Dirk Bezemer had investigated who saw the crisis coming and why. Now he has written a short piece for the Financial Times‘s readers.
It’s not an easy task. Many may have said that “there is going to be a crisis”. Some may even say the same thing their whole life. Even a broken clock is right twice a day!
So one has to choose some criteria to separate good analysis from fluke.
Also, What Bezemer observes is that the common theme of economists who saw it coming is the use of flow of funds accounting.
One small quibble in the latest article: Bezemer claims that lending to the financial sector “crowds out” production. I am not sure that’s the case. But it’s not important here.
Alex Izurieta compares and contrasts the UN Global Policy Model with models of other international organizations such as the IMF, the OECD and the EU:
A central proposition in this essay is that global models cannot be taken to represent objective and scientific tools for policy analysis. Clearly, all models have to make simplifications and in doing so they will fail to capture some dimensions of economic reality. … Unfortunately, the dominant models proposed by the mentioned IOs ignore essential features of the socio-economic system and therefore deliver a seriously distorted view of policy impacts. Most salient are their assumptions about economic growth, distribution, fiscal and monetary policy, and their failure to address problems of global aggregation—that is, of adding up variables for each world region to account for all relevant macroeconomic factors.
Also an important point on “structural reforms”,
In a different model, such as the UN GPM, structural reforms that depress wages and increase inequality in one country have negative repercussions in other countries that tend to reduce aggregate demand in the world as a whole
The question ‘what is your alternative?’ is a familiar one for most progressives, and too often we are overly defensive or self-critical about our supposed lack of alternatives. In truth, there are many economically-viable, socially-desirable alternative proposals in different contexts. The problem is not their lack of existence but their lack of political feasibility, and perhaps their lack of wider dissemination. …
While rejecting the totalising theory, it is possible to think of a broad framework around which there could be much agreement, even among people who do not necessarily identify themselves as of the ‘left’, but are nevertheless dissatisfied with current economic arrangements at both national and international levels.
…
The obsessively export-oriented model that has dominated the growth strategy for the past few decades must be reconsidered. This is not a just a desirable shift – it has become a necessity given the obvious fact that the US and the EU are no longer engines of world growth through increasing import demand in the near future. This means that both developed and developing countries must seek to redirect their exports to other countries and most of all to redirect their economies towards more domestic demand. This requires a shift towards wage-led and domestic demand-led growth, particularly in the countries with economies large enough to sustain this shift.
Post-Keynesians frequently highlight the Kaldor-Verdoorn Law which states that aggregate demand affects the supply side. This was even used by economists who prepared the economic plan for Bernie Sanders’ presidential campaign in the United States, as explained well by John Cassidy for The New Yorker. Although, the law is not generally known, economists roughly understand it as a theory of “hangovers”.
The Kaldor-Verdoorn Law is:
rate of growth of productivity = constant1 + constant2 × rate of growth of production
where constant1 is the exogenous rate of growth of productivity.
These constants will be different for every nation and are to be found empirically.
Of course, productivity is not the only measure of the supply side, but that gives an idea about the general notion of super-hysteresis.
So Post-Keynesians would argue that slowdown, crises and recessions will affect the supply side but fiscal and monetary policy can be used to quickly recover and that delays will affect the supply side.
Carmen Reinhart and Kenneth Rogoff do an empirical analysis and claim that the hangover effect is permanent.
John Cogan, Glenn Hubbard, John Taylor and Kevin Warsh claim this all wrong and that policy can be used to recover.
The two ideas contain a mix of ideology and scientific validity. As Joan Robinson says, “I believe that economic analysis, though it cannot help containing an element of propaganda, yet can be scientific as well.”
While Reinhart and Rogoff’s analysis about hangovers is half right, what they wish to say is that nothing can be achieved via policy to change it. Taylor and Co.’s analysis is correct that policy can be used to resolve the slowdown. They however reject the hangover effect or that there is a damage to the supply side because of a slowdown of aggregate demand. They are rejecting super-hysteresis. Also, by policy, what they mean is deregulation.
Recently, The Economist had a cover story saying that surplus nations bear responsibility for global imbalances and weak economic growth. Now, the IMF is also advising surplus nations to expand domestic demand.
