Keynes, Einstein, and Scientific Revolution

One of the most intriguing and little-noted facts about John Maynard Keynes's masterwork, The General Theory of Employment Interest and Money, concerns the first three words of its title. These are evidently cribbed from Albert Einstein.* Alone that would be only a curiosum; but there is more. The parallels between Keynes's economics and Einstein's relativity theory are deep enough, and evidently intentional enough, to provide a useful framework for thinking about what Keynes meant to do with his scientific revolution.

Keynes and Einstein had met. Keynes traveled to Berlin in 1926 to lecture; Einstein attended. Keynes's impressions were not published until 1972:

Wordsworth, who had not seen him, wrote of Newton's statue: "The marble index of a mind for ever Voyaging through strange seas of Thought, alone." I, who have seen Einstein, have to record something apparently--perhaps not really different-- that he is "a naughty boy," a naughty Jew-boy, covered with ink, pulling a long nose as the world kicks his bottom; a sweet imp, pure and giggling. (Collected Writings, Vol. X, p. 382.)

A second reference appears in The New Statesman and Nation of October 21, 1933. For this issue, Keynes prepared a short commentary to accompany a sketch of Albert Einstein by the artist David Low. The playful imagery is now gone, and by this time Keynes has become concerned about Jewish refugees. Now, to Keynes's eye, Low's drawing evokes an Einstein under attack. Keynes quotes Einstein in the German:

"Assuredly you too, dear reader, made acquaintance as boy or girl with the proud edifice of Euclid's geometry"--thus begins the "Essay on the Special and General Theory of Relativity"--"assuredly by force of this bit of your past you would beat with contempt anyone who casts doubts on even the most out of the way fragment of any of its propositions." It is so indeed. The boys, who cannot grow up to adult human nature, are beating the prophets of the ancient race--Marx, Freud, Einstein. (Collected Writings, Vol. XXVIII, p. 21)

The first extant complete table of contents of Keynes's next book, then titled simply The General Theory of Employment, was found in a bundle of papers dated December 1933. (Collected Writings, Vol. XIII, p. 421). In the first proofs of that book there is a sentence, deleted from later proofs, that occurs exactly at the point where Keynes declares that the classical theory cannot be applied to the problem of unemployment, and just before this passage:

The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight--as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required in economics. (Collected Writings, Vol XIV, p. 366)

The deleted sentence reads, "We require, therefore, to work out a more general theory than the classical theory" (italics added).

Mark Twain writes somewhere that "some circumstantial evidence is very strong, as when you find a trout in the milk." But what, if anything, does it mean?


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Newtonian Physics and Classical Economics

Albert Einstein came of age in a world where the classical physics of Sir Isaac Newton still reigned. Two features of Newton's worldview are pertinent to understanding the classical economics that Keynes meant to attack.

The first is that Newton's physics presupposes an absolute separation of space and time. Space is Euclidean: a three- dimensional void stretching infinitely in all directions. The position of any particle in space can be defined, by means of a system of coordinates, with respect to any observer or any fixed reference point. Motion is the displacement of the particle from one position to another. Velocity is motion, divided by the number of ticks on a clock that it takes for the motion to occur. The clock that is used to measure velocity lies, in a conceptual sense, outside the universe itself. In other words, all observers of an event, provided they were equipped with accurate timepieces, no matter where they might be, would always agree on the exact time that the event occurred. Newton imagined time as an absolutely regular phenomenon that could not depend on the location of the clock or be affected by its movement or any other physical force.

The second feature is reductionism: Newton's universe was neither more nor less than the sum of its component particles. Gravity in Newton's system is the basic force exerted by one massive body on any other. Gravity produces the acceleration of a particle in space, according to the position and mass of all other particles in the universe that exert gravitational force. And, in Newton's view, this interaction of each particle on every other is all there is. Once you knew the position, mass, direction, and velocity of every particle in the universe, you would not need to know anything else. Every future event would be fully determined by the laws of motion.

Without going into great detail, it is possible to trace out the role of each of the above features in the classical economics of Keynes's time and in modern neoclassical economics. The analog of space is the market. Look at any supply and demand diagram. The graph itself is a two-dimensional space. Every point on the graph is a position defined uniquely with respect to the origin. The relationships between variables are presented as forces in this space: in the labor market, demand aligns wages and employment in a downward sloping relation; supply aligns them along an upward slope. If two curves cross in that space, their point of intersection is an equilibrium position, where the forces balance and the market clears.

