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Keynes, Steindl, and the Critique of Austerity Economics

Nina Shapiro is professor of economics at Saint Peter’s College, New Jersey, and a member
of the editorial board of the Journal of Post Keynesian Economics.

One may feel tempted to apply the term paradigm to the changes in economic doctrines and especially to the great revolution brought about by Keynes and Kalecki. If one considers the great bulk of the economic profession, however, the term is misplaced. Keynes has never been accepted by more than a minority. Kalecki’s importance has hardly been known outside a small circle. The dominant doctrine was the neo-classical synthesis, a hotchpotch of ideas. I do not think I am excessively frivolous if, instead of paradigms, I speak of fashions in economics.

Joseph Steindl1

Austerity is now “in fashion,” as governments respond to the revenue shortfalls of the crisis through deficit reduction plans and fiscal stability pacts, and economists blame it on the profligate spending of households and countries.2 Consumers, they say, bought houses they could not afford and countries consumed more than they produced, while loose monetary policies made this spending possible. Governments “got prices wrong,” keeping interest rates too low for too long,3 and while increases in government spending might alleviate current employment problems,4 this deficit spending is inflationary, and in any case will not help in the long run as budget deficits raise interest rates, “crowding out” business and household spending. It is as if we have stepped back in time, to the depression years of the 1930s, when monetary theories of the cycle were dominant, the “overinvestment” of the boom blamed for the downturn, and effective fiscal actions proposed by Keynes and others blocked by preoccupation with the public debt and its burdens.

The analysis here is concerned with the systematic rejection of Keynes’s and Kalecki’s revolution in economics and the resurrection of Say’s Law (supply creates its own demand) of pre-Keynesian economics in all but name—a view that underlies today’s austerity economics. It was Josef Steindl, author of Maturity and Stagnation in American Capitalism, who offered the most thoroughgoing critical perspective on this shift—a shift in fashion rather than paradigm, reflecting the inability of received economics to accommodate a genuine scientific revolution.5 Steindl was a great neo-Marxist/post-Keynesian economist, who lived long enough into the present period to provide critical insights into the growth of the neoliberal fashion. When stagnation returned this time, after Keynes, it was stagnation not only as an underlying tendency, but also what Steindl called “stagnation as policy” backed up by a reversion to pre-Keynesian thinking.6

This pre-Keynesian stance of the economics profession perhaps should not be surprising in that most economists, as Steindl notes, never accepted Keynes, and the “dismantling of the General Theory started as soon as it was published if not before.”7 Critics argued that the new theory was not as new as Keynes claimed; it was just a “special case” of the conventional (“classical”) theory, applicable only under special conditions—such as inflexible labor markets (“sticky prices”) or “money illusion.” Its demand constrained, unemployment equilibrium occurred under these conditions alone, so that while Keynesian employment policies could be effective—and many members of the new “neoclassical synthesis” school advocated them—their Keynesian justification was invalid. Not only was the new theory not so new, it was quite wrong.

But while the Keynesian revolution never took hold, and the Monetarist “counterrevolution” occurred long ago, Keynes’s influence remains. His ideas are still voiced in the profession, in however a muted form, and his arguments form the backdrop for the discourse on monetary and fiscal policies. Thus, while Bernanke emphasizes the importance of fiscal discipline in his policy prescriptions, he also warns us of the risks of cutting budget deficits too soon, before the economy strengthens.8 In spite of his monetarist background—he is known for his monetary account of the Great Depression—he still seems to remember something about Keynes. The relevance of Keynes to the economic debates of the day is evident, as is the importance of reconsidering his arguments—reminding ourselves, as Steindl said in another context, of what Keynes and the experiences of several decades have taught us about full employment. And the best account of these lessons is Steindl’s own.

