Transcript Adjusting to Global Change

NS3040
Winter Term 2015
Adjusting to
Global Economic Change
Overview
• Robert A. Levine, “Adjusting to Global Economic
Change: The Dangerous Road Ahead,” Rand, 2009
• Main Points:
• Crisis that began in 2008 latest in a series of over
exuberance-based financial bubbles
• Fortunately governments and central bankers learned
how to cope based on the 1930s great depression
• Crisis may be imposed on longer-term economic shifts
that make it extremely difficult to handle
• Similar situation to the stagflation period in 1970s –
monetary and fiscal policy ineffective due to shift in
incomes to OPEC countries
• Current crisis may be compounded by the shift in world
income to East Asia – especially China
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1929-1939 I
• Up to the 1930s public policy mainly ignored bubbles
collapses
• Assumed that free markets and new technologies worked
things out – often with considerable misery
• Change in views in 1930s – not merely a financial crash,
but more importantly a collapse of aggregate demand
• Federal Reserve did not recognize problem and instead
contracted the money supply
• Hoover Administration balanced budget by cutting public
spending – compounded demand problem
• Congress made things worse by passing Smoot-Hawley
tariff – setting off a trade war which reduced US exports
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1929-1939 II
• Classical economics predicted a recovery once wages
and prices started to fall – did not happen
• Keynes criticized classicals – lacked feedback loops –
what works for individual does not work for economy as
a whole
• Keynes solution – put more purchasing power into
economy – government deficits, easy money policies
• Roosevelt apparently not a Keynesian – he just felt public
works/make work programs might help reduce
unemployment
• Keynesianism not clear on what caused depression –
overshooting of investment, under consumption – no
consensus
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1929-1939 III
• Schumpeter, an anti-Keynesian Austrian economist
explained the depression in a business-cycle framework
• Cycles built around innovation and “creative destruction”
• New innovations set off an investment wave – demand
increases with eventual overshooting and contraction
• Three main cycles – usually one is on the upswing
making it easier to come out of recession
• Depression a case where all cycles are down at same
time.
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1929-1939 IV
• Three theories of the Depression – Classical, Keynesian
and Austrian
• Classical explanation -- Stock market crash – bubble
based on the overexertion of post World War I
speculation
• Keynesian – subsequent down turn make worse by
contractionary monetary and fiscal policies
• Schumpeterian/Austrian – above factors made worse by
being on ebb-side of along Schumpeterian wave
stemming from the automobile-airplane-radio revolution.
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1929-1939 V
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1929-1939 VI
• Chart seems ambiguous about Keynesian policies in
1930s
• Federal budge in balance in 1930 and 31
• Then rose sharply in 1932 and 1933 – drop in revenues
• First year of Roosevelt administration deficit went to 5%
and then around 3 percent after that
• New Deal deficit finance seemed to work – unemployment
started down from more than 25% in 1933 to 15% by 1940
• Levine suggests it took WWII to get us out of depression
– controversial, Marxian explanation
• Remember from Deutsche Bank paper, the Austrians
explain the slow recovery to reduction in credit by the
banking system
• Post War inflationary pressures due to high spending
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rates
1940-65 I
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1940-65 II
• After war Congress removed wage and price controls –
inflation accelerated
• Federal Reserve targeted interest rates – very low to
reduce cost of government deficit
• Phillips Curve may have developed
• Kennedy Administration first Keynesian one in U.S.
• Successful tax cut in 1964 actually caused a surplus in
the Federal Budget
• Vietnam financing largely through borrowing –
inflationary pressures again
• Large U.S. deficits and outflow of dollars put too much
stress on Bretton Woods System – collapsed in early
1970s.
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1972-1986 I
• OPEC prices increases 1973-74 – more stress on system
• Cost-push inflationary pressures developed
• Dilemma – contract economies due to inflationary
pressures or keep them at full employment and risk more
inflation
• West chose full employment since traditional antiinflationary approaches ineffective – not demand pull
inflation.
• Monetary and fiscal policies to reduce demand and
inflation would bring about stagnation of economic
growth
• Stimulating demand to restore employment accelerates
inflation
• Result – period of stagflation
• Many Western governments fell due to poor economic 11
performance – increase in misery index
1972-1986 I
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1972-1986 III
• In U.S. Reaganomics introduced – tax cuts, antiinflationary monetary policy
• Risky – interest rates had to fall fast so lower taxes might
stimulate investment leading to growth and more
revenues with a federal budget going to surplus
• Did not happen – inflation came down fast, but nominal
rates slow to drop – result very high real rates of interest
and little investment – federal deficit larger
• Finally, falling oil prices helped the economy gain some
traction
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1986-2000 I
• IT revolution begins – example of a Schumpeterian
innovative long wave
• Ended the period of modest economic growth in the
1980s – Misery Index improves
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2000-2008 I
• IT wave probably crested in early 2000s
• Unfortunately the timing coincided with new phase in
global economy similar to that in 1970s
• Shift in incomes to Asia
• Not zero sum, but because of rigidities in economies hard
to adjust to shift in demand toward Asian countries
• Levine claims that there is a pattern between the income
shares of US in world economy and the Misery Index
• Other associated factors – rise in price of oil due to rapid
Chinese economic growth
• Losses in manufacturing jobs due to rapid
industrialization in China
• Both factors result in sub-optimal growth in U.S. up to
2008
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2000-2008 II
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2000-2008 III
• Problem – Shift share not a Schumpeterian process – he
focused on the upside that was brought about by
technological growth
• On other hand fits in his framework – shift share can
begin a long-run declining wave – a trough, with mirror
image effects on well-being and shorter cycles.
• A rising Schumpeterian wave will eventually fall as the
initial technologies run their course and investment
overshoots.
• There is less evidence as to whether downward
movements also contain seeds of their own reversal.
• The 1970s stagnation began to end with OPEC overshot
and lost control over oil process, but finally ended only
by IT revolution.
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Prospects I
In 2008 -• New shift-share long trough triggered by credit crisis
• In U.S. consumption is down with investment likely to
follow
• Will increase unemployment and produce a downward
spiral?
• Need for Keynesian stimulus, but will it be large enough?
• Problem with Keynesian economics now is leakages into
imports – not an issues in original 1930s version.
• Means countries will have to coordinate economic
policies --
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Prospects II
• Possible Scenarios
• 1. Shift share analysis wrong – once credit crisis is over
coordinated monetary and fiscal polices may restore
growth in a tolerable time
• Additional wise policies developed and emerging economies
spread prosperity to developing countries
• 2. Downward spiral may continue – stimulus insufficient
• No international coordination – may be period of increased
protectionism and long stagnation
• 3. Turnaround policies may be effective but shift/share
correct
• Emerging economies may grow quickly -- outpace developed
countries
• Growth restored -- oil prices start going up
• Stagflation in developed countries until a new Schumpeterian
wave sets in
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Prospects III
Policy Responses (Levine)
• Both classical and Keynesian theories suggest
turnaround possible
• Classicals (Monetarists) stress use of monetary policy
• Keynesians cite liquidity trap and prefer fiscal policy
• However, stimulus in one country not likely to be
effective – may need a new Bretton Woods to provide
framework for new global environment
• If shift share correct U.S. policy complicated by fact that
growth is likely to lead to prosperity for some but real
declines for major portions of the population
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