Mr Tim Cavanaugh’s clear-headed criticism of a principal government economist’s waffle seems to me apt and exactly on target. E.g. he says: “The real purpose here is Panglossian: to convince you that whatever Power does is the right thing to do, and to discredit the idea that government should ever again reduce its presence in the private sector.”
In an article dated Sep 18 2008 titled “October 1929? Not!”, I argued “that the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.” A few weeks later in “America’s divided economists” I said
“Beyond the short run, the US may play the demographic card by inviting in a few million new immigrants (if nativist feelings hostile to the outsider or newcomer can be controlled, especially in employment). Bad mortgages and foreclosures would vanish as people from around the world who long to live in America buy up all those empty houses and apartments, even in the most desolate or dismal locations. If the US’s housing supply curve has moved so far to the right that the equilibrium price has gone to near zero, the surest way to raise the equilibrium price would be by causing a new wave of immigration leading to a new demand curve arising at a higher level. Such proposals seek to address the problem at its source. They might have been expected from the Fed’s economists. Instead, ESSA speaks of massive government purchase and control of bad assets “downriver”, without any attempt to face the problem at its source. This makes it merely wishful to think such assets can be sold for a profit at a later date so taxpayers will eventually gain. It is as likely as not the bad assets remain bad assets.”
Restoring a worldwide idea of an American dream fuelled by mass immigration may be the surest way for the American economy to restore itself. America was at its best when it was open to mass immigration, and America is at its worst when it treats immigrants with racism and worse.
In the summer of 1983 Dr James Dorn of Cato Institute invited me (then in Menlo Park) to comment on the influential papers then being given by the prominent trade economist Dr J Michael Finger.
I think I might have said I hadn’t worked on trade since LSE days a decade earlier but Jim said something sweetly persuasive like “We want to put you in the limelight” — and limelight there was, a full house in Washington (the Capitol Hill Hyatt Regency), with the bright camera lights of C-Span and local television.
I do not recall what current trade issues dominated the agenda, certainly it was years before NAFTA or China were being discussed, perhaps tariff removal on US textiles, probably Japanese auto-imports: Michael Finger certainly gave a devastating example of the difficulty US beef exporters had entering Japan’s beef market at the time.
But whatever I said, as a 28 year old Indian from Cambridge and India, was very well received by that packed Washington audience. And I did not say much more than offer a Hahnian-Keynesian scepticism about textbook economic theory being divorced from ground realities.
[Twitter 21.10.2016 et seq: I recollect three interactions after the talk, Donald J Trump or someone like him was seated midway in the hall in an aisle, introduced himself praised the talk to me, and may have said “Remember the name”! (He looked like a “preppie”, like myself.) Bernie Sanders, or someone like him made a momentary comment as he charged by at speed; a third man said I “waxed eloquent”. Trump sat toffishly dressed in an aisle seat, congratulated me and introduced himself, Sanders charged out at speed after a momentary word…I recall three interactions after the talk, one each with Trump and Sanders, or someone like them.) I seemed to recall coming from Blacksburg by car to give the Washington talk, but the letter Jim Dorn sent was to Menlo Park, California, where I had been in the summer; and later in Fall 1983 I was visiting at Cornell; I have not yet been able to reconstruct how I travelled to Washington, I would be surprised if I drove from Ithaca and back but perhaps I did. (I had just driven from Blacksburg to California and back, then up to Ithaca).
[I apparently flew from Ithaca to Washington National, then stayed at the hotel for one night, and after my talk (and encounter with the future POTUS Trump), drove to Baltimore airport where I had to pick someone up and drove back to Ithaca in the rented car. The phone conversation about “limelight” must have been in the summer. Oddly enough, I was at Ithaca from Blacksburg teaching History of Economic Thought for a semester in the Economics Department because, from my point of view I could talk to Max Black in Philosophy, and from Cornell’s point of view, Ken Burdett the Economics chair told me, History Department students had demanded the course: those History Department students were led by Ms Ann Coulter, who became a quite quiet pupil in my class.]
Half a dozen years later at the University of Hawaii in March 1989 I amplified the argument a little bit as follows:
“Risk-aversion explains resistance to freer trade (and explains protectionism during a recession)
Textbook economics suggests world trade improves material welfare: consumers are better off when imports may compete freely in the home-market. Yet from Adam Smith’s critique of mercantilism to modern theories of rent-seeking, domestic producers in import-competing industries have been described as trying to restrict international trade by tariffs or other means. How is it producers so often succeed in persuading governments of the social costs of imports? Why are there not (or not as many, or not as powerful) consumer lobbies? Certainly there are high costs of organizing consumer lobbies relative to producer lobbies, but leaving that aside, is it possible consumers are ignorant and irrational? J. Michael Finger (1982, 1983/84) argued that in this respect consumers are in fact ignorant of their own best interests.
