I have chosen
as the title of my lecture a phrase used by Professor Joan Robinson, who,
in her book Economic Philosophy,
talks of "the humbug of finance which Keynes had destroyed". What she means
by the phrase "the humbug of finance" is the view held by British
finance capital, based in the City of London, in the late twenties, and
propagated by the British Treasury (because of which this view came to be
known as the "Treasury View") that in all circumstances the government's
balancing its expenditure with its income, i.e. not resorting to any fiscal
deficit, is the most desirable policy for an economy. The British colonial
government in India, it may be recalled, had used precisely this argument
for pursuing deflationary policies even during the years of the Great Depression
because of the fall in its tax revenue. This had succeeded in worsening
the impact of the Depression on our economy,
had thwarted the industrialisation prospects which the policy of protection
of the inter-war period had opened up,
and had resulted in a wholesale running down of the economy's infrastructure.
This view in short was pervasive in the pre-Keynesian era. A slight variation
of this view is that the fiscal deficit must under all circumstances never
be allowed to exceed a certain small limit.
The theoretical articulation of the Treasury view was contained
in a White Paper of the British Treasury in 1929, called "Memorandum
On Certain Proposals Relating to Unemployment", and written in response
to Lloyd George's suggestion that Britain should undertake public works
for reducing unemployment which at that time stood at 10 percent (it was
to reach 20 percent later). The White Paper argued that in any economy there
is at any time only a certain pool of savings, and that if more of it is
used for home investment then less becomes available for foreign investment,
or if more of it is used for public works financed by government borrowing,
then less is left over for private investment and foreign investment. It
follows then that public works can never increase total employment in an
economy since the increase in employment brought about by public works would
be exactly counterbalanced by the reduction in employment arising from reduced
private and foreign investment.
The fallacy of this argument was exposed by a young Cambridge
economist and pupil of Keynes, Richard Kahn, in a classic paper published
The argument was simple: total savings in an economy depend, among other
things, on its total income. There is therefore no fixed pool of savings,
unless we assume that income cannot be augmented, i.e. the economy is already
at full employment, in which case the need for public works does not arise.
The Treasury View in other words was arguing against proposals for reducing
unemployment on the basis of a theory that implicitly assumed that unemployment
did not exist at all. In an economy in which there is unemployment, in the
sense of resources lying idle owing to lack of aggregate demand, if investment
increases then these resources start getting used up directly and indirectly,
through various rounds of the "multiplier". As a result, income
rises and so do savings. Indeed, Kahn showed, the whole process of increase
in income and employment would go on and on, until an amount of savings
had been generated which exactly equalled the increase in home and foreign
investment. Far from there being a predetermined pool of savings above which
investment cannot increase, it is the total investment that determines the
total savings: the direction of causation in other words is precisely the
opposite of what pre-Keynesian theory believed. A corollary of Kahn's theorem
was that if the government expanded public works for generating employment
and financed these by borrowing, i.e. by enlarging the fiscal deficit, then
an exactly equivalent amount of savings would accrue in private hands. A
fiscal deficit in other words finances itself.
The argument advanced by Kahn in 1931 was central to Keynes'
opus The General Theory of Employment,
Interest and Money published in 1936. Keynes argued in a similar manner
that in a situation of "involuntary unemployment", or "demand
constraint", the government can
enlarge employment and output by increasing its fiscal deficit; far from
there being any adverse effects of this on any other stream of expenditure,
such government action in fact would stimulate the total expenditure from
these other streams via the "multiplier", and not even generate
any significant inflationary pressures. Moreover, since the government can successfully pursue such a policy,
it must do so, because, as Keynes
put it, "it is certain that the world will not much longer tolerate
the unemployment which, apart from brief intervals of excitement, is associated
-- and, in my opinion, inevitably associated -- with present day capitalistic
Even if the government used the fiscal deficit for no worthier purpose than
"to dig holes in the ground", that is still preferable to letting
unemployment persist, since "'to dig holes in the ground' paid for
out of savings, will increase, not only employment, but the real national
dividend of useful goods and services"
(again because of the "multiplier"). To argue against the mitigation
to human suffering that an increased fiscal deficit can provide is therefore
bad theory, the sheer "humbug of finance".
