You will no doubt have heard about the battle of ideas – Keynes v Hayek. In the 1930’s this was probably the most famous debate in the history of economics – the battle of ideas -government v markets.
Now there is Chinese version of the debate:
Justin Lin (Keynes) versus Zhang Weiying (Hayek) – both are Professors at Peking University. Lin is on the right of the image below.
Their latest debate is about industrial policy and the concept that the government can set the example of how to run successful industries – in the 1980’s textiles and today renewable energy. Although China’s growth record would seem to justify this some have seen these state run industries produce little innovation. Lin believes that countries that have a comparative advantage should receive help from the government whether it be in the form of tax cuts or improved infrastructure. Furthermore, because resources are limited the government should help in identifying industries which have earning potential. This assistance includes subsidies, tax breaks and financial incentives — aimed at supporting specific industries considered crucial for the nation’s economic growth.
Zhang sees this industrial policy as a failure in that he believes government officials don’t know enough about new technologies. He uses the example in the 1990s, when the Chinese government spent significant money on the television industry only for the cathode ray tubes to become outdated. He is also concerned about industrial inertia with local officials following the central government’s direction which tends to lead to an overcapacity. Zhang, however, credited the free market — not politically motivated government subsidies — with game-changing innovations that benefit society eg. James Watt and the steam engine, George Stephenson’s intercity railway, and Jack Ma’s innovative online marketplaces under Alibaba.
China’s ongoing transition to a market-based economy has relied on labour, capital and resource-intensive industries. But the transition’s negative side effects have included structural imbalances and excess capacity in certain sectors. Moreover, some state-owned enterprises such as telecoms have been challenged by disruptive innovators, such as social networks.
Zhang said industrial policy can foster greed. For example, companies may collude with government officials to win special favours. And policymakers can make mistakes, given that even the most well-informed intellectual cannot always predict market trends. Other economists have contributed to the debate stating that a lot of the most successful companies have not had any government assistance in their early years.
However the debate is sure to continue – what works best ‘Markets or Governments’?
The Economist – 5th November 2016
With the Cambridge A2 exam coming up here is a revision note on Keynes 45˚ line. A popular multi-choice question and usually in one part of an essay. Make sure that you are aware of the following;
1. C and S are NOT parallel
2. The income level at which Y=C is NOT the equilibrium level of Y which occurs where AMD crosses the 45˚ line.
1. OA is autonomous consumption.
2. Any consumption up to C=Y must be financed.
3. At OX1 all income is spent
4. At OB consumption = BQ and saving= PQ
5. Equilibrium level of Y shown in 2 ways
a) where AMD crosses 45˚ line
b) Planned S = Planned I – point D
Remember the following equilibriums:
2 sector – S=I
With Govt – S+T = I+G
With Govt and Trade – S+T+M = I+G+X
Here is a powerpoint on “Keynesian and Monetarist Theory” that I use for revision purposes. I have found that the graphs are particularly useful in explaining the theory. The powerpoint includes explanations of:
– Circular Flow and the Multiplier
– Diagrammatic Representation of Multiplier and Accelerator
– Quantity Theory of Money
– Demand for Money – Liquidity Preference
– Defaltionary and Inflationary Gap
– Extreme Monetarist and Extreme Keynesian
– Summary Table of “Keynesian and Monetarist”
– Essay Questions with suggested answers.
Hope it is of use – 45˚line shown. Click the link below to download the file.
Keynes v Monetarist Keynote
I have discussed with my A2 class the end of the Gold Standard and the new era of self-regulating markets that started in the 1980’s under Reagan (US) and Thatcher (UK). This relates to Unit 5 in the A2 syllabus – Main schools of thought on how the macroeconomy functions – Keynesian and monetarist.
