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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.

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.

The Languishing Finances Of The United States

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Two recent statistical releases which needs attention: the US international investment position and the primary income in the balance of payments turning negative.

Charts from the BEA:

US NIIP

Source: U.S. International Investment Position, 3rd Quarter 2024

US Current Account and Component Balances

Source: U.S. Current-Account Deficit Widens in 3rd Quarter 2024

For an idea, the US GDP was $29.4 trillion in Q3 on an annualised basis, according to the Fed’s Z.1.

Now a lot has been written on this but I suppose rise of the US net indebtedness (the negative of the net international investment position) has been slower than anyone expected, including the great Wynne Godley. One of the reasons of course is that the primary income balance has been positive for long, which is surprising in a way. Primary income mainly consists of income from income from direct investment, dividends and interest income. Lots has been written on this too, and the connection between the two, but once the balance on primary income turns negative, the net indebtedness will rise at a faster rate.

Now, even though a lots has been written on this, mainstream economists have shooed measures such as import controls and improvement of exports. The only exception among economists was Wynne Godley.

Some measures have been taken by the United States such as tariffs, industrial policy. These have been taken in limited ways as there is a lot of ideological opposition to such things. But obviously with China on the rise and its ever expanding rise in its current account balance in its balance of payments, there is some realisation that the United States needs to do something more. The rise in China also injures other countries, so the problem is becoming more international.

Generally economists make it look like international trade is a small complication in the economic theory, and lack understanding of how it is central to the way the world works. With rising imbalances—on the negative in the United States and the other way round in China, is not good for the world in another way because a slowdown of the United States to keep its finances in check slows the growth everywhere. So from the point of view of a poor country, say India, the need to address both US imbalance and the rise of China are highly important.

A Fine Wynne Godley Article On Keynesianism From 1984

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There is a fine Wynne Godley article from the year 1984 titled Confusion In Economic Theory And Policy — Is There A Way Out? in the book After Stagflation: Alternative To Economic Decline, edited by John Cornwall, 1984, in which he discusses his worldview and how Keynesianism should work. In this he talks of how Keynesianism requires international coordination of not just fiscal policy but also management of international trade.

He starts off by how Keynesianism demand management works:

The policy makers of that era and those who advised them particularly in Britain and the United States came, generally speaking, to share a view, the authorship of which was correctly attributed to Keynes, that governments could, and therefore should, accept responsibility for ensuring real growth and full employment. And those same people also believed that the success, at that time, of the industrialized economies was the consequence of the implementation of Keynesian policies.

While the idea that governments can and should accept responsibility for maintaining full employment can be attributed to Keynes, the theoretical basis of the explicit or implicit models used in practice to underpin Keynesian policy advice was pretty crude. The essential points were as follows.

  1. To obtain real growth and full employment it was necessary and sufficient to expand aggregate demand for goods and services. Governments could achieve this by expanding their own expenditure on goods and services or releasing disposable income by cutting taxation.
  2. There might be a temporary constraint on the growth of real output imposed by shortage of physical or human capital. A constraint might also be imposed if exports did not rise sufficiently to pay for imports.
  3. Subject to these constraints, fiscal policy could safely adopt full employment as a target while disregarding any imbalance in the Budget — that is, any excess of public spending measured in nominal terms over revenue receipts.
  4. Monetary policy under this system of ideas did not matter much, the quantity of money itself being a residual number thrown up by everything else that happened which could safely be ignored. It was even the case through much of the post-war period that statistics relating to what are now called ‘monetary aggregates’ (the stock of money and various other financial assets) were not regularly available, if at all.¹

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NOTES

  1. In other words people thought and built econometric models which were based on an ‘IS’ mechanism without any (operative) ‘LM’ process; if these models contained a representation of the financial system, that did not make any important differences to the solutions they generated.

And later:

…  I am prepared to assert that the macroeconomic theory on which policy was based in the successful post-war period was essentially correct after all.11

…

I do not for a moment accept that the post-war Keynesian consensus has been in any way confuted by events.

NOTES

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  1. In the appendix I have attempted to set out rigorously, if briefly, why this is so, and how the confusion in Keynesian macroeconomics can be resolved and why the most important change which I have had to make in my views about macroeconomic policy has nothing to do with the theory of inflation as such, nor about monetary aggregates, ‘crowding out’ etc. It has to do with the importance of the proper inflation accounting of all national-income accounting concepts i.e. stocks as well as flows. It is (maybe?) slowly coming to be realized that, to be meaningful as a measure of fiscal stance, a budget deficit must be corrected for cyclical movements. It has still to be understood that public deficits, if they are to be measures of the determinants of real demand and output, must also be corrected for the erosion of the money value of the stock of government debt (including ‘inside’ money) from inflation.

