Tag Archives: wynne godley

UNCTAD On Economic Dynamics

From United Nations’ Conference on Trade and Development (UNCTAD)’s 2015 report, page 44:

… exposure to unregulated and large financial flows alters macroeconomic developments in ways that can lead to a slowdown of GDP growth as well as unstable internal dynamics marked by sudden shifts of income and wealth between the main sectors (private, public and external). A convenient way to map these shifts and their relationship with economic growth is by using the “demand stances” framework (see Godley and Cripps, 1983; Godley and McCarthy, 1998; and Taylor, 2001 and 2006). This framework reasserts the Keynesian principle that sustained growth requires continuously increasing injections (which, in simple macroeconomic terms, include private investment, government expenditure and exports) into the flow of income. These injections, in turn, require a steady growth of leakages (measured by the propensity to save, the tax rate and the import propensity), which over time ensure financial stability, as credit rises along the circular flow of income. Thus GDP growth can be explained as the growth, along stable norms, of injections relative to leakages; these eventually determine financial transfers between the main sectors. Such ratios of injections to leakages are termed stances and provide a measure both of demand drivers and financial balances.


In mathematical terms, the main accounting identity defines GDP as the sum of consumption (C), private investment (I), government expenditure (G) and exports(X) minus imports(M). Simple assumptions allow specifying the tax rate (t) and the savings and import propensities, s and m respectively, as: T = t · GDP; S = s · GDP; M = m · GDP, where T stands for total tax revenue and S for private savings. Arrangements of these equations around the accounting identity yield the expression: GDP = (G + I + X)/(t + s + m), or alternatively: GDP = wt · (G/t) + ws · (I/s) + wm · (X/m) where wt , ws and wm are the weights of each of  the leakages (tax, savings and import propensities, respectively). This equation establishes that growth of GDP depends on the growth of the three variables, G/t, I/s and X/m; defined as fiscal stance, private stance and external sector stance, respectively, amplified by the strength of the respective multipliers, given the mentioned weights, in the macroeconomic context. To avoid complicating the presentation with derivation of the steady state conditions, it is sufficient to note that these stances reflect financial conditions as well, where a larger numerator than the denominator points towards a net borrowing position. Thus, a steady path of sustained growth and financial stability requires that none of these stances grow at a proportionally faster pace than the others for a prolonged period of time.


Economists Can Be So Wrong

Oh boy! Krugman could not have been more wrong about Macroeconomics than what he said recently in his blog The Conscience Of A Liberal for The New York Times. In a blog post, Competitiveness And Class Warfare, he concludes:

International competition is a mostly bogus notion; …

In a sense it is not surprising. Paul Krugman has done enough to push free trade. With that position, one is forced to take a position that competitiveness doesn’t matter (or that free trade will lead to a convergence between successful and unsuccessful nations).

The notion that balance of payments does not matter is as old as Monetarism. If it is understood that competitiveness does matter and that for a nation it hurts domestic producers and hence one needs some sort of protectionist measures goes against the notion of free trade. For neoclassical economists other than Paul Krugman, competitiveness does matter but in a different sense. They would argue that it there is divergence in performance of nations because of “loose fiscal policy” or “fiscal profligacy” and so on and that once the government balances its budget and behaves the way as per a standard textbook model, there’ll be convergence in performance because market mechanisms will do the trick. But Krugman is different. During the crisis, he has understood that fiscal policy is important and that it is not impotent as claimed by his colleagues.

There are of course other factors at play in the examples Krugman provides. Japanese producers are highly competitive but at the same time, the government of Japan didn’t expand domestic demand by fiscal expansion and so the performance of the economy of Japan has suffered. But that doesn’t mean that the competitiveness of Japanese producers doesn’t matter. Had they been less competitive, Japanese exports would have been lower than otherwise and Japan would have imported more because foreign producers would beat them at their home. Moreover, a weaker current account balance of payments would have led to a bigger government deficit and the Japanese government would have (incorrectly) tightened fiscal policy in response, with the result that both balance of payments and fiscal policy would have reduced domestic demand and hence output.