The IMF tweeted this, with a link to a new report (2017 External Sector Report) on global imbalances:
click to view the tweet on Twitter
As I have said before, this is the biggest concession to Keynes’ idea that surplus countries bear the responsibility.
In an article, The General Theory In An Open Economy, published in 1996, Paul Davidson says:
Keynes was well aware that the domestic employment advantage gained by export-led growth ‘is liable to involve an equal disadvantage to some other country’ (p. 338). When countries pursue an ‘immoderate policy’ (p. 338) of export-led growth (e.g., Japan, Germany and the NICs of Asia in the 1980s), this aggravates the unemployment problem for the surplus nations’ trading partners. These trading partners are then forced to engage in a ‘senseless international competition for a favorable balance which injures all alike’ (pp. 338-9). The traditional approach for improving the trade balance is to make one’s domestic industries more competitive by either forcing down nominal wages (including fringe benefits) to reduce labour production costs and/or by a devaluation of the exchange rate. Competitive gains obtained by manipulating these nominal variables can only foster further global stagnation and recession as one’s trading partners attempt to regain a competitive edge by similar policies.
Neil Irwin writing for The Upshot seems open to the idea that aggregate demand affects aggregate supply, quoting the work of J.W. Mason:
… But what if this is the wrong way of thinking about it? What if productivity growth is not so much an external force that proceeds in random fits and starts, but is rather deeply intertwined with the overall state of the economy and labor market?
It’s a chicken or egg problem: Does low productivity cause slow growth, or does slow growth cause low productivity?
Discussion of such matters was also welcomed by Narayana Kocherlakota on Twitter.
Recently, Simon Wren-Lewis also wrote recently in a post on his blog, Mainly Macro, titled, Why Recessions Followed By Austerity Can Have A Persistent Impact.
In standard economic theory, productivity rises explains the rise and fall of nations, although this shouldn’t really be happening because of the convergence promised by advocates of free trade!
In Kaldorian models, aka the principle of circular and cumulative causation, nations with higher competitiveness will see a large rise in production at the expense of other nations. Higher production leads to higher productivity, so the observed relation between success and productivity has a different story! Also, competitiveness has two aspects: price and non-price. Higher productivity does improve price-competitiveness. Further, I believe, competitiveness itself isn’t something fixed. Initial success feeds into higher competitiveness and the reverse for failure. So there’s a complicated story of causality.
The recent cover story of The Economist on Germany’s trade surpluses—titled The German Problem: Why Germany’s Current-Account Surplus Is Bad For The World Economy— is the biggest concession the magazine has made to Keynesianism. Of course, it’s not as if the publication is now a full Keynesian but still, it’s a large admission.
So it was expected that The Economist‘s story was going to be opposed by other publications pandering to the establishment. For example, FT‘s Martin Sandbu who wrote a piece, Germany Bashing Falls Flat.
That means the accusation against Germany comes about five years too late. There was indeed a strong jump in the nation’s trade surplus half a decade ago, at a time when the world was still struggling to come out of recession. But that surplus has not changed much since.
He also says:
[the] claim [that Germany’s penchant for high saving … is a drag on global growth] trips up both analytically and contextually. Analytically, because the impulse from net trade on aggregate demand is the change in the external balance, rather than its level — much like the impulse from a fiscal deficit is the change in public borrowing as a share of economic output. So long as imports, exports and other macroeconomic aggregates grow at the same rate, a stable external balance goes along with the same steady growth of aggregate demand.
This claim has a pretense to be analytical but it’s hardly the case. This can be seen in stock-flow consistent models but it’s not the easiest to show that in a blog post, so here’s an attempt:
Divide the world into Germany (and other surplus countries) and the rest of the world. The rest of the world’s current account deficit means (without minor qualifications about “revaluations”) that its net international investment position is deteriorating by the amount of its current account deficit. So it’s not the case that if some aggregates grow at some rate, everything is fine because others—such as NIIP/GDP—aren’t.
There are many debt sustainability conditions and each should be used with care. One condition is that
cad(g) < g
where the lowercase cad is the ratio CAD/GDP, CAD is the current account deficit and g is the growth rate of GDP. It’s not as simple as it looks, because growth rate of GDP also affects the current account balance or deficit. The notation cad(g) is to indicate that it is so.
For high growth rates, cad(g) is larger than g.
In other words, sustainability implies that growth is restricted to be low.