The Paradigm

Keynes is not easy to understand. The General Theory was written for his “fellow economists,” and thus encumbered, as Steindl says, by the traditions of the discipline,while the textbook presentations of his ideas are their “neoclassical synthesis.”9 Yet, as Steindl emphasizes, the basic ideas are simple; the difficulty in understanding them lies not in the ideas themselves, but in the way “many economists as well as laymen” think about the economy. They reason from the “analogy between the individual household and society as a whole,” assuming that what holds for the individual household holds also for all households together. Conclusions drawn from this analogy, Keynes argued, are misleading, and dangerous if applied to the economic problems of our times.10

While the individual household can accumulate assets by saving, households as a whole cannot. For when households spend less they reduce each other’s income, reducing household wealth. One person’s spending is another person’s income; spending determines income in the case of households as a whole, whereas income determines spending in that of the individual household. Macroeconomic relations are quite different than those experienced in the day-to-day operations of households and businesses. They can only be understood by looking beyond these experiences, to the interconnections between them. Examining these shows that there are feedbacks, “circular relations” such as the spending-income-spending loop, which are not very important for the individual household or firm—their spending is too small a proportion of overall spending to react back on their own operations—but are critical for large economic units, such as governments, and for the operation of the economy as a whole.

An important instance of these circular economic relations is the relation between wages and employment. Here, as Steindl notes, “it is the analogy between the firm and the economy as a whole which gives rise to the usual faulty reasoning”: that a cut in wages can increase employment.11 If a firm could pay lower wages, its costs would be less, and this would increase the profitability of its production and probably lead to an expansion of output and employment. But the wage cuts that increase the profits of firms reduce the sales of others. Wages are incomes as well as costs—“purchasing power.” A cut in the wages paid by an individual firm will not hurt its sales—its employees are not a significant part of its market—but a reduction in the wages paid by all enterprises will hurt theirs. Sales revenues will fall by the amount of the wage cuts, so that the profits of firms will be no greater than they were before the wage reductions, and instead of improving the employment situation, as the “classical economists” argued (and their contemporary counterparts still do), the wage cuts will probably worsen it. The deflation of wages and prices will increase the debt burdens of households and firms, reducing their purchasing power; more of their income will be taken up with debt payments, and demand for products will fall as firms cut costs and households save more.

The “circular flows” in the economy—the transformation of income into sales revenue, revenue into production expenditure, and thus back into income—do not maintain themselves. Households do not buy, and firms do not produce, the same amount of products year after year. There is no “invisible hand” that leads them to spend what they spent in the past; it is not necessarily in their interests to do so, or to spend the amount that would ensure the full employment of resources. The “profit maximizing” output need not be the full employment output—its production may leave a part of the labor force unemployed. There is, as Steindl puts it, “always a danger of leakages,” of household and business saving taking income out of the income-spending stream.12

These leakages have to be offset by spending “injections” for sales revenues to replenish income flows, and sustain output and employment levels. If households spend less than their income, businesses or the government must spend more than theirs. Production and employment will be cut otherwise, as firms will suffer revenue shortfalls. Firms, as opposed to households, can also sell products abroad, and foreign sales can make up for sales losses in home markets. But all countries cannot sell more to other countries than they buy from them. The trade surpluses of countries are the trade deficits of others; they can only be achieved if other countries “do not live within their means.” Trade surpluses can increase growth and employment in some countries, but they cannot ameliorate the problems of the global economy. The idea that they can is, again, as Steindl would say, the result of a “false analogy,” in this case between the national economy and the world economy.

Business savings depend on the profit share of national income, whereas household savings depend on the personal income distribution. Higher-income households have higher saving rates; they can save a greater percentage of their income in that they have more income to spend, while the savings rates of all but the highest-income households—the “1%”—tend to rise in a recession, as the unemployment rate increases and fear of job loss spreads through the labor force. This rise in savings rates worsens the recession as the expenditure of households will not only fall with their income, but fall by a greater percent than their income.13 As Keynes would put it, the “propensity to consume” falls in the downturn, intensifying the “multiplier” effects of the initial decline in output.

