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can be seen as the end states of iterative processes where learning’ has temporarily ceased. Furthermore, both views claim the existence of different layers of economic reality, such that not everything can be explained on the grounds of the same principles.
Given that they consider different kinds of layers, taken together, they provide a more complete picture of the economy. Keynes’s macro theory appears as a particular layer where it is legitimate to take for granted some of the institutions and rules of the game that complexity theorists would like to account for on the grounds of computer simulations. Indeed simulations reveal the formation of certain patterns or conventional views which Keynes’s structural model ‘compresses’ behind its equations.1
On the other hand, complexity theory seems to require integration with aggregate macro models, such as Keynes’s, to deal with certain issues. In particular, computer simulations appear to be insufficient in dealing with macroeconomic issues such as stability. While helpful for understanding the evolution of particular markets or industrial sectors, they provide only limited insights into the evolution of the economy as a whole.
What they lack is the necessary force of abstraction; a structural model capturing the key factors and market interactions thus seems to be indispensable for interpretation and development of policy guidelines.
Fourth, like complexity theory, Keynes’s views are consistent with key tenets of the neo-modern research programme based on a combination of universal claims and more historical and contingent claims. For example, Keynes’s approach is consistent with the notion of light theory. He made rather modest assertions concerning capitalist dynamics.
Not only did he rule out the long-run equilibrium concept and the stability assumption underlying neoclassical theory, but he was also quite sceptical about the possibility of modelling disequilibrium or of building models focusing on paths or convergence processes towards equilibrium. As already noted, in contrast with complexity theory, Keynes’s model identifies the determination of instantaneous equilibrium as the core of scientific efforts concerning ‘universal’ theoretical claims. All we can do in theory, his work seems to suggest, is to focus on ‘fragile’ equilibrium points. In particular, equilibrium states should not be understood as predefined positions towards which the system inevitably tends but ‘as positions of conditional or provisional equilibrium…positions which do not possess the mechanical stability property of conventional equilibria, and/or which may not be indefinitely reproduced over time as
“states of rest”’ (Setterfield 2002:4 emphasis in the text; see also Gaserta and Chick 1997).
In addition, as can be seen in the final chapters of the General Theory, Keynes also sought to complement the focus on instantaneous equilibrium with consideration of historical factors that are bound to affect the evolution of capitalist economies. In other words, Keynes’s model seeks to combine the generality of theoretical claims and the specificity of historical evolution, thereby avoiding the extremes of a general, a- historical, all-encompassing theory on the one hand, and a mere historical-descriptive account of evolution on the other.
The generality of the General Theory
On these grounds, we are now able to see why Keynes’s theory can be considered as more general than neoclassical theory in their limited field of application, that is, instantaneous equilibrium. The issue of generality has been the subject of heated debate in macroeconomics ever since the publication of Hicks’s ‘Keynes and the Classics’. We do not wish to recapitulate the entire debate; nevertheless, we argue that the analysis developed in this book helps shed new light on it. One convenient way of illustrating this is to assess some of the most recent exchanges on the issue, making reference to contributions by Hodgson (2001, 2004b). Davidson (2004) and King (2004). All of them have the merit of tackling the generality issue thoroughly and explicitly, and of examining some of the presumed weaknesses in Keynes’s contribution. We shall try to show not that it ‘is all in Keynes’, but that Keynes did actually achieve what he claimed in his book. Moreover, we shall argue that he made several mistakes that partly account for the distortion of his key contribution in much of later ‘Keynesianism’, although they are not the same mistakes pointed out by many of his critics.
We start by considering some of Hodgson’s claims. Hodgson subscribes to a certain consensus view currently emerging among economists of all persuasions, including many like Hodgson himself who are broadly sympathetic to the General Theory. According to this view, Keynes’s theory is not truly a general theory, and the title of his book was misconceived. Hodgson asserts that a truly general theory is an all-encompassing and comprehensive theory that fits all circumstances, including other forms of economies such as barter or feudalism, while Keynes’s theory was built upon a combination of highly specific institutional conditions and universalistic psychological foundations.
