Keynes on the SlumpA Guide to Keynes' Thoughts During the 1929-32 Crisis, with a Focus on International Relationships and ProtectionIntroduction When you take one of the most capable and insightful economists of all time, and then combine him with the biggest and most infamous period of economic turmoil the world has ever seen, there was always a good chance that the outcome was going to be interesting. In this essay, I want to try to walk through and reproduce part of this interesting combination. The whole subject would be a long book, not a 32k word essay, so I have chosen to focus mainly on Keynes' thoughts on trade, currency and protection issues. I am writing from a not dis-interested point of view, as I personally believe there is a place for a certain new kind of targeted post growth protectionism in attacking our future inequality and sustainability issues. But I hope to not misrepresent Keynes. A quip which I am all together too pleased with myself for making, is that Keynes is rather like the Bible and Shakespeare, in that it is very easy to find something he wrote to suit your particular requirement. I hope I am not too guilty of this. On the other hand, I would urge in the same vein it is important for the reader not to see phantom parallels being drawn, and phantom points being scored, for the cause of contemporary protectionist sentiment where this is not intended. Most of this essay really is just about the troubled early 1930's, and the enjoyment of following Keynes' masterly writing and thinking from that dramatic period. There are many instances during the story where I found myself in sympathy with those who were against the messy and complex quagmire which those examples of protection did tend to encourage. The blanket revenue tariffs common during that time, could not be further from what I consider useful for today, and protection from that time serves as a cautionary example as much as anything else. However I do also try to answer those free market supporters who would lay the blame for the whole depression at the door of protection, as this is also an unfair conclusion, and a conclusion that Keynes himself certainly did not share. On starting out, I intending this essay to be shorter and focused more strongly on the protection angle. But, as you will see from the middle part of the essay, the larger economic story of the period, including the exit from the Gold Standard, was too hard to resist attempting to convey, and too many of Keynes' words and insights seemed too good to leave out. A case of serious mission creep I am afraid. Speaking of mission, the most obvious omission or bias of this essay, is the time

period it covers. In the later years of Keynes' life, he devoted much of his energies into helping to reconstruct a less protectionist post war international trading system, for the common good. Therefore some commentators have claimed he had changed his thinking completely away from protection. I would argue that this reversal of Keynes' sentiment has been exaggerated, in that although he considered it desirable to reduce international trade barriers in general, he continued to maintain the belief that each country had the right to use limited sensible protection policies where necessary. This is the subject of a future project in progress. Below is most of the transcript of a radio broadcast Keynes did for the BBC in November 1932, which was notably after much of the tumultuous activity recorded in this essay. This was the piece that first got me hooked on Keynes' sublime writing surrounding the subject, which is partly why it is by far the longest extract I have included. In case you have limited interest or time, I hope that you to at least read this extract, before the essay gets down to the larger 1929-1932 story: PROS AND CONS OF TARIFFS . . . I can claim that I have considerable sympathy with both parties; though, as you will find, I sympathise with both more from the practical than from the theoretical side. For the theoretical arguments which free traders and protectionists have each used are, many of them, as I think, invalid or misapplied. Each, on the other hand, has got hold of an important practical maxim. The Free Trade Position Let me begin with the essential truth of the free trade position. It is best illustrated by beginning at home. We all know that, individually or taken by groups, we are much richer if we concentrate on those activities for which we are best fitted, become specialists in the production of certain articles, and live by exchanging our products for the products of other specialists. We do not doubt that we shall be richer if we concentrate industry in the towns. We know that it would be stupid to put a higher licence duty on a motor-car used in a county where it was not manufactured. It never occurs to us to put on special taxes designed to prevent a Lancashire man from using a car made in Birmingham. And all this is just as true between countries, as it is between individuals or between districts. It is a waste and a stupidity for us to make one thing inefficiently when we might be better employed making something else. There is no mysterious quality in a frontier which upsets this obvious conclusion of the common sense. Most protectionist arguments to the contrary are sophistriesparticularly the one which contends that what I have been saying holds good under universal free trade, and that, if other countries impose tariffs, then it becomes advantageous to us to do the same. The tariffs of the foreigner reduce the opportunities for advantageous trade; but that is no reason why we should reduce them still further. Moreover, if we have to pay more than we need for what we use, that will raise our costs even in those branches of production for which we are best

suited; so that our efficiency will go downhill all along the line. All this is, surely, obvious; but that does not make it unimportant. On the contrary, it is frightfully important. The free trader starts with an enormous presumption in his favour. Nine out of ten times he is speaking forth the words of wisdom and simple truth-of peace and of good will also-against some little fellow who is trying by sophistry and sometimes by corruption to sneak an advantage for himself at the expense of his neighbour and his country. The free trader walks erect in the light of day, speaking all passers-by fair and friendly, while the protectionist is snarling in his corner. Nor does practical experience of tariffs in the least modify this general presumption. Quite the contrary. There is no important country with an old established tariff system which has not committed a hundred stupidities-stupidities difficult to reverse, once done, without doing a further injury-stupidities frankly confessed by all understanding people within the country itself. . . . The Limitations of Free Trade Why, then, did I begin by saying that I sympathised with both sides? I will tell you. In spite of all that I have just said, there are some important respects in which those who are not afraid to use tariffs have a broader conception of the national economic life and truer feeling for the quality of it. Free traders, fortified into presumption by the essential truths-one might say truisms-of their cause, have greatly overvalued the social advantage of mere market cheapness, and have attributed excellences which do not exist to the mere operation of the methods of laissez-faire. The protectionist has often used bad economic arguments, but he has sometimes had a truer sense of the complicated balances and harmonies and qualities of a sound national economic life, and of the wisdom of not unduly sacrificing any part even to the whole. The virtues of variety and universality, the opportunity for the use of every gift and every aptitude, the amenities of life, the old established traditions of a countryside-all those things, of which there are many, even in the material life of a country, which money cannot buy, need to be considered. National protection has its idealistic side, too-a side which a well-balanced national economic policy will try to marry with the peace and truth and international fair-dealing of free trade. If it were true that we should be a little richer, provided that the whole country and all the workers in it were to specialise on half-a-dozen mass-produced products, each individual doing nothing and having no hopes of doing anything except one minute, unskilled, repetitive act all his life long, should we all cry out for the immediate destruction of the endless variety of trades and crafts and employments which stand in the way of the glorious attainment of this maximum degree of specialised cheapness? Of course we should not-and that is enough to prove that the case for free trade, as I began by starting it, has left something out. Our task is to redress the balance of the argument.

. . . For the free trade argument against the use of a tariff for drawing workers into an industry for which they are relatively ill-suited fundamentally assumes that, in the absence of a tariff, they will be employed in some other more suitable industry, and does not allow for the contingency that they may not be employed at all. Protection for motor-cars Now for my examples of tariffs which I deem to be justified. First, our motor-car industry. I have always maintained that the protection which we have accorded to this industry ever since the War [WWI] was wise and beneficial. This was a new, progressive, ever-changing industry, of first-class interest and importance in itself, of a kind for which one would expect our national aptitudes to be excellent, offering highly congenial and attractive tasks and problems to one typical kind of Englishman. Indeed, it would be a shocking thing if we were to be without a prosperous and inventive motor industry. But during the War, when we were otherwise occupied, the United States had gained a great start on us both financially and technically; so that it was certain that the English industry would be bankrupt before it could pay, if it were to be exposed to the full force of foreign competition. The results today are a triumphant vindication of the protection we gave it. Can anyone deny it? For iron and steel That is a new industry. My next example is an old oneiron and steel. Here is a case of an industry with a great past, languishing to decayby our own fault, in no small degree. The problem is intricateI cannot enter upon it here. But I should not discard the assistance of a tariff if it were part of a well-concerted general scheme for the regeneration of the industry. For I am convinced that this is an industry for which, if one thinks in decades and not in single years, we are singularly well adapted. Yet it is obvious that much lasting injury can be done to it in a short time. Its further debilitation will devastate whole neighbourhoods; it will root up tens of thousands of men from their homes and associations to throw them helpless on the world; and it will render valueless miles of houses the financial fortunes of which the steel plants cannot take into account in their calculations of what will or will not pay. I do not consider it important, over against this, that steel today should be as cheap as possible to the consumer. I wish to see the blast furnaces of the north-east coast roar again and ships of British steel sail out of the Clyde. And I am prepared, if necessary, to pay a little for the satisfaction. And for agriculture My last example is the greatest crux of all for the uncompromising free trader agriculture. Suppose it to be true that the average farmer in this country will be ruined unless the prices of his output are raised by taxes on food or equivalent

