toward this alternative. The second, and
Keynes's preferred remedy, is to extirpate the root cause of the
problem by forthrightly abolishing markets and monetary calculation
for investment, i.e., by socializing investment. Writes Keynes ([1936]
1964, p. 164): :

I expect to see the State, which is in a position to calculate the
marginal efficiency of capital-goods on long views and on the basis of
the general social advantage, taking an ever greater responsibility
for directly organizing investment; since it seems likely that the
fluctuations in the market estimation of the marginal efficiency of
different types of capital . . . will be too great to be offset by any
practicable changes in the rate of interest.

Given his analysis of the MEC, Keynes ([1936] 1964, p. 378) must
be taken very seriously when he concludes that “a somewhat compre-
hensive socialization of investment will prove the only means of
securing an approximation to full employment.” This is in contrast to
the conventional view, as expressed, for example, by Alvin Hansen
(1953, pp. 215-16), which portrays Keynes as advocating short-run
fiscal fine-tuning, at the same time discounting lengthy discussions of
socialization of investment and the attainment of capital saturation as
examples of Keynes allowing “his fancy to roam in an irresponsible
manner,” “flying his kite,” and engaging in “fascinating flights of fancy.”

Indeed, it has been definitively established by Meltzer (1988, p.
182), that in the General Theory “Keynes’s main policy recommenda-
tion is for public direction of investment” and “Keynes believed that
his main recommendations were policy implications drawn from his
theory.” Moreover, as Meltzer (1988, p. 295) also shows, Keynes did
not originate the basic concept of fiscal fine-tuning or functional
finance but learned it from Abba Lerner. After initially rejecting
Lerner’s ideas, Keynes intellectually accepted and praised them, but


===== PAGE 47 =====

Salerno: The Development of Keynes’s Economics 49

never gave any indication that “he accepted functional finance as a
basis for policy.” Accordingly, in his wartime memos on post-war
reconstruction, Keynes “favored policies to stabilize investment and
opposed policies to increase consumption on grounds. . . [that] income
can be raised permanently by increasing and stabilizing investment”
(Meltzer 1988, p. 186).

We now turn to the liquidity preference theory of interest, which
may be characterized as the keystone of Keynes's analytical structure.
With the interest rate determined solely by the interaction of the
liquidity preference function and the quantity of money, rather than
by the supply and demand for saving as in the classical theory, the
progressive social force of capital accumulation is, at long last, ren-
dered logically and wholly independent of the sin of saving. In the
process, the activity of saving is thoroughly criminalized and de-
prived of its last shred of redeeming social advantage. No longer is
an increase in the rate of saving seen as operating to lower interest
rates and thereby to induce the additional spending on investment
necessary to offset the negative effect on income of the concomitant
decline in the rate of consumption expenditure. To the contrary, the
attempted allocation of savings to the accumulation of additional cash
balances to satisfy heightened preferences for liquidity actually
raises the interest rate and reduces investment.

In a nutshell, the theory of liquidity preference tells the story of
how the interest rate develops as a purely monetary phenomenon,
which is rooted in avarice and precaution and determined on a
superfluous market ruled by convention and speculation. Once deter-
mined, the interest rate confronts an irrationally determined MEC
in an arbitrary monetary calculation that serves only to limit invest-
ment and to burden society with an artificial scarcity of capital goods.

In explicating his theory, Keynes begins by bifurcating the
decisionmaking process which expresses the individual's “psycholog-
ical time preferences.” In the initial stage of the process, the propen-
sity to consume determines what proportion of his current income the
individual will consume and what proportion “he will reserve in some
form of command over future consumption.” Once this decision has
been made, the individual’s liquidity preference dictates how much
of his current stock of savings, which includes savings accumulated
from past income flows, he holds in the form of money, which yields
“immediate liquid command,” and how much he invests in debt, which
represents “deferred command over specific goods” convertible into
money only at an uncertain future market price.

From this ad hoc and contrived description of the process by
which an individual allocates his monetary assets, Keynes ([1936]


===== PAGE 48 =====

50 The Review of Austrian Economics, Vol. 6, No. 1

1964, pp. 166-67) deduces that “the rate of interest cannot be a return
to saving or waiting as such. For if a man hoards his savings in cash,
he earns no interest, though he saves just as much as before. . .. Thus
the rate of interest at any time, being the reward for parting with.
liquidity, is a measure of the unwillingness of those who possess
money to part with their liquid control over it.”

But why does such a thing as liquidity preference exist, especially
when it is considered that the holding of money yields no explicit
return? The first reason that Keynes ([1936] 1964, p. 168) gives
involves the “transactions motive”: the current transaction of busi-
ness by consumers and producers requires a ready supply of cash and,
in a world in which the individual’s income receipts and disburse-
ments are not synchronized, this entails that “up to a certain point it
is worthwhile to sacrifice a certain amount of interest for the conve-
nience of liquidity.”

