Review of International Political Economy

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Keynes, capital mobility and the crisis of

embedded liberalism

Jonathan Kirshner

To cite this article: Jonathan Kirshner (1999) Keynes, capital mobility and the crisis
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 Review of International Political Economy 6:3 Autumn 1999: 313–337

Keynes, capital mobility and the crisis

of embedded liberalism
Jonathan Kirshner
Department of Government, Cornell University

A BS T R A C T
This article argues that in an era characterized by increased practical and
analytical concern for the domestic consequences of international market
forces, through the study of Keynes’ own writing we can better under-
stand the signiŽcance of the contemporary challenges to the compromise
of embedded liberalism and the consequences of the possible unraveling
of that order. A Keynesian interpretation of the Asian Žnancial crisis illus-
trates both the application of Keynes’ philosophy of political economy and
its continuing relevance.

K E Y WO R D S
Keynes; capital mobility; embedded liberalism; Žnancial crisis; middle way;
political economy.

it will be the role of this country to develop a middle way of economic life
which will preserve the liberty, the initiative and (what we are so rich in)
the idiosyncrasy of the individual in a framework serving the public good
and seeking equality of contentment amongst all.
(Keynes, 1944e: 369)

In the past decade, the world has witnessed a movement in the direc-
tion of unregulated market forces. While many hail these developments
as the ultimate triumph of capitalism, others raise concerns about the
erosion of social-democratic bargains which emerged after World War
II, that were designed to insulate the majority of the population of indus-
trial states – the middle and working classes – from the rougher edges
of the capitalist system. To better understand the political and economic
consequences of these recent developments, there could be no more
appropriate time to revisit the writings of John Maynard Keynes, who
© 1999 Routledge 0969–2290
 REVIEW OF INTERNA TIONAL POLITICAL ECONOMY

had a profound inuence on the shape of those postwar arrangements,

and whose work speaks directly to these issues.1
Keynes campaigned against unregulated capitalism. He argued that it
would lead to suboptimal economic outcomes, and that it would elicit
political responses that would compound those difŽculties. While Keynes
is most famous for The General Theory of Employment, Interest and Money
(1936a), his fundamental challenge to ‘classical’ economic theory, Keynes
offered much more than a voice of dissent.2 His broader writings illus-
trate how, dissatisŽed with the existing alternatives to unregulated cap-
italism, Keynes articulated another choice: the ‘middle way’, a capitalist
economy in which some market forces would be managed and contained.
A fundamental challenge to the practice of the middle way was the
existence of market forces that were beyond the control of the sovereign
state – especially international market forces. For the middle way to be
sustained, such forces must be mediated as well. Ideally this would be
done through international institutions or other forms of cooperation
designed to insure that the international economy would not disrupt
states’ pursuit of the middle way. From this perspective, then, increas-
ingly powerful and untethered international capitalism is a problem in
that it tends to undermine the middle way, and consequently will yield
profoundly negative economic and political outcomes.
An example of this is the contemporary Asian Žnancial crisis, which
is considered from a Keynesian perspective in the Žrst part of this article.
I argue that this interpretation of the crisis ows naturally from a coherent
general philosophy of political economy that can be derived from Keynes’
writings. It also illustrates the continuing relevance of Keynes’ thought
in contemporary political economy. The following section establishes the
foundations of this philosophy, the middle way. It will then show how
Keynes recognized that even if he could convince a nation of the bene-
Žts of the middle way, the policies associated with his approach might
not be sustainable in the face of international market forces. It is Keynes,
not Polanyi, who can claim title to the philosophy of embedded liber-
alism, the compromise of market forces and social contract which
characterized the post-World War II international economic order. The
following section reviews how the postwar international economic order
was designed to accommodate the middle way, and shows how recent
changes undermine that accommodation.
The challenges to the middle way in the contemporary system – the
international pressures and their domestic manifestations – are very
similar to those addressed by Keynes in the interwar period. In an era
characterized by increased concern for the domestic consequences of
international market forces, it is through Keynes that we can understand
the signiŽcance of these challenges, and of the possible unraveling of
embedded liberalism.
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

K E Y NE S A ND C O NT E MP O R A R Y PO L IT IC A L EC O N O MY
The contemporary relevance of Keynes is well illustrated by the distinct
internationalist explanation Keynes’ perspective offers for the Asian
Žnancial crisis. Most orthodox explanations, on the other hand, have
stressed the proximate domestic origins of the crisis. But these inter-
nal factors, while certainly present, are much clearer in retrospect than
they were just a few months before the crisis. In November 1996,
for example, the IMF touted ‘ASEAN’s Sound Fundamentals Bode
Well for Sustained Growth’ in a banner headline of its newsletter.
In May 1997, IMF Managing Director Michael Camdessus stated that the
international economic environment justiŽed an atmosphere of ‘rational
exuberance’. The IMF reported further that ‘overheating pressures
have abated in many emerging market economies, especially in Asia –
where growth has stayed strong for several years’ (IMF, 1996a: 377;
1997b: 129–30).
Not only are the internal sources of the crisis largely evident in
hindsight, they do not address the underlying structural cause of the
crisis, which, from a Keynesian perspective, derives from the functioning
of the international Žnancial system. As one of the principal architects
of the IMF and the post-World War II Žnancial system (about which
more below), Keynes favored capital controls, especially over short-term
capital movements. While he favored an open international economy
that facilitated foreign investment, Keynes drew a sharp distinction
between mobile capital and completely unregulated capital. As a result,
the rules of the IMF were written to explicitly accommodate capital
controls. From a Keynesian perspective, there are three reasons why
completely unregulated Žnancial capital is unwise.
The movement of short-term capital falls into a class of economic
activity central to Keynes’ approach: where the sum of individual actors
responding rationally to incentives does not result in collective efŽciency.
Such spheres need to be identiŽed, and are the appropriate targets of
government intervention. Especially today, with technology that
combines very large Žnancial markets with very low transactions costs,
the result is ‘too much’ movement of short-term capital. This is because
capital mobility can impose costs to society that are not borne by its
producers, and thus, like other negative externalities, tends to be over-
produced. There are three principal reasons why completely unregulated
capital is an example of such a market failure.
First, the movement of huge amounts of capital in and out of states
can alter dramatically, and literally overnight, the value of crucial assets
such as national currencies and local equities. Macroeconomic variables
such as interest rates and ination can also be subject to sudden varia-
tion. Pure capital mobility thus heightens uncertainty, which Keynes
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(1936a: 148) considered to be a fundamental detriment to business conŽ-