So while there are other factors affecting economic performance, none of it ever means that competitiveness doesn’t matter.

Cambridge economists were clear on this. Here’s Wynne Godley in a 1993 article Time, Increasing Returns And Institutions In Macroeconomics, in S. Biasco, A. Roncaglia and M. Salvati (eds.), Market and Institutions in Economic Development: Essays in Honour of Paolo Sylos Labini, (New York: St. Martins Press), page 79:

… In the long period it will be the success or failure of  corporations, with or without active help from governments, to compete in world markets which will govern the rise and fall of nations.

In trying to defend the importance of fiscal policy, some economists such as Paul Krugman become forceful in their views about the way the world works and underplay the importance of matters such as international competitiveness. They seem to falsely believe that this strategy would work for them because accepting the importance of competitiveness would give enough chance for their opponents to argue against worldwide fiscal expansion.  It is a sad and counterproductive strategy.

Ben Bernanke Embracing Heterodox Ideas

It’s remarkable how some economists were ahead of the time, while others such as Ben Bernanke seem to just catch up. In a recent post on his blog Ben Bernanke gives out some unorthodox ideas to resolve the Euro Area crisis.

Ben Bernanke says:

… Germany’s large trade surplus puts all the burden of adjustment on countries with trade deficits, who must undergo painful deflation of wages and other costs to become more competitive. Germany could help restore balance within the euro zone and raise the currency area’s overall pace of growth by increasing spending at home, through measures like increasing investment in infrastructure, pushing for wage increases for German workers (to raise domestic consumption), and engaging in structural reforms to encourage more domestic demand. Such measures would entail little or no short-run sacrifice for Germans, and they would serve the country’s longer-term interests by reducing the risks of eventual euro breakup.

Second, it’s time for the leaders of the euro zone to address the problem of large and sustained trade imbalances (either surpluses or deficits), which, in a fixed-exchange-rate system like the euro zone, impose significant costs and risks. For example, the Stability and Growth Pact, which imposes rules and penalties with the goal of limiting fiscal deficits, could be extended to reference trade imbalances as well. Simply recognizing officially that creditor as well as debtor countries have an obligation to adjust over time (through fiscal and structural measures, for example) would be an important step in the right direction.

That’s in 2015.

Compare that to the conclusion from a 2007 paper titled A Simple Model Of Three Economies With Two Currencies: The Eurozone And The USA written by Wynne Godley and Marc Lavoie for Cambridge Journal Of Economics (journal link):

… it should be noted that balanced fiscal and external positions for all could as well be reached if the euro country benefiting from a (quasi) twin surplus as a result of the negative external shock on the other euro country decided to increase its government expenditures, in an effort to get rid of its budget surplus. This case, where the surplus countries rather than the deficit countries adjust, as many authors have underlined, would eliminate the current downward bias in worldwide economic activity. Now this would require an entirely new attitude towards government deficits. One would need an anti-Maastricht approach, that would run against the Stability and Growth Pact and its neoliberal obsession with fiscal balance and government debt reduction. For instance, one would need a new Pact, that would discourage fiscal surpluses. National governments that ran budget surpluses would pay large proportional automatic levies to the European Union, who would be compelled to spend the sums thus collected in the deficit countries. In this manner, the ‘weak’ and the ‘strong’ members of the eurozone could converge towards a super-stationary state, with balanced budgets and current accounts, through an increase rather than a decrease in government expenditures and economic activity.

Alternatively, the present structure of the European Union would need to be modified, giving far more spending and taxing power to the European Union Parliament, transforming it into a bona fide federal government that would be able to engage into substantial equalisation payments which would automatically transfer fiscal resources from the more successful to the less successful members of the euro zone. In this manner, the eurozone would be provided with a mechanism that would reduce the present bias towards downward fiscal adjustments of the deficit countries. This raises the profound question as to whether in the long term it is possible to have a community of nations which have a single currency which does not have a federal budget of substantial size, and by implication a federal government to run it—a point that was made very early on in Godley (1992).