The effects of household saving thus look quite different when viewed from the macroeconomic perspective of Keynes rather than the microeconomic perspective of “classical economists.” They are, in fact, the exact opposite. The adverse effects of that saving cannot be emphasized enough, for, as Steindl argues, the savings rates of capitalist economies are the root cause of their problems, the reason for their periodic downturns and depressions. These occur not because there is too much spending in these economies, but because there is too little, because their savings rates make full employment dependent on a “high growth rate,” and the investment needed for this is not necessarily there.14

Investment in plant and equipment, in the expansion or modernization of production facilities, is essential in a capitalist economy. This expenditure on means of production is the critical offset to the saving of households, what keeps the “income-spending” stream flowing. But that investment is decided by firms, their owners or managers, not by households, and the factors that decide it have nothing to do with saving propensities or consumption preferences.15

Investment depends on both the profit available for it, and the profit expected from it. The profit for it is accumulated out of the earnings of firms, and in this respect, the business saving is not as inflexible, or as damaging to the economy, as the household saving. Business savings automatically adjust to conditions in the economy in that the profits of firms rise and fall with their sales, and while households save for the purposes of future consumption, to finance their children’s education or provide for retirement, businesses save for the purposes of investment. They retain earnings in order to accumulate enough for expansion, and insofar as the external (“debt”) financing of their investment is constrained by their own capital, business savings promote investment.16

Yet, investment is undertaken for profit—the firms that undertake it are capitalist enterprises. They will reinvest profits only if they expect that investment to be profitable, and its profitability depends not only on current conditions in the economy, but also on future conditions. These, as Keynes emphasized, can be quite different from the conditions of the past, and in a capitalist economy, where businesses are free to produce and invest to whatever degree they deem profitable, the future will necessarily be different from the present. It will not, as the orthodox economists assume, be just a “statistical shadow of the past.”17 And, since plant and equipment investments are long-lived with their profit dependent on product sales and costs over their entire lives, the return on them will be uncertain and investment ultimately based on business “optimism”—what Keynes called “animal spirits” and what we call today “business confidence.”18

As investment depends on uncertain expectations, it will vary with the “hopes and fears” that decide them. No specific level of investment can be counted on, still less the level needed for full employment.19 The difficulty of securing this investment is compounded by the results of investment itself, for, as Steindl emphasizes, investment not only increases the demand for products, it also increases productive capacities, and firms will not expand these if they already have a sufficient amount, enough to meet the demand for their products. Capacity utilization is thus an important determinant of investment—as important as business savings—and when excess capacity develops in an industry, because sales fall off or there is excessive investment, investment will be cut unless competition can “knock” the excess capacity out, eliminating it through the elimination of firms.20

This elimination of excess capacity is the critical function of competition, and reason for its importance. In ridding industries of their excess capacity, competition creates space for expansion, sustaining the investment in them. But, for competition to perform this function, it must take a certain form. It has to be a competition between differently placed firms, with enough differences in their costs and finances for the price competition of the lower cost, “progressive” ones to drive out the high cost “marginal” concerns. For if the costs of the firms were similar, and finances strong, the price cuts needed to eliminate any of them would cut out the profits of all. The “special sales efforts” required would be too costly, and the price (and/or advertising) war too protracted, for any of the firms to try to take over the markets of the others, driving them out.

Cutthroat competition is rare today, though it does erupt.21 Manufacturing industries, such as automobiles and commercial aircraft, are highly concentrated, with a small number of enterprises dominating the market; indeed airplane manufacture is a duopoly. In neither case are there any small, “marginal” firms that can be easily or swiftly “knocked out,” so there will be no intensification of competition when a recession reduces industry sales and firms left with more capacity than they can utilize. In these industries such recessions will reduce the investment of firms rather than their numbers as these try to adjust capacity to sales through postponement of investments. And since prices will not fall either—the competition that cuts them is not present—there will be no increase in real incomes to boost consumer spending and thus offset the fall in investment.

