Comparison: Keynesian Political Economy And Liberal Economy

The differences in Keynesian political economy and liberal economy’s approach to the state stem from whether they believe state involvement is necessary for the market to function. Whilst, this appears to be a fundamental difference, the significance of this main difference in terms of how it effects the role of the state is, in practice, not as striking as it seems. This essay will focus on the practical implications of following each economic theory on how large of an effect the state would have on its population. By focusing on macroeconomic policy followed by the state, referring to the period after the 1929 Great Depression in the US shows a practical example of the Keynesian political economic theory which can later be compared to the introduction of different liberal policies. Also, the essay will look at the impact each theory has on the state’s control of labour market. By using practical examples of the economic theory’s differences being used, it allows to decipher how significant the differences actually end up being, after being implemented. Hence, to conclude that the differences, are not as significant as they appear in the theory and how both aim for the same goal of market forces controlling the majority of the system.

Deciphering the significance of the differences is important to be able to study how the state’s role changes depending on a country’s’ ideology. The liberal economy follows the laissez faire approach, arguing a free market needs to be unregulated with minimal regulation. On the other hand, Keynesian economics centres on capitalisms tendency to have a downward spiral into recession which can becoming indefinite when aggregate demand is in deficit and so, relying on external intervention to stop it (Forges Davanzati and Pacella, 2016, p.25). In terms of the role of the state and the understanding of how it is involved, Keynesian political economy emphasises the need for demand side policy as money supply is endogenous and demand-driven (Forges Davanzati and Pacella, 2016 p.25) so can be controlled by the state in order to allow the constant flow of income (Heilbroner, 2000, p.266). The liberal economy focuses on reducing state involvement with on supply side policy in order to minimise production costs for markets. Thus, to distinguish the practical significance of these differences, this essay will firstly look at the role the state would play in macroeconomic policy and how effective they are. Then, looking specifically at the impact the differences have on the labour market. Hence, the essay will explain how, in practice, the extent to which the differences are significant for how we view the state is not as different as it appears.

Macroeconomic Policy

The differences in the states involvement with macroeconomic policy appear to be hugely different. Using the Keynes example, a country going through a recession, firms will seek to create a profit and reduce losses. The liberal economy would argue that any state involvement with regulation or taxes would prevent factors of production being paid their worth and so, the role of the state could only lower social well-being (Palley, 2004, p.2-3). Consequently, the state is only to remove restrictions, regulation or lower taxes. The liberal economy, in theory, would not need state involvement in the market as lower prices should mean more propensity to save which would put pressure on interest rates and lead to investment so the economy would rebound (Heilbroner, 1999, p.266-267). Whilst, Keynes originally agreed with the concept of automatic stabilisers, the 1929 Great Depression highlighter how longer periods saw the economy could lie stagnant permanently (Heilbroner, 1999, p.270). American private citizens make $3.7 billion in savings and by 1932 and 1933 it was saving nothing and the economy had not improved (Heilbroner, 1999, p.270), there was no foundation of savings to put pressure on interest rates which would lead to increased business investment. Hence, the Keynesian theory argues for policy focusing on aggregate demand, like quantitative easing or an expansionary fiscal policy. Forges Davanzati and Pacella (2016) infer that the creation of money by the banking system followed by movements of interest rates is necessary to create a willingness to satisfy the demand for credit (p.18). Hence, the expectation of the state in a Keynesian political economy is to restore the confidence and so, plug the leakages and increase injections into the ‘circular flow of income’.

The significance of this different approach to macroeconomic policy during periods of recession. Whilst, in theory, the supply side policies that aim to remove state involvement from the market should force the market to rebound, the 1929 Great Depression shows how that is not always the case. Furthermore, the New Deal period in the US post World War II highlights how successful the Keynesian political economic theory can be, as it increased prosperity with a new approach to monetary policy and increased domestic intervention in areas from banks to farming (Patel, 2016, p. 9-26). Thomas Palley (2004) argues the very success of the New Deal period caused US citizens to view the policies introduced as dispensable, disregarding the success, and instead pushing for radical individualism (p.2-3). Hence, the success of Keynesian demand-side policy may successfully solve the problem, but notably, in the US, it may be viewed as unnecessary state involvement. Palley (2004) also highlights Milton Friedman’s argument for transparent rules to take the discretion out of policy decisions which means the market forces solve the problem, notably in situations where the banks or state had involved wrongly (p. 4). Hence, the extent to which the difference here is significant is limited. The supply side policies aiming to reduce production costs are only implemented to allow the supply side to easily adjust for demand. Effectively, both are aiming for the same outcome, just going through different means to get there. Noticeably, neo-Keynesians often accept the neoliberal rhetoric of being paid your worth (Palley, 2004, p.2). Whilst, the Liberal economy does focus on limited state involvement in its role, the Keynesian political economy wants to use the state as a means of strengthening market forces (Clarke, 1988, p. 193) and so, both believe in the use of market forces.