The reason for my reviving this old and familiar discussion is
that today in India we are once again witnessing the parading as wisdom
of this "humbug of finance", and there is even large-scale acceptance
of this "humbug" as wisdom. What is more, the "humbug"
that is being paraded as wisdom in our country is even more of "humbug"
than what Kahn and Keynes had attacked. In other words the "humbug
of finance" that we are being subjected to even "out-humbugs"
the "humbug of finance" that the British Treasury was purveying
during the Depression of the late twenties. Let me explain this last point
There were no public sector enterprises in Britain during the
late-twenties. The government sector's transactions therefore were co-terminus
with budgetary transactions, so that the term fiscal deficit corresponded
to the deficit of the government sector. This deficit had necessarily to
match, as an algebraic truism, the surplus of the rest of the world vis-à-vis
the British economy plus the surplus
of the British private sector. An increase in the fiscal deficit, assuming
foreign transactions were unaffected, would necessarily correspond to an
equivalent increase in the private sector's surplus of income over expenditure.
What Keynesian theory argued is that an increase in the fiscal deficit in
a demand-constrained system would cause an equivalent increase in private
surplus (and hence finance itself) through an increase in the private sector's
income (via larger employment and output through the demand stimulus
obtained from the government) rather than through a reduction in private expenditure, in particular
investment expenditure, which the Treasury View with its fantastic notion
of a savings pool had claimed. As the government deficit goes up by Rs.100,
employment, output and incomes go up until private savings have gone up
by Rs.100 (assuming private investment remains unchanged), i.e. an extra
Rs.100 of wealth has been put into private hands, which is held directly
or indirectly in the form of claims on government.
Now, even though the use of fiscal deficit for increasing employment
is perfectly legitimate, one may have reservations about this particular mode of raising employment,
for three reasons: first, a fiscal deficit-financed expansion in activity,
as just mentioned, does accentuate wealth inequalities compared to an equivalent
tax-financed expansion of activity. In a society wishing to keep wealth
inequalities in check, it is better to finance government expenditure by
taxing capitalists than by borrowing from them. Secondly, there may be problems
about knowing how much fiscal deficit is needed to get to "full employment"
(which in a capitalist economy would never mean employment for everybody
willing to work, but would only entail lowering unemployment to that level
of the reserve army which is the minimum necessary for the avoidance of
cumulative price instability). Suppose for instance that the owners of wealth
increase their consumption as their wealth increases but with a time-lag.
Then if, say, with Rs.100 of fiscal deficit the economy gets pushed to full
employment before private consumption has responded to the increased wealth,
then once it begins to respond, Rs.100 of fiscal deficit would turn out
in retrospect to have been too large, since now there would be too much
demand. Thirdly, even if private wealth has no effect on private consumption,
if the economy gets taken to full employment through a fiscal deficit-financed
expansion in activity, then at full employment there would be a large overhang
of private wealth in liquid form (as direct or indirect claims upon government)
and these, when resources are being fully utilised, can give rise to speculation-engendered
None of the above considerations justify the "humbug of
finance". What they say is that while an increase in the fiscal deficit
can increase employment, and should be
used for doing so if necessary, there are other
ways of increasing employment, through tax-financed increases in government
expenditure for example, which might be even better for the purpose. Of
course if the latter cannot be implemented easily then fiscal deficit should
be resorted to rather than keeping unemployment going.
Even these residual objections to fiscal deficit however vanish
when the result of the fiscal deficit is to increase not private savings and wealth but those of public sector
enterprises. When this happens, there is in effect no increase in the
government sector's deficit. What appears as an increase in the fiscal deficit
is counterbalanced by a surplus in the rest of the government sector not
reflected in the budget, so that the appearance of a fiscal deficit is entirely
on account of the convention of making the budget reflect only a part of
the government sector's transactions; it
has no economic significance. To object to an increase in the fiscal
deficit in such a situation is even more theoretically illegitimate than
to do so in a situation where there is no public sector. If the objection
even in the latter case is the sheer "humbug of finance", then
in the former case the "humbug" is, if anything, compounded several-fold.
And yet in India there is an objection to an increase in the fiscal deficit
even when the consequences of such an increase would accrue as larger surpluses
to the public sector, which is why the "humbug of finance" being
purveyed in our country today "out-humbugs" the "humbug"
attacked by Kahn and Keynes. I shall give three examples of such "supreme
humbug" (if I may call it so).