In 1936, in the depths of the worst depression the industrial world had known, John Maynard Keynes published a book that began by denying the thing every economist had taken for granted: that an economy left to itself tends to employ everyone who wants to work. Not so, he argued. The level of employment is set not in the labor market, by the wage, but in the market for goods as a whole, by the total demand for what the economy can produce — and there is no law that compels that demand to be high enough to put everyone to work. An economy can come to rest, in full equilibrium, with its factories half-idle and its workers walking the streets, and stay there, not for want of any resource but for want of spending; and nothing in the market's own machinery need ever lift it out.
The book was The General Theory of Employment, Interest and Money, and its argument was a reversal so complete that it has fairly been called Copernican. The classical economist began with the economy's capacity to produce — its labor, its capital, its known techniques — took for granted it would be fully used, and let Say's Law guarantee a buyer for whatever was made. Demand, on that view, was the passive partner: it accommodated itself to supply, and full employment was the natural resting state. Keynes stood the relation on its head. Demand, he insisted, is the active partner and the prime mover; the amount of spending decides how much will be produced and how many set to work, while supply trails obediently behind, expanding when demand is brisk and contracting when it is slack. The economy does not produce to its capacity and then sell; it produces to its market, and its capacity is merely a ceiling it may fall far short of.
To see how demand could fail, Keynes anatomized it, and the first of its parts is consumption. How much a society spends on consumption depends, he observed, chiefly on its income, and by a relation regular enough to be called a law: as income rises, consumption rises too, but never by quite as much. A family whose income climbs by a hundred pounds will spend perhaps eighty and save the rest; a richer society saves a larger share than a poorer one. This is harmless enough in itself, even prudent — but it carries a sting. For if consumption always lags behind income, then the higher the output an economy achieves, the wider the gap between what it produces and what its people will buy back in consumption. That gap is no flaw to be scolded away; it is the structural space that the rest of demand must fill. The richer the economy, the larger the hole at its center.
That something is investment, and on its shoulders the whole burden falls. Investment — the spending of firms on new plant and equipment, on buildings and stocks of goods — is what must fill the gap that thrift leaves, taking up the income consumption does not claim. But investment is a fickle thing to lean on. Unlike consumption, which follows income docilely, investment follows expectation: a firm builds a factory not for what it earns today but for what it hopes the factory will earn over the years of its life, and those years are wrapped in an uncertainty no calculation can pierce. Investment therefore swings with confidence, with the mood of the markets, with what Keynes called the animal spirits of those who must act in the face of the unknowable — and, crucially, it is tied to nothing that matches it to the size of the gap it is needed to fill. No hand ensures that investment will be just enough.
Suppose, then, that investment is too little — that firms, gloomy about the future, build less than the public at full employment would wish to save. The classics had an answer ready, but follow first what Keynes said would happen. Demand falls short of the full-employment output: goods go unsold, and firms respond not by cutting prices to clear them but by cutting production. Output falls, and as it falls, incomes fall with it, for one man's output is another's income. And here is the turn that makes the theory: as incomes fall, saving falls too — people save less out of less — and they keep falling until saving has dropped all the way to the level of the meager investment. At that point the gap is closed, demand again equals output, and the economy is in equilibrium — but an equilibrium reached by the destruction of income and the throwing of men out of work. The slump is not a disequilibrium straining to correct itself; it is a resting place.
Now recall the answer the classics had ready, for everything turns on whether it works. Saving that is not invested, they said, cannot pile up uselessly, because the interest rate will see to it: an excess of saving over investment drives the rate of interest down, cheap borrowing revives investment, and the two are brought back into balance at full employment, as a thermostat returns a room to its setting. Keynes's deepest blow was to sever this connection. The interest rate, he argued, is not the price that equilibrates saving and investment at all; it is the price of holding money rather than parting with it, fixed in the market for cash by how much money the public wishes to hold. And that desire may hold the rate well above the level at which investment would suffice — may, in the worst case, pin it there however much is saved. The balancing wheel was off its axle. Saving and investment are brought into equality, yes, but by the rise and fall of income, not of interest — and income does it by carrying employment up and down with it.
