Unless you are explicitly anti-Keynesian you are for all practical purposes pro-Keynesian. There is one economic issue at the moment that is paramount and that is whether public spending can add to economic growth and employment or whether such expenditure actually damages a country’s growth and employment prospects. And building from that is the question whether a major part of the answer to contemporary economic problems are cuts to public spending.

However you look at it, this is the core issue of Keynesian economic theory and the policy that comes with it. If it is your conclusion that increases in non-value-adding public spending can contribute to growth and employment you are a Keynesian. If that is not your conclusion, that you think it will make things worse, then you are not. There is nothing else to it. At a minimum 95% of all economists practising today accept the Keynesian premise. At a maximum there may be 5% of the profession who do not. Even with the dismal and disastrous effects of the stimulus everywhere to be seen, either the stimulus was insufficient or it saved us from far worse are the standard answers. That we are now living out the consequences of a major and fundamental error in policy is virtually stated nowhere. The debate over Keynesian economic theory has not even begun never mind having been brought to an end.

The supposed locus of anti-Keynesian sentiment was found in a paper by Carmen Reinhart and Kenneth Rogoff discussed here. R&R argued in a jointly published book that “when a government’s debt rises to 90 percent of its country’s gross domestic product, the country’s economy contracts by (on average) one-tenth of one percent per year.” Turns out that their maths may have been wrong and the descent not as precipitous as that.

The usual motley crew of Keynesians therefore piled on to discredit the very idea of fiscal sense. The most recent and central of this Keynesian assault has been a book review by Paul Krugman in The New York Review of Books under the catchy title, “How the Case for Austerity has Crumbled” which would have been far better titled, “Who You Gonna Believe, Me Or Your Lying Eyes?”.

As scholars, R&R have had their feelings bruised and are now attempting to reply to their critics. Rogoff has written an article which was forwarded to me from Canada’s Globe and Mail which came with the title, Anti-austerity: Keynes never met the euro zone. It’s not, you see, Keynesian economics that is intrinsically wrong, it’s only just that the particular circumstances of the Euro as a single currency unit that are at fault. Here is the final para of the article which tries to deflect attention away from Keynesian theory per se:

To my mind, using Germany’s balance sheet to help its neighbours directly is far more likely to work than is the presumed ‘trickle-down’ effect of a German-led fiscal expansion. This, unfortunately, is what has been lost in the debate about Europe of late: However loud and aggressive the anti-austerity movement becomes, there still will be no simple Keynesian cure for the single currency’s debt and growth woes.

“No simple Keynesian cure” of course leaves room for a more complex Keynesian cure which would be appropriate in a different set of circumstances. Since it’s all numbers without theory who knows what anyone believes about anything, and that even includes Rogoff himself who may be completely baffled by his own results.

But prior to that R&R wrote a joint post on Reinhart’s blog titled Letter to PK. Their problem is with debt, not with Keynesian theory. To wit from the paper:

Let us be clear, we have addressed the role of somewhat higher inflation and financial repression in debt reduction in our research and in numerous pieces of commentary. As our appendix shows, we did not advocate austerity in the immediate wake of the crisis when recovery was frail. But the subprime crisis began in the summer of 2007, now six years ago. Waiting 10 to 15 more years to deal with a festering problem is an invitation for decay, if not necessarily an outright debt crisis. The end may not come with a bang but with a whimper.

And from that Appendix, first Reinhart:

Reinhart Testimony before Senate Budget Committee, February 9, 2010. ‘In light of the likelihood of continued weak consumption in the U.S. and Europe, rapid withdrawal of stimulus could easily tilt the economy back into recession. To be sure, this is not the time to exit. It is, however, the time to lay out a credible plan for a future exit.’

And then Rogoff:

Farheed Zakaria, GPS ‘Krugman calls for Space Aliens to Fix US Economy,’ August 12, 2011, Ken Rogoff: ‘Infrastructure spending, if it were well-spent, that’s great. I’m all for that. I’d borrow for that, assuming we’re not paying Boston Big Dig kind of prices for the infrastructure.’

But how bout cutting all that wasteful public spending that is going on right now? Rogoff again:

The Economy and the Candidates, Wall Street Journal Report with Maria Bartiromo, October 21, 2012 (interview with Kenneth Rogoff) on Fiscal Cliff: ‘Hopefully we won’t commit economic suicide by actually putting in all that tightening so quickly. I like to see something like Simpson Bowles….If we did, we could have our cake and eat it too, we could have more revenue without hurting growth.’

