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Wynne Godley’s Views About How The Economy Works

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You may have noticed the expression (G + X)∕(θ + μ), where G is government expenditure, X is exports, θ is the tax rate, and μ is the propensity to import in stock-flow consistent (SFC) models.

In the book A Biographical Dictionary of Dissenting Economists, Wynne Godley (pages 232-240) says:

… As a result of this apprenticeship at the ‘sharp end’ of economic policymaking, I had formed by the late 1960s a system of views about how the economy works which corresponded roughly to what people now call ‘crude’ Keynesianism. That is, I thought real output and employment were determined by the exogenous variables of the model – government expenditure and exports – interacting sequentially through the combined effects of the multiplier and accelerator, while inflation was a largely contingent process (which, as stated by the OED, ‘may or may not happen’) only weakly related to the pressure of demand (1974a). But I recognized early on that performance in foreign trade was an abiding constraint on growth. In no sense did this set of views make me into a ‘dissenting’ economist. The same opinions were held by virtually all my colleagues in the Civil Service and, so far as I could discern, in comparable institutions in foreign countries. I had, for instance, no sense of any difference in Weltanschauung when discussing any aspect of economics with Arthur Okun.

(The entry seems to have been first published in the year 2000).

I thought if you’re writing on economics, you should say that frequently and especially when you’re introducing the subject to someone.

That the worldview was widely held seems surprising to me though.

Edward Nell On Managed Trade

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Edward Nell in Free Market Conservatism: A Theory Of Critique And Practice, 1984:

… The second set of controls needed would prevent the flight of capital overseas. Some capital mobility would be permitted; the point would be to regulate it in the national interest, rather than permitting capital flows to follow anticipated profits (profits that may never be realized, as in the loans to some ‘developing’ countries, which went into the pockets, and Swiss bank accounts, of corrupt officials). Along with these controls, a policy of managed trade will be needed; countries must not be required to generate recessions in order to bring imports down to the level of their exports. Selective import controls must be permitted and balance of payments deficits must be financed without requiring ‘austerity’. Again, it is not technically impossible to see how to do this; instead of penalizing the weak—those who run deficits—penalties could be assessed against the strong—the surplus countries—who would be required to promote the loans to finance the deficits. Instead of cutting back imports through austerity, deficit-running countries could be encouraged to modernize their export industries

Marc Lavoie On The Euro Area And Neochartalism

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Marc Lavoie has a new paper MMT, Sovereign Currencies And The Eurozone. It’s based on a lecture he was asked to give in 2021 STOREP conference. In this he analyses what neochartalism (“MMT”) is and what is says about the Euro Area.

Marc Lavoie also discusses Sergio Cesaratto’s work. Sergio had an excellent book Heterodox Challenges In Economics: Theoretical Issues And The Crisis Of The Eurozone and I somehow missed Marc’s review of it earlier.

My view on these issues—with good grasp of the institutional details—is that countries face a balance-of-payments constraint and the way the Euro Area is set up makes the balance-of-payments constraint stronger. Euro Area countries can no longer devalue their currencies (or hope their currencies depreciate by market forces) and the government can’t make overdrafts on their central banks.

It’s true that the European Central Bank (ECB) can buy government bonds but that it can doesn’t mean it actually will do to the extent needed. Indeed, the ECB has also pushed for tightening of fiscal policy using its powers. Countries face a BOP problem because like in other institutional setups, they’re at the mercy of foreigners. In fact more it’s more than otherwise in case of the Euro Area. And international indebtedness ultimately falls on the shoulders of the governments and hence we saw crisis in the government bond markets.

Countries with a strong international investment position such as Germany do not face this problem.

Ultimately, the problem is that the Euro Area doesn’t have a central government which would be involved in large fiscal transfers and keeping imbalances between countries in check. But as Sergio Cesaratto argues, it was never meant to be that way as the founders of the Euro Area designed it in a way to take away powers from national governments.

