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Anatomy of the Financial Crisis: Between Keynes and Schumpeter

It is instructive to see how the issue of business cycles was looked upon by John Maynard Keynes and Joseph Schumpeter, each of whom wrote masterly tracts on the subject in the 1930s. Though Keynes was concerned with a short-run problem, Schumpeter was concerned with the long-run dynamics of the capitalist system. Given the present financial crisis, it is possible to argue that the true rationale of a stimulus package in countries such as India that are still low in terms of their average level of living ought to be to address fundamental, long-term, rather than short-term, issues.

LEARNING FROM THE PAST

Anatomy of the Financial Crisis: Between Keynes and Schumpeter

Pulin B Nayak

It is instructive to see how the issue of business cycles was looked upon by John Maynard Keynes and Joseph Schumpeter, each of whom wrote masterly tracts on the subject in the 1930s. Though Keynes was concerned with a short-run problem, Schumpeter was concerned with the long-run dynamics of the capitalist system. Given the present financial crisis, it is possible to argue that the true rationale of a stimulus package in countries such as India that are still low in terms of their average level of living ought to be to address fundamental, long-term, rather than short-term, issues.

Pulin B Nayak (pulin@econdse.org) is with the Delhi School of Economics, Delhi University.

1 Introduction

I
t is widely agreed that the western capitalist world is at present undergoing its severest financial crisis since the Wall Street crash of 1929. The fallout of the crash snowballed into the Great Depression which substantially crippled the economies of the United States (US), the United Kingdom (UK) and western Europe. By 1933, the aggregate unemployment rate in the US had peaked to about 25%, with the rates in parts of the mid-west of the country being considerably higher. The US manufacturing output fell to around 54% of its 1929 level. Being closely linked with the US economy, the UK and Germany were also particularly badly hit.

The trigger for the present crisis has been a downturn in the US housing market. During the last phase of the long tenure (1987-2006) of Alan Greenspan as Chairman of the Federal R eserve of the US, interest rates were adjusted to historic lows that contributed to one of the most major housing bubbles. Lower interest rates enabled homeowners to obtain greater l iquidity to finance house purchases, thereby boosting house prices to unprecedented levels. Many of the financial innovations that originated in the Thatcher-Reagan era of the early 1980s provided prospective homeowners with access to greater sources of funding. Loans were liberally given out to sizeable numbers of borrowers with weak credit histories. By late 2006, it was abundantly clear that this process could not possibly be sustained. The sub-prime mortgage industry collapsed in March 2007, with many of the p rominent lenders filing for b ankruptcy protection.

But the housing sector was only a part, albeit a very major part, of the contributing factors to the current financial meltdown. Possibly, a more significant factor had to do with the climate of free market fundamentalism and deregulation that was the hallmark of the core thinking during the Thatcher-Reagan years. Two factors contributed to the ascendancy of this free market conservatism. First, the protracted period of cold war, from the 1950s through the 1970s, was drawing to a close even as deep fissures were surfacing in the workings of the economic arrangement in the command economies of the Soviet Union and east Europe. The logical culmination of this process was the fall of the Berlin Wall in 1989 and the disintegration of the Soviet empire. Forces of free market capitalism appeared very much to be in the a scendant with some influential opinion makers endorsing the notion of “the end of history”.

Second, after nearly a quarter century of steady unprecedented rise in living standards in the US, western Europe and Japan, the

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capitalist world was confronted with the oil crisis in the aftermath the Arab-Israeli war of 1973. If the term dismal science had its nomenclature originating in the Malthusian notion of relative scarcity of food in the face of rising human population in geometrical progression, there was now another profound dimension that mankind had to contend with. And this had to do with the stark reality of dwindling reserves of oil even as the world capitalist system was on the threshold of an unprecedented phase of expansion. The confirmed certitude of the Keynesian mode of thinking which seemed to have worked wonders during the three decades after second world war appeared now to be wearing thin in the face of the stagflation that seemed to be the order of the day.