Then Wynne Godley talks of how Keynesianism would need international coordination:

Even if I am correct in supposing that the post-war Keynesian system of ideas was a basically correct foundation for economic policy this does not, unfortunately, mean there is a simple solution to the problem of world recession by simply reverting to old ways. Even if my views about the key role of fiscal policy were generally accepted and monetary targeting were abandoned, the world economic situation has now gone so badly wrong that it would be very difficult to put things right again. To achieve sustained growth would require that countries cooperate with one another in an altogether new way, coordinating their plans as they have never done before.

…

The conclusion must be that even if we could now coordinate fiscal policies to accommodate the fact that different countries are in different degrees of recession, I am quite sure that very large current-account imbalances would emerge. So we need not only to coordinate our fiscal policies, we also need to coordinate our trade policies and payments as well. Yet, under the present system of floating exchange rates, we have been deprived of the traditional means of making balance-of-payments adjustments. Paradoxically, by having floating exchange rates we have deprived ourselves of exchange rates as an instrument of economic policy.

In sum, I believe that there is no intrinsic reason why growth and full employment in the industrialized world should not be achieved by coordinated fiscal policies in combination with an appropriate configuration of exchange rates. The difficulties are first that action and cooperation along these lines are not at all what governments at present have on their agenda; second there does not at present exist a system of information and analysis which could form the basis for such a coordinated plan of action; third, even if exchange rates could be adjusted to satisfy the long-run conditions for equilibrium, the trade responses to currency adjustment are known to be very slow so there would be a long transitional period during which potential-deficit countries would have to suffer large increases in import prices (and therefore inflationary pressure) and cuts in real income.

I am, therefore, very doubtful if, even supposing that international cooperation was attempted, it could now really be successful without some form of international trade management. By trade management I do not mean protection in the sense ordinarily understood, i.e. a situation where individual countries unilaterally protect individual weak industries without international agreement and in a way unrelated to general macroeconomic management.

What I have in mind is that deficit countries adopt the kind of protection specifically catered for in the little read and, I believe, never used Article 12 of GATT which is specifically designed to make full employment possible in countries which would otherwise be subject to a general balance-of-payments constraint. The key point of such trade management would be, first, that it would be operated as a macroeconomic instrument, in harmony with fiscal policy, so as to ensure that the balance of payments would not be any more favourable than would otherwise be the case; in other words such protection would be used entirely to make possible higher domestic production reducing the import propensity without reducing total imports themselves below what they otherwise would be. Under such conditions the rest of the world does not suffer (its exports being, by assumption, fully maintained) and the recovery of output can be much more rapid and less inflationary.

Economists On US Manufacturing And Trade

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Recently, Paul Krugman wrote two articles in The New York Times on recent surge in US manufacturing: Making Manufacturing Great Again (June 6, 2023) and Making Manufacturing Greater Again (April 20, 2023).

Post-Keynesians stress the importance of manufacturing and exports/international trade. Before the economic and financial crisis which started in 2007, Wynne Godley was worried about all this and proposed to improve exports and take measures such as imposing non-selective protectionism, as he thought—rightly—that a crisis would happen and fiscal policy should be used and would be used but that alone will not be sufficient. In other words, the market mechanism won’t do the trick.

The reason manufacturing is important is because of the potential for expansion of exports.

Economists however have been denying all this. Especially with the rise of Donald Trump when attempts to improve the US balance of payments/international investment position were looked upon as clownish. But now the establishment has accepted that it needs to be addressed. But they don’t want to accept that they were behind. At the same time, Joe Biden has gone beyond measures that Trump has taken.

However, there are many economists who still live with old dogmas. For example, see Adam Posen’s article America’s Zero-Sum Economics Doesn’t Add Up for Foreign Policy.

So we have two types of mainstream economists: a) those who grudgingly accept that they were wrong and b) who are still wedded to dogmas.

There’s of course a limit to this, so the solution to the problems lie in disbanding the system of free trade and move toward a system of balance-of-payments targets.