I should add one question which arises: the question about the political role of the ECB, which is similar to the role of governments in other places such as the US. There seems to be an inconsistency in the position of people such as Sergio (and I) that we treat the ECB and the US government differently. We say that the US government should be involved in more fiscal stimulus but don’t exactly say that the problems of the Euro Area can be resolved by proposing that the ECB promises to purchase government bonds without limits.

The answer to that is: even outside the Euro Area, rich countries’ central banks can bail out poor countries facing balance-of-payments financing problems. Does that mean that countries outside the Euro Area don’t face a bop-constraint??

It’s a rhetorical question posed as an answer.

Ultimately the balance-of-payments problems in the Euro Area is more severe than otherwise.

Where does neochartalism (“MMT” or “M.M.T.”) fit in my description? The idea that Euro Area governments cannot make overdrafts at their national central banks (NCBs) is something stressed by neochartalists is right but many authors who didn’t call themselves MMTers stressed this such as Wynne Godley in 1992. The idea that current account deficits don’t matter isn’t useful as you still have to explain why Germany didn’t go into a crisis like Greece.

Paul Krugman And Free Trade As Mercantilism

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In a recent article How The West Is Strangling Putin’s Economy for The New York Times, Paul Krugman makes this point about international trade:

One final point: The effect of sanctions on Russia offers a graphic, if grisly, demonstration of a point economists often try to make, but rarely manage to get across: Imports, not exports, are the point of international trade.

That is, the benefits of trade shouldn’t be measured by the jobs and incomes created in export industries; those workers could, after all, be doing something else. The gains from trade come, instead, from the useful goods and services other countries provide to your citizens. And running a trade surplus isn’t a “win”; if anything, it means that you’re giving the world more than you get, receiving nothing but i.o.u.s in return.

That’s quite a deceit!

Now, he has some caveats but tries to minimise them. But the main point about imports, not exports being the point of international trade is something top corporations claim since they want to open markets in poor countries. This reminds of Joan Robinson’s quote that free trade is a subtle form of mercantilism. A poor country needs protection from foreign competition. In Post-Keynesian theory, exports/success of corporations in international markets is quite important. As Anthony Thirlwall in the paper Kaldor’s 1970 Regional Growth Model Revisited says about Nicholas Kaldor’s model (which I believe):

The first proposition of the model is that regional growth is driven by export growth. Kaldor regarded exports as the only true autonomous component of aggregate demand, not just at the regional level but also at the national level because consumption and investment demand are largely induced by the growth of output itself …

So that’s quite the opposite view from mainstream economics.

Mats Lundahl — Twelve Figures In Swedish Economics

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Mats Lundahl has a new book Twelve Figures In Swedish Economics. The book has a chapter Gunnar Myrdal On Poverty And Circular, Cumulative Causation.

In my opinion, the principle of circular, cumulative causation is the most important principle of economics. The explicit way how it works via international trade is in the works of Nicholas Kaldor. As Anthony Thirlwall points out in his article Kaldor’s 1970 Regional Growth Model Revisited:

Kaldor was more than familiar with Myrdal’s ideas having worked with him in the Economic Commission for Europe (ECE) in Geneva from 1947 to 1949, and remained close friends.

In Lundahl’s words (page 105):

Myrdal wanted to explain the pattern that he observed and once more resorted to his idea of circular, cumulative causation. The traditional theory of international trade, in his view, could not explain the disparities. It was conceived in terms of stable equilibrium and pointed to equalization of incomes. Instead, Myrdal suggested, the analysis would have to concentrate on the quality of the factors of production and the effectiveness of their use in different uses. The notion of stable equilibrium was false. The economic system is ‘not steering towards such a position at all but, rather, is continuously en route away from it’ in the cumulative fashion sketched in An American Dilemma. His claims were extraordinarily strong: ‘I have suggested that the principle of interlocking, circular interdependence within a process of cumulative causation has validity over the entire field of social problems.’

A full book version of Mats Lundahl’s article is in his recent book from earlier this year: The Dynamics Of Poverty: Circular, Cumulative Causation, Value Judgments, Institutions And Social Engineering In The World Of Gunnar Myrdal.

