The difference between Keynesian and classical economics

Just posted on Quora in answer to the question: What is the difference between Keynesian and classical economics? There are 13 other replies which not much more than prove to me that no one without a truly specialist knowledge of classical theory would have the slightest idea what an economist between the late eighteenth and nineteenth centuries would have understood about anything in relation to the operation of an economy. Their ignorance of what classical economists believed is matched by their ignorance of how an economy actually works. Anyway, this is what I wrote.

The differences between classical and Keynesian economics are so vast that to accept one version of how an economy works means you must reject the other. Classical economic theory is the theory that was developed between let us say 1776 and the 1870s, almost entirely by philosophers and business people who were actually looking at the economy. Modern economic theory has almost entirely been developed within universities by people who have neither a philosophical training nor have ever run a business as their primary mode of earning a living.

Here’s the difference. Classical economic theory begins from the existence of a market economy in which, on one side of the equation, there is a mass of people who would like to buy goods and services, and on the other side there are people who would like to earn their living by producing and selling things to others. The producers continually try to work out what to produce that others will buy, and do it by trying to decide what buyers will pay enough for in total to cover their production costs. These producers hire employees and the combined incomes of producers and wage earners become the purchasing power of the community.

Classical economic theory is thus entirely supply-side driven. And what is particularly interesting about reading the classical literature is that government regulation was an important part of how the economic system worked. The very first Factory Act in Great Britain was introduced in 1802, and there were many others that came after. The notion that classical economics was simply leave everything to the market is 100% wrong. If you look at the greatest economics text of the era, John Stuart Mill’s 1848 Principles of Political Economy, the final 200 pages are devoted to discussing the role of government in ensuring that economic activity was carried out in a morally acceptable way to the benefit of the entire community.

But crucially, classical theory assumes the role of the independent entrepreneur as the linchpin in making an economy work. Try to find a modern economic text that starts from there. Other than my own – Free Market Economics, Third Edition – none of the major mainstream texts starts from the supply side and none – as in zero – feature the role of the entrepreneur.

Keynesian economics assumes economies are driven from the demand side. That is, it is buying goods and services that makes an economy grow and employ, not their production. It is based on the total confusion between the demand for a single product – the greater the demand for shoes the greater the production of shoes will be along with the greater the level of employment for shoemakers. Demand affects individual products; demand in aggregate does not affect the level of output in total. The more that is produced, the higher the level of demand, for the obvious reason that the more that is produced, the more there is that buyers are able to demand. But if you are a Keynesian, you will go on believing that the cause of higher output is higher demand, whereas the reason more can be demanded is that more output is being produced. Public spending may have many benefits, but increasing the level of income and speeding up the rate of economic growth is not one of them. If anything, higher levels of public spending slow things down and lower real incomes below levels that otherwise would have been reached.

Keynesian economics is based on the fallacious belief that buyers will not buy as much as an economy can produce, and therefore demand must be stimulated to ensure everything produced is bought and that everyone who wants to work is employed. A great theory if you are in government and need a justification for taking as much money as you can get away with from income-earning citizens and spending it yourself. But a pernicious theory if you are interested in raising living standards as rapidly as possible.

 

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