John Quiggan, an economist, political commentator and fellow Australian, wrote an article recently for foreignpolicy.com entitled "Five Zombie Economic Ideas That Refuse To Die". His article fits into the same tone that Richard Werner wrote in "New Paradigm in Macroeconomics" in 2005, namely that neo-classical economic ideology (called neo-liberalism here in Australia) has failed to deliver what was promised.Before I begin my critique of Quiggan's article, I need to first point out that I regularly enjoy reading Quiggan's blog. I find his point of view interesting and his arguments compelling. Like Quiggan I have a lot of sympathy towards Social Democracy and its tenets, as well as some of the wars he has engaged in (namely an informed disdain for News Limited and defending the science of global warming). I also need to point out that much of my critique of Quiggan's article is not based upon a defence of neo-classical economics but upon policy that I believe is simply the best choice.
Let me start with Quiggan's first point, that of "The Great Moderation". Quiggan says:
More importantly, central banks and policymakers are planning a return to business as usual as soon as the crisis is past. Here, "business as usual" means the policy package of central bank independence, inflation targeting, and reliance on interest rate adjustments that have failed so spectacularly in the crisis.Quiggan then goes on to quote Jean Claude Trichet's comments about inflation, namely the importance of maintaining price stability in good times and bad. Quiggan points out that this attitude is "startlingly complacent".
My argument is that Central Bank independence should be maintained and that monetary policy should be geared towards keeping inflation down. Unlike many who argue that an "inflation target" should be set, it is my point of view that absolute price stability be the goal of monetary policy, whereby money neither increases nor decreases in value over the long term. Now while neo-classical and neo-liberal economic ideology argues for strict price stability, my reasons for holding this position do not come from either of these movements but from a much older idelogy - Ordoliberalism. This economic school was developed in Germany in the post war years and was responsible for Germany not just recovering from the devastation of World War Two, but becoming the economic powerhouse of Western Europe.
Let me just do a quick history lesson here. Please be patient.
After the hyperinflation of the Weimar Republic years and the disaster of the Hitler years, West Germany suffered under some very vengeful and short-sighted policy by occupying US forces. Joint Chiefs of Staff Directive 1067, signed by President Truman in 1945, attempted to de-industrialise Germany. Even though Germany did gain some relief from the Marshall Plan, the amount of money they were forced to pay in war reparations was greater than anything they received from the US. In short, West Germany, wrecked from the war, faced the prospect of paying the allies (net) war reparations while being forced to de-industrialise and turn into an agrarian economy. The result was disaster for Germany: poverty went hand in hand with growing inflation. In the years following the end of World War II, poverty in Germany grew worse and worse.
JCS 1067 was eventually overturned and the West Germans were granted the responsibility to look after their own economy. The philosophy that guided them was Ordoliberalism - the idea that the state should regulate the free market in order to allocate resources effectively. It was neither the Democratic Socialism that was embraced by the UK and France in the 1950s nor the Laissez-faire model of the US. One of the tenets of this philosophy was low inflation: Price Stability. The Deutschmark replaced the Reichsmark under this change, and stable prices formed the basis of Germany's growth during the years now known as the Wirtschaftswunder.
What we have learned from economic history is that any major swing towards inflation or deflation leads inevitably to hardship. Deflation beset the world during the Great Depression; Inflation beset the world during the 1970s and hyperinflation has led to ruin in numerous nations, including Ancient Rome, Weimar Germany and Zimbabwe today.
So what level of inflation does Quiggan want? Is 5% inflation too high? is 7%? Is 50%?
Ah, Quiggan might respond, what about the US over the last ten years? They had low inflation and that didn't stop the financial crash did it? To which I would respond by pointing out two things: Firstly that interest rate policy alone will not prevent a crisis from occurring, but is one important part of a whole host of things that should prevent a crisis. If a driver gets injured because another car rammed into him, it would be disingenuous of him to blame it on his tyres.
Secondly, that while inflation was historically low in the US for the past ten years, real interest rates were negative between 2002 and 2005. Many economists have pointed out that the US Federal Reserve kept interest rates too low during this period which, in turn, created the property bubble which burst and helped create the current financial crisis. The Washington Consensus, a neo-classical and neo-liberal text that has guided IMF policy for many years, specifically highlights the need for real interest rates to be positive. Had the US actually kept in lockstep with neo-classical ideas, this period of negative interest rates would never have been allowed. The crisis thus did not stem from a complete adherence to neo-classical ideology but from a deliberate rejection of what I consider to be good policy. If we go back to the car analogy, a driver who has injured himself by driving irresponsibly shouldn't blame the laws that he neglected to follow.