[italics in original]

Is A Fiscal Union Expensive For Its Rich Members?

Josh Barro writing for The New York Times claims that a fiscal union for the Euro Area will be an enourmous expense for its rich members.

He cites the example of Connecticut:

But the American fiscal union is very expensive for rich states. According to calculations by The Economist, Connecticut paid out 5 percent of its gross domestic product in net fiscal transfers to other states between 1990 and 2009; that is, its tax payments exceeded its receipt of government services by that amount. This is typical for rich states: They pay a disproportionate share of income and payroll taxes, while government services are disproportionately collected in states where people are poor or old or infirm.

This is blatantly wrong. It assumes that output of individual regions and the whole of the the Euro Area will roughly be the same with or without a fiscal union. It ignores the notion that each region may be better off because a supranational fiscal authority will have powers to raise output via expenditure and taxes which individual regions cannot achieve.

In his 1997 article Curried EMU — The Meal That Fails To Nourish for Observer, Wynne Godley made this point well (link):

A useful comparison can be made with the US. Americans often point that if would make no sense if each US state had its own currency, so what is all the fuss about? But the question should be asked the other way round. How would the US make out with no President, no Congress, no federal budget, and no federal institutions apart from the ‘Fed’ itself, plus a powerful central bureaucracy?

The analogy is useful because the United States does so obviously need a federal budget as well as a federal bank, and the activities of the two authorities have to be co-ordinated.  If there is a recession, remedial (expansionary) fiscal policy at the federal level is the only proper response; it is inconceivable that corrective action could be left to component states, which have neither the perspective nor the co-ordinating machinery to do the job. If there is a federal budget there must obviously be a legislative and executive apparatus that executes it and is democratically accountable for it. Moreover, the need for federal institutions extends far beyond economic affairs.

[emphasis added]

So it is incorrect to claim that a fiscal union is highly expensive for rich states. If there is a fiscal union, while rich regions will receive less from the supranational fiscal authority than what they pay in taxes, there’ll be higher output and income than otherwise simply because there is a powerful institution which raises output of each region. Rich nations will be able to net export more than otherwise, for example, compensating for transfers in absolute terms.

Analysis such as by Josh Barro are erroneous usually because of implicit assumptions made such as an aggregate production function, which implies a neutral role for fiscal policy. This can easily be verified: his assumption is that output is determined by other factors, not fiscal policy (because he doesn’t say so) and hence the role of a central government is one which just transfers from rich regions to poor, instead of having any impact on the output of the whole region. Silly.

Free Trade? Heterodox Dissent

One of the most important message of this blog is that “free trade” is quite devastating to economies. In a recent article Economists Actually Agree on This: The Wisdom of Free Trade for The New York Times, Greg Mankiw once again pushes for free trade and also mentions that there is consensus in the profession.

Many of heterodox economists dissent on the issue of free trade. In this post, I will provide two examples: Joan Robinson and Wynne Godley.

Mankiw says:

Economists are famous for disagreeing with one another, and indeed, seminars in economics departments are known for their vociferous debate. But economists reach near unanimity on some topics, including international trade.

In the article, Mankiw tries to show among other things how free trade is the opposite of Mercantilism. Joan Robinson explained in her 1977 essay What Are The Questions? how foreign trade is important and that free trade is a subtle form of mercantilism.

According to Robinson:

A surplus of exports is advantageous, first of all, in connection with the short-period problem of effective demand. A surplus of value of exports over value of imports represents “foreign investment.” An increase in it has an employment and multiplier effect. Any increase in activity at home is liable to increase imports so that a boost to income and employment from an increase in the flow of home investment is partly offset by a reduction in foreign investment. A boost due to increasing exports or production of home substitutes for imports (when there is sufficient slack in the economy) does not reduce home investment, but creates conditions favorable to raising it. Thus, an export surplus is a more powerful stimulus to income than home investment.

In the beggar-my-neighbor scramble for trade during the great slump, every country was desparately trying to export its own unemployment. Every country had to join in, for any one that attempted to maintain employment without protecting its balance of trade (through tariffs, subsidies, depreciation, etc.) would have been beggared by the others.

