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1 the Keynes Solution for Preventing Global THE KEYNES SOLUTION FOR PREVENTING GLOBAL IMBALANCES By PAUL DAVIDSON, Editor Journal of Post Keynesian Economics (Paper presented at conference on AFrom Crisis to Growth? The challenge of imbalances, debt and limited resources@ Berlin , Germany, October 28, 2011BResearch Network Macroeconomics and Macroeconomic Policies [FMM]) The mainstream economic solution for curing persistent global imbalances in international payments is for the deficit nation(s) to become Amore competitive@ to increase exports and reduce imports. Traditionally this has meant that the deficit nation should devalue its currency in terms of exchange rates and/or reduce money wage rates and fringe benefit costs thereby reducing production costs relative to the nation=s trading partners. This is still the orthodox solution despite the experience of the Acompetitive@ exchange rate wars of the 1930s.These exchange rate devaluations were seen as a way to becoming more competitive and therefore Aexporting your unemployment@ to your trading partners. The result was to increase global depressionary forces. As a sage once said: AThose who do not study history tend to repeat its errors@. Most of today=s central bankers and politicians are on track to repeating historical economic errors When Greece=s international debt problem became obvious, many observers suggested that if Greece was to resigned from the Euro and reinstate the drachma as the nation=s currency, its problem could be solved by reducing the exchange rate of its drachma currency relative to those of its trading partners. For example, the New York Times :@[Returning Greece to the Drachma@; september12/ 2011 page B2] noted that Areturning Greece to the drachma, would allow market forces to set the country=s wage levels.... Greece=s continuing current account deficit....indicates that it remains deeply uncompetitive.... Greece may require living standards 1 [i.e., wages] to decline by as much as 40 per cent to become competitive....the drachma=s value would fall sharply....The equilibrium drachma would make Greek workers internationally competitive. Greece also could achieve a trade surplus... [devaluation] would help push unemployment down rapidly...Good behavior would result from self-discipline alone.@ Even today Central Bankers recommend this competitive solution to international payment imbalances. For example, at the annual central bankers Jackson Hole August 2011 conference, the New York Times reported that the European Central Banker Jean-Claude Trichet did not mention the European debt crisis, nor the ECU=s purchases of Italian and Spanish bonds to contain runaway borrowing costs of European governments. The Times noted AInstead, Mr. Trichet suggested that Europe=s problems are fundamentally a question of which governments have taken steps to promote growth and become competitive and which have not.@ Trichet is then quoted as saying AGreece, Portugal and Ireland, in particular have progressively lost competitiveness vis- a-vis their main trading partners in Europe. Germany is now an example of how big dividends of reform can be if structural adjustment is made a strategic priority and implemented with sufficient patience@. [AIMF Chief Chastises Policy Makers@, The New York Times, August 28, 2011, Italics added] Germany=s positive trade balance must create negative trade balances with at least some of its trading partners such as Greece, Portugal, and Ireland. Of course, if these latter nations were to succeed in achieving a new level of competitiveness (as Mr. Trichet suggests), then they will have reduced the production costs of labor relative to German workers and therefore the real income of workers in Greece, Portugal, etc. If these nations successfully become more 2 competitive and expand their exports, then their Euro trading partner nations such as Germany must become relatively less competitive and lose export market share as well as shares in domestic markets where the now newly more competitive nations can inundate. In his September 2011 speech to Congress urging the passage of a jobs bill, President Obama ultimately endorsed the same classical canard of solving jobs and payment problems via competitive free trade. The long run solution of the US unemployment problem and thereby restoring prosperity, President Obama indicated, will rely on Aa series of trade agreements that would make it easier for American companies to sell their products in Panama, Columbia, and South Korea B while helping the [American] workers whose jobs have been affected by global competition. If Americans can buy Kias and Hundais, I want the folks in South Korea driving Fords and Chevys and Chryslers. I want more products sold around the world with three proud words >Made in America=@. As Keynes [ANational Self-Sufficiency@ (1933) reprinted in The Collected Writings of John Maynard Keynes, vol. 21, p. 238] noted , however, AExperience accumulates to prove that most modern production processes can be performed in most countries with equal efficiency@. If, therefore, labor costs per man-hour in places