It also needs to be pointed out that the Federal Reserve Bank, unlike the ECB and Australia's Reserve Bank, did not have an inflation target to aim for, but kept markets guessing. The Fed certainly had a goal for price stability, but it was amorphous and opaque. This of course shifts the issue to whether a Central Bank should be independent. The original reason for making a Central Bank independent was to insulate it from political pressure in order to enact monetary policy that would be governed by price stability and not political interference. While I still believe in this, I am also willing to admit that Central Banks are not necessarily immune from market influence. The Federal Reserve, for example, has an unusual amount of employees working for it who once worked for Goldman Sachs. The fact that the market has been able to influence central bank policy does not therefore mean that they should come back under government influence, but that steps be taken to insulate it from all forms of undue influence. In other words, I am advocating a Central Bank that is not just independent, but also transparent and accountable.
To summarise my position on central banks and the current economic crisis: Central Banks should focus upon price stability as their main goal and set realistic low inflation targets (and again let me advocate absolute price stability instead of low inflation targets). Central Banks should be independent of government and market influence, while remaining transparent and accountable for their actions. Jean Claude Trichet, head of the ECB, was quoted by Quiggan as saying this, which I heartily affirm (and which Quiggan criticises):
Keeping inflation expectations anchored remains of paramount importance, under exceptional circumstances even more than in normal times.There is nothing "neo-classical" or ignorant about this policy. In fact one could argue that had this policy been abandoned during the current crisis, we would be suffering even more.
One last thing before I move on: shouldn't central banks have a wider focus of reducing unemployment and fostering economic growth and not just price stability? To me that question is moot. Worrying about economic growth and the unemployed should be the focus of the government, not the central bank. "Pump priming" the economy through Keynesian stimuli should not be ignored as a policy, and nor should increasing the size of government to bring about a better economy over the long term. These I advocate, which plainly shows just how different I am from the neo-classical mould of "keep government small and let the market do everything", though I would point out that the government needs to control the level of debt throughout this process.
Quiggan's points on modern day monetary policy and the so called "Great Moderation" were my main problem. Now let me move on to Quiggan's other points.
The second point Quiggan critiques is the "Efficient markets Hypothesis". While Quiggan and I agree that letting the market do everything is a silly and dangerous policy, so to would be the idea that the government do everything. Quiggan is not a communist who advocates a planned economy, but his article is light on what he thinks should replace the current crazy "markets are always wonderful" idea. My argument has been that there are sectors of the economy that the government is better suited to controlling and sectors which the market is better at controlling, and that there are even areas where a combination of government and market result in the best outcome. Health Care, for example, has been shown to work best when a government run universal health care system operates alongside a smaller market system aimed at those who wish to pay more for their health. It is this combination of majority government and minority market which works so well in Western European Social Democracies and in countries like Canada, Australia and New Zealand. The US system, in which government healthcare is limited and which the market is dominated by health care companies, has been shown to be less efficient and less effective than the one employed by social democracies.
So while I agree with Quiggan that the "efficient markets hypothesis" is bunk, I would also argue that some markets are efficient while others are not - and those that are not should have some level of government intervention, which ranges from a stricter regulative environment at one end to complete government control at the other end. This again shows my belief in Ordoliberalism.
Thirdly Quiggan points out the stupidity behind Dynamic Stochastic General Equilibrium. I'm certainly in complete agreement with him on this one, as with his fourth point, that of the complete failure of "trickle down economics" to trickle anything down to lower income earners. Median wages in the US have certainly stagnated in the last ten years, and were affected most by Reaganomics, which cut taxes for the rich. While I admit that income and wealth disparity will (and should) always exist, there is a point at which it becomes ridiculous. Aiming for a GINI coefficient of under 30 should be a policy goal for any nation who wishes to intelligently reduce poverty levels.
Quiggan's final point concerns privatization: the selling off of government assets and economic sectors and their replacement by private companies. Again this is one area that I am in partial agreement. There are some government entities that definitely needed to be privatised. In the case of Australia, Qantas, the Commonwealth Bank and Telstra were progressively privatised over many years and I have no problem with these changes. Why should the government compete in the airline industry if private industries can do it better? Nevertheless the privatization debate is grounded on the efficient markets hypothesis, which I have written briefly about above. Privatization might lead to better economic and social outcomes, but then again so might nationalization of some industries. The guiding principle here should be pragmatism and social and economic harmony.
Like many post-crash commentators, Quiggan's points are a mix of good and bad. There is no doubt that the previous policy regime needs to be challenged but there is a point at which the proverbial baby is thrown out with the bath water. Marxism and Communism made the mistake of treating capitalism as an enemy that should be destroyed, while modern-day market advocates treat government as a similar enemy. Different ideologies, same blindness. Neo-classical / neo-liberal economics has certainly failed, but in developing alternatives we cannot ignore some of the truths hidden within its failure: Not all markets are efficient, but some are; Not all government programs are efficient, but some are; Price stability won't solve everything, but it does solve some things.
The reason for the silence? Holiday. To