Wynne Godley and economics – forecasts, policy and the drivers of prosperity

I have just finished reading Alan Shipman’s fascinating biography of the late economist Wynne Godley, who passed away in 2010. Godley worked in the UK Treasury in the 60s, before moving to Cambridge University and heading the maverick Cambridge Economic Policy Group (CEPG). He became known for his prescient economic forecasts of the UK and later the US, predicting the demise of the ‘Barber Boom’ in the 1970s, the mass unemployment of the 1980s unleashed by Margaret Thatcher’s professed adherence to monetarism, the end of the ‘Lawson Boom’ and return to recession in the late 80s and early 90s, and finally the Global Financial Crisis (GFC) of the 2000s, which followed the build up and subsequent unwinding of unsustainable macroeconomic imbalances in the US, which he had identified as early as 1999.

Through his career, Godley’s approach to economics developed into what are now termed ‘stock-flow consistent’ macroeconomic models. His final book, Monetary Economics, co-authored with Marc Lavoie, develops models of increasing complexity of a hypothetical economy, in which flows of income, expenditure and production interact in a comprehensive and logically consistent way with stocks of assets and liabilities.

One of the key lessons of Godley’s analysis is that incorporating banks or a financial sector into macroeconomic models yields important insights. Thus, the so-called ‘Great Moderation’ period of steady economic growth, moderate unemployment and low inflation which preceded the GFC in economies such as the US and UK, in a way concealed the unsustainable accumulation of private debt, which financed consumption and a boom in asset prices, particularly housing.

The subsequent financial crisis and deep recession were therefore not an ‘exogenous’ shock which arose randomly from outside the system, but were ‘endogenous’, arising from within the economic system itself. Godley, along with economists such as Steve Keen, modeled the dynamics of debt accumulation and predicted an inevitable crisis, as debt accumulation went into reverse, private saving rose, and unemployment rose sharply, even as central banks reduced interest rates towards zero.

Fiscal policy, in the form of tax cuts and public spending increases, made a comeback in many countries, at least until the premature turn towards austerity. Godley and Keen had both predicted that public deficits would soar as governments let the automatic stabilisers operate, and borrowed and spent on top of that, to try and combat the recession. Such was the level of private debt that, as the private sector scrambled to pay it down by curtailing spending, these deficits proved insufficient to prevent recession. In their absence, it would likely have proved even deeper.

Keynesianism and the Golden Age

Godley’s economic models have today spawned an expanding literature applying his stock-flow consistent approach to both the economy as well as the environment. Many of those inspired by his work, as well as the man himself, would be classified as post-Keynesian economists, broadly speaking the heterodox or more radical followers of Keynes. They argue that economic growth, and aggregate supply, are usually constrained by aggregate demand, of which investment is the main driver, as it provides both a source of spending and of capacity on the supply-side. They hold to the vision that sufficiently ambitious public policy can create and sustain full employment, moderate inflation, and widely-shared rising living standards. They tend to take great inspiration from the post-war ‘Golden Age of Capitalism’, which witnessed around 25 years of such outcomes.

The Golden Age ultimately came to an end as a combination of rising unemployment and inflation, or stagflation, apparently discredited the Keynesian consensus, and the Bretton Woods system of fixed but adjustable exchange rates unravelled. The monetarist creed which followed saw policymakers shift their attention to combating inflation with monetary policy and, in theory, fiscal austerity. Unemployment soared in the UK and manufacturing output collapsed.

Left economists of all persuasions, from Keynesian to Marxist, decried these developments. The post-Keynesians argued that their own ideas for economy policy could be used to solve these problems, while some Marxists viewed them as inevitable under capitalism, even if they were hugely damaging to society, as they could encourage a restructuring which would restore business profitability, and create the conditions for a new period of economic growth to take place. Strangely, these latter arguments are in some ways close to conservative ones, although Marxists tend to see socialism as a better answer to the problems created by capitalism, while conservatives would continue with the creative destruction unleashed by capitalist production, often favouring little in the way of the social protections or industrial interventions favoured by those to their political left.

