Keynes’ uneasy relationship with income distribution
Branko Milanović is an economist specialised in development and inequality. His newest book is “Capitalism, Alone: The Future of the System That Rules the World”. His new book, The Visions of inequality, was published October 10, 2023.
Cross-posted from Branko Milanović’s Substack blog
I was asked several times, and most recently only a couple days ago, why in Visions of Inequality I do not discuss Keynes. He doesn’t have a chapter like the other six authors and when I mention Keynes it is only in passing and simply in relationship to the marginal propensity to consume. My answer is twofold. First, I think that Keynes was not interested in income distribution. And, more importantly, at one point where he clearly could have, or even should have, brought income distribution into discussion he declined to do so and decided to ignore it.
It is all tacitly assumed throughout The General Theory that the functional income distribution (labour share In total output) is unchanged. Keynes believed, or pretended to believe, in the so-called Bowley’s law, a relative fixity of labour and capital shares, found to have existed in Britain over the first two decades of the 20th century. The fact that “the law” applied to only one country and held for a short period of time did not seem to have bothered Keynes. This in turn meant that Keynes believed that interpersonal income inequality was also fixed. If both functional and interpersonal inequalities are fixed, there is no need to discuss income distribution, and Keynes indeed does not discuss it at all.
The second reason is more interesting and to some extent more dramatic. It illustrates what I believe was Keynes’s politically-induced unwillingness to bring income distribution into The General Theory.
It is well known that the lack of effective demand, the main topic of the book, arises from the fact that consumption and private investments are not necessarily equal to the aggregate supply. As Keynes writes, total consumption increases only as a fraction of the increase in aggregate output. That means that the shortfall between the two (aggregate supply on one hand, and aggregate consumption on the other) has to be filled in by private investments. It is only in a special case that the desired private investments will be exactly equal to that gap. But when investments fall short of it, government spending has to be brought in to increase the effective demand and to balance supply and demand (at a given level of employment).
Even a very cursory look at the fundamental equation which is A (aggregate supply) = C + I + G shows that if C (aggregate consumption) is a function of income distribution an obvious way to rebalance supply and demand is to “improve” income distribution, that is to transfer purchasing power from the rich to the poor. If $1 is transferred from a rich person who normally consumes only 50 cents, to a poor person who would consume 95 cents, aggregate consumption will increase. One can then fine-tune it until it closes the gap between the aggregate supply and the effective/aggregate demand. There is no need to introduce government spending, G.
The question is then, why was such an obvious path out of insufficient demand not taken by Keynes? He had in front of him two possibilities: one was to increase government spending; the second was to redistribute income towards the poor. The latter is an easier solution and entirely within the logic of the model itself, including within the logic of a new concept of “propensity to consume” which Keynes has introduced. But if income distribution is assumed unchanged or unchangeable, or if one does not want to touch income distribution for political reasons, then the only way out is the one taken by Keynes: increased government spending.
It is remarkable that in the entire General Theory income distribution plays absolutely no role at all. When Keynes discusses the forces that affect aggregate propensity to consume he lists no fewer than fourteen: six of them “objective”, eight “subjective”. Just to give an idea what are the forces that affect consumption, here is a list: among the objective factors: (i) change in wage units (i.e., change in real income), (b) change in the difference between net income and income, (c) windfall changes in capital values, (d) change in the rate of discount, (e) change in fiscal policy, (f) change in the expected relation between present and future level of income; as for the psychological causes, they are (a) to build a reserve against unforeseen contingencies, (b) to provide for an anticipated future relation between income and the needs of an individual and his family different from which exists at the present, (c) to enjoy interest and appreciation, (d) to enjoy a gradually increasing expenditures, (e) to enjoy the sense of independence, (f) to enjoy a masse de maneuvre to carry out speculative or business projects, (g) to bequeath a fortune, (h) to satisfy pure miserliness. It is rather curious that among this plethora of causes, there was no place for income distribution.
