Two faces of John Maynard Keynes

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Economists, both left and right, are championing Keynes as the answer to the crisis. Since his theories do little to challenge the fundamental grip of capitalism, isn't it time for those on the left to recognise his flaws?

"Everyone is in thrall to the great economist now." So ran a piece in the Financial Times about John Maynard Keynes. And so it seems. The same message comes from US treasury secretary Hank Paulson and the Fed's Ben Bernanke at one extreme and from left wingers like Larry Elliot and Graham Turner at the other. Keynes showed in the 1930s how to stop crises, they all say, and his methods can work now.

There is, however, one big fault with the message. Keynes did not show how to stop crises in the 1930s. What he did do was polemicise mercilessly against those who held that crises could be solved by cutting workers' living standards and were, in any case, a price worth paying to keep the market system going.

Keynes's arguments about the idiocy of relying on the market to solve its own problems are still relevant today. Conventional economists of the time relied on something called "Say's Law" which held there couldn't be general crises of overproduction because every time someone buys something someone else sells it.

Keynes made a point which Karl Marx had made over 60 years before - although Keynes refused to read more than a few pages of Marx. All the goods produced in a market system can only be sold if workers spend all their wages and capitalists all their profits. Workers cannot avoid, on average, spending all their wages. But capitalists can decide to keep their profits in the banks or under the bed rather than investing them, or spending them on themselves. In that case a gap opens up between what is produced and what can be sold.

To those who argued that more goods would be sold and that unemployment would disappear if workers accepted wage cuts, so allowing prices to be cut, Keynes replied that would simply mean workers would be able to buy fewer goods. This would necessitate further wage cuts and even lower sales. In this way he destroyed the conventional arguments used to justify doing nothing about mass unemployment. But he did not see his arguments as anti-capitalist: rather they were meant to persuade capitalists to accept changes that would keep their system going.

Keynes wrote that his theory was "moderately conservative in its implications". His biographer, Lord Skidelsky, argues that his proposals were tailored "taking into account the psychology of the business community. In practice he was very cautious indeed." All that was needed was for the existing state to intervene to raise the level of spending on investment and consumption. Two sorts of measures were necessary.

First, governments should drive down the rate of interest. This would both encourage better off people to spend rather than save their incomes, so providing a market for the output of others, and encourage firms to invest. But Keynes admitted to being "somewhat sceptical of a merely monetary policy".

Second, governments could undertake direct expenditures of their own, to be financed by borrowing. Such "deficit financing" would pay for itself eventually, since as the economy expanded, the government's revenue from taxes would rise.

But when it came to putting these policies into practice, Keynes was always worried about upsetting capitalists, since it was their psychology that determined whether investment would take place. Consequently, his proposals were far too mild to have ended the great slump. In the early 1930s, when unemployment was rising by 100 percent, he backed Lloyd George in calling for a public works programme which would have left the rise at 89 percent. He advised Roosevelt against pushing "business and social reforms which are long overdue" in case they "complicate recovery" through an "upset" to "the confidence of the business world".

One estimate is that an increase in government spending of some 56 percent was required to provide the 3 million jobs needed to restore full employment at the deepest point of the 1930s slump. Such an increase was not possible using Keynes's "gradualist" methods, since it would have led directly to a flight of capital abroad, a rise in imports, a balance of payments deficit and a steep rise in interest rates.

At points in his most important book, The General Theory of Employment, Interest and Money, Keynes half realised that such moderation might not be enough. He suggested that something fundamental to the system was causing a decline in investment - a decline in "the marginal efficiency of investment". This is an idea similar in some respects to Marx's declining rate of profit, and implies that there is something fundamentally wrong with capitalism that can't be cured by adjusting just interest rates or government spending levels. It led Keynes to his single most radical assertion, "that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment".

Keynes himself did not follow through on these insights, nor did most of his followers. Instead, like him, they tailored what they called for to what they thought capitalism would accept.

Today's new converts to Keynesianism in the US, British and European governments aim, as Keynes did, to save capitalism from itself. That means they are going to make the rest of us pay in order to keep capitalists happy. The left Keynesians have a choice: go along with this approach and simply look at ways to keep capitalism going, or take seriously Keynes's more radical insights and join Marxists in challenging capital's grip on the economy.