From Keynesianism to industrial policy

Wynne Godley’s economic framework ultimately eschews ‘fine-tuning’ or short-term policy interventions in favour of medium-term strategies which can sustain the goals of most Keynesians, mentioned above. They require management of the public budget, incomes policies to sustain low inflation, and sometimes even import controls such as tariffs or quotas to manage the balance of payments, and prevent a boost to demand at less than full employment ‘leaking’ into foreign demand in the form of imports, rather than encouraging the growth of domestic production and employment.

Also implicit in this framework is the potential for industrial and technology policies to increase the international competitiveness of domestic firms, and thus to encourage a faster growth of net exports given the growth of world demand. The more competitive such firms are internationally, the more of this demand they can capture and serve and the faster the growth of net exports, all else being equal. Another Cambridge post-Keynesian and colleague of Godley’s, Nicholas Kaldor, made arguments along these lines to justify the need for an industrial policy.

Industrial policy can not only create a boost to foreign demand, but it also potentially encourages faster structural change and the adoption of new technologies, which are part of the workings of a successful capitalist economy able to raise productivity and living standards over time. This falls more into the category of microeconomic analysis, but taken together with the ideas of Godley and others, it shows that ‘macro’ and ‘micro’ need to be integrated, rather than kept artificially separate, as is often the case in mainstream analysis, which even drops the case for considering emergent macro properties completely with its arguments for ‘microfoundations’ of macroeconomics.

Marx, Shaikh and competition

For Keynesians of all kinds, aggregate demand, whether domestic or foreign, is seen as a key driver of growth in output and employment, but for modern classical and Marxist economists, Anwar Shaikh being one prominent example, competition between firms and industries drives investment and growth in the search for greater profitability.

Godley was nicknamed the ‘cassandra of the fens’ for his gloomy forecasts for the economy. Although his predictions of recession often turned out to be right, he was perhaps too pessimistic about the prospects for subsequent recoveries in the absence of Keynesian fiscal reflation. Many post-Keynesians, who have historically often prioritised macro over micro analysis, neglect the role of the profit motive and competition in driving economic growth. ‘Accumulate, accumulate, that is Moses and the prophets’, proclaimed Marx, and Shaikh, who has integrated many ideas from classical and Marxist thought as well as some from the post-Keynesian tradition in his own magnum opus Capitalism, makes a strong case for the imperative of profit-making and competition as the central regulating mechanism under capitalism.

For Shaikh, firms and industries compete in the long run by investing in new technologies to increase productivity and cut costs, enabling them to cut prices and expand market share, with the aim of achieving greater profitability. Over the long term, crises or recessions are inevitable from time to time, even if they can be temporarily prevented or postponed with state interventions.

Thus economic growth, despite its often disruptive form in both good times and bad, derives from the intrinsic motives within the capitalist system, and the disruption can only be temporarily ameliorated. Despite this, growth can be seen as being constrained by demand or by supply. It is just that Keynesians tend to see the former as being the dominant tendency and requiring sustained intervention by the state.

As part of an industrial policy, public investment in modern infrastructure and research into and development of new technologies can ‘crowd in’ private investment by opening up new opportunities for firms to take advantage of. The state can therefore ‘create’ new markets for the private sector. This idea is contrary to the conservative view that public investment or borrowing more generally will tend to crowd out private investment. The state can thus expand both demand and supply.

Keynesianism and politics

There is no doubt that Keynesianism offers an attractive political program for the left, with its hope that state intervention can create ‘jobs for all’, poverty reduction and well-funded social policies, not least in the form of a strong welfare state. History seems to suggest that these outcomes cannot be sustained indefinitely, only periodically, under capitalism, while waves of creative destruction and structural change are perhaps more of a constant.

Such changes can prove a threat to sustaining liberal democracy, as the aftermath of the GFC has shown. Keynesianism purports to be able to do so, in the presence of sufficient political will and mass support for progressive parties. But the classical and Marxist canons and their interpretation of economic history show this vision to be at best incomplete, even in the absence of a path to socialism.

Trade Wars are Class Wars – models of development

PettisKleinTWACWThis is the third in a recent series of posts which draws on ideas discussed in the book Trade Wars are Class Wars by Matthew C. Klein and Michael Pettis. Previously, I explored the importance of a macro or systemic analysis in economics, and the nature and dynamics of savings and profits in the economy. Today, I want to look at the two broad models of growth and development outlined by the authors: the high savings model and the high wages model.