It is in this context that there was a return to the laissez-faire orthodoxy which stood for giving the maximum free play to individual initiative and agency. The underlying rationale of this mode had always rested on Adam Smith’s notion that the “invisible hand” would ensure that the pursuit of individual self-interest would ultimately be consonant with the broader collective good. There was also an underlying belief that the system was selfcorrecting, which is to say that if per chance the system were to be perturbed by some external shock, then there would be automatic, internally generated forces that would lead it back on to the desired path.

The intellectual basis for the desirability of the private ownership competitive market system rests on the so-called first fundamental theorem of welfare economics, which states that all competitive equilibrium allocations are Pareto efficient, in the sense that no individual can be made better off without making some person in the economy worse off. It is well known, however, that the requirements for the ideal competitive equilibrium system are extremely demanding. It presupposes that there be no externalities which would rule out public goods, no imperfections in the goods and factor markets, no informational asymmetry amongst agents, and fully specified contingent futures markets, among many other highly restrictive and even patently unrealistic assumptions. There is hardly any real economy which could conceivably fit this bill in toto. Yet, it must be conceded that the notion of the Walrasian general competitive equilibrium encapsulates the pinnacle of economic theorising, and this notion may be regarded as an abstract ideal state against which to juxtapose any real actual economy.

The conceptualisation of the ideal system of Smith-Ricardo-Say has another very important dimension. It posits that the system is flexible enough to ensure that all factors will always be fully employed, and if per chance there would be any mismatch of demand and supply of any good or factor, then there will be forces generated which will automatically bring the system back to equilibrium. However, Robert Malthus had early on foreseen the possibility of gluts or general over-production, which would allow mismatches to persist in one or more markets. This immediately opens up the possibility of booms and busts that have actually characterised the development of all capitalist economies. For Marx, this instability constituted an intrinsic feature of the capitalist system and indeed was the differentia specifica which distinguished it from other possible economic systems.

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2 Keynes and Schumpeter

It might be instructive to see at this point how the issue of business cycles was looked upon by John Maynard Keynes and Joseph Schumpeter, each of whom wrote masterly tracts on the subject in the 1930s. Keynes’ substantial formulation on the issue of instability of capitalism is contained in his Treatise on Money, published in 1930. Keynes was 47 at this point of time and his brilliance was already well established. He had shot into fame after the The Economic Consequences of the Peace (1919), which he wrote after the Treaty of Versailles where the UK was party to the Allies imposing heavy reparations on Germany. Keynes was a member of the official British delegation and resigned in protest, after which he penned the book in a short span of time. In the negotiations, Keynes had made an impassioned plea to treat Germany in a considerate, humane way rather than insist on imposing heavy reparation charges. But France’s Prime Minister Georges Clemenceau was bent on delivering a crushing blow to Germany and prevailed over the other two key participants, US President Woodrow Wilson, who was simply outmanoeuvred, and British Prime Minister Lloyd George, who seemed to be preoccupied with his short-term political future. Keynes’ critique was to prove prophetic. Within a few short years, Germany began its precipitous slide into fascism.

Prior to writing the Treatise, Keynes had written A Tract on Monetary Reform (1923) which contained a systematic statement of his view on the means of economic policy as well as a presentation of his abiding interest in the stabilisation of economic activity. This was further definitively elaborated upon in the Treatise. In both these works, Keynes, like Malthus before, was interested to understand the forces that determine the level of savings and investment in an economy. In the phase of early capitalism after the onset of the industrial revolution, the individuals who saved were also the ones who invested. Large-scale, mass-producing monopolistic units were still not the order of the day. As production became more roundabout and technological progress enabled and even necessitated large-scale, mass-production units to come into being, there was a possibility for investment and saving activities to be delinked. This also concomitantly created the need for banking and financial intermediaries to mobilise savings that could be channelised to the investors. The savers and investors were now typically two distinct sets of economic agents. But this also implied that the manner in which Ricardo-Mill-Say had presumed the savings-investment identity to always necessarily hold could no longer obtain. There could now be the very real possibility, for example, of savings exceeding investment, thereby bringing in the possibility of gluts. As a result, national income and employment would now be set to shrink.