Two additional factors, unrelated to anticipated transactions,
motivate a preference for liquidity: precaution and speculation. Ac-
cording to Keynes ([1936] 1964, p. 168), the necessary precondition
of both the precautionary and speculative motives for holding
cash “is the existence of uncertainty as to the future of the rate of
interest. . . .” The precautionary motive explains the compensation
for the sacrifice of interest by the insurance which the possession of
liquid wealth provides against the capital loss that may be incurred
when an unforeseen need for cash necessitates a hasty liquidation of
debt securities. The speculative motive for cashholding emerges in
an economy where, in addition to interest-rate uncertainty, there
exists “an organized market for dealing in debts,” e.g., a bond market
(Keynes [1936] 1964, p. 169). Thus the individual “who believes that
future rates of interest will be above the rates assumed by the market,
has a reason for keeping actual liquid cash” (Keynes [1936] 1964, p.
170).

While liquidity preferences due to the transactions and precau-
tionary motives are assumed by Keynes to depend on income and to
be insensitive to fluctuations in the current rate of interest, the
demand for liquidity for speculative purposes, where there exists a
divergence of expectations among speculators regarding the future,
is portrayed as varying inversely with the rate of interest. Thus,
concludes Keynes ([1936] 1964, p. 171), “the rate of interest and the
price of bonds have to be fixed at the level at which the desire on the
part of certain individuals to hold cash (because at that level they feel
bearish of the future of bonds) is exactly equal to the amount of cash
available for the speculative-motive.” Particularly where “the existence
of an organized market gives an opportunity for wide fluctuations in


===== PAGE 49 =====

Salerno: The Development of Keynes's Economics 51

liquidity preference due to the speculative motive” (Keynes [1936]
1964, pp. 170-71), changes in the interest rate in a capitalist economy
reflect nothing more significant than the irrational migrations of
speculators to and fro between the herds of bulls and bears.

From this analysis, Keynes ([1936] 1964, p. 203) is led to conclude
that “the rate of interest is a highly conventional . . . phenomenon.
For its actual value is largely governed by the prevailing view as to
what its value is expected to be. Any level of interest which is accepted
with sufficient conviction as likely to be durable will be durable. . ..”
Moreover, where the opinion prevails that “the level of the rate of
interest is self-adjusting, so that the level established by convention
is thought to be rooted in objective grounds much stronger than
convention,” the interest rate may persist at a level that is too high
for full employment. Keynes ([1936] 1964, p. 204) refers to “[t]he
difficulties in the way of maintaining effective demand at a level high
enough to provide full employment, which ensue from the association
of a conventional and fairly stable long-term rate of interest with a
fickle and highly unstable marginal efficiency of capital. . . .”

Even if an enlightened monetary authority were determined to
drive the gross market rate of interest down in order to create a gap
between the MEC and the interest rate sufficiently large to call forth
a full-employment or “optimum” level of investment spending, its
efforts in this direction would be limited by two factors. First, there
is what has come to be termed the “liquidity trap,” which raises the
possibility that “after the interest rate has fallen to a certain level,
liquidity preference may become absolute in the sense that almost
everyone prefers cash to holding a debt which yields so low a rate of
interest” (Keynes [1936] 1964, p. 207).

While a good case can be made that many commentators on the
General Theory have routinely misinterpreted and overemphasized
the theoretical and practical significance which Keynes attaches to
the liquidity trap (Meltzer 1988, pp. 270-80), the same certainly
cannot be said of the second factor that Keynes cites as impeding any
attempt to reduce the interest rate, which has been virtually ignored.
This second impediment consists, according to Keynes ([1936] 1964,
p. 208) of “the intermediate costs of bringing the borrower and
ultimate lender together, and the allowance for risk, especially for moral
risk, which the lender requires over and above the pure rate of interest.”
Thus, even if the monetary authority were to succeed in reducing the
pure rate of interest or the liquidity premium to zero, an insuperable
barrier to optimum investment and full employment could still exist
in the form of the “effective rate of interest” stuck at too high a level
and composed of irreducible costs of financial intermediation plus a


===== PAGE 50 =====

52 The Review of Austrian Economics, Vol. 6, Np. 1

risk premium to compensate the lender for moral and other risks of
the borrower’s default. This factor “may prove important in an era of
low interest rates” (Keynes [1936] 1964, p. 208), which, as we shall
see, Keynes looks forward to as the precondition of the transition to
capital superabundance.

The liquidity preference theory thus represents the perfect in-
strument allowing Keynes to translate his longstanding ethical pre-
possessions regarding usury and avarice into scientific policy dicta.
Keynes's reference to the impending “euthanasia of the rentier” is not
an isolated flight of fancy but the central implication of his program
to rid the economy of the baneful effects of usury and avarice by
suppressing the rate of interest and thereby abolishing the bond
market.