The analog of Newtonian time, in the classical economics, is money. Just as time is absolutely separate from space, money is absolutely separate from the market. Prices and wages may be measured in money terms, but this is only a convenience. The prices that count are relative prices--prices in relation to the prices of other goods. The wages measured in a proper labor market are real wages--an hour's work in terms of the commodities that an hour of work can purchase. Like time, money is an invariable standard. And just as it does not matter whether one measures time in seconds or in hours, or from Andromeda or Cassiopeia, it does not matter whether one measures prices in dollars or dimes, in pesos or yen, or in dollars of 1958 or dollars of 1993. The quantity of money has no effect on the equilibrium of the market; nothing real depends on money in any important way.

The reductionism of Newton's system is equally fundamental to classical economics and remains so today. Economists are taught that societies, like Newton's universe, are nothing more than the sum of their individual components. Macroeconomic expressions, though they purport to describe the behavior of society as a whole, are only a shorthand for the mass of individual human actions. In principle, therefore, the best macroeconomics would be built strictly and rigidly from the theory of individual behavior, or microfoundations. If there are operational difficulties with this, they must lie mainly in the difficulty of acquiring all the information that is necessary about all of the individuals whose preferences and behavior must be considered. Fundamental difficulties of theory do not arise.


Einstein and Newton's Mechanics

By the time Keynes came along, the Newtonian view of the physical universe had crumbled. Einstein's theories of relativity had done it in. The absolute separation of time and space collapsed with Einstein's introduction of a new universal constant, the speed of light. If light traveled through empty space, everywhere and always and irrespective of the direction and velocity of the observer (as Einstein argued and experiments have confirmed) at the same identical speed (186,000 miles per second), then the absolute simultaneity of two or more very distant events could no longer be defined. Clocks in different places will record these events at different times, and none is more correct than any other. Moreover, Einstein showed that space and time are interrelated--time itself advances more slowly near massive bodies than it does in empty space.

Furthermore, this newly unified concept, space-time, also destroyed the Euclidean concept of emptiness extending forever in all directions. Space-time is curved, and Einstein's relativity is the extension of the Riemannian geometry of curved spaces to the physical universe. Near any massive body, the shortest distance between two points curves around, as does the path of a ray of light. For this reason, parallel lines may meet if extended far enough. (Keynes's reference to overthrowing Euclid's axiom of parallels is an unmistakable allusion to this feature of Einstein's theory.)

But if space-time is curved by the presence of matter, then the shortest distance between two points is no longer defined independently of the distribution of matter in space. And then the system is no longer reducible to its elements; you can no longer get to the whole merely by adding up the parts. The universe is, instead, more easily and more correctly understood by looking at the whole and placing the parts within it. The whole can impose rules on the parts: in a famous phrase, "Space tells matter how to move; matter tells space how to curve."


Relativity Theory and Monetary Production Economics

When Keynes wrote his General Theory, he had in his gunsights--I shall argue--both Newton's reductionism and his space-time dichotomy, as both were reflected in the classical economics. First, Keynes sought to disestablish the "absolute space" of classical markets and to end the separation of markets from the world of money. Keynes characterized his theory as a monetary theory of production, giving lectures on this subject in the fall of 1933 as the General Theory of Employment (the preliminary title) was taking shape. Keynes contrasted monetary-production economics with what he called the real-exchange economics of the classical view. In so doing, he broke down the traditional non-monetary concepts of a "labor market" and a "capital market," suffusing both subjects with ideas--"effective demand" and "liquidity preference"--that cannot be conceived of properly except in monetary terms.

Monetary-production is Keynes's space- time: the marriage of conceptual domains previously held to be distinct. In the classical theory of the labor market, for example, Keynes found a first postulate that held that the demand for labor would rise when real wages fell, and vice versa. This was a consequence of the principle of diminishing returns, an idea that Keynes did not choose (at that time) to dispute. But the idea that demand for labor rises as wages fall cannot, by itself, establish the actual level of employment or the value of the real wage.

The classics had closed their model with a second postulate, which held that work-time offered would increase when real wages rose. This second postulate was precisely that part of the classical vision that reduced unemployment to a matter of individual decision. If a person was apparently unemployed, it should always be possible for him or her either to find work or to eliminate the desire to work and therefore the appearance of unemployment, by sufficiently cutting the wage.

For Keynes, this second postulate, the upward-sloping supply curve of labor, was akin to the axiom of parallels in Euclid's geometry. It should likewise be rejected. In doing so, Keynes threw over not only the supply curve of labor but also the whole idea of a self-contained labor market in the normal supply-and-demand sense, a construct in which real wages and employment could be modeled together as though one depended directly on the other. In its place, Keynes offered the now-familiar, but then revolutionary, idea that employment was determined by effective monetary demand for output. Since there was no reason why the total demand for output would necessarily correspond to high or full employment, involuntary unemployment in the strict sense would now be possible in economics.