Wynne Godley Vs. The Mundell-Fleming Model

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In mainstream economics, the Mundell-Fleming model is central. It’s however wrong to the core!

As early as 1978, Wynne Godley in a paper “New Cambridge” Macroeconomics And Global Monetarism: Some Issues In The Conduct Of U.K. Economic Policy (with Martin Fetherston) had a model with the compensation thesis which is contrary to the neoclassical model. As per Marc Lavoie’s paper Wynne Godley’s Monetary Circuit, where he also refers to the paper, according to the compensation thesis:

central banks set a target interest rate and supply bank reserves and cash on demand. Thus, if there is an increase in the amount of foreign reserves held by the central bank on the asset side of its balance sheet, so as to keep the overnight interbank rate on target this will be compensated on the asset side of the balance sheet of the central bank by either a decrease in the size of the advances provided to domestic banks or a decrease in the amount of government securities held by the central bank. As a third possible compensatory mechanism, the central bank may instead issue central bank bills on its liability side.

Marc Lavoie and Wynne Godley, Levy Institute, 2002. Picture via Marc Lavoie’s site.

Some Wynne Godley Quotes On Planned Trade

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There’s an interesting review of Jagdish Bhagwati’s book Protectionism published in the year 1988 by Wynne Godley in the journal Economica, year 1993. Without going into the review, I wanted to highlight how Wynne Godley’s views were quite similar to Nicholas Kaldor’s and Godley proposals such as planned trade and international cooperation of a new kind:

… Kaldor’s chapter, ‘The Foundations of Free Trade Theory and Their Implications for the Current World Recession’ (in E. Malinvaud and J. P. Fitoussi (eds.), Unemployment in Western Countries, 1980), which, in the context of a fundamental critique of the abstract theory of international trade, suggests that, because of the scope for dynamic economies of scale, free trade in manufactured goods leads to the concentration of manufacturing production in certain areas, what Kaldor called ‘a polarisation process’. ‘In principle such trade is of great practical benefit since specialisation between industries of different areas should enable the benefits of the economies of scale to be realised more fully. However … this … depends on the trade being balanced in both directions … But as past experience … has shown this does not come about naturally.’

These ideas were further developed in Kaldor’s 1981 article in Economie Appliquee, ‘The Role of Increasing Returns, Technical Progress and Cumulative Causation in the Theory of International Trade and Economic Growth’, where he related his concern about dynamic imbalances in trade to the ideas of Roy Harrod (himself a strong advocate of protection as a way of improving Britain’s economic performance throughout the postwar period), who had put forward the theory of the foreign trade multiplier in his International Economics (1933). As the trade imbalances constituted a growing threat to the continued expansion of the world economy, Kaldor concluded that we should not ‘stick to free trade (whatever the cost) but introduce a system of planned trade between the industrially developed countries on a multilateral basis’.

Also in an interview to the magazine Marxism Today in 1981, Wynne Godley says how he is openly opposed to free trade and the destructive aspect of it:

Let’s turn to some international questions. How do the problems of the UK economy — and your solutions to them — tie in with problems in the world economy?

Well, the general answer is that I don’t think that free trade is the best way of organising international trade. The classical theory of international trade, which appears in text books and which is extremely influential in peoples’ minds, is based on a postulate of full employment. If you assume full employment you can easily prove that free trade is mutually advantageous. But if you think, as I do, that full employment cannot be assumed, then it’s easy to make out a realistic case that free trade is extremely destructive to economies that are relatively unsuccessful. Instead of making them more prosperous and better-off, it destroys them. I think this is a general proposition; it applies to the United Kingdom at the moment because it’s a relatively unsuccessful country, and I think it is beginning to apply to the United States, which is also becoming a relatively unsuccessful country.

When you say that you think that the free trade system is a bad system, how do you think it should be changed? It’s easy enough to say Britain should have import controls, but how do you see this in international terms?

Well, the logical answer to the question which, as an academic, is what I am primarily called on to give, is quite clear to me. If all relatively unsuccessful countries protect in the way we suggest — using import controls to raise domestic output and not to strengthen their balance of payments — the system of protection can be generalised advantageously. But that assumes a high degree of international co-operation, and international co-operation of a new kind.

