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John Maynard Keynes On Surplus Nations’ Obligations

Recently, The Economist‘s cover story declared that the government of Germany ought to expand domestic demand and its refusal to do so is a threat to the world economy. It also said, “Germany’s surpluses are themselves a threat to free trade’s legitimacy.”

Post-Keynesians have long recognized this problem with the world economy. Keynes himself said in 1941:

It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments. … The contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors. Nor is this all. … The social strain of an adjustment downwards is much greater than that of an adjustment upwards. … The process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannotfall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion

– in Collected Works, Vol. XXV, pages 27-28.

Few things:

Keynes is building a narrative to argue that creditor nations have responsibilities, although at that time (and also at present), they have no obligation. This was the motivation for his plan for Bretton-Woods, where he proposed to impose fines on creditor/surplus nations and set out some responsibilities for them.

Also, although the above was written keeping in mind a new world order (at 1941), it’s still valid for the post-Bretton-Woods era. This is because, although floating exchange rates help making adjustments, their power is completely exaggerated.

It’s also important to keep in mind, that the world is more complicated now. Creditor/suprlus nations have achieved their status by making adjustments, i.e., by keeping wages and domestic demand low. So it’s not exactly or literally like what Keynes presented. It’s not the best of worlds in Germany or China.

Still, what Keynes said was highly insightful.

It’s also interesting that for The Economist, Germany’s behaviour is a “threat to free trade’s legitimacy.” Nicholas Kaldor also said the same in 1980:

In the absence of … measures all countries may suffer a slower rate of growth and a lower level of output and employment, and not only the group of countries whose economic activity is ‘balance-of-payments constrained’. This is because the ‘surplus’ countries’ own exports will be lower with the shrinkage of world trade, and they may not offset this (or not adequately) by domestic reflationary measures so that their imports will also be lower.

– in Foundations And Implications Of Free Trade Theory

For The Economist, Germany’s behaviour is a threat to free trade. For Post-Keynesians, Germany’s behaviour is expected (and ought to be different) and is a good reason to reject free trade.

But it’s not a bad thing that The Economist recognizes Keynes’ insights.

The Economist On Germany’s Balance Of Payments

The Economist‘s latest cover is about the German balance of payments. The subheading of its editorial says, that it “[t]he country saves too much and spends too little”.

That’s welcome, although the article claims that the German government’s policy is not mercantilist, while at the same time saying that wages have been held down to achieve more competitiveness in exports.


Anyway, it’s good that it has recognized that this is a problem for the world economy. Funnily, the editorial is still defending free trade, without realizing that the ideology is based on the assumption that market forces will resolve imbalances. If the magic of the price mechanism works, why do you need active policy?

It’s important to remember that John Maynard Keynes recognized that active policy measures are needed to resolve global imbalances. He proposed to impose a penalty on creditor nations in his plan for Bretton-Woods and also require them to take measures such as:

(a) Measures for the expansion of domestic credit and domestic demand.
(b) The appreciation of its local currency in terms of bancor, or, alternatively, the
encouragement of an increase in money rates of earnings;
(c) The reduction of tariffs and other discouragements against imports.
(d) International development loans

– page 24 of The Keynes Plan

A lot of times, people argue that the moral stand that Germany reduce its surpluses is vacuous. Germany is independent and responsible for its own decision. Who are others asking German politicians to raise domestic demand?

The answer to that is Germany makes huge gains out of its success in international trade. What if deficit nations form a union and impose high tariffs and quotas on their imports? International trade runs under a set of rules (the “rules of the game”) and other nations have a right to demand this from Germany and ask for fairer rules.

Anyway, The Economist has finally accepted what Keynes was saying 80 years ago!

Two Hundred Years Of Ricardian Trade Theory

Ingrid Kvangraven has a nice article200 Years of Ricardian Trade Theory: How Is This Still A Thing? on the blog, Developing Economics. In that, she asks how “the observation of persistent imbalances (and recurring debt crises in the deficit countries) appears to have little impact on the popularity of Ricardo’s theory.”

It’s a nice article going into details about the assumptions of the trade theory, but let me just add another perspective. New Consensus Economics is based on the assumption about the magic of prices and market forces acting to resolve imbalances. Government “intervention” (a loaded word), supposedly spoils this magic and economists are trained to think that this is the reason for crisis. So a New Consensus economist doesn’t find this to be contradictory. “Hey government, why did you interfere with the workings of the market”, an economist is likely to say.