measure. Is the free trader prepared to sayWell, let farming go? Of course we must not be foolish in our remedies, or attract the farmer into crops for which the country is unsuited compared with other crops. But that is not the dilemma I am putting to the free trader. Suppose that it is not possible for British farming today, so long as it is exposed to the uncertainties of unrestricted competition, to provide for those employed in it the standard of life set by the mass-produced industries of the towns and this supposition is by no means improbable. Are there any free traders who say Well, let farming go? I hope there are none such. For, anyone who does not imprison his mind in a straight-jacket, must know, as well as you and I do, that the pursuit of agriculture is part of a complete national life. I said above that a prosperous motor industry was a national necessity, if only to give an opening to one kind of typical Englishman. It is true in the same way that another kind needs as his pursuit in life the care and breeding of domestic animals and contact with the changing seasons and the soil. To say that the country cannot afford agriculture is to delude oneself about the mean of the word 'afford'. A country which cannot afford art or agriculture, invention or tradition, is a country in which one cannot afford to live. The path of wisdom in these matters is, then, a narrow one, to be trodden safely only by those who see the pitfalls on both sides. Neither free trade nor protection can present a theoretical case which entitles it to claim supremacy in practise. Protection is a dangerous and expensive method of redressing a want of balance and security in a nation's economic life. But there are times when we cannot safely trust ourselves to the blindness of economic forces; and when no alternative weapon as efficacious as tariffs lies ready to our hand. Keynes The Listener, 30 November 1932. vol XXI p204-210

Part One: The Background, and Keynes' Changing Thinking on Trade Questions From Free Trader Don't sacrifice the substance to the symbol I was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt but almost as a part of the moral law. I regarded departures from it as being at the same time an imbecility and an outrage. I thought England's unshakable free-trade convictions, maintained for nearly a hundred years, to be both the explanation before man and the justification before heaven of her economic supremacy. vol XXI p233-4 Above, in an article for the New Statesman and Nation in 1933 called National Self Sufficiency, Keynes is reflecting on how he was a firm believer in free trade right through his early career, up till the late 1920's. Although the USA in recent decades has become the champion of free trade, it must be remembered, as the above alludes to, that in the 19th and first decades of the 20th century, it was Britain that was the main agent, supporter and enforcer of free trade around the world. A key point to make is that when Britain did decide to introduce an all out protectionist tariff in 1932, it was in the context of being a follower and not a leader, as most of the rest of the significant countries in the world were already protecting heavily. Towards the end of the 19th century, second generation industrial countries like Germany, France and the USA, had started to use protection heavily to gain shelter from Britain's established advantages, and develop their own industrial base. With these markets being limited to British exports by tariffs, and arguably as Britain fell behind in investment and innovation in some key sectors also, Britain tended to rely more heavily on other less developed economies, including to a growing extent her empire and dominions, as markets for her goods. The high tariffs of second generation country protectionism from the likes of America and Germany, set the precedent for some to believe Britain should also fight to protect her own manufacturing interests. This sentiment was growing gradually in some sectors well before the depression came along. For example the Mckenna Duties, which aided amongst other sectors the car industry, were still in place, even though conceived as a temporary luxury tax measure to boost revenue and save Atlantic shipping capacity in WWI. The high tariffs of industrialising countries and the natural fit between Britain's manufacturing exports and the rural country markets of her colonies and dominions, provided support for 'Imperial Preference' policies throughout the first third of the 20th century. Imperial preference advocates envisaged a kind of large imperial trade bloc, with trade between Britain and her empire being subject to smaller or no tariffs, while the countries maintained their own higher tariffs with the rest of the world. But The City of London, being the specialist provider of

the many financial services connected to all the aspects of trade and shipping, was always a strong voice in support of free trade. The City, alongside the mostly free trade preferences of the Lancashire textile industry, served to keep the protectionists at bay in Britain. After WWI, Britain had made small but significant steps towards a 'safeguarding' notion of protectionism in some industries, and had created various limited means of closer economic ties with her empire and dominions. But it was the 'Import Duties Act' in 1932 which marked the big break from the free trade tradition. After being the key international advocate of free trade for many generations, Britain had succumb to introducing a general revenue tariff like her neighbours, which initially levied a 10 per cent and later higher, tariff on all manufactured imports, and allowed for even higher rates to be later applied piecemeal where they were deemed necessary. The conditions and arguments for this decision, including Keynes' support, will be discussed in detail later. Limited further Imperial preference polices were also negotiated later in 1932, meaning that some intra empire trade experienced advantages in escaping from this new tariff. Only once Britain had such a tariff, did she now have concessions she could award in return for the favourable treatment of her own exports. However the unwillingness of Britain to risk raising too far the domestic cost of living, and Britain's key investment interests in non empire countries like Argentina and Scandinavia, stunted the scope of this Imperial preference system. Also, to a growing extent later in the thirties as the fear of war returned, the unwillingness of Britain to let her self-sufficiency in agriculture wither even further in the face of greater empire imports, was a constraining factor to empire trade negotiations. Furthermore Dominion countries such as Canada and Australia had their own industrialising ambitions, and did not relish being kept in a perpetual agriculture and commodity role, which the imperialists envisaged. The high tariffs of many countries in the 1930's were reversed during the post war decades, and imperial preference was effectively ended even sooner by the Bretton Woods process. In these plans and negotiations for a post war world, the Americans, whom now held all the cards over a bankrupt Britain, were determined to end this old fashioned colonial state of affairs, and allow access on equal footing for their own trade interests in these developing countries. By the time the slump came, Keynes had already lived through a few periods where protectionism had risen up to become prominent in national debate. There had been two notable unsuccessful surges of political support for protection / imperial preference in the recent past. The first was lead by Joseph Chamberlain, (prominent Birmingham MP, one time Birmingham Mayor, and father of Neville) in the first decade of the last century.

The second was in 1923, when new Conservative Prime Minister Stanley Baldwin called an election in the hope of achieving a mandate for his proposed protectionist policies. During this election, Keynes campaigned for the opposing free trade Liberal political party, and in November 1923, wrote the following in The Nation and Athenaeum: Before we examine Mr Baldwin's contention that new facts have changed the significance of old proposals, let us remind ourselves of some principles which have certainly not changed. Free trade is based on two fundamental truths which, stated with their due qualifications, no one can dispute who is capable of understanding the meaning of the words:-I. It is better to employ our capital and our labour in trades where we are relatively more efficient than other people are, and to exchange the products of these trades for goods in the production of which we are relatively less efficient. Every sane man pursues this principle in his private life. He concentrates his energies on those employments where his efficiency is greatest in comparison with other peoples; and leaves to others what they can do better than he can. ... II. The second great principle is that there can be no disadvantage in receiving useful objects from abroad. If we have to pay at once, we can only pay with export of goods and services, and the exchange would not take place (subject to necessary exceptions just stated) unless there was an advantage in it. ... Our imports are our income. To put obstacles in their way is to be as crazy as a businessman would be who tried to prevent his customers and his debtors from paying their bills. vol XIX p147-149, Baldwin and the Tories lost the following 1923 general election, just as Chamberlains protectionists of 1906 had lost their election. The loss was seen largely as a rejection of Baldwin's proposed protectionist solutions to the high unemployment of that time. Years later, in his most famous book The General Theory (1936), Keynes reflects on the complete certainty in which he had held certain free trade beliefs, views which he had by this time come to modify. He illustrates this by citing the same old 1923 article: It will be fairest, perhaps, to quote, as an example, what I wrote myself. So lately as 1923, as a faithful pupil of the classical schools who did not at that time doubt what he had been taught and entertained on this matter no reserves at all, I wrote: if there is one thing that Protection cannot do, it is cure Unemployment. ... Never the less, if we contemplate a society with a somewhat stable wage-unit, with national characteristics which determine the propensity to consume and the preference for liquidity, and with a monetary system which rigidly links the quality of money to the stock of the precious metals, it will be essential for the maintenance of