dence and economic activity.
Second, to an important extent, Žnancial assets are worth what people
think that they are worth. Keynes’ (ibid.: 156) famous allegory is to a
beauty contest, where the goal of each competing judge is not to pick
‘the faces which he himself Žnds prettiest, but those which he thinks
likeliest to catch the fancy of the other competitors, all of whom are
looking at the problem from the same point of view’. In uncertain Žnan-
cial markets, fears regarding what other people are thinking can cause
herding behavior, unleashing Žnancial stampedes with economic conse-
quences that veer far from the path suggested by any reading of the
economic ‘fundamentals’.
Finally, it is a fallacy to think that every country should pursue the
same macroeconomic policies. This concern was a consistent theme
throughout Keynes’ writings, although he suggested different remedies
in the 1920s, 1930s and 1940s, as international conditions and his own
thought evolved. States face diverse economic conditions, and need to
tailor their economic policies accordingly. The problem is that investors,
scanning the globe for the best rates of return, create pressures for confor-
mity across countries’ macro policies. Nations that deviate from the
international norm, even when pursuing policies appropriate for local
needs, are ‘punished’ by capital ight.
Thus a Keynesian perspective would focus on the international origins
of the Asian Žnancial crisis: capital deregulation that resulted in inefŽ-
ciently high levels of short-term capital ows.3 The current conventional
wisdom, it should be noted, runs in the opposite direction.4 In September
1996, the IMF asserted that ‘international capital markets appear to have
become more resilient and are less likely to be a source of disturbances’
(IMF, 1996b: 294).5 Following this assumption, the Fund embarked upon
a fundamental revision of its charter, and in May 1997 announced plans
to amend its constitution – the Articles of Agreement – ‘to make the
promotion of capital account liberalization a speciŽc purpose of the IMF
and give it jurisdiction over capital movements’ (IMF, 1997b: 131–2). This
is of course the opposite of what Keynes and the other founding fathers
of the IMF intended. They thought that capital controls were necessary
to assure the smooth functioning of an open international economy, and
the Bretton Woods era, the ‘golden age of capitalism’, was a period of
ubiquitous capital control. Now, however, the IMF has declared explic-
itly that ‘Forces of globalization must be embraced’. Its new policy has
been repeatedly characterized as a proposition ‘to make unrestricted
capital ows a condition of membership in the global economy’ (IMF,
1997a: 131–2; McDermott and Lopez, 1998; Goad, 1998). From a
Keynesian perspective, this will probably lead to additional crises and
lower global growth.
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

K EY N ES A N D T H E ‘ MI DD L E WA Y ’
This interpretation of the Asian crisis derives from a more comprehen-
sive philosophy of political economy that was developed by Keynes: the
middle way, which is facilitated at the international level by an embedded
liberalism. It was Ruggie (1982: 393) who coined the term ‘the compro-
mise of embedded liberalism’, which he deŽned as states’ consensus that
‘multilateralism would be predicated upon domestic interventionism’.
This meant that postwar institutions would support an internationalist,
market-oriented order, but would allow for mechanisms, safeguards and
escape clauses through which states would not be forced to sacriŽce
domestic social policies in order to maintain international equilibria. In
contemporary politics, one can observe evidence for the unraveling of
this compromise (Schwartz, 1994; Helleiner, 1994; Hall, 1986). This may
have profound consequences that will be unanticipated by those who
are unaware of the extent to which the compromise of embedded liber-
alism was designed to allow for the practice of the middle way – and
in so doing, to avoid the economic horrors of the interwar years.
Ruggie attributed the concept of market embeddedness to Polanyi,
and his book, The Great Transformation (1944). Polanyi argued that
the breakdown of the international order was a consequence of the
nineteenth-century laissez-faire economic system, which was unsustain-
able because, unlike other periods in human history, ‘Instead of economy
being embedded in social relations, social relations are embedded in the
economic system’ (Polanyi, 1944: 57).
But while Polanyi did call attention to the relationship between state
and society, it would be wrong to associate him with embedded liber-
alism, and an even greater mistake to consider him a founding father of
that philosophy.6 While Polanyi criticized laissez-faire capitalism, he was
not a reformer, and in fact was skeptical of the prospects for the types
of reforms that would be associated with embedded liberalism.
Additionally, despite the obvious merits of the book, Polanyi did not
offer a clear course of action.7 Finally, by the time Polanyi wrote in 1944,
Keynes had already presented a clearly articulated and well-known
argument in favor of what could be called embedded liberalism: the
need to accommodate the middle way.8
What was Keynes’ middle way? It was his conception of the economic
structure and organization of society, designed as an alternative to the
existing approaches of the day, laissez-faire liberalism and Marxism.
Neither of these nineteenth-century philosophies was capable of
sustaining economic progress in the twentieth century. While Keynes
spent a good portion of his career elaborating the middle way, there are
three or four works in particular which represent the core of the philos-
ophy: ‘Am I a Liberal?’ (1925b); ‘The end of laissez-faire’ (1926); ‘Poverty
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 REVIEW OF INTERNA TIONAL POLITICAL ECONOMY

in plenty: is the economic system self adjusting?’ (1934b); and Book VI

of The General Theory (1936a). 9
From these four documents, the essence of the middle way can be
derived. ‘The end of laissez-faire’ provides a theoretical foundation to
justify deviations from laissez-faire economics by tracing the historical
and philosophical roots of the doctrine, and demonstrating that even
within the temple there exists ample support for various forms of inter-
vention. ‘Am I a Liberal?’, on the other hand, shows Keynes exploring
the practical politics of the middle way, as he rejects the platforms of
both the Labour and Conservative parties, and throws his lot in with
the Liberals, despite his dissatisfaction with many of their policies as
well. Here the strong (and daring) libertarian aspects of Keynes’ philos-
ophy are also displayed. ‘Poverty in plenty’ emphasizes the distinctness
of the middle way, with its argument that there is a fundamental qual-
itative difference between those who believe that the market system is
essentially self-adjusting and those who do not. Finally, Book VI of The
General Theory, ‘Short notes suggested by the general theory’ (almost 20
percent of the volume), broadens the scope of discussion beyond the
framework of the theory itself. It includes, among other things, Keynes’
discussion of the mercantilists,10 and other themes of particular interest
for present purposes, especially in Chapter 24, ‘Concluding notes on the
social philosophy towards which the general theory might lead’.
Taken together, four common themes of the middle way emerge. The
Žrst is dissatisfaction with unregulated capitalism. The second is the
signiŽcance of the distribution of income, which is of positive, norma-
tive and practical signiŽcance. Third is a strong respect for the market
mechanism, a consequence of its obvious efŽciencies, Keynes’ grave
reservations regarding collectivist economic policies, and his passionate
individualism. Finally, an anti-economistic philosophy rounds out the
characteristics of the middle way.

