Category Archives: Economic Crisis

A Superpower Trade War Looms – Liam Dann. 

“If America, China relations become very difficult, our position becomes tougher because then we will be coerced to choose.”

It’s a nightmare scenario for a small trading nation with historic cultural and political links to the US, but an increasing economic reliance on China. A full blown trade war between China and the US could have devastating political consequences for us all.

In this case, it’s not New Zealand’s Prime Minister doing the worrying, it’s Singaporean leader Lee Hsien Loong.

His simple, blunt assessment of the risk posed by Donald Trump’s anti-China trade rhetoric caused a minor uproar in the diplomatically cautious Asian nation.

Here in New Zealand, where we face the same risks, we’re yet to officially confront the issue. And as issues go, it’s a big one: in the year to June 2016, New Zealand’s total trade (imports and exports) with China was $22.86 billion, compared to $16.25b with the US.

Reserve Bank governor Graeme Wheeler has spoken most openly about his fears for the economic risk to New Zealand if the Trump Administration does some of the things it has threatened to do.

In a speech last month, Wheeler suggested that Trump’s Administration represents the greatest source of uncertainty for our economy – both in terms of his impact on the domestic economy and his potential to increase global trade protectionism. “Rationally speaking, there shouldn’t be a reason we should go into a trade war. But we have to be prepared,” says Auckland University Business School trade economist Dr Asha Sandra. China and the US are like Siamese twins, she says. In other words, their economies are now so intertwined that doing damage to one must hurt the other.

“I think they both know that if they start this, they will both go down. So I don’t think it should be a big risk. But the thing with Donald Trump, is you just don’t know. He has been running the most incoherent Administration we have seen,” Sandaram says. “What he says today is not correlated with what he says tomorrow … and what he’ll actually do. So we have to consider the possibility of an escalating trade war.”

For anyone who relies on global trade, Trump has said some frightening things. On the campaign trail, he talked about hitting Chinese imports with 45 per cent tariffs and accused China of currency manipulation. Since becoming President, he has pulled the US out of the Trans-Pacific Partnership free trade agreement. In a leaked recording, he has talked about imposing 10 per cent tariffs on all imports and is said to be considering border taxes.

His key trade adviser has been China hawk Peter Navarro, author of Death by China: Confronting the Dragon. And he has nominated Robert Lighthizer – who has accused China of unfair trade practices – as his US Trade Representative. Bloomberg has surfaced an article Lighthizer wrote in 2011 praising Ronald Reagan’s aggressive trade stance when Japan’s economic rise threatened the US.

There are concerns that Trump may look to follow those Reagan-era tactics, invoking section 301 of the US Trade Act, which allows a President to bestow “unfavourable trading status” on certain nations. It’s a measure the US hasn’t used since it adopted World Trade Organisation rules in 1995. And, as the many critics have warned, the world has changed. China is not like Japan, politically and militarily dependent on the US.

Last month, Wheeler told the Herald that his trade concerns deepened after visiting Washington DC at the start of the year. “I was in Washington recently talking to a number of senior people – very well connected to the Trump Administration. They were saying that the concerns around China are deeply felt. In other words, the Trump Administration has very strong views about currency manipulation and trade practices out of China. I found that deeply worrying.” Wheeler warns that the Trump risk comes on top of a protectionist trend which is already dampening global trade and threatening growth.

Long-time New Zealand trade advocate Stephen Jacobi agrees. “Undoubtedly it is a concern,” he says of Trump’s protectionist rhetoric. “It was already a concern. Protection was already on the rise and we had seen a slowing in trade growth as well.” The advent of the Trump Administration has thrown the spotlight on this he says. Jacobi, who was head of the NZ US Council as executive director from 2005 to 2014, is now executive director of the NZ China Council, so has a good perspective on New Zealand’s relationship with both economies.

“It is early days for the [Trump] Administration,” he says. “In fact the Administration isn’t even in place yet. We just have to withhold our judgment for a bit, however much it might pain us to do so, to see what actually happens.” From discussions he has had in Wellington, Jacobi believes New Zealand officials are very much taking that wait and see approach. That said, the Government has been working on a new trade policy strategy and is expected to release it this month. It will have to acknowledge the growing risks and look at alternatives to the TPP, Jacobi says. “But I doubt whether they will have given up on the US just yet. “So concern, yes. Panic no,”

Professor Natasha Hamilton-Hart, with the Department of Management and International Business at Auckland University, says one of the direct risks to New Zealand is the prospect that Trump scores an own goal with his economic policies. “I know the markets seem to be pricing in good times on the horizon but I’m pretty sceptical that that is going to last. She doesn’t see a sustainable growth trajectory coming out of either the tax or infrastructure programme.

Things like border taxes and tariffs would be distortionary and depress consumer spending, she says. “We will see an increase in military spending and with the tax cut will start to see an increase in the deficit, which is going to have implications for US interest rates. “There are potentially quite contractionary processes in the medium term. They just don’t seem to have a coherent, workable plan.”

Then there are the diplomatic risks around a President who tweets his midnight thoughts to the world.. Trump’s impact on Asia-Pacific trading relationships is a serious concern. “This might be overly optimistic,” Hamilton-Hart says. “I’m doubtful that it will come to a 45 per cent tariff on Chinese exports because that would be so disrupting and damaging to US firms and US consumers. It’s going to double the price of everything in Walmart.”

“What I think is more likely is that we will see a stronger line of creeping protectionism … so cancelling the TPP, looking at alternatives to dispute settlements outside the WTO, that kind of thing. I imagine we’ll see a lot more of that. And I imagine that is what China is gearing up for. So yeah, a less rule based trading system.”

The irony of Trump’s trade deficit obsession is that running big deficits is what actually gives you power on the global economic stage, Hamilton-Hart says. In other words, a big net importer is the customer and the customer is always right. “So if you stop running those trade deficits, then you no longer have the ability to throw your weight around. If Donald Trump were to significantly withdraw the US from world trade by putting up barriers and shrinking the US economy … that can only go with a reduction in US influence.”

China, for its part, doesn’t appear keen on a trade war and isn’t rushing to fill the trade leadership void left by the US . For example, it appears to be carefully maintaining the strength of the Renminbi to avoid inflaming US currency hawks. “They certainly do not want a trade war,” Jacobi says. “They’ve got enormous economic interests with the United States. And I think you can rely on the Chinese to manage all of that in a very sensible way.”

What worries Jacobi more is the risk of America over-playing its hand on security and sovereignty issues – like Taiwan. “That’s much more worrying because you can’t always guarantee how a nationalistic China might react,” he says. “When you touch on issues of national sovereignty with the Chinese, you don’t get the same sort of reaction that you do on other things.”

Jacobi does have faith that the US system, with its constitutional checks and balances on executive power, will work – in time. “But he [Trump] has a lot of power to do things in the short term. While congress catches up.” Likewise, there will be powerful lobbying forces in the US business community who will push back at things he might want to do. “But they also take time,” Jacobi says. “I’m confident that over time the right decisions should be made. But what damage will be done in the meantime is a bit of an unknown. And the world has lost a whole lot of leadership around open markets and free trade.”

So where does that leave the New Zealand and its Asia-Pacific trading partners?

The remaining TPP signatories head to Chile later this month to discuss what, if anything, is salvageable without America. The Americans have said they will send a representative to that meeting, although it’s not clear who that will be or what level of interest they will take, say Jacobi. “And China will also be around. Because there is a Pacific Alliance meeting [a Latin American trading bloc] and the Chinese have been invited to that.”

There is a need for quiet diplomacy behind the scenes and New Zealand could play a key role in that, says Jacobi. But we need to be careful not to upset the other members of the TPP. Particularly the Japanese who, says Jacobi, “are in a very invidious position”. “They had this ballistic missile sent from North Korea the other day. They have got real security concerns, for which they have to rely on the US. They are not going to be drawn to take issue with the United States unnecessarily.”

China is already a member of an alternative multilateral trade group – the Regional Comprehensive Economic Partnership (RCEP), which also includes New Zealand. If completed, that free trade agreement (FTA) would include the 10 member states of ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam) and the six states with which ASEAN has existing free trade agreements (Australia, China, India, Japan, South Korea and New Zealand).

There have been suggestions that China may look to push this deal as a TPP alternative. But China hasn’t yet shown any signs of taking the lead, says Jacobi. On the one hand, we’ve heard rhetoric from Chinese President Xi Jinping about China’s global leadership, but the reality is that they haven’t taken a major role in multilateral negotiations yet, Jacobi says. “Maybe it’s time. They do have an enormous ability now to fill a vacuum.”

It is a different game now, says Hamilton-Hart, who believes the TPP is effectively dead. “So do we make a much better effort to get on board with RCEP?” she says. “Or are we going to hang in there and hope that we could do a bilateral with the US … which I think would be a bad thing to do as we’d be massively disadvantaged in the negotiations.” 

Jacobi agrees that the bilateral path is problematic. “We can’t afford not to push on any open door,” he says. “But the reality is that is bloody hard going. Look at the experience we had with Korea, very complicated.”

Trump has said he’ll do bilateral deals with TPP partners. But we would want dairy concessions and the US would want a lot of movement on medicines, says Jacobi. And neither would play well politically for either nation. “We’ve got to talk, but will we be high up on the list? And will it be better than TPP? Most unlikely”

“I don’t want to be too pessimistic,” says Auckland University’s Sandaram. “There may be some opportunities as a small country where you could fly under the radar. It’s harder for a big country to be non-aligned.” This could be a unique opportunity, she says. “We could try and stay neutral and expand into both markets.” Sandaram, who has been based in New Zealand for only a year, feels New Zealand is sometimes overly cautious about Chinese sensitivities. “It’s not a traditional link like the UK or Australia, so maybe it is because it is new that we are so cautious.”

Jacobi believes the Chinese have a good understanding of our deep political and economic ties with the Western nations, and particularly the US. “In fact, one of the positive aspects they see in our relationship is that we are an interesting interlocutor because of our attachment to the West,” he says. “But they also know our trade and economic ties are towards China. So whether that will amount to cutting slack … I’m not sure.”

Both Sandaram and Jacobi believe we have more options than we did a generation ago. “We need to diversify,” says Sandaram. “China is decelerating. But we have Asian powers that are fast growing economies. India, Malaysia, Indonesia – with the emerging middle class there is going to be demand for goods that New Zealand exports. “That’s a great opportunity I think we’re uniquely placed.”

New Zealand, both at a government and a business level, has to be proactive about trade, now more so than ever, says Jacobi. “This is not something that New Zealand can just sit back and observe. We don’t have that luxury. This is about our economic livelihood and we have to have a say in it.”

NZ Herald 

What Mainstream Economists Get Wrong About Secular Stagnation – Servaas Storm. 

Forget the myth of a savings glut causing near-zero interest rates. We have a shortage of aggregate demand, and only public spending and raising wages will change that.

Introduction

Nine years after the Great Financial Crisis, U.S. output growth has not returned to its pre-recession trend, even after interest rates hit the ‘zero lower bound’ (ZLB) and the unconventional monetary policy arsenal of the Federal Reserve has been all but exhausted. It is widely feared that this insipid recovery reflects a ‘new normal’, characterized by “secular stagnation” which set in already well before the global banking crisis of 2008 (Summers 2013, 2015).