Both the above works created the stage for Keynes’ tour de force, The General Theory of Employment, Interest and Money, which was published in 1936. The revolutionary breakthrough consisted of the recognition that there could now be a possibility for the equilibrium level of income to be strictly below the full employment level of national income. This is an outcome that could not possibly have occurred in the Ricardo-Say-Mill system. If employment were to be at less than the full employment level, then wages would go down till full employment is restored.

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Keynes suggested that since wages are typically sticky downwards, this would eliminate the possibility of self-adjustment below a certain level of institutionally agreed upon nominal wages. The economy could then settle for an equilibrium at a less than full employment level of employment and income. The idea that the equilibrium could possibly occur at any level other than the full employment level itself constituted a revolutionary departure from the essential stance of classicism wherein full employment of all factors was regarded to be axiomatic.

Keynes diagnosed the problem as one of lack of effective d emand. The problem that he was addressing was that being faced by mature capitalist economies. It was not a problem of any supply constraint. Factories were all there; only that they stood idle because there was no demand for their produce and labour was not being hired, and the ones who still had jobs faced the imminent possibility of being fired. Keynes showed that if somehow the level of aggregate demand could be triggered, possibly by the government printing currency notes to employ people to dig holes and fill them up, the wages that would be paid out would resuscitate the economy by generating successive rounds of demand through the multiplier process.

The higher the marginal propensity to consume of the workers, the greater would be growth of national income. Since there was idle capacity, the system could immediately set to work. There would be no problem of a g estation lag. The seemingly i ntractable problem appeared to have a neat, pat solution.

The other epochal figure who produced a major study on business cycles was Joseph Schumpeter. Schumpeter and Keynes were contemporaries, both having been born in 1883. Schumpeter’s reputation as one of the foremost economists of the times was already well established as the author of the insightful and brilliant work, The Theory of Economic Development (1912), which he published at a relatively young age. After a somewhat unusual career, which included a brief and not particularly glorious stint as the finance minister of Austria and later the presidentship of Biedermann bank, a private bank in Vienna, he had come to take up a chair in the Economics Department at Harvard in 1932. The bank had to be liquidated, and unlike present-day chief executive officers (CEOs), who do not baulk at granting themselves generous bonuses in times of liquidation, the president of Biedermann found himself in considerable personal debt. Characteristically Schumpeter paid his creditors in full rather than hiding behind bankruptcy laws. He continued to pay his debts from the somewhat meagre professorial salary that he earned at Bonn. One of his principal motivations to shift base to the US was the salary which was substantially higher than in Germany, and this enabled him to repay his debt from his Biedermann misjudgments quite a bit faster. Rather hard though this financial burden was, the act of repaying his past debts was a moral duty to be carried out unquestioningly, and there was no question of running away from it. In every other regard, especially on the cultural front, he found the American milieu rather unlettered, at least during the early years.

At the time of his shift to the US, Schumpeter was possibly at the lowest point in his emotional life. He had just recently lost his mother, the person he was most attached to and who doted on him, and soon after, also his second wife, who tragically died in childbirth (see, for example, Allen 1991). He was a virtual wreck emotionally, and he turned more and more to work to stay away from dark thoughts. Within a few years of his having settled down at Cambridge, Massachusetts, he set to work on what he himself regarded to be his magnum opus. This was to be his massive 1,100-page scholastic tome on business cycles, which appeared in two volumes. It appeared in 1939, three years after Keynes’ triumphant General Theory, which had almost immediately earned for him an impressive list of acolytes that included Alvin Hansen and John Kenneth Galbraith. Schumpeter’s case was a study in contrast.

Timing of Schumpeter’s Work

The timing of this work could not possibly have been more unfortunate. The book sank without making any impact whatsoever. This could not possibly have been uplifting to his already fragile psyche. Schumpeter was very much conscious of this. Behind the usual bonhomie and banter of social intercourse, he was a deeply disappointed at the reception to his long years of labour. Intellectually he was cold to the Keynesian prescription of massive government intervention in times of depression. Also, in S chumpeter’s mind, Keynes’ General Theory was not “general” at all, and it was specific to the conditions obtaining in England. He contended that the prescription was not likely to yield fruit in any other setting.