prosperity that the authorities should pay close attention to the state of the balance of trade. For a favourable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavourable balance may soon produce a state of persistent depression. for we, the faculty of economists prove to have been guilty of presumptuous error in treating as a puerile obsession what for centuries has been a prime object of practical statecraft. [mercantilism] General Theory p207-10. It is in itself interesting to note that, towards the end of the most famous book written by one of the most prominent, influential and respected economist of the 20th century, there is at length, a detailed discussion of mercantalism and its historical thinkers; concluding how it may have been neglected in presumptuous error by the economists of his own generation. It was certainly a surprise to me to find that discussion in that book, so perhaps one could argue that the subject of mercantalism has since also been neglected. Especially interesting and potent is the suggestion made that a trade surplus is stimulating to an economy, whilst an unfavourable balance can cause a state of persistent depression. I was careful to include the qualifications Keynes describes in the first half of the second paragraph above, in which mention of precious metals may seem to make the writing dated and relevant only to the gold standard era. But substitute the constraints of a gold based exchange scenario, for the similar constraints of a shared currency scenario, and we can see that Keynes has something to say about the current economic positions of trade deficit Greece and trade surplus Germany. (more on this theme later). Back to the early 1930's, and the long extract titled Pros and Cons in the introduction of this essay gives a good general impression of why Keynes softened, then changed his mind, on free trade issues. Then also there is the 1933 National Self-Sufficiency article, already cited at the top of this chapter, which lays out some of Keynes' mixed views on trade. You may recognise the second paragraph below, as it is a favourite citation of anti free trade writers: The divorce between ownership and the real responsibility of management is serious within a country when, as a result of joint-stock enterprise, ownership is broken up between innumerable individuals who buy their interest today and sell it tomorrow and lack all together both knowledge and responsibility towards what they momentarily own. But when the same principle is applied internationally, it is, in times of stress, intolerableI am irresponsible towards what I own and those who operate what I own are irresponsible towards me. There may be some financial calculation which shows it to be advantageous that my savings should be invested in whatever quarter of the habitable globe shows the greatest marginal efficiency of capital or the highest rate of interest. But experience is accumulating that remoteness between ownership and operation is an evil in the relations between men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.

I sympathise, therefore, with those who would minimise, rather than with those who would maximise, economic entanglements between nations. Ideas, knowledge, art, hospitality, travel--these are the things which should of their nature be international. But let goods be home spun when ever it is is reasonable and conveniently possible; and, above all, let finance be primarily national. vol XXI p236 This adds up to quite a surprising side-swipe at globalisation, and the themes raised will have only become more significant since the recent unravelling of many part of the world's financial system. The stock market crash, price slump and subsequent depression starting in 1929, violently swung the economic landscape around to a different perspective, and this added a great deal of credibility to Keynes' opinions and previous writings. As he famously remarked to his wife in an October 1929 letter: I am becoming more fashionable again. vol XX p1. Having before been a voice of concern on the outside, he now became more of an establishment and government insider, being heavily involved in the British government's response to the ensuing crisis. He became the key member of 'The Macmillan Committee' which was set up by the British government to look into the economic situation. The committee and its subsequent report became a platform for Keynes' views and proposals, which contrasted with the then Tresury's traditional, more laizze faire 'sound money' approach. He was also a member of the government's own 'Economic Advisory Council' which was chaired by the Prime Minister and included other key government ministers. Keynes was on personal terms with most of the other leading British and some international economists, and now with many of the leading British politicians of his day. Throughout his 'Collected Writings' volumes from this period, there are many examples of his corespondences with Prime Ministers and Chancellors. One such is a long letter written by Keynes in July 1930, to the Labour Prime Minister Ramsay Macdonald. The letter was initiated by the PM's request for his views regarding the unfolding deppression and price slump. In the part of this letter shown below, Keynes describes further his sentiment as moving away from being a free trade believer; this being as an accompaniment and a preparation to suggesting a protectionist approach to the PM later in the letter: I am no longer a free traderand I believe that practically no-one else isin the old sense of the term to the extent of believing in a very high degree of national specialisation and in abandoning any industry which is unable for the time being to hold its own. I believe, for example, that this country is in the long run reasonably adapted for, and ought always to have, a motor industry, a steel industry, a farming industry. If it is proved to me that in present circumstances and at present wages these industries cannot live, then I am in favour of protecting them. But a real free trader would answer without hesitationlet them go. For some months past I have been trying to find some responsible person who was in this good old

traditional sense a free trader but I have not found one. Persons calling themselves free traders nearly always retort either that the industries can thrive without a duty or even that a duty would be actually injurious to them. But such answer has nothing whatever to do with free tradea real free trader would not even want to know the answer to these questions ... vol XX p379-380 The point Keynes makes here can still be applied to free trade arguments made today. How many free trade supporters have the courage of conviction to stand up and say let them go, to industries struggling with foreign competition. The USA, supposedly the present home of free trade, certainly has always been unwilling to let its car industry go when the market has suggested that it should. (And that is pre Obama as well as during the Obama administration). Arguing free trade is the best system to maximise the wealth creation of the world, and arguing it is the best system for your own country are two different things. When these objectives converge, such as Britain in the 19th century, or the USA in the mid 20th century, the economists life is simple. But when they diverge? This alludes to the fact that there is arguably a game theory dimension to the nature of trade relationships, where the best outcome for all as a whole is to follow the common good and seek efficiency and cheapness. This is in contrast to a country cheating by gaming trade conditions in favour of its own producers. It is this benevolent ethos which Keynes is responding to below, in a letter he sent to The New Statesman and Nation in March 1931, referring to comments made by Professor Lionel Robbins of The London School of Economics, who was a prominent key adversary to tariffs: Professor Robbins taunts me in conclusion with abandoning 'the service of high and worthy ideals in international relations' for 'the service of the means and petty devices of economic nationalism'. I know that he sincerely feels this, and that for him, as for many others, free trade stands as a banner and as a symbol of fundamental reason and decency between nations. Free trade unbesmirched invokes old loyalties, and recalls one of the greatest triumphs of reason in politics which adorns our history. It is a poor retort, perhaps, to this, to say that one must not let one's sense of the past grow stronger than one's sense of the present and of the future, or sacrifice the substance to the symbol. vol XX p497 Many contemporary alternative economists still note the reluctance of right wingers to let go of one of the few strong scientifically well disposed areas of economics, that being free trade theory. In a subject such as economics often embarrassed by the lack of scientific rigour it can yield, trade theory has been likened to the crown jewels of the profession. Keynes never stopped believing in the fundamental truths regarding the general benefits and wisdom of trade, but, ever the pragmatist, he was prepared to break with the strong bonds and attachments of 19th century economic ideology, which lets remember had made Britain rich, when he believed he had a good case to do so. As Keynes was supposedly to have said: When my information changes, I alter

my conclusions. What do you do, sir?

Understanding Trade Relationships It is a complicated business As mentioned above, free trade theory has been described as the crown jewels of economics. It is an area where the rational and instructed person can be educated to appreciate the higher wisdom of the benign mechanisms of free trade theory, and enlightened away from the narrow minded instincts of the selfish, short sighted protectionist or mecantalist. Much of the basis for this enlightenment is the fundamental recognition that trade relationships between countries have a circular nature, in that international exchanges inherently involve the exchange of currency, which means sellers of a currency need buyers, and buyers of a currency need sellers. Keynes explains it better: It is a necessity for a country that its international debits and credits (including those which arise out of movements of gold) should at all times be balanced. This seems a simple truth. But a great deal of what is said and written ignores it. For every seller of a county's exchange there must be a buyer. For no one can sell a currency unless he can find a counterparty who will buy it from him; and whilst the buyer and the seller need not both belong to the same one of the groups distinguished above, they must each belong to one or other of these groups. vol XXI p64-65 In referring to the different groups, he meant the different type of international transaction, i.e. import / export transactions, foreign or inward capital investment (FDI), short term speculation in currencies or bonds etc. made by traders, income from foreign investments going in or out. Taken together these inherently must balance, as all currency transactions require a buyer and seller. For example if China exports to the USA, it has put labour and resources into those exports and wants something back in return. It can either: buy US goods; buy some US assets; or, (which may be the same thing e.g. Treasury Bonds) lend its dollars to US entities in return for interest. While many economic theories contain or propose causation relationships which are roughly correct or roughly provable scientifically, trade relationships contain a higher degree of precision, because the money has to go somewhere. During trading transactions, the currency in which the trade is priced almost never leaves its home country, but instead the country's currency market works to essentially match the transaction to a currency transaction in the opposite direction. I expect like many others, I fully got to grips with these knotty, counter-intuitive concepts of trade embarrassingly late in my economic studies, and still often have to stop and walk myself through certain aspects or trade conundrums that I come across. The left wing American economist Paul Krugman has been one of the best communicators of trade theory over recent years, and his tiny book Why a Country is Not a Company offers a concise particular explanation as to why business minded people often overlook, or have difficulty with, the circular mechanisms contained in trade relationships. Central to his approach is the idea that there is a fundamental