The role of the government in this model is mainly about law and order and is supposed to balance its books. Whenever a crisis arises, economists tend to blame “fiscal profligacy” and recommend contraction of fiscal policy and “economic reforms”.

Of course, since the financial crisis started about ten years back, economists have conceded that they have been wrong about several things. Fiscal policy is one major area where this is so. But the “learned intuition” is so deeply ingrained and ramified into every corner of their minds—borrowing words from Keynes—that it is difficult for them to escape old ideas.

It’s unfortunate that Keynes didn’t stress much about this problem, which is huge. In his GT, he did have a chapter on mercantilism and discussed how the mercantilists behaved the way they behaved because of their distrust in the role of market forces in resolving imbalances. Keynes also had a plan called the Keynes Plan, before the Bretton Woods established. Keynes proposes a fine on creditor nations as well (page 23-24):

from page 23 of IMF’s document on Keynes’ Plan

Usually one only hears of this in Post-Keynesian literature but this was not all. He also proposed other responsibilities for creditors:

from page 24 of IMF’s document on Keynes’ Plan

Of course, the idea of a Bancor sounds crazy because of its similarity to the Euro. The trouble with the Euro is that there is no central government with large fiscal powers, such as in a federation like the United States. Bancor would need a world government. Nonetheless, we can still embrace Keynes’ genius that creditors should take responsibility in the rules of the game and reject Bancor. So apart from the principle of effective demand, this is one of Keynes’ biggest contribution to the history of humankind—that creditor nations have a responsibility.

Unfortunately, the world is still stuck with Ricardo’s ideas!

Robots, Globalization, Unemployment, Etc

Worker: I am losing my job because of globalization.

Economist: No, you are losing it because of automation.

[Plus calling them ‘losers’, such as by saying, “losers of globalization should be compensated”]

This is not just unhelpful but wrong too! Actually, saying it is wrong is underplaying it. It’s okay to be wrong sometimes—everyone is wrong sometimes—but how bad can getting it precisely the opposite every time? Anyone throwing darts at the dartboard can hit the bulls eye by fluke but what is it like throwing darts in the opposite direction?

Economists should be more modest and remind themselves of what Keynes said about workers in The General Theory:

… workers, though unconsciously, are instinctively more reasonable economists than the classical school

There is some irony to all this. Economists have played down the notion of technological unemployment. If production is constant and productivity rises, there’s a fall in employment because less labour is required to produce the same output. So output has to rise to keep employment from falling because of “automation”. In Post-Keynesian economics, the principle of effective demand matters both in the short run and the long run. So technological unemployment is a real possibility. New Consensus economists concede that John Maynard Keynes rules in the short run but assume that Jean-Baptiste Say rules in the long run. The irony hence is that New Consensus economists seem to show worry about automation these days.

In my opinion, this is because the sacred tenet of free trade must be defended by economists at all costs. So they make a concession about loss of employment to robots. Unfortunately that’s not right either. Globalization—both because of competition by international producers and offshoring of jobs via global supply chains—has led to the loss of livelihood for many in the Western world.

Political parties with fascistic tendencies have noticed this huge error at the heart of the New Consensus economics and the liberal political parties to whom these economists advise. They have understood that by pointing out that globalization—under the current rules of the game—can destroy jobs. They have seen support from people. It’s true that the political movement is not likely to deliver much but at the same time, liberal leaning political parties should try to understand this to regain lost ground.

Instead, we see writing such as The Productivity Paradox by Ryan Avent of The Economist. It’s only a paradox if you view it using the lens of the New Consensus Economics. He himself seems to appreciate others’ claims that:

the robot threat is totally overblown: the fantasy, perhaps, of a bubble-mad Silicon Valley — or an effort to distract from workers’ real problems, trade and excessive corporate power.

Not sure why the Silicon Valley gets the blame, and not economists themselves, but anyway, that is some conceding.

Remember the concept of technological unemployment is a race condition.

If productivity rises a lot and demand not much, we have unemployment. If the latter rises fast, we have more employment.

