Keynes again – very good article by Martin Wolf

Leading economist and FT columnist Martin Wolf has written a superb article in today’s FT calling for pragmatic approach as a way forward.

Sir, you spoke for all of us who wished that people push aside their puritan ideologies and without going into left and right of it take pragmatic steps solving the crisis.

The article takes its inspiration from the the great John Maynard Keynes, but the theme of article is that we need Keynes’ much more than Keynes policies ditto. If there is one thing that separated Keynes from his contemporaries, according to the article, it is the fact that he took much more pragmatic approach to solving issues as against being ideologically correct.

According to the author, the three main lessons to take from JMK were (emphasis mine),

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”.

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so.

The third and most important lesson is that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

We need not dump the idea of free market economy saying that markets don’t work, nor we should fool ourselves in believing that markets will find their way out of this crisis on their own. This is an unusual event that calls for radical measures which may not be ideal, but may work. Results are more important than the means right now.

The article goes on to outline the present priorities in front of us (emphasis mine),

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand, as Keynes would have recommended. Also important will be direct central-bank finance of borrowers. It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak. Given the correction of household spending under way in the deficit countries, this period of high government spending is, alas, likely to last for years. At the same time, a big effort must be made to purge the balance sheets of households and the financial system. A debt-for-equity swap is surely going to be necessary.

The longer-term challenge is to force a rebalancing of global demand. Deficit countries cannot be expected to spend their way into bankruptcy, while surplus countries condemn as profligacy the spending from which their exporters benefit so much. In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.

I think Europeans are too complacent at this point. With deflation and demand destruction staring in the face, ECB’s procrastination to cut rates is baffling. Also the concerted effort for fiscal stimulus, which is required to get spending back on track, seems unlikely thanks to adamant Germany. On the other hand, Chinese still wants to rely on US exports to bail their economy out as against stimulating their domestic consumption. China will do a lot good by letting RMB appreciate a bit. But alas, they want to stack up more and more US dollars and throw good RMBs at bad RMBs.

The article concludes the message as (emphasis mine),

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us. The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible. We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinkers.

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches.

Well Said!