Dissatisfaction with unregulated capitalism

The Žrst step on the road to the middle way was, for Keynes, the break
with laissez-faire economics, which he had previously mastered and
taught. In ‘The end of laissez-faire’, he declared: ‘The World is not so
governed from above that private and social interest always coincide’
(1926: 287–8).11 In The General Theory, Keynes was more speciŽc: ‘The
outstanding faults of the economic society in which we live are its failure
to provide for full employment and its arbitrary and inequitable distri-
bution of wealth and incomes’ (1936a: 372). But dissent was not sufŽcient.
Keynes knew what the problem was: unregulated capitalism ‘is not intel-
ligent, it is not beautiful, it is not just, it is not virtuous – and it doesn’t
deliver the goods’; but he also recognized that ‘when we wonder what
318
 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

to put in its place, we are extremely perplexed’ (1933c: 239). Thus dissat-
isfaction with unregulated capitalism was but a Žrst step. But toward
what? There was no justiŽcation for proceeding further without
providing a viable alternative, and it was this to which Keynes devoted
much of his career.

SigniŽcance of income distribution

One aspect of the break with orthodoxy was greater attention to the
question of income distribution. Keynes was not a crude leveler of
incomes. In fact he found ‘justiŽcation for signiŽcant inequalities of
incomes and wealth’ (though he quickly added, ‘not for such large dispar-
ities as exist today’) (Keynes, 1936a: 374). Some inequality, with its
inherent incentive structures, was necessary for the market-based
economic system to function. But great disparities in income were to be
avoided, by government intervention if necessary, for three reasons. First,
from a purely positive economic perspective, Keynes argued that a highly
skewed or increasingly unequal distribution of income would yield insuf-
Žcient aggregate demand and as a result reduce economic growth and
facilitate below full employment equilibria. Second, from a normative
perspective, unregulated market forces tended to distribute wealth and
income arbitrarily and unjustly, and rewarded those who already had
means. There was no philosophical justiŽcation for such a mechanism
of distribution.12 Finally, from a practical perspective, the perception of
injustice would lead to political upheaval, or at least elicit a political
response with potentially disastrous economic consequences. Thus one
good reason to reform the economic system was that in the absence of
reform, there might be a stronger reaction against the capitalist system,
which would be even less appealing.13

Respect for market mechanisms

What makes Keynes’ approach a middle way is the importance of the
market mechanism. This is embedded liberalism, with an emphasis on
the latter, which is sharply distinct from Polanyi’s concept of an economy
embedded within a social structure. Keynes’ concerns focused on the
aws inherent in the macroeconomy. Microeconomic questions – what
is produced, how it is produced, and how it is distributed – are best left
to the market system. This certainly circumscribed the role of govern-
ment in Keynes’ vision.14 Whatever the imperfections in this system, they
would not be overcome by centralized decision making. Indeed, the
‘advantage to efŽciency of the decentralization of decisions and of indi-
vidual responsibilities is even greater, perhaps, than the nineteenth
century supposed’. Just as importantly, decentralized individualism
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 REVIEW OF INTERNA TIONAL POLITICAL ECONOMY

encourages vital experimentation, assures liberty of choice, and protects

society from totalitarianism (Keynes, 1936a: 379–80).
Market forces should be managed and contained, but not eliminated:
‘Whatever may be the best remedy for poverty in plenty, we must reject
all those alleged remedies which consist, in substance, of getting rid of
plenty’ (Keynes, 1934b: 486).15 Abandoning market forces would throw
the baby out with the bathwater. This was certainly Keynes’ interpreta-
tion of Marxism, socialism and other forms of collective economic
planning. Socialism, he said quite plainly, ‘offers no middle course’. In
fact, one reason laissez-faire had managed to endure was the unattrac-
tive nature of the alternatives, among which he counted protectionism
and Marxism. His distaste for the latter was particularly profound
(Keynes, 1925b: 304; 1926: 285). Regarding Das Kapital, he wrote:
I know that it is historically important and I know that many people,
not all of whom are idiots, Žnd it a sort of Rock of Ages containing
inspiration. Yet when I look into it, it is for me inexplicable that
it can have this effect. Its dreary, out-of-date, academic controver-
sialising seems so extraordinarily unsuitable as material for the
purpose.
(Keynes, 1934a: 38)16
Keynes’ dissatisfaction with collectivist economic philosophies was not
simply the result of their economic incoherence. Such approaches also
cut against the philosophy of the middle way, which stressed the
individual. Keynes was, in Harrod’s words, ‘an individualist to the
Žnger tips’ (Harrod, 1951: 191). This was the Keynes who could write
to Hayek that The Road to Serfdom was ‘a grand book’: ‘morally and
philosophically I Žnd myself in agreement with virtually the whole of
it; and not only in agreement with it, but in a deeply moved agreement’
(Keynes, 1944c: 385).

Philosophy and economism

Rounding out the essence of Keynes’ middle way is his anti-economism.
This characteristic is less central to the practice of the middle way,
but a sensitivity to it does help clarify the underlying coherence of
Keynes’ system. To what end was the middle way directed? Keynes
envisioned that the role of the economist was to solve the economic
problem: the struggle for comfort and the necessities of life. Liberated
from economic fear, individuals would be free to pursue their goals.
These would differ from one individual to the next, but they were
unlikely to be found solely in the pursuit of wealth, which was a means,
not an end. Keynes repeatedly critiqued the crude economism of both
of the ‘nineteenth century orthodoxies’, classical liberalism and Marxism.
320
 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

He wrote that it was the ‘escape from Bentham, joined with the unsur-
passable individualism of our philosophy, which has served to protect
us from the Žnal reductio ad absurdum of Benthamism known as Marxism’
(Keynes, 1949b: 445).17
In sum, the political economy of the middle way was that of the market
nested in a system of domestic management that contained those aspects
of the market process which led to inferior economic, social and polit-
ical outcomes. The market plays a central role in this story: it is too
efŽcient to be discarded, and it safeguards individual liberty. Yet unfet-
tered, it will lead to suboptimal economic outcomes, and will generate
injustice, which is both inherently unappealing and politically dangerous.
But the tools for that management are those of ‘coarse tuning’ – ensuring
that there is adequate investment and aggregate demand – through the
manipulation of incentives to invest and the propensity to consume.
Philosophically, the goal is to achieve adequate social justice (which
would fall far short of ‘perfect’ equality) without sacriŽcing economic
efŽciency or individual liberty. This is the challenge of the middle way:
Liberals are in a more difŽcult position. They are inclined to sympa-
thise with Labour about what is just, but to suspect that in the
ignorant blind striving after justice labour may destroy what is at
least as important and is a necessary condition for any social process
at all – namely efŽciency.
(Keynes, 1927: 638)18