Ashwani Saith’s New Book — Cambridge Economics In The Post-Keynesian Era: The Eclipse Of Heterodox Traditions

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Ashwani Saith’s new book is out. It’s the history of how Post-Keynesianism was dethroned at Cambridge through power and influence of neoliberalism.

Wynne Godley is on the cover!

From the book’s description of the cover:

COVER

St Michael’s victory over the devil.
Jacob Epstein, Coventry Cathedral

On 14–15 November 1940, “a bright moonlit cloudless night made navigation simple” for the Luftwaffe operation—fatefully code-named Moonlight Sonata—of the blanket bombing of Coventry in which “almost a third of the city was fattened” with its medieval cathedral reduced to rubble. (GCHQ 2021). Wynne Godley was married to Kitty Garman, daughter of Kathleen Garman and the famous sculptor Jacob Epstein, one of whose creations lives on the wall of the cathedral in Coventry evoking the unbroken spirit of the city, with Benjamin Britten composing his War Requiem for the consecration of the reconstructed cathedral in 1962. It depicts St Michael—representing the good—slaying the devil. Epstein used a model of his “impossibly handsome” son-in-law, Wynne, to sculpt the head of St Michael. Though Wynne and his research team, along with other celebrated heterodox lineages, lost out proverbially to “the devil” in the Cambridge war of economics, there has subsequently been a defiant phoenix-like revival of the reputation and work of the famous Godley-Cripps Cambridge Economic Policy Group of the 1970s, as well as of other renowned radical traditions nurtured since the 1920s in Cambridge, the crucible of heterodox economics. The allegorical symbolism of Sir Jacob Epstein’s sculpture resonates with the leitmotif of the book.

Here’s Marc Lavoie’s review:

Ashwani Saith’s book is monumental, enthralling, beautifully written with its occasional satirical tone, but as we are being warned, depressing. It explains how the Faculty of Economics of the University of Cambridge—the world centre of post-Keynesian economics—was gradually and entirely taken over by neoclassical economics and why the Department of Applied Economics, also at the heart of heterodox economics, eventually came to be dismantled. This was so far an untold story, except for a chapter on ‘Faculty wars’ in Saith’s previous book, the intellectual biography of Ajit Singh. The current book provides 14 chapters of a meticulous detective story, relying mostly on Cambridge archives, but also on testimonies, interviews, emails, and previous articles of participants to these events. The book makes clear that, besides possible strategical mistakes by the incumbent heterodox economists, there were inexorable and ineluctable outside forces that led to this dismal state of affairs, through the Americanization of the economics profession and through the changing political winds that blew out heterodox and left-wing economics nearly everywhere in the world. The last chapter shows that all is not lost, both in Cambridge and elsewhere in the world.

…

REFERENCES

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GCHQ. (2021, April 19). The bombing of Coventry in WWII. Retrieved December 19, 2021, from https://www.gchq.gov.uk/information/the-bombing-of-coventry-in-wwii

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The book is 1217 pages long.

Word count of “Kaldor” and “Godley”: 428 and 512 respectively.

Mainstream Economics On A Better Globalisation

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The United States policies and maintains the “liberal international order”, a totally unfair game built on laissez-faire/anti-Keynesian ideas. That was advantageous for the United States because its corporations are highly competitive because of historical reasons and who don’t need protection at home. Of course the US has still been using protectionist measures, so there’s hypocrisy there too. But the general system is the removal of protection from countries whose producers need it. Free trade in general. Low tariffs, no import quotas and industrial policy is shooed away.

There’s a good Noam Chomsky video on What Is The WTO? (with transcripts on that page).

Post-Keynesians have argued how the system of free trade has a deflationary bias and causes polarisation in the fortunes of nations.

The solution is, as proposed by Nicholas Kaldor in his book Causes Of Growth And Stagnation In The World Economy, page 87:

… coordinated fiscal action including a set of consistent balance of payments targets and “full employment” budgets.

Anyway, China has gamed this too well to cause troubles to the United States. The US balance of payments and international investment position is on an unsustainable path now because of this. Slower growth for the US also implies slower growth for the world as a whole because the United States is a spender of the last resort (or more like the first resort). High imbalance also means that many countries can’t expand fiscal policy.

So there is a need to change the rules of globalisation, which is more than about free trade but free trade is an important part of it.