difference between the open ended system nature of the markets faced by individuals and businesses, and the closed system nature of trade relationships between countries. Businessmen are used to dealing with markets that are open ended in nature, in that their company can expand its sales, sometimes for all intense purposes indefinitely, by capturing a greater market share and crushing competitors. Where as when countries seek to grow their exports, the circular nature of trade relationships mean this growth will generate a corresponding change somewhere else in the country's economic relations with its neighbours. Or to put it another way, squeeze the half inflated balloon at one end, and the effects will show up somewhere else in their international double entry accounts. This assertion has led purist free trade economists to criticise the instinctive mercantalist notions of people from practical business rather than an economics background. Free trade purists try to point out the fallacy of notions such as 'national competitiveness', as the circular and equilibrium generating theories of trade suggest such approaches are irrelevant. The supposedly enlightened insight is that, unlike a company or an individual, a country can never be competed out of the game / market, because the naturally adjusting mechanisms of the value of the country's currency and the counter workings of the capital and physical trade accounts mean that a country will always find a role in the international trading system. If a country gets too good at exporting, its currency will tend to appreciate to make it less competitive and push it back towards an equilibrium. If a country exports more goods than it imports, it will tend to end up investing in the importer country, as the capital movement counter balances the movement of funds used to buy the goods. In business, there are many factors which accrue advantages to the biggest and strongest competitors, such as positive externalities, which perpetuate the lead of the leader. In contrast, for countries, as free market theorists will claim, there are equilibrium checks and balances which hold back lead countries and help each country to find and maintain its most suitable role in world trade. Strong exporter countries by definition cannot inhabit every sector and cannot cause your country to close down like an uncompetitive business. The circular nature of trade relationships can produce counter intuitive outcomes, alien to the businessman's expectations. Hence the phenomena of the countries with the best business investment prospects often becoming net foreign investors (present China), or, for example, when at times the 'export led growth' Asian Tigers of the 80s and 90s became net importers of goods in certain instances, because they were receiving very high levels of foreign direct investment from the West. Keynes never ever neglected the role of these trade principles in his writing, and his famous intellect and capacity for absorbing information meant he comes across as effortlessly all over both the implications of these theories, and the real world facts and figurers which populate any trading scenario. Unlike myself, you get the impression that he never had to 'walk himself through' any implications or relationships in this area. In short, he was a lethal adversary if you became engaged in

a public economic disagreement with him. In March and April 1931 in The New Statesman and Nation in an article titled Economic Notes on Free Trade , Keynes openly question the hard line sound money 19th century approach of the then Chancellor of the Exchequer, Mr E.D. Simon: I would put it like this. I believe that it would be of great advantage to the international equilibrium of this country if we could increase our favourable balance of trade by, say, 50m; and that it will be much easier to do this by checking imports to this amount than by increasing exports. For how are we to increase our exports? For Mr Simon tells us that he would have to reduce his [Britain's] wages by 20 per cent in order to be on level terms with Germany, and I have no doubt that he is right. Has he any prospect of doing this? If he could, does he feel sure that Germany would not reply with a further reduction of her wages, seeing that we have bound her by treaty under dire penalties to compete successfully with ourselves (in effect), however much we reduce our wages to reduce hers by more? vol XX p499. Of course Keynes had partly made his name as a vocal opponent of the harsh reparations obligations put on Germany after WWI. He was now pointing out the logical inconsistency of both expecting a country to pay you reparations, which inherently means through foreign earnings / exports, and at the same time presuming to win in a trade battle with them, by means of achieving a competitive wage advantage over them. Keynes' writing in this area is characteristically sharp, and often is centred on pointing out such a logical inconstancy missed by an opponent, as above. It is noticeable that he chides his adversaries both for instances where they neglect aspects of the theoretical circular logic of trade relationships, and also sometimes he chides them for taking the logic of the theories a step beyond what he believes is justified. When Keynes was publicly proposing a broad tariff policy for Britain, after generations of relatively free trade, it was inevitable that he should attract opposition from other economists. To a free trade economist, enlightened with the knowledge that efficiency, equilibrium theory and the common good were on their side, tariffs represented the uneducated, irrational and short sighted solution. One example of Keynes' response to a free trade attack was to highlight subtle inconsistencies in views regarding a country's trade relationships; inconsistent free trade views which still ring true today. One could almost feel sorry for the much respected Sir William Beveridge, (Contributor to the Beveridge report which helped to initiate the welfare state of the Atlee government), when Keynes sought to lay an intellectual economic trap for him in this letter to 'The Times' in March 1931: Sir William Beveridge believessubject to two exceptions which he mentions only to dismiss them as not applicable to present circumstancesthat a restriction of our imports will lead at once to a more or less corresponding reduction of our exports,

because it will mean 'a reduction of the power of foreigners to buy in Britain'. It will help me to clear up what appears to be a deep-seated difference of opinion if I may be allowed to ask him some questions. (1) Does he believe that it makes no difference to the amount of employment in this country if I decide to buy a British car instead of an American car? For it seems, clearly, to follow from his argument that the reduction last year in the imports of foreign cars must have injured our export industries to the same extent that it benefited our motor car industry. I say that our difference of opinion must be profound, for to me such a conclusion seems quite silly. (2) Does he believe that an increase in our imports would at once increase our exports also, by providing 'an increase of the power of foreigners to buy in Britain'? For example, I have always thought that it was a difficulty in the way of home development schemes that they might lead to increased imports of raw materials and also of food to meet the increased consumption of the newly employed, since this, by weakening our trade balance, might lead to a loss of gold. But according to Sir W. Beveridge this would, apparently, be an extra advantage in favour of such schemes, because, by increasing our imports, they would increase our exports and hence augment employment in the export industries as well as in the home construction industry. Is this right? And if not, why not? (3) Suppose that our imports were to fall off as the result of a lowering of our own costs of production in the iron and steel industry so that our own producers could compete more successfully with Continental producers. Does Sir W. Beveridge hold that this would do nothing for employment, because 'by reducing the power of foreigners to buy in Britain' it would increase unemployment in the export industries by an amount equal to the improvement in the iron and steel industry? I see nothing in Sir W. Beveridge's argument which would not apply just as forcibly to a reduction of our imports caused by a diminution in our own costs as to a reduction caused by a tariff. Moreover, even if it did not have this effect, we should be just as much in the soup according to Sir William. For, in the event of our balance of trade becoming more favourable, he holds it 'unproved that an increase of lending abroad could take place without harmful contraction of lending at home'. When I know Sir William's answers to these questions I can, if necessary, pursue the matter further. vol XX p508-9 After Beveridge attempted to redraw the issues as he saw them in a letter of his own to The Times, and after he recognised that Keynes was trying instead to entangle me in rather elementary dialectical difficulties (vol XX p510), Keynes, in another letter to The Times about a week later, went on to drive home the logical pay-off produced by his trap: I could not hope in my previous letter to expound my own theory of international