Roy (1983/84) suggested that a simple Keynesian observation offers a different explanation. A domestic household may be definitely better off by trade-liberalization on the expenditure side of its budget but the increased competitiveness of the economy accompanying liberalization may so decrease the expected value of its income that a risk-averse household would prefer the trade-protected status quo and have no incentive to lobby for trade-liberalization. Conversely, in a recession when the expected value of a household’s income declines, households have an incentive to lobby for trade-protection despite this worsening the expenditure side of their budgets.
The simplest of examples suffices to show all this. Let x1 be a non-traded domestic good, and x2 an imported good, and let a domestic household have preferences
U (x1, x2) = x1α . x2β
α + β < 1; 0 < α, β < 1 (1)
Let x1 be numeraire, p’ and p be the world and domestic prices of x2 respectively, and t be the tariff-rate on x2 such that p = (1 + t). p’. Let the household’s expected income be ya in the trade-protected state and yb in the trade-liberalized state, so its budget constraint is either
ya = x1 + (1 + t).p’. x2 in the trade-protected stated (2a)
yb = x1 + p’. x2 in the trade-liberalized state (2b).
Maximizing (1) subject to (2a) gives a “final utility” in the trade-protected state, Ua*. Maximizing (1) subject to (2b) gives a “final utility” in the trade-liberalized state, Ub*.
Hence Ua* > Ub* as
[ya/yb] (α + β)/β > 1 + t where (α + β)/β > 1.
If income is certain in the trade-protected state but uncertain in the trade-liberalized state, a household’s risk-aversion will require loss in the expected utility of income in the trade-liberalized state to be offset by a gain in final utility that it receives as a consumer due to tariff-reduction.
E.g., let α = β = ½ and let the household have a certain income in the trade-protected state of $20,000; let it place a subjective probability of 1/4 on being unemployed with zero income in the trade-liberalized state, and 3/4 on maintaining the same income of $20,000.
Then Ua* > Ub* as [4/3]2 > 1 + t.
I.e., for any tariff-rate less than about 78% with these particular data, the household may rationally think itself better off in the trade-protected state than in the trade-liberalized state, and hence have no incentive to lobby for the latter.
Cooper (1987) remarked: “There should of course be a strong appeal to consumers of imported goods for removing restrictions. For a variety of reasons, political mobilization of consumers has been difficult in most countries. Many of these consumers also are employed in producing tradable goods, and they worry more about their jobs than about the purchasing power of a given wage. But most goods that move in international trade are not consumer goods. They are capital goods and intermediate products, and it should be easier to appeal to buyers of these intermediate products for import liberalization, because such buyers would enjoy a reduction in their costs.” The sentence italicized above may be consonant with the simple point made here.
Richard N. Cooper “Why liberalization meets resistance” in J. Michael Finger (ed.), The Uruguay Round, A Handbook on the Multilateral Trade Negotiations, World Bank, November 1987.
J. Michael Finger, “Incorporating the gains from trade into policy”, The World Economy, 5, December 1982, 367-78.
“The political economy of trade policy”, Cato Journal, 3, Winter 1983/84.
Subroto Roy, “The political economy of trade policy: comment”, Cato Journal, 3, Winter 1983/84″
I sent it to Economic Letters but the editor Professor Jerry Green rejected it, perhaps because it was too simple and unpretentious. And it remained unpublished until I put it on my blog in March 2009.
Yes it is relevant to the trade-problem America may face today, and yes perhaps both Mr Trump and Mr Sanders were in my audience at Cato, I do not know.
From Twitter 21.10.2016: I recollect three interactions after the talk, Donald J Trump or someone like him was seated midway in the hall in an aisle, praised the talk to me afterwards; he looked like a “preppie”, like myself. Bernie Sanders, or someone like him made a momentary comment as he charged by at speed; a third man (I think he was a Florida State professor who became a friend and later invited me there but I could not go) said I had “waxed eloquent”.