This ‘new normal’ is characterized not just by this slowdown of aggregate economic growth, but also by greater income and wealth inequalities and a growing polarization of employment and earnings into high-skill, high-wage and low-skill, low-wage jobs—at the expense of middle-class jobs (Temin 2017; Storm 2017). The slow recovery, heightened job insecurity and economic anxiety have fueled a groundswell of popular discontent with the political establishment and made voters captive to Donald Trump’s siren song promising jobs and growth (Ferguson and Page 2017).

What are the causes of secular stagnation? What are the solutions to revive growth and get the U.S. economy out of the doldrums?

If we go by four of the papers commissioned by the Institute for New Economic Thinking (INET) at its recent symposium to explore these questions, one headline conclusion stands out: the secular stagnation is caused by a heavy overdose of savings (relative to investment), which is caused by higher retirement savings due to declining population growth and an ageing labour force (Eggertson, Mehotra & Robbins 2017; Lu & Teulings 2017; Eggertson, Lancastre and Summers 2017), higher income inequality (Rachel & Smith 2017), and an inflow of precautionary Asian savings (Rachel & Smith 2017). All these savings end up as deposits, or ‘loanable funds’ (LF), in commercial banks. In earlier times, so the argument goes, banks would successfully channel these ‘loanable funds’ into productive firm investment — by lowering the nominal interest rate and thus inducing additional demand for investment loans.

But this time is different: the glut in savings supply is so large that banks cannot get rid of all the loanable funds even when they offer firms free loans—that is, even after they reduce the interest rate to zero, firms are not willing to borrow more in order to invest. The result is inadequate investment and a shortage of aggregate demand in the short run, which lead to long-term stagnation as long as the savings-investment imbalance persists. Summers (2015) regards a “chronic excess of saving over investment” as “the essence of secular stagnation”. Monetary policymakers at the Federal Reserve are in a fix, because they cannot lower the interest rate further as it is stuck at the ZLB. Hence, forces of demography and ageing, higher inequality and thrifty Chinese savers are putting the U.S. economy on a slow-moving turtle — and not much can be done, it seems, to halt the resulting secular stagnation.

This is clearly a depressing conclusion, but it is also wrong.

To see this, we have to understand why there is a misplaced focus on the market for loanable funds that ignores the role of fiscal policy that is plainly in front of us. In other words, we need to step back from the trees of dated models and see the whole forest of our economy.

The Market for Loanable Funds

In the papers mentioned, commercial banks must first mobilise savings in order to have the loanable funds (LF) to originate new (investment) loans or credit. Banks are therefore intermediaries between “savers” (those who provide the LF-supply) and “investors” (firms which demand the LF). Banks, in this narrative, do not create money themselves and hence cannot pre-finance investment by new money. They only move it between savers and investors.

We apparently live in a non-monetary (corn) economy—one that just exchanges a real good that everybody uses, like corn. Savings (or LF-supply) are assumed to rise when the interest rate R goes up, whereas investment (or LF-demand) must decline when R increases. This is the stuff of textbooks, as is illustrated by Greg Mankiw’s (1997, p. 63) explanation:

“In fact, saving and investment can be interpreted in terms of supply an demand. In this case, the ‘good’ is loanable funds, and its ‘price’ is the interest rate. Saving is the supply of loans—individuals lend their savings to investors, or they deposit their saving in a bank that makes the loan for them. Investment is the demand for loanable funds—investors borrow from the public directly by selling bonds or indirectly by borrowing from banks. [….] At the equilibrium interest rate, saving equals investment and the supply of loans equals the demand.”

But the loanable funds market also forms the heart of complicated dynamic stochastic general equilibrium (DSGE) models, beloved by ‘freshwater’ and ‘saltwater’ economists alike (Woodford 2010), as should be clear from the commissioned INET papers as well. Figure 1 illustrates the loanable funds market in this scheme. The upward-sloping curve tells us that savings (or LF-supply) goes up as the interest rate R increases. The downward-sloping curve shows us that investment (or LF-demand) declines if the cost of capital (R) goes up. In the initial situation, the LF-market clears at a positive interest rate R0 > 0. Savings equal investment, which implies that LF-supply matches LF-demand, and in this—happy—equilibrium outcome, the economy can grow along some steady-state path.

To see how we can get secular stagnation in such a loanable-funds world, we introduce a shock, say, an ageing population (a demographic imbalance), a rise in (extreme) inequality, or an Asian savings glut, due to which the savings schedule shifts down. Equilibrium in the new situation should occur at R1 which is negative. But this can’t happen because of the ZLB: the nominal interest cannot decline below zero. Hence R is stuck at the ZLB and savings exceed investment, or LF-supply > LF-demand. This is a disequilibrium outcome which involves an over-supply of savings (relative to investment), in turn leading to depressed growth.

Ever since Knut Wicksell’s (1898) restatement of the doctrine, the loanable funds approach has exerted a surprisingly strong influence upon some of the best minds in the profession. Its appeal lies in the fact that it can be presented in digestible form in a simple diagram (as Figure 1), while its micro-economic logic matches the neoclassical belief in the ‘virtue of thrift’ and Max Weber’s Protestant Ethic, which emphasize austerity, savings (before spending!) and delayed gratification as the path to bliss.

The problem with this model is that it is wrong (see Lindner 2015; Taylor 2016). Wrong in its conceptualisation of banks (which are not just intermediaries pushing around existing money, but which can create new money ex nihilo), wrong in thinking that savings or LF-supply have anything to do with “loans” or “credit,” wrong because the empirical evidence in support of a “chronic excess of savings over investment” is weak or lacking, wrong in its utter neglect of finance, financialization and financial markets, wrong in its assumption that the interest rate is some “market-clearing” price (the interest rate, as all central bankers will acknowledge, is the principal instrument of monetary policy), and wrong in the assumption that the two schedules—the LF-supply curve and the LF-demand curve—are independent of one another (they are not, as Keynes already pointed out).

I wish to briefly elaborate these six points. I understand that each of these criticisms is known and I entertain little hope that that any of this will make people reconsider their approach, analysis, diagnosis and conclusions. Nevertheless, it is important that these criticisms are raised and not shoveled under the carpet. The problem of secular stagnation is simply too important to be left mis-diagnosed.

First Problem: Loanable Funds Supply and Demand Are Not Independent Functions

Let me start with the point that the LF-supply and LF-demand curve are not two independent schedules. Figure 1 presents savings and investment as functions of only the interest rate R, while keeping all other variables unchanged. The problem is that the ceteris paribus assumption does not hold in this case. The reason is that savings and investment are both affected by, and at the same time determined by, changes in income and (changes in) income distribution. To see how this works, let us assume that the average propensity to save rises in response to the demographic imbalance and ageing. As a result, consumption and aggregate demand go down. Rational firms, expecting future income to decline, will postpone or cancel planned investment projects and investment declines (due to the negative income effect and for a given interest rate R0). This means that LF-demand curve in Figure 1 must shift downward in response to the increased savings. The exact point was made by Keynes (1936, p. 179):

“The classical theory of the rate of interest [the loanable funds theory] seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shift, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.”

Let me try to illustrate this using Figure 2. Suppose there is an exogenous (unexplained) rise in the average propensity to save. In reponse, the LF-supply curve shifts down, but because (expected) income declines, the LF-demand schedule shifts downward as well. The outcome could well be that there is no change in equilibrium savings and equilibrium investment. The only change is that the ‘natural’ interest is now R1 and equal to the ZLB. Figure 2 is, in fact, consistent with the empirical analysis (and their Figure of global savings and investment) of Rachel & Smith. Let me be clear: Figure 2 is not intended to suggest that the loanable funds market is useful and theoretically correct. The point I am trying to make is that income changes and autonomous demand changes are much bigger drivers of both investment and saving decisions than the interest rate. Market clearing happens here—as Keynes was arguing—because the level of economic activity and income adjust, not because of interest-rate adjustment

Second Problem: Savings Do Not Fund Investment, Credit Does…

The loanable funds doctrine wrongly assumes that commercial bank lending is constrained by the prior availability of loanable funds or savings.  The simple point in response is that, in real life, modern banks are not just intermediaries between ‘savers’ and ‘investors’, pushing around already-existing money, but are money creating institutions. Banks create new money ex nihilo, i.e. without prior mobilisation of savings. This is illustrated by Werner’s (2014) case study of the money creation process by one individual commercial bank. What this means is that banks do pre-finance investment, as was noted by Schumpeter early on and later by Keynes (1939), Kaldor (1989), Kalecki, and numerous other economists.  It is for this reason that Joseph Schumpeter (1934, p. 74) called the money-creating banker ‘the ephor of the exchange economy’—someone who by creating credit (ex nihilo) is pre-financing new investments and innovation and enables “the carrying out of new combinations, authorizes people, in the name of society as it were, to form them.” Nicholas Kaldor (1989, p. 179) hit the nail on its head when he wrote that “[C]redit money has no ‘supply function’ in the production sense (since its costs of production are insignificant if not actually zero); it comes into existence as a result of bank lending and is extinguished through the repayment of bank loans. At any one time the volume of bank lending or its rate of expansion is limited only by the availability of credit-worthy borrowers.” Kaldor had earlier expressed his views on the endogeneity of money in his evidence to the Radcliffe Committee on the Workings of the Monetary System, whose report (1959) was strongly influenced by Kaldor’s argumentation. Or take Lord Adair Turner (2016, pp. 57) to whom the loanable-funds approach is 98% fictional, as he writes:

“Read an undergraduate textbook of economics, or advanced academic papers on financial intermediation, and if they describe banks at all, it is usually as follows: “banks take deposits from households and lend money to businesses, allocating capital between alternative capital investment possibilities.” But as a description of what modern banks do, this account is largely fictional, and it fails to capture their essential role and implications. […] Banks create credit, money, and thus purchasing power. […]  The vast majority of what we count as “money’ in modern economies is created in this fashion: in the United Kingdom 98% of money takes this form ….”

We therefore don’t need savings to make possible investment—or, in contrast to the Protestant Ethic, banks allow us to have ‘gratification’ even if we have not been ‘thrifty’ and austere, as long as there are slack resources in the economy.

It is by no means a secret that commercial banks create new money. As the Bank of England (2007) writes, “When bank make loans they create additional deposits for those that have borrowed” (Berry et al. 2007, p. 377).  Or consider the following statement from the Deutsche Bundesbank (2009): “The commercial banks can create money themselves ….”  Across the board, central bank economists, including economists working at the Bank for International Settlements (Borio and Disyatat 2011), have rejected the loanable funds model as a wrong description of how the financial system actually works (see McLeay et al. 2014a, 2014b; Jakab and Kumhof 2015). And the Deutsche Bundesbank (2017) leaves no doubt as to how the banking system works and money is created in actually-existing capitalism, stating that the ability of banks to originate loans does not depend on the prior availability of saving deposits. Bank of England economists Zoltan Jakab and Michael Kumhoff (2015) reject the loanable-funds approach in favour of a model with money-creating banks. In their model (as in reality), banks pre-finance investment; investment creates incomes; people save out of their incomes; and at the end of the day, ex-post savings equal investment. This is what Jakab and Kumhoff (2015) conclude:

“…. if the loan is for physical investment purposes, this new lending and money is what triggers investment and therefore, by the national accounts identity of saving and investment (for closed economies), saving. Saving is therefore a consequence, not a cause, of such lending. Saving does not finance investment, financing does. To argue otherwise confuses the respective macroeconomic roles of resources (saving) and debt-based money (financing).”

Savings are a consequence of credit-financed investment (rather than a prior condition) — and we cannot draw a savings-investment cross as in Figure 1, as if the two curves are independent. They are not. There exists therefore no ‘loanable funds market’ in which scarce savings constrain (through interest rate adjustments) the demand for investment loans. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

“Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.”