equilibrium in the space at my disposal. It seemed, therefore, that the best hope of bringing the issue to a head within a reasonable compass was to invite Sir William to tread the path of the reductio ad absurdum. Sir William believes (answer 1) that if I buy a British car instead of buying an American car this causes a diminution in our exports, but (answer 2) that if I buy an American car instead of buying a British car this will not cause an increase in our exportswhich hideous it would be if true, since, if I sometimes buy an American car and sometimes a British car, it seems to follow that British exports would gradually sink towards zero! Of course, Sir William is right that we cannot increase our exports merely by increasing our imports. I had hoped that this would lead him gently to the perception that his first answer might not be correct. But there is, in my opinion, no simple or direct relationship between the volume of imports and the volume of exports, and it is a complicated business, beyond the scope of a letter, to analyse the various reactions, domestic and international, which would be set up by a reduction of our imports, and the possible ultimate effects of these on our exports. vol XX p511-512 This inconsistency between theory and behaviour found in free trade supporting governments, is an insight that still rings true today. Governments shelter under the intellectual banner of free trade, which if they were to live by this Bible, would entail a healthy disinterest in what your own country produced or exported. But the reality is that the instinctive common sense of the mercantalist still resides when it matters, and politicians spend great effort trying to increase or improve the competitive makeup of their exports. Would it be possible during a recession, to find a free market politician who would publicly advise that any policy that leads to increasing imports is OK, because it will directly increase exports to the same extent? Add in the dimension of jobs, outsourcing and off-shoring, and a politician promoting this kind of argument in a recession soon gets into hot political water. Also politicians instinctively know that certain sectors and certain industries, such as car production, are more important than others, but there is nothing in basic free trade theory which suggests they should act on such a mercantalist instinct. Keynes scores a hit at the expense of Beveridge through his sharp rhetorical brinkmanship. But his victory in pointing out what he later called the inverse proposition (vol XX p513) is more clever and crafty than it is complete, and it is easy to have sympathy with both sides. It is a complicated business. After all, a point Sir William makes in his response contains a fundamental truth; especially considering that the British unemployment Keynes was aiming to solve was largely concentrated in the old staple export industries: Does he think that the ability of (say) the Argentine to take exports from us is unaffected by what we take from them? Could we cut off all imports from that (or any other) country without reducing our exports? vol XX p510.

Around the same time, Keynes wrote the more comprehensive article in The New Statesman and Nation already cited at the top of this chapter, titled; Economic Notes on Free Trade. In this article he goes into more detail regarding his thoughts on the complex and not necessarily fixed relationship between imports and exports, and his critique of the way free traders seem to over rate the precision of the equilibrium forces governing the relationship: The course of the present controversy seems to indicate that a large proportion of free traders hold their faith, not as the outcome of a nice balancing of advantages against disadvantages, but believing it to be an obvious inference from a simple truth. If you keep out an import, then 'since imports and exports pay for one another' it follows mathematicallyso it is believed-- that you will lose an export after an interval of time so short as not to matter. and Sir William Beveridge, in 'The Times' newspaper, has produced the doctrine in its full purity, asserting that it makes no difference to employment in this country whether I buy an American car or a British car, or whether our cost of manufacturing iron and steel are reduced to a competitive basis with foreign costs. No, not quite in its full purity! For Sir William's credulity falters at a critical point; whilst he believes that a reduction in our imports would cause a reduction in our exports, he does not believe that an increase in our imports would cause an increase in our exports. Now, if all this were trueif a reduction of imports causes almost at once a more or less equal reduction in exportsobviously a tariff (and many other things) would be completely futile for the purposes of augmenting employment or of increasing the balance of trade in our favour. But, of course, it is not true! To believe it is to fly in the face of common sense and of experience, and cannot be supported by argument. It would only be true in a hypothetical economic system possessing such an inherent capacity for stable equilibrium, that not only were both the initial and final positions in equilibrium, but that the elasticity of the system was such that any disturbance was responded to so immediately that the system was incapable of ever departing appreciably from equilibrium. At any rate, I am sure that the assumptions required for their conclusion are far remote from contemporary fact; and in the proof along these lines, that a tariff cannot diminish unemployment, one of the inappropriate assumptions which has tacitly slipped in is, I suggest, that there is no unemployment to diminish! On the contrary, whilst the position of every element in the economic system is, in a sense, dependant on that of every other, there is not, according to my view of the subject, any direct and simple relationship between the volume of exports and the volume of imports. A change in imports, due to the interposition of a new factor such as a tariff, sets up a series of complex reactions on the economic body, which are likely, indeed, before they have completely worked themselves out, to have some effect on almost every factor in the situation. But the nature of this effect depends profoundly (amongst other things) upon whether the initial position was one of

equilibrium. vol XX p502-4 So the conclusion can be drawn that Keynes at the time of the 1930's depression, can be found to have what could be summed up as an 'its complicated' general opinion regarding the effects of tariffs on a country's own export industries. This is in contrast to free traders like Robbins and Beveridge, who adhered to a more strictly circular and strong relationship, which implied tariffs were immediately and proportionately damaging to exports. While Keynes does not dispute the basis of the free traders simple truth, i.e. the circular and counter balancing nature of trade and money flows between countries, he claims that they have made an incorrect obvious inference from a simple truth. It is testament to the complexity of these issues that many of the same charges can still be made against free trade theorists today. As Keynes recognised and used in his arguments as much as anyone, there are important inferences to be found in trade theory. But he was quick to point out where ivory tower theoretical inferences are taken a step too far.

Part Two: Keynes' Qualified and Conditional Support for the Protection Option It appears to me that Keynes' writing on tariffs and protection can be divided into two distinct areas, by considering two rough types of motive a government may have to protect. Firstly in Keynes' writing there are many examples of him supporting protectionist sentiment in what could be conceived as a strategic industrial policy kind of motive. In other words protection used to maintain domestic production of certain products, or encourage domestic production in certain sectors. In the language of that time, the word commonly used is 'safeguarding'. For example in the 'Pro's and Con's' BBC radio speech in the introduction of this essay, Keynes clearly explains the merits of protecting Britain's: Iron & Steel, Motor Cars, and Agriculture sectors. On the other hand, most of Keynes' writing on protection and tariffs was during the early 1930's, when he also believed the urgent economic crisis and the unique position of Britain required a 'revenue tariff', to solve its wider macro economic problems. As the name suggests, a primary aim, but by no means the only aim, of a revenue tariff was to raise funds for the government. The revenue tariff was considered, by Keynes at least, as a short term policy aimed at tackling specific urgent macro economic and trade balance issues. Even by 1937 he is advocating a partial reversal of this strand of broad, economy wide protection, as detailed later, and of course his later key involvement in designing the post war economic system goes further along these general tariff reduction lines. This general or revenue tariff protection, as represented by the 1932 Act, was in contrast to and always alongside, the more strategic protectionist policies which would fall under the more long-term safeguarding label. The motive for the one strand of protection was related to the immediate strains on the country's finances, the motive of the other strand was a desire to shape, or to 'safe-guard' against the unfavourable re-shaping of, Britain's economy. The two different motives of a general or revenue tariff, and safeguarding protection, which are the basis of the above distinction, obviously overlap in practise, and therefore the distinction can appear artificial. In aiming for revenue, you cannot help safeguarding, and in safeguarding you probably collect revenue, (unless using another form of protection such as quotas or limitations). Therefore, the distinction is more useful in terms of clarifying the theoretical motivation for protection, than it is effective in differentiating the actual practise of, or specific examples of, tariff implementation. This is demonstrated by the fact that the key 1932 tariff, which was on the face of it a revenue tariff also designed to restore a trade balance, had an initial base rate of ten per cent, but this rate was increased substantially and in areas like iron and steel became very high. This shows that the revenue tariff was also used as a safeguarding tool, and the distinction becomes blurry. But the theoretical differentiation is still useful when analysing Keynes' thoughts and arguments. The distinction between the two approaches to protection is also inherently connected

to the time scale envisaged. The sectoral type of safeguarding protection would be of little value unless its advantages to certain sectors could be relied upon by investors in those industries to last a reasonable period of time. In contrast, because the revenue tariff is partly a macro economic tool motivated by special circumstances, the protection it offers by implication, is of a temporary nature. Basically the protection a revenue tariff offers is broad, temporary, and in being usually only around the lower percentages, marginal rather than industry changing. Whereas a sectoral kind of safeguarding protection is targeted, usually applied at a higher rate, and applied and removed for strategic micro rather that macro economic reasons. The temporary macro economic motive of the 1932 tariff is implied by Keynes below, in his essay called Mitigation by Tariff, March 1931: It should be the declared intention of the Free Trade parties acquiescing in this decision to remove the duties in the event of world prices recovering to the level of 1929. Persuasion p151 This inherently means that in some ways the infamous general or revenue tariff of 1932 is less relevant to those interested in contemporary protectionism, because it is specific to the macro economic crisis and thinking of that time. Where as the strategic protection of the three areas Keynes mentions in the Pros and Cons broadcast, is where more fundamental philosophical arguments in favour of long-term protectionist policies are made. However it is the subject of Keynes' thoughts on, and support for, the 1932 tariff which this, part two, mostly deals with.