As noted above, for Keynes, the bond market is born out of the
irrational and otiose separation between those who finance and those
who implement investment projects. This separation serves to create
a unique and unnecessary risk, i.e., of the borrower’s default, which
increases the cost of investment. Furthermore, by providing an arena
for speculation on interest-rate uncertainty, the organized bond mar-
ket promotes avarice in the form of the speculative demand for cash
holding. It is this demand which is the active factor in determining
and driving the pure rate of interest; that is, the liquidity premium
which must be paid to the avaricious for parting with monetary
investment funds. Because the existence of the pure interest rate
renders the ownership of debts competitive with the ownership of real
capital assets, it further raises the cost and retards the rate of
investment.

It is because the liquidity preference theory of interest estab-
lishes such a clear causal link between vice and economic instability
and waste that Keynes steadfastly refused to relinquish it in favor of
the scientifically more rigorous, general-equilibrium explanation, which
emphasizes the simultaneous determination of the levels of income and
the interest rate by saving and investment on the one hand and liquidity
preference and the quantity of money on the other. As Patinkin (1976,
p. 99) argues: “This tenet [that liquidity preference is the sole determi-
nant of the interest rate] indeed served Keynes as a test of faith for all
who wanted to be regarded as true converts to his new theory.” In this
spirit, Keynes was to “absolve” Harrod of misunderstanding this
crucial aspect of his analysis (Patinkin 1976, p. 99).

Hansen (1953, p. 155) characterizes those chapters of the General
Theory in which Keynes discusses the nature of capital as “another
detour which could be omitted without sacrificing the main argu-
ment.” And it is true that Keynes did not. emphasize the “scarcity


===== PAGE 51 =====

Salerno: The Development of Keynes's Economics 53

theory” of capital, which he develops in chapter 16, as a contribution
on a par with effective demand, liquidity preference, and the mar-
ginal efficiency of capital. Keynes may have downplayed his contri-
bution in this area because his treatment consisted of a series of
loosely connected observations rather than a fully integrated theory.
Nonetheless, the view of capital which emerges from these observa-
tions is crucial to the analytical progression of the main argument of
the General Theory.

Keynes aims at establishing two fundamental propositions re-
garding capital. The first is that “an asset offers a prospect of yielding
during its life services having an aggregate value greater than its
initial supply price . . . because it is scarce; and it is kept scarce
because of the competition of the rate of interest on money” (Keynes
[1936] 1964, p. 213). The implication is that, given its physical
productivity, the less scarce capital becomes the lower its yield in
excess of its supply price.

In support of this proposition, Keynes ([1936] 1964, p. 213) al-
ludes to the “pre-classical doctrine” that “everything is produced by
labor,” aided by technology, natural resources and capital or “past
labor embodied in assets.” Like natural resources, then, the price of
the latter aid to labor is also determined by its “scarcity or abun-
dance.”

Keynes's second proposition holds that at any given moment in
time, the opportunity for capital investment is strictly limited. Ac-
cording to Keynes ([1936] 1964, p. 214), while there are admittedly
some roundabout processes of production that are physically effi-
cient, probably most are very inefficient due to the phenomenon of
“spoiling or wasting with time.” This implies a conception of round-
aboutness that is restricted to currently used techniques and produc-
tion functions in which there is little scope for intertemporal substi-
tution among inputs. Thus Keynes ([1936] 1964, p. 217) writes that
“[iln the case of the great majority of articles, it would involve great
technical inefficiency to start up their input more than a very modest
length of time ahead of their prospective consumption.”

But the investment of labor in the production of capital assets is
even more narrowly limited by the fact that, for any given quantity
of labor, there is an optimum proportion between capital and labor,
i.e., “between the amount of labor employed in making machines and
the amount which will be employed in using them” (Keynes [1936]
1964, p. 214). The structure of production could be advantageously
lengthened beyond this limit to exploit the remaining physically more
efficient and even some inefficient lengthy processes of production,
only if preferences to postpone consumption into the future were


===== PAGE 52 =====

54 The Review of Austrian Economics, Vol. 6, No. 1

strong enough to necessitate a rate of investment so great as to
provoke a negative MEC. In this case, short efficient processes must
be rendered sufficiently scarce to compensate for the effect on their
product price of the relative disagreeableness attending early con-
sumption.

The optimum roundaboutness of the production structure is thus
fixed and depends on the given supply of labor in conjunction with the
given structure of dates at which consumer demand for the various
products is expected to become effective, taking into account the circum-
stance that the lengthening or shortening of certain processes may so
improve the quantity or quality of their products as to induce consumers
to postpone or anticipate their prospective demands. Thus, in the case
of a zero rate of interest, “there would be an optimal interval for any
given article between the average date of input and the date of consump-
tion, for which labor cost would be a minimum” (Keynes [1936] 1964, p.
216). A shorter or longer interval would be technically, as well as
economically, less efficient. If the interest rate were above zero, the
optimum interval would be contracted, necessitating a curtailment of
current investment so as to achieve the greater scarcity of future
products necessary to raise their prices enough to absorb the interest
charge and the higher costs associated with the employment of techni-
cally less efficient shorter processes.

