Limited Applicability of Keynes Theory: 9 Main Reasons

The following points highlight the nine main reasons for limited applicability of Keynes theory of underdeveloped countries. The reasons are: 1. Cannot be applied Without Modifications 2. Meant for Advanced Industrialised Economies 3. Limited Applicability of Effective Demand 4. Keynes’s Policies are Inflationary and Others.

Reason # 1. Cannot be Applied Without Modifications:

The general impression is that Keynesian Theory, with its assumptions and tools cannot safety and without modifications, be, applied to the problems of other advanced countries much less to the problems of underdeveloped countries.

“Those who seek universal truths; applicable in all places and at all times had better not waste their time on the “General Theory.”

Reason # 2. Meant for Advanced Industrialised Economies:

It is not applicable everywhere because it was meant for application to countries like the U.K. and the U.S.A. which are relatively advanced, rich, industrialised and mature economies with occasional bursts of booms and depressions.

According to Professor Schumpeter, “Practical Keynesianism is a seedling which cannot be transplanted into foreign soil; it dies there and becomes poisonous before it dies….left in English soil, this seedling is a healthy thing and promises both fruit and shade…. all this applies to every bit of advice that Keynes offered.”

Reason # 3. Limited Applicability of Effective Demand:

A.K. Das Gupta remarked, Whatever the generality of the “General Theory” may be in the sense in which the term general was used by Keynes, applicability of the “General Theory to conditions of an underdeveloped economy is at best limited.

According to Dr. Brahinananda, the general theory refers only to lack of effective demand as one of the bottlenecks that prevents the attainment of the high level of employment. A comprehensive theory of employment should explain the causes and remedies for the lack of a high level of employment in both advanced and backward countries.

The effective demand in underdeveloped countries can increase only if labour productivity increases. For an increase in effective demand, the vicious circle of poverty has to be broken by synchronized application of capital over the wide range of industries.

A high rate of capital formation is needed to increase the supply of capital in the economy; but the rate of capital formation is conditioned by the rate of savings in the economy. A backward economy needs more savings through control on spending. Evidently, the Keynesian theory, being a theory of spending, is out of place in the context of a backward economy.

Reason # 4. Keynes’s Policies are Inflationary:

Dr. V.K.R. V. Rao also observed that the, blind application of Keynesian formula to the problems of economic development has inflicted considerable injury on the economies of underdeveloped countries and added to the forces of inflation that are currently afflicting the whole world.

The old fashioned prescription “work harder and save more’ still seems to hold good as the medicine for economic progress, at any rate, as far as the underdeveloped countries are concerned.” It has been contended that any attempt to apply Keynesian remedies to these economies is not only frustrating but even harmful to the efforts at development.

Reason # 5. Inapplicability of Keynesian Depression Conditions:

According to Keynes, the level of income, output and employment can easily be raised if the following conditions exist: excess capacity in consumer goods industries, a well- developed monetised and organised sector including well-integrated bonds and securities markets; involuntary labour force ready to work at current money-wage rate; comparatively elastic supply of the working capital required for increased output.

These conditions are generally prevalent in advanced capitalist economies where there are frequent slumps because of the deficiency of effective demand. It must be realised that a developed economy in a state of depression is quite different from an underdeveloped economy in a state of chronic unemployment and stagnation.

Reason # 6. Cures Occasional Recessions:

Keynesian remedies can be fruitfully used to cure occasional recessions of business activity in advanced economies on account of the deficiency or excess of effective demand. Such a problem does not exist in an underdeveloped economy.

The problem is not of an excess or an insufficiency of effective demand, but of basic economic development of massive unemployment and underemployment of predominance of primary sector with people living at extremely low levels of income.

Keynes’s theory of employment tries to solve the problem of cyclical unemployment, and in particular, unemployment caused by a depression. Since unemployment is the result of a deficiency in effective demand, in order to increase the level of employment a shift in the level of effective demand is necessary.

In underdeveloped countries, however, there is chronic unemployment and not cyclical unemployment, which is not so much due to a deficiency in demand as due to a deficiency in the supply of capital.

Apart from chronic unemployment, poor countries such as India have a peculiar type of unemployment called disguised unemployment. In certain sectors of the economy, people are apparently employed, but are actually unemployed because their marginal productivity is zero. This is referred to as disguised unemployment. In his general theory, Keynes has not discussed this phenomenon, let alone provides a solution to it.

Reason # 7. Inapplicability of assumptions of the General Theory:

Keynes has built up his theory on the basis of a number of assumptions-institutional, technical and social. These assumptions are of short-run, of closed economy, of involuntary unemployment, of given techniques of production, organisation, capital equipment, size and efficiency of labour force remaining constant and easy availability of skilled labour at the current money wage rate.

These assumptions do not hold true in underdeveloped economies: for example, the problem of an underdeveloped economy is a long-run problem of economic development, of raising the economy from the bootstraps, rather than a short-term problem.

The mass unemployment, underemployment, disguised unemployment and low incomes are the results of the stagnation of centuries and cannot be overcome within a short span of a few years. Again, most of the underdeveloped economies are not closed economies because they depend upon foreign trade, which plays an important part in the economy of such countries.

The organised sectors of such economies are foreign trade oriented and suffer from fluctuations in business activities on account of the fluctuations in international trade.

Besides, whatever little favourable multiplier effects are generated within the economy on account of public expenditures may be lost to other countries, while depressions travel through international trade to perpetuate stagnation in underdeveloped economies.

Reason # 8. Supply Side cannot be taken for Granted:

In his General Theory, Keynes takes for granted the conditions on supply side of effective demand by taking technology, capital equipment and efficiency of labour as given. In underdeveloped economies, however, more difficult problems lie on the side of supply than on the demand side. Underdeveloped countries have been suffering from inflation on account of inelastic supply of output.

The problems in these economies have been how to increase savings help capital formation, improve means of production and how to raise the efficiency of labour. It is only after these factors have been obtained that the supply of output can be increased. Thus, it appears as if Keynes assumed away the real problems of underdeveloped economies.

Reason # 9. Supply of Labour in LDC’s Not Elastic:

Moreover, for expansion of the industrial sector we have to use the surplus labour present in the subsistence sector of the economy. But the mobility of labour is low on account of the unwillingness of the labourers to leave the villages and their families.

Further, higher wages have to be paid to attract them to urban areas, where there are problems of housing, congestion, overcrowding and high cost of living. Thus, it is altogether unrealistic to assume an elastic supply of skilled labour at the current wage rate in an underdeveloped economy.

All this goes to falsify the belief of even the remotest relevance of the assumptions of Keynesian economies to underdeveloped countries, thereby rendering it largely inapplicable.