TH E I NT E R N A T IO N A L E C O NO M Y A N D T H E
M ID D LE W A Y
Keynes faced a dual problem in his time, which has resurfaced in the
contemporary era. First, a domestic consensus must be achieved on the
need for a middle way: the view that unfettered markets would lead to
suboptimal economic outcomes. While this could come about from a
shared normative perspective, Keynes, as seen above, rooted his argu-
ments in both positive economic and practical political foundations: such
a system could not sustain itself indeŽnitely and would, as a conse-
quence, probably elicit a dangerous political reaction.
However, even if the Žrst problem could be solved – achieving
domestic consensus – there remained the international problem. Market
forces spill across sovereign boundaries. Thus even if a particular state
attempted to contain the market in its domestic economy, it might be
undermined by international forces. For the middle way to work, the
international economy also had to be managed to insure that interna-
tional market forces did not disrupt domestic management. The middle
way requires embedded liberalism. Disembedded liberalism – unŽltered
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 REVIEW OF INTERNA TIONAL POLITICAL ECONOMY

international market forces – poses a threat to the middle way. Somewhat

surprisingly, these threats did not usually emanate from the real side of
the economy, i.e. from international trade. Trade in general played a
relatively small part in Keynes’ analyses.
Keynes’ views on international trade, however, are worthy of explo-
ration because they highlight a number of features of Keynes’ style of
analysis and of the middle way in general. It should be noted, Žrst of
all, that for most of his life, from his earliest days as a Cambridge under-
graduate through 1930, by which time he had lived more than
three-quarters of his days, Keynes was an ardent free trader of the most
passionate kind.19 In 1930 and early 1931, however, Keynes began to
experiment, much to the horror of many of his colleagues, with the
concept of a revenue tariff. He did this reluctantly and half-heartedly.
He saw it as the least unpalatable technique for taking pressure off
Britain’s international economic position, given the commitment of the
government to the gold standard, which he was careful not to criticize
publicly once it had been restored. The revenue tariff could not be consid-
ered a shift to protection, and Keynes pitched the proposal in a highly
qualiŽed way. With the suspension of the gold standard and the deval-
uation of the pound, Keynes wrote that the question of a revenue tariff
should as a result be put on the back burner (1931f, 1931c).20
Keynes’ willingness to consider any form of protectionism in his forty-
eighth year, after a life-long commitment to free trade, is a demonstration
of his remarkable pragmatism, his willingness to look the facts uninch-
ingly in the eye and let the chips fall where they may. While in this
case that pragmatism may also have served his iconoclastic spirit and
growing disenchantment with laissez-faire in general, this admirable
open-mindedness was noticeable across a number of issue areas.21
However, Keynes’ support for and later retreat from a revenue tariff
cannot simply be dismissed as pragmatism sharpened by desperate
hours. Keynes became increasingly disenchanted with international trade
in the 1930s, although he still recognized the underlying logic of the
traditional arguments for free trade and always couched his proposals
in a clearly qualiŽed fashion. He was under few illusions and was not
a crude protectionist. Keynes’ disillusionment with trade can be traced
to his concern for the viability of the middle way in the context of inter-
national market forces unŽltered by international cooperation. Keynes
never made a pauper labor argument, recognized that interference with
trade would be economically inefŽcient, and understood that if protec-
tionism would in fact increase British employment, it would do so at
the expense of employment in foreign countries and the world as a whole
(Keynes 1932d: 103; also 1932b: 204, 207, 210).22
Yet Keynes did irt with some protectionism in the 1930s.23 He did
so on now-familiar grounds: that the unqualiŽed economistic philosophy
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

might erode other aspects of the quality of life that are left undercounted
by the market’s abacus, and that unŽltered market forces might make
it difŽcult for states to pursue varied and experimental economic poli-
cies at home (Keynes, 1933c: esp. 242–4). However, even this must be
further qualiŽed, for Keynes renewed his enthusiasm for international
trade once the prospects for international cooperation and thus
embedded liberalism appeared more likely.24 Further, trade was never
the true focus of Keynes’ concern. Much of Keynes’ preoccupation with
trade centered on the persistent and structural pressures on Britain’s
trade balance (Keynes, 1943: 259). Such pressures could easily manifest
themselves in chronic balance of payments crises which would force the
same types of contractionary policies once used to defend the gold stan-
dard. This underscores the extent to which the international threat to
the middle way almost always ultimately emanated from the monetary
side of the economy.
In Keynes’ time, the principal challenge to the middle way did come
from the monetary side. This should not be surprising, given the
emphasis on money in Keynes’ career. On the question of the middle
way, he wrote: ‘It is not an accident that the opening stage in this polit-
ical struggle, which will last long and take many different forms, should
centre about monetary policy’ (Keynes, 1925b: 306). It was Keynes’ view
that an unregulated international monetary system would impose a
contractionary bias on all domestic economies, particularly by imposing
higher than optimal interest rate policies and affecting the overall level
of investment.
The international monetary system presents immediate problems for
all states, since, except under circumstances of happy coincidence, they
must choose between stability in the domestic or in the international
price level. If the external price level is stable, e.g. if the exchange rate
is Žxed, then states lose control over their domestic price levels. Fixed
exchange rates serve as efŽcient conductors of monetary phenomena.
Flexible exchange rates, on the other hand, allow for deviations between
states’ domestic price levels, since those can be mediated by movements
in exchange rates. Throughout his career, when forced to choose, Keynes’
preference was to retain control over the domestic price level. Stability
in exchange rates was desirable, and if international monetary cooper-
ation could assure this, then so much the better. But if such international
coordination was not possible, then, when push came to shove, domestic
price stability should take precedence over exchange rate stability.25
The essential problem of monetary cooperation – which practically by
deŽnition involves efforts to inuence exchange rates – is that it involves
a sacriŽce of national monetary policy autonomy. Under a gold stan-
dard, for example, ‘bankers are not even trying to preserve the stability
of prices and of employment’, because their policies are ‘necessarily
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 REVIEW OF INTERNA TIONAL POLITICAL ECONOMY