For Keynes, then, the interest rate constitutes the narrowest limit
on investment. But even if a zero interest rate prevailed, Keynes's
analysis implies that “there is a strict limit to the proportion of
consumers’ demand which it is profitable to begin providing for in
advance” (Keynes [1936] 1964, p. 217).

In terms of practical policy, the conclusion Keynes ([1936] 1964,
p. 375) draws from this analysis is momentous: “I feel sure that the
demand for capital is strictly limited in the sense that it would not
be difficult to increase the stock of capital up to a point where its
marginal efficiency had fallen to a very low figure.”

Keynes's analysis of capital completely ignores Béhm-Bawerk'’s
seminal insight that capital accumulation permits the adoption of
new techniques and production functions which, though previously
known, remained unexploited precisely because the prevailing scar-
city of capital rendered their implementation uneconomic. Thus,
contrary to Keynes, progressive accumulation of capital requires and
facilitates, within wide limits, an ever-increasing proportion of the
given labor supply to producing capital goods. The growing quantity
of labor inputs is applied not merely to “making machines,” i.e.,
replicating existing machinery with existing techniques, but to making
different and more efficient machines, to making existing machines


===== PAGE 53 =====

Salerno: The Development of Keynes's Economics 55

more efficiently by building and using machines to make machines,
to making the new machines necessary to mass produce luxury goods,
e.g., the automobile, and to inventing new production processes and
machines intended to supply heretofore latent wants.

It is illuminating to note the subtle connection between Keynes's
analysis of the limits to capital accumulation and his Marshallian
theory of wants and its key role in his millennialist social vision. It
is precisely the assumption that the broad classes of wants are
definitely limited, easily identified and enumerated, and capable of
being supplied by existing production techniques, which enables
Keynes to envisage that human wants will be surfeited and the
millennium achieved with an extra generation or two of capital accu-
mulation. However, once the possibility is raised, as it is by Béhm-
Bawerkian capital theory, that capital accumulation itself is capable of
stimulating the realization and expression of hitherto undreamed of
wants, the rat race for progressively increasing living standards is on and
the vision of capital saturation amid the blissful stagnation of the
millennium recedes into the remote future or dissipates altogether
(compare Johnson and Johnson 1978, pp. 80-81, and Minsky 1975, pp.
151-53).

As Minsky (1975, p. 154) perceptively comments, Keynes’s world
is one “in which ‘civilized’ standards discipline and control relative
needs and move consumption away from capital-intensive patterns.
A world in which an endless accumulation of gadgetry and weaponry
is the desire of man is not a world in which full investment will soon
occur.” It is open to speculation whether Keynes's initial hatred of the
automobile (Hession 1984, p. 57) and his reported discomfort with the
telephone stemmed from his view that such capital-absorbing gad-
gets represented a departure from the “state of disciplined wants”
(Minsky 1975, p. 155) that is necessary to achieve capital saturation.

Indeed, it is precisely because almost all “Keynesian” economists,
especially in the United States, have ignored the fourth building
block of the strict limitation on the demand for capital that they have
been able to regard the analytical technique of the General Theory as
providing the means for fine-tuning and stabilizing capitalism, in-
stead of, as Keynes intended it, the justification and recipe for its
destruction. Thus, no sooner is the fourth and final building block
represented by the scarcity theory of capital rolled into place, than
Keynes uses his completed theoretical apparatus to deliver the coup
de grace to capitalism. This is the demonstration that laissez-faire
capitalism, given prevailing institutions and psychological propensi-
ties, even if it miraculously found itself in the blessed state of capital
satiety, would be unable to sustain this economic Eldorado.


===== PAGE 54 =====

56 The Review of Austrian Economics, Vol. 6, No. 1

For his demonstration, Keynes ([1936] 1964, p. 217) supposes a
society that possesses a capital stock of such a magnitude that any
further investment would render the MEC negative. In graphical
terms, we may envision an MEC schedule which intersects the origin
and otherwise lies entirely within the second and fourth quadrants,
with any level of positive investment inducing a negative MEC. It is
also supposed by Keynes that, in this economy, money does not
physically depreciate or involve significant costs of storage, therefore
implying that the interest rate can never be negative, and the social
propensity to save exceeds zero at the full-employment level of in-
come. In these conditions, effective demand would consist only of
expenditures on consumption and would be insufficient to take up the
full flow of output forthcoming at a full-employment level of income.
The result is that both the level of employment and the capital stock
will have to shrink in order to reduce income to a level at which
aggregate saving is zero.