Furthermore, the introduction of neoliberalism allows more individualistic approaches for firms as there’s less central state control. Hall and Soskice (2001) state that this is beneficial for breading radical innovation in constantly changing, dynamic fields like technology and so, relies on limited regulation to constantly be able to change production (p. 38 – 39). However, the significance of this difference is limited as Keynesian economic theory also believes that microeconomic questions like what should be produced and by who, should also be left to the market mechanism (Kirshner, 1999, p. 319). Hence, in microeconomic terms, the understanding of states role can be conceived as more involved with Keynes however, not significantly more so as it doesn’t focus on solving microeconomic problems.

Labour Market

The labour market is another key aspect to identify how significant the differences between the role of the state. Income distribution theory which links to the macroeconomic policies is an example of how the two different theories are similar in beliefs. Keynes believed in marginal product theory of income distribution, as does liberal economy (Pallay, 2004, p.3). This is the idea that workers are paid how much they are worth to the firm depending on the supply of and demand for workers of those skills and so, removing a need for trade unions or state intervention in the labour market. However, Keynesianism still argues that there is a need for state involvement in order to maintain the flow of income from person to person, so whilst there was ‘justification for significant inequalities of incomes and wealth’, he argued that not for the size of the inequality you can see today (Keynes, 1936, p. 374). Kirshner (1999) highlighted Keynes reasoning for why this was the case as unequal distribution of income would not generate enough aggregate demand and so, stagnating economic growth and preventing full employment being achieved (p.319). On top of this, the unequal distribution of wealth would unfairly further reward those who did not need it and in practice, this causes political unrest and upheaval (Kirshner, 1999, p. 319). Liberal market economies (LMEs) are more likely to have an unequal distribution of income (Akkermans, Castaldi and Los, 2009) Hence, Keynesianism shows the need for state involvement in order to prevent a need for a larger amount of state involvement later on. Therefore, by not having Keynesian state involvement of some sort, there is a risk of major political unrest and so, the practical implications of little to know state involvement to reduce inequality of income distribution could be significant.

The emergence of zero-hour contracts in the labour market further this as weak regulatory environment feeds the legitimisation of ‘If and When’ contracts that can limit workers’ rights (O’Sullivan et al., 2017, p. 665). The use of the liberal economic theory has seen the state, as its role of the employer, using ‘If and When’ contracts in areas like education, health or outsources community care services (O’Sullivan tt al., 2017, p. 665). Schmidt (2007) furthers this by saying in liberal market economies (LMEs) the state is an agent to conserve the market but has ‘an arm’s length approach to business and labour’ (p. 5). Thus, implying heavily that an LME would rather not intervene in labour markets at all but for Keynesianism the widening wage inequality would prevent the balance of power in labour markets from being preserved (Pallay, 2004, p. 5). This is reflected by some LMEs changing from the Keynesian policy of full employment to aiming for a ‘natural rate of unemployment’, which is an unobservable measure supposedly determined by labour market forces (Pallay, 2004, p. 5). Hence, the policy changed reflects liberal economic theory and means there is a lack of expectation of the state to encourage full employment. The emergence of ‘If and When’ contracts highlight this as the goal of ‘natural rate of unemployment’ is to allow for a flexible and competitive workforce. The 1950s in the UK saw the use of full employment as a government policy, they saw issues of choosing between it as a policy and maintaining price stability (Clarke, ???, p. 177). Furthermore, LMEs are often known to have generally higher rates of unemployment and longer average working hours (Akkermans, Castaldi and Los, 2009). This heavily implies that by using full employment or ‘natural rate of unemployment’ as policy objectives that determine the extent of the state’s role in labour markets, there will be a significant impact on the populations’ livelihoods. Whether that be because of inflationary pressure, changing workforces or standards of living. Hence, meaning the differences between Keynesian and liberal theory is practically impactful. However, Clarke (1988) highlights that the state wanting to be a competitive strength of domestic productive capital relative to the world scale meant the ability to achieve full employment was constrained (p. 178). Thus, if a state working with a full employment policy also have conflicting policy aims that aim to make the workforce competitive, then the extent to which the policies end up changing livelihoods is limited. Consequently, the difference is significant depending on what other policies or role the state has in conflicting areas like inflation.

Conclusion

Therefore, the extent to which the differences change our understanding of the role of the state is limited depending on what aspect of the economy you look at. Whilst, the use of policies like interest rates and quantitative easing is Keynesian by nature, in practice, liberal economies do not always appear to stick to theory with monetary policy. However, in terms of labour markets, the impact on the country depending on which policy you take could be drastic. Hence, the differences could be significant if in practice, states were to stick entirely to theory. However, in reality they are more likely to follow a mixture of policies which would prevent one extreme or another happening.

01 August 2022
close
Your Email

By clicking “Send”, you agree to our Terms of service and  Privacy statement. We will occasionally send you account related emails.

close thanks-icon
Thanks!

Your essay sample has been sent.

Order now
exit-popup-close
exit-popup-image
Still can’t find what you need?

Order custom paper and save your time
for priority classes!

Order paper now