Therefore, Keynes’s 1936 book
did not provide a general theory of the nature and level of employment in all past, present or possible human societies. What Keynes analysed was the quite specific relationships in modern capitalism between employment, expectations and effective demand. Rather than providing a truly general theory of interest or money, Keynes explored the quite specific, capitalist type of system in which ‘money is the drink which stimulates the system to activity’ (Keynes 1936:173). Money has existed for thousands of years but it did not become such an elixir of production until the rise of modern capitalism. Keynes favoured the ‘general theory’
rhetoric but always ended up exploring the particular circumstances of the contemporary capitalist system. Absent in the General Theory is a truly general theory of employment, interest or money. Keynes’s book applies to modern capitalism, and not to all forms of economic society.
(Hodgson 2001:222) On these grounds, Hodgson criticizes the defenders of the generality of Keynes’s theory, such as Davidson, according to whom this theory always applies—to new and old forms of economies alike—because it relies on a few basic postulates concerning the unique
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properties of money (which involve the rejection of key principles of standard value theory, such as the gross substitution axiom). In Davidson’s view, Keynes’s theory can alternately apply to different types of economies simply by adding further restrictions.
Keynes’s General Theory is meant to explain a modern, money using, market economy. If one wishes to analyze (explain, discuss) feudalism, or the economies of biblical times, one must add additional restrictive axioms to Keynes’s general theory to obtain a special case theory of feudalism, or of biblical economics, etc. Nevertheless, a common general theory will underlay all these specific cases of historical economies.
(2004:3) However, Hodgson criticizes Davidson for not clearly specifying what this ‘common general theory’ is or whether it is based on ‘psychological laws’ like Keynes’s theory, or not. He also neglects to indicate which ‘additional restrictive axioms’ must be added to Keynes’s theory to adapt it to the analysis of feudalism or earlier socio-economic systems.2
In our view, these observations are well founded. Keynes certainly did not set out to build a ‘general theory’ covering all conceivable circumstances and forms of economy, as he wanted to focus on ‘modern capitalism’ (see also King 2004). Nevertheless, we see two major problems with Hodgson’s approach. The first is that his definition of ‘general theory’ lacks validity as a benchmark for assessing macro-economic theories. The second is that other notions of ‘general theory’ seem more relevant to both Keynes and the
‘Classics’ than the one sustained by Hodgson.
Let us start from the first point. Hodgson’s definition of ‘general theory’ is so stringent that no theory could satisfy it. Indeed, as Hodgson himself points out, no theory, at least in the social sciences, can possibly account for all circumstances, owing to tractability and computational limits (Hodgson 2001:4, 16). In the case of macroeconomics in particular, restrictions of some kind are practically inevitable. Hodgson is therefore not mistaken in pointing out that general equilibrium theory is also not a general theory, because it ‘fails to incorporate key phenomena, such as time and money’ (ibid.: 225).3 The problem is, however, that the restricted nature of Hodgson’s definition leads him to remain sceptical concerning the claims of generality made by the two theories. He notes, for example, that ‘overall, it is difficult to say whether the classical or the Keynesian theory is more general’ (ibid.). In other words, Hodgson’s definition of generality is problematic in that it fails to discriminate between theories or to make sense of macroeconomic disputes.