This makes it all the more remarkable that some of the authors of the commissioned conference papers continue to frame their analysis in terms of the discredited loanable funds market which wrongly assumes that savings have an existence of their own—separate from investment, the level of economic activity and the distribution of incomes.

Third Problem: The Interest Rate Is a Monetary Policy Instrument, Not a Market-Clearing Price

In loanable funds theory, the interest rate is a market price, determined by LF-supply and LF-demand (as in Figure 1). In reality, central bankers use the interest rate as their principal policy instrument (Storm and Naastepad 2012). It takes effort and a considerable amount of sophistry to match the loanable funds theory and the usage of the interest rate as a policy instrument. However, once one acknowledges the empirical fact that commercial banks create money ex nihilo, which means money supply is endogenous, the model of an interest-rate clearing loanable funds market becomes untenable.  Or as Bank of England economists Jakab and Kumhof (2015) argue:

“modern central banks target interest rates, and are committed to supplying as many reserves (and cash) as banks demand at that rate, in order to safeguard financial stability. The quantity of reserves is therefore a consequence, not a cause, of lending and money creation. This view concerning central bank reserves […] has been repeatedly described in publications of the world’s leading central banks.”

What this means is that the interest rate may well be at the ZLB, but this is not caused by a savings glut in the loanable funds market, but the result of a deliberate policy decision by the Federal Reserve—in an attempt to revive sluggish demand in a context of stagnation, subdued wage growth, weak or no inflation, substantial hidden un- and underemployment, and actual recorded unemployment being (much) higher than the NAIRU (see Storm and Naastepad 2012). Seen this way, the savings glut is the symptom (or consequence) of an aggregate demand shortage which has its roots in the permanent suppression of wage growth (relative to labour productivity growth), the falling share of wages in income, the rising inequalities of income and wealth (Taylor 2017) as well as the financialization of corporations (Lazonick 2017) and the economy as a whole (Storm 2018). It is not the cause of the secular stagnation—unlike in the loanable funds models.

Fourth Problem: The Manifest Absence of Finance and Financial Markets

What the various commissioned conference papers do not acknowledge is that the increase in savings (mostly due to heightened inequality and financialization) is not channeled into higher real-economy investment, but is actually channeled into more lucrative financial (derivative) markets. Big corporations like Alphabet, Facebook and Microsoft are holding enormous amounts of liquidity and IMF economists have documented the growth of global institutional cash pools, now worth $5 to 6 trillion and managed by asset or money managers in the shadow banking system (Pozsar 2011; Pozsar and Singh 2011; Pozsar 2015). Today’s global economy is suffering from an unprecedented “liquidity preference”—with the cash safely “parked” in short-term (over-collateralized lending deals in the repo-market. The liquidity is used to earn a quick buck in all kinds of OTC derivatives trading, including forex swaps, options and interest rate swaps. The global savings glut is the same thing as the global overabundance of liquidity (partying around in financial markets) and also the same thing as the global demand shortage—that is: the lack of investment in real economic activity, R&D and innovation.

The low interest rate is important in this context, because it has dramatically lowered the opportunity cost of holding cash—thus encouraging (financial) firms, the rentiers and the super-rich to hold on to their liquidity and make (quick and relatively safe and high) returns in financial markets and exotic financial instruments. Added to this, we have to acknowledge the fact that highly-leveraged firms are paying out most of their profits to shareholders as dividends or using it to buy back shares (Lazonick 2017). This has turned out to be damaging to real investment and innovation, and it has added further fuel to financialization (Epstein 2018; Storm 2018). If anything, firms have stopped using their savings (or retained profits) to finance their investments which are now financed by bank loans and higher leverage. If we acknowledge these roles of finance and financial markets, then we can begin to understand why investment is depressed and why there is an aggregate demand shortage. More than two decades of financial deregulation have created a rentiers’ delight, a capitalism without ‘compulsions’ on financial investors, banks, and the property-owning class which in practice has led to ‘capitalism for the 99%’ and ‘socialism for the 1%’ (Palma 2009; Epstein 2018) For authentic Keynesians, this financialized system is the exact opposite of Keynes’ advice to go for the euthanasia of the rentiers (i.e.design policies to reduce the excess liquidity).

Fifth Problem: Confusing Savings with “Loans,” or Stocks with Flows

“I have found out what economics is,’ Michał Kalecki once told Joan Robinson, “it is the science of confusing stocks with flows.” If anything, Kalecki’s comment applies to the loanable funds model. In the loanable fund universe, as Mankiw writes and as most commissioned conference papers argue, saving equals investment and the supply of loans equals the demand at some equilibrium interest rate. But savings and investment are flow variables, whereas the supply of loans and the demand for loans are stock variables. Simply equating these flows to the corresponding stocks is not considered good practice in stock-flow-consistent macro-economic modelling. It is incongruous, because even if we assume that the interest rate does clear “the stock of loan supply” and “the stock of loan demand”, there is no reason why the same interest rate would simultaneouslybalance savings (i.e. the increase in loan supply) and investment (i.e. the increase in loan demand). So what is the theoretical rationale of assuming that some interest rate is clearing the loanable funds market (which is defined in terms of flows)?

To illustrate the difference between stocks and flows: the stock of U.S. loans equals around 350% of U.S. GDP (if one includes debts of financial firms), while gross savings amount to 17% of U.S. GDP. Lance Taylor (2016) presents the basic macroeconomic flows and stocks for the U.S. economy to show how and why loanable funds macro models do not fit the data—by a big margin. No interest rate adjustment mechanism is strong enough to bring about this (ex-post) balance in terms of flows, because the interest rate determination is overwhelmed by changes in loan supply and demand stocks. What is more, and as stated before, we don’t actually use ‘savings’ to fund ‘investment’. Firms do not use retained profits (or corporate savings) to finance their investment, but in actual fact disgorge the cash to shareholders (Lazonick 2017). They finance their investment by bank loans (which is newly minted money).  Households use their (accumulated) savings to buy bonds in the secondary market or any other existing asset. In that case, the savings do not go to funding new investment — but are merely used to re-arrange the composition of the financial portfolio of the savers.

Final Problem: The Evidence of a Chronic Excess of Savings Over Investment is Missing

If Summers claims that there is a “chronic excess of savings over investment,” what he means is that ex-ante savings are larger than ex-ante investment. This is a difficult proposition to empirically falsify, because we only have ex-post (national accounting) data on savings and investment which presume the two variables are equal. However, what we can do is consider data on (global) gross and net savings rates (as a proportion of GDP) to see if the propensity to save has increased. This is what Bofinger and Ries (2017) did and they find that global saving rates of private households have declined dramatically since the 1980s. This means, they write, that one can rule out ‘excess savings’ due to demographic factors (as per Eggertson, Mehotra & Robbins 2017; Eggertsson, Lancastre & Summers 2017; Rachel & Smith 2017; and Lu & Teulings 2017). While the average saving propensity of household has declined, the aggregate propensity to save has basically stayed the same during the period 1985-2014. This is shown in Figure 3 (reproduced from Bofinger and Reis 2017) which plots the ratio of global gross savings (or global gross investment) to GDP against the world real interest rate during 1985-2014. A similar figure can be found in the paper by Rachel and Smith (2017). What can be seen is that while there has been no secular rise in the average global propensity to save, there has been a secular decline in interest rates. This drop in interest rates to the ZLB is not caused by a savings glut, nor by a financing glut, but is the outcome of the deliberate decisions of central banks to lower the policy rate in the face of stagnating economies, put on a ‘slow-moving turtle’ by a structural lack of aggregate demand which—as argued by Storm and Naastepad (2012) and Storm (2017)—is largely due to misconceived macro and labour-market policies centered on suppressing wage growth, fiscal austerity, and labour market deregulation

To understand the mechanisms underlying Figure 3, let us consider Figure 4 which plots investment demand as a negative function of the interest rate. In the ‘old situation’, investment demand is high at a (relatively) high rate of interest (R0); this corresponds to the data points for the period 1985-1995 in Figure 3. But then misconceived macro and labour-market policies centered on suppressing wage growth, fiscal austerity, and labour market deregulation began to depress aggregate demand and investment—and as a result, the investment demand schedule starts to shift down and to become more steeply downward-sloping at the same time. In response to the growth slowdown (and weakening inflationary pressure), central banks reduce R—but without any success in raising the gross investment rate. This process continues until the interest rate hits the ZLB while investment has become practically interest-rate insensitive, as investment is now overwhelmingly determined by pessimistic profit expectations; this is indicated by the new investment schedule (in red). That the economy is now stuck at the ZLB is not caused by a “chronic excess of savings” but rather by a chronic shortage of aggregate demand—a shortage created by decades of wage growth moderation, labour market flexibilization, and heightened job insecurity as well as the financialization of corporations and the economy at large (Storm 2018).

Conclusions

The consensus in the literature and in the commissioned conference papers that the global decline in real interest rates is caused by a higher propensity to save, above all due to demographic reasons, is wrong in terms of underlying theory and evidence base.  The decline in interest rates is the monetary policy response to stalling investment and growth, both caused by a shortage of global demand. However, the low interest rates are unable to revive growth and halt the secular stagnation, because there is little reason for firms to expand productive capacity in the face of the persistent aggregate demand shortage. Unless we revive demand, for example through debt-financed fiscal stimulus or a drastic and permanent progressive redistribution of income and wealth in favour of lower-income groups (Taylor 2017), there is no escape from secular stagnation. The narrow focus on the ZLB and powerless monetary policy within the framing of a loanable-funds financial system blocks out serious macroeconomic policy debate on how to revive aggregate demand in a sustainable manner. It will keep the U.S. economy on the slow-moving turtle — not because policymakers cannot do anything about it, but we choose to do so. The economic, social and political damage, fully self-inflicted, is going to be of historic proportions.

It is not a secret that the loanable funds approach is fallacious (Lindner 2015; Taylor 2016; Jakab and Kumhof 2015). While academic economists continue to refine their Ptolemaic model of a loanable-funds market, central bank economists have moved on—and are now exploring the scope of and limitations to monetary policymaking in a monetary economy. Keynes famously wrote that “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”  In 2017, things seem to happen the other way around: academic economists who believe themselves to be free thinkers are caught in the stale theorizing of a century past. The puzzle is, as Lance Taylor (2016, p. 15) concludes “why [New Keynesian economists] revert to Wicksell on loanable funds and the natural rate while ignoring Keynes’s innovations. Maybe, as [Keynes] said in the preface to the General Theory, “‘The difficulty lies not in the new ideas, but in escaping from the old ones …..’ (p. viii)”

Due to our inability to free ourselves from the discredited loanable funds doctrine, we have lost the forest for the trees. We cannot see that the solution to the real problem underlying secular stagnation (a structural shortage of aggregate demand) is by no means difficult: use fiscal policy—a package of spending on infrastructure, green energy systems, public transportation and public services, and progressive income taxation—and raise (median) wages. The stagnation will soon be over, relegating all the scholastic talk about the ZLB to the dustbin of a Christmas past. 

Institute For New Economic Thinking 

*

Servaas Storm

Servaas Storm is a Dutch economist and author who works on macroeconomics, technological progress, income distribution & economic growth, finance, development and structural change, and climate change.

Reclaiming the State. A Progressive Vision of Sovereignty for a Post-Neoliberal World –  William Mitchell and Thomas Fazi. 