In fact, I posted on this a couple of years ago here, following a blog post by Pettis, so I will try not to repeat myself too much and explore some different aspects of the topic. If you haven’t read their book, or any of the authors’ previous output on this, I recommend reading my blog post first, as well as that of Pettis. Continue reading

Industrial policy – blurring the boundaries

AfricanEconDev2The debate over the merits or otherwise of industrial policy, broadly defined, is less polarised in policymaking circles these days. Former World Bank chief economist, Justin Lin, has for some time been arguing for the adoption of his ‘New Structural Economics’ to aid development in the poorest nations, while one of his predecessors, Joseph Stiglitz, is a firm advocate of policies which aim to overcome the numerous market failures which he argues characterise such nations.

Many development economists coming from a more heterodox tradition have long advocated industrial policy as essential, based on the rich historical experience of successful periods of growth in a wide range of countries. Most if not all of today’s richest nations have made use of industrial policies, and still do, if in different forms from the past.

Such economists have followed the arguments of the Cambridge Keynesian Nicholas Kaldor, claiming that there is something ‘unique’ about manufacturing that makes its promotion essential for accelerating economic growth and development. Continue reading

Accelerating development – rejecting fatalism and the case for experimentation

AfricanEconDev2Here is another clear and inspiring quote from the newly published book African Economic Development (p.244-5). It rejects what the authors, who combine long experience in research, in the field and in policymaking, call ‘impossibilism’ in the realm of development policy, whether it comes from the mainstream or heterodox camps:

“Some development economists have relatively recently come to acknowledge what before were dismissed as unsound arguments: that the development of capitalism has always owed a particular debt to the role of manufacturing; and that industrialization has always and everywhere depended on state intervention that has ‘got prices wrong’. But the typical refrain of common sense is still: ‘well, it may have worked before – in Taiwan, in Vietnam, or somewhere, but please please don’t try this yourself!’ The argument is that the risks of failure are so high (and the historical record certainly does show many failures), and capacities in Africa so low, that it would be unwise to try to emulate the ‘lessons’ of economic history. For example, Paul Krugman came to recognize that theoretically, there was a very good case for ignoring the principle of comparative advantage, but, he argued, officials should actually stick to the principle and to producing unsophisticated goods because otherwise politics will get in the way and ruin things. Rather, prudent African policy officials should bide their time, getting the elements of good governance aligned, gradually building capacities, and confining themselves to the modest work of the facilitating state. African states, this plausible version of impossibilist common sense has it, should intervene up to and not beyond their current level of capacity.

Meanwhile, the other strand of impossibilist common sense rolls out a series of warnings suggesting that almost all policies or accumulation strategies simply have no chance of succeeding because the dominant material and ideological forces of global capitalism are stacked against low-income peripheral countries. Global value chains are controlled tightly by powerful systems integrators that brook no significant technological upgrading by developing country producers, who remain constrained to producing relatively simple goods on a lowly rung of the ladder. The world market prices for all the goods produced in poor countries are so volatile that the imports required for dynamic growth and political stability cannot reliably be acquired. The World Trade Organization (WTO) imposes rules so binding on developing countries that they are now unable to avail themselves of the kinds of policies in the trade and financial sectors used successfully by earlier ‘catching-up’ countries.

We acknowledge that it is easier to fail than to succeed with development policy – often more for domestic political reasons than reasons of measurable technocratic ‘capacity’. For example, in Ghana and Kenya political pressures were able – at some times more than others – to overwhelm sophisticated economic technocrats. We also acknowledge that the external financial and economic environment confronting developing country economies and governments is prone to wild fluctuations, often hostile, and poses risks to improving welfare. But there is still significant, proven scope for governments to intervene in support of an accelerated dynamic of accumulation, structural change, and not insignificant welfare improvement. And there is scope for governments to intervene beyond their current capacity levels, to experiment.”