governed by the policies of all the other central banks’ (Keynes, 1930b:
199, 255). This phenomenon was at the heart of Keynes’ criticisms of the
interwar gold standard system, which, Keynes argued, perpetuated the
Great Depression and, more speciŽcally for our purposes, made it impos-
sible to introduce policies that would be associated with the middle way.
With a gold standard, if any country’s macroeconomic policies depart
from the average policies of the other participants, there will be move-
ments of gold. If a country attempts to expand its economy, under
conditions of perfect capital mobility, the resulting gold outow will
threaten its ability to remain on the gold standard. Either the policy or
the commitment to gold must give way. Essentially, interest rates must
be uniform throughout the system. However, the optimal domestic
interest rate for a given state may deviate from the one established by
the average of all states (Keynes, 1930b: 271).26
This problem became signiŽcant in the interwar period. Keynes
opposed Britain’s return to the gold standard on the grounds that the
Bank of England would be forced to take measures which ‘necessarily
involves intensifying unemployment’ in Britain (1925c: 220).27 Indeed,
this was at the heart of Keynes’ critique of the interwar gold standard.
Given the need to stem outows of gold that threatened convertibility,
the gold standard essentially ‘involved a competitive campaign of dea-
tion’, which ‘intensiŽed unemployment and business losses to an
unendurable pitch’ (Keynes, 1931b: 248). This was compounded by the
inherent fragility of the international Žnancial system which was never
properly reconstructed after World War I, and was essentially a tangle
of untested currency restorations, debt payments, and reparations quiv-
ering in the winds of political contestation and discord.28 Under such
conditions, central banks were particularly conservative in the manage-
ment of their reserves – but it is the ow of reserves that ultimately
allows an international monetary system to function. Not only were
central banks overly cautious: given the perceived scarcity of interna-
tional reserves, they each attempted to assure an adequate supply,
resulting in rounds of competitive tightening of credit. Even states that
were secure in their gold holdings, such as the United States, could exac-
erbate this problem if they pursued tight monetary policies for domestic
reasons. In either case, such policies draw gold from the rest of the world
and force responsive credit contractions elsewhere.29
Leaving the gold standard was necessary for the practice of the middle
way. As Keynes noted in his famous phrase, ‘There are few Englishmen
who do not rejoice at the breaking of our golden fetters’ (1931b: 245).
Adherence to the standard had meant that ‘the objective of maintaining
a domestic rate of interest consistent with full employment was wholly
ruled out’, and now Britain had ‘at last a free hand to do what is sensible’
(Keynes, 1936a: 339).
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But while breaking with gold was necessary, it was not sufŽcient to
assure recovery. Depreciation was helpful in that it stimulated economic
recovery, and caused output, employment, investment and exports to
rise more quickly than in states that remained on the gold standard. But
depreciation was not the remedy in itself: rather, it was signiŽcant in
that it liberated Žscal and monetary policies from the constraints imposed
by the gold standard. Keynes felt vindicated by the positive beneŽts
associated with the end of the gold standard, but he argued that Britain
could have taken even greater advantage of the opportunities that it
presented (Keynes, 1932e: 41; 1933b; see also Eichengreen, 1992: 21, 293).
Additionally, breaking with gold and reating, however welcome,
especially given the economic conditions of the time, do not end the
story. The problems of the international monetary system don’t simply
disappear with the overthrow of King Midas. Keynes’ legacy includes
a broader theoretical argument about the international monetary system
in general: his argument was that such a system, left unregulated, imparts
a deationary bias onto the international economy, which is most visible
under a gold standard system but to some extent is always present.
Fixed exchange rate systems are problematic because they force
the main burden of adjustment onto debtor countries.30 ‘The process
of adjustment is compulsory for the debtor and voluntary for the cred-
itor’. With greater pressure on debtors to deate than there is on creditors
to reate, there is an obvious deationary bias at work. Additionally,
since debtors are typically small they are also forced to make propor-
tionally large adjustments in prices and wages to restore equilibrium to
their international accounts – and this without even considering the fact
that ‘the social strain of an adjustment downwards is much greater than
that of an adjustment upwards’ (Keynes, 1941b: 27–8). Thus the inter-
national monetary system tends to promote deation and has a tendency
to political instability.
Keynes spent much of his career searching for ways to mitigate this
deationary bias. In the 1930s, he explored marginal reforms, such as
increasing the ‘gold points’ – the spread between the price at which
central banks would buy and sell gold in exchange for their currencies.
Such spreads would provide some room for macroeconomic policy
autonomy. He also considered the possibility of a transactions tax to
mitigate speculative ows. In this era Keynes also raised the possibility
of supernational management, but recognized that such an outcome was
highly unlikely (Keynes, 1930b: 291, 357; 1936a: 160). But with World
War II, the USA and Britain began to explicitly prepare for the construc-
tion of the postwar international economic order – and supernational
management suddenly became feasible.
Keynes, again at the British Treasury for the war, saw the opportu-
nity to resolve the problem of the deationary bias in the international
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economy. His proposed Clearing Union was designed to provide ‘the

substitution of an expansionist, in the place of a contractionist, pressure
on world trade’, and to ‘require the chief initiative from the creditor
countries, whilst maintaining enough discipline’ on debtor states. In such
a system, ‘Nothing is more certain than that the movement of capital
funds must be regulated’. This was not designed to discourage interna-
tional lending – quite the contrary. But it was designed to allow states
to insure productive capital ows while retaining some discretion to
contain speculative ones (Keynes, 1941b: 31; 1941a: 46; 1942: 149).
Successive drafts of Keynes’ Clearing Union proposal formed the basis
of the British negotiating positions, and Keynes led the British delega-
tions to the USA to discuss these matters. The Žnal outcome – the Bretton
Woods institutions, including the International Monetary Fund – were
much closer to the vision of the USA and Harry White than of Britain
and Keynes.31 Still, and most importantly, they certainly did represent
an embedded liberalism: the promotion of an open, market-based,
outwardly oriented international economy, but one which was embedded
in an institutional structure designed to preserve domestic autonomy,
ease pressure on debtors, control the ow of capital, and provide
adequate safeguards and escape clauses. Thus domestic economic pref-
erences would not have to be sacriŽced on the altar of economic
adjustment. If not Keynes’ vision, they would sufŽce, and he fought hard
for the set of Anglo-American agreements.

D IS EM B ED D ED LI BE R A LIS M A ND IT S
C O NS EQ U E N C ES
The postwar international economic order was, as Ruggie argued,
designed around the principle of embedded liberalism. International
trade and monetary arrangements were designed to prevent international
market forces from forcing governments to abandon policies associated
with the middle way. Over time, however, international liberalism has
become increasingly disembedded, especially, and crucially, with regard
to money and Žnance.32 One of the reasons that this has happened is
that the lessons of the interwar period, upon which the international
economic order was constructed, have faded from memory, along with
the teachings of Keynes.
Forgetting Keynes means that a set of theories regarding the con-
sequences of unregulated capitalism have also been forgotten. Those
consequences include a tendency for decreasing income equality
and a deationary bias in the international monetary system. Keynes
held that domestic government policies were required to manage
aggregate demand, and assure adequate investment; and that the
international economy must be mediated to assure that global market
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

forces did not prevent governments from introducing the policies of the
middle way.
Keynes justiŽed the middle way on three foundations: normative,
positive and political. With the passage of time, the normative argu-
ments have tended to obscure the positive and the political. This may
have actually facilitated the retreat from the middle way, by diverting
attention from the potential costs of such an evolution. But Keynes
identiŽed the economic and political costs of unregulated capitalism,
and held those costs to be signiŽcant. These issues remain relevant in
contemporary politics.