Based on this analysis, Keynes ([1936] 1964, pp. 217-18) con-
cludes that thus “for a society such as we have supposed, the position
of equilibrium, under conditions of laissez-faire, will be one in which
employment is low enough and the standard of life sufficiently mis-
erable to bring savings to zero. . . . [T]he equilibrium stock of capital
which will have a marginal efficiency of precisely zero, will, of course,
be a smaller stock than would correspond to full employment of the
available labor; for it will be the equipment which corresponds to that
level of unemployment which ensures zero saving.” The implication
of course, is that pushing the rate of interest to “vanishing point” via
government monetary policy may not be sufficient to induce the state
of full investment prerequisite to entering the millennium. There is
the possibility, however, that the desire of the public to make provi-
sion for the future would become satiated, causing the propensity to
save out of full-employment income to fall to zero, at some point
before the rate of interest reaches zero.

However, this unlikely possibility of spontaneous salvation under
capitalism, according to Keynes ([1936] 1964, pp. 218-19), is ren-
dered even less likely when it is considered that there are certain
institutional and psychological factors, “in particular, the costs of
bringing borrowers and lenders together and uncertainty as to the
future of the rate of interest,” operating to set a lower limit on the
rate of interest significantly above zero.

Ensconced as it is in the generally neglected chapter on capital,
most commentators on the General Theory have overlooked the most
important application of its analytical apparatus. This is to the
explanation of how an accumulation of capital, “so large that its


===== PAGE 55 =====

Salerno: The Development of Keynes's Economics 57

marginal efficiency has fallen more rapidly than the rate of interest
can fall in the face of the prevailing institutional and psychological
factors, can interfere, in conditions mainly of laissez-faire, with a
reasonable level of employment and with the standard of life which
the technical conditions of production are capable of furnishing”
(Keynes ([1936] 1964, p. 219). The ultimate moral and technical
perversity of capitalism thus rests on the demonstration that it
transmogrifies and diverts the process of wealth creation and prog-
ress toward moral perfection to a descent into a permanent state of
relative impoverishment wherein vice can never be transcended.

For Keynes ([1936] 1964, p. 219), however, there is a way out,
because “This disturbing conclusion [regarding the effects of capital
accumulation] depends, of course, on the assumption that the propen-
sity to consume and the rate of investment are not deliberately
controlled in the social interest but are mainly left to the influences
of laissez-faire.” The political economy of the General Theory is thus
primarily addressed not to securing the short-run stability of output
and prices but to promoting the long-run, evolutionary goal of solving
the economic problem,

Keynes lays out his politico-economic proposals in the final chap-
ter of the General Theory, and they are clearly and specifically aimed
at “depriving capital of its scarcity-value within one or two genera-
tions.” The measures elaborated to achieve this aim involve “central
controls,” a term Keynes ([1936] 1964, pp. 377-79) uses four times
within the space of three pages. These measures are designed to
enable the State “to determine the aggregate amount of resources
devoted to augmenting the instruments [of production] and the basic
rate of reward to those who own them” and also “to bring about an
adjustment between the propensity to consume and the inducement
to invest” (Keynes [1936] 1964, pp. 378-79). In addition to full
investment, these measures are designed to achieve the supplemen-
tary goals of full employment and equitable distribution of income.

Keynes's primary policy prescription is for a gradual and steady
reduction in the rate of interest to zero. Because Keynes is referring
to the market or effective rate of interest, which includes, in addition
to the liquidity premium, the various costs and risk premiums asso-
ciated with bringing borrowers and lenders together, he argues that
monetary policy is incapable of effecting this outcome on its own.
Thus he advocates “a somewhat comprehensive socialization of in-
vestment,” which is the only way in which the institutional rigidity
of the interest rate can be broken and, therefore, “the only means of
securing an approximation to full employment” in the conditions of
accumulating capital and a secularly declining MEC.


===== PAGE 56 =====

58 The Review of Austrian Economics, Vol. 6, No. 1

While a longtime advocate of neo-Keynesian fine-tuning, such as
Tobin (Brunner 1987, pp. 53-54), downplays the significance of
Keynes's use of the term “socialization of investment” by adducing its
varied connotations, Keynes is reasonably clear about the economic
arrangements he intends to connote by the term. The central controls
which Keynes ([1936] 1964, p. 378) advocates do not necessitate the
assumption by the State of “the ownership of the instruments of
production.” Indeed, Keynes ([1936] 1964, p. 374) expatiates, albeit
patronizingly, on the social usefulness of “money-making” and “pri-
vate wealth-ownership” in the pre-millennial world in which men
have not yet been “taught or inspired or bred” to take no interest in
such activities.

What Keynes does envision in proposing the socialization of
investment is the replacement of individual saving and allocation of
investment funds via debt and equity purchases on private markets
by “communal saving through the agency of the State” ([1936] 1964,
p. 376).% In this way, the irrational and speculative stock and bond
markets will give way to Marshallian owner-entrepreneurs, who, in
consultation with Burkean State financiers and using the principles
of Keynes's probability theory, will rationally forecast the marginal
efficiencies of the various types of capital goods and defeat “the dark
forces of time and ignorance” (compare Brunner 1987, p. 38).