Robert Skidelsky, in his book “Keynes – The Return of the Master”, outlined the Keynesian and Post-Keynesian periods. The Keynesian period was the Bretton Woods system whilst the “New Classical” Washington consensus system succeeded it. Both are outlined below:
The Bretton Woods system was designed to improve the rules and practices of the liberal world economy which had grown up sporadically in the 19th century. However in 1971 the fixed exchange rate system collapsed (see post Fixed exchange rates and the end of the Gold Standard) and the full employment objective was cast aside. Futhermore controls on capital were removed in the 1990’s. The new system introduced was more free market based and took the name of the Washingotn Consensus System.
According to Skidelsky the two regimes were shaped by two different philosophies. The Bretton Woods system broadly reflected the Keynesian view that an international economy needed strong political and institutional supports if it was to be acceptably stable. The Washington consensus was driven by free market principles of self-regulation and limited government intervention.
Alan Blinder wrote a review of Jeff Madrick’s book “Seven Bad Ideas: How Mainstream Economists Have Damaged America and the World” – in the December edition of The New York Review of Books. The basis of the book is that ‘economists’ most fundamental ideas contributed centrally to the financial crisis of 2008 and the Great recession that followed.” Blinder quoted George Stigler’s contrary verdict “that economists exert a minor and scarcely detectable influence on the societies in which they live.” He comes up with a test that asks you which of the statements below comes closer to the truth.
The dominant academic thinking, research, and writing on economic policy issues exert a profound, if not dispositive, influence on decisions made by politicians.
Politicians use research findings the way a drunk uses a lamppost: for support, not for illumination.
Most people chose the second statement but Madrick’s answer seems closer to the first.
Blinder is at odds with three of Madrick’s ‘Bad Ideas’
1. The Influence of Economists – they don’t have as much influence on economic policy as Madrick suggests.
Blinder quotes his idea of Murphy’s Law of Economic Policy:
Economists have the least influence on policy where they know the most and are most agreed; they have the most influence in policy where they know the least and disagree the most vehemently.
However when you consider who has the most influence on the election of politicians it is the general public and not economic experts. According to Binder the GFC of 2008 has in part been the fault of economists. Most graduate take at least one economics paper but professors have failed to convince the public of even the most obvious lessons, like the virtues of international trade and the success of expansionary fiscal policy in a slump. It’s a pedagogical failure on a grand scale. Many economists teach and praise the efficient market hypothesis.
2. Mainstream economics is right wing.
Milton Friedman (University of Chicago) is targeted by Madrick with regard to right wing doctrine. It is quoted in the book that Keynesian economics is not part of what anybody has taught graduate students since the 1960’s. Keynesian ideas are fairly tales that have been proved false. Blinder refutes these statements with the latter being farcical. One can argue over the macroeconomic policies of the Chicago School but it’s clear that their views are far from the mainstream.
The success of Keynesian policy since the GFC has been well documented. Experts were asked whether they agreed or disagreed with the two statements about fiscal stimulus.
1. Because of the American Recovery and Reinvestment Act of 2009, the US unemployment rate was lower at the end of 2010 that it have been without the stimulus bill. 82% agreed 2% disagreed
2. Taking into account all the ARRA’s economic consequences – including the economic costs of raising taxes to pay for the spending, its effects on future spending, and any other likely future effects – the benefits of the stimulus will end up exceeding its costs. 56% agreed 5% disagreed and 23% uncertain.
So from this the mainstream is overwhelmingly Keynesian.
3. Bad ideas
Madrick’s first bad idea was Adam Smith’s invisible hand. Blinder sees this as a great idea as throughout history, there has never been a serious practical alternative to free competitive markets as a mechanism for delivering the right people at the lowest possible costs. So it is essential that students learn about the virtues of the invisible hand in their first economics course.
Blinder also challenges another of Madrick’s Bad Ideas – Say’s Law, which states that supply creates its own demand, means that an economy can never have a generalized insufficiency of demand (and hence mass unemployment) because people always spend what they earn. Therefore: no recessions, no depressions. The Great Depression and then Keynes put an end to Say’s Law.