The second point raises the issue of possible alternatives to Hodgson’s definition of generality. While undoubtedly correct in recognizing that Keynes’s focus was on a broad entity such as ‘modern capitalism’, Hodgson rules out the possibility that a general theory concerning at least this form of capitalism may exist. Instead, this is precisely the type of theory we argue that Keynes actually tried to achieve. Hodgson follows Schumpeter’s interpretation here, according to which the General Theory was not truly general because it carried ‘meaning only with reference to the practical exigencies of the unique historical situation of a given time and country’ (1936:792, quoted in Hodgson 2001:224). Thus, in Schumpeter’s view, the General Theory does not quite apply outside the conditions of the
US in the 1930s. It is important to note that he also provides an explanation for this lack of generality, one which Hodgson does not mention. For Schumpeter, the key point is that the General Theory focuses on the ‘short-run’, thus leading Keynes to abstract from the essence of the capitalist process consisting in the long waves of technology breakthroughs and structural change. Indeed, in his view, Keynes’s aggregative approach
keeps analysis on the surface of things and prevents it from penetrating into the industrial processes… It invites a mechanistic and formalistic treatment of a few isolated contour lines and attributes aggregates a life of their own and a causal significance which they do not possess.
(Schumpeter 1939:44) Although Hodgson does not subscribe to Schumpeter’s distinction between surface and essence, he does accept a few key implications of his view. First, following Schumpeter, he considers Keynes’s policy conclusions not to be valid outside the unique conditions of the great depression:
[T]he genuine defect that Schumpeter recognised was that Keynes simultaneously revered a ‘general theory’ and attempted to derive quite specific policy conclusions from such an edifice. For instance, the scope for governmental management of the level of effective demand would depend crucially on the economic institutions of a particular country and the nature and extent of its engagement with world markets. An entirely
‘general theory’ can tell us little of these vital but specific details. In this respect, Schumpeter’s criticism hit home. It may be possible to regard Keynes’s work as a framework for viable analyses that addressed such specific circumstances, but Keynes himself did not lay down guidelines for the development of historically sensitive theories.
(Hodgson 2001:225) On these grounds, Hodgson is thus led to conclude that Keynesian policies are obsolete and should not be adopted in the NE (ibid.: 224). Second, like Schumpeter, he suggests that Keynes’s theory is, at least to some extent, responsible for the neglect of historical factors in economic analysis and the rise of abstract modelling approaches in modern macroeconomics:
Keynes’s use of the ‘general theory’ term to analyze what were highly specific historical circumstances helped to obliterate all consideration of the problem of historical specificity from economics. Furthermore, it helped to create the post-war synthesis between the neoclassical general equilibrium theory and post-war macroeconomics.
(ibid.: 227) In the face of these claims, our views can be stated as follows. We subscribe to an intermediate stance between the two polar interpretations of Hodgson and Davidson. On the one hand, we hold that Keynes’s theory is not universal, as Davidson seems to
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suggest. We believe that his theory is limited in two specific ways. First of all, it is limited in the sense of the object of analysis to which it applies, that is, the modern economy. It is not just money that distinguishes this economy from other types of economy and marks the difference between Keynes and the Classics. As we shall see in what follows, the principle of effective demand makes sense only within a broader, although quite limited, set of institutions, such as developed capital markets and trade unions. Second, the scope of the General Theory is also limited from the standpoint of its explanatory power. Indeed one of the key advantages of Keynes’s theory is that, unlike its neoclassical counterpart, it does not imply a concept of equilibrium over time or try to model the evolution of the economy.
On the other hand, unlike Hodgson we believe that, given these limitations, it is still possible to regard Keynes’s theory as being quite general and, above all, more general than neoclassical theory. While Hodgson is right in suggesting that Keynes’s theory is not a universal, all-encompassing model of the economy, he is wrong in believing that it lacks any generality, or that it fails to explain any common features between different economies, that is, that it cannot be general in a narrower sense, such as that defined by our ‘light theory’, which refers only to modern capitalism and is based on the concept of instantaneous equilibrium. We hold, instead, that it is precisely in this context that the claim to generality in Keynes’s book can be assessed and the comparison with general equilibrium theory can be made in a meaningful way.