Successive batches of graduate students at Harvard had heard Schumpeter say during the height of the depression years: “Depression is for capitalism like a good cold douche.” The idea was that the best way to deal with an economic depression is to simply let things be and allow the inefficient units and institutions to e ither reform themselves or die out, and let the robust actors s urvive and in time prosper. This was very much akin to the Darwinian notion of self-selection and Schumpeter fundamentally concurred with this. He believed that one should not be afraid of depression because it is part of the necessary dynamism of the capitalist process, and to introduce government intervention to soften its blow would be to thwart the inherent d ynamism of the capitalist process.

One way to understand the essential difference between these two epochal figures is to recognise that Keynes was concerned with a short-run problem. “In the long run we are all dead” is possibly the most famous of his numerous quotes. Keynes was fundamentally committed to make capitalism work as a stable system without in particular the travails and miseries that are concomitant to the bust phase of the business cycle. After Keynes’ death in 1946, Schumpeter penned a highly touching and generous portrait of the man and possibly his arch rival, which is contained in his justly famous collection of biographies called Ten Great Econo mists Keynes’ was the last entry, Marx being the first, and Schumpeter himself died in January 1950.

In contrast to the Keynesian obsession with the short run, Schumpeter was decidedly concerned with the long run dynamics of the capitalist system. In his Theory of Economic Development, the key agent of the developmental process is the entrepreneur who takes risks and is the one who undertakes innovation.

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Schumpeter believed that bureaucratised intervention would kill the entrepreneurial spirit.

3 The Current Conjuncture

The Thatcher-Reagan era of the early 1980s witnessed a resurgence of conservative free market fundamentalism. By the mid1970s oil prices were beginning to harden as a result of the geo political fallout of the Arab-Israeli war of 1973, even as labour unions were driving hard bargains across the mature capitalist world, especially in the UK and France. This was not the situation Keynes had analysed and it should not have been any surprise that the Keynesian prescription did not work. It was at this juncture that Margaret Thatcher and Ronald Reagan spread out in the political firmament of the UK and the US. It is this setting that provided the intellectual basis for deregulation and a return to the Smithian laissez-faire philosophy. The votaries of free market fundamentalism got a further boost with the collapse of the B erlin Wall and the demise of the command economies of the Soviet Union and east Europe.

The intellectual basis of deregulation of the late 1980s and early 1990s is to be traced to the efficient market hypothesis. Among the major economists who have contributed to this idea are Milton Friedman, Eugene Fama and Robert Lucas of the Chicago school. It essentially says that prices of stocks, bonds and other speculative assets reflect everything that is known about economic fundamentals, such as corporate profitability, inflation and export possibilities. Consider for a moment that stock prices have risen above the levels justified by the fundamentals. Then rational economic agents would step in and sell them, causing the relevant stock prices to go down. The process would continue till stock prices are restored to the levels that are justly warranted by the fundamentals. If stock prices were to fall below their fundamentals, then the reverse process would be expected to operate.

The efficient market hypothesis has an interesting corollary. It is that if stock prices already reflect everything that is known and knowable, then rational investors cannot hope to outperform the market using trading strategies based on publicly available information. There are two implications to this. First, rather than waste time and pick individual stocks, investors would be well advised to place their savings in broadly diversified mutual funds. Largely owing to the work of Fama and some of his followers, the so-called mutual or index funds today play a key part in the r etirement planning of millions across the world. Second, if there are some agents who are privy to insider information and are willing to use it, then they can potentially make a huge profit.

The difficulty however with this hypothesis is that it does not and cannot adequately account for the fact that stock markets are at least as much driven by investors’ expectations and exuberance as by market fundamentals. It is this exogenous and usually spontaneous shift in moods – optimism or pessimism – that is at the heart of the fluctuations in stock prices. Keynes called them “animal spirits” in The General Theory. He argues,

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than

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on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities (Keynes 1936, 161).

Later, again, Keynes observes,

Individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death. This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man… In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends …We are merely reminding ourselves that human decisions affecting the future, whether personal or political or e conomic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and it is our innate urge to activity which makes the wheel go round…(Keynes 1936, 162-63).