In fact productivity rises in the Western world has been quite low recently and we should embrace robots. This is because measured productivity is likely to rise if output rises. Productivity rise (as per the Kaldor-Verdoon Law) is due to two things: an exogenous component and an endogenous component which depends on the rise in output. Also, remember Keynes talked of autonomous and induced expenditures as component of effective demand, which drives output. So if governments around the world design policy in which demand rises fast, then “automation” can not just be welcomed, it will be a cause of it, i.e., higher production leading to more automation because of learning-by-doing. But economists will continue to get it backward!

“In The Long Run”

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.

–  John Maynard Keynes, A Tract on Monetary Reform (1923), Ch. 3, p. 80.

As you might know, the Indian government cancelled the legal tender nature of majority of bank notes in circulation, earlier this month and asked Indians to deposit them at banks or exchange them for new. The aim according to the government was to curb counterfeiting and what’s called black money here. This is damaging as a large amount of transaction is in bank notes and the implementation has been a failure. People have been standing in queues for the whole day and some even reach banks at 2 am to get a good position in the queue. For many, standing in queues means that the day’s labour is lost. For others, there are delays in wage payments since their employers have problems getting hold of new bank notes. More than 50 people have died. Even 11 bank managers have died due to stress and work overload.

Despite this we keep hearing from the government and the ruling political party’s defenders that the benefits will be long term.

The previous Indian Prime Minister (who was the nation’s leader during mid 2004-mid 2014), Manmohan Singh gave a scathing speech in the Indian Parliament yesterday in which he quotes Keynes on the long run. Manmohan Singh was a student at Cambridge and his heroes are Nicholas Kaldor and Joan Robinson and presumably John Maynard Keynes as well. In this era where politicians are promoting neoliberal ideas, it’s good to see the master being quoted in a Parliament.

The seven-minute video is linked below.


click the picture to see the video on YouTube. 

This question about the long-term reminds me of super-hysteresis which was referred by Marc Lavoie recently in an article for INET. It’s closely related to the Kaldor-Verdoorn law in which demand affects supply.  The damage done to the demand side because of slowdown in production caused by the Indian government’s poor implementation of its decision to replace majority of bank notes by value affects the supply side as well. Almost nobody who talks about the long-term benefits talks about this issue.

Free Trade And Balanced Budgets

Wikileaks has released “The Podesta Emails” which show Hillary Rodham Clinton’s political positions best explained by an NYT article:

[Clinton] embraced unfettered international trade and praised a budget-balancing plan that would have required cuts to Social Security, according to documents posted online Friday by WikiLeaks.

The tone and language of the excerpts clash with the fiery liberal approach she used later in her bitter primary battle with Senator Bernie Sanders of Vermont and could have undermined her candidacy had it become public.

Neoliberalism, the “New Consensus” and pre-Keynesian economics stand exactly for this idea: free trade and balanced-budgets. John Maynard Keynes’ true followers starting with Joan Robinson stood exactly in dissent against the idea of free trade and balanced budgets. Keynes himself understood the trouble with free trade, as can be seen by reading his chapter on Mercantilism in the General Theory, but didn’t emphasize it enough. Unlike what others see, Joan Robinson stood for her opposition to free trade more than anything else.

According to the New Consensus of economics, fiscal policy is impotent and hence budget should be balanced. Free trade will lead to convergence of fortunes of nations according to this view. Instead what we see is polarization. In my previous post, I quoted a top advisor who conceded how economists had been wrong about fiscal policy. But the damage seems to have done. Progressive and Keynesian ideas have a long battle ahead.

Needless to say Donald Trump is not the alternative. So there’s a lot of fight ahead for economists in years ahead to overthrow the new consensus. Macroeconomics makes a difference in people’s life, and it’s a battle worth fighting.

On The Blogs

Two things caught my attention in the last two days.

First is the claim by Roger Farmer:

The Keynesian economics of the General Theory is static.

That’s the strangest critique of the GT I have ever seen. How is the GT static? John Maynard Keynes highlighted how a fall in the propensity to consume reduces output. His mechanism was quite dynamic. He was arguing that a fall in the propensity to consume will reduce consumption and hence firms’ sales and hence production and hence employment and hence consumption and so on. Keynes did not explicitly write down a mathematical model like as done for example in the book Monetary Economics by Wynne Godley and Marc Lavoie. But his arguments were quite dynamic in nature. So was his argument about how investment creates saving. And also the Keynesian multiplier. “Stock-flow consistent” models are quite close to Keynes’ spirit.

