Many cite Adam Smith’s noted work to decry government intervention. But Smith thought otherwise: “Civil government, so far as it is instituted for the security of property, is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all.” Citing this extract, the public intellectual David Korten goes on to infer that “Smith never suggested that government should not intervene to set and enforce minimum social, health, worker safety, and environmental standards in the common interest or to protect the poor and nature from the rich. Given that most governments of his day were monarchies, the possibility probably never occurred to him.”

But the world did not wait for Korten to say this in late 20^th century. In 1929 itself, the Great Depression prompted economists like Keynes to side with state intervention; Keynes may have been inspired by his recent trip to Russia. He argued that “investment, which responds to variations in the interest rate and to expectations about the future, is the dynamic factor determining the level of economic activity.”

The ensuing World War II may have drawn US late into the race, but it was already in the midst of a golden period starting 1933 and lasted till 1966. But the Arab-Israeli war in October 1973 resulted in the Arab oil embargo that drastically tilted the balances and threatened US as well as the world economy. Inflation was an offshoot and unemployment spiked -- they combined into stagflation. Then came the conservative era, of minimal government intervention and maximal corporate free-play. Regan in US and Thatcher in UK led this era of neo-liberalization.

Economists also responded, creating their own schools. Milton Friedman of the Chicago School of Economics was the spotlight; a leading critic of Keynesian economics, which believed government policy pedals business cycles (periodic fluctuations in the general rate of economic activity).

Friedman argued that it is not fiscal policy, as reasoned by Keynes, but monetary policy that will help neutralize the effects of recession. It is money supply that determines economic activity; it is not rising oil prices or declining wages, as popularly claimed, that resulted in inflation but the amount of money in circulation. Money supply would affect output in the short run and price level in the long run. “Friedman also argued for the cessation of government intervention in currency markets…as well as promoting the practice of freely floating exchange rates.”

Stagflation of the 1970s was not possible under a Keynesian system and this in a way confirmed Friedman’s hypothesis. Friedman also nailed Keynes in one of his cornerstones, the Phillips Curve that saw a tendency of wages rising faster when unemployment is low. But again the stagflation presented a contrast: high unemployment and higher wage increases. This is not to say that Friedman overrode Keynes, but that science is built upon the shoulders of the past giants. So was Friedman also overridden by newer economists. More on them next...