The large body of work on behavioural finance in the last three decades buttresses the conclusion that asset prices are as much driven by the mathematical expectations of their returns as they are by Keynes’ animal spirits or what Greenspan and Shiller were later to call irrational exuberance. It, therefore, follows that there is always a real possibility for the market to spin out of control.

The possibility of market instability is a matter of no small concern for practitioners of mainstream neoclassical economics as it has been practised and propagated in the dominant Anglo-American setting in the post-war years. As noted above, the discipline of modern economics has fundamentally been premised on the central role of the market system to efficiently allocate r esources. The epitome of theoretical formalism was achieved in the early 1950s when the existence of competitive equilibrium was demonstrated in the path-breaking contributions of K J Arrow, Gerard Debreu and Lionel McKenzie in the most g eneral setting. This was the old problem that Leon Walras had set for himself, which was to check the existence of a price vector that would clear all markets. His pioneering work, which involved counting the number of independent equations and unknowns, was able to demonstrate that under certain reasonable conditions, competitive equilibrium does in fact exist. Walras’ solution however was not fully satisfactory. There were many loose ends and generations of major economic theorists tried to finesse the problem till it was decisively dealt with, and shown to be true in the most general setting by McKenzie (1954) and Arrow and Debreu (1954).

Interest in the existence of Smith-Walrasian general competitive equilibrium was due to the fact that such equilibrium has the desirable property that it is Pareto efficient, which is the statement of the so-called first fundamental theorem of welfare economics. Interestingly, Keynes regarded all this at an intuitive level to be a given and had no time for the niceties of the theory of value. Joan Robinson chided Keynes for this neglect in

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her Economic Philosophy (1962). She observes, “Keynes himself was not interested in the theory of relative prices” (76). She a ttributes to fellow Cambridge economist Gerald Shove the view that “Maynard had never spent the 20 minutes necessary to understand the theory of value”. Keynes was focused on the issue of stability of equilibrium, for it is ultimately this issue which would be relevant for the preservation and growth of the capitalist system. But the manner he was posing the problem was very uniquely his own. He was not using the Walrasian general equilibrium system. Keynes’ model was aggregative and therefore in the realm of macroeconomics. He was interested in demonstrating the existence of equilibrium when there is a less than full employment level of employment and national income and he was able to do this conclusively. The policy prescription was obvious: the government has to step in to increase effective demand to move the system back to the full employment level of equilibrium.

But, as noted above, Keynesianism appeared to have run its course by the early 1980s and there was a point of view held in influential quarters that the government was part of the problem and not the solution. It was at this juncture that a significant segment of the economics profession came to be dominated by “finance” theorists who likened their specialisation to “rocket science”. This group deployed much mathematical firepower to forecast risk. Following the influential work of Fischer Black and Myron Scholes on option pricing, clever financial managers sold mortgages to investors in a variety of newfangled financial instruments and derivatives. Small sums of equity capital were leveraged to generate large volumes of loans. This was especially true of the US housing market through the early years of this decade. As long as the market was in a boom phase this posed no major threat, but if per chance investor confidence were to sag due to any external shock, there would be no preventing the s ystem from collapsing like a house of cards.

4 Some Tentative Lessons

How is one to understand the present world financial and economic crisis as it relates to India? It would be idle to pretend that we are fully insulated from the US financial meltdown. There is no doubt that the relatively conservative policy stance of the R eserve Bank of India (RBI) over the period the crisis was brewing has proved to have been a boon. Specifically, not having gone in for full capital account convertibility has decidedly been proven to have been the right stance in hindsight. Yet, it is well known that some of the most prominent members of government, and a large posse of influential economic policy experts, constantly kept calling for full capital account convertibility all through the reform years, starting in 1991.