From this reversal springs the most startling of Keynes's conclusions, and the one that most offended common sense. Thrift, the homeliest of virtues, the very engine of accumulation in the classical story, becomes in a slump a public menace. The reasoning is unanswerable once its premise is granted. If, in fear of bad times, every household resolves to spend less and save more, then total spending falls; falling spending means falling sales, falling output, falling incomes; and out of the diminished incomes people find they can save no more than before, and perhaps less. The attempt at thrift is self-defeating in the aggregate — a textbook fallacy of composition, in which the truth for one is the ruin of all. The classical economist urged the public to save its way out of the slump; Keynes saw that this was the surest way to deepen it.
The same trap closes on the classical cure for unemployment itself. Workers are idle, runs the old prescription, because the wage is too high; let it fall, and employers will hire the cheaper labor until all are employed again, just as a lower price clears any glutted market. The logic is impeccable for a single trade, where the wages paid are a small thing and the buyers of the product lie mostly outside it. But it fails for the economy entire, and fails for the reason that haunts the whole of this volume: the wages of the many are the incomes of the many, and those incomes are the demand for what the economy makes. Cut wages everywhere at once and you have cut the very spending on which sales depend; employers, facing slacker demand, take on no more hands and may shed some. The labor market, which the classics trusted to clear itself like any other, cannot, because the thing whose price is being cut is also the thing that does the buying.
If the economy will not right itself — if neither falling wages nor falling interest can be relied on to summon the missing demand — then the demand must be supplied from outside, and here Keynes drew the conclusion that changed the practice of every government. The state, which can spend without first having to sell, can fill the gap the private economy leaves: it can borrow the idle savings that no firm will invest and spend them into the slack directly, the multiplier carrying that spending outward in widening rings. Monetary policy might help, by forcing interest rates down, but in a deep slump it may merely push on a string; fiscal policy, the government's own spending, acts on demand directly and surely. The implication was heresy to an age that prized the balanced budget. In a slump, Keynes answered, the budget ought to be unbalanced by design, and the debt repaid in the boom that follows. To the old faith that the economy would mend itself if only given time, he returned his coldest line: that in the long run we are all dead, and the idle of today cannot eat the equilibrium of tomorrow.
What Keynes had done was to dislodge a fact of nature and put a contingency in its place. Mass unemployment, in the classical telling, was either an illusion — the idle were between jobs, or holding out for wages they would not get — or a passing disequilibrium the market was even then correcting; either way not a thing to remedy but to wait out, the tendency to full employment as fixed a feature of the economic world as gravity is of the physical. Keynes denied the fixity. The level of employment rides on the level of demand, and demand can settle anywhere, full employment being one outcome among many and in no way the privileged one. The unemployment of a slump is therefore real, and involuntary, and need not be borne: men want work at the going wage and cannot find it, not through any fault, but because the spending that would employ them is absent and the market holds no mechanism bound to restore it. A price is a verdict on a hidden contest, mistaken for a fact of nature; and the going wage, which the classics read as the verdict of a labor market clearing itself, turns out to settle nothing — for the labor market may not clear at all, and the millions left standing in the street are the measure of how far the fact of nature was a failure in disguise.
Full employment, the classics' resting state of the world, proved to be merely one demand among many — and the slump no accident the market was repairing, but a place it could come to rest.
This is the revolution the volume's first plate left at the warehouse door: the answer to the question of what governs how much an economy makes, and why it can make too little to employ us all. It is not the last word, and the plates that follow are in large part the long counter-attack upon it — the monetarists who would restore much of what Keynes overthrew, the new classicals who would deny his involuntary idleness altogether, the synthesis that grants his stickiness while keeping their rigor. But the question he forced can never again be unasked. Whether the slump is a failure to be cured or an equilibrium to be accepted; whether the unemployed are victims of a coordination the market botched or agents of a choice the theorist failed to see; whether demand can fall short, and if it can, what is to be done — these are the terms on which the rest of the argument is fought. Keynes did not settle them. He made them unavoidable. The argument remains open.