A disintegrating Europe? Why the region needs a more ambitious industrial policy

threads_eu_600x423The pandemic crisis has spurred EU institutions into proposing a sizeable economic response. In May the European Commission “unveiled the Next Generation EU recovery plan that aims to address the damage caused by the pandemic and invest in a green, digital, social and more resilient EU”. It is a shame that it took this historical turn to galvanise such ambition. Despite all this, EU member states are some way from agreement over the size and distribution of the Covid-19 recovery package. But ambition is needed, now more than ever, to respond in a way that promotes a renewed, sustainable and socially cohesive prosperity across the continent. Continue reading

Covid-19 and creative destruction – Marx, Schumpeter and the role of the state

The impact of the uncertainty generated by Covid-19 and the subsequent lockdown in countries across the world has been devastating for economies and societies. There is more to come. The world economy was already struggling somewhat in 2019, with slowdowns in the US and China, the two largest economies. In fact, what was at best sluggish growth in output and productivity in many countries had been a feature of the decade or so which followed the financial crisis of 2008. The onset of the pandemic has hit already weak or fragile economies hard.

Keynes famously argued that the ‘animal spirits’, or waves of optimism and pessimism among businessmen potentially looking to invest, were a major factor in the determinant of growth and employment, and hence economic prosperity. Uncertainty about the future could lead to spending on new industrial capacity and jobs being postponed, driving the economy into stagnation or recession. It was the job of government, he said, to ‘socialise’ investment. In other words, through judicious policy choices, it should try to maintain optimistic expectations among businessmen and make sure that there were sufficient investment opportunities to keep spending, and therefore employment, at a socially optimum level. Continue reading

Can Vietnam escape the middle income trap?

samsungvietnamelectronics1A recent article by Trinh Nguyen of the Carnegie Endowment for International Peace (which can be accessed for free here) describes Vietnam’s recent development success story, its lessons for other late-developers and its prospects for the near future. According to the author, this success has been based on a rapid growth in manufacturing exports, much of it from foreign invested firms. This is in turn down to a liberal approach to international trade and investment, incentives for foreign firms to invest, including the provision of “industrial parks, infrastructure building, and tax breaks”, and more widespread “improvements in its electric system, national highways, and air and sea ports”. Continue reading

The Chinese economy: development, finance and reform

800px-Chinese_draakEven before the Covid-19 outbreak, the Chinese economy was slowing, after more than three decades of rapid economic expansion. Thirty years of recorded growth at around ten per cent per annum is unprecedented in human history. This has enabled hundreds of millions of people to be lifted out of poverty, and the material transformation of a poor country to one that is classified by the World Bank as upper-middle-income.

Despite all this, there is a broad consensus, including among Chinese government officials, that the country’s development model needs to change if it is to continue its transformation and become a rich country. Many economists argue that this will involve a rebalancing of the economy, in order to continue to grow and develop in a way that is more sustainable both for China itself, and for the rest of the world, given that as the world’s second largest economy behind the US, internal changes now have a major impact globally. Continue reading

Ha-Joon Chang: why free trade may not be best

ha-joon-chang“When they hear someone criticizing free trade, free-trade economists tend to accuse the critic of being ‘anti-trade’. But criticizing free trade is not to oppose trade.

Apart from the benefits of specialization that the theory of comparative advantage extols, international trade can bring many benefits. By providing a bigger market, it allows producers to produce more cheaply, as producing a larger quantity usually lowers your costs (this is known as economies of scale). This aspect is especially important for smaller economies, as they will have to produce everything expensively, if they cannot trade and have a bigger market. By increasing competition, international trade can force producers to become more efficient – insofar as they are not developing country firms that would get wiped out by vastly superior foreign firms. It might also produce innovation by exposing producers to new ideas (eg., new technologies, new designs, new managerial practices).

International trade is particularly important for developing countries. In order to increase their productive capabilities and thus develop their economies, they need to acquire better technologies. They can in theory invent such technologies themselves, but how many new technologies can relatively backward economies really invent on their own?…For these countries, therefore, it would be madness not to take advantage of all those technologies out there that they can import, whether in the form of machines or technology licensing (buying up the permit to use someone else’s patented technology) or technical consultancy. But if a developing country wants to import technologies, it needs to export and earn ‘hard currencies’ (universally accepted currencies, such as the US dollar or the Euro), as no one will accept its money for payments. International trade is therefore essential for economic development.

The case for international trade is indisputable. However, this does not mean that free trade is the best form of trade, especially (but not exclusively) for developing countries. When they engage in free trade, developing countries have their chances of developing productive capabilities hampered…The argument that international trade is essential should never be conflated with the argument that free trade is the best way to trade internationally.”

Ha-Joon Chang (2014), Economics: The User’s Guide, Pelican Books, p.412-4.