New industries inevitably experience a shakedown process during which there is considerable price competition, but as they mature such industries become more oligopolistic in nature. Few would have expected two decades ago the degree to which some of the high-tech information and communication industries have become oligopolies (even near monopolies due to extensive network externalities) as in the case of Microsoft, Apple, Google, and Cisco. Despite relatively high competition in this area, such growing concentration and centralization can be expected to proceed with similar effects on price and investment.

The monopolization of industry ends the competition that sustains demand and revitalizes investment, and this industrial concentration was, according to Steindl, the underlying cause of the Great Depression.22 It was the reason for the long-term decline in investment that preceded the Depression (its rate fell off at the turn of the twentieth century), as well as the difficulty of ending it. And while the stock market boom of the 1920s held off the downturn, lifting “animal spirits” and reducing the financing costs of investment, when the market crashed the full effects of the industrial concentration were felt. The economy collapsed and remained depressed until an exogenous development, the Second World War, brought demand back up.

Past and Present

What would Steindl say about the “lesser” depression of recent years—the slow growth and continuing high unemployment of the U.S. economy and double-dip recessions of the European? He would probably point to the parallels between this depression and that of the 1930s, reminding us of the recurrent downturns of capitalist economies, and the difficulty of maintaining unemployment under the savings rates of these economies. But while he would explain the current crisis in the same Keynesian manner as he explained past crises, he also would probably say, as he did in his explanation of the “stagflation” of the 1970s that “economic theory cannot be the same for every country, nor for different time periods in one and the same country.”23 New situations demand “new explanations,” and, as was the case in the 1970s, economic policies as well as economic developments were a part of the problem.

An obvious parallel between the current crisis and the Great Depression is the inflation in asset prices that preceded them—the stock market boom of the 1920s and housing market bubble of the early 2000s. Both were financed with credit, with borrowings from banks and other financial firms, and would not have been possible without their “margin-lending” and debt securitizations (collateralized debt obligations). This credit expansion fueled the bubbles, and while these stimulated the economy while they lasted, when they “burst” their investment and wealth effects reversed. Instead of increasing consumer spending through the optimism and capital gains they created, or the debt refinancing and equity withdrawals they allowed, they depressed it, collapsing household wealth and necessitating greater household saving, while the debt that financed the bubbles remained to be serviced and repaid.

Debt-financed consumer spending is quite different from income-financed spending. The latter can continue as long as income is earned, whereas the debt financed spending cannot. Consumers have to pay interest on the debt they contract, and this interest can be paid in only one of two ways: out of their incomes or through incurring more debt. In either case, the interest payments on the debt will reduce purchasing power,24 and though the recipients of this interest may spend some of it on consumption, they are likely to be financial firms and wealthier households, neither of which spends much of their earnings.25 Most of the interest paid out of household income will go back into finance, used for the purposes of financial investments or speculations, so that while consumer credit can increase consumer spending in the short run, raising it above the level of household incomes, it cannot do so in the long run. Its long-run effects are, as Steindl emphasizes, the same as an increase in household saving: they reduce effective demand, worsening rather than ameliorating the employment problems of capitalist economies.26

Another important parallel between the decades preceding the current crisis and that of the 1930s is the rise in income inequality. Steindl certainly would have emphasized this, given the importance of income distribution in the determination of household savings, and, in fact, he had already warned us of the adverse effects of this increasing inequality in his writings on the economic developments of the 1970s and ‘80s. Here he noted the connections between the upward trend in household saving and rise in “rentier” income—interest, dividends, capital gains, and other financial earnings (such as bank commissions and fees). These financial incomes increased, in both absolute and relative terms, as the long post-war (1950s and ‘60s) prosperity of capitalist countries raised household incomes, resulting in a “significant accumulation of personal savings held in the form of financial assets.”27 This growth of finance was furthered by the oil price hikes of the 1970s, which produced a “class of international rentiers from the OPEC countries,”28 and today, of course, we have a similar source of financial accumulations, in the trade surpluses of China and other nations.

