From Keynes to Bretton Woods

Soros, Stiglitz and other establishment critics of neo-liberalism draw upon the work of John Maynard Keynes, who believed in the necessity of managing capitalism, both to provide a fair society and to maintain a capitalist system. During the 1930s Europe and North America were plunged into recession. Economies shrank and unemployment figures mushroomed to millions. The resulting turmoil fuelled the political chaos that lead to World War Two. The conventional ‘liberal’ or ‘classical’ free market economists believed that the economy worked best without government controls and tended to automatically correct any disequilibria. If demand for goods fell, prices would fall too and eventually shoppers would increase demand as they snapped up bargains. If individuals were unwilling to borrow money, interest rates (the price of money) would fall, and if rates fell low enough demand for loans would pick up rescuing the economy. Furthermore if workers became unemployed they could cut their wages until firms found them cheap enough to employ. These market advocates believed that apparently humane attempts to deal with poverty and unemployment such as state welfare benefits would simply make the recession deeper by discouraging wage-setting. Even socialist politicians such as Hilferding in Germany and Snowdon in Britain accepted this orthodoxy. As the years went by and liberal policies of non-intervention were accompanied by deeper recession, conventional economics became increasingly discredited. The only economies that seemed to work were to be found in Hitler’s Germany and Stalin’s Russia.

By the late 1930s the western economies were slowly pulling out of slump and demand rose with employment as war led to large factory orders for guns, planes and assorted military paraphernalia. Nonetheless by the 1940s and 1950s the economic orthodoxy was largely abandoned for Keynesianism. Keynes suggested that economics has a psychological element that means if confidence is low, so too is consumption and growth. Prices, wages and interest rates may be ‘sticky’, by which Keynes meant they would not fall easily, because firms, banks and workers may be reluctant to lower them if they feel that they will still suffer when demand is low. Keynes argued that if people think bad economic news is on the horizon they spend less and the bad economic news becomes a recessionary reality. Businessmen and even women are particularly edgy and suffer from a herd mentality, cutting investment when they fear bad economic news. Like deranged beasts they stampede towards slump. The answer is for governments to inject spending in the economy when recession looks likely. In turn if excessive spending threatens the economy, governments can control it by raising taxes and cutting expenditure.

In July 1944 Keynes acted as the British government’s representative to the Bretton Woods Conference in New Hampshire, USA. Bretton Woods aimed to create a new financial architecture and new global institutions to restore economic stability and remove the threat of world recession, after the war had been won. It called for the creation of three key institutions. During the 1940s the General Agreement on Trade and Tariffs (GATT), now known as the WTO, was established to sweep away barriers to trade so as to promote faster economic growth. The International Bank for Reconstruction and Development, commonly known as the World Bank, was set up to lend money to countries, initially for restoration of infrastructures decayed during recession and smashed by war. Its role has increasingly shifted towards funding development projects in the south of the globe. Finally the IMF was created to help countries faced with severe debt problems or balance of payments deficits. Stiglitz sees all three institutions as essentially Keynesian, examples of government intervention, aimed at making the market work and capitalism expand.