The progressive expansion of the capital stock brought about by
the policy of continually reducing the interest rate will drive the MEC

There has been recurring and unresolved controversy surrounding the question
of whether or not Keynes was an advocate of socialism. Of course, the resolution of
this issue turns on the precise meaning to be attached to Keynes's call for “the
socialization of investment.” If it is interpreted, as I argue it should be, as a scheme
to abolish equity and debt markets, then Keynes was indeed advocating the substi-
tution of socialist central planning for a market economy. For as Mises points out,
the existence of a stock exchange is precisely what distinguishes a functional market
economy from a socialist economy. The retention of nominally private ownership of
the means of production without the effective right of alienating such ownership
titles in monetary exchanges deprives entrepreneurs of the ability to ascertain
production costs, calculate ever-changing profit opportunities, and respond to these
opportunities by rearranging existing combinations of capital goods. Centrally con-
trolled investment, therefore, implies centrally planned production processes. Thus,
for example, under National Socialism in Germany, although private ownership of
business assets was formally retained, all important production activities were
carried on under the directives of state officials.

Mises’s remark on the existence of a stock exchange as the sine qua non of a
market economy is reported in Rothbard 1991, p. 59. For the original statement of
Mises’s classic argument that the abolition of markets and prices for capital goods
renders the rational allocation of resources impossible, see Mises [1920] 1990. For
a detailed description of the pre-war Nazi economy which emphasizes its essentially
socialistic character, see Reimann 1939.


===== PAGE 57 =====

Salerno: The Development of Keynes's Economics 59

schedule steadily to the left until it reaches its evolutionary terminus
at its intersection with the origin point. Actually, the MEC would not
quite reach zero but would fall to “a very low figure” which would
provide “some margin to cover risk and the exercise of skill and
judgment” of the investing entrepreneur. Thus the gross yield on
capital goods over their lives would “just cover their labor costs of
production plus an allowance for risk and the costs of skill and
supervision,” there being no surplus left over for payment of a scarcity
premium for the use of capital (Keynes [1936] 1964, pp. 375-76). In
this state of full investment would therefore occur “the euthanasia of
the rentier” and “the euthanasia of the cumulative oppressive power
of the capitalist to exploit the scarcity-value of capital” (Keynes
[1936] 1964, p. 376). Depriving the rentier or functionless investor of
an income would also improve the equity of income distribution.

While the goal of an optimum rate of investment is to be insured
by the policy of steady reduction of the interest rate, the goal of full
employment depends upon the level of aggregate demand, composed
of consumption and investment expenditures. Although a declining
interest rate also tends to weaken the incentive to save and thus to
stimulate consumption, Keynes still requires a second lever adapted
specifically to changing the average propensity to consume. Accord-
ing to Keynes ([1936] 1964, pp. 378, 380), “[t]he State will have to
exercise a guiding influence on the propensity to consume. . ..” by
virtue of its involvement “in the task of adjusting to one another the
propensity to consume and the inducement to invest” to generate a
full-employment level of income.

For this purpose, Keynes proposes a “scheme of direct taxation”
which aims at redistributing income from higher to lower income
groups and thereby raising the average propensity to consume.
Keynes discounts any adverse supply-side effects of this taxation
policy by asserting that the prevailing price of entrepreneurial ability
and risk-taking is far in excess of its supply price. According to
Keynes ([1936] 1964, pp. 376-77) “the entrepreneur et hoc genus omne

. are certainly so fond of their craft that their labor could be
obtained much cheaper than at present. . ..” Thus Marshall’s attempt
to enlist economic chivalry in the service of his fondest dream of
increasing standards of life for the workers by reducing the supply
price of “business ability in command of capital” is replaced by
Keynes's intuition that the dream is already half true and awaits for
its completion only the arrival of the tax collector.

With the interest rate, the rentier, and the speculator on financial
markets suppressed by socialized investment and the “economic
rent” received by entrepreneurs taxed away and used to subsidize


===== PAGE 58 =====

60 The Review of Austrian Economics, Vol. 6, No. 1

State-provided benefits for laborers, the monetary expenses of pro-
ducing goods are effectively reduced to reflect only their “real” costs
of production, basically the disutilities of labor and legitimate risk-
taking. Thus, for Keynes, the same central controls that secure full
investment and full employment also operate to squeeze out from the
production process all income payments that are unrelated to labor
costs and to establish an equitable distribution of income.