From a long-run point of view, export-led growth is the basis of success. A country that has a competitive advantage in industrial production can maintain a high level of home investment, without fear of being checked by a balance-of-payments crisis. Capital accumulation and technical improvements then progressively enhance its competitive advantage. Employment is high and real-wage rates rising so that “labor trouble” is kept at bay. Its financial position is strong. If it prefers an extra rise of home consumption to acquiring foreign assets, it can allow its exchange rate to appreciate and turn the terms of trade in its own favor. In all these respects, a country in a weak competitive position suffers the corresponding disadvantages.

When Ricardo set out the case against protection, he was supporting British economic interests. Free trade ruined Portuguese industry. Free trade for others is in the interests of the strongest competitor in world markets, and a sufficiently strong competitor has no need for protection at home. Free trade doctrine, in practice, is a more subtle form of Mercantilism. When Britain was the workshop of the world, universal free trade suited her interests. When (with the aid of protection) rival industries developed in Germany and the United States, she was still able to preserve free trade for her own exports in the Empire. The historical tradition of attachment to free trade doctrine is so strong in England that even now, in her weakness, the idea of protectionism is considered shocking.

[emphasis: mine]

According to her colleague Wynne Godley, dissenting against free trade was one of the most important reasons for his dissent against the profession. In his short autobiography written in 2001 for A Biographical Dictionary Of Dissenting Economists (Edward Elgar book site), Godley says:

There are two aspects (in particular) of the work of the CEPG [Cambridge Economic Policy Group] which put its members into a category which may he termed ‘dissenting’. The first – a matter mainly of concern to the modelling fraternity and academic econometricians – was the unconventional view we took about how to construct and use an econometric model. Thus we attached prime importance to what may be termed ‘model architecture’ by which I mean that the underlying accounting was coherent, without any ‘dustbin’ equations or sectors; everything came from somewhere and went somewhere. Our view, by which I still stand, was that model architecture in this sense takes priority over parameter estimation; I am even prepared to conjecture that a properly a ‘architected’ model will deliver much the same results over a wide range of parameter estimates, particularly if the model is used for the simulation of medium- or long-term scenarios. Furthermore our use of the model was unconventional in that we treated it, not as something which would generate accurate forecasts of what would actually happen, but as a tool that informed our minds as to a great many possible outcomes conditional on a wide range of alternative assumptions both about exogenous variables and about parameter values. In using our model in this way we were greatly assisted by Cripps’s programming expertise, which permitted us to work with a speed and flexibility not generally available at that time. I should add that econometrics, as usually defined, played (advisedly) a relatively minor role in our work.

The second, and more egregious, respect in which we became a ‘dissident’ group was that, as a result of trying to think through the possible ways in which Britain’s net export demand might be improved, we entertained the possibility that international trade should be, in some sense, ‘managed’. There might, we argued, be no way in which the adverse trends could be reversed other than some form of control of imports. Our argument (see for instance Cripps, 1978; Cripps and Godley, 1978) was never one in favour of protectionism as normally understood – that is, the selective and unilateral protection of relatively failing industries under conditions of general stagnation. On the contrary, we were most careful to lay down conditions under which the management of trade would benefit not only our own country (without making its industry less efficient) but would also increase the level of trade and output in the rest of the world. The two basic principles were, first, that trade management should reduce import propensities without ever reducing imports themselves (in total) below what they otherwise would have been; and, second, that ‘protection’ should be as minimally selective as possible (for example, through the use of market mechanisms such as auction quotas) so that industrial inefficiency would not be sponsored.

I was surprised by the hostility with which our ideas about trade were received. It seemed to me at the time, and still seems to me, that the arguments actually used against us (at their most coherent by Maurice Scott et al., 1980) did not, in practice, rest on a well-articulated theoretical position but on very special assumptions about behavioural relationships and international political responses. (I have, to the best of my ability, answered these particular points in Christodoulakis and Godley, 1987.)