Similarly, on the creditor’s side, an economy (i.e., Germany) growing at about 2.2% (nominal) and current account balance of 8.3%, that implies that its NIIP/GDP is rising fast (and hence deteriorating the ratio of others).
So Sandbu’s claim that those asking Germany to expand domestic demand aren’t analytical itself falls flat. His analysis just does a chart eyeballing of some numbers. Just because a few things aren’t worsening, doesn’t mean things are fine. Other metrics may be worsening.
Handelsblatt‘s analysis doesn’t really say much except claiming that Germany’s trade surplus just means its expenditure is less than its income and nothing more. It also errs on endorsing the claim that, “that national economies cannot be managed like large firms.”, which the crisis taught us is highly incorrect.
I wasn’t too excited about “agent-based models” before this, but I saw this paperWhat Drives Markups? Evolutionary Pricing In An Agent-Based Stock-Flow Consistent Macroeconomic Model by Marc Lavoie (co-authored with Pascal Seppecher and Isabelle Salle) and it got me a bit interested.
From the paper:
ABMs are conceived to analyze out-of-equilibrium dynamics and adaptation processes from heterogeneous and interacting entities … On a more specific note, we use a stock-flow consistent (hereafter, SFC) framework … there has been a multiplicity of macroeconomic models that combine two important features: the principle of decentralization/disaggregation which is found in ABM and the principle of stock-flow consistency … In an ABM, macroeconomic variables are the result of a simple process of aggregation of individual data, as in the real word [sic] …, so that the accounting accuracy provided by the SFC ensures the relevance of the aggregation process …, as well as the interconnected nature of the balance sheets of all agents. Symmetrically, AB principles could provide micro-foundations to SFC macroeconomics, that is, a way to logically articulate and rigorously organize the interactions between the micro and the macro levels.
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.
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.
This is a continuation of a recent post at this blog, Public Debt And Current Account Deficits, in which I argued that the current account balance of payments affects the public debt.
A usual objection to the connection is that the two deficits—current account deficit and the budget deficit—although connected by an identity, don’t move together and in fact move in the opposite direction frequently. This point was raised by the blog Econbrower, yesterday.
The identity in question is:
NL = DEF + CAB
where, NL is the private sector net lending, DEF is the government’s deficit and CAB is the current account balance of payments (and is to a zeroth order approximation, exports less imports).
This is not a behavioural hypothesis but still a useful tool to build a narrative. Also, the causality connecting the identities is domestic demand and output at home and abroad.
Imagine, initially that NL is a small positive relative to GDP (for example, NL/GDP = 2%), Also remember that,
NL = Private Income − Private Expenditure
Now assume that private expenditure rises relative to private income. This will lead to higher GDP, a higher national income and a rise in imports because of income effects and hence a lower CAB. It will also lead to higher taxes because of higher income and hence will reduce the budget deficit, DEF, ceteris paribus.
So if the current account balance is in deficit, it would mean that the budget deficit and the current account deficit move in opposite directions.
That’s the theoretical basis for the empirical relationship. But that in itself isn’t the whole story. This is because the other balance—net lending, NL—has a life of its own. As is the case in the United States and several western countries, it turned negative once or twice in the 1990s the 2000s, and when the private sector’s debt rose, it made a sharp U-turn into the positive territory. The blue line in this graph:
Click the graph to see it on FRED.
So, if net lending reverts to its mean of staying positive, one can then conclude that the cumulative budget deficit, or the public debt is affected by cumulative current account deficits.
At any rate, the public debt shouldn’t be the main object of study. What’s more important is the international investment position. And it’s an identity that:
NIIP = cumulative CAB + Revaluations
where, NIIP, is the net international investment position.
A nation which runs current account deficits can become indebted to the rest of the world. IIP is the position of assets and liabilities of resident sectors of a nation. So, the net debt (the negative of NIIP) is the nation’s debt.
The above linked Econbrowser post brings in the complication of revaluations to deny the relationship between CAB and NIIP. But revaluations can’t save you for long.
In short, both public debt and NIIP depend on current account deficits.
Finally a weak analogy: if you play in the rain, you might enjoy it as well. But then if you get sick, you can’t say, “I felt so good playing in rains, so playing in the rain didn’t make me sick”. Saying the two deficits (current account and budget) move in opposite directions is an argument like that.