Introduction: 

Make the Left Great Again 

The West is currently in the midst of an anti-establishment revolt of historic proportions. The Brexit vote in the United Kingdom, the election of Donald Trump in the United States, the rejection of Matteo Renzi’s neoliberal constitutional reform in Italy, the EU’s unprecedented crisis of legitimation: although these interrelated phenomena differ in ideology and goals, they are all rejections of the (neo) liberal order that has dominated the world –and in particular the West –for the past 30 years. 

Even though the system has thus far proven capable (for the most part) of absorbing and neutralising these electoral uprisings, there is no indication that this anti-establishment revolt is going to abate any time soon. Support for anti-establishment parties in the developed world is at the highest level since the 1930s –and growing. At the same time, support for mainstream parties –including traditional social-democratic parties –has collapsed. 

The reasons for this backlash are rather obvious. The financial crisis of 2007–9 laid bare the scorched earth left behind by neoliberalism, which the elites had gone to great lengths to conceal, in both material (financialisation) and ideological (‘the end of history’) terms. 

As credit dried up, it became apparent that for years the economy had continued to grow primarily because banks were distributing the purchasing power –through debt –that businesses were not providing in salaries. To paraphrase Warren Buffett, the receding tide of the debt-fuelled boom revealed that most people were, in fact, swimming naked

The situation was (is) further exacerbated by the post-crisis policies of fiscal austerity and wage deflation pursued by a number of Western governments, particularly in Europe, which saw the financial crisis as an opportunity to impose an even more radical neoliberal regime and to push through policies designed to suit the financial sector and the wealthy, at the expense of everyone else. 

Thus, the unfinished agenda of privatisation, deregulation and welfare state retrenchment –temporarily interrupted by the financial crisis –was reinstated with even greater vigour. Amid growing popular dissatisfaction, social unrest and mass unemployment (in a number of European countries), political elites on both sides of the Atlantic responded with business-as-usual policies and discourses. 

As a result, the social contract binding citizens to traditional ruling parties is more strained today than at any other time since World War II –and in some countries has arguably already been broken. 

Of course, even if we limit the scope of our analysis to the post-war period, anti-systemic movements and parties are not new in the West. Up until the 1980s, anti-capitalism remained a major force to be reckoned with. The novelty is that today –unlike 20, 30 or 40 years ago –it is movements and parties of the right and extreme right (along with new parties of the neoliberal ‘extreme centre’, such as the new French president Emmanuel Macron’s party En Marche!) that are leading the revolt, far outweighing the movements and parties of the left in terms of voting strength and opinion-shaping. 

With few exceptions, left parties –that is, parties to the left of traditional social-democratic parties –are relegated to the margins of the political spectrum in most countries. 

Meanwhile, in Europe, traditional social-democratic parties are being ‘pasokified’–that is, reduced to parliamentary insignificance, like many of their centre-right counterparts, due to their embrace of neoliberalism and failure to offer a meaningful alternative to the status quo –in one country after another. 

The term refers to the Greek social-democratic party PASOK, which was virtually wiped out of existence in 2014, due to its inane handling of the Greek debt crisis, after dominating the Greek political scene for more than three decades. A similar fate has befallen other former behemoths of the social-democratic establishment, such as the French Socialist Party and the Dutch Labour Party (PvdA). Support for social-democratic parties is today at the lowest level in 70 years –and falling. 

How should we explain the decline of the left –not just the electoral decline of those parties that are commonly associated with the left side of the political spectrum, regardless of their effective political orientation, but also the decline of core left values within those parties and within society in general? 

Why has the anti-establishment left proven unable to fill the vacuum left by the collapse of the establishment left? More broadly, how did the left come to count so little in global politics? Can the left, both culturally and politically, become a major force in our societies again? And if so, how? 

These are some of the questions that we attempt to answer in this book. Though the left has been making inroads in some countries in recent years –notable examples include Bernie Sanders in the United States, Jeremy Corbyn in the UK, Podemos in Spain and Jean-Luc Mélenchon in France –and has even succeeded in taking power in Greece (though the SYRIZA government was rapidly brought to heel by the European establishment), there is no denying that, for the most part, movements and parties of the extreme right have been more effective than left-wing or progressive forces at tapping into the legitimate grievances of the masses –disenfranchised, marginalised, impoverished and dispossessed by the 40-year-long neoliberal class war waged from above. 

In particular, they are the only forces that have been able to provide a (more or less) coherent response to the widespread –and growing –yearning for greater territorial or national sovereignty, increasingly seen as the only way, in the absence of effective supranational mechanisms of representation, to regain some degree of collective control over politics and society, and in particular over the flows of capital, trade and people that constitute the essence of neoliberal globalisation. Given neoliberalism’s war against sovereignty, it should come as no surprise that ‘sovereignty has become the master-frame of contemporary politics’, as Paolo Gerbaudo notes. 

After all, as we argue in Chapter 5, the hollowing out of national sovereignty and curtailment of popular-democratic mechanisms –what has been termed depoliticisation –has been an essential element of the neoliberal project, aimed at insulating macroeconomic policies from popular contestation and removing any obstacles put in the way of economic exchanges and financial flows. 

Given the nefarious effects of depoliticisation, it is only natural that the revolt against neoliberalism should first and foremost take the form of demands for a repoliticisation of national decision-making processes. 

The fact that the vision of national sovereignty that was at the centre of the Trump and Brexit campaigns, and that currently dominates the public discourse, is a reactionary, quasi-fascist one –mostly defined along ethnic, exclusivist and authoritarian lines –should not be seen as an indictment of national sovereignty as such. History attests to the fact that national sovereignty and national self-determination are not intrinsically reactionary or jingoistic concepts –in fact, they were the rallying cries of countless nineteenth- and twentieth-century socialist and left-wing liberation movements.

Even if we limit our analysis to core capitalist countries, it is patently obvious that virtually all the major social, economic and political advancements of the past centuries were achieved through the institutions of the democratic nation state, not through international, multilateral or supranational institutions, which in a number of ways have, in fact, been used to roll back those very achievements, as we have seen in the context of the euro crisis, where supranational (and largely unaccountable) institutions such as the European Commission, Eurogroup and European Central Bank (ECB) used their power and authority to impose crippling austerity on struggling countries. 

The problem, in short, is not national sovereignty as such, but the fact that the concept in recent years has been largely monopolised by the right and extreme right, which understandably sees it as a way to push through its xenophobic and identitarian agenda. It would therefore be a grave mistake to explain away the seduction of the ‘Trumpenproletariat’ by the far right as a case of false consciousness, as Marc Saxer notes; the working classes are simply turning to the only movements and parties that (so far) promise them some protection from the brutal currents of neoliberal globalisation (whether they can or truly intend to deliver on that promise is a different matter). 

However, this simply raises an even bigger question: why has the left not been able to offer the working classes and increasingly proletarianised middle classes a credible alternative to neoliberalism and to neoliberal globalisation? More to the point, why has it not been able to develop a progressive view of national sovereignty? 

As we argue in this book, the reasons are numerous and overlapping. For starters, it is important to understand that the current existential crisis of the left has very deep historical roots, reaching as far back as the 1960s. If we want to comprehend how the left has gone astray, that is where we have to begin our analysis. 

Today the post-war ‘Keynesian’ era is eulogised by many on the left as a golden age in which organised labour and enlightened thinkers and policymakers (such as Keynes himself) were able to impose a ‘class compromise’ on reluctant capitalists that delivered unprecedented levels of social progress, which were subsequently rolled back following the so-called neoliberal counter-revolution. 

It is thus argued that, in order to overcome neoliberalism, all it takes is for enough members of the establishment to be swayed by an alternative set of ideas. However, as we note in Chapter 2, the rise and fall of Keynesianism cannot simply be explained in terms of working-class strength or the victory of one ideology over another, but should instead be viewed as the outcome of the fortuitous confluence, in the aftermath of World War II, of a number of social, ideological, political, economic, technical and institutional conditions. 

To fail to do so is to commit the same mistake that many leftists committed in the early post-war years. By failing to appreciate the extent to which the class compromise at the base of the Fordist-Keynesian system was, in fact, a crucial component of that history-specific regime of accumulation –actively supported by the capitalist class insofar as it was conducive to profit-making, and bound to be jettisoned once it ceased to be so –many socialists of the time convinced themselves ‘that they had done much more than they actually had to shift the balance of class power, and the relationship between states and markets’. 

Some even argued that the developed world had already entered a post-capitalist phase, in which all the characteristic features of capitalism had been permanently eliminated, thanks to a fundamental shift of power in favour of labour vis-à-vis capital, and of the state vis-à-vis the market. Needless to say, that was not the case. 

Furthermore, as we show in Chapter 3, monetarism –the ideological precursor to neoliberalism –had already started to percolate into left-wing policymaking circles as early as the late 1960s. Thus, as argued in Chapters 2 and 3, many on the left found themselves lacking the necessary theoretical tools to understand –and correctly respond to –the capitalist crisis that engulfed the Keynesian model in the 1970s, convincing themselves that the distributional struggle that arose at the time could be resolved within the narrow limits of the social-democratic framework. 

The truth of the matter was that the labour–capital conflict that re-emerged in the 1970s could only have been resolved one way or another: on capital’s terms, through a reduction of labour’s bargaining power, or on labour’s terms, through an extension of the state’s control over investment and production. As we show in Chapters 3 and 4, with regard to the experience of the social-democratic governments of Britain and France in the 1970s and 1980s, the left proved unwilling to go this way. This left it (no pun intended) with no other choice but to ‘manage the capitalist crisis on behalf of capital’, as Stuart Hall wrote, by ideologically and politically legitimising neoliberalism as the only solution to the survival of capitalism. 

In this regard, as we show in Chapter 3, the Labour government of James Callaghan (1974–9) bears a very heavy responsibility. In an (in) famous speech in 1976, Callaghan justified the government’s programme of spending cuts and wage restraint by declaring Keynesianism dead, indirectly legitimising the emerging monetarist (neoliberal) dogma and effectively setting up the conditions for Labour’s ‘austerity lite’ to be refined into an all-out attack on the working class by Margaret Thatcher. 

Even worse, perhaps, Callaghan popularised the notion that austerity was the only solution to the economic crisis of the 1970s, anticipating Thatcher’s ‘there is no alternative’(TINA) mantra, even though there were radical alternatives available at the time, such as those put forward by Tony Benn and others. These, however, were ‘no longer perceived to exist’. 

In this sense, the dismantling of the post-war Keynesian framework cannot simply be explained as the victory of one ideology (‘neoliberalism’) over another (‘Keynesianism’), but should rather be understood as the result of a number of overlapping ideological, economic and political factors: the capitalists’response to the profit squeeze and to the political implications of full employment policies; the structural flaws of ‘actually existing Keynesianism’; and, importantly, the left’s inability to offer a coherent response to the crisis of the Keynesian framework, let alone a radical alternative. 

These are all analysed in-depth in the first chapters of the book. Furthermore, throughout the 1970s and 1980s, a new (fallacious) left consensus started to set in: that economic and financial internationalisation –what today we call ‘globalisation’–had rendered the state increasingly powerless vis-à-vis ‘the forces of the market’, and that therefore countries had little choice but to abandon national economic strategies and all the traditional instruments of intervention in the economy (such as tariffs and other trade barriers, capital controls, currency and exchange rate manipulation, and fiscal and central bank policies), and hope, at best, for transnational or supranational forms of economic governance. 