And here the two of them signing off on a joint statement:

A couple of Senator Coburn’s quotes from us at the meeting, taken without the full context of our introductory remarks have been interpreted as saying we endorsed immediately closing the budget. This was at odds with our position, notably our work on slow and often halting recoveries from financial crises, which we also emphasized. In fact, taking into account our opening remarks, it is our impression that the Senators full well understood the urgency we were expressing referred to adopting a long-term Grand Bargain a la Simpson Bowles.

No one supports immediately closing the budget since it cannot be done “immediately” anyway. But as Simpson-Bowles will take more than a decade, you cannot interpret R&R’s underlying theoretical position as stating that wasteful spending is the problem that must be cured. As I read what they wrote my conclusion is that they don’t get it. They just don’t get it. They don’t see that the wasteful spending is the problem in and of itself. That they share this perspective with 95% of economists means that there is no constituency whatsoever in favour of taking the only kinds of actions that will actually produce a return to a solid foundation for future economic growth, higher living standards and full employment.

I was asked to review a book on economic development by a former head of the Bank of Korea by a publisher which wondered whether it ought to be published. I thought the book was extremely eccentric but quite worthwhile for all that. It was eventually published but not by them as Supply-Side Development Theory: Growth Policies for Developing Countries Based on Successful Korean and Chinese Economies. But as Mr Park informed me, it was on the strength of this review that he ended up with the book being published. This was the review

Sung Sang Park: Growth Policies for Developing Countries:
Based on Supply Side Economic Development Theory and Successful Korean and Chinese Policy Experiences

To begin at the beginning: I believe this book deserves to be published and ought to have a large and interested readership.

I concede that its arguments go very much against the grain of modern development theories and that some of its proofs are often amateurish and will carry little weight in any serious academic discussion. But the author, rather than being a professional economist, actually helped direct the Korean economy into its present highly successful state. Moreover, he did so following the various precepts that are outlined in the book. Just listening into the way he thinks about the various issues is a strong reason to encourage publication.

But that is only just the start. The book really ought to make economists who are rusted onto existing theories of development take a second look at how one of the architects of an extraordinarily successful economy explains how that economy went from abject poverty to first world living standards in under two generations. The theory may require some refinement and polish to fit into the latest journals, but the common sense and practical value of its specific prescriptions ought to make others take notice.

What makes this book different is that it begins with the assumption that the chronological profile of how the first industrial revolution progressed provides a contour map of what an underdeveloped economy should do today. Why wait for the invisible hand to make visible the structure of growth? Instead, just copy what others have already done. And the basis for this copying is in following through with a series of classical and semi-classical propositions as the guiding principles.

Classical Concepts

The following are the five classical concepts that are used to explain the general approach to development policy. They seem to make an integrated and sensible framework, although far different from anything one might find in a modern text.

Say’s Law – The central proposition is the supply side concept built around Say’s Law. Development can only occur through production of what others want to buy. The continued use of Keynes’s version, “supply creates its own demand”, does emphasise the supply-side nature of his argument. Nevertheless, it would be more accurate to re-phrase the concept as, “supply is the basis of demand where what is supplied is what is demanded” although using Keynes’s expression allows a reader to accept the arguments since this is the standard form of words. Based on supply-side theory and Say’s Law, the author proposes that the government encourages the domestic supply side by encouraging the production of those particular manufactured goods that are both import replacing and exportable.

The proposal requires a very high level of government involvement. Governments control credit growth and foreign exchange and ensure that both are allocated towards productive manufacturers and virtually no one else. Businesses are chosen for their proven ability to produce efficiently and given what amounts to a ten year or more licensed monopoly. The assumption is made that if your most ruthlessly efficient profit maximising businesses are given the right to go ahead and make as much money as possible, that they will do just that, and raise productivity levels for the population at the same time.

The book is also very dismissive of demand-side economic theories which are seen to be inapplicable for developing nations. Will others understand why this is so? The worry is that they will not, but the argument is sound and would apply just as much to a developed economy, although that’s neither here nor there as far as this book is concerned.

Law of Colin Clark – The concept here is that the historic profile of development as agriculture gives way to manufactured goods and then on to services is a pattern that should be expected to play out in any underdeveloped economy. Governments should therefore insist that manufacturing industry is given every assistance as the industry that, if supported, will pull all of the others out of their poverty.