Disequilibrium Can be long enough to compass the decline and downfall of nations As mentioned above, Britain was the standard bearer for free trade up until this period, and indeed some economists have claimed that Britain was the only major country ever to have practised pure free trade, for a short period of time during the mid 19th century. Keynes' lifetime was far closer to this zenith than we are now. As represented by Chancellor Simon mentioned above, there was still in the 1930's, many of the great and the good who held onto 19th century notions of economics, where laissez faire alongside 'sound money' was the wisest policy. In the old British economic system of the 19th century, the economics of trade was centred around the Gold Standard. For non-economists, this was an international monetary system which used the set rate of convertibility into gold of the major currencies, to regulate trade relationships, and settle international trade accounts between countries. Because the volume of gold in the world was almost finite (it was being mined which slowly increased its quantity), and because gold had to move between different countries' central reserves to settle trade imbalances, it provided a confidence enhancing, but constraining mechanism upon the international system. Governments had to arrange their economic policy to suit the needs of maintaining their currency to a fixed value in gold, and had to respond if their reserves were being depleted. This was done by maintaining the required balance of attractiveness between their currency and others, and also by maintaining the domestic cost level, in terms of gold, at a level to which aided the balance of payments to not generate a gold shipment. The gold standard also constrained other financial policy options for national governments, like running a government spending deficit or printing money. The capability that a gold standard had to constrain governments has inspired renewed interest from some of those on the right of the Republican party in America, although not many economists support such a draconian move. In the meetings of the Macmillan Committee in February 1930, Keynes describes in detail how this 19th century system was regulated. This masterful exposition of classical economic policy was an introduction which served as the starting point for Keynes to debate what was now going wrong with the economy, and what should be done. He is describing how, for generations, classical monetary policy had been used to maintain equilibrium between Britain and other countries, both by effecting Britain's capital inflows and outflows, and by effecting Britain's balance of trade through managing the domestic price level: Now the only normal method which is open to the Bank of England for its currency management is by altering the terms of bank lending. I shall often use Bank rate as a convenient shorthand for the terms of lending as a whole including alterations in the quantity of credit as well as in the price for it. The great historic virtue of Bank rate policy is, as we shall see, that it works on both factors in the situation and on both in the right direction. If Bank rate is raised it tends to restore equilibrium,

partly by diminishing the adverse balance on lending account [Britain's capital account or net capital outflow (net foreign investment), plus in Keynes terminology he includes net cash transfers or short-term liabilities (the short-loan situation) to foreigners] and partly by increasing the favourable balance on income account [net exports, and net foreign investment income]; and the beauty of Bank rate is that double effect. Its influence on lending is rapid, but not permanent. By raising Bank rate we can rapidly diminish the rate of our lending for the time being, The Bank rate could not restore permanent equilibrium, if it merely affected the short-loan situation. On the other hand, its immediate efficacy on the short position is very great. Its influence on the price factor is much slower, in fact it may be intolerably slow, but when it has produced its final effect on price levels this effect is much more lasting. It is the real change which, in some circumstances, is necessary for the restoration of real equilibrium. So the Bank rate sets in motion rapid forces to diminish the cause on us to lend abroad, and slow forces which will have the effect of increasing our ability to lend abroad by reducing our price level to a more competitive level with the outside world. vol XX p41 What I have been trying to set forth is the historic doctrine of Bank rate policy as it was evolved during the nineteenth century as a means of maintaining monetary equilibrium. You see what a very good doctrine it is, because the completely harmonious disposition of the economic forces of the world is preserved merely by the Bank of England changing the Bank rate from time to time in an appropriate way and leaving all the rest to the operation of laissez faire. And not only so; the Bank of England is set, in a sense, a very easy task, because movements of gold will always operate as a barometer to tell the Bank of England exactly when a change of Bank rate has become necessary, so that the method, assuming that it works according to the way in which it is supposed to work, is as simple as possible. when one sees the way in which one part dovetails into anotherthere is no need to wonder why two generations, both of theorists and practical men, should have been entranced by it. vol XX p53 In other words, as is still the case in modern government, raising base interest rates is a way of cooling an economy and therefore reducing domestic price levels which improves international competitiveness. In the aftermath of the 1929 crash, Britain's balance of payments accounts were deteriorating fast. The traditional response was for the Bank of England to use the Bank Rate, as described by Keynes above, to both improve the immediate capital flow (short-loan situation), and also to deflate the economy and therefore reduce costs, most significantly wage rates, in the long term. This explains why, thinking in a 19th century gold standard mindset, Chancellor Simon above naturally first proposes that wage rates need to fall in order to regain competitiveness / equilibrium. In this mindset, in contrast to ours today, it was the currency which was fixed, and wages absorbed any shocks or divergences in the international system.

In Keynes' letter to Prime Minister MacDonald of July 1930 already cited above, he expresses his concerns regarding what he views as an unwise tendency of the British establishment to hold onto this 19th century mindset, and remain slaves of sound general principle, when Keynes thinks the economic circumstances, and the world, have moved on: All the same I am afraid of 'principle'. Ever since 1918 we, alone amongst the nations of the world, have been the slaves of 'sound' general principle regardless of particular circumstances. We have behaved as though the intermediate 'short period' of the economist between our position of equilibrium and another really were short, where as they can be long enoughand have been before nowto compass the decline and downfall of nations. Free trade is profoundly based on the assumption of equilibrium conditions and in particular that wages always fall to their strict economic level. If they do not, and if for several reasons we do not desire them to, then it is only by means of a tariff that the ideal distribution of resources between different uses, which free trade aims at, can be achieved; and there is an unanswerable theoretical case for a countervailing import duty (and also for an export bounty) equivalent to the difference between the actual wage and the economic wage. vol XX p 379 This writing alludes to the fact that Britain maintained the old free trade, laissez faire and sound money notions long after countries like Germany and America had moved on to become more managerial and interventionist. Back to the subject of equilibrium and one of Keynes' most famous economics 101 assertions, is that classical economists or free market supporters often tend to over estimate the ability of certain markets to return quickly and easily to equilibrium conditions. Echoing the quote cited in the heading of this chapter, one of Keynes' most famous responses to the question of free market adjustment being the best long-run solution is: in the longrun, we're all dead. During the 1930's depression, while much of the economic establishment was willing to wait for markets to slowly adjust, Keynes felt the economy was jammed in disequilibrium, and more urgent action was called for. The slump had pushed the economy of Britain further out of equilibrium, in that given the dramatic fall of world prices, sticky British wages, and therefore costs, were too high to achieve a manageable balance in Britain's trading accounts. Below, again during the discussion in the Macmillan Committee in February 1930, Keynes summarises the essential nature of how Britain had in the past, and now needed to, manage her economy under the 19th century gold standard tradition: If we have a system of laissez-faire the amount we want to lend abroad is governed by the relative attractions of investment abroad and at home which is not a thing which depends very much on prices. The amount the want to invest having been settled by relative interest rates we have to get our cost down to a level which will allow us to export an amount corresponding to that. vol XX p51 To understand the reasoning in this extract, you need to fully understand the