While the upward trend in household saving increased the importance of the financial sector, the increase in financial incomes increased income inequality, shifting income from households with lower saving rates to those with higher ones and thus further increasing the household savings rate. This adverse effect of finance is probably even greater today than it was at the time Steindl noted it (1982)—the financial sector has become still larger—and its growth, as Steindl also emphasized,has a depressing effect on investment as well as consumption.29 Bull markets provide lucrative alternatives to investments in production, as financial investments are liquid and their returns quick, while real investments, in plant and equipment, new products and technologies, are risky and long-lived. They require a greater financial commitment than stock or bond investments, and, according to Steindl, industrial firms had already been drawn into finance by the 1980s, attracted, in part, by the growing importance and prestige of the financial sector, but the oligopoly that was highlighted in his explanation of the Great Depression also played a role.

The increasing size of industrial enterprises, along with the persistence of oligopoly, affected the internal organization and management of enterprises. Management became more and more concerned with the market power and position of the enterprise, and since this can be achieved more quickly through mergers and acquisitions than battles over market shares, and these battles, in any case, are usually ruinous under oligopoly, attention shifted from production to finance. This change in the outlook of management developed gradually through the years, and, in this sense, was the modern expression of the “maturity” of economies that Steindl associated with stagnation in his work on the Great Depression,30 but it quickened in the 1970s, when the monetarist high interest policies became dominant. These made it profitable for industrial firms to turn themselves, or their divisions, into financiers (“rentiers”). This lure of finance has, if anything, been strengthened by the regulatory policy changes of the 1980s and ‘90s: the deregulation of the financial sector and the new financial instruments (such as derivatives) developed with its freedom.

The decline in the growth rate of the U.S. economy in the 2000s—both the average annual growth rate of output and investment was lower in that decade than in the 1990s31—may have been the result of this financialization of industry. Steindl certainly would have investigated its role in the current crisis, perhaps arguing that the full effects of the stagnation it caused were warded off by the housing market bubble and accompanying increase in household debt. And he most definitely would have emphasized the role of economics, for its ideas about finance, about the efficiency of financial markets and rationality of their risk pricing, played a major role in both the deregulation of the financial sector and the financial innovations that brought on the current crisis.

Steindl thought that economics had “reached rock bottom” with the supply-side economics of the 1980s.Its arguments were too simplistic to be taken seriously, while the “rigorous” rational expectations models in fashion were too abstract and implausible to be influential. He had not realized their appeal to financiers, who were seeking new markets for their risk management and had found a rationale for new credit instruments in the “efficient market hypothesis” of the rational expectations models. But, since the financial crisis has exposed the bankruptcy of these notions, and countries have become disillusioned with the austerity prescriptions of today’s “classical” (pre-Keynesian) economists, the “time for new fashions cannot be far away.”32