The ‘dissident’ argument in favour of managed trade is well summarized in Kaldor (1980), where he points out that the modern theory of international trade is based on the assumption that all production takes place according to the conditions described by the neoclassical production function, with constant returns to scale. Kaldor postulated instead, and he was surely right to do so, that the principle of circular and cumulative causation leads (through dynamically increasing returns) to a process, not of convergence, but of polarization between successful and unsuccessful economies in which success in competitive performance feeds on itself and losers become immiserated by trade.

The above quote is interesting from another perspective: it explains Godley’s views about modeling, policy, “forecasting” etc.

The Illogical Golden Rule

There’s a nice article by Wynne Godley written in 2005 for The Guardian on the fiscal policy golden rule. There are two things wrong about the golden rule. The first is to think that capital expenditure is somehow superior to current expenditure. This is the reason one frequently hears “wonks” stressing on government infrastructure spending. The other is to ignore changes in private sector behaviour and foreign trade performance.

From the article:

Criticism of the fiscal policy regime has focused too much on whether Gordon Brown will break his self-imposed Golden Rule and not enough on whether the rule is acceptable. The Golden Rule states that the balance between receipts and current expenditure should be zero over the cycle, exempting public investment, which does not ‘count’ for the purpose of making this calculation.

A relatively minor objection to this arrangement is that there exists no relevant difference between, say, capital expenditure on school building and current expenditure on teachers. Both are equally necessary for education and both absorb resources (pound for pound) to roughly the same extent.

More fundamentally, the budget balance is equal to the difference between the government’s receipts and outlays, but it is also equal, by definition, to the sum of private net saving (personal and corporate combined) plus the balance of payments deficit.

If the private sector decides to save more, the government has no choice but to allow its budget deficit to rise unless it is prepared to sacrifice full employment; the same thing applies if uncorrected trends in foreign trade cause the balance of payments deficit to increase.

A sensible target for the budget balance cannot be set unless it is integrated into a view about what will happen to autonomous trends and propensities in private net saving and foreign trade. Moreover, as those trends and propensities change, it will never be possible to determine viable targets for the deficit that are fixed through time such as, for instance, that it should never exceed some number such as 3 per cent of GDP or that it should on average be zero.

Coming back to the medium-term future of the British economy: if, as seems quite possible, there is now a growth recession initiated by a fall in personal expenditure, the government will have no option but to allow the deficit to rise well beyond what the Golden Rule permits. The authorities will look ridiculous if they move the goalposts again, so the rule will have to be jettisoned. I don’t think it will be long before discretionary fiscal policy, once discredited by a few serious errors in the Sixties and Seventies, has to be rehabilitated.

Interest Rate, Growth And Debt Sustainability

Frequently, discussions about debt sustainability have discussions about the importance of the interest rate and growth in debt sustainability analysis. See for example, today’s Paul Krugman’s post on his blog. It is concluded that as long as the rate of interest is below the rate of growth, the ratio public debt/gdp doesn’t explode. Unfortunately, this result is erroneous.

John Maynard Keynes’ biggest disservice to the profession is to not start with the open economy. In my view, debt sustainability is tightly connected to balance of payments.

Imagine a nation whose exports is constant. If output rises, it will have adverse effects on the current account balance of payments because of income induced increase in imports. This will have an adverse effect on the international investment position of the nation: the net international investment position will keep deteriorating unless output is slowed down or some measure is taken to improve exports. In the case of rising exports, there is a similar constraint, except it is weaker but dependent on the rate of growth of exports.

If the ratio net international investment position/gdp keeps deteriorating, either the public debt to non-residents or private indebtedness to non-residents or both have to keep rising, all unsustainable.

There are some complications. A nation’s balance of payments also depends on how assets held abroad and liabilities to foreigners affect the primary income account of balance of payments. Also, the exchange rate can depreciate (or be devalued in fixed-exchange rate regimes) improving exports and reducing imports. However assuming that exchange rate movements do the trick is believing in the invisible hand. Foreign trade doesn’t just depend on price competitiveness but also on non-price competitiveness. These complications are highly interesting but do not affect the fundamental fact that a nation’s success is dependent on the success of corporations to compete in international markets for goods in services.