The tendency of unregulated capitalism to generate inequality

Keynes argued that unregulated capitalism tends to generate increasing
disparities of income and wealth.33 While Keynes and others have
stressed this as important in and of itself, that is, as a dependent vari-
able, Keynes devoted much greater attention to the consequences of
inequality as an independent variable: the idea that great inequality of
income would undermine economic performance.34 He argued in par-
ticular that great inequality would not generate sufŽcient aggregate
demand. Further, once aggregate demand was deŽcient, there may be
natural forces which magnify the resulting negative consequences. One
example of this is a collective action problem faced by Žrms in a reces-
sion. Each might contract its employment to restore proŽtability. But the
consequence of many Žrms taking that same action would be to reduce
aggregate purchasing power even more and further weaken the economy
(Keynes, 1930c: 130; 1933d: 149). Thus, downward pressure on wages
could unintentionally reinforce economic contraction, and, contrary to
conventional wisdom, greater income equality can be associated with
superior economic performance (Keynes, 1936a: 372–3).35
Keynes was also concerned with income distribution from a political
perspective: inequality might generate a political reaction that would
almost certainly throw out both baby and bathwater. ‘The maintenance
of prosperity and civil peace’, he argued, are ‘absolutely dependent . . .
[on] more equal distribution of incomes’. He continued:
If capitalist society rejects a more equal distribution of incomes and
the forces of banking and Žnance succeed in maintaining the rate
of interest somewhere near the Žgure ruled on average during the
nineteenth century (which was, by the way, a little lower than the
rate of interest which rules today), then a chronic tendency towards
the underemployment of resources must in the end sap and destroy
that form of society.
(Keynes, 1937c: 132; see also Keynes, 1919: 13; 1923a: 24)
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The tendency for the international monetary system to

be deationary
International market pressures which affect income distribution take
on greater signiŽcance in light of the view that increasing income
equality undermines economic performance. Once again, as demon-
strated by the quote above, these pressures emanate from the monetary
side of the international economy. Disembedded liberalism imparts
a deationary bias on the international economy, and prevents states
from pursuing the middle way. In theory, exible exchange rates offer
states greater autonomy than do Žxed rates, but given the expansion of
capital mobility in recent years, oating rates have provided much less
insulation than expected.36
International Žnancial ows are a double-edged sword: not only do
they undermine states’ ability to pursue policies of the middle way, but
they exert their own pressures on income distribution. Conservative
monetary policies, reinforced by international market forces, have signif-
icant domestic distributional consequences. Keynes was sensitive to the
political consequences of domestic monetary policy, yet another lesson
which has retreated from salience in recent years.37
Keynes proposed reforms designed to mitigate these problems (beyond
those of his Clearing Union), which have largely been overlooked by
contemporary scholars. Recent arguments in favor of an international
transactions tax do have a Keynesian avor (Tobin, 1978; Eichengreen
et al., 1995). But with regard to other issues, such as optimal contracts
for central bankers, recent debates have not considered Keynes’ contri-
bution (Walsh, 1995; Waller, 1992; Lohman, 1992). Once again, Keynes
pointed towards the middle way. On the one hand, he argued that central
bankers’ contracts should be explicit, and should be designed to insure
that the interests of the Žnancial community are not privileged over the
aggregate national interest. But on the other hand, ‘The less direct the
democratic control and the more remote the opportunities for parlia-
mentary interference with banking policy the better it will be’ (Keynes,
1932c: 131; see also Keynes, 1930b: 243). The method remains consistent:
a recognition of the power and efŽciency of market forces, coupled with
the need to insure that those forces are operating for the beneŽt of society.

C ON C L U S IO N: T HE M ID D LE WA Y I N T H EO R Y A N D
HI ST O R Y
Unregulated capitalism is tough stuff. Many of the recent changes in
economic relations across and within nations have expanded the role of
the market. In many, if not most, of these instances, these changes might
prove appropriate. But the work of Keynes suggests that unfettered
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

market forces, within states and between them, will lead to suboptimal
economic and political outcomes. The contemporary Asian Žnancial
crisis, fueled by unregulated international capital and contained only by
severe domestic contraction, is a clear illustration of this.38 The problem
of unregulated capitalism may be observed more generally in Eastern
Europe and the former Soviet Union. When Keynes wrote that ‘The
treaty includes no provisions for the economic rehabilitation of Europe
– nothing to make the defeated Central empires into good neighbors,
nothing to stabilize the new states of Europe, nothing to reclaim Russia’
(Keynes, 1919: 143), one can Žnd parallels to the consequences of the
end of the Cold War.39 More than that, it should be remembered that
the triumph of capitalism in the postwar era is not the triumph of laissez-
faire, it is the triumph of the middle way and embedded liberalism. The
postwar ‘golden age of capitalism’ featured an embedded liberalism
which accommodated domestic social policy, built on the lessons of the
past and the failures of unregulated capitalism earlier in the century.
Forgetting history – the lessons of history and the theorists of history –
risks cultivating the conditions which contributed to the economic and
political upheavals of another age.

N OT E S
I thank Rawi Abdelal, Richard Bensel, Tom Christensen, John Ikenberry, Peter
Katzenstein, Charles Kindleberger, Karl Mueller, Jonas Pontusson, Gustav
Schachter, Martin Shefter, two anonymous referees, and the participants in the
Political Economy Research Colloquium at Cornell University for helpful
comments on earlier versions of this article.

