of this classical liberal order saw the state as a threat to liberty and therefore tried to tie it down through various constitutional, legal, and political constraints. The new roles that Keynes assigned to the state were precisely the kind that liberal constitutions were designed to preclude: large public expenditures, public borrowing, and political management of economic affairs. In challenging the classical theory of economics, Keynes also challenged the political doctrine of classical liberalism to which it was attached.
Keynes never spelled out a theory of the state to correspond to his economic theory of public spending and investment. He did acknowledge in the final chapter of The General Theory that in order to maintain full employment the state would have to take on functions never envisioned by those earlier proponents of liberal government. These would include setting tax rates to promote consumption and directing investment to productive and socially useful goals. Yet he was never specific about how the state should organize itself to carry out these functions.
There is one obvious requirement for a Keynesian-style system: the state must command resources at a level commensurate with its responsibility to stabilize the economy. This condition was never met through most of the history of the United States. From 1800 to 1932, the U.S. federal government never had a budget that exceeded 3 percent of GDP except in times of war, when it exceeded that percentage for brief periods. During that long period, the federal government had few responsibilities beyond national defense and running the postal service, and relied mainly on the tariff to fund its operations. In 1930, at the onset of the Depression, the federal government spent about 2.5 percent of GDP, a proportion far too small to enable it to leverage enough debt to stimulate consumer demand across the economy. Federal spending increased to 10 percent of GDP by 1940, on the eve of World War II, then increased four- or fivefold during the war years, before stabilizing throughout the postwar era at around 20 percent of GDP—or at a level large enough to finance Keynesian-style policies.
The Keynesian revolution, in order to succeed, also had to push back against inherited suspicions about government debt. In 1932, both President Hoover and FDR campaigned for the presidency in favor of a balanced federal budget. Throughout the nineteenth century, leaders of both political parties in the United States expressed horror at the prospect of a permanent public debt. After the Civil War, Republican Party platforms consistently inveighed against government debt and in favor of the tariff to finance limited federal operations. From 1800 to 1932, total U.S. government debt never surpassed 20 percent of national GDP except during wars, after which the debts were rapidly paid off. But by 1940, total federal debt approached 40 percent of GDP and then increased to more than 100 percent of GDP by the end of the war. Rapid growth in the postwar period enabled the government to reduce that total back to about 40 percent of GDP by the late 1960s, after which time it began to grow again as a result of slowing economic growth and the burdens of increasing expenditures to pay for Great Society programs. From the late 1960s to the present, the U.S. government has achieved budget surpluses on only two occasions, notwithstanding the general prosperity of the period. Today, total federal debt (public and private) exceeds 100 percent of annual GDP and continues to grow steadily in the aftermath of the financial crisis. In 2009 and 2010, due to efforts by the Obama administration to engineer a Keynesian-style recovery from the crisis, the federal government ran budget deficits that amounted to more than 10 percent of GDP.
The most problematic element of the Keynesian state turns on the forms of political organization required to sustain it. Here, too, it stands in contrast to the classical liberal state. The dominant political parties in the United States from 1800 to the 1930s—the Democratic Party before the Civil War and the Republican Party afterward—were organized around the dispersion of political power in order to protect local or private interests. State and local governments jealously guarded their rights and privileges under the federal system. In the modern age, the fiscal power of the federal government has drawn all major interests into a national orbit, including state and local governments, whose representatives make routine pilgrimages to Washington in search of funds to cover their budgets. Both political parties—but especially the Democratic Party—organize constituent groups with interests in the federal budget, and enterprising politicians learned long ago that they could organize new voting blocs with promises of federal funds. This kind of politics—“Keynesian politics”—maintains a continuous demand for federal spending that facilitates Keynesian-style economic policies.
Yet this kind of politics also creates inflexibilities in public budgets that make it difficult to adjust fiscal policy to movements in the business cycle. Politicians have found it all too easy to increase spending and to approve stimulus programs during slumps; but those expenditures, once made, are difficult to scale back during subsequent recoveries. Every item of expenditure on the public budget develops an interest group whose main purpose is to keep it going. Under those circumstances, it is not hard to understand how and why political leaders can gradually lose control of public budgets.
Nearly eighty years after the publication of The General Theory, the problems that Keynes diagnosed of too much saving and obsessive thrift have given way to the opposite problems of exploding debt and uncontrolled spending. With the United States and the developed world facing new challenges of public debt and insolvent governments, the question arises as to how and on what terms the system of political economy that Keynes helped to design can be maintained in political and economic circumstances that superficially resemble those of the 1930s but in fact are far different.
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There have not been all that many clear-cut cases in which efforts to apply Keynesian fiscal policies have rescued modern economies from recession or depression. FDR’s spending policies during the 1930s are sometimes cited in this connection, but those policies were too inconsistent, quixotic, and uncertain in their effects to be judged as Keynesian successes. The Kennedy tax cut of 1964 is more plausibly cited as a triumph of Keynesian policy, since it was explicitly crafted by Kennedy’s advisers as a demand-side stimulus and it did produce a boom, at least for a short time. It is of special interest that this effect was achieved by cutting taxes rather than by increasing expenditures. There is also the argument that our modern political economy incorporates built-in stabilizers such that recessions create automatic and self-correcting deficits; in other words, we have constructed a Keynesian system that automatically prevents or corrects for slumps. From this point of view, Keynes no longer stands for a set of policy prescriptions but rather for a fiscal system that is built into the structure of governance.
On the other hand, there are several contrary cases that must be considered, such as the British experience in the 1960s, when Keynesian policies led to a major devaluation, and the American experience in the 1970s, when similar policies resulted in “stagflation.” For the past twenty-five years, since the collapse of its real estate and stock markets, Japan has tried various Keynesian-type policies, including major stimulus packages and public works programs, with little success in producing sustained growth but leaving a public debt roughly twice the size of the annual gross domestic product. The United States also enacted a Keynesian stimulus package in 2009 to deal with a major recession, but the results were disappointing. Once the funds were spent, the expansion slowed and unemployment rates began to creep up again, provoking calls for further stimulus spending. Meanwhile, government debt levels in the United States now exceed annual GDP, a condition that is manageable only so long as the nation’s central bank can maintain interest rates at low levels. In the United States, Japan, and several European countries, governments have come close to expending whatever Keynesian ammunition they once had.
For a theory of such longstanding influence, this one has had decidedly mixed results when applied to real-world economies.13 Of course, there are many economists who claim that his approach does not work at all or that the market economy adjusts much more smoothly to shocks than Keynes or his followers contend. There are others who suggest that recent experiences in Japan and the United States show the growth effects of Keynesian policies to be getting weaker with the passage of time.
One possible reason for this weakening may be that political processes in Western democracies