In particular, we make two major claims. First, Keynes’s theory applies not only to the US in the 1930s, but also to several different countries in different times that can be considered forms of ‘modern capitalism’ or ‘modern economies’ in that they share a common set of features with the US. Moreover, we claim that Keynes’s theory is still a valid and useful source of policy advice today, since—as we shall see in the following chapters—the NE can actually be regarded as having accelerated some features of the modern economy, rather than having overhauled it completely.
Second, we argue that Keynes manages to highlight more causal mechanisms potentially at work in the economy than the neoclassical model, even if they are not observable or do not give rise to regularities. In other words, we agree with Hodgson in asserting that, in Keynes’s battle with the ‘Classics’, only the concept of generality in the intensive sense (rather than the extensive sense advocated by Hodgson) matters: ‘the claim made…by Keynes was that his “general” theory would embrace and explain more phenomena within the single “economic society in which we actually live”’ (2001:220).
The distinction between primary and secondary variables
As a first step in demonstrating the generality of Keynes’s analysis in the context of ‘light theory’, one must have a proper grasp of the differences between Keynes and the Classics. The view taken by standard macroeconomics concerning these differences is, in our opinion, completely misguided. Typically, standard macro-economics considers the two basic theories as sharing the same basic model of the economy, as described by general equilibrium theory, and differing mainly in their empirical assumptions. Such differences lead Keynesian theory, for example, to depart from the neoclassical norm because of special values of parameters, price rigidities on particular markets, money
illusion or asymmetric information, all of which impair the adjustment process to full employment equilibrium. What we find particularly misleading is the familiar textbook view suggested by the postwar Neoclassical Synthesis (e.g. Modigliani, Samuelson and Patinkin), according to which Keynesian theory applies to the ‘short-run’, disequilibrium aspects of the economic process, while neoclassical theory applies to the long-run’
growth processes. Even more objectionable is the similar distinction made by Schumpeter and, in more recent times, by Lucas, between the Keynesian analysis focusing on the surface or ‘phenomenic’ reality, and other kinds of analyses dealing with structural phenomena or ‘essential’ reality and based on the so-called deep parameters.4
It is important to note that in order to get a more balanced view of the ‘Keynes versus the Classics’ dispute, it is not enough to suggest, as do most postKeynesians, that Keynes’s novelty rests in his consideration of various structural features of a modern economy neglected by the Classics, including uncertainty, the fact that production takes time and the key role of money and expectations. While these are undoubtedly important features of the General Theory, one can question whether they constitute the uniqueness of Keynes in and of themselves. For after all, even the neoclassicals claim to take these issues into consideration; for example, they include money and expectations in their models and seek to account for uncertainty. Indeed, at some level of abstraction, the two models can be seen as relying on a common set of elements. In our view, this means that the crucial differences between them should be sought in another direction, namely in the role these common elements play in each model. But then a few questions naturally arise:
how should these different roles be assessed? How can the theories be identified?
In order to answer these questions and draw definite conclusions concerning the generality issue, a first major step to take is to draw new distinctions between the possible variables included in a model that go beyond the familiar distinctions (e.g. between exogenous and endogenous). More specifically, capturing the difference between the two basic theories also requires the creation of finer distinctions between different types of exogenous variables, particularly in terms of their ability to influence income. One reason for this is that, while both the Keynesian and the neoclassical models can, in principle, accommodate an exogenous money supply and are thus similar in terms of the exogenous/endogenous distinction, they nonetheless appear quite different if one examines the role played by money in each of them. It is one thing to let money affect income as in the Keynesian model, but it is quite another to let it remain neutral as in the Classical one (at least if one thinks in terms of instantaneous equilibrium). A similar conclusion holds for exogenous expectations.
On these grounds, variables that can directly affect outcomes that represent the true determinants of the level of activity and which account for equilibrium at a given point in time are referred to here as primary or causal variables, whereas the others we label secondary variables. The latter can be taken as ‘constant’ or ‘given’ when dealing with the problem at hand. It should be noted, however, that the secondary factors are not completely irrelevant. For example, they may play an indirect role by affecting the primary variables.
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