1 John Maynard Keynes (1883–1946) lived a remarkably rich life that deŽes
quick summary. Editor of the Economic Journal for over thirty years, promi-
nent pamphleteer and private advisor to the British government, his books
include The Economic Consequences of the Peace (1919), A Tract on Monetary
Reform (1923a) and A Treatise on Money (1930a, 1930b). Keynes also main-
tained an active interest in the arts, which provides insight into aspects
of his general philosophy. He founded and managed a theater in Cam-
bridge in 1935, and was later a member of the board of trustees for the
National Gallery and chair of the Committee for the Encouragement of Music
and Arts. During World War II Keynes represented the British government
in negotiations that shaped Lend-Lease, Bretton Woods and the postwar
British loan.
The literature on Keynes is enormous. I would call attention to three biogra-
phies: Harrod (1951) which has the distinct perspective that only a
contemporary could provide; Moggridge (1992) written by the principal
editor of Keynes’ Collected Writings; and Skidelsky (1983, 1994) (third volume
forthcoming).
2 A frustrating aspect of The General Theory is that it is the most famous yet
among the least clearly written of Keynes’ works, which is particularly
distressing since Keynes usually wrote beautifully. Some of the book’s main
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themes can be found in other writings which were directed at a more popular
audience: see Keynes and Henderson (1929); Keynes (1930c, 1933d, 1932a).
It should also be noted that history has tended to ignore Keynes’ atten-
tion to the management of excessive demand. Keynes (1940a) addressed this
issue most comprehensively. Three years earlier, Keynes (1937d: 388) also
wrote: ‘Just as it was advisable for the Government to incur debt during the
slump, so for the same reasons is it now advisable that they should incline
to the opposite policy . . . The boom, not the slump, is the right time for
austerity at the Treasury.’
3 The data suggest that 80 percent of all foreign exchange transactions involve
round trips that take place in less than a week, and more than half of those
in under two days (ul Haq et al., 1996: 3).
4 In the wake of the crisis, however, there has been some backlash against the
consensus on capital deregulation. See Bhagwati (1998) and Rodrik (1998).
5 Under the headline ‘International Capital Markets Charting a Steadier
Course’, the Fund also noted that ‘Although the scale of Žnancial activity
continues to grow, market participants – including high-risk high-return
investment funds – are more disciplined, cautious, and sensitive to market
fundamentals’ (IMF, 1996b: 293).
6 Ruggie does not make this mistake, noting both that ‘Polanyi’s prediction
of the end of the capitalist internationalism does not stand up well’ and that
‘Some of Polanyi’s thoughts about the future had already been entertained
by the individuals who would come to be directly responsible for negoti-
ating the monetary component of the postwar international economic order’
(Ruggie, 1982: 388, 387). But the second point is a dramatic understatement,
and it is too easy for the reader to come away from Ruggie’s paper associ-
ating Polanyi with embedded liberalism.
7 It should also be noted that the postwar practice of economic intervention
in the domestic sphere looked much more like the ‘middle way’ described
below (macroeconomic management but with circumscribed micro controls)
than it does Ruggie’s interpretation of embedded liberalism. See Nau (1990:
72–4); also Brinkley (1995: 266–8). I thank an anonymous referee for bringing
this point to my attention.
8 On Polanyi’s skepticism about reform, see for example Polanyi (1944: 130),
where he argues that the ‘countermovement checking the expansion’ of the
market, which was ‘vital . . . for the protection of society, in the last analysis
was incompatible with the self-regulation of the market, and thus with the
market system itself’. It was Keynes, undercast in Ruggie’s play, who inu-
enced those who contemplated the postwar order. See for example the
Economist (1941: 222), which declared the postwar problem to be ‘combining
a New Deal in world trade with New Deals in domestic and social policy’;
also Hansen and Kindleberger (1942). It also quite likely that Polanyi’s (1944)
emphasis on the international monetary system as an important transmitter
of destabilizing international market forces (see for example Chapter 16,
‘Market and productive organization’, pp. 192–200, 205, 219) was inuenced
by Keynes’ earlier arguments in this vein; see pp. 322–323 below.
9 ‘Am I a Liberal?’ was Žrst given as an address and subsequently published
in two parts in The Nation and Athenaeum, 8 and 15 August 1925. It was
reprinted by Keynes in Essays in Persuasion. ‘The end of laissez-faire’, also
originally a lecture, was published as a pamphlet by Hogarth Press in July
1926. The pamphlet was excerpted in Essays in Persuasion, and the Collective
Writings (CW) version (vol. IX) reprints the full pamphlet. (Page numbers
here and elsewhere in this article refer to CW versions.) ‘Poverty in plenty’,
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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

originally a radio broadcast, was published in The Listener in November 1934

and in a revised form in The New Republic. Care should be taken in using
this source, since Keynes refused to allow ‘the informal talk’ to be published
in a volume which collected similar broadcasts (CW: XIII, 485).
10 Keynes’ attempt to rehabilitate some mercantilist theories was highly contro-
versial at the time and is too easily misunderstood. Keynes did not Žnd
mercantilist theories of trade appealing, and suffered no illusions regarding
the zero-sum consequences of mercantilist international policies, of which
he was not in favor. (On Keynes and trade, see pp. 322–323, below.) Rather,
Keynes found ‘an element of scientiŽc truth in mercantilist doctrine’, which
had to do with its recognition of the need to insure adequate liquidity.
Keynes was attempting to demonstrate historical precedent in economic
thought for the idea that the market system might not be self-adjusting, espe-
cially with regard to the interest rate, and for the importance of the concept
of effective demand. See Keynes (1936a: 335, also 336–8, 341; 1933a: esp. 88).
11 The break with laissez-faire was a watershed event for Keynes, and this
was a recurrent theme in his correspondence. Regarding the evolution
of economics in the light of the innovations of the interwar years, Keynes
(1937a: 165) wrote to D. H. Robertson: ‘You are, so to speak, bent on creeping
back into your mother’s womb; whilst I am shaking myself like a dog
on dry land.’
12 Skidelsky (1994) is more cautious about the importance of Keynes’ views on
distribution from the perspective of his moral philosophy. See especially pp.
62, 223. But see also p. 233 for strong evidence to the contrary. It is safe to
say that Keynes’ ideal society would place great emphasis on equality of
economic opportunity, but that such a society would not ‘level individuals’,
and would still feature marked inequalities of income and wealth.
13 As Keynes (1944c: 387) wrote to Hayek, ‘Your greatest danger ahead is the
probable practical failure of the application of your philosophy in the U.S.
in a fairly extreme form.’
14 ‘The important thing for government is not to do things which individuals
are doing already, and to do them a little better or a little worse; but to do
those things which at present are not done at all’ (Keynes, 1926: 291).
15 Keynes added: ‘A large part of the established body of economic doctrine I
cannot but accept as broadly correct. I do not doubt it’ (1934b: 487). He also
spoke out against excessive taxation of business and emphasized that
measures to support labor and efforts at redistribution should not under-
mine business incentives. See for example, Keynes (1930h: 12, 14; 1940b).
16 See also Keynes (1926: 290–1; 1925a: 258). Keynes (1944a: 467) opposed large-
scale nationalization on the ground that industries ‘to be run solely or
primarily on commercial considerations’ should be left in private hands.
17 This point merits some elaboration:
It can be no part of this memoir for me to try to explain why it was
such a big advantage for us to have escaped from the Benthamite tradi-
tion. But I do now regard that as the worm which has been gnawing
at the insides of modern civilization and is responsible for its present
moral decay. We used to regard the Christians as the enemy, because
they appeared as the representatives of tradition, convention, and
hocus-pocus. In truth it was the Benthamite calculus, based on an over-
valuation of the economic criterion, which was destroying the quality
of the popular ideal (Keynes, 1949b: 445).
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As Skidelsky (1983: 133) notes, ‘My early beliefs’ is ‘a key document for
understanding his life’s work’. Similar themes are also explored in Keynes
(1933c: 242). On the similarities between Marxism and laissez-faire in this
regard, see Keynes (1934b: 488). On the philosophical poverty of economism,
see Keynes (1926: 293; 1925a: 267). On the role of economists in solving the
economic problem, see Keynes (1930d: esp. 332).
18 Keynes also noted: ‘If society had always been strictly just, I am not sure
that we might not still be monkeys in a forest.’ On these themes of the
middle way, see also Keynes (1927: 640; 1926: 294); and on the ‘true destiny
of New Liberalism’ (1925b: 305).
19 Representative of Keynes’ view at this time was his characterization of protec-
tion as ‘a disastrous and deceptive prescription’, while free trade was ‘a
necessary and essential defense against a crushing poverty’ (Keynes, 1922:
2). See also his passionate support for free trade (Keynes, 1923b: 147).
20 Keynes (1931g: 231) subsequently wrote that he made the proposals ‘some-
what in desperation’; see also (1931e: 12). Note as well the highly qualiŽed
nature of these proposals raised by Keynes in various forums Keynes (1930e;
1930g: esp. 120, 123, 125; 1930f). On the retreat from the revenue tariff, see
Keynes (1931a: 243).
21 This occasionally led to charges of inconsistency, which once provided
Keynes the opportunity to respond to a heckler: ‘The difference between me
and some other people is that I oppose Mr. Lloyd George when he is wrong
and support him when he is right’ (Harrod, 1951: 396). More impressively,
Keynes, who ardently supported a policy of unilateral disarmament and
paciŽsm in the 1920s, in the 1930s supported a vigorous rearmament policy
and emerged as a strong critic of British appeasement policies. On disar-
mament and paciŽsm, see Keynes (1923d: 451; 1925b: 301). On the 1930s, see
Keynes (1936c, 1937b, 1938).
22 Even in the latter, Keynes’ strongest protectionist statement, he notes that
‘Nine times out of ten [the free trader] is speaking forth the words of wisdom
and simple truth’ (1932b: 204).
23 Moggridge (1992: 575) makes the important point that Keynes’ support of
protection was highly qualiŽed, and that ‘those who have been inclined to
cite Keynes in support of their protectionist views should do so with caution’.
However, in my view Moggridge under-emphasizes the extent to which
Keynes was willing to entertain such measures.
24 See for example his speech before the House of Lords, 16 May 1944, where
Keynes argued ‘The expansion of our export industries which is so vital to
us would be much easier if obstacles to trade can be diminished or done
away with all together’ (Keynes, 1944d: 4; see also 1944b: 316).
25 ‘[T]here does seem to be in almost every case a presumption in favour of
the stability of prices’ (Keynes, 1923a: 125). For a quick summary of the prin-
cipal themes maintained by Keynes regarding international monetary
relations, see Keynes (1936c: 500).
26 In 1923 Keynes (1923a: 139–40) argued that given the distribution of the
world’s gold, a restoration of the gold standard would ‘surrender the regu-
lation of our price level and the handling of the credit cycle to the Federal
Reserve Board of the United States’. Even if this untested institution was
able to overcome domestic pressures on its autonomy, it was not certain,
‘apart from weakness or mistakes, that the simultaneous application of the
same policy will always be in the interests of both countries’.

