Monthly Archives: April 2025

Wynne Godley On Resolving Imbalances In International Trade

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International trade is central in Wynne Godley’s models and work. Wynne Godley not just foresaw the unsustainability of US private sector imbalances and the return of Keynesianism, he also proposed non-selective protectionism for the United States. Over time, he thought that more international efforts are needed, such as changing how international institutions are run.

In his article The United States And Her Creditors — Can The Symbiosis Last? written in 2005 (with coauthors), he said:

A resolution of the strategic problems now facing the U.S. and world economies can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment.

In his last article Prospects For The United States And The World: A Crisis That Conventional Remedies Cannot Resolve (with coauthors), he said:

Need for Concerted Action
…
At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

But, however well coordinated, this approach will not be sufficient.

What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade.

Since this series of reports began in 1999, we have emphasized that, in the United States, sustained growth with full employment would eventually require both fiscal expansion and a rapid acceleration in net export demand. Part of the needed fiscal stimulus has already occurred, and much more (it seems) is immediately in prospect. But the U.S. balance of payments languishes, and a substantial and spontaneous recovery is now highly unlikely in view of the developing severe downturn in world trade and output. Nine years ago, it seemed possible that a dollar devaluation of 25 percent would do the trick. But a significantly larger adjustment is needed now. By our reckoning (which is put forward with great diffidence), if the United States were to attempt to restore full employment by fiscal and monetary means alone, the balance of payments deficit would rise over the next, say, three to four years, to 6 percent of GDP or more—that is, to a level that could not possibly be sustained for a long period, let alone indefinitely. Yet, for trade to begin expanding sufficiently would require exports to grow faster than we are at present expecting, implying that in three to four years the level of exports would be 25 percent higher than it would have been with no adjustments.

It is inconceivable that such a large rebalancing could occur without a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.

Francis Cripps, Alex Izurieta and Ajit Singh also talk of a different way to run the world, in their 2011 article Global Imbalances, Under-consumption And Over-Borrowing: The State Of The World Economy And Future Policies:

John Maynard Keynes repeatedly observed that the economy is a highly complex machine which we do not fully understand. This article and the Cambridge-Alphametrics-Model on which it is based represent an effort to appreciate the complexities of the world economy and its components and to seek avenues for international policy coordination. The main message that comes out of this exercise is the realization that the world economy is highly interdependent and increasingly needs far-reaching and very many specific interventions for it to achieve its full potential while pursuing a better distribution of income and employment. This in turn requires deeper knowledge of the functioning of the world economy and new institutions to achieve the required high levels of cooperation between nation states. At the moment the primary global institutions of economic coordination such as the IMF are, regrettably, more a part of the problem than its solution.

Not Bancor, But An International Agreement

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While John Maynard Keynes understood that trade/current account deficits can become a problem, not just for a country with it but also for the whole world, he quite underplayed the role of international trade.

(You can read about the downplaying in Nicholas Kaldor’s essay Keynesian Economics After Fifty Years, in the book Keynes And The Modern World : Proceedings Of The Keynes Centenary Conference, King’s College, Cambridge, written in 1983)

To resolve imbalances, Keynes proposed Bancor, a word which is a combination of the words ‘bank’ and ‘or’, which means gold in French, according to a paper The Eurozone: Similarities To And Differences From Keynes’s Plan by Marc Lavoie.

From the paper:

… The plan is based on a fixed exchange rate system, each foreign currency being expressed as a fixed value of the bancor …

A comprehensive explanation can be found in Marc Lavoie’s paper, which I won’t delve into here. But the important point is that there is a supranational central bank—an International Clearing Bank/ICB—like the ECB, in which national central banks hold accounts and which clears international payments.

Now Keynes proposed various rules, based on settlement balances of national central banks at the ICB, to give a sort of responsibility to surplus countries, such as fines but also that they expand their economies, so that they import more and deficit countries able to take measures such as devaluation.

But there is a problem!

The problem is that surplus/deficit etc are defined from settlement balances of national central banks at the ICB, which are not current account deficits, or not necessarily any indication for other things such as the net international investment position!

Imagine a country such as China which has huge trade or current account surpluses and then the counterpart in the financial account of the balance of payments is the Chinese government accumulating US government bonds. The Chinese central bank’s account at the ICB hardly changes, and the balances show no indication that any surpluses are being built up, and no rules need to triggered.