The second is this paragraph from Michael Pettis:

… This is one of the most fundamental errors that arise from a failure to understand the balance of payments mechanisms. As I explained four years ago in an article for Foreign Policy, “it may be correct to say that the role of the dollar allows Americans to consume beyond their means, but it is just as correct, and probably more so, to say that foreign accumulations of dollars force Americans to consume beyond their means.” As counter-intuitive as it may seem at first, the US does not need foreign capital because the US savings rate is low. The US savings rate is low because it must counterbalance foreign capital inflows, and this is true out of arithmetical necessity, as I showed in a May, 2014 blog entry (link broken: archive.is link).

Oh boy! That’s confusing accounting identities with behaviour. A simple way to show how inaccurate this is by using standard Keynesian analysis. Assume US households reduce the propensity to consume. This leads to a fall in output and income and hence a fall in imports and an increase in the current account balance of payments (assuming exports are exogenous to the model). This can be seen more precisely in a stock-flow consistent model.

Pettis’ arguments are in response to Stephen Roach’s recent article on US balance of payments and I discussed that recently here.  Both Roach and Pettis are incorrect.

Balance of payments is important and in my opinion, the most important thing in Economics. Michael Pettis gets the attention because he realizes the importance of balance of payments in the economic dynamics of the world. However looked more closely, many of his arguments appear vacuous.

Kalecki And Keynes, Part 2

Continuing from the previous post, Kalecki And Keynes …

The General Theory of Employment, Interest and Money was published in January, 1936.

Meanwhile, … , Michal Kalecki had found the same solution.

His book, Essays in the Theory of Business Cycles, published in Polish in 1933, clearly states the principle of effective demand in mathematical form. At the same time he was already exploring the implications of the analysis for the problem of a country’s balance of trade, along the same lines that I followed in drawing riders from the General Theory in essays published in 1937.

The version of his theory set out in prose (published in ‘Polska Gospodarcza’ No. 43, X, 1935) could very well be used today as an introduction to the theory of employment.

He opens by attacking the orthodox theory at the most vital point – the view that unemployment could be reduced  by cutting money wage rates. And he shows (a point that Keynesians came to much later, and under his influence) that , of monopolistic influences prevent prices from falling when wage costs are lowered, the situation is still worse, because reduced purchasing power causes a fall in sales on consumption goods …

Michal Kalecki’s claim to priority of publication is indisputable.

– Joan Robinson, Kalecki And Keynes in Essays In Honour Of Michal Kalecki, 1964. 

Kalecki And Keynes

Michal Kalecki swam into my ken just after the publication of the General Theory of Employment, Interest and Money, in 1936. The small group who had been working with Maynard Keynes during the gestation of the book understood what it was about, but amongst the public as a whole it was still a mystery. Kalecki, however, knew it all. He had taken a year’s leave from the institute where he was working in Warsaw to write the theory of employment but Keynes’ book came out, and got all the glory. Michal never made any claim for himself and I made it my business to blow his trumpet for him, but most of the profession (including Keynes) just thought that I was being kind to a lame duck. Only since the publication of his essays written in Polish from 1933 to 1935 has it been generally recognized that he had already worked out all the essentials of what became known as Keynes’ theory (Selected Essays on the Dynamics of the Capitalist Economy, Cambridge University Press, 1971). He showed that it is investment, not private saving, that brings about capital accumulation; that a government deficit, in a slump, will increase employment; that cutting wages only makes the slump worse; that the rate of interest depends upon supply and demand of the stock of money, not on the flow of saving, and that it is the forward-looking expectation of profits that induces firms to accumulate.

The question of glory did not seem to me to be important. As Michal was the first to admit, his ideas would have taken a long time to establish while with Keynes they burst upon the world as a revolution. But I was deeply impressed by the fact that two thinkers of such different background and habits of thought could arrive at the same diagnosis of the economic situation. Logic is the same for everybody; the same logical structure, if it is not fudged, can support quite different ideologies, but for most social scientists ideology leaks into the logic and corrupts it.

