By the mid-1960s, when the editors of Time wrote that “We are all Keynesians now,” the revolution was essentially complete. Keynesians had largely taken over the economics profession, and the Kennedy-Johnson administration was busy putting Keynesian policies into operation at the national level. Even Richard Nixon could announce that he was “a Keynesian in economics” as he slapped wage and price controls on the U.S. economy in 1971.
The Keynesian consensus began to come apart in the 1960s, first when some influential liberals (Galbraith most prominently among them) began to question growth and production for their own sake, and then more dramatically in the 1970s when inflation and unemployment provided openings for conservatives and market-oriented economists to question the effectiveness of Keynesian policies and point to “big government” as a cause of the nation’s economic troubles. In that decade, both Friedrich Hayek and Milton Friedman won Nobel Prizes in economics for work that challenged Keynes’s theories and the consensus that had formed around them. Margaret Thatcher and Ronald Reagan moved that debate to a higher plane in the 1980s as they implemented policies to reduce marginal tax rates and free up the British and American economies from regulatory burdens. During that period, Keynesian advisers were largely absent from influential government posts in the United States.
The success of those measures tended to polarize the economic debate, as advocates of Keynesian and “classical” free-market theories moved into rival political parties, think tanks, and academic departments. This is one of the elements of the polarized politics of the present time. The so-called “classical” theory, which many thought Keynes had buried in the 1930s, returned in full force in the 1980s as an alternative to the Keynesian consensus. As things turned out, the financial crisis of 2008 did not end the debate, as many thought it should have, but rather intensified it by providing a new occasion for quarrels over stimulus packages, taxes, and regulation. The financial crisis and the policy response to it proved that the “age of Keynes” had not yet run its course, in large part because Keynes’s ideas were now woven into the fabric of national politics and the American state. At this point, extricating them would probably require a “revolution” similar to that which occurred in the 1930s and 1940s.
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In making his economic case, Keynes meant to overturn not just the “classical” theory of economics but also the doctrine of limited government linked to it. In economics and economic policy he emphasized consumption, debt, and public spending as foundations for growth, rather than thrift, saving, and laissez-faire. In opposition to Schumpeter, he argued that if capitalism was to be saved, it had to be placed on a modern moral foundation in which spending, consumption, and debt were no longer seen as vices. He looked forward to a stage of capitalism when scarcity would be overcome, along with the harsh moral principles associated with it. Keynes understood that the revolution he proposed in economics had to be accompanied by corresponding breakthroughs in morality, culture, and political institutions.
The political economists of the eighteenth and nineteenth centuries saw a strictly limited state as an elemental feature of an efficiently operating market system. It was for this purpose that they devised the constitutional rules and institutional checks that we associate with the liberal states of that time. The architects of this classical liberal order saw the state as a threat to liberty and therefore tried to tie it down through various constitutional, legal, and political constraints. The new roles that Keynes assigned to the state were precisely the kind that liberal constitutions were designed to preclude: large public expenditures, public borrowing, and political management of economic affairs. In challenging the classical theory of economics, Keynes also challenged the political doctrine of classical liberalism to which it was attached.
Keynes never spelled out a theory of the state to correspond to his economic theory of public spending and investment. He did acknowledge in the final chapter of The General Theory that in order to maintain full employment the state would have to take on functions never envisioned by those earlier proponents of liberal government. These would include setting tax rates to promote consumption and directing investment to productive and socially useful goals. Yet he was never specific about how the state should organize itself to carry out these functions.
There is one obvious requirement for a Keynesian-style system: the state must command resources at a level commensurate with its responsibility to stabilize the economy. This condition was never met through most of the history of the United States. From 1800 to 1932, the U.S. federal government never had a budget that exceeded 3 percent of GDP except in times of war, when it exceeded that percentage for brief periods. During that long period, the federal government had few responsibilities beyond national defense and running the postal service, and relied mainly on the tariff to fund its operations. In 1930, at the onset of the Depression, the federal government spent about 2.5 percent of GDP, a proportion far too small to enable it to leverage enough debt to stimulate consumer demand across the economy. Federal spending increased to 10 percent of GDP by 1940, on the eve of World War II, then increased four- or fivefold during the war years, before stabilizing throughout the postwar era at around 20 percent of GDP—or at a level large enough to finance Keynesian-style policies.
The Keynesian revolution, in order to succeed, also had to push back against inherited suspicions about government debt. In 1932, both President Hoover and FDR campaigned for the presidency in favor of a balanced federal budget. Throughout the nineteenth century, leaders of both political parties in the United States expressed horror at the prospect of a permanent public debt. After the Civil War, Republican Party platforms consistently inveighed against government debt and in favor of the tariff to finance limited federal operations. From 1800 to 1932, total U.S. government debt never surpassed 20 percent of national GDP except during wars, after which the debts were rapidly paid off. But by 1940, total federal debt approached 40 percent of GDP and then increased to more than 100 percent of GDP by the end of the war. Rapid growth in the postwar period enabled the government to reduce that total back to about 40 percent of GDP by the late 1960s, after which time it began to grow again as a result of slowing economic growth and the burdens of increasing expenditures to pay for Great Society programs. From the late 1960s to the present, the U.S. government has achieved budget surpluses on only two occasions, notwithstanding the general prosperity of the period. Today, total federal debt (public and private) exceeds 100 percent of annual GDP and continues to grow steadily in the aftermath of the financial crisis. In 2009 and 2010, due to efforts by the Obama administration to engineer a Keynesian-style recovery from the crisis, the federal government ran budget deficits that amounted to more than 10 percent of GDP.
The most problematic element of the Keynesian state turns on the forms of political organization required to sustain it. Here, too, it stands in contrast to the classical liberal state. The dominant political parties in the United States from 1800 to the 1930s—the Democratic Party before the Civil War and the Republican Party afterward—were organized around the dispersion of political power in order to protect local or private interests. State and local governments jealously guarded their rights and privileges under the federal system. In the modern age, the fiscal power of the federal government has drawn all major interests into a national orbit, including state and local governments, whose representatives make routine pilgrimages to Washington in search of funds to cover their budgets. Both political parties—but especially the Democratic Party—organize constituent groups with interests in the federal budget, and enterprising politicians learned long ago that they could organize new voting blocs with promises of federal funds. This kind of politics—“Keynesian politics”—maintains a continuous demand for federal spending that facilitates Keynesian-style economic policies.