But what would determine effective demand? Such demand could be divided into two major elements: the consumption demand of households and the investment demands of business. Here Keynes's reasoning led him to dismantle the second metaphorical classical, supply-and-demand market, namely the capital market. In the classical theory, the supply of and demand for capital jointly determined a quantity, namely the total volume of savings and investment, and a price, namely the rate of interest. Investment was demanded by firms, with more being demanded at low interest rates than at high. Savings was supplied by individuals, with more being supplied at high interest than at low. Thus a market for capital determined how much of current output would be consumed and how much saved and invested. This market, it should be noted, operated wholly apart from the determination of output. Investment and savings did not affect employment and output, only the division of output between current consumption and capital formation.

Here again, Keynes attacked the supply curve. Savings, he proposed, had nothing to do with the interest rate. They were, instead, merely the leftovers after consumption out of income. Investment, he believed, did depend on the interest rate. But a curve of investment demand alone could not determine both the volume of investment and the rate of interest. Keynes now needed an independent theory of the interest rate.

To get an interest rate, Keynes brought in a new market, up to that point largely ignored in economics: the market for debt instruments and, in particular, for money. Interest, he proposed, was not a reward for saving but the reward for giving up the liquidity, the easy access to immediate purchasing power, that could be had by holding money. As anyone who has bought a bond or a certificate of deposit knows, the longer the term (the greater the liquidity forgone), the higher the rate of interest. Keynes argued that the interest rate thus reconciled the supply of liquidity (quantity of money) with the demand for it. And in Keynes's new sequence, the interest rate determined in the money market in turn determined the volume of investment.

To complete his theory, Keynes tied these elements together. The market for money determined interest. Interest (and the state of business confidence) determined investment. Investment, alongside consumption, determined effective demand for output. Demand for output determined output and employment. Consumption out of incomes determined savings. Employment determined the real wage.

In this world, a change in monetary policy, such as a cut in interest rates leading to an increase in bank credit, now had fundamental real consequences. The classical dichotomy, in economics as in physics, had been broken. And with the deconstruction of labor and capital markets, the reductionist idea of microfoundations had also to be abandoned. Workers, Keynes pointed out, bargain for money wages, not real wages. The act of dropping money wages would generate feedbacks through previously unrecognized--monetary--channels in the system. In particular, prices would fall, and real wages (the ratio of wages to prices) would therefore not necessarily change. Falling prices might, however, depress business profit expectations and so cut into demand for investment. This would actually reduce the demand for workers and prevent total employment from rising. The system interacts with itself, and a full employment equilibrium cannot be achieved within the labor market. Economic space-time is curved.


Consequences

In the long run, Keynes did not achieve what he hoped. His parallel to Einstein went virtually unnoticed. Lawrence Klein, writing an early interpretation in his 1947 work, The Keynesian Revolution, did emphasize Keynes's attacks on microeconomic supply curves. But in the United States, the prevailing view became that of Paul Samuelson, who transposed Keynes's unemployment theory into the proposition that wages are "sticky." In this interpretation, unemployment occurs simply because labor markets, characterized by supply and demand curves just as in the good old days, do not clear. What Samuelson did--and he is, I think, too good a student of physics not to have known it--was to push the daemon of Keynesian relativity back into its box. And modern American Keynesians, even down to the New Keynesians currently in fashion around Harvard, MIT, Princeton, and the Council of Economic Advisers, are Newtonian and Samuelsonian to the core, perhaps with a touch of Von Neumann thrown in nowadays. As such, they have denied themselves the high ground of principle Keynes sought to claim, conceding an enormous advantage to classical free market conservatives on every important policy matter.

Too bad. For one cannot say, as one can with Newtonian physics, that Newtonian economics is good enough for practical situations. The scale of the whole, in the economic case, is not that of the universe or the solar system; it is merely that of the nation-state or the global region. Interdependence afflicts us all. The global irrationality of wage cutting, American budget balancing, zero-inflation Federal Reserve targets, and Third World austerity programs is an everyday occurrence. The failure of Keynesian macroeconomics to establish full theoretical independence from the classical labor market and the classical neutrality of money means that we are, in effect, now denied fair discussion of Keynesian solutions to policy problems. The end result is that we cannot cope now, any more than could the classics in their day, with stagnation and involuntary unemployment.


* This point was first made to me in private conversation by Robert Skidelsky. The economists Ching-Yao Hsieh and Meng-Hua Ye devote a short chapter in their book, Economics, Philosophy and Physics, stating it would not be an exaggeration to assert that Keynes's theory of involuntary unemployment was inspired by Einstein. They do not, however, explore the parallelism between space-time and monetary production. Nor does Skidelsky, who discusses the Einstein link in his second volume on Keynes. Philip Mirowski, whose 1989 book More Heat than Light is a fundamental treatment of the relationship between physics and economics, also leaves out the Keynes-Einstein tale. (Back to Text)

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