Where Keynes and Beveridge turned out to be wrong

The Spring 2013 edition of the Journal of Liberal Democrat History has a fascinating article on the role of Maynard Keynes and William Beveridge in developing Liberal Party policy, culminating in the party’s manifesto for the seminal election of 1945. These men took the party’s thinking decisively into what is now called “social liberalism”. Their vision was inspiring and coherent; much of it is now simply accepted wisdom. But I detect a tendency to treat these men’s ideas as holy writ. But nobody can be right on everything, and the world was changing fast. It is interesting to pick out the places where they got it wrong. This will perhaps help us to reflect on the challenges we face today.

Beveridge (in his report to the wartime coalition government) memorably set out the challenges to society presented by the “five giants” of Want, Disease, Ignorance, Idleness and Squalor. The answer was to extend what we now call the Welfare State, establish the National Health Service, nationalise a series of critical industries (railways, coal and power in particular) and to adopt a system of macroeconomic demand management, which we know as “Keynesianism”. These policies were largely adopted by the subsequent Labour government, albeit with more enthusiasm for their collectivist aspects, and retained by the Conservatives that followed them. The success of their ideas on the wider political stage contrasts with the Liberals’ disastrous performance in the 1945, when Beveridge lost his seat, and the Liberal Party faced extinction – in a crisis that makes its successor party’s current woes look like a picnic. Which only goes to show that winning the battle of ideas and having coherent policies is on a small part of how a political party succeeds.

But what has gone wrong? The Welfare State grew to be a monster of a size that Beveridge would have been horrified at, though it made much headway in combating Want and Squalor. The contributory principle, central to Beveridge’s vision, has largely broken down, with entitlement being based on need rather than past contribution. It has never broken free from the dependency problem, where people don’t have enough incentive to sort out their own problems – an issue that Beveridge foresaw. It strikes me how Beveridge’s system was overwhelmed by the breakdown of the traditional family, and of traditional working class communities. These were inevitable consequences of economic progress, as well as the march of liberal social values. But needs that used to be met within the community were now thrown at the state’s door, and, perhaps, the breakdown of discipline in some communities (about starting families in particular) added to the problem. Beveridge’s carefully worked out system of benefits and entitlements was not equal to the task.

Nationalisation has proved another disappointment. Keynes was convinced that these critical industries would not be managed for society’s overall benefit if they continued in private ownership. He also wanted to incorporate them into his system of macroeconomic management. But the state proved inept at setting strategy, and was often a prisoner of the short term interests of managers and workers. Strategic decisions tended to be made badly, and investment declined. They were all subsequently privatised and, except arguably the railways, have performed much better since. Regulation has proved a much more effective answer than state management.

Keynesian economic management has proved highly controversial, after two major economic crises, in the 1970s and now. But it is clear that widespread adoption of Keynesianism has moderated the economic cycle, and this has been of huge benefit. We have to accept though that it cannot deliver full employment sustainably unless the overall economy is in the right shape. In the 1970s it was too dependent on cheap oil. Now it is too dependent on finance and government jobs and funding.

But it is interesting to read that in 1945 Keynes thought that the main means of managing the business cycle was investment. He understood that private sector investment tended to follow the cycle (i.e. increase in the good times, and fall back in the bad – just what we are currently experiencing), and so make it worse. Government investment should counterbalance this – and he wanted to nationalise key industries so that the scope of government investment increased. This just hasn’t happened. Instead the expansion of the welfare state has created a counter-cyclical dynamic (called “automatic stabilisers” by economists) that has proved perfectly sufficient until now, with a few tweaks here and there.

But since the size of the welfare state and government generally is now part of the problem, using it to manage the cycle has hit its limit without the job done. A lot of economists (like Martin Wolf of the FT) now urge that we go back to Keynes’s original idea and increase the level of government investment. But I suspect that the reason why governments did not follow Keynes’s original system, apart from the growth of automatic stabilisers, is that this is much more difficult in practice than in theory. Examples of where it has been tried, such as Japan in the 1990s, and China in the present crisis, are not particularly encouraging. Vested interested and construction businesses close to the government have reaped benefit, leading to wasted investment and a corrupted political system. As a developing country China’s investment needs are huge, so they may still end up ahead, but the case for developed economies is much weaker.

What does this say to us now? The five giants are still with us, although they may not loom as large as they did. But I think the era of grand political projects established by clever men from on high has run its course. What is needed is a reshaping of government to make it more local, participative and people centred. But that is a very long journey.