In other words, government intervention in the economy came to be seen not only as ineffective but, increasingly, as outright impossible. This process –which was generally (and erroneously, as we shall see) framed as a shift from the state to the market –was accompanied by a ferocious attack on the very idea of national sovereignty, increasingly vilified as a relic of the past. As we show, the left –in particular the European left –played a crucial role in this regard as well, by cementing this ideological shift towards a post-national and post-sovereign view of the world, often anticipating the right on these issues. 

One of the most consequential turning points in this respect, which is analysed in Chapter 4, was Mitterrand’s 1983 turn to austerity –the so-called tournant de la rigueur –just two years after the French Socialists’ historic victory in 1981. Mitterrand’s election had inspired the widespread belief that a radical break with capitalism –at least with the extreme form of capitalism that had recently taken hold in the Anglo-Saxon world –was still possible. By 1983, however, the French Socialists had succeeded in ‘proving’ the exact opposite: that neoliberal globalisation was an inescapable and inevitable reality. As Mitterrand stated at the time: ‘National sovereignty no longer means very much, or has much scope in the modern world economy. …A high degree of supra-nationality is essential.’ 

The repercussions of Mitterrand’s about-turn are still being felt today. It is often brandished by left-wing and progressive intellectuals as proof of the fact that globalisation and the internationalisation of finance has ended the era of nation states and their capacity to pursue policies that are not in accord with the diktats of global capital. The claim is that if a government tries autonomously to pursue full employment and a progressive/redistributive agenda, it will inevitably be punished by the amorphous forces of global capital. 

This narrative claims that Mitterrand had no option but to abandon his agenda of radical reform. To most modern-day leftists, Mitterrand thus represents a pragmatist who was cognisant of the international capitalist forces he was up against and responsible enough to do what was best for France. In fact, as we argue in the second part of the book, sovereign, currency-issuing states –such as France in the 1980s –far from being helpless against the power of global capital, still have the capacity to deliver full employment and social justice to their citizens. 

So how did the idea of the ‘death of the state’come to be so ingrained in our collective consciousness? 

As we explain in Chapter 5, underlying this post-national view of the world was (is) a failure to understand –and in some cases an explicit attempt to conceal –on behalf of left-wing intellectuals and policymakers that ‘globalisation’ was (is) not the result of inexorable economic and technological changes but was (is) largely the product of state-driven processes. All the elements that we associate with neoliberal globalisation –delocalisation, deindustrialisation, the free movement of goods and capital, etc. –were (are), in most cases, the result of choices made by governments. 

More generally, states continue to play a crucial role in promoting, enforcing and sustaining a (neo) liberal international framework –though that would appear to be changing, as we discuss in Chapter 6 –as well as establishing the domestic conditions for allowing global accumulation to flourish. The same can be said of neoliberalism tout court. 

There is a widespread belief –particularly among the left –that neoliberalism has involved (and involves) a ‘retreat’, ‘hollowing out’ or ‘withering away’ of the state, which in turn has fuelled the notion that today the state has been ‘overpowered’ by the market. However, as we argue in Chapter 5, neoliberalism has not entailed a retreat of the state but rather a reconfiguration of the state, aimed at placing the commanding heights of economic policy ‘in the hands of capital, and primarily financial interests’. 

It is self-evident, after all, that the process of neoliberalisation would not have been possible if governments –and in particular social-democratic governments –had not resorted to a wide array of tools to promote it: the liberalisation of goods and capital markets; the privatisation of resources and social services; the deregulation of business, and financial markets in particular; the reduction of workers’ rights (first and foremost, the right to collective bargaining) and more generally the repression of labour activism; the lowering of taxes on wealth and capital, at the expense of the middle and working classes; the slashing of social programmes; and so on. 

These policies were systemically pursued throughout the West (and imposed on developing countries) with unprecedented determination, and with the support of all the major international institutions and political parties. 

As noted in Chapter 5, even the loss of national sovereignty –which has been invoked in the past, and continues to be invoked today, to justify neoliberal policies –is largely the result of a willing and conscious limitation of state sovereign rights by national elites. 

The reason why governments chose willingly to ‘tie their hands’ is all too clear: as the European case epitomises, the creation of self-imposed ‘external constraints’ allowed national politicians to reduce the politics costs of the neoliberal transition –which clearly involved unpopular policies –by ‘scapegoating’ institutionalised rules and ‘independent’ or international institutions, which in turn were presented as an inevitable outcome of the new, harsh realities of globalisation. 

Moreover, neoliberalism has been (and is) associated with various forms of authoritarian statism –that is, the opposite of the minimal state advocated by neoliberals –as states have bolstered their security and policing arms as part of a generalised militarisation of civil protest. In other words, not only does neoliberal economic policy require the presence of a strong state, but it requires the presence of an authoritarian state (particularly where extreme forms of neoliberalism are concerned, such as the ones experimented with in periphery countries), at both the domestic and international level (see Chapter 5). 

In this sense, neoliberal ideology, at least in its official anti-state guise, should be considered little more than a convenient alibi for what has been and is essentially a political and state-driven project. Capital remains as dependent on the state today as it was under ‘Keynesianism’–to police the working classes, bail out large firms that would otherwise go bankrupt, open up markets abroad (including through military intervention), etc. 

The ultimate irony, or indecency, is that traditional left establishment parties have become standard-bearers for neoliberalism themselves, both while in elected office and in opposition. 

In the months and years that followed the financial crash of 2007–9, capital’s –and capitalism’s –continued dependency on the state in the age of neoliberalism became glaringly obvious, as the governments of the US, Europe and elsewhere bailed out their respective financial institutions to the tune of trillions of euros/dollars. 

In Europe, following the outbreak of the so-called ‘euro crisis’ in 2010, this was accompanied by a multi-level assault on the post-war European social and economic model aimed at restructuring and re-engineering European societies and economies along lines more favourable to capital. This radical reconfiguration of European societies –which, again, has seen social-democratic governments at the forefront –is not based on a retreat of the state in favour of the market, but rather on a reintensification of state intervention on the side of capital. 

Nonetheless, the erroneous idea of the waning nation state has become an entrenched fixture of the left. As we argue throughout the book, we consider this to be central in understanding the decline of the traditional political left and its acquiescence to neoliberalism. 

In view of the above, it is hardly surprising that the mainstream left is, today, utterly incapable of offering a positive vision of national sovereignty in response to neoliberal globalisation. To make matters worse, most leftists have bought into the macroeconomic myths that the establishment uses to discourage any alternative use of state fiscal capacities. 

For example, they have accepted without question the so-called household budget analogy, which suggests that currency-issuing governments, like households, are financially constrained, and that fiscal deficits impose crippling debt burdens on future generations –a notion that we thoroughly debunk in Chapter 8. 

This has gone hand in hand with another, equally tragic, development. As discussed in Chapter 5, following its historical defeat, the left’s traditional anti-capitalist focus on class slowly gave way to a liberal-individualist understanding of emancipation. Waylaid by post-modernist and post-structuralist theories, left intellectuals slowly abandoned Marxian class categories to focus, instead, on elements of political power and the use of language and narratives as a way of establishing meaning. This also defined new arenas of political struggle that were diametrically opposed to those defined by Marx. 

Over the past three decades, the left focus on ‘capitalism’ has given way to a focus on issues such as racism, gender, homophobia, multiculturalism, etc. Marginality is no longer described in terms of class but rather in terms of identity. The struggle against the illegitimate hegemony of the capitalist class has given way to the struggles of a variety of (more or less) oppressed and marginalised groups: women, ethnic and racial minorities, the LGBTQ community, etc. As a result, class struggle has ceased to be seen as the path to liberation. 

In this new post-modernist world, only categories that transcend Marxian class boundaries are considered meaningful. Moreover, the institutions that evolved to defend workers against capital –such as trade unions and social-democratic political parties –have become subjugated to these non-class struggle foci. What has emerged in practically all Western countries as a result, as Nancy Fraser notes, is a perverse political alignment between ‘mainstream currents of new social movements (feminism, anti-racism, multiculturalism, and LGBTQ rights), on the one side, and high-end “symbolic” and service-based business sectors (Wall Street, Silicon Valley, and Hollywood), on the other’. 

The result is a progressive neoliberalism ‘that mix[es] together truncated ideals of emancipation and lethal forms of financialization’, with the former unwittingly lending their charisma to the latter. 

As societies have become increasingly divided between well-educated, highly mobile, highly skilled, socially progressive cosmopolitan urbanites, and lower-skilled and less educated peripherals who rarely work abroad and face competition from immigrants, the mainstream left has tended to consistently side with the former. Indeed, the split between the working classes and the intellectual-cultural left can be considered one of the main reasons behind the right-wing revolt currently engulfing the West. 

As argued by Jonathan Haidt, the way the globalist urban elites talk and act unwittingly activates authoritarian tendencies in a subset of nationalists. In a vicious feedback loop, however, the more the working classes turn to right-wing populism and nationalism, the more the intellectual-cultural left doubles down on its liberal-cosmopolitan fantasies, further radicalising the ethno-nationalism of the proletariat. 

As Wolfgang Streeck writes: Protests against material and moral degradation are suspected of being essentially fascist, especially now that the former advocates of the plebeian classes have switched to the globalization party, so that if their former clients wish to complain about the pressures of capitalist modernization, the only language at their disposal is the pre-political, untreated linguistic raw material of everyday experiences of deprivation, economic or cultural. This results in constant breaches of the rules of civilized public speech, which in turn can trigger indignation at the top and mobilization at the bottom. 

This is particularly evident in the European debate, where, despite the disastrous effects of the EU and monetary union, the mainstream left –often appealing to exactly the same arguments used by Callaghan and Mitterrand 30–40 years ago –continues to cling on to these institutions and to the belief that they can be reformed in a progressive direction, despite all evidence to the contrary, and to dismiss any talk of restoring a progressive agenda on the foundation of retrieved national sovereignty as a ‘retreat into nationalist positions’, inevitably bound to plunge the continent into 1930s-style fascism. 

This position, as irrational as it may be, is not surprising, considering that European Economic and Monetary Union (EMU) is, after all, a brainchild of the European left (see Chapter 5). However, such a position presents numerous problems, which are ultimately rooted in a failure to understand the true nature of the EU and monetary union. 

First of all, it ignores the fact that the EU’s economic and political constitution is structured to produce the results that we are seeing –the erosion of popular sovereignty, the massive transfer of wealth from the middle and lower classes to the upper classes, the weakening of labour and more generally the rollback of the democratic and social/economic gains that had previously been achieved by subordinate classes –and is designed precisely to impede the kind of radical reforms to which progressive integrationists or federalists aspire to. 

More importantly, however, it effectively reduces the left to the role of defender of the status quo, thus allowing the political right to hegemonise the legitimate anti-systemic –and specifically anti-EU –grievances of citizens. This is tantamount to relinquishing the discursive and political battleground for a post-neoliberal hegemony –which is inextricably linked to the question of national sovereignty –to the right and extreme right. It is not hard to see that if progressive change can only be implemented at the global or even European level –in other words, if the alternative to the status quo offered to electorates is one between reactionary nationalism and progressive globalism –then the left has already lost the battle. 

It needn’t be this way, however. As we argue in the second part of the book, a progressive, emancipatory vision of national sovereignty that offers a radical alternative to both the right and the neoliberals –one based on popular sovereignty, democratic control over the economy, full employment, social justice, redistribution from the rich to the poor, inclusivity and the socio-ecological transformation of production and society –is possible. Indeed, it is necessary. 