That Keynes was aware that income distribution can affect propensity to consume is shown, very briefly and discreetly, in a couple of references in Chapter 22 (“Note on Trade Cycles”; importantly, the chapter is not in the main part of the book, but in “Short Notes Suggested by the General Theory”, rather sundry reflections stimulated by Keynes’ writing of the main text), where Keynes writes: “I should readily concede that the wisest course is to advance on both fronts [increasing investments and consumption] at once. Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital, I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume. There is room, therefore, for both policies to operate together; — to promote investment and, at the same time, to promote consumption” (p. 325). Since this section opens with a clear discussion of “schools of thought” which “maintain that chronic tendency of contemporary societies to underemployment is to be traced to under-consumption;…that is to say…to a distribution of wealth which results in a propensity to consume which is unduly low (p. 324), it is clear that the increase in consumption that Keynes has in mind here comes from changed distribution of wealth or income. However, here too, he believes that working on increasing investments and, if needed, government spending, is more immediate and better (since investments result in augmentation of productive capacity) than altering distribution to increase consumption. This is the furthest that Keynes has come in the entire book to acknowledging a role for income distribution.
All but universal omission of income distribution was quickly noted. In a 1937 article in The Review of Economics and Statistics, Hans Staehle shows how German wage distribution has changed in the period 1928-1934, and how it has affected consumption. He registers his disbelief that Keynes could have overlooked such an obviously potent force that affects aggregate propensity to consume and in turn effective demand. He writes:
it is obvious that any modification in the distribution of incomes entails a modification…so that the marginal propensity curve of the market can be derived from the individual curves…only on the assumption that the size-distribution of incomes is constant. Keynes has entirely overlooked this implication. He takes it that the derivative of the market function [of aggregate consumption] will have the same characteristics as that of any individual curve…Among the factors capable of shifting the market curve, he does not list changes in the size-distribution of incomes, but only mentions changes in the income distribution as between entrepreneurs and rentiers [and this very modestly and in passing]. But even this Keynes does not consider to be an important factor. The only other reference to the income-distribution in connection with the propensity to consume is in the chapter on the trade cycle, where the “redistribution” of incomes is spoken of as a measure by which the propensity to consume may be stimulated; but what type of “redistribution” Keynes here has in mind is not clear; at any rate, there is no proof that he meant a modification of incomes according to size (p. 138).
The decision not to use “improvement” in income distribution to solve lack of aggregate demand could have been, I think, politically motivated. By weighing the political acceptability or political risks of the two solutions, Keynes probably decided to go with greater G as politically and ideologically more acceptable. Neither approach was politically easy, of course. Most of the economics profession and business interests at the time (e.g. US Chamber of Commerce in the late 1930s) were opposed to increased government spending. It involved higher taxes or printing fiat money and surely greater involvement of government in the economy. But Keynes might have thought that arguing in favor of redistribution could have been even less politically popular among the ruling classes, and for the academic acceptance of his theories even worse, bringing him too close for comfort to Hobson and Sismondi and similar “schools of thought”.
I think there is little doubt that Keynes, under the best and the most favorable interpretation, had no interest in income distribution because he believed that—at least analytically—it can be taken as fixed in its functional and interpersonal aspects. A less charitable interpretation of what he did is to argue that he was worried that his theories may be conflated with those of “underconsumptionists” from the “underworld of economics” (Keynes’ term), who tended to favor change in income distribution as a solution for the lack of effective demand. Keynes did not want to “be” like them and he therefore ignored income distribution throughout.
PS. In the very opening chapter of The Economic Consequences of the Peace, Keynes mentions income distribution, but in an unusual way, to argue that high inequality before the World War I was not socially destabilizing so long as the rich were seen not to engage in ostentatious consumption, but to use their excess money for investments—which, of course, create jobs. “…the capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit understanding that they consumed very little of it in practice” (p. 20). They were just simple vessels through which the surplus of purchasing power flowed to get transformed into investments. This was, according to Keynes, a part of the social compact that existed prior to the War and ensured social peace: “I seek only to point out that the principle of accumulation based on inequality was a vital part of the pre-war order of Society and of progress as we then understood it” (p. 21). He was not sure that it would endure after the War.
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