Barely three years ago, the prime minister asked the RBI to prepare a roadmap for full capital account convertibility. In a speech at the RBI, Mumbai, on 18 March 2006, the prime minister referred to the need to revisit the subject of capital account convertibility. He said, “Given the changes that have taken place over the last two decades, there is merit in moving towards fuller capital account convertibility within a transparent framework … I will therefore request the finance minister and Reserve Bank to revisit the subject and come out with a roadmap based on current realities.” Most of the earlier forceful voices for full convertibility have lately spared the country their wisdom on this issue. This is a salutary development. There is still some reason to believe that economics has the power to persuade.

There are four issues that need to be highlighted here. First, over the reform years, the integration of the world financial system has proceeded at a dazzling pace. Large volumes of financial flow transfers are today possible at the touch of a computer key, which was inconceivable even a decade ago. It is all the more important therefore for us to recognise that we could not possibly have been totally sheltered from the US financial meltdown. For a start, confronted with extensive job losses domestically, US corporates are already reducing their outsourcing and that has an obvious direct impact on jobs in India, though this would constitute a minuscule number of our massive labour base. Yet, it would be wrong to hold that we are unaffected or that it is business as usual. Need we remind ourselves that the rate of growth that we are finally able to achieve may at best be only 7.1%, if that? In a recent communiqué, the RBI explicitly states, “India’s growth trajectory has been impacted both by the financial crisis and the follow-on of global economic downturn. This impact has turned out to be deeper and wider than anticipated.”

Second, thanks to strict adherence of capital adequacy norms as required by the RBI, our domestic banking sector has been largely insulated from the US financial crisis. There are a few individual cases of exposure to toxic assets, but the degree of exposure is limited. As Joseph Stiglitz has observed in several places, globalisation has enabled the US to export its toxic assets to the rest of the world, particularly to Europe, but fortunately for us, the Indian banking sector has been relatively free of this contamination.

Third, the fiscal stimulus plan of US President Barack Obama is a straightforward Keynesian prescription that needs to be carried out with due diligence. In the recent meeting of the World Economic Forum at Davos there were labour leaders with experience of attending previous meetings who emphasised the need for a better understanding of the concerns of working women and men. They were particularly angry at the financial community’s lack of remorse. Their call for the CEOs and captains of finance and investment majors to repay past bonuses was received with applause.

Fourth, the stimulus packages being worked out in India ought not to be confused with the packages in the US and Britain. In true Keynesian fashion, the US stimulus packages are geared to boosting aggregate effective demand. The objective condition pertaining in countries like India is however altogether different.

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It is possible to argue that the true rationale of the stimulus package ought to be to address long-term, rather than shortterm, issues in countries that are still remarkably low in terms of their average level of living. As per the latest per capita income figures for the year 2007 contained in the World Development Report 2009, India is at $950 per capita whereas China is at $2,360 and the US is at $46,040. Of course, the purchasing power parity (ppp) figures are more favourably placed at $2,740, $5,370 and $45,850, respectively, but still the gulf between the poorest and the richest regions would seem to be almost unbridgeable. The relevant potion for any similar crisis in a country like India has got to be by way of freeing supply-side constraints rather than focusing on true Keynesian aggregate demand issues.

To take a concrete example, after the global meltdown, car sales in the large car segment in India have suffered a slump in demand. The question is whether there should be a stimulus package to help this segment or whether one should allow this sector to sink if the extent of demand for its product is known to be in only the niche market segments. Would it be judicious to use the Keynesian format to resuscitate this class of industries or would it be prudent to let them be closed down if low demand or, more generally, lack of general interest dictates that such projects be abandoned? The Schumpeterian logic of a depression being regarded as a good cold douche must have a natural appeal here. For a country that has over a quarter of the population below the poverty line as per official Planning Commission figures, though other bodies like the National Commission for Enterprises in the Unorganised Sector (NCEUS) place the figure at several multiples of it, the obvious moral imperative is one of placing exchange entitle ments or simply purchasing power in the hands of the poor and the destitute. There would be an immediate round of demand of food and other items of mass consumption: there need be no fear of inadequate demand as a result of such income generation measures.