As J. W. Mason writes: Whatever [supranational] arrangements we can imagine in principle, the systems of social security, labor regulation, environmental protection, and redistribution of income and wealth that in fact exist are national in scope and are operated by national governments. By definition, any struggle to preserve social democracy as it exists today is a struggle to defend national institutions.  

As we contend in this book, the struggle to defend the democratic sovereign from the onslaught of neoliberal globalisation is the only basis on which the left can be refounded (and the nationalist right challenged). However, this is not enough. 

The left also needs to abandon its obsession with identity politics and retrieve the ‘more expansive, anti-hierarchical, egalitarian, class-sensitive, anti-capitalist understandings of emancipation’ that used to be its trademark (which, of course, is not in contradiction with the struggle against racism, patriarchy, xenophobia and other forms of oppression and discrimination). 

Fully embracing a progressive vision of sovereignty also means abandoning the many false macroeconomic myths that plague left-wing and progressive thinkers. One of the most pervasive and persistent myths is the assumption that governments are revenue-constrained, that is, that they need to ‘fund’ their expenses through taxes or debt. This leads to the corollary that governments have to ‘live within their means’, since ongoing deficits will inevitably result in an ‘excessive’ accumulation of debt, which in turn is assumed to be ‘unsustainable’ in the long run. 

In reality, as we show in Chapter 8, monetarily sovereign (or currency-issuing) governments –which nowadays include most governments –are never revenue-constrained because they issue their own currency by legislative fiat and always have the means to achieve and sustain full employment and social justice. 

In this sense, a progressive vision of national sovereignty should aim to reconstruct and redefine the national state as a place where citizens can seek refuge ‘in democratic protection, popular rule, local autonomy, collective goods and egalitarian traditions’, as Streeck argues, rather than a culturally and ethnically homogenised society. 

This is also the necessary prerequisite for the construction of a new international( ist) world order, based on interdependent but independent sovereign states. It is such a vision that we present in this book. 

*

PART I 

The Great Transformation Redux: From Keynesianism to Neoliberalism –and Beyond 

1 Broken Paradise: A Critical Assessment of the Keynesian ‘Full Employment’ Era 

THE IDEALIST VIEW: KEYNESIANISM AS THE VICTORY OF ONE IDEOLOGY OVER ANOTHER 

Looking back on the 30-year-long economic expansion that followed World War II, Adam Przeworski and Michael Wallerstein concluded that ‘by most criteria of economic progress the Keynesian era was a success’. 

It is hard to disagree: throughout the West, from the mid-1940s until the early 1970s, countries enjoyed lower levels of unemployment, greater economic stability and higher levels of economic growth than ever before. That stability, particularly in the US, also rested on a strong financial regulatory framework: on the widespread provision of deposit insurance to stop bank runs; strict regulation of the financial system, including the separation of commercial banking from investment banking; and extensive capital controls to reduce currency volatility. 

These domestic and international restrictions ‘kept financial excesses and bubbles under control for over a quarter of a century’. 

Wages and living standards rose, and –especially in Europe –a variety of policies and institutions for welfare and social protection (also known as the ‘welfare state’) were created, including sustained investment in universally available social services such as education and health. Few people would deny that this was, indeed, a ‘golden age’ for capitalism. 

However, when it comes to explaining what made this exceptional period possible and why it came to an end, theories abound. Most contemporary Keynesians subscribe to a quasi-idealist view of history –that is, one that stresses the central role of ideas and ideals in human history. This is perhaps unsurprising, considering that Keynes himself famously noted: ‘Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.’ 

According to this view, the social and economic achievements of the post-war period are largely attributable to the revolution in economic thinking spearheaded by the British economist John Maynard Keynes. 

Throughout the 1920s and 1930s, Keynes overturned the old classical (neoclassical) paradigm, rooted in the doctrine of laissez-faire (‘let it be’) free-market capitalism, which held that markets are fundamentally self-regulating. The understanding was that the economy, if left to its own devices –that is, with the government intervening as little as possible –would automatically generate stability and full employment, as long as workers were flexible in their wage demands. 

The Great Depression of the 1930s that followed the stock market crash of 1929 –where minimal financial regulation, little-understood financial products and overindebted households and banks all conspired to create a huge speculative bubble which, when it burst, brought the US financial system crashing down, and with it the entire global economy –clearly challenged traditional laissez-faire economic theories. 

This bolstered Keynes’ argument –spelled out at length in his masterpiece, The General Theory of Employment, Interest, and Money, published in 1936 –that aggregate spending determined the overall level of economic activity, and that inadequate aggregate spending could lead to prolonged periods of high unemployment (what he called ‘underemployment equilibrium’). Thus, he advocated the use of debt-based expansionary fiscal and monetary measures and a strict regulatory framework to counter capitalism’s tendency towards financial crises and disequilibrium, and to mitigate the adverse effects of economic recessions and depressions, first and foremost by creating jobs that the private sector was unable or unwilling to provide. 

The bottom line of Keynes’ argument was that the government always has the ability to determine the overall level of spending and employment in the economy. In other words, full employment was a realistic goal that could be pursued at all times. 

Yet politicians were slow to catch on. When the speculative bubbles in both Europe and the United States burst in the aftermath of the Wall Street crash of 1929, various countries (to varying degrees, and more or less willingly) turned to austerity as a perceived ‘cure’ for the excesses of the previous decade. 

In the United States, president Herbert Hoover, a year after the crash, declared that ‘economic depression cannot be cured by legislative action or executive pronouncements’ and that ‘economic wounds must be healed by the action of the cells of the economic body –the producers and consumers themselves’. 

At first Hoover and his officials downplayed the stock market crash, claiming that the economic slump would be only temporary. When the situation did not improve, Hoover advocated a strict laissez-faire policy, dictating that the federal government should not interfere with the economy but rather let the economy right itself. He counselled that ‘every individual should sustain faith and courage’ and ‘each should maintain self-reliance’. 

Even though Hoover supported a doubling of government expenditure on public works projects, he also firmly believed in the need for a balanced budget. As Nouriel Roubini and Stephen Mihm observe, Hoover ‘wanted to reconcile contradictory aims: to cultivate self-reliance, to provide government help in a time of crisis, and to maintain fiscal discipline. This was impossible.’ In fact, it is widely agreed that Hoover’s inaction was responsible for the worsening of the Great Depression. 

If the United States’ reaction under Hoover can be described as ‘too little, too late’, Europe’s reaction in the late 1920s and early 1930s actively contributed to the downward spiral of the Great Depression, setting the stage for World War II. 

Austerity was the dominant response of European governments during the early years of the Great Depression. The political consequences are well known. Anti-systemic parties gained strength all across the continent, most notably in Germany. While 24 European regimes had been democratic in 1920, the number was down to eleven in 1939. 

Various historians and economists see the rise of Hitler as a direct consequence of the austerity policies indirectly imposed on Germany by its creditors following the economic crash of the late 1920s. Ewald Nowotny, the current head of Austria’s national bank, stated that it was precisely ‘the single-minded concentration on austerity policy’ in the 1930s that ‘led to mass unemployment, a breakdown of democratic systems and, at the end, to the catastrophe of Nazism’. 

Historian Steven Bryan agrees: ‘During the 1920s and 1930s it was precisely the refusal to acknowledge the social and political consequences of austerity that helped bring about not only the depression, but also the authoritarian governments of the 1930s.

*

from

Reclaiming the State. A Progressive Vision of Sovereignty for a Post-Neoliberal World

by

William Mitchell and Thomas Fazi.

get it at Amazon.com

Superpower trade war Looms. How it will affect New Zealand – Liam Dann.

“If America, China relations become very difficult, our position becomes tougher because then we will be coerced to choose.”

It’s a nightmare scenario for a small trading nation with historic cultural and political links to the US, but an increasing economic reliance on China.

A full blown trade war between China and the US could have devastating political consequences for us all.

In this case, it’s not New Zealand’s Prime Minister doing the worrying, it’s Singaporean leader Lee Hsien Loong.

His simple, blunt assessment of the risk posed by Donald Trump’s anti-China trade rhetoric caused a minor uproar in the diplomatically cautious Asian nation.

Here in New Zealand, where we face the same risks, we’re yet to officially confront the issue. And as issues go, it’s a big one: in the year to June 2016, New Zealand’s total trade (imports and exports) with China was $22.86 billion, compared to $16.25b with the US.

Reserve Bank governor Graeme Wheeler has spoken most openly about his fears for the economic risk to New Zealand if the Trump Administration does some of the things it has threatened to do.

In a speech last month, Wheeler suggested that Trump’s Administration represents the greatest source of uncertainty for our economy – both in terms of his impact on the domestic economy and his potential to increase global trade protectionism.

“Rationally speaking, there shouldn’t be a reason we should go into a trade war. But we have to be prepared,” says Auckland University Business School trade economist Dr Asha Sandaram.

China and the US are like Siamese twins, she says. In other words, their economies are now so intertwined that doing damage to one must hurt the other.

“I think they both know that if they start this, they will both go down. So I don’t think it should be a big risk. But the thing with Donald Trump, is you just don’t know. He has been running the most incoherent Administration we have seen,” Sandaram says.

“What he says today is not correlated with what he says tomorrow … and what he’ll actually do. So we have to consider the possibility of an escalating trade war.”

For anyone who relies on global trade, Trump has said some frightening things.

On the campaign trail, he talked about hitting Chinese imports with 45 per cent tariffs and accused China of currency manipulation.

Since becoming President, he has pulled the US out of the Trans-Pacific Partnership free trade agreement.

In a leaked recording, he has talked about imposing 10 per cent tariffs on all imports and is said to be considering border taxes.

His key trade adviser has been China hawk Peter Navarro, author of Death by China: Confronting the Dragon.

And he has nominated Robert Lighthizer – who has accused China of unfair trade practices – as his US Trade Representative.

Bloomberg has surfaced an article Lighthizer wrote in 2011 praising Ronald Reagan’s aggressive trade stance when Japan’s economic rise threatened the US.

There are concerns that Trump may look to follow those Reagan-era tactics, invoking section 301 of the US Trade Act, which allows a President to bestow “unfavourable trading status” on certain nations.

It’s a measure the US hasn’t used since it adopted World Trade Organisation rules in 1995.

And, as the many critics have warned, the world has changed. China is not like Japan, politically and militarily dependent on the US.

Last month, Wheeler told the Herald that his trade concerns deepened after visiting Washington DC at the start of the year.

“I was in Washington recently talking to a number of senior people – very well connected to the Trump Administration. They were saying that the concerns around China are deeply felt. In other words, the Trump Administration has very strong views about currency manipulation and trade practices out of China. I found that deeply worrying.”

Wheeler warns that the Trump risk comes on top of a protectionist trend which is already dampening global trade and threatening growth.

Long-time New Zealand trade advocate Stephen Jacobi agrees.

“Undoubtedly it is a concern,” he says of Trump’s protectionist rhetoric. “It was already a concern. Protection was already on the rise and we had seen a slowing in trade growth as well.”

The advent of the Trump Administration has thrown the spotlight on this he says.

Jacobi, who was head of the NZ US Council as executive director from 2005 to 2014, is now executive director of the NZ China Council, so has a good perspective on New Zealand’s relationship with both economies.

“It is early days for the [Trump] Administration,” he says. “In fact the Administration isn’t even in place yet. We just have to withhold our judgment for a bit, however much it might pain us to do so, to see what actually happens.”

From discussions he has had in Wellington, Jacobi believes New Zealand officials are very much taking that wait and see approach.