Even the conclusion that the government should contract fiscal policy and aim for a primary surplus in its budget balance or else the ratio public debt/gdp keeps rising if the rate of interest is greater than the rate of growth is erroneous. Consider a closed economy. An expansion in fiscal policy will automatically raise output and gdp and hence tax collections to prevent the ratio public debt/gdp from exploding. The public sector balance may hit primary surpluses but not due to contraction of fiscal policy or targeting a primary surplus in its budget balance.

In short, although the rate of interest and the rate of growth are important in debt sustainability analysis, it is not as easy as is usually presenting in macroeconomics textbooks and in the blogosphere. For a more detailed analysis see the reference below.


  1. Godley, W. and B. Rowthorn (1994) ‘Appendix: The Dynamics of Public Sector Deficits and Debt.’ In J. Michie and J. Grieve Smith (eds.), Unemployment in Europe (London: Academic Press), pp. 199–206

Updated 8 Apr 2015, 6:52 am UTC.

The U.S. Net International Investment Position At The End Of 2014 [Updated]

The U.S. Department of Commerce’s Bureau of Economic Analysis today released accounts for the United States’ international investment position. The U.S. is sometimes called the world’s biggest debtor and its net international investment position is now (at the end of 2014) minus $6.9 trillion.

Here’s the chart from the BEA’s website. U.S. Net International Investment Position 2014A few points. The importance of the U.S. balance of payments and international investment position is quite neglected in analysis of the crisis. The United States’ economy went into a crisis (and the rest of the world with it) because a huge rise in private indebtedness led to a fall in private expenditure relative to income when the burden of the debt started pinching. This caused a drop in economic activity and was saved partly due to automatic stabilizers of fiscal policy as tax payments fell due to a drop in economic activity and partly due to a relaxation of fiscal policy itself by the U.S. government and governments abroad. But the huge rise in the U.S. government debt meant that resolving the crisis by fiscal policy alone would have been difficult. This is because a huge fiscal expansion would have meant that the U.S. trade deficit would have risen much faster into an unsustainable path.

See Wynne Godley’s article The United States And Her Creditors: Can The Symbiosis Last? from 2005 here arguing such things.

Back to the international investment position. There are a lot of interesting things about it. Although the U.S. in a huge debtor to the rest of the world, the return on assets held by resident economic units of the United States earn more than paying on liabilities to nonresidents. So according to the BEA release U.S. International transactions 2014, investment income in the full year was about $813 billion while income payments was about $586 billion. (More complication arises from “secondary income”).BEA-2014-U.S.-International-Transactions

In addition, revaluations of assets and liabilities also affect the international investment position and revaluations of direct investment held abroad has acted in the United States’ favour.

Of course this cannot always be the case. Take a simple example: Suppose an economic unit’s assets is $100 and liabilities is $150 and suppose assets earn 8% every year and interest paid on liabilities is 5%. So even though the economic unit has a net indebtedness of $50, it is earning

$100 × 8% − $150 × 5% = $0.5

However, if liabilities rise to $160 and beyond the net return turns negative.

In a similar way, there is a tipping point, beyond which the net primary income of the current account of balance of payments turns negative. Because the United States has a negative current account balance and the deficit adds to the net indebtedness every year, at some point in the future, the international investment position may reach a tipping point.

All this sounds as if domestic demand and output are unrelated. This is of course not the case. Imports depend on domestic demand and exports depend on economic activity abroad. Hence the constraint on output at home because if output were to rise fast, the net indebtedness of the United States will also rise fast.

Of course the concept of a tipping point may itself be misleading. Indebtedness can keep rising even if net primary income turns negative without any trouble in financial markets because it all depends on how the financial markets see the problem. But it may be said that once a tipping point is reached, the debt will start to rise much faster than now. My article here hasn’t gone into any analysis here with numbers but I will leave it for another day.