From Twitter 09.11.2016: Trump sat toffishly dressed in an aisle seat, congratulated me and introduced himself, Sanders charged out at speed after a momentary word…I recall three interactions after the talk, one each with Trump and Sanders, or someone like them
I have put these documents here now in 2017 after recollecting in 2016 during the American election campaign that both Bernie Sanders and Donald J Trump had been present at that trade policy conference in Washington in September 1983 and both had interacted with me briefly! Mr Sanders had expressed a momentary word of praise and had charged out of the large crowd at speed with I think a small retinue of staff. (I asked someone who that had been, and recall Vermont being mentioned, and recall the spectacles and the fierce earnest expression.) Mr Trump had sat in an aisle seat in the middle and he had looked at me and I at him (we were both relatively young men in that middle aged milieu) as I had walked up to the podium. He was toffishly dressed, looking somewhat out of place in a nerdy conference of academics, journalists, politicians and policy wonks. As I had come down from the podium he had stood up and introduced himself as “Donald J Trump”, and said “Manhattan real estate” possibly upon my enquiry; he praised my talk quite profusely and might have said something like he was surprised that “coming from the part of the world” I did I had grasped what I had done about America.
[I would have looked a year younger than this, Mr Trump a bit older than this…]
The encounter was no more than two minutes and ended with him saying “Remember the name”… which as it happens I did not even when I walked by his tall buildings in New York a decade later.
It was only when I heard his primary campaign speeches in the American Midwest about March 2016 that I said “Hey I said that”, and recalled my own argument and our meeting. Was the future American President conspicuous in that nerdy policy wonk conference of academics, congressional staff, journalists etc? I would say he was… in both dress and manner. “Make no mistake #Trumpisapolicywonk…a preppie by education, an American nationalist, a commonsense pragmaticist (Peirce)” I have said at Twitter, starting the hashtag mentioned. As it happened, earlier that summer I had stopped with my Sheltie puppy for a night at a motel in Little Rock, Arkansas, where Mrs Clinton was First Lady; a leprechaun could have told me, Hey, those two are going to square off in 2016… .
Lehman Brothers filing for bankruptcy protection, Merrill Lynch taken over by Bank of America, Fannie Mae and Freddie Mac and now AIG being nationalised by the US Government, Bear Stearns getting a government bailout, many thousands of low-quality loans going bad … Does it all add up to an American financial crisis in the autumn of 2008 comparable to that in the autumn of 1929? Even Alan Greenspan himself has gone on record on TV saying it might.
But there are overriding differences. Most important, the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.
Besides, the roots of the crises are different. What happened back then? In 1922, the Genoa Currency Conference wanted to correct the main defect of the pre-1914 gold standard, which was freezing the price of gold while failing to stabilise the purchasing power of money. From 1922 until about 1927, Benjamin Strong of the Federal Reserve Bank of New York adopted price-stabilisation as the new American policy-objective. Britain was off the gold standard and the USA remained on it. The USA, as a major creditor nation, saw massive gold inflows which, by traditional gold standard principles, would have caused a massive inflation. Governor Strong invented the process of “sterilisation” of those gold inflows instead and thwarted the rise in domestic dollar prices of goods and services.
Strong’s death in 1928 threw the Federal Reserve System into conflict and intellectual confusion. Dollar stabilisation ended as a policy. Surplus bank money was created on the release of gold that had been previously sterilised.
The traditional balance between bulls and bears in the stock-market was upset. Normally, every seller of stock is a bear and every buyer a bull. Now, amateur investors appeared as bulls attracted by the sudden stock price rises, while bears, who sold securities, failed to place their money into deposit and were instead lured into lending it as call money to brokerages who then fuelled these speculative bulls. As of October 22, 1929 about $4 billion was the extent of such speculative lending when Chase National Bank’s customers called in their money.
Chase National had to follow their instructions, as did other New York banks. New York’s Stock Exchange could hardly respond to a demand for $4 billion at a short notice and collapsed. Within a year, production had fallen by 26 per cent, prices by 14 per cent, personal income by 14 per cent, and the Greatest Depression of recorded history was in progress — involuntary unemployment levels in America reaching 25 per cent.
That is not, by any reading, what we have today. Yes, there has been plenty of bad lending, plenty of duping shareholders and workers and plenty of excessive managerial payoffs. It will all take a large toll, and affect markets across the world.
But it will be a toll relative to our plush comfortable modern standards, not those of 1929-1933. In fact, modern decision-makers have the obvious advantage that they can look back at history and know what is not to be done. The US and the world economy are resilient enough to ride over even the extra uncertainty arising from the ongoing presidential campaign, and then some.