  1. Josef Steindl, “Reflections on the Present State of Economics,” Monthly Review 36, no. 9 (February 1985): 37. First published in Banca Nazionale del Lavoro, Quarterly Review 37, no. 148 (March 1984): 3–14.
  2. Such as the “Austerity Treaty” of the EMU, Obama’s Budget Control Act (signed in to law in August 2011), and Britain’s 2010 Fiscal Responsibility Act. For the details of the British plan, and Cameron’s modifications of it, see Malcolm Sawyer, “The Tragedy of UK Fiscal Policy in the Aftermath of the Financial Crisis,” Cambridge Journal of Economics 36, no. 1 (January 2012): 205–21.
  3. This, according Robert Hall, is the reason that they cannot reduce interest rates enough today, restoring the “inter-temporal equilibrium” between saving and investment, and ending the slump. See his essay on “The Long Slump,” American Economic Review 101, no. 2 (April 2011): 431–69.
  4. Though there have been a number of econometric studies that have attempted to show the opposite. For a review of these see Paul Krugman, “Austerity Games, Here and Now,” New York Times blogs, March 30, 2011,
  5. Josef Steindl, Maturity and Stagnation in American Capitalism (Oxford: Basil Blackwell, 1952), 195. This was reprinted with a new introduction by the author by Monthly Review Press in 1976.
  6. Josef Steindl, “Stagnation Theory and Stagnation Policy,” Cambridge Journal of Economics 3, no.1 (March 1979): 1–14.
  7. Josef Steindl, “J. M. Keynes: Society and the Economist,” in Fausto Vicarelli, ed., Keynes’s Relevance Today (London: Macmillan, 1985), 113.
  8. See his speech on “The Near- and Longer-Term Prospects for the U.S. Economy,” delivered at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 26, 2011, http:/
  9. Steindl, “J. M. Keynes: Society and the Economist,” 109.
  10. Ibid., 99.
  11. Ibid., 100.
  12. Ibid., 101.
  13. See Steindl’s discussion of “The Role of Household Saving in the Modern Economy,” Banca Nazionale del Lavoro 35, no. 140 (March 1982): 69–88.
  14. Steindl, “Stagnation Theory and Stagnation Policy.”
  15. Steindl, “J. M. Keynes: Society and the Economist,” 101.
  16. Steindl, “The Role of Household Saving in the Modern Economy,” 69.
  17. This is emphasized in Paul Davidson’s writings. See his paper on “Risk and Uncertainty in Economics,” presented at the conference on “The Economic Recession and the State of Economics,” House of Lords, Westminster, London, February 6, 2009,
  18. Steindl, “J. M. Keynes: Society and the Economist,” 101.
  19. This is the reason Keynes argued that “the duty of ordering the current volume of investment cannot be safely left in private hands.” Keynes, The General Theory of Employment, Interest, and Money (London: Macmillan, 1936), 320.
  20. This is argued in a number of Steindl’s works, with the fullest discussion in Maturity and Stagnation in American Capitalism.
  21. It happens most often, as Steindl notes, when new firms enter an industry, overcoming its entry barriers through radical changes in its products or technologies. See Steindl, “Distribution and Growth,” Studies in the Surplus Approach 1, no. 1 (1985): 53–68.
  22. See his classic work on the subject, Maturity and Stagnation in American Capitalism.
  23. Josef Steindl, “From Stagnation in the 1930s to Slow Growth in the 1970s,” in Maxine Berg, ed., Political Economy in the Twentieth Century (Savage, MD: Barnes and Noble Books, 1990).
  24. They will have to be paid out of income eventually in that the debt cannot increase indefinitely—creditors will not allow it, especially in the case of consumer debt where there are no income-earning assets to “cover” it.
  25. Indeed, the financial firms do not spend any on consumption, though their executives or traders might.
  26. See, in particular, Steindl’s “Effective Demand in the Short and in the Long Run,” paper presented to the 1990 Summer School of Centro Internazionale Di Studi Di Economia Politica, Trieste, Italy.
  27. Amit Bhaduri and Joseph Steindl, “The Rise of Monetarism as a Social Doctrine,” in Philip Arestis and Thanos Skouras, eds., Post Keynesian Economic Theory (New York: M.E. Sharpe, 1985), 62–63.
  28. Ibid, 66.
  29. See Steindl, “From Stagnation in the 1930s to Slow Growth in the 1970s.”
  30. Steindl, Maturity and Stagnation in American Capitalism.
  31. See Josh Bivens and John Irons, “A Feeble Recovery, The Fundamental Economic Weaknesses of the 2001-07 Expansion,” EPI Briefing Paper, December 9, 2008,
  32. Steindl, “Reflections on the Present State of Economics.”