Derailed: Wynne Godley On The Euro Area

I am in favour of Britain having much closer ties with other European countries, provided that appropriate institutions are created and the whole thing is brought under effective political control. But I have never been able to understand what it is that those who support the Maastricht Treaty think they are going to get out of it. Maastricht supporters are keen on ‘not being left out’. But left out of what exactly?

It seems clear that the Maastricht criteria for the establishment of ‘convergence’ were far too narrowly conceived. To fulfil the conditions necessary for a successful currency union it is not nearly enough that member countries agree to follow simple rules on budgetary policy and achieve some minimum period of low inflation and currency stability. They need to reach a degree of structural homogeneity such that shocks to the system as a whole do not normally affect component regions in drastically different ways. Moreover, arrangements should be made which ensure that when substantial changes of a structural kind do turn up the federal authority is equipped to share out any burden which ensues. It would be wrong to suppose that there exist well-defined ‘fault lines’ which can be cured once and for all. Structural changes are always going to be taking place as a consequence of political earthquakes, or for other reasons, and the Community must have some way of dealing with them.

– Wynne Godley, Derailed, 1993

A list of articles by Wynne Godley on the Euro Area:

  1. ‘Commonsense Route To A Common Europe’, Observer,  6 January 1991, page 28 (scan)
  2. ‘Maastricht And All That’, London Review of Books, Vol. 14 No. 19, 8 October 1992, pages 3-4 (link)
  3. ‘Derailed’, London Review of Books, Vol. 15 No. 16, 19 August 1993, page 9 (link, more here)
  4. ‘Curried EMU – The Meal That Fails To Nourish’, Observer, 31 August 1997, page 24 (scan)

Wynne-Godley-July-1981Wynne Godley, July 1981
(picture source)

Greg Mankiw And Empirics

Greg Mankiw wonders if teaching students empirics is feasible and answers in negative:

Noah Smith says introductory economics needs to be more empirical. I understand his argument, and have some sympathy with it, but I wonder if the substantial change he seems to be proposing is practical. Economists usually do empirical work with statistical tools that most college freshmen have not yet learned.

We teachers of introductory economics can and should explain where and why economists disagree. That is part of helping students develop their critical thinking skills. But I doubt students are in a position to try to evaluate the competing empirical work that shapes the differing views.

In the end, introductory economics is just that: an introduction to the economist’s way of thinking. That means giving students basic concepts–comparative advantage, supply and demand, market efficiency and market failure–that will make them more perceptive readers of the newspaper.

The failure to teach empirics to students and how it distorts their vision was well understood by Wynne Godley. In a 1993 article Time, Increasing Returns And Institutions In Macroeconomics, in S. Biasco, A. Roncaglia and M. Salvati (eds.), Market and Institutions in Economic Development: Essays in Honour of Paolo Sylos Labini, (New York: St. Martins Press), pp. 59-82 he wrote:

… But my objection goes beyond skepticism that the world we live in is being described realistically. My additional concern is that the NCP [neoclassical paradigm] is prejudicial with regard to the understanding of some of the most important processes going on in the world today. Thus in the ‘classical’ version of the NCP real output is determined by supply side alone; fiscal policy is entirely impotent and the government can only affect anything by changing the money supply; even then all it can do is affect the price level. The idea that fiscal policy is impotent, which seems to be based entirely on this model, has been extremely influential in contemporary political discussion; it is not just a provisional result suitable for a week or two in an elementary class.

Then the abolition of time prejudices the perception of inflation as an evolutionary process; the equilibria generate ‘explanations’ of price levels not changes, and theories of inflation cannot be convincingly coaxed forth. As if this were not enough, the whole construction leads by virtue of its axioms to the conclusion that wage and price flexibility, in combination with free trade, will generate full employment and convergence, if not equalisation, of living standards between countries and between regions within countries. In sum, while the absence of processes occurring in historical time means that the NCP does not encourage students to go and look up figures in books, if and when they are forced to do so their vision is likely to have been for ever distorted.

[emphasis added]