That said, the Government has been working on a new trade policy strategy and is expected to release it this month.

It will have to acknowledge the growing risks and look at alternatives to the TPP, Jacobi says.

“But I doubt whether they will have given up on the US just yet.

“So concern, yes. Panic no,” he says.

Professor Natasha Hamilton-Hart, with the Department of Management and International Business at Auckland University, says one of the direct risks to New Zealand is the prospect that Trump scores an own goal with his economic policies.

“I know the markets seem to be pricing in good times on the horizon but I’m pretty sceptical that that is going to last.

She doesn’t see a sustainable growth trajectory coming out of either the tax or infrastructure programme.

Things like border taxes and tariffs would be distortionary and depress consumer spending, she says.

“We will see an increase in military spending and with the tax cut will start to see an increase in the deficit, which is going to have implications for US interest rates.

“There are potentially quite contractionary processes in the medium term. They just don’t seem to have a coherent, workable plan.”

Then there are the diplomatic risks around a President who tweets his midnight thoughts to the world.

Trump’s impact on Asia-Pacific trading relationships is a serious concern.

“This might be overly optimistic,” Hamilton-Hart says. “I’m doubtful that it will come to a 45 per cent tariff on Chinese exports because that would be so disrupting and damaging to US firms and US consumers. It’s going to double the price of everything in Walmart.”

“What I think is more likely is that we will see a stronger line of creeping protectionism … so cancelling the TPP, looking at alternatives to dispute settlements outside the WTO, that kind of thing.

“I imagine we’ll see a lot more of that. And I imagine that is what China is gearing up for. So yeah, a less rule based trading system.”

The irony of Trump’s trade deficit obsession is that running big deficits is what actually gives you power on the global economic stage, Hamilton-Hart says.

In other words, a big net importer is the customer and the customer is always right.

“So if you stop running those trade deficits, then you no longer have the ability to throw your weight around. If Donald Trump were to significantly withdraw the US from world trade by putting up barriers and shrinking the US economy … that can only go with a reduction in US influence.”

China, for its part, doesn’t appear keen on a trade war and isn’t rushing to fill the trade leadership void left by the US .

For example, it appears to be carefully maintaining the strength of the Renminbi to avoid inflaming US currency hawks.

“They certainly do not want a trade war,” Jacobi says. “They’ve got enormous economic interests with the United States. And I think you can rely on the Chinese to manage all of that in a very sensible way.”

What worries Jacobi more is the risk of America over-playing its hand on security and sovereignty issues – like Taiwan.

“That’s much more worrying because you can’t always guarantee how a nationalistic China might react,” he says. “When you touch on issues of national sovereignty with the Chinese, you don’t get the same sort of reaction that you do on other things.”

Jacobi does have faith that the US system, with its constitutional checks and balances on executive power, will work – in time.

“But he [Trump] has a lot of power to do things in the short term. While congress catches up.”

Likewise, there will be powerful lobbying forces in the US business community who will push back at things he might want to do.

“But they also take time,” Jacobi says.

“I’m confident that over time the right decisions should be made. But what damage will be done in the meantime is a bit of an unknown.

“And the world has lost a whole lot of leadership around open markets and free trade.”

So where does that leave the New Zealand and its Asia-Pacific trading partners?

The remaining TPP signatories head to Chile later this month to discuss what, if anything, is salvageable without America.

The Americans have said they will send a representative to that meeting, although it’s not clear who that will be or what level of interest they will take, say Jacobi.

“And China will also be around. Because there is a Pacific Alliance meeting [a Latin American trading bloc] and the Chinese have been invited to that.”

There is a need for quiet diplomacy behind the scenes and New Zealand could play a key role in that, says Jacobi.

But we need to be careful not to upset the other members of the TPP.

Particularly the Japanese who, says Jacobi,  “are in a very invidious position”.

“They had this ballistic missile sent from North Korea the other day. They have got real security concerns, for which they have to rely on the US. They are not going to be drawn to take issue with the United States unnecessarily.”

China is already a member of an alternative multilateral trade group – the  Regional Comprehensive Economic Partnership (RCEP), which also includes New Zealand.

If completed, that free trade agreement (FTA) would include the 10 member states of ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam) and the six states with which ASEAN has existing free trade agreements (Australia, China, India, Japan, South Korea and New Zealand).

There have been suggestions that China may look to push this deal as a TPP alternative.

But China hasn’t yet shown any signs of taking the lead, says Jacobi.

On the one hand, we’ve heard rhetoric from Chinese President Xi Jinping about China’s global leadership, but the reality is that they haven’t taken a major role in multilateral negotiations yet, Jacobi says.

“Maybe it’s time. They do have an enormous ability now to fill a vacuum.”

It is a different game now, says Hamilton-Hart, who believes the TPP is effectively dead.

“So do we make a much better effort to get on board with RCEP?”  she says. “Or are we going to hang in there and hope that we could do a bilateral with the US … which I think would be a bad thing to do as we’d be massively disadvantaged in the negotiations.”

Jacobi agrees that the bilateral path is problematic.

“We can’t afford not to push on any open door,” he says. “But the reality is that is bloody hard going. Look at the experience we had with Korea, very complicated.”

Trump has said he’ll do bilateral deals with TPP partners. But we would want dairy concessions and the US would want a lot of movement on medicines, says Jacobi.

And neither would play well politically for either nation.

“We’ve got to talk, but will we be high up on the list? And will it be better than TPP? Most unlikely”

“I don’t want to be too pessimistic,” says Auckland University’s Sandaram. “There may be some opportunities as a small country where you could fly under the radar. It’s harder for a big country to be non-aligned.”

This could be a unique opportunity, she says. “We could try and stay neutral and expand into both markets.”

Sandaram, who has been based in New Zealand for only a year, feels New Zealand is sometimes overly cautious about Chinese sensitivities.

“It’s not a traditional link like the UK or Australia, so maybe it is because it is new that we are so cautious.”

Jacobi believes the Chinese have a good understanding of our deep political and economic ties with the Western nations, and particularly the US.

“In fact, one of the positive aspects they see in our relationship is that we are an interesting interlocutor because of our attachment to the West,” he says. “But they also know our trade and economic ties are towards China. So whether that will amount to cutting slack … I’m not sure.”

Both Sandaram and Jacobi believe we have more options than we did a generation ago.

“We need to diversify,” says Sandaram. “China is decelerating. But we have Asian powers that are fast growing economies. India, Malaysia, Indonesia – with the emerging middle class there is going to be demand for goods that New Zealand exports.

“That’s a great opportunity I think we’re uniquely placed.”

New Zealand, both at a government and a business level, has to be proactive about trade, now more so than ever, says Jacobi.

“This is not something that New Zealand can just sit back and observe. We don’t have that luxury. This is about our economic livelihood and we have to have a say in it.”

NZ Herald

How economic boom times in the West came to an end – Marc Levinson. 

Unprecedented growth marked the era from 1948 to 1973. Economists might study it forever, but it can never be repeated. Why? 

The second half of the 20th century divides neatly in two. The divide did not come with the rise of Ronald Reagan or the fall of the Berlin Wall. It is not discernible in a particular event, but rather in a shift in the world economy, and the change continues to shape politics and society in much of the world today.

The shift came at the end of 1973. The quarter-century before then, starting around 1948, saw the most remarkable period of economic growth in human history. In the Golden Age between the end of the Second World War and 1973, people in what was then known as the ‘industrialised world’ – Western Europe, North America, and Japan – saw their living standards improve year after year. They looked forward to even greater prosperity for their children. Culturally, the first half of the Golden Age was a time of conformity, dominated by hard work to recover from the disaster of the war. The second half of the age was culturally very different, marked by protest and artistic and political experimentation. Behind that fermentation lay the confidence of people raised in a white-hot economy: if their adventures turned out badly, they knew, they could still find a job.

The year 1973 changed everything. High unemployment and a deep recession made experimentation and protest much riskier, effectively putting an end to much of it. A far more conservative age came with the economic changes, shaped by fears of failing and concerns that one’s children might have it worse, not better. Across the industrialised world, politics moved to the Right – a turn that did not avert wage stagnation, the loss of social benefits such as employer-sponsored pensions and health insurance, and the secure, stable employment that had proved instrumental to the rise of a new middle class and which workers had come to take for granted. At the time, an oil crisis took the blame for what seemed to be a sharp but temporary downturn. Only gradually did it become clear that the underlying cause was not costly oil but rather lagging productivity growth – a problem that would defeat a wide variety of government policies put forth to correct it.

The great boom began in the aftermath of the Second World War. The peace treaties of 1945 did not bring prosperity; on the contrary, the post-war world was an economic basket case. Tens of millions of people had been killed, and in some countries a large proportion of productive capacity had been laid to waste. Across Europe and Asia, tens of millions of refugees wandered the roads. Many countries lacked the foreign currency to import food and fuel to keep people alive, much less to buy equipment and raw material for reconstruction. Railroads barely ran; farm tractors stood still for want of fuel.

Everywhere, producing enough coal to provide heat through the winter was a challenge. As shoppers mobbed stores seeking basic foodstuffs, much less luxuries such as coffee and cotton underwear, prices soared. Inflation set off waves of strikes in the United States and Canada as workers demanded higher pay to keep up with rising prices. The world’s economic outlook seemed dim. It did not look like the beginning of a golden age.

As late as 1948, incomes per person in much of Europe and Asia were lower than they had been 10 or even 20 years earlier. But 1948 brought a change for the better. In January, the US military government in Japan announced it would seek to rebuild the economy rather than exacting reparations from a country on the verge of starvation. In April, the US Congress approved the economic aid programme that would be known as the Marshall Plan, providing Western Europe with desperately needed dollars to import machinery, transport equipment, fertiliser and food. In June, the three occupying powers – France, the United Kingdom and the US – rolled out the deutsche mark, a new currency for the western zones of Germany. A new central bank committed to keeping inflation low and the exchange rate steady would oversee the deutsche mark.

Postwar chaos gave way to stability, and the war-torn economies began to grow. In many countries, they grew so fast for so long that people began to speak of the ‘economic miracle’ (West Germany), the ‘era of high economic growth’ (Japan) and the 30 glorious years (France). In the English-speaking world, this extraordinary period became known as the Golden Age.

What was it that made the Golden Age exceptional? Part of the answer is that economies were making up for lost time: after years of depression and wartime austerity, enormous needs for housing, consumer goods, equipment for farms, factories, railroads and electric generating plants stood ready to drive growth. But much more lay behind the Golden Age of economic growth than pent-up demand. Two factors deserve special attention.

First, the expanding welfare state. The Second World War shook up the social structures in all the wealthy countries, fundamentally altering domestic politics, in particular exerting an equalising force. As societies embarked on reconstruction, no one could deny that citizens who had been asked to sacrifice in war were entitled to share in the benefits of peace. In many cases, labour unions became the representatives of working people’s claims to peacetime dividends. Indeed, union membership reached historic highs, and union leaders sat alongside business and government leaders to hammer out social policy. Between 1944 and 1947, one country after another created old-age pension schemes, national health insurance, family allowances, unemployment insurance and more social benefits. These programmes gave average families a sense of security they had never known. Children from poor families could visit the doctor without great expense. The loss of a job or the death of a wage-earner no longer meant destitution.