A Bad Idea – Efficient Market Hypothesis (EMH)
This Bad Idea became destructive as the EMH gave Wall Street managers the tools with which to build monstrosities like Collateralized Debt Obligations and Credit Default Swaps on top of the rickety foundation of subprime mortgages. This was further backed up by the credit rating agencies who gave AAA ratings to risky investments. EMH also handed the conservative regulators a rationale for minimal financial regulation.
According to Blinder, Madrick is an important and eloquent voice for what’s left of the American left – at least in economic matters.
A number of articles from The New Yorker magazine have outlined the problems facing Greece’s anti-austerity party Syriza. The party came to power on the election promise of reducing Greece’s debt burden and to liberate Greece from the Troika – the ECB, the IMF and the European Commission. However the extension recently granted to Greece will take place only within the framework of the existing arrangement. The budgetary targets for 2015 and 2016 have kept the economy stuck in recession.
* the Greek economy has contracted by 30% since 2008.
* 25% of the workforce are officially unemployed
* 50% of those under 24 years of age are unemployed
* 40% of Greek children live below the poverty line.
Money has been flowing out of the economy leaving the banking system on the verge of collapse see graphic from The Economist.
As with the Keynesian doctrine, Syriza’s solution in to create effective demand by pumping money into the system. One economics professor at the University of Athens called it “pure Keynesian policies. The big question is where will the money come from although some seem to think that it can raise revenue from tackling corruption and tax evasion. The latter is widespread in Greece amongst the upper-middle class and the very rich – the top-most bracket of households and businesses are responsible for 80% of the total tax debt owed to the government.
Greece’s creditors were mostly European banks, which had, in part, used public bailout money following the 2008 credit crunch to scoop up Greek bonds. For example, French and German banks were on the books for thirty-one and twenty-three billion euros, respectively. The troika stepped in during the spring of 2010, and again in 2012, to orchestrate bailouts of the Greek government, offering two hundred and forty billion euros in loans in exchange for a drastic reduction in government spending and other measures to make the Greek economy more competitive. Source: New Yorker
The conventional wisdom is that returning to the drachma would be a catastrophe for Greece. There are pros and cons to this decision – the following would be concerns about returning to the drachma:
* An immediate devaluation;
* The value of savings would tumble;
* The price of imported goods would soar.
However on the positive side of things you would get the following:
* Greek exports would become cheaper
* Labour costs even more competitive.
* Tourism would likely boom.
* Regaining control of its monetary and fiscal policy for the first time since 2001
It would give Greece the chance to deal with its economic woes. Other countries that have endured sudden devaluations have often found that long-term gain outweighs short-term pain. When Argentina defaulted and devalued the peso, in 2001, months of economic chaos were followed by years of rapid growth. Iceland had a similar experience after the financial crisis. The Greek situation would entail an entirely new currency rather than just a devaluation.
This conflict is as much about the ideology of austerity and whether smaller countries will have a meaningful say in their own economic fate. However one needs look back in history to remember that in debt-saddled Weimar German, humiliation and dispossession festered until it a gave rise to the Nazi party. Greece’s neo-nazi party won the third greatest number of parliament seats in the last election.
Went through an A2 multiple-choice question on calculating the equilibrium level of income with my A2 class. There are two ways that it can be worked out. Here is the question:
In a closed economy with no government C = 30 + 0.8 Y and I = 50, where C is consumption, Y is income and I is investment.
What is the equilibrium level of income?
A 64 B 80 C 250 D 400
Below is the most common way of working the question out:
Y = C + I
Y = 30 + 0.8Y + 50
0.2Y = 80
Y = 400
Here is the other way that you should be able to work out the equilibrium
Remember: Savings = Income – Consumption
S = Y – C
S = Y – (a + cY)
S = Y – a – cY
S = -a + (1-c) Y
So if we put the figures into the equation you get:
50 = -30 + (1-0.8) Y
50 = -30 + 0.2Y
80 = 0.2Y
Y = 400