First published in The Statesman, Perspective Page Nov 22 2006
Milton Friedman, who died on 16 November 2006 in San Francisco, was without a doubt the greatest economist after John Maynard Keynes. Before Keynes, great 20th century economists included Alfred Marshall and Knut Wicksell, while Keynes’s contemporaries included Irving Fisher, AC Pigou and many others. Keynes was followed by his younger critic FA Hayek, but Hayek is remembered less for his technical economics as for his criticism of “socialist economics” and contributions to politics. Milton Friedman more than anyone else was Keynes’s successor in economics (and in applied macroeconomics in particular), in the same way David Ricardo had been the successor of Adam Smith. Ricardo disagreed with Smith and Friedman disagreed with Keynes, but the impact of each on the direction and course both of economics and of the world in which they lived was similar in size and scope.
Friedman’s impact on the contemporary world may have been largest through his design and advocacy as early as 1953 of the system of floating exchange-rates. In the early 1970s, when the Bretton Woods system of adjustable fixed exchange-rates collapsed and Friedman’s friend and colleague George P. Shultz was US Treasury Secretary in the Nixon Administration, the international monetary system started to become of the kind Friedman had described two decades earlier. Equally large was Friedman’s worldwide impact in re-establishing concern about the frequent cause of macroeconomic inflation being money supply growth rates well above real income growth rates. All contemporary talk of “inflation targeting” among macroeconomic policy-makers since the 1980s has its roots in Friedman’s December 1967 presidential address to the American Economic Association. His main empirical disagreement with Keynes and the Keynesians lay in his belief that people held the intrinsically worthless tokens known as “money” largely in order to expedite their transactions and not as a store of value – hence the “demand for money” was a function mostly of income and not of interest rates, contrary to what Keynes had suggested in his 1930s analysis of “Depression Economics”. It is in this sense that Friedman restored the traditional “quantity theory” as being a specific theory of the demand for money.
Friedman’s main descriptive work lay in the monumental Monetary History of the United States he co-authored with Anna J. Schwartz, which suggested drastic contractions of the money supply had contributed to the Great Depression in America. Friedman made innumerable smaller contributions too, the most prominent and foresighted of which had to do with advocating larger parental choice in the public finance of their children’s school education via the use of “vouchers”. The modern Friedman Foundation has that as its main focus of philanthropy. The emphasis on greater individual choice in school education exemplified Friedman’s commitments both to individual freedom and the notion of investment in human capital.
Friedman had significant influences upon several non-Western countries too, most prominently India and China, besides a grossly misreported episode in Chile. As described in his autobiography with his wife Rose, Two Lucky People (Chicago 1998), Friedman spent six months in India in 1955 at the Government of India’s invitation during the formulation of the Second Five Year Plan. His work done for the Government of India came to be suppressed for the next 34 years. Peter Bauer had told me during my doctoral work at Cambridge in the late 1970s of the existence of a Friedman memorandum, and N. Georgescu-Roegen told me the same in America in 1980, adding that Friedman had been almost insulted publicly by VKRV Rao at the time after giving a lecture to students on his analysis of India’s problems.
The other document on Mahalanobis is published in The Statesman today for the first time, though there has been an Internet copy floating around for a few years. The Friedmans’ autobiography quoted what I said in 1989 about the 1955 memorandum and may be repeated: “The aims of economic policy (in India) were to create conditions for rapid increase in levels of income and consumption for the mass of the people, and these aims were shared by everyone from PC Mahalanobis to Milton Friedman. The means recommended were different. Mahalanobis advocated a leading role for the state and an emphasis on the growth of physical capital. Friedman advocated a necessary but clearly limited role for the state, and placed on the agenda large-scale investment in the stock of human capital, encouragement of domestic competition, steady and predictable monetary growth, and a flexible exchange rate for the rupee as a convertible hard currency, which would have entailed also an open competitive position in the world economy… If such an alternative had been more thoroughly discussed at the time, the optimal role of the state in India today, as well as the optimum complementarity between human capital and physical capital, may have been more easily determined.”
A few months before attending my Hawaii conference on India, Friedman had been in China, and his memorandum to Communist Party General Secretary Zhao Ziyang and two-hour dialogue of 19 September 1988 with him are now classics republished in the 1998 autobiography. Also republished there are all documents relating to Friedman’s six-day academic visit to Chile in March 1975 and his correspondence with General Pinochet, which speak for themselves and make clear Friedman had nothing to do with that regime other than offer his opinion when asked about how to reduce Chile’s hyperinflation at the time.
My association with Milton has been the zenith of my engagement with academic economics, with e-mails exchanged as recently as September. I was a doctoral student of his bitter enemy yet for over two decades he not only treated me with unfailing courtesy and affection, he supported me in lonely righteous battles: doing for me what he said he had never done before, which was to stand as an expert witness in a United States Federal Court. I will miss him much though I know that he, as a man of reason, would not have wished me to.
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