Second, in addition to the growing welfare state, strong productivity growth contributed to rising living standards. Rising productivity – increasing the efficiency with which an economy uses labour, capital and other resources – is the main force that makes an economy grow. Because new technologies and better ways of doing business take time to filter through the economy, productivity improvements are usually slow. But in the postwar years, productivity grew very quickly. A unique combination of circumstances propelled it. In just a few years, millions of people moved from low-productivity farm work – more than 3 million mules still plowed furrows on US farms in 1945 – to construction and factory jobs that used the latest machinery.

In 1940, the average working-age adult in western Europe had less than five years of formal education. As governments invested heavily in high schools and universities after the war, they produced a more educated and literate workforce with the skills to produce far more wealth. Advances in national infrastructure gave direct boosts to national productivity. High-speed motorways enabled truck drivers to carry bigger loads over longer distances at higher speeds, greatly expanding markets for farms and factories. Six rounds of trade negotiations between 1947 and 1967, ultimately involving nearly 50 countries that signed the General Agreement on Tariffs and Trade (GATT), brought a massive increase in cross-border trade, forcing manufacturers to modernise or give up. Firms moved to take advantage of technological innovations to operate more productively, such as jet aircraft and numerically controlled machinery.

Between 1951 and 1973, propelled by strong productivity gains, the world economy grew at an annual rate of nearly 5 per cent. The impact on living standards was dramatic. Jobs were just for the asking; in 1966, West Germany’s unemployment rate touched an unprecedented 0.5 per cent. Electricity, indoor plumbing and television sets became common. Stoves burning coal or peat were replaced by central heating systems. Homes grew larger, and tens of millions of families acquired refrigerators and automobiles. The higher living standards did much more than simply bring new material goods. Retirement by 65, or even earlier, became the norm. Life expectancy jumped. Importantly, in Western Europe, North America and Japan, people across society shared in those gains. Prosperity was not limited to the urban elite. Most people began to live better, and they knew it. In the span of a quarter-century, living standards doubled and then, in many countries, doubled again.

The good times rolled on so long that people took them for granted. Between 1948 and 1973, Australia, Japan, Sweden and Italy had not a single year of recession. West Germany and Canada did almost as well. Governments and the economists who advised them happily claimed the credit. Careful economic management, they said, had put an end to cyclical ups and downs. Governments possessed more information about citizens and business than ever before, and computers could crunch the data to help policymakers determine the best course of action. In a lecture at Harvard University in 1966, Walter Heller, formerly chief economic adviser to presidents John F Kennedy and Lyndon B Johnson, trumpeted the success of what he called the ‘new economics’. ‘Conceptual advances and quantitative research in economics,’ he declared, ‘are replacing emotion with reason.’

Wages and investment were private decisions, but Schiller hoped government guidelines would contribute to ‘collective rationality’

The most influential proponent of such ideas was Karl Schiller, who became economy minister of West Germany, Europe’s largest economy, in 1966. A former professor at the University of Hamburg, where his students included the future West German Chancellor Helmut Schmidt, Schiller was a centrist Social Democrat. He stood apart from those on the Left who favoured state ownership of industry, but also from extreme free-market conservatives. His advice called for ‘a synthesis of planning and competition’. Schiller defined his philosophy thus: ‘As much competition as possible, as much planning as necessary.’

Most fundamentally, Schiller believed that government should commit itself to maintaining high employment, steady growth and stable prices. And it should do this all while keeping its international account in balance, within the framework of a free-market economy. These four commitments made the corners of what he called the ‘magic square’. In December 1966, when Schiller became economy minister in a new coalition government, the magic square became official policy. Following Schiller’s version of Keynesian economics, his ministry’s experts advised federal and state governments how to adjust their budgets to achieve ‘equilibrium of the entire economy’. The ministry’s advice was based on an elaborate planning exercise that churned out five-year projections. In the spring of 1967, the finance ministry was told to adjust taxes and spending plans to increase business investment while slowing the growth of consumer spending. These moves, Schiller’s economic models promised, would bring economic growth averaging 4 per cent through 1971, along with 0.8 per cent unemployment, 1 per cent annual inflation and a 1 per cent current account surplus.

But in an economy that was overwhelmingly privately run, government alone could not reach perfection. Four or five times a year, Schiller summoned corporate executives, union presidents and the heads of business organisations to a conference room in the ministry. There he described the economic outlook and announced how much wages and investment could rise without compromising his national economic targets. Of course, he would add, wages and investment were private decisions, but he hoped that the government’s guidelines would contribute to ‘collective rationality’. Such careful stage management cemented Schiller’s fame. In 1969, for the first time, the Social Democrats outpolled every other party. The election that year became known as the ‘Schiller election’.

Schiller insisted that his policies had brought West Germany to ‘a sunny plateau of prosperity’ where inflation and unemployment were permanently vanquished. Year after year, however, the economy failed to perform as he instructed. In July 1972, when Schiller was denied control over the exchange rate, he stormed out of the cabinet and left elected office forever.

Schiller left with the West German economy roaring. Within 18 months, his claim that the government could ensure stable prices, robust growth and jobs for all blew up.

The headline event of 1973 was the oil crisis. On 6 October, Egyptian and Syrian armies attacked Israeli positions, starting the conflict that became known as the Yom Kippur War. By agreeing to slash production and raise the price of oil, Saudi Arabia, Iraq, Iran and other Middle Eastern oil exporters quickly backed the two Arab countries. Shipments to countries that supported Israel, including the US and the Netherlands, were cut off altogether.

Oil-importing countries responded in dramatic fashion. Western European countries lowered speed limits and rationed diesel supplies. From Italy to Norway, driving was banned on four consecutive Sundays in order to save fuel. The Japanese government shut down factories and told citizens to turn out the pilot lights on their water heaters. US truck drivers blocked highways to protest high fuel prices, and motorists queued for hours to top off their gasoline tanks. In a televised address, the US President Richard Nixon warned Americans: ‘We are heading toward the most acute shortages of energy since the Second World War.’

Faced with higher petroleum prices, economic growth in 1974 collapsed. Around the world, inflation soared. When oil prices receded, the world economy failed to bounce back. Double-digit inflation dramatically undermined workers’ wage gains. From 1973 to 1979, average income per worker grew only half as fast as it had before 1973. Help-wanted signs vanished as unemployment rose. The economic experts, only recently so confident that their rational mathematical analysis had brought permanent prosperity, were flummoxed. Stable economic growth had given way to violent gyrations.

The underlying problem, it turned out, was not expensive petroleum but slow productivity growth. Through the 1960s and early ’70s, across the wealthy world, productivity had risen a strong 5 per cent a year. After 1973, the trend shifted clearly downward. Through the rest of the 20th century, productivity growth in the wealthy economies averaged less than 2 per cent a year. Diminished productivity growth translated directly into sluggish economic growth. The days when people could feel their living standards rising from one year to the next were over. As the good times failed to return, voters turned their fury on political leaders. In fact, there was little any Western politician could do to put their economies back on their previous tracks.

To give a short-term boost to an underperforming economy, central banks and governments have a variety of tools they can use. They can lower interest rates to make it cheaper to buy a car or build a factory. They can lower taxes to give consumers more money to spend. They can increase government spending to pump more cash into the economy. They can change regulations to make it easier for banks to lend money. But when it comes to an economy’s long-term growth potential, productivity is vital. It matters more than anything else – and productivity growth after the early 1970s was simply slower than before.

Turning innovative ideas into economically valuable products and services can involve years of trial and error

The reasons behind slowed productivity growth had nothing to do with any government’s economic policy. The historic move of rural peoples to the cities, around the world, could not be repeated. Once masses of peasant farmers and sharecroppers had shifted into more productive work in the cities, it was done. The great flow of previously unemployed women into the labour force was over. In the 1960s, building thousands of miles of superhighways brought massive economic benefits. But once those roads were open to traffic, adding lanes or exit ramps was far less consequential. In rich countries, literacy had risen to almost universal levels. After that historic jump, the effects of additional small increases in average education were comparatively slight. If higher productivity growth were to be regained, it would have to come from developing technological innovations and new approaches to business, and putting them to use in ways that allowed the business sector to operate more effectively.

When it comes to influencing innovation, governments have power. Grants for scientific research and education, and policies that make it easy for new firms to grow, can speed the development of new ideas. But what matters for productivity is not the number of innovations, but the rate at which innovations affect the economy – something almost totally beyond the ability of governments to control. Turning innovative ideas into economically valuable products and services can involve years of trial and error. Many of the basic technologies behind mobile telephones were developed in the 1960s and ’70s, but mobile phones came into widespread use only in the 1990s. Often, a new technology is phased in only over time as old buildings and equipment are phased out. Moreover, for reasons no one fully understands, productivity growth and innovation seem to move in long cycles. In the US, for example, between the 1920s and 1973, innovation brought strong productivity growth. Between 1973 and 1995, it brought much less. The years between 1995 and 2003 saw high productivity gains, and then again considerably less thereafter.

When the surge in productivity following the Second World War tailed off, people around the globe felt the pain. At the time, it appeared that a few countries – France and Italy for a few years in the late 1970s, Japan in the second half of the ’80s – had discovered formulas allowing them to defy the downward global productivity trend. But their economies revived only briefly before productivity growth waned. Jobs soon became scarce again, and improvements in living standards came more slowly. The poor productivity growth of the late 1990s was not due to taxes, regulations or other government policies in any particular country, but to global trends. No country escaped them.

Unlike the innovations of the 1950s and ’60s, which were welcomed widely, those of the late 20th century had costly side effects. While information technology, communications and freight transportation became cheaper and more reliable, giant industrial complexes became dinosaurs as work could be distributed widely to take advantage of labour supplies, transportation facilities or government subsidies. Workers whose jobs were relocated found that their years of experience and training were of little value in other industries, and communities that lost major employers fell into decay. Meanwhile, the welfare state on which they had come to rely began to deteriorate, its financial underpinnings stressed due to the slow growth of tax revenue in economies that were no longer buoyant. The widespread sharing in the mid-century boom was not repeated in the productivity gains at the end of the century, which accumulated at the top of the income scale.

For much of the world, the Golden Age brought extraordinary prosperity. But it also brought unrealistic expectations about what governments can do to assure full employment, steady economic growth and rising living standards. These expectations still shape political life today. Between 1979 and 1982, citizens in one country after another threw out the leaders who stood for the welfare state and voted in a wave of more Right-wing politicians – Margaret Thatcher, Reagan, Helmut Kohl, Yasuhiro Nakasone and many others – who promised to tame big government and let market forces, lower tax rates and deregulation bring the good times back. Today, nearly 40 years on, voters are again turning to the Right, hoping that populist leaders will know how to make slow-growing economies great again.

More than a generation ago, the free-market policies of Thatcher and Reagan proved no more successful at improving productivity and raising economic growth than the policies they supplanted. There is no reason to think that the populists of our day will do much better. The Golden Age was wonderful while it lasted, but it cannot be repeated. If there were a surefire method for coaxing extraordinary performance from mature economies, it likely would have been discovered a long time ago.

Aeon

NZ Inflation now at dangerously low level. 

The deflation risk will weigh heavily on the Reserve Bank, which is required to target an inflation band of between 1 and 3 per cent, which it has been outside for two years.

The idea that falling prices are a bad thing for an economy can seem counter-intuitive. But the problem as economists see it – and as witnessed in Japan over the past 20 years – is that when people expect inflation to be consistently low or deflation takes hold this can create a recessionary spiral. Expectation things will become cheaper suppresses consumer spending and business investment. The two feed off each other as lower consumption forces businesses to contract and focus on costs. That can start to cost jobs.

A cheaper TV or overseas holiday doesn’t look so good if you’ve been laid off. NZ Herald