like China and Korea are at no more than 10 per cent of the American auto companies labor costs of producing the identical Fords, Chevys, etc in the USA with the same technology, then American auto companies will produce cars at lower costs in Asia for the Asian market rather than hiring workers in the USA. Only if American wages can be pushed down by more than 90 percent so as to be competitive with those of Asian workers, will American companies even consider selling cars that are really AMade in America@ 3 in foreign markets. In other words, the labor costs of America=s mass production industries must become Acompetitive@ with production costs in cheap foreign labor markets before the AMade in America@ label on autos, that President Obama endorses, will create employment in the USAi. Keynes [1936, pp. 382-383, Italics added] noted Awhilst economists were accustomed to applaud the prevailing international system as furnishing the fruits of the international division of labour and harmonizing at the same time the interests of different nations, there lay concealed a less benign influence...if nations can learn to provide themselves with full employment by their domestic policy, there need be no important economic forces calculated to set the interests of one country against that of its neighbours... There would still be room ...for international lending in the appropriate circumstances. But there would no longer be a pressing motive why one country need force its wares on another or repulse the offerings of its neighbour, not because this was necessary to enable it to pay for what it wished to purchase, but with the express object of upsetting the equilibrium of payments so as to develop a balance of trade in its favour. International trade would cease to be what it is, namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets ...which, if successful will merely shift the problem of unemployment to the neighbour which is worsted in the struggle.@ It is time to revive Keynes=s analysis of the perverse problems raised by the current system of international trade and payments, of using bank credit to buy foreign assets, of outsourcing, and of a blind desire for free trade at all costs. We must make central bankers and government policy decision makers aware of the Keynes=s Solution for preventing international 4 global payment imbalances while pursuing policies that assure global economic prosperity. For if policy makers such as Chancellor Merkel, Banker Trichet and President Obama continue to urge policies based on the classical theory=s long run solution, then as Keynes said AIn the long run, we will all be dead@ and the long run will not be very far away. We must instead pursue policies that bring producer and consumer of products and services withing the same scope of national economic and financial institutions to assure full employment. To do this we must reform the world=s monetary payment system to prevent stimulus policies in any one nation creating import-export imbalance problems with its trading partners as the domestic stimulus policy induces Amultiplier@ employment in the trading partners. For if the latter occurs, then the only solution for the nation with a significant deficit international payments problem will be Aausterity@ which by itself will be inadequate to rebalance international payments among nations. REFORMING THE WORLD=S MONEYB AN UPDATED KEYNES PLAN The Bretton Woods Solution Since the Second World War, the economies of the capitalist world have conducted experiments with the different types of exchange rate systems. For almost a quarter of a century after the war (1947-1971), nations operated under the 1944 international Bretton Woods Agreement that provided for a fixed, but adjustable, exchange rate system where, when necessary, nations could invoke widespread limitations on international financial movements (i.e., capital controls). Since the 1970s, as many economists abandoned any support for Keynes=s policies and instead accepted the classical theory of efficient markets as correct dogma, the conventional wisdom of economists and politicians has been that nations should liberalize all financial markets to permit 5 unfettered international capital flows to operate under a freely flexible exchange rate system. As the second world war was winding down, the victorious Allied nations called a conference at Bretton Woods in New Hampshire. The purpose of this Bretton Woods conference was to design a post war international payment system that avoided creating conditions for another Great Depression. Keynes was the chief representative of the United Kingdom delegation at this Bretton Woods conference. In contrast to the classical view of the desirability of free exchange rate markets, Keynes=s position at Bretton Woods was that there is an incompatibility thesis in the classical approach to international trade and finance. Keynes argued that permitting free trade, flexible exchange rates and free capital mobility across international borders can be incompatible with the economic goal of global full employment and rapid economic growth.
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