An excerpt from a chapter by my old tutor at SOAS, Mushtaq Khan, who has written extensively on industrial policy in a range of late-industrialising countries, analysing case-studies with a range of outcomes in terms of development, successful or otherwise. Here he considers both the differences and the similarities with an industrial policy in the UK, which needs to innovate, rather than simply emulate already existing technologies and catch-up with the richest countries:
“For an advanced country like the UK, industrial policy clearly has to support both innovation and the development of competitive production capabilities that can convert ideas and knowledge into marketable products. There is no question therefore that industrial policy must have a focus on supporting innovation and the development of new knowledge. This involves investment in public bodies such as universities as well as in networks linking public and private players engaged in innovation. Countries such as the UK still have a lead over most emerging Asian countries in the organization of innovation, though there may be particular strategies of financing or organizing innovation that may be worth looking at. However, the second plank of any effective industrial policy has to be the development of competitive manufacturing capabilities so that good ideas and technologies can be converted into competitive products. Here the UK can learn a lot about the types of problems countries can face when they try to acquire (or, in the case of the UK, re-acquire) firm-level competitive capabilities. Britain’s gradual loss of manufacturing competitiveness after the Second World War was exacerbated after the 1980s in the context of rapid de-industrialization. The country lost much of the tacit knowledge embedded in the organizational routines of manufacturing firms, and as a result fell even further behind in terms of its capacity to regain a broad base of competitive firms. The experience of Asian industrial policy shows that the achievement of competitiveness in new sectors and technologies can be a difficult problem to crack. The two planks of industrial policy are closely connected because without a broad base of firms that can organize production competitively, a successful innovation strategy will simply result in the offshoring of manufacturing somewhere else.”
Mushtaq Khan (2015), The Role of Industrial Policy- Lessons from Asia, in David Bailey, Keith Cowling, and Philip R. Tomlinson, New Perspectives on Industrial Policy for a Modern Britain, Oxford University Press, p.80.
The Levy Economics Institute of Bard College is ostensibly non-partisan but much of its published output is in the post-Keynesian tradition, and inspired by the work of Hyman Minsky and Wynne Godley, who both worked at the Institute in their later years. Continue reading →
A break from the economics (sort of), with a quote from the late social philosopher and eclectic thinker, Robert Anton Wilson, from one of his most popular books (and one of my favourite), Prometheus Rising, which tries to make sense of the workings of the human mind and its role in human development in its broadest sense. Here he is on page 113:
“All wealth is created by human beings using their neurons intelligently.
A neurotic young man once went to a Zen Master and asked how he could find peace of mind.
“How can you lack anything,” the Roshi asked, “when you own the greatest treasure in the universe?”
“How do I own the greatest treasure in the universe?” asked the young man, baffled.
“The place that question comes from is the greatest treasure in the universe,” said the Master, being more explicit than is common for a Zen teacher.
Of course, as a Buddhist, the Master had taken a vow of poverty and did not mean exactly what we mean here. But he knew that the brain produces all that we experience – all our pain and worry, all our bliss states and ecstasies, all our higher evolutionary vistas and trans-time Peak Experiences, etc. It is also “the greatest treasure in the universe” in the most materialistic economic sense: it creates all the ideas which, socially employed, become wealth: roads, scientific laws, calendars, factories, computers, life-saving drugs, medicines, ox-carts, autos, jet planes, spaceships…”
There is a nice piece in this week’s New Statesman by economics commentator Grace Blakeley on the dangers of the unresolved eurozone crisis, with Germany at its heart. With growth in the eurozone currently slowing, after a brief spurt, unemployment is set to remain unsatisfactorily high in a number of countries, not least Greece and Spain. Germany itself is teetering on the brink of recession.
As Blakeley argues, resolving the crisis requires the northern states of the currency block to expand domestic demand. This is particularly necessary in Germany, the largest economy in the eurozone, which is running a current account surplus of nearly eight percent of GDP. It is thus overly dependent on external demand, and growth in world trade.