Moreover, he makes the distinction between forms of services. Services to business will form as manufacturing expands. Consumer services will come eventually but are not first in line. Business services will thus expand the proportion of activity that are classified as services but should not be seen as the immediate origins of a service economy. But in this the ontology of the historical pattern will be seen to predominate.

Schumpeter’s Entrepreneurial Class – Found this very interesting and very much like Adam Smith. The book is 100% free market and looks to business people to be the authors of economic prosperity. But at the same time, there is a sense in which these same business people are more of a necessary evil than a virtuous group whose values epitomise the nation. I positively loved this:

“We should not expect private businessmen to follow social ethics and extreme social justice, because the profit-oriented, selfish-motivated, and money power-oriented private businessmen are providing new and better consumer goods that make people richer and provide jobs and income that make the poor people in huts and villages happier. Socialistic idealism-oriented politicians and scholars, who hate rich businessmen, overlook this important contributory role of Schumpeterian businessmen that can benefit the very poor people in their own country.

“In fact, the profit-oriented and rich businessmen actually help poor people more than the noisy socialist-oriented politicians and scholars.” (p. 138)

Entrepreneurs who know how to get things done are the key ingredient. Governments have no role in running businesses and should keep absolutely out of the boardrooms. These business people know how to take care of themselves and will make their businesses profitable. And where they do not, well then, out they go.

The government role is to create an environment in which these sharks of the business world are able to achieve the specific ends the government has in mind. It is not entirely left for businesses to make their own decisions without government poking their noses in to see what they are doing. The government is seen as having a very large interest in making sure that these businesses are following the national plan of developing productive industries where import replacement and export growth are seen as having the highest value. Very collaborative, but once the general direction is set, the government appears to have little further role.

Leontief’s Industrial Linkage Effects – The notion here is that manufacturing is the linchpin of the entire economic system. As goes manufacturing so goes the rest. It is built on his own reading of the lessons from the input-output table. Hard to say if he has this right, but it is not entirely certain whether he has to be right about this for the rest of his programme to work.

Moreover, if he is right, then this is an important contribution. It is for him to put the proposition on the table and for others to perhaps investigate.

Fisher’s Quantity Theory of Money – Presented here is a very different theory of finance and interest rate adjustments from that found I suspect almost anywhere else. The basic theory of saving generation is that the only addition to saving that can come from the economy generally is from households. Governments have their expenditures and business profits get ploughed back into business. But household savings are too paltry to make any serious difference, especially in the early days of trying to generate growth, but even afterwards as well.

This part I found unfortunately more vague than I would have liked, but my understanding is as follows. To supplement the savings available from the population generally, the central bank should just increase the flow of newly created money year by year by around 15%. It should also insist that nominal interest rates are kept low. Both of these principles provide the stimulus for growth. The swing variable that allows a government to do so is to permit, indeed insist on, a continuous fall in the value of the currency.

Allowing credit to expand by 15% or so beyond the actual saving level of the community represents the classical concept of forced saving. Money is put into the hands of businesses whose spending pushes up the price level but also changes the internal terms of trade in their direction. As businesses have the first use of purchasing power, they attract resources more readily than do others, so that there is a bias in the growth of the economy towards productive activity. Definitely inflationary, but as it seems that wages policy is accommodating, workers are bought off through being paid at higher levels, but the growth in wages is kept within relatively tight constraints. Part of the process is to make the head of the trade union movement the Minister of Labour.

Clearly inflation is not allowed to be the core of policy. Instead, policy is driven by the desire to grow the productive side of the economy to the largest extent. And so long as the working population is being allowed to share in the growing prosperity, no one is going to complain.

At the same time, because of the relatively faster inflation rate, the exchange rate is under continuous downwards pressure, and this seems to be a matter of policy. Keeping parity with the US dollar or any other currency is seen as a fool’s game. Better is to allow the currency to fall to promote exports and accommodate the inevitable inflationary pressures that the programme of forced saving must inevitably lead to.

Lastly, nominal interest rates are kept low. I’m not entirely sure how this is done given all else, but the underlying reasoning seems worthy of attention. Business borrowing is a tragedy for any firm that gets locked into the kinds of interest rates that are prevalent in a high interest rate economy. It becomes a game of chasing one’s financial tail and heads a firm into the bankruptcy rocks once it loses control in a world of compounded high rates of interest. This is what the policy attempts to prevent.

