A Hundred Years After Keynes

1

Maynard Keynes is best known for advancing the theory of effective demand and laying the foundations of modern macroeconomics. But in his earlier years he served as a bureaucrat in the British India Office before WWI, and then represented the Treasury at the Versailles negotiations at the war’s end — Keynes’s insight came directly out of his lived experience of the violent shocks to Europe’s economic order before and after the war. The Economic Consequences of the Peace, written in 1919 in the wake of Versailles, sounds like a critique of the harsh terms imposed on Germany and the slow recovery they would cause. At a deeper level, it is an anatomy of capitalism’s underlying growth logic and its fragility. From 1921 on, Keynes managed the King’s College Cambridge endowment and effectively became a forerunner of long-horizon equity investing — a transition that can be read as a direct outgrowth of his evolving economic thought.

Among the lesser-recognized wonders of the twentieth century, Philip Morris — the maker of Marlboro — should probably be on the list: roughly 17.0% annualized over its 1925–2003 run, ending in something like 250,000× total return (15.4% annualized from 1925 to today, ~2,000,000×). Set against the Netherlands — capitalism’s birthplace — during the heyday of the VOC across 1500–1700, with annualized growth of just 0.26% and cumulative growth of 1.68×, the contrast sounds like fiction. (Double-entry bookkeeping, paper money, marine insurance, public debt, partnership companies, savings banks, and early central banking can all be traced back to Renaissance Florence and Venice — but Italy was unable to sustain growth: under hard population constraints, total scale stalled around 1500 and then declined as Atlantic trade displaced the Mediterranean.) Philip Morris is not the exception. The S&P 500’s 10.2% annualized, ~18,000× cumulative return is already an astronomical figure utterly unimaginable in pre-modern times.

2

Keynes’s opening claim is this: the sustained compounding growth produced over the roughly 50 years between the maturing of the Industrial Revolution around 1870 and the end of WWI was not inevitable. It was the result of hundreds and even thousands of years of institutional evolution in Europe stretching back to the Middle Ages.

Across the long stretch of history outside the Industrial Revolution, the Malthusian trap — capping a region’s economic scale at some steady state through famine, plague, and war — was the norm. The Taiping Rebellion around 1850, which caused roughly 50 million direct or indirect deaths (10–15% of late-Qing China’s population), is the most recent and most vivid example.

But just as someone today, swiping their phone in a luxury apartment in New York or Shanghai — ordering goods from anywhere in the world, or carrying nothing but a credit card or Alipay across borders without ever touching local cash — the bourgeoisie sipping their morning tea in bed in London a hundred years ago took it equally for granted that the world’s goods were within easy reach, the world’s labor was at their service, and global travel and business faced no barriers. The slightest inconvenience was treated as something annoying and avoidable.

Until the governments they elected and the media they controlled dragged them into a war that lasted four years, with mass casualties to witness. The hyperinflation that followed wiped out their monetary holdings — and that finally destroyed their confidence.

And the unwritten social contract that capitalism actually relied on to keep functioning — the propertyless accept inequality in exchange for security and social mobility; the propertied hold most of society’s wealth but, like Puritans, voluntarily restrain consumption and reinvest, growing total social wealth and ultimately raising aggregate welfare — quietly fractured amid the extravagant excesses of the Belle Époque, eventually giving rise to the Russian October Revolution of 1917.

3

Wealth growth in an economy is created by firms. If we want to quantify the overall vitality of the corporate sector, one available metric is the aggregate profit of that sector.

What’s interesting is that, just like income-side GDP, total profit is also a flow concept, and there is an accounting identity for it (derived in 1942 by the Polish economist Michał Kalecki from the national income identity; Keynes himself expressed a similar but less rigorous view in The General Theory):

Profits = I + (G − T) + NX + C_capitalist − S_worker

Where the identity comes from:

• Starting from the income side of GDP: Y = Wages (to labor) + Profits (to investors)
• The expenditure side decomposes into consumption, investment, trade, and government spending: Y = C + I + G + NX
• Consumption splits into capitalist consumption and worker consumption: C = C_capitalist + C_worker
• The identity uses the condition that any wages workers don’t spend, they save: W = C_worker + S_worker
• Folding the tax term T into government spending gives (G − T)

Like a law of physics, we start from the basic fact that “income equals expenditure — if anyone earns money, someone must have spent money,” so the identity must be true. But also like a law of physics, the identity tells us something not at all obvious: the sources of aggregate profit in an economy add up to just four positive contributors, plus one negative drag.

The conclusion: even though profit looks like the thing every participant in the economy most wants to forecast and finds hardest to grasp, if we hold investment, trade, government spending, and the savings rate fixed at the macro level, short-run aggregate profit is uniquely determined.

The identity holds in any economy, not just market economies. In a planned economy, profit is administratively set to zero, prices equal calculated average cost, and high investment must be offset by a combination of high government surplus (T > G, so the (G − T) term is negative) and high worker savings — exactly the situation in pre-1978 reform China. Or take Japan after the bubble burst in the 1990s: investment slowed sharply but corporate profits did not fall into a serious long-run decline, only stagnation, because the Japanese government subsidized the corporate sector for years through deficits (QE combined with fiscal expansion).

When asking after the source of growth, the modern undergraduate textbook answer is investment (I): more capital input on the supply side — physical assets like plants and machinery, and more importantly intangible assets — R&D and technical innovation.