Dani Rodrik has two interesting recent articles on this. He is different from the establishment but unfortunately falls short. In his article US-China Rivalry: Geopolitics Is Ruining The Chance To Shape A Better Globalisation, he talks of how the US has taken measures which are more than just tariffs raised by Trump:

US President Joe Biden has added to these challenges by launching what Edward Luce of the Financial Times has called “a full-blown economic war on China”. Just before the party congress, the United States announced a vast array of new restrictions on the sale of advanced technologies to Chinese firms.

As Luce notes, Biden has gone much further than his predecessor Donald Trump, who targeted individual companies such as Huawei. The new measures are astounding in their ambition, aiming at nothing less than preventing China’s rise as a hi-tech power.

In Trump’s four years, economists led by Paul Krugman dismissed Trump’s actions on China but the current Biden administration for which Krugman—acts as a lackey—have gone way beyond.

It’s such a blot on the economics profession that almost nobody saw all this coming. The exception of course was Wynne Godley who was recommending import controls and policies to expand exports in the 2000s. The bigger solution of course is one in which trade is overall balanced. Wynne Godley mentions in his article The United States And Her Creditors — Can The Symbiosis Last? written in 2005:

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.

The other Dani Rodrik article How To Build A Better Order although interesting doesn’t go much far than proposing some changes. And Rodrik is a kind of dissenter from mainstream economics from within the establishment, so the profession doesn’t have a clue!

Mainstream Economics Vs. PKE On Manufacturing

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Post-Keynesian growth theory (based on the work of Nicholas Kaldor) highlights the importance of manufacturing.

Mainstream theory denies it.

That’s because once you start talking along those lines, the idea of free trade appears even more dubious than at first sight. Mainstream economists don’t want that to happen as they represent the interests of Western corporations which have an interest in finding more markets for their products and services, at the expense of local producers abroad.

A recent denial of the importance of manufacturing came from Adam Posen who uses what’s called woke language. It also highlights how the woke ideology/identity politics is simply class politics disguised as concerns for identity.

Here’s what Adam Posen said in a talk at the CATO Institute:

I’m sure I’m gonna piss off both left and right, so I apologize. The fetish for manufacturing is part of the general fetish for keeping white males with low education outside the cities in the powerful positions they are in in the U.S., and that is really what’s going on here, because when you look at the costs of manufacturing and Susan Houseman and her co-authors have done a lot not of manufacturing but of trade and job displacement and community. Susan Houseman and her co-authors have done a lot of work on this and I’m sure she’ll have a different view than I do but when I look at the so-called cost of the China shock or the cost of the decline of manufacturing, I always think ‘compared to what’?

This is ridiculous as it sort of implies that people of other races somehow don’t want a position in manufacturing, are okay with offshoring work abroad or are okay with closing down of factories due to competition from abroad.

In reality this kind of analysis is just cover for class politics favouring the upper class and the super-rich.

Compare Post-Keynesians:

Here’s a quote from Wynne Godley from 1995 from the article, A Critical Imbalance In U.S. Trade, The U.S. Balance Of Payments, International Indebtedness, And Economic Policy:

It is sometimes said that manufacturing has lost its importance and that countries in balance of payments difficulties should look to trade in services to put things right. However, while it is still true that manufacturing output has declined substantially as a share of GDP, the figures quoted above show that the share of manufacturing imports has risen substantially. The importance of manufacturing does not reside in the quantity of domestic output and employment it generates, still less in any intrinsic superiority that production of goods has over provision of services; it resides, rather, in the potential that manufactures have for expansion in international trade.

RIP, Lance Taylor

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Lance Taylor has passed away.

Among other things, he promoted stock-flow consistent modeling. He had a book Reconstructing Macroeconomics.

I hold dear the review of Lance Taylor of Wynne Godley’s work, titled: A Foxy Hedgehog: Wynne Godley And Macroeconomic Modelling.

The article starts:

The fox knows many things, but the hedgehog knows one big thing (Archilochus, seventh century BCE).

Lance Taylor clearly understood the importance of accounting. In the paper A Simple Model Of Three Economies With Two Currencies, Wynne Godley and Marc Lavoie quote him:

As pointed out by Taylor (2004, p. 206), ‘the best way to attack a problem in economics is to make sure the accounting is right’.

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Bibliography

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Taylor, L. 2004. Exchange rate interderminacy in portfolio balance, Mundell–Fleming and
uncovered interest rate parity models, Cambridge Journal of Economics, vol. 28, no. 2, 205–27

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Here’s the link to that Lance Taylor paper.