Although sparse in its details, Keynes's scheme for State direc-
tion of investment and remuneration for productive activity bears
more than a passing resemblance to Hjalmar Schacht’s Nazi com-
mand economy, which was “based on three main controls: of costs,
investment, and international trade” (Woolston [1941] 1968, p. 236).
Indeed, as Brunner (1987, p. 38) points out, in order to preclude the
inevitable capital efflux induced by the pegging of domestic interest
rates below world levels, Keynes recognized the necessity of a system
of exchange controls that “would have to be rather far-reaching and
also cover domestic transactions related in some manner to inter-
national transactions.” In the early 1940s, Keynes also vigorously
promoted the “Schachtian device” of international barter as an
alternative policy for Britain in the post-war world, if some version
of his scheme for international monetary reconstruction were not
accepted. Keynes (quoted in Hession 1984, p. 331) labelled anyone
who signed an agreement to preclude the use of such a device in
advance “as great a traitor to his country as if he were to sign away
the British navy before he had a firm assurance of an alternative
means of protection.”

There is some evidence that Keynes himself recognized the sim-
ilarity between the nationalist system based on socialized investment
which he espoused and the National Socialist system of political
economy implemented by Schacht in Germany. Thus, in the Foreword
to the German edition of the General Theory published in 1936,
Keynes notes that the aggregative theory of production expounded in
the book “can be much easier adapted to the conditions of a totalitar-
ian state than the theory of production and distribution of a given
production put forth under conditions of free competition and a large
degree of laissez-faire.” Keynes also expresses satisfaction if his
theory “can contribute a single morsel to a full meal prepared by
German economists” (Martin 1971, pp. 203-05).

In the foregoing, I do not intend to tar Keynes with the brush of
National Socialism. Far from it, I merely wish to point out that, as a
millennialist theorist, Keynes trusted to his own intuition and moral
rectitude in choosing and applying policies which, in the hands of the
less enlightened or less righteous, would result in a social holocaust.


===== PAGE 59 =====

Salerno: The Development of Keynes’s Economics 61

Keynes himself makes this point in a revealing letter written to
Hayek, in which he comments on the latter’s critique of planning, The
Road to Serfdom. Writes Keynes (quoted in Meltzer 1988, p. 191):

I should say that what we want is not no planning, or even less
planning, indeed I should say that we almost certainly want
more. ... Moderate planning will be safe if those carrying it out are
rightly oriented in their own minds and hearts to the moral issue. . . .

I accuse you of perhaps confusing a little bit the moral and the
material issues. Dangerous acts can be done safely in a community
which thinks and feels rightly which would be the way to hell if they
were executed by those who think and feel wrongly.

While a great deal more can and should be said regarding the
evolution of Keynes’s economics under the influence of his sociopolit-
ical vision, I believe that my investigation is sufficient to indicate that
the technical economics and the political economy of the General
Theory have a definite millennialist orientation. The analytical ap-
paratus was developed by Keynes to embody the ethical principles
which he believed would govern his envisioned millennium. It was
designed ab ovo to link up the economic failures of capitalism with the
vices it characteristically fosters, “avarice, usury, and precaution.”

Moreover, it was Keynes's eagerness to attain the economic pre-
condition of this millennial state, the abolition of capital scarcity and
the satiating of “disciplined” wants, which guided his application of
this apparatus in formulating policy conclusions. Thus, to emphasize
again, the policies which Keynes deduced were not policies of short-
run fiscal fine-tuning that have come to be associated with his name.
Keynes was single-minded in his politico-economic advocacy: What
was required was a socialized investment policy designed to abolish
financial markets and the interest rate and achieve capital satura-
tion.

Even when he was specifically addressing the issue of short-run
instability in his chapter on the “trade cycle,” the tune he was playing
never changed or even wavered in pitch. Under laissez-faire capital-
ism, the recurrence of “wide fluctuations in employment” could not
be avoided “without a far-reaching change in the psychology of invest-
ment markets such as there is no reason to expect.” He concluded that
“, . . the duty of ordering the current volume of investment cannot
safely be left in private hands” (Keynes [1936] 1964, p. 320). Again
this is not to deny that Keynes ([1936] 1964, p. 325) supported
measures for manipulation of the level of consumption, but it is clear
that he viewed such measures as supplementary to his policy of
socialized investment.


===== PAGE 60 =====

62 The Review of Austrian Economics, Vol. 6, No. 1

References

Brunner, Karl. 1987. “The Sociopolitical Vision of Keynes.” In David
A. Reese, ed., The Legacy of Keynes. New York: Harper & Row.
Pp. 23-56.

Hansen, Alvin H. 1953. A Guide to Keynes. New York: McGraw-Hill.

Harris, Seymour E. 1955. John Maynard Keynes: Economist and
Policy Maker. New York: Charles Scribner’s Sons.

——. [1947] 1973. The New Economics: Keynes’ Influence on Theory
and Public Policy. New York: Augustus M. Kelley.

Harrod, R. F. 1951. The Life of John Maynard Keynes. New York:
Harcourt, Brace. |

Hayek, F. A. 1931. “Reflections on the Pure Theory of Money of Mr.
J. M. Keynes.” Economica 3—4 (August 1931-February 1932):
270-95, 22-44.

Heilperin, Michael A. 1962. Studies in Economic Nationalism. Ge-
neva, Switzerland: Librairie E. Droz.