What the piece misses, maybe in order to avoid unnecessary complexity, is that a decade of wage stagnation in the 2000s, while rendering German exporters more competitive and profitable, and boosting employment, has also squeezed household incomes and raised national savings relative to investment. This is reflected in the aforementioned large current account surplus, which is by definition equal to the gap between domestic savings and investment. Continue reading →
Alexandria Ocasio-Cortez, the youngest woman ever to be elected to the US Congress, has made headlines recently with her arguments for much greater marginal rates of tax on the highest earners. Oxford University’s Simon Wren-Lewis yesterday posted this helpful piece on some of the economics and politics of such a policy. He is broadly in favour, and makes a good case for it.
Wren-Lewis is something of a New Keynesian, coming from the centre-left of mainstream thinking. The post covers plenty of ground, but tends to only focus on the microeconomics, while neglecting the macroeconomics, of higher taxes and redistribution. Continue reading →
A fascinating piece from Michael Pettis, an economist I regularly reference, on how China is probably growing much more slowly than the official GDP figures make out, alongside a discussion of the nature and measurement of GDP itself.
This would confirm his long-held thesis that China’s ultra-high investment growth model has been unsustainable for some years, and will change of necessity, either through enlightened policy or, more painfully, in the absence of such a policy.
Trade tensions and rising protectionism are combining with the exhaustion of the recent economic upturn to slow growth in many countries.
The slowdown in China could lead to a ‘lost decade’ of relative economic stagnation there, until growth rebalances away from a significant share of unproductive investment and towards a higher share of consumption and a lower but more productive share of investment in overall demand.
Although the country is already economically powerful, its rise to global dominance could be much further away than many ‘China bulls’ have predicted. Even so, given its prominence in global manufacturing value chains, relative stagnation will have a large but uneven impact on global economic activity.
David Pakman’s videos are well worth watching for his incisive and progressive analyses of US current affairs. But on the question of the global role of the US dollar, which he describes below, I think he is wrong. Watch this short video first, before reading my critique below.
Is the US dollar’s dominant role in world trade and reserve policy an exorbitant privilege or an exorbitant burden? I go with the latter. The argument that it is a privilege and benefits the US economically is often made. This argument draws the conclusion that the US is able to borrow and spend beyond its means as a result. The US current account deficit is therefore a good thing, as it reflects the higher consumption and lower savings that can be sustained. It also apparently allows the US to sustain a higher level of debt, whether on the part of the private sector or the government, which boosts aggregate spending or demand.
But as Michael Pettis argues in his book The Great Rebalancing, it is perhaps just as accurate to say that the dominance of the US dollar in global payments and reserves forces the US to consume beyond its means. It results in lower US savings relative to investment, reflected in the current account deficit, and higher savings relative to investment in the rest of the world.
The stronger demand for US dollars in the rest of the world produces a stronger dollar than would otherwise be the case. This makes US exports more expensive abroad, and imports cheaper in the US, and will thus tend to widen the trade deficit (exports minus imports) and the current account deficit, other things being equal. Production and employment will be lower among US exporters, who will find it harder to compete with rivals abroad. US firms producing for the domestic market will similarly find it harder to compete with cheaper imports.
Larger trade and current account deficits act to drain demand from the US economy. A larger capital account surplus is the flipside of a larger current account deficit, and represents the net inflow of funds required to fund the latter, or what the US is borrowing from the rest of the world. These funds will either be used to fund domestic investment, which can be productive or unproductive, or to fund domestic consumption.
The result is that the US savings rate will be lower relative to the US investment rate than it would otherwise have been. The savings rate could fall, while the investment rate stays the same, necessarily leading to a higher rate of consumption. Or the savings rate could remain the same, while investment, whether productive or unproductive, rises.
If the new investment is productive, and generates flows of income in the future greater than its overall cost, then the US economy will end up larger and more productive, while employment should be higher. If the new investment is unproductive, such as takes place in a housing bubble, then this will ultimately raise the debt burden and slow future growth in output and employment.