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 KIRSH NER: KEYNES AND THE CRISIS OF LIBERALISM

27 Keynes (1923c: 100) raised this criticism as early as 1923, in his opposition
to an interest rate hike: ‘There is no necessary reason why disturbances on
the continent need cause a million or two Englishmen to stand idle.’
28 On the fragility of the international Žnancial system, see Eichengreen (1992).
This important book not only surveys the Žnancial terrain, but develops, in
many cases more fully and systematically than Keynes did, the argument
that the interwar gold standard transmitted deationary shocks that elicited
responses which magniŽed their consequences and prevented states from
introducing compensatory measures, and that the key to recovery lay in
abandonment of the gold standard to pursue domestic expansion. On the
politicization of the interwar international monetary system and its conse-
quences, see Kirshner (1995: 175–92).
29 ‘A further consequence of the very dear money in the United States was to
exercise a drag on the gold of the rest of the world and hence to cause a
credit contraction elsewhere’ (Keynes, 1931d: 350; see also Keynes, 1929).
30 These problems are less acute in a system of oating rates. However, as
discussed below (p. 328), they can still be signiŽcant.
31 Gardner (1980), emphasizes the differences in the US and British proposals;
Ikenberry (1992) emphasizes the similarities. The successive versions of
Keynes’ proposals, with other drafts, and related documents and corre-
spondence are in CW, vol. XXV and the Žrst part of volume XXVI.
32 Cohen (1996); Goodman and Pauly (1993); Cosh et al. (1992). It can be argued
that Žnancial markets were highly integrated in earlier periods of history
(Neal, 1990; Zevin, 1992) but this does not affect the argument regarding
trends and consequences in the postwar period.
33 Again, this was most visible in the Žnancial side of the economy: ‘The powers
of uninterrupted usury are too great. If the accretions of vested interest were
to grow without mitigation for many generations, half the population would
be no more than slaves to the other half’ (Keynes, 1923a: 56).
34 It should be recalled (as noted above, p. 319) that Keynes held that there was
both philosophical and economic justiŽcation for signiŽcant income inequal-
ity. He also placed a greater priority on assuring adequate investment.
35 As Keynes (1936d: 16) wrote to Hawtrey ‘I favour a scheme of direct taxa-
tion in order to redistribute incomes in such a way as to increase the
propensity to consume.’ Recent studies lend support to the view that income
equality and economic growth are positively correlated. See Persson and
Tabellini (1994); Chang (1994); Corry and Glyn (1994). Note that the focus
here is on developed states and not intended to contradict Kuznets’ argu-
ment regarding changes in income equality over the course of economic
development.
36 Exchange rate exibility gives states some breathing room, but does not elim-
inate the international constraint unless states are completely indifferent to
their exchange rates. Few states, if any, have this luxury, and the dramatic
increases in the speed and scale of capital mobility have reduced the time
it takes for states to reach the limits of their capability to tolerate exchange
uctuations.
37 The idea that price changes do not work their way uniformly through the
economy is, I believe, one of the most signiŽcant and underappreciated
aspects of Keynes’ economics. See Keynes (1930a: 82, 244; 1923a: 1).
38 More subtly, unregulated capital may contribute to a chronic condition of
slower growth and increased political contestation in the advanced indus-
trial states. See Kirshner (1998).
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39 For more by Keynes on the peace conference, see the exquisitely written ‘Dr.
Melchior: a defeated enemy’ (Keynes, 1949a).

R E F E R EN C E S
Bhagwati, Jagdish (1998) ‘The capital myth’, Foreign Affairs 77: 7–12.
Brinkley, Alan (1995) The End of Reform: New Deal Liberalism in Recession and War,
New York: Alfred A. Knopf.
Chang, Roberto (1994) ‘Income inequality and economic growth: evidence and
recent theories’, Federal Reserve Bank of Atlanta Economic Review 79: 1–10.
Cohen, Benjamin (1996) ‘Phoenix risen: the resurrection of global Žnance’, World
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