In the natural sciences, it is common enough for the same discovery to come almost simultaneously from two independent sources. The general development of a subject throws up a new problem and two equally original minds find the same answer, which turns out to be validated by further work. In the history of economic thought, the case of the discovery of the theory of employment by Keynes and Kalecki is unique.

– Joan Robinson in PORTRAIT: Michal Kalecki, Challenge, Vol. 20, No. 5, November/December, 1977, pp. 67-69, http://www.jstor.org/stable/40719591

Being Keynesian In The Short Term And Classical In The Long Term

I am not. But the post is about the possibility. The title is borrowed from a paper by Gérard Duménil and Dominique Lévy.

Steve Roth has an article titled Note To Economists: Saving Doesn’t Create Savings. If you follow his blog regularly, his pieces read

The definition of saving is wrong. Saving is equal to income minus expenditure.

That’s not an exaggeration. He actually says it:

… Since saving = income – expenditures, [aggregate] saving must equal zero.

Steve Keen on Twitter supports Steve Roth.

Steve Keen Tweet

What’s with economists’ dislike for national accounts?

Steve Roth uses the phrase “savings” as a stock. Obviously his claim is just wrong as we know from national accounts:

Change in net worth = Saving + Holding Gains.

(with netting in holding gains).

Steve Keen doesn’t use saving as a stock but as a flow and a plural of saving. But Steve Keen’s point is also wrong. National saving is equal to the sum of saving of all economic units, such as households, firms, government etc. Even the household sector’s propensity to save collectively matters. That’s what macroeconomics is all about.

Now moving the more important point: is it possible that a higher propensity to consume reduces the long run rate of accumulation?

There are several Post-Keynesian economists who have considered the possibility. Of course it should be contrasted with supply side neoclassical economics. A few are Basil Moore, Wynne Godley, Marc Lavoie, and Gérard Duménil and Dominique Lévy as mentioned at the beginning of this post.

In their paper Kaleckian Models of Growth in a Coherent Stock-Flow Monetary Framework: A Kaldorian View, Godley and Lavoie find this in their models (draft version here):

We quickly discovered that the model could be run on the basis of two stable regimes. In the first regime, the investment function reacts less to a change in the valuation ratio-Tobin’s q ratio-than it does to a change in the rate of utilization. In the second regime, the coefficient of the q ratio in the investment function is larger than that of the rate of utilization (γ3 > γ4). The two regimes yield a large number of identical results, but when these results differ, the results of the first regime seem more intuitively acceptable than those of the second regime. For this reason, we shall call the first regime a normal regime, whereas the second regime will be known as the puzzling regime. The first regime also seems to be more in line with the empirical results of Ndikumana (1999) and Semmler and Franke (1996), who find very small values for the coefficient of the q ratio in their investment functions, that is, their empirical results are more in line with the investment coefficients underlying the normal regime.

… In the puzzling regime, the paradox of savings does not hold. The faster rate of accumulation initially encountered is followed by a floundering rate, due to the strong negative effect of the falling q ratio on the investment function. The turnaround in the investment sector also leads to a turnaround in the rate of utilization of capacity. All of this leads to a new steady-state rate of accumulation, which is lower than the rate existing just before the propensity to consume was increased. Thus, in the puzzling regime, although the economy follows Keynesian or Kaleckian behavior in the short-period, long-period results are in line with those obtained in classical models or in neoclassical models of endogenous growth: the higher propensity to consume is associated with a slower rate of accumulation in the steady state. In the puzzling regime, by refusing to save, households have the ability over the long period to undo the short-period investment decisions of entrepreneurs (Moore, 1973). On the basis of the puzzling regime, it would thus be right to say, as Dumenil and Levy (1999) claim, that one can be a Keynesian in the short period, but that one must hold classical views in the long period.

So there is a possibility that a higher propensity to consume leads to a lower growth in the long run. I do not think this is generally true, but this could be possible in some economies.

Two conclusions. It’s counter-productive to mix the definition of saving and what’s called “net lending” in national accounts. It’s possible (which shouldn’t mean that it’s necessarily the case) that Keynes’ paradox of savings doesn’t hold in the long run. I don’t believe that’s the case but purely arguing using national accounts and/or changing definitions won’t do.