So a larger current account deficit need not be a negative factor for an economy, if the funds borrowed from abroad are used to fund productive investment. But this only tends to be the case for an economy which is short of domestic sources of finance for investment. For an economy like the US, with sophisticated and liquid financial markets, there is little evidence that domestic investment is constrained by a shortage of domestic saving. So capital inflows will tend not to lead to higher productive investment, but rather to higher unemployment or higher debt.
The capital inflows to the US, resulting in a capital account surplus, and reflected in the gap between domestic investment and savings, described by some commentators as a shortage of savings, are the consequence of excessive savings relative to investment in the rest of the world, or a ‘savings glut’.
Savings and investment must be equal for the world economy as a whole, but can be out of balance for individual countries. If savings rise in one country but investment does not, the surplus must be exported abroad, and lead either to higher investment or lower savings in the rest of the world, so that global savings and investment continue to balance.
The US can only be a net borrower from the rest of the world and therefore continue to run a current account deficit if foreign economies are net savers in aggregate relative to the US. Economies such as China, Japan and Germany have run the largest current account surpluses (meaning that they are net savers) in recent years. It is their policies as much as those in the US which lead to a lower savings rate in the latter.
This is because, for the world as a whole, the balance of payments must balance! Current account deficits in some countries must be offset by current account surpluses in others. The major surplus countries are avoiding significant appreciations of their currencies by accumulating dollar reserves. They do this in part to sustain relatively weak currencies which boosts net exports by making their exporters more competitive.
These surplus countries are relying on their exporting sectors to boost demand, growth and employment because the growth in their domestic demand is relatively weak. So any rapid appreciation of their currencies would hobble their exporters and growth would falter. It would also probably take some time for the necessary adjustment and certain economic reforms in order for domestic demand to take up the slack.
The surplus countries therefore have a strong incentive to sustain the status quo, which helps to maintain the dollar as the dominant world currency, keeping it stronger than it otherwise would be. This is the exorbitant burden which the US, and ultimately the world, must carry.
All this played a significant role in causing the global imbalances which led to the Great Recession of 2008. These imbalances need to be resolved in order for the world to begin a new period of sustained growth. So Trump and his advisers may be on to something when they complain about the US trade deficit. It may therefore be a good thing if the dollar becomes less widely used for global trade and the accumulation of reserves, whether this is intended or not. Everything else being equal, a decline in the dollar would help the US economy rebalance in the longer run, boosting growth and employment and reducing the debt burden.
Is there a solution to all this, which would go beyond Trump’s muddled bluster? There is, and it has been around since the formation of the Bretton Woods institutions in 1944. It was then that Keynes proposed the creation of an international currency, bancor, which would be used to prevent excessive international payments imbalances and the unsustainable buildup of debt, which he strongly believed would tend to stifle growth. His US counterpart Harry Dexter White rejected the idea.
We have been left with Special Drawing Rights (SDR), a basket of international currencies maintained by the IMF, which were created in 1969 as the Bretton Woods system of fixed exchange rates and managed international payments began to unravel.
If, as Keynes had hoped, something like the SDR were used more widely, then global payments imbalances should be less severe and more easily resolved. But this would, in the short to medium run, and contrary to the arguments of many economists, benefit the US economy and harm the major surplus countries which would be less able to run up large current account surpluses by keeping their currencies relatively weak and boosting their exports. Despite this, the argument should be made that it would create a more balanced global economy, and more sustainable growth.
Perhaps the trick is to appeal to the right vested interests, since ultimately consumers in the current surplus countries would benefit. Exporters in the US, and also in other major and long-standing current account deficit nations, such as the UK, would gain too.
As ever, one can’t ignore the politics. For Trump, whose muddled policies are currently encouraging a stronger dollar, a successful reduction in the US current account deficit might reflect a reduced global role for the US, as Pakman argues in the video, but a less dominant dollar would ultimately be good for US growth and stability. There might be some debate over whether the outcome would be making America ‘great’ again or not. But more widely-used SDR would also be a good thing for the prosperity and stability of the global economy, though this is perhaps a long way off, if it happens at all. Politics will get in the way of good economics, and not for the first time.