Some Comments

The question is this: how much of this book is total nonsense, how much is relevant only to Korea with its own historical circumstance and particular society, and how much is transferable to other economies? Very hard to judge. But at the core of the book are a series of practical ideas that others may find of value. The supply-side orientation based around Say’s Law seems a crucial part of the necessary understanding within any economy that is seeking to find its way into sustained rates of economic growth. Hammering that alone ought to make the book worthy of finding its way into print.

I also found the writing style engaging, but only after a while. It is certainly repetitive, but eventually I found the constant repetition of the various phrases and tag lines pleasant. Perhaps one does not have to hear about “poor people in huts and villages” page after page, but the quote is from John F. Kennedy and it is intended to make a serious point. Others may find it annoying, but I found it sort of Homeric in its constant repetition of these various epithets. (It occurred to me that the book is really a series of essays and speeches he gave in the past which have been tied together since things are stated over and over.) There is work for a good editor in bringing out the underlying concepts and text but without ruining the style of the author. For myself, once I entered into the rhythm of its style, I had no problem reading it through. The question is whether a book that is written in such a relaxed informal way will earn the credits its underlying ideas ought to earn.

However, in regard to his stylised facts found in the various contrived arithmetical examples he provides, I found those worse than unconvincing since they are too superficial to ever prove his point and their very flimsiness will, I think, lead readers to discount the book’s otherwise sound ideas. I think they work against his basic arguments since I think (but on one reading cannot be certain) they are profoundly wrong as he has put them together. They often feel like the sorts of examples that you might find in some early nineteenth century work on economics before there had been any bedding down of the fundamental concepts and ideas. They are hardly necessary and seem misconceived. Someone needs to go through them with the author to make sure that they genuinely do make sense. Certainly, they are not well explained and as found in the text feel wrong.

I might also note that his use of the Will Rogers quote, that mankind’s three greatest inventions have been fire, the wheel and central banking, was a joke and not necessarily intended as a serious comment. Rogers was a humorist and not a social philosopher. Some early indication that this is understood would help with the book’s credibility. Also, I wonder whether the weight put on Antonio as an entrepreneur and on the Merchant of Venice generally as a pivotal presentation that altered the idea of usury is all that sound. Perhaps it doesn’t matter; to me it merely added to the book’s charm.

Let me just finish with this. The first industrial revolution, mainly amongst those nations bordering on the North Atlantic, were basically a trial and error process of floundering within the particular cultural and religious atmosphere of those times. And while these unusual times may well ultimately have permitted free markets to develop and flourish, there is no certainty that this is the only way for an economy to develop now that the course has been charted. Focusing on export-led import-replacing manufacturing industries may be sub-optimal in some cosmic sense in which everything is known in advance. However, where the alternative is prolonged poverty and repeated error, it may make more sense to use the historical knowledge available to policy makers to repeat the same process by force of will rather than repeating the same mistakes of the past 250 years.

Niall Ferguson, historian, buys in on the anti-Keynesian debate with the totally superfluous comment that Keynes developed his theory of the short run because of his absence of children and etc. And what about all those fathers of six who thought that Keynesian theory was the answer to our economic problems? I just wish people would concentrate on the theory and leave the rest alone. Ferguson has apologised but so what. One more distraction away from what really needs a bit of discussion: the harm that Keynesian theory is doing and the reason why his theories are so economically unsound. The rest is trash.

Here is an article on Ferguson’s claim, “Sex, Economics, and Austerity“. The one useful bit that I did pick up was this:

As Mark Blyth has shown in his new book Austerity: The History of a Dangerous Idea, the power of arguments for austerity come from the fact that they invoke the traditional moral system of the West, a way of thinking that is rarely questioned because it seems like common sense. Implicit in austerity are all sorts of moral adages: no pain, no gain; suffering builds character; thrift is virtue.

Austerity: The History of a Dangerous Idea! I fear life is too short but I suspect that if I run across it on a shelf I will pick it up just because. We are ruining our economies before our eyes by this madcap spending but it’s austerity that’s the dangerous idea. Well so far as dangerous economic theories are concerned, I came first with my Dangerous Return of Keynesian Economics in Quadrant in March 2009. Four years later and I wouldn’t add a word or change a comma.