Keynes and the post World War II

international economic order

By Aftab Ahmad Khan

John Maynard Keynes (1883-1946) was the greatest economist of the 20th Century. He was a many sided genius who aside from economics distinguished himself in the fields of mathematics, philosophy and literature. During his lifetime he wrote ten books, and close to one hundred articles, reviews and pamphlets. He presented a profound challenge to economic thinking of his time and laid the foundations for the development of modern macro-economics.

From his earliest days, he was in public affairs, which led him to make recommendations for revising the treaties after World War-I and for ending the worldwide depression of the 1930s. During World War-II he advised the British government on the financing of its war efforts. He also made path breaking recommendations for the rebuilding of the world’s international financial structure after World War-II. His strong advocacy of measures designed to improve national and international economic management, increases his stature in the company of scientific immortals. The noble laureate Paul A. Samuelson measures his against Newton and Darwin.

Keynes, though a radical reformer of the capitalist system, nevertheless remains loyal to it. In the worlds of Prof. John Kenneth Galbraith; “Keynes was extremely comfortable with the economic system he so brilliantly explored. He was not attracted by Marx.”

As World War-II drew to a close, Keynes participated in discussions regarding the detailed design of the post – 1945 international economy. He was convinced that in the absence of conscious international economic management, the world economy could not be stabilised. This belief is reinforced in what came to be known as the Bretton Woods system. This is the corpus of conventions and rules implicit or explicit in the Articles of Agreement of the International Monetary Fund (IMF) which were agreed upon at Bretton Woods, New Hampshire (USA) in July, 1944. That conference came together to finalise the details and ratify the outline of an agreement hammered over the two previous years between the British and the Americans (Who at that time dominated the economic thinking of the Allies).

The Bretton Woods agreement is primarily to be attributed to the dominant role of Keynes and Harry D. Wight, who at that time was Assistant Secretary of the United State Treasury.

Both Keynes and White drew up their own different plans for re-structuring the international monetary system. Keyne’s proposals envisaged the establishment of an international clearing union, involving the creation of a new international reserve asset called “bancor”. Countries would hold most of their international reserves, not in the forms of gold or foreign exchange but rather in the form of “bancor” deposits with the new clearing union. The proposal of the US Treasury, the White Plan, was essentially that the existing system based on the gold exchange standard be retained and reinforced by the creation of a stabilisation fund that eventually emerged.

It is well known that when the initial views of Keynes and White were in conflict, White almost always won. There was, however one significant exception. This concerned the extent to which the Fund was to be a passive observer of the policies of its member countries. The Keynes Plan which insisted on Fund passivity in the policies of the member countries was ultimately accepted.

But even in this context there is a qualification, for a similar argument concerned the extent to which member countries ought to be able to draw automatically on the resources of the Fund, when they are in balance of payments deficit. The British held that such drawings should be automatically available within agreed limits, whereas the Americans increasingly insisted that drawings should be conditional upon the adoption of approved balance of payments adjustment policies. The argument about the appropriate extent of Fund conditionality started as far back as 1944 and continues down to the present day. This British thought they won the battle at Bretton Woods, and, in fact everybody else seems to have thought that the American side had agreed that drawings would be essentially automatic. But it turned out that the decision not to fight everyone else was tactical and US domination of the Fund’s executive boards was subsequently used to insist on Fund conditionality for anything other than minimal drawings. The Fund’s policies involving a high degree of conditionality were accepted and built into the operational procedures of the Fund in the 1950s

It was only one of several decisions on which Keynes was defeated. There were some other more significant ones also.

Keynes had envisaged his international clearing union as settling bilateral balances between a series of central banks. He had assumed that all exchange market transactions would be channelled through central banks as under British wartime system. White on the other hand, envisaged a return to competitive foreign exchange markets, as was eventually incorporated in the agreement.

A second instance is provided by Keynes suggestion of a clearing union that would have held the account of individual countries in the form of the new reserve asset “bancor” which would have been exchanged between member countries and simple maintenance of the gold exchange standard supplemented by a stabilisation fund. Keynes again lost out.

The third instance involved the proposal embodied in Keynes’ system that interest be charged on excessive capital balances of “bancor” A country that ran too big and cumulative balance of payments surplus would run up balances of the “bancor”, but instead of being rewarded for by earning interest, it would have had to pay interest. The idea was denounced at the time as penalising what was thought to be (erroneously as subsequent history revealed) the permanent surplus country US and it had to be withdrawn.

Finally, there was big difference in regard to the size of the Fund. The original American proposal was for a Fund of $5.5 billion. This was eventually topped in the agreement to $8.8 billion. Keynes, on the other hand desired initial over-draft rights aggregating a total of $26 billion. Twenty six billion dollars in 1944 amount to something like $1000 billion in to-days dollars.

Hence on all basic issues about the new international order, Keynes’ proposals were rejected. In spite of this Keynes fought passionately for its acceptance by the British government, in which he succeeded. He made an eloquent speech in the House of Lords in its support.

Keynes’ support for the Bretton Woods agreement despite its inadequacies could be explained due to his passionate belief in the need for on international economic order of some form. In particular he felt there was a need to have United States participation, and indeed leadership. He accordingly decided to accept defeat on particular issues for the sake of furthering cooperation.

Keynes in his design of the post war monetary and financial system was not concerned with the subsequent demands of the Third World countries for a new international economic order with a built in mechanism for some measures of international redistribution to benefit the poor countries. This was not an issue in his days, though it could be argued that it is a natural extension of his thought.

Keynes in his economic theory explains why the free market theory is not and cannot be applicable to the competitive entrepreneurial market oriented systems which prevail in most countries of the world. The unregulated or under-regulated market economies are extensively volatile. In these booms (investment bubbles) are often followed by collapses. In the absence of positive government action there could be long periods of economic stagnation. To avoid such collapses as Keynes indicated governments have two important roles to play. First, governments must develop institutions, rules and regulations to ensure the stability and liquidity of financial markets domestically and globally. Furthermore, governments must take steps to increase employment opportunities and reduce arbitrary and unequal distribution of income and wealth.