“Globalization” can be understood as a grand experiment to test the laissez-faire doctrine of neoclassical economics, which claims that a capitalist economy will become more efficient and stable as markets spread deeper and wider around the world. The “once a century” global economic crisis of 2007-9 stands as a testament to the failure of this grand experiment.

*     *     *

Abstract

Following the lead of Wicksell and Keynes, this article argues that a capitalist economy is subject to an inevitable trade-off between efficiency and stability because of its essentially “speculative” nature. First, while a financial market requires the participation of a large number of professional speculators to support its risk-diversifying function, competition among professionals can be likened to a Keynesian beauty-contest that constantly exposes financial markets to the risks of bubble and bust. Second and more fundamentally, the use of “money” itself—the ultimate source of efficiency in a capitalist economy—is also the ultimate source of its instability. To hold money is to take part in the purest form of the Keynesian beauty contest, since we accept money only because we expect everybody else to accept it as money in turn. A speculative money bubble can plunge the real economy into depression, while a speculative money bust eventually leads to hyperinflation. Indeed, the Wicksellian theory of cumulative process shows that any disturbance in monetary equilibrium triggers a disequilibrium process that cumulatively drives all nominal prices further away from equilibrium. The Keynesian principle of effective demand demonstrates that it is the stickiness of nominal wages that saves the capitalist economy from its inherent instability, albeit at the expense of full employment. This article also contends that in the context of the current global crisis, monetary instability has manifested itself in the form of the collapse of liquidity in the financial markets as well as in the form of the loss of confidence on dollar as the key currency of global capitalism.

Why a Sequel?

It is high time to write “The Second End of Laissez-Faire.” I say “the second” because an essay entitled, “The End of Laissez-Faire” was published as long ago as 1926, by John Maynard Keynes. ² But if it was none other than Keynes who wrote the first “End,” why on earth should its sequel need to be written at all?

The reason is that Keynes wrote his essay before he became a true Keynesian. Indeed, Keynes’ main criticism was targeted not at his fellow neoclassical economists but at “the popularisers and the vulgarisers” (p. 17) of the already defunct doctrines of eighteenth-century political philosophy.. “It is not a correct deduction from the Principles of Economics,” he claimed, “that enlightened self-interest always operates in the public interest” (p. 39). He went on to fault the naive advocates of the laissez-faire doctrine for having taken insufficient notice of such factors as economies of scale, indivisibility of production, external economies or diseconomies, adjustment lags, imperfect information, imperfect competition, and inequality of incomes and wealth. ³ But these are no more than “complications” in the simple and beautiful edifice of neoclassical theory, which no undergraduate microeconomics textbook would now fail to mention as possible sources of “market failures.” At the time, all Keynes could propose as “ Agenda ” of the state were the deliberate control of currency and credit, as well as the full publicity of useful business data, intelligent guiding of the way savings are allocated across sectors, and an enlightened policy on population size (pp. 47-49) ⁴ — agenda so modest in scope that even die-hard neoclassical economists might find them not unreasonable. ⁵ When he wrote the first “End of Laissez-Faire,” Keynes was simply a neoclassical economist—a leading disciple of Alfred Marshall, no less—albeit one who happened to have a warm heart.

In October 1929 the US stock market crashed and the world economy plunged into a depression so wide, so deep, and so prolonged that it has been known as the Great Depression ever since. It was during this economic crisis that Keynes published his Treatise on Money (1930) and The General Theory of Employment, Interest, and Money (1936), transforming himself from a warm-hearted neoclassical economist into the cool-headed founder of a new school of economics that sometimes carries his name.

¹ The author is Professor of Economics at University of Tokyo and Senior Fellow at Tokyo Foundation. Part of this paper is taken from my “On Twenty-first Century Capitalism: Crises of the Global Market Economy,” the first essay in Twenty-first Century Capitalism (Tokyo: Chikuma Shobo, 2000), “The Second End of Laissez-Faire,” Nihon Keizai Shimbun (2008.10.24), and “When Will the Dollar Abdicate as the Key Currency of the World?” an interview article in Bungei Shunju , January 2009, all in Japanese.

² John Maynard Keynes, The End of Laissez-Faire , London: Hogarth Press, 1926.

³ He wrote that: “Apart from other objections to be mentioned later, the conclusion that individuals acting independently for their own advantage will produce the greatest aggregate of wealth, depends on a variety of unreal assumptions to the effect that the processes of production and consumption are in no way organic, that there exists a sufficient foreknowledge of conditions and requirements, and that there are adequate opportunities of obtaining this foreknowledge. For economists generally reserve for a later stage of their argument the complications which arise - (1) when the efficient units of production are large relatively to the units of consumption, (2) when overhead costs or joint costs are present, (3) when internal economies tend to aggregation of production, (4) when the time required for adjustments is long, (5) when ignorance prevails over knowledge, and (6) when monopolies and combinations interfere with equality in bargaining - they reserve, that is to say, for a later stage their analysis of the actual facts. Moreover, many of those who recognise that the simplified hypothesis does not accurately correspond to fact conclude nevertheless that it does represent what is ‘natural’ and therefore ‘ideal.’ They regard the simplified hypothesis as health, and the further complications as disease. …. Yet, besides this question of fact, there are other considerations, familiar enough, which rightly bring into the calculation the cost and character of the competitive struggle itself, and the tendency for wealth to be distributed where it is not appreciated most.”(pp. 32-33.)

⁴ pp. 47-49. Note that at that time Keynes equated saving with investment and never took into consideration their ex ante divergence.

⁵ Indeed, Keynes’ Tract on Monetary Reform (1924) can be regarded as a precursor of Friedmanian monetarism.