Thomas Palley On NATO Expansionism And The Russian Invasion Of Ukraine

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Thomas Palley has written some fine stuff on the NATO/Russia/Ukraine. He had predicted a Russian invasion while at the same time identifying NATO expansionism as the root cause of the crisis, a totally rare combination!

In his latest blog post Ukraine: What Will Be Done And What Should Be Done? he is straight and accurate:

The inevitable has happened. Russia has invaded Ukraine. It was inevitable because the US and its NATO partners had backed Russia into a corner from which it could only escape by military means.

In effect, Russia confronted a future in which the US would increasingly tighten the noose around its neck by further eastward expansion of NATO, combined with military upgrading by the US of its Eastern European NATO proxies.

Accompanying that militarization was the prospect of a ramped-up propaganda war in which western media fanned the flames of public animus against Russia. Side-by-side, US government financed entities (such as the National Endowment for Democracy and the German Marshall Fund) would seek to influence European and Russian politics with the goal of regime change.

At this stage, there are two questions. What will be done? And what should be done?

Thomas Palley had predicted all this in two previous posts:

  1. A Crisis Made In The USA: Why Russia Will Likely Invade Ukraine, written Jan 16th,
  2. American Exceptionalism And The Liberal Menace: The US And Ukraine, written Feb 13th.

In Brazil, Lula’s Worker Party had initially blamed NATO expansionism but soon withdrew the statement. It’s not easy saying such things. And the sort of culture also discourages independent thought. Hence it’s important to denounce NATO expansionism if you really are anti-imperialist.

Marc Lavoie — Godley Versus Tobin On Monetary Matters

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The fourth Godley-Tobin lecture was by Marc Lavoie on February 2021. The video of the talk is on YouTube.

There is now a paper by the same title published with ROKE (Review Of Keynesian Economics).

It’s interesting how James Tobin had a lot of things right but yet his model has a lot of neoclassical economics.

In the paper Marc Lavoie argues how Tobin seems to get a lot of things right but those were just weapons for criticisms of extreme views such as of Friedman. Tobin didn’t actually believe in them. Wynne Godley’s models are quite successful in escaping old ideas, if you remember the ending line of the preface of the GT.

Houthakker And Magee On The Importance Of Income Elasticity Of International Trade

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There’s a 1969 paper Income And Price Elasticities In World Trade by H. S. Houthakker and Stephen P. Magee where they realise that nations may have a balance-of-payments constraint:

In the econometric analysis of international trade the emphasis has traditionally been on price elasticities. The practical and theoretical importance of price elasticities is beyond question, and we shall have something to contribute to their estimation, but it has also been increasingly realized that income elasticities are at least as important, especially in a growing economy. Thus Harry Johnson [7] has pointed out that under certain conditions the direction in which the trade balance moves over time depends critically on each country’s income elasticity of demand for imports and on the rest of the world’s income elasticity of demand for each country’s exports.

Johnson showed that if trade is initially balanced in a two-country model, if prices are constant and if income growth is the same in both countries, then the trade balance between them can still change through time if their respective income elasticities of demand for the other’s exports differ. In this case, the country with a higher income elasticity of demand for its imports than the foreign income elasticity of demand for its exports will experience more rapid import growth than export growth, a deterioration in its trade balance and eventual pressure on its exchange rate. For this country, even relatively slow domestic income growth may be insufficient to cure payments imbalances if the relative income elasticities are sufficiently adverse.

We shall show, in fact, that disparities in income elasticities appear to be significant in the case of certain countries whose balance of payments performance is either much worse or much better than might be expected on other grounds. The United Kingdom and Japan are polar examples; the United States is also in this category.

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References

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  1. Johnson, H. G., International Trade and Economic Growth (Cambridge: Harvard University Press, 1958).

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That’s not quite as sharp as Nicholas Kaldor’s work but yet some neoclassical economists acknowledging it is quite something.