technicalities of the Balance of Payments mechanisms, which will be dealt with in more detail later. The implication of the old system was that the wage rates and costs in the British economy need to be the variable, not the starting point in economic policy. But the key point was that in recent years, deflationary Bank rate policy had not been successful in forcing wages to fall to correct the persistent disequilibrium, but instead wages had remained static or sticky. In terms of the scale of this disequilibrium to be surmounted, Keynes proves a characteristically essential and concise illustration. Keynes had an impressive habit of seeming to fluently pluck figurers out of the air to illustrate his points. One would presume that he was confident that he simply had the superior knowledge and judgement required to carry this off: I have made the guessit has not very much behind; it is just a statistical judgement that we are increasing efficiency about 1 per cent per annum. Over 50 years that is a terrific rate. In 5 years that is 7 per cent [the numerically literate amongst you should have spotted that in compound this is more, but only very slightly], therefore, if prices had not fallen abroad we should have got a very long way towards the 10 per cent task which have set ourselves. To get back to equilibrium with the gold standard would have meant 10 per cent, but with the subsequent fall of world prices it has meant 20 per cent so while we were 10 per cent out in 1925, we are 12 per cent out now. That is just a guess but it gives you and idea of the order of magnitude, and to cure that will take 8 years assuming there is no further misfortune. vol XX p58. In other words, the costs of Britain's exports were 12 per cent higher than the costs of other countries' producers. The high gold standard re-entry in 1925 discussed later, meant Britain entered the slump already with an uncompetitive high pound (+10%), which five previous years of growing efficiency and static costs / wages had only partly neutralised (-7 %). The effects of the international slump then came and added further to this existing disequilibrium (+10%). Later in the Macmillan Committee discussions, Keynes highlights how the inadequacy of the government's 19th century policy approach, in an economic environment lacking the 19th century characteristic of wage flexibility, is translating into unemployment and bankruptcies: One can put it another way by saying that we have a currency policy and a wages policy which are incompatible with one another. We have, as I have heard Mr Brand put it, two fixed points in our system, two fixed millstones between which we are being ground; whereas, the system assumes that there is one fixed point, namely, the currency policy, that wages will always sooner or later follow business receipts. In effect our currency policy fixes the total monetary receipts that we get from the sale of our goods. there is not the normal margin of profit for the businessman and his only course today is gradually to withdraw, first by reducing the employment he offers and, secondlywhich is much slower in effectby not investing in new

enterprises. vol XX p68. After much thought, Keynes' favoured approach was to solve this disequilibrium by using a tariff to raise import prices, and then to presume that wages would remain the same, not keep up with the rising prices of imports, and therefore fall in real terms. The disequilibrium was tackled therefore at multiple levels; the trade imbalance between net foreign investment and net exports would be resolved at the national macro economic level, and at the micro economic level, the tariff would make the purchasing power compared to the productivity of workers in better equilibrium with foreign workers. Also the lacking business confidence which had encouraged investors to look abroad would be reversed slightly by the better prospects of protected industries. In a letter to The Daily Mail in March 1931, titled Put the Budget On a Sound Basis: A Plea to Lifelong Free Traders, Keynes again tries to emphasise the urgency of the situation and the inadequacy of existing policies: I have been asked to develop a proposal for a revenue tariff which I put forward last week in an article contributed to the 'New Statesman and Nation'. I do so from the point of view of one who believes that tariffs are dangerous. If we were in our usual economic equilibrium with the rest of the world, I should be opposed to such an expedient. But the world slump and a fall of wholesale prices of a quite unprecedented severity, coming on the top of other difficulties, have created a position of great anxiety, when one must be ready to consider extraordinary remedies. Unqualified free trade is part of an austere philosophy which depends, and indeed insists, on things being allowed to find their own levels without interference. But if economic changes are very violent and very rapid, human nature makes it impossible for some things to find their proper levels quick enough. In particular, we all know that it is not practical politics (whether we like it or not) to bring down wages generallythough some money wages ought to come down somewhat and probably willto an extent corresponding to the fall in prices. When a free trader agues that a tariff cannot increase employment but can only divert employment from one industry to another, he is tacitly assuming that a man who loses his employment in one direction will lower the wage rate which he is willing to accept until he finds employment in another direction. When small changes only are in question, there may be much long-run truth in this. But in present circumstances stances it is sheer nonsense. vol XX p489-90

Don't Try Reducing Wages A sort of civil war or guerilla warfare carried on, industry by industry, all over the country As discussed, before the 1930's the established 'sound money' laissez faire approach to a situation of deficit in Britain's international trade accounts, was to expect deflationary government policies to push national wage rates downwards, until international competitiveness was regained. As has likewise since been the wisdom of many free market believers, they also held that the short term pain of downward wage adjustment was a necessary evil to be experienced, in order to achieve the greater long-run good. As a kind of prequel to the wage reducing arguments faced in the early 1930's, it is interesting to consider Britain's situation five years earlier, and an essay by Keynes which helped to further establish his name as an insightful economist. The sketchy impression of the economic history of this period which I used to hold, until I learnt better, was that things were basically going OK up until the 1929 stock market crash, and then the infamous depression was triggered. This is fairly accurate in terms of America, whose experience tends now to make the deepest impression on our collective cultural memory. But in Britain in the 1920's, although the economy was growing healthily, there was high unemployment of over ten percent throughout the decade. The unemployment was concentrated in areas which were and had been Britain's staple export industries, like textiles, ship building and coal mining. In the early part of the decade, Britain was still recovering from WWI, and then after 1925, it is commonly believed that the rejoining of the Gold Standard at the ambitiously high pre war rate, caused difficulties for Britain's competitiveness for the remainder of the decade. The Gold Standard had been abandoned by Britain during WWI, as the characteristics of a total war economy distorted usual trade relations, and made adherence impractical. There was precedent for countries coming off monetary standards during wars, and then seeking to rejoin after, so by 1925 there was strong pressure from the financial establishment to return to the standard. Just as in present times US dollars are used around the world as the default trading currency, in those days, British pounds were still the worlds currency of choice. Therefore there was a large international interest and support for returning the worlds key trading currency back into the worlds key international currency system. Winston Churchill was the Chancellor during that time, and although he was sceptical himself, not being a strong economist he was persuaded by the weight of establishment opinion to re-enter at the old rate. In hindsight it certainly seems over ambitious to re-enter at the same rate as before the war, given how much foreign capital assets had been liquidated and given how much the economic tide had turned in favour of the US. But the mindset of the time was that stability, continuation and confidence were paramount, and returning to the old rate was, in the light of this, a strong statement. Another more cynical interpretation is that the figurers of the establishment had an interest in the maintenance of the higher value of the pound, due to their connections and interests

in The City, and they prioritised these benefits at the expense of other non financial export sectors. More on this subject in a later chapter. Below, in one of Keynes' most famous early essays called: The Economic Consequences of Mr Churchill, Keynes in 1925 describes, (in a way which the Greek population today may find bitterly familiar), how the overly strong currency required a lowering of British wages and price levels, in order to return to competitive equilibrium. With a floating currency, the exchange rate moves to suit the price level of that country compared to its neighbours, through the balancing effect of flows of money and trade. The currency of a country not exporting enough falls, until a balance returns. Greece today is arguably being forced to relive an old 19th century gold standard scenario, where the exchange rate is presently fixed too high for their individual needs, compared to their internal costs and wage levels. Therefore the authorities (Greek and Euro Zone technocrats) wait for, or pursue? a deflation in prices and wages instead, as a means to attempt to return the country to international competitiveness: ... The policy of improving the foreign-exchange value of sterling up to its pre-war value in gold from being about 10 per cent below it, means that when ever we sell anything abroad, either the foreign buyer has to pay 10 per cent more in his money or we have to accept 10 per cent less in our money. ... Our export industries are suffering because they are the first to be asked to accept the ten per cent reduction. If every one was accepting a similar reduction at the same time, the cost of living would fall, so that the lower money wage would represent nearly the same real wage as before. But, in fact, there is no machinery for effecting a simultaneous reduction. Deliberately to raise the value of sterling money in England means, therefore, engaging in a struggle with each separate group in turn, with no prospect that the final result will be fair, and no guarantee that the stronger groups will not gain at the expense of the weaker. ... Those who are attacked first are faced with a depression in their standard of life, because the cost of living will not fall until all the others have been successfully attacked too; and, therefore, they are justified in defending themselves. Nor can the classes which are first subjected to a reduction of money wages be guaranteed that this will be compensated later by a corresponding fall in the cost of living, and will not accrue to the benefit of some other class. Therefore they are bound to resist so long as they can; and it must be war, until those who are economically weakest are beaten to the ground. ... On grounds of social justice, no case can be made out for reducing the wages of the miners. They are the victims of the economic Juggernaut. [see the subsequent miners strike of 1926] They represent in the flesh the 'fundamental adjustment' engineered by the Treasury and the Bank of England to satisfy the impatience of the City fathers to bridge the 'moderate gap' between $4.40 and $ 4.86. [The latter was