But Keynes’s 1936 General Theory of Employment, Interest and Money offered a completely different answer — demand is the lifeblood of all market economic activity. When workers, out of insecurity, prefer saving to consuming each marginal dollar earned, and investors choose savings over investment, the economy slips into severe depression — even in the 1930s, when the second industrial revolution was producing rapidly compounding outputs, when automobiles, electrical equipment, and chemical industries reached unprecedented levels. The Faustian human appetite for knowledge does not change with the economic system, from Socrates to Fourier. Abel, who built the modern foundations of algebra, did not stop his research because nineteenth-century Norway could not support a living through mathematics. But conversely, the modern consumer society of endless wanting — of always wanting more and better — is the most fundamental source of economic growth. When demand exists, profit’s lure gives people inexhaustible drive to apply the knowledge and technology that exists or is about to be created, and to manufacture supply matched to that demand. From the opening of new spice trade routes to the race against the physical limits of the transistor under Moore’s Law — through repeated amplifications of human desire, civilization has reached a wholly new chapter.

4

The statement above isn’t logically airtight, of course: Sumer had Gilgamesh wanting eternal life, ancient Greece had Icarus wanting to fly, but it wasn’t until the Wright Brothers that humanity actually got the chance to soar.

The main institutional developments are:

• Property rights (whatever I produce, what I get keeps belonging to me)
• Money (I can produce for future consumption)
• Credit (others can trade their future production for my current production)
• The corporate form (the productive organization, as a legal entity, persists regardless of any natural person’s life or death)
• Double-entry bookkeeping (producers and owners can be separated — the precondition for large-scale organizations)

These have become almost foundational laws in any market economy.

And the conditions Keynes described — taken for granted a hundred years ago, but by no means inevitable — are:

• A stable, open financial-and-trade system underwritten by hegemony. If a country’s people are forced to buy only domestically made goods, even at the same income level they will visibly find the things they can buy shrinking.
• A currency with stable value. Under hyperinflation, if creditors cannot predict the real purchasing power of future repayments, the most basic borrowing-and-lending activity in the economy becomes speculation.
• Workers willing to enter a social contract with investors. Because of wealth-concentration effects, workers always make up the absolute majority under any system; if they are no longer willing to keep this contract, the political pressure for redistribution will become very strong.
• An abundant entrepreneurial spirit. If a society no longer believes in value creation and pays more attention to the inheritance of cross-generational wealth and power, the economy will lose its vitality.

Looking at the U.S. over the past decade, almost all four of these conditions are deteriorating: from Trump’s mercantilism, to the inflation pressure that has lingered after the pandemic, to the redistribution pressure brought on by conspicuous-consumption culture (such as California’s billionaire wealth tax), to estate lawyers in Wyoming who can’t keep up with their caseload — dynasty trusts are quietly rebuilding the hereditary model that the U.S. was supposed to reject from the Enlightenment onward.

And yet, at least in major cities like New York and San Francisco, the overall economy still looks vibrant. If we trace the composition of total profit, we find that under the triple influence of 1990s financial liberalization, the new economy, and globalization:

• Investment demand has fallen. The share of corporate profit going to physical capex has slid from 80% in the 1990s down to 50%; meanwhile, the share going to share buybacks has surged from below 20% to above 50% — the leftover cash didn’t go to new factories, it went back to shareholders. Today, America’s most profitable companies all use their abundant cash flow to buy back their own stock. But deindustrialization is not only because globalization shifted capex to other countries — industry concentration (which weakens competitive investment), asset-light models like financial services and software (which require less investment to begin with), and an aging population all stack as overlapping factors.
• Personal savings rates have fallen. The rise in asset prices for stocks and real estate makes people no longer feel the need to save against risk.
• The drag on profit from trade deficits had already halved by the 2008 global financial crisis.

Decompose those three structural shifts through the Kalecki identity, allocating each component’s contribution per dollar of pre-tax corporate profit, averaged by decade:

Across three decades: the physical investment supporting each dollar of profit fell from $2.98 to $1.56 (nearly halved), while the contribution from government deficits jumped from $0.30 to $0.72 (more than doubled). This is the accounting picture of the three structural shifts above — investment-driven growth replaced by deficit-driven support.

So the U.S. economic growth captured during the past 30 years of globalization is essentially this: households and firms simultaneously lowered their savings/retentions while raising consumption and buybacks, with households reducing savings faster than firms reduced retentions — producing strong consumption demand.

And in the short term, during both the 2008 financial crisis and the pandemic, the U.S. government stabilized sharp drops in investment and consumption with massive deficits.

Where exactly did those deficits go? Take 2024 as an example: federal expenditures of $6.75 trillion, revenue of $4.92 trillion, deficit of $1.83 trillion. Of which:

• Social Security — $1.47 trillion
• Medicare (health insurance for those 65 and older) — $0.92 trillion
• Medicaid (low-income / disability health insurance, federal portion) — $0.62 trillion
• Interest on federal debt — $0.88 trillion
• Defense — $0.85 trillion
• Income security — $0.70 trillion

By comparison, total AI capex from U.S. hyperscalers across 2024–2027 (projected) comes to only $1.41 trillion. Put differently, just one year of U.S. healthcare spending alone (Medicare $0.92T + federal Medicaid $0.62T = $1.54T) already exceeds the entire hyperscaler industry’s four-year AI spending total. The aggregate profit pool is still growing, but a large share of it is flowing into low-productivity sectors, and the structure underneath it is also unsustainable.

It may not be long before we, too, are jolted into realizing that — just as the sustained growth of those 50 years from 1870 to 1920 was not eternal — what we know as “normal” is not inevitable either.