So obviously Bancor cannot be the solution. The solution is diplomacy at the international level, mainly with current account deficit numbers, but other data in the balance of payments and international investment position too. With responsibilities for surplus countries.

International Trade And Demand Management

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It seems that even post-Keynesians—with rare exceptions—are largely inattentive to open economy macro. Exceptions in this century are Wynne Godley and some people highly influenced by him.

In an article Wynne Godley Calls For General Import Controls, for LRB, published in the year 1980, Wynne Godley, argued:

For growth to be sustainable, it is essential that the management of domestic demand be complemented by the management of foreign trade (by whatever policies) in such a way that the net balance of exports less imports contributes in parallel to the expansion of demand for home production

Although in pedagogy Wynne Godley used to introduce the open economy late, it is central to his ideas. For example, you can expressions such as:

GDP ≈ (G + X)/(θ + μ)

where G, X, θ and μ are government expenditure, exports, the tax rate, and propensity to import. This is to first approximation

Even many post-Keynesians—not just neoclassical economists—giving public commentary recently in the aftermath of Trump’s tariffs however seem to be saying “do nothing“.

Before the financial crisis which started in 2007, fiscal stance was tight and US exports relative to imports was also low. So the above expression was lower than the actual GDP and growth was mainly driven by private sector borrowing at a large scale. When the recession happened, the fiscal part of the expression (G + X)/(θ + μ) was relaxed, although not enough to reach full employment. The process was still unsustainable since the international trade part of the expression did not grow in parallel with the fiscal part, continuing the worsening of the US balance of payments and international investment position.

The New Tariffs

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US President Donald Trump’s new tariffs seem haphazard but to me the reaction of people—including that of post-Keynesians—seems more interesting. The general reactions seem to be that the United States does not need to do anything. Across the political spectrum, people seem to peddle do-nothingism.

The United States’ balance of payments and international investment position is on an unsustainable path.

US NIIP/GDP

United States NIIP/GDP ratio. Chart via FRED

−1.0 means −100% of GDP.

Now that is just a chart but even from a theoretical perspective one can provide an analysis such as using Wynne Godley’s models.

Since the market mechanism does not reverse the process, an official intervention is needed.

Wynne Godley worried a lot about this and had proposed non-selective protectionism for the United States.

But going by people’s reactions with even the most radical sounding people sounding like fans of free trade, it seems to me that people simply would have rejected any proposal even if it were not haphazard.

Wynne Godley’s biographer Alan Shipman says this about him in his biography:

Of all Godley’s policy prescriptions, direct import controls were the one most roundly rejected by other economists, and least likely to be adopted by politicians with any chance of gaining power. The accusation of advocating a policy that was economically illogical, politically infeasible and inadmissible in international law hurt deeply, but never crushed his belief that import quotas should be seriously considered as an additional macroeconomic instrument. The depth of the wound emerged in an unusually personal statement to a 1978 conference on ‘Slow Growth in Britain’, convened by Oxford University’s Wilfred Beckerman in Bath. ‘I am disconcerted and distressed to find myself, together with the group of people with whom I work in Cambridge, in such an isolated position. For we seem to be the only group of professional economists who entertain the possibility that control of international trade may be the only way of recovering and maintaining the prosperity of this country; that free trade may be an enemy for the relatively weak’ (Godley 1979: 226).

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References

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Godley, W. (1979). Britain’s chronic recession—Can anything be done? In W. Beckerman (Ed.), Slow Growth in Britain. Oxford: Clarendon Press.

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Talking of Wynne Godley, I found this nice autograph in his own book ‘Monetary Economics’, presumably to Lance Taylor?

Anyway, there are is one thing I wanted to address which is often made … that the trade deficit is just a reflection of the saving and investment decision of the private sector (or the country as a whole including the government) because there is an accounting identity connecting the two:

S − I = DEF + CAB

Where, S, I, DEF and CAB are private saving, private investment, government deficit and current account balance respectively.

But this accounting identity is not causation itself. Exports and imports depend on income and price elasticities, and income and price at home and abroad, so while private sector parameters of saving and investment can affect the trade balance, it is also affected by the elasticities. And if elasticities for imports are high relative to imports of the rest of the world, then that is a problem of competitiveness which the US is facing.