the rate of the Gold Standard exchange per British pound, while the former was presumably what the floating exchange rate had been]. They (and others to follow) are the 'moderate sacrifice' still necessary to ensure the stability of the Gold Standard. The plight of the coal miners is the first, but not--unless we are very lucky-the last, of the Economic Consequences of Mr Churchill. ... Their [the Treasury Committee on Currency advising Churchill] arguments--if their vague and jejune meditations can be called such--are there for any one to read. What they ought to have said, but did not say, can be expressed as follows:-... To begin with, there will be great depression in the export industries. This in itself will be helpful, since it will produce an atmosphere favourable to the reduction of wages. The cost of living will fall somewhat. This will be helpful too, because it will give you a good argument in favour of reducing wages. Nevertheless, the cost of living will not fall sufficiently, and, consequently, the export industries will not be able to reduce their prices sufficiently until wages have fallen in the sheltered [industries which are not effected by imports or exports] industries. Now wages will not fall in the sheltered industries merely because there is unemployment in the unsheltered industries, therefore you will have to see to it that there is unemployment in the sheltered industries also. The way to do this will be by credit restriction. By means of the restriction of credit by the Bank of England you can deliberately intensify unemployment to any required degree until wages do fall. When the process is complete the the cost of living will be have fallen too, and we shall then be, with luck, just where we were before we started. [i.e. internationally competitive]. We ought to warn you, though perhaps this is going a little outside our proper sphere, that it will not be safe politically to admit that you are intensifying unemployment deliberately in order to reduce wages. Thus you will have to ascribe what is happening to every conceivable cause except the true one. We estimate that about two years may elapse before it will be safe for you to utter in public one single word of truth. By that time you will either be out of office or the adjustment, somehow or other, will have been carried through. Persuasion p132-142 There are many others who have recognised the parallels between the gold standard in the 1920's and 30's, and the present Euro difficulties, so this is not at all original, but isn't the language Keynes uses dramatic! It was especially satisfying for me to link together in my understanding of British history, the sparse knowledge I had regarding the miners strike and general strike of 1926, with the ambitious 1925 gold standard re-entry. From a modern standpoint, as Keynes also alludes to below, the practicalities of tying the ability of the worlds financial system, and its ability to expand its monetary volume, to the ability of the worlds miners to dig up a random metal element from the ground, seems very arbitrary. Imagine the implications if an exceptionally rich gold mine had been discovered? In hindsight it was fortuitous for the whole system at that

time, that the gold production of California, Australia and South Africa allowed the steady-ish level of economic expansion that it did. It is a measure of the reassurance and order (and perhaps discipline?) which politicians and bankers felt that the gold standard brought to international trade relations, that they were willing to bet on such an arbitrary system. They must have considered the benefits to be worth it, or the alternatives far worse? In conditions where the current output of the precious metals from the mines is on a relatively small scale, an influx of money into one country means an efflux from another ... The General Theory, p209. It is important to note that the theoretical position of reducing a whole country's wages, if it is able to be done in a complete and automatic way, is not necessarily some grand exploitative conspiracy against the working man. In theory if everyone's wages and incomes fall, real incomes (spending power) would remain the same for everyone in relation to domestic goods. Keynes' issue was that in reality this kind of clean and pure adjustment was confined to ivory tower theory, and the reality, as he explains above so colourfully, is that the outcome is inevitably unequal. The growing influence of trades unions and generally more civilised contractual arrangements between employers and employees, was also a factor in making wage reductions unlikely for all but the most powerless of workers, as compared with the previous century when such an approach was more common and wages less sticky. Five years later, during his lengthy exposition of the slump situation to the Macmillan Committee in February 1930, Keynes below argues that the classical economic policy of using interest rates to regulate the wage rate in service of the gold exchange had, during the 100 years or less that it had been a method in use (p57 after below) never been used or expected to support such a large downward adjustment in wages: prices were on the whole tending upwards, and allowing for the sharp increase of efficiency which was going on all the time there was never any occasion to use Bank rate to bring about a downward adjustment of wages. It was sufficient to use it as the regulator of the rate of the upward movement. Efficiency itself was enough to allow wages to rise quite materially year by year, and all the Bank rate did was to regulate the rate rate at which we could afford to pay higher wages. The position in the last four years has been entirely different. The return to the pre-War gold parity in 1925 committed us to use Bank rate policy to force wages down 10 per cent, except in so far as increased efficiency could diminish the amount by which we had to reduce them. That was setting Bank rate policy a task it had never been asked to do before in the economic history of this country. vol XX p56 My reading of history is that for centuries their has existed an intense social resistance to any matters of reduction in the level of money incomes. Throughout history I can only recall two occasions at all comparable to the present one. One was the highly analogous deflation which followed the Napoleonic Wars, very much

like the one we are going through now, was one which brought this country to the verge of revolution, The other analogous case was the price fall in the middle ages prior to the discovery of America and the influx of precious metals to Europe. The fall of prices was, then, an appalling problem, and it was only mitigated by monetary readjustments. Many of our monarchs rest under unjust imputations of depreciating the currency for their own personal advantage. I am sure they only did it to avoid what they regarded as intolerable wage adjustments. There is no question as to the impoverishment of the world that occurred; and subsequently the High Renaissance and the general process of recovery were based on the accumulation of profit which took place during the period of the rise in prices, lasting about 100 years, which followed on the influx of gold from America. But apart from these two periods I do not think there is anything to prove that it was ever easy to bring about material fall in the level of money incomes. vol XX p 64. A year later in March 1931, Keynes in a letter to The New Statesman and Nation was back on familiar ground, making the same points. In considering the possible economic action required to urgently regain Britain's competitiveness / trade balance, he was adamant that putting any further hope in the old 19th century approach of expecting a fall in wages to take up the slack was misplaced. As he mentioned above, historically deflationary high interest rate (Bank Rate) policy had never been used for an adjustment of such a scale, and its potency as a lever of policy had already ran out of steam in the previous four years, even before the further downward impact of the slump on international prices had occurred: Now free trade, combined with great mobility of wage rates, is a tenable intellectual positionthough it presents a problem of justice so long as many types of money income are protected by contract and cannot be mobile. The practical reason against it, which must suffice for the moment, whether we like it or not, is that it is not one of the alternative that we are in a position to choose. We are not offered it. It does does not exist outside the field of pure hypothesis. vol XX p496-7 Below in even more vivid language, Keynes conveys his strong feeling regarding the nature of such a policy, and reveals part of the reason why he has concluded that the lesser evil of a tariff policy was preferable. Keynes included the following as the last point in an 18 point paper titled A Proposal for Tariffs Plus Bounties for discussion in a session of the Economic Advisory Council in September 1930: 18. I would also repeat, what I have stated above, namely that a great advantage of this method [a tariff plus bounty] is that it is capable of being put into force by legislative enactment, where as a reduction of money wages cannot be enforced in this way, but only as a result of a sort of civil war or guerilla warfare carried on, industry by industry, all over the country, which would be a hideous and disastrous prospect. vol XX p419

A Creditor Nation Should Not Devalue The special circumstances of Great Britain Although Britain was on the gold standard at the beginning of the 1930's crisis, the prospect of devaluing the sterling to gold rate was by no means impossible, and in many respects from today's perspective it looks more attractive, and less of a wrench from historical habits and customs, than the tariff route. Indeed a short period later in September 1931, as will be discussed later, speculation against sterling forced Britain off the gold standard anyway, before the full blown 1932 revenue tariff had even been enacted. So why was the tariff route initially favoured over the more obvious devaluation? There are a few references Keynes makes at the time which help us to understand this choice. From the same discussion paper cited in the last chapter, the following points show that it was Britain's or in some ways more accurately London's special position in world economics and finance which made tariffs preferable to a sterling devaluation: 1. My proposal is for a uniform tariff of, say, 10 per cent on all imports