John Maynard Keynes and Welfare

John Maynard Keynes’s General Theory of Employment, Interest and Money, and the role played by the notions of liquidity and effective demand in equilibrating the aggregate economy, has been so exhaustively discussed in the economic literature that little needs to be said here. However, it should be noted that the late nineteenth-century Cambridge contributions to welfare economics, and indeed Pigou’s (1912) association of reductions in industrial fluctuations with a gain in economic welfare, make it abundantly clear that Keynes contributed significantly to the development of Cambridge welfare economics.

In brief, Keynes held that one general feature of modern economies was that the marginal aggregate propensity to consume is positive but less than unity. Consequently, an increase in income is associated with a smaller increase in expenditure on consumption. The resulting gap in effective demand might, or might not, be filled by investment spending. Outlays on new capital equipment, in turn, would be determined by the interaction between the scale of the marginal efficiency of capital and the prevailing interest rate, the former depending on the state of long-term expectations and the latter on the state of liquidity preference and the supply of money. The final result of the mutual interplay among these factors could well be a situation of equilibrium that may be below full employment. From a dynamic point of view, the Keynesian theory admitted that aggregate output and the employment level would be subject to an intrinsic volatility, with wide fluctuations in investment magnified by the action of the multiplier, the magnitude of which was inversely related to the marginal propensity to consume (Keynes 1973a: 109-123).

To the extent that Cambridge economics followed Neville Keynes and Pigou in considering economic theory more valuable for the fruit that it generates than the light that it sheds, Maynard Keynes’s work is particularly significant for its ready application to public policy. In this regard, Keynes’s nexus between public expenditure, the multiplier, effective demand, and the full employment level of output had direct short-period relevance to welfareenhancing policy in terms of Pigou’s first criterion (increase in the national dividend) and third criterion (decrease in the variability of the national dividend) for economic welfare enhancement. But Keynes’s work had relevance for Pigou’s second (reduction in income inequality) criterion too, as, in the last chapter of The General Theory, Keynes referred to the unfair distribution of wealth and income as one of the outstanding faults of modern societies.

In Keynes’s theoretical framework, any initiative designed to stimulate saving during times of less than full employment will only discourage investment expenditure by reducing consumption. So, policies to support the redistribution of incomes, such as progressive taxation, may favour investment in capital formation in the short period through an associated increase in consumption. Furthermore, the increase in the multiplier resulting from a policy of income redistribution to the poor would lessen the amount of investment necessary to achieve a position of full employment. Notwithstanding this, Keynes believed that some moderate income inequality was still essential since money-making activities were required not only to assure the continuity of the capital accumulation process but also to keep man away from reckless and cruel forms of self-aggrandizement which could be dangerous to society (Keynes 1936 [1973]: 372-384, 1973b: 128-131, 161).

In a radio talk on poverty in 1934, Keynes stressed that the safest course to enhance welfare in the long run consisted in promoting employment along with greater aggregate income. The best way to reach this ideal trajectory involved a combination of increased consumption with a parallel growth in investment. As the capital stock becomes more abundant, its reward would decline progressively to a level so low that profits would become an acceptable form of income to the whole society:

The right course is to get rid of the scarcity of the 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 (Keynes 1973a: 491).

For Keynes, then, a long-run policy towards full employment, with some redistribution of income and low interest rates, would be the surest way to eliminate the capital scarcity factor from profits, making this kind of gain an exclusive remuneration of individual effort and organizational skills. To get there, progressive taxation, easy money, and the socialization of a number of investment possibilities would be the most appropriate mix of policies to bring the economic system to its maximum potential by avoiding waste and poverty through a constant state of full employment (Keynes 1936 [1973]: 372-384). As is well known, Keynes directly inspired many at Cambridge to follow in his path, and their work also has welfare implications. However, those contributions are beyond the scope of this particular chapter.