Hession, Charles H. 1984. John Maynard Keynes: A Personal Biogra-
phy of the Man Who Revolutionized Capitalism and the Way We
Live. New York: Macmillan.

Johnson, Elizabeth S. and Harry G. Johnson. 1978. The Shadow of
Keynes: Understanding Keynes, Cambridge and Keynesian Eco-
nomics. Chicago: University of Chicago Press.

Keynes, John Maynard. 1933. “National Self-Sufficiency.” Yale Re-
view 22 (June): 755-69.

——. [1930] 1958. A Treatise on Money. 2 vols. London: Macmillan.

——. [1921] 1962. A Treatise on Probability. New York: Harper &
Row.

——. [1931] 1963. Essays in Persuasion. New York: W. W. Norton.

—. [1951] 1963. Essays in Biography. Ed. Geoffrey Keynes. New
York: W. W. Norton.

——. [1936] 1964. The General Theory of Employment, Interest, and
Money. New York: Harcourt, Brace and World.

——. [1920] 1971. The Economic Consequences of the Peace. New
York: Harper & Row.

——. 1973. The Collected Writings of John Maynard Keynes. Vol.
13. Ed. Donald Moggridge. London: Macmillan.

Lerner, Abba. 1983. “From The Treatise on Money to The General
Theory.” In idem, Selected Economic Writings of Abba P. Lerner.
New York: New York University Press. Pp. 393-97.


===== PAGE 61 =====

Salerno: The Development of Keynes’s Economics 63

Levitt, Theodore. 1976. “Alfred Marshall: Victorian Relevance for
Modern Economics.” Quarterly Journal of Economics 90 (Au-
gust): 425-43.

Marshall, Alfred. [1920] 1949. Principles of Economics: An Introduc-
tory Volume. 8th ed. New York: Macmillan.

Martin, James J. 1971. “J. M. Keynes's Famous Foreword to the 1936
German Edition of the General Theory.” In idem, Revisionist
Viewpoints: Essays in a Dissident Historical Tradition. Colorado
Springs, Colo.: Ralph Miles. Pp. 197-205.

McWilliams-Tullberg, Rita. 1975. “Marshall’s Tendency to Socialism.”
History of Political Economy 7 (Spring): 75-111.

Meltzer, Allan H. 1988. Keynes’s Monetary Theory: A Different Inter-
pretation. New York: Cambridge University Press.

Minsky, Hyman P. 1975. John Maynard Keynes. New York: Columbia
University Press.

Mises, Ludwig von. [1936] 1951. Socialism: An Economic and Socio-
logical Analysis. Trans. J. Kahane. London: Jonathan Cape.

— . 1966. Human Action: A Treatise on Economics. Chicago: Henry
Regnery.

——. [1920] 1990. Economic Calculation in the Socialist Common-
wealth. Trans. S. Adler. Auburn, Ala.: Ludwig von Mises Institute.

Moggridge, D. E. 1976. John Maynard Keynes. New York: Penguin.

Parsons, Talcott. [1937] 1968. The Structure of Social Action: A Study
in Social Theory with Special Reference to a Group of Recent
European Writers. Vol. 1. New York: Free Press.

Patinkin, Don. 1976. Keynes’ Monetary Thought: A Study of Its Devel-
opment. Durham, N.C.: Duke University Press.

——. 1982. Anticipations of the General Theory and Other Essays on
Keynes. Chicago: University of Chicago Press.

Reimann, Ginter. 1939. The Vampire Economy: Doing Business
under Fascism. New York: Vanguard Press.

Rothbard, Murray N. 1990. “Karl Marx: Communist as Religious
Eschatologist.” Review of Austrian Economics 4: 123-79.

——. 1991. “The End of Socialism and the Calculation Debate
Revisited.” Review of Austrian Economics 5 (2): 51-76.

Salerno, Joseph T. 1990. “Ludwig von Mises as Social Rationalist.”
Review of Austrian Economics 4: 26-54.

Schumpeter, Joseph A. [1951] 1965. Ten Great Economists: From
Marx to Keynes. New York: Oxford University Press.


===== PAGE 62 =====

64 The Review of Austrian Economics, Vol. 6, No. 1

Skidelsky, Robert. [1983] 1986. John Maynard Keynes. Vol. 1: Hopes
Betrayed, 1883-1920. New York: Viking Penguin.

Viner, Jacob. 1952. “Viner on Marshall.” In Henry William Spiegel,
ed., The Development of Economic Thought: Great Economists in
Perspective. New York: John Wiley & Sons. Pp. 718-33.

Whitaker, John K. 1977. “Some Neglected Aspects of Alfred
Marshall’'s Economic and Social Thought.” History of Political
Economy 9 (Summer): 161-97.

Woolston, Maxine Y. [1941] 1968. The Structure of the Nazi Economy.
New York: Atheneum House.