To put it in yet another way, an obvious way of thinking of stimulus strategies in our context would be to pump money into rural infrastructure to resuscitate the vast agricultural sector that now contributes a bare 18% of gross domestic production (GDP) whereas almost 60% of the population of the country is still dependent on it. But alas the most vocal voices that have been pleading for stimulus packages are invariably the captains of industry through their powerful guild bodies that exercise huge clout in the corridors of power.

In conclusion, it may be useful to offer two thoughts. First, when we look at the lifetime contributions of a figure like S chumpeter we see a person of aristocratic demeanour, widely and deeply read, author of the brilliant Capitalism, Socialism and Democracy (1942), which restored his élan after the perfunctory response to his Business Cycles (1939), and one who very perceptively understood the capitalist system as one of a perennial gale of “creative destruction.” There can hardly be a more apposite description of the present-day information and technology-driven capitalism. Schumpeter believed that the capitalist system offers the most conducive setting for growth where entrepreneurs have the option to freely innovate. Yet, paradoxically, he was ultimately pessimistic about the system and believed that capitalism would not survive. And this because even though the system will deliver the best possibilities in terms of material goods, it will also make the system receptive to the growth of rationalist thought which will ultimately question the system itself and undermine it. He knew that capitalism would be prone to instabilities, but he was decidedly against government bailouts. Most importantly, when he himself was in deep debt due to his misjudgments as the president of Biedermann Bank, he slogged for years to repay each deutsche mark of his debt.

Second, even though Keynes, like Schumpeter in Austria, was a member of the English upper class, had studied at Eton, and had a lifelong loyalty to King’s College, Cambridge, he was, in contrast to his great contemporary, quite optimistic about the capitalist system. In his famous essay entitled “Economic Possibilities for Our Grandchildren” written in 1930, during the dark days of the Great Depression, Keynes suggested that in a hundred years’ time the economic problem may be solved. He was referring not to the immediate problem of depression, but of the economic problem itself, the essential problem of not enough to distribute among all. He believed that for the first time in the history of mankind – English mankind, at any rate – human beings would have the possibility of emerging from perennial want to a state where there would be enough for everyone’s needs at the communal table. Though Keynes was decidedly not enamoured of Marx, he was painting a picture here that was the slogan

– from each according to his ability and to each according to his need – of Marx’s 1875 Critique of the Gotha Programme. The e ssential element was the aspect of abundance and optimism that both Marx and Keynes fundamentally believed in. For Keynes, capitalism was the least imperfect system one could have and it was necessary to make it function efficiently. It is this lifelong obsession that led him to provide the precise antidote to the depression situation, because more than anyone else he was committed to using the subject of political economy to improve the human condition.

References Keynes, John Maynard (1919): The Economic Robinson, Joan (1962): Economic Philosophy (Har-

Allen, Robert Loring (1991): Opening Doors (New Brunswick, NJ: Transactions Publishers).

Arrow, K J and Gerard Debreu (1954): “Existence of Equilibrium for a Competitive Economy”, Econometrica, 22, pp 265-90.

Black, Fischer and Myron Scholes (1973): “The Pricing of Options and Corporate Liabilities”, Journal of Political Economy, 81, pp 637-59.

Fama, Eugene (1970): “Efficient Capital Markets: A Review of Theory and Empirical Work”, Journal of Finance, 25, pp 383-417.

C onsequences of the Peace (London: Macmillan & Co Ltd).

  • (1924): A Tract on Monetary Reform (London: Macmillan & Co Ltd).
  • (1930): A Treatise on Money (London: Macmillan & Co Ltd).
  • (1936): The General Theory of Employment, Interest and Money (London: Macmillan & Co Ltd).
  • McKenzie, Lionel (1954): “On Equilibrium in Graham’s Model of World Trade and Other Competitive Systems”, Econometrica, April.

    mondsworth: Penguin Books).

    Schumpeter, Joseph Alois (1939): Business Cycles (New York: McGraw-Hill).

    – (1942): Capitalism, Socialism and Democracy (London: George Allen and Unwin Ltd). Shiller, Robert J (2000): Irrational Exuberance (Princeton: Princeton University Press).

    Walras, Leon (1874): Elements of Pure Economics, translated by William Jaffe 1954 (London: George Allen and Unwin).

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